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What happens when trillions of dollars move from being an ASSET to a LIABILITY?
I am talking about REAL ESTATE. An asset class people & pension funds believe to be ‘low-risk’, ‘conservative’ and have strong cash flows in perpetuity.
A never lose investment.
But what if something else was brewing beneath the surface, that you and I and Harvard’s endowment fund couldn’t fully see coming?
Let’s ask an even deeper question: What happens when YOU hold the liability on that asset which is now becoming a liability in itself?
For the next two weeks I will cover REAL ESTATE in a 2-part series:
Physical Real Estate 👉 Dead Zones & Makeovers
Digital Real Estate 👉 Property Technology (PropTech)
This week, let’s breakdown Physical Real Estate in <5 mins:
Bonds ‘Holding the Bag’ 😳
Bad vs Good 🕵️♀️
Physical to Digital 📲
Let’s get started!
1. Bonds ‘Holding the Bag’
Remember the scene in The Big Short when homeowners are defaulting on their mortgages yet the ‘Credit Default Swaps’ that Michael Burry, Steve Carell and Brad Pitt hold don’t reflect this?
Some are saying a version of this is happening with Commercial Real Estate.
Except, it’s the central banks printing endless money rather than the rating agencies covering up the value deterioration and heightened risk.
For now cheap money has lent a lifeline to the commercial real estate sector. But the can cannot be kicked down the road indefinitely.
And indeed cracks are starting to show.
First, the Junk Bond market (which contains many REITs) is starting to look like a ticking time bomb!
Second, two large REITs declared bankruptcy in 2020 on the same day – a historical first.
Commercial real estate is a $20 trillion dollar market in North America and banks have big exposure.
Specifically small banks, they have 4x more exposure and far less resiliency. What could go wrong?
But let’s remember, that great wealth transfers happen in times of turbulence.
If Baron Rothschild who famously said — "the time to buy is when there's blood in the streets.” — were alive today, I would ask him:
What if people don’t go out in the streets anymore?
Today, they don’t go out because of COVID. But tomorrow they might not go because as the cost of delivering pizza via drone drops to $0.25 a trip — Why go anywhere?
Let’s go through each of the Brick & Mortar segments and do a quick BAD vs GOOD analysis.
2. BRICK & MORTAR
Office Space (BAD)
No-one knows exactly what % of people are going back to work in an office. But it will definitely not be 100%.
The MATH doesn’t make sense.
From a time & money perspective, it’s a low to negative ROI proposition:
Employee time: Remote gives employees back 2 weeks per year in commute times. Add another 2 weeks for ‘getting ready’ and we’ve just bought back 1/12 of the year.
Brain Power: Commuting to work expends mental effort that could be used to solve bigger problems. There’s a reason Jeff Bezos holds his most important meetings at 10am. That is when our mind is the sharpest.
Company Expenses: “On average, companies in major cities spend $1-2k per month to keep their employees at a desk in an office. Imagine what they could do with +$24k per person per year”
Environment: “If just 50% of workers returned to offices, traffic in cities would be eased and employees’ quality of life would be improved.” – Blackrock. COVID has been a natures paradise with clear skies seen from space and animals revenging by roaming the streets.
It seems unjustifiable to send everyone back and experts don’t think we will.
On a positive note, exciting times ahead with the re-invention of the workplace. The recent takeout of Slack, the leader in remote team communication, was one of largest ever for the software industry. This should tell you something about the trend!
Next week, I will discuss tools gaining traction like Virtual Offices.
Financial Institutions (BAD)
Fancy bank branches in fancy parts of town are a dinosaur concept.
Younger generations, who will one day hold all the wealth (millennials & GenZ), don’t want to talk to anyone to do their banking let alone go into a physical location.
Branches account for a large part of banks’ operating costs, rendering their customer acquisition cost (CAC) significantly higher than their FinTech competitors.
The trend of closing bank branches had already begun pre-COVID. I expect this trend to accelerate over the next few years. Banks will break leases and offload corporate owned real estate.
Retail (BAD)
The U.S has 10x the retail square footage footprint than the rest of the world.
With COVID accelerating eCommerce which is expected to reach 60% of retail by 2025 — there is trillions of dollars in physical retail at risk.
In December I wrote an entire newsletter on eCommerce. Since then, I have already seen some of my predictions about the re-purposing of malls play out:
Malls becoming Warehouses:
Malls becoming Affordable Housing:
Malls becoming eSports Centres:
The good news is, “one man’s trash is another man’s treasure”
Great innovation can be born from dire circumstances. For example, Tesla’s first plant in California was bought from GM for a bargain price just after the financial crisis.
Schools (BAD)
A 60 year old university in Canada has filed for creditor protection. It owes +$90MM to 3 of the country’s top banks.
Virtual schools with significantly lower operating costs have a bright future. EdTech is still in its infancy with only 5% market penetration.
Major disruption is coming here.
Movie Theatres (BAD)
Attendance has been trending down for years (peaked in 2002) and theatres had offset this by jacking ticket prices 50%.
Now, because of COVID and the adoption of streaming, they are increasingly losing their theatrical release moat with Hollywood studios.
Although AMC, the world’s largest movie theatre chain, did just get thrown a 6 month lifeline raising +$900MM, it still has +$5B in debt and burning $400MM/quarter. Looking grim!
I think movie theatres to a large extent will suffer the same faith as movie rental stores.
