Lead Story… I was reading the Wall Street Journal this weekend and came across a story that reminded me of some of the best advice that I ever received: work hard enough at something to become an expert and then stick with what you know. The WSJ story was written by Rob Copeland and Peter Rudegeair and was entitled: How a Hedge-Fund Ace Chased Silicon Valley Riches—and Embarrassed Himself. It was about how superstar hedge fund manager Nick Adams of Wellington Management Company who made his career investing in bank stocks decided to start pouring money into tech startups and is losing his ass as a result. The Wellington story is a classic and cringe-worthy tale of investment style drift that seems to rear it’s ugly head more frequently in the mature stages of a bull market.
This is nothing new and it’s something that we’ve become well attuned to in the real estate world when developer clients start chasing deals that aren’t in their core competency in the quest for yield. Suddenly, a builder who excels at developing infill housing in LA is trying to take down a 1,000 unit master plan in the Coachella Valley or build a class-A apartment project in a different state. The reason this typically ends in tears is threefold:
- Success in one sector of real estate or investment does not beget success in another sector – in fact it may even be a detriment since it makes overconfidence more likely.
- The devil is in the details and a lack of experience executing a complex business plan means that you simply don’t know what you don’t know.
- Newbies and out-of-market folks always pay the “dumb tax.” If it were such a good deal, why aren’t the locals or experts in that niche not doing it?
Sure, there are a few style drift success stories. Everybody wants to be the next John Paulson, the hedge fund manager who became a billionaire when he abandoned his merger arb strategy to place a massive short bet against the US housing market. However, for every Paulson, there are dozens upon dozens of examples where style drift has disastrous results.
When it comes to real estate development, the most blatant example that I can recall happened during the North Dakota fracking boom. From about 2009-2014, soaring oil prices led to a booming economy in the frozen tundra of North Dakota while much of the rest of the nation was struggling to emerge from the lasting impact of the Great Recession. The unemployment rate was non-existent, pay was soaring and people were moving to formerly desolate, rural areas in droves. The problem was that much of North Dakota simply didn’t have the infrastructure to accommodate the newcomers. There was essentially no reason to live there other than newly-found fracking riches and the place was woefully short of everything from housing to restaurants. There were more than a few out of town developers who were still licking their wounds from the housing crash and decided that they were going to go develop in North Dakota to cash in on the boom. They were enticed both by high yields (I recall seeing multi-family cap rates around 12% when many markets in California were trading in the 5%’s) and the comforting mantra that oil would keep going up in price because it was so necessary to power the global economy (note the echoes of the housing boom justifications in that rationalization). So long as oil was stable, demand was off the charts and rents were soaring. To some, it seemed like a no-lose situation. We saw some of these and passed every time when we pushed the developer to explain why the locals who were now flush with oil money wouldn’t do the developments on their own. No one ever answered this question in a satisfactory manner.
We now know that the North Dakota story ended in tears once oil supply – ironically driven by fracking technology – surged and prices plunged. This sent real estate rents and values into a tailspin as rig counts shrunk, roughnecks who had been making 6-figures left and vacancy soared. It turns out that no one actually wanted to live in a frozen tundra with an inhospitable climate and no amenities once the oil money stopped flowing. Guess who got left holding the bag: out of town developers with no prior experience in the area. Some of them are now sitting on underwater properties where rent is often 40% lower than pro-forma. This is the aforementioned “dumb tax” and the projected 12% yield on cost doesn’t look so good now.
Fast forward to the present day. Times like this when yields are thin and returns are light after a period of increasing values are when we start to see the most style drift. Developers are quite often searching for better yields then those available in their area of expertise as a way to make theoretically greater returns (albeit often at greater risk). However, as both the Wellington and North Dakota stories show, the grass is not always greener elsewhere. If you can’t explain what your edge is and how a project fits in with your business plan then your deal is probably not a deal that should get done.
Warning Signs: The odds of a recession are rising as the yield curve continues to flatten out. (h/t Doug Jorritsma)
Pop: The bubble has quietly burst for over-valued tech unicorns that most of you have probably never heard of.
Going to Leave a Mark: The Congressional Budget office is projecting that the Fed will keep hiking interest rates until they level out at a 3% Fed Funds Rate in 2020 (it’s 0.75% today). (h/t Doug Jorritsma)
Not Much Slack: We are getting awfully close to full employment.
Fighting Back: Walmart is trying to compete with Amazon in the eCommerce space through it’s purchase of Jet.com.
Fixer Upper: It’s a really good time to be in the home remodeling business as profits rise.
While Rome Burns: Golden State politicians are doing nothing or worse as the state’s housing crisis continues to grow.
F&$k Yeah! A new study found that swearing makes you stronger, which is my excuse from now on.
Sister Act: Meet The Sisters Of The Valley: California’s cannabis-growing, medicine-making outlaw nuns.
Chart of the Day
Housing has never been so expensive and that’s not a good thing for the economy.
FAIL: Meet the Pennsylvania man who lit a pile of leaves in his back yard to scare off some possums. He burned his house down.
Eat Up: A new study found that eating boogers is good for your teeth and overall health. Looks like Spaulding Smails was ahead of his time. Also, my 2-year old is going to be so psyched about this. (h/t Steve Sims)
Whip it Out: A man has requested to show his schlong in court as part of the defense in a murder trial, because Florida.
Exposed: A porn actress was bitten on the foot while filming a promotional scene in a shark tank. Sharks are such prudes. This is one of those things that could only happen in the great state of Florida.
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