Brandon L. Raatikka, JD

Background 

I’m going to get this out of the way right now. I don’t know where cap rates will end this year, and certainly can’t predict where they will be in five years or in ten. What I do know is that cap rate compression has provided a notable tailwind to real estate performance for the past several years. With cap rates for most real estate sectors touching record lows during fourth quarter 2021, I also know that investors should be more closely analyzing each driver of projected investment returns and determining the margin for error embedded in each one. It seems unlikely that cap rates will be below current levels in five or ten years when investment programs currently on offer are looking for an exit.

Inflation is running at 8.6%, and the Fed has been aggressively raising interest rates. It is now signaling that equally large rate hikes could be on the horizon as early as next month. The Fed’s dual mandate is to keep the economy at full employment while at the same time keeping inflation under control. During the time since the financial crisis of 2008, which includes the Covid-19 slowdown in 2020, the Fed’s primary focus has been on full employment (economic growth). Since 2008 we have witnessed massive government bailouts beginning with the TARP bailouts, to combat the financial crisis, and culminating with $4.6 trillion being spent through the CARES Act and other relief measures to combat the impacts of the Covid-19 pandemic. For more than a decade after the 2008 crisis, economic growth was stubbornly slow, and the pandemic did not help matters. For all the government’s efforts to grow the economy, real economic growth averaged a paltry 2.3% per year from mid-2009 through 2019, and actually contracted by 3.4% in 2020 before growing by 5.7% in 2021. Accommodative monetary policy in the form of quantitative easing, and accommodative fiscal policy in the form of government bailouts conspired to keep interest rates (the cost of borrowing money) low. Unsurprisingly, only because economic growth never really took off, inflation remained subdued. But much like waking up from a party that went on way too long, only to find silly-string on the furniture and a pizza spinning on the record player, what comes next may be sobering.

In 2017, Congress created the qualified opportunity zone (QOZ) program to encourage long-term investment in economically distressed communities by providing investors with three tax incentives to help drive private capital to lower-income areas throughout the country. Since then, the FactRight team of analysts has reviewed several qualified opportunity funds (QOFs) that focus on real estate development located in QOZs. Over the last year, we’ve received a number of questions from broker-dealers and RIAs regarding whether any changes to the QOZ program are on the horizon, and it looks like the answer might be yes.

An investment committee (IC) provides wealth management firms a formalized mechanism for improved due diligence, ongoing monitoring, and decision-making.  A good IC aligns organizational goals, roles, and processes and enhances accountability, clarity of purpose, and shared knowledge among the team.