Goodegg Investor Letter – Q4 2023
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    Dear Investors,

    It’s officially fall 🍁 and the leaves aren’t the only things that are changing. For many months now, the commercial real estate market has been in a continual state of flux, as interest rates have continued to climb. 📈

    As a result, lenders have reacted with tightening their restrictions on new financing and refinancing terms, and thus we’re feeling the effects of the slowdown 🐌 on all real estate transactions, which impacts both buyers and sellers.

    This dynamic between buyers and sellers has played out many times before and in many different arenas. In fact, Nobel Prize winning economist Richard Thaler once did a study on this exact topic – to better understand this push and pull dynamic. 🤓

    One morning, before employees came into the office, Thaler and his team put mugs on every other person’s desk. These randomly chosen employees were now the proud owners of coveted new mugs, which the non-mug owners were now envious of. 

    Then, Thaler and his colleagues opened up a marketplace to try to entice mug owners to sell their newly acquired mugs. What happened next sent shockwaves through the field of behavioral economics. 😱

    First, let’s start with the mug owners. Even though the mug owners had owned the mugs for less than 24 hours, they put a fairly high price on the mugs, in part because they didn’t want to lose something they already owned. 

    And those who didn’t have mugs? They put a fairly low price on what they would pay for the mugs, in part because they would have to go out of their way to gain something they didn’t already have.

    Due to this gap in pricing, very few mugs actually traded hands. 🐌

    Similarly, this significant gap in what sellers are willing to accept and what buyers are willing to pay is exactly what we’re seeing in the commercial real estate market right now, which is exactly what’s leading to the slowdown in sales activity. This push-pull effect is only compounded by the high cost of commercial financing and debt. 

    Sellers aren’t willing to budge (at least not yet), and buyers aren’t willing to pay higher prices and thus take on additional risk. 😑

    But the million-dollar question is this. What are we as investors to do while this slowdown in sales activity ensues? 

    When the market shifts, we as investors must get crafty and resourceful and shift our investing strategies accordingly, which is what this investor letter is all about.

    So buckle up, grab a pumpkin spiced treat (buy a mug from a neighbor if you need to 😜), and let’s dive in.

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    Q4 2023 Commercial Real Estate Outlook

    As another quarter passes by, the commercial real estate market has continued to sluggishly move forward. 🐌

    That being said, slow doesn’t always mean bad; it’s a signal that things are shifting, which is why it’s important to stay alert and in-the-know, so we can all adjust our strategies accordingly. 

    Although the economy has shown some surprising buoyancy 🛟over the past two quarters, inflation has persisted, and the specter of a potential recession has remained. 👻

    This general uneasiness has created a fairly dramatic and prolonged impact on the US commercial real estate investment market, and you’ve probably sensed some of that continued uncertainty and general wonkiness. 😵‍💫

    But not to fret! This is all part of the normal cycle of real estate, and in this Quarterly Investor Letter, our goal is to give you a clear overview of what’s going on, what we’re focused on, and how we’re adjusting our strategy, so you can do the same.

    Commercial Real Estate Sales Have Slowed To A Crawl

    As stated in our last quarterly update, investment sales volume continues on a downward trend by more than 60% in 2023 versus years prior (no one wants to sell their “mugs” at a discount 😉).

    Interest rates have continued to increase throughout 2023, and the Federal Reserve is signaling that there may be more increases to come. 

    Treasuries have likewise continued to increase, making the spreads difficult to manage for those looking to refinance. Loan proceeds have diminished, and lender scrutiny has increased. 

    These factors have all coalesced to create a dampened market, but there is sunshine on the horizon. Even as 2023 continues to be difficult for commercial real estate investors throughout the country, there are many who anticipate the beginnings of opportunities resurfacing as we enter 2024, and these opportunities are slightly different than our traditional trades in the space. 

    Based on their latest US Market Outlook, CBRE is forecasting an additional 37% decrease in year-over-year activity through the remainder of 2023. Most prognosticators are predicting this trend to continue into 2024 until interest rates start declining and property acquisitions can begin to pencil for investors. 

