The Legacy Letter

On September 30, LRHM completed the initial closing of Fund VIII. At closing, investors’ capital was deployed into four performing seed investments acquired for approximately $124 million, putting capital to work from day one.

Each seed investment carries either fixed rate debt or an interest rate cap, which helps protect debt service costs as rates rise.

We anticipate at least one to two subsequent closings over the next 12 months. If you would like to learn more, please reach out to Preston Hoge or David St. Pierre.

For most of the past year, the conversation in real estate capital markets centered on when interest rates would finally come down. The Federal Reserve’s decision last month to raise rates for the first time since 2023 has changed that conversation. Rather than trying to predict the next move, we think the more useful question is what today’s environment means for apartment values, existing owners, and the opportunities available to well capitalized buyers.

Although the Federal Reserve receives most of the headlines, real estate borrowing costs are influenced more directly by Treasury yields. As Treasury yields rise, debt becomes more expensive and investors generally require higher returns from real estate.

That yield matters because real estate competes with other investments for capital. If an investor could earn 5% on a U.S. Treasury with very little risk and no operating responsibilities, a 5% yield on an apartment property would not be particularly compelling on its own. Real estate investors generally require additional return to compensate for property level risk, illiquidity, and operating complexity.

The cap rate, however, represents only the property’s current income yield, not the entire expected return. Investors may accept a relatively lower going in cap rate when they expect NOI growth, operational improvements, value creation through renovation, tax benefits, or appreciation.

Still, when Treasury yields rise, required real estate returns generally rise as well. All else being equal, that puts upward pressure on cap rates and downward pressure on property values.

The more significant issue today may be the financing attached to properties acquired several years ago.

A large volume of apartment loans will mature between 2026 and 2028. Many were originated when interest rates were substantially lower and, in some cases, relied on short term or floating rate debt and aggressive rent growth assumptions.

As those loans mature, owners may have to contribute additional equity, refinance at a materially higher cost, sell, or return the property to the lender.

Importantly, that does not necessarily mean the real estate itself is underperforming. In many cases, a fundamentally sound apartment community simply has a capital structure that no longer works. Those are precisely the situations we find interesting.

At the same time, higher financing and construction costs are slowing new apartment development. We are not underwriting a dramatic rent recovery, but reduced new supply should improve the competitive position of existing, well located communities over time.

Our approach is straightforward: underwrite to today’s environment rather than assume lower rates or higher property values will create the return.

We are using conservative rent assumptions, underwriting exit cap rates above purchase cap rates, favoring fixed rate and longer term financing with moderate leverage, and stress testing acquisitions at Treasury yields at or above current levels.

We remain focused on apartment communities of 150 to 350 units, particularly situations where an owner faces near term financing pressure. Our vertically integrated property management and construction capabilities also allow us to focus on what we can control: operations, renovation execution, and cost management.

We believe this is an environment where disciplined underwriting, patient capital, and strong property level execution matter more than trying to predict the next move in interest rates.

As always, we welcome the chance to talk through what we are seeing.