Q4 2020 Real Estate Update
As the effects of the coronavirus pandemic continue to evolve, so do shifting dynamics that undergird commercial real estate markets. EquityMultiple Co-Founder & Head of Real Estate Marious Sjulsen and Director of Investments Milan Parekh join host David Lofgren for a discussion about the current and future states of CRE investing.
David Lofgren [00:00:21] Hi, I’m David Lofgren with the EquityMultiple Growth Team. Today, I’m going to speak with EquityMultiple’s head of real estate, Marious Sjulsen and the director of our real estate team, Milan Parekh. It’s been an interesting year, to put it mildly. EquityMultiple’s thesis, and one of our guiding principles, is that private real estate investments are a wise addition to any investor’s portfolio, really at all moments in the market cycle, but perhaps most of all, during times of volatility. Further, we believe that diversified real estate allocation can help investors potentially mitigate risk and tap into distressed opportunities during downturns and recoveries. As such, our real estate team has pursued a diverse set of opportunities to help our investors position their portfolios for the recovery. I’m delighted to have Marious and Milan on the line to get further perspective of what our real estate team is seeing in the capital markets right now and how EquityMultiple is reacting with regard to originating and conducting diligence on new opportunities. Gentlemen, thanks for being here.
Marious Sjulsen [00:01:34] Thanks for having us.
David Lofgren [00:01:37] Let’s start broad. The pandemic has already had a massive impact on the U.S. economy and on real estate markets. At this moment, roughly six months into the crisis, I’m wondering if you could sort of lay out what you’re seeing in real estate markets broadly. Maybe we can start with you, Marious.
Marious Sjulsen [00:01:58] The market has gained a little bit more footing in the last two to three months from the sort of nadirs of March through May. And what we’re seeing is that the credit markets have really started to come back in to their own. Lenders are lending again. They’re being a lot more conservative on how they’re lending and their underlying metrics, and they tend to be focusing on several sectors of the economy that have, for obvious reasons, succeeded and proved to be more resilient than others, namely sort of the industrial sectors, multifamily, medical sectors, life sciences, and data centers, which we can talk about later, probably. But as a result, we’re seeing some credit markets unfreeze. So we’re seeing a lot more activity now than we were back in March through May. And while we did see a lot of middle market commercial activity then, what we noticed was, was that sellers were trepidatious about the market, were unsure about selling. And as a result, the transactions fell through at the last minute on a number of deals.
Milan Parekh [00:03:18] And I would echo that now that we’ve been in this market for approximately six months, the shock factor has worn off a little bit. Where, you know, when the deals were first seeing in late Q1, Q2, you know, it was it was a lot of rescue capital situations as lenders or equity partners were pulling out or paring back their investments and sponsors were looking to get their deal closed or save their deal. And also, you know, a larger bid (inaudible) from the buyer’s perspective that sellers just weren’t willing to entertain because nobody knew what was going to happen. And, you know, you had such volatility in the equity market as well. Where as, you fast forward to Q2 and Q3, you know, you’re starting to see, as Marius noted, the credit markets come back. Rates are attractive. It’s creating an opportunity for buyers, you know, in in the preferred asset classes. Call it residential industrial medical office, where there is an opportunity to buy a good basis, bases, and generate attractive returns and and provide diversification within the alternative space.
Marious Sjulsen [00:04:54] And to that point as well, I think that a lot of people, when the pandemic primarily hit and they had liquidity, were trying to take advantage of the stock market, which they sort of saw at historic lows. I think that over time you’ve seen, you know, the stock market ramp up dramatically over the last, like, you know, two, three months. But it’s had corresponding peaks and troughs. And I think that as you’re sort of seeing more and more people wanting to get away from that level of volatility, they have actually sort of, you know, real estate does prove to be a fairly attractive long term yield, given the low cost of financing and the ability to generate, you know, healthy returns with an underlying fixed asset. So we’re seeing a lot more activity in the space in general. In fact, our Q3 was probably our busiest quarter since we launched the company several years ago.
David Lofgren [00:05:56] It’s been interesting to see how the velocity of the deals that we have on the platform has increased in the midst of this situation where at least public markets are sort of on the fritz at times. I know we’ve we’ve put a heightened focus on real estate funds over the past several months. I’m wondering if you could say a bit about why we feel like private real estate funds might make sense or individual investors right now. Milan, you want to take this one?
