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THE PATHFINDER

REPORT March 2014

IN THIS ISSUE 2

THANKS FOR WRITING IN

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CHARTING THE COURSE WWWD? (a.k.a. What Would Warren Do?)

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FINDING YOUR PATH The Millenials, the Millenials, the Millenials.

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BREAKING NEW GROUND: GUEST FEATURE Navigating Today’s Lending Environment

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ZEITGEIST: NEWS HIGHLIGHTS

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TRAILBLAZING Ada Townhomes, Chula Vista, CA

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NOTABLES AND QUOTABLES Investment Wisdom

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THANKS FOR WRITING IN Thanks for writing in. Please keep those cards and letters coming. If you have expertise in an area that could be of interest to our readers, please email us at info@pathfinderfunds.com with information about your proposed subject matter. We will be happy to consider it for a future edition.

CHARTING THE COURSE WWWD? (a.k.a. What Would Warren Do?) By Mitch Siegler, Senior Managing Director Reading Warren Buffett’s annual letter to Berkshire Hathaway shareholders is kind of a financial rite of spring – we’ve been reading these letters religiously for more than 30 years. Reading the 2013 letter, it’s apparent that Berkshire is betting heavily on a sustained housing rebound. Berkshire is now the largest owner of building products company USG Corp. and owns Prudential Realty (renamed Berkshire Hathaway HomeServices), paint manufacturer Benjamin Moore & Co., carpet maker Shaw Industries, Jensen Brick, Acme Brick, home furnishings retailer Nebraska Furniture Mart (opening a 1.9 million square foot store in Dallas next spring!) and railroad BNSF Corp. – which makes a fortune hauling these products hither and yon. Not to mention Berkshire’s large stakes in home builder Clayton Homes and mortgage lenders Wells Fargo and Bank of America. Great investors make money in one of several ways: They buy quality assets and hold them forever (Buffett), they’re more clever than everyone else (legendary Apple CEO the late Steve Jobs) or they look for event-driven situations – a catalyst for a sale or a market undergoing positive changes not yet visible to the masses where they can create value and transform the company or property – the latter is Pathfinder’s style. Hockey great Wayne

Gretsky described this anticipatory approach well, saying “I skate to where the puck is going to be, not to where it has been.” The market has been flooded with capital thanks to the Fed’s zero interest rate policies since 2008. That explains record low bond yields, record high stock market values and a feeding frenzy for certain types of real estate, especially in gateway markets like New York, Los Angeles and San Francisco. Widely available, low cost debt financing from government-sponsored enterprises Fannie Mae and Freddie Mac has helped push apartment values to sky high levels. Today, buyers of institutional quality multifamily properties in the best markets often compete with 20 other potential buyers. Not the best recipe for “making money on the buy.” So what do these highly sought after assets have in common? We believe that over long periods of time, investors get paid for being willing to accept illiquidity. The corollary – that investors willingly pay a premium for highly liquid assets – is also true. When things hit the fan a few years ago, money poured into U.S. Treasury bonds – the ultimate safe haven investment. Global investors view other U.S. assets – blue chip U.S. stocks, commercial real estate (especially apartments, in the best markets) and even luxury homes in New York, L.A. and San Francisco – as highly liquid. That liquidity, together with plenty of cheap debt explains why there’s plenty of demand (and relatively tight supply) and prices have been steadily rising.

