Alternative Lending in Real Estate - [Business Breakdowns, EP.195]

28:05on the speed part. I think this is one of these things where the traditional we can close in 90 days, not sure if that applies to real estate, but the 90 day close and you think, well, what can take 90 days? And there are so many things that go into it. What is it that differentiates you in terms of being able to speed up that process or deliver on time? Are there certain things that you can point to that are tangible things inside the business that allow for that speed? a pretty flat organization at the top from a decision -making standpoint and a very experienced staff that have all the different disciplines within real estate.

28:40We have legal, we have a development team, we have zoning, we have underwriting, asset management, construction management, servicing. Again, the way we look at this is sort of a SWAT team that goes into review a project and various elements within the firm that kind of opine on different pieces and bring that all together to a closing. From the developer standpoint, the equity perhaps inside these deals, or some percentage of the equity in these deals, how much has the makeup of that changed over the years to still see players that look more or less the same than what you had 20 years ago, has there been any material changes?

29:17I do think there've been material changes. I mean years ago, when we started, everything a bank didn't wanna do. Quick closing, asset -based loan, maybe it had cash flow, maybe it didn't have cash flow. I think what's happened is private credit in real estate is really evolved as an asset class, where again, the largest of sponsors are borrowing from private credit institutions. So I think there was a learning curve as to what that meant for borrowers. There's been a real evolution of the business from that standpoint. The experience of what that means borrowing from private credit versus bang versus insurance company is now well defined.

29:52And I think when we started the business, This one, it was really convincing investors that this was a true asset class, and a lot of times, institutional investors didn't know where to put it. Is it real estate? Is it credit? And there was a lot of back and forth. So we had to create this asset class from the beginning, and then it was convincing borrowers that this is a better means by which to borrow. This is a better user experience and more customized experience we can do things banks can't do because we're not regulated the same way. So I think what's happened is as an asset class, it's evolved both from an investor standpoint and a borrower standpoint.

30:24The market is that much larger today. Yep, it certainly seems just in terms of the whether it's institutionalization or redevelopment of certain things in terms of what the players look like. There's been adjustments shifting a little bit into portfolio management and what that entails. certainly there's some monitoring and what not that goes on. But can you talk through the process just in terms of loan gets allocated? What are the steps from there? You laid out some of it just in terms of the draws that take place. And I think that's less traditional than what you might see in some other markets where it's an outright balloon that's delivered up front.

31:02And balloon that's expected at the end with some amortization over. As soon as we close on a loan, there's the asset management team here that's assigned to that. A lot of times they're involved in the project before the closing as well. We have our construction and development team that's reviewing a budget. We have our asset management team reviewing what are the milestones that the borrower needs to achieve in the near term and far term over the course of this loan. So that's first and foremost. Second of all, again, we have outside personnel consultants that are going to visit a project on a monthly basis to see what work was done.

31:38and that comes back to our internal construction management team to make construction advances. There's also a weekly asset management team meeting where we go through every position of the firm, walk through are they on budget, on time, on business plan, where they off business plan, has something changed in the market, what's the leasing market like today versus when we made the loan, what's the sales market today versus when we made the loan, what's the product mix out there, our one bedroom selling, our two bedroom selling, there's a lot of this that goes into that. A lot of times a project will come to an extension time period.

32:14You have a two year alone and there's a six month extension and then it's re -reviewing and re -undering the project where we thought we would be. What's the extension test? So there's a lot of back review and being on top of your project. We have about 140 positions in the firm, 130, 140. We are consistently reviewing those positions on a weekly by a weekly basis. When it comes to the management of the portfolio, I have a friend who oversees some construction in Manhattan and he was telling me we deals with 38 different tradesmen's and keeping anything on track is next to impossible. What percentage of these projects look the same throughout the process as they're originally presented and how much cushion can you actually build into that?

32:59Because I think you've mentioned, there's all types of dynamics that you factor in, But do you have any just general mantras in terms of approaching that knowing that there are a long list of hurdles that you have to clear and a lot of things that you have to be managing at the same time as a developer? Well, I think a lot of times we're reviewing it when we go into a deal and underwriting a scenario if it takes longer and cost more, what does that look like? Who's our counterparty? What does a completion guarantee look like? Who's our counterparty? what do the guarantees look like to the extent things take longer, cost more and more interest carry.

