2011: Residential & Commercial Real Estate Market Transactional Values, Trends and Challenges with Mike Zlotnik

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My name is Andrew and I live in the Pacific Northwest. So far, I've got six properties in about three and a half years and I'm pretty happy about it. And it's all because his team of experts and just his, his knowledge and his time that he spent doing it, he can really guide you through it. And his podcast is excellent and I highly recommend it for anybody, whether you're a beginner or an expert. There's a ton to learn there and it'll help you get to the next level.

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Welcome to episode 2011 2011, and greetings from the beautiful Danube River. This cruise is about to come to an end, so I just wanted to share with you this beautiful, gorgeous scenery. It was actually a little bit better before I started recording, you know how that goes. It's just never quite, quite right, you know, but we do the best we can. Anyway, we've got a great interview for you today. One of our guests who's been on the show a few times before over the years, will be back with us today talking about just an overview on the market, on the syndication market, which is quite interesting. A lot of perilous things going on there right now. But before we get to that, I wanted to share this CNBC article entitled the shortage of houses is hitting some people and areas harder than others. And it just brings to mind, you know, one of my ten commandments, thou shalt be area agnostic. And also talking about how all real estate is local because it really does vary quite a bit. But overall, throughout the country, of course, we know that we have a shortage of supply. We are still in that supply shortage market. In fact, this article, one of the bullet points, says the supply of Homes for sale in the United States is about half of what it was in 2019. And just a reminder there, in 2019, there was a shortage of inventory, right? Because that was down by a third of what it should be to be, quote, unquote, normal market. And the shortage is hitting some buyers more than others based on income and area. Far fewer homes are available for people who make $100,000 a year than just a few years ago. So again, we are in this time of extreme shortage, especially in the entry level housing market. Anywhere you're below the median price, severe shortages still apply. So again, all of those Crash Bros just continue to be wrong, wrong, wrong. But we'll see. Look, someday they will be right. Chicken Little will be right someday also right. The sky will be falling someday. But when we don't know, we'll see. I did want to also say be sure to check out the YouTube channel if you're not watching on YouTube right now. We broadcast these on audio in the podcast and then we also broadcast them on YouTube. I just got this note that you see on the screen 700 videos uploaded to our main YouTube channel. 700 videos. Lots of guests, lots of great thought leaders, lots of commentary and tons of charts and graphs and visual aids. And maybe one of the visual aids today that's the best is the background. I'm here in my cabin on the cruise ship on the Danube river. And as you can see, this is just beautiful. It's 63 degrees out here, cool, crisp, sunny, gorgeous on this river cruise and it's about to come to an end. After this, I go on to phase three of my European trip. We're going to visit Munich, which I've been to before. That's a wonderful city. I love Munich and also the Naschweinstein Castle. This phase two of my European trip is with my mom and she's always wanted to go to Budapest. We did that about a week ago. And then she's also wanted to go to Nashweinstein, the castle. So we're going to do that here in the next couple of days. And then mom goes home and I meet some other friends to do a Mediterranean cruise and then head back to Canada, not the U.S. my friend's wedding in Montreal and then back home. This is again my longest trip ever. Five weeks away on this trip. So it's been a very long journey. And gosh, I gotta get a haircut, I need to do some laundry. You know, there's all these little things that you kind of take for granted when you're not traveling when you're just home. It's so easy to do all this stuff. And anyway, we got a great show for you today. So let's listen in as we get some good insights on the market and especially the world of funds and syndications and the overall real estate market. So here we go with today's guest.

It is my pleasure to welcome a returning guest back to the show. He's been on a few times over the years and that is my good friend Mike Zlatnik with the Tempo family of funds. He has insight into the markets because they are vetting deals, constantly deciding, making the go or no go decision as to whether or not they want to participate in a deal. And they're doing this with debt and equity. So they're lending on properties as well as partnering on properties from an equity perspective. Mike, welcome back. How are you doing?

Hi, Jason. Thank you kindly for having me on the show.

It's good to have you back. You're coming to us from Brooklyn, New York still, right? You haven't moved?

I haven't moved, yes, from Brooklyn, New York.

