I thought it worth providing you an update on some new investments I’ve been considering, along with some perspectives on the current economic environment. If there is a theme, it is that I feel now is a good time for caution. This doesn’t mean we should sell, or run for the exits, but that we should maintain discipline in the face of declining investment standards as other reach for yield. On that note, I’ll leave you with a quote on ‘reaching for yield’ from Howard Marks, one of my favorite investment professionals and commentators:
Bond investors call this process “reaching for yield” or “reaching for return.” It has classically consisted of investing in riskier credits as the yields on safer ones decline, in order to access the returns to which investors were accustomed before the market rose.
On to the review…
Latest Investment News
The biggest news this week is that I’ve made some headway on my search for the right mobile home community (MHC) investments. MHCs are one property type I’ve been considering to help diversify my portfolio and add some strong cash flow that will be resilient to downturn and recession. I wrote about MHCs in my primer on real estate investment strategies:
With MHCs you typically own the land and the infrastructure (water, power, shared buildings / amenities etc.) that support the community. Your tenants own their own mobile homes and hook them up on a pad that they rent from you. I haven’t invested in MHCs myself (yet!) but would definitely consider it. Returns tend to be focused on yield (I’ve seen preferred cash returns in the 8%+ range, with annualized total returns targeting ~15%). Risk during a downturn is typically lower than other property types, because with a MHC your tenants own their mobile home and it’s expensive to uproot and move it somewhere else. Also, there really aren’t a ton of great options for them to go into cheaper housing. The next step lower on the rung is probably living out of their car. Lastly, there isn’t a lot of new MHC supply coming online, because most communities are opposed to new MHC development. In my opinion, this is the sort of thing you want to invest in through a fund or syndicate. You definitely don’t want to be managing a MHC yourself, and if you get a good syndicate General Partner, they will be able to force appreciation on the property by making the right investments to change up the tenant profile and increase occupancy.
The current market for many assets feels, at the very least, frothy. Generally speaking, I have been slowing down my deployment of capital, and increasing my scrutiny of deals. Almost every sponsor and syndicator I spoke with over the last ~3-6 months has agreed that prices are elevated and it’s harder to find good deals. So in that context, now feels like a good time to give MHCs a more serious look. Perhaps the biggest draw for me is the sheer resilience of the asset class – historically, changes in GDP have had little to no impact on MHC net operating income (NOI), and the returns from MHCs were basically untouched through the 2007-2012 housing market crash. So, with ever present fears of a recession on the horizon (see more on this below!), putting money to work through an MHC fund seems like a decent move at this time.
One investment I’ll be making is in the Bedrock MHC Fund II available through RealCrowd. Target annual cash of 12% (8% preferred) and IRR in the 18% range. They have been investing in MHCs since 2012, and have a depth of experience. Current acquisitions in the fund are already promising, and they have a strong pipeline of opportunities. There is another fund I’m considering that has an ambitious plan to become one of the largest MHC operators in the country over the next couple of years. This scale will give them some operational advantages, and will potentially set them up for a large scale liquidity event through public markets. This second fund includes a ladder over a few years to a 10% preferred return, with targeted 20% IRR. In both cases, I would be content with the cash flow alone, and if we get the upside on sale that will be nice. I believe there could be potential for material appreciation as well, due to value add on the properties, and in some cases the appreciation of the land itself – certain MHCs are sitting on valuable land where a city has literally ‘grown around’ it. That land could be repurposed at some point for material upside gains.
In addition to exploring MHC opportunities, I’ve also been diving deeper into certain types of Office properties. I’m not bullish on expensive class A office properties in the downtown core of cities like SF, but certain Office properties (in particular, medical buildings) seem like a pretty resilient class to me as well. Probably a topic for a future review.
As alluded to above, I have a fragile outlook on the future prospects of the economy and financial markets. While I never like to be one to cry wolf, I continue to have a very conservative stance. On the whole, my cash reserves are increasing, as I’ve all but stopped putting new money into the public markets, and I’ve slowed the pace of my real estate investments.
The first issue is that assets are expensive today by almost any historical standard. Hussman Funds estimates that at current valuations, the prospective 12 year returns for the S&P 500 (compared to treasuries) will be negative:
But expensive assets alone are not enough to cause an immediate downturn. Assets can remain inflated for years. We still need a catalyst to drive a major correction in prices. One potential catalyst appears on the horizon in the form of rising interest rates, and tapering GDP growth as the massive tax cut stimulus fades into 2019 and 2020:
In that context, we could see a lot of borrowers get into trouble as interest costs rise, at exactly the same time that growth is slowing. It’s hard to predict the future, but we can at least take a look around and identify what kind of environment we’re in today. I would say that environment is one with enough risk to warrant greater caution. Therefore we should act accordingly. As always, invest scared, and keep some dry powder in storage.
My real estate investment goals: I include my personal real estate investment goals with every Ramen Review, as it will help to put things in context. Generally speaking I look to real estate to provide me with inflation protected passive income (IPPI), with an emphasis on tax efficient cash flow and conservative downside protection (i.e. capital preservation!). Given that, I look for deals that are going to generate cash flow from day one, and be resilient to recession and financial shock. This means I tend to stay away from more ‘growth’ oriented markets, and ‘riskier’ real estate strategies like new construction – particularly in the current environment. My historical comfort zone is multifamily value-add investments in A & B sub-markets, with ~B grade properties that have potential to move up to B+ / A- with the right investments. I branch out from there on occasion, but try to stay within my circle of competence.
Learn more: If you want to check out any of these investments yourself, join the big four online real estate platforms at CrowdStreet, RealCrowd, RealtyMogul, and RealtyShares. If you’re interested in one of the sponsors or syndicators I reference above, drop me a line at email@example.com and I can put you in touch with the right person. And please remember, this is not financial advice, and I am not a financial advisor to you or anyone else. Please read the disclaimer for more details. Everyone’s situation is unique. With any investment, you should do your own diligence, and you should consult professional financial and legal advice if you’re not comfortable and / or capable of understanding and navigating the risks yourself. In short, invest scared, invest wisely.