Yield and Risk Management in Uncertain Times

Our first quarter 2016 update highlighted the challenge of capturing yield in the post-financial-crisis world.  As the second quarter unfolded, this challenge became more difficult.  Global interest rates continued to trend lower reflecting geopolitical event risk and global growth concerns.  Brexit in itself changes the political dynamic in the Eurozone, and the subsequent acknowledgement of widespread weakness in the Italian banking sector and election uncertainties in Spain add to the turmoil.  These events in the Eurozone are compounded by continued conflict in the Middle East, political issues in Brazil and ongoing weakness in many other markets.  As highlighted by a number of market observers, these events have all contributed to an interest rate environment that is unprecedented (see graph[i]): of the $33 trillion of outstanding G10 Sovereign Debt, 41% is negative yielding, 83% below a 1% yield and 96% below a 2% yield.[ii]

Sovereign 10 Year Yields Over Time

Popular investment themes early in the global recovery – if anemic growth since the depths of the financial crisis can be described as such – have lost luster.  “Bargain hunting” in Europe has proven to be anything but as equity markets and asset prices have declined.  Emerging markets’ economic and market performance have sputtered, as has performance in Japan. Although quantitative easing and monetary policy have become the economic planning tools of choice around the world, the efficacy of these actions is being called into question.  With so much liquidity globally, and with asset prices reflecting this excess liquidity, many markets seem to be valued above fundamental levels.

 

In this context, we continue to believe that the US markets remain attractive overall, and that selective US asset classes offer meaningful opportunity.  Recent global capital flows into the US demonstrate this.  It is rare that the US, a traditional safe haven, is also imbued with growth characteristics.  Commercial real estate (“CRE”) is among the most attractive asset classes in the US.  The fundamental dynamics of some real estate verticals remain strong, with supply and demand in balance and lending restrained by regulation and caution on the part of balance sheet lenders.  Having said that, some real estate assets are manifesting the overabundance of capital chasing investments.  Core assets appear fully valued (unless the US joins the 41% of G10 sovereigns which have a negative interest rate environment) and new supply in some sectors may overwhelm demand, at least in the near term (we are particularly cautious about luxury multifamily in gateway cities; whether in New York, San Francisco, or even Atlanta or Austin, construction cranes dominate the skyline, and projected rents for newly-built units are higher than the average resident can afford).

Investors always have a choice, but choices are constrained today given the state of global affairs.  In an environment characterized by low and declining global growth, ongoing quantitative easing and a structural low-interest-rate environment, we believe risks outweigh rewards in many asset classes.  We believe the benefits of a specialized focus which attempts to discern and invest in those sectors with the strongest fundamentals allow Bridge to find opportunities that deliver yield and capital appreciation underpinned by solid demographic trends.  Fully conscious that we are “talking our book,” we highlight selected verticals within US real estate which we believe offer meaningful opportunity:

Middle-Class Multifamily:  We anticipate continued growth of the renter class, with 575,000 to 600,000 new multifamily renter households projected per year through 2024[i] and constrained supply of “middle class housing.”  We focus on assets available in secondary cities projecting strong population growth and household formation, generally at cap rates of 6.0x and above.

Seniors Housing:  We are seeing a dramatic increase in elders coupled with redefined expectations for quality of life and wellness in later years.  900,000 baby boomers are projected to turn 75 each year for the next 15 years.[ii]  We believe value-add assets in Seniors Housing, in targeted markets exhibiting the right characteristics, offer solid investment returns comprised of yield and capital appreciation, for those owners who can maximize value.

Fixed Income:  Our “directly negotiated” opportunities in debt strategies, by virtue of relationships, focus and illiquidity, can potentially achieve DOUBLE DIGIT YIELDS with carefully managed risk.

Bridge is well-placed to source attractive returns and manage risk in this environment.  We have an established national platform of over 1000 professionals, allowing us to fully leverage our specialized focus on selected core sectors.  We field specialized teams with significant experience focused on generating extraordinary deal flow across our verticals.

I wanted to take this opportunity to highlight key performance and growth metrics for Bridge during Q2.  We are now well over $5 billion USD AUM and most of our latest investment offerings are well over-subscribed.  We limit the size of our investments to manage prudently – in keeping with our consistent strategy of limiting capital to an amount we can deploy in assets that are thoroughly underwritten and offer the value-added returns that we seek.  We are highly selective in what we acquire:  in 2015, we reviewed over 7,000 assets to find the 25 or so that met our strict criteria.  Many of our existing portfolio assets are significantly better than projections.

On the fixed income side, we continually have investment opportunities in the Freddie Mac portfolio purchases, which have performed very well for our investors, providing current income, a stabilized yield, and quarterly cash distributions. In fact, Bridge is a “preferred purchaser” and trusted partner with Freddie Mac and, from 2014 until 2016 YTD, has been awarded eight K-Series investments overall.

We continue to build out the team as we grow our platform prudently.  We added senior resources in our asset teams, our fund management infrastructure and in the capital markets group, to name a few of our recent hires.  We continue to find excellent candidates who are excited to join our growing organization, and the new perspectives they bring add meaningfully to our capabilities.

We thank you for your continued support and engagement.  We would be delighted to discuss further the items touched upon in this update, your specific investment objectives and concerns, and how our firm might assist you in achieving your objectives.

With Warm Regards,

Robert Morse

Chairman

[i]Bloomberg

[ii] View From the Coast, July 7th 2016, www.vftc20.com

US Census Bureau, Mortgage Bankers Association, Fannie Mae

[iv] US Census Bureau

[v] No assurance can be given that we will continue to identify and be awarded such opportunities or that RDS II will satisfy its investment objectives.

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