People ask me all the time what I think about various real estate asset types. Is multifamily still a good option or is it overbuilt and overpriced? Is office product more dangerous than other asset types, with the high capex requirements, leasing commissions, and such? Do I think retail is dying, given the “Amazon effect” and online competition? What are my thoughts about self-storage, or industrial, or hotels, or senior living, or student housing, or medical office? How do I feel about (name your asset type) in the current market environment vs. (name a different asset type)? Do I think that debt is safer than equity at this stage of the cycle? These questions come nonstop, and everyone has an opinion on the answers.
Are Certain Asset Types Better Investments?
For me and Fairway, we apply what I consider to be a pragmatic belief system towards middle market real estate asset-based investing. I don’t believe that any one asset type is fundamentally any better or worse than any other asset type, they are just different. Equity is not better than debt. Debt is not better than equity. Multifamily is not better than office, which is not better or worse than retail or industrial. They all have their place in the world at the macro level, and they are all viable to one degree or another. At the micro level, I admit to having personal preferences, all things being equal, towards property types that produce (or can produce) reliable income streams and which are generally more financeable and therefore liquid (liquidity in real estate being relative, of course) under most market conditions. But at our core, we take the real estate asset-based investing equivalent of a geopolitical-centric worldview that subscribes to the existence of an underlying order of impersonal forces that can be discerned and applied to decision making to produce more reliable results. And those forces are not asset-class specific.
There is no doubt in my mind that there are opportunities to invest successfully in ALL asset classes, property types, and swaths on the capital stack, all the time, with more or fewer opportunities available in any specific area at any given time, depending on what is happening in the world at that time. These opportunities ebb and flow, take different forms, and may be easier or more difficult to find and procure at different stages of economic cycles, but they are always available. This is particularly true in the middle market space which is vast, fragmented and inefficient. Small to mid-size, nimble real estate entrepreneurs are located in every market, big and small, in the United States, looking for deals in every one of the aforementioned asset types and strategies and more. Situations, people and property are always in flux and one person’s difficulty is simultaneously another person’s opportunity to take advantage of or, as I prefer to do, help resolve that difficulty.
So when I answer people who ask me these questions, I tell them that, all things being equal, while we may have our preferences as to asset types, we focus more on working with the right people who know how to find opportunities and execute an intelligent strategy and business plan for an opportunity. As markets cycle, there may be areas of opportunity that are more pronounced and attractive for some time periods over others. This does not mean that there are not simultaneously attractive opportunities in the other asset classes, even if they are more broadly overpriced, oversupplied, or out of favor. A sponsor-by-sponsor, market-by-market, asset-by-asset approach focused on basic value investing fundamentals makes the most sense to us. It starts with the people.
How We Choose Who to Invest With
If you are dealing with high quality people who are experts at a given approach or strategy, I believe you can make excellent investments across a variety of asset types. This belief has been reinforced to me again and again by direct experience. I have witnessed people both achieve success with generally out of favor asset types and experience failure in generally loved asset classes. An experienced jockey who knows how to win (and how not to lose) will win or at least finish in the money more often than not, even riding an average horse. Match the jockey with a great horse and they will win even more often. And the best jockeys know how to pick good horses to ride, most of the time.
Let me define what I mean by high quality when we are seeking relationships with sponsors and managers. While there are multiple factors we ultimately consider, it really comes down to two main criteria. First and foremost, they must have deep integrity. They do not bullshit us, ever. An extremely close second is that they are highly competent. They know what they are doing, and they execute. Integrity without competency is ineffectual. Competency without integrity is dangerous. Both are required in order to produce reliable long-term results. It is not that they never make a mistake or an error in assumptions – everyone does sometimes. It is that they limit their mistakes and they own up to those they do make, and then they are resourceful enough to work their way through them effectively. If they possess these characteristics, along with the same value investing DNA as us, there is usually enough margin for error in their deals to overcome inevitable surprises and limit downside, regardless of property or asset type.
The Three Questions I Ask Before Investing
Many years ago, I attended a lecture where the speaker provided what I have long considered an elegantly simple approach to effective decision making. His admonition was to ask yourself three questions when considering any decision (for our purposes, let’s say an investment decision). First, what do you believe is the best-case outcome? Second, what is the worst-case outcome? And third, what is the most likely outcome? Apply some intellectual rigor to each of those questions and assess your answers. Then, if you can live with the worst-case outcome and the most likely outcome achieves your objectives and moves you toward your goals, you proceed.
As we apply this process to making an investment decision, the worst-case outcome must be that we believe that even if everything goes against us, we can get all our principal investment back and make at least a small amount of money. The most likely outcome should mean we are hitting or exceeding our targeted returns based on what we believe are reasonably conservative assumptions in key areas. Best-case outcome means we significantly exceeded our objectives and we overperformed our most likely scenario. It is always nice to have what we think is a stronger than average chance to achieve a best-case outcome, but we try to never shoot for best-case at the expense of forfeiting consideration of a worst-case outcome.
It is easy to put money out. It is harder to get it back. It is even harder to get it back plus more, regardless of market developments. Yet all over this country, competent middle market real estate entrepreneurs with integrity do this consistently across all asset types. These are a subset of the whole. It is our goal to find them, provide them mission-critical services and reliable capital, and generate predictable outcomes to our investors, even when conditions are not perfect. People and principles are more important than asset type.