Good deal. Good deal. Well, Mike, you know, you have inventing these deals all the time. I mean, just every day deals are coming across your desk. You have some really good insights into the market. And you're investing in multifamily apartment properties, self storage industrial properties and retail properties. So there's no office property in there, I'm guessing, right?

Correct.

Okay, good. But I am surprised. Retail, I mean, that's another sort of bloodbath area. We know the office space market is so you know, whatever you want to start with. But those different asset classes kind of give us an overview of what's going on with them. Sure.

So thank you, Jason. And just for the folks, we run family of diversified funds and syndications. We do many things, we diversify among many dimensions of diversification, location operator strategy, so on. So quick comment. We actually love open air shopping plaza environment. The product hasn't been built for years and existing properties, some of them are being sold at a distress by REITs that need to sell. So we're participating in these deals at a great prices, great location assets. So I'll leave that alone as retail is a very broad term. But open air shopping service oriented continue to do really well in this environment. Multifamily. Obviously storage, industrial are more mainline type of investments. But let me make this comment. Things have come to a halt from a transaction volume perspective in commercial space. And quite often you hear the word commercial and it's referenced to the office space. The office is a bloodbath, no question about hasn't recovered from COVID and there's a lot of pain and more pain to come. But multifamily self storage continue to do relatively well. Obviously the entire commercial and some residential real estate sector is at immersive this high interest rate environment and happy to chat about that, but the longer we stay at the high interest rate environment, the more pain is going to be in the system, in a manner of speaking. But transaction volume is down and I think it's beginning to impact residential too. So we're all from the last year's transactions, about 75% which is impacting a lot of actually bankers and a lot of folks who finance these type of deals are getting laid off and will get laid off.

Yeah, I just want to make sure people heard that right or I heard it right. Did you say transaction volume in these various commercial real estate asset classes is down by 75%?

Yeah, year to year.

That is shocking. I mean that's a bloodbath if there ever was one. And you mentioned office space. I mean look at what's going on in San Francisco. That iconic Wells Fargo building just sold for 75 or for 25% of its prior value pre Covid. That is just unbelievable. I mean the, the wow. It's just crazy. So transaction volume down 75% and all of those ancillary services that the title insurance, the attorney firms, the law firms, the financing, all of these impacted businesses are just ancillary to that. Not to mention the brokerage business itself and just the people making deals. 1031 exchanges, all of that stuff way, way down. Now the residential is down in volume. Two you hear different numbers, but anywhere from 20 to about 35% in the worst markets in volume decline. A lot of people are confusing that though with prices and those are two completely different things for sure. But tell us more about that in terms of the amount of deal flow.

Yeah, it's pretty common sense. The sellers are not capitulating. So the bid and ask prices have really widened and the buyers just don't want to pay what they used to pay when interest rates were lower. So it took a little time to sink in. But the BMS spread is, is wide and transactions take place in need to sell type of environment. So need to sell, have to discount. The buyers are ready to come in with vengeance. A non distressed situation. Sellers are sitting and waiting until better conditions improve. So it's almost came, it kind of clicked in. I don't want to Say overnight. But from the beginning of the year it was a major impact of slowdown and this transaction volume fell off the cliff. And as far as the prices themselves, it's a downtrend. Right. The cap rates are supposed to expand in a high interest rate environment. In a non distressed sales, they haven't heavily expended, but distress transactions are taking place. And one of the big drivers of distress is the fact that a lot of value at projects were acquired with bridge loans. So bridge loans, typically two years, three years, many of them carry variable interest rate. Some of them have bought a rate cap. So a rate cap is like an insurance protection mechanism against rates going up above the rate cap level. And what has transpired is that some of these value adds haven't completely executed their, their plan and they're maturing. And these assets are effectively need to sell at a discount. Otherwise the bank default is going to happen because of debt service coverage ratio, just not there. So major, major pressure point is brewing. At the same time, assets that are refinanceable and assets that are high quality are not being discounted. From the point of view that there's a general belief at this point that the Fed is done raising interest rates and if you're patient enough, the rates will cycle back down.

Which makes me surprised that the banks holding those or the lenders, I should say, not the banks necessarily, but the lenders holding those bridge loans won't just renegotiate the deal, won't they won't extend them. Now rates are much higher than when they made those loans. So they got to get a higher rate. And maybe there's just no way the project sponsor can pay those higher rates. That I understand. But what's going on there? I mean are any of them extending, are they renegotiating these deals, are they doing workouts so that people aren't forced to sell these properties?

