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Multifamily vs Treasury/MBS


Gregmal
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3 hours ago, Gregmal said:

haha yea thats a good question. Best guess would be that "glut" is a subjective term, there is limited supply of buildable space in desirable markets, and sandwiched in there somewhere is the fact that people want to live in decent areas. But thats just a guess. Similar things have been said about warehouses. Which are even more glaring and something that by and large Ive missed as an investment opportunity. But why cant you just build that to wazoo? Relative to building an office tower or even a multi family campus, throwing up a warehouse is easy. Of course theres zoning and permits and all that shit, but same question applies. 

 

In the dense urban areas, warehouse traditional has the "flour" that multi-family developers turn into "bread"  So in cities in NYC, SF, and SoCal, warehouse and warehouse land is actually being depleted.  That's why urban warehouses trade for, gasp, 2.5% cap rate.  I know that's crazy.  But if you have 4% cap upon lease renewal in a market with supply depleting, it may not be all that crazy.  Add in the fact that warehouses have much lower cap ex than MF and Offices, more of the NOI dollars goes to the owner.  

 

In regions like LeHigh Valley where it seems like there are land everywhere, the bottleneck is on the local residents hesitancy on having 18 wheelers throttling their 2 lane roads.  Sure the jobs are good and pay more than retail or fast food, but many of the people in these communities want a nice pleasant farming community.  As more warehouses get built and the road capacities start to suffer and traffic start to appear, there will be more oppositions against new supply.  Ranking NIMBYism, it goes something like this 

 

Chemical Plants > Waste Management > Rock Quarries > Prison > Self Storage > Warehouses > Affordable Housing > Offices, retail, apartments > parks and amenities 

 

The order goes from least desirable to most desirable 

 

NIMBYism score is one of the top 5 analysis that I do when analyzing a real asset investment 

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44 minutes ago, BG2008 said:

 

In the dense urban areas, warehouse traditional has the "flour" that multi-family developers turn into "bread"  So in cities in NYC, SF, and SoCal, warehouse and warehouse land is actually being depleted.  That's why urban warehouses trade for, gasp, 2.5% cap rate.  I know that's crazy.  But if you have 4% cap upon lease renewal in a market with supply depleting, it may not be all that crazy.  Add in the fact that warehouses have much lower cap ex than MF and Offices, more of the NOI dollars goes to the owner.  

 

In regions like LeHigh Valley where it seems like there are land everywhere, the bottleneck is on the local residents hesitancy on having 18 wheelers throttling their 2 lane roads.  Sure the jobs are good and pay more than retail or fast food, but many of the people in these communities want a nice pleasant farming community.  As more warehouses get built and the road capacities start to suffer and traffic start to appear, there will be more oppositions against new supply.  Ranking NIMBYism, it goes something like this 

 

Chemical Plants > Waste Management > Rock Quarries > Prison > Self Storage > Warehouses > Affordable Housing > Offices, retail, apartments > parks and amenities 

 

The order goes from least desirable to most desirable 

 

NIMBYism score is one of the top 5 analysis that I do when analyzing a real asset investment 

 

The NIMBYism is real, for sure. I actually got a flyer a couple weeks ago for a pretty interesting industrial piece in Denville off 46. I'm in those areas, IE the 80/46/206 spaces all the time. Poconos, East Stroudsberg, out to Lehigh Valley. And yea, theres TONS of "say no to the warehouse!" signs on lawns. Indeed, its largely farmland and all that good stuff. But its also not impossible to get things done there. You can go out a few miles and make something happen. The key IMO is the tailwind. With industrial you have two things going for you...construction costs and labor, as well as rising e-commerce based demand. Industrial Ive seen those things go up in much less than a year., MF takes 18 months at best. Several years at worst. Thats before the horrendous supply chain issues which are much more complex for housing then shells for storage space/warehousing.....With MF I dont think its all that different, if you're in the right area. If you're talking DC, yea, maybe over the years it gets flooded, IDK. I haven't followed it long term. Right now DC looks appealing. But comparing Austin, TX  or a Raleigh to a DC is going to be a lot of apples to apples and a lot of oranges to apples. But as @thepupilsaid, it gets hot, supply increases, it stalls, catches up...whatever. I mean people talk like buying at a 4 cap you need magic for it to work...Maybe if you're looking to compound at 20%...but then you stop and realize how many institutions and funds are doing 2-3, maybe 5%....parking cash LOL...So you buy a solid new build in DC and for 5 years you clip 4% NOI with no growth...which is greater than 4% if you can slap some financing together. This is a big deal to the negative? So thats kind of what I'm getting at. Relative to the safety of these things, the returns, despite surface level wincing and "oooh thats euphoric" rhetoric, are actually quite good for a large swath of folks who a currently wasting their time in this other near zero crap. Some obviously have mandates, but a lot dont. Theres oodles of foreign money coming in. Theres a strong possibility this can sharply adjust as more folks get shaken out of the 0 interest, no inflation investments/trades. 

