Giving Thanks for Transitional Lending

In our 28th episode, Dechert 4 Real hosts Jon Gaynor and Kate Mylod sit down with Richard Flohr of CrossHarbor Capital Partners for a discussion on all things transitional lending, including construction financing and Richard’s passion for industrial CRE. Plus, Dechert partner Mauricio España stops by with the 411 on recent cases involving Western Alliance and Zions Bank, and the group gets “4 Real” about Thanksgiving day Turkey Trots.

Transcript

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Jon Gaynor: 0:10

Hello, and welcome back to the Dechert 4 Real podcast, where we discuss current issues and trends in commercial real estate finance. We aim to bring market commentary about developments, updates you can use, and maybe a little bit of banter along the way. I'm John Gaynor, a partner based in Dechert's Philadelphia office.

Kate Mylod: 0:25

And I'm Kate Mylod, a partner based in Dechert's New York office.

Jon Gaynor: 0:28

In this episode, we are joined in our New York office by Richard Flohr of CrossHarbor Capital Partners. We'll be talking with Richard about all things related to transitional lending, including construction financing and why Richard remains passionate about industrial CRE.

Kate Mylod: 0:44

And today's 411 segment will feature Dechert partner Mauricio Espana to talk with us about the recent Western Alliance and Zions Bank fraud cases.

Jon Gaynor: 0:54

But first, let's get 4 Real with the hosts. So it's mid-November, and we find Thanksgiving creeping up on us.

So I got one for you, Kate: 1:00

Thanksgiving turkey trots. Are you for them or are you against them?

Kate Mylod: 1:06

So I'm going to give a lawyer's answer. I'm a little mixed on this, Jon. I am a runner. I do my fair share of Turkey trots, including one in my own backyard, the longest standing road race in Connecticut, the Manchester Road Race. But I'm also a fan of having a lazy start to the day and watching a little bit of"Planes, Trains and Automobiles." So I usually let the weather be the arbiter.

Jon Gaynor: 1:27

Ah. I am against them generally, because I live in a cold place during Thanksgiving, and I am a cold wimp. I do not like to run outside if it is below 60 degrees outside. I did one turkey trot in Dallas with my my wife when I was there for Thanksgiving. But other than that, you can leave them. I am not a turkey Trotter,

Kate Mylod: 1:47

So you don't try to get some mileage in so you can have that extra slice of pumpkin pie? All right.

Jon Gaynor: 1:51

I have a treadmill in my basement, and I'll do it All right. So I think that counts as getting for at home on my own time at night after the kids are in bed. real with the hosts. Now on to our 411 segment, we welcome back Dechert partner Mauricio Espana. Mauricio, thanks for making time to join us on the podcast again, this time to talk about two potential fraud cases that were filed by Western Alliance and Zions Bank in pretty quick succession against the Cantor Group. Now we want to note for our listeners who probably already know this, but the Cantor Group in these cases has no affiliation with Cantor Fitzgerald, a well known real estate investment firm.

Mauricio Espana: 2:35

Jon, thanks for inviting me back.

Jon Gaynor: 2:37

This has been something that the industry has been processing for a little bit. Tricolor kind of made waves, and then hot on the heels of Tricolor, we also heard about these potential fraud cases that were filed by Western Alliance and Zions Bank in pretty quick succession. Can you tell us a little bit about these cases and why they might feel relevant to people who do commercial real estate finance?

Mauricio Espana: 3:02

Sure. So essentially, the allegations against Cantor Group entities and their principals, who, many of whom are guarantors under these deals, is these two banks, Western Alliance and Zions Corp, had warehouse revolving credit facilities to these entities, and the deals relied heavily on representations by the Cantor entities that the loans that were serving as the collateral behind these belong to not only these entities, but they were giving them first priority, perfected liens, and obviously were not pledged to anyone else. And so the alleged fraud is pretty straightforward and simple - that allegedly Cantor Group lied. They misrepresented those obviously very important representations in fact. And in fact, many of the loans were actually pledged to other banks, and it wasn't pledged, you know, a week ago or two weeks ago, many of them were pledged years ago, and in order to induce the banks to provide the obviously the facilities they provided title reports, and so obviously the title reports would provide and disclose these prior liens. But what allegedly they did is they doctored those and removed any notice mention of any prior liens, and made it sound like there were no prior liens, and what these banks were getting was first priority, perfected liens. And obviously one of them was not performing as it should. And when the bank looked into it and tried to sort of collect on those, did its own diligence, sometime after the deal closed and ran its own title reports, it learned that these many of these properties were already pledged to other banks. Many of those were already in foreclosure, and obviously prompted the litigation. And as a result of that, one of the other banks, which obviously was also having trouble, saw the litigation, and it prompted itself to also file its own lawsuits. So essentially, it's significant, but this fraud itself is pretty straightforward and simple. They lied. They lied, and unfortunately, it sounds like these banks didn't do too much work to try to uncover the underlying fraud on their own until afterwards

