finyork.com

Tag: investment tips

  • What’s Next for Cryptocurrencies and Digital Assets, Post-2020s Recession

    The macroeconomic outlook for the cryptocurrency/digital asset market is definitely not looking good, at this time. There are a multitude of reasons. I think this is largely because Cryptocurrencies are considered “trendy” in financial services, however I’ve recently been asked for my take on specific Crypto’s (Bitcoin primarily) and what I’ve come to refer to as “Complex Crypto’s” (ETFs, other Exchange Traded Crypto Securities, Crypto IRA’s, etc.). Of course, at the center of this conversation is Cryptocurrency mining and trading. As most who follow this market even casually know, the two are intimately related.

    Standpoint on Cryptocurrency and Digital Assets Throughout the Recession

    Disclaimer: Pro-crypto enthusiasts will not be happy. This is how I’d put it, favorably. I see the cryptocurrency market, coming out of the recession – assuming it does – with entirely new technologies, marketing strategies, market dynamics, etc. To elaborate, let’s take what we can all agree to be true about the cryptocurrency fan base today, largely speaking. They’re a) not long-term strategists, b) very weak (or completely incoherent) when it comes to basic knowledge of financial markets and even more complex financial instruments, and c) the composition of cryptocurrency investors is not one you’d generally – or ever – consider “cash rich” compared to other investors (both individual and institutional).

    We’re looking at a market with the majority of participants being short-term, stubborn and perhaps unqualified thinkers, with little to no savings to boot. Market dynamics aside, Bitcoin has been religiously dropping for quite a while now. If conceptually it doesn’t make sense and the numbers aren’t there, investors are in deep trouble.

    Fast forward a few months. The Fed continues their ongoing strategy of “deflating the inflation” with historically “aggressive” rate hikes. The participants in the market described above would generally be considered high in terms of price elasticity. Meaning, their sensitivity to pricing changes is above average. In prices rise, they are more likely to sell quicker than someone who is more price inelastic, perhaps because they have a larger savings (as an example). On average, the same cryptocurrency enthusiasts who decided to invest in a Crypto ITF are the ones who will be forced to sell off their digital asset portfolio the quickest.

    When the average cryptocurrency enthusiast starts to get more and more burdened by everyday essentials, their digital wallet’s intrinsic value will diminish rapidly. Are you willing to struggle to pay rent to hold onto Bitcoin at the price you bought it? If you’re already a short-term thinker, the answer is more or less common sense. No. Nor are you willing to sell your house to maintain a bullish position on Bitcoin (if you’ll be in one of the unfortunate groups that lose their job in the recession).

    The Cryptocurrency Enthusiasts with Never-ending Dedication

    Cryptocurrency enthusiasts will undoubtably disagree with the short-term thinking narrative, but it’s respectfully backwards. There’s no other asset in financial markets you’ve analyzed as a better bet for the long-term. Really? Not the S&P 500 Index? US Treasuries that have never defaulted? If you’re looking for enhanced potential for extravagant short-term returns, cryptocurrency is an area for you. But that’s a complete contradiction to the long-term value proposition. There is none.

    Their last standing argument: Blockchain Technology. This is debated in part, but the general consensus among the Crypto community appears to be along the lines of, “Blockchain technology is considered a commodity and regulated by the CFTC that we simply cannot live without as a society. Therefore, Bitcoin will survive and prosper through any recession, since we have propriety technology that will revolutionize the world” [I’m paraphrasing]. This technology is by no means universally accepted in traditional financial markets. Bill Murray’s Ethereum wallet was recently infamously hacked. This will no doubt bolster the SEC’s position against institutionalizing digital assets.

    It’s relied on even less so by traditional financial investors. Let’s not forget, the SEC is still unwilling to budge on a Bitcoin spot ETF with the number one concern being lack of technological innovation to eliminate jacking and market manipulation. If the SEC says it’s too dangerous, where do you think institutional investors will fall with the current macroeconomic trajectory? Why is Bill Murray’s Ethereum wallet suddenly the focus of all the daily financial newsletters?

    Near and Long-Term Cryptocurrency and Digital Assets Outlook

    In the near term (3-4 months), look for prices to continue dropping steadily. This goes across the board for all digital assets. In the long term (1.5-2+ years), that becomes a very complicated question when you dig into potential hypotheticals. Digital assets and cryptocurrencies are almost completely unregulated. There are no remotely serious regulatory requirements or disclosures of any information about holdings reports, portfolio allocation, investor reports, or any other typically standard financial accounting. That was part of the initial pitch: anonymity.

    Now, when purely digital asset portfolio managers like Grayscale want to get through to institutional investors, they start to create SEC approved Bitcoin Trusts, strategically push for Bitcoin spot ETFs, make it publicly known they own roughly 4% of all of Bitcoin, etc. That goes back to an original point. Bitcoin and cryptocurrencies may not get completely cratered like the dinosaurs did, but will we have thousands – or tens of thousands – of different cryptocurrencies, trading on infinite different platforms, with an unlimited amount of different marketed benefits? I don’t see it.

    Are Cryptocurrencies and Digital Assets Going to Crash from the Recession?

    To the more interesting question, can digital assets become the modern-day dinosaurs? It’s vaguely possible, but unlikely. This is where global politics, luck, and irrational/unconventional investor behavior tend to make the largest impacts. Let’s say Bitcoin drops below $5,000 and Grayscale, owning roughly 4%, assesses a further drop to $3,000 by next month. What does Grayscale do? Every financial product they sell is a digital asset and they’ve marketed Bitcoin as the obvious face. They get absolutely no protections from bankruptcy and neither do their investors. Yet, with the amount of Bitcoin they own, could they theoretically have backdoor discussions that would lead to the price of Bitcoin artificially being propped up? It’s a definite theoretical possibility.

    Again, we don’t know who Grayscale would be in the room and how much bargaining power they’d have. To the cryptocurrency enthusiasts who think it’s “cool” to invest in cryptocurrencies specifically because executives at traditional investment institutions are known for appeasing shareholders (in other words, doing their jobs) and “throwing investors under the bus”, well what do you think will happen to you? Will the CEO responsible for making those decisions that has the potential to change investors lives do the “ethical” thing because they don’t have shareholders to protect? I think the fair and impartial response is that remains to be seen. That’s the truth.

    Let’s face it: cryptocurrencies and digital assets are in for the fight for their existence. This is newfound territory for this comparatively new market. It will absolutely shed so much more light than we have today about investors true perspectives and feelings on digital assets. At the end of the day, in a world where quantitative data leads investment decisions, rather than personal belief and alleged loyalty, we’ll have to see what executives and cryptocurrency holders alike do on a broad scale.

    The Bottom Line and What to Do

    The “correct” decision – meaning the decision statistically likely to have the most favorable outcome – would be to reinvest your holdings elsewhere. The risk is way too big, while the reward is way too small or nonexistent. Of the at-risk assets on the chopping block, digital assets are first in line. There is no remotely likely scenario where cryptocurrency supporters get to say “I told you so” anytime soon.

    In reality, what you do is listen to the experts, at least in this case. No one’s saying you need to get your IRA, or any other investment vehicle out for that matter, but you can’t think of a more prudent investment given the economic climate you’re being explained? What about real estate? You have the benefit of a physical asset, upside to earn capital gains if market prices increase, and at the simplest level, housing is essential. Individuals will never not need housing. If the recession impact results in a catastrophic scenario, you have an asset with no real danger of going to zero.

    If you’re going to hunker down and stay invested in digital assets until the end, you can still diversify and reduce your exposure. There are Bitcoin futures ETFs, like the VanEck Bitcoin Strategy ETF we discussed last time. There is the SEC-backed Bitcoin Trust; Grayscale’s GBTC. You can invest in hard currencies that would offset your exposure to digital currencies.

