Market Update - Volatility, Opportunity, and How to Invest in this Market
Pugh Management Note to Existing & Potential Investors & Partners
Big Idea: In the next 12 months pricing dislocations will arise as interest rates increase and market volatility continues. Long term investors should look to acquire quality assets and strategically located development sites at discounted prices.
Supporting Evidence:
Institutional investors and allocators have taken a pause to wait and see how capital markets respond to the 300 basis points of hikes the Federal Reserve has spiked into the system. Many over leveraged or under-capitalized deals have fallen apart or are on hold due to rate increases and higher return requirements resulting from increased, real or perceived, market risk.
Construction cost inflation has driven the number of development opportunities down and will continue to do so over the next 6 months. Prices on construction materials have peaked, but construction labor costs will remain stubbornly high. Until construction costs come down 15-20% ground up development opportunities will remain limited, but will create buying opportunities for well positioned investors.
Interest rates continue their march upwards. Higher interest rates result in higher cap rates and less opportunities in the real estate market for sellers in the short term. Short to medium term sellers who need to exit positions will begin to take lower prices providing opportunities for patient capital.
Rent growth will continue though it will slow. Rent growth today is mostly due to higher input costs and/or property level expenses. As rents remain stubbornly high, over the next 6 months we expect owners will experience some continued value appreciation, but at some point this will cease and property values will ultimately decrease over the next 12 months.
The cyclical nature of the market will provide the next leg up in the next 18-24 months. We believe the market will experience an uptrend once the extended exuberance shakes out. As market participants know property values skyrocketed due to historically low interest rates and cost of capital over the past 12+ years. Once the interest rate increases work their way through the economy and adjust risk and return expectations Pugh Management expects value appreciation to restart in about 12+ months after the completion of Fed interest rate hikes. Which investors and the market currently projects as the end of this year to early next year 2023.
Next Steps:
Identify existing market dislocations in target markets. Pugh Management is currently active in the Tampa, Austin, and Boston areas. Investment opportunities we are focused on should be priced at or below replacement cost and in strategic “Value Fortress” locations.
Acquire high value, cash flowing properties for carried land development opportunities or long term cash flow investments.
Build and expand strategic partnerships in new markets such as Tampa/St Pete, Austin, and Central Florida and in the Boston market.