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But, liquidity is often misunderstood. If you want maximum liquidity, just keep your cash under the mattress – but that doesn’t really work in the long-haul for obvious reasons. The next best thing – Treasuries – are safe and highly liquid but good luck earning more than 4-5%, at best (far less on a real return basis, when you factor in the long-term rate of inflation), over the long run. In fact, the potential downside risk of fixed income may be asymmetrical (what feels safe may in fact be risky) – when rates move up, you could lose 5-10% on your bond portfolio in a flash). We believe that in today’s environment, multifamily properties, single-family rental homes and luxury homes are quite liquid – but, of course, you have to be cautious in your underwriting, careful about your purchase price and detail-oriented in your operations (lest you overpay for liquidity). More Lessons from the Ultra-Affluent Earlier this month, we participated in a family office investor conference in the Big Apple – attended primarily by folks with 9 and 10-figure investment portfolios – and us. (We’re reminded of the famous exchange between F. Scott Fitzgerald and Ernest Hemingway: Fitzgerald is supposed to have told Hemingway that “the rich are different than you and me.” “Yes, Scott,” Hemingway supposedly retorted. “They have more money.”). We heard lots of happy talk from speakers and attendees about the 30% run-up in stock prices in 2013, today’s “hot” investing sectors (hedge funds, long-short funds, energy and private real estate were mentioned repeatedly) and tapering by the Federal Reserve and other central banks (generally seen as positive as it moves us to a more stable, healthier economy). Plenty of discussion, too, about less popular subjects like government and tax policies, REITs – seen as fully, in some cases over-valued – and the 30-year downward trend in interest rates (the consensus view seems to be that this trade is about over, even for higher-yielding bonds in emerging markets). Now, there’s a time and a place for every investment strategy. When the economy tanked in 2008, investors shunned mortgage-backed securities from Countrywide and its subprime brethren. Clever bond traders scooped up these bonds at deep discounts and made a fortune when the housing and mortgage markets stabilized. As the economy was recovering in 2010-2011, there were

great deals to be had on well-located apartments in better markets where investors could realize 10% cash-on-cash returns and 18%-20% internal rates of return. It’s much harder to earn superior returns on either asset today. Sure, there are still oddball mortgage-backed securities, under-managed (and under-valued) apartments in great neighborhoods and mispriced publicly-traded stocks but it’s not like 2008-2009, when stocks were trading for about half of where they are today or even like 20102011 for multifamily properties. It’s another season. As noted earlier, real estate investors are flocking to the gateway cities and swarming over multifamily assets. It’s a feeding frenzy for single-tenant net (NNN) leases. The Lone Star state – fueled by an energy boom – is on fire. The Golden state, California, is also red hot – it almost doesn’t matter whether it’s a primary, secondary or tertiary market. Investment strategies of yesteryear don’t apply like they did before and today’s investment strategies will likely also have a relatively short half-life. As Pathfinder approaches its 8th anniversary, we pause to examine the real estate landscape, very different than the one we faced in 2006. Our view of today’s landscape and opportunities: • Banks – It’s a new day. The financial sector has healed, rates are ultra-low and banks are lending again. A few de novo banks have even filed for initial public offerings. The overwhelming majority of bank non-performing loans have now been sold, foreclosed (and subsequently sold) or restructured. It’s a pretty good time to be a bank, especially one with a clean loan book. • Securitized Loans – Collateralized Mortgage Back Securities (CMBS loans), often extended for a couple of years during the worst of the downturn (2009-2011) have again matured (most for the final time) and have been foreclosed by the special servicers, who have been active sellers for the past couple of years. The banks resolved their issues earlier – the special servicers are still in the middle innings of the game and will likely continue to sell for the next few years.

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• Corporate Profits Strong – Following the Great Recession, companies closed plants and laid off staff. This was a once in an 80-year opportunity to cut costs and boost profits. The strategies succeeded but many of the moves were one-timers, not to be repeated. Makes us wonder whether today’s equity values are sustainable for companies without meaningful top-line and/or bottomline growth. • Retail – The consumer is feeling more confident, which bodes well for housing starts and the resale market. We see bifurcation in retail. It’s a great time to be a luxury retailer (think Tiffany® and Coach®) and the 99-cent stores and Walmart® are doing pretty well also. Value-oriented retailers without a clear value proposition like JCPenney® are squeezed and Big Box retailers like Best Buy® and Barnes & Noble® continue to lose ground to Amazon® and other Internet retailers. We’re seeing select opportunities in certain types of retail properties, in very specific geographies. Essentially no new retail stores or centers were built from 2008-2012 so with employment and housing starts growing again and the consumer feeling more ebullient, we can sometimes make a case for certain types of retail investment. Pathfinder’s 2013 acquisition of a 50% leased southern California retail center in a 90% leased sub-market is a case in point. By investing in and working the property, we believe we’ll be able to achieve market occupancy in several years. And, our bottom of the cycle purchase price should look better with a bit of future rent growth. (If you’re shopping or looking for a lunch spot in Temecula, CA, visit the shops in our Bel Villagio center.)