Milan Parekh [00:06:28] Sure. You know, we’ve been monitoring funds for a while now, pre-pandemic as well. We see access to these funds as a great opportunity for investors to get access to, you know, proven institutional fund managers that generally have a larger investment sizes that, you know, retail investors don’t get access to. Deep dives into strategies that that we like where you can’t really fully capitalize on on one off deals and then, you know, given the nature of the funds, we’re looking at currently stable dividends. And so, combining those aspects along with diversification across a portfolio, we think makes a lot of sense for investors who want more, call it macro effect with their with their investment dollars. And can benefit from aligning themselves with proven fund managers that have a really strong established track records in the space.
Marious Sjulsen [00:07:41] Yeah. To echo Milan’s point, I think that what we’ve always encouraged investors to do on our platform is to ensure that they’re sort of diversifying their risk and not necessarily just pick one one deal and put all their eggs in that basket. While we underwrite each deal diligently and go through a multi-step diligence process, we also think that having sort of diversification to a multitude of deals alongside an institutional manager whose primary job it is to go out and find these deals, take advantage of the market when it makes sense, can prove to be a, you know, a huge stabilizer on individual’s portfolios. And that’s part of the reason that we put an increased emphasis on funds. We think that at this point in the cycle, given the fact that prices, there is volatility in underlying prices. There is volatility in the credit markets, even though that’s stabilizing. Not every deal that’s going to be sort of targeted is going to necessarily be a homerun. And as a result, like you want to be exposed to a multitude of deals to sort of ensure that, you know, you’re not overexposed to anyone deal.
David Lofgren [00:09:08] Marious, is offering funds on the platform, something we’re doing specifically in response to this economic crisis that’s come along with the pandemic, or is this something that investors can expect to see more of moving forward?
Marious Sjulsen [00:09:28] I think investors to see more can expect to see more of it moving forward. I don’t think that you know, I don’t think that this pandemic and the effects of it are going to just turn off on the switch and then people are just gonna get back to normal. I think that are certain sectors of the economy, you’re going to have to sort of see how they’re going to play out. The office sector, retail sector, and hospitality sector are the three that come to mind in terms of, you know, they’re going to take a while to sort of play out over time. So while I do think that, you know, there are going to be opportunities in the immediate term for sort of distressed funds, I don’t think the distressed funds are necessarily going to exist, you know, at the same level they are in the next in 18, 24 months. I don’t think you’ll see a tremendous amount of distress fund launches in two years. So I think that’ll be a sort of unique opportunity set to sort of get involved in. But I do think that over time, having, you know, more exposure to sort of debt funds, institutional managers that allow investors to stabilize their sort of one-off individual deals are going to be something we’re going to continue to offer on the platform.
David Lofgren [00:10:40] You know, recently we had David Bittner, the head of America’s research at Cushman Wakefield, on our podcast on Multiple Perspectives, and his feeling was that asset classes like data centers, medical office, to some extent, industrial specifically like supply chain related warehousing, were clear bright spots in this moment. I spoke with him, I guess it would have been August. So, you know, sort of in the midst of this that those asset classes are are really benefiting from our shifting lifestyles. Obviously, we don’t know how the recovery will play out. You know, there are no crystal balls here. But at this point. Do you agree with that assessment? Are you guys seeing any other asset classes that sort of stand out right in this moment?
Milan Parekh [00:11:35] First off, know, I think Bittner is correct. It’s no secret that, you know, industrial and specifically supply chain and warehouse is at an all time high from a demand perspective. And similarly with data centers. Given the expansion of corporate America and the use of these facilities and, you know, in this technology-forward environment, also has strong demand. On the medical office side, we’d agree. Well, we actually made a recent investment into a medical office portfolio outside Atlanta. We see strong patient demand there and continued growth within the various specialties with little pushback as it relates to the pandemic. I think the precautions people are taking across that sector are, you know, have been effective and are conservative in nature. You know, where we are seeing additional opportunity is in the multi-family sector, which we invested a lot in the past, and continue to like the macro trends there. While we aren’t necessarily necessarily seeing, you know, the home run value-add plays as relates to repositioning assets and in capturing rent growth, I think there’s a lot of opportunity and a more stable housing-type assets in both urban and suburban markets where, you know, occupancies have held up, collections remain strong. And, you know, with Fannie and Freddie and CMBS debt providing relatively low, attractive interest rates on long term financing creates an opportunity to generate an attractive yield on a year over year basis.
