#9: Coronavirus and Its Impact on Commercial Real Estate ft. Eric Tait

Welcome to the Passive Income MD Podcast, where we talk about creating your ideal life through multiple streams of income. I'm your host, Peter Kim. If you enjoy hearing about this stuff, make sure to hit subscribe so I can bring it to you every week. Now let's get on with the show.

Hey, everyone, it's Peter. I know that it's been a crazy last couple weeks. My hope is that everyone out there is staying safe and healthy. I want to say a big thank you to all those involved and helping to keep things running as smooth and as safely as possible. That includes healthcare workers and everyone from food delivery people to, you know, even factory workers and everybody at banks and supermarkets who are helping out. It's just been a collective effort to keep, again, people safe and healthy. And all those people who are keeping their distance from others, I quarantined in the house and the parents that are sitting out there, you know, homeschooling their kids, I really commend you. And I know that every week that passes is a week closer to being at the end of this. And so I hope everyone is doing okay out there this week. You know, I have gotten a lot of requests from people to talk about how real estate is going to be affected by all this. I know there are a lot of people who have investments in real estate, both in their own properties as well as with syndications and funds, and everyone is concerned about how things are going to be affected by it. Are people going to pay their rent? Are banks going to foreclose on properties and things like that? And so I wanted to get somebody who I felt has a good pulse on these type of things. And So I invited Dr. Eric Tate to come speak with me on this podcast. If you don't know who Dr. Eric Tate is, he's well known, especially in the physician world, as an expert when it comes to real estate investment. He runs his own investment fund known as Vernonville Asset Management. He is a board certified internal medicine physician. He's also the founder of a resource called the Physician's Road. And if you don't know what that is, that's a physician services firm that's really dedicated to helping physicians and other medical professionals create their ideal lives in medicine on their own terms. Now that sounds very familiar to what I'm trying to do as well. And so he, he and I, we get along quite well. And, you know, when we get together, we love talking real estate and about investments. So I hope you enjoyed this episode. If you have any other further questions about this, again, there will be many, many shows regarding our current economic environment, as well as how everything's going to be affected by this current recession. So I hope you enjoy this podcast. Enjoy and stay safe.

Hey Eric, how's it going? Thanks for being here today.

Hey, Peter. We've had better times, but we will get through it as always.

Better times. Tell me what's going on.

Well, we're actually in the beginning stages of COVID right. And so from the standpoint of those of us who are real estate investors, passive real estate investors, it's very much a situation of wait and see right now, waiting for Congress to pass their bill to see kind of how relief is going to be initiated. Many municipalities have put a moratorium on evictions. So if you're in the residential space, your own apartments, things of that nature right now, if you're an owner, you can't evict your tenants whether they pay or not. And so that puts people in a little bit of a bind. But we do hear rumblings from Fannie Mae and Freddie Mac that they will be working with owners to work out forbearances and deferments on payments. And so this is kind of what we expected would happen if another 2008 style event happened that affected the real estate market. Because up until 2008, banks had never had a history of having to work with borrowers who were unable to pay. But because of the massive amount of people that couldn't pay during 08, they have worked out mechanisms and realized that they took a much larger hit on their assets if they tried to sell them during the down portion, as opposed to just deferring payments, putting that money on the back end of the loan, restructuring the loan, and then moving forward as the economy recovers. That appears to be the playbook that's going forward. You can look at the Federal Reserve right now. They're doing the same kind of things, figuring out how to get lending down to commercial mortgages because we have so many different types of assets. I can literally walk through many of these asset classes in terms of what we're doing, what we're looking at, and kind of how we structured some of the things to give us the best chance to get out on the backside. But again, this is still a fluid situation. And so we're looking from a wait and see standpoint, but this is a temporary demand shock. This is something that once we get kind of herd immunity through the population, we know what a modern society looks like. We know kind of what food distribution looks like, we know what Power distribution looks like, we know what water distribution looks like, we know how to sell things. And so our economy was fundamentally okay before this. Unemployment was fairly low, people were actually working extra shifts. And so we've had a fairly lean economy coming out of the Great Recession. So as soon as people are able to get back to working again, I expect that demand function to kind of ramp back up and people to get rehired fairly quickly, maybe in different jobs, in different industries. But the ability for us to continue to function as a consumer based society, that really hasn't changed it, just a function of what the new jobs might look like from that standpoint. So I'm actually relatively optimistic in the long run. And we're going to have some short term bumps in the short run and it'll be an opportunity to try to, if you're liquid and have some money to get into some nice opportunities coming up potentially. I don't think the opportunities are going to be as plentiful as people think they're going to be, which is very interesting. There are a lot of investors who've been waiting and so there's a lot of money sitting on the sidelines. So massive price drops, massive valuation reductions on the real estate side I'm not really seeing probably, but we'll see how it plays out. But getting things for 40 and 50% off, I really don't see that happening. 10, 15, 20% off maybe. And that's a strong maybe. Right? And the reason why is if they do a moratorium on mortgages, those of us who have mortgages don't have to pay. So we have no reason that we have to sell. And so if we don't have to sell, we just wait for our tenants to get back on their feet and then we roll everything on the back end. They're not building more assets. So the same amount of money is in the same amount of assets. There's no reason for it to fall necessarily on the onesies, twosie scales. Now what's happening with mortgage REITs and what's happening with REITs, they structure their things very, very differently. So the ability for us to maybe buy some things from them if they have to sell might be available on a one off basis. But it'll be interesting to see from that standpoint. But on our end we're looking like we're probably going to be able to defer a lot of mortgage payments at least for the next three months, if not longer. And so as long as there's not a forced sale, there's no reason for prices really to fall in an exorbitant kind of way. The same way you saw prices falling in the stock market. Gotcha.

