Janet Yellen, US Treasury Secretary. What does it mean for Commercial Real Estate space?
Thoughts on the implications on the Industry based on her track record and economic views.
[{"id": "ge29imp", "text": "I think Yellen is less of a concern for CRE than the overwhelming state of CMBS and inflation over the next 5 years\n\nOn top of that WFH and companies downsizing space \n\nWhat\u2019s currently been kicked into motion is of more concern IMO", "replies": [{"id": "ge2e5a0", "text": "Can you elaborate a little more on that? Specifically the CMBS and inflation?", "replies": [{"id": "ge2fuox", "text": "Not OP but CMBS is a total disaster right now with lower tranches facing a total wipe out as hotel and retail defaults mount, and who knows what office is going to look like in 12 months. The only bright spot, Multi, Lab, &amp; Industrial aren't heavy weighted to typical CMBS pools (with multi almost never getting a spot since the GSEs are so cheap and issue their own K series CMBS), so you're left with kind of cats and dogs and a lot of sponsors who are cash out. Recipe for disaster.\n\nInflation could get bad given the massive stimulus packages - although Yellen for what its worth is a Keynsian monetarist who doesn't think inflation is a real risk to bail out unemployment. As fed chair her focus was on unemployment primarily, and she recognizes that there are no tools left in the monetary shed to bail out the economy so it will have to come from the fiscal side which typically leads to inflation. Inflation is bad for the \"good\" real estate with long term leases in place that pay fixed amounts - even in a NNN structure you're still capped on expense pass thru on a lot of leases so it'll eat into your margin. The only propety types that work as really good inflation hedges in CRE are in hospitality (hard pass right now) and multi (although a lot of people have been signing longer term leases right now so as not to try and catch a falling knife on continued rate reduction....).", "replies": [{"id": "ge2grh6", "text": "Well said", "replies": [], "depth": 4}, {"id": "ge399mi", "text": "Why hard pass on hotels right now? Seems like there could be an opportunity in the next 6-24 months?", "replies": [{"id": "ge3gpnb", "text": "First everyone isn\u2019t anticipating a return of precovid EBITDA until 2025, 2nd most are currently operating at a loss that you\u2019ll need to bridge, 3rd for anything but limited service hotels there is no idea what group demand will look like post-COVID and without group (or contract for that matter who knows when the airlines will start taking rooms) you really can\u2019t get rate compression, 4th there\u2019s still a big bid-ask spread on product with people thinking there\u2019s some intrinsic basis that there hotel should sell at even if that\u2019s not realistic anymore, and finally they\u2019re really really difficult to get financed right now. The blood hasn\u2019t even started to get shed in hospitality yet, the lenders are all doing blend and extend / forbearance and hoping the problem wil resolve itself. \n\nHere\u2019s a hint - it probably won\u2019t and you\u2019ll see a debt fire sale over the next 12-18 months on hotels. However you\u2019ll also probably (at least in the balance sheet space, won\u2019t see it on CLO/CMBS because they can\u2019t) see a lot of active loan trading of good loans in conjunction with the bad ones so that quarterly mark downs on the bad shit that gets sold gets offset by some mark ups on the good stuff. Soften the blow a little bit for your investors. NB I manage an equity fund not a credit fund but imagine that\u2019s the approach a credit fund manager would take as an offset if they ever want to raise money again. \n\nAnyways my $0.0002.", "replies": [{"id": "ge3ll1f", "text": "That's super helpful context and thanks for sharing. In terms of the bid-ask spread you mentioned... any idea what type of discounts buyers are seeing for limited service hotels off of pre-Covid pricing?", "replies": [{"id": "ge3lvas", "text": "I don\u2019t think there\u2019s been enough arms length transaction volume this year to know. I mean generally there\u2019s been super thin trade volume across the sector. Starting to see hotels marketed as conversion to multi ...