Arixa Capital organized its 9th Annual Real Estate Investment Roundtable Discussion at UCLA on Tuesday, April 21, 2015. The event, entitledThirst for Yield, was co-hosted by UCLA Anderson's Ziman Center for Real Estate and brought together over 300 industry professionals for networking and a lively panel discussion on the state of the residential real estate market. To view photos of the event, click here.
The event was moderated by Jesse Sharf, the Co-Chairman of the Real Estate Department at Gibson, Dunn & Crutcher. The panelists included Ambrose Fisher, Managing Director of Oaktree Capital; Emile Haddad, President & CEO of FivePoint Communities; William Lindsay, Founding Partner at PCCP; Jonathan Roth, President of Canyon Capital Realty Advisors and Jan Brzeski, Managing Director & Chief Investment Officer of Arixa Capital Advisors. Sam Freshman of Standard Management Company delivered opening remarks.
The theme for this year's panel, Thirst for Yield, was fitting given that the capitalization rates for multi-family properties on the west side of Los Angeles, where UCLA is located, are approaching 3-4%.
After receiving an award for his eight years of service on the UCLA real estate investment panel, Samuel Freshman (Standard Management Company) addressed the declining yield environment in his opening remarks. Mr. Freshman said that capitalization rates in primary markets such as Beverly Hills and Brentwood are approaching bubble levels.He remarked that he is seeing ever more deals in which the seller references the pro forma cap. rate as opposed to the actual historical cap. rate. This is an indication that the market has become frothy. "Attractive cap. rates however can still be found in certain secondary markets," said Mr. Freshman, coyly adding, "But I'm not going to tell you where these markets are. You're going to have to do your own homework and find them for yourselves." Just as cap. rates have declined for income property, Mr. Freshman noted that declining yields also characterize what has become an aggressive lending market, especially for senior lenders. The market indeed appears to be thirsty for yield.
1. Following Mr. Freshman's opening remarks the panel began as it often has over the past eight years with Jesse Sharf asking the panelists to describe a deal that they felt was representative of the current market.
- Jan Brzeski (Arixa Capital) described a loan that Arixa Capital recently originated to a borrower who was renovating a home in Venice for resale. The undersized World War II era home was purchased for $1.1 million. The developer put $500,000 of renovations into the house which was subsequently sold for $2.3 million, illustrating the opportunity in luxury price point urban infill single family home development. As the lender on this very specialized project Arixa Capital feels that it has homed in on a niche asset class where investors can generate meaningful yield in a low yield environment.
- Jonathan Roth (Canyon Capital) described a $150 million senior construction loan on a condo/hotel mixed use development with ground floor retail in Miami, Florida. Ambrose Fisher remarked that the infamous 30,000 busted condominiums in Miami resulting from the financial crisis have all been reabsorbed. "It's the Latin American buyer who is fueling demand in Miami, and which makes it a unique market," said Emile Haddad. Mr. Roth said that Canyon Capital has found that the demand for construction lending in Miami is high at this point in the cycle, and they are capitalizing on this trend to generate yield for their investors.
- William Lindsay (PCCP) spoke next, describing a condo development in downtown Los Angeles on which PCCP is the lender. Mr. Lindsay remarked that this is PCCP's first investment in downtown Los Angeles in 25 years. He joked about how the inevitable revitalization of downtown can be evidenced by the opening of an artisanal jam shop on Spring Street. PCCP is finding yield in this environment by betting on the growth of downtown L.A. Mr. Lindsay added that they are rooting hard for the developer of the condominium and the jam shop.
- Emile Haddad (FivePoint Communities) has been active developing the Great Park Neighborhoods, a 2,000 acre mixed-use master planned community in Irvine, CA since before the financial crisis. In describing a deal that is representative of his market, Mr. Haddad said that he recently sold 1,000 lots entitled for single family home development, all above peak price, to 10 different homebuilders. Mr. Haddad went on to explain that of his finished homes, 75% of the buyers are from places like China, India, and the Middle East. Mr. Haddad said that the number one reason that these families buy residences in California is to access the public university system for their children. He also said that these foreign nationals are looking for a safe haven for their capital and residential real estate in California is seen as such a haven.
- Ambrose Fisher (Oaktree Capital) spoke next describing in general terms a strategy employed by Oaktree to generate alpha in a low return environment. Oaktree will purchase properties with low occupancy rates (65%) in secondary markets. Their target capitalization rates for these types of properties is 6%. Oaktree will then create value by improving the properties and increasing the occupancy rate
2. Mr. Sharf asked the panel how opportunistic they could still be given the amount of distress that has been removed from the system. Mr. Lindsay said that $100 billion of distress still exists. Often this is a result of ongoing litigation which keeps the properties in a distressed state. As the litigation is resolved real estate investors can opportunistically find distressed product that is still left over from the financial crisis. Next the panelists were asked if there was too much capital in their respective areas of investment.
