Three  Arch  Investors  Quarter  Newsletter        July  2013          The  second  half  of  2013  marks  a  rather  significant  change  in  the  residential  housing  market:  distressed  

properties  have  been  mostly  absorbed.  The  foreclosure  wave  -­‐  which  began  in  2009  -­‐  is  now  in  a  clear  and  distinct  downtrend.    In  fact,  all  the  distressed  housing  funds  that  raised  capital  in  the  past  12  months  have  experienced  an  inability  to  find  product  at  acceptable  margins.    Fund  managers  are  

changing  their  mandates  to  hold  properties  for  three  to  five  years  because  they  can  no  longer  quickly  resale  or  “flip”  the  homes  -­‐  as  was  the  norm  in  the  previous  three  years.    The  completion  of  this  cycle  is  simply  a  logical  next  chapter  as  we  move  from  “over  supply”  to  “lack  of  supply.”  This  situation  demands  

a  fundamental  change  in  business  models.    Over  the  past  three  years,  Three  Arch  Investors  has  created  five  separate  funds  that  purchased  REO  and  

foreclosed  residential  homes  in  the  Western  United  States.    Our  five  funds  have  generated  average  net  returns  in  the  mid-­‐teens  for  our  investors.    However,  beginning  in  March  2013,  we  found  it  increasingly  difficult  to  maintain  both  margins  and  timely  possession.    This  led  us  to  conclude  that  the  flipping  model  

has  run  its  course.    Due  to  new  consumer  protection  acts,  we  have  noticed  changes  in  financial  institutions’  policies  that  increase  investors’  risks  and  exposure  by  attempting  to  sell  homes  via  quit  claims  and  deed  assignments.    The  downtime  for  dealing  with  the  eviction  process,  coupled  with  the  skill  

of  defense  attorneys  in  prolonging  evictions,  has  lengthened  the  time  period,  causing  costs  to  accelerate  at  the  same  time  margins  are  squeezed.      

While  we  have  had  a  95%  success  rate  in  our  home  flipping  programs,  in  the  current  environment  we  are  fairly  sure  that  the  odds  of  success  have  substantially  changed.    We  simply  are  not  comfortable  with  the  level  of  risk  that  banks  demand  investors  should  assume.    We  have  therefore  moved  most  of  our  

funds  out  f  the  flipping  model  and  will  monitor  the  banks’  REO  program  towards  year’s  end.    

Many  investors  were  caught  off  guard  and  are  quite  surprised  that  we  are  now  experiencing  housing  shortages.    We  see  three  reasons  for  these  shortages:      

1)  Although  family  formation  was  postponed  during  the  downturn,  we  now  have  a  substantial  number  of  22-­‐27  year  olds  leaving  their  parents’  homes.    This  has  resulted  in  increased  demand  for  both  multifamily  and  first-­‐time  housing.    

 2)  Investors  who  have  rented  single  family  homes  have  been  absorbing  significant  inventory.    

       3)  Over  the  last  five  years,  production  of  new  housing  was  off  by  60%.    Homebuilders  are  once  again  gearing  up  -­‐  permits  have  gone  from  a  low  of  360,000  annual  units  to  a  projected  800,000  in  2013.  

However,  even  with  that  substantial  recovery,  builders  cannot  meet  the  demand  of  the  coming  housing  shortage  due  to  the  delays  in  getting  actual  housing  permits.  

 On  June  25th  the  monthly  S&P/  Case  Shiller  Index  reported  their  strongest  uptick  since  2006.    Mr.  Shiller  indicated  on  CNBC  that  he  believes  house  prices  will  continue  to  rise  throughout  the  next  12  months.    

Given  this  information  and  its  potential  impact  on  portfolios,  investors  should  understand  how  they  can  best  profit  from  a  strong  housing  recovery.    

While  we  believe  housing  markets  will  always  be  subject  to  boom  and  bust  cycles,  it  is  very  advantageous  to  be  a  participant  in  the  early  part  of  any  recovery.    Three  Arch  Investors  has  over  35  years  of  experience  navigating  these  cycles.    We  believe  we  are  in  a  clear  transition  that  requires  

investors  to  move  out  of  distressed  funds  or  bond  funds  and  to  allocate  a  portion  of  capital  to  the  production  of  new  residential  housing.    It  is  clear  that  Private  Equity  and  Opportunity  Funds  will  shortly  move  to  this  model.    This  is  simply  the  next  logical  step,  given  that  we  have  absorbed  most  of  the  

surplus  housing  inventory  or  altered  the  usage  pattern  from  ownership  to  rentals.      We  have  seen  a  moderate  spike  in  yields  that  will  likely  result  in  10-­‐year  bonds  hovering  close  to  3%  

over  the  balance  of  the  year.  In  addition,  with  job  formation  and  GNP  growth  muted,  housing  is  one  of  the  bright  spots  in  this  current  evolving  recovery.      In  most  markets  we  are  experiencing  the  first  signs  of  home  values  approaching  their  replacement  cost    -­‐  which  allows  builders  to  compete  with  new  product.  

Historically,  new  housing  has  always  done  well  when  there  is  a  close  alignment  between  existing  values  and  new  construction  prices,  primarily  because  the  public  usually  prefers  the  latest  and  greatest.    Based  on  recent  survey  of  20  metropolitan  areas,  we  expect  most  cities  will  reach  parity  in  the  next  18  months.  

According  to  the  May  report  by  the  Commerce  Department,  new  homes  sales  are  up  a  seasonally  adjusted  2.1%  with  production  of  roughly  476,000  new  homes.    This  is  the  highest  rate  since  2008  –  yet  still  50%  below  the  normal  production  of  the  1990-­‐2006  period.    

 This  information  strongly  suggests  that  redeployment  of  capital  towards  residential  housing  in  the  United  States  will  be  rewarded  with  outsized  returns.    We  believe  that  our  latest  Fund  is  a  timely  and  

compelling  investment  that  will  focus  on  financing  and  partnering  with  proven  residential  builders.    We  will  be  participating  with  developers  that  have  well-­‐located  land  parcels  purchased  below  today’s  values  that  require  equity  capital  to  finish  their  entitlements.    Our  objective  is  to  balance  the  potential  for  

current  income  with  future  long-­‐term  capital  gains,  which  we  believe  can  still  produce  mid-­‐teen  returns.    

       If  you  desire  to  move  out  of  bond  funds  in  a  likely  rising  interest  rate  environment,  while  reducing  your  exposure  to  stocks  which  have  risen  over  145%  since  the  2009  bottom,  we  strongly  suggest  

directing  a  portion  of  your  investment  funds  toward  residential  housing.    The  housing  recovery  is  just  beginning  and  offers  both  current  income  as  well  as  projected  capital  gains.      

 Please  consult  your  advisor  regarding  this  program,  as  this  newsletter  is  not  intended  to  be  a  solicitation  nor  a  recommendation.    Three  Arch  Investors  sponsors  real  estate  funds  for  accredited  

investors  only,  and  any  information  contained  herein  is  not  intended  for  the  general  public.    Please  consult  with  your  own  advisors  to  determine  the  suitability  of  investing  in  real  estate  funds.      

Please  visit  www.threearchinvestors.com  to  read  a  number  of  articles  that  support  our  position,  with  well-­‐known  investors  such  as  Sam  Zell,  Warren  Buffet,  Dan  Loeb,  John  Paulson,  Leon  Black,  and  many  others  publically  calling  the  housing  bottom  and  recovery.    Please  feel  free  to  contact  us  for  additional  

information  on  our  upcoming  Fund.