David Pascale of George Smith Partners joined us on the podcast to provide an updated look at the market.
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.
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RealCrowd (00:00):
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 (00:23):
This time the Fed did all of that in two weeks, everything and triple and quadruple what they did in '08.
Adam Hooper (00:37):
Hey, Tyler.
Tyler Stewart (00:37):
Hey, Adam, how are you today?
Adam Hooper (00:40):
Tyler, you know we're getting by. It's Earth Day. It's April 22. We got a little bit of rain here in Portland. We're grateful for that. But we're still trying to kind of make sense and be a student of this new environment and see what we're looking at out there. How about you?
Tyler Stewart (00:56):
Yeah, same. I'm still trying to figure out my day-to-day routine, especially now that the entire routine is taking place at home. But on the topic of helping us to make sense of this new world, we brought on David Pascale, Senior Vice President of George Smith Partners.
Adam Hooper (01:12):
We had David back on again, it's been a while since he's been on the show. The George Smith Partners is super active in the debt and equity markets. He gave us an insight as to how they're helping clients right now, which led into a conversation about some of the inner workings of forbearance, which I'm sure a lot of our listeners have heard about. I thought it would be good to kind of talk about what that actually means, and what those impacts are to them as investors. Then we talked a little bit update on the transaction activity and what they're seeing in the market right now and how lenders are changing some of their underwriting, some of their tolerances, and what that environment looks like here, as we adjust to what this new normal or this new period of time until we maybe get to normal is.
Tyler Stewart (01:55):
And in this period, David broke down what key factors and metrics he's really tracking. He's very focused on consumer demand. So the metrics he's looking at our consumer-driven metrics. So be sure to listen for that during the interview. And then David also broke down what property managers are doing to help their tenants and consumers feel safe while at properties. He mentioned that safety right now is really the new value add. So when a property manager is looking to update their building, what they're factoring in is things like sneeze guards and social distancing.
Adam Hooper (02:31):
And we got into a bit at the end there of the episode, some forecasting of what that might look like going forward. What those new normals might be, and how that will affect the different asset classes. So really, really good conversation. Again, really appreciate David's time coming on the show today. And also he has some great information, again, check the show notes, FINfacts, the weekly newsletter that George Smith Partners puts out. Really, really good resource. David is a key contributor to that. So you'll read his, Pascale's Perspectives, really, really great piece of weekly content. So be sure you subscribe to that newsletter. Well, Tyler Stewart, I think that's almost enough of us talking. But as always, if you have any questions or comments, please send us a note to podcast@realcrowd.com. And with that, let's get to it.
Adam Hooper (03:17):
David, thank you so much for coming back on the show today. It's been a while since we've had you on and we thought it would be a good time to check back in and see what's going on in the world of real estate debt. And here, I guess, first maybe an update on what's going on and what the sentiment is within George Smith Partners right now.
David Pascale (03:36):
Well, right now we're looking at the best way to service our clients. And there's a couple of things that are happening now. One is a lot of our regular clients or irregular clients that we've done loans for in the past, we're helping some clients navigate the forbearance process, as a retail or hotel has been shut down. This is just something we're doing for our clients. We're not charging fees for, and it's something that came all of a sudden where a lot of borrowers, and this is a good place starting about to start about the capital markets, especially hotels, especially retail, and especially workforce housing apartments or just apartments. I mean, if your apartment complex is located in Orlando near Disney World, you've got some issues now, or if it's in Dallas, and there's just a lot of people who were working at the restaurants in Las Calenas or something like that, so a lot of apartment properties.
David Pascale (04:54):
So this is a process where the lender is allowing a borrower a certain amount of time to not make principal and interest payments, or maybe just pay interest and letting interest accrue and hopefully things come back, or we don't know, snap back or come back slowly. And then they're able to be current on the loan again without having had a default. And the bottom line is these lenders don't want to take these properties back. They don't want to take a property back that was 98% occupied for a year or for years, and all of a sudden went to 20% collections in a month. The sponsor is still the right person to operate that property.
Adam Hooper (05:43):
Well, no, maybe we can take a minute before we get into the rest kind of state of the market. For a lot of listeners out there that are passive investors in these projects, they might not be that familiar with forbearance. Maybe we can take a minute and just talk through what does that mean? How does that typically come together? What's some of the different scenarios are there? Does it require immediate repayment of that period as a token at the end, is there need to be capital cores? How does how have you guys seen, on the ground, some of these forbearance agreements work out?
David Pascale (06:15):
Good question. And we've seen, it depends on the lender, it depends on how they're regulated, it depends on the situation with the particular property. But as a rule, we've seen lenders require what I call full transparency, where's the cash flow, now? Where's it going to be? And how long do you anticipate needing the forbearance which is a forgiveness of paying interest and principal, a temporary forgiveness And usually, the situation is where the sponsor, the borrower agrees to give the lender, all the excess cash flow after operations to make whatever payment they can, or to keep operating the property. And any unpaid interest in goes on to the note to be paid back in the day when things get better, when things normalize. And then the six to 12-month payment plan from there, or possibly being tied to the end of the loan, if it's a shorter loan. But most lenders, if it's a 10-year loan, with seven years left on it, they want to have a period of time where it gets paid back.
David Pascale (07:38):
During that time, the sponsor is usually not able to collect profits, obviously, and to get distributions. They need to even up the accounts before going on and it being like it was before the crisis. So it's just kind of a temporary forgiveness. What is important about forbearance is it is not a discount of the note, it is not a lower interest rate, that's a whole nother world that's called loan modification. And to be honest, we're in the cycle yet, where we may see that, they're all depends on how long this lasts.
Adam Hooper (08:22):
And so for a passive investor in a deal, maybe they get a notice from the manager that they're going to explore a forbearance agreement with their lender, how does that affect them? What is the net effect to that investor at the end of the day?
David Pascale (08:37):
Right. The limited partners, the the non-managing investors, what they should know is that, first of all, the property is not able to make its debt service. And so when a property can't make debt service, it's obviously cannot pay any distributions, unfortunately, to those limited partners. And that's the real tough thing about right now. These limited partners, and the general partner, and anyone who owns it, is not getting anything, any distributions that they've been getting, call it on the 95% apartment property that I described. So they're not getting distributions. They're waiting for the property to at least be able to pay debt service, and then they get even with the lender, and hopefully, then in a future day, start getting distributions again. And the other key aspect here is this is a risk of being an equity investor because there's not going to be, I surely don't think so, any kind of recompense or bailout from the federal government for owners of real estate.
David Pascale (09:59):
I mean, they're helping the debt markets remain liquid. That's just because if the debt markets freeze up, or in another great recession of elongated time. So it's an important thing to remember, the Fed is there backing up lenders, making sure that lenders are liquid, but they're not going to forgive lenders who have to take care of cuts as of now, and they're not going to make up for lost equity.
Adam Hooper (10:30):
And that's one of the things we've been talking about internally and I think one of the struggles of a equity owner right now is there seems to be relief for the tenants, which is great, right? I think we all need that. We need to have the rent relief, we need to have, whether for your apartment, or for your single family home, or your office space, whatever that retail space, or what that might be. But then, that's pushing all of the risk onto the property owner, right? There's still operating expenses, there's still taxes that need to be paid. There's still utilities that need to be paid, there's still the mortgage that needs to be paid.
Adam Hooper (11:07):
Do you foresee any relief coming from any of these stimulus programs or anything that would help offload some of that risk that is being placed entirely on the ownership and on the landlords from these programs that are providing relief downstream? The lenders are kind of getting squeezed in the middle, they've got relief going to the banks and possibly get relief going to the tenants, but then the landlords are burdening. They're being shouldered with all that burden. Anything you've been hearing or talked about, or anything on the horizon for landlord relief?
David Pascale (11:41):
I would say the following, that landlord relief is really going to be specific to what relief can be gotten for those tenants, that then goes to landlords in the form of rent. I mean, I'm not getting political here but I don't know how much appetite that Congress and the Senate would ever have, or how they could sell to America, a landlord relief bill that would that make landlords whole. And I know that RealCrowd is a place for limited partners to aggregate and to buy real estate, and so it's an important subject. But I would state the following, and I've invested in properties, myself, and arranged equity and arranged a lot of debt, is if you talked about our apartment building, we're talking about, let's say, it's in Orlando, and it's a $15 million asset with $10 million of debt on it, if Disney World needed to expand, or Universal, and build a studio, and they had to have that parcel. And they paid $30 million for it, I'm just making up a scenario, but things like this do happen.
