Magnolia Preserve, 173 Units, Dothan, AL
How We Got It We faced limited competition due to the tertiary location.
Investment Rationale In early 2016 when we closed, Magnolia Preserve was just stabilizing and was favorably positioned as the newest and best-located asset in a town. Better, no new apartment supply was pending at that time, something that was both unique and compelling in early 2016. And the entry basis was very attractive and well below replacement cost at roughly $110,000 a unit, about 25% below replacement cost at that time (calculated inclusive of a typical developer profit at exit).
What We Did We achieved many successes at Magnolia. First, we burned off the 2 months of free rent offered by the seller within the first year of operations, pushing effective rents by more than 20% in short order. Second, we pushed rents more than $200 ahead of the other Class A asset in town, a beautiful complex with fabulous amenities and excellent curb appeal. Third, we achieved that outcome through top 1% tenant service and the submarket’s best online ranking and tenant engagement. But we were never able to successfully combat pervasively high turnover owing to a heavy supply of cheap home rental product and renters buying inexpensive area homes.
Results First, we completed a supplemental refinancing. Second, we were producing a 10% cash return. Our updated models showed it as a 15+% IRR if held through the mortgage maturity. But Magnolia turned out to be our worst buy as we were forced to exit early. And that early exit forced us to incur a $2.7mm mortgage prepayment penalty that pushed the net returns, after all closing costs, down to a 4.5% IRR and a 1.12x multiple on invested capital.
Early Exit Explained Dothan has a very thin swath of Class A rental demand despite many economically capable renters. In evidence of this, Magnolia was the only asset in town that achieved a Class A rent structure. While Dothan has no less than four Class A assets (Highland Hills phases I and II, Magnolia, The Cottages and Summerfield Square), only Magnolia achieved a Class A rent structure. And it took us a very long time and a massive advertising spend and significant investment in staffing to achieve that outcome. It was a long, slow, bumpy, and costly ride. Again, the shadow supply from cheap rental homes is part of the problem. But we knew Dothan can’t successfully absorb more Class A units without undercutting the rent structure we painstakingly built at Magnolia over our 3-year hold period. So, we elected to exit right before the new asset entered lease-up. We had achieved asking rents to $1,298 right before we sold. We won’t be surprised if that drops to $1,100 once the new asset starts leasing. Had local developers not launched marginal new supply, we’d have gladly held to the mortgage maturity. We had wrongly assumed developers wouldn’t be able to raise equity for this location but apartment development exploded nationally in the 4 years following this acquisition, leading equity to warm to marginal locations like Dothan where Class A rental demand appears insufficient to produce an adequate IRR for merchant-built product.
Tax Consequences 100% of the Magnolia LP’s elected to roll their share of the sales proceeds, via a 1031 tax-deferred exchange, into Midtown Nashville (two assets across from Vanderbilt University).