On-Demand: The Evolution of Risk & Reward in Real Estate Investing During and After COVID

May 04, 2021

Our panel discussed what types of deals equity and debt capital is targeting as we begin to emerge from the pandemic.


Transcript

Adeola Akinrinade:Good afternoon and welcome. Thank you for joining our webinar this afternoon. I know we've all attended many virtual events but I promise this'll be worth the time. We have a great panel.

As Lexi mentioned, we'll be discussing the evolution of risk and reward in real estate investing during what has been a very challenging time.And thankfully with the rollout of the vaccines, hopefully soon there'll be a light at the end of the tunnel. By way of intro my name is Adeola Akinrinade. I'll be moderating our panel this afternoon. I'm a director in the financial advisory services group at EisnerAmper, and focused on bankruptcy and restructuring engagements.

Right now, I will turn it over to our panelist for a quick intro. Panelist if you can, please provide name, firm, what you do. In the interest of time, you have 60 seconds, no pressure. And we can start with Mark, Mark, please go ahead.

Mark Bahiri: I thank you for having me, very much appreciate it. My name is Mark Bahiri. I'm a managing partner at Emerald Creek Capital. We are a debt origination fund providing short-term commercial loans on commercial real estate throughout the United States. We are headquartered here in Midtown Manhattan.  So the bulk of our portfolio is secured by collateral located in New York City.

But about 35% of our loans are secured by commercial real estate in other national markets, primarily core markets, Chicago, Miami, Los Angeles, San Francisco. We launched our company in 2009. It's been about 12 years and we're on our fifth fund and actively lending for short term commercial needs.

Adeola Akinrinade:Thanks Mark. Ray?

Raymond Gong:Thanks Adeola. Thanks for having me. My name is Raymond Gong. I'm a managing director at Oaktree Capital and we manage about $14 billion in real estate assets here at Oaktree. We manage them across a few different strategies. We have a core plus vertical, an opportunistic vertical in debt as well. I work across all three and across all asset classes.

And have historically focused personally in the Midwest and Northeast and Mid-Atlantic, but has spent time around the country. And so I think we've seen a little bit of everything over the last 13 years here at Oaktree. So glad to be here.

Adeola Akinrinade:Thanks Ray. Josh?

Josh Winefsky:Thank you. My name is Josh Winefsky. I'm a partner in the real estate group at Kramer Levin. We have a full service national transactional practice at Kramer Levin. We do work for owners, operators, developers, and all types of capital providers. In New York, our development work is complimented by a market leading condominium practice, and we really pride ourselves on finding creative and practical solutions for our clients.

Over the past year, I'd say a majority of my time I've spent on acquisitions and well as deals involving ground leases, leases, and also complex condo transactions. On a personal note, I'm a proud and very exhausted dad of two little kids. And today was the first day of my six-year-old daughter's school being open five days a week.

So to all the working with the parents out there, we got this. But professionally and personally, I think this thing is very exciting as we are seeing more and more things continue to open and hopefully I'll get back on our feet. So thank you, and looking forward to this.

Adeola Akinrinade:Thanks Josh. Joe?

Joseph Rubin:Good afternoon, everyone. It's great to be here. I'm Joe Rubin with EisnerAmper. EisnerAmper has a really great real estate group focused on all service types and all types of clients, whether it's private companies or private equity funds and REITS. My focus is on the advisory side. So I've been working to help our clients get through the pandemic, focusing on new investment strategies, operational efficiency, the diligence in transactions, and also doing advisory around distressed debt.

Adeola Akinrinade:Thank you Joe. And I apologize. I forgot to mention we would like this session to be as interactive as possible. If you have any questions, please feel free to type them in the Q&A box and we will try to address them during the panel. And I think we can get started. So let's do a quick overview here. Why don't we start with a general overview of the market, when you think about the transaction market today what types of deals are you seeing? Ray maybe we can start with you.

Raymond Gong:Sure. It's interesting I'd say 13 months into the lockdown or, I guess we're coming out of it finally. I'd say I'm the busiest I've ever been. Potential deal volume is pretty high. And in fact, I feel honestly busier than pre-COVID. That said we're not necessarily transacting more. We're definitely seeing a lot.

I think there was certainly a pretty large log jam of opportunities that sellers weren't quite ready to hit the market with. And you're starting to see a flood of those opportunities come out in a variety of different ways and a variety of different types of transactions. And so from a sheer volume, there's a little bit of everything quite honestly from, small retail opportunities to large portfolio recaps. We're seeing a little bit of everything right now.