Marious Sjulsen [00:13:44] I think like, some some other sectors of the market that you’re seeing on a are is in the triple net space. Right?
Milan Parekh [00:13:52] Yes, exactly. And again, it kind of the theme of cash flow. So you go across kind of office, industrial, and specific retail that is on long term leases with, you know, investment grade or strong credit tenants. You know, we see attractive financing in that space as well, an opportunity to generate high single digit, low double digit cash and cash yields and, you know, fairly conservative leverage so that, you know, if you had to work through a re-leasing scenario, that you have the flexibility to do so.
Marious Sjulsen [00:14:39] Yeah, I mean, and there’s certain sectors of the economy even in the triple net space, like, you know, we’ve been looking at, you know, sort of Family Dollars, General Dollars as an example. We’ve also been looking at gas stations with operators, with, you know, strong balance sheets and strong credit. One of our biggest investments, you know, if you’ve been a frequent visitor on the platform, has been the car wash space, which we’ve actually seen to be incredibly resilient in sectors of the economy. It’s such like, you know, in Florida where we’re based and we’re sort of focused on that market continues to hold up and customers continue to sort of, you know, get their cars washed. So those sectors, there’s general sectors of the market that we see in the middle market space that we are always attractive for us. But I do think that, you know, everything the Milan mentioned has continued to remain a focus. And I think that will continue to be a focus going forward. We just want to be sure that, you know, our sponsors and our partners are evaluating deals and evaluating the risks properly and ensuring that they’re not taking, you know, they’re not being to rose colored in terms of their forecasts, given sort of the state of the economy.
David Lofgren [00:16:06] Yeah, it’ll be interesting to see how this evolves moving forward, I think. You know, as I mentioned, we don’t know what the recovery is necessarily going to look like, although there have been some promising numbers coming out that indicate that, you know, we’re on our we’re on the path. I’m wondering if you guys have any insight into, as we look down the road in the next couple of quarters, are there signs of other types of assets that may be strategic investments? You know, in the next, let’s say, two to three quarters?
Milan Parekh [00:16:42] Look, I think everyone’s right to be wary of retail, hospitality, office. But we also don’t think those asset classes are going away. And, you know, I think there is a strength to the hub and spoke model as it relates to office and suburban office in secondary markets. You know, we can go upside there on the hospitality side while, you know, occupancies are low and travel is extremely down. We do think that’s temporary. Well, while we’re not jumping into those sectors just yet, we are seeing some interesting distressed opportunities there and we’ll continue to reevaluate and can work with, you know, what we feel are best in class sponsors that can really capitalize and execute on those business plans?
Marious Sjulsen [00:17:47] Yeah, and to Milan’s point, I think that, you know, a sector that’s gonna be interesting and proved to be sort of, you know, a target of ours is identifying sort of parts of the capital stack as well, where we can slide in to and get sort of, I guess, the most bang for our investors’ buck. I know in the multifamily industrial space, we’re obviously looking to sort of generate, you know, fairly high current yield with stable, you know, sort of underlying assets. On some of these other on some of our other projects, we’re sort of looking to come in as a co-GP sponsor, which I know is unique to the space. But, you know, offer some upside to investors going forward. And given sort of the liquidity crisis in the market is a really interesting niche for us to focus on. And then, in the debt space, as we mentioned earlier, sort of there are still remains to be, you know, sort of freezing of the credit markets in assets that are not industrial and not multifamily necessarily. And so consequently, we’re seeing a gap where once you have senior lenders were able to go to, you know, let’s just say 75 percent of the stack. Now, senior lenders is capping their sort of leverage levels at 60, 65 percent and providing an interesting opportunity for some of these middle market players that have debt funds to step in and bridge the gap, allowing sponsors to sort of get their business plan, stabilize the asset, and then getting refinanced out once the assets stabilized. And so we’re partnering with, you know, institutional managers that are targeting those type of assets and those type of returns.
David Lofgren [00:19:42] Interesting. In the first episode of the podcast that we did, I spoke with one of our sponsors who identified that one of the things that we do well, that EquityMultiple does well, is that we’re able to slip into these these slices of the capital stack where it can be really difficult for them to find funding and it’s interesting, it sounds like what you’re saying is some of those areas might actually be expanding as a result of the situation we’re in right now.
