Odd Lots - The CEO of a $1.4 Billion REIT Explains The Surprising Year In Housing

Episode Date: August 24, 2020

When COVID hit, people had visions of a plunge in home prices and a massive wave of evictions. So far, that largely hasn’t played out. On this episode, we speak with Ivan Kaufman, the CEO of Arbor Realty Trust, a $1.4 billion player in the real estate finance market, about what’s going on, and how the industry has weathered the storm.See omnystudio.com/listener for privacy information.

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then bring you the best conversations in our daily podcast. Search for Bloomberg Law on YouTube, Apple, Spotify, or anywhere else you listen. On the East Coast, listen as you start your day, and on the West Coast, catch up in the evening. That's the Bloomberg Law podcast with me, June Grosso. Subscribe today wherever you get your podcast. episode of the Oddlots podcast. I'm Joe Wisenthall. And I'm Tracy Al-O-Wa. Tracy, one of the really interesting things about this crisis is that the real estate market hasn't exactly behaved as one might expect during a typical downturn. We have sort of depression levels of unemployment, a major plunge in economic activity, and yet not all aspects of the real estate market have

done badly. Yeah. I guess it depends. on what you're looking at, right? So housing or residential housing has been surprisingly resilient. You know, some of the stimulus has helped people actually stay in their homes, keep up with the mortgage payments. In some places, we're actually seeing a housing boom. But if you look at the other half of real estate, which would be commercial real estate, there are a lot of concerns out there. Right. So if you're a retail landlord in New York City, you have a lot of ground level tenants, that's probably trouble. On the other hand, if you want to sell your house in the suburbs, this is an amazing time to do it. And of course, it's further complicated because there have been all these temporary moratoriums on evictions for certain types of renters. There's also been the stimulus, which has allowed people who haven't had jobs to main a good degree of their income. And so that allows people to pay rent, lots of just weird moving parts, unpredictable nature, things you wouldn't just expect to see during a typical

downturn. Yeah. I mean, moving parts is the right way to describe it, because one of the interesting things about the real estate market is all of these things are interconnected. And if one person gets debt relief or some sort of moratorium on paying their rent, it means that a landlord out there is missing out on some sort of income, and that can have knock-on effects for things like the banks. So it's not that easy to say, well, everyone's not going to pay their rent or their mortgage for the next few months. That leads to strains in other parts of the system. Yeah, exactly right. So in theory, it's great to have temporary halts to moratorium, to evictions and to foreclosures. And that's actually arguably been a big part of why

the recovery hasn't been slower, why we have had this economic recovery because people who are out of a job have had more spending money, but it creates all kinds of issues. And obviously, long term, what we need is genuine economic recovery and jobs and income. So today we're going to break down what's going on in the real estate market with someone who really has a great view on all these moving parts. Right. Let's do it. All right. So I want to bring in our guest for today. He's Ivan Kaufman. He's the CEO and chairman of the Arbor Realty Trust. It's a publicly traded reed on the New York Stock Exchange with a $1.4 billion market cap. And they're in all different areas of the real estate market. So Ivan, I want to bring you in. Thanks for joining us.

To get us started, why don't you describe the different areas that Arbor Realty plays in? Sure. Well, first, let me give you a little overview of Arbor Realty Trust, where a mortgage REIT with a primary focus on multifamily assets. We originate loans for sale to Fannie Mae and Freddie Mac on the multifamily side, and we provide bridge lending, and we have about a $5 billion balance sheet. And very fortunately, 80 to 90 percent of the business we do is in the multifamily sector. And as everybody's been reading, the multifamily sector has really outperformed almost all other asset classes. And that's really a result of a lot of factors, of course, the CARES Act, which will touch upon later on, and the supplemental payments have allowed the renters to continue

to make their payments. And the positive domino aspect of that is when they make their payments, people make their mortgage payments and the system works. So that's been a very, very positive aspect of what's taken place on the multifamily side. With respect to other asset class participation, You know, we'll get into that a little bit later. But, you know, the office market, the retail market, industrial hospitality, those are other asset classes which we participate in, but to a lesser degree. Well, can you give us some color on how that sector has actually been doing over the past few months? I know you're primarily invested in multifamily, but what have you observed in retail and commercial real estate in the particularly troubled sectors? So just in terms of total perspective, the commercial real estate market is about a $14 trillion market. And the, you know, I look at it as winners and losers, right? And, you know, looking at the pandemic and the recession, there are winners and losers.

