Now that 2022 has come to a close, I think as a community, we should do some reflecting on our real estate investments and learnings and the lessons that we all have learned to make us better professionals. What were your most important takeaways and what goals do you have for 2023?
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Pretty easy to say that most of my network didn't learn anything too new about the industry as a whole, but rather learned how this Fed is going to behave and the steps they are willing to take. No one was shocked that rates rose to combat inflation, and everyone expected cap rates to lag behind this (the extent to the lag is always variable so nothing earth-shattering about a gradual expansion in cap rates right now). I'd also say that even the potentially distressed loans and assets are nothing new since there will always be firms that are hyper aggressive and eternally optimistic that will either get crushed or payoff massively, but there will also be firms that are in constant doomsday mode and always extremely conservative with their investments and they will be rewarded once the dust settles.
Those of us that have been around for multiple economic cycles in real estate have seen this before ('08 rings a bell or two) but it's definitely beneficial for the analysts to get exposure to downturns in the real estate market. The analysts and associates that are experiencing this for the first time obviously are smart enough to put together in theory what should happen under these circumstances but it's definitely different to see it in practice.
An interesting question. For one, in a historically low interest rate environment, locking in long term stability on debt may outweigh the juiced returns that comes with a lower coupon when you do a medium term ARM. Not that that is rocket science, and we found that we had to go with the latter option to keep our back end IRRs competitive, but still... real estate is about surviving the downturns and picking up the pieces of those who didn't on the other side. Accepting that you aren't going to become Steve Ross in the space of one cycle, and prepping to make sure you get through the inevitable downturn without letting go of assets, is a kind of mentality that I think a lot of younger folks in CRE just don't have. Everyone is looking for the next big thing, the huge score, the equivalent of being a tech con artist.
To be honest, it's not like there is anything new under the sun in this industry. It's just a question of each new generation learning the lessons firsthand. It's been almost a decade and a half since we had anything other than a hot market (in NYC, at least), so that was time for an entire generation to exit the business and a new generation to enter. A lot of people will learn the true value of liquidity, for example.
I joined a new company about 18 months ago and their entire portfolio is financed with fixed rate debt. I actually thought it was a little strange and initially pushed to explore some floating rate debt b/c it was a solid 150bps cheaper. My old firm almost never used fixed rate financing and it had never burned us. The guy that owned my company would usually reply with, if the deal works with fixed rate financing, that's a variable you don't have to worry about for the next 7-10 years.
Boy was he right...
Yeah. Major lesson learned here is "if the deal doesn't work with debt that actually amortizes, then it's not worth doing with floating rate or I/O". That'll be a concrete lesson we apply to every underwriting we do from here on out!
And by "work" that just means hitting a respectable return. If we're shooting for 18% IRRs or something, and the deal returns 12% with a 7 year ARM with 24 months of I/O, that's fine! Just can't be 15% and 5% or something like that.
Some folks might be learning a tough lesson about interest rates and sufficiently baking in risk.
Tenant credit is important! Think you’ll see a lot of these life science funds blow up now that the VC money is gone.
Would recommend reading the lessons learned from the S&L crisis that trammel crow did, was floating around on LinkedIn a few weeks ago. Chairman or whomever had all the regional principals send in lessons learned from the blow up and aggregated them all and published. A lot of common sense stuff, but difficult to stick to when things are hot so ultimately lesson just may be don’t try to overdo it with the rest of the market, stay disciplined no matter what.
Biggest Takeaway: Almost every time people run around with their hair on fire saying the world is going to end, it most likely won't.
Way too many people in this business still have Great Recession PTSD
Agreed. I think you're seeing a little bit of that in acquisitions right now where people are expecting 2010-type discounts. And maybe they will get here, but I think it's unlikely in most asset classes.
Development continues to be a different story, at least in my opinion. I don't think we'll see the demand destruction that we saw in the GFC, but we are seeing record supply levels in multi coupled with development pro formas that are really strained with interest rates at these levels.
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