The Purchase Opportunity and Strategy:
The properties purchased through this Fund vehicle met all of our basic underwriting criteria, including breaking-even at 60% occupancy and having the total purchase price, together with renovation expenditures, being well below the cost of new construction. In addition, all properties selected and purchased had ample upside through renovation/rehabilitation as well as through improved operations.
The management of all properties was transitioned to Equilibrium’s in-house management, in most cases, replacing external third-party management companies. With our internal owner-centric management in place, we not only saved by not paying third-party management company fees, but we have also been able to identify other areas for cost savings and ways to increase revenues. The resulting physical enhancements to the properties coupled with the improved operating cash flows have resulted in significant gains in terms of net operating income (NOI) and property value.
Given the unavailability of traditional credit for distressed properties and the exorbitant costs of the limited alternative financing options that could be obtained, the Fund purchased properties on an all-cash basis. Cash flows from operations were reinvested until properties reached stabilization, typically 2 years, further mitigating the need for cost-prohibitive alternative financing. Pursuant to our strategy, properties would either be sold upon stabilization, or where opportunities for accretive improvements remained following stabilization, properties would be refinanced utilizing traditional loans at a higher property valuation given the improved condition of the property and greater NOI. With refinancing, investor capital would be returned and the properties would generate meaningful distributions to investors while the accretive improvements were undertaken to further enhance property value and resident satisfaction.
FINANCIAL OVERVIEW
INITIAL OCCUPANCY:
42%
CURRENT OCCUPANCY:
90%
The Challenge:
There were a total of 221 units purchased under this structure across four (4) properties, each with its own specific set of challenges. Three (3) of the four (4) properties were purchased directly by Equilibrium out of bankruptcy/foreclosure, with one of the three (3) having been won at an auction at the courthouse steps. The fourth property was purchased from a real estate agent who have acquired it at a foreclosure auction, but was unable to undertake the repairs and investment that the property required in order to derive meaningful value.
One of the properties purchased directly out of bankruptcy had significant plumbing issues that required immediate remediation. The propertywas built in 1985 with polybutylene plumbing, an alternative to copper that was deemed innovative at the but later found to be unstable as oxidants in the public water supply reacting with the polybutylene piping and acetal fittings caused them to scale and flake and become brittle, creating micro-fractures, in the case of this purchase leading to varying levels water penetration in almost every unit, requiring that all 38 units be replumbed as part of the property renovation process.
A second property required primarily exterior improvements to make it more desirable. The improvements included adding wrought iron fencing and decorative rock and revitalizing the community pool area to make it the focal point for the property.
The third property had suffered through years of neglect. Once a thriving community, overleverage eventually lead to the prior owner’s inability to maintain the property, leading to a decrease in occupancy, which further decreased the prior owner’s ability to maintain operations. This downward spiral ultimately lead to foreclosure and bankruptcy proceedings that lasted multiple years. As a result, when Equilibrium acquired the property out of bankruptcy in February 2012, there was an extraordinary amount of deferred maintenance. In addition to tackling the deferred maintenance, EQ was tasked with replacing 101 swamp coolers (evaporative cooling systems consisting of water slowly dampening absorption pads with a fan blowing cooled air generated from those pads into apartment units) with standard HVAC systems, replacing all roofs, and building 6 foot separation wall at multiple property boundary locations as well as for enclosing individual backyards for each tenant.
A majority of the issues with the fourth property resulted from a lack of ownership oversight from an out of state prior owner combined with ineffective and unprofessional on-site management. At acquisition, both the physical condition and operations of the property where is disarray, exemplified perhaps best by the lack of copper piping in several of the vacant units. In addition, most of the existing residents had failed to pay rent for extended periods of time during their tenancy.
Across the portfolio, initial occupancy at purchase was 42%. In addition to the improvements highlighted above, all properties required standard improvements such as exterior building and trim painting, parking lot resurfacing, the replacement of outdated and worn-out flooring with interior vinyl “hardwood flooring” and appliance replacements, to name a few.
Implementation and Property Results:
By removing deferred maintenance across the portfolio and enhancing the physical condition of the properties held by the Fund, we were able to drastically improve the status of all of the properties purchased and improve the living conditions of all of our residents while meeting our stabilization objective of occupancy levels above 90% for each property. At the same time, we increased revenue through improved occupancy, collections and increased rents while also implementing strategic cost savings.
The property with the least amount of deferred maintenance (a 24-unit property) was the Fund’s first disposition, which occurred in the first quarter of 2017 for $832K. It had been purchased in 2013 for 432K.
The largest property in the Fund has benefited from a cash-out refinancing ($2.6M) that nearly equaled the total capital invested for purchase ($2.1M) and renovation ($800K). We plan to add further value to this property by undertaking additional renovations, including upgrading the clubhouse and adding washers and dryers to a number of upgraded units. Pursuant to our plan, we will sell this property after the value has been realized from the completion of the additional renovations.
The remaining two properties have reached stabilization and provide consistent cash flows for investors. In the near term, we will undertake either cash-out refinancing or property sales for each of the properties depending on our ability to capitalize on remaining accretive renovations and a decision as to whether immediate or prolonged sale with additional cash flow will ultimately yield greater returns to our investors.