Square peg for a square hole, couldn’t be a more applicable metaphor for today’s real estate business. Businesses are quickly made and broken by their capital structures more so than ever in momentous cycle changes. This now more than ever applies to the changing nature of investor expectations, real estate assets and their unique requirements.
So, how do we navigate the myriad of capital sources, complicated structures, and investor expectations for optimal results? The answer is…. “let the market drive it.” In order to be effective in defining investment objectives, it is critical to understand the broad array of offerings driven by the appetites of investor capital and the opaque sources underlying them.
For this post, I will liken a successful real estate investment to a dinner party where the pairing of proper wines with the different stages of the meal is an important detail which, in itself, will vary according to the setting, dinner guests, and, ultimately, what is the desired outcome.
Most of us are familiar with the overused tenets of a successful real estate enterprise: Location, Location, Location. Then we witnessed the donning of MBS and superstructures that enabled
the explosion in real estate values where those tenets evolved — or devolved — into Finance, Finance, Finance. With this we have the changing of setting, as it were, from how real estate was positioned on the geographic plane; our setting changed to an abstract plane of sorts, to accommodate the demands of available capital for any kind of product in almost any location.
An article in a recent issue of The Economist, “Free Exchange: Betting the house”, details various property booms and busts throughout US history (see graphic below). One example is Robert Morris, a signatory of the Declaration of Independence, who acquired of millions of acres from Native Americans and friends of the crown, and then sold them to speculators. The prospect of increasing values led to demand — then purchases — that drove prices up on the land purchased by Morris. The crown effectively financed the drive to seemingly stratospheric prices until “dearer credit” left Morris bankrupt. The setting, a piece of the new frontier, changed overnight to an abstract plane — without available credit — and all was lost.
Source: The Economist
LANDCO has long supported the notion of “true value” defined as “NOI divided by a market return on capital,” or, free and clear return, the cap rate. Commercial tenants — our dinner guests — can pay rent based on the profitability of their enterprises. As such, the success of our dinner party is somewhat determined by the attire, the degree of interesting conversation, and the compliment or interplay amongst the guests. It’s hard to know what to expect until the party is underway. But with all due respect to our guests, they can only be their best.
If an underlying employment decline translates to an inability to bolster consumerism, or topline revenue (residential mortgage payments and commercial rents), then a negative affect is in the offing. We have no disagreement on that. So at the dinner party we may see familiar guests but a decidedly different mood, a very different outcome can and should be expected. Knowing what is going on with our dinner guests in advance will clue us in to how we may wish to place the seating cards but rearranging the setting might not be as easy on short notice
The desired outcome never changes: It is always to meet or exceed our investment expectations. There are only so many variables to alter before we are
forced to reconcile with the constraints of our otherwise predictable variables. Fred and Betty are getting a divorce. Do we invite Fred and Betty or run the risk of offending Fred by inviting only Betty? Do we not invite either? These questions our host (or investor) must ask and in almost every situation, and a decision is required.
Adjustments are in order and
for best results they begin with changing the expectation. In the current economic environment, it is critical that we understand everything we can reasonably be expected to before pulling the trigger on any capital deployment. To do this, and be effective, LANDCO advocates positioning based on an overall investment strategy which includes
setting, dinner guests, and the ultimate desired outcome. In order to do this effectively we are believers that comprehending capital availability for any given geography, product type, and duration is the keystone element to achieving a successful outcome in any investment endeavor.
LANDCO Capital assesses numerous funding sources and aligns them with targeted investments in its select markets. The benefits are many if we understand the capital sources going into a deal, then we will understand who the likely buyers of our assets are when we go to sell them, and if we
have looked at as many alternatives, then there is an implied assurance that we are getting the best possible outcome for a particular client, ourselves or third party.
Nearsightedness has been the undoing of inestimable fortunes. Capital is not behaving as it did five years ago, or might in the future. A clearer vision of history and shorter steps in difficult to predict times underlies LANDCO’s approach to investments in 2013 and the foreseeable future.
A hard look at recently legislated banking regulations and their effects on regional banks is one area to watch closely. Our nation’s appetite for debt, the lock-jaw position of congress on austerity (see David Rosenbaum’s LANtelligence piece on austerity) and overall world financial condition greatly influence capital, and its willingness to deploy.
As we conclude, raising capital is more an art than a science. Creativity on perspective is critical to attracting the optimal capital for any successful real estate endeavor.