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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.

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.

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.

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.

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 subscription here.

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.

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.

Matthew Pestronk, President & Co-Founder of Post Brothers, joined us to discuss office-to-residential conversions. On the heels of the firm’s $228 million acquisition of Universal North and South in Washington DC, Pestronk explains the key elements for a successful adaptive reuse project.

Daily Beat: What’s your background?

Matthew Pestronk: I started my career around 23 years ago as a commercial office leasing broker at the Colliers’ affiliate in Philadelphia and thenjoined Ackman-Ziff as a mortgage broker.

I then decided that I wanted to own commercial real estate. My brother Michael and I bought our first building in 2006. He leads construction, development, and management, while I focus on acquisitions, financing, and raising capital.

Daily Beat: Which markets are you focused on?

Matthew Pestronk: We primarily focus on the East Coast cities of Philadelphia and Washington DC. Our team develops major urban multi-family and mixed-use projects. We have 2 billion square feet of active projects right now, in addition to our stabilized cash flowing properties under management.

Daily Beat: I gather that you’ll be converting Universal North and South, a 659,459–SF near Dupont Circle in Washington DC, into apartments. How long have you been doing projects like this?

Matthew Pestronk: We’ve been doing office building conversions and adaptive reuse for as long as we’ve been around. Our team has probably done more of it than anyone on the East Coast.

As office buildings have become more difficult to lease after COVID, the opportunity set that presents itself is basically how we formed our business.

Daily Beat: Is Philadelphia conducive to these types of conversions?

Matthew Pestronk: Yes. As a Philadelphia-based company, there are a lot of old structures in the area and adap- tive reuse was the preferred development business for a long time. It’s hard to take a commercial building – where everything inside is obsolete – rip it out and convert it to multi-family.

The less light & air, the less space you have. There’s three subsets of challenges – floor plates, light & air, and location. The depth of the floor plate is the key.

Daily Beat: Does the size of the floor plate matter?

Matthew Pestronk: No. The width is much less relevant than depth. To illustrate, if there’s a hallway going into an apartment, when you enter the front, the nearest window can’t be 60 feet from you. The ideal depths are not really much more than 40 feet. When building ground-up, depths are less than 30 feet.

Daily Beat: What type of cost savings do you gain when doing a conversion over an adaptive reuse? Having the foundation in place and all of the concrete and steel should help.

Matthew Pestronk: Yes. If you execute well, there’s 10 to 20% savings in the hard costs. You should be able to save some time, but there might be complications with the structure in terms of making it into a shell to start improving. It’s also advantageous not to have exposure to price swings of concrete and steel.

Daily Beat: So the cost savings aren’t as high as some might assume.

Matthew Pestronk: Yes. Generally, the market is pretty efficient. Cost savings will not be much greater when you pencil everything out because there’s a greater inefficiency of the structure of the building.

What’s happened after COVID is that there are now buildings in better locations available for a good basis because the owners don’t know what to do with them. If not for COVID, this build- ing would have remained as an office building. It would have never been priced appropriately enough to support a multi-family conversion.

Apartment conversions in this real estate cycle have been confined to outlying locations where there’s not an established market for commercial office. Investors would take a vacant building and renovate it, with the hope that tenants will live in an emerging location.

Five years ago, you would never find something in DuPont Circle that would be ripe for conversion. There’d be no chance.

Daily Beat: When you’re looking at these conversion opportunities, what are the ideal floor plates that you’re looking for? Light & air is obviously also key.

Matthew Pestronk: When you build a ground-up apartment development, you can make the floor plates a perfect rectangle, but it’s rare that an office building will work as perfectly as a ground-up residential floor plate.

A conversion almost ends up resulting in a bigger unit than you do ground up and therefore you wind up near the basis. The biggest advantage of conversion is twofold. There might not be land in a given location and there is not a lot of pricing exposure to concrete and steel because the structure is already built.

Daily Beat: Are there zoning challenges with conversions?

Matthew Pestronk: No. Most cities, other than New York, have moved to allow any office building or a hotel to be converted into an apartment building. The opposite is not true. We don’t have a lot of zoning risk in the cities we operate in.

Daily Beat: So there are clearly tradeoffs.

