Public Market & REIT Volatility vs Private Real Estate Investing?
A volatile stock market in 2018 and increasing treasury rates has many investors questioning the direction of the market and if their asset allocation has them prepared for what is to come. Instead of losing sleep at night while worrying about what is next in the public markets, consider some more stable alternatives like private real estate investments.
Public REITS are NOT the same as investing in private real estate despite the fact that REITS only own real estate. In fact, from 1/2/18 to 2/8/2018, Public REITS (as measured by the IYR ETF) dropped a whopping 11.4% as the US 10 year Treasury rate rose from 2.43% to 2.85%. This period is a great example of the core difference between investing in REITS and private real estate.
MLG Capital tracks the performance of the stock market with publicly traded REITs and private real estate investments. The graph below reveals a 10-year history of how volatile the stock market (S&P 500, red line) and public REITs (IYR ETF, black line) are when compared to private real estate investments (NCREIF property index, green line). It is easy to see that the publicly traded investments are significantly more volatile than private real estate.
*The S&P 500 is the leading indicator of US Large Cap Equities. **The IYR ETF seeks to track the investment results of the Dow Jones US Real Estate Index, which measures the performance of the publicly traded real estate sector of the US equity market. ***NCREIF Property Index is a quarterly measure of the unleveraged composite total return for private commercial real estate properties held for investment purposes only.
The above graph also reveals that the returns of REITs and the S&P 500 are more correlated to each other than private real estate. Too much correlation inside a portfolio, especially in volatile investments, could result in unnecessary risk. There may be more volatility to come and your portfolio should be well positioned to manage the risk. Private real estate investments provide some relative stability and help investors diversify their holdings.
Could you benefit from greater diversification and stability in your portfolio? Consider further diversifying your portfolio, give MLG Capital a call to learn more about the benefits of investing in private real estate like its favorable tax treatment or how it performs in inflationary cycles.
Read 7 Ways that Private Real Estate Investment Can Impact your Investor Portfolio
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Table of Contents
•
What Makes Us Experts
•
How to Use This eBook
•
Ongoing Excess Capital Defined
•
Liquidity Event Caused Excess Capital
•
Glossary of Terms
5 Reasons to Consider Alternative Investment Strategies for Ongoing or
Excess Capital
1. Alternative Investments Typically Have Lower Correlation with The Public Markets
2. Alternative Investments May Provide Lower Portfolio Volatility
3. With Lower Volatility, Alternative Investments Can Provide Greater Long-Term
Compounding Returns
4. Manager Expertise May Give Alternative Investments an Edge Over Public Markets
5. Alternative Investment Managers Can Have More “Skin in the Game”
Conclusion
•
Why MLG Capital is The Right Choice for Alternative Investments in Private Real Estate
•
About the Authors
MLG Capital works hard to be an industry leader in
private real estate investment. We’ve learned consistent
education is a key factor for us to be the best private
real estate investment managers we can be. Educated
investors are better able to handle the nuances of the
private commercial real estate investment market.
Plus, since we’re active investors ourselves, we have
30+years’ worth of highs, lows, stories and experiences
to share. Real estate is our passion.
Since the inception of MLG Capital in 1987, we’ve had
active, exited, or pending investments of approximately
14.4 million square feet of total space across the United
States inclusive of more than 10,600 apartment units,
with exited and estimated current value exceeding $1.2
billion*. Finally, MLG Capital’s series of diversified
private funds target cash on cash yields of 8% with all-in
net return targets of 13-15%/year for our investors**.
Through this eBook, we’re sharing our knowledge and
experience. We’ll show you how inclusion of private real
estate in your portfolio may be an excellent investment
strategy for your excess, or ongoing excess investment
capital.
What Makes Us Experts
MLG Capital is nothing without our investors. Doing well
by them is the core of our success. Through 30+ years
of highs and lows, strong markets and recessions,
we’ve built a strong track record, and continued to adapt
to the myriad of changes in the commercial real estate
investment space.
How to Use This eBook
This eBook was prepared to provide you with key
information about the potential advantages of investing
your excess or ongoing excess capital into private real
estate.
Ongoing Excess Capital Defined
Ongoing excess capital are typically defined as funds
from the profits of a business or funds after living
expenses generated by a highly compensated individual
(such as an attorney, doctor, CPA, or C-suite executive.)
* as of 3/5/2018. Value is consistent of disposed of assets as well as the current internal valuation of currently held assets as
of 12/31/2017. Values may not have been reviewed by an independent 3rd party and may be internal projections.
**Offers to sell an interest in an offering of MLG Capital or affiliates will only be made to a qualified purchaser by the delivery
of a confidential private placement memorandum and current supplements, accompanied by a subscription document booklet.
Please reference confidential private placement memorandum and current supplements for full details of investment.
Whether you own a small to mid-sized business or
are a successful professional who generates a high
income, you may be generating significant excess
capital. If yes, you could benefit from an alternative
investment vehicle such as private real estate.