Yes, it is happening to a degree. Generally speaking, there are cash in refis now, not cash out cash in. In other words, need more equity. Right.

So in other words, rather than getting, you go to refinance the property and rather than pulling cash out of the property, you gotta bring cash to the table in order to get the refinance correct.

Debt service coverage ratio the easier a.

Foreign idea to many people. Yeah, yeah.

It is incredibly painful when you have to do that and some deals can do it. The problem is if it's a portfolio property and you have the equity in the bank and you need to refinance, you bring in the equity and you get it done. If it's a syndication and you got to go to all the LPs and ask for capital call, many of them may say no. So there's a little bit of that problem. I've seen the refinancing taking place two ways. One, cash in equity. Number two, there's additional fresh capital bridge equity coming in, preferred equity to, to satisfy the bank. And number three, if you can't pay, if you can meet that service coverage ratio, you need substantial cash to buy down a fresh rate cap. So one way or the other, more cash is needed to complete these refinancings. So again, it's a cash in, not a cash out type of situation.

Right. And sometimes they just can't raise the cash. So a lot of these deals are inside of funds and syndications and some sort of pooled. So are they, they're going back to their investors and doing a capital call. Right. And saying, hey, look, if they can. Yeah.

If they cannot, they, that's, that's the pressure point to sell. If you can't refinance and you're going to default on a loan, what options do you have? Try to sell? Yeah, it is. So it depends asset by asset, depends on strategy by strategy. Some deals are refinanceable. I've heard different statistics but, but there's a number circulating that something like 25 or 30% of these loans are just not refinance. Really pretty bad number. Really high number.

Wow.

And that's going to cause substantial correction. If those properties flood the markets, then we may see some correction.

Yeah. And so then the next stage in this chain of doom is that we have all these banks that are holding these cmbs is these commercial mortgage backed securities. And as the defaults start then the banks are in peril. And we've already seen some bank failures obviously. What do you think about the banking side of it?

Well, that's back to the creature from Jekyll Island. The Fed may actually need to start taking the reverse action from the point of view that once they start seeing a lot of cracks in the ice in the banking system and they're not responding to just one sector. So real estate is a painful sector and as it creates pressure for the banks and they will have no choice, either start lowering interest rates and providing liquidity or lots of banks could fail. So that's kind of the thought process here, is that they're done hiking, they've done enough, they are kind of stuck between the rock and a hard place. They have a dual mandate. Obviously one of the key mandates is inflation stable, stable prices and inflation fight, in essence. And they can claim that they've done enough. That's my opinion at this point. Crystal ball. But it might still, still do another quarter raise or not. I think they're done. How fast they're going to cycle back down, it depends on how fast these cracks in the ice will appear. That's a directional statement. Normally they want to hold the rates at the peak flat for six months or longer. Will they be able to do it now? It depends. So that's kind of what I think.

So what do you think? I mean, go ahead and give us your prediction here. What do you think the Fed is going to do? I mean, I think they are going to be forced to lower rates because of the distress in the banking sector, because of the distress in the commercial real estate sector. And I think they're just going to be forced to accept higher inflation.

Yes, Jason, I mostly agree with you, so I'll let me just provide a little commentary. That's generally the thought process that the pressure from banking sector problems and other economics issues will give them no option but to start easing sooner rather than later. So if you want to speculate when they're going to start easing, my guess is very late Q4 of this year unless something really badly breaks. So if something breaks bad much sooner, they'll have to act sooner. Otherwise they'll probably keep dealing with the pressure accumulating, which you might see something interesting, you might see that the Fed funds rate will stay where it is, you know, in the five to five and a quarter percent range. But the ten year treasury will cycle back down. If the inflation expectation and the market prediction that the Fed will ease the broader market might actually let 10 year treasury, which impacts mortgage rates get back down. So on a Fed side Q4, late Q4 probably when they start easing, when the 10 year Treasury, I think it's going to come back down. It's already moving. It's already dropped below at the time of recording. It's dropped below 3 and a half percent. I think it's moving towards 3% sooner rather than later and then it'll dip below 3% probably by the end of, of the year. I may be, I may be off, but again the directional trends are there.

