Sam: Hello everyone, welcome to NOYACK’s second thought leadership presentation. Thank you for joining us today. I’m Sam, I’m COO of NOYACK Capital.
CJ: I’m CJ, CEO of NOYACK.
Sam: And NOYACK is a leading wealth tech firm providing education and access to private investments for the next generation of investors. Today we’re discussing what investors should do in a high-interest rate environment. Little housekeeping before we get started: if you have any questions during the presentation, please type them into the Q&A, and we will have time to answer the questions at the end. CJ, why don’t we start with your background and introduce yourself to the attendees we have?
CJ: Well, assuming we have new attendees since we know we do.
Thank you, welcome for joining us. I have been a private investment expert for 35 years. I led a large multi-family organization, an investment syndicate for over three decades, with a specialty in commercial real estate, venture capital, special situations, consumer packaged goods, and last but not least, investment-grade fine art.
Sam: So, similar to our conversation last week, I think what’s interesting about your background, CJ, in this environment is that you’re one of the few managers who actually remembers high interest rates, particularly from the time period during the ’80s. So, I think it’s worthwhile to mention that history because the last time interest rates were this high was probably the late ’80s, is that right?
CJ: Well, 1982, I’ll give an anecdote. I am first generation. My father is an immigrant from Italy who built a large building and construction firm here in New York City. My mother also was an immigrant from Italy, so as a first generation, I was thrust into a lot of situations earlier than most in order to help with things that my father didn’t have a background in. First and foremost was commercial real estate investing. At 15 years old, I was co-developing a large international trade center in Mount Olive, New Jersey, with the Rockefeller Group. At the time, we went for financing, and I remember distinctly how proud my father was to get the best customer rate at the then-bank, which no longer exists. It was purchased by Chemical, which also no longer exists—National Westminster Bank. The bankers were there, and it was a very celebratory moment, and they said, “CJ, Mr. Follini, we’re going to give you the best lending rate we have available for our best customers, and that is 9%.” We were crowing, and my father was beaming. If you put that into perspective now, people would be apoplectic, and there would be catastrophic events in the capital markets if 9% was the prime lending rate for any industry, but that’s what occurred in 1982. That was the experience that I draw upon to look at the playbook going forward. Of course, everything is relative. We have inflation-adjusted numbers, and we have high inflation, which also harks back to those times because if you remember, the last time inflation was at this level, not just interest rates, but the last time inflation was at this level was around the same time in the early ’80s. There are not many young investment professionals who have ever dealt with or encountered a high inflationary and increasingly high interest rate environment, so that’s why we’re here today—to give you some insight from my experience and some ideas.
Sam: So, our goal for the presentation today is to answer these three questions: What to do in a rising rate environment, how to reduce risk while increasing yield during a high interest rate environment, and how do rates affect private investments in general, and to give you some ideas about how to allocate capital in this type of environment.
CJ: So, we should note, I should tack on to the back, that we are solely focused on the private investment universe. We do not opine nor do we comment on public markets or fixed income. We will have a brief foray into short-duration credit but mostly as it pertains to private opportunities. That is the NOYACK universe—the private investment universe. We’ll have another webinar, 3, 4, 5, that’ll talk about why, but yeah, you can watch CNBC for the public markets or Bloomberg.
Sam: CJ, we’re looking at a graph of the average annual 10-year treasury since 1972 versus inflation. They’re clearly quite correlated. What’s the lesson from this graphic?
CJ: Well, obviously, correlation—I don’t think anyone needs me to say that. But there’s also a lag effect, so when you think of the cycle, which we’re about to get into—actually, could you go to the next slide? I thought the next slide was going to be first. This is the correlation that affects where you start in this cycle, and it is a cycle, some say a vicious cycle. So, there is either a Black Swan event, i.e., pandemic, or the 2007-2008 economic crisis due to the lending standards in the residential housing industry. Those are Black Swan events—some are man-made, some are obviously not—both tragic in their own ways. That Black Swan event will then cause a seizing of the credit markets, which then causes the Federal Reserve to lower the federal funds rate. There might also be fiscal stimulus. So, that’s monetary stimulus—tremendous monetary stimulus. Using the pandemic as an example, we had PPE, loans, rent abatements in every municipality. This is all monetary stimulus. And then you have some fiscal stimulus, so it was a blend, and it was larger than this country has ever seen.
