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Written by Elijah Levine

CEO of Black Mountain Investment Group

April 29, 2024

We are in a slow burn market repricing… transactions are slow because both buyers and most sellers don’t necessarily have a lot of pressure to transact. Sellers, even if faced with higher debt burdens, do not want to refinance and potentially have a lot of their equity value wiped out, while buyers simply can’t afford the debt payments on their target assets at the prices of yesterday’s low interest (and cap) rate environment that sellers are seeking to transact at.  

That said, I just happen to think that most building owners are in a lot worse situation than many are letting on to, especially publicly, and we are already starting to see signs of this happening (see ‘The Greater Recession,” the first part of this three-part article series).

What that means is that those with cash, particularly those who have had to transparently show their cash holdings- like REITs and well capitalized funds, family businesses, asset managers, and perhaps even some local operators- are going to be in prime position to negotiate with banks in these times of distress to get great assets at attractive prices. I think this is something a lot of people see, but that just takes time to be reflected- hence the “slow burn.”

REITs are the underdogs of the current real estate markets. While most real estate investment businesses have spent the last decade plus over-leveraging and purchasing assets at nonsensical valuations, REITs have largely been transacting at modest leverage rates and valuations. Now that rates have risen, public REITs have been crushed in terms of their valuations to a rate that private markets have not even begun to catch up with.  

Why is this happening? Well first and foremost, REITs give investors much more liquidity and much more transparency into their operations as compared to private real estate owners, investors, and operators. This creates all sorts of opportunities for REITs but also problems in times of required liquidity and uncertain valuations like we see today.  

Take Apollo’s ARI REIT, for example, which is down 44%+ from pre-COVID levels yet still offering investors a 14% annual dividend yield- better than many private real estate fund investments.

There is clearly a dislocation across these markets, and something has to give. As I talk about in much more detail in The Greater Recession, it’s very likely that private real estate prices will have to fall for it to make sense for buyers to buy them, but who will be the buyers? 

Well, in order to buy something, you need cash. And who has the cash? Firms like Berkshire Hatheway that don’t over-leverage like most of the businesses in the world. If I had to guess, 70-90% of private firms are over-leveraged in a big way.  

We all know Apple, for example, has a lot of cash because they must publicly report their cash holdings and Steve/Tim have built one of the most successful and resilient businesses of all time. However, most people and businesses never have to disclose their cash holdings publicly and this is especially true in the world of commercial real estate.  

From the conversations I’ve been having, it seems like most people are extremely stressed out right now over money and don’t have a lot of cash- which makes sense as most people have grown so accustomed to free money during a prolonged period of low interest rates. That goes for wealthy business owners I know as well as my middle class friends.  

At Black Mountain, we underwrite dozens of deals every week and have reviewed over 1,000 business plans since inception. From what I’m seeing and the discussions I’m having, it’s clear that middle market players are nowhere to be found- an enormous chasm has been created in the investment space. A world of “haves” and “have nots” in a bigger way than most people realize. That goes for real estate, tech, private equity, crypto, and more. 

Not only is the middle market nowhere to be found, but the biggest players in private real estate aren’t transacting much at all- at least openly and honestly- and small players aren’t paid attention to in any meaningful way- although they absolutely should be… In my experience, small transactions set the tone for medium-sized transactions which then set the tone for the larger transactions and therefore the overall state of market sentiment.  

Setting that aside, much like Apple and other public companies, REITs are businesses that must transparently report cash holdings, asset valuations, and other operational cash flows. Because REITs have remained disciplined while private markets have taken exuberant advantage of cheap money, REITs are now in a prime position to scoop up these distressed private assets that are starting to pop up and are only going to continue doing so.  

Think about the current positioning of REITs like SPACs, shell companies with lots of cash that can go out and buy a business (these businesses being distressed private real estate assets). Even though most REITs obviously have their own assets already, many also have meaningful amounts of cash that they can go out and buy other assets with as well- putting them in a prime position to take advantage of this distress being caused by higher interest rates. 

There are massive counteracting forces of supply and demand happening across geographies and asset classes- not to mention the deflationary impact of modern technologies like AI that we are only beginning to understand the true implications of. Things are heating up and cooling down at the same time. Even though we are likely to experience some level of wealth destruction, the rubber must meet the road at some point in time (price discovery). 

I could be completely wrong about this, but I happen to think that we are sitting on an absolute house of cards when it comes to our global financial system and that supply-constrained assets like Bitcoin, very strong tech businesses, and real estate are going to be some of the only assets left with any value worth fighting for. Those left with cash and those lending money at these higher rates will be the ones who determines exactly where that rubber meets the road and therefore the ones who set the tone for where prices should ultimately land.  

This will once again of course be different for all assets and across different geographies, but I think it’s safe to say this is one of the most thrilling times ever to be an investor. 


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