Michael Zeuner: 00:00
Welcome to the wealth enterprise briefing. Hi everyone. This is Michael zerner, one of the managing partners at we family offices. Thanks for listening to the wealth enterprise briefing. I’m joined today by Matt Farrell, our deputy CIO, and we’re going to talk about something that we really haven’t covered in the last at least two years or so, and that is investing in broadly, real estate. Real estate has been a very difficult space for the last couple of years. Most investors have important existing exposure to real estate, but I would say it’s fair to say, in the last year or two, there’s been relatively little incremental capital going into real estate, certainly on the equity side. We’ll talk with Matt about what’s happened in the last couple of years, why people might be concerned about real estate going forward, but more importantly, what some of the fundamental trends he see are, and why. It may be early days, but it may be time to focus once again on real estate, given the macro environment that we’re in and some of the conditions underlying the real estate market. So Matt, welcome and as I said, let’s start by taking a step back and just give us a little bit of an overview as to what it’s been like for real estate investors in the last three, four years.
Matt Farrell: 01:26
Yeah, thanks for having me. I think we can separate this backward looking basis as bifurcated between debt and equity, maybe starting with equity, looking back a couple of years, really, in 2022 it’s essentially been pencils down in terms of looking at new opportunities. Interest rates started to spike in 2022 and they rose at a historical pace. And what that did was was kind of freeze the market. We did not have we were really in a period of price discovery. There wasn’t a lot of M and A activity, and I’m speaking broadly about commercial real estate, and so you just didn’t really have a good sense of value, what that value should be given the lack of M and A activity. So what you know, interest rates spiked in 2022 so we kind of held off. We felt that there was a broad range of outcomes, anywhere from interest rate activity to what valuations would look like. So when you’re underwriting a deal, you want to make sure that these are standalone projects that you can go without leverage if needed, and on a standalone basis, it could be a successful project. So given those dynamics, we were holding off, you know, we looked at some of the non traditional real estate asset classes, like manufactured housing and marinas looking for kind of those fragmented opportunities. But by and large, we were kind of frozen there. Conversely, we have found value on the debt side. A lot of this goes back to, if we recall Silicon Valley Bank. There were some issues there and some other banks. So a lot of commercial banks were kind of pulling back on their lending activities, and that introduced an opportunity for private credit to step in, specific to real estate and so on a risk return basis, we found it much more compelling on the debt side, unless you’re, you know, senior in the capital structure, your target returns are actually pretty comparable on the equities to the equity side. So that’s another reason we’ve mainly, you know, shied away on the equity side.
Michael Zeuner: 03:27
So it makes lots of sense why investors had shied away from making incremental commitments to real estate in the last few years, on top of the exposures they already have, and with the focus, as you said, on the debt side of real estate investing. But if I connect this now to our macro thesis, which, as we enter 26 you know, Sam was with me on the last podcast talking about how we see the future, and it’s very much of what we call, or what he calls, a growth, an inflationary growth cycle. So he does expect to see growth in GDP, you know, growth in the economy. But he also expects, and as do many others, that inflation is not going away, and that it could be elevated for some time in an inflationary growth environment, real assets become particularly important. We’ve been particularly focused within real assets, on natural resources, on commodities, on infrastructure, but we haven’t really talked about real estate in the context of real assets and providing some protection in an inflationary growth environment. How do you think, given everything you said about the past and where we might be now, is it time to start thinking about real estate again as an important part of a real asset portfolio in an inflationary growth environment?
Matt Farrell: 04:50
I think certainly the backdrop is improving. I think the challenge with real estate, it’s very asset class specific. It’s sub strategy. Civic and it’s hyper local, so I still would exercise caution, and that’s for a variety of reasons. I think the most straightforward example is multifamily. And if we look historically during call it 2020, 2021, when interest rates were zero, it made a lot of sense to construct new multifamily properties. So that’s caused due to the cost of financing being cheap. And so what we saw was just this mass influx of deliveries and construction starts. So if we look back, just to put some numbers to it, there were roughly 200,000 deliveries, essentially on a quarterly, quarterly basis. You know, the average somewhere around 202 50, I’d say, during that time period. And so we had this massive influx of delivery over the past couple of years. Conversely, as interest rates rose in 2022 the cost of financing went up, and therefore the math didn’t make as much sense from a development standpoint. So we saw new housing starts specific to multifamily dropped to about 50,000 so essentially a fourth of what we saw previously. So you know, if we looked right now on the ground, some of those markets where a lot of this inventory was flooded, a lot of in the southeast, or what’s called the smile states across Southeast and Texas and Austin and Phoenix, those markets are actually flooded with inventory, and so it’s going to take a little bit longer to work through. Rent growth is slower. They’re having to offer concessions to attract new tenants. So, you know, I’d exercise caution there, but there’s other parts, you know, coincidentally in the Northeast, where, you know, back during covid, no one was really building or just the new inventory was coming in southeast. So now the Northeast is actually an opportunity, and the Southeast is still working through that inventory. So the point is, I think you just need to be selective on the opportunity set, and both geographic in terms of property type, just being cautious.
Michael Zeuner: 07:03
Okay, but let’s widen the lens a little bit Matt and say if you were going to be looking to position assets into real estate as part of building out a real asset portfolio, where would you be looking, not so much at specific vehicles, but the spaces or the themes that you think are interesting positive trends in the real estate market?
Matt Farrell: 07:30
I think that’s a little bit to be to be determined, but what I think it could be interesting are these opportunistic strategies, and that’s essentially outsourcing that decision to a third party manager who can go across asset classes. So you know, office has been taboo for a few years, and I think structurally, there’s still some unknowns there around occupancy needs, but we see Class A in particular, is in high demand. There’s very, very low vacancies in office. So if you can find a tier one property, perhaps in a downtown and a city with high growth, and you’re able to acquire that at a discount to replacement cost, maybe there’s an opportunity there. We looked at these over the past couple years, and we just felt given the uncertainty with Office or any real estate in general, and also the uncertainty with interest rates and the cost of financing, the lack of M and A activity to find what that value would be, an underwriting we’ve kind of avoided, but I think those range of outcomes have narrowed significantly, and there could be an opportunity even in office. But you know, again, exercise and caution multifamily, I think you have to take the long view. You know, this is, this isn’t like a six month trend that we’re we’re following. You know, I think starting in 26 maybe 27 there’s going to be a very short supply of multi and as we’ve seen, single family homes. They those haven’t really come down in value as much. You know, the pricing, the spread between the cost of single family home ownership and renting is the highest on record, and it’s actually expanded more over the past couple years. So all of those present actually an opportunity. You just have to look further out into the future.
Michael Zeuner: 09:12
Okay, So suffice it to say, Matt, that you and the team will be looking, perhaps a little more than you might have in the last couple of years into opportunities in the real estate space, but still on a very, very selective and opportunistic basis, too many things that still need to resolve themselves, with respect to interest rates and the overhang of valuations from four or five years ago when rates were zero, right? What’s happening at Cap rates? All of that we’re watching, but we’re we’re starting to potentially see maybe there, there are some opportunities. So watch this space, I guess is the is the conclusion?.Okay, thank you, Matt.
Matt Farrell: 09:51
Thank you.
Disclosure: 09:55
The wealth enterprise briefing is for informational and educational purposes only. And does not consider the specific investment objectives, financial situation, or particular needs of any listener. The information in the briefing is not a recommendation of any security and should not be relied upon as investment legal or tax advice.