Liquidity Event Caused Excess Capital
Liquidity events yielding excess capital are funds
generated by some form of a liquidity event. A prime
example of this is selling a business. Overnight, you
go from operating a successful business to having a
seven or eight figure lump-sum. And, it’s money you
want to preserve, generate a return on, and grow over
time.
Liquidity events can also be situations other than
the sale of a business. For example, say you were a
co-founder of a successful startup that’s gone public.
You’ve sold your shares and generated a tidy amount
of excess capital. This is a textbook liquidity event.
Besides other types of business/stock dispositions
(partnership exit or asset sale), a liquidity event could
also occur if you inherit liquid or hard assets. What
unites these disparate events is the need for you to
put that money to work. That means finding ideal
investment vehicles to grow, produce returns, and
preserve the proceeds.
Commercial real estate investing is more than buying
properties and generating cash flow. There’s a steep
learning curve with important industry nomenclature
and business fundamentals to learn before you
dive into one of the most competitive (but lucrative)
investing areas.
Whether you choose to partner with MLG Capital, or
with another firm, our goal is to empower you with
the education and background necessary to help you
make successful real estate investments.
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Glossary of Terms
Alternative Investment:
Asset classes beyond
the traditional investment options (stocks/bonds/
cash). Types of alternative investments include
hedge funds, private equity, institutional real
estate, small/mid-cap real estate, managed
futures, and commodities.
Cap Rate:
The ratio of net operating income
(NOI) relative to the asset value of a property.
For example, if a property is worth $10 million,
and generates an NOI of $500,000, the
property’s cap rate is 5%.
Cash on Cash Return:
The ratio of pre-tax
cash flow to the total amount of equity (cash)
invested in a property. This metric allows you to
assess the pre-tax cash flow return of an income-
producing property.
Core Strategy:
Commonly employed by
institutional real estate investors, this strategy
entails the purchases of high-quality properties
(such as downtown real estate or retail space
leased to investment-grade tenants) typically
using lower amounts of leverage. This strategy
targets lower returns and is often quantitatively
similar to a bond type investment return.
Inflationary Cycle:
The cycle in which inflation
rates see periods of long-term increase
(inflation), followed by periods of long-term
decreases (deflation). As the inflationary cycle
is tied to interest rates, this dynamic plays a
major role in predicting the returns generated by
commercial real estate investments.
Information Asymmetry:
An important element
of successful real estate investing. Information
asymmetry occurs in transactions where one
party has greater knowledge/better information
than the other.
Institutional Real Estate:
Also known as
“Institutional-Grade Real Estate”. These are
properties (typically in top-tier “gateway” markets
such as NYC or San Francisco) that meet the
size and stature requirements of institutional
investors. A core strategy is typically employed in
conjunction with purchases of such assets.
IRR:
Internal rate of return, mathematically, is the
rate at which the NPV (net present value) of the
cash flows from an investment equal zero. From
a high-level IRR is a way to see the projections
or delivered returns of an investment, annually.
If an asset is held for 5 years and achieves
a 17% IRR, an annual return of 17% was
generated by the investment. This metric is used
to assess the attractiveness of an investment
and overall returns. IRR must meet the required
rate of return to be a worthwhile investment
choice.
Market Correlation:
The relation of an
investment’s return to the public equities market.
A high market correlation means an investment
follows a similar pattern to the movement of the
stock market. A low market correlation means
an investment’s returns do not mirror the public
stock market. Investing in both high and low
market-correlating assets is a part of intelligent
portfolio diversification.
NCREIF:
The National Council of Real Estate
Investment Fiduciaries (best known for their
real estate investment benchmark, the NCREIF
Property Index), is typically a concentration of
pension fund real estate investments.
NCREIF Property Index:
Index that tracks the
performance of commercial real estate. The
NCREIF Property Index measures returns on an
unleveraged basis and excludes properties that
are not operating such as properties undergoing
redevelopment/construction.
Net Operating Income:
The net of all rental
revenue from a property minus necessary
operating expenses. This calculation excludes
depreciation so it’s analogous to the EBITDA
metric used for operating businesses.
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Opportunistic Strategy:
An investment that may
require significant rehabilitation or investment
capital. This could mean converting an existing
property into a new use, such as converting an
office building into a multifamily property or hotel.
Preferred Return:
A set return that accrues
to investors in a private real estate fund/
syndication. Ideally this is paid before investment
managers are entitled to profit participation.
Promote:
The profit participation the real estate
investment manager receives after investors in
the fund/syndication have typically accrued their
targeted return, and ideally received a return of
their initial capital investment
Public Markets:
An umbrella term
encompassing all publicly traded investments,
either via an exchange or over-the-counter. This
universe includes stocks, bonds, public REITS,
options, and other securities bought and sold in a
centralized marketplace.
Public REIT:
A publicly held owner of income-
producing real estate properties or mortgage
assets. To qualify for tax advantages, REITs must
invest the bulk of their assets in real property/
mortgages and pay out at least 90% of their
taxable income in the form of dividends.
Small/Mid-Cap Private Estate:
“True” private
real estate. While institutional real estate
investing focuses primarily on a “core strategy”,
small/mid-cap can employ a greater use of
the “value-add” and “opportunistic” strategies,
providing you with more opportunity to achieve
higher targeted returns. Typically acquisitions in
this space are in the $5-60 million range.
