I live in an area that was quite COVID casual. Even in the height of COVID mania last year there was very little talk or stress about COVID, and masks were rarely seen. I went to the airport for a business trip to an area that was quite the opposite. Extremely COVID cautious. I had to get a mask from the airline counter because I had forgotten that I would need one to fly. Upon getting to my destination, I was confused to see people crossing the street to avoid walking past me on the sidewalk. That first day I consistently walked into offices only to realize I forgot my mask, having to then go back to the rental car to get it. The second day I did a little better, generally keeping my mask close by and abiding by the local norms. On the third day, before flying home I found myself moving away from people on the sidewalk, avoiding the sharing of elevators, and having a general unease about getting sick. You can imagine the system shock when I stopped by the grocery store after flying home and saw all the shoppers walking around the store mask free and with no more regard to personal space than what would have been standard pre-March 2020.
I like to think of myself as a reasonably self-aware person. I like to think of myself as someone who makes investment decisions based on logic and reasoning. I used to like to think of myself with Warren Buffet type stoicism, avoiding emotional influences to be able to make sound investment decisions even if a tempest was raging around me. And I think many people that know me would have largely agreed with my self-assessment.
And yet, here I was, after only three days in an environment of different concern, catching myself being considerably influenced by the fear around me. And then seeing how quickly that new cautiousness faded when I returned to an environment lacking that same level of heightened emotion. My risk of being influenced by the virus itself was not appreciably different between my home base and the area of my travel. There were no differences. None. Other than in one area people had heightened fear and exhibited that fear in their actions, and in the other area there was not the heightened fear, and as a result no actions were taken. Simply being around that fear, and only for a few days, raised my own level of fear.
If my fear levels can be so impacted in such a short amount of time by those around, AND when there is no change in the underlying situation, how can I say/pretend that I wouldn’t likewise be impacted by fear in the investment world when people start freaking out? AND when things (prices/economic activity/etc.) are in fact changing?
Simple answer is, I can’t. And with that I feel like I need to completely change my approach to periods of volatility. I’ve written in previous Insights about having investing rules. By determining (and physically documenting) our rules for action when the seas are calm, we have a roadmap for action (or often refrainment from action) when the going gets rough. To go through the process of putting such rules in place acknowledges we will have, and in turn be influenced by, emotions at some point in the future. It can be hard to acknowledge we are human, but having these rules in place can be so, so beneficial. I am sticking with my previous conviction on this matter.
Where I am changing my philosophy, and thus action, is that I no longer believe it is beneficial for me to pretend that I am not being influenced by the fear around me. That fear around me almost certainly will become fear within me. If I have the afore referenced rules it will help, but there will be situations that we didn’t previously war game for and we won’t have the predetermined rules in place for every scenario. This is especially true when investments aren’t just an account or something needed for the future, it is a career, as it is for myself and all my fellow Altusians.
Make no mistake about it. There is a massive amount of fear in the markets right now. And maybe it is warranted. Very few people in the investment world today have ever dealt with inflation or a rapidly rising interest rate environment. No one, especially the Federal Reserve, knows how this all plays out. With uncertainty comes fear. It is the natural reaction. It is what saved our ancestors from being eaten by a saber tooth tiger. It is good to run to some place safe when they saw the tiger. But it was bad to run to some place safe every time they saw a shadow move or heard a twig snap.
So what is there to do once we are in a situation of societal/market fear? This is the third true implosion of my career, with another two during my early (pre-professional) adult life. Many readers of this Insight have experienced far more than I. Despite my previous hubris, I now freely recognize that I am not Spock…I do have emotion. And with that admittance, I now believe acknowledging and understanding the fear is the very (most?) important first step in the analysis of any situation before taking action. When being chased by the saber tooth tiger we better hope that our instincts kick in. But when we are talking about our investment portfolio, we have time. Time to contemplate. Time to analyze. Time to make sure we understand what is influencing, or at least threatening to influence, our decisions.
The difficulty is that sometimes decisions made out of fear are the right decisions. The key, at least the way I see it, is to make that same decision while acknowledging the fear, and also being able to separate our decision-making abilities from the fear to make that decision based on our logical analysis. While sometimes the fear-based decisions are the same as what would be made logically, often they are not.
To recap, #1 is putting rules in place during the calm times so there is a road map for times of turbulence. #2. Don’t pretend we are without emotion or in control of our emotion. Is there anyone out there that can? Maybe, but I am pretty skeptical. #3. Understand our emotions so that we can appropriately weight that emotion in any decision-making process. #4. Bring other people into our decision-making process. I didn’t mention this previously, but it is always good to have other perspectives and experiences brought into a decision process, especially when the process is highly emotionally charged.
