Goodegg Investor Letter – Q2 2023

Ah, what an interesting time we are living through. Over the last quarter, we’ve seen the Federal Reserve continue to raise interest rates, with more rate hikes likely to come.

We’ve also seen some cracks in the banking industry, sending ripple effects through the financial landscape as a potential indicator of a larger economic downturn and looming recession.

And while the higher interest rates of late might make it more tempting to leave your money sitting idle in your savings account to collect interest, smart investors know that you can’t save your way to true wealth and freedom.

But where do you find the “right” investments in this environment? Especially given that the rising interest rates have led to tighter lending restrictions and increasing difficulty securing low fixed rate debt, thus also making it increasingly difficult to find great investments. 

So what is a smart investor like you to do? Should you plan to keep your money in your savings account and watch from the sidelines until things “settle down”? Or should you continue to invest, albeit with a more scrupulous eye and extra sharpened pencil?

As we’ll discuss in a bit, we remain extremely bullish on commercial multifamily opportunities, particularly as major players like Blackstone are doubling down, closing on the largest real estate private equity fund they’ve ever raised.

As Blackstone global co-head Ken Caplan notes, some of the firm’s best investments have come in “periods characterized by the market volatility and dislocation,” which is exactly what we’re experiencing now.

Just like Blackstone and other major players in commercial real estate, we foresee tremendous opportunities to come in the latter half of 2023 and beyond, and we are putting all the pieces in place to help all of YOU take advantage of that opportunity. 

That being said, this doesn’t mean that you should sit idle on the sidelines in the meantime, twiddling your thumbs while waiting for those opportunities. 

While there will certainly be a greater quantity of strong opportunities in the coming months and years, that doesn’t mean the quality of current opportunities is any lower. 

Great opportunities may be a bit harder to find right now, as compared to the potential onslaught of great opportunities likely to come. 

But! Consider that there are always two sides to every coin.

In the coming months and years, when there are ample opportunities, there will also be ample competition. And if you take the wait-and-see approach, you might miss out on a lot of great opportunities in the meantime.

Right now, while great opportunities may be sparse, there’s also significantly less competition, which means there are fewer people looking for these hidden gems.

But here at Goodegg, gem hunting is what we excel at. Even in the face of the current uncertainty, we continue to approach acquisitions with creative outside-the-box strategies, which help us to access the best opportunities.

In this Quarterly Investor Letter, you’ll learn more about our outlook for the remainder of 2023, our acquisitions standards and strategies, the assets in our current portfolio, and more.

Q2 2023 Multifamily Outlook

With 2022 firmly in the rearview mirror, we are now focused on new expectations and predictions for Q2 2023 and beyond. 

The US multifamily sector is expected to continue above average performance in 2023, despite economic turmoil and disruptions in the capital markets. We will likely not see the sub-3% vacancy rates or double-digit rent growth as in the past two years, but overall market demand is expected to remain steady.

As always, we try to put ourselves in the best possible position to find quality opportunities, no matter the current economic cycle. We are well positioned to take advantage of great opportunities that lie ahead.

Vacancies & Rental Rates

According to CBRE’s US Multifamily Q4 Report, the overall US occupancy rates are expected to remain above 95% with annual rent growth expectations of over 4%. 

Although growth expectations remain strong, we are keeping a close eye on new inventory  to the market. CBRE expects 450,000 units to be delivered in 2023, adding 2.6% to the total inventory. Additionally, there are another 300,000 units under construction that will be delivered in early 2024. 

While we expect these new deliveries to affect short-term leasing activity, demand is expected to grow. CBRE predicts that nearly 3.5 million new market-rate multifamily units will be needed by 2035 to keep pace with overall demand throughout the US. 

According to Berkadia’s 2023 Forecast, net absorption is projected to reach the second highest level in more than two decades. Berkadia forecasts the national occupancy rate to settle at 95% in the fourth quarter of 2023, only down 70 BPS (basis points) from 2022. 

The year-end rate would be higher than the pre-pandemic cycle average of 94.7% during 2010 to 2019. What this means is that multifamily continues to be a strong and stable investment.

As interest rates continue to rise, renters continue to grapple with the idea of purchasing versus renting. CBRE calculates that the average house payment for newly purchased homes in late 2022 was 57% more expensive than the average monthly apartment rent, the widest cost gap on record. 

Even if home values continue to fall and mortgage rates drop in the latter half of 2023, the relatively lower cost of renting will support multifamily demand going forward. 

We remain bullish on multifamily acquisitions and for the multifamily rental market in general.  

