20 February 2021

In today’s show, we speak with Mr. Ian Formigle, about the COVID-19 impact and how to identify value in commercial real estate.

Ian has over 24 years of experience in the Real Estate market, while his company has over 400 offerings with over $13 billion in commercial real estate.

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  • How to value commercial real estate
  • How to take advantage of the trends not fully priced into the market
  • The best 5 cities to invest in
  • Which habits we have changed and the impact on commercial real estate


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

Stig Brodersen (00:02):
On today’s show, we bring back a guest by popular demand, Mr. Ian Formigle. Ian has over 24 years of experience in real estate, private equity, startups, and options trading. As the CIO of CrowdStreet, Ian has over 400 offerings with over 13 billion in commercial real estate. Today we talk about how to value commercial real estate, how to take advantage of trends not fully priced into the market, and the five best cities to invest in right now. So, without further delay, here’s our interview with Ian Formigle.

Intro (00:36):
You are listening to The Investor’s Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.

Stig Brodersen (00:56):
Welcome to today’s show. I’m your host, Stig Brodersen, and by popular demand we have one of our favorite guests with us here today. And that is Ian Formigle, Chief Investment Officer at CrowdStreet, and he is with us for the sixth time. So first of all, thank you, Ian, for joining me today here in The Investor’s Podcast.

Ian Formigle (01:13):
Stig, it’s a pleasure to be back on this show. As you know, I’m a big fan of what you do, and I love coming on this show. So, I’m eager for today’s conversation.

Stig Brodersen (01:23):
That sounds fantastic. And Ian as we kick off this interview, talking about the outlook for commercial real estate in 2021, let’s first take a look at 2020 because it’s not possible to say 2020 without talking about the Coronavirus. So let’s get right to it. How did commercial real estate perform in 2020?

Ian Formigle (01:44):
So, to begin with, the key theme for commercial real estate performance in 2020 was just simply unprecedented price dispersions that was driven by the effects of the pandemic. The results were either good, or very bad depending upon varying circumstances. So to begin, let’s provide some context as we get into the numbers. And I think we can look to some benchmarks for a little bit of help. I think the first is the S&P. That finished 2020 at up 16.26%. I think we can all agree Stig that that’s a fairly amazing annual performance number given where the index at mid year. Second is public REITS. The MSCI US Index captures 99% of all US REITS, so it’s a pretty good proxy. And that was down seven and a half percent for the year. And that’s an unlevered number, and I’ll get into that in a minute.

Ian Formigle (02:37):
So for the commercial real estate sector, when we think about private returns, there aren’t really any good publicly available data for price indexing. But there are good proprietary sources of data. And Green Street Advisors commercial property price index, or their CPPI is one of the better ones as it tracks a large sample size of private US real estate returns on an unlevered basis. So across all asset classes, Green Street CPPI was down 8.2% for 2020. But blending across all asset classes I think creates noise in the data because of that massive price dispersion that we witnessed in 2020.

Ian Formigle (03:19):
So now, when you break out that data by asset class, you have two types of real estate that were up across the board last year. And they were industrial at 9.5%, and manufactured housing at 11.5%. And on the downside, you have retail at negative 20.7%, and hospitality at negative 25.1%. And I think those numbers shouldn’t surprise anyone as we all saw the massive distress that hit these property types throughout the pandemic still continue to do so, really. Apartments, they were down a bit in 2020 on a blended basis, but nominally at 3.4%. But when you take this data, I think to truly get a sense of how private investors actually fared in real commercial real estate deals across the United States in 2020 you need to apply additional filters.

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Ian Formigle (04:15):
The first is leverage. Practically, all commercial real estate is leveraged to some degree. So an unlevered analysis, I just don’t think it really gives you a correct assessment of levered returns. So if we want to apply a leveraged assessment, a benchmark number for example, I think assuming 60% is a decent blended assumption across all risk profiles. And when you apply a 60% leverage assumption to the unlevered analysis, you create a multiplier effect of 2.5. So now let’s go back and look at that Green Street CPPI index data on a levered adjusted basis. And now we see industrial and manufactured housing spike up to nearly 24% and 30%, respectively, so pretty strong returns on the upside. And then on the downside, while the returns get pretty dire, you see negative drops for hospitality at 51.6%. And then on the downside, you see pretty dire drops. For retail, you see it hit negative 51.6%, and negative 61.6% for hospitality.

Ian Formigle (05:26):
The second filter that I think you have to apply when looking at 2020 performance is geography. Because the price dispersion that I mentioned a minute ago not only occurred by asset class, but it also really occurred by location. So to get a sense of how location affected returns, let’s look at apartments for example. As I just mentioned, apartments were down 3.4% on an unlevered basis, or roughly 8% on a levered basis across the US. But the blended doesn’t really tell the story for apartments because on the downside locations such as New York City and San Francisco, they were hit pretty tremendously.

Ian Formigle (06:05):
Asset values are probably down 20% in those cities, so applying that 60% leverage assumption to that scenario, that’s going to equate to a negative 50% return. Conversely, apartment values were up in many cities, many secondary markets. Phoenix, for example, is a great example. We saw a 4.4% rent growth in that city in 2020. Pricing is up there double digits in multiple submarkets. So, if you assume a 10% price appreciation there, well now you’re up 25% on a levered basis. So take it in its totality, it really mattered what you were invested in, and where you were invested when it came to estimating total returns for commercial real estate in 2020.

