The DI Wire’s publisher, Damon Elder, interviewed Daniel Oschin, Shopoff Realty Investments’ chief strategy officer, to discuss real estate investing in the currently turbulent economy.
Damon Elder 00:10
Thank you for joining us for another episode of focus on alternatives hosted by ADISA the Alternative and Direct Investment Securities Association. I’m Damon Elder, publisher of The DI Wire.com and I’m joined today by Daniel Oschin who’s the chief strategy officer with Shopoff Realty Investments, thanks for joining us Daniel.
Daniel Oschin 00:27
Thanks for having me today.
Damon Elder 00:28
Today we’re going to talk about what is very rare a turbulent economic time in the United States with rising interest rates high inflation something we haven’t seen since the late 70s early 80s your real estate guy cheap money is good for real estate low inflation is good for real estate what’s going on?
Daniel Oschin 00:50
Well first of all I don’t know that they’re always good for real estate because one of the things that comes with low interest rates is typically higher prices and as people get set in those when they try to do something with those assets down the road it becomes more complicated. I think for a long time our interest rates have been far too low for the real estate industry in general you can argue it worked out call for a period of time. Right now I mean as everybody knows interest rates are rising as the Fed is raising rates to try to offset inflation. Inflation is high relative to US standards and we’re trying to slow that down for real estate inflation is actually primarily of a big positive in some cases you can say well cost of wood or other things cost more so everything costs more but rents are rising along with everything else the the hedge that real estate provides is typically that inflation whatever inflation is is raising the the rate you can charge for rent whether that’s multifamily or whatever it is and that as those rates go up revenues rise and on a cap rate basis typically the value the real estate is rising with it.
When you have rising interest rates even though theoretically economically our economists would tell you that rising rates don’t necessarily mean rising cap rates. I think anybody in real estate would tell you they do go along with each other there are some variations in there. For instance, as I said with rental rates rising there isn’t the same caprate decompression in many asset classes as there could be with rising interest rates but you’re still seeing the effect on cap rates. So right now you have rising interest rates affecting the ability to transact decreasing prices to some degree but generally in most asset classes offset by either current rental rates or the prospect for what people think will be rising rates particularly in multifamily and industrial.
Damon Elder 02:46
So are these rates obviously we’ve seen the Fed consistently now over the last several meetings take historically recent historically large jumps in interest rates how from just just speaking about interest rates how is that impacting in general the real estate community?
Daniel Oschin 03:03
Well, the biggest effect is is the the the speed with which these rates increases have been made which is unprecedented from anything I’ve ever seen or know about. It’s rising so fast and there’s so much uncertainty that pretty much the lending market is seized there’s not that there’s no lending, but it’s gotten complicated much much harder a lot of lenders are out of the market when they are lending the spreads are high and so with difficulty getting financing and a lot of other unknowns most sellers are not selling. If you don’t have to sell, why would you sell into a market where you’re likely going to sell for less. Most sellers are just going to wait this out there’s an expectation that rates will taper off as inflation gets under control and then eventually probably decrease, I think most people I’ve talked to think that there’s going to be an arc with a decrease in the not-too-distant future whether that’s a year or two years or three years it’s not like it’s 20 years.We may not see the rates we saw you know in the last say 5 or 10 years.
Damon Elder 03:59
Which were artificially low.
Daniel Oschin 04:00
Incredibly low but arguably also high relative to the rest of the world. You know, places where there was negative interest rates so part of what’s going to affect the ability to to manage the the lending environment is going to be global economics but within domestic economics I think we’re probably going to see some tapering of interest rates fairly soon and then a some decrease happening down the road as inflation gets under control. In the meantime, most sellers are waiting to sell to get the most out of their real estate unless they have to deal with it now. What it’s really affecting at the moment is people have to refinance in this environment and that’s just you know the luck of the draw when however long your loan was if it’s coming due now what do you do if you’re not over leveraged, you’re probably OK. It’s the people at high leverage deals or high leverage relative to the real value of their real estate that are having a difficulty refinancing in this market and may face the requirement to sell.
