One of Canada’s largest owners of apartment buildings and multifamily properties is struggling to turn around two funds that bet on U.S. rental housing, with higher rates and an oversupply of new units eating into profits.
Starlight Investments, run by Canadian real estate magnate Daniel Drimmer, launched two funds that invested in U.S. rental properties during the COVID-19 pandemic with hopes that rising rents and low interest rates would keep sending property values soaring.
By November, 2022, however, the two publicly traded funds, known as the Starlight U.S. Residential Fund and the Starlight U.S. Multi-Family (No. 2) Core Plus Fund, faced some significant headwinds, and both halted their distributions because higher interest rates had sent their mortgage costs soaring.
The pain has only worsened since, and this week both funds reported negative funds from operations in 2023, which is a measure of profit for real estate investment funds. Not only have elevated interest rates continued to weigh on profits, because the funds’ mortgage costs have jumped, but there is now also a growing supply of multifamily properties in the markets in which the funds have invested, including cities such as Phoenix, Orlando and Austin, Texas.
Because interest rates have soared, last year the U.S. Residential Fund’s weighted average interest borrowing cost climbed to 5.78 per cent, up from 1.97 per cent in 2021. At the same time, the completion of new rental properties has hurt rental prices, and the fund’s average monthly rent fell 0.4 per cent last year.
“The primary markets in which the fund operates in have seen an elevated level of new supply delivered during 2023 which contributed to the deceleration in rent growth in the primary markets during late 2023,” Starlight told investors when reporting earnings.
Starlight also explained its U.S. funds are particularly vulnerable to higher interest rates because the fund largely relied on variable rate debt.
Starlight owns roughly $25-billion worth of properties across Canada and the U.S., and its two publicly traded funds that focus on U.S. rental properties have $1.1-billion in assets under management. Both U.S. funds were set up to buy American properties that could benefit from rental rate increases as tenants turn over, and they were designed to be short-term investment vehicles that bought properties and then sold them after three years.
Because the market dynamics have changed so quickly, both funds’ unit prices have plummeted since going public in 2021 and are now down nearly 70 per cent.
Their struggles mirror those of Starlight’s third publicly traded investment fund, True North Commercial REIT, whose units are down nearly 80 per cent since February, 2020. True North largely owns Class B office towers across Canada and last November the REIT halted its monthly distribution, just like the two U.S. funds.
Starlight’s short-term strategy has worked before, and its U.S. Multi-Family (No. 1) Core Plus Fund sold its portfolio in September, 2021, and investors earned a roughly 28-per-cent return in less than two years. However, Starlight was eventually caught off guard by the magnitude of interest-rate hikes.
“The size and pace of interest rate increases has been unprecedented and has resulted in interest rates that are significantly higher than projected at the time the fund financed its properties,” Starlight told investors when it first halted distributions on its two existing U.S. funds.
Starlight isn’t the only Canadian real estate manager to struggle with U.S. rental housing. Dream Residential REIT went public in May, 2022, hoping to capitalize on rising rents, but its units have also fallen, down 50 per cent.