Market Approach

Everything starts with and depends on the price. There are times when certain types of investments are ‘hot’ and certain times when they are not. The key, as with any investment, is to be able to evaluate the true intrinsic price and buy below it. As Warren Buffet famously says “it’s hard to go wrong when you buy a dollar for less than a dollar”. The next question is how to sort out those components which make up a sober assessment of an asset. In popular sectors and frothy markets such analysis is first slowly, then fast abandoned in favor of optimistic projections tending more and more on reliance on ‘capital appreciation’ for no other reason than the expectation of a buyer who will come along with even more optimistic assumptions. Some refer to this as ‘the greater fool theory’. Everybody can repeat the ‘buy low and sell high’ mantra, but when it comes to execution most will ‘buy high’ and hope to ‘sell higher’; an excellent formula for capital demolition that we have all seen played out over and over again sector after sector from tech to debt to real estate and everything in-between.

For now close to three decades, our area of expertise has been real estate. Our rules for purchasing are detailed under ‘Investment Principles’. Suffice to say that the philosophy is not to follow the crowds or simply claim to be a genius by ‘going against them’ but simply to follow the facts which sometimes are very far away from crowds in lonely and unloved places. Close to thirty years ago, the Savings and Loans crisis led to the collapse of real estate mainly felt in the US South East and in Texas in particular. So that is where we went. A portfolio of residential real estate was accumulated and close to ten years later sold to a large U.S. REIT. After a period of instability in Quebec in the late 90’s and early 2000’s due to fears of separation, we built up a portfolio of properties some of which were sold to a local REIT at prices we felt were impossible to resist.

Then came what is being referred to as ‘The Great Recession’.

The world became negative on parts of the U.S. and particularly the Midwest where it still is to some extent ‘common knowledge’ that it is a ‘dead place’. We specialize in ‘dead places’ as sellers are often all too eager to get rid of assets at fire sale prices believing the dire tone of the current apocalypse du jour narrative. In June 2011 we closed on our first US purchase, a portfolio of three commercial properties comprising of 175,000 SF in Fort Wayne Indiana (yes, far from Silicon Valley and New York City and other such ‘gateway markets’ where everybody currently loves to be). The seller was GE Capital who let the asset go for a third of the mortgage it had on it and for a quarter for what it was built twenty years before. At our purchase price, we positioned ourselves to undercut the competition, comfortably pay full commissions to leasing brokers on both ends incenting traffic our way, pay for TI’s and fill up our space – doubling our NOI and the portfolio’s unlevered value. It is first and foremost all about the price and not on the popularity of an asset class, its location etc. As a side note, eighteen month after we bought, another division of GE moved in leasing over 30,000 SF for seven years effectively doubling our portfolios’ unlevered value. It gets better – about a year later, GE decided to move its operations to Mexico so they had to pay a substantial penalty and left all their brand new furniture behind. Shortly thereafter, we backfilled the space and for good measure used some of the furniture for our New York office. Then we refinanced out for the third time.

In the interim we have closed on over 5,300,000 SF more of Office making us Indianapolis’ largest suburban landlord with close to 2,000,000 SF and its second largest landlord overall. In Columbus with close to 1,400,000 SF we are also the largest suburban landlord and with over 1,000,000 SF in the Cleveland/Akron area, we are one of the largest owners in the market. We also have assets in Montgomery AL, in Maumee OH and over 800,000 SF in Overland Park, KS. Such scale carries many advantages, not the least the ability to attract the best talent. An attribute all too often underrated.

A deeper analysis shows that beyond the reasons cited above, there are more subtle causes for the availability of such low prices in markets such as the Midwest and other ‘unloved’ smaller localities in the U.S. There is a phenomenon we have noticed in other secondary and tertiary markets – where we bought almost all our assets in Quebec. And that is that when the mood is bad, these assets tend to be discounted far further than similar properties in larger markets. Interestingly, many U.S. secondary markets have larger GDPs than most cities around the globe and some even more than many nations.

