Learn what the latest rate cuts and the inverted yield curve mean for real estate investors.

How the federal funds rate impacts real estate

Mr. Pascale joined George Smith Partners more than two decades ago, leaving behind a successful career in intellectual property rights management. Now, as GSP’s most Senior Vice President/Deal Manager, Mr. Pascale has directly overseen the placement of nearly $4 billion capital into commercial real estate. He has an expertise in virtually every aspect of commercial real estate debt placement with distinct specializations in CMBS, bridge loans, credit tenant leases. He has worked extensively on retail, multifamily, hotel, office, and mixed use transactions. With a background in law, Mr. Pascale also brings loan document expertise and is able to explain and negotiate deal points and structure. He serves as an advisor to new company members.

In addition to his primary responsibility of client management, Mr. Pascale has been involved with the marketing of the firm in a number of different capacities and is primarily credited with transforming the firm’s highly regarded FINfacts newsletter from a quarterly to a weekly publication. Mr. Pascale now offers his expertise via a weekly column in FINfacts known as the hugely popular “Pascales Perspective.” This column provides readers detailed information on trends affecting the United States Real Estate Markets by combining national/international macro overviews with specific microeconomic events.

David’s Links

Check out David’s weekly column in FINfacts: https://www.gspartners.com/pascales-perspective/

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Transcript

RealCrowd – All opinions expressed by Adam, Tyler, and podcast guests are solely their own opinions and do not reflect the opinion of RealCrowd. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. To gain a better understanding of the risks associated with commercial real estate investing, please consult your advisors.

David Pascale – When the Fed makes a rate cut, they cut the Federal discount rate, the overnight rate, and that also pretty much directly affects LIBOR, which basically, 90% of our floating rate loans are based over 30 day LIBOR.

Adam Hooper – Hey Tyler.

Tyler Stewart – Hey Adam, how are you today?

Adam Hooper – Tyler, it’s another fantastic day in the podcast studio.

Tyler Stewart – Oh yeah, why’s that?

Adam Hooper – We got a guest coming back.

Tyler Stewart – Great.

Adam Hooper – Yeah, we got a repeat.

Tyler Stewart – A repeat, David Pasqual, Senior Vice President at George Smith Partners.

Adam Hooper – Yeah, so David was kind enough to join us almost a year ago now. Really, really interesting conversation. Again, I feel like we say that on almost every episode, but it’s kind of right, it’s kind of true.

Tyler Stewart – It’s kind of true, and I always know when we have a solid episode, because I have four pages of notes, and I hit that number today.

Adam Hooper – Yep, so we talked about a lot of stuff. We kind of started macro, talking about some of the trends that have been occurring in the kind of national economy, some of these global impacts that we’re seeing out there. Talked about the capital markets, who we’ve got really favorable loan environment right now. Starting to see some trends in the cap rates that you’ll have to listen to to find out. He even threw a little forecast in there for each of the main property types. We covered a lot of ground. Again, really, really in depth conversation about kind of the state of local, global, national economies.

Tyler Stewart – What was great about David is not only did he give us an update on all those factors, he told us where he looks for that information. He gave us a list of his favorite economists to follow along with the magazines and journals he follows on the daily to stay up to date on what’s happening in the market.

Adam Hooper – Of course, check the show notes for links to all those different resources as we talk about later in the episode, go to the George Smith Partners website, sign up for the FINfacts Newsletter. Really, really good resource. Interesting thing that we talked about too is just kind of the uncertainty that’s out there right now. A lot of the public equity markets seeing some volatility, not really sure whether it’s a buying or selling market, but again, as we kind of got back to the fundamentals of the real estate space, pretty positive on that front. Really interesting conversation, I think one of the interesting concepts we talked about was kind of this new normal that we’ve been operating in since the 2008 recession, and David even threw in the potential for a new new normal, so you’ll have to listen to the end to talk about that again. Just really, really interesting topic.

Tyler Stewart – Again, we took a lot of notes during this episode. Fantastic to have David on again, and he went over a lot of information this might be want to listen to a couple times.

Adam Hooper – Absolutely. As always, we really appreciate your feedback, comments, suggestions. Send us a note to podcast@realcrowd.com. Hop on iTunes, Google Play, wherever you listen to us, we love ratings. Leave us a review. That helps get the information out to a larger audience. Tyler, that’s enough of us rambling on here, so with that, let’s get to it. Well David, thanks so much for coming back on the show. It’s been a little over a year since you were on last, and again, really appreciate you comin’ on today to talk about what’s goin’ on in the economy.

David Pascale – I appreciate the opportunity, thank you.

Adam Hooper – As we said, it’s been a little over a year since you last came on the show. We’ve had some ups, we’ve had some downs in the market. Would love to just kind of get a quick high level view, how’s the market behaved, what changes have we seen? Came out of a rough Q4 in 2018, had some recovery, seen some more volatility. Why don’t you just give us kind of the snapshot and lay the foundation for where you kind of, what the last year has looked like in the markets.