    There’s a plethora of options of the astute investor, but the question in my mind continues to be, why? Why go through an agonizing recession, where you’ll make difficult financial choices just to maintain your current cryptocurrency holdings? Again, if you’re so over-the-top for Blockchain technology, it will be available for purchase at a lower price in the future. But the near future? No chances from the present. Bitcoin will continue to systematically drop daily until there is major turnaround. There’s no telling what that will look like yet.

    The Warren Buffett Philosophy

    Consider this quote from Warren Buffett and how it applies to this debate. Buffett is universally known as the most intelligent and disciplined value-based investor of our generation.

    “People should only [make investments] in companies that exhibit solid fundamentals, strong earnings power, and the potential for continued growth.”

    -Warren Buffett, Unpublished

    Does the cryptocurrency market currently a) exhibit solid fundamentals, b) has strong earnings power, or c) has a solid potential for future growth? The answer to all three is no. That’s likely why Buffet has always remained a staunch opponent to digital assets. Buffet’s average holdings are somewhere from 10-34 years. It’s more than fair to say he views investing as a marathon, not a race.

    Concisely, as all other major financial news agree, the cryptocurrency market is at a crucial testing point, at bare minimum. We know crypto products aren’t going to gain market value during a recession, for sure. However, the extent of the damages digital assets will take compared to other “at-risk” assets remains to be seen. Time, Forbes, CNBC, and Reuters all predicted major cryptocurrency market tumbles during the recession just this week. Again, a lot of it will depend on luck and how things play out, but there are actions you can take as an investor to mitigate your exposure to the bullish side of the crypto/digital asset market during a recession.

    I’ll end with one final argument against cryptocurrencies and digital assets. Ironically, this goes against Warren Buffett’s main investing principle (at least in part). I believe he’s said that during a recession, his investment philosophy changes, but I was unable to find that quote.

    “Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a fly epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”

    -Warren Buffett, Unpublished

    The Secret Behind Buffett’s Legacy: Some Deals are Simply too Risky

    Whether you agree with the risks to digital assets now or not, Buffett is spot on as usual. He has more famous quotes regarding investing in the stock market for the long-term, which is what he starts with. Buffett has held AXP (American Express) since 1964, KO (Coca-Cola) since 1988, and Wells Fargo (WFC) since 1989. Buffett’s outlook on the stock market is almost exclusively dependent on his analysis of that specific business. He’ll look at the financials in extensive detail, but he’ll also study the business model. How the company generates profits, what kinds of costs they incur. He’s the third richest person in the world off investments alone. Warren Buffett – rather than major investment banks or cash lenders – is known to have plenty of available cash during a recession or financial panic.

    Why? He hedges anywhere he’s far too overexposed and to boot, he has a knack for taking good bets on massively successful companies. In the context of cryptocurrency and digital assets, are they going to withstand all those arduous times? WWI & WWII, Vietnam, the Great Depression, over a dozen recessions and financial panics, oil shocks, a fly epidemic, and a political catastrophe? That wasn’t just an ego-trip; Buffett lived through those eras and more so, he prospered through them. Very few, if any, can say the same. Buffett stays away from a certain level of risk, period. No matter what the potential or hypothetical reward is, Buffett doesn’t execute the deal unless it’s met his standards.

    In Conclusion…

    With the way Blockchain was initially pitched, then repurposed, and gained little traction since is worrisome to me. The bottom line is cryptocurrency and digital assets have nowhere to go but down during an impactful recession. What you should do, in full sincerity, depends almost exclusively on your investing goals and available capital. In common, everyday situations – for example purchasing an overpriced digital currency – you should still mitigate your losses.

    You don’t want to be taking a bigger loss because you were too stubborn to take a much smaller one initially. I believe we’ll wind up seeing a lot of cryptocurrency investors in that boat. At what point will they be willing to toss it in and accept this investment just didn’t work out? Will they get to that point? Time will tell. What’s certain is the magnitude the recession’s impact will have on the cryptocurrencies and digital assets markets.

  • What’s Next for Cryptocurrencies and Digital Assets, Post-2020s Recession

    The macroeconomic outlook for the cryptocurrency/digital asset market is definitely not looking good, at this time. There are a multitude of reasons. I think this is largely because Cryptocurrencies are considered “trendy” in financial services, however I’ve recently been asked for my take on specific Crypto’s (Bitcoin primarily) and what I’ve come to refer to as “Complex Crypto’s” (ETFs, other Exchange Traded Crypto Securities, Crypto IRA’s, etc.). Of course, at the center of this conversation is Cryptocurrency mining and trading. As most who follow this market even casually know, the two are intimately related.

    Standpoint on Cryptocurrency and Digital Assets Throughout the Recession

    Disclaimer: Pro-crypto enthusiasts will not be happy. This is how I’d put it, favorably. I see the cryptocurrency market, coming out of the recession – assuming it does – with entirely new technologies, marketing strategies, market dynamics, etc. To elaborate, let’s take what we can all agree to be true about the cryptocurrency fan base today, largely speaking. They’re a) not long-term strategists, b) very weak (or completely incoherent) when it comes to basic knowledge of financial markets and even more complex financial instruments, and c) the composition of cryptocurrency investors is not one you’d generally – or ever – consider “cash rich” compared to other investors (both individual and institutional).

    We’re looking at a market with the majority of participants being short-term, stubborn and perhaps unqualified thinkers, with little to no savings to boot. Market dynamics aside, Bitcoin has been religiously dropping for quite a while now. If conceptually it doesn’t make sense and the numbers aren’t there, investors are in deep trouble.

    Fast forward a few months. The Fed continues their ongoing strategy of “deflating the inflation” with historically “aggressive” rate hikes. The participants in the market described above would generally be considered high in terms of price elasticity. Meaning, their sensitivity to pricing changes is above average. In prices rise, they are more likely to sell quicker than someone who is more price inelastic, perhaps because they have a larger savings (as an example). On average, the same cryptocurrency enthusiasts who decided to invest in a Crypto ITF are the ones who will be forced to sell off their digital asset portfolio the quickest.

    When the average cryptocurrency enthusiast starts to get more and more burdened by everyday essentials, their digital wallet’s intrinsic value will diminish rapidly. Are you willing to struggle to pay rent to hold onto Bitcoin at the price you bought it? If you’re already a short-term thinker, the answer is more or less common sense. No. Nor are you willing to sell your house to maintain a bullish position on Bitcoin (if you’ll be in one of the unfortunate groups that lose their job in the recession).

    The Cryptocurrency Enthusiasts with Never-ending Dedication

    Cryptocurrency enthusiasts will undoubtably disagree with the short-term thinking narrative, but it’s respectfully backwards. There’s no other asset in financial markets you’ve analyzed as a better bet for the long-term. Really? Not the S&P 500 Index? US Treasuries that have never defaulted? If you’re looking for enhanced potential for extravagant short-term returns, cryptocurrency is an area for you. But that’s a complete contradiction to the long-term value proposition. There is none.

    Their last standing argument: Blockchain Technology. This is debated in part, but the general consensus among the Crypto community appears to be along the lines of, “Blockchain technology is considered a commodity and regulated by the CFTC that we simply cannot live without as a society. Therefore, Bitcoin will survive and prosper through any recession, since we have propriety technology that will revolutionize the world” [I’m paraphrasing]. This technology is by no means universally accepted in traditional financial markets. Bill Murray’s Ethereum wallet was recently infamously hacked. This will no doubt bolster the SEC’s position against institutionalizing digital assets.

    It’s relied on even less so by traditional financial investors. Let’s not forget, the SEC is still unwilling to budge on a Bitcoin spot ETF with the number one concern being lack of technological innovation to eliminate jacking and market manipulation. If the SEC says it’s too dangerous, where do you think institutional investors will fall with the current macroeconomic trajectory? Why is Bill Murray’s Ethereum wallet suddenly the focus of all the daily financial newsletters?

