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The Real Estate Philosopher


A Faux Liquidity Crisis What To Do Now

Nov 14, 2022

It seems that there is no money around, which means there must be a liquidity crisis – right?  However, there are actually many zillions of dollars in sitting on the sidelines, which means there is no liquidity crisis after all. The reality is that there is plenty of money, but the parties with the money are fearful of putting it out into the choppy markets. I call the current situation:
 
          A Faux Liquidity Crisis
 
To dig into things more deeply, the lenders that are open to lending want a ton of money for their dollars, which leads borrowers to conclude that if their lender gobbles up too much of their upside, then the deals don’t make sense based on risk and reward. 
 
It’s even worse on the equity side of the equation, as many parties with equity are either not putting it out at all or trying to put it out in the guise of expensive debt. 
 
In either case – whether debt or equity – the parties with capital are all believing that any day now, there will be a use for their capital, and they are optimistic about mid-teens returns for their investments. Note the article I just saw today in The Real Deal, “Vultures circle as distress looms for commercial real estate.”
 
One way or another, although there is money around, you can’t get it; hence, my concept of this Faux Liquidity Crisis. So what should one do? Here are my thoughts:
 
Following Howard Marks’s thinking, you would first answer the question of whether you seek to outperform or whether you instead seek average performance.  As he points out, for many parties, average performance – sort of like an index fund – is the safest and most logical alternative. This is because, for some investors and/or organizations, the downside of underperformance is much higher than the upside for outperformance; hence, the logical conclusion is to seek average performance.
 
Right now, many (most) parties are sitting on their hands, with the belief that within, say, the next 90 days, some clarity will come into focus. Of course, no one has a crystal ball, but there is a good chance that in a reasonably short timeline, some sort of interest equilibrium will be determined. Tautologically – this would mean that interest rates will either go up or down or stay where they are. 
 
This – sitting on the sidelines – is generally market timing, and I am not a fan of it as per prior articles; however, many parties are doing exactly this.  And I think there is safety in seeking average performance by following the herd to non-action right now.  Certainly, the herd is mostly saying that they are not planning to do anything by year-end.
 
If, however, you seek to outperform, then, as Lucy Liu said in Kill Bill, ‘Now’s the __ing time!”
 
Continuing with Howard Marks, as he said in his book, the first thing one must do to outperform is to be ‘different’ from what others are doing. And if others are doing nothing, it is easy to be different by doing something, so to speak. 
 
Here are some thoughts for you to consider:
 
First – if you are trying to sell property, and the buyer agrees with you on pricing and wants to buy it, but financing is too expensive, or even non-existent, then:

  • Have the seller offer seller financing – pretty obvious.
  • Have the buyer buy a preferred equity, common equity, or other piece of the seller entity with provisions that permit the buyer to acquire the remainder in the future when financing alternatives are more available. This is essentially a recapitalization of the ownership and hopefully structured in a manner that does not result in a tax hit.
  • Get some Fulcrum Capital to make the deal work. Since right now that capital is uber-expensive, exercise every possible option to take as little of this capital as possible.
  • Crowdfund a chunk of the capital stack. This isn’t super cheap capital, but overall is reasonably priced, and as I have written in prior articles, crowdfunding platforms are now raising significant dollars (sometimes up to $30M for a deal).
  • Coax the existing lender into letting the buyer assume the loan. Usually, such coaxing is a combination of a paydown, fees, or both.
  • Utilize PACE Financing.  This is a sleeper issue but can wake up nicely.  Sometimes PACE doesn’t work if the first lender just nixes it; however, in a workout situation, the PACE financing can be found money that can save the day.  Here is a quick primer on PACE financing from my firm’s PACE team.
  • If you can find a new lender after all, and you have CMBS or other defeasible debt on the property, you might find – to your shock and amazement – that there may actually be upside in defeasing due to interest rate reversals. You might end up with positive arbitrage. I admit I haven’t done this and don’t have the specifics of how this works, but I bet it is easy to figure out.

Second – if you are a lender, then lend! You can get impressive terms right now, so why not put out dollars? Since there is fear of rising rates – and by the way, there is always a fear of rising rates – make the debt floating rate or put in other protections. And if there is fear of a recession, lend to borrowers that will not be hurt too badly. And if there is fear of inflation lend to borrowers with pricing power. 
 
Third – it is just about impossible for owners to obtain equity right now. Even for relatively safe real estate projects, equity is hard to get. And for prop-tech and more risky propositions, equity is close to non-existent. So it would seem that the smart move would be to provide this equity on over-optimal terms. Some parties are so eager for equity they will proffer both the regular real estate deal plus a sweetener of warrants or equity in their company to move a transaction forward.
 
I am just scratching the surface with these ideas; some of what I am saying is pretty obvious. Overall, I am suggesting that when a large number of players are sitting around watching, this is a nice opportunity if you are seeking outperformance.
 
I will also make a prediction here, which is that I don’t think there will be as excellent an opportunity for the vultures circling (see the above article) as the vultures are hoping for.  Or another way to look at it, is that the opportunity will not last very long; indeed, once the herd stampedes the opportunity will end as fast as an egg timer.  My thesis is this:

  • A hypothetical party needs the investment of Fulcrum Capital
  • A third party will offer this capital at, say, an 18% interest rate
  • The party in need will go out to a broker to solicit other offers
  • Once the herd is back and putting out money again – and The Faux Liquidity crisis abates, someone will say that a 17% interest rate looks pretty good
  • And then someone else will conclude that 16% isn’t that bad, either
  • And then 15%
  • And then…
  • Sooner or later, the price of capital will hit equilibrium

So my prediction is that (i) this equilibrium will result in robust pricing for the providers of this Fulcrum Capital, but it will not be the amazing pricing sought by the over-eager parties mentioned above, and (ii) the really strong pricing of Fulcrum Capital will not last that long.
 
I will end by saying that for those who seek to outperform, opportunity is knocking at the door, and it is a choice whether to open it.
 
Best of success to everyone.
 
Bruce Stachenfeld aka The Real Estate Philosopher™

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As the Chairman of Duval & Stachenfeld – a law firm in mid-town NYC known as The Pure Play in Real Estate Law – I am inviting you to join The Real Estate Philosopher™. This will consist of my thoughts and also thoughts of friends and colleagues.

It will not be published in any traditional media – it will go only to friends of our firm. The purpose here is very simple – to put forth thoughts in the real estate world that are different, provocative, and challenging of accepted wisdom. Hopefully, nothing said here will be mainstream thinking.

You may be wondering how I am qualified to write on these topics since I am “just” a lawyer. However, I have an unusual place in the real estate world. As the Chairman of The Pure Play in Real Estate Law (one of the largest real estate law practices in NYC), I interact with an incredible number of real estate players. This ranges from small real estate shops with nothing but a gleam in their eyes, to some of the largest real estate institutions in the world, and everything in between. This gives me a unique and global perspective and allows me to act as an amateur philosopher in the real estate world. This has always been my hobby and it is what I love doing.

Regards,

Bruce Stachenfeld
a.k.a The Real Estate Philosopher™

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