“With COVID, we had an explosion of online commerce that has driven the fundamentals of industrial real estate to unprecedented levels.”
Robin Potts is co-head of real estate investments and director of acquisitions at Canyon Partners Real Estate. Mike Levy is CEO of Crow Holdings where he leads the real estate company’s overall business activities. The talk is moderated by Jan Brzeski, the founder, managing director and CIO of Arixa Capital, a private real estate investment advisor group.
COVID has brought about many changes to the real estate investment landscape. As a result of the pandemic, debt markets have reopened much quicker than the equity. We’re also seeing lenders work with their borrowers to put in place extensions and modifications to account for the challenges faced to during COVID. Industrial real estate has seen rapid acceleration in its existing growth. “With COVID, we had an explosion of online commerce that has driven the fundamentals of industrial real estate to unprecedented levels.“
There has been steady movement into the southeast and southwest of America, a trend that only accelerated during the pandemic. Real estate investment strategy will focus more and more on those regions as the populations continue to grow.
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SPEAKERS
Robin Potts
Co-Head of Real Estate Investments
Canyon Partners Real Estate
Mike Levy
Chief Executive Officer
Crow Holdings
EPISODE TRANSCRIPT
John Darcie: (00:08)
Hello everyone. And welcome back to salt talks. My name is John Darcie. I'm the managing director of salt, which is a global thought leadership forum and networking platform at the intersection of finance technology and public policy. Salt talks are a digital interview series with leading investors, creators, and thinkers. And our goal on these salt talks is the same as our goal at our salt conferences, which is to provide a window into the mind of subject matter experts, as well as provide a platform for what we think are big ideas that are shaping the future. And we're very excited today to welcome you to a panel discussion about the future of real estate in the wake of the COVID-19 pandemic. And our panelists today are Robin Potts and Michael Levy. Uh, Robin is the co-head of real estate investments and director of acquisitions for canyon partners, real estate.
John Darcie: (00:56)
Uh, she has been with canyon for 14 years and is responsible for overseeing the origination and acquisitions of debt and equity investments across canyon partners, real estate platforms, and holds a seat on all canyon partners, real estate investment committees. Michael Levy is the chief executive officer of Crow holdings where he's responsible for leading and overseeing the company's overall business development activities, including strategy investments and organizational resources. He joined the firm in 2016 from Morgan Stanley, where he was the chief operating officer for the investment management division and a member of the firm's management committee hosting. Today's talk as a guest host. His name is Yon Brzeski, he's the founder of, uh, Rick's uh, capital, which he founded in 2006. And he serves as the managing director and chief investment officer for the firm in this capacity. He has ultimate responsibility for the firm's investment strategy, risk management and operations prior to founding a Rick Suh. Mr. Brzeski was the vice president of acquisitions at standard management company, a Los Angeles based private real estate investment firm. And with no further ado, I'll turn it over to Yon, to host today's interview.
John Brzeski: (02:04)
Terrific. Thank you so much, John. And thank you, Robin and Mike for joining this conversation. And why don't we just start out with you could each give a little background on yourself and your firm, uh, Robin, if you could go first, that'd be great.
Robin Potts: (02:19)
Absolutely. Well, thank you for having me. Uh, so I co-head real estate investments at canyon partners. I've been with the firm since 2006. Uh, canyon is an investment manager headquartered in Los Angeles. We have about 26 billion of assets under management. Uh, the firm was founded in 1990 and has a wide variety of strategies across, uh, corporate credit as well as real estate. And within our real estate platforms, we're active up and down the capital stack. So we invest in both debt and equity strategies, um, and we're active across all property types in the top 40 markets across the U S uh, so that includes, you know, being active in ground-up development repositionings lease-up situations and distressed opportunities as well. Um, and our market activity is about evenly split between our debt and our equity strategies.
John Brzeski: (03:15)
Terrific. Mike, uh, tell us a little bit about yourself and your firm and also, um, the, kind of the legacy of your firm as well. Your, your firm has an interesting history in our industry. Sure.
Mike Levy: (03:27)
Um, well, uh, first thank you for having, having me. I am a, uh, a lifelong new Yorker who built a career in real estate finance and five years ago, moved to Dallas, Texas to join the Crow family, uh, in the real estate business, uh, Yon to your, to your point in 1948, a guy named Trammell Crow started building industrial buildings. And over the past 70 years, the Crow family has overseen, uh, numerous businesses across the real estate industry throughout that period of time. Uh, the company is owned by the Crow family today, and, uh, we're engaged primarily in two areas of real estate. One is as a real estate developer. We have a national platform across the United States. We develop, uh, multi-family properties, industrial properties, office buildings across the United States. And that's about half of our business activities in real estate. And the other half of our activities are as a real estate, private equity investor through funds. We invest in value add real estate strategies throughout the United States.
John Brzeski: (04:25)
So Mike, is it fair to say then that on the family side, your holding period is longer and potentially forever. And then on the private equity side, I guess you have to hit return targets. So you need to exit after a certain number of years.