David Pascale – We’re talking about just a general capital market?

Adam Hooper – Sure, yep.

David Pascale – Capital markets, I think the major headliner is, especially in commercial real estate and the macro economy is the cost of capital has plummeted for everyone, governments, investors, people buying companies, people buying real estate. I was looking at the Wall Street Journal’s New Year’s Day survey of economists on where the 10 Year Treasury would be by the end of June and by the end of 2019. I arranged some loans in November and December last year and people were rushing to get rates in to get their loans locked, because the Treasury was going to shoot up and 5% loans were on their way out and the loans were soon to be six or 7% based on a Treasury of 250 to 3% to 3.75%. Last year, Jamie Dimon, the CEO of JPMorgan, famously said that the Treasury should be 450. The survey had yields ranging from 275 to 4% for the end of 2019 and for the middle of 2019, anywhere for the middle from 2.5 to 3.75. Today, the 10 Year Treasury is 1.55. It is about 20 basis points above its all-time historic low, which was the day after the Brexit in 2016. We have negative yielding debt all over the world, trillions of dollars of negative yielding debt. The big story of the year has been no one really predicted this outcome in fixed rates. A lot of it, the backdrop of it is, I often use the term new normal, which was quoted by one of my favorite economists, Mohamed El-Erian, and the new normal is this post-2008 world that we’re living in where essentral banks flood the market with liquidity,

David Pascale – and there’s little to no inflation. Last year, there was a thought that inflation was coming back, and we were going back to the old normal, the pre-2007 world where the Fed had their discount rate anywhere from four to 6%, and inflation was basically in check but would often hit two or 3%, and we never hit that. All of a sudden, the combination of storm clouds in Europe, continuing worries about Brexit, trade, tensions, stubborn inflation, and sometimes even deflation have driven yields back down to the bottom and we have a new wrinkle which is currency devaluation and currency wars that may spring up, and there really is no precedent out in the modern economy like post-1970 gold standard removal Europe of the U.S. and China, the two biggest economies in the world engaging in a currency war, which is now a very real possibility. There’s just a lot of, there’s a big surprise that we’re still in this ultra-low rate environment.

Adam Hooper – That also just underscores this lack of predictability or uncertainty around where are we. We’ve had a really long expansion, really good recovery, he’s going to be seeing a couple really big selloffs, Q4, 2018, the equity markets just got absolutely crushed. As a commercial real estate investor, how should we be thinking about this? Does this uncertainty, does this volatility, do some of these bigger macro impacts have a direct effect on the commercial real estate space, does it lag, what are some of those things that we should be looking at as commercial real estate investors with everything that’s going on in capital markets, equity markets, in this kind of global just shift that’s going on right now?

David Pascale – Well I think commercial real estate still has the advantage of being a so-called hard asset, and when people are seeing negative yielding bonds and wild fluctuations in stocks, real estate is an attractive, kind of stable investment, especially with the cost of capital so low. But what real estate, what I’ve been talking about lately with my clients is there’s no reason to invest just because rates are low. Deals still have to pencil, and what I think is going on with commercial real estate is it’s getting very market specific, property type specific, and in the new normal of real estate, we’re seeing a lot of disruptors, like Amazon, and I don’t have to go into detail about that, but I have before, and so investors are really watching for the property types and the markets that are going to thrive in the next 10 years in this new disruptive economy.

Adam Hooper – Let’s start kind of digging then a little bit on just overall economy. I guess before we get to that, you mentioned Mohamed El-Erian with the new normal, are there any other economists out there that you’re looking at right now or kind of paying attention to that some of the listeners might be able to either follow on Twitter or kind of get a little feel for what’s goin’ on out there?

David Pascale – I watch Kyle Bass a lot, and he’s an analyst, very watchful of negative yielding investments around the world and he’s very, a very good capital markets analyst, and I watch him a lot.

Adam Hooper – And you mentioned the Wall Street Journal, what other sources do you use on the daily to keep up to date on what’s happening in the markets?

David Pascale – I like CNBC and Bloomberg, I enjoy their both, their XM Sirius, and their TV channels, and their websites. I like MarketWatch, I also like a site called Seeking Alpha that’s a little bit edgier and talks a lot about quantitative analysis and things like that. Surprisingly, the New York Times is also very good on financial and up to date. Those are my main sources, and then a lot of the Los Angeles real estate sites, like LA Curbed and LAist, et cetera, to watch for what’s going on with developments and what’s getting approved right now.

Adam Hooper – Perfect. Now, when you’re looking at those publications or kind of following some of these economists out there, what are some of the factors that you’re paying attention to when you’re looking at, kind of again, the overall health of the economy or some of these different statistics or facts that you’re trying to kind of parse from all this information that are important to you?

