From a small northwestern observatory…

It was a rough month for the S&P 500, but a great month for ACCRE. This was exactly the sort of roiling market for which ACCRE was designed, and it paid off handsomely.

To be specific, the S&P 500 declined 0.83% in November. Don’t get me wrong, though, we hate to see that as much as anyone. Real estate in general also took a hit — the S&P Property Index was down 2.12%. However, ACCRE was up 8.44%, the second of two very solid months of returns. Thus, a dollar invested in ACCRE at the inception would be worth $1.85 today.

Overall, the S&P continues to best ACCRE for the life of the fund, stemming from a very powerful bull run in 2021. ACCRE continues to be only partially correlated, although the monthly correlation numbers have moved into positive territory again from last month’s aberration.

Best wishes to you all for a great holiday season! As always, if you have questions about this or any other real estate related topic, please don’t hesitate to reach out.

John A. Kilpatrick, Ph.D., MAI — john@greenfieldadvisors.com

We hope all of you had a great Thanksgiving, and any indigestion you felt Friday was from too much turkey rather than too much stock market.

The broader stock market indices had a terrible day Friday — the S&P 500 was down about 2%, although as of this writing it has re-gained about half of its loss. Our in-house REIT fund, ACCRE, was developed in no small part to attenuate such falls. We lost only 0.9% on Friday, and we’ve re-gained all of that and then some today.

More to the point, though, what’s happening? Consumers (and yes, the stock market, too) hears about “the Omicron variant” and “inflation” and not surprisingly reacts defensively to unsettling news. We’re no experts on the Covid virus (although we listen carefully to the folks who are legit experts!) but perhaps we can sort out some of the noise with the aid of some charts from CNN Business and some others.

First, let’s look at inflation. If you’re under, say, 55, for your entire adult life inflation has hovered around a very manageable 2% to 3%. In the 1970’s and early 80’s, of course, inflation was a big deal and double-digit annual price increases weren’t unusual. In the past few years, both pre- and post-COVID, inflation has actually been on a downward trend, getting very close to zero in early 2020. However, the flood of stimulus money in the economy, and the rebound after over a year of semi-lock-down, has triggered prices. On an annualized basis, prices in October were about 6.24% above a year earlier.

So, how big of a danger is this? In other words, is this inflation both real and permanent? A peek at the interest rate market may be insightful. Both the US Treasury long-bonds and the 30-year mortgage market have barely reacted. Both are up from their COVID-recession doldrums, but neither seem to have reacted to consumer prices.

10-year Treasuries and 30-Year Fixed Rate Mortgages

So, bottom line, is the economy healthy? In most respects, yes. As of October 1, the economy was adding about 148,000 jobs per month, which is near the high end of the “healthy” range (100,000 to 150,000). The unemployment rate stood at 4.6%, not quite at the pre-pandemic lows, but about where it was five years ago. Real gross domestic product stood at $19.5 Trillion (annualized) as of the end of the 3rd quarter, which is a new record high and nearly back on the pre-pandemic trend line. Consumer spending — which is driving the inflation fears — is also at a record high of $13.9 Trillion and has been back on its pre-pandemic trend line for most of 2021. All of these are healthy signs of a stable but growing economy.

That said, there are a few clouds on the horizon to be watched carefully. The S&P Case-Shiller home price index sets a new record high each month, but annualized housing starts are actually somewhat lower (1.6 million) than the peak of about 1.7 million set earlier this year. However, housing starts are still well above the 1.2 million level we saw for most of the past four years. It remains to be seen if accelerated housing starts will ameliorate housing prices. Retail inventories as a percentage of sales are lower than we’ve seen any time in the past five years, standing at about 126% (the pre-pandemic average was about 140%). This suggests more consumers chasing fewer goods with commensurate price pressure.

The stock market is a pretty good gauge of economic expectations. Looking at the trends for the past five years, the hic-cup on Friday appears to be nothing more than post-Thanksgiving indigestion. We hope that is the case.

As always, we enjoy hearing from you folks. If you have any questions about economic topics, particularly with a bent toward real estate, please let us know!

