News of the Day: Real Estate, Private Equity, Automotive
Real Estate
Canadian real estate has been long pointed to by the rest of the world as an example of a classic bubble. Bears pointed to YoY price increases and the market that only got hotter, with a significant portion of the population particularly in the younger cohort being priced out of urban metropolitan areas in Toronto and Vancouver. Bulls on the other hand touted more secular demographic trends with consistent population growth and foreign capital inflows arguing that real estate will not lose its value. In the midst of the much larger economic shock that forced much of Canada to slowdown, Canadian buyers are taking some pause but so far not so much as Natalie Pearson writes
A week into a pandemic that has forced a swath of Canada’s economy to shut down and wiped hundreds of billions of dollars off the nation’s stock market, a Vancouver mansion sold for C$150,000 ($105,000) over the asking price.
Meanwhile, Canada’s six biggest lenders, including Royal Bank of Canada, Bank of Montreal and Toronto-Dominion Bank, said they would consider six-month mortgage-payment deferrals for small businesses and individual borrowers impacted by the pandemic.
In the longer run, relentless demand means any pullback will likely be short-lived and prices should hold up, said Robert Hogue, senior economist at RBC.
Meanwhile falling mortgage rates will act as a spur. Borrowers can now get a five-year variable mortgage at 2.1% and a three-year fixed at 1.99%, according to RateSpy.com.
At this time I want to point towards Real Estate Vehicles such as Canadian Apartment Properties REIT (CAR-U:CN) that has dropped from peak of 61.25 a few weeks ago to 46.17 a loss of 25%, currently trading at below its book value by almost 10%.
There are some interesting parallels here to a topic we have discussed on Monday concerning Bond ETFs that were not priced according to their underlying Net Asset Value. Both underlying markets (bonds and real estate) are much more illiquid than the open market in which the ETFs trade. This lack liquidity in the bonds ETF case lead to mispricing between the underlying and ETFs as ETFs were more reflective of the true market value of the bonds with arbitrage existing due to middlemen’s need for cash.
Naturally the mechanics of the situation in the real estate market are very different, for one the underlying properties do not trade the same way as securities such as bonds and this potential arbitrage opportunity (if it exists, it is unclear whether book value is the best gauge of market value of underlying properties) is much harder to take advantage of. However one can not help but ask if the underlying real estate market is projected to remain strong is it truly the case of mispricing of underlying or is it a case of panic amidst a much wider sell off.
If the latter is the case looking into U.K.’s example of regulatory protection for funds experiencing massive withdrawals, might be an interesting exercise. Here is Mark Gilbert:
New rules proposed by the FCA last year compelling fund managers to suspend redemptions if there’s “material uncertainty” about the value of 20% or more of a funds’ real estate holdings were due to come into force later this year. Asset managers clearly aren’t hanging around in the current climate for their cash holdings to be depleted by investors demanding repayment.
As I argued then, while it’s clearly desirable for retail investors to have different ways of investing in bricks and mortar, the illiquidity of real estate is incompatible with the pretense that such vehicles can be redeemed on a daily basis. Regulators need to provide official cover for asset managers to drop their pledge to let customers take their money out on a continuous basis; three- or six-month lockups make a lot more sense, provided the industry moves in lockstep.
PE May Not Be All That Bad
Liquidity is not always a great thing both as a fund manager and as an investor. As an investor rational about your own irrationality with a long term horizon being locked up into an investment can help ease the panic that comes with major shocks to the markets. As Matt Levine wrote in his column a month ago:
It is well known that one of the best services a retail broker can provide is not answering the phones during a crash. The market is down, the customers panic, their timing is terrible, they want to sell at the bottom, they call you up to say “sell everything,” you say “we’re sorry all our representatives are assisting other customers, your call is important to us,” they hang up and get distracted, the market rallies, they forget about selling, you have saved them a fortune, good work.
Similarly for a fund manager especially in an illiquid market such as private equity there are certain advantages of not having to deal with day to day fluctuations of asset prices. In particular in theory this allows them to focus on actual company management with long term focus. Additionally, there is no need to write down their investments until those go bankrupt. The benefits of this last point can be debated on the grounds of misallocation of capital. Furthermore there are obvious questions about accountability as fund managers can simply collect their salary without any outflows while doing a not so great job. In practice the latter isn’t so much of a problem as generally managers have a reasonable amount of their own capital invested in their funds aligning the incentives between them and other shareholders. Recently with aforementioned inflows into PE funds and rising valuations across the board it has been hard to separate truly great managers from the rest.
One of the major reasons behind these massive cash inflows into the funds over the last few years has been this long term focus that has allowed private equity to capture some of that liquidity premium. Many of these funds have built up a stockpile of cash and as Nisha Gopalan writes are now eyeing at attractive opportunities to deploy it:
Having sat on their hands for much of the past year in protest at unappealing valuations, the virus-induced stock market meltdown is creating a potential parade of bargains. Blackstone Group Inc.’s reported plans to acquire Hong Kong-listed property company Soho China Ltd. may be just the start.
Deal prices eased only slightly last year, to a median ratio of 12.9 times enterprise value to Ebitda, from 13.3 times in 2018. Valuations remain above levels before 2017, according to Bain.
The problem here however is shrinking amount of available credit, coupled with uncertain valuations for companies in PE funds portfolios:
The MSCI Asia-Pacific Index has slumped 23% this year, opening up potential buyout targets in the public markets and dragging valuations of unlisted companies down in its wake. While tightening dollar liquidity threatens the financing that private equity firms need to make deals work, shrinking availability of credit may also weaken the reluctance of startup founders to yield control, which has been a hindrance to transactions, particularly in Southeast Asia.
As the valuations in recent years have skyrocketed and the dreaded threat of the write downs is finally on the horizon, now will be the time for great PE firms to separate themselves from the rest of the pack.
Things Are Bleak For Auto Manufacturers
Car manufacturers are facing a double whammy. They can’t make cars and consumers can not buy them. As Chris Bryant Points out
This time, though, the shutdowns are happening simultaneously and slumping demand isn’t the only problem carmakers face. Workers are understandably fearful to step onto crowded production lines, plus the supply of key components risks being disrupted.
Manufacturers hope the production hiatus will be brief but that could prove to be wishful thinking because the virus is a long way from being under control. (The fact that some have offered to re-purpose factory space to produce life-saving ventilators underscores the severity of this global health emergency).
Meanwhile, consumers are struggling too. From Bloomberg
Treasury Secretary Steven Mnuchin raised the possibility with Republican senators that U.S. unemployment could rise to 20% without government intervention because of the impact of the coronavirus, according to people familiar with the matter.
At this point it is unclear what, if anything could auto manufacturers do except sit tight and burn through cash reserves. Here is to hoping COVID-19 will be under control soon.
