IMN Deal Making Notes

We still have more room for cap rates to go up and match treasuries. This means we did not hit the bottom yet.

So many institutional investors are shaying away from the Los Angeles market this created an opportunity for family office and buyers with different risk profiles to come in and make bank.

Suburban multifamily rents kept par with pandamic rents. Downtown Los Angeles rents are still down but recovering. The demand in California for units stayed fairly high in 2023.

The pain in office building is at its peak now, and this can be the new frontier for super high returns.

Economic and Banking Update

With Beacon Economics and Chris Thornberg

Beware of the narrative- Robert Shiller said that trying to understand the economy by just looking at data is missing the point.

Currently the ecinomic narrative and reality are not allianed. That is a result of Covid and politics.

Current Yield curve is invesrted and that is a sign on recession. Mixed economic signals. We have a very low unemployment, industrial production is the highest it ever been abd GDP grow of 1.1%.

Inflation is hurting consumers. Main street recession on main syreet is unlikely. Asset prices will continue to deflate yet the fundamentals will ramian fine. Consumer and business investments should offset weakness in real estate and finance.

What to worry: housing shortage, labor shortage, public defcits, and banking credit crisis…

Covid effect is still in the market. Loss of life and labor is still effecting the economy. Covid created the deepest and shortest recession. Congress added $6 trillon of stimulus. Congress webt to Federal Reserve in April 2020 and the FED offer $5 trillon in quantative easing.

Bad recession comes after a deflation. Cash in the hands of household is 130% more than usual. The consumer is doing well.

Labor shortage is still a hige issue and business have to invest in automation and productivity. Income inequality is falling in the US and a result of that.

We need to increase labor via: immigration, labor participation and housing. People leaving California because of housing supply.

In summary, we are dealing with aftershock of covid. We have political issues that are not helping the recovery.

Mid Year Economic Notes

Single family starts are down 6.9% in the year and 16.1 % this quarter. Home prices are declining but sliding. California population decline by 1% and that helps with home decline.

Less people means less tax revenue and that is not great.

1.123 mm units are available. That is a tight market inventiry for homes.

18.4% less units starts that is bad for GCs.

Stock market is not out of the woods yets. Still profit vs value ratios are not great from a historical level.

Labor bottles necks are getting better it will get tighter. Its not going to get better in the long run. Its going to be a consitant issue.

2030 is going to be a rral recession year.

Commercial real estate is currently killing the small regional banks. They are sitting on a lot of bad paper and office product is getting killed and dragging with it many lenders and borrowers.

Winter Forum Analysis and Investing

We have maturing loans problem. We have 300bn this year, and $375bn maturing in 2024. The problem is that these properties are not will not cover the debt service at the current interest rate environment. These are huge risks that are in the the market.

Hospitality real estate is doing great now. During the pandamic, hotels were hurting, which is why they did not trade at a ridiculous low cap. Now, their income is good, and they are actually stable.

Sponsors are struggling to find acquisitions since Simon Goldstien feom Buckingham Advisors is actively looking at deals but still very difficult to find the right deals.

Who are the sellers today. In reality, the sellers are the people who have to sell. The sales out there are between very very long-term owners and distress or semi distress.

The cost of capital for JV Equity went up by 200bps, and Real Estate Product is trading now way below replacement cost. That is putting a huge pressure on developers. Why build if you can buy cheaper already built argument.

Funds Notes:

Bora Ozturk raised 3 funds, and he is with March Capital Management. Matt Posthuma from Ropes and Gray is servicing funds and is providing support to the fund managers. When launching a real estate fund, a manager will need to have a good story and a program that he wants to execute.

Retail is back. As usual, it’s location driven. Retail assets are doing OK now mainly since the caps did not go too low during covid. Assets valuation did not go through the roof because of covid. Sharpshooter approach is the right way to find assets and needs to really understand the underlying fundamentals to underwrite well and find value.

Homelessness continues to be a huge issue in California. Leaders at IMN believe the solution is a cross agency solution. That is, the state has to combine a few agencies to work together and deliver a few different solutions.

Finance mid-2022 Update

Intro: Remote work is not common in Asia.  Its still not common even during covid. We have inflation because of china.  China held inflation down by providing cheap labor and product for the past 25 years in fact China was exporting deflation.

Most economist feel that we are post globalization.  The world is now disconnecting and that increase inflationary pressure.  Industrial market had eclipsed in price per foot. 

Finance activoty is lower as Banks are trying to hold more reserves.  lender areore selective and push away deals.

Borrower increased signings as rates came up.   DSR changed for take out.  Debt Yield is not a great place to look at deals at a raising interest rate.  

Brent Wagner from Acore feels that in this environment he can still look at debt yeild.   In his opinion, rents are also going up.  He is doing less Multi and Industrial since the competition is too hard. 

Chris Allman from CIM believes the most important is the sponsor abilities to solve problems and have a forward look.  He is not doing much office.  Worried about long terms Cap Rates on Multifamily and believes that caps will raise.   Chris recommends to raise a lot of equity. 

