Frankly Speaking: The Discipline of Value Investing vs. Investing in Cyclical Trends

Clearly, the commercial real estate market, like any other market, is one that experiences cyclical trends. There will be strong moments with properties valuing at higher than average rates, and on the flip side, there will be moments in the commercial market in which properties will be valuing weak. Many times these peaks and valleys are inspired by the trends of the greater economy. Now with bringing this topic up, by no means do I want to say that those operating in the commercial real estate industry should not have an understanding of the fundamentals behind cyclical trends. Understanding why a commercial real estate market experiences a peak and why it experiences a dip is absolutely essential in order to succeed in the business, and, personally, after operating in the commercial real estate business for more than ten years and forming my own commercial real estate investment firm – the Calgary-based Arlington Street Investments – I know very intimately how crucial a greater understanding of the market is.

But, there is a very significant distinction between understanding the reasons behind the trends in a market and basing investment decisions almost exclusively on this understanding. Highlighting the difference between these two separate modes of thought I think is extremely crucial.

At my firm, we have a well-rooted and experienced understanding of peak to trough cycles. This understanding is of course incorporated in our investment model and strategy. But, the major point is that this understanding does not form the basis of our investment choices and it does not form the basis of our investment strategy either.
No, we have an investment strategy that I’d like to think has a far more sound base of reasoning. What we do, very simply, is look for property assets that will provide strong cash flow for our firm and our investors and, at the same time, will provide a strong markup in valuation after redevelopment of the property or, as the case may be, a rezoning, increased densification and/or ultimately a repositioning of the property. Of course, the devil is in the details, and understanding which properties will provide strong value-added propositions and understanding how to best develop or redevelop our property assets are questions that take the experienced and talented minds of my project team to answer. But, our core investment strategy is actually very simple and we always hope that it makes commonsense to our investors.

Now, of course there may very well be commercial real estate investment firms out there that base the fundamentals of their investment strategy around the cyclical patterns of the real estate market. But, personally, I’ve always considered such an investment strategy to be highly questionable and, in a hypothetical scenario, as a leader of a firm that used such an investment model, I know I would become very frustrated at the limited control and disproportionately increased risk such a strategy would provide. After all, yes, you may be able to accurately predict the trends of the market. But, market trends are ultimately outside of one’s control, which means the times and situations in which you can act on your investment is also limited and outside of your control. That’s definitely not ideal.

A value-added investment philosophy, such as the one promoted at my firm, not only increases the amount of control a firm has over their investments, it also, in my mind, creates a more stable, more shielded base of investment. And although we have had several projects that demonstrated Arlington’s disciplined investment strategy, a very good and recent project, as an example would be our 8th Avenue Limited Partnership property. What we did in this project was find a languishing, building in a high-growth area in the downtown part of Calgary and took advantage of its investment potential through a major redevelopment of the building. It was a tremendously exciting project and it makes us very proud to know that our 8th Avenue Limited Partnership project has earned the admiration and respect from the greater investment industry. Most recently, Arlington Street Investments was awarded the 2013 Commercial Real Estate Deal of the Year by the Exempt Market Dealers Association of Canada, as a direct result of our accomplishment on this project, an award that I’m very proud to have my firm’s name and my own, Frank Lonardelli, associated with.

The success Arlington Street has had on our last three projects over the past 2 years including our 8th Avenue Limited project reaffirms my belief in the soundness of our value-added investment strategy and my firm and I continue to look forward to applying this same investment strategy to larger, more expansive commercial projects in the near future. Especially as we are preparing to launch two more projects with the possibility of a third before year end 2014.