And 60% of the market has been on the winning side, meaning multifamily, single family rental, and industrial. So those have been the real positive asset classes, and that takes up about $6.5 trillion. The other asset classes, which everybody understands is going through a real struggle, and some of those asset classes were going through a struggle, you know, pre-COVID or retail and hospitality. They're suffering dramatically, as we know, the leisure and travel business doesn't really exist. it's going to take a while to recover. That industry is suffering and will take anywhere between six to 12 months to get back on its feet. Some of the government programs have helped those operators at least maintain some of their staffing. Then you have the retail sector, which is going through

a total dislocation, was suffering, and not sure how that will get reshuffled, but it will have an adjustment. And then the most talked about market is, of course, there's the office market. And there were a lot of opinions on the office market because you take a look at the urban markets, which are definitely going to suffer to some degree. And then you have the suburban office market, which is starting to boom. And everybody's going to focus on, you know, what does behavior look like, you know, post-COVID? Is there going to be more remote working? Are people going to be living in the suburbs?

And our business is going to be opening up satellite offices. But I don't think the impact on the office market will be as tremendous. is many say in these urban areas. I think there's still a lot of demand in in these urban areas. It'll suffer, but not to degree that people are speaking about. So when everyone talks about some new work from home future and everyone living in the suburbs and nobody wanting to commute, your sense is that that's just over extrapolation from the moment? I think there are going to be a lot of behavior changes in terms of patterns. there are going to be a lot of people who move to the suburbs and they commute to the city maybe twice a week or three times a week and they, you know, work remotely.

So you're going to have some of that. You're going to have, you know, some of the suburban office expand their footprint. But totally working remotely from home, I don't think that effectively works. I think it's going to be more of a variable setup where it'll be a mixed bag. And then you have the offsetting factor in these urban areas where I think you're going to have to change the density. So even with a reduced footprint of workforce, you're going to have to have a larger footprint per individual. So there'll be some level of offsets. So maybe there'll be some shrinkage, but not to the degree that people are speaking about.

I wanted to dig into some technicalities of the real estate market. So I was reading, I think it was Morgan Stanley. and they had transaction volumes down by, I think it was 73% year on year in June. That was the last estimate I saw. But if transactions have fallen off a cliff, what is price discovery like right now? That's a tough one. I mean, there are no transactions being done in the retail market and the hospitality market. And certainly the office market is almost a standstill.

Price discovery will come out in the next 60 days. That's also was impacted to a large degree because of the lack of liquidity. When the crisis hit in mid-March and April, the markets were fully dislocated, except for the multifamily sector. There was absolutely zero liquidity. So as liquidity returns to the market and as transactions begin to get in place and people understand or start to calculate what the impact on retail leases are and office leases and the hospitality, you'll see some level of price discovery. But I think we're probably,

you know, 60 days off before you start to see a flow or the beginning flow of transactions. Is there some, when you say 60 days, is there some specific date or catalyst you have in mind or is that just your sense of the timing of the market? Well, the first is liquidity was gone. it's returning to the system. So you need liquidity to begin to have transactions, and that's starting to normalize. So that was the first step. The second step is getting a handle on, you know, the return to employment. The eye of is, is COVID going to dislocate employment for another three months, six months, nine months, 12 months. And as we're getting to see the light at the end of the tunnel,

