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

Daily Beat: Can you please share your background?

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

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

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

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

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

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

Daily Beat: What were your next steps?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Daily Beat: What’s your role at Wexford?

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

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

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

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

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

Matija Pecotic: I plan on playing 25 this year.

Daily Beat: How are you managing your schedule?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Daily Baat: How many people work in the firm?

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

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

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

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

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

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

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

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

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

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

*The interview has been edited and condensed for clarity.

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

Daily Beat: Can you please share your background?

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

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

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

Daily Beat: What’s the strategy?

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

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

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

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

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

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

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

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

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

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

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

Daily Beat: Why do you choose this approach?

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

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

Daily Beat: Do you leverage the book at all?

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

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

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

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

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

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

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

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

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

The return is higher for the less risky position.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Stephen Quazzo: Mezz is our preference.

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

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

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

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

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

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

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

*The interview has been edited and condensed for clarity.

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

Daily Beat: Can you please share your background?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

*The interview has been edited and condensed for clarity.

Seth Weissman, Founder & President of Urban Standard Capital (USC), joined us for an interview. We spoke about the alternative lending space, the harsh reality of the New York City condo market, and his entrepreneurial journey.   

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

Seth Weissman: I started my career as an analyst at Goldman Sachs and then joined Perry Capital in their real estate private equity group. During my time there, I focused on multi-family and hospitality investing, in addition to bridge lending. 

Perry Capital was strictly a capital provider and was not involved in operations and development. I was very much drawn to what our sponsors were coming to the table with in terms of identifying a business plan and executing on it. 

I always wanted to do something entrepreneurial, so I put together a list of every person I knew that could write a $25,000 or $50,000 check and did a syndication. We were focused on a value-add strategy and acquiring well located properties. One area we honed in on was West Chelsea, which was still before the High Line opened. 

I was fortunate to have success in those initial investments and was able to raise a small fund of over $10 million. We then bought another 10 buildings. I subsequently raised another $30 million. 

Daily Beat: And this was all on the equity side? 

Seth Weissman: Yes. In 2015-2016, it became harder to find equity investments that were compelling. One of the ways we like to think about both equity and debt deals is through the lens of assessing probability of different outcomes. We utilize scenario analysis to analyze risk adjusted returns. 

From 2008 to 2012, deals made a lot of sense. You could buy a real five cap in Chelsea with upside and take on financing that was accretive to the investment. It started to get to a point where we were seeing fake four caps in Bed-Stuy and Crown Heights. 

When someone buys a property at a fake four cap and you start applying real expenses and reserves, you’re drowning out of the gate. That’s not an investment dynamic that I thought was sustainable or something that we wanted to pursue. 

Daily Beat: Those are tough deals!

Seth Weissman: We decided to continue pursuing those equity opportunities as they arose, but I felt it was a hard business to scale. The attractive deals are situational – a bankruptcy sale, foreclosure, or a seller who needs to close really quickly. Those are one off opportunities and it’s hard to deploy significant amounts of equity capital with that strategy. 

Daily Beat: Got it. So that led you to the lending space? 

Seth Weissman: Yes. We realized that we can leverage our experience to generate premium returns for our investors in a post Dodd Frank environment. 

We speak the same language as our borrowers, which allows us to be more thoughtful and creative about how to structure deals and help them achieve their business plans. Traditional banks are hamstrung by regulations or if there’s simply an underwriter who doesn’t want to take risk and lose his job. There’s a significant spread between real risk and perceived risk. 

Daily Beat: This is the vacuum the alternative lenders have filled.

Seth Weissman: Absolutely. A good example is a bank might flag a potential loan about a sidewalk lien from 1978 or an HPD violation from 1996 that no longer even exists! The banks get really caught up in minute details.As an owner / operator, it’s a challenge to find them to be reliable banking partners. 

In the first year, we did around $20 million in loans and then we did $40 million the next year. 

Daily Beat: What’s the size of your average loan?

Seth Weissman: We focus on the middle market space and our typical loan is roughly $5 to $10 million. Our volume last year was a little over $200 million and we will do around $300 million this year. 

Daily Beat: After you lend, are you in the business of selling tranches of the debt? 

Seth Weissman: We maintain our loans pretty much universally on our books and service all of them. The reason we operate this way is because the borrower relationship is very important to us. If there are any modifications or changes that need to be made in the business plan, it’s important that we have that direct relationship with that sponsor.

A lot of sponsors get frustrated when they make a loan and their lender is ultimately not who they thought. We are also dealing with transitional, bridge, and construction loans that typically are 18 to 24 months. These are not traditional cash flowing multi-family assets. Our sponsors are using the financing to get there.

Everyone has their pro forma in their Excel, but I can guarantee that the actual results are not going to match the Excel results. 

Daily Beat: How aggressive is USC in leveraging your book? 

Seth Weissman: We have internal guidelines to set leverage rates that are based on the underlying product type. If it’s a ground up construction project, we will take lower leverage than if it’s a partially cash flowing building. 

Generally, we target one-to-one leverage on a blended basis. We don’t chase yield by maximizing leverage because this can lead to a lot of trouble. Some alternative lenders might have a 75% leverage across their book, but we’re much more conservative on that number. 

We look at it based on the underlying asset profile, so that as a portfolio we are balanced.  Any individual loan is a small percent and typically will not exceed 5% of our overall loan book. 

Daily Beat: Where are you doing most of your business? 

Seth Weissman: We lend in New Jersey, New York, Connecticut,, Pennsylvania,, Texas, and Florida, but roughly 50% to 60% of our book is in the Tri-State area. 

For a New York City focused lender, we are mindful of the geographic risk and concentration.   We mitigate that by knowing these markets inside and out. Some of our peers have gone into new markets for the sake of diversification. USC would rather be concentrated in a market that we know very well. 

Daily Beat: Insofar as fundraising is concerned, do you maintain an open-ended fund or is it closed?

Seth Weissman: We have different buckets of capital. The first is core plus capital for lower risk, lower yielding projects that have no leverage – that’s open ended. 

The second is a closed-end, value-add bucket, which is primarily family office, foundations and high net worth individuals. That has a higher yield target, but in our deal origination funnel, we see opportunities for both. 

Daily Beat: Our research team noticed that you’re doing a lot of single family housing deals in the Hamptons? 

Seth Weissman: I think we’re the largest private spec lender in the Hamptons. That’s a market we have always really liked and have successfully grown our business there. We’ve identified the hundred builders in the Hamptons who own 90% of the new construction and we reach out and build relationships. It’s a lot of breakfast, coffee, lunch, and dinner. 

We also do a lot of high-end single family lending in Miami, South Florida, and the Palm Beach market. 

Daily Beat: What percentage of your deals would you say are direct versus ones that come through brokerage firms?

Seth Weissman: About 50% to 60% of our deals are direct. It’s a lot of repeat deals. We bet on the horse and the jockey. The jockey’s super important and we spend a lot of time investing in potential relationships. 

Daily Beat: These are residential deals when they’re building on spec and there’s no future cash flow, so the localized knowledge is key. 

