Industrial Insights with Rob Quarton

Rob Quarton 00:36

Likewise.

Rob Quarton 01:09

Yeah, I appreciate the time Justin. It really means a lot to get the invitation to come on here and talk to you and your guests, your tribe, and look forward to giving some insight. Like you mentioned, I work with Walker and Dunlop. I've been over here. Little over seven years, almost eight years, and I focus on the financing advisory brokerage side. And we work with investors and developers to help them find the complete capital stack, starting with the top of the LP equity all the way down to a bridge loan or construction loan. More often than not, it's a development deal or a value add kind of renovation, but we also work on kind of more stabilized products, whether it's industrial, multifamily, retail, and a couple their product types. you know it's a good time to have this conversation because things are dynamic and I think they're shifting, momentum is building to really kind of take us in a more positive direction as we close out this year and then carry over into 25. It does, looking at some of the data that Q1 24 of this year appears to be kind of the bottom and things are gaining momentum anecdotally and now the data is certainly supported so it's refreshing. Hahaha!

Rob Quarton 02:28

You're right. Yeah, me too.

Rob Quarton 02:39

HULK!

Rob Quarton 03:29

Yeah, that's a good avenue to have a great conversation. Starting in 20, early in the year, I remember launching some assignments and was quite optimistic about ability to get him down. There was a large land portfolio that we launched at the time and then there was a couple other development projects. then I actually was getting ready to have a kid at the time in March and then the world kind of turned upside down. And really, especially in California, things stopped for a good quarter or so. Things were unfolding. People were hunkering down. Capital markets stopped. Thankfully, there was a lot of money in the system. It's just at the time it was scary and it caused a freeze of sorts. But as we approached the summer, things really started to thaw and then starting called probably July or August. That was one of the busiest moments of my career. It's just you talked about the floodgates opening. I the money just came roaring back. Interest rates were ultra low at the time. And for real estate, because we're so heavily dependent upon it, that just made amazing levered returns, cap rate compression. and it was quite a wild ride. And then housing along with industrial really accelerated at that point because people either wanted bigger houses, were moving, families were moving around, there was remote work and so that caused a lot of flow. And then industrial just tremendously benefited from people having discretionary income savings to buy online purchases, e -commerce, really, etc. at that point because in certain states you couldn't even buy in person. And so that all really accelerated those two trends. And then on the flip side, the recalibration of certain product product types, retail and office was accelerated. So you have one that, you know, a couple of classes that really benefited and then others, it just, it caused a, you know, a really big dramatic shift. But then from, you know, late 20 to early 22, I mean, looking back, that was one of the more dynamic periods, at least in my career. I'm not, you know, I'm not the youngest guy in the room anymore. And I'm not, you know, I'm not the oldest one yet, but I've seen a few cycles at the this point and it was a fun ride. a lot of folks benefited from it. then, you know, thankfully, this last two years, it's been more of a I've heard the term the great rate reset where, know, because of real estate heavily relying upon interest rates and then, you know, there in some instances, if you had a floating rate deal going up three X in your rate, that has a big shock to the to the system. But, you know, at the same time. for the most part, if you owned your property for a couple years, that the operating fundamentals were still pretty decent. So at least at the NOI operational level, you had some good strength there. Not to say that it was easy, but that at least gave you a competitive mode or a ceiling to really ride through that tough period. And it appears now that we're going through... you know, another period of rates and lending improving. I the treasury rates peaked around four and a half this year in June, the end of June, and now they've gone down tremendously. The 10 -year treasury to around, it was closed around 380 today. And then the dominant floating rate index is SOFR, and that peaked at about 5 .35, and that's already started to go down, and it appears that it's going to approach four next year. So, you know, the economy still seems relatively healthy. It's expansionary, mild inflation, hard assets do really well in that environment. And so that, you know, that gives a great backdrop as rates improve for real estate to perform pretty well over the coming years. And you saw it at the very top level, some of the big institutional money starting to take down portfolios or buy REITs. And so that all starts at the very top mega public level. It's filtering down to the large. private and then in the middle market regional trades you're gonna start to see that permeate as we end this year and next year and so you know talking to folks it's still cautious optimism but that that's building and then you know new listings or whether it's a sale or at least that that's starting to build momentum and it's just it definitely has a better environment and 25 should be a lot better.