and if it's nine months down the road, people will start to understand or predict what the behavior will be. We'll travel, come back, and to what degree, and then they'll start to do transactions based on having good data. I don't think it's that far off. So in the intro, we sort of described the real estate market as a machine with many moving parts, and if one of the cogs gets clogged up or stops working, that ends up having an impact. on another part of the system. Can you walk us through what exactly happens when tenants start to

roll off? Sure. So let's talk about that aspect of the domino effect, right? If the CARES Act wasn't in place and people who were renting individual units couldn't pay their rent and then the landlords couldn't pay their mortgage, the domino effect would be a large number of defaults. And on top of that, there'd be no liquidity in the market to continue to buy transactions. And then the securitization market would come to a halt. So from not paying your rent would actually cause a seizing of the system for quite a while until there was an understanding when people would get back to work. So what the CARES Act did, and hopefully they'll get it renewed to some level, it allowed the system to continue to work.

And what some of the other government programs did, it allowed people to be able to keep their people employed and be able to pay their mortgage payments. Once all of that stops, then the entire market comes to a standstill. And then getting back to your discussion of price discovery, there's no price discovery for a long time because there are no. transactions because there's no concept of where the bottom is. And that's really what's happened now. The price discovery comes when there's a feeling where the bottom is. People really have a good sense that we're bouncing off the bottom and then you'll begin to see price discovery. The news doesn't stop on the weekends. Context changes constantly. And now Bloomberg is the place to stay on top of it all. Hi, I'm David Gurra. Join us every Saturday and Sunday for the new

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Bloomberg business app, or listen to the podcast. That's Bloomberg this weekend. Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg television, radio, and wherever you get your podcasts. I want to get more into the residential in a second, but sticking on commercial for a moment. I read all these stories. Lumberg has written a lot of them about some of these commercial areas of New York City, just obviously brutal restaurants, if they're opened up, barely hanging in there, might not survive. Popular tourist areas for shopping, obviously almost gone with no imminent prospect of that returning from the perspective of a landlord. How do they think about the problem?

Because you could theoretically evict a commercial tenant, but who's going to replace them that be better or that would be in any position to pay rent. How did they think about the sort of tension of working out something with a struggling commercial tenant? I think everybody has to approach it and they've been approaching with pure common sense, right? We're in a dislocated period. There's going to be a return to some normalcy over a period of time. And people will look at the strength of the tenant, how they've been impacted and their ability to pay. In many circumstances, they'll allow the tenant to defer their obligations if in fact they're truly impacted by this dislocation. At the same time, the owner of the building will turn around to the lender,

such as us, and say, look, we have an issue. We've been impacted. How can you help us? Can you allow us to defer some of our payment? And in certain circumstances, circumstances when they've proven that they've been impacted will allow them to defer that payment. So that's how that system works. But the real area that you're asking is, what does a new world look like? What a new lease is going to be signed at? And are there enough tenants to take over the old tenant space? And there's a building that was 95 or 98% occupied, going to be 85% occupied, and the lease rate's going to be lower.

in certain areas that will be the case. And there'll be an adjustment and value. And there'll be some level of defaults or re-equitization of some of the projects. So in a year from now, we'll all turn around and take a look at how is this pandemic changed, you know, the behavior patterns in some of the urban areas. And what's the long-term impact of office leases and occupancies? Our restaurant's going to return and a restaurant's going to be able to open up. and how long will that take. So there will be some hurt to some degree and there will be adjustments

and value. So if we look at the long-term development of residential real estate now, I know you're invested primarily in multifamily and multifamily performed perhaps surprisingly well this summer. Do you think there might be a transition from multifamily to single family because of the coronavirus crisis? It's happening right now. It was already beginning to happen. And, you know, pre-COVID, the trends were a migration out of the urban areas. And it was household formation, specifically with the millennials. And that trend had already started. And now it's being accelerated.

You have an enormous boom for home sales. There's home appreciation. There's a lack of inventory. and I think the home builders are going to do great. And even on the single-family rental pool, you're seeing occupancies at the highest level on single-family rentals. People are leaving the urban areas. It's a density issue.

