Deals We Recently Passed On & Why
We’ve been analyzing real estate investments for over a decade and currently have access to a lot of deal flow from our operating partners. Most of the investment opportunities we access are not shared with others online, they are sourced through relationships we’ve created over many years.
It’s important to keep in mind that investments that are projected to provide an average annual ROI of 12-15%+ may look attractive, but ROI can be easily manipulated and due diligence is critical to investment success. Many investments simply do not meet our buying criteria and are not considered for investment. Some deals are underwritten too aggressively, some have tight margins and others may be located in less desirable neighborhoods.
It is critical in today’s market to be very selective with your investments and we are happy to share an overview of a few recent deals we’ve analyzed and passed on, along with a brief summary as to why we chose not to invest.
A Few Recent Deals We Passed On:
A 6 Community Mobile Home Park Portfolio –
Deal Summary: We recently analyzed a portfolio of 6 mobile home parks in Alabama located near another mobile home park that we have had an ownership interest in for about 2 years. Our current mobile home park investment in the local area has been doing well so we were excited to see this deal.
What we liked: The investment was projected to provide investors with annual cash flows of 9% in year 1 (this is hard to find in today’s market) and an IRR of 13.4%.
The 6 parks included 206 lots, of which 81% were occupied at acquisition. The deal came with a strong value-add opportunity to rehab a few park owned homes and fill vacant lots to increase the occupancy.
This is what we look for in a deal, the ability to increase the NOI by executing on a very specific business plan and adding value. Overall, the strategy and financial projections met our performance requirements.
Why we passed: The main reason we passed on this opportunity was due to the fact that only 30% of the homes in the park were owned by the residents. The remaining 70% of the homes would be owned by us. This would essentially have been a rental portfolio due to the high # of tenants vs home owners. When investing in mobile home communities we seek opportunities where the vast majority (80%+) of the mobile homes are owned by the residents. We prefer to own primarily just the land which reduces risk and uncertainty of operating expenses including maintenance and tenant turn over.
An apartment community in Waco, Texas –
Deal Summary: We love the investment opportunity in Texas, as noted in our update: Where we are investing a spotlight on Texas, we recently looked at an investment in Waco, TX.
What we liked: The property was at high occupancy and had a strong value-add strategy to increase the rents by about 20% through renovations and upgrades, an attractive business plan.
Why we passed: The projected returns for investors were on the lower end of our requirements and while Mark was in Texas viewing other opportunities he visited the property in the evening during the week. Ultimately we were deterred by the tenant quality and loitering outside of the building and the marginal projections of the opportunity.
A Mobile Home Park in Illinois –
Deal Summary: This was a small deal with an acquisition cost around $1m.
What we liked: The investment opportunity projected an average annual ROI of 21.75% to investors.
Why we passed: The mobile home park consisted of 46 spaces of which only 24 homes were owned by the residents which is far below our desired 80%. In addition, the operating partner’s financial model lacked sophistication and had several mathematical errors. Expenses were projected at a fixed % of the total rental income and not broken out annually. We prefer to see expenses separated out by each line item to ensure all costs are properly accounted for annually.
2 opportunity zone funds and an opportunity zone development land play –
Deal Summaries: An Opportunity zone investment is a type of tax-advantaged investing that came out of the tax law that passed at the end of 2017. An investor is able to take capital gains from a different investment and put it into real estate located in certain ‘opportunity zones’ and defer the tax. There are clear tax advantages, which we are constantly seeking, and we expect the popularity of this vehicle to increase in the future.
Why we passed: After analyzing numerous O-Zone opportunities our take is that the tax advantages also come with added risk. Due to where we are in the market cycle, we are currently avoiding investments that don’t produce immediate income (development/ground up construction). Further, for O-Zone properties that aren’t development/ground up construction, the amount of capital invested into a property needs to be matched by the amount of “improvements” added over 2.5 yrs. With the cost of improvements needing to be equal or greater than the capital invested, it is extremely hard to find an opportunity zone investment in a desirable area, that produces positive cash flow at the commencement of the investment and therefore most opportunity zone investments don’t meet our buying criteria.
A 10 property self-storage portfolio –
Deal Summary: This opportunity consisted of 10 self-storage facilities across 7 states valued at over $37,000,000.
What we liked: Generally, we like portfolio investments consisting of several properties as they provide greater diversification over single investments. This opportunity projected investors to earn 15-16% annually and it came from an operating partner that we have invested with numerous times.
Why we passed: On some of the more recent deals we have reviewed from this operating partner, our independent analysis yielded less attractive returns. We believe this is due to a few factors: their firm has experienced a lot of growth over the past few years including numerous acquisitions and internal staff changes. This growth coupled with the increase in overall supply of self-storage across many US markets, has resulted in under performance in some of their existing investments.
In addition, this operating partner has had positive success selling facilities above projections, primarily due to the past few years of self-storage cap rate compression, however they have also had difficulty selling some recent assets due to new supply coming online causing a reduction in occupancy and net operating income. This gave us less confidence that they would continue out-performing projections.
A few of the properties in the portfolio looked like they may have already been partially owned and operated by the operating partner and may be a situation where they are selling from one investor to another, while keeping an ownership interest in the property. Although there are a few reasons why this may be OK (investor #1’s risk vs reward appetite is different than investor #2), this requires a lot more due diligence to better understand all the moving parts of those involved to ensure a favorable sale price and investment structure. If there is a possibility the transaction is not arms-length, we look at it with added scrutiny.
Overall, we’ve been concerned with their recent track record, and the cash flow projections of the portfolio in years 1-3 were already low without much room for error. And we found that some of the property locations were in less than desirable tertiary markets with minimal projected long-term growth and low barriers to entry of new supply.
2 separate C/O self-storage deals –
Deal Summaries: Certificate of Occupancy deals (C/O) are investments where the buyer avoids construction risk and acquires a property that has just had an expansion completed and the new units are delivered vacant.
What we liked: C/O deals can be highly attractive since they are acquired after the local municipality issues the seller a certificate of occupancy on new construction and the buyers can now start renting/leasing out the new units immediately. Avoiding construction risk and acquiring C/O deals often comes with a hefty price tag. These 2 deals were in South Carolina and projected to provide investors with 18%-20% IRR.
Why we passed: They unfortunately did not pass our sensitivity analysis which is typically the result of a high acquisition price and rosy lease up projections.
Our sensitivity analysis determined that if annual rent growth was 2% vs the projected 4%, the IRR dropped from 18% to 12% and should rental rates remain flat after year 2 when the lease up was projected to be completed, the IRR dropped to 5%. In addition, if the stabilized occupancy dropped from the projected 90% to 85% (which is more in line with self-storage historical occupancy levels) the IRR dropped to 13%.
All assumptions on these 2 deals needed to be met exactly in order to achieve the projected result, there was essentially no margin for error.
In Conclusion…
In addition to the above deals, we also recently passed on an apartment opportunity in Fort Worth, another in Las Vegas, 2 self-storage deals in Denver, a multifamily student housing deal in Ohio, and a food hall in Tennessee.
As investment managers trusted with the stewardship of our clients precious assets we recognize our value is in being able to source more deals, analyze them, and choose the highest quality deals for our investment criteria and being able to do this better than our investors could without us. We are happy to share some behind-the-scenes narrative around deals we have passed on as a way to allow you to learn more about our investment selection process.