Matthew Pestronk: If you have always built ground-up, dealing with the confines of conversion presents a challenge; however, If you start doing conversions and you go to ground-up, you question why you ever did a conversion.

Sometimes, you’ll have an elevator shaft that someone filled in 15 years ago that wasn’t on the plans and then suddenly you have a hole the size of an elevator in 30 floors that must be filled.

You still have to do pretty elaborate construction drawings and design the unit layouts with the building mechanical systems around what’s there. It’s not that hard, but it’s just different.

Daily Beat: I remember when Nathan Berman did one at 20 Broad Street in Manhattan’s Financial District.

Matthew Pestronk: Yes. He’s the only person who’s done more than us in the whole country in the last 20 years.

Daily Beat: When you got started in the business, you chose the conversion path. Do you view this as less speculative than ground-up?

Matthew Pestronk: It’s all speculative. We started this way because over 20 years ago, buildings were inexpensive relative to their replacement cost by a large margin and rents weren’t particularly high.

Rents could not support new construction in many markets and there was not a lot of ground up apartment development. Fast forward to today, your basis is fairly comparable for either a conversion in a prime location or ground-up.

That used to not be the case. Ground-up costs were higher on a total basis because residential rents were low and buildings were relatively cheap to buy on a per foot basis.

Now, we’re at an inflection point where the market’s never seen. People see conversion potential and might be fine with the same basis as a ground-up project because they have less exposure to commodity prices and it might go faster.

Daily Beat: Are there any other factors to bear in mind when doing a conversion?

Matthew Pestronk: The office building needs a path to vacancy. Tenants can’t just abandon their lease obligations and move out of their office buildings. When leases start rolling over, opportunities will continue to increase.

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

Matthew Pestronk: No. We invest our own capital and have private investors that are typically high-net-worth individuals and family offices. The company doesn’t raise funds for discretionary investment.

*The interview has been edited and condensed for clarity.

Tommy Craig, Senior Managing Director at Hines, joined us to discuss his background and how the company has evolved over the years. We delved into what Amazon’s pullback means for the industrial market and why he’s so excited about 555 Greenwich.

Daily Beat: Can you please share with our readership your background and how long you’ve been at Hines?

Tommy Craig: I joined Hines in 1982 directly out of Columbia. At the time, we were a small firm and sole proprietorship. It was called Gerald D. Hines Interest.

We really focused on iconic urban office buildings. Gerry Hines got a well earned reputation as introducing high-end architecture to corporate America. If you fast forward 40 years, our firm now has grown from 300 people to 5,000 people

I’ve led the New York office since 1996 and I’m currently co-running it with my colleague Jason Alderman. I also now lead our Boston office, which has led to both expanded and contracted responsibility.

Daily Beat: What does the AUM look like today?

Tommy Craig: We have $80 billion of assets under management as a fiduciary and another $80 billion for third party work. Hines is active across all geographies around the world and all sectors, including office, various forms of living, and industrial.

In fact, if you look at our investment committee where they’re allocating money, our primary sources of growth have been more in the living and the industrial sectors than office. This comes as no surprise given COVID.

We are as active these days as an investment manager as we are a developer. My generation at Hines would say that our secret sauce is that we’re a vertically integrated real estate company. We’re not a financial institution that allocates money to operators nor are we an operator focused on a single sector like Prologis would be.

Daily Beat: I gather that fundraising numbers have been very strong recently.

Tommy Craig: Yes. It’s unusual when you combine our access to capital and our development expertise. We’re raising about three times the amount of capital today than we were before COVID.

Capital can be deployed across every sector in every geography and we’ve been successful in finding alpha return and beta to manage risk. It took 65 years to get a business model scaled to a global footprint and it’s exciting to be a part of it.

The basic business model of the firm is very different than I believe any of our peers. Hines is private, but what makes the compay unusual is that 50% of every Hines project is owned by employee partners. We own our work in capital accounts and are therefore fully aligned with the Hines family. This helps foster a culture of managing risk and pursuing opportunity.

The firm allows its local partners to have a lot of autonomy because Gerry Hines understood that real estate is fundamentally a local business. Our service platform and obviously the global capital we raise is shared.

Daily Beat: And I gather that this helped with the recent NPS deals with SL Green?

Tommy Craig: Yes. Hines’ relationship with NPS led them into One Vanderbilt and One Madison. We also have a fund with NPS called the Atlas Fund.