 

One of the greatest gifts of 2008 was the RE shakeout and narrative buster. But the truth is, while I won't say "home prices never go down"....these seismic shifts in a negative direction really arent common, and take a TON of things going wrong to happen. Thank the GFC for effectively conditioning the majority of people to expect these sort of things to happen every few years. "Yea home prices never go down" is almost even a snarky quip of the cash up, risk paranoid worry wort quant. Buuuut...do they really, generally go down in a way where tons of folks get hurt? Let alone half intelligent ones? People put these odds at many multiples of what they really are. I wouldnt put them at zero, but certainly low single digit. Whereas theres folks who are underwriting 20-30% corrections........Laughing at that has historically been the proper move. So size up the risk/reward right now in MF to the nth degree and to a lesser but still relevant extent, SFH....for a good while Ive thought its massively skewed in favor of the long trade, its been wildly profitable, and the purpose of the thread was really to kind of gauge what people thought because frankly, I still think its got a very long way to go. 

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15 minutes ago, Gregmal said:

 

The NIMBYism is real, for sure. I actually got a flyer a couple weeks ago for a pretty interesting industrial piece in Denville off 46. I'm in those areas, IE the 80/46/206 spaces all the time. Poconos, East Stroudsberg, out to Lehigh Valley. And yea, theres TONS of "say no to the warehouse!" signs on lawns. Indeed, its largely farmland and all that good stuff. But its also not impossible to get things done there. You can go out a few miles and make something happen. The key IMO is the tailwind. With industrial you have two things going for you...construction costs and labor, as well as rising e-commerce based demand. Industrial Ive seen those things go up in much less than a year., MF takes 18 months at best. Several years at worst. Thats before the horrendous supply chain issues which are much more complex for housing then shells for storage space/warehousing.....With MF I dont think its all that different, if you're in the right area. If you're talking DC, yea, maybe over the years it gets flooded, IDK. I haven't followed it long term. Right now DC looks appealing. But comparing Austin, TX  or a Raleigh to a DC is going to be a lot of apples to apples and a lot of oranges to apples. But as @thepupilsaid, it gets hot, supply increases, it stalls, catches up...whatever. I mean people talk like buying at a 4 cap you need magic for it to work...Maybe if you're looking to compound at 20%...but then you stop and realize how many institutions and funds are doing 2-3, maybe 5%....parking cash LOL...So you buy a solid new build in DC and for 5 years you clip 4% NOI with no growth...which is greater than 4% if you can slap some financing together. This is a big deal to the negative? So thats kind of what I'm getting at. Relative to the safety of these things, the returns, despite surface level wincing and "oooh thats euphoric" rhetoric, are actually quite good for a large swath of folks who a currently wasting their time in this other near zero crap. Some obviously have mandates, but a lot dont. Theres oodles of foreign money coming in. Theres a strong possibility this can sharply adjust as more folks get shaken out of the 0 interest, no inflation investments/trades. 

 

One of the greatest gifts of 2008 was the RE shakeout and narrative buster. But the truth is, while I won't say "home prices never go down"....these seismic shifts in a negative direction really arent common, and take a TON of things going wrong to happen. Thank the GFC for effectively conditioning the majority of people to expect these sort of things to happen every few years. "Yea home prices never go down" is almost even a snarky quip of the cash up, risk paranoid worry wort quant. Buuuut...do they really, generally go down in a way where tons of folks get hurt? Let alone half intelligent ones? People put these odds at many multiples of what they really are. I wouldnt put them at zero, but certainly low single digit. Whereas theres folks who are underwriting 20-30% corrections........Laughing at that has historically been the proper move. So size up the risk/reward right now in MF to the nth degree and to a lesser but still relevant extent, SFH....for a good while Ive thought its massively skewed in favor of the long trade, its been wildly profitable, and the purpose of the thread was really to kind of gauge what people thought because frankly, I still think its got a very long way to go. 