Marious Sjulsen [00:20:11] So a lot of these funds that were created back in the day were heavily reliant on warehouse lines and lines of credit. As a result, like, many of them shut their doors in March, April, May, because they were unable to meet the commitments of those lines of credit. Many of the funds that we’ve been targeting don’t have as heavy reliance on line credit. So as a result, like it’s it’s created a, you know, an open playing field for people that do have fresh cash, are able to put it to work. You’re not competing with funds and having a low cost of capital. You’re finding a true sort of market rate cost of capital for a lot of projects. We continue to see interesting opportunities, not in different parts of the capital stack, but in certain markets as well. I mean, you know, there have been interesting plays. We think that, you know, as much as not the sort of, predict too much in the future, but, you know, there have been interesting plays here in New York City where we’re based, where value does not equate to anything historically. Currently on some sort of transactions. And so we’ve been selective and parsimonious about how to insert ourselves into those transactions to allows for for the maximum return, but maximum protection for investors. And we see that in several markets around the United States currently where we’re sort of you know, it’s too small of a check for institutional investors to write. But it’s too big of a check for your mom and pops. One sector that we have, sort of like we will be sort of more focused on in the coming months is in the mobile home space. That space has seen incredible resiliency. Collections remain high. And even though a lot of manufactured home, mobile home renters were buoyed by the stimulus checks? I think that in part, many of them continue to pay their rent first because, you know, and so collections remain high and they continue to pay rent even in sort of, you know, as stimulus checks have now evaporated. So we think that that sector of the market will continue to shine as it provides like enormous, you know, attractive cash flow yields. And, you know, the middle market sector is often ignored, but it still is proving to be very valuable, as we saw last week with Blackstone’s purchase of a 500 million dollar manufacturing home portfolio. Yeah, we we believe in that market and we’ll continue to target it in the coming months.
David Lofgren [00:23:10] Know, there’s really interesting dynamics at play here. We’re about out of time, so I want to give you guys who throw one more question at you. This was a bit of a hypothetical, so bear with me. But given all of these factors that we’ve discussed, I’m wondering if you could just sort of go through what your thought process would be if you were newly signed up with platform looking to increase your exposure to private real estate. How should investors be thinking about the types of investments that they might want to get in to either currently or know heading into Q4 of this year?
Milan Parekh [00:23:50] You know, if I was an investor. You know, on the site, I’d probably look to stay safe initially and then slowly increase that risk. And, you know, I think there is stable plays that we offer on the platform. Again, kind of, the multifamily, net lease sector. You get access to good yields, fairly predictable type cash flow. But we also offer a mix of preferred equity opportunities in ground up construction or major repositionings that I think offer outsized returns. But they do carry a lot of risk. And so I would look to try those out as well, but take advantage of the low, minimum investments and try and allocate across a few of these different opportunities so you can get access to your opportunities across the risk/return spectrum and not be tied to any one deal. And I think that’s one of our biggest value adds in EquityMultiple provides for its investors.
Marious Sjulsen [00:25:03] Yeah, I mean, just look at that. I don’t think that when you’re sort of… I would ask and I would say, as you know, to an investor, you’re not telling investors like day one, ok, you’re sitting on cash. You’re going to go and buy a stock and you’re just gonna put all your money into this one stock. Right. No one is sort of advocating for that sort of methodology. I think that, you know, what we offer on the platform is sort of a multitude of sort of investment opportunities, whether it’s from common equity deals to preferred equity to debt and in some instances, tax-advantaged 1031 deals. And I think investors should think about this creating sort of a portfolio within their portfolio or, you know, a real estate portfolio within their overall larger portfolio and diversify risk in that portfolio based on, you know, a combination of stability, upside, you know, and sort of down the middle deals as well.
David Lofgren [00:26:10] Great. Yeah. I should mention, too, to the viewer here that if there’s any questions or if you’re ever trying to sort of figure out what the best play might be as far as how to diversify on the platform, our investor relations team is always available to talk through the options.
Marious Sjulsen [00:26:31] Gentlemen, thank you so much for doing this. Really appreciate it. Well, thanks, David. Appreciate you taking the time.
Milan Parekh [00:26:36] Always a pleasure.
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