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Bob Knakal, the Head of JLL’s New York Private Capital Group, joined us for an interview. We discussed his background, the evolution of the brokerage industry, and the current market environment.

Daily Beat: Can you please share your background?

Bob Knakal: When I was a freshman at Wharton, I wanted to be the next Gordon Gekko. Over spring break, I returned back home to Northern Jersey and started looking for a summer job.

I began dropping off my resume at commercial banks and investment banks. When I came out of a Paine Webber office, I saw Coldwell Banker (CB) across the hall. I thought it was a bank, so I gave them my resume.

Once I learned it was a real estate company, I almost didn’t go to the interview, but they were the only ones hiring college students for the summer.

I took the job, and loved it from day one. After two summers doing market research, I got my salesperson’s license and worked on the industrial leasing team.

Daily Beat: Where did you work upon graduation?

Bob Knakal: When I got out of school in 1984, I started with CB in Manhattan and met Paul Massey. On my first day on the job, my bosses told me to follow him around – he had also just got into sales.

We quickly decided to work together and split everything 50-50. That was the start of a 30-year partnership.

I got into the business very serendipitously, but I’m happy that I did because I think it’s the greatest business in the world. I’ve now been brokering the sale of investment properties in New York City for 39 years.

Daily Beat: Why do you think it’s the best business out there?

Bob Knakal: Commercial brokerage is like mental chess. You’re dealing with psychology, salesmanship, persuasion, and human tendencies. It’s a complete meritocracy.

I also value being able to do something different every day, having full control over my time, and meeting interesting people. It’s a fantastic business. I love everything about it.

Daily Beat: How have you seen the brokerage business evolve since you started? The advent of technology and the proliferation of data has obviously been a game changer.

Bob Knakal: The changes have been profound. Going back to 1984, there was no cell phone, computer, or even fax machine on your desk. You carried a roll of quarters in your pocket to make phone calls from the street when you were out showing buildings.

Brokers wrote notes down in a day-timer keeper, which we kept in our pocket. It was a very different world. Technology has definitely made brokers more productive.

The availability of public information is also more widespread and transparent now than ever before.

Back in the old days, we had the blue owners’ book, and that information was about 50% accurate. Now, there are services that even provide cell phone numbers.

Daily Beat: And I gather this is why you and Paul were so keen on the territory system.

Bob Knakal: When we started Massey Knakal, our territory system was one in which we dug into every single block and worked to connect with every owner on the block. If we couldn’t get in touch with the owner, we called the neighbor.

If that didn’t work, we’d stay out front, wait for the mailman to show up, and see who the mail was being delivered to at the building.

In an age when publicly available information was only about half-accurate, our databases were probably 99% accurate. That gave us a tremendous competitive advantage.

Daily Beat: How do you think brokers can differentiate themselves in the market nowadays? Providing basic data is no longer going to cut it.

Bob Knakal: While publicly available information is much more significant today, it’s not great quality. There’s no publicly available data source that’s comprehensive relative to the true ownership information and comparable sales.

Although the correct company might be listed as the owner, they may only own 1% of the deal. It’s important to understand the main equity partner and how the decision making process works.

Once that’s done, you need to come up with something constructive and interesting to share with the owner. That’s hard to do unless you have firsthand information about a particular relevant sale, including the revenue and expense information.

I sell a lot of development sites and most comparable sales data provided in that sector is highly inaccurate. Many transactions are not included because they appear to be typical small walk-up buildings and are classified that way. We call the buyers to better understand the intended-use and intricacies of the deal.

Perhaps it’s eligible for some bonuses or the seller had purchased inclusionary housing rights. You might also find that he had to pay $10 million to buy a couple of tenants out or pay for an easement. That will not be reflected in the data.

A good broker adds value and differentiates themselves by demonstrating granular knowledge. Articulating why your data is different and how it can help your client is key.

Daily Beat: Are you still cold calling?

Bob Knakal: I cold call every day. My goal is to speak to at least 50 property owners every week. During the pandemic, I was actually a lot more productive working at home and got to over 100.

Cold calling is the gasoline that drives the brokerage engine. If you’re not prospecting, you’re not putting anything into the front of the pipeline. I love making calls.

If you’ve been a successful broker for a long time, you could rest on your laurels and wait for deals to come in; however, proactively seeking out opportunities is the best way to stay at the highest level.

Daily Beat: Once you become more well-known within the industry and have prior business interactions with many owners, picking up the phone is suddenly not as cold.

Bob Knakal: Yes. I think that’s been an advantage for me. Back before email started to become popular, we were sending out 3 million pieces of hard mail every year. All that mail had my name on it. People still remember getting all that mail from Massey Knakal.

The calls are not really as cold as you would think, but I still call people that I’ve never spoken to before and enjoy that. Most of the people that I’m calling are people that I’ve done business with, met before or at least spoken to many times before.

Daily Beat: And how many dials are you expecting from brokers on your team every day?

Bob Knakal: A good goal for everyone is to try to get 50 connections a week. If you’ve been around a while and folks know you, you could probably do that in as little as 100 dials. But it could take you 300 or 400 dials to get 50 connections.

I also think it’s important to differentiate when you’re making those dials. Between 10:00am and 12:00am and between 2:00pm to 5:00pm are the highest probability times to get people to pick up. I’ve had a very good success rate calling people on the weekends since the pandemic too.

Daily Beat: New York City is a unique and competitive market. How do you look at the big picture as an investment sales broker?

Bob Knakal: If you think about the nature of the New York market, there are about 165,000 investment properties in the four boroughs, not including Staten Island. Of those 165,000 properties, there are about 250,000 owners. Some people own 100 buildings; others own one, but there could be 30 partners in that building.

If you think about that group of 250,000 owners, it’s impossible to call all of them regularly, so to a large degree, it’s not who you know, it’s who knows you. I was very skeptical about social media, but have been very pleased with its effectiveness and reach to help achieve this objective.

Networking and meeting people is key. The more people that know you and the more people that like you, the more business you’re going to do. That’s a full-time job.

My broker coach Rod Santomassimo refers to it as a market presence. You want to be out there and be on top of mind for people when they decide that they need to do something in the market.

The average turnover rate within Manhattan is 2.6% of the total stock of buildings over the last 40 years. In other words, on average, people own a building for 40 years before they sell it, so they’re not always in the market to do something.

As a broker, your job is to be front of mind when they do decide to make a move. You want to have that market presence so they think of you at those times.

Daily Beat: How long does it take for pricing shifts to be reflected in the market?

Bob Knakal: Even comparable sale data is stale in a way. If a property goes through the transfers today, it’s probably under contract for anywhere between two to four months. It took a month to negotiate the contract, and the deal was made two or three weeks before that.

You’re talking about information that might already be five or six months old.

For instance, just in this most recent period, you saw a significant shift last September when the Fed’s rate hikes started impacting the lending market in a very tangible way. The market shifted at that point in time.

Since September, New York land market values went down by 20 to 25%. Many comparable sales from before September don’t have that much credibility when we’re doing a valuation on a new site.

Daily Beat: What are you seeing insofar as the number of bids you’re getting on a property today versus before then?

Bob Knakal: The number of bids is certainly not nearly as robust as it was, but there’s still a number of people that are very active with certain sectors. Although multi-family cap rates have increased with rate hikes, the depth of demand is staggering and shocking really given the political headwinds in that space.

If you look at the land prices, the market has reset. The condo land market is still very robust with strong activity at this lower price point, but the rental land market has completely evaporated because of the lack of 421-a.

There’s a huge air bubble building in that pipeline. If you look at the retail sector, I think it is a bright spot.

Within the office sector, everyone is still trying to figure out what’s going to happen to aggregate office demand –– it remains very opaque.

Daily Beat: How would you explain the condo land market staying strong in light of macro-economic headwinds and the stock market?

Bob Knakal: Let’s look at the perspective of developers from a bird’s-eye view. Every single one in the country had optimism injected into their DNA when they were born. Developers need to be confident and optimistic. If you ask 100 developers if the market will be in a better or worse place three years from now, all of them will likely say better.

Daily Beat: What are you seeing in the rent-stabilized market in terms of cap rates? There are obviously differences in sub-markets and it’s hard to paint a broad brush, but overall what are you seeing?

Bob Knakal: Lending rates on multi-family assets today are in the 5.75% to 6% range. There’s no reason why cap rates should be below lending rates unless there’s immediate upside potential in an asset.

We’ve had two distinct periods in the history of New York City over the past 40 years where there’s been negative leverage. The mid 1980’s and then again between 2004-2007.

The first negative leverage period was created by a co-op conversion craze, and the latter by condo conversion. Both of those optional exits don’t exist today based on the rent law changes in 2019.

Daily Beat: With increased expenses and the Rent Guidelines Board structured the way it is, that’s a tough market unless the Supreme Court overturns the rent laws or we see significant unlikely political change.

Bob Knakal: Yes. Since the government is constricting supply with poor policy, I think free-market rents are going to go up maybe 10 or 15%. Our policymakers fail to understand that increasing supply can solve so many of our housing issues.

Daily Beat: What are your thoughts on refinancing risks within the rent-stabilized market? There’s distress out there.

Bob Knakal: It’s the biggest obstacle facing property owners today. The overwhelming majority of refinancings are going to require cash-in, and an overwhelming number of owners are reluctant to put fresh capital into old buildings to hold onto them. This will lead to an increased number of properties for sale.

*The interview has been edited and condensed for clarity.

The Daily Beat equips real estate firms and industry leaders with exclusive news and insights to inform impactful decision making. Learn more about subscriptions here.

Ron Zeff, CEO & Founder of Carmel Partners, joined us on the heels of raising $1.58 billion for the firm’s Investment Fund 8. We discussed his background, the multi-family sector, and how he plans on deploying capital in this environment. 

Daily Beat: Can you please share the firm’s background?

Ron Zeff: Carmel Partners is a successor firm to my father’s company. He was a large apartment developer and property owner in the Denver area.

After a stint at Trammell Crow, I started Carmel in 1996 with the idea of following the DNA, experience, and values of my father, while bringing on institutional partners.

By 2003, the firm got into the fund business and had done around 19 large transactions, including buying Parkmerced with JPMorgan from Leona Helmsley in 1999.

The main investors at that time were endowments and foundations that were looking to disintermediate the allocators. They were looking for fiduciary minded managers in a given segment, and a number of them selected Carmel to be their exclusive vehicle for multi-family.

We were given flexibility within the U.S. multi-family sector to pursue development opportunities, value-add deals, and sometimes opportunistic debt investments. This exclusive mandate has led to a series of funds.

Carmel has been fortunate to broaden our investor base to include state and corporate pension funds, insurance companies as well as foreign investors. We just closed Fund 8 at $1.58 billion, our largest fund to date.

The last fund was a little over $1.2 billion. By dollar amount, we had a 100% investor re-up rate.

Daily Beat: CBRE put out a report last month that cap rates for prime multi-family assets are starting to stabilize. They found that going in cap rates for those types of assets in Q1 was 4.72%. What are you seeing?

Ron Zeff: I think that’s a pretty good estimate if you were going to come up with an average. There’s still a pretty wide bid-ask spread. I don’t think people are really willing to sell at a 4.7 cap rate for a property that would deserve that. Obviously secondary properties and secondary locations are going to have a higher cap rate than prime newer properties in excellent locations.

Daily Beat: How are you thinking about national rent growth in the next few years?

Ron Zeff: Cap rates are a function of discounted cash flows. Your future rent growth assumptions are key to that.

Most people are underwriting fairly flat rent growth over the next two years, but I think it’s a market where we’re going to see declines in rent, which is going to push cap rates higher. It all depends on what happens with long-term interest rates. In general, if people don’t have to sell, I think to a large extent they’re not selling. Carmel is looking for forced sellers.

At the same time, there’s a lot of dry powder that wants to own apartments at that yield. Buyers are underwriting to achieve positive leverage by year two, which is hard to do.

Daily Beat: How much of the fund have you already deployed? Blackstone just raised a $30 billion fund and they were very happy to promote that fact that was mostly dry power. I’m wondering what about your latest fund?

Ron Zeff: We raised most of this money a year ago, and kept the investment period open to allow a few select investors to come in.

