Market Comments, 5-5-21
My secretary, Misty, brought me a petition justifying her skills to write you her thoughts on the market. While only 3 (21 in dog years), she’s in my office daily overhearing my phone calls, listening to my comments on the hundreds of emails I get, and capturing the essence of my ramblings while structuring spreadsheets, fliers, etc. In spite of the evidence of her similar K-9 associates, I don’t think she’s quite ready for primetime. So, I’ll be authoring this and the next several issues until her in-house research memos pass muster.
But this raises the question … Do you know who’s sourcing your research?
After staying below zero for a year, the Wells Fargo Animal Spirits Index (ASI) turned positive in March. All five components contributed positively over the month, indicating widespread optimism. This strong reading is just the latest piece of data pointing toward an accelerating economy. Much like the broader recovery, the ASI's turnaround is the fastest in decades, with the index returning to positive territory after just 12 months. By comparison, the ASI took after 75 months (6 ¼ yrs.) to turn positive after the Great Recession, and 33 months after the 2001 recession.
We monitor this index because it’s a single encapsulation of the emotions and attitudes of investors, business owners, and decision makers. It includes among other indicators the Consumer Confidence Index. We think this is a “best read” of the pulse of the market.
The index had been negative since the start of the pandemic, as any improvement over the last year proved fleeting and successive waves of COVID prevented the return to normal economic engagement. While the virus is still prevalent, the accelerating pace of vaccinations provides some reason to believe the recent improvement in sentiment could prove durable.
Financial markets continued their steady advance. The S&P 500 index notched another all-time high, while the VIX (short-term volatility index of the S&P 500 – one estimate of market risk) hit its lowest monthly average since January of last year. The yield spread between the 10-year and 3-month Treasuries increased as markets continued to price in higher inflation and expectations of further fiscal stimulus. The Economic Policy Uncertainty Index dropped to 140.8 in March, the lowest level since January 2020. Consumers’ perception of the economy improved rapidly in March as COVID case counts dropped and the labor market recovery picked up momentum. The Conference Board’s Consumer Confidence Index jumped to 109.7, the highest since March 2020. We’ve all heard by now that Q1-21 GDP came in at 6.4% (annualized) growth, the highest in decades. It’s fairly common now to see 2021 GDP forecasts of 6-8% increase for the year.
The labor market recovery has begun to accelerate, with 916K jobs added in March, and the ISM indices for the manufacturing and service sectors hitting 37- and 24-year highs, respectively. Labor hit a speed bump, however, in April. Forecasts were for jobs to increase 1mm (yes that’s a million) but the jobs report came in at only 266,000 – just a bit off! Yet, unlike last year when re-openings led to a mechanical jump in various indicators as the country exited lockdown, sentiment is now improving. Rising animal spirits, in addition to historic fiscal stimulus and an improving public health picture, underpin the expectation for further improvement in economic activity over the coming months. It’s going to be a choppy ride.
Small business leaders, however, are more cautious in their optimism than the ASI would suggest. The National Federation of Independent Business' (NFIB) Small Business Optimism Index rose 2.4 points to 98.2, which brings the index back above its long-run average for the first time since November. While the improvement is encouraging, this past month's rise was less than expected and is in sharp contrast to the more significant gains seen in many other economic indicators. Seven of the 10 components of the NFIB survey increased in March, led by an 11-point rise in the proportion of business owners expecting the economy to improve and an 8-point rise in expectations for sales. Both series, however, remain relatively low. Plans to increase staff rose 4 points to 22%, but business owners continue to report extreme difficulty in filling open positions and rising wage pressure. (They’re competing with the Government’s free hand-outs for not working!)
Having diverse market data and opinions in this post-COVID recovery environment should not be surprising. Markets hate uncertainty! And uncertainty we’ve had by the bucket-loads for the last 100+ days. Although COVID data may be expected to improve as vaccines continue to be administered, the daily policy salvos out of Washington will likely continue unabated.
The take-away from all the economic market data is that the market – our market – is trying mightily to breakout of a Government-induced mask-wearing slumber. Much was made of the consumer spending in Q1-21 GDP growth. I heard an interesting term last week with regard to the consumer’s contribution to Q1 GDP: “excess savings”. It wasn’t defined, but seemed to bear a relationship to stimulus payments received but not spent. The figure mentioned was something over $1 trillion! If so, those sensitive to such things will recognize that the money the consumers spent was from the Government via one of the many stimulus plans. Hence, it was Government spending under the cloak of the consumer. Does this matter? We argue yes. It begs the question, at what point will the Government stop, slow, or re-work the Government payments? Under the current administration, that may be never, or at least not until Nov 2022. But since our Comments here have a short-term focus, we won’t peer over that further-term horizon.
As suspected last winter, sellers are now beginning to step forward with inventory. While not a flood, it’s encouraging to see some balance to buyer interest. Always a primary factor in valuing for the market, today price discovery is a major consideration. Lack of sales over the last year or so mitigates the effort of pricing to recent (comparable) sales. Pricing for capitalization of the income stream brings into question how to handle 2020 financial performance. Some businesses had banner years in 2020 (which sellers would like to emphasize), and some were off as much as 50% (which sellers would like to forget). In either case, how do you adjust valuations to reflect this? Much depends on whether you’re the buyer, or the seller … or the lender. We believe it will take most of ’21 and likely into ’22 to develop enough “non-COVID” data to get across the valley (or over the mountain). Incidentally, lenders and appraisers are dealing with the same problem.
The credit markets don’t seem to be an obstacle at this time. I’ve been getting a couple-three calls a week from lenders looking to place money, i.e., make loans. The tone of the calls suggests lending parameters are softening … a lowering of the bar. Interest rates seem to have bubbled a bit, but not to deal-breaker levels. They’re definitely heeding the lead of the bond market rather than standing pat with the Fed. (Not a surprise here.) With inflation showing its hand (to everyone but Powell & Co.) expect further rate increases as the summer unfolds.
