“Workforce housing is not necessarily exciting and can be challenging to operate, but it is consistent and high-income generating when operated correctly.”
In just five years, Watermark Capital Real Estate has grown from a friends and family fund with a handful of investments in Michigan to a $300 million company with 6,500 apartments in five Midwestern and Southeastern states. And it has done so with an investment thesis that many firms might find constraining. In the words of Managing Partner, Thomas Carroll, Watermark strives to create high-income, tax-shielded diversified funds with a positive social impact. Or in the words of the company tagline, Watermark is Managing for Investor Income and Community Growth.
In workforce housing Carroll and his colleagues found a way to reconcile these two objectives. “Workforce housing is not necessarily exciting and can be challenging to operate, but it is consistent and high-income generating when operated correctly,” Carroll maintains. Over the last five years, they have assembled an organization with the skills, systems, and talent required to create safe, clean, affordable places for workers to live while generating attractive returns for their investors. Carroll sat down with Hunt Real Estate Capital to talk about the challenges of working in this demanding corner of the multifamily market, the steps Watermark has taken to succeed, and the value-added that the team at Hunt have provided.
Where did Watermark’s emphasis on having a positive social impact come from?
Watermark has had a community focus from the very start. When they launched our first fund in 2014, our founders — John Nechiporchik, Elan Ruggill, and Stewart Beal — bought properties just blocks from where they lived. As a result, they could see firsthand what a difference good housing could make to a neighborhood and decided to try replicating this experience in other communities. Over time, this emphasis became self-reinforcing. It has become even more deeply engrained in our culture as we attracted employees and investors who value having a positive social impact.
How did you extrapolate from these first experiences to the communities you are investing in now? What are your criteria for choosing a community for investment?
We look for cities with a number of well-defined attributes. They should have a significant industrial presence, a strong workforce, and a diversified economy. We favor towns with universities, healthcare, government, and S&P national corporations. Together, all these factors contribute to a stable or growing tenant base. In the Southeast, we are concentrating in such cities as Columbia, South Carolina, Augusta, Georgia, and the Piedmont Triad of North Carolina, Greensboro, High Point, and Winston-Salem. In the Midwest, we are in places like Akron, Ohio, and Lansing, Michigan.
At the same time, we are constantly debating the merits of geographic diversification versus geographic concentration and operating scale in a given city. We know that part of what gives us better performance is being able to pool our resources. This is particularly important because of the number of properties we own — we have executed more than 100 transactions in the last two or so years — and their relatively small size.
That is a lot of transactions. How do you find these deals?
We buy low- to moderate-income housing, usually from individual owner-operators. We have developed a broker network that consists of a mix of larger companies and local independent brokers. We also proactively reach out to owner-operators and smaller real estate investment groups.
Deal flow is extremely important to us. In the last two years, we’ve looked at more than 250 properties in the Southeast alone. If we think a deal has legs, we spend more time underwriting, and, eventually, if we do get into contract, we go through a very exacting due diligence process.
We have learned a massive amount over the past five years about how to do this well. We have developed clear procedures as well as clear requirements for sellers. We are also extremely responsive. We come back to brokers and potential sellers within a 24-hour period after a first read and can be onsite in 24 hours. That’s one advantage of being based in Charleston as compared to New York, Los Angeles, or Dallas.
Our responsiveness and discipline have gained us credibility. We regularly hear from brokers and sellers that we are the most professional buyer they deal with — and that sometimes means that we see deals first.
What sort of properties are you looking for?
We buy assets that are capable of generating income from the moment we purchase them. At the same time, we are also focused on long-term income generation. Although a property may be 90 or 93 percent occupied, there is often significant deferred maintenance, which we will take care of. We will renovate units, add playgrounds, improve the landscaping, and get pools back online. We want to make our communities nicer and more enjoyable places to live, which is good for current residents, the surrounding community, and ultimately for investors. We are not a charity. When you create a nicer community, you can eventually charge higher rents.
In making purchases, we also try to factor in our views of the economy. Barring exogenous events, I think we are looking at a period of slowly diminishing economic growth nationwide. This assessment has subtly shifted the types of assets we are considering. We are focusing a little more on assets where there is operational upside required but not massive heavy lifts.
Why are you focused on the Southeast and Midwest?
We are looking for locations where there is a significant spread between retail cap rates and the cap rates on institutional deals. In places like the New York metro area, there is zero basis between these deal sizes and no ability to capture cap compression by going smaller. We started in the Midwest, which was harder hit by the recession and slower to emerge than the rest of the country. At the time, there was some cap rate compression to be had. Currently, the area with the widest differential is the Southeast.
Your business is transaction-heavy. What does it take to maintain that pace of activity?
It all comes down to the team. We run at a very high rate. This week alone, my team was in three cities in two states looking at deals — and next week they will be doing the same thing. You need people who have the energy and drive to maintain this pace.
At the same time, you need people who are smart and who are interested in becoming smarter. We have people from a variety of different backgrounds, an advantage we try to leverage when we make decisions, but the one thing they have in common is they’re interested in learning how to become better at what they do.
Character is another quality we are looking for. We need people who are responsive to and respectful of the needs of others, whether they be residents, investors, vendors, brokers, sellers, or fellow team members. And finally, we look for people with a social conscience, who want to do make our communities better places to live.
What are you looking for in debt provider? How does Hunt measure up?
We could not do what we do without debt financing. It enables us to create returns that are attractive for our investors. But because of the nature of our business, we are looking for a partner that goes beyond the obvious — competitive pricing, competitive terms — and provides the degree of insight, flexibility, and responsiveness that’s vital for our business.
For instance, our sellers often have very poor quality financial data. We need a financial partner who can help us work though complicated underwriting and tease out information from sellers. We also need a partner who comes up to speed quickly. We are repetitive borrowers, and we just don’t have the time or patience to answer the same questions over and over again with each deal. And we need a partner who is knowledgeable and responsive, who will answer our calls and get right back to us with insight and information we need.
We’ve explored hundreds of deals in the Southeast and Midwest over the last few years, and just about every one of those deals has some sort of twist or turn that we need to understand. Having a partner that we can bounce ideas off of and ask questions of is critical in determining whether or not we can proceed.
About a third of our deals have been agency financing, and we’ve done the bulk of those with Josh Messier and the team at Hunt Real Estate Capital. Quite simply, their execution is the best we have dealt with. They are knowledgeable, fast on the uptake, and responsive. Equally important, Josh’s willingness to advocate for us within his organization is critical. I worked at two large institutions during my Wall Street career, and I am extremely aware of how important it is to have an advocate that believes in you and represents you within a large institution. He’s staked his reputation on us, and that matters tremendously.
When it comes down to it, we demand the same qualities from a financial partner that we expect from the rest of our team. That’s what Hunt delivers.