Alternative Lending in Real Estate - [Business Breakdowns, EP.195]
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This is Matt Russell, and today we are breaking down commercial real estate lending with Josh Ziegen, co-founder and managing principal of Madison Realty Capital. Now, we've covered the underlying private credit industry in our primer earlier this year, but real estate is particularly interesting. It's an asset class in and of itself, but you mostly know of it from the equity side.

Josh and his team at Madison launched in 2004 and have evolved from hard money lender when there was really no alternative industry called commercial real estate lending. And today they've developed into a single source capital provider with $21 billion in assets under management.

No matter how often we talk about it, the shift away from traditional bank lending cannot be overstated enough. And I think Josh gets into great detail here about how it's not an all or nothing story when it comes to real estate. So we covered some of the basics in this conversation, construction loans and the life cycle of capital in a new development. And then we get into some of the current market dynamics, post-COVID, interest rate environment, post-SVB, and much, much more.

And my favorite part of this conversation is how Madison's story has evolved with the market. So real estate is a market that any participant would associate with leverage. And that just means being a lender, you have to be very thoughtful about underwriting, portfolio management, and even developing if the situation calls for it. So we get into everything here.

Please enjoy this conversation with Josh from Madison Realty Capital. All right, Josh, I am excited to have you here today to talk about Madison, to talk about a very interesting market that has evolved a lot over the years. And I think you've had a front row seat to everything that's been happening in commercial real estate, commercial real estate lending,

And I just want to start at the beginning of your career and really getting involved in this space. And I think it's pre-financial crisis. So that gives us a sense of how different it might have been. But can you bring us back to 2004, the early 2000s? What was the commercial real estate lending market like? And what were those early years like for you in terms of starting out the business?

Well, so I'll bring you back slightly further. So I started out my career at Merrill Lynch Investment Banking. All I wanted to be was an investment banker. And I got there and of course, it wasn't exactly what I expected, but a good enough experience. Then I went to Salmon Smith Barney a year and a half after I graduated.

Also, another investment banking experience, not what I exactly envisioned, but I met some great people. I got recruited to a VC firm, which was my dream job. It's called 1999-2000. Unfortunately, tech market meltdown crisis at that time, they laid off everyone and I was really stuck in a position to redefine my career, who I was.

And I moved home to New Jersey and I randomly started a residential home loan mortgage brokerage company. I was always an entrepreneur. As a kid, I was an entrepreneur. And from there, I started on the ground being literally a home loan broker. But I'd get all these opportunities to broker commercial loans and I just had to figure it out. But one of the most interesting opportunities that used to come about were deals that had to close really, really quickly.

At that time, and still today, sometimes they're called hard money loans, where someone needs to close something quickly. It's a few million dollars. They have to close on a time of the essence purchase of a property. A bank backs out last minute, and they're stuck in a bind. So I brokered a couple of those deals and quickly understood that that was one of the greatest opportunities in terms of

commercial or residential real estate brokerage or lending. And at that point, I realized that given my background, I was in the financial sponsors group at Solomon, I understood private equity, we should start a fund around this. So if you take that back to 2003, 2004, I got together and said to my former college roommate,

Brian Schatz, who also started at BlackRock and worked at a hedge fund. I said, we need to start a fund around this because this is such a great opportunity. People need money quickly. It's senior secure. They're willing to pay a premium for it. And that really was the foundation of Madison Realty Capital. If you went back to 2004,

The market of private credit as it exists today didn't exist. The word private credit didn't exist. It was everything that didn't fall into what a bank could do or even wanted to do. And banking was very fluid at that time. So it's not that banks weren't more aggressive, but there were always things that fell out of banks. Then, obviously, global financial crisis hits. And then private credit became not just what banks didn't want to do, but what they couldn't do because of regulation.

So if you went back to 2004, Brian and I started the firm. We brought in our third partner within about six months of starting the business, Adam Tantliff. He focused on capital raise. And that first fund, I was 29, he was 28. We raised about $350 million of equity in that first fund. We were really off to the races. And it was a huge opportunity at that time. Yeah, it is absolutely incredible. You captured some of the dynamics and some of the evolution there.

Talking about that gradual evolution, particularly post-financial crisis, is there any way to conceptualize that in terms of how that's opened up the market, whether we take something like New York and how much lending is being done via alternative lenders today versus from the banks? How much has that actually changed in terms of what's being underwritten and how it's being underwritten?

Well, if you went back to call it that global financial crisis period, there was the whole recalibration of the banking sector. And all of a sudden, regulation skewed what a bank could do. You know, higher value-add lending, construction lending,

Prior to 2008, you had a bank called Chorus Bank in Fremont that failed, but they were providing 80% non-recourse construction loans. You had the Lehman Brothers that provided 90% of the capital stack. So lending became a very different place. And obviously, if you looked at that 2009 period of time, we were buying loans, we were

originating loans. But it was a very hard period of time because between '08 and '12, we were in between funds. And we really had to redefine our business because we had this

fund business that we really had to make the best of, even though there's this great global financial crisis. And it was about survival at that time. So there was so much of an opportunity, but between 2009, 10, 11, no one was lending. So it was a time where the Blackstones of the world were able to gather capital because there were huge behemoths. And then there was everyone else. And everyone else was like, Madoff was going on. There was a lot of things that happened. And if you weren't the big guys, there was a lot of suspicion as to who you were.

So for us, it was just how do we recreate our business? We went through that first fund. That first fund was an open-ended fund. And we were able to find this opportunity to find these real asset-based fund-to-fund investors. So they weren't pure real estate investors in our fund. They were ABL fund-to-funds.

