Decoding the Debt Markets: Lessons Learned from Financial Crises of the Past

 Learn to leverage debt strategically with Devin Jolley, debt markets expert and President of Davidson Companies. Jolley shares his experience navigating financial upheavals from the Great Financial Crisis to COVID-19. Discover how past crises reshaped risk management, shifting from deal-making to caution. Understand the recovery of financial institutions post-pandemic, the resurgence of community banks, and regulatory shifts. Get expert insights on securing favorable loans in today’s debt landscape.

Transcript

Rachel Oh 0:04

Welcome to Peaks and Portfolios presented by PEG Companies, your go-to podcast for all things commercial real estate investment. I'm Rachel oh, and together we're diving into current events, trends, issues and opportunities impacting the CRE investment space, from dissecting the latest market moves to sharing insights on today's commercial real estate landscape. It's time to maximize portfolios here in the peaks of the Mountain West and beyond.

Rachel Oh 0:37

Okay, welcome everybody again from the peaks of the Mountain West high up here on the Wasatch Front. We are excited to talk all things real estate, the economy and anything else that may come about. Thank you for joining us today for this week's episode of Peaks and Portfolios presented by Peg Companies In commercial real estate, equity and capital markets gets a lot of attention, which, in my role at Peg, is what I'm most focused on. However, the larger part of the capital stack is the debt secured and, like during any cycle, the debt story has its twists and turns and we're definitely seeing that as headlines loom about the trillions of dollars of debt maturing. To better understand commercial real estate finance in today's market, I can't think of anyone better than my good and dear friend and now esteemed guest Devin Jolly, president of the Davidson Family Office, a family with roots in the firearm industryemed guest Devin Jolly, president of the Davidson Family Office, a family with roots in the firearm industry. Welcome, Devin.

Devin Jolley 1:29

Thank you, Rachel. Appreciate the introduction.

Rachel Oh 1:32

Thank you so much for joining us today. Just curious what have you been kind of focused on lately in your role at Davidson?

Devin Jolley 1:39

As a family office, we're focused on finding commercial real estate deals, primarily in the debt and equity space. We would do private loans. We're seeing a lot of opportunity in that space and we're also willing to come in with equity investments for the right transaction, provide guarantees where it makes sense. They have a number of firearm businesses, they have a cell phone business, they have a Tesla charging station business, and then on the family office side, we are looking to deploy capital into different commercial real estate assets. So, whether that's debt or equity investments, we're looking at both, seeing a number of different opportunities in both those spaces. It's a really good time to kind of be in this space. These troubling times bring opportunities and these are some of the best times to invest, you know if you're in the right spot. So still heavily involved in the capital markets in a lot of ways.

Rachel Oh 2:35

I'm going to come knocking on your door for money. By the way, you know this right.

Devin Jolley 2:38

That's right. Hey, we would love to invest with Peg Awesome. We've seen a lot of good. Hey, we would love to invest with Peg Awesome. We've seen a lot of good deals and I love what Peg's doing, so we would absolutely welcome that.

Rachel Oh 2:51

Awesome, I'm going to hold you to that. Thank you, devin. Okay, so to give everyone a little bit of background on Devin, let me kind of toot your horn a bit. You've been now at this close to 16 years right of experience in the commercial real estate finance industry. Obviously, you're now heading up a company. You spent most of your career in banking where you financed construction, bridge, permanent and line of credit facilities at KeyBank, symmetra, life Insurance Company, agon and a boutique mortgage banking firm called Glacier a boutique mortgage banking firm called Glacier.

Rachel Oh 3:25

You have a unique understanding of debt through your various roles, including seeing debt from the broker perspective side, the lender perspective and, most recently, from the borrower side. So I wanted to ask you a little bit about debt from your experience. If you wouldn't mind, can you take me back to when you first started in this industry and what it was like? I mean, this is what you said about 16 years. So what was debt like back then? And just tell me what the economy and what was. You know, what was commercial lending like back then?

Devin Jolley 3:56

Yeah, and I'll even back up a little further than that. You know my first entry into the commercial or into the real estate was in college. So actually Garth Davison, who I work for now. I worked for him back in college. So we were doing residential loans back in early 2000s, 2003, 4, 5. And I thought that's what I wanted to do for my career. I wanted to do residential loans and I remember I had a buddy that was doing residential loans and I was working at a cell phone but there was kind of a big craze to get into that space and you know I was young and it looked really exciting and got myself into the residential real estate side and there was a couple of really good years and it was very exciting to be in college.

Rachel Oh 4:59

This was the early 2000s, yeah.

Devin Jolley 5:00

Okay, yeah. And then I was introduced to commercial real estate from an uncle who was in the space on the finance space and he said why are you doing residential? You should be doing commercial. And kind of lined up an internship in Cedar Rapids, iowa. So I moved out there.

Rachel Oh 5:16

Cedar Rapids. What's in Cedar Rapids, Iowa?

Devin Jolley 5:19

Yeah, agon Life Insurance Company. Okay. So a big life insurance company was out there and got a role to work for Agon, and that was kind of my first entry into commercial real estate finance and then, kind of the rest is history. I, you know from there, went on to a boutique mortgage banking shop where we were brokering loans to different life insurance companies. Then the great financial crisis happened.

