What to Do While You’re Waiting for the Turnaround
Standard Management Company founder Samuel K. Freshman on the post-pandemic economy
Samuel K. Freshman, owner and chairman of private real estate investment and management firm Standard Management Company (SMC) and chairman emeritus of Stanford Professionals in Real Estate (SPIRE), has been in real estate since 1958.
Under Freshman’s leadership, SMC has acquired and managed more than 6,000 apartment units and 5 million square feet of office, retail, mixed-use and industrial space across 12 states and 25 U.S. cities during the past five decades. Freshman looks at it all with a mixture of pragmatism and patience.
After spending this past spring working from home, he’d really like to get back to his Los Angeles office. He’s not holding his breath that he’ll get his wish anytime soon,however.
“I think this turnaround is going to take longer than people expect,” Freshman said in a recent interview with REI-INK. “It’s going to take some time, and we could see some sectors experience significant crises before it’s over.”
REI-INK sat down with Freshman to talk about how the current economic environment is affecting his company’s investments and whether the effects of the COVID-19 pandemic are as unprecedented as many would argue.
Q: What kind of timeline do you expect for the economic recovery, or will there be one?
A: First thing I would say to you is, “Your guess is as good as mine!” Then I would say, it is going to take longer than people expect right now. Until they actually solve the COVID-19 virus problem, things will remain tough. Unfortunately, efforts to alleviate financial strain on tenants by delaying or prohibiting evictions could stretch the recession farther because landlords will be in crisis as well.
For example, there is currently a proposal to reduce rents by 25% in some jurisdictions. While this sounds nice, the reality is that nearly no operators make 25% returns to begin with, so there is nowhere to cut that much. It would immediately put operators under, and every single landlord out there would be asking for relief from that initiative. It would destroy the rental industry. The disaster and the disaster response both must be measured and proportionate or we will stretch the crisis out.
Q: In March, many analysts predicted staggering delinquencies on rents. Did those delinquencies manifest this past spring?
A: They have not yet [as of June 27, 2020]. We are collecting about 94%, down from 96%. The problem that many policymakers do not understand is that this means we are 6% down each month, which is about half of our net operating income (NOI). The “top dollars” in real estate go to NOI after you maintain the building, pay your taxes and loans, utilities, water treatment, etc. So, if you write down rents by 25% across the board, that eliminates all the NOI and puts the building into duress because no operator is making 25% NOI.
Q: What types of assets do you find attractive right now?
A: I would not be particularly enthusiastic about Class A assets, and I’m not sure what is going to happen to communities with Class C buildings, either. We are focused in the range between B- and B+, which seems to have held up pretty well so far; we have not yet had any great loss of rentals or ability to pay.
There is a lot of risk across the board right now. Some people are starting to move back home; others are doubling up so they can afford rent on an apartment if they lose their job or lose hours at their job. We have not acquired much this year so far because
we are sort of waiting to see what the trends are going to be. We have talked to people who say they are quite optimistic buying at a 4% CAP rate because they expect to increase rent, but I think rents may decline in the multifamily arena.
Q: Is SMC still lending in today’s environment?
A: Yes, although maybe not as much as we were. There are always exceptions. We are making loans on properties in Malibu, which is coming back pretty strong because of the beach. After all, they are not making any more of it! I would not necessarily want to do much lending on construction, but if there is an existing property, we will make the loan. We have to become more conservative because we do not really know in what direction we are going.
Q: What regions of the country particularly interest you?
A: As a practical matter, I prefer to stay invested in places that are no more than 90 minutes from L.A. However, if I lived in the Midwest or Eastern U.S., I would definitely be looking at Florida and Texas. Atlanta, Georgia, seems to be doing well also. We look primarily to invest in Nevada, Arizona, secondary California markets and the states on the West Coast.
Q: Does state reopening policy affect your interest in an asset?
A: It depends on how the economy in the state is doing. We just look at which states are doing well and which aren’t in order to decide. We don’t necessarily review their policies.
Q: Is the current economy and national environment as unprecedented as most people seem to think?
A: Unfortunately, the biggest problem is that the two main political parties in the country are at loggerheads. That is making the entire situation harder to resolve on top of the issue that the coronavirus is historically unique. Probably the closest comparison would be the Black Plague in Europe during the 1500s.
The most important thing we can do is to get control of this thing or it will become even more serious. It’s very frustrating for me because they have opened my office building back up, but because I am over 65, they don’t want me to come in! As a nation, we need to watch the education system carefully going into the fall to make sure grade school through high school children are learning effectively.
Q: What do you think investors should do in the current environment?
A: There are always opportunities out there, and now is no different. It depends on where you want to go with your investing. If you want to expand, then keep looking for chances to do so. There are a lot of people that have to sell right now, so occasionally you will run across something.
The elephant in the room, however, is the concern about inflation and the devaluation of the dollar. At SMC, we are being very conservative with our offers, even though we are still making offers all the time. Because we are concerned about how long it is going to take for the economy to recover and what direction rents will take in the meantime. I would not buy anything you cannot afford to hold long-term. Shopping centers have lost maybe 30% collective rents, but they could lose even more. Apartments are holding pretty steady with 6% or 7% losses. If you have a long horizon like we do, there are lots of opportunities, but you have to get a good enough deal to get through the period we are in right now. It’s a risky market at the moment, but in the long run I think we’ll get through it.
