Scotsman Guide asks Managing Director and CIO of Arixa Capital, Jan Brzeski his thoughts on what's ahead for the commercial market in 2018.
Arixa Capital has released a new white paper focused on the U.S. housing market and single family homes as an asset class for investors to consider. The white paper is based on Arixa's concrete experience investing in this area in recent years, working with local operators who buy properties in a specific geographic area, renovate them, and either lease the homes or resell them.
The white paper explains various ways that investors can gain exposure to this asset class, which Warren Buffett recently endorsed as underpriced and attractive. The author explains the advantages and disadvantages of various investment strategies for both active and passive investors.
The white paper also explains that the activity of thousands of local operators is already helping to work through the backlog of foreclosed homes. Attracted by appealing profits, local operators will help the housing market to heal over the next several years. Policies that aim to solve the problem on a mass scale are neither needed nor advisable.
For a copy of our white paper, please click here.
This edition of Arixa's newsletter includes:
- The growth of our investment programs and the launch of our second fund
- Our annual panel discussion at UCLA in conjunction with the Ziman Center and the Anderson School
- An update on Arixa's first assignment as a court-appointed receiver; and
- Information on a new white paper by Jan Brzeski
To all who registered for and/or attended our event last week, thank you for coming. If you were able to attend, we hope you found it valuable. If you are interested in the photos that were taken of the event, please click here.
To read more about the event, please click here.
The unique value proposition for this event series is the high quality networking and educational opportunity combined with the very low registration fee ($15 for pre-registration or $20 at the door). The fact that beer, wine and appetizers are included in the price is also popular with participants.
For those of you who were unable to attend, or would simply like to listen to the discussion again, the UCLA Ziman Center was kind enough to record the event again this year. We plan to post this video very soon, so please check back on this blog for that link.
If you have suggestions for making the event even better next year, or would like to reach us for any other reason, we would love to hear from you. Please email Jan Brzeski at firstname.lastname@example.org.
Jan published a new article on Seeking Alpha last week, entitled "Apartments‚ÄîA Contrarian View." The article analyzes a recent prediction by Moody's Investor Services that apartment values will increase substantially in the next few years. While Jan is not bearish on apartment values, he believes that the projections reveal a substantial misunderstanding of the market and that the projections are very unlikely to prove accurate. To read the article, please click here.
Nine years ago I began working full time in the real estate investment field. While I use an HP 12C calculator and I like it a lot, I find it cumbersome to use for common real estate calculations. With a little help from Google, I found the attached spreadsheet online which I have adapted for my own use. Perhaps you will find it useful, too. Please click here to download the excel file.
What is it good for? This spreadsheet comes into play when you are interested in determining the cash flow you will receive from buying income property and financing that purchase with a loan. To do this, it is really helpful to know the mortgage constant for the loan given the interest rate and amortization period. This spreadsheet gives you that information, and it shows you exactly where all the money goes (unlike the HP 12C which just gives you the amount of the payment, if you are able to remember the sequence of buttons to press correctly).
How it works On the tab entitled, "Worksheet," you enter the items in red. Specifically, you need the interest rate on the loan that you can obtain; and the amortization period. You can enter the actual loan amount, although I usually don't bother because I am interested in the mortgage constant, not the actual monthly payment.
Why does the mortgage constant matter so much? As a buyer of income property, investors should be very interested in the relationship between the capitalization rate and the mortgage constant on the loan they can obtain for the acquisition. We like situations where the cap rate is higher than the mortgage constant, because this means our cash-on-cash return will be higher than the cap rate. This situation is known as "positive leverage" in the world of income property investment.
If you are interested in learning more, please contact us and we would be happy to go into more detail on this subject. The topic is addressed in some detail in my book, which is available on Amazon (click here if interested).
This podcast introduces some of the issues involved when underwriting income property such as apartments or shopping centers, when considering making or investing in a loan secured by income property. The key is to understand the value of the property and value is driven by ability to generate cash flow, which in turn is driven by a variety of factors, depending on the property type.
This podcast addresses the issue of how to value income property, in the context of making a loan secured by an income property such as a shopping center or apartment building. The concept of the capitalization rate is introduced.
This podcast explains briefly how to look at income property investing, and specifically, how to think about the value of apartments, shopping centers and industrial buildings. Coming up with a good estimate of the property's projected cash flow is the the key to understanding the risk of investing in a trust deed secured by that property.