That was an open-ended fund. We realized soon after 2008, the strategy was great, but the fund structure was not great. Because like everyone, you had redemptions at that time. So we had to really make sure we were able to preserve our track record, make sure we really built the organization to withstand the

the shocks. And at that time, we actually pivoted to not only having the real estate credit business, but if we were going to survive that vintage, we added on property management, asset management, construction management, because there were cases where you did have to step in and take over real estate and reposition that real estate. So that redefined the DNA of the firm, not only of a credit business from 05 to 08, but a vertically integrated business that had all the pieces in place.

Yeah, it's so easy in times of crisis to think about just the opportunity set that is available. And sometimes for outsiders to overlook the portfolio management that is required for the existing business. The evolution is fascinating. Before we get...

too far into this. I do want to just get a little bit of 101 in terms of the lending market. And maybe the easiest lens to use is new construction and what that would look like just in terms of financing. I understand the construction loan dynamics, but if there's any way to piece out, there's the life cycle of this through construction into something that looks like a mortgage. How would you best frame that just in terms of the various steps and putting a simple primer for us into words?

Sure. So one of the products we provide is construction lending, which is typically a very customized product. Again, prior to that global financial crisis, banks served a lot of that construction lending market because they were able to provide somewhere between 65% and 80% loan-to-cost construction loans. Now, a developer needs lending to be able to produce the returns, that development, which typically you would need.

When regulation happened to the way it did post-global financial crisis, banks now were pushed back to typically provide 50%, 60% construction loans or higher value-add loans. No developer really can make returns work with such low leverage.

Real estate is a levered business. So there created that opportunity to create a whole loan lending platform where we were able to provide 65 to 75% of cost construction loans because we weren't regulated the same way.

And what we would do is provide that whole loan, and we still do that today. And then we lever with banks. We leverage our position, and that satisfies them with their 50% of cost or so. So in some ways, we're partnering with banks to produce a private credit product to borrowers. Now, back in 2010, 11, 12, 13, private credit wasn't the asset class that you have today. So borrowers were reluctant in many ways to even go to private lenders. It was more of a dirty word.

But the market really evolved over time where it was a necessity. It was something that we produced that borrowers, institutional, the largest of institutional borrowers needed. And it was one more item on the menu. You could go to a bank, you can go to an insurance company, you can go to CMBS or private credit.

Talking a bit about that just in terms of who the sources are, I imagine those early days, a lot of this is relationship driven. I have some context broadly for the real estate market in New York. And again, we'll use a lot of that as a lens for this conversation, given how much you do there.

Can you talk about those early days and then you compare it to today just in terms of how much of it is dependent on specific developers or partners that you're working with over and over again versus obviously you've diversified over the years, but how important is that to the business and to the strategy?

So one of the things, because we have a development business here, we really understand how a developer or owner and operator needs to be serviced from a lending standpoint. And one competitive advantage we always felt we had was we actually have internal servicing. So we control servicing by having our own servicing team.

Now, in a CMBS loan where someone borrowers and they get a fully funded loan at close on a occupied building, you don't need to necessarily have that servicing ability or customized financing through the life cycle of a deal. But in a construction loan, that's a three to four year project and you're consistently going to your lender and getting draws on a monthly basis. So it's a very iterative process where you have to have a really strong relationship and understand the dynamics of

Lending and construction lending and servicing the client. We have a ton of repeat borrowers because of that, because in construction lending, things always come up along the way. And whether it's a lien on the project or one contractor that's having an issue or something with the city that's having an issue, your borrower is consistently in dialogue with you to continue and make sure the project is moving.

And if you have an inexperienced construction lender, a lot of times, sometimes banks, that time is money. So if there's delays along the way because your lender's not funding you, that's a real problem. So we've really consistently lent to a repeat borrower clientele. We're always getting new borrowers, but there's many borrowers that have borrowed from us 7, 8, 9, 10, not because we're always the cheapest source of capital, but we're really providing a customized product that can really fulfill the need of a project and understand it from a real estate perspective.

There's a theme in terms of having good partners, whether it's your fund structure, your lenders, it goes on and on and on in terms of the capital markets. And that certainly makes sense. When you think about the competition that exists, it's obviously evolved. You mentioned private credit.

Private credit is considered an asset class. And I think you see plenty of private credit providers try to operate in different sectors and different segments. How much of who you're competing with is dedicated to real estate, whether it's commercial, whether it's more broadly real estate versus the private credit markets more broadly where you have these diversified players?

So, most of it has been direct real estate players. What has happened recently is you have large diversified asset managers that have added on real estate, usually from an equity standpoint initially, and then added on credit.

And usually it's a team within a team that in some cases has been only around for five years, six years, seven years as this has become an asset class that has evolved. So we focus primarily on credit and that's what we do day in and day out. So I think a lot of the borrowers we deal with like the fact that we have decision making that is more of a flat organization. We can tackle a project, a situation correctly.

quickly rather than getting lost in the flow of a large asset manager. It is definitely a more bespoke process and execution.

On the bespoke process execution, you mentioned if it's anything construction related, everything is nuanced. How do you approach the idea of risk management from a portfolio basis? And do you think about each, whether it's building, project, whatever it might be, in idiosyncratic terms, how much do you group them together in terms of location exposure, things like that? What's been your general process and how much has it evolved over the years?

Well, look, we're one of a handful of real estate credit businesses that's been around for 20 years. So you can imagine in 20 years, there's been a few shocks to the system. There's global financial crisis, there's COVID, there's location issues, political situations. So you look at that and asset management is a huge part of what we do. And it's really just being on top of a project, understanding the project,

We have a full asset management team. We have a servicing team that continually is dealing with the borrowers from an execution standpoint, making sure things are on business plan, making sure basis is what we think it is relative to value, making sure leasing is being executed a certain way once the building's built or sales are going a certain way. So I think all of these things are part of the secret sauce in terms of not only being able to put out money, but also getting it back.

