Investing in LMI Communities
Allagash understands that prices for secondary properties in LMI communities almost always trade at significant discounts to the cost of ground-up development because so little capital is being allocated to buying existing properties in these areas (even after the creation of the OZ Program) and because property on which ground-up development can be built usually exists in LMI communities. Therefore, owners of existing properties have effectively no expectation of being able to receive more for their buildings than someone could build a new property in the same neighborhood. As a result, in order to make economic sense, ground-up developments must charge rents at the high end and often above the high end of the rent range that currently exists in any community.
In contrast, the Allagash Opportunity Zone CRE Fund I, by targeting existing underperforming properties in LMI neighborhoods, can purchase properties at 50%-70% discount to ground-up development cost. Such discounted prices can be achieved because these properties have been run in a highly suboptimal way, both with respect to rental revenue and cost structure. The owners of these properties are often second or third generation, absentee owners who have generally been running their properties for the sole purpose of taking out as much annual income as possible. Their behavior has resulted in many of these properties having significant deferred maintenance and fallen into a state of noticeable disrepair. The endgame for such properties is already evident in many LMI neighborhoods where only partially inhabitable or even completely uninhabitable buildings already dot the landscape. As a result, the supply of workforce housing has been decreasing drastically, despite the size of the workforce population increasing. Research indicates that over the last 20 years for every new unit built, 2 units have been lost to age and neglect.
From a pricing standpoint, the result for properties whose owners have not invested in CapEx appropriately is that these properties are no longer competitive within their marketplaces. They need to charge bottom quartile rents in order to maintain a reasonable level of occupancy. Simultaneously, properties with extreme deferred maintenance generally require significant and continuous repairs. The result is that expense ratios increase dramatically, even to the point of doubling. The net effect of the combination of low rental income with high expense ratio is that NOI can drop by over 50% versus median performance in any market. Combined with the natural discount that LMI area properties generally trade at compared to ground-up development costs, the severe NOI reduction results in extreme pricing discounts for these types of properties.
As a result of such low purchase prices, the Fund can own these properties at 20% or more discount to ground-up costs even after performing the renovations required by the property (and by the OZ Program). As a result, the properties can charge rents that are well within the ranges in each of their communities and still generate generous returns for investors. In conclusion, the Fund returns are purely execution based and do not depend on forward-looking changes to the communities in which they are located. The Fund return projections do not rely upon any gentrification to raise rents in the area or to maintain full occupancy. Additionally, to the extent that such higher rent levels are achieved in the area, then Fund investors should realize higher than projected returns as the Fund will own a newly renovated property in a quickly appreciating neighborhood.
Community Development Entity
Allagash is in the process of becoming certified by the U.S. Department of the Treasury as a Community Development Entity (“CDE”) which will allow the LMI communities into which Allagash-managed funds invest to understand that Allagash plans to work with the members of their community to provide the best outcome for both the community members as well as the investments in any Allagash QOF.