Battle of the Inflation VS Return Math

Investor · Member since 2018 · 260 posts · 74 votes

I recently listened to a podcast interview with a very accomplished and intelligent syndicator. He said that the annual return you anticipate for your investors needs to be at least equal to the rate of inflation in order to match/beat inflation.

For example, if inflation were 10% per year and his return structure had only a preferred return with no split, his argument would be that the pref needs to be at least 10% in order to match or beat inflation.

I question if this is a true statement.

Example: If inflation for example is 10% per year, and I have $1M in the bank, that money has buying power of $900k at the end of the year after being inflated away.

Instead, if I invest the $1M in a real estate investment, I assume that the value of the property increases roughly with the rate of inflation.

So for example, if I sold the property after one year, my $1M should have appreciated to $1.1M from inflation, so I'm receiving back $1.1M at least which now has buying power of $1M after inflation.

I've preserved my capital by simply investing in real estate. I don't need any return to protect my capital from inflation.

And for that matter, any return above 0% would mean I'm "beating inflation".

Even moreso (thanks Hunter for this point), if I use leverage and say only put $300k down for this million dollar purchase, I've made $100k on my $300k which 3x beats inflation.

Even if the appreciation rate of the property doesn't trend perfectly with inflation, it still should be close and the point remains the same.

Thoughts?

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Bruce WoodruffPro Member

Contractor/Investor/Consultant · San Diego / Phoenix · Member since 2021 · 12k+ posts · 15k+ votes

Quote from @Kim Hopkins:

Example: If inflation for example is 10% per year, and I have $1M in the bank, that money has buying power of $900k at the end of the year after being inflated away.

Instead, if I invest the $1M in a real estate investment, I assume that the value of the property increases roughly with the rate of inflation.

First, none of these guys has a clue what they're talking about...always remember that.

Second, the bolded above is where you are making a big mistake. We are in a high inflation period right now and home prices are dropping pretty much everwhere.

I'm not saying I disagree with your premise that this guy is not exactly right in his assertion, but he does have a point....

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Bruce WoodruffPro Member
Contractor/Investor/Consultant · San Diego / Phoenix · Member since 2021 · 12k+ posts · 15k+ votes
3y
Quote from @Kim Hopkins:

Example: If inflation for example is 10% per year, and I have $1M in the bank, that money has buying power of $900k at the end of the year after being inflated away.
Instead, if I invest the $1M in a real estate investment, I assume that the value of the property increases roughly with the rate of inflation.
First, none of these guys has a clue what they're talking about...always remember that.
Second, the bolded above is where you are making a big mistake. We are in a high inflation period right now and home prices are dropping pretty much everwhere.
I'm not saying I disagree with your premise that this guy is not exactly right in his assertion, but he does have a point....
6 Reply
Kim Hopkins
OP
Investor · Member since 2018 · 260 posts · 74 votes
3y
Quote from @Bruce Woodruff:

Quote from @Kim Hopkins:

Example: If inflation for example is 10% per year, and I have $1M in the bank, that money has buying power of $900k at the end of the year after being inflated away.
Instead, if I invest the $1M in a real estate investment, I assume that the value of the property increases roughly with the rate of inflation.
First, none of these guys has a clue what they're talking about...always remember that.
Second, the bolded above is where you are making a big mistake. We are in a high inflation period right now and home prices are dropping pretty much everwhere.
I'm not saying I disagree with your premise that this guy is not exactly right in his assertion, but he does have a point....

