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Inflation and Real Interest Rates

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This morning, the Philadelphia FED released an “update” to their periodic inflation report. “Updates” should always get your attention, and this one is particularly loaded with questions and, perhaps, a few answers.

First, the Phily FED’s forecasts interest rates over the next 10 years using a hybrid model that combines information from the yield curve plus a Delphi-type survey of professional forecasters. A year ago (June, 2020), their model forecasted very low short-term inflation, rising to about 2% – 2.1% in the longer term. However, inflation fears led to revisiting the model in May, and at that time, the inflation curve had flipped — somewhat higher short-term rates (about 2.4+%) and then calming down to about 2.3% in the longer term. Today (June, 2021), the short-term inflation rate is still expected to come out in the 2.4% range, but inflation should settle out a bit lower (roughly 2.25%) in the future.

However, this model is highly dependent on real versus nominal interest rates, and right now, under any reasonable estimates of inflation, real rates are negative. Indeed, for the past 20 years, real rates have generally trended downward, with some occasional hic-cups into positive territory. While the outlook for real rates is somewhat more positive than it was a year ago, forecasters still see negative rates for the coming decade.

Before returning to the topic of inflation, it may be useful to explore how and why real rates would be negative. This may seem counter-intuitive — why would I PAY YOU to borrow my money? To consider that, it’s helpful to recall from ECON 101 the four principal factors of production: Land, Labor, Capital, and Entrepreneurship. The value of any of these at any point in time is dictated by its marginal productivity. For example, the marginal productivity of labor is the amount of value-added to the system by an additional unit of labor. Unfortunately, not all labor has the same value. Right now, for example, there is a high value-added for truck drivers, skilled trades persons (e.g. — electricians, plumbers) and health care workers. Conversely, there is very little value-add for unskilled (counter staff at a fast food joint). As such, employers for unskilled workers have little incentive to pay a penny higher than minimum wage, and employees have little incentive to work for those minimum wages. Hence, we have the paradox of a shrinking workforce and unfilled jobs.

As for interest rates, the system is awash with funds. Automation has made production extremely efficient, and so a lot of money gets spent — and thus multiplied in the system — with little demand for borrowing or investment. Even though returns to equity have been quite good of late, and are forecasted to continue to be good, there are lots of structural reasons why some tranches of capital need to go into bonds. Hence, there is a surplus of lendable capital and surprisingly little demand for that capital, driving down real interest rates. If nominal short-term rates are, say, 0.5%, but inflation is 2%, then the real rate of interest is (0.5 – 2.0 = ) negative 1.5%. That’s the world we live in today, and the world that market participants forecast for the next decade at least.

But, back to inflation. If the Phily FED has a model that depends on the somewhat flawed yield curve as well as a Delphi-like survey of forecasters to guess at inflation, how good can that model be? Yes, it’s the model we all use, but anecdotal evidence suggests some contrarian thinking may be deserved right about now. While models like this are used to forecast inflation, the actual measure of inflation comes from the Consumer Price Index, which tracks the prices of a basket of goods and services used by a typical household. Certainly, there are discussions about what goes into that basket and how those constituents ought to be weighted. Nonetheless, this is supposed to reflect how a consumer experiences actual pocketbook issues. Unfortunately, it’s not an instantaneous measure, and so we don’t actually know what inflation was until a while after it happens. However, we can examine anecdotal evidence and perhaps understand why both consumers and sophisticated researchers and investors are raising the red flag.

Clearly, some components of the basket of goods and services are all over the map. Gasoline is most likely just a rebound from a year ago when no one was on the road. Coffee is a head scratcher (although my local grocery is running a sale, so go figure…) and certainly residential real estate is giving us all pause.

So, is inflation a problem or are the models correctly forecasting that the shorter-term spikes will ameliorate over time? One thing that is obvious is that a lot of capital is being converted into real estate right now. In part this is a flight to safety, but in part it is simply a reflection of the negative returns in to bonds.

