Harvest Creative

While big picture numbers can provide a general idea of what’s happening in the market, there’s more to the image than national figures suggest. It’s important to look at the difference between deliveries, permits and starts to evaluate future supply. The dynamics of supply and demand shift constantly, but it’s particularly important to understand that supply exists on a continuum of time. As everyone in the industry knows, permits don’t always indicate a project will go forward immediately and starts are no guarantee of a delivery date.

Perhaps more importantly, all real estate is local. Macro trends are national or even global. If you break down the numbers to markets and submarkets, they start to paint a very diverse set of pictures.

When you take the math for all 50 states, combine them together and come up with one number, it creates a very broad, fuzzy picture. When you start to drill down to different places, you get new numbers, and you get different stories. Some places are in equilibrium, some are vastly oversupplied, and some are undersupplied. There are nuances to every marketplace that go well beyond simple supply and demand figures.

For example, in one area, there might be a lot of apartments being delivered today, but there might be zero starts. So, two years from now, that market will be supply constrained.

When you look at marketplaces today, there are some where there’s a ton of supply being delivered. In those markets, there may be concessions and pricing pressure. We’re not seeing a massive amount of discount accounting to move product in any market right now, even though apartment deliveries are anticipated to be 51% above 2022 by the end of 2023.

Even in some of those submarkets where there’s a lot of supply, there’s also a tremendous amount of household formation and growth, so apartments are being absorbed in an orderly fashion and rental rates are staying in line. In submarkets where some concessions are being offered, this could be a short-lived phenomenon because the number of people moving to those jurisdictions and locations could be increasing. So, while yesterday there might be too much supply, tomorrow it might be completely gone. That’s why we take the long view when investing in different submarkets. While we do our research like everyone else – well, we like to think better than everyone else, of course – we don’t make short-term decisions based on deliveries. We look deeply at market predictions about migration patterns, job growth and other commercial and residential development to evaluate the long-term viability of any location, and then we work hard to create an enduring community where residents will thrive.

While it’s pretty common for people to tell others to stay in their lane, at Bonaventure we sometimes like to try a different route. Our business model of owning apartments and investing in communities hasn’t changed a bit. But we did take a slight detour earlier this year to experiment with a different kind of investment: a self-storage facility.

Now, I don’t want to confuse anyone here. We’re not suddenly going to invest in different types of commercial property all over the place. But we saw an opportunity where the numbers worked and, more importantly, we recognized the potential benefit to our residents.

We got out of our lane because we think self-storage could be a key to housing affordability and to help small businesses.

To explain: people rent an apartment that’s bigger than what they need 90% of the time. They pay more all year because of the 10% of the time that they need that extra space. A second bedroom is great if you can easily afford it, but for residents whose budget is tight, we’re providing a different solution to their need for space. That way, they can rent an apartment that’s the actual size they need.

If you work from home, you may not want a desk taking up space in your bedroom. Or you maybe you must meet people in person occasionally and would rather not invite them into your home. Instead of opting for a second or third bedroom, you can easily work from the clubhouse or reserve one of our conference rooms for a meeting.

If you run a home business, you may have supplies or inventory that you need to store, so you rent a two-bedroom apartment. That can be an expensive way to get space for your business.

Here’s where self-storage comes into play: you can lease a small storage unit to store materials and inventory, then rent a one-bedroom apartment. The total cost of your home and your storage unit is cheaper than if you rent a larger apartment.

A lot of people can’t run a small business out of their home, but they don’t need an expensive warehouse or storefront. Having a secure space where they can store stuff provides a valuable alternative.

As we know, small businesses are the vast majority of job creators in this country. A self- storage unit can be a great tool to help people become entrepreneurial. Leasing a storage unit costs very little, and, as their business grows, they can rent a different size unit. Plus, it’s a short-term lease so they don’t have to make a 10-year commitment.

Self-storage can be an important amenity to apartment residents and be part of the mosaic of building a vibrant community.