Rachel Oh 5:45

Okay, so let's talk about that. What was lending like during the GFC?

Devin Jolley 5:52

You know that was interesting, right? I mean prior to that time-. And you were young, right. You were early in your career.

Rachel Oh 5:59

Were you just like oh my gosh, what did I just do Exactly?

Devin Jolley 6:03

I am in the commercial real estate finance industry and going through the GFC crisis, it was a unique time to be in that space. Right Banks were failing, life insurance companies were failing AIG, lehman Brothers but at the same time, I think it was probably the best time to have an introduction into commercial real estate why? Because tell me why.

Devin Jolley 6:27

Yeah, I mean, you saw the problems right, you saw what could go wrong, and it made you think about risk differently and how we should underwrite, how we should, you know, consider risk in commercial real estate. And you know, some of those lessons have not. You know, I haven't forgotten some of those lessons. It was a scary time, you know. I think that's the interesting. You know part of where we're at today because it's been 16 years. Yeah.

Devin Jolley 6:54

Right, I look at some of these newer guys that are coming out of college. Yeah, and where were they during the last financial? They were in elementary school or junior high or high school.

Rachel Oh 7:05

They have lived the high life right, yeah and they probably just didn't see, and also like zero interest rates, right? I mean, they don't even know what they don't know.

Devin Jolley 7:15

Yeah, in a lot of ways, and so I think in prior to this time, we had a recession on average every seven to eight years, and here we've had a long expansion cycle 16 years and I think it's good right. I think we're in some ways. There needs to be a little bit of reset and we can get into that later on the podcast and where some of maybe the pain points are Devin.

Rachel Oh 7:36

did you just say we're old?

Devin Jolley 7:38

I don't feel like that at all.

Rachel Oh 7:40

I just feel like You're like 16 years and we're talking about the young kids.

Devin Jolley 7:43

They don't know anything but you know I look at Cameron Gunter over there at PEG and you know some of the other executives that have been through multiple cycles, and you know I only have one. I have one experience under my belt and I guess more recently COVID, if you want to count that as a small blip. But no, I think I think learning during those times. Well, first of all, there's a lot to learn during those times and it gives you a much different perspective, which I think is needed. Yeah, no for sure.

Rachel Oh 8:15

Okay, so let's go back to the GFC. You're young in your career. Now the world has literally collapsed. It's the greatest financial crisis the world has really seen since, probably even surpasses the great depression. So you know, what did you guys do? Did you? Were you making any loans? Were you just underwriting and just passing on everything? And what were deposits looking like? I mean, they're probably gone, right, they're just they're what? What happened? I mean, the dow was at what? Seven thousand some insane. I don't even remember what it was.

Devin Jolley 8:45

I just remember driving into work every day and it was like the Dow dropped 1,200 points, the Dow dropped 800, and it was like day after day after day, and I didn't even know what that meant.

Rachel Oh 8:56

So you had a job.

Devin Jolley 8:57

So I had a job and you know, at some point you know, I kind of realized that you know a job's a luxury.

Devin Jolley 9:09

I wasn't paid very much at all but a job was a luxury and I was gaining a ton of experience. That's good perspective. And you know I had a lot of buddies that went back to college. You know they went back to get their master's degree and I felt I was learning so much in my role from going through that that that was part of my master's degree in some extent. You know I was learning.

Financial Crisis Impact and Recovery

Devin Jolley 9:24

But you got a master's degree I did. Later I went back and got a master's degree in finance and yeah, it was interesting. You know, I worked for a small boutique mortgage banking company and their business was to place life insurance company debt with their borrowers and that was primarily their business. They really weren't doing a whole lot of bank debt or anything else. It was life insurance companies and, as we saw from the great financial crisis, you know, there's ripple effects. This did not just affect the banks, but this affected the life insurance companies as well. Aig failed right, and everyone, everyone was entangled in this right.

Rachel Oh 10:02

Wall.

Devin Jolley 10:03

Street is very entangled amongst each other and it affected everyone, so our business quickly dried up. At Glacier, life insurance companies weren't really lending. Everyone was trying to figure out what type of exposure they had on their balance sheet, so my job was to put together a list of any bank anyone with a pulse that was lending.

Rachel Oh 10:27

Who was lending?

Devin Jolley 10:29

You know, it was random banks.

Rachel Oh 10:32

So they had healthy deposits in place.

Devin Jolley 10:35

You know, for whatever reason, there were some banks that weren't hurt nearly as bad as others.

Rachel Oh 10:42

Was it regional? By any chance, it was more community banks.

Devin Jolley 10:44

To be honest, it was kind of hit or miss. Hurt nearly as bad as others, right, was it regional, by any chance, or was it it was more community banks? To be honest, it was kind of hit or miss, and so I would make hundreds and hundreds of calls and figure out who was on first and who was lending who was not. What were they lending on what?

Devin Jolley 10:58

asset types and I put together a big list for the company and that's what we used to place loans for our clients and you know, it kind of shifted from life company debt placement to banks or really anyone that was lending at that point. So there was a low period and for some time yeah. And then you know it kind of picked back up.

Rachel Oh 11:21

When did it pick back up roughly?

