Madison at Schilling Farms

Madison at Schilling Farms, 324 Units, Collierville, TN

How We Got It
This 2000 vintage 324-unit beauty is located in the most desirable bedroom community of Memphis. We closed the acquisition in June of 2016. Like Meridian in Jacksonville, it was a low LTV, high rate, amortizing debt assumption that narrowed the field of bidders. Further, Memphis was not on buyers’ radar at that moment. We knew capital would flow out of Nashville and other hotter markets as groups chased yield or became frustrated by valuations in hotter submarkets.

Investment Rationale
We first identified the flight of capital out of the interior southeast to the coasts back in early 2010. It was a natural outcome, albeit incorrect reaction to the Great Recession and resulting credit crisis of 2009. When too much capital flocks to “safer” markets, valuations escalate to levels that are unsupportable. Some infer that higher land costs make certain coastal markets immune to new supply but that’s a fallacy. Look no further than the NYC metro area where more new supply was added than in any other MSA. And when capital exits certain attractive markets, valuations fall causing yields to rise making the risk-adjusted returns compelling. That was the case when we entered Memphis. But at the exit valuation, we knew we had to exit Memphis for the reasons noted below.

What We Did
We upgraded 40% of the units including some structural changes to widen the opening of the serve-through kitchens. We added a wide range of amenities while enhancing all existing amenities. We revamped property operations, staffing and marketing.

We netted a 21.5% IRR (after mortgage prepayment costs, exit costs and the sponsor promote). Our gain per unit was 6x the gain realized by the prior owner who held the asset about as long as we did. In other words, we managed to unlock value the seller didn’t realize when they sold to us. That speaks to our ability to unlock value which we achieve through dozens of day-to-day operating improvements and dozens of asset improvement projects to make the rental experience more rewarding for the property residents.

Early Exit Explained
Memphis has the highest millage rate in the southeast. So, it was imperative that we exit before the next quadrennial reassessment. The Buyer assumed the assessment would only escalate to 80% of what he paid but the 2017 quadrennial reassessment saw the sales ratio (assessed value to recent sales price) top 93%. Our experts forecast a 95-97% sales ratio for the next cycle. If they were right, we captured upwards of $6mm of value by exiting ahead of the reassessment. Further, our upgrade program had stalled, meaning we upgraded 40% of the interiors, the percentage we guessed before we closed, and found it hard to rent additional upgraded units at a fair premium after that 40% threshold was reached, because not all renters have the budget or interest to cover the monthly surcharges associated with the executive upgrades we added at this asset. Yet, many buyers were assuming they’d complete the program while achieving the same high ROI we had achieved on the first 40% of the unit upgrades thereby arguably overpaying us for value-add that wasn’t achievable.

Tax Consequences
100% of the investors in the Madison syndicate elected to roll their sale proceeds into a forward tax-deferred exchange. The replacement asset is in high-growth Durham, NC and it has more value-add upside than Madison had when we bought it about 3 years ago. The exchange asset is wedged between Duke University and UNC Chapel Hill in a job rich location weighted towards health care and education at two of the nation’s leading universities and affiliated research hospitals. Our models showed that investors will make upwards of 9x more cash via this repositioning of capital out of Memphis and into Durham.