The term “junk fee” seems pretty charged to me. After all, application fees, fees to pay the rent with a credit card or for trash removal aren’t the equivalent of eating a box of Twinkies for lunch and a bag of Doritos for dinner. Residents are paying for real services.

Is it a “junk fee” when you go to dinner and you can pay with your debit card for free, but they’ll charge you 2% more to pay with credit because that’s what the credit card company charges the restaurant?

We’re transparent. If it’s going to cost us more to accept one form of payment, we’re going to let the consumer know that it will cost them more. They can make a choice.

Those fees are not for us to make money. They provide value, a product and a service. Ultimately, if consumers don’t find value in the services we provide, we want them to make an informed decision.

We offer a variety of customer services. For instance, in many of our communities, we provide a service that takes trash from their front door to the dumpster in the parking lot. Some apartment communities are enormous, and no one wants to drag their nasty garbage halfway across the planet.

I could see someone whose job it is to protect consumers might say we’re charging a “junk fee” to handle trash. Consumers that find value in that service want to live at a Bonaventure community that offers it. If they don’t value it, then they’ll choose somewhere else where they don’t have to pay for it.

It’s no different than when an airline says you can get the exit row for $20 more. The airline is very clear that they’re assigning a value to an enhanced benefit.

A lot of the services we offer cost extra and are part and parcel of living in a community. Others are a la carte. Ultimately, we leave it in the consumer’s hands as to whether they think that represents a compelling value trade.

But sometimes you can’t unbundle things. For instance, if you left the trash fee up to everyone, some people might decide not to pay. They might drag their trash bag that’s leaking last night’s leftovers down the hall and destroy the carpet. Then everyone’s rent would rise because we’d have to replace the carpet.

Plus, there’s always someone who wants a free ride when you offer an a la carte menu. They’ll dump their trash in front of someone else’s door for pickup instead of paying.

Unbundling things and letting the consumer choose what to pay for isn’t as easy as it seems. Neither are “junk fees.”

Higher for longer interest rates and changing market dynamics are doing some damage in the commercial real estate sector, there’s no question about that. But we’ve all been through economic cycles before and know the drill. What’s different this time around is that lenders aren’t foreclosing and they’re not taking title to properties. Instead, they’re more likely to sell the note to an investor.

In the previous two or three stress cycles, the Federal Reserve and banking regulators became very accommodative to help lenders. They either lowered interest rates or they provided regulatory relief to allow lenders to hold onto property. The idea was to avoid a vicious downward cycle and asset repricing, so banks weren’t forced to liquidate assets quickly.

Right now, the Fed’s most important mission is inflation. That’s job one. So, there may be some casualties in the form of distressed real estate but that’s not their priority.

For banks, it’s much more efficient for them to sell a note because they can do that very quickly versus go through the foreclosure process. A foreclosure can be stymied by legal issues, plus by selling the loan instead of acquiring the property, they don’t have to own the physical asset. In many cases selling the note and letting someone else do the dirty work of resolving the asset is preferential for banks.

So, sure, that means there’s definitely an opportunity for investors to step in and acquire the note at a discount. But it’s not without its risks. People talk about earning high returns, but you’re taking a considerable amount of risk when you take on a mortgage for a distressed asset.

If the current owner sees no opportunity to redeem any of the capital they put into it, then are they really taking care of the asset during that period of time? What are you going to get when you don’t know how much you will have to invest? How long is it going to take to put the asset back on its feet?

You need to earn a big return for taking those risks. I think the capital markets are pretty efficient and will recognize value appropriately. And we all know there’s no free lunch, so investors need to do a thorough analysis of every deal.

At Bonaventure, we’re not seeing the valuations yet being compelling enough for that level of risk.

What we are doing, though, is investing capital to help people unlock the trapped equity they have in good assets so they can use it to bolster their bad assets. That’s where we see the opportunity now that benefits everyone, which is real gold to us.

Sun Belt cities in the Southeast have grown significantly in recent years, a pattern that accelerated when the pandemic quickly increased the number of people who could work and live anywhere. Naturally, businesses want to locate where they can attract talented workers and people want to live in an affordable place with plenty of work and a nice lifestyle.