Stig Brodersen (06:49):
It’s amazing whenever you went through those different classes, how they performed. I mean, this is unprecedented. Now, Ian, here on the show, we talked about the excessive money printing, and the impact is really had on asset prices, and we primarily talked about stocks. You mentioned how the S&P had performed in 2020, probably something that we didn’t expect to happen given everything that’s been going on. And here we are. So how have money printing in 2020, and also the expected money printing in 2021 effected commercial real estate prices as an asset class in general?

Ian Formigle (07:24):
At CrowdStreet, we’ve also been paying attention to how the debasing of the dollar is affecting the commercial real estate market. I think the data point that really stands out to me and continues to somewhat astound me is that over 20% of all dollars now in existence were created in 2020. Now, I’m not an economist, but I simply don’t see how this much liquidity pumped into the market this fast doesn’t put at least some upward pressure on commercial real estate prices over time. When you combine that level of injected liquidity with a telegraphed stance from the Fed holding interest rates down over the next two years, even if it is at the expense of some inflation, I think you have a recipe to suggest that while some inflation will occur, even if its effects may be relatively temporary, maybe a few years or so.

Ian Formigle (08:17):
So let’s discuss why inflation puts upward pressure on asset prices. So, when we combine an inflationary scenario with a return to economic growth you will typically see rent growth. And as rents are a key driver for asset values, well, you would expect values to increase over time. And as long as interest rates remain low, we would not expect cap rates to increase much, if any at all. When net operating income of properties grows faster than cap rates, prices rise. And in fact, right now, not only are cap rates not rising, we’re actually seeing them continue to compress. As multiple asset classes sit at historically high spreads to the 10 year treasury. And you can see that over time, and you can look at data on this, cap rates tend to migrate within bands relative to the 10 year treasury rate. So that spread is just, it’s bumped out. And now that interest rates are held low. Well, prices got to go up. So I think when you roll it all up, I expect to see upward pressure on asset prices over the next few years.

Stig Brodersen (09:25):
It’s crazy what you see going on. You mentioned 20% of all dollars were just created. It really makes me think of Charlie Munger, Vice-Chairman of Berkshire Hathaway, he used to say whenever people asked him about macro, especially at times like this. He said that if you’re not confused, you don’t understand what’s going on. So, I think that would be my disclaimer going into the next question. Throughout 2020, and again here in 2021 we’ve seen many people in the commercial real estate space calling for more fiscal stimulus to provide a safety net for the market, which might seem a little counterintuitive to what we just talked about. Also, on the other side of the spectrum, we heard multiple concerns about inflation taking off urging investors to seek hot assets. So how do you see the role of fiscal stimuli for commercial real estate investors whenever we assess our portfolio?

Ian Formigle (10:14):
Well, for starters, I think it’s easy to understand why people on the commercial real estate sector would call for fiscal stimulus as it’s absolutely good for the sector both in terms of stabilizing operations as well as for providing floor undervalues. So let’s consider both of those. First, the two rounds of stimulus in 2020 provided a tremendous amount of temporary relief for all kinds of commercial real estate throughout the year. The biggest beneficiaries, well, those were hotels and senior housing. As we saw the PPP loans that rolled out middle of the year, they literally provided lifelines to those operators. And they filled multiple months worth of negative operating deficits. The PPP was what we would call a direct form of support to the sector.

Ian Formigle (11:03):
But from there, you also have to consider indirect forms of support. I think the biggest example of that is the $600 per week of additional unemployment benefits that were distributed throughout the year. They might not have directly benefited the commercial real estate market. But I think they definitely indirectly benefited it with apartments as the biggest winner. This money going into people’s pockets. Well, it helped them keep paying rent, and I think that showed up in the data. So for example, despite the fact that most analysts out there were predicting a precipitous drop off in rental collections in Q4 2020. When the time actually came, we never saw them drop below 93% at the national level, and that’s according to data provided by the National Multifamily Housing Council.

Ian Formigle (11:50):
So continuing with multifamily, we can also see how 2020 stimulus provided a pricing floor under these asset classes. So continuing with multifamily, we can also see how 2020 stimulus provided a pricing floor under this asset class. With collections remaining strong and interest rates dropping when actual operators were bidding for deals out there, most of them that we talked with, they noted a feeling of what they described as paying a bit more to get a bit less. And to me, there’s this little doubt that the stimulus dollars helped ensure the stability of multifamily operations, and that translated into the stability of asset prices. Now and finally, as we’ve already discussed, the massive amounts of liquidity injected into the market by the Fed in conjunction with their rate guidance supports a thesis around hard asset appreciation over the next few years. So across the board, I just think commercial real estate has been one of the winners for sure when it came to 2020 stimulus.

Stig Brodersen (12:56):
Interesting. So go to the next question, Ian. I don’t think there’s any shred of doubt that we changed our habits with the Coronavirus. It’s just not the amount of hand sanitizers that we never bought before that we are now using. It’s the way we communicate, it’s the way we commute or not commute to work, everything is just different. So many habits have changed. And what we investors are trying to think about is what kind of impact has that had for our portfolio. We try to guess, make the right investment in figuring out how can we benefit from estimating the impact of those habits? So in your space, which habits do you think that we have changed for good in 2020? And how would that have an impact on how we’ll invest in commercial real estate going forward?

Ian Formigle (13:41):
Well, Stig, I think there’s definitely a lot of behavioral changes that have just occurred. I think somehow short-term, midterm, and long-term effects. I see two primary behavioral changes coming out of COVID that I do think have substantial effects on the commercial real estate market, and they’re in the office and industrial sectors. I would say that as we get into these two, it’s hard to categorize either of them as permanent, but I do see multi-year effects. So first, let’s talk about office.

