Growing Disconnect Between Risk and Reward in Opportunity Funds
Due to low interest rates and the availability of capital, for the first half of 2004, RCG Longview has noted a disproportionate amount of deals in Ground-up residential development, condo conversion, un-entitled land aquisition and 90% plus leverage transactions.
By David Valger & Gideon Gil
June 23, 2004
The headline for this article could just as easily have been ‘Record Capital Availability Grips the US Real Estate Industry’ or ‘There’s Never Been a Better Time to be a Borrower’.
The observations which we can make about the high-yield sector of the real estate market correlate directly to the fact that there is approximately $47+ billion of capital awaiting deployment in some 35 + fund strategies.
During the first half of 2004, we at RCG Longview have seen a disproportionate amount of deals with at least one of the following four characteristics:
1. Ground-up residential development,
2. Condominium conversion,
3. Un-entitled land acquisition, and
4. Ninety-percent plus leverage transactions.
Geographically, the areas experiencing a high level of activity include the Tri-State New York area, Washington, DC, Coastal Florida, Southern California and Las Vegas. Taking advantage of historically low borrowing rates, it sometimes seems like everyone is working on some type of condominium project.
The super-competitive lending market, fueled by the consumer’s desire for home ownership (and in some cases second-home ownership), will be tested as interest rates continue their upward climb.
Experts agree that as interest rates return to the historical mean, the real estate market will readjust to a new equilibrium which could include: decreased liquidity as investors re-allocate funds to alternative investments, decreased valuations driven by an increase in cap-rates, and a decrease in supportable leverage at the property level.
While the volume of activity is encouraging, we at RCG Longview are faced with the challenge of originating longer term deals that have the appropriate risk-adjusted level of return we believe our investors expect.
In this competitive capital markets environment, we believe that pricing of returns has dropped to a level that does not appropriately compensate the investor for the level of risk.
It is a phenomenon that we believe will create opportunity in the next cycle.
While the market makes competing on price alone tempting, we believe that fund specificity is what ultimately wins us deals.
At RCG Longview our differentiation does not change but always includes our ability to close transactions quickly, structure creatively, no re-trading and overall deal flexibility.
Our strategy is to take an owner’s perspective and focus on the real estate, not the financial engineering. We are able to deliver on this as our General Partners own and operate over 30 million SF of real estate and 15,000 apartment units in almost every major U.S. submarket.
So far this year RCG Longview has invested over $50 million in a dozen transactions and has another $70 million of deals in the pipeline slated for closing within the next 45 days. Our hope and expectation is that as interest rates rise, and we enter a new real estate cycle, the risk versus reward proposition will be positively impacted by additional yield on future transactions.
