CRE Analyst

Here are the trends and events that we think will define commercial real estate in 2024.

Winners and losers: This track record tells the story of the last real estate cycle... Bridge is a multifaceted investment manager ($1.2 billion market cap) with just under $50 billion under management. Unlike many investment managers, Bridge specializes in property type-specific funds, so the firm's track record shares direct performance insights. "The returns for Total Office Funds are not presented because Bridge Office I is incalculable." Ouch.

We're all above average? 94% of professors, 87% of Stanford MBAs, and 80% of drivers say they're above average. Reality check: there are no career trophies in commercial real estate. We encounter thousands of early-career real estate professionals, and now that we've been at this for several years, we see very strong correlations between what works and what doesn't in terms of career paths. Broad observations... 1. The competency difference between the top few and the top 10% is massive. The difference between the top 10% and "average" is even greater. 2. People aren't static. Some people have it and lose it while others learn, practice, and thrive. Then there's a big group that has all the answers but never seems to find what they're looking for. Success tends to follow humility and curiosity. 3. Not about smarts. This is real estate, not rocket science. B students are fine, but you must show up in full. 80% of the battle is bringing it every day and getting the easy stuff right. 4. Real estate skills are not innate but they're 100% learnable. You typically don't find them in a textbook. It's an apprentice industry and early-career professionals need direction, frameworks, and practice. 5. There are no shortcuts. Many people are looking to find 'the answer' under a rock. If they flip enough rocks, they'll get lucky. Skills don't work this way. You have to have effective practice. Any observations you would share with early-career professionals?

Great listen! Michael Levy’s candor is refreshing and interesting for real estate professionals of all ages and backgrounds.

Less bid, more ask: Sobering fundraising trends “Dry powder” gets a lot of attention, but capital’s influence on volume and pricing is nuanced. Two subsurface realities: 1. Every dollar comes with return expectations. Closed end funds are inherently value-oriented (non core), and open end funds are much more income-oriented (core/core plus.) Higher returns = lower prices. 2. Closed end funds have defined hold periods. Investors want their money back after __ years. Here’s the sobering part… CRE markets experienced an epic fundraising run with non-core capital between 2015 and 2022, and most of those funds had stated lives of 7 years. Those investors want their money back. I.e., there will be sellers. What about buyers? Closed end fundraising has fallen off a cliff. It’s also been extremely concentrated in the the big mega funds. Less capital on the buy side in the near term. These dynamics could create stronger pressures on the sell side, putting upward pressure on sales volumes and downward volumes on pricing.

Which $10B+ real estate company missed revenue estimates last quarter? A) Big brokerage (JLL) B) Big office owner (Boston Properties) C) Big data center owner (Digital Realty) D) Big manufactured housing owner (Sun) Answer: D No offense to our friends in the REIT space, but REITs are pretty boring. Sun Communities' earnings call last week was not boring. ---------- Sun's CEO introductory statement: "First, I want to emphasize my disappointment in the results we're reporting..." "…we acknowledge that our third quarter results and our adjusted 2024 guidance are below both our and the market's expectations, and we are very disappointed by our performance." "Starting with our Board of Directors, the entire Sun organization is committed to proactively addressing our challenges and restructuring Sun..." "We undertook a comprehensive bottom-up review throughout the organization, and concurrent with today's earnings release, we are announcing a broad repositioning effort to more effectively align the company's operating expense and G&A infrastructure to deliver earnings growth." "As of today, we have identified and expect to realize annualized G&A and operating expense savings of between $15 million and $20 million or approximately $0.11 to $0.15 per share as we rebase our cost structure for 2025. I want to emphasize that this is just the starting point..." "Additionally, as announced this evening, I have informed the board of my intention to retire in 2025 following more than 40 years with the company." ---------- Manufactured housing was trading sub 4% before sub 4% was cool. Strong and consistent cash flow growth is the only way to make that math work. But now NOI growth is flat?! Separately, how can you suddenly find up to TWENTY MILLION DOLLARS of cost savings?! ---------- Where there's smoke or just another short seller? A few months ago, a short seller issued a report claiming that Sun's CEO benefited from an inappropriate financial relationship with a board member, that he had committed insurance fraud, and that the company had been overstating cash flow. Sun pushed back on these claims in its earnings release. Is this a one-off incident of bloated G&A or something more systemic? Should manufactured housing be the most inflation-hedged real estate asset class?

Extend and pretend vs. accelerate and liquidate ---- Federal Reserve's take ---- "...banks 'extended-and-pretended' their impaired CRE mortgages in the post-pandemic period to avoid writing off their capital, leading to credit misallocation and a buildup of financial fragility." ---- Question for the Fed ---- Question for authors Matteo Crosignani and Saketh Prazad: You concluded that "banks have extended the maturity of their distressed CRE mortgages coming due and pretended that such credit provision was not as risky to avoid further depleting their capital." Is it possible that "pretending" (as you defined it) actually mitigates losses in this environment? ---- Here's a realistic scenario ---- The Texas apartment market over the last four years... In 2021 and 2022: -- $300B+ of annual transaction volumes -- Low 4% cap rates -- 65% LTV financing, floating, short-term maturities Since 2023: -- $100-200B of annual transaction volumes -- Mid 5% cap rates -- 65% LTV available on revised values Scenario: -- You bought a $100M property with $65M debt. -- That property is now worth $78M due to higher cap rates. -- You've lost $22M on paper and have $13M in remaining equity. -- Lenders will only finance $51M. -- So at maturity, you must come up with $14M or face foreclosure. Your loan is about to mature, and the bank is playing hardball. Do you come up with the $14M to save $13M? Where do you get the additional $14M? [Sidenote: If 50+ years of lending is indicative, there's a decent chance the bank would be unfavorably surprised if they foreclosed on the property and tried to sell it. i.e., LGDs are rarely less than 0%.] Or, instead of big paydown, the bank could just extend the maturity. The Fed calls this calls this strategy 'extending and pretending.' But the alternative would be to have a maturity wall today on a struggling property with a borrower who wouldn't presumably walk away unless you forced a major paydown. Notably, most loans have built-in extension provisions, but these usually come with tripwires (e.g., interest rate caps, max LTVs, etc.) As long as borrowers invest in their properties, wouldn't an extension mitigate potential losses by preserving full recovery scenarios? This is a hypothetical situation, but it's being felt all over the country, especially in sunbelt markets where capital was the frothiest. Apartment fundamentals are recovering, but we may still be in the early innings of the balance sheet reckoning.

