Pack Your Bags

Right before the market crashed in March 2020, I put a good amount to work in real estate funds. These private companies focus on buying large condominiums with 200-400 units, with the purpose of optimizing and stabilizing them, then putting them on the market, priced as turnkey operations.

The business plan is to raise the initial capital from investors in the fund {myself, among them}, leverage the seed money to secure a bank loan or add a strategic partner, and perform a managerial value-add.

By allowing tenants to end their lease and letting their contract expire, instead of renewing it, units go empty and can undergo renovations that would attract higher-paying renters.

This process optimizes the building complex, by attracting a demographics group, who can afford to pay more and has a higher probability to rent for longer terms, with potentially fewer issues.

The end result is that the entire complex appreciates in price for the fund to sell it and exit at a profit, while it performs cash flow distributions along the way.

The investor’s total return is comprised of the cash flow disbursements throughout the holding period {4%-5% annualized}, plus the appreciation upside {60%-80% for the duration of the fund, because of the leverage}.

These funds project a 70%-100% return in 3-5 years.

If one looks at the day-to-day, monthly or even quarterly financials, though, the income and expense columns look weird, since they include old leases paying lower rents, newer ones paying better rates, plenty of one-off expenses such as paint, floors, drapes, and all of the maintenance and landscaping.

It’s a mess, but it’s a transitory chaos.

The next owner will not have to deal with any of it, but the heavy lifting is what adds the value; therefore, that’s where the bigger potential is.

The risks are that tenants are going to be problematic, the construction company will experience delays, or that a molecule in China will escape the lab and disrupt global supply chains. But it doesn’t have to be that dramatic; most of the time, it’s just dealing with hundreds of families coming in and out of the complex, while the fund is attempting to optimize and stabilize the project.

My point is that though this is a very short time span in the bigger picture – after all, people will occupy this apartment complex even fifty years down the road – for a brief moment in its life, the entire project will be going through a transition, which the fund anticipates will last three years. If a Black Swan event occurs, however, it could take up to five or six years.

This is analogous to what’s happening with inflation in America right now; first, lumber prices went up daily, jacking up real estate prices around the country, but has since retraced the whole move up. Recently, used cars prices exceeded new automobiles, fresh from the lot, but they’ll sort itself out… after that, something else will come along, but they’re all originating from the shutdown of the economy; what’s going to remain much more permanent are rising wages and rising consumer prices! These are staying, as they are.

It’s a big mess, a transitory chaos, but just like an apartment building under renovation, it can experience delays and hiccups.

Therefore, understand that in the big picture, the Federal Reserve is right and wrong {the FED chooses to simplify its message, in order to keep markets running smoothly}: There’s no fundamental reason that inflation will rocket higher ceaslessly in a developed economy, but also understand that they cannot foresee delays that are out of their control.

To limit exposure, if you’re worried, have more cash on hand. On the other hand, to capitalize on this, know that green pastures lay on the other side.

This uncertainty has driven speculators away, so there will always be opportunities within this chaos and we find them.

Best Regards,

Lior Gantz
President, WealthResearchGroup.com