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The Real Estate Philosopher


Big V Recovery: Nine Predictions for the Real Estate Industry

Jun 6, 2020


About a month ago I wrote that there will be a Big V Recovery.  So far I have not been getting positive reinforcement for that article.  Indeed one response I got – from a fellow who has his own crystal ball – called me “clueless.” 
 
However, yesterday the employment news surprised the economists but not The Real Estate Philosopher, as so far this is exactly what I thought would happen, and I will stick to my belief that this is only the beginning of the Big V Recovery.  Sorry I can’t resist a bit of humbug here. 
 
I will not bore you again with my reasons that I think this is going to happen.  All are still extant – just see the article.
 
I would now like to apply my thinking to the real estate world.  Here are my thoughts, after extensive conversations and interactions with a very large number of players of all different types and with all different strategies:
 
Background:
 
I will make a few observations before delving into suggested courses of action:
 
First, although the public markets are going wild, the private markets are still (mostly) frozen.  There are an extraordinary number of tires being kicked but, so far, few are actually buying the car. 
 
Second, boy is there a lot of cash around!  In this regard, it is pretty amazing and I think even unprecedented.  High net worth people have tons of cash.  Family offices have tons of cash.  Investment funds have tons of cash.  Even developers have tons of cash.  The words “dry powder” pop up in almost every single interaction I have with clients and other players in the real estate world.
 
There was a ton of cash sitting around before COVID, looking for deals.  But since COVID, there has been even more cash raised.  Every day – and I mean every day – I hear about another major player “exceeding” its fund-raising target, and/or getting the targeted fundraise really quickly. 
 
I don’t know the real number of course, but I suspect it is getting near a trillion dollars of dry powder for real estate.  Even today a trillion dollars is still ‘real money.”
 
Third – all the dry powder is waiting for the distressed deals to come by.  Each month it is projected to be next month, or the month after, or the third quarter, or the fourth quarter, or next year that the distressed deals will be here.  Surely, after the lenders stop giving forbearances then the property owners will come desperately asking to purchase some of that dry powder, which will be “for sale” only for exorbitant prices. By the way, the latest article I read just a day or so ago headlined “Distress Investors May Have to Wait as Long as 3 Years for Non-Performing Loans to Come to Market.” Also, by the way, someone at CBRE has coined the phrase “forebearaggedon.”  With all this cash around, I don’t see that there will be nearly enough bargains to go around. 
 
Fourth – I predict that there will be dramatic pressure for parties with the dry powder to put it to work promptly, both individuals and institutions.
 
From the perspective of individuals and similar parties, we just watched prices in the public stock markets crash and those who didn’t buy after the crash are certainly bummed out that they just missed 8000 – now 9000 – points on the Dow Jones as it rocketed it up perhaps faster than ever before.  I think many are worrying that they are “missing out” or already “missed out” in the chance to invest in real estate at an opportune time.
 
From the perspective of institutions, they are more considered in investment decisions for sure, but they too have pressures.  Consider if you just raised $1B and you are being evaluated for performance metrics against, say, 29 other players who do similar real estate investing.  If the other 29 players invest “now” and you don’t, and the market goes up, you have a severe risk of underperforming, just as the others have that risk if the market goes down.  The safer course of action is to follow the herd, and there is a ton of pressure to do that, since it eliminates the chance of underperformance (albeit also eliminating the of outperforming).  But no one loses their job for average performance, but underperformance can be devastating. 
 
Summarizing these background facts, due to understandable caution, right now there is a dramatic dearth of real estate deals – most of the markets are still frozen – but I predict that as soon a few intrepid souls venture to transact, then the enormous amount of cash plus the foregoing pressures will push real estate investors to move strongly into the markets, as soon as the metaphorical bell is rung at the bottom.  And I think that bell is not far off from being rung, and may even be ringing now.  And once that bell rings I predict a great deal of transacting will take place.
……
 
Now let’s talk about the application of the foregoing to the real estate world.  These are my predictions, which like all predictions should be taken with grains of salt:
 
Distressed Real Estate Debt:  As per my prior article, I believe that prices of distressed debt will rise to fair value all too quickly.  Experienced players will do quite well, but those who are changing their business models from what they do best to become distressed debt players will find themselves on a frolic and detour, nullifying their competitive advantages to play in markets where they have no such advantages.
 
Opportunity Zones:  I admit I was surprised to hear that there is dramatically increased investment interest in them again.  But I shouldn’t have been surprised I guess.  There is an extraordinary pile of capital gains unleashed in the past few months as people sold, and bought, stocks and other assets.  Opportunity Zones are one of the few ways of decreasing the tax burden.  Also, the ten-year hold for a development deal was a bad thing pre-COVID, but now looks kind of interesting and even a bit tantalizing since no one thinks that COVID is a ten-year phenomenon.
 
Industrial:  My clients in this space are quite pleased.  No two ways about it.  I don’t have much to say here that hasn’t been said by others, so I will not weigh in
 
Multifamily:  I have only two points to make here.  The first is that political sentiment in the city or state you are investing is likely a much bigger concern than COVID.  The second is that I would not underestimate co-living as a trend.  I don’t advocate investing in it as “new business” but I think it will become “a new way of doing business” and I foresee many property owners having “a co-living floor” as just a general part of their properties.
 
