No. of Recommendations: 6
Hello Jim,
> "I usually eliminate industries with high risk or no control over their pricing ... real estate)."
This statement sounds strange to me. Real estate isn't an industry but rather a diverse variety of industries.
In terms of 'high risk', there are REITs you can choose where you have excellent insight into cashflow for years ahead and macro risks are hedged.
In terms of 'pricing power', again it depends on the REIT, and it depends how you perceive pricing power.
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Take NVIDIA GPUs. If you wanted to work with CUDA-based engineering applications, you had three choices for most of the last decade:
- buy a new NVIDIA GPU
- buy a used NVIDIA GPU
- rent a NVIDIA GPU in someone else's machine.
Pricing power can be demonstrated by stagnant offerings that people relentlessly buy - NVIDIA GPUs today have 8GB and NVIDIA GPUS in 2016 had 8GB.
It can be seen in the absence of special offers and deals to incentivise bringing purchases forward.
It can be seen by continual supply shortages and buyer desperation.
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Now, suppose NVIDIA announced a new '20 year subscription' GPU package. You would no longer be able to buy GPUs as you need them.
Instead, you'd have to commit to an annual subscription for 20 years, and every few years you will get a GPU shipped to you.
The price each year would continually rise contractually, and the quality of the GPU would hardly improve much over time.
Further, they insist you must secure your subscription against assets you own, in case you try to back out.
I don't believe most businesses or consumers would rush to embrace that deal.
NVIDIA simply doesn't have the pricing power to force that on consumers.
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Similarly, imagine a 'Disneyland for 20 years' package where you can only go to Disneyland if you commit up front to 20 years of annual holidays there.
With the price set so that it will rise if there is inflation, but will not go back down if there is deflation.
And if there's sudden huge demand for theme park holidays, the contract lets them push the prices up *even more*, every few years, if they want.
I don't believe consumers would rush to embrace that deal.
Disney simply doesn't have the pricing power to force that on consumers.
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But there are REITs that have their contracts set that way and businesses /government desperately rush to take up the offer!
Because there is no choice. To operate the business, they *must* have warehouses or hospitals or student flats or whatever in a particular place.
Or because demand is so outrageously strong, that if a 20 year contract is what it takes to secure the site, that's what you sign.
Unite is pivoting to this model - looking for places where they get 100% occupancy year after year, and universities will guarantee the cash flows without fear.
These are the kinds of REIT I am quite interested in.
When the customers have to sign up for long term contracts at prices that keep going up for decades, and can't easily get out.
When you can see who their customers are, and whether those customers are going to be able to pay for years to come.
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"You will pay what I ask, and more each year, for 20 years, or you are screwed" is pricing power to a degree you hardly see outside of real estate.
Perhaps in defense? I'm not sure what other sectors can force customers into 20 year contracts that always go up in price for the same dull product each year.
If you have ideas, I'd be interested to hear them.
Anyway this is why I would disagree with you about real estate lacking pricing power.
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In cases where real estate / REITs operate on a short-term basis, and compete to attract customers regularly, those don't have pricing power.
Offices and high street shops, which are quite 'substitutable', often require incentives to bring in business, have fierce price competition.
Personal storage facilities like Safestore and Big Yellow, are always competing with attic space, garages, and 'your friend's spare room'.
Residential properties can be substituted; they lack pricing power except where there are more people needing homes in an area, than there are homes.
But there are real estate sectors - logistics, health, elderly care, some student accomodation - where you may see good pricing power and relatively low risk.
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Pricing power is also driven by the ability for someone else to set up shop in competition, by the substitutability of the thing being bought.
In some sectors, some places, and some times, this happens a lot in real estate, but in other times, places and sectors, it doesn't seem to.
TRS
