Episode Transcript:  

Hello everyone. Welcome to another episode of REady2Scale. I'm your host, Ellie Pearlman, broadcasting from sunny, beautiful California. Let's get started. Let's get REady2Scale

All right, and today on the show we're going to talk about the recent rate cuts that finally the Feds have delivered so recently, a few days ago, the Fed just announced the rate cut of 25 basis points, which is something that we've all waited for a long time. Personally, I prefer multiple moderate rate cuts, 25 bibs month over month rather than one large rate cut.

And then a pause because something like that would indicate that there is no stability in that impact investors' behavior and also the public markets behave accordingly. But let's not jump the gun here. Let's talk more about what we're going to actually talk about on today's episode. So obviously the headline, the Fed just announced red cut.

That's a pretty. Simple headline, but implications are a lot more nuanced than that, especially for family offices. And I want to share my thoughts and also other family offices strategies and view when it comes to this. Rate cut. So what is changing, what is not changing and how this rate cut is going to impact deal flow, underwriting assumptions and capital allocation strategies.

Yes, there is gonna be a change, but sometimes it's not the change that investors would've hoped for. So my goal is to help you think beyond the headline numbers and understand where the real opportunities are. So let's do it. Okay. So let's start with talking a little bit about the macro implications of the rate cut.

Obviously the first one that comes to mind is the fact that. There's lower cost of capital. That's pretty understandable. That's, I would say, one of the best benefits, the obvious benefits of the rate cut For borrower, it means that the DSCR is getting better. The DSCR coverage, they're all in. Financing costs are going to be lower.

It doesn't change a bad deal into a good deal. But it definitely helps. There's some deals that just need a little bit more breathing room and that could give them that breathing room. There's some deals that it's really hard to refinance them at this point. For many deals, the Delta is still too wide for this rate cut to be impactful, but for some of them that are borderline, they're, this is definitely going to help.

But more than that, it's, in my opinion, it's really about the messaging. And so this cut. Is more about the messaging than the actual math because it signals to the market, to investors, into lenders that because of the inflation, the feds essentially. Want to encourage growth, and that means that they're more likely to have multiple rate cuts by the end of the year.

So this confidence can shift the outlook of investors, mainly all the dry powder that has been sitting on a sideline. Now, I will say that two years ago and a year ago, I personally saw a lot more dry powder, a lot more groups and family offices that just. Decided to not invest, and the reason was actually not the high interest rate.

The reason is instability. And so when they're unsure whether the feds are going to. Cut rates and how many rate cuts are going to be out there. Essentially when that is going to start, there's instability and predictability in the market is pretty low, and essentially family offices are waiting. They've been waiting for that signal to start understanding what's going to happen in the next 6, 12, 18 months, and that is a good step in the right direction, even if interest rate is 7%.

When you're quoting a deal, let's say a value add deal, 2015 vintage, if you know that interest rates are going to remain high for five years and you underwrite a deal in a certain way, and that impacts valuation, but when you do not know as a potential buyer. How, you know what? When the feds are gonna cut rates and what the rate would be, it's very hard to underwrite because it's not just the interest rate, it's also the costs, and we're gonna talk about it later, payroll, insurance, et cetera, that also need to be taking into consideration.

But this is a very good signaling from the feds that they want to encourage growth in the market and they should. And so that is the right step. In the right direction, at least from an investing standpoint Now, and I alluded to it earlier, there's really a really strong psychological impact on it because even if the cut itself, yes, it was modest, it wasn't 50 basis points, it wasn't higher than that, but it changes investors.

Psychology. So some of the families that have been waiting online, waiting for some stability, now they feel that it's safer again to reengage because they see the beginning of the stability. And that can also impact transaction volume because now sellers would feel that putting the deal in the market would yield better, more bids, and probably higher bids as well, because.

New debt is lower, so that also will have impact on deal volume, but the psychological impact is going to be pretty direct and pretty remarkable. That would be remarkable to see from my standpoint as a sponsor who works in family offices and with will TryNet Worth individuals. I can tell you that in the past six months we have witnessed.

A transitioning of investors mindset where more and more investors actually started to deploy capital or even underwriting and looking at deals more seriously than two years ago, 18 months ago, where a lot of things that we've been hearing. Was, we're not deploying anything now and some investors are starting to reengage now with the intention of deploying in Q1 and Q2, but we definitely, we've definitely noticed this change in the market.