Yeah, there are so many factors that go into it. Looking at construction loans specifically, and then the evolution of at a certain point, there is this refinancing that happens. What does that look like? Do you ever partake in terms of underwriting what might be the mortgage or correct me if there's other things that come in between the mortgage and that initial construction loan?

What does that look like? And how involved are you in terms of that next step in terms of the maturity of a property? So it's interesting because the first 15 years of the firm, we had one product. It was a higher value add lending product. It's our flagship series product. We just closed on our sixth fund, which exceeded $2 billion. And if

If you look at that product, it was higher value-add lending, construction, renovation, buying performing, non-performing. And then one of the things we realized was to really expand

the business. We needed other products within the real estate credit business to really take a deal through the life cycle of a deal, not only from construction or higher value ad lending, but what about when the building got built? And one of the things we found was we do all the heavy lift in terms of providing that loan to get built.

And then all of a sudden, there were lots of lenders that would take us out at that point in time. And our view was we needed to create another product which had a different risk profile to take that through the transitional lease up of a project. And we created what we call our income series in 2020. And we capitalized that through separate investors, some of which overlap with our flagship series. And now we're able to attract a

a different profile of deal, but keep that borrower along for a different life cycle and also have that borrower think of us in a different context, not only for the heavy construction loan or heavy value add loan, which is typically more expensive, but also a cheaper source of capital. That was the evolution of the second form of capital.

model. Within that, we've also had another major opportunity. We're now not only providing whole loan lending to borrowers, but we're trying to think how do we serve the private credit industry in providing leverage to other private credit institutions? And in some ways taking the place of where banks were, because a lot of banks provided A notes and credit lines and loan on loan financing.

But the private credit industry needed the flexibility that was offered to borrowers. They need that flexibility as well. And that was another product we created, providing back leverage to private credit funds. Just using the example of the next iteration of loans, the income generation, do the majority of those deals end up coming from the construction loans that you have in the portfolio? Are you also sourcing them from outside? How does that evolve?

It's not majority, but there's a small portion of those deals where in some cases we want to provide that whole transitional loan. In other cases, the borrower wants more money than the construction loan that we provided. And sometimes we may say, you know what, borrower, you take us out, but we'll provide an A note to that lender. And that actually happened. We had provided a

construction loan to complete the St. Regis residences in Boston. And this is just residences, not a hotel. And it was about a $350 million loan that we did at the end of 2021. The borrower completed the project, had a ton of sales, paid us down to $200 million, and then needed more money to carry the project through from an interest carry standpoint to get the rest of sales.

And at that point, we basically said to the borrower, "We're good where we are. If you want to go take us out, take us out." So that borrower found a $240 million loan to take us out. And we provided $180 million A note to that lender in another one of our vehicles in the income series. Again, less execution risk, more sales risk, but a little more senior in the capital stack. So the key thing was being able to provide a lot of products that can serve different elements of the real estate credit business.

Yeah, it's amazing how many different products within each individual loan, but then as the life cycle of a property goes on as well. On the leverage point, can you contextualize that just a little bit

in terms of the numbers and what that might look like. And we can use maybe a bank for an example. You mentioned you might be willing to bribe up to 75% financing on a construction loan, but the bank you'll ultimately bring in essentially to equate to that first 50%. That's right. Can you talk through what the gaps might look like in terms of the various rates? And you can use broad numbers, contextualize however you like, but what's the spread difference between those two?

Yeah. So let's just take a multifamily construction loan today. If you look at today, we'll provide a 70% of cost construction loan today at 550 over SOFR, 500 over SOFR or so. And typically we'll go lever that with a bank at about 70% of our loan amount. So that's about 50% of cost for the bank. And that generally is somewhere between three and 350 over SOFR.

And again, in doing that, the borrower is not really thinking of two sources of capital. They're thinking about us providing that whole loan and how we're financing that on the back end is our problem. It's not the borrower's problem. And you have some...

firms out there in the credit business that are levering up these positions to very great lengths. And the more leverage a private credit fund has, the less flexibility they have for borrowers. So we try not to lever our positions too much because we want to be able to provide that customized experience to our borrowers.

Makes total sense. And how big of a market is that today versus what is being traditionally sourced from banks? I mean, do you see a lot of banks just competing in the traditional underwriting up to whether it's 65%, 70%, whatever it might be? Or is most of that business going into that, whether we call it shadow leverage or just owning a portion of the loan at a lower rate? Well, what happened was...

Look, you had from 2000, call it nine or so to 2022, you had banks active in this loan on loan financing market, anode financing market, and there were a number of banks that did it. The banking crisis in 23 that happened pushed a lot of these banks out of the market because now there was a liquidity mismatch between depositors who provided deposits to banks and lend

lending. And really, banks, the model of borrowing short and lending long became a really broken model. It's always been an issue in many ways, but the banking crisis in March 23 brought new light to that model. And it's really held a lot of banks out of the market right now, but has given us this huge opportunity in private credit to back leverage the private credit industry.

And we're doing that in a few ways. I mean, we're doing that in a loan-on-loan financing on a single asset basis. We're doing that in an A-notes to other lenders. And then we have

Another division of our firm that has about $10 billion out in non-mark-to-market credit facilities to almost 100 different counterparties that are real estate credit businesses. So we actually are really fulfilling that gap that it's not only a borrower gap today, it's also a gap in the private credit industry.

