← The TreppWire Podcast: A Commercial Real Estate Show
The TreppWire Podcast: A Commercial Real Estate Show
354. Behind the Debt Yield Metric in Commercial Real Estate with John Barkidjija of Byline Bank
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Welcome to the Trepwire Podcast, the show where commercial real estate meets data and insights. This is a special guest podcast. I'm Hailey Keen with trep, a data modeling and analytics firm for the CMBS commercial real estate and CLO markets. I'm with Lonnie Hendry, Chief Product Officer, and Steven Buschbaum, Research Director. Today we are joined by John Barkadia, or better known to our listeners and our audience as Dr. Jet Yield. John is Executive Vice President and head of Commercial Real estate and Specialty Finance at Byline bank. With more than 30 years in banking and real estate, John has originated over $3 billion in CRE loans and currently manages a CRE portfolio of over $1.5 billion. John has held senior roles in credit, risk and asset management and he is also recognized for his article Reset Ready, which talks about the great reset in commercial real estate. John, we are so excited to have you here with us today. You've been such a loyal listener and have been going back and forth with our team for years now, providing great insights and commentary. So we're really excited to welcome you to our show.
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C
Thank you, Hailey. Yeah, that's a great introduction and I'm so excited to be here with you. It's. I feel like I've known all of you for so long and with our email exchanges back and forth and you guys are being really great about recognizing me and the shout out. So thank you for all of those and I'm so excited just to be here with you in person and live.
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B
Yeah, this is going to be a great episode. Maybe we can set the stage for our audience here first and you could just start with a little bit about your journey in commercial real estate. How did you find yourself in this industry and then how did you get to where you are today?
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C
So really by accident is the short answer. I grew up in New York City, went to Columbia College undergrad, NYU Law School. My plan was to become a corporate lawyer. I did that after practicing for a little while in New York about four years, I decided that law was not for me and that I'd rather be a client than a lawyer. Ended up a couple years later in Chicago getting my MBA to make that transition from being a lawyer to being a business person. At the time, my wife, while I was a lawyer, went and got her MBA at UPAN at Wharton and she was working as a management consultant in the Chicago market and got a great offer from one of her clients to go in house. And so with no plans on really staying in Chicago when we went here for me to go to school. I ended up redirecting my search efforts for a job and ended up at what became Chorus Bank. And Chorus bank at the time was about a $2 billion in asset bank, obviously located here in Chicago. And one of their primary businesses was commercial real estate. And I thought at the time that doing commercial real estate deals and still being a deal guy would be a great way to meld my newfound business school skills with my old legal skills. And so it just, that was a job that presented itself, and that seemed to be the best fit at the time. And so I became a commercial real estate lender. And then going forward from there, I was very lucky in that one of the first projects I worked on was an adaptive reuse of an SRO building in Atlanta in anticipation of the Atlanta Olympics the following summer. But the caveat was we had to turn that SRO into a hotel. It was the first hotel loan that Chorus bank had ever made. And so I had to get smart about how to lend to hotels and hotel construction, hotel development. And in that process, I learned about the industry, Learned who the players were, and became a large ish hotel construction lender. And I ended up financing the construction of over 10,000 hotel rooms all across the country. And that was kind of my how I built my name in commercial real estate lending. And then after that, I kind of went and did more deals in New York, Did a lot of adaptive reuse, Converting office buildings to apartments, office buildings to condos, office buildings to hotels all across the country. And then finally with Korus bank, was a condo lender. By the early 2000s, mid 2000s, Korus had become kind of the poster child of being the condo lender, biggest condo lender in the country. In 06, I saw the writing on the wall and realized that housing prices shouldn't go up 30% a year as the the way they were, and stopped lending for my own portfolio. I went from being one of the top lenders at Korus to being the low guy in the totem pole. That led me to have very few problem loans in going into the great recession. So I took over running the portfolio after the bank was closed. I transitioned with the portfolio and my team from Chorus bank to the Starwood platform. Starwood, tpg, Perry Capital and Will Frank family entered into a joint venture with the FDIC to to take over running the portfolio to resolve the portfolio of Korus bank, which is about 4.5 billion in assets at the time. After a couple of years there working out the portfolio and transforming Problem loans into either Oreo or Resolve loans. I left there, looked for my next thing, ended up being a chief credit officer at a small bank and then eventually ended up at what is today Byline. Byline was the recapitalization of a bank group located in Chicago. Also coincidentally with about 2 billion in assets. We had 90 plus branches and 12 different charters. So operating under 12 different bank charters, 12 different bank names, et cetera. The bank was losing our first year, we lost $30 million. So we transformed that bank. I came in to run commercial real estate. We during the intervening time. So from 13, the summer of 13 till today, we rationalized the bank network, the branch network. We went public, we rebranded as Byline, we bought four or five banks, bought some different businesses and today we're about a $10 billion in asset bank located in Chicago with about 40 some odd branches and commercial real estate makes up about 20% of the total.
