Betas and definition of risk:

Although I disagree with the use of betas to identify the level of risk an investment carries, it is understandable. At bottom using betas as a gauge of risk says your’ definition of risk is volatility. This fits with the reasoning that the more uncertain a future benefit is the more risk it carries and the more it should be discounted today, which is correct. The issue becomes whether variance or volatility and uncertainty are the same thing. The answer is inseparable from your investment time horizon. If for example you had a strong conviction that the competitive strengths of an investment would produce a very good return over the next 10 years, but there could very well be a terrible two or three years during that time (and maybe that’s the case at time of purchase which makes the price appealing), if your horizon was 10 years, you don’t care about the volatility, because you feel there is a high degree of certainty that it will perform well over your ownership period. If, however, your time window was 6 months, volatility would more equate to uncertainty. This concept has similarities to the concept of “probability as a limit” or “relative frequency”. The probability of rolling a 3 on a six sided die is 1 in 6 or 16.6%. It is however possible to roll a die 20 times and not get a 3 once. But eventually, as more and more rolls are made the probability of 1 in 6 will take affect. If the time horizon was 3 rolls, the volatility would dictate your level of certainty, however if the time horizon was 200 rolls, the degree of certainty would be less affected by variance.

Real estate is local. This means that the national trend can be doing one thing while certain cities are doing the opposite. Multifamily sector health is largely driven by job growth and some cities are better at attracting jobs than others. This is the dynamic behind a recent article in The Economist title: ” The Recovery: Still Patchy” (click here for the full article: http://www.economist.com/node/17906059?story_id=17906059&CFID=153908198&CFTOKEN=72312851 )

One of the elements that we look for in a market during the initial high level review is the education of the workforce. This is referenced in the Economist article stating that those cities with a higher education workforce have lower unemployment since college educated workers have lost fewer jobs that non-college educated workers. This is also appealing to potential new employers who may be looking for a more advantageous place to relocate their business or start their business since it gives them a better qualified labor pool. A good example of this is Little Rock, AR where we have a 126 unit property under contract to purchase. Little Rock has 38.2%  of its population (over the age of 25) with a bachelor’s degree whereas the average for the US is 27.5% and Little Rock’s unemployment rate is 6.6% versus the national average of 9.4%.

Wise location decisions are important to successful real estate investments in both good economies and bad…so don’t forget that when things are recovering and looking rosy!

A recent article by Multi Housing News discusses a very important trend in the housing markets across the nation… a coming under supply. I talked months past about a “perfect storm” that was shaping up that could make mutlifamily investments that were bought right do very very well. The three main converging winds were the echo boomer demographics, the recession choking out new construction, and the flight from homeownership to renting (both voluntary and involuntary). Here’s an excerpt from the article. Click here for the full version:

http://www.multihousingnews.com/news/national/special-report-apartment-construction-is-inadequate-to-meet-growing-demand/?utm_source=WhatCountsEmail&utm_medium=Daily+News&utm_campaign=Daily

NAHB projects that job growth may now be finally sustainable and will reach a “decent level” of 200,000 to 250,000 per month by the end of 2012. That is presumably when demand for rentals will become even more intense. However, even if banks return to the market today, developers may not produce apartments in time to meet the demands of the much stronger market. “We would love to build more,” says McGlaughlin. However, in Avalon Bay’s classically supply-constrained coastal markets, it takes more time to get developments off the ground. “Even if we start today, we will not deliver the units in 2012, 2013, when demand heats up.” In effect, a severe apartment shortage in 2012 and 2013, at least in some markets, could be assured.

“There is a huge supply of end users coming” to the market, agrees Jacobson. Jacobson says what scares him the most is that the continuing dearth of jobs may constrain many people’s ability in the future to pay for housing–either rentals or homes

By Greg Picone:

While betting against the US economy has never proved to be a wise move, there is legitimate concern over the current economic policies that we are using, namely increasing the money supply as much as we have and continue to. While I don’t believe that our currency will collapse, these are good reasons to consider owning hard assets that will do better then paper money in inflationary times. Needs-based commercial real estate (apartments) is one of those hard assets that should do well against inflation and is able to be valued based on it’s net operating income.

Here is an interesting snapshot of 5 failed currencies in the recent past:

http://www.investopedia.com/slide-show/5-failed-currencies-why-they-crashed?partner=basics12

The spill in the gulf could wind up being the biggest in U.S. history. Now there is a website with a live feed where you can watch the oil come shooting out of it’s casing and into the ocean. You can just watch millions of dollars of oil being lost while it’s simultaneously causing millions of dollars in damage.

The nature of sitting back and watching it happen live makes you ask the question why can’t it be stopped. In thinking about this, there are two basic reasons: 1- inaccessibility and 2- foreign environment. Simple but true and this has a lot to do with building wealth…

1-      Inaccessibility. The break is about 1 mile below the ocean’s surface. This is a very challenging area. People can’t just dive down there and mend the break. Pressures at that depth would be over 2,000 pounds per sq. in. and would crush a human.  This makes for a place that’s difficult to get to. This is also the case with certain investments, they are inaccessible to those who have not specialized in that specific arena. Everyone has their niche, their focus, their own business, etc. While you can’t know everything about everything, you can know others whose expertise you can leverage and benefit from. This opens up possible investment opportunities that would otherwise be closed.

2-      Foreign Environment. This level of the ocean in largely an unknown. You may disagree, but this is why the attempt to correct the problem by placing an oil catching dome above the leak failed. They placed the dome and there was an unexpected build up of icy gas hydrates that prevented a seal. It was unexpected because the environment is largely unfamiliar. This also is instructional in wealth building. Straying outside of your area of understanding can lead to undesirable results. Real estate is no different. It’s actually a fairly illiquid investment, which does not lend itself to incompetence. We’ve watched those who did not gain the proper expertise and give their investments the attention they needed, wind up becoming the motivated sellers that provide opportunities to those who are prepared.