Ian Formigle (14:07):
The first change that I see coming is how we will use office space moving forward. I think there is enough data out there now to support the argument that companies will utilize office space differently in the years ahead in comparison to how they utilized it in 2019. And the way that I see this changing most is in the percentage of daily use by office employees since we clearly have a trend right now towards granting them more flexibility for how often they work in an office. There’s a bunch of research out there that’s been published so far, and also we’ve spoken with a number of office leasing brokers around the country that are getting live dynamic real-time feedback. And I think there’s a general consensus has emerged, and I’m sure it’s going to evolve over time. But it kind of currently looks like the following.

Ian Formigle (14:54):
You see about 60% of workers out there that when the office reopens, they want to return to it full time. Then on the flip side, you’ve got about 10 to 12% of workers who want to remain fully remote indefinitely. And then you have that balance, that 28 to 30%. Now they want some form of hybrid environment. That’s part of the interesting part of the story. I think there’s a couple of notes, things to note in this data. First, pre-COVID, about six to 8% of our office employees were already remote. So increasing to 10 to 12%. Well, to me, that’s a material change, but just not necessarily a drastic one.

Ian Formigle (15:33):
Second, the big question immediately becomes, wow, this is a lot of change to the office environment. Does this movement spell doom for office demand in the United States? And while we don’t have real evidence out there, and probably won’t for at least a year or so. I think the answer is no as I see the results is being mixed on demand once things shake out. I think a simple example will help illustrate this. So for starters, if we take a condensed open office format from 2019, it’s tech oriented, it’s a pretty fairly dense build out. That use is going to equate to about 125 square feet per employee. So if we assume 100 person office, we now need about 12,500 square feet to house that company. And that’s going to assume up to 100% daily attendance. Although we knew for the people who have those offices that never actually happens.

Ian Formigle (16:27):
So now let’s consider the change in use that I just discussed. If 10% of workers are now fully remote, and 30% are now hybrid users, and let’s assume that the hybrid users come into the office three days per week, well, now you’re averaging about 80% of your previous daily attendance, all else equal. So now you stop and say, “Well, does that mean that we need 20% less space?” The answer is no. And the reason for that is that in the new hybrid office, you’re going to have to repurpose at least 50% of that space, if not more, to accommodate your hybrid, part-time workers in what looks like a hotel office environment.

Ian Formigle (17:09):
And when we have this hotelling environment, we have to create more space around them. And that’s 125 square feet per employee just simply won’t accomplish that. And also, one thing that I think is that we’re just simply going to need to give people some more space just to make employees feel comfortable. I think that’s a multi-year trend. So now adjusting for the new hybrid office build out, we’re probably now looking at about 150 to 175 square feet per employee to retrofit that same 100 employee office. Taking the midpoint of that range, applying an 80% utilization factor to it as I just mentioned, it’s going to translate into a need of 13,000 square feet.

Ian Formigle (17:50):
So I think you can easily move these numbers around a little bit, different users are going to have different stresses, are going to want more or less space. But I think my point is that the space demands of the new hybrid environment are probably going to look somewhat similar to the overall space demands of the pre-COVID “full attendance office” once everything is considered. And these spaces are actually built out, which we will see happen in the next couple years.

Ian Formigle (18:19):
That’s office. So let’s talk about industrial. The change that I see is relatively permanent in the industrial space is the adherence to the jump our country just took in the percentage of our retail purchases coming from e-commerce. We entered 2020 with about 12% of our total sales coming from e-commerce. And then we saw a 40 to 50% year over year growth during the pandemic. We saw this total percentage of e-commerce sales spike up to 17 to 18% during 2020, even hitting 20% according to some sources. So, I mean, I fully expect this rate of growth to come back down to single digit levels in 2021 as we start to have a more normal lifestyle, and we focus more about getting out and doing things and buying things and shipping them to our houses. But then when you look to most research groups, from there, they project a return to a roughly 10 to 15% year over year growth rate over the next decade. And that’s going to get us all the way up to 30% of all retail sale is occurring by e-commerce by 2030.

Ian Formigle (19:25):
And so I think the key point here is that no one is expecting anything to go backwards on e-commerce sales. And that to me means that the vast majority of the behavioral changes that we just made in 2012. And how we utilize e-commerce in our daily purchases, well, those are sticking. And so once we apply this to the industrial real estate market, it’s interesting because it means that we are now roughly under-supplied by between 100 million square feet and 200 million square feet. According to GLL, we’re going to need an additional one billion square feet of industrial real estate in the United States by 2025. So just a really interesting time and just overall strong underlying demand for the industrial sector.

Ian Formigle (20:10):
I think there’s a couple of additional smaller behavioral changes that I see out there as interesting. I think there are revised hospitality expectations of consumers out there that may change, staffing requirements at the hotels as they really get back up and running. But I think those are minor compared to the two major changes that I see in office and industrial.

Stig Brodersen (20:32):
So, Ian, one of the questions that I’m most excited about asking you here today is really going back to one of our early discussions. Actually, I think we quite a few times have talked about your investment thesis for the 18-hour cities, and the opportunities that it entails for the investors. Now, whenever we see a shock like this happening, this is not just commercial real estate, I guess that goes for everything we are asking ourselves, has the investment thesis changed? I know that it hasn’t changed for you. If anything, you have a strong conviction than ever. Why?

