Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.
Speaker 2: I'm Joe Wisenthal and I'm Tracy Alloway.
Speaker 1: Tracy. When it comes to real estate troubles, you know,
Speaker 1: one surprising thing is, I guess how strong the housing
Speaker 1: market has remained this year despite the rate increases. When
Speaker 1: people talk about troubles in the real estate industry, though,
Speaker 1: it's mostly the conversation has been on commercial real estate.
Speaker 2: Yes, and actually a specific segment of commercial real estate.
Speaker 2: So for obvious reasons, everyone has been very focused on
Speaker 2: what's happening to office properties. You know, the whole work
Speaker 2: from home trend means there's less demand for offices ostensibly. Meanwhile,
Speaker 2: higher interest rates are increasing expenses, and so that has
Speaker 2: been the predominant area of attention. But of course there's
Speaker 2: also the forgotten I call it the forgotten commercial real estate,
Speaker 2: which is actually multifamily residential, which counts as commercial real
Speaker 2: estate technically.
Speaker 1: Right totally. And you know what we talk about residential,
Speaker 1: and we often talk about it in terms of just
Speaker 1: single family homes and what's happening to home prices specifically,
Speaker 1: and of course that's a huge part of the real
Speaker 1: estate industry and where people Live, but we talked about
Speaker 1: this in September, I think it was with Julia Coronado.
Speaker 1: One other big thing that's happened over the last several
Speaker 1: years is just this incredible boom in apartment buildings, multifamily dwellings,
Speaker 1: particularly across the Sunbelt.
Speaker 2: Yes, so I remember this sort of twenty twenty twenty
Speaker 2: twenty one is just staggering amounts of construction of multifamily
Speaker 2: properties that were intended, I think, primarily to be rented
Speaker 2: out in super popular areas of the country like Texas
Speaker 2: or Arizona, places like that. Of course, since then, my
Speaker 2: understanding is that we've obviously seen an increase in interest rates.
Speaker 2: We've also seen or started to see a decline in rents,
Speaker 2: and so your cost of financing is going up while
Speaker 2: your income from rentals is actually going down. That seems
Speaker 2: like a bad combination.
Speaker 1: Right, So a big question is like, who are I
Speaker 1: guess the bag holders, or maybe that's a question, or
Speaker 1: maybe that's when or how heavy is that bag? Because presumably,
Speaker 1: you know, no one anticipated the surge in financing costs,
Speaker 1: no one really anticipated the surge in inflation construction costs,
Speaker 1: and you know, rent growth had been one of those
Speaker 1: things that just like went up and up, it went
Speaker 1: wild during twenty twenty, twenty twenty one, twenty twenty two,
Speaker 1: one of the most dominant drivers of inflation overall. But
Speaker 1: supply and demand seems to be a real thing. And
Speaker 1: it seems as though, with this incredible boom and supply
Speaker 1: that we actually have seen some softening in rents.
Speaker 2: Here's hoping.
Speaker 1: But this is where we have to caveat that we
Speaker 1: never actually see the softening rents. None of us will
Speaker 1: ever have rent cut.
Speaker 2: But some mythical unicorn like I have heard that rents
Speaker 2: go down. I have yet to experience it. Actually, you know,
Speaker 2: I just got my new lease agreement offer.
Speaker 1: What's them?
Speaker 2: I'll just say it's gone up, Joe. Okay.
Speaker 1: See, let's put it this way. Charts exist on the
Speaker 1: Internet that show the line going down the other direction.
Speaker 1: Whether those charts are actually reflective of anyone's reality, that's
Speaker 1: a separate question. But I have seen charts that at
Speaker 1: least in some cities, again probably more Sun Belt boom
Speaker 1: cities Austin, Nashville, Atlanta, that rent prices have gone down. Okay,
Speaker 1: I've seen the charts.
Speaker 2: Okay, I too have seen charts. Okay, let's keep going.
Speaker 1: Well, so then the question is what is really happening
Speaker 1: in reality? And we sort of got to get a
Speaker 1: uperger check on. Okay, if rents are going down unexpected Lee, supposedly,
Speaker 1: if all these things have caught the industry by surprise,
Speaker 1: how big is that bag, who's holding it? And how
Speaker 1: much trouble could it be in? And I think we
Speaker 1: have to have this conversation because again, so much of
Speaker 1: the convo in the discourse has been about office.
Speaker 2: It's all offices, all the time. So now we turn
Speaker 2: to the again the forgotten corner of commercial real estate.
