How many units do you own?

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Brian D. Milovich

Managing Principal, Calvera Partners

I attend the National Multifamily Housing Council’s (NMHC) annual conference every year. There, I’m reminded how fragmented the apartment industry is. Amongst the thousands of attendees, industry behemoths mingle with mom-and-pop owners. Rent-controlled urban specialists talk shop with garden-style cash flow owners. Debt originators from more companies than I can count want a chance to convince you that they’re different. And everyone’s favorite question, “how many units do you own?”, gets asked with each new handshake.

Personally, I really don’t like that question. Perhaps it’s because unit count has never been a concern of ours. It’s also not a good measure of success. An individual with a 200-unit portfolio in the high-cost Bay Area is likely worth more than a syndicator who did joint ventures to amass 10,000 units. Instead of unit counts, I’d rather ask: Where are you investing? What’s your strategy to generate higher returns? What type of leverage do you use to finance acquisitions? What is your ideal acquisition? What tax considerations do you make?

These questions tell me how an owner or operator works and how they’re different. From this, I can learn something. The experience of others who approach the industry differently than we do is valuable. We don’t have all the answers, and neither do our competitors. The apartment industry is so large and diverse that different strategies in different markets can all be successful.

Since I’m suggesting reframing real estate conversations, I’ll answer these questions for Calvera and our new Calvera Income and Growth Fund (“CIGF”).

Where are you investing?

We started by acquiring and renovating small (<50 units) properties in the San Francisco Bay Area. Our first property was a 7-unit apartment building in unincorporated San Jose. Subsequently, we purchased other properties in Santa Clara, Sunnyvale, San Jose, Mountain View, Alameda, Oakland, and Walnut Creek. We love the Bay Area, but the political environment makes it difficult to operate. The political environment has changed immensely since 2010, and Covid only made the trend worse.

Today, with CIGF, we’re targeting markets that have the same high-growth characteristics we once saw in the Bay Area. However, our new markets are more business friendly. Recent successful acquisitions have been in Austin, Fort Worth, and Dallas, TX, as well as Raleigh-Durham, NC. In addition to those markets, we’re targeting Charlotte, Nashville, Denver, Phoenix, and Salt Lake City. These are all markets poised for substantial growth.

What’s your strategy to generate higher returns?

Our strategy has two key components. First, we’re mindful of basis. That’s the cost per apartment unit or per square foot. We compare our basis to replacement cost (what it costs to build new) and other sales transactions. If we can buy below those metrics-and now is a great time to do that-we believe the deal has a head start.

Second, we initiate targeted renovation programs. It can be anything from major $60,000/unit full renovations to modest amenity and exterior improvements. We need to see a significant return on cost to execute a particular plan. In today’s market, we believe adding technology and moving away from the gray color-palette in unit renovations are key value drivers.

What type of leverage do you use to finance acquisitions?

Notice that I didn’t discuss financing as a way to generate higher returns. That’s because we don’t believe in financial engineering. Some of our competitors unabashedly used high-octane capital to juice returns. Now many wish they never did. Unlike those groups, we do not finance acquisitions with high-leverage bridge debt. We also do not have any floating rate loans or expiring interest rate caps.

Our leverage strategy is basic and old-school. We like traditional bank or agency (Fannie Mae or Freddie Mac) financing. Those lenders evaluate a deal based on cash flow today, not tomorrow. This limits the amount of debt we can obtain on a given deal. We generally target a loan-to-value of 65% on our acquisitions. We’ve taken more leverage, and we’ve taken less. The key point is that the leverage needs to be accretive to the returns and should be supportable by the property’s cash flow.

What is your ideal acquisition?

CIGF is a long-term fund, but that doesn’t mean we only want low-yielding core assets. With values 30% off peak pricing, there’s a short-term opportunity to buy newer and better located assets. We’re doing that right now in Dallas. We found a 152-unit, 2016-built property in a great location, with low-interest debt, and with the ability to make laser-focused improvements.

Ideally, we find properties in our markets that are mispriced, regardless of age. Ones where we can add value and improve the yield to a sufficient level. We need properties large enough (usually 150+ units) to support professional management and to provide a quality tenant experience. We’re also looking more in the suburbs of major markets as those appear to have the best growth prospects.

What tax considerations do you make?

Historically, the best tax decision we could make for our investors was to use accelerated depreciation. A cost segregation analysis allowed us to take advantage of significant depreciation in the first year of ownership. That outsized paper loss was particularly meaningful in a year where we had a big sale and corresponding gain.

However, we found that the big paper losses were going unused by our investors. We created the Calvera Income and Growth Fund to provide a more tax efficient opportunity. Whenever we sell assets, we’ll do a 1031 exchange to defer capital gains. Currently, there is a 20% deduction for REIT distributions through 2025. And a portion of the distributions may be categorized as a “return of capital.” This defers ordinary income taxes and helps lower the effective tax rate. This is more meaningful to and practical for our investors.

I don’t fault my fellow multifamily owners when they ask the dreaded units question. It’s an easy question with an easy answer. I’d just like to learn more. Especially at a time when many groups are not buying properties.

Because we’re buying.

We believe apartment demand is here to stay. Despite large levels of new supply now, it won’t be sufficient in 2 years. This will result in a spike in rents, particularly in high-growth markets. Home ownership continues to be out of reach for many, forcing more into the renter pool. The demographics favor apartments. This, combined with low values makes now a great time to be acquiring assets.

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