Ian Formigle (21:04):
Stig, it’s interesting because as we saw 2020 unfold what we saw actually happen in terms of job and population migration. It gave us greater than ever conviction around the thesis. And so I’ll get into it, but let’s start with population migration. I think that as we all spent time in our home sheltering in place in 2020 I think it’s fair to say that we all thought a lot about how we want to spend our time post-pandemic and where we want to spend it. So to me, I view the population migration data from 2020 as arguably more strategic, maybe, perhaps than in other years.

Ian Formigle (21:42):
I mean, in essence, if you moved in 2020, I think there was more conviction in your decision than somebody moving in previous years. So the actual migration data in 2020, they saw people leave a lot of large markets such as California and New York. That population outflow on a percentage basis wasn’t large, but I think it did tell a story. And so, for example, we saw Californians depart the state last year and move to places like Boise, Phoenix, and Austin, amongst a bunch of other places. But those are some of the ones that received more than their fair share.

Ian Formigle (22:20):
I think, for example, there’s an interesting data point that popped up in November that during that month it cost eight times more to rent a 26 foot U-Haul truck one way from San Francisco to Phoenix than it did to rent the same truck for the opposite one-way trip. It just tells you where people were going. And then that’s in West Coast, and if we look to the East Coast you see where New Yorkers were moving. Well, they mostly moved to Florida as well as some other locations such as Charlotte and Nashville.

Ian Formigle (22:50):
So moving on, the other thing that was really interesting to watch in 2020 was job migration. At CrowdStreet, we’ve had conviction for multiple years around the growth of Texas and Florida, and how it will translate and is translating to increase demand for commercial real estate. So for Texas, it was a winner in 2020 from a jobs perspective. You saw major announcements come out from companies such as CB Richard Ellis, Hewlett Packard, and Oracle, announcing they will move their headquarters to Dallas and Houston and Austin respectively. As for Florida, well, we’ve seen a slew of financial firms, such as Goldman Sachs and JP Morgan come out and announce that they’re looking to move either major divisions, contemplating either possibly even moving their entire HQs to Miami.

Ian Formigle (23:43):
And so, I think, in many respects, COVID acted as an accelerant of certain existing trends. So when we saw some of our favorite secondary markets see strong growth both in terms of population and job migration during the pandemic. Well, that’s what really gave us confidence coming into 2021 that not only are these trends still in place, they’re strongly in place, and we believe they are likely to continue through the next real estate cycle.

Stig Brodersen (24:12):
So, as you’re talking about that year, and we have seen pandemic-induced population migration spiking in certain markets. You mentioned also Central and South Florida. We can include the Mountain Region too. And also some secondary markets seem to have been the beneficiaries of epidemic-induced decision-making as companies recognize change within their organization and adapt accordingly. How much of these trends are already reflected in the market? And what are your expectations of that in the next few years?

Ian Formigle (24:40):
For both markets that are winners and losers coming out of the pandemic, the trends overall, I guess I would view them as only partially priced in. I think that the downside trends, well, I expect them to reach a trough, and then recover faster than what will play out in the upside trends. So, let’s consider both of those. So on the downside, markets such as New York and San Francisco, I think it’s fair to say that they have yet to find their bottom as transaction volume mostly evaporated in these cities during 2020.

Ian Formigle (25:15):
But I think they might find their trough is earliest later this year. Typically speaking, when downside corrections occur, they tend to do so faster than upside trends because you have buyers that quickly step out of the way, and they let the knife fall, so to speak. Then when signs of stabilization occur, it’s at that point that buyers will quickly step back in. So I think that once you hit a trough, you can also see a balance come to that market relatively quickly. So the upside trends, they’re different. They typically take longer to play out. And I think that’s the case because they rely on the realization of things that are unknown.

Ian Formigle (25:58):
I think a really interesting case study right now is Boise, Idaho. So in 2020, we saw Idaho attract more population on a per capita basis than any other state in the US. Now, Boise is still a relatively small metro at about 750,000 people. And why that’s important is that means for the most part, it’s still off the radar of major institutional owners. It’s just too small. And that to me means that while pricing will almost certainly increase in 2021 because of the momentum that we’re seeing occur here, it’s probably not going to spike majorly because the capital inflows that are coming into this market will tend to be smaller than those that are flowing into larger markets where the big institutions play.

Ian Formigle (26:47):
And this, to me is the opportunity. If you can front-run those larger institutional capital flows, essentially buy in now. And then later this decade, see Boise hit the institutional radar, it’s at that point that those large capital inflows will occur. And you’re going to see a more direct dramatic acceleration of appreciation. So, we see other upside trends also taking multiple years to really take shape. I think an example of one is you’ve got large secondary markets, such as Dallas, Atlanta, and Seattle. And I think over time, those markets gained primary market recognition status. If they do, they’re going to see new forms of capital flow into them, predominantly offshore capital. But again, I think those kinds of trends, they simply take longer to play out because they depend upon the realization of speculative factors.

Stig Brodersen (27:41):
So, whenever we talked back in August, we discussed the report from Green Street Advisors discussing the city it sees at the best position to thrive post-pandemic, whenever that would be if I just might add. And its top-five status at the time was Raleigh Durham, Denver, Charlotte, Austin, and Phoenix. So, I guess the first part of the question is whether or not that has changed. But also I know that CrowdStreet has also created their own best, and what does that show?