Rob Quarton 08:11

Right. Hahaha

Rob Quarton 08:34

Mm -hmm.

Rob Quarton 08:46

Mm -hmm. Yeah. Great question. Great point. Our clients are reaching out or even proactively following with them. And then, you know, that's actually been a good avenue to establish new relationships with folks to try to find solutions for some of their problems. And, you know, we'll sit down and holistically advise them. You know, does the path make best sense to negotiate with their existing lender? You know, what does it look like if they want to go refinance? And then even sometimes, you know, we suggest to maybe a sale path or a dual track process might be the best for them. because, know, Walker & Dunlop is one of the top financial services lenders in the countries, we have some really deep relationships with the top lenders and equity providers in the country. So not only can we access the key people at the regional level when need be, we can get directly to the important decision makers. And we pride ourselves and give them candid advice, even if it, you know, in the long run. it's to benefit them and you know if there is in the short run a way for us to kind of get some business you know and we want the best outcome for them and so we went through a very detailed process earlier this year and it ultimately came to it to do an extension there you know there was a pay down with the loan but at bottom time it made the debt service more manageable they really believed in the sub market and the metro in the long term it was in Texas and you know They found a good outcome to give them some runway for two more years to let the property performance. And then hopefully the valuation of the capital markets to come back. So there's some value recovery there.

Rob Quarton 10:59

Yes. Mm -hmm. Exactly.

Rob Quarton 11:26

Mm -hmm. Because a lot of our activities tied to deal acquisitions or acquiring land, acquiring new properties with the volatility and rates, because it hasn't just been a steady up or a steady down. It's been all over the place.

Rob Quarton 11:48

Right? Yeah, no, still cranking away. But when there's big spikes or up or down, it crazes a shock. And that's when we saw pauses to activity because it kind of paralyzes people, for lack of a better word, in the short term. And it seems like it took about 45 to 60 days to kind of absorb the magnitude of big volatile swings. But we've been in a good environment of relatively down in rates over the last quarter. So I think that has been helpful. You know, we talk about a lot as the amount of dry powder in the system. And so that that's capital is ready to be actively deployed, whether it's it's private equity capital and value add and opportunistic funds raised. There's well over one hundred and seventy billion in those two sectors, and they have not been actively deploying money over the last couple of years. And so, you know, they get paid to place money and that money is going to it has a weight that needs to be put into work. And that that's only going to gather further momentum to the market as the year ends and you know lenders still you know thankfully you know you hear office headlines and distress but for the most part that's a small part of the portfolio and lenders have a pretty healthy loan portfolio and even talking to some over the last just last 30 days that the market's been improving from a financing perspective when they're starting to get payoffs so they've started to become more aggressive to replace those previous loans and create new loans. And so, you you put all those factors together, you know, it's creating a lot more activity. You know, talking to some lenders, I remember, you know, about a week ago, I talking about an assignment, and he was saying over the last 30 days, his activity is up over 30 % on new deals, kind of inbound reviewing.

Rob Quarton 13:38

those haven't converted to closings quite yet, but that's the leading indicator. So, real estate deals take a long time to close. So in about 90 days, you're going to see all that start to lead to closings. And then that's going to create kind of the herd to start to move to activate and transact, which we'll carry over into Q1 next year.

Rob Quarton 14:01

Yeah. All right.

Rob Quarton 14:41

Correct. it's usually our point in the year that this is the last push that you really need to get something under an LOI or a term sheet sign because it takes, right.

Rob Quarton 14:56

Great. New Year's is going to be here before it. It's going to be, you know, had Halloween's coming up and it's Thanksgiving, the end of the year. And then just people start to get a little bit distracted. And if you don't start to sign up something now, people start to hunker down on those key things that are in front of them. And it gets more difficult, not impossible to get new business effectuated. But, you know, we have a major election coming up, a little bit of geopolitical uncertainty that's going on. And

Rob Quarton 15:26

know one thing to do is you know what type of strategies do you put in place to kind of insulate yourself from some of that volatility? And one you know a couple things that we like to suggest is if you can always give you put structure in contingencies for time whether it's a longer escrow for purchase or maybe an extension with the lender you know something that if you need it it's great to have that structured on the front end because you know stuff happens Murphy's law.