We started making investments out of the vehicle more than a year ago and are slightly more than half committed. Prior to this fund, we tended to do more development because we could find those big margins of safety, which turned out to be a positive from a valuation standpoint because we could withstand cap rate increase without being hit with write downs. Now, the quality of existing deals is really improving.

I am skeptical about what other people are doing on their marks. We have taken significant write downs in terms of our calculation of higher cap rates. All that points to declines in value. I’m somewhat surprised that some of our competitors are not taking those hits on their current funds and then raising capital on the premise that everything’s going to be cheap. It’s kind of hard talking out of both sides of your mouth.

Daily Beat: It’s always fascinating to observe how the mark-to-market system of PERE works. REITs tend to be a couple quarters ahead.

Ron Zeff: Carmel has been more aggressive on that front. We just closed on a 3,000-unit property in Daly City, which is just outside of San Francisco. The asset traded at $925 million. When you study the appraisal from the fall of 2019, the property was valued at over $1.3 billion. The seller was a foundation that inherited the project from a long-term owner and they were content to take market value.

Daily Beat: What’s the breakdown for this fund in terms of how you deploy the capital? I gather that there’s an equity focus with existing assets and new development, but there’s also a debt component.

Ron Zeff: On the debt side, we don’t invest in those deals too frequently. It needs to be a special situation where we think there’s equity like returns. There are a lot of highly-qualified debt funds in the marketplace that are more aggressive than we are, so it really needs to be a special situation. Our focus is on equity.

Daily Beat: Can you please discuss a few of the deals in the fund?

Ron Zeff: We have our large Long Island City project at 43-30 24th Street. The 66-story, 938-unit residential development is grandfathered in under the old 421-a program, so we are excited about it. If the project was finished today, the yield would likely be 5.6%, so we have lots of margin there.

Daily Beat: When you buy a property in this environment, what’s your ideal capital stack? Are you buying all cash and refinance later? Or what type of debt are you looking at?

Ron Zeff: For operating properties, we are doing a mixture of both floating and fixed. We really focus on obtaining loans with term, so we don’t have to have to be forced to refinance in the near future.

The idea is to push out those refinances five to seven or even 10 years. We’re mainly going with Fannie or Freddie type loans.

For new construction, we’re talking to bank lenders and insurance companies. This is a good environment for Carmel where most people are struggling to get debt and might have to go to the debt funds, which can be very expensive. We’re still able to get debt, although lower proceeds than you could get before.

Daily Beat: What type of LTV are you looking at when you go to the traditional lenders for construction?

Ron Zeff: Maybe 50 to 52% on the low end and maybe 60% on the high end. Occasionally there’s a 65% out there. It depends on the margin of the banks’ underwriting of the deal. Spreads are probably closer to 300 than 200, so we have to put a little more equity in, which makes the deal safer, but the IRR underwriting is a little bit lower.

Daily Beat: What do you closely monitor in the debt markets daily?

Ron Zeff: For me, it’s understanding what that long-term Treasury is and thinking about what rate we can borrow and what’s happening to spreads. Essentially, we are looking at what our borrowing costs are from a long-term standpoint. That becomes the rate that you have to manage around and understand that on a valuation basis in this notion of getting positive cash flow by year two. For development deals, we obviously want a positive margin from that underwriting. We pay a lot of attention to the SOFR curve because that’s the market’s estimate of the floating-rate cost over time, which has a big impact on our construction loans.

Daily Beat: How do you approach hedging when locking in debt?

Ron Zeff: We obviously have hedging costs. Fannie and Freddie require hedges and also require that you reserve cash flow to buy your new hedge that’s coming up.

If the strike price is below the current interest rate, that’s just like pre-paid interest. Your biggest worry in this market are buyers who have borrowed money on two- or three-year, floating-rate loans from debt funds under a very aggressive business plan at low cap rates. Those are going to start blowing up over time.

Daily Beat: Would you infuse equity in those deals, or are you looking to eventually buy them directly? How creative do you get with deal structures?

Ron Zeff: We look at all that. During the financial crisis and the pandemic, we picked up some opportunities that were really buying from debt sources and getting to the properties that way. We sometimes bought properties directly from lenders.

Just like last time, I think there’s going to be a tendency to kick the can down the road, so I’m not sure how much stress there’s going to be. Often the ones that are stressed are questionable properties in secondary markets and you don’t want to necessarily own those.

Daily Beat: Redfin recently found that rents in Austin are down 11% over the last 12 months, which contrasts with New York where rents continue to hit record highs. Do you think rental trends are going to continue to revert back to the mean? How do you view that moving forward?

Ron Zeff: That’s been our thesis all along. In the Sunbelt I think there will be rent declines, while in the coastal gateway markets, except in a few individual pockets, there will continue to be rent growth. I think people are underestimating the wall of supply that’s going to hit the Sunbelt.

Although some people only focus on multi-family supply, it’s important to think about all the single family supply. When people move from being renters to buyers, they’re permanently out of the rental market. That’s going to surprise people as to how much rents could move downwards and vacancy rates could climb.

If you have to be a seller at that time, you’re going to be very unhappy, and if you’re honest with your marks, they’re not going to look good on paper either.

Long term, most markets will recover and do well. The reason people like apartments from an inflation standpoint is the idea that you can move rents to market every year. However, the only way you can move rents is based on local demand and supply. These gateway markets like New York, most of the supply was started pre pandemic, so there’s not a lot delivering.

Daily Beat: What are you seeing in San Francisco?

Ron Zeff: San Francisco is coming back slowly. I think work-from-home trends are taking a toll, but it’s starting to come back. Presumably when companies require employees to return to the office – even only a few days a week, you are going to start seeing these markets improve.

Amazon is now requiring employees to be in the office three days a week, which presumably should help the Seattle market. It’s all local supply and demand, so some markets are softer than others.

Daily Beat: Expenses have increased tremendously ever since Covid. Part of that cap rate conversation we were having earlier is really taking that into account, as income will likely remain flat in the immediate future. What do you make of the operating expenses in your portfolio? Which line items are up the most?

Ron Zeff: We’ve definitely felt the increase in expenses, mainly in insurance and payroll. Depending on the market, you might have some real estate tax exposure. Many of our markets have very limited exposure because of the way their property taxes are calculated, but that’s a big factor.

Regarding rent growth, I think there will be pretty good rent growth in markets like San Francisco and Seattle because of the massive hiring of people that took place during the pandemic. We hear about these 20% layoffs at Facebook, but they still doubled the size of their company during the pandemic, so they are still 60% bigger than they were pre-pandemic.

Where are all those people living when they start to have to come back to the office? That should have a positive impact. I think people are going to be hesitant to buy in this market because of uncertainty, so that should balance out to some degree what you normally see in a tech slowdown.

People without children often like to live in cities. There are parts of San Francisco that the New York press likes to report on, but it really has gotten a lot better and the neighborhoods are quite fun like they are in New York.

Daily Beat: Are you looking at office-to-residential conversions?

Ron Zeff: We’ve looked at a lot of them. Outside of New York, it doesn’t pencil in 99.9% of office buildings. The cost, layout, are very expensive and then you end up with a compromised product.

New York has a little bit of a leg up because land prices are so much higher as a percentage of total cost, but who wants to live in Times Square or in the middle of Midtown around a bunch of office buildings, so there’s that impact as well.

There’s also a lot of risk on the cost side on these conversions. When underwriting that risk, it’s hard for us to find those types of opportunities.

Daily Beat: I gather that the Wardman Hotel would have been more expensive to convert –– and that’s not even an office building.

Ron Zeff: Yes. We just bought the Wardman Hotel in Washington DC. It was an 1,110-unit Marriott hotel and convention center that we bought out of bankruptcy. We underwrote trying to convert the building to residential versus tearing it down, and it was much more accretive to tear it down and build new.

Daily Beat: How do you underwrite political risk, particularly in San Francisco?

Ron Zeff: We pay a lot of attention to it. The asset we bought was in Daly City where the vast majority of its population are homeowners. They have a more conservative bias. It’s on a local and deal by deal basis.

Generally, we found new construction is exempt for a long period of time from these rent control policies because they want to encourage new housing, but that being said, it’s something we pay a lot of attention to.

They recently passed some big transfer taxes in LA, San Francisco, Washington DC, and Seattle and these things really impact your underwriting and hurt your NAV right away. That’s disappointing in the short-term, but from a long-term standpoint it makes it that much harder to build more housing and ultimately helps push rents higher.

Daily Beat: Are you planning to invest in SFRs?

Ron Zeff: We have owned some large projects that are similar to single family rentals in Hawaii and California. They were former military based housing that we converted to regular rentals.

I think it’s a really interesting market, but it’s hard to do it at scale. When you look at it on a micro basis, you really have to look at what you can buy versus rent for similar product.

I think the industry is getting ahead of that and trying to justify build-to-rent type stuff in places where you can buy for similar cost after tax. With the rise in rates, maybe that’s going to have a little more legs to it. I’ve heard there’s some softness there, but we’re really not chasing because we don’t have a clear competitive advantage yet in figuring that out.

Daily Beat: Does fundraising get easier with every successive fund?

Ron Zeff: Most of the people we work with– even if they are re-ups – are fiduciaries and the level of diligence I think they’re expected to do is as high as it’s ever been. Then you add in ESG. We’re also SEC registered. The level of questions that people have has grown.

We’ve had to grow our investor relations team. I’ve generally found that the more educated and thorough the investor is, the more likely they’ll be attracted to Carmel because we’re so transparent and provide a lot of data, but it’s a time-consuming process.

Firms have changes in management and denominator effects, so they have a lot of pressure on them.

Building trust is everything, so that’s great about our existing investor base. For new investors, it takes a lot of time to build that level of trust.

*The interview has been edited and condensed for clarity.

Matija Pecotic recently beat Jack Sock, the former No. 8 ranked tennis player in the world at the Delray Beach Open. His day job? A Director at Wexford Real Estate. We sat down with the 33-year old tennis sensation to discuss his fascinating journey, how he’s juggling two careers, and thoughts on the market.

Daily Beat: Can you please share your background?

Matija Pecotic: I was born in Belgrade, Serbia. My parents fled the war and moved to the Island of Malta.

We lived there for 17 years – I had a great upbringing. I enjoyed school and loved sports. When I was teenager, I wanted to discover what was beyond the Island.

Daily Beat: And I guess that’s where tennis comes in?

Matija Pecotic: Yes. I recorded videos of myself playing and uploaded them to YouTube. I also burned it onto a DVD and sent 200 copies to every college in the United States.

The head coach at Princeton responded! We started a conversation, and one year later I was attending the school. That was the first big domino piece in my life. Turning a kid from a small Island into an Ivy Leaguer.

I had a very close relationship with the coach and I ended up becoming the captain of the Princeton team. When it was time to graduate, my classmates at Princeton were going into hedge funds, consulting, and private equity. I decided to continue to focus on tennis.

Daily Beat: What were your next steps?

Matija Pecotic: I had to figure out how to find a backer to go on to the tennis tour. A couple of months after graduating, I met Bill Ackman and he decided to invest in my tennis career.

We entered a partnership – it wasn’t a sponsorship. This was a business transaction.

Daily Beat: Is this something that’s prevalent in the tennis world?

Matija Pecotic: No. Tennis players are not that entrepreneurial, so it’s very rare. Novak Djokovic had a backer when he was 12, but it’s very uncommon.

I had to figure out a way to get someone to fund me because you’re bleeding cash for the first two to three years and are similar to a startup.

Daily Beat: That’s so fascinating that you viewed your tennis career like a business.

Matija Pecotic: Yes. It’s very much a business. I just happen to be the asset. Instead of building a product, I am the product.

Daily Beat: Bill Ackman’s late father Larry was the CEO of Ackman-Ziff, so Bill has a lot of real estate blood.

Matija Pecotic: Yes. Bill is a great teacher and it was really through that interaction that I started getting excited about the business side of life. I learned everything I could from him; read all the books he recommended, and started following Pershing Square closely.

I wrote him quarterly reports and annual letters. We had fun with it.

Within two years, I rose to the 200 ranked player in the world, but an injury and an infection after the surgery threw off my tennis timeline.

At that point, I decided that I wanted to get into the business world. Bill advised me to work for his family office and apply to Harvard Business School, which is what I did.

Daily Beat: How was the experience at the family office?

Matija Pecotic: Great. I started getting exposure to deals and understanding the way Bill and his late father Larry thought about things.

