US Industrial Property Values Driven By Global Forces

Published: 08-16-22    Category: Investing

Specializes in providing actionable insights into the commercial real estate space for investors, brokers, lessors, and lessees. He covers quarterly market data reports, investment strategies, how-to guides, and top-down perspectives on market movements.

Industrial propertyIndustrial  property

By Brian Kidder - Economics and Markets Editor

On July 14, 2022, the Industrial and Logistics Property Trust (Nasdaq: ILPT) announced that it’s cutting its dividend from $0.33 per share to $0.01 per share, which prompted large institutional selling of the issue, wiping 25% of its nominal value from existence.

The REIT recently acquired Monmouth Real Estate Investment Corp, an acquisition that it’s still metabolizing and trying to complete longer-term funding for but that has improved ILPT’s scale and geographic diversity. The company stated the large dividend cut was necessary in light of ‘unexpected’ interest rate hikes and the need to improve cash flow as it digests the acquisition.

This is useful information for CRE investors, particularly industrial and logistics property buyers and speculators, because it represents a prudent, early move by competent management to meet cash flow needs in response to changing market conditions.

It also signals something in the bigger picture: Rising rates haven’t surprised the bond market, suggesting that management could have anticipated these moves sooner.

It also signals that others likely will follow suit and the properties that underlie their value are about to present a buying opportunity in and of themselves.

The Bigger Picture Back Story

After World War II, the US economy and its military, particularly its Navy, were the only ones left standing.

Prior to this time, the dominant, emergent economic system (emergent because nobody sat down and planned it this way) was one of imperial mercantilism: Essentially, greater nations colonized lesser nations that had resources they needed, and this was how empires flourished.

In many ways, both world wars represent the inevitable end to this type of system because empires are about ensuring the availability of resources and revenue. Where empires overlap, they necessarily conflict.

One empire’s resources are not the others’. Nations construct complex webs of alliances with other nations, all aimed at systemic continuity that proves elusive, and prone to flash points and conflict.

Alliances Can Create Systemic Triggers

These alliances necessarily come with if/then rules about what happens if someone is attacked, and under these systems, it’s essentially guaranteed someone will be attacked as these structures are in place to facilitate the endless flow of scarce resources others have their eyes on.

The Japanese Empire’s attack on Pearl Harbor was, for example, a response to US machinations that impacted its ability to source oil.

The US’ response to this systemic quagmire, rather than repeat more of the same, was to bring its allies together under the Bretton Woods Agreement, which essentially enabled the global economy as we know it.

US Navy Super Carrier

Photo by Michael Afonso on Unsplash

Under this system, the US Navy safeguards international shipping, and any member nation can, with the US’ blessing, trade with any other nation.

Two major results of this agreement were that, under this US-led international order, more people had been lifted out of poverty than existed at the outset of the agreement, and the US dollar had become the global reserve currency.

Implications of the US Dollar as World Reserve Currency

Nations trade with each other in dollars because it can happen with one less currency conversion, and the US doesn’t manipulate the dollar’s value to facilitate trade because Bretton Woods was only about trade to a limited extent; it was in fact about security, for the US.

The US bribed itself up a global alliance to stand against the Soviet Union and communism. Today, 30+ years on from the demise of the USSR, this system is going away.

The implications of this fact cannot be overstated. The system that allowed raw inputs to be sourced in country A, shipped to country B, and machined into value-added products and sold on to countries C to Z, all at a profit, is going away.

This means that, to sell product into the world’s largest and richest consumer base, countries need to be more than a manufacturing powerhouse; they have to co-locate their manufacturing and logistics facilities alongside their consumer base.This is evident in the strategies of Japan and South Korea, for example.

But technology has changed manufacturing. Not only have wage costs risen by a factor of 20 in countries known for their manufacturing edge such as China, but even the low-end manufactures, like textiles, can be nearly fully automated, and the US has lots of land.

This re-shoring of manufacturing capacity is but one pillar of a multi-faceted argument with one inescapable conclusion: In the next 5 years, the US needs to roughly double its industrial plant, if we are to maintain our access to value we’ve come to expect from global markets.

Slowly…then suddenly

Market moves tend to arrive in three distinct phases: denial, migration, then panic. At first, the idea that the market is changing directions is denied and opposed through mean tweets and other ways. Then, migration ensues.

The Market Dynamic

Slowly at first, but then suddenly, the panic phase sets in. With liquid securities, this is where falling knives are caught, blood is spilt, and the imbalance of pessimism can finally begin to correct.

With illiquid investments, however, this must be planned in advance, which brings us full circle.

If you knew there would be highly probable demand for industrial property in the next five years, and that buyers would be just as likely foreign as domestic, could this not confer an extraordinary informational advantage? Let me answer with an analogy.

A Useful Parallel From Blackjack Card Counting

Blackjack is unique among casino games because it is the only game in the casino that can be fairly beaten.

