Cadre Vantage: Quarterly Insights (Q3 2023)

In our most recent quarterly letter to investors, we explain why patience and perseverance are key in the current market environment. Cadre is being extremely cautious as we await emerging dislocations.

Executive Summary

• We believe patience is essential to achieving attractive real estate returns, while perseverance is key to sourcing new investments.
• The premium to buy versus to rent a home is now historically high in the U.S., supporting our belief that multifamily properties will prove more compelling investments as capital markets begin to reflect asset fundamentals.
• As new construction starts substantially decline, we expect both multifamily and industrial demand to overtake supply over a mid-term horizon.
• Cadre is patiently but prudently vetting investments that fit our stringent criteria. With high interest rates and low debt availability, we are being extremely cautious with sourcing and due diligence as we wait for dislocations to emerge.

Optimism about a plausible soft landing rather than an impending recession came courtesy of Federal Reserve Chair Jerome Powell in September. That doesn’t erase the current market challenges, however. Just past quarter-end, the 10-Year Treasury yield hit 4.88%, its highest level since 2007. As a result, most owners looking to refinance are finding difficulties securing debt. This dynamic leads us to expect increasing levels of compelling investments to shake loose in the coming months and quarters. Thus, patience is the watchword, while perseverance remains key.

We believe that compelling investments will surface for a number of reasons, chief among them:^[1] As refinancing costs increase, we believe that owners will sell at lower prices, benefitting value investors;^[2] New construction starts are slowing, particularly in multifamily and industrial;^[3] A record high delta between the costs of homeownership and renting a residence will likely continue to favor multifamily investors.

As a fiduciary, we invest alongside our investors and always look for quality over quantity. Our new investment levels have remained lower than typical. We intend to remain patient and only deploy into new assets when we can acquire them at an attractive basis, and/or deliver compelling returns alongside our local operating partners. 

As your coinvestor, we are equally eager to put our capital to work alongside yours. Rest assured that we are scouring high-growth markets for compelling investment opportunities. We intend to take full advantage of the dislocations and distress coming to commercial real estate.

The Status Quo

Across the industry, acquisitions have slowed. Valuations could certainly be rosier. We believe they will be. Presently, however, we are looking at interest rates that in some cases are twice as high as they were pre-pandemic. We are also facing rising costs of insurance and slowing fundamentals. While cap rates are steadily inching upwards, pricing and projected returns today are both less attractive on a relative basis than they were pre-pandemic. 

As you can see from the chart below, Cadre has seen multifamily cap rates increase by approximately 200 bps from their peak in March 2022, reflecting volatile market conditions. Commercial real estate investments are significantly riskier now than they were 18 months ago. Thus, patience. There is good news ahead for acquisitions.

Multifamily Cap Rate Expansion for Cadre-Sourced Deals

Underlying Data: Multifamily Deals Sourced Since January 2018, Number of Deals Utilized for Analysis: 399. Excludes (i) 1979 vintage and earlier, (ii) tertiary markets, (iii) lease-ups & development deals, and (iv) deals for which no cap rate, market, or year built data exists.

Discounted Pricing On the Horizon

An impending wall of $1.5 trillion in real estate debt is due by 2025. A recent statement from Newmark predicts that 44% of the debt maturing in the next two years “is potentially troubled.” As higher rates lead to deteriorating cash flow, lender liquidity dries up, loan maturities come due, and macroeconomic growth slows, owners of assets that had been performing well in the recent past may struggle to generate positive cash flow. 

Tailwinds for Multifamily

For appropriately capitalized multifamily investments, we remain bullish on the fundamentals. The delta between the cost of purchasing a home and renting one is now the highest it’s been in history, which should drive rental demand. Founder and CEO Ryan Williams spoke with Marketwatch about Cadre’s study that quantifies this affordability gap. 

The quarter ended with the average 30-year, fixed-rate mortgage at a 23-year high. As the chart below shows, the cost of buying a house is now 73% more expensive than it is to rent a residence. Cadre’s team believes that this sky-high premium will keep more renters in the market, benefitting multifamily investors.

We’re Encouraged by Decreased Supply

Decreased construction starts in both multifamily and industrial are particularly encouraging. Our belief is that this decline will lead to a meaningful pause in deliveries over the medium-term, allowing many overbuilt markets to absorb their current supply overhang. This vacancy compression should drive rent growth as it adds to our conviction regarding outperformance in these asset classes over the next few years.

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Construction starts in multifamily are now 35% lower than they were pre-pandemic (2017-2019), and 68% below their peak level at Q1 2022. For industrial assets, starts are now 49% below pre-pandemic levels (from 2017-2019) and currently 78% below their peak. Supply should drop off further for both property types in the next several quarters, leading to new deliveries well below normal levels in 2026-2027. 

Cadre’s Differentiated Approach

We firmly believe that current market dislocations will lead to compelling investments in the quarters ahead. Cadre’s single-asset approach is spot-on for this environment, wherein opportunities are idiosyncratic and thematic investors are disadvantaged. 

This differentiated approach to sourcing and investing helps ensure that once more attractive opportunities become available our investors will not be crowding into the same deals as everyone else. We work with a broad network of sponsors, brokers, lenders, and other professionals to source often off-market opportunities. Our Investments team is closely tracking both pricing and fundamentals across multiple markets and property types. We look primarily for mid-cap assets ($50-150mm) with inefficiencies we can improve through pricing, operations, or capital expenditures to generate alpha for our investors. The mid-cap range is our team’s “sweet spot.” Recent data shows increased opportunity in this niche.

According to data sourced by Cadre from Real Capital Analytics, mid-cap properties transacted approximately six times more than large-cap properties over the past two years. The data supports our long-held belief that our Investments team has more options and may benefit from increased liquidity in our preferred cap range.

Perhaps most importantly, the team at Cadre takes a hyper-focused approach to investing, selecting each asset individually. As thematic and “sweep” investing lose both favor and effectiveness, Cadre proudly sticks to its origins as a single-asset investor. We believe that this approach will continue to serve us well. 

Valuations are hyper-specific in the current economic climate. We continue to favor multifamily and industrial properties and do not have strong conviction in office assets as of Q3. Our team is looking for jewels across property types, in specific U.S. submarkets, to generate compelling risk-adjusted returns.

We believe that Cadre’s diversified funds (CDAF II, Cadre Horizon Fund) have strong potential to benefit from the current market dislocation. While specific opportunities may yet be several quarters out, investors are encouraged to invest now before these funds hit our close limits. Once they close, new individuals will not be able to take advantage of the discounted properties available in our commingled funds. 

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Cadre Updates

Cadre Podcast Launch: Real Estate of Mind

In Q2, Cadre launched a new podcast series, Real Estate of Mind, hosted by our Founder and CEO Ryan Williams, which is now available on Apple Podcasts and Spotify. Our inaugural episode features real estate legend, co-owner of the Milwaukee Bucks, and Co-Chair of Cadre’s Investment Committee Michael Fascitelli.

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Mike spoke with Cadre’s Founder and CEO and Investment Committee Co-Chair Ryan Williams about his wealth of experience investing through previous market downturns and how he is managing his investments in the current market environment. 

Upcoming episodes are planned to launch monthly and will feature leaders of the real estate industry.

Watch now the Cadre platform or listen on Apple Podcasts and Spotify.

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To learn more about our views on commercial real estate, and what’s new at Cadre, sign up for free to read our full Quarterly Investor letter, available only to Cadre members.