We’re just back from another incredible Investor Summit at Sea™ … and it was EPIC!
With 234 people, 2018 was our biggest ever … and many have already reserved their place for next year. Click here to get YOUR name on the Advance Notice List.
We kicked off the 2018 Summit with a two-day land conference based on our theme, The Future of Money and Wealth. Our speakers hit it out of the park!
Fortunately, we videotaped the whole thing. Watch for more details … or if you already know you want it, click here to pre-order the entire two-day series.
Meanwhile, it seems the world continued to spin while we were gone. So as much fun as it might be to keep cogitating on currency, bonds, gold, oil and interest rates …
… we decided to dig into our real estate news feed and see what’s happening with our favorite investment sector.
But a funny thing happened …
A couple of related headlines jumped out as particularly interesting after a week of contemplating the future of money and wealth.
CRE Valuations Are Trending Down – NREI Online, April 6, 2018
For the uninitiated, CRE is short for Commercial Real Estate. And when the industry talks CRE, it includes large multi-family.
But even if you’re a Mom & Pop single-family home investor, you can still learn a lot from following CRE trends.
So this first article opens with …
“… real estate investors can expect that property prices will trend downward in the near future …”
“‘Value appreciation has practically stopped …”’
“However, there are variations among sectors. Industrial … has seen rising values … malls have seen big losses …”
“Cap rates have been inching up … for all sectors except industrial …”
After two days at Future of Money and Wealth, then another seven days at the Investor Summit at Sea™, these comments make a whole lot more sense to us.
First, interest rates are rising. But the impact on real estate is much deeper than just mortgages getting more expensive. If only it were that simple.
So without getting lost in the weeds, consider the impact of rising rates on the overall economy …
With record levels of consumer, corporate, and government debt … rising rates put a pinch on budgets at every level.
This means it’s harder for consumers to spend more, for businesses to sell more, and for landlords to raise rents on those consumers and businesses.
And when you realize income property values are driven by income, it’s easy to understand why stagnant rent growth means stagnant equity growth.
But this article also reminds us why we LOVE real estate … “there are variations among sectors” … so while retail (malls) are losing value, industrial is gaining.
We discussed this trend in our February 14 newsletter, so we won’t revisit it here. The point is …. when things shift, pain and profit are NOT equally distributed throughout the economy.
So if you’re alert and proactive, you can get in front of an opportunity … or out of the way of a problem … faster than investors on cruise control.
Meanwhile, while rising cap rates can come from income rising faster than prices, most of the time it’s from prices falling.
(Again … no investor left behind … cap rate is income divided by price. Just grab a calculator and play with numbers until you understand. It’s an essential investor skill.)
So why might cap rates be “inching up” … that is, why would buyers be offering less for the income?
Conversely, why would sellers be offering more income for less price?
(That’s two different ways of saying the same thing … go back and play with the numbers until you get it.)
One likely reason is investors aren’t willing to overpay today (bid up) expecting income to grow in the future. The numbers need to make sense TODAY.
So cap rates are like a barometer of sentiment. Rising cap rates are an indicator of a less bullish, more bearish outlook.
If rents rise (creating more income) and/or interest rates decline (reducing expenses), then cash flows improve.
If the rents don’t rise (stagnant income) and/or interest rates climb (expenses increase), then cash flows stagnate or decrease.
So investors are saying the think either rents won’t rise, or interest rates won’t decrease (or even increase), or both. That is, they don’t expect market forces to improve cash flows going forward.
Which leads to the next headline …
Competition Intensifies for Value-Add Assets, NREI Online, April 17, 2018
“… competition is becoming increasingly stiff as the industry faces the likely end of the cycle and rent growth has moderated for core assets.”
“As yields get lower and lower … two strategies have emerged … speculative building and value-add …”
Quoting a research director at a commercial research firm …
“‘Value-add has become quite attractive … people are less afraid to take on vacancy risk and reposition buildings.’”
So let’s break this down real quick, then you can go get a snack …
When you hear “the likely end of the cycle”, it’s code for “the party’s nearly over.”
Real estate, like the rest of the economy, has been partying on easy money since 2009.
At Future of Money and Wealth, Fannie Mae chief economist Doug Duncan reminded us we’ve been in one of the longest (and weakest) recoveries in modern history.
In other words, we’re nearing “the likely end of the cycle.” Duncan thinks the U.S. will be in full-fledged recession in 18-24 months.
So now instead of just buying a property and riding a wave, you actually have to buy smart and do some real work to improve the income … like “take on vacancy risk and reposition buildings.”
And if you’re like our pal, the apartment king Brad Sumrok, and you’ve already been doing value-add and achieving spectacular results … be prepared to settle for “only” solid results.
Here’s the bottom line …
Rising interest rates are moderating the economy, so it’s important to focus your growth plans on things you have more control over.
This is probably not the environment to bet big on rising rents, falling rates, and lots of passive equity growth. You’ll need to buy smart, have a good plan, and work hard. We call it “force the equity.”
Pick your sectors, markets, properties, and financing structures for the long haul.
And remember … real estate is a highly inefficient investment vehicle with lots of nooks and crannies for good deals to hide.
So when you’re well-connected, diligently searching, and properly prepared with a solid team and resources so you can act quickly and carefully, you improve your odds of landing profitable opportunities.
Until next time … good investing!
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