How much capital should a sponsor invest in a deal? It’s a fair question, and one that investors may ask to gauge how vested the sponsor is in a deal.   Typically, the prevailing thinking is that when sponsors invest their own capital, they have “skin in the game,” and, therefore, are more incentivized to ensure the deal performs. While there’s some truth to that idea, there are also legitimate reasons why a sponsor may not invest (or not invest much) in a deal.   The primary reason is liquidity.   Liquidity means cash on-hand. Liquidity is important to sponsors for several reasons.   First, sponsors need significant liquidity to secure loans. Typically, lenders require a sponsor to have 10% of the total loan amount in liquid investments following the loan closing. For example, on a $20 million loan, the sponsor must have $2 million in liquid assets to meet loan criteria.   Second, sponsors need liquidity in case of emergencies. What if unforeseen issues occur and the deal needs more capital? A well-capitalized sponsor is able to address these issues without a capital call to investors.   Third, sponsors need liquidity for deposits on new deals. This is known as EMD money. In today’s market, the competition for new investment opportunities is fierce. Sponsors need to quickly provide EMD money, typically 1%-2% of the purchase price, to lock-in the opportunity. On-hand cash provides the flexibility to ensure the good deals aren’t missed.   So, it’s always fair to ask sponsors if they are investing in a deal. Many do. But many don’t – for good reasons.

When making any investment, those investing expect the value of the investment to increase over time. What’s unique about apartment investing (compared to say, single-family rentals or homes) is that investors can deploy strategies to force an increase in property value by increasing Net Operating Income (NOI). This is called “forced appreciation” and is very different than “market appreciation.” Here’s an example to illustrate the difference: In 2020, a group of investors purchased a 100-unit apartment building for $8.3 million. At the time of purchase, the property’s NOI (revenue minus expenses) was $500,000. The NOI divided by the purchase price reflected a 6% cap rate.   Market Appreciation Scenario After two years, the property is unchanged. Rents and expenses are the same, so NOI is also the same. However, investor sentiment shifted upward. As more and more investors chase apartment deals, pricing is rising (and cap rates are falling). Today, a broker believes the property would sell for a 5% cap rate (compared to 6% at purchase), which means the property is valued at $10 million (with $500,000 NOI). Market appreciation increased the value of the property by $1.7 million (and the investors did nothing). Market sentiment, not property fundamentals, drove the price higher (and cap rates lower).   Forced Appreciation Scenario Instead of maintaining status quo for two years, the ownership group invested $200,000 to improve curb appeal and security and replace the underperforming management team. As a result, rental rates increased by $150/unit/month – and, therefore, so did the NOI. Here’s the math: 100 units X $150/month X 12 months = $180,000 increase in NOI. The new NOI is now $680,000. Assuming a 6% cap rate (market sentiment unchanged since purchase), the value of the property is now $11.3 million (with $680,000 NOI).   Forced appreciation increased the value by $3 million (less $200,000 in investment) for a net increase of $2.8 million. By increasing the NOI, the investors proactively (or forcibly) increased the property value.   Market + Forced Appreciation Scenario (the best of both worlds) Now, consider if market sentiment increased (and cap rates dropped to 5%). The value of the property climbs to $13.6 million. A combination of forced appreciation and market appreciation increased the value by $5.3 million. Call that a “win-win”! As investors, it’s important to be conservative and always assume that market sentiment will not increase (i.e. cap rates will be higher in the future). Using strategies to increase NOI and forcibly increase property value, increases the chance of a successful investment via forced appreciation, while also protecting downside risk if market appreciation does not occur.

