Podcast Transcript
Speaker 1:
Welcome to Real Wealth Real Health, the show that empowers you with insights, information and inspiration to achieve your version of financial wellness. Learn how to balance living a full life today with planning for the future. This podcast is brought to you by Alpha Investing, a real estate centric private capital network that provides exclusive investment opportunities to its members. And now here are your hosts AdaPia d’Errico and Daniel Cocca.
AdaPia d’Errico:
Hello, welcome back to another episode of Real Wealth Real Health. Our guest on this episode is Craig Ramsay. Craig is a senior executive with deep experience in institutional real estate capital markets with a track record that encompasses over $40 billion in private direct transactions completed across asset sale, mortgage financing, joint venture and funds formation products in major institutional markets globally. His experience includes senior executive positions within the investment banking, private equity and tech enabled investment management disciplines. The episode today begins with a professional investor’s viewpoint on crowdfunding real estate, which is an important perspective, especially when we learn the size of crowdfunding versus the size of institutionally managed money and real estate investments.
AdaPia d’Errico:
Then we take the conversation into the theme of the financial crisis, where we are now comparing and contrasting that to the Great Recession. We get an institutional view of real estate, especially how registered investment advisors, RIAs are considering real estate as part of their clients portfolios. Craig provides a ton of data and we’re including links in the show notes for everyone’s reference. Though our world shifts and changes so quickly and whether you’re listening to this at its launch or later, Craig’s insights are invaluable at any point in any market cycle. Craig, thanks so much for joining us today on our podcast.
Craig J. Ramsey:
Oh, pleasure to be here.
AdaPia d’Errico:
It’s great to have you. I’m really excited about the episode today, you are a longtime real estate finance executive, you’ve been in investment banking, private equity. I know we’re not allowed to talk about what you’re doing now, because you’re in stealth mode launching a tech enabled investment platform. But your background is so deep and so broad. You’ve been in the industry for a long time and what we want to focus on with you is our current crisis, how we got here and how it compares also to previous financial crises. I know you’ve been through more than one. So for the listeners, we’re going to get a lot of information to help contextualize what’s going on right now with a historical and a deep financial view. So, to start, Craig, can you give us a brief background about yourself?
Craig J. Ramsey:
Sure. I guess I’d start with, I entered the real estate finance industry in a strange way at least by way of my background. My undergraduate, which was at Boston University was as a classical musician studying music performance. And shortly after graduation… And I had started in that career and got off the ground and had about six months post graduation an automobile accident that, well, no long lasting damage, it created just enough nerve damage for me to need to assess a career change. After a couple of years of working, I went to business school, the alternative was law. And my father who was in the legal profession, talked me out of that one. I went to the Graduate School of Business at Columbia in New York and following that, entered a career on Wall Street focused on the real estate industry, but specifically within the finance discipline of that.
Craig J. Ramsey:
Largely, because one of the things that really hasn’t changed about real estate over the years is that it’s an exceptionally capital intensive business and anywhere from 60 to 95 plus percent of the capital that’s used in real estate acquisitions or portfolio construction, is really from third parties beyond the sponsor. There’s always got to be some skin in the game, but it really is in a sense, not only from a debt perspective, fairly highly leveraged as an industry but it’s also a lot of third party equity that comes into play. As you mentioned in the intro, broadly speaking my career has involved positions in senior management at Bulge Bracket investment banks, always interestingly, perhaps focused on the private side of real estate capital. The big move in the 90s was public issuance of publicly traded real equity, while my colleagues in those firms certainly focused on that I had always been on the private side of things.
Craig J. Ramsey:
It was an interesting side of the business where… And we’ll get to the points on it later, but the private side of the market is almost uniquely uncoupled from the public side in terms of how returns work, in terms of the correlation with other asset classes and that provided a very interesting basis for me to grow in my career approximately, over five years ago now. After the global financial crisis, I’ve been doing some consulting, a consulting assignment for an investment management firm in the Midwest, came through and asked about crowdfunding and how all of that works because they thought there might be an interesting way to combine the financial advisors that they had inside of their registered investment advisor complex, their parent had that with raising capital from those clients for a captive investment management firm.
Craig J. Ramsey:
And I built that platform out, roll that out, got it successfully adopted by Fidelity Investments on their wealth advisor solutions platform, really covering over a lot of the at the time at least, shortcomings in the crowdfunding business. And here we are now. I’m presently working as you mentioned on a tech enabled investment manager that is operating right now in stealth mode. So, that brings us to date. I don’t know if there’s anything in there you want to drill down on.