    Near and Long-Term Cryptocurrency and Digital Assets Outlook

    In the near term (3-4 months), look for prices to continue dropping steadily. This goes across the board for all digital assets. In the long term (1.5-2+ years), that becomes a very complicated question when you dig into potential hypotheticals. Digital assets and cryptocurrencies are almost completely unregulated. There are no remotely serious regulatory requirements or disclosures of any information about holdings reports, portfolio allocation, investor reports, or any other typically standard financial accounting. That was part of the initial pitch: anonymity.

    Now, when purely digital asset portfolio managers like Grayscale want to get through to institutional investors, they start to create SEC approved Bitcoin Trusts, strategically push for Bitcoin spot ETFs, make it publicly known they own roughly 4% of all of Bitcoin, etc. That goes back to an original point. Bitcoin and cryptocurrencies may not get completely cratered like the dinosaurs did, but will we have thousands – or tens of thousands – of different cryptocurrencies, trading on infinite different platforms, with an unlimited amount of different marketed benefits? I don’t see it.

    Are Cryptocurrencies and Digital Assets Going to Crash from the Recession?

    To the more interesting question, can digital assets become the modern-day dinosaurs? It’s vaguely possible, but unlikely. This is where global politics, luck, and irrational/unconventional investor behavior tend to make the largest impacts. Let’s say Bitcoin drops below $5,000 and Grayscale, owning roughly 4%, assesses a further drop to $3,000 by next month. What does Grayscale do? Every financial product they sell is a digital asset and they’ve marketed Bitcoin as the obvious face. They get absolutely no protections from bankruptcy and neither do their investors. Yet, with the amount of Bitcoin they own, could they theoretically have backdoor discussions that would lead to the price of Bitcoin artificially being propped up? It’s a definite theoretical possibility.

    Again, we don’t know who Grayscale would be in the room and how much bargaining power they’d have. To the cryptocurrency enthusiasts who think it’s “cool” to invest in cryptocurrencies specifically because executives at traditional investment institutions are known for appeasing shareholders (in other words, doing their jobs) and “throwing investors under the bus”, well what do you think will happen to you? Will the CEO responsible for making those decisions that has the potential to change investors lives do the “ethical” thing because they don’t have shareholders to protect? I think the fair and impartial response is that remains to be seen. That’s the truth.

    Let’s face it: cryptocurrencies and digital assets are in for the fight for their existence. This is newfound territory for this comparatively new market. It will absolutely shed so much more light than we have today about investors true perspectives and feelings on digital assets. At the end of the day, in a world where quantitative data leads investment decisions, rather than personal belief and alleged loyalty, we’ll have to see what executives and cryptocurrency holders alike do on a broad scale.

    The Bottom Line and What to Do

    The “correct” decision – meaning the decision statistically likely to have the most favorable outcome – would be to reinvest your holdings elsewhere. The risk is way too big, while the reward is way too small or nonexistent. Of the at-risk assets on the chopping block, digital assets are first in line. There is no remotely likely scenario where cryptocurrency supporters get to say “I told you so” anytime soon.

    In reality, what you do is listen to the experts, at least in this case. No one’s saying you need to get your IRA, or any other investment vehicle out for that matter, but you can’t think of a more prudent investment given the economic climate you’re being explained? What about real estate? You have the benefit of a physical asset, upside to earn capital gains if market prices increase, and at the simplest level, housing is essential. Individuals will never not need housing. If the recession impact results in a catastrophic scenario, you have an asset with no real danger of going to zero.

    If you’re going to hunker down and stay invested in digital assets until the end, you can still diversify and reduce your exposure. There are Bitcoin futures ETFs, like the VanEck Bitcoin Strategy ETF we discussed last time. There is the SEC-backed Bitcoin Trust; Grayscale’s GBTC. You can invest in hard currencies that would offset your exposure to digital currencies.

    There’s a plethora of options of the astute investor, but the question in my mind continues to be, why? Why go through an agonizing recession, where you’ll make difficult financial choices just to maintain your current cryptocurrency holdings? Again, if you’re so over-the-top for Blockchain technology, it will be available for purchase at a lower price in the future. But the near future? No chances from the present. Bitcoin will continue to systematically drop daily until there is major turnaround. There’s no telling what that will look like yet.

    The Warren Buffett Philosophy

    Consider this quote from Warren Buffett and how it applies to this debate. Buffett is universally known as the most intelligent and disciplined value-based investor of our generation.

    “People should only [make investments] in companies that exhibit solid fundamentals, strong earnings power, and the potential for continued growth.”

    -Warren Buffett, Unpublished

    Does the cryptocurrency market currently a) exhibit solid fundamentals, b) has strong earnings power, or c) has a solid potential for future growth? The answer to all three is no. That’s likely why Buffet has always remained a staunch opponent to digital assets. Buffet’s average holdings are somewhere from 10-34 years. It’s more than fair to say he views investing as a marathon, not a race.

    Concisely, as all other major financial news agree, the cryptocurrency market is at a crucial testing point, at bare minimum. We know crypto products aren’t going to gain market value during a recession, for sure. However, the extent of the damages digital assets will take compared to other “at-risk” assets remains to be seen. Time, Forbes, CNBC, and Reuters all predicted major cryptocurrency market tumbles during the recession just this week. Again, a lot of it will depend on luck and how things play out, but there are actions you can take as an investor to mitigate your exposure to the bullish side of the crypto/digital asset market during a recession.

    I’ll end with one final argument against cryptocurrencies and digital assets. Ironically, this goes against Warren Buffett’s main investing principle (at least in part). I believe he’s said that during a recession, his investment philosophy changes, but I was unable to find that quote.

    “Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a fly epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”

    -Warren Buffett, Unpublished

    The Secret Behind Buffett’s Legacy: Some Deals are Simply too Risky

    Whether you agree with the risks to digital assets now or not, Buffett is spot on as usual. He has more famous quotes regarding investing in the stock market for the long-term, which is what he starts with. Buffett has held AXP (American Express) since 1964, KO (Coca-Cola) since 1988, and Wells Fargo (WFC) since 1989. Buffett’s outlook on the stock market is almost exclusively dependent on his analysis of that specific business. He’ll look at the financials in extensive detail, but he’ll also study the business model. How the company generates profits, what kinds of costs they incur. He’s the third richest person in the world off investments alone. Warren Buffett – rather than major investment banks or cash lenders – is known to have plenty of available cash during a recession or financial panic.

    Why? He hedges anywhere he’s far too overexposed and to boot, he has a knack for taking good bets on massively successful companies. In the context of cryptocurrency and digital assets, are they going to withstand all those arduous times? WWI & WWII, Vietnam, the Great Depression, over a dozen recessions and financial panics, oil shocks, a fly epidemic, and a political catastrophe? That wasn’t just an ego-trip; Buffett lived through those eras and more so, he prospered through them. Very few, if any, can say the same. Buffett stays away from a certain level of risk, period. No matter what the potential or hypothetical reward is, Buffett doesn’t execute the deal unless it’s met his standards.

    In Conclusion…

    With the way Blockchain was initially pitched, then repurposed, and gained little traction since is worrisome to me. The bottom line is cryptocurrency and digital assets have nowhere to go but down during an impactful recession. What you should do, in full sincerity, depends almost exclusively on your investing goals and available capital. In common, everyday situations – for example purchasing an overpriced digital currency – you should still mitigate your losses.

    You don’t want to be taking a bigger loss because you were too stubborn to take a much smaller one initially. I believe we’ll wind up seeing a lot of cryptocurrency investors in that boat. At what point will they be willing to toss it in and accept this investment just didn’t work out? Will they get to that point? Time will tell. What’s certain is the magnitude the recession’s impact will have on the cryptocurrencies and digital assets markets.

