Is The CRE Finance Revolution Over Already?

The deal itself was nondescript.

In January of this year, a buyer paid $445,000 for unit 1805 in the Reach at Brickell City Centre in Miami, which Swire Properties developed.

The mystery wasn’t in the purchase itself. The intrigue was in the buyer. It wasn’t a Manhattanite seeking a place to stay warm in the winter or a foreigner seeking to park money in the US.

In fact, the buyer wasn’t an individual at all. It was approximately 100 investors who came together on Compound—a global real estate investment marketplace that connects retail investors through an app and allows them to pool their capital to buy apartments.

Investors can get in for as little as $50, though the typical investment is more like $5,000. “Because of that low minimum, we’re working with people who have historically been shut out of this space,” Janine Yorio, CEO and co-founder of Compound told us earlier this year.

“Our product allows a greater universe of people to participate in this unique wealth creation opportunity, which is owning the housing stock in the markets where people are moving to and jobs are being created,” she said at the time.

That was then.

As the coronavirus began its ransacking of the US economy, Compound began to pivot.

“Although this crisis is unlike anything we’ve seen before, we already see familiar patterns emerging—and we’re doing everything in our power to use them to our advantage,” Yorio told us in a follow up.

Compound sees an opportunity to become a dominant distressed real estate investment platform for retail investors, she explains. Unlike other retail real estate investment platforms such as Fundrise, Cadre and Crowdstreet, Compound does not have a large legacy portfolio to unwind or explain, according to Yorio. “This represents an enormous opportunity for our company and for our investors,” she says.

“We are watching the markets carefully for opportunities to acquire real estate and related assets at discounted prices in locations that we believe will exhibit resiliency. This is the same tactic utilized by private equity firms after the 2008-2009 financial crisis when they amassed enormous real estate portfolios at deeply discounted prices,” Yorio says.

While these price adjustments have not yet taken effect, the company believes that attractive opportunities will present themselves in the near term, she adds.

Among other measures, the company has launched the Compound Recovery Opportunity Fund, a retail investment fund for distressed real estate focused on public securities for hotel and real estate-related stocks.

CORONAVIRUS DISRUPTS THE DISRUPTORS

Compound is part of a new generation of real estate finance companies that launched with the idea to disrupt the more traditional parts of the industry. As the economy is expected to struggle for at least a year, if we are lucky, it will be telling to see what steps these firms take to survive—and whether they will be successful. In some cases, a complete 180-degree turnaround in their models will be necessary. Other companies will double down on what is needed right now.

Before the coronavirus entered the US, Paul M. Fried, executive managing director and head of equity capital markets for Greystone Co., was another industry watcher who believed that technology and new thinking could make real estate more accessible to a broader range of investors.

“I think this idea of reaching out to investors whose check size is too small to garner the attention of large investment houses, is good,” he said at the time. “It’s a natural means to fit certain types of sponsors and projects with smaller investors or smaller check writers that otherwise wouldn’t find each other.”

But once the coronavirus forced employees to work from home, other technologies became a lot more essential, at least to Greystone.

“We have been investing in tech support systems for several years, and while we employed video conferencing as a way to connect offices around the country for meetings, it’s now our new normal for conducting virtually all aspects of business,” Fried says.

Fried predicts that the current pandemic will force others in the industry to incorporate tech as quickly and as much as possible

“Our younger colleagues started ‘halfway there,’ Fried says. “They are totally comfortable with tech-supported communication, and a remarkable number are already in jobs with some telecommuting element. The duration of the pandemic is unknown, and potential smaller ‘blooms’ can be anticipated.”

Fried thinks the pandemic will change the way business is done. “It’s unlikely that we’ll all revert to the way we conducted business before this,” he says. “This [technology] has become an essential spend that cannot be cut if it’s the key to a business operating.”

Another consideration for innovation investment in commercial real estate is that these upstarts have not proved their case, at least in the eyes of some.

Matt Ruark, head of commercial and healthcare mortgage production for KeyBank Real Estate Capital, thinks many of these structures with diverse groups of investors at different levels can give lenders pause.

“I know there’s this desire to open up the marketplace to a wider cut of investors, whether it’s via crowdfunding or other structures that are out there,” Ruark told us in late February. “There’s real hesitancy [from banks]. We’ve seen some crowdfunding try to come and assume loans or recap certain sponsors and lenders are uncomfortable in approving that.”

Why is it so tough to get through that approval process? Ruark says their access to capital is holding them back.

“If you can’t raise a fair amount of capital, and then borrow with the most competitive sources, it will be tough to compete with private equity firms that have a lot of capital,” Ruark says. “In that instance, you’re forced to compete on assets that have higher cap rates and are not mainstream because they don’t have the same access to capital a big institutional fund or private equity firm would have.”

Besides these issues, it should also be noted that investment in innovation, even at the best of times, can be an iffy proposition. “The fact is, a lot of the stuff that is out there is two steps forward and one step back,” Brian Stoffers, global president of debt structured finance for capital markets at CBRE, said in late February. “You make great progress, but then there’re issues, and you’ve got to work through those issues. All that kind of slows up when there’s a pullback.”

Perhaps the biggest concern, at least in this current uncertain environment is this: Even with the massive amounts of money invested into improving transactions, there are still some things in the transaction process that can’t be automated, says Jason Shapiro, managing director of Aztec Group.

