As we look at making deals late in this expansion phase, I have been doing a lot of thinking about what, exactly, we risk by buying high.
After all, we are (effectively) permanent holders, so it’s not exactly clear why we should care about prices going down after we acquire an asset.
But I am uneasy, and so I am trying to get at the source of my discomfort.
Forgive the disorganized nature of this post… as you can see, I’m working this stuff out in real time:
| Fear | Why? | Why not? |
| Reputational costs of missing on rents | A big part of our credibility comes from ALWAYS delivering the rents we have promised. | Investors are adults who understand that there are things the sponsor can’t control, with the rental market being A or A1 on that list. |
| Opportunity cost of buying high | If we buy high and prices decline, our investors might be less willing to capitalize us to buy low later, when there are better opportunities. | When prices are low again, our projects will look even better, and, as long as we’ve behaved honestly and executed well, investors will stick with us. |
| Reduced refi proceeds upon stabilization depressing levered yields | Decreasing prices (eg increasing cap rates) will cut into our ability to pull capital out via refinance, making our deals worse. | Our refi proceeds are most often limited by our own willingness to accept high leverage. In a market with depressed pricing, we would accept higher leverage, because we’d be confident prices / rents would eventually increase. |
| Effect of reduced rent on yields | The rental market is pretty hot right now. If rents cool off, our projects will be less likely to deliver the yields we’ve forecast. | Our rent projections are generally pretty conservative. And, even if we miss (there’s always a first time!), the resulting yields won’t be too bad… while a 5.5% is worse than a 6.5% (obviously), rents in LA go up over time, so yields will improve. |