Yeah, I was not connecting the dots there in terms of why you may have been rolling that out or doing more of that. But it makes a ton of sense in terms of what's happened recently. Well, again, if you believe private credit is going to pick up a huge part of the opportunity that banks once had for direct real estate lending, then private credit needs leverage to generate the returns that institutional investors want.

And the only way to generate those returns is levering the positions. So if there's not enough leverage out there, this has become a huge opportunity for us. Absolutely. Yeah. There needs to be a source of capital and that source of capital needs to generate the return that is warranted or is required by its investor base, which makes absolute sense. When you package things all together...

Just in terms of the lending spectrum today, what is the primary differentiator in terms of capital? We hear this in different markets where capital can become commoditized and you really need to figure out whether it's relationship-based or something else. But what does that look like in this space in particular? What is most in demand for lenders when borrowers are looking? What is really differentiating about capital sources?

I think every private credit firm has the same tagline, which is speed, certainty, and flexibility. And it absolutely has been a tagline we've had from the beginning of time. But there's so much more to it because it's easier said than done. I think a lot of it is building the infrastructure within a firm to have that

understanding that depth of resources to be able to tackle a project, a deal, understand all the pieces to deliver that speed, certainty, and flexibility. I think when you find a lot of

the private credit real estate business today, you have 100 firms, but 95 of them do the same thing, which is transitional lending. A lot of that is very much driven by CLOs, warehouse lines, and that's the more commoditized part of the market. The more customized the financing, the more of a premium you can get in offering that premium financing. So again, the more construction, higher value add, things that have

more nuances. And that's not to say these aren't very large institutional projects. It's just sometimes to finance a project that has construction or development, that takes more than some CMBS guy that came from a CMBS firm that really understands it at that level. It's a lot more servicing and more to it.

Absolutely. I spent some time in private credit and came to appreciate understanding things that are structured and become commoditized in nature are a lot different than what is bespoke. Usually, the more financial engineering there is, the less bespoke. Just that's how it is. Yes. And I think in the corporate credit business, you hear similar things.

100%. Now, interestingly, it's typically harder to have bespoke and customization when you start getting into bigger sizes. And you mentioned $2 billion fund recently. How do you grapple with the size of the fund growing and whether it's competing for bigger deals, which you may not necessarily...

have increased your size and deals. You can correct me there. But also just keeping some of that customization in order when you're trying to deal with more scale, more dollars being put to work.

we have not found a problem in terms of sourcing. One thing that's interesting about us is we'll do a larger deal, a $300 million, $350 million deal, but we'll still do $50 million deals. So I think a lot of our investors like the fact that we typically have a pretty diversified fund. Our fund five was about a little over 2 billion as well. So usually these funds have about 50 positions or so in a fund.

Again, I don't think that's been the challenge typically sourcing. On the speed part, I think this is one of these things where there's the traditional, we can close in 90 days. Not sure if that applies to real estate, but the 90 day close and you think, well, what can take 90 days? And there are so many things that go into it. What is it that differentiates you in terms of being able to speed up that process or deliver on time? Are there certain things that you can point to that are tangible things inside the business that allow for that speed?

a pretty flat organization at the top from a decision-making standpoint, and a very experienced staff that have all the different disciplines within real estate. We have legal, we have a development team, we have zoning, we have underwriting, asset management, construction management, servicing. Again, the way we look at this is sort of a SWAT team that goes in to review a project and various elements within the firm that kind of opine on different pieces and bring that all together to a closing.

From the developer standpoint, the equity perhaps inside these deals or some percentage of the equity in these deals, how much has the makeup of that changed over the years? Do you still see players that look more or less the same than what you had 20 years ago? Has there been any material changes?

I do think there have been material changes. I mean, years ago, when we started, everything a bank didn't want to do. Quick closing, asset-based loan, maybe it had cash flow, maybe it didn't have cash flow. I think what's happened is private credit and real estate has really evolved as an asset class where, again, the largest of sponsors are borrowing from private credit institutions. So I think there was a learning curve as to what that meant for borrowers. There's been a real evolution of the business from that standpoint.

the experience of what that means borrowing from private credit versus a bank versus an insurance company is now well-defined. I think when we started the business, one, it was really convincing investors that this was a true asset class. A lot of times, institutional investors didn't know where to put it. Is it real estate? Is it credit? There was a lot of back and forth. We had to create this asset class from the beginning. Then it was convincing borrowers that this is a

better means by which to borrow. This is a better user experience, a more customized experience. We can do things banks can't do because we're not regulated the same way. So I think what's happened is as an asset class, it's evolved both from an investor standpoint and a borrower standpoint. The market is that much larger today. Yep. It certainly seems just in terms of the, whether it's institutionalization or redevelopment of certain things in terms of what the players look like, there's been adjustments. It

Shifting a little bit into portfolio management and what that entails, certainly there's some monitoring and whatnot that goes on. But can you talk through the process just in terms of loan gets allocated? What are the steps from there? You laid out some of it just in terms of the draws that take place. And I think that's less traditional than what you might see in some other markets where it's an outright balloon that's delivered up front and balloon that's expected at the end with some amortization over.

As soon as we close on a loan, there's an asset management team here that's assigned to that. A lot of times they're involved in the project before the closing as well. We have our construction and development team that's reviewing a budget. We have our asset management team reviewing what are the milestones that the borrower needs to achieve in the near term and far term over the course of this loan.