Jamie Zadera from PGIM lending in a lot of office conversations to life science.  Howeber, she still worries about the quality and quantity of deals. 

Josh Katzin from AECOM is seeing deals reproced however not hige repriced. But is it the beginning of something bigger? AECOM is very focus on ground up. The deals are going the opposite way: Construction is higher, and Rate is higher. Now we need rents to go higher…thats the big question. Investors want an inflation adjusted yield. Going in yeild is lower. Product need to be differentiated to attract top dollar rent across all product type.

Ash Baraghoush is worried aboit leverage. Buyers did not assume the rent growth enough. In theorty, we need to look at a cap rate growth of 50pbs. Lenders are sizing to a higher DSCR test. There is a pricing discovery mode in the next 6-12 months. The issues present opportunities on the back side. Short term turbulence are coming but good opportunities are coming on the other side.

Matthew Gorelik is believes developer will hold properties longer. High net-worth is tue driving force of real estate investments. Cash is scary. Pricing right and underwriting the exit debt is very important as the rates are going to be higher most likely

Opportunity Zone Investment Notes

Passed as part of the Tax Cuts and Jobs Act of 2018, the Opportunity Zone program gives investors a tax break in exchange for investments in low-income communities in census tracts designated by each state’s governor.

The Opportunity Zone program gives investors a tax break similar to that of a 1031 exchange, allowing investors to invest capital gains in so-called “Opportunity Zones”. Investing into an Opportunity Zone reduces, and in some cases eliminates, the taxes owed on those capital gains.

o Investors have 180 days to invest into the QoF (Qualified opportunity Fund).

o Investors who maintain a hold period of five years in a qualified Opportunity Zone investment gain a 10% reduction on capital gains taxes. Those who hold for seven years gain a 20% reduction.

o Investors who hold their investment for 10 years reduce their capital gains taxes to zero (not only on the original capital gain invested in Opportunity Zone as principal, but also on any gains accrued from the Opportunity Zone investment).

For example, an investor can sell stock and invest the capital gains into an Opportunity Zone. This would eliminate the taxes on the capital gains from selling the stock. Furthermore, any gains from the Opportunity Zone investment would be excluded from Capital Gains taxation. Opportunity Zone investments require improvement of the properties. When investors buy a property, they must invest more than 100% of the value of the building (in order to fund improvements).

One persistent question: what qualifies as an opportunity fund—the investment vehicle for an opportunity zone investment. Who can start one? What are the requirements?
o The proposed regulations generally permit any taxpayer that is a corporation or partnership for tax purposes to self-certify as a Qualified Opportunity Fund, provided that the entity self-certifying is statutorily eligible to do so.
o Investors need not be attached to a big fund run by a bank or a private equity firm.
o Investors simply need to self-certify, fill Form 8996, and attach it to their federal income tax return.

Investors seeking to benefit from Opportunity Zone projects should partner with knowledgeable operators and fund managers:
o The areas within opportunity zones vary and can be vastly different. Some have already gentrified while some are lagging far behind.
o Investors often do not possess adequate knowledge of the market in general and Opportunity Zones in particular.

Developers that have projects in Opportunity Zones and are that trying to connect to investors should note:
• Cash out refinance is allowed. At the same time, there are exception and exclusions such as death, gifting
• QoF can still do a 1031 exchange. QoF have 34 months to invest the fund.
• 98% of the funds need to be invested in the QoF.

CA Cannabis: A Rocky Start to Compliance

California has blazed the trail of efforts to reform Cannabis laws, standing at the forefront as early as 1972 with the nation’s first ballot initiative attempting to legalize Cannabis. Although the 1972 effort (Proposition 19) failed, California voters did legalize medicinal Marijuana 24 years later in 1996. Today, with full legalization, the Cannabis market in California has evolved and grown to become one of the leading potential growth engines for the state.

Rosano Partners has a 6 Agents dedicated team led by Korena Ellis: kellis@rosanopartners.com and George Cornelson: gcornelson@rosanopartners.com who are executing, leases and sales in retail and industrial cannabis facilities and are expanding to execute license deals in the California Cannabis Market.

As the legal Cannabis market continues to evolve, regulations are still flux. While a slew of rules currently governs both the production and consumption ends of the market, there are still adjustments that are being made. While common in emerging industries, such flux and uncertainty can cause investor concern. For example, California’s changing Cannabis delivery regulations have caused problems for investors seeking clarity about the ability for retail locations to thrive without competition from asset light door-to-door services.

Aside from regulatory clarity, the logistical strain of permitting presents the most formidable problem. Currently, the state is engaged in a dual licensing regime. That is Cannabis operator have to get license in the city or municipality where they are located at and with the state. In addition, the City of Los Angeles has fallen behind in its permit issuance due to a late start. Although the city has issued 180 licenses, 600 applications remain in process.

