It was the best of times, it was the worst of times

It was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair…

We sometimes discuss psychology here within the Altus Insights. Some might say we do it too much, others might say we don’t do it enough. As I write this today, I find myself in the second camp. Execution of a business plan can be difficult, but generally speaking, investment analysis is pretty straightforward. Sure, there are all kinds of acronyms, lingos, and strategies that the various industries put together to try and justify their worth, but at its core, investing is pretty simple. The goal is either to buy something that is more valuable tomorrow than it is today (because of an expected increase in the cash flow it will produce) or buy something that produces cash flow for consumption or reinvestment. Or, buy something that has both current cash flow and the hope of growing cash flow in the future. Pretty simple.

And yet, most humans are terrible at it. The few icons that have dramatically outperformed the market over time generally admit they didn’t do so because of a special wisdom, but rather because they were able to make decisions independent of the influence/pressure of the decisions being made around them. Or said another way, they were able to overcome psychology.

I used to think that I was one of the few brave and strong souls that could be Spock-like in my decision making. I no longer hold myself in such light. But nor do I now believe the Warren Buffets, Howard Marks (more on him below), and Sam Zells of the world are without emotion or subject to their own psychological roller coasters. Instead I have found for myself, and I believe it to be true for the aforementioned icons (and others like them), I can overcome psychology through three distinct methods.

1. Most importantly, heeding the words of Socrates, “Know thyself”. The better I can identify when I have emotions influencing my moods, and thus decision making, the easier I can identify and call out those emotions, and then isolate my decision making from them. While hopefully at the same time also acknowledging when there is legitimacy in those emotions and including that legitimacy in the decision-making process.
2. Creating “rules to invest by” during times of low emotion that can be executed during times of high emotion. For instance, if I like a company, but don’t like the stock price at a 30 PE multiple, where do I like the stock price? If the answer is a 15 PE, then my rule is to purchase the stock if a market decline pulls that company price down to a 15 PE. It is just math, no emotion.
3. Have and use other people, hopefully that are emotionally aware, as sounding boards to discuss decision making within any particular life or market cycle. And to compare current situations to the rules to invest by. That person (or people) being emotionally aware will hopefully keep them from even allowing themselves into the conversation if they are also emotionally triggered. Discussing my fear of a market situation with someone who just lost a lot of money because of that market situation is probably not going to help me make clear decisions.

Charles Dickens “The Tale of Two Cities” captures the contrasts and contradictions of the time period. It is not so different today. All around us, two (or more) seemingly contradictory things are both true at the same time. This dissonance is, to my observation, increasing frustration and fear within the investment world. I can’t speak directly to the public markets, because I am not as integrated into that world, but certainly within the real estate, debt, and small business worlds fear is elevating to levels I haven’t seen since at least 2007, and possibly not even then. How do we reconcile the contradictions?