David Pascale (13:16):
Then that $15 million of profit goes to those owners. That's why you invest in real estate, or one of the reasons because the big score can happen, property appreciation, all that endures to the owners. But when values fall, that's the risk on the other side. The lender, I mean, when you think about the returns that equity gets and you compare it to the world of interest rates that we're in now. 3%, 4%, 5%, I mean, these are small and steady returns. The lenders, they're the rock, but they don't share in any of that upside. And real estate is a hard asset. It has tax benefits. It is a preferred vehicle of investment in the United States since the 1800s. And it has all those things going for it but in a moment like this that is so dramatically affecting commercial real estate, call it a black swan event.
David Pascale (14:34):
Ray Dalio in one of his pieces called it a white swan event because pandemics do happen, and they have happened, and etc. So you have these events and these events can and do, I hate to say, diminish owner equity, just like, again, as everyone else there who invests, I would imagine they own their home or condo, if you are now investing in real estate or many do. I mean, when you buy a home, and it was right near the Nissan headquarters, and then Nissan picks up stakes and moves, and all those executives aren't buying in your area anymore, and your home goes down, that's your risk for buying that. I mean, that's the rough and tumble reality.
Adam Hooper (15:32):
Same with public markets and any other asset, right? I mean, there's always that risk as an equity investor of those…
David Pascale (15:39):
Buying stock. Right. Exactly.
Adam Hooper (15:43):
What are you guys seeing on the transaction side. You said a lot of the energy now is more focused on services and help that you guys are providing to existing borrowers. Are you seeing that much if any new transaction activity?
David Pascale (15:57):
What we're seeing in the new transaction activity is best summed up by, call it the range of lenders or the world of lenders. And I'll go through each one because it's meaningful. The banks are in much better shape than they were in '08 during the liquidity crunch. They have money to lend, their balance sheets are strong, they are allocating money for losses down the line because no one knows how long this is going to last and what kind of losses. They are lending but we've really seen a return of recourse or a focus on sponsorship. So before, banks, they've always been customer-oriented and they weren't getting very transactional. Now, they're returning to being about the customer. Loans are getting done, we're seeing our core, core retail, industrial office, and apartments, and not a lot of cash out, some conservative construction loans. If a construction loan parameter was 65% loan to value pre COVID, we're now seeing 55%, 50%, or 50% to 60% loan to cost, excuse me, loan to cost for a construction loan. And on a perm loan from a bank or a bridge loan, they don't want to be giving any cash out and they want to be on a good product type in a great market.
David Pascale (17:37):
Life companies have become very conservative because their main competition for fixed rate loans, CMBS, is now a frozen up market. So life companies are basically, we had a long call with a couple yesterday, 45% to 55%, 10% debt yield rates in the 4.5% range. And some of them are pricing a little under that maybe 4% or higher 3s. Life company spreads have widened because they price off of their alternative investments. And one of their alternative investments is corporate bonds. Corporate bond spreads have widened because all risk spreads have widened. So we're seeing life companies, many of them are on the sidelines or being very conservative.
David Pascale (18:37):
The key part of our business or one of the key parts of American real estate finance is the secondary market, the securitized market. For the simple reason that there's not enough money sitting in all the pension funds, life companies, and banks in their allocations for commercial to service all the commercial real estate in this country. So the way it's been serviced since 1995, has been through secondary markets, both CMBS, which is Commercial Mortgage-Backed Securities, which is a group of fixed rate loans that are bundled together and sold in loans, or a giant loan that is sold in its own security and investors buy them and makes a lender, like Goldman Sachs or Deutsche Bank, able to lend, call it $500 million into 100 properties, and then sell the securities and take that $500 million and lend it again. To lend it again over and over to investors that would never originate their own loans. And they become lenders.
David Pascale (19:57):
So the other market, that's on the fixed rate side, and that's typically 10-year fixed rate money. And on the floating rate side, there's something called the CLO market, the collateralized loan obligation, where it's LIBOR-base bridge loans, usually people fixing up apartments is the classic CLO or fixing up an office building by getting a floating rate loan, usually three to four years. And those loans are bundled together in the collateralized loan obligation and sold to floating rate buyers. So those are critical markets because those are the high-leverage, non-recourse loans that a lot of the syndicated equity groups need because they don't have a big customer for the bank or life company. And those loans are securitized and that liquidity, when it is stopped, which it is stopped now, that means that all the volume in a tough market now falls on the people that are more conservative, the portfolio lenders, and then they double down on being conservative. And so we're in a very limited market of financing right now.
Adam Hooper (21:22):
And now, before we started recording, you were talking about some new programs that are coming, TALF, and some of the others that are trying to inject liquidity back into the CMBS, CLO markets. Right?
David Pascale (21:36):
Right.
Adam Hooper (21:38):
When you say they've stopped, is that a entire complete turnoff of the spigot? Are these TALF programs and other the Feds buying essentially stepping in for where investors would normally purchase these government steps in and purchase these securitizations to keep that liquidity going? Where are we at in that process? What does that forecast look like?
David Pascale (22:00):
Good question. In the last month, a couple weeks ago, TALF, which is Term Asset Lending Facility…
Adam Hooper (22:09):
I was hoping you were going to note it because [crosstalk 00:22:11].
David Pascale (22:12):
Term Asset Lending Facility which is an entity that buys bonds in these markets that are now frozen. The mentality is that the Fed then helps restart these markets, a recovery ensues. And then the things that the TALF entity bought, the bonds, are then sold into the market for a profit, or at what they paid for them at least. And at least in 2008 through 2011 approximately, the TALF facility had zero losses because all they did was help restart. So right now, we've seen TALF buy legacy CMBS. They were authorized to about two weeks ago. And so they're buying older CMBS from March 23 and before, which means they're not buying new issue. But the secondary market has started up again. And we've heard only in the last week or two, that some lenders are now cautiously doing CMBS loans at about 65% loan to value. Only the best office, and industrial, and some apartments, and maybe some grocery-anchored retail but very careful on retail.
Adam Hooper (23:36):
And now 65% loan to value compared to where it was that…?
David Pascale (23:42):
Compared to 70% or 75% with lots of interest only and pushed proceeds, and I wouldn't say loose underwriting, but right now it's super stringent upper underwriting looking at every collection during the process. And sticking to 65%, everything amortizes but at least it's a start.
Adam Hooper (24:06):
It's just almost going back to what we would have expected from a more traditional bank balance sheet program before.
David Pascale (24:13):
Right. And meanwhile, the banks might be at 55% now because they're retrenching themselves. So you're exactly right. They're going back to where the banks were when the CMBS was farther out. On the CLO market, there's been no love from the Fed and some Congress people are pushing them. They have allowed some very limited CLO purchases, which is a very minor part of the market, and not what we call the big time CLO which groups like Apollo and Fotris uses it to help them buy companies and it's non real estate. And then there's the real estate side which neither one of those groups is in the eligible securities list. When you look at the world of bridge lending, and what's bridge lending, for some of your listeners?
David Pascale (25:12):
Bridge lending is buying an asset, usually with some cash flow, renovating it in some way, repositioning it in some way, fixing up units, new management, new look, new marketing strategy, maybe even changing the use, and then charging higher rents and then getting a promo selling and making a profit. So that classic bridge loan, majority of those bridge lenders were called debt funds. And what a debt fund is, is, it's an unregulated pile of money, as I would always call it. Meaning it's not a bank, it's not a life company. It's a group of investors or investment bankers that put together a fund. They then use a CLO, sometimes a mortgage REIT, or sometimes bank lines to then lever the money in there because the basic core money in a debt fund went to returns of 9% or 11%, 9% or 10, or 11%, for their trouble.
David Pascale (26:21):
So in order for them to lend it out at 4%, or 5%, and 6%, they lever it with a bank line at LIBOR plus 100, or use a CLO. With bank lines being called and CLOs being more abound right now, that whole market is pretty much frozen up. And then it also gets into the broader question, I've been doing bridge loans for a long time, you're always taking the rents, and you're moving them up to the nicer property down the street, what they're charging, or across town. Right now, there's also a feeling amongst lenders, just to get away from the whole liquidity issue of who has money and who doesn't, is what are you bridging to? What's the new world look like? Will there be a vaccine? Well, we can get into a long conversation about what the economic picture is in America, fourth quarter 2020, or second quarter 2021.
