Income Fund Update - Q1 2023
Hello Partners,
Hope this update finds you well.
The average distribution yield for 2023 YTD is 8.0%.
Below are the Q1 returns for the Income Fund.
As of today, publicly traded REITs are discounted significantly relative to their historical earnings multiples and private market values.
The below chart helps demonstrate the lead / lag dynamic between REITs and private RE values.
Short term predictions are fairly useless in public markets, but the interest rate forward curve suggests these lines will probably meet somewhere in the middle over the next year.
Blackstone - the largest owner of private real estate seems to agree. Their president Jon Gray on a recent quarterly earnings call:
“The best opportunities today are clearly in the public markets and that’s where we’re spending a lot of time.”
Banking Implications on Real Estate
It’s interesting to think through the 2nd order effects the regional banking distress, along with stricter regulations imposed by financial regulators.
Decreased loan liquidity will benefit the largest, best capitalized buyers that have alternative options for financing. They will use that as an acquisitions weapon to win more deals from smaller, less established operators.
When capital is cheap and abundant, everyone and their brother has a new RE fund and can compete for great assets.
The best part about being an investment grade, publicly traded REIT is the ability quickly issue unsecured debt and equity at stellar terms. As noted in prior updates, REITs (excluding office) have record strong balance sheets and are well positioned for this next real estate cycle.
After wrapping up Q1 earning calls, it’s clear that REIT Management teams are excited by the opportunity to flex that strength via new acquisitions over the next few years.
This is especially true for the most disciplined capital allocators that “went to the beach” in 2021 when only the most aggressive + over-leveraged buyers were winning deals.
CRE Mortgage Market
The below is CRE loan exposure by property type.
Office loans dominate the headlines, but actually make up only 16.7% of all CRE loans. Plenty of office loans will default, but that could take years given their staggered maturity dates (~$180B mature this year).
In other words, office loans are a major headache for some regional lenders (who don’t want the keys back), but a rounding error vs. the overall banking system. These loans are not a systemic issue / will not cause another 2008 credit crisis.
Multifamily loans are the most significant exposure at 44%. But apartments fundamentals are still solid and there is a deep sea of capital (both debt and equity) ready to step and take over any loan workouts. Unlike office, some lenders will be thrilled to get the keys back on 2020/2021 apartment purchases.
Parting Economic Thought
Plenty of TV “economists” are saying we’ll see a hard landing any minute now.
We’ll see, but I’m not confident in either direction. I’ve certainly never seen a recession look like this. We have a stubbornly strong job market and there is still a lot of extra cash sloshing around in the economy.
Obviously this can change quickly if unemployment spikes. Hard or soft landing, it’s good to remember that the stock market is forward looking (12+ months) and that our portfolio is geared towards high cash flowing assets which tend to outperform during recessionary periods.
That may mean we leave a little on the table this year if the Fed gets overly aggressive on rate cuts into economic weakness. Reason being - the most cyclical, highly levered REITs would likely recover faster than our higher quality holdings. However, I’m comfortable with that tradeoff and remain focused on long-term earnings power.
Housekeeping
The audit from Spicer Jefferies was recently finalized. Once again, it was clean. The fund admin has uploaded it to the Portal (if you’d like to review).
Thank you,
Brad Johnson
Evergreen Capital