J. Powell (Head of the Fed) has stated repeatedly that his primary determinant for raising rates is unemployment. At last check the difference between U-3 (low 6%s) and U-6 (mid 11%’s) gives at best a false reading, but U-3 (popularly quoted) serves to present a positive spin – as of end of April was 6.1%. However, we note a structural fly in the ointment not spoken of in this context: What about the illegals coming across the border? At the current flow they must be worth at least several basis points in unemployment, if they’re counted … another problem. As disbursed across the country, different states will account for them differently. Where and when (or if) do they become part of the employment/unemployment picture? Of course, we don’t know – another wild card. However, if this is the arena Powell is looking at for signals of inflation – a tight labor market – we may well have inflation well-entrenched and going strong before he looks over the other side of the fence.
But will this affect us … our market? Only to the extent that inflation affects interest rates, and Fed QE-style bond purchases affect liquidity, but other than that, not so much!
Market Comments, 4-7-21
A brief scan through a couple of my favorite websites for gas stations & c-stores showed the following listings for sale – Arizona statewide:
Biz Buy Sell: 22 available. Most had businesses with the real estate. Some were offered & priced for the business only, then showed the real estate available for an additional amount. Pricing on viable operating gas stations, with or without real estate, suggests they’re really in a CA ZIP code.
Loopnet: 57 available. This was largely a contaminated grouping, i.e., there were more plain retail buildings, strip centers, closed gas stations, mechanical repair buildings, some carwashes (no fuel), etc. than there were gas stations with convenience stores. Bear in mind Loopnet is primarily a CRE site, not for businesses. They’ll accept business listings if they include the real estate.
The sum of it is that there is little inventory, and what is available is hard to find, and priced dearly. We’ve had poor inventory since before COVID, but this is as poor as it’s been this cycle.
I say this cycle, because we had a similar market, although with different conditions, back in about 2003-2007. I suspect product will start to surface again by H2-21, possibly as early as Q2. The recovery will be driven by the success of the COVID vaccines and the subsequent opening up of the state economies, which should not be expected to be simultaneous or even synchronized.
Fiscal and monetary salvos continue being launched from Washington with unsettling effect. This strains the optimism of the most stalwart consumer/employer/tax payer. We won’t see what the real economic response will be until all the stimulus packages and accommodations run their course. If the Biden Administration’s Infrastructure Program is signed into law, the U.S. will have spent nearly $10 TRILLION in a single year. This number is:
Equal to the GDPs of Japan, Germany and the U.K. combined.
More than the U.S. has spent during the last FIVE recessions combined.
More than the combined annual wages of all Americans.
A fundamental question occurs to us: Can we transition to a capitalistic economy (again) from the socialistic (Government paid for) economy that we’ve been enjoying for the past 3 months before the bond market raises its required rate for buying the next Treasury auction? Of course we don’t know, but this is becoming more than a conceptual question. And what if the next auction is undersubscribed? Katy bar the door!!!
When considering interest rates, we have to be cognizant of the Fed’s posture, even though historically they’ve missed the boat consistently since the ‘70s. From the recent FOMC meeting, the Fed is telling us only 4 of its members see rates rising next year ('22), and none in ’21.
However, the market continues to assign close to an 80% probability of liftoff in 2022. It’s important to note that the Fed will not raise rates while conducting QE. It means that the central bank will need to announce tapering as soon as late this year to gradually reduce securities purchases. Given the Fed officials’ statements, that seems unlikely. If the bond market stops supporting the Fed’s money printing via Treasuries, might there be a surprise announcement of a rate hike without the customary warning? It’s happened before! This then would be a Black Swan that we never want to see. There is a clear disconnect between the markets and the Fed’s communications, i.e., the Fed isn’t listening.
Fed Chair Jerome Powell has maintained a calm exterior when discussing rising interest rates. Powell believes the spike in inflation that often accompanies an economic recovery will be short-lived this time and not significant. Investors aren’t convinced Powell is right, as the selloff of long-term Treasuries continues. Their concern: the surge in government spending coupled with a vaccine-driven increase in consumer spending this summer will result in inflation and force the hand of the Fed to play catch-up with multiple rate hikes.
Mr. Powell has stated repeatedly that a, if not the, primary indicator the Fed will use to que a suspected rise in inflation is the labor rate. A tight labor market (low unemployment) is needed.
Inflation – What to Expect:
But is this really a tight labor market with unemployment over 6%? (The popularly stated rate of 6% is the U-3 rate; the more accurate and usually unstated rate is the U-6 rate, last checked a couple weeks ago at about 11.5%.) U-3, U-6, or other calculation notwithstanding, we have over 11 million able-bodied workers idle. How can we have a tight labor market with so many workers unemployed? Simply stated, it’s “structural unemployment” … unemployed workers don’t have the job skills for the jobs available. This anomaly was most recently highlighted by V.P. Harris’ suggestion that all the workers losing their jobs by the termination of the XL Pipeline should be re-employed making solar panels! We’ve been here before, and our previous experience shows us that structural unemployment takes time to cure. This time may well give inflation a running head start before the Fed acts … terminating liquidity provision programs and raising rates. Might the Fed indeed fiddle while Rome burns? They have before. Since the late ‘60’s-early ‘70’s the Fed has consistently been behind the power curve. Should we expect anything different now?
All of this is impacting the short-term horizon of our market … the market for buying and selling gas stations. It doesn’t seem to be tempering investor enthusiasm, but is throwing cautionary cold water on decision-making.
On the supportive side of transactions, credit interest rates are remaining low in spite of what can only be described as a bond market explosion … in rates … prices tanked. The 10-year Treasury about doubled since August, from 0.91% to 1.72% as of April 2. Meanwhile mortgage rates are firm, maybe up a bit on conventional loans, but largely unchanged. Lenders are tightening the terms, raising the bar, and decreasing LTVs 5-10%, but unless the deal was thin to begin with, these aren't deal-breakers.
Also, there’s a lot of cash parked for the rainy day, or the screaming good deal that can’t be passed up. Not too many of these around yet, but what constitutes a good deal is largely subjective, in spite of the analytics that surround the negotiations.