33:32And there was no greater time where that came into play during COVID. All of a sudden you had a huge inflationary period where you had two problems going on. One, major inflation. Two, a lot of borrowers had to shut down projects. Or if they were building through projects, there were a lot of delays in terms of bringing goods on. So that was a period of extreme asset management, making sure that your borrower can actually execute and get a project done. What would delays mean? So, again, that was an example of a shock to the system. And I would say, for the most part, most of our projects got out and were able to withstand some of the shocks.

34:12In scenarios where a project does not get out, you have situations where the borrowers can't make the payments. There's some requirement for closure or however you might deal with it. How do you handle that? It sounds like you've built up some internal muscle to be able to deal with any type of situation that presents itself I think there was this long theme in the distress world that banks don't want to own these assets so oftentimes They'll be more willing to just kick the can down the road you have to protect capital How do you approach that and just operationally as well? How do you approach it?

34:45The first and foremost when we make a loan we want to get paid back. That's it ideally we don't want to own a project through the debt. So usually first and foremost when they're a borrowed default, hopefully you're up to speed on the project and understand where things stand. First step is where are you from a value standpoint? And that usually drives how you deal with a workout. We'll give many chances for a borrower to make good on an obligation. Sometimes it's saying to a borrower, listen, there's an added balance or you need more interest carry. will allow you a little extra time to make that.

35:19Maybe it's over three payments when you were supposed to make it on one payment. Maybe it's put up some additional collateral. Maybe it's put up other guarantees. I mean, there's lots of ways to approach it, but I think the worst way to approach it is with a huge hammer. A lot of times it's just really a give and take and look, it's a client -oriented business. So how you deal with a borrower is very important because your reputation is very important. That being said, if you give a borrower many, many chances and they really can't get their own way and that does happen, then you have to take the next course of action.

35:50So I think that's how we really look at it. It's again, make a loan, you want to get paid back. We're looking for scalability at this point in our business. That's number one. And you can't have a scalable business if you're constantly taking over real estate and that being said, in shocks to the system, it's going to happen. It happens. It's just part of the business. And we definitely have the full team. And as I mentioned before, a vertically into great business to be able to execute, which is very different from most real estate credit businesses. A lot of times they're pure lenders, they don't understand what to do if you actually had to take over real estate.

36:24And I think it's something our investors really like about our business that we do understand it at that level. And just in terms of the timeline, if you were to take over real estate, I mean, how long will you stay in that position as being responsible for the project? Is that something that you contract out or essentially look to unload that portion of the operations quickly. Yeah, it really comes down to where we are in the life cycle of deal. Sometimes you have a project that may be partially complete. We're almost done. So if that's the case, then you wouldn't want to sell it as partially complete because you're not going to get bid very well.

37:00That's how it is. Everyone's going to put in say, oh, it's going to take this much of time or this much money to complete. So when you have a project like that, usually one of the big advantages about our team, we do have a development team that can finish a project if need be. In some cases, the borrower is the best person to finish that project. So sometimes it's a workout strategy with a borrower to get a final certificate of occupancy. It really just depends on the deal. First and foremost, where are you in the deal? What's the value of the real estate? What's our best exit plan? How do we protect downside?

37:32In some cases, it's okay. We already own it. What is the best execution plan from here? Can we entitle it further? Can we get more density, can I do XYZ? You talked about some of the ongoing dynamics or more recent dynamics, COVID being one of the major ones. I'm just curious, obviously there was a shock to the system. Have there been impacts that have stayed in place since then that show up in your business and just generally looking at the change post COVID, what stands out to you? Well, COVID was like 60 to 90 day major shock to the system, where the first thing people thought and those that had been around in the global financial crisis were like, oh my god, liquidity is going to dry up.

38:18It's going to be years of no lending. Investors aren't going to fund capital calls. Better pull down my subscription line because I need liquidity. I mean, again, having that experience in 2008 helped us drive those initial thoughts in COVID. We also, fortunately in COVID, we had just closed on our fun five and we did a first close, I think it was about $700 million in February 2020. So we were in this very, very unique position of having a lot of capital from a fundraising standpoint, ready to deploy and we're able to, you know, we originally loans, but we also buy performing a non -performing loans.

