Investment Overview
In June of 2005, Croatan Investments closed on Audubon Parc, a 180-unit garden-style apartment community located in Cary, NC. This Class A physical asset was purchased below replacement cost with 40% of the units operating as furnished corporate housing with rentals as short as one night. With Croatan Investments acting as property manager, the business plan entailed growing the corporate housing revenue and leveraging high operating margins to drive NOI growth and value creation.
Challenges
Croatan was unprepared to serve as the property manager for the corporate housing units. These units effectively operated as an extended stay hotel with very high turnover and a complicated pricing model, which was driven by a “black box” software that was designed for the hospitality industry. The sales effort for the corporate housing units was also more time-intensive than anticipated. Creating and maintaining corporate client relationships consumed a lot of the available bandwidth from our leasing and marketing team. During the Global Financial Crisis, corporate travel declined dramatically and the occupancy of the corporate housing units went from 75%-80% down to 30%-50%. The property NOI suffered as a result, and our debt service coverage ratio approached 1.0x. Additionally, by 2009, the the furniture package for our corporate housing units became outdated, and we lacked the working capital to upgrade the furniture.
Solutions
Croatan gradually de-furnished the corporate housing units and converted the asset to 100% traditional rental housing. Occupancy recovered, and we were able to stabilize operations and generate cash flow. At the same time, we wound down our in-house property management division and converted to a pure play asset management structure across our platform. We sold the asset in 2015 and generated a gross IRR of 11.08% and gross equity multiple of 2.20x on a 9-year hold.
Lessons Learned
▪ Croatan now works exclusively with third-party property managers, evaluating and selecting best-in-class teams based on project and market competencies.
▪ We should have been more aware of the operational challenges of owning and managing corporate housing units that had a short-term stay component. Today we better analyze challenges like this in our underwriting.
▪ We failed to budget the need to upgrade our FF&E package in the corporate housing units to maintain our competitiveness with the market.
▪ Moving forward, we are wary of investments that deviate from our core-competency as multifamily/rental housing specialists.