With rising construction costs, supply chain disruptions, labor shortages and a rising cost of debt for construction loans all expected to pose strong headwinds to new construction for the rest of 2022 and into 2023, a value-add strategy of buying older multifamily properties and renovating them is proving to be a lower-risk path to solid returns.

DB Capital Assets, a Playa Vista, CA-based company with more than $500M in AUM, specializes in acquiring and operating multifamily properties in submarkets it has strategically targeted after closely analyzing market conditions.

In November, DB Capital put its bullseye over San Antonio, where it had projected steadily increasing demand—including a surge of in-migration—and limited supply of quality multifamily rental homes, which turned out to be an accurate description of the market in H1 2022.

DB Capital moved aggressively into the San Antonio market, acquiring 1,864 multifamily units in two acquisitions. In June, the company acquired ReNew TPC, a 408-unit garden apartment complex with 18 three-story buildings that opened in 2007 in a central neighborhood near some of the largest employers in San Antonio.

DB Capital’s strategy in San Antonio involves acquiring an asset in an exceptional location at a purchase price well below replacement cost and upgrading it with renovations to a quality level consistent with new developments, at a more competitive price point.

Before buying the property, the company closely examines the cost of new construction in the market and as well as future construction pipeline expectations.

“As value-add investors, one of our primary hedges to future supply is buying well below what a developer would be able to deliver a project at, because it means our rents are better, but not completely, insulated from softness or absorption issues related to significant changes in the delivery pipeline,” DB Capital CEO Brennen Degner told GlobeSt.com.

“We generally see relatively comparable underwritten returns for our value-add projects when compared to where ground-up developers are solving to. Maybe +/-200bps of projected return in favor of ground up projects,” he explained.

“We take the position that the return delta is not sufficient to mitigate the incredible difference in risk profile. From a risk-adjusted perspective, acquiring existing projects with a value-add component is a much better position to be in.”

DB Capital’s aggressive portfolio expansion in San Antonio has a two-year timetable, designed to rapidly build economies of scale.

“The advantages of building economies of scale in a market are extensive. It allows our construction and management arms to build a deeper, more reliable bench of labor and vendors, and it allows us to purchase and store materials in larger quantities, reducing overall costs,” Degner said.

Having scale in the market also allows DB Capital, which standardizes the materials it uses across its portfolio, to hedge the current supply chain issues by proactively buying in the largest quantities possible, he added.

We asked Degner if he is counting on rising construction costs, supply chain disruptions and labor shortages to hold down deliveries of new multifamily units while the company executes its rapid portfolio expansions.

“We see the rising construction costs and supply chain issues having a very significant impact in a market like San Antonio that still has on average a more affordable rent profile,” he said, adding that in markets with higher rents, like Austin, developers can cover their construction costs buy building higher-end units that command higher rents.