AdaPia d’Errico:
I would want to drill down on everything, but actually, let’s start with this. I would love to just quickly talk about the crowdfunding first before we really get into the… I’m super interested in the finance side of everything, but let’s talk a little bit about crowdfunding because we have all different experience, as you know I helped launch crowdfunding in late 2013, I came at it with my own background coming from hedge funds. And seeing this go retail, I saw the potential, but I also saw the need for institutional capital from the perspective of essentially scale of allowing a business to thrive before you could really onboard retail. So, it’s been an interesting few years. So, what’s been your perspective coming into it from your very deep background?
Craig J. Ramsey:
Well, let’s take a step back and talk about the quantum of the market that we’re talking about. Because the thing, I view very much crowdfunding is an industry which best case is still sorting itself out. It largely, not entirely because there have been some offshoots, but its incubation was really in the wake of the JOBS Act. And the ability of typically smaller issuers to raise more retail capital, the idea with the JOBS Act was to streamline that process, reduce regulatory requirements so that you could reduce the cost of issuing equity to new startup ventures that historically had been locked out of the more institutional side of the world. That’s certainly a logical reaction to it. But hen the question becomes, okay, how do we build a business if we already start with the notion that there is an in place institutional market for real estate investment management? Let’s keep it to real estate, although it generally applies to other kinds of alternatives, whether it’s private equity or hedge funds. Real estate is the one that’s received most of the attention.
Craig J. Ramsey:
The major projections that I have seen and these data come from Ernst and Young, in a report that was put out about nine months ago, we’re doing this the first week of June 2020, estimated that in 2021, year end, all real estate crowdfunding globally would total about nine billion US dollars or the equivalent in local currency. Okay? And that’s fine, that’s very nice. But just to put it into context, globally, institutional investment managers, there are 78 institutional global investment managers who individually exceed the size of the entire crowdfunding market. You were talking about… And just again, by way of context, institutional real estate investment management, as we know it, has basically been around for 45 years or so.ERIS, the Employee Retirement Income Security Act, was passed in ’74, ’75 and Gerald Ford signed it. Its fundamental underpinning was, “Okay, if you run a pension fund, you have to be diversified.”
Craig J. Ramsey:
And the market responded with that by creating a series of not only real estate, but private equity managers. And this was just as private equity to do corporate acquisitions were being formed with the idea that the investors would be pension funds, who had to diversify. All of that itself, and I’m sure we’ll get to this later, was backed by a great deal of academic research on modern portfolio theory primarily by Harry Markowitz, who ultimately won a Nobel Prize, I want to say in the late 50s, for this work. It took 15 years for it to become more than just a nice idea and take on the force of law. But since that time in the mid 1970s, you’ve seen globally this industry of investment management targeting the institutions as clients, as investors grow from zero to several trillion dollars with a couple hundred firms managing about 80% of the global real estate investment capital that’s out there. And it totals in the trillions of dollars completely.
Craig J. Ramsey:
So while crowdfunding has gotten off perhaps to a nice start, it looks like it’s starting to sort itself out a little bit with a couple of folks who raised over a billion dollars as platforms. Most of them have not, most of them are still bound by that shaping out process and just a couple of themes around that. I think, if I were to assess it right now, I think although it’s getting better, you’re still talking about investments themselves that are on sub-institutional quality, largely driven by transaction size limits, which may just be a function of, “I have 100,000 Some investors in my database and only 5000 of them are going to invest in any one deal and that puts a cap on how much I can raise if my average investment…” Those kinds of things. I think you’re also seeing if not questioning at least some concern over the fact that the asset management function is essentially being performed by De Novo asset managers, these are firms that five years ago, most of them did not exist.
Craig J. Ramsey:
And now they’re taking on investor capital and they’re investing that and even if they have great deals, it’s still an investment product. So you have to take a look at who it is that is going to be the steward of that capital. They do and you mentioned this earlier, they are all facing the issue, despite the fact that they use technology in their operations to wring cost out of what would otherwise be clerical administrative human labor and they can automate that through technology and move funds and all of that and save a lot of money. Crowdfunding still represents a fairly expensive way to raise equity. When you start layering on even in the upper reaches of it with some of the title for stuff, the Reg A+, where you can raise $50 million a year, that’s still a quasi public offering.
Craig J. Ramsey:
The standards are a little bit lower. It’s very expensive all of a sudden and you’re looking by the time you load the marketing budgets in and all of the legal fees and everything else yeah, you can raise 50 million bucks per year inside that vehicle, but at least in your first year, you’re looking at something on the order of two and a half million dollars of expense, 5% and all of a sudden, you’re faced with the age old problem, how do you scale? And with the limitations on size, it becomes very difficult to scale those costs. By contrast, the institutional market in which five and seven and $10 billion funds are not uncommon, I just told you there are close to 80 firms that in and of themselves have $10 billion of assets under management, you can play in much larger check sizes, asset sizes and the absolute dollar cost of an attorney’s bill for instance, if that gets spread over 100 million dollars, that’s a very different drag on return than it would be if that transaction was 10 million or five million, et cetera.