It's a household formation issue. And the real question becomes, is once people move out of the urban areas and they have families and they're settled in their communities, do they stay there? my view is most of the people, once they move out of the cities and they settle down with their families, they're not returning to the urban areas. So you'll continue to see a decline in these urban areas and an increase in the suburban areas. And clearly the winners are, you know, the people who are selling their homes, the realtors in these suburban areas and those communities.

What does it mean from an arbor-specific perspective if there is a secular shift away from multifamily? So we're actually very, very active and one of the leading providers of what's called communities that are built for rent, single-family built-to-rent communities. And we're one of the most prolific lenders in that space. And I'd say about 10 years ago, that space barely existed. and right now it makes up for close to 4 to 5% of all new housing starts where communities are being built specifically for renting. So we'll be active in that market. On the multifamily side, fortunately, Arbor Realty Trust is not as active in the urban areas.

Most of what we do is workforce housing throughout the United States. And that workforce housing and those communities have. the right amenities and the right density configurations and we're not as impacted. In fact, as of now, our occupancies and economic collections are only down like one, one and a half percent. And we have zero delinquencies and only a handful of people asking for forbearance. So that has tracked extremely well. But the big question is going to be what happens with the CARES Act and how long does it take for the virus to receive? get under control.

Aside from the CARES Act and what happens with the virus, is there anything else that could maybe cushion some of the blow to prices here? Like, for instance, we used to talk about a lot about dry powder on the sidelines. What's your sense of that? Could investors come in and maybe lift up the market? I think there is a lot of liquidity in the market. There's a lot of money sitting on the sidelines, and people are waiting. And they're waiting for that price. discovery that you asked about earlier. If there is some level of price discovery, you'll see a lot of transactions and you'll see very quickly that liquidity return to the market and boost up pricing. In our sector, in the multifamily sector, it's quite fascinating because there are for many people,

not a lot of investable asset classes. So people have to put their money in certain places. and the multifamily sector is the most attractive asset class right now. And by the way, historically, the multifamily asset class has been the most resilient, even when it falls or recovers very quickly. So my prediction is that you'll actually see what we call cap rate compression. People will want to put more money into the multifamily sector, driving prices up, cap rates down. And that will offset a little bit of the decline.

in potential rents and occupancies. So I think the multifamily asset class, because of those factors, will be an outperformer. How surprised are you by the lack of requests for forbearance? And how much do you attribute that to the expanded unemployment insurance on the CARES Act? So it's interesting. We were all in mid-March and April, as I'm sure you were sitting in a period of fear, right and the unknown and we're not sitting there right now but there was so much fear so much unknown and how long would this dislocation be we've never seen unemployment levels like this what was close to 20 million people on the unemployment the unemployment rate at 14 15 percent and the question was how are people going to pay their rent and if they can't pay their rent

how they're going to pay their mortgages and we were preparing for the worst and the cares Act came along. It was a little, you know, delayed in getting there. And it was clear that the CARES Act gave people the adequate ability to pay their rent and to pay their mortgages. And that was very important to keep the system going. And that's one of the reasons why we had very little, you know, forbearance requests, was people were paying their rent. So that was an amazing accomplishment, given where things were. It was fear and confusion, and now there's some level of clarity, and as soon as they pass the next level of the CARES Act will have a high degree of clarity in terms of what the delinquencies and forbearance requests will be.

So we're all sitting and waiting. What happens if we don't get another stimulus agreement, something like the CARES Act or the HOPE Act, something like that? Well, I think there will be some, you know, there will be a stimulus program. The question is at what level? And, you know, one of the data points I was looking at was, you know, 75% of the money that was coming in on the CARES Act was being spent on, you know, housing, you know, retail and food. So if that is reduced, you'll see increased delinquencies. You'll see retail sales going down. And you'll see the domino effect of what happens when people don't have income.