Sorry, I should have clarified that this is commercial real estate I'm talking about, not houses. Commercial real estate is almost always valued as a function of its net operating income so as the rents increase (even partially) with inflation (which they certainly do in my product type where we have short term leases) and the NOI goes up in general, so does the market value of the property. (of note, while cap rates could increase and drive prices down, the typical hold period will remedy this if it's a good buy, and if it's not a good buy or if income is decreasing, you wouldn't be able to pay the pref either so that scenario is not really relevant to this question).
1 Reply
Ash Hegde
Lender · Fort Lauderdale, FL (Lending in FL CT GA MI PA) · Member since 2022 · 470 posts · 349 votes
3y
It's factually a true statement but returns are relative to what else you could do with the money. If inflation is 10% and your commercial real estate returns are 9%, you are losing value over the year. But if your other options are a bank account returning 2% and stocks returning 7%, you are still better off with the real estate.
3 Reply
Chris SeveneyBusiness Member
Moderator
Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
3y
@Kim Hopkins
Recently I have seen syndicators increasing preferred returns - my guess is because of inflation.
As someone who runs a fund I don’t at this time and here is why:
1. Prior inflationary periods real estate values increased. This cycle is very different. Cap rates are increasing and real estate is actually losing value (pricing going down).
2. Returns on real estate will be more difficult in next few years because of interest rates and #1 above
If my profits are being compressed, it will be harder to make the preferred return and increasing the rate makes it even more difficult.
3. Markets are getting pounded. Real estate is an alternative investment
4. We can accept non accredited investors, so our investor pool is significantly larger.
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Henry ClarkPro Member
Developer · Member since 2020 · 4k+ posts · 4k+ votes
3y
Just to clarify your example is a preferred position with a guaranteed annual return and no participation in any appreciation?
If so, the syndicator is correct, but he still needs to pay out higher for tax effect. If inflation is 10% against your cash position you need a higher tax adjusted return.
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Kim Hopkins
OP
Investor · Member since 2018 · 260 posts · 74 votes
3y
Quote from @Henry Clark:

Just to clarify your example is a preferred position with a guaranteed annual return and no participation in any appreciation?
If so, the syndicator is correct, but he still needs to pay out higher for tax effect. If inflation is 10% against your cash position you need a higher tax adjusted return.

How is what I said incorrect? Are you claiming the property doesn't appreciate?
0 Reply
Kim Hopkins
OP
Investor · Member since 2018 · 260 posts · 74 votes
3y
Quote from @Chris Seveney:

@Kim Hopkins
Recently I have seen syndicators increasing preferred returns - my guess is because of inflation.
As someone who runs a fund I don’t at this time and here is why:
1. Prior inflationary periods real estate values increased. This cycle is very different. Cap rates are increasing and real estate is actually losing value (pricing going down).
2. Returns on real estate will be more difficult in next few years because of interest rates and #1 above
If my profits are being compressed, it will be harder to make the preferred return and increasing the rate makes it even more difficult.
3. Markets are getting pounded. Real estate is an alternative investment
4. We can accept non accredited investors, so our investor pool is significantly larger.
Hi Chris I totally agree with everything you've said here and I think you make some great points about the market etc.
My only point was that I think that the statement that one must have an annual return equal to or greater than the rate of inflation in order to beat inflation is not necessarily mathematically correct.
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Joe VilleneuvePro Member
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
3y
All of this confusions is because the bottom line that is used to judge success is based on percentages rather than actual dollars. I don't give a rats a$$ what percentage my money makes me. All I care about is if I put cash in, and I get more cash out than I put in, and the timeline is less than 5 years where the cash coming back to me equals the cash I put in, and while all of this is going on, the equity I paid for (the DP) is duplicated by the equity gained from appreciation, then I'm a happy camper. Percentages in REI tells you nothing of value at best, and lie to you at worst, because it tells you nothing about the reason shy you are investing....$$$$$$$.
3 Reply
Henry ClarkPro Member
Developer · Member since 2020 · 4k+ posts · 4k+ votes
3y
What I am asking is for you to clarify.
In your example on the preferred position. Are they just getting a 10% return, with no participation in property appreciation? And is this what the podcaster meant also?
Or are you saying they get a 10% return plus property appreciation?
If no participation, then 10% matches up to 10% return, disregarding Tax impact.
If participation, then you can take a lower % return, if they are also participating in the property appreciation.
2 Reply
Carlos Ptriawan
Member since 2019 · 7k+ posts · 4k+ votes
3y
Quote from @Kim Hopkins:

Quote from @Bruce Woodruff:

Quote from @Kim Hopkins:

Example: If inflation for example is 10% per year, and I have $1M in the bank, that money has buying power of $900k at the end of the year after being inflated away.
Instead, if I invest the $1M in a real estate investment, I assume that the value of the property increases roughly with the rate of inflation.
First, none of these guys has a clue what they're talking about...always remember that.
Second, the bolded above is where you are making a big mistake. We are in a high inflation period right now and home prices are dropping pretty much everwhere.
I'm not saying I disagree with your premise that this guy is not exactly right in his assertion, but he does have a point....

Sorry, I should have clarified that this is commercial real estate I'm talking about, not houses. Commercial real estate is almost always valued as a function of its net operating income so as the rents increase (even partially) with inflation (which they certainly do in my product type where we have short term leases) and the NOI goes up in general, so does the market value of the property. (of note, while cap rates could increase and drive prices down, the typical hold period will remedy this if it's a good buy, and if it's not a good buy or if income is decreasing, you wouldn't be able to pay the pref either so that scenario is not really relevant to this question).

Could you please ask him how Class A syndicator could work for their targeted exit IRR in Class A apartment, if their market cap rate is 3% and cost of financing is 7% , with 5 year balloon payment ? assuming the year 5 reset is tomorrow.
1 Reply
Curtis Mears
Property Manager · Raleigh, NC · Member since 2014 · 729 posts · 596 votes
3y
@Kim Hopkins
I would disagree. You really need to compare where else your money can go and what risk each option presents. If you can put your money elsewhere for less risk then it is a no brainer. But if you believe the risk in real estate is less than other options and it gives you a better return, then inflation rate is not a factor.
0 Reply
Hai Loc
Specialist · Toronto, Ontario · Member since 2012 · 2k+ posts · 891 votes
3y
Quote from @Kim Hopkins:

So for example, if I sold the property after one year, my $1M should have appreciated to $1.1M from inflation, so I'm receiving back $1.1M at least which now has buying power of $1M after inflation.
First of all appreciation and inflation do not go hand in hand with Commercial Real Estate.. 10% inflation does not mean 10% appreciation. If the value of CRE property increases its bc of the NOI increasing or Cap Rate compressing.. Last I heard interest rates are being increasing which causes cap rates to rise as well hence CRE values dropping.. Half of what you mentioned makes no sense..

2 Reply
Paul Kingsley
Investor · Chicago · Member since 2022 · 7 posts · 13 votes
3y
In your example (or the syndicators?), if you have are receiving a preferred return with "no split" that means you aren't sharing in any profits, so the property appreciation doesn't matter. Basically a pref with no split is the same as debt (financially speaking). So you are just loaning him funds at 10% (which acts like non-guaranteed interest). If you are investing $1 mil and he is giving you $1.1 mil back in one year and inflation is 10% over that year - you are breaking even in real terms. So using the example, he is correct mathematically.

If what he was really saying is what you stated in your first paragraph (not the example) - that annual return he anticipates in his pro forma needs to be higher than the rate of inflation to match/beat inflation - that is also true. If annual return is less than the rate of inflation, in real terms, you aren't matching/beating inflation.

If what he was saying is the annual return he anticipates in his pro forma needs to be higher than the rate of inflation in order to attract investors - that's not true.  It just needs to be higher than alternative investments that his investors are looking at.