    Even so, there is an air of positivity in the market. Commercial real estate companies CBRE and JLL are predicting investment volume to increase in the second half of 2024 to coincide with a predicted expansion in cap rates across all asset types. 

    Predictions and the possibility of interest rate cuts and falling treasuries in the latter part of 2024 going into 2025 have inspired  some positive forecasts. The US investment market is quite strong and always resilient, and backed by quality, well-performing, brick-and-mortar assets. It will simply take a bit of willpower and a great deal of patience

    According to their most recent US Outlook Report, CBRE is forecasting an average 15% rise in cap rates in 2024. Although cap rate expansion is typically correlated with diminished valuations, it will also usher in new sales activity that the market is desperately waiting for. 

    Multifamily Absorption

    Absorption is a key measure showing the demand for new units coming to the market. According to CBRE, absorption is nearly double their initial expectations in the first half of 2023. Their absorption prediction through the balance of the year is for over 300,000 new multifamily units. 

    This number is still well short of the anticipated 500,000 units being delivered in 2023, but it is a positive metric as compared to predictions earlier in the year. Positive absorption is a sign of the general strength and stability of the US multifamily market.  

    Expected: Increased Tenant Demand & Decreased Vacancy

    As new construction starts continue to decrease through the remainder of 2023 and into 2024, absorption is predicted to increase even further, this will usher in increased tenant demand and a predictable decrease in vacancy rates. 

    According to CBRE, average vacancy rates have continued to hover around 5% nationally, but are expected to reach nearly 5.4% as new deliveries continue to hit the market into early 2024. 

    As new supply diminishes and we reach a point of equilibrium in early 2025, vacancy rates are again predicted to stabilize around 5%.   

    Strong Rental Growth

    Regardless of absorption or vacancy rates, the multifamily market still enjoys strong rental growth year-over-year across the country, albeit at a slower rate than in years past. 

    The first quarter of 2023 saw an average annualized growth rate of 4.5% while recent predictions through the balance of 2023 have downgraded those growth estimates to an average of 2.2%. 

    Although these growth estimates are expected to increase in 2024 and beyond, this dampened rental growth has been a significant contributor to cap rate expansion (and thus lower valuations) throughout the market, resulting in the lack of investment activity.

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    Debt Financing 

    As reported in our last quarterly update, much of the new supply in the Sun Belt states was spurred on by attractive fixed-rate financing that was in place prior to the recent volatility in the capital markets. 

    Many of these projects began well before any of the regression in the market and were put into action to meet the population demands in key growth markets around the country.  

    As access to new financing continues to tighten, new construction has quickly tapered off, and supply is starting to level off. As stated above, this is expected to create an overall increase in rental rates as we begin to absorb that limited supply. 

    This process will take a bit longer in markets throughout the Sun Belt. Along with decreased construction starts, this limited access to debt financing is also affecting owners of in-place properties, whose current financing may be reaching maturity.

    Short-Term Bridge Loans Expiring Soon

    Starting in late 2020 and continuing through the end of 2022, the market saw an ever-increasing cost per unit for multifamily sales. Many of these deals were structured with short-term bridge financing (with floating rate debt, often with a short-term rate cap in place) that is now set to expire in the next 6-12 months. 

    Based on the many economic factors listed above, most of these properties have likely experienced depressed valuations and will have difficulty renewing or renegotiating their loans unless new capital is infused into the deal. 

    As floating rate loans have significantly elevated monthly debt expense numbers, many owners have been forced to limit or pause distributions, and many have found it necessary to use up their cash reserves to bridge the gap. 

    As cash flow has continued to deteriorate for many owners, so have many of their baseline lending metrics. These include debt yields, net operating income growth,  and debt service coverage ratios. 

    Tightening Lender Requirements 

    In what seems like an unfair confluence of requirements, many lenders have simultaneously increased their expectations of these very metrics. As owners are seeing their ratios falter, lenders are requiring elevated numbers when contemplating debt refinancing or modifications.

