Letter to Our Limited Partners — 2020
February 21st, 2020
Dear Limited Partners:
As I reflect on the last 12 years as the General Partner and operator of twenty-one (21) independent commercial real estate investment projects, I am very grateful for what we’ve been able to accomplish with the effort of allocating, growing, and returning your capital quickly. The returns that we all have been fortunate to experience in every project sold to date are at a level we are very grateful for and humbled by and appreciative of to say the least. To say that we have been fortunate with our performance would be a gross understatement. I am, and will remain, grateful to have been a successful steward of your investment capital thus far which is a responsibility I take extremely seriously. I am blessed to have had your trust and confidence and I sincerely thank you for that.
It’s interesting to me that our total project count to date has landed on 21 at this point in the real estate cycle. That number carries a very positive meaning for card players and usually is an indicator of the best hand that any player can attain in a hand of blackjack. Given the benefit of hindsight, it’s difficult to come to any other conclusion (regarding the seventeen real estate projects that we have sold and fully exited to date) other than to conclude that the returns realized (approximately 60% annualized on average) are as favorable as we possibly could have expected and in many cases far exceeded our conservative underwriting. I honestly cannot contemplate a realistic return scenario that would be superior to the result that actually occurred with all of our investments to date. This observation is made with great respect for the challenge of allocating and growing capital, (which is typically not an easy task), and with great humility and appreciation for the good fortune and blessings we’ve experienced and, perhaps most importantly, with a very keen interest in not drawing the wrong conclusions about my or my team’s abilities. To produce these returns involves many dynamics that we don’t control including overall market cooperation, interest rates, capital flows, risk appetite and behavior of other investors and users of real estate, demand, supply, government policies, etc. Each of these variables (and many more) contributes to the performance of an investment. Given the many moving parts with commercial real estate investing that are all endlessly fluid, it would be inappropriate to conclude that good luck is not part of our success story and especially when asset performance functions as well as it has within our investment portfolio. We’ve been blessed (and now potentially cursed!) with setting a very high standard of performance that is going to be challenging to maintain and hard to replicate in the near term within the current investing environment. Our investment approach always maintains a focus on “controlling the controllables” and not inviting any more risk than is necessary by managing our investments to this end. Some of the variables that we ultimately do control in any investment we make is when we buy, the entry basis, the construction expense allocation, the amount of leverage utilized (sometimes zero), the asset investment strategy and assumptions, our operating partners, the holding period, and when we sell. Any one area within this controllable universe can either mitigate risk to the investment or add risk to the investment with either result being due to proper, or improper, asset management. I obviously cannot predict any future return performance with any investment yet to be made (and especially in the current investment environment which I will speak to shortly) but what I can predict with 100% certainty is that Wyatt Capital and our team will always work extremely hard to focus on the “controllables” properly and always with a bias towards maintaining a margin of safety with appropriately conservative investment assumptions and an intense focus on capital risk management. Selecting investments that prevents impairment of capital while providing the greatest upside potential for that capital is always Wyatt Capital’s #1 objective.
With regards to the current investment environment, market conditions include very high asset pricing, very high construction costs, abundant debt and equity capital, accommodative interest rate policy, rosy assumptions by investors, low cap rates, and compressed returns, etc.- all of which exist at a time that is late in the business cycle (in my opinion). Sam Zell’s recent assertion that real estate is “priced for perfection” is accurate. If nothing materially changes in market conditions, (which we all know is inevitably unrealistic), new capital acquiring assets at today’s pricing may realize marginally appropriate returns on their investments and largely do OK by allocating capital today- perhaps. I also generally believe that returns in commercial real estate are not commensurate with the current risks that correspond with making illiquid real estate investments today and in some cases asset pricing has potentially decoupled from fundamental and rational valuation processes. While there are always inefficiencies in any real estate market that will allow for certain rifle shot investments to be made in specific cases within certain niche’s or micro markets that will allow for outsized returns, (and we will be seeking these opportunities diligently), generally speaking, we expect those opportunities to be difficult to locate in current market conditions. In short, there’s too much capital chasing too few opportunities resulting in overpriced assets that don’t properly reflect the risk being incurred. I expect this will end badly for some new capital entering this market at today’s pricing when the tide eventually goes out but have no idea when such a market correction may occur.
I won’t speak in great detail here about specific remaining active investments that we are busy with given that each limited partner receives our detailed individual investment updates regularly. However, for those limited partner investors who have exposure to our remaining investment portfolio, generally the prospects appear good for monetizing these assets in the near term and returning your capital and more. We are currently already under contract to favorably exit one office/warehouse asset (scheduled for closing in late March) and have agreed to favorable sale terms (and buyer due diligence has commenced) for another office/warehouse asset which is scheduled to close in May. Additionally, another office asset we own has gone from only 30% occupied at acquisition in October 2018 up to 90% leased as of this past week (as a result of three new long term credit tenants who have leased space from us recently) which positions us to sell the asset well ahead of schedule at a favorable exit price (assuming the capital markets remain stable). And the last asset in the portfolio has essentially been de-risked and we intend to hold it indefinitely. If each of these scenarios stays on the track that it’s currently on, each of these investments will conclude favorably and consistent with previous asset performance in the Wyatt Capital portfolio. Perhaps we will be fortunate enough to see these remaining investments safely across the finish line. We will learn either way soon enough.
My passion level is as high as it’s ever been for investing in real estate assets and there’s nothing I’d love more than to locate great investment opportunities that I can share with you that will increase your wealth and provide the above market returns that Wyatt Capital and our limited partners have grown accustomed to. My strength continues to be developing a thesis that other capital sources aren’t considering and sourcing opportunities ahead of the broader market. Additionally, I have ALWAYS intentionally managed overheard expenses such that we don’t “have to go do deals” to keep the bills paid. To the extent opportunities can be identified, we will be active capital allocators. To the extent they can’t be, we won’t be. Market conditions may dictate that we “stick on 21” for the time being which we are perfectly comfortable doing if investing conditions dictate that new acquisitions should not be made. I have great appreciation for the symmetry between “not hitting 21” (which would not make any sense in the game of blackjack) and the parallels between that hand of cards and “the hand” that has been dealt Wyatt Capital with regards to our past portfolio performance, the remaining runway for our current investment assets, and the limited opportunity to invest with a margin of safety in the market today. We certainly can and will be patient and wait for the deck to get reshuffled and dealt again before putting chips back on the table. As soon as a clear path to allocating capital responsibly becomes visible, Wyatt Capital will participate.
Thank you for your trust and confidence and I appreciate having you as a client.