Ian Formigle (28:08):
Yeah. So, for starters, to my knowledge, the Green Street Advisor rankings, and again, check this data recently, it hasn’t really changed in terms of what they’re seeing right now post-pandemic. But to your point, what has changed is that in the last few months CrowdStreet has gone through and created a top 20 consolidated markets ranking for 2021. We’re going to publish that in the month of February. And we also even broke out our top rankings of markets by individual asset types because industrial is going to have very different kinds of drivers than apartments will versus office.

Ian Formigle (28:42):
So, as we talked about at the beginning, at the top of the show, you really do need to think about asset class and location when you want to get specific about where to invest. So to rank CrowdStreet’s top 25 markets when we went through it, we considered 25 different factors that blend across macroeconomic and microeconomic drivers, geographic factors, market dynamics, and quality of life measures. And so when we created our rankings, our top five were similar, not exactly the same as Green Street’s, but our top five markets for 2021 are number one, Raleigh Durham, two Austin, number three Phoenix, number four Salt Lake City, number five Dallas.

Ian Formigle (29:28):
So when we compare that to Green Street’s top five markets, we concur on three of them, and we rank Salt Lake City and Dallas ahead of Denver and Charlotte. Now, we definitely like Denver and Charlotte a lot. Those two markets came in at number 13 and number 11, respectively, in our top 20. So a little bit lower, but we definitely like those markets as well. We see great opportunity there. And aside from our favorite growing secondary markets, we’re also I think maybe a bit unique to us ourselves. We’re staking a claim to a couple of additional mountain regions. So as I mentioned, Salt Lake City, we’re big fan of that market. We see great upside growth for it in the years ahead. And as I just mentioned a minute ago, Boise, well, that came in as a top 10 consolidated market for CrowdStreet in 2021. I think that’s probably a little bit different than most other institutional sources. And we even went in and ranked Bozeman, Montana in our top 10, specifically under the strategy of multifamily development.

Ian Formigle (30:31):
As I mentioned, we’re in the process right now publishing this entire 2021 marketplace outlook. It’s going to be a detailed report. It’s probably 50 plus pages when it hits the street. And like I said, we’re going to probably publish it in the month of February. So, it’s not available as the date of this recording, but maybe by the time someone listens to it, it should be available.

Stig Brodersen (30:51):
Ian, in stock investing, ranking agencies and investment banks, they typically have three different recommendations on stocks. And I do apologize for making this a bit pop if I could use that term. But we’re used to hearing like it’s a buy recommendation, a hold recommendation, or a sell recommendation. So using those terms, what was not a buy before the Coronavirus hit, and what is a buy today?

Ian Formigle (31:18):
Yeah, so let’s talk about what was not a buy pre-COVID? And what were we cautious on, and then how has that maybe changed? So two asset classes I think are mainly characterized by us as not a by pre-COVID coming into 2020 and those were hotels and senior housing. So for hotels, at the time, even before the pandemic hit, we were getting cautious on the space as we viewed this as the asset class that is most immediately exposed to a downturn given simply for the fact that rents are marked to market every day at a hotel. And we were also in a market cycle that was demonstrably over 10 years in existence by January 2020. So we were long in the tooth, so to speak on the market, and we were a little bit trepidatious about what hospitality was looking like coming into that year. We also saw a lot of supply stacking up in many markets. For example, my hometown of Portland, Oregon was a good example of oversupply hitting the market in 2019, and leading to hyper supply by 2020.

Ian Formigle (32:23):
For senior housing, that sector also entered 2020 in a weakened state. Primarily, as a result of a spike in supply that was driven by an overestimation of the demand by that sector. And that led to a drop in occupancy levels. So between roughly 2017 to 2020, we saw the average age of a new assisted living resident increase from 81 to 83 years old. So a two year swing when you’re 20 years old doesn’t necessarily mean a lot. But a two year swing in a demographic when you’re over 80 years old is a meaningful difference. And that’s going to change demand significantly on commercial real estate as it pertains to assisted living.

Ian Formigle (33:07):
So now when we think about these two asset classes today, hopefully now post-pandemic in 2021 I think that hotels are becoming a buy, and I think senior housing is still a little bit out, but will become a buy eventually. So hotels, obviously they encountered more immediate distress in 2020. So to me, they sit much closer to their pricing trough right now. Hotel investing is certainly high risk in early 2021, will be throughout the entire year. But I do think that at an appropriate discount to 2019 values, hotels can present a strong argument for opportunistic acquisitions.

Ian Formigle (33:47):
So now when we think about senior housing, ultimately, we’re going to regain our bullishness on senior housing. We do have the baby boomer demographic that’s going to drive what is called the silver tsunami as they’re calling it on the street, probably by that by the middle of this decade. So if it were to occur in 2021, and we saw opportunities to purchase senior housing deals at significant discounts to 2019 levels that could be attractive. I think our expectations are definitely tempered for operations in the immediate term. So probably, to me, senior housing looks more like a buy in 2022. But as you know, Stig, the commercial real estate market is really inefficient. Sometimes the right deal is only going to come along once every few years. So you might have to make that decision when it’s presented.

Stig Brodersen (34:36):
One thing that we see in most financial markets is that after a crisis, we see a consolidation happening. What do you expect to happen post-pandemic and perhaps already today, and how do we take advantage of that consolidation happening?

Ian Formigle (34:52):
Consolidation is an interesting concept for the commercial real estate market and the cycle that’s now emerging. If I think about consolidation, I mostly see it coming to two asset classes, retail and self storage, but for very different reasons. So first for retail, I see consolidation coming to the sector as this asset class finds its footing as we exit the pandemic, and emerges from some of that distress. Brick and mortar retail is still highly relevant to our lives. I mean, like we discussed a minute ago, even by 2030 most economists and research groups are projecting that we’re still going to do 70% of all our purchases through brick and mortar retail. So it’s not like it’s going away. And that relevancy today, and I think going forward, I think it’s fair to say that it is still more heavily weighted, will be heavily weighted going forward towards grocery-anchored centers. As well as what I characterize the one or two best located shopping centers in each sub-market.