Devin Jolley 11:23

You know, I don't remember exactly. I think it was probably a good year year, year and a half maybe, or more.

Rachel Oh 11:30

So like about 2010-ish Mm-hmm 2000,. Okay.

Devin Jolley 11:32

Yeah, I think these banks needed to understand what type of exposure they really had, what this meant. You know, anytime you go through a crisis, you know cap rates are maybe slow to react yeah, Right, or slow. Anytime you go through a crisis, you know cap rates are maybe slow to react yeah, Right, or slow to rise Right. And you see you start seeing the stress sales and then you know there's transactions and slowly you see kind of that rise in cap rates and kind of the reset, and so it just takes time. Yeah.

Rachel Oh 12:00

Yeah, I mean we know, like in hindsight, that that would have been the time to buy everything, Right? Just?

Devin Jolley 12:06

right.

Rachel Oh 12:07

Everything from the public markets, you know, to just private everything. So how did the banks then see it? I mean, which banks came out strong as a result?

Devin Jolley 12:17

And during the great, great financial crisis, you know, I think it was more community banks that kind of came back and they were probably first to come back. Yeah, for sure.

Rachel Oh 12:27

Which we're kind of seeing. Well, we can get to that in a little bit as we fast forward. But OK, so you're, you're, you know you've got the GFC a little bit behind you You're. When did you go back to get your graduate degree?

Devin Jolley 12:41

Yeah, I spent a couple more years out in Seattle. I worked for Symetra Life Insurance Company. They were a Berkshire Hathaway company and they were they were.

Rachel Oh 12:48

Warren Buffett, great Warren Buffett, yep. A lot of money behind them and the Oracle of oh Omaha. Sorry, I don't know why. I thought Omaha, iowa, ok, different law, but OK, ok.

Devin Jolley 13:00

So you're in.

Rachel Oh 13:01

Seattle, which is my hometown, by the way.

Devin Jolley 13:03

Yeah, love it. Seattle's great. And yeah, I went to Symetra. They were a newer life insurance company. They were not hurt by the great financial crisis, didn't have a whole lot of loan exposure. So my thought was, hey, let's go work for the most active lender in the market. And that's why I went to Symetra and literally saw hundreds and hundreds of deals and that was just rapid growth and development on my side to see volume when everyone else was kind of which makes sense, because I've seen you grind like no tomorrow with all the deals you have.

Rachel Oh 13:38

So that makes so much more sense why you are the way you are. Okay, so you're at an active group that's just doing deal flow. And then lead me up to sort of the next. I mean again, in our lifetime we see different market cycles. What was the period like post the GFC? And then what was your next big? You know?

Devin Jolley 14:03

You know I didn't have a whole lot of commercial real estate experience prior to the GFC. It was very short-lived. But I have a lot of colleagues, former bankers, that would kind of tell me the good old days, the stories of prior to the Great Recession and kind of what banking was like. Yeah, and you know it's very different.

Rachel Oh 14:24

What was it like? Was it just cushy and easy?

Devin Jolley 14:26

It was, there were big bonuses, big payouts and you know real estate always went up and there wasn't a whole lot of risk assessment. In some ways, I think and I think that's the biggest change you know what happened was. You know there was committees formed Basel committee. You know there was committees formed Basel Committee and they are now hyper-focused on looking at the financial you know, solvency of the banking sector, right.

Banking Landscape Post-Pandemic Adjustment

Devin Jolley 14:51

We saw what can happen global meltdown when some of these banks fell. And you know also, you know, remember the great financial crisis. You had some major major banks merge with each other and these banks formed super banks. Sure, and so today we have four ginormous banks. Is that a word? I think so.

Both 15:12

Yeah, anyhow, let's say it. Yeah, let's just pretend it's a word.

Devin Jolley 15:16

So you have four huge banks in the country, multi-trillion dollar banks, and then you have kind of a middle tier I've calledillion dollar banks, and then you have kind of a middle tier of, call it, 20 banks and then the rest of the banks and, by the way, there's 4,800 banks in the country. Give or take. The rest, you know, are much, much smaller. To give you a little bit more perspective, you know the largest bank, jpmorgan Chase by the time you get to the 50th largest bank in the country.

Devin Jolley 15:44

That bank is less than 1% of the size of JPMorgan Chase. So you have these super banks. And you know these committees were formed to make sure that the banking sector was never going to see bank failures again or limit them, and there was a lot of oversight committees. And now, instead of lenders just doing a loan and putting that loan to bed until maturity, now they have to risk rate and re-underwrite their deal on a quarterly basis and be much more diligent on monitoring the progress or monitoring the business plan of these loans and if they're performing or not. And so you know banking became very regulated.

Rachel Oh 16:28

It sounds like it created a bunch of new jobs. Honestly, new job titles, and I mean a lot more risk management, right, a lot more risk management, whereas before it was just kind of like Exactly right, fell into the sunset Interesting, okay.

Devin Jolley 16:39

It's the part of banking that I think everyone hated right, and it was fun making loans and doing deals. It's not so fun monitoring and doing all the administrative reporting that's now involved with banking.