So, if you think of the entire monetary system as a cycle, when you inject something into this cycle, like your body, the economy and the U.S. monetary system is a holistic being. When you inject something that is out of balance to what is normal, you get consequences. We did that both fiscally and monetarily during the pandemic, in order to—well, we know why we did it, but there are consequences. So, here’s the primary consequence: inflation. Now the lag effect of interest rates is being felt. So first there is the inflation, which comes from either a surplus of fiscal or monetary stimulus—both occurred in the last two years to historic levels—and now interest rates have to react. The bond market is reacting, which is a decentralized group of individuals, but also the government is reacting with interest rates. So, you have a centralized gatekeeper, i.e., the Fed, and then you have the market, which is a group of individuals making decisions for their own good to advance their financial well-being. Together, they’re making the same decision—higher interest rates, we want more to put money where there is this much fluidity in the monetary system. Fluidity is counted in the M2 money supply.
Sam: Next slide, please.
CJ: This is what I mean by the M2 money supply. So, M2 is, again, the entire stock in the body—in the financial being that flows. Consider it blood—you have more blood, you have less blood, and then there are consequences for being out of balance in any way. But M2 is the blood of the economic being I’m referring to, and as you can see, in periods of 1982, which we just referred to, M2 grew. Then interest rates go to 2008, M2 grew, and then there was inflation. So, the growth of M2 is directly correlated to the rise in inflation.
In policy, the Fed is trying to restrict and reduce the amount of M2 money flow that is in the system, in the monetary being.
Sam: Quantitative tightening—is that what you’re referring to?
CJ: That is quantitative tightening, and they have two main tools: Federal fund rate—next slide, please.
Oh, you can also see—excuse me, back please. You’ll look at 2020—look, these are—you have 2008, you can see the divergence in ’82, and ’76. These were all inflationary, leading to high interest rate environments. I’ve lived through every one since 1982. I was there in ’76, but I wasn’t investing—I think I was playing junior hockey. In 2008, for two years, and then things normalized. You see periods of normalization—look at the period from 2010 to 2019, which was then shocked by the pandemic. True norm, true equilibrium within a range creates a bull cycle—there’s expectation, there’s consistency. But the Black Swan event of the pandemic caused—well, it was both ameliorated and exacerbated by the fiscal and monetary easing of historic amounts, and now it is proving the consequences that everyone expected—high inflation, now lagging, where we have to fix that with higher interest rates.
Sam: So, CJ, one of our—we’re a little early in the Q&A here, but one of our attendees asked, how long do you expect interest rates to continue to rise? And I would add to that, does the Fed have the right toolbox to even tackle inflation with the federal funds rate?
CJ: Excellent question. The nuance is—well, I would pose a question back: Are you referring to the federal funds rate, or are you referring to the market interest rate? Because they are different, and that’s what they mean by saying the Fed loses control—they lose control when the market doesn’t believe that they have the toolkit to stanch what is happening with inflation or general economic conditions. So, the market has a rate, saying, “I am demanding a higher rate for the money I’m investing in treasuries or whatever credit instrument is being put at auction.” The Fed has one tool—what they charge banks to borrow at the Fed funds rate. It’s a blunt—well, we have a slide that says that.
So, do I expect it to continue? I expect the Fed to stop by Q2, but by Q2 they’re also going to see now the reverberations and the effects of raising rates this fast in such a short period of time. Now, I don’t think the rise that the Fed has done over the last 8-12 months has been serious, relatively speaking—it’s the duration of when they did it. They could have risen the same amount, and there wouldn’t have been a ripple in the market if they had doubled the duration and done it slower. But they didn’t have that—they didn’t have that option, frankly. Inflation took that option and took control of what the Fed could and should do.
So, are interest rates going to rise? The government-mandated interest rates, no, they will rise for the next four to six months. The rest—I have no idea because the market is a group of individuals that I can’t tell what they’re feeling, and then you also have the algorithms and the quants in that market also determining what they want. So, I have no idea if they’re going to continue the interest rate rise once the Fed stops the federal funds rate rise.
Sam: Let’s pivot slightly and talk about how specifically interest rates affect real estate. I’ll let you start, CJ.
