Apartments don’t usually return 20%

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Brian D. Milovich

Managing Principal, Calvera Partners

Since 19781, apartment investments have produced a 9.3% annual return over rolling 10-year periods. There is not one 10-year period where apartments lost money. This is without using leverage and based on institutional properties and ownership. Apartments have been resilient and are known for stability, not excess risk-taking. It also shows that time is a great salve to get through rough economic patches.

The past low interest rate cycle spoiled investors with high returns. Returns of 20% or more became commonplace. At Calvera, we generated close to 30% annual returns on our sold apartment investments. We have a value-add strategy to improve properties and increase income, and many of our peers generated similar returns. But we did it with conservative, traditional leverage. Many of our peers used high-risk, high-leverage bridge debt to boost their returns. We all had value-add strategies and delivered similar returns. However, we (Calvera) did it without taking on additional debt-related risk. This makes it difficult for investors to know who they are investing with. Is it an astute acquiror/operator or someone who is good at financial engineering?

Now that values are down from the peak by a wide margin, we must recalibrate expectations. Should they be even higher because of the great buying opportunity? Should returns be lower with more uncertainty and higher debt costs? It depends on the strategy and appetite for risk.

The general expectation is, the riskier the investment, the higher the expected return. New ground-up development is risky and needs to return 20%+. But wait. This past cycle, we achieved even higher returns doing less risky value-add deals. If you timed the market right and sold in 2021 or early 2022, you didn’t even have to do anything to get those returns. Market dynamics and high-leverage operators skewed our collective perspective. In normal times, value-add strategies should generate 12-15% returns. A minor renovation plan is in the 10-12% range. And the longer you hold a property, the lower the leverage, and the lower the return.

When we started Calvera, another professional told us that “you can’t make money in apartments.” Low cap rates, slow rent growth, and basic debt options meant apartment returns weren’t great. At least not compared to office buildings or hotels. Apartments were boring, and large-scale renovation programs weren’t widespread. Generating big returns meant building new or finding a needle in a haystack. Investors didn’t often flip properties and, instead, held onto apartment assets. Cash flow was king.

We may be going back to those days if debt remains elevated. If so, the focus should be on the operator and how they will execute their business plan. A skilled operator can find properties with dependable cash flow. They can uncover assets in high growth markets. The best operators can add value in creative ways. And, they can sustain performance over the long-term.

That’s great, but I still want 20% returns. Then take more risk. Otherwise, invest in cash flow at an opportune time, now, and watch what happens. We know we can deliver great returns with a long-term strategy focused on cash flow. Despite achieving 30% returns, our underwriting was always around 12%. Our best investments involved buying at the right time and price. The next 12-24 months will be another great buying opportunity. You’ll like that you changed your perspective on returns.

1 According to NCREIF historical data using the average of rolling 10-year hold periods of the NCREIF total return index.


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