Dear Investors,
There is a storm coming for the economy. The world is different now than it was a year ago, and it’s never going back. This is the environment Nectar was created for.
We are in a period where our financing is in very high demand and where we are generating particularly attractive returns relative to the risk we are taking. We are playing a crucial function in the market for our borrowers.
Before talking about Nectar’s positioning, let’s discuss what is going on in the market.
Why do we think a storm is coming
By now, everyone has read the headlines about tariffs. While tariffs have been dominating headlines and public market movements for the past several weeks, we believe tariffs are a symptom of de-globilization, not the cause. Major importers of product or labor from abroad are currently figuring out how to become less exposed to global trade. This trend began during the pandemic and is accelerating. It is inflationary, which means pricing will go up and consumption will go down.
Uncertainty is a dominant theme in the market. Tariffs are one cause, however, the path of interest rates, changing geopolitical alliances, the very high US debt burden, and disruptive technological and climate changes are all contributing factors. This makes capital allocators more conservative and makes capital more scarce.
When costs go up quickly in the form of interest rates and taxes (tariffs), while productivity and economic activity from trade goes down, that has caused recessions in the past. This time may be different, but Nectar is not going to make that bet. We are preparing ourselves for an economic storm.
How will an economic storm impact our market
The practical and immediate impact of the current economic conditions on real estate are predictable, long term impacts are less so. Let’s start with impacts we are confident in.
1. It will be more expensive to build and rehab properties.
Tariffs immediately make it more expensive to buy materials. This has an outsized impact on rehab and new construction projects. 27% of our construction materials come from China, which is likely to remain at the center of the tariff war.
Further, labor costs are expected to rise, largely driven by the immigration policies of the current administration. It’s estimated that 13% of construction workers are undocumented immigrants and immigrant labor can be as high as 40% in some booming markets like Texas. As those workers are removed from the construction workforce, it puts even more strain on the existing labor pool.
These two primary forces, increases to material and labor costs, will push the cost of building higher. In the short term, operators who own construction projects are likely to see cost overruns. Further, projects that have yet to begin may get canceled or significantly altered to account for expected cost increases.
2. It will be more expensive to operate properties, particularly ones that haven’t been recently renovated.
Rising cost of materials and labor don’t only impact construction and rehab projects. They will also make it more expensive to operate properties, particularly ones that have older systems and appliances that need periodic maintenance and replacements.
In the longer term, newly renovated or constructed properties completed before tariffs will have nicer units. They will also be at a price point that new supply cannot compete with given post-tariff input costs. Pre-tariff newly renovated and constructed properties will also have an operating cost advantage as they will not have to replace and maintain older, foreign-made parts.
3. Capital will be more scarce.
The uncertainty caused by tariffs will make investors and lenders more conservative. It is not clear whether interest rates will go down (if the economy slows, for instance) or up (if people are worried about a US debt default or inflation) long term. But either way, the uncertainty will make capital more scarce at a time when capital needs will be higher because input costs are higher.
4. Some markets will be more resilient than others.
Some sectors will be hit harder than others, and this will impact occupancy and rent levels. This is where there is the most uncertainty. We think areas that have a dependence on oil employers or retail workers will be hit harder as decreased trade decreases demand for their products. We believe that properties near data centers, manufacturing centers, and urban areas with diversified economies will be more resilient. However, we have the least amount of conviction on where impacts will be felt the most, and we will be paying attention to the data.
How Nectar will meet the moment
The current environment involves more risk than the commercial real estate market has endured in many years, potentially since the Great Recession. Nectar is particularly well structured and prepared for this environment. Here is how we will capitalize on it.
We will maintain our standards.
We only invest in low-leverage, cash-flowing assets with long-term, fixed-rate debt. We have seen our inbound pipeline increase every quarter for a year, and we expect this trend to accelerate. This influx of demand has allowed us to improve our credit quality and portfolio metrics quarter after quarter. This will be a core area of continued focus. We will not take construction risk, asset price appreciation risk, or refinance risk. As demand increases for our product and we deploy more capital, we will maintain discipline.
We will focus on assets that have been recently built or renovated.
As mentioned earlier, recently renovated properties already have materials that can no longer be acquired at the same cost basis. Newer systems and appliances will have lower maintenance costs and leave less room to be impacted by inflationary pressures. We believe over the next several years, recently renovated properties will have a bigger and bigger advantage as it becomes more costly for new properties to compete with them. They should have pricing power in a market with reduced supply, and they should have a higher ability to control cost in a market that doesn’t have cheap, imported materials. We will focus our origination efforts on these recently built or renovated properties.
We will identify tariff-resistant sectors and avoid large concentrations.
The impact of a slowdown in global trade will have an uneven impact on renters and markets. We will do our best to predict resilient markets, but this is a very hard thing to predict. Instead of putting a lot of faith in our ability to predict future performance, we will focus on diversification. We are currently in 29 states. We will continue to invest small amounts in various markets to ensure that no one deal or market has an outsized impact on our overall portfolio.
We will continue to invest in great sponsors.
The best owners and operators know their markets incredibly well. They are aggressive about adopting technology and positioning their portfolios and businesses for the future. This environment will produce many opportunities for forward-looking and prudent real estate investors. We believe these people are the key to creating capacity for a more healthy housing market in the future. We will partner with these sponsors to weather the challenges and capitalize on the opportunities inherent in a dynamic and challenging market.
Looking ahead
We don’t know exactly what the future holds, but our mission of providing flexible capital to owners of low-leverage, cash-flowing apartments has never been more important. We will continue to be deliberate about protecting our invested capital and we will continue to deploy into the great opportunities that we are seeing in the market.
If you have any further questions regarding how Nectar is approaching the current environment, I’d be happy to speak with you. We will be hosting our quarterly Investor Town Hall in late April (more details to come), or you can schedule a call directly with us here.
Derrick Barker
Co-Founder and CEO, Nectar
