Why one multifamily firm is switching from building to buying

With its latest move, Tricon is switching from development to acquisitions in the US sector.

Construction of new product

Canadian real estate firm Tricon Capital Group is expanding its residential real estate strategy into US multifamily rentals with the acquisition of the entire portfolio from Starlight’s US Multi-Family (No. 5) Core Fund.

The Starlight core-plus portfolio is Tricon’s first acquisition of fully built multifamily properties and it represents a pivot from the firm’s prior strategy in the space, which had focused on development.

Tricon’s previous activities in the sector centered around multifamily ground-up development with the intention to immediately sell the properties rather than hold them as long-term investments. However, the rising cost of land and construction, and an increase in the perceived riskiness of construction in the market environment, have made the existing multifamily strategy less attractive, according to Tricon chief executive and president Gary Berman.

Indeed, the National Association of Home Builders’ multifamily production index, which measures market conditions and confidence in multifamily production, fell seven points from the last quarter of 2018 to 40 during the first quarter of 2019. The index operates on a scale of 0-100, where any number lower than 50 demonstrates that more multifamily builders reported weaker market conditions than stronger conditions. The index score of 40 is the lowest point since the third quarter of 2010.

Ground-up development for multifamily is nearly always Class A product that charges higher rents, according to Los Angeles-based TruAmerica Multifamily founder and chief executive Bob Hart. The high rents must justify the costs of construction. However, Hart has observed some softening in rent and increasing costs in major US cities where materials and labor are both expensive. At the same time, new supply continues to come onto the market, which ramps up competition for builders and landlords, he added.

An oversupply of new Class A buildings in major cities can make existing multifamily buildings, which are more likely to be Class B product, more attractive from an overall return and cashflow perspective, Hart said. Class A rents are softening because the renters tend to be renters by choice. Meanwhile, Class B apartments tend to attract renters of necessity: younger, middle-class workers that rent apartments because they cannot afford to purchase a house or condominium. There is more opportunity to raise rents for Class B multifamily because supply remains limited and the demand for the product is more durable. As a result, Hart has noticed an increasing number of pension funds and insurance companies showing interest in buying Class B multifamily assets.

Tricon, best known for its single-family rental strategy, acquired the 23 Class B multifamily properties just as Starlight’s fund was coming to the end of its life. The life of the fund expired in October and the firm needed to sell the portfolio to provide fund investors with liquidity, Berman explained. The portfolio, which has been valued at around $1.4 billion, was purchased in a stock exchange rather than a cash transaction for tax purposes.

The portfolio is fully owned by Tricon now, but Berman said the properties could later be syndicated to interested institutional investors. For the time being, the firm intends to warehouse the portfolio, which includes garden-style apartments across the core to value-add risk spectrum. There will be a one-year transition period during which Starlight will continue to manage the portfolio. After a year, Tricon will take over the management and can start considering whether to include third-party investors in the equity ownership of the assets.