CJ: Well, it’s real assets—I don’t want to focus just on real estate, it’s all real assets. There are different buckets of real assets. There’s essential, and there’s discretionary, there’s luxury, there’s many different buckets. Obviously, tightening lending standards means that all real assets purchased with debt are going to see a decrease in value because generally, everyone buying a large-priced real asset—even art or commercial real estate, definitely large private equity—requires debt. It’s the ratio that is only to be determined. For example, the sane ratio in commercial real estate is about 60-68%, 65% being optimal, proven over history with a lot of data. Private equity does a little bit higher because they feel there are more levers to raise gross revenue and profits, and thus they can tolerate a higher ratio of debt. Even homeowners—I just saw this morning Barry Sternlicht said it—that the household balance sheet went from 33% cash to 3% cash. And what that means is that they’re raising their individual householders, raising their debt, buying things on credit cards, spending all the stimulus money they got individually, and they’re now going into the negative. And that happened over a very short period of time due to inflation.
So, interest rates are the control on inflation. If inflation has the leverage over interest rates, this is what is happening. So, when you are in the business of investing in real assets and you can’t borrow money at the rate you expected, well, the only other lever you can pull is the price. The price goes down. You say, well, if the price was X, and I was going to borrow Y at a Z rate, but I can no longer borrow at that Z rate, something has to come down in order for that investment to still yield the return expected. They could accept lower returns—that’s always a possibility. They can increase risk—that’s also a possibility. But usually, it affects price. The price comes down to maintain the same levels of return and risk. But these are the three levers that people have when they’re acquiring real assets, and the lending standards change, which they have very dramatically in the last six months.
Now refinancing—again, mostly refinancing. There are so many different—residential, individual, personal, corporate debt—there is a lot of refinancing that is coincidental to this time. Because for a while, people, the investors, corporations, real estate developers, real estate asset acquirers of stabilized properties, utilized floating rate debt, which was generally short- to medium-term duration, two to five years. Well, there’s a large amount of it that is going to be required to refinance. For 10-12 years, it was easy to refinance at the same or lower rate. In fact, refinancing became a profit center. We did it to a great degree—we went from four and three-quarters percent on a $30 million loan, we got more proceeds and a lower rate, paying the same amount, and we were able to distribute 50% of our initial basis investment. It was a fantastic opportunity, and we fixed it so we didn’t have to worry about it for another 10 years. That is the opportunity that was available that we availed ourselves of in an individual fund last year. But people can’t do that anymore because if the refinancing is happening coincidentally at a time where these lending standards are tightening, you’re going to have a lot of corporations, all the stakeholders I mentioned, including real estate owners, say, “I can’t afford the property anymore because I planned on this 2-4%, 3-5% interest rate forever, and that’s not there anymore. It’s 6, 7%, maybe higher. What do you do? I have to sell, and I have to sell fast.”
Sam: Go ahead, please.
CJ: Lower property values—well, sorry, excuse me, I meant go ahead to the next one. Lower property values would—I’ve explained that, obviously—that’s one of the three levers, and that’s the one that usually gets pulled. If you want to sell, and you want to sell quickly, you’re going to lower your price. I don’t think it’s a supply issue right now. I think it’s more of a demand issue in that prices are lowering in real estate, and it’s very, very different by asset class. So, that was a very broad brush I painted, so please don’t quote that as a soundbite. Cap rates are expanding, prices are lowering, but it is different asset class by asset class, and that’s for another moment. I think there’s going to be significant commercial property distress and corporate debt, but we were focused on commercial property distress here. Particularly, there’s going to be particular distress due to the inconsistency of the rates that are going to be presented due to the refinancing that’s coming online. More than the inconsistency, there’s just a lack of it at any price.
So, what is happening in the system is it’s becoming even more out of balance: interest rates go up, but the injectors of this liquidity are pulling back. So, just the amount of blood in the being is reducing. That is how markets seize, which is what happened in 2008. Everything stopped, and that is when you approach the word I never like to use—catastrophe—but a near or total seizing of the capital markets is where you start to get catastrophic economic events. And it did happen in 2008, and we had Bear Stearns and Lehman Brothers go out of business because they all depend on the flow of M2, on the flow of liquidity. Liquidity is basically people with equity or banks or lenders with debt to provide, and that is shrinking in total. There is a potential—not a great one yet, far from a great one—but there is a potential for a seizing of the capital markets.
Now, my last sentence here: buyer opportunities. If you have cash, you are going to be king again. The person I consider a mentor, Sam Zell, always seemed to have cash, as his nickname indicated—Grave Dancer. When graves started to happen, Mr. Zell was always there with cash to buy those opportunities at prices that were very attractive. That’s sort of what we plan on doing this time, and we’ve planned for it over the last three years.
Sam: Plus, I think there are probably some other—you know, there are some creative structures with the tax code, for instance, in 721 exchanges, which we talked about in our last webinar. But anyone who’s ready to buy in this type of macro environment will gain in the future. Is that what you’re getting at?