38:53And one of the greatest opportunities we've had in many years was it was a mortgage read in March 2020 that had a major liquidity issue. I was down in Florida figuring out where we were going to live for the next couple of months. I was talking to see all this mortgage read, realized that there was this issue. We bought 200 million of performing loans on multi -family in a week and that was one of the most exciting deals in my 20 -year history. I mean it played on everything that we've been able to achieve. Understanding real estate debt, buying debt, putting together our SWAT team, getting out to the properties because some of them were in New Jersey, New York, California.

39:33We had people in the ground in all these places, and we really helped that red -deliver and withstand a major shock to the system. Yeah, it puts speed in that theme in the Cross -Air too. Impressive to be able to allocate that in that short of a period of time. You mentioned it a few times, the ability to do that, the flexibility to buy, whether it's non -performing loans, just secondary on the secondary market. How big of a piece of the business is that today? Is that something that you see continuing to grow in the future? It's been a part of every one of our fund ventages. Today it's actually both performing and non -performing loans, but there's a lot more performing out there with banks.

40:12The problem has been a lot of those performing loans that are out there to buy have long -term fix rate loans at very, very low rates that originated in 2020. And this past year we bought three loans totaling about $250 million. These were one -off deals that we bought. They were very, very senior loans to restructure. But you look at a lot of the product and there's this view. There'll be tons of loan sales. There aren't tons of loan sales. And the ones that are being sold are either office that really have a lot of unknown still or long -term fixed rate loans from banks that are at such low rates that's hard for investors like ourselves to buy without having such a huge discount.

40:49So I think that again, I think the experience and knowledge of being able to both originate alone by a performing or not performing loan and back leverage of credit fund is what gives us this major opportunity and deal flow to be a very versatile player in the real estate credit business. Is there anything different about sourcing those loan opportunities versus obviously you're dealing with the banks you deal with them in different ways typically, but is there anything different about how you're actually able to source something like that, those three loans and $250 million, which is not a small amount?

41:21Yeah, it's very different. It's usually having knowledge of banks and just dealing with the right people at banks. It's also very different to originate alone as compared to buying alone. Most of the private credit funds originate loans. And when you originate loan, you're getting all new clean documentation, you're getting your forms, you're getting every piece of information and knowledge. When you're buying alone, one you have to understand the real state. So that's you don't have all the information to you have to understand loan docs. What are the impairments in these loan docs things that you would want in a loan doc but things that aren't because this bank originated with XYZ So you're really thinking about it from what does it look like from a real estate standpoint?

42:04What do the docs look like and if there is an issue what would it take through a foreclosure process time? Every state is different. So you have to understand a new york that may take three years in Texas that make take 60 days So like I mentioned, we really started buying loans in 2009 as a function of the global financial crisis But it's something that we understand and usually when we're buying debt We're not looking to own the real estate. It's usually a restructuring play But we do have to know that if we do on the real estate, what do we do with it? Very interesting certainly from the Documentation standpoint that bespoke nature of the market makes any secondary transaction a bit more unique But I hadn't considered all the geographical uniqueness from property perspective.

42:47It's fascinating. You hit on one of the more interesting points just in terms of whether it's office versus residential versus just retail or more traditional commercial. When you think about those various markets and we'll go into a little bit more of where we are today and we can extend this out for some period of time. But how do you see the differences in those markets today and whether you want to put a scope in a certain geography, I'll leave that up to you, but different dynamics would be interesting to hear from your perspective. Well, I would say traditionally as a firm, we've invested in, you can call it the five major food groups, which is multi -residential, retail, industrial, hospitality, and office.

43:28Fortunately, as a firm, we've done less than 1 % in office. Some of that was on purpose because it was definitely more of a binary business plan, chunkier, tendency, rents, more cat -backs needed. The other reason is a lot of institutional lenders, banks, insurance companies, and other private credit funds, office was a major way to put out a lot of capital with very, very institutional borrowers at a lot of times very cheap competitive pricing. So there's a reason why we don't have any and have never had a San Francisco office loan. Everyone wanted to be in San Francisco. It was the no -brainer loan to make.