Best non-U.S. cities for real estate careers?

Why shut down a $6 billion real estate fund platform? [Ameriprise/Lionstone] A doomed marriage? Ameriprise bought Lionstone back in 2017, saying: “Real estate is an important asset class for institutional and retail clients, and we are enthusiastic about the opportunity to further our capabilities in this growing asset class.” Why was Lionstone attractive to Ameriprise? "We already have a nice property business in the UK and it’s been a great complement and we leverage through distribution what we do there. We weren’t in that space in the U.S. and Lionstone gives us a beachhead. We can help them expand. They have good capability to launch other products that we thought would be interesting in the retail space, which they’re not in today." Estimated acquisition economics... Although the acquisition price was never disclosed, we think Ameriprise probably bought the firm for a low AUM multiple. Nothing like Legg Mason's similarly-timed acquisition of Clarion for about $600M. Wild guess: call it $50M, plus a pledge to invest $150M or so in funds/JVs and maintain about $30M of annual G&A (per pension fund and SEC disclosures). ...in exchange for about $6 billion in assets. A concentrated investor... We think Lionstone's biggest investor (by far) was the State of Oregon. Two years ago, Oregon listed Lionstone as its fourth largest manager with $800M, but it fell to $483M earlier this year. Lionstone's approach: AI, office, and development... Lionstone overinvested in office, but the firm has always tried to differentiate itself by its "data-driven" approach and investments in AI: "Lionstone analyzes diverse data sets and uses a proprietary algorithm-based approach to translate information into a detailed understanding of location and physical space. Lionstone’s advanced analytics isolate submarkets and specific locations where the greatest demand for space exists relative to supply." This week's news... "Ameriprise Financial, Inc. announced today that it has decided to wind down Lionstone Investments, its U.S. real estate investment subsidiary, and exit this business after a strategic evaluation." ---- Our takeaways ---- 1) $6B of AUM sounds meaningful, but it wasn't diverse, discretionary, or promote-earning (on balance). 2) Key Lionstone staff departed in recent years. 3) The retail channel never materialized. 4) Lionstone's average deal size was $30M pre-acquisition but swelled to $100M pre-Covid. Very competitive space. 5) Blackstone and Brookfield boast that investment management mandates are consolidating with the largest firms. This may be a consequence. 6) Ameriprise's business is skewed away from private assets and U.S. real estate. How many other investment managers are facing similar pressures? Is Lionstone's shutdown a one-off event or a sign of more pressure to come? Affected by Lionstone's wind down? DM us if we can help with training or job leads.

Career implications of investment styles… “Contrarian thinking” is a pre-requisite for outperformance but comes in different forms. Most of us think of it as running into the fire, but that’s often not how institutions outperform. E.g., office properties currently trade 50% less vs. a few years ago, but value declines don’t necessarily equate to value discounts, which is why there’s very little capital interest. Another way to ‘think different’ is for investors to expand their opportunity set, focusing on underrepresented parts of the market. Nuveen, a TIAA company finds value in smaller, non-indexed CMBS offerings. The Carlyle Group is wrapping up an $8-10 billion raise for its 10th real estate fund, and primarily focuses on relatively small investments (<$25mm) in housing developments. And Artemis Real Estate Partners similarly closed a $2 billion fund last year focused on small/mid-market, operationally intensive assets. Their pitches are all similar: ‘we go into areas before the herd, but we aren’t pioneering.’ …and they’re working, as evidenced by track records and fundraising. Career implication for early-career professionals: focus on the difference between the various approaches to finding value in an efficient market… — Index huggers hide. They move capital around and hide behind research, but their goal is fundamentally to stick with the herd. Hard to fail in the short term, but big risks long-run. — Wildcatters gamble. They occasionally hit it big but typically get wiped out. They often recover/rebound in future ventures, levering their experience, but the learning curve is expensive for investors. Hard to win in the short run, but the payoffs are huge when successful. — Pioneers establish new norms: They expiriment with incremental moves in capital and fundamental markets. When they get a win, they double down. Being ahead of the crowd comes with huge benefits when the crowd actually arrives (e.g., Carlyle has successfully predicted capital shifts into niche sectors.) The approaches Nuveen, Carlyle, and Artemis are deploying likely fall between two of these styles (index hugging and pioneering?) Think about how your firm offers value to its constituents. Does it fit into one of these style buckets? What style resonates the most with you? What style gives you opportunities to build skills?