Scott Everett had pioneered the biggest private REIT to focus solely on multifamily.
He wasn’t looking to buy. Or at least, not yet. The head of S2 Capital was inoculating syndicated deals against this cycle’s plague: floating-rate debt.
“If this is what happened, S2 just showed other syndicators how to survive until ’25,” LinkedIn account CRE Analyst wrote this spring, a few months after the REIT’s securities filings dropped.
Everett had slipped on the same banana peel that laid out Tides Equities, GVA and Nitya Capital. S2 had done billions of dollars in deals with floating-rate loans before the central bank cranked the federal funds rate above 5 percent.
In a podcast appearance about that time, Everett had also pronounced, “fixed-rate is for suckers,” parroting something a Starwood Capital director once said to him.
Less than two years later, Everett hasn’t changed his mind, a source familiar with the REIT said.
But he has created a vehicle to bail out his debt-burdened properties.
S2 in February launched an open-end fund to convert investors’ equity in 26 assets into shares.
Some of the deals are performing, some not so much, the source said. But pooled, the diversification let S2 tap better debt. And fundraising should pull in the capital needed to complete renovations and boost revenue.
Every syndicator in trouble has gone searching for a solution. Tides hunted for preferred equity that threatened to wipe out limited partners. GVA called for more capital, throwing good money after bad.
S2, meanwhile, has whipped up a tonic that may heal deals without the side effects, buoying them until the firm can realize its value-add plan.
At least, that’s how the source put it.
When the plan hit LinkedIn, skeptics pounced.
In the comment section of CRE Analyst’s post, investors and lenders questioned how S2 would value assets, or explain to investors in good deals that they would now have exposure to a host of bad ones.
“Seems highly suspect to convert equity in distressed assets into REIT shares,” Bobby Larsen, the founder of multifamily investment firm Vanamor, wrote.
“Sounds like Reindeer Games to me,” Clay Barnes, a structured-finance guy, chimed in.
There were other questions. Many of S2’s LPs came through feeder fund Trinity Investors. Would they understand the risk for reward?
If Everett convinces the naysayers, he may cement himself as an innovator — one of the few to break free from the multifamily doom cycle with his investors in tow.
If he fails, the critics will be waiting, scalpels in hand, for the autopsy.
Balls to the wall
The head of S2, who declined to comment for this article, citing regulatory restrictions associated with launching the REIT, brands himself as a Horatio Alger type. In interviews, he presents as a self-made disrupter who ran toward risk to climb the rungs of real estate.
Everett was a teenage father, then a college dropout, then a restaurant waiter relying on government assistance. He took his lumps as a house flipper in the Great Recession. In 2012, he carved out his current form: value-add investor and founder of S2.
“People [let] fear paralyze them,” Everett said on The Fort podcast episode where he dragged floating-rate debt. “We’re not splitting atoms here; it’s just the confidence in yourself to go do it and take the risk.”
Twelve years later, S2 has done over $7.5 billion in deals and has over 27,000 units under management.
“If this is what happened, S2 just showed other syndicators how to survive until ’25.”
S2’s REIT embodies Everett’s can-do spirit.
It’s a complex, ambitious, exhausting road to salvation. S2 had to get the bulk of 1,400 investors to convert their equity into the REIT, according to the source. It took nine months, and forming the REIT has cost $5 million so far.
Other syndicators, notably Rise48, have tried to replicate S2’s approach but couldn’t surmount the challenges, sources say. Rise48’s Zach Haptonstall did not respond to a request for comment.
Eight months into the REIT’s life, the source described progress as: so far, so good.
S2 folded $1.4 billion in senior debt into the REIT, about half fixed-rate agency and half floating. Of the latter, it has refinanced about $500 million into a Fannie Mae credit facility at a five-year, fixed-rate term, a notable improvement from the 8.25 percent it was paying.
It has two more loans to go, which it expects to refinance in the next two months.
But that’s just one part of the equation. S2 still needs to renovate buildings. About 10,000 units were rolled into the REIT and half need a facelift, according to investor documents. To drum up capex funds, S2 has sold founder’s shares to existing LPs who wanted to invest above and beyond their converted equity. Fundraising is just shy of S2’s $75 million goal, the source said.
Trouble in paradise
In a market where few multifamily properties are selling, fair prices are elusive, a point some of the LinkedIn commentators got stuck on.
“…Dump underperforming assets into a new REIT?” Peak Financing’s CEO Anton Mattli commented. “At what value (crucially important question for the current and the new REIT investors)?”
Valuing an asset for less than an investor thinks it’s worth is a recipe for rage.
“When you see people get really pissed off is when they’re losing money,” one investment manager said.
Sam Sherman, an LP in a profitable S2 deal in Florida, said he received just 80 cents on the dollar for his equity when it converted into the REIT.
He said S2, which used BBG as an appraiser, according to investor documents, “never provided documentation for how they came up with those conclusions or decisions.” BBG is currently under review by Freddie Mac as part of an investigation into mortgage fraud.
