Paul having come from an environment that was focused on NAV (derived from capitalised NOI) we were always acutely aware that 25bps of compression at 4% was twice as valuable than 25bps at 8%. Taking it to the extreme, if we were at 20% yields it would be bizarre to be buying at the same spread. The lack of increased threshold / spread as acquisition yields moved up has surprised me.
That said my perspective that balances this is that RE acquired at higher cap rates will more likely see a greater % of the total return generated from compression than RE purchased at lower cap rates. (This assumes the owner trades some portion of the portfolio in some way or form). It will also benefit (typically) from higher escalation rates. The "excess rental escalation" which compounds through the long lease would provide an uplift to value which is exaggerated as yields compress.
If mathematically this sufficiently balances out the lack of additional spread sought at higher yields Im not sure.
Those things you mention do add risk, of course. Compression is not guaranteed on any timescale. And escalators are not guaranteed either. It seems to me that valuing escalators in particular is tricky.
As to balance or not, perhaps sometime I will think about hat.
"others costs 5% of NOI" .. I assume your experience tells you this is typical for NNN Reits. I did not know this was the number. Does it vary much REIT to REIT? Which properties tend to be higher in the range? I struggle with the transition of the equations to your graphs / tables sometimes.. These are simple equations and graphs are well done so perhaps I'm just getting too old...
5% of NOI is a reasonable cost for a large NNN RIET. It will be larger for smaller ones. You can see how that cost has dropped with size for ADC in my recent article on them. REITs in other subsectors encounter additional costs for maintenance capex, tenant replacement, and sometimes other items. These often run near 10% of NOI but can at times be quite a bit larger, especially for office.
As to the equations and the graphs, there is a balance between explaining every detail and boring readers who are not interested. Sometimes the math/graphic connection is clearly drawn but other times (e.g., AFFO/sh here) a few words encompass quite a bit of thinking and calculating.
Paul, I am not going to lie, I struggled for a long time following some of your tables and spreadsheets. But I diligently read, and reread many of your old articles looking for where you explained different concepts. Now I feel I have the concepts down and I can follow your articles quickly enough although sometimes I still struggle. Ultimately, it made me a better investor.
Paul having come from an environment that was focused on NAV (derived from capitalised NOI) we were always acutely aware that 25bps of compression at 4% was twice as valuable than 25bps at 8%. Taking it to the extreme, if we were at 20% yields it would be bizarre to be buying at the same spread. The lack of increased threshold / spread as acquisition yields moved up has surprised me.
That said my perspective that balances this is that RE acquired at higher cap rates will more likely see a greater % of the total return generated from compression than RE purchased at lower cap rates. (This assumes the owner trades some portion of the portfolio in some way or form). It will also benefit (typically) from higher escalation rates. The "excess rental escalation" which compounds through the long lease would provide an uplift to value which is exaggerated as yields compress.
If mathematically this sufficiently balances out the lack of additional spread sought at higher yields Im not sure.
That is really interesting, PJ. Thanks.
Those things you mention do add risk, of course. Compression is not guaranteed on any timescale. And escalators are not guaranteed either. It seems to me that valuing escalators in particular is tricky.
As to balance or not, perhaps sometime I will think about hat.
Very clever analysis. This is worth finding a way to be published on a much broader scale than Substack.
"others costs 5% of NOI" .. I assume your experience tells you this is typical for NNN Reits. I did not know this was the number. Does it vary much REIT to REIT? Which properties tend to be higher in the range? I struggle with the transition of the equations to your graphs / tables sometimes.. These are simple equations and graphs are well done so perhaps I'm just getting too old...
5% of NOI is a reasonable cost for a large NNN RIET. It will be larger for smaller ones. You can see how that cost has dropped with size for ADC in my recent article on them. REITs in other subsectors encounter additional costs for maintenance capex, tenant replacement, and sometimes other items. These often run near 10% of NOI but can at times be quite a bit larger, especially for office.
As to the equations and the graphs, there is a balance between explaining every detail and boring readers who are not interested. Sometimes the math/graphic connection is clearly drawn but other times (e.g., AFFO/sh here) a few words encompass quite a bit of thinking and calculating.
Paul, I am not going to lie, I struggled for a long time following some of your tables and spreadsheets. But I diligently read, and reread many of your old articles looking for where you explained different concepts. Now I feel I have the concepts down and I can follow your articles quickly enough although sometimes I still struggle. Ultimately, it made me a better investor.
Oh definitely! I often have to re-read the equations. Not easy! I think of it as an opportunity to exercise my brain now that I'm in my 60's