Gas station dealers on balance had a banner year in 2020. A different business model to be sure, but record high bottom lines. Stations that may have otherwise come to market for sale have been held back so the owners can continue to enjoy the unprecedent profits. Might they be holding on too long? Its likely!
Translating COVID improvement into market activity, we suspect listings will begin to materialize later this spring or into summer as the economy “normalizes”. If you’re a seller, you can sell now into a seller’s market. A normalized market favors neither side.
Market Comments, 3-13-21
Those of you accustomed to receiving this Report on a monthly basis will recognize its absence over the past couple months … since the Presidential election and through the first 7 weeks of the new Administration. This was not an oversight, but an intended delay.
With the continued uncertainties of the COVID-driven economy, the added confusion and additional uncertainties from the election followed closely by Biden’s early activities post-inauguration were too much for the markets to digest in any meaningful manner. Just so much noise!
However, the dust has begun to settle and a dim horizon is coming into focus.
So how has the consumer weathered the storm? (We’re all consumers, even gas station buyers, sellers and investors.) The University of Michigan's survey of consumer sentiment jumped to 83.0 this month, its highest level since March 2020 . With more fiscal stimulus on the way and the tide turning with the pandemic, we fully expect a continuation of this upturn in consumer confidence. The $1.9 trillion fiscal relief package became law yesterday, and some stimulus checks will hit personal bank accounts as soon as this weekend. Aside from the longer-term impact of the Government printing & spending money, the short-term impact can’t be ignored.
Considering commercial real estate (CRE), average asking prices per square foot across all CRE property types dropped the most in February since the pandemic began a year ago, according to new data released by commercial database CREXi. Newly listed asking price averages decreased 7.34% over January numbers, owing in part to some listings being marked as “unpriced,” while square footage across asset classes rose by 11.2%.
“Just as in the early months of COVID, sellers and brokers are preferring to use the market as their pricing mechanism to begin the negotiation,” CREXi analysts write in the firm’s National CRE Report for February 2021. “This trend had been generally reverting back to pre-COVID levels of unpriced listings, but seems to have returned in earnest in February.” This will be most interesting to gas station investors, not so much for owner-operators. (Privately owned small businesses price by a different mechanism than investment CRE.)
Although small businesses and CRE are different markets, its notable that the investment CRE market is coming to life also.
The US economy showed its clearest sign yet of recovery with February’s unemployment report released earlier this week by the BLS: Some 379,000 jobs were added to US payrolls last month, led by the leisure and hospitality sectors.
To be sure, the jobs market is nowhere near its pre-pandemic health. First-time unemployment claims totaled 745,000 last week, up from 736,000 the week before, while both the unemployment rate, at 6.2%, and the number of unemployed persons, at 10 million, changed little in February. Although both measures are much lower than their April 2020 highs, they remain well above their pre-pandemic levels in February 2020 (3.5% and 5.7 million, respectively).
All that said, the gains in February were very telling, particularly for the CRE industry. There were 355,000 jobs added in the leisure and hospitality sector; in the bar and restaurant sub-sector alone 286,000 positions were added. This is a strong signal of the service sector reopening.
The new positions at bars and restaurants are in part a reflection of relaxed restrictions on dining that took effect last month, particularly in California and New York, according to Marcus & Millichap Research Services, but they also signal the beginning of a more robust stage of employment growth after a pause in the recovery late last year. “The positive momentum, aided by ongoing stimulus measures, speaks to the underlying demand and resurging confidence in the retail and hospitality sectors that were most impacted by the pandemic,” it said.
I speak of momentum often. Entrepreneurs, business owners, and investors are a forward-looking people … “the trend is your friend” … “don’t fight the trend”. Markets discount time. We don’t invest by looking over our shoulder (or shouldn’t), but by looking forward. For this to work, however, requires a stable continuum of the environment – markets don’t like change, disruption, surprises. All these things interrupt confidence, and break the momentum.
Markets continue momentum by improving on the things that give us our confidence. Perhaps at this time its more favorable reports of COVID data. Will more socialistic programs and bills before Congress be seen as favorable improvements? Ask somebody who’s getting the next $1,400 check. We’ll see, but keep an eye on the horizon for the next black swan. The next threat to momentum that’s begun getting some press lately is inflation.
We’ve been writing about this for some time, ever since the Fed’s debt-to-GDP ratio passed about 105% a few years ago. Keep the money printing going and it’s just a matter of time.
As long as the Fed’s money (QT, etc.) was going to Wall St. inflation remained in the public markets (30,000 on the DOW). But now with all of the COVID Relief programs the money is finding its way into the real economy. The difference: the velocity of money. If you take “extra” money & put it in the market, in the dog house or under the mattress it has no velocity, hence, no inflation. But put it into the economy, e.g., via stimulus checks to the world and you get velocity, and then inflation. This is where we’re at.
Inflation is what happens when real assets adjust (re-price) for financial assets. Real assets: real estate for one, also precious metals (gold, silver, etc.) and commodities in general. Financial assets: stocks, bonds, essentially financial contracts or evidence of ownership. If you’ve been to the grocery store lately – or gas station! – you’ve experienced inflation. I was told today that rack rates for unleaded (87 octane) are over $3.00. To have the Fed tell you we don’t have inflation is denial on their part, and more that a bit insulting to consumers.
The bond market has already reacted to the above data. Perhaps you’ve heard, although it doesn’t get the press that the stock market gets. The bond market traditionally has led the stock market by a considerable amount, up to 2 years.
A brief glance will tell you the 10-year Treasury has about doubled in the last 6 months.
I’ll have more on inflation, Fed policies and the bond market in our up-coming Blue Paper.
And so, what does this have to do with the market for buying and selling gas station businesses?
Since this Report deals with the short-term horizon, 3-6 months, we’ll limit our comments to this period.
Buyer activity took a pause during the first few months of 2020 while we were figuring out how to handle COVID, then during the summer broke out to new higher levels of activity. For Californians I believe this was as much an effort to leave the state than business or financial reasons. Buyers again took a pause about a month before the election, and for the first few weeks after, but now again have returned to active. This most recent spike having to do with what is perceived as radical, unsettling policies coming out of Washington, and yes, continued turmoil at several state levels. Their motivations notwithstanding, buyers are back.
