“I learned one of the most critical axioms of real-estate investing: ‘Most, if not all, the return is made at the purchase’.”
Steven started his journey through stock markets which led to the on-floor options markets of San Francisco, Chicago and New York. He is now a Partner at Far Hills Capital Partners. He believes that it is “always most important to understand that all real estate is local!”
Q1: Tell us your journey. How did you go from trading to real estate?
My journey has hardly been a straight line. An initial exposure to sports-wagering (then illicit) in my college years (1970s) led me to the stock markets and ultimately to the on-floor options markets of San Francisco, Chicago and New York. The trading floors of the early 1980’s were the modern equivalent of the California Gold Rush. The floors mated funny-looking jackets, Hawaiian Shirts, and scissored-off ties with bright, ambitious people from all backgrounds. Fortunes were there for the making.
The migration from options-trading to real estate was a long, gradual step. I’d made a number of real-estate investments, active and passive, across multiple-classes over decades. I’ve owned a number of residences, primary and secondary, and some investment properties since the early 1980s. These properties helped create a good beginning for understanding transaction strategies. It was here that I learned one of the most critical axioms of real-estate investing: “Most, if not all, the return is made at the purchase.” That was intriguing and placed a premium on understanding the matrix of conditions of whatever the real estate market presented at the time.
Trend-recognition and strategic risk-assessment skills learned in the derivative-trading business contributed to work to create a natural fit for the slower, more methodical world of real-estate development and investment. As trading edges moved from human to computer, option-trading held less interest for me than the attraction of dealing in tangible assets like land, buildings, homes and apartments.
Q2: What is your thesis for investing in distressed retail? How are those deals structured?
Distressed Real Estate appears in many forms. For example, the decline of terra firma retail began with the worldwide adoption of e-commerce in the early 2000’s. We witnessed publicly-traded retailers driven by their shareholders, CMBS-buyers and regional developers to expand and grow with little regard for smart, prudent development. The resulting over-development led to hyper-competition and store cannibalization. Malls, once the darling of retail strategy, starting moving to near extinction. These trends have been firmly intact for the last decade. The pandemic only accelerated their demise. COVID-19 has functioned to “spread the fire.” Levered hotel & hospitality properties are suffering huge valuation drops, along with more moderate drops in certain office and multi-family properties.
Our thesis— not limited to retail— is to find properties in markets we know that present multiple options to value creation. We strongly prefer to use distressed bank or CMBS debt as our entry point, buying debt for cents-on-the-dollar, then either taking over debt collection, or initiating foreclosure. Sometimes we will deal directly with a distressed owner/seller, taking a joint-investment position, albeit always with a controlling stake.
From there we’ll examine potential adaptive reuse (i.e. converting a mall, office or factory into multi-family residential, and or warehouse/distribution, healthcare facilities). We evaluate the local market, relevant entitlement issues and the highest, best-uses…all identified in initial and post-deal due diligence. Our experience in entitlement and approval work yields a nice advantage over other distressed debt investors. This detailed work creates a smart margin-of-safety and buys us time to be patient. Sometimes though, when the local markets recover, we might just sell the debt note to larger, more aggressive investor-buyers.
Deal structures vary considerably from deal-to-deal, but I work with a well-regarded and highly knowledgeable family that is willing to provide purchase-thru-stabilization and/or sale financing. They are real estate-centric, egoless and incredibly helpful and always trustworthy. They allow for outside investor partners and in those situations we’ll aim for asset stabilization and then offer liquidity (if desired) or joint venture ownership going forward.
Q3: How did COVID-19 impact different asset classes within real estate? Which asset classes are you now bullish or bearish on?
As previously mentioned, COVID -19 has widened and accelerated the shifts in different real estate asset classes. The clear losers are regional malls, big and medium-box retail reliant on terrestrial locations, hotels and stand-alone hospitality properties. Certain central business district (CBD) Class-B offices will continue to suffer along with some Class-B multi-families burdened with substantial leverage and/or underperforming tenancies. Financial leverage is the critical variable here. If the pandemic damages cash flows and they’ve no pricing elasticity, these kinds of jeopardized assets will find themselves highly vulnerable, especially if interest rates make any sustainable upward move. Of course, those are exactly the kind of assets I hope to buy when sufficiently distressed.
Single family and apartment rental properties will thrive in the right markets…..more on that later.