Speaker 1: Well, I'm very excited we have the perfect guest to
Speaker 1: discuss it, someone with a lot of experience in the
Speaker 1: multi family world. We are going to be speaking to
Speaker 1: Lee Everett, head of research and strategy at Waterton. It's
Speaker 1: a multi family investment manager. It's been around since nineteen
Speaker 1: ninety six. So Lee, thank you so much for coming
Speaker 1: into the studio and coming on odd lots.
Speaker 3: Thank you very much. It's some pleasure to be here.
Speaker 1: Who are you and what is Waterton? And I just
Speaker 1: asked that at the beginning because I figure listeners might
Speaker 1: want to know why we're talking about.
Speaker 3: My name's Lee Everett. As you stated, I've been in
Speaker 3: the industry now for roughly twenty years, the entire time
Speaker 3: focused on the residential sector, and I've touched everything from
Speaker 3: senior living to multi to single family, and primarily I've
Speaker 3: spent that time advising internally or externally as a consultant
Speaker 3: sea level executives on the multifamily sector. Today, I head
Speaker 3: up research at Waterton that's a multi family investment advisor
Speaker 3: with about fifteen billion AUM today. We operate in the
Speaker 3: top thirty markets in the US. We're primarily a value
Speaker 3: add shop, so we're buying, improving selling homes. Our funds
Speaker 3: are primarily closed end funds, so it's a controlled hold
Speaker 3: period and a controlled time.
Speaker 2: You mentioned research, and you also mentioned that you were
Speaker 2: a consultant. What are the kind of things that you're
Speaker 2: hearing in the market right now.
Speaker 3: I think it's it's dark days in general for a
Speaker 3: lot of the market right now, and it's primarily been
Speaker 3: driven by a capital markets event that we've never experienced
Speaker 3: in this industry. I tend to think that we're going
Speaker 3: to end up seeing the twenty one and twenty two vintage,
Speaker 3: which was the largest transaction volume years on record for
Speaker 3: multifamily by huge amounts, end up one of the worst
Speaker 3: vintages in the history of our industry in twenty twenty one.
Speaker 3: In the fourth quarter alone, over one hundred and fifty
Speaker 3: billion in apartments transacted.
Speaker 1: Wait sure which quarter in twenty twenty one.
Speaker 3: Q four Okay. Over the course of the year, over
Speaker 3: three hundred almost four hundred billion transacted. To put that
Speaker 3: in perspective, the previous high in twenty nineteen was under
Speaker 3: one hundred and ninety billion for an entire year. WHOA.
Speaker 3: So capital came into the space like we've never seen
Speaker 3: before now, this capital entrance, it was primarily driven by
Speaker 3: two things. The rent growth that you both have alluded
Speaker 3: to earlier. What we saw that year was over seven
Speaker 3: hundred thousand renter households form in the US. That is
Speaker 3: over two and a half times the prior record. As such,
Speaker 3: we ended up with rent growth that pushed over fifteen
Speaker 3: percent some markets Phoenix, other Sun Belt markets. You saw
Speaker 3: rent growth on new lease turns coming over twenty and
Speaker 3: thirty percent pretty consistently. And what was really crazy about
Speaker 3: this was there was a massive spike in renter incomes.
Speaker 3: So these rents were relatively affordable, as incomes were actually
Speaker 3: rising quicker than rents at this period.
Speaker 2: Was that driven by people moving into the area and
Speaker 2: maybe doing more work from home and bringing higher salaries.
Speaker 3: With them, or in many instances, yes, that's what would
Speaker 3: primarily drive the large renter income increases. And say a
Speaker 3: Las Vegas, where you're getting some la people that may
Speaker 3: not have been as wealthy there coming into a market
Speaker 3: where your meeting incomes like sixty thousand dollars eighty thousands,
Speaker 3: a lot wealthier relative to the median in Las Vegas.
Speaker 3: It also was driven by, frankly, a lot of household
Speaker 3: fractionalization that was pent up demand. You had people losing broommates,
Speaker 3: you had people moving out of their mom's house it
Speaker 3: had been there for a long period of time, I
Speaker 3: mean being frank In twenty twenty one, we had working
Speaker 3: age population losses as a country while we were generating
Speaker 3: all of these households. So the explosion in the labor
Speaker 3: force allowed people to form households, both as millennials that
Speaker 3: hadn't and this filled a lot of the suburban product,
Speaker 3: the single family rental product and such, and gen Z
Speaker 3: backfilled the city at an incredible rate. This wasn't like
Speaker 3: the millennials coming out of the GFC, where everybody had
Speaker 3: three and four roommates. Gen Z was living one, maybe
Speaker 3: two roommates at the most, and a ton of them
Speaker 3: were able to live alone in our major cities, and
Speaker 3: that just drove demand that we'd never seen real quickly.