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That's an incredible, incredible story. I mean, I think, and I know our listeners are going to love the perspective from today's episode for all the reasons you just mentioned, John. I mean, you've seen banks go under, you've seen how that process plays out. You've seen the great financial crisis. You've seen, you know, post GFC where we went on this incredible bull run that, you know, some would argue was never going to stop until Covid came. And then now we're where we are with interest rates and everything else. So before we get into the serious nuts and bolts which we're going to let myself and Steven kind of ask you some, some questions that we can't wait to hear your response on A Little More Light Hearted. You're continuing the streak of our guests that have said that they kind of accidentally got into commercial real estate, which is great. And you've been very successful in doing that. On our show, you're known as Dr. Debt Yield. So I want to give you an opportunity on the front end of the podcast. Just walk us through why you think that metric is the metric and us some color behind that.
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C
Yeah, thanks, Lonnie. So I guess it started it's something that we use at Byline and I use as kind of a shortcut to analyze real estate. And you could see from the emails I sent in over the years to you guys that you'd be talking about a loan and it was going into special servicing and it had a 2.0 debt service coverage or something like that. And that in my mind only told part of the story. Right? So. So if the Interest rate if for the loan was 3% and it was interest only at 2.0 coverage, that's a 6 debt yield. And so a 6 debt yield would, would have been a much more interesting data point to talk about why that loan is heading into special servicing when, you know, today debt yields on current loans are depending on the asset class, etc. Are 8 to 10, 12, etc. Right. And so I lob in emails with kind of those comments to you guys. Hey, great, great story. But you didn't talk about the debt yield. And then I think it was February of last year. We were, I was at a, at a banking conference focused on commercial real estate and Stephen was there with me. And during one of the breaks we ran into each other and Stephen looked at me and said, I know you are Dr. Dale. And that was how I got the nickname. So thank you Stephen for that.
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Absolutely. It's, it's one of my, my favorite nicknames that we've come up with over the years and I think has been, you know, very much like aptly embodied. I'm just curious for some historical perspective for our listeners. Can you give me a sense for when debt yields really became the go to metric? Because I have my perspective, but I'm curious to hear from your experience, when did this metric really rise to prominence?
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C
So I think it was maybe 10 years ago or so when it's something that came into my analysis. So let's go back historically. So for a long period of time, interest rates were kind of stuck where they were. Right. So LIBOR so far was around 3%. Right. The 10 year was around 6% and that kind of was what it was. Right. So for, for years and years. And so if in a, an environment where rates are steady like that, then you, you kind of assume rates are what they are and then you can talk about that service coverage ratio. Right. As a better metric. But once rates started moving around, I think that's when, when lenders started thinking about, hey, it's to really understand debt service coverage and to understand the math, you need to know the interest rate and the amortization. Right. To figure out what the debt service coverage is. And so the shortcut is, well, let's just talk about debt yield. And then you can ignore interest rates, you can ignore amortization.
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Yeah.
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And from, from my perspective, timing wise, that's exactly in line with, you know, I think kind of generally what I saw from the market was maybe like the very first rumblings of debt yields coming into research might have been around 2010. But then in terms of a widely applied metric, it was 2012 to 2015 was around. All of a sudden that became the headline metric. And really when you're working with data, it's such a convenient metric to use because you're not making any assumptions about what the new underwritten AM schedule is going to be or the interest rate on debt. It simplifies your assumptions a ton.
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C
I always like to keep things simple if I can. And that's a really simple shortcut way. Just like we talk about cap rates, right? I mean cap rates are one way to ascertain value, but really behind that cap rate is, is, you know, the 10 year projected cash flow and then the discount rate and then the terminal value and you add it all together and you come up with a number. Well, the shortcut is the cap rate.
