July 2024 Newsletter
Dear friends,
What a month it’s been.
Staying focused on the economy - we had a solid Q2 GDP Report (2.8%), coupled with a soft inflation read, weakening job figures (and retroactive job updates that indicated job creation was substantially worse than previous reports indicated), and a PCE report on Friday the 26th that further validates that inflation is slowing down. And then we’re ending the month with a plethora of data about jobs that strongly urge a rate cut.
We spend a lot of time on these reports talking about inflation, because what rates are doing is so important to real estate. For our July edition, we’d like to shift the focus a bit to some narratives we’re hearing about in real estate right now. But to just finish this perennial topic – the markets are now anticipating almost 100% chance of a rate cut in September, and another in December. The Bank of Canada also just cut rates, so globally, a rate cutting cycle is definitively commencing.
This is all a good reminder though of the most recent Howard Mark’s Memo (The Folly of Certainty), which is strongly encouraged reading for anybody with a passing interest in investing. We link the memo at the bottom of the report. He made this point before the GDP report – and without stealing his thunder too much, his point is basically that people have a lot of certainty and that having a lot of certainty is often a mistake. One item that everybody has been certain of for quite a while is that we would have a recession. And we will certainly have a recession, someday, but the timing of it is suspect. A robust Q2 GDP report is indicative that the talking heads (and us, to an extent) have been wrong on this topic, though I wouldn’t be surprised to see this revised downward in the coming months.
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What’s Up with West Coast Real Estate (as compared to the “rest”)
?We’ve been, contrary to popular opinion, continued believers in both the West Coast and in real estate investing here. Our thesis was/is straightforward – lack of supply, good climate, plentiful jobs and robust university ecosystems, and perhaps most importantly – everybody else was looking at and investing in the Sunbelt. If everybody is convinced the Sunbelt is the place to sink capital, then there is a lot of competition for those deals. For quite a while everybody has been absolutely convinced (certain – to use Howard Mark’s terminology) that the Sunbelt was where capital needed to go.
We don’t want to be contrarian just to be contrarian. There are good arguments for investing in the “red state exodus” play. Population growth, lack of regulation and business growth are three very good and rational arguments. The issue, in our view, is that if everybody thinks that, then the opportunities to find good deals are just that much harder (and it’s very hard to find good deals). It’s a simple law of numbers – if 100 people bid on a building, but in downtown Portland you have 2 other competitors for a deal, then the final pricing on the downtown Portland building is going to very likely be better (not certainly, but it’s more likely that you can get a good price). In other words – markets are relatively efficient, even in a relatively inefficient asset class like real estate. And when you have more buyers, you get more efficient, which means pricing moves swiftly and finding deals is that much harder.
What’s more, the lack of regulation in the Sunbelt markets is both good and bad. One of our central theses was that it is quite easy to build in these markets, but not in our own chosen geographies. Ultimately ease to build is good because it keeps rents lower, which means you should, in theory, have continued population growth. On the other hand – the second the population growth dips or slows down – then you have more of the “boom-bust” market psychology. And the confluence of more extreme weather events, lack of access to water, and the ability for many of these cities to simply sprawl in every direction, in our mind, means that you will have consistent oversupply issues.
You can see below that rents are, in fact, falling hardest in high-supplied markets. Florida happens to top the list.
I love Florida by the way – is there another market where we have 100 + years of boom and bust cycles quite the way Florida operates?
Here's a helpful quote from the article on the causes of the Great Depression:
The land boom, not the stock market, was the true catalyst for the disasters that befell the nation as overvalued housing and property prices everywhere began to collapse in the wake of the Florida debacle.
The phrase “selling swampland in Florida” comes from somewhere, after all.
Take a look at insurance expenses. Yes, it’s trending down (great news for the whole country) but who tops the list? South Central and Florida. Interesting note on California, which coincides with the huge wildfire issues we had there. But again – the point remains – high supply, high insurance costs, overly dependent on population growth – and only the third option can potentially create gains for investors.
By contrast, the West Coast has some very understood and appreciated negatives. The local governance is a huge pain. The law is stacked against landlords. We have rent control! And of course, prices are exorbitantly high so people can sometimes choose to move to lower-cost jurisdictions.
However, that’s all priced in at this point and it creates a unique opportunity to pick up great deals in major cities in great locations while everybody else is fighting over Florida real estate.
By the way - we don't have anything against these parts of the country, but just want to point out (aggressively) that it's not only the West Coast that has issues. Here are a few bullet points on Seattle and Portland, two of our major cities for investment, that we thought were informative. ?
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Multifamily News Portland OR
In addition, there have been major political developments on the West Coast that are working to counteract the prevailing (and priced) notion on West Coast real estate.
As active practitioners of West Coast investing, we're always shocked by “outsiders” firmly held convictions on what’s happening in our market. It’s "usually" informed by the national media and certain political perspectives, and so we think it’s a big advantage to be here, working in these markets, and seeing the actual on-the-ground changes.
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In short, substantive improvements across the board, and the best part is most investors are still operating off stale information, which means the buying opportunities are still unique and plentiful.
As always, please reach out if you want to schedule a call to discuss upcoming investment opportunities in our chosen market.
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Arie van Gemeren, CFA
Founder & Managing Partner
Lombard Equities Group LLC
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