Chimney Hill Case Study - Piping Rock Partners

Demographic Data Look Backward, But Investors Must Look Forward

The Chimney Hill Story

We patiently and persistently negotiated the purchase of Chimney Hill over the course of many months. Ultimately, we were able to purchase the property 25% below the asking price and far below replacement cost.

After 10 years, 100% of initial equity capital was returned using tax-deferred refinancing proceeds, and the refinancing also generated a substantial tax-deferred profit. From closing through December 31, 2022, Chimney Hill has generated a net annualized return to investors of 21.50%* vs. a 8.57% return from the FTSE NAREIT Equity REIT Index over the same period.

The Opportunity

Chimney Hill was part of a real estate portfolio owned by an Ohio-based family investment office. Their investment strategy eventually changed, and the real estate portfolio was listed for sale. Chimney Hill had an uneven operating history, and it was located in a market that was then very weak. Ultimately, the entire portolio was sold except for Chimney Hill, and the family then became an even more committed seller of this property. This allowed us to negotiate very favorable acquisition terms for Chimney Hill.

We liked Chimney Hill because it was located in the middle of a growth corridor along I-75 between Cincinnati & Dayton. It was also a uniquely designed asset with good construction quality, and it was well-located within its submarket. In addition, although it was a smaller property, it had an on-site leasing office and a full-time on-site manager. This allowed us to underwrite the purchase inclusive of all management costs, including salaries, and to manage it remotely.

The Problem

Chimney Hill was located in a distressed market dominated by a steel mill whose management had locked out their union labor. The steel mill was the town's largest employer, but its future was in doubt. In addition, while growth was readily apparent along the I-75 corridor, this growth had not yet reached the general area around Chimney Hill. Furthermore, the decades-long decline in Ohio's manufacturing economy resulted in very poor state-wide demographics, and this caused Fannie Mae to designate the entire state as a "Pre-Review" market.

This meant that DUS lenders could not offer any agency debt quotes without first obtaining formal written approval from Fannie Mae. This made all lenders cautious, including local bank lenders such as Key Bank, and these local banks would often refrain from lending without full personal recourse. However, if we had allowed ourselves to be distracted by this market's poor demographic data and the financing challenges this created, we would not have been able to see around the corner toward its future promise.

What We Did

The lack of liquidity in Ohio at the time created a buyer's market, and this enabled us to negotiate very favorable acquisition terms that would almost fully protect our downside. On the other hand, owning the property meant that we could participate in the recovery upside we envisioned. Our favorable purchase price gave us a nearly free option on the latter, and since we were patient capital, time was on our side. In addition, thanks to our capital markets experience, we were able to place the debt directly with a CMBS conduit at nearly full leverage with no recourse whatsoever. This increased our return on equity and lowered our risk.

After closing, we increased occupancy from 85% to 95% almost immediately. Ultimately, we were able to increase NOI by over 80%, and this allowed us to refinance the original CMBS debt with new FNMA debt on more favorable terms. The refinancing returned 100% of initial equity capital plus a significant tax-deferred profit. Most important, we accomplished these results in a market that many thought was stagnant at best.

Epilogue

In 2008, two years after we purchased Chimney Hill, Forbes published an article entitled "America's Fastest Dying Towns." To compile their list of the fastest dying towns, Forbes used U.S Census Bureau data from 2005-2007 ranking income growth, the rate of domestic in-migration, the change in poverty levels and the percentage of the local population with advanced degrees. The article was a top ten list, and our town and its poor demographic data were featured prominently.

Ironically, the article and the data it relied upon failed to predict the turn around that was already underway. Today, the steel mill is contributing to record revenues at its parent company, the I-75 corridor is burgeoning with new growth, Intel just announced the largest single private-sector investment in Ohio history, and the Cincinnati MSA is posting its strongest demographic data since 1950.

We are now on track to grow NOI at Chimney Hill by another 70% simply due to the strengthening local economy, and we are preparing to refinance Chimney Hill's mortgage once again. The strong local economy gives us great confidence, and we will be reinvesting a significant portion of the proceeds into the long overdue and highly accretive exterior upgrades shown below. These investments will allow us to future proof the property and take it confidently into the next stage of growth.

Exterior Prior to Renovation