  • Why the SEC will Ultimately Deny VanEck’s Third Application for a Bitcoin Spot ETF and What it Means for Digital Assets

    Late last month, August 2022, the SEC announced a 45-day delay to rule on VanEck’s third Bitcoin Spot ETF application. This comes on the heels of the SEC denying Grayscale’s GBTC – an SEC backed Bitcoin Trust – conversion to a spot ETF, as well as Bitwise Asset Management’s application for a spot ETF, on the same day in late June 2022. VanEck currently has an SEC-backed Bitcoin futures ETF, the “VanEck Bitcoin Strategy ETF” (Cboe: XBTF). Their two previous applications for a Bitcoin spot ETF were rejected first in 2017, then late in 2021. VanEck is considered somewhat of an “investment giant”, with roughly $65B currently in AUM.

    Grayscale, with roughly $20M in AUM and a digital asset manager giant themselves, a subsidiary of Digital Currency Group (DCG) – who’s also the parent company of CoinDesk – sued the SEC immediately after they rejected the GBTC’s conversion from a SEC-backed Bitcoin Trust to a SEC-backed spot ETF. A ruling from a Federal Appellate Court is expected sometime in Q4 2023 or Q1 2024.

    Why Will the SEC Reject VanEck’s Application for a Bitcoin Spot ETF a Third Time?

    A better way to phrase the question is: why wouldn’t they? Has anything dramatically changed about either the SEC’s mandates, Bitcoin, market conditions, or is VanEck’s application unique? No, for all the above. VanEck’s Bitcoin spot ETF, which they’ve proposed to list on the Cboe BZX Exchange, would still create direct Bitcoin ownership for investors who purchased it. In my opinion, the SEC’s had to issue a 45-day delay because VanEck’s argument appears to differ from Grayscale’s. VanEck isn’t relying on a futures versus spot Exchanged Traded Fund [ETF] derivative comparison. Rather, they’re urging the SEC to reconsider because investors can access Bitcoin spot ETFs through our neighbors in Canada.

    They’re not wrong. As early as February 2021, Canada became one of the first countries in the world to place a Bitcoin spot ETF on one of their national exchanges. But given that was back in February 2021, the question remains: what’s changed? It’s completely unrealistic for the SEC to admit they weren’t aware of a Bitcoin spot ETF on a Canadian exchange. Hypothetically, it would very likely give Grayscale the green light to pursue further, more substantial legal action against the SEC.

    At the time Grayscale’s GBTC was rejected, many analysts cited the heightened potential for fraud and malpractice amongst digital assets being a key reason institutional investors, who generally purchase far more spot products than futures derivatives (as part of their traditional investment strategies), should not get access to an SEC-backed Bitcoin spot ETF yet. They said digital currency exchanges needed total transparency inside their marketplaces, like the DOW and NASDAQ. While this flies in the face of many reasons investors purchase digital assets and it’s not practical, it didn’t matter. That’s what the institutional investor community who was with the SEC just two months back demanded. VanEck is not purely a digital asset manager like Grayscale and in terms of AUM, they’re over 3 times larger.

    As another interesting reference point VanEck currently has 3 CO (Commodity) ETFs. The first is XBFT (Bitcoin Strategy ETF) and the second is OUNZ (VanEck Merk Gold ETF). XBFT has $19.2M in total net assets, while OUNZ has $600.4M. Interestingly, VanEck offers 65 EFT products and only 3 fall in the Commodities Asset Class. The other 62 are split between Fixed Income (Corporate, International, & Municipal Bonds, Rates products, etc.) and Equity ETFs. VanEck’s GDX has $9.4B in total net assets, while their ITM has 1,939 holdings (September 2, 2022). The XBFT has just $19.2M in total net assets and only 8 people holding it (September 2, 2022). Of the roughly $65B VanEck has in AUM, XBFT – a Bitcoin futures ETF – represents around .002% of their investment portfolio.

    Concisely, VanEck is a bigger, more established firm that has broader appeal to institutional investors already compared to Grayscale, who owns roughly 3.5% of all of Bitcoin and is purely a digital asset manager. They have the first SEC-approved Bitcoin Trust ETF with GBTC, trading on the NASDAQ. They are doing their best to bring digital assets to institutional investors. That’s why they’ve gone all out for a Bitcoin spot ETF, whereas VanEck seems to have strategically made a push when they’ve felt they had a compelling case.

    Does the SEC’s 45-Delay Mean VanEck has a Real Chance?

    I believe it means they have a better chance, but will ultimately suffer the same fate as Grayscale and Bitwise. I don’t even think it gives them much of a better chance; only if the SEC makes an unexpected blunder. Nothing has changed about their concerns related to GBTC that would warrant VanEck’s application to get approved.

    “The Commission [SEC] finds that it is appropriate to designate a longer period within which to take action on the proposed rule change so that it has sufficient time to consider the proposed rule change and the issues raised therein.”
    -SEC Spokesperson, in a letter to VanEck (August 2022)
    Tweet

    The verbiage in this quote seems to be hinting that the SEC is actually considering accepting VanEck’s argument. However, the SEC issuing a delay on a ruling isn’t exactly breaking news. They’ve shot down over a dozen attempts at a Bitcoin spot ETF in the last 12-month calendar year alone. There is no new information to indicate Bitcoin is any less susceptible to fraud – thereby posting inherent investor risk – than two months ago. The SEC is buying time in hopes of making a more compelling case regarding Bitcoin spot ETF’s in Canadian markets. What’s going to make more headlines in 45 days, the macroeconomic conditions from rising rates, inflation, and other recessionary indicators, or the SEC rejected the 15th (or so) Bitcoin spot ETF in the last year? After all, the SEC isn’t completely unaware of the current dynamics in financial markets.

    If VanEck is Ultimately Denied, What Does that Mean for Cryptocurrency?

    The overall impact is unlikely to be large, unless the SEC gets unpredictable here. Assuming they stay consistent with their rationale, this matter will go back to the DC Appellate Courts. But if you’re an institutional investor of SEC-approved Bitcoin assets, you’re not going to be majorly impacted by this. Inflation and rising interest rates? That will likely negatively impact at risk assets across the board and digital assets are certainly in that category. But the long-term ramifications for Bitcoin from this latest SEC ruling are likely to be very minimal.

    Just to end with a key point we just touched on, watch out for at risk assets considering this is very likely going to be the realest felt recession since 2008. There won’t be a major economic downturn because we’ve learned our lessons from 2008, but investors will sell off at-risk assets as soon as financial markets show signs of destabilization. Digital assets in an investor’s portfolio will be one of the first to go. Combined with the seasonality of Bitcoin slumps, expect the price to drop below 15,000 and who knows how much lower. How much lower would it take for the strongest crypto asset enthusiasts to wave the red flag? Would that ever happen? Only time will tell, but again, considering we have a lot of indications a recession is coming, taking a bullish position on Bitcoin in the short-term is unwise at best.

  • Why the SEC will Ultimately Deny VanEck’s Third Application for a Bitcoin Spot ETF and What it Means for Digital Assets

    Late last month, August 2022, the SEC announced a 45-day delay to rule on VanEck’s third Bitcoin Spot ETF application. This comes on the heels of the SEC denying Grayscale’s GBTC – an SEC backed Bitcoin Trust – conversion to a spot ETF, as well as Bitwise Asset Management’s application for a spot ETF, on the same day in late June 2022. VanEck currently has an SEC-backed Bitcoin futures ETF, the “VanEck Bitcoin Strategy ETF” (Cboe: XBTF). Their two previous applications for a Bitcoin spot ETF were rejected first in 2017, then late in 2021. VanEck is considered somewhat of an “investment giant”, with roughly $65B currently in AUM.