Rob Quarton 15:55

And then whoever you're dealing with, if you can, whether it's a landlord or lender, equity provider, know, now is probably a time to gravitate to best and breed well -capitalized folks. So, you know, in those environments of uncertainty, the best in class tend to navigate it a little bit better. So hopefully, you know, that can help you ride. If there is a wave or something that comes up that, you know, you're not going to be knocked over from it. And then if you can, you know, structure teams that have continuity, that have worked together. We're going through a closing right now and the lender has their counsel and then our client has their counsel. We tried to make sure that they worked on deals before or that type of financing, because if they're starting from scratch and in a stressful environment or potential stressful that's when things can really hit roadblocks. So the much that you kind of can put those contingencies or tactics in place it's really going to benefit you to navigate a lot better.

Rob Quarton 17:01

Right? Mhm.

Rob Quarton 17:39

Right. The two dominant ones the last few years have been industrial and multifamily. Whether it's lenders or the equity providers, those have the strongest secular themes behind them in performance. In both, they're going to continue to do well over the medium to long term. you have an industrial, you know, depending on the pocket pockets in the markets and sub markets, there's more supply issues. But, you know, what we are still seeing, if you look at like a Phoenix or Vegas, there's still leasing velocity going on, thankfully. And it's there's just a lot of deliveries. then, I mean, it's amazing. Yeah.

Rob Quarton 18:55

Yeah.

Rob Quarton 19:20

Right, that's a good point. know, luckily a lot of those, the bigger deals, they're put together by some pretty substantial players. And so, you know, they have the resources to probably hold a little bit longer than maybe some of the more entrepreneurial type developers. you know, thankfully, hopefully we look back at 24 and that seems to be the, again, that I hate to beat the dead horse, but the trough of the activity and leasing activity, people are going to start to, you know, the fact has been started to lower rates economy is still doing well hopefully that gives users tenants the conviction to start maybe investing in space or new space or renewals and that that can pick up the velocity and you know looking because we do a fair amount in southern California but we go across the countries on the deals that we capitalize a fair amount in the kind of southwest kind of western areas but a lot of the lenders and investors always look okay yeah there's a lot of supply but what's that relative to the existing base. And thankfully, you're right, exactly, especially in Southern California. But if you look in other markets, that number is bigger. It could be 20 or 30 % of the base.

Rob Quarton 20:44

Right, exactly. But I think as we get into next year and then even in 26, industrial is still going to perform strong. The multifamily has some supply issues in certain markets, but it's still absorbing. It's just the landlords, they're having to offer more concessions to get the lease up. But they are leasing up and they're occupying and then those concessions will burn off because both in an industrial and a multifamily, starting this year, there has not been a lot of new starts at zero depending on the market. And so, and you know, the tenants still are occupying space and if the economy continues to thrive, absorption will happen. And when there's no new supply, then the demand driver shifts the other way and then the landlords get the pricing power again. And so, you know, we're starting to see and think next year could be a good time to have, you know, a better environment to capitalize new development deals.

Rob Quarton 21:47

And so that I think that that's one thing that's going to start to shift next year and already starting to in the fourth quarter this year. A pleasant surprise and other asset class that's really come back strong is retail and shopping centers, grocery and good centers, unanchored center, neighborhood centers. know, class A malls have done OK. know, lower quality malls, maybe not quite as much, but just the retail ecosystem in general has really performed well. We talked about COVID earlier. Pre -COVID, retail was kind of going through a recalibration. Online e -commerce, you know, probably built too much retail the previous couple of decades. And so there, there was some, some shifting, but it has emerged in a lot of markets. Occupancies are super robust in the mid to high nineties. Tenants are expanding. Rink growth is prevalent, especially in coastal kind of California, Southern California, even other markets. And so. that started to attract better capital from lenders and equity. And so that is, I would say, a close second tier of asset class that has a desirability. And then they have other things like self -storage and other kind of maybe good quality hotels like limited service or strong destination travel luxury kind of hotels. Those are performing well.

Rob Quarton 23:13

The office is is is challenging, it does appear maybe that we're we're starting to go back the other way, or at least near a bottom. There's the return to office.

