Love Letter to San Francisco

1Too Much Office Space (Not Enough Housing)

I Left My Heart in San Francisco… We launch our Valentine’s Day issue with Tony Bennett’s signature love song to the “Golden Gate City.”

Which, to be honest, hasn’t been so golden recently. Nonetheless, real-estate heir — and Warren Buffett protege — Ian Jacobs is banking on San Francisco’s comeback.

“The 47-year-old spent much of the past year getting financial commitments from relatives and other wealthy families to snap up San Francisco office buildings,” says an article at The Wall Street Journal.

Recall: “Landlords abandoned properties and defaulted on mortgages. Losses from the loans flowed through the financial system, hitting shares of banks and insurers.” Arguably, San Francisco was the axis of the banking crisis last March.

WSJ adds: “San Francisco is the epicenter of a national commercial real-estate collapse. The transition to work from home crushed demand for downtown office space.”

Office Property

Source: WSJ

Jacobs has secured $75 million in funding to finance his initial commercial real estate purchases. His goal is to buy approximately 3 million square feet of office buildings for 70% less than the cost of new construction.

“Jacobs has told investors it might take San Francisco 10 years to recover, according to his marketing materials. The key to the trade will be buying cheap and holding on until technology companies ultimately return.”

(In our editorial chat yesterday, Paradigm editor Byron King commented: “Might be a good long-term play. San Fran's problems are all political, and politics can change. It's [hard] to find another natural locale like San Francisco.” Word.)

So far, Jacobs hasn’t finalized any deals.

“The truth is America’s major cities have had too much office space for decades,” says Paradigm’s income-investing authority Zach Scheidt. “Meanwhile, these same cities have a severe housing shortage.

“Currently, there’s an estimated deficit of 3.2 million housing units in the U.S.,” he says. “And simply building more homes won’t help dig the country out of this deficit anytime soon.

Housing Units

Source: Rich Retirement Letter

“The steep imbalance means real estate investors are bleeding money on their commercial spaces while residential properties are still in high demand.

“Keep in mind that many of these office buildings also have debt that needs refinancing over the next few years,” Zach says.

“But with higher interest rates, the revenue from these buildings can't cover the financing costs in their current state.

“Now you might think the solution is obvious: Just redevelop the vacant properties and build more housing, right? It’s turning out to be a bit more complicated than that…

“For one thing, local zoning laws could still prevent developers from converting a building from commercial to residential use in the first place.

“After clearing this first hurdle, the fact remains that office buildings are laid out completely differently from apartment buildings,” Zach says. “Newer high rises in particular are often so big that an apartment floorplan simply won’t work.

“Ironically, old office buildings generally make better candidates for conversions than new ones.” For instance: “It’s easier to work out an apartment floor plan without running into the issue of windowless units in the center of the building.

“Office-to-apartment conversions were already on the rise before the pandemic,” says Zach. “Remember, the office surplus has been a problem for decades.

Office Apartment

Source: Rich Retirement Letter

“Currently, there are an estimated 2,600 office buildings in the U.S. that are viable candidates for residential conversion.

“Converting offices into housing will prove both difficult and expensive. But there is an investment angle to it all,” Zach says.

“There are a handful of industrial companies that specialize in [updating] older buildings. This includes things like installing new high-efficiency HVAC systems for comfort and energy savings…

“Electrical, lighting and security upgrades for safety and lifestyle along with digital building management. And don’t forget about other essentials like updating building fire protection systems.”

Zach’s key takeaway: “Companies that produce these in-demand technologies to retrofit old buildings stand to win big as cities convert office spaces into housing.

“Many of these companies are already seeing their order backlogs rise as the trend takes off,” he says. “I expect this to be the defining real estate trend over the next several years.”

Zach likely has a few actionable plays in his back pocket. We’ll keep you in the loop.

2The Cure for Bad Breadth

“The rally really started broadening out yesterday, with small caps and Bitcoin breaking out,” says Paradigm’s trading whiz Greg “Gunner” Guenthner.

“That was great to see!” he says. “The only issue is we saw some potential reversals in the frothy semiconductor names that became exacerbated by the less-than-ideal CPI report.

“Tech has obviously been the top dog this year, dragging the averages higher and covering up a lot of other issues below the surface,” Gunner adds. “But the tech stocks all moved lower yesterday. 

“Can the rest of these stocks (small caps, midcaps, tech-growth, biotech) that have snapped back continue to stay strong?” To answer Gunner’s question, the iShares Russell 2000 ETF (IWM) is up 1.5% today while ARKK is up almost 4%.

As for the rest of the market, the three major U.S. stock indexes are bouncing back with the tech-heavy Nasdaq leading the way: up 0.65% to 15,755. At the same time, the Big Board is barely hanging onto green, taking a breather at 38,200. The S&P 500 is up 0.40%, but still stuck below 5,000.