    Grayscale, with roughly $20M in AUM and a digital asset manager giant themselves, a subsidiary of Digital Currency Group (DCG) – who’s also the parent company of CoinDesk – sued the SEC immediately after they rejected the GBTC’s conversion from a SEC-backed Bitcoin Trust to a SEC-backed spot ETF. A ruling from a Federal Appellate Court is expected sometime in Q4 2023 or Q1 2024.

    Why Will the SEC Reject VanEck’s Application for a Bitcoin Spot ETF a Third Time?

    A better way to phrase the question is: why wouldn’t they? Has anything dramatically changed about either the SEC’s mandates, Bitcoin, market conditions, or is VanEck’s application unique? No, for all the above. VanEck’s Bitcoin spot ETF, which they’ve proposed to list on the Cboe BZX Exchange, would still create direct Bitcoin ownership for investors who purchased it. In my opinion, the SEC’s had to issue a 45-day delay because VanEck’s argument appears to differ from Grayscale’s. VanEck isn’t relying on a futures versus spot Exchanged Traded Fund [ETF] derivative comparison. Rather, they’re urging the SEC to reconsider because investors can access Bitcoin spot ETFs through our neighbors in Canada.

    They’re not wrong. As early as February 2021, Canada became one of the first countries in the world to place a Bitcoin spot ETF on one of their national exchanges. But given that was back in February 2021, the question remains: what’s changed? It’s completely unrealistic for the SEC to admit they weren’t aware of a Bitcoin spot ETF on a Canadian exchange. Hypothetically, it would very likely give Grayscale the green light to pursue further, more substantial legal action against the SEC.

    At the time Grayscale’s GBTC was rejected, many analysts cited the heightened potential for fraud and malpractice amongst digital assets being a key reason institutional investors, who generally purchase far more spot products than futures derivatives (as part of their traditional investment strategies), should not get access to an SEC-backed Bitcoin spot ETF yet. They said digital currency exchanges needed total transparency inside their marketplaces, like the DOW and NASDAQ. While this flies in the face of many reasons investors purchase digital assets and it’s not practical, it didn’t matter. That’s what the institutional investor community who was with the SEC just two months back demanded. VanEck is not purely a digital asset manager like Grayscale and in terms of AUM, they’re over 3 times larger.

    As another interesting reference point VanEck currently has 3 CO (Commodity) ETFs. The first is XBFT (Bitcoin Strategy ETF) and the second is OUNZ (VanEck Merk Gold ETF). XBFT has $19.2M in total net assets, while OUNZ has $600.4M. Interestingly, VanEck offers 65 EFT products and only 3 fall in the Commodities Asset Class. The other 62 are split between Fixed Income (Corporate, International, & Municipal Bonds, Rates products, etc.) and Equity ETFs. VanEck’s GDX has $9.4B in total net assets, while their ITM has 1,939 holdings (September 2, 2022). The XBFT has just $19.2M in total net assets and only 8 people holding it (September 2, 2022). Of the roughly $65B VanEck has in AUM, XBFT – a Bitcoin futures ETF – represents around .002% of their investment portfolio.

    Concisely, VanEck is a bigger, more established firm that has broader appeal to institutional investors already compared to Grayscale, who owns roughly 3.5% of all of Bitcoin and is purely a digital asset manager. They have the first SEC-approved Bitcoin Trust ETF with GBTC, trading on the NASDAQ. They are doing their best to bring digital assets to institutional investors. That’s why they’ve gone all out for a Bitcoin spot ETF, whereas VanEck seems to have strategically made a push when they’ve felt they had a compelling case.

    Does the SEC’s 45-Delay Mean VanEck has a Real Chance?

    I believe it means they have a better chance, but will ultimately suffer the same fate as Grayscale and Bitwise. I don’t even think it gives them much of a better chance; only if the SEC makes an unexpected blunder. Nothing has changed about their concerns related to GBTC that would warrant VanEck’s application to get approved.

    “The Commission [SEC] finds that it is appropriate to designate a longer period within which to take action on the proposed rule change so that it has sufficient time to consider the proposed rule change and the issues raised therein.”
    -SEC Spokesperson, in a letter to VanEck (August 2022)
    Tweet

    The verbiage in this quote seems to be hinting that the SEC is actually considering accepting VanEck’s argument. However, the SEC issuing a delay on a ruling isn’t exactly breaking news. They’ve shot down over a dozen attempts at a Bitcoin spot ETF in the last 12-month calendar year alone. There is no new information to indicate Bitcoin is any less susceptible to fraud – thereby posting inherent investor risk – than two months ago. The SEC is buying time in hopes of making a more compelling case regarding Bitcoin spot ETF’s in Canadian markets. What’s going to make more headlines in 45 days, the macroeconomic conditions from rising rates, inflation, and other recessionary indicators, or the SEC rejected the 15th (or so) Bitcoin spot ETF in the last year? After all, the SEC isn’t completely unaware of the current dynamics in financial markets.

    If VanEck is Ultimately Denied, What Does that Mean for Cryptocurrency?

    The overall impact is unlikely to be large, unless the SEC gets unpredictable here. Assuming they stay consistent with their rationale, this matter will go back to the DC Appellate Courts. But if you’re an institutional investor of SEC-approved Bitcoin assets, you’re not going to be majorly impacted by this. Inflation and rising interest rates? That will likely negatively impact at risk assets across the board and digital assets are certainly in that category. But the long-term ramifications for Bitcoin from this latest SEC ruling are likely to be very minimal.

    Just to end with a key point we just touched on, watch out for at risk assets considering this is very likely going to be the realest felt recession since 2008. There won’t be a major economic downturn because we’ve learned our lessons from 2008, but investors will sell off at-risk assets as soon as financial markets show signs of destabilization. Digital assets in an investor’s portfolio will be one of the first to go. Combined with the seasonality of Bitcoin slumps, expect the price to drop below 15,000 and who knows how much lower. How much lower would it take for the strongest crypto asset enthusiasts to wave the red flag? Would that ever happen? Only time will tell, but again, considering we have a lot of indications a recession is coming, taking a bullish position on Bitcoin in the short-term is unwise at best.

  • Is there a Difference Between a ‘Buyer’s Market’ and a ‘Market that’s Rapidly Getting Less Advantageous Towards Seller’s’?

    The vast majority of latest prognostications point to a shift in the housing market, in favor of buyers over sellers. It’s about time. America’s housing market has been brutal on homebuyer’s, renters, and those looking to lease in prime locations for years now. There is a lot of qualitative and quantitative analysis to suggest that despite rising rates, buyers currently have the advantage.

    Realtor’s Weekly Housing Market: “The Four Big Bellwethers”

    Realtor has a weekly column called “How’s the Housing Market This Week?”. Realtor’s real estate economists are some of the most trusted in the industry. Weekly, Realtor delivers the most up-to-date statistics on what they coined “the four big bellwethers of the housing market”. These include home prices, # of new listings, total days on market, and of course, mortgage rates (Dutton, Realtor).

    “The housing market is resetting in a buyer-friendly direction,” notes Realtor Chief Economist Danielle Hale in her evaluation. We’d be remised if we didn’t note a “buyer-friendly direction” is certainly not the same as a true buyer’s market. While the same analysis notes the obvious, historic seller’s market that’s raged since COVID-19 began, it points out that the window for sellers is closing, rapidly. Below are the previously mentioned Realtor weekly housing trends, for week-end August 6th, 2022.

    -Realtor.com – Weekly Housing Trends, August 6th, 2022

    What jumps out to me are the top two statistics. A 15.5% median listing price increase, coupled with 8% fewer listing than the week before (Realtor.com). Hale has a unique and thought-provoking perspective on this phenomenon.

    Is There Surprisingly Good News in a 15.5% Increase in Median Listing Price?

