The Wrap Podcast | Episode 066 | Managing Unpredictability in the Real Estate Industry | Warren Averett

Commentators (0:02): You’re listening to The Wrap, a Warren Averett podcast for businesses designed to help you access vital business information and trends when you need it. So, you can listen, learn and then get on with your day. Now, let’s get down to business.

Paul Perry (0:20): Hello, everybody, and welcome to another episode of The Wrap podcast. I look forward to having this discussion with you today. This is episode 66. We are talking to some of our experts, both internal and external, as it relates to the real estate industry. We’re happy to have them with us today, but also with me is one of my co-hosts: Derek Johnson. Derek, a pleasure to have you back, sir. Thanks for being with us.

Derek Johnson (0:41): Paul, the pleasure is all mine. I appreciate you having me back again. It’s immediate gratification when I get the invite to come back because it means I didn’t mess it up too bad the last time.

Paul Perry (0:52): You did a great job there. We’re glad to have you. So, who do we have with us today? We’re talking about real estate.

Derek Johnson (0:57): As excited as I am to be here, it’s because we have our own personal firm expert and fan favorite Cristy Andrews with us. We also have a very special guest in Dave Borsos. He is with the National Multifamily Housing Council. I’ll let them share a little bit more with you about their proficiencies and expertise.

Cristy Andrews (1:19): Well, thank you, Derek and Paul for having us. I’m Cristy Andrews. I lead Warren Averett’s Real Estate Industry Group. I have been hearing lots of concerns from clients, and I’ve had multiple conversations with Dave Borsos. So, we thought we would have him come on and talk to you a little bit more about the capital markets.

Dave Borsos (1:44): I appreciate the opportunity to spend some time with all of you. As Cristy has mentioned, she and I have spoken quite a bit over the last couple of months about what’s going on in the multifamily industry. So, I look forward to sharing a little bit of what’s going on at NMHC, or National Multifamily Housing Council. We are a federal-facing advocacy firm for the apartment industry. We typically represent more of the larger owners, operators, developers and managers, as well as people who finance the properties throughout the country, and any of the issues both from a legislative perspective or a regulatory perspective that may be impacting the industry.

My own specific responsibilities at NMHC are that I cover anything related to capital markets. So, whether it’s debt access or equity, and putting those together to finance a property. If there’s any regulatory or legislative issues that are impacting those issues, then I get involved. One other vertical I’m also responsible for—and those who have kids either going to college or in college—is purpose-built student housing. I get to spend some time advocating for that sector—as well with somebody who currently as a kid at Clemson University—understand what the ins and outs are of that with personal experience. So, look forward to the conversation with all of you.

Paul Perry (3:09): We’re happy to have both of you with us today. For our listeners, you’re going to get a little bit of both outside the industry and the accounting industry and the accounting aspect of the real estate industry. So, this is going to be a good discussion day, but let’s start it off with what Cristy mentioned. Give us that overall status, if you will, of the capital markets and everything that’s related to that as of today. We do need to say that we are recording this as of November 7, should anything be different once this gets released. I just want everybody to have a timeframe of when we’re talking about this.

Dave Borsos (3:41): The specific date is actually very interesting, given the challenges in the capital markets right now. Liquidity is certainly a challenge, right? Every one of us has seen the continued rising interest rates, which has had a dramatic impact on overall liquidity and has also actually ground to a halt some of the other typical activities you see in the capital markets. Be it transactional, right? If you look at a lot of the large brokerage firms are reporting—not just a little double-digit decrease—but dramatic double-digit decrease in their total sales volume for this year. A lot of that is dependent on where interest rates have gone.

You know, I went back and looked at the 10-year, and the reason I look at the 10-year is because oftentimes, the frequency of pricing debt for multifamily is from the 10-year treasury. There’s a lot of others, but that’s probably the most common one. Rolling back to sometime in August, we were at about 3.98 percent. So, we were under 4 percent. Then over the last 60 days, it went as high as 5 percent. It’s now back down to in the 4.60s, and it will be something different tomorrow as you talk about wanting to pick a particular date. That volatility is really a big hinderance for people looking to access debt, and it’s causing a lot of confusion in the marketplace. It’s causing a lot of people to step to the side and say, “I’m just going to wait this out. When is the Fed going to be done? What’s the impact on long term interest rates? How can I actually finance a property if I need to do that?”