As always, if I can elaborate on any of this, or answer any of your questions, please let me know.

John A. Kilpatrick, Ph.D., MAI —

Written by johnkilpatrick

June 30, 2021 at 1:25 pm

Posted in Uncategorized

Real Estate Investing 101

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OK, maybe not 101… but certainly this is a pretty basic primer. Real estate is an excellent inflation hedge and provides diversification to a broader portfolio of assets. If you want liquidity (and this is true with any sort of investment) you may have to give up some potential returns by investing in publicly traded REITs. If you are willing to give up liquidity, you can potentially achieve higher returns with either direct investments or some pooled investment, such as a private equity or hedge fund. Either way, higher potential returns usually entail higher risks, and so diversification is key. I frequently use the word “curated” to describe a carefully selected and managed portfolio of real estate assets.

There’s more, but that’s a good start. So if this is so basic, why was the market shocked — SHOCKED, I say! — when Scotland-based Aegon shut down it’s £381 million property fund last week and Aviva shut down its £367 million fund due to liquidity problems. It comes as no surprise that Brexit has been a real mess for investments in the UK, and coupled with the pandemic, liquidations in British property funds have outstripped new investments. Aegon said last week that they hoped to begin distributions in the 3rd quarter, and it would take a year or two to get the money out to everyone. Apparently the same is expected for Aviva.

This says a lot about investments in the UK in general, and particularly the future of real estate in the UK in the post-Brexit, post-Pandemic world. It also says something about whomever had been investing in these funds in the last year or two. However, it says very little about real estate in general.

Here in the U.S., we know that some sectors are having some problems. Retail, for example, looked like it was going to completely tank last year, but then rebounded this year after we started making some headway on COVID. Of course, some funds are dug in too deep (see my recent commentary on Washington Prime Group, here) but we’ve been fully invested with ACCRE throughout the pandemic, and while this hasn’t always been a smooth ride, care and caution have paved the way. However, even an index fund of REITs this year has outperformed other indices, as shown below from the Financial Times FTSE index:

Data courtesy NAREIT and FTSE

I hope this helps a bit. As always, if I can answer any questions, please let me know.

John A. Kilpatrick, Ph.D., MAI —

Written by johnkilpatrick

June 28, 2021 at 2:46 pm

Posted in Uncategorized

US Global Leadership Coalition

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This may sound wildly off the subject, but last week I had the very real privilege of attending (via Zoom) the US Global Leadership Coalition’s annual Global Impact Forum, followed up by a day-long “virtual” visit to Capitol Hill to meet with several members of Washington State’s congressional delegation and/or their staffs. I was invited to join the Advisory Council for USGLC back in 2020, and I’ve thoroughly enjoyed and appreciated the interaction.

Yes, my focus is on real estate finance and economics, and we usually think of real estate as being highly localized. However, real estate finance and investment is truly global. Just take a peek at a the holdings of any random sovereign wealth fund to confirm this. The vigor and vitality of America’s real estate market depends in no small part on America’s economic leadership in the world, and USGLC is focused directly on that.

Speakers at the Forum included a panoply of luminaries, such as former NATO commander Admiral Jim Stavridis, CEO of “Save the Children” Janti Soeripto, Deputy Sec. of State Wendy Sherman, Sen. James Risch (R-Id), “CARE” CEO Michelle Nunn, UN Foundation CEO Elizabeth Cousens, among many others. USGLC brings together more than 500 businesses and non-profit organizations to engage policymakers in D.C. and around the country to build support for America’s International Affairs Budget. “In today’s interconnected world, America must use all its instruments of national security and foreign policy to ensure we keep our citizens safe, strengthen our economy, and save lives. Our nation’s civilian tools of diplomacy and development are underfunded and undermanned, which is why the USGLC supports a strong and effective International Affairs Budget.” Former Sec. of State Gen. Colin Powell (USA-Ret) heads up the Advisory Council, and Admiral Jim Stavridis (USN-Ret) and Gen. Anthony Zinni (USMC-Ret) head up the National Security Advisory Council.

