5 Predictions for 2017: The Shifting of The Commercial Real Estate Landscape

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Nobody ever met an economist who made an accurate prediction—but they still get paid to make predictions.

Same thing in real estate. Appraisers generally don’t own any real estate, nor are they wealthy people.

So why do so many people rely on them for valuing real assets?

Now, you may be asking why I would want to put myself into the same aforementioned groups by crafting my predictions for the New Year.

To prove a point. That my view of the world – as cynical and as paranoid as I am – is much different than that of a paid cheerleader.

Now, what does that mean?

It means that I have to be really meaningful and thoughtful about how I look at the year ahead. As a capital allocator, I don’t get paid to make mistakes. That’s what weathermen do.

I am responsible for people’s life savings.

So here are some of the financially-oriented predictions I am taking from my annual letter to investors that we are sending out this week – for you, my loyal readers. And in case you’re wondering what my track record is for such prognostications, you can see what I did here

1. Make America Buy More Stuff

By and large, American’s are buying more stuff. They feel happier and wealthier.

Their 401(k)’s have had a nice shot in the arm approaching the storied 20,000 on the Dow Industrials. President-elect Donald J. Trump’s unlikely rise to power is providing a shot in the arm for global financial markets, with stocks and commodities rallying on optimism that his fiscal-stimulus plans will boost the global economy.

Even before his inauguration, Trump has already strong-armed several companies to keep their manufacturing in the United States, making the first time any president elect has done something of the such since NAFTA was introduced in 1993.

As America wins, so America buys. It’s in our DNA.

2. IPOs Will Make A Comeback. Bigly.

Largely due to a several year’s worth of red tape and prohibitive regulatory landscape, IPOs will make come back under a Trump administration.

In Silicon Valley, the pressure is palpable. You can cut it with a knife. Private equity and venture capital investors have been waiting to get taken out of their deals for years; you can actually count the number of IPOs that were executed last year on both hands.

And when that happens, you can bet that those outsized, made up valuations may actually hold true as the demand is so pent up, using the recent, post-election stock market as a proxy.

Whether or not those valuations are justified is a whole different conversation altogether; keep in mind, stock market values, as evidenced since the election are emotionally driven.

A key driver for this is likely to also be the addition of some Wall Street dealmakers to the Trump Administration’s cabinet such as Jay Clayton whose bio can be seen here.

America wins again. Open the capital markets and jobs and prosperity will flow to the middle class.

However, please heed this advice from a talk I gave to a major publication a while back before you bet the farm on any companies going public on their IPO day:

A company preparing to go public can best be compared to a
bride on her (first) wedding day. 

A company is cutting expenses, a bride is sucking weight like a high school
wrestler. 

A company is getting leaner generating profits, a bride is training like a
Pilipino boxer. 

The company uses some creative accounting to hide some losses, a bride uses
layers of veneers to cover up her blemishes and imperfections. 

The company hires expensive lawyers and investment bankers, a bride
purchases the best couture she can afford… 

The company will never be as highly valued, or the bride as beautiful, on
their respective special day debut. 

Why anyone would want to buy a company so richly valued and dressed up is
ridiculous on the IPO day is financial ignorance at best. 

If you think you’ll always remember this analogy next time someone tells you
about a hot IPO.

For real estate, raising funds and entity-level investments may become easier to do.

3. Many State Pension Funds Will Go Broke, Followed By A Witch Hunt For Pension Fraud

Over the course of this past summer, many cops in Dallas – and throughout the country for that matter – handed in their resignations.

And, we’ve been talking about here for a while, this placed an incredible burden on all respective pensions as many beneficiaries at once wanted to cash in their chips.

Now, this wouldn’t be an issue if these pensions were fully funded; however, perpetually low interest rates at 1% or 0% – over the past 15 years or so – have made these pensions insolvent. Sure, there will be calls for government bailouts, but that is not likely to happen.

There will be painful cuts and promises will be broken.

The long term of upside of this: real estate will probably be widely viewed as a more mainstream investment class as compared to stocks and bonds in the future.