Daily Beat: And then what did you decide to do after Harvard Business School?

Matija Pecotic: I decided to go back and play tennis for a year, and got to the top 300 in the world, but then Covid hit and the tour got canceled.

I ended up in Palm Beach at an Israel tennis fundraiser event, and that’s where I met Joe Jacobs of Wexford. With the tour canceled, I decided to go and work for their firm.

Daily Beat: What’s your role at Wexford?

Matija Pecotic: My role is twofold. The first is to find development sites that we can potentially acquire and develop. My second responsibility is to be the Ambassador for Wexford outside of the office on the capital markets side.

Historically, we used to invest in our real estate through our own balance sheet, but as the founders grow older, there’s been a concerted effort to grow the platform into a real business and open up opportunities to outside investors.

Daily Beat: So you’re both on the acquisitions and capital markets side?

Matija Pecotic: Yes. Joe wants me to get exposure to as many different parts of the firm, so I’m rotating across a couple of different roles. We don’t have a fund and do things on a deal by deal basis, and I help with the fundraising.

Daily Beat: How many tournaments are you going to play this year?

Matija Pecotic: I plan on playing 25 this year.

Daily Beat: How are you managing your schedule?

Matija Pecotic: From 8:00am to 12:00pm, I’m a professional athlete and then from 1:00pm and on, I’m a real estate professional.

Daily Beat: The story of how you ended up playing in the tournament is incredible. Can you please share it?

Matija Pecotic: I’m not ranked high enough anymore to get into the marquee events. This event was the highest level of tennis outside of the Grand Slams.

I signed up but didn’t get in. Given that it’s down the street, I showed up a day before to try again, but didn’t get in.

Then on the day of the match, I happened to have left some rackets at the club. When I went to pick them up, the tournament director bumped into me and told me to stick around because one participant might pull out.

When the spot opened up, I was thrown into the tournament ranked 784 in the world. My first match was against the former number 8 in the world, Jack Sock. Everyone thought he was going to just blow right past me, but I had different plans!

Daily Beat: What similarities do you see between athletes and real estate professionals?

Matija Pecotic: In my mind, they are just two different kinds of athletes. Both are extreme competitors.

Everyone likes associating tennis with the country clubby gentleman mentality, but this is war and just as much as it is in business. You are fighting for a finite resource and it’s a zero sum game.

What you lose is another persons’ gain. The most prepared players and investors usually do the best. The ones who are able to outthink the other person are the ones that get ahead. It’s not just brute force that guarantees a victory, it’s very much a cerebral exercise.

That’s why all these business guys love sports because they recognize that it’s a thinking man’s sport just like real estate investing, so those are the parallels.

Daily Beat: Can you please speak to Wexford’s approach in this environment?

Matija Pecotic: Wexford’s core focus has recently been multi-family ground-up development. We have a couple of sites in Boca that are currently under development, in addition to one in Flagstaff, Arizona. The projects are doing well and are on budget.

The firm believes that new projects are going to be tricky. We got some estimates for a site in downtown West Palm Beach, and we almost got a heart attack when the hard costs came back. New deals are not going to pencil out for a while.

We’ve been starting to poke around looking to buy existing multi-family assets, but the spread is still pretty wide.

Daily Beat: That Bid-Ask Spread continues to widen.

Matija Pecotic: Yes. People are still asking for yesterday’s prices and cap rates have compressed to where it still doesn’t make sense for us to buy.

Daily Beat: It sounds like you’re pretty opportunistic in your approach.

Matija Pecotic: Yes. Wexford is not wedded to development. In fact, we only want to develop when we can build at a discount relative to the cost of buying when taking the additional risk and aggravation of development into account

These spreads move around, and so do property types. To illustrate, if we could buy office at $1 /sf vs. $1,000/ sf, we would obviously choose office. In this environment, we are therefore looking at multi-family sites because that’s still compelling, but if the spread shrinks enough we will look at buying existing assets.

And since most residential deals don’t pencil out today, the development sites we are looking at have optionality. They are cheap enough to hold onto and allow us to build when the numbers work again.

Daily Baat: How many people work in the firm?

Matija Pecotic: We have around 10 employees in the company.

Daily Beat: What’s Wexford’s thesis on the barrier to entry in Florida with land prices much lower than markets like New York City? Are you concerned with the rapid growth in inventory?

Matija Pecotic: Florida is in a protected spot given the tailwinds that it has going for it. The migration trends have been urban to suburban and north to south, and we don’t think that’s going away.

Businesses continue to relocate here, as people are getting fed up with either the politics or taxes in their states. I think that trend continues.

Ten years ago in Miami, the typical check size for a hospital philanthropy donation was $100,000. Today, the average check size is $10 million. I find that tracking philanthropy dollars is a very good indicator of trends.

Ultimately, the key is finding good sites and saying no to a lot of deals.

Daily Beat: Do you see a shift at these corporate events? Are people more interested in talking to you with your newfound fame?

Matija Pecotic: Fame is a fleeting experience. One person wisely told me, “people don’t love you, they love what you can do for them. And when you can’t do that anymore, they forget you.”

I’ve had fun at a couple of events where people recognize me. My LinkedIn was previously getting like 37 views a week, and now I’m getting 22,000!

People have come to know the Wexford name and have reached out. A lot of them are just fans and excited by the story, but amongst those inbound messages, you find some interesting people.

*The interview has been edited and condensed for clarity.

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Stephen Quazzo, Co-Founder & CEO of Pearlmark, joined us for an interview in late January. We discussed the firm’s lending strategy and how it’s deploying capital in this environment.

Daily Beat: Can you please share your background?

Stephen Quazzo: I got started in real estate investment banking at Goldman Sachs. My first three years were spent in the New York office, and I then worked out of their Chicago office for two years.

Sam Zell was one of our largest clients and I went to work for him. I spent five years there and in 1996 left to co-found Pearlmark’s precursor, an entity called Transwestern Investment Company.

We built up a terrific team and have sponsored a number of both equity and debt funds. This most recent fund is Pearlmark Mezz V.

Daily Beat: What’s the strategy?

Stephen Quazzo: It’s a continuation of a high yield lending strategy that we started in 2001.

The current environment is extremely conducive for it. We’re seeing our doors get kind of knocked down with people looking for this type of gap financing.

Whereas in the past, many of the opportunities would be construction loans and other deals that were harder to finance, our team is now seeing a steady dose of refinancings, acquisitions, in addition to development opportunities.

Daily Beat: Do you still focus on the equity side, or are you solely focused on debt?

Stephen Quazzo: I would say that we’re about 50-50. We’ve been active on the equity side over the years, and are in the process of launching an equity fund.

The common thread for us is that we’re a mid-cap player, and generally invest or lend against assets that are $100 million or less. We’re not taking huge positions in assets like the Chrysler Building or 425 Park. Generally, the deals have a value-add orientation, as opposed to core.

Daily Beat: Which markets have been your focus over the past decade?

Stephen Quazzo: For the last eight to 10 years, we’ve primarily invested in the Sunbelt, with a heavy emphasis on apartments.

Daily Beat: How does a typical Pearlmark debt investment look like? In other words, how do you go about only providing the mezzanine (mezz) piece? Are you supplying the whole loan and then selling off tranches of debt?

Stephen Quazzo: We tend to be collaborative and generally team up with traditional senior lenders for situations that need gap financing.

The beauty of having been in this business since 2001 is that we have 150 intercreditor agreements that we can just pull off the shelf with almost every lender from Bank of America, Ozarks, Madison Realty Capital, Prime, and many others. Historically, our strategy does not involve originating whole loans and then selling off pieces.

Daily Beat: Why do you choose this approach?

Stephen Quazzo: It’s more collaborative. We don’t want to compete with the senior lenders – we want to compliment them. The strategy works well because we’re on the short list of firms they authorize for the mezz piece.

We’re not trying to fill a massive bucket. This isn’t a $3 billion fund. Generally our fund sizes have ranged between $200 to $400 million.

Daily Beat: Do you leverage the book at all?

Stephen Quazzo: No. We did in the old days, but we don’t anymore after the 2007–2008 financial crisis.

With that being said, we do have co-invest capital to place alongside our fund. So while our typical mezz loan size is the $10 to $20 million slug, we’ll do larger mezz loans because we have co-invest capital.

In some cases, we’ll also bring in co-invest capital to diversify our construction risk. We have a 35% limit in our fund on construction, so we’ll bring in partners because these days you’re getting pretty juicy returns on those deals.

Historically on the mezz side, you were limited to getting 1.3x multiples, but now you’re fully getting 1.5x multiples on your money.

Daily Beat: What percentage of your loans are floating-rate?

Stephen Quazzo: It’s a mix and generally we’ll be the same as the senior lender. Floating rate comprises roughly two thirds of our portfolio.

As you can imagine, a lot of borrowers these days want to lock in rates, particularly on stabilized assets.

Daily Beat: Can you please step us through the differences between deals you look at today compared to before the downturn?

Stephen Quazzo: We’re basically taking less risk for higher returns. In simplistic terms, our attachment point today in the senior loan is generally around 60% versus 65% before. We’re only going up to 70 to 75% today, whereas before we were going up in the 80% range.

The return is higher for the less risky position.

Daily Beat: How do the fixed-rate loans you originated 18 months ago look like in this environment?

Stephen Quazzo: The good news is that most of our loans in the current fund were put into after May of last year.

The few that were put in place prior to that were primarily floating rate. There was one fixed rate loan, but the value of the asset appreciated in that case in part because of the value of the low fixed rate senior debt. It’s a good question and that’s why almost two-thirds of our book is floating-rate.

Daily Beat: To flip the question to when you sit on the equity side, what does your capital stack in this environment look like?

Stephen Quazzo: Generally we’re levering around 60% today. The equity returns are attractive enough at those leverage levels that you don’t really need to push it. Debt costs are obviously high today, so you want to minimize the negative leverage because by definition value-add investing means that you’re certainly not getting accretive leverage out of the box.

The lower you go in terms of leverage, the less negative kind of arbitrage you have. In this market, a lot of the investors are doing all equity deals, with plans to move the NOI, prove the asset, and then hope the debt markets are better when they have a stabilized asset a year from now.

Daily Beat: And that explains what we’re seeing in today’s market.

Stephen Quazzo: Yes. In those cases, the buyer is extracting a pound of flesh from the seller. There’s a pretty wide bid-ask spread.

As we’ve seen in the past, it’s only when forced sales happen that the log jam starts to unblock because people finally recognize they are not going to get February 2022 pricing anymore.

Daily Beat: What are your ballpark rates on the debt side? Obviously every deal is different, but perhaps you can provide some ballpark numbers?

Stephen Quazzo: In today’s world, it’s double digit spreads on SOFR. Obviously, it depends if it’s a stabilized property, value-add deal, or ground-up construction.

Equity today is 20%, so our argument is that 11% to 12% of debt costs for that chunk of the capital stack from 60 to 75 when you blend it with a reasonable senior loan is fair.

We’re seeing some loans where our attachment point has been as low as 50% where we’ll cover from 50 to 70.

When you blend that from the borrower’s standpoint, it’s palatable because they don’t have to bring in outside equity and they can weather the storm and refinance us out in two to three years.

Daily Beat: Where do you anticipate seeing the most distress?

Stephen Quazzo: I think you’re going to see a lot of distress on the office and the retail side. Underlying cash flows are going down and capital expenses are going up in order to keep tenants.

There are probably five or six buildings on LaSalle Street in Chicago that are going back to the lender. The Board of Trade Building, 135 South LaSalle, 30 North LaSalle, 10 South LaSalle, and BMO’s old headquarters. The distress is happening.

At some point, investors will decide that the basis is low enough to dip their toes back in the water, but we’re not there yet and it’s going to take a while.

As someone in our firm said, it’s one thing to hit bottom, but you don’t know how long the bottom’s going to last, so there’s no point in rushing in.

You might be able to wait 12 months and you’ll still be at the bottom. It’s going to take a while for that to kind of ripple through the system and I think we’re looking at a tough couple years coming up in the real estate sector.

Daily Beat: Have you looked at lending on any office-to-residential conversions? They are just so expensive and probably only save 10% on the entire project cost if everything goes as planned. What are your thoughts?