It’s really causing a lot of concern. One of the other things is, you know, we need more housing. You look at increase in housing costs. It’s not just because of inflation, it’s from overall demand. One of the problems is when people stop building—which is what’s happening right now because of interest rate levels, volatility in the markets, etc.— it takes about two years, right? Getting something ready to go takes about two years. Well, two years from now, if construction is way down because of all the things we just talked about, a housing problem is just going to get exacerbated. So, we may have a lot of deliveries coming in 2024.

But we can have this conversation two years from now, and I think we’re going to be seeing a significant decrease in the number of apartments being developed, which certainly is going to be a negative impact to the housing costs and market.

Derek Johnson (6:04): Cristy, maybe you can help us out here. But how are these challenges and these opportunities going to be impacting things for our clients and for whom you know in the industry?

Cristy Andrews (6:16): Well, I know a lot of my clients are just really concerned with some of the banking issues, liquidity, and the fact that they are having a hard time with getting financing. Then, once they can, just with the interest rates being so high, they don’t want to get locked in on a high interest rate and not being able to really fund the deals and make them work from a financial standpoint. So, I think there’s just a lot of uncertainty and concern approaching this in 2024, and what’s going to happen from a tax standpoint, which is some of the expiring aspects of the Tax Cuts and Jobs Act along with the interest rates and liquidity. All of it is causing a lot of concern and nervousness, honestly.

Dave Borsos (7:11): Yeah. So, along the lines of bank liquidity, I think it’s a great question, Derek. Roll back to the beginning of this year where we had a couple of bank failures. You know, some of those were caused by nothing other than the rise in the interest rate, what the banks had on their balance sheet and how they managed that risk profile. The second part of that is: we all might be sitting in an office right now, but a lot of people are not. If you look at the vacancy rates in office buildings where banks have been a big provider of finance for that sector, there’s a lot of disruption going on. A lot of offices that are really struggling to try and maintain any level of occupancy in their buildings, and a lot of people are taking a hybrid approach back to work where they may be downsizing in the number of seats that they want to do, you know, take on an expiring lease.

So, there’s going to be a lot of disruption in that office sector, which is going to have a negative impact on banks as they pull back overall and say, “How much capital do I need? What are the losses that I may experience?” They’re looking at that aspect of it. Then secondly, as again I talked about, I focus on the regulatory side. I spend a lot of time with bank regulators, as well, and there’s been a couple of things that they’ve been working on that are going to put pressure on the total amount of capital that banks must hold—partially because of some of these bank failures that we saw in the beginning of the year. By the way, interest rates are high.

Where those banks got into trouble earlier this year, besides their commercial real estate portfolios, they weren’t paying us anything to put our money in a bank, right? And suddenly, interest rates started going up, and people said, “I can go make a return on going to buy treasury.” So, suddenly, banks have gotten more expensive in terms of how they fund their loans. This has also caused a pullback for them as well. So, there’s a whole bunch of things that are unfortunately coming to a head at the same time from the banking sector that are really constraining the availability.

You know, we have some nationally based very, very large owners who go to access debt when they’re going to go construct or finance something. And historically, because they’re great owners, they have a great portfolio and had historically performed very well—they used to say, “Oh, I’ve got 20 banks lined up or 25 banks lined up.” Now even those guys are saying, “Yeah, there’s maybe only four or five banks.” While it’s great that they’ve got a couple, it still is a very constrained market. Overall, that liquidity is a challenge.

The one group that’s providing liquidity happens to be Freddie Mac and Fannie Mae. I also cover their regulator. However, just talking about the overall size of the market. Each year, their regulator puts in place a cap. How many loans can they buy? Each one of them has $75 billion dollars’ worth of total capacity that they can purchase loans in the open marketplace. Given the decreasing amount of REFIS that are going and the decrease in the number of transactions that are going on—I will give you Fannie Mae’s end of third quarter was only at $42 billion out of $75 billion. Fourth quarter is not going to be all that big.

What you’re going to see is even Fannie Mae and Freddie Mac are providers of liquidity. They are going to see dramatic decreases and not even getting close to meeting their cap. So, just to give you a sense that it’s overall. The market is super nervous and very much constrained in terms of what their outlooks are right now.

