A drastic and unforeseen rise in construction costs coupled with the complexity of restoring an historical building resulted in project budgets growing significantly. The inflated budget still penciled based on projected rents and recent sales comps provided by a third-party feasibility study conducted based on the top tier product we had designed. As market conditions worsened and interest rates rose, the revised risk profile of the conversion exceeded our tolerance levels for the Axia Capital Fund and the decision was made to halt progress on the project prior to construction commencing (fortuitous timing). We have moved forward with marketing the project for sale, with the potential for public private partnership and an assemblage deal on which we are coordinating with the County. We had a Seller under contract in Q4 of 2022 at an attractive price, however, the deal ultimately fell through as that group too decided to pull back on new projects citing an uncertain economic outlook.

On December 26th we received distressing news that the structural integrity of the building had deteriorated, and our engineers concluded the best course of action would be to demolish the building (we are still investigating the causes, as this building has stood for 100 years without issue). There are benefits to the site’s value as a blank canvas, as demolition was previously not an option due to the building’s historic significance. We are working with the City to structure development incentives and grandfathering of variances in order to maximize the attractiveness of this site from a sale perspective. The negative impact of this project on the Axia Capital Fund currently is that the capital invested in this project (roughly $4m total) has not produced positive cash flow and the disposition value will likely be impaired. There is no debt on the project, so nothing is forcing our hand other than the desire to get this capital back to work for our investors. We are pursuing all avenues to maximize the value of this property for our investors.

Occupancy and therefore Net Operating Income at this property have been suppressed as we took 30+ units offline to complete full renovations before the expiration of our loan’s improvement funding portion, however, we have recently negotiated an extension of this period. With more time on the clock to fund unit improvements from the project’s loan we will be able to increase occupancy as the renovations are completed, which will increase the property’s cash flow through the remainder to the improvements. It has also been proven that this property can achieve the same above-target rental rates on units with a reduced improvement scope and thus we have decided to scale back the extent of the remaining interior value-add. This, coupled with the extended timeline on our loan terms has resulted in a need for less equity capital committed to this project, as reflected in the reduction to the “Net Improvement Equity” figure for this property. While more units were taken offline than we would typically target due to perceived timing constraints, this property is and will be one of our strongest performers once occupancy is normalized in the coming months. Property performance will be further enhanced by the utility bill back system enacted in January, in which residents will pay for a portion of utility expenses previously borne by ownership.

We find ourselves at an interesting crossroads where inflation is still running high and rates have been ratcheted up in an effort to combat said inflation. Monetary theorists would posit that the Fed’s actions to reduce the money supply should bring inflation back towards the desired threshold, however, the result is not instantaneous and thus we have the misfortune of teetering on the precarious edge between two phases of an economic cycle. Add to this the knock-on effects from blistering pandemic fueled demographic shifts and the resultant flood of cheap cash seeking to capitalize on market opportunities and we are left with an environment in which the post-pandemic pendulum has begun to ricochet the other direction.

The post-pandemic years leading up to 2022 saw record breaking sales activity in the commercial real estate space. Now, however, transaction volume has slowed to a trickle. The $156B in deals executed in Q4 2022 was the lowest for that quarter, which typically sees the highest volume of the year, since 2013. To put things in perspective, fourth quarter deal activity representing <25% of total annual transaction volume has only occurred 3 times in the past century – Q4 2022 being one of those instances. Large institutional sales activity is mostly to blame as deals in this space were down 64% from quarters prior, so the magnitude of the pullback may be slightly inflated, however, it is important to note the slowdown can be primarily attributed to Sellers pulling deals due to valuation changes.

The second half of 2022 also saw the pendulum begin to swing in the other direction for rent growth and demand. After many desirable pandemic growth markets experienced near zero vacancy across multi-family, industrial, and self-storage assets (sorry retail and office), driving rent growth through the roof, these same markets are now seeing rents move the other direction and vacancy creep up as a glut of new supply comes online. Of the 171,000 multi-family units absorbed in 2022, only 9,000 units were absorbed in Q4. As rent inflation priced many renters out of new Class A properties national vacancy rose to 6.2% from 4.9%.

Stalling rent growth, shrinking demand, and rising interest rates and construction costs have also put the brakes on new projects. As anyone trying to build or find construction labor in 2021 can attest, there was so much development activity that general contractors and subs were worth their weight in gold. Now, the momentum fueling the overstuffed new product pipeline seems to have frozen to a crawl. Of great importance is the fact that this curtailing of new development is NOT demand driven, but purely a product of project economics.

Last, but not least, pricing seems to have reversed course as well after industrial and multi-family assets printed double digit appreciation throughout 2019-2022. According to CoStar Analytics all property types, except for land, declined in price based on their repeat sales index.

Among multi-family assets rent growth held up well on an annualized basis as of year-end 2022 at 6.4%. While the 2023 outlook for rent growth from Yardi Matrix has been revised downward to 2.6% from 3.1%, this is not far off from historical averages. As noted previously, occupancy has declined somewhat, but is only 0.9% off the 2021 peak. New supply for delivery in 2023 is expected in the range of 440,000 units, or 3% of the national apartment stock, which should bump vacancy slightly higher. For reference, the last time >400,000 new units entered the market was in 1972. In terms of valuation, multi-family cap rates vary greatly from market to market as location is of such great importance, however the national average cap rate across property classes hung around 4.5% throughout 2022 and will likely creep higher in the later half of 2023.

For now, transaction activity favors smaller deals in smaller markets for multi-family assets. We at Axia foresee a fertile acquisition environment arising in the second half of 2023 for multi-family deals once the Buyer-Seller gap in valuation narrows and a wave of expiring debt maturity and rate caps force properties onto the market at solid discounts.

RV Parks tend to fly under the radar when it comes to headlines and reports detailing the successes or failures of particular asset types, and for this we are thankful. Parks and campgrounds continue to be highly sought after recreational destinations, and those that can control expenses stand to benefit from good opportunities to grow revenue and keep occupancy high. In a survey conducted by RVShare 61% of participants plan to RV this year, up 13% from 2022. In this same survey 50% of participants expressed their preference for RV travel over all other forms and 98% of RVers said they do not plan to cancel their camping plans despite economic uncertainty. The RV community is very sticky and once someone has a good experience at a park or campground they tend to be repeat guests. Additionally, younger generations are now entering the RV demographic base in a meaningful way as remote work fits very well with the RV lifestyle. As a result of this continued and growing demand, 1/3 of privately owned campgrounds plan to expand their facilities in 2023 to accommodate increased demand and lengthy waitlists according to a study by the Dyrt.

Self-storage can be one of the most recession resilient assets due to its ability to meet needs in both economic expansions (more stuff) and downturns (less space for stuff), however, this asset type’s performance does correlate to some degree with that of the housing market. High mortgage rates and building costs have slowed the sale of new and existing homes and, as a result of less packing and moving, self-storage has seen street rates decline by 2.3% in Q4 2022. That decline can also largely be attributed to the natural seasonality experienced by self-storage facilities with demand tending to wane in winter months. While street rates may be down slightly, self-storage operators are able to achieve rate increases among in-place tenants as many self-storage renters would rather eat a 5-10% rate increase than move their stuff. New supply for delivery in 2023 is not insignificant at 3.6% of the national stock, which should negatively impact occupancy in some markets, however, much of this development is concentrated in areas of high demand so we do not expect the effects to be pervasive. Importantly, self-storage performance is primarily linked to multi-family fundamentals in the market served, and as such market selection will be key for anyone acquiring or operating self-storage facilities in 2023.