Ian Formigle (35:54):
So as a result, I feel like we see opportunity in that best located center as it’s going to be the location that will be able to backfill any vacancies that occurred during COVID by the other surviving tenets post-COVID that are going to look to improve their location. So, to me that’s those less well-located centers in our cities. They might not ultimately be able to survive. And if they don’t, I expect them to be repurposed into other things, such as well, self-storage, for example, or last-mile distribution, or potentially demolished and reformatted into multifamily housing.

Ian Formigle (36:35):
So this repurposing, that’s what would translate into the consolidation for the sector at the ground level, and investors who buy into best located centers today at discounts to 2019 values to the extent that they trade because there hasn’t been a lot of retail trading. Well, I think they actually probably do pretty well. So now thinking about self storage, I do see consolidation coming into that sector. But the consolidation is really more in the ownership, and not necessarily the actual real estate itself. Self storage is a growing asset class. And what’s interesting is that it has historically been mostly operated by what we would call mom and pop operators.

Ian Formigle (37:20):
There has been a sustainable trend in place for many years, that is leading to a gradual transition to institutional ownership, particularly with publicly-traded REITs. And I see this trend continuing in the next cycle. And it’s for this reason that we often like opportunities in self-storage where we can partner with a developer who has a live conversation going with one of the public REITS translating into operating management by that REIT. They’re typically right now cube smart and extra space are the two leading providers that are most active. And once you build and stabilize that property, it’s at that point that the REIT steps in and wants to buy it for its public REIT portfolio.

Stig Brodersen (38:07):
You wrote a fantastic 2021 outlook that I’ll make sure to link to in the show notes. And you were talking about how you sold this year. And you divided that into different asset categories within commercial real estate. One of the things that you mentioned was hotels, and you also mentioned this previously here in our conversation. And while you also say that it’s on the higher end of the risk spectrum, it’s also an interesting, perhaps long-term opportunity that you can find. So could you please elaborate a bit more on hotels as an investment class right now?

Ian Formigle (38:41):
What’s really interesting as we enter 2021 for hospitality, it does sit in a unique position for a number of reasons relative to every other asset class. The first is the near uniformity that we saw in the distress to the sector in 2020. Shelter in Place in March and April, it caused an 80% drop in occupancy levels nationwide by April 2020. And there’s a little bit of variation across geography and category. I mean, generally speaking, COVID was just a massive tsunami for the sector that wiped out everything. This means that almost without exception, every hotel in the United States is worth less today than it was in January of 2020. And that fact alone means that there is opportunity out there. Just haven’t seen this kind of uniform level of massive distress hit a market. This is even more than we saw in the GFC.

Ian Formigle (39:43):
The second thing about hospitality is the fact that while the distress was inflicted uniformly across the board, it was also just unprecedented in its level of distress. We’ve just never simply seen any market anywhere in the United States drop by 80% level of occupancy in a month, just simply never happened before. And because that level of sector wide distress was so unprecedented, to me it suggests that the market will be highly inefficient in pricing it. So to me, that also supports the notion that there’s opportunity to be found out there. There’s also a lot of risks to be found out there. So, again, to our point about why it is high risk.

Ian Formigle (40:26):
And then the third thing I think it’s really interesting for hospitality is that given everything that’s happened, you have an outlook that now strongly supports the thesis of a near certain recovery for the whole sector with groups such as Green Street calling for a full recovery to 2019 revenue levels by around 2024. So, I personally believe that there is just a ton of pent up demand for the hospitality sector, predominantly right now in the leisure hospitality part of the sector that will start to show up in force by 2022. This is totally anecdotal evidence. But I think if you get out there and you talk to anybody, it seems as if one of the first things that we are all looking forward to do once we reach mass immunization is to go somewhere.

Ian Formigle (41:15):
I think we can even look at that phenomenon. Now, let’s take that concept. Let’s apply it to our largest hospitality market in the United States, which is Orlando. At its peak we saw in 2018 to 2019, we saw roughly 75 million annual visitors to that market. It made bigger than New York, right? New York comes in at 50 million. Orlando is at 75, major market. So once Disney is back up and running at full capacity in 2022. I mean, do you really think it’s going to struggle to attract visitors and hordes? I think that market snaps back fast. I think you could even hit, break a new record in ’23. I mean, think about all the families out there, their kids are aging, time is short, you got to get your kid that Disney experience before they’re too old to really get it.

Ian Formigle (42:06):
So I think that just like Orlando is a market to me that just comes back roaring in hospitality once everybody really feels safe to get out and move around. So, I think when we think about Green Streets data, for example, I mean, they call for full recovery in 2024. I mean, who knows that might be a little bit conservative. We might see full recovery by sometime in 2023. There’s another thing about hospitality, there’s just a punch there. So, the fourth thing about hospitality is how the pandemic has turned off the spigot of new supply. Lenders, totally understandably, they were simply not willing to capitalize a new hotel development in 2020. So if you play this forward, and understand that typically speaking, you need about two years to develop a hotel. This is going to suggest now that when we hit 2023, we’re going to have our relative dearth of new supply.

