Strategies for Investment Success: Tempus Realty Partners and the Life of Our Fund
Uber Freight - Northwest Arkansas
Many have heard the saying, “…one makes his/her money on the Buy…” In the life of our fund, it could not be more true. It is, of course, impossible to know how an investment will turn out the day you buy it, but today, we are going to highlight a few things we do on the front end of each investment to increase our odds of success.
Basis and Use Mitigate Credit Implications
Market values are impacted significantly by the strength of credit behind lease contracts of commercial real estate. For real estate investors, highly rated investment-grade, net-leased opportunities are an efficient market and absent a special story or angle; these properties provide little upside opportunity as they trade at values similar to the company’s credit. At Tempus, we look to take advantage of opportunities to invest in quality properties with a risk profile similar to those with investment grade tenants but with the more attractive income stream of smaller company credit. To do this, we look for properties with certain characteristics which mitigate the credit risk of the tenant. Two of the key criteria of these properties include: (1) confirming the basis in the property lies within a market range and (2) ensuring the property’s improvements, if needed, could be utilized by a multitude of alternate users in the future. Many times, particularly in a sale/leaseback transaction, our team is able to set the market lease rate near or even below that of nearby comparable properties. By getting the property basis right, the security of the income stream is enhanced beyond the credit of the individual tenant as if necessary a replacement income stream could be implemented with limited disruption.
Cap Rate and Current Borrowing Costs
Historically, cap rates typically lag behind borrowing rates following a run up of interest rates. Sellers are usually unwilling to adjust to market because their existing debt has been fixed for at least 3-5 years and are still seeking pre-inflationary return thresholds. Current interest rate quotes range from 7.0% to 9+% compared to much lower current average cap rates, which renders many projects infeasible given the negative leverage. Buyers, like Tempus, who secured fixed rate drawable financing 12-24 months ago, maintain an extreme competitive advantage for acquiring new quality assets. Sale/leaseback is a particularly active space in this environment because those sellers are typically less sensitive to selling at a higher cap rate and are more likely to be motivated by the transaction as a financing source, which is more attractive now as interest rates have risen rapidly and traditional lenders have become stricter on credit requirements.
Minimize Tertiary Markets Exposure and Gateway Market Volatility
As one moves up the location risk curve, higher yields are available, especially in rural or tertiary markets. Conversely, larger gateway markets like New York, Chicago, Atlanta and Los Angeles often see rapid increases in rental rates and provide for excellent liquidity on disposition. Both these options can be tempting, particularly for those looking to make outsize returns by properly timing the market and moving between these two extremes depending on developing conditions. For Tempus, however, we believe the mid-size market space provides an ideal blend of enhanced yield with reasonable market resilience and liquidity that make these markets perfect for reliably growing our capital. For this reason, it has been important in our portfolio construction to maintain discipline when considering assets in these large and small markets. Tempus plays between the two extremes, with minimum Metropolitan Statistical Area populations no less than approximately 100,000 and a high of around 2,000,000, venturing outside these areas only in rare circumstances. In addition, we look for markets with compelling indicators of future stability and growth. Markets such as Greenville/Spartanburg, NW Arkansas and New Albany, OH (Columbus MSA) are great examples of niche markets which have historically been somewhat tertiary but propelled onto radars of large institutions in recent years due to their rapid growth. These are the type of markets which can allow for higher yields on the buy and a very competitive sale process.
The stronger the score of the above three tenets, the higher potential quality of opportunity for our investors. While this list is far from comprehensive in terms of how we select quality opportunities, these are some of the most common themes found within our portfolio. Beyond these basics, we use financial analysis, deep market research, our experience and much more to guide our decision-making as we select assets for our portfolio. Of course, it is impossible to plan for everything that may come about during the life of an investment, but by employing some of these tactics when buying property, the odds of an investment performing well in spite of future adversity can be tilted in our favor.
Isaac Smith
Partner - Acquisitions & Dispositions