Capital Preferences

Take a look around the market and you will quickly find construction (and refurbishment) costs are greatly elevated, cap rates are in a state of transition, and financial institutions are setting a raft of new guidelines as the rates get re-priced. So, what is the right play and what do you do with your money, or how do you access money?

For context, last time we saw global economic volatility, it was a credit crunch off the back of world-wide liquidity issues. This time we have vast amounts of free capital but are confronted by inflationary pressures. There is never a reliable crystal ball for volatile markets, but there are a few ways to navigate some of the obvious pitfalls.

• Net leases for investors – They may be a little harder to obtain with the CPI (consumer price index) numbers looming large in peoples’ minds, but worth the effort for the de-risking.

• Price in “downside scenarios” so that surprises are less impactful.

• Looking for capital? What about sale and leaseback if you are an owner operator. Run a detailed cashflow on a rental vs debt facility post a sales realisation.

• Look at what rent increases are contained in leases and where the resets to market occur.

• Remember patience and discipline. There have been incredibly thin margins left on the table in many deals over the past year and some of those will inevitability come back to market.

• The quality of your assets will play a role in protecting their longer-term values. The market continues to display a distinct shortage in terms of quality assets. Assets that display stability and have strong cost controls will continue to perform, especially in light of a vastly different LVR (loan to value ratio) regime to what is playing out in over-heated residential markets that have permitted extremely high mortgage percentages.

• It has become noticeable that whilst the results are still there, the absolute giddiness has started to subside, and investors are seeking advice again, in lieu of charging in at pace. A great question to ask yourself would be “If I have found this, and find it great value, who else has found it?” and applying a price to it, at what point does the investment represent value, or not?

• There is an incredible number of blogs, articles and videos that will all tell you about capitalisation rates and yields. If you head down this path then soon you will run into IRR formulas, calculations of NPR (net present value), weight average cost of capital (WACC) and so forth.

Credit: NAI Harcourts, CRE market update, October 2022.