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July 2022 Newsletter
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On behalf of the whole Peak 15 team, thank you for your continued support. There is a lot of exciting news to get into this month, so let’s jump right in.

We have a new acquisition to announce with our great friends over at Victory Capital. DJ and Dante have been friends of ours for years and it is so exciting to lock up a deal with them so close to us in Hickory, North Carolina. The asset is in a great location, right next to Lenoir-Rhyne University, and we have a fantastic team to realize its full potential. Thank you to all of you who invested with us to make this acquisition a reality.

As you may very well know, the biggest stories in the economic world are inflation, and the various responses to the phenomenon. We covered the history and mechanics of inflation and capital markets, but let’s take a look at where the market has moved over the past few months, and where it might be going next.

Previously, when we discussed the history of capital markets and one of the first capital markets in the Netherlands, we gave a historical precedent to the kinds of syndications that we continue to use to this day. Since the 1600s, capital markets have developed and our understanding of them has as well. Back in the earliest markets, the concept of underwriting was still foreign. Today, we have a clearer picture of value and capital returns. Thanks to our more scientific approach, we even understand what kinds of economic conditions allow for certain assets to thrive. So what kind of market are we in? And how does real estate fit into that picture?

There are two main drivers responsible for the changing asset prices: the inflation, and the Fed's response: interest rate hikes. Right now, the Federal Reserve has the tremendously difficult job of lowering inflation to comfortable levels, while also not cooling off the economy too much as to plunge into a recession. Concerns over the Fed’s ability to “land the plane”, so to speak, is being called into question more and more. The inflation rate is still above 8%, and the Fed is acting more and more aggressively to control the situation. 

I think it is easy to criticize our financial governing bodies in this situation. It is the job of the chair of the Federal Reserve to ensure a healthy economy for the United States. As I have stated repeatedly, trust is the glue that binds our economy together and it is important to have a Fed chair that projects confidence and optimism. During the 2008 financial crisis, then Secretary of the Treasury Hank Paulson was found having breathing issues by Senator Judd Gregg and Representative Rahm Emmanual. This news was kept private because the markets simply could not handle the news that the Secretary of the Treasury was suffering from extreme anxiety. So instead of simply playing Monday morning quarterback, I want to acknowledge where we are economically, and how real estate as an asset class is faring under these conditions. 

Real estate, in some ways, is the crown jewel of investing because it is a real asset that appreciates in value (generally) and, most importantly, it cash flows. Government bonds, and other debt products, are by far the most reliable sources of cash flows, but it is almost unfair to compare these products to real estate. Where you gain stability in debt products, you lose in the potential upside. Even with the interest rate hikes that we have seen this calendar year, the price of debt is still too cheap for this kind of investment to compete with the cash flows of real estate. The truth is that interest rates have been too low for too long and the recent interest rate hikes seem dramatic, but, from a more historical view, a 2% rate is still low. One way to think about placing debt is that you do not invest in bonds for return on capital, you invest in bonds for the return of capital. 

For more of a traditional return on capital, investors tend to look towards equities in companies. Obviously, there will be outliers when discussing something as broad as the stock market, but If there is one thing that the stock market hates, it is uncertainty. And there is nothing more uncertain than a war. There are plenty of other sources contributing to the choppy stock prices though, the aforementioned jousting match between Jerome Powell and the inflation dragon being one.

Another brief point to mention about investing in equities is that the vast majority of stocks do not cash flow at all and are purely speculations. Unless you hold dividend stocks in companies like Williams (WMB), Microsoft (MSFT), or Lowe’s (LOW), the only way that you make money is to sell your stock to someone willing to pay more than you did. In fact, even if you did buy one of these stocks, the dividend return is rather poor. Not only that, but the money mechanics behind the scenes of a stock trade is more than a little troubling. The process is not transparent at all, and most of the time when a stock is purchased, that money does not actually go to funding the company. The company that you buy a share of will almost never get to use your investment for any meaningful capital expenditures. 

So where does real estate fit into this picture? Well, we have some competing pressures to deal with since the inflation rates and the interest rate hikes tend to push the asset in different directions. Lenders have had to raise their interest rates, and/or offer risky floating interest rates, making acquisitions more difficult. This is the pain point that we have been hearing most from our sponsor partners, and it is a pain point that we have felt ourselves. That being said, real estate is traditionally one of the best performing assets in times of high inflation. Why? Because of the proximity to the revenue source: in this case, the renter. The reality is that inflation costs are generally passed down to renters and rent increases are captured in inflation figures. High inflation generally means that rents are going up.

So the initial inflation jump certainly brought more dollars to the commercial real estate space as investors understood the value of real estate in high inflation markets. The concern is that the interest rate hikes will scare away this money leaving real estate in a tricky place. Last week at the IMN conference in Newport Rhode Island, we heard a mixture of feelings about the current economy and there was no shortage of doom-and-gloom mentalities. We at Peak 15 do not fully subscribe to the doom-and-gloom mentality of the coming real estate market. The fact of the matter is that there is more demand for housing than there is supply. That has been true for a long time and it is true today. The demand for multifamily housing is inelastic. From an investment perspective, this is a great opportunity to provide a greatly needed service to a market that has consistently shown demand.

We at Peak 15 do not have a crystal ball. We do not see into the future to determine the effectiveness of our future investments. To quote our founder, John Azar, investing is about “time in the market, not timing the market”. Our job is to find the best value in the market, no matter the conditions.

I want to close out this newsletter by saying that investment is about recognition of value. Real estate is a real, physical asset that people have demanded for centuries, and will continue to demand for centuries to come. Yes, it is true that the rising interest rates are making commercial real estate more expensive, but the value in these investments is still there and we will continue to find value for our sponsors, our investors and ourselves.

Keep climbing!

Contributed By: Peter Vermette