Adam Hooper (27:32):
Let's maybe explore that a little bit. We've talked a bit on the show here about, everything is still so new, we're still very, very early in this whole progression. Again, we're recording this on April 22, as a note to future listeners, where you can come back and see history real-time.
David Pascale (27:49):
Right.
Adam Hooper (27:50):
But everything is happening. I mean, you mentioned even within the last week or so you're seeing more information coming out of the CMBS space. What are you what is your sense? Or what are you hearing out there in terms of what has to happen before we feel like there's some comfort or consistency in the information that we're getting that we can start to feel like we have a some footing underneath us as to what normal might be?
David Pascale (28:18):
I mean, it's a great question. And in America, it's often quoted, and a lot of people kind of take it for granted, but now it's very important. We have a consumer-driven economy. The typical number out there is 70%. And do not get into a lot of financial theory. For example, Japan doesn't have a consumer-driven economy, it's more industrial-driven. So back to America, where 70% is consumers and doing what consumers are good at doing. Which is shopping, getting on airplanes, going to hotels for conferences, and parties, and concerts, and football games, and traveling, and buying things, in our open society. And that is a critical part of what makes Americans economic strength.
David Pascale (29:18):
What's interesting is we're talking to property owners about the future. The future in retail might be a lot of stores that don't reopen, but stores that reopen, there will be a line outside the store with spacings, everyone masked, sneeze guards everywhere inside the store with arrows pointing you down aisles so you don't ever cross another person coming the other way. And then a whole staggered checkout system. And that sounds safe, and you'd want to know, would a consumer be confident in that environment? Maybe yes. Then there's the problem of how much volume are you going to be doing on those cash registers, and are you still going to be able to pay the rent you were paying pre COVID? And so, there's that issue. There's hotels and airline flights. And if we're able to reopen gradually, with these half measures, and we pray, no second wave or big second wave of infections while we're looking for the key principles, which are treatment, and vaccine.
David Pascale (30:51):
And I often point out even these treatments like [remzibidor 00:30:55], the Gilead treatment, is it's not just a pill you're going to pick up at the pharmacy, it's a very promising treatment. But it involves you being in a bed and strapped to an IV. And so these are things to think about. And if hotels are at a quarter occupancy, and retailers are at half occupancy, then we're looking at the winners are going to be industrial, and certain apartments, and some people are saying, "Maybe a winner is going to be single family residential for rent." Which is a huge thing now as people really realize they don't want to be in an elevator in a corridor, and they'd rather walk in their front door and all their kids in a fenced in-yard.
Adam Hooper (31:49):
Are there any new metrics that you guys are looking at, or anything different that you're following now in a current or post COVID space that that was maybe different than what you were looking at before or is it still the same metrics and markers that you guys are tracking?
David Pascale (32:05):
It's retail sales. I mean, it's employment. Employment drives everything because because everything's driven off the consumer and their disposable income, which is all based on employment. Because the majority of our consumers are not lucky enough to be investors. The investor part of our economy is probably the top 5%. So it's a consumer, employee-based world. And so we're looking at those metrics, we haven't seen, I'll go back for a second. We have not yet seen a lot of sales. We're talking about property selling as there have been people asking me, "Has there have been a discount?" And so a lot of these presentations I've been on with Guggenheim or Goldman Sachs, or the big REITs, they go well… I saw one estimate that said, "We think industrial might be even apartments are down 10%. Office is down 5%. Retail is down 20%." This is on price in a hotel might be 40%. As far as if all those assets were $10 million on January 20th, call it before any COVID fear because there was a lot of sales in January.
David Pascale (33:38):
And if you needed to sell them today, they'd be you know, 9.59% etc, down the line with those discounts. But even that is a misnomer because the financing world's not together. You're going to see a lot of people buying things for cash. And we're seeing a lot of lenders in capital, I'm going back to my lenders in capital. We may fix that later, but I would say, we're seeing a lot of lenders in capital now in the vogue of rescue capital. Meaning, I talked to a lender while I was doing bridge loans and preferred equity at LIBOR plus 300, and preferred equity, which is secondary behind a construction loan at 10% or 11% before the COVID. Now, I see a lot of opportunity out there where I can be a first trusteed lender with an equity kicker. So I think one of the things we're going to see in the future depending on how long this lasts, and how deep the pain is, is eventually, you're going to see the mark to market and it's going to be an asset that needs to refine.
David Pascale (35:03):
Someone who has a loan that matures in 2024, I like their chances now. They're not going to have to mark that asset down. Maybe on their personal financials if they're using GAAP or FASB accounting standards, but they're in good shape, especially if they're low-leverage. But someone with a high-leverage loan coming due might have to mark that asset to market really quickly. And maybe there's some equity that's going to be lost or new equity and new debt comes in. We're going to see a lot more of that where the lender marks it down and says, "I'll do this loan if I see new equity come in." That new equity will prime the old equity.
Adam Hooper (35:47):
Now it's been a good, what? 10, 11 years since we've heard those words in that order, mark to market.
David Pascale (35:55):
Exactly.
Adam Hooper (35:55):
For those that…
David Pascale (35:56):
And remember, the playbook.
Adam Hooper (35:59):
I see those that maybe weren't investors in this asset class back in the global financial crisis, maybe take us just a couple, high-level, mark to market, what does that mean? What is the impact to the different parts of capital stack if we get back into that kind of a scenario?
David Pascale (36:16):
So I'll use the $10 million value item. So an apartment complex is worth 10 million, there's three million of equity in it right now, cash and appreciation and there's $7 million loan. If that property needs to be reified, and someone can only get a $6 million loan today, because things are so upside down, you might need to restate the value at eight million, and a new investor will have to come in for a million dollars. The old investors that have the three million are now going to be subordinate to this new investor of the one million because he's coming in at the mark to market basis. And they were part of the old inflated basis so their equity is now going to be worth less than the million.
David Pascale (37:19):
So the point is, is that when you have $7 million worth of debt, and $3 million worth of equity on a property that's now worth $7 million, call it 7.5 million, then that three million cannot have all the equity standing it had before because you still need to pay off all that debt because we're not in a market yet where debt is being marked down.
David Pascale (37:53):
And then if the market continues to erode, then you might see where the where even the debt lender then probably discounts their note to five million, for example, because the property is in such bad shape. And at that point, usually that means that all the equity is gone. And the new equity that comes in based on that note will then be a million dollars of new equity and $5 million worth of debt on the new $6 million value. The old equity, it's almost like a hope certificate that, "Hey, if it goes back up to 10 million, then some of that equity will be restored."
Adam Hooper (38:37):
And there's all numbers of complex structures that can be worked out is in this scenarios.
David Pascale (38:42):
Right. Between the debt.
Adam Hooper (38:45):
The net effect is that if there's a trigger or there's an event on the loan, if there's a maturity issue or something like that, that happens, if the lender has to basically recognize and mark to market, the current value of that asset that can sometimes trigger either resizing of a loan or having to come back in with fresh equity to get that loan back in compliance with whatever it's a loan to value covenants or terms in that loan are.
David Pascale (39:13):
Exactly.
Adam Hooper (39:13):
And again, we haven't seen that since the global financial crisis, right? It's been a long time since we've had to discuss mark to market. I think, at least from my perspective, a lot of this, the severity of what these impacts will be to the real estate space are largely going to be determined by how long we're in this shutdown. Right? If we can get out of this and we have a handle on the health side of this thing. And we can start getting back to, again, more of a footing of what a recovery might look like. The hope is that real estate might be able to avoid the sharper bottom of whatever this dip is, right? Because of its illiquidity, if we can start to see some recovery, maybe we can kind of skip the very bottom of that V or that smooth shape, whatever that turns into, again, assuming that's the shape of the recovery.
Adam Hooper (40:10):
The longer this becomes a protracted thing, I think the more risk there is for real estate coming into some of these mark to market issues. That would have a bigger impact on the economy as a whole and as our asset class. With that, is there anything that you guys are seeing that would indicate the timing of when we'll see some of these things start to shake through our space? Or what we think the recovery might look like, or still again, too early at this stage? And nobody really knows yet?
