CRE and Lending Update with Aaron Jodka, Colliers

In Season 3 Episode 5, the guys are joined by Colliers Director of Research Aaron Jodka and DCG colleague Justin Bakst. The four dig into multiple topics in the commercial real estate landscape, including: why "commercial lending" can't be painted with a broad brush, differentiation between community and larger bank exposures,  investor outlook on “work from home” policies, contagion fears, and why loans written today could have some tremendous upside.  

For more insights and ideas, visit DCG at DarlingConsulting.com or follow us on LinkedIn.

Transcript

On the Balance Sheet S3E5 CRE and Lending Update with Aaron Jodka, Colliers

[Vinny, 00:06]

Welcome to On the Balance Sheet, Season 3 Episode 5. Today we have Aaron Jodka, Director of Research at Colliers and Aaron; we're so fortunate to be joined by him. He has expertise, particularly commercial real estate, and he knows so much about the real estate market. So, this is a treat. Right, Zach?

[Zach, 00:24]

Yeah, Vin, absolutely. And I think you can't go anywhere in Q1, Q2 of 2024 and not see headlines about commercial real estate, credit, etc. and Aaron's certainly an expert in there. So, I think this is a pretty timely discussion. You know a little bit different than some of our other interviews. But I think our listeners, we've got this good feedback that they like to hear things like this from time to time, and I mean Aaron's at Colliers, they're a massive global real estate investment company. They might not be a bank like our listeners, but they see tons of deals, they look at it from the buyer standpoint. They obviously understand the trends that folks were holding the debt, so it depends on which side of the table you're on in terms of the outlook that he's probably going to give today. But I think with all the information, it’s going to be really great to hear his thoughts. And we're also going to have our colleague, Justin Bakst, join us as well, who has a long history working with Aaron through the years as well. So, I think it's going to be a great interview with the four of us, and I'm looking forward to hearing what he has to say.

[Vinny, 01:16]

Yeah, and if I give our listeners a little tease, it's not all bad. So, without further ado, Aaron Jodka.

[Zach, 01:32]

Welcome back to the show. Here, we are joined today by Aaron Jodka, Director of Research Capital Markets at Colliers. Aaron, how are you doing this morning?

[Aaron, 01:39]

I'm great. Thanks for having me.

[Zach, 01:40]

We're very pleased to have you here. You know, obviously I'm with Vin Clevenger and Justin Bakst. I think just to start and kind of level set, could you give the listeners a quick background of what you do at Colliers? Where you were before, too? And then maybe how you're helping banks in this very interesting time, certainly in the in the lending space?

[Aaron, 02:00]

Oh, very interesting signs, that is for sure. So, I lead capital markets research for Colliers where I get to work with all of our professionals across the country. So, all asset classes, coast to coast. Before joining Colliers, I was at Property Portfolio Research, which was acquired by CoStar Group, where I covered a number of different markets, helped advise institutional investors on their real estate allocations across private, public, debt equity, etc. I’ve been with Colliers since 2016 and it's been a really, really fun ride. In terms of what we're doing with clients and helping banks today, part of it is really helping them understand what they have exposure to. Some of these banks don't understand necessarily the nuances of performance from one asset class to another, where they are within different regions and that can make a big difference. We’re also helping them figure out which properties may be worth reinvesting in, where there may be others that a foreclosure, short sale, loan sale, etc., may be the most prudent decision for them. So, we're helping across the capital stack.

[Zach, 02:58]

Terrific, it sounds great. I think this is going to be a great interview. And would you mind, before we get into maybe some more really specific questions, Aaron, could you give maybe a quick state of the state in commercial space? Just what are you seeing? What are you hearing? You travel a lot, and you speak a lot out there. You're an expert in this area. Office gets a lot of discussion, certainly multi-FAM, retail, industrial. Could you give us a high level and then we can drill in as the interview goes on about what you’re hearing and seeing generally?