Rob Quarton 23:26

Right. Yeah. But the big question the last couple of years is, know, what's a natural stabilized occupancy? And nobody had a good question to that. it appears that maybe it's they're getting better ideas of what that might be. then employers throughout all this employers, think consensus is employers would rather have their people in office and not. if. Yeah, I'm in the office. Yeah.

Rob Quarton 23:54

And you know, humans are social creatures in nature and when you have a fast moving environment or new teams or active in person communication is critical. If you want to grow your team, your colleagues, that's another key component. It's hard to replicate that via Zoom or conference call or whatever. But the point being is that the big corporate employers are starting to have more of a call back to office. Amazon made that big news. There's others that are. I would be surprised if you ever go back to five days a week, but I think around three to four is probably what people will adjust to. And you still need the same amount of office space on those days. And so I think you're gonna see that over the next coming years getting a better performance spot and kind of have a swing back up. Still takes some conviction and some probably some private capital to get those deals together but it you know I think there's better days ahead for office properties.

Rob Quarton 24:57

Yeah. Right? Yeah. Mm -hmm.

Rob Quarton 25:30

Yeah, thankfully one more comment there is that some of our clients, own properties. The last big development boom, at least in Southern California, was probably in the early 2000s, mid 2000s. And a lot of those initial kind of junior anchors, maybe it was like a Ross or Home Good or something, you know, good quality tenants, they had longer term leases. Maybe they had a 10 and then they had three or four or five year options after. All of those are starting to roll and those embedded leases are substantially below market. so, you know, market rents have moved a lot and there's a lot of value creation there because they're moving those tenants to market now. And you're seeing the next rung of value in the step up there that's really benefiting the

Rob Quarton 26:17

Right. Yeah. Yeah. So. Yeah, on the financing side, what we're seeing a lot of folks implement potentially, if they're more attracted to a fixed rate execution, is implementing a payment of points or paying fees to buy down the rate. And then that allows them to maximize the loan and have a better debt coverage ratio. So if you paid 1 % in a five -year loan, that, know, plus or minus, that gives you about 0 .24 or discount to the rate that improves your debt service coverage ratio and then nominally you're going to be able to push proceeds. And so that's a tactic folks are using and you can capitalize that amount into the deal. Still gets you better net proceeds, lower debt service. It is a way of prepaying the debt service, but it allows you to get some better leverage returns. And we're seeing that implemented from multifamily to industrial to, all types of lenders, whether it's a a life insurance company, an agency financing Fannie Freddie with a multi -deal, or even it's very popular CNBS too. So I'd say that's one tactic.

Rob Quarton 27:51

Yeah, you could use that for a smaller medium or large balance loan. You can kind of implement that across the board. Another structure. that we're seeing is if it is a floating rate deal, folks, and it's a new floating rate deal that may be doing an in the money cap, an interest rate cap, which would be, it's how you would set the SOFR rate. And so, you know, today it's around, 4 .9%. Maybe you want to buy a SOFR cap that's at three and a half, and that will tease your rate down. Interest rate caps have actually gotten a lot cheaper once the Fed has made the pivot. and the rates are escalating. And so that could be another way to make your debt service lower. And then also if you're using a floater rate, typically the prepayment penalty or prepayment structure is more flexible. And so if you had a medium or shorter term plan, that might be a way for the owners to either refinance or to sell it without that penalty in place.

Rob Quarton 29:05

Right. It fluctuates based on interest, you know, future trading. So, you know, what's the movement on treasuries? What's the movement on so for and so that it's a very dynamic and a very large market. You can go to third party providers who you buy that for. You know, personally, I like pins for a lot. Jay them is another one. They have pricers you can put in there on a two year loan. for like a spot cap. think the last time I priced it was around 20 basis points that you would add. 12 months ago that might have been closer to a point. So it has thankfully the the cost load that's add to financing if you're required to do it or wanted to do it, it's gotten a lot cheaper because they perceive in the future the rates are coming down and so that that risk is less and so therefore it's being priced a little bit cheaper. So that's one tactic. Another one too that we found pretty effective. for kind of medium, middle market size deals is using a participating debt structure. And it's kind of a hybrid debt equity structure. It can go up to 85 to 90 % of cost. And this would be for a value add or development deal. And then it has a pretty effective fixed rate interest only to carry out your business plan. And then they go, the lender takes a participation at the profits. upon sale. One of the nice features, Yeah. Yeah. But I mean, it gives you leverage, which is nice. And then the fixed rate during the execution of the business plan is a lot lower than you would pay for even a