44:06It was a way to efficiently put out capital and with a very institutional sponsor. That was too competitive for us to achieve. So we've always been more skewed towards residential -related real estate. And when I say residential, that's multi -kondo, built -to -rent housing, and single -family for sale housing. Hospitality is something we've done a lot of. And we have an operating partner who helps us execute on hospitality credit. Obviously industrial student housing, we've done all asset classes, but fortunately we've had less than 1 % office exposure. And that has allowed us to play more offense today because you have a lot of firms that are really bogged down by office exposure.

44:45And the problem with office is that there's very, very liquidity today. Now it's picked up a little bit, but that being said, it was typically 15 to 30 % of real estate credit providers as well as equity providers book and within that asset class in such a challenging period of time Those lenders aren't getting money back quickly. They're not getting paid off and Investors aren't getting money back from their fund investments or deal investments because office isn't really trading So it's bottling up bogging down a lot of capital in the system That's not getting reallocated and that's a challenge right now if you look at investment sale activity One of the reasons it's been lackluster and obviously it's picked up a little bit with rates coming down a bit has been this log jam of capital caught in the system in the office sector.

45:33There's just not a lot of transactions and there's obviously less transactions than there were in a 21 -22 in all asset classes, but office very little. With a market like that where you have somewhat of a freeze and certainly evolving dynamics in terms of what's going on. And how long does that take to play out when you have existing buildings, but probably mature in nature or at least look that way? When you think about that being something that's more opportunistic, let's say in the future, what type of time horizon are you looking at when you think about something like that? Is it the next two years or could it be the next 10 years?

46:10Well, I think you look it off and it's bifurcated between the haves and have not in the sense that you have a AAA brand new office and every city has the premier buildings and a place like New York has a bunch of premier buildings and then there's everything else. So the Class A office is attracting tendency at record rents, it's fully leased and then there's the B &C office buildings in New York that B &C maybe third avenue office corridor. That may be the Garmin district and these are antiquated buildings. These are just old and frankly they're not seeing the absorption. They're seeing more than they did a year ago, but still way less than 2019.

46:48So the real problem here is what will this look like on forward? And with banks full on office and insurance companies full on office, this is very little credit to get these new deals out, so to speak. There's very little that's greasing the wheels. I do think it's probably a two to four year situation. Some of it is getting solved by conversion to other. So, I mean, there's a lot of talk about office to rezy conversion, not that much action, but more action than there was a year ago. You're starting to see more of it happen. Part of that is because in a place like New York, they added on a tax abatement for office conversions.

47:26And that is a step in the right direction, but not all office buildings can be converted. They may not have the right dimensions, the right egress, the CAPEX may be too much. So I think a lot of it boils down to some of this can get out through conversion to other, but it's easier said than done. And is the suburban shopping mall evolution where classes were still as strong, if not stronger than ever, B &C properties, is where you saw most of the pain? Is that your reasonable parallel here? Do you think there's major differences in terms of those two dynamics? I think there is some parallel because if you look at Simon properties, the mole read.

48:08They have their class A, excellent locations, very high per foot sale by moles. And then there's the second or third generation Simon mole that was the excellent location. One of our worst deals was a mole that we did in 2007 in Dallas, Texas. And it was a third generation Simon mole. Okay? And fortunately the experience was so bad for us that it kept us out of the mall sector for 20 years. So terrible deal, but kept us out of the sector where people lost a lot more money over the years. But again, to your analogy, it's the best in class and then there's everything else. And I do think retail has come back a lot since COVID.

48:48There was this period of time where it was a belief everything was going to move online. But then there were certain changes, and I don't know the specifics, but certain laws that were changed online customer acquisition online became much more expensive and it brought a lot of the traffic back to retail So I think you're finding that retail in a lot of locations and grocery and shopping centers are performing really really well And it took a recalibration of rents to achieve that in New York for example Fifth Avenue rents are not what they were, but the spaces have turned over things are relatively hot again Yeah, looking at some of the foot traffic numbers for what those are worth over the past weekend too are impressive to see that people still like the experience.

49:29The other fallout or whatever we'll say evolution from COVID is some shift in terms of the work schedule and whether the five day in office goes to four days or three days which feels like based on a small sample size where it is even down now. How much of a trickle down impact does that have on some of the other properties or opportunities as you look at them? And then from a timeline perspective, is that pushed out even further just in terms of when you could see that impact? Do you think about that much? What are your thoughts around that? I think the pendulum is really starting to swing the other way in terms of you have a lot of tech companies and companies just saying back to work, financial companies in New New York, back to work, five day a week.