John A. Kilpatrick, Ph.D., MAI — john@greenfieldadvisors.com

In MBA school, students learn about economies of scale. The concept is pretty simple — the more of something you do, the more you can flatting out overhead. Let’s put this in the most basic terms. Joe owns a small plumbing company. He has to buy a truck and tools and a supply of plumbing gadgets. If he only services one customer a day, he may barely break even. However, if he can service 10 customers per day, he might be able to hire a cheap apprentice and make a lot of money. Economies of scale. Get it?

Mostly, students are shown graphs that look like this:

The implication is pretty straightforward — if we can just build a bigger and bigger algorithm, we can own the universe. Indeed, some real estate companies have certainly tested the boundaries of this idea. Until the mid-1990’s, most REITs were fairly small, compared to today. Sometime around 1996, there was a systemic shift upward in the size of REIT IPOs, and today, REITs are orders of magnitude larger than they used to be.

Nonetheless, in some corners of the real estate field, smaller still seems to be better. Brokerage, for example, benefits a bit from some aggregation, but is still very much a local hand-shake sort of business. Less-than-investment-grade investing (“B” and “C” properties) is still a localized business. Brownfield redevelopment and other niches are have proven difficult to aggregate. Indeed, in some niches of nearly every field of endeavor, the economies of scale equation looks more like this:

Beyond a certain point of inflection, the cost of doing business actually rises. Span of control is a difficult problem, particularly in complex fields. The more something can be commoditized, the further out that point of inflection is. However, there are limits to commoditization.

I was brought to think about this by the recent embarrassment of Zillow and their iBuying experiment. It was a very simple idea, really — local “flippers” were making tons of money buying dog properties in good locations, spending a few bucks on cosmetics, and selling into the rising price market. Indeed, my pet Pomeranian could have made money in residential real estate in the past 2 years. However, when markets start to flatten, some localized talent is needed. “You gotta know when to hold ’em, know when to fold ’em” as the old song goes. When markets shift, the economies of scale inflection point scales with it.

For those of you who weren’t keeping up with the Zillow news, the company set up a buying service a few years ago and started simply cutting a check on properties that their algorithm indicated could be flipped for a profit. I would argue that in normal markets, this is the sort of business that requires extensive localized knowledge. In rapidly changing markets, even more so. This isn’t a critique of mass appraisal models. Indeed, I’m a big fan of those, and they prove useful in many situations. However, the act of taking an individual property thru the “flip” process is complex and fraught with risks. A mass appraisal model can inform the participant, but can’t be a substitute for entrepreneurial effort.

Reportedly, Zillow had quite a few billions of dollars on the table, so this isn’t a small undertaking. Zillow is laying off about 1000 people — around 25% of their entire workforce. The investments were in about 25 or so secondary sunbelt cities, like Phoenix and Las Vegas. They’re said to be dumping about 18,000 residences, expecting to take a 5% to 7% loss on the transactions.

About 5.64 million homes sold in America in 2020, so 18,000 isn’t a real macro market mover. Of course, this is a pain for the 1,000 Zillow employees who are losing their jobs, and Zillow stock is down about 40% from the peak in late October. Conversely, the housing market is still pretty good and Zillow’s exit may create niches for local entrepreneurs. We’ll keep you posted.

As always, if you have any questions on these issues, please don’t hesitate to reach out. We look forward to hearing from you!

John A. Kilpatrick, Ph.D., MAI — John@greenfieldadvisors.com

It’s been a busy month, both for the stock market and here at Greenfield!

First the S&P 500 — our primary benchmark — scored one of it’s best months all year, up 6.91% by our metrics. Note that puts the broad market up 22.6% on the year. ACCRE was no slacker this month, up 4.75%, besting the S&P Real Estate index which was up 3.93%.

These are of course reflective of monthly returns. When we dig in a bit to daily returns, a somewhat different picture emerges, as shown in the Sharpe Ratio metrics, below:

Well, THAT was interesting! ACCRE and the S&P 500 are generally positively correlated, both overall and on a month-to-month basis. We want ACCRE to serve a diversifying role within a larger overall portfolio, and correlations in the 50% range, while not a target, are certainly viewed positively. Further, one month does not a market make, but given the long bull run in both the broader market and real estate, is a one-month negative correlation telling us something? Particularly in light of the fact that both indices ended up the month on a positive note?

