Meaning we expect a slowdown, as opposed to a collapse. A lot of my concern boils down more broadly to rates. If interest rates remain in this ballpark, lots and lots of things will squeak by. But if we see a rate spike, the real-estate market will face even more risk, and that will have a substantial impact on consumption. People's discretionary income will fall dramatically as the cost of keeping a roof over their head rises. Lastly -- and this is very important -- the discount rate that we as investors use, and particularly what private-equity firms use to calculate their beloved terminal value -- the present value of future cash flows -- will go up, and the terminal value will fall. The private-equity put that has been so valuable of late across industries will start to wither. And the leverage that private-equity firms and hedge funds use to support some of these valuations will also go away. A lot hinges on what happens with rates, and we don't see any immediate spike in rates. But that's the one thing that most concerns us.
This is a very important point. Private equity is very important to the stock market right now. When a private equity firm is looking at an acquisition, they perform an analysis that calculates what all of the expected future cash flows are worth in today's dollars. One of the variables in this calculation is interest rates.
I don't know what the break-even point of rates is, and it probably varies from deal to deal. However, as rates increase expect the number of deals to drop.
2 comments:
Do you see any hope for the Realtors figures on housing declines?
Looking grim at the over inflated prices of the last few years.
A lot of time is spent on the alpha versus beta debate but little consideration is given to another equally important but often ignored greek letter - rho or the sensitivity to changes in interest rates. Some San Diego business investors fund strategies have negative rho, that is depend on interest rates staying low. Ironically pension funds have positive rho as rising rates permit them to use a higher number to discount future liabilities. That can be a pyrrhic victory because on the asset side of the balance sheet their portfolios of stocks and bonds tend to fall in such times. It therefore makes sense for investors to diversify with OTHER strategies that tend to perform well in a RISING interest rate environment.
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