In a world currently filled with more uncertainty than I’ve experienced in my lifetime, it’s only appropriate to write an article discussing how 2021 might look. At first blush, one might very well consider the Ouija board as reliable a source of guidance these days as any other. But upon reconsideration, I find there are some great lessons worth sharing from my perspective as a small owner of multifamily property in Northern California.
My home in Chico, California, has certainly had its share of challenges over the past few years. My wife and business partner, Geralyn Sheridan, and I have been most fortunate to have weathered the storms well. This outcome is thanks in large part to our business and property management decisions, along with, of course, a certain amount of luck.
The lead-up to 2020
We are risk-averse cash flow investors and always have been. Our view is simple: Why purchase an asset for the long term that does not generate an acceptable cash flow? This aversion to risk has led us to be generally cautious when making business decisions. Leading up to 2020, the pillars of our multifamily operations were based on strong underwriting of our residents, responsive facility maintenance, the retainment of strong cash reserves, and an overarching philosophy that if we take good care of our property and our residents, the profits will surely follow.
Our thoughtful and studious approach to the profession has led us to carefully study the practice of being a real estate investor and operator both in professional organizations and within academia. This combination of a solid education and a well-maintained professional IREM network have proven to be invaluable to us and our business strategy.
The decision to transition
In late 2019, we decided to sell our student housing property in Chico and began looking for a new opportunity. The uncertainty being injected into the real estate rental business in California presented a risk that was too great for comfort, so we began to consider investing in other states. Moreover, the city of Chico is essentially a single-industry town, with the primary employer being the California State University, Chico. That reality also presented significant financial risk. As long-term cash flow investors with a goal of achieving stability well into the future, we ultimately determined that investing exclusively in California was no longer looking like a sensible approach.
Search location determination
After careful consideration, we focused our search in two markets: Reno, Nevada, and Denver, Colorado. As previously mentioned, we rely on our professional network of colleagues and mentors for decision support. That cadre is also key to our business continuity strategy.
In Reno, several friends I have known for years oversee local management operations and are personally invested in that metropolitan statistical area. Unfortunately, we found nothing there that sufficiently whet our appetite.
We then explored Denver. As an alumnus of the University of Denver’s Burns School of Real Estate, where I earned a master’s degree in real estate, I have friends and advisors who I knew could provide the local support we would need if investing there. Fortunately, I hold a real estate broker license in Colorado, which we knew would allow for a smoother transition. Each of these factors made Denver an appropriate locale to consider.
Asset class determination
When we went in search of an opportunity, we decided that a pure multifamily asset was not something we wanted to pursue, so we studied various other asset classes. The most desirable was the logistics subclass within the industrial asset class, but that proved to be unfeasible for a couple of reasons. First, it would probably be a single user, and in late 2020 that simply presented too much risk. Second, being a competitive player calls for a large facility, probably over 500,000 RSF. I would have wanted precision-leveled floors, 32 feet or more in clear height, and modern construction.
A nice wish, but beyond our means.
Other possible choices included grocery-anchored properties with inline tenants, properties that included essential businesses like medical office and other service-provider tenants, or flex space in great locations. We utilized this search criteria in line with our financial limits and began to explore.
The search and the purchase
First, we took a run at a beautiful 65,000-square-foot flex space in Broomfield, Colorado. When studying the tenant rollovers, we consulted with experienced tenant reps who advised that we should budget $50–$70 per square foot for tenant improvement allowances—a cool $1 million in tenant improvements for a 20,000-square-foot space. Then, we obtained the roofing report, which indicated that the 65,000-square-foot roof would need replacement soon at a cost of $750,000. We passed on that opportunity, as it seemed like a fast track to oblivion.
Next, we found a five-building, mixed-use property in nearby Arvada. It was newer, with buildings constructed between 2002 and 2019. Its construction was top notch—all steel and concrete with brick curtain walls. The tenancy was primarily medical office, professional consultancy, some multifamily, salon services, the neighborhood bar and grill, and a successful pizza restaurant. We liked the diverse tenant mix, the asset class of the tenants, and the quality of the asset.
