[00:02:12] Charles Clinton: You know, I think one of the most interesting things that has changed over the last decade-plus is the position of real estate in the broader investment market. It has transitioned from being an alternative asset to becoming one of the primary asset categories, alongside stocks, bonds, and cash. This shift has primarily been driven by institutional adoption.

[00:02:35] Charles Clinton: Real estate has long been a part of institutional portfolios, but there has been a significant secular trend over the last decade, particularly in private equity. Real estate has emerged as the dominant force in this space, with Blackstone serving as a bellwether. In 2010, Blackstone had approximately $100 billion of assets, spread across various sectors, including traditional private equity.

[00:02:59] Charles Clinton: Today, that number is approaching a trillion dollars. Blackstone is on track to surpass this milestone, perhaps even this quarter, and the majority of their investments are in real estate. This influx of institutional capital has had a tremendous impact on valuations, significantly driving up the value perspective in the market.

[00:03:19] Charles Clinton: I mean, there are several reasons why valuations have risen dramatically over the last 10 years. One of them is the prolonged period of low interest rates that we have experienced, although there has been a significant reversal in the past year or so. Another significant macro trend that impacts the real estate market is the affordability crisis in housing.

[00:03:43] Charles Clinton: This issue has colored the real estate market both in retrospect and looking ahead. It’s no secret to anyone, whether you own a home or rent, that rental rates and home prices have increased. The pandemic has certainly accelerated this trend, but it has been ongoing for a decade.

[00:04:03] Charles Clinton: The underlying reason is that construction struggles to keep up with the demand. Whenever there is market volatility, such as during the pandemic or with rising interest rates currently, it leads to a slowdown in construction. Consequently, several years down the road, there is a shortage of new housing units entering the market as initially planned. Unfortunately, there is no catch-up path to bridge this gap.

[00:04:29] Charles Clinton: Considering future investments, we continue to focus on housing because of these factors. Another significant area is industrial real estate. Looking back, it’s hard to imagine, but industrial properties used to be seen as less favorable, closely tied to the decline of American industries and the offshoring of manufacturing. However, this trend has reversed in the last 10 years, especially in the last five.

[00:04:55] Charles Clinton: The rise of e-commerce has transformed the usage of industrial properties, shifting from on-site manufacturing to logistics. Consequently, industrial real estate has become one of the preferred options for commercial real estate investors. Moreover, there are interesting tailwinds expected in this sector over the next five or 10 years.

[00:05:15] Charles Clinton: Whether they end up coming true or not, I think that there’s a lot of momentum right now behind onshoring. You know, given the way that supply chains broke down during the pandemic, and given how, you know, we’re reliant – we realized we are in China, in particular. I think there is both, you know, political and also at the grassroots kind of move towards onshoring.

[00:05:41] Charles Clinton: That could be a major, you know, tailwind over the next decade. So, you know, I know that’s a little bit all over the place, but those are definitely some things that are standing out to me at the moment.

[00:05:57] Clay Finck: Yeah, you bring up some really good points there, especially with the onshoring. I think about trends like the mass exodus from states like New York and California due to affordability issues, being one of the main reasons, and then the trend to work from home.

[00:06:15] Clay Finck: I’m curious, throughout the past decade, if any of these trends or sort of bigger trends have really surprised you, and maybe some that you’ve been writing about?

[00:06:27] Charles Clinton: Yeah, I mean, look, I would say we’ve been riding the housing wave. You know, over 50% of all the investments we’ve done since 2015 have been in housing. We’ve been thinking about that long-term trend. And honestly, the same goes for industrial.

[00:06:45] Charles Clinton: I think we were a little late to that; it came more into focus for us probably in 2018 or 2019. The most surprising one, which I’m sure we can discuss further today, is the office sector. You know, the idea of remote work certainly existed before the pandemic.

[00:07:04] Charles Clinton: Smart people may have been saying that there’s some long-term pressure there, but the office sector was, in many ways, the most institutional part of the commercial real estate market, dominated by big private funds. Now, the future is incredibly uncertain, and I think that caught the whole industry by surprise.

[00:07:25] Charles Clinton: The way that this moment in time really accelerated it, it didn’t create it, but it accelerated it to a degree that I don’t know if anyone could have imagined.

[00:07:37] Clay Finck: Traditionally, I think a lot of people, when they hear about commercial real estate, naturally just sort of think of office space. However, there’s actually much more to it than that.

[00:07:49] Clay Finck: I’m curious if you could expand on what some of the other segments of commercial real estate are and how large this commercial real estate market is in comparison to the residential space.

[00:08:02] Charles Clinton: Yeah, no, that’s a great question. I think it’s a pretty common misconception when you hear “commercial,” you think it’s office, but it really encompasses all real estate that’s owned and rented for business purposes.

[00:08:16] Charles Clinton: So, even when you’re thinking about residential, you know, anything that’s multifamily apartments that are for rent, that’s really in the commercial real estate bucket. I think there are traditionally six categories: multifamily, industrial, office, retail, hospitality (which mostly includes hotels but also things like casinos and resorts), and this big bucket of specialty. So, that’s a huge range with big subcategories like healthcare, data centers, self-storage, sports and entertainment. And then you have smaller categories like car washes or dealerships. It’s really a giant universe.

