As real estate investors we are often conditioned to focus on rates of return as the primary criteria for investment.
The past year has clearly adjusted investor expectations across the board.
So far the stock market is down 25% this year. The bond market has been a traditional safe haven. There is no safety to be found in the bond market either.
Our own criteria for investing has been steady for much of the past decade. Our aim has always been to create enough value that we can design an interim exit upon completion of the project. That means refinancing into permanent financing to recover the initial investment including the equity investment. The problem with that model is that the rise in interest rates has made all of these project debt coverage limited such that there is no path to a full cash-out refinance. The loan to value ratio for a refinance would have been at 75%. But today you would be lucky to refinance at 55%-60% LTV. That means tying up a lot of equity in a project for the long term which fundamentally changes the IRR and the rate of return to investors. Projects under these criteria would no longer meet our investment criteria. Many real estate investors and developers in North America have similar criteria. If you can design a project that allows you to pull your initial investment out within a year or two at the front of the project, then even a modest cash flow looks like infinite return once you have your money back.
Rising interest rates have attracted funds into short term government treasuries like US Treasuries, British Gilts, Canadian Bonds.
Many international investors are experiencing much higher yield in their home markets, but against the backdrop of falling currency valuations. For example, investors in Ecuador can earn 8.5% on their money. Venezuela can get 57.5% on their money. Turkey’s central bank rate is 9%, down from 14% earlier in the year. But the inflation rate in Turkey is running at 88% on an annual basis. The business owner can make enormous profits on a nominal basis. The question is, what are those profits in real terms? Who can really say when the ground is constantly shifting beneath your feet.
What about in Ghana where the deposit rate in bank accounts have been very steady at 7.625% for all of this year. Commercial lending rates have been pretty steady near 20%. But inflation has mushroomed from 13.9% at the start of the year to over 50.3% at the end of the year.
Business owners in all those countries and more are increasingly looking to opportunities in the UK, the US, and Canada. They are not looking for high returns. They are looking for safety.
They’re fine with five percent, or three percent, or even zero percent return on their money. Why? Because it’s not -50.3% or -88% or -15%.
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Host: Victor Menasce
email: podcast@victorjm.com