CJ: I was speaking strictly of supply and demand and the access to liquidity and/or debt, so liquidity in the form of equity and debt. But you’re right. I think there’s also additional financial engineering tools that will lead to efficient cash use. And if you don’t avail yourself of them, and I wasn’t aware of them my whole life—I did things in a very straightforward way, like families or groups of families that get together, how they invest. Everyone puts in money, you buy pro-rata, and everyone has an equal share, more or less, and that’s it—in a monolithic limited liability corporation or some similar structure. But when you realize that this country has tremendous financial tools and if you use them effectively, then the world of investment opens up. And again, that’s sort of why we exist now as NOYACK.
Sam: Eulogy for the 60/40 portfolio? Should I read the quote?
CJ: I’ll read the quote: “For a given level of return, if you diversify, you can get that return at lower risk. For a given level of risk, if you diversify, you can get a higher return. Private investment achieves both objectives.” That’s from David Swensen. David Swensen—the late, great, unfortunately—was the CIO for many years—I think he was there for 28 years—of the Yale endowment. I think it’s still number one in terms of size and return of university endowments, and that was all due to Mr. Swensen’s tenure. If I already said that Mr. Zell is someone I look up to in the commercial real estate sector, well, David Swensen is what I would say is a mentor in the private investment sector, broadly speaking.
I think the 60/40 portfolio put forth by all private wealth management and RIAs, and the entire system of private wealth management, is going to disappear. More than that, we have the great wealth transfer. We’re going to do a whole—I think we’re planning on a whole thought leadership presentation on that. Baby Boomers are passing away, accelerated by the pandemic, and now you have, I believe, it’s $30 trillion passing from Baby Boomers to the next generations—Millennials, or late Gen X where I am, Millennials, Gen Z, and over the next five to ten years, a little bit more in the future, Gen Alpha. They are going to inherit, and there are a lot of surveys that indicate their behavior, and their behavior leads to private investment. They don’t trust the public markets given what’s happened, and look, today FTX is yet another example. They don’t trust the public markets, they’re not keen on gatekeepers, they prefer to direct their investments as self-directed investors with control, and they like to do so in a digital-first environment. And last but not least, these generations prefer private investment.
So, the 60/40 portfolio will morph into 60% stocks, fixed income, and everything else, and 40% private investment that these individuals direct themselves. That is my point for the eulogy.
Sam: So, I think it’s interesting, CJ, that you bring up Baby Boomers and the transfer of wealth to their kids and heirs. I think there’s also an interesting macro narrative as well, because many Baby Boomers turned 65 during the pandemic and aged out of the workforce. There’s a macro argument that they’re raising the dependency ratio of our economy, and that’s going to lead to inflation for a long time, which we could, of course, dedicate a whole webinar to, but I think it’s an interesting tangent from your point.
CJ: I’ll mention on that, absolutely correct. One thing that is not measured by the U6 or even the participation rate—the employment rate, the unemployment rate, U6, the participation rate—or M2 for that matter, all of these government-focused indices don’t measure one thing: skills. It is one thing to say we have the right number of people seeking jobs, but the next thing is: do we have the right skills match to the jobs that are available? Skill mismatch will make inflation more persistent. I laugh when people said “transitory,” they made up that term. Unfortunately, my former classmate at Tufts, Mr. Scaramucci, said it a few times, and I even sent him a note saying, “Please, for your own benefit, don’t keep saying it.” Unfortunately, it’s not aging well—it looks very bad.
Skill mismatch is going to keep inflation more persistent than we’ve had in the last 10 years. And if you don’t know how to do business in a consistent or inflationary environment, learn fast.
Sam: I would also say we’re getting to the best ideas. So, look at this. Historically, I’m going to say one last note—Mr. Sternlicht today on CNBC did say that he believes a recession is imminent. I think he said it was a guarantee.
CJ: Okay, I think that’s a little… it’s a little deterministic. I would say there are things that would lead to a recession, I agree with him to some degree, but it seemed—I think there’s a different issue that is more concerning: stagflation. Stagflation happened in the ’70s and early ’80s. It is worse than a recession. A recession you can grow your way out of; stagflation is a much more difficult challenge. I believe that stagflation is due to the skill mismatch in our economy, and that’s why it takes a long time to train employees or to train for future skill sets for crypto—for, excuse me, cyber security, for software engineering, for video production. These skills don’t happen overnight—robotics, virtual reality—all the things that our economy needs. And that’s why I believe we’re going to start seeing a fourth industrial revolution. That fourth industrial revolution will change, will terminate the stagflation that I believe we’re about to see at some point next year.