Mike Levy: (04:38)
Yeah. Yon, we have three per, I would say we have three perspectives on real estate. One is as a developer, as someone who is out in the marketplace on a local basis, securing land, going through the entitlement process, buying concrete and steel and building buildings. And we have that perspective as an undergrounds real estate for our real estate, private equity business has a slightly different perspective where we're raising capital alongside partners in co-mingled vehicles. And we're, we're targeting higher return strategies, which sh you know, relatively short duration, three to five year investment periods. And finally, in the third area, the family on behalf of the family over the years has acquired or developed many properties that we owned some of them 30, 40, 50, 60 years. And so we have the perspective of a long-term owner operator and that component of our real estate business.
John Brzeski: (05:30)
Terrific. So why don't we go into a recent investment that you made since COVID, and I think this will be a good way to segue into where's the market today and where do you see the opportunities, uh, Robin, maybe you could give us an example of, of an area where you saw some value and maybe outline a particular investment you made, and then Mike I'd love for you to do the same.
Robin Potts: (05:51)
Sure. Um, so COVID, you know, has reset the marketplace and a number of really interesting ways. So from our perspective where we have, you know, platforms that can go within the debt area, as well as the equity area, uh, there's been an expanded opportunity set in terms of what we can do relative to what we saw over the last eight years. Um, in general, within the marketplace, we've found that the debt markets have reopened more quickly than on the equity side. Although the equity side is definitely, uh, now resurfacing with the vaccine rollout. Um, so on the debt side, I think, you know, the interesting situations from our perspective, uh, that have emerged post COVID have been on the loan sale opportunities. Um, we've seen following COVID since last March, over 13 billion of loan sales that have come to market. Um, and that's really been driven by, uh, initially margin calls.
Robin Potts: (06:48)
So a lot of different lenders, uh, from debt funds to mortgage REITs and other types of lenders that had, um, mismatched leveraged facilities, uh, and faced obligations to pay down, um, uh, the leverage facilities on their portfolio at a very inopportune time. So that created some forced selling situations. Um, and now we're seeing, uh, that those margin calls situations have passed, but, uh, you still have a lot of loan sales being brought to market by banks and debt funds and other lenders who are just rebalancing and repositioning their portfolio based on, uh, where they want concentration and different areas of stress and distress that they're seeing within their balance sheet. Um, and so we've been able to, uh, capture this opportunity set, which really hasn't been available for a decade since the great financial crisis. Um, so one of the interesting transactions, uh, that we recently completed was the acquisition of a portfolio of loans, uh, in excess of 300 million, uh, across a variety of, uh, different properties, uh, the largest concentration being multifamily. Um, and in our view, just a really interesting way to gain access to a repriced situation, um, as a result of, you know, lenders, uh, need to rebalance their portfolio, um, on what in our view were really high quality assets. Um, so, you know, interesting dynamic in the marketplace were, um, kind of secondary opportunities are available, uh, in, in a much different way than they were a year ago.
John Brzeski: (08:31)
So Robin, I'm going to ask you a few detailed questions about that, and if you, if you can't provide all the detail, then just provide what you can. So you bought that at a discount to par I'm assuming what kind of discount is it a few percentage discount or is it, is it, does it get to be bigger than that? And the follow on question would be, um, did you perceive that the, that the debt was really underwater or cross or I'm guessing a few assets were, but probably the multifamily wasn't underwater.
Robin Potts: (09:04)
So, um, as you can imagine, I can't get into specifics on that transaction, but I can just kind of give you the general landscape of, of the loan sale dynamics that are happening. So, um, there are loan sales brought to market that are performing, that are, uh, needing to be sold because of the sellers balance sheet issues there alone sales, where the underlying assets in the loan are stressed. Uh, so maybe they're performing, but moving toward non-performance pretty quickly. Um, or there are loans being brought to market that are true. Non-performing already, they're already in maturity default. And so kind of the level of discount between those three categories varies pretty substantially. Um, so you, you've seen a lot of loans, um, trade, you know, in the nineties are at par, um, uh, but the true non-performing loans, uh, you know, those, those ultimately are a much more tailored discount because you're really anticipating to end up owning the property. Um, and I would say that the, the true non-performing loans that ended up being, uh, ultimately priced at a very significant discount, um, uh, are much more concentrated toward hospitality and retail, um, given the overall, you know, challenges that COVID has presented toward those,
John Brzeski: (10:27)
Right. I'd love to come back to that because this whole, this is an area of, uh, that kind of speaks to what's how, how everything's repriced and what types of assets of reprice. Just one last question, before we go back to Mike for one of his recent investments, uh, who who's actually selling, like, where are the transactions actually clearing the market right now? Because there's been a lot of talk about sales of debt, but, but who is it? Debt funds that are the first to sell? Is it, um, special servicers of CMBS loans? Is it banks, is it domestic, regional, national international? Who are you seeing? That's actually first to acknowledge what's changed and ready to sell,
Robin Potts: (11:10)
Uh, debt funds have been the most active sellers, uh, in what we've seen. Um, banks and insurance companies have also brought a number of loan situations to market. Uh, the least active seller has been CMBS. Um, and it's, I think that's pretty interesting. And I think the, the reason for that is, um, it takes special servicers, such a long time to make decisions and for loans within CMBS to work through the system. Um, whereas debt funds can make much, uh, you know, much more expedient decisions in terms of how to adjust their balance sheet. Um, and we've seen, uh, you know, banks be able to do that as well. Um, but CMBS will just take, I think, a lot more time to work through the system. Um, I would also say that, uh, there've been many situations where loan sales have been brought to market, and then they ultimately didn't transact and the, uh, loan holder just use those bids as a way to mark their balance sheet.
