Castleforge
A Basis for Value
May 20, 2021 by castleforgedev
Howard Marks is worried that value investors have lost the plot. In his January 2021 memo, "Something of Value", he writes that their obsession with cheapness—or more specifically, with a naïve definition of cheapness—has confounded their ability to spot genuine value. This focus on "cheap" as a byword for "value" above all else has arguably produced some nasty results. For example, according to Morningstar, large-cap value funds underperformed large-cap growth funds by 32% last year, in their fourth straight year of underperformance. That underperformance has made many value investors question whether something has fundamentally changed.
Marks traces value investors' woes to what he dubs the "false dichotomy of value and growth" or the idea that there is a sharp delineation between the two. He argues that value investors must abandon this false separation and consider intangible traits too, like competitive advantage, economic moat, and long term potential for earnings growth. Broad structural trends relating to macroeconomics, demographics, or technology also weigh heavily on investment returns in the long run, and investors who simply focus on firm-specific fundamentals may miss the forest for the trees. According to Marks, "successful investing has to be more about superior judgments concerning (a) qualitative, non- computable factors and (b) how things are likely to unfold in the future." In other words, they must also study the big maps.
We think that's absolutely right.
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A Future for Offices
June 22, 2020 by castleforgedev
"We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten. Don't let yourself be lulled into inaction." – Bill Gates
Another day, another article announcing the end of demand for office space. A couple weeks ago, it was a piece in the Wall Street Journal entitled "When It's Time to Go Back to the Office, Will It Still Be There?" It outlined a reduced number of offices in big city centres and covered the idea that employees will demand more hybrid schedules "that allow workers to stay home part of the week." This would lead to reduced demand for offices as employees would make use of other spaces, including the home, to carry out their work. Countless other similar articles have appeared over the past month or two, as companies try to understand what a post-Covid-19 world might look like, at least from a workplace perspective:
"How Your Company Office Could Change in the Post-Coronavirus Era" from CNBC
"The End of the Office?" from the FT
"Will Coronavirus Spell the End of the Traditional Office Working Space" from the Telegraph
The list goes on. In this respect, some investors we've spoken to over the past month have likened investing in city centre offices to investing in shopping malls and retail warehouse parks in 2014-2016. Back then, buyers thought they saw merely a cyclical adjustment to cap rates but they missed the underlying structural changes to the industry that were happening as increasing e-commerce penetration led to a reduced need for physical retail. Those who failed to understand the structural change happening in the retail space paid the price by investing into value traps that were cheap for a reason. And while the jury still seems to be out on the office market, we would be remiss if we did not even consider the potential that our biggest sector of focus is about to go the way of the regional shopping mall. The truth is, in the aggregate, we do believe it is very possible that overall demand for office space falls – or, at least, it falls for the ways we typically use office space today. The extent to which this occurs depends on whether:
reducing office square footage and replacing it with remote working saps productivity;
the cost of office space is so high that companies will choose to meaningfully reduce square footage, even after weighing these savings against expected productivity losses; and
an alternative form of office space demand takes its place, that is more productive than working from home, yet still allows for material cost savings to firms.
Anyone who has recently spent extended time at home with roommates, in-laws or a crying baby can attest to the fact that while the office may not be perfect, neither is working from home. As a consequence, we believe even a structural fall in aggregate office space demand will not necessarily impact all types of office space and all geographies equally. In fact, we see the arguments for a fall in office demand leading toward higher relative demand for other, newer ways of using office space. Covid-19 appears to have accelerated a trend that was already happening up to early 2020 – the more efficient use of office space provided by flexible office operators. Given these dynamics, we think an office investor who wants to be well-positioned to weather the structural changes that are likely to affect the office markets over the coming decade should hedge her exposure by getting involved in flexible office operations. The irony – and the opportunity – is that the public implosion of many of the well-known flexible office providers, like WeWork, is going to result in a slowdown in the addition to supply of flexible offices due to hesitancy from debt and equity capital, over the same period in which tenants increase their demand for the product.
Incentives Matter: A WeWork Update
November 1, 2019 by castleforgedev
Our readers will know that we have been covering the WeWork story for a number of years now and that we have been sceptical, at least to the extent that WeWork's business model was a poor bargain for landlords and likely obscured a reduction in net absorption in central London that would have otherwise led to greater rental declines than we saw. So, the company's tribulations over the past few months came as no great surprise to us. We have, however, lived in England long enough so that you won't see us standing next to a huge "Mission Accomplished" banner. But if we were being slightly truer to our country of origin, the shameless victory lap would go right here.
There was certainly one thing that came as a surprise. We did not expect the "how" and "why" to it all falling apart to have been so self-inflicted. Some journalists have used the term "Death by S-1" – hurrah, the public markets work! WeWork's senior management and founders have been exposed for the jumble of conflicts of interest, self-dealing, lack of effective oversight and potential cases of fraud that plagued the company. And while these conflicts and mismanagement alone probably didn't bring the company down, they did bring to the fore a discussion on WeWork that highlighted some real risks, such as nearly $50 billion in future lease obligations, negative EBITDA and stalling growth.
London Serviced Offices
September 20, 2017 by castleforgedev
History never repeats itself exactly, but we often experience echoes of history where the characters are the same, even if the actors change. It is therefore often helpful to draw parallels to previous market cycles as a way to help us understand what may be happening now. For the London office market, we think we need look no further than the run-up to 2007.
There are three major players in today's real estate world that seem to us disturbingly similar to the three major players involved in the CMBS debacle only a decade earlier. First, serviced office providers such as WeWork, cast as the part of the very highly leveraged property owner; second, the London property developer, in the supporting role as the international investment bank; and third, the yield-obsessed investor as…well…the yield-obsessed investor.
U.K. Planning System Pitfalls and Opportunities
July 24, 2017 by castleforgedev
Given the substantial attention dedicated to a market update at our recent Annual Meeting, we thought that rather than a letter about the market, it would be more interesting to put together a one-off discussion piece focused on the U.K. planning system.
It has occurred to us that planning risk can act as a blind spot for some investors who are not as familiar with the U.K. system. When these investors use heuristics from other markets or work with a partial understanding of U.K. idiosyncrasies only, they risk investing in projects where the risk profile is misunderstood and inappropriately priced. They may also avoid areas that present a considerable opportunity due to greater planning-related supply constraints than would have otherwise been assumed. Therefore, it is a useful exercise to run through a brief summary of the U.K. planning system and identify some areas where pitfalls and opportunities are created. For those of you who would like a more market- focused update, we will follow on with one of these in the near future and are available for direct discussion in the interim.
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