Of course, most of you are familiar with Hans Christian Andersen’s famous tale “The Emperor’s New Clothes,” in which the weaver plays on the emperor’s vanity by saying the suit is only visible to people who are clever and competent. In reality, he was naked. Warren Buffett is famed for saying, “When the tide goes out, we’ll find out who’s wearing a swimsuit.”
I recently went on a Disney cruise with part of my family and some of my grandkids. Now, I am not a big Disney fan, but my grandkids and daughter-in-law are. It was a great time for all and it was fun to see the amazement and joy of the grandkids as they got to meet and see their favorite shows and characters. They even got autographs from many of them.
While standing in line with my grandkids for an autograph, I was surprised by the number of adults without children standing in line for an autograph. Now don’t get me wrong. I get that there are lots and lots of adult Disney fans. What I don’t get is why they were standing in a long line for an autograph from a 20-year-old kid dressed up as a Disney character. I am all for autographs from famous and important people. I get that value comes in various forms, but that has me scratching my head.
So how do we know what is real and what is of value? In commercial real estate, value is generally based on income and increase in value based on development or improvement of the property and inflation of rent, all of which increases income and therefore value. As an investor you can work to control expenses, but not so much that you receive less rent/income (i.e. deferred maintenance or disrepair).
You can also increase rent, but only so far as the tenant can afford to keep paying you. However, if you spend a little money on the property and it increases traffic or business for your tenant, they can now afford to pay more rent. Keeping in mind that for every dollar more in rent you receive per year, it adds about $15 to $16 of value to your property ($1.00/.065 cap). Now that’s a value proposition I can wrap my head around.
One of the reasons I like real estate so much is that it is tangible. I can understand what it should rent for or what needs to be done to rent it. The second thing I love about real estate is leverage. If you told someone you bought your stocks with 25% – 50% down and borrowed the rest, most would consider you a bit of a speculator. But we do this routinely in real estate. This leverage, when used correctly, substantially increases your gains.
So how can a country with a debt-to-GDP of 124% be an investment-grade credit, let alone be AAA rated? Well, just tell the people they aren’t clever or competent if they don’t see the fine clothes! But alas, we can print more money to pay people back. Yes, you can, but paying interest in a depreciating currency is also a form of default. Investors got this, and that is why interest rates have risen and aren’t likely to come down soon. When my dad was dying with dementia, someone told me that dementia was a long goodbye. So is a fiscal death spiral.
With bond prices (and mortgages) continuing to rise and show no signs of reduction, we continue to see the market kind of frozen. Deals are happening, but they are opportunistic, often all cash or low leverage. As the tranches of loans come due, we will see more pain as property owners are forced to pay down loans or settle for large debt payments and less cash flow. If not, properties will start coming to market and pricing will start to adjust downward. The only hope for stopping the slide is if mortgages got dramatically cheaper. And that’s not likely to happen. I see interest rates staying where they’re at through at least the end of the year.
Nick’s Numbers
Great news! San Diego’s unemployment rate fell to 4.2% in March, down from 4.4% in February. Unfortunately, a lot of those jobs were local and state government jobs. The office-using sector (information, professional and business services and financial activities) reported 5,500 jobs lost in the past year. During that time, San Diego’s office vacancy rate climbed to 12.5%, which is the highest level since 2012.
If you would like an analysis of your properties’ value or discuss what you should be doing with regard to interest rates or inflation and their impacts on your business, tenants, or property, I’d be happy to talk. (Nick Zech, 858-232-2100, nzech@cdccommerical.com).
So how do we buy the emperor some clothes? First, we must reduce the $2 trillion annual deficits and stop creating money out of thin air, which is really just a slow default. Then interest rates can come down. The only way I see that happening is with equalized tariffs and a new era of American exports to world markets.
In the meantime, how much is the value of a unique number that you can store on a 99-cent thumb drive? If it is over $100,000, I’ll trade you for an authentic Mickey Mouse signature recently obtained. Hope you enjoy the story.
Once upon a time in a village, a man appeared and announced to the villagers that he would buy monkeys for $10 each.
The villagers, seeing that there were many monkeys around, went out to the forest and started catching them.
The man bought thousands at $10, and as supply started to diminish, the villagers stopped their effort. He further announced that he would now buy at $20. This renewed the efforts of the villagers, and they started catching monkeys again.
Soon the supply diminished even further, and people started going back to their farms. The offer increased to $25 each, and the supply of monkeys became so little that it was an effort to even see a monkey, let alone catch it.
The man now announced that he would buy monkeys at $50!
However, since he had to go to the city on some business, his assistant would now buy on behalf of him.
In the absence of the man, the assistant told the villagers, “Look at all these monkeys in a big cage that the man has collected. I will sell them to you at $35, and when the man returns from the city, you can sell them to him for $50 each.”
The villagers rounded up all of their savings and bought all the monkeys.
They never saw the man nor his assistant, only monkeys everywhere!
Now you have a better understanding of how the cryptocurrency market works.