I mean, you just said a whole mouthful in probably just a few minutes. So I want to unpack some of that back up and kind of go into some of what you said so that maybe people can understand a little bit about where you're coming from. From a mindset point. Obviously this. Everything's kind of taking a shock right now. There's been a shock to the system. Do you think we're better prepared than we were back in 2008 to handle something like this because of what happened back then?

So let me break it out. As a society. No, as a banking system. Real estate system, yes. And what I mean by that is the shock before was people somewhat losing their jobs in the real estate sector. And then they could just go rent. They could go find another job. They move to the south, they could move to the Sunbelt, they can rent. This is actually an income shock. Not just the US population, the whole world. Right. We've never seen an income shock for the whole world in our lifetimes. There might be some people who were around for the Spanish flu, for the Great Depression, but like literally everyone is at home. And they're at home. Not because like World War I or 2 that destroyed like manufacturing capacity and was a big shock to infrastructure. We haven't had any shock to infrastructure. All of our factories are still there. All of China's factories are still there. All of India's factories are still there. All of Vietnam's factories are still there. The people just have to stay home. Right. And so infrastructure has not been destroyed, but incomes have. And so from a societal standpoint, we are not prepared from a banking standpoint as it relates to working out mortgages. We are absolutely prepared because we did this literally 10 years ago. So the ability to look at people's payment histories to put kind of money on the back end. The banks know how to do this because they've already done it in their REO divisions. And so we have a dichotomous situation when it comes to banks abilities to work with borrowers versus kind of society as a whole having an income issue. And so on the banking side for borrowers in real estate, I think we're in a decent position. We kind of know what the playbook should look like to minimize losses. But the issue will be unemployment side and the income side. And hopefully Congress and the President will figure out a way to get money in people's hands consistently over the next few months as we come out of the quarantine situation.

Gotcha.

I mean, for someone like me, I'm an investor, so not only do I own my own properties, but I also invest in other people's deals. Is this something that I should be really concerned about right now in terms of some of the deals that I've invested in with these other professionals and that sort of thing? Should I be really worried that these investments will ultimately fail? Yeah, exactly. Just go belly up like some of these things in 2008, that's hard to say.

Right. So I'm guessing here I have no specific insider knowledge.

Well, what are you seeing in your own investments? I guess some of the deals that.

