Everything is expensive, but not on a relative basis.
This is especially true of real estate. But, it’s easy to look at pricing today and assume valuations have gone too far. It’s hard to pull the trigger on 4% cap rate deals when you remember buying those sweet 6% caps not that long ago.
Context is needed to avoid throwing up your hands.
So what are your options? Sure, you can choose to not play the game, sit in cash and pray for rain, but A) you might be waiting a long time and B) what will inflation do to the value of that cash if idle for long?
While I wish we could all anchor to absolute values, this market is about relative values. Not as easy, but we still like this game. Plus, we don’t try to time the market based on macro factors (future interest / cap rate predictions). Mostly because we can’t do it.
If you can with any consistency, don’t bother with sleepy real estate; start trading 30x leveraged foreign currencies immediately. Please invite us to your private island someday.
For Evergreen, we’ll stick to watching both sector and our portfolio holdings valuations like a hawk, tweaking as needed.
Below is a tool we use to help frame valuations compared to opportunity costs. While not a perfect indicator (wouldn’t that be nice), the spread between corporate bond yields and real estate cap rates is a rarely cited but useful gauge on RE valuations. This data point is a way to take a temperature check on pricing relative to other assets with similar income and risk profiles. In this case, investment grade corporate (Baa) bonds.
Historically, real estate cap rates average ~90 bps higher than corporate bond yields. As you can see from the chart - despite all-time high prices - most real estate sectors are fairly valued based on this barometer.