Harvest Creative

The term “missing middle housing” sometimes refers to the size and style of homes and focuses on the lack of small single-family homes, townhouses and low-rise apartments in many markets. The missing middle also refers to the lack of housing for people who make an average income. Too often, new homes today are either luxury places or affordable with a capital “A” for households with incomes below 60% area median income (AMI) and generally significantly below that, which is what government programs support. To me, the “missing middle” is housing meant for people who earn 60% to 125%of AMI, depending on the cost-of-living index and adjusted by family size.

At Bonaventure the “missing middle” has always been a core part of our strategy. Why?It’s just good business.

Think about any other product. For instance, you can buy a pocketbook at Target or you can buy one at Louis Vuitton. They both hold your cell phone and wallet. Is Target a better business or worse business than Louis Vuitton? I don’t know. They’re just different.

Our values and our principles align more with the mass market than with the luxury purveyors, but that doesn’t make us right or wrong. We understand our customers. We focus on driving value rather than driving artificial price increases through branding, perceived scarcity and a label. I could never tell you how to get another $500 price increase for the same bag next year at Louis Vuitton, but I could certainly tell you how I can come up with some ideas to save $3,000 a unit on an apartment building.

Our strategy is to design our products to be as affordable as possible to people whose incomes fall into that middle range.

For example, if you take a unit that rents for $1,600 monthly, that comes to $19,200 annually. Generally, people should spend a maximum of 30% of their income on housing costs. So, to rent that apartment your annual income should be around $55,000. In the markets we’re in, that fits squarely in that 60% to 125% AMI.

Of course, if you’re a larger family, you need a larger home. Units with two or three bedrooms in our buildings will be proportionately more expensive, but they still typically fit into the budget of households in the 60% to 125% AMI range.

These apartment buildings offer more than just affordability – they have amenities such as a pool, strong internet service and a fitness center. While it’s great to offer a solution to missing middle housing, it’s even better to provide a comfortable home with a nice lifestyle that makes good business sense for us, too.

For investors, perhaps the most shocking thing in this wild ride we’ve been on for the past few years was the upending of the 60/40 portfolio. Since the 1980s, portfolios with 60%stocks and 40% bonds were kept in balance because typically when one went up the other fell. The average return on those portfolios was 7% between 1999 and 2022, according to BlackRock. Then 2022 hit: 60/40 portfolios lost 17%.

The big question for every investor is this: were those positive returns a matter of luck, like flipping heads 30-plus years in a row? Or was 2022 just an outlier?

The appeal of the 60/40 portfolio is clear: investors want a passive investment with decent returns and not a lot of risk. They really only have to look at their portfolio once a year to make sure they’re still allocated in line with the formula. But a 60/40 portfolio isn’t the only way to get there.

At Bonaventure, we’re confident that alternative investments such as a real estate investment trust offer a similar solution to the intent of a 60/40 portfolio. It’s a simple, long-term investment and, over a long period of time, the investment will compound. Of course, there are other alternative investments with esoteric trading strategies and hedges on commodities and things like that. But I’m talking about real estate as an alternative to stocks and bonds.

The thing is, you can walk up to our buildings and touch them. They’re real. And it’s to invest in our buildings. Most people understand the long-term value of investing in real estate.

We want people to get the benefit of that proposition without buying a single-family home and renting it to people for the next 20 or 30 years. You can get the same advantages of paying down the mortgage, collecting rent and watching the value rise without the terrible trio of toilets, trash and tenants to manage.

With a REIT, you don’t have to become an expert in real estate or know how to select a site, finance it and operate a multifamily building. But you can invest in something that’s easy to understand like housing. People will always need a place to live.

People are sometimes afraid of the term “alternative investment” but what we provide is long-term compounding. The goal of most investors is to accumulate enough wealth so they can stop working someday. Investing in leveraged real estate with fixed-rate debt offers a similar scenario to that low-touch experience of the 60/40 portfolio because it has equity-like features and debt-like features.

So, instead of the headline “60/40 portfolios are dead,” the headline should be: “consider investing in real estate to replace your 60/40 portfolio.”

