Large Funds Waiting for Distressed CRE Deals | Top of Mind Series

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, kind of one-hitters. We're focusing on one topic, usually 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, you know, 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 and 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 going to 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 want to kind of refer to the article and kind of tee it off here?

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There's a couple articles. I'm going to go ahead and just share my screen here. You know, 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 raising new funds to acquire office buildings, apartments, and other troubled commercial real estate, looking to scoop up properties at 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 CRE assets. So these are articles that we've just read. And so, you know, we can, let's jump in into some of the fundamentals. So what's happening here? You know, 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 like, let me not invest. They're doing the opposite. They are going and saying, okay, buying opportunity. Can anybody say buying opportunity? Right? And so let's talk about why they think this is a buying opportunity. So Ben, I'll hand it over to you. Why do the big boys think this is a buying opportunity? Yeah.

Well, first off, you know, to invest like a billionaire, you a lot of times have to think contrarian, right? And it's easy to jump in and invest when everything's going up, right? But generally when you're investing with the herd, you're going up usually when it's too late and you're going back on the downside here. Yeah.

You're late buying in, you know, is basically right.

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 kind of what has caused a lot of the distress, well, first off, most of it is office, right? When people say commercial real estate is falling, is in trouble, is down 50%, you know, all the headlines that are just trying to get the clicks, they're mostly referring to 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's to us still remains to be seen. We're not quite bullish on office because there's a lot of challenges in 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, usually deals that were purchased in very hot markets at very low cap rates, going cap rates in the 3s and lower, purchased with very high leverage, 80% to plus, you know, with floating rate debt, with very aggressive business plans, right? The real market only ever goes up. And so we're just going to ride that.

I mean, classic bubble, right? It only could stop. 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, you know, maybe 25% of assets. So it's not like the entire market. So it's not going to be as devastating and we're not going to see a 35% crash. I don't believe in it. We've already seen them, maybe roughly a 15%. Kind of retracement in values. And that might be it. We might see a little bit more from here, but yeah.

Yeah. And if you look at the fundamentals, right? So people are investors we've talked with like, oh, I've got too much multifamily and you know, that was yesterday's investment. Well, that you have to look at the actual fundamental supply and demand, right? And you know, 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. Stocks are down this week. Real estate is very hyperlocal. 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, 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 going to get into a lot more of this in future podcasts, Top of Minds, because this is a very nuanced topic that requires a lot more investigation in. But let's say for conservatism, there's a lot of range of estimates that housing supply is undersupplied right now around 1.7 million units. And it's forecast over the next 10 years, we're going to need another 17 million units to help with population growth, with household formation, with people buying secondary homes and then teardowns of old properties. And so that's just to meet the current demand. We're already behind the 8-ball. So what's happening, it's really interesting at a fundamental level, we're seeing this kind of, you know, 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 you 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 going to be in troubled situations. Meanwhile, a lot of the projects in the new construction that was started in multifamily several years ago is all coming online this year. We're actually going to have record number of deliveries this year in multifamily. And Yeah, that might, some people might say, oh, that's the end of the asset class, right? We're oversupplied, we're overbuilt, time to get out. Well, no, not so fast. You gotta look at what is the go-forward plan, right? 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 I think these are the projects that were started You know, when the bubble was at its height and really before and through. And so we're seeing all these deliveries coming on. It's going to increase the supply in the short term. We're 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, so negative rent growth. But if you look at the new housing or the new multifamily construction starts starting now, It's fallen off a cliff, right? Because the financing has made it very, very costly. And developers are not wanting to take all the risks right now. And so we have kind of in the short term a convergence of a lot of potential distress, which hitting the market, a lot of new supply slowing down rent growth, but we have a really big problem of undersupply over the next, you know, multiple years. And so, you know, 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 going to be back in a situation that we've been in where we've been undersupplied. And so that's kind of the fundamentals. We could talk more about the market and why is the market raising billions and billions of dollars to go buy these assets.

So, and just to hit your undersupply point, I'll show a little chart from Fred. 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 you see is 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, it's low from before relative to population. So it, so there's just simply not been enough housing built to accommodate the new population growth. And so just supply is a big problem, you know, 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 so, but we still think Sunbelt states are very attractive, right? You know, good, good weather, low taxes, and they're attracting population growth. So they're probably still a good bet. Well, what's happening in the short term, let's say for the next year, year and a half, We're going to see softness in these, 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 and 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, you know, overly aggressive market participants. During, during this, the last couple years. And so we're very bullish long, long term and are going to be creating a lot of oppor— we're seeing tons of opportunity in multifamily in the next couple years. So we are going to be really backing up the truck as Aspen to go and buy as much multifamily as we can in the next 2 to 3 years.

And again, it, 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, you know, headed for, you know, not a great place. So it's difficult to, you know, compartmentalize, this is what happened in the past to what's happening right now. And then you have to have conviction. You have to look at the data and look at what the big investors are doing. You know, they're raising that one, one article you pulled up, $200 billion of dry powder just ready to scoop up these assets. And to me, I mean, this is another reason why, you know, 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-dollar hedge funds, they're not just on a whim, they always go do this and they know their 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 going to go take advantage of a little bit cheaper price to play into this long-term trend that we believe in. And so 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, you know, if there is any big crashes of deals that hit the market and a big new glut of deals that are distressed, it's likely going to be— there's a—

wait, yeah, the billionaires, not the billionaires. They're not worried. They're sitting there, they're writing checks. Yeah.

All right guys. Well, thanks so much for tuning in. Hopefully this was insightful and helpful for you. And we're going to be diving into more of this type 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.