• Housing – The housing crisis has largely passed, foreclosures have plummeted, home values have risen steadily for the past couple of years and mortgage loan underwriting standards are again more reasonable. As in retail, we observe bifurcation in housing, with strong demand and limited supply of entry-level homes and multi-million dollar, luxury homes – particularly in the most desirable, coastal markets. Price appreciation in the most desirable markets seems like a reasonable bet for the next few years though the pace won’t be nearly as torrid as in 2012-2013. The situation in the middle market (both move-up homes and homes in the Midwest) is considerably better than it was but it’s not nearly as strong as in entry-level and luxury sectors, particularly in coastal markets. So, coming back to the Oracle of Omaha – WWWD? Berkshire has a long-term perspective, avoiding quarterto-quarter and even year-to-year market swings. Warren may not actually have a 99-year strategic plan but it often seems like he invests as though he does. For the next couple of years, at least, continued improvement in the American economy – helped by relatively low interest rates, improving consumer spending and a more robust housing market – feels like a pretty reasonable bet. Mitch Siegler is Senior Managing Director of Pathfinder Partners, LLC. Prior to co-founding Pathfinder in 2006, Mitch founded and served as CEO of several companies and was a partner with an investment banking and venture capital firm. He can be reached at msiegler@pathfinderfunds.com.

• Consumer Spending – When the stock market tanked and home values plummeted in 2008, consumers went into a cave and hibernated. As the market and home prices have steadily risen these past few years, the consumer feels much better. That bodes well not only for retail spending but for other forms of consumer discretionary spending as well, like travel. That’s one reason Pathfinder made its first ever hospitality investment (with an experienced hotel operating partner) earlier this year – acquiring an extended-stay hotel near Palm Springs, CA. (If you’re looking for a place to stay in the desert, check out our Homewood Suites by Hilton® hotel in La Quinta, CA.) T HE PAT HFI NDE R R E PO R T: MAR CH 2014

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FINDING YOUR PATH

The Millenials, the Millenials, the Millenials. By Lorne Polger, Senior Managing Director The last four real estate conferences that I’ve attended have had a shared focus on the Millenials. Where they live, what they do for work, who they hang out with, how much they spend and which colors they like to wear (okay, kidding on the last point). And if they are so important, it begs the questions of who, what or where are the Millenials? A largely forgotten but recently discovered native tribe? A hockey team from a small city in northern Canada? A Broadway-bound Neil Simon play? We like to dig deep here at Pathfinder. No stone goes unturned in our quest for information. So I started right at the top. Me: Honey, do you know what a Millennial is? Mrs. Pathfinder: Seriously? Me: Well, I’m doing some research on our investment demographics, and I would like to learn more about these people. Mrs. Pathfinder: Isn’t it time for you to go on another business trip? Okay, that didn’t go so well. So I decided to dig even deeper. Webster online defines a Millenial as a person born in the 1980s or 1990s. Someone reaching young adulthood around the year 2000; a Generation Y’er. There are no precise dates when the generation starts and ends. Various commentators use birth years ranging from the early 1980s to about 2000. As of July 2012, there were approximately 73.7 million people in the U.S. between 18 and 34. That’s a lot of folks. Millennials are the social generation. They’re the founders of the social media

movement – constantly connected to their social circles via online and mobile. They prefer to live in dense, diverse urban environments where social interaction is right outside their front doors. A recent, in depth Nielsen Company study provided further interesting data and commentary. Millennials are more racially and ethnically diverse than any previous generation. In July 2013, the unemployment rate for young Millennials (20-24) was 13% and 8% for older Millennials (25-34), compared with 6% for baby boomers. Notwithstanding being hit the hardest by the recent recession, Millennials are optimistic and ambitious. While 69% don’t feel they currently earn enough to lead the kind of lifestyle they want, 88% think they’ll be able to earn enough in the future. Millennials are more likely than their older counterparts to indicate that they’re willing to spend more for goods and services from companies that have implemented programs to give back to society. Over 60% are also willing to pay more for a product if it’s good for the environment. The majority of Millennials prefer to live in the type of mixeduse communities found in urban centers where they live in close proximity to a mix of shopping, restaurants and offices and currently live in urban areas at a higher rate than any other generation. This is the first time since the 1920s where the growth in U.S. cities outpaces growth outside of the cities. And, 40% say they would like to live in an urban area in the future. The “American Dream” is transitioning from the white picket fence in the suburbs to the heart of the city. The concept of “urban burbs” is becoming more popular in redevelopment as suburban communities make changes to create more urban environments with walkable downtown areas and everyday necessities within close reach. Two-thirds of Millennials are renters, and they’re more likely to live with roommates or family members than alone. Millennials account for 43% of current heads of household who intend to move within the next two years. With the onset of the recession, many of the Millennials who were formerly homeowners went back to renting. In 2011, 14% of Millennial homeowners