You put together, we're all in a holding pattern. Right. So we're hearing from tenants. So if we're talking about the single family side of our portfolio, I've had one tenant who's been laid off sent me the letter. We'll be contacting the bank probably in the next week or two to let them know, hey, we need a forbearance on this. What does the process look like? Give us the paperwork, make sure it won't affect credit, things of that nature. Right. The way we're handling it is at least on the single family side of the portfolio. As long as people are paying their rent, we will pay the mortgage. When people stop paying the rent, we will then call the banks and work something out. But the tenants will have to send us documentation that one, they've applied for unemployment, two, that they've actually been laid off for real. Like we need documentation, otherwise we will be going after them. Even though we can't, quote, unquote, evict, we can still file and we can still go through it. Now, I'm one of those kind of mini preppers. We have a decent amount of liquidity. So if I need to pay these mortgages for a year, I could do that. Right. On the single family side, I don't want to do that, but I could do it from that standpoint. But we'll see, right? I mean, everybody's taking a hit. So the banks need to take a hit. Everyone needs to take a hit. So that's kind of my stance on it. On the commercial side of our portfolio, a couple of our products have actually have business interruption insurance. Now I'm sure there's going to be an insurance fight to try to get that paid out. But it is there, it is out there from that standpoint. And then on the other Commercial side of things, we're in a wait and see whole pattern. Those are large loans, 10, 15 million dollars loans, 8, 9 million dollar loans. Those are loans that banks really do not want to go bad. And so my partners and I will talk to the banks and kind of figure out what that looks like from that standpoint. This is all going to be negotiation. This whole thing is negotiation. Now, for those of you who are limited partners in those kinds of projects, I know you all feel super helpless right now. There's really nothing that any of us can do. It's literally going to be a wait and see negotiation process. I know for us, we held back, we cut our distributions last quarter purposefully because we didn't know where this was going to go. So we've got some reserves and most of the deals, if I look back at them, probably reserves for three to six months on each property if we just were paying the mortgage only that does not necessarily count for property taxes and insurance because that on a triple net side that comes from the tenant. And so I'm probably going to be looking down the road for municipalities to have to work with commercial tenants as well. Same issue, right? So now we, instead of one lump sum, you do payment plans to catch up and those kinds of things. And so this will literally be a negotiated process every step of the way on every single asset. And so the thing about being a limited partner is you are limited in terms of your liability. This will not blow back on you, your personal credit, anything of that nature. The only thing you're on the hook for is the original amount of money that you put into the project. And so everybody's pro forma is going to be delayed. And what does that mean exactly? Well, if we're saying we're going to get out in three to five years, we might be getting out in five to seven years now to hit the numbers. Right. And so what I look at this is almost a 6 to 12 month, not reset, but just freezing period. And so like a delay, you're saying.

Like more like a 6 to 12 month delay?

Yeah, yeah, I'm seeing more of a delay than anything else. And so the pro forma numbers that people gave, you throw those out the window, probably none of us are going to hit those numbers anymore. Right. So if we were paying a distribution at a certain rate, that ain't going to continue to happen at this point.

Right.

But in terms of the value of the asset, the thing you have to look back at and see is did you buy the asset at below the replacement cost value. Did your general partners do that? If they did, well, you know, theoretically it can't be worth less than that. Just from a pure sticks and bricks standpoint. Right now from a valuation standpoint of the income that flows through it, depending on how the tenants hold up, the only value might be the sticks and bricks of it. You have to wait to re tenant it over time. Right. And that just means that things are going to be slow. It's going to mean that your money is potentially locked up in the deal for longer than you expected it to be. But it doesn't mean that it's necessarily written down at this point. Right. The only time it's written down, just like a stock, if you didn't sell a stock when it went down, the only time you lock in a loss is if it sells. So if we have to sell it below that or if we get foreclosed and the recovery doesn't cover the full equity amount, then there might be a haircut there. But we're not really looking towards any of that as it stands right now because we are pretty sure banks don't want these assets right now. And so they're going to do everything within their power to keep it on the books at what we call not a mark to market rate. Meaning it'll be kept on the books at its original value. Very likely. I'm pretty sure the Fed is going to allow that, which won't damage the banks kind of capital reserve requirements. And interestingly enough the Fed already dropped banks capital reserve requirements the first week. So everybody understands that this is a momentary pause. We all just have to regroup and work together to figure this thing out. Gotcha.