David Pascale – I’m looking at what they see happening in the next year or two down the line, I’m looking at government deficits, and I’m also looking at people’s prediction of, we have contrarian views right now from the government as far as the effects of the tax cut and our deficit, and what’s really going on with GDP, and I also very closely watch the ECB and the IMF and their predictions of worldwide growth, because they’ve often been very spot on and very non-partisan. I really look to these big aggregators of info still as the leading growth predictors because so many people follow them, often their sentiment can affect the sentiment of investors.

Adam Hooper – Getting to sentiment, we have the Fed rate drop in July, just this morning actually, Bob Chiller said that maybe that actually had an opposite effect that had dampening sentiment signaling this kind of sense of alarm. How has that manifested into the commercial real estate space, or I guess generally, if the fad continues to drop rates or did that rate cut have any impact on our space yet that you’ve seen?

David Pascale – The rate cut was so highly telegraphed that it had been basically priced into people’s expectations. When the Fed makes a rate cut, they cut the Federal discount rate, the overnight rate, and that also pretty much directly affects LIBOR, which all the floating, basically 90% of our floating rate loans are based over 30 day LIBOR. Those cuts were had been kind of priced in, and investors were expecting them. Their cost of capital got a little lower, but we’re seeing cap rates starting to… The cap rate compression is starting to get to the end of that process. We’re seeing a little bit of cap rate expansion certain markets. So that combined with a lower cost of capital in the right market on the right buy can really help an investor’s leverage. It’s really, you get into property type specific and market specific.

Adam Hooper – That’s actually very interesting, that you’ve got this diversion, and most people would assume that interest rates and cap rates are going to move in lockstep. That’s kind of the typical understanding. You’re seeing actually cap rate expansion, which means you’re getting a better yield, plus you’ve gotten out of this potentially lower borrowing cost, which is going to increase your net yield, you could be, substantially or just a little bit?

David Pascale – Just a little bit, and it’s in certain markets–

Adam Hooper – Little bit for now?

David Pascale – But it’s also showing that the long period of type cap rates, I believe, hit has pretty much hit its breaking point. I don’t think cap rates could get much tighter now, and certain markets like San Francisco and Silicon Valley that are outliers that are so red hot, you’re going to see continue type cap rates. But I think in a lot of the secondary kind of meat and potatoes markets out there in America, I think investors have seen cap rates get pushed to the limit and then the question is is when will these sellers start to capitulate a little bit and start to come off their price and kind of increase their cap rate on their sales? That’s a whole psychological process that needs to play out.

Adam Hooper – Before we explore that a little bit, I just wanted to take just a little step back. You mentioned LIBOR floating rates for listeners out there that maybe aren’t entirely familiar with how that works. LIBOR, London Interbank Offering Rate basically is the index that floating rate loans, so variable rate loans in the commercial space are pegged to and then some spread on top of that.

David Pascale – Yes, exactly.

Adam Hooper – LIBOR, right now, is what?

David Pascale – About 217.

Adam Hooper – Okay, and then so a loan, again, a floating rate loan is going to have some spread priced on top of that, and that’s basically the interest rate that you pay. It’s LIBOR plus 400 basis points, right?

David Pascale – Right, and typicals, a very tightly priced loan right now might be in the LIBOR plus 150 to 250 range, that’s 1.5 to 2.5 with more risky deals that involve a lot of renovation or some negative cashflow, or what we call heavy bridge, or construction ranging all the way up to LIBOR plus 300 to 600. What we’re seeing among lenders is, we’re seeing a little bit of a perfect storm. We see a risk-off trade with Treasuries, meaning investors are running into Treasuries ’cause they’re avoiding risk. But we’re still seeing a risk-on trade amongst spreads by lenders because there’s so much competition for good deals, there has not been a big wave of defaults yet, there’s not been a big unemployment wave or consumer credit shutdown or any of the other recessionary stuff. We might talk about that later in the podcast, like what the signs are there. You’re seeing spreads pretty tight, about as tight as they ever get, and I’ve been in the business for about 25 years. All-in rates for both fixed and floating of, for some 10 year fixed rates loans, I’m seeing rates in the 3.5 range, 3.6 range. That is absolutely rock bottom. On a floating rate loan, if you have a stabilized asset, you can get LIBOR plus 200 about, you’re at about 4.2 floating interest only, and with the ability to have flexibility. You’re not locked into a fixed rate. The cost of capital and the leverage point is very, right now, we’re seeing perm loans at 70, 75% LTV, bridge loans 80% of cost. We’re seeing a lot of, if equity cannot get their returns in this environment,

David Pascale – then there’s something wrong with the property.

Adam Hooper – I want to again, go back to a word that you, you qualified when those statements with yet, or with with, and that was the word yet. We haven’t seen a default wave yet, you said.