Adeola Akinrinade:That's great. Mark, is it okay if I go ahead and ask you that same question just from a lender standpoint, what types of deals are you seeing?

Mark Bahiri:Sure, sure. So yeah, I agree with Ray. I mean, if I look at the pipeline of the loans that we have today with attorneys scheduled to close, it's as large as it's been over the past 12 months. I think when COVID first came about, we obviously took a pause. There was a major pause in the overall marketplace.

But it was slow to coming back, and I think with the vaccine now being distributed people are getting more confidence in the marketplace. And the majority of what I do is on the acquisition side. So we provide acquisition loans generally to people who don't have time to wait around for a bank. Now maybe the banks they're still slow to close.

So I think it illustrates a level of confidence in the market today that didn't exist in the past 13 months, just by the very nature that all of the loans that are with the attorneys for the most part are acquisition loans. So people are looking to transact again, looking to buy and sell real estate assets. And that's something that I don't think we've seen a lot of over the past year.

Adeola Akinrinade:And would you say with some of these deals that you're seeing are these transactions with well-performing properties, recaps, distress.

Mark Bahiri:Yeah. Look, so we're opportunistic in nature. So we're not really lending on distress situations if someone's needs a foreclosure bailout, they're not going to come Emerald Creek Capital for that. It's more optimistic looking to purchase an asset that maybe needs some renovation, some rehab money, stabilize the asset and then take me out with a conventional bank.                                            
But we are seeing a lot of requests that we haven't seen pre-COVID, which we see a lot of hospitality deals now where they're looking at convert the hotels to multi-family, to the extent that it makes sense. We were seeing a lot of condo inventory deals six months ago, we're seeing less of that today. I think part of that is a reflection of the general market.                                            
And Manhattan still has a little ways to go on the condo market. But we were seeing a good number of condo inventory deals six to nine months ago. We're seeing a little less of them today. And then the other thing that we're seeing a lot of maybe more so than we were pre-COVID is construction completion requests.

So we have construction loans in our portfolio as well. It's not the majority of what I do. So we do involve ourself with construction deals, we don't love mid construction deals. It's just difficult to understand the risk involved if you weren't involved from day one. But with that said, we sometimes do them and we're seeing a lot more of them today.

And I think part of that is because, well, there was a shutdown in all construction activity for three months at the peak of the pandemic. And I think borrowers because of that have gone over the time allotment allowed for the construction term. And a lot of them are over budget. And the values maybe aren't what they thought they would be if the construction started pre-COVID. So we're seeing a lot of those opportunities as well.

Adeola Akinrinade:Well, thank you for that. Ray, maybe I can ask you just with regards to their property types or markets that you're avoiding, anything of that nature.

Raymond Gong:Yeah. And just to chime in on what Mark was saying, it does feel like there has been a lot of pent up supply and demand. I think there's certainly pent up demand to acquire assets, and that's certainly driving Mark's business. But there's certainly a pent up supply of deals out there. And I think a lot of sellers that wanted to transact in 2020 decided let's table it and wait till 2021 and see how things go.

And that's big, it's opened up at this point. And so I think definitely a reflection of where we are in the world right now. And I'd say there's been a dichotomy of opportunities out there. I mean, anyone that's been pursuing industrial, it's as if the market got better for industrial, right? I mean, there was barely a blip in the industrial world.

And so transaction activity is still very strong there. And if you have a well located triple net leased asset whether it's office, retail or industrial that's been extremely attractive for investors. And so we're seeing a lot of activity on that end. And then I think if anything is lagging, I'm not seeing as much office and retail transactions actually happening yet.

I think just by the nature of an office deal, I think it's still somewhat finding its bottom. And so I think everyone's in wait and see mode still when it comes to office. And so I'm not seeing so much action on the office side. And again, I think all retail is certainly not made equal. And so you're seeing the grocery anchored well leased retail trade.

You're not seeing the B-Mall that was troubled before COVID, transacting post-COVID. And so there are certain pockets of opportunity there, but I'd say those are somewhat lagging and all the other asset classes seem to be back to quite honestly pre-COVID transactional levels at this point.

Adeola Akinrinade:And I have a follow-up to that. When we think about the competition for deals, what would you say distinguishes the winners from the losers?

Raymond Gong:That's a great question. Other than paying the most for the asset, look, I'd say our mantra is we joined venture with operators on almost every deal. And we try to find the best operative work with in each market because we fully recognize that, ultimately real estate is a local business. It's a boots on the ground business.

And I think we do a great job of finding the best boots on the ground. And honestly with that comes really good proprietary local relationships, really good information about the sub market, really good angles into opportunities. And so that's something our partners can bring to the table, whether it's deals in their own portfolio, whether it's deals that they had developed at one point, they had owned at one point.