That would mean we have a very inverted yield curve. Right. Does that go with that?

Yeah, the spread is widening between 10 year treasury and 2 year between the long and then the short end of the curve. Very inverted. Meaningful recession, substantial recession is coming. Hard to say exactly but it's coming.

I, I just put quite a bit of money into six month Treasuries and the advisor said don't do it longer, the curve's inverted. You're better off doing the shorter term deal.

Correct.

Just a quick comment on this. The optimal point is around four months. Six months is a good spot. But the general concept is your parking cash in relatively safe investment, good faith and credit of the United States. As safe as that sounds, if it's a default, who knows if there's actually.

No, they're not going to default. They'll just print more money. They always do.

Yeah, in general I would agree. But it would appear that they haven't made the deal yet at the time of the recording. Hopefully the politicians will come together and make it work.

Yeah, okay. So look, the Fed is going to push us into a recession. They're going to, they're going to pivot. Maybe the recession is before or after the pivot. And then what happens? What happens to the commercial mortgage backed securities, the commercial real estate market in general, what does it mean for the residential market, the overall economy? How do you see that playing out?

Crystal ball questions, as usually, and you've heard me correct this joke. Crystal ball broke, hard to find another one for sale. But what I see is obviously technical recession, a few quarters of negative gdp, a lot of slowdown in the economy. Obviously real estate is one of the sectors taking it on a beating that they're taking beating on the nose.

There's going to be more problems with banks, probably some more bank failures. Nonetheless, the Fed has unlimited printing power and they're going to start pumping in liquidity and lowering the rates sooner rather than later. And it's hard to say exactly what soft lending could look like. I don't believe it's going to be soft, in a manner of speaking, for soft landing, maybe in general for the economy without major unemployment. So unemployment is too damn low. In essence, we need way high unemployment for the inflation to come down. It's the Phillips curve concept you're obviously familiar. And unless unemployment figures get worse, we're going to be dealing with inflation. We may be dealing with the, let's ease a little bit, slow down the recession and then if inflation comes back down, they'll be stuck between the rock and a hard place.

I don't know if the Fed's Phillips curve problem is going to be solved as much by the Fed's tightening policy as, as it is by technology and specifically artificial intelligence. I think that is going to give them the Unemployment they're seeking could be. I mean, it's crazy that these central planners want to put people out of work, but you know, that's the way you kill inflation. Right.

So, well, centralized planning, this is the problem. I mean, I grew up in the Soviet Union, you know, and centralized economy, centralized planning just doesn't work in my view. It didn't work for socialism. And we have a little bit of that or maybe a lot of that in the United States. And the central banks is a form of central planning and their work is not necessarily easy at all. It's very difficult and they're often wrong. So you may be right. That chad GPT will take a lot of jobs away from lawyers and a lot of the white collar folks support that work in that industry. But you may be right. Technology is heavily deflationary and it may create more unemployment. So theoretically speaking, with the amount of undocumented immigration we're getting into the country, unemployment rate should be going up. I don't know what's happening. Maybe they're not counting all these folks, but they are coming into labor force in theory. A lot of these folks coming in unless they get a lot of entitlements and don't have to work.

Well, there's such a, there's such a giant shortage of workers. You know, it's just a band aid. It doesn't solve the problem. I mean, specifically housing construction. You know, the average housing construction worker is older than they've ever been. These are not guys in their early 20s out there building houses anymore like it used to be. There's a tremendous shortage of labor in the housing construction sector and throughout the economy. So it's a very unusual situation we're in. You know, this isn't playing out like the normal Phillips curve debate.

Well, my view on this is if you lighten up on the entitlements, you force people to enter labor force, then you're likely going to see a whole lot more supply of labor versus the, the current environment. Sure.

Rather than out of luxury. Yeah.

All those Democrats would lose votes if they did that. So we can't, we can't lighten up on the entitlements. It's just.

Well, yeah, I mean, the political debate. Without getting into politics, it is unfortunate that we're just not incentivizing folks to work. The American dream. When I came to this country And I came in 89, the American dream, you come here to work, to succeed. You come to the United States because it's a great country. It's A great democratic experiment. It's still an experiment that's evolving and it's a better place for many folks. But in the current environment, there's no adjustment made. The United States I think is short 10 million legal immigrants. That's what I heard, 10 million legal immigrants. So we'll see.