“I don’t know that executing a transaction can ever be done without ever getting into the car and looking at the real estate, meeting the people on the other side of the table with whom you’re negotiating,” Shapiro says.

REAL-TIME BORROWER DEMAND

But can the coronavirus permanently turn back the clock on real estate finance tech? After all, technology not only opens a new world of investors, but it also makes the transaction process much more seamless for borrowers of all stripes. That process has been occurring for a while and, as social distancing is expected to be part of the landscape for the foreseeable future, it will surely continue.

Despite his earlier observation that human contact is still necessary to close a deal, Shapiro also acknowledges that much of the commercial finance transaction process is done online.  “No one sits around at a conference room table with their lender to sign paper documents anymore.”

Al Brooks, head of commercial real estate for JPMorgan Chase, agrees that technology has had a “massive” impact on finance. And he adds that pre-coronavirus borrowers made it clear that they wanted more.

“Borrowers want more seamless and digital ways to conduct their businesses, streamlining processes and providing their tenants with easier payment solutions,” Brooks says.

A newer generation of borrowers is partially driving this change. Stoffers, who also serves as the chairman of the Mortgage Bankers Association, says millennials enjoy doing things online and through their mobile devices. “But they want to have somebody to talk to if they run into a roadblock,” he says.

Indeed, innovation must first be in a firm’s DNA, Fried says. “You have to have a culture that says, ‘We’re prepared to try things that aren’t always going to work.’”

Stoffers thinks the Quicken Home Loans model can meet those needs.

“The model that Quicken uses is a combination of real people at the end of the phone with a lot of data-enabled technology,” he says. “To be honest with you, we don’t see as much of that on the commercial multifamily side because the asset size is typically a lot bigger and less uniform than a home loan. But we see more people gravitating toward the technology piece.”

TAKING BOLD STEPS

Some of these developments that were underway before the coronavirus seem, in retrospect, to be the perfect investment for this new age.

For example, KeyBank wants to minimize touchpoints, such as the number of times people pick up and put down a file. Ruark says tech is driving the process of how the company gets things done and interacts with its capital partners, vendors and customers. “We are very much thinking about how to streamline the process, how do we make it a better experience for our customers and our employees,” he says.

Stoffers sees similar opportunities. “Innovation will make it a more efficient process ultimately,” he says. “It will reduce timelines. And we will make better and more informed decisions by other innovations and largely using technology.”

Progress is already being made. For small balance loans, Stoffers says technology has shortened the timeline for closing, shaving eight days off the process such a loan last year.

CBRE is spending “a lot of money on technology,” according to Stoffers. For instance, clients can go online and sign up for something the organization calls “deal flow,” which pushes investment opportunities to them based on deal size, product and geography, among other things.

“Internally, we have databases that are monitoring the activity, occupancy levels and loan maturities,” Stoffers says. “Then we can enable our clients to make better decisions or to refinance at opportune times.”

CBRE has also invested in an electronic system that registers every quote it has received from a lender. That allows its producers, in real-time, to see quotes on an asset-by-asset level in a given market. “It’s like watching a Bloomberg terminal, but it’s for commercial mortgages,” Stoffers says.

Even law firms who work on real estate transactions are looking at tech to improve their processes. For instance, Bilzin Sumberg wants to use artificial intelligence to automate specific procedures to be as efficient and cost-effective as possible.

“Some of it [where AI can help] is analyzing a set of documents to extract information and provisions from them,” says Adam Lustig, partner and a real estate practice group leader at the firm. “You could feed in 50 loan agreements into an AI software program, and it can pull out certain key terms or provisions and put it into a report. That report can be generated in seconds instead of having attorneys spend hours and hours.”

One impact COVID-19 has had is a back-to-the-basics orientation on the part of the users.

For example, Fried’s first thought isn’t about the shiny new products and all their features. He wants to know about the information and competitive advantage that they can provide. “It’s about gathering and sifting and understanding large amounts of data,” he says. “This is the age of big data. Within real estate, we had a tiny version of that, in CMBS, in the 90s, and we have watched it just continue to expand to become refined.”

The industry has grown accustomed to having access to critical past information about assets, regions, asset performance and borrower performance, according to Fried.

While the use of data has expanded, there is still room to grow. “Five years ago, nobody was talking about the tech on the debt side or the equity side in terms of the decisions people make to move money,” says Darren Wesemann, EVP and chief innovation officer at Berkadia.

But now, as market conditions dramatically change, Wesemann thinks groups will use data to uncover competitive advantages.

“Tech is helping us make acquisition decisions that are smarter, faster and more informed,” Wesemann says. “You can get eaten alive if you try to go in there with the same methods that people have used in the last 10 or 11 years. You have to go into it with analytics.”

While CRE lenders continue to “slice and dice” data, as Fried puts it, there isn’t as much collaboration going on with equity. “There are lots and lots of different investment groups, making investments and not a lot of sharing,” Fried says.

Fried thinks crowdsourcing could lead to the “beginning of collecting data on how assets perform from an equity perspective.”

“We have this very early stage in this business in which a lot of middle-market borrowers are reaching out and accessing equity money from middle-market retail investors,” he says. “Over the next several years, as we see those assets perform and we see which business plans work and don’t work, we will see data and data sharing on the equity side of the business.”

The organizations that are making back-office investments, such as workflow automation, into analytic systems, are the ones that will thrive no matter what the environment is like.

“He who has the best crystal ball from a data analytics perspective will be a winner,” Wesemann says. “That’s where the money will follow.”