2024 Yearly Kick-Off Letter

As the new year kicks off, we’re keeping up with our tradition of sharing an annual letter that dives into our experiences and learnings from the past year, along with some thoughts on what 2024 might have in store. We reflect on the realities our clients face and the deals on which we’re advising. We hope these thoughts, grounded in our direct work and observations, offer you some valuable perspectives and assist in shaping your plans for 2024.

2023: In Review

Overview: 2023 proved to be challenging for many of our clients as well as the various sectors in which we engage. The surge in interest rates extended well into 2023 casting a long shadow over the year. This shift became the central theme leading to market uncertainties, escalated borrowing costs, and restricted access to debt financing. This widespread impact was particularly felt in the commercial real estate sector.

However, the market dynamics were complex and sometimes contradictory. For instance, while the cost of construction loans increased, the prices of single-family homes rose. This created a peculiar situation for our homebuilder clients – while they faced higher costs for their projects, the market for selling homes remained surprisingly robust, offering higher sale prices.

The private equity markets, on the other hand, faced a near standstill, significantly impacted by the fluctuations in interest rates. Finally, the crypto space experienced a dramatic downturn, with activities grinding to a near halt.

Real Estate

Interest Rates: The rapid increase in interest rates was the defining factor for the year, particularly in how the Federal Reserve employed this singular mechanism to influence the broader economy. While the reverse approach led to an initial period of over-stimulation (in the run-up to the summer of 2022), 2023 saw significant suppression of the real estate sector. This introduced a level of uncertainty that has been particularly challenging for developers and investors, as risk capital is averse to unpredictable environments.

Office Sector: Challenges were particularly acute in the commercial real estate sector. The market continues to grapple with an oversupply of office space in a post-COVID era. The difficulty of repurposing these properties for other uses like residential conversions haven’t been the panacea many had hoped for.

As we start to see the expiration of 5 and 10-year leases, the true state of office space renewals – or the lack thereof – is becoming apparent. The industry is still trying to navigate these changes, and it's evident that finding solutions will be a slow process. This uncertainty casts a lingering shadow over the sector, affecting not just property owners and developers but also lenders, who will likely continue to face these challenges in the years ahead.

Industrial Sector: Industrial real estate experienced its own fluctuations. The original surge in logistics development during COVID to provide e-commerce more capacity to ship to everyone, was followed by a post-COVID lull due to higher rates, and now a cautious revival. This sector is showing signs of returning to normalcy and will hopefully stabilize in 2024 as 2023’s over-supply and under-demand come back in to balance.

Residential Sector: The residential real estate market, particularly single-family homes, defied expectations in 2023 with a strong performance. In an unusual twist, the higher interest rates led to a decreased supply in the market, which in turn drove up home prices. Typically, we’d expect to see the opposite – lower prices accompanying higher rates.

The demand for more housing is clear, but the financing challenges have resulted in a decline in new construction. Looking ahead to 2024, there's some optimism for market stabilization. Mortgage rates have begun to retreat from their peak of 8% down to the mid-6% range, which could encourage more development, albeit slowly.

That said, construction financing remains a significant hurdle. Developers who can navigate the high-interest environment and manage low loan-to-value (LTV) loans, which necessitate substantial cash investment, are finding success. These developers are frequently seeing quick, all-cash sales.

Another interesting development to watch is the changing dynamics in brokerage fees. As real estate services increasingly move online, we’re seeing a dramatic reduction in brokerage fees. This shift offers developers the potential to improve their margins by 1-3%. By the end of 2024, we might witness total brokerage fees being capped at 2-3% or even moving towards fixed-fee models. And it goes without saying – it’s not a good time to enter the real estate brokerage business.

Private Equity

The private equity markets in 2023 faced a landscape also altered by rising interest rates, which led to a noticeable shift in investor behavior and market dynamics. As rates climbed, risk premiums increased, prompting investors to reconsider the appeal of illiquid, private investments. Many began favoring debt (even US Treasuries), drawn by their reasonable, risk-free returns and liquidity. This change in investor sentiment, combined with the increased operating costs for debt dependent startups, significantly impacted the IPO market. A lack of exit opportunities and tighter margins for debt-reliant companies marked a challenging period.

For new private equity and venture capital funds, including several of our clients, this environment proved particularly difficult. Uncertain market conditions prompted GPs to adopt a more cautious stance, often choosing to wait on the sidelines for a more favorable investment climate. This period of waiting was marked by a need for greater market stability and clarity on the potential for investment growth. In 2024, the private investment sector needs a stable rate environment and the promise of higher returns to draw capital away from the public markets, which have been performing well.

Crypto

The crypto space faced a tumultuous year, marking a stark contrast to its previous growth trajectory. Company after company in this domain encountered legal challenges, leading to a dramatic downturn. Investors, increasingly aware of the sector's unregulated nature, grew wary. The perception that the space was rife with dubious operators (notably SBF) only added to the skepticism.

The result was a significant retrenchment of what was once a very hot growth sector. While there's been an impressive rise in Bitcoin's value recently, the overall confidence in the crypto market has taken a severe hit. It’s uncertain if and how the sector will recover from this setback and the overall business activity we see is a fraction of what it was in 2022. Several projects we've been advising in the crypto space have also hit a standstill, becoming almost a complete write-off.