Value-Add Strategy:
A strategy in which a
building’s use is kept the same, but the asset is
upgraded (through property improvements and/or
occupancy improvements) to enhance operating
income/eliminate inefficiencies (expense
reduction.)
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1. Alternative Investments
Typically Have Lower
Correlation with The Public
Markets
Alternative investments live
up to their name by typically
having a lower correlation with
the returns generated by the
public markets (stocks, bonds).
This low correlation gives you
the opportunity to grow excess
or ongoing excess capital even
if the public markets-at-large
are experiencing a bearish or
stagnant market.
The importance of diversification
is that it can help in targeting
consistent returns in low
or negative market cycles,
especially between asset classes
and alternative investments.
In an age of increased volatility
or uncertainty in the equity
markets, alternative investments
such as private real estate may
be a viable consideration for
targeting substantial returns for
your excess or ongoing excess
capital.
5 REASONS
TO CONSIDER
ALTERNATIVE
INVESTMENT
STRATEGIES
FOR ONGOING
OR EXCESS
CAPITAL
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2. Alternative Investments May Provide Lower
Portfolio Volatility
Historically, investing in private real estate
(demonstrated by NCREIF for purposes of
correlation to the public market) has had lower
volatility relative to public market indices such as
the S&P 500 and the iShares U.S. Real Estate
ETF (IYR.)
Low volatility and consistent targeted returns
are key ingredients in successful long-term
compounding of capital. It’s difficult to hit targeted
returns if asset values decline at rates exceeding
the broader market during downturns. Typically,
it’s easier to get back on track when an asset
suffers a 5% negative impact, as opposed to a
25% negative impact.
Diversification among asset classes is critical for
both capital preservation and balanced returns.
For example, private real estate, historically, has
a low correlation ratio with the S&P 500, IYR,
as well as bonds. This low correlation can help
hedge your portfolio in times of high volatility.
Along with market volatility, another macro risk
to your portfolio can come from higher interest
rates. While we have experienced a long-term
trend of extremely low interest rates, in times of
higher interest rates, public market assets such
as stocks and bonds have had a poor history of
generating sufficient returns.
In our offering book, we show a chart from an
S&P study showing how between 1978 and
2008, private real estate materially outperformed
all other asset classes in inflationary cycles (if
high inflation drives higher interest rates.)
While you might assume that public real estate
investing vehicles such as REITs share the same
low correlation, they don’t. Public REITS are
highly correlated to the S&P 500. A volatile stock
market such as in early 2018, combined with
increasing treasury rates has many investors
questioning the direction of the market and if
their asset allocation has them prepared for
what is to come. Instead of losing sleep at night
worrying about what’s next in the public markets,
consider more stable alternatives like private real
estate investments.
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MLGCAPITAL.COM
Public REITS are NOT the same as investing
in private real estate even though REITS only
own real estate. In fact, from 1/2/18 to 2/8/2018,
Public REITS (as measured by the IYR ETF)
dropped a whopping 11.4% as the US 10-year
Treasury rate rose from 2.43% to 2.85%. This
period is a great example of the core difference
between investing in REITS and private real
estate.
MLG Capital tracks the performance of the
stock market with publicly traded REITs and
private real estate investments. The graph above
reveals a 10-year history of how volatile the stock
market (S&P 500, red line) and public REITs (IYR
ETF, black line) are when compared to private
real estate investments (NCREIF property index,
green line). It is easy to see the publicly traded
investments are significantly more volatile than
private real estate.
The graph below shows the returns of REITs
and the S&P 500 are more correlated to each
other than to private real estate. Too much
correlation inside a portfolio, especially in volatile
investments, could result in unnecessary risk.
There may be more volatility to come and your
portfolio should be well positioned to manage
the risk. Private real estate investments provide
relative stability and help investors diversify their
holdings.
Could you benefit from greater diversification
and stability in your portfolio? Consider further
diversifying your portfolio, give MLG Capital a
call to learn more about the multiple benefits
of investing in private real estate such as its
favorable tax treatment or how it performs in
inflationary cycles.
*The S&P 500 is the leading indicator of US Large Cap Equities. **The IYR ETF seeks to track the investment results of the
Dow Jones US Real Estate Index, which measures the performance of the publicly traded real estate sector of the US equity
market. ***NCREIF Property Index is a quarterly measure of the unleveraged composite total return for private commercial real
estate properties held for investment purposes only.)
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3. With Lower Volatility,
Alternative Investments Can
Provide Greater Long-Term
Compounding Returns
As the old maxim goes, slow
and steady wins the race.
Lower volatility investments
that have historically shown
consistent quarterly returns
may be more beneficial for long
term capital compounding in
your portfolio:
As seen in the infographic on
the right, the NCREIF Property
Index showed consistent
quarterly returns compared to
the S&P 500 and IYR (iShares
US REIT ETF).
