Nobody goes to sleep fantasizing about aging apartment buildings. But Sean Kia and Ryan Andrade know how to bring out the sex appeal of a drab asset.
Last summer, Kia and Andrade, founders of Tides Equities, pitched their latest Class B play: a 270-unit apartment complex in Fort Worth, Texas. The property, which they dubbed Tides on Oakland Hills, was ripe for a value-add play, the young duo told potential investors, promising a 20 percent return in just two years.
The plan: Using a floating-rate loan, Tides would buy the apartment complex for $35 million and perform an assembly-line-style renovation of its units. The booming Dallas-Fort Worth rental market would allow Tides to hike rents by 24 percent, setting up a lucrative resale.
Tides ended up raising about $10 million. But the firm is now grappling with a new reality.
Rents in the Dallas-Fort Worth metroplex have actually declined since Tides made that deal. Meanwhile, the debt service on the property jumped with soaring interest rates. To keep up with payments, Tides will have to double the property’s net operating income over the next two years.
The Los Angeles-based company has emerged as one of the most aggressive multifamily buyers over the last two years, exploiting low interest rates to scoop up more than $6.5 billion worth of apartments across Sun Belt markets that have seen hefty rent growth. But as a floating-rate operator, its success is bound to the debt markets: As rates rise, Tides’ headaches do, too. Debt payments on properties Tides purchased in the latter half of 2022 have soared, putting the firm in a tough spot on a number of its recent deals: Raise rents and net operating income, or risk default.
In one instance, Tides gave one cap rate figure to its lender and another to potential investors, making it difficult to determine how much investors could lose if a deal were to go upside down.
“They were betting on the capacity to raise rents with minimal renovations,” said the head of a rival investment firm familiar with Tides’ pitches. But the firm is “incredibly exposed” to monthly and even daily changes in interest rates and apartment demand, the competitor said.
Demand for apartments turned negative in January — meaning more apartments came up for lease than were leased — for the first time since 2009, according to RealPage.
“There will be pockets of challenge,” RealPage’s Jay Parsons, who authored the report, said in an interview. “Especially for short-term floating-rate holders that have aggressive revenue expectations they have to meet.”
Tides says it typically only underwrites for 3 or 4 percent rent growth, and that even in markets that saw double-digit rent increases, it never underwrote anything more than 5 percent year-over-year growth. Those projections, they said, would leave it with some breathing room to survive a weaker market.
“All of the pain that’s occurred in 2022 is just from rising mortgage rates,” Tides’ Andrade said, adding that renter demand hasn’t waned. “Otherwise, we’d all be partying.”
Rinse and repeat
Andrade, now 32, was working in acquisitions for TruAmerica Multifamily, an L.A.-based Class B specialist, while Kia, also 32, worked in asset management for Benedict Canyon Equities, another West Coast multifamily investor. Working in the same office building and meeting for lunch, the two would bond over how they’d do things differently if they ran the show.
They became close friends — Kia was the best man at Andrade’s wedding — and as they compared notes, they developed the basic rinse-and-repeat value-add strategy that would become their signature. In 2016, they made their move.
Comparing Tides properties is a bit like playing spot the difference. Tides on Rosemeade East is a three-story, ring-shaped complex of 252 apartments wrapped around a pool in Dallas. It was built in 1990 and gives off the vibe of a La Quinta.
Tides on Rosemeade West, less than a mile away across the President George Bush Turnpike, is a bit smaller and a bit older — just 200 units built in 1986 — but you’d have trouble telling them apart.
Of the dozens of properties Tides owns in Texas, almost all were built before 2000. The typical Tides complex in the state has about 300 units across a little over 200,000 square feet, according to data from Property Shark. There’s almost always a pool, and rarely a facade taller than four stories.
That’s no coincidence.
“Our big thesis is reducing the variables of every investment,” Andrade said. The firm takes an “assembly-line approach,” Kia said during a June investor Q&A with crowdfunding site RealtyMogul.
In 2021, the firm spent more than $1.5 billion on almost 9,000 units in Dallas-Fort Worth. It often returns to the same contractors and brokers, in an effort to mechanize the process.
“It’s putting lipstick on a pig,” one rival said of the firm’s renovations, adding that the work is often cheaply done.
Another competitor, though, praised how quickly the firm could turn properties around: “They were doing 10,000 units a year — that’s insane.”
So far, things are working out. Together, Kia and Andrade had a combined net worth of $69 million in 2021, according to a DBRS Morningstar report for a loan Tides scored on a property in Irving that the two personally guaranteed.
On a recent visit to Tides on Overton Ridge, a 416-unit apartment complex in Fort Worth, two helpful young salespeople sat inside the leasing office. One provided a pricing sheet for the apartments: Renovated units typically cost about $200 more per month, and Tides renovates them as they come vacant.