Lenders, the other part of the buy equation, have been largely unresponsive since H2-20. About Q2-20 most ratcheted up the lending criteria, not so much pricing. Interest rates that have their basis a legislated rate, e.g., prime, have been marked up selectively by asset class (type of real estate, and the type of business conducted on the property). Lenders have put more of the underwriting burden on the basic creditworthiness of the borrower. Interestingly, gas station properties & businesses are considered to be a desired asset class in the COVID environment.
If the bond market keeps pricing rates up reflecting anticipated inflation, at some point the Fed will have to capitulate and begin raising Fed Funds. They will also be called to this by the continued weakness of the dollar. This will not be received well by public markets! Whether they can hold this off until the end of 2022 as advertised is considered by many to be doubtful.
Our market will continue to improve over the short-term. Previous run-ups in gas prices as we are experiencing now have served as a magnet for buyers. This is won’t be an exception, but will provide another reason for new entrants to want in.
Sellers, don’t get carried away with pie-in-the-sky pricing. Lenders will remain a governor keeping a lid on run-away pricing. They don’t want a repeat of 2005-2008. For owner-operators selling a business that includes the real estate, the price rises will be from the real estate, not from the business component. Lenders for investment real estate that would typically loan up to 60-65% LTV have now whittled down to 50-55%. Expect a similar reduction when financing the business, with or without the real estate. Other terms may also get tightened. Tightening terms puts a greater burden on cash flow to meet debt service coverage ratios. Lenders know this, which is why they’re paying greater attention to the strength of the borrower.
Market Comments, 10-9-20
“The markets recovering” he said.
“No it isn’t.” came the reply.
They’re both right!! Seems we’ve been talking about bifurcated, and in some cases trifurcated, markets since the 2010 Great Recession recovery. And we’re at it again … bifurcation. But the salient question is ... what are the lines, boundaries, and segments of bifurcation? Today they’re dictated by the pandemic. Essential businesses, and the properties they occupy, are doing well in the market – being bought and sold. Non-essential businesses and their properties are struggling and languishing in the market.
At MJG, gas station business and real estate are selling and in demand, even more so than before the pandemic.
What are not seeing activity – yet - are dark properties for redevelopment and land. There are a couple events on the near term horizon that could change this in a hurry:
1. the election (now less than a month away), and
2. the actual release of a COVID therapeutic, and/or a preventative vaccine, the latter frequently advertised as “coming soon”.
We won’t offer speculation as to the outcome of either event, only to note that there is an abundance of dry powder waiting for ignition.
What is not talked about nearly as much but is likely soon after the election is the passage of a CARES ACT 2. The only uncertainty seems to be whether it will be $1.5 or 3.0 trillion – this will largely be determined by the outcome of the election. From the markets standpoint, either is a winner, i.e., it will re-energize optimism in the economy. This may very well ignite the dry powder looking for a spark. I’ve had several inquiries in the last month or so for gas station land to develop … positioning inquiries I call them – not ready yet, but getting ready to get ready!
Backing up my own grass roots survey are my friends at the University Michigan with their Consumer Sentiment and Expectations Index, below.
Feeding into economic enthusiasm is employment. The employment base continued to expand at moderated pace last month. Security in a job is a big factor in consumer’s expectations. Employers added 661,000 personnel to payrolls in September, restoring 11.4 million of the 22.2 million positions lost in March and April. September unemployment rate: 7.9%. Despite these gains, last month’s total of under 1 million new roles continued the recent trend of slowing growth.
Firing up the economy by either of the catalysts mentioned above could get our markets “exciting”, the CARES Act notwithstanding.
Some, not all, but some banks are active in the market, particularly with SBA loans. (Trump wants small business to survive and thrive, and he’s passed down those marching orders.)
We’re not out of the pandemic crisis woods yet, but the natives are restless. Given the opportunity, or excuse, and they’ll make a break for it.
Market Comments, 9-4-20
After enduring a U.S. real (net of inflation) GDP plunge of 32.9% in the second quarter, consumer and business confidence is holding up much better that would be anticipated. The NFIB’s Small Business Optimism index fell 1.8 points in July to a still solid 98.8. Consumer Confidence fell in August to 84.8, and is lower now than it was in April and May at the height of the lockdowns. Still confidence is not as battered as it typically might be during a recession.
The market – any and all markets – hates uncertainty.
Still, how much uncertainty will the markets tolerate?
Q2 CRE transaction volume was down 40% overall, and as much as 70% in some segments. CRE loan originations were down 48% year-over-year, and 31% vs. Q1. The lack of transaction volume translates into not much price movement. The dry powder is waiting for the bottom to fall out of the market, and that hasn’t happened. Forbearance, lease re-negotiations, Government money pumped into the system to maintain liquidity, etc. And how long might these tactics last? Hum-m-m-m!
And from where might the next threat of uncertainty come from? A Biden announcement … a Trump announcement, a Democratic acquisition … a Republican rebuttal, another cop or black rioter shot, another city burned. Such is the socio-political landscape. The financial and investment markets, however, have been digesting these events for at least 6 months or so. It’s unlikely they’ll crack between now and Nov. 3. The surprise uncertainty may be that these activities may not stop on Nov. 4, regardless of who wins the election, or regardless of when we may get a COVID vaccine or therapeutic treatment.
A closer look at our arena. Buyer inquiries have accelerated, again, mostly originating from CA. Those actually submitting offers, however, are few. My suspicion is that they’re waiting for the market to soften as reflected in public markets. The reality is, however, that private markets for businesses bear little correlation to public market pricing. That’s been the case going up, it will continue to be the case going down. Private markets are much more sensitive to the price of money (interest rates), and availability. 7(a)’s that will finance the business as well as the real estate I see quoted are regularly showing 5-5.5% (Prime + 1.5-2%. The SBA ceiling is Prime + 2.75%.) LTVs are still 80-85%. I recently received a term sheet for the ground-up construction of a gas station/c-store and carwash at 81% LTV … yes, a construction loan.
