HF guy in Real Estate, no clue what i'm doing
Hi CRE guys,
I come from a liberal arts and equity investment background but I have no clue what I am doing in terms of valuing real-estate, especially NNN with long lease terms.
It seems that you should at these like bonds with an option for appreciation due to land value, but that apprecation won't be realized because you have what is essentially a locked-in return until full-lease closure. Should I think of it this way to value it? Also where do I get a lot of cheap debt (Japan?)[not worried about forex from Japanese debt]. What are some of the rates for debt right now for AAA corperate grade secured?
Also if you're an American CRE guys y'all got to move to Asia if what you're looking for is prestige. It's like the complete opposite there since during the China boom alot of the equities were scams but housing went crazy. (Now the housing market is fucked but someones got to unfuck it).
Based on the most helpful WSO content, here’s how you can approach your situation:
Valuing NNN Properties:
Debt Options:
Asia vs. U.S. Real Estate:
If you’re diving into CRE, consider brushing up on key concepts like NOI, cap rates, debt yield, and DSCR. These will help you better evaluate deals and understand the financial mechanics of real estate investments.
Sources: https://www.wallstreetoasis.com/forum/real-estate/state-of-the-cre-debt-markets?customgpt=1, I'm long office properties, Modeling ground lease payments into a pro forma, I'm long office properties, Industrial Properties - What are the key things to know?
I'm RE guy who wanders into the HF forum sometimes, but you'll also certainly get good quantity and quality moving this to the RE forum. I'll assume we're talking US NNN; Asian NNN (called FRI in SG/HK/other UK-influenced markets) different in some ways and similar in others.
The US NNN space is hyper-competitive due to how attractive it is to nontraditional investors looking for "mailbox money" (local business owners looking to diversify, etc.). This means they bid these assets down to really thin spreads over the 10Y (important in RE bc of pricing debt and it's another income-providing alternative). For me, there's never really been enough of a spread to justify bearing the idiosyncratic risk of a single asset but markets & motivations vary.
That aside, basically yes - "it's like a bond" is one of the most overdone platitudes by NNN brokers, but there's validity to it. Things to note:
- Obviously credit of the tenant and amount of lease term remaining are the most important factors driving the value. The market prices these assets basically as a yield (cap rate), and an empty building falls out of that income buyer group.
- It seems obvious, but if the lease expires you have to re-lease it. This should lead you away from both under-specialized and over-specialized buildings. For a rural Dollar General, they can just build a brand new shed next door; for the USPS, who else are you gonna lease a post office to? You also don't want your in-place lease to be over-rented because you eventually have to reset to market rates.
- Lastly, while credit is important, you don't own credit. You own the equity slice of a real estate asset. So if the RE market gets concerned about sector (like retail) or location, your exit yield could widen out just based on sentiment and impair value without any change in the underlying performance. You don't get a bullet payoff like a bond - you have to realize the value in a sale that depends on the market at sale. I find this risk really underprioritized; Blue Owl for example is a big victim of this IMO in their RE business.
I touched on this earlier but debt is tougher because spreads between unlevered yield and debt are usually pretty thin. Your best bet is going to be local banks or some of the specialized NNN lenders. If you get non-recourse debt, I'd recommend mortgaging it rather than trying to borrow elsewhere for cheap and put it into the real estate - the embedded ability to "put" the asset to the lender and wash your hands in a downside case to me is more valuable than whatever yield pickup you find (a good way to hedge some of that idio I talked about earlier).
Long story short, I'd value it on the income you want (adjusted for risk/effort), on a long enough horizon the exit value matters less. Feel free to PM also.
Hi, not OP but found it insightful. Two questions: A) What's the comment about Blue Owl underprioritizing exit - are they guilty of overemphasizing yield during the hold and not considering terminal value as much (specifically the exit cap rate)? How short sighted have they been here? I find it hard to imagine a large company like that would so badly miss on their exits compared to their income yield.
B) When you talk about the ability to "put" an asset to a lender, are you mainly saying that taking on non-recourse debt is worth the higher spread from a risk vs. return perspective?
Would love any links to articles, books, etc where I can learn more about the things you're talking about!
Sure, re: Blue Owl, to me it seems like much of their skill is in origination: negotiate portfolio purchases in bulk from corporates at high cap rates and then sell off to retail at lower cap rates. This leads to short hold periods but if that music ever stops the portfolio doesn't seem to be thoughtfully distributed with regards to sector imo. They have emphasized how they almost entirely focus on the credit underwriting, but my point above is that you don't need a black-swan IG-credit bankruptcy for value to be impaired. The size of their more recent, post-Oak Street funds doesn't lend itself to that high-churn model, and I think you can see that in some of the unrealized assets of latest funds.
On B), I'm really just saying the common non-recourse debt is attractive because you can just hand the keys back if something goes badly wrong as compared to borrowing with recourse anywhere else just for lower other interest rates in other currencies. I'm not even sure there's a big spread from US lenders between non-recourse and PG'd - was really just making a point on the carry trade idea of borrow in yen, buy US assets (also tough to stomach given illiquidity of real estate).
Can you help me understand this first line. Are you saying the asset you purchase is more important than how you fund that purchase?
So I was really getting at the idea some net lease fund managers have that credit rating of the tenant is all-consuming; credit rating is certainly important, but you don't own their bonds. You own real estate, and real estate value is subject to other aspects besides the credit of the tenant.
For example, if you bought an office fully leased to an IG tenant in 2019, you probably paid a much higher price than you would get for it today, just because of the sector - nothing to do with the quality of the tenant. Moreover, you also have concerns similar to the bond too: higher interest rates lowers value, but you can't just hold the real estate to maturity like you can a bond. You have to actually crystallize the value in a sale, that depends on the market at sale, not a company's ability to refinance/pay you back your bond.
On the debt side, you can broadly divide your tenants into two buckets - investment grade and non-investment grade. You have a lot more options on the debt side for investment grade tenants, including credit tenant lease (CTL) financing where you float bonds that are backed by the lease/underlying real estate. There's a lot of nuance to that financing source, but the debt yields relative to a bank are phenomenal and they don't worry about leverage nearly as much. Theoretically, you could get a loan for 100% of the purchase price. Lifeco's will also be very active and competitive on rate, albeit at lower leverage points.
Non-investment grade people focus on the real estate a lot more, so you fall back into banks and credit unions. Some lifeco's will play in this space for the right tenant/real estate, but they tend to be picky.
I'll happily trade you knowledge. I'm based in Hong Kong and worked in real estate PE for the highest returning fund in the region. I did a lot of China and Singapore deals, and I can understand the current appeal of Japan.
In turn, I'm hoping to learn more about public equities. I think we can be mutually helpful.
slap a cap on it and call it a day
This is the way. Bonus points if you use crayons
idk call CBRE and plug their number into your model. That's what the banks do anyways.
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