Acquisition / Deal Analysis
Lone Star Capital first began pursuing the acquisition of Verandas at Bear Creek in early 2019 when the seller engaged a local brokerage firm to market the property for sale. Lone Star participated in the bidding process, but a buyer was never chosen since no one was able to meet the seller’s initial high price expectation. Lone Star continued to engage with the sales broker to see if the seller would be willing to lower their pricing and potentially transact outside of a competitive marketing process (also known as a “best and final offer” process which can go on for multiple rounds and often squeezes pricing to the absolute maximum). Finally, in February 2019, Lone Star was awarded the property for $11,500,000 ($71,875 per unit) and closed on the asset on June 26, 2019. We found this acquisition compelling due to its low basis and the possible upside through lease up and improved management, neither strategy being capital intensive. Lone Star planned an initial capital expenditures budget of $500,000 (a modest $3,125 per unit). The capex spend ended up marginally over budget at $518,000 but the business plan proved effective as demonstrated by the speedy and successful lease up of the asset, reaching 100% occupancy in less than 12 months while raising rental rates by over $50 (6.6% increase).
Verandas at Bear Creek (“VBC”) is a 160-unit multifamily property located in the Bear Creek submarket of Northwest Houston, Texas. Built in 1982, Verandas at Bear Creek is situated in a pocket of similar vintage communities serving a largely B class tenant base, with relatively strong median incomes of around $70,000. This pocket of communities had an average occupancy of around 93%, yet VBC was in the low 80s upon Lone Star’s acquisition despite being nearly fully renovated by the seller. Prior to acquisition, according to Apartment Data Services, the Bear Creek / Copperfield / Fairfield submarket ranked 1st of 42 total submarkets in their list of “Houston’s Hottest Performing Submarkets” with annualized growth rates of 6.7% in occupancy, 5.7% in rental rates and 1.17% in absorption over the prior 3 months. Additionally, there were no new or proposed apartment communities in a 3-mile radius of VBC.
Business Plan / Value-Add
As indicated previously, Lone Star identified operational inefficiencies that caused suboptimal performance:
• Part-time manager overseeing the asset
• Lack of regional corporate oversight of that manager
• Furthermore, over year-long sale process, the on-site team at VBC experienced management fatigue and failed to maintain stable occupancy.
Fortunately for Lone Star, this below-stabilized occupancy limited the buyer pool since:
• Most buyers seek stabilized value-add assets, rather than mostly-renovated assets with non-stabilized operations, which show a less straightforward path to value creation than simple interior renovations.
• Deals under 90% occupancy are not eligible for permanent agency debt, requiring a bridge loan with a higher interest rate and shorter term than permanent financing.
• Confident that we could execute the business plan, we pursued a bridge loan execution with a plan to refinance the debt quickly post-stabilization.
Lone Star’s business plan included:
• Renovation of 10 remaining classic units
• Install backsplashes in all kitchens throughout the property
• Complete 30 remaining washer / dryer installs
• On the exterior, Lone Star added perimeter fencing, as demanded by the residents to improve safety and enhance image / perception of the community.
• Lastly, we upgraded amenities –poolside barbeque grilling and picnic station, repainted stair railings, restriped the parking lot, upgraded exterior LED lighting, patio fence repairs, siding repairs, additional minor deferred maintenance items.
Both management improvement efforts and these capital expenditures were extremely effective in turning around the property’s performance in less than 12 months.
Asset Management / Performance
VBC’s operational performance has been roughly 5% below underwriting projections (based on net operating income), which can at least partially be attributed to the negative impact to rent collections associated with the coronavirus pandemic. Lone Star’s management team handled the coronavirus pandemic extremely well and the resident base worked with staff on payment plans to maintain occupancy and mitigate collection loss.
Refinance / Exit
Verandas at Bear Creek has been a tremendous success for Lone Star and its investors as the partnership executed a cash-out refinance on October 9, 2020 at an appraised value of $14,700,000 ($91,875 per unit), returning 36% of investor’s original capital. Lone Star’s acquisition underwriting assumed a sale in five years (July 2024) for $14,284,728 ($89,280 per unit) using a very conservative 6.5% terminal capitalization rate. On April 27, 2022, Lone Star closed on the sale of the property for $17,500,000 ($109,375 per unit), which delivered a 30.5% IRR for investors and a 1.97x equity multiple over a 34-month hold. The investment’s actual performance and execution is a strong example of Lone Star’s ability to under-promise and overdeliver.
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