Before I get to my article I thought I would start with a quote from one of my favorite movies – John Wick – actually John Wick IV:
Friendship means little when it is convenient
It is said at what I thought was a beautiful moment in the film. Okay, make fun of my taste in movies – everyone else does.
But at this time in the real estate world – when many of your ‘friends’ are in trouble – or situations exist when by saving the day you could make ‘friends – this is the essence of inconvenient. So perhaps this is a moment to not only go all out for opportunities, but also to go all out to be a good man/woman to those around you in the real estate community. There are many ways to do this you don’t need me to tell you – indeed, possibly just not exercising your rights to the fullest is an example. You may end up benefiting from this a great deal and – who knows – someday you may need one of those friends who find friendship more meaningful than just convenient.
Okay – now for my article….
Over the past year-ish, many equity players are moving – or have moved – into debt. Generally, the view is something like this:
Why should I do equity, when I can do equity returns with less risk in debt?
Yet this point of view is, in my opinion, significantly flawed for several reasons:
First – when I assess the real estate investment world in a macro sense (debt and equity), my theme and theory have always been that a savvy player would seek “to be overpaid for risk.” If you cannot pull that off, then at best you can be an average performer. Moving your investment target from equity to debt doesn’t necessarily move that needle unless you are indeed being overpaid for risk by doing so.
Second – if you are at heart an equity player, and you know that business so well, why would you want to start competing with players who know debt as well as you know equity? In martial arts terms, you are now a white belt stepping in the ring with black belts. Why not stay in a ring where you are already a black belt.
Third – my strongest point, is that when people say the words ‘equity returns,’ they impliedly mean 15% to 20% -- right? But that is what equity returns were 18 months ago! Today, in a market where no one wants to put out equity and many are begging for it, I would think true ‘equity returns’ would be in the thirties. So at 15% to 20% for debt (if you can even find opportunities for that), you aren’t really getting equity returns for debt after all.
Fourth – one of the historical advantages of real estate investing is that it is supposed to go up in value during inflationary times. Accordingly, one countervailing wind to the perceived pricing pressure in today’s markets might be that when we come out the other side, real estate will have gone up quite a bit in value. Debt, of course, does worse during inflationary times for the same reason in reverse.
Fifth – and finally – if you are offered two propositions: Proposition One is to compete in a crowded debt market for a deal. And Proposition Two is to be the absolutely only player for an equity deal. I ask you which one is more likely for you to be overpaid for risk?
I think opportunity (to do advantageous equity deals) is not just knocking on the door for equity players to open it up. Nay, opportunity is outside begging and hammering on the door to be let it in.
I will end with an – obvious – caution. My article is by no means to advocate that one should do foolish equity deals. Instead, it is a suggestion to assess the risk/reward of both equity and debt opportunities with the foregoing in mind.
Best to all.
Bruce Stachenfeld aka The Real Estate Philosopher®