Robin Potts: (12:17)
Um, so kind of sussing out whether someone's a real seller or not has been a challenge throughout this process. Um, and, uh, you know, in addition, a lot of lenders have taken the approach of working with their borrowers and providing for barons and modifications and extensions. So, um, you know, as much as possible, I think that's the approach lenders have taken. And then the loan sales that have been brought to market, um, for the most part have been situations that, uh, kind of are past that for Berenson modification, um, and for whatever reason that's no longer possible, uh, to do, which is really, I think, most lenders first choice.
John Brzeski: (13:02)
Terrific. Mike, um, tell us about a recent transaction that you, that you did at Crow holdings.
Mike Levy: (13:10)
Um, um, I'm going to comment on that investment theme is I suppose, as, uh, uh, as compared to a one-off investment and, but that investment theme is e-commerce, um, and that theme isn't distressed from e-commerce, but growth from e-commerce. And specifically what I'm talking about is in the industrial space. Um, we have seen, you know, this was a trend we could see beginning in 1994 with Netscape navigator, that the beginning of e-commerce, if people were going to buy goods online, but what, what we had happen here as we went through COVID in this period of time, is an explosion of online commerce that has driven, uh, the fundamentals of industrial real estate to levels that are unprecedented. And certainly my lifetime and industrial real estate today across the United States is being driven by three primary forces. One is just the sheer penetration of online commerce and the movement from retail stores into industrial fulfillment centers to get to the customer.
Mike Levy: (14:04)
But there are a couple other trends that are bubbling up and have been bumbling up one directly as a result of COVID. And we've moved from a world of just-in-time inventories to resilient inventories and have corporate America needs to have just a little bit more inventory of certain essential goods like pharmaceuticals or other supply chain, disruption items that, that small amount of additional space results in large amounts of additional demand for industrial real estate. And then finally you had this last trend, which was taking place pre COVID, but I it's pretty clear it's continuing today, which is onshoring and the movement of manufacturing around the world and because of tax and trade matters, moving to the United States. And so what we've been doing in response to that is financing the development and developing, uh, significant of industrial real estate across the major distribution markets. The United States, we will probably this year finance and developed 25 million square feet of industrial real estate. And so it's not about one industrial building or the exact economics of the building in Los Angeles versus the building in New Jersey. But fundamentally we're seeing this across the country and the major distribution markets, unprecedented levels of bright red growth and impressing them to levels of net absorption. And that's been an opportunity
John Brzeski: (15:19)
Financing. Um, the development Mike is that equity financing. So are you prevail providing JV equity to the local, uh, developer typically? Correct.
Mike Levy: (15:30)
We we're, we're, we're not a lender, uh, we're not in the credit business, but we have a real estate development company that builds industrial properties across United States. And we have a real estate private equity business that, that partners with other developers and provides the equity financing for their projects. And so we see the market from both lenses.
John Brzeski: (15:50)
Is that a traditional JV equity, or is it ever take the form of sort of fixed return preferred equity that can be refinanced out later by the owner? Or is it all
Mike Levy: (16:03)
It's traditional common JV equity. It's where traditional, you know, 95, 5, uh, common equity, we'll put up a construction loan of 60 or 65% below that equity. And we'll, uh, we'll build a building together and, and, and sell it either before it's leased or after it's leased in today's market. Sometimes selling a building before it's least as, uh, as attractive to investors is they anticipate more and more rent growth, but it's traditional JV equity. And
John Brzeski: (16:34)
Last question on that, are you doing that both on the family side and also on the real estate private equity side, where you provide a JV equity to the local developer.
Mike Levy: (16:45)
So we're, we're doing it, we're doing it on the real estate, private equity side. So about 40% give or take of our activity as a real estate. Private equity investor today is an industrial development. Uh, but we also pursue it in the real estate development company. Uh, and that activity is in partnership with institutional investors. And so, so those are the two areas that we're approaching the market today.
John Brzeski: (17:05)
Got it. And then, um, Amazon, are they building their own industrial now? And what does that mean for industrial developers like yourselves?
Mike Levy: (17:16)
Well, Amazon is doing many things. They're doing many things on their own, and they're doing many things in partnership with other people and they're acting in built to suit opportunities. And they're also acting as a tenant for buildings. Uh, the people like us build on a speculative basis and they decide as a tenant that, that we built a building in the right location to the right specifications. So Amazon is clearly a major market participant in building out their industrial footprint across the United States today. Uh, and they're, they're, they're certainly able to move the market from there, their solo activity, but this is much bigger than Amazon.
