Ballast Rock Real Estate Market Update

Mixed Signals But Our Thesis of Investing in the Southeast Remains Unchanged

The economy continues to appear relatively robust, though there are some signs of cooling, e.g., the 07/07 jobs report reflected a slowdown in job creation from previous months. We are also seeing rental growth in our markets start to normalize – with rent increases typically more broadly in line with CPI rather than significantly leading it, as had been the case for the last couple of years.

Conversely, the amount of dry powder on the sidelines (equity raised but not yet deployed) in multifamily is still significant after hitting record levels in 2022. In particular, assets in the Southeast are very much in demand as the economy there has proved incredibly resilient. According to a recent report by Bloomberg, for the first time, Florida, Texas, Georgia, the Carolinas and Tennessee now contribute more to national GDP than the Northeast. In addition, the Southeast accounted for more than two-thirds of all job growth across the U.S. since early 2020 and is home to 10 of the 15 fastest-growing American large cities.

Cost of Debt Remains Volatile

The yield on the 10-year Treasury is a good proxy for the cost of debt – Ballast Rock, like all sponsors, borrows at a spread to a benchmark which generally tracks the 10-year. As you can see in the graph below, since the Fed started raising rates in March 2022, the 10-year Treasury increased from 1.5% to a high of 4.25% in October 2022. Since then, it has moved significantly tighter and wider several times, trading in a 100bps range. This volatility makes it difficult to forecast cost of debt, which makes it hard to accurately underwrite deals.

Transaction Volumes Are Low

With so much uncertainty around the economy and the cost of debt, transaction volumes remain extremely low. As can be seen in the chart below, all sectors except Net Lease have seen significantly lower transaction volumes in Q1 2023 vs. Q1 2022. Multifamily saw the largest decline, down ~80%.

No Distressed Selling But Some Sellers Are Adjusting Expectations

To date, we have seen no real “distressed” asset sales in our markets. There is a significant amount of preferred equity looking to be deployed, helping sponsors restructure their equity stack and right-size Loan To Values (“LTVs”), where necessary, to allow loans to be refinanced rather than being foreclosed. If and when foreclosures do occur, any properties that have been taken by the banks will be sold through a fully marketed process with multiple buyers looking to participate. However, while there are no distressed sellers, we are starting to see some limited repricing of assets that have been on the market for some time, or where assets went under contract and then fell out of contract to come back on the market again.

Ballast Rock Real Estate Underwriting, By the Numbers

Despite lower transaction volumes across the industry, our Atlanta-based acquisitions team has been extremely busy. Over the last six months or so, we have underwritten an average of about 10 properties every week, showed indicative pricing on a third of those deals, and submitted offers on a third of those. We’ve generally been submitting about one offer a week.

That means that, to date in 2023, we have submitted around 20 LOIs and, where we were one of the best-and-final bidders, we have been on-site to diligence a handful of those deals. We haven’t taken any properties under contract yet, as none of the assets we’ve seen have met our strict underwriting standards.

Conclusion

We are seeing lower transaction volumes, volatile borrowing costs, and some signs of a cooling economy.

However, we continue to see little evidence of any significant weakness hitting our markets. Positive fundamentals for the Southeast combined with significant capital waiting to be deployed, either as restructuring capital or acquisition equity, and no significant new building in the secondary and tertiary markets we focus on, give us increasing confidence to begin deploying capital, particularly as we continue to see more sellers with realistic pricing expectations.

The acquisitions team is closely monitoring changes in the cost and availability of debt and any signs of increased distressed transactions. We remain patiently focused on identifying the right first asset to acquire at the appropriate time.