Seth Weissman: Yes, absolutely. 

Daily Beat: Thoughts on the condo market in New York City?

Seth Weissman: I have not seen any developer who started a project after 2016 doing well. Very few, if any, are making any money. The recent recovery in the condo markets has minimized the pain, but we’ve consistently seen either complete equity wipeouts or significant impairments. The winners who are breaking even are getting back 50 to 75 cents on the dollar. Everyone’s project took longer and cost more to build.

Development projects are a speculative and cyclical business. If you get caught on something that typically takes you three to four years to build and it gets delayed a year or two on top of that because of a global pandemic, it’s hard to figure out a path to profitability within that formula. That’s before layering on inflation and supply chain issues. 

Many condo projects that appear to be successful in the headlines are blood baths behind the scenes. Some are hitting sales numbers way above what their schedule A, but the cost of construction was double and it took them twice as long as anticipated, so they’re still losing money. 

Daily Beat: This coupled with the political environment has probably pushed some of the developers to other markets. 

Seth Weissman: Agreed. There’s a frustration with the cost of doing business in New York City and all of the administrative bureaucracy. Being a developer in New York is waking up and getting punched in the face every day. There’s a general fatigue for that.

Daily Beat: What are the average rates you’re seeing on condo inventory loans?

Seth Weissman: The market is pretty tight. I would say it’s between low sixes up to 9.5%. You don’t really see north of that range unless there’s a significant underlying problem tied to the proceeds.

If you’re lending $1,600 to $1,700 a foot on a development that’s selling for $2,000 per SF, that’s obviously a very high loan-to-value; however, most condo inventory loans range from $1,000 to $1,200 a foot in Manhattan. 

Daily Beat: When underwriting a luxury condo deal, how much have hard costs gone up on per SF basis?

Seth Weissman: Hard costs are going to be $600 to $700 a foot. Most developers are trying to hit a 2x multiple in three to four years, so if you are projecting to sell for a blended $2,000 a foot, you can’t pay more than $200 to $300 for the land. 

Daily Beat: The 570 Washington deal is a good example of how the land market is still very strong. How would you compare the total development costs to before the pandemic?

Seth Weissman: Prior to COVID, the total development cost would be roughly $1,500 to $1,600 per SF and the blended sellout would be $2,200 to $2,300. Now, the blended sellout might have stayed the same, but the cost basis has crept up to $2,000. If you’re selling at $2,300 per SF, less commissions, transfer taxes, you’re right at that break even number. 

Daily Beat: When we talk to developers and ask about construction costs and they say that everything’s locked in at predetermined rates, it’s hard for me to believe that the costs actually stay the same. 

Seth Weissman. You are correct. It only works to the extent that your counterparty has the credit and financials to support it. On the equity side of our business, we had a small project where we could have held them legally to that number, but we would’ve put our subcontractor out of business and then who really cares what the contract says. Developers are coming back to the table and recutting it. 

Daily Beat: In a hot market, the lending space clearly affords great opportunity. 

Seth Weissman: Yes. It’s clearly been the right decision to really be focused on the lending side because alternative lenders make money on those condo projects and the equity does not. 

There is an attractiveness to investing on the equity side of development, but there’s not enough attention paid to the downside risk. 

Daily Beat: The same thing is true with hotels.

Seth Weissman: Yes. Restaurants and theaters too.

*The interview has been edited and condensed for clarity.

James (Jim) Simmons III, CEO & Managing Partner at Asland Capital Partners, joined us for an interview. We discussed his background, the mechanics of credit enhancement, and suggestions for how to increase affordable housing in the country.

Daily Beat: Can you share some of your background on how you got into affordable housing?

Jim Simmons: My mother likes to say that I’ve had three careers and that’s if you subtract out my academic career. I have two masters and spent a lot of time in school. I started off in engineering first and worked on Wall Street second. I was then involved in public policy at the Upper Manhattan Empowerment Zone, which led me to join the world of real estate.

I recognized that it’s really difficult to effectuate positive change on a community unless you control or can influence the real estate. When I looked at Harlem, Washington Heights, and Inwood between the 1960s and 1970s, I realized that the depopulation and disinvestment were mostly decisions made by individuals.

Similarly, by investing in assets and goods and services, you can rapidly change a neighborhood into a place where people do want to live and stay. These development decisions are generally speaking made by individuals, not institutions. The United States’ capitalistic society results in real estate being in the hands of individuals.

By positive change, I am not talking about the removal of pre-existing individuals, but what I mean is giving them high quality living existences just like anybody else has within the city. If someone who lives on the Upper West Side can expect to have a gym or a door person in their building, someone who lives in the Bronx should be able to expect those things too.

You just have to fashion ways to do it economically such that returns can be made or garnered and be acceptable to the investor base. They don’t have to be 20 plus IRR transactions, but they also can’t lose money.

As we’ve done these public private partnerships, we find the compromise between investment returns and the benefit. I am a firm believer that there’s a middle ground where you can generate acceptable returns, while also providing a benefit to the communities and individuals who live there both historically and prospectively.

Daily Beat: Asland Capital and Pembroke Residential recently landed a $100 million financing package to build a 154-unit project affordable senior housing development in the Bronx. Goldman Sachs’ Urban Investment Group provided a $67 million letter of credit for the development to credit-enhance the construction loan. Can you please speak to the origins of the project?

Jim Simmons: The building was previously a Mitchell Lama building and the project is a product of a ULURP that was approved in 2018.

There’s a critical shortage of affordable housing. The New York City Department of Housing Preservation and Development (HPD) has identified various programs to reduce the high costs associated with building affordable housing. High cost markets like New York are particularly difficult because you are subject to wage rules like Davis-Bacon.

Most of the Mitchell Lama vintage buildings have extra space surrounding the property. As everyone tries to look at where the next generation of affordable housing production will come from, developers are looking at existing assets and finding ways to use the underutilized part of the property. In this case, you had underutilized parking on both sides of the preexisting building.

More importantly, the existing Mitchell Lama was going to be eligible to exit the program in 2023. The affordability was therefore at risk of being lost. I went into HPD, which I had negotiated several prior regulatory agreements and preservation transactions with, to show how this was an opportunity to partner together. The idea was to preserve the affordable housing in the existing building and invest capital to make it sustainable over the next 40 years.

When you go through ULURP, the entire community has a voice, including all of the elected officials, many of whom I worked with previously. Deeply affordable housing for seniors was at the top of the list for the needs of the community, so that’s what got approved.

Daily Beat: Can you please describe the process of determining the best course of financing when putting together an affordable housing project?

Jim Simmons: There are only four or five levers to make a deal pencil out. You have the cost of land, supplies, and labor to build the property, in addition to the cost of financing, equity, and whatever subsidy is brought to the table. Once you put that in the pie, the equity return expectations must be at a place where all the other sources and uses add up. In this inflationary environment, the places that are now becoming more difficult are the cost of goods and services to build.