    According to Hale, yes, this number is good news for prospective buyers. The last data from July 2022 shows a median nationwide listing price of $449,000. For the week ending August 6th, a 15.5% listing price increase means the new median was $518.595. While this marks the 34th straight week of double-digit price growth, Hale points out it’s also the “second consecutive week of deceleration” (Dutton, Realtor). The previous two weeks – at the end of July 2022 – median listing prices rose by 16.6% and 15.6%, respectively. This third ‘relatively temperate’ hike offers buyers hope home price growth will finally continue steadily dwindling.

    “The improvement has been substantial”, confirms Hale. She’s just as quick to add, “buyers in today’s market may still face meaningful affordability challenges as the typical home listing price remains near a record high”. But there’s little long-term evidence to suggest sticker price is a major deterrent for buyers (Dutton, Realtor). Hale reaffirms, “Persistent [homebuyers] may still continue to find success”. She goes on to add, “Second quarter data showed that homeownership rates increased from a year ago, both overall and for nearly every age and racial and ethnic group”.

    Given that homeownership rates have surged — amid rampant inflation, rising mortgage rates, and other deterrents — strongly signals that buyers who are willing to have some flexibility will ultimately win. Participants who are been willing to purchase somewhere they may not have considered pre-pandemic have largely become homebuyers. It’s a true testament to the lengths that homebuyers are willing to go today, provided sellers meet them halfway.

    Are Sellers Undermining the ‘Buyer Friendly’ Market?

    Anything positive for homebuyers is a negative for home sellers and of course, vice versa. Many sellers with properties on the market are panicking they ‘missed the mark’ by not closing a sale on their property during the COVID-19 real estate boom. For week-end July 30th, 2022, the number of new listings dropped by 8%, year-over-year (Dutton, Realtor).

    “New listings fell from a year ago for a fourth week. This is looking more and more like sellers may be wary of current market conditions, which have shifted substantially, even though they remain quite favorable to sellers who have owned for just about any length of time.”

    – Danielle Hale, Chief Economist, Realtor

    Hale appears to be hesitant to commit to buyer-friendly market conditions. However, she does definitively comment that conditions are becoming less and less favorable for sellers. The same message seems to be resonating across the board: if you’re a seller, the longer your property stays on the market, the worse-off your position will be.

    “While overall inventory [of new and old listings] grew by 28% over this same week last year, the active listings count still trails its 2020 and 2019 levels by more than 15% and 45%, respectively. More improvement in active inventory is likely needed to bring balance, but the recent trend may be at risk if homeowner attitudes toward selling now continue to deteriorate.”

    – Danielle Hale, Chief Economist, Realtor

    Once again, Hale seems to reemphasize the same underlying position. ‘We’re not in a pro-buyer’s market, we’re in a market that’s rapidly growing less favorable to sellers.’

    Are Rising Mortgage Rates to Blame for Homebuyers not Rushing to Close a Deal?

    The last question Realtor’s frequented market assessment addresses is why buyer’s aren’t rushing to close the deal. We are in a market that’s getting less and less favorable towards sellers, after all. What happens when we hit that market floor and conditions start to change against homebuyers. That has been the case – at a staggering rate – for well over two years now (Dutton, Realtor).

    In July 2022, listings lingered on the market a mere 34 days before getting snapped up. That’s nearly half the time it took two years earlier (Dutton, Realtor). Conversely, after having entered August 2022, it seems homebuyers are pumping the breaks and not feeling in such a rush. Hale’s prediction? Expect more of the same. She stated, “We expect more slowing ahead as the housing market reset”. The question remains, why?

    According to data provided by Freddie Mac, rising mortgage rates are a good place to start. For week-end August 11th, 2022, the average 30-year fixed mortgage rate increased to 5.22%. That’s considered a significantly steep spike from the previous week’s 4.99% (Mortgage Rates, Freddie Mac). Realtor predicts the future will hinge on how large corporations will view the potentially looming recession.

    “The big question for consumers is whether companies will over-react to the recession concerns and start trimming payrolls. A sharp pullback in hiring could have a direct impact on people’s ability to keep spending, especially with today’s high inflation.”

    – George Ratiu, Senior Economist, Realtor

    Realtor ultimately winds up agreeing. Prospective homebuyers should take full advantage of this buyer-friendly market while it lasts (Dutton, Realtor).

  • Four Major Valuation Methods Explained: Commercial Real Estate (CRE)

    From the perspective of investors, coming up with an accurate property valuation is the most significant factor in making investment decisions. Commercial real estate (CRE) investment has become increasingly popular in the past few decades. That’s because it’s viewed as an excellent vehicle for corporate and public wealth investors to achieve stable returns.

    In this post, we’ll look at four primary valuation methods investors use when looking at CRE proposals. It should be no surprise that technology deeply impacts a potential CRE investment valuation. It’s truly astounding how powerful software solutions can support the consistency, transparency, and standardization across the valuation industry.

    Cost Approach

    The cost approach involves estimating a rough total budget for how much the structure would cost to build from scratch. The cost approach accounts for the original value of the land, plus the cost to build the structure from the ground up. Investors typically look at this approach to see if it’s financially more profitable to develop a new property, versus buying an existing one. The cost approach is comprised of two major methods:

    • Reproduction Method – Costs of rebuilding an exact replica of the existing structure, using the same materials, construction methods, etc.
    • Replacement Method – Costs of rebuilding a new structure with brand new materials, construction methods, designs, etc.

    This logic is generally sound. However, it’s critical to note this method does not account for additional effort of development and construction involved in building a property from the ground up. Similarly, it does not account for the long-term cash flow of a given CRE project.

    Sales Comparison Approach

    Comparisons between key market factors are one of the most important inputs to any valuation method. Furthermore, sales comparisons are usually the source of information, such as cost of reproduction, current market capitalization rate, loan-to-value ratios, and others (Atlus Group). Prospective buyers use this approach to compare current CRE listings to recently sold projects. Though this list isn’t exhaustive, it includes major components of the sales comparison approach:

    • Price per square foot
    • Capitalization rate
    • Price per unit (multifamily CRE)
    • Price per key (hospitality CRE)
    • Physical condition
    • Location
    • Tenant profiles (income, credit quality, cash flow stability, etc.)
    • Income (financial statements)

    The closer in similarity a prospective CRE property is to a comparable sale – especially a recent one – referencing the above components, the more effective this approach tends to be. Finally, once the quantitative characteristics of the perspective CRE property are compared, there is a qualitative analysis to ensure any more or less favorable attributes are accounted for. These adjustments are an essential precaution, if using this valuation method for CRE purchases.

    One notable downside to this method is a lack of analysis of any long-term cash flows or property valuation.

    Capitalization Rate Approach (Income Capitalization)

    The “cap rate” approach is one of the most popular methods of property valuation. It’s very frequently used by analysts in both the lending world and intended acquisitions (Atlus Group). When you hear real estate professionals mention what a property “traded at”, they’re almost always citing either the cap rate, or the price per square foot, a property sold for.

    The formula for calculating cap rate is simple. It’s equal to the net operating income (NOI) of the property, divided by the capitalization rate. The outcome represents the ownership’s approximate value of the property, based on the first year’s expected cash flow.

    Like the Sales Comparison Approach, this tool is most valuable to estimate the current value of CRE properties. Furthermore, it’s even more useful if the property has relatively stable and easily predictable cash flow. New, complex projects that have essentially zero NOI are not good candidates for this valuation approach. In such circumstances, investors are much more likely to turn to the Discounted Cash Flow Approach.

    Discounted Cash Flow Approach

    While the three previously detailed CRE valuation methods are undoubtably useful under certain conditions, they share a major drawback. Each of first three valuation methods estimate the value of a CRE property at a specific point in time. This is in fact a major drawback for real estate investors, who are rarely investing primarily for short-term gains.