Speaker 1: Save the numbers again for twenty twenty one, what was
Speaker 1: the total for that year?
Speaker 3: The total transaction volume? Yeah, it was between three hundred
Speaker 3: and fifty and four hundred billion.
Speaker 1: And the previous high one nineties.
Speaker 3: Yeah, it was around one ninety.
Speaker 2: And when you say vintage, that's that's a very specific
Speaker 2: or I think of it as a specific term related
Speaker 2: to to CMBs, so commercial mortgage backed securities. So is
Speaker 2: the suggestion that the financing for these multi family properties
Speaker 2: was bundled and sold off as bonds.
Speaker 3: It was bundled, but primarily as clos which I think
Speaker 3: we're going to need to get into because that's sort
Speaker 3: of the other side of the coin here. Was at
Speaker 3: the same time we had this vintage. First off, what
Speaker 3: I mean by that is deals that traded in that
Speaker 3: year or were purchased in that year, and you had
Speaker 3: basically a half a trillion dollars trade between the beginning
Speaker 3: of twenty one and the middle of twenty two. That
Speaker 3: vintage is everything that traded over that period. And while
Speaker 3: you had these soaring fundamentals I spoke about at the
Speaker 3: same time. So fur was zero, the tenure was zero
Speaker 3: to one, so financing was so easily available. You had
Speaker 3: people enter the space that had never been in the
Speaker 3: space before. They were projecting massive revenue growth, and they
Speaker 3: were able to buy it very low yields because of
Speaker 3: the low financing costs. Now, what were those low yields?
Speaker 3: Cap Rates in the space got down to, say, in
Speaker 3: Phoenix two for nineteen seventies and eighties vintage product that
Speaker 3: wasn't ideally located, you were looking at a three and
Speaker 3: a half percent cap rate.
Speaker 2: Can you just remind me cap rates from what I remember?
Speaker 3: Right?
Speaker 2: Yeah, so maybe this has changed, but from what I remember,
Speaker 2: like less than five percent was considered pretty good, not
Speaker 2: that risky, and like more than seven percent is kind
Speaker 2: of bad. Is that right?
Speaker 3: You're backwards, am I? So the higher the cap rate,
Speaker 3: the higher your income to price ratio is. So it's
Speaker 3: NI over price, okay, and the less NOI you have
Speaker 3: over price. Essentially, the more risk you're taking on in
Speaker 3: the deal because you're relying far more on value to
Speaker 3: be driven by price growth rather than NI growth. And
Speaker 3: when you're buying it, say a three and a half
Speaker 3: cap a not ideally located property, you're very much relying
Speaker 3: on that income to price ratio staying the same or declining,
Speaker 3: especially if you're doing so with interest rates that are
Speaker 3: around two percent, which is what you're looking at at
Speaker 3: that period in time for short term floating rate debt,
Speaker 3: which is what really flooded the space, and this is
Speaker 3: what's become what fed these clos that have grown.
Speaker 1: So there's all kinds of a million questions already, But
Speaker 1: why don't we actually just since you talked about the
Speaker 1: financing structure short term floating rate debt. So Tracy and
Speaker 1: I have done a number of episodes on credit and
Speaker 1: the looming maturity wall for corporation. Tracy, it's just I
Speaker 1: say looming, but there's not in the case of this,
Speaker 1: this has to be refinanced very quickly, like talk about
Speaker 1: this sort of Okay, someone does a deal, what are
Speaker 1: the terms, how far when do they have to pay
Speaker 1: it back? How does that work?
Speaker 3: So these deals were primarily financed by debt funds, and
Speaker 3: what ended up happening was they were issuing what's called
Speaker 3: bridge loans. These bridge loans were meant for people who
Speaker 3: entered the space to be able to buy a property
Speaker 3: with floating rate high leverage. By high leverage, I'm talking
Speaker 3: seventy five to eighty percent, sometimes even higher. Now, when
Speaker 3: you're buying floating rate at a two to twenty five
Speaker 3: interest rate handle with eighty percent leverage, your returns look
Speaker 3: really good until that floating rate debt starts to move upward.