Rob Quarton 30:59

more traditional leverage or a bridge loan. So it doesn't put the pay current rate on the deal. It puts a lot less financial pressure. And so you don't have a high rate while you're trying to execute the plan. So you can navigate them. know, stuff happens over three to five years. And so that's nice. And then the participation is not too, you know, too high. And then the levered returns to the sponsor can be really accretive. And so if, feel free to reach out to me if you want more details, but it's a really effective program we've been implementing over the, during this rate reset environment.

Rob Quarton 31:47

All right. Mm -hmm.

Rob Quarton 32:08

They are. really over the last 30, or so, the leverage has been improving. A lot of that ties to what's the stabilized debt service coverage ratio or debt yield. And now that...

Rob Quarton 32:29

Correct. There you go. Because they take whatever the loan amount, the lesser of the loan amount amongst these various tests, whether it's debt coverage or loan value or debt yield. But it has been because even with cap rates rising, the debt service has been a little more to the sizing because rates have been a lot higher recent. of history. But with rates coming back down, that's allowing the LTV to kind of float back up. you know, on a newer CNBS financing today, you know, for a while there was hard when rates were higher to get much above 60 percent unless you had a really high cap rate. But now it's not too uncommon to get closer to 65 or 70 and still maintain a full term interest only there. But then even going across the spectrum to a life insurance company loan, which typically is kind of more moderate leverage levels. you know, with kind of peak rates, you might have seen LTV, you know, 50 to 55%. Now it's not too uncommon to say 60%, maybe even 65, depending on what the NOI sizing kind of looks like. So you are in an environment where leverage is starting to go back up, rates are dropping, good quality.

Rob Quarton 33:55

Yeah Correct. Yeah, financing leverage it is. So, know, that's a good segue into what rates might be today for a good quality industrial project. know, max leverage insurance company financing is probably going to be somewhere between 170 to 190 over a treasury. And so if you added that, that's in the mid fives rate financing, you 5 .3 percent for a good quality industrial deal. If you're paying a six cap, you know, that's some positive financing leverage there, which is can be helpful to the leverage returns. You're seeing that multifamily to some degree as well with the rates sometimes approaching in the mid to low fives in the current environment. And then it travels through to the other sectors to retail, sometimes hotels. And then definitely it actually is there in office because office cap rates have gone up so much. So that's a good environment there. Leverages come up, rates have come down for good quality sponsors and for properties. Lenders are willing to compete because they want to try to get those monies out the door. so that all around, it's a lot better than it was 12 months ago. I'm not going to say it's ever flowing, but it is, again, it's getting into an environment that's increasing. Another trend that we're seeing is from 20 to 22 banks were like the dominant provider. real estate capital. It's, you know, it was close to 50 % market share. Last year, there was some trouble in the banking sector, know, Silicon Valley Bank, some other bank failures and that really pulled back. Right. Yeah. And at that time, because their balance sheets were under distress, there were, there was a theme that emerged that they wanted deposits to, if you wanted to get a new loan for them. And then it was peaking at 20 % of the loan amount. That is backed off in the banking sectors.

Rob Quarton 36:04

know, they still some will try to push to get that deposits but it might be five, ten, maybe fifteen percent on our construction loan but it's gone down from that peak which helps because just you know real estate investors and developers they want to put their money in their deals because they get great returns and that's their business they don't want to keep it in cash and give it to a bank so it's nice to see that trend go back the other way.