When the cost of steel, labor, and sheetrock goes up, that means that there must be a higher subsidy or higher rents. Fortunately, most of the guaranteed rent payments are set based on AMI with any increases based upon an economic formula tied to CPI. This works well as the increase reflects the cost to operate a building; however, increases that are subject to a political process are more challenging and may not end up covering the operational costs.

As long as the following factors are met; namely, coverage ratios on the debt are conservative, equity can get a commensurate return, and that through a process of Guaranteed Maximum Price with contractors, the building can get constructed and tenanted in a reasonable period of time, we can feel comfortable with a transaction.

Daily Beat: Dan Ulger from Goldman Sachs’ Urban Investment Group spoke with our team about the credit enhancement element of the deal with the Housing Finance Agency (HFA) bonds works. Can you please describe to our readers the precise mechanism that’s operating here?

Jim Simmons: The agency issues the bonds, which are either doubly or triply tax exempt. Those bonds get sold to institutions and individuals who want to enjoy a return. Those returns are set by the issuing agency, which in this instance was HFA. That’s a market based mechanism where they’re priced and investors can buy them.

The bonds are backed by the full faith and credit of the state of New York. The credit enhancement component deals with the risk from the time you close until the asset is stabilized. The property needs to be built and tenanted to demonstrate an operational alignment with the projections.

Daily Beat: Meaning, the credit enhancement is giving investors a comfort level?

Jim Simmons: Yes. Credit enhancement gives investors a level of comfort that a development will reach the point of stabilization where the risk is much lower. Once these assets are tenanted and you have some operational history, there is a very low likelihood of a risk of default. Historically, it’s less than 1%.

The credit enhancement is giving bond buyers the idea that there is strong financial backing and there are players at the table who are going to make sure the building gets built because they are on the hook just like the developers.

Psychologically, a bondholder is confident because they see a financial institution at the table that will make sure that whatever is broken gets fixed. Investors want to know that there’s a financial institution at the table that has deep pockets with skin in the game.

Daily Beat: So Goldman does not provide any funds in this arrangement.

Jim Simmons: That’s correct. It’s built on the full faith of the State that issues the bonds, Goldman Sachs, and the developers. This entire arrangement makes them comfortable and when they go out to sell the bonds, they can price them accordingly.

Daily Beat: So credit enhancement is the mechanism to reduce risk.

Jim Simmons: Correct: Not every municipality has pristine credit rates.

Daily Beat: What are your thoughts on Good Cause Eviction?

Jim Simmons: I’m not in favor of it. You cannot tell an owner that a tenant who won’t pay rent can retain legal ownership of the unit without recourse. In a scenario, where a tenant creates life, safety, and other issues for the other residents in the building, it would be difficult to remove them.

I believe that there are other mechanisms to determine whether an owner is harassing tenants to leave. There are obviously bad owners out there, but I fully believe that those are in the minority. My view is that as you go after the individuals who are doing the bad acts, as opposed to making broad reaching blanket statements or legislation affecting the industry writ large.

Daily Beat: Thoughts on 421-a?

Jim Simmons: It’s extremely difficult and expensive to build affordable housing, certainly for the lowest income individuals, but even the middle at 60% to 140% of AMI. The cost of dirt in New York City is expensive because in many instances it is backed into based upon profit margins of a condo or rental development. There has to be a program in place to incentivize developers to include affordable units in their projects.

I don’t know if 421-a is the best answer, but it’s the best one that we currently have. Maybe it needs to be tweaked and amended. People believe that it’s not good enough, but if there isn’t a viable incentive, developers are simply going to say that it’s easier to build condos like Billionaire’s Row and be done with it.

Daily Beat: Should the type of financing mechanisms unique to affordable housing be expanded to higher income thresholds?

Jim Simmons: I view all big problems the same way. If there are a bunch of smart people at- tacking it, you can come up with multiple ways to solve them. If you look at COVID, we have three separate vaccines and now have a couple of pills. There was not one right answer – there were multiple right answers.

I believe that people should focus on coming up with the best ideas and then take the best ones and do a pilot and act accordingly based on the 30 results. If they all work, let’s do them all and If only one works, let’s do one.

It is solvable. The private sector is putting people in space. We can solve this problem. It just takes people thinking outside of the box and it takes the government to accept that. People can’t object to doing it a new way simply because it hasn’t been done that way historically.

If that’s the case, COVID would have been much more severe. It took a lot of smart people to say that this is my expertise and here’s how I think I can solve it. The government, private sector, and society funded it to see if it can be solved. Once you arrive at a solution, everyone will follow that path, but it started with trials.

*The interview has been edited and condensed for clarity.

David Loo, Managing Partner at Hudson Realty Capital, joined the Real Estate Daily Beat for an interview. We discussed the firm’s new lending platform with RXR, market trends, and the rise in CMBS issuances.

Daily Beat: Congratulations on the new joint venture with RXR. Did you merge lending operations or is this a completely new vehicle?

David Loo: It’s a joint venture where we are both putting in our respective credit and operations. expertise. RXR and Hudson are still separate entities, but from a functional perspective we’re working as one organization. In the future, all Hudson debt deals will be done through this vehicle and the same thing is true with RXR.

Daily Beat: Perhaps you can speak to some of the synergies that you see?

David Loo: RXR is obviously a best in class real estate owner and operator. They are a full services real estate firm and offer a lot of resources, including development management, leasing, property management, and ownership experience.

From our perspective, we are adding our credit expertise, which makes this a very strong lending platform. Our primary focus is going to be investing in construction loans or mezzanine / preferred equity investments.

Daily Beat: How did the deal come together?

David Loo: One of the things that made this lot easier is that the Principal of both companies have long standing personal relationships. I moved to New York in 1987 and one of the first people I met was Mike Maturo. Some of the senior people within RXR at the time like their acquisitions person Frank Patafio and their head of development Joanne Minieri are still at the firm. We’ve all known each other for a long time.

When my co-founder Rich Ortiz was a banker at First Boston, he worked with Scott Rechler on the Reckson IPO in 1995. From that perspective, it’s much easier to do business with people that you know and have long standing relationships. The tie-ins and the synergies makes this a great fit.

Daily Beat: I gather there’s going to be a major focus on housing?

David Loo: Yes. Within the area of housing, the focus is going to be multi-family. Hudson has an FHA lending capability for both multi-family and healthcare, so we’re looking for opportunities where we can do construction or bridge for the multi-family and then potentially find synergies with our FHA platform.

RXR is also looking to expand pretty rapidly across the country, particularly in the multi-family space. They recently acquired Phoenix properties and are also looking at deals in Tampa and Nashville. We plan on following them across the country, looking for interesting debt opportunities in those markets as well.

Daily Beat: How about e-commerce and logistics?

David Loo: Yes. We’ve lent on industrial assets in the past. RXR has also expanded pretty rapidly into the e-commerce and logistics space, so we’re hoping to work on transactions into that area too.

Daily Beat: Have you raised money yet for this venture or have you simply formed the JV?

David Loo: We formed the joint venture and are now in the process of raising capital. In our short history together, one of the things that we’re finding is that sponsors have found our participation to be attractive to other market participants and lenders.