Sam: Okay, so what to do? What to do, right, CJ? That’s what we’re talking about. What do we do?
CJ: Yes.
Sam: So, we’ve got the 10-year treasury here on the bar chart. We’ve got U.S. stocks in blue and then gold in yellow. What can we learn from this graph, CJ?
CJ: Okay, so unfortunately, the graph doesn’t go back to the ’70s and ’80s. I’m, again, dating myself—it’s a little depressing, especially at 10 a.m. in the morning, or 11 a.m., depending on what your time zone is. But gold hit $1,000 in the late ’70s. $1,000—think of what that is in inflation-adjusted terms—insane. Because everyone assumed the right playbook was “Go to gold when there’s a higher interest rate environment, inflation interest rate—go to gold.” And you’ll see the same thing in 2002 as inflation was coming back post the dot-com crash. And then as things normalized, everyone flees gold because there’s no yield, really. It’s strictly a legacy store of value. It has been effective as that for a long time. I think that’s changing. It’s definitely not going to be Bitcoin, but I think the idea of a store of value with gold as number one is changing. And 2020, ’21, ’22—you’ll see that the non-correlative nature of what people thought gold provided is no longer valid. Look at how correlated it is to what we’re seeing in the stock market, to the treasury. Unfortunately, it is a positive-to-negative event correlation, so gold is not my suggestion.
Sam: Next?
CJ: Okay, the blue obviously is the rise in interest rates, the blue bar. Now look at mortgage and equity REITs—we’re using them as proxies. There’s a lot of nuance in even that very statement. There’s a lot of segmentation in mortgage REITs and equity REITs, so forgive me if I don’t have another two hours to go into the detailed microeconomic discussions for either of those. So, let’s just use them as a simple proxy. Short-duration credit, taking advantage of these interest rates—but on the side of the investor, meaning you’re now the lender, or you’re investing in lenders, is a great idea. Something that I have individually, and as a group, as an organization, is pursuing and will pursue: short-duration mortgage. There are ways to do it. One of the ways we’re choosing is a REIT—a mortgage opportunity REIT for luxury home builders, two years with the credit markets freezing up and seizing, as I’ve said before. Well, who’s going to give them the credit to build these $500,000, $1.2 million homes on the four lots that they own for? They need construction lending for 18 months. Well, they used to pay 6-7% to M&T Bank, Bank of America, or similar institutions. Now, those players are not available, so they go to private credit. And now it’s no longer 6-7%, it’s 9-11%. Well, they’re still going to do business, but it’s going to affect more inflation on the sale price of those homes. But someone is going to get the benefit of that 9-11% rate that those home developers are paying. The mortgage REIT—and I like short duration, meaning one to two years, which is what construction lending is. So, I also like short duration in the fixed-income treasuries, but that’s not for this conversation.
Sam: And what’s the benefit of short duration in this kind of environment? Can you go into that a little bit?
CJ: Well, things change, and in one to two years, you can control the time of the pivot. So, first of all, the yield curve has inverted greater than we’ve ever seen. So, the yield provided by the one- to two-year treasury is north of 4%, and it’s risk-free. It’s very hard for alternative investments to compete to gain equity or gain investors when the risk-free trade is over 4%. People think that’s good enough, so why would I take risk—even minimal risk—when I can get no risk and still get 4% plus? That’s what’s happening. Everyone is fleeing, including the sovereign wealth funds. That’s why Blackstone is selling so many buildings. Almost every—it’s insane how much they are selling, because all of their investors are saying, “Hey, why am I in those big boxes? Put me into treasuries—I’m leaving, get me out. I want to go into treasuries.” Unfortunately, they may not have heard that it’s not that easy to sell real estate in one, two, three—it’s not a public market. You’re supposed to be there for a long duration, not in and out.
And if you look at the equity REITs represented by the—what is that, the ochre gold line? What color is that? I think that’s our colors, I’m not even sure. The ochre line. Same thing, if inflation is inflating certain critical need assets—well, if you have a time horizon greater, then you’re going to have the tenants raise their rates. And if you don’t have to refinance, you may be locked in at a low rate, gaining a much greater spread, because a lot of smart commercial real estate investors fixed rates for seven to 10 years at the best times. We did that last year on everything, so we don’t have to worry about refinancing. So, critical need commercial real estate that does not require refinancing is very attractive.
