AMA - Is It A Deal?

This question is from Dan in Alberta Canada

I just put an apartment under contract and working through the DD.

It’s a 32 unit 4 storey for $50,000/door in a town with heavy reliance on the oil industry. At present the gross monthly revenues are 17k. The property was mismanaged and vacancy is 45%. The rest of the market has about 20% vacancy. Rents are now 20% less than the present market rents. In it’s peak days, gross rents were 60k.

I’m having mixed thoughts In these uncertain times... What are you suggesting?

1. Wait and see

2. Buy during these fearful times, as deals are best.

Dan this is a great question.

On the surface, when you look retrospectively, it looks like the property might be a deal. The purchase price is well below construction cost, and the market has delivered stronger performance at this property in the past. That’s all in the rear view mirror. We would both agree that driving a car using the rear view mirror alone for guidance is a recipe for disaster.

We are about to embark upon one of the largest economic slowdowns in our lifetime. The impact of this is unknown in many respects.

We don’t know what the credit markets will look like in 15 days or 30 days, let alone six months.

You mentioned that the local economy is driven by the oil industry. The oil industry is in the middle of a price war and the community that depends on oil production for its lifeblood will very quickly experience even greater reduction in workforce if prices remain anywhere near current levels. We’ve experienced a massive drop in global oil demand over the past two weeks which has caused prices to drop as stronger players aim to protect their income streams at the expense of weaker players. At a certain point with prices near levels we haven’t seen in over 20 years, these companies are losing money. The price of oil varies widely based on the cost of transportation. In places like Alberta where the transportation costs are high due to the lack of pipeline infrastructure, oil prices hit a low $7.23. Let’s let that number sink in for a moment. Even the OPEC price of $27.31 is at extremely low levels we haven’t seen in decades. So much of the global oil industry has been financed with debt. Many companies will end up defaulting on their debt and the stronger players hope that will result in a drop in supply.

If you don’t have an influx of population into the market, it’s hard to see how you’re going to implement a turnaround on this property in the current environment.

Making investment decisions requires a measure of certainty in the market conditions. There’s always a degree of risk in any market. But today we have so many risks that it’s virtually impossible to quantify the impact of each of the individually, and then in combination, it’s well above my analytic ability.

The key to answering this question. How long will this economic disruption last? The true answer is that nobody knows. There have been a few promising announcements that chloroquine, a 70 year old anti-malaria medication has been shown to be effective in treating patients with Covid-19. If that’s the case, and the clinical trials prove positive, we might be looking at a shorter period of economic disruption. That depends on whether this drug, or perhaps another, or a combination of drugs proves effective.

The chances are high that this situation will precipitate a credit crisis. Government backed loans only represent a small proportion of all lending activity. If there is a crisis in the private lending market, then we can expect a fall in asset prices just like we saw in 2008.

This particular building may be a deal, but I personally would advise you to be patient and continue to monitor the situation. You might find an even better deal in the weeks and months to come.