Craig J. Ramsey:
And so, while the tech has taken a whack at the cost problem, it hasn’t eliminated it and you’re still stuck with that. And when you Compare the costs of crowdfunding relative to the investment management industry that services the institutions, there’s still a huge gulf between that cost burden that the retail investor is doing. They’re going to sort it out just like everybody else has. I was joking with a colleague earlier on this very topic, that in the early 1900s, there were hundreds of automobile manufacturers in the United States. This isn’t… I say that because we’re not dealing with anything different in that sense. It’s a new industry, it’s going to have to shake out, we’re going to have to figure out and it will go through a period of consolidation following best practices, et cetera.
AdaPia d’Errico:
And it already has been, right? It already has been –
Craig J. Ramsey:
… First failure, yes.
AdaPia d’Errico:
Yeah, yeah.
Craig J. Ramsey:
And see how it shakes out.
AdaPia d’Errico:
Yeah. It’s interesting that you’re saying. I did a quick search. This is not a Jeopardy question I already have the answer to in my head, but the size of the real estate market; so, you talked about $8 billion in assets and crowdfunding just the whole thing. The whole thing’s eight, right? You said eight billion – give or take – and based on 2018 data from MSCI, the size of the professionally managed global real estate investment market is almost $9 trillion.
Craig J. Ramsey:
Right? It’s 1000 times bigger.
AdaPia d’Errico:
Yeah.
Craig J. Ramsey:
Yeah, just a different way of saying the same thing. Look, it’s an industry, it has to grow up, it has to gain scale, it has to get size. Let’s talk about it in a few years when we see some of that traction and who at least the early winners are going to be. It’s got a long way to go. You’re comparing that, or we’re comparing that to an institutional investment market that has been growing for 45 years and has sorted a lot of those big problems out of the mix.
Daniel Cocca:
Like any new market though, the crowdfunding, private syndication world really popped up as a product of shortcomings of the existing model. Right? And individual retail investors tend to have lofty expectations to say it nicely, probably bordering on unreasonable a lot of times, but they want direct access to high quality institutional real estate, they want to pay very low fees, they want the ability to make commitments on a deal by deal basis. They want all of the ongoing portfolio management and financial reporting that comes with an institution deal or lawyers, accountants, what have you. It can’t all be done, but at the same time, the existing model hasn’t provided enough of an outlet for the average retail investor. And you see that when you look at larger aggregated data around no percentages of investor portfolios in alternatives, specifically real estate, that number typically drags, especially for those folks outside the top half percent of earners in the country, typically drags the 20% suggestion you see from a lot of financial advisors.
Daniel Cocca:
And so, the question really is, where are we in this process, stage one, stage two, of creating something that does appeal to the individual investor who wants something that is a little bit more hands on than a read, maybe more transparent than a read gains that aren’t correlated with the stock market, but isn’t necessarily a kind of shout to the past of the country club equity or writing this small cheque. And so somewhere there’s got to be a hybrid. One of the benefits in my opinion of venture capital is that it gives industries the opportunity to experiment a bit to see what works with before you have a company that can exist on its own, I.e, a profitable company, we can go out, we can play around and the first wave of crowdfunders I think, did a great job of showing us that there’s demand for this type of product on the investor side.
Daniel Cocca:
The question now is, how do you optimize the investor experience so that you’re getting all of those things that you’d want to see from an institution or as an institutional investor, but you’re able to do it on terms that work for you? And so, that’s the problem I think, we’re trying to solve here. If you have comments or thoughts on that long soliloquy, I would love to hear them.
Craig J. Ramsey:
Totally agree with all of it. I think you’re right and there are several issues, some of which I pointed out in my earlier comments on it. You’re correct that earlier syndications included the typical country club syndication, that was largely if you look at it from a broad market perspective, that was not a broadly available product, it was done by affinity pay and they call it a country club syndication. But it was… Hey, I know through some social connection or some business connection, a local real estate developer who is pulling together a small deal to do a local shopping center or even in the largest case in that kind of thing, I don’t know, building a 200 unit multi-family and that pretty much taps out the quantum available through that personal networking kind of thing that any local developer might have.
Craig J. Ramsey:
What’s really being attempted here is to not commoditize the real estate investment itself, but to commoditize the product or the wrapper around which individual investors gain access to high quality real estate investments. That to me, it’s more… Look, maybe this is just because this is what I’ve been focusing on for the past five years. But I think the plumbing in all of this really makes a difference. I’ve had the benefit of being inside the institutional real estate world where I’ve seen the last 20, 25 years of growth in that business and once it got off the ground and it was mandated by law that you had to diversify. So there was that tailwind to the investment managers that they knew they had an installed client base that had to buy their product or that of their competitors, but the industry as a whole had a tailwind. And it’s grown radically as the baby boom first approached and then entered retirement, the pension fund system has grown alongside it so that there was always the need to put more and more and more money in.
