Bonfire Smore's - A Memo on the Current Real Estate Landscape
 
Print Icon
 
Memo on the Current
State of the Market


Bonfire believes that sound investment strategy is born from an understanding of where we currently are and preparing for a variety of outcomes, with some thoughts on the probability of each of those. To that end, this memo was written by our COO, Brent Donaldson, and draws upon his experience in investing in more than $2 billion in commercial real estate in his career.

Introduction

This is a highly unusual time, with the U.S economy presently exhibiting strong performance, even in the face of dramatically increased interest rates across the board, which are at levels not seen for decades.


Meanwhile, the increase in rates has paralyzed both residential and commercial real estate markets with potential sellers preferring to defer and “wait and see” if rates decline to anything close to their recent historic levels (which themselves were lows not seen for decades).

Existing owners in a pickle

Importantly, the increase in mortgage rates has left those investors owning properties with debt rolling over in quite a quandary as the rates on their mortgage service payments could soon increase significantly. Consequently, particularly in the office sector, there have been notable investors giving back the keys to lenders such Starwood and Blackstone.


Indeed, office properties are in a double bind as leases that roll over are highly likely to, if renewed at all, lease far less space than formerly. This leaves many office buildings with gaps between their income and debt payments. Those who sell will experience very large price adjustments until and/or unless:

  • Rates decline
  • Occupancy trends and WFH reverse and space fills up with existing tenants
  • Economic expansion grows demand for office space sufficiently to refill vacancy
  • Inflation pushes up rents with some combination of the above


In the office sector, three likely scenarios will occur when debt rolls over:

  • Owners will need to raise further equity
  • Owners will ask the lender “pretend and extend” the debt leaving the status quo in the meantime to be reckoned with at a further time
  • Owners will give the keys back to the lender who likely sells at a price often less than the mortgage.

Doomsday stories

Consequently, being that sensationalism sells, the press is filled with doomsday stories of commercial real estate, which is largely related to the office sector. Given that mainstream and social media make money by drawing eyeballs - and humans have an inherent propensity to paying attention to negativity - the question at hand is:


Is this is the time to go with the “herd” and be negative or be contrarian and invest in a sector, like office?


At Bonfire, we believe in “strong convictions, loosely held”. We value data over news stories. 


One of Bonfire’s investment hypotheses is that with short-term interest rates increasing more than 525 bps in the last 18 months, the 10-year yield approaching 5%, and $1.5 trillion dollars of commercial debt resetting in the next three years, a once-in-a-generational opportunity to purchase distressed assets at a significant discount is coming.

Another investment hypothesis of Bonfire’s is that with certain properties, in certain places and at certain times, there are opportunities to purchase and renovate/add value and or undertake short-time frame development that can realize a higher than average return. Our three most recent projects (a $60MM hotel, $70.4MM apartment building, and a $46.8MM shopping center, respectively)  are examples of Bonfire partnering with exceptional operators who saw an opportunity to buy a cash-flowing asset at a compelling price and upgrade it to its most productive use.

Judo as an investing philosophy

How can a startup like Bonfire break into the crowded field of offering real estate investments and - more importantly - how can we offer our community “alpha” returns that exceed most of what our competitors are offering? 


To do this, we borrow from the martial art Judo. If you have ever seen an exhibition of Judo, the primary idea is to harness the energy of another and use that to one’s own advantage.  This is why someone weighing 120 lbs can defeat someone 300 lbs in combat. 


Bonfire is harnessing Judo by piggy-backing on exceptional real estate operating partners who have demonstrated track records in successfully under-promising and over-delivering on a niche, sub-market (or ideally both) and who are well-positioned to capitalize on dislocations in the market.  


The lens we are using to screen opportunities include:  

 

Investments are presently more difficult to source

than in the recent past as sellers are waiting for rates to decline to sell and buyers are wanting to pay lower prices.


Opportunities will be coming

in the near future as $1.5 trillion of debt resets. Even so, it's crucial to invest at a low enough cost basis that can support low occupancy/rents that caused the default. 


Investments must be made at "positive leverage"

meaning that debt service cannot exceed free cash flow.


Higher Interest rate risks are mostly behind us

however, incremental and small rate increases may lie ahead and rate declines are unlikely to be large. Rates are likely to remain higher than the 0-2% range the Federal Funds Rate has been for much of the last 15 years.  


Focusing on value-add and short-term repositioning projects

in addition to distressed opportunities, may provide the best stabilized current returns available in the shortest time.


All investment decisions must protect the downside

While many investors chase the highest returns, Bonfire will always take into account risk adjusted returns; analyzing the impacts of possible events which could reduce returns so as to provide an element of safety and not endanger principal in downside circumstances.


Agnostic as to property type but sensitive to location and operating prospects

This is the time to sharpen our pencils when it comes to looking at market and submarket data related to occupancy, rental, supply, and absorption assumptions and trends.

Conclusion

The current investing landscape is in a time of upheaval, with a spectrum ranging from distressed assets to new development opportunities. This is the time to have a clear investment thesis, patience, and capital but not chase deals for the sake of doing them. 


Bonfire's value proposition is simple: We present you, our our investor community, with rigorously-vetted opportunities, handpicked to capitalize on market anomalies. We seek partnerships that promise value at an attractively low cost, run with minimal debt, all while eyeing stabilization of operations and, hopefully, a dip in rates.


At Bonfire, our goal remains steadfast: to strike the best possible balance between risk and reward, while always prioritizing our investors’ capital. Only when a potential partnership aligns with our stringent criteria do we bring it to the Bonfire platform.

Thanks for being a member of our community,

 

Joshua Kagan,

Co-Founder, Bonfire


Forwarded this newsletter? Sign up here
To sign up for an account and get access to exclusive passive income opportunities, go to app.bonfire.capital (it takes 30 seconds and is free) 

About Bonfire: Our mission is to provide investors with carefully curated tax-sheltered cash flow and capital appreciation investment opportunities they would otherwise not have access to. 

Follow us on:

You are receiving this email as you signed up for our newsletters.
Would you like to change how you receive these emails?

Please update your preferences or unsubscribe from this mailing list.