Wayne Gretsky, the famous ice hockey player once said, “I skate to where the puck is going to be, not where it has been.” Investors, have a lot on our minds; where will interest rates go, will our tenants pay, will the economy hold up, etc. While there are many cross currents to consider with any given decision, a significant challenge for investors is making correct assumptions about the impact of changing variables and determining the proper course of action based on the perceived impact of the sum of those variables.
When investing, making decisions based on recent experiences (think 5-10 years), and extrapolating those experiences into the future anticipating the environment will remain the same, or at least rhyme, is a classic and sometimes catastrophic mistake.
Let’s examine several scenarios that could influence real-estate going forward, and specifically the value of syndicated Self-Storage assets. You be the judge of their individual and collective impact.
First scenario: interest rates will rise. If there was one aspect of the economy that characterized the 1970s, it was inflation. Persistent for most of the decade, it choked off much of the growth in our nation’s businesses. Paul Volker, then the chairman of the Federal Reserve, had to eventually take decisive action and raise the Fed Funds rate to near 20 percent to “slay the inflationary dragon.” Money tightened, interest rates spiked, and homeowners with adjustable-rate mortgages (ARMs) were jammed as their mortgage payments shot higher. The recession began as unemployment peaked above 10 percent due to restrictive Fed policy. Thankfully, it worked. From 1980-1983, inflation dropped from above 13 percent to under four. It seems plausible, we are entering a secular trend of rising interest rates and governmental protectionism. Whatever your investment philosophy, it should accommodate a much higher cost of capital. As an investor looking at various syndications, make sure the sponsor is running a multi – scenario analysis and ask to see the results of those analyses.
Second scenario: 401(k) plans become fascinated with Real-Estate that can increase its Net Operating Income. Last summer the Department of Labor (DOL) made a change to how retirement plan administrators (think 401(k) and 403(b) plans) can invest the assets they manage in their target-date retirement funds. To affirm this, take a moment to do an internet search for “US Department of Labor Information Letter On Private Equity Investments”. Retirement plan administrators are now permitted to invest a reasonable amount of the assets in their target-date funds in private investments such as syndicated Self-Storage. These are fantastic options due to the cumulative preferred returns, as well as the increase in the assets value due to the building of additional net rentable square feet at the property thereby increasing the Net Operating Income. NOI / Cap Rate = the increase of market value. Frequently, when syndicating small market (below 50mm purchase price) self-storage the Value-Add deals could have equity multiples is north of 1.75 x in 4-5 years. Investors with 401k plans that are interested in real estate investments should ask their advisors about options they may have. Investors in traditional 401ks that don’t offer the opportunity to invest in self-storage syndications could opt to move their funds to a self-directed IRA with additional control by the individual investor.
Third scenario: tax rates on stock dividends go up causing common stockholders to look elsewhere for yield. This scenario is subjective based on a specific household’s income and filing status, but it is plausible that legislation is rolled out which will bring a higher tax rate on dividends paid by common stocks. An advantage that all real estate investments can provide is depreciation and particularly self-storage is well placed to offer significant depreciation benefits. In addition, there is the bonus depreciation received by LP members in a syndicated self-storage asset may neutralizes the passive income earned by the investment. Overall, comparing apples to apples this may cause syndicated self-storage to become incrementally more attractive to investors. That is not to say it is the end all be all answer, as there are a variety of issues to weigh such as liquidity, position sizing, credit quality etc. Investors, inquiry with your sponsors about whether they do cost segmentations. If they don’t, you’re missing out.
As investors weigh risk and reward, remember a few core tenants of investing. The reward you seek should be totally commensurate with the risk you are willing to take, and to reduce your risk you should diversify. Secondly, don’t assume the environment that you are in will continue forever. Trends change, interest rate environments change and everything cycles. Best to you as you evaluate the opportunities that lie ahead. Thirdly, always do your due diligence on both the deal and the sponsor.
Ted Greene is a third-generation Seattleite who married his high school sweetheart. Ted and Melissa have two children attending the same High School where they first met. After graduating from Seattle Pacific University with a BA in Finance Ted spent 24 years in the financial services industry as an investment advisor and Fiduciary.
Scott Lewis is the co-founder and Chief Executive Officer of Spartan Investment Group, LLC (SIG). To date SIG operates over 5500 storage units, 200 RV pads, has completed $11M in development projects, has $115M more underway, and has raised over $42M in private equity. As the CEO, Scott is responsible for the strategic direction of the company and ensuring it aligns with SIG’s mission to Improve Lives Through Real Estate. In addition to Spartan, Scott is also in the US Army Reserves and a combat Vet. Scott graduated from Michigan State University with degrees in Chemistry and Marketing, from Catholic University with a MS in Management, and from Georgetown University with a Certificate in Project Management.
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