June 10, 2020
As we share this third installment in a series intended to provide insights into what we are seeing in the commercial real estate investing landscape, I want to start by addressing the Black Lives Matter protests occurring across our county. The past two weeks that began with the tragic death of George Floyd and the ensuing protests demonstrates just how un-united our United States of America is. We want to be clear that RealtyMogul stands for equality for all, for kindness and for inclusiveness, and stands against racism, discrimination, and intolerance.
2020 is shaping up to be a challenging and distressing year in many ways. Our country is facing an intractable pandemic, a massive economic disruption and now a societal upheaval. Each is a major event yet combined they are without modern day precedent. While there is good news regarding US unemployment – 2.5 million jobs were added in May vs. an expected loss of more than 8.3 million, the unemployment rate has fallen to 13.3% and certain states and counties across the US are slowly opening - it is unclear when or if our economy will return to “normal”. There is much doom and gloom in the daily news cycle and one can see how the US could be headed for a depression. At RealtyMogul, we do not believe we are headed for a depression. Given what we know, we are inclined to agree with Joe Zidle at Blackstone who sees a “’square root’ recovery, characterized by 1) the initial sharp drop that we have already experienced; 2) a sharp, but smaller, bounce back to a lower level; and 3) a long, flat recovery.” As stewards of capital at RealtyMogul with a mission to uncover the best commercial real estate risk adjusted returns, we believe that there are opportunities to be had now and in the future because of the economic turmoil we are experiencing.
We believe we are already starting to see situational stress in some real estate transactions, and we are actively seeking ways to “play offense”.
One of the key lessons we know inherently about real estate is that it is not an efficient market. People and firms make decisions for all kinds of reasons, not necessarily optimizing for financial gain. For example:
- A patriarch dies and the family wants quick cash or needs to pay an estate tax, settling for speed over financial gain in selling an asset.
- A fund that has bank leverage gets a margin call and must sell assets quickly (which leads to depressed prices) to meet capital requirements (we saw this play out in real time for public firms like New York Mortgage Trust, AG Mortgage Investment Trust, MFA Financing, Investco Mortgage Capital and TPG RE Finance Trust).
- A private equity fund is at the end of its fund life and has a few assets left to sell; timely disposition is more critical than squeezing the last dollar out of the trade.
- A firm that has a lot of exposure to poor performing asset classes (i.e. hospitality and retail today) sells better performing asset classes (i.e. multifamily) to raise liquidity on the balance sheet.
Knowing that there is situational opportunity in today’s market, we thought it would be helpful to share our playbook for discovering investments for our members:
- We have identified over 100 institutions – banks, lenders, funds, public REITs etc. where we have personal relationships to uncover distressed deals that need to be liquidated.
- We are significantly investing in data to identify properties that have delinquent or overdue mortgages or stressed net operating incomes that may lead to future delinquencies.
- We have mapped every property in 5 target states that has a mortgage coming due in the next 12 months.
- We are marketing to over 15,000 real estate companies in our database to provide capital for situational opportunities they uncover in this market.
Considering the activity above, we expect a few hundred transactions to hit our desk. And we expect to fund less than 1%. We believe in prudent underwriting both in good times and in bad.
Choosing to invest in today’s market means two things: 1) you must assume the world is not ending and 2) you believe the country will recover in the future. I’m reminded of Warren Buffet’s quote from his recent Berkshire Hathaway shareholder meeting in which he said “One of the scariest of scenarios, when you had a war with one group of States fighting another group of States, and it may have been tested again in the great depression, and it may be tested now to some degree, but in the end the answer is never bet against America, and that in my view is as true today as it was in 1789, and even was true during the civil war, and the depths of the depression.”
We do not believe we are in for a depression, namely because of recent massive government intervention. As Ethan Penner shared as a guest on our podcast , “Don’t Fight The Fed.” The US has never seen the extent of monetary and fiscal stimulus that we are seeing today. Consider the PPP program which provides eight weeks of funding for payroll, rent and other basic expenses for small businesses across the country, the main street lending program for larger companies, the Term Asset-Back Securities Loan Facility (“TALF”) which is buying asset-backed loans from banks and the most recently proposed $3 trillion coronavirus relief bill that was passed by the House. We do not see this government allowing the country to sink into a depression.
As we set (and sometimes re-set) strategy here at RealtyMogul, there are some markets and asset classes that we do expect to perform better than others. As one example, markets that rely upon unskilled labor and hospitality could be hit the worst while markets with heavy tech and life science presences are likely to do better.
