The most meaningful story in the Wall Street Journal...

How to remove risk from our real estate deals...

Editor's note: Today, we continue our weeklong series featuring insights on the real-estate market from Michael Stein, cofounder of Pensam Capital.

In today's installment, Michael shares some techniques his firm uses to reduce risk in its investments. And he describes what a sharp rise in interest rates would mean for his firm's portfolio...

  We underwrite all of our properties for a five-year holding period, but we put seven- or 10-year debt on our assets. So we don't have a defined exit time frame. Instead, we try to time when we think we've maximized the value of the property.

Our exit can come in two different forms. We can sell a property outright, which we're doing on a couple of deals right now. Or our exit can come in the form of a refinancing, taking what they call "supplemental financing" from our lender and essentially putting a second mortgage on the property and cashing out our investors through supplemental debt.

And we've done that on a few assets already, where we've returned up to 20%-40% of the investors' capital, which is a tax-free or tax-deferred event.

  Really, the $64,000 question is, what are cap rates and interest rates going to be in seven or 10 years when you're facing a capital event? And it's hard to tell. Nobody has a crystal ball.

We underwrite everything with a residual cap rate 50 basis points (0.5%) higher than where we bought it. And we're amortizing our debt down over the holding period. So we're taking a lot of the risk out of the deal through the paid-out debt.

And our long-term view is that rents will continue to increase, albeit modestly. But long term, the multi-family industry enjoys strong fundamentals.

  There's not a point in my career where I've seen multi-family housing take any type of meaningful dip, other than in maybe 2004 to 2007. At that time, people were converting apartments to condos, which was kind of a fool's game. A lot of guys did well, but others got caught holding a lot of inventory.

So if you just look at it really as a fundamental operating business, I think long term it will be fine.

  Our business is sensitive to interest rates... And right now, interest rates are near all-time lows (the 10-year Treasury yield is less than 2.5%). But what happens if rates go to, say, 5% in the next year?

If rates shoot up to 5% in a year, one thing is for sure... Our portfolio, which has an average debt rate of maybe 4%, will look much more valuable with that long-term fixed-rate, low-cost financing.

Two, if we see a market that has a much higher interest-rate environment, we'll see some inflation and potential rent growth.

Three, a higher interest-rate environment would push mortgage rates up and lead to a decline of single-family home purchases. You may see home ownership rates drop into the 50s, from the current 65%. So we'll end up with more people coming out of the single-family home market into the renter market.

  I don't view a fundamental shift in interest rates as necessarily a bad thing for us. I think it will weed out a lot of investors from the market, and we'll have a bit of a different cap-rate environment.

Clearly, the flipside of that is we're going to be facing much higher interest and cap rates when we sell or refinance in the future. Our bet is that we've created enough value within the assets that we should be fine on the exit. And our investors have received significant cash flow along the way. So even in a worst-case scenario – where, let's say, we have to sell the property for close to what we bought it for – I still think an investor's capital is protected.

– Michael Stein

How to remove risk from our real estate deals...

In today's Digest Premium, Michael Stein, cofounder of the real-estate investment firm Pensam Capital, explains how his company handles the inherent risks of cyclicality and interest rates in the real estate business.

To continue reading, scroll down or click here.

How to remove risk from our real estate deals...

In today's Digest Premium, Michael Stein, cofounder of the real-estate investment firm Pensam Capital, explains how his company handles the inherent risks of cyclicality and interest rates in the real estate business.

To subscribe to Digest Premium and access today's analysis risk-free, click here.

The most meaningful story in the Wall Street Journal... The best investment Porter's readers have ever made?... As expected, crude oil is falling... Curzio's top shale play is soaring... Another 'Three-Minute Trading Expert' video...

  The main stories of today's Wall Street Journal yield no surprises.

But tucked behind the headlines is an article that covers a tremendously powerful idea.

First, the headlines...

The Obamacare website is a disaster. Mix bureaucrats with technology and that's what you get.

The U.S. was just busted for spying on Germany. It's been snooping on every other nation for decades.

The price of oil is falling. Again, no surprise. More on that below...

  The "tremendously powerful" idea is located in an article covering Hershey's latest earnings report...

Today, the candy maker reported higher quarterly earnings because of strong U.S. sales. Revenue climbed 6.1% to $1.9 billion. Profit increased 32%. Where it made sense, Hershey has been able to raise prices for its branded chocolates.

  Regular readers are familiar with the Hershey story. It doesn't change much.

That's the benefit of owning truly exceptional businesses. They are boring. You buy them, forget about them, and enjoy the effects of long-term compounding. These businesses don't excite the masses. They just make you rich.

In his December 2007 issue, Porter urged readers of his Investment Advisory to buy Hershey. Porter noted how Hershey generates extremely reliable cash flows and dividends. It owns one of the world's most cherished and respected brand names. It generates huge returns on its tangible assets.

He called Hershey "the utter picture of capital efficiency." (If you're unfamiliar with this key term, make sure to read this educational piece).

