“About eight years ago, I was going down the elevator of a hotel in Las Vegas with a friend of mine,” Arnaud Karsenti told me. “The elevator skipped the 13th floor. And my friend said to me, ‘How come there is no 13th floor? What a bunch of wasted space!’”
The lack of a 13th floor comes from the same fear that prevents people from walking under ladders or causes them to shiver when a black cat crosses their path. But Arnaud decided to make a business out of it. The idea is to find value where others fear to go.
Arnaud is the managing principal and co-founder of 13th Floor Investments. The firm manages the Florida Real Estate Value Fund, which, as the name implies, focuses on real estate value investing in Florida. Recently, while in South Beach, I tried to catch up with Arnaud, but our mutually jangled schedules couldn’t mesh. We talked later by phone a couple of times.
I want to share what Arnaud and 13th Floor are up to, because you’ll get a fascinating ground-floor view of what’s happening in real estate in the post-bust world. There is also much investing wisdom in what he shared. Finally, the Florida Real Estate Value Fund itself is a fine alternative investment idea. (Later in this letter, we’ll look at another opportunistic way to play distress in real estate.)
Arnaud and I started talking about how there can be a big gap between the big picture and the view on the ground.
“There’s been a lot of conflict in the data,” Arnaud told me. “Housing is a great area where you can take out the paper every day and read about pricing going down or unemployment pressures, yet the local data in Dade and Broward counties [in Florida] indicate a reverse trend. One challenge for us is to decide what we believe and try to cut through some of the noise of the big macro stuff to really understand what’s going on.”
To do this, Arnaud and his team rely on the good old spadework of due diligence. His business partner, Robert Suris, is a local developer and contractor with a keen sense of property value. Together, they meet with builders and bank presidents and dig into local markets.
This helps avoid the two big problems with the big-picture statistics: They are backward looking and tend to paint with too broad a brush. Still, Arnaud says there are unmistakable big-picture trends unfolding in real time that are worth paying attention to. He highlighted some important ones:
Housing has bottomed. Housing sales and starts are as low as they’ve been going back to the 1960s. Prices have fallen and interest rates are at all-time lows. In most markets, it is now cheaper to buy than rent. Strong rental yields help set something of a floor under prices. There is still a lot of distressed inventory, which is an opportunity that investors slowly munch away on.
There is a continued influx of foreign buyers. Buyers from South America in particular fuel a lot of activity in South Florida. Arnaud noted they typically pay all cash. They also focus on Miami’s urban core. To a Brazilian, Miami is cheap. While I was in South Beach, I was not surprised to hear so much Spanish. I was surprised to hear so much Portuguese.
Money is cheap. The amount of money sloshing around and the cost of that money drive real estate activity. With interest rates at all-time lows, some rental properties already trade above pre-recession levels. Cheap money won’t last forever, but with the Fed committed to low interest rates to 2014, it seems unlikely to change soon.
A shift from homeownership to renting. The homeownership rate dropped big-time when the bubble popped. After peaking at 69.4% in 2004, the national homeownership rate is now the lowest it’s been in 13 years. There are a lot more renters now, and not only because of the stresses of the bust.
“It used to be that people got married and then they’d move into a house,” Arnaud said. “Now people do that in their 30s. If you look at what people are doing for that extra 10 years of single life, you see that they are spending more time renting.”
Let this speak to the danger of looking too much at past statistics and thinking that they will automatically revert to some magical mean (or average) of the past. “You can’t just pick one statistic and then assume that things are going to revert to the mean because the mean itself changes,” Arnaud said. “Secular changes within a trend can affect the mean permanently.”
I asked Arnaud about how long of a window he thinks we have to pick up bargains in real estate. His answer was it depends on the property type and location.
“In Miami, forget about it,” he said. “Apart from a couple of special situations that we are involved in, I think it is very hard to find distressed opportunities in Miami right now, as most of it has been picked through. The world has decided that ‘Miami is back.’ It’s almost a boom-like feeling. I thought it would’ve haven taken longer to come back. But it’s right here before us now. People are developing everything from condominiums and multifamily to retail and hotels.”
Arnaud’s fund, though, is not purely focused on distressed opportunities, nor is it focused on Miami. “It’s just that distress has been where the most opportunity and action have been in the last couple of years,” he said. “And we’re not focused just in Miami. We have a minority of our holdings in Miami. We’re very active in other parts of Florida, such as Naples and Fort Myers. And we’re starting to get active in Orlando.”