I can’t help but note that ACCRE and its two benchmarks have all continued on a positive trend thus far in November. We’ll watch this closely, and keep you updated.

Best wishes for a great upcoming Thanksgiving Holiday! As always, if you have any questions about REITs or real estate in general, please don’t hesitate to reach out!

John A. Kilpatrick, Ph.D., MAI — john@greenfieldadvisors.com

In many ways, the explosive growth of the built environment in China has been breathtaking. In my adult life, they’ve moved about 500 million people out of rural peasantry into urban dwellings. The social impacts of this are a matter for another day, but one has to marvel at their industriousness.

That said, Chinese real estate, like so very much of the Chinese economy, is terribly unbalanced. From the outside looking in, we may think that the emergence of “Chinese Capitalism” (very different from what we practice in the west) is a step away from central planning. In fact, Chinese Capitalism, and particularly in real estate, has created all too many too-big-to-fail businesses. In a well ordered, balanced economy, risk taking is a good thing and it is balanced by a small number of businesses failing and a small number hitting home runs. However, when businesses are too big to fail, there is enormous up-side and little down-side. These huge entities are enabled to take on inappropriate risks, leaving it to others to pick up the pieces.

Real estate in the west is surprisingly atomistic. While there are a lot of big players, none of them, individually, has the size to impact the market. The 2008-2010 recession came about because of systematic factors, not any idiosyncratic failures. However, real estate in China has become aggregated in a handful of multi-tiered companies that have taken on enormous debt, are financed operationally by supplier credit, and have had no disincentives regarding risk-taking. Four of them are now approaching the edge of bankruptcy:

Evergrande — This real estate developer and property manager became the most valuable real estate developer in the world in 2018. However, it now has roughly $300 Billion in total liabilities, including $20 Billion of international bonds. Last week they reportedly failed to make a $148 million interest payment on these international bonds, and this appears to be the third missed payment in a row.

Fantasia — A luxury apartment developer that failed to make $315 million in payments to lenders last week and announced that they would probably default on external debts. Rating agencies have already Fantasia a “default” rating.

Modern Land — This developer has appealed to lenders for extra time on a $250 million bond which is due on October 25, and the Chairman and President of the company are making personal loans to support the business.

Sinic Holdings — This homebuilder has announced that they will likely default on at least some of $250 million in bond payments due October 18. It’s stock is down 90%, and last week, Fitch downgraded their credit rating to ‘C’.

These problems will most likely reverberate throughout the Asian economy, if not beyond. Obviously, the bank lenders and other bond holders will feel the pain, but these developers are also in-hoc to suppliers, subcontractors, and even employees. However, Natixis, the French multi-national investment house, has stated that the Chinese government will avoid such failures in the lead-up to the 2022 National Congress of the Chinese Communist Party. They note, however, that this means the failures may snowball down the road. Chinese generic economic growth has bailed them out of past large-scale financial failures, but experts believe this will not be the case today. These failures may have very real impacts on Chinese GDP growth.

In the short-run, the Chinese will probably see a managed restructuring in which other developers take over uncompleted projects in exchange for land holdings. However, in the longer run, this will make it increasingly difficult for Chinese entrepreneurs to have unfettered access to global debt markets, and I would suspect that, like their western counterparts, Chinese entrepreneurs will be expected to have more “skin in the game” in the future.

Back in the hey-day of pedal-to-the-metal real estate development here in the US, there was a saying among developers, “A penny borrowed is a penny earned.” The 2008-2010 bubble burst was a real wake-up call for western developers. It may be that the events unfolding in China could be a similar eye-opener for Chinese entrepreneurs.

As always, we look forward to your comments and questions!

