CRE Advisory in the Time of COVID-19: Q&A
RCLCO's Gadi Kaufmann and Taylor Mammen discuss how they are steering clients through today's murky investment and development scenes.
With so much uncertainty in the air, the role of today’s commercial real estate adviser is not an easy one to play. How do you advise clients on the best defensive and offensive strategies to pursue amid a pandemic and at the advent of a recession?
To get the adviser’s perspective, Commercial Property Executive spoke to Gadi Kaufmann, managing director & CEO of RCLCO (Robert Charles Lesser & Co.) Real Estate Advisors and Taylor Mammen, an RCLCO senior managing director and director of the firm’s Institutional Advisory Services. With verticals in institutional investment advisory, management consulting, and real estate economics, RCLCO has a 360-degree view of the industry. Kaufmann and Mammen are using that vantage point to help clients gain clarity and make decisions under unprecedented circumstances.
What do you advise clients to do internally so they can emerge from the crisis in a strong position?
Kaufmann: We do hope most clients simply are dusting off the playbook and turning the page over to: “What happens during the crisis?” and implementing that. That’s the best prepared operator. But for those who maybe are not there, I would suggest the following basic steps:
First, communicate internally and externally, and do it realistically, honestly and transparently with everybody. Don’t pretend to know things you don’t know and don’t hide the ball, because the truth will reveal itself without a doubt.
Next, leaders need to stay calm and show a vision for the future and be realistic about what aspects of the vision they know or believe, and act upon those beliefs.
Next, manage expenses. It’s really important to clean house. This is an opportunity to prune the tree, if you will. Not to be cutting in panic but to be managing expenses with an eye toward the future: What do we envision the company to be in the environment that we picture on the other side of the crisis, and how do we want to shape the company’s evolution from an organizational and expense point of view?
Next, establish a point of view: What do you think will happen? How do you think it’s going to impact your business or your portfolio? Based on that point of view, reforecast every property or every line of business in the company, so that you now have a believable game plan or projection—which you can adjust anytime—for what should happen to the business,
Next, try to force the entire company—the assets, the people, the offices and all of your activities—into three buckets: the crown jewels—the things that will be defended at all costs; the things that are great and you want to keep on but they are not quite crown jewels; and the things that are maybe a luxury. And then consider setting down tripwires. Under these conditions, we may need to let go of the things that are good but not essential. The next tripwire would be letting go of the things that are really terrific but not crown jewels—all of that with an eye toward defending the crown jewels.
Another internal initiative is to identify those key levers a company can move that will help it get ready to make the next transitions. And then, finally, you must have the courage to actually pull on those levers.
Mammen: (It’s about) really getting good at communication. The frequency and the quality is really important. Getting better data, and finally having a perspective and not being afraid to act on it. People perceive a lot of uncertainty now but what is going to set apart those groups and companies that really take advantage of this are those who have a perspective and are not afraid to act on it.
Let’s talk offense now. If I am your client and I am looking for a safe haven, what asset class should I invest in?
Mammen: I think it is important to note that everything is going to feel risky right now, because we are going through an unprecedented event. You hear so much from people that things are uncertain. But we try to remember that we live and invest amid a constant level of uncertainty. Things didn’t feel as uncertain back in January, but that is only because we didn’t know COVID-19 was about to happen. What we are confident with right now is that we are closer in time to more attractive investment vintages than we were back in January or any time over the past few years. So investors should be gearing up to invest money at this point, and there are going to be broad opportunities, if only because we have reset the cycle.
There are safer havens, of course, and the way to identify those is really to look where trends are most easily understood: growth of e-commerce supports industrial; growth of data usage supports digital real estate. People always need housing, and, at this point in time, are thinking about it a lot. These are probably the safest havens both on the debt side as well as the equity side. And of course, existing income-generating properties are going to offer lower risk than value-add opportunities.
Kaufmann: And perhaps one of the safest things to invest in is triple net properties—net lease properties that are occupied by players in the spaces that Taylor described a moment ago. Not necessarily taking a development risk to build a logistics center, but, if you are looking for a really safe investment, you can buy a building that’s leased by Amazon for the next 15 years. The chances that it will not play out according to the business plan are very low.