Now, if we're talking about the market, let's talk about specifically about multifamily. So when it comes to transaction volume. In the past, again, six months with the slow return of capital. We've seen also our, the pipeline getting bigger and bigger. Meaning more and more sellers are back in the market placing, put in their assets in the market.

So if in the older world of 2023 and some of 2024. Or MA mostly of 2024 sellers, were not willing to adjust prices. They still remember the good old days where they could have exited at a three cap and now they're forced to exit at a five, maybe six cap. It's painful, and a lot of sellers did not want to come, did not want to essentially make peace with the fact that this is a different world.

Now, especially with the rate cuts, they understand that now that the economy is improving, cap rates may move a little bit, but they're not going to be 3%. I personally have seen deals trading in the last six months at four and four and a half cap. Usually it's all the way from four to five cap when it comes to deals that are class A, class B in solid locations, five and a half sometimes, but six cap and higher than that.

These are usually. Distressed assets, whether it's distressed above the line, which means that it's just high bad debt or in a struggling area, or if it's just distressed below the line, which you know, means that the asset is well located, good tenant base, high occupancy, high collection rate, but it's just the debt that is really putting a lot of pressure on cash flow or.

The loan is due and it matured and there's, there's a need to refinance, but transaction volume will increase the deal, the amount, the number of deals that we are going to see in the market. And this is, this. Cut is the first step towards narrowing that bid ask spread between seller's, unrealistic expectations, and what the market was willing to pay.

Now I mentioned earlier refinancing. So for the assets that mature this year, that could be a lifeline. Again, depends on the deal. Sometimes the gap is way too big between the new loan proceeds and the current loan proceeds is sometimes if you refinance many groups, they refinance. Now the new. A loan is not going to cover the proceeds from the old, the current loan.

So that's still an issue. But for the deals that were borderline, this could be, definitely could be a lifeline. So some deals that look maybe unworkable can be saved now. So it will be interesting to see how that changes in a few months. And as the fed's going to decide whether they're gonna cut more, I do see.

Two more rate cuts until the end of the year, and hopefully that trend is going to continue in, in Q1 of next year. But here's the thing, even when deal flow is going to improve, refinancing pressure is going to be better. Valuation may, may not be directly impacted in a significant way from this single rate cut.

So if there are any operating headwinds, if, if it, if there's an asset or many assets that are suffering from a constant increase of expenses, that single 25 bips rate cut is not going to give them much relief. So, for instance, insurance, taxes, payroll. I can tell you, I remember when we were underwriting when was back in 20.

18, we were still underwriting a thousand dollars for payroll per unit per year. This world does not exist anymore. Now, for instance, we're underwriting $1,800, sometimes $1,900 per unit per year for payroll, 25 basis points. Cut. That's nice. It's better than zero, but the cost. Of the operating burden on the asset is just this, not something that's going to improve overnight.

And with inflation, all these numbers will go up. And so sometimes a moderate rate cut doesn't really move the needle by much, especially for assets that you already, that we already own, that other companies already own. It will need more than 25 basis points to, to essentially impact the expenses. We talked about the rate cut and how that would impact real estate and multifamily.

Specifically, I wanted to share what we are focused on as Blue Lakes, so we still love the Sunbelt region. Some markets in the region more than others. We see the A positive migration, a cost of living is very attractive to tenants, and so we really like those, those markets. When it comes to specifically sub-markets within them, we focus on suburban locations, strong tenant base, and it's more important than ever now, strong pockets, good bones, because you really don't wanna compete with another asset when.

Your asset looks very old and not attractive. And so we are focused, as I mentioned, in a Sunbelt region and even within those markets, we focus and we target pockets that do not have, that do not experience a lot of pressure from new supply. New supply is going down throughout the country, which is wonderful news for multifamily owners.

New start. S are down about 72, 70 3% compared to the height of 2021. And this trend is going to continue into next year. And that's of course good news because as owners of already established multifamily assets, we don't need to essentially cut rates to compete with new construction, and we don't need to offer higher concessions.

But it really depends on the submarket. Usually urban locations. They attract a lot of institutions, but they also attract a lot of, a lot of builders and, and, and so we are trying to stay away from urban locations and we like to be in those suburban micro locations. And again, we're, the tenant base is very strong.

Again, the fact that the feds have cut rates, that's great. That doesn't change much from our point of view. We're still gonna going to. Underwrite conservatively, we're still going to underwrite with very moderate rent growth assumptions. We're still going to account for increase in expenses year over year.