Damon Elder 05:00
So, how does this turbulent volatile time this again some volatility and and things happen that we haven’t seen in decades. How does it affect the underwriting for an asset or assets or or how you look at your portfolio or manage it what’s how does it change things?
Daniel Oschin 05:15
Actually, easier now the difficulty was for the last 12 – 15 years how long you want to go back in time since since the great financial crisis, everybody’s been waiting for interest rates to rise. And we had a little blip a couple times where they rose and then they dropped back down I refinanced an apartment building actually three apartment buildings that are rated at the time a few months later seem crazy high now seems very low but everybody…
Damon Elder 05:47
Go back to the 70s you’re talking 18%, right?
Daniel Oschin 05:48
Of course, and even in in the 90s when rates were selling apartment buildings over to Marcus & Millichap and they were seven and 8% interest rates were normal. But we’ve been waiting for rates to go up so, most firms like ours have been underwriting assuming a lot of their rates were going to go up I don’t know maybe as high as they are now but an expectation that rates were rising. But it was really unknown today you know where rates are and where they’re probably going to end up at least within some range. It’s actually a little easier to do the underwriting the complexity again is being able to even source the financing to make that underwriting real.
Damon Elder 06:24
So, what’s the outlook then what do you see how are things going to shake out in the mid to long term you know what should advisors be telling their clients?
Daniel Oschin 06:34
Well with any kind of holding power I think people were mostly OK, if you’re buying today and you’re buying in a higher interest rate environment in theoretically lower price environment you should be fine in the long run. If you have financing that makes sense and if you’re underwriting is real for the type of asset and that’s a really important thing because this expectation of incredible rental growth across a pretty broad spectrum of asset classes that may or may not turn out to be as real as people hope it is.
Damon Elder 07:02
Yeah, at some point rents can’t continue to rise the way they have been right? Or can they?
Daniel Oschin 07:07
Well, can’t is a is a tough word but I think it’s unlikely so, for instance we have an industrial property where the rents are almost double or actually are double of what they were underwritten at two years ago. When you have 100% increase in rents in two years so call it 50% a year that’s theoretically unsustainable, I would say likely unsustainable there’s no such thing as for sure but yeah, I would say rental growth is going to be hard at those levels. And same with apartments rental rates are rising particularly now that people can’t afford to get into a home because of the interest rates to buy one they’re renting more rental prices are going to be pushed up a little bit and I think you’re going to see a decrease in in construction because construction and financing is harder to get over time that market’s going to get even tighter you’re probably still going to see a lot of rental increases but maybe in the long run maybe not as much as we have seen. So, there’s a lot of kind of who knows happening in the market.
What I would say for people we’re thinking about investing there’s some just basic logic. Right now, interest rates are higher pricing should be lower there isn’t a lot of of velocity of sales like so most sellers are not selling so the idea that it’s going to be these great discounts is and there will be some if you’re very lucky and know how to negotiate and you’re in the right place. But I don’t think the markets going on a fire sale and I think it will resolve itself through stability and interest rates and inflation long before people were exiting out of real estate mass. So, there will be some opportunities and we should be looking for those, but proper underwriting is the key because even for the assets we bought before the the interest rate rise and even though we we had some underwriting that offset some of that.
Those assets are doing fine because because rental rates have risen so much and other values have rented are increased so much that the value of those assets are essentially similar. Now there is some price changes going on but all things being equal it hasn’t been real hasn’t had a substantial effect on existing legacy assets we are buying somethings cheaper so I would say now is a very good time to buy that’s also not a time to panic and and there’s I have yet to see these miraculous opportunities materialize.
Damon Elder 09:20
Well and so that’s the keyword right opportunity there’s always a flip side right people think we’re going into this recession certainly can’t be near anywhere near what we saw in 08 and 09 but we’re going into a downturn. What are the opportunities that arise from recession for a real estate investor?