Rachel Oh 16:52

Yeah, so I know that there were more regulations that were put in place post-GFC and it sounds like, based on what you just shared, the banks adjusted and there's far more oversight committees and different risk management roles and et cetera. So let's fast forward a little bit. So pandemic, I mean that hits in 2020. And, by the way, I should mention Devin used to work with us here at PEG For a number of years. He was our director of capital markets over debt. That's how I got to know him, very impressive individual. So just so for some background for our listeners, I remember I think you started at PEG during the pandemic, am I right? Like the week of, or something?

Devin Jolley 17:32

Yes.

Rachel Oh 17:32

Because I didn't know you. We were back in the old building and I was sitting on the fifth floor and I just remember this Devin Jolly like running around with a bunch of papers, just scurrying from Craig's office to the I don't remember where you'd go back and forth, and you were like running around like a chicken with a head cut off. And we're, of course, trying to figure out how do we raise equity when no one was meeting with us, but describe what you were. I mean, I know a little bit about what you're doing, but describe what you were doing, because I think you literally had just joined the company and then all I saw was just you scurrying back and forth it was a wild time.

Devin Jolley 18:01

Yeah, I put in my notice at my old employer and during that two-week period where I put it in, uh, covid became a thing. Remember rudy gobert came out on espn and said I have covid and that's like it. Like broke the news and all of a sudden, like covid was like a real thing. It wasn't just something in France and it was like here in the US.

Rachel Oh 18:19

Now it's like oh my gosh, that was March.

Navigating Market Changes and Challenges

Devin Jolley 18:21

right yeah, the Ebola virus is here, you know we're all going to die. And so, yeah, you're right. I came into new higher orientation day, first day at PEG, and the Dow had dropped and I'm thinking, oh boy, here we go again. This is the second time. You know, I started a new career, you know, and the great financial crisis happened, you know. Now, I start a new role, a new career.

Rachel Oh 18:46

Because you oversell all of debt for PEG.

Devin Jolley 18:49

Yes.

Rachel Oh 18:49

And we're, you know we're at $2 billion AUM right now, so you've helped us secure a lot of that debt. So okay, so brand new role and, once more, another financial crisis.

Devin Jolley 18:59

Yeah, watch out when I changed jobs oh wait, I just did. Maybe you should look out. Right, I get my timings impeccable. So maybe that's foreshadowing something. I don't know.

Rachel Oh 19:09

It better be for the good this time, right.

Devin Jolley 19:12

So yeah, I mean my new role. I think a lot of developers, when the going's good, it's time to make money right, and PEG was no different. We were. Things were going. I mean, you were here, rach, you were raising equity and we had a lot of great projects in the hopper and you know, I thought I was going to come over here and do a lot of debt placement In the first year. It was PPP loans. You know, we had a portfolio with probably 30 hotels that's right, and and you know, during covid there was a.

Devin Jolley 19:43

There was a couple months there, like you know it was. It was scary, you know. No one was staying in hotels.

Rachel Oh 19:48

Our occupancy dropped to almost zero, you know I don't know some places in some places, not all, there were some that like yeah, resort markets, right, yeah, and there was that like one or two month period where like no one knew Nothing.

Devin Jolley 20:01

Yeah, it was. It was kind of crazy, I think it kind of ramped up from there very quickly. But yeah, it was. It was trying to figure out what we had on our books. All these assets were foreign to me. Yeah, you know what were our reserves. Yeah, negotiating, you know, modifications on our loans. Yeah, yeah. Then you know modifications on our loans, yeah. And then you know submitting PPP applications. Yeah. And in some case we had to do that six or seven times because these portals for some of the banks broke down.

Rachel Oh 20:28

I remember it was kind of a disaster. I remember hearing you saying oh my gosh, I have to do this again and again, and again, and again.

Devin Jolley 20:35

It was a wild ride for the first couple of months.

Rachel Oh 20:37

Okay, so that was most of 2020, right? Mm-hmm. And keep in mind, logan and I were in the other room and we were just dialing for—I mean, we were making calls but nobody was traveling. The greatest thing about my time during that time is that I could get like five to ten meetings a day because nobody was traveling. So it was super easy. We were all on—back. Then you know Zoom. Now we use Teams, but that was a thing Like we didn't used to do calls and now everyone's on Zoom and I could literally do five to 10 meetings a day because everybody was at home working and nobody was traveling. So we actually, leading into 2021, had our largest fundraising year ever in history thus far.

Devin Jolley 21:22

In 2020?.

Rachel Oh 21:24

On 2021. 2020, we raised a bunch of capital in the fourth quarter. Nothing in the first three. And then 2021, we had our largest fundraising year to date.

Devin Jolley 21:35

Yeah, and you were financing those loans, by the way. Yeah, we had a couple of huge years. Yeah, it was really date. Yeah, we had a couple of really good loans and you were financing those loans. By the way. Yeah, we had a couple of huge years. Yeah, it was really fun.

Rachel Oh 21:42

Yeah, and then yay for 2023. No, I'm just kidding. Okay, so 2020, a lot of PPP stuff. The world is changing On the lending side. Did you do any? I mean, I don't feel like there was much because you were focused on PPP. It wasn't really until 2021, probably. No, that's not true. We had that portfolio acquisition we did At the end of 2020.