50:15It's moving in that direction, little by little. And I think that's a great thing. The impact on other real estate, a place like Midtown and Hatton in 2022, you didn't have this mandate of back to the office. So all these restaurants and retail, they were really, really suffering. They did not have the traction. You came in on a Monday or Friday, it was empty. So Wednesday was the big day, but that little change made a huge difference in terms of whether a tenant could pay the rents that they once were able to pay. So it has had a real impact, but I think again the pendulum has started to really swing, and we're starting to see because of this back in the office work mandate, I think you're starting to see cities like LA start to really benefit from that or even New York.

50:59You're seeing people have to come back, and that's really important from a real estate standpoint. We interviewed somebody who has a lot of coffee shops around Manhattan, and when I did the math in my head of if you have somebody who's in the office twice a week and they go to the shop versus five days a week, that is a material impact on a business where the product price is not significant. So you could see how much of a trickle down impact it has. One of the other dynamics and you touch on a little bit is just rates and you don't need to take a view on rates and where they're going. But just in terms of how much they impact the market, I think there's a lot of debate on this in terms of the residential side and I've been impressed that where I live it It just feels like there's less inventory, maybe less sales, but people are still paying prices that are extremely high.

51:43How much does it impact your business where people are very institutionally focused, very return focused in terms of volume and just what gets done? Well, look, for putting out new money, rates, it's great. Higher rates, everything we do is floating, great for returns. That being said, rates have an impact on value, and this theme of higher for longer has had a major impact on the investment sale market, the real estate market. I do believe directionally we're in a position where rates are not just short term rates, but the 10 year will start to come down, or even out somewhere in this range between four and four and a half percent.

52:22I think that one of the challenges is from an investment sales standpoint and an equity investment standpoint, you can have rates all over the place. You can have a treasury that's three and a half to five percent because how can anyone buy real estate knowing that they create this value and they renovate and they get to 7 % yield on cost and you want to know am I going to sell that for a six cap a five cap a four cap It's very very hard to drive what you can sell for if the 10 years all over the place How do you finance that how does a buyer finance that so I think we need consistency and when consistency in the 10 years somewhere in a 50 basis point band, I think people for a period of time, I think that's where people can really underwrite what that's going to look like.

53:05That started to pick up a lot. Directionally, obviously, since the election, there's been a much more bullish outlook. That also comes with an outlook that there may be greater inflation because of tariffs, because of a whole host of reasons. I do believe that the U .S. has compared to other places. It's viewed globally as a safer place to invest. And I think that will ultimately have an impact on the 10 year from a compression standpoint. It's very interesting to hear your point on the volatility of rates relative to just the direction of rates You're the second person that's actually mentioned the volatility is the most disruptive thing in terms of fluctuations So I think it's a strong point to make with something like residential and There's development of these projects they can take extensive periods of time to develop and then at the end you're going to have if it's purchases, it's going to be different than rental, but if it's purchases, there's some dependence on rates in terms of the demand from the buyers.

54:01Does that come into the equation at all with these projects? And I know you're putting your brain inside the borrowers mind, but I'm just curious how much of a trickle down impact does it have on a specific space like that residential where you see rates show up in multiple places? It really depends. So if you take a look at the housing market, you've touched on it before. One of the reasons you're still seeing activity in the housing market is because even though rates are much higher, so many people are locked into such cheap mortgage rates from 2020 -2021, they're not moving. So the supply of secondary houses to be sold is non -existent today.

54:37And that is really kept supply and check. I also believe that there's this more normalized scenario where people believe that rates are higher for longer and they've adjusted. And there's life events that force people to have to move at some point. So I just had another kid. I got to move to a house. I just got married. So there's some of that that goes on and again the supply and demand dynamic one of the bright spots of real estate Is housing has been in short supply and it's kept a very healthy housing market today I think when you look at condos. I mean again, we're looking at a project We're looking at how many units is someone delivering?

