2025 Calvera Partners Annual Investor Letter

Re: 2025 Calvera Partners Annual Investor Letter

Dear Investor:

Welcome to our 2025 investor letter. We’re going to make this year’s edition short and sweet by attaching the 2024 letter and calling it a day. See you in 2026! In all seriousness, 2024 was a lot like 2023, but we’ll outline the continued challenges, new surprises, and our thoughts for 2025 in this letter.

Stuck in Neutral

There hasn’t been a singular event to put the multifamily market in gear and get back out on the road to growth. The latest blog post for Calvera, Stuck in Neutral, summarizes the current state of the apartment market. In essence, interest rates haven’t fallen enough to drive multifamily sales, and sellers have yet to capitulate and meet market pricing. All while the economy appears to be in good shape, and 40-year-high levels of new apartment supply flood major markets across the US. The good news (i.e., the economy) hasn’t been sufficient to overcome the new supply and numerous other headwinds facing the industry. We, like many of our peers, believe there will be a strong resurgence in apartment performance once this supply wave subsides later this year and into 2026.

Investment landscape

In 2024, value-add apartment acquisitions of older (i.e., 1989 construction or older) properties were not interesting to investors. While distress is higher in this segment, very few value-add properties were sold in 2024. Lenders and borrowers, hoping for a drop in interest rates, frequently delayed selling and either agreed on loan extensions (likely with a paydown) or preferred equity was inserted into the capital stack. Either way, a wave of distressed apartment sales at bargain basement prices has not materialized. The non-distressed assets in this category that did sell were priced based on current performance (not future) because rents are flat-to-down in many markets, minimizing a value-add strategy. With interest rates remaining elevated in 2025 and unlikely to return anywhere near to the previous cycle’s lows, we believe transaction activity will increase in this part of the market. Sellers have yet to fully capitulate, and until lenders force their borrowers’ hands, not much will change.

The most in-demand properties in 2024 were 1990s or newer assets with minimum 9-foot ceilings in non-downtown locations, ideally located in the Sunbelt. These properties have traditional value-add components (e.g., unit renovations, rebranding, amenity creation, etc.), but with modern floorplans. Additionally, brand new construction still in lease up and not fully stabilized created an interesting opportunity for well-capitalized institutional investors. These deals can be difficult to finance as many lenders won’t provide financing until a high percentage of the property has been leased. The size of these acquisitions proved to be too large for the average apartment syndicator, which has left the few institutions playing in this space to acquire new assets at low bases.

We identified our own version of this in 27TwentySeven Apartment Homes (“2727”). Calvera, through our Calvera Income and Growth Fund (“CIGF”), acquired the 2016-built, 152-unit apartment property in Dallas, TX in June. Our price was within 5% of what the seller paid back in 2017, well below current replacement cost, located in one of the highest growth markets in the country, and ripe for a technology-based value-add project. As part of the purchase, we assumed a below-market Fannie Mae loan at a 4.15% interest rate through 2027. The property has a value-add return profile without the risk of unit renovations, wrapped up in a modern building.

For 2025, we expect a slow start to the year as the market continues to grapple with a 10-year Treasury rate around 4.5%. Additional uncertainty from the whirlwind start of the Trump administration will also keep the market in a “wait and see” mode. We are optimistic for an improved second half of 2025 as the supply wave calms down and rent growth starts to emerge.

Operations

We have been saying for a while that rents have been soft across our portfolio. The San Francisco Bay Area, while still undersupplied, is dealing with a demand problem as employers haven’t mandated a return to the office. Our other markets, downtown Minneapolis, Dallas-Fort Worth, and Raleigh-Durham, have all been hit with a surge in new apartment supply. This has prevented our assets in those markets from growing rents. However, we are still finding ways to improve revenue while market rents aren’t moving. In Minneapolis, we instituted an amenity fee on all renewing and new leases. And at our newest property, 2727, we began the process of incorporating smart tech (thermostats, locks, leak detection) with a $30/month/unit additional charge.

In a sign of things to come, downtown Minneapolis, which had its supply surge earlier than DFW and Raleigh, is experiencing a surge of leasing activity. We’re seeing strong leasing interest during a normally slow period in Minneapolis. And some institutional properties have reduced concessions from 2 months down to 1 month. This has created a wider rent gap between our property and its newer competitors, allowing us to lease faster. On renewals, we have been successful in weening tenants off large concessions by reducing from 2 months to 1, 1 month to 0, and giving 0% increases to those already at market rent. While market rents will likely not increase, effective rents (i.e., including concessions) should see real gains in 2025. We expect this same dynamic to take place in DFW and Raleigh in about 12 months.

