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Private Placement Investing – Changing Conditions in 2023

Marc Halpern, Part Time Investors LLC

In May 2022, the Fed started raising interest rates in an attempt to control inflation and that put in motion a series of domino effects.

In this article, I will describe some of the effects and lessons learned for private placement investments in 2023 that relate to real estate, using examples from my own portfolio. I will also discuss how well my risk management strategies are performing in 2023 and beyond in the face of rising interest rates together with inflation that jumped from 1.4% in 2020 to 7.0% in 2021 and 6.5% in 2022.

1. Exits Were Delayed - Redeployment Deal Flow Decreased

The first effect of the increase of interest rates in 2022 was that exits of some private placement investments were delayed or cancelled in 2022 and 2023.

As an example, one of my investments in an apartment complex went under contract for sale in March 2022 with a scheduled closing in July 2022. The valuation was outstanding and had the sale been consummated, the IRR would have been close to triple digit! The Fed tightened in May (between contract and scheduled closing) and the buyer that was using financing couldn’t close. The timing of the Fed increase couldn’t have been worse. It’s now a year later (April 2023) and there is no talk about a sale of the apartment complex anytime in the near future.

On the other hand, the apartment complex is cash flowing extremely well and the preferred returns are being distributed like clockwork. We do not expect any change in this reliability of distributions.

As always when owning rental real estate, as long as you have positive cash flow, you always have the choice to “hold ‘em or fold ‘em” if the market experiences a hiccup.

My portfolio of private placement investments includes several apartment complex syndications in Florida, Georgia and Indiana and they are doing very well with cash flow that are delivering reliable “pref” distributions. The growth of valuation since purchase is still there, albeit less than before the Fed raised rates. The growth just can’t be realized until the financial environment stabilizes. The fact that distributions continue uninterrupted constitutes strong evidence that the investment is healthy on top of the full transparency of the syndicators.

In contrast, there are private placement investments for which distributions HAVE been interrupted after the Fed started raising rates nearly a year ago.

A case in point is a land development lending fund in which I made a significant investment a couple of years ago.

The basis for making that investment was that there was (and still is) a large shortage of inventory of single family homes that resulted from the slowdown in new home building after the crash of 2008-2011 while new households continued to form as babies born 25-30 years ago come of age. I invested in a fund that lends money to land developers to purchase raw land and “entitle” the land with the paperwork to make it shovel-ready. Homebuilders then buy the shovel-ready land and build homes that are in demand.

I made the investment since the preferred return is a whopping 12% plus back-end kicker distributions upon liquidity events when the land developers sell entitled land to the home builders.

The double whammy of inflation of home prices plus increase in interest rates, in 2022, resulted in new homes that are unaffordable, especially for first time home buyers. The reality is that the building of new homes slowed down significantly even while the formation of new households continues to chug along. Housing starts in March 2023 were 1.42 million which is down 17% from March 2022 (1.72 million).

Now in April 2023, those of us investing in a certain land development lending fund have not yet seen the preferred return distributions for the 4th quarter of 2022 and the 1st quarter of 2023. These distributions typically hit our accounts by the end of the first month following the end of a quarter. These distributions were very reliable through the middle of 2022.

However, even though the distributions from the land development lending fund have stopped for the time being, the preferred returns continue to accumulate on paper. I’m not worried about the future of this investment because the underlying fundamentals of the home inventory shortage remain and grow. At some point this market must come back.

Since my investment was in cash (actually Roth 401k funds) with no debt (i.e., no arbitrage), and there is collateral securing my investment, I can simply wait out the market conditions until home builders get back to building homes which requires that they buy land. At that time, the cumulative preferred returns will be paid as will the back-end kickers.

In addition, the land developers to whom we lend, divided their business between classical land development and “build-to-rent.” The build-to-rent segment diversifies the investment and generates enough revenue to keep them afloat.

OPPORTUNITY! There is a semi-morbid silver lining in the difficulty to secure financing for large projects such as apartment complexes. Financing for some large projects include balloon payments that need to be refinanced. Some syndication deals that were bought several years ago are now coming up for refinance and the new high interest rates are causing stress for some of the deals that may have been marginal at the time of purchase. This creates the occasional motivated seller for large projects and at least two of my best syndicators are right now identifying value-add buying opportunities in the apartment complex space.

There are also new opportunities in the self-storage sector since more than half of self-storage operators are mom-and-pop operations. Some percentage of these mom-and-pop operators are struggling due to a combination of economic conditions, mismanagement and lack of economies of scale. When that happens, the large experienced self-storage syndicators pick up these distressed properties and turn them around with their expertise, economies of scale and string financial position. Two weeks ago, I invested Roth money in a high-performing self-storage fund with a great track record that I was able to access after getting qualified. I am planning to increase my Roth's position in self-storage as soon as my Roth gets proceeds from the next exit.

2. Conservative Investment Criteria Performed Well

I have always built my investment portfolio with diversification in the forefront of the strategy when assembling the portfolio one brick at a time. This is true for private placement investments as well.

The private placement investments in my Roth include apartment complexes, self-storage, land development lending, farming, notes, student housing and a resort. The demand for resorts is suffering and that is less than 5% of this diversified portfolio. That particular investment has no debt, so we can wait out the market speed bump. The other investments are doing well with the exception of the pause in the distributions from the land development lending fund, noted above, and the expectations to make up the delayed distributions are quite strong based on underlying fundamentals.

To state the obvious, conservative investors (like me) invest in private placement opportunities ONLY when they can be bought at a verifiable significant discount to current market value at the time of purchase after accounting for repositioning and renovation. This is one of many obvious risk management strategies and criteria that we implement with discipline.

The bottom line is that my well-diversified portfolio of private placement investments is performing well, despite the combination of inflation and Fed actions. This is a result of a prudent weighted composition of multiple projects in multiple sectors with multiple syndicators, fund managers and project sponsors with whom I invest after performing DEEP due diligence on the merits and risks of each specific investment that meet my conservative investment criteria.

If you are an accredited investor and could benefit from perspectives on successfully building a portfolio of private placement investments with strong performance in good times and during downturns, please contact Marc Halpern of Part Time Investors LLC to inquire about private placement investment coaching and training.

Do not make any investments without performing your own deep due diligence on each investment, including consulting with your trusted licensed advisors relevant to each investment.


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