Stephen Quazzo: Since rents in New York City are so expensive, people will basically live anywhere in Manhattan, but in Chicago, that’s not the case. People are not going to live on LaSelle
Street.

They have too many other options along the lake and in neighborhoods. New York is a 24-hour city, so there’s always a bodega nearby. I don’t see that happening in Chicago. We wouldn’t lend against those deals.

Daily Beat: Would you lend against an office building that’s benefiting from flight-to-quality trends?

Stephen Quazzo: Yes. Our team recently did our first office loan in four years. It was a suburban Seattle office property with excellent sponsorship and the right loan-to-value. It’s always important that we make good mezz loans because we are not interested in loan-to- own. We have to get repaid.

I sometimes joke with my team not to make the loans too good because we’ll get repaid too quickly. I don’t mind extending it for two or three years because we’re clipping away and that’s a great return for our investors, particularly if we have a sponsor who’s willing to pour money in the asset.

Daily Beat: Trepp noted in October that more than $18.8 billion worth of CMBS, CLO, Fannie Mae, and Freddie Mac loans covering 1,468 multi-family properties with DSCRs of 1.25x or less are set to come due in the next two years. Would you buy those loans? What type of flexibility do you have with loan structures?

Stephen Quazzo: The documentation in the 6 CMBS world is incredibly difficult and a lot of them preclude mezz. Where we’re likely to be part of the solution is to essentially be rescue capital or maybe even preferred equity. Depending on the situation, it could come out of our equity or mezz bucket.

That’s where I think we can be useful to a borrower who wants to get out from under the securitized debt and pay it off if their coverage is close enough. The problem with those 1.25 coverages is that the new rate is much higher, particularly when the NOI is declining.

Daily Beat: How do you decide if mezz or preferred (pref) equity is a better fit?

Stephen Quazzo: Mezz is our preference.

Many of our investors, particularly insurance companies, prefer mezz from a regulatory and reserve standpoint. Pref will likely be more expensive and would come out of our equity bucket.

Daily Beat: What would be the advantage of preferred equity? I know you get an ownership stake, but it seems like there’s a lot of semantics.

Stephen Quazzo: In some cases it’s semantics; however, there are a number of instances where pref equity is really equity.

In other words, I think there’s a lot of risk associated with that position, but the investor feels comfortable because if things don’t improve or go sideways, then essentially they’re buying an asset at a basis that they feel comfortable with and they have additional capital to protect it, de-lever it, and invest in it.

It is semantics in a situation where there’s a construction loan on an apartment project. We’re going to get a redemption either way. Instead of an intercreditor agreement, we’re going to get a recognition agreement.

Daily Beat: Happy hunting out there. I’m sure your originations folks are super busy.

Stephen Quazzo: Thanks. At this point we’re over 30%, 35% invested in this fund already. Given the pace of opportunities that we see, I think we’ll be fully invested by the end of the year.

*The interview has been edited and condensed for clarity.

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Jonathan Bennett, President at AmTrust Realty, joined us to discuss his background, the firm’s office portfolio, diversification, lending opportunities, and what he’s seeing in the market.

Daily Beat: Can you please share your background?

Jonathan Bennett: I am very entrepreneurial and initially wanted to work in the high-tech and venture capital world in the late 90s.

I started my career working for a small investment bank that raised money for early-stage technology companies. After a big stock market correction in 2000, I went to work as investment banker at American Express, helping them sell off minority interests in venture capital (VC) companies.

That was the first iteration of Fortune 500 companies creating their own VC arms because they needed to be strategic. They were afraid of getting displaced.

I didn’t love the process because I would spend endless amounts of time doing the spreadsheets, putting together the private placement memorandums, and then things just would fall apart and you would have nothing.

Daily Beat: How did you end up in real estate?

Jonathan Bennett: I always had an interest in real estate, but I thought I was going to make my fortune in banking or technology. My initial plan was to invest in real estate afterwards.

Many of my friends were doing extremely well and weren’t dealing with many of the headaches that I was, so I decided to change course.

Daily Beat: Did you start on your own?

Jonathan Bennett: Yes. I started off putting deals together on my own. My father’s best friend was a big multi-family developer in Williamsburg, and we subsequently partnered to build a couple of rental buildings.

I then segued into an opportunity to work for the Nakash family. I had known them because I had been in their office to raise money as an LP and knew one of the family members from growing up. We clicked very quickly.

Daily Beat: Were they doing deals before you joined?

Jonathan Bennett: Yes, they were partners with Lloyd Goldman, Jeffrey Feil, Tony Malkin on many deals. The family was very fortunate to get involved as LPs with that small group of uber-rich, multi-generational players.

Joe Nakash wanted me to come in to grow the platform and complement that existing business. They didn’t know brokers at JLL, Eastdil, Newmark, CBRE, and Cushman. When I got in there, I spent six months calling every brokerage firm and telling them to send us direct deal flow because we’re now looking to purchase our own assets. This was before the days that Real Capital Markets existed.

Thankfully, we had a great run. We bought properties all over the country across all sectors, including The Setai Miami Beach, Versace Mansion, half a billion dollars of retail properties on the Las Vegas strip, and office buildings in Washington, DC.

Daily Beat: Can you please speak about AmTrust and its current portfolio breakdown? I gather there are a lot of older office buildings, which presents a challenge.

Jonathan Bennett: The portfolio is majority office, but the multi-family share is starting to increase. We’ve been investing in the asset class over the past year and plan on continuing to do so. Half of the 12-million-SF portfolio is in Chicago.

Daily Beat: With your recent acquisitions on the multi-family side out in Phoenix and Tampa, are you looking to diversify the portfolio further? What’s the strategy moving forward?

Jonathan Bennett: I look to companies like Tishman, Related, Brookfield, and Blackstone as examples of success in the industry. We aim to follow their best practices – they have kind of paved the way.

Based on recent market trends, a company like ours can learn from their success and diversify into other asset classes.

The previous leadership was very successful in their role, but chose not to invest in other asset classes and regions. We are interested in continuing to diversify.

Daily Beat: Are any of your existing office buildings ripe for conversion to residential? Costs, path to vacancy, light & air, zoning, floor plates are obviously serious considerations. Matt Pestronk recently told us that the cost savings on these projects are only 10-15%. Ultimately you’re really just benefiting from geography, the structure of the building, and some lesser costs.

Jonathan Bennett: Absolutely. We evaluate every asset and determine if it makes sense for it to remain an office building. The issues you mentioned all make it a challenge.

A lot depends on the existing floor plate, vintage of the building, and if it requires major changes, such as cutting a hole in the middle of it. This can eliminate some buildings as conversion opportunities; however, we are actively evaluating this and considering options such as conversion or demolishing the building entirely for a new development.

Daily Beat: Do you have a lending arm?

Jonathan Bennett: We are not lenders, but we’ve seen a lot of opportunities to do preferred equity that seems to be flavor du jour. Our team has bid seriously on those opportunities, but we have not yet closed one yet.

Daily Beat: I know the Karfunkel family’s primary business is as an insurance company. Many will use the float accordingly to go ahead and lend. Why do you think historically the families chose to go the equity route rather than lend?

Jonathan Bennett: The regulatory issues surrounding the insurance company preclude it. This is a little bit beyond my scope; however, I have regular communication with the president and executive team and they are interested in expanding opportunities through joint ventures with experienced lenders.

Daily Beat: How many people do you have at the real estate arm?

Jonathan Bennett: We have around 140 people in the company. There are 40 to 50 on the corporate side, with the rest managing the buildings. We are vertically integrated and have been doing a lot of hiring –– it’s an exciting time to be here!

Daily Beat: Do you do any public market investing in REITs?

Jonathan Bennett: Not out of this office.

Daily Beat: Are there any specific markets that you’re looking at?

Jonathan Bennett: We love New York and we are constantly bidding on properties in the city. We have experience in other markets such as Nashville, Austin, and Miami. I have bought properties there in the past when there was less competition.

While we are excited about the potential of red states like Florida, we are cautious as well. Markets can change quickly and you have to be prepared.

New York has a special power because of its immigration community. People come to New York with the goal of making it, and that provides an incredible talent pool and labor force. I’m not sure if other cities like Nashville, Austin, and Miami can replicate that.

We love New York, but we’re also closely watching those markets.

Daily Beat: So it sounds like you avoided overpaying for 3.5 to 4 caps, while projecting unrealistic annual growth rates.

Jonathan Bennett: Yes. I get nervous about things like that. On the flip side, you can buy assets at a lower cost on a price per SF in New York. The yield may not always be there, but we’re seeing resets in the market, which may lead to yield.

Buildings in Manhattan are selling for as low as $500 per SF, compared to a couple of years ago when they were selling for $800 to $1,000 per SF. It’s difficult to say if prices will ever return to those levels on the office side.

Daily Beat: Are you looking at office acquisitions in this environment?

Jonathan Bennett: Yes. We will definitely invest in the office market. The biggest challenge now is the lack of financing available.

As we discussed earlier, we’re also considering providing financing in this market as the lack of lending makes it more attractive for lenders. When you look at just what your all-in basis is as a lender, it gets even more attractive. You can kind of name your price because people don’t want to lend in that market.

There’s a lot of dislocation going on. Real estate markets can change quickly, and it’s easy to look back and think that the opportunities were obvious, but it’s not always clear at the time.

Daily Beat: Some of the existing office buildings on the market are fascinating. How do you see the office sector shaking out?

Jonathan Bennett: The question is also what’s motivating sellers. Are owners motivated? If a seller has a loan that’s coming due and they can’t refinance it, they might have to put in more equity to pay down the loan.

Daily Beat: Blackstone at 1740 Broadway was one of the first.

Jonathan Bennett: The lenders don’t want them. We’re betting on reversion to the mean and human nature.

Daily Beat: I gather that you’re investing in renovations in your Chicago office portfolio.

Jonathan Bennett: Our approach to the renovations is a heavy lift. We have hired experts like the former head of Tishman Speyer in Chicago and the construction manager for Blackstone’s $500 million renovation of Willis Tower to lead our portfolio.

We’re taking a hospitality approach to renovating the buildings by creating gathering spaces, lobbies, restaurants, coffee shops, outdoor spaces, fitness facilities, lounges and conference rooms to make the buildings more attractive to tenants. Google’s purchase of a 1.3 million-SF building in the heart of Chicago was a big boost to the market.

*The interview has been edited and condensed for clarity.

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Scott Rechler, CEO and Chairman of RXR, joined us for a wide ranging interview. We discussed the macroeconomic environment, RXR’s pivot to multi-family, the ideal capital stack, office-to residential conversions, and other timely topics.

Daily Beat: Can you please share the history of RXR?

Scott Rechler: We first had a public company called Reckson Associates Realty that was sold to SL Green Realty in January 2007. One of the reasons we sold Reckson was because the public markets were becoming too restrictive as our customer’s needs were changing at an ever-increasing pace.

We felt as if we were being forced into more of a narrow box, while believing that we needed to have the flexibility to adapt to the changing nature of how people lived and worked. This led us to decide that we’d be better off selling the company and reestablishing ourselves as a private company where we could be much more agile and focus on the future of where the real estate industry was going versus how it operated in the past.

We built a strategy that leaned into shifting demographics, new technologies, and understanding the changing needs of our customers to drive our investment decisions. We believe is not just about building a building with four walls but actively servicing the customers that live and operate within those four walls. The basis behind the RXR strategy was providing customers with differentiated real estate solutions and services that helped them meet their goals.

As a private company, we were able to take a clean sheet of paper and form a strategy based on our previous experiences as a public company. The vision was to marry the ideal organizational structure with the right capital structure and strategy so that RXR could excel.

Daily Beat: When did you jump back into the market?

Scott Rechler: Even though we sold Reckson in 2007 and started RXR on the exact same day, we didn’t make our first investment until August 2009. We were circling around, waiting for opportunities, but the fog of uncertainty remained heavy for quite some time. When we finally jumped in, we did so in a big way to take advantage of the dislocation that existed in the office market. From 2009 to 2011, we invested $4.5 billion in office properties.

Our investment strategy was to lean into the knowledge worker and buildings that appealed to them, focusing on services, community engagement, authenticity, and character. We continued to acquire office buildings but bought our last one in 2016 when we saw the sector getting too hot.

Daily Beat: And then you shifted into multi-family?