America’s international aid budget takes up a surprisingly small portion of our overall fiscal picture — less than 1%. However, we gain enormous leverage via that chunk of the budget, and any top military leader will tell you that diplomacy is cheaper than bullets. Our strong military, coupled with our international leadership, sets the stage for America’s powerful economy. “America’s diplomats and development workers help put the building blocks in place so that U.S. companies can expand their exports, reach new markets, and create more jobs here at home. With 95% of the world’s consumers outside of our borders and the fastest-growing markets in developing countries, it’s vital that we stay competitive in the global marketplace, ensure a level playing field for American businesses, and reach more customers.”

John A. Kilpatrick, Ph.D. —

Written by johnkilpatrick

June 23, 2021 at 8:58 am

Posted in Uncategorized

Monday, Monday…

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Washington Prime Group (WPG) filed for Chapter 11 reorganization late last evening, saying that COVID-19, “created significant challenges.” The stock dropped 55% in early trading this morning (although had rebounded somewhat by mid-day), and is down almost 60% on the year.

This apparently came as a bit of a surprise to the market. While equity REITs in general had a down year in 2020 (-5.12%), retail REITS performed the worst of any sector, down 25.18% overall, with regional malls leading the way at negative 37.15%. However, as of the end of the 1st quarter (the most recent data available to us), retail REITs were back on track, having clawed back most of their 2020 losses. (Overall, US Equity REITS had a total return of 8.32% in the first quarter, 2021.) WPG had a lackluster year, and from Dec 31 to May 28 was down 56%. However, it was in a rebound mode in June, having tripled in price by the beginning of last week. No analysts were rating WPG as a “buy”, but two were rating it a “hold” as of two weeks ago. Intriguingly, since the first of the year, numerous class-action suits had been filed against WPG, alleging they concealed the true financial picture from shareholders. Notably, as of their annual report in March, they had disclosed some “potential deleveraging or restructuring transactions” with certain holders of senior notes.

WPG owns about 100 shopping malls throughout the US., but mostly east of the Mississippi. They invest in a variety of retail malls, including both open-air and enclosed malls. Major tenants include Signet Jewelers, Dick’s Sporting Goods, Footlocker, Jared’s, Kay Jewelers, and ales Jewelers. As of their annual report, 59 stores comprising 4% of total rents were on their high credit watch list.

At Greenfield, in our in-house REIT fund “ACCRE”, we have purposely avoided long positions in retail since the beginning of the pandemic. For those of you tracking ACCRE, I might note that as of mid-day today. ACCRE was up 7.5% for the month, compared to less than 1% for the S&P 500.

As always, if you have any questions regarding real estate in general or your real estate investments, please don’t hesitate to reach out.


Written by johnkilpatrick

June 14, 2021 at 11:57 am

Posted in Uncategorized

ACCRE Report, May, 2021

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We have mixed emotions when ACCRE beats the S&P 500. ACCRE is a diversifying adjunct to a well rounded portfolio. Hence, we want to see both ACCRE and the broader index do well each month. After a rocky year, ACCRE put together two great months — April we were up 2.94% followed by a 3.25% return in May. While the broad index had a super April (up 5.62%) it was flat in May, only up 0.55%. The global real estate metric has been positive for four months in a row, most likely emblematic of the continued positive sentiment for real estate as the economy gets back on its feet.

A dollar invested in ACCRE at the inception would be worth $1.61 today. Of course, that same dollar invested in the S&P 500 would be worth $1.78, having enjoyed the great “bull” run that started about 14 months ago. If you had invested that dollar in the S&P Global Real Estate index, you’d have $1.34 today. ACCRE is a carefully curated fund of REITS, with a goal of achieving liquidity, diversification, and superior returns.