But you know how that goes: popularity = demand = higher prices. That affordability angle may be fading a bit now that more businesses and people have migrated from coastal gateway cities. While these Sun Belt locations are still affordable relative to some of the coastal cities, the cost of living – especially housing – has increased.

Now a new twist may affect the lack of affordable housing throughout the country and in some of these Sun Belt locations, too. Low Income Housing Tax Credits, a federal government tool to increase the production of affordable housing, generally require an affordability provision of 30 years. After that period, the owners can raise the rent to market rate. An estimated 20% of apartments built with tax credits are likely to see the expiration of their affordability protection by 2027, according to Moody’s.

Whenever you have regulatory constraints on prices and availability go away, it changes market dynamics. If certain units have been held at a regulatorily imposed reduced rent and then all of a sudden they’re free to go wherever the market is, there’s a ripple effect.

I don’t see those affordable units as a direct competitor to our buildings, but that doesn’t mean they won’t have an impact on markets and submarkets where we own and operate buildings. Many of those buildings are 30 or 40 years old. But there’s probably a segment of people who will say, “I’d live in that apartment. I was overqualified for it before, but now that I can move in, I might shift from the apartment I live in now to save money.”

That scenario directly competes with non-rent restricted but affordable apartments. Plus, some of those apartments might be renovated and rehabbed because of the opportunity to get paid a return on additional invested capital.

That will ripple throughout the entire spectrum of apartments. Most of our buildings are at the other end of the continuum in terms of their age and quality and caliber versus rent restricted buildings. They’ll add to the supply-demand characteristics we’re dealing with in a particular submarket, but we probably won’t even notice the source.

I expect the amplitude of the ripple effect will be dampened by the time it reaches our end of the continuum. We’ll stick to our strategy and provide homes for our residents with great amenities and outperform the competition no matter where it comes from.

Sometimes the multifamily sector reminds me of that Simon and Garfunkel song “Feelin’ Groovy” – not because I’m so happy about the way things are going, but because of the opening line: “Slow down, you move too fast.”

Not so long ago, rents were climbing by double digits, which was clearly too fast. A slowdown was inevitable. But we hold our property for decades and that means we anticipate at least one recession or maybe two during our ownership period.

The latest Quarterly Survey of Apartment Market Conditions from the National Multifamily Housing Council shows that both debt and equity financing have pulled back for multiple quarters because of higher interest rates and slower rent growth. Transaction volume fell again too.

The Fed seems poised to keep interest rates higher for longer to tackle inflation, so to me, what’s happening in the multifamily market is a natural reaction to market conditions. I don’t see this as an overall weakness in the market because demand drivers are still in place for rental communities, such as the high cost of homeownership, a good job market and more household formations. We’ve got downsizing baby boomers, young Gen Zers renting their first place and millennials leaving their parents’ basements and roommates, along with the usual migration for jobs or a new lifestyle.

But naturally, owners are holding onto their property for longer. The capital required for buyers to buy them is less available. No one wants to sell at what seems like below peak prices.

Everyone wants to wait and see if interest rates fall or the cash flow rises on their business. People who don’t have to sell won’t when values fall. People that do need to sell still haven’t used up all of their rope before they’ve hung themselves.

At some point, if rates stay high enough for long enough, those sellers will need to do something. They’ll either sell their assets or they’ll need to refinance them, and they’ll need to inject capital to facilitate the refinance.

The market can’t stay this way for an extended period of time. Eventually, there will need to be market clearing, which is something people are delaying right now in the hope that their cash flow rises or interest rates drop back.

That’s where we can come in. We’ve locked in long-term low interest rate debt, so we’re not at risk. In fact, we can help other owners solve their problems by facilitating a 1031 Exchange to mitigate tax issues, provide management services to improve NOI, do a joint venture to capitalize on land opportunity or discuss our private non-traded REIT. Market slowdowns can be managed in a variety of ways – and we’ve got six decades of experience to share.