Turning to commodities, crude is down 1% to $77.05 for a barrel of WTI. And gold continues to slide; the yellow metal is down 0.10% to $1,991.50 per ounce. Silver, on the other hand, is rebounding, up 1.20% to $22.40.

The big market story today is crypto… Bitcoin is charging up 4.5% to $51,630 while Ethereum is up over 4% to $2,740.

3Follow-up File: Russia Sidesteps Sanctions (Gold)

Russian banks appear to be exchanging gold for U.S. dollars and other currencies.

“Russia has faced a shortage of dollars and euros as it’s increasingly shut out of the Western financial system,” Bloomberg says. “It’s possible that some of the country’s banks sought access to the currencies to facilitate imports and other transactions.”

According to research firm Sayari, during the first quarter of 2023 alone, Russian banks — including sanctioned Lanta Bank JSC which has ties to gold producer GV Gold — brought in over $82 million worth of euros, dollars and UAE dirhams.

Of course, our firm has been following Russia quietly amassing gold reserves. And the day Russia invaded Ukraine, Paradigm’s own Jim Rickards said Russia would prove more resilient than the White House could possibly appreciate…

jim tweet

Today, the UAE, Turkey and China “rank among Russia’s most important trading partners.”

“Those three jurisdictions” — UAE, Turkey and China — “have also been used by Moscow to get around trade restrictions imposed by the EU and U.S. on key technologies, like advanced chips,” Bloomberg says.

To wit, the mainstream outlet Newsweek is connecting some truly disparate dots today — blaming Moscow’s hours-long stock exchange outage yesterday… on Western chip sanctions?

“The Moscow Exchange said the issue was caused by a hardware error on the main server,” Newsweek says. The outlet continues, citing that “demand from Russian companies for the repair of hard drives, tape drives, controllers, motherboards and other components of foreign computer equipment increased fivefold in 2023, compared to the previous year.”

Be that as it may, we think it’s a stretch to link the stock-exchange outage to a lack of spare parts. And it’s not often we include market notes from Moscow, but…

“The ruble-based MOEX Russia index edged up to 3,260 on Wednesday, having resumed trade after the technical pause in the early morning and inching closer to its highest level since the beginning of full-scale invasion of Ukraine in February 2022,” Trading Economics reports.

4One Lucky Son of a Gun

A metal detectorist in northern Poland uncovered a rare gold coin minted almost 250 years ago in a bygone European confederacy.

The gold ducat, dated 1777, was struck by the Republic of the Netherlands — a confederation of states in existence from 15811795 which included parts of modern-day Netherlands, Belgium and Luxembourg.

According to the Royal Dutch Mint, gold ducats were important in early international trade and valued for their consistent gold content and weight, making them a globally recognized currency.

coin

Source: Facebook

With a one-inch diameter, the front of the coin features a knight brandishing a sword and clutching arrows alongside the Latin motto: Small things flourish by concord.

The inscription on the reverse side of the ducat translates: Gold coin of the Kingdom of the Netherlands by law of the Empire.

“Despite the dissolution of the Republic of the Netherlands, the legacy of the golden ducats endures,” BNN Bloomberg says. “The Royal Dutch Mint continues to mint these coins annually, remaining faithful to their original design.”

Predictably: “This article is sold out.”

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5M-I-S-S-I-S-S-I-P-P-I… and “a Royale With Cheese?”

“Interesting piece on the Darien, Connecticut, McDonald’s. I lived in a town adjacent to Darien, and I understand that this is not a cheap part of the country,” a reader comments on Saturday’s “McPricey” issue.

“Currently, I live in Switzerland. In Yverdon-les-Bains, a Quarter Pounder meal (with medium fries and Coke) costs 15.3 CHF. At current exchange rates, that comes to about $17.75. Still cheaper than Darien!”

“Great piece!” says a reader about Tuesday’s 5 Bullets.

“After more than 26 years in sunny San Diego, we left. At a time near retirement age, we started looking for a place that met our needs. Warm, green, better home prices and a political environment that did not make me a felon for owning a certain type of rifle.

“We spent the next five years touring our great country (46 of the lower 48 states and most at least twice) to finally settle in Mississippi. Great home and utility prices, friendly people, veterans and police are respected and thanked for their service and it’s very green (color). People here ask if you’ve found a church that you like, not who you voted for.

“We loved the weather in Southern California and the friends we made there, but the taxes, politics and oppressive rules and regulations drove us out forever.”

“I moved from Chicago to the Atlanta Metro Area in 2018,” a first-time contributor replies. “I moved for family and financial reasons alone. Despite my leftist political leanings, I am and have always been comfortable in conservative parts of the country.”

Emily: Welcome one and welcome all! And thanks for the feedback.

We’ll sprinkle more of your opinions into our 5 Bullets this week. Join us tomorrow for another episode…

Happy Valentine’s Day,

Emily Clancy
Associate editor, Paradigm Pressroom's 5 Bullets

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