The challenge is to balance value investing principles with growth. “If you read about Seth Klarman’s investing approach, for instance, it’s all about buying below book value, below liquidation value, below replacement cost [or the cost to rebuild].” Klarman, as you may know, is a great investor. His Baupost Group has delivered a nearly 500% return to its investors over the past 11 years, while the market rose 7%.
“If you do your job right as a value investor, you’re going to benefit from the growth whether you like it or not. But if you rely strictly on your value investing lens, you may miss out on some growth opportunities,” Arnaud warns. “Still, as an opportunistic value guy, you have to be able to live with the trains you didn’t catch.”
There are other pitfalls in being too cheap. “One of the dangers of value investing in real estate is buying the wrong product,” he said. “Buying something at a big discount to replacement cost could be a mistake. We just passed on a deal that we could still buy for below replacement cost. But we realized that the reason was the product itself was not a quality product. If you just value everything off a spreadsheet, you can lose sight of some of the intangibles of real estate that drive demand.”
Those intangibles include aesthetic considerations. “The Brazilian guys who come and want to buy property in Miami are only going to buy quality. They are going to buy value, but they also want something that they think is attractive.”
So far, 13th Floor has done a great job navigating the waters. It was early picking up condos in Miami and is now in a position to sell a condo tower for a 36% annualized return. It land-banked a lot of inventory for national homebuilders when no one wanted empty lots. Now 13th Floor is in a position to sell lots to national builders seeking new land, earning annualized returns of 21%, 34% and 29% on three projects. These returns kill what the stock market has done over the same short time frame.
Chris Mayer,for The Daily Reckoning
Chris Mayer is managing editor of the Capital and Crisis and Mayer's Special Situations newsletters. Graduating magna cum laude with a degree in finance and an MBA from the University of Maryland, he began his business career as a corporate banker. Mayer left the banking industry after ten years and signed on with Agora Financial. His book, Invest Like a Dealmaker, Secrets of a Former Banking Insider, documents his ability to analyze macro issues and micro investment opportunities to produce an exceptional long-term track record of winning ideas. In April 2012, Chris released his newest book World Right Side Up: Investing Across Six Continents.
Does due diligence include looking at a weather report? When housing actually does bottom, and that would be when the Great Correction finally overtakes the Fed, the Gov, Wall Street and Main Street, I’d prefer to invest where there isn’t a Black Swan season. If the fight against the correction goes generational, then we have a great deal of time before we need to worry about opportunities in housing. Just look at Japan. Are people buying? Sure. If they bought last year are they underwater this year? Probably.
Did someone make money on the deal? Usually.
New Orleans still hasn’t fully rebuilt…
Ben Graham was Warren Buffett’s mentor and the founder of value investing.
Buffett even named his son after Graham and calls Graham, his second greatest influence after his own father.
Anahin (www.anahin.net) gives a comprehensive analysis of the stock market – all 4000 stocks listed on the NYSE and more – using all of Ben Graham’s principles.
Generally speaking, gold miners are bad businesses. They bury perfectly good cash in the ground and tend to issue lots of shares just to stay afloat. So when one comes along that actually turns out to be a good business, it's important to take note. Chris Mayer has found just such a company. Read on...
Ukrain's new anti-Russian government may soon privatize the country's energy sector... at least according to one pro-Russian news agency. Of course, if the reports are true, this could have significant implications for entire region, and may be a win-win scenario for anyone reckless enough to buy Ukrainian government bonds. Dave Gonigam explains...
People tend to believe they are endowed with a few specific "rights" - property, liberty, happiness, etc. Unfortunately, as Harry Browne explains, rights only exist in theory. In practice they don’t accomplish much - no matter how much people may discuss them. Read on...
Politicians and bureaucrats are notorious for manufacturing euphemisms - clever but deceptive substitutes for what they really mean but don’t want to admit. That’s how the phrase “revenue enhancement” entered the vocabulary. Apparently, some courageous government officials can't bring themselves to say "tax hike." Lawrence Reed continues...
Whatever your feelings on global warming, the fact is, right now, the world produces an unsustainable amount of carbon dioxide. So much so, that the UAE - a nation that depends almost solely on oil production - is committed to the development of renewable energy sources in the near future. Stephen Petranek has more...
There are only two possible outcomes of the Russian annexation of Crimea. And neither one involves Putin withdrawing from the region. But what does this conflict portend for the financial markets? Anatole Kaletsky explains, with an examination of how similar scenarios developed, along with the corresponding market reactions. Read on...