Letter to investors
In his most recent “Eye on the Market” investment letter, JP Morgan’s Chief Investment Officer Michael Cembalest shares pessimistic thoughts of investments past but ends with a glimmer of hope for investors.
“If actual Wall Street and oil industry misdeeds did not exist, politicians would have to invent them, so as to distract the public from what they have created, a leviathan of poorly disclosed obligations, which are 10 times the cost of all wars since the American Revolution,” Cembalest wrote.
Failure: staying invested in commercial real estate
Like most investors, JPMorgan was hit hard by the commercial real estate collapse, and BusinessInsider reports that in total, US banks will subsequently take a $160 billion hit. Cembalest says failure to get out of commercial real estate was one of his biggest mistakes.
Cembalest wrote, “what stings in hindsight, at least in our own experience, are the prices paid for properties, rather than the quality, location or long-run viability of the properties themselves. Among the decisions I would make differently if I could turn back time: an earlier and larger exit from commercial property tops the list.”
Perhaps a silver lining?
The investment letter outlines that bargains were found after the crash, perhaps the silver lining in JP Morgan and others’ losses.
“Since the onset of the recession, we have been opportunistically adding exposure to commercial real estate through distressed property funds, mezzanine financing and commercial mortgage backed securities. To be clear, there are plenty of impaired properties after the construction boom shown on the prior page; but there are just as many valuable ones that are simply over-leveraged, or held by banks that need to shrink their exposure to the sector,” Cembalest informed.
Time to get back into commercial real estate?
Because of the deals and asset values, Cembalest advises it might be time to get back to the business of commercial real estate investment. “As we look forward to where we go from here, most of our managers benefit from two things. First, they did not use leverage at both the fund and property level, which mitigated the severity of the decline in Net Asset Values. Second, many portfolios retain the benefit of extremely low-cost, long-maturity, non-recourse funding that was borrowed during the credit bubble. The terms and conditions of this financing are often irreplaceable, and as rents stabilize, should contribute to the recovery in NAVs, an effect we are already witnessing over the last two quarters.”
He continues, “there’s less new construction to impede a recovery, and prices have been marked down to reflect a new era of cautious underwriting, slower GDP growth and less demand for space. The new realities of the commercial property markets have finally arrived; while they are painful for existing (pre-crisis) holders, they are more promising for new ones.”