Charting a Course for Success: A Year Ahead with Hamilton Zanze

The apartment industry endured some challenges in 2023, and our company had a relatively quiet year on the transaction front. However, the fundamentals of HZ’s multifamily portfolio remain strong.

We anticipate that both debt and equity capital will return to the apartment market in 2024, and we feel that our firm is well-positioned to make strategic acquisitions aimed toward driving long-term value and returns for investors.

In 2023, HZ embarked on a monumental endeavor—the comprehensive relaunch of our esteemed brand. With 22 years of a rich legacy, this initiative was meticulously designed to not only modernize our visual identity but, more importantly, to encapsulate the essence of our firm’s unwavering vision and values. This ambitious undertaking delved into every facet of our brand presence, from reimagining our logo and refining our messaging to re-developing our digital platforms. The primary objective was to enhance the investor experience.

Moreover, this spring will mark the launch of HZ’s Evergreen Fund, an investment vehicle designed to deliver diversification, liquidity, and stability to investors. The Evergreen Fund will be structured as a tool to help investors work toward a more secure financial future for their families.

I’ll discuss the year ahead and the year that just passed in more detail below, but I wanted to start off by saying that we expect 2024 to be an important and productive year in the history of HZ. We look forward to sharing and experiencing it with you.

A Softening Market

From an operational standpoint, the apartment market performed more sluggishly in 2023 than it did in preceding years. A wave of new construction has dampened rent growth and softened occupancy rates, as has the fact that household formations have slowed. Statistics show that younger adults are living with their parents longer or choosing to remain with a roommate because they are concerned about the economy.

The impact of new construction on HZ’s portfolio has been mitigated to an extent. That’s because the communities coming online are typically situated in urban markets, and our portfolio primarily consists of garden-style properties in suburban infill areas. Still, we have felt the effects of new transit-oriented developments in the suburbs.

Rent growth and occupancy rates are poised to remain somewhat soft this year as the marketplace works itself through the uptick in new deliveries. As a result, we are working with Mission Rock Residential to emphasize keeping current residents. The portfolio’s 55% retention rate compares favorably to the overall market, and we are seeking to keep more renters in the fold by making our properties even better places to live. That means improving our amenities and common areas, as well as implementing green initiatives that appeal to residents’ desire for sustainable living and making our communities preferred places to live by reducing utility costs.

Looking further down the road beyond 2024, we are optimistic about the operational performance of the apartment sector. The delivery of new units into the marketplace is likely to slow within the next two years as developers in the current economy are having difficulty obtaining financing to build new communities. After the absorption of the existing oversupply that is hitting the market, rents may be expected to increase in late 2025 and throughout 2026 and 2027. Demand in the apartment sector should be further driven by the reality that buying a home is, and will likely continue to be, prohibitively expensive for many Americans, keeping them in the renter pool.

One more note on operational challenges: like all owners and operators, HZ dealt with a significant surge in costs last year because of inflation. Year over year, our total expenses increased by 8.1% in 2023. We expect overall costs to rise again this year, but at a more moderate pace—by approximately 6.2%—as inflation is brought under control.

Notably, we have seen a significant increase in insurance costs. From 2016 through 2023, our average per-unit insurance cost rose by nearly 340%. We expect another 20-25% increase in 2024. As stewards of the capital we invest and manage, HZ prioritizes risk management. Instead of scaling back on coverage to counter rising premium costs as other investors in the multifamily sector may have elected to do, HZ pursues best-in-class coverage at a reasonable value by layering coverage from various insurers. To achieve this objective, HZ senior leadership, led by our risk manager John Gilmore, travels to London, Bermuda, and across the U.S. to personally meet with carriers and tailor a proprietary insurance program for our portfolio.

A Return of Investment Sales

With interest rates and the cost of capital soaring, it is no surprise that multifamily investment sales decreased in 2023 compared to prior years. To cite one example: according to a Newmark Group report, apartment sales totaled $30.1 billion in the third quarter, a 62% decrease from the same period one year earlier¹.

At HZ, our transaction volume in 2023 slowed as well. We were very selective in our pursuit of assets, acquiring three communities for a total purchase price of $200 million. The properties we purchased not only presented opportunities to add value and drive NOI, but are also located in submarkets — like Deer Valley in Arizona and Hendersonville, Tennessee — that are experiencing significant capital investment. In Deer Valley, the Taiwan Semiconductor Manufacturing Co. is building a $12 billion factory, while Hendersonville is near Meta’s new $1 billion data center. We are optimistic that the creation of jobs and economic growth in these areas will drive apartment demand and help our communities achieve higher NOI over time.

Looking ahead, we believe 2024 should experience an uptick in apartment investment sales. Banks’ balance sheets have become more stable, and they will likely be looking to deploy debt. Likewise, on the equity side, we expect institutional investors to be willing to re-enter the marketplace after about a year on the sideline, albeit with perhaps a measured approach. Potential buyers should be reassured by more certainty in interest rates.

When banks and equity investors do return to multifamily, they will be looking to work with experienced, stable operators who have been through economic cycles before—who have a track record of success across market conditions—and that perfectly characterizes Hamilton Zanze. So, we believe we are well-positioned to benefit from an upcoming influx of capital.

At the same time, we pursued apartment assets in MSAs centered around job growth and infrastructure improvements at a significant discount to replacement cost. These opportunities arose as owners were forced to sell due to redemption concerns and debt issues. We think these pride-of-ownership assets are positioned for long-term growth in desirable locations.

Similarly, we believe certain distressed and underperforming assets in San Francisco and Los Angeles could present promising acquisition opportunities. Statistics indicate that residents are moving back to these urban areas, especially as people finally begin returning to the office after the pandemic. Buying properties at a discount that are positioned to benefit from this trend over the long-term is a sound investment thesis.

Many assets were acquired by other sponsors using floating-rate debt, and the ballooning interest rates over the past 18 months have made it too expensive to service their debt, subsequently putting pressure on these owners and causing asset level distress. At HZ, we have traditionally used fixed-rate financing to acquire properties. Out of our 91 total loans secured by 129 properties, only seven involve floating-rate debt. With more limited exposure to loan maturities and rate volatility, we are preparing to go on offense in the current climate and grow our portfolio in a thoughtful, strategic way that serves investors well.

Fund Launch

As we anticipate the year ahead, 2024 marks a significant milestone for HZ. Following the successful 2022 launch of our first discretionary general partner fund, HZ GP Fund I, we are thrilled to unveil our flagship product this spring—the HZ Evergreen Fund. This new fund represents a transformative evolution for our company and is poised to empower investors in building generational wealth.

Throughout the past year, our dedicated team has diligently laid the groundwork for the HZ Evergreen Fund, recognizing the vital components investors value most: diversification, long-term capital appreciation, predictable and durable income, enhanced liquidity, and access to our broader HZ portfolio.

In the coming two years, the HZ Evergreen Fund is anticipated to acquire over 50 institutional-quality assets carefully selected from HZ’s existing portfolio.

As we embark on this exciting journey, we look forward to a prosperous and successful 2024.

Kurt Houtkooper
CEO

¹Page 2, “3Q23 United States Multifamily Capital Markets Report,” Newmark Group