“History does not repeat itself, but it rhymes” is probably the most famous thing that Samuel Clemens (aka Mark Twain) didn’t actually say. Despite the oft-misattributed nature of the above quote, its a typically a good description of recessions: they aren’t exactly the same but they do tend to share similar characteristics. That being said, this time is proving to be more than a bit out of tune. Past recessions have resulted from a build up in leverage or inventory that weighs on the economy when growth slows but the cost of those buildups in debt and inventory eat away at margins. This time around we were blindsided by black swan event, resulting in an instant crash where valuations were elevated but leverage was not crazy and inventory was normal. Take a look at today’s Chart of the Day for perspective.
One thing that happens in every downturn is that we are forced to look at different ways stress our assumptions on business and investment performance. During a prolonged expansion, its fairly easy to become complacent and continue looking at the underwriting scenarios that would have been the most predictive of poor asset performance during the last downturn. From revenue impairment to cost and fee inflation to cap rate expansion, we keep close tabs on these variables on every opportunity that we look at.
This recession is shedding light on a new and frightening metric that has not really shown up in the past as it is representative of the end-of-the-world/everyone-is-fucked anyway scenario that had previously seemed extremely far fetched. The metric that I’m speaking of has not been christened but it is the number of days a company can stay solvent at zero revenue. I came across this while listening to an interview with Gavin Baker of Atreides Management on the Investor Field Guide podcast. Since no one has come up with a better moniker (at least that I’m aware of), I’ll start calling it the Bloodletting Test since it reminds me of a medieval doctor emptying a body of its blood as a “cure” to diseases ranging from plague to smallpox (irony given our current situation noted). The scary thing is that most every business fails this test pretty quickly since a relatively high portion of costs are fixed (ie rent, financed capital items and software) and can’t be easily scaled down when revenue drops to zero. To put this into perspective, here is a chart that shows how long small businesses think that they could survive if sales stopped completely.
We are truly in uncharted territory here. This is not something that had ever been contemplated before, and really for good reason. Most businesses are accustomed to downturns where they have to scale for 20%, 30% or even 50% drops in revenue. Real estate investors are accustomed to doing the same since those aforementioned businesses are their tenants. Sometimes that results in a business that can’t control costs failing, but its never been reasonable to assume that nearly all of them do so at once. The stark reality is that no one can scale to zero revenue. Its just not possible in a modern economy that is designed to run on the velocity of money. The best that you can hope for is to have enough cash on hand to ride out the (hopefully brief) storm. Unfortunately, the bloodletting test is now a metric that we are going to encounter more regularly and it will undoubtedly impact asset values.
What I’m Reading
Emerging Issues: The mounting fiscal costs and humanitarian consequences of coronavirus could result a wave of sovereign defaults in emerging markets.
This Will End in Tears: Mark Calabria, the director of the FHFA has come out and said that mortgage deferral is ‘on the honor system’ and is asking borrowers to be honest. This will work out great because, if there is one thing that I know about human nature its that absolutely no one will take advantage of this sort of situation. See Also: The FHFA is warning that coronavirus related defaults could possibly give rise to a greater number of delinquencies than the subprime bust.
Thoughts and Prayers: SoftBank finally pulled their agreement to buy $3 billion of WeWork stock and Adam Neumann is now no longer a billionaire.
Domino Effect: Landlords are going to have to think twice before granting rent concessions. Some loan documents and joint venture agreements restrict amendments impacting financial components of leases such as rent amounts.
Muni-Massacre: As markets plunged, perhaps no investment flipped from coveted haven to spurned hot potato as quickly as municipal bonds. However, the problem has been building for decades as a high degree of concentration among large managers and an insatiable appetite for yield pushed muni investors into risky projects like charter schools and nursing homes and even shopping centers.
Rational Actors: Most people assume that the toilet paper shortages being experienced across America are being driven by hoarding. However, there is a simpler explanation that has gone largely overlooked:
In short, the toilet paper industry is split into two, largely separate markets: commercial and consumer. The pandemic has shifted the lion’s share of demand to the latter. People actually do need to buy significantly more toilet paper during the pandemic — not because they’re making more trips to the bathroom, but because they’re making more of them at home. With some 75% of the U.S. population under stay-at-home orders, Americans are no longer using the restrooms at their workplace, in schools, at restaurants, at hotels, or in airports.
Georgia-Pacific, a leading toilet paper manufacturer based in Atlanta, estimates that the average household will use 40% more toilet paper than usual if all of its members are staying home around the clock. That’s a huge leap in demand for a product whose supply chain is predicated on the assumption that demand is essentially constant. It’s one that won’t fully subside even when people stop hoarding or panic-buying.
Color Me Shocked: US intelligence is saying that China concealed the extent of the coronavirus outbreak. If you can’t trust a totalitarian communist regime these days, who can you trust?
Chart of the Day
Everything about this chart is both terrifying and depressing. Its easy to get caught up in numbers but every one of those numbers represents a human being who is suffering. It is happening at a scale that is not only unprecedented but is orders of magnitude worse than anything we have witnessed before.
Covidiot of the Day: A man spit in the face of a police officer and then told her that he had coronavirusbecause Florida.
Exposed: A man infiltrated an online 8th grade Zoom class and exposed himself because Florida. This is not the first security issue that has come up with the suddenly popular video conferencing platform. Earlier this week LA City Council couldn’t figure out how to turn off participant video sharing in their meetings – which are now being held via Zoom – and got spammed with multiple dick pics. What a time to be alive.
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