Much like the oil spill, inability to act on an opportunity equals value slipping away. The remedy is to engage those who you can leverage…

Is inflation coming? I think the better question is can you increase the money supply as much as we have and as fast as we have and not have inflation.

Recently an article was published by investopedia and the author suggested three ways to protect yourself against inflation. They were:
1. Invest in stocks
2. Invest in real estate (he referring specifically to a primary residence)
3. Invest in yourself
The article was fairly general, but worth a few minutes: http://www.investopedia.com/articles/basics/10/protect-yourself-from-inflation.asp?partner=basics4

Inflation, on a personal level, is ok, as long as your assets and income are increasing faster than your liabilities. I call this fixing vs. floating…
If you’ve ever gone clamming or hunting for muscles in the mud flats at low tide, you know that you want to be careful not to be alone and get stuck in the mud when the tide starts coming in. Let’s make believe that two guys had to stay out there overnight. One guy was standing in a little rowboat on the mud and right next to him was another guy, without a boat, stuck in mud up to his shins. These guys have a good time carrying on conversation and laughing for several hours, until the tide starting coming back in. The water didn’t bother the first guy in the boat, he just simply kept rising along with it. The other guy, however, well, it was bad news for him!
This is a picture story of inflation. The key is to pile your assets and income in the boat so they rise with the tide, and let you liabilities get stuck in the mud. This is why seniors get hurt so much during inflationary periods, there income is fixed in the mud and their liabilities (cost of living) is floating up on the boat. Float your assets and fix your liabilities.

One asset that floats well is real estate. An asset that does not float well is savings. I particularly like that the author of the article I mentioned said that investing in yourself in an important inflation hedge. This is true because if you don’t gain more understanding, you’ll be prone to believe that savings is an investment strategy and be like the 2nd guy that was having a good time until the water quietly reached his nose.

Imagine a primitive people long ago who lived in a village called Bubbleville. Bubbleville was primarily a meritocracy and its citizens all earned different incomes and had different credit ratings based on their merits and work ethics. Only about 65% of the residents of Bubbleville owned their own huts, the rest were renting.

One day, the congress of Bubbleville, decided that they didn’t think it was fair that 35% of its citizens didn’t own a hut like the majority did, so they met with the village’s main money lenders and asked them to lend to the Bubbleheads that were deprived of hut ownership. A couple of the money lenders thought that might not be a good idea since those Bubbleheads that didn’t own their hut, for the most part, didn’t have enough income to afford it or couldn’t prove that they were good at paying money back, but if all the other money lenders were going to do it, they would either have to as well or lose market share!

Soon, many more Bubbleheads owned huts, and not just plain, thatch roofed huts—no, large 5,000 sq. ft. huts with imported exotic dirt floors and 5 piece firepits.  As a result, many huts grew quickly in price (not value), until one day when both the lenders and the Bubbleheads realized that the payments could not be made on all those newly owned huts and their plan B–selling the huts since prices were going up– was no longer an option.

Soon every other hut had a foreclosed sign on it. Now the Bubbleheads were mad at the money lenders, the money lenders were mad at the Bubbleheads and congress, and congress was mad at another village entirely, but no one could figure out what they had to do with anything.

In reality there were many things that contributed to the Great Recession, but the housing problems really do have roots in simple mistakes. Former Federal Reserve Chairman, Alan Greenspan, recently testified to the newly created Financial Crisis inquiry Committee on April 8^th stating:  “I mean, I sat through meeting after meeting in which the pressures on the Federal Reserve—and on, I might add, all of the other regulatory agencies—to enhance lending were remarkable.”

What does this mean for you? There are certain types of opportunities that only present themselves with the types of economic problems we’re experiencing right now. Exciting real estate opportunities are surfacing. It would be wise to disconnect from mass media (that helped promote the bubble when astute investors should have been selling) and gain knowledge on how to participate. But remember, knowledge is not power, the application of knowledge is.

A “perfect storm” refers to a rare set of circumstances that come together to produce an unusual result. The term originated after severe storm in 1991 when 3 ingredients came together:

1. warm air from a low-pressure system coming from one direction,
2. a flow of cool and dry air generated by high-pressure from another direction, and
3. tropical moisture provided by another storm

Where am I going with this?? There’s a similar economic perfect storm happening that will benefit multi family.

We like the essential aspect of multifamily, meaning that it’s primarily a needs based business, which are the businesses that remain strong in times of economic instability.  BUT, in addition, much like the unusual hurricane that formed in 1991, there are 3 ingredients that are all coming together NOW for multi family:

1. The Housing Crisis: According to the Wall Street Journal article from May 10, 2010,  millions of former homeowners are becoming renters again after losing their houses.
2. The Great Recession:  Depressed operations have limited new supply. According to Marcus and Millichap Research Services: “in 2010, only 1 apartment will be built for every 15 people entering the prime renter demographic, aged 20-34, compared to an average ratio of 2.6 people for every apartment in the first half of this decade”
3. The Echo Boom: In the late 1980’s, for the first time since 1964, we surpassed 4.16 million live births. If you’re not aware, 1964 was the baby boom- a huge demographic swell that has driven the economy. Now the echo boom has repeated it and these people are hitting the prime renter age!

We’re experiencing the definition I mentioned at the start: A rare set of circumstances that come together to produce an unusual result. Now, a catalyst that will speed things up is household formations. Ideal capital Investments is positioning…provided you buy wisely, this could be a great time for multifamily!