That's first and foremost. Second of all, again, we have outside personnel consultants that are going to visit a project on a monthly basis to see what work was done. And that comes back to our internal construction management team to make construction advances. There's also a weekly asset management team meeting where we go through every position of the firm, walk through, are they on budget, on time?

on business plan, where are they off business plan? Has something changed in the market? What's the leasing market like today versus when we made the loan? What's the sales market today versus when we made the loan? What's the product mix out there? Are one bedroom selling or two bedroom selling? There's a lot of this that goes into that. A lot of times a project will come to an extension time period. You have a two year loan and there's a six month extension. And then it's re-reviewing and re-undering the project.

Are we where we thought we would be? What's the extension test? So there's a lot of back review and being on top of your project. We have about 140 positions in the firm, 130, 140. We are consistently reviewing those positions on a weekly, biweekly basis.

When it comes to the management of the portfolio, I have a friend who oversees some construction in Manhattan. And he was telling me he deals with 38 different tradesmen and keeping anything on track is next to impossible. What percentage of these projects look the same throughout the process as they're originally presented? And how much cushion can you actually build into that? Because I think you've mentioned there's all types of dynamics that you factor in. But do you have any just

general mantras in terms of approaching that, knowing that there are a long list of hurdles that you have to clear and a lot of things that you have to be managing at the same time as a developer.

Well, I think a lot of times we're reviewing it when we go into a deal and underwriting a scenario. If it takes longer and costs more, what does that look like? Who's our counterparty? What does a completion guarantee look like? Who is our counterparty? What do the guarantees look like to the extent things take longer, cost more, more interest carry? And there was no greater time where that came into play. During COVID, all of a sudden you had a huge inflationary period where

where you had two problems going on. One, major inflation. Two, a lot of borrowers had to shut down projects, or if they were building through projects, there were a lot of delays in terms of bringing goods on. So that was a period of

extreme asset management, making sure that your borrower could actually execute and get a project done. What would delays mean? So again, that was an example of a shock to the system. And I would say for the most part, most of our projects got out and were able to withstand some of the shocks. In scenarios where a project does not get out, you have situations where the borrowers can't make the payments. There's

some requirement for closure or however you might deal with it. How do you handle that? It sounds like you've built up some internal muscle to be able to deal with any type of situation that presents itself. I think there was this long theme in the distress world that banks don't want to own these assets. So oftentimes, they'll be more willing to just kick the can down the road. You have to protect capital. How do you approach that? And just operationally as well, how do you approach it?

The first and foremost, when we make a loan, we want to get paid back. That's it. Ideally, we don't want to own a project through the debt. So usually, first and foremost, when they're borrower defaults, hopefully you're up to speed on the project and understand where things stand. First step is where are you from a value standpoint? And that usually drives how you deal with a workout.

will give many chances for a borrower to make good on an obligation. Sometimes it's saying to a borrower, listen, there's an out of balance or you need more interest carry. We'll allow you a little extra time to make that. Maybe it's over three payments when you were supposed to make it on one payment. Maybe it's put up some additional collateral. Maybe it's put up other guarantees. I mean, there's lots of ways to approach it, but I think the worst way to approach it is with a huge hammer. A lot of times it's just really a give and take.

And look, it's a client-oriented business. So how you deal with a borrower is very important because your reputation is very important. That being said, if you give a borrower many, many chances and they really can't get out of their own way and that does happen, then you have to take the next course of action. So I think that's how we really look at it. It's again, make a loan. You want to get paid back. We're looking for scalability at this point in our business. That's number one. And you can't have a scalable business if you're constantly...

taking over real estate. And that being said, in shocks to the system, it's going to happen. It happens. It's just part of the business. And we definitely have the full team. And as I mentioned before, a vertically integrated business to be able to execute, which is very different from most real estate credit businesses. A lot of times they're pure lenders. They don't understand what to do if you actually had to take over real estate. And I think it's something our investors really like about our business that we do understand it at that level.

And just in terms of the timeline, if you were to take over real estate, I mean, how long will you stay in that position as being responsible for the project? Is that something that you contract out or essentially look to unload that portion of the operations quickly? Yeah, it really comes down to where we are in the lifecycle of the deal. Sometimes you have a project that may be partially complete. We're almost done. So if that's the case...

then you wouldn't want to sell it as partially complete because you're not going to get bid very well. That's how it is. Everyone's going to put in, say, oh, it's going to take this much time or this much money to complete. So when you have a project like that, usually one of the big advantages about our team, we do have a development team that can finish a project if need be. In some cases, the borrower is the best person to finish that project. So sometimes it's a workout strategy with the borrower to get a final certificate of occupancy.

It really just depends on the deal. First and foremost, where are you in the deal? What's the value of the real estate? What's our best exit plan? How do we protect downside? In some cases, it's okay, we already own it. What is the best execution plan from here? Can we entitle it further? Can we get more density? Can I do X, Y, Z?

You talked about some of the ongoing dynamics or more recent dynamics, COVID being one of the major ones. I'm just curious, obviously, there was a shock to the system. Have there been impacts that have stayed in place since then that show up in your business? And just generally looking at the change post-COVID, what stands out to you?

Well, COVID was like a 60 to 90 day major shock to the system where the first thing people thought and those that had been around in the global financial crisis were like, oh my God, liquidity is going to dry up. It's going to be years of no lending. Investors aren't going to fund capital calls. Better pull down my subscription line because I need liquidity. I mean, again, having that experience in 2008 helped us drive growth.

those initial thoughts in COVID. We also, fortunately in COVID, we had just closed on our Fund 5 and we did a first close, I think it was about $700 million in February 2020. So we were in this very, very unique position of having a lot of capital from a fundraising standpoint, ready to deploy and working

were able to, you know, we originate loans, but we also buy performing and non-performing loans. And one of the greatest opportunities we've had in many years was it was a mortgage read in March 2020 that had a major liquidity issue. I was down in Florida figuring out where we were going to live for the next couple of months.