The source countered that investors in the Florida deal had already received some of their equity back when S2 refinanced with agency debt, and the 80 cents on the dollar value didn’t reflect the equity that had already been returned.
Most S2 deals have lost value any way you cut it. Market participants estimate that multifamily values have fallen about 20 percent since 2021, as interest rates have surged and cap rates expanded.
S2 itself marked down the equity value of the properties that seeded the REIT by 32 percent, which is peanuts considering top-line value declines.
But selling into the REIT solidifies that loss, just as a market sale would. It also levels the playing field, destroying one investor’s belief that he’d made a better bet than the next guy.
“When you see people get really pissed off is when they’re losing money.”
All told, the blended value of the assets that converted was 93 cents on the dollar, the source said. Though the portfolio as a whole received an equity markdown, some deals had more equity in them than others.
Some investors converted at a much lower multiple.
Weston Medical Center Apartments, a 793-unit multifamily complex in Houston, converted at an MOIC, or multiple of invested capital, of 0.31x, meaning investors in the deal will see less than one-third of their equity returned, documents show.
The source said the haircut was another example of a value that looked worse than it was: The deal was refinanced with agency debt a few years ago, and investors had already received some equity back.
Investors who end up with fewer shares than they think they deserve might decipher a silver lining: a more diversified portfolio. If the rising tide lifts all boats and the REIT performs, they could see their money back and then some.
Coercion
Investors and industry observers say some LPs felt they were forced into the REIT when they just wanted out.
Sherman, for example, claims he declined to vote on conversion, yet his abstention was recorded as a yes. The limited partner, part of a team that invested $250,000 in two S2 deals, expected to exit the “bad” one, bought in 2018, in a matter of years.
The REIT required two-thirds of investors to sign off on conversion for a deal to go in, the source said. S2 scored hard yeses from an overwhelming majority of investors, the source added.
Sherman said he now has to wait until 2028 to submit a redemption request to the REIT.
“It’s a 10-year investment with these people,” he said. “I’d rather just get wiped out and not have to deal with it, frankly.”
A letter circulated to mezzanine investors in the Phoenix-area asset Oxford Apartment Homes similarly urged LPs to invest an additional $11 million into the REIT for the deal, which was worth the loan balance, through the founder’s shares.
If they didn’t invest, S2 would sell, wiping out investors.
S2 did raise the $11 million, the source said. Most of it went to paying down Oxford’s loan.
What’s it really worth?
Everett has built himself a runway to ’25 and beyond. The clincher for S2 is a two-parter: refreshing properties and finding tenants to pay higher rents; then, attracting capital to spend in new deals over the next three years of the REIT’s life.
The firm aims to deploy $500 million annually to buy about 5,500 units each year from 2025 to 2027, investor documents show, in what would be a Herculean feat considering S2’s historical performance. That amount in equity shakes out to between $1 and $2 billion in deal volume, depending on leverage. By comparison, Equity Residential, one of the nation’s largest landlords, did $1.2 billion in deal volume last year, according to CoStar data shared with The Real Deal.
“That’s a lot to put out, especially with smaller properties,” the investment fund manager said of S2’s game plan. “He would have to be doing some big stuff.”
The source familiar with the REIT countered that S2 wants to do $500 million in deals a year — debt included — to the tune of 2,500 units, which aligns with its typical pace.
Either way, S2 will tweak its game plan when it starts buying again, trading value-add investing for core-plus: newer properties that will be immediately profitable, according to investor documents.
Class A is the new black for Sun Belt syndicators hoping to distance themselves from the value-add game. Tides, for example, said it was eyeing the asset class about the same time it tried and failed to buy a newly developed building in Phoenix after an equity investor pulled out. The thesis is that the record-breaking deliveries for 2024 will suppress pricing in the short term, but when new deliveries fall off a cliff, more demand will boost rents. Purchasing a new multifamily development below replacement costs is the first move.
Whether S2 scales will affect investor returns, particularly for those who bought founder’s shares, effectively doubling down on S2. If the REIT hits its mark, LPs that threw in for founder’s shares make 2.5 times their money; if it doesn’t, they come in just shy of 2x, investor documents show.
But as of mid-October, S2 had yet to find any newer multifamily priced right for investment in markets where rents are also poised to grow, the source said.
The bigger variable for investors is whether S2 can not only fund and finish renovations, but also raise rents in markets where organic growth has slipped and tenants are struggling to pay.
S2 may have a shiny new REIT at its disposal, but it still has to execute its value-add plan, the same as other syndicators, to keep investments afloat and make conversion worth it. It also needs the market and interest rates to move in its favor; there have to be buyers that support the values S2 thinks it has achieved.
Otherwise, it could have a rash of redemption requests on its hands and no liquidity to fulfill them, a problem even the source familiar with the REIT acknowledged when asked what could go wrong.