It is with this understanding that I, along with others on the Altus team, have examined our own business and investment decisions. (As an aside, I want to brag on our team. One of the things I love about Altus is our ability to bring all kinds of different thoughts and opinions into discussions, parse those viewpoints, and then come up with a game plan together. Frankly, I am inclined towards rapid action and can be impatient when we aren’t moving forward, so it is really the team that keeps me in line with this). Our business can be broken down into four major components. The first is our existing portfolio. Second is our current (and in the pipeline) projects. The third is our ability to continue to operate as a business even if markets slow down or fall. Lastly is our capability to raise investment capital during a time of fear:
- Our portfolio: Many times over the past decade we questioned our use of permanent long dated financing as others in the industry opted for cheaper and more aggressive shorter term, higher leverage, and/or adjustable debt. Frankly, their use of such cheap debt often resulted in wins for the sponsors, and sometimes for the investors as well. Even as recently as six months ago we had internal conversations about our strategy, wondering if we were doing what was best for investors and the company. We feel a lot better about that strategy now. Nearly all of our existing portfolio has debt with at least 5 years of fixed interest rate remaining. And all of that is also amortizing, meaning we will have a lower balance when the loan has to be paid off or reprices to a higher interest rate than we currently have. None of our current portfolio was purchased with the intent of flipping out as the means towards profit. With that, changes in market prices ort interest rates really don’t impact our portfolio, and hence don’t impact our investors. In fact, the opposite is more accurate. The reason for the increasing interest rates is inflation. Inflation usually shows up in lease rates. The vast majority of our portfolio is residential and industrial, which are experiencing upward lease rate pressure in most markets. Additionally, as rising rates (and general fear) have increased the difficulty of new product being brought to the market, there is an increasing demand relative to supply. Lease rates going up, locked in debt rates that are historically low…that is a recipe for investor success for whatever time period it lasts. This doesn’t mean all properties are performing where we think they should be, nor does it mean there won’t be a protraction of demand under certain economic conditions, but for the time being, regardless of how much fear might be influencing our psyche, our portfolio is in a good position.
- New/current projects: This area of the business is a little harder to wrap our heads around. Costs are incredibly volatile. Institutional investors (yes, those investors that claim to not be emotional) are jumping in and out of projects on a whim. And some lenders are completely shutting down new loans, even loans that were actively in the pipeline. All those factors make getting a project started incredibly complicated. However, as noted above, rents continue to increase (especially in our current new project markets) as both inflation and lack of supply continue to squeeze demand. If we do our job correctly, we will be able to largely lock in costs going into the project, meaning we have a fixed cost base even while rents continue to appreciate, from a base level that provides a reasonable return at the time of project initiation. The difficulty is getting the lender, the institutional investor, and the general contractor all on the same timeline so contracts can be signed before the contractor has to reprice their bid. However, with success in that specific area (flexible investors are key here – they are the ones that are going to crush it over the next couple years), any new product brought to the market benefits from premium values, simply because there is less competition making it across the finish line. And the biggest reason less product is making it across the finish line is what I mentioned above, it is not making it past the starting line. In short, having reviewed the projects in our pipeline, we feel that all the projects are still strongly economically feasible. We just need to hang in there and continue to fight through the challenges to get these projects delivered. Which is okay, after all, it is our job.
- Cashflow to operate business: As readers will know, Altus has a pretty heavy investment philosophy bias towards long term ownership. As mentioned above, a long-term focus largely mitigates concerns over short term market volatility, which investors continue to receive distributions. From an operating business perspective, it does create some challenges, especially the way we have historically structured our investments with the vast majority of Altus’s compensation based on the success of each project, which is often times really only realized at sale. This dichotomy (preferred philosophy results in reduced near time income) is something we have been trying to solve for years. Interestingly, larger (think institutional) investors have a pretty standard format for investment structures. It doesn’t allow for nearly as much sponsor benefit on the upside, but does have called out revenue to the sponsor throughout the project. This leaves us with our share of portfolio distributions, some property management income (mostly on commercial properties), and assuming we get projects past go, project management income. With project management income, the company will be in a strong financial situation, not only able to service the existing portfolio, but also then in position to be able to aggressively take advantage of any outsized opportunity that comes from market/economic volatility. If none of the six or seven projects we have in our pipeline progress, cash available to invest in the business will be reduced and shareholder distributions will be impacted. But we have long expected this sort of economic turbulence and have put reserves aside for its eventuality. This doesn’t mean this sort of scenario would be without pain, but pain is largely temporary, so we have confidence in the long-term viability of the company. More importantly, if things in the economy and financial markets get bad enough that we are not able to push our existing projects forward, there will be other distress in the markets, which means opportunity.
- Ability to raise capital: This is a question that is yet to be answered. We have seen (and experienced) institutional investors pulling back on investment, mostly because other people are also pulling back on investment. Generally, in that environment, decision makers get fired for being wrong and different, not just wrong, and they don’t receive great benefit for being right and different. It results in a group think of sorts. We experienced this in spades coming out of 2008 when real estate was incredibly cheap and the yields produced were historically strong, and it was extremely difficult to get anyone to write checks. In general, I think individual investors are better at avoiding the impact of cascading fear than are the institutions. This doesn’t mean every individual investor is better, but by and large it seems like most of our individual investors continue to be pretty levelheaded. My personal opinion is this will be a long-term benefit to them versus the institutional investors. There may be a shift in desire to invest in more conservative investment structures (i.e. more debt or higher level of preferred return), but that is okay. Altus doesn’t have a problem betting on the come. If we didn’t believe in a project, we wouldn’t be doing it anyway. From a higher level, and wearing my investor hat, it is hard to contemplate not doing anything with my investment dollars, and leaving it sitting as cash, therefore choosing to accept an 8% annual real loss as inflation eats away at my purchasing power.
These are interesting times. These are times of high investor emotion; and emotion can be contagious. Being able to separate emotion from reality is largely what will separate the winners from the losers. Despite what is going on around us and the potential for short term impacts, Altus feels good about our, and our investors’, chances to be among the winners.
About the Author: Forrest Jinks is CEO of Altus Equity Group Inc and a licensed real estate broker. Forrest has decades of experience as principal in a variety of alternative investment segments including real estate (residential rehab, in-fill development, multi-family, office and retail), debt, and small business start-up (online marketing and site retail). He can be reached at email@example.com.