 

I had a conversation with an investor who said "OMG, 4.25% cap rate for the Maren, what if interest rates go to 6%?"  I sat down and did a model on a 6% interest rate at year 10-12, and figured that rent will probably grow 5-6% a year in that kind of inflationary environment.  When you lock in mortgages for 10-12 years, you get a lot of rent growth to alleviate cap rate expansion.  I came out with nominal returns that are still around 9-12% on a 10-12 year hold until mortgage maturity.  This assumes you own great products like Dock 79 and The Maren by the water which is naturally supply constrained.  Replacement cost will be higher.  There are other ways to value a piece of hard asset.  I spoke with someone smart once and I said "I own x units of residential in NYC, I don't think of it in terms of $, I think of it as I own 1/4-1/3 of the gross income of a family in NYC for perpetuity while my debt servicing cost stays flat."  Sometimes, we have to look through the clutter that is "financial analysis" and figure out what we really own which is the very bottom layer of the pyramid in Maslow's hierarchy, namely shelter for people.  

 

On that note, I need to do my 2020 taxes.  

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10 minutes ago, BG2008 said:

"OMG, 4.25% cap rate for the Maren, what if interest rates go to 6%?"  I sat down and did a model on a 6% interest rate at year 10-12, and figured that rent will probably grow 5-6% a year in that kind of inflationary environment.

Thats why my DD on a @BG2008 name, is often quite minimal, assuming I havent done some work on it already myself. The man is thorough!

 

I love seeing the same bear case arguments redundantly. Its often very bullish as it confirms the narratives holding back future buyers hasn't changed. Well if rates go to "x%".....yawn.....its why housing is probably now maybe in the 2nd/3rd innings or so IMO. As @Spekulatiussaid awhile ago in another thread, indeed tons of people over the past 6-9 months have come around....but there's still many, many more to go before things start running their course. Canadas been in a housing bubble for decades. Australia had what? 30 years of growth? But we're ready to burst in 12-18 months? yea.....no!

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2 hours ago, BG2008 said:

 

I had a conversation with an investor who said "OMG, 4.25% cap rate for the Maren, what if interest rates go to 6%?"  I sat down and did a model on a 6% interest rate at year 10-12, and figured that rent will probably grow 5-6% a year in that kind of inflationary environment.  When you lock in mortgages for 10-12 years, you get a lot of rent growth to alleviate cap rate expansion.  I came out with nominal returns that are still around 9-12% on a 10-12 year hold until mortgage maturity.  This assumes you own great products like Dock 79 and The Maren by the water which is naturally supply constrained.  Replacement cost will be higher.  There are other ways to value a piece of hard asset.  I spoke with someone smart once and I said "I own x units of residential in NYC, I don't think of it in terms of $, I think of it as I own 1/4-1/3 of the gross income of a family in NYC for perpetuity while my debt servicing cost stays flat."  Sometimes, we have to look through the clutter that is "financial analysis" and figure out what we really own which is the very bottom layer of the pyramid in Maslow's hierarchy, namely shelter for people.  

 

On that note, I need to do my 2020 taxes.  

 

My main concern is that in a 6% interest rate environment no one can service their debt and you're not getting 5-6% rent raised but stagnant, or declining, rents. 

 

Maybe you still come out on top - haven't done the math.

 

But at 6% interest rates my concerns are the govt is spending 40-50% of current budget on interest coverage.  Government largesse stops. Corporate buybacks stop. Equities no longer look reasonable at 22x earnings. Profits? Stagnate because revenues can't keep pace with financing cost growth. Raises/bonuses/wage growth slows as corporate profitability stagnates, etc. 

 

If lower interest are a financial boon. Then higher rates must be the opposite. And so I don't think you can count on 5-6% rent growth in said environment when the price was so high to have required 5-6% rent growth to be attractive to begin with. 

 

I'm not in the inflationist camp - I think rates stay lower for longer. But my fear for the markets is that I'm wrong (as I often am), because a 6% treasury yield would absolutely wreck the economy. 

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5 hours ago, TwoCitiesCapital said:

 

My main concern is that in a 6% interest rate environment no one can service their debt and you're not getting 5-6% rent raised but stagnant, or declining, rents. 

 

Maybe you still come out on top - haven't done the math.

 

But at 6% interest rates my concerns are the govt is spending 40-50% of current budget on interest coverage.  Government largesse stops. Corporate buybacks stop. Equities no longer look reasonable at 22x earnings. Profits? Stagnate because revenues can't keep pace with financing cost growth. Raises/bonuses/wage growth slows as corporate profitability stagnates, etc. 

