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What Is Really A Return To Normal?

By Joel Ross

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There is a continuing stream of articles and panels discussing how far have values declined and when they will once again be back to “normal”. Green St and Moody’s continue to provide differing indexes of how far down values are. Various pundits opine as to when we will be normal again. It is my contention that everyone is measuring the wrong metrics.

I recently reviewed what purported to be a series of hotel values over the past ten years and a projection of where they will be in 2014. What was most striking was that values trended upward over the period until 2006, and then they just took off into the classic hockey stick as we all know. The 2008 value number was still way high due to transactions in the early part of that year. The general value increase was about 25%-30% during the bubble years of 2005-2008. Then the number settled right back to close to where it had been early in the decade. In short, it reverted to the mean.

I believe everyone needs to reset their metrics to 2004 values and consider that as normal. Maybe it is an average of 2003-2005, but that would put things in far better perspective than measuring against 2007 which was clearly a number that reflected nothing other than stupid underwriting, gross over leveraging, and totally irrational exuberance brought about by far too much money in the hands of mostly young fund managers who had no idea what real estate ownership and operation is really all about. Securitization and enormous flows of funds into all sorts of investment vehicles, drove a historic rush of capital into what is really a long term asset play, converting it into a trading card. Real estate is not a security or a commodity. It takes intense and intelligent management even for multifamily and office that may be well rented. Value increases through good management, good lease strategy, good maintenance and smart marketing of space, be it office, hotel rooms or apartments. It also means a good economy and some good luck in the evolution of a local market. Long term it is not just because the securitization market went insane and stopped underwriting.

I believe we need to start to look at the long term mean and trend and ignore 2006-2008 as a measure of anything other than what can happen when investors lose their senses and debt markets have no discipline. If you are measuring when will values return to the 2007 levels you may be developing a strategy that is based on more unreality. The price today is the price today. If the past is any guide, then values will rise in most markets at a slow steady pace if you manage the asset well. If you are looking at projecting returns you cannot look at 2007 as the benchmark. That is over and dead. Hopefully we are not repeating those stupid mistakes for a very long time. You need to look at here we are, here is the slow economic recovery, there are all sorts of black swans circling and this is the situation in my local market. There is not going to be insane leverage in the hold period, the Mideast is exploding and there is no way anyone knows what that will mean, oil prices are much higher, there will be historic changes to the way governments at all levels are funding and providing services and the level of taxes, the dollar is weak, the EPA is running wild and will possibly cost you a lot with new rules, investors are more cautious, there is a real bifurcation between places like New York and Washington and the rest of the country. In short, projecting where anything will be in 5 years is really just a wild guess. While there will be good returns generated if you can buy a solid distressed note or asset at a good price today, and if you have very good operational skills to rework that asset and the debt to produce a solid return, then you will do well, but that is all based on how good the buy is, which is always what really matters. With too much money chasing too few deals, really good buys are hard to find today.

Forget what something was worth in the biggest bubble in history. It does not matter, and is irrelevant. What is it worth today based on what can I realistically expect to do with that asset over time, based on the very uncertain world we live in today, and based on proper leverage levels. How can I protect my downside if the world really does go badly. Those are the metrics you need to be looking at.

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