In a place like New York, being a global firm with access to global capital for vertical devel- opment, it gives us a really competitive advantage. Some of that capital wants to be in New York, but they want somebody who is a like minded thinker and thinks more in global terms rather than purely local terms.

Daily Beat: So it sounds like you can essentially be asset agnostic?

Tommy Craig: Yes. Our CIO David Steinbach likes to say that we have now arrived at the point where we can be agnostic as to use-type. It’s our job to find the highest and best use in any given real estate equation.

Daily Beat: Amazon said that they’re halting new leases and expansions in terms of acquisitions and leasing. A CBRE report recently found that rents for large warehouses rose 16% last year as vacancy rates plunged. What happens when the biggest player pulls back?

Tommy Craig: I think because they’re the biggest player they are setting marginal prices. I’m not going to claim to be an industrial expert, but we’re actually starting our first logistics project in Northeast Pennsylvania’s Hazleton. All that’s happening now is that Amazon announced they have enough space capacity for others.

I’ve seen four major cycle changes in my life – 1991, 2001, 2008, 2020. Often what happens is that projects that have been planned that are marginal are either canceled or postponed. Product that is dated are often abandoned for better properties. Fortunately, we don’t have any old industrial buildings. Investors have been underwriting a uniformly rosy picture and it’s not uncommon for the capital markets to get out in front of the fundamentals, so there will probably be a natural rebalancing.

Daily Beat: They were leasing a staggering amount of space.

Tommy Craig: It’s actually a good thing when something like this happens. It helps take the speculative fever out of the market and allows a more natural equilibrium and I suspect that’s what’s been happening since they released their earnings report.

Daily Beat: There are many speculative, industrial developments out there.

Tommy Craig: This favors a firm like Hines that has the capital capacity. It’s not like our margin of safety for our project is a dollar or a day. When this happens, it’s the guys that don’t have the strength that falter. The thing you learn in real estate over decades is you need timing, location, and long term hold structures to carry you through this kind of volatility.

We have some really favorable capital. Hines has been very careful. We’re not highly leveraged and don’t always rely on a lot of debt.

There are a lot of guys out there that have been playing the debt markets to their favor the last couple years, but we don’t partake in that.

Daily Beat: That puts you in a strong position now.

Tommy Craig: Yes. Our New York office does not have a single loan that’s maturing in the next two years. This is a time where there are other guys that have a major loan maturing and a lease expiring. That’s where the pressure is going to be. If you’re under capitalized, you will be subject to pricing squeezes.

Daily Beat: Hudson Square Properties officially topped out 555 Greenwich in April. Can you please describe the genesis of the project?

Tommy Craig: The paternity of 555 Greenwich is unusual and is probably the most innovative project we’ve ever done. I’ve been the principal on this project since we conceived of it in 2018. It’s the byproduct of a venture we formed in 2016 with Norges and Trinity. Hines was selected as the operating member of the partnership between those two entities.

After Hurricane Sandy, Trinity Church realized that they had 100% of their financial assets specific to one asset class in one neighborhood and were susceptible to flooding. Their legacy real estate goes back 300 years to a grant they got from Queen Anne.

They were very intentional about a strategy to diversify on behalf of the church as custodian of those funds and they brought in Norges after they submitted a non-conforming bid to acquire a 49% interest in an 11 building portfolio at a valuation of $3.5 billion.

Norges insisted that if they were going to come in with that much capital, the church was no longer going to operate its own real estate and retain a real estate company to do that. Hines was selected in 2016 to be that company.

We came into the partnership and put a very substantial amount of money to acquire a 1% interest. Today, this portfolio consists of 6 million SF, and is valued above $5 billion and will approach $6 billion when we finish this building.

Asides from the appraised value of the underlying real estate having gone up, we also acquired 375 Hudson for $650 million right across the street. It was always the intent of the partners to try to create a living organism through our work and not just limit ourselves to the 11 buildings.

Daily Beat: What else would you like to share about the project?

Tommy Craig: The building was designed with leading-edge clean energy technology and the most advanced building systems available to create a healthy environment for tenants and minimize the environmental impact.

Rick Cook of COOKFOX Architects did an amazing job. He was one of the founders of Terrapin Bright Green and his commitment to sustainable design goes way beyond this project.