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went back to renting compared with 4% of the general homeowner population. So you can see why they might be an important group to understand for people who have things to sell or lease. Like us. According to a recent Bloomberg article, Millenials have benefited the least from the economic recovery following the recession, as average incomes for this generation have fallen at twice the general adult population’s total drop and are likely to be on a path toward lower incomes for at least another decade. “Three and a half years after the worst recession since the Great Recession, the earnings and employment gap between those in the under-35 population and their parents and grandparents threatens to unravel the American dream of each generation doing better than the last. The nation’s younger workers have benefited least from an economic recovery that has been the most uneven in recent history.” So they have that going for them, although it doesn’t seem to stop them from paying $4.75 for a triple mocha frappasomething. So you have lots of mobile people, who don’t make as much money as they used to, but want to make more. What does that mean from a real estate sales perspective? A March 2014 research piece from the National Association of Realtors provided some interesting demographic insights: • Millenials comprise the largest share of home buyers at 31% and Millenials have the largest share of first-time buyers at 76%. • Millenials are most likely among generations to look online for information about the home buying process as a first step in the process. So don’t wear your gold sport jacket with the emblem on it for these folks. • More than half of Millenial and Gen X buyers used a mobile device during their home search. Among those who did, 26% of Gen Y and 22% of Gen X found the home they ultimately purchased via a mobile device (I wonder if Qualcomm is entitled to a commission on those sales?). • Nearly all (97%) of Millenials financed their home acquisitions.

What are our takeaways? First, from a seller’s perspective, your presentation and marketing materials had better be as technologically savvy as the online Apple® store. Second, the residences you are selling should be equally in tune with modern technology (we suspect that rumors of a nonfunctioning WiFi system would spread faster through cyberspace than Ellen Degeneres’ tweet at the Oscars). Third, you’d better figure out a way to get your buyers financing. This remains a challenging ordeal, especially for attached product (condominiums and townhomes), given the extremely tight restrictions on purchasing those mortgages imposed by the Federal agencies during the downturn. Any bankers out there willing to make (and actually keep on balance sheet?) a loan? Fourth, you need to build/own more than a building – you need to build a community. But the story doesn’t end there. Although they are the most likely home buyers, Milennials are buying at a pace far below their predecessor generations. Which means that a large share of this large population segment are now or will soon be renters or boomerangers (i.e., young adults that move back home after college, or in some cases, long after college). So what are they looking for in their rental communities? We found some interesting comments published in a recent article in the National Multifamily Executive magazine. “Walkable communities are incredibly important,” says Scott Ziegler, founding principal at Ziegler Cooper Architects, especially with the Gen Y desire to live in urban communities. “You need to make walkable spaces more meaningful.” He suggests building communities where necessities are close to the tenant’s fingertips – not just close to public transportation. Renters expect amenities that are within walking distance to shopping, food and leisure. Further, with a boom in biking, it’s smart to have cycling options available for renters, including biking racks and shops. Ziegler noted that they are putting bike maintenance shops in most of their communities.

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We’ve also seen proximity to Zip Car locations (and similar companies which lease cars by the hour through a credit card processing system) as an important amenity.

“Security is an important feature. So is a decent gym. But a super WiFi system is much more important to me than both of those features.”

A recent article in the Arizona Republic noted that Millenials have demonstrated much less interest in a suburban lifestyle. Infill projects, proximity to mass transit and good design are sweet spots for Millennials. And CBS News’ Money Watch recently noted that a number of cities have seen increased economic activity in the real estate sector led by this generation, particularly Austin, Seattle and Portland. Pathfinder is active in all of these markets.