Sam: Next?
CJ: And you can see this data—excuse me, I didn’t even point to the data previously, sorry. You’ll see this is an agglomeration of equity REITs, and you’ll see how well it’s been doing the last two years, and continuing to do so.
Sam: REIT strategies?
CJ: I’ll focus just on REITs—triple net leases. Every increase goes right to the tenant. Unfortunately, they have to pay more. CPI indexation—well, if the CPI is going up, your rent is also going up. So, these two ways are leasing strategies that insulate an owner of real estate or a REIT from the risk of inflation and even higher debt service.
Those two things—long-term fixed rate debt—I already mentioned that. It is an asset to real asset owners, all real asset owners. If you imagine your home, you got a 15-year mortgage at less than 1%—maybe it’s a jumbo or less than 2%—and you’re set for 15 years. Imagine if you didn’t do that and you now have to do it, and you’re saying, “Well, it’s not 2%, it’s 5% now.” Well, think of how much money you don’t have available to you as an individual because it’s all going to the lender. That’s the difference, and that’s why long-term fixed rate debt done at the right time is actually an asset. It brings value to the asset it has been leveraged against because anyone would say, “Hey, can I assume that long-term fixed rate debt at 3%? Because I can’t get 3% now, so if I can assume yours, I’ll pay you a little bit of premium—the spread between 3% and the 6% I can get, I’ll give you 1% added onto the overall value.” That’s why it’s an asset or added value.
Sam: Lease duration?
CJ: Well, lease duration is tricky, and it depends by asset class. Lease duration is better for some, shorter is better for other asset classes. We deal with critical essential need real estate, mostly in markets where rents are going up. So, I want the opportunity to raise rents when a tenant departs or when a lease expires. So, we seek shorter lease expiration in supply chain assets because demand still outstrips supply. So, any real estate where the demand outstrips supply, you want a shorter lease. If your tenant is paying more than the market and there is not a lot of demand in the same market, well, you want that tenant to stay right where they are.
Sam: Next?
CJ: Asset selection—I already talked about that. It is critical, it’s everything. We focus on essential need assets critical to all of our living lifestyles, obviously multi-family or homes in general, single-family homes. For us, it’s supply chain and logistics because we all want our Amazon deliveries same day, we all want our food there when we want it, and we don’t want to drive really far to go get these things. So, if we want that e-commerce that we have become addicted to, we need a lot of supply chain assets—and a lot more.
Sam: I think it’s interesting you mention Amazon in the context of the duration as well, because I bet they wish their Amazon leases from two years ago were a little shorter right now.
CJ: You know, that goes both ways. Again, this is really getting in the weeds, but it depends by market. It depends even by asset. You could get so microeconomic on that issue, so granular, as to say that in the same market, “I wish that asset had a longer duration, and that one had a shorter one.” It’s tricky. It’s too broad a brush to really understand the benefit of lease duration in particular markets and asset classes.
Sam: Okay, we’re getting to the end. We have some questions, but we’ll get to them in a second. So, conclusions?
CJ: I don’t think you want—I think everything public is going to have a taint, and I think there is a broad brush that is wiping across the stock market because not everything is this bad. In fact, that’s a general statement—nothing is ever as bad as it looks, and nothing is ever as good as it looks. But the reality is that there are a lot of good stocks out there that are being affected by the overall public market because of the volatility, which is why private investments are not subject to the same volatility. One of the things—there are many—diversification, stability of income, control over asset class—but one of the things I really appreciate about private investments is you normalize volatility because you have a longer time horizon. You can control your time of exit, and you’re not affected by the vagaries of someone waking up in the morning in Bali or the Bahamas and realizing they’ve done bad actions. And then the entire crypto industry or some other industry collapses, and everyone sees the negativity on Bloomberg and CNBC, and they just sell everything, even if they shouldn’t. You’re not subject to that, to those bad decisions.
The public markets are about emotion, private investments are about investment fundamentals. People will affect a public market based on how they feel that day—on negativity, on positivity. You cannot do that in the private market, so I do not want to be at the whim of how someone feels that day.
Sam: I was just looking at a comparison of public versus private REITs yesterday, CJ, and on a 20-year basis, private REITs have something like 70 or 71% less volatility than public REITs, just to crystallize this conclusion here.