Devin Jolley 22:04

Yeah, late, late 2020. You know, I think anytime there's kind of a crisis, the banks kind of put it on pause, right. I mean, you got to understand for them. You know they got to risk their entire portfolio on a quarterly basis. And so.

Devin Jolley 22:16

I liken that to you know, if you're a lender, why catch a falling knife? If you think that values are declining, you may not jump in and you're going to be very hesitant. And we saw a lot of that with banks. They didn't want to jump in early 20. You know, I remember I was calling, you know, some banks. We had a hotel, if you remember, our Buffalo Hotel, rachel, and it was in Buffalo, new York, and I'm calling banks in June of 20. And they're like why are you calling me? It's like an apocalypse outside.

Rachel Oh 22:47

And in Buffalo it probably was, it was.

Devin Jolley 22:49

Yeah, I think the mark has recovered. Banks started to tiptoe back in Around when you know, probably fourth quarter of 20. And we got a couple of deals done in fourth quarter of 20, then 21 kind of loosened up again and 22 was a great year for Peg 23,. You know we saw the rise of interest rates, 23 was tough for me. I don't know about you, but it was tough for me yeah, we started to really see the rise of interest rates. We saw Silicon Valley Bank and Signature Bank fail.

Rachel Oh 23:25

First Republic Well, I guess they got acquired right, so they didn't fail. Quote unquote.

Devin Jolley 23:30

Yeah, I think that's the second and third largest bank failures in US history. Right, that was a big deal, but we had learned our lessons, right?

Rachel Oh 23:38

Hadn't we learned our lessons from the GFC? There was—I mean, the carnage was not as bad as it could have been because of the— Right. It was a different risk, though, right.

Devin Jolley 23:46

Like the Great Recession, it was don't do bad loans. Because lesson learned if you do, you're going to fail. You know this was different. Yeah, they. There weren't bad loans. Yeah, right, and in some ways you could argue that these banks were maybe too conservative.

Devin Jolley 24:03

Yeah Right, Certainly didn't manage their money well, you know, and they didn't hedge against the inflation risk out there. But I don't think a lot of people thought that rates would rise as fast as they did, and actually I have a chart here that talks about. You know, this is the fastest rise in rates we've ever seen, or at least in some time period, right? So you know now is you know? The narrative is you can fail as a bank if you do bad loans or if you're too conservative, you can fail too.

Banks' Underwriting Criteria in Post-Pandemic Environment

Devin Jolley 24:33

And if you put it in low yielding you know, bonds and investments that aren't hedged against inflation you can fail too. So it's different this time. To your point, the banks have been, you know, stringent in their underwriting.

Rachel Oh 24:47

They've been conservative.

Devin Jolley 24:48

It's not the same as it was last time.

Rachel Oh 24:51

So let's talk about that. What are banks looking for now, now that we're okay, so pandemic is we're in a post-pandemic period, right to your point, interest rates are higher than they have been in recent memory, which, by the way, my parents, who are in their 80s, always like to tell me you guys don't know high interest rates, you complain, but we were, we were, you know, we were, we lived during double digit, uh interest rates. So tell me a little bit kind of about that. Then, how has that affected underwriting and what are the banks looking for now? That's different than maybe before.

Devin Jolley 25:24

Yeah, I mean just going back to last year. I think there was a ripple effect with some of these banks. The question was well, what type of exposure do we have to some of these same investments that Silicon Valley and First Republic and Signature Bank had?

Rachel Oh 25:39

So like asset class wise yeah.

Devin Jolley 25:42

And how are they hedging against inflation? You know, are they going to have the same? Do they have the same type of risk?

Rachel Oh 25:48

And so, and let's see, at its peak it was inflation was like at what? 19%.

Devin Jolley 25:52

Something like that. You know, I don't remember the number, but yeah, I think it was roughly about 19% which is crazy is crazy I mean, we're trying to get down to two.

Rachel Oh 25:59

We're at about 3.4 ish or something, but okay, yeah, so hedging against inflation.

Devin Jolley 26:06

Okay. So I think you know there's a lot of banks that need to understand how, you know what, what was their game plan for that? How high are rates really going to go? And unfortunately, kept seeing rate hikes right up until you know the latter half of right Up until you know the latter half of last year. And I remember thinking, you know, in the fall of last year we were doing a couple of loans and I'm like man, I don't know how much, how much more we can take, like nothing's penciling anymore.

Rachel Oh 26:31

Back in the day. What was it? It was LIBOR plus. What LIBOR plus? You know?

Devin Jolley 26:44

maybe $230, know maybe two 230, and now we're at what you know um now we switch to sofa, or are we now we switch to sofa and sofa, is that? You know 530 basis points? Yeah, up from you know 10 basis points at one point dang in march, um, of I think, 22, I believe it was yeah.

Devin Jolley 26:58

And so we've seen, you know, a 500 basis point increase. You know, and yeah, there was a period I was just like man this. I don't know how much more we can take of this. The interest rate's rising and, you know, nothing's really penciling. How do you get a development deal to work?

Rachel Oh 27:16

I mean they had to have adjusted what was acceptable or what was deemed lendable. At this point I mean right, the whole world is is no one's immune from this interest rate environment. So I mean, for the banks to make any loans, they had to make some adjustments right on how they looked at underwriting. Yeah.