[00:08:51] Charles Clinton: Oh, speaking of the size of the market, the residential market is huge. It’s roughly the same size as the stock market, around 40 trillion. And the commercial real estate market is about half that, around 20 trillion or just over.

[00:09:07] Clay Finck: As we’ve been chatting and connecting, you mentioned to me that you’ve actually been entering these more niche markets, such as self-storage and car washes. These are sectors that I think of as not being fully institutionalized. You see a lot of mom-and-pop types, you know, people owning these types of properties. Let’s talk about the dynamics of these more niche markets in comparison to your traditional commercial real estate deals.

[00:09:35] Charles Clinton: Big picture Investing’s a constant search for relative value, and it’s a bit of a game of whack-a-mole.

[00:09:43] Charles Clinton: So, something is interesting and has value. Money goes into it, valuations drive up, and then the value proposition goes down, right? So, it leads to this constant search for new opportunities. You know, I think multifamily, as attractive as it is, a lot of people know it’s attractive. So, you know, valuations have really soared.

[00:10:05] Charles Clinton: You know, that leads us and a lot of other players in commercial real estate to look for things that haven’t seen as much institutional investment over time. Self-storage and car wash are two that we’ve identified and made investments in over the last five years. You know, you’re right.

[00:10:25] Charles Clinton: The common characteristic here is that they’ve basically been mom and pop. They’re really fragmented, you know, owned by non-professional owners who aren’t as good at driving rents or managing the bottom line. These were historically cash-based businesses also, particularly on the car wash side. So, I think there was a little bit of sketchiness on how much income these things were actually producing.

[00:10:51] Charles Clinton: And then, you know, I think as private equity-style investors have come into both, they really look at these as subscription revenue opportunities. So self-storage, you know, it’s still rental-based. You know, it’s not really a new opportunity to turn it into a subscription. But I think the commonality is that the customers, once they’re in, are incredibly sticky, right?

[00:11:15] Charles Clinton: And that’s, we all have software subscriptions that we don’t realize we have for six months until we see them on a credit card bill. And I think for many people, self-storage is like that. Once it goes in, you kind of don’t think about it anymore. So, as a result, you know, a lot of professional owners realize that they can kind of keep slowly escalating rents and that basically people aren’t going to move out because people don’t want to move.

[00:11:48] Charles Clinton: And they could also manage expenses better and have bigger portfolios, which gives you some economies of scale on car washes, the subscription revenues. Uh, just a new way of thinking about it. You know, everyone obviously is used to shelling out their 10, 20 bucks or whatever when they go to the car wash, but you know, increasingly, especially in high traffic areas and states where people like to get their car washed the most.

[00:12:18] Charles Clinton: Car washes are increasingly offering monthly memberships, you know, converting some of that one-time revenue into a subscription and, you know, getting higher multiples when they sell as a result. So, you know, I would say with both, they’re kind of midway through the institutional capital attraction process. Self-storage is probably further along than car washes are, but, you know, for both, you’ve seen car washes get sold in big portfolios to multi-billion-dollar private equity companies in the last three years.

[00:12:51] Charles Clinton: So, you know, I think the window is now because once you have the opportunity to, you know, buy now from a mom and pop, but maybe sell later to an institution that’s willing to pay more of a premium for something that’s already been brought up to standard, that’s a really nice point in the market cycle to participate.

[00:13:15] Clay Finck: Yeah, I find these more niche asset classes to be really interesting, relating to self-storage. You have so many units, and you’re diversified. When you’re buying a duplex, you have two different units, so it can be a bit more difficult if you have trouble with one of the tenants or whatnot.

[00:13:35] Clay Finck: On the other hand, with self-storage, you may have a hundred or 200 units just in one property. And relating to the car wash, I was just recently getting my car washed for the first time, probably in April. And I could tell the guy there was trained to sell that subscription hard. You know, I said no one or two times, and he’s given me discounts and just pushed that subscription really hard.

[00:14:05] Clay Finck: So it’s apparent that that is a trend that a lot of these bigger, more institutionalized car washes are going for.

[00:14:13] Charles Clinton: You know, and your first point on self-storage, I think is generally a good point on the argument for investing in these larger commercial real estate deals, right? It’s the economies of scale that you start to realize, and you just have more diversified risk, right?

[00:14:32] Charles Clinton: I mean, there’s a huge difference in losing a tenant in a two-unit building, which you own personally, versus losing a tenant in a hundred-unit building that you own a small part of.

[00:14:45] Clay Finck: We’ve talked a lot about the pace of interest rate hikes on the show and how that can put a lot of pressure on many real estate sectors, especially commercial real estate, due to higher borrowing costs.

[00:15:00] Clay Finck: How have you seen prices trending within some of these different segments? Since you mentioned earlier that you’re always looking at where you can get the best bang for your buck and the most value, how have you observed price trends in some of these sectors?