That all said - as Chris and Hai said, CRE values (especially multifamily) are dropping from their peak earlier this year in most markets, as cap rates decompress and rents plateau. Your idea of just buying real estate for $1 million in a 10% inflationary environment doesn't mean the real estate will be worth $1.1 mil in a year due to "appreciation" from inflation.
1 Reply
John M.
Investor · Fairfax, VA · Member since 2015 · 1k+ posts · 801 votes
3y
Beating inflation is low on my list of criteria for investing. 1st and foremost I need be secure in the asset. If it's a syndication then I need to be secure in the operational team. We can't beat inflation because we don't have control over it, although I suspect to some degree I could control my spending as a type of hedge against inflation. A lot of investors will look at the 10 year treasury as a guideline for comparison (roughly 4.2%) of what is out there in the marketplace. Syndications are appealing because of the PROPOSED digit IRR, but those spreadsheets are a changing as we speak. Kim I agree with your personal example of how you can stay ahead of inflation assuming the appreciation you mentioned. Also the tax benefits of real estate can be a hedge as well which in turn increases your buying power.
0 Reply
Carlos Ptriawan
Member since 2019 · 7k+ posts · 4k+ votes
3y
Quote from @Kim Hopkins:

I recently listened to a podcast interview with a very accomplished and intelligent syndicator. He said that the annual return you anticipate for your investors needs to be at least equal to the rate of inflation in order to match/beat inflation.
For example, if inflation were 10% per year and his return structure had only a preferred return with no split, his argument would be that the pref needs to be at least 10% in order to match or beat inflation.
I question if this is a true statement.
Example: If inflation for example is 10% per year, and I have $1M in the bank, that money has buying power of $900k at the end of the year after being inflated away.
Instead, if I invest the $1M in a real estate investment, I assume that the value of the property increases roughly with the rate of inflation.
So for example, if I sold the property after one year, my $1M should have appreciated to $1.1M from inflation, so I'm receiving back $1.1M at least which now has buying power of $1M after inflation.
I've preserved my capital by simply investing in real estate. I don't need any return to protect my capital from inflation.
And for that matter, any return above 0% would mean I'm "beating inflation".
Even moreso (thanks Hunter for this point), if I use leverage and say only put $300k down for this million dollar purchase, I've made $100k on my $300k which 3x beats inflation.
Even if the appreciation rate of the property doesn't trend perfectly with inflation, it still should be close and the point remains the same.
Thoughts?

Here's the relationship between Inflation and Appreciation/IRR.

During Cheap Money Policy Era (2008-2020):

Actual Inflation: 2.8-3.0%.
Starting cap rate during 2009 era in many city is 8-10%.
Appreciation Algo: 2x $inflation + city multiplier (for low cap city) ; by average the appreciation rate is 6.8-7% per year
Now if use exponential per year for appreciation from 2008-2020, the average IRR is between 9-11%.

I've checked maaannnnyyyy syndicator track record, and the average of their Exit IRR is 15%, which is pretty good I think. They beat the inflation.

Now coming 2022, post inflation, this number is extremely hard to digest if actual inflation is 8%.
Actual cap rate is now like 3-5% esp in low cap rat city. Lower than 6%. In midwest we can still find 7-8% cap.
Per Zillow and others, home growth til 2024/2025 is only like 0.3% per year (Freddie Mac even saying negative one percent growth), assuming we will be always forever in this situation, then lets say we have 1% appreciation for good sake simplicity, then the IRR is like what: 1% LOL

As result:

When cap rate is very low and interest rate is very high (like 11/7/2022) THEN
even real estate can not beat the inflation rate ... LOL
0 Reply
Joe VilleneuvePro Member
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
3y
Quote from @Carlos Ptriawan:

Quote from @Kim Hopkins:

I recently listened to a podcast interview with a very accomplished and intelligent syndicator. He said that the annual return you anticipate for your investors needs to be at least equal to the rate of inflation in order to match/beat inflation.
For example, if inflation were 10% per year and his return structure had only a preferred return with no split, his argument would be that the pref needs to be at least 10% in order to match or beat inflation.
I question if this is a true statement.
Example: If inflation for example is 10% per year, and I have $1M in the bank, that money has buying power of $900k at the end of the year after being inflated away.
Instead, if I invest the $1M in a real estate investment, I assume that the value of the property increases roughly with the rate of inflation.
So for example, if I sold the property after one year, my $1M should have appreciated to $1.1M from inflation, so I'm receiving back $1.1M at least which now has buying power of $1M after inflation.
I've preserved my capital by simply investing in real estate. I don't need any return to protect my capital from inflation.
And for that matter, any return above 0% would mean I'm "beating inflation".
Even moreso (thanks Hunter for this point), if I use leverage and say only put $300k down for this million dollar purchase, I've made $100k on my $300k which 3x beats inflation.
Even if the appreciation rate of the property doesn't trend perfectly with inflation, it still should be close and the point remains the same.
Thoughts?

Here's the relationship between Inflation and Appreciation/IRR.

During Cheap Money Policy Era (2008-2020):

Actual Inflation: 2.8-3.0%.
Starting cap rate during 2009 era in many city is 8-10%.
Appreciation Algo: 2x $inflation + city multiplier (for low cap city) ; by average the appreciation rate is 6.8-7% per year
Now if use exponential per year for appreciation from 2008-2020, the average IRR is between 9-11%.

I've checked maaannnnyyyy syndicator track record, and the average of their Exit IRR is 15%, which is pretty good I think. They beat the inflation.

Now coming 2022, post inflation, this number is extremely hard to digest if actual inflation is 8%.
Actual cap rate is now like 3-5% esp in low cap rat city. Lower than 6%. In midwest we can still find 7-8% cap.
Per Zillow and others, home growth til 2024/2025 is only like 0.3% per year (Freddie Mac even saying negative one percent growth), assuming we will be always forever in this situation, then lets say we have 1% appreciation for good sake simplicity, then the IRR is like what: 1% LOL

As result:

When cap rate is very low and interest rate is very high (like 11/7/2022) THEN
even real estate can not beat the inflation rate ... LOL
So what, who cares? This is just another example of how percentages mean nothing, and can lie to you in the process. In the end, it means very little if your measure of success is based on beating inflation as the end all. It doesn't matter to me what this comparison is since the goal of REI isn't to win this battle. You can win this battle and still lose money, and lose this battle and be a highly successful REI. Why? You win the battle of spreads as defined by dollars, not percentages. I will change my mind the day we spend percentages. Until then, I will use dollar spreads to gauge my success.
If my return is less than inflation, but my cash flow still pays the bills, I'm not losing...I'm winning. On the other hand, I can have a high return (percentage) and not be able to pay my bills. How is that good? If I buy a property for $100k, that's worth $200k, but I have negative CF because the rents can't cover the taxes, insurance, property manager, etc..., I can have a great percentage gain, and lose the property. Gee, how many of those can I have?
0 Reply
Marcus Auerbach
Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes
3y
The argument of the syndicator is weak and short sighted, not to call it transactional. When you buy real estate it should always be with a long term approach, at least a decade, if not 2 or 3. If you look at it this way it takes out all the noise. What if the CPI drops to 5% in spring, then he is going to change everything?
I agree with you Kim that RE itself is a hedge against inflation, which is really a devaluation of currency. It is not prices that are going up, it is currency going down. Wages and rents will follow, even with a lag.
Someone said prices are falling, I'd like to challenge that. You have to look at it in the context of typical seasonality of real estate prices: October is always a few % lower than June. The only true gauge is YoY price changes, and with a median home price of $403,000 in the US we are still 7.% over last year - about the rate of inflation.
0 Reply
Carlos Ptriawan
Member since 2019 · 7k+ posts · 4k+ votes
3y
Quote from @Joe Villeneuve:

Quote from @Carlos Ptriawan:

Quote from @Kim Hopkins:

I recently listened to a podcast interview with a very accomplished and intelligent syndicator. He said that the annual return you anticipate for your investors needs to be at least equal to the rate of inflation in order to match/beat inflation.
For example, if inflation were 10% per year and his return structure had only a preferred return with no split, his argument would be that the pref needs to be at least 10% in order to match or beat inflation.
I question if this is a true statement.
Example: If inflation for example is 10% per year, and I have $1M in the bank, that money has buying power of $900k at the end of the year after being inflated away.
Instead, if I invest the $1M in a real estate investment, I assume that the value of the property increases roughly with the rate of inflation.
So for example, if I sold the property after one year, my $1M should have appreciated to $1.1M from inflation, so I'm receiving back $1.1M at least which now has buying power of $1M after inflation.
I've preserved my capital by simply investing in real estate. I don't need any return to protect my capital from inflation.
And for that matter, any return above 0% would mean I'm "beating inflation".
Even moreso (thanks Hunter for this point), if I use leverage and say only put $300k down for this million dollar purchase, I've made $100k on my $300k which 3x beats inflation.
Even if the appreciation rate of the property doesn't trend perfectly with inflation, it still should be close and the point remains the same.
Thoughts?

Here's the relationship between Inflation and Appreciation/IRR.

During Cheap Money Policy Era (2008-2020):

Actual Inflation: 2.8-3.0%.
Starting cap rate during 2009 era in many city is 8-10%.
Appreciation Algo: 2x $inflation + city multiplier (for low cap city) ; by average the appreciation rate is 6.8-7% per year
Now if use exponential per year for appreciation from 2008-2020, the average IRR is between 9-11%.

I've checked maaannnnyyyy syndicator track record, and the average of their Exit IRR is 15%, which is pretty good I think. They beat the inflation.

Now coming 2022, post inflation, this number is extremely hard to digest if actual inflation is 8%.
Actual cap rate is now like 3-5% esp in low cap rat city. Lower than 6%. In midwest we can still find 7-8% cap.
Per Zillow and others, home growth til 2024/2025 is only like 0.3% per year (Freddie Mac even saying negative one percent growth), assuming we will be always forever in this situation, then lets say we have 1% appreciation for good sake simplicity, then the IRR is like what: 1% LOL

As result:

When cap rate is very low and interest rate is very high (like 11/7/2022) THEN
even real estate can not beat the inflation rate ... LOL
So what, who cares? This is just another example of how percentages mean nothing, and can lie to you in the process. In the end, it means very little if your measure of success is based on beating inflation as the end all. It doesn't matter to me what this comparison is since the goal of REI isn't to win this battle. You can win this battle and still lose money, and lose this battle and be a highly successful REI. Why? You win the battle of spreads as defined by dollars, not percentages. I will change my mind the day we spend percentages. Until then, I will use dollar spreads to gauge my success.
If my return is less than inflation, but my cash flow still pays the bills, I'm not losing...I'm winning. On the other hand, I can have a high return (percentage) and not be able to pay my bills. How is that good? If I buy a property for $100k, that's worth $200k, but I have negative CF because the rents can't cover the taxes, insurance, property manager, etc..., I can have a great percentage gain, and lose the property. Gee, how many of those can I have?

True Joe. Totally agree. Same view here.

I think the result here is only showing that investing in real estate for equity is very favorable during low interest rate/cheap money policy (08-20).
If not, becoming a creditor would be better in high interest-rate market. Now if I invest at bonds I could have 4-5% return with very much less compared to equity investing. I could still lend money to a syndicator on 1st lien position, for example, with 10% return.
0 Reply
Joe VilleneuvePro Member
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
3y
Quote from @Carlos Ptriawan:

Quote from @Joe Villeneuve:

Quote from @Carlos Ptriawan:

Quote from @Kim Hopkins:

I recently listened to a podcast interview with a very accomplished and intelligent syndicator. He said that the annual return you anticipate for your investors needs to be at least equal to the rate of inflation in order to match/beat inflation.
For example, if inflation were 10% per year and his return structure had only a preferred return with no split, his argument would be that the pref needs to be at least 10% in order to match or beat inflation.
I question if this is a true statement.
Example: If inflation for example is 10% per year, and I have $1M in the bank, that money has buying power of $900k at the end of the year after being inflated away.
Instead, if I invest the $1M in a real estate investment, I assume that the value of the property increases roughly with the rate of inflation.
So for example, if I sold the property after one year, my $1M should have appreciated to $1.1M from inflation, so I'm receiving back $1.1M at least which now has buying power of $1M after inflation.
I've preserved my capital by simply investing in real estate. I don't need any return to protect my capital from inflation.
And for that matter, any return above 0% would mean I'm "beating inflation".
Even moreso (thanks Hunter for this point), if I use leverage and say only put $300k down for this million dollar purchase, I've made $100k on my $300k which 3x beats inflation.
Even if the appreciation rate of the property doesn't trend perfectly with inflation, it still should be close and the point remains the same.
Thoughts?

Here's the relationship between Inflation and Appreciation/IRR.

During Cheap Money Policy Era (2008-2020):

Actual Inflation: 2.8-3.0%.
Starting cap rate during 2009 era in many city is 8-10%.
Appreciation Algo: 2x $inflation + city multiplier (for low cap city) ; by average the appreciation rate is 6.8-7% per year
Now if use exponential per year for appreciation from 2008-2020, the average IRR is between 9-11%.

I've checked maaannnnyyyy syndicator track record, and the average of their Exit IRR is 15%, which is pretty good I think. They beat the inflation.

Now coming 2022, post inflation, this number is extremely hard to digest if actual inflation is 8%.
Actual cap rate is now like 3-5% esp in low cap rat city. Lower than 6%. In midwest we can still find 7-8% cap.
Per Zillow and others, home growth til 2024/2025 is only like 0.3% per year (Freddie Mac even saying negative one percent growth), assuming we will be always forever in this situation, then lets say we have 1% appreciation for good sake simplicity, then the IRR is like what: 1% LOL

As result:

When cap rate is very low and interest rate is very high (like 11/7/2022) THEN
even real estate can not beat the inflation rate ... LOL
So what, who cares? This is just another example of how percentages mean nothing, and can lie to you in the process. In the end, it means very little if your measure of success is based on beating inflation as the end all. It doesn't matter to me what this comparison is since the goal of REI isn't to win this battle. You can win this battle and still lose money, and lose this battle and be a highly successful REI. Why? You win the battle of spreads as defined by dollars, not percentages. I will change my mind the day we spend percentages. Until then, I will use dollar spreads to gauge my success.
If my return is less than inflation, but my cash flow still pays the bills, I'm not losing...I'm winning. On the other hand, I can have a high return (percentage) and not be able to pay my bills. How is that good? If I buy a property for $100k, that's worth $200k, but I have negative CF because the rents can't cover the taxes, insurance, property manager, etc..., I can have a great percentage gain, and lose the property. Gee, how many of those can I have?

True Joe. Totally agree. Same view here.

