By: Nitin Chexal, CEO & Co-Founder, Palladius Capital Management
Current Buying Opportunity & Investment Strategy
The investment environment for the next few years should provide for attractive acquisition opportunities for both multifamily and student housing. We expect distressed opportunities to materialize, caused by the Federal Reserve's rapid hike in interest rates. This distress, which we believe will be mostly capital structure in nature, should lead to better risk-adjusted returns in an environment with less competition and new supply. The chart below highlights some of what we anticipate seeing in the multifamily sector over the next 24 months:
In a tighter monetary environment, there is only room for experienced operators with strategic business plans. Owners can no longer rely on a market’s inherent demand to drive returns and value creation will need to come from operational expertise and/or physical renovations. This will sideline equity syndicators, merchant builders with limited operational experience, and institutional owners with passive asset management.
Investment Strategy 1: Flagship University Spillover
We note that commercial real estate is a broad investment sector, and while certain property types (Class B and C office / regional malls) may experience a sharp contraction in value, there are others we expect to flourish in the coming years. We believe student housing, particularly in Sunbelt states where population growth has exploded, is one such area.
The flagship university spillover investment strategy, highlighted above, should perform well over the next 7-10 years until we see supply/demand equilibrium for student housing assets within Sunbelt states. The key to this strategy is flagship university infrastructure being unable to support a spike in applications as the population continues growing. Demand then falls on the corresponding feeder universities interested in expanding enrollment. These spillover universities (in the short-term) lack adequate housing supply to support expanded enrollment, pressuring rents on existing housing options higher. We highlight Texas as an example below with UT-Austin as the flagship and note the corresponding changes at spillover universities.
Investment Strategy 2: Dislocated Class-A in High-Growth Suburbs
We believe that a number of developers leasing up recently built assets will experience operational headwinds that delay stabilization. These delays will coincide with construction debt maturity, and property operations will not support a cash-neutral refinancing. This in turn will lead to forced selling at healthy discounts to replacement cost. By taking on limited lease-up risk from a merchant builder as a management value-add business plan, the deal-level returns mimic that of a conventional renovation-based value-add execution.
The chart above highlights 5 key metrics we evaluate when considering acquisitions through this investment strategy, and the Austin MSA is a good example of a market that fits all of our criteria.
(A)High-growth suburbs outside the core where rent to income ratios are below 30%.
(B)Rental rates in these submarkets are meaningfully lower than the core. (C)
(C)Supply that is getting rapidly absorbed.
What we have observed historically is that Class A renters looking for value will often relocate to these submarkets to save money in an economic pullback. We expect the same to be true in this cycle. Class A assets also historically trade at a premium when markets begin moving higher. We believe positioning into these assets now when they can be acquired at a discount to stabilized value is an investment strategy that can be paired with traditional value-add assets to produce a balanced residential (multifamily/student housing) real estate portfolio.