We're still going to look at fixed rate debt and very moderate LTV. So all of it doesn't really change. I would say that really the one thing that does change in our underwriting is. The quote, the debt quote. So when we get a debt quote, if it used to be 5.3% a week ago, now it's gonna be a little bit cheaper, but all the other assumptions are really not going to change.

Nothing really changes what we think at this point when it comes to rent growth or rent stagnation or the cost of CapEx and projects. If anything, that would increase because if essentially it. Because there's, if you believe that it's gonna be a continuous inflation in the next year or so, as you renovate, you should definitely believe that the cost is going to go up.

So this is something that we're also underwriting as well, but nothing really changes from an underwriting perspective. We're still conservative. And again, just a dead quote, once we get. The debt is being sized by our lenders. That's the only thing with an actual quote in hand at hand, we're going to adjust that.

But nothing more. My advice to family offices to really prioritize quality assets with a very strong demographics. Those who can, who have people, the tenants that have the appetite, and have the ability and the willingness to pay for rents that are not. On the lowest level of in the rent schedule, and also prioritize those micro locations where competition is not something that they should be worried about.

There are a lot of reports out there that essentially show. At what time the, the new construction within a mile, five miles, 10 miles away at what point they're going to be completed. And then you can pretty easily from there estimate the, the lease up period. During the lease up period. You probably want to underwrite, softening in your rents because you may need to compete with them unless they're pretty far away.

And, but that combination of focusing on good. Assets, good bones and good locations in areas where there's actually not a lot of competition from new construction and new buildings. That's the one thing that I would say, or not the one thing, but the, this is essentially what is advisable for family offices to focus on, and it's really the big question is.

Right now, is this going to be, is this only one one time rate cut or are there gonna be more of those? And so if this is just a one time rate cut, it's actually beyond the math, which means that in new debt is going to be lower. It's actually really negative because it signals to investors that there's no stability, that they cannot really.

Predict or understand what's going to happen in the future. But if the Feds are gonna stay consistent and stable and keep and provide us with two, three more consecutive rate cuts as small as they are, that signal of easing of getting into that period would be very impactful. And we're gonna see more and more.

Dry powder entering the arena again. Now, when that happens, the interesting thing is that usually cap rates compress. And the reason why that happens, among other things, cap rates is it's a function of interest rates, but also when interest rates essentially decline or when interest rates go down. Then many investors are looking for alternative investments.

If the 10 year is not as attractive, then real estate is looks pretty strong. But essentially what happens is now that the feds are signaling that type of stability with cons, hopefully with consistent rate cuts, then more investors are coming back to the table and now you have a lot more bidders. For every asset that is out there and the pricing war is going to start again.

And that means that groups are going to be, they will be willing to pay higher price for the same asset with the same NOI that they're willing to today. So if someone is making the move right now before the next rate cut, before there's gonna be before the third rate cut. Because every rate cut will bring more investors into the table with more stability.

And so those who buy now are buying before cap rates are going to expand, are going to compress in the next few months, probably towards the end of the year. Now, of course, nobody knows what's gonna happen. If they are not, if they're gonna pause and not going to cap rates, then cap rates may expand. But this is a really interesting timing in real estate and multifamily to buy at a time where you can see, or at least I can see how rate cuts are going to compress.

Now, I'm not an investment advisor. Not a registered advisor by any means. This is just my view and my hypothesis, and so I, by looking at how family offices operate. Speaking with them, speaking with institutions with private groups. I can tell you that many of them want to see if there's still gonna be a couple more rate cut by the end of the year, and then they're gearing up to deploy capital in Q1 of next year.

And when that happens. Cap rates will definitely compress. There's gonna be many more bidders like I've mentioned, and pricing will go up. So any, anything that is being purchased between now and the end of the year before the influx of capital is back in the market, that would be the golden move. That would be the golden move before rates.

Before the cap rates are going to compress and then valuations are gonna go up. So this is, hopefully, we're not gonna talk about ano another bubble, but if it is a bubble in Q1, we are gonna be very smart for buying. Now it's all, it's all about risk. And when you think the next move will happen from the feds, it's very hard to know.

I definitely did not think that they would hold the rate. For that long. I know they've always said that there, it's gonna be higher for longer. I know Jerome Powell talk about talks about that all the time. Finally, they started with cutting rates, but there's definitely gonna be a change, a big change coming in Q1 of 2026, and we can go back to this episode.

