Understanding and applying these three sentences could make you wealthy:
“In bad times, securities can often be bought for prices that understate their merits. And in good times, securities can be sold at prices that overstate their potential. And yet, most people are impelled to buy euphorically when the cycle drives prices up and to sell in panic when it drives prices down.” – Howard Marks (2013 Memo “Ditto”)
I’m excited to share some thoughts about fear and greed. But I’ll start by sharing a few comments on the current economy to set the stage.
Not long ago, I opened my computer to a startling CRE email subject line:
“Prices Plummet to 2010 Levels”
It was a great attention-grabber but was inaccurate. The publication went on to say that the sharpness of the decline in CRE values (not the prices) had not been seen since the Great Recession, which is still disconcerting. (Note that the headline was changed at some point since the original publication.)
But it makes sense since we witnessed a decade of ever-rising asset prices fueled by low interest rates, skyrocketing attention from a whole new community of CRE investors, and irrational demand from a host of Newrus (new gurus running syndications, mainly in the multifamily arena).
The value decline was indeed significant, reported at 28% year-over-year.
“Yikes! Isn’t that alarming?” you may ask.
It is quite alarming for many syndicators and investors. But we find it not at all surprising. And we see a potential opportunity on the horizon.
How Did This Sharp Decline Take Place?
It is a simple matter of math. It is based on decompression in cap rates resulting from the series of 2022 interest rate hikes. As a reminder, here is the value formula for commercial real estate:
Value = Net Operating Income / Cap Rate
As you can see, and as most of you know, the value is directly proportional to the income (which operators have some control over) and…