 

If lower interest are a financial boon. Then higher rates must be the opposite. And so I don't think you can count on 5-6% rent growth in said environment when the price was so high to have required 5-6% rent growth to be attractive to begin with. 

 

I'm not in the inflationist camp - I think rates stay lower for longer. But my fear for the markets is that I'm wrong (as I often am), because a 6% treasury yield would absolutely wreck the economy. 

You currently have the UBI/child tax credit. Thats $300 per child and an average of 2.5x that per American family. Rates go to 6%, SFH/mortgages get more expensive, more folks get priced out of homes. Guess what happens to rentals? BG is on the money. Everyone talks about theoretical "what if rates go to x?" situations. They never contemplate what gets them there. The universal accord is wage inflation is here to stay. Thats another notch on the MF bull case. 

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9 hours ago, TwoCitiesCapital said:

 

My main concern is that in a 6% interest rate environment no one can service their debt and you're not getting 5-6% rent raised but stagnant, or declining, rents. 

 

Maybe you still come out on top - haven't done the math.

 

But at 6% interest rates my concerns are the govt is spending 40-50% of current budget on interest coverage.  Government largesse stops. Corporate buybacks stop. Equities no longer look reasonable at 22x earnings. Profits? Stagnate because revenues can't keep pace with financing cost growth. Raises/bonuses/wage growth slows as corporate profitability stagnates, etc. 

 

If lower interest are a financial boon. Then higher rates must be the opposite. And so I don't think you can count on 5-6% rent growth in said environment when the price was so high to have required 5-6% rent growth to be attractive to begin with. 

 

I'm not in the inflationist camp - I think rates stay lower for longer. But my fear for the markets is that I'm wrong (as I often am), because a 6% treasury yield would absolutely wreck the economy. 

If inflation is really at 5% and the government is paying 5% on bonds then it isn’t really paying anything, as the principle is getting eroded at the same rate than interest rates are paid. It is an even better deal for the government, if you take into account that taxes get paid on interested. This is effectively still a negative interest rates.

 

Also keep in mind that with 5% inflation, the GDP will go up by 5% in nominal terms, plus whatever real growth we get, so the borrowing base gets larger. Again government never pay back debt, they just roll it over.

Edited by Spekulatius
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8 hours ago, Gregmal said:

You currently have the UBI/child tax credit. Thats $300 per child and an average of 2.5x that per American family. Rates go to 6%, SFH/mortgages get more expensive, more folks get priced out of homes. Guess what happens to rentals? BG is on the money. Everyone talks about theoretical "what if rates go to x?" situations. They never contemplate what gets them there. The universal accord is wage inflation is here to stay. Thats another notch on the MF bull case. 

 

I'm sorry - I just can't buy "low rates is good for housing" and "high rates is good for housing".

 

There are absolutely environments where housing will do poorly. Maybe I'm wrong about it being higher rates, but at some point, lack of affordability doesn't equate things becoming even LESS affordable. I think that type of environment has been afforded to us by low rates and won't persist if rates rise. 

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3 hours ago, Spekulatius said:

If inflation is really at 5% and the government is paying 5% on bonds then it isn’t really paying anything, as the principle is getting eroded at the same rate than interest rates are paid. It is an even better deal for the government, if you take into account that taxes get paid on interested. This is effectively still a negative interest rates.

 

Also keep in mind that with 5% inflation, the GDP will go up by 5% in nominal terms, plus whatever real growth we get, so the borrowing base gets larger. Again government never pay back debt, they just roll it over.

 

1) 5% inflation and 5% rates wasn't the scenario that I was discussing. Nominal rates were higher and I didn't say anything about inflation. 

 

2) GDP doesn't automatically go up by 5%. There's a lag effect. Prices rise first. Then, slowly, wages rise. GDP, with some adjustments, basically measures aggregate incomes and incomes will lag inflation. 

 

Another way to look at it is  this scenario. If prices rise faster than wages, people have choices with what to do. 1) buy cheaper alternatives 2) buy less of the same good or 3) cut into savings and keep buying the same volume at the higher price. Only the 3rd option supports GDP expansion and the 3rd option also can't persist indefinitely. The other 2 are slightly contractionary on real consumer spending. If inflation is up 5%, GDP may very well lag that 5% as consumers opt for cheaper alternatives and less volume. 

 

3) Government can only roll debt as long as the market allows them to. Just because the markets have doesn't mean the markets always will. History is littered with regime changes and I don't trust thesis built on the premise that the US will be the most favored nation forever. 

