JackChat February, 2018

Last month, I introduced to you the first issue of JackChat. I am very pleased that so many of you noticed that I was back writing; and, so many sent me a note with positive reinforcement to continue. This now becomes the second issue of JackChat.

I just returned from the MBA CREF conference in San Diego, and one of my colleagues made the observation that “forecasting and making predictions of future movements in the cycle (property, economic, and capital flows) were based upon the past.” This really got me thinking.

Laurence Gonzales wrote a book called Deep Survival, wherein he made the claim that to survive in a crisis one needs to “give up their mental memory of the future.” Think about THAT! What is it about the last 30 years that should be relevant as you look forward and forecast out your investment thesis for the next 30 years? Is it confirmation bias that blinds us the most? If so, what opportunities and what risks are we missing?

My conclusion as I look back at my almost 40 years in the business is that: 1) investors do not chase yield, they chase excess return on a risk adjusted basis; 2) where an investor finds excess return on a risk adjust basis, over time, shifts up and down the capital stack AND across property asset classes.

The bell of the ball, two conferences in a row, seems to be The Rise of the Alternative Investor. Though many think this is somewhat shocking news, I do not. I posit that this is a natural evolution of the industry and the capital markets given the affect of Dodd Frank, HVCRE, Basel III, the constraints imposed on most of the banking industry (I say “most” because the Community Banks still seem to be immune to all of this as THEY seem to be making all the same excessive lending mistakes of yesteryear.  The more experienced Banks and regulated institutions have moved past this taking unnecessary risk for improper pricing. )

I do think that the next crisis in our industry will come from the massive numbers of “new” short term (leveraged internally), floating rate, “Bridge” lenders. Too many folks seemingly have raised money because they could. PE funded? Funds “redirected” from equity to debt? All raised on the same “Dodd Frank Thesis”? In any event we now have (in my judgement):

• Too many Bridge lenders chasing too few opportunities through even lesser distribution channels.
• The existence of all this new capital seemingly is creating
• Too few of these Debt Funds are being managed by experienced diverse teams who have done this before.
• Too many folks believing “there are no bad assets; only badly priced assets.”
• Stable markets in the US making it tough to find outsized returns so these lenders create return for their investors through the use of internal leverage that may or may not be at proper levels and/or matching assets and liabilities.
• Too few markets have real rent growth.
• Too many markets have rising construction costs.
• The consensus is that interest rates are going up.
• Growing concerns (albeit maybe misplaced) about inflation.

I certainly believe that the debt funds will be a gamechanger for the industry. My 2 cents are that for them to be a positive influence, I sure hope these Bridge lenders limit their focus to event driven activities wherein they take advantage of misperceived asset classes, misunderstood opportunities, and deals with time constraints. One of my partners recently reminded me “There are no heroics in Lending.”

Things that I am seeing:

• Why aren’t more folks commenting about the Euro/Dollar exchange rate?
• (Hate to sound like an old guy) It was really great to see all the new younger faces showing up at the conferences. Youth, new blood, is good for us all; even if it pushes us old folks out. Caution:not only have these folks generally only seen a growing marketplace where interest rates AND cap rates go down; but, I worry that these folks with these perspectives do not yet realize that a workout is a 24/7 experience full of hand to hand combat.
• YEA for the prospect of INFLATION.
• YEA for the prospect of unabated influx of foreign capital seeking yield (is THAT why values are up in the top 6 markets WAY MORE than the next 44?)
• YEA for the prospect of corporate repatriating of capital back to the states (is wage growth inflation or acknowledgement of the value of a more efficient and effective US Worker?)
• Collaborators NOT Disrupters.
• Better borrowers being smarter about the use of leverage (I hope the bridge lenders follow suit).
• Better borrowers, mostly institutional, causing lenders to reprice (reduce) default risk.
• “This time it is different” – we have a low interest rate environment starting to rise (vs last time where we had a higher interest rate environment that in some way helped the bail out by going into a lower interest rate environment).
• Why aren’t more folks commenting about the consumer debt levels?

I implore everyone to focus on their relationships in the business. What do they mean to you? Which direction do they run – to your customers or suppliers? Are you listening to them and contributing to making these relationships mutually beneficial?

I encourage everyone to be focusing on with whom they can collaborate with – internally and externally.

All businesses are a combination of Product and Distribution wherein they “major” in one, “minor” in the other. Do you know where you sit on this spectrum? Do you have an idea with whom you should be seeking partnership in collaboration? Capital doesn’t seem to be the issue; finding product is. The Origination/Distribution networks are a changing.

Keep on thinking. Focus on Why, What, How. Challenge the status quo.

Press coverage

http://www.globest.com/2018/02/15/the-evolution-of-private-debt-funds/?channel=markets&section=san-diego
http://www.nreionline.com/lending/nine-takeaways-mba-s-crefmultifamily-convention-and-expo-2018
http://www.globest.com/sites/paulbubny/2018/02/12/moving-with-speed-and-discipline/