Investing in LMI Communities
Allagash understands that secondary market prices for 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 existing properties in LMI communities are rarely in mint condition. 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, investors who target not only existing operating properties but also properties which are underperforming in their marketplaces, can buy properties cheaply enough (50%-70% discount to ground-up development cost) to renovate the properties and bring the properties back to market well within the existing rent range for that community while still creating compelling returns on their invested capital.
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 Net Operating Income (“NOI”) can drop by over 50% versus median performance in any market. Combining low NOI with the natural discount that LMI area properties generally trade at compared to ground-up development costs results in extreme pricing discounts for these types of properties.
As a result of such low purchase prices, investors generally and the Allagash Opportunity Zone CRE Fund I specifically can own these properties at a 20%-50% discount to ground-up costs even after performing the renovations required by the property (and by the OZ Program). As a result, the properties in the Fund portfolio can charge rents that are well within the ranges in each of their communities, and the Fund can generate 14% projected net returns for investors.
In conclusion, the Fund returns are purely execution based and do not depend, as most QOFs which are doing ground up development do, 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.
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 investors in any Allagash QOF.