Finally, banking comprises one of the most important and obstinate barriers to conducting business in the Cannabis industry; however, this might soon change. As US commercial banks are chartered and regulated by the federal government, they must comply with federal laws on Marijuana sales. As such, they continue to deny service to Cannabis producers and retailers. As the industry seeks to enter the space and exploit the large profit potential, bank executives and lawyers are exploring new regulations and loopholes. The State Treasurer’s office has also begun exploring ways to facilitate banking activities in the Cannabis industry either through regulation or the creation of alternate financial channels. Given the amount of attention and focus on this issue, we predict a solution soon. Currently, REITs and non-bank financial companies (finance companies, hedge funds, and other entities involved in “shadow banking” AKA “non-banks”) have filled the void.

BisNow Conference Multifamily Analysis

Costa Hawkins repeal in November is on everybody’s mind. This potential repeal is the single most important issue in the multifamily business in California. Barry Altshuler and many other developers believe that Costa Hawkins was the main reason for the robust multifamily construction during the past 20 years. Imposing rent control on new product will cost this state a significant amount of development, decreasing housing supply precisely when we should be increasing it. In various cities, officials are seeking vacancy controls as well—the practice of capping rents on renewals and new tenants. These policies threaten to open a Pandora’s Box of issues such as: reduction of property tax revenues; and, creation of slum properties as landlords neglect properties given the lack of return to capital investment.

Bob Hart CEO of TruAmerica said we need to put together a Marshal plan to deal with Homelessness, and we have affordable housing crisis. Bob requests that municipalities participate and help developers increase the supply and give incentives to developers for low income product to build more. The housing costs are causing economic distress among the working and middle classes, and even driving many people homeless. In fact, some studies have shown that almost the entire increase in the homeless population over the past few years is due to increasing housing costs. However, rent control and rent stabilization are not the answer because they produce perverse incentives. They decrease development, and, as such, make the housing problems worse. We need to encourage more development not less. This affordability and supply problem will not be solved fast enough because how long it takes to get development off the ground.

Construction and Development
Notes:
• Steve Anderson from CityView is trying to understand the renter / consumer and better engage and communicate with the them.
• James Bloomingdale from JRK Property Holdings is talking about his IRR. He is shooting for 18% IRRs and investing in lower end markets to achieve this type returns.
• Richard Mayer from GGLO experimenting with materials and parking solutions like mechanical parking to allow for more density and units.

Mark Sanders from Fifteen Group further talks about density and the need for more density in LA. Everything move down the scale because operators are buying B product and present it as A product. This is actually a positive trend, but it feeds into the affordability issue.
As with any market, in real estate, we must consider supply and demand.

The fact remains: we are not building enough apartment buildings in LA! Currently, LA registers only 2% growth and development activity compared to other cities such as Charlotte and Nashville which are growing at 8-9% . Also, looking at case studies like Seattle that managed to stop rent growth through high volume of Development that is a great example to cities in California.

The issue is that people now think that new development doesn’t help since it is concentrated mainly to luxury product and class A product. That is not true! The fact is that the market continues to exhibit pent up demand for such product. People who cannot find it, go down market, causing over demand in those markets. In order to stabilize B and C markets, we need to immediately expand supply in the A market it will trickle down no matter what.

In addition, The affordability crunch created with lack of class B and C development. Rent growth running at 3× for class B and C product that creating even a bigger affordability issue. San Diego market lower end product is also suffering as people move down the supply chain.

1.2mm renters in LA which is 53% of renter make in the market are making under $50K another 18% or 404,000 people are making $50K to $75K of income. The market and apartment developers are missing the opportunity in the lower income and lower end product, and building too much high-end product. It is very hard to build B and C product because of construction costs and land cost; however, we need to ultimately push all type of development to increase affordability.

Sagiv and Stas from idevelop.city

Los Angeles Retailer Game Changers at ICSC Event

Looking at the evolution of retail is like chasing a moving train. So much is going in and its moving very fast.

Trends like big box shrinkage, food is the new anchor, mixed use, demographic lead by millennial, e-Tail, and the distribution revolution are changing retail.

Retail business pursue relevance and profit in a very fast changing environment. Changes like consumption, commuting, communication effecting retailers in the US now. Consumption is changing as customers are buying differently: Brick and mortar vs. Online, demand for convenient and last mile delivery.

Uniqueness of each area in retail. People want unique and better products and local products. Consumer prefer authenticity and experiences that are local and real. Consumers are tired of national chain and cheap stuff. Food is hot and LA has become the best food market in the country.

Commuting is also changing in LA. People dont want to sit in traffic forever. We have an expanding transit system and ride sharing changing commuting.

Non-emotional goods or commodities type goods are all going online whether grocer or basic goods. Retailers need to adjust to that mentality.

We are shifting from consumption to connections. More people in America do Yoga then play football. That is an example of change.

Type of retail: consumption driven and Distribution driven. Consumption is moving to experiential (entertainment and food) and blended use. Distribution driven is e-dustrial and I-tail with Last mile delivery. Malls may have a role in this and change how the big boxes on malls are being consumed by tenants.