We’ve actually been invited into transactions by other lenders who want somebody with real estate expertise to be in some of the subordinate mezzanine positions, because in case something does go wrong, they want somebody with a capability to assess the project and potentially finish it if necessary.

The place we find ourselves in the life of the real estate cycle makes us very excited about the opportunity.

Daily Beat: During the pandemic, everyone was raising distressed funds, but they were never really able to deploy it for those purposes.

David Loo: Good point. People have always looked for the distressed debt investing markets, but the reality is that we haven’t seen it in any kind of volume over the past number of years.

Daily Beat: Are you concerned that this lending environment has gotten too aggressive? What happens with the anticipated rise in rates?

David Loo: We’re trying to figure out how the rising interest rate environment is going to impact real estate lending. To your point, I think what we anticipate and what we’re already seeing is that senior lenders are starting to curtail their loan lending amounts. Some of the credit underwriting standards are tightening up a little bit. Borrowers are not getting sort of the robust loan proceeds that they were even three to six months ago.

That’s another reason why we think this is a good market for us because transactions will rely more on mezzanine / preferred equity type investors. Given the synergies between RXR and our platform, we think it puts us in a good spot strategically because we can handle both the credit and the real estate side.

Daily Beat: Will lenders start being a little more conservative?

David Loo: We could run into some volatility and we’re a firm believer that lenders with real estate capabilities are the ones that are going to survive and ultimately thrive.

That’s why we’re very excited about the opportunity because we’re not just a capital markets, execution type lender, but we actually have the real estate chops to understand projects from the beginning all the way to the end.

Daily Beat: Blackstone’s BREIT raised $7.9 billion in the last quarter, which was a record for them. I think it only requires a minimum investment of $10,000. Obviously the major capital of your fundraise will come from institutional investors, pension funds, and SWF funds, but do you think the fundraising game has changed?

David Loo: Yes. Real estate real estate credit has always appealed to institutional investors, particularly some of the large state pension plans and sovereign wealth funds. There’s now more of a concerted effort being made to open real estate investing on the credit side to individual investors. Blackstone is a very good example of a major player in the market that continues to take advantage of that shift.

Daily Beat: Would you guys on an office or retail deal in this environment?

David Loo: With RXR as a partner, there’s probably not an office deal in the land that they wouldn’t understand; however, there are headwinds against the retail and office sectors due to work-from-home and e-commerce trends. We don’t expect these sectors to be our main focus.

Daily Beat: It seems like there’s been an increase in lenders securitizing deals these days. What caused that shift?

David Loo: I am by no means a CMBS expert, but I’ve been in and around the mortgage business. CMBS provides a lot of liquidity – both for borrowers and lenders – and given where fixed income spreads have been, it can be a low cost provider of capital and that’s why it’s been attractive for a lot of people.

There are also borrowers that don’t like to use CMBS debt because if you get into some sort of an issue at a property or you need some additional time, the borrower discussions can be a little inflexible. It certainly is a low cost option, but not always the most flexible if you need someone to pick up the phone.

Daily Beat: Very good point. Thanks for joining us!

David Loo: Thank you, Joe. Congratulations on the job you’re doing with the Daily Beat!

*The interview has been edited and condensed for clarity.

Stephen Rosenberg, Founder & Corporate CEO at Greystone, joined the Real Estate Daily Beat for an interview. Our conversation came on the heels of Greystone selling a 40% minority stake in their Agency, FHA, and Servicing businesses to Cushman & Wakefield for $500 million. We discussed his vision for the deal, how to create a moat in commercial real estate, the potential privatization of Fannie & Freddie, the SFR market, and other interesting topics.

Daily Beat: Congrats on the Cushman news. What was the impetus behind the deal?

Stephen Rosenberg: The deal is driven by two main factors that complement each other well.

We are always looking for access to more transactions where we can provide the debt. Cushman gives us access to a few thousand originators instead of the hundred we have at Greystone. The ability to build relationships with some of their clients and provide debt was really exciting. I think that’s the low-hanging fruit.

Secondly, we want our debt products to be cutting edge, not just the typical products that everyone else is offering. The $500 million that they gave to us for their minority interest in the agency lending & servicing platforms allows us to be very creative with clients in ways that other lenders would not do.

Whether it’s early rate lock or hedging without requiring margin calls for borrowers, there’s a lot of things that Greystone has been doing for 30 years that we can now do for a larger population of the world.

It’s also worth noting that the deal for the minority interest is not across the entire Greystone, but was only for a stake in the agency lending and servicing divisions. The deal didn’t include other divisions like our bridge lending and CMBS platforms.

Daily Beat: What’s the vision moving forward?

Stephen Rosenberg: I feel like my job is to make Cushman the number one real estate services firm in the country. CBRE and JLL are currently ahead of them and my job is to make sure that doesn’t continue. And the way I’m going to do that is we’re going to provide unparalleled cutting edge solutions for their clients and things that public companies like CBRE and others just don’t do.

Daily Beat: What’s Greystone’s moat? Is it more about relationships or the product?

Stephen Rosenberg: I think it’s kind of both. My kids always ask me why I always do the triple backflips to win business when sometimes just showing up is enough, but I tell them that the key to our success is a combination of relationships and offering the best product out there.

Sometimes because of the relationships, the borrowers are too busy doing something else, so they’re not really digging into how good the product is – they just get used to it. If all you’ve seen on a scale of one to 10 is an eight, then you don’t know that a nine or a 10 exists. It’s a combination of the two and depends on the personality of the client.

Daily Beat: The Trump administration decided against privatizing Fannie Mae and Freddie Mac. Recent comments from Sandra Thompson about loosening capital requirements and lifting some restrictions on preferred stock purchase agreements had the industry buzzing. What happens to your business if they come out of conservatorship?

Stephen Rosenberg: I don’t really want to be in a position of having to predict how much business the agencies will be doing in any given year. So even though, this past year, they reduced the amount of business they can do, they also said half of it has to be affordable, which left a lot of market-rate transactions seeking financing solutions away from the GSEs.

The way we have to manage our business is we have to assume that the agencies are not there. If they are there, that’s fantastic. We have to assume that they won’t be and create alternative products to satisfy the demand of our clients. I think that’s the only way to manage the business these days.

Daily Beat: How does the recent decline in the vitality of the traditional brokerage world impact your business? Do you see yourself as a brokerage in any sense?

Stephen Rosenberg: We are immune to it and maybe in a great position because of it.

We are lenders, not brokers. Everything we do is taking principal risk. Now it is true that with Freddie Mac & HUD there isn’t principal risk – Fannie Mae does have risk sharing – but our bridge lending platform is really thriving because people want to buy properties, increase the rents, and then put permanent financing in place.

When we’re making a loan, we will frequently carve off the A piece, sell it to someone and keep the B. Everything is getting cut up and sold in part or in whole these days.

Daily Beat: What are you seeing in the multi-market nationally? Which markets are you most excited about? Deals in Miami and Austin are trading at three caps!