Jon Gaynor: 5:15

Ahead of pledging the loans, because they were relying so heavily on these representations and warranties. Now, Mauricio, you are our go to when we get these kind of litigations between lenders and borrowers. Do the rest of the complaints strike you as particularly unusual for defaulting borrower scenario? Or is it really just the fraud that stands out here?

Mauricio Espana: 5:36

It's the fraud. I mean, essentially Cantor Group, actually, if you do a search for Cantor Group, it's got maybe another five or 10 lawsuits that are the run of the mill, right? They didn't pay. There's a default. Typical lawsuits against borrowers who may be going through some troubles and are a little late, but these stand up because the underlying allegations here are straight fraud. They obviously didn't pay back what was owed. But the default are based almost entirely on the fraud and the misrepresentations.

Jon Gaynor: 6:05

And that's really relevant, because a lot of the times you get these full recourse guarantees that will be triggered on bad acts like fraud, and that's at stake in these complaints too, right?

Mauricio Espana: 6:15

Absolutely right. Because you go after, obviously, the borrower, but you go after the guarantors.

Jon Gaynor: 6:22

Okay. So fraud is a kind of persistent risk in any kind of lending transaction. We do a lot of things to guard against potential fraud and to make sure that we've got a perfected security interest, but this is causing some consternation. But if you talk to people one on one, loan originators will tell you that they are constantly catching and stopping fraud before it gets any further from, you know, their borrowers. And I'll also kind of note that, like this is something the industry in commercial real estate is reckoning with. We're paying attention to it because we want to guard our structures and make sure that we're in good shape in warehouse, which, you know, I do a lot of, we take the original promissory note, because you perfect a security interest. By having that promissory note in your possession, we get assignments in blank for that. We have a custodian that holds a recorded mortgage in the name of our counterparty. And by doing that, we at least have some comfort that at some point there was a mortgage recorded in their name. But it seems like things like having direct access to third parties like title companies for their reports, so that you're getting those reports directly, having the ability to do ongoing due diligence so you can run your own title searches like you mentioned, these are all prudent things that the industry is looking at in order to make sure that they are protected.

Mauricio Espana: 7:42

And I think that that's right, Jon. I mean, obviously, if you can take those steps in terms of getting a custodian in place, getting the original notes, that gives you significant protection. But there are some simpler things too, like you just mentioned, right, getting the title report directly from the title company. It's something that should be pretty feasible if you can do your own searches even better. I understand sometimes the deals are on a tight timeframe, and you can't do it right before the deal closes, but I'm sure there's usually time right after deal closes for you to do that and take whatever remedies and exercise any remedies you have in the event you do find that there aren't instances, maybe it's a mishap, maybe it's a mistake, or maybe it's straight fraud. But if you do realize that the loans are pledged to someone else, or that the borrower may have misrepresented some of the facts, you exercise your remedies as soon as possible,

Jon Gaynor: 8:33

Right, to limit the damage. There's a real trust but verify thing that's got to be put into place. Mauricio, thank you so much for your time and for breaking down these two cases for us and maybe helping people understand like the nature of the risks that we're facing here.

Mauricio Espana: 8:48

Absolutely thanks again for having me, Jon.

Kate Mylod: 8:53

Now on to today's guest, Richard Flohr. Richard is a partner of CrossHarbor Capital Partners, where he is the portfolio manager for CrossHarbor's debt strategies. Prior to CrossHarbor, Richard had an illustrious career at Prudential where for more than 25 years he led the capital markets and CMBS programs. Richard has been with CrossHarbor for just shy of eight years, where he heads the commercial lending platform, Richard, we're delighted to have you on today's 4 Real podcast. Welcome.