 

 

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22 hours ago, Gregmal said:

Probably somewhere in between. While some dont like the loans, this is why I love them...they pay outsized rates and most have purchase options. You'll have to shuffle with it a bit because the developers have buyout options which is were a good chunk of the one off earnings have been coming from....so that question if you want to get real granular is where the trade off is when a developer buys it out, IE theres massive profit bringing it to market, vs when the company takes the property...but no doubt its below market however I wouldnt underwrite the assumption thats its a tick over construction cost either. 

 

Straight from the supplemental page 24 2Q/2021:

 

"Certain option purchase prices may be negotiated at the time of the loan closing and are to be calculated based upon market cap rates at the time of exercise of the purchase option, with discounts up to 15 basis points (if any), depending on the loan."

 

Two of the 3 recent properties came with the discount of up to 15 basis points.

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14 hours ago, TwoCitiesCapital said:

 

My main concern is that in a 6% interest rate environment no one can service their debt and you're not getting 5-6% rent raised but stagnant, or declining, rents. 

 

Maybe you still come out on top - haven't done the math.

 

But at 6% interest rates my concerns are the govt is spending 40-50% of current budget on interest coverage.  Government largesse stops. Corporate buybacks stop. Equities no longer look reasonable at 22x earnings. Profits? Stagnate because revenues can't keep pace with financing cost growth. Raises/bonuses/wage growth slows as corporate profitability stagnates, etc. 

 

If lower interest are a financial boon. Then higher rates must be the opposite. And so I don't think you can count on 5-6% rent growth in said environment when the price was so high to have required 5-6% rent growth to be attractive to begin with. 

 

I'm not in the inflationist camp - I think rates stay lower for longer. But my fear for the markets is that I'm wrong (as I often am), because a 6% treasury yield would absolutely wreck the economy. 

 

I have been thinking about this scenario as I have a lot of hard asset exposure.  It is certainly possible.  The takeaway is that do you 1) Do nothing and continue let your cash erode its purchasing power?  2) Buy hard assets with long term debt?  3) hedge the interest rate exposure by shorting some 10-30 year debt (can really backfire if rates go even lower) 4) Some combo?  I don't have an answer and I am looking for one.  I think the scenario that you laid out hurts all asset classes.  It goes back to picking 1) or 2).  I would argue that good hard asset is probably better than rolling the dice on O&G or metals or some other commodity.  Okay I am biased.  But I have warmed up my mind to having 2-3% O&G and just view it as heavy inflation protection.  I appreciate you "red teaming" the scenario.  

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1 minute ago, BG2008 said:

3) hedge the interest rate exposure by shorting some 10-30 year debt (can really backfire if rates go even lower)

 

This is essentially what Bridgewater has been saying. Buy things which benefit if nominal GDP goes higher and sell nominal bonds against it.

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50 minutes ago, TwoCitiesCapital said:

 

I'm sorry - I just can't buy "low rates is good for housing" and "high rates is good for housing".

 

 

I agree. That said, it may be a (partial) hedge to have in-place, low cost fixed debt. Both as a company and as an individual. When I have a mortgage at 2.875% on a 30 year schedule and I'm using my savings to buy FRPH which owns multifamily levered with 12 year interest only 3% debt and has a $10mm agg royalty linked to inflation at its disposal (plus a bunch of cash)*, I feel somewhat secure. It's not that there's no risk, but rather that the risk is mitigated for some time (assuming NOI holds: assuming rents can keep pace with property taxes, insurance, labor costs, maint capex etc). 

 

I think it's certainly possible that rates rise and we no longer get the sweetheart leverage that we have and there's a situation where one owns a depleting asset (a liability at a below market rate of interest); this will not be great if one has to sell (subjecting oneself to worse cap markets), but may still work out well one doesn't. 

 

 

*or whatever corporate high quality borrower you prefer

Edited by thepupil
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49 minutes ago, TwoCitiesCapital said:

 

I'm sorry - I just can't buy "low rates is good for housing" and "high rates is good for housing".

 

There are absolutely environments where housing will do poorly. Maybe I'm wrong about it being higher rates, but at some point, lack of affordability doesn't equate things becoming even LESS affordable. I think that type of environment has been afforded to us by low rates and won't persist if rates rise. 

IDK but to me, the exercise of low rates = good for housing, high rates = bad for housing is a little too academic. Sure, low rates are better for housing. Sure higher rates mean less affordability. In the real world people still need homes and adversity on the macro level is ALWAYS met with flexibility and subsidy. Rates go higher to the point its severely impacts the ability of people to buy homes, 1) you'll see either subsidies or lending standards relaxed, or probably both. 2) you have a ton more folks in the renting pool. 

