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We are excited about 2025 and the investment opportunities in the pipeline. Our strategy at Taylored Investments is finding best-in-class operators to partner with and acquire income producing assets. We’re VERY selective about who we work with and only have a few partners that we are currently doing acquisitions with. Our goal is always quality over quantity. We’ve seen a lot of operators struggle the last few years due to the economic environment and hard lessons learned. Fortunately our business has not been impacted by these challenges and our investors have been in a great position with the properties we’ve purchased. At a personal level, we have one Limited Partner (LP) position in a multi-family deal with another operator that is not distributing. The property itself is doing well, but CapEx has consumed a lot of the reserves, so it’s impacted the LP cashflow. Our other LP and GP positions are all distributing at different levels. We are considering a build-to-rent opportunity in West Virginia and very excited about what’s in store in this growing area of the country. We purchased the Gables of Cornerstone (100-units) this last summer and our partner (RockBridge Investment Group) has been doing a fantastic job with day-to-day operations. They have purchased other build-to-rent communities and they provided insight on their underwriting below. It’s very detailed and will take you some time to read through it, but I encourage you to take a look as this is SO important when acquiring property. Here is a picture of our partners (we had dinner together a few months ago). We’re very grateful for these relationships and the chance to work together! |
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A Look at the Underwriting |
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“Underwriting Changes Year Over Year Anyone in the Industry who has done at least one deal knows that underwriting involves a lot of guesswork to say the least. At RockBridge we understand that many of the inputs within our underwriting are completely out of our control. With that being said, we do have a number of basic principles that we stick to year over year regardless of the investment environment. These are principles that we’ve either unknowingly violated in the past and as a result committed to never making the same mistake again, or are principles born out of observing other’s mistakes. To give an example, every time we underwrite a deal, we make sure to have at minimum one year of expenses and mortgage payments in cash controlled by us. While this may be overly conservative in some cases and certainly has a drag on underwritten returns, we’ve learned it’s better to have too much cash on hand than to wish you had more when you need it most. Another simple principle that we factor into all of our underwriting models, is to always budget more than both we and our property management company think we need to for Marketing and Payroll. We’ve made the mistake in the past of getting tight on these two line items, only to later realize we’ve hired underqualified staff with an inadequate marketing budget. As you can imagine, this can quickly spiral. The purpose of this newsletter is to discuss the items in our underwriting that are more fluid based on our understanding of the market today, the business plan for a specific asset and the specific market dynamics that change more regularly than the various principles we stick to across all deals regardless of market cycle. Insurance Rising Insurance costs have been a hot topic in the Multifamily world over the last couple of years. Due to factors such as high-magnitude catastrophe losses, supply chain issues, rising inflation and major changes in the Re-Insurance market, premiums have skyrocketed over the last couple of years. About a year and a half ago is when we first started receiving significant year-over-year increases on our insurance policies, and in turn is when we started to change how we underwrote and thought about Insurance on new deals. To highlight the issue, in Florida specifically, Insurance costs have increased roughly 250% on average from 2017 through 2023. It’s difficult to imagine how that impacted cashflow on certain deals in which the Owners were most likely underwriting and expecting 2% – 3% annual increases over the life of the hold period. Luckily, in 2023 Insurance Costs only increased an estimated 11% on average over the year, significantly higher than we’ve experienced in past years, but still manageable. Based on our understanding, there are three main trends impacting property rates so far in 2024. First is an increase in losses driven by historically “non-modeled secondary perils”, which are smaller to mid-sized weather events that happen after a larger event such as a hurricane or an earthquake. This would include events like flooding, storm surges or hailstorms. Secondly, there is apparently a more balanced reinsurance market as compared to 2023 which experienced what is considered to be one of the toughest reinsurance markets in decades. The good news is that for the moment, it appears that the volatility that was experienced in 2023 has mostly stabilized so far this year. Lastly, there were a large number of properties that were underinsured and undervalued. Since the writing of this newsletter in mid-September, we received news that US Property Insurance Rates fell for the first time since 2017, falling roughly 1.0% in Q2 2024. This drop is apparently due to insurers returning to profitability due to lower catastrophic losses. That however has likely been countered by the major flooding event that recently occurred throughout Asheville, NC and the surrounding area as a result of Hurricane Helene. In summary, the Insurance market has experienced a ton of volatility over the last couple of years, and with insurance representing a significant line item for all multifamily properties, it’s forced us to think more about Insurance when underwriting new deals then we ever have before. To address this volatility, we’ve taken two primary actions as it is related to underwriting new acquisitions. First, is that we are much more thoughtful and selective on whether we pursue an asset based specifically on how that asset is to be perceived by the insurance market. It seems like common sense, but when the market was relatively stable and seemingly everything was getting insured without much issue, it wasn’t as much of a focus on the acquisition side. The thought process now is that while we may be able to get relatively attractive insurance on this asset now, if the useful life of an asset is questionable over the next 20 – 30 years, if there is a high amount of historical insurance losses on the asset, and there are other factors that insurance carriers may perceive as a risk to the particular deal 10 – 20 years from now, the asset may be perceived much worse by the insurance market, resulting in elevated insurance premium pricing and ultimately a reduced market value and attractiveness of that asset when it comes time to sell. This has resulted in us passing on a handful of deals that we would have otherwise considered. The second thing we’ve changed is simply underwriting much higher insurance costs than we are getting quoted to account for the risk of potential unexpected premium increases in the future. While this has unfortunately resulted in us missing out on a few opportunities, we are confident that this more conservative stance from an insurance standpoint will pay off in the long run.