John Brzeski: (17:50)
Okay. Let's move on to winners and losers with COVID. And I want to kind of touch on that, the, the kind of the obvious, but also get into some things that may not be as obvious to, to all of our listeners on this, on this webcast. So, for example, I think it's, it's easy to say that working in the office five days a week is not going to be, uh, as it's not going to be necessary and every single company going forward. So office demand is going to be a little lower hotel. Demand clearly has been terrible the last year, but maybe it comes back. Let's get underneath the surface a little, we talked about industrial, um, being a long-term trend and maybe, uh, COVID has accelerated that. But, um, what, what are some other winners and losers? And you could go a product type, or you could also go geographically, like, like a, I mean, here in Los Angeles, in west Los Angeles, the suburbs are doing a little better, smaller cities are doing better. California's kind of doing worse. Phoenix is doing better. So, so, so maybe how about one observation, which is just you can't, you can't miss this, you gotta know that this is happening. And then one observation that might be, um, not as obvious to people that are outside of our industry. So Mike, why don't we go with you first?
Mike Levy: (19:15)
Okay. The obvious people are moving to the Southeast and Southwest in America, that trend was occurring pre COVID COVID, it's accelerated that trend. It's for many, many different factors that are in it that are engaged in that you can argue it's taxes. It's not just taxes. It's the totality of experiences. It's infrastructure. It's whether it's the build up of these cities, but America is moving to the Southeast and the Southwest. You can look at the domestic migration trends. You should not miss that. If ultimately you want to be successful in real estate, being in a market where people are moving to is a great formula for being successful over long periods of time. So that would be an area that I would, I would find as a bit self-evident, um, maybe in an area that gets a lot of discussion, um, and we're not active in it, but nonetheless is, is, uh, we've obviously seen a secular impact against malls.
Mike Levy: (20:07)
And there's a lot of discussion about converting these malls into whether it's industrial fulfillment centers or mixed use properties, uh, across America. And, uh, and that seems to be something that's grabbed a lot of attention from the marketplace. I would just caution people that converting malls into other uses requires, uh, entitlement and zoning, restructuring, and community groups and residential communities around these malls. That the last thing that these people want is 18 wheel trucks coming through the neighborhoods at night. And they're going to work really hard to keep a single family homes or apartment buildings from being built because they don't want to tax their school systems with additional kids. And so the duration to convert these malls, what they are today to alternative uses it'll happen. But the duration is not three to five years. This will take a long period of time in order for these properties to be redeveloped because the entitlement and zoning considerations that may not be self-evident to everybody involved in the business. Terrific.
Robin Potts: (21:08)
Um, you know, to echo, uh, some of Mike's commentary, uh, certainly the kind of secondary market growth has been an area that we're very, very focused on. Um, uh, you know, meaning we want along with a lot of other managers, uh, exposure in those high growth markets like Austin, Dallas, Atlanta, Charlotte Raleigh, et cetera. Um, but beyond the headlines of just, um, those secondary growth markets, uh, to your comment at the beginning, um, I do think an area that, that does deserve more focuses just the strength of, um, suburban or secondary markets within, or very close to, uh, the gateway markets, um, because you do have this tale of two cities just within, uh, kind of the greater gateway markets as well. Um, so for example, if you look at, uh, the bay area and the challenges that multi-family rents have had, um, an occupancies within the bay area with, you know, double digit, uh, impacts on rents, um, and significant occupancy challenges.
Robin Potts: (22:20)
Um, you're seeing the inverse of that in Sacramento, which has been, you know, a top three rent growth market, uh, over the last 12 months. Um, and so, you know, there are, well, there are a number of people, um, and companies focused on, uh, you know, moving from California to a different location. There are also a lot of people who need to stay in California for a variety of reasons. Um, and it's making those secondary locations within some of these, um, uh, areas, very attractive and high growth. Um, so we've been spending some time on that as well. Um, and then from a property type perspective, you know, I would just say, uh, our view on the hospitality industry, um, is you really have to dig down asset by asset because it's not one size fits all in terms of the effects of COVID on, on hotels.
Robin Potts: (23:16)
And we, um, absolutely think that this is a kind of temporary shock to hospitality, as opposed to what you're seeing in retail, which has been, you know, a structural decline over a very long period of time. Um, but within hospitality, you see, um, areas of bright spots and, and, uh, segments of the hotel industry that are going to come back much more quickly. So, you know, your select service sets that don't have a heavy FNB component, um, you know, your assets in a drive to markets that have, you know, demonstrated a lot of resilience, uh, post COVID. Um, and then at the other end of the spectrum, in terms of the assets that are going to take longest to recover, you know, it's those assets that rely on group business and corporate travel. Um, so your big box convention center hotels, uh, really do need quite a fair amount of time to restabilize. So, um, you know, it, it's, it's the winners and losers really require a granular exercise and, uh, you know, pursing asset profiles and sub-markets in a quite detailed way.