On the sell side inventory is still lacking – particularly quality inventory, i.e., businesses that are actually making money, and real estate without much deferred maintenance. And what comes to market, or would like to come to market, is priced at levels reminiscent of CA ZIP codes. Even if these were to contract, it’s unlikely they would appraise at a level that would support the transaction.
CRE-only properties, i.e., no business included with the real estate, have been quiet. These would include investor-owned with a tenant, idle properties (vacant) including those for redevelopment, and land-only.
We recently (last month) started a beta test period with a listing platform called CREXi. (CREXi.com). This is the first apparently authentic competitor to Loopnet I’ve seen surface since Loopnet was acquired by CoStar. They offer some additional marketing tools beyond Loopnet, and internal support mechanics. I’m still learning the program, but it looks promising.
One of the marketing tools they offer is an auction platform for CRE. This is not a viable tool for businesses, even if the business includes the real estate. There are several dedicated auction platforms around, and have been for years. Historically they do well in bringing buyers to markets during periods like we’re going through at this time … previously 2002-2003
(post 9-11), and 2009-2010 after the financial crisis and recession. One of the implications an auction has is for the buyer is that the subject property is distressed, and can be acquired at a bargain price. The operative term here is “implication”. The required distress of the property is clearly not a requirement, or even a condition. Compared to other auction services I’ve explored over the years, CREXi offers some favorably slanted conditions for the seller. Give me a call if you’d like to discuss this further.
Market Comments, 8-5-20
All, literally all, I read about commercial real estate (CRE) is about how transaction volume has collapsed, prices are unknown (primarily because lease income is uncertain), and we don’t know when it will recover. I have no doubt the macro data and reporting are true, but it masks over our particular segment, and business brokerage in general. A few observations from this month’s data:
Conventional CRE financing has fewer types of lenders participating in new loans, particularly money center (big-boy) banks. SBA lenders who are financing businesses, however, are more aggressive, even for businesses that don’t include the real estate.
NOTABLE DISTINCTION: Buyers of, and lenders to owner-occupied property have greater transparency and confidence with the historical income stream than with a tenant. With gas stations/c-stores, essential businesses, there is greater confidence in continuance of the income than with non-essential businesses. Those Q2 financials received at this time show that most gas station/c-store businesses are doing as well as, or better than, pre-COVID. Buyers and lenders are suspicious of these and question the continuance, but it is what it is.
The NFIB Small Business Optimism Index jumped 6.2 points to 100.6 in June. The bounce back in Small Business Optimism to the 100 level is heartening, but we fear it may be a bit premature. The survey likely came too early to reflect the sustained rise in new COVID cases in late June & July which have now elicited a new round of shutdowns. Sales expectations surged 37 points, swinging from -24% to 13%. The proportion of business owners that expect the economy to improve rose 5 points to 39% and plans to hire doubled to 16%. The rise in the NFIB is tempered by the declining share of firms showing earnings improvement, which fell 9 points to -35%. Capital spending plans edged higher, climbing 2 pts to 22%. The rise may reflect needs to invest in personal protection equipment. June’s rise in Small Business Optimism appears to have gotten a temporary assist from prior business re-openings, modifications and expansions to the PPP, and the buoyant stock market.
As mentioned in our Blue Paper last month, we expect the economy to progress and digress in fits-n-starts for the near-to-intermediate terms.
Opportunity Buyers Get Your Money Ready. Money being accumulated for distressed property purchases led real estate fundraising in the first half of the year as investors looked to take advantage of falling property values due to the impact of the coronavirus and efforts to contain its spread.
Investors are moving up the risk spectrum, away from the best properties in the best markets, private equity data provider Preqin said in its quarterly update. Opportunistic funds, those set up specifically to buy properties at a discount, have amassed $22 billion, the most capital targeting any real estate strategy, accounting for 56% of the total raised so far this year.
Moreover, property sales in June began to show the first signs that investors were beginning to put some of that opportunistic capital to work, according to June sales tracked by CoStar.
Distressed property sales made up a larger percentage of total sales in June than in May for hotel and retail properties — the two property sectors hit hardest by the coronavirus. Distressed sales include auctions, deed in lieu of foreclosure transfers, foreclosures, bank-owned sales and short sales.
“In the wake of the challenges our economy has faced in recent months, we believe there will be significant opportunities,” according to a statement from Rockpoint co-founders Bill Walton and Keith Gelb.
While the above comments reflect institutional CRE investors, the smaller entrepreneur investor is of the same mindset. The lessons and opportunities coming out of the Great Recession in 2010 are still fresh, and those who missed the boat then are preparing not to miss it again this time. Although the dynamics of the CRE market are decidedly different this time around, the result may look very similar.
Discounting similar to the global financial crisis not anticipated. The prospects of acquiring real estate at deeply reduced prices has buyers lining up capital in preparation of a wave of distressed assets becoming available. However, investors may be disappointed by the volume of distress this cycle. For properties not financed through CMBS, most financial institutions are committed to delaying foreclosure, following a trend established during the global financial crisis. CMBS may also take longer to become available as Congress considers legislation to prevent automatic foreclosure triggers that tie the hands of the loan servicers when considering forbearance. Furthermore, prompt action by the Fed and Congress could dampen this downturn, limiting the amount of distress that comes to market as a result.
Distressed properties will be concentrated in a few sectors. As the world’s largest economy adjusts to a post-pandemic world, entire sections of investment real estate may need to be altered. Hotel and retail properties could go into receivership if travel fails to resume and a permanent shift away from dining out emerges. Additionally, less traffic in large office districts will soften demand for retailers that cater to commuters, potentially forcing those assets to shutter permanently and be foreclosed. Investors with a penchant for repositioning real estate may be able to acquire these properties for below-replacement costs. However, most distressed transactions are not expected to be based on relative price. Low interest rates will make deals attractive based on the property’s underlying operating fundamentals.