\n\nEdit: also for what it\u2019s worth the most recent \u201cbig trades\u201d were Xenia\u2019s trade of the the ren austin and hotel commonwealth in Boston which both sold for 20-30% pre-covid pricing. Also probably 2 of the bigger trades this year, I haven\u2019t seen much in RE Alert and haven\u2019t seen anything tracked on our end. Most hotel owners are just kind of asset managing to hold onto their equity by their fingertips right now. \n\nLimited service is a mixed bag, thy stuff is reliant on a weird mix of transient and low cost business transient. Booking curve isn\u2019t that great, it\u2019s like 45 days, so it\u2019s tough to make an investment decision to buy one (IMHO) unless you\u2019re taking a more macro bet. Not really all that much in the space that you can do to drive rates like you can in full service. I\u2019m admittedly biased though I enjoy working on investing in full service hotels.", "replies": [{"id": "ge3ye77", "text": "Also all hotel sales are being made because of COVID either. Some were planned winddowns preCOVID.  So whatever comps being used may be sale comps but the deal was negotiated based on a bulk price even if it's not actually posting that way.\n\nI would stay away from hotels just because there is a  lot of inside baseball related to some of the few comps that are available.", "replies": [{"id": "ge44tyo", "text": "Interesting. So you\u2019re saying if you saw a limited service hotels at 30% discount to pre COVID prices you wouldn\u2019t be a buyer? Or at least consider? Feels like that would provide some decent upside and compensate for risk.", "replies": [], "depth": 9}], "depth": 8}, {"id": "ge44pnc", "text": "Interesting. So you\u2019re saying if you saw a limited service hotels at 30% discount to pre COVID prices you wouldn\u2019t be a buyer? Or at least consider? Feels like that would provide some decent upside and compensate for risk.", "replies": [{"id": "ge46tjb", "text": "As with everything, it depends, but probably not. Keep in mind we have no idea what post-covid travel trends are going to look like. I\u2019m not smart enough to make that bet, I\u2019d rather pick up stuff I can financially engineer the crap out of or feel good that I\u2019m at least not going to lose money (ie multi). I just pulled RCA and trades for 3q are down 80% YOY and pricing is off 25%. On a rolling t12 pricing is down 17%, but again, on a rolling basis it\u2019s still off 52%.\n\nDrilling down to just limited service it\u2019s still off 70% yoy on volume with pricing down 14%. I wouldn\u2019t take that bet would you? There\u2019s just like... no data on what stuff should sell for, a lot of these deals were baked pre-covid kept on life support and are now trading anyways because a fund is in wind down / seller needs cash / whatever, they aren\u2019t like, real transactions. Unless you know the game I wouldn\u2019t touch it. \n\nAlso like... not sure how to interpret it but we hadn\u2019t even gotten back to 2007 peak pricing yet!", "replies": [{"id": "ge46zfu", "text": "Good pts. What\u2019s RCA?", "replies": [{"id": "ge47ftm", "text": "Real capital analytics, it\u2019s the gold standard database for sales comp tracking.", "replies": [], "depth": 11}, {"id": "ge48xle", "text": "Real Capital Analytics... good RE data source", "replies": [{"id": "ge4c9lf", "text": "How to get access to it?", "replies": [{"id": "ge58dv2", "text": "Pay a lot of money for a license", "replies": [], "depth": 13}], "depth": 12}], "depth": 11}], "depth": 10}], "depth": 9}], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}, {"id": "ge3ywm0", "text": "There\u2019s a lot of opportunity right now with hospitality IMO", "replies": [{"id": "ge47ddt", "text": "To do what? Nothing is for sale and it\u2019s impossible to come up with a decent business plan. I mean shit even for non-hotel assets 2021 business planning is just like... that expense makes sense, I guess the revenue looks in line, but maybe my market rent / mla/ adr will look like this maybe it won\u2019t, but more importantly what are my debt covenants and what\u2019s it going to take to trip one?