I was talking to the CEO of this mortgage rate, realized that there was this issue. We bought 200 million of performing loans on multifamily in a week. And that was one of the most exciting deals in my 20-year history. And it played on everything that we've been able to achieve.

understanding real estate debt, buying debt, putting together our SWAT team, getting out to the properties because some of them were in New Jersey, New York, California. We had people in the ground in all these places. And we really helped that re-de-lever and withstand a major shock to the system.

Yeah, to put speed in that theme in the crosshairs too. Impressive to be able to allocate that in that short of a period of time. You mentioned it a few times, the ability to do that, the flexibility to buy, whether it's non-performing loans, just secondary on the secondary market. How big of a piece of the business is that today? Is that something that you see continuing to grow in the future?

It's been a part of every one of our fund vintages. Today, it's actually both performing and non-performing loans, but there's a lot more performing out there with banks. The problem has been a lot of those performing loans that are out there to buy have long-term fixed rate loans at very, very low rates that originated in 2020. And this past year, we bought three loans totaling about $250 million. These were one-off deals that we bought that were very, very senior loans to restructure.

But you look at a lot of the product and there was this view there'd be tons of loan sales. There aren't tons of loan sales. And the ones that are being sold are either office that really have a lot of unknown still or long-term fixed rate loans from banks that are at such low rates that it's hard for investors like ourselves to buy without having such a huge discount.

So, I think that again, I think the experience and knowledge of being able to both originate a loan, buy a performing or non-performing loan, and back leverage a credit fund is what gives us this major opportunity in deal flow to be a very versatile player in the real estate credit business.

Is there anything different about sourcing those loan opportunities versus obviously you're dealing with the banks, you deal with them in different ways typically. But is there anything different about how you're actually able to source something like that, those three loans and $250 million, which is not a small amount?

Yeah, it's very different. It's usually having knowledge of banks and just dealing with the right people at banks. It's also very different to originate a loan as compared to buying a loan. Most of the private credit funds originate loans. And when you originate a loan, you're getting all new clean documentation. You're getting your forms. You're getting every piece of information and knowledge. When you're buying a loan, one, you have to understand the real estate so that you don't have all the information. Two, you have to understand loan docs.

What are the impairments in these loan docs? Things that you would want in a loan doc, but things that aren't because this bank originated with XYZ.

So you're really thinking about it from what does it look like from a real estate standpoint? What do the docs look like? And if there is an issue, what would it take through a foreclosure process time? Every state is different. So you have to understand in New York, that may take three years. In Texas, that may take 60 days. So like I mentioned, we really...

started buying loans in 2009 as a function of the global financial crisis, but it's something that we understand. And usually when we're buying debt, we're not looking to own the real estate. It's usually a restructuring play, but we do have to know that if we do own the real estate, what do we do with it? Very interesting. Certainly from the documentation standpoint, the bespoke nature of the market makes any secondary transaction a bit more unique, but I hadn't considered all the geographical uniqueness from property perspective. It's fascinating.

You hit on one of the more interesting points just in terms of whether it's office versus residential versus just retail or more traditional commercial. When you think about those various markets, and we'll go into a little bit more of where we are today, and we can extend this out for some period of time, but how do you see the differences in those markets today? And whether you want to put a scope in a certain geography, I'll leave that up to you. But different dynamics would be interesting to hear from your perspective.

Well, I would say traditionally as a firm, we've invested in, you can call it the five major food groups, which is multi or residential, retail, industrial, hospitality, and office. Fortunately, as a firm, we've done less than 1% in office. Some of that was on purpose because it was definitely more of a binary business plan.

chunkier tenancy rents, more CapEx needed. The other reason is a lot of institutional lenders, banks, insurance companies, and other private credit funds, office was a major way to put out a lot of capital with very, very institutional borrowers at a lot of times very cheap competitive pricing.

So there's a reason why we don't have any and have never had a San Francisco office loan. Everyone wanted to be in San Francisco. It was the no-brainer loan to make. It was a way to efficiently put out capital and with a very institutional sponsor. That was too competitive for us to achieve.

So we've always been more skewed towards residential related real estate. And when I say residential, that's multi-condo, built to rent housing, and single family for sale housing. Hospitality is something we've done a lot of. And we have an operating partner who helps us execute on hospitality credit. Obviously, industrial, student housing,

We've done all asset classes, but fortunately, we've had less than 1% office exposure. And that has allowed us to play more offense today because you have a lot of firms that are really bogged down by office exposure. And the problem with office is that there's very, very liquidity today. Now, it's picked up a little bit, but that being said, it was typically 15% to 30% of liquidity.

real estate credit providers, as well as equity providers book. And within that asset class, in such a challenging period of time, those lenders aren't getting money back quickly. They're not getting paid off. And investors aren't getting money back from their fund investments or deal investments because office isn't really trading.

So it's bogging up, bogging down a lot of capital in the system that's not getting reallocated. And that's a challenge right now. If you look at investment sale activity, one of the reasons it's been

lackluster, and obviously it's picked up a little bit with rates coming down a bit, has been this logjam of capital caught in the system in the office sector. There's just not a lot of transactions. And there's obviously less transactions than there were in a 21-22 in all asset classes, but office, very little.

With a market like that, where you have somewhat of a freeze and certainly evolving dynamics in terms of what's going on, how long does that take to play out when you have existing buildings, but probably mature in nature or at least look that way? When you think about that being something that's more opportunistic, let's say in the future, what type of time horizon are you looking at when you think about something like that? Is it the next two years or could it be the next 10 years?