Or deals where they belong to the same golf club as a particular seller in that sub market. And so that's helped us really find interesting opportunities, but also giving us a little bit of a competitive edge. So I'd say honestly, finding those great partners and being a good partner with them has been our leg up ultimately.

Adeola Akinrinade:Yeah, absolutely. Thank you for that. So I know Josh earlier when we were going over these things, I know there was an example that you wanted to share with the group.

Josh Winefsky:Yeah. I think that the issue of how to distinguish yourself obviously as Ray pointed out dollars help, a lot usually. But I think that in addition to showing that you're able to pay the top price and also are able to show a seller that you can close. With that comes having the in deal savvy and ability to be a deal-maker and know what the issues are that you should be focusing on, and what the issues are that you could move past and live with.

It's a market where there are a lot of people kicking the tires on deals and I think you just need to have that deal-making hat on in order to get a deal done. And Ray mentioned retail. I was working on a retail transaction a few months ago, where it was not a distressed transaction our client was buying into; there was credit and term on both of the leases.

And so it was by no means a distressed deal, but there was a garage component to the property as well. And through the course of our diligence, before we signed the contract, it came out that the garage operator was in default, that they were not leaving and that the seller had actually already initiated a lawsuit to get them out.

So we were at this crossroads, how are we going to deal with this? Are we going to kill the deal? Are we going to assume the litigation on the other of the deal, on the other side of the closing? Or are we going to try to come up with some middle ground, some way to save this without having to go through the time and legal fees that it would take to really wrap your arms around the diligence, that it would take to step into a litigation?

And so what we ended up doing was, we agreed upon an indemnity that we were going to be getting from the seller from a credit worthy entity. And the seller also agreed to pay us a monthly fee that was for the carry of the garage portion, enough to cover the expenses and also to keep our lender happy.

And taking this alternative approach and not letting this garage issue cloud what the real deal was, which was a retail acquisition in a prime location. It allowed the deal to proceed without any interruption, without an unnecessary amount of legal fees span without a time passing by and possibly another buyer coming out of the woodwork who was willing to do something different.

So I think it's just a matter of always being on your toes and willing to identify the things that don't matter as much as the things that do.

Adeola Akinrinade:Absolutely. Thank you for that Josh.

Raymond Gong:I might just jump in real quick. I was just going to say, I think Josh brings up a really a great point, being that is he's in the middle of a lot of transactions, is that I think we've been able to grow our business. Because I think we're obviously great partners with our operators but, you have to be a great buyer, you have to be a great seller, you have to be a great borrower.

Because to Josh's point if you don't have a reputation of being a group that can get creative and figure out how to wrap your head around different risks, then you won't be selected as a buyer if you're not known to be someone that can get over those issues. And honestly, I think same goes when you're a seller, right?

Because the reality is we're buying and selling from each other all the time. And you want to develop a relationship or a reputation that you're easy to work with, that you find a way to bridge those gaps. And even as a borrower, always doing the right thing as a borrower. And I think clearly over the last 13 months I think if you had a reputation as a good borrower, it probably got you through the trough a lot easier than if your reputation was not so good as a borrower.

And so I think all those things are important and ultimately, could make the difference between winning a deal or not. So I think Josh brings up a great point.

Adeola Akinrinade:No, absolutely. Absolutely. Thanks for that. So we've talked a little bit about just the transaction market. I'd like to switch over and delve a little bit into the diligence/underwriting. And my next question, this question is actually for Mark. Just as a lender, how has the criteria that you use to analyze a potential sponsor changed relative to 2019?

Mark Bahiri:Well, we look very closely at the sponsor we always have I mean with that said, we are collateral based lender. So the average loan to value in my portfolio is somewhere between 50 and 60%. And we get first mortgages, we generally get a pledge of the membership interests, and we often do get personal guarantees.

So we look at the guarantees, it's obviously very important to us. We need to understand the exit strategy. But I would say we're looking closer at it today than we were pre-COVID in the sense that if I look at the portfolio, it held up very well throughout the pandemic. There were only a handful of deals that needed some forbearance or modification.

And the ones that didn't, that maybe you would think maybe it's a retail center, maybe their tenants weren't paying the rent, so how's he going to pay the mortgage? Well, it comes down to the financial strength of the sponsorship. And so obviously a sponsor with more experience with deeper pockets and liquidity, is going to be able to survive a storm like COVID.

And so I think it's important when we underwrite our deals to really understand the sponsorship and how strong they are.

