2023 Investor Letter

Dear Investors,

It is with an incredible amount of gratitude and a deep breath that I can say that it has been a decade since the inception of Urban Asset Advisors (UAA). To celebrate this milestone, it feels like time to start the tradition of an annual letter to the people that have believed in, advised, encouraged, and partnered with us over the last ten years. This will be a consistent opportunity for UAA to talk about our investments and loyal investors, review where the market is currently today, and share some thoughts about where we feel we might be heading.

As most of you know, UAA has the privilege of managing multifamily real estate investments for a large number of investors, including a handful of larger corporate and institutional partners. I am grateful for the trusted partnerships, many of whom I’ve had the honor of working with and calling friends for over 20 years. It is to you that I write and dedicate this letter as none of this would be possible without you.

As a team, we took this opportunity to look backwards and wanted to share what has been accomplished in this past decade. We analyzed our overall returns and looked more closely at “You”, our investors. Some of our findings included:

     • Our typical private investor has invested in at least three UAA projects and on average $800,000 across UAA projects.

     • 85% of you are private investors and live in Oregon/SW Washington.

     • UAA has acquired and developed over 2,200 units of apartments across 38 different projects. 21 of those 38 projects have been sold and investments completed.

     • The average annualized return (IRR) across all completed multifamily projects was 22.17% with an average equity multiple to investors of 1.81. For perspective, the average S&P 500 return for the last 10 years is 12.39% (9.48% when adjusted for inflation).

When you have been involved in multifamily real estate/investing for as long as I have (27 years) you tend to think you have seen almost everything. This of course is not the case, and I can squarely say that the most important thing I have learned in those 27 years is that the world will always be changing, and we must also change to continue to be successful. What a ride the last four years have been; a global pandemic shutting down the world, followed shortly by rampant inflation, an overbuilt apartment market in Portland and then the federal reserve tightening credit by increasing the federal funds rate from near zero in the first quarter of 2022 to over five percent by October 2023! I can effectively say that none of these unique major events were even remotely on our radar. Fortunately, with our conservative nature and planning, UAA projects are in relatively attractive shape to weather the current storm. A couple of exceptions include projects where we had loans coming due and needed to do cash-in refinances with the credit markets in disarray. However, through creative brainstorming, collaborative teamwork, and exemplary partnerships, we were able to find solutions and opportunities even in unprecedented scenarios.

Let us talk about the bigger picture/national landscape and the impacts these events have had and where that leaves us today. To say that increasing the federal funds borrowing rate was tightening credit would be a severe understatement. I cannot even think of a good example to compare this to; undoubtedly most if not all of you have felt this effect in some way and can appreciate how extreme this was. And while it has created a lot of pain in the banking and real estate industries, my opinion is that it was very likely the best choice the Federal Reserve Chairman had and by doing so abruptly we have potentially avoided runaway inflation and a deep recession with longer term consequences; no doubt we will need to wait and see if this plays out and it’s not clear if we’re finished yet. UAA continues to stay conservative as I am not convinced we are in the clear and heading to a soft landing and/or a quick recovery “yet” but am positive when much of the data is suggesting this may be the case.

Impacts of Inflation and Credit Tightening. We all felt some Déjà vu when Silicon Bank failed this past March, followed shortly by Signature Bank of New York and then First Republic Bank in May. For many of us with account balances over $250,000 it was a scramble to move money around and make sure we were protected within the FDIC insurance limits. With commercial real estate transactions decreasing by over 70% due to lenders being heavily exposed to falling commercial prices and most properties no longer meeting their debt service covenants with lenders, bank lending came to a screeching halt. For borrowers facing loans coming due right now, they soon discovered there are few if any banks willing to meet borrowers' refinancing needs and the options available, most often require a substantial infusion of additional borrower equity to meet the lower debt qualifications. All of this at a time when most borrowers have much less liquidity and/or access to liquidity. Fortunately for apartment owners, Fannie Mae and Freddie Mac (agency lenders) along with debt funds and credit unions have all stepped up to provide more options to apartment investors than to other commercial real estate investments such as Office, Retail and Industrial. If banks were required to mark-to market (adjust property value to today's much lower values) the commercial real estate on their lending balance sheets, many would be in serious trouble.

Where are we heading? It is my belief that we are at or near the end of increasing interest rates; I would not rule out another .25% - .50% of further rate increases if inflation does not stay settled and continues towards the 2% annual target. The Federal Reserve has some motivation from multiple fronts to decrease rates once they believe we have stabilized inflation at or near 2% as evidenced in their most recent announcement to start reducing rates in 2024. Many optimistically predict that we could see rate decreases in early 2024; I tend to be more conservative and believe the earliest we will begin to see the decreased rates will be the last half of 2024. Only time will tell, and it will be interesting to look back in hindsight to see what really did happen and how close to reality these different forecasts were.

Where to invest? Many times and by many of you, I am asked what the best cities/places are to invest in. The answer is always similar; it depends and is constantly changing. Primarily we look at places with growing population and employment, under or oversupply of housing, weather patterns and access to natural resources (such as water supply) and quality of life among other factors. Also, many people will look too broadly at an area, for example, “Portland is a bad place”. Portland, like all cities, has its good areas, bad areas, and everything in between. We all know this instinctively from our own neighborhoods and cities we visit. We may live in a nice area of Portland, but a handful of blocks away, it may have some challenges. It also depends on what kind of investment we are making. For instance, if we are investing in workforce type housing, we want that investment to be near jobs that our residents work at but also a safe area with good access to schools and services. For our urban projects, it is vital that they be on or near “Main Street” corridors; urban residents want to be in the heart of the city and have walkability to access their favorite coffee shop, restaurants, shops, and other important services. They prefer to not drive to meet their daily needs and are willing to pay a higher rent per square foot for this lifestyle of convenience.

Where will the opportunities be in this current environment? It is my belief that 2024 will show us the bottom or near bottom of the real estate market overall. With the tightening credit, most banks not lending on commercial real estate, and the bulk of investors sitting on the sidelines, I believe we will see more sellers that need to sell, selling at attractive prices in 2024. This decrease in overall investor demand coupled with stagnant income growth has resulted in sales that are setting new market lows with significant discounts on replacement costs for apartments across the country. In Portland specifically, we have already started to see opportunities and attractive sales occurring and believe that will continue and grow into 2024. There are two specific areas in which we are seeing these opportunities come up: newer projects where the developer needs to refinance their construction loan and they need a large amount of additional equity to do so and purchasing existing apartment buildings that have not been managed effectively and/or need some capital investment back into the buildings. We are in a tougher rental market right now and unless an owner is closely monitoring their assets and their property manager, there is a good chance the property is not being optimized and has significant upside.

It has always been my belief that these difficult market times bring tremendous opportunities to acquire attractive assets with wonderful returns. With that we will be launching our second fund to be prepared with the capital to be active investors in several markets when these opportunities come across our desks. All of us at UAA wish you and your family a happy holiday and we look forward to talking with you in 2024.

Sincerely,

Tim O’Brien