  In that issue, Porter noted how Hershey's cheap valuation and steady growth rate would lead to giant returns for investors:

Porter went on to explain that there aren't many businesses you can realistically expect to make you 20 times your money – and even fewer that you can expect to safely hold for two decades.

But with Hershey, he says, you can. Porter also pointed to the company's prospects for international growth as another reason he was so bullish.

  Hershey is performing just as Porter expected.

As of yesterday's close, shares were up 158% since his recommendation.

And as the most recent quarterly numbers show, selling high-margin, branded chocolate is a great business. It's exactly the kind of business we recommend readers take large positions in... and hold forever.

We urge you to read Porter's original Hershey recommendation. It's one of the best, most useful pieces of research we've ever published. It will give you a good idea of what we look for when recommending long-term investments. Access it for free right here.

  As for crude oil, the world's fuel of choice has fallen from $108 to $97 per barrel in the past two months. The drop comes as no surprise to readers of DailyWealth Trader.

In August, we (Brian Hunt and Amber Lee Mason) sent out an alert to readers that detailed the "extreme" situation in crude.

After enjoying a summer price rise from $94 to $108, crude oil drew in a massive amount of "hot money" from hedge funds and computerized trading funds. We pointed out how there was an all-time record amount of speculative long positions in the crude oil market.

We used a simple boating analogy to illustrate the danger of being in the "consensus" trade with the rest of the crowd:

  As you can see from the one-year chart of crude oil below, the crowd is getting harmed... and it is exiting the "long crude oil" trade. This week, crude fell below the psychologically important $100-a-barrel level and hit its lowest level in months.

  As for what's next for crude, we can't tell you. We only knew back in August that crude was unlikely to make any meaningful progress higher. Judging by their all-time record long position, hedge funds had "exhausted their ammo."

It takes an enormous amount of buying power to send a market higher. This buying often comes in at a steady pace... and causes prices to gradually rise. It only takes the absence of buying to send a market sharply lower.

That's why we often say, "The bull climbs the stairs and the bear jumps out the window."

  Despite the short-term correction in crude, oil prices are still plenty high enough to drive shares of oil producers higher... especially those operating in our favorite shale areas... like Texas' Eagle Ford Shale and the Permian Basin. Even $80 oil allows many of these companies to mint money.

Our own Frank Curzio has performed a huge amount of "boots on the ground" research in these areas. Just yesterday, he updated readers of his Small Stock Specialist newsletter on how the North American oil boom is playing out...

Today, Frank says everyone is talking about the Permian Basin... the new technologies... and the best ways to invest in the area.

Investment firm Goldman Sachs recently published a report on the best investing opportunities. Investment firm Morgan Stanley followed suit with a report to its clients, stating that the Permian has "the most operational momentum" of any shale area. Frank continues...

  We leave you with another installment of our new "Three-Minute Trading Expert" series. Remember, each installment of this series lasts about three minutes... and it teaches a timeless investment or trading lesson.

It's part of our ongoing efforts to help readers (and now "watchers") learn timeless wealth ideas. Building a foundation of these timeless ideas to guide your decisions is 100 times more important than any single stock or option recommendation.

  New 52-week highs (as of 10/23/13): Becton-Dickinson (BDX), Fidelity Select Medical Equipment & Systems Fund (FSMEX), Corning (GLW), ProShares Ultra KBW Regional Banking Fund (KRU), Ligand Pharmaceuticals (LGND), Medtronic (MDT), National Fuel Gas (NFG), ONEOK (OKE), Sequoia Fund (SEQUX), and Walgreens (WAG).

  We got more feedback on Porter's manifesto: "Three Ways to Get America Back on Track." Porter argues for a flat income tax rate, a balanced budget amendment, and reduced regulation in the financial sector. What policies would you add? Tell us here: feedback@stansberryresearch.com.

  "Amen! Preach it brother!!!!" – Paid-up subscriber Jeff K.

  "The more I spend on insurances for my business, my family, and myself, and the more I see business strangled by lawsuits, the more I see the need for true tort reforms. Here is what I see we need:

"I know these are pipe dreams because most of our politicians are attorneys and our universities graduate ten times as many lawyers every year as they do scientists. But I have a dream." – Paid-up subscriber Joe

  "Congress and the president's pay should be tied to performance, just like the real world. No balanced budget, no pay increase. Even better, no budget surplus, no pay increase. Jeopardize the credit rating of the US you get a pay cut. No pay, back pay, or unemployment for any govt employee in the event of a shutdown." – Paid-up subscriber John P.

Regards,

Stansberry & Associates Hall of Fame
(Top 10 all-time, highest-returning closed positions across all S&A portfolios)

Stansberry & Associates Top 10 Open Recommendations
(Top 10 highest-returning open positions across all S&A portfolios)

As of 10/23/2013

Please note: Securities appearing in the Top 10 are not necessarily recommended buys at current prices. The list reflects the best-performing positions currently in the model portfolio of any S&A publication. The buy date reflects when the editor recommended the investment in the listed publication, and the return shows its performance since that date. To learn if a security is still a recommended buy today, you must be a subscriber to that publication and refer to the most recent portfolio.