David Pascale – Right.

Adam Hooper – Where are we in that space? The new normal, maybe there was this sentiment that maybe we’re getting back to the old normal. I don’t know if the old normal worked out that well given the 2006 to seven, eight, kind of run-up. How was the underlying health of that lending environment? We’ve got, you just said the loan to values, loan to cost going up 70, 75% on permanent, 80% on bridge, you’ve got extremely low borrowing costs, very available, cheap credit right now. Does that cause any alarm for you?

David Pascale – On the safe side, the good news today is we do not have trillions of dollars of toxic mortgages, residential mortgages out there. The commercial mortgage market is just a fraction of the residential market. So the commercial market in ’07 and ’08 also was very over leverage. Like then, we were seeing permanent loans 80, 82, 85% loan-to-value with 10 years of interest only and underwriting on proforma. We are not seeing that now. There has been a lot more discipline since the last crisis. I mean, credit officers remember. A credit officer that was 40 years old in 2008 is now 50s, he has a good memory of what happened before and there is a wish, even though people want to do production, there is a feeling out there that the excesses of last time are to be avoided. On the residential side, we have nowhere near the oversupply of SFR. In fact, there’s a shortage of SFR construction, and we’re not seeing waves of unqualified borrowers getting 90% loans on homes that are overpriced. We’re seeing a lot of discipline with the FHFA and the post-crisis Dodd-Frank and other requirements, involving risk retention and underwriting standards, have really helped keep the housing market pretty stable. We’re not in the situation where we have a lot of low wage people very thinly mortgaged on their homes. Other recession signs include slow downs in manufacturing, which we’re seeing a little bit of, but it’s not a big contraction. The consumer is the key, I think, this time.

David Pascale – Consumer spending drives more of our economy than ever, whether it’s Amazon and car buying and that kind of thing, and so we’re not seeing, the American consumer’s been very strong. I think some of the dangers could come from tariffs and trade wars. That can affect manufacturing and the uncertainty can affect American companies’ investments. It’s hard to say in this expansion, which is now as long an expansion as we’ve seen in the post-World War II era, and what the black swan event or the storm clouds are that will activate the next recession and what it will look like.

Adam Hooper – I think what we have is you on record as saying this time is different.

David Pascale – I think it is different. Maybe this time, with Uber and all the disruptive forces and people buying less cars, or millennials don’t buy cars as much, that won’t be a sign of a recession. That’s just an example of we need to, what to watch for this time.

Adam Hooper – That’s a really interesting point of how some of these other shifts away from these traditional markers, how they change just at their core. Car buying, that’s an excellent example. You might see that same trend in the data but for a completely different reason than what we saw before, so how do we start to interpret that? That’s pretty interesting.

David Pascale – Yeah, it is, and to go off not quite on a tangent, but other things as the nature of home ownership and living is changing as people turn to co-living arrangements and new, innovative, there’s new zoning, there’s a wave of new zoning laws that may come to America in a lot of areas where they’re going away from the giant swaths of SFR and getting more into denser development within these, the major MSA cores, and so maybe the old indicators of home ownership and car ownership and consumer spending are going to be upended and we’ll have a new measure of what an economic success is.

Adam Hooper – One that I’m curious again to get your take on, and you mentioned at the top here, 10 Year Treasury now about 1.5%, there’s been a lot of talk about this yield curve inversion. Why don’t you explain that for listeners real quick and then we can talk about kind of what that impact is again, what that’s been historically, and maybe what some of the interpretations are of of this time.

David Pascale – The yield curve inversion is very, very interesting because there’s two major, the yield curve is always expected to be a, an upward slope, meaning the shorter term Treasuries yield less than longer term Treasuries. And the traditional fear of the yield curve inverting is because the traditional banks would borrow short, meaning they borrow from the Fed or using certificates of deposit or 3 Month Treasury Bills. They borrow short and they lend long, and they lend based on the five and 10 – Treasuries. They always need to make that spread, and so when the 10 Year Treasury goes below the 3 Month Treasury Bill or the 2 Year Treasury is when alarm signals go off worldwide, and you saw that last week when the two year went above the 10-year, because that has been an indicator of every recession in the modern era. Now, is the question is, are things different this time? Now, the answer is yes, because we have, in before other recessions, we didn’t have 10 or $15 trillion of negative yielding bonds around the world. That is forcing long-term, the U.S. Treasury to be almost artificially low because its relative value, compared to a negative yielding German or Japanese or Swiss bond is huge, even at 1 1/2%. And so previous recessions have not had that feature built into them. The issue last week was is it a self-fulfilling prophecy? Is, investors saw the inversion, they said, “A recession is coming, I’m going to sell everything.” That can then, businesses can say, “Oh, a recession is coming. I’m going to stop hiring.

