The Paradigm Shift

Ever since I launched my commercial real estate advisory business, I've been blessed to see different components of the real estate industry. By getting access to the brokerage, lending, GP, and LP sides of the business, I've had an awakening into how each respective participant views opportunity within the sector. It's been a wonderful experience.

However, since I'm exposed to the different levers being pulled within the space, I also get some insight into some of the pain points beginning to unfold within the overall market - both real estate and non-real estate alike. In my opinion, I believe the market at large is undergoing a systemic Paradigm Shift and it seems that most are missing the forest for the trees.

Though I am not anything remotely close to an expert in any of these manners, in this article I'll discuss what I believe to be unfolding and how I hope to plan for what comes next. As a disclaimer, nothing is investment advice.

Let's begin.

Why the F*ck is the stock market ripping higher?

Weren't we supposed to hit a recession? Weren't we supposed to be crippled by the meteoric rise in interest rates to curb consumer demand for goods and services?

If we were supposed to hit a recession - whether a soft landing or hard one - why hasn't it hit? Moreover, why is the stock market ripping higher almost every day?

I believe the story is one of fiscal dominance.

Despite higher interest rates typically translating into higher cost of capital, lower future returns, and a more challenging investment landscape, the opposite is unfolding.

Because the U.S. government is operating insanely irresponsible deficits, propping up the banks with liquidity in the form of stealth programs used to artificially inflate deteriorating assets (looking at you BTFP), cash is abundant and finding its way into companies and assets with high growth opportunities and strong pricing power.

Additionally, since every business and individual refinanced their mortgages at 2% - 3% in 2021, the average consumer is actually cash rich and in a very strong financial position. Therefore, the stark rise in interest rates perpetuated by the Federal Reserve is actually more inflationary than deflationary.

How so? Well, since most operators are sitting on low interest rate debt, why invest in growth and take on more debt at higher rates if they can park their cash in a treasury account and clip a 5-6% return?

Exactly! Demand remains the same or grows, while supply decreases.

So the only real struggling entities out there are those that are heavily tied to active credit markets i.e. the government, banks, and commercial real estate. As a result, capital is flowing out of those entities and into companies/assets that benefit in highly inflationary environments. Assets such as high growth companies with tremendous pricing power (Google, Apple, Nvidia, Amazon, Microsoft) and assets with fixed or low supply with increasing demand (Bitcoin, gold, commodities).

But, shouldn't real estate be a strong inflationary hedge?

In theory, yes, but in practice, no.

Which brings me to my next section, where is the bubble?

Where is the bubble?

If hiking interest rates higher hasn't slowed down inflation and cutting interest rates will also lead to higher inflation, where exactly is the bubble?

Additionally, if the government continues to spend more money than is sustainable, if geopolitics continue to impact supply chains, and the consumer - with low interest rate debt - continues to spend healthily, the bubble is not in inflationary hedges like Bitcoin and commodities, the bubble is in the bond market.

Why should an individual purchase a government T bill at 4% if true inflation, measured by the cost of groceries, the cost of oil and gas, and the cost of healthcare, keeps rising rapidly.

Why should a bank offer a mortgage to a commercial property investor at 4% if they'd get a negative real rate of return due to inflation normalizing at 5% - 10% annually.

Yes, you heard that right. Inflation is not 2% like the headlines say. True inflation is much, much higher.

How do I know? Just look at the gold market.

Gold has completely decoupled from interest rates - a trading pattern that generally exists when inflation begins to run rampant.

So if inflation continues to press higher, all assets tied to the bond market will continue to deteriorate.

Bond yields, cap rates, insurance premiums, replacement costs, and credit wonkiness will likely continue to rise. As a result, real estate and regional banks will continue to face tremendous downward pressure as capital looks to move into assets with low counter-party risk and with supply inelasticity.

So, what's next? Capital flight.

The hard-ass battle for hard assets

To prepare for the Paradigm Shift, I think it is extremely important to position accordingly. For me, that's been buying gold, Bitcoin, Bitcoin Cash, Uranium, oil services, and other financial assets tied to inflation beneficiaries.

I've also been working with clients to help advise them on various real estate deals I believe could still benefit in this challenging market. Now more than ever do I think it's extremely important to be cautious when analyzing real estate deals.

Central banks across the globe have been aggressively selling U.S. Treasuries to purchase gold. Yields need to trend higher (or at least stay constant) to meet a ramp-up in inflation. As a real estate investor tied heavily to credit markets, you have to underwrite to these risks.

Once the market picks up on inflations stickiness, the deterioration of the sovereign debt market, and weakening of the U.S treasury market, there will be a massive flight to hard assets tied to energy and production.

We are truly in a Paradigm Shift. Are you ready?