Awaiting deep discounting reduces opportunities. Investors searching for deals to trade for “pennies on the dollar” could miss out on attractive properties as the economy recovers. In situations where buyers can acquire assets at a fraction of the previous valuation, new considerations will need to be made regarding their future viability. Following the global financial crisis, investors only needed to wait for the economy to recover. After the health crisis, however, fundamental shifts in the economy and real estate are anticipated. Namely, dispersed working could reshape office districts and population density in several areas. Some assets may never recover previous valuations as demand shifts.
Numerous investors await discounted properties. The pool of capital sitting on the sidelines is at a record level with close to $5 trillion sitting in money-market funds. Due to the liquidity in the market and access to capital by a broader range of investors, the competition for bank-owned assets will be significant when the time comes for lenders to move properties off their books. Opportunity funds have raised hundreds of billions in anticipation of discounts, and that capital may need to be deployed prior to any significant price cuts as banks kick the proverbial can down the road. As capital does move off the sidelines, it may be focused on property fundamentals rather than replacement cost. Investment real estate that trades at attractive cap rates relative to pre-pandemic levels will be the benchmark for distress during this cycle rather than price discounts.
Unique distress creates opportunity. The sheer magnitude of the economic downturn will result in some assets being returned to lenders, namely properties that cannot reopen in their pre-health crisis format due to a shift in demand. Buyers willing to target these deals may find the discounting that is not expected elsewhere. Adaptive reuse strategies are already in discussion for real estate. Experience-oriented retailers have the greatest likelihood of falling into this category. The other major opportunities will be found in assets where the business and real estate are intrinsically linked, including hotels and seniors housing. A significant share of these properties are owned by business operators and opportunity funds are likely to target more passive real estate, paving the way for private buyers to compete.
HOW SHORT IS THE FUSE?
The fuse is now lit on about $10 trillion in corporate debt.
Back in April when the economy was on lockdown, it became clear that many large businesses were in serious trouble – specifically restaurants, commercial real estate, and retail. At that time, multiple large chains informed their lenders that they would NOT be paying rent in April. Here’s a headline from March 26:
Cheesecake Factory, Subway, other major retailers tell landlords they can’t pay April rent due to coronavirus.
To deal with this issue, banks and large financial institutions gave their borrowers 90-day forbearances on their debt payments… meaning those groups wouldn’t be required to make debt payments for 90 days.
Put another way, the banks told these businesses: “Don’t worry about making any debt payments for 90 days… think of this as a debt holiday.”
That was in April. The 90-days was up last month! Will lenders offer a re-do of another 90-days? Or maybe scale back to 30-day bites at a time? Will the Government step in with yet another plan to keep the carnage down? Prior behavior suggests that a “stay of execution” will be forthcoming. Lenders and the Government don’t want a repeat of 2009-2010 … 2-3 months before the election!
But without a savior, this means these same businesses will now have to start making debt payments again. And if they have not yet truly recovered from the economic shutdown… we’re about to see a tsunami of defaults and bankruptcies, as well as layoffs and shutdowns.
This process has already begun. Take a quick look at a few recent headlines:
All told, US corporations have over $10 trillion in debt. And corporate leverage is worse today than it was in 2008. It’s only going to get worse from here on out.
Meanwhile gas station/c-store buyer activity remains brisk. Sellers, however, are holed-up on the sidelines. Many believe if they come to market now, they’ll be beat up by the dynamics of the economic condition – this currently is looking like an erroneous assumption. Buyers stepping up seem willing to pay non-distressed prices for the operating business. Many if not most gas station/c-store businesses have held up well through the first half of the year, digesting the ups-n-downs thrown at them by COVID.
Pricing is still driven by the financial performance of the business that owns the real estate. This is different than the landlord/tenant relationship that typically exists in other segments of investment CRE. What buyers and lenders want to see is how the business faired through the interim COVID 2020 period vs. 2019. If you’re business is holding up well, your valuation should hold up also. Most gas station buyers are already in the gas station business, and know well their unique situation vs. the economy in general.
OK, here it is … The U.S. GDP decline in the 2nd quarter. A record-setter to be sure. This was worse than any quarter during 2008 crisis, worse than any quarter during the stagflation of the 1970s, and worse than any quarter of the Great Depression! And yet the stock market rallied on the news. We’re not investment analysts, Registered Representatives (stock brokers), investment advisors, or any of the like, so comments on the disparity between market performance and the economy will be left to more qualified sources.
We do note, however, that the Fed just announced it will be providing at least $125 billion in liquidity to the markets every month from now until the end of 2021/early 2022, a total of
$2.1 trillion in the next 18 months. (Unlike economic data, the stock market REALLY cares about liquidity.) The downstream effect of this, of course, is inflation and the strength of the dollar. But that’s a discussion for another day – keep an eye out for the next Blue Paper.
And for our part, we also really care (or should care) about liquidity. The mechanisms the Fed uses in flushing funds into the economy and markets has a lot to do with where the money ends up (Wall St. or Main St.) and what use it can be in the hands of those receiving the funds. Without grinding down into the details, we’ll note a fair amount of this will be funneled to member banks to not only shore up potentially, or actually, delinquent loans, but also to make new loans! Yes indeed – new loans. New conventional CRE loans will be on the menu for investors and developers, but a significant amount will go to the SBA for small businesses. This segment of the economy has been Trumpeted (pun intended) as a major focus for economic recovery and maintaining & creating jobs. Fortunately for us, participants in the small business market and largely dependent on small business financing, our good fortunes are endorsed by the administration – as long as it lasts. At least another 168 days regardless of whether Trump gets re-elected or not. (His 4-year term officially ends Jan 20 … by act of Congress!) Of course if he is re-elected we’ll get “4 more years”. But no politicking here!
Market Comments, 6-6-20
Let’s start by seeing how bad the market is behaving in response to COVID-19. (Unless otherwise specified, the market we’re talking about if the gas station-c-store market.) Data gathering from the 2 leading marketing websites, Loopnet and Biz Buy Sell (BBS), gives us the following activity. (Loopnet is primarily a commercial real estate site, and Biz Buy Sell is for businesses. There are others to be sure, but these 2 are dominant.) The data is drawn from my listings only.