Adeola Akinrinade:And that wasn't something that you were necessarily doing pre-COVID with regards to the sponsor's liquidity?

Mark Bahiri:Well, it was. But I didn't foresee a complete national lockdown.

Adeola Akinrinade:Of course.

Mark Bahiri:And when I underwrote a retail strip center, I never anticipated that by law, they would have to all close for a period of time and then no one would be required to pay rents. So we look at things differently today obviously than we did pre-COVID, anything can certainly happen.

Adeola Akinrinade:No, absolutely. And I know you mentioned collateral and personal guarantees and things like that. One follow-up I would ask is, have you changed the types of security that you're asking for in some of these deals?

Mark Bahiri:We generally get most forms of security on a deal to begin with. Obviously the first mortgage. Pleasure the membership interests, and we try to get personal guarantees. There may have been some deals pre-COVID, the on non-cash flowing assets, whether that's a vacant warehouse or a development site. Where we made some exceptions and did not require personal guarantees on those particular asset classes where today we are requiring this perspective.

Adeola Akinrinade:Yeah, absolutely. That makes sense. And then Josh, I don't know if you have just a few minutes to maybe just talk a little bit about just from a legal perspective, how much faith are your clients putting in guarantees right now?

Josh Winefsky:Well, I think it depends on the type of deal we're talking about. At loan origination, it's a different story. I mean, it's more of a business decision and it is market driven if there's a particularly attractive debt package, for example. That lenders might be fighting over, a borrower might have some success in dictating the terms of the type of guarantee that they're willing to give.

If it's a deal though where you're buying alone and, or for example, I know that it's not the same type of market, but if you're underwriting an office building where there are at lease guarantees, part of the analysis it's really twofold. You need to understand the current credit of the guarantor and make sure that it's a worthwhile paper that you're getting, and also the likelihood that you're going to need to enforce it.

So is the tenant that the guarantee is backstopping, is that tenant performing? Is the loan that you're looking to purchase, is that going to be something that's going into default or is already in default possibly? And so when you're doing that, if you think that you're coming into a situation where the guarantee is going to come into play, it doesn't mean you run away from the deal.

It just means that it could become a very different transaction if that suddenly factors into it, and it changes how you have to underwrite it. And so if that's the case, it's very important and it's conversations that we have all the time. Because we work very closely with our real estate litigators. It's really important to bring litigation folks into a diligence process, because they're going to help you understand how well written the guarantee is, how clearly it's tied to the obligations that it's backstopping.

Because at the end of the day, if you're stepping into the shoes of either the lender or the landlord, you want to make sure that you can enforce that guarantee ideally through a motion for summary judgment. Which really means that from a timing perspective, you could potentially enforce it and be successful in anywhere from let's call it, eight to 12 months, right?

And that's a best case scenario, right? When the facts are lined up in your favor. If you can't prevail on a motion for summary judgment, you could be in court for years. And so that changes the entire underwriting dynamic. It changes your investor expectations. And so that's why it's critical at the diligence phase to really look at it and map it out and what the timing is going to be with for that process.

Adeola Akinrinade:No, absolutely. That's very important. So why don't we switch over to what I'll call the financial advisor's perspective and Joe, this question is for you. How has the approach to diligence changed and, what are you focused more on just given everything that's happened in the last year?

Joseph Rubin:Thanks Adeola. So first of all, we in the real estate business know that every multi-family or commercial property is unique. And I think that was absolutely proven out during the pandemic, because each property performed in its own special way, depending on where it was and what it is and what the tenancy looks like.

So we have to remember that each opportunity that we're looking at in terms of an acquisition, has its own risks and its own rewards, and not every hotel or retail is in distress and not every industrial property is doing great. So we try to look at the specifics of each situation to build out a diligence program that's appropriate for that particular deal.

And our main focus really is quality of cash flow. We've been looking more probably than before COVID, looking more through the leases to the tenants themselves, understanding their businesses, understanding their credit and their cash flow and liquidity situation. Certainly looking at their payment track record during the past year.

And of course on a property level, looking at collectability generally and what the arrearage rents might be, some properties have racked up quite a lot of arrearages that I've seen recently. And you have to assess how collectible that ultimately will be. And so we're looking more at the tenants and then of course, you know, by property type, there's different hot buttons.

In multifamily, which of course in many places around the country is doing great. And some places like New York City is really struggling. We look at tenant turnover trends, we're looking at, again, the collectability. We're looking at eviction moratorium depending on where it is and when those are going to be lifted, and how much that particular state is working to provide rent relief to tenants that the landlord might work with the tenants to try to achieve.

