Now more than ever, high net worth investors have endless opportunities to preserve and grow capital via private commercial real estate investments.

Along with traditional real estate managers operating limited partnerships/funds, the innovations of “fintech” have brought us real estate “crowdfunding”: while past vehicles required larger capital commitments and limited scope, crowdfunding offers accredited investors the opportunity to commit smaller amounts of capital to a wider array of real estate deals.

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Navigating Real Estate Investing and COVID-19

Timothy J Wallen

To Our Extended MLG Family,

With the public market volatility and fear being caused by the Coronavirus, we continue to receive questions on our view of Private Real Estate investing today. Overall, our core message remains that we are maintaining our 30-year history of discipline and due diligence. We are also focused on maintaining our attitude of caring for our clients, tenants and employees as we navigate the challenges and risks of the Coronavirus.

Here are a few of the bigger questions that we are getting asked by our investor clients.

Is MLG continuing to accept subscriptions for Fund IV to allow further acquisitions?

Yes, for the following reasons:

  1. Forced selling for those needing cash now. When there is fear in the market or when certain people or organizations need cash now, assets will likely be sold at a discount.
  2. Likely temporary economic impact. As scary as the Coronavirus is for all of us, it will pass in terms of economic impact, and markets will recover over time as has happened in past health scare environments.
  3. Lower interest rates. In addition to possible attractive pricing of assets, our borrowing costs will likely be materially better. For example, we are seeing fixed-rate loan quotes at 2.75% for 5-year loans and around 3% for 10-year fixed rate loans.
  4. Likely fewer buyers. The current market will also likely scare some buyers away, so there will likely be less demand from buyers and will likely limit the pushing of prices higher.
  5. Lower NOI, lower values. Net operating incomes (“NOI”) will likely be lower caused by the likely temporary slowdown in demand for all asset classes. Lower NOI will likely bring lower prices.
  6. Ability to move quickly. If we have signed subscriptions for Fund IV, we will be able to move quickly to capture these opportunities as they present themselves.

What is MLG’s view of each asset class: Apartments? Office? Retail? Industrial?

  1. Apartments: Overall, over 95% occupied nationwide with supply and demand in balance. However, there are local markets that have supply in excess of demand on a very local basis, so we will need to do our homework on local market conditions. In markets with material supply growth, we will have to be mindful of the risk of excess supply versus demand, especially with the current challenges of the Coronavirus.
  2. Office: Overall, about 90% occupied nationwide. Very difficult asset class with high turnover costs as tenants come and go. We have no interest in stabilized office investments unless we get a high cap rate valuation, or the lease rates are materially below market rates. Our only likely buy would be an office building with below-market occupancy that we are confident in our ability to lease up and sell for a profit.
  3. Retail: Overall, about 95% occupied nationwide. Very difficult asset class with high turnover costs as tenants come and go. Retail tenant needs are changing fast and turnover costs will be exceptionally high versus prior decades. We have no interest in stabilized retail investments unless we get a high cap rate valuation, or the lease rates are materially below market rates. Our only likely buy would be a retail project with below-market occupancy that we are confident in our ability to lease up and sell for a profit.
  4. Industrial: Overall, about 95% occupied nationwide. We like the industrial asset class with much lower turnover costs as tenants come and go than office or retail. We do have interest in stabilized industrial investments with reasonable cap rate valuations or where the lease rates are materially below market rates. Unfortunately, it is very difficult to find industrial assets to purchase at reasonable cap rates, but we will diligently pursue sourcing them.

I spoke at an RIA (registered investment advisor) conference in Austin, Texas last October. My long-term views have not changed on these asset classes since that time frame. However, in the near term, all asset classes will struggle due to the Coronavirus. If you want to learn more on my view of the asset classes above, download the presentation click here , or watch the live recording click here.

What is MLG’s view of the impact of a possible upcoming recession?

We have been asked about our approach to a possible recession in the context of the coronavirus, COVID-19. Recession risk exists for most asset classes. The key question to ask lies in our overall approach to investing, long before any recession comes upon us. At MLG, we have already taken steps in our overall approach to buying private real estate that helps to reduce the risk and effects of a recession. Let me explain further.

