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Uncertainties & Opportunities | December 2023 Newsletter

As we head into the end of 2023 and celebrate the holidays with family, we reflect on the year we've had and where we're heading in 2024. The world is in a much different place right now. Geopolitical tensions are extremely high with wars in the Middle East and Ukraine continuing on with no end in sight. Economically, many countries are experiencing high inflation and have been raising interest rates to combat it.

If we zoom in on the US, inflation has been like wildfire, which caused the Fed to raise rates at an unprecedented pace, to a level we have not seen since 2006. Inflation has cooled from the high of 9% to just above 3% today, but the Fed has not hinted at cutting rates just yet. The economic fear and higher rates have caused many to slow down on deploying resources and have also forced som to cut back, with companies reducing expenses through layoffs. Not to mention, 2024 is an election year and if 2020 serves as any indication, we may live through more internal polarization and social divide.

Right now, interest rates remain elevated and the Fed may raise again to kickoff 2024. Consumer credit card debt sits at the highest levels ever. The US deficit is increasing and the government is only increasing debt issuance to cover itself. Many investors are sitting on the sidelines, waiting to see how everything plays out. So what does all of this mean moving forward, for the economy and real estate specifically?

Up until 2023, investors were throwing cash around at properties, taking on floating rate bridge debt and promising significant returns. Now that interest rates are high and prices have dropped, real estate has seen a tremendous shift. Transactions are down 60% since Q4 2022. There are billions of dollars in outstanding distressed debt with many more billions on the way. Most buyers are fearful that the market will get worse, causing them to drop their pricing guidance or even not buy at all, waiting to clean up when the distressed sales begin and prices fall even further.

Our perspective is that in the short term risk potential is high with risk probability being uncertain. We are taking a risk averse investment approach. We will continue to purchase properties under the following conditions.

1. Pricing is adjusted to today's market conditions and risk potential, i.e. cap rates and interest rates are balanced.

2. Properties are located in more desirable areas to reduce our exposure to vacancy and rent decrease potentials.

3. We protect our downside with the property's current operating cash flow or have high certainty on executing our business plan.

Long term we remain optimistic. We believe that we are currently going through a lower point in the real estate market. If we are able to grow our portfolio while pricing is suppressed, we will not only have regular asset appreciation, but we will also ride the market timing appreciation on the upswing. People will continue to want to live in good parts of Los Angeles, most will continue to be priced out of buying homes and apartments will continue to be in limited supply given the difficulty of developing here.

Given our opinion that the current downward market shift is a transient period of time in a longer course cycle, we will take advantage of securing property at a lower price than we would have otherwise as long as such pricing justifies the short term risk potentials.

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