“Yep, these are the dog days of summer,” my oldest said to me during a car ride last week. Thinking that sounded overly jaded for a 9-year-old boy, I asked him where he heard that. He responded that it was on some show he’d watched on TV— that these are just boring, hard, long days of summer. I don’t think he fully grasped what it meant, but he liked the phrase. I started to agree with him but then flashed back to the true dogs days of the summer in 2008. How hard was that year? I remember that was the summer my family didn’t take our annual beach trip. We started planting more vegetables in our garden and even put some cash on ice in our freezer just in case. We’ve come a long way! This summer of 2014 has no real dog days, just “salad days” filled with much activity. For that I am very thankful.
I recently read a secular market outlook by Bill Gross of Pimco entitled “The New Neutral.” You can find it here. Bill Gross and Pimco are at their best when they are forecasting the next 5 years within a unifying conceptual thesis. In 2009 they coined the term ‘The New Normal’ predicting five years of much lower than normal GDP. In “The New Neutral,” they posit that for the medium term, U.S. 10-yr treasury pricing will remain low, range-bound between 2.5-4%. Surprisingly that range is not at odds with its long-term historical average:
“In the U.S. real policy rates of 1-2% and nominal policy rates of 3-4% before the end of decade are currently priced into the markets. Logic and history would suggest otherwise. PIMCO internal research as well as historical statistics over the past century suggest “neutral” (normal policy rate) is so much closer to 0% (especially during periods of high leverage and low growth) than the 1-2% currently anticipated by asset markets. Before Paul Volcker broke the back of inflation beginning in 1979, real policy rates averaged .5% in the U.S., 0% in the U.K. and negative for Japan and much of Euroland for the first 8 years of the 20th century.”
For us regular folks, that means we shouldn’t expect to go back to a “prime rate” of 8% at our local bank for a long, long time.
One market rule of thumb that I firmly believe is that when everyone thinks something is going to happen, it rarely ever does. Four years ago, three years ago, two years ago, and last year, we all said that when inflation hit, there’d be hell to pay along with much higher interest rates.
So if you’d allow that we are now swimming in a period of much lower interest rates and will be for five years, doesn’t it then follow that real estate values should rise? The coupons used to buy these assets are 300-400 basis points less than they were during the first decade of my career. And if this is a new normal, then values still haven’t fully baked that in. Perhaps triple net investments have.
Case in point, Shannon Waltchack has decided to sell the brand new Taco Bell we developed on the Southside of Birmingham. It comes with a 25-year lease, and recent comparable sales of other NNN investments indicate that we should be able to achieve a 5 cap!! Unreal. In the late 90’s, that same asset would have traded for a 10 cap. So in 18 years, the amount the market is willing to pay for the same set of cash flows has more than doubled.
The Triple Net market may have over-corrected for our new interest rate environment, but the bigger market of shopping centers and office buildings still hasn’t come close to pricing in lower interest rates. If rates stay the same over the next year or so, we believe the market will start to get the message and begin to accept that rates aren’t moving. You then will see more aggressive underwriting, which will cause a big upward swing in non-NNN asset pricing. That may very well be the time to sell.
Is there ever a time in the cycle when it’s right to be BOTH a seller and buyer? We think so. Time to sell your Triple Nets and time to buy stabilized shopping centers and office buildings.
Enjoy the rest of your summer and here’s to a strong close of 2014!