Operating expenses remain a challenge across all properties. In particular, insurance expense has increased 2-3x in our portfolio due to large losses incurred by the insurance companies. We have creatively found cost-effective solutions to keep this expense as low as possible. The best course of action has been to join master policies, whether through our property manager or another source. Utility expenses also continue to grow. For example, usage aside, water rates in Carrboro, NC have risen 33% since 2021. Furthermore, unit turnover expense has grown across the multifamily sector in conjunction with higher rates of delinquency. The people who choose not to pay their rent and end up being evicted generally do not leave their unit in good condition. This has led to a significant capital spend in flooring, countertops, cabinets, and paint/wall repairs.

The properties with the best expense management are those with lower rates of delinquency and with an established onsite staff. Often those go together, and good people are hard to find. With considerable new apartment supply, the better property managers have been able to “move up” to newer properties with fewer headaches in the form of fewer maintenance requests, a more financially sound tenant base, and bigger capital budgets. As the supply wave dies down, and staffing stabilizes nationally, we also expect the operational challenges to temper and the power shift away from the renter.

2025 Outlook

When will the multifamily market finally thaw?

Oddly, the thawing (figuratively, and operationally) is starting during the winter months at our Minneapolis asset. We expect the overall market to begin seeing rent and operational improvements in the second half of 2025. High supply markets may not begin their recovery until early 2026. For transaction activity to improve, one of three things needs to happen:

1. Interest rates fall
2. Sellers capitulate at market pricing
3. Rent growth returns

The 10-year US Treasury looks comfortable around 4.5%. We don’t believe interest rates are going to move down meaningfully in 2025. Historically, a 4.5% 10-year is not a high number, but the industry got accustomed to much lower rates in the previous cycle. With the long-term rate at this level, borrowing costs are +/- 6%. Therefore, either cap rates (i.e., the yield of a property over a one-year time horizon) need to be higher than the loan’s interest rate, or there needs to be enough upside in the financials to justify a lower going-in yield. Right now, it seems like the market is only pricing in one Federal Funds rate cut in 2025, supporting our rate outlook.

If rates don’t go down and cap rates for apartments remain elevated at mid-5 caps (though not elevated enough to us), owners won’t sell. Many who bought their properties in 2020-2022 paid a 3-cap and cannot sell at today’s market prices. For example, a property with net operating income (NOI) of $900,000 purchased at a 3% cap rate sold for $30M. At today’s 5.5% cap rate, NOI needs to have increased by $750k to $1.65M in order for the property to be worth $30M today. That’s an 83% increase. With large increases in operating expenses and flat or negative rent growth, there’s no chance that’s happening. Even if this buyer took on 75% debt ($22.5M), the NOI still needs to grow 38% to just pay off the loan. Would be sellers largely cannot transact at market prices and their lenders are not forcing them to…yet.

It’s our belief that the multifamily market won’t get back on track until rent growth returns. With real rent growth, cap rates can settle back around 5% even if interest rates stay at today’s levels. We can talk about rate declines or rent growth, but the real driving factor is capital flows. As more money chases apartment investments, cap rates will reduce, and values will rise. Though we believe rent growth will accelerate, and values will rise, it’s difficult to underwrite it until you see proof. That proof will surface later this year, allowing the market to improve.

What does this mean for 2025?

We predict the following will happen this year:

1. Interest rates will remain in the 4% range.
2. Cap rates will stay in the mid 5% range, on average.
3. Apartment rents will begin to grow by Q4.
4. Net operating income will stabilize and trend upwards.
5. There’s opportunity in every real estate market, but 2025 will mark the bottom.

If 2025 is the bottom, like we expect, then it’s a good time to buy apartments. The Sunbelt markets we like, because of their growth prospects, were the hardest hit with new apartment supply. Acquisitions there will have little current cash flow in the first year or two, but will have above average growth prospects, more capital flows, and more buyer interest at sale. The difficult part is capitalizing those purchases because loan-to-values are low, and the equity required is high. That’s not a typical formula that real estate investors like, but it’s great for CIGF. We may also explore new markets where current cash flow is available, though growth would be more muted.

We appreciate your investment and interest in Calvera Partners. An arduous market like this is when an investor’s character and performance is challenged. Not only have we been active buyers in a tough environment, but we’ve also made hard decisions to strengthen our existing portfolio. As always, please don’t hesitate to reach out to any one of us with questions.

Best regards,

Brian, Brian, and Dave