    Suppose an example of a long-term, direct real estate investor, looking to maximize their return of a 10-year period. The below formula, taken from Investopedia shows the common formula for the Discounted Cash Flow (DCF) approach.

    Source: Sabrina Jiang, Investopedia (2021)

    Investors utilize this method to factor in both the delta of the initial buying price and the value of the property after ten years, in addition to the net present value (NPV) of any cash flows that come in from owning that property over 10 years. This gives real estate investors a great formula to input prognostications, then make transactions based on those forecasts.

    Reverting to the drawbacks of point-in-time valuations, firstly, it’s critical to understand fundamental psychology real estate investors utilize. Typically, real estate investors have a longer-term vision, especially compared to investors who purchase various securities. This makes a point-in-time valuation much less relevant, since in the long-run real estate investors are not just looking at an easily predictably present value. As we saw in 2008 most famously and during the COVID-19 pandemic most recently, real estate prices can tank from unrelated market activities, political changes, or even a completely unexpected global health pandemic (Altus Group).

    Conclusion

    Long-term volatility concerns necessitate real estate investors to rely on more than increases in value over time. This is a primary explanation why investors generally rely on the cash flow, plus a final value increase. If an investor holds a property for ten years from purchase to sale, as an example, the overall return will be a combination of cash flow from all ten years of ownership, plus any difference between the initial purchase price and the ultimate sale price.

    The cost, sales comparison, and capitalization rate approaches all fail to account for both potential changes in the cash flow, or value of the property, over the investment hold period. Hypothetically, if an investor knows that in year three of the hold period, a major tenant is going to vacate the property and cause a significant decrease in the property’s cash flow for the period, this clearly negatively impacts the overall return the investor attains. The only valuation method that takes into consideration time value of money and captures the future performance of the property is the DCF method.

    The DCF method predicts future cash flows over an estimated property hold period. This includes both annual cash flow and profit at the time of sale. Many practitioners found that attempting to accurately predict revenue, expenses, and the future value of the property at the time of sale, is actually quite difficult. It essentially forces them forces them to think deeply and more critically. Long-term risk factors, management, quality of tenants, and trends in the real estate market suddenly appear on their immediate radar.

    While not perfect (valuation models are not a crystal ball), the DCF method is generally preferred by real estate investors. Bluntly, the DCF approach best matches the reality of the investment, compared to the others discussed above.

    The Closing Argument to Real Estate Investors (Primarily CRE Investors)

    Selecting the best-fit valuation method is akin to choosing the right tool for a homeowner’s repair project. Most of the decision is decided on a case-by-case basis, based on the best information available. With the varying subjective methods and information, asset appraisal in the world of commercial is part formula, part art form.

    In practicality, most appraisers don’t limit themselves to one method, instead taking an average of two or more methods. It’s hardly surprising appraisers have toned down their aggressive approach, especially compared to nearly 15 years ago. After the catastrophic downward spiral of 2008, the more analysis real estate investment projects undergo, the better. To build on the methods discussed, a well-known method rapidly gaining increasing popularity is called the stress test. Perhaps this test is more commonly referenced in the investment banking sector, namely to monitor volatility ratios of aggressive investment banks who also hold client checking and other deposit accounts, to ensure we don’t need to worry about anymore “bank runs”, but nonetheless the same logic applies to the real estate sector and it’s played an indispensable component to accurate real estate valuations. 

    If you take nothing else away from this article, use the DCF Method whenever possible. Especially in today’s ever-changing real estate market, periodic cash flows are a must to have a successful, long-term real estate holding. As with any other investment, do your due diligence, ensure you have the right team around you, and take calculated, well-thought risks. Good luck to all continuing to navigate the post COVID-19 real estate landmine!

  • Four Major Valuation Methods Explained: Commercial Real Estate (CRE)

    From the perspective of investors, coming up with an accurate property valuation is the most significant factor in making investment decisions. Commercial real estate (CRE) investment has become increasingly popular in the past few decades. That’s because it’s viewed as an excellent vehicle for corporate and public wealth investors to achieve stable returns.

    In this post, we’ll look at four primary valuation methods investors use when looking at CRE proposals. It should be no surprise that technology deeply impacts a potential CRE investment valuation. It’s truly astounding how powerful software solutions can support the consistency, transparency, and standardization across the valuation industry.

    Cost Approach

    The cost approach involves estimating a rough total budget for how much the structure would cost to build from scratch. The cost approach accounts for the original value of the land, plus the cost to build the structure from the ground up. Investors typically look at this approach to see if it’s financially more profitable to develop a new property, versus buying an existing one. The cost approach is comprised of two major methods:

    • Reproduction Method – Costs of rebuilding an exact replica of the existing structure, using the same materials, construction methods, etc.
    • Replacement Method – Costs of rebuilding a new structure with brand new materials, construction methods, designs, etc.

    This logic is generally sound. However, it’s critical to note this method does not account for additional effort of development and construction involved in building a property from the ground up. Similarly, it does not account for the long-term cash flow of a given CRE project.

    Sales Comparison Approach

    Comparisons between key market factors are one of the most important inputs to any valuation method. Furthermore, sales comparisons are usually the source of information, such as cost of reproduction, current market capitalization rate, loan-to-value ratios, and others (Atlus Group). Prospective buyers use this approach to compare current CRE listings to recently sold projects. Though this list isn’t exhaustive, it includes major components of the sales comparison approach:

    • Price per square foot
    • Capitalization rate
    • Price per unit (multifamily CRE)
    • Price per key (hospitality CRE)
    • Physical condition
    • Location
    • Tenant profiles (income, credit quality, cash flow stability, etc.)
    • Income (financial statements)

    The closer in similarity a prospective CRE property is to a comparable sale – especially a recent one – referencing the above components, the more effective this approach tends to be. Finally, once the quantitative characteristics of the perspective CRE property are compared, there is a qualitative analysis to ensure any more or less favorable attributes are accounted for. These adjustments are an essential precaution, if using this valuation method for CRE purchases.

    One notable downside to this method is a lack of analysis of any long-term cash flows or property valuation.

    Capitalization Rate Approach (Income Capitalization)

    The “cap rate” approach is one of the most popular methods of property valuation. It’s very frequently used by analysts in both the lending world and intended acquisitions (Atlus Group). When you hear real estate professionals mention what a property “traded at”, they’re almost always citing either the cap rate, or the price per square foot, a property sold for.

    The formula for calculating cap rate is simple. It’s equal to the net operating income (NOI) of the property, divided by the capitalization rate. The outcome represents the ownership’s approximate value of the property, based on the first year’s expected cash flow.

    Like the Sales Comparison Approach, this tool is most valuable to estimate the current value of CRE properties. Furthermore, it’s even more useful if the property has relatively stable and easily predictable cash flow. New, complex projects that have essentially zero NOI are not good candidates for this valuation approach. In such circumstances, investors are much more likely to turn to the Discounted Cash Flow Approach.

    Discounted Cash Flow Approach

    While the three previously detailed CRE valuation methods are undoubtably useful under certain conditions, they share a major drawback. Each of first three valuation methods estimate the value of a CRE property at a specific point in time. This is in fact a major drawback for real estate investors, who are rarely investing primarily for short-term gains.

    Suppose an example of a long-term, direct real estate investor, looking to maximize their return of a 10-year period. The below formula, taken from Investopedia shows the common formula for the Discounted Cash Flow (DCF) approach.

    Source: Sabrina Jiang, Investopedia (2021)

    Investors utilize this method to factor in both the delta of the initial buying price and the value of the property after ten years, in addition to the net present value (NPV) of any cash flows that come in from owning that property over 10 years. This gives real estate investors a great formula to input prognostications, then make transactions based on those forecasts.