Thanks also to the 14-month bull market, the risk-adjusted returns for the S&P continue to dominate, as evidenced by the Sharpe Ratio, as shown below. Again, the Sharpe Ratio measures the average daily returns (daily return minus the T-bill rate) divided by the standard deviation of those returns. In short, it tells you how much return you get for every unit of risk. In long bull markets, with little variation over time, the Sharpe Ratio is expected to be highly positive, as we see below. The correlation between ACCRE and the S&P over time is about 50%. This is our goal — to move in more-or-less the same direction but to offer some portfolio attenuation via diversification.

S&P 500
Average Daily Excess Return0.0494%
Standard Deviation1.2908%
Sharpe Ratio3.8296%
Excess Return0.0389%
Standard Deviation1.1947%
Sharpe Ratio3.2572%
Correlation (life of the fund)51.8333%
Correlation (month of May, 2021)43.0532%
Accre Metrics as of May 28, 2021

As always, if you have any questions about ACCRE, about REIT investing, or real estate investing in general, please drop us a note. We’re always glad to hear from you!

John A. Kilpatrick, Ph.D., MAI —

Written by johnkilpatrick

June 1, 2021 at 10:43 am

Posted in Uncategorized

Inflation and Real Estate

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First and foremost, I came of age in the 1970’s, a period that gave rise to the term “stag-flation”. Significant inflationary pressure was real not just in the U.S. but across the globe, and for a variety of reasons. The complexity of the 1970’s is well beyond the scope of a single simple article, but suffice it to say, the past 40-ish years of relatively mild year-over-year price inflation has put the problem out of sight and out of mind for most economists.

That said, the Labor Department reported that April’s consumer price index rose by an annual rate of 4.8%. According to a great article in the Wall Street Journal yesterday by Konrad Putzier, most analysts think this is transitory. I tend to agree. None-the-less, savvy investors should properly be asking the question, “what if?”

Real estate has historically been considered a nearly perfect hedge in times of heightened inflation. Even for the past 40 years, real estate prices/values have out performed the CPI year after year. For example, the median price of a single family home in America in 1970 was $17,000. I’ll let that sink in for a minute. Now, let’s compare the 50-year return on that home to the consumer price index (CPI) as well as the S&P 500 (all three at the end of the respective years).

 House PricesCPIS&P 500
Compound Annual Change5.7%3.8%7.7%

Wow. Plus, this doesn’t come close to telling the whole story, If you had invested in that house, you’d either enjoy rents (net, on average, around 5% – 7% per year) or alternatively you would forego having to pay rent to someone else. Further, there have been and continue to be enormous tax advantages to real estate ownership.

Now, here’s the problem, as well described by Mr. Putzier. An inflation hedge, like insurance, is something you want to have BEFORE the wreck happens. Today, we see investors rushing out to bid-up the prices of every piece of property that comes on the market. It’s likely that some of these purchases will be ill-advised and not justified by future rents. Indeed, as I’ve noted on this blog before, wages since 1970 have not kept up with real estate prices, and given the cost of housing today, it would not be surprising if rent increases in the future lag inflation in general.

Nonetheless, existing, well-curated real estate portfolios will undoubtedly be positive compliments to an overall diversified portfolio of investments. Even with the hot-bid market today, we continue to stay active in this market, looking for value opportunities.

If you have any questions about your real estate portfolio, please don’t hesitate to reach out. We look forward to hearing from you.

John A. Kilpatrick, Ph.D., MAI —

Written by johnkilpatrick

May 26, 2021 at 11:24 am

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ACCRE Report, April, 2021

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Not a bad month, as all things go, and certain a great month to own the S&P. With that in mind, the real estate sector continues to “figure out” what the post-pandemic world will look like. After two “down” months, ACCRE rebounded nicely in April, although we’re still behind the S&P both on a single-month basis and cumulatively. Nonetheless, some of our metrics (particularly diversification) make us continue to stay the course. So, on with the report…

As shown, a dollar invested in ACCRE at the inception (four years ago) would be worth $1.56 today. For most of the last four years, ACCRE has handily beaten the S&P, but the strong bull market for the past year has really turned that around. Conversely, the S&P Real Estate index languished for most of the last four years, but has performed nicely in the last 12 months.