[00:15:18] Charles Clinton: I guess I’ll give a very, very mini primer on how commercial real estate is valued, bought, and sold. It’s based on what’s called a cap rate, which is essentially an inverse of a multiple on net income.

[00:15:33] Charles Clinton: So, as interest rates go up, this puts pressure on cap rates to go up and multiples to go down. Ultimately, you think about it as the unlevered yield on whatever you pay for. It has to be higher than your cost of putting leverage on it. You don’t want to buy something at a 7% cap rate and take out 9% debt because then you’re taking any kind of return out of your equity and paying it to your mortgage lender.

[00:16:06] Charles Clinton: So, basically right now, all valuations are getting crunched in commercial real estate. The big difference with private markets, like commercial real estate, versus a public market, of course, is that pricing is just much more opaque and much less instantaneous. So it’s hard to say exactly how much valuations have moved, in part because there’s just a lot less market activity today than there was a year ago. There’s kind of a classic bid-ask spread, right? I mean, a seller thinks that their property is worth more than a buyer thinks it’s worth today, and as a result, sellers don’t want to sell and buyers don’t want to buy. So, you know, that will start to crack.

[00:16:53] Charles Clinton: It kind of always does, but there’s definitely a delay between interest rates going up, putting that pressure on prices, and when that actually starts to play out in the market, at least in a big way. But, you know, from an estimated perspective, kind of a more theoretical perspective, and tracking the sales that are happening, I would say you’re looking at a 10 to 15% dip in valuations, you know, as a big picture matter.

[00:17:24] Clay Finck: When you think about the way interest rates rose the way they did, a lot of times when you run the numbers, you see your monthly payments going up 40% or 50%, assuming you’re paying the same price. So, what do you think is making up for that difference of valuations only coming down 10% or 15% or so?

[00:17:48] Charles Clinton: You know, it’s honestly much easier to show you in an Excel spreadsheet.

[00:17:53] Charles Clinton: But, you know, the gap in interest rates is kind of magnified by leverage, effectively, right? Or your gap in purchase price and cap rates is magnified by leverage. So your cap rate can go up 10% or 15%, and you’re not seeing that same translation down below to the cash yields. The other fact is…

[00:18:15] Charles Clinton: You know, cap rates and interest rates are related, but it’s not a perfect relationship, right? It’s not like the cap rate is always 2% above the interest rate. It will get closer, it’ll get wider depending on other factors in the market. So right now, I would say it’s trending. They’re trending closer together, and if that expands more over time, then you’ll start to see more dip in valuation.

[00:18:44] Charles Clinton: So, I think, you know, for many of us, that’s the moment that we’re waiting for, right? You know, it’s when is the point to start pouncing? When do we feel like valuations are at their endpoint, at their bottom? When is that buying opportunity really going to be there? So right now, it’s happening on a one-off basis.

[00:19:07] Charles Clinton: You know, everything’s a little bit more idiosyncratic, but that will start to hit the market, you know, more broadly over the next year. And I think then you’ll start to see that pace of transaction volume really, really start to pick up.

[00:19:25] Clay Finck: Yeah, so it sounds like profit margins are definitely getting squeezed to some degree for some in the real estate market.

[00:19:32] Charles Clinton: For sure. The other thing, though, is there’s also the forecasting into the future, right? So, with a real estate investment, for most of them, you’re making some of your return through cash flow, which is definitely more hit now. But you’re also making a big chunk, for most deals, in your kind of back-end appreciation and where the forecast happens.

[00:19:56] Charles Clinton: There is: What are cap rates and interest rates going to be in three years or in five years when I go to sell this? So, you know, some of the things that make cap rates stickier are, you know, exactly that, right? Oh, well, interest rates are high now, but the Fed is indicating that interest rates might be 2% lower in three years.

[00:20:22] Charles Clinton: So, you know, we think there’s a little light at the end of the tunnel.

[00:20:28] Clay Finck: Another thing that really stuck out to me as we’ve been chatting is that you guys tend to avoid office space, at least at current prices. I’m curious about your view of office space and maybe what’s keeping prices from coming down as much as some people might expect with all the headwinds they’re facing.

[00:20:50] Charles Clinton: Yeah, and I may have expressed this wrong when we were talking. Prices are definitely coming down in the office. You know, I would say it’s more of the famous expression. You don’t want to try to catch a falling knife as much as they have dropped for things that have actually sold. I don’t think we’ve seen the bottom yet.

[00:21:14] Charles Clinton: And I think that’s the general feeling within the industry. You know, if you look at it, you have foreclosures or defaults in major office buildings, major cities with the biggest landlords in the world. And when you start to see that at the top of the market, you know, you can only imagine what’s happening at the bottom of the market. You know, those three units, kind of office buildings that were built in 1970, because those always feel the pinch, you know, much more than the kind of big New York City Glass Tower does.

