Re: Inflation/Real Estate-Around The World In 90 Minutes.

Last week, I participated in a private panel for global Real Estate entrepreneurs/investors. This thread summarizes some of my key learnings without attribution to specific speakers/firms.

As the only non-RE specialist on the panel, I was invited to give a big picture macro backdrop. I opened the discussion with my thesis of the last 18 mos:

The return of STRUCTURAL INFLATION spells the END OF THE LIQUIDITY LOTTERY of the last several decades and has far-reaching ramifications on Risk Assets of ALL stripes, from Equities to Bonds to Real Estate.

Specifically, the notion of a quick Fed Pivot at the first sign of economic slowdown is subject to RUG-PULL as I foresee Tag-Team Effects between Commodity Inflation and stickier Core Inflation.

IMPLICATIONS FOR ALL RISK ASSETS: “Tighter For Longer” is going to force Risk Premiums UP across-the-board, be they Equity Risk Premiums, Credit Spreads, or CAP RATES.

My fellow panelists (some of whom manage multi-billion dollar portfolios) then gave a rapid-fire, 30,000-ft snapshot of their respective geographies. I will now bullet each region. We visit ASIA first...

In Asia, CHINA/HONG KONG have become “NO GO” zones for US/Euro investors, and JAPAN/SINGAPORE are benefiting at their expense. China’s Three Red Lines Policy may have worked too well given Evergrande's implosion, and the gov may have to backstop the market somehow.

As an aside, I see this as yet another sign that CNY will continue to DEVALUE against USD for now. Y'all know what I'm concerned about as a result:

Asia Industrial HAD been holding up but it is no longer a safe-haven either with $AMZN pulling back. “Work From Home” trends continue to challenge Office and have especially hammered secondary markets in this space.

Savvy investors are looking for 15-20% valuation hits and recall the great opportunities that arose out of Asia Contagion 1.0 (1997-1998), but I pointed out that the FED RESPONSE TO 1998 WAS POSSIBLE ONLY BECAUSE THERE WAS NO STRUCTURAL INFLATION.

AUSTRALIA had been a safe-haven for a long-time, but now everything is “on hold” given the rapid rise In cost of debt from 2% to 5%. Ditto for NEW ZEALAND, where mortgage rates have tripled in a short time.

Australian construction costs are "out of control" even as transaction volumes have plunged. Areas that had benefited the most from easy money (e.g. MELBOURNE) are likely most vulnerable.

Australian Office still struggling even with 3% unemployment due to “Work From Home” trends. Retail still challenging, and Industrial/Hospitality have been outperformers.

UNITED STATES: one asset manager specializing in Industrial/Logistics gave some very interesting leasing statistics. Although he thinks we are near “peak leasing momentum,” he notes only 2.5% VACANCIES in this space and <1% VACANCIES IN CORE AREAS.

“Exponential rent growth” in 2021 appears to be slowing, but it is STILL GROWING IN 2022:

Q1’22: 10% qoq / 40% annualized Q2’22: 6% qoq / 24% annualized Q3’22: 2.5% qoq / 10% annualized

From this, I have a nagging suspicion that CORE CPI WILL REMAIN ELEVATED LONGER THAN MANY THINK, AND EVEN WHEN THAT COOLS, COMMODITIES MAY SURGE AGAIN -- THE "TAG-TEAM EFFECT."

Back to US RE: Areas like TX / FL have outperformed given “pro-business governance” of those states; TX in particular has benefited from the “Near-Shoring" trend and its proximity to Mexico.

Once again, LABOR SHORTAGES are the biggest challenge in construction right now. Residential still firm due to wage growth and resilient consumer demand. Office is much more bifurcated between “Haves vs. Have Nots.”

In terms of capital markets, there is still tons of equity capital out there, but DEBT CAPITAL HAS ALL BUT SHUT DOWN. BBB CMBS for example has blown out 270 bps in a very short time.