Richard Flohr: 9:23

Well, thank you for having me. It's a pleasure to be here. I don't get to ask about the turkey trot thing. I don't get to opine? Because, you know, your lawyerly answer was really good. Like, it depends, like, 5k. Yeah, 10k. Not so much. Half marathon? I don't even like to drive that far.

Kate Mylod: 9:40

I don't know if there are half marathons on Thanksgiving. God bless those runners.

Jon Gaynor: 9:45

Well, the guest got 4 Real with us before we could get 4 Real with them. So that counts too.

Kate Mylod: 9:49

I think that's the first time we lost that jump off.

Jon Gaynor: 9:52

That's right

Kate Mylod: 9:54

Well done, Richard.

Jon Gaynor: 9:55

Do you want to tell us a little bit about cross harbor and its origination story? Sure.

Richard Flohr: 10:00

Sure. So we are a real estate private equity firm founded 32 years ago by two partners who are still partners today. So I think we're the longest running show in the real estate private equity business from a continuity standpoint. And we basically have three lines of business. The one that I head up on the direct lending strategy. We have an equity strategy, opportunistic where we do a number of different things, ground up development. We do high octane preferred equity and mezzanine debt. And then we have another part of our business that is probably the most exciting part of our business. I call it our Montana business. It's really kind of special situations, but we have, as a result of distressed debt deals, acquired a fair amount of real estate in Big Sky Montana, and have developed some of the nicest hotels and ski resorts that you could possibly imagine. So that's the fun part of our business. Now we can talk about the boring part of our business.

Jon Gaynor: 10:51

I think your part of the business is really interesting and fun, and that's why we brought you in to talk about it. What distinguishes CrossHarbor in the space of alternative lenders?

Unknown: 11:01

The biggest distinction is that our first deal 32 years ago was a debt deal. You know, I like to say that we've been doing debt before it became trendy to do debt. I never thought I would say that sentence. And 50% of our business over the last 32 years has been debt. So we understand debt in a way that I think differentiates us in the private equity space. And, you know, again, I'm not suggesting that we're the only ones that can do it. I am saying that we've probably been doing it for longer than anybody else.

Kate Mylod: 11:30

So with doing debt for that long, Richard, for 32 years at this point, how has your debt investment strategy changed over that time period?

Richard Flohr: 11:39

I mean, I think you have to look property specific in terms of sectors that you like and don't like. 32 years ago, you know, I don't know that people were so focused on industrial and multifamily. Nobody wanted really, yeah, and there were no data centers, and people didn't want anything know what they were going to be, right? And nobody wanted to do anything where there was a bed, because you thought, Oh, my God, I'm gonna have to go fix a toilet. So I think that that's changed dramatically, but the fundamental thesis behind it hasn't changed in terms of just where there are opportunities to get paid attractive returns with downside protection. I mean, that's what debt investing is. And you know, 32 years ago, I don't think it was institutionally as accepted as it is today. And it's still not institutionally accepted. It's becoming more institutionally accepted. So to me, the biggest change is that acceptance hopefully increasing, and then just the acknowledgement that real estate debt, if you think about the real estate universe, two thirds of it is debt. I mean, that's a lot. And now I think people are focusing on the fact that there are attractive opportunities, and especially in an environment where you have uncertainty around values, the downside protection that debt affords you is, let's just say, valuable.

Jon Gaynor: 12:52

Totally. So speaking of kind of like property types, and it ebbing and flowing over time, one sector that we've seen a lot of chop with is multifamily. It was super hot during covid. It was everyone's darling. And then we saw more stress in that space for the last, say, 12 to 18 months, especially in kind of like those 2022 vintage loans, we saw some markets oversaturated. What are your thoughts on multifamily, and how have you been weathering this market shift? And like in the current environment, what are you thinking about multifamily?

