Lone Star Capital 2022 Annual Letter

We at Lone Star Capital had a very busy, prosperous, and challenging 2022. Lone Star Capital successfully acquired $225M (just short of our $250M acquisition volume goal) in multifamily properties across six assets (1,483 units) in Houston.

• Parc at Champion Forest (2000 vintage, 232 units, February)
• Broadstone Briar Forest (1983 vintage, 342 units, April)
• Timberwalk (1983 vintage, 300 units, July)
• 5 Oaks (2008 vintage, 228 units, August)
• Briar Court (1970s vintage, 201 units, September)
• Madison at Bear Creek (1983 vintage, 180 units, November)

Broadstone Briar Forest is our largest deal since inception by both unit count and purchase price (342 units, $48,750,000). The total capitalization of the project is $56,540,000 and required $14,000,000 of equity.

One of our 2022 goals which we didn’t meet was to acquire at least two properties in Dallas-Fort Worth. Our focus historically has been on Houston but after deciding to expand into DFW, we have been splitting our acquisition efforts roughly 50/50 between the two markets. Our goal in 2023 will be to acquire $100M+ in DFW and shooting for a total of $350M in acquisition volume.

Lone Star Capital sold one property in April 2022, Verandas at Bear Creek (160 units), which returned a 37% gross IRR. 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 30.6% 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. To learn more about this past investment, you can access the full Verandas at Bear Creek Case Study.

Since inception, Lone Star has acquired over $350M and sold $40M in multifamily property; almost 100% of these properties have been in Houston. We will continue to be opportunistic sellers with the goal of achieving returns above original projections. However, we will avoid selling in a down market and will patiently wait to have more successful exits when appropriate. This may mean delaying the sale timelines of some assets given softer, current market conditions and a likely recession in 2023.

Portfolio

Our current portfolio consists of 10 properties, totaling $330M AUM. Property performance remains extremely strong as the Houston market shows little signs of slowing down. With rent growth and collections robust, net operating incomes across the Houston portfolio are anywhere from 1.5% to 17.7% above underwritten projections from an investment-to-date perspective.

Unfortunately, this positive news is more than offset by the unprecedented rise in interest rates which occurred during 2022. With most of our portfolio exposed to interest rate risk due to floating rate loans, our portfolio’s cash flow has been dramatically reduced. While interest rate caps are helpful as they have turned out to be a tremendously profitable interest rate hedge on our portfolio, they haven’t protected us completely. This is because interest rate caps vary in duration, and we chose shorter duration caps because the incremental cost of term wasn’t projected to be worth it at the time. However, the market significantly underestimated 2022’s rise in interest rates, making the math for shorter duration caps wrong.

Irrespective of the duration of one’s interest rate caps, lenders require a monthly escrow for a replacement cap purchase so the hedge can always remain in place. With the forward curve (projections for SOFR) projecting rates to be much higher, the escrow calculations for replacement caps are causing escrow amounts to increase 10x to 20x from what they were calculated to be at acquisition for investors who bought property prior to mid-2022.

Higher monthly escrows further hinder free cash flow (even though the money isn’t necessarily spent) but they are necessary in the event a property’s current rate cap expires and replacement cap costs remain elevated. On the bright side, we should see a substantial drop in interest rate cap costs in 2023 as the Fed finishes their rate hike initiative hopefully in Q2.

Team

The Lone Star team grew tremendously in 2022. We finally moved into our new office at the One World Trade Center (though we still don’t have furniture) and brought on two new members on the team full-time in NYC, a part-time intern, and one full-time virtual assistant in the Philippines. My sister, Dasha, has been working for Lone Star part-time since June 2021 but since she graduated from USC in May 2022, she has moved to NYC to work full-time with Lone Star. Our other full-time hire was Brad Oliver who grew up in my hometown in the San Francisco Bay Area and graduated from University of Washington in 2022. On the property management side, our subsidiary, Radiance Living, hired a construction manager, two new regional managers, and a maintenance supervisor.

Marketing

I published my new book, Structuring and Raising Debt and Equity for Real Estate in October and sold 2,437 copies in 2022. My first book, The Definitive Guide to Underwriting Multifamily Acquisitions, published in May 2020, sold 3,477 times in 2022 and has 7,508 lifetime sales. These figures are only from Amazon sales and don’t include sales from our own websites. Altogether, we have sold over 10,000 copies which I couldn’t be more excited and proud of.

I had the pleasure of speaking on a handful of stages in 2022 including at Intelligent Investors Real Estate Conference in Manhattan Beach, Best Ever Conference in Denver, Multifamily Investor Nation Summit in Charlotte, IMN Middle Market Multifamily Conference in New York and a few more.

We hosted our second annual LSC Summit in October 2022, which turned out to be another huge success. Nearly 100 high level investors, sponsors, lenders, and service providers attended and enjoyed great content and even better networking. You can watch the recap video here: LSC Summit 2022 Recap. Next year is going to be bigger and better (yet intimate) and will be hosted at One World Trade Center. We hope to see you there!

We also hosted our first investor dinner in December 2022 in Palo Alto, California and plan to expand these efforts across the country. Nothing can replace the value and connection of in person interaction as well as the serendipity associated with bringing high level people together.

Looking Ahead

Our team is excited about 2023 and has ambitious goals, which include $350M in acquisition volume ($100M+ of which to be in DFW) and launching our first development deal. We will also hire a full-time Asset Management Analyst in NYC as well as an asset management-focused virtual assistant to assist with the management of our expanding portfolio.

As we reflect on the past year, we are proud of our accomplishments and progress. We are excited about all the new relationships we made over the course of the year as well as the time spent growing with our existing partners. Thank you for your trust and partnership.