“The ‘burbs. Probably a place to go after I have kids. But I wouldn’t want to stay there too long.”

We tend to get pretty granular with our research here at Pathfinder. I’ve been known to obsess about esoteric real estate subjects like paint colors and water faucets. So I decided to really sharpen my focus here and spoke with ten Millenials, ranging from 18 to 33 years old. Here are some interesting quotes from those conversations: “I want to move to the city after I graduate.” “The common area features and community activities within a building are more important to me than the amenities inside.”

“I want to have my work life, my home life and my social life intertwined. I want to be able to walk to restaurants, bars and theatres. I want a place where I can walk my dog. My social life is more important to me than proximity to public transportation.” “A good beer pong game with friends is more important than two weeks off of my first month’s rent. But I’ll take the free rent if you throw it in.” It’s a brave new world. Consumer tastes and trends change rapidly. The bus is flying down the road nowadays. It’s WiFi enabled and you can order specialty coffee drinks on your smartphone while you ride. Are you hip enough to ride along? Lorne Polger is Senior Managing Director of Pathfinder Partners, LLC. Prior to co-founding Pathfinder in 2006, Lorne was a partner with a leading San Diego law firm, where he headed the Real Estate, Land Use and Environmental Law group. He can be reached at lpolger@pathfinderfunds.com.

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BREAKING NEW GROUND - GUEST FEATURE

reminder of what to focus on and how to navigate the vast availability of financing today. Here you go:

Navigating Today’s Lending Environment

1. Do Match Your Debt to Your Business Plan

By Brent Rivard, Managing Director

It’s happened more than once – we explain our business plan on an asset (hold period, exit strategy, etc.) to a potential lender and we receive a term sheet that isn’t even close. How does a two-year bridge loan help us on an asset we intend to hold for five years? Of course, having a detailed business plan on every asset is a requirement. Making sure your debt financing matches that business plan (as to holding period, lease-up, cash flows, release provisions, pre-payment penalties, etc.) is imperative for the success of the investment. A lot of borrowers get tunnel vision and focus on only one of the primary loan terms, whether it’s rate, loan term or proceeds. All of these “primary terms” are part of the risk equation for a lender and often work against each other. Lenders may eventually give you the rate, term and proceeds you want, but will manage their risk through other areas in the loan documents. Debt financing can be complicated and lenders are mostly focused on what happens when things go wrong, but most borrowers aren’t. This eternal buyer optimism can cause you to gloss over some of the other important terms that could impact your business plan like pre-payment penalties, covenants (minimum liquidity ratios, for example) and debt service coverage ratios that could cause the bank to re-margin the loan. It’s important to review every loan term, match it up to your business plan and determine the risk impact to your investment.

At Pathfinder, we’ve always believed in using leverage strategically and making sure debt doesn’t increase the risk of a transaction. We’ve been able to take advantage of those that took excess risk prior to 2008 and a significant part of our acquisition strategy has been purchasing notes or real estate-owned (REO) properties from those lenders and others who are over-leveraged. For the first few years of the current cycle – 2008-2011 – real estate financing was, for the most part, unavailable at attractive terms. We were executing most transactions on an all cash basis and using leverage sparingly and only where it enhanced returns without increased risk. Well…..the availability of real estate debt financing changed drastically in the last 18-24 months. Banks (and other, mostly private and non-regulated lenders), after holding onto capital for an extended period of time to get through the Great Recession, finally started lending! We’ve seen banks relax underwriting standards (higher loan-to-value, non-recourse financing, etc.) and reduce interest rates. This increased competition has driven down rates charged by non-bank financial institutions and created a buyer’s market for debt. Overall, the greater availability of debt financing has been great news for the real estate investment market. At Pathfinder, we haven’t really changed our leverage strategy, only enhanced it to take advantage of the availability of financing. Throughout this cycle, Pathfinder has closed on over 35 separate loans with a number of different lenders. Banks, hard money lenders, debt funds – we’ve seen it all. We’ve completed a dozen of those loans just in the past year. Our strategy is super top secret…but… we thought we’d share some do’s and don’ts of real estate financing in today’s market. Just don’t tell anybody, OK? Seriously, none of this is rocket science – but it’s a great