David Pascale (40:38):
Well, I'll go with the good news, or what we've seen so far, that it's been better than 2007, 2008. Back then, I would say three gentlemen really kind of saved the financial world. And that was Ben Bernanke, Timothy Geithner…
David Pascale (41:01):
Ben Bernanke, the Fed Chair, Timothy Geithner, the New York Fed Chair, and Henry Paulson, who was ex Goldman Sachs and was the Secretary of the Treasury. Supposedly, I read Geithner's book and they would just sit in their office and just kind of throw ideas against the wall. And they came up with TALF and HARP, and HAMP and all these acronyms, and TARP, of course, over a period of a year, and they would roll out liquidity programs. This time, the Fed did all of that in two weeks, everything and triple and quadruple what they did in '08.
Adam Hooper (41:47):
Right.
David Pascale (41:47):
So that was critical. And we have that liquidity to banked on. Now, if I can be a sociologist for a second, or Dr. Fauci, expert. I mean, if a vaccine and the one from Johnson & Johnson seems like the most likely one, because they have the ability to ramp up to a billion doses, and they've been on all the channels that I've seen lately talking about, their goal is to have a billion doses out in second quarter 2021, they feel good about it. So let's use that as next summer, it's all over and everyone… But you always also wonder, will people ever act the same? But you hope that by next summer, we're at 90% capacity or 95% of where we were.
David Pascale (42:52):
And I read an article in MarketWatch, the next 45 days are the most important in the history of capitalism. I mean, I love headlines like that. But the next few months, this interim period, and while we're hoping for vaccines and cures, and as we roll out, and a lot of it's going to be not just the governors and the mayors and the president, it's going to be the attitude of the consumer and how strong that comeback is. So I think we have a good base of liquidity, we understand how to control the curve. But the consumer has gone completely flat. Mall tenants will never reemerge, and we're going to have to adjust to a new life. So I think the next three or four months, we'll have a lot of clarity on how this end game is going to be played.
Adam Hooper (43:53):
I agree. And I think what you mentioned in there, too is… Then you talked about, what does the retail landscape look like after this, right? What are some of those behavioral changes that are going to stick with us through this experience that we're all going through collectively right now. That we might not even have an idea what the second or third order impacts of how this goes, right? I mean, think about my kids 10 and 11 years old, they have an awareness of what's going on. This is so bizarre of an experience to go through a child. What kind of an impression does that cause on their worldview going forward?
Adam Hooper (44:27):
I don't know if you have any thoughts in terms of some of the behavioral changes that we might see in those impacts on the different asset classes. And that's something we're continually trying to explore and see what that might impact going forward.
David Pascale (44:41):
Well, I think that the jury's still out on what type of co-living and there's been so much apartments. Everything in LA, here we're at LA, there's so much of an massive emphasis on TOD, Transit-Oriented Development. And we're building out a train system. We have legendary, terrible traffic. And I mean, Nellie is spending billions, and we've been doing this for 30 years to get. And we're about to hit a point, again, 2024 for the Olympics, which are really now in 2028, but to have the train system basically done, including a people mover to LA act, and all kinds of dense apartment. And I'm not talking about just Mom and Pop apartment, I mean, big REITs building, huge apartment complexes near transit.
David Pascale (45:44):
So what's that model going to look like? People walking down the hallway then getting on a train? Are they going to be masked up? Are they going to be confident doing that? Because we're trying to get away from the suburbanite in their car with their house out far away. So I think apartments, it's going to be very interesting to see how this develops. I think industrial has is now going to be stronger than ever. Last mile, supply chain, everything about online. and then obviously, our healthcare system has been to a certain degree exposed as far as certain deficiencies, as far as our ability to massively do testing and things like that. So will we see medical office maybe become very strong or stronger than ever? Facilities near hospitals, kind of the urgent cares that are in a lot of shopping centers. So industrial, in that being strong, retails going to be changed, hotels are really… I mean, I saw Barry Sternlicht today, he's very hopeful that 2021, second half, the hotel industry is at pre COVID levels.
David Pascale (47:12):
I would say that's the most optimistic as far as people running around going to hotels. Hotels are going to have a whole new program of sterilization and things like that. Then you get into some of the details. I know someone building an office building and now they're changing all of the fixtures to a certain type of copper where a virus can't live. And so you're going to see office buildings, maybe half the workforce shows up one day, the other half the next day in the cubicles so they can space enough. Obviously, elevator queuing, Purell, dispensers, wipe downs, and people will marktet…
David Pascale (47:58):
I've heard a lot of talk about people marketing offices. Remember when it was all about LEED and having clean sustainability carbon footprint, gardens on the roof, they'd cool the property? I mean, I think LEED is very exciting. There might be a new certification, clean.
Adam Hooper (48:18):
Health-based.
David Pascale (48:19):
Someone said, C-L-E… And so you'll see offices changing that way. But I think there's been a lot of publicity about people working at home from Zoom. But I've seen a lot of people say that it's inefficient. That congregating in the office where everyone is in an office, doing the same thing when we're all in a law firm, or whatever we're doing, it will always be more efficient than someone with their roommates, or family, or loved ones, or dogs, sitting there with all the different agendas that are in the house. And so, I mean, I like office, I like industrial. Apartments are always going to be needed, they're going to be changed. Retail is going to have a very tough time and emerged maybe leaner and meaner but different.
David Pascale (49:18):
And I think the big retailers, there's a famous quote from one of the major investors like Dalio that said, Target, Walmart, Costco, and Amazon will survive and what we call the Fotris grocers, the Kroger's and the Publix, and they've actually adapted very well to curbside pickup and delivery which could be the future. So definitely, a changed environment, and you'll see cap rates and things change and maybe there's a new market for people to convert real estate to something that's more palatable in the post COVID world, and new bridge loan opportunities. So self storage, going through the product types still very strong. And so it's going to be property by property and market by market. And we hope that we see everyone heal better. But certain markets might have a lingering problem for whatever reason, and other markets are doing better. And a lot of it will depend on that.
Adam Hooper (50:37):
Okay. Well, we'll be sure that we get you back on the show. And we can see if any of these things have come to fruition. And again, really, thank you so much for coming on today. And again, sharing your insights.
David Pascale (50:50):
Thank you for having me.
Adam Hooper (50:51):
Was there anything else that listeners should be thinking about or paying attention to you right now with everything that's going on?
David Pascale (51:00):
I mean, yes. This is unprecedented, so the recovery will be unprecedented, and there's steps in it. And things will happen that no one could have predicted. So it's really, I think, right now, is be informed and also there was a famous comedy album in the '70s, called Everything You Know Is Wrong. But it's something like the things that you assumed before in the old world, be ready to have new assumptions and be watching for new opportunities. And I think, again, that groups of investors, tend to talk about equity, who are brave and take risk right now with their cash in the right markets are going to be rewarded in a way that was not around a couple years ago. There's going to be some opportunity to buy something in your market. So people should be watching in the in the markets they know. They should be watching for opportunities at the new basis.
Adam Hooper (52:26):
I like that. That sounds right. There's going to be opportunities coming out of this for sure. And it'll be interesting to see where those are and what that looks like. How can listeners keep up to date with what you guys have going on and everything at George Smith Partners, and your weekly email, which is a treasure, I would recommend everybody sign up for that.
David Pascale (52:46):
Oh, thank you. We have a weekly newsletter called FINfacts, F-I-N-F-A-C-T-S, and anyone can join our newsletter. It's free and you can subscribe or unsubscribe at will, there's no advertising on it. And we do not sell the list to anyone. It is our list, it is pure real estate content. If you go to our site, wwwgspartners.com on your phone, or tablet, or computer. The first thing you'll see is an opportunity to sign up for FINfacts, and I would really appreciate if you do that because you can subscribe and unsubscribe anytime.
Adam Hooper (53:30):
And we'll have we'll have links in the show notes for everybody out there, again. And we always love reading your commentary, David, on what comes out on those FINfacts.
David Pascale (53:36):
Oh, thank you.
Adam Hooper (53:37):
So, again, really appreciate your coming on the show today. We'll be sure to get you back on as this is such a quickly evolving space. What we talk about this week, who the heck knows? It might be completely out of date by next week or next month, so you'll have to be back on.
David Pascale (53:51):
Exactly. Then I'll have to come back on.
Adam Hooper (53:53):
Perfect. All right, David.
David Pascale (53:55):
Thanks, Adam Hooper.
Adam Hooper (53:56):
Thanks for coming on. Listeners, as always, that's all we've got for today but if you have any questions or comments, please send us a note to podcast@realcrowd.com. And with that, we'll catch you on the next one.
