BFP Management Blog

Maintaining Your ‘Value Investments’

My opinion about the Southern California real estate market hasn’t changed much over the last 3 years as there is little value for an investor to purchase at current prices.  Inventory of unsold properties is increasing while interest rates continue to move higher.  I believe that the only way that we won’t see significant price reductions (ignoring the prognostications of both the National Association of Realtors and the California Association of Realtors) is if we have a large rise in wage growth.  Over the last several years, more than 70% of local purchases were made using adjustable rate mortgages (or short-term fixed loans that will float adjustable after 3 or 5 years) and this might well cause large portfolios of debt and the properties they secure to go back to the bank.

In the commercial sector, the flow of funds into real estate has been enormous and the allure of converting apartments to condominiums has caused capitalization rates to fall below interest rates.  I believe this trend to be unsustainable and thusly temporary.

Beach Front has continued to be cautious when others are aggressive in the same contrarian manner that we were aggressive when others were cautious.  Our purchases have always been made as “value investments” and not based on predicting market fluctuations whereby we’d be happy owning even if the resale market were closed for ten years.  I’m very patient (as evidenced by this long dry spell) and am waiting until solid opportunities come along before actively investing again.

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The Broader Real Estate Perspective

Instead of continuing my prediction of the correction in the real estate market that doesn’t want to come, I will say that fundamentals remain unfavorable for value investors and we are comfortable with our position on the sideline. I can’t remember what precipitated the dot.com correction but I remember the fall-out for those who invested on the sole bet of appreciation. The sky will fall when it falls. . .

I’m in the process of educating myself on the intricacies of other real estate asset classes, focusing mainly on mobile home parks. I’ve traveled to Georgia, Texas and Oklahoma and while I’d like to think that I’ve found something that other real estate investors have overlooked, it appears that there is plenty of equity chasing deals in “everything real estate.” Before syndicating any deals in a new asset class, we would make the initial purchases ourselves so that we could beta-test. So far however, I haven’t found anything worth purchasing.
In my February letter, I introduced a market that we had just visited, Berlin, Germany. We initially looked at doing a joint venture with a Berlin based developer. We opted against the venture with him as he wanted to buy a billion dollars worth of real estate throughout Germany right away much like large funds managed by George Soros, Cerberus and Blackstone are doing as a macro-play. Instead, we opted for a smaller and more focused approach on apartment properties in Berlin like we did in Southern California and Shanghai. This investment won’t be without risk as Germany is suffering from the worst recession since World War II and is in dire need of structural economic change. Thusly, the real estate market has suffered and we see this as a contrarian investment with large upside if/when Germany makes the needed changes.

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