Devin Jolley 27:36

I think they did. I think historically, the way banks have looked at underwriting is, you know, maybe your note rate right. You've got a SOFR plus 230 note rate. That's your actual, what you're actually making your payment on. And a lot of banks looked at you know, when they make a loan they have what's called an underwriting rate and the underwriting rate looks something like this. They'll say hey well, what is the perm rate today? If this loan was stabilized today, what would be the rate? Yeah.

Devin Jolley 28:06

Then they look and say, all right, well, this loan that we have is not going to be stabilized for two years, and so, therefore, I'm going to take today's permanent loan rate.

Devin Jolley 28:15

And apply it and apply a premium or some cushion on that to account for interest rate rise and apply it and apply a premium or you know some cushion on that to account for interest rate rise. And that's how they underwrote. And historically you know balance sheet construction bridge debt was cheaper or less expensive than permanent loan debt. You maybe got a construction loan for under 3% and your perm debt might have been 3.5% to 4%.

Rachel Oh 28:42

Now, what are we at?

Devin Jolley 28:43

And now it's the exact inverse. Right, your short-term construction bridge debt with banks is more expensive than permanent loan debt. So it's really kind of thrown a loop in how banks underwrite, you know, do they underwrite with perm rates plus a cushion? Do they underwrite with the current note rate? And it's not as clear today. It's kind of all across the board, I think. You know, still lenders are sizing to the takeout but you know, I see a lot of lenders just sizing to the actual note rate today. And you know, today, when SOFR is 500 and you're 300 over you're, you know, you're eight and a half nine percent sometimes. Right, it can get very, very expensive and tough to make deals pencil.

Rachel Oh 29:25

Yeah. So what deals, then, are getting you know what's getting approved, what? What are banks lending on Like? Is it asset class base, is it location, is it relationship? I mean because if you look.

Rachel Oh 29:40

So just for additional, I mean, we keep hearing about trillions of dollars of debt maturing. I think the most of it is in multifamily and I'd love to hear your thoughts on that. But obviously another big component is office. You've got, I think, a spike in hospitality for this next year, but then it kind of you know, kind of trickles down. I mean. But you know, in in the last recent report I've seen is like 2.2 trillion coming due between now and 2027. So with that that's, I mean, and again it's all across every asset class, nothing's immune. So how is that affecting where people put their, you know, put their monies and what are? How are banks looking at it?

Devin Jolley 30:22

Yeah, I think there's a flight to quality. Right now, banks are paying close attention to location right and access and all the fundamentals of real estate, but they're also focused on sponsorship right. What is the sponsorship experience and track record? Have they gone through a downturn?

Rachel Oh 30:42

right have they managed through this, so experience matters.

Devin Jolley 30:44

It matters a ton, right. Then you know, I think the third is you know the guarantee, and you know I look at lending and there's kind of a three-legged stool. It's property, it's your, you know property, all the, you know access, visibility, all the fundamental real estate components. And then there's borrower, you know the sponsorship, and then there's guarantor, which is kind of the secondary exit strategy for a lender. If something goes wrong, who can they look to for financial strength? And so there's kind of a three-legged stool.

Devin Jolley 31:18

And you know, before I think you know you might have got away with having two of those three stools. Today you really need or legs on the stool, excuse me, you know, and today I think you really need three, right. And so weaker sponsors, sponsors with less experience, sponsors with less liquidity. You know my advice to them would be team up with someone that does have the experience or does have the liquidity. And you know that's where I'm coming in. Right now, companies is helping sponsors maybe look a little bit better on paper to their lender, helping with the liquidity, helping provide a guarantee, or so you'll guarantee some of our loans moving forward.

Devin Jolley 32:05

Potentially yeah, if the price is right.

Rachel Oh 32:07

Again, you've said it on air and. I'm going to hold you to it.

Devin Jolley 32:11

I don't think PEG needs us. They got deep pocket money behind them.

Rachel Oh 32:17

It took us time. It took us time. So, there was definitely a time when we partnered with groups, but yeah, no, okay, so underwriting it sounds like the fundamentals are still there, right? Yeah, and flight to quality is obviously important.

Devin Jolley 32:33

Yeah, you're not seeing lenders. You know trend rents right. We've seen a huge spike in rent growth. You know you look at ADRs today on hospitality. Look at rents on multifamily today.

Rachel Oh 32:45

Yeah, they're leveled right now. I mean they're not going down, but they've leveled off a bit.

Devin Jolley 32:49

Yeah, I think there's some hesitancy to lenders to underwrite further growth rates. You know they don't want to underwrite on the come. They really want to underwrite kind of what's out there today. It's hard to predict what tomorrow is going to bring and being too aggressive with growth rates is something they're very sensitive right now.

Rachel Oh 33:10

I know that on the equity side everyone's looking at untrended yield rates so they're no longer accepting and you know we used to do a 2% to 3% modest growth. Right Now it's and numbers have eased up a bit. I think what investors are looking for has eased up a bit. Last year was tough. This year I definitely see an easing up. Are you seeing the same trend on the commercial lending side?