(00:00):
All opinions expressed by Adam Hooper, Tyler Stewart 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 (00:23):
This time the Fed did all of that in two weeks, everything and triple and quadruple what they did in '08.
Adam Hooper (00:37):
Hey, Tyler Stewart.
Tyler Stewart (00:37):
Hey, Adam Hooper, how are you today?
Adam Hooper (00:40):
Tyler Stewart, you know we're getting by. It's Earth Day. It's April 22. We got a little bit of rain here in Portland. We're grateful for that. But we're still trying to kind of make sense and be a student of this new environment and see what we're looking at out there. How about you?
Tyler Stewart (00:56):
Yeah, same. I'm still trying to figure out my day-to-day routine, especially now that the entire routine is taking place at home. But on the topic of helping us to make sense of this new world, we brought on David Pascale, Senior Vice President of George Smith Partners.
Adam Hooper (01:12):
We had David back on again, it's been a while since he's been on the show. The George Smith Partners is super active in the debt and equity markets. He gave us an insight as to how they're helping clients right now, which led into a conversation about some of the inner workings of forbearance, which I'm sure a lot of our listeners have heard about. I thought it would be good to kind of talk about what that actually means, and what those impacts are to them as investors. Then we talked a little bit update on the transaction activity and what they're seeing in the market right now and how lenders are changing some of their underwriting, some of their tolerances, and what that environment looks like here, as we adjust to what this new normal or this new period of time until we maybe get to normal is.
Tyler Stewart (01:55):
And in this period, David broke down what key factors and metrics he's really tracking. He's very focused on consumer demand. So the metrics he's looking at our consumer-driven metrics. So be sure to listen for that during the interview. And then David also broke down what property managers are doing to help their tenants and consumers feel safe while at properties. He mentioned that safety right now is really the new value add. So when a property manager is looking to update their building, what they're factoring in is things like sneeze guards and social distancing.
Adam Hooper (02:31):
And we got into a bit at the end there of the episode, some forecasting of what that might look like going forward. What those new normals might be, and how that will affect the different asset classes. So really, really good conversation. Again, really appreciate David's time coming on the show today. And also he has some great information, again, check the show notes, FINfacts, the weekly newsletter that George Smith Partners puts out. Really, really good resource. David is a key contributor to that. So you'll read his, Pascale's Perspectives, really, really great piece of weekly content. So be sure you subscribe to that newsletter. Well, Tyler Stewart, I think that's almost enough of us talking. But as always, if you have any questions or comments, please send us a note to podcast@realcrowd.com. And with that, let's get to it.
Adam Hooper (03:17):
David, thank you so much for coming back on the show today. It's been a while since we've had you on and we thought it would be a good time to check back in and see what's going on in the world of real estate debt. And here, I guess, first maybe an update on what's going on and what the sentiment is within George Smith Partners right now.
David Pascale (03:36):
Well, right now we're looking at the best way to service our clients. And there's a couple of things that are happening now. One is a lot of our regular clients or irregular clients that we've done loans for in the past, we're helping some clients navigate the forbearance process, as a retail or hotel has been shut down. This is just something we're doing for our clients. We're not charging fees for, and it's something that came all of a sudden where a lot of borrowers, and this is a good place starting about to start about the capital markets, especially hotels, especially retail, and especially workforce housing apartments or just apartments. I mean, if your apartment complex is located in Orlando near Disney World, you've got some issues now, or if it's in Dallas, and there's just a lot of people who were working at the restaurants in Las Calenas or something like that, so a lot of apartment properties.
David Pascale (04:54):
So this is a process where the lender is allowing a borrower a certain amount of time to not make principal and interest payments, or maybe just pay interest and letting interest accrue and hopefully things come back, or we don't know, snap back or come back slowly. And then they're able to be current on the loan again without having had a default. And the bottom line is these lenders don't want to take these properties back. They don't want to take a property back that was 98% occupied for a year or for years, and all of a sudden went to 20% collections in a month. The sponsor is still the right person to operate that property.
Adam Hooper (05:43):
Well, no, maybe we can take a minute before we get into the rest kind of state of the market. For a lot of listeners out there that are passive investors in these projects, they might not be that familiar with forbearance. Maybe we can take a minute and just talk through what does that mean? How does that typically come together? What's some of the different scenarios are there? Does it require immediate repayment of that period as a token at the end, is there need to be capital cores? How does how have you guys seen, on the ground, some of these forbearance agreements work out?
David Pascale (06:15):
Good question. And we've seen, it depends on the lender, it depends on how they're regulated, it depends on the situation with the particular property. But as a rule, we've seen lenders require what I call full transparency, where's the cash flow, now? Where's it going to be? And how long do you anticipate needing the forbearance which is a forgiveness of paying interest and principal, a temporary forgiveness And usually, the situation is where the sponsor, the borrower agrees to give the lender, all the excess cash flow after operations to make whatever payment they can, or to keep operating the property. And any unpaid interest in goes on to the note to be paid back in the day when things get better, when things normalize. And then the six to 12-month payment plan from there, or possibly being tied to the end of the loan, if it's a shorter loan. But most lenders, if it's a 10-year loan, with seven years left on it, they want to have a period of time where it gets paid back.
David Pascale (07:38):
During that time, the sponsor is usually not able to collect profits, obviously, and to get distributions. They need to even up the accounts before going on and it being like it was before the crisis. So it's just kind of a temporary forgiveness. What is important about forbearance is it is not a discount of the note, it is not a lower interest rate, that's a whole nother world that's called loan modification. And to be honest, we're in the cycle yet, where we may see that, they're all depends on how long this lasts.
Adam Hooper (08:22):
And so for a passive investor in a deal, maybe they get a notice from the manager that they're going to explore a forbearance agreement with their lender, how does that affect them? What is the net effect to that investor at the end of the day?
David Pascale (08:37):
Right. The limited partners, the the non-managing investors, what they should know is that, first of all, the property is not able to make its debt service. And so when a property can't make debt service, it's obviously cannot pay any distributions, unfortunately, to those limited partners. And that's the real tough thing about right now. These limited partners, and the general partner, and anyone who owns it, is not getting anything, any distributions that they've been getting, call it on the 95% apartment property that I described. So they're not getting distributions. They're waiting for the property to at least be able to pay debt service, and then they get even with the lender, and hopefully, then in a future day, start getting distributions again. And the other key aspect here is this is a risk of being an equity investor because there's not going to be, I surely don't think so, any kind of recompense or bailout from the federal government for owners of real estate.
David Pascale (09:59):
I mean, they're helping the debt markets remain liquid. That's just because if the debt markets freeze up, or in another great recession of elongated time. So it's an important thing to remember, the Fed is there backing up lenders, making sure that lenders are liquid, but they're not going to forgive lenders who have to take care of cuts as of now, and they're not going to make up for lost equity.
Adam Hooper (10:30):
And that's one of the things we've been talking about internally and I think one of the struggles of a equity owner right now is there seems to be relief for the tenants, which is great, right? I think we all need that. We need to have the rent relief, we need to have, whether for your apartment, or for your single family home, or your office space, whatever that retail space, or what that might be. But then, that's pushing all of the risk onto the property owner, right? There's still operating expenses, there's still taxes that need to be paid. There's still utilities that need to be paid, there's still the mortgage that needs to be paid.
Adam Hooper (11:07):
Do you foresee any relief coming from any of these stimulus programs or anything that would help offload some of that risk that is being placed entirely on the ownership and on the landlords from these programs that are providing relief downstream? The lenders are kind of getting squeezed in the middle, they've got relief going to the banks and possibly get relief going to the tenants, but then the landlords are burdening. They're being shouldered with all that burden. Anything you've been hearing or talked about, or anything on the horizon for landlord relief?
David Pascale (11:41):
I would say the following, that landlord relief is really going to be specific to what relief can be gotten for those tenants, that then goes to landlords in the form of rent. I mean, I'm not getting political here but I don't know how much appetite that Congress and the Senate would ever have, or how they could sell to America, a landlord relief bill that would that make landlords whole. And I know that RealCrowd is a place for limited partners to aggregate and to buy real estate, and so it's an important subject. But I would state the following, and I've invested in properties, myself, and arranged equity and arranged a lot of debt, is if you talked about our apartment building, we're talking about, let's say, it's in Orlando, and it's a $15 million asset with $10 million of debt on it, if Disney World needed to expand, or Universal, and build a studio, and they had to have that parcel. And they paid $30 million for it, I'm just making up a scenario, but things like this do happen.
