On behalf of the whole Peak 15 Capital team, thank you for your continued support and welcome to the final newsletter of the year.
As you all know, our fund is launched and we are well on our way to raising our target. You may have also heard about our live webinar that we will be hosting on December 7th. At this event, we will be diving into our strategy with this fund, where we see the market going over the next few quarters, and answering any questions that you may have. If you are interested in joining us for this live, intimate event, you can learn more by following this link: https://www.peak15cap.com/landing/webinar
For this newsletter, we wanted to do something a little bit different from what we have done before and take a retrospective look at the current year and what lessons we can draw from it. 2022 was a strange year. We began the year still taking fairly extreme measures from Covid-19 while enjoying a Fed target rate of around 0%. Today, we are sitting at a target rate between 3.75%-4.00% that will likely rise again in December. Going from a 0% interest rate to a 4% interest rate is a monumental change and many in the real estate industry have decided to sit on the sidelines for that change, and who could blame them? A rising interest rate, especially with this velocity, means that debt gets expensive very quickly. In theory, higher rates and more expensive debt will cause prices to decrease dramatically in order to make the deals continue to make sense. In reality, we saw brokers refusing to lower prices for too long and we saw very few deals make sense for us for most of the year.
One reason why we have seen such a decrease in deals that make sense is the fact that owners were not necessarily forced to sell earlier in the year. Real estate is an illiquid asset, meaning that it is not always viable to buy or sell these assets at the drop of a hat. In other markets, the buyers and sellers have to agree on a price in a fairly short timespan, but in real estate there can be periods of several months where nobody really agrees on the value of an apartment. This buyer-seller disconnect is plainly visible when we look at the best-and-final rounds we have been a part of. 6 months ago, the whisper price from a broker would be the starting point for bidding and we could easily expect several rounds of best-and-final offers with 5+ groups making that round. Today, we are seeing deals trade for under the whisper price and terms like hard money on day one are being phased out. We fully expect that the market will continue in its pro-buyer trends over the next several months and 2023 will be ripe with opportunity.
For now, we do not anticipate that the Fed will deviate from it’s interest rate increasing path. As you know, we follow the Fed’s words closely and as of right now there has been no indication of a change of course. The labor market is still incredibly robust with unemployment still under 4%, and the inflation rate is still not creeping down as quickly as anticipated. A few months ago, we projected that rate hikes would continue and end the year with a 50 basis point hike in December. With the current indicators that we are seeing in the market, we would not be surprised with a 75 bip hike in December with more hikes on the way for Q1 of 2023. This shift would actually work in our favor for the fund because it means that even more deals will be coming to market. Every hike that the Fed announces will apply more pressure on distressed properties to sell since debt payments will sharply increase.
From our perspective, the biggest lessons that we learned here in 2022 have come from paying close attention to public sentiment and consumer confidence. Whenever there is movement from the Federal Reserve, all eyes naturally turn to the current chairman and a delicate balance must be achieved. Movement in any direction in target interest rates indicates that the Fed is currently unhappy with some aspect of the economy. However, a full admission of this would sink otherwise stable parts of the economy. As we have mentioned before, the Fed chair must project confidence at all times while delicately correcting the United States’, and therefore the world’s, economy.
Back in October, we published a blog post titled “The Emotional Investor” which I later mentioned was a preview to the Fed announcement on November 1st. What I did not anticipate, was that The Emotional Investor would really be a preview to a modern bank run in the collapse of FTX and the criminal actions of Sam Bankman-Fried. In that piece, we discuss how banks and other financial institutions experience bank runs and errosions of consumer confidence. All it takes is for something to change the public’s perception of the underlying assets of an institution, what follows is a rush of people withdrawing their assets and the bank collapses.
In FTX’s case, the event that eroded consumer confidence was the insight that assets from the crypto exchange FTX were being funneled to SBF’s other venture, Alameda Research. Other assets were being siphoned out for SBF’s personal expenses. As soon as this information was made public, the bank run that ensued echoed every bank run in history all the way back to Johan Palmstruch in the 1600s. History does not repeat, but it certainly rhymes. Mr. Fried’s future is quite uncertain, but with Theranos founder Elizabeth Holmes being sentenced to 11 years, I think we can expect something similar for the quickest evaporation of $32B that I have ever seen.
The fallout from this collapse is yet to be seen. FTX was one of the two main crypto exchanges along with its rival Binance, and now it is unclear how the industry for crypto exchanges will shake out. While it is true that select private equity groups have investments in these digital assets, right now, there are exactly 0 dollars invested from sovereign wealth funds and pension funds. These players are the ones who hold the kind of wealth that Bitcoin’s future valuation is based on. Bitcoin faithful will tell you that it is a store of value and that large institutional investors will hold Bitcoin as a way to hedge against inflation. The reason that none of these entities currently hold any Bitcoin is because there is no regulation, meaning that rugpulls and bad actors are still very much in play. It is possible that, in the wake of the FTX fallout, regulation is achieved in some form and crypto generally comes out of this better than before. It is also possible that investors see this snafu as just another domino to fall spelling the end of the crypto hype train. We will wait and see.
From us at Peak 15 Capital, the largest takeaway from witnessing this modern day bank run is that we are in the right place. By this I mean that we are investing in real tangible value that affects people’s lives. Our investments are not speculations. Instead, our deals are diligently underwritten so that we have a clear understanding of what our cash flows will look like and what our investors should expect over the hold period. Another huge takeaway is that radical transparency is not just a luxury, it is a necessity. One of the main reasons that trust in the FTX empire collapsed so swiftly was that the upper management was opaque and undemocratic. Contrast that with our approach where we share our underwriting, projections, and fees with our investors. This, in our view, is how financial services were always meant to be. As investment professionals, our job is not to be omniscient agents seeing the whole world from our glass towers, our job is to help our network of sophisticated investors make intelligent choices with their capital.
When it comes to intelligent choices, all of us on the Peak 15 team have determined that our fund is a good investment and all of us will be investing our own money alongside our investors. With a shaky future in equities and underwhelming returns from other asset classes, real estate is the place to be and our strategy is highly investor favored. The money that we will be investing will participate at the partner level and garner general partner level returns as opposed to the limited partner level returns that are typically seen. I could go on about how much we believe in this project, but there is no better indication of our confidence than our willingness to put our money where our mouth is and invest ourselves.
With that, let’s cap off this final newsletter of the year with a reflection from our Partner and Managing Director, Francisco Herrera…
This year, we had a great start with one of our placement closings in San Antonio for $4M of JV Equity (Q1). As we pushed through the advent of COVID in 2020-2021, we pushed to fight through the biggest crisis of the year: rate hikes. Coalescing with low cap rates, this made it difficult even for the astute operator as debt proceeds were a constraint, and well, price correction was still lagging. With our focus in our most current fund: Peak 15 Capital Fund I, I believe we are in for a whirlwind of opportunities to come in 2023 and the market will dictate those who are “syndicators” and those who are true “operators”. I am extremely proud of our team, and we are bullish on the opportunity that multifamily will bring in 2023; we are ready.
Keep Climbing!
