About a month ago we closed on a 124-unit property in Marquette, Michigan. This deal evolved over a period of about 18 months. It was not a typical transaction. At times it felt like it would never happen. And it is a prime example of why being patient, staying disciplined and not chasing a deal will get you amazing results!
A broker first showed us the asset in October of 2019! Remember the good old “before days”, when we could congregate, go to sporting events, have friends over for barbecues? We took a cursory look then and passed on the deal as it was in Marquette, a fairly small town in the Upper Peninsula of Michigan, on the shores of Lake Superior. A few weeks later the broker, who we have bought several properties from, followed up again, encouraging our team to take a harder look at the property due to the strong performance, low occupancy and competitive pricing. We did the work, asked a number of questions, analyzed the sub-market and presented the seller with an offer. They thought about it. They told us that while our logic made sense, they believed that they could get more for the property, citing a number of strengths which we could not argue with. In November we agreed to pass.
Next the world got hit with COVID-19 and everyone’s universe got turned upside down. Elementary school kids became college students, waking up 5 minutes before class starts, brushing teeth with their laptops in bathrooms, all while being expert with the mute button. Capital markets froze. A number of us lost friends and loved ones. It was a difficult time emotionally, mentally, physically. In March of 2020 the property again appeared for sale. We reached out to verify that it was indeed available. Our broker communicated that someone had tried to buy it but they were eventually not able to close the deal. We let them know that we still liked the property at the price we had offered previously. The response we received was “They would think about it.”
April went by without news and in early May the seller let us know that they would entertain our offer. We proceeded to negotiate a Purchase and Sale Agreement. This took about a month. Towards the end of June we had a signed agreement to purchase the property. The seller had one big request: they did not want to sell the property too quickly. The reason–they had an outstanding mortgage and they had a prepayment penalty which depended on the 10 Year Treasury Yield. Because of the global pandemic the 10 Year Treasury Yield had fallen off a cliff. Over the past 20 years this rate had averaged roughly 2.5%. It had spent most of 2019 bouncing between 2.8% and 1.8%. In June of 2020, when we signed the contract the rate was at 0.67%. The larger the difference between the seller’s interest rate and the 10 Year Treasury Yield the higher their prepayment penalty. This would translate into a penalty of over half a million dollars for the seller! See the dramatic drop in the 10 Year T-note over the peak of COVID below.
US 10 Year Treasury Feb 2019 – Mar 2021
We agreed to work with the seller. We agreed to not close for at least five months. We also gave the seller the option to extend closing by 45 days, if they needed it, once we were ready to execute. Since the seller was not in a hurry we decided to explore the possibility of a loan type which typically takes longer to execute but comes with a super low interest rate and allows the loan to be amortized over a longer period of time. This would increase cash flow to our investors. The seller thought that this compromise was reasonable and would be a win win.
The due diligence came and went. We became even more excited about the property as we learned more about it. The seller had done a lot of heavy lifting on exterior capital expense items–roofs, siding, windows, porches. The property qualified for an EPA Green Certification which further made us eligible for an interest rate discount.
The execution did drag on though. There is a reason why many investors do not use the HUD loan–it does take time. Our package was submitted to HUD for final review in January of 2021. In another three weeks we were granted a closing date in late March. A month ago, in March of 2021, almost 18 months after we first looked at this deal, we finally we closed. The upside: we locked our interest rate at a whopping 2.46% fixed for 35 years!
In this environment it is important to not overpay. Pricing has moved quickly. A lot of money is chasing a few good deals. Stick to your underwriting. While you can make money by forcing appreciation over time, it is very difficult and sometimes impossible, to make up on the backend, what you give up in a higher purchase price. At Cape Sierra Capital our philosophy is to not chase a deal. We invest our own capital alongside investors and if things get too hot we feel it is ok to say “we missed it”.
Related Article: Cape Sierra Capital HUD Multifamily Acquisition in Michigan
Tahquamenon Falls, Michigan’s Upper Peninsula Pictured Rocks National Lakeshore, Lake Superior