    This has created a decrease of lending proceeds available to owners throughout the country. It has become typical that an expiring loan will be decreased by upwards of 5%-15% when refinancing. 

    The Need For Creative Financing Solutions 

    This difference between the new lenders’ proceeds and the expiring debt  must be covered by the property owner and will often require creative financing solutions such as mezzanine debt, land leases, and preferred equity. In the worst case scenario, there could even be a need for a capital call from current investors. 

    Although the choices for property owners seem daunting, there is light at the end of the tunnel. Many of these properties that are currently facing the need for renegotiated debt financing have the potential for rekindled profitability and appreciation as market metrics continue to improve over the next 2-3 years. 

    There is a growing mantra of “Survive Until 2025” bubbling up within the market. Much of this turmoil is widely believed to be somewhat short term. 

    With over $10 Billion of CMBS debt expiring by the end of 2023, there is a great deal of work to be done. As reported previously, new loan originations continue to be historically low, hence the current low sales activity across the market. 

    Although the Fed has made it clear that lenders should work with commercial borrowers to minimize the overall macroeconomic impact, the current debt environment continues to be difficult for many owners. This is expected to continue throughout 2024 into 2025. 

    As with any perceived market downturn, new and creative opportunities tend to surface during these types of events. Although we remain bullish on the multifamily market in general, we also see an opportunity to take part in these creative financing solutions, by placing our investments in a different position within the capital stack.

    Tricky Debt Scenarios

    As loans mature, some borrowers are having to contribute additional capital to bring the principal balance down to an acceptable level based on the current interest rates. The size of that check is all about timing. 

    When a ten-year loan matures, the property’s NOI has likely grown significantly and the borrower has some cushion to push through a refinance even at a much higher interest rate. 

    On more recent value-add deals where the business plans’ execution got cut short and the investors were relying on a cash-out refinance to achieve their yields, negotiations are getting messy. 

    Receiving a capital call notice is an investor’s nightmare, especially when there are few prospects for seeing a return on that new capital. The result is a large number of borrowers “giving back the keys” to the lender, which is becoming a trademark of this downturn.

     Of course, taking back a property is a lender’s worst nightmare (unless they are an opportunistic debt fund). This has led to many interesting opportunities on the acquisition side of the business. 

    These competing scenarios are bringing parties to the table to negotiate extensions with capital infusions, and also prompting an increasing volume of bank loan sales. With all of this noise, it’s important to remember that the many successful refinances do not make the headlines. 

    The Opportunity At Hand – Preferred Equity

    Unfortunately, the data shows that more and more loans will be difficult to refinance, and there is almost $1 trillion of maturities in the pipeline. 

    This unfortunate situation – where sponsors are in the position to either proceed with a capital call or give the keys back to the bank (for otherwise well-performing assets) – has allowed for an interesting opportunity in the preferred equity space. 

    Preferred equity lenders are able to step into the second position in the deal, behind the senior lender, and provide a cash infusion for the sponsor.

    The sponsor gets out of a tricky financing situation and does not have to come out of pocket, and the preferred equity investors receive a nice preferred return with a higher position in the capital stack than the common equity.

    On top of that, existing common equity LP investments would be safe from the dilution that would result from new capital coming into the common equity stack.

    A win-win for all!

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     Acquisitions Strategy & Outlook

    We remain engaged with sellers and partners in multiple markets across the country. We are opportunistic and aggressively seeking out strong acquisition targets. We are continuing to dig and search for the right deals, but they are few and far between. 

    We see tremendous value in multifamily over the next few years, but we are not willing to buy until the metrics and underwriting truly show a path to profitability. We are willing to be patient and wait for the appropriate deals to take shape over the coming months. 

    The truth of the matter is, there is distress specific to debt financing in the real estate market right now that will take some time to phase out.  