Jan Brzeski is a contributor to Seeking Alpha. The article below is a copy of what he posted on August 30, 2011. To access his article on Seeking Alpha, please click here. Real estate investors know that generalizations are of little value when describing the real estate investment market. Some markets see rising rents while others see the opposite. Results vary by asset class as well.
Today we are seeing an unusual divergence in values as indicated by the two charts below.
The Broad Commercial Real Estate Market: Still on the Floor The first chart is the Moody's/REAL All Properties commercial real estate index:
The index from which the chart above was made tracks repeat sales of all properties across the U.S. where the sales price was $2.5 million or above.
The Institutional-Quality Commercial Property Market: Bubbly Now let's look at the Green Street Advisors Commercial Price Property Index (CPPI). This index tracks the price at which public REITs are buying and selling real estate. This index also gives higher weight to higher dollar volume transactions, whereas the first index gives equal weight to every transaction (only repeat sales of the same property are tracked in the Moody's/REAL index; the CPPI tracks all large transactions by REITs, including those that are not repeat sales).
Mixed Signals The index of REIT-quality properties is up almost 50% since it hit bottom in early 2009. Meanwhile the broader index that includes many smaller, lower quality properties has actually gone down since 2009.
Consider for a moment that the broader index, which is still near its bottom, includes some large transactions where the price is presumably up 50% from where it was two years ago. This must mean that the prices of all non-large properties are down substantially since two years ago, in order for the broader index to be flat.
Imagine if the Dow Jones Industrial Average were up 50% in the past two years while the Wilshire 5000 Index was flat in the past two years. That is more or less what this data says.
Possible Explanations Let's examine some possible explanations of this dramatic divergence. Note that I am not advocating for the superiority of one or another explanation below, only trying to draw out arguments that could explain what we are seeing.
Explanation #1. The income of Class A buildings has gone up 50% in the past two years, while the income of all commercial property as a whole is flat. This explanation, if true, would be satisfying. It would suggest that the indexes are diverging for sensible reasons. However, that is not the case. On page 4 of the 2010 Annual Report of Vornado Realty Trust, "same store sales" EBITDA for Vornado's office properties rose 3.2%. And that includes more than a 5% increase from Vornado's big investment in the government bubble market of Washington D.C. which benefitted from stimulus spending during the period.
Explanation #2. Large, institutional quality assets are experiencing a bubble and are over-bought. Interest rates for both individual savers and institutional investors such as pension funds are near all-time lows. As investors look for yield, they are buying high quality REIT stocks, driving the dividend yields on those companies to very low levels. In turn, the REITs have issued huge quantities of equity on favorable term. If they only need to pay investors 2-4% dividend yields, they can afford to pay very low capitalization rates (very high prices) when they go shopping to invest the cash they raised. Of course if they are going to pay top dollar, they want to buy only the highest quality properties.
Explanation #3. Smaller properties will from now on be relegated to their appropriate place "on the wrong side of the investment railroad tracks." There has always been a gap between the value of a dollar of cash flow from a San Francisco or New York high rise and a dollar of cash flow from an Ohio shopping center or an Arizona mobile home park. The gap has now widened and will remain huge forever.
My Own Interpretation Personally, I think the rise in REIT stocks, and the related jump in values for top quality real estate assets, is part of a larger flight to safety. Investors are scared. They lost a huge amount of money on real estate in recent years. They need to get back into real estate because there is no way to fund retirement with a 1% or 2% yield from government bonds.
As Warren Buffett said, "be fearful when others are greedy, and be greedy when others are fearful." The best way to apply that advice in commercial real estate today is avoid pricy REIT shares and to embrace the healthy income that can be had from less prestigious properties. Small is beautiful in real estate today.
Disclosure: Our own strategy is to make loans to investors who are buying properties at beaten down prices. This provides healthy income with a margin of safety because the borrower's equity acts as a cushion for our investment in case values fall. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
This podcast explains the organic process through which we launched our residential bridge lending program. The founder of Standard Capital had cash available and was looking for something very safe with a fairly short maturity as an interim investment. The residential bridge loans went so well that Standard Capital launched a program allowing other investors to participate in these investments. The process was not planned out ahead of time, it evolved naturally as it became clear that the program really works.
What we saw: A 46-acre commercially-zoned parcel located within the City limits of the rapidly growing town of Shafter, California. The site is bordered by State Highway 46 and Santa Fe Way, a busy county road leading back to West Bakersfield. The property generates solid cash flow and will eventually be redeveloped into a shopping center.