By Jason Lesh, Managing Principal
Founded in 2010, we built the firm we wanted to steward our family's resources. And equally as well for our clients, cutting through all the noise and focusing on them and their families.
Investment management, financial planning, tax coordination, estate planning, insurance reviews and business consulting. It is all incredibly important, but if they aren't all aligned towards clearly articulated goals, then it quickly becomes a very expensive exercise in mediocrity.
Synthesizing all these different areas can be challenging which is why we lean heavily on experts whom we know very well. An area of continual focus for us is the evolving real estate landscape. With that in mind, we have partnered with the University of Portland's Pamplin School of Business to host a panel discussion with three thoughtful leaders to share their insights and would like to invite you to join.
Held Thursday, April 19th, the panel will include:
- Brad Christiansen - Vice President, Colliers International
- Scott Kirkland - Branch Manager/Mortgage Advisor, Root Mortgage
- Patrick Kessi - President/Founder, PHK Development, Inc.
- 4:30-5:00 pm - Networking Reception including appetizers and drinks
- 5:00-5:30 pm - Intros, background, insights into the current marketplace
- 5:30-6:30 pm - Interactive panel w/ Q&A
- 6:30-7:00 pm - Networking, Conclusion
Nick Fisher, our portfolio manager, shares some of his recent musings on the real estate market below and we look forward to exploring them in greater detail with our panelists.
I hope this email finds you well and hopefully our paths will cross soon.
Real Estate: With Rising Interest Rates and High Prices, is Caution Warranted?
By Nick Fisher, Portfolio Manager
Our goal as a Registered Investment Advisor is to provide our clients with the best risk adjusted returns in the pursuit of achieving their goals. We try to be agnostic regarding how investors achieve their return and many of our clients invest in real estate as part of their overall strategy. Many we have spoken with recently are increasingly cautious when it comes to acquiring new real estate investments. This is a result of either prices being too high relative to potential rents and/or a worry about the Federal Reserve’s change in monetary policy. So, how worried should we be? Do high prices and higher interest rates justify caution?
It won’t surprise anyone that I think about real estate and stock market valuations in similar terms. The major determinant of valuation is simply the present value of all future cash flows (conservatively estimated). Just like the p/e ratio of stocks, the capitalization rate (cap rate) is a quick shortcut in understanding the relative value of real estate income properties. The cap rate gives you a rough idea of what yield an owner would earn from a property.
Given low cap rates, many of the current real estate “deals” fail to compensate investors adequately for risk (just like low earnings yields in stocks). The following shows the average cap rates over time of different types of commercial real estate compared to 10 year treasury yields. In this limited data set, as government bond rates have fallen, so have the yields on commercial real estate.
As government bond rates continue to rise, will valuations follow suit and therefore make current real estate prices unattractive? The following scatter plot shows the relationship of the two over a 22-year period.
There is a strong positive correlation (+0.7), albeit not perfect, which means that cap rates may in fact increase as rates rise. This points to higher risks of prices decreasing in the short-term. Other factors such as economic growth, local supply, lease terms/structure, and availability of leverage all have additional impacts on real estate prices and therefore investor returns.
If all signs point to using caution, what approach is most sensible?
First, an investor should have a deep understanding of the investment in question. This goes beyond a “good deal” with a nicely assembled deal packet that a friend has recommended. Second, the time horizon must be long enough to allow for inflation and an improving economy to grow rents (cash flows). This will balance out short-term price changes from any change in cap rates.
We are in uncharted territory, as far as higher interest rates are concerned due to the magnitude of monetary policy changes over the last several years. It is unclear how this normalization process will work and just like in the stock market, there is a lot to be said for having patience around the market cycle and changes in cap rates/valuations.