As 2024 begins we feel proud of what we are building at Glencrest and optimistic about the future. Despite weakening conditions in our industry, ongoing macroeconomic uncertainty, and political unrest at home and around the world, our portfolio of 14 apartment businesses is generating solid cash flow and poised for ongoing success. We continue to believe that our company can do the following for investors who consistently entrust us with capital:
Beat the stock market;
Beat treasuries;
Beat inflation;
Preserve principal;
Provide secondary liquidity; and
Minimize income taxes.
The foundation of this belief stems from (i) the fundamental human need for shelter (ii) the strong long-term economic prospects of the markets we target and (iii) the fragmented ownership and inefficient operations endemic in our industry. Regarding our target markets, Glencrest recently completed an analysis and found that rent growth over the last 20 years significantly outpaced inflation in each of them. We expect this will continue and allow our investments to thrive.
As we did last year, we wanted to give you an update on macroeconomic and industry conditions and a forecast for the remainder of the year. Additionally, please do let us know if you have any ideas on great candidates for our open job positions.
Macroeconomic conditions
Our opinion is that excessive monetary and fiscal stimulation drove the quixotic growth of a number of areas of the economy during and immediately after the Covid-19 pandemic. There is still a great deal of liquidity seeking a home in our economy, which continues to keep asset prices high and feed inflationary forces. While uncertainty and many countervailing forces remain, in general we don’t think our economy has fully taken the medicine necessary to unwind the excessive conditions of recent years and it is therefore likely that more economic difficulty is on the horizon.
In particular, we think interest rates – especially long-term rates – will probably settle higher than many market participants expect because the Federal Reserve will not return to buying such a substantial portion of the treasury and mortgage bonds issued each month. The good news for Glencrest is that a thoughtfully curated collection of quality multifamily properties with sustainable leverage should perform relatively well in various market conditions.
Industry conditions
On a national basis, the multifamily industry has experienced two significant challenges recently.
First, rent growth is weakening, primarily due to a dramatic increase in the supply of new apartments. Easy money and robust operating conditions caused a spike in multifamily development in recent years and new apartment deliveries in 2024 are expected to surge by more than 50% (an all time record). This supply is causing rent growth to drop. Year-over-year it is essentially 0% (down from 15% not too long ago!) and the vacancy rate is approaching 6%, the highest in nearly a decade.
The good news, however, is that demand for apartments is still strong and the excessive supply pipeline should moderate sharply by the end of 2025 as the easy money that fueled excess construction has gone away. At that time strong rent growth should resume.
Second, interest rates are much higher than they were a few years ago. This is making it more expensive and difficult to finance apartment buildings for everyone, but creating acute challenges for owners who borrowed short at high leverage levels when interest rates were low, apparently assuming this condition would last for an extended period. You have likely seen headlines about how some multifamily investment companies are issuing investor capital calls or even facing foreclosure and a total loss of equity due to their financing decisions of the last few years. As discussed above – in contrast to the rent growth situation – we don’t think this situation is temporary, at least for long-term rates. Short-term rates are likely to fall somewhat but still remain much higher than the recent past.
But these are national and general conditions. Every sponsor of multifamily investment constructs a unique portfolio. Glencrest’s goal over time is to materially beat the average and we think we have done so to date. When interest rates plummeted and many markets began experiencing unusually high rent growth, we steadfastly avoided the siren song of “following the herd” in our industry and believing this was the new normal. Instead, we stuck to the basics, only acquiring quality assets with excellent long-term rent growth prospects where we were confident that our price would soon result in significant positive leverage over the then-current cost of the long-term fixed-rate debt we utilized. We focused on markets and submarkets that had a smaller supply pipeline and favored simple garden-style construction that is easier to diligence and maintain.
Portfolio performance
The result is that the portfolio Glencrest constructed from 2020 through 2022 (we exclude properties acquired last year to have relatively stabilized performance numbers) is weathering the difficult industry conditions well. We are still seeing market rent growth, with new lease “trade out” (the difference between the rent of a tenant moving into a particular unit compared to the rent of the tenant that just moved out of the unit) exceeding 4% in February 2024. Many residents still have in-place rents that are significantly below market, and this “loss to lease” should allow us to keep growing revenue in 2024 even if market rent growth falters.
Our portfolio is in great shape from a leverage perspective, having a weighted-average fixed interest rate of 3.5% and remaining term in excess of eight years. This compares to an in-place cap rate of 6.1% (with significant embedded upside), creating substantial positive leverage and the ability to utilize cash flow both for capital reinvestment and investor dividends.
Last quarter we paid an average dividend of about 6% (annualized) even while funding large renovation projects at several properties. By contrast, the average dividend of the major public apartment REITS is approximately 4%, and buying shares of these companies doesn’t come with the significant income tax benefits of the Glencrest Generations program. We are pleased about the relative current success of our portfolio and are committed to continue the investment approach that led to it.
Individual property performance varies, of course, and you recently received an update about your specific investments. We do want to reemphasize our belief that consistently investing in each of our offerings and building a diverse apartment portfolio in terms of geography, vintage, asset-specific characteristics, etc. will result in a better risk-adjusted return over time than trying to “cherry pick” and preferring certain offerings over others.
2024 forecast and initiatives
Glencrest’s operational initiatives in 2024 are heavily focused on resident renewals, expense management and future capital investment forecasting, all of which become relatively more important when market rent growth slows down.
On the transactions side, we are working to expand our geographic coverage in anticipation of growing our ownership footprint and to improve the efficiency of our prospecting and underwriting functions. Thus far this year, transaction volume remains muted and asset prices, on average, have not fallen quite as much as we think they should to deliver our target returns, although the trend is favorable on both fronts. We are also planning to add leverage on a few assets with particularly strong cash flow, which will result in larger one-time distributions for investors in these assets.
Glencrest is also actively working on programs to provide additional structural avenues for equity investment and to deliver secondary liquidity to existing investors. We expect to have more to share on these programs later this year.
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If you have any comments or questions about these thoughts, please feel free to reach out by phone or email. We are always happy to talk. Thank you, as always, for your partnership.
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