Because of these consistent
returns relative to public
market alternatives (S&P 500,
IYR), over the same period
the NCREIF showed a larger
compounded return:
$500,000 invested in the S&P
500 at the beginning of 2005
would be worth $919,908 at the
end of 2015. $500,000 invested
in the IYR would be worth
$974,738.
$500,000 invested in the
NCREIF Property Index
would be worth $1,266,797, a
meaningful improvement over
the S&P and IYR!
The low volatility of alternative
investments, such as private
real estate, can create a
strong opportunity for long-
term compound growth on
your investment of ongoing or
excess personal capital.
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As established earlier, there are many
ways to invest in real estate, and each
type entails its own unique set of risk
considerations:
Public REITS
Real estate investment trusts, better
known as REITs, are tax-advantaged
entities that own income-producing real
estate. Congress approved the creation
of REITs in the 1960s to give individual
investors a vehicle similar to mutual
funds in which to invest in commercial
properties.
Along with real property, REITs can
also invest in mortgage securities and
receive the same tax treatment. REITs
focusing on mortgage investment are
typically known as “Mortgage REITs”
To quality as a REIT for tax purposes,
the REIT must have at least 100
shareholders, derive at least 75% of its
gross income from rents or mortgage
interest, have at least 75% of its assets
invested in real estate or mortgages,
payout at least 90% of its taxable
income in the form of dividends, among
other restrictions.
Typically, public REITs are more liquid
than private real estate investments
and have lower targeted returns
compared to true private real estate
investments.
For example, a public REIT would focus
on stabilized, more blue-chip assets,
such as prime downtown real estate,
higher-end multifamily developments,
and industrial distribution centers
leased by major corporations. The
stronger markets and tenant base of
these properties leads to lower risk and
more liquidity, but typically targeting
lower returns (4-6%).
Institutional Real Estate
Institutional Real Estate, or Institutional-Grade
property, is real estate that meets the size and
stature requirements of institutional investors.
The largest private equity real estate investment
firms focus on institutional-grade properties. These
types of investments are typically “trophy” properties
in what are called “gateway markets” (top tier real
estate markets such as the New York metro area, the
San Francisco Bay area, and the Washington, DC
metropolitan area.)
These types of investments typically seek lower
overall returns, potentially in the 8-10% range. The
lower returns are a function of the lower amount of
leverage used, as well as the cash flow generated
during the hold of the asset,
in typically higher priced assets. These returns are
comparable to a bond-type targeted return.
Small/Mid Cap (True Private Real Estate.)
Small/Mid Cap real estate investments are
investments in properties below institutional quality.
But, these properties offer many other attributes
enabling their use as part of your alternative real
estate investing strategies.
While institutional real estate focuses on a “core
strategy”, purchasing prominent properties using
lower levels of leverage, Small/Midcap real estate
investing includes greater use of “Value-Add” and
“Opportunistic” real estate strategies.
An example of “Value-Add” is purchasing an
apartment complex where rents are lower than
comparable properties in the area. Perhaps the
property is out of date and needs a revamp, or
the previous owners have been less aggressive
in charging market-level rents. Taking an active
approach to increase the value of the property, a
“Value-Add” investment might involve renovating
the property or other activities permitting rents to be
materially increased. The increase in rental income
increases the cash flow of the asset and improves
the asset’s valuation. After several holding years
(where cash flow is maximized and generated), the
property is sold, presumably with an appreciated
asset value due to higher cash flows from the asset.
This transaction provides both cash flow and asset
appreciation, enabling you to hit an investment
trifecta: you’ve preserved your capital, grown it, and
generated positive cash flow during your holding
period. Win, win, win!
“Opportunistic” investments come with much
higher risk than “Value-Add” but offer a greater
opportunity for higher targeted returns. An example
of an “Opportunistic” real estate play is the
purchase of a property, such as an office building,
and converting the property into a different use,
perhaps a multi-family dwelling or hotel. This
strategy has become more common, as demand
for office space has slackened and demand for
residential property has grown.
Small to mid-cap real estate investments are
the true “private real estate” investments. These
properties provide a greater potential for higher
targeted returns and generate a higher yield/higher
cap rates. But, there are risks for you to consider.
True “private real estate” is illiquid, and the success
of your investment hinges on the expertise and
active involvement of your investment manager to
a greater degree than other types of real estate
investment. A trusted and experienced manager is
imperative to help you wade through what’s real in
the assumptions and what’s not. Lots of real estate
deals can look good on paper, or online. It takes an
experienced eye with extensive real-life experience
in the space to best assess which deals will most
likely meet expectations.
A preferred investment structure, where passive
investors accrue a preferred return before
the investment manager is entitled to profit
participation, is imperative to mitigate the risk and
enable you to hit your targeted return.
When investing excess capital or ongoing
excess capital, protecting the corpus is as
important as seeking investment growth.
MLG Capital Focuses on non-institutional real
estate, which compared to public REITs and
institutional investments, is a more fragmented
industry. There are attractive investment
opportunities and there’s a high degree of
competition among professionals in the niche.
People make mistakes; this creates
opportunities.
At MLG Capital, our job is to find opportunities in
these mistakes, correct them, and create value for
our investors.