2024: A Look Ahead

Federal Reserve Stabilization: As we look ahead to 2024, the foremost priority is achieving stability, particularly in the Federal Reserve's policies. Stability is more than just a comfort; it's a necessity for coaxing risk capital back into the markets, While we're all keen on seeing lower interest rates, what we need most is a firm, consistent policy direction. This kind of stability would be a significant boost, not just for the real estate sector, but for the broader market as well. And the good news is that it feels like some of that sentiment started to arrive in December, with the stock market reacting accordingly.

Additionally, with 2024 being an election year, it's likely that we’ll see a political push for 'calm waters' and ways to demonstrate economic growth. The combination of a stable Federal Reserve policy and controlled inflation is what we expect the current administration to be pushing for as they hope to claim the elusive ‘soft landing’ ahead of November.

Private Equity and Venture Capital Outlook: The situation for PE and VC funds remains ambiguous. With the stock market (S&P 500) performing well, investors might continue to favor the lower risk and higher liquidity of public markets over private equity. This trend could persist, We don’t have strong views this sector, but are anxious that private markets might be slow to reopen for new investment as the public equity markets continue to perform nicely.

Pent-up Demand for Risk Capital: There's a significant backlog of demand for risk capital deployment. While cautious investment strategies were the norm in 2023, there's a limit to how long investors and developers can sit on the side lines. Based on previous market recoveries, once there's a sense of stability, a resurgence in investment activity ensues. That said, it’s worth noting that the recovery post-2009 took a considerable amount of time, and the debt overhang, particularly from the office sector, may slow the pace of activity. All else being equal, we’re rooting for a surprisingly quick rebound in development and construction activity by this summer.

Commercial Real Estate Debt: Given the current landscape, debt may be harder to secure than equity in the coming year, particularly in the real estate sector as was the case in 2023. Developers should maintain strong relationships with their existing lending partners, as these connections will be crucial in navigating the potentially tight credit market.

A Word About AI (see attachment!)

For the past two months Dan’s been immersing himself in the world of Artificial Intelligence (AI). We firmly believe it’s a game changer. The advancements in AI technology are not just incremental; they represent a leap forward that’s going to have significant repercussions for professionals of all sectors. We’re only just beginning to scratch the surface of its potential applications, especially in knowledge-based professions like ours. We’re actively encouraging everyone to stay engaged in this fast-moving technology.

That said, when we talk to anyone about AI the common refrain is “sounds cool, but how do I actually use it?” Here are two use cases that we actively use right now:

• Email Drafting with Chat GPT 4: For anything more than a couple of sentences, Chat GPT 4 is a superb drafting tool. It helps organize scattered thoughts and produces well structured messages efficiently. Attached a simple primer on how to leverage this for your email drafting. Feel free to give it a try and let us know if you find it helpful (though, as always, use it at your own risk).

• Legal Document Drafting and Review: The latest iterations of GPT, particularly version 4, have shown remarkable proficiency in both reading and creating legal documents. Although the most recent update (Ultra) seems a tad less robust than its predecessor, it is still incredibly valuable. There are considerations regarding the security of uploading sensitive legal documents, but the 'personal GPT' function offers a workaround. One prediction for 2024 – AI-driven legal services will become a significant presence by year-end, if not earlier.

The impact of AI is set to expand rapidly in the near future – we're talking months, not years. This acceleration is partly driven by the impending launch of competitive tools from major players like Google and Amazon. We’re committed to staying at the forefront of these developments and will do our best to keep you informed with the latest and most relevant updates as they unfold – particularly as they apply to the actual work we do day-to-day.

What’s New At TriPeak

2023 has been a year of foundational work at TriPeak, as we continue to build our platform.

Growth in Construction Accounting: There's been a noticeable uptick in requests for construction-related services. To better serve this sector, we've developed TriBuild, a specialized system for construction accounting. TriBuild offers detailed, cost-based accounting tailored for construction projects and, crucially, enables cash tracking across multiple projects. Proper cash management for developers has been a crucially missing piece in platforms like QuickBooks Online and is often out of reach for our clients due to the high cost of more advanced tools like Yardi We're excited about the potential of TriBuild and look forward to expanding our footprint in construction accounting in 2024.

Expansion into Fractional CFO/COO/HR: We've also broadened our portfolio to include fractional CFO, COO, HR, and Financial Advisory roles for a number of new operating companies. This expansion has allowed us to support our existing clients, with a renewed focus on cash management and the efficient utilization of debt.

Fund Structuring Advisory: On the Advisory side, we've been actively involved in structuring several new funds, focusing on building bespoke financial models and assisting in crafting legal documents. That said, only one of these funds entered the market in 2023 with the rest on hold until later in 2024, reflecting the current state of the private equity markets mentioned above.

Final Thoughts

Thank you for taking the time to read this update. We hope you’ve found something in here that resonates with you or proves helpful in some way. As we move into 2024, our team at TriPeak is excited about discovering new ways to collaborate with you.

Our goal remains unchanged: to alleviate the day-to-day financial and operational challenges you face, while simultaneously offering valuable advisory support. We’re here to assist you in growing and expanding your business and projects, and we look forward to being a part of your journey.

Your feedback is always invaluable to us, so please don’t hesitate to share your thoughts or suggestions.

Best wishes for a prosperous New Year!

Dan and Beth