John A. Kilpatrick, Ph.D., MAI — John@greenfieldadvisors.com

Wow — the market was a real roller coaster in September, and continues so in October. The broader S&P 500 was down 4.76% last month, and ACCRE was also off but by only 2.19%. The S&P Real Estate index fell 4.83%, again showing the benefits from a carefully curated real estate fund rather than a blind, broad index. More telling, the S&P 500 daily returns showed a significant level of volatility in September, but ACCRE’s volatility (measured as standard deviation of daily returns) was about 25% less. Again, a well curated REIT portfolio goes a long way to attenuating volatility.

As shown above, a dollar invested in ACCRE at the inception outperformed the S&P for several years, but has underperformed in this year’s bull run. Naturally, we hope the bull market continues, but one of the principal strengths of ACCRE is to serve as a hedge in downturns. This past month was a case in point.

As usual, if you have any questions about ACCRE or REITs in general, please don’t hesitate to reach out.

John A. Kilpatrick, Ph.D., MAI — john@greenfieldadvisors.com

Oil spills have a very real economic impact on real property, both private and public real estate. Value diminution includes, but is not limited to, loss of use-and-enjoyment, marketability losses, and income losses. In addition to this, remediation costs, loss of habitat, and loss of resources are all potential problems.

As of this writing, we’re still gathering information on the recent California spill near Huntington Beach. Greenfield has consulted on previous spills in that state (Santa Barbara, Avila Beach, etc.) and we’re gearing up for this one as well. Thus far, a reported 126,000 gallons of oil have leaked from one of Amplify Energy’s offshore rigs, although some estimates put that as high as 144,000 gallons. According to CBS News, it is the largest spill that part of the California coastline has seen in many years. The last major spill off Huntington Beach was about 32 years ago, when a British Petroleum oil tanker ran aground spilling 400,000 gallons. Huntington Beach’s economy is heavily dependent on clean beaches and water, and it dubs itself “Surf City USA”.

As of Sunday, an estimated 13 square miles of ocean surface were slicked with oil, with the oil moving southward toward Dana Point and Newport. Sticky balls and patties of oil, similar to what we saw with the Deepwater Horizon spill, are already hitting the beaches. California’s Department of Fish and Wildlife has deployed booms in an attempt to protect the Bolsa Chica wetlands, a valuable ecological reserve. Fisheries within six miles of shore have been closed from Sunset Beach to Dana Point, and warnings have been issued concerning tainted fish and shellfish. Newport Harbor, home to thousands of recreational boats, has been closed.

We’re continuing to track this problem, and as we know more, we’ll keep you posted. If and as you have any questions about this, please let me know.

John A. Kilpatrick, Ph.D. MAI — john@greenfieldadvisors.com

Sorry we’re running late this month — Labor Day travels and such really got us behind the curve.

One challenge of running a “hedged fund” is that when the market is going straight up, the hedges tend to work against you. August was a case in point. This was one of the very few months when the S&P real estate index beat ACCRE, and of course the S&P 500 was on a huge bull run this month, earning nearly 3%. I would note that so-far in September, ACCRE is doing much better, but we’ll get back to you on that in a couple of weeks.

Our Sharpe Ratio statistics also tell an important story. We continue to be uncorrelated with the broader market, but the S&P’s average daily excess return is has been nothing short of amazing of late. Naturally, we hope this bull run continues, and we’ll continue to monitor our hedge positions going forward.

We hope everyone had a great Labor Day holiday! As usual, if we can answer any questions on these or other real estate topics, please don’t hesitate to reach out.

John A. Kilpatrick, Ph.D., MAI — john@greenfieldadvisors.com

Last week, I had the very real pleasure of speaking to partners in several boutique law firms about real estate, and specifically about issues facing their clients who invest in single family rental housing. Note that I am not a critic of these investments — far from it, in fact. However, there has been an explosive growth in single family rental investing in the past few years, and particularly during the pandemic. The investment growth, creating a significant supply of such housing, has been matched with demand growth as rental householders move out of central business districts into the suburbs and into larger rental units providing more room for home-work, home-schooling, and extended family households. Nonetheless, as new investors move into this market, and as prices are bid up to record levels, an abundance of caution may be in order.

First, some of the numbers. There are about 140 million housing units in America. If the average value of each unit is $200,000, then this is a $28 TRILLION market. Hence, even small shifts at the margin have very large economic impacts.