Richard Flohr: 13:23

I mean, there's no doubt in 21 in early 22 it was overheated. I mean, you were seeing cap rates that just didn't make any economic sense. At the end of the day, people buy real estate because it produces cash flow. And if you can buy cash flow at the risk free rate, you can buy a treasury at a rate comparable to what you're buying a risky asset at. That doesn't make any sense, and that's what people were doing now in terms of just the overall perspective on multifamily. I mean, I do think I'm sitting in New York right now. I'm a New Yorker originally. I live in Chicago now, but I'm familiar with how unaffordable home prices are in the New York area. And when you think about it, if you're 30 years old, 35 years old, and you want to buy a house, you have to save up a lot of money after taxes, and then still have to pay an expensive mortgage, so you're staying in your apartment longer, and that's a trend that's going to be for the foreseeable future. So I look at multifamily and I see really good dynamics. We have a slide in one of our decks the average cost of buying a unit, and just, let's just say it's a random unit, is $3,200 the cost of renting that unit is $1,800 now, again, I'm taking some poetic license with the numbers, but that's the biggest gap we've ever had over the last 30 years. So the future of multifamily is bright. You're 100% right. You know, three years ago, four years ago, people were making unrealistic assumptions about rent growth, and that is what tripped up a lot of folks. By the way, we like multifamily and industrial I have two kids. I love them both the same.

Jon Gaynor: 14:53

That's what they all say.

Richard Flohr: 14:54

Well, my daughter listens to this, Honey, I love you more. No, I love. You just as much, but in industrial you can push rents at a much higher and more aggressive rate than you can in multifamily, because at the end of the day, multifamily rents are capped by how much someone makes, and we're entering a phase in the cycle where there's going to be some ceiling on terms of compensation. So that's going to be a challenge that we are going to continue to deal with. But at the moment, we need more multifamily housing. Yes, there's markets where it's overbuilt and concessions are definitely rampant, but if you look at absorption in those markets, the last couple of quarters have been strong, so that supply overhang is going to go away, and that's part of the reason we are like leaning into multifamily at this phase in the cycle. That was a long answer there. Sorry.

Jon Gaynor: 15:39

That was really in depth, and it gives some real market color.

Kate Mylod: 15:44

No, that was great. Richard, I want to unpack that a little bit more. One thing that I know that cross harbor also invests in, and maybe you can overlay this with your two beloved children, industrial and multi-family construction, ground up construction. Tell us how that fits into your strategy.

Unknown: 16:00

So from a lending standpoint, it's actually, I think, in today's environment, the best risk adjusted returns that we can provide on the debt side, because in our thesis, the market sort of MIS prices construction risk because they lump all the asset classes together. We're sitting in a beautiful office building in Bryant Park. I don't know exactly how long it took to build this building, but it probably took two to three years to build this building. It's fair. We finance industrial real estate. It's four walls, a roof and a floor. It takes six months to build. It's a much different level of construction complexity. So when you think about like, how do lenders think? Which is a scary, scary thought, Low risk, low return. That's the bank and the insurance company. Then you take a little bit more risk at a little higher return. That's us on the bridge lending side. And then there's construction lending, and that's the highest risk, and you theoretically get the highest return. Well, the risk of an industrial construction loan is way different than the risk of 40 story or 50 story office building, but you get paid the same so you're getting alpha, and that's our thesis, and we've been doing it now for eight years, since I joined CrossHarbor, and the returns that we're getting are just, just say, in many instances above what you're getting on the equity, and yet, we're the debt.

Kate Mylod: 17:18

Which is phenomenal.

Jon Gaynor: 17:19

Yeah. And, I mean, like, break it down, right? You have a loan. It has some sort of prepayment premium. The project finishes on time and leases early. They want to get out of expensive construction debt and refinance it with either a bridge debt or term debt. They're willing to pay that prepayment premium, and then that's, that's your return.

Unknown: 17:38

exactly, exactly. And I'm not suggesting that borrowers are, you know, price insensitive. They're very price sensitive. But one fundamental difference between construction lending and the transitional lending is interest on a construction loan is capitalized so it becomes part of your cost structure, and the costs of interest is a small component of the overall construction project. So you have a level of price sensitivity. If every month I have to write a check based upon the amount of income I get, I'm very price sensitive. If every month there's an interest reserve that's already pre funded, I'm price sensitive, but not as much, and I'm more sensitive about proceeds and certainty of execution.

Kate Mylod: 18:17

And then how does construction lending fit into the life cycle of your funds?