David Pascale – I’m going to stop investing in factories ’cause I saw the yield curve inverting and I was taught that’s the metric that a recession is coming.” There’s a lot of psychological drama with the yield curve inverting as with actual metrics.

Adam Hooper – Well, and I think like you said there, and as we just talked about, there’s the indicator, which would be this relationship between the two year and the 10 year in a silo as that single indicator sounds the alarm bells, but like you said, relative to other bonds out there, other, again, like you said, these negative yielding bonds, relative to where this 10 year is, 10 Year Treasury still looks pretty attractive, which is different than it was in the past. And that’s kind of what you said there, right? The bigger picture taking all these other factors into consideration, maybe there are some differences about how to interpret that data, versus just the alarm bells sounding, “Oh my God, Treasury, the yield curve is inverted and therefore, a recession is coming.”

David Pascale – Right, right. And there’s other factors, such as the Federal Reserve, it has meddled in markets during the quantitative easing. They bought a lot of long-term bonds. They still have $4 trillion about, of long-term bonds on their balance sheet. And then the Fed raised rates, because from 2009 to 2015, they never raised rates, and since then, they’ve raised rates about seven times. And so the Fed has raised the short-term rate and then depressed the long-term rate by buying bonds, and there’s a new actor in the equation, that in previous years, that was not the case.

Adam Hooper – And so now with this, again, the rate cut that we saw in July, do we anticipate more cuts coming or what’s kind of the forecast for where those rates are going to go?

David Pascale – This is very interesting because the Fed has always had two targets, inflation and unemployment, and they fear low inflation because if deflation ever occurs, it is a fiscal nightmare, where consumers hold back on buying things because they see prices going down, you get into a deflationary spiral, and it’s very difficult to ease your way out of that. So inflation started to tick back up in the recent CPI reports, and a pretty broad-based inflation tick up and that usually would make, create a sell-off in the bond market and cause the 10 year yield to spike. We have that factor and we have $1 trillion annual budget deficit because of the recent debt ceiling deal, and the 2017 tax cut has really depleted corporate taxation. We’re seeing massive, massive supplies of Treasuries, and then we also have a little quirk in the Treasury, where because of the way the Treasury delayed the debt ceiling crash by doing a lot of creative accounting in the Federal books, they now need to sell a huge amount of Treasuries to, now that they have the debt ceiling deal, to now bolster those, the months from, I’ll say from March to August, when we were short on tax collecting but long on spending. All of this supply of Treasuries and the recent inflation news would usually, I would say, tick Treasury up to three, 3 1/2, 4% maybe. But instead, there’s so much fear out in the market and so much worry about the future and uncertainty that we’re seeing unprecedented buying of Treasuries. It’s a little bit of an anomaly.

Adam Hooper – Again, just kind of more uncertainty.

David Pascale – Yes.

Adam Hooper – Hard to forecast at this stage.

David Pascale – It’s hard to forecast, and I think that the U.S. economy is stronger than the European and Chinese economies right now, but the bad news, in like German manufacturing and other things and more worries about a messy Brexit with the new Prime Minister in England, Hong Kong unrest, which is a major financial center, and then there is a massive amount of unrest there. We are seeing the U.S. economy almost alone in an expansion mode but there is a worry that the effects of the 2017 tax cuts are starting to wane. Businesses didn’t invest a lot, they did a lot of corporate buybacks, and the U.S. did not pass an infrastructure deal in 2016 and 2017 which would, there was a lot of hope with the new administration. So I think that some of those chickens are now going to come home to roost where there is a possibility of a slowdown here, but I don’t see a contraction.

Adam Hooper – What kind of timeline are you thinking before we can get to some certainty around some of these questions? These are pretty fundamental pieces that are shifting around us. With that uncertainty, is there any visibility into a timeline to get a better understanding of how these pieces are going to fit together? Is it a six, 12 month, 18 month kind of a timeline?

David Pascale – I think in the next six to 12 months, people are hopeful that some kind of resolution or predictability in the… with the U.S./China and U.S./Europe trade disputes because it’s, so people want, investors want to see some kind of path forward. The post-World War II economy, the post-Cold War economy has really been based on free trade, and so if it’s something that’s different from that, we’re going to be going down a new path and that has some uncertainties where I think investors would probably rather see a continuation of free trade policies. Also, some kind of more stability or an understanding of how the, how would the new economy’s going to work, for example, with all these negative yielding bonds and how, is there going to be a great reckoning where assets need to be re-priced. I don’t see a single event occurring, but I just think investors are looking for some clarity, mainly on trade, mainly on trade.

Adam Hooper – Okay. As a commercial real estate investor in the private markets, how does this boil down to me looking at assets either in my local markets or maybe major secondary markets? How much of an impact does this have? These kind of bigger global uncertainties versus what we talked about earlier? Was this just really, really good capital markets prospective in terms of borrowing costs, potentially an increase in yield on the acquisition side? Is it good news, is it bad news, is it kind of wait and see news in the real estate investment space?