Scott Rechler: Yes. We started shifting our focus to multi-family and transit-oriented developments with projects that were within thirty minutes of New York City. These projects create an urban style of living in suburban locations but at a more affordable price point than living in the city, with rents 30% to 40% less than equivalent apartments in the city.

We have also been focusing on redeveloping and repositioning competitively obsolete properties to uses that are consistent with today’s demand. A recent example is a mall in downtown White Plains that has been vacant for almost two decades. It is a block away from the train station and a 30-minute train ride into Grand Central. We demolished the mall and we are building over 800 units of multi-family.

In addition to our focus on “transit-oriented developments,” we have capitalized on opportunities to acquire multifamily. For example, during the heat of Covid, when people were fleeing New York and apartment occupancy rates were hitting the low eighties, we invested in over $2 billion of multifamily properties. In hindsight, I wish we were able to acquire more, as residential buildings are now back to over 95% occupied, and the rents are higher than they were in 2019.

Daily Beat: What are your thoughts on the macroeconomy? How do you see interest rates playing out? I know you are on the New York Fed’s Board of Directors.

Scott Rechler: The Fed is obviously committed to taming inflation. This situation is complex as there are inflation drivers that are not directly related to the economic cycle such as supply chain disruptions, structural changes to the service sector job market, post-covid pent-up demand, and the war in Ukraine.

The Fed has been pretty clear that it’s going to focus on demand destruction to drive down inflation, which will also drive down economic growth. While people are focused on how high rates will increase, I think the bigger question is going to be how long rates will stay high.

If you go back and look at past cycles, particularly when you’ve had an inverted yield curve like what we have now, the Fed has historically started to taper back down the rates. I am not sure that is going to be the case this time, as they have made it clear that they want to make sure that inflation is fully out of the system. This heightens the risk of a more severe economic downturn.

Daily Beat: What do you see talking to your clients and customers?

Scott Rechler: Sitting in my seat watching what’s happening from a fiscal standpoint and then talking to our clients and seeing what’s happening to them first-hand, I describe it as “a pig in the snake” situation.

As interest rates rise, it starts working its way through the snake –– the financial markets are hit first but eventually, it hits the real economy. The longer interest rates stay at higher levels, the bigger that pig is, and the harder it will be for the real economy to digest it. That’s what we’re dealing with right now – the pig is getting bigger, and it’s starting to make its way into the real economy.

I speak to a lot of different CEOs, and they are approaching their 2023 business plans cautiously with the backdrop of this economic uncertainty. People are pulling back on hiring, capital investments, expansion plans, etc.

I think this will result in a more pronounced impact on the economy in early 2023. Until businesses see an all-clear that there’s not some financial shock or a deep recession ahead, they will prepare for the worse and hold back on spending.

Daily Beat: Many point to the relationship between the 10-year treasury and cap rates. Do you think this analysis sometimes overlooks the notion of convexity?

Scott Rechler: When focusing on real estate cap rates, you need to also focus on the total return of the investment, which takes into account both income growth and the exit cap rate to determine the exit value. Real estate that has the potential to grow its NOI more quickly during these inflationary times will see its cap rates less impacted by the rising rates.

While there’s a relationship between where interest rates are in terms of the risk-free return and what premium an investor needs to invest in real estate, cap rates are also impacted by externalities. If you go back and look through history, there’s not always a direct correlation between interest rates and cap rates. It has a lot to do with alternatives as to where institutions can invest, growth potential, and expectations for future economic conditions.

Take multi-family as an example. Investors view the sector as a hedge on inflation because one can increase rents on a regular basis. The same is true with hotels. It also has to do with the flow of capital. If an institutional investor is seeking to allocate big dollars into real assets, they might be concerned about investing in office buildings or malls in these uncertain times, which means they will need to allocate into multi-family, logistics, or self-storage.

Those sectors are much smaller in terms of investment size and thus require more investment in this space to meet your capital allocation. You may have to do five multifamily investments to equate to one office building. Therefore, I think that you’ll have these higher capital flows to keep cap rates lower.

Daily Beat: How do you employ leverage at this point of the cycle?

Scott Rechler: One of the things that we’ve looked at is using much lower leverage in this environment. The higher rates reduce the positive leverage and increase your overall cost basis. The lower leverage provides you with greater financial flexibility, and you can always refinance when things normalize. In addition, if there’s a higher shift in cap rates, the impact on your return on equity is not as amplified by the leverage.

Daily Beat: What’s your ideal capital stack?

Scott Rechler: We use relatively low leverage and are generally in the 50% to 60% loan-to-cost range, particularly on developments. For an investment right now, I think the sweet spot is preferred equity.

We are looking at more and more preferred equity deals similar to what we recently did with the Solow portfolio. We invested $261 million of preferred equity as part of the acquisition of three multi-family buildings on Manhattan’s east side. I believe that it’s a moment in time where you can get equity-like returns with debt-like instruments.

Daily Beat: Is there a reason you focus more on preferred equity than alternative lending?

Scott Rechler: Because a lot of the alternative lenders can’t do preferred equity. Their mandate requires them to do debt, so if you’re comfortable in our shoes of being someone that could ultimately step in and own equity or take the equity-like risk, there’s much less competition in preferred equity than there is in the mezzanine lending business.

Daily Beat: Doing for others what you did at 5 Times Square?

Scott Rechler: Exactly.

Daily Beat: What are your thoughts on Blackstone and Starwood limiting investor withdrawals?

Scott Rechler: We are seeing redemptions industry-wide, and people are pulling money out of real estate funds. You’re seeing some investment funds that are dealing with the “denominator effect” as the stock market has gone down, which by default has increased their proportional allocation to real estate, so they need to rebalance their holdings.

Daily Beat: What’s going on behind the scenes on the lending side in the secondary markets?

Scott Rechler: On the bank side, regulators are coming in and forcing banks to mark their assets and sell them at the discounted value to get them off their books. I think we’re going to see more of this which will accelerate the revaluation process.

Daily Beat: Some of these Asian investors seem savvy in pulling their money out of BREIT when valuations in the vehicle are still marked at 10% higher for the year!

Scott Rechler: ​​There’s clearly some logic behind some of these investment decisions. If you are an Asian investor that can sell not only at a mark that’s higher, but you’re also bringing it back to your country and get the benefit of the currency gain and the higher valuation mark.

Eventually, you can get a little bit of the run-of-the-bank mentality. Retail investors that have heard the news about the redemptions are picking up steam, which probably creates an oversell on what needs to be sold.

This will clearly impact the amount of liquidity in the marketplace and takes some of the most active investors out of the market.

Daily Beat: And I gather that this is happening industry-wide, not only in retail.

Scott Rechler: It’s not just retail. Think about all the secondary funds that have been set up to buy LP interests from other funds. Institutions over the last 12 to 18 months have been redeeming or creating liquidity out of their LP interest by selling to secondary funds. These secondary funds that have been doing these recapitalizations and have been one of the biggest segments of the fund business during this time period.

Daily Beat: What’s RXR’s current portfolio breakdown between office and multi-family?

Scott Rechler: We have 25 million feet of commercial, which includes office and logistics; 11,400+ units of multifamily; a debt book; and infrastructure.

Daily Beat: Has that shift from office to multi-family accelerated after Covid?

Scott Rechler: The mega-trends that we were considering pre-Covid have become even more important in the post-pandemic world. These trends allow us to benefit from structural demand drivers outside of the cycle that’s not just tied to the economy.

In our minds, that’s investing to create affordably priced housing and e-commerce-related investments like logistics and self-storage. High-yield debt is also an area of growth.

Daily Beat: What makes you excited about investing in the U.S. over the next 10 to 20 years?

Scott Rechler: There’s a great recalibration happening that structurally is going to put the US in a spot for incredible growth when we get past this current economic moment in time.

I think 10 to 20 years of harvesting the innovation that took place during COVID and some of the drivers related to decarbonization, digital transformation, de-globalization, and onshoring will create significant growth opportunities as we go through that transition. And the knowledge worker will be at the center of that.

Daily Beat: What type of rent growth were you projecting in Denver, Phoenix, and Tampa when acquiring assets in those markets? Do you think the rent growth is sustainable?

Scott Rechler: We underwrote around 3% rent growth, so we’re getting the benefit of 15% to 20% growth that we didn’t pencil in for those projects because of such strong demand. Our focus is on cities where the talent pool wants to be.

We call it the Eds, Meds, and Well Led cities. Good education systems, good healthcare systems, and good leadership that provides the quality of life that makes it a place to capitalize on sustainable growth for the knowledge worker.

That’s really what drives us when identifying where to invest. We are executing in those locations similar to what we’ve done in the outer ring of New York. If there’s a superstar city, we focus on the next ring that’s connected to transit to help create a superstar region.

Daily Beat: What are your general thoughts on multi-family rent growth in New York City vs. the Sunbelt in the next few years? Is the expiration of 421-a an accelerant for the city?

Scott Rechler: We’ve always been big believers in New York City, even during the height of the pandemic when everyone was leaving. As I mentioned earlier, we invested in over $2 billion of multi-family with the belief that the city was going to come back, and we were proven right.

In the coming years, I think there’s going to be more demand than supply. You’ll have a little bit of a pull forward from the expiration of 421-a, which was in last June. There will be a bit of a blip of new housing, but when that supply is digested, I don’t think there will be any new supply built until there are new programs in place. That should create an additional shortage, which will result in higher rents.

The question then is when does rent become too much? How high can you raise the rents before people just say I can’t afford it and I have to move? That’s why as a public policy matter, we really need to develop policies that create affordable housing at all levels.

Just focusing on lower-income housing alternatives sometimes overlooks the fact that we need housing for young professionals and working people. We need housing for all income levels, and there are different strategies to deal with this challenge.

Daily Beat: The political tide appears to be slowly shifting, particularly with the death of member deference. Hopefully, we will have more instances like what happened with Silverstein, BedRock, and Kaufman Astoria Studios’ Innovation QNS.

Scott Rechler: You need to get ideology out of the way and focus on good public policy.

Daily Beat: From a statistical vantage point, can you please break down how you view the housing shortage in the country? A recent Newmark report found a 400,000-unit shortfall in 2021 when comparing single-family and multifamily completions to household formations. What’s your take on this?

Scott Rechler: There’s clearly more household formations versus new construction of housing. However, focusing on macro is always a little dangerous, so the focus should be micro on the types of housing in locations that meet people’s needs.

We take a submarket-by-submarket, project-by-project approach and analyze the supply-demand dynamic within that circumstance. And then, we’ll go to the outer rings of different markets and identify the growth potential because, eventually, people will move there. The process really must be micro.

With that being said, everything that we’re seeing argues that there is already a housing shortage. As the economy gets weaker, the demand for housing will also get weaker because people will stay with roommates and their families a little bit more.

On the other hand, there are also going to be fewer single-family and multi-family housing units built. We’ll absorb what comes to market in 2023 and 2024, but by 2025 and 2026, there’ll be a real shortage of supply because the debt and equity markets aren’t permitting continued development.

Daily Beat: How has the increase in office lease expenses been absorbed?

Scott Rechler: At least in New York City, office leases are structured that, at the outset of the lease, you set based on their expenses, and all the additional expenses are paid by tenants, so they get passed through. The risk you take is that when their lease expires, the new tenant comes in, and they get the higher base. Meaning if the expenses were $10 a foot when the old tenant came in and you passed it through, and now it’s $15 a foot, the landlord must absorb that new $5.

Daily Beat: Any office-to-residential conversions in the offing for RXR? Silverstein just came out and said that their acquisitions team is now solely focused on finding office buildings that can be converted.

Scott Rechler: If valuations come down, the regulatory process is streamlined, and the government offers incentives, I think it’s a great business model and a great public policy proposition, but they all need to align.

We’ve done a comprehensive review of our own portfolio, and there’s a handful where conversion could work. I’m not sure it’s a business yet, but I think you could see a case again where values come down, the regulatory environment changes, and incentives are put in place where it can become a significant business.

*The interview has been edited and condensed for clarity.

The Real Estate Daily Beat equips real estate firms and industry leaders with exclusive news and insights to inform impactful decision making. Learn more about corporate subscriptions here.

Craig Deitelzweig, President & CEO of Marx Realty, joined the Daily Beat for an interview. He laid out his bullish outlook for the office market, and why he thinks it’s a generational buying opportunity.