Rob Quarton 36:41

Mm

Rob Quarton 37:05

There you go. They are. We're actually in the, I'm in the market right now on a construction kind of request. again, that's another theme of leverage has started to come back up for a period of time, kind of in the peak kind of movement in rates. was, it was getting difficult to get to, you know, 50, maybe even 55 % leverage on a construction loan for multi -year industrial. That is definitely creeping back up towards 60, maybe a little bit higher in certain circumstances. Banks are still available to give that financing. They're going to probably gravitate towards maybe existing clients or best and breed developers to attract that, but that's still an avenue. But what has emerged is insurance companies stepping up to kind of fill the void. Some of them have historically had a product that was a construction to a perm where they allowed the developer to build it and then

Rob Quarton 38:15

converted to a fixed rate kind of perm loan. Now they've developed products where it's just the construction phase called a two to four year financing, which is more akin to what the banks offered. And it doesn't require deposits, which is nice. And then it's typically non -recourse or maybe just a completion guarantee. And so that has been.

Rob Quarton 38:47

Correct. Yeah, you know, it depends on the developer profile. If it's a developer that likes to build and hold for the long term, that makes a lot of sense. Others that are more merchant in nature where they want to build at least it sell it and get the pop. Having that perm feature is not quite as important to them. Or, you know, some people might want to capitalize on the ability once it's leased and, you know, maybe rents are better or just, you know, it's at that time or maybe the financing markets is to, to use that, that future point in time.

Rob Quarton 39:18

to go to refinance the property and take advantage of it then.

Rob Quarton 39:27

Correct.

Rob Quarton 40:02

Yeah. You know, couple thoughts there. You know, one is a kind of a sports metaphor is to, you know, to hang around the hoop, go out there, keep talking to people, talk to folks like yourselves that have active access to deal flow, maybe dust off old deals that they looked at 12 months that didn't make sense then because they're starting to make a little bit more sense now and stay in the flow because I just get a sense of been through a couple of cycles and stuff shifts, it shifts quickly. If you're prepared to jump and you're active and in the market, you're going to be able to take advantage of that. So I think that.

Rob Quarton 40:47

Great. Yeah, it's amazing how quickly it moves. So that would be one that I would definitely be positioned for. And I'm trying to think if there's any others. That's the one that I think that comes to mind the most.

Rob Quarton 41:18

Mm -hmm. All right, yeah. Hahaha.

Rob Quarton 41:40

Yeah, it's been an amazing organization. I first got involved in the mid 2000s. Earlier on in my career, was actually when I was at GE Capital at the time, went through their young profession. Yeah, I know. That's a legacy name now. They're not even around anymore.

Rob Quarton 42:00

But it got involved in their young professionals group, a year long kind of leadership group. that was an amazing connection and in training, got some really great relationships through that and soft skills development. And then got involved with the board, their board, and then eventually moved on to get involved with the greater Southern California chapter board. I've been pretty involved with the night of the fight.

Rob Quarton 42:29

Yeah. Yeah. Tim Campbell is amazing. actually I had coffee with him not too long ago to catch up, but, and Then there's been night of the fights, which is an amazing event that's coming up on, October 10th for those that you can still get your tickets, but it's, it's well over a thousand people. It's now at the Orange County fairgrounds and it's like the premier networking and fun event to see top people in the industry. Rekindle old relationships, make new ones and really have an amazing night. So that's been fun. I've been involved with that for the past 10 years. And then the last two years I've moved up to be part of the greater kind of executive board and helping kind of guide the various kind of groups and functions and working with the good leadership group that's put in place there. But it's, I mean, it's no better organization, particularly for industrial and office. There's other product types too that are involved, but the opportunity to. network with folks, get good lariationships. It's very active on the legislative side, particularly for industrial right now and what the state sometimes or even federal laws that they're trying to put up roadblocks for us in our industry. But it's an amazing experience and encourage anybody to get involved and happy to answer any questions if folks want to learn more about it.

Rob Quarton 44:05

Mm -hmm.

Rob Quarton 44:24

Exactly. Right. Yeah, I appreciate the time. It's a good conversation to talk about the various segments of the market and the momentum it's building, the optimism. then if folks are ever interested, our team puts together a monthly newsletter, The Structured Buzz, that gives us the trends, some insights, usually a cool chart or two on what's going on in the market. So feel free to reach out to Justin or myself. And we're happy to share that with you.

Rob Quarton 45:13

The Walker webcast.

Rob Quarton 45:36

Exactly. Yeah, it's some good lessons and it is entertaining.

Rob Quarton 45:45

Thanks Justin, take care.