[Aaron, 03:25]

Yeah, I’d be happy to. So, we'll start with office, that tends to get most of the headlines. One thing just to set the stage, CRE equals office in the view of many publications. That is not by any way, shape, or form the entire breadth of commercial real estate. So that's one thing I just want to sort of put out there first and foremost. While it has faced some challenges, they're structural in nature in the sense that we went through a vast change in the way that we work and operate businesses. A pandemic was not something that was on many people's bingo cards. What was going to happen next with the economy when that all went down? It caused us to change the way that we operate, change the way that we work and that's still having ramifications on fundamentals. So, vacancies continue to rise. They're at all-time highs from the day that we’ve ever tracked. Rents are still generally holding up, though. So, you look at concessions and effective rents are down, but face rents are still really holding, and we are seeing some momentum on the sales side which we can get into in a few minutes. Industrial asset class that's been in favor for quite some time, phenomenal performance for a number of years. We're now facing the challenge of an imbalance of supply and demand. So, a wave of development is coming online causing vacancies to push up into the mid sixes, which historically is still a low number. It just feels tougher because we were coming off of all-time lows. So, part of that, too, is setting that stage of what we've experienced in the last few years for vacancies in industrial were not normal and not sustainable. So, we had to have some type of a give, essentially, and now we're seeing some imbalance in certain markets. Multifamily is similar in that sense. Real estate darling, phenomenal performance, great fundamentals that are unwinding because of a need for housing and a new development wave that's hitting markets across the country. Looking at a number of the forecasters they're expecting around now, next quarter or two, to be the bottom from an occupancy standpoint, and that conditions should start to improve in the not-too-distant future. So, we're at an inflection point in some of these asset classes, which is really exciting. Retail has actually performed quite well for a long time. It's been off of investors radars where they put retail in a bucket after the global financial crisis of alright, retail apocalypse is coming. We have this pandemic causing everything to change in e-commerce and while e-commerce certainly is nothing to sneeze at, the vast majority of business and retail is still done in a brick-and-mortar location, whether you order it online and then pick it up in store or you just go to the store directly to purchase it. So, retail has been off the investor checklist for a while, which I think is a mistake. Performance has been very, very strong. We've built very little in this asset class for quite a number of years. So, the product there has survived really tough times, so it's doing quite well. And then on the hospitality side, we're seeing that mixed bag of what used to be local travel - US domestic type of activity is now broadening out where we're seeing international travel reemerge in the US. We're seeing business travel pick up and remain strong. So, we're seeing different markets a little bit later in the cycle here. I guess relative to that hospitality cycle picking up where Florida and coastal markets were doing really, really well early. Now you're seeing the Bostons, you're seeing the New Yorks start to do quite well.

[Justin, 06:47]

So, Aaron, we know that you cover commercial real estate nationally. Our clients at DCG are in all 50 states. And clearly, when we hear these concerns in the media about commercial real estate concentrations, I think typically people think about large office buildings in San Francisco or New York or some of the other kind of hot bed areas. But when you look around this country, what are some opportunities, but also some risks that you see that maybe aren't widely discussed?

[Aaron, 07:22]

One strategy will really probably dictate the answer to that question. I think office is a really phenomenal opportunity right now. Now it's hard to get a bank to say, alright, I'll make a new loan on an office loan. But at the end of the day, your basis is being reset. You were able to recalibrate to today's market. I think that loan performs quite well over the life of that loan versus potentially some of the stuff that was done before. Now the problem is that there's likely some pain that needs to happen in order for that loan to now be redone because someone is taking a loss on a number of these properties given the way that the market is working. But if I can be an early adopter of buying a Class B, Class A- building, you certainly have to put some capital into it, but I release that, I have a lower basis, I’m able to undercut the market from a rent standpoint, I get my occupancy and I'm performing quite well. So, we really see that as a tremendous opportunity. It's not for the faint of heart, and it will be a big check from an equity standpoint just because that lack of availability of financing is there. Now in terms of some other potential risks that we're seeing in the market, I would watch out for some of the groups that were very heavily focused on a value-add play, short term hold who didn't necessarily have a long-term property management as part of their strategy. So, I think some of the syndicators that got into multifamily and acquired a number of assets at record pricing, low cap rates and now their interest costs have gone through the roof. They're managing these assets, which is not something they were planning to do. Those deals are getting broken and there's an opportunity to refinance some of those. And likewise, from an opportunity standpoint, I like looking at recapitalizing some of the capital stack on the new development that's coming on the market, whether that's multifamily, whether that's industrial, etc. There are some really intriguing plays there.