Why invest in aging workforce housing when common practice today leans towards razing them to make room for Class A developments? Is managing the challenges of these types of properties worth the risk? The truth is, it may not be right for everyone.With the right partner, however, the returns can be unbelievably rewarding.   What’s the secret recipe for transforming Class B and C properties to benefit the community, its residents – and your bottom line? Entering into each property with a genuine interest and desire to do what is right and what matters- for the residents that call this property home. The age-old philosophy, “by doing good you will do well,” still holds true today.   Yet, navigating some of the more pervasive challenges common with these types of properties is no small feat.Our team at Crown Bay Grouphas exclusively focused on investing in, improving and managing workforce housing properties throughout the Southeast for the benefit of the community – and investors – for more than 15 years. Our goals and our gains are two-fold: residents experience heartfelt gratitude for a higher standard of living, while investors continue to reap healthy returns on their investments.   Market Demand   First, let’s talk about the overwhelming demand for this type of asset. Essentially all new development over the last decade has been Class A luxury – yet the Class A market makes up only 20 percent of the total rental market. New construction of affordable, marketrate units is just not financially feasibletoday. Consequently, no meaningful workforce supply has been added this past decade. In fact, despite the pervasive need for workforce housing, the supply has decreased with older units being demolished to make room for Class A construction.   Government subsidies help fund the development of some types of low-income housing with the assistance of Low Income Housing Tax Credits (LIHTC). Oftentimes, however, essential workers earn too much to qualify to rent those properties – while still not being able to afford Class A property rentals. Market rate workforce housing is critical to ensuring access to housing for some of our most essential workers in construction, healthcare, transportation, government, education, nursingand public safety.   Unlike government-subsidized developments, market rate workforce housing receives no construction subsidies and is not subject to the same qualifying factors for renters. Market rate workforce housing generally includes Class B and C properties that are comprised of mostly older communities with limited amenities and basic interior finishes. These types of properties tendto be located in suburban areas, with low-rise or garden style construction and rentsthat are affordable for lower-middle and middle-income families.   Navigating Challenges: It’s Not Just About Upgrading Units   The critical need for workforce housing deserves to be met by safe, well-managed, well-maintained options. Delinquencies, crime, disrepair and poor management are common hurdles to overcome in creating desirable workforce housing communities.   A well-developed business plan – with an appropriate allocation of funding for property improvements – is imperative to successfully navigating the most commonchallenges of Class B and C properties. An in-house property management team further ensuresthe goals for improving the standard of living for the community are stringently pursued. This dedicated resource ensures the success of the community – and ultimately the investment.   Critical areas for improvement this team enforces often include:   • Customer service: A leak, a broken stove or refrigerator, or having your heat stop working in the middle of winter can be a real disaster. Slowrepairservice is often the number one complaint by tenants. By adopting a strict 24-hour response policy, our in-house management team is motivated to ensure repairs are quickly addressed and tenant needs are well managed.   • Value: Sometimes it’s the little things that matter most. Updated playgrounds, dedicated BBQ areas, repaired pot holes, and returningswimming pools to service are just a few of the first steps we take to increase community satisfaction – and value – to properties. The net result? A higher standardof living begets a higher standard of behavior. Modest updates contribute to significant improvements in living environment. Tenants feel valued and work harder to pay rent on time, turnover is reduced – and we see an uptick in renter referrals.   • Safety first: From car break-ins to gang activity, safety infractions erode goodwill and a sense of security in the community. Improving lighting and ensuring entry gates function properly are helpful remedies, as is taking a zero tolerance approach to problematic tenants. Establishing partnerships with local authorities and hiring off-duty officers to patrol propertiessignificantly curbs or eradicates criminal activity.   Some wonder – how did eviction moratoriums impact the bottom line on such properties during the pandemic? Whereas many Class B and C properties experienced a great deal of delinquency in rent payments, well-maintained properties with management that was committed to its residents experiencedlittle variation with monthly collections consistent with pre-COVID conditions.   In fact, some of our property management teams went the extra mile to assisttenantsin findingnonprofits to provide rent subsidies, completing forms to receive stimulus funds, and identifying ways to stay current on their rent.   Financial Benefit   Investments in these types of properties can earn significantly above average ROI – not only through passive, quarterly distributions, but also through end-of-cycle returns upon the sale of the property.By improving the property and elevating the caliber of renters, and with proper care and efficient management, above averagereturns are possible.   There is an art to making workforce housing a lucrative investment. The secret recipe?A sincere commitment to doing good by these communities, coupled with a well-funded development plan. Together, these can generate tremendous rewards to both the living environment and overall wellbeing of the residents – as well asinvestors’ portfolios.   Steve Firestone is Founder and Principal of Crown Bay Group, a real estate investment company passionate about multifamily workforce housing. Firestone is dedicated to creating a superior environment for residents and above-average returns for investing partners.

