Objective
Identify and opportunistically purchase, intelligently renovate and improve, and efficiently manage underperforming and often under-maintained market rate, workforce multifamily properties in the Mid-Atlantic region in order to:
• Provide investors with 14% projected net returns, including the distribution of an average annual cash-on-cash income yield of almost 10% that should be shielded from income taxes by depreciation, while allowing qualified investors to capitalize on the tax benefits of the Opportunity Zone Program.
• Provide capital to Low or Moderate Income (“LMI”) communities to begin to remedy the crisis in workforce housing caused by the shrinking housing stock and the growing population as much research indicates that housing stability significantly increases the economic productivity of a community.
Market Opportunity
The multifamily housing stock in most low- and moderate-income (“LMI”) areas such as Opportunity Zones has not seen a major capital infusion in over 40 years. The average vintage of affordable housing across the U.S. is 1972, and over the last 20 years, for every new unit of affordable housing built, two units have been lost to age or neglect. As the workforce population continues to grow in the U.S. and the housing stock which is affordable for workers and families earning 60%-100% of average median income, the housing crisis for this section of the population deepens. The consensus among housing researchers is that renovating aging and under-maintained properties offers the most effective method for stabilizing housing and improving community resiliency.
Because institutional commercial real estate investors continue to seek larger investments in Class B+ or better property types in primarily the top dozen metropolitan areas, multifamily properties in LMI areas, especially underperforming or under-maintained properties in mid-sized cities, can be purchased at 50%-70% discounts to ground-up development/replacement cost. As a result, even after full renovation, the total post-improvement investment basis should remain 30%-50% below replacement cost. With such a low basis, the post-renovation rent increases can still allow rents to remain affordable for current members of the community. As a result, these significantly improved properties can be expected to achieve full occupancy without needing gentrification or more affluent individuals or families to move into the community. That demand for affordable housing should continue to create organic rent growth of 3%-4%, as has been the case for the past 10 years throughout the Mid-Atlantic region into which the portfolio is investing.
Finally, the Fund is modeled to a conservative exit with a portfolio sale to large multifamily investors such as REITs, private equity funds, pensions, endowments, and sovereign wealth funds. Upside to the base case exists in the event that the Fund portfolio can be sold into a REIT IPO such that property valuations can be increased and liquidation valuation can be greatly enhanced.
Community Impact
The planned capital improvements made to the portfolio properties should directly and positively impact tens of thousands of people living in Opportunity Zones throughout Virginia, North Carolina, and the other target areas. By renovating properties, the Fund strategy can prevent thousands of units within the focus area from being lost to the market, thereby significantly improving housing stability for residents and resiliency for their communities.
“We met with a small group of residents who shared their stories of how safe and affordable housing had improved their lives: stability in school for their children (#4), a short commute to work (#11.2), a safe place for a grandmother to care for her granddaughter (#3). We spoke with a neighborhood store owner who told us how business had improved (#1) and crime had dropped (#16.3) in the years since the redevelopment project was completed.”
—Catherine Godschalk of Calvert Impact Capital from Dear Impact Investors: Consider Affordable Housing (with Allagash additions of related UN SDGs) 4/24/2018
Investment Parameters
• The fund capital target of $300 million would enable the purchase of $675 million cashflow positive but inefficiently run properties suffering from elevated vacancy, turnover, deferred maintenance, and extremely high expense ratios. As a result, rents have not been able to sustain the 3% historic sub-market growth rates and have fallen over 20% below respective sub-market averages.
• Modeled purchase prices are based upon Cap Rates (i.e. Property Net Operating Income / Purchase Price) of 6.25% with a range of 5.75%-8.25%. Approximately $400 million in renovation and improvements is expected to be performed which should be started within 6 months and completed within 3 years.
• Properties (including a 12% allocation to non-QOZ Properties at 63% of QOZ property-level return) are expected to be purchased and renovated with $300 million of equity and an $888 million 3-year drawdown loan.
• As a result of capital improvements, rents expected to increase by an average of 22% in fully renovated properties which will result in post-renovation rents that fall well within the rent range associated with each property’s respective neighborhood.
• Renovation and improvements are projected to enable each property’s currently elevated vacancy rate to be reduced to their submarket average by year 6. Capital improvements and quality management reduce expense ratios from 50% to under 40%
• Properties are projected to be sold at an average Cap Rate of 6.25%
• After-tax returns include the assumption that investors borrow the deferred initial capital gains tax from a third party when due in 2026 paying a 6% interest rate on the loan and subsequently repaying the loan from Fund liquidation proceeds
Competitive Advantages
Run by 5 partners, each with 30-years of experience – much of which is LMI real estate specific, Allagash offers investors unique insight into OZ investing and seeks to provide uniquely compelling Qualified Opportunity Funds for investors.
The multifamily workforce housing focus of the portfolio should provide significant downside protection as that sector of the commercial real estate market has been one of the most stable over the extreme economic and market cycles that investors have experienced over the last 20 years.
The Fund’s very specific real estate focus should provide investors with a higher level of confidence with respect to returns than can be provided by an unfocused multi-property portfolio which may have ground-up development or renovation projects across the entire range of commercial real estate from hotels to multifamily to office to retail.
The Fund strategy of creating a multi-property portfolio of currently operating and moderately profitable assets spread throughout a range of metropolitan areas in the target region allows investors the benefit of risk-reduction through diversification while also avoiding the speculative risks and uncertain economic viability associated with any ground-up development, which is the focus of so many Opportunity Zone funds.
The income generated by the fund over the 10-year holding period should allow investors to recoup over 100% of their initial capital investment from income alone, before the fund portfolio is sold. Additionally, that income should be full shielded from taxes by depreciation.
The Fund’s structure is designed specifically to align interests between the Fund Manager and investors maximize after-tax wealth generation through their investment.
Qualified Purchasers
Investors into the Allagash Opportunity Zone CRE Fund I must be Qualified Purchasers as defined by the U.S. Securities and Exchange Commission and applicable law regarding fund management.