Loopnet (90 day period) BBS (26 week period)
Avg. Hits/Listings Jun ’19–Mar ’20: 6,521 11,7890
Avg. Hits/Listing Apr ’20-May ’20: 5,345 14,574
Percent Change Pre-COVID Down 18% Up 24%
10 Mo’s vs. Post-COVID 2 Mo’s:
Data from MJG website: % Change vs. 2019
Avg. Hits/Listing/Mo. 2019: 1,032
May ’20 Hits: 907 Down 12%
Avg. Hits/Listing/Mo. 896 Down 13%
Jan ’20-May ’20:
Many if not most of closed transactions during the Mar-May period were transactions initiated before COVID became known. Consequently, we’re not considering closed transactions during the last 3 months as indicative of the market’s response to COVID.
Observations & Conclusions:
Clearly the CRE market is reacting much more poorly to COVID than is the business market. If fact, the gas station business for sale market appears to be having a positive impact from COVID.
This points to the different participants in these 2 markets. The CRE market is largely made up of investor/landlords, many of whom are not intimate with the gas station business. The business market is composed of owner-operators, many of whom are currently in the gas station business either locally (AZ) or out-of-state. The later group has experienced the impact of the violent decline in crude prices a few weeks ago, and the resulting effect on pooled margins. Most don’t expect these to be sustained but it does point to the resilience of the gas station business. They also see the impact of being designated an “essential business”. Many of these have already started scavenging for the weak members of the industry that they anticipate being to acquire at going-out-of-business prices.
Also, the gift the SBA is offering of paying the first 6 months of payments on new loans closed before the end of Sept. is an added kicker.
The investor market has a different mindset. Conventional CRE loans (non-SBA) that investors can acquire are unsettled in their pricing (interest rates) and other terms. Lenders are rapidly trying to acquire data points to price loans, but the slowdown in transaction volume exacerbates this effort. Also, the Fed & Treasuries continuous flooding of new emergency programs into the market further muddies the water, as well as tying up lender (primarily banks) resources administrating these Government programs.
Investors are also leery of pricing points. Gas stations as investments are categorized as single tenant net lease (STNL) properties, as opposed to multi-tenant, e.g., a shopping center. Traditionally lease rates/cap rates follow interest rate movements in the economy, and with Fed Funds at 0-1/4%, the expectation is for rents to follow. That would imply a rise in prices, but these don’t happen in lock-step. If rents fall as is expected in a recession (which some have already pronounced) the effect is to pull prices down with them. The notable thing is that at this time, STNL rates, (cap rates) have held firm for gas stations. Not so for other type of STNL properties, e.g., drug stores, QSRs, auto after-market stores, etc. This process is based on the tenant being able to make the monthly rent payment. When tenants start missing rents, or negotiate for new terms, lower rent, etc., it sets the negative tone in the market. This will play out over the next several months. We expect several STNL tenants will fail and the properties go dark. At the same time, we expect the gas station to be the shining light on the hill. As this is seen we expect a migration of investor dollars to leave money market funds, rolling bank CDs, and tin cans under the dog house and search out investments in gas stations.
We expect lenders to have similar observations … just not as quick.
The good part for sellers (that’s most of you reading this) is that buyers are finding few and fewer stations available. Some sellers have pulled listings thinking that when the dust settles there will be a better market (higher prices) for their offerings. Also, some potential sellers are back-peddling on coming to market for the same reason. And as long as they can keep pooled margins up, the overall gross profit is up even if volume is down. The result is that the thin inventory we had pre-COVID is now even tighter. We call this a supply:demand imbalance in favor of the seller.
One demographic observation. The frequency of buyer inquiries from CA has accelerated. I’ve commented on this for months – maybe years. During COVID the public policies dealing this have become more intolerant by the citizenry. Their calls are expressing more urgency in “getting out”. I suspect this will continue throughout the year. If the current leadership is sustained through the November election, expect the floodgate to open for every conservative who might be left.
An update on the PPP. We know many of you have participated in the Paycheck Protection Program offered out a few months ago. This next bit of news may be of interest to you.
The President was expected to sign the “Paycheck Protection Program (PPP) Flexibility Act of 2020” (H.R. 7010) as soon as last Friday, Jun 5. Highlights include: This may have been done, but at this time we don’t have confirmation of that.
Extends the PPP loan forgiveness period from eight weeks to 24 weeks or through the end of the year, whichever comes first.
Reduces the 75 percent threshold needed to be spent on payroll to 60 percent which allows a greater percentage of the PPP loans to be used on rent and other approved non-payroll expenses.
Increases the PPP loan repayment period from two year to five years.
Allows businesses that receive loan forgiveness to defer payroll taxes.
Extends the June 30 rehiring deadline to December 31, 2020. PPP loans will be forgiven if businesses restore staffing or salary levels that were previously reduced. The provision would apply to worker and wage reductions made from February 15 through 30 days after enactment of the CARES Act, which was signed into law on March 27.
Provides additional flexibility on loan forgiveness for PPP recipients who show they could not rehire workers or reopen due to safety standards.
Also, we note a brief observation of the economy, specifically labor. The unemployment rate from the Labor Department for May actually fell to 13.3% from 14.7% in April, and was much lower than the 19.5% estimate from economists (“much lower” is an understatement of the error!). We are forced to temper our enthusiasm of this figure, and are not ready to call a start to the recovery. We expect labor statistics as well as other economic data to be volatile, this to translate into volatility in the various investment markets. Characteristically, the CRE and private business brokerage markets are more opaque, cushioning the knee jerk response to every bit of data that comes down the pike. Data is harder to get, less available, and takes longer to analyze before it leads to action – a decision. I suspect there are very few day traders of private businesses or CRE.
Market Comments, 4-3-20
So much happening so fast – COVID-19 … current and downstream effects! We’ll try to sift through the clutter and focus on those factors affecting our market over the next few month. As I review data accumulated since our last letter, this will be a challenge. So here we go.