55:11Is this luxury? Is it not luxury? When you look at luxury that may be less mortgage dependent If someone that's buying a $20 million apartment, a $10 million department may view the mortgage market differently than a first time home buyer buying a $500 ,000 house in Texas. So we really look at market fundamentals, who's the buyer, and how mortgage dependent other, and then what are rental options as compared to buying? What does that look like? Makes a lot of sense, yeah. It's interesting to hear the nuance. If we step back, I think we've talked a lot about the various trends and themes in the market, some cyclical, some secular, what stands out the most to you, and it can be repetitive in terms of what you've been saying, but when you think about the next few years, the opportunity set, and especially with what you're doing, what stands out to you as the most interesting theme that exists in the market?

56:05I think for us, if we believe that private credit is a major market opportunity, what's the best way to address that. And from a direct bar or standpoint to levering other lenders, those are two themes that we're really seeing as interesting. I do believe that you do have to have lots of different creative ways of originating and finding deals because there's less deal flow activity right now with the 10 year where it is. The bid ask spread is still wide and there's less investment sale activity. And I think about our 20 year history, there've been few times where I've seen this kind of time period where it had such an extreme change in rates.

56:44We're finally having situations where borrowers are pushed to act. They've been floating around and sitting around here for a couple of years and some of it was by the way masked by rate caps. There were a lot of 2020 -21 borrowers that bought properties. It got a rate cap so rates were being masked by the fact that they were paying this really, really low rate. And when rate caps expired over the last 12 months, the inevitable happened where bars weren't able to stomach the debt. There's certain places in this country in states where foreclosures can happen quickly, where that effect has happened quicker than others.

57:20Like transactions are happening because the lender is acting on a foreclosure. Things are happening. We just finance, for example, someone that bought a non -performing loan from an institution here, Just to give you some dynamics, the property was bought, class A multi -family in Las Vegas for 120 million in 2021. Now obviously cap rates were very different there. There was a very different market fundamentals. Now today, that same loan, which was about $87 million loan, got bought for $85. That's probably close to what it's worth. They bought the loan for that price because they could own the real estate quickly.

57:56We financed that group with 60 million of NPL, non -performing loan financing. So again, I think that you're starting to see some of these things come through the system because lenders, borrowers, this frustration where things have to happen. This finally, an impetus for transactions to happen. Yes. I mean, you get it with private markets in general relative to public markets where there's a daily scorecard and a certain amount of liquidity. But it's so interesting in the real estate terms when you think about the time horizon and for some of these things, as you mentioned, the geography and how much that matters.

58:32So it's interesting to hear how you've positioned yourself for the opportunity set as well and some of those opportunities. This has been a fascinating conversation, Josh. I really appreciate you sharing the knowledge and getting in the weeds, getting below the surface in terms of all the different things going on. Just closing out, if you had a case study from history that you think is most instructive, I think you've given us several as we've gone through the conversation, but most instructive for prospective real estate investor or an allocator to study or to read about. And it could be within your own business, if it's publicized or it could be outside of your business, if it's something third party.

59:08But what would you point to in terms of one of the more interesting case studies from this market? That's interesting. I think when I think back to just flexibility and capital, I don't know everything about this, but when Blackstone bought Hilton in, I believe it was 2007. and it was one of the biggest private equity real estate deals of all time at that time. And it's interesting because global financial crisis happens and it's such a shock to the system. And I think one of the ways they were able to stomach that was flexibility of capital. They were able to actually, I believe they bought a lot of their debt in one of the other vehicles they had or one of the funds and it became one of the most successful deals of all time for them.

59:50And I think the key thing is, again, having flexibility in capital, having many tools in your toolbox opportunities. And I think it's particularly important in withstanding shocks to the system, really being nimble, navigate. And again, I always believe this, but you have to make your own luck. So it's a lot of making sure you're in that right place at the right time. So again, that's one thing that comes to mind. It's a great example. It's one that I think immediately comes to mind and one that at one point they had written it down 70 % and in the end 14 billion of profit on a 26 billion dollar purchase price.

1:00:29So yeah, it comes to mind. I mean, there's many, but that's one thing to think about. Well, thank you again, Josh. Appreciate you sharing all of the detail and all the knowledge. Appreciate you joining us. Thank you. To find more episodes of breakdowns ranging from Costco to Visa to Moderna or to sign up for our weekly summary check out join Colossus .com. That's J -O -I -N -C -O -L -O -S -S -U -S .com.

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