Four Steps to Being Prepared for a Recession

  1. Leverage: In the MLG funds, we target debt leverage at 60-65% of all in costs on a consolidated basis, which is lower than many real estate sponsors in our industry. We try to do a mix of fixed rate financing and low floating rate debt. You want some fixed rate financing in case interest rates go up and some floating rate debt in case a recession hits that brings interest rates down. We usually also purchase interest rate caps on floating rate debt to avoid the risk of rates going up materially. In general, most properties we acquire are set up to handle about a 20% drop in gross revenue and still pay all bills and debt service.
  2. Proactive Strategy: to Grow Income: Most MLG fund investments have a strategy to grow operating income. For apartments, it usually involves investing in property improvements to grow rents, identifying assets with below market rents or expense control strategies. For commercial properties, it usually involves properties with low occupancy or rental rates versus market conditions. For example, take one of our specific deals, three years ago monthly collections were $400,000/month and today we’re collecting $500,000/month thru a proactive improvement plan. We also installed low flow shower heads and toilets, which reduced our water bills by over 30% per year. The best defense is strong offense of revenue growth!
  3. Deep Due Diligence: on the Buy Side: In any economic cycle, there are sure to be impacts felt by all. In the private real estate investment world, financial performance is generally contingent on the fundamentals of local supply and demand. If there is a good balance of supply and demand, there are generally less opportunities for things to go unexpectedly sour. The MLG team does extensive due diligence on each acquisition identifying risks of supply grow, confirming proforma assumptions by researching the local competing marketplace of any asset and identifying the opportunity to add strategies to improve operating incomes and values.
  4. Diversification: Historically, many investors only invested in a couple of real estate assets with their local real estate friends. Now, with the crowd funding availability of real estate nationwide, people have the ability to get more diversified but likely take a lot of single asset risks. In the MLG Funds, we target acquiring 25-35 assets within each fund which alleviates the risk of single asset investing.
    • 90% in Four Main Asset Classes: We commit in our legal documents that 90% of the fund will be in multifamily, industrial, retail and office investments (in general order of preference).
    • No Asset Class Limits or Minimums: We do not set any limits or guidelines for each individual asset class (i.e. we do not set a minimum or maximum amount of office assets in our fund). We use this method as markets change and certain assets look better to us in different market conditions. For example, office and retail have very large capital costs as tenants come and go, so we usually do not buy stabilized office or retail assets. We usually look for retail and office assets that have above market vacancy in a submarket where we feel confident in the ability to lease up such asset to market occupancies and then sell it for a profit. In Fund IV, we have more multifamily assets than the prior funds. Fund IV is about 95% in multifamily and 5% in industrial assets. In the past 15 months, we have not found a good office or retail investment. We are not going to buy an office or retail asset just to say that we have such assets in the fund.
    • “Smart” Investments: For the MLG team, “Smart” investments are investments in which we believe that the assumptions in the proforma are believable and achievable to achieve a 12% or higher net IRR to our fund investors. When we talk about being diversified in our funds, our goal is to buy a basket of 25-35 properties from multiple states in one fund where we believe that the investments are “smart” investments. We currently have 24 assets closed or under contract for acquisition in Fund IV, which we believe are 24 “smart” investments.

Now what? What should investors expect?

So, what does this mean going forward? If a recession does happen, we will continue to buy assets with our continued deep due diligence approach, while being realistic to the market conditions. Recessions bring significant opportunities and conditions, which we want to take advantage of. Regarding future cash distributions from our funds, it is likely that we will have some temporary occupancy issues and collection issues with tenants. In general, we estimate that a 5% drop in our collections will temporarily reduce future distributions on equity invested by about 1.5% per year, so there will be short term pain with a recession. It’s hard to know how far collections will drop in a recession.

Personally, I am thankful to have a material investment in private real estate versus the incredible volatile public financial markets with computerized selling of assets. It makes us all very nervous. Hopefully, this virus will get under control and the financial markets will settle down. In the meantime, we will work diligently to grow the value of the assets that we own and maximize the after-tax cash flows to all investors.

Finally, we encourage any investor to continue to reach out and ask questions about our funds. I hope and pray for a quick resolution of this virus and the safety and protection of all your loved ones.

Sincerely
Tim Wallen, CEO
MLG Capital

 

About Tim Wallen:  As a Principal & CEO, I sit on our investment committee and am involved with daily, integral functions of the investment and development segments, including long-term and short-term business strategies, innovative concepts to debt financing, & complex partnership structures.

I am passionate in helping our clients, who are typically those looking for alternatives to the stock market & interested in real estate investing. Our company helps them invest in smart commercial & multi-family properties across the USA.

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