Did you attend this year’s “Woodstock for Capitalists” event? We’re talking about Berkshire Hathaway’s annual meeting in Omaha. I took note of the entire event. Warren Buffett is 93 years old, Charlie Munger is approaching 100, and any year could be his last.
What Munger said about commercial real estate was alarming, but not surprising.
Munger has previously warned about the dangers of brewing. Storm in the US commercial real estate market, American banks are full of bad loans due to falling real estate prices. At that meeting, he reiterated his fears, and Buffett reinforced them.
For years, during real estate’s upswing, investors competed for higher and higher returns. They asked, “How much money will you make?”
However, trends always reverse over time. Now investors are asking, “How much can I lose?”
At times like this, investors stop discussing. Return value And back to the discussion Risk-adjusted return.
Calling all recovering speculators
I’m a recovered speculator. Decades ago, I focused only on returns and ignored risks. What my company is currently obsessed with is: risk adjusted Honestly, this is a completely different metric.
While risk-adjusted returns have always been a focus for good investors, there are certain seasons when special opportunities surface. That deal doesn’t show up on St. Patrick’s Day when cash and profits flow like Chicago’s green river.
We are in such a rare moment right now.
Preferred stock has many benefits, including increased security from its higher status. capital stackimmediate cash flow, management rights in the event of arrears, and a cushion of common stock behind investors in initial loss positions as a shield against declines in asset values.
To be clear, this is not a “preferred return” that investors receive as part of the payment structure from the syndicator. That’s great, but that’s not what I’m talking about.
These opportunities are quite different from the typical preferred stock offerings you may have seen as part of the services offered by multifamily properties or other sponsors. Many offer investors a debt-like cash flow stream (e.g., 8% to 10%) with little or no upside.
Investors accept lower cash flow return potential and a more secure position in the capital stack. We think these are great and now is a good time to consider those options. But I’m talking about something else.
Transaction details
I made a strong case for preferred stock. Previous article.in another, I explained why the windows for preferred stock trading are limited. Some people have asked for more information about some of the deals we’ve been evaluating.
While we don’t have space to discuss them all here, we will discuss opportunities that we have recently evaluated where the risk and upside potential seem to be misaligned in favor of investors.
this The deal still allowed the operator to make a successful acquisition.
We are evaluating a significant number of preferred stock opportunities with these characteristics. Here are the details:
- Value-added multifamily acquisitions with experienced sponsors next to currently successful projects.
- As a shield to protect preferred stock investors, 25% of common stock is in an initial loss position.
- 9% of the current payroll cash flow is paid in advance for one year, and an additional 8% cumulative increase is compounded.
- The lower MOIC (multiplier on invested capital) is 1.30x, with a minimum total return of 30% and an expected exit within 18 months (up to 20% annual return if this goes well).
- Cash flow sweep rights and management control rights (including forced sale rights) to protect investors in times of trouble.
When investing in such deals, you probably won’t sign a boilerplate contract like a retail investor would. You will want to hire an experienced attorney to draft a document with provisions to protect you and provide rights that retail investors (if they have access to) do not have.
The opportunity described here is one of many. The 17% total return (with the potential for higher returns if the MOIC floor is triggered within 18 months) is more attractive than many common equity investment opportunities.
However, in theory, the risk is much lower due to the state of the capital stack, the priority of distributions from cash flow (including cash flow leaching), current salary reserves, and the manager’s removal rights.
This investment aligns with many BP investors’ first priority: capital preservation, second priority: predictable income, and third priority: stock price appreciation.And this passes tax incentives from depreciation expense start up.
To be clear, I am not suggesting that investors abandon individual LP investing. We believe in broad diversification and think preferred stocks can be part of a great portfolio.
We recently mentioned one of our most sophisticated investors who helped us explain what a rare and short opportunity to make an investment like this is.
I forgot to mention that he scolded me a bit when I was explaining the rationale for investing in preferred stocks. But his gentle rebuke wasn’t about investing in preferred stocks.he scolded me for not investing more In county equity, especially during this rare and narrow period.
He senses an opportunity. I think we have a chance. I hope many of you do too.
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Note by BiggerPockets: These are the opinions expressed by the author and do not necessarily represent the opinions of BiggerPockets.
