I love sports and in my spare time enjoy sitting very close to the action. Whether it is basketball, football, baseball, hockey, soccer, water polo or boxing, there is nothing like seeing top athletes competing to win. Perhaps it is because I was an athlete through college or that I appreciate a true meritocracy which draws me to it.

In sports, when your team is on a winning streak and enjoying the momentum of good fortune through hard work, there is a feeling of invincibility. There have been times where one of my teams is rolling and I can’t imagine how we would lose; until we do. This can be translated into business and other aspects of life and I want to share that analogy to purchases of apartments.

In the last few months, precious metals like gold have been battered and are well off their highs. Bonds are getting hammered and one of the most successful funds (The New York Yankees of the bond funds if you will) in that market (Pimco’s Total Return Fund) has faced losses and large redemptions as bond yields have jumped. In Figure 1, we see the downward momentum that the price of gold is enduring.

 

In Figure 2, we see that gold had a very nice multi-year run and enjoyed positive tailwinds. In fact, I remember articles stating that this precious metal’s price would soar past $2,000 and that this would be the new hard deck (low price) for its value.

 

What about apartment values? Just about every market across the US has enjoyed appreciation over the last few years. In other words, there is plenty of momentum behind the strong market and it can be easy to forget that we as apartment owners are in a cyclical business which thrives and suffers due to forces that are outside of our control. Bond yields moving up which gave the whacking to bond investors are one such force which are a negative for apartment owners.

While a number of industry economists (shockingly the most that I read about or watch on the varied financial networks are employed by brokerage houses that benefit from upward momentum of a bull market) are still quite bullish about apartments, please allow me to refer you to last month’s Apartment Reporter as a reminder to remain cautious.

I have certainly opined that I believe interest rates will not remain at record low levels forever and that investors will eventually demand higher interest rates to continue buying US government debt. As that happens and interest rates rise for debt to purchase apartments, capitalization rates (Cap Rates = unleveraged rate of return on an investment) will rise as well. Unless the property income increases at the same rate, values of the properties will drop.

Therefore, as interest rates have roughly risen about 50 basis points (1/2%) from the low, one would assume that Cap rates have moved up by that same amount. That has not happened.

The big question that all potential buyers should be asking themselves is whether momentum will turn negative. My answer is that of course it will but who knows when that will happen. As mentioned, there are forces outside of our control that will affect valuations in our industry.

Therefore, it is vital that we use the Warren Buffett’s standard when making a purchase. His buying principle is that we must be willing to own and never sell an asset that we decide to buy.

Regarding interest rates, I do not believe for one second that the Eurozone has solved their debt problems and think we will see many more ugly announcements coming from across the ocean. China has its debt and transparency issues as well. Japan is printing Yen faster than we are printing dollars while seeing their population decline. Unemployment in most places across the planet is also high. In other words, cans have been (and are still being) kicked everywhere. All the while, governments from Washington DC to nearly every capital around the globe desperately want low interest rates to finance their deficits and will do almost anything to keep them low for as long as possible.

In other words, I think we will see low interest rates in the United States for the foreseeable future which is how I am basing short-term decisions. At the same time, I am paying higher rates for 10 year debt on my purchases now so that when our Federal Reserve and governments around the world run out of powder, I don’t find myself in a squeeze as quickly as I would with five or seven year debt.

Lastly, I am typically borrowing at a lower loan to value so that I have some breathing room should that squeeze come in a decade. I sleep better knowing that I have built in some theoretical cushion for the future.

For those of you who are selling right now, I hope you are enjoying this momentum. It is great while it lasts!