When Q1 concludes in 2026 and see if I was right. I was definitely right many times and I was definitely wrong. Many times it will, it'll be interesting to understand whether that was a, a move that this is how and when wealth is being created multiplied. And so speaking of wealth, and I wanna end the episode with that, just some.

So maybe a different perspective for, and advice for family offices. So the way that I see it in, in today's market liquidity, it's not just about the ability to buy, really gives you a negotiating power. So family offices that have cash on hand, they can dictate a term. What downside protection they want.

What's the governance rights? Any share of the code of the GP economics. Some institutions, they can move this way because they have pretty rigid mandates and very strict waterfalls and structure, so family offices that recognize now an opportunity to buy an asset at the right price. And our flex, and they're flexible also in their structure.

They can really win amazing deals right now, and I see it being done right and left. Also, if they have the flexibility, if you as a family office has, if you have the flexibility to not buy and hold for just five years because you can never know and if you underwrite it differently for seven or 10 years, that might make more sense and so.

Families, a lot of funds need to exit in five to seven years, and families usually don't. And if you're buying quality assets, it might be worth holding for more than five, more than seven years. Very hard to underwrite for a 10 year hold. Very hard to predict what's gonna happen in year four, let alone year eight or nine.

But it does make sense to look into it a bit differently because again, as a family office, you're competing. With institutions and public companies with stricter structure and exit, their mandate is allowing them to deploy for five, usually five to seven years. This is where you can be different. This is how you can seize the moment and take advantage of this Very interesting last quarter of the year where essentially almost Q4 of 2025, where you can really get.

Strong assets in a very, the opportunities are all around us, and when it comes to hold, period, the structure. Some institutions, for instance, are not going to sit behind pref. If you're, if you feel comfortable, sit sitting behind pref, you can get great deals that institutions just cannot. They don't have the mandate.

To, to take. And there's a lot of, in my opinion, a lot of assets that they are, a lot of opportunities that they're, that they are missing. And that's my advice to you. You're in a very different position than institutions. Liquidity. It's not something that, that, it's something that you should use as an influence and you can demand better terms than you would've gotten two years ago.

And definitely better terms than you would get three, four months ago. So. You don't have to overly focus or chase short term irs. You can extend a whole period and then a lot more opportunities are going to open up to you. And there's, it's really interesting and I'm very happy that Powell finally cut rates.

I think there's been a lot of political and nonpolitical pressure on the feds. I'm not gonna let, we're not gonna get into politics right now, but to also want to leave you with this last thought. The rate cut is not a magic bullet. It does not make a good deal. It doesn't make a bad deal, an attractive good deal all of a sudden, and it doesn't change the, it may impact the short term interest rates, but when it comes to long-term mortgages over 25, 30 years, et cetera.

It doesn't really impact that as much. 'cause long-term interest rate can go up because now there's their fears of even worse inflation. Or they can go down because they actually look at the interest rate cuts as a signal to, to the strength of, of the economy and or at least to the lending environment.

So it really depends whether the long-term. Interest rate is going to be impacted by the Fed's action or the reasons behind that action, which is inflation and weakening job market. So yet to be seen and in any case, expenses are still rising. So I would not, I would not underwrite anything, any, any part of my, of our underwriting any differently than how we used to underwrite in, especially in the last 18 to 24 months.

Not significantly if anything ever stricter because expenses should and may go. Go up in the near future, but again, as a family office, you're in a unique position to take advantage of where you are in and where we are in the cycle right now. Take advantage of the fact that you don't, if you don't have strict mandates, that you can be flexible and you can get a lot more.

This is a great opportunity and those opportunities are not gonna be around much longer. Probably q the end of Q1. We're gonna be in a very different market and that's also exciting. Alright, that was me, Ellie Perlman. Thank you so much for listening. That was fun. I haven't done those in a while, so maybe I'll come back for a few more episodes.

But, uh, thank you so much and if you like the content, please leave us a review, leave us the rating, and I hope to see you again. Probably next time it's gonna be Jeanette Friedrich, our head of investor relations, and until then. Take care. Be great and thank you.

Ready to Scale is brought to you by Blue Lake Capital, where we hunt down the best multi-family investment opportunities that we can find and invite investors to join in with us. We target class B value, add multi-family properties across the Sunbelt. Our CEO Ellie Perlman, invest a substantial amount of capital into every deal.

This means our interests are aligned with yours. If you're an accredited investor looking to expand your portfolio and diversify sponsors, be sure to visit us@bluelakecapital.com. Blue Lake Capital, be bold, be extraordinary, and keep moving forward.