Castle Lanterra Properties illuminates how it stays ahead of the due diligence curve.
Who wouldn't enjoy the luxury of a head start? Two steps ahead of the nearest competitor offers a significant advantage in any competition, not unlike proactive due diligence in apartment investments.
By doing homework well in advance, many due diligence tasks that other buyers have yet to complete become more confirmatory—even before moving on a deal. This includes an in-depth study of operations, market fundamentals and tax analysis. Conducting due diligence in advance ensures Castle Lanterra Properties is ahead of the curve when the time to bid on a communnity arrives.
This due diligence process is consistent with best practices in the industry, and it is surprising how many companies do not follow them. Being thorough is critical. It requires walking through every unit, touring every building, executing complete engineering assessments and hiring third parties specifically to examine the plumbing, roofs and other building systems. Bids are solicited from local contractors for any repairs that may be required.
Armed with this information, aggressive bidding begins knowing there is a fully vetted capital budget.
Onsite teams are provided with state-of-the-art technology, such as iPads with apps to input data, that assist in expediting the due diligence process. Less time is spent both onsite and in collating the due diligence information, resulting in minimal time requirements for onsite management and a faster, more efficient process for the team.
Racing Toward the Finish Line
Conducting due diligence on the seller is a must for any investment opportunity. It is important to feel comfortable transacting with a seller, and to have confidence in their reputation for honesty and integrity in terms of execution. Every group Castle Lanterra Properties has been involved with to-date is a candidate for repeat business.
Another "must" is based on the concept of risk and reward. Any opportunity must have a good risk/reward profile. There is a willingness to take risks, but these risks must be quantified; moreover, there must be a willingness to mitigate any risks during due diligence. Because every deal has an opportunity cost, any risk taken on must be compensated with a commensurate expected return.
Due diligence, of course, includes analysis of the quality of the property and market, as both affect investment returns. A high quality property rarely overcomes the headwinds of a bad market and, likewise, even in a strong market a property with unexpected repair requirements can result in significant losses. The company's due diligence will not only focus on "what is," but also on "what may be," as markets can change. Properties that may appear solid on the surface can mask defects that must be addressed post-acquisition.
Adapting Approaches
Approaches to due diligence differ from market to market. For example, in stable markets, due diligence is focused more on the property level, whereas in growth markets, the focus is more on the market itself-understanding what's driving that growth and any potential for continued growth. To define and classify a market as growing, stable or otherwise, transaction volume is studied and the property trading prices are compiled. All demand drivers are correlated with rental growth, such as employment trends, population migration, income level, supply and demand and so on.
Hot markets. A "hot" market is one in which there is a tremendous amount of investment activity. Competition and buyers are typically willing to bid aggressively for the market exposure. The reasons for this are generally consistent: Strong income growth coupled with diversified job growth. The ability to successfully complete deals in this type of market is a result of several competitive advantages, including the willingness to put up a significant, non-refundable deposit very early in the process and deploying a large team quickly to begin outside due diligence. This approach allows the firm to get comfortable with the risk of a deal and offer terms that are more competitive than other buyers.
Lower-tier markets. At the same time, there has been a willingness to invest in lower-tier markets that provide attractive entry points and exhibit good value and growth drivers. One example is Tuscaloosa, Ala., where Castle Lanterra Properties acquired the 304-unit Heights at Skyland. In addition to a double-digit yield at inception, the company identified considerable value upside potential by repositioning the asset to a higher class and implementing institutional management procedures.
The recent multi-billion-dollar expansion of the Mercedes Benz plant there further strengthens Tuscaloosa's intermediate and long-term outlook. As such, the team believes there is a strong demand for a higher quality product. This is evidenced by the rent premiums the company has been able to achieve on renovated units.
Off-the-radar markets. In Bayonne, N.J., Castle Lanterra Properties acquired the 544-unit Harbor Pointe in October 2015. Rather than viewing Bayonne and Tuscaloosa as declining markets- which the team steers clear of-the company believes they are more accurately defined as markets "off the radar," and therefore less attractive to many large institutional investors.
Moving forward is contingent on being comfortable with the yield at the property and where the property is positioned within the market. If a market is stable and a property is underperforming, growth is still a strong possibility regardless of current market conditions. In cases like this, the team looks at the demand drivers "around" the market and whether or not they point to future growth. This was the approach taken in Bayonne.
Deal-Breakers
As for any absolute deal-breakers, as previously mentioned, one would be the reputation of the seller. If the seller is solid and reliable, most other issues are solvable. However, if a physical problem is uncovered within the asset or new information is inconsistent with what was initially provided, this may affect the value of the property. In this case, it becomes a question of determining the right price.
Another significant issue of concern is a clear title. Castle Lanterra Properties (nor any management company) does not want to be involved in lawsuits over title issues.
Based on the firm's experience, risk tolerance related to due diligence is always an issue. Because Castle Lanterra Properties is an extension of a large family office, there is a mindset and ability to be more flexible and opportunistic-resulting in a higher risk tolerance than that of institutional players.
Where many groups are afraid of exposure to certain risk, the team at Castle Lanterra Properties is not. The risk needs to be understood, thereby allowing the company to find solutions that help mitigate it. The bottom line is to be as thorough as possible during due diligence to quantify and limit risks. The team strives to do this quickly and efficiently, allowing the company to proceed and transact in a timely and decisive manner. n
Elie Rieder is Founder and CEO for Castle Lanterra Properties. Contributing to this article: Castle Lanterra's Benjamin Loney, Head of Acquisitions; Austin Alexander, Managing Director.