Warehouse, distribution, and last-mile delivery hubs are in the early innings of a longer-term bullish macro trend. Same goes for cold-storage, technology centers, regional healthcare and lab facilities, however it’s always most important to understand that all real estate is local! Locations in markets that are experiencing strong job growth and family formation will continue to work well across most all asset classes. The first phases of pandemic-related changes in real estate are mostly over, however substantial structural risks and future behavioral changes remain.
Q4: Housing prices are at an all time high. What is your long term outlook on home prices?
We are in a perfect storm for rising home prices. Interest rates remain low, yet are threatening to move higher. Capital markets have produced outsized gains for individuals with investment exposure allowing for a greater nominal dollar spent on residences. COVID-19 has shifted focus away from expensive Northern cities to new growth markets in the South, Southeast and Southwest and Western regions. Inventories are low, developable land dear, and high taxation states (i.e. CA, NY, NJ, IL) are seeing a definitive migrational shift to no-or-low tax states (FL, TX, NV, etc.). Inflation is upon us and it’s indeterminable right now as to whether it’s transitory and manageable, or persistent and threatening?
SFR (Single-Family Rental) markets are booming now and allow for entry-level access and workforce mobility. Large capital sources are chasing this asset class and will, as is usually the case, over reach eventually allowing for market cooling-off down the road. Until then, they will represent some damper on rising home prices in growing markets.
I am somewhat sanguine about median home prices over this decade, but see the current torrid-like prices (especially in uber-hot markets like Miami and Austin) slowing down over the next few years. Too much, too soon, is usually a recipe for trouble.
Q5: How will data science and PropTech startups influence the real estate private equity industry?
Data Science will always help educate and advance all facets of the Real Estate industry, however once again, all real estate is local and must be measured as such. Trends and patterns can be discovered and expressed algorithmically with macro investments made accordingly, but the wrong product in the wrong neighborhood will always underperform the locationally correct one. Smart RE private equity players unequivocally know this. Some PropTech startups will understand this….some won’t. I believe those with deep pockets and service orientation will do better than others. Private equity players will always embrace RE-related data science and be inquisitive about the value of some proptech propositions, however, most will want to see an empirical proof before they spend real time and money to produce better data sets.
Q6: How would you allocate your hypothetical personal $100M portfolio?
With a hypothetical personal $100M RE portfolio, I’d dedicate the majority to properly-vetted multi-family income-producing properties, a healthy slug to distressed loan purchases (or fund) and some smaller portion (speculative capital) to interesting start-ups (i.e. Home LLC).
Q7: What about golf do you love applying to business?
Golf is a wonderful activity that compliments business extremely well. It’s a great activity to meet and entertain people you might want to know, work or invest with. It’s a game predicated on personal honor and integrity and as Arnold Palmer once perfectly said: “ a golf course is a place where character reveals itself.” I believe you can learn all you need from spending four hours with a person. It’s also a game of 18 holes, allowing for plenty of time to experience ups and downs…..much like the ebb and flow of most deals. It’s fair to say, a great part of my real estate network is found on the nearby links whenever they can.
Q8: How do you teach grit to your daughters?
Glad you asked. My teenage daughters have been imbued with a strong academic work ethic and have learned that it’s okay to fail, so long as you give it your best. Rarely, does success come without risk. They know we have their back and its best to get back up and reapply themselves. They know that few, if any, successes come from pure luck. Their mom is ruthlessly pragmatic, runs the family property management business and has taught them how valuable hard work is.
My oldest, Sydney, is a brilliant student and will be enrolling at the Ross School of Business at U of Michigan (with great RE programs endowed by the likes of Sam Zell and Steve Ross). She’s quite interested in real estate and may eventually pursue a graduate law degree for that purpose. Like her younger sister, she’ll be a great success at whatever she does. With any luck, I’ll be working for her in the next decade!
PS….my youngest, Whitney, is a card-counting shark-in-training. She’s shrewd, super-creative and already earning a summer wage as a 15-yr old. She’s the one in our family with the killer instinct. She’ll be successful at whatever and wherever she applies herself.
Q9: Which real estate friend (or mentor) would you like to give a shoutout to?
Undeniably, I am blessed and owe great and continuing thanks to my close friend and confidant, Michael M, one of the four sons of the aforementioned family partners. He and his family are commonly considered one of the country’s smartest real estate investing families. Michael has been a brilliant and patient teacher as well as the definitive source for my advanced education about real-estate, and its deal making and the processes. Our regular breakfasts cover lots of topics, yet invariably there are always invaluable lessons to be learned.
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