[Justin, 09:17]

One thing you said that I just wanted to follow up on was it's not for your typical investor. So, who are the types of investors that you're seeing out in this market? How's that changed over the last 12 to 18 months?

[Aaron, 09:30]

What I meant when I said typical, I meant more faint of heart. So, you do have to write a big equity check here. You're not going to be able to get a 65% LTV loan from your local bank or community regional bank for some of these office deals. And if we're talking a big tower, of course you need to go to certain bigger lenders that can handle a loan of that magnitude. I guess if you're talking the atypical investor or what's not available to everyone, I'd probably go data center because that's an area where we're seeing a tremendous amount of push, lots of activity, lots of demand and need. But these are billion-dollar facilities and in some cases multiple billion-dollar campuses that are being built. That's not for everybody to get into, right. So, you're looking at specific institutions, you're looking at specific operators in a lot of cases, you're seeing your hyperscalers that are building these for themselves or you're seeing major private equity partnering with existing operators building out platforms. It's not something that your typical investor can tap into outside of the public markets of course, in the real world.

[Vinny, 10:35]

Aaron, thanks so much for that. This is Vinny Clevenger. Thanks again for joining us. We feel fortunate to have somebody who's an expert in this space. You put on, whether it's CNBC or any of these other things you're reading, you keep hearing about all this money on the sidelines and folks are building piles of cash to take advantage of what we've already talked about in the office space. Does that, in effect, just put a floor under these assets? And when will there be that price discovery? Is it just a byproduct of these deals coming up to maturity or having to reprice? And then you're just put in a situation where these properties have to come back on the market? Or will we see, at some point, all these legendary real estate investors who are all sitting there waiting, will we see them all kind of rush and say – Alright, I think this is the floor. I'm just trying to quantify, if you will, what the downside really could be for some of these properties. Is it more they've got to come to maturity? Or is it these investors, there’s not real price discovery? You know, it's hard for us to see that info and try to glean what the exposures really are.

[Aaron, 11:44]

There is price discovery. While volume is down particularly, you're comparing it to 2021 and 2022, which were just absolutely phenomenal years for volume and arguably something that we may never see again in our careers. That level of volume was just so astounding. If you compare it to the 2015-2019 average of pre-pandemic level, we’re certainly down, but it doesn't look as harsh. And  industrial level asset classes tend to look the strongest relative to that pre-pandemic level of trading volume. So, there is discovery, office is still challenged, the CBD volume last year was one of the weakest years we've seen on record and is the weakest year since 2009. So that was not a strong year for commercial real estate as we can all recall. So, there is some price discovery that still needs to be done but generally speaking, that pile of capital on the sidelines to me, does set a floor. It does create an opportunity where things generally will not go to 0. Now in certain assets, if it's really been struggling and there is no cash flow, what is the land value, is essentially where you start to get to pricing. That's above zero, but it wasn't probably where the loan was originally underwritten. So, there can be some challenges there, but I like the argument for stockpiles of capital on the sidelines can come in and really fix the capital stack and that's where a lot of this capital will likely go. If you look at where it's targeted, it's value add, it's opportunistic and it's debt oriented. What do you need in the market today? All of those. So, it's oriented correctly for where the market needs it. The challenge is ultimately finding the right IRR and finding the right deal to make everything work. At the end of the day, real estate investing is based on return thresholds. So once that capital sees those deals, and it has that conviction, I think they'll start to jump in. We are starting to see more institutional, heavy-hitting companies coming back into the market on bid sheets. So deals that we have out in the market, we're seeing the names that have been on the sidelines for a while, which to us is a really good indicator that we’re probably close to that bottom if we have not already hit it. And then, using Blackstone as an example, they announced a $10 billion acquisition of air communities that sent a shockwave through the market of look at that deal, the magnitude, the scale. Other multifamily investors are saying – Well, let's get on board too. So, there are a few a few green shoots here that could really indicate a thawing of the market.

[Zach, 14:14]

Aaron, in a similar light or maybe on the other side of it, do you see when you're out there talking with folks and internally, what's the case going the other way? Is there a case where you guys see where there is more contagion, there is more of an issue? The cash doesn't come out as much or the floor isn't as high. I think that that to me, most folks we talked to are hoping for an optimistic scenario, but we're all getting ready for the real pessimistic one. So, do you see that? I'm not asking you to, you know, tell the future here. But I'm just curious what you're hearing and seeing, or what the conversations are like? If there's a more of a contagion type issue with values and things start to spiral in a more negative way?