Managing large multifamily properties is difficult. An onsite team can make or break a community – and, in our case, an investment.   When Crown Bay first started, our management strategy (and really only option!) tapped a third-party property management company to run day-to-day operations. However, as business grew and experience abound, we learned.   We learned the importance of in-house property management, a revelation that played a critical role in our investing success.   We went to work.   We created a separate subsidiary. We hired an Director of Operations with 30+ years of property management experience to run it. Crown Bay Management only manages and operates our properties.   Why is this the right move for us?   1. Alignment of Interests Our property management team is incentivized to operate our properties as efficiently and financially aggressive as possible. If the property performs well, the team is rewarded.   For typical third-party management companies, their fees increase only with the addition of more management assignments regardless of how properties are performing.   2. More control Crown Bay Management is laser focused on only properties owned by Crown Bay Group. A third-party management company reports to several owners, oftentimes giving most attention to the largest landlord.   For us, having more control and oversight of management and operations has created a stronger alignment of interests that has also led to superior property performance. Not only does this benefit residents – but also our investors as net operating income inevitably climbs and property values increase.   And we sleep better with this peace of mind.

Our investment strategy focuses primarily on multifamily workforce housing. What is that, and why is it our strategy?   What? Multifamily workforce housing generally includes Class B and C properties, which are mostly older communities with limited amenities and basic interior finishes. They tend to be located in suburban areas and are often low-rise or garden style construction. The rents are affordable to lower-middle and middle-income families with jobs in fields like construction, healthcare, retail, transportation, government, office adminis­tration, hospitality, education, nursing, and the police force. Note these communities are not government-subsidized housing. Renters in these communities are often renters by necessity instead of by choice.   Why? Let’s take a closer look at the fundamentals.   Demand   There is demand across nearly the entire renter spectrum, and the demand does not appear to be letting up any time soon. While demand for workforce housing tends to come from households who make 60% to 100% of the Area Median Income (AMI), some households with higher incomes may decide to live in workforce housing due to proximity to a job, debt, saving for a home, etc. Some low-income households (<60% AMI) on vouchers or government subsidies also live in market rate workforce housing due to the shortage of low-income housing.   Most of these renter households tend to be “renters by necessity.” They may have aspirations of owning a home, but may not have the financial means. For the past decade, housing prices have risen faster than median household incomes, putting home ownership out of reach for most. It is becoming increasingly difficult, especially in large metros, for workforce housing renters to purchase a home near the area in which they work which also suits their family’s needs. Moreover, fewer starter homes are being built due rising to land costs and construction costs. Multifamily rents have risen too, albeit not as fast as single-family home prices, making it even more difficult to save for a down payment. This cycle is keeping households in the renter pool for longer.   Supply   Land, labor, materials, and regulation are driving up the cost of new construction. Rising costs are not new, but the topic is carrying more weight because of the rapid increase. It took almost 60 years, from 1940 to 1998, for the national RSMeans Construction Cost Index to climb from 0 to 100, but only 20 more years to climb from 100 to 200, doubling the index’s measure in one-fifth of the time. At no other point in America’s history have construction costs accelerated so aggressively (CBRE Research, Southeast Construction Costs, 2019).   Rising construction costs means higher rents are required to justify new construction. In other words, for real estate developers to turn a profit on a multifamily development, they must focus their attention on the upper-end of the rental market. For the past decade, essentially all new development has been Class A luxury. For context, the Class A market makes up only 20% of the total rental market. Building affordable market-rate units is just not financial feasible, and likely won’t be for some time. For this reason, there’s been virtually no new meaningful workforce supply added this past decade. In fact, not only has the total workforce housing supply not increased — it’s actually decreased, with older units being torn down to make room for Class A construction.     As shown above, in metro Atlanta, the total number of Class A units increased by 84% from 2000 to 2019 while the total number of Class B/C units decreased by 3%. Every year some of the oldest product is leveled to make way for new Class A development or other higher and better uses of the land. Importantly, though, occupancy rates for Class B/C surpassed Class A, as shown below.   