 

Its the same stuff over, and over, and over with the "what if the market crashes" stuff. And people spend all this time doing all this worrying and the playbook is the same every time. There is ALWAYS a rabbit hole you can go down to come up with a risk you cant assess but in the real world I really haven't seen a situation that warrants making these assumptions a base case. "What if the Fed loses control" is the new one. If the Fed really loses control Ill still be on the right end of the curve and do better than most. Bring it. 

 

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1 hour ago, BG2008 said:

 

I have been thinking about this scenario as I have a lot of hard asset exposure.  It is certainly possible.  The takeaway is that do you 1) Do nothing and continue let your cash erode its purchasing power?  2) Buy hard assets with long term debt?  3) hedge the interest rate exposure by shorting some 10-30 year debt (can really backfire if rates go even lower) 4) Some combo?  I don't have an answer and I am looking for one.  I think the scenario that you laid out hurts all asset classes.  It goes back to picking 1) or 2).  I would argue that good hard asset is probably better than rolling the dice on O&G or metals or some other commodity.  Okay I am biased.  But I have warmed up my mind to having 2-3% O&G and just view it as heavy inflation protection.  I appreciate you "red teaming" the scenario.  

 

Some combination, but cash is king. Let's say inflation does spike and interest rates do go to 5%. Sure your cash lost 5% that year. How much do you envision you'd lose in stocks? Bonds? Way more than 5% so your purchasing power has actually increased despite the nominal value loss. So I do hold some cash. I also own some real asset exposure (it's been what's been dirt cheap for the last 10 years), and have some financial instruments that will do well if 20-year rates rise to a certain point. 

 

But real estate has been so financialized at this point I'd expect it to behave more in line with other financial assets - negatively impacted by higher rates. 

 

1 hour ago, thepupil said:

 

I agree. That said, it may be a (partial) hedge to have in-place, low cost fixed debt. Both as a company and as an individual. When I have a mortgage at 2.875% on a 30 year schedule and I'm using my savings to buy FRPH which owns multifamily levered with 12 year interest only 3% debt and has a $10mm agg royalty linked to inflation at its disposal (plus a bunch of cash)*, I feel somewhat secure. It's not that there's no risk, but rather that the risk is mitigated for some time (assuming NOI holds: assuming rents can keep pace with property taxes, insurance, labor costs, maint capex etc). 

 

I think it's certainly possible that rates rise and we no longer get the sweetheart leverage that we have and there's a situation where one owns a depleting asset (a liability at a below market rate of interest); this will not be great if one has to sell (subjecting oneself to worse cap markets), but may still work out well one doesn't. 

 

 

*or whatever corporate high quality borrower you prefer

 

The partial hedge only really works if you go short the bonds and hold that in cash. Buying real estate with the short mortgage proceeds just opens you up to leveraged basis risk. Maybe it acts as a hedge. Maybe it doesn't. Maybe the mortgage gets easier to pay in a higher rate environment with dollars worth less and higher rents. Or maybe your tenants default othe higher rent and the mortgage becomes MORE difficult to pay. 

 

Going short nominal bonds and putting the proceeds in cash or TIPS would be the sure-fire way to profit if you were right. Maybe even gold/silver. But buying real estate with the proceeds where the initial price was justified by 5-6% annual rent increases that may not occur just sounds like a leveraged basis trade to me - not an inflation hedge. 

Edited by TwoCitiesCapital
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16 hours ago, TwoCitiesCapital said:

 

My main concern is that in a 6% interest rate environment no one can service their debt and you're not getting 5-6% rent raised but stagnant, or declining, rents. 

 

 

 

In 1970 the median rent was $108; in 1983 it was $315.

 

 

 

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If we were playing Jeopardy I would smash the button and declare, What is, Why The Opportunity Exists!

 

This isnt quite "COVID killed retail, malls are dead" on SPG in the 50s/60s but "inflation kills real estate" is up there. In a way, as Ive been saying for over a year now, covid blew spreads out of whack. With MF, even of the ESS ilk, but especially the smaller cap with some hair, if rates stay low..you have massive upside. If rates rip theyre gonna crush it. So yes, in this instance, higher rates, lower rates...doesnt matter. Personally, I'd prefer higher rates so tons of other stuff gets crushed and I could pick up some of the bodies. 