Stephen Rosenberg: U.S. multi-family has turned into something that everybody seems to want to get their hands on – it has become a true global asset class. Markets like South Florida, parts of Texas, and New York are extremely sought after.

Yes, there are low cap rates and people are betting on the fact that rents will continue rising because there’s a lack of housing. We’re seeing a ton of action in the affordable housing space. Everyone is kind of stunned that the market has continued to be so hot.

Daily Beat: What happens to the multi-family market when interest rates go up?

Stephen Rosenberg: I don’t know. It could be that cap rates will go up, but maybe not. Perhaps people will just take lower yields, but many are stunned – who ever thought multi-family would sell with a three handle cap rate?

Daily Beat: What are you advising your multi-family clients in this market?

Stephen Rosenberg: If you’re taking out a five-year or a ten-year loan, multi-family is such an interest rate sensitive product, how do you not take advantage of a 35-year self-amortizing HUD loan with a two handle interest rate? Utilizing a loan like that protects you from the inevitable rise in rates.

The reason people often give is that with either banks or the agencies, they can get an interest-only loan, which allows them to generate more immediate cash flow for their investors even though their debt is amortizing.

The bottom line, though, is that on a low interest rate, self-amortizing loan, the principal portion of it could be a point and a half or almost a point in three quarters. That could eliminate the cashflow to you, even though the debt is the best debt for you.

Daily Beat: Buyers who are over-leveraged will be in trouble when interest rates rise.

Stephen Rosenberg: Yes. The reality is that interest rate sensitivity can mess people over even if they’re not over-leveraged. If in five years or in 10 years from now, you’re looking at 300 basis points higher interest rates, you could be cooked.

Daily Beat: Has Greystone gotten involved in the SFR market?

Stephen Rosenberg: We are in the process of getting involved.

Daily Beat: Will the asset class simply be at the mercy of the overall housing market?

Stephen Rosenberg: I think the single-family rental market is larger than the multi-family market. It used to be more mom-and-pop and it’s become more institutional over the recent couple of years. The mindset of the country has changed with regard to the American dream and owning your own house. There are a lot of people that don’t have the deposit or the ability to get the financing, but they still want a house and this is a good option for them.

Daily Beat: So if the housing market were to go down by 15%, you’re suggesting that this won’t result in the SFR market decreasing by the same amount because it’s basically a rental unit. And especially with build-to-rent where the economics are more similar to multi-family?

Stephen Rosenberg: That’s exactly right. The kids can go out and play and you don’t have to get dressed and go down the elevator.

Daily Beat: Can you please share why Greystone’s CMBS platform is so important?

Stephen Rosenberg: We hired the leader of the Starwood CMBS platform and we’re hoping that’s also going to position us well because that’s an agency alternative. When you talk about Fannie and Freddie maybe not being there or perhaps being smaller – whatever the government decides – the closest agency alternative is the CMBS program.

Given that Cushman is smaller in multi-family than all the other asset classes, I’m thinking that our CMBS platform should serve those investment sales brokers – the non multi-family ones – very well.

Daily Beat: What are your thoughts on the ever expanding alternative lending universe? How does Greystone differentiate itself?

Stephen Rosenberg: As a private company, Greystone is able stretch for borrowers in a way the competition just can’t. Sometimes it’s early rate locking, while other times it’s putting a mezzanine piece behind the CMBS or preferred equity behind an agency.

In the 11th hour of a deal, the borrower often loses a piece of equity and we have to fill in that gap, which gives another six months or a year to repay us. We have a special situations group that just focuses on bridging equity.

We already raised $1 billion, but we probably need an additional billion or two – which itself gets leveraged three of four times – just to just to keep up with the volume. For every billion, we can do $4 billion of lending. The way the volume is now we probably need another $2 billion, which would give us an additional $8 billion of lending.

Daily Beat: And you attribute that demand to the velocity to the market and new sponsors?

Stephen Rosenberg: I think there’s just a lot of transactions on the multi-family front and many are value-add opportunities that people are trying to uncover. Also, with the agencies cutting back on market-rate housing to do more affordable, investors are looking for good financing and many are looking at bridge right now.

Daily Beat: The Cushman deal is obviously a major inflection point for Greystone. When you look back at the journey, what are you most proud of?

Stephen Rosenberg: The thing that I’m most proud of is that the mission of Greystone is really to enhance people’s lives. We give a significant percentage of our profits away to families in distress around the world.

The number of families that we have impacted in a positive way – some of them stay with us where we’re helping them on a monthly basis for years. We may not give a lot to universities or hospitals or other sophisticated organizations, but we’re very grassroots and help individual families out of really tough situations. That’s certainly what makes me most proud.

 *The interview has been edited and condensed for clarity. 

Andrew (Andy) Carmody, Managing Director at Tricon Residential (TSX:TCN), joined the Real Estate Daily Beat for an interview. We discussed the firm’s new $5 billion single-family-rental venture, build-to-rent strategies, the bull thesis for the housing market, and where the growing institutional category goes from here.

Daily Beat: In the past year, the SFR space has continued to solidify itself as an institutional class. With lots of new competition in the space, how does Tricon differentiate itself from the Blackstone and KKR’s of the world? What was the pitch?

Andy Carmody: There are three big things ingrained in our strategy and it’s a big reason why we’ve been successful in growing our SFR business and raising third-party capital.

Number one is our focus on the middle market. We’re targeting homes for residents that earn between $60,000 to $100,000 a year. They tend to be residents that are seeking single family housing, not apartments or condos. Our tenants tend to be hardworking American families. I found that to be a good niche. We’re not going for the lower level of the market or the ultra luxury space – it’s the middle that’s been very good to us.

The second thing is that we run a technology enabled platform. We’ve essentially been able to build and scale the business by using technology to better manage home maintenance, leasing, and operations. It’s not easy to manage a lot of individual scattered homes.

The last thing is our focus on being an excellent landlord or manager for our residents. Customer service is something that we’ve put at the forefront.

Daily Beat: When it comes to the build-to-rent (BTR) space, GTIS partners and Walton Global Holdings come to mind as firms that recently did large deals. The thesis is basically if we build to rent, the margins are better and properties are easier to manage. It sounds like Tricon’s vehicle is more focused on acquiring homes, not developing. Why did you choose this approach instead of BTR?

Andy Carmody: We also have an active build to rent strategy, but it looks a little smaller on the page from today because the resale business is larger for us. Supply is a meaningful issue across the country. We haven’t built enough houses for Americans’ most preferred product type, which is a single family home. And in particular, on the rental side, we have fewer units today available for rent than we did a few years ago. We are also working on solving the supply problem as much as we can. It’s a longer lead and longer process to do so, but we are building that business similar to GTIS and others. We ultimately think that bringing more supply to the market as a whole will be very well received, but we’re also continuing to acquire, renovate, and lease existing homes in the business.

Daily Beat: What’s the average hold period for houses Tricon acquires?