David Pascale (13:16):
Then that $15 million of profit goes to those owners. That's why you invest in real estate, or one of the reasons because the big score can happen, property appreciation, all that endures to the owners. But when values fall, that's the risk on the other side. The lender, I mean, when you think about the returns that equity gets and you compare it to the world of interest rates that we're in now. 3%, 4%, 5%, I mean, these are small and steady returns. The lenders, they're the rock, but they don't share in any of that upside. And real estate is a hard asset. It has tax benefits. It is a preferred vehicle of investment in the United States since the 1800s. And it has all those things going for it but in a moment like this that is so dramatically affecting commercial real estate, call it a black swan event.
David Pascale (14:34):
Ray Dalio in one of his pieces called it a white swan event because pandemics do happen, and they have happened, and etc. So you have these events and these events can and do, I hate to say, diminish owner equity, just like, again, as everyone else there who invests, I would imagine they own their home or condo, if you are now investing in real estate or many do. I mean, when you buy a home, and it was right near the Nissan headquarters, and then Nissan picks up stakes and moves, and all those executives aren't buying in your area anymore, and your home goes down, that's your risk for buying that. I mean, that's the rough and tumble reality.
Adam Hooper (15:32):
Same with public markets and any other asset, right? I mean, there's always that risk as an equity investor of those…
David Pascale (15:39):
Buying stock. Right. Exactly.
Adam Hooper (15:43):
What are you guys seeing on the transaction side. You said a lot of the energy now is more focused on services and help that you guys are providing to existing borrowers. Are you seeing that much if any new transaction activity?
David Pascale (15:57):
What we're seeing in the new transaction activity is best summed up by, call it the range of lenders or the world of lenders. And I'll go through each one because it's meaningful. The banks are in much better shape than they were in '08 during the liquidity crunch. They have money to lend, their balance sheets are strong, they are allocating money for losses down the line because no one knows how long this is going to last and what kind of losses. They are lending but we've really seen a return of recourse or a focus on sponsorship. So before, banks, they've always been customer-oriented and they weren't getting very transactional. Now, they're returning to being about the customer. Loans are getting done, we're seeing our core, core retail, industrial office, and apartments, and not a lot of cash out, some conservative construction loans. If a construction loan parameter was 65% loan to value pre COVID, we're now seeing 55%, 50%, or 50% to 60% loan to cost, excuse me, loan to cost for a construction loan. And on a perm loan from a bank or a bridge loan, they don't want to be giving any cash out and they want to be on a good product type in a great market.
David Pascale (17:37):
Life companies have become very conservative because their main competition for fixed rate loans, CMBS, is now a frozen up market. So life companies are basically, we had a long call with a couple yesterday, 45% to 55%, 10% debt yield rates in the 4.5% range. And some of them are pricing a little under that maybe 4% or higher 3s. Life company spreads have widened because they price off of their alternative investments. And one of their alternative investments is corporate bonds. Corporate bond spreads have widened because all risk spreads have widened. So we're seeing life companies, many of them are on the sidelines or being very conservative.
David Pascale (18:37):
The key part of our business or one of the key parts of American real estate finance is the secondary market, the securitized market. For the simple reason that there's not enough money sitting in all the pension funds, life companies, and banks in their allocations for commercial to service all the commercial real estate in this country. So the way it's been serviced since 1995, has been through secondary markets, both CMBS, which is Commercial Mortgage-Backed Securities, which is a group of fixed rate loans that are bundled together and sold in loans, or a giant loan that is sold in its own security and investors buy them and makes a lender, like Goldman Sachs or Deutsche Bank, able to lend, call it $500 million into 100 properties, and then sell the securities and take that $500 million and lend it again. To lend it again over and over to investors that would never originate their own loans. And they become lenders.
David Pascale (19:57):
So the other market, that's on the fixed rate side, and that's typically 10-year fixed rate money. And on the floating rate side, there's something called the CLO market, the collateralized loan obligation, where it's LIBOR-base bridge loans, usually people fixing up apartments is the classic CLO or fixing up an office building by getting a floating rate loan, usually three to four years. And those loans are bundled together in the collateralized loan obligation and sold to floating rate buyers. So those are critical markets because those are the high-leverage, non-recourse loans that a lot of the syndicated equity groups need because they don't have a big customer for the bank or life company. And those loans are securitized and that liquidity, when it is stopped, which it is stopped now, that means that all the volume in a tough market now falls on the people that are more conservative, the portfolio lenders, and then they double down on being conservative. And so we're in a very limited market of financing right now.
Adam Hooper (21:22):
And now, before we started recording, you were talking about some new programs that are coming, TALF, and some of the others that are trying to inject liquidity back into the CMBS, CLO markets. Right?
David Pascale (21:36):
Right.
Adam Hooper (21:38):
When you say they've stopped, is that a entire complete turnoff of the spigot? Are these TALF programs and other the Feds buying essentially stepping in for where investors would normally purchase these government steps in and purchase these securitizations to keep that liquidity going? Where are we at in that process? What does that forecast look like?
David Pascale (22:00):
Good question. In the last month, a couple weeks ago, TALF, which is Term Asset Lending Facility…
Adam Hooper (22:09):
I was hoping you were going to note it because [crosstalk 00:22:11].
David Pascale (22:12):
Term Asset Lending Facility which is an entity that buys bonds in these markets that are now frozen. The mentality is that the Fed then helps restart these markets, a recovery ensues. And then the things that the TALF entity bought, the bonds, are then sold into the market for a profit, or at what they paid for them at least. And at least in 2008 through 2011 approximately, the TALF facility had zero losses because all they did was help restart. So right now, we've seen TALF buy legacy CMBS. They were authorized to about two weeks ago. And so they're buying older CMBS from March 23 and before, which means they're not buying new issue. But the secondary market has started up again. And we've heard only in the last week or two, that some lenders are now cautiously doing CMBS loans at about 65% loan to value. Only the best office, and industrial, and some apartments, and maybe some grocery-anchored retail but very careful on retail.
Adam Hooper (23:36):
And now 65% loan to value compared to where it was that…?
David Pascale (23:42):
Compared to 70% or 75% with lots of interest only and pushed proceeds, and I wouldn't say loose underwriting, but right now it's super stringent upper underwriting looking at every collection during the process. And sticking to 65%, everything amortizes but at least it's a start.
Adam Hooper (24:06):
It's just almost going back to what we would have expected from a more traditional bank balance sheet program before.
David Pascale (24:13):
Right. And meanwhile, the banks might be at 55% now because they're retrenching themselves. So you're exactly right. They're going back to where the banks were when the CMBS was farther out. On the CLO market, there's been no love from the Fed and some Congress people are pushing them. They have allowed some very limited CLO purchases, which is a very minor part of the market, and not what we call the big time CLO which groups like Apollo and Fotris uses it to help them buy companies and it's non real estate. And then there's the real estate side which neither one of those groups is in the eligible securities list. When you look at the world of bridge lending, and what's bridge lending, for some of your listeners?
David Pascale (25:12):
Bridge lending is buying an asset, usually with some cash flow, renovating it in some way, repositioning it in some way, fixing up units, new management, new look, new marketing strategy, maybe even changing the use, and then charging higher rents and then getting a promo selling and making a profit. So that classic bridge loan, majority of those bridge lenders were called debt funds. And what a debt fund is, is, it's an unregulated pile of money, as I would always call it. Meaning it's not a bank, it's not a life company. It's a group of investors or investment bankers that put together a fund. They then use a CLO, sometimes a mortgage REIT, or sometimes bank lines to then lever the money in there because the basic core money in a debt fund went to returns of 9% or 11%, 9% or 10, or 11%, for their trouble.
David Pascale (26:21):
So in order for them to lend it out at 4%, or 5%, and 6%, they lever it with a bank line at LIBOR plus 100, or use a CLO. With bank lines being called and CLOs being more abound right now, that whole market is pretty much frozen up. And then it also gets into the broader question, I've been doing bridge loans for a long time, you're always taking the rents, and you're moving them up to the nicer property down the street, what they're charging, or across town. Right now, there's also a feeling amongst lenders, just to get away from the whole liquidity issue of who has money and who doesn't, is what are you bridging to? What's the new world look like? Will there be a vaccine? Well, we can get into a long conversation about what the economic picture is in America, fourth quarter 2020, or second quarter 2021.