[00:21:54] Charles Clinton: So, you know, from our perspective, I think that there will always be a point at which asset prices will make sense for the opportunity. We just don’t have conviction that that point is here yet, or a lot of visibility into when it’ll arrive. Right, and you can tell yourself a lot of stories right now about what the future of office usage and remote work looks like.

[00:22:21] Charles Clinton: You know, I think there is certainly a gang that says the traditional office is basically over. This is going to be the, you know, longest going out of business sale possible. What was it, Kmart that, you know, basically went out of business over the course of 15 years? I think there are definitely the strong advocates that feel like we don’t need an office.

[00:22:48] Charles Clinton: It’s over. On the other hand, I think you have people saying, “Well, let’s see what a recession does if that puts butts back in seats,” because there’s a perception, true or not, that it’s a lot easier for an employee who doesn’t know their boss to get cut than an employee who does see their boss.

[00:23:10] Charles Clinton: And you know, right now employment is at an all-time low or close to an all-time low. So that’s not getting tested. But you know, from my perspective, I don’t know how it’s gonna play out candidly, and you know, until we have conviction about what the trend is actually going to be over the next few years, we’re approaching it incredibly cautiously.

[00:23:36] Clay Finck: Yeah, it sounds to me like you need a pretty large margin of safety when you’re getting into these office deals just due to where this could be five, 10 years from now.

[00:23:49] Charles Clinton: Yeah, absolutely. And you know, again, if you are investing, there’s definitely a school of thought that everything has a price that will settle and make sense.

[00:24:00] Charles Clinton: You know, some people don’t like that. They prefer to only invest in things that have true, deep underlying value. It’s two different schools, but I think you’ve seen in commercial real estate, in particular, that the market will drive value to where it needs to be over time, and that can create opportunities.

[00:24:21] Charles Clinton: And things that were really disfavored three to five years ago, retail is actually a good example of that. With the rise of Amazon and its acceleration, there was this sense that retail is dead and no one’s ever gonna go to a store again. But there has been a post-pandemic bounce back.

[00:24:42] Charles Clinton: People are using traditional brick and mortar stores a lot more, and many e-commerce sites continue to open brick and mortar locations. So valuations needed to change, but they are now at a point where people feel like the opportunity here is great, and they’re starting to be bid up again, though tempered, of course, by the interest rate environment.

[00:25:06] Clay Finck: One theme that’s been recurring in the residential housing market has been the historically low inventory, with much of the current market locked in at a really low interest rate. I’m curious if a similar dynamic is playing out in the commercial real estate market as it is in the residential.

[00:25:26] Charles Clinton: Yeah, it’s a great question.

[00:25:28] Charles Clinton: And you know, I would say that if you tell people at a cocktail party that you work in real estate, the first thing they ask you about is homes and what’s happening in that market. The big difference you see in commercial real estate, which I think drives more transaction momentum, is the duration of the debt.

[00:25:51] Charles Clinton: A typical mortgage in commercial real estate is not 30 years. The longest you ever see is 10 years, and that’s a relatively small slice of the market. There’s a ton of mortgage debt with shorter durations, like two years or five years. Additionally, I think there’s more floating rate debt than fixed rate. Fixed rate has really come to dominate the residential lending market for single-family homes.

[00:26:18] Charles Clinton: So, the debt becomes the catalyst for needing to sell. Even for owners who believe in the long-term future and think interest rate hikes are temporary, if they can’t get a loan to replace their existing one at a price and interest rate that makes sense, that’s when they become forced sellers.

[00:26:39] Charles Clinton: And, you know, I think the low inventory that you’re hinting at, the issue in the housing market, is just driven by the fact that no one is selling if they have a mortgage at 3%, unless they absolutely have to. And you know, life happens, right? People need to move, they have a job, they need to move for family reasons, whatever it may be.

[00:27:05] Charles Clinton: But at the end of the day, you really almost look at that 3% mortgage as an asset right now, which is creating a lot of reluctance.

[00:27:16] Clay Finck: Yeah, when people say that commercial real estate is the next shoe to drop, it makes a lot of sense. When you think about the floating rate debt, if their costs are going up substantially and it goes above the rents that they’re bringing in, then you know something eventually has to give.

[00:27:37] Clay Finck: And something you mentioned there that really stuck out to me was that the debt on commercial real estate is much more short-term, tends to be 10 years or less. I’m curious why that is and what has led to one segment of the real estate market being long-term fixed, 30 years, and another segment being much more short-term.

[00:28:01] Charles Clinton: I think that it goes back to the ownership horizon versus an investment horizon. So, you know, of course, people move more now than they ever did in the past. But when the 30-year commercial mortgage was created, it was really based on the premise that you buy your house, live there, eventually own it, and it becomes an asset for your family that can be passed on. The goal is to build intergenerational wealth. However, when people approach commercial real estate as a business, the focus is primarily on making money within a defined period of time.

[00:28:40] Charles Clinton: A common strategy you often see is a value-add business plan. This involves buying a 20-year-old building that hasn’t been well maintained, where rents are significantly cheaper compared to those across the street. The idea is to renovate the building, bring it up to standard, raise rents, and then look to sell. The goal here is to create value and then wait for the market to improve before selling.