[Aaron, 14:54]

So, it's really going to depend on each lender, particularly from a banking standpoint. Where is their exposure? What asset class? What market? What region? How is it performing? Because it's not all created equally. The phrase of real estate is very, very local. Location, location, location. That is completely true. So, if I have exposure to a certain asset class or a certain market, that could be great, it could be a challenge. So just looking at overall CRE exposure may not be a great answer, so to speak. But as we get down into folks’ portfolios and looking at what they have, where their exposure is, in some cases they're seeing where the values are coming back and it's not necessarily a pretty number. But they understand that's where the number is and where business needs to go in order to transact that. And we need to clear some of those deals in order to get that next round of financing up and running and recalibrate that market and really get us going. So, we're seeing a bit of all of that and that's where some of that capital hopefully will come in and can help fix. And we're seeing plenty of debt funds raised and equity investors saying – Well, I'll just take a safer position in a debt position at mid-teens return here. And if you can make that work, phenomenal, that's great. It seems to be a very safe position and a nice return. The challenge is if I'm struggling with my property and I need to go out to you guys and say – Alright, I need some money. I need 20% at 14% interest. That's hard to make some of those numbers work. So, it can be a stopgap and hopefully some groups can make that work. But oftentimes the financing rate is just too high to ultimately make a deal work.

[Justin, 16:40]

So, on the contagion discussion, Aaron. One of the things that I think about is OK, on this hybrid workforce, 25% of white-collar folks are still working remotely and that number really hasn't changed over the last 12 months, it's stayed at around 25%. At the same time, you have these leases, these office leases that are long term in nature. And so, when Vinny talks about price discovery and you know we talk about CBD office and contagion. Could this still play out a little bit differently? And I guess how are you thinking about some of those risks as well?

[Aaron, 17:24]

Yeah, unfortunately I don't expect the vacancy rate for office to come back down in the near term. I think we still have a few quarters of that to rise. So, as you said, leases are five to ten years, typically, in a downtown market and many of these leases have not rolled out yet. Those that are generally seeing a reduction in occupied square footage upon that renewal or move, wherever that might be. Of course, that range can go from a growth company to someone consolidating substantially, but generally we're seeing about a 15 to 20% reduction in occupancy upon that lease expiration. So that's still pushing down the market. One thing that I'm really trying to focus on is where that growth is coming from. If you look at office using employment, it's never been higher. Of course, Justin, to your point, they're sitting at home in some cases, so they don't need as many desks in the office, but we're still looking at that hybrid environment where Tuesday, Wednesday, Thursday are high in the office type of days. You still need a desk for people, so while I may not have everyone in 100% of the time, they're still trying to figure out how much space we need and how to use it. So, what we're seeing on the design side is more and more office users are putting in higher technology. So, the cost of building is higher than it was before. So, rows and rows of cubes kind of go away and you start to see more huddle spaces, more collaborative room, really enhancing the value of being in the office and outperforming what you have at home. At the end of the day, if I have a big important pitch, it makes a lot more sense to be in the office where I have high end internet, I have my team with me. We're looking at each other, we're face to face with those clients. Then, I'm at home, and boy, I hope the neighbor doesn't come and mow his lawn because it's going to be a little annoying in the background. So, trying to figure out that balance and I gave a presentation recently which had a couple of students in the audience and one piece of advice that I offered is well, it sounds great to just sit in your pajamas and be at home all day, every day. I would not be where I am in my career if I started my career at home. I sat in an office with a lot of people who were letting me sit in like a fly on the wall in a conversation. They say – hey, come on, Aaron, listen in, hear what's going on in the market. Don't say anything because you don't know anything yet, but just understand how it works. So, you start to learn. How do you talk to clients? How do you respond? What is customer service? What is client service? What questions are there that they're asking. So, you're prepared for those type of responses when you have a conversation yourself. You learn a lot of that by osmosis and just by hearing and experiencing. If I have a Zoom call, if I have a Team’s call, it's usually for a purpose. We have to talk about the new XYZ, whatever. I'm not going to sit there and be like – Hey, Vinny, can you tell me about what your experience was when this happened last time? Or what is your thought on such and such? Hey, Zach, what do you think about? Blah blah blah. That usually doesn't happen in that dynamic because they're so specific, whereas you're in the office. Well, yeah, I'm going to go over and bump into you and ask you a question. So that part to me, I think starts sending the pendulum back. When companies start to look at the productivity, the advancement of their younger workforce and realize that they should be VP now. They should be a senior or whatever, however their title structure works. And they might not have that skill set, and we might not know that for three more years, and we might know it for five more years. But I feel for some of the younger professionals who may be stunting their careers inadvertently and will realize that I'm not ready for that next step and what that might mean for local businesses.