I think the result here is only showing that investing in real estate for equity is very favorable during low interest rate/cheap money policy (08-20).
If not, becoming a creditor would be better in high interest-rate market. Now if I invest at bonds I could have 4-5% return with very much less compared to equity investing. I could still lend money to a syndicator on 1st lien position, for example, with 10% return.
All true. The trouble with using percentages to compare results is percentages lie. They don't tell the whole story, because they don't take into account leverage and the potential/real exponential returns that the liquidity of REI offers, that other investments don't.
0 Reply
John M.
Investor · Fairfax, VA · Member since 2015 · 1k+ posts · 801 votes
3y
liars figure and figures lie! Stay diligent my friends.
0 Reply
Mike Dymski
Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
3y
2 additional items:
1 - The leverage scenario has negative cash flow if the interest rate is higher than the cap rate. For example, if the cap rate is 4% and the interest rate is 6.5% (on $700k in debt), the $1M property generates NOI of $40k, debt service of $56.7k using 25-year amortization, and has negative cash flow of $16.7k (plus cap ex).
2 - Property values are declining due to #1 above; so, $1M may be $900k after one year.
1 Reply
Kim Hopkins
OP
Investor · Member since 2018 · 260 posts · 74 votes
3y
This has been a very interesting discussion! Thank you everyone who weighed in.
Mathematically (that means, not talking about what is actually happening in this market, but the actual math in a theoretical example): I think the consensus is that with a few caveats, I'm correct that you don't have to cash flow to investors at the rate of inflation in order to beat inflation because of the properties of (forced and organic) appreciation.
Caveat 1 was pointed out that if there is pref with no upside, then it's a moot point since the investor does not participate in the appreciation. Regardless of what this particular podcaster had in mind, I've heard several people say the rate of return has to match inflation in scenarios which include upside participation, and that statement, I believe based on our discussion, has errors.
Caveat 2 was pointed out that if the property depreciates, then my claim is false. However, this challenges all the hypotheses - including the one that a syndicator would even be able to match the returns with the rate of inflation. Though it's possible that the property would continue to cash flow strongly for the hold period while it also deflates, that is certainly in no way a guarantee and really takes the scope of the math problem outside of the intended assumptions.
There's also been a lot of interesting "real world" observations on what is happening in the market right now. I will say that the differing opinions on this thread says a lot in and of itself! I will also say that personally, I would rather participate in a syndication right now where there is a conservative pref with potential upside and downside (i.e. participation in the appreciation) over a syndication with a "guaranteed" preferred return at a high % to "beat inflation" with no upside. That guarantee seems only as good as the paper it's written on, and my biggest concern is that the operator even feels comfortable offering that in this market. There are many exceptions and I know of many experienced operators who I'm confident could pull off a high pref right now, but based on the point of potential depreciation of assets, and the possibility of a recession which will surely effect commercial rents, I'm looking for conservative underwriting right now. And as Warren says, my goal right now is to "never lose money".
0 Reply
John M.
Investor · Fairfax, VA · Member since 2015 · 1k+ posts · 801 votes
3y
Whatever you decide to do make sure you do your due dilligence on the operator. You don't want to get too caught up in chasing returns. If you truly have a conservative mindset you might consider a syndication into a Class A NNN property.
0 Reply
Kim Hopkins
OP
Investor · Member since 2018 · 260 posts · 74 votes
3y
Quote from @John M.:

Whatever you decide to do make sure you do your due dilligence on the operator. You don't want to get too caught up in chasing returns. If you truly have a conservative mindset you might consider a syndication into a Class A NNN property.

I usually just stick to my own deals. Thou shalt maintain control. :)
0 Reply
Paul MoorePro Member
Commercial Real Estate Fund Manager · Lynchburg, VA · Member since 2015 · 1k+ posts · 1k+ votes
3y
Hi @Kim Hopkins! You did a great job with this question and spurred a wonderful discussion with this question. Thank you for staying involved along the way. It's so much better than the posts where somewhere asks a question and then never responds again (it makes you wonder if they are even reading the responses that people take collective hours to write.)

You got a lot of great responses above. A lot of food for thought. I especially like @John M.'s thoughts above.
The decompressing cap rate can potentially be overcome by finding and executing deals with significant intrinsic value. Value add deals where a seasoned operator can extract value others have missed. That's the way I like to invest and I think others would agree on that.
Some of these issues can also be offset through a long hold time as was mentioned above Warren Buffett (when talking about stocks of course) said I wouldn't hold a stock for 10 minutes that I didn't want to hold for 10 years. A long hold time as as also mentioned above can compensate for a decompression and hopefully a recompression of cap rates. Then inflation of rents and therefor net operating income should do its work to increase values over time. And if you're getting payouts along the way all the better. Good luck and happy investing!
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