    As mentioned earlier, there is a significant amount of debt that is set to mature over the coming years, and this will create opportunity in the multifamily space in late 2024.

    Our Acquisitions Focus: Preferred Equity Multifamily & Select-Service Hotels

    In the meantime, many multifamily offerings currently on the market are set at unrealistic numbers with a need for market rate debt. This confluence creates underwriting models that simply do not create positive cash flow. 

    For that reason, we have found very few new multifamily opportunities that meet our strict underwriting criteria and targets.

    However, as mentioned, we still anticipate traditional multifamily investments to make more sense in the latter half of 2024, and we will continue to underwrite and review opportunities. 

    Since we still see the huge potential with multifamily on the horizon, we don’t want to just sit on the sidelines. So, we are continuing to invest in multifamily, but from a different angle – via preferred equity.

    If you are new to preferred equity as an investment, start here to learn more about what it is, how it works, and whether it’s right for you.

    Additionally, we are continuing to focus on a hidden gem within the greater commercial real estate market – select-service hotels in the greater midwest with high cap rates (creating a low acquisition basis) and assumable in-place debt financing. 

    Because select-service hotels offer limited amenities (a self-serve market instead of a full-service restaurant, for example) and a more affordable per-night rate, they can be run more efficiently and also attract a stable and repeat customer base of business travelers.

    In 2022, we successfully acquired 2 select-service hotels just outside of Chicago, and just last month, we acquired another 3 select-service hotels in Indiana. 

    In most scenarios, we have acquired our hotel properties with fixed financing rates at or below 4% and have created cash flow to our investors in the range of 9-11%+. 

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     The Goodegg Portfolio – Strong & Steady 

    As for the Goodegg Portfolio, multifamily continues to be a mainstay, although we’re tweaking our approach to multifamily by placing our investment in a different position with the capital stack, as pref equity.

    While we have faced a number of challenges that have kept us on our toes since March of last year when the Federal Reserve began its first of 11 interest rate hikes, the Goodegg Portfolio has persevered through this period of downward economic pressures by relying on the fundamentals and best practices of quality asset management

    We have worked closely and creatively with financing partners and lenders on recapitalizations, extensions, modification of senior debt, and other solutions to successfully navigate this economic climate, all the while keeping tight controls on the performance of the assets within our portfolio.    

    This steadiness contrasts with the disastrous office market and tepid retail outlook due to a recent surge in the producer price index that complicates inventory decisions for both online and brick and mortar store owners.

    The long-term outlook for multifamily is bullish, as the nation is projected to have an eventual shortage of housing even with the new multifamily developments coming to market. 

    In the short term, select markets are absorbing new units at a brisk pace, with slight effects to their occupancy, while other markets are seeing downward pressure on rents and the introduction of concessions.

    The 4 P’s Of Our Asset Management Strategy

    The  toughest multifamily sector to be in, and one Goodegg has avoided, is new construction lease-up. Developers are struggling to obtain the rents necessary to service their new-build debt loads, where construction costs and interest rates escalated well beyond expectations. 

    This has left them sitting with expensive inventory and still subject to interest rate increases as they work toward stabilization. 😬 Not an enviable position for an owner / investor to be in. 

    In stark contrast to new construction, we are looking forward to closing on our most recent multifamily offering, Encore Metro at Millenia in Orlando, where we are assuming in-place debt with a long-term fixed rate of 3.8%.

    As always, going forward we will continue to focus on the 4 P’s of Asset Management – People, Price, Product, and Promotion – to garner the best performance possible for each asset in the Goodegg Portfolio. (Read more about the 4 P’s in our Q3 Investor Letter.)

    Our goal is to provide the highest quality apartments at the most competitive prices. Constantly checking on the four P’s to ensure each section is working as close to its optimum level as possible gives each asset the opportunity for the best possible outcome.

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     Goodegg Portfolio Asset Overview

    Below are some key insights on select assets within the Goodegg Portfolio.