1. The economy has never been this large, there has been strong economic growth over the past year, average earnings are up, average wealth is up, unemployment is still historically low, and despite ongoing predictions of recession, the economy continues to grow. And yet, US citizens cite the economy as their number one concern going into the election. Consumer confidence is the fourth lowest it has been in the last 30 years (and falling); behind only 2008 – 2009 (duh), early 2020 (onset of COVID), and 2022 – which was the lowest reading ever. After falling in the years leading up to 2020, the rich/poor gap (as measured by the percentage of wealth owned by the top 10%) has again started to climb steadily. The bad news shouldn’t exist if the good news exists, but it does. And dissonance is almost assuredly due to different definitions of “average”: mean versus mode, or even median.
2. Our politics are an absolute mess. According to Gallup, the president has the lowest incumbent approval rating for this point in a presidency in US history. Despite the voter disdain, the president is still neck and neck in the polls, because the challenger is likewise a terrible candidate. Congress removed its first speaker ever. The two insider parties each maneuvered to freeze out viable challengers. But these terrible candidates are only candidates because people voted for them. There is a legitimate third-party candidate (at least by comparison). Despite the narrative, the Supreme Court has done what Supreme Courts are supposed to do, with voting patterns completely outside what was expected (and what people assume to be true). And most of all, when looking around the world, we can celebrate that the terrible candidates are a direct result of our individual choices, and not because the elections are a sham. Things may be bad, but we have only ourselves to blame.
3. Real estate mostly continues to perform well (with the exception of considerable office and hospitality) but many real estate investors/sponsors are feeling a lot of pain. Lenders, at least certain of them, are taking large losses. Financing is getting incredibly difficult, and banks are almost not worth working with. As I speak with others in the industry the pain is obvious. Balance sheets have blown up. Income for many is down to a fraction of what it was only a couple years ago. Investors are taking losses. But as mentioned, an awful lot of real estate continues to perform without hiccup. And for those without expiring debt and no forced sale, portfolios are still producing cash flow, and in many cases even strong sales prices. Thankfully Altus largely fits that description. And also, the amount of opportunity continues to grow, and with far less competition for that opportunity than existed even a year ago.
4. I didn’t mention multifamily in the paragraph above, but even within multifamily there is a considerable dislocation across geographies and product types. There is absolutely distress due to financing structures, but there is also distress in some markets due to fundamentals. This is a growing issue that didn’t exist even six months ago. Dallas occupancy is reported to be 88%. That means the average property doesn’t qualify for the most ubiquitous type of multifamily financing (Fannie and Freddie requires 90% occupancy). Phoenix occupancy is better, but has dropped substantially over the past 12 months, with expectations of further erosion. In San Francisco and the North Bay (where I spent the past couple days), asking rents for some apartment sizes/types are reported to have dropped by 20%. And yet, nationally, rents INCREASED last month. According to the US census, national rental vacancy was 6.6% in the first quarter, up slightly from a little under 5% in 2021/2022 but flat versus the second half of 2023 and far, far below earlier cyclical highs (2009). In a micro sense, there is a lot of pain, but on a macro basis, things don’t look so bad.
5. Drilling down further, even our own portfolio shows contradiction. Overall, the portfolio continues to produce cash flow and we have had (or in the process of having) some great sales. All of that is good. But we do have some properties that are functionally challenged. Hospitality without question. And even an apartment property that is dealing with some of the same vacancy and rent issues as referenced above. Poor performance on any individual property is extremely stressful on the team (especially when a capital call is required or capital losses are expected), and the wins – the portfolio performance more broadly – can easily be lost in the shuffle.
6. When looking at Altus as an operating company, for the first time in our history, the stock price fell on a year over year basis. There are two components included in our share price with the price being calculated as of December 31^st of each year: our equity in the larger portfolio, and a small multiple on the value we are creating as an operating company (our enterprise value). Amazingly, the portfolio value increased, but with effectively zero new purchases/transactions during 2023, the enterprise value portion of the stock price fell. That is bad. But that time that wasn’t spent on purchase transactions was spent on preparing for what we are seeing now, a time period that we believe will be the best time to buy over at least the last 15 years, and maybe even longer. A contradiction between a falling stock price while simultaneously creating an environment for a much higher stock price a couple years down the road as the work done over the last years leads to larger and more profitable transactions.

The good and bad, the bad and good. The dark and light, the light and dark. Wisdom and foolishness, foolishness and wisdom. The contradictions abound. This is the truth of times of distress.

I attended the Strategic Investment Conference last month for the sixth or seventh year in a row (if anyone is interested in seeing the notes please email me). Howard Marks was a presenter for the second year in a row. For those not familiar with Howard Marks and Oaktree Capital Management, it is one of, and quite possibly THE preeminent distressed debt investor, through the purchase and resolution of busted bonds. The moderator noted the billions and billions of dollars in investment capital raised by funds to invest in the most anticipated distress at any point over the past several decades, then asked, “With all this money on the sidelines, aren’t you concerned that the distress will be bought out of the market and you will not be able to produce the returns you are expecting?” Paraphrasing Marks, he said he isn’t concerned about that at all. Investors (and the sponsors) always say they want to invest in stress and they (we) all think that we will be ready when there is distress, but once distressed situations actually manifest themselves, the investors come up with lots of reasons not to invest, even if they have the funds available to do so. “We are going to wait until things get worse”, We aren’t at the bottom yet”, “We shouldn’t try to catch a falling knife.” Marks said Oaktree actually tries to catch falling knives, but are just very careful about it. By the time people realize we are at the bottom, and the knife has stopped falling, the distressed opportunity is already well on its way to being gone, and the opportunity will have largely been lost.

And this is what brings us back to the importance of understanding and protecting ourselves against the psychological impacts of the contradictions that are around us. I may be bummed because a good friend is losing their business. I may be even more bummed because one of the properties within our own portfolio is not going to treat us and our investors well. But as investment professionals, Altus (and me as an individual) have to be able to separate our discouragement in what is happening around us (or even among us) from our analysis of the opportunity before us. It is not a contradiction that both disappointment and excitement can (and should) exist at the same time and alongside each other.

It was the best of times, it was the worst of times…

Happy Investing.