Daily Beat: Can you please share your background?

Craig Deitelzweig: I started out as a real estate lawyer at Skadden and really enjoyed working there. I developed a love for real estate and wanted to focus more on the business side than the legal.

I then worked for a private developer and subsequently joined a private equity firm. At that point, I realized that I had a real aptitude for repositioning assets. Over the years, I have been fortunate to reposition more than fifty.

Around five years ago, I joined Marx and have been growing the company. We have been rethinking our assets and bringing a hospitality mentality into the office space.

Daily Beat: That trend has certainly accelerated over the past few years.

Craig Deitelzweig: We did it at 10 Grand Central about four and a half years ago and it’s really successful today. The whole experience is very hospitality-like. We have a doorman outside, a Marx Mobile, which is a house car that drives our tenants to different meetings and lunches.

The building is very anti-corporate. We are the opposite of so many of these buildings that are white, marble, and cold –– Marx buildings are warm and inviting. That’s really been our success before the pandemic, but it’s really accelerated ever since then.

Daily Beat: What’s your portfolio breakdown?

Craig Deitelzweig: Probably around 60% office, and the rest retail. 

Daily Beat: What’s the average age of the office buildings? 

Craig Deitelzweig: ​​We have a lot of historic buildings from the 1920’s and 1930s, but we think of them as modern new buildings, even though they have a historic shell. Our average age is probably around 50 years old.

We’ve been buying a lot recently too and bought two older office buildings during the pandemic. Both became generic and lackluster and we brought back its heritage, beauty, and soul. One was called the Herald, which is where Jackie Kennedy had worked for her first job. All the furniture is based on items of clothing that she wore.

This approach is not commonplace in the market, but tenants really gravitate toward these types of buildings that have been repositioned.

We also have had great success with 545 Madison, which we repositioned during Covid. Occupancy increased from 68% to now 100%. When tenants came to tour that space, they appreciated the hospitality aesthetic.

Daily Beat: ADP Research found that 64% of workers would rather quit their jobs than return to an office full time. How has occupancy been in your buildings?

Craig Deitelzweig: Flight to quality is real and we have been the beneficiaries. Our physical occupancy has been at 87%.

Leasing and touring activity from August was the most robust it’s ever been. People are touring spaces and we’re seeing a lot of employers bringing in groups of workers to get buy-in on the new space.

They all want space that will get their employees excited to go back into the office.

Leaders have often said they want their employees back in the office because they think it’s the best way for them to engage with their employees and create culture. When people are remote, they’re more inclined to quit because they don’t have any attachment to their company. That’s what you’re seeing in the poll.

Daily Beat: So it sounds like you believe that office will fully come back.

Craig Deitelzweig: Yes. If you look at these companies that say that they’re going to remain remote forever, my guess is they will not exist in five years. When Yahoo and IBM experimented with it, remote work failed. It’s really hard to get your mojo back once you make that shift. That’s what a lot of companies are going through right now. The various polls don’t paint a full picture.

For instance, my son recently graduated college and he wants to be in the office and learn. Younger people really do want to be in the office.

Daily Beat: Kastle says that the average physical occupancy in Manhattan is around 47%. The 87% number in your buildings is impressive.

Craig Deitelzweig: Yes. People who come into this building have come in for a reason and want to be there. We have a lot of groups who were coming in four days, and are now coming in five days a week.

Additionally, a lot of tenants are expanding because there was a lot of growth during the pandemic period and they need more physical space. It’s a lot of contradictions that you’re seeing, but I think it’s all going to settle out in a really good place. I’m bullish on New York City office.

Daily Beat: Is flight to quality overrated? Ultimately, are employees going to work?

Craig Deitelzweig: No. It’s really an experience that starts with the doorman outside. I think we’re still the only office building that has a doorman opening the doors for their guests and visitors. That whole experience is really important to the psyche of the employees in the building.

A lot of tenants really care about our lounge floors and conferencing spaces. It’s probably more important than the actual physical office spaces that they’re using, which was never the case previously. Tenants really do use those spaces all the time for meetings and also more casual types of experiences.

Daily Beat: Where else do you own office assets?

Craig Deitelzweig: We’ve been focusing on New York, Washington DC, and Atlanta, but we’re in sixteen states.

Daily Beat: Vornado had too much floating rate debt and they didn’t prepare for macro conditions. How have you prepared?

Craig Deitelzweig: We saw this coming and thought that inflation rising would have an impact on interest rates. Marx Really therefore locked in all of our debts for the long term, so we don’t have any loans maturing for the next three years.

Daily Beat: How much have operating expenses increased?

Craig Deitelzweig: We locked in a lot of our energy expenses, so we’re good in that sense. The same with our cleaning, which are the two biggest cost items. Ultimately, we’re going to start to see increases in operating expenses, but it hasn’t been that impactful yet. In terms of build-outs, those have continued to increase because of supply chain issues.

Daily Beat: Do you manage your own buildings?

Craig Deitelzweig: Yes. That’s something that changed since I joined. Nobody is better than an owner in managing their physical properties. We see things that others won’t see and add thoughtful details that make all the difference in the world to tenants.

Daily Beat: Do you see good acquisition opportunities in the office sector?

Craig Deitelzweig: We’ve been looking in New York for years to acquire assets and we just haven’t seen properties at a cost basis that made sense to us. Now we’re finally seeing deals that make sense, but you have to be very careful in this market.

The downtown market is a difficult one, so we’re focused on mostly Midtown, which is a dynamic area near transportation. In terms of the assets itself, we have to make sure it’s not just a price play and has the physical attributes that can really excite people to that space.

Daily Beat: Have you seen a shift to shorter lease terms? We’ve seen many five to seven-year renewals.

Craig Deitelzweig: That’s been happening for a while. Renewals are typically five or seven years, while new lease are 10 or more. We’ve been seeing that for quite some time.

Daily Beat: What’s your typical structure? Do you go out and raise for every new acquisition or do you operate out of a fund?

Craig Deitelzweig: We acquire some assets from our own balance sheet and there are also multiple groups that we partner with. Our team plans to increase institutional partnerships right now, especially with the generational types of opportunities that we are seeing in the office market.

Daily Beat: A borrower loses control once they close on a loan, with a CMBS deal being the most obvious example. How do you protect yourself as a borrower?

Craig Deitelzweig: We don’t take on CMBS debt. All of our debt is with lenders where we have relationships with and they keep it on their balance sheet for that very reason. In the CMBS world, you have no control over it. Additionally, there’s nobody to talk to if something goes wrong.

Daily Beat: Even if you have a good relationship with a lender, I guess there’s really no way to prevent them from selling it too.

Craig Deitelzweig: The lender groups we work with have a history of keeping loans on their balance sheet, which we have seen across many deals with them. Moreover, when underwriting your company, if they feel particularly comfortable, they’re going to want to keep it on their balance sheet. We have not run into that issue.

With that being said, we do think that there will be assets or notes to acquire based on borrowers having a difficult time with their lenders.

Daily Beat: Do you think Proptech is a complete bubble or is there any valuable technology at play?

Craig Deitelzweig: I think it’s a mix. Some of the technology is not necessarily very unique, but there is some that’s meaningful. I think Proptech on the construction side has enormous possibilities. For instance, using robots to lay bricks is wonderful.

The reality is that a lot of the big names in the space like WeWork are not real technology companies.

*The interview has been edited and condensed for clarity.

The Real Estate Daily Beat equips real estate firms and industry leaders with exclusive news and insights to inform impactful decision making. Learn more about corporate subscriptions here.

Martin Nussbaum, co-founding principal of Slate Property Group, joined us to discuss the current economic environment, Scale Lending, and why he’s so bullish on multi-family in New York City.

Daily Beat: Can you please share your background?

Martin Nussbaum: I started off in real estate investment banking right out of college, which was a great way to learn the underwriting side of the business.

I then moved into the management side of actual construction and development for six years at a large family office. We focused on building apartments, condos, and for-sale single-family homes. The experience helped round out my knowledge.

And then in 2009, I started Silverstone Property Group to acquire multi-family buildings in Manhattan. I subsequently bought out the partners and took the company with me, which has morphed into Slate Property Group.

A large majority of the senior management is still the same. There’s about 150 people who work in the company.

Daily Beat: I gather that your business is still primarily in New York.

Martin Nussbaum: Yes. I’d say that about 90% is in New York City, while the rest is in California and Florida.

We focus on residential investments on both the equity and debt side of the business. This includes luxury, market-rate, workforce housing, affordable housing, and transitional housing.

The equity business is roughly $6 billion, while on the lending side, we have a debt balance of about $2 billion in loans outstanding.

The equity side is our bread and butter, but we focus on residential anywhere in the capital stack.

We have multiple branches: an underwriting / acquisitions team; a full accounting division; in-house property management; a leasing group; and a construction company. All of those divisions only work on our own assets. They are self performing services to ensure that the entire process is under our control from start to finish.

Daily Beat: What led you to the debt side with Scale Lending?

Martin Nussbaum: Around four years ago, we started to think about getting into the debt space and it was mostly because we were being outbid on many deals. We simply weren’t comfortable at the last dollar basis that other people were.

Our underwriting standards led us to believe that these weren’t deals we could get comfortable acquiring; however, lending at 70 or 75 cents on the dollar was very interesting to us. We could create a business and generate returns in a way that really capitalized on our market knowledge and relationships.

Fast forward to today, our team has done 30 to 40 loans. They all fit into the bucket of what we do on the equity side; namely, ground-up construction, value-add repositioning, and commercial-to-residential conversions. We have financed a lot of deals that we’ve been outbid on the equity side.

Daily Beat: How aggressive are you in leveraging your book?

Martin Nussbaum: We’re somewhere in the 50 to 60% leverage range.

Daily Beat: Do you lend out of a fund? I know you mentioned Carlyle Group in the initial announcement, but I haven’t seen any fundraising announcements since then.

Martin Nussbaum: There are different buckets of capital that we have for the debt business. Some of it is backed by the private equity side, while others are one off deals with existing LP investors. It really depends on the loan, but a big chunk of it comes out of Scale Lending, which is backed by Carlyle Group.

Daily Beat: Are there any plans to raise a fund?

Martin Nussbaum: It’s still to be determined. We have plenty of capital to deploy, so I think we’re going to deploy all of it and then take the next step beyond that.

Daily Beat: Do you keep all the debt on your book or are selling any of the trenches? How do you approach that?

Martin Nussbaum: It depends on the loan, but we have a lot of relationships with specific lenders and they may lever our positions or various different lines of credit. It’s truly just a lot of strong banking relationships that we’re able to take advantage of.

Daily Beat: You hold the loan, so there’s not much a borrower can do, but when you sell off a more senior piece to a bank, do you get pushback or do they understand that it’s part of the business?

Martin Nussbaum: A lot of times we’re doing it behind closed doors. We may close on a loan in cash and lay it off later, so it’s not something that the borrowers are really seeing.

Daily Beat: How are you underwriting rent growth in parts of the Sunbelt where the growth rates appear to be unsustainable? And what are your general thoughts on rent growth in New York City vs. the Sunbelt in the next few years?

Martin Nussbaum: New York has seen dramatic improvement in rents over the past year – high double-digit kind of trade outs and strong year-over-year growth. Although it has certainly slowed down in the last 45 days, it’s still in the high single digits, so I think there’s still a lot more room for growth.

We are particularly bullish on New York in light of the fact that there’s no new starts of any new rental product due to the expiration of the Affordable New York program (aka 421-a tax abatement).

The result will be a huge supply and demand issue that’s going to benefit the supply side and lead to much smaller vacancy rates and higher rents.

Outside of New York, from a lending perspective, we underwrite deals in markets like Florida, California, and the Carolinas based on where rents are today. It’s our right to be conservative.

We don’t assume 7% growth a year like we see other people doing. Our team stays very focused on deals that can support themselves based off of in place rent because there could be a pullback on rent growth.

We also very much focus on deals where there’s been an appreciation of value in land through a rezoning or a recapitalization of an existing landowner. We haven’t financed any deals that are highly marketed where someone’s buying a piece of waterfront land in Florida for $300 a foot to develop a project. That’s not really where we play.

Daily Beat: Insofar as expenses are concerned as a percentage of EGI (Effective Gross Income), how has that changed for existing buildings?