Conclusion   Our strategy makes sense because strong workforce housing fundamentals — strong and growing demand, coupled with steady to declining supply — are driving rent growth and, in turn, cash flow to investors.   Few market rate solutions exist to add new supply. Legislators are focused on housing solutions for the low-income households (<60% of AMI), while developers and institutional investors are focused on the only segment whose rents can justify their construction costs: the high-end renters. Opportunities abound in the middle, and we can capitalize there.   Investing in workforce housing isn’t without risk, of course. Investors must consider housing affordability (i.e., are renters able to absorb rent increases), resident credit risk, rent control policies and other widespread public programs that may improve the supply/demand imbalance. Despite the risks, given the fundamentals described above, we feel confident that workforce housing is and will continue to be an attractive strategy for Acorn Property Group and our investors.   Source: CBRE, The Case for Workforce Housing – A Market Perspective, November 2018 Source: CBRE, Southeast Construction Costs, 2019/2020 Edition

When talking about multifamily properties, there’s often a lot of jargon used. As an investor, it will be helpful to understand the general characteristics of the three multifamily product types, the four main investment strategies, and the three classes of multifamily real estate. While none of these definitions is absolute, they should help frame your understanding of an investment opportunity.   Product Types   Multifamily product is typically categorized as garden-style/low rise, mid-rise, and high-rise.                 1.Garden/Low Rise 2-4 story walk up Oftentimes repeated floor plans Constructed of wood frame on top of concrete slab Mostly suburban locations Low density Surface parking                 2.Mid-Rise 5-8 stories with elevators and central halls for apartment access on each floor Constructed of steel frame or reinforced concrete Mostly urban locations                 3.High-Rise Above 8 stories Constructed of steel frame or reinforced concrete Mostly urban locations High density Parking is likely at grade but below the first floor of the building (which may sit on a podium), in a full-fledged parking structure, or in a below-grade parking garage   Investment Strategies   Real estate investment opportunities vary across the risk/return spectrum, but generally fall into four categories, from lowest perceived risk to highest risk: Core, Core Plus, Value-Add, and Opportunistic. For these strategies, think of risk this way: it’s the possibility that future investment performance may deviate over time in a manner that is not entirely predictable at the time of the investment.   1.Core A Core strategy has the lowest perceived risk/return profile. Core investors typically take a longer-term view of commercial real estate investing, use low leverage (30% to 50%), and value predictable cash flow. Income makes up a majority of the total return. Core multifamily is typically newer, high quality, stabilized assets in primary markets which trade at the lowest cap rates. The performance of Core is most influenced by market cycle timing and market fundamentals.   2.Core-Plus A Core-Plus strategy has a moderate risk/return profile. Core-Plus investors use moderate leverage (55% to 70%), and they are drawn to the stable cash flow and value add component. An example of Core-Plus multifamily is a stabilized apartment community with below market rents in need of light renovations.     3. Value-Add A Value-Add strategy has a somewhat more elevated risk/return profile than Core-Plus. Value-Add investors use 65% to 80% leverage, and they acquire under-performing assets with physical and/or operational deficiencies. Most value-add assets tend to be older. Value-add business plans usually involve curing deferred maintenance, upgrading the property and tenant base, improving management, and raising rents. These investments typically offer low initial yields while the property is being re-positioned, but once the business plan is executed, the increase in cash flow and appreciation can be significant.   4. Opportunistic An Opportunistic strategy has the highest risk/return profile. Investors who acquire opportunistic investments tend to use moderate to high leverage. Examples includes ground-up development or a very comprehensive repositioning. These investments don’t offer yield in the early years, but once the plan is executed, offer investors significant yield and appreciation. These projects are typically the most complicated and require daily oversight.   Classes There are three classes of real estate: Classes A, B and C. I’ve included a fourth (Class D), as you’ll sometimes hear it discussed in the industry.   Class A New construction or very high quality renovation Prime location High occupancy level High end finishes and amenities Attracts Core investors Class B 1980s to 2005 vintage Average to good location Stabilized occupancy level More limited amenities and basic unit finishes and fixtures compared to Class A Minor to no deferred maintenance Attracts Core-Plus and Value-Add investors Class C 1970s to early 1980s vintage Average to good location Outdated or original finishes and fixtures Some deferred maintenance Attracts Core-Plus, Value-Add, and Opportunistic investors Class D 1970s or earlier Declining growth area Outdated or original finishes and fixtures in need of replacement Significant deferred maintenance Management issues Most investors usually pass these opportunities