2. Do Pay Close Attention to Interest Rates Face it – we’ve all become accustomed to the low interest rate environment we’ve been enjoying for the past five years. Some have even grown complacent. Nobody knows when interest rates will rise, but I think we can all agree we’re at or near the low point for the cycle and there’s probably only one way for rates to go – up. It’s critical to avoid this complacency and keep a close eye on the interest rate environment. At Pathfinder, we’ve tried to create diversity in our borrowing like we have in our investment portfolio. Depending on the

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time horizon to exit the investment, we’ve executed both fixed and floating rate debt structures. While we believe that rates will remain low for the near term, we are poised and ready for an increase when it happens. This is especially important when looking at the borrowing index on a floating rate loan. Is it Libor-based, primebased, etc.? Today, 3-month Libor is around 0.25% and the 10-year Treasury rate is approximately 2.80% – that’s a pretty large spread. If you go back to September 2007, right before this recent cycle began, 3-month Libor was approximately 5.49% and the 10-year Treasury rate was around 4.50%. We believe that when interest rates start to move, they’ll move quickly and the current spread between Libor and the 10-year Treasury compared to historical spreads suggests Libor could move even more quickly – so we’re paying close attention to how interest rates are trending and making sure our debt terms, primarily the index, won’t put us in a more risky position. 3. Don’t Over-Leverage This one is easy – if you need to push loan proceeds to make a deal work, it’s probably not a deal worth doing. We put this one in the “lessons learned from the last cycle” category. Depending on the risk profile of your capital, your leverage point may vary – it could be 50% or 80% loan-to-value. Either way, establish your threshold based on the impact on overall risk and stick to it. 4. Do Invest in Building Your Relationship With Your Lender/Broker Just like any good business strategy, creating a strong trusting relationship with your lender (and loan brokers) is important. Don’t treat your loans like a commodity – if you do, you’ll get a commoditized result. We’ve made it our priority to create strong relationships with several lenders. We believe it’s made us more competitive in the market where we can offer on a transaction with confidence. When you’re working closely with your lenders, you can better understand their lending limits, flexibility on loan terms and confidence of loan approval. We also believe that it’s important to build strong relationships with brokers. There are always new lenders and banks in the market and if you’re not

out there every day (like the brokers are), you might miss a great opportunity well worth that brokerage fee. 5. Don’t Forget the Other (Hidden) Costs of Debt There are a number of other costs of debt that you can lose sight of if you focus on those primary terms of rate, loan term and proceeds. Some of these are somewhat “hidden” (yield maintenance, recourse) and some not so hidden (origination fees, appraisal costs, legal fees, etc.). Either way, we wanted to provide a list of the ones we pay close attention to – sometimes these can make or break a loan: • Origination Fees – probably one of the most negotiable terms in the loan • Extension Fees – make sure you understand how they work, how much they are and when they come into play • Legal and Documentation Fees – we’ve seen these range from a few thousand dollars if a bank uses internal forms to tens of thousands of dollars if they use outside counsel. Understand up front what these fees will be and try to negotiate a ceiling. • Appraisal and Third Party Fees – in some transactions, these can really add up. Get multiple quotes from the lender early in the process. • Title Insurance – same here – request multiple quotes and understand the cost early. • Pre-payment Penalties – another negotiable item. Understand when and how pre-payment penalties will be charged. Most lenders will give you flexibility on a sale, but not so much on a refinance with another institution. • Recourse/Non-recourse and Cross-Collateralization – these are some additional hidden “costs” for the eternal optimist. Recourse debt is finally available on most transactions – make sure you shop the market to find it. Brent Rivard is Managing Director, CFO and COO of Pathfinder Partners, LLC. Prior to joining Pathfinder in 2008, Brent was the President of a national wealth management firm and CFO/COO of a one of southern California’s leading privately-held commercial real estate brokerage firms. He can be reached at brivard@pathfinderfunds.com.