[Vinny, 20:57]

Aaron, this is Vinny. And I actually think about that on the other side of that argument, which is if I was a younger professional, it would be easier to get it because you just have to come to the office and by definition, you go right up the food chain. Are you suggesting in the folks you're working with and some of these investors there over the longer term, this paradigm shift, do you think it might go back to the more traditional everyone's in the office or do you think that two days at home is here to stay? What are investors banking on? Again, you're making longer term investments in properties that need tenants. I'm just curious, is this a new paradigm that's here or will it eventually shake out differently?

[Aaron, 21:43]

I do think it's a paradigm that is here, and I think it's going to be one to two days at home, generally speaking, because in some cases I can get some tasks done at home more efficiently than I can in the office. There are potentially less distractions here at a home office than there would be in the office office. I just gave that example; I'm going to bump into you, and I'm going to ask you a question that you were not expecting me to ask you and it's 12:15 and you're getting ready to run to a meeting. So sometimes there's that conflict within the office. So, I do expect that the hybrid environment will likely stick around. And it was something that was slowly emerging pre-pandemic, we just pulled all that forward in a hurry. So, we’ve gone from something that would have been a slow adoption over time into just boom here it is, we just have to figure it out on the fly. But those days that you're in the office, you have a really good group of folks. And I think those Tuesday-Wednesday-Thursdays, Monday-Wednesday-Thursday, whatever days, each group ultimately picks, you're going to have a higher attendance rate and that will continue to escalate. So, the days that you're in the office, you're going to see that attendance rise. That in itself puts a limit on how much space you can get rid of, and it will determine how much space you need because if I've got 100 people and 100 of them are in on Wednesday, I can't have room for 80 people. Those 20 are going to be pretty upset, and then they stop coming to the office and then you go backwards from what you were trying to do. Now I'm scrambling and I need flex space, I need to add another floor, I need to figure out a satellite office, whatever it might be. And that's a lot of brain damage at the end of the day, real estate is there for companies to utilize, to help operate their business. Most of them are not in the business of every day trying to figure out their leases. So, it's a challenge for occupiers to constantly be needing that space thought, they just want to get it done, get it right and go. And since we've had a few years after the pandemic, we're seeing more examples of what is working and what is not working within an office and how that mandate versus a magnet of the office works and that, ultimately, will guide the decision making of others.

[Justin, 23:45]

Hey Aaron. When we look at the news and see the reality that commercial real estate concentrations in the banking industry are under pressure. Have you seen in your experience with the debt markets, how's that changed over the last 12 to 18 months? Are there different players? What is the makeup of those players and how do you see that play out in the next 12 months?

[Aaron, 24:13]

Some banks have felt like they've pulled back and there's certain things that they'll land on, and it has to be in a fairly tight range and in some cases they'll just say – I can't do XYZ. I have too much exposure to ABC. Part of that comes down to regulation. Where all of a sudden, they're answering questions they were not answering before when they were making loans. Or they have to go to their boss or their boss's boss and say – here's why I made that particular loan. I think that could be a mistake and that they're losing out on opportunities to, again, that reset basis, the new price points, those loans will perform very, very well. And I think if you look at history and you see the loans that were made in 2009, 2010, 2011, they performed pretty well. Now they got refinanced because rates came down and you didn't stick to it forever, but those were generally good vintage years for commercial real estate. We'd be in that same type of position today. What we are seeing is a lot of debt funds who are active and they're willing to go out and take something with hair on it. They will help with the redevelopment. They will help with a conversion play. The challenge there is that it's a higher cost of capital than you would find at a bank, than you would find at a life company. We are seeing more liquidity on the CMBS side, single asset, single borrower deals in particular. Those spreads have come way in which is a really good indicator of potential liquidity going forward where I can bring XYZ building essentially to market with that CMBS pool and there will be bidders, there will be buyers, and there will be activity there. So, we see CMBS as an interesting play this year, and probably out into the next several, as we're recalibrating the capacity of your local, regional, and massive banks.