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4. Manager Expertise May Give Alternative
Investments an Edge Over Public Markets
In an age where widely available information and
consistently emerging technology is minimizing
the role of the human element, it’s become more
difficult for public equity portfolio managers to
outperform the market.
Studies have shown that managers of public
equity portfolios time and time again have, on
average, underperformed market indices such as
the S&P 500.
On the other hand, alternative investments
such as private real estate typically operate
in less efficient, more fragmented markets,
where experts in the niche can have a greater
opportunity to gain an edge and achieve targeted
returns.
Managers of private real estate investments
have advantages over less experienced or less
active real estate investors. For example, a
private real estate investment manager will likely
have strong experience handling multiple market
cycles. They will probably have stronger sourcing
ability, stronger models for assessing potential
investments, and other types of information
asymmetry giving them an edge over others in
the private real estate space.
Managers of alternative investments typically
employ greater control over the assets in which
they invest, providing greater opportunities to
improve the asset’s value, and in turn, the value
of the portfolio.
Public equity investment managers, at times,
can play a less-active role in managing the
companies in which they invest, ceding much of
the power to outside forces.
While market and economic forces still have
major influence, real estate investors have more
control over the destiny of the assets in which
they invest.
Maintaining reasonable leverage is important.
At MLG, we target 65% debt and 35% equity
on a consolidated basis.
Real estate financing typically allows for up to
80%+ leverage, sometimes more with creative
financing. But, high amounts of leverage can be
a double-edged sword, especially when down
cycles create challenges beyond our control.
Patience is key in owning real estate. We wait
for the good deals to buy, and wait for the good
times to sell.
There are always great deals out there; the
challenge is to find them.
Patience requires waiting for an owner being
willing to sell, deciding to retire, or being a poor
operator who simply decides to bail out of the
investment.
2009 was a foolish time to sell anything, but
assets were put on the market, creating many
buying opportunities. However, due to poor
capital liquidity, it was difficult to execute such
purchases.
In today’s strong valuation environment, it’s much
easier to execute repositioning strategies to grow
operating income when the right opportunities
come along.
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5. Alternative Investment Managers Can
Have More “Skin in the Game”
The fee structure of traditional asset
management firms is typically a fixed 1% annual
fee based upon assets under management. This
incentivizes asset gathering as opposed to hitting
targeted returns.
Managers of alternative investments may receive
an asset management fee, but their primary
incentive stems from earning the “promote” or
profit participation generated by a successful
investment.
Investing in Private Real Estate is similar
in nature to investing in a business. Like a
business, Private Real Estate must execute a
business plan to generate the targeted results.
The fee earned by the manager reflects their
involvement/time commitment in successfully
executing the business plan.
With a compensation structure better aligned
with your investment interests, alternative
investment managers have more skin in the
game, creating a more successful partnership.
This is an example of our typical fee structure*:
•
MLG Capital accrues an annual 8% preferred
return to our investors, paid quarterly.
•
Once MLG Capital is current on the 8%
preferred accruals, we begin returning
capital.
•
After our investors are current on their 8%
annualized accrual (and have received 100%
return of capital), MLG become entitled to
profit participation, which is split 70/30, with
70% of remaining cash flow/sale proceeds
flowing to our investors, and 30% of
remaining cash flow/sales proceeds flowing
to MLG Capital.
Since MLG Capital only participates in the
“promote”once you, the investor, has both
accrued an 8% annual return and received
100% return of capital, we have genuine skin in
the game to work diligently to deliver significant
value to our investors.
*Offers to sell an interest in an offering of MLG Capital or affiliates will only be made to a qualified purchaser by the delivery of
a confidential private placement memorandum and current supplements, accompanied by a subscription document booklet.
Please reference confidential private placement memorandum and current supplements for full details of investment.
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Compared to traditional investments (public
equity/bonds), alternative investments in private
real estate could provide you with certain
benefits when you’re seeking ways to invest
excess or ongoing excess capital.
With lower correlation and lower volatility than
public markets, alternative investments in private
real estate may offer a better opportunity for
long-term capital compounding, achieving an
optimal risk profile, and target the best risk-
adjusted returns.
As opposed to the public equity markets, where
greater market efficiency makes it more difficult
for individual managers to outperform the market,
the niche nature of alternative investments, such
as real estate, provides greater opportunities for
managers with the expertise and resources to
gain an edge and hit targeted returns.
The fee structure of alternative investments,
with profit participation playing a greater role
than assets under management, gives the asset
manager more skin in the game, better aligning
their interests with your interests.
With all these advantages over traditional
investment vehicles, investing ongoing and
liquidity event excess capital into private real
estate investments may be one of your best
options if you’re seeking to diversify your assets
and set your portfolio up for long-term capital
growth.
Why MLG Capital is The Right
Choice for Alternative Investments
in Private Real Estate
Now that you’ve learned more about alternative
real estate investments, you’re probably asking
yourself, “Why MLG Capital?” As mentioned
earlier, small/midcap real estate is a fragmented
industry. There are hundreds of managers vying
for your capital. What separates MLG Capital
from the rest?