Why Adding Commercial Real Estate to Your Portfolio is Good (and Multifamily is Better)   “Ninety percent of all millionaires become so through owning real estate. More money has been made in real estate than in all industrial investments combined. The wise young man or wage earner of today invests his money in real estate.” — Andrew Carnegie, billionaire industrialist     Many people think of investing as selecting a basket of stocks and bonds and hoping for the best. The reality is that investment portfolios that focus on just stocks and bonds force investors to compromise — either by sacrificing return for lower volatility or enhancing return at the expense of higher risk. Here are some reasons we believe investing passively in real estate is good (and multifamily is better!).   Diversification   Commercial real estate, which includes multifamily, has almost no correlation to stocks and a slightly negative correlation to bonds. That means the asset classes don’t move together which is the key to diversification.   In 17 of the 20 worst quarters for a 60% stock / 40% bond portfolio, from 1978 to 2012, private real estate (measured by NCREIF index) had positive returns. Why? Commercial real estate returns are largely driven by different economic risk factors than stocks and bonds.   Most Resilient Property Type to Recessions   Multifamily is the most resilient property type to cyclical downturns, according to CBRE Research, as measured by rent changes during and after the past two recessions (2001 and 2008-2009). They found that multifamily rents were in a negative growth trend for a shorter period of time, recovered quicker, and far surpassed the previous highs.   Historical performance isn’t always indicative of future performance, and each recession is different. The amount of oversupply certainly impacts recovery time. It’s reasonable to assume during and shortly after a recession, multifamily rents will likely decline to some degree, but that decline is usually short-lived and followed by a strong rebound and growth beyond the previous peak rents.   Cash Flow   In multifamily, after tenants pay rent and property expenses and the mortgage are paid, the remaining cash flow is distributed to investors, usually quarterly. Bonds and dividend yielding stocks provide some yield but it’s low. It’s common in a real estate syndication for passive investors to earn a preferred rate of return in the 6-8% range, plus a majority share of the profits.   Tax Benefits   For tax purposes, real estate owners can deduct mortgage interest and depreciation from property’s Net Operating Income (NOI). This benefit can be passed on to all investors in a real estate syndication. The result is the investor likely won’t pay any taxes on cash distributions until the property is sold, at which point they will pay a lower blended tax rate than their ordinary income tax rate. It’s important to note that an investment in a REIT, which is a real estate flavored stock, does not provide this tax benefit.   Shorter (and Staggered) Leases Allows Flexibility   Multifamily leases are typically 1 year versus 5+ years for retail, office, and industrial. Short-term leases and staggered lease expiration dates means consistent volume of leasing activity, both new leases and renewals, which often leads to higher average occupancy rates, and steadier cash flow. The shorter-term lease structure gives the owner the advantage of adjusting rents upward more quickly in a tight market or after making value-add improvements to the property.   Diversified Credit Risk   Multifamily properties have many leases, and each lease only represents a small portion of the overall income. The tenant default risk is therefore spread out across many tenants. This gives multifamily a distinct advantage over office, industrial and retail assets, each with much fewer tenants.   Lower Tenant Turnover Costs   Apartment unit turnover requires only minimal investment to get the unit physically “rent ready.” Additionally, downtime between leases can be days or weeks. By contrast, there are significant costs associated with new leases and renewals in office, industrial, and retail (e.g., tenant improvement allowance and leasing commissions). Downtime between a move-in and move-out in those asset classes can be months (or longer!). During that time there is no revenue, which significantly impacts investor cash flow.   Favorable Loan Terms   Loan terms and interest rates are more favorable for multifamily than other property types due to lender comfort with the asset class and its lower volatility. In addition to the banks, life insurance companies, and CMBS lenders who provide debt, the multifamily sector also benefits from the government-backed lending programs (GSEs) not available to other property types. Fannie Mae, Freddie Mac, and the FHA are major sources of non-recourse debt capital and liquidity. The GSEs have an especially strong appetite for lending on properties that are affordable to lower and middle-income families.   Basic Need of Shelter   After the grocery bill, the next thing people pay is rent. Investing in multifamily communities is investing in the basic need of shelter.   Sources: CBRE Research, U.S. Multifamily Research Brief, Multifamily Most Resilient Property Sector to Recessions   Sources: CBRE, U.S. MULTIFAMILY HOUSING: A Primer for Offshore Investors