All Forum Posts by: Jonathan Twombly

People talk about LLCs as if they are a kind of magical entity, which they are not. If you are dealing with investors, you should have an LLC through which you deal with them, as you don't want to deal with them in your personal capacity. Then, for each deal you do, you want a separate LLC.

Why?

Because the purpose of an LLC is to limit liability, which is why it's called a "limited liability company." What it does is protect your assets OUTSIDE the LLC from stuff that goes on with/under the LLC.

Anything that is inside/under an LLC is reachable by creditors of the LLC. If you manage the LLC properly, then things outside the LLC are not reachable.

I see lots of people here who think that all they need is "an" LLC to put their property under. This may protect your personal assets from creditors of those properties, but if the majority of your net worth is in the properties you have all put under one LLC, you've just exposed the majority of your net worth to creditors of every property under the LLC. This is why each property should be under its own LLC, especially when you have investors involved.

And, if you are dealing with commercial property (i.e., 5+ units), the lender will insist on it, because they want their asset protected from claims levied against your other properties.

"Upstate" New York covers a whole lot of ground, and it depends on who you ask what it even means.  Do you mean Albany or Buffalo?  Or are you a downstater who thinks everything north of the Bronx is upstate?  Where, specifically, are you looking? Drilling down on that would be a good start.

The issue right now is really the uncertainty.

There are aggressive buyers out there who are mistaking the current uncertainty for fear, and thinking that they are being contrarian by racing full-steam ahead to buy assets right now, while everyone else is "afraid."

But fear has not hit the markets yet, because rent collections are strong as a result of the CARES Act.

The issue for most investors is that they feel they cannot trust the current numbers.  Typically, you think of the trailing 3 months financials as representing as closely as possible what the next three months will look like.

But, right now, everyone understands the T3 numbers are being propped up by CARES Act stimulus - especially for C class assets where tenants may actually be making more money on unemployment than they were at their jobs.

No one in their right minds expects this continue this way indefinitely.  Currently the stimulus checks are set to end July 31.  And, though they are certain to be extended, it is also certain there will be a huge fight in Congress over the level of generosity that's appropriate, and for how long it will last.

In addition, no one knows exactly how big the rebound will be when all the economies are re-open, or whether there will be a second wave of Covid when they do.

Because of all this uncertainty, buyers and sellers are far apart right now.  Sellers want to point to the good collections numbers and claim everything is fine and they should still get peak pricing.  Buyers don't know what they are buying and want to build in a margin of safety of 20% or more from peak pricing.

(I actually know of people who are both buying and selling at the moment and taking these two contradictory positions, depending on which hat they are wearing at the moment.)

The disconnect alone has forced cap rates up, though it's not translating in the data yet because the deals closing recently were in the pipeline before Covid hit, and everyone else is holding their deals off-market in the hopes of a quick rebound.

If either (a) the economic openings do not restore the economy to where it was in January 2020 or (b) a second wave of Covid hits because of the openings, happen, then all bets are off.  I predict that in those circumstances MF asset prices will drop by far more than the 20% discount buyers are demanding now.

Maybe that's a metric all by itself.  You know that the market has peaked when it hits "peak broker."  And it's bottomed out when the number of brokers stops falling after a correction . . .

@Ivan Barratt

The institutional with the cash are not looking for 5% discounts or to "support the market" because they have nothing better to do with their cash.  They are looking for big bargains and won't move until they see them.  In my experience, investors are not in the business of altruistically supporting the market at inflated prices when they believe it's not the best use of their money.  See today's National Real Estate Investor.  https://www.nreionline.com/dis...

@Ivan Barratt

 If the Fed can waive its magic wand and support asset prices at will, then why did the Fed this very morning warn about asset prices potentially tanking? This includes commercial real estate. 

If the Fed can control asset prices, it seems to me there’s no need for this warning. All it needs to do is take its magical action. 

Low interest rates cannot make people invest if they don’t think the investment is worthwhile or they believe asset prices are still falling. 

Low interest rates and tons of liquidity and cash on the sidelines did not prevent the last crash. They did not prevent cap rates from expanding as investors demanded higher risk premiums. Eventually they did fuel an overpriced market in all asset classes, but that took several years. 

As an aside, I find it rich that the Fed, whose low interest rate policies were directly responsible, saying in its warning this morning that asset prices were higher than justified by the fundamentals before Covid. 

Capital doesn’t move simply because it’s there sitting in a bank account. 

All the capital on the sidelines is there because there were no uses for it deemed to generate sufficient opportunity with more upside and less risk than cash. 

The money has accumulated in anticipation of a crash, when bargains appear. It won’t move until the perception is that the market is nearing a bottom. It will be looking for bargains. 

It will not move if the common belief is that the bottom has not been reached and patience will be rewarded with bigger bargains.

Right now it’s too early to say exactly what will happen. But in my opinion most of the sidelines money will not enter the market to support high prices. It will not enter the market simply because borrowing costs are low. It will not enter the market if it believes the market still has substantial downside risk, unless assets can be acquired at such a discount that they can absorb that further downside risk. The money will move when it appears advantageous to move, and not before. 

Of course! You can’t time the absolutely bottom.  You can only know it happened in retrospect. 

I will be looking for deals where I can pay my investors and 8% pref and 2% to myself from year one without having to do a value add or raise rents aggressively to get there.  That where we were in 2013, when I really got traction - several years into the last recovery so not the absolute bottom.

If I’m going to put investor money at risk to do a value add play, then I want to receive a premium in return for the risk. Not like recently, where people were paying the after value add price and then having to take the risk of doing the value add to get to their 8 pref - or maybe just to get to a 6-pref. 

Don’t know if we will get there. If we don’t I will have to adjust. But that’s what I will be looking for. 

They famously overpaid and ended up selling at big losses. It was so bad that it took 20 years for Japanese institutional investors to return to the US markets.  

You’re exactly right. The further the market climbs the more conservative you need to be - but this is the opposite of what most people are doing. As the market climbs they loosen their standards to continue to make deals happen. Everyone claims to be underwriting conservatively, but if that were true cap rates would never compress. It’s precisely because the market as a whole justified loosening it’s standards that cap rates compress so much. (Low interest rates are a justification for, not the cause, of cap rate compression.) 

At the top of the market, you have to get everything exactly right to have your deals work out as you planned. The looser an investor’s standards get as to what “works,” the greater the deviance from the plan they will end up with. At the extreme, deals bought at the top with too loose standards will go back to the bank. 

The average investor’s perception of risk is backwards. When everyone is buying and prices are rising, they perceive risk to be low, which causes more people to jump in, raising prices further, and increasing risk. 

Conversely, when the market nears the bottom, the risk is at its lowest. You can be most aggressive at this time. Cap rate compression as the market recovers will hide a lot of sins. You’ll often exceed your underwriting. 

But at this point in the cycle, news of the crash is recent. And the casual investor believes risk is high. However, in fact, risk is at its lowest point. 

The cap rate tells you everything. When cap rates for the asset in that market are at their cyclical low, risk is highest. When they are at their cyclical high, risk is lowest. 

Anyway, that’s my view of things. Others will no doubt differ.