At MLG Capital, Small/Mid-Cap Private Real
Estate is Our Bread and Butter
While other real estate investment firms may
try to be everything to everyone, MLG Capital
sticks to what it knows best: taking advantage of
the opportunities in the small/mid-cap property
space.
People Make Mistakes: It’s Our Job to Find
Them and Correct Them, Creating Value for
Our Investors
With our strong sourcing network, expertise in
the majority of property types, and a solid track
record encompassing several market cycles,
MLG Capital has what it takes to find the best
opportunities, and act upon them, allowing us to
meet your targeted returns.
CONCLUSION
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Our Experience Through Several Market
Cycles Gives Us a Greater Understanding of
Opportunities in Any Market Environment
There’s more to real estate market cycles
than buying at the bottom and selling at the
top. Dynamics are at play dictating an optimal
strategy in any market situation.
At each part of the economic cycle, opportunities
and risks exist. At MLG, we buy real estate
through all points of the market cycle, as both
good and bad environments create different
types of opportunity.
In a tough real estate cycle, such as the period
between 2008 and 2011, there could be great
buying opportunities on a cost basis, but the
economic downturn created difficulties in
improving the income generated from an asset
due to lowered rental demand.
Making purchases at the bottom of the market
requires patience to wait it out until the economy
recovers. Bottom of the market acquisitions also
require lower amounts of leverage to avoid cash
flow issues.
In strong markets, it’s harder to find acquisition
opportunities, but much easier to improve
operating income and asset value, since
economic demand for real estate is high. This
is where our sourcing strategy comes into play:
our rich sourcing network enables us to find,
and take advantage of, opportunities during the
upswing in the cycle.
MLG Capital Takes a Proactive Approach to
Create Value
While the market dictates much of the result of a
real estate investment, it’s imperative for a real
estate manager to have a proactive strategy in
place to enable them to mitigate negative market
forces and optimize the positives.
While other real estate investments firms may
focus on purchasing undervalued properties
and sitting on them until the market appreciation
increases their value, MLG Capital doesn’t sit
idle.
We take a proactive approach: A typical MLG
deal has an active strategy to grow revenue/
improve operating income, either through
property improvements, expense reductions,
or occupancy improvement. Most deals have
a minimum rent growth over a 5-year hold
depending on the asset and overall objective.
As most operating costs are fixed in private
real estate, a large percentage of the increased
revenue falls straight to the bottom line (NOI/
EBITDA) when expenses fall or are executed
more efficiently..
While others wait for asset appreciation to do
their job, MLG proactively works to increase both
the cash flow and asset values of the properties
we acquire. This provides our investors with a
greater opportunity to achieve targeted returns
(in our opinion!)
MLG Capital Understands the Inflationary
Cycle’s Role in Real Estate Investing
External dynamics (political changes, natural
disaster, tax policy changes, changes in
insurance costs, and climate change, for
example) can affect performance, and interest
rates may play the biggest macro role in a real
estate investment.
Real estate has historically outperformed stocks
and bonds in inflationary/rising rate cycles. In
a market environment where the PE ratio of
the S&P 500 is 24+, investors can become
concerned of the future.
Times of market euphoria can lead to increases
in interest rates, impacting real estate valuations.
This correction is a counter to the higher demand
and higher operating incomes generated in frothy
markets. This brings up the potential for changes
in cap rates, or the rate at which properties trade
for on the market.
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Cap rate changes are not proportional, but are
correlated, to interest rate changes. If interest
rates and cap rates go up, it is likely due to a
stronger economy. A stronger economy allows for
increases in rents/cash flow from a property.
MLG Capital understands the inflationary cycle’s
role in real estate investing. By taking active
steps (property improvements, leasing) and
steps to grow operating income, we can do a lot
to offset a worsening in valuations (cap rates)
caused by higher interest rates (Underwriting
conservatively on an exit).
Above is an example of how cash flow can be
impacted in a strong market experiencing an
increase in interest rates. In the below we are
taking into consideration the margin, or spread,
in loan rates that banks impose by looking back
over the last few cycles, specifically the 2008
cycle and pre-election cycle of 2016.
•
If a multifamily property had an NOI of $1
million at acquisition, and cap rates grow
from 5.46% to 6.3% during the hold period,
to retain the value of the equity, the NOI must
grow by ±15.4%.
•
Such growth would require gross rental
revenue growth of 7.7% during the holding
period (or 1.55%/year for 5 years).
•
There is also the impact of inflation to
consider: however, as multifamily leases are
typically short-term, rents can be raised to
counter increases in operating costs.
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The key assumption is that cap rates are
heavily driven by debt constants, which is what
we believe. The debt constant is a function of
the interest rate on a loan plus the term being
amortized. For multifamily, there is plentiful debt
available with a 30-year amortization. In fact,
interest only debt is also available, which forgives
any principal amortization for usually 2-3 years.
The other key factor is the margin added to the
index (usually 10-year treasury rate) to determine
a loan rate. For example, today a usual margin is
2% plus a 2.80% 10-year treasury rate to obtain
a 4.80% interest on a loan.