And in office as was said earlier, that may be the biggest question mark. So we're certainly looking at a lease expirations very, very carefully. Thinking about what's going to happen when leases expire, has the tenant said or done anything to indicate that they may want less space, they may have already sub-let, or they may have already put in a request for an early lease termination or a reduction of space.

So we look at all those kinds of things and in all these property types, what concessions have been granted over the last year to existing and new tenants and what the burn-off period will be. Hotels of course are a different animal. The demand there will recover based on the demographics of the guests, is it leisure? Is it business? Is it group? Is it fly in? Is it drive to? Is it international baser, domestic based?

And so we definitely have a bit of work there to try to project when cash flows will recover fully. So the bottom line in all of this is, for each property that due diligence is customized and it really needs to be designed to hit on those relevant topics for the situation.

Adeola Akinrinade:Great. Thanks Joe. So my next question, putting on the equity hat Ray, how are you analyzing and underwriting vacancy rates today relative to 2019?

Raymond Gong:That's a great question. I think we're all trying to figure out how exactly to underwrite in this new environment. I'd say a shutdown hotel is easy, that's a zero. But I think to Joe's point every asset's a little bit of nuance, and so I think when it comes to vacancy rates take office for example. We are definitely ultimately a bottoms up shop.

I think we're looking at things similar to Joe where we're looking at really the quality of the tendency, are they going to stay? Are they going to go? Will they downsize? And really try to understand their needs ultimately. And I think one of the advantages we have is it is again our local boots on the ground, right?

Which provides us with some insight into the performance of a lot of relative assets. And so we can work with a partner who happens to own competitive assets in the market and get insight into how are those assets performing, and what the trajectory of those are. Or simply just insights into other competitive assets that you can't find in CoStar or REIS.

And so again, I think being able to have that local color has been pretty helpful for us, and ultimately we're building up our cash flows again from the bottom up trying to figure out what the demand is and taking it from there. And so it's not that different than pre-COVID. I think it just introduces some more variables and introduces a little more work. I think we all took for granted how people were going to use office going forward. And now we have to be a lot more thoughtful about how people use office. And so I don't think anyone has as the right answer but, I think we always have to be a lot more deliberate and thoughtful about how to think about those.

Adeola Akinrinade:No, absolutely. Mark, maybe we can get your perspective as well from a lender standpoint.

Mark Bahiri:Yeah, no, I agree with both of them. I mean, I think it really depends. I mean, vacancy rate is largely dependent on the asset class and to some extent, certainly the geographic location. I think states like Florida obviously are coming out very strong, and the Southeast in general. But when I look at Manhattan office market, there's a lot of uncertainty there.

I don't think that it's work from home going forward. But it's probably somewhere in the middle, when I think about my company, is everybody super excited to go back full-time working in the office come the fall? Probably not. So we'll probably meet in the middle of somewhere and yeah. Probably need less office space because of it.

So I think we definitely have to be more thoughtful, and it's a bit of a wait and see approach. I think the next six to 12 months we'll bring a lot of things to light as it relates to that.

Adeola Akinrinade:No, you're absolutely right. Yeah. Well, we'll see what happens in the near future. Thank you for that. Josh, I think this would be actually a good place to maybe share from a legal standpoint the importance of getting estoppels from tenants, especially in this environment.

Josh Winefsky:Sure. So my job is to make sure there are no surprises and, we use the purchase and sale agreement or whatever the appropriate document is to make sure that everyone's disclosing what's required to be disclosed. And so really that comes about in two different ways. First one I would say is, and everyone's touched on this. You have to have the contractual right to actually talk to the tenants, to make sure you can get in there to have access to the property, to make sure that you could see what's going on, that you could put eyes on the physical space. It really is so much more of an art and a science right now with diligence, because everyone it's just guesswork sometimes in terms of how the space is going to continue to be used.

And so making sure that you have this contractual rights to speak to tenants, is so important. Estoppels are also incredibly useful. I don't think anyone's going to get an estoppel certificate from every single tenant. It never hurts to ask, but I don't think it's going to happen. What's even more important I think is making sure that you're getting appropriate reps from a seller, and using estoppels to interplay and reconcile with the information that you're getting with the seller.

And here's a really I think a good way of thinking about it. So it's not enough to just have a seller tell you that a particular tenant was not in default or is not in default. What you really need to seller to tell you is that they've delivered to you an entire lease file, including material correspondence like notices that relate to a potential default. Or requests from a tenant or relief for some sort of economic concession.