[00:29:08] Charles Clinton: In commercial real estate, everyone has investors. Whether it’s a fund with a targeted holding period of five years, seven years, or ten years, or in the private markets where holding periods tend to be even shorter.

[00:29:23] Charles Clinton: It’s really about what your patience is. Of course, you have family offices and individuals who approach real estate in an intergenerational way, wanting to be long-term holders. They tend to look at debt markets with a much longer-term perspective compared to the majority of other players.

[00:29:41] Clay Finck: Another thing that sticks out to me in our discussion here is that you mentioned that cash tends to chase where the biggest profit opportunities are. So, you know, if one sector is really offering high returns, then money’s gonna start flowing in that direction. I think about the residential space and how there’s this super low inventory.

[00:30:05] Clay Finck: No one’s wanting to sell their home because they have, you know, this low interest rate debt tied to it. And then I think about things like Airbnb units, with all these people purchasing Airbnbs in 2020 and after, you know, starting their own side business. And, you know, that might not be something that they traditionally have a good background in.

[00:30:29] Clay Finck: So they might have paid way too high of prices, and now they kind of find themselves in trouble. I’m thinking that might lead to some sort of catalyst to unlocking some of that supply. But another thing that comes to mind, since you mentioned cash flowing where there’s profit opportunity, is part of me wonders why home builders aren’t, you know, trying to fill in the gap on that still strong demand.

[00:30:59] Clay Finck: I’m curious about your thoughts on how the low inventory and the residential housing situation might play out over the medium to long term.

 

[00:31:08] Charles Clinton: I think there’s a lot of pieces there. I guess starting with the kind of top-level question first, you know how this might play out. I think that, even though there’s not a metaphorical gun to your head to sell your home, there still is this sort of rising pent-up demand to move. That does happen, right? So people will hold out longer than they typically do right now because the cost to replace their house is just going to be higher since the debt is more expensive. But at the end of the day, life factors are life factors, and whether it’s someone passing away, someone getting married, someone moving away from home, someone graduating college—whatever it is—people’s circumstances change, and you can only resist the change in circumstances in terms of where you live.

[00:32:03] Charles Clinton: For so long and so hard, I do think that at some point, it is going to have to break for that reason. And then, once you get a little momentum in the market, right, more inventory is going to depress prices. Once people start to see that happening, they go, “I don’t want to be the last person to sell because then my price is going to be way down.”

[00:32:31] Charles Clinton: So, these things can turn relatively quickly. I do think that short-term rental is a really interesting thing. I mean, you know, there’s, of course, a plethora of businesses that have been built around short-term rentals, and I know people personally who did this over the last few years and are now feeling like, “Oh man, there’s way, way more competition in this town, wherever, than there was when I bought this place a few years ago.”

[00:33:02] Charles Clinton: So, I don’t really know if this is viable in the same way, but in terms of impacting the market overall, I just don’t know if it’s enough total units compared to the massive size of the housing market. And I think you also tend to see more of those short-term rental strategies outside of core urban areas, especially since a lot of cities have made it really difficult to use Airbnb.

[00:33:31] Charles Clinton: You know, they’ve really pushed against it, but no doubt that group is feeling the pressure right now. And was there one other question here that I missed?

[00:33:42] Clay Finck: Let’s see. I just mentioned the home builders, if there’s an opportunity. 

[00:33:46] Charles Clinton: Oh, home builders. Yeah, so they are actually starting to get moving again.

[00:33:51] Charles Clinton: But for a while, you know, they’re forecasting future market conditions, right? Because it takes them, you know, 12 to 18 months to deliver new homes. Longer than that if there’s planning and permitting cycles. So they’re trying to say that in 2020, they’re looking ahead to 2022 and what demand is gonna be there.

[00:34:13] Charles Clinton: So that’s been one of the funky things over the last few years: the way things have played out versus the way people thought they would play out has been really different. So during the pandemic, home builders slowed down because they didn’t see this big pop coming, which then creates this tale that happens years in the future.

[00:34:37] Charles Clinton: And I think the same’s true over the course of the last year. When interest rates go up, the home builders all say, “Oh man, our profit margin’s about to get squeezed,” and it looks like the economy is headed for a recession. Housing prices are about to fall. So, you know, they slowed down and, you know, as we’ve seen it today, housing prices aren’t really falling.

[00:35:04] Charles Clinton: I mean, they’re falling in some places, of course, but not at the level that I think people had forecasted six months ago, 12 months ago.

[00:35:15] Clay Finck: Yeah, that home builder dynamic with the huge delay, 18 to 24 months, and that just… I don’t know how anyone can forecast how that’s all gonna play out with all the different factors.

[00:35:28] Clay Finck: But I want to transition here to private credit. It’s an area that EquityMultiple is very involved with on your platform and what you guys offer. So maybe you can give just a general overview of what private credit is and what attracts investors to it on your platform.

[00:35:48] Charles Clinton: Yeah, yeah, absolutely.