Adam Hooper (27:32):
Let's maybe explore that a little bit. We've talked a bit on the show here about, everything is still so new, we're still very, very early in this whole progression. Again, we're recording this on April 22, as a note to future listeners, where you can come back and see history real-time.
David Pascale (27:49):
Right.
Adam Hooper (27:50):
But everything is happening. I mean, you mentioned even within the last week or so you're seeing more information coming out of the CMBS space. What are you what is your sense? Or what are you hearing out there in terms of what has to happen before we feel like there's some comfort or consistency in the information that we're getting that we can start to feel like we have a some footing underneath us as to what normal might be?
David Pascale (28:18):
I mean, it's a great question. And in America, it's often quoted, and a lot of people kind of take it for granted, but now it's very important. We have a consumer-driven economy. The typical number out there is 70%. And do not get into a lot of financial theory. For example, Japan doesn't have a consumer-driven economy, it's more industrial-driven. So back to America, where 70% is consumers and doing what consumers are good at doing. Which is shopping, getting on airplanes, going to hotels for conferences, and parties, and concerts, and football games, and traveling, and buying things, in our open society. And that is a critical part of what makes Americans economic strength.
David Pascale (29:18):
What's interesting is we're talking to property owners about the future. The future in retail might be a lot of stores that don't reopen, but stores that reopen, there will be a line outside the store with spacings, everyone masked, sneeze guards everywhere inside the store with arrows pointing you down aisles so you don't ever cross another person coming the other way. And then a whole staggered checkout system. And that sounds safe, and you'd want to know, would a consumer be confident in that environment? Maybe yes. Then there's the problem of how much volume are you going to be doing on those cash registers, and are you still going to be able to pay the rent you were paying pre COVID? And so, there's that issue. There's hotels and airline flights. And if we're able to reopen gradually, with these half measures, and we pray, no second wave or big second wave of infections while we're looking for the key principles, which are treatment, and vaccine.
David Pascale (30:51):
And I often point out even these treatments like [remzibidor 00:30:55], the Gilead treatment, is it's not just a pill you're going to pick up at the pharmacy, it's a very promising treatment. But it involves you being in a bed and strapped to an IV. And so these are things to think about. And if hotels are at a quarter occupancy, and retailers are at half occupancy, then we're looking at the winners are going to be industrial, and certain apartments, and some people are saying, "Maybe a winner is going to be single family residential for rent." Which is a huge thing now as people really realize they don't want to be in an elevator in a corridor, and they'd rather walk in their front door and all their kids in a fenced in-yard.
Adam Hooper (31:49):
Are there any new metrics that you guys are looking at, or anything different that you're following now in a current or post COVID space that that was maybe different than what you were looking at before or is it still the same metrics and markers that you guys are tracking?
David Pascale (32:05):
It's retail sales. I mean, it's employment. Employment drives everything because because everything's driven off the consumer and their disposable income, which is all based on employment. Because the majority of our consumers are not lucky enough to be investors. The investor part of our economy is probably the top 5%. So it's a consumer, employee-based world. And so we're looking at those metrics, we haven't seen, I'll go back for a second. We have not yet seen a lot of sales. We're talking about property selling as there have been people asking me, "Has there have been a discount?" And so a lot of these presentations I've been on with Guggenheim or Goldman Sachs, or the big REITs, they go well… I saw one estimate that said, "We think industrial might be even apartments are down 10%. Office is down 5%. Retail is down 20%." This is on price in a hotel might be 40%. As far as if all those assets were $10 million on January 20th, call it before any COVID fear because there was a lot of sales in January.
David Pascale (33:38):
And if you needed to sell them today, they'd be you know, 9.59% etc, down the line with those discounts. But even that is a misnomer because the financing world's not together. You're going to see a lot of people buying things for cash. And we're seeing a lot of lenders in capital, I'm going back to my lenders in capital. We may fix that later, but I would say, we're seeing a lot of lenders in capital now in the vogue of rescue capital. Meaning, I talked to a lender while I was doing bridge loans and preferred equity at LIBOR plus 300, and preferred equity, which is secondary behind a construction loan at 10% or 11% before the COVID. Now, I see a lot of opportunity out there where I can be a first trusteed lender with an equity kicker. So I think one of the things we're going to see in the future depending on how long this lasts, and how deep the pain is, is eventually, you're going to see the mark to market and it's going to be an asset that needs to refine.
David Pascale (35:03):
Someone who has a loan that matures in 2024, I like their chances now. They're not going to have to mark that asset down. Maybe on their personal financials if they're using GAAP or FASB accounting standards, but they're in good shape, especially if they're low-leverage. But someone with a high-leverage loan coming due might have to mark that asset to market really quickly. And maybe there's some equity that's going to be lost or new equity and new debt comes in. We're going to see a lot more of that where the lender marks it down and says, "I'll do this loan if I see new equity come in." That new equity will prime the old equity.
Adam Hooper (35:47):
Now it's been a good, what? 10, 11 years since we've heard those words in that order, mark to market.
David Pascale (35:55):
Exactly.
Adam Hooper (35:55):
For those that…
David Pascale (35:56):
And remember, the playbook.
Adam Hooper (35:59):
I see those that maybe weren't investors in this asset class back in the global financial crisis, maybe take us just a couple, high-level, mark to market, what does that mean? What is the impact to the different parts of capital stack if we get back into that kind of a scenario?
David Pascale (36:16):
So I'll use the $10 million value item. So an apartment complex is worth 10 million, there's three million of equity in it right now, cash and appreciation and there's $7 million loan. If that property needs to be reified, and someone can only get a $6 million loan today, because things are so upside down, you might need to restate the value at eight million, and a new investor will have to come in for a million dollars. The old investors that have the three million are now going to be subordinate to this new investor of the one million because he's coming in at the mark to market basis. And they were part of the old inflated basis so their equity is now going to be worth less than the million.
David Pascale (37:19):
So the point is, is that when you have $7 million worth of debt, and $3 million worth of equity on a property that's now worth $7 million, call it 7.5 million, then that three million cannot have all the equity standing it had before because you still need to pay off all that debt because we're not in a market yet where debt is being marked down.
David Pascale (37:53):
And then if the market continues to erode, then you might see where the where even the debt lender then probably discounts their note to five million, for example, because the property is in such bad shape. And at that point, usually that means that all the equity is gone. And the new equity that comes in based on that note will then be a million dollars of new equity and $5 million worth of debt on the new $6 million value. The old equity, it's almost like a hope certificate that, "Hey, if it goes back up to 10 million, then some of that equity will be restored."
Adam Hooper (38:37):
And there's all numbers of complex structures that can be worked out is in this scenarios.
David Pascale (38:42):
Right. Between the debt.
Adam Hooper (38:45):
The net effect is that if there's a trigger or there's an event on the loan, if there's a maturity issue or something like that, that happens, if the lender has to basically recognize and mark to market, the current value of that asset that can sometimes trigger either resizing of a loan or having to come back in with fresh equity to get that loan back in compliance with whatever it's a loan to value covenants or terms in that loan are.
David Pascale (39:13):
Exactly.
Adam Hooper (39:13):
And again, we haven't seen that since the global financial crisis, right? It's been a long time since we've had to discuss mark to market. I think, at least from my perspective, a lot of this, the severity of what these impacts will be to the real estate space are largely going to be determined by how long we're in this shutdown. Right? If we can get out of this and we have a handle on the health side of this thing. And we can start getting back to, again, more of a footing of what a recovery might look like. The hope is that real estate might be able to avoid the sharper bottom of whatever this dip is, right? Because of its illiquidity, if we can start to see some recovery, maybe we can kind of skip the very bottom of that V or that smooth shape, whatever that turns into, again, assuming that's the shape of the recovery.
Adam Hooper (40:10):
The longer this becomes a protracted thing, I think the more risk there is for real estate coming into some of these mark to market issues. That would have a bigger impact on the economy as a whole and as our asset class. With that, is there anything that you guys are seeing that would indicate the timing of when we'll see some of these things start to shake through our space? Or what we think the recovery might look like, or still again, too early at this stage? And nobody really knows yet?
