We are pleased to provide you with our 2022-2023 investor update. Below, we deliver our annual overview of the marketplace, specifics about the properties in our current portfolio, and projections and strategies for the year ahead.
We made some predictions in last year’s update and thought we’d start with a recap.
2022 Predictions • Rent growth assumptions of 3-4% annually. ✔️ (Although most of the market was underwriting high annual rent growth, we stayed disciplined.)
• As people reenter the in-office workforce and return to their pre-2020 lives, the Phillips curve—stronger employment pushing up inflation—should continue to drive rents upward. ❌ (Rent growth was strong in 2022 Q1 and Q2 but slowed significantly in Q3 and Q4, while turning negative in some markets.)
• Now is a great time to buy and a great time to sell. ✔️/❌ (Maybe—more on this below.)
• Strength in an assumable fixed-rate and subordinate preferred equity strategy—buy the real estate at a discount because of “onerous” debt with counter exposure to interest rates. ✔️ (We have also purchased three assets in the last year with this strategy. This means if rates continue to climb, our prepayment penalty, which is tied to interest rates, will be lower than what we budgeted in our underwriting and will ultimately increase returns.)
Market Overview 2022 was a pivotal year. The Fed started its most aggressive campaign in 40 years to fight inflation through monetary policy via rate hikes and quantitative tightening. While we were conservative with leverage and rates through the Covid mini-cycle, we did not anticipate the unprecedented rate hike cycle that ensued—with the Fed raising its benchmark rate by 25 basis points in March 2022, and continuing to move the rate from 0% to 4.25% by year-end 2022, to a terminal rate which will likely rise to over 5%. The market reacted almost immediately. Institutional investors were the first to pull back, resulting in very little capital available by summer. Private capital lagged, and all but disappeared by year-end. As for credit, we don’t recall a time when lenders pulled back so quickly, even during the GFC. Capital providers in every part of the stack went “risk-off,” which made executing acquisitions extremely difficult.
Relying on our strong industry relationships, we were able to continue arranging off-market opportunities and acquire assets at discounted purchase prices. Growing our portfolio to 5,851 units in 2022, we are excited about the prospects of those investments.
As typical with most bear markets, the pendulum on the risk-off approach likely swung too far. We closed on an acquisition in Sacramento in January 2023, with a 20% discount to where offers were coming in prior to the rate shock. We are under contract on a property in the Southeast at a discount to the peak and favorable debt terms because of a seller-carry which helps the investment’s economics. We continue to be on the lookout for new opportunities, in any market. There are always sellers who are highly transactional, or need to sell for internal reasons and are willing to meet the demands of a changing market.
An interesting dynamic in today’s market is lower projected returns at a 5% in-place cap rate than there were at a 3.5% in-place cap rate a year ago. Why? Because there are two ways to acquire a property in a challenging debt market. A buyer can either:
Finance the acquisition with a lower interest rate loan by over-equitizing and financing to a Loan-to-V alue of 50-55%.
Finance the acquisition using bridge debt, which will allow the buyer to reach a market leverage of 65% but the cost of the loan is extremely expensive.
Scenario A financing can be as low as 5.8-5.9%, while scenario B nears 7-8%. As a result, creative deal structuring is critical to outperforming the market.
Portfolio Specifics
We followed an immensely successful 2021 with yet another record-breaking year in acquisitions. Purchasing 11 properties with over 2,000 units at a total capitalization of $545 million, we grew Trion’s portfolio value to more than $1.4 billion. Our average acquisition size, not including recapitalizations, was over $61.2 million.
In 2022, we secured our largest acquisition to date: 6201 W 26th Ave., a 402-unit community in Edgewater, CO. We acquired the asset through a rare off-market opportunity for a purchase price of $108.75 million. This marked our fifth acquisition in Colorado, since first entering the market in Q4 of 2020. As of December, we successfully completed a management takeover at four of our five properties in the state. We remain committed to the virtues and financial advantages of vertical integration, even as we move into multiple new markets.
In the Southeast, we successfully expanded our portfolio with three acquisitions in Georgia, as well as two more in Florida, totaling over $300 million in capitalization. We continued to see historic growth in these markets and secured each acquisition at a favorable purchase price, relative to the submarket average at the time of sale.
On the West Coast, we acquired a portfolio in Beaverton, Oregon, doubling down on our strategy of targeting assets in supply-constrained, high-growth markets, and continuing to scale in the Portland suburbs. We have acquired a total of 17 properties in Washington County since 2015. We also purchased additional properties in Sacramento, which continues to be one of the fastest growing markets in the Western region due to continued migration from neighboring cities in California.