Craig J. Ramsey:
What you’re describing on the retail investor side is a different kind of thing. Pardon me, there is certainly the need for the uncorrelated return you mentioned, the absolute return offered by real estate and just within a portfolio construction, real estate alongside other direct alternatives really plays a very powerful diversifying role to return. And I’m hearing this post COVID or post inception of COVID as registered investment advisors and people contacts in the industry are saying, “Look, the need has never been greater to access that uncorrelated return, I think the question is still, how does that happen on an economical basis where just using the institutional universe as a measuring stick, where you can still have highly professional investment managers advising these vehicles and pulling together these vehicles for the benefit of the individual investor. And that’s what I think, just by way of example, that a firm like Alpha differs greatly from the typical crowdfunding outlet. Crowdfunding is almost always the self-directed investor who’s got to do all that work him or herself.
Craig J. Ramsey:
Your structure in providing it, yes, you have tech enabled administrative processes, capital movement processes, you’re pushing out information to investors via electronic means all of those are means of putting a lasso around the fee bucket that would otherwise have to be charged. But it’s providing the third party advisory perspective on things that to me is a huge part of it. Because if you’re trying to compare this to institutional investing, the institutions have world class advisors to them and they’ve scaled that business and they’ve scaled it around size. If you get the best advisors in the world, they’re going to have to be paid a certain amount of money and they get that tears up just like the quality of any other occupation.
Craig J. Ramsey:
It’s easier to spread that cost over a massive portfolio. And the real trick is how do you scale those costs down to make not only the access to institutional deals available, but also make it such at reasonable fees and at reasonable minimums. Those are really the balls that are being juggled in the air. And it’s largely around that, I think the industry is going to shake out as it goes forward.
AdaPia d’Errico:
Yeah, I think… Thank you first of all, for the shout out, I guess for Alpha, we’ve always had the perspective of technology being in service to the business as opposed to it being a technology business. If this is a real estate business and that… Even for myself when I first joined real estate crowdfunding and I came at it not from the perspective of a professional real estate investor and I thought, how fantastic we’re going to change the world, we’re going to change the industry, lofty ideals with good intentions. And then it quickly became apparent that, no, this is real estate business and that is what must be focused on and technology in and of itself is not going to change how you evaluate underlying risk in real estate.
Craig J. Ramsey:
Yeah, I totally agree with that. And I would characterize it in the following way. The tech really gets to the how, it doesn’t get to the what. It’s still real estate investment management, how you do it… The day to day of checking a rent roll, making sure that the rent collections are okay and all of that stuff, that’s still pretty much the same. It’s all the connective tissue to pull all that stuff together, that we can now automate and copy paste and that works. It brings an enormous amount out of the thing. A former colleague of mine once described his view of at least early meetings with potential crowdfunders who were trying to raise money from him or use them as an underlying fun sponsor, that kind of thing. He said, “I just got so tired of people showing up telling me that the business was going to be revolutionized and that it was no longer going to be investment management, it was going to be technology.”
Craig J. Ramsey:
And that he at the time, a 25 year veteran of investment management was being told this by four groovy guys who had a server. I’ll put that in the sources list that I gave you. I’ll put his name up. He’s a longtime colleague and friend. And it just captured it for me. And I think, that view of things has certainly changed. I think we’re now past that initial euphoria, “Oh my God, this is going to change the world.” Maybe it’s not so much about disruption as it is creating efficiencies and optimizing the trade offs and tech will now help us get there. But you still need top flight investment management, you still need top flight deals on the retail side, you’d like it to be at low minimum so you can broaden the potential marketplace and the cost that goes into it can be scaled down to a point via technology and using standardized documentation, all kinds of other things. But that’s basically describing how tech has affected every single industry on the planet Earth. Right?
AdaPia d’Errico:
That’s right.
Craig J. Ramsey:
Yeah, we’re not that different. Are we?
AdaPia d’Errico:
Yeah. No, we’re not. And I think just to take this a little bit in to some of the financial markets, the jobs that came at a time, it came out of the financial crisis like so much innovation. Something that I find really fascinating is the Chinese symbol for crisis is composed of two characters, one means danger and the other means opportunity. And there’s always all this opportunity that comes from a crisis if we’re geared… If that’s our focus. And so the JOBS Act and all this innovation and the tech and the VCs and all this stuff that came from the crisis of 2008. And we’re in a crisis now. So, I would love to shift the conversation into the crisis that we’re currently in, what you’re seeing and also how it compares to prior crises that you’ve lived and work through.