It's important that those are the words that are actually in the contract. And then it's also important to get a statement from the seller that says that we have not granted any concessions, right? Or to say what the concessions are, because all of that gives a buyer a lens into what the actual financial viability is of the tenants.

Because you get to look in the past, not just the fact that as today, as of the day that a representation is being made, a tenant might not be in default or a tenant is paying rent. So it's really important to know that, because if a landlord or if a seller is just asked to say attendance, not at default, it's just really not telling the whole picture.

And similarly, if you're getting a tenant estoppel certificate, a tenant might just say, "I'm not presently in default, but it doesn't necessarily speak to the past." And you're not necessarily allowed to ask a tenant based upon its lease for all these little nuanced kinds of statements like, "Hey, did you ever request rent relief?" 

They might not have an obligation to actually answer that question. So that's why it's so important to get the answers from the seller to have those backstopped by a credit worthy entity. And to make sure that you are not going to be surprised the day after you close to find out something about the property.

Adeola Akinrinade:No, absolutely. Thanks Josh. And as I think about underwriting the property and all of the different things that go into it, one question comes to mind and I think Joe would probably be a good person to speak to this. But when you think about situations where CapEx has been delayed, so deferred maintenance and things like that. How should we think about that, or assess how well a property has been maintained during the pandemic?

Joseph Rubin:Sure. So I mean, obviously one of the really key issues for many property owners over the last year or so has been liquidity. If the rents haven't been able to be fully collected, it puts a liquidity squeeze. And as we all know, when we underwrite usually the first thing that goes is the maintenance. So the good news is that now we can actually look at properties again, now that the lockdowns are being lifted and hopefully people are vaccinated and can travel.

So we can take a good look. And obviously whether it's debt or equity, there'll be an engineer come and you'd give a good inspection of the property is part of the due diligence. But we may find that there's a little extra deferred maintenance than we typically didn't used to. And that just needs to be provided for either in the pricing or in the negotiations, to make sure that the property can get cleaned up in a reasonable amount of time.

And that's particularly true if there's vacancy and we need to lease up and attract new tenants. We want the property to look its very best.

Adeola Akinrinade:Thanks Joe. And I'm just watching our time I think we're still good. So we've talked through the transaction market, the due diligence, I'd like to switch over now to cash flow and valuations. And Joe's into which you're speaking, maybe we could turn it over to you to just talk about some of the general considerations people should be thinking about with regards to that.

Joseph Rubin: Well, just, I guess on the cash flows I mean, we've said it all in different ways here over the last half hour. And when we're doing cash flows, I think there's more uncertainty than we would have had in a normal market. And as Mark articulated perfectly in his own situation, I think a lot of tenants just simply don't know what they're going to do.

They don't really know if their folks are going to come back to work or how many days are they going to all come back and then they may need more space because they need to separate them a little bit more, or are fewer going to come back, and so they need less space. It seems to me that the one certainty is not knowing and that tenants may ask going forward as leases turn for more flexibility.

And so what that really translates into is maybe doing different scenarios in the cash flow model. I mean, often we used stress tests here and there, but it was often a minor exercise and there was the base case was the base case, and that's how you won the deal. But I think investors now we're probably going to have to have a little bit more scenario analysis where they play around with the assumptions a little bit more and tweak here and tweak there and say, "What's the pace of lease up? What's the renewal probability?"

I mean, that's a great example. You put renewal probability in an Argus model, and it's the same percentage you've been using for the last 20 years. Well, maybe this year, it can't be quite so high. So I think that there's just got to be a little bit of variability in the assumptions, and then see where the cash flows come out and where you're comfortable pricing risk.

Adeola Akinrinade: Yeah. Thanks for that. Maybe I can turn it over to Mark or Ray for the next question and just talk about if you're running more tests done on your cash flow projections currently.

Mark Bahiri:Well, when we're underwriting a debt opportunity we have to make assumptions on a going forward basis as to absorption periods and vacancy rates. And depending on the asset class, it's obviously more difficult to do that today, especially from my perspective as a short-term lender our loans are anywhere from one to three years.

So I'm not projecting out cash flow models for the next 10 or 20 years, because I'm expected to be out of the transaction usually within 24 months. And so obviously that creates some hurdles of its own, when you're trying to project cash flows for the next 24 months on an office building in Manhattan or a retail center in the suburbs.

I can tell you, just driving through Manhattan the other day, it seemed like one out of driving on Broadway South going all the way downtown it seemed like one out of every three storefronts was closed, like totally vacant. So I don't know what the vacancy rate is right now for ground floor retail downtown.

