The Discovery Channel
With Q2 behind us, we believe the title for our Summer 2022 investment letter is aptly named “The Discovery Channel”. The past few months in the real estate markets have been a rapidly changing environment, challenging us to thoroughly assess and re-assess both existing and potential new investments. For our investment team here at RanchHarbor, this period has been a focused period of ‘discovery’ – or more specifically, ‘price discovery.’
As a real estate investment manager and asset owner, we leverage the knowledge gained through our existing investment portfolio to help inform us on new investment opportunities. We are focus on yield-oriented opportunities in class B multifamily, light industrial and RV & Boat storage sectors. In Q2, we launched RanchHarbor Fund I and held our first closing in the Fund – San Dimas Industrial.
Below is our current investment portfolio which is a cross section of small-cap, value-add investments across six states. Total estimated asset value under management (“AUM) is approximately $170MM.
Ranchharbor’s Investment Activity:
We represent both our personal capital and investor capital in all the investments above. At all times, especially right now, we are applying a high level of focus to many variables that impact the financial performance of these investments. Here’s a snapshot of key variables we have been watching closely:
- Debt pricing and terms
- Hedging costs
- Exit cap rates
- Rent growth
- Leasing activity
- Vacancy rates
- CAPEX estimates
- OPEX ratios
- Property management expertise
- Transaction volume
These are all critical aspects of our ‘Discovery Channel.’ Considering the significant move in interest rates and overall consumer sentiment, there is no question that real estate valuations will be adversely impacted.
When it comes to our approach on new opportunities, we focus diligently on these variables and how the assumptions behind them impact valuation. When valuing a new opportunity, we firmly believe the underwriting must be supported by conservative assumptions that have the potential for outperformance. Too many deals are being done with overly aggressive assumptions (i.e., high rent growth, low expense growth, and exit cap rates not reflective of increasing debt costs) that could underperform in the long run.
To put it bluntly – Price discovery ain’t easy right now!
Rather than pontificate on Fed actions, whether we are in a recession or if cap rates are going up 15bps or 50bps, we are going to provide you with a simple ‘scorecard’ of few key ‘value drivers’. This is real-time evidence of what we have been experiencing in both our asset management activities as well as our acquisition efforts. This is what we are seeing on our ‘Discovery Channel.’
We are certain this experience is shared by all investors who are actively in the market attempting to buy or sell. We are not naïve to fact that the capital markets have changed dramatically in the past 120 days. Spreads have blown out; cap rates are increasing, and real estate values are retracing downward. The vast majority of stabilized transactions today are being done at negative leverage (cost of debt higher than the acquisition cap rate). Buyers are still betting on large NOI growth to make their deals work. In our opinion, this is not healthy and a sign that deals are still not correctly valued, especially in the current economic environment. Fortunately, we are not a ‘forced seller’ on any of our assets. At the same time, we know there are many asset owners that will be forced sellers – opportunities are on the horizon.
We see this dysfunction in the markets as the early stages of new price discovery.
It simply takes time for sellers to adjust their price expectations to what buyers are willing to pay. Hence, our view is that there is currently a bid – ask spread that is not in sync with the realities of a quickly changing investment landscape.
RanchHarbor Fund I Outlook
As we enter the 2nd half of 2022, we believe attractive investment opportunities will begin to emerge. Of particular note, the syndication market for small-cap, value-add real estate has chilled recently leaving many operators searching for a single check equity partner.
Over the past few years, investor syndications, specifically for multifamily deals, were extremely aggressive buyers. With private investors searching everywhere for real yield, syndicators were having an easy time raising capital. Given our focus on equity investments in the $3MM to $10MM range, the syndication market has been our greatest competition.
While we have screened ~$2 billion of equity investment opportunities and over 270 deals since 2020, we have only executed on approximately 3% of those opportunities. Most deals have been quick passes due to unrealistic (in our opinion) underwriting or subpar locations. Many deals we lost out on were to syndicated investors raising capital from friends, family, or crowd funding platforms. Our view is that the underwriting was aggressive on many of these deals, thus we stayed disciplined and chose not to pursue these opportunities.
With volatility in rates and the narrative of a less than favorable economic outlook, we have observed activity in the syndication market slow down dramatically. We experienced this in real time on an asset we were under contract to sell. Just days before closing, the buyer informed us multiple investors backed out of the syndication and they could not close. Combine this with third parties telling us crowd funding platforms have failed to raise them capital and we see a market where access to capital has significantly decreased.
RanchHarbor is in a position of strength. With the launch of Fund I in May, we believe our ability to provide single check equity positions us to take advantage of the current environment. Certainty of closing, single point of contact, and ability to offer institutional asset management will become even more in demand as we move into the latter half of this year.
In the words of the famous value investor Benjamin Graham, “The intelligent investor is a realist who sells to optimists and buys from pessimists.” RanchHarbor takes these words to heart. The realist understands how to adapt quickly to changing conditions.
The Discovery Channel will be on.
Be real and stay tuned!
ABOUT RANCHHARBOR
RanchHarbor is an integrated real estate investment firm based in Newport Beach, Calif., focused on investing in sub-institutional value-add opportunities. RanchHarbor offers joint venture equity and general partner co-invest equity, targeting commercial and multifamily real estate investments between $2 million and $15 million in select U.S. markets. The firm also provides sophisticated asset management, capital advisory and receivership services to institutional and private investors, asset owners and operators. Since its founding in 2020, RanchHarbor has closed on nine investments exceeding $100 million in total AUM across five states. For more information, visit ranchharbor.com. Follow the company on LinkedIn.