John Brzeski: (24:24)
Okay, I'm going to give you each a little, uh, heads up I'd like for you to each think of one question for each other that you can ask the other person based on what each, each of you does that you'd be interested in knowing more detail about. And I'll get back to that in a minute, in the meantime, uh, want to do a quick, quick feedback question. So let's talk about New York city and San Francisco, how long in each case until COVID is in the rear view mirror, and things are going great guns again, and everybody wants to be there again, if ever, if ever, if you think that's going to happen in our careers. And, and, you know, I, I give me, give me, uh, an estimated number of years for each one, when you think fully back to where it was. Um, and let's go with you first, Mike, as a native new Yorker
Mike Levy: (25:15)
Look, th the, the mega trend, the 500 year trend can continue to be around urbanization and major cities in great cities like New York and San Francisco being, uh, along the coasts and in port areas. Uh, I wouldn't bet against them over a 10, 20, 30, 40 year period of time. Uh, that's not exactly the question you asked. So we're going to this as society be vaccinated by the summer, give or take, that's pretty clear whether anyone chooses to get vaccinated, it's their decision, but it will be available to us. And so arguably one would think that by the end of this year, that we will absorb, have absorbed this in our lives and be able to manage it a level to allow us to engage with one another in a city like New York has been so crushed like San Francisco because of public transportation and tall buildings and elevators and people not wanting to get close to one another.
Mike Levy: (26:04)
So that should begin to burn itself off, you know, as we go into the end of the year and people are expected to get back to work, but there will be a residual here for quite a number of years. There are people who have already taken decisions to leave. There are people who've made temporary decisions that are turning into permanent decisions. New York's mega trends around population growth had already started to turn against it prior to COVID. There were, there were forces at work prior to COVID that were not positive in terms of continued migration into the city. Um, you know, I think it's going to be 3, 4, 5 60 years, uh, before the totality of these burn off on a generation of people. And now a new group of 22 to 26 year old people come into the city who didn't have any of these experiences. I don't think it's 24 months from now, and we're back to the same population, the same economic activity, uh, and the same tax base that we had.
John Brzeski: (27:01)
Do you think Sanford, do you think San Francisco snaps back sooner then New York? Is that one of the things you're saying,
Mike Levy: (27:07)
You know, it's interesting, cause we're all biased by the seats. We sit in and I now sit in Dallas and I can't tell you the number of people from Los Angeles and San Francisco that are moving here between Dallas and Austin. And so I see a stronger tug away from California than New York right now, based upon my interaction with people and the experience that they have that are not just COVID, but that are the totality of their life experiences in these cities right now. And whether those are taxes or other like quality of life factors, uh, I've also seen quite a number if you listen to corporations across America, the most prolific corporations across America that have said my workforce will work from home and no longer need to be here. They're from San Francisco. The company's making the strongest statements that you'll never need to come back into. The officers are coming from San Francisco. So I wonder how will that take hold? Okay.
John Brzeski: (27:58)
Robin, what do you think
Robin Potts: (28:03)
I agree with, with at least a three-year timeline to see, um, kind of the convergence back to 2019 numbers across asset classes for New York and San Francisco, um, and maybe longer in certain areas, but, uh, three years seems I think a reasonable assumption. Um, the challenges with the gateway markets and New York and San Francisco in particular is that, um, COVID has shut down the international migration and international travel. And so all you're seeing right now is the domestic trends and, um, New York and San Francisco relies so heavily from a demographic perspective on that international activity. Um, you know, for a long time, if you've, if you've stripped out, um, uh, the international and migration, uh, the New York and California, uh, population growth would not have been positive. And it's that, you know, international attraction that keeps, keeps that growth positive. So this isn't, um, necessarily COVID specific in terms of the kind of domestic and migration shifting to, um, lower cost and more affordable states. Um, so once you're able to have that, uh, international movement resume that will really help support those two cities in particular. Um, and that's also why they've been hardest hit from a hospitality perspective, you're missing all of that tourism element, um, as well as the longer term, uh, movements as well.
John Brzeski: (29:44)
Okay. Let's talk about office for a minute. I know I'm neither of you as an office specialist, but, uh, many international investors, especially sovereign wealth funds and pension funds. They're attracted to class, a office central business district, and the, you know, in the top markets in the U S is there any distress buying opportunities for those types of buildings today? And, and talk about how much have values come down and give me give a range if you can, from peak values, which presumably would have been a little before the pandemic to today, any information either of you can shed on that.
Robin Potts: (30:25)
So I think, you know, um, the, the winners in terms of multifamily and industrial and life science are very clear post COVID and the losers that are having the most challenged time in terms of hospitality, the hospitality and retail are very clear and office sits in, in this middle area that people, um, it's going to take time to play out because you still have, um, the, the corporate decision makers in terms of leasing and relocation activities. A lot of those decisions have been put on hold. I mean, you've obviously seen some, uh, companies make those decisions during COVID, but for the most part, the leasing, uh, activity has been kind of short-term extensions and companies have postponed a lot of that normal decision-making for the long-term. Um, and as a result, just overall office transaction activity is, is way down. Um, you know, if you're an office owner, uh, selling right now in this, you know, strange environment obviously is something that, that most owners are looking to avoid.
Robin Potts: (31:30)
So there's not a lot of data points in terms of valuations to, you know, really answer your question. Unfortunately, I would say we've seen more movement on the office side, um, on the notes sale, uh, side. And, um, the values that we've seen be impacted from that perspective really are you're kind of class B older commodity office product. That type of office is very, very challenged, um, especially coming out of COVID. Um, there's a lot of cap ex that's needed in those buildings to address today's health and wellness standards to attract or keep tenants. Um, so the, the amount that it costs for older class B office, um, to, to, uh, essentially keep your rent roll is pretty extraordinary, um, for your newer class, a office that can actually meet the, um, you know, new technology and health and wellness and touch, you know, touchless and outdoor amenities standards that people want to see in this post COVID worlds. Um, you know, there's going to be in our view, this flight to quality from both the tenant and buyer perspective. Uh, so I think there's going to be this winner and loser segment within the office market as well, but the transaction activity hasn't transpired to really pinpoint the value impact.