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17 hours ago, TwoCitiesCapital said:

 

Some combination, but cash is king. Let's say inflation does spike and interest rates do go to 5%. Sure your cash lost 5% that year. How much do you envision you'd lose in stocks? Bonds? Way more than 5% so your purchasing power has actually increased despite the nominal value loss. So I do hold some cash. I also own some real asset exposure (it's been what's been dirt cheap for the last 10 years), and have some financial instruments that will do well if 20-year rates rise to a certain point. 

 

But real estate has been so financialized at this point I'd expect it to behave more in line with other financial assets - negatively impacted by higher rates. 

 

 

The partial hedge only really works if you go short the bonds and hold that in cash. Buying real estate with the short mortgage proceeds just opens you up to leveraged basis risk. Maybe it acts as a hedge. Maybe it doesn't. Maybe the mortgage gets easier to pay in a higher rate environment with dollars worth less and higher rents. Or maybe your tenants default othe higher rent and the mortgage becomes MORE difficult to pay. 

 

Going short nominal bonds and putting the proceeds in cash or TIPS would be the sure-fire way to profit if you were right. Maybe even gold/silver. But buying real estate with the proceeds where the initial price was justified by 5-6% annual rent increases that may not occur just sounds like a leveraged basis trade to me - not an inflation hedge. 

Why do you think rent / NOI falls for decent assets? It’s not clear to me. 
 

I feel like the entirety of getting wealthy is kind of a “leveraged basis trade”. Borrow at < 3% invest in stuff that makes more. This describes much of my financial life lol. 

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3 hours ago, thepupil said:

Why do you think rent / NOI falls for decent assets? It’s not clear to me. 
 

I feel like the entirety of getting wealthy is kind of a “leveraged basis trade”. Borrow at < 3% invest in stuff that makes more. This describes much of my financial life lol. 

 

I don't have a problem with borrowing. I've borrowed to buy a little crypto and it's worked out well. I'm just not telling myself that it's an inflation hedge or that I'll be fine if rates go up simply because the amount I owe goes down.  

 

I don't necessarily think they RE prices HAVE to fall. But homes are already largely unaffordable if prices remain stable and interest rates go back to 4-5%. Rents are fairly high as well as a result. I don't think we can just continue to assume the the American consumer can pay more rent indefinitely - at some point they can't, or won't, pay it. Particularly if their wages aren't keeping pace with inflation which they haven't most years for the last 4 decades. 

 

My main point isn't to say that real estate is a bad trade or that your guaranteed to lose money. My only point is that I don't think it's a no-brainer in a 6% interest rate environment as it's being presented here nor do I believe its an inflation hedge now that the market is financialized. 

 

All that being said, I don't believe we're in an inflationary environment either so maybe none of this actually matters. 

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To each their own. I know folks who are levered 3-4x and sleep like a baby and I know folks who have 20%+ cash and stay up at night sweating because they have too much exposure. Whatever you gotta do to have a clear head is what you need to do and everyones different. Personally, I almost NEVER incorporate macro risk into individual company analysis or decision making. Why? Because 1) every friggin stock shares the same broader macro risks and 2) the larger macro stuff is super easy to hedge both at the portfolio level with larger index products/derivatives and then also at the company level. I only really focus on company specific risks on a single stock/company investment. IE AIV has development risk and although now largely gone, the mezzanine loan risk. 

 

I mean think about it...how silly is it to spend 95% of your time worrying about things that only happen <10% of the time? Or less. Or are still largely unlikely? Its like going around your house 24/7 fretting about a fire starting and the whole thing burning down. Whereas, me? Just buy some homeowners insurance and stop wasting time thinking about it. In the market its even easier...whereas my home can be totally destroyed, Berkshire for instance, cant. So through that lens, what am I hedging Berkshire for? What? Maybe to avoid a temporary drawdown? Totally not worth it. Of course I can then naturally go down the rabbit hole of "well in this scenario Berkshire doesnt come back" but if thats the concern you're worrying about things that are wayyyy too far out the probability curve and will just inevitably spend most of your time finding excuses not to take likely money because something unlikely can occur, which to me doesnt make sense. 

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Equity Lifestyle Properties, who own manufactured housing, RVs, and Marinas, have a good LT chart of multifamily and REIT same store NOI growth. I think a base rate of ~2.5% NOI growth rather than 4% NOI growth is a better starting point. We're in a great environment now and some markets are blowing up so 4% feels conservative but historically, it is not over a full cycle.