[00:35:49] Charles Clinton: Private credit is obviously a big bucket, but it’s lending instead of making investments in equity, simply put. And from a real estate perspective, there are definitely a lot of different flavors of it. We’ve mostly approached it through bridge lending. So essentially lending to someone who needs 1, 2, 3, or 4 years to execute a business plan.

[00:36:13] Charles Clinton: Their plan is then to refinance with a new loan, pay you back, and continue to own the property. We think that the opportunity set in private credit is massive. The best it’s been in at least a decade. And the factors are pretty simple, right? I mean, interest rates go up, so that, of course, just drives absolute returns up and…

[00:36:38] Charles Clinton: The other factors are a little bit more below the surface. I’m sure I’m guessing you guys have covered it in a podcast at some point. Everything that happened with the banking crisis a few months ago, with a few of the larger mid-tier banks going bust. And that’s had some downstream ripples on commercial real estate lending, in part because regional banks are maybe the most important player in commercial real estate lending.

[00:37:07] Charles Clinton: The big banks certainly do it, but that’s limited to a pretty small slice of the market, mostly the largest deals in the largest markets. Regional banks are kind of the default lender, and now they’re scared. They’re working with regulators who are looking at their balance sheets more tightly than ever. They made a bunch of investments at interest rates that don’t make sense now, which is putting more pressure on their balance sheet. So they’re just pulling back from lending. They’re doing a lot less of it.

[00:37:43] Charles Clinton: That opens up more opportunity for non-bank lenders and for us. We’ve historically done about 50% in the lending side and about 50% in the equity side. And we really switch that mix based on where we are in the market cycle, what’s happening with interest rates. Right now, we want to do as much credit as possible because these are generally short-term opportunities.

[00:38:09] Charles Clinton: If the value of a property falls by 10% or 20%, it doesn’t impact you in the same way as an equity holder. And then you’re recycling your money relatively quickly. So if you feel conviction, which we do, that in 12 months or 24 months, there’s going to be a major buying opportunity on the equity side.

[00:38:32] Charles Clinton: It becomes this great place to make income as you watch the market unfold more. 

[00:38:39] Clay Finck: I think many of our listeners are aware of the benefits of getting exposure to real estate. I’m curious if you could share some of the benefits that investors look for when investing in private credit. I assume it’s somewhat similar to a bond allocation, maybe with a slightly higher interest rate.

[00:39:00] Clay Finck: Could you also provide more information on the rates people are getting in private credit?

[00:39:06] Charles Clinton: Yeah, absolutely. I mean, that’s exactly how we think about it, right? Is that we think you should think about real estate the same way you do your stock and bond portfolio, right? That it’s a matter of allocation that’s driven by your own risk preferences and your duration horizon.

[00:39:26] Charles Clinton: You know, obviously, your focus on income versus appreciation could be a big factor in building that portfolio that works for you. I do think, though, that unlike the horizon in the public market where many folks are kind of, “Let’s put my money in, and I’m gonna ride this pretty passively until my retirement.”

[00:39:48] Charles Clinton: I think you can really find an advantage by being a little bit more active in the private markets where the durations have start and end dates. So you’re trying to match your investment to what’s happening at that particular point in the market cycle a little bit more. As I said, today we see there’s a premium on income just overall across the market, and the equity volatility is high.

[00:40:16] Charles Clinton: So that’s naturally a kind of flight to safety and a flight to some safety with shorter duration. In terms of those yields we’re targeting in the 12% range, something like that. You know, it’s pretty variable depending on the type of underlying real estate project. Debt now starts at a similar rate to your home mortgage, probably in the 7% range, and then it can go all the way up into the mid-teens if it’s for construction.

[00:40:47] Charles Clinton: So we’re following somewhere in that middle zone, you know, focusing on these kind of value-add investments. They have income, but you know, they have a business plan to improve value. I mean, that’s really what they want the money for. They’re like, “We think we can execute in 12 to 24 months. The value’s gonna improve this way.”

[00:41:11] Charles Clinton: Even if the market is doing things on the side, and you know, then we’ll look to refinance or hold or sell at that point.

[00:41:21] Clay Finck: I’d love for you to talk more about EquityMultiple, which is a company you founded in 2015, and today you’re the CEO of. Talk about what led you to start this company and how that sort of evolved, and what types of offerings you guys have.

[00:41:40] Charles Clinton: So I was working as a real estate lawyer for a firm called Simpson Thacher for big private equity companies. So most of my work was with Blackstone, and then KKR and Carlisle. You know, I was really steeped in that kind of real estate private equity world. And there are a few things that I think really made this look like a big opportunity.

[00:42:06] Charles Clinton: The first was a simple change in law. In 2013, the Jobs Act was passed, which really allowed for a different way of investing online. The second is my own attempts to invest in commercial real estate privately. I just couldn’t find a lot of access. Theoretically, living in New York City and working on deals for Blackstone, I was about as well situated as anyone to put $30,000 into a real estate project, but I just didn’t find it.