Devin Jolley 33:35

Yeah, a little bit. You know it's still challenging out there. Banks are still very cautious. You know, if I could describe the market today, you know, a being you know banks are in growth mode, you know and full bore. B being maybe cautiously optimistic, c being being cautious and D being out of the market, I would say we're somewhere between cautiously optimistic and cautious. Cautious in that we've seen rents go up quite a bit and we've seen a lot of oversupply in certain markets. Sure, we know there's some trouble, particularly maybe in the office sector. Oh, huge.

Rachel Oh 34:19

There's got to be a huge yeah.

Devin Jolley 34:21

And maybe some other asset types. I think it's somewhat isolated to certain geographies and certain asset types.

Rachel Oh 34:29

I feel like urban downtown areas are different. Now, right, we certainly see that in our portfolio, so I imagine that's across the country. But yeah, okay.

Devin Jolley 34:39

So you know, for those reasons and the fact that you know there's new regulations coming out with the banks to potentially have more liquidity on their balance sheet, you know to, you know, maybe offset some potential losses, and some of those regulations are coming out right now by the Basel Committee.

Rachel Oh 35:01

So you know, more and more Basel. Yeah, I know of Art Basel, but sorry, basel, this is not the art. Obviously. This is what is Basel it's an oversight committee for banks.

Devin Jolley 35:13

They set some regulations for banks to follow just to make sure that they can withstand financial shockwaves in the economy. So there's stress tests and things like that that are ongoing with banks and they're the oversight committee. So we're constantly looking at the solvency of know what they need to be looking out for.

Rachel Oh 35:36

Okay, so underwriting the fundamentals remain the same, obviously, as a flight to quality. What's the pecking order for lenders Like? Are there certain asset classes that they prefer and you have less you know consternation over getting you know debt? For Tell me a little bit about that from your perspective.

Devin Jolley 35:55

Yeah, I think you'll be kind of a no shocker. I had this conversation literally yesterday with the bank. You know, I think top is, you know, permanent debt, obviously. You know banks historically have not done a lot of permanent debt on their balance sheet that has gone to life insurance companies or CMBS or agencies. They're starting to put more permanent debt on their balance sheet. They know they need to make loans and so where's the safest place to make a loan? Probably a stabilized asset. So you're seeing more banks willing to do permanent debt on their balance sheet, followed by bridge debt. Then, you know, construction's challenging right. I think some markets there's a lot more appetite than others but, it's again geography matters.

Rachel Oh 36:39

Yeah, location, location, location. Yeah Right, you never heard that before.

Devin Jolley 36:45

But yeah, I mean asset type wise, no shocker industrial multifamily kind of top of the pecking order Retail the lender I talked to yesterday, you know grocery-anchored retail specifically, you know they're, and even some other retail they're still bullish on retail is doing quite well Hotels, self-storage with, you know, the bottom of the stack certainly being office. I think there's a lot of pain still to be had in some classes of office, particularly maybe the Class B and C Class Bs and Cs.

Rachel Oh 37:19

Yeah, I feel like Class A, highly amenitized in the right location, are probably the only ones that would get any kind of— yeah, I mean we saw that at PEG right we had a brand-new Class A office building recently.

Devin Jolley 37:33

sign three new leases oh yeah Right, that's awesome new class A office building recently signed three new leases. Oh yeah, right, so you know we had, you know we had a great office building, highly amenitized, and we just didn't see what. What you're seeing in maybe the class B, c office space, and so I think even even office is isolated to certain. You know class B or C or A, right? So the details matter.

Rachel Oh 37:57

No, absolutely Okay. So we are well into our 2024 now. Just curious what you know from your vantage point, your perspective. Where do you see the opportunities in commercial real estate? I mean, I feel like I see them on my side of the capital stack, but just curious where you see things.

Real Estate Market Trends and Predictions

Devin Jolley 38:16

Yeah, I think there's a lot of the capital stack. But just curious where you see things. Yeah, I think there's a lot of opportunity on the debt side too. You're seeing more of that. Debt funds pop up. Yeah, it seems like every day there's another 20 debt funds that are coming out of nowhere a lot of capital ready to deploy in the debt space. So I think that's a very intriguing spot for some people, something that we're looking at on our side too, at Davidson. But you know, I think that you know the news and the media about commercial real estate kind of paints everything with a broad stroke. But I don't think everything's in trouble. You know, and just to give you a quick example, you know, from call it 2021, we saw permanent interest rates on multifamily at 3%. Right.

Rachel Oh 38:59

You know they're around those were the days Right.

Devin Jolley 39:02

And in today it's like six, you know, maybe six and a quarter. So you've seen three, 320, 300 basis point rise in interest rates since that time, when you've seen in office though that might be 400 to 500 basis points, and so that's challenging. You know, in multifamily you've seen rise in rents. Right, vacancies haven't been hit that hard in a lot of areas and it's been pretty resilient. On office. Adrs have gone through the roof. Right, expenses have been cut in the office they're operating more lean.

Rachel Oh 39:39

Office or hotel, I'm sorry. Hotels, yeah, so hotels. So ADRs in hotels, oh yeah, have you tried to book a? I keep saying this, have you?

