How We View the Current Investing Landscape
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Episode Transcript:
Well let's talk about the investing landscape today. Uh, what an interesting time or not to be, uh, investing. How do you see the landscape this next year, uh, for investing? Right. Well, I'll start by backing up a little bit and looking at what has hap transpired over the last year? Uh, a lot. I would say the, the real estate market has not seen such seismic shifts since the Great Recession, the global financial crisis.
I. Dramatic. Um, and that's, you know, primarily because as interest rates go up, as the fed fed rate goes up, interest rates go up. As interest rates go up, values go down. Yeah. Uh, and as interest rates go up, the risk-free rate is going up, which means that cap rates go up, which also makes value go down. So a lot of factors at play that effectively have put a big damper on the real estate market and.
Start started the process of value decline. Um, we, about this time last year, I think we could probably pretty safely call the top of the market at this point. It was about, 'cause it really started not as much in Q one, but definitely by Q two. We were starting to see those rates rise up. It looks like it was about May or June of last year was the, was the top, yeah.
During that period of time, what, what has happened since then is we've entered the phase of price discovery where sellers are, they're probably not at May or June prices, they're probably at September. Prices at this point. Yeah. But it's this whole process of, uh, sellers remembering that price, the price of my asset was here.
Buyers simply doing basic underwriting and saying, based on current interest rates and future expected cap rates, And your price is here. Yeah. And then we're going through this process of further decline as interest rates go up and sellers and buyers still being out of parity. Obviously we're getting closer and closer and I, I would say as we sit today, we're, we're getting pretty close to where broadly speaking, buyers and sellers are getting toward agreement.
Mm-hmm. So, given that, Overlay of where we are today. How do you see value shaking out over the next 12 months? Yeah, this is really a desert period for investing. It's, uh, there's a, a lot of factors at play. Uh, if you look at Green Street's commercial Property price index, we did peak at about May or June last year.
And, uh, we're down about 14% on, across all properties in the Western us. If you look at the, uh, secondary and tertiary markets, uh, we're down about 18%. Um, What's interesting is with the rapid, uh, interest rate increases, we saw, um, price price declines happen quickly. This was a shock. It's likely that further, uh, price decreases are, are going to happen.
And, um, for example, cap rates have moved about, uh, a hundred basis points. They may move another 50 or 60 basis points, but that it's gonna be much slower. Um, and, and it, it depends if you're looking at CoStar data versus Green Street versus Yardi, but, um, there will be further movement in cap rates, um, that, that said, it will be more slowly.
Interest rate, uh, increases are likely to be much slower now. Um, those things aren't exactly aligned, but, uh, over this next year, I would expect prices to go down a little bit more. I would also expect that as appraisals start to come in, especially on the institutional side, Uh, appraisals look backwards.
So they're gonna be, they will be filling a lot of pain around, uh, values coming down, and there will be headlines around values coming down. The truth is we're looking backwards. There's been a tremendous hit that's, that's happened in the last year, and there is more to come. Yeah. That said, on, on the industrial side, uh, rental rates continue to grow rapidly.
Uh, on the deals we're doing, the boots on the ground deals, we are seeing still, uh, rapid growth in bringing, uh, rents to market, um, on, on multi-tenant industrial. I. On, uh, value add, we're seeing much slower growth. It's, uh, we had really high on, uh, multifamily value add multifamily. Yeah. We had eight to 10% growth.
Now we're seeing, yeah, four to 5%. In some cases, 3%. It's much more normalized. But, um, but there's this cocktail of value. There's, uh, cap rates, which are, uh, moving up. There's rents which are also moving up, and you've got expenses moving up. So across that, um, it's likely that we're nearing. Uh, uh, uh, uh, it's likely that we'll bottom out on value this year, uh, because the, the rent growth will, uh, offset that.
Yeah. Um, that said, these next few years are a great time to be investing and for the type of investing we do the value add piece where we don't just ride the macro park, but we buy properties that we can add value to. Um, there's this mix of, there's very few buyers in the market right now, which gives us, uh, More advantage, advantageous, uh, pricing and opportunities that we would've had to bid a little bit on in the past.
So, what am I saying? I'm saying now's the time. We, we will be buying this year. We will be buying cautiously this year. We will be making lots of low offers and seeing what sticks and, um, we will be escalating our buying, uh, as we get. Uh, later in the year and into next year, there are kind of two postures to take during this time of declining prices or price discovery.
And, you know, one or two prudent postures, one is pencils down. We're just sitting on the sidelines and we're just gonna wait until we see the bottom and we see things rebound. Um, the other approach is a, we are always in the market. We are always active, but we take a more cautious posture, and that's the approach that we take.