Andy Carmody: We have no set schedule on holding homes and intend to own any home that we buy in perpetuity. So we’re in this for the long haul. We do thin the portfolio occasionally by a few hundred units a year because either they’re in poor locations, hard to service or have been underperformers, but it’s a very small fraction of the total.

Daily Beat: Why specifically the Sunbelt over other parts of the country?

Andy Carmody: We believe that demographics is destiny and the Sunbelt is growing at about twice the national average, which is really favorable for demand. And these are the markets that American families want to live in. The high quality of life, warmer weather, and more affordable lifestyle is a real draw. You see that in Texas, Arizona, the Carolinas, and Florida as companies continue to relocate there, which bodes well for housing demand.

Daily Beat: There was recently a report that institutional investors only own 300,000 U.S. homes, which is only 2% of rental homes, with 85% being owned by investors of 10 or fewer properties. What does this number look like in a few years?

Andy Carmody: I think there is a meaningful growth opportunity for institutional owners, but I believe that will grow slowly over time. It is hard to buy 5,000 to 10,000 homes, which doesn’t move the needle in terms of the whole housing market. We really just own a tiny sliver of the entire market. And the vast majority of rental homes today are managed by what we call mom and pops. That’s the vast majority of the single family housing stock. Institutional owners are adding slowly to that in aggregate. Maybe we add 10,000 to 20,000 homes per year to the 300,000, perhaps a little more than that, but I think it’s a slow process relative to the entire housing market in the U S.

Daily Beat: What’s your bull and bear cases for the housing market in the next couple of years?

Andy Carmody: The SFR market is the most preferred housing type for Americans. In fact, most economists and forecasters believe we are still undersupplied. So we expect that that demand – some would say elevated levels – to hold and stabilize. Some argue that there’s some risk in the housing market, but today we think there is more demand than supply and has been for several years. Whether that’s in a home that a resident buys and mortgages and owns and manages themselves, or in one that we buy and lease and manage on behalf of the resident, we think there is meaningful excess demand in the current market.

Another indicator that gives us some confidence that the market is reasonably strong is that it’s very hard to mobilize supply. In fact, it’s harder than ever in the United States to source, title, and develop new single family projects. It’s challenging in all asset classes, but particularly difficult for home builders to get sites approved today. And we think that will continue to hold back supply in light of this excess demand, which gives us a bit of an optimistic outlook in today’s environment. If rates rise very sharply that obviously curtails buying power for anyone who wants to buy a new home. So we may see new home demand be curtailed a bit if rates see a meaningful spike of a hundred basis points or more and even slower if they were to increase more. But that would really be about the only concern we have in the housing market today.

Daily Beat: Would you say it’s a fair characterization to say, “as goes the housing market, so goes to the SFR space?

Andy Carmody: I think that’s fair, although you’d have to decouple for sale and for rent because we think that the rental product is generally more accessible and tends to be a little more durable in a downturn. The for sale business tends to run a little hotter in an economic upturn or in the case of this unique situation that we’re growing out of here with COVID. So I do think the businesses are reasonably coupled, but one may prevail more over the other depending on where we are in an economic cycle.

Daily Beat: The FICO score of the average home buyer in the United States is over 700. So credit conditions look solid.

Andy Carmody: Mortgage underwriting is still fairly tight in the U.S. And it does seem like the credit risk is less than it has been in quite some time. Credit quality is way better than it was 15 years ago – it does seem reasonable, but it’s hard to predict what’s going to happen in the next 10 years right in this business, but we’re cautiously optimistic.

 *The interview has been edited and condensed for clarity. 

Delving into the world of commercial real estate, Madison Realty Capital’s Managing Principal & Co-Founder Josh Zegen joins Joe Richter to discuss how the firm got started, and why it’s strongly positioned to succeed in today’s lending market. We also covered timely topics, including the secular decline of physical retail, the hospitality sector, WeWork, crowdfunding, and more:  

Joe Richter: Before delving into timely market topics, it would be great for you to give us some background on your journey and how you started Madison Realty Capital (Madison).

Josh Zegen: When I graduated college, I went into investment banking at Merrill Lynch and Salomon Smith Barney. I then got my dream job around 2000 at a venture capital firm. Unfortunately, the timing wasn’t great because the market crashed in March 2000. 

The firm basically laid everyone off, so unfortunately – or fortunately – I was forced to reinvent myself. At the time, I was around 26 years old and moved back home, basically trying to figure out what to do next. It was a very tough time, companies were making lots of layoffs, and it was hard to find a job. 

I’ve always been an entrepreneur and have been starting businesses since I was a kid. So I co-founded a mortgage brokerage company in 2001, and started facilitating commercial real estate bridge loans. This opened up a huge opportunity for me, as I came to the realization that there was a real need for flexible and fast capital. It was very mom-and-pop, and I brokered a number of deals. 

Joe Richter: And I guess this brings us to around 2004. 

Josh Zegen: Yes. I got together with my college roommate Brian Shatz and pitched him on the idea of starting a fund around bridge lending. His first job was at BlackRock and then he joined a hedge fund where he was able to build a Rolodex of investors. At the time, there was almost no one in the real estate lending business. It was highly fragmented and not institutional. We saw the opportunity and decided to start a fund around this.

We launched with $10 million of LP Capital [limited partner capital], and completed our first deal in 2005. It grew from there. That fund ultimately became a $300 million fund. We created a large global investor base and started lending. We were very early, the word private credit didn’t really exist back then, it was a mom-and-pop business that we set out to institutionalize.

Joe Richter: And then a few years into Madison’s history, the industry is of course confronted with the great financial crisis. How did that affect the firm?

Josh Zegen: Our growth was accelerated by the global recession in some ways because banks changed their business completely. We were often identifying deals that were special situations or quick closings and finding opportunities that banks couldn’t act on between 2005 and 2008. We were well positioned to lend at a time when no one was lending. 

It was a very challenging period too, because we had to make sure that we preserved our investor’s money. Obviously, the markets were very illiquid in 2008-09, and it was very hard to raise another fund. We really had to figure out how to manage best with what we had. At that point, we recognized the importance of becoming a vertically integrated company. We realized that we needed to bring in asset management, property management, and construction management because our track record was going to be dictated by how we managed that vintage.

It put us in the next vintage in 2009-10, and while we were in between fundraising for a new fund, we set up a joint venture with a hedge fund to buy loans in the New York area and make loans as well. We weren’t just a loan originator, but we were buying loans from banks. 

Joe Richter: That seems like a pretty exhilarating stretch in a company’s infancy! 

Josh Zegen: The DNA of Madison was created in that period of time, as a vertically integrated firm that can tackle all kinds of opportunities from direct lending to buying loans, to restructuring loans, to owning real estate. We started buying real estate at that time in 2010-11. That got us to Fund II where we raised $350 million, and then almost $700 million in Fund III; and $1.35 Billion in Fund IV. 

Joe Richter: That’s a great story. As you know, everyone in the market is trying to get into the lending business. With all your experience, what would your advice be to them? I think there’s definitely a misnomer out there, with people thinking lending is as simple as a standard equity deal. Right now, there’s so much liquidity out there and I was wondering what your thoughts were on the landscape and how this evolves in the next few years?