Cristy Andrews (10:53): Dave, I guess the real estate industry—they’re not taking the opportunity from Freddie Mae and Freddie Mac. Just from the standpoint of interest rates, they don’t want to lock themselves in. So, they’re just waiting and they’re not at capacity, just from the standpoint that nobody’s willing to take the risk right now.

Dave Borsos (11:15): Yeah, so there’s a couple of different things that are going on. In terms of if I’m an owner and I have a long-term loan, and it’s not maturing anytime soon, I don’t really have a lot of incentive to do anything with that. I don’t want to REFI it, and I probably don’t want to sell it because interest rates are super high. It’s going to depress the price in which I could probably sell that out. You have a lot of people who are just operating their properties.

On the other hand, there are some people that have loans maturing. There are some floating rate loans that either have their caps or their floating rate loan is expiring. So, what are they doing if they’re forced to go to the debt markets? So, what’s happening? If you look at it, a lot of people are doing short-term loans.

Fannie Mae and Freddie Mac have been doing a lot of five-year loans. Even though I talked about earlier that we were going to oftentimes do 10-year loans, a lot of people are doing five-year loans. The reason they’re doing those is because it’s almost like getting a floating rate loan without having to buy a cap, which is exceedingly expensive right now.

So, when you take a floating rate and look at where the 10-year treasury or where SOFR is, and you add a spread. Then, you must add a cap. If you’re going to borrow on a floating rate basis with a cap on it, you’re probably paying somewhere at 9%, maybe even up as much as 10%. Whereas if you did that with a five-year, and you can refinance earlier out of that? You’re going to save some money. You’re seeing some people take advantage of the ability to do shorter term loans, because they are worried about what you said: I don’t want to lock up 10-year money at 8%. I don’t want to do that. What can I do to make it less costly to reposition myself, when I think interest rates may come down on the future?

Paul Perry (13:04): That’s a really good question, Cristy, and a great answer there. Dave, thank you very much for that. Dave, when you start talking about liquidity issues… Cristy, I want to go to you, because when he says liquidity issues, business owner clients are sitting there going: “Well, there’s going to be some more expense on my books this year, right?” That always fits, right? So, if we’re looking at the financial statements of a real estate industry client, what are some of those other expenses that they’re probably going to have this year that maybe they didn’t have last year or are higher this year? Can you speak to that a little bit?

Cristy Andrews (13:41): Yeah, so right now, our clients are dealing with increased property tax assessments. You know, with the increase in values, those assessments are just through the roof. Also, insurance costs—those have gone up exponentially. I don’t think I’ve talked to a client in the last several months who hasn’t complained about insurance and really are just trying to figure out a way that they can minimize that cost. They’re looking at reevaluating their coverage and really trying to price that out. They’re trying to do anything they can do to control those fixed costs that really have just gone through the roof. Dave, I know that you all have seen that as well. A couple of months ago with the annual meeting, I know a lot of your customers were complaining about that. That was one of the hot topics at the conference: insurance cost and property tax assessments.

Dave Borsos (14:47): Yeah, so with insurance, the heat has not turned down. It continues to be a major problem. In fact, there was a hearing here in Congress last week that we submitted a comment letter raising those concerns that you’d mentioned. Clearly, if you’re in areas such as Florida, Louisiana and California, that have experienced climate issues, your property insurance has gone through the roof. That has clearly been a big concern. Sometimes you can’t even get access to it. So, we did a study earlier this year, and we also made recommendations. I think that historically, you just called your broker up and said, “Hey, you know, I’d like to renew my insurance.” If people are owners out there that are seeing these big increases, take a look at your properties and take a look at if the insurer understands what you may have done to your own property to make it more resilient. That may be a way to drive down some of those increases that people are seeing. But it still is a concern. If you look at last year, Florida experienced some pretty bad weather events. There were several insurers that either withdrew from the state or they went bankrupt, so it continues to be a major issue and a big focus for us. We even are hearing from some of the regulatory agencies that they’re trying to figure out what they should be doing as well.