Well, I think you look at it often, it's bifurcated between the haves and have nots in the sense that you have a AAA brand new office and every city has the premier buildings and a place like New York has a bunch of premier buildings and then there's everything else. So the class A office is attracting tenancy at record rents. It's

fully leased. And then there's the BNC office buildings. In New York, that BNC may be 3rd Avenue office corridor. That may be the Garment District. And these are antiquated buildings. These are just old. And frankly, they're not seeing the absorption. They're seeing more than they did a year ago, but still way less than 2019. So the real problem here is what will this look like going forward? And with banks full on office, insurance companies full on office, there's very little credit to

get these new deals out, so to speak. There's very little that's greasing the wheels. I do think it's probably a two to four year situation. Some of it is getting solved by conversion to other. So, I mean, there's a lot of talk about office to resi conversion, not that much action, but more action than there was a year ago. You're starting to see more of it happen. Part of that is because in a place like New York, they added on a

a tax abatement for office conversions. And that is a step in the right direction. But not all office buildings can be converted. They may not have the right dimensions, the right egress, the capex may be too much. So I think a lot of it boils down to some of this can get out through conversion to other, but it's easier said than done.

And is the suburban shopping mall evolution where class A's were still as strong, if not stronger than ever, B and C properties is where you saw most of the pain. Is that a reasonable parallel here? Do you think there's major differences in terms of those two dynamics?

I think there is some parallel because if you look at Simon Properties, a mall read, they have their class A, excellent locations, very high per foot sale by malls. And then there's the second or third generation Simon Mall that was the excellent location. One of our worst deals was a mall that we did in 2007 in Dallas, Texas. And it was a third generation Simon Mall. Okay.

Okay. And fortunately, the experience was so bad for us that it kept us out of the mall sector for 20 years. So terrible deal, but kept us out of the sector where people lost a lot more money over the years. But again, to your analogy, it's the best in class. And then there's everything else. And I do think retail has come back a lot since COVID. There was this period of time where it was a belief everything was going to move online.

But then there were certain changes, and I don't know the specifics, but certain laws that were changed online, customer acquisition online became much more expensive, and it brought a lot of the traffic back to retail. So I think you're finding that retail in a lot of locations and grocery and shopping centers are performing really, really well, and it took a recalibration of rents to achieve that.

In New York, for example, Fifth Avenue rents are not what they were, but the spaces have turned over. Things are relatively hot again. Yeah, looking at some of the foot traffic numbers for what those are worth over the past weekend, too, are impressive to see that people still like the experience of

The other fallout or whatever we'll say, evolution from COVID is some shift in terms of the work schedule and whether the five day in office goes to four days or three days, which feels like based on a small sample size where it is evened out now, how much of a trickle down impact

does that have on some of the other properties or opportunities as you look at them? And then from a timeline perspective, is that pushed out even further just in terms of when you could see that impact? Do you think about that much? What are your thoughts around that?

I think the pendulum is really starting to swing the other way in terms of you have a lot of tech companies and companies just saying, "Back to work." Financial companies in New York, "Back to work five days a week." It's moving in that direction little by little. I think that's a great thing. The impact on other real estate, a place like Midtown Manhattan

In 2022, you didn't have this mandate of back to the office. So all these restaurants and retail, they were really, really suffering. They did not have the traction. You came in on a Monday or Friday, it was empty. So Wednesday was the big day, but that little change made a huge difference in terms of

whether a tenant could pay the rents that they once were able to pay. So it has had a real impact. But I think, again, the pendulum has started to really swing. And we're starting to see, because of this back in the office work mandate, I think you're starting to see cities like LA start to really benefit from that, or even New York. You're seeing people have to come back. And that's really important from a real estate standpoint.

We interviewed somebody who has a lot of coffee shops around Manhattan. And when I did the math in my head of if you have somebody who's in the office twice a week, and they go to the shop versus five days a week, that is a material impact on a business where the product price is not significant. So you could see how much of a trickle down impact it has. One of the other dynamics, and you touch on a little bit, is just rates. And you don't need to take a view on rates and where they're going. But just in terms of how much they impact the market,

I think there's a lot of debate on this in terms of the residential side. And I've been impressed that where I live, it just feels like there's less inventory, maybe less sales, but people are still paying prices that are extremely high. How much does it impact your business where people are very institutionally focused, very return focused in terms of volume and just what gets done?

Well, look, for putting out new money rates, it's great. Higher rates, everything we do is floating, great for returns. That being said, rates have an impact on value. And this theme of higher for longer has had a major impact on the investment sale market, the real estate market. I do believe directionally,

We're in a position where rates are not just short-term rates, but the 10-year will start to come down or even out somewhere in this range between 4% and 4.5%.

I think that one of the challenges is from an investment sales standpoint and an equity investment standpoint, you can't have rates all over the place. You can't have a treasury that's three and a half to 5% because how can anyone buy real estate knowing that they create this value and they renovate and they get to a 7% yield on cost? And you want to know, am I going to sell that for a six cap, a five cap, a four cap? It's very, very hard.

to drive what you can sell for if the 10-year is all over the place? How do you finance that? How does a buyer finance that? So I think we need consistency. And when consistency in the 10 years, somewhere in a 50 basis point band, I think people, for a period of time, I think that's where people can really underwrite what that's going to look like. That started to pick up a lot. Directionally, obviously, since the election, there's been a much more bullish

outlook. That also comes with an outlook that there may be greater inflation because of tariffs, because of a whole host of reasons. I do believe that the US, as compared to other places, it's viewed globally as a safer place to invest. And I think that will ultimately have an impact on the 10-year from a compression standpoint.