Josh Zegen: There’s another lender that pops up every day and the reality is that most of these new entrants to the market have not seen a true downturn – what we saw in March 2020 wasn’t even a downturn. The liquidity that’s been pumped through the system rescued a number of firms and a number of mortgage REITs. 

Generally, none of the firms out there started on the credit side and then added equity. Most came from equity and then added credit. So, the experience we’ve had over 17 years, and our track record of $14 billion plus in business is really what sets us apart. Being able to close on small, medium, or very large deals quickly with flexibility. We also service all of our loans in-house.

The way we’ve set up our business as a vertically integrated firm, allows us to tackle deals that are complicated or require a unique understanding of the market. Our focus is not on the commodity part of the lending business, which is the case for most debt funds out there.

We’re creating more customized financing solutions, which leads to many value-add deals. We can both buy and originate performing or non-performing loans. We also make new loans, which is a substantial part of the business.

The number of repeat borrowers is a testament to the fact that we can control everything in our process. We’re not syndicating or bringing in different investors. We’re not closing subject to leverage. This allows the whole loan solutions we’re providing to be very flexible, efficient, and valuable to our customers.

During the last year, we launched another product, which we call our income product. It’s a fund where we provide lender financing to other lenders. So while alternative lending has grown like crazy, we think there is more of a need for flexible financing to lenders in the business, whether that be through loan-on-loan, A-note financing or lines of credit. The typical credit sources to other lenders (i.e. the alternative lending universe) are very rigid, it’s not as customized, and we can offer a lot more flexibility.

Joe Richter: Is there anything in the lending universe that you see as a red flag?

Josh Zegen: The mistake that I see being made is the lack of downside protection – your last dollar exposure. Unfortunately, the big mistakes that cause firms to blow up in our business are repeated. They go high, leverage up the spectrum in terms of the capital stack and people aren’t really being paid for risk, especially with so much liquidity in the market. The second problem is levered lenders – the way people leverage today through warehouse lines, CLOs, and repo – unfortunately, every few years you have a blowup in the market and that’s what we saw in March. People don’t necessarily learn their lesson and they do the same thing.

It’s worth noting that most of the new lending arms out there don’t have discretionary capital. Madison did $1.6 billion of transactions in the pandemic because we had capital and conviction at a time when no one was doing business. We didn’t have leverage issues or some of the portfolio issues some others had. We were able to play offense big time last year. Now, all those debt funds that were sitting on the sidelines are trying to play catch up. 

Joe Richter: Now that we have some background, I’d love to get your perspective on the current market. I want to first discuss the supply gut we are seeing in the Manhattan condo market. I know Madison has been pretty active in the space for the past few years. 

In 2018, you invested in 111 West 57th, and then a couple of months later you did Ian Eichner’s condo inventory loan at 45 East 22nd Street. And last week, there were 47 contracts in Manhattan for deals over $4 million, which extends the record-breaking streak of more than 30 such deals to 11 weeks in a row.  

And with the national, general housing market the way it is, how do you view the condo market shaking out in the next year or so? Gary Barnett recently said that he’s only expecting to make money on three out of his six active projects. So I was just wondering what your outlook is for that market. When will the supply gut be absorbed? Are we headed for some distress?

Josh Zegen: We are seeing a substantial amount of absorption across the board. From luxury properties to the middle and low-end. Pricing was already going down in March before the pandemic hit. Generally we are seeing somewhere between 5% to 15%, with an average of 5% to 10% off of March pricing.

There has been a huge kind of absorption in the first quarter, which we identified in the fourth quarter as well. Basically, as soon as the vaccine was announced, we started to see a huge pickup in momentum. People started to feel like they were missing out on something, such as empty-nesters, who couldn’t sell their homes in the suburbs, and they always had a dream of trading into New York City. With all of the renewed interest in the suburbs, people were able to sell their homes and get a bargain in the city. I saw a lot of tech executives from the West Coast look to buy units in New York City. It was families trading up to get substantially more space for a lot less than what it would have been pre-pandemic. We are also seeing foreign buyers – a number of investors in Israel and South America are interested.

Joe Richter: Even without them being able to travel, you’re saying they are just buying virtually.

Josh Zegen: Yes. What’s hurting the international buyer is that the world isn’t vaccinated at the rate we are here in the U.S. and it will hold back some of the market. It has been holding back the hotel industry and the condo sector.

Joe Richter: 100 percent. I know you have a few projects in South Florida. What are you seeing there?

Josh Zegen: We have three major projects there: Monad Terrace, the Four Seasons Hotel and Private Residences Fort Lauderdale, and The Residences at Mandarin Oriental, Boca Raton. All three are substantially sold and continue to sell every day at record prices.

Interestingly, going into the pandemic certain parts of Florida were strong, but Miami was weak because of condo unit overcapacity. That started to change as the housing inventory narrowed and people started to renew interest in the condo market, and anything that’s available for sale is selling units every week.

Joe Richter: So do you think when everything gets back and running in New York City, we could see the same type of thing happen in that market?

Josh Zegen: I think so. I believe that the inventory available is another 18-months out. Renewed interest in condo inventory loans in New York City, which we are participating in, has just begun. We are looking at whole loans for inventory, but also looking at leveraging other lenders in inventory loans. In those cases, we’re competing with banks that are providing A-notes or loan-on-loan financing. We’re seeing that as a very big opportunity where we may not want to take the last dollar of exposure, but where someone is, we can lend to them.

Joe Richter: We recently published a survey with KayoCloud, which was featured in the New York Times. One of the interesting results was on the question of which asset class will see the most bankruptcies in the next 12 months: Interestingly, 48% said hotel, 42% said retail, and 10% said office. Based on what you’re seeing – you guys are at the front lines – where will we see most distress in the next 12 months?

Josh Zegen: The distress is more around retail. In terms of hotels, it depends on locations because obviously the business traveler creates a big question mark as to how that comes back regionally.

Joe Richter: Yes. Demand for leisure travel should really spike.

Josh Zegen: Business travelers can say for now I’m okay on Zoom for the first meeting and maybe the second meeting. There may be less business travel because you can accomplish a lot through video conferencing platforms, but it doesn’t mean that the first handshake isn’t valuable. That all being said, we have someone on the fundraising side and as he says, he can be in seven countries in one day.

Joe Richter: There’s an efficiency that didn’t exist previously.

Josh Zegen: From a hotel perspective, the major question is how quickly will the world open up? Meaning, how quickly does Europe and the Far East get vaccinated, which will determine some of the tourism industry in the U.S., and around the globe for that matter. 

From the retail vantage point, it is a more binary business. We learned a major lesson from a bad mall loan we did in 2007, it kept us out of retail lending for the most part for the last 14 years.

Joe Richter: That seems like a good mistake to have made.