John Brzeski: (32:55)
So no, there are no data points really on, on how much office values have changed. I mean, I'm sure that you could, uh, there must have been some transactions of, of, you know, large office buildings. Mike, do you have any insight into that? Look there.
Mike Levy: (33:11)
What there is in the office space. Now I'm going to repeat quite a bit. What was said is just, uh, an uncertainty. Um, look, you've seen big, w you asked the question about distress, big distress in big retail, big distress in hotels. Now there's not a lot of trades there either because the lending community is being too cooperative, but, and maybe that's a question I'll ask the Rob and later about distress, but in office it's uncertainty, right? And uncertainty paralyzes people. And unless the lenders are going to foreclose and take control, but there hasn't been massive operational distress in office, even New York city, where I believe something like only 15% of the office buildings are occupied today, people are still paying rent. And so you haven't seen that kind of distress forcing, you know, the sales and the lenders have actually been too cooperative. You've been willing to work with waiting to get to the other side.
Mike Levy: (34:01)
But when you talk to people in the office business, whether you're a buyer or seller, it is the uncertainty. What percentage of people will really work from home? How many, a days a week will they come in? How do I underwrite the future cash flows? How do I know what this thing might be worth? And as a seller, if your lender is enforcing you to sell it, you're not going to sell into that uncertainty. And as a buyer, you're careful about your capital buying into that uncertainty. And so this uncertainty has really stifled activity. One of the things that seems to be clear from a design perspective is we went through a 40 year trend to densification, right? We went from 250 square feet to 125 feet, 125 feet per, per person in an office building. My sense is this COVID is certainly going to push people a little bit further apart from one another.
Mike Levy: (34:51)
And that's going to be a lingering feeling. And then owners of office buildings, if they're not modern buildings with modern, uh, health and wellness and ceiling Heights and HVAC systems, there's going to be a real renewed focused on wellness and the office space. And how close are you to me every single day. And that could be ultimately, that's going to be a big cost to the owners of office buildings, but it could expand in some areas, the actual square footage that a given company's going to need, because they may, might not be as dense with one another, but those are all topics on design. But in terms of transaction activity, I'm not an office investor. We do develop office buildings in high growth states in Greenfield areas like Frisco, Texas, where people are moving to, but we're not acquirer of existing office buildings, but I don't see a lot of transaction flow out there right now
John Brzeski: (35:43)
That raises another question. You both invest on behalf of institutional investors, and I believe your, you need to mark to market quarterly, the value of assets that are in the portfolios that you, that you manage do either of you have data points, either from your own portfolios or elsewhere of, of asset types that have declined based on the appraisal, or have the appraisals come through close to their peak value because cap rates have compressed since, since COVID as well.
Robin Potts: (36:18)
Um, we've seen appraisal adjustments and, um, hospitality, um, and non-grocery anchored retail as a retail. You know, the grocery anchored and high credit tenant, long duration retail is, is actually a favorite asset class still, but all other types of retail, uh, definitely are reappraised downward. Um, and, you know, uh, kind of anything that has restaurant FNB, entertainment, oriented exposure, that's, uh, that's been, uh, shut down during COVID or a very low occupancy during COVID. All of those have certainly had effects, um, from an appraisal perspective. Um, but otherwise, you know, the, the, just the broad lat lack of transaction activity, um, uh, because appraisers are backward looking in terms of comparable sale data points, uh, it continues to be largely supportive. Um, for us, that's not to get reappraised significantly beyond the most hurt property types, because appraisers just don't have those new data points, uh, to comp to,
John Brzeski: (37:33)
Okay, Mike, um, if you have anything to add, go ahead. Otherwise I want to get to one other topic, and then I want to let you each ask questions of each other.
Mike Levy: (37:42)
Well, I'll, I'll try and just go a little further out of the limb. UK obviously looked up public markets and, and you can look to appraisers and private markets I'll make a generalization across the spectrum just for, for the group. It seems to me that when you're looking at these various metrics of value, it looks like the hotel industry kind of down 10 to 25%. Uh, you know, you look at these big malls and these big power centers, these big retail, these, the, these are worth less today as well, but not all retail is worth less today. Grocery-anchored shopping centers and small food and service centers have done great, right? And so retail is a dichotomy of values. You know, the office sector we talked about, it's uncertain. It's probably not a net positives, but you haven't seen much movement there. Multi-families done great. I know there are headlines out there that people aren't paying rent, but the truth of matter is in class a in high-quality multi-family throughout the United States, people nesting in their homes and they're paying rent and rent is going up and multi-family is more attractive today than it was. Cap rates are lower and industrial is on fire and worth more. And so this valuation spectrum, the impact here has been, there's been winners and losers from evaluation perspective. And that's how I see it based upon appraisals and private market pundents and public market forecasters and, and transactions that are taking place today.