Craig J. Ramsey:
Oh, yeah. I guess again, Just some bookends on what we’re seeing here. The easiest way to measure this in financial terms, the Dow on February 12th hit a peak of 29,500 ish. So just shy of 30,000. Three weeks later, it was below 19,000, it had lost 37% of its value in three weeks. Since then, 90 days after that low, exactly 90 days after that low which came on March 4th, we’re back up to 26,300 ish couple of points below. So we lost 37% initially, we’re already back up so that… We haven’t gotten to the peak again yet, but we’re still only 11% down. Now that’s remarkably resilient and remarkably quick. However, and this is where the nuance comes in. The Dow is not a measure of current assessment, it’s a measure of current assessment of future events as they play out for these particular companies. These are long standing industrials so the Dow may not be the best proxy, which was just the easiest for me to get immediate data on. But the idea here being yeah, we got whacked by almost 40% but three quarters of that loss has already been recouped.
Craig J. Ramsey:
Now, we’re in territory where it’s like, “Oh yeah, it’s 11% off that’s not great, but we’re in correction territory.” We’re not in, “Oh my God, what are we going to do?” Compare that to 2008, which was the global financial crisis. And we’ll get to some of the real differences but just comparable numbers. September 1st of ’07, the Dow was just under 14,000, five months later, it was 7000, a 49% drop. In interest, not only was the drop deeper, 37 versus 49 then, that it took much, much longer to come back. It took two years to revert to the same 11% discount if you want to look at it that way. The same 11% loss that we recovered in 90 days in the most recent crisis. So, things are moving faster.
Craig J. Ramsey:
I think that really gets to what’s the difference between these crises and we talked a little earlier before we came on that, we’re looking at a market right now or an economy pardon me, where second quarter 2020 looks like GDP is going to be a full 40%, four zero percent lower than second quarter 2019. And so, we’re trying to pull all these data together. The main thing is you can already see, yes, unemployment claims are brutal. They’re up 40, 42 million since this started, the pace of new claims is slowing down. You are starting to see things opening back up. It may be a little slower. A lot of the future is going to depend on how quickly that opens up and whether we get hit with a second wave of COVID or not.
Craig J. Ramsey:
But the bottom line is we came into the COVID crisis in pretty solid economic… You could say everything was already fully priced into the market. We had historically low unemployment across demographics, we had growing GDP, if not four or three and a half percent, it was still better than it had been for a number of years, it was still pretty solid. You can argue about tariffs and all that other nonsense, but we went into this crisis in relatively good shape with the banks themselves also being in much better shape than they were previously. Because we can’t forget that the global financial crisis ’07 going into ’08, ’09, was really a credit led crisis. We had a housing bubble, we had a lot of leverage on personal and corporate balance sheets, that leverage is much lower. I think just in terms of the real estate business private equity funds that focused on real estate, we’re about 65% levered on average. They’re now about 50 to 53% levered on average.
Craig J. Ramsey:
So, not only do we have less leverage, which is less of an overhang and an albatross hanging around the neck, there’s also much more dry powder that’s sitting there to provide rescue capital. And the banks are much better capitalized than they were at the time they’re not on that trip wire. There will be bank losses and you can probably count on a good year’s worth of those. But I don’t think you’re seeing anyone talking about big banks being in danger of insolvency, for instance. And so, in that sense, I think this one is really, really different. Then the question is, how rapid is the recovery? We don’t know. We know what it took to get out of the last one, prices on real estate took about 36 months from the low to get back to pre-crisis levels. The latest numbers I’ve seen on that same index, which comes out of Green Street Advisors, very reputable firm. The decline in ’08 in commercial property prices was 37%. The peak pre-COVID to now is about 11%. And we’re already starting to see some improvement not in the index itself.
Craig J. Ramsey:
That’s kind of a lagging indicator, but at least some of the underlying fundamentals where, okay, the worst is behind us, at least the pace of decline is slowing and that tells us we ought to be coming out of this. So I do think broadly speaking, largely because of the underlying causes of this, ’08 was a credit induced crisis, it took a ton of time to work that through on balance sheets. This one is not the same, there was generally widely available credit, it was inexpensive, it’s still largely there, the banks are going to have to deal with some losses like they did then, but it’s going to be nowhere near that problem. And there’s a lot more private equity on the sidelines to pick up that slack.
