Top of Mind: Large Funds Waiting for Distressed CRE Deals

Wall Street Journal Article – ⁠https://www.wsj.com/articles/wall-street-is-ready-to-scoop-up-commercial-real-estateon-the-cheap-6edac64f⁠
New York Magazine Article – ⁠https://nymag.com/intelligencer/2023/08/rent-growth-is-slowing-where-housing-got-built.html

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Ben Fraser: Welcome back to another episode of the Invest Like a Billionaire podcast. Today we’re coming to you with a top of mind episode, so these episodes are shorter. One hitters, we’re focusing on one topic using an article that we’ve read, a headline that we saw on the news, and something that’s really trying to be more reactive to things that are going on in the economy and give our listeners real time, thoughts, perspectives, and really just help in sorting through all the things that are coming at us, right?

And so much of it’s negative a lot of times, and so much of it’s, one data point pulled out of context. And so what we’re trying to do is just create a broader framework for how to interpret things that are going on. Really create a narrative that is in line with the fundamental analysis that’s going on in the economy.

So today it’s really we’re gonna be focusing on multifamily and just commercial real estate in general. And some of this, the distress that people have been talking about that may be coming but where opportunity, May actually be coming in the midst of all this. So Bob, you wanna refer to the article and tee it off here?

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Bob Fraser: There’s a couple articles. I’m gonna go ahead and just share my screen here. Just to have people be able to see that with me here. So this is the first one is from the Wall Street Journal and it says, Wall Street is ready to scoop up commercial real estate on the cheap. And they talk about how Wall Street firms raise new funds to acquire office buildings, apartments, and other troubled commercial real estate, looking to scoop up properties that a fraction of the price investors paid a few years ago.

And then another one from Globe Street says, 205 billion of dry powder ready to pounce on distressed c r e assets. So these are articles that we’ve just read and we can, let’s jump in into some of the fundamentals. So what’s happening here, our podcast is called Invest Like a Billionaire, right?

And here’s what the billionaires are doing, okay? They’re reading the headlines of the distress and all the problems and they’re not doing what retail investors are doing, which is let me not invest. They’re doing the opposite. They’re going and saying, okay, buying opportunity. Can anybody say buying opportunity?

And so let’s talk about why. They think this is a buying opportunity. So Ben, I’ll hand it over to you. Why? Why do the big boys think this is a buying opportunity?

Ben Fraser: Yeah, first off, to invest like a billionaire, you a lot of times have to think contrarian. And it’s easy to jump in and invest when everything’s going up.

But generally, when you’re investing with the herd you’re getting going up usually when it’s too late and you’re going on the back on the downside here. Yeah. 

Bob Fraser: You’re late buying in.

Ben Fraser: Is basically you’re late buying in, and you have to have conviction. And the way you get conviction.

Is really looking at the underlying data, right? And so if you look at what has caused a lot of the distress first off, most of it is office, right? When people say commercial real estate is falling, it is in trouble, it is down 50%. You know all the headlines that are just trying to get clicks.

They’re mostly referring to the office, and there’s a big reason why that is, right? Because the whole covid and pandemic era has shifted fundamentally how employees, employers are using office space. And that, to us, still remains to be seen. We’re not quite bull in an office because there’s a lot of challenges and how do you repurpose it and these big metros, et cetera.

But on the multifamily side, where we do invest a lot in, and we are fairly bullish on certain metros and certain strategies in multifamily, a lot of deals that are distressed right now are really due to a few simple things. One, I. Usually mar deals are purchased in very hot markets at very low cap rates.

Going to cap rates in the threes and lower purchases with very high leverage, 80% to plus, with floating rate debt. With very aggressive business plans, right? The real market only ever goes up, and so we’re just gonna ride that up. 

Bob Fraser: Classic  bubble, right? It only goes up, therefore you get too aggressive, put on too much debt, right?

This is the same story, and this has happened in multifamily, but it’s happened in a small percentage. It’s only 25% of assets. So it’s not like the entire market, so it’s not going to be as devastating, and we’re not gonna see. A 35% crash, I don’t believe. And we’ve already seen maybe roughly a 15% kind of retracement and values and that might be it.

We might see a little bit more from here, but 

Ben Fraser: yeah. Yeah. And if you look at the fundamentals, people are investors. We’ve talked with, oh, I’ve got too much multifamily, and that was yesterday’s investment. That you have to look at the actual fundamental supply and demand. Right?

And we’ve made this point before in other podcasts that, real estate, the real estate market is not one market, right? The real estate market isn’t like the stock market. The stocks are down, this week, the real estate is very hyper-local. It’s very specific to the market that you’re in.

So you have to look at not only the national data, but the market data that you’re investing in. And if you look, there’s actually. A very strong case that we are pretty massively undersupplied in housing in general. And this is inclusive of both single family and multifamily. And we’re gonna get to a lot more in this in future podcasts top of mind, because this is a very nuanced topic that requires a lot more investigation.

But let’s say for conservatism, there’s a lot of range of estimates that housing supplies are under supplied right now. Around 1.7 million units. And as forecast over the next 10 years, we’re gonna need another 17 million units to help with population growth, with household formation, with people buying secondary homes and then tear downs of old properties.