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Yeah. It's interesting when we post online, I think the most misunderstood term in commercial real estate is probably cap rate because depending on which side of the table you sit on or what role you're playing in the transaction, they all view cap rates slightly differently. But I agree with you in the sense that debt yield is just a simple metric that just tells you exactly where you're at on this. So it kind of lends itself to our next question here in terms of, you know, where we're at in the macro environment today. I mean, you know, we saw the run up post GFC, we saw unprecedented stimulus in 2021 post Covid. Then we started dealing with inflation. The Fed obviously does what everyone has, you know, dealt with over the last couple of years. Or this higher for longer narrative has become the higher for longer reality? 500 basis points in about 18 months. You know, what are the macro events or what are the macro forces that you think are, you know, potentially setting up for some favorable things for cre, if any. Or what are some things that are still causing you some major concern that maybe haven't fully played themselves out in today's market.
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C
So I guess two things. I think stability of rates is a good thing, right? I mean, historically, if we've had rates come down dramatically the way they did, it's because something bad was happening in the economy, right? We had a recession, job losses. Covid. Right. Something bad happened to, to create the, to give the Fed a reason to drop rates drastically and then, and then that distorts the market over time. And then, you know, we saw with this latest increase back to kind of what I would call normal, right. As I said earlier, rates on the ten year were for years and years and years at six for six percent. They just were. And, and so for Libor back then it was a 3% and it just was. And that, that was the number. And everyone could kind of assume what, what the world looks like based on that. So when rates go up and down, that's, that's distorts markets. And so we saw, you know, incredibly low cap rates on certain property types like multifamily, etc. Over the past couple of years. And then now that's, that's kind of reverting back to the meat. I think going forward, one of the issues that I think we still have, that's creating a lot of uncertainty. And I think I sent an email to you guys earlier in the year that I think uncertainty is the word of the year. In between tariffs and immigration policy, what's happening with the Fed, et cetera, there's just a lot of uncertainty in the market. And I think it's showing up now in things like leasing velocity for industrial assets. Right. For a long time, industrial was the favored property type. Huge increase in supply, huge increase in demand post Covid especially. And now we're seeing with uncertainty, companies are saying, you know what, we don't know if we need more space today. So there's been a slowdown. Right. And so given that uncertainty with companies not being able to make decisions based on where tariffs might be or other things might happen in the economy, I think that's the concern as to where that's leading. Then on top of that, we've also just seen the revision in the jobs number for last year and then the current job weakness the past three, four, five months. And so that's also throwing even more uncertainty kind of into corporate decision making, which ultimately leads to, are they, are they going to lease more offices? Are there at least more warehouse space? Are they going to hire more employees to fill those offices? Are the people going to have jobs to be able to keep the economy going? Right. All those things work together. So it would be great if the uncertainty were lessened and companies can make decisions again.
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D
So in terms of like the AI revolution outside of data centers, I guess maybe office is where we're going to see some of perhaps the most pronounced effects on reduced office demand. Is that something that's coming into your forecast horizon at all yet? And how are you thinking about that possibility of AI revolution impacting any property sector really, for that matter?
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C
That's a really good question. I feel like we're at the very beginning stages of that Obviously there's been a ton of money poured into it, a ton of money still being poured into it in data centers and Nvidia chips, et cetera, et cetera.
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Right.
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And a lot of smart people are trying to figure out how to use it and how to use it with, within companies. I think, I think it's going to reduce the need, at least in the beginning, for entry level analysts, call it, or analysts without a lot of experience. Right. So in the old days you needed to have analysts crunch numbers, input data into, into, into spreadsheets, create, create presentations, et cetera. I think a lot of that could now be done by AI. The question though is that is, is the output of AI accurate enough? Right. And so someone that has some experience in looking at these things will have to look at the output to make sure that AI didn't make something up. Right. And I think that's, that's one of the criticisms of AI today is that it still makes things up. And so you'll need someone higher level to figure that out, but maybe you won't need as many as many of them younger folks. And that's concerning to me because then how are we training the workforce of the future?
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Right?
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Because doing the numbers and inputting the numbers and playing with the spreadsheets is how you learn, right? Just having an output done, you don't really learn from that. And so I'm worried about the learning kind of in the big picture macro environment. But then if that happens, right, then we're going to need less office space and then that'll be counter. The counterbalance of that is that, that a lot of companies are requiring people to be in the office more and more. Right. So that's moving in the other direction. So it'll be interesting to see, I think from, while we're talking about office, I think what we've seen is that there's the haves and have nots in the office space, right? So the class A buildings, the better buildings that can attract people that have landlords, that have ti leasing commission dollars to spend are winning and attracting, attracting leases and tenants and those properties that are older, maybe not as well located, that are already 50% vacant, don't have strong landlords, that have a lot of capital to put to reinvest in the offices, they're the ones that are slowly fading out and that's happening all across the country. So we'll see, we'll see where that push pull goes in the future. But it seems like we still have too much obsolete office supply that will need to be redeveloped or torn down.
