Margin of Safety: Navigating Market Volatility

If you spend any amount of time researching private real estate investment opportunities, you will come across the industry standard sensitivity tableProjected returns based on a variety of outcomes such as rent decreases, cap rates, occupancy. The objective is to present the reader/potential investor some level of comfort that in a downside scenario, “capital is still protected”.

In reality, bull markets paper over most underwriting mistakes. Negative surprises on any individual investment can be overlooked by broad market growth. Even properties with little margin of safety may still produce healthy returns initially despite underperforming the initial projections.

In any investment scenario, the baseline assumption is that the capital markets are functioning: Leases are still occurring, credit is available, etc. But for brief periods of time in the financial markets, that is not the case. It no longer matters whether rents are 10% less than expectations if your loan comes due and you cannot find a replacement lender or if a handful of tenants go bankrupt and you are not sufficiently well-capitalized to hold the asset through a period of disruption.

This is why we place such a significant emphasis on the margin of safety. The “what if we’re wrong” aspect of underwriting is where we start and “what if it goes according to plan” is where we finish.

Properties that generate cash flow from strong tenants are less susceptible to refinance risk and reduce the exposure to residual values and cap rate volatility. 

Conservative property-level leverage means a higher likelihood of being able to refinance, if necessary, during adverse market conditions. Long-term, fixed rate financing means holding through periods of extreme distress.

Despite the considerable effect of the Covid-19 pandemic on the broader economy, our portfolio performance has yet to be materially impacted. This is in large part attributable to our adherence to our investment criteria:

  • Institutional quality buildings
  • Creditworthy tenants
  • Conservative leverage.

All our tenants are current on their rent payments, and we are servicing our debt and intend to continue regular dividends.

Streitwise is focused on providing institutional-quality office buildings with conservative leverage to withstand near to medium term downturns while generating cash flow over the long term. These are just some of the factors behind why the Motley Fool rated Streitwise as the best real estate investing service for conservative investors in 2020.