Maintaining A High Bar For Underwriting & Acquisitions

We remain steadfast in our conservative approach to underwriting. As cap rates have expanded and interest rates continue to increase, a critical eye on deal metrics becomes increasingly important as we look to limit risk.

According to CBRE’s 2023 multifamily report, rising interest rates have led to more multifamily purchases in which mortgage rates exceed the cap rate. While this gap is expected to narrow over the coming months, lowered rental growth expectations throughout the market have caused a slowdown in deal velocity. 

Sale transactions for multifamily assets are still closing, but they are focused primarily in high-growth markets throughout the South and Southeast. Individual markets with population and job growth expectations that beat the national averages are still in great demand. Some of the standout stars are Dallas, Orlando, and Jacksonville.

As in the previous quarter, we have updated our underwriting standards and investment thesis with the expectation of lowered projected rental growth in year one and two for any new acquisition. 

We have also underwritten higher exit cap rates in an effort to compensate for continued interest rate expansion. We firmly believe that taking this conservative viewpoint is the appropriate step for protecting cash flow and limiting risk for all of our investors.

Acquisitions Strategy & Outlook

In Q1, our acquisitions focused on a few key strategies to optimize returns and mitigate potential risks. 

One such strategy was the acquisition of properties with long-term, in-place, fixed-rate, debt. This approach allows investors to reduce exposure to rising interest rates, which can have a significant impact on real estate investments.

The Federal Reserve’s interest rate increases have created challenges for navigating the real estate market. Higher capital costs, rising rents, and expensive cap rates are impacting both multifamily investment and development in various ways. 

Despite these challenges, the demand for rental housing remains strong, driven by the supply-demand imbalance. The interest rate hikes are making it difficult for potential homebuyers to enter the housing market, which is driving demand for rentals and keeping top-line income steady.

Due to the higher required return from risk assets, cap rates for apartment assets have generally increased, depending on market and investment profile. The financing environment today is different from previous years, resulting in lower leverage and higher costs. 

Some borrowers who have relied on low interest rates since 2020 and borrowed up to 80% or 85% of cost without buying rate caps may face challenges as their loans mature and refinancing becomes necessary. 

This could lead to capital calls, underwater refinancings, and other issues that require deeper pockets. We anticipate seeing more of these types of investment options in 2023 as investors with near-term debt or investment vehicle maturities seek an exit, or open-ended funds seek to raise liquidity to accommodate redemption requests.

Despite these challenges, we see opportunities in this unique market situation by taking advantage of the opportunities from distressed debt sellers. We plan to invest in deals with lower basis than previous buyers, using lower leverage debt and fixed rate options to lower the risk profile of the investments. 

We are optimistic about the longer-term prospects for multifamily, and we see potential in investing in “rescue capital” in the form of preferred equity to owners of distressed properties who are still trying to keep them. There is huge potential to purchase these deals or provide rescue equity at a great basis with relatively higher interest rates. 

We anticipate interest rates cooling off in the next 2-3 years, which should create opportunities to refinance and return significant capital back to investors or sell properties as cap rates should compress with lower interest rates, resulting in higher sales prices. 

We have been able to leverage this strategy with both of the active acquisitions currently in the pipeline:

• With Encore Metro at Millenia in Orlando (Asset #1 in Goodegg Wealth Fund II), we are assuming a long-term HUD loan with a low fixed interest rate of 3.80%.
• With the acquisition of the hotels in Goodegg Diversification Fund III, we are assuming a fixed-rate debt at 3.87%.

By locking in favorable rates on all acquisitions currently in the pipeline, we have been able to protect your investments against current and potential future rate hikes, thus providing stability and predictability for your investments. 

Market Spotlight: Orlando

Another critical element of the Goodegg’s acquisitions strategy has been its focus on strong investment markets, such as Orlando, Florida. 

Orlando has a rapidly growing population, driven in part by a thriving tourism industry that attracts millions of visitors each year. This growth has led to increased demand for housing and rental properties, creating opportunities for investors to capitalize on a robust market. 

Orlando’s economy is diverse and growing, with a strong job market and a range of industries, including healthcare, technology, and finance. This economic stability helps to support the real estate market and creates opportunities for long-term investments. 

Orlando’s real estate market has historically shown resilience during economic downturns, making it a relatively stable and predictable investment. The city’s growing population and strong economy also help to support property values and rental rates, providing investors with reliable income streams.

Through continuing to pursue strong assets in growing markets like Orlando, we are able to provide recession resilient investments to help you grow your wealth and diversify your portfolio.

Acquisitions In Progress