In a recent episode of CBRE’s The Weekly Take podcast hosted by Spencer Levy of CBRE, Rob Finlay, CPM®, Founder and CEO of Thirty Capital and WSJ best-selling author of ‘Beyond The Building’, discussed why waiting for rates to drop is not a sound strategy for commercial real estate (CRE) investors. Instead, he encourages them to focus on strategies for managing their assets and debt effectively.
Listen to the full interview on-demand here. Or, read below for highlights of their conversation.
Spencer Levy
One of the innovations of the late nineties real estate malaise was the explosion of the CMBS industry. One of the innovations of the post GFC was that the CMBS industry got better and there were more debt funds that weren’t related to CMBS. But now we’re coming out of this, and it seems to me to be the one area- the sticky wicket to use a cricket term -that we have today is the assumption of debt. And if we had an easier way to assume debt, you’d see a lot more transactions getting done today. So what do you see as the debt market innovation coming out of today’s difficult market conditions?
Rob Finlay
You know, it’s funny- you guys talk about the debt market and people complain about yield maintenance penalties or defeasance penalties. But yet the debt markets, especially on the capital market side, are the most efficient in the world. You’re able to provide cheap debt, you’re able to provide flexible terms, non recourse, in many cases. It’s a great vehicle. I think we’ve just become so skewed as an industry because the past ten years – and in particular the past five years – money’s been free, right? And so when money’s free and you don’t have to worry about the consequences of what you’re buying with it (basically the performance of your real estate), everybody turns and complains that interest rates are too high and that now debt is unattractive. So I really think that with the debt markets and innovation of debt, I don’t know if you actually have to have innovation in debt too to make it better.
Spencer Levy
There are a lot of people who aren’t defeasing their debt today, even though they may get a discount by doing that. Going back to my innovation question earlier, are they looking at their property and saying, “My debt is so far below market, this is worth X amount. I’m going to sell the building, let somebody assume the debt, and I’ll get the upside.” So I guess that’s another way to capitalize on cheap debt.
Rob Finlay
Absolutely. It’s just a lever that you have. In real estate, you’ve got these levers – asset, equity, and debt – and they have to work together. But ultimately they result in an equity lever, and that’s what you’re trying to solve for. Most people own real estate to make money. And the question is, “How do I make money the fastest?” And it’s by using those two levers, pure and simple.
Spencer Levy
Well, I guess the other question there, and this is in your book, Beyond the Building, depends upon not the cost of your capital, but the time horizon. And so some real estate enterprises, generally speaking, publicly traded REITs, have an indefinite life or time horizon. But open-ended or some closed-end funds are three- to five-year holders. Some opportunistic holders are even shorter than that. So I think ultimately, it’s not wrong to keep that ten-year debt in place if you’re a long-term “set it and forget it” enterprise. But if you’re looking to maximize the dollars over time, you have to look at the debt that way and then accept a certain level of risk and volatility.
Rob Finlay
Sure. But, as I said, I would challenge you to think of debt just as a lever. Yes, if you’re going to hold it for ten years, that’s great. But that doesn’t mean in that ten-year horizon that the situation for the asset is where it makes sense to refinance or pull equity out. You have asset appreciation. There’s many other things out there that might have demands on equity that you might not have had five years ago. My only point is just to think about it as a bigger picture. It’s just a part of the equation.
Spencer Levy
Let me ask one more technical question because this is a new concept to most of our listeners. So let’s assume for the moment, you got a loan four years ago and your interest rate was 4%. Today, if you were to get the identical loan for the identical asset, your loan would be 8%, and you’ve got seven years to run. Let’s assume it was a $10 million loan. About how much money could you get by defeasing that loan today? Is it a $1,000,000 win? Is it a $500,000 win? How do you look at it?
Rob Finlay
There’s several elements of the way you look at this and you evaluate this. The defeasance cost is just the differential between the average portfolio that we can buy on the treasuries or securities versus what your loan coupon is. So if you’re over 4%, yeah, maybe it’s a few points, maybe it’s a hundred grand, maybe it’s a couple hundred grand.
Now you look and say, okay, I know what I can get for my new loan. Am I pulling equity out? And then most important to that is why are you doing this transaction? What is it that you’re going to do with this money that’s left over from this transaction? And that’s what you’re evaluating. I’m pulling cash out. You’re obviously not going to swap coupons, right? You’re not going to say, oh, I’ve got 4%. I’m going to go to 6%. I’m just going to go do that for fun, right? You’re not going to do that. But you might do it to say, hey, I can pull out maybe a couple bucks and I might need that a couple bucks because I want to have my coffers full. Or maybe, maybe I need to do it because I need to support my organization because I no longer have acquisition fees coming in for the next year or two, and I need to keep my team.
How are commercial real estate firms paying for themselves right now? If you’re not doing acquisition fees and you only have a handful of assets, maybe you’re pulling asset management fees out. How else are you making money? How are you supporting the organization? So those are things that you have to think about. As an owner of a real estate company, you have to think about how you’re going to support the business, how you’re going to cover the business so that you can be around when the market rates come down, asset appreciation comes up, and transactions happen.
Spencer Levy
What I liked about your book is that it focuses on the enterprise rather than talking about the “dirt”. It wasn’t getting down to the level of ”you need to put in X building systems to keep your heating and cooling costs below X amount”. Instead, you go above that level and talk about leadership. You even used several examples of companies that aren’t in the real estate business, such as IGT, Mondelez, and others. You talk about how they run themselves and suggest that maybe real estate companies should follow suit. Explain.
Rob Finlay
I’m glad you felt this way about the book. It’s not about real estate. The real estate is your product. I’m not going to talk to you about your product because your product could be multifamily, industrial, office, and so on. It’s about how you run your organization. So many real estate shops are fundamentally the same. You have groups that manage acquisitions, operations, finance, etc. that sit there in silos and sort of do the same thing. They buy real estate, they operate some real estate, and they sell it. And that works, but only for so long.
Now, it’s about understanding how to create enterprise value. For so long, the industry has been focused on individual assets and not necessarily the company whose job it is to manage those assets, the private equity side, the capital markets side, whatever you want to call your organization that owns the real estate.
Spencer Levy
Let’s shift from the book to the market. You use the old Warren Buffett statement: Be greedy when people are fearful; be fearful when people are greedy. So given your company, tell us a little bit more about what you find most attractive today and why.
Rob Finlay
As I said, I like suburban office. There are some people who are buying it and could be buying some good assets, but I think it really comes down to finding the right investment based upon the appropriate risk-adjusted returns. And that’s what we’re looking at. We don’t take in billion dollar funds, so we don’t have to worry about deploying capital. We can be very specific and very methodical about the deployment of capital. But until the market breaks/corrects itself, there’s really not a lot to do other than focus on your own assets.
Spencer Levy
What does 2024 and 2025 look like for the commercial real estate industry?
Rob Finlay
As I mentioned earlier, if you’re waiting for rates to drop, you should be thinking about something else. Sure, the Fed might cut rates – that just means that there could be a potential of a recession.
Learn how to think Beyond the Building! Get your copy of the best-selling book today. And be sure to follow Rob Finlay and Thirty Capital on LinkedIn for more insights.