[Vinny, 25:58]

Aaron, I read an article in the Wall Street Journal this morning. It was talking a little bit about legislation that's been proposed. I think there's actually bipartisan support, depending on how you view it for limiting institutional investment in the residential real estate market and I feel like we were missed to not even get any sort of insight you may have into the not just that, but just the housing market in general in the United States. I went through the Colliers website on your bio, you had these quick hits. I encourage all of our listeners to definitely take a look at this stuff. It's really, really cogent and it's good stuff. But I'm curious, with regards to maybe we need more housing in this country. Does that sort of buoy home prices moving forward? I don't know if you have any insight on that forementioned the legislation I just kind of shared with you. 

[Aaron, 26:57]

It is very challenging to build housing in this country and depending on who you listen to, we are short of 1 million to 5 million houses in this country. And by houses, it can be an apartment. It could be a single-family residence. It could be a condo, some type of residential unit. We are building plenty of multifamily in the near term. That level of supply peaks and it is starting to ease off. But even then, in many markets, vacancies are still very low. We're seeing rents rising in higher barrier to entry markets, in places that did not see a wave of development. They're leading the country in rent growth, depending on which source you use. Some Midwest markets, some upstate New York markets are leading the country in rent growth and those are not typically the markets you see leading in that category. We need housing in this country, and to rely on small local developers to do that, there's no way we're going to meet the housing needs of our country. My guess is some of the legislation is coming around, you know, potential power structures within the ownership of different forms of residential. It's a heavy investment market and you need a lot of capital to build tens of thousands, hundreds of thousands of units a year. So, you have to have a scale, you have to have that taking place. At the same time, you want affordability, and you want families to be able to afford a home to stay in the communities they want to stay in. And right now, we're facing a challenge. We look at Canada, we can see what's happened up north for a number of years in a place like Toronto has just seen their prices move up, up, up, up, up and up. And they've built a ton of condos, and it keeps going up, up and up. We are also somewhat challenged by the low interest rate environment we've had, particularly on single family homes, so I'll shift to that form right now. I can't remember the exact statistic, but I think it's something like 60% of homes are locked into a mortgage rate below 4%. So, why would you trade out a 4% mortgage for a 7% plus mortgage today? Unless you have to, right? If I'm moving, I got a new job, divorce, death, get married, have kids, whatever it is, those big life events. Sure, you change, but if I'm happy in my community, I have zero incentive to move right now and to trade and upgrade my home or upgrade in the sense of move to a different home. So, you have a lot of folks who are locked in, which prevents inventory from coming to the market, which props up home prices. So, I don't see a crisis in any way, shape, or form developing on the single-family side from a pricing standpoint, the crisis is – I can't afford to move into a home. Therefore, you've got a larger base of renters by necessity or by force, as opposed to by choice. And that could change some of the dynamics in the US because, historically, the American dream is owning a home, in most of the country. If you're in New York, you don't own a home, there's a density as a city factor there. But in most parts of the country, a lot of folks aim for home ownership. So that may be an area that we're going to be challenged on for a while. At the same time, how do you build to the middle? How do you build affordable, and not just for low-income individuals, but for your general middle class? That's hard to do today regardless of where you are, local, institutional, etc.

[Justin, 30:17]

Aaron, I've known you for a while, and I know you to be a rather optimistic person. And when I hear about your outlook on all the asset classes, you seem to be more bullish than others in the industry. With that being said, if you were talking to a bank CEO or CFO and they weren't dealing with any specific regulatory issues around commercial real estate concentrations, what's some advice or guidance you'd give to them as they look at their book and growing their book over the next, say, 12 months?