Speaker 3: And what we've seen today is a five hundred basis
Speaker 3: point increase in SOFA over since those that debt was done,
Speaker 3: So you're looking at five percent higher interest rates. The
Speaker 3: fundamentals that were there in twenty one are no longer there,
Speaker 3: so you have declining NI and as such, what you've
Speaker 3: seen is these bridge loans that need to be refinanced
Speaker 3: in twenty three, twenty four, and somewhat in twenty five,
Speaker 3: they don't pencil anymore. You were essentially to get this
Speaker 3: debt writing to a debt service coverage ratio in twenty
Speaker 3: one of about one point twenty five, and that's how
Speaker 3: much your income can cover your debt Today because of
Speaker 3: increase in debt costs, decreases in net operating income, and
Speaker 3: increases in another expenditure such as insurance, some of these
Speaker 3: buildings are looking at a debt service coverage ratio below seven,
Speaker 3: and that's very common, and that means these buildings can't
Speaker 3: pay their debt. And this is a mounting wall. I
Speaker 3: think in twenty four we're looking at about thirty four
Speaker 3: billion in clos that are going to need to be refinanced,
Speaker 3: another twelve and twenty five, and we've got another seven
Speaker 3: to nine to get through this year.
Speaker 2: Wasn't the original pitch okay? So sure, these are financed
Speaker 2: with floating rate loans, so if interest rates go up,
Speaker 2: the cost of that financing is going to go up
Speaker 2: and put stress on the property itself. But wasn't it
Speaker 2: supposed to be able to raise rents to offset that?
Speaker 3: Yes, and some properties did, many did, but ultimately people
Speaker 3: started to project rent growth to continue for longer than
Speaker 3: was rational. As I sort of described earlier, we had
Speaker 3: this household formation explosion in twenty twenty one, But ultimately
Speaker 3: what that was was it pulled some demand forward from
Speaker 3: twenty twenty two, and the massive apartment supply wave began
Speaker 3: to come to market in twenty one. And then on
Speaker 3: top of that, even if you raise rents today, insurance
Speaker 3: costs have gone up in such a way that it's deeply,
Speaker 3: deeply impacting the market. You're looking at renewals right now
Speaker 3: costing thirty to fifty percent additional every year. I've heard
Speaker 3: quotes of three thousand a unit to ensure in Florida
Speaker 3: right now, over one thousand in Texas. So you have
Speaker 3: massive increases on the cost side, debt increases that were
Speaker 3: never underwritten for, and rent growth that you achieved some of,
Speaker 3: but you're not going to achieve in the longer term,
Speaker 3: particularly with the nature of this product. A lot of
Speaker 3: it in markets like Phoenix was bought by syndicators, new
Speaker 3: people to the space, social media sensations, fundraising on LinkedIn,
Speaker 3: and people such as that this.
Speaker 2: Is like real estate TikTok.
Speaker 1: Yeah, Tracy, I was gonna say, you know, like it's
Speaker 1: been one of our recurring jokes over the year on
Speaker 1: the podcast, like what if we get into a trucking?
Speaker 1: What if we get into this? It sounds like a
Speaker 1: bunch of people took that joke literally and said, what
Speaker 1: if we get into.
Speaker 2: X what if we became landlord?
Speaker 1: Yeah, what if we get what if we became multi
Speaker 1: family landlords in Phoenix?
Speaker 2: I have Can I just say right now, I have
Speaker 2: no desire to take that up neither.
Speaker 3: Well, and I don't think these people really had that
Speaker 3: desire either or their ultimate goal was to flip these
Speaker 3: apartment buildings. They wanted to buy them, renovate them, use
Speaker 3: the bridge loan to get through that period, and then
Speaker 3: sell it to someone that would then use Agency Fanny
Speaker 3: or Freddie fineansing to hold the building long term. And
Speaker 3: whoever they sold to, they planned on being the true operator.
Speaker 3: Now a lot of these people that have no operating
Speaker 3: experience and entered the space are stuck being landlords and
Speaker 3: they had really aren't necessarily sure how to do that,
Speaker 3: So that's also hurting the revenue side. You have to
Speaker 3: have economies of scale, experience, vertical integration and such in
Speaker 3: order to be a landlord, and those structures don't exist
Speaker 3: at a lot of this new capital that entered our space.
Speaker 2: Can I just ask you know, we're talking about all
Speaker 2: the various calculations that go into underwriting one of these things.
Speaker 2: So insurance cost, the cost of the actual money to
Speaker 2: build or buy the property, expected rental income, things like that,
Speaker 2: how do people normally make those estimates, or like what
Speaker 2: kind of data do they use to make presumably again
Speaker 2: in normal times, like rational forecasts for what all those
Speaker 2: moving parts might look like. And then I guess to
Speaker 2: your point about the oddity of twenty twenty one twenty
Speaker 2: twenty two, what were they looking at then?
