Alternative Access - May 2020

IT COSTS MORE MONEY TO EXIT THE BUILDINGWHEN IT IS ON FIRE

as home buyers. A whole generation has been raised on home remodeling reality shows. This could be a jolt — a jolt to housing, a jolt to the markets through construction and other industries that will follow. Uber and Lyft drivers will become mortgage brokers and Realtors again. The service economy will roar even louder, fueled in part by some form of a student loan modification program. For instance, in August 2019, President Trump started the first domino of student loan forgiveness by forgiving the debt of U.S. veterans with disabilities. In principle, this could affect multifamily, as it may compel a whole generation of millennials with less debt to then vacate apartments and shared living arrangements and purchase homes instead. This unexpected jolt may bring some instability to the apartment market that some observers think has peaked. You’re not hearing much of it yet. I don’t know what this looks like other than a trial balloon that started first with the most disadvantaged: permanently disabled U.S. veterans. This will give Trump the time he needs to structure a meaningful trade deal with China and insulate the U.S. from any shocks that may occur during a protracted, perhaps decadelong, trade stabilization effort with China, a country that desperately wants to play the long game but can’t afford to currently. An easy solution is this: Extend the duration of student loans to 50 or 100 years. Increasing a debt’s duration is not the same as reducing it, but it gives the perception that leverage is lower as this debt is less burdensome to service over 100 years than, say, 20. Again, duration is a developer’s best friend.

flushed Quikrete down all the toilets in your rental property. Now you understand risk a little differently, perhaps? Why did I mention this? Because in a world where there are few conventional investment opportunities left, speculation becomes much more appealing, acceptable, and socially encouraged. Other drivers, besides conventional economics, move asset prices and can cause jolts. From 2005–2008, even the most marginal buyers could purchase homes with no money down because of low interest rates and loose lending terms. People two months out of incarceration were able to buy new construction spec homes in Phoenix. Almost all of these home builders would offer free televisions, cash-out refinancing at closing, and anything else you could think of — even a Mustang. Those home builders also made an incredible amount of money by acting as private label mortgage originators, too. For example, you couldn’t buy a new construction house from D.R. Horton without using their mortgage banker.

Risks today are more asymmetric than they appear. But what is risk? Here’s how I explain it. Let’s pretend that you purchase a single-family home as a rental property. You’re getting a 10% return. That’s great — until your tenant loses their job tomorrow and moves out. Now you have a vacant house you need to pay to clear out and lease up, and you’re not going to have a positive cash flow for a while. You can’t sell it fast, and you paid retail for this turnkey property, so there’s not enough equity to pay the Realtor to sell it. You have leverage on it, and you have debt payments coming in soon, too. Your tenants are now harassing you on social media and embarrassing you in front of everyone from those who you went to preschool with to your coworkers on LinkedIn. And now both an eviction and new toilets are needed after your tenant

If you can materially improve the credit quality of the average entry- level homeowner, then you make the dream of homeownership that much more of a reality.

If you offer an entire generation of people — who are ostensibly financially incentivized to do so, via special

mortgage and down payment assistance programs implicitly backstopped by

the government — the chance to become

homeowners, you will see marginal borrowers coming into the market again disguised

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discretion to opt into what I feel are more meaningful opportunities. However, if you make a commitment and you fail to honor it for any nontechnically defined reason, this will result in a very difficult conversation that you and I really don’t want to have. Work only with best-in-class, experienced operators. Many of us know who these families are, and we know them well, too. In the 20 years that I’ve managed my own balance sheet after leaving Goldman Sachs, I can tell you that in real estate, operator experience is a tremendous hedge against having a good deal and a bad deal. Working with operators and developers who have audited track records, or going through at least two cycles with a strong balance sheet, helps materially discount the risk to you, the investor. Investors who only focus on a pro forma and consider getting the highest possible return, without regard to risk, a badge of honor will be wise to remember an article I wrote for Forbes several months back ( Forbes.com/ sites/theyec/2019/10/29/eight-reasons- commercial-investment-partnerships-go- bust ) that lists out the eight reasons why commercial investment partnerships go bust.

Opportunity Through

Thankfully, we have such a robust deal flow pipeline that we don’t have to pick through the stale transactions that have been re- traded several times like other investors do. This is because of our reputation for doing what we say we are going to do, as efficiently as possible. In the industry, we call this providing certainty of execution. This is exactly why when we call in the capital after you say “I’m in,” we need you to pay attention. If you don’t follow through, it makes the firm, our other investors, and me, look bad. It hurts my reputation, and it hurts my ability to serve those who have been with me since they so steadfastly joined at the beginning. The only reason we’re able to source exceptional cross-asset opportunities is not because of anything other than our reputation of following through on our past commitments — NFL limited partnerships, Class A commercial real estate, fine art, and so forth.

Behind closed doors, most uber- large and established multifamily operators and families have stopped buying multifamily altogether in blue states. In NYC, I’ve already heard of equity impairments of up to 20% recently, and it’s not getting any better. The risk in multifamily is extraordinarily high, and that’s exactly why we’ve looked the other way into more competitive sub-asset classes with much higher barriers to entry that only the very well-heeled can participate in meaningfully and appreciably. That’s not to say there aren’t going to be opportunities in this space later, and when that time comes, we already have those world-class operators we can tap into. I perceive a wave of technical defaults coming in the multifamily sector. Let’s be patient and watch what happens. We have you covered.

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COMMI TT ING TO OPPORTUNI TY

I made the conscious decision to not use what is called a classic LP fund structure because there’s no reason for you to pay fees on capital that I’m not sure if I can get out the door prudently. If you see a video of an opportunity, you know it’s close to being fully accepted because that video has already been across the globe once on WeChat and WhatsApp.

This direct investment structure makes things easier since I don’t have a proverbial IRR clock in my head to perform analyses immediately. This structure allows you, the investor, the

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