    Waterleigh at Leland

    – 248 Units | Wilmington, North Carolina –

    • 95.2% occupied and 96.4% leased
    • Minimal concessions
    • The market is absorbing newly constructed units at a reasonable pace thus far.

    Mission Antigua

    248 Units | Tucson, Arizona –

    • 94.4% occupied and 96.0% leased
    • The market is holding steady, with minor adjustments made to specific unit types to lease excess inventory.

    Royal Spring

    351 Units | Houston, Texas –

    • 94.3% occupied and 94.9% leased
    • The market is steadily absorbing an aggressive amount of new construction.

    The Sarah at Lake Houston

    – 350 Units | Houston, Texas –

    • 95.4% occupied and 96.86% leased
    • Leasing activity has remained steady amid absorption of new construction.

    Congaree Villas

    – 106 Units | Columbia, South Carolina –

    • 96.07 occupied and 99% leased
    • This property has four apartments that are off-line due to damage from lightning. Insurance is funding the repairs and rent loss. 
    • The market is holding steady, and we are still getting incremental increases on renewals and new leases.
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    Investor Sentiment 

    We know that many of you may feel like you’re investing in a silo, and though you don’t necessarily want to follow the masses, you want a peek into what other investors might be doing at this time, particularly investors who have been through a downturn before.

    What we can tell you is that – investors have been incredibly cautious in 2023. Clouded by rising interest rates, tight credit conditions, and an uncertain economic outlook, many investors have opted to sit out and wait for a bit more stability before taking action.

    That being said, we can also tell you that many of our experienced and savvy investors are continuing to invest alongside us as we shift our strategy to meet investors’ interests. Our investment volume has remained about the same as 2022.

    The consistent refrain from nearly all investors is a desire for consistent cash flow with a conservative approach to risk. This all sums up to a focus on capital preservation. Being investors alongside each of you, we completely understand this sentiment. 

    No matter the current state of the market, opportunities always exist. It simply requires a critical eye and a willingness to explore creative alternatives. 

    We are excited to be in such a position with all of you. We strive to create surety and consistency with a long-term view on strong returns on exit. 

    To that end, and based on feedback from all of you, we are looking at investments outside of traditional multifamily acquisitions. 

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    As We Move Forward…

    As we continue to face a volatile economy, we stay focused on sourcing strong investments opportunities in both multifamily and hotels.  

    We are bullish on the overall market and have an incredibly strong pipeline of projects that we are considering. 

    As we kick off Q4 2023, we are excited about the opportunities ahead. The current economic climate has dared us to step up and get creative, and we are rising to the challenge. 

    As we continue to navigate the seas of uncertainty ahead, we are incredibly grateful for the opportunity to help you strategically and intentionally grow your wealth.

    If you’d like to invest with us and haven’t already, be sure to join the register on the Goodegg Investor Portal so you can stay in the loop on all future investment opportunities.

    And, remember that we currently have four investment opportunities for you to explore:

    And of course, if you know anyone who wants to build their wealth, we would love it if you would forward this letter to them or send them to our open deals page to learn more about our current or upcoming opportunities.

    Remember – we are never too busy for your introductions and referrals.

    Learn More

    If you’re not yet ready to invest but are curious about how all of this works, we invite you to dip your toe in the water with us through our free 7-day email course – Passive Real Estate Investing 101 – or to get a copy of our book – Investing For Good.

    To learn more about us and our experience, be sure to download a copy of our track record, which shows the projected and actual returns we’ve achieved across all the deals we’ve exited to date.

    Connect With Us

    If there’s ever anything we can do to help you on your journey, feel free to email us at [email protected] or call / text us at (888) 830-1450

    Here’s to a very sunny-side-up remainder of Q4 ahead!

    Julie, Annie, and The Goodegg Investments Team

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    Annie Dickerson

    Annie Dickerson

    Annie Dickerson is an award-winning real estate investing expert with 15+ years of real estate investing experience. Annie is the Founder & Chief Brand Officer of Goodegg Investments – an award-winning boutique real estate investment firm.

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