David Pascale – It is wait and see and we’re still going through a shakeout in product types. I’ll start with retail. Retail is still, is undergoing some big changes with Amazon, et cetera. There’s a new game changer that is coming along, and that is 3D imaging allowing people to try on apparel at home, virtually, and get perfectly, and to do a scan of their body, and to get perfectly fitting apparel. And why is that important, because women’s apparel drives so much of the mall traffic because there’s, when I’ve talked to some of the big retailers, they’ve done some deep studies, and for example, I’m talking about women’s clothing right now, so women like to go in and try on clothing because fitting is the art and they want something that fits because to go out on Saturday or to be at work on Monday. The same thing with men. And so that’s always been an edge that the bricks and mortar had, was the fitting room and looking in the mirror. Now if they lose, start losing some of that on top of all the other quote unquote showrooming, where people will go into stores and then bring up the app on their phone and are able to buy it cheaper online and get it delivered that day or the next day, you’re just going to see more and more of a shakeout with retail. What’s going to end up winning, in my opinion, are the daily needs and the experiential retail, but the boxes full of boxes are going to start to lag, but also the way some of those big box stores are winning now is by doing omnichannel,

David Pascale – where you can buy things online and pick up there, or you can return things that you ordered online at the store and people go in and get a credit and then shop at the store. It’s a new world in retail. We’re starting to see industrial. I’m really fascinated on industrial with the last mile concept, which is delivering food or goods to the consumer. These are these well located kind of like hyper, quick warehouses that are not in these giant distribution areas in the middle of nowhere where the highway nodes are. They’re in the core markets, and there’s new things, like giant urban kitchens delivering food and I think there’s a lot of excitement in kind of local industrial, and then on the big side, you’re seeing some, a really new concept with multi-level industrial, where there’s warehouses stacked four high and giant elevators, and so you’re seeing the, I think the solid investment are these massive distribution centers that are strategically located in places like southern Illinois and Reno, Nevada and Phoenix, Arizona where all the highways come together and they have critical mass. I’m excited about that kind of industrial.

Adam Hooper – I’d say that was a new one for us. We had, on a just past episode, we had Melinda McLaughlin at ProLogis come on, and they’re developing, like you said, multi-story industrial in Seattle core, which is just fascinating. I mean, that’s–

David Pascale – On so many levels. It’s just amazing. Three years ago, we’d never heard of that. Now, it’s the hottest thing. From the core, outside the core. Going over to hotels, Airbnb has disrupted that space, but some of the hotels are adopting different Airbnb type of feelings or as you would say, vibes, and there’s a lot of new hotel concepts, catering to millennials and social media, and a lot of the older hotels are getting to be a little bit, I would say, not functionally obsolete, but need to do more to keep up. And again, that being said, I always like to stress that there’s the hip, urban cores, but there’s still plenty of real estate out there in suburban Atlanta or suburban Kansas City or outside of Houston that’ll still be the old Fairfield Inn and need, and there’s a need for those, or the old suburban office. In the office base, we’re seeing creative office. A huge demand, it’s fascinating that all the predictions, when I first started in the business in 1995, the internet was coming on and there was a feeling like everyone’s going to telecommute, and there will be no more need for office. And the tech companies are now the biggest, the people that were going to destroy office were Facebook and Google, et cetera. They’re now driving office demand in Silicon Valley like nothing we’ve ever seen in the history of commercial real estate. The answer is companies still like their employees to gather and collaborate, bottom line. And the whole working from your house with the baby crying or the TV on,

David Pascale – might not be the best way to be productive.

Adam Hooper – What’s your hot take on WeWork, real quick?

David Pascale – On WeWork… It’s a wait and see because they are leasing long and renting short. They’re signing long-term leases and then they’re renting short-term, but there is a–

Adam Hooper – Sounds kind of like our yield curve we were just talking about.

David Pascale – Exactly. Maybe this is smart in the new normal, and they have, SoftBank is a very critical part of their funding and the mood there, where I was closely watched, but no matter what happens with WeWork, they will have permanently changed the office landscape in America because again, people want a place to go and collaborate, and what WeWork has really tapped into is the single entrepreneur who’s got a partner in Charlotte and he’s in Atlanta, and they both come into a WeWork and work separately and entertain clients there, but they don’t sign this long-term lease of this old-fashioned office with an assistant up front and a receptionist and all that. I think they permanently changed it, whether it will be they are the winner or Regis or one of the old companies is left to see. That’s more to do with their funding, but co-working and co-living are changing the face of urban America, no doubt.

Adam Hooper – Okay, so we’ve got retail, industrial, hotels, office. What’s your take on multi-family?