But the real question is: what in fact is this so called risk? A lease from a credit tenant in NYC or Kansas City or Columbus is equally binding and equally safe. Therefore the risk is in reality illusory, but nevertheless still offers a further discount. The knee jerk response is then ‘liquidity’ risk. The answer is that it is only a risk if there was a promise to sell the asset by a specific date. That date may end up being a horrible time as it was for those who had to sell in NYC in the mid-seventies or the early nineties.

The only real and legitimate risk comes from over paying. Consequently, if we buy at a price where the margin for error is wide as defined against replacement cost and against the ability to undercut the competition, then catastrophizing based on macro scenarios only serves to irrationally drive prices down to levels where five to ten years later people will comment longingly, as they always tend to do with the comfort of retrospective analysis, and say: ‘boy, I wish I had bought then; it was so obvious that prices couldn’t remain that low…’. But the interesting part of this sort of cycle is when the mood is high, these small markets benefit and the properties can be sold to a REIT as part of a larger portfolio. As John F. Kennedy once said “when the tide rises, it lifts even the smallest boats”. It is worth remembering that as long as twenty years ago somebody felt it was worth spending four times the price we paid for the Fort Wayne portfolio many of our properties Those enthusiastic and hopeful ‘investors’ will be back; they always are. The key is to make sure it’s never us.

There is a further and complementary reason why discounts can be so high in these smaller markets. It is to do with the somewhat uniform investing behavior exhibited by REIT’s, pension funds, private equity groups and institutional investors in general. Again quoting from Warren Buffet, it’s what he first referred to in his 25th letter to the shareholders of BKH: ‘the institutional imperative’. Even he was surprised at its stubborn endurance. It is not in the inherent advantage of an asset manager to risk career and reputation for doing something out of the norm. For quite some time now, large institutional investors have been focusing their attentions on certain big and ‘safe’ markets. No manager will be fired for buying at a 4 cap in NYC with little upside simply because all the others are doing it and therefore the strategy has ‘consensus’. However, ironically institutional managers can get in trouble for buying in a small market at a 10 cap with upside solely because no other manager is and therefore is not considered a ‘consensus’ approach. That is why sellers tend to write off (or let go an asset for a huge discount) in secondary and tertiary markets. Not because it’s necessarily a wise economic move on their part but rather it takes an ‘embarrassment’ off their portfolio. It’s better for the portfolio manager when he can say at his next conference call that he ‘got rid’ of the Fort Wayne asset which for them was a rounding error in any event. These managers are far from being silly or ignorant. It’s simply that their motivation set is different than ours. In fact, some of our LP’s work at hedge funds, investment banks and so on. When it comes to their own money, their motivations revert out of the institutional imperative.

Concerning the U.S. and its opportunities, Warren Buffett is generally recognized as a wise and credible source for astute, prudent and intelligent perspective. He continually warns us that the naysayers who discount the U.S. are making a serious mistake. They have made that mistake over and over in the past crisis after crisis only to be proven wrong every time. The U.S., Mr. Buffett reminds us, remains the world’s leading nation, with great minds with a diverse and growing population benefiting from a constant inflow of people striving to make their dreams come true. According to Mr. Buffett as well as many other reflective minds, there is no other place on earth or in history where human potential and utility can be so unleashed.

Right now, specialized pockets of the U.S. are still on sale, though this situation is rapidly changing as economic circumstances improve with optimism flowing right behind. Nevertheless, occasionally opportunities do still arise. For those who understand the fundamental economics of real estate and are clear-headed in their mathematics, the next little while offers an opportunity that does not come around very often – particularly in the world’s greatest economy. This does not mean it’s easy to find the jewels. In fact these now seem to be restricted to very large Office portfolios sold by institutions for reasons unrelated to the economics of the disposed assets. Even at the best of times for bottom feeders (that is during the most pessimistic times for most others), much dirt needs to be sifted through and then examined by experienced and cautious eyes before nuggets of opportunity are found. Pickings are getting slimmer by the year as optimism returns and time is running out.

The information on this website is intended solely for the benefit of firms and companies seeking private equity investment capital by providing general information on our services and philosophy. The material on this site is for informational purposes only and does not constitute an offer or solicitation to purchase any investment solutions or a recommendation to buy or sell a security nor is it to be construed as investment advice. Additionally, the material on this site does not constitute a representation that the solutions described therein are suitable or appropriate for any person.