Speaking Into the Chaos
D. Dean Macfarlan, Managing Partner
Macfarlan Capital Partners, L.P.
Our economy and our country have experienced unprecedented changes in the last few months and change appears to be continuing on a daily basis. Wall Street, as we have known it, is forever changed and the global capital markets are being reshuffled before our eyes.
We at Macfarlan firmly believe that the next 12-18 months will present one of the best buying opportunities in recent history. Credit markets will unlock and a bottom will form. Those who remain calm, communicate with their advisors and develop a plan to take advantage of the bounce that is sure to come will have the opportunity to earn back a significant portion of what has been lost...if not more.
I was reflecting on these dramatic changes we are all experiencing in our world and it made me think of one of my wife’s favorite poems, “If” by Rudyard Kipling. It offers a good reminder to all of us in the midst of financial chaos.
“If you can keep your head when all about you
Are losing theirs…
Yours is the Earth and everything that's in it,
And - which is more - you'll be a Man my son!”
My advice to our clients and friends is don’t panic, rather “keep your head.” If you are paralyzed by fear, the opportunities will be lost. Fear is such an interesting emotion. Think about it. The one indispensable element for courage to exist is fear. Without the presence of fear, no courage is required. There is no shortage of fear today but there exists a glaring shortage of courage. This provides a great opportunity for leaders to step into that void.
As some of you know, my wife and I recently returned from our second trip to central Africa. We had the opportunity to partner with a unique organization which shares Macfarlan’s desire to develop responsible leaders, enhance healthy conflict resolution skills and promote peace-building in the central African community that has and continues to experience significant turmoil.
The timing of our Africa trip could not have been better, as these types of experiences give us crystal clear reminders of how fortunate we are to call America “home.” Even with all our current economic issues we have so much to be thankful for. An out-of-culture experience serving and getting to know people who have experienced so much trauma, yet have so much joy, is a paradigm-shifting experience. It is a wonderful way to center oneself on the things that matter, and the internal rate of return is incalculable. Faith, Family, Friends and serving those in need…these are the things that allow us to experience more significance, meaning and hope.
So, I began to consider the strengths of firms, organizations and people that stand out in times of crisis.
How the Turmoil Will Affect Real Estate
As I consider our firm and the economy, I realize that we are well positioned to be a solid force in the midst of this historic financial storm.
Our firm is a trusted advisor and we’ve generated profits by helping other firms and owners unravel complex distressed situations for over 24 years. We’ve seen down markets before. Our people are diligent and we are executing a solid plan. Let’s take a look at the landscape.
Capital and liquidity rule the day during times of chaos. Core assets with low risk profiles will maintain values as core capital continues to seek safe havens for investments. New development across all asset types will slow due to a combination of increased cost of capital, increased cost of construction and more stringent underwriting requirements.
Commercial property values have held up surprisingly well, but most experts expect this won’t continue. With large amounts of debt and equity investments being placed into the market for sale and many loans coming due (forcing owners to sell rather than obtaining refinancing), we expect the net effect will be domestic commercial values declining 10%-20% depending upon product type and geography. Residential land, finished lots, planned communities and resorts, have declined 50%-70% and seem to have formed a bottom. We believe this is the place to focus at the moment, and commercial asset re-pricing will follow in the months ahead.
Our funds were able to sell a number of assets prior to the sub prime meltdown, but a few assets acquired in the last 2 years will likely underperform with the exception of the recently acquired, deeply discounted Centex Destination Properties portfolio which we expect to perform as projected. In the short term, our historical high return performance will probably adjust down some as these assets mature, are sold and flow through the system. Conversely, as the assets we purchase over the next 12-24 months flow through the system, we are optimistic that our historical returns will adjust back up.
How Macfarlan is Responding
Relationships matter and are built over time. Investors, lenders, sellers and brokers will go back to those they can count on. Trust and reputation have never been more important, and these qualities should be your first determinants of how to invest into this cycle. Also remember that recapitalizations only work with sustainable stabilization, growth and exit strategies. Investing early without long-term solutions can be devastating (see early investors in Washington Mutual).
At Macfarlan we believe we are entering one of the greatest periods of wealth transference that we have seen in our careers. Capital, experience and expertise will all be required to win this game. Our investment strategy focuses on three primary points:
- Finding dislocations in commercial, residential and resort properties or underlying debt at deep discounts--on an all-cash or owner financed basis in the near term;
- Providing mezzanine and preferred equity capital to good sponsors with performing assets that are faced with a recapitalization squeeze;
- Assisting financial institutions by either acquiring discounted loans or providing fresh equity as part of a borrower restructuring.
Significant value will be created by experienced operators capable of reducing or removing risk from assets. Risk in a faulty or short-term capital stack can be reduced by recapitalization with longer-term money. Real estate risk can be reduced by leasing or repositioning assets with proven operating expertise. Non performing debt acquired at a discount is very attractive if you have the ability to service the loans and facilitate complex borrower workouts.
Our advice is to invest with organizations and people that can accomplish this type of risk mitigation while focusing on the basics of the underlying real estate.
We are also pleased to introduce Terramesa LLC as a strategic partner. This platform allows us to acquire and operate new acquisitions in the residential, finished lot, planned community and destination resorts categories similar to the recent acquisition of several premier resorts from Centex. Between Macfarlan Capital Partners and Terramesa we are well-positioned to execute on both commercial and residential fronts.
This is a challenging yet potentially rewarding time in the arena of real estate investments. The winners will be the ones that keep their heads and avoid the panic, stay focused and disciplined and stay close to their investors and lenders. We will continue to share more thoughts with you as opportunities present themselves.
Dean Macfarlan |