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So it's really interesting, John, in a couple of the presentations I've done over the last six months, I show a slide where we look at office origination, call it 2016-2020. And the going in cap rates on Those originations were sub 6%. Those were for the same offices that today we're calling functionally obsolete. So the buildings haven't changed. Like the bricks and sticks were either functionally obsolete then or they were fine then and they're fine now. What's changed is just the mindset and I think some of the AI stuff, you know, entering the equation has rendered some of those offices maybe obsolete just based on, you know, worker preference and the ability to do things without having to have a physical analyst in the building. So it'll be very interesting to see how that plays itself out. We agree with you. It seems like the higher end, well located, class A, highly amenitized buildings across the US for the most part, if they're not setting, you know, rental rate records, they're, they're at least maintaining good stabilized occupancy. It's this class B glut that, that we're going to have to deal with. So I guess that kind of jumps me to my nick. Next question. Having seen some of the challenges caused by the GFC and it sounds like, you know, you spotted and identified some of those things before it actually hit. You know, you mentioned that you stopped condo lending because you realized that the numbers just didn't make sense. What are some parallels that maybe some of our listeners that just got in the market in 2012, 2013, 2014 and they've only seen values go up until the last maybe year and a half or so. Are there some parallels? Are there some things that you learned from that first experience that have helped you now or that you could share some, some wisdom with some of our listeners that may maybe haven't seen the downturn part of the cycle yet?
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C
Yeah, that's a good question. So I think if we step back a second, right, CRE always cycles, right? And the cycle is, times are good, money's flowing, developers are optimistic about the future, they bring on new supply, kind of hoping that demand will come to fill it. If you build it, they will come kind of scenario, markets get overbuilt and then vacancy starts to drop, rents start to drop, and then that's usually correlated with some kind of recession. And then you have a recession and then jobs are lost, things aren't going well. There's a dearth of new supply. There's some pain, some properties are given back to the lenders, there's a value loss happening, and then nothing gets built for a while as that supply is absorbed over time. And then the cycle starts again.
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A
Right.
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C
And so that, that's kind of a typical commercial real estate cycle. What's different this time is that we've had this great run since the gfc and partly because there's nothing built for four or five years. Right. So there's a lack of supply everywhere. Right. No one, no one started new construction in 09. Right. Didn't happen in any property type. Right. So over time, that was absorbed and things got. Things got better. Values went up. When Covid struck, we had this massive response by the federal government, not just by the Fed when dropping interest rates, but massive stimulus to kind of push off that recession. That could have happened when the market shut down because of COVID And that money is still percolating through the system. Right. It's the PPP money that went out, the checks that individuals got. Right. That still has not been completely worked through the system. So we haven't seen a recession yet, but we're seeing some overbuilding that happened over the past couple of years. You look at some of the apartment markets in the south, right. In the Sun Belt, Austin, in Charlotte, Phoenix, Dallas, places like that, where there's a lot of bill, a lot of enthusiasm, people were moving there during COVID Lots of demand increases, lots of new supply. We're seeing rents dropping, vacancies high, lots of concessions to bring tenants in. Similarly, with industrial assets, if you look at markets like Savannah, last time I looked, there were half a dozen or so million square foot buildings sitting empty, Right. In anticipation of tenants signing leases. And they didn't sign leases. Right. So that market's gotten overbuilt, at least on the big box space, it'll take some time to correct. If we have a recession, it might take longer. And then it kind of comes back down to the, the ability of the owners to carry those properties through these kind of slim times. So that's, that's kind of the cycle and, you know, we'll see where we end up. If some of the uncertainty that I talked about earlier goes away, maybe that doesn't happen, or maybe it's really mild, but it may not be that mild. So we'll see.
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D
You mentioned your law background is really kind of what you started with. Can you tell us a little bit about how that has helped shape and frame some of what you've done in real estate, for example, from my experience, the more I kind of leaned into the law side of things in origination and lending, the more creative I really could be and how we could come up with deal terms. So can you give us a little bit of insight as to how that law background has helped you shape just some of what you've done in real estate?
