Unprecedented fiscal and monetary stimulus by the Federal Government and the Federal Reserve in response to COVID-19 continue to impact the economy in 3Q2022. The initial view that inflation observed in 2021 was transitory did not prove to be true and the Federal Reserve has prioritized tackling high inflation rates at the expense of the broader economy. The impact of these actions on real estate has materialized in several ways including dramatically reduced transaction volume, increased borrowing costs, and lenders and buyers moving to the sidelines. The days of easy and cheap money are gone.
We predict that deals underwritten with overly aggressive assumptions and high leverage will be the first to see distress. We have not seen any meaningful levels uptick in transactions like this yet, but it’s likely a matter of time. While there is tremendous uncertainty in the market and the ability to underwrite new transactions is challenging, we are excited about the opportunities that we believe will present themselves in the upcoming months.
The market expects the Federal Reserve to continue to raise interest rates throughout 2022 and maintain rates at higher than usual. We do not purport to be economists and our expertise does not reside in predicting interest rate moves. However, we are focused on sourcing investment opportunities that provide attractive risk-adjusted returns and are able to weather the rising rate environment. The property types that we have focused on have been multi-family and industrial for many reasons. For one, both property types are an inflation hedge because they’re on shorter term leases, which allows them to react quicker to the market. Second, in the case of multi-family specifically, the rising cost of a mortgage acts as a tailwind, as renters tend to rent for longer and are driven by necessity rather than choice. Lastly, while many lenders have retreated from the marketplace for a multitude of reasons (i.e., issues in their existing portfolio, warehouse lenders pulling funding, capital markets being closed), debt for multi-family is still available albeit at a higher cost. That should provide a deeper bench of lenders and buyers, setting a floor for this property type.
Yieldstreet launched a REIT Fund that seeks to primarily make equity investments in commercial real estate properties across key U.S. markets and property types. The fund’s main investment objective is to generate capital appreciation, while its secondary objective is to generate current income.
The property maintained an average occupancy of 90% through August 2022 which is in-line with its competitors and the overall market. The sponsor began its renovation plan in August and completed renovations
. The sponsor has increased rents by ~16% on newly signed leases and ~10% on renewals across the property, resulting in average in-place rents that were 6% above projections at closing. Submarket rents have posted gains of ~10% over the trailing 12 months, outpacing the underwritten average annual growth rate of 5.3% projected at closing and in-line with the achieved rent growth at the property to date. In addition to starting interior renovations, the sponsor completed pool and exterior lighting upgrades over the summer. While the investment is performing in line with projections, the higher debt service expense due to the Fed interest rate hikes, has impacted the property’s cash flow. To mitigate this risk and insulate the property from volatile moves in interest rates, the sponsor purchased an interest rate cap at closing. The current Secured Overnight Financing rate is now above the strike rate, protecting the investment from further interest rate increases.
The property maintained an average occupancy of 94% through August 2022 which is in-line with the underwritten projections. The sponsor began a renovation program and has completed 14 unit interior renovations that have achieved average rental premiums of ~$100/unit, or a 46% ROI. Across all units, the sponsor increased rents by ~20% on newly signed leases and ~13% on renewals, resulting in average in-place rents that were 10% above projections at closing. Submarket rents have posted gains of 10% over the last 12 months, outpacing the underwritten average annual growth rate of 5.7% projected at closing and in-line with the achieved rent growth at the property to date. In addition to interior renovations, the sponsor began exterior upgrades and plans to complete exterior painting of the entire property over the next months. The net operating income from the property is outperforming projections from closing by 5%; however, rising interest rates due to the Fed’s rate hikes aimed at lowering inflation have impacted property cash flow due to higher debt service costs. To mitigate this risk and insulate the property from more volatile moves in interest rates, the sponsor purchased an interest rate cap at closing. The SOFR rate is currently above the strike price of this instrument, protecting the investment from further interest rate hikes.
The property reached stabilized occupancy in July 2022 and is currently 97% occupied and 100% leased as of 8/31/2022. Its average in-place rent is $1,989, approximately 4% higher than closing. The property faced leasing headwinds over the summer months with new rentals in the submarket beginning their leases, forcing the sponsor to offer higher concessions than underwritten. However, as the building is now fully leased, the sponsor is not offering any more concessions and is instead focusing on increasing rents for new and renewal leases. Despite the increase in competition from new properties, the submarket posted a 5% increase in rents over the last 12 months, positioning the building to take advantage of market fundamentals. Property performance is expected to meet the Year 1 budget now that the property is fully stabilized. The rise in the Fed’s interest rates has impacted property cash flow due to higher debt service costs; to mitigate this risk and to insulate the property from volatile moves in interest rates, the sponsor purchased an interest rate cap at closing. The SOFR rate is currently above the strike price of this instrument, protecting the investment from further interest rate hikes.
Some of the best opportunities that we have seen over our careers manifest themselves when the entire market runs away from a particular segment. Looking at the real estate market right now, the word “office” is a bad word. Lenders do not want to lend against it and the equity to buy it is looking to price 35%-40% lower than 2019 levels (mostly class B office). We believe that real estate investing is a market by market, block by block and asset by asset analysis. We are committed to evaluating all investment types (debt and equity) and all property types to source the most compelling investments for our investors.
For the past 2.5 years, the ability to get paid appropriately in the lending space was non-existent. The risk premium in debt was mispriced and we pulled back our exposure because we were not being adequately paid for the risk. That is no longer the case. We are seeing some compelling lending opportunities but expect the volume of those investments to increase. We will lean in on those situations and seek to get paid equity like returns without needing to take first loss risk. In times like these, patience is the operative word. Things may get worse before they get better but we believe the ability to weather near term headwinds will provide outsized returns in the long run. That is the mindset that we are in and we are confident in our ability to source these opportunities for you.
Previous Snapshot: Q2 2022
1 All investments involve risk, including the possible loss of capital. There can be no assurance that any product or strategy described herein will achieve any targets or that there will be any return of capital. Past performance is not a guarantee or reliable indicator of future results. Current performance may be lower or higher than the past performance data quoted. Any historical returns, expected or target returns are hypothetical in nature and may not reflect actual future performance. All performance and/or targets contained herein are subject to revision by Yieldstreet and are provided solely as a guide to current expectations.
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