[00:42:38] Charles Clinton: And really, this is something that has been operated out of country clubs and friend-of-a-friend kind of connections. That’s what has dominated these kinds of private market real estate investments. And I think that anytime a business has moved online, you’ve seen a lot more transparency and efficiency. That really felt like the opportunity, like, wow.

[00:43:00] Charles Clinton: Now money can flow from this whole new group of investors who’s really been kind of kept out by a combination of market practice and regulation. 

[00:43:11] Clay Finck: What sort of offerings are the main ones that people are most interested in on EquityMultiple? 

[00:43:18] Charles Clinton: Yeah, we divide our offerings into three buckets, which we call “Keep,” “Earn,” and “Grow.”

[00:43:24] Charles Clinton: In the “Keep” bucket, we have very diversified, short-term notes with durations of three months, six months, or nine months, backed by a pool of real estate. These are designed as cash management investments, allowing investors to dip their toes into the market.

[00:43:41] Charles Clinton: The “Earn” bucket consists of income-oriented real estate, representing a middle level of risk. This could include preferred equity, mortgage debt, or, in some cases, an equity investment in a stabilized property. These properties typically generate contractual cash flow from long-term tenants or have a history of stable operations.

[00:44:01] Charles Clinton: The “Grow” bucket focuses on equity-oriented investments with upside potential. These investments offer the possibility of higher returns.

[00:44:08] Charles Clinton: Within these categories, we offer both individual property investments and funds. For individual property investments, you can visit our website and view details about specific properties, such as a multifamily value-add property in Charlotte. You’ll find information on current rents, comparable properties, and projected improvements that can drive rent increases.

[00:44:28] Charles Clinton: We provide transparency to investors who prefer knowing the exact type of property they’re investing in. However, we also understand that strategy-based investments make sense for many people. That’s why we offer portfolios consisting of five or six multifamily properties. With these portfolios, you don’t have to select individual properties yourself, but if you believe in the housing market, it could be a good entry point for you. Really, I would say the calling card here is just kind of information transparency, right? We’re trying to expose all the work we’re doing in the background in a way that’s understandable, digestible to investors who might be new to commercial real estate. 

[00:45:11] Clay Finck: You mentioned the changes in law in 2013, specifically the Jobs Act, which, in my mind, led to the rise of different crowdfunding platforms in recent years. I’m curious if you could share what you think your edge is relative to other platforms that has allowed you to be so successful in your continued growth.

[00:45:33] Charles Clinton: I think it comes down to two things. One is a business model thing. Many crowdfunding platforms are simply platforms, marketplaces. It’s like, “Come on here and buyer beware.” We, on the other hand, operate more like a private equity-style model. All the members of our real estate team, who find and vet investments, come from institutional real estate backgrounds. We conduct site tours, perform due diligence, analyze comparable property values, and consult with brokers in the market to ensure the viability of the business plan. That’s why we accept very few investments compared to what we review historically. On average, only about 5% of the investments we see actually make it onto our platform for investment.

[00:46:20] Charles Clinton: The other significant aspect is the diversification of offerings. Our market has mainly been dominated by equity investments, primarily because it is challenging for real estate companies to secure equity. They attempt to generate revenue through fees from that side, so they aim to attract investors to the equity and enhance their bottom line in that manner. In contrast, we approach it from a perspective of portfolio construction, as I mentioned earlier. Equity works well for some investors, while debt is suitable for others, but a combination is beneficial for most investors.

[00:46:57] Clay Finck: You’ve also mentioned to me that value add is something you really focus on. Is that sort of part of your criteria when you’re narrowing down to 5% investments?

[00:47:06] Clay Finck: Is that something you guys really hone in and focus on? 

[00:47:10] Charles Clinton: Yeah, I would say we have a heavy leaning towards it. It’s not a hundred percent of what we do. We’ll do some properties that have less value add, where the cashflow is kind of more where we think it will be in two to three years already. We do some ground-up development more.

[00:47:31] Charles Clinton: Obviously, that’s kind of more opportunistic and speculative, but for the most part, we think the sweet spot for risk and return lies in value add. And obviously, over a large number of transactions we’ve done, about 185, you start to develop our expertise that helps you with the evaluation. So that can be, how much is it really gonna cost to renovate a unit and put in a new kitchen and a washer dryer, new floors?

[00:48:02] Charles Clinton: How long will that actually take? Are the market rents that people are saying they’re going to hit after those renovations really achievable? And the more you do the same thing like that, the more data you can bring to bear. Third-party data sources, our own asset management team, the data they collect on our existing portfolio of properties, and really kind of hone in on this as that sweet spot, but also that sweet spot where we have built up expertise.

[00:48:35] Clay Finck: I’m also curious how sort of your users view their experience. They see a deal on your site and there might be some sort of targeted return, but how do you communicate the risk associated with the property? Is there ever a case where the capital is returned back to investors or how does that sort of process work in terms of one investment doing really well and investors benefiting and other investments maybe not up to par with somebody, the ones that succeed?