Craig J. Ramsey:
And it’s really just going to be, when do you get back to a market where willing buyers and willing sellers are transacting in the absence of distress, because I’m always very leery about looking at things that get done. There may be great opportunities to do that, but that will be much more episodic, if you will. “Hey, here’s a great deal, it’s time to pounce and we can buy it cheaply enough so that we can write out another year of problems if that’s what we have to do. It’s a great time.” But that’s unique. That’s ad hoc. It’s not systemic. We’ll know when we’re out of this thing when things start to trade again and where sellers are looking at last year’s cap rates and they’re actually transacting.
Daniel Cocca:
Yeah, the interesting thing from my perspective is that, when we were coming out of 2008 and depending on who you talk to, even people on our team, they would say, we never really even paid the price for 2008 where there were some things happening in the background in the way of quantitative easing and what have you, that really allowed us to escape in the short term without really feeling the punishment and when does that come… Does it come down the line at some point, but that aside, briefly, the question then was, where do we need to see certain financial numbers in order to… Weren’t starting to make these trades again. Today, it feels a little bit different in that the data point that we’re looking for is much more qualitative. Right? And there’s a lot of uncertainty around what the world is going to look like going forward from a pure behavior perspective as opposed to a financial perspective. And so, I’d be interested to hear how you think that distinction plays into the ultimate timing of any rebound we could expect to see here.
Craig J. Ramsey:
Yeah, there was… Actually, I will give a plug here. There was an interesting short article by a guy named Matt Hershey, who is a business acquaintance of mine who works at a firm called Hodes Weill. They are the very, very top echelon of private equity oriented firms in the real estate space and they’ve been very active in publishing a lot of thought pieces, as this is going on. And Matt makes exactly that case. When he says… When we were looking at reaction to the ’08 global financial crisis, it was painful, it was horrible, it was awful, but at least we had very solid numbers on it. We could measure Feds reaction, we could look at the banks. These were all relatively objective data points that were available. And that made decision making much, much easier. What you’re describing now and I agree with it is, there are going to be a lot of decisions that are not made based on underlying objective data, they’re going to be made by choice.
Craig J. Ramsey:
For instance, what does this mean for housing in New York City? The typical high rise has 35 stories and an elevator that’s six feet by six feet. That’s less than optimal in terms… And how does that work? Well, a lot of that is going to be dependent on how the residents feel about that. Are they locked into that? Is that a condominium kind of product or that sort of thing? And so, the short answer to what you’re saying is, it’s going to be really hard to get solid metrics on it because so much of it is going to be wrapped up in human choice and human feelings where it’s not just data driven, it’s going to be feelings driven and concern driven. That squishy your stuff, you can measure it after the fact by seeing reactions, but it’s hard to do it in real time because it’s so squishy and it’s so imprecise, if that makes sense.
AdaPia d’Errico:
Yeah. And the other thing that comes to mind when you’re saying this is, as far as behavior, but also people’s ability to pay rent with the job losses and for those who are on the unemployment and are getting the federal subsidy, especially, they’re able to pay their rent, people that maybe weren’t even making this much money before. Now, they’re making more and they’re able to pay rent in the lower income bracket. But as we also talked about, there’s job losses going upstream. And so, how are people going to be able to pay rent in six months? Basically, is what I’m getting at. Because we’re still going to see more job losses even though things will start to reopen. We also have civil unrest, which is a topic for another time, but that’s also going to affect a lot of things. We don’t know the repercussions of that yet.
AdaPia d’Errico:
So, as you’ve said, indices are indicators, sometimes lag but also on future ideals or projections or… But it’s so hard because we’re getting so many completely unanticipated, unimaginable things getting thrown at us right now. And so, that’s a lot that I just said, but basically, it comes down to… It’s almost like moment by moment right now and we don’t even know where we’re going to be in six months.
Craig J. Ramsey:
That’s precisely correct, because every single facet of this, every factor that goes into trying to assess how this is going to work, “Okay, I own a multi-family complex. What do my collections look like? What does the employment history of my current residents who may be… Are they getting close to not being able to pay rent? Or are they actually doing a little bit better off for the time being until the federal subsidies run out?” How is that going to play into this even in the larger economy? A personal concern of mine is, I don’t know how the economy… I know how we did it last time, there was a lot of quantitative easing over several rounds, because the assets that had been created got bought up so that they didn’t get devalued quite so badly.
Craig J. Ramsey:
How does that all play out here? What’s the dollar going to be worth? Are we going to be in a period… The classical economics would tell you, “Yeah, you write three and $4 trillion worth cheques in excess of receipts, the only way out of that is to inflate the currency.” However, you’re doing it in a declining economic environment. So, are you stuck like we were back in the late 70s with stagflation, which no one even knows about now. Where you have inflation but stagnation on an economic front. And in each case, it’s sort of like, “Okay, what does tenant demand look like for high rise in New York City?” I don’t know.
