Last Cast Letter #5: One Potential Approach

Hi All - Happy Wednesday. It’s the last day of the month, which means it’s time for the Last Cast Letter.

What a unique epoch (great word) to be trying to buy real estate. It makes me think about Bane from The Dark Knight Rises:

I love that quote. It’s a little bit how I feel about where we are currently. If you can make it through this dark downdraft, then you’ll be a menace when times are “good” again. A mad lad, as it were. I have to think that being an operator now, with the current macroeconomic headwinds, can only make you stronger in the long run.

For what it’s worth, this theme is playing out across multiple sectors: technology, media, you name it. Can you grin and bear it? Can you survive, and possibly even thrive while some of your competitors are exploding like landmines around you? Since we’re citing movies already, it feels a little bit like this.

If you can, and you make it to the other side, well then you’ve developed a pretty lethal skillset, even if that’s simply the internal confidence that comes from knowing you can navigate whatever is thrown your way.

Seeing Things in a Different Light

Now, part of making it to the other side and navigating the darkness has to do with seeing things in a different light. Right now, there seems to be a staring contest between buyers and sellers in the multifamily space. A lot of sellers still think it’s 2021. As a result, they think they’re going to get 2021 prices for their listings, especially in good markets. Buyers, on the other hand, are asking them “how many pots have you smoken?”

In all seriousness, buyers are having a hard time making bids pencil because the rapid rise in rates means that a lot of deals don’t make sense. That is, unless you’re a foreign buyer who needs to stash your cash somewhere opaque because the currency in your homeland is rapidly depreciating and your country just introduced a new 2,000 peso banknote that is now worth just $4. That, or you’re executing a 1031 exchange.

As some of the research houses would say, the “price discovery” process is in flux because we still don’t have a great idea where rates will land. Jaime Dimon said the Fed rate might hit 7%. That would be … depressing. But, that’s where we are, and until we have more clarity, transactions might look a little different.

One Potential Option

On some of the calls I’ve had with a few of you over the past month, I’ve explained how I think I might take a run at some of the properties we’re looking at. I stress the word “think” because I’m obviously keeping all of my options open, and markets could shift at a moment's notice thanks to a range of factors. Given that both rates and listing prices are still elevated, however, I think one way to get some of these deals done is with an all-cash purchase and delayed refinance.

This isn’t an overly complicated concept. Just type “all cash” in Google News and you’ll see that major PE shops are using the same playbook for transactions in various sectors. As it relates to the multifamily space, here’s a super high-level example.

Let’s say a property you’ve identified is listed at $3 million. You know after underwriting it, however, that it’s worth $2.4 million, tops. So, if you have the cash, you make an all-equity offer for that full amount with a quick close. For the sake of this example, let’s say this works and you do close. Now, you wait. Rates are high right now, but you’re making a bet that they won’t stay this way forever. For example, some think the Fed Funds rate will fall back to 3.75% in 2024 and 3.25% in 2025. If and when they do, you work with a lender then to refinance the property.

Nothing’s Perfect

As with everything there are pros and cons. Although this can give buyers a competitive edge and allow them to bundle closing/financing costs into a future refinance, it also requires a sizeable amount of cash upfront, limits lenders buyers can use, comes with added costs and fees, allows only certain types of loans, and is subject to the eligibility rules in place.

So, as I mentioned, right now this is just something I’m thinking about as we continue to look at deals. It’s not perfect and it may not be the right approach for every transaction, but it’s an option that a few of you thought was interesting when I spoke to you over the past month.

To that end, I’ve really enjoyed our calls. I’d love to speak to more of you so don’t forget to fill out the form below and I’ll be in touch.

— Brooks

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