Obviously it very much depends on the street and the block, but it seems extremely high to me today. And so if I'm going to make a loan on a retail condominium on the corner of Broadway and down there, we're probably going to reserve for interest on that deal for the term of the loan. I mean, I'm not going to make an assumption.

Maybe they present an LOI or just tell us there's a lot of interest. We're not going to make an assumption that the retail tenant’s coming in, in the next six months, and it'll be cash flowing one-to-one. We're probably going to take interest reserve for the whole thing. And the same thing with office we always cover, we always build in an interest reserve to cover for any debt service shortfall.

Which can often exist even on a stabilized asset because being a short term lender my interest rate can be seven, 8%. So it may not cash flow one-to-one, so we will cover for the shortfall. But now we're obviously looking very closely at lease expirations and probability of renewables and we're more apt to now build in an even larger cushion of interest.

Just to weather another potential storm, or just because it may take longer for things to come back to normal.

Adeola Akinrinade:Yeah, absolutely. Ray, do you have anything that you'd like to add?

Raymond Gong:Yeah. Look, we'll run a pandemic scenario from now on I guess. Just a full 18 months shutdown see what happens but, we've always run a lot of scenarios. And I think there will certainly be a little more focus on what that downside scenario is. We've always run a downside I think, we'll generally be a little bit more conservative.

But I think that we pride ourselves on being smart about how we take risk and ultimately being contrarian too. And so we're certainly not running away from anything that seems hard to underwrite, right? So I think we ultimately box our risk by really focusing on true fundamentals, right? I mean, I think there will be across all asset classes, a real flight to quality.

And so I think if we're focusing on the right assets on the right corners, with the real eye towards what the credit of our tenants are, I think Joe had touched on that. And being pretty thoughtful about what the recovery is going to look like for those types of assets. I think our underwriting won't be that different.

I think we'll just be a lot more careful about how we, "Pick our spots." But I think the tough environment out there doesn't scare us, I think we'd like to jump back in and wherever we can.

Adeola Akinrinade:Sure.

Raymond Gong: But definitely being a little bit more conservative, and definitely being very careful about picking those spots.

Adeola Akinrinade:Well, absolutely. And maybe you could talk a little bit just with regards to the valuation, how to assess values in an environment where we have such few benchmarks today.

Raymond Gong:Yeah. It's a great question. Luckily, the transaction market is starting to thaw a bit and so the points out there, but look, I think again we come back to we're a bottoms up, very fundamentals focused shop. And so we look at everything certainly on a relative basis and in the context of the greater economy and sub-market.

But at the end of the day we're also looking at if it's an office building in Hudson Yards or, a suburban multifamily asset outside Chicago. We're diving into the actual demographics and demand and, and really drilling down on the fundamentals of that particular asset. And so I think what that generates as a price we can pay based on the returns we're trying to generate.

If there was no comps for it, it doesn't really concern us. And in some ways, if there are no comps or data points. In some ways it's a little bit of an opportunity, right? And I think it shows that perhaps we're uncovering opportunities that others haven't yet. And so we're not too concerned about lack of transaction comps and data points.

I think it's possible that that poses opportunities and I think as long as we continue to focus on the fundamentals and, it really comes back to the sticks and bricks and the demand of those sticks and bricks. And so we'll just continue to stick to our guns that way.

Adeola Akinrinade:Oh, absolutely. One other follow-up I have is just when you think about the property appraisals and things like that, are you scrutinizing those assumptions more? And how has the process changed?

Raymond Gong:That's a good question. I think maybe personally that there's probably a little more of an education process as we work with the appraisers and, I think there's a lot more dialogue that goes into collectively figuring out what valuation is. And so I think oftentimes we get an interesting viewpoint from the appraisers and they get a pretty interesting viewpoint from us and we're finding some middle ground there.

But I think it's always been that way and honestly, it may be today's environment poses a little more challenge. But we haven't again like we aren't necessarily relying on appraisals, they are important but for our own investment purposes we do a very deep dive of our own. And so we're trying to find ways to perhaps have the appraisers learn from them and hopefully educate them as well.

Joseph Rubin:Yeah. I'd just add to that. I think you're right on the middle ground. I've been through a lot of these cycle turns, and it seems the appraisal industry often takes a little while to catch up not necessarily any fault of theirs. And some treat a downturn by getting more aggressive on price and some get super as conservative.

So the key thing is just to dive into all the assumptions the appraiser is making, and make sure everybody agrees that those assumptions are supported in doubt, validated by the demographics and supply and demand in the market.

Adeola Akinrinade:Yeah. Thanks Joe. Mark, do you have any thoughts to add to that?