For the last 50 years, somewhere between 63% and 70% of these housing units have been owner-occupied. The trend got very close to 70% during the pre-2008 bubble, but generally hovers around 65%, slightly higher in the South and Midwest, and slightly lower in the Northeast and on the West Coast. At the end of the 2nd quarter, 2021, the number stood at about 65.4% nationally, but that was sharply down from 67.9% just a year ago. While a 2.5% movement may not sound like much, that’s a shift of about $700 BILLION in housing from owner-occupied to tenant occupied (and thus, investor owned) in one year.

Of that big slice of the market that is tenant-occupied (and investor-owned) about 37% is in single family residential (“SFR”) homes. By the way, another 29.4% is in duplexes, tri-plexes, four-plexes, and small apartments with 9 or fewer units. Historically, this type of investment has been owned by individual investors or perhaps small partnerships, although that model is rapidly going by the wayside.

Both publicly traded REITs and private funds (including private REITs) are getting into the game big-time. Public REIT investing offers a high degree of liquidity, but sometimes with the trade-off of lower returns. Private REITs and funds promise higher returns (although don’t always deliver) but with almost no liquidity. Traditional rules of thumb suggest that a public REIT may aim for combined returns, both price-return and dividend income in the range of 7% over the long haul. Statistics from the National Association of Real Estate Investment Trusts bear this out. Private investors aim somewhat higher, and usually there is a trade-off between potential price gains and potential dividend returns.

That said, this year has been nothing short of amazing for OWNERS of SFR homes, although perhaps not for those who have been buying into this bull market. Case in point, last week, Bloomberg News reported that US SFR rents rose 7.5% year-over-year in June. The largest increases were in the Southwest, with Phoenix reporting an increase of 16.5% and Las Vegas showing 12.9%, year-over-year. Not surprisingly, investors have been flocking to funds that are in those markets. Just as an example — and there are others we could use — Invitation Homes (INVH), a publicly traded REIT, owns over 80,000 SFR homes, mostly in those hot sunbelt states. Enjoying a 96% occupancy, their stock price has risen over 40% just this year, driving their dividend yield down to 1.67%.

Not all is smooth sailing, though, and increases in rents don’t always lead to an increase in rent INCOME. Case in point, in the face of such great statistics, why not raise the dividend yield? Consider, however, pandemic-related collection issues, commonly referred to in the industry as “tenant chargebacks.” In a normal year, we would expect this number to be in the range of 1% – 2% for a well-run fund. However, another REIT we examined, American Homes 4 Rent (AMH) has also exhibited greater than 40% stock price appreciation this year, but has a dividend yield at 0.95%. Digging deeper, we find that AMH reports a 13.5% tenant chargeback. As bad as this is, after the pandemic-related eviction moratorium runs out, this may be a ticking time bomb for some funds.

Private funds – with almost no liquidity – promise substantial returns when they finally close out, usually in 3 – 7 years. Expectations in 12% and above range are not uncommon. We were recently shown one fund, which shall remain nameless, and buried deep in their offering circular was some nebulous language about a 3-year maturity and a 13+% expected annualized return. However, upon closer examination, we found that this will be the developer’s third fund, and the only one of those to reach maturity (this summer) ended up with a somewhat disappointing 5.17% annualized return. Nonetheless, this developer will almost assuredly raise $20 million in $25,000 increments from hungry individual investors.

This chase after the bull real estate market isn’t just limited to individual investors. Consider New Residential Corp, which until recently was a publicly traded REIT. They owned 14,600 homes in nine sunbelt states with a “carry value” of $1.873 Billion. They’ve been losing money for a while, and in the third quarter, 2020, managed to lose $63 million on revenues of $57 million. Their debt/equity ratio was about 85%, which is comparatively high for a REIT. The “book” equity was only $312 million. Nonetheless, a private fund bought New Residential, lock, stock, and barrel, for $2.4 Billion.

