Just Who Is Marcel Arsenault?
Look Out Below
Back in the late 1980s, Marcel was a hippy/entrepreneur in the Ben & Jerry mold who had spent the previous decade mixing up vats of Mountain High yogurt, eventually turning the brand into one of the most popular in the West and selling it Beatrice Foods for a nice profit. He then started buying up Colorado real estate. “I couldn’t have picked a worse time,” he says now. The junk bond implosion was metastasizing into the S&L collapse, and the value of office buildings and shopping malls was plunging.
But he held on, and in a couple of years was rewarded with the mother of all fire sales. The government began liquidating the assets it had acquired from failed thrifts, and prime properties were suddenly available for pennies on the dollar. Marcel loaded up on empty office buildings and leased them out for a fraction of the going rate—possible because of the low purchase price. The buildings filled up, their values rose, and he leveraged their cash flow to buy more offices, shopping malls and condos. As western real estate values soared, so did Colorado Santa Fe’s portfolio. It now manages upwards of $350 million of property and is sitting on well over $100 million of unrealized capital gains.
In other words, this is a guy who has prospered in both good and bad real estate markets, which makes his current take worth noting. And right now he’s excited—about the prospect of another 1990-style crash. Below are some excerpts from the previously mentioned report. The capitalized headings and italicized comments are mine, the rest is Marcel’s. As your read this, keep in mind that it’s the analysis of someone who for the past fifteen years has been very successfully LONG real estate.
THE BIG PICTURE
We believe that the apparent ‘irrational exuberance’ in the real estate market is, in reality, an asset bubble that has been inflated by a flood of capital attracted to real estate. The effect of this flood has been to drive down yields and push up prices. We believe this value trend is unsustainable and that we are at a crucial inflection point. Based on the analysis detailed below, we believe that cap rates will inevitably rise back to trend (and possibly overshoot), thus driving values down dramatically.
HOW WE GOT HERE
Phase I: Stimulus through Monetary Easing. Following the recession and 9-11, the U.S. Federal Reserve implemented monetary easing to a degree not seen in almost 50 years. Cheap money and credit flooded the U.S. economy in an effort to prevent a serious recession (which had the risk of turning deflationary like Japan’s). The lax monetary policy had the intended effect of stimulating consumer spending (particularly on assets like homes and real estate).
Phase II: Illusion Becomes Reality. By 2003, prices of real estate began rising faster than the rate of inflation. In effect, investors began noticing how “profitable” it was to accumulate real assets. Rising prices created a “virtuous cycle” whereby more and more buyers participated in the equation of purchasing real estate. While admittedly rising prices were driving down yields, few cared about yield because the Fed was not rewarding saving. The preferred game was appreciation.
Phase III: Lenders “Pile In” (the final period of play). Given a few years of rising prices, real estate began looking very safe; low rates made the cost of debt very manageable, justifying higher prices and larger loans. By 2005 real estate lending was extraordinarily competitive, (after all, default rates were at historic lows). By 2006, cheap and easy mortgages had grown to epic proportions throughout the real estate industry. “No money down” became the way to purchase a home. Foreign and hedge fund capital poured into mortgage markets chasing yields of the “risky” tranches of mortgage paper (why settle for the 5% yield of “A tranche” if the risky “B tranche” yielded at 8-10%?) With rising property values, the “B tranches” were soon re-rated to “A”, rewarding the buyers with phenomenal appreciation in their mortgage paper. Mortgages become more plentiful and the tide of easy money rises into uncharted territory, and bringing real estate values even closer to rocky shores hidden beneath a tidal flood.
Phase IV: Inflection Point Achieved (the cost of money rises). Satisfied that it had prevented a serious deflationary recession, by June 2004 the Federal Reserve begins to slowly increase rates. By 2006, the Fed Rate had increased from 1% to 4.5% (the “neutral rate” – not deemed excessively simulative by economists). With yields this high, it again makes sense to hold cash at the bank. By 2006, the cost of mortgage debt is returning to the long term average.
THE NEXT FEW YEARS
Phase V: - The Future: Look Out Below. The problem becomes obvious and virulent when real estate values begin to fall. With debt service costs rising, real estate begins to flounder, and more risky real estate ends up on the rocks. As default rates rise, mortgages slowly become more expensive and difficult to obtain (“real estate becomes a four letter word” in the parlance of an old banker). Only brave and knowledgeable entrepreneurs venture onto the scene of real estate wreckage at the lowest tide. Only a “foolhardy lender” would venture between the rocks of the now quiet ebb tide.
The “virtuous cycle” has completed its turn into the “vicious cycle.”
The piece includes a report by Mr. Arsenault with an interesting conclusion, he plans to liquidate most of his real estate investments.