Unknown: 18:23

So that's a great question. So we have a fund right now. We launched it about three years ago. It's coming up on its investment life. It's a closed end Fund, and the thought would be to do it again, you know, it'll be more than likely a series of closed end funds. I don't know, you know, I'm not smart enough to look into the future. I can tell you that I don't see this opportunity going away anytime soon, but it lends itself to a closed end strategy, because if it does feel like the opportunity is not there anymore, we'll just stop doing it.

Jon Gaynor: 18:53

Right. So you can, you can pause so an evergreen structure or something like, that doesn't feel like it can meet the moment in terms of market dynamics.

Unknown: 19:00

So our other fund is an evergreen fund, and I'm a fan of evergreen funds, but I think the other part is investors who invested in evergreen funds. Why'd they do it? Because they thought there's some measure of liquidity. What has this cycle taught us? There is no liquidity in evergreen funds. Now debt actually has more liquidity than equity, because in order for me to create liquidity in a debt open end vehicle, all I have to do is get paid back, as opposed to, if I'm in an equity, open end vehicle, and aim to create liquidity, I got to sell an asset. And selling an asset when everybody wants liquidity is typically not the best time to sell the asset.

Jon Gaynor: 19:34

Yeah, you're gonna lose on price. Real bad. I get that.

Unknown: 19:36

So I think, you know from just again, my crystal ball is flawed. The demand for evergreen funds is going to be significantly low going forward, in my opinion, because a lot of investors who thought they had liquidity realized that they don't have liquidity.

Jon Gaynor: 19:51

Yeah, and evergreen funds will do things like cap your ability to redeem or get out of it, and all sorts of ways to kind of manage and protect the kind of vehicle itself.

Richard Flohr: 19:59

Right. You have all the liquidity you want until you want it, and then you don't have any.

Jon Gaynor: 20:02

Precisely.

Kate Mylod: 20:03

Whereas, with the closed end funds, you can keep rinsing and repeating until you don't need to repeat.

Unknown: 20:07

Right. And so you know, the strategy, look, you asked about 32 years ago, the strategy 32 years ago would be different from what it is today. I promise you I will not be doing this 32 years from now, but whatever, whoever's in this chair is going to be talking about something different than what I'm talking about.

Jon Gaynor: 20:22

My crystal ball gets real flawed that far. I'm hoping you know, I mean, I might be sitting in this chair in 32 years, but I guess we'll see. We've had the chance to work together putting back leverage in place for the benefit of CrossHarbor. How do you think about back leverage? Does it fit into all of your strategies? Have you found banks that are willing to work with you? Like give us a little bit of an overview there.

Unknown: 20:43

Yeah, I mean, I think back leverage is something that if you do it right, it's a wonderful thing. If you do it wrong and put on too much, it's like anything else. I mean, milk is great for you, but if you drink eight gallons of milk a day, that's really bad for you. So it's a question of quantity, right? And if you apply back leverage judiciously, it can enhance your returns without dramatically increasing your risk profile. And we've done that in our open end fund. You guys have been, were instrumental. You led our CLO, we did a CLO I'm a huge fan of CLOs. The challenge with CLOs is, you know, the marketplace is somewhat fickle. I don't have to tell you guys that, right? So we look at all forms of back leverage, a notes, note on note, warehouse lines, and I think you just have to look at, where's the best cut off point, right, for the leverage that you're comfortable putting on, what's your best execution? And if you have all the options of open to you, well, explore all the options. Construction lending is a little more challenging, because at the moment, the CLO market is not really open for that. And I think that may change. There was a deal I think that you guys were involved in where there was some construction component to it. I think that's the exception, rather than the rules. So you have to look at a notes, note on note and warehouse line for us. And again, we explore all of those, we're fortunate in that we've been able to obtain a warehouse line for construction lending. That is not an easy thing to do in this environment. I do think that will maybe slightly change. Banks are starting to look at their own cost of capital as they do things, and the cost of them doing the loan itself is greater than if they do the note on note, even if it's the same economics. That doesn't make any sense, but those are the rules. So you know, we're exploiting that, and I think that is critical to our strategy, because we can generate incredibly attractive, unlevered returns, but if we can do back leverage appropriately, we can generate even more attractive returns without fundamentally changing the risk profile.

Jon Gaynor: 22:44

The fact that you're finding folks willing to work with you on back levering the construction assets, takes an already great return and then kind of like, moves it even a step further, which I think is really awesome for you and for your investors.