Craig J. Ramsey:
Tell me how scared people are about getting into a six by six elevator and I’ll let you know more. Or is there a staging tech fix that can be done to that to mitigate that problem? What it really boils down to is these are going… And we’re only going to sort it out once we start to see trends emerging, as to how much each of these countervailing factors pushes against some other factor that’s pushing exactly opposite and coming to an optimal solution. And unfortunately, just to get back to the Daniel’s question, I think a lot of that boils down to personal decisions, which are not necessarily made on the basis of hard data, but on really squishy things like feelings and fears and optimism and where each of us individually shakes out on all that stuff in the context of our personal economic circumstances moving forward.
Daniel Cocca:
Yeah, man, I think that’s spot on, AdaPia and I… And I know Craig, you and I have spoken about this before. We love talking about behavioral economics and just this idea of investors or individuals not always behaving rationally. And so, now we’re in this interesting scenario where a lot of those theories I think are going to be tested. And we’ll see how folks behave going forward. And for a group like us and I would think for most investment firms, whether you’re real estate or otherwise, it’s about being flexible and nimble of course, but, also being patient. One thing we talk about a lot is, the type of real estate we’re investing in doesn’t require us to be a first mover, we feel much more comfortable sitting back, assessing the data and then leveraging relationships to make what we believe are smart investment decisions.
Daniel Cocca:
There are groups on the other hand, who are out there trying to benefit from being more forward thinking, forward looking, maybe there’s a period of time, particularly during the beginning of COVID, where you may have been able to find a larger discount on a property than you can today, in my opinion, you are more often than not taking on much more risk than potential gain you were acquiring. But there are folks out there who are behaving in a variety of ways depending on their own individual risk appetites. And so just a long way of saying it’ll be interesting to see how things play out in the same way we look back to 2008, as a historical learning point. I think this will be something similar and however long it is in the future, when we deal with that major global economic issue that results from climate change or something else outside the hands of humans or the control of humans, rather. I think we’ll point to this and use a lot of this data as well. And so, at the very least really interesting time to be alive.
Craig J. Ramsey:
It is. And I think, one of the interesting things that investors should looking forward on as they contemplate investing into a post COVID world and selecting investment managers who are offering products for investment. Let’s not forget that pre-COVID, we were in a pretty toppy market. In just some of the fundamental data under that, we have had an exceptionally lengthy period of very, very low interest rates. Now, the impact that that has on capital values for people who are contemplating entering the real estate market is low interest rates means you can bid up price because your leverage is a lot cheaper, it allows you to put more leverage per dollar of cash flow that otherwise and you’re chasing values up, I think it’s very important to take a look at, who was smart and didn’t buy the last deal before we learned about COVID.
Craig J. Ramsey:
Because it really… And I’m not in the business of dispensing investment advice, but I do know that the people that made it out of the last one better were those that were maybe a little more sober and weren’t chasing the last 200 basis points of return and were much more interested in being solid stewards of capital making sure that downside was protected either on the revenue side or on the capital value side or some combo platter of both or other factors. I do think it will be like every other shakeout, there will be winners and losers in this. And the losers, I mentioned that on average, we are much better prepared for this one than we were in the ’08/09 global financial crisis.
Craig J. Ramsey:
We’re in the low 50s levered as opposed to the mid 60s then, but there are still those firms that are very highly levered that whether it’s in real estate or in stocks, where they’re margined up and leverage is a very unforgiving thing to the extent that people were aggressive on pricing and levered up, those are going to be the ones that… Where the chickens come home to roost fastest and most brutally. And that happens in every market decline.
Daniel Cocca:
And to be honest, that’s the most challenging dynamic we face as stewards of capital for retail investors of varying investment sophistication, which is this idea that, if I show you a project that has a return profile that is high teens, maybe low 20s from an average annual return, that presents really, really attractive to you. But we know from our experience that the risk in that transaction given all the other factors that exist in the marketplace today, is probably not worth it. And so, we live in this world where we have to find this happy medium where investors are saying, “Well, I’m okay with 60% leverage, even though that takes my 15 IRR deal at 75%, LTV down to 12 in a vacuum.” And some investors get that a lot of them don’t. They look at return profiles in a vacuum unfortunately. And we spend a lot of time, we share a lot of educational materials, we record these podcast trying to get that point across, that every deal needs to be looked at on a risk adjusted basis and there are a variety of factors that play into what creates risk.
Daniel Cocca:
And there are different ways to look at downside protection, but that’s always been the challenge with the retail investor, is finding that happy medium where you put something in front of them that they like and they want to invest in, but that also protects them from some of these known biases that we know exist and from personal experience are really easy to get excited about a deal that has huge potential upside. We’re all chasing yield in a lot of respects. And that’s where a lot of times it makes sense to rely on real estate professionals to say, “Hey, this is the universe of risk profiles that you should be looking at for reason X, Y and Z.” And so, a little bit of an aside, but just this whole thing is very… Given the current uncertainty that exists today, that way of thinking in my opinion, has become more important than ever.