[Aaron, 30:51]

Yeah, not to just keep beating that same drum, but I think making loans today will pay off. It's a great time to be a lender. The market needs it across asset classes, you're essentially getting in at a reset basis across most asset classes, if not all asset classes. You're coming off of, probably the low point of fundamentals on industrial multifamily, they're only going to get better. You're going to see rent growth in the future. There's a fairly strong probability of better performance on those properties going forward. Now, I'm not saying the pie in the sky, I'm going to get 15% rent growth and our company is going to grow 10% a year, everything would be amazing, but legitimate due diligence and a reasonable underwriting I think will pay off very, very well. Now the downside here is any kind of recession. Right now, the elusive soft landing was pretty much a good to go scenario a few weeks ago and now not so much, right? Are we going to cut rates this year or are we not going to cut rates this year while we're hearing stagflation starting to pick back up again in terms of popular phrases, which is a terrible thing to have in this country. So, we certainly don't want that. There’re geopolitical challenges in many parts of this world. There’re numerous wars going on right now. We've seen challenges with supply chains and bottlenecks and what can happen if we're cutting fiber cables underneath the ocean. There's certainly issues here that could derail what's otherwise a pretty solid economic background for us. And there will be a recession, there's always going to be a recession, that happens. It's part of the business cycle; when they're going to happen, we'll see. Prognosticators have been guessing on that wrong for the last several quarters and several years. There's been challenged time periods where I look at the numbers and I'm not feeling great, and there's others you feel like, alright, we can make this work. I don't think at the end of the day this is CRE's fault. This is an interest rate environment that rose and it's challenging not only real estate but it's challenging local businesses, it's challenging asset values across the board where if you go back to that pandemic period, the cost of everything was going up from a valuation standpoint, not just real estate. You saw the meme stock trends where companies that were bankrupt all of a sudden are worth a bunch of money. You're seeing watches go up, art, cars, Pokémon cards. It was everything. They’re soaring in value, and that had to recalibrate, it’s in the process of doing so. And real estate, unlike stocks that you can trade in any minute of any day, it takes time to transact those and it's a slower moving train.

[Zach, 33:31]

Aaron, last question for you from me and then we'll see if Justin or Vinny have any more. But from that perspective, if you had a magic wand and say – hey, do we want rates to stay where they are, do we want to see if they cut a little bit more. What do you think, from the lending standpoint that you see, is the best environment, if we're just to isolate rates? I noticed a thousand, a million other variables. Is it the Fed dot plot soft landing a couple hundred BPs down? Is it, no, we're good up here? Or is it, do we need rates down back to zero again to make things look a lot better?

[Aaron, 34:07]

I think you can find a happy medium. I don't think you need to stay up here. I think where we are today is starting to crimp the US consumer. We're seeing challenges on, every once in a while, I look at these news articles and I'll read the comments that are in there and anybody with a keyboard can type something in, but there's a pretty resounding commentary on how unaffordable things are. And it's not just that I can't buy a million-dollar home because that's too expensive now. It’s that I can't afford groceries, or I can't afford take out, or I can't afford whatever it is. Those types of situations become concerning, so you have more buy now, pay later for the type of things you have to resort to in order to get by. Those are some things that make me a little bit worried. So, I do think we need to lower interest rates in order to help our U.S. consumer, local businesses. If you go down to zero again, cap rates plummet, you get tons of value growth and everything's back to the rah-rah days of the pandemic or post pandemic era there. That's not necessarily a great thing either. Now from an investment sales perspective, we would certainly transact more than we are today as the market would, in general. But that level was not sustainable and not predictable and something that we should expect from a 0% interest rate environment. It's just not beneficial. So, I think the Fed, if they start actually cutting and can mention again that we are still looking at cuts, that will make the market feel a little bit better and we'll start to see some lease rates come down. And of course, the Fed controls the short end and you're looking at the 10-year treasury that has risen pretty dramatically over the last few weeks. Those don't necessarily move in lockstep, but we do expect to see that yield curve uninvert, I suppose, how we want to face that. You get that inverted yield curve back to where it belongs. I think we need some cuts, but it doesn't have to go to zero.

[Justin, 35:57]

Aaron, I have more of a macro question about you and Colliers. How do you guys help banks with their business?