John Brzeski: (39:02)
Okay. I want to switch gears. We've got probably a little less than 10 minutes to go and ask a different type of question. Many of the people in our audience are in a position of placing capital with sponsors, either fund managers or individual transaction sponsors that are raising LP capital. And I want to see if you could each give them some advice, maybe even ideally, based on mistakes that you've experienced in your career, that, you know, the, the worst transactions you've been involved with, what would you tell our audience that, that they should not do or avoid that maybe so they could save them some trouble that you experienced through each of your extensive careers in real estate when they're making investments with real estate sponsors of any time, whether it be a fund manager or a, um, or someone that's buying a specific property and is raising capital for that project, any, any learnings that you can share and maybe, uh, whoever chooses, uh, whoever's got something to say first, please go ahead.
Robin Potts: (40:08)
Um, I guess I'll jump in first. Uh, so, you know, when investing with the fund manager, um, I think one of the things that, that a lot of investors may have learned over the last year is that, um, you know, that fund managers existence and experience across multiple cycles really does matter. Um, you've seen, you know, over the last 10 years, just a proliferation of new funds and new managers, uh, that didn't have experience managing portfolios through the great financial crisis. Um, and a lot of those new funds and new managers, uh, didn't necessarily have a fully built out asset management team to deal with the very unusual types of challenges that COVID is thrown at all of us. Um, and may not have, uh, you know, we've seen firsthand a lot of funds who didn't structure their leverage in a way that, um, could withstand shocks to the system and, um, uh, you know, ciao deep challenges within the portfolio. Um, so, you know, my, my advice would, would really be to dig into the track record and understand how, um, a manager has performed at different challenging points in time. And, uh, there should be lessons learned. There will be deals that have lost money if you've invested through multiple cycles, um, and making sure that you have a manager who, um, has actually incorporated best practices based on those lessons learned, I think is just incredibly impressive.
Robin Potts: (41:44)
Um,
Mike Levy: (41:45)
Look as any asset class, there are many ways to invest in real estate and, and, and, and different funds and sponsors out there looking for lower risk, low return strategies, higher, higher risk, higher return strategies. But within all that, if I had to boil down to one thing over cycles, and over time, it's leverage, it's fundamentally our ability where private illiquid asset class, no one can guess economic trends or capital market cycles with any degree of specificity, make sure that you financed your property in a way that if you get that incredibly wrong, that there's no scenario where you can't get to the other side of that economic cycle. It is fundamentally leverage that will destroy your returns more than anything else. Uh, and that's something to be incredibly careful of and make sure that your sponsor manager is really capitalizing their investments in a way that if they're wrong in terms of their exit, and they need to hold this through a cycle or through a period of time that they'll be able to do that, whether it's the underlying leverage of the real estate or the capital reserves necessary to protect, protect, and preserve that asset during a period of financial market distress.
John Brzeski: (42:53)
Okay. Mike, why don't we go to your question for Robin?
Mike Levy: (42:58)
So when COVID first broke, there was a huge amount of activity and energy around raising large pools of capital to pursue distress in real estate, let alone the tens hundreds of billions of dollars. It's already on the sidelines from existing market participants, but there was all sorts of folks out there raising large funds to pursue it. What's going on in the pursuit of distressed real estate today. What is the reality of the capital being, being, being put to work in, in any of these distress real estate areas?
Robin Potts: (43:32)
Um, so I think a lot of, a lot of the capital that was raised initially post COVID, um, uh, was best suited if it was able to take advantage actually of distressed in the public markets where, you know, things are liquid and could actually transact a distressed prices, um, within the private real estate markets. Um, there definitely has been, uh, I think less distressed volume than investors were anticipating because of the dynamics that we discussed originally, where, um, lenders have been forbearing and modifying and extending, um, uh, to the extent possible with their borrowers, uh, to, to provide a lifeline. Um, but it, you know, it will unravel it's, it's just a matter of time. Um, and there have been situations to, uh, to pick off over the last 12 months. And I think that as the, the, uh, economy reopens, you'll get to the point on a number of assets where the borrowers just, or the owners just aren't able, uh, to continue to fund the operating deficits, uh, given that this has gone on for so long. And so it will just take time for the distress to work through the system. Um, but ultimately, uh, from a volume perspective, we are not expecting it to be as large as, uh, what everyone saw on the great financial crisis where essentially, uh, parties on multiple sides of a transaction were forcing that sale. And, uh, in many cases that that's not happening today.
Robin Potts: (45:11)
Thank you.
John Brzeski: (45:12)
All right. And Robin, your question for Mike.
Robin Potts: (45:16)
So, you know, we've seen, uh, cap rates on a multi-family and industrial over the last 12 months, tighten up to 50 basis points in certain markets, um, given that, you know, incredible pricing dynamic, are you a buyer or seller today and multifamily and industrial?