TRD toured a 727-square-foot renovated unit near the communal pool and grills. It had wood-patterned vinyl flooring, fresh paint and stainless-steel appliances, all the marks of a standard Tides upgrade.
Just a five-minute drive south along Chisholm Trail Parkway, Tides on Hulen offers an almost identical apartment community of three-story white buildings in a sea of parking spaces. In fact, Tides owns 19 other communities within 24 miles of Overton Ridge, more than 4,000 apartments in just a small section of the Dallas-Fort Worth metroplex.
Decorative flags hung from several apartment windows, and the parking lot hummed with activity, signs of life amid all the sprawl. Asked whether there were other Tides properties in the area, the salesperson inadvertently summed up Tides’ strategy:
“They like to gather them up like Pokemon cards.”
Doing more with less
Though on a smaller scale, Tides’ situation resembles the bind Tishman Speyer and BlackRock faced at Stuyvesant Town, an 11,200-apartment complex in Manhattan. The investment giants were forced to walk away after a judge prevented them from raising rents on thousands of rent-stabilized units in the complex. Without the higher rents, Tishman and BlackRock couldn’t reach their projected net operating income and make their interest payments.
Consider Tides on Oakland Hills. Servicing the debt there wouldn’t be a problem if Tides could keep raising rents. But the rental market isn’t what it was a year ago: The median rent on a one-bedroom in Fort Worth hit a high of $1,275 a month in October 2022 but has been dropping since, to $1,227 a month in January.
Tides’ own projections show the firm was not covering its debt service on the property. When Tides bought it in June, it was bringing in about $1.1 million in net operating income, or $50,000 a month short of what’s needed to service the loan.
By the end of the second year, when it hoped to sell the asset, Tides told its lender, MF1 Capital, it would be reeling in $2.2 million in net operating income — just enough to cover the debt payments. That assumed Tides could raise rents by up to 21 percent for some of the units.
But in its pitch to investors in June, Tides estimated it would be making $2 million in net operating income by the end of the second year — not enough to service the debt at the 6.75 percent rate cap, which it hit in August.
Kia said the firm gave RealtyMogul “very conservative assumptions,” adding the figure MF1 Capital has is more “in line with what Tides plans to achieve by the end of the second year.”
“We always try to underpromise and overdeliver,” he said.
It was not the only discrepancy Tides executives gave to investors.
In the same RealtyMogul Q&A, Jason Beckstrom, a director of acquisitions for Tides at the time, said Tides on Oakland Hills was bought at a cap rate of about 5 percent. Tides was expecting to sell the property at a cap rate of about 5.25 percent, he said.
But to its own lenders, according to Morningstar, Tides said it bought the property at a cap rate of 3.4 percent. A higher cap rate tells investors they’ll score greater returns.
Asked about the discrepancy, Kia said the cap rate after one month of owning the asset was 4.12 percent, which did not include certain expenses.
When including certain “below-market expenses” — which come from bulk contracts and one-off pricing, he said — “we get close to a 5 percent going-in cap.” He did not comment on the 3.4 percent number disclosed on loan documents.
Float your note
In the multifamily boom of 2021, buyers turned to cheap, floating-rate debt to win competitive deals. Since then, many buyers have hit their interest rate caps — a hedge against rising rates. What was once a 2.5 percent loan has quickly become a 4.5 percent deal.
“Frankly, we’re into our caps. And I believe most of our peers are probably in a similar situation,” Andrade said. “It is kind of a worst-case scenario when you buy the properties. But that’s why rate caps exist.”
Tides holds properties for an average of two years, performing quick renovations and then flipping them for a profit. But on recent purchases, Tides has been exposed to significant downside.
Take Tides on Haverwood, a 376-unit complex in Dallas that it bought in December 2021. The firm took a $62 million mortgage on the property, which had an interest rate of 2.9 percent upon origination, according to Morningstar. At that rate, Tides would have been paying just under $150,000 a month. Today, Tides is at its rate cap of 4.88 percent, resulting in monthly payments of about $250,000, a two-thirds increase.
When the firm bought Tides on Oakland Hills, its starting interest rate on the acquisition loan was 4.85 percent. At that rate, Tides would have been paying about $1.8 million a year to service the debt. But the rate didn’t hold there for long. Tides now has to pay about $2.2 million a year on the debt.
Tides is far from the only multifamily firm in this bind. Multifamily mortgage debt increased by $35.7 billion in the first quarter of 2022 to $1.9 trillion, according to the Mortgage Bankers Association. Banks, as a matter of habit, do not want to become landlords or auctioneers, but as the debt that financed the buying bacchanal comes due, they will want their money one way or another.
Andrade called the situation a “waiting game.” If the Fed chooses to lower rates this year, Tides’ interest rates will dip.
He seemed hopeful: “The pain is finite.”