March 1, 2019
March 2019 Market Commentary
Gary Cooper has left the building.
When we last left, our hero Gary Cooper (Jerome Powell) was about to face down the local criminal Frank Miller (interest rates). But then something happened. Gary/Jerome Powell decided he did not want to fight and turn and ran.
It looks like High Noon will have to wait.
What we thought was going to be a steady rate increase has turned into “just kidding” by the Fed.
This will just delay the inevitable “adjustment” in values and coming equity disruption, but for now we are stuck at 11:59am for the foreseeable future.
Prior to Powell hitting the brakes, we were expecting four rate hikes in 2019. We now foresee one or even none.
You will not hear us say:
- This is a new paradigm, or
- It’s different this time
Although we can’t fight the Fed, we can structure around the current environment to provide investors defensive, attractive risk adjusted returns.
So, what happens now? Fast facts:
- Investors continue to over pay for cash flow
- Banks are healthy and for the most part disciplined. They are not and will not be the problem.
- Cap rates have not gone up, but NOI growth has slowed down and loan proceeds from real lenders are shrinking. Many investors are not happy with the equity markets, fixed income returns, or the political environment.
- The lowering of loan proceeds is causing transactions to require more equity
- The equity demand is being met, but only via aggressive equity underwriting (low cap rates) which JCR will not participate in
Overall the debt market is healthy. Bank, insurance, GSE and CMBS lenders are not chasing loans to the bottom. They are holding the line on credit and proceeds.
In fact, loan proceeds are actually declining because they are debt service coverage constrained.
The last two real estate melt downs, the S&L crisis and 2008 mortgage crisis, were caused by over aggressive first trust lenders and senior debt defaults. That will not happen this time.
Most of the risk lies in this sector:
- Rising interest rates (costs)
- Flat or lower cash flow
- Less loan proceeds
- The risk of cap rate expansion
All will lead to stress on equity investors’ legacy investments and make new equity deployment more challenging.
JCR Capital Approach:
- It’s time to keep defensive and not let our guard down. Thus, we are focusing on:
- Preferred equity investments vs. joint venture investments
- Making sure we have a diversified portfolio
- Sticking to our principals on structuring
- Accepting lower returns, if needed, on transactions we really like and where we are principal protected
- Preparing for distress in the equity portion of the capital stack by having dry powder ready for when this market turns
- Staying in the middle market, which always has unique opportunities