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C
That's a really interesting question. So when thinking about being a lender, just in general, you can compete on structure, which is basically leverage, right? Give more leverage or on price, right? Those are the kind of the two easiest levers to pull. The, the one I'd rather compete on is, is competing with our brains. And that's something that I've tried to do throughout my career and especially and at Byline where you know, we'd rather, I'd rather do that complicated deal, the one that we'd have to figure out kind of some something, right? Or compete on speed. Something has to happen really fast. We'll use our skills to go really fast and improve it. I'll give you an example. So we had a project where our customer was buying an iOS site that was leased to an international container storage company. Long term lease, it was under market. They were hoping to buy it and increase rents. The issue with it though was that the access to the site was through two easements, one from ComEd and one from a water reclamation district. The COMED easement was assignable to a lender. No problem, we'll take an assignment as part of our collateral package. The water reclamation easement was not. And so in the unlikely scenario where I had to take the property back, I may not be able to get an easement. And so the property would. So I wouldn't have zero access, which would be bad. And so we went back and we thought about it, well, what can we do to get around this issue? And oh, by the way, the first lender that looked at it couldn't figure it out and kind of backed out. So I was kind of the backup. And so we looked at it and said, you know what, we will be co applicants with the borrower and get ourselves on the easement today versus by assignment. And that solved the problem and we got the loan. So it's that kind of creative thinking, as you said, right, to kind of think outside the box to be able to figure things out. That's been helpful to me in my career.
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D
I love that solution. I mean, that's such a gorgeously simple approach to what would otherwise be an insurmountable legal issue from the lender side. Love it.
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C
Yeah. Yeah. It's one of my favorite examples of competing with our brains versus with our pricing.
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A
Yeah, it's great when you have some of these challenging opportunities present themselves. You have some credibility when you're talking with folks of saying like we're going to work with our brains to try to find a solution. Think that probably has really served you well in a number of occasions. Obviously this is a fairly short show, but I think you could probably fill up an hour or two with kind of these, you know, one off things that you guys have done. So I know in some of the emails you've sent to us, you've talked a little, you've spoken a little bit about good and bad resolutions in delinquencies. Maybe give us what your perspective is on the differences. And then what you're seeing right now are you seeing, you know, finally some capitulation and some realization that maybe values have in fact dropped and so there's going to have to be some resolutions that maybe are not favorable. What are your thoughts on just those two things generally?
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C
Sure. So first, the first is just a general comment that the delinquency rate, while interesting, isn't in the fluctuations in. It isn't. Doesn't tell enough of the story. Right. There's a lot more nuance there. Right. So you think about what it is. It's. It's just the ratio. It's the dollar amount of loans delinquent divided by the total total amount of loans in that category. Well, for month to month, depending on what's in the denominator. Right. That ratio can change. So if you add a bunch of good loans, new loans, then the delinquency rate goes down. If a lot of loans, more loans pay off than not, then the delinquency rate goes up. So, so that's just the math of it. And then if you look at what's actually delinquent. Right. And in my mind, good resolutions versus bad. Well, so you had a, whatever $100 million loan in the delinquency category and it came off because it was resolved. Well, a good resolution from a lender standpoint would be that that it got paid in full.
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A
Right.
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C
They were able to sell the property, refinance it, et cetera, and the lender got paid in full. That's a good resolution. If, however, the it was resolved because the, that $100 million loan resulted in a $50 million loss of the lender, that's a bad resolution. And Tracking that number I think is more interesting than just the delinquency rate. It's like, well, well, how is, how has the delinquency rate changed? Is it because of a denominator effect or is it because we resolved X number dollars amount of loans and then how were those resolved? Was it a good resolution and lender got paid back or is it a bad resolution and lenders were taking losses? And so I think that nuance in talking about delinquencies would be helpful. And the second part of your question is what I think is going on out there. So I think two things. I read a couple of articles about the great reset and about uncertainty around the reset. And generally what I was thinking about was assets that were, that in loans that were put in place under a different cap rate and interest rate environment, assuming that analysis have stayed flat, are in a different situation today than they were. And even to the point where perhaps in the office context especially the loans are impaired, but even if they weren't impaired, it's an equity wipeout, right? And so the equity has taken impairment, assuming that the lenders are forcing the issue. There's been a great amount of extended pretend by existing lenders and there's also been a tremendous amount of debt fund activity out there coming in and taking, taking on those loans at par, close to par, away from the banks and setting up interest reserves, etc. Charging higher rates and kind of being that rescue capital, if you will, without the owners having to pony up additional significant amounts of equity to pay down the loan. So that's phenomenon is still happening, although we're seeing cracks, we're seeing lenders finally saying, I think saying, you know what, enough's enough. You've had your second, third, fourth extension. Sell the asset or refinance us. And if they're, and if the metrics don't work, the assets are being sold, sometimes the banks or the lenders are taking hits, sometimes they're not. But the reset is starting to happen and I think we all need that, right? We need the values. This is interesting too, if you think about it. About a year ago, everyone, including you guys, was talking about the great wall of maturities, right? Trillions of dollars, whatever it was, huge numbers of loans maturing. I haven't heard that phrase in six months at least, and no one talks about it anymore. Those maturities are still out there, right? They've been pushed out, they're still sitting out there, but no one's talking about it because it wasn't this catastrophe that Everyone was thinking it was going to be, but I don't think the problems have gone away, it's just been deferred. Steven and Lonnie, I'm curious to hear your perspective on that.