Devin Jolley 39:50

tried to book a hotel lately anywhere. Yes, it's insane, it is crazy, yes, and so I think hospitality has come back in a lot of ways and that's been able to offset some of the higher cost of capital. Maybe it's 400 basis point rise, but then you get to office. Have we seen rents rise? Have we seen vacancies? You know, drop and you have a 500 basis point increase in the cost of capital. That's a problem. And so I think it's going to be very isolated.

Rachel Oh 40:20

And then this hybrid working model is here to stay, obviously.

Devin Jolley 40:23

Yes.

Rachel Oh 40:24

I mean PEG is unusual in that majority of people come in, I think, every day. Well, not majority, but a large group. I do if I can, if I'm not traveling, but I know tech companies.

Devin Jolley 40:35

Would you want to come in every day if you were in a class B C space?

Rachel Oh 40:39

Oh, good point. We used to. I feel like, yeah, good point, Probably not as much. I love our. I mean our space is beautiful and we've got that gym and we've got all the restaurants all around. That's a very good. I didn't even think about it that way. It's a miniatized right. I mean, all you know, we got restaurants within walking.

Devin Jolley 40:56

We got what? Is it? 25 restaurants.

Rachel Oh 40:58

No, like 75 or something 75. Don't you know our circular? It's like 75.

Devin Jolley 41:02

It's an amazing. I didn't even know there's that many restaurants here in Provo, but we're all walking distance right, Like I think we have more walking restaurants to our office building than any other office building in Utah County. Right, and yeah, those things matter a lot when it comes to leasing.

Rachel Oh 41:18

That makes a lot of sense, right.

Devin Jolley 41:20

So yeah, I mean it's been nice when we moved into this building. It was you could feel the energy at PEG right, like it brought some new energy to our company moving to a Class A space, and if you have nice space, I think people want to be here and I do think we're all more productive if we're in the office. I think that experiment didn't work for a lot of folks and it's a very good point.

Devin Jolley 41:46

So yeah, even the class A. Here's an interesting statistic. I read something the other day. It said 60% of the office vacancy is concentrated in 10% of the buildings 60% of occupancy. Office vacancy is concentrated in 10% of the buildings.

Rachel Oh 42:03

Dang.

Devin Jolley 42:04

What are those 10%? You know, I think it's certain locations geography. And again Class B C you know, unaminitized buildings. They're taking a hit. They're taking a hit, they're taking a beating, yeah, and you know, going back to kind of the point of this whole podcast on kind of where we are seeing, I think you know I think borrowers got the pass during COVID. Everyone kind of got a blanket modification and at this point if deals aren't working, at this point you can't really blame COVID.

Devin Jolley 42:40

And so lenders are kind of stepping back and now they're starting to have some tough conversations with borrowers and so I think we're on the cusp of seeing some trouble in certain asset types and it's going to be very interesting to see the office. It's well documented right. It's all over the news that there's going to be some pain in that sector and I think it's going to take some time to bleed some of this, to bleed out right. It always does. It's not going to be. It's not going to be quick.

Devin Jolley 43:10

And you know, I think we're going to see interest rates lower. But I really doubt the Fed is just going to lower interest rates quickly. They just caused the second and third largest bank failures in the country last year by the rise of interest. I shouldn't say they caused it, but that was a result, that was a result, and I think they are going to be very hesitant to willy-nilly lower rates. Yeah.

Devin Jolley 43:35

And you know, some of the excess needs to bleed out of the system. Yeah, and maybe a small minor correction, or whatever this correction brings, is maybe a good thing. Yeah. In some ways In opportunity for those that you know are ready to capitalize on the opportunity, which is exciting for you and I and, being in the companies that we're at, that you know have staying power. Yeah. Have liquidity, have financial backing. Yeah, there's a lot of opportunity.

Rachel Oh 44:05

Yeah, and you know, a conservative approach. I think that's the big thing, right, like just trying to go, not trying to swing for the fences always, but keeping stability, as you mentioned.

Devin Jolley 44:14

Okay.

Real Estate Discussion With Devin

Rachel Oh 44:15

Well, devin, I super appreciate it. It's so good chatting with you again. I miss having you around the office, but I am excited. I'm hoping you get me a firearm for a good deal, maybe A .22. That's all I can handle, but okay. Thank you so much, devin, for joining us this week.

Devin Jolley 44:33

Thank you for having me. It's been great. Good to see you again, Rachel. It's good to be back here in the PEG headquarters and to see everybody again.

Rachel Oh 44:40

I know we miss you. We miss you around here, so you need to come back more often. So maybe we can do an episode in the future about firearms or something I don't know enough about that.

Devin Jolley 44:54

I'm a real estate guy through and through, that's where I'm a real estate guy, true and through. Okay, and that's where I'm spending my time today. I mean, it's certainly the moneymaker for Davidson, but the family office side is where I'm spending my time.

Rachel Oh 45:05

Okay, excellent. Well then we'll talk about the next big deal we do together. How's that? Let's do it, okay, awesome, okay. Thank you to all who have joined us today. From the peaks of the Mountain West, I am Rachel Oh, your host for Peaks and Portfolios presented by PEG Companies as we dig into all things real estate. Until next time, see everybody.