David Pascale – Multi, I’m doing a lot of multi-family business myself here at George Smith Partners. A lot in Texas, Arizona personally, and my team here. And I think that this dovetails with some of my earlier comments on the SFR market. You don’t have unqualified people buying houses anymore. They’re renting apartments, which they are qualified. There’s a group out there that, Estrada, that is not quite qualified to buy a house. They don’t have enough money yet, but they have a fining come and they definitely qualified for what I would call workforce housing. I’m very bullish on workforce housing and the employment centers, Dallas, Atlanta, Nashville, Phoenix, Sunbelt South, and I think BNC Apartments are very strong right now and there’s a lot of demand because there is a shortage of single family, there’s an affordability issue, we’re at max employment, and I think that even though there’s been a big building boom in multi-family, that it’s still just, we might see a little softening with rents, but multi is very strong for years to come, and there’s a fascinating multi-family development in the markets right now. Fannie and Freddie have a new conservator at the FHFA, a new gentleman has taken over. The long-time head of the FHFA retired and he is in charge of bringing Fannie and Freddie into the next few years, and they are thinking about ramping down their production, and we’re seeing Fannie and Freddie get a lot more conservative lately, and some new lenders, or some new sources are coming in to fill the void.

Adam Hooper – New lenders on the private side, or what kind of–

David Pascale – On the private side. Banks, CMBS, life companies, because they’ve always loved multi-family, but the agencies Fannie and Freddie have been getting all that business–

Adam Hooper – Just couldn’t be competitive.

David Pascale – Right, they couldn’t be competitive, but now that they’re allowed to compete, they’re jumping in hard, so we just see a lot of liquidity there in the bridge space. It’s the first dollar out for the family, the prioritization of payments, it’s shelter, food, drugs. That’s why apartments, grocery stores, and drug stores are one, two, and three when we’re talking about preferred product types.

Adam Hooper – That’s a really good overview on where we’re at with the kind of, I mean, food groups there. And then again, kind of distilling that down, if I’m an investor looking in my local market or again, through a platform like RealCrowd, where you’re looking at other, more local investment opportunities, how much attention do you need to pay to what’s going on nationally, globally, versus more, kind of locally, regionally, down to city or MSA or state even?

David Pascale – The global affects the local, but I think it’s so important to look at the demand drivers locally. For example, I worked on a property in Grand Prairie, Texas, for example, in the Dallas-Fort Worth area, and there is a massive Northrup type missile facility there. It’s been there since the ’50s. It employs hundreds or thousands of people making 50,000 to $500,000 a year. It is a demand driver that will be there forever because it’s a core part of our, of the American defense. That’s just an example. I think that it’s important when you’re making a decision to look at the local demand drivers and how they are going to fare in the new normal disruptive commerce world we’re in right now. You don’t want to be next to the Yellow Cab distribution center in the era of Uber. I mean, but maybe you want to be back to Dallas, Uber’s now opening up their second headquarters in downtown Dallas and all those jobs are going to pay 100,000 a year, so there’s all of a sudden, there’s a lot of interest in condos and apartments in downtown Dallas. It’s really watching Silicon Valley, Portland, Seattle, and these local markets and what’s going to be driving the economies nationally and locally for the next 10, 20 years.

Adam Hooper – We talked about some of the again, kind of the national, global metrics and stats that you’re looking at on a market level. Are there certain key indicators that investors can access or certain, is it population growth, is it job growth, is it employment, unemployment, what are some of those more kind of local, regional factors that investors might be able to start looking at or maybe where could they even get that data to start some of that critical thinking?

David Pascale – You’d be surprised at how good Wikipedia is. When I’m looking at a city, I bring up Wikipedia, and it lists all the population trends in basically any city in the United States, it lists the local demand drivers, and then I will try to find articles or reports that talk about those dremand drivers. That’s just an example, and then different Chambers of Commerce reports, and again, the old standard CBRE, Axiometrics, and looking at, for example, institutional sales in a certain market or institutions buying there. And a lot of it is colloquial and local knowledge. Because when you’re buying something, you want to know who else is buying there. Is it mom and pop investors or is it institutional investors? I’ve tried to get reports from Real Capital Analytics. I’m not plugging any of these, by the way. I mean, these are just the tools that we use. Real Capital Analytics, Axiometrics, CoStar, and things like that. Do you want to be able to see what your exit might be, how much liquidity’s in the market, and then also use the Chambers of Commerce and local economic reports to see where companies are going.

Adam Hooper – And do the local, regional markets usually act as a fractal of the overall economy or are there different factors that will insulate, I guess how localized are some of these factors? Are there insulating factors within these local markets or are they still susceptible to the overall kind of national, global trends?