After some discussion, we prepared a letter of intent and optioned the property. At the same time, we prepared an offering memo for us to be relinquished of the student property in Chico. Our sale in California consummated in December 2019, and we closed on our new Colorado property in January 2020.
Fast forward—February 2020
In early 2020, we were well postured to address a market cycle. Having said that, nothing could prepare us, or anybody else, for COVID-19.
On Feb. 28, we notified all tenants of the serious nature of this pandemic and sent a copy of the CDC guidelines to each tenant. This was immediately after people from around the nearby Travis Air Force Base tested positive for this new virus.
In the ensuing months following the outbreak of COVID-19, we fared somewhat better than many. We attribute our good fortune to our adherence to applying industry best practices and ethical behaviors toward all tenants and to our careful considerations when making the Arvada purchase.
As we enter 2021, I can evaluate just how we have fared.
Our Chico multifamily asset, a conventionally financed 84-unit property, has experienced a normal cycle of notices and re-rents. We did have one COVID-19 request for relief, but that tenant had a capable co-signer; clearly our underwriting policy paid off there. As of this writing, that asset is unaffected by COVID-19, but our concerns for the next few months remain as the impact of COVID-19 benefits phasing out takes hold.
Our decision to diversify outside of California was in part a result of the single-industry community based in Chico, as related to California State University, Chico. On May 12, 2020, California State University Chancellor Timothy White ostensibly closed the entire CSU system, including the Chico campus. In August 2020, when the limited students did return, many proceeded to socialize in groups, and COVID-19 spiked. Immediately thereafter, the campus was again shut down for all on-campus classes. Our old asset appears to be struggling, and we are fortunate to be watching from afar.
Our management philosophy has served us well in the past and serves us well today, despite industry challenges brought about by the pandemic. And we aren’t the only ones. Jeff Lapin, CPM, vice president of property management with Rocklin, California-based Coastal Partners, LLC, echoed this confidence. “We are optimistic about the market prospects in most areas in 2021 based on the strong pre-COVID-19 economy and how quickly the economy is currently recovering.” He added, “Our goal remains the same as it was before COVID-19, which is acquiring properties that have significant upside potential based on solving preexisting issues with marketing, market positioning, physical challenges, and large vacancies.”
Claudia Yorton, CPM, of C.Y. Property Management, Inc. in Chico, California, is looking ahead to 2021 with an eye on keeping properties competitive. “Going into 2021, we would advise that property owners and managers keep rents stable, keep a close eye on the competition, focus on tenant retention and satisfaction, cut unnecessary costs, and start planning now for big expansion and new strategies to implement as soon as the market starts to open up again.”
I believe the next pandemic is around the corner and will probably occur within our lifetimes. We want to be ready and generally well prepared. Below are a couple of key takeaways from our experience as property owners heading into 2021.
Tweaked asset management criteria
We have changed our search parameters for any future business we may engage in. We now augment our asset class approach to include an essential tenancy consideration. We thoroughly think through questions like: “Does current or emerging technology threaten the tenants’ business models?” and “Do COVID-19 or social distancing requirements threaten the viability of the tenants’ businesses?” This approach will give us more clarity and foresight in decision-making on all levels as we move forward. When looking at a prospective asset, we apply the same asset-class consideration in our search criteria, but we will evaluate the tenancies or potential tenancies to ensure these entities are essential in nature.
The rush to keep deal flows going can be insatiable for investors, brokers, and lenders throughout the nation. On Oct. 22, 2020, Trepp noted in its podcast that large commercial mortgage-backed securities (CMBS) borrowers, primarily with shopping malls, are now offering and obtaining approval to engage in “deed in lieu” workouts, whereby mall owners hand over the keys and a quitclaim deed, losing all equity. It was reported by Trepp that some $40 billion in loans are in the pipeline or have already deeded back property. Also concerning, especially with respect to CMBS deals, are the looming maturities that must be refinanced. Lenders will adjust spreads as a risk mitigation on these lower-quality properties and borrowing costs will increase substantially for some.
As we move through the new year, investors would be well advised to curb their desire for deal flow in favor of a more responsible asset-class selection criteria.￼