Martin Nussbaum: Those numbers have blown out completely. Repairs and maintenance in general are up. Cost of OpEx has gone up probably 15% in the last 12 months.

Daily Beat: That’s a big number. Rent growth has been strong enough to gloss over it.

Martin Nussbaum: We’ve seen growth in the 20 plus percent range in the last 12 months, so right now that’s okay, but hopefully both of those will settle into a place that’s more normal.

Daily Beat: I’m sure you’ve a lot of the deals on the equity side in the Sunbelt that were bought on the 3.5 caps, projecting rents of 10%. That just doesn’t seem to be a recipe for long-term success.

Martin Nussbaum. We have never gotten involved in that space on the equity or debt side. In fairness, people who have in the last few years have done well, but we’ve lived through a couple of cycles over our career, which leads us to believe that you’re playing a game of musical chairs and when that music stops, it can be very dangerous.

Daily Beat: The CMBS special servicing rate rose for the first time in two years in August. Granted, it was primarily due to the retail sector, but there was some slight distress on the multi-family side. How do you see this playing out in the next year in this macro environment where the Fed continues to raise rates?

Martin Nussbaum: This is all going to come down to where interest rates ultimately settle. Retail and office have obviously suffered pretty dramatically.

On the multi-family side, there’s not as much distress as other asset classes. Since property owners can reset rents on an annualized basis, they have the ability to get through tougher times. The real question will be when does inflation come and when can the Fed start pulling back on interest rates.

If you can live through the next 18 to 36 months and allow the economy to get back into a normal place and the Fed can contract rates, you’ll be in a much better place.

The question will be who can sustain themselves until then and I think that’s where “rescue capital” will come in. Take an owner who has to refinance a building in the next six to 12 months where they have to pay down the loan by 20% because the debt yield has blown out due to interest rates. If that firm can’t write the check themselves, it might look for someone to come in and write a check on your behalf. That will address the distress in that market, but I don’t think that will be the case with office and retail assets because people don’t believe in the equity position.

Daily Beat: Have you tightened your lending standards since the macroeconomic changes?

Martin Nussbaum: Yes. We’re obviously underwriting an exit and takeout that’s now going to require a new lender to be underwriting in the current interest rate environment. We’ve also adjusted our underwriting from a rent growth perspective. Proceed levels have also been impacted.

When you combine these factors with a lot less deal flow due to the environment, the result has been less loan origination. We’re holding all of our other metrics the same.

Daily Beat: There’s a very interesting dynamic with the national housing market and the rental market. When buyers are priced out, they need to rent. Moreover, if the Cost of Shelter (i.e. rentals or housing) goes down, interest rates can potentially follow suit. How do you deal with these inverse relationships on a macro level? Do you focus on them or do you just underwrite deals, trust your process, and live with the consequences?

Martin Nussbaum: All you can do is update your underwriting based on what you see in the marketplace regularly. Real estate is typically a very slow moving asset class compared to the stock market and other asset classes that almost get marked to market hourly, daily, or monthly.

What I find interesting now is that since interest rates are fluctuating so much, real estate is marking to market much more frequently.

For us that means that almost every week we sit down and go through our underwriting assumptions as a company. We look at changes to operating expenses and rent growths on our properties, in addition to reviewing what’s happening to construction costs.

Fortunately, we have a very large portfolio of almost $8 billion worth of real estate that we can leverage to get real time data to make decisions. That’s been our competitive advantage. Others might read about it in a CBRE report six months after we see it.

Daily Beat: How long does the average deal on the lending side take from start to finish?

Martin Nussbaum: It could be as quick as 30 days to as much as 90. Generally speaking, it’s a 45 to 60 day process.

Daily Beat: How many are direct versus those that come through brokers?

Martin Nussbaum: I would say at least 40 to 50% are direct. A great example is the $185 million loan we just did with Namdar Group in Florida. That’s a repeat borrower that we’ve done three or four deals with. They have been great.

Daily Beat: Let’s take a ground-up rental development. What are your ballpark numbers on rates and LTC / LTV?

Martin Nussbaum: We are somewhere in the range of 70 to 80% of cost, which typically equates to somewhere between 55 to 65% of value. Our pricing ranges from 500 to 600 bps over SOFR.

Daily Beat: Slate recently bought a pair of Upper East Side rental buildings for $78 million. Can you speak to the play?

Martin Nussbaum: On the equity side, we are bullish on buying existing multi-family below 96th Street in prime Manhattan. We think that there’s a huge need for rental products with no new starts on anything. That’s a very attractive buy for us right now.

Daily Beat: I gather that Slate is further exploring the Environmental, Social, and Governance (ESG) side of the business. Trying to capitalize on the massive inflows with the housing shortage in the country is a smart idea.

Martin Nussbaum: We’ve really branched out into the ESG side of the business over the past 18 to 24 months. Our team develops transitional and fully affordable housing buildings, which is something that’s very needed today.

We’re trying to figure out how to bring our experience in New York into other markets that have the same needs in terms of homelessness and housing.

*The interview has been edited and condensed for clarity.

The Real Estate Daily Beat equips real estate firms and industry leaders with exclusive news and insights to inform impactful decision making. Learn more about corporate subscription here.

Don Peebles, Chairman & CEO of The Peebles Corporation, joined us for a wide ranging interview. We discussed the advantages of public-private partnerships, the shifting political climate, Affirmation Tower, and why he’s bullish on the hospitality sector.

Daily Beat: Can you please share your background with our readers?

Don Peebles: I was first exposed to real estate as a young child when I was eight years old. After my parents divorced in 1968, my mother got into real estate sales and built a brokerage business.

I initially anticipated going to medical school, but changed my mind when I was an undergraduate at Rutgers and left to work in real estate.

Daily Beat: I gather that you started on the residential side.

Don Peebles: Yes. I started my career trying to sell houses as a real estate agent in 1979. During that time, the industry faced a highly inflationary environment – eerily similar to where we are today. Interest rates were raised to try to control inflation and they ran all the way up to about 15%, which meant real interest rates were 18 to 20%. People wanted to buy, but could not qualify for a mortgage, so I got into appraising when I was 21.

I started as an appraiser apprentice and a few years later started my own appraisal firm. I grew up in Washington DC, so I’d known politics and government for awhile and was able to secure some contracts from HUD.

Daily Beat: What was your first experience with the government?

Don Peebles: My last two years of high school were spent as a Congressional Page on Capitol Hill. At that time, there was a school for us on the top floor of the Library of Congress. Our classes were from 6:00 AM to 10:30 AM, and then we walked across the street to the Capitol and we’d work from 11:00 AM until Congress went out of session.

Daily Beat: That sounds like a formative experience.

Don Peebles: I got a good crash course on politics and time management. We were able to grow the business from there and three years later in 1986, I found a development opportunity and built my first office building. The government pre-leased the property and was our sole office tenant, which made it easier to finance.

The real estate market had a good run in the 1980s after the recession, but we then faced the S&L crisis. During that period, our business focused heavily on consulting and property assessment appeals.

As we were going through this down cycle, we acquired some sites at heavily discounted prices and those became future development opportunities for us in the 1990s as the market recovered.

Daily Beat: How did you get active in Miami?

Don Peebles: I went on vacation in 1995 and loved it! By the following year, we had won the development rights to the Royal Palm hotel. The City of Miami beach redevelopment agency owned the site and was looking to develop more convention quality hotels. This created the primary focus of our business for many years, which was public-private partnerships. This was a great fit in terms of my skill set because I remained actively engaged in local and national politics as I built the business.

I was on Bill Clinton’s national finance committee when he first ran for president and was a corporate co-chair at his inauguration. I was very active in the political process. Between that activity and my real estate experience, Peebles Corporation developed an expertise in the public-private space.

Daily Beat: What are the advantages of public-private partnerships over standard development?

Don Peebles: Throughout our company’s history, we have done many private sector deals and in such cases the buyer is simply looking to maximize profit and high probability of execution. The seller rarely cares about how or what you build on it. They just want to maximize their price and move on.

The public sector is very different. These public-private deals are typically done with a local municipal government like Washington DC or Los Angeles, but occasionally the arrangement is with the state. Across the board, these government entities are primarily focused on ‘outcome’ when they sell.

Governments are not land speculators, they’re not land investors. The amount of money they’re going to get from selling a piece of property is almost meaningless in terms of their overall budget and spending capacity.

In some cases, they might want to increase affordable housing, while in others there might be a shortage of office space in a location. As an example, we recently won a few Requests for Proposals in Miami Beach to develop office space because they felt that based on migration patterns from the Northeast, the growing number of entrepreneurs would need offices close to where they lived.

Across the board, governments are focused on how you take into account the economic considerations of local residents and businesses.

Daily Beat: And in private development, the seller only cares about price.

Don Peebles: Correct. Unlike the private sector where the sole focus is price and the ability to execute, there’s a multitude of measuring and evaluation standards in the public-private process.

Financial capacity, offer, design, and use type. Moreover, the government receives all kinds of revenue that’s generated.

For example, in a place like Washington, DC, where there are city, state, and county functions, they all receive tax revenues. Hotels are very attractive to them because of all the different tax sources and jobs that are generated. The public sector looks for job generating activities and economic stimulus.

Governments will also look to support investments that they’ve already made like a convention center and request that hotels are developed nearby. They’ll evaluate based on those criteria and price will have some relevance, but rarely will you see price being more than a third of the evaluation criteria.

Daily Beat: This presents some excellent opportunities for developers like you.

Don Peebles: Overall, we like this approach because it gives us the opportunity to be competitive without having to pay the most money. Structurally and fundamentally from a real estate investor perspective, if you can buy assets at below market prices by providing other types of benefits that are not necessarily costly to you as a developer, that’s much more attractive.

The private sector is looking for very quick execution on the purchase, while the public sector generally does not allow a developer to close on the acquisition until you’re ready to commence construction. If you don’t ever get to that point as a developer, they’ll take the property back and go through the process again.

While that presents a risk, we see that as an opportunity because then we don’t take entitlement and land carry risk. We like the public-private process because we don’t close until we’re ready to dig a hole in the ground.

Granted, we risk a smaller sum up front, but that is offset by the fact that we don’t have to pay to carry the property and the land arbitrage we get on the price.

Daily Beat: A misleading report from city Comptroller Brad Lander’s office unfortunately helped shape the media narrative surrounding 421-a in New York City. It claims that the city will lose $1.77 billion in tax revenue from the program in 2022. The reality is that without the tax abatement, developers would not build these housing units in the first place. Can you please discuss these political headwinds? How do we combat this?

Don Peebles: This has been a two-to-three decade process.

Developers were initially perceived entrepreneurs and innovators who were improving communities by building urban infrastructure and developing suburban markets.

However, as the process of relocating back into urban cities and the progressive nature of politics, there became this view that developers were gentrifying communities and pushing people out. The narrative started becoming more negative.

To combat this, I encourage a greater focus on economic inclusion because development stimulates economic activity. If we could have a broader lens of who we give opportunities to and make it more reflective of the population, demographics that we are building, then we’d be perceived as job generators. Jobs were being generated from outside the communities and this created this narrative of an anti-development approach.

Politics has unfortunately always been about misinformation. How you take a fact and spin it. That’s why they’re called the spin doctors and the messengers because they take a basic fact and mislead the voters with it.

Daily Beat: Who can forget about Amazon in Long Island City.

Yes. There was a false narrative that the deal was going to cost the government $8 billion. In reality, Amazon was going to provide New York with $30 billion and would get a rebate of that $8 billion to make the economics work. Now, we’re sitting here with zero revenue.

The same thing is true with 421-a. The government incentivizes certain uses; namely, affordable housing. In markets like Los Angeles and New York where construction workers are heavily unionized and land is expensive, the cost to produce housing is higher than other states and developers are forced to build higher revenue generating products.

Providing property tax incentives to developers to build affordable housing helps close the tremendous gap between revenue versus cost.

Bricks and mortar will cost the same overall – whether you build luxury or you build affordable housing – it’ll just be some of the finishes that’ll change the price perspective. The government needs to look at that more closely. Now they’ve eliminated 421-a in New York State, that’ll have a chilling effect on the development of affordable housing.

There’s minimal profit for a developer in affordable housing because there’s no upside of owning the real estate. Most developers look to use that as a stepping stone. This is a sector of the market that is going to need greater incentives. Unfortunately we’re in a political narrative where there’s an anti-development and anti-wealth environment. I think that the Comptroller is making a mistake.