Ian Formigle (42:58):
So now, what’s interesting is that if you get to the timing of when the market is really coming back and acting strong, at the same time, that you actually have a market that is historically now under-supplied. Now you see the opportunity for some real growth and rev par that year. This is all fair to say that we’re not yet out of the pandemic. There’s still today in early 2021 a lot of distress in the sector. It’s going to continue to play out over this year. We’re going to see hotels continue to fail, there’s no doubt about that. So everything about hotel investing is certainly very risky right now. However, I do think that if you can find a hotel asset priced at a substantial discount to its 2019 value, and you buttress it with enough operating reserves to see it through to 2022. I think that’s your potential for real upside by 2024.

Stig Brodersen (43:51):
Yeah, I really like you say that. And to your point about Disneyland, I planned on bringing the family to Disneyland in May, and that clearly didn’t happen. And all I heard since was when are we going? So, completely anecdotal, but I completely agree with your assessment that once the world opens, that’s probably going to be the first stop not just for my family, but for so many others. And really like also, Ian, how you talked about hotels as an opportunity. I think most people would say, that’s the last place he wants to be. But you comparing price with the value and not just the value today, but the long-term value. And I think that’s so important for people to understand. There have been investors who have made a killing in airlines in 2020 because they were selling so cheaply and people are thinking that they’re almost priced as they would never ever going to fly again. Obviously, they eventually would.

Stig Brodersen (44:42):
But I wanted to transition into that outlook you talked about before. Multifamily also stood out to me. Specifically, you mentioned New York City and San Francisco in your outlook. And you also did that previously here in the conversation we had because they’re trading at a discount to the 2019 prices and you argue that they will bounce back, perhaps by 2024. So could you please go through your investment thesis on multifamily?

Ian Formigle (45:07):
Sure, Stig, and I think what’s interesting about what you just mentioned is that I think whenever we look at any type of investing, you see recency bias show up. Anytime something goes bad, people tend to want to extrapolate what’s currently happening, and then draw that out to infinity and then determine that everything is either going to be the most valuable thing ever imaginable, or going to go to zero. And as you and I both know that over time that generally tends to not be the case. So I think, and now when we think about some of the markets that were hit pretty hard in 2020, there’s definitely some recency bias showing up. So, let’s talk about New York and San Francisco, I think those are the two markets that really stand out as hit hardest during 2020. But now let’s think about like, are these cities over time, they demonstrated resiliency.

Ian Formigle (45:57):
Take New York, for example, people called for the end of New York in the 1980s. That’s during its period of high crime. Then you go to 9/11, New York’s over, it’s not coming back. And then during the great financial crisis, again, it’s over. In every instance, that city came roaring back and it only took a few years. So I think, it’s just like betting against New York historically been a pretty bad bet. San Francisco, maybe to a slightly lesser degree, but it is a bit of a roller-coaster market sometimes, but it has also demonstrated resiliency. We also have a dark period in the 1980s, for New York in the early ’80s, things did not look good. It also bounced back really strong after the GFC. So again, these are two major cities that demonstrate resiliency.

Ian Formigle (46:45):
The second aspect I think about to think about these markets is you have this intersection of desirability and relative value. And so, what I mean by that is that with starters for like, well, New York City and San Francisco, they are desirable. These are both world-class cities. They have amazing culture. They’ve got amenities. They have global connectivity, and they have a strong intellectual capital. And those things, you just don’t find that in every city. And these types of things, they don’t evaporate overnight.

Ian Formigle (47:16):
And so now when we think about relative value, it’s definitely fair to argue that both New York and San Francisco were reaching unsustainable levels of affordability in 2019. When you have a small condo that’s trading at well over a million dollars in both cities, and a small studio can rent for over $4,000 per month, it sets a really high bar on the level of income that it takes to afford life there. So if you reset real estate values now to a degree, and rents down to down like 20% in these cities. Now, these cities start to price more in line relative to other cities that have been actually surging during the pandemic. It also presents a window of opportunity. Now, if you think about from an affordability factor, if somebody was starting to feel priced out of that market in 2019. Well, now they feel like they can jump in, and they have what they feel like is a relative bargain.

Ian Formigle (48:14):
I think the third thing to factor to acknowledge this here is that while each city took this tremendous hit in 2020, and then when you ask yourself whether the underlying factors are temporary or permanent in nature as we discussed this recency bias, I think it’s going to support the argument that they’re going to be a little bit more temporary than permanent. And so, considering that the pandemic hit the cities heavily, both in terms of the rate of infection, and then the real estate utilization rates. I mean, for example, New York and San Francisco, their offices hit as low as 10% for office utilization. And then, when other markets were trending in the 40s. And then you also saw apartment dwellers flow out of both cities in fear of infection.

Ian Formigle (49:00):
So that makes it fully logical to see these cities end 2020 as the biggest losers from a market perspective during the pandemic. And then while 2020 may have lingering effects in both New York and SF, I just don’t see these effects as permanent. Neither city has ceased being great in my opinion, just maybe a bit beat up. As I mentioned just a minute ago, great cities, they have resilience over time. I think that still applies here. So as a result, I think if you could find substantially discounted asset values, either multifamily or an office in 2021. We’d be buyers in both markets. Time will ultimately tell but I’m going to not be surprised if you see New York and San Francisco being back to full swing by 2025.

Stig Brodersen (49:49):
So, using either multifamily or hotel as an example. Let’s try to put some numbers on this. Could you be as specific as possible about how to determine and value the expected cash flows of potential deals that you see here in 2021?