Kate Mylod: 22:57

So we're talking about this great track record that CrossHarbor has had with this strategy and that you've been able to oversee. Let's talk a little bit about distress though. What do you do when things go sideways?

Richard Flohr: 23:10

Do we have to talk about construction, considering we play the whole field here?

Kate Mylod: 23:15

I think sprinkling and then a little bit of distress is good.

Unknown: 23:18

So the biggest thing is, when you make the loan, there's no building there, right? So that creates a different risk profile than we make a loan from our transitional lending fund, there's a building there, so the most important thing we do to minimize distress is make sure the building gets built. That's the most important thing we can do. But what people don't realize, let's just pretend for a moment, I make a 75% loan to cost construction loan, well, I don't put that money out until the borrowers put their equity in. So my initial disbursements, my loan to cost is like 10% 20% so the alignment of interest for the borrower to make sure the building gets built is pretty high. And I don't get to 75% loan to cost until the building is built, when the risk of construction is gone. But the most important thing that we can do, and I'm very fortunate, and I'm not marketing here, we've never had a default. We've never had a late payment, because construction lending is incredibly labor intensive. And what do I mean by that? It means every month, we're going out to the property to make sure that the materials that were billed were delivered and installed properly. Every month, we're re underwriting the loan to make sure the interest reserve is sufficient to cover you through the construction period. This is a very labor intensive process, but it minimizes distress. If you fail to do any of these steps, the probability of distress goes up. And what I can tell you is distress in a construction project is way worse than distress in a finished project, because in order for you to remedy it, you're stepping into a failed construction project, and that's what you have to avoid, right? That's what you have to avoid. And the good thing about cross harbor is we're not just lending on this stuff. We're developing it on the equity side. We're very active developers. So in the event something did go wrong, which it hasn't, we can step in and finish the project, but the key is making sure each month, everything is as it's supposed to be, and if it's not pausing the funding of the construction to put the loan back in balance, to get things back on track.

Kate Mylod: 25:17

So speak about this being a labor intensive business, which you know, both literally and figuratively. It is. It's also what I thought you might say, Richard and I want you to speak on this a little bit. It's a relationship intensive business, too. I mean, right? We all say in across the commercial real estate spectrum, it comes down to who you know. But I would imagine, particularly in the construction space, those relationships really matter.

Unknown: 25:40

If they do for sure, you know, again, without trying to talk our own book, if you're selective and who you do business with, you can create some very strong relationships. And again, I am a big believer when we make non recourse construction loans. Now, there is a recourse component to the completion of the building, and there's a recourse component to the interest and carry but at the end of the day, when the building's done, you can hand us back the keys. I'm not upset by that, right? That's the contract that we've made. There are lenders who get, Oh, my God, they defaulted on a loan. I'll never do business with them. Well, you know, if the reason for the default, if the if the loan is so far out of the money that it's not in the borrower's best interest to fund more capital, I don't that's the contract, right? That's a non recourse loan. But to your point about relationships, if you do that often enough, you're going to run out of people to do business with. So what we lend on is probably the most important thing. If that's one A, 1b is who we lend to. Because what I can tell you about construction is something's going to happen during the process that you hadn't thought of and you need to be able to remedy that by either experience or capital or both. So if you damage your relationship with lenders so that you can't get that construction loan, then you're in essence, putting yourself out of business. And we're very selective, and I know everybody says that, but it's true, because again, one day, who you do business with is going to determine whether or not the project gets built the way you want it to get built.

Kate Mylod: 27:06

I would imagine that relationship works both ways. Right? It's not just you and your sponsor who's developing the project, but also turn around where you've done back leverage, right? Your relationship with that back leverage provider?

Unknown: 27:18

Oh, yeah, well, the back leverage providers have got it figured out, and John can talk. They're not dumb, like, you know, there's all sorts of safety mechanisms built in to credit facilities that, you know, sure would make it hard for us to but it has to all hang together. It does, and you have to have a relationship with them, because what I can tell you is, servicing these loans, it's a living, breathing thing. So if you have credibility with your back leverage provider, you're going to have a lot more latitude on the servicing front. That's just critically important.

Jon Gaynor: 27:47

And a lot of these facilities are premised on an idea of consistent and open communication about what's going on. And my experience has been that most back leverage providers will work with you, even if the docs allow them to start really putting the screws in?