Office:  Everyone is wondering whether WFH (a new acronym for Work-From-Home) or social distancing will tank, or invigorate, the office markets of the world.  No one knows of course, but I will fall back on Bill Gates here who famously said: “People consistently overestimate what will happen in one year but underestimate what will happen in ten years.”  What I mean here is that in the short run I doubt that COVID and WFH will affect the markets that much and people will indeed mostly return to work.  But over the next ten years property owners should be vigilant, creative and open-minded to the overall trends (including WFH, co-working, technological disruptions, etc.), all of which are already happening, in order to properly position themselves. 
 
Hotels:  Regarding hotels, is there anyone who isn’t trying to buy hotels right now?  I just reached out to a group that I am a part of, informing several hundred real estate lawyers that I have a significant number of high quality clients seeking to buy, invest in or rescue hotels.  Guess how many responses I got?  Zero.  Yes, zero.  I didn’t get a single response of anyone wanting to sell or even having interest in one of my clients investing in a hotel.  Someone - I mean everyone - must see the upside there.  So, yes, prices are down, but they are down for a reason; namely, that one needs to price in the time-to-recover, but it does seem like almost everyone is expecting a recovery.  So I don’t see bargains or particular outperformance there; instead, I see logical underwriting that prices in a lower price due to time-to-recovery.  
 
My point is a bit subtle here, so I will restate it, to say that just buying hotels at a lower price, when they are lower in price for a logical reason will not result in out-performance, because the wall of cash will push pricing to fair market value.  Instead, the way to outperform will be the old-fashioned way; namely, increasing operational efficiency, creative marketing, a high-quality product, excellence in management, differentiation, etc.  
 
Retail:  I think the biggest bargains will be found here.  My thesis is that many investors talk about “retail” like it is a single asset class, whereas I would suggest it is really two completely different industries, delineated, at least by me, as follows:
:
Retailers that were already teetering on the edge and COVID hastened their demise.  This basically means parties who take other peoples’ products, stick  them on a shelf, mark them up, and hope people will buy them at the increased price.  I think that business is dead and has been dead for  long time – COVID just rushed it to the end-game. 
 
Retailers with Power Niches, that were doing well before COVID and will do even better after they reopen due to the lessening of competitors and other factors.  This, Power Niche Retail, is a healthy and vibrant business and I think could become its own asset class.
 
Investors that assess retail as a single asset class will understandably shy away from “retail.”  However, those who peer through the wreckage to focus on Power Niche Retail will have the ability to glean some solid upside, i.e. bargains. 
 
Finally, there will be a lot of distress here due to the flotsam and jetsam from the struggling retail businesses that disappear and I suspect the concept of “change-of-use” investing will be useful here.
 
New York City:  Okay, I can’t help saying that I LOVE NEW YORK.  And I am not the only one.  No matter what bashes us, we always come back.  There is no question that New York City is having the heck beaten out of it due to its density, a terrifying prevalence of COVID cases, public unrest and a robust political climate, but as I suggested in an article a month-ish ago, I am confident that those who count NYC out will be wrong yet again – New York will revive stronger than ever.  
 
The Biggest Bargains of All:  Peter Drucker famously said that in good times it is statistically likely that every new hire will reduce the quality of your workforce and in troubled times it is the reverse.  So there is no better time to look for people.  That is where the really amazing bargains are right now.
 
Conclusion:  I conclude by saying what I keep saying, in my prior article; namely, that the use of money to “find good deals” is just not going to lead to long-term outperformance.  Instead, real estate players will be distinguished by those who can “create” good deals using competitive advantages like brainpower, creativity, reputation, social interactive skills, hard work, differentiation, willingness to take chances and all the other qualities that we believe in.
 
……
 
Oh – two last comments on a macro basis…..
 
First – I like the fact that economists are largely predicting the opposite of a Big V Recovery, i.e. a long slow recovery over many years.  Anecdotally, my not-really-that-tongue-in-cheek belief is that when economists agree it is almost a certainty they are wrong.
 
Second – I always try to make up my own mind and not let the media make it up for me.  For the past three months good news was ignored and bad news had the headlines.  Then most of us got bored reading words like “record drop….” and “worst since the Great Depression” and similar headlines.  Now, all of a sudden, good news is news since it is “surprising”.  I suspect that just as the media gave us a tailwind on the way down it will do the same on the way up.  Yesterday’s headlines only strengthen my thinking in this view.
……
 
To finish, I could be completely wrong here in my thinking.  There is no question about that.  And if I am, I will have egg all over my face.  Indeed, it is probably foolish of me to stick my neck out to try to predict the future now, or at any time.  But my job as The Real Estate Philosopher is not to just tout out the wisdom of others and follow the herd wherever it leads.  Instead, my job is to think for myself and give you my honest thoughts and the reasons for these thoughts.  All of this with the goal of stimulating debate and thought.
 
I do promise not to do what many hucksters do; namely, make a lot of predictions, then crow and shout about it when they were right and keep quiet when they were wrong.  If I am wrong I will be just as loud and strong admitting it as when I am right.
 
I wish the best of success to everyone in the real estate industry.  Stay safe.
 
Bruce 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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