Blockbuster is a classic case study. In 1999, the world’s largest chain of video rental stores did an IPO to buy itself time by raising money. They could have bought Netflix for $50MM but by 2010 they filed for bankruptcy.
Last year, I was lucky enough to speak with the founder of Netflix, Reed Hastings, about this!
OTHER BAD REAL ESTATE:
Car Dealerships. “Ark Investments believes auto sales will decline by 40% over the next decade because of autonomous vehicles.”
Business Hotels (Marriott, Hilton etc).
Now let’s get into the GOOD side of Real Estate!
AirBnBs & RV’s (GOOD)
I predict business travel, especially the <3hr trips, will die a swift death and so will business hotels like Marriott, Hiltons etc – maybe not all but many.
Working from anywhere will mean more time and flexibility to travel. Which means AirBnB and luxury ‘glamping’ will continue to flourish.
Home Ownership (GOOD)
Cheap money and inflation have made people who owns homes significantly richer.
The median housing price in America is at an all-time high of +$320,000 – and showing no signs of slowing.
But for those who are saving for a down-payment the ‘American Dream’, of homeownership continues to slip out of reach.
Thankfully, Silicon Valley has spawned an entire new category of companies in Property Technology (PropTech) that aims to make home ownership more accessible (co-sharing equity risk) and more liquid. I will discus this next week!
Ghost Kitchens (GOOD)
Under utilized spaces like warehouses, restaurants and even parking lots are being turned into temporary rentable kitchens.
Giving chefs a place to cook without worrying about the dine-in portion of a brick-and-mortar location.
This is the new major trend in food.
One of the leaders in the sector, Reef, launched 2 years ago, just raised $700MM achieving unicorn status. They operate ‘ghost kitchens’ across 4,500 parking lots and reach 70% of North America’s urban population.
The former CEO of Uber and even Amazon are getting in the game!
Industrial (GOOD)
Smart money has been selling commercial REITs and buying industrial REITs. Now seen as safer yield with growth!
I have been buying a new stock in this sector this week – I reveal at the end!
OTHER GOOD REAL ESTATE:
Co-Working Spaces. Although WeWork was a fiasco I do think smaller & more nimble ones will thrive.
Retirement Homes. Although these were at hot spot for COVID outbreaks, the population is aging and many cannot afford home care. I also think we will see more FUN lifestyle retirement communities like Jimmy Buffet’s Margaritaville.
Funeral Homes/Cemeteries. Aging population/no alternatives.
Self-Storage. We have shopping & hoarding addictions.
Are you subscribed to my YouTube Channel yet?Every week I turn my newsletter into a video. Check it out here👇
Back to the newsletter…
3. PHYSICAL TO DIGITAL REAL ESTATE
This week, the world’s biggest eCommerce company, Amazon, reported its biggest quarter ever.
But that wasn’t THE STORY.
The story was that Bezos, is stepping down as CEO and choosing as his replacement Andy Jassy who leads Amazon’s most lucrative division Amazon Web Services.
AWS is the world’s largest provider of cloud computing aka DIGITAL REAL ESTATE.
I think digital real estate is going to outperform physical real estate going forward.
Bandwidth demand is exploding!
Which should bode well for Cell Towers & Data Centres – two of the industries tied to this theme.
This week, as Tech companies reported big Q4 earnings beats it became clear we are more addicted to our devices than ever before.
Earnings for Tech companies were up +21% vs +2.5% for the S&P 500 (of the companies that had reported to date).
Record amount of capital is flowing into Technology and Property Technology is a beneficiary.
Next week we will discuss this booming sector including OpenDoor & Lemonade!
How’s Grit Playing it?
Since I launched this newsletter (in Nov. 2020) I’ve highlighted a few real estate stocks. Happy to report they are all up. But please never judge my picks on a few months. These are long-term holds.
This week I started buying a position in Parkit (PKT-V, $165MM) at ~$1.43. I like it because:
Dream Team: Steve Scott who was behind the success of Storage Vault (SVI-T), which I’ve made a lot of money on, joined the board at the end of December 2020.
Sector: Rolling-up industrial properties to service the growing eCommerce market.
Institutional Capital: $60MM bank-led upsized financing just announced (Jan 26th 2021). The size of this financing and the fact a bank was involved says to me large institutions are now investors. This gives me comfort as the company will need big capital to scale.
Warning! The stock could easily pullback to the $0.95 level where the financing happened. I will be averaging in my position as it consolidates recent gains.
Until next time. Always Yours. Incessantly Chasing ROI,
-Genevieve Roch-Decter, CFA
P.S ‘Keep your friends close and your enemies closer.’ A one-time enemy of bitcoin VISA is now helping +70 MM merchants onboard it.
What else we Grittin’ On:
$GME Over. The U.S. House of Representatives Financial Services is holding a hearing on GameStop on Feb 18th. Citadel, Robinhood and even ‘DeepF—ing Value’ are on the list to appear!
Crypto Bull. Ethereum hits an all-time high. Elon Musk won’t stop tweeting about speculative crypto DogeCoin sending the little puppy to record levels.
Leveraged-up. Hedge Fund leverage can be a blessing or a curse – as we saw last week. Now, their leverage level is at an all-time high – what could go wrong?
Sources: Bloomberg, Barrons, Ark Investments, Zacks.com, Nebraska FB, Not Boring Newsletter.
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