\n\nI wouldn\u2019t go anywhere near a hotel right now, there\u2019s still a lot of room for pricing to fall. Also it\u2019s not like you can buy one right now, there\u2019s like no debt availability for new hotels unless you\u2019re also pledging your family as collateral\n\nEdit - also brand is still going to hit you in the face with a CoC PIP on trade, so like great you just bought a struggling hotel are cash flow negative and need to dump another $20k / key into the hotel in the next 24 months because Marriott says so. No thanks, would rather wait it out for the money to actually be accretive.", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}, {"id": "ge4alxs", "text": "This is interesting. So, inflation is a risk for property types with typically long term leases such as office, industrial and retail vs not so much for hospitality, or MF. Makes sense. \n\nI wonder if there's something on the leasing side/lease up that you can do to account for the risk? For instance, annual escalation &gt;= CPI / Inflation rate.", "replies": [{"id": "ge561dw", "text": "That\u2019s how leases are done but there\u2019s typically a cap on the amount that can be passed through - like maxed out at say 5%\\ year with no cumulative catch up", "replies": [], "depth": 5}], "depth": 4}, {"id": "ge4dvjg", "text": "Thanks for the detailed response. I\u2019m a multifamily guy so neither of those concerns are front and center in my mind, but certainly good to get the pulse of the broader market.", "replies": [], "depth": 4}], "depth": 3}, {"id": "ge2gape", "text": "Sure. Inflation: Basically for the past 12 years quantitative easing has allowed the US government to put the gas pedal on currency whenever it wants. Essentially what was created as a temporary solution has for some reason become a main stay of the monetary/fiscal policy of the fed. There is 0 problem with a temporary solution becoming a mainstay, but QE essentially allows the US govt to essentially inject money into institutions whenever it wants. Which in turn allows for improved economic activity through borrowing.\n\nThis is important because interest rates are essentially at 0% right now. So with interest rates at 0% the Fed stimulates the economy by creating currency and providing liquidity to financial institutions so those financial institutions (think JPM, BAC, etc) can improve their balance sheet to lend to CRE firms, individual RE investors, M&amp;A deals, people looking for car loans. Basically it improves the banks ability to lend money. The kicker is that the Fed's rates are essentially 0% but the banks rates are not. So what is happening? The Fed is essentially providing money, FOR FREE, to other financial institutions to create liquidity, but the financial institutions are charging interest rates, so although the fed has low rates, the banks have higher rates. So the banks are being given a better balance sheet, at NO CHARGE. This means the strength of the US dollar will be weakened. It's not a matter of if, but when do we see horrifying inflation. Our money used to be cheap, but now it's being given to banks for free? That is not good.\n\nHow do we remedy this situation? Well, ask [Paul Volcker](https://en.wikipedia.org/wiki/Paul_Volcker). He is given a bad rap, because he instituted double digit interest rates and created a recession, fortunately for us, that was the only solution to fight inflation, unfortunately for us, it really still is. What we saw afterwards though could be seen as the set up for creating some of the best times in American budget. Remember that Clinton had a surplus? That's in large part because of the Paul Volcker war on inflation.\n\nRegarding CMBS, that's simpler. Tons of loans are in forbearance and reporting of the true status of these loans has been worse and worse. If we look around and see where our cash flow is being shifted you can see it's not to CMBS. Example? Middle market IB's have been slashing office and leasing space in Manhattan and downsizing drastically. As for my own experience, I work at a F10 company and the company is assessing it's CRE needs for the next 10 years. WFH won't be permanent but it will be for some segments of companies. CMBS will most likely experience a reckoning with small to mid size companies defaulting and larger companies downsizing from their current obligations.\n\nAll of this combined is fairly scary because it means that we see interest rates through the moon during a time where CRE and CMBS will need lower rates to be able to develop the spaces companies need, while large commercial spaces will largely be taking a huge hit. A lot of people feel this can be a recipe for a concentrated 2008 style recession, but specifically for CRE rather than affecting the \"little guy\".", "replies": [{"id": "ge2q75d", "text": "Good analysis. I'd also like to chime in and say that this election will also have a huge impact on what we're seeing right now. If Biden goes get in, the rate of inflation will soar as he will allow Chinese currency to pump into our government and nation like no one has ever seen, while our debt to them and the rest of the world will skyrocket even past what we are.