One of our main goals with ACCRE is to provided positive-return diversification with a fairly low-risk portfolio. Most months, we demonstrate this with a Sharpe Ratio — this is a measure of the average daily excess return (fund return minus the T-Bill return) divided by the standard deviation of those returns. In short, it tells us how much return we are buying proportional to the risk we are taking. A higher Sharpe Ratio means we’re doing well, and if our Sharpe Ratio consistently beats the S&P, it means we’re providing more return than the market as a whole relative to the risk we’re taking.

S&P 500
Average Daily Excess Return0.0498%
Standard Deviation1.2977%
Sharpes Ratio3.8369%
Average Daily Excess Return0.0365%
Standard Deviation1.2010%
Sharpes Ratio3.0393%
Correlation (life of the fund)51.9182%
Correlation (month of April)16.3113%
ACCRE Metrics as of April 30, 2021

The Sharpes Ratios are calculated for the life of the fund, as is the overall correlation. Most months, ACCRE beats the S&P, but as we all know, the S&P has been on a very real bull tear this past year. Certainly, we all hope that continues! The overall correlation (life of the fund) is just where we want it, but the correlation for April, while positive, is surprisingly low. Digging into the data a bit further, we find that the S&P, while doing great, nonetheless had some bounces during the month. ACCRE, on the other hand played the “slow and steady wins the race” game.

We may reconsider some of our positions this month, and of course our subscribers will get immediate notification of any trades. In the meantime, if I can answer any questions about REITs or Real Estate Finance in general, please don’t hesitate to reach out.

John A. Kilpatrick, Ph.D. —

Written by johnkilpatrick

May 5, 2021 at 10:21 am

Posted in Uncategorized

Home Price Paradox

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If there’s a recession, why are home prices still going up? That was the focus of an article last week by Anna Bahney form CNN Business titled “Home Prices Hit a New Record Because There Simply Aren’t Enough Houses for the Crush of Buyers.”

Two things she does not mention. First, this recession is nothing like the last one. Indeed, the last recession was deepened in no small part because because of the surplus of foreclosed homes. (Yes, there were a LOT of other reasons, and we can go into that later.) Second, our studies at Greenfield indicate that since WW-II, home prices generally do not fall during recessions (the last one being the exception). However, this recession is odd in that it is not being felt evenly throughout the economy. The bottom tier of workers — who are most likely to be renters — are suffering disproportionally. At the middle of the economy and above — the folks who are likely to be homebuyers — the recession hasn’t hurt quite as badly. Coupled with that, there is a very real material and labor cost problem.

Not surprisingly, according to Ms. Bahney’s article, the median price of a home in March in the U.S. hit $329,100, up 17.2% from a year ago. The inventory of homes for sale is down 28.2% from a year ago. Worse still, the inventory of homes for sale between $100,000 and $250,000 is down 36.6%.

According to Lawrence Yun, chief economist for the National Association of Realtors, this is resulting in a widening gap between haves and have nots. “You will have homeowners gaining wealth and renters missing out,” he said. He used San Francisco a few years ago as an example. If one middle income household purchase a home a few years ago, and the other did not, the first household are now millionaires. Yun calls this rapid price appreciation an “arbitrary outcome” for family wealth.

Anecdotal evidence suggest something of a flight from urban areas to the suburbs, somewhat as a reaction to COVID and a need for space to work from home and home-school. Since owner-occupied residences are more likely in the suburbs, this suggests an increasing demand, and no real end to the price crunch in sight.

Written by johnkilpatrick

April 27, 2021 at 2:13 pm

Posted in Uncategorized

New York Office Space

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Let’s start out by admitting that New York City real estate is unique. In very many ways, what happens in NYC has no bearing on “Anytown America”. However, COVID has put pause to many economic rules-of-thumb, this one included.