David Pascale – Employment and wages are critical and you’re seeing different tax, people really, for example, with the last tax bill, they stopped SALT, which was the state and local tax deduction on the federal tax return. So now New Jersey and New York and California taxpayers have a huge burden of a deduction that they’ve had for 100 years. You look at certain markets like, I would say Texas, Arizona, Idaho, Tennessee, Nevada that have ultra low taxes, and they might be able to withstand some, their consumers might be able to withstand a little more storm clouds than in high tax states, like California and New Jersey, New York, where if there is a little headwind to the consumer, they’re going to pull back sooner because they have less post-tax income. I think you got to watch, I think we’re in a consumer-driven economy and I very much watch the behavior of the consumer and locally.

Adam Hooper – Perfect.

David Pascale – The consumer and employment.

Adam Hooper – Good, well I think that’s a great overview, and that’s a lot of good stuff for listeners to be checking in on and kind of, starting to do some of that thinking about again, the national and the local and some of these bigger trends that are going on. As we kind of round out the conversation today, what are we, what should we be keeping an eye on here as we kind of get into the Q4 and start to think about the end of 2019 into ’20? We’ve talked about a lot today, but what are some of the kind of major things that investors should be keeping an eye on or setting their Google alerts for news updates, or kind of those main things that we should be expecting to see kind of unfold here in the last part of this year?

David Pascale – Would be watching trade talks and some resolution or predictability there. I would be watching for potential stimulus out of Washington, payroll tax cut and things like that. I always watch the price of oil. I think that you will not see interest rates rise until there’s significant inflation and I really look at wages and oil prices because that’s our big commodity. So I’d watch, like if there’s stirrings there, you might see rates go up. I’m going to closely watch the next few months of Treasury fundings just because that’s our bedrock index. I’m also watching the wave of populism around the world and isolationism amongst governments, meaning is there going to be a new new normal where there’s huge barriers around countries with trade and immigration, and are we going to be entering kind of a new era of something we’ve never seen before, and how will investors navigate this, maybe what I call the new new normal.

Adam Hooper – There we go, now what we’ve got again on record as the new new normal potentially too.

David Pascale – Exactly.

Adam Hooper – It’s fascinating again, there’s so many interesting factors that play right now a lot of really, pretty crucial time. There’s a lot of these factors that if a couple things go one way or the other, can have a pretty big impact on the investment landscape as we know it.

David Pascale – I agree, I agree, because the thing about it is we’re always watching for this concept called contagion. And that, like there was a fear a couple years ago with Greece, even though it’s a very small country on the overall scale, if they defaulted on their bonds and then Italy defaulted, that could then spread to the United States and you could see spreads double and triple. Everything is connected, and so it’s always, you want to be watching any early signs of what I call contagion in the markets, and being able to be ready, whether you, by rate gaps, or do some hedging, or you increase your equity, or you have reserves, I think investors should always be ready for those headwinds.

Adam Hooper – Great. Well so outside of listening to this episode of the podcast, what’s one thing listeners could do this week if they want to learn more or develop some more of that knowledge about these key factors that they can actually put into action to start getting more in tune with some of these factors?

David Pascale – I would say just stay on top of MarketWatch and CNBC, and watch current events around the world, and watch for the fear and greed indices and what’s driving the behavior of the markets, and I think, so I think it’s a holistic answer. There’s no single place. But I think politics and economics and social change are really converging right now, and again, I don’t think there’s a precedent for what we’re going through, so we’re in uncharted territory, so it’s really, I wish I had a good answer, but it’s like watch everything.

Tyler Stewart – You never know, because a way an investor’s going to get an edge is through some, what I call information arbitrage, where they see something that others don’t see and maybe a contrarian trend that they pick up on could be the path to a great investment.

Adam Hooper – ‘Well this is fascinating. I think I’ve got three full pages of notes. I know Tyler’s got about the same. Lots of really good stuff here. How can listeners learn more about what you’re up to in your world?

David Pascale – You can go on our website, www.GSPartners.com, and that’s G like George, S like Smith, the word Partners dot com. Sign up for our newsletter. It’s called FINfacts. I write a column every week. But more important than my column is we talk about all the transactions that we’re closing and give details to the structure, et cetera.

Adam Hooper – Perfect, and it’s a great resource. We’ll have links in the show notes there. FINfacts is a fantastic newsletter, so strongly recommend listeners go and subscribe to that. A lot of really good information in there. Well, David, again, really, really appreciate you comin’ back on the show today. This is a fantastic update. Lot of interesting stuff goin’ on in the markets right now, so maybe we can pick up sometime end of Q1 and Q2 and see where we’re at and where things have been going.

David Pascale – Perfect, perfect, thank you for the opportunity. I really appreciate it.

Adam Hooper – Absolutely, it’s a pleasure and our honor to have you on. Listeners, as always, we love your feedback, comments. Send us a note to podcast@realcrowd.com with any requests or questions. With that, we’ll catch you on the next one.