Daily Beat: The setbacks in those images are very creative.

Tommy Craig: Yes. The façade will feature numerous setbacks with outdoor terraces and floor-to-ceiling windows. The building connects seamlessly to the adjacent 345 Hudson Street on nearly every floor, providing users with large floor plates and no obstructions.

The building will feature state-of-the-art mechanical, engineering and plumbing systems, including geothermal piles, and is the first new office building to utilize its concrete superstructure for thermal energy storage. All of this will create an expected 46% overall carbon reduction and a 29% reduction in electrical consumption.

We collaborated with global sustainability design experts. Jaros, Baum and Bolles is providing MEP services. Additionally, the project represents the first office building to utilize a thermally activated slab with a radiant activated system which reduces carbon emissions by 50% while eliminating any fossil fuels utilized for heating and cooling. It will also em- ploy a DOAS system to maximize the quantity and quality of fresh air to the workplace, which will be supplemented by geothermal wells and more than 10,000 square feet of outdoor space.

We’re very excited about the project and believe it’s well positioned to succeed in this unique office environment.

*The interview has been edited and condensed for clarity.

Aaron Jungreis, Founder and CEO of Rosewood Realty Group, joined us for an interview. We discussed the firm’s national expansion, New York’s 2019 rent laws, and why he’s so bullish on the multi-family sector.

Daily Beat: How have the 2019 rent laws influenced Rosewood’s strategy?

Aaron Jungreis: The rent laws were a blessing in disguise. It forced me to start selling other types of properties and expand multi-family deals to other states. The geographic constraints are no longer a barrier, especially with remote working, improved data, and technology. The amount of information and research available now is incredible.

I have some buyers who acquire properties they never visited. They’ll have one of their acquisitions guys or a trusted advisor go see it.

The severely unconstitutional legislator has led investors to bring their businesses elsewhere. Most investors are still physically in New York, but the exit capital has to be in the multiple billions.

Many New York investors are taking their capital gains and spending it in Texas and in Florida. That helps those economies by creating more jobs and hurts us here. I think it’s very misguided. The local politicians don’t realize what New York is all about.

Daily Beat: When it comes to New York, you’ve historically done a lot of off market deals. How has this translated to other states? Are buyers putting down hard contracts?

Aaron Jungreis: The off market process is definitely taking hold in these states. There are also many deals being done with hard money. Sellers are really attracted to an efficient and swift, four-week process. Other firms take three months planning the market strategy, three months marketing, and then three months signing.

Sellers love the fact that I’ll have a signed hard contract in three weeks. I think it’s the biggest reason why we’re selling so much property out of town. We’re offering them an off market process where they get the same price that they think they’re going to get anyway, but we just do it quietly. The tenants don’t have to know that it’s for sale.

We don’t need more than one or two showings to get a deal done. Our group does a very targeted marketing process. There will always be sellers who want to see a full process with 10,000 emails, 500 Confi’s signed, 40 inspections and 22 offers, but off-market deals are really taking hold in other markets too.

Daily Beat: In an ascending market – especially what we’re seeing nationally on the multi-family side – the off-market approach works very well because people don’t realize how much their properties are worth. What are you seeing in the New York rent-stabilized market?

Aaron Jungreis: In New York, we’re definitely seeing an uptick in activity, but buyers are concerned with potential good cause eviction legislation and looming interest rate hikes. Rent stabilized rents are essentially frozen. The 1% to 2% increase from the Rent Guidelines Board (RGB) will get canceled out with increased expenses. As rates go up, you can lose money on the stabilized assets.

On the free market side, properties are trading at low cap rates because everyone sees rents flying up, which allows them to be more aggressive on the pricing.

Daily Beat: Investors are buying rent-stabilized deals for cashflow now, so there’s this interesting dynamic where you have free-market deals in Florida and Texas trading at sub three caps and then regulated deals in New York trading closer to five gaps.

Aaron Jungreis: Yes. Buyers tend to feel more comfortable when they can use their entrepreneurial creativity to increase rents. The rent stabilized market shut that element down, but you still have the panache of Manhattan and the boroughs. New York is still a vibrant culture in a great city, but the rent laws have made buyers more skittish about the market.

