2022 Year in Review and 2023 Outlook

Cross Mountain Capital is coming off a strong year, eclipsing $100 Million in assets under management in combination with our property management affiliates. Our growth has come at a time of great dislocation in equity, debt and real estate markets. Notwithstanding the deterioration in asset prices that occurred starting in the summer of 2022, we facilitated two successful exits on smaller multifamily buildings for an average 68% deal level IRR and locked in a refinance with attractive agency debt on a 54 unit repositioned asset in Denver implying a?27% IRR at re-appraisal. Our fixed debt cash flow deals outperformed with double digit annualized cash on cash returns across three deals (about 250 units).

We did not anticipate the Federal Reserve would end an era of low rates in the swift, forceful and abrupt manner that occurred. Notwithstanding, our focus on affordable housing, heavy value-add properties, growth markets, and most importantly, acquiring below market price, has allowed us to navigate the financial storms and outperform. While we don't factor in growth or market cycles in our underwriting, we believe 2023 will be a rare opportunity to buy assets at a deep discount before the Fed begins to pivot and restart the asset inflation cycle.

2022 Review

Summary

In 2022, we were active with?acquisition, refinance and sales, including acquiring three new deals totaling over 300 units?(two buildings in Colorado and a portfolio in Vermont).?Our affiliated property manager, 3GEN Real Estate, repositioned two smaller third-party assets in Colorado Springs to go full cycle for a average 68% IRR across these two deals:

• Fontmore Apartments (10 units) was acquired for $1.46 million in October 2020 and sold in July 2022 for $2.2 million. This exit resulted in a deal level 52% IRR and 2.14x equity multiple over a 21-month hold period.
• The Elms Apartments (12 units) was acquired for $1.455 million in May 2021 and sold in September 2022 for $2.2 million.This exit resulted in a deal level 83% IRR and 2.14x equity multiple over a 15-month hold period.

We also locked in a refinance for a 54 unit in a Denver Suburb -?Sloan’s Lake West, to exit our high leverage (88%) floating bridge loan and replace it with long term agency debt at a fixed 5.4% and 35 year amortization. The appraisal during refinance implied a 27% deal level IRR (Acquisition cost: $10 Million, appraised at $12.4 Million with remaining value-add).

Our cash flowing deals with fixed debt continued to outperform with double digit cash-on-cash returns delivered on three deals out of the gate. We have two buildings?across Colorado (about 250 units) in the middle of a reposition, and the execution remains on track and on budget.?

In addition, in 2022 we fully integrated across markets and created new websites for our affiliated property management entities -?MSA Properties?(Vermont, New Hampshire) and?3GEN Real Estate?(Colorado).We continue to scale our property management business with over 800 new units on-boarded in?2022.?

?2023 Outlook

Wage Inflation Continues for Class C and B Tenants

Despite the economy heading towards recession, with headlines of big tech firms slashing hiring and downsizing coming across daily, the experience for blue collar workers has been quite different. The demand for labor has been very strong, and workers at companies like Trader Joe’s, Starbucks, and Amazon have been striving to unionize while commanding higher wages than pre-pandemic. Many of our tenants are from this demographic; working people in blue collar or low-level white collar jobs who cannot afford (or choose not) to spend on expensive Class A rentals but still want a renovated, clean, well-managed place to live.??

When wage inflation starts, it’s hard to stop: While the definition of?“tight labor market”?varies, wages and salaries increased 5.1% for the year ended September 2022 and 4.2% for the year ended September 2021, according to the?U.S. Bureau of Labor Statistics.

?Multifamily Outlook

We continue to focus exclusively on value-add class B and C multifamily in our markets where we are vertically integrated. Al Brooks, Head of Commercial Real estate at JP Morgan notes:?“Multifamily is currently the highest performing of all asset classes.?As of the third quarter of 2022, multifamily vacancies are at 4.4%—a five-year low. Multifamily owners and investors aren’t immune to cost increases. But they can adjust rents annually—sometimes even monthly—to account for market changes….Demand for affordable and workforce housing far outweighs supply and continues to offer ideas for how commercial firms can fill this need.?Because the cost of development is high, especially in this high interest rate environment, the systemic supply shortage for affordable housing will not be addressed for a long time.?When interest rates are lower and the Fed is accommodative, perhaps more affordable housing will start to get built…with 3 year lead times.”

The type of properties we buy are considered affordable.?For example, one of our properties Sloan’s Lake West in the desirable Denver suburb, recently qualified for a 35 year amortization period on an agency loan due to being affordable, according to their definition.?This allowed us to get maximum proceeds and proves how affordable our renovated rents are, an ideal attribute in an adverse economic climate.

Negative data points have many potential buyers on the sidelines.?Softening absorption and vacancy moving up point to a weakening outlook for real estate, which will will result in significant price softness in 2023. Operators who financed with bridge debt will be in big trouble if they did not execute on their strategy. This has tended to be the case more often than not, as inflation and labor shortages posed significant challenges to execution. We?have been able to overcome these challenges through vertical integration and being able to control our costs and speed of execution.

We continue to be net buyers and believe 2023 will present significant opportunities.?We would rather buy properties at lower valuations and higher rates as it creates room for organic appreciation by establishing a low basis at the nadir of the cycle. We don't factor in organic growth or count on market cycles, but anytime you get one of these dislocations we believe it is generally a good time to buy at discount. Opportunity exists to find well priced properties in locations that are somewhat insulated from recessions and that can be repositioned to class B affordable, housing.?These high value-add deals are the low risk, high reward plays that will benefit from good execution, performing well in an adverse environment, and participating well in the upside from a potential Fed pivot and asset re-inflation.

Macro Outlook and Re-inflation

Our outlook is that the macro picture is worsening as the restrictive rate environment takes its toll with several indicators, including?Baltic Dry Index, US Services PMI, Auto Sales, Housing, Philly Fed New Orders and the Copper to Gold Ratio,?pointing to recession on the horizon, which many economists expect to arrive between second quarter 2023 and early 2024.?As this happens, we believe the roadmap for the Fed’s response will be similar to 2001, which was the last time there was an inflationary environment followed by deflation.?As the economy deteriorates, and deflation replaces inflation, the Fed will be forced to pivot quickly and start lowering rates to avoid systematic breakdowns.?The below chart of the Fed Funds rate for the past 25 years demonstrates that when the Fed pivots, they bring rates down hard quickly, and stay accommodative for an extended period. It is is during this period that asset price inflation occurs.?

We continue to focus on assets with significant value-add trading at a discount in Colorado Front Range as well as in our high cash flow New England markets where we are vertically integrated. Though the near-term outlook for the economy is cloudy, our ability to source quality deals at below market prices allows us to take advantage of the low current demand and cherry pick great assets trading at a discount with strong fundamentals and value-add potential.?We are seeing many more opportunities than we have seen in the last 5 years. We are currently wrapping-up a 350 heavy value-add portfolio in Colorado Springs over several closings.?Please don't hesit