[00:49:01] Charles Clinton: Yeah, it’s a great question. That, of course, is the nature of investing, right? You can forecast all you want, but some investments are going to outperform while others are going to underperform. The goal is to do well through a good process over the average of all investments. So, I’d say one very simple thing is that we always preach diversification.

[00:49:26] Charles Clinton: When an investor comes to us and says, “I have $200,000 I want to invest,” we don’t say, “Alright, put it all in the first deal you like.” Our recommendation is always this: If you want to select your own investments, that’s great, but build a portfolio. That’s how you should be thinking about this. Just like there has been a move in public investing towards index funds for non-professional investors, diversification is always a great rule. Going back to portfolio construction, it’s important to have both debt and equity investments, shorter-term and longer-term, to give people options in terms of matching their desired level of volatility. 

[00:50:09] Clay Finck: I’m also curious. The range of your deal sizes is there some sort of tight range that your deals tend to be, or is it really vary in terms from being a million bucks to tens of millions or what’s that sort of look like?

[00:50:23] Charles Clinton: We generally operate in what we call the middle market, so deals between $10 million and about $50 million in total value, and that cap. We certainly have gone past that with the real estate operator we’re working with; they’re incredibly experienced and are doing a larger transaction. But as a general matter, we just think that there’s more value in that slice of the market than in the larger deal sizes.

[00:50:52] Charles Clinton: Going back to our original portion of the conversation, there’s just less institutional capital there. Most funds don’t want to write checks below $20 million. So if you take $20 million of equity and $30 million of debt, you’re at a $50 million transaction. Below that, you’re facing a lot less institutional capital competition.

[00:51:13] Charles Clinton: So there’s a little bit more room in terms of margins.

[00:51:18] Clay Finck: That also brings the question how much leverage is used? Are these deals typical amount of leverage, or what does that look like? 

[00:51:27] Charles Clinton: I would say it’s variable. Generally we put leverage, we use leverage caps, so it varies also by point in the market.

[00:51:35] Charles Clinton: I would say right now across the board, just leverage is lower. Leverage is not as high in commercial real estate as it is in residential real estate. Generally, you’re not taking out at 80% mortgage hardly ever. Usually the mortgage falls somewhere in the sixties, something like that. Between 60 and 70%.

[00:51:52] Charles Clinton: There are cases where you would opportunistically say, All right. We’ll use more leverage because we like the risk and it increases the risk, but it’s also commensurately increasing the return. What I would say as a general rule, we’re kinda looking at that 65% in less leverage. 

[00:52:12] Clay Finck: I’m also curious with your guys’ continued growth and continued success and all the different offerings you’ve launched over the past eight years that you guys have been in operation, is there any new types of offerings you’re looking to deliver to users in the future?

[00:52:28] Charles Clinton: Near term, we’re launching a debt fund. We’ve had a prior iteration of a debt fund that we launched a couple of years ago. We’re launching a new one. That strategy is tightly tied to where the market is today, and investors will still be able to invest in the individual loans that the fund is involved in. But for those who believe in the thesis that Bridge Lending is going to be a great opportunity for the next 12 to 24 months, this is a way to kind of buy into that basket. So we’re very excited to launch that one. It will probably be coming in the next few weeks.

[00:53:13] Charles Clinton: Beyond that, we’re also looking at a similar equity fund, but the timing is yet to be determined. As the market opportunity arises, we want to offer something similar to investors on the equity side as we do on the debt side. Additionally, over the last six months, we’ve been diving deep into other potential alternative investments outside of real estate. At this point in the market cycle, it definitely breeds interesting opportunities.

[00:53:42] Charles Clinton: However, we’re really reluctant to get over our skis. We’re experts in real estate, so there’s a lot to be said about sticking to what you know. Therefore, we’re being very cautious in how we approach any expansion in that area. But I’ve definitely been digging in, and I think we’ll be able to bring something to the market sometime in the next six to 12 months.

[00:54:09] Clay Finck: All right. Well Charles, this is great. Really appreciate you coming on. This is, I know I learned a lot during this conversation. Before we close it out, I’d like to hand it off to you so you can give a handoff to the audience on how they can learn more about you, learn more about EquityMultiple and anything else that the listeners should know.

[00:54:28] Charles Clinton: Yeah. Yeah, absolutely. Well, first, thanks so much for having me on, and for everyone who made it to the end of the podcast, thanks for listening. If you want to learn more about equity, one simple thing you can do is just go to equitymultiple.com. And one thing I would encourage is, we are an online platform, but very, very human-backed. We’re not just a bunch of bots on a website. So if you have questions about signing up, about us, about investing in real estate, or about any investment we have on our platform, you can chat with someone. You can call someone. We see investor education and direct communication as a big part of this because we know for many investors this is either something new for them or something that they’re looking to grow their allocation into. So we definitely have a lot of resources available for folks.

[00:55:29] Clay Finck: Great. Thanks so much again, Charles. Really appreciate it. 

[00:55:32] Charles Clinton: All right. Thanks again for having me on, Clay. Good talking to you. 

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