Lone Star Capital 2023 Annual Letter

As we conclude another eventful year at Lone Star Capital (LSC), it is my pleasure to share with you the progress and milestones we've achieved in 2023, none of which could be possible without you. 2023 presented challenges throughout the industry primarily due to the dramatic rise in interest rates, which I will discuss in greater depth in this letter. This year has been a testament to our resilience, adaptability, and continuous pursuit of delivering excellent results in partnership with our investors.

Acquisitions

We set an ambitious goal of acquiring $350M in multifamily properties in Dallas and Houston in 2023. Unfortunately, the market did not present us the opportunity to do so given the changing interest rate environment resulting in an extremely wide bid-ask spread between buyers and sellers. All throughout the commercial real estate industry, transaction activity was significantly depressed last year.

LSC ended up acquiring five properties in 2023 totaling $145M (purchase price plus budgeted capital expenditures) and 884 units:

·         Candlelight Park: Dallas, 1980 vintage, 128 units, March

o   Notably, this marks our first acquisition in Dallas-Fort Worth, which is an important initiative for us as we look to both scale and diversify. Our goal for the year was to acquire $100M in DFW; while we failed to do that, we do have a full-time regional manager in DFW and are ready to grow. We hope to get busier in Dallas-Fort Worth in 2024.

·         Azul: Houston, 2020 vintage, 90 units, July

o   Azul was a unique acquisition from a few standpoints. Firstly, Azul sits directly adjacent to a property we already own, Parc at Champion Forest. This made Azul a convenient and strategic add-on acquisition, which could be integrated seamlessly into our existing management infrastructure. Given Azul’s awkward size of 90 units, we were easily the best buyer for the asset since other sponsors would likely have higher payroll costs (as 90 units is an inefficient unit count).

o   Additionally, Azul was unique for us in that nearly the entirety of the equity for the investment came through 1031 exchanges. LSC has plenty of experience in bringing 1031 exchange investors into our deals. If you’re interested in learning more about investing with us via a 1031 exchange, please reach out to Craig McGrouther (craig@lscre.com).

·         Portfolio: Beckley (Houston, 1999 vintage, 210 units, October), Highland (Houston, 1994 vintage, 216 units, October), Meritage (Houston, 2008 vintage, 240 units, November)

o   The “Houston 3 Pack” totaled over $105M in price and 666 units, which represents our largest transaction ever. However, the 666 unit count most certainly seemed cursed because the closing ran into many delays.

o   This portfolio was acquired in partnership with the Houston Housing Authority in a structure which provided a 100% property tax exemption in exchange for income and rent restrictions at each property.

o   This acquisition endured seemingly endless delays due to the mayor of Houston blocking the transaction and then Texas state law being changed. Eventually, we were able to renegotiate terms with all parties (seller, mayor, lender, and housing authority) to finally close after ten hard months. Thank you very much to all investors involved in this deal that stuck by us through this difficult and uncertain escrow.

We experienced a severe setback in the middle of the year. Unfortunately, we decided to walk away from the closing of 1001 Ross, a 205-unit midrise asset in downtown Dallas built in 2003. We put 1001 Ross under contract in May when the 10-year US treasury yield was approximately 3.5%. This is significant because our debt interest rate was based on this index rate. While under contract, treasuries rose to approximately 4.2%. This is an extreme amount of volatility which changed the investment’s projected cash flow and returns.

It was painful, but even with all of the equity sitting in escrow ready to close, we made the decision to cancel the deal and return capital back to investors because we were unable to negotiate a price reduction with the seller and were not comfortable partnering with our investors on a deal we did not feel 100% comfortable with. Kent and I personally lost a large earnest money deposit but we felt it was well worth the cost to walk away rather than force a deal and regret it later.

Later in 2023, we decided to add on a new market for LSC, San Antonio. San Antonio is a great market which has strong and steady fundamentals for workforce housing as well as opportunities to employ affordable housing strategies. While not closed yet, we put our first San Antonio acquisition under contract in November and plan to close in February 2024.

One of our goals for 2023 was to start our first development project. In the end, we decided it was better to hold off on this initiative given the timing of the market and how busy we were with our existing strategy and operations. Development, while still a long-term goal, remains on hold for us.

Similarly, given the deterioration in capital markets, we decided not to perform any dispositions in 2023 and instead focused on securing our investments and ensuring our ability to protect our investors’ capital through the downturn.

Portfolio Management

Since inception, Lone Star Capital has acquired $514M in multifamily properties in Texas. The portfolio currently consists of 3,609 units across 17 properties. While our property operations have been generally positive, we have observed a slowdown in rent growth and an increase in vacancy across our portfolio. This is consistent with the broader market and is likely due to the general softening of the US economy.

The Federal Reserve raised interest rates at the fastest pace in history, resulting in a dramatic tightening of monetary policy. It is very likely that the Fed’s actions will result in a recession in 2024 (and not necessarily a “soft landing” in my opinion). With the high interest rates and the potential for weakened property performance in 2024, we have dedicated ourselves to preserving the strength of our portfolio and avoid any losses for our investors.