Ian Formigle (50:05):
I think of those recent examples. Let’s see is multifamily an asset as an example, I think just easier to understand. And so, when we think about a private multifamily investment on CrowdStreet, it’s on average can have about a five-year business plan associated with it. And so, that would then be the number of years that we would expect to hold the investment going in although it’s totally fair to say that the actual holding period, it could be shorter, or it could be longer depending upon how things go. So if we’re acquiring an existing multifamily property, let’s just use Salt Lake City, for example, one of our top five markets. In most cases, that multifamily property in Salt Lake is going to have three forms of cash flows associated with it.

Ian Formigle (50:52):
The first form of cash flow is going to come from distributions back to the limited partners out of net cash flow over the course of the holding period. Your net cash flow is really what’s leftover after you collect rents, you pay all of your operating expenses, pay the mortgage. And then you also fund reserves for things like upcoming capital expenditures, maybe a roof replacement or modernizing the pool. These distributions are typically issued on a quarterly basis. And they commence after the property has been owned for a period of time, perhaps a few quarters or so. And that’s at that point where the property would start to amass some excess cash. And on an annualized basis, these distributions may start out at a relatively modest level, maybe three to 5% on an annualized basis. But they tend to grow over time as properties are improved, and rents increase. And when the rents increase, they often increase at a faster rate than operating and debt costs.

Ian Formigle (51:55):
So, let’s move on to the second form of cash flow. And that is what we would characterize as a return of capital. And this can occur either at the time of a refinance, or if it’s not refinancing at the time of a sale of the property. If you’re invested in that multifamily property in Salt Lake, and you see rents at your property grow substantially. Let’s say that they grow at five to 6% over the first few years, that would be pretty strong. Your net operating income will increase to the point that there is now a decent chance that the operator of that property can refinance it and return a substantial percentage of your originally invested equity to you. What’s important to note here is that the refinances, they are a nontaxable event. This is why they’re really popular for private investors.

Ian Formigle (52:46):
So for example, anytime that you can invest $1, and you can get 50 cents back, maybe within three years with no tax consequence to you, you’re free to reinvest that full 50 cents elsewhere, and start earning a return on it while you still own your same multifamily property in Salt Lake. And so again, like I said, this is just an aspect of why commercial real estate can be very attractive to private investors. They tend to want to do this repeatedly over time. And when you do it repeatedly over time, you can really generate tremendous compounded rates of return.

Ian Formigle (53:20):
The third form of cash flows coming out of this private deal is going to be the profits at sale. Now that assumes the property goes well, and we make money. We could lose money. And that is what we call a form of return on capital. So if we sell that property, we have $50,000 invested in it, for example. Well, we’ve got some operating cash flow throughout the way. We got to get back to the $50,000 first to get repaid our money. Anything above that, that’s the return on capital. And this final form of cash flow, it’s going to almost invariably occur at the time of sale when the property is disposed. All funds that come out of that property after the cost of the sale are netted out, and the sponsor has calculated its profit percentage share. And then what’s leftover is returned to the partners, limited partners.

Ian Formigle (54:06):
And typically, when we see that come out, it’s typically in two installments. You’re going to see a large distribution that occurs relatively quickly after the sale. And then you’re going to see a smaller installment months later, kind of after all the final bills are paid, and the investing entity is wound down. In a normal multifamily deal that we think has some value to be created and is owned over a five-year period we might see that property deliver a mid-teens annualized rate of return compounded, and maybe that doesn’t even need a refinance. Now, when you see this disposition cash flow occur, that’s probably going to equate to roughly 50% of your total net gain in that scenario while the other 50% was paid out over time through those operating cash flow distributions. So I think that’s just a way to think about a hypothetical story scenario when you invest in a private real estate deal.

Stig Brodersen (55:03):
Fantastic. Ian, as always, it’s been a pleasure speaking with you. I’m sure that the audience have learned a ton, again, from hearing from you. Where can the audience know more about you, CrowdStreet, and perhaps take a look at some of those deals that you were talking about before?

Ian Formigle (55:19):
The easiest way to find me is to pull me up on LinkedIn. I am the only Ian Formigle on the LinkedIn platform. So it’s pretty easy to find me there. I’m happy to have conversations with investors. They ping me all the time and we chat about real estate. I always love talking deals. I love talking to real estate, happy to educate anybody. And then also, our website is just… There’s a lot of resources there. That’s www.crowdstreet.com. We’re popping up new deals every day. It’s obviously free to join. You could just start checking things out, look at information. We always say the first thing to do when you come onto CrowdStreet and join is just to start reading some information and get up the learning curve. Private equity investing can be pretty exciting. It can also be a little bit daunting going in, but I think if you take it a step at a time, you can start getting really further up the curve pretty quickly and get to the point where making an investment makes sense.

Stig Brodersen (56:16):
Absolutely amazing. Ian, thank you so much for taking time out of your schedule to speak with me here today. Thank you so much.

Ian Formigle (56:24):
It’s absolute pleasure to come on again. I look forward to doing it again in the future.

Stig Brodersen (56:28):
All right, guys. So, as we let Ian go, make sure to subscribe to the We Study Billionaires feed. This was the sixth time we had Ian Formigle on so if you want to listen to the seventh interview with Ian Formigle, and all other interviews, make sure to subscribe to our feed on Apple Podcast, Spotify, or wherever you listen to a podcast. Next week, Trey and I will be back with the outlook on the current market conditions.

Extro (56:51):
Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by The Investor’s Podcast Network, and learn how to achieve financial independence. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.


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