(NOTE: Raising capital for your deals? Download a free resource for raising millions for all your real estate deals with a “Wall Street” grade, done for you investor Pitchbook. Grab it here.)

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4. Commercial Will Get Stressed.

Buyers who have been pouring in over the past few years have bid up commercial income assets to nosebleed levels. You can thank that to that a multi-year run of near 0% interest rates that have driven commercial real estate soaring.

There is no reason to pay a 4% cap for a self-storage facility in Laredo, Texas. To get out of it or to refinance it you would have to sell at a higher price – meaning a cap rate lower than 4%.

No reason to buy Class B multi-family at a 5% cap either.

However, those buyers who did buy probably did because:

  1. They had nowhere else to place their cash, and since the risk-free rate has been around 0%, this would make sense.
  2. They were just inexperienced, emotionally-driven buyers who had access to funding (i.e.: doctors and dentists).

Another phenomenon has been that there has been a surge in new multi-family supply that has been driving down rents.

You may be old enough to remember that last time this much supply came on the market was during the late 80s.

Which was followed by the RTC in the early 90s…

Now it’s important to understand that the driver behind what happened way back then was the curse of the real estate cycle. Savings and loans lent money to developers who go their plans approved in up cycles. Only to have all of their newly developed product brought on line and delivered during a down market cycle.

And if you overpay for something, that makes your debt payment higher. And we’re already seeing evidence of that here. And no, you can’t just hike the rent up 10% per year as most tenants in most cities already spend close to 50% of the after-tax income on housing.

So the debt will be stressed, the equity investors will really be stressed as these weak and inexperienced operators are forced to sell at distressed levels.

Let us not forget the political winds are at the backs of the opportunistically-driven investors as Donald Trump’s pick for Treasury Secretary, Steven Mnuchin, has been himself a distressed debt investor as evidenced here.

Many bet that he will not allow the banks to “reset” themselves like the Obama administration did in 2010 and will force them to purge themselves of bad assets.

5. Many Lower-End Restaurants and Hotels Will Go Out Of Business

Restaurants are a tough business and have traditionally operated on very thin margins.

Now with the minimum wage hike that starts to take affect this year at the state level, many restaurants states such as California will probably be forced to close.

Math is math, and when it comes to minimum wage, just a $1 per hour minimum wage increase can reduce an independent restaurant’s already thin profit margins by $20,000, or 10%.  So we imagine the $5 minimum wage hike that California just passed is probably slightly less than optimal for companies in California.

Unfortunately for all restaurateurs, as the Wall Street Journal recently pointed out, California hardly alone in their implementation of a massive minimum wage hike in 2017.

Meanwhile, when it comes to Obamacare, these restaurants were also hit with an incremental $72,000 of annual expenses in 2015 that didn’t exist in 2012, which eroded another ~30% of the average company’s peak net income.

Hotels to the uninformed and inexperienced are seen as real estate plays.

But they are really operating companies. With operating-like expenses. Like staff that require Obamacare and perhaps and an increase in minimum wage.

Not to mention, Airbnb is a major factor in several urban and resort markets, and is a major factor in several urban and resort markets. The industry tries to make believe Airbnb is not an issue, but that is a lie. On citywide sell out nights it is a big restraint on ADR. When the Pope was in New York there were 20,000 Airbnb rooms sold and there were empty rooms in some hotels.

And hotels are a whole different animal for another blog post later on.

 

If you hate these predictions, then you’ll absolutely love my book.

Until next time.

(NOTE: Don’t forget to download your free resource for raising millions in capital for all your real estate deals with a “Wall Street” grade, done for you investor Pitchbook. Grab it here.)

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Salvatore M. Buscemi
A former investment banker for Goldman Sachs in NYC, Sal is one of the nation’s leading authorities when it comes to investing in residential and commercial real estate. He’s raised over $50 Million in capital for his real estate hedge funds.

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Salvatore M. Buscemi

About Salvatore M. Buscemi

A former investment banker for Goldman Sachs in NYC, Sal is one of the nation’s leading authorities when it comes to investing in residential and commercial real estate. He’s raised over $50 Million in capital for his real estate hedge funds.
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