Buy, or Wait. And Why.
Priyaranjan Kumar, GAICD
Private Markets Investor I Board Advisor I Global Property Leader I Alternative Investments
Conditions favor continued liquidation in the next few quarters.? Liquidation is, after all, the result of a series of reinforcing incremental outcomes and a change in mindset.?
Preservation of capital, positioning for value over growth as factor preferences, and a need to be conservative in the face of mounting evidence of continued economic challenges leads to a largely risk off posture.
There is also a competing urgency to build for the future on the back of evidence, as and when available, that points to stability and emerging conditions that skew the risk reward asymmetrically in favor of growth.
The cycle of HOPE[1] is playing out exactly as it always has.?
§? The last leg, an absolute and relative fall in employment levels, is now anticipated, given central banks’ resolute focus on taming inflation by holding interest rates at high rates for an extended time frame.? The ghost of Arthur Burns still haunts policy makers[2].
§? As measured by rate of change, corporate bankruptcies are rising at the fastest pace since the great recession, spreads are under pressure as risk-free[3] bonds test 15-20 year highs across the entire yield curve, LEI (leading economic indicators) firmly point to a global economic deceleration and profit margins are retreating from pandemic era all time highs.
§? Housing, while mostly resilient through the post COVID period, is now showing cracks that point to a potential dislocation.? Prices of existing homes now lag new home prices in several major markets and housing permits are showing signs of decline as new home buyer affordability comes under pressure thanks to 20-30 year high mortgage rates.
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Where are we now cyclically? And, what are time tested winning strategies to seed the next phase of wealth creation in a current global macro headlined by slumping fundamental demand and bond markets threatening to show increasing signs of bear steepening[4]?
Risk Assets, such as commercial real estate, face many headwinds looking further into 2024 and beyond.
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§? Near Term: A 2-year US Treasury rate of ~5% is a great alternate use of cash with a potential carry should central banks cut benchmark rates in response to falling inflation. The reluctance of investors to deploy record stacks of dry powder in response to emerging signs of value emerging in some markets and strategies is understandable.
§? Intermediate Term: Financial history in the post war era suggests that central banks are almost always too late to provide relief via rate cuts. The economy has almost always been shoved into recessionary conditions before oppressive financial conditions alleviate.? Large economic blocks such as China, Germany, UK, France and Japan are barely eking out sustainable growth numbers in real terms despite continued doses of targeted industry support. Refinancing, for most borrowers, is a nightmare and is forcing dilute equity raises or sales.
A possible synchronized recession across the world’s largest economic blocks is not conducive for occupiers of real estate who tend to rationalize and postpone occupancy as demand for business expansion dips. Occupier strength or lack of it translates directly to changes in income trajectory.
Financial conditions remain softer than what central banks ideally want to see, despite real rates now turning positive, Will this time be different and the Fed, ECB and PBoC succeed in engineering the all elusive Soft Landing? How will this be achieved given apparent lack of coordination between the two largest central banks, the US Fed and PBoC?
?§? Long Term: As inflation expectations remain elevated, there is a material risk that rising costs of business may get ossified.? Some of these longer-term structural costs relate to big shifts in:
o?? Climate change mitigation investments.
o?? Bifurcation or at the minimum realignment in global supply chains
o?? Higher taxes given rising and persistently high budgetary deficits in most economies exacerbated by the risk of falling business taxes given recessionary conditions.
o?? Wage levels resetting at significantly higher levels.
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The longer-term risks matter most to real estate investors given the duration that is underwritten in proforma cash flows.? Most of these risks are external and heavily influenced by sovereign geopolitical considerations, emerging cultural shifts, and central banks policies. ?These are risks that are mostly out of control and hence calls for a proactive strategic engagement plan.
Given the recent track record of policy excesses, both over and under, what will change that will give investors the confidence to trust the policy makers to adjust before markets bear (no pun intended) the brunt of such policies leading to existential crises?
From a pragmatic risk-adjustment build perspective the pressing issues for the industry are probably best summarized by a consideration of the following factors. These also tie into UN SDG goals which are now top boardroom priorities.
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Depending on the time frame, these factors both shape and take roots in tactical deployment and strategic capital allocation outcomes. Large institutional investors are solving for these needs with increasing urgency.
Dispersion (strategy and returns)
Alternative real estate user cases are mostly under built and in many geographies far from maturity. These are the organic demand led growth corridors. Sustainability linked factors driving the deployment of capital in these areas include – Equitable communities; Housing (student housing, affordable urban homes, multifamily, senior living), Climate Change mitigation (cold storages, renewable energy), Resilience (Life Sciences, Logistics, Sustainable Hospitality) and Innovation (Media centres & studios, Data Centers, Research parks).
Value
Skew towards high quality development pipeline backed by strong operators, and core plus-value add assets which reflect appropriately new discount rates.?Ability to drive operational efficiencies, mitigate risks and drive alignment of outcomes with capital partners is increasingly under the scanner. Fund managers have tough choices to make to invest in such capability given P&Ls are that increasingly constrained.
Fundamentals
This can be filtered at many levels – target countries/ cities with fiscal discipline and budgetary prudence, geopolitical alignment to country to capital origination, positive demographics[5], and strength of institutional frameworks.
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The Asian real estate industry has done a commendable job faced with some of the most challenging conditions since the end of World War II.??
There is clear value emerging in mature markets such as Australia, South Korea, Hong Kong and Japan.?? India and some countries in ASEAN are positioned for continued surprise on the upside on economic growth fueled by a strong and fast-growing consumer base, fears of over concentration of industrial value add in China, and prudent economic policies as compared to historical precedence.?
Some strategies that can help take advantage of current market conditions include;
-??????? Scaling in on high conviction ideas and ramping aggressively as macro turns more favorable.
-??????? Beefing up strategy and product ideation sessions with Limited Partners, building a circle of confidence and alignment.
-??????? Deploying resources to intelligently scout for information and build brand awareness, great time to invest in corporate business development.
-??????? Aligning internal teams and concentrate into differentiated competencies to address the new narrative and long term investor priorities.
-??????? Aggressively de-risk legacy underperformance issues, drag on management bandwidth and threat of capital obsolescence.
When it is time to buy and expand aggressively, the baggage from the legacy issues have historically hampered the best of firms.? Every cycle gives rise to a new group of best in class custodians of capital who grab market share disproportionately faster than distracted legacy incumbents who often try and preserve status quo.?
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As the adage goes, it is darkest before the dawn. When it is time to buy, will you be ready?
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(views expressed are personal opinions and does not constitute investment advice)
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[1] Housing, Orders, Profits, Employment.? Michael Kantrowitz, CFA of Piper Sandler is credited with popularizing this framework, follow him on X at @michaelkantro or connect with him at https://www.pipersandler.com/about/people/michael-kantrowitz-cfa
[3] US treasury bonds and like fixed income securities issued by investment grade economies.
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Democratizing bank-grade security and controls for building financial experiences
1 年Really good macro overview and commentary on global real estate market cycles and potential impact and opportunities. Thanks Priyaranjan Kumar, GAICD, in your typical style, to the point!