And so that’s just to meet the current demand. And we’re already behind the eight ball. So what’s happening, it’s really interesting. At a fundamental level, we’re seeing this kind of multiple things that are converging right now where maturing debt on certain properties that were purchased a couple years ago with this bridge debt that usually have short terms with higher interest rates.

These deals are not working right now, right? They don’t have enough income to meet the debt service requirements of their lenders, and so they’re gonna be in trouble. Meanwhile, A lot of the projects in the new construction that was started in multifamily several years ago are all coming online this year.

We’re actually gonna have a record number of deliveries this year in multifamily. And that might, some people might say, oh, that, that’s the end of the asset class, right? We’re oversupplied. We’re overbuilt, time to get out. No, not so fast. You gotta look at what is the go forward plan, right?

Now, if you think about multifamily, These are very large projects that can take many times, 2, 3, 4 years to fully complete construction and bring to market. And so these are the projects that were started, when the bubble was at its height and really before and through. And so we’re seeing all these deliveries coming on.

It’s gonna increase the supply in the short term, already seeing that, especially in the Sunbelt markets where there’s. There’s been a lot of new supply coming on, especially seeing rent growth declines. So negative rent growth. But if you look at the new housing or the new multifamily construction starting now, it’s fallen off a cliff, right?

’cause the finance scene has made it very costly and developers are now wanting to take all the risks right now. And so we have kind in the short term, a convergence of a lot of potential distress, ma hitting the market. A lot of new supply. Slowing down rent growth, but we have a really big problem of undersupply over the next, multiple years.

And my, my real kind of gut sense is that fast forward a year from now to 18 months from now when a lot of this new supply has been absorbed into the market. We’re gonna be back in a situation that we’ve been in where we’ve been undersupplied. And so that’s the fundamentals. We can talk more about the market and why is the market raising billions and billions of dollars to go buy these assets?

Bob Fraser: And just to hit your Undersupply point, I’ll show a little chart from Fred’s my good friend the Atlanta Fed. And Fred. Fred loves data like I do. And what I did here is I showed new housing starts, privately owned housing starts relative to population, and what was during the great financial crisis, 2010 down here, absolutely everything crashed, and it’s never really recovered, even though there has been some new recovery.

It’s not recovered back to even its norm. It’s low from before relative to population. So it, so there’s just simply not enough housing built to, to accommodate the new population growth. And so just supply is a big problem. And as you said, so Sunbelt states, they were overbuilt.

And so what’s happening? Oh, and another article we just read too was about tracking the fact the places where rents were actually dropping was the place that had been overbuilt, which again makes a lot of sense. And we still think Sunbelt states are very attractive, right? Good weather, low taxes, and they’re attracting population growth.

So they’re probably still a good bet. But what’s happening in the short term, let’s say for the next year and a half, we’re gonna see softness in these A in the pricing there. Okay? Again, then that says buying opportunity. So this is what the big boys know, right? So we’re seeing long-term demand.

Long-term trend up, short-term problem and short-term distress. So for the two reasons that you said, one, overbuilt, oversupply and two, but it’s short-term oversupply and two, overly aggressive market participants. During this the last couple years. And so we’re very bullish long term and are gonna be creating a lot of op, we’re seeing tons of opportunity in multifamily in the next couple years.

So we’re gonna be. Really backing up the truck as Aspen to go and buy as much multifamily as we can in the next two to three years. 

Ben Fraser: And again it’s difficult as an investor sometimes, right? When the deals you invested in over the past couple years, maybe they’re not doing well. Maybe you’ve had some capital calls.

Maybe you have a deal that’s headed for, not a great place. So it’s difficult to, Compartmentalize, this is what happened in the past two, what’s happening right now. And you have to have conviction. If you look at the data and look at what the big investors are doing, they’re raising that one.

What our, you pulled up $200 billion of dry powder just ready to scoop up these assets. And to me, this is another reason why we’ve seen some retracement in commercial real estate pricing and obviously the office segment has been the biggest drop in value. But at the same time, we’re not predicting a real estate crash like we’ve seen in past recessions because of the fundamentals, right?

These billion are these billion dollar hedge funds, they’re not just on a whim. They always should go do this. And they, they’re fiduciaries. They have to be held to certain standards with the money they’re raising, and they’re looking at the same data that we’re looking at and saying, you know what?

We’re gonna take advantage of a little bit cheaper price to play into this long-term trend that we believe in. And again, this is something that’s really important to understand. As we are in this kind of unique economy and a lot of people are worried about a big housing crash.

We’re just not seeing it. And the money that’s being raised to scoop this up, if there is any big, crashes that of deals that hit the market in a big new glut of deals that are distressed. It’s likely gonna be quick. 

Bob Fraser: Yeah, the billionaires not the billionaires.They’re not worried. They’re sitting there writing checks. 

Ben Fraser: Yeah. Alright guys, thanks so much for tuning in. Hopefully this was insightful and helpful for you. And we’re gonna be diving into more of this type of topic. In future episodes. Be sure to subscribe, leave a review and give us some feedback.

We always love hearing from listeners and other things you’re reading that are interesting. I appreciate you listening. Thanks.