Richard Flohr: 28:01

Yeah. I mean, I think we saw that during COVID for sure, right?

Jon Gaynor: 28:04

Yeah.

Richard Flohr: 28:04

I mean, your point is spot on about relationships, right? We always say this is a relationship and it is a relationship business, and one of the things that we pride ourselves on is 65% of the business we've done is with repeat borrowers. It amazes me. I'm not going to speak badly about anybody, but, you know, there's some large financial institutions, and I've talked to borrowers after they did loans with them, they said, I'll never do another loan with that group again. To me, that's the dumbest thing that you could do, right? You go through the brain damage of doing the first loan, get docs in place, but you made the closing process so brutal that they never want to do another loan with you again. That's the opposite of what you want to do.

Jon Gaynor: 28:39

That's right, there is some real benefit to getting comfortable on a deal and being able to, like, replicate it some way or another. Thing on the labor intensive part that got me thinking is, how do you see AI fitting into the future of real estate lending? Like, what are your thoughts on that? Like, do you think it's there? Is it getting there.

Unknown: 29:01

I mean, it's definitely there in a sense it exists. It's getting there in a sense that we're all trying to figure out how to use it. I think there's still always be a human overlay to this, but some of the analytics that we do, AI will be able to do that at some point in time, if not in the very near future. That said, AI can't go out to the site and make sure that the steel was installed correctly, right? I mean, AI can't do that, at least not yet. Maybe there'll be robots one day.

Jon Gaynor: 29:31

I see the advertisements in New York, there's, like, a robot they're marketing now, you buy it early and like, there's literally a human piloting the robot from a data center somewhere else. So, like, the robots are still far away too. It'd still be your people just going in robot form.

Kate Mylod: 29:46

Save on airfare.

Unknown: 29:47

This is sort of, sort of a bit of a tangent. I was out in San Francisco a couple of months ago, and I took a Waymo, yeah, and it was really cool, except it was during rush hour, and the way mo got stuck because. The intersection. You know, the traffic light was changing. So of course, there were cars in the intersection, and like, seven light changes later, the car hasn't moved. We finally hit a button and some human overrode the Waymo to actually make the left turn right. So I think there's going to always be a human element to this, by the way, it was a cool experience.

Jon Gaynor: 30:19

Yeah. I haven't done a Waymo yet. I think they're not in Philly as of yet. I also think that, you know, some cities like Boston, I'm not sure that I ever want to be Chicago is also not a great like, you know, driving city, in my opinion, there's like, one intersection where it feels like you're driving directly into oncoming traffic to go to your your street.

Richard Flohr: 30:37

I was like, here's what I'll say. As a New Yorker, I can say this, when I moved to Chicago, they have four way intersections of big streets with stop signs. I'm like in New York, that would never work. No one's gonna be in the middle of the intersection. No. But going back to your technology, I think it's we're just in the early innings of this. It's going to develop. We're going to be able to use it. It's still not going to be a replacement for the human element.

Jon Gaynor: 31:01

Hard pivot from relationships with AI, sounds like you've been very fortunate being in the driver's seat in this space, and I think you've seen a lot over your career. So what do you have to say to developers or sponsors that are interested in working in doing, you know, project finance for industrial and multifamily, like, what's the advice you would give them?

Unknown: 31:24

It's a great question. I think it's probably similar across both property sectors in that there's an advantage to being a first mover. You mentioned markets where there's a huge supply overhang, Austin, for example, but if you look at the trend, two years from now, there won't be a supply overhang. So you want to be the first one with a new project, not the last one with a new project. And just ask the people that delivered in Austin in 21 versus the people that delivered in 23 much different experience, right? And there's an opportunity now, because I do think it's still a little unclear where values are. So if you're going to start a new construction project. You know what the cost is going to be, but you really know what the value is going to be. And there's going to be people that pause, and I think two years from now, they're going to regret it, because certainly in the multifamily space, you can connect the dots very easily in terms of just we need more multifamily. In the logistics space, it's the same thing. I mean, I do think there's markets where it's an under supply of what brand new logistics, what you need, right? There's, I live in Chicago. Chicago is a billion square foot market, but a lot of the inventory was from 40 years ago, right? That building is functional for certain type tenant, but not for the new logistics user that that needs it today. So if you're gonna go do this, don't be reluctant to be a first mover. You're going to be happy about it two years from now, because there's a lot of people right now, they're still waiting for that moment of perfection. And I'm a big believer that perfect never comes.