Daniel Oschin 09:38
Well, the theory is is that you’re buying at a better price right, all things being equal, but I would argue again the question of better pricing just because something’s cheaper than it was yesterday doesn’t mean that it’s worth more in the long run. There may be things that affected in the long run they’re keeping that price down so it depends what you’re buying and what the prospect is for real growth and having really realistic underwriting that doesn’t hope too much for the future to get better. You also keep in mind I mean, and this was true from almost every cycle interest rates today seem high because they’re higher than what they were. They may be get much higher than this and they may sustain being higher for a long period of time I don’t think so but maybe so you have to accept that that’s a possibility. You have to accept that that rental rates may not rise as much as you hoped there may be other issues with all kinds of things population shifts and declining populations and a lot of different markets and other things that will affect real estate. So, it’s all in the underwriting and being conservative about it but when there’s when there is volatility when there is chaos in the market that is typically the best opportunities to buy for the right companies.
Damon Elder 10:48
So, Daniels we move into the future what are some of the key asset classes you’re looking at what do you think are going to provide the best opportunity moving forward?
Daniel Oschin 10:55
Well the ones that everybody was looking at today and we are two industrial multifamily seem like the obvious ones multifamily should have substantial rental growth industrial seems to be on the path for continued tightness of of of of occupancy and and rental growth that goes along with that. But then here’s where contrarians come into the picture nobody wants to talk about retail and office there’s a lot of asset classes that are less favorable today. My bet is is those are you going to find some of the best opportunities because that’s also going to be where it’s the hardest to sell those assets particularly if there’s anything that goes back to a lender or is it a certain circumstance so we’re looking at all those asset classes. I think with office it’s going to be figuring out if there’s an adaptive reuse for those office spaces whether it’s a different kind of office use or some other functionality same with retail. There are things that are going to change so what you’re going to do with it is is a big part of it but even keeping some retail and some office there going to be opportunities.
The hardest place to buy Is where everybody’s gravitating to where it’s the theoretical best opportunities in industrial and multifamily are also the most highly priced and so the question is what you are getting for that money. So, it’s not I think there’s opportunity everywhere it’s about finding that opportunity and then figuring out how to make something out of that opportunity that others don’t see that’s where certain companies really shine.
Damon Elder 12:19
OK so big picture to wrap it up. What are we looking at? How long is this downturn going to persist? When will when will interest rates stabilize? When will inflation be tamed? Give me your thoughts Daniel.
Daniel Oschin 12:32
I’ll do my Carnac impersonation…
Damon Elder 12:34
Please no impersonations.
Daniel Oschin 12:38
First answer is who knows right, I would tell you that all things being equal I think inflation will be under control fairly soon famous last words but I do think 6 months 12 months from now you’re going to start to see inflation isn’t what it was it may not be completely under control but I think the Fed is doing a very good job of putting severe brakes on on the economy right now. I think there’s gonna be a lot of side effects of that, and I think everybody’s aware they may not be known but I think there’s going to be severe side effects. Some of those things are going to be as the economy slows it may slow too fast which causes all kinds of other problems, but I don’t think it’s going to have a major effect on real estate in a substantial way.
It will have a short-term issue with lending with with pricing people trying to figure out where the market is but as it stabilizes the market will find its place transaction volume will reappear. I think inflation gets under control I think the Fed will wait a period of time and then start to decrease which they always do. Whether rates are going to go down to 4% or 2% who really knows right, you don’t know where the market will eventually lead. But I do have an expectation that it will resolve itself sooner because they have accelerated the speed of the increases so much, I would expect the timeline to be shorter and and much more severe the outcomes of everything they’re doing is going to have a more sizable impact. I don’t know that it was the best way to do It but that’s the way it’s being done.
Damon Elder 14:06
Yeah, the fed said look it’s gonna cost some pain, but they’re committed they seemingly are committed to taming the inflation bug, so I guess we’ll just have to wait and see.
Thank you for your insights, Daniel. Always good to talk to you. And thank you for joining us again for another episode of focus on alternatives.
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