Blackjack table

Photo by Aidan Howe on Unsplash

Yes, this takes highly-developed skill and, yes, this is officially frowned upon by casinos, but the truth is they make far more from card counters than they lose because, for every card counter who knows what he or she is doing, there are ten more who think they do, and are in fact just repositories of investment alpha for casinos (alpha refers to returns not due to market conditions).

But there’s another technique good blackjack machinists use occasionally, and it involves using a spotter to catch tiny bits of useful information the dealer inadvertently gives away.

Getting a Truer Advantage

It’s typically done in the early morning hours when the tables are least crowded, and one can play every hand at the table with a partner without anyone else there to mess anything up.

The way it works is the spotter sits at one of two locations: first base, the farthest seat to the player’s left - on the dealer’s right; or at another table across the pit. They are looking to catch a glimpse of the bottom card when the dealer rolls the decks of cards into the shoe, which refers to both the acrylic box from which the cards are dealt, and the entirety of the multiple decks in play.

What’s the advantage of seeing a single card? Most times there’s very little advantage because most times the card seen is little help to the player; but when it’s an ace or a ten, then things change considerably.

If the ace or ten can be spotted on the bottom of the deck, the spotter signals the player, and the player then goes to work with the cut card. With proper training, a player can learn to cut precisely one, two, or three decks of cards into a shoe (the shoe is that fancy box-type contraption they deal out of, or the entirety of the multiple decks of cards).

Once trained, most players can tell if they cut the correct number of cards within plus or minus one card. If they meant to cut 104 cards (two decks) but actually cut 106, they can usually feel it. Now the countdown starts.

The Execution

The dealer takes the cards from the cut card to the bottom and moves them to the front of the shoe, then burns the first card. The fresh shoe is now 103 cards from a known ace or ten. This is why you play at down times: So you can play every hand on the table.

The player proceeds to play basic strategy on every hand until the round where the known card will be dealt. He then estimates where it will land and bets very heavily on that hand as well as the two on either side of it, with the middle one receiving the most chips.

As the cards are dealt, the player hits or stands not based on basic strategy but to get the known card to the correct destination: the hand with the money in the case of an ace or the dealer in case of a ten.

Here’s the kicker: when steering a known ace to a hand, the player has a 60% advantage on that hand and about a 33% advantage in the case of a ten. Note: this is not the same as having a small advantage overall, like the ‘house advantage.’

Not Your Father`s House Edge

The house advantage stems from the fact that the casino pays odds that are lower than the true odds; in craps, for example, the odds of a single roll bet being a specific number are determined by the math of rolling two dice, but the casino doesn’t pay those: It pays less.

The odds of rolling a twelve, for example, are 1:36: one way in six to roll a six on one die times one way on the other die (expressed mathematically: 1/6 X 1/6 = 1/36).

This implies that the other 35 chances in 36 (36 possible combos, only one of which is called twelve) are against your rolling a twelve. If you wanted to bet you’ll roll a twelve in a single roll, a fair game would pay you 35:1 if you hit it. Most casinos pay 30:1.

House advantages tend to be low in most games because people won’t play if they’re too egregious but, in blackjack, they’re especially low: just 2% on average.

If a player simply learns basic strategy and plays it perfectly, they can eliminate this advantage and play an essentially fair game. But if they count cards, they can actually turn the house edge around for themselves and have a 2% edge.

This means that every $100 bet wins $2 on average. But on this specific hand where you’ve spotted an ace or ten and are steering it to a known location carries a 60% or 33% advantage on this particular hand.

That means you’ll win 60% of the time when steering an ace, or 33% of the time when steering a ten. That is a game-changing swing.

The Value of Information

Many people have been exposed to the Monte Hall problem as a sort of off-kilter brain teaser, but it points up the value of information in determining odds, so it’s instructive in this context.

The contestant is shown three doors. Behind two of the doors are goats, and behind the third is a car. The contestant’s job is to choose the correct door. Initially, the contestant chooses a single door, giving him a ? chance at success; but then, one of the doors is opened to reveal a goat.

New information is revealed. What is the value of this new information?

The Value of Information

The contestant is then asked if he would like to change his door choice. What is the correct play? It is always to switch. Why? Because new, valuable information was revealed. The first choice was made between 3 unknowns, yielding a 1/3 chance of success. The new information is revealed, so that if he chooses again, he is making a one-in-two blind choice, not a one-in-three.

The value of the information is therefore one in six (expressed mathematically: (½ = 3/6), (1/3 = 2/6), (3/6 - 2/6 = 1/6).)

In case you fell asleep, that’s HUGE. That’s the difference between winning half the time and a third of the time, thanks to one simple piece of information.

Conclusion

The value of pertinent information can be game-changing. Understanding the macro-drivers of the world economy can pay dividends at the micro-level in your investment performance.

In this case, understanding that the US needs to double its industrial plant, and that this will affect the commercial real estate on which it sits in the next few years, and that foreign purchasers will compete with US buyers allows savvy investors to focus (and potentially steer the ace, as it were) to improve their hand.

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