And if I wanted an opportunistic play, where should I look?
Mammen: Investing in land and development, which, again, is going to seem fairly scary given the general risks of construction added onto potential concerns that arise because of COVID-19, including work stoppages and supply chain disruptions. But you get to develop a post-COVID-19 product that takes into account some of the lessons learned from this event and is likely to deliver in a growing economy.
But, in particular, we’re fairly interested in office developments. There were already many signs that most existing office space had elements that were unattractive to tenants or obsolete, and we think COVID-19 may be fast-forwarding that to a large degree. Tenants are interested in—and have been for a long time—the healthy or wellness features of office space. They’re going to be really interested in those coming out of this.
I think we’ll see a lot of innovation in this area, and potentially the best way to get to the right product is through development or significant rehabilitation. There is potentially some risk, but also potentially huge rewards for getting these new post-COVID-19 products right.
Kaufmann: Currently, the pricing of REITs is very attractive, relative to what we believe to be their underlying asset value. There’s some opportunity there for somebody who’s not necessarily interested in investing directly in real estate but is trying to benefit from the potential upside of real estate investing in the short term.
Mammen: But be prepared to ride the roller coaster that REITs may go through over the near term.
Kaufmann: That’s correct. It’s not safe, but it’s an opportunistic investment. The bet is that ultimately—and the ultimate may happen sooner or later—REIT prices will get closer to where they were before the crash than where they are today.
Another area of opportunity that’s risky— but an opportunity—is investing in debt, getting aligned with broken loans for which the borrower is unable to bridge the difference between the covenants or coverages, etc., and stepping in with rescue capital. Again, risky and hard to get to, but for those who can, that could be a significant payoff. Once again, they’re going to be in the highest-risk category of the debt structure, so it is risky and one needs to be mindful of that.
Debt underwriting has changed since the beginning of the year. How do you help clients prepare a story that newly cautious lenders will want to back?
Kaufmann: For lenders to get comfortable, we need to show them a range of possible outcomes. It’s not enough to say, “Here’s my expectation, and that’s the end of it.” A lender will want to see what it takes to actually risk the principal loan amount and how likely it is for this asset to experience that disruption, relevant to the business plan. If the business plan says that the asset is worth $10 million, and the loan is $7 million, then what kind of changes in assumptions for rent and occupancy and operating expenses could happen that might drive the resulting value to $7 million or below.
And to the extent the lender can get comfortable with the demonstration by the loan applicant that such a scenario is unlikely, then I think the borrower should be able to rely upon being able to get that loan.
If, on the other hand, the valuation is so sensitive to the assumptions, then the borrower may need to come up with more equity and ask for less of a loan amount—at least for the short term.
So, from a borrower’s perspective, particularly if it’s an asset that is riskier in fluctuation in value, you might want to get a more flexible loan—maybe even a shorter-term loan.
But if it’s a solid asset with a track record of good performance and good prospects for maintaining the income stream that you are currently projecting, you should have no trouble borrowing. Show scenarios, be flexible, be realistic and show what in your track supports the case that you can actually manufacture the results that you are projecting.
Mammen: The good news for lenders is that they don’t have to be super precise on value. Equity has to be really precise on value. Lenders just have to make sure that there’s enough cushion in the equity to get comfortable with. What all lenders are asking for—whether a borrower is going in to request some type of deferment or for a new loan—is a good outline of the scenarios that Gadi discussed: a request in advance, and the data and analysis to support it. So, it just means more upfront work, which is going to be good for everybody in any case.
And if a client is pursuing a new equity partner to infuse capital into their business, how can they be most successful?
Mammen: I don’t think it is materially different in many ways. Right now, relationships are incredibly important. That’s what we’re hearing from our lender partners as well as our clients who are borrowers. It’s the relationship forged over the past few years that’s making all the difference in the world. It’s a similar story—and maybe even more important—for equity, since you are putting capital at greater risk. You really want to make sure that the partner you’re going with is somebody that you know and trust very well.
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