Unknown Unknowns

DSTs and the ‘Unknown Unknowns’

Donald Rumsfeld a former politician and more famously twice Secretary of Defense under Gerald Ford and again under George W. Bush is famous for coining the terms “known unknowns.”

In doing so he was referring to categorical security threats to our nation such as hostile regimes, international bad actors, etc.  These individuals and institutions are known threats due in large part to their unpredictable and unknowable hostile behavior, hence “known unknowns.”

Investment managers and fiduciaries are tasked with much the same thing; dealing with the “known unknowns” where the capital markets are concerned. However, the big lesson of 2020 is that investors cannot count on any degree of predictability from the government.  Therefore, government is the new “unknown unknown.”

It is “unknown” and in many ways “unknowable” due to the size and arbitrariness of its impact on commercial real estate in 2020.  Unlike the stock market, which the myopic FED has again flooded with money, fueling equity valuations that have no relationship to the broader economy, it is crushing much commercial real estate.

Government hugely accelerated the demise of bricks and mortar real estate by unilaterally declaring many businesses “non-essential.”  In doing so, it’s estimated that the internet’s (read Amazon) share of transactions has doubled from 15% of total retail to 30%.  And you thought Jeff Bezos didn’t have friends in high places. 

Always nice when marketplace winners and losers are determined by government fiat.  In retail it used to be; location, location, location, now it’s government, government, government.  As a result of this, retail bankruptcies are expected to increase by 300% in 2021.

Office isn’t too far behind.  Already under attack from telecommuting, government mandated social distancing has put paid to much office work as we know it.  Signs of stress in the office sector are everywhere as more and more is done remotely.  What was once convenience is now necessity.

Even after we are given the ‘all clear’ from the powers that be, not everyone will return to their cubicles.  Many businesses will find that much work can be done as effectively and more cheaply from home, a modern day version of piece work if you will.  Add to this a slowing recovery and many buildings will remain dark.

The not so invisible hand of government has also had a big impact on the multi-family sector.  Initially well intentioned eviction moratoriums have now morphed into serious and growing rent delinquency issues.  The longer government in all its forms extends this courtesy to renters, the greater the ‘free-rider’ problem becomes.  In emulation of less fortunate neighbors, individuals who otherwise can pay rent are now choosing not to.

This was foreseeable and preventable.  In its rush to play savior, government ignored the long term potential consequences of its poorly conceived legislation.  Landlords have bills too.  However, I see no one or nothing rushing into the breach here.

I’m sure everyone appreciates the spirit of the CDC’s extended eviction moratorium.  But the longer government displaces market forces the more out of balance things will become.

Therefore, when choosing replacement properties for exchange purposes, comprehensive risk assessment must be done across all asset types to attempt to mitigate potential threats.  Given the increasingly unknowable nature of all this, unconventional thinking that places an absolute premium on valuing diversity is a must. Whether it is diversity of property type, geography, management, etc. investors must undertake this responsibility if they seek to be well served in the end.

The increasingly REIT like structure of many DST property programs arguably does this better than anything else in the real property investment space.  These programs can and do bring multiple assets of a type together to work to diversify equity as broadly as possible.

Investors can further expand upon this by selecting multiple programs driven by different professional management teams.  By yourself, this is nearly impossible to do.

Contemplating the unknown or unknowns isn’t easy.  However, bringing others aboard with diversity of experience, background, opinion and thought to assist you should improve the odds of success in an increasingly arbitrary and capricious ownership environment.

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