Adapting To A Changing Market with Zack Streit  | StreetBeats Ep. 110

- Welcome to another edition of CrowdStreet "Street Beats". My name is Ryan Strub. I am the head of commercial investments here at CrowdStreet. And today I'm joined by one of our regular guests, Zach Streit from George Smith partners. Zach, how you doing today?

- Hey I'm doing great Ryan, great to be back with you.

- Yeah, great to see you. It's been a couple of weeks now. I know you've had a very busy travel schedule as a lot of our team members have as well going to conferences, you know, sleep tours, market tours. I know you were actually at ULI in Chicago with a couple of members from our CrowdStreet team as well. How did that go?

- ULI was great. A ton of optimism for the future, for sure. It was probably at like, half capacity, but for them that's probably 2000 to 2500 people. So I'd say that's still considerable. Our product council was great. There were a lot of folks there. They asked for proof of vaccination, which I think is becoming more regular at conferences, but I think that made people feel a lot more comfortable. And I think that's probably the key to, you know, getting attendance back up. But I think, you know, major issues discussed at ULI, supply chain issues were a really big one. They're out there, they're real, they're not going away overnight. I think a stat that was quoted is that there's something like 96 ships that are off the coast of LA right now, when I think there were like 62 a month ago. And the coast of LA accounts for about 40% of the cargo going into the US, so. And you can't just, in Peter Linneman's words, and people were quoting him saying, "Turn off the economy for a quarter, two quarters globally and then turn it back on." And so you're sort of seeing that, you know, in these supply chain issues, logistics issues. Labor issues, that's another thing everybody was talking about at ULI. And how long does it take for the labor force to get restored? And a lot of that has to do with, you know, government incentives. And I think there's a lot of optimism that in the next quarter or two, you could see two to three million people return to the labor force, which probably helps with some of those supply chain issues.

- Yeah, on the supply chain side Zach, we've encountered some of those problems as well. I think from our standpoint, how that's adjusted our underwriting a little bit, right? Getting to make sure that we have enough kind of built into our construction schedule to deal with delays of supplies coming in, you know, delays in terms of actually being able to get workers out to the site. And so we're starting to see those construction timelines expand a little bit. I wouldn't say it's been dramatic you know, kind of pro forma busting by any means. But it's definitely something we've been cautious of as we look at new deals.

- It's so interesting, to your point, a bunch of the developers at ULI were saying, okay, we're pleased that lumber, for example, which is like the poster child of supply chain issues has moderated. And it isn't like, $1600 per 100 square foot board anymore. But even though it's gone down to $500 or $600 last I checked, all the developers were saying, hey, I can't buy at that spot market price yet. But at least I'm not locking in my GMP up here. So absolutely to your point, any additional contingency and some room in your construction numbers for sure.

- That's right. Yeah, no, it's been interesting for us. And I think it's starting to get a little bit easier. But you know, we have worked with some sponsors who, you know, have kind of their own ability to buy in bulk, you know, store it at a place. And so if you can really get with a group that, you know, has that capabilities, it takes a major risk off the table, you know, in terms of executing.

- Huge. And the guys that bought in bulk or the big GCs that could offer that before all this happened, I think we're a big beneficiaries of it. And guys that can delay a little bit and don't have to lock it in right now, you know, I believe will be beneficiaries of this also. You can't, and with those is, you know, what's interest rates and what is inflation going to do? And everybody was talking about that. And you're seeing a little bit, I mean the 10 year's gone up. It was down, you know, in the low ones. And now I think it's at like 1.67% or 1.69%. So it's gone up a bit. All of a sudden you're seeing five hikes priced in the next two years. You know, what does it mean? I think the consensus was, that's probably a little overblown. And as labor gets restored, the supply chain issues moderate and therefore inflation really is more transitory, but nobody knows for sure. And so I still say for CRE, if you can lock in a long-term loan now is an excellent time to do so, because you will lock it in, depending on what asset class you're in, you know, somewhere between call it the high twos and call it mid to high threes. And historically that is still just an absolute incredible time. If you're a short-term borrower, the cost of your rate hedges have gone up a lot. They've roughly doubled. And so we're trying to help folks, you know, negotiate two-year hedges instead of three. But I also don't think that you're going to have a massive problem where the 10 years is going to, you know, double and become 3% or 4% a couple of years down the road for the reasons I mentioned earlier. I still think it's a great time to be a bridge borrower when you can lock in rates that are anywhere between, call it 3% and 5% on most transitional light value add, and even some medium transitional deals. So I'm still very optimistic. And in general, the view at ULI and I was at the PCBC home builder conference too, was a lot of optimism about the future of the strength of the economy, people returning to work, and also real estate values and rents across the spectrum. So that was really nice to be around. Last thing I'll say on conferences is I think the folks that were there were super happy to be there. People were so happy to interact like, face to face again, and to feel like we are returning to normal. And it was just sort of wonderful to be around that energy.

- Well Zach, that's great to hear that, you know, conferences are back up, people are still engaged. And I think part of that proof of vaccination, you know, making everybody feel a little bit better about it, you know, also creates a more intimate dialogue. So going out to dinners, you know, being kind of in smaller spaces, smaller groups versus, you know, everybody's six feet apart and spread out. So that was kind of some of the feedback that we got from our team was just the quality of the conversations at this conference was head and shoulders above where they've been at some of the other ones that we've been attending. And then, you know, taking a step away from the conferences. I know we have a bunch coming up here, you know, down the road. But you know, one thing I would like to get your insight on because you're in the market on a daily basis and trying to find capital on both the debt and the equity side for projects, any interesting deals you've seen over the past couple of months that you guys are getting ready to close on?