And that's why providing money to people to pay their bills keeps the system going. So we're all waiting and they have to come to the right level to keep the system flowing. And this dislocation, you have to have some level of empathy for many people. they didn't do anything wrong, right? They're just sitting there. They can't leave their homes. And for the system to keep flowing, they have some level of replacement of that income until they're able to go back to work. I'm Francine Lacqua, an award-winning journalist. And I've got a new podcast, leaders with Francine Lacqua from Bloomberg Podcasts. I've interviewed everyone from heads of state to fashion icons about the news of the moment. But I've always been curious, who are these people as leaders?

Think there's one right way to be a leader. Make decisions. A poor decision is always better than no decision. Listen to new episodes every other Monday. Follow leaders with Francine Lacroix wherever you get your podcasts. So just backing up for a second, thinking about multifamily and renters. So Arbor provides financing for the developers of multifamily units. Do you see that slowing down the development of these units if there is this transition towards more people wanting to have a yard, a detached single family home?

Or is there enough sort of secular demand for that as well that regardless of those trends, multifamily would just continue to grow as a sort of share of overall housing? I think there'll be a pause. I think people are going to think twice about starting new developments in specific areas. They'll go to areas where there's positive growth and maybe start housing, you know, building units there. But this boom period of 10 years that we just went through where there was a lot of units being added, I think there's going to be a considerable slowdown in new multifamily starts. And I think the banks are going to be very cautious about doing construction lending right now when there's a decline in occupancy and rents in this sector.

So it will slow down. It could slow down for 12 to 24 months as people get a look at the data. But the forecasts are flat to declining rents in a lot of markets and slow growth in occupancy. And I think what is being experienced right now with a lot of the new projects, the lease up rates are significantly slower now than they will. a year ago, probably by about 50%. You know, I asked about this on the commercial side, but I'm also sort of curious about this on the residential side, which is evictions.

Lots of interest in this question of whether we're going to have a tidal wave of evictions, either some of these moratoriums wear off or if the next stimulus bill doesn't replace people's income to the same degree. But I also kind of wonder if, you know, some of the kids. calculus that you mentioned with respect to commercial also applies to residential in terms of what good does it do to evict tenants if there aren't a wave of people trying to come in. So I'm curious what you think, because I read stories every day. The eviction wave is coming.

The eviction wave is coming after this deadline. I'm curious if you do see an eviction wave coming at all. Well, I think that when you don't have evictions for three, six, nine months, there'll be a little bit of a catch-up and a little bit of a wave. But what we're really seeing is landlords and owners be very reasonable and try and work things out with their tenants. So if a tenant has been impacted, they'll work with them. They'll give them the leeway. They'll be reasonable. And you're seeing more of that flexibility than I've ever seen before. So that'll slow down that wave. And, And, you know, if there isn't demand for new apartments, then the landlords will exhibit a high level of flexibility.

The wave will be only because you couldn't evict for six or nine months and there's pent up. Once that backlog gets reduced, I don't think it'll be an overwhelming issue. But I think there is a great level of sensitivity. And landlords are being somewhat flexible and reasonable to try and manage that through the system. We haven't talked that much about the business model of REITs themselves. If you look at a lot of the publicly listed ones, such as yourself, they got hit pretty hard in March, and a lot of them have yet to recover. What can you as a REIT do to offset the pressures and the challenges of the current climate? So the first thing that you have to do is run your business as we have with an eye that.

that recessions do occur and you have to be prepared for them. And this dislocation that we're in is a recession. Certainly COVID is an unusual event. But we had a 10-year bull run. And companies like ourselves, you know, had adequate liquidity, had less use of leverage. And having been through many cycles, understood what we were in the cycle and really prepared for it.