The spreadsheet on the previous page highlights
this concept of margins added to an index. For
example, when the 10-year treasury was 1.6%,
the margin was about 2.2%, and the loan rates
were about 3.8% with a 5.59% debt constant.
Back when the 10-year treasury was around
4% (1.2% above today, or about 2.4% above
bottom), the margins were only 0.9 to 1.25%.
With a 1.2% margin and a 10- year treasury of
4%, loan rates were about 5.2% or a 6.59% debt
constant. So, a move from 1.60% to 4% (2.40%
move) on the 10-year treasury, only changed
the debt constant by 1% (6.59% vs 5.59%).
Therefore, you cannot assume that 2.4% move in
interest rate changes cap rates by 2.4%. In fact,
history shows that is not the case. Our example
shows a 2.4% move in 10 year treasury that only
changes a debt constant by ±1%.
Our experience is that cap rates do not move
proportionally with interest rate changes. Moves
are certainly correlated, but not proportional.
There is also another key consideration of
interest rate growth. You must ask what is
causing rates to grow. If it is caused by strong
economic growth, rents usually grow as demand
starts to exceed supply. The spreadsheet
attached shows the NOI or EBITDA growth
needed to offset cap rate growth. If the NOI was
$1,000,000 at acquisition and cap rates move
from 5.46% to 6.30% during the hold period, the
NOI needs to grow by 15.4% to offset higher cap
rates to keep the value of the equity flat. A 15.4%
NOI growth requires gross revenue growth of
about 7.7% over the hold period or a little over
1.55%/year, for 5 years, of gross revenue growth.
This assumes operating expenses are about
50% of the gross income, which is typically the
case for multifamily properties. See lines of the
spreadsheet showing a value of $18,329,305.
There is also the impact from simple inflation,
which likely covers the impact of rising rates as
most leases are short term giving real estate
owners the ability to raise rents.
As we’ve discussed, all the deals that MLG
invests in have a proactive strategy to grow
revenues thru either property improvements and/
or occupancy improvement. Most deals have a
minimum rent growth during a 5-year hold. Also,
most costs are fixed in private real estate so
a high % of any growth falls to the bottom line
NOI or EBITDA. These growth amounts greatly
exceed the 1.55%/year growth needed to offset
impact of a 4% 10 US treasury rate.
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MLGCAPITAL.COM
A strong understanding of the inflationary cycle
requires optimal use of leverage. Examples
include using short-term financing (allowing for
refinancing once rates come down), as well as
using interest-only financing (which removes
the principal pay-down element). Removing the
principal pay-down element improves the cash-
on-cash return.
Here’s an example of how we may approach the
use of leverage considering the inflationary cycle:
•
A Class B or Class C multifamily property is
purchased using 40% equity and 60% debt.
The debt is interest-only for 3 years, then
goes to fully amortizing, and matures in 10
years.
•
Class B and C assets currently trade in the
5.5% to 6% cap rate range.
•
If the 10-year treasury is at 4%, and the
interest-only debt employed in the deal is at
5.25%, the investment will achieve a 7.125%
cash yield on a 6% cap rate asset.
Now compare a 7.125% yield buying a Class B
moderately leveraged apartment property (60%)
to the risk-free yield of 4% of US Treasuries. We
think there is a worthwhile opportunity at this
yield difference.
Despite these cap rate changes, the market
finds a way to do deals. Higher cap rates (8%
range) have not been seen since the early-to-mid
1990s. Highly leveraged central banks requires
low interest rates. Assuming the financial
condition of the United States does not change,
10-year treasuries will continue to generate lower
yields (2%-4%) for the coming decades (opinion).
This creates difficulties in modeling for higher
interest rates. An interest rate spike will cause
economic damage, which again could result in
lower rates.
The impact of the inflationary cycle on investment
returns makes it an important factor to consider
when determining the fit of any investment
opportunity.
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MLGCAPITAL.COM
Notice that in inflationary cycles, private real
estate outperforms even gold, because of
current income from rents. After all, if there is an
inflationary cycle it’s common for wages to also
rise, causing increases in rental rates.
MLG Capital Understands Diversification
Diversification is a key ingredient in creating
successful alternative investments in private
real estate. Historically, our industry has failed
to create a vehicle able to adequately diversify
within private real estate.
A large portion of private real estate investments
are done on a local basis, meaning investors
are primarily invested in their local community.
While this is a boon to the community, it fails to
diversify an investment portfolio in terms of asset
class and geography.
At MLG, our funds typically target 20-25
acquisitions per fund, spanning multiple
asset types, quality, partners, and multiple
markets, providing you with a better element of
diversification compared to only investing in your
local market.
These are just a few of the things that set
MLG Capital from the rest. Combined with
our sourcing strategy, more than 30 years of
experience, and expertise in multiple asset
types and multiple markets, we have what
it takes to make us the right choice for your
alternative investments in private real estate.
* as of 3/5/2018. Value is consistent of disposed of assets as well as the current internal valuation of currently held assets as
of 12/31/2017. Values may not have been reviewed by an independent 3rd party and may be internal projections.
