One relationship says it all 1

Real estate and the Federal Reserve
May 16, 2016

A real estate mogul finds history a bore; and focuses on Fed actions instead.

Ms. Nunez had prepared her dress outfit the night before. “Since I was a girl,” she said, “I didn’t leave any room for chance. I not only prepared myself for a prosperous future, but I knew it would eventually arrive.” And as it turned out, she was right.

Her career in real estate spans over five continents, with over two million square feet of real estate owned and managed. It is a humbling experience to hear this vibrant 74-year-old woman discuss real estate.

Ms. Nunez’s real estate portfolio consists of ten office buildings, seventeen retail properties, and twenty-eight residential homes. California represents 65 percent of her geographic exposure. Her portfolio market value is $165 million and is encumbered by $110 million of debt. Her wholly owned management company consists of an executive assistant, a leasing director, and an engineering director. That’s it.

With higher interest rates, Ms. Nunez wanted to sell a major part of her portfolio because she was not sure she would be able to continue to service the debt. Some of her properties debt coverage ratio is so thin, she felt that even an increase in 25 basis points would hurt her ability to service the debt.

She also expected property values to decrease due to an environment of rising interest rates. The standard relationship capitalization rates are higher in an environment of rising interest rates and market property value will adjust downwards.

 “I was expecting to liquidate 70 percent of the portfolio in 2015-2016,” Ms. Nunez explained. “I mean, at my age, I’m just too old to experience another shakeup in markets like we saw six years ago. But it seems that even with a decrease in unemployment rates, and a somewhat prosperous economy, the Fed refuses to increase rates.”  

“I feel interest rates will stay low for a long time - maybe another five to seven years. And, as you know, real estate and time are positively intertwined, so I expect my portfolio value to increase as a result.”  

 “I expect upward pressure on real estate. Fixed income investors will eventually reallocate their positions and invest in real estate. This will result in further demand for properties, and will serve as an additional force in augmenting property values.”

Ms. Nunez recently bought options to purchase five properties in two years. “The way I look at it,” she said, “I earn about eight percent on my retail properties and, my cost of carry, fixed for ten years, is between four to five percent. It’s a very attractive spread, even on a historical perspective.”

Pen&Paper asks: Why does the interest rate environment play such a major role?  

We argue that a focus on interest rates level change, as a catalyst for decision-making, is a fallacy.

Let's delve more into this subject on Thursday.