\n\nIf trump gets in, which I have 100% faith will happen, our national debt I believe will be reduced significantly. I believe he will use the chinese virus and then election interference to wipe our national debt clean from any and all of those countries who participated in the election theft and also the cover up of COVID-19.. \n\nIf scenario b happens, the united states of america will see the biggest economical boom of its lifetime and America will have the strongest currency, the least amount of debt, the strongest and biggest military and life will be great. The tariffs trump has imposed I believe will also stay and we will finally be a great nation that actually is profiting every year, and life will be great. I cannot wait for this. It is going to happen. I enjoyed your post. God bless", "replies": [{"id": "ge2rthr", "text": "Ok I can\u2019t address a lot of what you said until you take off the tinfoil hat.\n\nBiden will be be the one selling us down the river to China, but it\u2019s our business class appealing to a 1B person market that will actually have a very real effect on our economy.\n\nTrump lost. Biden won. \n\n\u201cIf you have faith in a system to elect who you support, or have faith in a system to find guilty those you think are guilty, you are nothing more than a hypocrite and a liar if you then shout at that system when it doesn\u2019t go your way.\u201d", "replies": [], "depth": 5}, {"id": "ge3f465", "text": "Hmmm, usually the batshit insane people don't find their way in here.  Good luck with your delusions though!", "replies": [], "depth": 5}], "depth": 4}, {"id": "ge4efsu", "text": "Thanks for the excellent response. I\u2019m a multifamily guy so I don\u2019t have CMBS front and center in my mind - appreciate the breakdown. \n\nAs far as the inflation fears, I\u2019m extremely interested in how things will play out (are we Japan 2.0 or Weimar Republic Germany?), but think that we may wait a while before seeing higher interest rates, and may see a tailwind to real estate prices in the short/medium run. At this point it feels like there *has* to be cap rate compression in the near future with stocks and bonds near the 100th percentile of historical expensiveness/lack of yield - what other asset class are you going to go chase cash flow in? I\u2019ve also been interested in the Fed saying that they might let inflation run a little bit before raising rates, and really wonder if the gargantuan US debt doesn\u2019t create a political incentive to let inflation eat away at the debt pile while keeping interest rates and therefore debt service cheap for as long as we can sustain it.", "replies": [{"id": "ge58nrz", "text": "Well there has been cap rate compression in multi, industrial, data centers and labs. Everyone wants their money on a safe thing. If you\u2019re a closed end fund manager and anywhere close to realizing your business plan for any of these assets now is the time to sell since you don\u2019t have to reinvest money. It\u2019s the putting new money in part that\u2019s scary....", "replies": [{"id": "ge5tmog", "text": "Placing money right now is tough. I took advantage of that industrial cap rate compression to exit a property, but man I've been searching high and low for three months to place those funds and nothing looks good. Risk abounds.", "replies": [{"id": "ge677gq", "text": "It\u2019s super tough, we\u2019re trying to buy but keep getting crushed on pricing. Starting to get kind of niche right now to get money out into some structured product that we can financially engineer to hit our return bogey", "replies": [{"id": "ge6ldot", "text": "I think there's still some time left on the clock, so to speak.  Pricing growth is still positive, though definitely weaker (according to what I'm looking at), and that's pretty much across the board.  But these things take time to shake out and the kind of transactions that hurt averages won't show up until next year.  \n\n\nMassive stimulus could forestall a lot of that, particularly in multi, but the retail reckoning has been slowly getting into gear for years now (that's not *only* COVID's fault) and I figure office has to experience some pain, based on the absorption I've seen.  