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D
Yeah, it's kind of the elephant in the room. And I don't know this for a fact, but the sense I get is that banking regulators, it's not like they're naive to this or turning a blind eye. They're very much aware of the problem on banks balance sheets, but it's in no one's best interest to force a sale or force a liquidation and essentially willingly walk into a variation of the RTC crisis. So you know, for me, the base case, I would say kind of hope is that we just inflate our way out of the problem. Right? That yeah, at some point maybe there will be the forced decision to refinance or sell and you know, realize the impairment to equity. But yeah, if we can just kind of inflate our way out of the problem and eventually refi out the loan, all's well, that ends well. I mean, sure, you're not realizing that higher interest rate on debt that perhaps you want or should be getting with that new money going out the door, but you're also not drawing down banks capital by forcing a loss today. The short of it is it definitely seems like we're still in a period of regulatory tension because there's no shortage of folks out there on social media, LinkedIn especially saying this tsunami wave is out there and the forecasting some doom and gloom. But I just don't see the doom and gloom hitting because we'd essentially be having to walk into that situation willingly. I could be wrong, but time will tell.
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C
Well, on top of that then you also have a lot of people in the equity raising business saying that they're stuck and it's really hard to raise equity partly because the capital hasn't recycled and there's this trapped equity. Is it good equity, not good equity? It's hard to tell. Right. But it's still sitting there. And until, until that gets recycled and paid back or written down, the equity, pension funds, et cetera, aren't funding new equity vehicles. Right, so that's a problem.
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A
Yeah, I think it's an interesting discussion. We've kind of gone away from the maturity wall kind of vernacular just because with the extent and pretend and everything that's taking place, to Steven's point, it got to the point where we're getting a lot of pushback in the marketplace of people saying okay, know mathematically there may be a trillion dollars worth of maturing loans, but we know practically based on what we've seen over the last couple of years that no one's hand at scale is getting forced here. Like everyone's going to try to do an extended and pretend. You know, for me personally, and I've said this on a couple of other podcasts that I've been on, I'm a little bit coming to terms with the fact that, you know, as you mentioned John, real estate by definition is supposed to be cyclical. But all of this intervention, all of this stimulus, all of this extend and pretend, all of these things that are just band aids to try to prevent the downturn, the real of losses in the cycle, to Steven's point, requires that you almost have to bank on this inflate away. But at some level we can't continue to do that. I mean like, you know, you talked a little bit about the condos going up in value 30% per year. I mean like just look at real estate values across the spectrum today versus five or six years ago. I don't care if it's single family residential, if it's multifamily. I mean when we started seeing 1970s multifamily properties in the Sunbelt, trading at three and three quarter cap rates on trailing twelve month income, you know, it's just broken like there, that doesn't make sense. And so I, you know, I feel pretty strongly that the broader powers that be are not going to allow a 2008 2.0. Like they're going to keep the banking system solvent, they're going to keep borrowers of, you know, liquidity available, et cetera. As you mentioned, we now have this private debt, private debt fund market that's a lot more institutional in nature, non bank lenders. I just don't know where this all ends up because at some level in order for things to work like they're supposed to, there has to be a down part of the cycle, there has to be a reset in basis, there has to be losses that are bad bets that were made, et cetera, actually realized or you just gone this perpetual path upward. And I just don't think the market can continue to support that.