Okay. So Mike, what else did you want to cover? You had a few bullet points we talked about. I just want to let you go free form for a couple of minutes and cover what you want to cover to share the insights you wanted to share.

Sure. So one point we chatted about is that we do some business we do is in the hard money space on fix and flip projects and that business has been relatively slow. Pretty well known fact that the in your neck of the woods, in your kind of area, the turnkey properties, the older product is very difficult to find. Most operators just cannot seem to find good enough assets.

And so these are just to just to tee this up for you. What we've moved to where most of our clients are buying brand new properties from our builder network now through, through our network in the past at certain times they've really been buying mostly renovated properties that a home flipper bought renovated, put stuck a profit margin on there, made some money selling a rent ready renovated house. Now most of our people are buying new houses and that is because of the massive shortage of resale inventory that's available to fix and flip. So go ahead with that and you finance a lot of those projects and so do I. Well, not anymore because there's just not many of them available. Right. So like do you have a number in terms of your hard money loan volume, finance, financing, those flips and fix and flip deals, how much has that declined?

Well, it's probably declined 50% of what we were doing before.

50%.

50%.

Okay, so. So that volume is half of what it used to be. Got it. Okay.

And we are not trying to grow the business so we purposely just continue to do business with the same folks again and again and again. Not looking for new. Maybe that's the reason we declined because we're not looking for new business. But I could tell you that we've seen some really, what I call them, difficult situations from folks who have continued to do fix and flip, model, fix and flip to the as a turnkey product and they've not been able to do to find quality assets. So they've gone to worse areas, worse product and then those properties malfunction when they just don't deliver good value. So most prudent investors have gone, like you said, built around, new product and that has been a great product, especially in the markets that have continued to appreciate. There's been a lot of demand in Florida, Texas and so on. We've actually participated in commercial syndications raising equity capital to buy literally communities of these built to rent properties. So we love this sector. As I said, Florida taxes appear to be great markets where you basically invest in a pooled acquisition of a lot of these properties in the built around manner banks are happy to finance. So you could think of it this way. You could participate in a single asset built around and get a mortgage and just own a whole portfolio of these. Or you can participate in a pooled vehicle where 200 of them are bought as a package and you're investing the same capital into a similar deal. So we've done a little bit of that and that strategy just again, built around is dominating the market, at least from what I could see. So, and I think it's your observation is very similar to ours.

How does that market come back? How do we see more fix and flip activity? Because that's a real stimulant to the economy. It would be a stimulant to our business because we would have more inventory to sell. We have this terrible inventory shortage that seems to be the thing we've been talking about for seven years. You know, it's like it never gets better. We never have enough inventory and a lot of people aren't able to make money because there's just no resale inventory of homes to fix and flip.

End of the day it needs a substantial recession. It means substantial recession where there are more, more distressed properties that the banks are forced to foreclose. And we're not reaching for 2008 crisis. But without substantial amount of foreclosure transactions, bank repossessions, we're just not going to see massive fresh product. My properties that are struggling, there are assets that are already in distress, but you need to have more of them and you need this product to be going through something towards 2008 problem. But I don't think Fed will allow it at this point. The tolerance for pain is very short lived.

Yeah, I agree. Yeah, there's just nobody, nobody's willing to take medicine anymore. Although Powell does seem like he's trying to make us take the medicine for the past 10 rate hikes. But again it's not doing the job. So I kind of differ with you, Mike. I'm not really sure a recession will solve that problem. And what I Mean by that is you've got virtually the whole country refinance their properties.

Right.

And 25% of the country has mortgages at or below 3%. 65% of the country has mortgages at or below 4%. How are you going to put them in distress? 42% of the country has no mortgage at all. They have the free and clear homes. How do you put any, how do any of those people get in distress? I mean yes, there will be a few, a small number of course with job losses, et cetera. But. But it's just awfully hard to be in distress when your mortgage is that cheap.