Hospitality is all but a foregone conclusion. Industrial has enough secular momentum that I figure e-commerce growth will generally bail it out, especially since supply is slowing down, which just leaves multi.  Again, stimulus could solve a lot of those problems, but either way I'd consider patience if you want to go bargain shopping.  \n\n\nThough I'm of the opinion a lot of the bargains are going to be, to put this delicately, value-add propositions, and I'm also figuring a lot if is going to be smaller scale.", "replies": [{"id": "ge7hqtd", "text": "Weak fundamentals are tough to overcome when private buyers without leverage limits can bid stuff to the moon and get super cheap debt. I mean if I could buy multi or long WALT credit industrial and get 10 year money 80% at 265 I\u2019d be competitive. Unfortunately I have an LPA that restricts my fund leverage to 65% so I continue to see deals go to \u201cno name\u201d shops which is frustrating but hey they can make the math work through leverage. It also doesn\u2019t help that capital flows from allocators are converging on the multi and industrial space now that retail, office, and hotel are d-e-d. \n\nI can\u2019t get comfortable with it but I know that shops are underwriting exit caps flat to going in with the assumption that LIBOR (or SOFR now I guess) stays flat forever and spreads don\u2019t gap. I personally think that\u2019s way too risky and won\u2019t do it - I need margin of safety on stabilized yield (and per pound metrics.... but I tend to think more per pound than yield). \n\nAnd I agree a lot of the opportunity is still a ways out once dead loans start trading, but like, at that point will you be able to underwrite CBD office / strip centers / hotels / whatever any better than you can today? That feels more like Wall Street bets than real estate investing IMHO", "replies": [{"id": "gee4pc0", "text": "Fair enough, if you're that restricted on leverage, yeah, I get why you're so constrained.  In some sense I don't hate a restriction like that for a fund, but the temptation is always going to be there for competitors to leverage to the hilt and reduce your pool of potential deals.  \n\n\nI get why you're nervous about exits.  You can call me crazy on this, but I think flat to slightly up is a pretty conservative call.  Now, I'll admit that the market doesn't think like this, but when I consider the multiple that real estate caps get as opposed to the spread, I feel like there's still room for downward pressure.  If your going in cap in 2006 was a 7.5 and treasuries were at 4.5, your spread is three, but your multiple is like 1.6.  Today let's say you go in at a 4 and the treasury is at 1, your spread is still 3, but you're earning 4x on the dollar.  And I know, caps don't trade on treasuries, and there is a ton crap I'm ignoring, not least leverage and rent growth today that's probably going to be kind of crappy, but I'm still convinced that considering cap rates based purely on percentage point gap isn't a great gauge, not when everything else is yielding so low.  Even BBBs are at 2.2, thank you Fed.  The counter argument falls to inflation, and that's not unreasonable, but if you've got to place money, I think real estate starts attracting even more cash and once you get past the rash of deals gone bad that we're likely to see in 2021 and part of 2022, cap rates push down further in MF and Ind, and the caps underwritten earlier as flat start to look pretty conservative.    \n\n\nSo yeah, some of this is Wall Street bets, but if that's who is winning bids ipso facto that's now real estate investing.  Hopefully they're hiring good asset and property managers.  Or not, I guess, if you're rooting against them.  I'll cop to the fact that it's going to be tough to underwrite office and retail when there's blood in the streets, but there are gonna be some winners; value-add and conversion deals might stop being priced so rich.  But to your point any vanilla deal is going to have a lot more risk associated.", "replies": [], "depth": 10}], "depth": 9}], "depth": 8}], "depth": 7}], "depth": 6}], "depth": 5}, {"id": "ge5jd5k", "text": "All things being equal, I do not think it'll get nearly as bad as Weimar Republic. I do think it will be like the 1970s USA inflation although probably worse than that.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "ge499jb", "text": "True. I would think Yellen will probably have some influence over Federal Reserve and it's chair, give it was her past experience.", "replies": [], "depth": 2}], "depth": 1}]