It's very interesting to hear your point on the volatility of rates relative to just the direction of rates. You're the second person that's actually mentioned the volatility is the most disruptive thing in terms of fluctuations. So I think it's a strong point to make with something like residential. And there's development of these projects. They can take extensive periods of time to develop.

And then at the end, you're going to have if it's purchases, it's going to be different than rental. But if it's purchases, there's some dependence on rates in terms of the demand from the buyers. Does that come into the equation at all with these projects? And I know you're putting your brain inside the borrower's mind, but I'm just curious, how much of a trickle down impact does it have on a specific space like that residential where you see rates show up in multiple places?

It really depends. So if you take a look at the housing market, you touched on it before. One of the reasons you're still seeing activity in the housing market is because even though rates are much higher, so many people are locked into such cheap mortgage rates from 2020, 2021, they're not moving. So the supply of secondary houses to be sold is non-existent today. And that has really kept supply in check.

I also believe that there's this more normalized scenario where people believe that rates are higher for longer and they've adjusted. And there's life events that force people to have to move at some point. So I just had another kid. I got to move to a house. I just got married. So there's some of that that goes on. And again, the supply and demand dynamic, one of the bright spots of real estate is housing has been in short supply and it's kept a very healthy housing market today.

I think when you look at condos, I mean, again, when we're looking at a project, we're looking at how many units is someone delivering? Is this luxury? Is it not luxury? When you look at luxury, that may be less mortgage dependent. Someone that's buying a $20 million apartment, a $10 million apartment may view the mortgage market differently than a first-time home buyer buying a $500,000 house in Texas.

So we really look at market fundamentals, who's the buyer and how mortgage dependent are they? And then what are rental options as compared to buying? What does that look like?

Makes a lot of sense. It's interesting to hear the nuance. If we step back, I think we've talked a lot about the various trends and themes in the market, some cyclical, some secular. What stands out the most to you? And it could be repetitive in terms of what you've been saying. But when you think about the next few years, the opportunity set, and especially with what you're doing, what stands out to you as the most interesting theme that exists in the market?

I think for us, if we believe that private credit is a major market opportunity, what's the best way to address that? And from a direct borrower standpoint to levering other lenders, those are two themes that we're really seeing as interesting. I do believe that

you do have to have lots of different creative ways of originating and finding deals because there's less deal flow activity right now. With the 10-year where it is, the bid-ask spread is still wide and there's less investment sale activity. When I think about our 20-year history, there have been few times where I've seen this kind of time period where it's had such an extreme change in rates. We're finally having situations where borrowers are pushed to

to act. They've been floating around and sitting around here for a couple of years. And some of it was, by the way, masked by rate caps. There were a lot of 2020-21 borrowers that bought properties, got a rate cap. So rates were being masked by the fact they were paying this really, really low rate. And when rate caps expired over the last 12 months,

the inevitable happened where borrowers weren't able to stomach the debt. There's certain places in this country, in states where foreclosures can happen quickly, where that effect has happened quicker than others. Transactions are happening because lenders acting on a foreclosure, things are happening. We just financed, for example, someone that bought a non-performing loan from an institution here. Just to give you some dynamics,

The property was bought, Class A multifamily in Las Vegas, for $120 million in 2021. Now, obviously, cap rates were very different there. There was a very different market, market fundamentals. Now, today, that same loan, which was about an $87 million loan, got bought for $85. That's probably close to what it's worth. They bought the loan for that price because they could own the real estate quickly. We financed that group with $60 million of NPL, non-performing loan financing.

So again, I think that you're starting to see some of these things come through the system because lenders, borrowers, there's a frustration where things have to happen.

There's finally an impetus for transactions to happen. Yes. I mean, you get it with private markets in general relative to public markets where there's a daily scorecard and a certain amount of liquidity. But it's so interesting in the real estate terms when you think about the time horizon for some of these things, as you mentioned, the geography and how much that matters. So it's interesting to hear how you've positioned yourself for the opportunity set as well and some of those opportunities.

This has been a fascinating conversation, Josh. I really appreciate you sharing the knowledge and getting in the weeds, getting below the surface in terms of all the different things going on. Just closing out, if you had a case study from history that you think is most instructive, I think you've given us several as we've gone through the conversation, but most instructive for a prospective real estate investor or an allocator to study or to read about, and it could be within your own business, if it's publicized, or it could be outside of your business, if it's

something third party, but what would you point to in terms of one of the more interesting case studies from this market? It's interesting. I think when I think back to just flexibility in capital, I don't know everything about this, but when Blackstone bought Hilton in, I believe it was 2007. Yes. It was one of the biggest private equity real estate deals of all time at that time.

And it's interesting because global financial crisis happens, and it's such a shock to the system. And I think one of the ways they were able to stomach that was flexibility of capital. They were able to actually, I believe they bought a lot of their debt in one of the other vehicles they had or one of the funds, and it became one of the most successful deals of all time for them. And I think the key thing is, again, having flexibility in capital, having many tools in your toolbox, opportunities. And I think it's an

particularly important in withstanding shocks to the system, really being nimble, navigate. And again, I always believe this, but you have to make your own luck. So it's a lot of making sure you're in that right place at the right time. So again, that's one thing that comes to mind.

It's a great example. It's one that I think immediately comes to mind and one that at one point they had written it down 70% and in the end, 14 billion of profit on a $26 billion purchase price. So yeah, it comes to mind. I mean, there's many, but that's one thing to think about. Well, thank you again, Josh. Appreciate you sharing all of the detail and all the knowledge. Appreciate you joining us. Thank you.

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