In addition to being a landmark year for acquisitions, we set new records for dispositions, with eight sales and four recapitalization transactions totaling $308.5 million, and an average project-level IRR of nearly 31%. We sold two and recapitalized one of the four remaining properties from our Fund I and we hope to sell the final property in the first half of 2023.
Further, we recapitalized two adjacent properties in Tigard, Oregon for $59.2 million while securing a new, $39.4 million loan from Freddie Mac. The two properties were originally acquired for $38.1 million in 2018, with a targeted five-year hold. After 51 months, we delivered a 21.51% project level return, and a 2.05x equity multiple with a low-leverage debt execution. Strong economic drivers, affordability, and income growth made Tigard one of the best-performing submarkets in the Portland MSA, and we look forward to remaining active in the area.
Lastly, we recapitalized two adjacent properties in Aloha, Oregon for $40 million after purchasing the properties as two separate assets in 2018 and 2019 for a total of $20.4 million. In doing so, we achieved a project level IRR of over 35%, and a 2.5x equity multiple.
Despite the unexpected macroeconomic challenges that arose later in the year, we are thrilled with our 2022 activity. The Covid mini-cycle represented one of the most fruitful periods for the multifamily sector. Economic headwinds including unprecedented demand, rent growth, and sales activity encouraged many sponsors to become increasingly aggressive during this period. While we were active in taking this opportunity to expand our portfolio into multiple new markets, we stuck to the same core principles that have allowed us to thrive during less favorable times. As a result, we remain confident in each of our recent acquisitions moving forward, and we expect to deliver excellent returns to our investors.
2023 Projections and Strategies
With the Fed starting an unexpectedly aggressive rate hike cycle and throwing the markets into disarray, there is no denying that 2022 was tumultuous. It resulted in an anomaly year where the stock and bond markets were both down by double digits, prompting the real estate markets to follow suit.
Yet, multifamily fundamentals remained strong throughout the rate hike cycle. There were some setbacks with increases in vacancy and a virtual halt to rent growth, but we are not seeing much softening of rents in our markets and NOIs are holding strong.
Our operational goal for 2023 is to recover occupancy levels at or close to those of 2022, unlike other years where the goal has been to drive rents post-renovation—even if it means holding occupancy levels slightly below market. Focusing on occupancy will allow us to preserve as much cash flow as possible through this period of high rates on floating rate loans.
We expect to sell a few assets into this market and continue to realize strong returns. We sold 196005 SW Boones Ferry Rd. in Tualatin, Oregon in Q4 of last year at a project-level IRR of nearly 37% and equity multiple of 1.80x. Although we don’t expect this year’s sales to perform as well as this, we have several properties that we purchased pre-Covid that are ready for sale.
We have a few properties in our portfolio with floating-rate debt, expiring rate caps, and maturities this year—but it’s not as ominous as it sounds. Our properties with higher rate cap reserves and maturing loans were purchased in 2020 and 2021, so the NOIs and values are significantly higher than at acquisition, giving us ample cushion to refinance or sell.
We have three properties currently on the market, all of which will be sold at a profit, and expect to list at least two more for sale this year. If any of the assets with floating rate debt do not sell, we can refinance with fixed-rate debt. The treasury market rally brought down rates on fixed-rate debt and we are now seeing loan quotes for 5-year money in the mid-5% range. The opportunity to acquire 5% caps with upside financed by 5.5% debt will certainly bring several investors back in from the sidelines.
We continue to grow our operating platform even though we are now in a more austere time. Undergoing a period of high growth since 2020, we are progressively hiring to right size for that growth and stay ahead of the curve. We have hired an additional seven members to the corporate team and continue to build across all levels in the business.
We have grown our portfolio to a total of 5,851 units throughout 34 properties with 26 in California, Oregon, and Colorado, and 8 in Florida, Georgia, and the Carolinas.
As for technology, real estate isn’t the dinosaur it has been historically and there are now inventive products to streamline operations incessantly rolling out. We continue to add technology and talent to our operating platform and have transitioned our property management system from AppFolio to Yardi. AppFolio is a great product, but we outgrew its modules and closed system that does not allow APIs. We switched to a more established product, Yardi, which allows for significantly more customization and is an open platform providing us with access to elite third-party modules. We are also onboarding AIRM (Artificial Intelligence Revenue Management), the newest and most cutting-edge revenue management system. Some of the features include dynamic pricing on renovations and views, the statistical likelihood of a resident renewing based on length of residency and delta between current and market rent, and pricing based on online reputation.
In conclusion, despite the expected slow Q1, we are optimistic for the coming year. We will continue to invest in quality opportunities in the best, high-growth markets, and hope to have more opportunities than ever for our valued investors.
As always, we are available to you and welcome your input.