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Derek Johnson (16:38): So, if we’re talking about finances, let’s go to one of the favorite topics people want to talk about beyond that: taxes. It’s exciting. It’s fun. But we’ve got all of these things coming up, right? We have the Tax Act expiring in 2025. We’ve got the deal with the bonus depreciation happening. By no means am I a pundit, but you guys are. So, share with us your thoughts around some of these taxes that you’re seeing out there now. What’s going to be happening?

Cristy Andrews (17:10): Well, you know, one of the great things about the Tax Cuts and Jobs Act is that it really allowed for 100% bonus depreciation on a lot of lesser-live assets. In the real estate industry, there was a lot of assets that could take advantage of this. You know, for instance: land improvements, personal property, for multi-family appliances and those type things. Real estate owners and developers really have been able to benefit from that. Well, starting in 2024, that is going to start reducing 20% per year until it expires. Dave, back in September at the annual meeting, there were many members of the Ways and Means Committee from Congress there. They spoke about some upcoming extensions of this, one of which was the bonus depreciation which really made everybody excited. Everybody loves an extension of a tax break. But as time goes on and fighting continues in Congress, I’m not so sure that we can predict whether that will get extended in 2023 as we hoped. I don’t know if y’all have heard any different.

Dave Borsos (18:33): I think it’d be hard to ignore the fact that the House took a while to get a new speaker. The current extension for the budget expires in 10 days. So, there’s a lot on their plate to get through the appropriations process to say, “We’re going to fund the government.” It’s got to be the major focus, right? Then, you hit if they can get that done, they’ll do another continuing resolution to kick it down the road. Then, you start to run into Thanksgiving.

You’ve got other things where Congress gets diverted in terms of where they’re going. The question is: can they pass anything from a tax perspective before the end of the year? It’s probably going to be more of a challenge this year than in other years because of this disruption that’s going on. The question would be: are people willing to sign on to something that’s an extension? I’d love to give better news, but this one’s a little bit up in the air on whether it’s going to get done or not. Even though 2025 seems like a long way off, I sometimes think of Congress as a bad student who doesn’t study for the final until two days before the final. Then, they really kick in and that’s a little bit like that.

This major Tax Act is expiring at the end of 2025. They’re probably going to wait a long time. But the other thing that interferes with that is we have a presidential election next year. The Senate has a good chance of flipping in the Republican direction, and the House has a good chance of flipping Democratic. Then what happens, right? And who knows who is going to be in the White House?

There’s a lot of unknowns that cloud the forward direction of what’s going to happen, but it’s something that is going to be meaningful. There are a lot of things that happen in that Tax Cuts and Jobs Act that were beneficial, that we fought to get included in there or to get excluded that were beneficial to the real estate industry. So, it’s something we’re monitoring very closely. It’s something that if I were to tell you to look at and to have your clients watching, you need to be prepared. You know, if things don’t go our way, what are we going to do to anticipate the impact?

Cristy Andrews (20:58): That’s a good point. Back in September, both sides of the aisle were promising to work together and compromise. We’re very hopeful. I think we can continue to hold on for hope. But I think that our clients and real estate developers out there need to be prepared for the anticipation that they may lose a portion of that deduction this year.

Paul Perry (21:26): Interesting information, and helpful for the folks listening in. You know, one of the things all industries mention is technology and its impact on that industry. It’s different for everybody, right? Manufacturing, governmental… Some are lagging in adoption, and some are trying to be trailblazers. Where does the real estate industry fall as it relates to using technology to drive solutions to some of these problems we’ve talked about? Is there something to speak on there?

Dave Borsos (21:59): Well, I would actually hope that some of your clients took the opportunity to visit with us at our OPTECH conference last week in Las Vegas. We had over 3,000 people there, so by far our largest attendance ever. Exactly, Paul, what you just mentioned. There’s a lot of technology-driven solutions that are out there. Some of them resident-focused, some of them are owner-focused and management-focused. There’s a lot of activity going on.

One of the things that I would walk away from are centralizations. They’re a big deal for those who own multiple properties and bigger property owners. They’re looking at: how do I centralize all of my operations and not have overlaps? The ability to address labor shortages: it’s anything from do you have an onsite manager or is everything a virtual tour to how do I find maintenance people for my properties?