Okay, so if I had to recap what you said, I mean there's been a lot of fancy terms been thrown around but essentially we weren't necessarily prepared for this I guess on a personal level. But in terms of the banking system and all this stuff, we're not looking at a collapse here. We're just kind of looking at a freeze period of likely 6 to 12 months. Things will be a little delayed. But in terms of being a limited partner and being an investor in these type of things, I guess the good thing is the liability wise it's kind of limited how much we put in. Number two, we have professionals like you taking care of all this stuff for us. Right? Number three, Yeah, I mean, just that we were given a range anyways when we actually invested in these things, anywhere from three to five to seven years. And so it's probably going to be in the longer end probably than the shorter end. Yeah, I mean, I think business as usual.

Right.

It's just kind of wait and see. I guess there's nothing else we can do anyways.

Correct. But let me clarify on the bank side. So when I'm talking about the banks, I'm talking about their lending capacity, what I will not talk about necessarily is their internal functioning capacity outside of their lending book. And what I mean by that is there are some banks that are on the brink from a liquidity standpoint that has nothing to do with the lending side of things per se. So their lending arm could absolutely work something out, but their operational arm could have a massive problem. And so whether or not their bank collapses or not is going to. I can't tell you that. But I know for a fact internally to the bank, they have the ability to work out loans. So them rushing down to the courthouse to try to foreclose because payments aren't being made, that's not the first thing they're going to do right now. But in terms of solvency of the individual banks. Yeah, I can't speak towards that one.

Gotcha.

So then I think looking forward, you mentioned some optimism. Right. I mean, I think everyone right now, we're all in the middle of this right now. And I think whether you are any type of investor right now, if anything, there's pessimism, a lot of pessimism because of the stock market, the housing market, again, all these jobs being, people being laid off, unemployment is now skyrocketing and things like that. But you mentioned the word optimism. And I think out of times like this, that's when opportunities kind of are born. So where do you see the opportunities, especially when it comes to being an investor, being a limited partner, investing especially in multifamily or these kind of things, is there an opportunity that you see kind of in the near future?

Yes, we're going to be very aggressive on the back end of this because what this always does is it shakes out weak operators or weak deals. Right. Interestingly enough, let's talk about the multifamily side. I think the multifamily is going to hold up pretty well because it's what I like to call base, you know, Maslow's base need in terms of housing. And so because municipalities are putting a moratorium on evictions, those multifamily lenders are going to have to put a moratorium on payments in many ways. And Those occupancy rates are 94, 95, 96% in most major cities. Right. And that's just a function and a need. And there's just not enough housing. So I think that will multifamily, I think, will bounce back fairly quickly if it even fall. I mean, the values I doubt are going to fall. Cash flows will fall for a little bit, but that should come back as well. And so I think multifamily is actually pretty well positioned. I think single family rentals are pretty well positioned as well. Harder to get into from a passive standpoint because most of us don't put together passive groups to go buy single family. But for those who are individual owners, there's going to probably some opportunity around that side of the fence. There's definitely going to be opportunity around commercial because people tend to run those a little bit thinner. But that's a much more delicate balancing act in terms of what kind of tenants you want in there. Like for us, we always like grocers because back to that base of Maslow. So we like groceries, we like dentists and doctors. But even like right now, right, everybody's closed. Right. And so that's why I say this is not a normal kind of cyclicality, recession kind of thing. This is just a full stop on all economies. I don't know if we've ever had that before. That wasn't because of some excess in some industry. At some point, we're not going to have a full stop anymore. People are going to have to go to the doctor. People have to get their teeth done. People are going to have to do these things. Right. So all of those things are going to come back because again, we know what a modern society looks like. And so I'm going to be very aggressive on the back end of this because the beautiful thing about real estate is you never have to buy at a price that you don't want. Right. You can always get to decide what you want to make on your money. And then you just decide and negotiate the price to get that return for yourself. And so you have the ability to look at the tenant makeup and say, okay, well, we're coming out of this quarantine. Hey, there's a grocer anchor right there. Oh, there's a physician anchor there. There's a liquor store there. There's a whatever. Pick the thing that's going to bounce back quickly. From a demand standpoint, if you can find centers that have that, you can jump on them. Right?

Well, how do we know? Most people that are listening to this are probably not coming from the operator standpoint Right. They're not putting together huge deals. They might be, but I think most of the people that are actually listening to this are people with professional jobs, high income professionals, and they want to make their capital work for them. And some of them have been waiting for this moment because they've been stocking some cash away to say, hey, there's eventually this whole bull market is going to crumble. And I think we've seen it. And so they're ready to pounce. So I guess the question is how do they know when to jump in?

