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Lone Star Capital 2021 Annual Letter

April 12, 2022

Lone Star Capital ended 2021 with approximately $96MM in acquisition volume (four transactions) and $21MM in dispositions (1 transaction). Our 2021 acquisition target was $100MM and overall, we are satisfied with the results of our 2021 efforts as well as our investment performance.

A major goal for 2021 was for Lone Star to launch its in-house property management company, Radiance Living. We successfully launched Radiance Living in August and, due to our strong preparation, the transition of our portfolio to Radiance was seamless. We are extremely pleased by all the efforts contributed to this project, including Radiance’s VP of Operations, Aaron Pitre. Aaron’s 15 years of property management experience coupled with his nearly four-year tenure with Lone Star allowed us to move quickly to build a full-service property management business.

Radiance Living, based in Houston, is Lone Star’s wholly owned property management arm and will not seek to provide 3rd party management to other multifamily owners. Instead, our team will remain focused on Lone Star’s portfolio to ensure the success of our investments for our investors. In 2022, we plan to build out the construction side of Radiance Living’s capabilities and bring many construction projects in-house, which will further save costs and allow us to more effectively underwrite/budget capital expenditures in our business plans as well as complete work more quickly.

Acquisition Highlights

Our first highlight of 2021 was the start of our partnering with Phase One Capital, a NYC-based broker-dealer led by Desmoine West and Dave Thompson. My partner, Kent Piotrkowski, and myself have had a relationship with Dave for over five years prior to finally working together in 2021. We are extremely grateful for our partnership with Phase One and enjoyed working with them on three acquisitions throughout 2021. We look forward to working on many more opportunities together in 2022.

One of our favorite deals of 2021 was Solano Apartments, a 262-unit multifamily property in Houston, Texas. Lone Star acquired Solano through an off-market process and our team worked closely with the seller and broker to win the bid at a fair price and close the deal quickly. We are enthusiastic about the going-in basis (on both a near-5% cap rate and $97,000 price/unit basis). We acquired the property with a Freddie Mac 10-year floating rate loan. This financing product fits our strategy well since it provides modest leverage, flexible pre-payment penalty so we can sell or refinance when most opportune and is nearly the cheapest cost of financing available anywhere in the multifamily market. Lastly, the 10-year loan term drastically reduces maturity risk. Solano’s business plan includes interior renovations, adding washers/dryers, and amenitizing the community with a luxury outdoor kitchen, resident club house, dog park, and business facilities.

Another important facet of the Solano acquisition is the fact that we facilitated multiple 1031 exchanges for investors. Many billions of 1031 exchange dollars are in search of a home every year and we are glad we can provide a complete solution where we take delicate care of the transaction and fully manage the investment. If you have upcoming 1031 exchange needs, please reach out to us to discuss how we can work together on our next deal.

Shortly after Solano, Lone Star acquired Hollister Apartments in Houston. Again, we facilitated a 1031 exchange and navigated complicated legal matters with the seller, lender, and partners to close the transaction. The strategy behind Hollister mirrors Solano’s in that we acquired quality real estate in a growing submarket at a near 5% cap rate with further upside to produce double digit cash flows and the opportunity to achieve mid-teens returns.

Hollister was financed using the same Freddie Mac 10-year floating rate facility for the reasons outlined above. We often discuss floating rate versus fixed rate debt options with our investors. Our primary reason for using floating rate debt, however, is not because we have a particular view about interest rates, but rather it is so that we have only a 1% prepayment penalty, rather than yield maintenance (a very expensive form of prepayment prevalent in fixed rate financing). This notwithstanding, our view regarding interest rates is that short term rates (Fed Funds, SOFR, LIBOR) shall remain acceptably low (less than 2%) for the next three years. Floating rate debt is typically tied to SOFR or LIBOR, and we are comfortable with such exposure. The Fed has its hands full in first attempting to reduce or remove monetary stimulation (quantitative easing, bond purchases) and then they will have an even bigger uphill battle of trying to raise rates from 0% to 2%. The Fed has proven itself to be at the behest of the stock market and we can certainly count on numerous “tantrums” which will drag out the Fed’s desired timeline of raising rates.

Our last acquisition of 2021 was Encore on the Bay, a 296-unit property beautifully situated on the water in Houston. Encore is our largest acquisition to date ($38MM total capitalization), but I am confident that we will easily exceed this deal size in 2022. This is a testament of our growing track record and relationships and our ability to perform. 2022, we are ready.

Dispositions

Lone Star sold its first acquisition, Cranbrook Forest, for $22,100,000 on December 31, 2021. We acquired the property for $15,400,000 on July 18, 2018 and dealt with initial management challenges, high vacancy, and the pandemic, which disrupted the original sale process. The disposition resulted in a net IRR for investors of 16%+. To read the full case study about this investment, click here.

Preferred Equity

Both of our short-term preferred equity investment, which were made opportunistically in 2020 in response to the changing credit dynamics due to COVID-19, were paid off in 2021, resulting in two successful full-cycle investments. To learn more about these unique deals, read the case study here.

Team

In May 2021, Lone Star hired Josh Hoffman as our Asset Manager. Josh has been an incredible addition to the team and has plugged himself into many critical processes, becoming a key player. Additionally, Josh is working on a few important projects to push Lone Star forward, including the build-out of a data visualization dashboard for our property management company.

Marketing

My book, The Definitive Guide to Underwriting Multifamily Acquisitions, has been sold nearly 5,000 times since launched in May 2020. I’ve received countless testimonials about the insights in this book. Even highly experienced and sophisticated partners have acknowledged the value of the book as a way to understand our process better. Certainly, the value we receive from this book through relationships is many multiples of the tiny profits we receive in book sales.

In 2021, we launched multiple webinar series including our quarterly Deal Flow Analysis and Portfolio Analysis webinars. Both of these webinars have forced us to be more data driven internally as well as provide extremely valuable insights to our partners and potential investors. In our Deal Flow Analysis webinars, hosted by our Director of Acquisitions, Charles Waldron, and me, we share insights related to our robust and detailed deal flow. We can confidently show our real-time knowledge of the numbers. Therefore, when we are excited about a deal, you should be too. Our Portfolio Analysis webinars, hosted by me and our Asset Manager, Josh Hoffman, share operational data and insights across our portfolio. You can watch recordings of these webinars on our YouTube channel here.

Our attendance of conferences in 2021 was still less than pre-COVID and we hope to resume more regular conference attendance. However, we did host our own event, The Advanced Real Estate Private Equity Summit in New York City in October. We were able to invite many of our close relationships as speakers as well as meet new people. We were delighted by the turnout as new relationships were formed and existing ones strengthened. The second day of the event featured a half-day negotiation workshop taught by Professor Stuart Diamond from Wharton. We will be improving upon the successes of our first event by hosting another event, LSC NY Summit in September 2022 in New York City. Stay tuned for more information about this great event. Because spots are limited, if you are interested in being a sponsor or getting a VIP ticket, please reach out to me now.

Looking Forward

In 2021, we aggressively pursued our goals and, while we both hit and missed a few, we are grateful for the outcomes and for the opportunity to look forward to making 2022 even better. Our goals for 2022 include $250MM of acquisition volume in Texas with two or more acquisitions in Dallas-Fort Worth, a new market for Lone Star Capital but one in which our team has experience.