- Mr. Brzeski answered first by saying that the business of Arixa Capital has evolved over the past couple of years. Whereas the company used to lend to opportunity investors cleaning up after the housing collapse, Arixa was now lending to what he dubbed "micro-homebuilders." This evolution is partially as a result of institutional players such as Oaktree and Blackstone pushing capital down into the single-family home private lending space. This has pushed yields down for loans that fit certain standard criteria and are easily underwritten en masse. Arixa has been forced to differentiate itself by lending outside of the standard box by providing larger loans, more personalized service, and customized financing solutions, such as construction lending.
- Mr. Roth described Canyon Capital's strategy in much the same terms, but for a different asset class and on a different scale. "Canyon differentiates itself from its competitors by being able to provide complex capital solutions for complex deals," said Mr. Roth. Mr. Roth added that there is more competition for more standard sized deals, which he defined as less than $75 million. "For deals above that threshold," where Canyon often plays, "the competition really thins out," said Mr. Roth.
- Mr. Lindsay supported the notion that for loans that fall outside of the box lenders can find yield. On the flip side, borrowers who require outside of the box solutions are having difficulty finding capital partners. Mr. Lindsay said that PCCP was finding that there were not many, as he described them, "bank-plus" lenders. Mr. Lindsay was using "bank-plus" to describe loans that almost meet banks' strict lending criteria, that pre-crisis would have been approved by loan officers, but that post-crisis are rejected. Mr. Lindsay thinks that the international regulatory framework of Basel III is having a major impact on the availability of these types of loans. "For loans less than 40% LTV you'll get 25 bids from banks. For loans from 65-75% of LTV you might get two bids," said Mr. Lindsay.
- Mr. Sharf then asked Mr. Haddad how FivePoint Communities was capitalizing their deals. Mr. Haddad said that pre-crisis, capital came from traditional sources, equity coupled with debt and Lehman Brothers as the lender. Subsequent to the financial crisis, FivePoint Communities was spun off after Mr. Haddad's company Lennar went through a major restructuring. Today capital is coming primarily from the cash flow of the assets themselves, as lots and homes are sold. Mr. Haddad said that he is also using debt financing, but not from traditional sources. "Lenders are not active in the homebuilding space," said Mr. Haddad. As an alternative, FivePoint Communities has raised $300 million in EB5 money at a cost of 4%. EB5 is a US visa that offers a path to permanent resident status for foreign nationals who invest at least $1 million in the US and create at least 10 jobs. Mr. Haddad said that while the EB5 capital is cheap and available today, he is concerned about relying on this program too much to finance his business. The reason for this concern is that immigration programs are vulnerable to reactionary legislative initiatives and that the EB5 program could easily be eliminated by Congress. Mr. Haddad said that if there is one terrorist act committed by an EB5 beneficiary, the whole program will have a dark cloud.
3. Mr. Sharf's next question to the panel was about the millennial generation and the notion that unlike their parents, they no longer view homeownership as a rite of passage.
- Mr. Fisher said, "Believe it or not, millennials want to drive cars. They are going to want to have kids one day. And one day they will want to buy homes, just like the rest of us."
- Mr. Haddad echoed this sentiment saying that one day these kids will become their parents and will want a family and yard of their own.
- Mr. Roth, while agreeing that millennials will one day buy homes, said, "Right now, they are sitting on the sidelines delaying that decision. This has the impact of keeping millennials in apartments." Mr. Roth continued by saying that this increases the demand for apartment units, increases rents, and contributes to high apartment building valuations. One reason for this dynamic, the panelists agreed, is that in Southern California home prices are unaffordable for most millennials.
4. Mr. Sharf switched gears with the next question asking about the impact of crowdfunding on real estate. Crowdfunding is the practice of raising capital for investment through a website that is open to the public. The purported benefits of crowdfunding are that it makes it easier for deal sponsors to raise capital, which lowers the cost of capital, and at the same time crowdfunding gives investors access to investment opportunities they otherwise would never have been exposed to.
- Mr. Brzeski said that crowdfunding is becoming a legitimate means through which to raise capital. He cautioned however that many of the existing platforms are being managed by technology people who lack the real estate background to make sure that the deals on their websites meet certain standards. Mr. Brzeski feels that crowdfunding platforms have a responsibility to protect investors from poorly conceived investments by evaluating the investments on their sites and making sure that the deals meet minimum criteria.
The panel ended with a few closing remarks and words of wisdom. Mr. Fisher cautioned investors that as the market approaches a top it is important to become more and more conservative in one's evaluation of opportunities. Mr. Haddad closed by saying that if you do find yourself in trouble, go ugly early. He credited this approach with mitigating losses during the crisis, and positioning FivePoint Communities to be successful following the crisis.
Arixa Capital thanks UCLA and all of our sponsors for helping to organize this successful investment roundtable event. And of course, thank you to all of our attendees. We hope that you found the investment roundtable both educational and enjoyable and hope to see you at one of our future events!