I was struck by a Business article this morning by Allison Kosik titled “New York City Hasn’t Had This Much Empty Office Space in Three Decades.” According to a Cushman Wakefield report, cited in the article, office space vacancies in Manhattan alone reached 16.3% in the first quarter of this year, up from 11.3% last year. By some estimates, there is about 240 million square feet of office space on that island, so about 12 million square feet went vacant in 2020, directly attributable to the COVID-19 recession.

Now, as Ms. Kosik pointed out, this represents people who are no longer working in an office, but working from home. In my experience (and I “zoom” with folks in NYC a lot) these folks are still busy, but happily telecommuting. What’s more, these aren’t temporary shifts — these shifts are permanent enough to cause their employers to give up the space.

Is this a trend? Will other employers continue to facilitate work-from-home? I would note that even 10 years ago, technology would probably not have supported this on a wide-scale. “Zoom” (and all of the other services, like Team and Webex), ubiquitous high-speed connectivity, smart-phones, and secure cloud servers are all necessary for this to work. However, 100 years ago, the office of today could not have been supported without technology like computers, telephones, and even air conditioning. Has COVID really triggered a sustained shift in the American workplace landscape?

I would have to note that the thousands and thousands of office workers who now work from home previously supported a vast secondary and tertiary network of businesses. Working from home means you don’t grab lunch at the corner deli as often. You don’t buy “work clothes” as often — if at all. Parking garages, busses, and subways all see downturns in business. Demand for Yellow Cabs in New York City has collapsed, and I don’t doubt that is true nationwide.

Offices occupy about 18% of all commercial space in America, and use about 20% of the electricity. This is not a trivial footprint, nor one which shifts quickly. One model proposed by Regus, a provider of flexible workspaces, is a variant on the old “hotelling” model of a few years back. Businesses shrink the office footprint by enabling work-from-home, but then provide some necessary space for customer/client contact and some flex space options for shifting project demands. This is probably a great model for professional businesses (attorneys, CPAs, researchers) but may not be a one-size-fits-all for ever office occupant. Nonetheless, this may very well be an increasing solution, suggesting at least a “flat” demand for new office space for quite a few years to come.

Graphic courtesy REGUS

We’ve actually made some of these shifts at Greenfield, with the attendant problems and benefits. As always, if you have any questions or comments about this, please feel free to reach out.

John A. Kilpatrick, Ph.D., MAI —

Written by johnkilpatrick

April 22, 2021 at 1:54 pm

Posted in Uncategorized

ACCRE LLC Report, March, 2021

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We’d LIKE for our fund to have positive returns every month, and to beat the benchmarks more often than not. March was certainly the exception to the rule.

We not only turned negative in the face of a strong, positive S&P, but also we underperformed global REITs. Part of the reason is that we’ve tried to stay defensive on the volatility front, and indeed we did that. However, that also means we may miss important market turns. I would note that this is the first month since we began keeping record that the S&P 500 cumulative SHARPE Index bested us, which is saying a lot for our defensiveness.

The first trades of April (not reflected above) are positive for us, but we’re going to have to go a long way to ameliorate the last two months of negative returns.

S&P 500
Average Daily Excess Return0.0457%
Standard Deviation1.3073%
Sharpe’s Ratio3.4967%
Average Daily Excess Return0.0343%
Standard Deviation1.2058%
Sharpe’s Ratio2.8466%
Correlation (history of the fund)52.2405%
Correlation (monthly)69.4484%
ACCRE Metrics as of March 31, 2021

Undoubtedly, we’ll consider our positions in the next few days, and if any changes are warranted, our subscribers will receive trade alerts accordingly.

Best wishes for a great April, and as always, if I can answer any questions on this or related topics, please don’t hesitate to reach out.

John A. Kilpatrick, Ph.D., MAI —

Written by johnkilpatrick

April 5, 2021 at 9:54 am

Posted in Uncategorized

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