Strategically, this asset manager is lowering exposure to long-duration non-inflation protected leases and focused on shoring up balance sheets. Sounds EXACTLY like what I’ve been doing in my own portfolio: SHORTENING DURATION AND BUILDING LIQUIDITY.

The biggest risk to everything is a CONSUMER SLOWDOWN, as it will ripple through ALL ASSET CATEGORIES.

I agree, as this would cause a DOWNWARD DEMAND SHOCK INTO AN INELASTIC SUPPLY CURVE (at least when it comes to Single-Family Residential).

Moving across the pond, the UK is “really challenged.” There is a huge gap between bids and offers now, and the emphasis is on “NO NEW COMMITMENTS UNTIL THERE IS MORE CLARITY ON WHERE CAP RATES WILL END UP.” Everyone is trying to handicap where Cap Rates will be in 3 years.

EUROPE is more nuanced. NORTHERN EUROPE most insulated from effects of war given the energy production. WESTERN EUROPE is somewhat binary depending on energy self- sufficiency: FRANCE is in decent shape because of nuclear, but GERMANY is a “disaster.”

EASTERN EUROPE is benefiting from Near-Shoring out of Asia but is also more dependent on Russian energy.

SOUTHERN EUROPE is saddled with HIGH DEBT LEVELS and has the most potential for SOCIAL INSTABILITY GIVEN THE TRIPLE-WHAMMY OF HIGH INTEREST RATES/HIGH INFLATION/HIGH UNEMPLOYMENT.

AFRICA’S FOOD INSTABILITY makes it completely risk-off to investors at the moment until this factor stabilizes.

A recurring theme I kept hearing:

HIKES HAVE BEEN SO FAST THAT NO ONE HAS ADJUSTED PSYCHOLOGICALLY; SMART MONEY IS AFRAID TO LOOK STUPID AND IS MAKING NO NEW COMMITMENTS UNTIL THERE IS CLARITY ON CAP RATES.

“Nobody survives a quick 250 bp adjustment in Cap Rates.”

INDIA is a bright spot for growth despite its weakening currency & is expected to vault from 5th largest to 3rd largest world economy in next decade. (In the Oil market, India certainly seems to be taking the growth mantle from China as well.)

India has in recent years benefited from 1) a unified national tax policy, 2) rollout of a national “tech infrastructure stack,” 3) manufacturing share gains from Asia.

Moving to the MIDDLE EAST, EGYPT has been hit hardest by a perfect storm of energy/food inflation, rising costs of debt, dependency on Russian tourists, lack of institutional capital flows.

UAE/DUBAI is one of the most interesting mkts in the region: 1) Oil flows and USD FX pegs give the region more cushion for subsidizing inflation, 2) Abraham Accords have helped open the region up, 3) Cap Rates have been artificially high, so not as much valuation risk.

SAUDI ARABIA/RIYADH might represent a “once-in-a-lifetime” opportunity because 1) Oil is making it one of the fastest growing economies in the ME, 2) significant SOCIAL TRANSFORMATION is liberalizing the region quickly.

LATIN AMERICA has been severely impacted by COVID given its general over- indebtedness, but exposure to commodities has mitigated some impacts. Idiosyncratic country POLITICS tend to define each market.

MEXICO is benefiting from Near-Shoring from Asia despite having 6.5% Inflation and only 1% GDP growth. Worries over AMLO policies have been overblown and Industrial/Resi/Office all doing relatively well.

BRAZIL, despite its commodity exposures, is also experiencing STAGFLATION with Inflation running at 7%, GDP growth at 2% with its CB rate at 14%! More than anything, the country is “politically frozen” at the moment with the prospect of a left-wing Lula government returning.

ARGENTINA unfortunately is experiencing HYPERINFLATION (again) with 7.5% Inflation PER MONTH, annualizing at >100% yoy! CB recently took rates to 75%, and Kirchener recently dodged an assassination attempt, so things are in flux to say the least.