Craig J. Ramsey:
I completely agree and I would point to one metric and it’s one of the things I always love looking at when I’m looking at a potential deal or understanding someone else’s deal, is how much of that total… You mentioned IRR. How much of that total return is cash flow along the way, versus terminal value when you exit the property? And because total value or exit pricing, even though it’s five or seven or 10 years down the road, can have an enormous influence on total return, it matters more when there’s higher leverage involved and so these things are like a balloon. You squeeze it in one place and it’s going to pop out in another. And there is sort of an organic thing. And in the market running up to the current crisis, things were pretty fully priced.
Craig J. Ramsey:
And to me, what placing a lot of emphasis on terminal value means really, is that you’re making a levered bet on what capital markets are going to look like five or seven or 10 years in the future, whenever it is that you’re going to do that. Because if that deal seven years hence, you are selling is not being sold into the same kind of capital market, if capital is more limited, it’s going to limit the ability of your buyer to pay up. Therefore, that’s going to be a big driver of your return. And so it’s always with an eye to that downside protection. Fundamentally, I agree with you on that.
Daniel Cocca:
And investors have short memories, right? Because over the last seven, eight plus years, what we’ve seen across the board, is cap rate compression. And so, deals that didn’t measure up on a cash flow perspective for lack of a better way of saying it, were bailed out generally across the board by cap rate compression. That’s not something we expect to see going forward, if it happens, great, we’ll all take the additional upside. But you need to be underwriting 25 to 50 bips of cap rate expansion at least, we would think into your exit cap rate, the significant majority of investor returns on most of these types of private real estate syndications come at sale and the sale is heavily impacted by the exit cap rate.
Daniel Cocca:
And these deals… This is something I lament about all the time, are forward looking projection based, which makes it very easy to create a narrative that is not always supported by underlying data. And so, having groups, financial professionals acting as intermediaries who are able to help even the playing field, so to speak, in terms of how you underwrite and evaluate transactions, we think is particularly important as part of the reason why we exist.
Craig J. Ramsey:
I could not possibly agree more. Look, the most optimistic human being on the planet Earth, is a real estate sponsor. And as investment managers, it’s your job, it’s my job to put the veil of reality over things and to say, “Well, that’s all great and it’s lovely that you’re projecting out a 16% return, but do you really think interest rates are going to stay exactly where they are for the time being? Do you really think you’re going to get 10% per year compound annual growth in rents?” I don’t think so. What is the incremental return on the money you’re getting from me to reinvest in this project and improve its performance? Is that realistic?
Craig J. Ramsey:
How have you figured in the brand new apartment complex down the street that’s in permitting right now is going to start construction in the next seven months? And what’s that going to do your rent? And maybe it’s just the fact of having been in this for over 25 years, you learn every trick in the book and you see how it works. It is fascinating and we need optimistic real estate sponsors, but we also very clearly need and the value has been demonstrated of more sober voices functioning as an intermediary between the direct users and providers of that capital.
AdaPia d’Errico:
Yeah. I think that’s such a great statement and probably a really great place to wrap up as you were saying that, I was thinking about the word real within real estate and what came through as you’re saying this, is that we have to be realistic, really realistic, these veils and these ideas and these ideals, but at the end of the day, it may be boring, because practical is boring and pragmatic is boring, but I think we stand a better chance of realizing the gains that we all want if we keep our feet on the ground. So, as you were speaking I really thought about that and just incredible amount of wealth that comes from you, I would love to have you on again maybe when we’re actually coming out of whatever this is, this massive crisis of sorts-
Craig J. Ramsey:
We’ll see how well I did.
AdaPia d’Errico:
Yeah, let’s have that conversation. But I’m sure that you’ll do well. So, thanks again so much for joining us and sharing so much insight in multiple different ways. It’s been very informative and very educational.
Craig J. Ramsey:
Well, the pleasure has been mine. Thanks for having me.
AdaPia d’Errico:
Thanks for tuning in to Real Wealth Real House. We hope that you’ve enjoyed today’s episode and found it both informative and insightful. We welcome all your questions and your feedback about today’s episode and especially, we welcome your questions about specific topics that you would like us to cover. So, shoot us an email at [email protected]. And if you have a moment, we really appreciate ratings and reviews as it helps us grow our online community and our interactions with you. And we’ll also be linking to a number of relevant articles on topics that we might have touched on during our conversations. Some of them are broad, some of them are technical, but we’re always aiming to provide information that helps you better understand the mechanics of building this healthy financial foundation especially if you’re looking to do this with real estate.
