Cypress Capital sees low-cost debt bolstering yields for US condo strategy

Cypress Capital Group is seeing opportunities to acquire excess condo units in New York and ground up developments in Silicon Valley, a strategy that benefits from abundant low-cost debt that it believes will help bolster returns its newly launched real estate private equity fund.

Acquiring excess condo units, already a strategy for Cypress Capital, became increasingly attractive due to the impact of covid-19 on sales. In 2020, closed transactions for condos plummeted, reaching roughly 7,000 sales, totaling around $14 billion. In comparison, 2019 saw 11,673 transactions and nearly $24 billion in sales, according to a survey by CityRealty.

Wen Shiau, a managing partner and founder of the single-family office, told Real Estate Capital USA that there’s a chance to acquire excess inventory at a discount. But determing the right amount of leverage could have a significant impact on returns.

At an 80 percent loan-to-cost, the capital’s senior debt costs about 7.5 percent. But this drops significantly with leverage, Shiau said.

“This is how we look at debt,” Shiau said, noting that the firm’s cost of euqity is between 20 and 30 percent. “If I want to go to 80 percent loan-to-cost, the cost of my capital is 7.5 percent [for] senior [debt]. Now, if I want to go 65 percent loan-to-cost, the cost of capital could be 4 percent – that’s almost cutting it in half – so then you ask, ‘How valuable is this leverage to you?’”

Even so, the company’s cost of capital for debt is much lower than for equity, which Shiau pegs at 20-30 percent.

“The cost of equity capital is expensive but the cost of debt capital is at worst 7.5 percent, so I’d rather borrow as much as I can at 7.5% than do equity.  However, excessive leverage can wipe us out in a downturn, and we balance return and risk by targeting 70 percent LTC,” Shiau said.

The company has different strategies for New York and Silicon Valley.

“In New York, we buy completed condos and use 100 percent of the loan on day one, [whereas] in Silicon Valley, we do ground-up construction and the loan is drawn down over time. Over half of the loan is in the back-end of the 12-month construction period,” Shiau said, noting that this means that its Silicon Valley loans are more expensive during the second half of the term.

New York dynamics

Cypress believes the current issues in New York are more related to oversupply than fundamental demand problems, with the city seeing excess inventory for the past six years. The units will be absorbed, but at a slower pace due to the slowdown, Shiau said.

“This is when you should start looking for deals,” said Shiau. “While the underlying economy is going well and there’s only a supply issue, you know the supply will be absorbed eventually – and we believe New York will do well over the long term.”

The firm recently bought a condo in Brooklyn Heights after assessing and underwriting one hundred construction sites and viewing 20. “We made some offers for three and closed on one – so we do a lot of work just to buy one asset, and we aim to do more of these types of deals, hence we are in capital-raising mode,” Shiau said.

The firm is raising capital for its fourth private equity real estate fund, which will target single-family and multifamily properties.

Thoughts on location

There are many conversations being had about people moving from key cities, New York being one, to the suburbs in search for cheaper living costs and better work-life balance. But Shiau firmly disagrees.

“People that left New York, half of them came back – and the ones that didn’t, they did not go to Florida. They went to Hudson Valley and the outer boroughs of New York,” Shiau said.

Shiau stressed that while London and Hong Kong once sat alongside the Big Apple as financial hubs of the world, certain economic and political factors have put New York in the limelight.

“London has entered Brexit, Hong Kong has a lot of political risk, and so on a relative basis, New York looks even better now – so when we look at where the value is, this is important,” he said.

However, for many institutional investors, New York and California are no-go zones. “I talked to the acquisitions development teams in some of the biggest funds out there, and they would prefer to do deals in Charlotte, Raleigh, Atlanta, Austin, in tier two cities that are cheaper,” Shiau said. “[Warren] Buffett has said that the best time to do a deal is when one is the only buyer in the room – [and] we were often the only buyer in the room in New York. There remains a lot of shadow inventory of which we can still take advantage.”