It’s a false narrative that any kind of tax abatement for affordable housing has been costly to the government because the alternative would be that the government builds this housing and they wouldn’t do it.

Daily Beat: We wrote in our publication that more than half a dozen affordable housing projects in California are costing more than $1 million per apartment to build. Developers must be part of the solution. Tenants could be getting very nice houses for that amount!

Don Peebles: Yes, I saw it. We’d be better served by allowing people to go out and buy private housing on the market.

Daily Beat: Are these migration patterns to nicer climate and Sunbelt sustainable?

Don Peebles: We’re going through a very transitional period in this country in terms of how Americans are going to work. That was all accelerated as a result of COVID and the whole country working remotely and learning how to do that more efficiently.

Obviously that’s going to have an impact on office demand and shift where people work. It’s also going to change what amenities are going to be available in apartment buildings and condos. Amenities like business centers with office, conference, and video conferencing capabilities are also going to be attractive. The speed and reliability of the internet is going to be very important.

Daily Beat: The fact multi-family deals in certain markets are trading at 3 caps has concerned us for the past few months. How do you see things shaking out with the rise in interest rates?

Don Peebles: We’ve operated from the perspective that cap rates have been too low on rental apartments for a long term hold. Interest rates have been so low for the past few years and the only place they could have possibly gone was up. We always thought that’s a risk in multi-family and it’s now coming to bear.

This will result in more development because you could still develop in the Sunbelt in places like Miami at 6 to 7% cap rates, which gives you a nice arbitrage and cushion. I think cap rates will go up.

But since rents in the Sunbelt are rapidly going up, I think values – despite the move in cap rates – will be relatively preserved. This is because the cost of housing is so expensive and there’s not been a lot of new inventory. With mortgage rates doubling in a very short window of time, that has priced a lot of people out of buying, which leads to more renters.

The mindset of the housing consumer has changed with a different generation.

Daily Beat: Lumber is already down 55% from its January high. Where do these costs for materials stabilize? When projecting hard costs for your development pipeline in the next few years, how do your numbers compare to before the pandemic?

Don Peebles: I think it will settle down to a rea- sonable price increase based on where we were in 2019. We’re building a lot in 2023-2024, and we think prices will level off by then.

Daily Beat: Do you raise individual funds or is it open ended. What’s the typical deal structure?

Don Peebles: Our typical structure has been one off fundraising. We retain our earnings and self-fund all of our pre-development work. We create a lot of value in that process and then bring on institutional partners.

We’re now in the process of beginning to do a private placement around our public-private business, because the scale of our business has gone up. We’ve got seven plus billion dollars in the pipeline and want to add to it because there’s tremendous opportunities for us, so we’re adding more structure now to our GP fundraising.

We also have some strategic partners that we’ve worked with in the past on the LP capital and plan to continue working within that pool of institutional investors on a one-off basis.

Daily Beat: Favorite REIT?

Don Peebles: Park Hotels & Resorts. The hotel sector was beaten up and luxury travel is back in a very big way. I anticipate corporate travel for meetings and business conferences to join in the recovery.

The pandemic has led to the closure of unproductive and marginally profitable hotels, which has led to a much stronger hotel base. Rates continue to increase.

I like Park Hotels & Resorts because they have a combination of conference hotels like the New York Hilton, but also like the Royal Palm in South Beach, which I developed.

I’d short and have shorted office built office REITs. I did that before the pandemic and was focused on New York office REITs because fundamentals were going the wrong way.

Daily Beat: Can you please share an update on Affirmation Tower and Site K?

Don Peebles: The Empire State Development Corporation owns the site and they issued a request for proposals.

We looked at answering the two moments that the country was really dealing; namely, COVID and the unprecedented protesting around the nation surrounding racial, economic, and criminal justice. We wanted to build a development that would address those two moments.

I partnered with McKissack, a black-woman-owned and run construction company and paired them up with our friend John Fish at Suffolk who is our contractor there. We wanted diversity and the tower will be 80% African American owned.

I then brought in my friend, Steve Witkoff who has extensive experience on super tall buildngs. The idea is to build something very unique – it would be the tallest building in the Western Hemisphere Two hotels, offices, an observation deck.

We are close to working out an agreement to house a civil rights museum. It would be a transformative project. The state and Governor Hochul are the decision makers and I anticipate that getting addressed this fall.

Daily Beat: Does this need to go through ULURP?

Don Peebles: No. Because it’s a state project, the governor could have a general plan and we’re planning for something that’s allowed within the current zoning. This should allow it to move forward expeditiously.

*The interview has been edited and condensed for clarity.

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Eric Samek, Founder of Brasa Capital Management, joined us on the heels of raising $450 million for the firm’s second non-core fund. We discussed current market volatility, Brasa’s strategy moving forward, and why deal syndication is so popular within the industry.

Daily Beat: Can you please share your background?

Eric Samek: ​​I founded Brasa Capital four years ago as a minority owned real estate investment manager. Prior to that, I had spent over a decade running the Western US for AEW’s Opportunity Fund.

Brasa’s Fund I had its first close in September of 2018. The first half was high net worth individuals and family offices. We were then introduced to GCM Grosvenor’s emerging manager program and they came in for a good chunk of Fund I. They invest on behalf of pension funds that don’t have the time and the resources to find an up and coming manager.

Daily Beat: What sectors and markets do you invest in?

Eric Samek: We’re geographic specialists and exclusively focus on the Western US and Texas.

Within those markets, we invest across all product types, so we’ve done everything from life science to self storage to medical office. Our investments over the past few years have predominantly fallen into the industrial and residential sectors.

Daily Beat: Those were good sectors to be focused on!

Eric Samek: Yes. We did 16 deals in our first fund and sold eight of those, which have generated nice returns to our investors.

We then went out to raise Fund II and had a first close in March 2021. The fund had a $300 million target and we had our final close last month at our hard cap of $450 million.

Daily Beat: Research shows that there’s arbitrage in the middle market and you’re able to find better deals because of that scalability issue. How do you define the middle market?

Eric Samek: We define the middle market as $5 to $35 million in equity checks. I agree with you that it’s much easier and scalable to write bigger checks. Interestingly, if you look back historically – even a decade ago – there were a number of firms that operated in the space that we’re in, but have now graduated with funds that are over $1 billion. That has left a void.

There are some studies that show that middle-market transactions are more efficient and the reason is simple. Many family offices and high net worth individuals cap out at a certain amount and then institutional funds won’t cut equity checks less than $50 to $100 million dollars.

This reality has left this inefficient gap in the middle. It takes the same amount of time to to cut a $25 million or $250 million check

Granted, the process demands more work, but we are grinding it out to the benefit of our investors and are proving that this method generates alpha.

Daily Beat: When it comes to fundraising, why do you think syndication is so popular in real estate? Why do investors choose specific deals over diversification?

Eric Samek: Real estate investors would much rather know what they’re buying. As an example, if you went to a New York investor and said that you’re buying an office building in Hudson Yards, they enjoy knowing the specific asset they are invested in over simply entering a blind pool fund.

That’s why there are a lot of syndicators because investors know exactly what asset they’re getting. From a sponsor standpoint, the benefit is that they’re not crossing their promote with the whole fund.

Syndicators’ economics are better than fund economics. Meaning, if a deal hits, they reap the rewards and if it doesn’t work out, it’s one deal and doesn’t take down the whole fund.

Daily Beat: I guess both approaches can serve investors well depending on the circumstances.

Eric Samek: I think it’s harder to raise money for a fund than a deal. People are entrusting you with their money for a long period of time and they don’t know what they’re buying, so it’s harder to get those investors.

Daily Beat: I’ve always found it ironic over the years that when you have a hot sector – take industrial / logistics as an example – the fundraising continues to pour in to chase deals after peak performance. Meaning, institutional investors and the pension funds want to get involved in the sector now, which likely will not offer the same growth rates over the next 10 years. How do you deal with having more capital to deploy in the sector at this point?

Eric Samek: I think exactly like you do. Investors pay us for the flexibility in our mandate to invest across the asset classes because it’s not always going to be logistics. That has certainly been the flavor for the past few years, but if you look forward five to ten years from now, it’s more likely than that that we’ll find interesting opportunities in different asset classes.

When I look back at different funds throughout my career, there are typically two sectors that dominated the early funds, but ones were rarely the same for more than two funds. Sometimes it was a medical office, self storage, or apartments, but it didn’t remain constant.

Daily Beat: For industrial specifically, what type of deals can still generate good returns?

Eric Samek: We don’t have the cost of capital to just go out and buy existing industrial assets. Our expertise is in either identifying ground-up development or finding value-add deals.

Daily Beat: So I assume that Brasa is an allocator and that you’re writing checks on some of these industrial development deals.

Eric Samek: We are the JV equity for a lot of ground up development for industrial because we can still get the spread with those deals.

Daily Beat: What type of returns are you targeting?

Eric Samek: We’re targeting 13 to 15% Net IRRs. If one is being intellectually honest, you can’t achieve that by buying existing industrial assets at current prices.

Daily Beat: How about multi-family? Are you seeing some existing properties that offer enough rent growth potential?

Eric Samek: Yes. Multi-family is more varied and are able to buy some existing assets, which tends to be on the smaller side or secondary high growth markets, not the gateway cities.

When it comes to development, we tend to build workforce, garden-style apartments on the outskirts of growing cities like Dallas, Phoenix, and Denver.

Daily Beat: Texas has been on fire. Are there any specific locations in Texas that you view as hidden gems?

Eric Samek: I grew up in Texas, so I know it pretty well. Most institutional investors in Texas are focused on the three big markets of Houston, Dallas, and Austin. Those are obviously markets that we’ve invested in.

To answer your question, though, we believe that San Antonio is a little bit of a sleeper and very interesting as well.

Daily Beat: Are you doing any debt deals?

Eric Samek: Yes. We buy non-performing loans or originate rescue capital in the form of mezzanine debt or preferred equity. The debt deals are done by ourselves without a sponsor.

Daily Beat: How has market volatility and rate hikes impacted deals that you’re currently working on?

Eric Samek: We’ve seen significant impacts in terms of pricing for assets that have long-term leases of 10 to 20 years – be it with a government or credit tenants where you only have 2 to 3% bumps. Those deals have taken hits because of what’s happened to rates and inflation expectations.

However, if you take an industrial building that we have on the market in the Inland Empire, valuations are only down slightly. The nice thing is that we don’t need to make the big macro bets because our fund size is small enough that we find interesting opportunities in good times and bad times.

Daily Beat: Office REITs aren’t doing well and many are trading near their March 2020 lows. Vornado stands as nearly two-thirds of its $6 billion in mortgages are floating rate. With the cost of caps skyrocketing, how are you protecting yourself?

Eric Samek: Historically, we have been more of a bridge borrower with a typical three year term, plus two, 1-year options. Now, we’re starting to look at more fixed rate options. Your point about the cost of caps skyrocketing is super on point and we’re seeing that every day.

Daily Beat: Who is getting impacted the most?

Eric Samek: A lot of the impact is dependent on how leveraged buyers are. One of the deals that we’re currency selling is going to an institutional all cash buyer, so as a result the pricing really isn’t impacted that much.

Syndicators can’t buy an apartment building at a three and a half cap anymore given the cost of debt, unless you think rents are going to go up to the point where you can achieve positive leverage.

Daily Beat: Has Blackstone’s BREIT changed the fundraising game?

Eric Samek: I think that trend of democratizing real estate investing for the mom and pop investors will continue. Before Blackstone’s BREIT and Starwood started doing it, the system was kind of flawed in terms of the fee structures where you invested a dollar and only put 85 cents to work.

That was a product that was sold, not bought. Blackstone, on the other hand, has structured this in a super smart way and I think it will continue attracting retail investors.

The institutional piece is still going to be a big part of it, but for them to have a whole new opportunity set of investors through these high net worth individuals is going to continue to grow.

Daily Beat: The irony is that Cadres and CrowdStreets of the world haven’t been able to capitalize it and here you have Blackstone demolishing them. It’s kind of amazing how it works out.

Eric Samek: Yes. Those guys probably raise more in a month than Cadre and CrowdStreet have raised since their inception.

*The interview has been edited and condensed for clarity.