Speaker 3: So, first off, I think there was a lot of
Speaker 3: faith in the sector and lower for longer. Too much faith, frankly,
Speaker 3: i'd believe. And now if you believe in a soft
Speaker 3: landing and higher for longer, that's a very painful transition.
Speaker 3: And the reason that such a painful transition is cap
Speaker 3: rates or your yields historically have had a two hundred
Speaker 3: basis point spread to the ten year. So normally the
Speaker 3: risk free rate should be at a discount to a
Speaker 3: real estate rate, and that held when sofur was zero
Speaker 3: and you were buying at a three and a half
Speaker 3: cap rate today, in order to buy with a ten
Speaker 3: year even at four to three as it is today,
Speaker 3: historically that would tell you you're going in cap rate
Speaker 3: should be a six to three and your exit cap
Speaker 3: rate should be even higher than that in order to
Speaker 3: be concerservative. Those metrics really don't work for what was
Speaker 3: bought in that vintage. But today you want to go
Speaker 3: into a not have negative leverage, so you need to
Speaker 3: be able to afford your debt. That's where kind of
Speaker 3: that two hundred basis point spread comes into play. You
Speaker 3: want to be conservative based upon long term history, supply
Speaker 3: demand balance, population growth and all that, and you want
Speaker 3: to look at that as you get into rent growth,
Speaker 3: expense growth has become much harder to pay, so you
Speaker 3: want to be as conservative as possible there and a
Speaker 3: lot of the longtime players understood this and were frankly
Speaker 3: priced out of a lot of deals over twenty one
Speaker 3: and twenty two because of this. Now, what also happened
Speaker 3: back then was when you have twenty percent rent growth,
Speaker 3: people just plan on raising rents for five percent a
Speaker 3: year every year after they mark to market to that
Speaker 3: twenty percent. So I think it was a lot of
Speaker 3: looking at recent history instead of long term history. It
Speaker 3: was a lot of denial about interest rates that today
Speaker 3: we take into account in every underwriting. And frankly, again
Speaker 3: the more experienced players were but the newer capital didn't
Speaker 3: really understand that at the time. So the relationships of spreads,
Speaker 3: population growth, and supply demand, we're all just distorted. And
Speaker 3: they've come a lot clearer now. But even today, as
Speaker 3: you model that, people don't want to feel the pain
Speaker 3: on the sales side, so you have a massive bid
Speaker 3: ask spread still in the market today. That's why transaction
Speaker 3: volume I gave those huge numbers before last quarter transaction
Speaker 3: volume was only thirty billion, which is almost as low
Speaker 3: as it was at the bottom of the pandemic.
Speaker 1: What happens when inexperienced operators are stuck holding the bag
Speaker 1: and have to be landlords.
Speaker 3: Well, if they can't afford the property, they give the
Speaker 3: keys back. And that's where a lot of I think
Speaker 3: pain is going to be felt in this sector. There's
Speaker 3: a lot of debt fund colo issuances out there, and
Speaker 3: if the debt service coverage ratios don't pencil today, they
Speaker 3: aren't going to pencil any better tomorrow barring a major
Speaker 3: recession resetting rates, which ironically it would be probably the
Speaker 3: bailout for the sector at this point in time.
Speaker 1: But actually, in your view, I mean, because the downside
Speaker 1: of recession is job laws and people not being able
Speaker 1: to pay the rent. But in your view, the greater
Speaker 1: stress is actually on the financing side rather than the
Speaker 1: rental income side.
Speaker 3: Absolutely, okay, And I think these debt funds are going
Speaker 3: to end up holding the bag, one of the largest
Speaker 3: ones out there. I think I saw issued fourteen billion
Speaker 3: in debt over that period. I'm discussing today the book
Speaker 3: value on that's already in the low nines. And that's
Speaker 3: not using the most true current market data and some
Speaker 3: of the more sort of down projections you're seeing because
Speaker 3: rent losses are occurring in some places such as Austin
Speaker 3: and things Place and places such as that, and those
Speaker 3: sort of losses are just going to continue to grow
Speaker 3: over the next couple of years as this supply works
Speaker 3: its way through the system.
Speaker 2: This is what I wanted to ask. Actually, you mentioned
Speaker 2: mark to market earlier. How often are these loans marked
Speaker 2: to market? And again, what are the sort of numbers
Speaker 2: that are going to feed into that.