[Aaron, 36:04]

Yeah. So oftentimes we are helping them try to understand, right now in particular some of the challenges that they have. I have a sponsor; I have a borrower who has an asset and they're not sure what they can do with it. It’s due to refinance and we're trying to figure out what the valuation is. So, can we do that? What type of equity contribution is there needed to be made to redo that loan. And if that's not a viable opportunity for them, how do we sell the loan? How do we sell the property due to a short sale? Do we do a foreclosure deed in lieu, whatever it might be. So, we're advising them in a number of different capacities today and it can help them understand the fundamentals of markets. We kind of touched on that before where if I'm in Los Angeles, if I'm in Dallas, if I'm in Miami, Nashville, Chicago, Boston, San Francisco and New York, all those fundamentals are different and they might be responding in one way or another, asset class to asset class and we can help them understand where some of those nuances are. There are markets that have held very, very steady in the face of a rising interest rate environment, those might be really intriguing markets to continue to have more exposure to. And there's other markets that we've seen historically that boom and bust and those are ones that maybe we need to be more strategic about where we're lending. 

[Zach, 37:18]

Aaron, thank you again so much for the time, I think that’s all we've got for you. I know you're going to be at our conference too, in June. So, we're really looking forward to hearing your thoughts there and we'll see what's changed in a month, given that this will be early May, we'll probably get this podcast out and see you in early June. So, thank you again. I thought it was terrific insight and we really appreciate it.

[Aaron, 37:43]

Thank you very much. I appreciate the invite, and we'll see you guys soon.

[Vinny, 37:52]

And we're back, Zach and Justin, I really enjoyed that conversation. Aaron has obviously a ton of expertise in areas that, quite frankly, we see topically but don't really ever get to kind of dig into. My major takeaway is, I think it's pretty obvious, it's you can't really paint all commercial real estate with the same brush. In fact, I guess if I were an editor for a financial publication, or if I was somebody who's curating a social media web page, I probably would paint it all with a brush and try to, I guess it's called clickbait these days. But the reality of it all is, yeah, there are clearly some places where there's challenges, but there are also some areas where there's opportunity and that there's also been a lot of great performance depending on what sector of commercial real estate you're looking at.

[Zach, 38:43]

Yeah Vin, I'll jump on top of that too. I think that was really an important message and trends will change certainly, whether you're bullish or bearish. But I think just the idea that it's not a broad-brush stroke, there was actually a Fed paper that came out in April talking just about that and it was an interesting insight because I think all of us are pretty aware of that. But they pretty much said – yeah, their theory risks vary greatly across the type of loan, the geography, the underwriting. I might even argue the bigger banks vs. the regionals vs. the community banks and a lot of the clients we work with in the community space may not be seeing the same things that the headlines of the regionals or the bigger banks are seeing and just to make sure that you're digging in there, understanding the collateral, the geographies and all those type of things that our bankers know. But some folks may be outside of there when they get a little nervous about the headlines, maybe board members or folks like that, to really understand what your bank does not be worried about the S&P Global or the Wall Street Journal headlines I think that was a really important point that he really talked about numerous times. You know, when he was giving answers that it does depend on a lot of that. Justin, how about you?

[Justin, 39:51]

Yeah, when I hear you guys discuss what Aaron had to say, I think about what we do every day. We often think about Murphy's law. What can go wrong, will go wrong. But it was nice to hear from Aaron that there're opportunities out there. And so, for those institutions that might not have large commercial real estate concentrations and may have opportunities in their market, it was good to hear the bright side. And as Vinny said, the negativity sells these days, but it was kind of a breath of fresh air to hear Aaron's positive take on where those opportunities may lie.

[Vinny, 40:28]

You know, certainly refreshing, and of course, very educational for all of us. So, I guess that's a wrap for today's show, and we very much look forward to you folks joining us for our next On the Balance Sheet.

[Dana, 40:47]

On the Balance Sheet is a podcast produced by Darling Consulting Group, DCG. All views and opinions expressed by the hosts and guests are solely their own and may not represent those of DCG. All third parties are independent entities and are not affiliated with DCG. This podcast is intended for informational and educational purposes only and is not considered as advice. All views and opinions expressed are based on the information available at the time and may have changed based on the current market and other conditions. For more information about DCG, please visit www.darlingconsulting.com or e-mail us at info@darlingconsulting.com. Today's background music is provided by John, Sid and Como Media and can be found on pixabay.com.

The text of this transcript was generated by an artificial intelligence (AI) model, and its organization, grammar, and presentation enhanced by AI, and as such may contain errors or inaccuracies. DCG is not liable for any damages, however caused, that may result from any use of this content.