Jon Gaynor: 32:52

Yeah, you have to have conviction around the thesis and go, like, follow where the people are, where are the jobs, that sort of thing.

Unknown: 32:59

I mean, you you touched on people ask like, how do you determine your markets? And I would love to say that we have a proprietary algorithm only we know how to use. It's so secret, I can't even tell you about it, but it's really that simple, right? Follow the people. Follow the jobs. If you have people moving to places where jobs are being created that need more housing, right? Okay, that's easy. Follow the goods, right? If the goods are coming into the Port of Los Angeles, and going through Chicago on their way to New York, well, you can figure out where you're going to need more logistics space. So it isn't that complicated. I wish it was.

Jon Gaynor: 33:32

Yeah, right.

Kate Mylod: 33:33

And I mean, Richard, this has been great. You've made construction finance sounds so easy. It would be fabulous to have you come and teach a whole bunch of people about this.

Richard Flohr: 33:43

Be careful what you wish for.

Kate Mylod: 33:46

But before we close out looking on the horizon to 2026 any thing that's on your mind, what do you see influencing cross harbor and its strategies, or just the things that you are keeping your finger on the pulse of as they're percolating as we wind down the year?

Unknown: 34:02

Yeah. I mean, I do think there's an uncertainty in the marketplace that's going to exist in 2026 I don't think we're going to have this moment of clarity, and I think a large part of that is interest rates, right? I mean, I think until you know what the risk free rate is, how do you price a risky asset? And you can look at different signals in the marketplace today about what the risk free rate is going to be in the future. What I can tell you is, a lot of times those signals are wrong. If you look at the forward curve, what people predict over the last 20 years, the one constant theme is is always wrong. So when I think about the risks facing our industry, high interest rates are a big risk. And you know, I'm not saying what I'm saying to be political. I'm just saying it as a fact. We're running at a big deficit, and we're going to increase our deficit, and we have to sell bonds to fund that deficit. Are the bond buyers going to be there at the rates that we think they're going to be? And if they're not, what does that mean? You may think you're getting a great deal on a class, a multi at a five and a half cap rate, but if the 10 year treasury is 5% you didn't get such a good deal. We need to have. A little bit more clarity about where rates are going to settle before we can have conviction about what the assets were.

Jon Gaynor: 35:07

All right. Well, Richard, it was awesome to talk with you. Thank you for making time to come to the podcast. It's my pleasure. Thank you for having me, and thank you for joining us for another episode of Dechert's 4 Real podcast. If you have any thoughts, please share them with us at our email inbox. Real podcast@decker.com Also, if you like what you heard, give us a five star rating on whatever platform you found this on this episode was hosted by Kate Mylod and me, Jon Gaynor, Stuart McQueen, Sam Gilbert and Matt Armstrong produced it. Production support is by Kara Ray, Mallory Gorham, Alyssa Norton, Peggy Heffner, James Wortman and Jacob Kimmel. Our editor is Andy Robbins of Audio File Solutions. Thanks for listening, and we'll see you next time on the Dechert 4 Real podcast. All right, we can't break without a few dad jokes.

Kate Mylod: 35:52

All right, I can get the ball rolling on this, Jon.

Jon Gaynor: 35:54

Okay.

Kate Mylod: 35:55

Speaking of running, why don't bananas run marathons? Why is that? They just aren't appealing to them.

Jon Gaynor: 36:04

Oof, ok. All right, so, all right, I'll do one, and then Richard, we're saving the best for last. I hope not to, like set expectations too high. But why did the cranberries turn red?

Kate Mylod: 36:17

I don't know, Jon, why did they turn red?

Jon Gaynor: 36:19

Because they saw the turkey dressing. All right, we're setting you up for success.

Unknown: 36:31

I really wish I studied harder for this test. All right, what's a better invention than the first telephone?

Kate Mylod: 36:38

I don't know, what?

Richard Flohr: 36:39

The second telephone.

Kate Mylod: 36:40

Ah, good point. That made our crowd here chuckle. Well done, Richard.