When we started our Opportunity Zone Funds, we knew our investments would be tested against a backdrop of varying economic cycles due to the nature of the long-term investments. We knew these cycles would require us to be nimble and make appropriate adjustments in our selection and underwriting diligence, zeroing in on only projects with the most robust demand sets.
While this has narrowed our focus, we continue to find fantastic investment opportunities supported by exceedingly strong demand for rental housing and minimal development competition. In support of these opportunities, we recently started raising our fifth Opportunity Zone Fund.
This is why and how we will continue to invest in 2023:
Rental demand in Colorado is at record levels and there are many reasons why similar levels should persist for the foreseeable future:
- The current interest rate backdrop is likely to create even more rental demand with less supply being built and less homes for sale
- The middle income workforce is the largest growing segment of the population in our target markets
- Our targeted markets remain some of the most desirable places to live in the country
- The move to ownership is likely to slow given the interest rate backdrop and the rent versus own calculus (according to Freddie Mac, more Americans are preferring to rent than buy than ever before)
The Colorado Housing and Finance Authority (CHFA) provides a quarterly report on apartments statewide. Their most recent report from Q2 2022 states that “Colorado continues to be ranked among the top multifamily markets in the country based on the generally low vacancy and strong rents… because of strong market fundamentals, combined with rising single family home prices throughout the state, we expect apartment permits and renter ratios to increase in most areas throughout the state during 2022 and into the future.”
The recent CHFA report also shows very low vacancy rates, with the highest vacancy rate in any of our submarkets at 2.4%, the lowest vacancy rate at 0%, and the average vacancy rate at 1.5%. For reference, we model a 5% vacancy rate for each of our developments.
Our first two ground-up apartment developments are now operational and leasing with demand that far exceeded our expectations. The Eddy Apartments in Grand Junction has 98 units and we preleased over 50% of the apartments within 20 days of activating our website. We were fully leased within 30 days of opening, exceeding our expectations by 4 months and achieving a 12% rental premium compared to our forecast.
The Altitude Apartments in Glenwood Springs has 65 units that opened on November 1, 2022 of which 90% were pre-leased sight unseen. Similar to The Eddy, we expect the project to be 100% leased within 30 days of opening. The Altitude is also achieving a rental premium of 5-10% compared to our pro-forma. Although a grand majority of our investing is in ground-up development, we have also purchased two existing apartments that have a total of 86 units that remain fully leased. We have an additional 595 units that are under construction or about to break ground throughout Colorado.
As rates have risen at an unprecedented pace in 2022, our underwriting examines whether a project can still perform with increased carrying costs. The increased interest rates can deteriorate returns enough to make some projects not pencil, while others certainly remain worth pursuing. We continue to ensure that each of our projects have the strong fundamentals of high barriers to entry, extremely limited supply, and high demand.
As we continue to grow and become a well known brand throughout Colorado, we have formulated great banking relationships resulting in competitive loan terms. On our Durango project in Fund IV, we were able to recently close a fixed rate construction loan which removes our interest rate risk for three years. On another project we are negotiating a construction loan with a favorable ceiling which enables us to underwrite our worst case scenario.
We do not believe rates will be where they have been for the last five years and expect historical trends to be a more accurate forecast. Our underwriting has adjusted for these changes and the projects still deliver our intended returns.
Due to the current high interest rate expense of construction loans, we are carrying more capitalized interest in our development budgets to make sure we can adequately service debt. We believe that pushing through this period will provide a competitive advantage as many projects have and will shy away from this environment. In turn, we will continue to be first to market in all to most of our developments.
As long-term investors, we invest in areas with strong fundamentals that enable us to succeed through ever changing economic scenarios. Compared to merchant developers, we are not as susceptible to cap rate and interest rate changes. Currently, we are experiencing rising interest rates and unprecedented rental growth. This enables us to increase our NOI and maintain project value even with increased debt assumptions. As interest rates change over our 10 year hold period, we have the ability to react and take advantage of market conditions when they improve in our favor.
The majority of developers are merchant developers who require their developments to be sold within one year of construction being finished. In contrast, all our investments are long-term (10 years+), which provides us a lot more optionality when we both refinance and eventually sell a project. As our current projects move towards stabilization, we will continue to establish our bank relationships to ensure we maximize our permanent debt solutions.
Lastly, our goal is not to charge expensive rents, although as long-term holders, our asset value and our income are poised to benefit from continued rent growth. Effective rent growth accelerated to 13.5% over the trailing twelve months, the highest rate on record.
info@fourpointsfunding.com
345 Lincoln Ave #206, Steamboat Springs, CO
© 2023 Four Points Funding, LLC