Mike Levy: (45:37)
So we're where for the most part, whether it's as an investor, as a developer, we're in the manufacturing business right now, or those asset classes is what I would say. Um, the opportunity for us to, as we look at the marketplace, we think, uh, cap rates are a component, but, but it's fundamental rental growth and rental demand is what we see. It's the operating fundamentals behind those asset classes. That that is what is attracting us. And those operating fundamentals, uh, seem to be screaming for more supply. You know, America is under house by millions of housing units, right? It's not all going to be met in single family homes. A lot of it's going to be met in apartments. Uh e-commerce and other forces are at work. And so this fundamental demand, uh, has, is putting us in a position that we see the opportunity is creating new properties, you know, for this underlying demand.
Mike Levy: (46:28)
And as we build on some of them, we do hold for long periods of time because that's the investment strategy for ourselves and our partners we're looking to build to core. Um, and when we develop these properties, we can develop them at, you know, 100 to 200 basis point yield on cost differentials to the current cap rate environment. And, and, or we'll sell at that point in time to someone who wants to own a core piece of real estate at those attractive cap rates. And we'll realize the profits at that moment in time from taking that risk and that work of building these buildings.
John Brzeski: (47:03)
Okay. So we're down to our last question and I'm going to make it a hybrid. So I'd like for you to share anything that you think might be valuable to the audience, um, if you have anything like that and, or answer my last question, namely interest rates and inflation, obviously, um, those two things both affect real estate investment decisions. And I'd like to know what your internal assumptions are today about both interest rates and inflation. When you underwrite, when you discuss investment strategy, what are you, what are you internally talking about with respect to both those things? So why don't we go to Mike and then let's end with Robin.
Mike Levy: (47:48)
So on the one hand, I've spent my entire career now from the very beginning that interest rates were on their way up, uh, then inflation was on its way up and I've spent my entire career now watching the exact opposite thing happen and the smartest people in the world from the most well-heeled institutions consistently telling the marketplace that it was going up tomorrow. And so now the question is we go to the COVID and we wind up with a 0.7, 10 year bond. The answer is, it must go north from here and there's in the marketplace in the past week or two, there's been inflation concerns out there, the ability for any of us to guess the future with respect to interest rates and inflation is a bit of a fool's errand. And so the question is when, you know, you don't know, right, how do you run your business?
Mike Levy: (48:30)
And so fundamentally we, we generally are from a modeling perspective, making some increase in interest rates on a forward curve. Uh, we're looking at exit cap rates that are slightly, uh, greater than the entry cap rates in the, in the, in the investments that we have. Uh, but we are not looking at a scenario of runaway inflation, uh, in our investment period over the next three to five years. And we would expect an inflation environment to be consistent with what it has been in the, in the very, very low single digits. That is how we're running our business at this moment in time, not withstanding all of the anxiety, given all of this money that is being pumped into our system today, uh, and the longterm implications that may happen.
Robin Potts: (49:16)
I think it's a really interesting, uh, backdrop economically for commercial real estate. You know, you have, um, the recent stimulus package hitting this quarter quarter of, you know, 900 billion, which just as an unprecedented enormous amount of stimulus being pumped into the economy. Um, and then you have on top of that, you know, the new administration's, uh, proposal that's multiples of that, uh, potentially also hitting this year. Uh, so you have just this tremendous amount of stimulus, which gives kind of a backdrop of inflation. Um, while at the same time, uh, the fed has been very clear from a monetary policy perspective that we're in a continued low interest rate environment for the meaningful future. Um, so that is just a broadly favorable backdrop for commercial real estate. Um, and, uh, you know, all of this, uh, underlying support, uh, between interest rates and stimulus, um, I think sets us up very well for an interesting recovery across, you know, multiple asset classes within real estate. Um, so we're, you know, we're pretty excited about, uh, leaning into those asset classes and markets that are going to benefit the most from that dynamic
Mike Levy: (50:42)
Yon. I think for the audience as well, inflation isn't necessarily a bad thing for the real estate industry. You know, we should, we should step back. And first of all, cap rates are not a hundred percent correlated with interest rates at all. Second thing is real assets and hard assets seems to do generally well and inflation of periods of time. And there are some asset classes like multifamily that rent to reset literally every day and taking advantage of that inflation environment. The hotel business rents are reset every day. So maybe if you have a 20 year fixed bondable lease with no, uh, with no bumps on an annual basis or CPI bumps that works more like a fixed income instrument. And that's physical building may be disadvantaged during an inflationary period of time, but a lot of real estate will do well in an inflationary period of time. And so it's not all bad
John Brzeski: (51:32)
Well said. I want to thank Robin pots from canyon, Mike Levy, from Crow holdings, uh, John Darcie and salt organization. And then I want to thank our audience as well for joining us for this conversation today. Thank you very much.
Robin Potts: (51:49)
And thank you everybody who tuned into today's salt talk with Robin Potts and Michael Levy hosted by our friend Yon. Brzeski just a reminder. If you missed any part of today's talk or any of our previous talks, you can access our entire archive and sign up for all future salt talks on our website@salt.org backslash talks. You can also watch all these episodes on our YouTube channel and you can become a subscriber there. Uh, it's called salt tube. We're also on social media. We're most active on Twitter at salt conference, but we're also on LinkedIn, Instagram, and Facebook. And please spread the word about these salt talks. We love growing our community and on behalf of the entire salt team, this is John Darcie signing off for today. We hope to see you back here soon again on salt talks.