That's why we're the best performing reed. That's why we've had the best quarter we've ever had. And that's why we didn't have the kind of issues other reits have. Once you're in a recession, once you're over leveraged, it's very hard to maneuver. So this recession is another dislocation. We had, as we all know, the great financial crisis, which was in many ways for companies like ourselves, even with. worse than this one because it was much more severe. And every cycle, you have to be somewhat prepared to be able to operate. And, you know, my answer to many people is why are we doing so well and why is your company outperforming? It's very simple. We've operated many cycles. You can't use liquidity to drive your returns. And you have to be able to have a solid balance sheet and the right asset classes. Once you've made the mistakes and you enter into a recession, it's very hard to

correct those mistakes. You mentioned that one of the areas that you saw is on the rise are single family houses, housing communities that are built with the express purpose of serving renters. Are there any other growth areas that you think look particularly interesting right now? you know clearly the single family rental market is is booming you're starting to see some of the suburban you know office parks starting to increase air occupancy um that has you know that has been you know extremely extremely beneficial and industrial as you all know the industrial sector is performing extremely well because people you know are using amazon they need places to store. So those are the sectors which are really outperforming. And right now on the single family

market, home prices are up, inventories are down, home builders are building quite a bit. So those are the sectors that are really beneficial. Ivan, thank you very much for joining us a really great overview of all the different moving parts and interesting, unexpected things happening in the real estate market right now. Thank you, Joe. Thank you, Tracy. Enjoyed to talk. Thanks, Ivan. That was really great. Tracy, I thought there was a lot of interesting stuff there. Just to start with, you know, the impact of the CARES Act. I really, you know, initially I think perhaps it was underappreciated just the degree to which it helped replace lost incomes as everyone was looking at insane numbers like 20 million dollars, 20 million people unemployed. but thinking about that just from a real estate perspective and how few requests they've still

seen for forbearance is pretty extraordinary. Yeah, I think I saw an estimate maybe a week ago from JP Morgan talking about how without the CARES Act, a certain type of residential mortgage would have been 70% something like that. Or sorry, the default rate for that type of mortgage would have been 70%, which is a lot, right? So yeah, you definitely get a sense. of what the CARES Act has meant for the real estate market. The other thing it makes me think about is how the coronavirus crisis is creating all these different winners and losers in a variety of markets. So even if commercial real estate is doing terribly, retail real estate, like malls and things like that is doing really badly, you still have some areas of the market that are outperforming

such as multifamily. And now you have some people getting excited about single family as well. Yeah, it'll be really interesting to see also then the flip side, you know, you think about what's doing extremely poorly, cities, touristy areas, retail, hotels, obviously totally clovered. Like, what is going to become of those spaces? I mean, I guess in theory, we could have a vaccine in a few months and then everything just returns to normal. But you have to figure that if there is this big structural shift where a lot of people are moving out of the cities, somehow that is going to change. the complexion of what cities look like, even when the virus is less of an issue directly. Right. And I mean, in a lot of ways, coronavirus has accelerated trends that were already in play in real estate. We had malls under pressure forever. We had lots of people trying to think of ways

to revive malls, make them more interesting, make them into attractions that people want to go to. So, yeah, it feels like coronavirus is sort of putting all of this into fast forward. It's interesting. If you look at lists of the big companies that have declared bankruptcy in 2020, and of course there have been an extraordinary number of bankruptcies overall. But if you look at the lists of the names, I guess I don't want to say silver lining, but I guess one good thing is these are all companies that were really trouble going into this. There are not too many examples that I've seen of companies that were really thriving in the pre-coronavirus era that have now just been completely wiped out, most of the prominent bankruptcies were companies

that were sort of structurally or securely in trouble long before coronavirus. And then coronavirus came along and sort of delivered the final blow, so to speak. Yeah. And we've also had some maybe surprising examples of people adapting to the coronavirus crisis as well and rolling out new products, new ways of doing business, which is also helping. So yeah, winners and losers is the theme for today. Very good thing. Okay. This has been another episode of the A Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Allaway. And I'm Joe Wisenthall. You can follow me on Twitter at The Stallworth. Follow our producer, Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg head of podcast, Francesca Levy, at Francesca Today. And check out all of our podcasts at Bloomberg

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