We see some of our clients buy a couple of the stabilized deals or then buy free-market opportunities out of town. Our team has been very busy in Texas, Georgia, and the Carolinas. We’ve also done deals in Kentucky, Indiana, Ohio, and Arkansas this year.

On the flip side, the New York market presents a real opportunity because local buyers are focused elsewhere. There are a lot of new, young players who are buying and adjusting to the reality of this market and are very creative.

Daily Beat: To your point, there’s not much creativity you could really employ.

Aaron Jungreis: You could still do the “Frankenstein” and combine two vacant units, but that’s likely to be deemed illegal too. Other buyers are focused on doing upscale renovations of the free market units, replacing the retail tenants, and generating antenna rent, but this is spitballs against the battleship when you think about it. Some people are hoping that the RGB gives you a 2.5% to 3% increase in June, but the current environment definitely removes the more creative buyer from the market.

Daily Beat: The value add piece has been removed.

Aaron Jungreis: These same deals that used to attract 40 to 50 buyers are now only seeing seven or eight people vying for it. The feeding frenzy and velocity no longer exists.

Daily Beat: Outside of New York, do you think rental growth rates can keep up with looming rate hikes?

Aaron Jungreis: Everyone wants to be in red states and the sunbelt. Clients tell me “Red or Sunny.” The reality is that you can’t only buy in the red states, so we’re seeing people buy in Pennsylvania and Connecticut. It’s important to note that I’m just in the middle and am selling merchandise, so wherever people want to buy, I’ll try to find it for them.

Daily Beat: Are you doing any SFR deals or build-to-rent?

Aaron Jungreis: Yes, we’re starting to get involved in build-to-rent, as we are selling a handful of development sites in Florida. We’ve been more focused on industrial though.

We’re also getting close to a few deals in Arizona, but it’s harder as you go further west because of the travel, which is impossible to do in one day if you want to visit the property. Florida and the Carolinas are so easy.

Daily Beat: Have you seen the success or lack thereof of cold calling change in recent years?

Aaron Jungreis: No. It’s still very successful because a lot of people like that personal touch. I find that owners want to pick up when it’s someone in their field and especially when we could be offering them a deal.

I always tell my brokers that as long as when you call someone, you’re not just trying to persuade them to sell a property, it’s very effective. Offering them a property for sale is a very effective good strategy. There are definitely a lot of cold calls that go on unreturned, but when you’ve done the research and know the market rents, cap rates, and recent sales, property owners really like it.

Daily Beat: Suddenly, the call is not so cold.

Aaron Jungreis: Exactly. I just did that with a seller on a deal I brokered in Florida. The neighboring owner was very surprised at the price we were able to achieve and we then sold his too.

Daily Beat: What’s the best way for a broker to advertise? Traditional advertising doesn’t seem to help individual agents too much.

Aaron Jungreis: Closing deals is the best form of advertising. When it gets done, the buyer and seller are going to talk about you to everyone. Both attorneys will spread the word if you do a good job. There are many influential people who witnessed your talents as a broker. To me, that’s what breeds the next deals. Referrals on the referrals.

Daily Beat: If you were investing in any sector or market, where would you be putting your money?

Aaron Jungreis: Multi-family. Even in an overpriced market, there’s always a deal. Rents will continue to increase. The home is the last place of refuge. From ordering online to working, you can do everything from your house.

Out of your home, there’s no other place where you can have all those basic human needs fulfilled. Multi-family is always going to be the best investment long term. I obviously like industrial and self storage too, but multi-family is best.

Daily Beat: If you had to own one REIT for the next 10 years, which one would you be most inclined to pick?

Aaron Jungreis: Anything Blackstone.

Daily Beat: What are you watching these days?

Aaron Jungreis: Cobra Kai.

Daily Beat: Thanks for joining us.

Aaron Jungreis: I love the publication. Keep up the great work.

*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.

David Schwartz, CEO & Chairman of Waterton joined us for an interview. We discussed the multi-family sector, how to reduce interest rate risk, and the attractive demographics in the SFR space.

Daily Beat: Waterton recently closed on its acquisition of Verona at Boynton Beach, a 216-unit rental in Paul Beach County, FL, from Robbins Property Associates for $80 million. Can you please discuss what you’re seeing in that market?