 

image.thumb.png.43a32dac2e544e25a5f6b0f5a3797560.png

 

Obviously ~2.5% NOI growth over 30+ years is still good but doesn't beat inflation by a whole lot. Again, I'm leaning on the ELS data and they are trying to paint multifamily / SFR as a worse asset class so take this info with a grain of salt.

 

image.thumb.png.c32f8cff9d94fd733a152c91f3c6a7c2.png

 

I think there is a good dose of exuberance going around due to the numbers that the MF REITs are posting for rental growth - a lot of which is justified (rents are going up a lot over the next couple of years) but a lot of which is also probably cyclical. High rents and low cap rates will likely pull forward a lot of supply as developers rush to get in the game while the going is good - especially in sunbelt markets where there really aren't that many barriers to entry. I like the prospects for US multifamily a lot over the next 3-5 years and the same for industrial but think its important to watch the supply-demand dynamics in the markets you own in as these trees can't just grow to the sky.

 

 

 

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10 minutes ago, realassetsvalue said:

Equity Lifestyle Properties, who own manufactured housing, RVs, and Marinas, have a good LT chart of multifamily and REIT same store NOI growth. I think a base rate of ~2.5% NOI growth rather than 4% NOI growth is a better starting point. We're in a great environment now and some markets are blowing up so 4% feels conservative but historically, it is not over a full cycle.

 

image.thumb.png.43a32dac2e544e25a5f6b0f5a3797560.png

 

Obviously ~2.5% NOI growth over 30+ years is still good but doesn't beat inflation by a whole lot. Again, I'm leaning on the ELS data and they are trying to paint multifamily / SFR as a worse asset class so take this info with a grain of salt.

 

image.thumb.png.c32f8cff9d94fd733a152c91f3c6a7c2.png

 

I think there is a good dose of exuberance going around due to the numbers that the MF REITs are posting for rental growth - a lot of which is justified (rents are going up a lot over the next couple of years) but a lot of which is also probably cyclical. High rents and low cap rates will likely pull forward a lot of supply as developers rush to get in the game while the going is good - especially in sunbelt markets where there really aren't that many barriers to entry. I like the prospects for US multifamily a lot over the next 3-5 years and the same for industrial but think its important to watch the supply-demand dynamics in the markets you own in as these trees can't just grow to the sky.

 

 

 

Do you have any thoughts on the CLIs and CLPR or any other names in the more restrictive markets when it comes to building? CLPR trades like such a piece of shit but its got a strong base ahead of it. I dont think the coastal stuff has nearly the same momo as the better located stuff but if the cycle dynamics you described take effect, I would imagine those(coastal names) experience far less of it. You could make the case NYC area already had its building boom in recent years. 

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interestingly there's a bloomberg article out today pointing out how much the multifamily REITS can save on interest if rates hold. AVB, CPT, EQR, ESS, MAA, and UDR all have $4.3B maturing through 2023 at a n average rate of 3.1% and pre-funding these maturities now (before tightening) could save $40mm/yr (1%) across the complex, because for these guys 3.1% is expensive lol. they're doing bonds in the low 2% range. 

 

Article points out that average apartment REIT is at 70 bps spread and also points out that they all trade at 24-28X FFO (up from 16x). Cheap debt and "richly" valued equity = firepower to buy whatever (if they want). 

 

just thought it somewhat relevant. 

 

Quote
Refinancing Bonds Could Save Apartment REITs Almost $40 Million

 

Apartment REITs have the potential to save close to $40 million in annual interest expense by refinancing bonds maturing through 2023, based on our scenario analysis, with Camden Property Trust poised to pare the most. With the 10-year Treasury yield rising and the Federal Reserve poised to tighten, we believe investment-grade rated apartment REITs may look to refinance early. (10/01/21)

 
1. Bonds Maturing Through 2023 Offer Savings

 

Investment-grade apartment REITs have about $4.4 billion of unsecured bonds scheduled to mature by year-end 2023 that we believe could be refinanced to save almost $40 million of combined annual interest expense, assuming current spreads and Treasury yields. In that scenario, overall annual interest cost could be reduced by almost 3% vs. levels in 2020, the last full year, excluding the effect of prepayment penalties. Camden Property Trust has the most to gain, with potential to lower its annual interest expense by over 11% vs. the 2020 baseline.

The 10-year Treasury yield may exceed 2% by 2023, based on consensus, which could trigger a refinancing wave. Our sensitivity analysis suggests coupons would need to rise almost 100 bps to eliminate profitable refinancing opportunities. (10/01/21)

 

Edited by thepupil
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