Portfolio Assessment at End of 2023

The year 2023 has meant tough times for pretty much everyone investing in real estate. That's been true for multifamily real estate syndication investors along with just about everyone else. Maybe there's been more pain in office, for instance, but multifamily has not been immune.

As we close out the year, it seems timely to offer a portfolio review. For those who have been following along, we have made a few dozen investments in real estate syndications and funds. Most are in single-asset deals (our preference).

The results for 2023: our portfolio follows a pretty clear "normal distribution" or "bell curve." Several at the positive end of the spectrum are in great shape--smooth sailing for the foreseeable future. Many are in the bulge in the middle of the distribution. And three are on the in-tough-shape end of the distribution. It is a well-balanced portfolio in this sense, for better or for worse.

The Red Zone

Start with the tough news: we have three single asset investments in multifamily real estate holdings in various states of what we consider the "red zone." One has had a capital call and, we hope, will stabilize from there–but it's been a long road back. One has threatened a capital call, never issued or completed, and the prospects continue to be bleak for a good recovery. Both of these first two, curiously, have OK debt on them–the issues have been, in our view, a simple failure of execution on the business plan. Both have relatively experienced operators involved; for whatever reasons, though, they have not gotten the traction they need to succeed. Both are on the lower end of the housing quality spectrum for our portfolio and the cash has been insufficient to complete all the expected renovations.

In the third case in the Red Zone, the property is in great shape and has been performing extremely well. It is a Class A development and should be a terrific long-term asset in a growing market. The issue is the debt. The syndicators plainly got the debt wrong on this one. The cap is expiring and the lender is pressing hard. The alternative strategies don't look too promising. A heavy-duty capital call is coming due most likely (more than 50% of the initial investment required) to stave off catastrophe. The alternative is a sale--with 100% capital loss likely in that event. Ideally, the syndicators will pull off an extension on the loan or a better financing deal to stave off the total loss scenario. With decent debt on the property, a good win should be in the offing.

The Yellow Zone

Most of the properties we hold are in a middle zone, or a "yellow zone," which is to say that they seem to be doing fine but the current rate environment is curtailing the ability for the syndicators to offer the expected cash flow. For many if not most of our deals, the expected cash flow started off great a few years ago but has slowed or been paused. Our "pref" or "preferred return" is still accruing. The syndicators are indicating that things are fine and they don't expect to need more capital. But in these numerous cases, they have moved from monthly to quarterly; or reduced the amounts; or paused the distributions altogether to preserve capital in the deals. The one self-storage deal we hold in this portfolio falls in this zone, too.

In these yellow zone deals, we don't worry about losing our capital. We do wonder when the expected cash flow might resume. That mostly has to do with the rate environment, as many of the deals have floating rate debt that is making the monthly cash flow very tight or non-existent. We are patient investors so this is not a big deal. A more gentle rate environment in 2024, 2025, or beyond will no doubt be welcome. The key will be solid, consistent execution and conservative cash management in the meantime. For these reasons, we are fine with the cash flow being slower or non-existent as we play for the longer-term outcome.

The Green Zone

The good news is a that a pile of our deals remain in strong shape, with healthy cash flow and what appears to be smooth sailing ahead. In these cases, the deals have fixed-rate debt for the coming years, often around 3% or so. The business plans to improve the properties and raise rates in a modest way have worked out, the markets continue to grow, tenants are perceiving the value to be fair, and the cash continues to flow. There is no need to do anything with these strong properties--they are proceeding according to plan and should provide an expected return over time.

One of these strong properties is under contract to sell for a healthy multiple. It is expected to close in early 2024.

We are not pushing for any of these strong ones to sell (not that we could, as LPs, affect that anyway). We are happy to have positive, cash-flowing deals doing what they are supposed to do. With good debt in place and a predictable income, these deals should do fine over time.

What could still go wrong? Plenty, as this is real estate we are talking about. One immediate pressure point in these growing markets has been the arrival of new supply of rental units to neighborhoods where some of these great properties lie.

So far, so good--the new supply has not yet diminished the returns, even if the pressure on rents has kept the increases low recently. That's just fine. The new supply will be absorbed in these growing markets. And there will still be fewer new units coming online in the next few years given the difficulty of financing new construction these days. Competition is good and productive for renters and we need these new units in the United States to meet the growing demand--so no complaints here.

The Big Picture

We are still glad to be multifamily real estate investors. We devote a percentage of our investment dollars to this asset class, consistent with a personal Investment Policy Statement (IPS). We continue to make steady investments in this space– from one to a few per year. We continue to look for great syndicators to work with. We will probably continue to refine that list of partners, to work with fewer people with whom we have greater trust, and to focus on the markets we know best and prefer over time. This process of continuous improvement and refinement works with our temperament and should lead to good returns over a reasonable period of time. We are patient investors, staying the course.