David Schwartz: Thematically we are very interested in acquiring more properties in Southeast Florida. The market has great fundamentals – it’s undersupplied and is benefiting from huge migration from Northern States. 

We’ve had difficulty buying there, but continue to look for attractive deals. A newer strategy for us has been partnering with local developers because in many cases it costs less to build than to buy today.

Daily Beat: The seller paid $43 million for the asset in 2018, a rapid $37 million appreciation. Cap rates are in the low 3’s. What’s the play here?

David Schwartz: A classic value-add deal. Verona at Boynton Beach is an early 2000 vintage property where we will be renovating the apartments, common areas, and amenities. Not much has been done to the property since it was built. There’s significant natural market rent growth there too. 

Southeast Florida in general had some of the highest rent growth rates in 2021 and is projected to continue on that track. This is a well-located asset where we can create value and generate returns. 

The cap rates are low across the nation and can average in the low three cap range. We like markets with strong rent growth and assets where we can create value. This Verona asset had those attributes. 

Daily Beat: The entire Sunbelt has benefited.

David Schwartz: Yes. The appreciation is staggering. If you look at the Sunbelt in general, there’s been significant appreciation. Markets like Phoenix, Las Vegas, and Atlanta have also been the beneficiaries. The reality is that asset appreciation in the multi-family sector has been a common theme across the nation. 

Last year was the highest rate of rent growth and there are real supply constraints in the market.  This reality comes from under-building housing in general for well more than a decade. 

Coming out of a great financial crisis, the housing industry as a whole was shell shocked and did not build enough. We’ve been talking about this notion for years, but it’s finally playing out. This shortage of housing will get exacerbated with higher interest rates. 

Daily Beat: With interest rates on the rise, will rental growth be strong enough in these multi-family markets? Are you concerned that this lending environment has gotten too aggressive?

David Schwartz: It’s a double edged sword because the interest rate environment is going to make it that much harder to buy. The rate hikes will pull buyers out of the market and make them renters. It’s going to increase one’s cost of capital and cap stack, which is going to have an impact on further appreciation. 

Depending on the market, it could cause valuations to go down. I think we’re starting to see that slightly. Anecdotally, as an active seller, we see fewer groups in the best and final rounds. 

Some of that froth that we had been seeing the past quarter or two simmer down a bit. It could cause values to flatten for a period of time. In some cases, I think you might see some pricing down from where it might have been a month or two ago, with the caveat that values were going up so much in Q4. 

Daily Beat: The frenzy had to settle down a bit.

David Schwartz: A lot of appreciation from the past two quarters may be given back because of an increase in the cost of capital. Cap rates are low and interest rates are going up pretty significantly. 

Most investors have negative leverage going in, but it’ll turn positive quickly because rents are going up so much. In the short term, you could have low cash-on-cash returns until the rent growth kicks in and it should turn positive. 

Daily Beat: As long your leverage is in check and rent growth continues based on the limited housing supply in this country, multi-family should be able to weather different maro-econimic environments. 

David Schwartz: We’re definitely concerned about rising interest rates and are fixing rates or swapping them to eliminate interest rate risk. Even though that’s available, when you’re fixing rates now, they’re up from where they were a month or six weeks ago before the war.  That definitely impacts how you price things.

Daily Beat: After acquiring a property, where do you ultimately find the most success in juicing the rent roll based on the Capex you put in?

David Schwartz: Our focus is on the value-add piece. We create value by upgrading kitchens, bathrooms, high impact areas, and amenities. The second piece is bringing our management team and what we call Resitality – the high level of customer service and technology at our properties. The resident experience not only results in higher rent, but we have higher retention rates and have satisfied residents when rent goes up. This helps lower your turnover, marketing, and leasing costs. This approach helps create a lot of value. 

Daily Beat: I know you’ve been in Florida and Texas since the mid 1990s. Can you speak to what you’re seeing in Dallas, Austin, and Houston? 

David Schwartz: We’ve been in Southeast Florida and Texas since the mid nineties. Regarding Texas, we are primarily focused on Dallas, Austin, and Houston. These have always been commodity markets with no supply constraints. You’ve always had more supply than demand. 

In our history of investing in Dallas, we’ve never had rent spikes and generally had some level of concessions – it was always a competitive market. In this cycle, it’s behaving more like the Bay Area. 