And part of the reason we take that is because, uh, it's easy from an armchair to say, I'm just gonna sit and wait for the market to turn right. But real estate is highly inefficient, highly uncorrelated. It's, it moves slowly. And if you're not constantly testing the market, And developing that deal flow by the time the market bottoms out and then it recovers, you're already well behind the eight ball in finding some of the best value in the market.
Yeah, our strategy requires a lot of churning. So the offers, uh, we, we live about six months in the future. The offers we're making today, uh, relate to deals that happen six or eight months from now. So, um, six or eight months from now, the, the market is going to be more active. There will be more competitors in the market. Now is a very important time to be getting on the Ferris wheel of sellers minds and testing their value and seeing those that, um, that are, that are looking to move on for whatever reason. Well, and I, I would add that it's asset by asset as well. Yeah. Um, or I should say asset type by asset type.
If you look at multifamily or small bay, I'd say start with small bay industrial, because that has some of the strongest. Growth and demand drivers right now. Yeah. Um, followed by multifamily, but then you look at retail or you look at office at what are probably, what are those? I don't, what are those exactly?
They're, they're at the extreme end of that. Uh, you know, if, if you're, uh, looking at finding a great purchase on, uh, Manhattan office space, there is a right time to buy and there will be value and there will be opportunity. But we're much earlier in that price discovery phase because there are bigger macro trends at play that are still discerning what that value will be.
So, I would just also caution that it really kind of depends on asset type, it depends on geography to, to really determine where we are in that, that part of the cycle. And the value pricing. What about financing? How do you see debt playing out this year? Yeah. Uh, we've saw a lot of movement over the last year.
Interest rates went up about 200 to 300, uh, basis points. So pretty significant move. And, uh, we see much like following the Fed rate, the, the Fed funds rate, we see additional increases happening, but then kind of leveling out. What's interesting is, uh, lenders have gotten more conservative. I think that's an important point to note.
So this isn't just a. Direct correlation to fed funds rate. Hey, fed moves up this much interest rates move up this much. That is true. But in addition to that, the sentiment of lenders has softened. Mm-hmm. They see the specter of a recession or some other, other, uh, they see distress in real estate, particularly in office.
Particularly in downtown San Francisco office. Right, right. And so there, the, the lender posture is just more cautious. And so we've already seen that, uh, you know, typical leverage has moved from 60 to 65% down to 50 to 55%. Yeah. Um, and we don't see that changing over the next 12 months. So I think really what we're, what we anticipate on the financing side, um, is kind of that lower leverage environment, higher interest rate environment.
And we've also seen that, uh, community banks, regional lenders, They tend to be a little bit more active. Um, they have been less kind of pencils down than some of the larger banks have been, so, mm-hmm. I think that's how, I think that's how financing will continue to play out over the next 12 months. So given the overlay of where the market is, where the financing is, how, how would you say that plays out for our strategy over the next 12 or 18 months?
Mainly, we are doing our jobs. We are doing the thing we know how to do, uh, hopefully better than anyone else in the world. Which is putting out, uh, finding the right deals in secondary and tertiary markets. Um, as it stands, we have about 400 million in current deals in our pipeline, uh, that those are either offers out or deals we're evaluating.
Um, we're putting out about 50 million, uh, dollars a week in offers. We tend to buy one in 20 properties, and our, our timeline tends to be six or eight months, so, I say all this to say we are engaged, we are grinding, we are in the flow, um, which is where we need to be. So that 4, 5, 6, 12, 18 months from now, uh, the deals that we started today or last year or six months from now are coming to fruition and we put in the works so that we were the ones that got those deals at the right price.
Um, this year is definitely going to be a grinding year. For us and for our style and for who we are, uh, it's important that we're hustling. It's important that we are, uh, in the mix and finding those deals, and we will get deals, uh, done that others don't because we put in that work and effort.
And, it's interesting just from a deployment timing, you know, we just finished fund three. We're launching fund four, and, uh, the investment period will be the next three to four years. And so if we look at the kind of, yeah. Averaging out over the next three or four years of investing. It's, it, it will, it will be a very fruitful time.
Um, I've heard some in the business call it a good vintage year, meaning that, you know, funds that start during this period of time will likely have a strong return profile. And, uh, so I think, I think from a, a market timing and from a deployment timing, uh, we're excited about the future. Thank you for listening to Durable Value an Investors podcast where we demystify commercial real estate with safe sound investment strategies to help you balance your portfolio.
Summary
Joe and Ryan share their view on the current investing landscape.