To that end, we successfully navigated the complex refinancing of six of our properties (Parc at Champion Forest, Broadstone Briar Forest, Timberwalk, 5 Oaks, Briar Court, and Madison at Bear Creek) in early 2023. These refinances were executed in partnership with the Houston Housing Authority which allowed for 100% property tax exemptions and the ability to refinance into long-term fixed-rate debt (some of the properties already had long-term fixed-rate debt but needed to be refinanced given the new legal structure). These refinancings totaled over $160M and took months of hard work to execute and years of learning and building relationships to get to the position of being able to partner with the Houston Housing Authority.

We felt that taking decisive action early was the best move to protect the performance of our investments. This proved to be correct as the Fed continued to raise rates through 2023 and long-term treasuries rose dramatically, making refinancing out of bridge loans virtually impossible. Heading into 2024, we only have one bridge loan in the portfolio, allowing us to focus on acquisitions rather than being bogged down with portfolio problems.

Three out of 17 properties have paused distributions and are the only properties with floating rate loans. Our properties are largely in stronger growth submarkets with limited new supply which will hopefully lead to outperformance against the general multifamily market. Given the relative health of our portfolio, we are excited by the opportunities coming in 2024 to take advantage of a dislocated market and attractive pricing due to decreased competition.

In line with our proactive nature, we have submitted applications for Low Income Housing Tax Credits (LIHTC) on The Landing at Pinewood Park (228 units in Lubbock, Texas) and Solano (262 units in Houston). Entering this program would restrict rents at the properties, provide property tax exemptions, and buyout our investors for a strong return via tax credit equity. These efforts speak to our ability to think creatively and create value for our investors above and beyond a typical business plan.

Team Growth and Development

We made significant strides towards building out our team in 2023:

·         We hired Hannah Wyatt, our Executive Assistant, at the end of the year who will help streamline operations in the New York office and support Dasha with our in-person events.

·         Josh Hoffman was promoted to Director of Asset Management. With Jason’s help, Josh oversees over half a billion in real estate projects and ensures our monthly updates and distributions as well as quarterly reports are timely, accurate, and insightful.

·         We brought on Jason Robbins to the asset management team here in New York who has done a great job of staying on top of our growing portfolio with Josh.

o   One of the goals for the year was to hire an Asset Management Analyst as well as a virtual assistant for the asset management team. We are pleased to share that both goals have been met with great satisfaction.

·         Craig McGrouther, our director of business development, began working with us part-time in 2022 and fully transitioned on January 1^st. Craig has been an invaluable asset on the investor relations side of the business as his infectious smile and sense of humor are far superior to mine.

·         Dasha Beardsley (my sister, not wife) was promoted to director of investor relations. She consistently receives high praise from our investors regarding her timeliness and attentiveness. The growth of Lone Star’s investor base is in good hands with Dasha.

·         Brad Oliver was promoted to Director of Acquisitions after exhibiting tremendous potential as our Acquisitions Analyst. While Brad is young, he has learned extremely quickly and has a true passion for deals and thinking creatively.

Towards the end of the year, we also launched our Fund of Funds Program. This is a robust and streamlined system for fund managers / capital raisers to partner with us. We make the process simple for our partners so they can raise more money with less effort. You can learn more about our FoF Program here: LSC FoF Program

Marketing and Engagement

We have published two books which have made a big impact on the commercial real estate community: The Definitive Guide to Underwriting Multifamily Acquisitions and Structuring and Raising Debt and Equity for Real Estate. To date, we have sold over 20,000 copies in total, which has brought us many great relationships.  

In 2023, we re-launched the Capital Spotlight podcast. The weekly show, hosted by Craig and me, discusses current events in commercial real estate, updates at Lone Star, and more. Aside from striving to provide the best industry insights, the podcast also aims to share more of our personal side. Craig also launched a segment called Fund Friday, where he interviews fund managers, capital raisers, and investors. You can check out the podcast on YouTube here: Capital Spotlight Podcast.

Our annual LSC Summit, hosted at the One World Trade Center, was a resounding success, drawing nearly 100 attendees from all over the country, including some of the very best of our network. We hosted insightful panels, keynotes, and curated networking. Topped off with a memorable steak dinner followed by scotch and cigars at the oldest cigar lounge in NYC, this event gives any conference a run for its money. You can watch the recap video here: LSC Summit 2023 Recap. We hope to see you there next year.

Looking Forward to 2024

As we look ahead, we are gearing up for another ambitious year. Our main goal for 2024 is to acquire $300M across DFW, Houston, and San Antonio. We believe 2024 will end up being a fantastic year to buy real estate as prices are going to continue to come down and interest rates may as well, resulting in the ability to lock in substantial positive leverage and capture significant appreciation as the cycle resets. While times may be uncertain and volatile, we believe it is time to get greedy.

In closing, I’d like to extend my deep gratitude to our investors who have chosen to partner with us out of the infinite investment options out there. Your support fuels our commitment to excellence and innovation. We look forward to continuing our journey together in 2024.

Warm regards,

Rob Beardsley, Kent Piotrkowski & The Lone Star Capital Team