    Reverting to the drawbacks of point-in-time valuations, firstly, it’s critical to understand fundamental psychology real estate investors utilize. Typically, real estate investors have a longer-term vision, especially compared to investors who purchase various securities. This makes a point-in-time valuation much less relevant, since in the long-run real estate investors are not just looking at an easily predictably present value. As we saw in 2008 most famously and during the COVID-19 pandemic most recently, real estate prices can tank from unrelated market activities, political changes, or even a completely unexpected global health pandemic (Altus Group).

    Conclusion

    Long-term volatility concerns necessitate real estate investors to rely on more than increases in value over time. This is a primary explanation why investors generally rely on the cash flow, plus a final value increase. If an investor holds a property for ten years from purchase to sale, as an example, the overall return will be a combination of cash flow from all ten years of ownership, plus any difference between the initial purchase price and the ultimate sale price.

    The cost, sales comparison, and capitalization rate approaches all fail to account for both potential changes in the cash flow, or value of the property, over the investment hold period. Hypothetically, if an investor knows that in year three of the hold period, a major tenant is going to vacate the property and cause a significant decrease in the property’s cash flow for the period, this clearly negatively impacts the overall return the investor attains. The only valuation method that takes into consideration time value of money and captures the future performance of the property is the DCF method.

    The DCF method predicts future cash flows over an estimated property hold period. This includes both annual cash flow and profit at the time of sale. Many practitioners found that attempting to accurately predict revenue, expenses, and the future value of the property at the time of sale, is actually quite difficult. It essentially forces them forces them to think deeply and more critically. Long-term risk factors, management, quality of tenants, and trends in the real estate market suddenly appear on their immediate radar.

    While not perfect (valuation models are not a crystal ball), the DCF method is generally preferred by real estate investors. Bluntly, the DCF approach best matches the reality of the investment, compared to the others discussed above.

    The Closing Argument to Real Estate Investors (Primarily CRE Investors)

    Selecting the best-fit valuation method is akin to choosing the right tool for a homeowner’s repair project. Most of the decision is decided on a case-by-case basis, based on the best information available. With the varying subjective methods and information, asset appraisal in the world of commercial is part formula, part art form.

    In practicality, most appraisers don’t limit themselves to one method, instead taking an average of two or more methods. It’s hardly surprising appraisers have toned down their aggressive approach, especially compared to nearly 15 years ago. After the catastrophic downward spiral of 2008, the more analysis real estate investment projects undergo, the better. To build on the methods discussed, a well-known method rapidly gaining increasing popularity is called the stress test. Perhaps this test is more commonly referenced in the investment banking sector, namely to monitor volatility ratios of aggressive investment banks who also hold client checking and other deposit accounts, to ensure we don’t need to worry about anymore “bank runs”, but nonetheless the same logic applies to the real estate sector and it’s played an indispensable component to accurate real estate valuations. 

    If you take nothing else away from this article, use the DCF Method whenever possible. Especially in today’s ever-changing real estate market, periodic cash flows are a must to have a successful, long-term real estate holding. As with any other investment, do your due diligence, ensure you have the right team around you, and take calculated, well-thought risks. Good luck to all continuing to navigate the post COVID-19 real estate landmine!

  • Did the Economic Slowdown (as a Result of COVID-19) Actually Impact CRE Positively?

    Did the Economic Slowdown (as a Result of COVID-19) Actually Impact CRE Positively?

    Succinctly, of course not. However, one may argue that the COVID-19 pandemic did create an opportunity for the CRE (Commercial Real Estate) market to generate innovative opportunities for at least this coming year. Some of the opportunities are lessons carried from 2020, when we saw CRE begin to show signs of gradual recovery before returning [Forbes Real Estate Council]. John D’Angelo, Deloitte Consulting’s U.S. Real Estate Leader agreed that at least a few emerging CRE trends will contribute to a recovery in 2021.

    Firstly, global CRE Corporations are researching how to attack the following:

    • Continuously evolving behavioral trends post COVID-19
    • Establishing more secure building spaces
    • Optimal efficiency
    • Improving in recognizing challenges, vulnerabilities, and risks at the early portfolio level

    CRE Corporations especially should be working extra hard to familiarize themselves with the results of this research as these are important trends that will likely impact the CRE market as a whole. Those who understand these trends will be able to provide their clients a better experience with access to this knowledge and, therefore, result in steady sales.

    Secondly (and in fact surprisingly), due to the pandemic, lockdowns have led more companies to have their employees working from home. While it may seem like there would be no use for office space in 2021, there are actually several opportunities in the CRE market for commercial offices that were not there before. Vacancies in high-traffic areas make this the perfect time for commercial owners who are looking to expand.

    While many businesses are still waiting to bring their employees back to the office, there are undoubtedly several good reasons for having an office in a post-COVID environment. In an office, employees have more space to work collaboratively, increasing cooperation and efficiency. CRE owners and investors would be wise to acknowledge the fact that even during the pandemic, there are still business owners out there looking for affordable office space and certainly have this in mind as they make their investment decisions this year.

    Finally, when it comes to e-commerce, an already growing sector prior to 2020, boomed during the pandemic [Forbes Real Estate Council]. In response, retail stores and third-party logistics businesses are not only growing or optimizing their fulfillment center footprints, but many of them are also switching from a “just-in-time” inventory model, to a “just-in-case” approach as they aim to prevent the shortages of goods encountered throughout 2020. As this trend continues, many online shops nationwide will need to lease a warehouse for their growing businesses. This will certainly lead to a steady increase in leasing opportunities in the CRE market that both owners and investors should take advantage of.

  • Did the Economic Slowdown (as a Result of COVID-19) Actually Impact CRE Positively?

    Did the Economic Slowdown (as a Result of COVID-19) Actually Impact CRE Positively?

    Succinctly, of course not. However, one may argue that the COVID-19 pandemic did create an opportunity for the CRE (Commercial Real Estate) market to generate innovative opportunities for at least this coming year. Some of the opportunities are lessons carried from 2020, when we saw CRE begin to show signs of gradual recovery before returning [Forbes Real Estate Council]. John D’Angelo, Deloitte Consulting’s U.S. Real Estate Leader agreed that at least a few emerging CRE trends will contribute to a recovery in 2021.

    Firstly, global CRE Corporations are researching how to attack the following:

    • Continuously evolving behavioral trends post COVID-19
    • Establishing more secure building spaces
    • Optimal efficiency
    • Improving in recognizing challenges, vulnerabilities, and risks at the early portfolio level

    CRE Corporations especially should be working extra hard to familiarize themselves with the results of this research as these are important trends that will likely impact the CRE market as a whole. Those who understand these trends will be able to provide their clients a better experience with access to this knowledge and, therefore, result in steady sales.

    Secondly (and in fact surprisingly), due to the pandemic, lockdowns have led more companies to have their employees working from home. While it may seem like there would be no use for office space in 2021, there are actually several opportunities in the CRE market for commercial offices that were not there before. Vacancies in high-traffic areas make this the perfect time for commercial owners who are looking to expand.

    While many businesses are still waiting to bring their employees back to the office, there are undoubtedly several good reasons for having an office in a post-COVID environment. In an office, employees have more space to work collaboratively, increasing cooperation and efficiency. CRE owners and investors would be wise to acknowledge the fact that even during the pandemic, there are still business owners out there looking for affordable office space and certainly have this in mind as they make their investment decisions this year.

    Finally, when it comes to e-commerce, an already growing sector prior to 2020, boomed during the pandemic [Forbes Real Estate Council]. In response, retail stores and third-party logistics businesses are not only growing or optimizing their fulfillment center footprints, but many of them are also switching from a “just-in-time” inventory model, to a “just-in-case” approach as they aim to prevent the shortages of goods encountered throughout 2020. As this trend continues, many online shops nationwide will need to lease a warehouse for their growing businesses. This will certainly lead to a steady increase in leasing opportunities in the CRE market that both owners and investors should take advantage of.