Speaker 3: So initially when I was talking mark to market, that
Speaker 3: was on the rent side, and this is that's something
Speaker 3: that doesn't happen that often. But everybody was buying buildings
Speaker 3: in twenty one and essentially assuming they could immediately raise
Speaker 3: the brands by twenty percent, marking them to market. Now,
Speaker 3: on the debt side, they aren't marked to market nearly
Speaker 3: as quickly as you'd like. Even on the valuation side,
Speaker 3: I think your cap rates are moving upward way more
Speaker 3: slowly than you'd expect. On the bank side, there's a
Speaker 3: lot of mark to market left to happen, and I
Speaker 3: guess the roundabout way of answering your question is it's happening,
Speaker 3: but not nearly quickly enough. On the debt fund side,
Speaker 3: it's going to mostly happen as these workouts happen, as
Speaker 3: these refinancings happen, and as this debt comes do in
Speaker 3: this wall of maturities, and the wall of maturities is real.
Speaker 3: On this short term debt, they're going to be able
Speaker 3: to extend somewhat. But these people that couldn't afford interest
Speaker 3: rate caps, that didn't have the reserves for it, that's
Speaker 3: going to mature and it's going to hurt.
Speaker 2: What's the catalyst for a lot of these to take losses?
Speaker 2: Is it like eventually they have to mark to market,
Speaker 2: although I'm still unclear like what the trigger is for
Speaker 2: having to do that or eventually they have to refinance
Speaker 2: and maybe they can't get the financing. Is that the
Speaker 2: thing that starts sparking losses because otherwise, as we've seen
Speaker 2: for the past year or so, it feels like they
Speaker 2: could just sort of string it out for a very
Speaker 2: long time.
Speaker 3: So the issue with string it out become how bad
Speaker 3: the debt service coverage ratios are today. So you have
Speaker 3: to have a really motivated lender, and these lenders have
Speaker 3: so much debt out in the space today, it's going
Speaker 3: to be difficult to do this for everyone. One of
Speaker 3: the larger syndicators that got themselves in trouble in the
Speaker 3: Phoenix area has done around six hundred and fifty million
Speaker 3: in workouts over the last year and a half.
Speaker 2: Wow in workouts. So like taking care of troubled loans.
Speaker 3: Yes, And that's where you're going to mark to market
Speaker 3: these things, is the loans get worked out, as they
Speaker 3: get refinanced, as they get brought back, and the trigger
Speaker 3: is either people not being able to pay their debt service,
Speaker 3: which is happening. I've been in New York for the
Speaker 3: week and seeing friends in the industry, and these are
Speaker 3: friends that work on the lender side, and they're getting
Speaker 3: keys given back to them all over the country already,
Speaker 3: So this is something that's starting to happen. Another friend
Speaker 3: just mentioned a deal he just bought New York for
Speaker 3: less than the construction loan. So there's pain and we're
Speaker 3: starting to see it. People are calling us that have
Speaker 3: been able to finish developments because the equity partner pulled
Speaker 3: out and they're offering chances to getting low and every
Speaker 3: bid that we place today is frankly low. And that's
Speaker 3: because we believe the market has more pain as this
Speaker 3: marked market happens. But the events haven't fully cascaded because
Speaker 3: not all of the loans have been dealt with. And
Speaker 3: the other thing people like to do is extend and
Speaker 3: pretend in our sector, But I don't think that's going
Speaker 3: to be as viable going forward because it's really hard
Speaker 3: to extend and pretend if your debt service coverage ratio
Speaker 3: is a zero point six. Wow.
Speaker 1: Talk to us a little bit more about supply specifically.
Speaker 1: So one thing that's happening is I maybe perversely, I imagine
Speaker 1: as supply chains have eased over the last couple over
Speaker 1: the last year or so, probably had a lot of
Speaker 1: projects that we're moving slowly that finally finished and opened
Speaker 1: the doors, and so you have on the one hand
Speaker 1: this looming maturity wall the next few years, and then,
Speaker 1: as you mentioned, more supply hitting the market into a
Speaker 1: weak market, and multifamily construction had a very good decade,
Speaker 1: even going into COVID is my understanding, and then it
Speaker 1: just took off in twenty twenty one. Talk to us
Speaker 1: about those dynamics.
Speaker 3: Yeah, there's been for over the last year, more than
Speaker 3: a million units under construction, and if you think about
Speaker 3: that in terms of the total housing market, you had
Speaker 3: what one point eight million total housing units under construction.
Speaker 3: So the majority of the housing instruction in our country
Speaker 3: at this point in time is the multifamily product. And
Speaker 3: between construction backlogs over the pandemic and then the low
Speaker 3: interest rate environment allowing tons of shovels to get into
Speaker 3: the ground for development, we just blew out records and
Speaker 3: we're at levels last seen in the early seventies and
Speaker 3: we're close to surpassing, if not haven't surpassed those levels.