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MLGCAPITAL.COM
Disclaimer: MLG Capital has been an active private
real estate investor for over 30 years. We’ve acquired
over $1.2B in assets* (approximation of current value
of assets owned + value of assets disposed), of
over 14.4 Million square feet of space, consisting of
10,600+ multifamily apartment units, in multiple real
estate asset classes, in multiple geographies, with
multiple real estate sponsors. Past performance is
never an indication of future results. As always be
sure to complete full due diligence on any investment
you make and consult with your trusted advisors.
This is not an offer to sell a security or an interest in
any investment offering made by MLG Capital or its
affiliates and is intended to solely be a resource of
thoughts, opinions, and materials to use in acquiring
more knowledge about making an investment into
private commercial real estate.
David Binder
is Vice
President at MLG Capital.
David currently has the
responsibility of overseeing
teams on the sourcing of
new investment partners,
overseeing relationships
with current investment
partners, coordinating marketing efforts,
external communication, and contributes to
sourcing of investment deals for MLG Capital’s
Private Equity platform. Life is relationships and
relationships are life in David’s eyes.
Building relationships with people who want
to invest capital into alternative investments,
outside of the public markets, and helping those
people achieve continued financial successes, is
the absolute best part of my career!
The concentration of David’s entire career has
been focused on management, value creation,
risk oriented underwriting, networking, marketing,
and relationship management. Coming from a
residential real estate and financial investment
background has provided David with the required
knowledge, experience, leadership, and capacity
to achieve success for our MLG Capital clients
and has been instrumental in the growth and
broadening of relationships with investment
partners for the series of MLG Capital Private
Real Estate Funds, and co-investment offerings.
He is also an avid dog lover (he’s adopted two
hound puppies from
WAR – Wilson Animal
Rescue – in Memphis, TN), coffee connoisseur
(love me a pour-over), Wisconsin sports team
die-hard, traveler, and enjoys spending time
with his wife and two young children (son and
daughter).
ABOUT THE AUTHORS
Rick Stoll
is Assistant
Vice President at MLG
Capital focusing on
marrying uniquely sourced
investment opportunities
with prospective investors
(breadth of competence)
through our diversified fund
strategy. Rick is critically interested in connecting
with like-minded professionals who believe what
we believe at MLG Capital: make investing fun
while upholding absolute integrity.
Rick is passionate about helping our
investors feel comfortable with private real
estate investing. Maximizing diversity, with a
concentration on low-to-moderate leverage
(debt), he tries to immerse his investors in the
rush of a real estate deal while attempting to
debunk the risks, pitfalls and perceptions that
historically befit real estate investing.
The most exciting aspect of his positive
experience with MLG Capital is sourcing off-
market opportunities through more than 1,400
relationships across the country.
He believes it’s incredibly exciting to form long-
term relationships and friendships with partners
who share a mutual goal of realizing successful
real estate investments, most of which go
undetected by the real estate market, at large.
Most recently, Rick was recognized as a
30 Under 30 nationally by the Institute of
Real Estate Management (IREM), honoring
“... individuals [who] have made various
contributions to the profession as demonstrated
by career success, professional leadership, and
community involvement.”
Personally, Rick’s incredibly passionate about
the homeless. He believes this is a forgotten
population. By 30, he plans to solidify planning
for a community (and faith)-based housing
program (via urban campground) aimed at
rehabilitating homeless individuals in the
Milwaukee metro, with a long-term goal of
streamlined implementation nationally.
MLGCAPITAL.COM
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This webpage/website is for informational purposes only and is qualified in its entirety by reference to the Confidential Private Placement Memorandum (as modified or supplemented from time to time, the “Memorandum”) of any offering of MLG Capital. Currently, MLG Private Fund IV LLC (the “Main Fund”) and MLG 1099 Dividend Fund IV LLC (the “Parallel Fund,” and together with the Main Fund, the “Fund”), is open for new investments. All information related to “Fund IV” listed is qualified in it’s entirety by the MLG Private Fund IV LLC (the “Main Fund”) and MLG 1099 Dividend Fund IV LLC (the “Parallel Fund,” and together with the Main Fund, the “Fund”, the limited liability company agreements (the “LLCAs”) of the Main Fund and the Parallel Fund, each as may be amended and/or modified form time to time, and a subscription agreement related thereto, copies of which will be made available upon request and should be reviewed before purchasing a Units in the Fund. This website/webpage is not intended to be relied upon as the basis for an investment decision, and is not, and should not be assumed to be, complete. The contents of this website/webpage are not to be considered as legal, business or tax advice, and each prospective investor should consult its own attorney, business advisor and tax advisor as to legal, business, and tax advice. This website/webpage does not constitute an offer or solicitation in any state or other jurisdiction to subscribe for or purchase limited partnership interests in an offering. Recipients of this summary agree that the manager and offerings, its affiliates and their respective partners, members, employees, officers, directors, agents, and representatives shall have no liability for any misstatement or omission of fact or for any opinion expressed herein. Each recipient further agrees that it will use this summary solely for internal purposes in evaluating a potential investment into an offering of the manager. An investment into a private offering is subject to various risks, none of which are described herein.
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