The Fed\u2019s efforts to cool strong demand coming out of the pandemic lockdowns and trillions of dollars of fiscal stimulus appear to be paying off, as reflected in the August jobs report. The central question on most investors\u2019 minds is can the Fed steer the economy to a soft landing and avoid a recession. If historical precedent is any indication, you can see why the mood of the stock market has been largely pessimistic this week.<\/p>\n
We expect the likelihood of a recession to be high over the next 12\u201018 months (inverted yield curves are highly reliable forward indicators), but we are optimistic about the prospects for a relatively robust recovery thereafter due to several factors: a tight U.S. labor market, relatively healthy financial sector and growing trend of onshoring manufacturing.<\/p>\n
Rising interest rates have had a significant impact on value\u2010added real estate investments. Putting aside the demand side implications described above, every 1% rise in interest rates reduces loan proceeds by about 10 to 15%. This has forced many value\u2010added investors who were reliant on 70%+ bridge financing to sit on the sidelines right now, as that source of debt financing has all but dried up in the last few months. For well\u2010capitalized investors like Paladin who don\u2019t rely on high leverage, this creates opportunity.<\/p>\n
Paladin has always favored conservative levels of fixed rate financing with loan durations that match our business plans. Consequently, our existing investments have been relatively well insulated from the recent rate hikes. Due to the specific type of investments we target (i.e., Class B\/C apartments with current rents 30% below market, subject to AB1482 rent control), inflation has provided more of a tailwind to our strategy than a headwind. Going forward, we will continue to assume increased debt costs, lower leverage and higher exit capitalization rates in underwriting new investments. For existing investments, we continually monitor market rents and renter traffic for potential indications of softening demand, and will adjust our renovation strategies accordingly.<\/p>\n
If you would like to see other blog posts and articles, please visit the Resources section of our website.<\/p>\n