Josh Zegen: Yes. We had a number of tempting deals along the way, but we didn’t like the risk of co-tenancy. If one anchor goes bankrupt all of a sudden, then the mall can turn into major distress. We just stayed away from malls and from a lot of retail because we were very worried about the asset class in general. We basically had no major retail exposure, other than in mixed-use assets where there’s an apartment building with a little retail in the base, so nothing major there.

We also had almost no hotel exposure. Other debt funds and mortgage REITs had a lot of hotel exposure going into this crisis with generally 15% to 30% of their portfolios were in hotel loans, because they were able to get a little more yield for hotel lending.

We never viewed the risk worth taking because hotels are operating businesses and just have more binary outcomes in times of distress. That doesn’t mean we don’t think there’s an opportunity today, especially with distressed hotel investments, preferred equity, and providing note-on-note financing.

Joe Richter: It sounds like you’re still shying away from retail because of e-commerce and the macro trends. Are you looking at retail deals now or more on the distressed hotel side?

Josh Zegen: We are still shying away from retail, though there’s some opportunity for us financing others that are buying distressed retail and turning it into something else. There’s a lot of interesting business plans around taking a mall, for example, and turning it into single family rental housing, multifamily, or distribution. 

We’re also seeing that business plan in distressed hotels where people are taking hotels in the Southeast and Texas and turning them into multifamily. There are a number of interesting business plans where we can be very relevant from a flexible capital perspective, not just a lender, but as someone who can understand a lot of moving pieces. There’s a void there, which presents an opportunity for us.

Joe Richter: Would also like to get your perspective on WeWork and the co-working space in general. If you guys were looking at a building where a co-working company was the anchor tenant, how would you approach a potential deal? 

Josh Zegen: Fortunately, we also avoided that pitfall going into the market. We didn’t have any exposure to WeWork on any co-working. We were actually looking at one deal where WeWork occupied the entire building and we looked at every one of those co-working deals the same way, which is basically what happens if that tenant blows out. What would that mean in terms of our time to lease up, cost to lease up, and the rents we can get if that took place. Generally none of those deals penciled out for us to be able to make a loan because there was such a drastic difference in value if that happened.

While we stayed away from co-working, I still see the concept as a valuable business plan in the future. Let’s say we wanted to test out opening an office in Seattle without locking ourselves into a 10-year lease, this model would be very valuable for someone like us. Meaning, let’s take 3,000 SF and be a presence there, and have a one, two year, or three year lease just to get going.

Joe Richter: Yeah. I think flexibility of office leasing in general is the lasting impact WeWork and its competitors have on the industry. 

Josh Zegen: The business plan was flawed amongst a number of the co-working companies, there was too much competition, too many commoditized products, and not enough of a value proposition to the tenants and the landlord.

It’s being reinvented and it’s here to stay because there is a value proposition, but only the strong will probably survive.

The same thing is true with a lot of these co-living companies, including Stay Alfred or Ollie, as expenses were too high at the operating company level. The expenses were just crazy, and it was always just about growth, and it was never about how to grow smart. There was too much money being thrown at the space.

Joe Richter: Yeah, they were flawed businesses. I mean, on the office side, look what happened to Regus in the last downturn. The business model was faulty from the start. And I think the partnership model is what will survive. The question obviously remains what the margins will look like and the profit it can generate. I’m not really sure, but that’ll ultimately be the arbiter.

Josh Zegen: I do believe that experience and technology are integral for the business. The less commoditized the product, the better. Just like in our business, the lending world. So much of the debt fund business today is based on everyone trying to do the same exact thing. What keeps us relevant is that we don’t do the same thing. We’re able to create opportunities.

Joe Richter: I wanted to get your thoughts on crowdfunding for commercial real estate deals. The space is definitely making strides and has gotten some more publicity because of what’s going on with Robinhood. 

Cadre, CrowdStreet, and Fundrise have been at it for years already with mixed results, and some like Prodigy Network have gone under, which shows the complexity at play. The truth is that it really started with Blackstone and Starwood when they raised from smaller investors with a minimum check of $2,500 for non-traded REITs. And I guess it’s evolved now where Jamestown is out there raising a $50 million fund concentrated on small investors. So I was wondering on the lending side, do you think there’s an opportunity to go ahead and raise from smaller investors? Or do you think this is just a small fad?

Josh Zegen: There’s an opportunity both from an equity and debt standpoint. The problem has been that there’s been negative selection thus far.

These crowdfunding groups are not getting the best deal flow because it is a process and a lot of uncertainty dealing with them. The most established will survive, and there’s a value proposition to both the developer and to individual investors out there that couldn’t access deals because they don’t have the capital. 

The key is to find the best sponsors and have repeat business. I’m a believer that there will be a handful of these groups that really make a mark and become big and there’ll be consolidation because there’s too many players out there.

The negative is when you have a real downturn and recession, which again, we didn’t see last year. COVID-19 was very different, as it was a health crisis not a financial one.

In times of uncertainty, investors put in money and then I don’t know how much more bandwidth they have from a capital call perspective. It wasn’t tested the way it was during the global financial crisis. At that time, you had years of not getting financing, years of working through deals, years of more capital that had to be put into things, I don’t think it would have survived that.

Joe Richter: It was a very short blip and everyone had forbearance agreements and there was so much liquidity in the system. So who knows what would have happened had it lasted for longer and the federal government had not taken such bold fiscal action. 

Josh Zegen: The model hasn’t really been tested –– individuals are the first to just say I’m not writing a check. I’ve seen it in deals. Unfortunately, that means the sponsor who’s going to be subject to completion and carry guarantees is really going to be exposed.

The plus is that it is a real way to raise capital. There is a business plan there that could be a major source of capital globally. The negative is that unfortunately in times of uncertainty, investors may not know what they’re buying into, and that may create a lot of risk for a sponsor, rather than coming in with a big JV equity partner. It doesn’t mean the JV equity partners can’t just walk away and leave a sponsor exposed, but there’s a little more certainty around it.

Joe Richter: Yeah. There’s the sponsor’s reputation at stake in contrast to a fragmented crowd-funded deal, which is pieced together from like 7,000 investors online. So there’s definitely a distinction. 

Josh Zegen: I’d say that’s an opportunity for a business like Madison Realty Capital. We’re seeing deals where equity investors aren’t ponying up money and there’s an opportunity to come in with preferred equity and restructure the debt in place. Our experience also means that we can tackle opportunities from many different lenses. That might mean making a loan, buying a loan, or restructuring a loan. It may mean coming up with some other way of tackling the situation through preferred equity and restructuring the debt. We are a creative solution provider.

Sponsors really appreciate that we look at a deal through the same eyes that went through the GFC (Global Financial Crisis), in addition to our investors appreciating the ability that we have to drive better returns because we can understand a deal in so many different ways.

And I just wanted to tell you, Joe, I really appreciate what you’ve done with the Real Estate Daily Beat. You’ve created something where there was a real void in the market. It’s probably one of the first things I look at every morning, because it sums up the news in a really nice way. 

Joe Richter: Thanks Josh. Really enjoyed chatting and very much appreciate your kind words. 

 *The interview has been edited and condensed for clarity.