JackChat May, 2019

Negligent in keeping up with my blogging, four months since my last, an attempt to catch up:

Multifamily – Sector affordability is a concern. While rent growth and rising property values have position connotations, these trends are not sustainable. Despite the stronger economic growth and wage growth in recent quarters, incomes have not and will not keep pace with rents rising at these rates. Yet to justify new construction, revenue must grow to cover the even faster rise in development costs. I am not aware of any major market, without aggressively trending rents, where development yields are above 5.75% to 6.5%; some are lower. Nor do we hear many operators pleased with recent Class A rent growth.

While the multi-family industry has seen too much Class A product and too few cost-based innovations, clever renters, developers and owners are addressing the situation. Smart first-adapters are testing new solutions (micro units, co-living, AirBnB relationships, hotel like apartment management) to make properties and the renter experience more attractive and efficient in delivering quality housing at attainable rents.

Four key investment conclusions: 1) despite new supply – and over supply of Class A in certain markets – continued demand in growing urban areas will keep the market stable. 2) expect more renovations and rehabilitations as higher costs enhance relative value and prompt the need for more of these projects. 3) in most localities, rent growth has outpaced middle and lower-middle class incomes. 4) existing properties produced at lower costs will be more appealing to renters than brand-new product that is less affordable due to higher development costs.

Yield Curve – We all have been reminded that the inversion of the yield curve has forecasted the last 9 recessions (with 2 false positives) happening within 18 months of the inversion. Don’t forget – 18 months leaves plenty of room for rising peaks prior to the deepening troughs. That aside, we also hear “this time it’s different”. Really? What if it was?

One new truth is that we seem to borrower shorter now (less than 3 years). As such, if relative borrowing long vs short was 50/50 as late as 2016, currently 80% of our borrowing is short duration. The artificially high demand for short paper therefore drives short rates artificially high. At the same time the larger balance sheet of the fed drives long term interest rates down.

Maybe it is, maybe it isn’t, different this time. What do you think?  One thing is for certain,  global debt has risen from $4.9T in ’07 to $9T today. And, much of corporate debt today is ‘covenant’ light. Sitting one tranche from junk.

Literally, where is your money on the bet if the next recession is garden style or a catastrophic failure/recession? My son tells me that “Situation X Behavior = Results”. I ask in this context, are we experiencing late cycle conditions or late cycle behavior?

What am I observing and/or concerned about:

• I am all in on the benefit of the shadow banking system of the new alternative lenders. What has me worried are the small community banks beating the alternative lenders at price and proceeds. And they are qualified how?
• There is a TON of capital in the system. I dig liquidity, especially with balanced fundamentals in most of our markets. However, are we climbing too high on the stack? Is the capital posting at unusually higher capital risk levels? Is it as simple as recognizing the risk of late cycle investing in the longest boom in history? Is risk being mispriced?
• I cheer every day for inflation (for our Real Estate Industry); historic low unemployment globally means wage growth which means more consumer spending which drives a healthy economy and more inflation. More inflation means more rental growth which means increasing asset values.
• Millennials are the largest demographic and have the biggest propensity to rent. See above on Multi-family; still a value and growth sector.
• Is there anyone qualified left to hire? If not, where are companies putting money into training for existing associates to move up the chain of authority and future associates to be hired.
• Feels like loan opportunities on the cusp – ready for prime time 6-9 months out in the future are being brought in for financing today. A leading indicator that borrowers think the end is near?

It continues to be a great time to be in our business. Innovation, liquidity, deal flow all on the rise. There seems to be more money than good deals in the debt space.  Is your discipline for a deal ‘strike zone’ a fixed principal or merely a suggestion of an idea?

For principles to be true, they need to cost something. If you stand for nothing you will fall for anything.

I’ll be back soon with comments before the Fourth of July. Promise.