They just have to start looking at projects, find operators you think are reputable and start looking at projects. And what you have to listen to is the investment thesis of the partners who are presenting it to you. Right. Does the thesis make sense? Does it jive with what you're seeing in your particular marketplace right now? If you're in a high cost of living area like New York or California, it's a little bit different. What I would argue for you and one of our thesis is to kind of be in the Sunbelt, southern Virginia, all the way through Arizona. That's where most people are moving, that's where the population is migrating to understand kind of the metrics in those areas. It's just like kind of medical school or whatever profession you're in. Once you begin to hear things over and over again, they're going to either make sense or they're not going to make sense. Right. And the good thing about doing private projects is you can ask the operator very specific questions. And to us there's no dumb question because we assume that you all don't necessarily know everything. And so we are happy to answer what are quote unquote dumb questions because they're not dumb. It gives us a chance to give you a clear understanding of what it is that you do or do not know or do or do not understand. And then you just have to figure out from your own kind of common sense or BS meter whether or not someone's just trying to get a deal done or they really see a light at the end of the tunnel for this thing that okay, this was a temporary situation, but there was massive growth in the tenant base that they had in there. Whatever it is, Right. Again, multifamily, I think it's going to be perfectly fine. But if you're looking for things that are not that, it's going to take a layer of due diligence down into the deal itself and who are the people that are part of it. You can only do that when you're looking at projects, so look at lots of projects, get information, look at presentations, and you'll begin to hear the themes over and over again and you'll begin to understand the people that you like in terms of how they think through things versus those who are just telling you to invest in something kind of what I call a black box. Well, just trust us, put your money in. And this is how it kind of, this is how it works magically as opposed to walking you through and saying, hey, we like this tenant here because this is the dollar per square foot that most of them have in terms of their sales. Or here's a picture of a parking lot on Tuesday afternoon, it's full, people coming out, those kinds of nitty gritty kinds of things. Okay, gotcha.

I think that this is an opportunity for people to really educate themselves, take a pause. There aren't a lot of deals right now. There's going to be some things frozen. But this is a time to kind of get do your reading, do your research, learn how to do it. And then when the deals start emerging, like you said, a lot of the operators that probably were a little thin or not operating very well, a lot of them will shake out. So you'll have some good ones that are coming out of here right out of the gate with some pretty good opportunities. And so you just have to be poised to understand what they're talking about. Yeah. And kind of get to know people right now. So I think that's a great opportunity.

And I would add to that, go ask people for their old deals. You may have to sign a non disclosure agreement, but ask for their old deals so you can see how they put them together. Your process of kind of doing due diligence on them is just kind of how do they put deals together? If there's someone you're interested in but have never invested with them, reach out to them and say, hey, I know you know, everything going now. Can you send us some of your old deals and kind of how are they working up until this point? Because again, this is not a normal kind of recessionary thing in the real estate business where we use leverage, we use debt. No one can model what is happening right now out. It's impossible. So I don't care if you had six months worth of reserves. The reason why the government and the Fed reserve and everybody is jumping and throwing so much money at this is because it's not a normal situation. And so it's not that people were necessarily over leveraged. It was Literally a demand shock on every level for every person. And so when people talk in their models about kind of recessions and kind of what that looks like, and okay, we're okay at a 20% drop in vacancy. Because if you go back and model even through the Great Recession, a lot of times none of that happened. You would have to literally go back through even the Great Depression, not everybody had to stay home. And so we've never seen this before. And because it's never been seen before, what I would argue is do not judge people based upon kind of their worst case scenario, because this scenario has never occurred before. So this is literally like an alien coming in and dropping down and saying, we're literally in a new dimension. Right. Right now from that standpoint. Gotcha.

Anyways, I'd love to check back in with you in about three to six months. And yeah, I mean, if you're hearing some changes in the market, you're hearing all these things, I'd love for you to kind of let us know, keep us updated.

Absolutely. I appreciate the time.

Okay, thanks for your time. Thanks for your expertise. And yeah, good luck with everything that's going on.

Thank you. We will need a little bit of it. But as long as everybody works together, we'll all get out of this on the backside with very few losses, if any at all, and just deferments.

Yeah, absolutely. Okay. All right, take care. Thanks so much.

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