Displaying items by tag: bear market

Every industry is dealing with the consequences of higher inflation and interest rates. Private real estate is no exception as construction and financing costs have soared. For Private Equity & Real Estate News, Peter Benson shares how the industry is grappling with these challenges and whether it will start to impact returns. 

Although inflation has been trending lower for the past few months, builders continue to grapple with higher insurance costs especially in certain coastal markets. Many are finding that insurance rates have doubled or tripled in certain cases especially as incidents of extreme weather increase. 

Another headwind has been an increase in property taxes as many local governments are dealing with lower tax revenues. Overall, rents have not increased enough to offset these additional costs, resulting in less income for landlords. Additionally, there is a glut of multifamily units that are coming online in major markets, leading to less opportunity to raise rents. Further, rents are at a historically high level relative to income which is also an indication that they cannot be further increased. 

Many private real estate fund managers are dealing with the challenging environment by prioritizing cash management to ensure that they have enough reserves to get through the current environment and take advantage of dislocations that emerge in the coming months. 

Finsum: Private real estate operators are dealing with a very challenging environment given that rents cannot be further raised, while rates are elevated. Another burden is that insurance costs have doubled or tripled in many cases.

In SeekingAlpha, Jussi Akola discusses the opportunity in REITs and identifies some that are yielding more than 8%. REIT stocks are down significantly over the past 18 months due to higher rates and increasing pessimism around real estate prices. Yet, prices have remained resilient despite these headwinds. Additionally, many REITs continue to increase their dividends and are quite attractive on a valuation basis.

And, there are some indications that the macro environment is improving. For one, recent economic data in terms of mortgage applications and housing stars has shown an uptick. Longer-term trends in terms of inflation and the economy also support the notion that the Fed is close to the end of its tightening cycle which should be a boost to the sector as well.

Akola likes Global Medical REIT which is a REIT that invests in medical offices in secondary markets and has an 8% dividend yield. By investing in less competitive markets, it has higher cap rates with less competition from new projects. Additionally, longer-term trends around medical spending are also supportive given the aging population and long-term trend of healthcare inflation outpacing inflation.

Finsum: REITs have significantly underperformed over the past 18 months. Yet, some investors see value in the asset class due to an improving macro environment.

In 2022, the energy sector was one of the few parts of the market that delivered positive returns for investors due to higher than expected global demand while supply was impacted by Russia’s invasion of Ukraine. However, the story is much different in 2023 as the sector is down 4% YTD, while the S&P 500 is up more than 16%. 

In Q2, energy stocks also lagged the market as covered by David Meats for Morningstar. Not surprisingly, the major reason is that oil prices were down by 10% and natural gas was off by 27%. Many were caught offside by weakness in oil given cuts from OPEC over the past few months.

According to Meats, energy stocks remain overvalued as most investors continue to assume higher prices. While he is shying away from most parts of the energy sector, he sees value in oilfield services. 

He believes the global oil market will be in a small deficit over the next couple of quarters due to the aforementioned cuts from OPEC in addition to stronger than expected economic growth. In total, he expects 2024 production to be about 1.1 million barrels per day lower than 2023. 

Finsum: Energy has underperformed in 2023 despite cuts from OPEC and a better than expected economy. While most energy stocks are not attractive from a value perspective, oil services are an exception.

Even at his advanced age, Warren Buffett continues to make prescient moves. The most recent example includes loading up on energy stocks just prior to the sector’s incredible gains in 2020 and 2021. While prices have receded amid concerns that a recession is near, Buffett is using the weakness to increase his exposure to the sector.

However, his most aggressive bet in the sector is on Occidental Petroleum of which Berkshire owns 222 million shares which is equivalent to nearly 25% of the company’s market cap. While Occidental is an integrated operator, the bulk of its revenues are from drilling which means that it’s sensitive to swings in the price of crude oil.

Based on his public comments, Buffett sees the energy supply chain as being constrained given a lack of capital expenditures over the last decade, Russia’s invasion of Ukraine, and changes wrought by increased electrification. At the same time, global demand for oil continues to increase, leading to a tighter equilibrium between supply and demand. 

In addition to his Occidental investment, Buffett also has a $22 billion stake in Chevron. Additionally, Berkshire Energy contributes $25 billion of revenue to its parent company and is composed of power generation and distribution companies like pipelines, renewables, and utilities.

Finsum: Energy has delivered poor returns in 2023 amid increased supply and growing recession fears. However, Warren Buffett continues to increase his exposure to the sector.

Over the last year, Elon Musk has been increasingly pessimistic about the US economy and warning that a more severe downturn is coming. Recently, he warned that the prospects of commercial real estate would suffer due to a lack of financing given stresses in the banking system, and workers who are not returning to offices. In an article for TheStreet, Luc Olinga covers Musk’s thoughts on the matter.

Now, the Tesla founder and CEO is also warning that the residential real estate market could face similar pain as inflation and a weakening economy mean that demand will be tempered, while supply is artificially constrained as homeowners with low mortgage rates are unwilling to sell. 

He sees the same underlying factor negatively impacting residential real estate and commercial real estate - banks raising their lending standards which curtails demand. This would lead many prospective buyers to fail to qualify for a mortgage. 

On top of this, there are a myriad of other economic stresses such as inflation and higher rates leading to higher costs and payments. At the same time, Musk sees it as inevitable that the labor market experiences its own downturn, adding to pain for the US economy and housing market. 

Finsum: Elon Musk has been quite vocal in warning about risks to the economic outlook. He recently shared why he thinks residential real estate could follow commercial real estate lower.