Mark Bahiri:No, I agree. I mean, we do our underwriting internally. We do get appraisals for every deal and we want to make sure that we cross check the data from the appraisal with our internal underwriting. But especially today, I think that the likelihood again, depending on the asset class for a property to over appraise if you will is higher today than pre-COVID.

Just because if they're using sale comps on retail from 2019, I'm not so sure it's going to sell today at that same price per square foot. And I'm not so sure that the rents today, a new lease going into place today for retail is going to be the same as it was in 2019.  I would venture to say that it won't.

So we obviously looked very closely to the appraisals if it's coming in much higher than what our internal underwriting is, we're looking very closely at how are they coming to their conclusion and to the extent that they're using sale comps pre-COVID. Especially on a retail or office asset, we're going to dive into that and we're going to question it.

Adeola Akinrinade:Yeah, no, thanks for that. So I mean, looking at the time right now we have a couple more minutes before we finish I think the next question that I'd like to spend one or two minutes talking about is just if you're currently fundraising, how has it been fundraising in this environment? And are you finding that capital as readily available for real estate investments?

Raymond Gong:I guess I could jump in. It seems like we're always fundraising for something at Oaktree, but I think folks I'm sure saw we raised large real estate fund through this last year. And so it's hard to know how much capital's out there and who has it but, I could say from a transaction activity standpoint we're seeing a lot of deals actually get done and not necessarily by us.

And so I think there's certainly a lot of capital out there because we're seeing deals that maybe we're not so comfortable with are getting done. And you're not seeing so many deals that are being shelved which we saw when the lockdown started. For several, maybe six months there, a lot of deals not transacting. And so I'm seeing a lot of deals actually transact which to me, tells me there's a good amount of capital out there.

Adeola Akinrinade:Mark?

Mark Bahiri:Yeah, I agree. We manage a little under a billion dollars of assets. And our last vehicle that we raised was oversubscribed by about 20%. So it's a good problem to have, but obviously we get phone calls because it's a commitment draw down structure. So if we anticipated drawing down full commitments within six months, it's taken a little bit longer, but at the end we want to be prudent, we want to be careful.

And I think investors at the end of the day appreciate that. But there certainly is an appetite, it appears to put capital to work, especially in our space.

Adeola Akinrinade:And Mark just a follow-up to that, one of the questions that came in is just with regards to the investors, how do you discuss the risks in the market to get them comfortable, whether they have to wait a couple more months and things like that?

Mark Bahiri:Well, we're very transparent. We obviously do a lot of reporting and we have a lot of dialogue with our investor base. But I think as we discussed earlier, if you stick to the fundamentals, I mean, what we're doing today is really not that different than what we were doing five or 10 years ago. I mean, we're looking for core assets in core locations, with quality sponsorship.

And if we stick to that as our mantra I think, we'll survive the downturns and we'll be okay. And that's something that our investors over time, I think have gotten comfort in our ability to remain conservative, stick to our fundamentals. I'm not trying to all of a sudden started lending on Bitcoin, we're sticking to what we know, and it's proven the case so far.

Adeola Akinrinade:Yeah. I think there's a new one now, Dogecoin maybe.

Mark Bahiri:Yeah.

Adeola Akinrinade: I can't keep up. So we have about a minute or so, I just wanted to open it up quickly to the other panelists if there was anything else anyone wanted to chime in on.

Joseph Rubin:Well, I'd only add that I think everyone's said it we've got to really look at deals closely, we're in a market that's emerging I'd like to think. But it's still got a bunch of uncertainty, a bunch of risks. And as we keep saying, you really have to pick your spots.

Raymond Gong:I think you mentioned the flight to quality. I think that it's going to be fascinating to see how that you have a lot of people who are perhaps willing to pay more than others are comfortable paying. Because the asset is actually standing out as a quality asset, maybe when there's a dearth of quality assets.

And so perhaps just to see how the middle market of this, where it's just not greater quality, but it's also not distressed. How is the middle of going to fill in? And I think that once that picture really starts to get painted, you'll start to really see the acceleration and deals getting actually done.

Adeola Akinrinade:Okay, great. Mark, Ray, Josh and Joe, thank you so much for participating in our panel. This is great, a very insightful conversation on behalf of EisnerAmper and Kramer Levin, thank you all for joining, stay safe and be well.

About Adeola Akinrinade

Adeola Akinrinade is a Director in the Financial Advisory Services Group and has over 10 years of experience providing financial and strategic advisory services to companies and creditors.

About Joseph Rubin

Joseph Rubin has experience working with real estate transactions, governance and reporting and distressed debt restructuring.

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