Anyone who runs a real estate company is by nature a risk taker. After all, only a risk taker would accept the countless variables of shifting market conditions and regulatory modifications while meeting the needs of residents, employees and investors. But at Bonaventure, we’re not risk takers in the usual sense. In fact, we’re a pretty conservative company with a slow-and-steady approach. You know, we’re the tortoise, not the hare.

Insurance premiums, which are all about risk, can play havoc with your NOI. The insurance market has shifted incredibly in the last couple of years, especially because of intense losses in California due to wildfires and to Hurricane Ian in Florida. Even though we at Bonaventure don’t have exposure to those markets, we’re impacted. Effectively, insurance risk gets spread throughout the industry because of reinsurance contracts, which are essentially insurance contracts for insurance companies.

Basically, this means that everyone is expected to pay more for their insurance than they did last year. So, at Bonaventure, we’re developing the tools to manage our own risk of exposure to increased insurance rates.

We’re self-insuring our risk in some cases. Look at it this way: when you buy a car insurance policy, you have very few levers to pull to change your premium. You can adjust your deductible or increase your liability insurance. But when it comes to insuring commercial real estate, there are about 300 variables. On a commercial policy, you can slice and dice different portions of the risk. For example, if our general deductible is $10,000, it could be $50,000 for wind damage. If the wind is part of a named storm, that deductible could be $200,000.

But we can manage our own risk. We can make our deductible $300,000 for every wind event and self-insure to cover any damage up to that amount. That can save us thousands of dollars a year in premiums across our portfolio.

Of course, like every other developer, we have minimum insurance requirements from our investors and our lenders. To manage that, we’ve created a captive insurance company. We’re working towards being nimble. That way, if an insurance renewal comes in and the price of a particular risk exceeds by a healthy margin what we think we could self-insure, we can retain our own risk and do it in a way that meets our contractual obligations. We’re still working on this, since we can’t self-insure for everything, but we anticipate that this process will result in a strong competitive advantage for us.

That may sound risky, but it’s actually just a smarter way to take control of our exposure to rising insurance costs, and, in the process, pass our savings onto our investors.

Remember the game Frogger? Depending on your age, you either played it in an arcade or on your PlayStation or Nintendo – or maybe you did both. Basically, the frog had to overcome a whole lot of challenges to get across the street. The better you got at the game, the harder it became. To me, dealing with package management has been like a game of Frogger for the past 15 years.

Years ago, no one needed a package room in an apartment building. Then we all got home internet and started online shopping. The inflection point came along with Amazon Prime, when free shipping made ordering online even more enticing. Then people got tired of seeing packages scattered all over leasing offices.

The first attempt to overcome that challenge was to build a package room. Building owners started with half of a square foot per apartment, so a 200-unit building would have a package room with 100 square feet. Then we went to one square foot per apartment, two square foot per apartment and to multiple package rooms.

But you know what? That didn’t get the frog across the road. Every one of those decisions was inadequate.

Then we tried package lockers that sent a code to alert residents about a delivery. Now we use third party package lockers where the delivery company places the package in the locker and communicates directly with the resident, but we still have to deal with oversized packages.

Single-family home residents face this too, but they have the power to decide for themselves if they want a delivery to be dropped on their porch, placed in their garage or even inside their home.

We need to find ways to empower our residents with that same flexibility, so they can authorize a package to be delivered to their front door, inside their unit, in a locker or in a central repository for oversized packages. We need variations on that for fresh deliveries such as refrigerated storage or to grant access to place it in the resident’s refrigerator. A few years ago, we all thought we’d have drone ports on our buildings. That’s still probably coming. And autonomous delivery vehicles on the ground will have to be accommodated, too.

There are three stakeholders to balance here: the residents, the building owners and the delivery companies, but sometimes that feels impossible. Just when we think we’ve found the perfect solution, something changes, and we need to evolve again. It’s a major logistical challenge with billions of dollars at stake. At Bonaventure, we keep leveling up to the next solution – just like in Frogger.