That's exactly right. That well this is part of the problem that the supply in the market of homes for sale is so small because nobody wants to sell. They've got such a great low interest rate debt that they are sitting on and they just don't want to move if they live in a property or obviously investment property. When you lock in that great interest rate a few years back, you're in phenomenal shape. So from that perspective there's going to be very limited supply of product for a while. Even if there's some distress, the distress can come from a real recession. Recession is typically accompanied by substantial layoffs, right? Think about this. That's one of the most important side effects over recession. Again, let's go to the beginning of this discussion. Transaction volume is down. All those bankers get laid off, all those company supporting ecosystem gets laid off. So these folks, as they get laid off, they can't afford to pay the mortgage. So the, the substantial layoffs, the increasing unemployment, has to proceed defaults, right. And if, if we never going to see a big problem there, we're not going to see big defaults. We may go back for you know, in a short recession and then maybe that's the soft lending, right? At the end of the day, as they cycle interest rates back down, if they say they've accomplished their goals, inflation is more or less under control, they start cycling interest back down and the pressure is removed. That is happening in the system. And when there's less distress, we might come out of this recession without major bloodbath. So the product that you are seeking is just unlikely to show up. New build to rent is the way to go. Will continue to be. And the difficulty with some of these older assets is it's difficult to estimate what they're gonna take to fix. And then they need constant maintenance and that all the product, it's kind of lost the popular appeal in a manner of speaking.

Yeah, it's a, it's a, it's a strange situation and I, I think we are going to have an inventory shortage for decades to come because these people have 28, 29 years left on these mortgages. So I don't know where the inventory is ever going to come from.

Oh, one more point on this. While the interest rates are high, most builders are, the cost of carry has gone up. Right.

So the, the builders will make deals, but the problem is they're starting. And that's why most people through our network are buying brand new properties now. Okay. New builds. Because they're starting at such a higher price because the construction quality requirements and the entitlement requirements are so much more exp. Expensive for those builders. So these houses are quite a bit more expensive to start with. And yes, the builders are making some deals because they don't have the luxury of those cheap long term mortgages. They can't hold the properties they need to sell them. That's their business obviously. So you know, they're just starting at such a higher price though. They can't, they haven't been building entry level homes for 14, 15 years. So that's part of the problem. But they just can't make the math work to build those homes anymore.

That's right. So. And the high interest rates are just not supporting the industry. And you're right, inflation has taken place even though it's slowing down, but the cost of build is a lot higher. So from directional perspective, I, I don't know where the product is going to come from, but if the interest rate cycle back down and there's more product will be constructed, if the interest rates will stay at the elevated level for extended period of time, then the supply will be tight.

Yeah, it's, it's quite a, quite a situation we're in. Well, Mike, any more of a prediction you want to share or anything else before we wrap up today?

Yeah, it's not a prediction, it's just more of a. For investors in our ecosystem, it's a game of being opportunistic right now. A lot of people sitting on cash, they're doing exactly what you said you're doing. You parking cash in short duration Treasuries, we're already beginning to see distressed deals. So in our ecosystem we're kind of sitting with ammunition ready to go when these deals come in. They, they are great deals. So the transactions that are happening, they are strong transactions from the buy side and from a need from distress seller type of situation. So it's not a prediction. It's just more of a prudent invest strategy. Obviously what you do is a steady Eddie buy turnkey property. Long term strategy. We're a little bit more opportunistic now. We're more of a short term. Can we. Great. Get a great deal. It's almost like this. You've heard Warren Buffett speak about that he would rather pay a fair price for a great company than a great price for a fair company. Right, Right. The same concept general applies in real estate as a long term strategy. Buying a build to rent property in Florida in a great location might be a great long term play. But we live often in a short term environment. So from a short term perspective, can you actually make a stronger irr or stronger rates of return by buying? Well. Right. I mean you make the money on the buy in real estate. That's a general rule of thumb. So the way to do it is be opportunistic in this environment and folks can reach out to see what we have from time to time. Templefunding.com that's our primary website. And we have a distressed deal now. We're buying a distressed asset and it'll continue to happen, but the volume will be. Will be shorter. It's kind of interesting. People reach out and say what else you got? What else you got? Like I don't have anything else. I have one deal right now. It's going to be a game of precision rather than game of volume in this environment.

Yeah, I agree with you. Mike Zlotnick, thank you so much for joining us. Appreciate it.

Thank you.

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