Don’t get me wrong — real estate over the long haul has been a strong contender for a well-balanced portfolio. If you had invested $1 in a SFR on January 1, 2000, by today you would have $2.46 with surprisingly little volatility. Even with the housing “bubble” and crash, your investment would never have been out-of-the-money. Plus, over the years, you would have enjoyed tax benefits and either a place to live or rental income. Compare that with investing that same dollar in the S&P 500. Today, you would be a bit richer — $2.85 — but your investment would have been a loser for most of the last 20 years. Indeed, you wouldn’t have been “in the money” until 2013, but for a short period in 2007. Further, the market volatility would make your head swim.

There is a very real growth in both the demand for and the supply of SFR rentals. Portfolio benefits can be quite good, but caution is the watchword for newbie investors diving into this market. Historic rules-of-thumb and trade-offs between current income and capital growth may be out-the-window for a while, and there will almost certainly be a settling out period after the COVID pandemic is over.

Note:  Dr. Kilpatrick and/or Greenfield Advisors may, from time to time, have investments which are mentioned in this presentation.  Nothing in this presentation should be construed as investment advice. 

If I can answer any other questions, or be of any assistance on these matters, please let me know.

John A. Kilpatrick, Ph.D., MAI — john@greenfieldadvisors.com

ESG is an acronym for “Environment, Social, and Governance.” It is the current buzz-word in the industry for what was formerly called “green building”, although as you can tell from the title, it is so much more than that.

The US Green Building Council was formed in 1993 to “promote sustainability in the building and construction industry”. While it is active in many areas of real estate, it is perhaps best known for the LEED building certification. For quite a few years, the National Association of Real Estate Investment Trusts (NAREIT) awarded the “Leader in the Light Awards” to honor REITs that “demonstrated superior and sustained energy practices.” Back in 2015, I conducted a study about these awards and presented a paper at the annual meetings of the American Real Estate Society investigating whether or not there was any stock price bump (or other meaningful market reaction) associated with such an award. While I couldn’t find any statistically significant market reaction to the award itself, there was anecdotal evidence to suggest that such “green” behaviors were already capitalized in the stock price and the return generating process.

In recent years, the focus has shifted away from just “green” issues toward broader themes, including all of the ESG topics. Both large and small consulting firms (including Greenfield) are engaged in some or all of the ESG issues, including such key elements as dealing with catastrophic events, setting corporate goals for community development, and establishing adequate data protection.

Real estate firms of all stripes are increasingly considering ESG in their business models. There are enormous direct benefits up and down the real estate ladder. Local governments are now looking policies, commitments, and goals in some or all ESG areas as a precursor for permitting. ESG is a significant marketing tool, and customers are reacting positively to the ESG message. For example, Blackrock’s CEO, Larry Fink, announced at last year’s Morningstar Investment Conference that they planned to integrate ESG metrics into all of their portfolio by the end of 2020. This year, NAREIT reported that 98 of the top 100 REITs reported publicly on their ESG efforts.

By some reports, climate change has been a primary driver of ESG attention. Energy usage at the property level can be immediately reported and analyzed for potential cost savings. Noting that the incidence of climate events causing $1 Billion or more in property damage have quadrupled in recent years, it comes as no surprise that this has nearly everyone’s attention. Recent back-to-back environmental disasters in Texas have been cited as particularly concerning to investors.

S&G — social and governance — have worked their way into investment underwriting, and despite a surplus of liquidity in the market, investors want to know that S&G issues are being meaningfully addressed. This is particularly acute with public funds and public securities holdings. The Pension Real Estate Association (PREA) has instituted annual ESG Awards “[T]o recognize excellence in ESG programs within institutional investors in real estate.”

Many say that the pandemic has catalyzed ESG policy adoption, although the trend was clearly strong before the COVID outbreak. Nonetheless, it is now almost universally recognized that the ESG momentum will continue to grow. This doesn’t mean that universal adoption is imminent. Some firms still stand on the sidelines waiting for the metrics to come in — capital flows and returns being key touchstones. Transparency and benchmarking will be key elements to further adoption down the road.

As usual, if we can answer any questions on this topic, please do not hesitate to reach out.

John A. Kilpatrick, Ph.D., MAI — john@greenfieldadvisors.com