Speaker 3: So supply is hitting and mass and the way it's
Speaker 3: hitting is typically in limited sub markets. In limited market
Speaker 3: a downtown Nashville has the majority of all of Nashville's supply,
Speaker 3: and right now you can't throw a baseball there without
Speaker 3: hitting three cranes, similar to a downtown Austin. These nodes
Speaker 3: within these markets are going to be fine in the
Speaker 3: long term, but this glut of supply is just overwhelming
Speaker 3: demand in the short term, and this is something we
Speaker 3: haven't seen for a long period now. The flip side
Speaker 3: is low interest rates, where the catalyst for that explosion,
Speaker 3: the higher interest rate environment has actually been driving starts
Speaker 3: down over the course of the last year, and we've
Speaker 3: seen a massive slowdown in starts. So as it looks
Speaker 3: currently through mid twenty five, you're going to continue to
Speaker 3: have really accelerated deliveries. You're going to continue to have
Speaker 3: some fundamental challenges. But late twenty five into twenty six
Speaker 3: you should start seeing a lack of supply in the
Speaker 3: market again again, that is without a reset of interest rates, and.
Speaker 2: Then rents can go up exactly. Okay, well, on this
Speaker 2: note you mentioned or sorry, let me say that. Well,
Speaker 2: on this note, if owners are handing back the keys
Speaker 2: to multifamily properties and you know, presumably maybe someone else
Speaker 2: is buying them, you know, another institutional investor or something
Speaker 2: like that, but could you ever get a situation where
Speaker 2: a multifamily property is like divided up and sold off
Speaker 2: as single family units? Like could could the multi Yeah?
Speaker 2: Could it become like could it? Could it become owned
Speaker 2: by people.
Speaker 3: You could convert to condo? It happened. I think back
Speaker 3: in five oh six during that rush, A lot of
Speaker 3: the challenge is going to be and I don't want
Speaker 3: to sort of state this too aggressively, but multi family
Speaker 3: construction is typically not going to be at hot as
Speaker 3: high as the level as a condo construction quality, yes,
Speaker 3: and that has to do with supply chains, economic economies
Speaker 3: of scale, the design of the units, and I don't
Speaker 3: know that it's as natural a transition as you would
Speaker 3: think now In the same point, these condos are still
Speaker 3: going to be really expensive too, so the switch off
Speaker 3: isn't going to be ideal. But what we are seeing
Speaker 3: and we get phone calls for this all the time now,
Speaker 3: is on the new developments, the senior debt or the
Speaker 3: construction loan doesn't quite go far enough because they can't
Speaker 3: get as much leverage as they had expected. So they're
Speaker 3: calling other players in the institutional world, such as ourselves,
Speaker 3: and looking for mes financing or preferred equity to fill
Speaker 3: a piece of the debt stack to get them over
Speaker 3: that hump. And that debt is highly accreative in terms
Speaker 3: of how it's pricing right now because of the demand
Speaker 3: but also because of some of the risk for the
Speaker 3: new supply. So that's been a big change in the space.
Speaker 3: Is this sort of aggressive appetite to plug the financing
Speaker 3: gap with preferred equity?
Speaker 1: So are there I guess you it sounds like in others.
Speaker 1: Is there is there a brewing sort of industry of
Speaker 1: opportunistic distressed investors who are bundled or getting capital together
Speaker 1: to take advantage of some of this pain that already
Speaker 1: that you're seeing.
Speaker 3: Yeah, we have been fundraising. We are sitting on the sidelines,
Speaker 3: and I think it's fair to say there's blood in
Speaker 3: the water and the sharks are waiting to swim. At
Speaker 3: this point, there's going to be opportunities through this pain
Speaker 3: that I don't think the sector's seen since the Great
Speaker 3: Recession in terms of opportunities for true, true, discounted and
Speaker 3: distressed purchases. You're seeing lenders already calling other players where
Speaker 3: people can't make the debt service coverage and being like,
Speaker 3: can you come in, Will you come in at a discount?
Speaker 3: Will give you X off par if you come in
Speaker 3: and can buy us and just bail us out of
Speaker 3: this bad situation. So there's one hundred percent going to
Speaker 3: be a lot of the more established institutions trying as
Speaker 3: hard as they can to take advantage of this market disruption.
Speaker 1: Lee Everett, that was great. That was very It's very jarring.