- [32:47]
C
I'd love it to continue, but I agree with you. And maybe this time it's a little different for banks anyway than it was last time. And I think banks were pretty well disciplined on leverage. Right. And so leverage was 60%, 65%. Right. This go around versus in the GFC where leverage hit 75 and 80. Right. And so that extra 15 or 20% of equity is I think, the cushion that we need this time versus last time. And then also, if you remember, I mean the gfc. Quick story. So I was a condo lender. I had. I had hundreds of millions of dollars of condo loans out there. I had one project deliver in February of 08. Fantastic project. South beach of Miami, great location, 100% pre sold, beautiful project. In February 08, it delivered. My $135 million loan was paid off in one month. The next month in March of 08, the mezzanine lender, $45 million or so. And all the equity got paid back in April. Bear Stearns went down in May. The market froze. There's no liquidity left in the market. We had projects in chorus, condo projects also in Miami that delivered in May and June. No one closed their condos. 00 sales. So we went from everything sold, everything's great to zero. And the lack of liquidity, the complete freezing of the liquidity in the market between April and then the rest of the summer, leaving one out in October. Right. And that's when all bets were off. No one was lending, no one was financing, no one was doing anything. Right. And so values collapsed for condos especially, but for housing in general and everything else that kind of followed. I don't see anything that's going to cause that kind of liquidity breakdown this time. So we may not see that, at least I hope we won't again. But it might be more a more typical kind of kind of slowdown in the economy with the jobs, with AI, as we were talking about earlier, with immigration, as we were talking about earlier, with just costs in general. Right. So costs have gone up so much over the past five years, call it that they're at a very high level and people's incomes haven't really kept up. If you blend all the numbers together, it doesn't look bad because the high end of the income scales had good increases, but kind of the lower end of the income scale really hasn't kept pace with the increases in costs, especially of housing. Right. The typical home cost versus the typical median household income is. The gap is dramatic compared to what it was even five years ago. And so that could be a tipping scale, something that tips us over into a downward cycle.
- [35:28]
D
I want to get your thoughts on. We talked about this topic last week about this proposed bank regulation change and how modified loans are reported. And I'm really curious to get an insider's perspective on this. Change in reporting of having any loan that's been modified over its entire life being reported as part of this aggregate statistic and changing over to, okay, let's report only loans that have been modified over the last 12 months. From, from your perspective, I mean, how do you view this, this reporting change and the, the balance of any positives or negatives as a result for transparency?
- [36:04]
C
Sure. So going back in time, right, it was, it used to be called a troubled debt restructuring, a tdr. And the old saying was once a tdr, always a tdr, right. And so if you had a loan that was a workout and you did something to modify terms that were market terms, you lowered the interest rate, you stretched out the M, or you did something else, then it was a TDR and it was always a tdr, regardless of what happened with the underlying collateral, with the underlying cash flow. You, even if they suffered a downturn and then they turned it around and things were better. So as a bank, you didn't want many TDRs on your books and you'd hope that they would pay off. Right? Just get rid of a loan, get it out of here. Because it's hurting my numbers. So that was extreme because it lasted forever, regardless of what was happening with the underlying asset and the underlying cash flow. This new regulation I think goes too far the other way is my personal perspective, right? Because in 12 months it's hard to know if that's really, if that's really long enough, right? So let's say you went from amortizing to interest only and the borrower can pay interest only because they have enough cash flow for that, but not enough to advertise. And you gave them a 12 month interest only extension. Well, after 12 months you still don't know anything, right? Is it cash flow going to be good enough to support advertising again or not? So I think a reasonable compromise would have been 2 to 3 years, not 12 months. Seems like 12 months is just too short.
- [37:27]
D
We should put out a call to action to all of our listeners that for those of you that think this regulation has gone too far and is working against transparency, that, you know, really we should write in as a, as an industry, as an audience to support that, that middle ground. Because I'm with you, like I get what they were going for and that perhaps a shorter examination window would have higher predictive power and explaining away bank failures. But yeah, I mean, your commentary here is spot on that it takes so long for ultimately the loan to resolve positive or negative, that what have you Learned in a 12 month period.
- [38:05]
C
Yeah, I think it's just too short it seems like. And a lot of banks are very happy with that. Right. Let's get rid of this tdr. Let's make our numbers look better. Okay. But you're right, as far as transparency goes, as far as actual risk, it's not helping the system, at least in my opinion.
- [38:21]
D
Oh yeah, no, I love that perspective. I appreciate you sharing.
