Q3 2024 Commentary: Reflections on Self-Storage, MHC, and Multifamily
For the first time, we’re offering a glimpse into our Q3 2024 Commentary. Traditionally, this has been shared exclusively with our investors, but we wanted to keep our wider community informed about the insights that drive our decisions. We hope you enjoy it!
It’s Thanksgiving weekend 2024, and I’m enjoying some downtime at my son’s Blue Ridge Mountain cabin. It’s given me a lot of time to reflect on what I am grateful for.
I’m deeply thankful for the opportunity to be in this role, to work with Ben and an amazing team of investment professionals, and to partner with 22 handpicked operators to steward your hard-earned money.
And I’m deeply grateful to all of our investors for their support and confidence in Wellings. It’s not a small thing to hand over $100,000 or more to someone you have likely never met in person, trusting them to help you protect and grow it. We never take that lightly.
We’ve obviously had big news since last quarter, in the form of two rate cuts and the initiation of Trump 2.0. Though we don’t have a crystal ball, it’s likely that both have the potential to benefit commercial real estate investors in the coming years. Much commentary on these topics is available, so I won’t comment on these topics here.
Today, I’m going to mix things up a bit. I’ve been reading the Howard Marks classic book Mastering the Market Cycle: Getting the Odds on Your Side again, and I’ll attempt to apply a few of his principles to self-storage, manufactured housing communities, and multifamily. Then, I’ll comment on how Wellings Capital’s strategy aligns with Marks’ insights.
Reflections on Self-Storage
“Success carries within itself the seeds of failure, and failure the seeds of success.”
This is one of my favorite Howard Marks quotes. We saw this in the euphoria of the last self-storage market cycle (in every cycle, in fact).
Self-storage took off in the past decade. Then COVID hit, and demand exploded further. (I even know a guy who wrote a book about it!)
It seems like a storage facility popped up on every corner. Unsurprisingly, the national self-storage industry has experienced about three straight years of declining rates and occupancy. The seeds of the current “failure” were planted in the soil of self-storage success.
You might be asking…aren’t you concerned since Wellings Capital invests in self-storage?
Not at all.
Everything is cyclical and we’re long-term holders. Additionally, our self-storage investments are primarily in secondary and tertiary markets with managers that employ value-added strategies and where the REITs (data above) haven’t overbuilt.
We believe longer hold times typically benefit investors. Shorter holds can be speculative. Long-term holds allow time for inflation to increase rents and for operational adjustments to correct for the unexpected so that intrinsic value can be realized. And long-term holds better position us for a successful disposition.
Wellings Capital set the term for our five income funds at ten years. While this longer hold period doesn’t guarantee success, we believe that it decreases risk and increases the chance of a successful investment (especially given recent inflation).
Howard Marks spoke to the issue of long-term investing: “Trading is putting money out based on what you think is going to happen tomorrow or in the next hour. We don’t do that – we invest. If you make investments for the long term, you don’t have to trade every day.” (Source: https://shorturl.at/zHLA6)
This also points to the importance of buying the right the right assets at the right price.
Marks stated that, “All other things being equal, the price of an asset is the principal determinant of its riskiness.” And “No asset is so good that it can’t be bid up to the point where it’s overpriced and thus dangerous. And few assets are so bad that they can’t become underpriced and thus safe (not to mention potentially lucrative).”
Many of our best-performing assets are Class B and C value-add self-storage facilities in small towns like Ishpeming, Michigan, and Beeville, Texas. One storage facility in our Wellings Real Estate Income Fund required the eviction of homeless tenants after acquisition. Rents and appraised asset value were more than doubled a short time later. Ask us for our full-cycle deal track record for examples of successful self-storage dispositions in 2022 to 2024.
You almost never get results like this by investing in a sleek new multi-story Class A storage facility. Couple that with a long-term hold and you’ve got good reasons to sleep well at night!
Reflections on Manufactured Housing Communities
Speaking of profiting from unfavored assets, consider our investments in manufactured housing communities (also known as mobile home parks or mobile home communities). I spoke woman who said people consistently looked down their noses at her because she owned and operated mobile home parks.
Meanwhile, starting in the 1980s, billionaire Sam Zell was quietly amassing over 150,000 mobile home park lots nationwide. Zell was widely considered America’s most successful real estate investor.
Consider the results of manufactured housing communities according to Green Street. Did you notice the downturn in 2008-2011? No, you didn’t.
As the housing shortage continues worsening, manufactured housing communities help solve the very real affordable housing crisis in America. Ironically, obtaining zoning and permits to build manufactured home communities is exceedingly difficulty because many towns say NIMBY “not in my back yard.” Check out this chart showing the cost of home ownership vs. renting.
Reflections on Multifamily
This home mortgage-to-rent disparity is also benefiting multifamily, whose medium and long-term prospects are undeniable. According to a Zillow report, the nation is still short 4.5 million homes, which will lead to further increases in home prices. Zillow expects it will take many years for supply to catch up to demand (https://www.zillow.com/research/affordability-housing-shortage-34153/).
So, what could go wrong in multifamily? A better question might be, what has gone wrong in multifamily?
Many multifamily syndicators seemed all too willing to overpay for multifamily and over-leverage with risky floating-rate debt from 2018-2022, apparently believing “trees (aka rents) would really grow to the sky” (another Marksism).
Honestly, it seemed they were right for quite a while. Some made a lot of money, and the euphoria reached a fever pitch. Until the music stopped.
Marks said, “Usually the crowd’s irrational euphoria will continue to take prices higher for a while – possibly a long while… The contrarian will appear wrong, and the fact that his error comes from acting differently from most people will make him look like nothing but an oddball loser.”
Yet the mistakes of this past cycle weren’t limited to overpaying and risky debt. Geography, supply, timing, and strategy also played a role. Check out rent growth in the best and worst-performing markets so far in 2024.
I was struck by the fact that every top performer was in the Northern or Central US…while every worst performer was in the South, mostly in “Southern Smile” states that so many have favored over the past few years (Texas cities highlighted to make a point!). This is another case of the seeds of failure being planted in the soil of success.
But ground-up development accentuates the risk. Why? Because of the time delay between the planning and completion of commercial real estate projects.
Marks speaks directly to this in analyzing the commercial real estate cycle in his memo Ditto. He states: “The period between the start of planning to the opening of a building is often long enough for the economy to transition from boom to bust. Projects started in good times often open in bad, meaning their space adds to vacancies, putting downward pressure on rents and sale prices. Unfilled space hangs over the market.”
Though we admire the courage of multifamily developers and applaud their well-earned profits, Wellings Capital has generally avoided development projects in favor of well-acquired value-add deals.
We’ve also enjoyed lower risk and higher certainty of return in multifamily by investing in tax-abated and preferred equity projects. This has created a margin of safety that we believe will benefit our investors in the end.
Because as we stated in the last quarterly update, we’re not seeking the best returns. We’re seeking the best risk-adjusted returns.
I can’t resist one more Howard Marks quote from Mastering the Market Cycle – Getting the Odds on Your Side:
“If I could ask only one question regarding each investment I had under consideration, it would be this: how much optimism is factored into the price? Skepticism calls for pessimism when optimism is excessive, and it also calls for optimism when pessimism is excessive.”
If you have any questions, please contact us or use this link to schedule a call with us.
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