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ZEITGEIST -

SIGN OF THE TIMES Apartment Construction on the Rise As residential construction has roared back to life over the past 12 months, we are noticing a few new trends in this cycle – much of the growth is being driven by apartment construction. In 2013, apartment construction represented nearly 31% of total U.S. housing starts, the highest level since the data were first tracked in 1974. This can be partially explained by the lifestyle of today’s Millenials who are unmarried, living in urban areas and burdened with student loans. Not to mention that the baby-boomers are retiring and cashing in on their home values while downsizing into smaller units. It’s interesting that many of these new apartments have a “condo map”, which allows for the sale of individual units in the future. So, today’s apartment craze could be tomorrow’s condominium boom. [Editor’s Note – Pathfinder owns several condominium projects in Seattle, Portland, Denver and San Diego. While we are currently operating them as apartments, we also like the optionality of possible condo sales in the future.] Are Changes Coming to the Mortgage Markets? After three decades of unprecedented governmentsponsored mortgage lending (to the tune of trillions of dollars), the U.S homeownership rate is still hovering around 65.6% – the same level as 1980. Aggressive government policies that encouraged bigger loans, larger homes and lower levels of savings contributed to our recent economic woes. Some experts believe that shifting mortgage risk from Fannie Mae and Freddie Mac (read “taxpayers”) to private investors would help.

currently several proposals before Congress looking to reform Fannie Mae and Freddie Mac. Who knows? Perhaps we’ll see the free market dictating mortgage rates in the not too distant future. Boomerang Buyers Not Necessarily Flying Back About 2.8 million of the 5.3 million U.S. households who lost their homes to foreclosure during the recent downturn are expected to purchase another home by 2021. The areas that are estimated to benefit the most from these boomerang buyers are those hit hardest during the downturn – Riverside, San Bernardino, Los Angeles, Phoenix and south Florida. Of the remaining 2.5 million foreclosed households, 889,000 have already purchased another home but 1.6 million will most likely be unable to purchase another home in the next seven years. Apartment owners and single-family home landlords will continue to benefit from rental demand from the foreclosed households, who are expected to continue to rent until 2021. Additionally, the large, institutional investment groups that purchased millions of singlefamily homes during the past few years are banking on these renters staying in the their rental homes for the long-term. The recent reductions in FHA loan limits will make it more difficult for boomerang buyers to obtain loans, especially in the more expensive urban markets.

Despite the likelihood of further increases in interest rates following privatization and a big hit to the Treasury from the loss of dividends from Freddie and Fannie, Congress appears to be slowly moving toward reigning in our 30-year run of mortgage subsidies. There are T HE PAT HFI NDE R R E PO R T: MAR CH 2014

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TRAILBLAZING: ADA TOWNHOMES, CHULA VISTA, CA Infill Development Project in San Diego, CA office condominium project, several dozen single-family rental homes and most recently, Ada Townhomes.

San Diego’s population has grown steadily – from 2.5 million in 1990 to 3.2 million in 2012. The reasons are easy to see: a vibrant, diversified economy, 245 days of sunshine, average temperatures of 76ºF in summer and 65ºF in winter, beaches galore and world-class golf courses, hiking and biking trails and bays. Plus, all of the attractions of a major city, including a symphony orchestra, outstanding theater and major league sports teams. A great place to live and work and a terrific place to retire. The downside, though, is that virtually all of the developable land is gone. San Diego is bounded on the west by the Pacific Ocean, on the east by the Laguna Mountains, to the north by Camp Pendleton and to the south by Mexico. There’s nowhere to grow and no more developable land. As a result, nearly all of the national homebuilders have pulled out of the market and the only remaining development opportunities are small, infill parcels. Our 1.0 acre site in Chula Vista, nestled amongst the coastal foothills that surround San Diego Bay – the future home of Ada Townhomes – is a perfect example. Chula Vista, Spanish for “Beautiful View”, is the second-largest city in San Diego County with a population of 250,000. Chula Vista boasts 50 square miles of coastal landscape, canyons, rolling hills, mountains and a variety of natural resources. The city is home to established neighborhoods, start-up companies, the country’s only warm-weather Olympic Training Center, an award winning nature center and an historic downtown. Pathfinder has made several investments in Chula Vista during the past several years, including the acquisition of a 68,000 square foot

