Black Swan Events in Real Estate Cycles

Today, as uncertainty over so-called “black swan events” and their effect on real estate cycles is high, old principles remain steadfast and true. As it has in the past, a focus on quality, experience, and a conservative approach will win the day.

Black Swan Events Throughout History

For us, the hyperinflation of the late 1970s, the savings & loan collapse of the late 1980s, the dot com bubble of the early 2000s, the Great Recession of 2008, and COVID-19 are examples of black swan events that will likely continue in various forms in the future and impact real estate cycles.

With many members of our executive team holding more than 30 years of experience, we believe the following real estate investing strategies to weather black swan events will continue to bear fruit:

• Seek quality
• Use debt sparingly
• Maintain a margin of safety

As you look back on the last two years, you might struggle for words to adequately describe your experience, but it would likely be referred to as a whirlwind – to put it mildly. This whirlwind has impacted our social, spiritual, and/or financial lives in different ways.

Post COVID-19, many people are searching for many things.

From a financial lens, I have spoken to hundreds of investors in the past few years and, to be extreme, they generally fall into two buckets: those who believe many frightful events to be lurking around the corner with hyper-inflation, war with China, redistribution, austerity, etc., and those who believe that post-COVID-19, everything will continue “up and to the right.” While I do not personally take either position, I believe the following sage advice still rings true today:

“Embrace uncertainty.” – David Booth

“When you buy a [business], plan to hold it forever,” and, “Never compromise on business quality.” – Warren Buffett

“A great business at a fair price is superior to a fair business at a great price.” – Charlie Munger

Seek Quality

When markets get frothy and money is too easily made, standards become relaxed and aversion to risk tends to evaporate. When self-reinforcing cycles of escalating prices become the norm, many choose to seek lower quality assets using higher amounts of leverage to generate desired returns. This may prove, in the long run, to be a mistake – especially when the next black swan event comes along.

Regardless of what others are doing, you will never regret buying quality assets with moderate (or less) leverage.

Use Debt Sparingly

Debt can be a double-edged sword. In good times, it can help one purchase more with less capital, creating the potential for increased returns (by taking more risk). In bad times, having too much debt can become incredibly oppressive and risk the survival of a business venture.

Today, when purchasing assets, we can potentially obtain leverage of up to 80% of the value of the property (known as Loan to Value, or “LTV”). While using this much leverage would significantly reduce the amount of equity needed, it also increases the risk.

Given our desire for moderate leverage, we often choose to obtain 50% LTV instead. While this requires more capital up front, it also reduces our debt obligations and can create a larger margin of safety.

Going back to the advice previously supplied, we believe that owning quality assets for the long term can produce good results. The key is to not lose the assets. Having too much debt can increase your risk of default in troubling times. For this reason, we would rather have too little debt than too much.

Maintain a Margin of Safety

If you want a thrill, ride a bull. For us, we strive for boring. Having a durable business comprised of quality assets, with moderate leverage and a wide margin of safety, can help contribute to a boring business – which can be thrilling!

A margin of safety is the cushion between your gross revenue and your operating expenses (those recurring expenses that must be paid). The thinner the margin, the more risk you are taking should your business encounter any volatility in its results during the real estate cycle.

Whatever your business is, make sure that you have thought through and determined an appropriate margin of safety based on the risk you want to take.

In all, we believe that the combination of quality assets, low leverage, a good margin of safety, and a long-term horizon can put the wind at your back and produce good results over time, while at the same time putting you in position to successfully navigate future black swan events.

This is not an offering to buy or sell any securities. Such offer may only be made through the offering’s memorandum to qualified purchasers. Any investment in Elevation Fund 8, LLC, and its Affiliates, involves substantial risks and is suitable only for investors who have no need for liquidity and who can bear the loss of their entire investment. There is no assurance that any strategy will succeed to meet its investment objectives. The performance of Elevation Fund 8, LLC, and its Affiliates, it’s not indicative of future results of other funds.