When most people open their freezer, they probably find a frozen lasagna, some green beans, a pepperoni pizza and a pint of Ben & Jerry’s Chunky Monkey. At Bonaventure, our freezer sometimes includes an apartment site. Not literally, of course, but in these days of uncertainty we take some projects that we think are in a great location, on a great site with long-term potential and put them in the freezer. We’ll thaw them out when market conditions change.

That’s what freezers are for: being prepared when you can’t necessarily get to the store. At Bonaventure, we’re prepared for every market contingency. We think in decades, not months or years. At the same time, we’re nimble enough to respond when things change.

We’re extremely rational with the way we deploy capital. The process of development is a very long cycle. From the moment you lay eyes on a piece of land to the moment you can put a shovel in the ground to the time when the building is complete and full of residents can be four or five years.

Let’s pause right there. Think back four or five years – nothing much has happened since 2019, right? If you think about what people thought the future held in 2019 versus what actually happened, it would be hard to write a script as crazy as what we’ve seen. It would be a science fiction movie. But it’s also our reality. While the past few years have been extraordinary, expectations and reality are always at least somewhat different over a four or five-year period.

Here’s how we handle these cycles: We pick great sites. We conservatively finance them with long-term fixed-rate HUD loans that provide stability to help us navigate changing market conditions. Now, with rising construction costs, rising interest rates and the total cost of capital, the investment merits don’t always look as strong for every project.

Some properties are still above the “go or no-go” line. Others have fallen below that line, so we’ve chosen to let go of that opportunity and look somewhere else. We’re keeping the sites in places that merit a 20-year bet.

We’re continuing to identify sites in suburban locations around primary and secondary cities where we believe the future will look like the past – before hyper rent growth, hyper migration activity and hyper cost increases.

When the new equilibrium arrives generally and in specific submarkets, we’ll use the techniques that work for us such as contracts with long closing periods or joint ventures with landowners. We have the strength and ability to wait to deliver a building that meets the needs of our customers as well as providing an adequate return on capital for our investors.

Remember the nursery rhyme “Jack Be Nimble?” It’s about jumping over a candlestick to generate good luck for the coming year. At Bonaventure, we like to be nimble but we don’t rely on luck when we make investments.

Bonaventure is a risk-adjusted return investor. In certain financial climates, we’re willing to take a lower return if the investment has a significantly lower risk. Then, potentially, we can invest for a significantly higher return if we see something that’s mispriced. We’re willing to invest anywhere in the capital stack if we can find the relative value.

The important thing is that we’re flexible enough to see that there’s more than one way to invest. If today investing in the mezzanine or preferred equity position offers a better relative risk–reward tradeoff than simply owning the entire equity of an apartment building, we’re willing to do that.

We’re not just nimble. We’re also looking at the landscape. There’s a lot of great real estate we’d like to invest in. Some of them have bad capital structures because they took out a large loan with floating rate debt when interest rates were cheap. The sponsors expected values to grow to the point that when interest rates normalized, they could refinance or sell their property and make a profit. Well, interest rates didn’t stay low as long as these investors needed them to and their balance sheet is off because their NOI didn’t grow fast enough. Their runway was shorter than they anticipated when they created their business plan.

These investors face two problems. First, they’re spending more on debt service because of higher interest rates. Second, if they try to sell now, they could take a loss. That creates a reputational problem for them as a sponsor. It’s a black mark against them.

The solution to all this is to stabilize the capital structure, especially for a great building in a great location. We know NOI can grow them out of this problem if they can get some additional capital.

That’s where Bonaventure comes in. We’re in a position to provide mezzanine or preferred equity investments to help those sponsors who have great buildings and great fundamentals but a bad capital structure. Several years down the road, they can get to the point where they can sell or refinance, return the capital to investors and pay us off.

What uniquely qualifies Bonaventure is that we’re not just offering capital. We’re practitioners ourselves. We know our business and we know what will have a good outcome. We also recognize the benefit of taking on significantly less risk in exchange for a lower rate of return – and so do our investors.