There are people that are providing solutions for those types of things. Then, the screening process for inbound residents is also something where—on one side—there’s a lot of issues that are getting created with fraud. I’m sure some of your clients are experiencing fraudulent applications. People can buy paychecks and W-2s off the internet. They all look very good, but they don’t have an intent of paying for any of their time in a unit that they then may be difficult to evict from.

I have two things where people commented there that 65% of their applications were fraudulent. There are people looking to provide those solutions as well. So, on the resident-centric side, there are people providing positive rent payment reporting. They are looking at splitting payments across a month if their clients are looking at that. There’s a lot that is going on.

There are technology-driven solutions for a lot of things that we do from A to Z, as it relates to everything that has to do with operating and managing a property.

Derek Johnson (24:18): There’s a lot of good information there, and definitely things to consider. As we look forward, what are some challenges or opportunities on the overall business strategy?

Dave Borsos (24:31): So, there’s a couple of things. I mentioned before about people having floating rate loans that mature. I think there are potential opportunities to the degree that some of the clients are good operators and they have access to capital. You may have some people who bought at the peak of the market in 2021 when the floating rate interest rates were basically zero and they bought them at a floating rate. They said, “Hey, this is great.” All of a sudden, they realize: I don’t really know how to manage a property and my interest costs are gone through the roof. They may be selling their properties in a stress situation.

Now, having said that, there’s a lot of other people chasing this kind as well, but it may create an opportunity if you know somebody off market or whatever else. I would encourage people to look at that and make sure that they are looking at those types of things. On the same note, from a purely strategy perspective, one of the mantras that came out in September is that there are people talking about surviving until 2025. The idea there is they think interest rates are going to be high. In 2024, you’re still going to see some stress and disruption in the market, but things will get better in 2025.

I can’t tell you whether they’re going to get better or not. They may. Look, we’re all going to be optimistic about it. I think people are still going to hunker down a little bit in 2024. We’ll see what happens. The one other aspect of it, which may help a little bit even though rates may be higher…last summer, when the Fed did their first pause, a lot of my finance members saw a significant increase in interest of people buying and selling properties. Part of the reason was because the 10-year was really flat and didn’t have a lot of volatility. We could take the volatility out of the 10-year. If the Fed finally says, “We’re done,” maybe that long end of the curve stays a little bit more consistent.

You may see some of the market movement with new pricing, new records. They’re going to recognize the fact that we’re not going back to a two percent 10-year loan. It’s going to be higher, and we’re just going to figure out how to make it work. Those are the things that if I were in the market and operating, I’d keep my eye on.

Cristy Andrews (27:02): I just would piggyback what Dave said: I think for many that do have access to equity, there’ll be some good opportunities. I think for others, they will hunker down and they will focus a little bit more on the cost they can control, on budgeting and those types of things. We’ll hang in there until interest rates come back down. You know, the market shifts, as it always does; it’s cyclical.

Paul Perry (27:30): Here on The Wrap, we’d like to wrap it up in 60 seconds or less: What is the one thing you want the listeners to know or to leave with? It may be something you’ve already said or it may be something we haven’t talked about yet. But what is that wrap up? Cristy, we’ll start with you.

Cristy Andrews (27:46): The wrap up would be to watch the market, stay in close contact with your advisors and hold on until 2025.

Dave Borsos (28:00): I’m going to put that plug in to survive until 2025. But the one other thing—again, I don’t know from your listeners who is a member of NMHC to the degree that you are—but we put out tremendous amount of research and information on advocacy. I’d mentioned earlier about insurance. We just put out papers on artificial intelligence, which certainly has the interest of Congress. They’re all scared about what does AI mean. I highly encourage you to stay informed.

You know, we put out a lot of great information to really keep people in touch with what’s going on in the marketplace. In addition, as soon as I hang up from this, you know, from a regulatory perspective, the Federal Home Loan Banks are getting some new guidance from the regulator that may be beneficial for finance. There’s a lot going on here in DC from a regulatory perspective that people should keep their ears and eyes open on.

Derek Johnson (29:04): That’s wonderful. Hey, listen, a heartfelt thank you to both of you, David and Cristy, for joining us. I certainly learned a lot and our listeners have a lot to take away and unpack. We very much appreciate your time. I know you’re both very busy with this. Thanks so much.

Dave Borsos (29:21): Appreciate it. Thank you.

Cristy Andrews (29:22): Thank you.

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