The Ada site is located in Chula Vista’s marina district – within the city’s approved redevelopment zone – less than one mile from the coastline and just one-half block from a San Diego Metropolitan Trolley station. The redevelopment area of Chula Vista is in the process of a major revitalization of the coastline and marina district, which includes significant commercial development coupled with wildlife preservation. Pathfinder purchased the site in May 2013 and completed the entitlements late last year to build a 21-unit townhome project. We are currently working with the City of Chula Vista on construction approval and we expect to break ground later this spring. Ada will be comprised of four, three-story Mediterranean style townhome buildings consisting of 13 three bedroom/three bathroom units and eight four bedroom/ three bathroom units, ranging from 1,600 to 1,700 square feet. The community’s common area will include a secure gated entrance, a paved trail encircling around the project’s perimeter and an open park with a “tot lot”, benches and tables. We believe that Ada will provide much-needed new housing to the growing City of Chula Vista and that this type of urban, in-fill development is the future of San Diego County – and most other mature cities. We plan to complete construction in early 2015 and will then evaluate our options – either selling individual townhomes or operating the project as a rental community. Sources: US Census Bureau, USClimateData.com

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NOTABLES AND QUOTABLES

Investment Wisdom

“Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.” - Warren Buffett

“Price is what you pay; value is what you get.”

“All intelligent investing is value investing – acquiring more than you are paying for.” - Charles Munger Vice Chairman, Berkshire Hathaway

“Invest at the point of maximum pessimism.” - Sir John Templeton

- Benjamin Graham

“Sometimes your best investments are the ones you don’t make.” - Donald Trump

“In all things, success depends on previous preparation and without such previous preparation there is sure to be failure.” - Confucious

“No matter how serene today may be, tomorrow is always uncertain.” - Warren Buffett

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IMPORTANT DISCLOSURES Copyright 2014, Pathfinder Partners, LLC (“Pathfinder�). All rights reserved. This report is prepared for the use of Pathfinder’s clients and business partners and subscribers to this report and may not be redistributed, retransmitted or disclosed, in whole or in part, or in any form or manner, without our written consent. The information contained within this newsletter is not a solicitation or offer, or recommendation to acquire or dispose of any investment or to engage in any other transaction. Pathfinder Partners LLC does not render or offer to render personal investment advice through our newsletter. Information contained herein is opinion-based reflecting the judgments and observations of Pathfinder personnel and guest authors. Our opinions should be taken in context and not considered the sole or primary source of information. Materials prepared by Pathfinder research personnel are based on public information. The information herein was obtained from various sources. Pathfinder does not guarantee the accuracy of the information. All opinions, projections and estimates constitute the judgment of the authors as of the date of the report and are subject to change without notice. This newsletter is not intended and should not be construed as personalized investment advice. Neither Pathfinder nor any of its directors, officers, employees or consultants accepts any liability whatsoever for any direct, indirect or consequential damages or losses arising from any use of this report or its contents. Do not assume that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended or undertaken by Pathfinder Partners LLC) made reference to directly or indirectly by Pathfinder Partners LLC in this newsletter, or indirectly via a link to an unaffiliated third party web site, will be profitable or equal past performance level(s). Investing involves risk of loss and you should be prepared to bear investment loss, including loss of original investment. Real estate investments are subject to the risks generally inherent to the ownership of real property and loans, including: uncertainty of cash flow to meet fixed and other obligations; uncertainty in capital markets as it relates to both procurements of equity and debt; adverse changes in local market conditions, population trends, neighborhood values, community conditions, general economic conditions, local employment conditions, interest rates, and real estate tax rates; changes in fiscal policies; changes in applicable laws and regulations (including tax laws); uninsured losses; delays in foreclosure; borrower bankruptcy and related legal expenses; and other risks that are beyond the control of the General Partner. There can be no assurance of profitable operations because the cost of owning the properties may exceed the income produced, particularly since certain expenses related to real estate and its ownership, such as property taxes, utility costs, maintenance costs and insurance, tend to increase over time and are largely beyond the control of the owner. Moreover, although insurance is expected to be obtained to cover most casualty losses and general liability arising from the properties, no insurance will be available to cover cash deficits from ongoing operations. Please add msiegler@pathfinderfunds.com to your address book to ensure you keep receiving our notifications. T HE PAT HFI NDE R R E PO R T: MAR CH 2014

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