CJ: Thank you, that’s a much better stat than I gave you. I gave you the overview, and Sam, of course, gave you the data because Sam is very good at that, and it’s exactly what I’m talking about. Thank you, Sam.
I think there’s a lot of opportunities, depending on which side of the transaction you’re on. If you’re looking for debt, not such a good time. If you have cash, and you’re a lender or a private lender, or you’re a buyer, it’s going to be a really, really good time. And luckily, we’re in the latter—we have and are gaining a cash position from decisions we made two and three years ago. So, yeah, I don’t want to sound like a grave dancer, but frankly, what is already going to happen—from no fault of mine, of course—but what the universe is going to bring is going to be beneficial for individuals and organizations that have cash to invest.
Sam: Diversification of debt expirations?
CJ: Well, that’s obvious. You never want, if you’re looking at an organization—even if it’s corporate—look at their debt, look at their balance sheet, and also you can get more granular. Find out when is the expiration over time of that debt. If there is one year where 70% of their debt comes due, that’s really bad because what if it’s a bad year? What if it’s a pandemic year or the reverse, this year? So, a diversified debt expiration over a longer period of time is a good organization and one you want to be either invested in or part of.
CJ: And last, last but not least, I’m going to give you the takeaway—the key takeaway. These are the three things I am personally investing in and that we are advising or offering, and I think they’re the most important:
- Commercial real estate, critical need—not all. There are many, I’m not going to talk about the ones I’m not going to do, but critical need multi-family housing, single-family housing, depending on whether it’s debt-sensitive. So, critical need commercial real estate does depend on debt, but if you’re entering it now and investing, you have a longer time horizon, and there are actually better opportunities than before.
- Investment-grade fine art—not going to go into too much detail here, but for a hundred years, in fact on CNBC again today, this is auction week, and the numbers are outstanding in what is generally a challenging economic time. Why? Because people know, and the data shows, that investment-grade fine art—that’s a definition of fine art that has had a liquidity history, it’s traded at auction, there’s a public sale of it, etc.—investment-grade fine art is one of the best stores of value in history. In history, back to the Renaissance, people stored value in tumultuous times in investment-grade fine art.
- Last, I already mentioned, short-duration private credit. I think there are tremendous yields and opportunities in shorter-duration private credit, and that’s one to three years, optimally two. And you just have to figure out the best way. Our way is in a REIT—the way we see the best opportunity is a REIT that lends to builders who are still going to build but don’t have access to the same credit they had before. Their lenders are no longer lending, or their prices are insanely high and their standards are tighter. So, we fill that white space, or short-duration private credit fills that white space at much higher prices and great yields.
Those are my top three ideas for 2023.
Sam: So, CJ, we’ve got a couple of questions here. We’re going to pivot to our Q&A section, the first of which is: Is there anything we can do now to avoid a longer period of stagflation?
CJ: Education. I know that seems—there’s no easy answer to that. First of all, let’s find out if I’m right, and that’s going to take time. I think training—workforce training, absolutely workforce training. Get more people—the people are there, skilled and ready to work, but the skills they do have are just not matching the jobs that are required in this new economy that’s entering a fourth industrial revolution. Close that mismatch gap—that will grow us, that will grow this country out of stagflation.
Sam: Yeah, I would add regulatory reform to that list. I think there’s a lot we can reform on the regulatory side, especially how we regulate different types of energy, that could be beneficial as well. But, very complex topic. I cannot answer a question without getting into an hour-long conversation on regulatory reform.
CJ: Yeah, but you just came up with another thought leadership presentation topic—we have five already from this one.
Sam: Okay, next: What other private investments would follow a similar trend to gold?
CJ: Good question, good question. I generally look for positives, not really for negatives. Obviously, if you’re looking for good ideas, you’re going to avoid, just by the definition of the Venn diagram, bad ideas. So, I haven’t really focused on what I would avoid because I don’t short. I am not in that business, so I’m going to have to get back to you on that. Again, I try and look at things to do, not things not to do. And again, I don’t short, so I’m not looking for the negative. Obviously, gold was apparent to me because I remember how important it was 30 years ago and 20 years ago—it’s been a standard playbook suggestion.
I would say another one is—I think venture capital provides a super critical need in this country. A lot of innovation has come from venture capital. Would I do it now? No, not at all. Not because it’s any worse or it’s not needed—because your exit is so much longer now. You just added two, three, four years to the life of a five- to seven-year investment. So, if you have a 10- to 12-year time horizon, fine, venture capital is still as good as it was, but if you don’t, the value of those cash flows is much lower with higher rates.
