Star Metals is a $6 million preferred equity real estate investment that is part of our IncomePlus Fund, an investment designed to deliver stable, passive income and appreciation. This multifamily development is located in the West Midtown submarket of Atlanta, Georgia, and will feature 409 Class A apartment units and 16,200 square feet of ground-floor retail space. The project is expected to be completed in 2021. We were motivated to participate in Star Metals due to its protected basis, high expected return, seasoned development team, and desirable location.
Preferred equity investments provide stability and protection in today’s real estate market environment because of its consistent interest rate payment and its position in the capital structure. As banks become more conservative with their lending, opportunity lies in providing a source of equity in projects that we ourselves would be open to owning if necessary. We target a position of 60% to 80% in the capital structure, providing a 20 – 40% cushion to loss.
Star Metals occupies the capital stack from 68% to 74%, sitting behind $88 million of senior bank financing and ahead of $34 million of equity provided by the sponsor, The Allen Morris Company. This means that, should something go wrong, the project can lose $34 million before a penny of the Origin IncomePlus Fund’s investment is at risk. Additionally, the developer’s projected profit on a project like Star Metals is roughly $25 million, so the project’s value would have to decline 42% before our position would be at risk.
Star Metals generates roughly 15% per year or $950,000 for the IncomePlus Fund on an accrual basis. This means the interest on the $6 million is not paid until the sponsor refinances the property upon completion of construction. Structuring the interest payment in this way allows Origin to take advantage of compounding, considerably increasing our return. We are comfortable with this structure because we are partnering with a seasoned developer (see more information about them below) and have underwritten the deal just as we would if we were the equity investor, but with a 42% cushion. This structure also allows the investment to be treated as a long-term capital gain, rather than ordinary income.
Seasoned Development Team
Reputation and history are crucial in choosing an investment partner. The sponsor of Star Metals, The Allen Morris Company, is a commercial real estate leader that has been in business since 1958. The firm is one of the largest diversified real estate firms in the southeast and has executed $6 billion of real estate transactions comprised of 80 successful and award-winning developments. Star Metals was also brought to us through one of our longstanding relationships.
A property’s location within each city and submarket is extremely crucial for success. The West Midtown submarket has transformed into one of the hottest neighborhoods of choice in Atlanta for the cosmopolitan demographic seeking a location conducive to community connectivity and walk-ability. The area is composed of warehouses and industrial space redesigned as urban residential lofts, creative offices, art galleries, live music venues, retail, bars, and restaurants. Star Metals is located only 5 miles northwest of the area’s central business district, offering an unrivaled residential experience due to its proximity to jobs, fine dining establishments and bars.
How Star Metals Impacts the IncomePlus Fund
The Origin IncomePlus Fund has performed as we have expected it to despite the current real estate market uncertainty due to the COVID-19 pandemic. Our preferred equity positions like Star Metals are protected in high-quality assets and continue to perform well. As a Fund manager, we can tactically adjust our strategy based on the current market conditions. Today, this opportunity leans towards preferred equity investments like Star Metals, allowing us to accomplish our number one priority of protecting our investor’s capital.