There is also the added element of government intervention on markets. We are concerned with the impact that policies certain state and local governments are implementing will have on commercial real estate. We continue to ask ourselves “How is This Legal?” when we see rapidly enacted state government policy effectively serving to steal income from landlords and investors. We have seen this play out through rent control mandates for apartment assets in California and New York prior to Covid-19, but we believe it is getting worse. In California, SB 939 was passed by the Senate Judiciary Committee on May 22, 2020. The proposed bill tells retail tenants that they do not have to pay their rent and if they want to walk away from their lease or renegotiate it, they can. SB 939 threatens the very fabric of the real estate business – that leases are contractual obligations that must be paid. While we have made several investments in California in the past, our largest concentration of investments is in Texas, which we continue to believe holds attractive long-term growth potential, in part due to less onerous government policy towards businesses, no state income taxes and a generally more favorable business environment.
Regarding asset classes, while we believe there will be a recovery in hospitality, as pent up demand for business and leisure travel slowly returns, we plan to remain on the sidelines. RealtyMogul initiated a policy of not investing in hospitality in 2015 and it remains in place today. On the retail side, we believe 20-30% of the retail assets in the US are not necessary and will eventually be obsolete. But well-located retail, at “main-and-main” will continue to thrive and we believe folks will go back to their neighborhood shops, nail salons, karate studios, etc. in due time. We also believe that Industrial will continue to thrive. Covid-19 has accelerated the pace for trends that were already in motion – including e-commerce and working from home – and industrial will likely continue to be a winner here. We have made investments with a multi-billion dollar industrial player and their rent collections were at 95% for April and May – many of their clients were deemed “essential businesses” and have kept operations open during the shelter-in-place orders. We believe investing in industrial (and other asset classes) where the properties are operationally essential will continue to be fruitful. On the office front, we have a lot of uncertainty. On one hand, companies may opt for more space because of social distancing while on the other, major companies have learned through this crisis that their teams are as effective or perhaps more effective working from home. We still like office with long-term leases to credit tenants that we believe are well poised to weather the storm and there may be more opportunity in suburban office than urban office as employers look to avoid high rise buildings with hundreds of people touching elevator buttons each day.
And lastly, we round out the major asset classes with the apartment sector. This sector has been our bread-and-butter for the last seven years and we have thus far invested in over 16,000 apartment units. I am reminded of a comment by Jeff Bezos, “I very frequently get the question: ‘What’s going to change in the next 10 years?’ And that is a very interesting question; it’s a very common one. I almost never get the question ‘What’s not going to change in the next 10 years?’ And I submit to you that that second question is actually the more important of the two – because you can build a business strategy around the things that are stable in time.” We fundamentally believe that the need for affordable and workforce housing is not going to change in the next 10+ years. However, there may be some temporary moments of pain for investors and landlords here. Thus far, apartment collections have held up well, but we believe this strong performance is being propped up by government fiscal intervention – both the $600 in additional federal unemployment and the stimulus checks sent directly to US citizens under a certain tax bracket. It is unclear if these policies will continue past the summer or not. While we believe they will probably be extended as President Trump acknowledges they are fundamentally important to his re-election campaign, at some point the stimulus will cease and bad debt and apartment vacancy will likely increase at a higher than normal rate, at least for a period of time. Despite that, we continue to believe in the apartment sector long term. We believe this downturn will allow us to acquire and invest in quality assets in quality markets – if we have the stomach and patience, which decades of combined experience in real estate among our team has taught us that we do. We also believe that we will see some form of Universal Basic Income in the years to come in the United States. If that comes to fruition, coupled with state mandated increases in minimum wage, affordable and workforce housing could be big winners.
Some may be simply unwilling to invest in today’s very turbulent climate under any circumstances, and we understand and respect that. It might be another 18-24 months before we have rent price discovery, vacancy discovery and asset price discovery, but in the meantime, we will remain steadfast in our mission of discovering the best risk adjusted returns in commercial real estate on behalf of our investors.
Thank you for your continued interest and trust in RealtyMogul and I hope you and yours are staying safe and healthy during these most uncertain times.
Jilliene Helman, CEO
All information provided herein is for informational purposes only and should not be relied upon to make an investment decision and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. Readers are recommended to consult with a financial adviser, attorney, accountant, and any other professional that can help you understand and assess the risks associated with any investment opportunity.