- [38:25]
B
So John, this has been such a great episode. I know we have so many more questions for you and so much we could ask about. But I think to close this out, we're recording this episode ahead of the Federal Reserve meeting this week where they will have a decision on interest rates. And I wanted to get your thoughts. By the time we release this, we'll already know what have happened. But what have you been looking for in terms of interest rate decisions and do you think there's any immediate impact?
- [38:52]
C
So I think you guys have covered it in the past. The Fed Watch tool says it's almost a guarantee that the Fed is going to drop short term rates by 25 basis points. I think that first of all, most of that has already been priced into the market. So if you look at SOFR over the past month or so it's come down about 20 basis points. So most of the 25 basis points are already kind of priced in into SOFR. As far as its impact on CRE goes, it's floating rates. Short term rates are generally reserved for construction loans and transitional assets. So while there's some benefit to having a 25 basis point decrease in rates, your rates are for those kinds of assets are in the 6 to 7% range, call it right. So now you're at 575 to 675. It's not that material. So I think it's minimal impact from the from just dropping the rate 25 basis points on short term rates and then long term rates. You know, the ten year is way more important in setting values and setting borrowing rates for commercial real estate as well as for things like home mortgages. And that's a 10 year rate. So theoretically it's looking out over the next 10 years and forecasting what market interest rates will be over that period. So 125 basis point decreases and shouldn't change the trajectory of that number dramatically. I think the market's anticipating two or three more cuts on top of the one this week. And so the 10 years kind of reacted and fallen to 20 or 30 basis points also over that same kind of time period. So that'll result in lower borrowing costs for homeowners and home mortgage rates and for CRE as well. To add my commentary to that, though, I think that I've said this before and published in articles, I think the long term rate should be right around 4.3% plus or minus 20 bips. So it feels like it's on the lower end of my prediction. And given the fiscal challenges of this country, given the increase in the overall debt load of this country, I think that rates are going to creep back up to that, to my predictive 4.3% rate. So I think we were overshot a little bit, but I could be wrong. Steven's nodding his head, so.
- [41:08]
D
I love how you framed it and I'm right there with you. The long term challenges have yet to be addressed in any serious way by our government and there's just going to be, I think, like you said, more upward pressure likely than downward on the long end of the curve. I'll be very interested to hear how the Fed frames their decision, not just this week, but going forward because the independence has been front and center. You know, if you want a 50 basis point cut, if anything, you should, you know, probably not be pushing so hard for a 50 basis point cut because it, you know, in a very perverse way, ends up politicizing what would otherwise be a non political decision.
- [41:46]
B
So John, thank you again so much for joining us today. You are frequently in our shout outs, which is how we like to round out our episodes on this Trepwire podcast. So maybe I'll let you give a shout out for yourself here first. If our listeners are looking to get in contact with you or learn more from you, how can they reach out? And then if you have any shout outs to give, we'd love for you to share them.
- [42:08]
C
So I guess the easiest way to find me is on LinkedIn. I'm pretty active there and you can reach out to me on LinkedIn. I'm happy to respond and with my email and phone number and we can chat some more that way and then I'd love to give each of the three of you shout outs. So Haley, you've been on this show now a couple of years at least and done a tremendous job kind of setting the stage and leading it and, and keeping the guys kind of in line, which I really appreciate. Lonnie, as always, your kind of more folksy wisdom I think is fantastic and how you deliver it and it kind of bring us back down to kind of the everyman kind of concept and So I love that. And then, Stephen, you're the technical guy, and I just love the way you bring the data in and explain really what aren't necessarily easy concepts and really bring it to the pod and boil it down so that even people that aren't PhDs can understand. So I appreciate all three of you guys.
- [43:07]
D
Thank you. That's really kind. It's been an absolute pleasure having you on, and our listeners get to hear firsthand the wisdom and insight and experience that you bring to us through your comments on just a regular basis. It's been a lot of fun.
- [43:22]
A
Yeah, this has been a great episode and thank you for the kind words. And I will tell you, of the three of us, Hailey has the hardest job keeping Stephen and I on track, so she deserves most of the credit.
- [43:33]
B
Well, thank you again, John. With that, we'll close this special podcast. Thank you, John, for joining us today. Join us later this week as we look at what's happened during the week and how it may be impacting you. If you have a question or a comment, send an email to podcastrep.com until then, visit trep.com for more info and subscribe to the TruckWire Podcast with your favorite provider. Thank you for listening and stay well.
- [43:57]
C
All right. Can I say all right?
- [44:00]
A
Yes. Perfect.