Financing Since our founding in 2018, we’ve used all types of Debt Products including Bank, CMBS, Bridge, Life Company, Credit Unions and Agency Debt. These days we are leaning towards utilizing Agency (Fannie Mae and Freddie Mac) debt in most cases. Focusing specifically on Agency Debt, there have been a ton of changes over the last year that have impacted our underwriting. Exit Cap Rates Anyone underwriting deals on a regular basis understands the importance of exit cap rates and their effect on underwritten returns for multifamily deals. The exit cap rate for those who are unfamiliar is the yield at which you are assuming you can sell an asset for at the end of a hold period. The lower the exit cap rate, the higher the price and the higher the projected returns. So, assuming a higher cap rate at the exit would be considered conservative as it assumes you will sell at a relatively lower price. Exit cap rates, like interest rates are a complete guess. When we first got started, we underwrite deals assuming that Cap Rates would expand by 10 basis points (.10%) for each year of the hold period. So if the current market cap rate was 6.0%, we would assume a 7.0% exit cap rate. This was a conservative way of projecting exit prices and resulting returns while also making sure the cashflow throughout the hold period was strong enough to justify doing the deal despite a lower projected exit price. While this was conservative, we ended up passing on a ton of great deals and in the following years, cap rates actually dropped significantly. We don’t regret being conservative on exit cap rates, but we have realized that the exit cap rate is much less important than the Yield on Cost and actual cashflow from the asset throughout the hold period. These days, we are typically underwriting cap rates to be flat over the hold period and instead of solely solving to an IRR hurdle, we are looking at the cashflow throughout the life of the deal, and looking at the total returns based on a sensitivity analysis with a range of potential exit cap rates. We also are paying a lot more attention to the exit price on a per door basis and thinking much more simply about whether or not we believe there will actually be a buyer at $xxx,xxxx per unit in 5 – 10 years, regardless of what that cap rate is. It’s easy to get lost in the weeds while underwriting deals and not think logically about whether what your underwriting model is saying is achievable and reasonable. Operating Expenses One of the benefits of looking at hundreds of deals each year is that we get a ton of information on how most properties operate in the real world. Over the last year, we’ve been able to get a lot more aggressive on certain operating expenses such as landscaping, service contracts, General & Admin and so on. We used to underwrite a number of these line items a little too conservatively based on rules of thumb or historicals, mostly because we weren’t confident in our assumptions or our ability to negotiate better contracts in certain circumstances and we wanted to make sure we had enough margin for error on some of these smaller line items. We’ve also found a few tools to be beneficial throughout the hold period and as a result have started to include them in our initial underwriting, these items have surfaced as a result of the various strengths and weaknesses we’ve seen across our portfolio. One tech package we’ve started utilizing, and consequently including in our initial underwriting is Elise AI, which can assist with Rent Collection, communicating with prospective residents, scheduling tours, answering questions and interacting with prospective residents, all while our onsite team is handling other important tasks onsite. The technology is so good that we’ve actually had prospective residents come in asking for the AI Robot by name, thinking they were a real person. The second example is a service we’ve highlighted in the past called Apartment Life. Apartment Life is a non-profit organization that seeks to build community onsite with residents which in turn reduces turnover onsite and has been proven to provide a net benefit to the bottom line for our properties. This is a tool and service that we like to add to our property typically in the second or third year of the hold period as we have seen the financial benefit of having Apartment Life teams in our communities. Real Estate Investing Utilizing Retirement Funds We wanted to take a moment this month to remind our investors about the opportunity to utilize a Self-Directed IRA (SDRIA) as a method of investment. To provide a seamless experience, we work with a great company called Midland Trust to help investors utilize their retirement funds to invest in our Real Estate opportunities. Over the last 6 years, we’ve had many investors invest in our deals with Midland Trust’s platform, and to date the process has been exceedingly easy. While Midland has been the top choice for our investors to work with, we’ve also worked with numerous other SDIRA companies and are able to facilitate investments from most of these companies. We really believe this is a great way for investors to utilize investment funds to diversify into real estate while not draining liquidity, and also take advantage of tax-deferred growth at the same time. As always, please reach out to us to learn more or if you’d like the contact information of Midland Trust for additional information.” – from RockBridge Investment Group |