- Yeah, so there's two that we closed on the commercial side, both office deals, both remarkably similar profiles that I think are really interesting because there's been a lot of questions about, can you get an office deal done today? The answer is you absolutely can. Of course depends on the profile. It's still tough to finance a high rise office building with, you know, weak occupancy and probably limited weighted average lease term. But some bright spots definitely are studio. And I think neighborhood suburban office has become interesting again. That kind of used to be a bad word for a long time. We closed two deals, one this past Friday and one a week ago that were both remarkably similar in profile. They were both, call it 100 to 200,000 square foot. Like I'd say neighborhood suburban office centers. One was in the San Fernando Valley and the other was in Ventura County. We closed both deals with debt funds, where we arranged on both 70% loan to cost non-recourse financings, three year interest only terms. The rate on one was just below 4% all in, I think we were 3.90% all in, and the rate on the other was like 5.1% all in. And I think, pretty amazing that you can get office financing at highly accretive rates and sponsors, call it right around five and right below four. You know, I guess, depending on what you're going in debt yield is and what your going in occupancy looks like. But you can get that done up to 70% leveraged today. I think that has been very tough in southern California, call it six to nine months ago. And it seems like liquidity is restored for that. On both deals we had multiple term sheets, so it really wasn't just a world of a unicorn, so to speak. And I think that speaks to strength and resiliency in the market. And eventually as I think employers turn the lights back on, you'll see that morph. You know, but for now for sort of neighborhood suburban deals that have gross leases, small unit footprints, and a fairly sticky track record of collections and occupancy during COVID because you generally have ingress, egress without walking through major common areas, interior courtyards, things like that. You can get those deals done. And so we were really excited about those two that closed.

- You mentioned studio space. We're working on a studio deal as well. We're going to be a small piece of that capital stack, but you know, very compelling metrics there, obviously with what you're seeing from, you know, the content creators, you know, Hulu, Amazon, Apple.

- Yeah, yeah. I mean, there is definitely an optimism in certain parts of the office sector. And it's great to see that come back. Two quick thoughts. One, I was in Austin on Friday and you can just feel like, it's palpable all of the momentum that's in the air, all the excitement about new opportunities that are in the air. And it didn't hurt that Formula One was in town. And I booked a Westin and I think my rate at Westin was close to $400 a night. So that looks pretty good.

- I'm assuming that all of that momentum was when CrowdStreet announced the HQ move. That was kind of what spurred it up, right?

- That spurred it up, man. You and like, I don't know if Tesla's going to Austin, but I know they're going to Texas. I'm sure that had something to do with it. I'll sneak one last deal in on the retail side that we're working on, We haven't closed it yet, but we put it in an application. It's an incredible deal. It's a trophy retail and a high street deal on let's say one of the two best streets in all of Los Angeles. And once it closes, I think I can disclose more. Very strong sponsor, very, very high lender basis per square foot and extraordinarily high rents. I'd say some of the highest in all of Southern California. We put a low leverage deal, around a 55% LTV deal into application with the lender. And I think what will be the cheapest interest rate of my entire career, you know, whether equity side lender or the last five years as an advisor, it was a 2.3% rate. I think it was SOFR plus five basis points.

- And that's on retail too, by the way.

- That was a retail deal. The reason it went bridge was it's fully occupied. All tenants are in it, paying rent, but there are some COVID leases that need to burn off before you can put a perm on it. Also there's one or two that roll and the sponsors are very bullish on the market. And they said, we don't want to perm this thing out because we think we're going to sign even higher leases than we have now. And so why would we lock ourselves into something with yield maintenance where we can't unlock the value of those leases? So really truly incredible. And this, to me, sends an interesting message about retail. I'm not suggesting send me, you know, zombie malls, those are probably difficult to finance still. But if you have retail in a good location with either an experiential, you know, sort of restaurant or yoga or a coffee shop tenant base, or in this case, you know, three or four sort of smaller footprints for different sort of like clothing retailers that are there, you can get very interesting financing quotes, even sub 3%. I thought we'd have been having this conversation about multi-year industrial, but it's interesting to see that at least one segment of retail can get it too. So that, I think, is also--

- It's good that you mentioned that. You know, we've done a couple retail deals this year. You know, and a lot of them have been just like, the cap rate going in. Like, there's a good story about the anchor, cost of occupancy looks good. And there's a little bit of a mispricing just from that type of product type not being as in high demand as it has historically been. But the last two retail deals I've looked at both of which, you know, we're still kind of working through so we haven't put them on the marketplace yet. But both of those is what I would call jewel box retail opportunities, right? And kind of same story there where you're going to get, you know, like one really good experiential kind of anchor for that space. And then, you know, you're kind of filling in the rest with, like you said, either a yoga studio or, you know, something like that. So people are back out and I think there's an interest to, you know, continue to kind of drive up value in those. And also anytime you're getting into a jewel box like that, you have confidence that it's going to be worth more, the real estate itself, right, worth more in 10 years than it is today. So those prices tend to not drop down, but you know, rather go up.

- And I think that's right. And I didn't think these sponsors were crazy for wanting that sort of, you know, flexibility on their loan and not just, you know, doing like a 10-year conduit, even though we probably would've priced it around 3% because it's such a unique property. So I'm with you 100%. And you know, near-term inflation shouldn't hurt either, bringing the conversation full circle.

- There you go, absolutely. Well, Zach, really appreciate you taking the time today. I'm sure we'll have much more to talk about in a couple of weeks after we all go to another conference or two and, you know, again share some of that feedback. But yeah, we're very excited for a strong end of the year. A lot going on both sides. And you know, like we talked about before this call, you know, a lot of groups that are trying to look to get that capital, you know, in their pockets before the end of December. So a lot of opportunities that are still out there.

- Likewise, Ryan, always a pleasure talking. And looking forward to doing this again.