Speaker 1: And when you like when you discussed the sort of
Speaker 1: like the raw math of it of rates going up,
Speaker 1: rents not penciling, household formation nothing like it was in
Speaker 1: twenty twenty one, inward migration, nothing like it was in
Speaker 1: twenty twenty one. All this sort of you know TikTok
Speaker 1: or podcast and realtors insurance costs. That's something that we
Speaker 1: talked about with the Howard Hughes CEO as well, which
Speaker 1: is just sort of this wild dynamic. Could see why
Speaker 1: more pain, more pain is on the web. So thank
Speaker 1: you so much for coming on my.
Speaker 3: Pleasure, Tracy.
Speaker 1: I'm really glad we had that conversation. It's we don't
Speaker 1: really say perfect storm as much as we used to
Speaker 1: when we used to talk supply chains.
Speaker 2: No, we just did on the the Wind Energy episode,
Speaker 2: that's true, we're bringing it back.
Speaker 1: This really Yeah, this one really does seem like a
Speaker 1: perfect storm of just all kinds of different things going on.
Speaker 3: Yeah.
Speaker 2: Absolutely, And I do think it's it's funny isn't the
Speaker 2: right word, but uh, it is intriguing the degree to
Speaker 2: which people saw, like the post pandemic period, which I
Speaker 2: think any reasonable person would have thought, like, there are
Speaker 2: weird things happening right now, Like you have this huge migration.
Speaker 2: Interest rates are super low because we've just had, you know,
Speaker 2: an emergency basically the economy just shut down. And yet
Speaker 2: it seems like some extrapolated that very short and dramatic
Speaker 2: period of developments to like it's going to keep going
Speaker 2: for the next five years.
Speaker 1: And you know, this is actually something that's striking to
Speaker 1: me is how we see this from industry to industry
Speaker 1: to industry. Everyone sort of fell into this to some extense.
Speaker 1: You certainly saw it tech, for example, with all of
Speaker 1: the oh, it's all e commerce now and no one
Speaker 1: is gonna everything is gonna be shopping online, and you know,
Speaker 1: eventually like those trends basically reverted to trend or Netflix
Speaker 1: shooting up, and then people realizing actually it's gonna go
Speaker 1: back to roughly the old trend, which is an upline,
Speaker 1: and it might be an upline and multi family too,
Speaker 1: but it got so far deviated. But it is weird.
Speaker 1: I mean, like you figure there's not going to be
Speaker 1: multiple migration waves from San Francisco to Las Vegas like
Speaker 1: that was. You sort of knew that had to be
Speaker 1: a one off almost by definition. And yet you get
Speaker 1: the impression that people saw the lines going up and
Speaker 1: they wanted to play.
Speaker 2: Yeah. I'm still amazed. I mean Lee mentioned this, but
Speaker 2: like the amount of construction in Austin that's like still
Speaker 2: going on. Yeah, And if you think that like in
Speaker 2: twenty twenty one, it would have been even more. I
Speaker 2: can't imagine they really were booming of sunbet people.
Speaker 1: If you people with a Bloomberg or I guess Fred
Speaker 1: to just pull up that US multifamily units started for rent,
Speaker 1: and you see it trending up very clearly from December
Speaker 1: two thousand and nine to twenty twenty, and then it
Speaker 1: just shot up, you know, exploded in twenty twenty one
Speaker 1: and twenty two to levels that really haven't seen in
Speaker 1: about you know, thirty five, thirty five years or something
Speaker 1: it's pretty striking. And so, yeah, it all came together well,
Speaker 1: and I thought Lee did a great job of putting
Speaker 1: it all together.
Speaker 3: Yeah.
Speaker 2: Absolutely, And it is going to be interesting to see
Speaker 2: how much of these deals get worked out. Now. I
Speaker 2: couldn't believe that one number from like just one institutional entity,
Speaker 2: like six hundred and fifty million in workouts. That's crazy.
Speaker 1: And the fact that keys are already being sent back
Speaker 1: is really interesting. And so it's not I mean, we
Speaker 1: talk about the loom is here. I mean, the bigger
Speaker 1: wall may still be coming, but obviously for some players
Speaker 1: it's already hit.
Speaker 2: The nature of the maturity wall is that it's always looming.
Speaker 2: It's always even when it's here, it's still looming. All right,
Speaker 2: shall we leave it there?
Speaker 1: Let's leave it there.
Speaker 2: This has been another episode of the Odd Thoughts podcast.
Speaker 2: I'm Tracy Alloway. You can follow me at Tracy Alloway Wisenthal.
Speaker 1: You could follow me at the Stalwart. Follow our producers
Speaker 1: Carmen Rodriguez at Carmen Arman, dash Ol Bennett at Dashbot
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