Bill Lenehan - Investing in Commercial Real Estate

Key Takeaways

• Interest rates have significantly increased, causing a freeze in the housing market. However, the situation is more complex as inflation has also increased and the Federal Reserve's actions to combat inflation are starting to take effect.
• Higher interest rates make it harder to pay for assets and make the same rate of return. Expectations of returns over a risk-free rate have also risen.
• The Federal Reserve should be pleased with the more measured way of hiring and the current market conditions.
• Interest rates have negative effects on real estate, but the situation is nuanced.
• Apartment stocks and buildings have had a difficult year, despite the assumption of high occupancy. Rents can be reset in most markets to meet demand, which helps keep up with inflation.
• “What's happened since I graduated from college in 1999 is there's gone from 172 publicly traded real estate companies to 151 today in 20 or so years. But the value, the equity market cap of that industry has gone up 10.7x.”
• Bill characterizes the return profile of real estate as stable and slightly lower than other asset classes, but capable of being financed creatively and at high levels.
• He notes that the use of financial leverage can turn a lower ROA investment proposition into a relatively high ROE proposition.
• Bill references a Sam Zell article which states that when people say "location, location, location" in real estate, they're not just talking about the physical location, but also the fact that the building is unlikely to change much over the next 20 years.
• He notes that the chance of a building becoming 10x more valuable is low, but also unlikely to become 1/10 of what it was.
• Bill highlights that the geniuses of real estate investing are those who can navigate the narrow band of the physical limitations of the real estate, while still being able to create a lot of return and risk through financial engineering.
• He emphasizes the importance of owning your balance sheet as a real estate investor, and not being swayed by lenders offering more than needed.
• He mentions that Microsoft Excel can be a dangerous tool in decision making, as it can give a false sense of confidence in forecasting cash flows.
• Private equity investments are rarely modeled for less than a 15% levered return, and advises not to overemphasize Excel models, but also not to underinvest in them.
• Four Corners' stock went from $33 a share to $12.50 in one week during COVID, but the company was able to recover and ended the year up.
• The knowledge and experience he gained from working at Farallon was opportunistic and global, but not replicable, and that Four Corners operates in a more specific and replicable way by buying lots of small, similar buildings.
• Malls should not be viewed as one entity as they vary greatly in value and success. The top 5 malls in America are worth more than the bottom 200.
• The decline of malls is due to a lack of reinvestment and focus on distributing cash flow to investors, rather than modernizing and adapting to changes in consumer behavior.
• The office market may be facing a similar decline as a result of the COVID-19 pandemic and the shift towards remote work. Class B undifferentiated office buildings may struggle to attract tenants without significant investment in amenities and modernization.
• As tenants have less leverage in rent negotiations, landlords who do not reinvest in their properties may see a decline in occupancy and value.
• Technology plays a crucial role in the management and experience of buildings and real estate. It is becoming increasingly important to attract talented and young people to the industry.
• Technology can improve the customer experience, such as using AI to check orders or using smartphones to navigate through stores.
• We are dramatically over retailed in the United States. Overparked also.
• Bill does not believe that the current period of required change for real estate due to the combination of technology deployment and societal changes brought about by COVID is the highest ever. He states that it is human nature to always feel like the present moment is the most important, but that there has always been a need for change in real estate and those who embrace it succeed.

Transcript