Sam: So, there’s that to consider as well at the moment.
CJ: Yes, but if you’re entering now, you’re not worried about an exit in the next one to two years. So, this is about what would I do going forward, not retroactively.
Sam: Well, and I think there’s an interesting connection between the VC point and this question of gold. And we were actually coincidentally just talking about other commodities that have a better investment profile than gold before the webinar started. But, you know, Andreessen Horowitz just did their American Dynamism Fund, and they’re investing in this onshoring trend and all those kinds of things. So, I think there is a pivot into what categories VCs are deploying dollars in.
CJ: Absolutely correct. I would just diversify by how to—like, for example, onshoring. You could invest in a supply chain REIT. I’m not saying that because we have one, but I agree with them, I agree that I want to invest in onshoring. I would just do it—I would just execute it differently than they would. I just don’t think, you know, high growth, no yield, high growth, no yield is going to be sought after for a long time. I just don’t. And again, I am a very active venture investor—75 investments over the last 10 years, but not now.
Sam: So, this is an excellent question: What should I tell clients who are deterred by private investments due to lack of transparency?
CJ: Well, in the world of FTX—great question. The world is going to move more toward what Cathie Wood and ARK Invest is doing. Obviously, I would prefer she had better performance, but her principle of radical transparency is going to become a norm. She was an outlier, she is an outlier in that respect, I believe. But this is about ESG. I think the “E” (environmental) and the “S” (social) should be government-directed; sustainability should be individual-directed. But governance should be corporate, and the “G” in ESG should be the focus of every corporation. I could go on another tangent about carbon credits and about greenwashing, fake environmental and sustainability trends, but there’s one thing that every company can affect meaningfully: their governance. And what is number one in providing better governance? Transparency. Every company can do that right now without any critique—be more transparent. So, my answer to you is: find the ones that believe in this, find the ones that are more transparent, because they are out there, and there will be more of them. Obviously, we believe in it because that’s why—just my voice rose because it’s a very important and personal point to me.
Sam: Next up: What would your allocation of 40% of private investments look like?
CJ: Wow, wasn’t ready for that question—I should have been. That’s a pretty broad question.
Sam: Yeah, it’s a little broad.
CJ: I’m going to—I hesitate to do this, but: 50% critical need real estate, 20% collectible asset with liquidity history, i.e., investment-grade fine art, and 30% private credit of multiple durations. I would put private equity in there, but I’m not ready to answer that question. I would probably change this answer in six months when I see recession versus stagflation. I need six months to give you a more appropriate answer where the future is, but for now, that’s what I have been doing. So, I would say the last 12 to 18 months is what I’ve been doing, but that may change in six months when I see recession versus stagflation or both—obviously, they can be both.
Sam: Yeah, that’s it.
CJ: Is that all our questions?
Sam: There’s one more.
Sam: What is an UPREIT, and how does that help your acquisition strategy during a rising rate environment?
CJ: For any viewers who don’t know, an UPREIT is a 721 exchange—that’s how it’s referred to in the tax code—and it’s a means of acquisition other than cash, or in addition to cash. So, CJ, can you take that question?
CJ: Well, I think we talked a lot about it in episode one, but for me, it’s about cash efficiency. If you can’t get affordable debt, that means you’re going to need more cash, or you’re not going to do something, or you’re going to take more risk. These are the options someone has to invest. For me, the UPREIT only pertains to REITs, and it only pertains to commercial real estate. But the general issue is cash efficiency—manage your cash. Another—wow, I had a lot of people preempt my presentation today—John Malone said it today in an interview: “Manage your cash.” That was his—he said, “I say it every time I speak to David Zaslav,” obviously Paramount. My number one advice is: manage your cash. Now that is king. Manage your cash, and UPREIT is a cash management, cash efficiency tool that’s part of a great tool in the U.S. tax code.
Sam: Great. I think some great questions—excellent questions, everybody. I really appreciate all of them.
CJ: So, I think with that, we will conclude. This has been our second thought leadership presentation. I certainly enjoyed it, and I think we had—we’re only at number two? I thought we were at eight or ten—God, it seems like we’ve done so many.
Sam: And I think we unpacked a lot of ideas that we can discuss in future episodes.
CJ: Love it. Thank you, Sam. Thank you to all of the attendees. Feel free to reach out—we’re happy to share. We’re all about education and transparency.
Sam: Thanks, CJ.
CJ: Bye. Thank you, Sam.