For-sale housing has gone up tremendously and it’s difficult for that to compete with rental housing because it’s getting expensive. Currently, you have more demand than supply and developers are having trouble keeping up, but trust me they will eventually catch up. They always do. 

The other issue with the supply of multi-family is that the replacement cost has skyrocketed. In the past year, Dallas multi-family costs are up approximately 50% because it’s more difficult for developers to create supply. If you couple that with the demand and migration patterns like we discussed in South Florida. We continue to see lots of household formations in Texas, so it’s been an exceptional market. Dallas has had the highest rent growth since we’ve tracked it. Austin has also been an extremely strong market. 

Houston, which has always been overbuilt, has been a late comer to the recovery, but it’s strong too. The market is not as good as Dallas and Austin, but it’s a solid market that’s primed to benefit from some of the energy issues globally. Higher oil and gas prices are generally good for the Houston market and the hiring of energy companies and great demand. Texas has been a terrific performing market. 

Daily Beat: You’ve also been active in Georgia and North Carolina.

David Schwartz: Yes. The whole Sunbelt has been very strong. 

Daily Beat: When it comes to the national multi-family market, have you seen any changes in the past couple years insofar as the transaction process is concerned? 

David Schwartz: There are more buyers, investors, and sponsors in the multi-family space because of all the real estate asset types, multi-family and industrial are the best performing ones and capital has migrated to those sectors.

Capital that was previously invested in office and retail is now shifting to multi-family and industrial. We’ve also seen many sponsors who in the past will only buy office buildings and now acquire multi-family properties. It’s a much more competitive asset class for good reason. 

The assets are very liquid and transactions happen very easily and quickly. Capital flows are so strong. Out of all the real estate asset classes, multi-family is the most liquid.  You sign a contract and people close. In the past six months, it’s been so aggressive that you’ve seen buyers put up a non-refundable deposit at contract. It has started backing off due to the war and inflation news, which has chilled the debt markets. 

Daily Beat: Can you please discuss what you’re seeing in the debt market?

David Schwartz: CMBS was a big player in the past year and has not been as aggressive recently. Fannie and Freddie have been very active in refinancing, but have not been an active player in acquisition financing. The insurance companies are picky, so you have a lot of bridge debt available. 

These debt funds are active, but they float over SOFR and their spreads are up because their senior debt costs have increased. The SOFR curve is super steep, so that’s expensive debt and comes along with floating rate risk. Then you have bank financing. This has all happened in the past month after the war started and has taken the froth out of the market. You’re seeing less of that hard money because there’s definitely financing execution risk.

We were looking at some debt funds recently. When you look at the SOFR curve and add their spread, the rate on recent deals that we’ve looked at would be 5%, and that’s just not interesting to us. 

Daily Beat: What you’re getting from the more traditional banks of course is much stronger than that. 

David Schwartz: Yes, it’s more attractive. Much lower spreads and you can effectively fix it with swapping.

Daily Beat: Favorite REIT?

David Schwartz: I don’t invest in apartment REITs because I invest in apartments and it’s fairly correlated, but I’m happy to discuss a few REITs that I think are very strong. 

Most of the apartment REIT CEOs are friends of mine, so I hate to pick one of them. The coastal ones like EQR and Avalon Bay are now very focused diversifying their portfolios in the Sunbelt, while maintaining their presence in the gateway cities – New York, LA, San Francisco, and Seattle. They are becoming much more diversified and will look more like Camden and Mid America, which have much less gateway and coastal presence. 

David Schwartz: They’ve all migrated to the same markets and are going to be great 10-year holds because housing in general will be so strong for the next decade.

Daily Beat: I know you recently announced a partnership with Second Avenue in the single family rental (SFR) space. What are your thoughts on those REITs?

David Schwartz:  We really like the SFR space.  Owning an SFR REIT like Invitation Homes is a really good bet too because the fundamentals of the SFR industry are strong and might even have an edge above multi-family because of the demographics. There are many millennials who need to move into a house that has the bedrooms, space, and outdoor yards for families. 

The SFR industry can create a reasonably affordable way to have a single family rental lifestyle that’s going to be hard to achieve for typical households in this interest rate environment. The SFR is the right business at the right time and I think those would be good, long-term holds.

*The interview has been edited and condensed for clarity.