David Pascale (40:38):
Well, I'll go with the good news, or what we've seen so far, that it's been better than 2007, 2008. Back then, I would say three gentlemen really kind of saved the financial world. And that was Ben Bernanke, Timothy Geithner…
David Pascale (41:01):
Ben Bernanke, the Fed Chair, Timothy Geithner, the New York Fed Chair, and Henry Paulson, who was ex Goldman Sachs and was the Secretary of the Treasury. Supposedly, I read Geithner's book and they would just sit in their office and just kind of throw ideas against the wall. And they came up with TALF and HARP, and HAMP and all these acronyms, and TARP, of course, over a period of a year, and they would roll out liquidity programs. This time, the Fed did all of that in two weeks, everything and triple and quadruple what they did in '08.
Adam Hooper (41:47):
Right.
David Pascale (41:47):
So that was critical. And we have that liquidity to banked on. Now, if I can be a sociologist for a second, or Dr. Fauci, expert. I mean, if a vaccine and the one from Johnson & Johnson seems like the most likely one, because they have the ability to ramp up to a billion doses, and they've been on all the channels that I've seen lately talking about, their goal is to have a billion doses out in second quarter 2021, they feel good about it. So let's use that as next summer, it's all over and everyone… But you always also wonder, will people ever act the same? But you hope that by next summer, we're at 90% capacity or 95% of where we were.
David Pascale (42:52):
And I read an article in MarketWatch, the next 45 days are the most important in the history of capitalism. I mean, I love headlines like that. But the next few months, this interim period, and while we're hoping for vaccines and cures, and as we roll out, and a lot of it's going to be not just the governors and the mayors and the president, it's going to be the attitude of the consumer and how strong that comeback is. So I think we have a good base of liquidity, we understand how to control the curve. But the consumer has gone completely flat. Mall tenants will never reemerge, and we're going to have to adjust to a new life. So I think the next three or four months, we'll have a lot of clarity on how this end game is going to be played.
Adam Hooper (43:53):
I agree. And I think what you mentioned in there, too is… Then you talked about, what does the retail landscape look like after this, right? What are some of those behavioral changes that are going to stick with us through this experience that we're all going through collectively right now. That we might not even have an idea what the second or third order impacts of how this goes, right? I mean, think about my kids 10 and 11 years old, they have an awareness of what's going on. This is so bizarre of an experience to go through a child. What kind of an impression does that cause on their worldview going forward?
Adam Hooper (44:27):
I don't know if you have any thoughts in terms of some of the behavioral changes that we might see in those impacts on the different asset classes. And that's something we're continually trying to explore and see what that might impact going forward.
David Pascale (44:41):
Well, I think that the jury's still out on what type of co-living and there's been so much apartments. Everything in LA, here we're at LA, there's so much of an massive emphasis on TOD, Transit-Oriented Development. And we're building out a train system. We have legendary, terrible traffic. And I mean, Nellie is spending billions, and we've been doing this for 30 years to get. And we're about to hit a point, again, 2024 for the Olympics, which are really now in 2028, but to have the train system basically done, including a people mover to LA act, and all kinds of dense apartment. And I'm not talking about just Mom and Pop apartment, I mean, big REITs building, huge apartment complexes near transit.
David Pascale (45:44):
So what's that model going to look like? People walking down the hallway then getting on a train? Are they going to be masked up? Are they going to be confident doing that? Because we're trying to get away from the suburbanite in their car with their house out far away. So I think apartments, it's going to be very interesting to see how this develops. I think industrial has is now going to be stronger than ever. Last mile, supply chain, everything about online. and then obviously, our healthcare system has been to a certain degree exposed as far as certain deficiencies, as far as our ability to massively do testing and things like that. So will we see medical office maybe become very strong or stronger than ever? Facilities near hospitals, kind of the urgent cares that are in a lot of shopping centers. So industrial, in that being strong, retails going to be changed, hotels are really… I mean, I saw Barry Sternlicht today, he's very hopeful that 2021, second half, the hotel industry is at pre COVID levels.
David Pascale (47:12):
I would say that's the most optimistic as far as people running around going to hotels. Hotels are going to have a whole new program of sterilization and things like that. Then you get into some of the details. I know someone building an office building and now they're changing all of the fixtures to a certain type of copper where a virus can't live. And so you're going to see office buildings, maybe half the workforce shows up one day, the other half the next day in the cubicles so they can space enough. Obviously, elevator queuing, Purell, dispensers, wipe downs, and people will marktet…
David Pascale (47:58):
I've heard a lot of talk about people marketing offices. Remember when it was all about LEED and having clean sustainability carbon footprint, gardens on the roof, they'd cool the property? I mean, I think LEED is very exciting. There might be a new certification, clean.
Adam Hooper (48:18):
Health-based.
David Pascale (48:19):
Someone said, C-L-E… And so you'll see offices changing that way. But I think there's been a lot of publicity about people working at home from Zoom. But I've seen a lot of people say that it's inefficient. That congregating in the office where everyone is in an office, doing the same thing when we're all in a law firm, or whatever we're doing, it will always be more efficient than someone with their roommates, or family, or loved ones, or dogs, sitting there with all the different agendas that are in the house. And so, I mean, I like office, I like industrial. Apartments are always going to be needed, they're going to be changed. Retail is going to have a very tough time and emerged maybe leaner and meaner but different.
David Pascale (49:18):
And I think the big retailers, there's a famous quote from one of the major investors like Dalio that said, Target, Walmart, Costco, and Amazon will survive and what we call the Fotris grocers, the Kroger's and the Publix, and they've actually adapted very well to curbside pickup and delivery which could be the future. So definitely, a changed environment, and you'll see cap rates and things change and maybe there's a new market for people to convert real estate to something that's more palatable in the post COVID world, and new bridge loan opportunities. So self storage, going through the product types still very strong. And so it's going to be property by property and market by market. And we hope that we see everyone heal better. But certain markets might have a lingering problem for whatever reason, and other markets are doing better. And a lot of it will depend on that.
Adam Hooper (50:37):
Okay. Well, we'll be sure that we get you back on the show. And we can see if any of these things have come to fruition. And again, really, thank you so much for coming on today. And again, sharing your insights.
David Pascale (50:50):
Thank you for having me.
Adam Hooper (50:51):
Was there anything else that listeners should be thinking about or paying attention to you right now with everything that's going on?
David Pascale (51:00):
I mean, yes. This is unprecedented, so the recovery will be unprecedented, and there's steps in it. And things will happen that no one could have predicted. So it's really, I think, right now, is be informed and also there was a famous comedy album in the '70s, called Everything You Know Is Wrong. But it's something like the things that you assumed before in the old world, be ready to have new assumptions and be watching for new opportunities. And I think, again, that groups of investors, tend to talk about equity, who are brave and take risk right now with their cash in the right markets are going to be rewarded in a way that was not around a couple years ago. There's going to be some opportunity to buy something in your market. So people should be watching in the in the markets they know. They should be watching for opportunities at the new basis.
Adam Hooper (52:26):
I like that. That sounds right. There's going to be opportunities coming out of this for sure. And it'll be interesting to see where those are and what that looks like. How can listeners keep up to date with what you guys have going on and everything at George Smith Partners, and your weekly email, which is a treasure, I would recommend everybody sign up for that.
David Pascale (52:46):
Oh, thank you. We have a weekly newsletter called FINfacts, F-I-N-F-A-C-T-S, and anyone can join our newsletter. It's free and you can subscribe or unsubscribe at will, there's no advertising on it. And we do not sell the list to anyone. It is our list, it is pure real estate content. If you go to our site, wwwgspartners.com on your phone, or tablet, or computer. The first thing you'll see is an opportunity to sign up for FINfacts, and I would really appreciate if you do that because you can subscribe and unsubscribe anytime.
Adam Hooper (53:30):
And we'll have we'll have links in the show notes for everybody out there, again. And we always love reading your commentary, David, on what comes out on those FINfacts.
David Pascale (53:36):
Oh, thank you.
Adam Hooper (53:37):
So, again, really appreciate your coming on the show today. We'll be sure to get you back on as this is such a quickly evolving space. What we talk about this week, who the heck knows? It might be completely out of date by next week or next month, so you'll have to be back on.
David Pascale (53:51):
Exactly. Then I'll have to come back on.
Adam Hooper (53:53):
Perfect. All right, David.
David Pascale (53:55):
Thanks, Adam Hooper.
Adam Hooper (53:56):
Thanks for coming on. Listeners, as always, that's all we've got for today but if you have any questions or comments, please send us a note to podcast@realcrowd.com. And with that, we'll catch you on the next one.