The primary factor affecting the market’s current negative behavior is the coronavirus … COVID-19. So the primary battle to be won is to neutralize this threat to the economy. Prior to the emergence of COVID-19 the economy was on fairly firm ground. Some pluses & minuses here-n-there, but largely stable. Retaining the economy’s structural framework through the crisis is paramount to positioning for a quick resurgence to where we left off. The Government’s quick actions over the last couple weeks have been directed to that end. We’ll be able to gauge the success of these actions
Consumer’s represent about 70% of the nation’s GDP. The decline in the University of Michigan’s Survey of Consumer Sentiment for April was the largest one-month plunge on record. However, the preliminary print of 71.0 for April is still 15.7 points higher than the November 2008 low. The bottom fell out beneath the current conditions index, which shed 31.3 points, nearly doubling the prior record drop of 16.6 points set in October 2008.
To the extent that any silver linings can be found in this report, the Expectations Index only fell 9.7 points. That is a considerable decline, but not nearly as bad as the record 16.5-point drop in December of 1980. Had it not been for this faith in tomorrow and hope for what is on the other side of this crisis, the drop in confidence would have been worse. We expect a record contraction in consumer spending in Q2.
After 44 consecutive months in positive territory, the Animal Spirits Index (ASI) dropped and turned negative (-0.33) in March. The global pandemic has led to a sharp turnaround in sentiment, with four of the ASI’s five components contributing negatively to the index: the S&P index, the policy uncertainty index, the VIX or volatility index, and the Consumer Confidence Index. The only positive contributor was the spread between the yield on the 10-year and 3- month Treasuries which turned positive in March after inverting in February. Expect further deterioration in April, and possibly May.
From where will the glimmers of hope originate? Why from day-to-day improvement in the control & ultimately eradication of the coronavirus, of course. As incremental improvements are made in winning the COVID-19 war, the economy will be put back on track with incremental improvements, e.g., lifting of travel restrictions, various segments of businesses will be allowed to re-open, specific geographical areas of the country are expected to begin hiring or reinstating employment.
But the Government is fighting to retain the economic structure with the few weapons it has – money … debt money. Be it funded from fiscal or monetary sources. The current legislatively approved commitment is about $3 trillion. (This is a day-to-day moving target.) But where does it go? Will this indeed shore up the main street economy or become another Wall Street boondoggle like all the QE’s of not long ago.
What isn’t spelled out is that somewhere in the Source-Recipient transfer is about $450 billion going to the Fed via the Treasury who is then to fund loans originated by banks. The way banking works is that this money can be leveraged 10X between the Fed and the banks. That
$450 billion, then, represents $4.5 trillion of potential loans. That makes the liquidity capacity of the CARES Act closer to $6-7 trillion than the advertised $2.3 trillion. Clearly a minor oversight in public disclosure. That additional $4 trillion net of additional liquidity could very well find its way to supporting financial markets. (More on this in our upcoming Blue Paper.)
But our job at hand is to remain informed, optimistic, and ready to resume life as we know it when circumstances permit.
Along that line … in every chaotic event there is opportunity!
Cloistered away as well are, our day-to-day emotional pulse is limited by sources that represent the mood of the nation, whether a small circle of family & friends or the national media – not a positive environment. We wonder is there really “normal” work being done out there? How much longer might this go on? How bad can “bad” get? No answers … only speculative opinion. War is hell!
But this from the front lines:
We closed escrow on one of the stations we had listed last week! An 18 day escrow – all cash. A CA buyer – are we surprised? Not really. As we’ve said in this report now for many months CA buyers are leaving the sinking ship. The COVID-19 has increased their motivation.
I have 1 loan that was approved prior to COVID-19 and are only pending updated documentation. Lender has not pulled their commitment or wanted to re-underwrite the loan for the current environment.
I have 3 loans in process of submission; two SBA and one conventional. Both loans are being aggressively received and we expect multiple offers on both. Underwriters across the board have not raised the bar on standards, although some of the more conservative lenders are starting to make moves in that direction. Not always as straight forward as reducing LTVs or raising states rates, but more subtlety in covenants, particularly with conventional loans.
The SBA has announced that it will pay the first 6 months of payments for 7(a) loans funded by the end of Sept. (Trump is trying very hard to protect his small business segment … responsible I’m told for about 40% of the workforce.)
Buyer inquiries remain firm, although the tone of conversations reflects caution.
Sellers, however, are in a quandary – that’s most of you reading this. (Lender’s aren’t yet, but soon will be.) The question is how will my business and/or real estate be valued for the negative effects of COVID-19? If it’s valued primarily on an income approach basis, what will that get me when my financials have to reflect Mar, Apr, etc., going out for how far? A concern not overlooked at MJG.
I’ve discussed this topic with 3 of the good gas station appraisers I know in the AZ market. They’re all working with various adjustments to data to reflect the anticipated situation, but nothing concrete … with one exception.
One of the appraisers is the AZ rep for a national company specializing in gas stations & truck stops. His company has developed a model reflecting just what we’re talking about. It was originally developed and released internally several weeks ago. They’ve been collecting data & updating weekly. The appraiser has offered to collaborate with me in their continuing development of their model. The more data collected, the more refined the model, and the more accurate the results – it’s a process. I suspect I’ll be able to apply their data and methodologies to current listings for pricing re-valuation, as well as new listings to be brought to market. (This area is also a big concern to folks who might want to bring their stations to market.) This also has direct application to the lending business – appraisers primary market. For underwriting, the primary basis their loan offers is the ability to service the loan from the underlying business, or property in the case of a rental.
INTRODUCTION - The following comments are offered to keep you abreast of the market for gas station and c-store sales in Arizona. At MJG, we identify 3 geographic markets statewide: the Phoenix metro area (an MSA), Tucson, and the rest of the state which we identify as "rural". By type of market, we follow and will discuss both the business and real estate markets, in as much as many if not most small business owners of gas stations and c-stores own both the business and the real estate that the business occupies. Our Market Pulse updates will be more frequent and less strategically detailed (dealing with shorter timeframes) than reports found in the News and Reports section of this website. As your read down the Market Pulse, you'll be reading the most recent comments first, progressing to older publishings, which if read in order, will allow you to develop an historical reference to the market. We will general keep up to 12-24 months of Comments online, but will archive older comments. You can request archieved comments by contacting us directly with your request.
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