September 26, 2023 • 29 mins
Delve into the senior housing transaction market with Beth Mace, Senior Advisor at NIC, in this captivating conversation with Al Della Porta, Managing Director and head of the Capital Markets Group at AEW Capital Management. Learn about the challenges and opportunities arising from the swiftly changing interest rate environment, and gain insights into how seasoned professionals like Della Porta are adapting to market shifts. Explore how senior housing fares in today’s shifting landscape.
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Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Beth Mace (00:03):
Hello, and welcome to the NIC Chats Market
Conditions podcast series. Myname is Beth Mace and I'm
currently a senior advisor atNIC focusing on the economy and
capital market trends andimplications. Thank you for
joining us today. The focus ofthis series of NIC Chats
podcasts is talking to expertsand industry leaders impacted
by today's property and capitalmarket conditions and trends as
(00:26):
they pertain to the seniorhousing transaction market,
property, pricing, deal flow,and market sentiment. As you
listen today, I hope that youwill find some insights and
ideas that are relevant to youin your business, be it as an
operator, developer, banker,private equity provider, public
entity, or other capitalprovider. Today's podcast will
(00:47):
be a free flowing conversationwith my guest Al Della Porta.
Al is a managing director atAEW Capital Management and head
of the Capital Markets Group.
Al and I have known each otherfor many years as we worked
with one another for nearly twodecades at AEW Capital
Management when I was adirector in the research team
at the firm. Hey Al, and thankyou for joining me today on our
(01:07):
NIC Chats podcast seriesfocused on capital markets.
Al Della Porta (01:10):
Hi, Beth.
Thanks for having me. Pleasureto be here.
Beth Mace (01:13):
Great, thanks. So Al, tell us a little bit about
AEW Capital Management and yourposition.
Al Della Porta (01:19):
Sure. I've been with the firm for 25 years
and head of capital markets.
And our primary responsibilityis to manage our financing
strategies across the firm,across all accounts and
property types. And thatincludes senior housing ,
additionally, that alsoincludes some of the
(01:39):
alternative investmentstrategies such as cold
storage, medical office, andlife sciences. The firm
currently has roughly $40billion of assets under
management here in the UnitedStates. We manage roughly $16
billion loan portfolio withlongstanding relationships
across all lender types,including the life insurance
(02:01):
companies, the agencies, thebanks, debt funds, etc., etc.
And our senior housing exposureis roughly three and a half
billion over 70 properties andover 9,000 units. Historically
speaking. We've averagedroughly two to three billion a
year in financings across allof those product types. But
(02:22):
obviously this year thosevolumes will be significantly
less than that. But given ourlongstanding history and track
record and our relationships wehave pretty good insight into
the broader credit markets andcapital markets which can be
proven to be sort ofadvantageous specifically for
senior housing.
Beth Mace (02:43):
That's terrific. So this is exciting 'cause I think
you're gonna give us a sort ofunique view on the capital
markets from your perspective.
Being in charge of thefinancing at AEW. So a lot has
happened in the capital marketssince the Federal Reserve began
raising interest rates in Marchof 2022. Today, the Fed funds
rate is in a range of five anda quarter to 5.5% up from
(03:06):
virtually zero 18 months ago.
As the Fed has hiked interestrates 11 times, the Fed acted
quickly to raise interest ratesto slow overall economic growth
to take the steam out ofinflation. Now, there's been a
lot of debate as to the causesof inflation that was as high
as 9% as measured by the CPI inJune of 2022. Since then, the
rate has slid down to 3.2% inJuly before advancing to 3.7%
(03:30):
in August on a year-over-yearbasis. According to the most
recent measure of consumerprices just last week, the FOMC
met again and kept interestrates flat for now, but it did
indicate that the Fed wouldremain data dependent in making
its decisions until inflationactually comes down and until
inflation comes down, the Fedhas said that it will do
whatever it takes. Fedprojections released last
(03:54):
Wednesday suggested that tobring inflation down to the
target of 2%, the Fed mightneed to move the Fed funds rate
up to 5.6% by the end of theyear, and hold rates above 5%
in 2024, higher for longer is aWall Street summation of the
Fed's current interest ratepolicy. Now , I know you
tracked this pretty closelybecause of the interest rates
(04:15):
and the impact that it has onthe financing. So what's your
view on Fed policy and thebroader economy and what the
fed's recent actions last weeksuggest?
Al Della Porta (04:23):
Certainly , I mean, there's no question We've
seen the fastest rate hikesprobably in our career, right,
since the early eighties. Andso we're going through a
transitional period of timeright now. Effectively all
risk-based assets are migratingfrom a low interest rate
environment into a highinterest rate environment. And
(04:45):
effectively we're going througha de-leveraging process. We
were the beneficiary of zerointerest rates for a good
portion of the last decade orso. But now it's time to sort
of deliver those assets. Butunfortunately it's not a smooth
transition and that's gonnatake time and certain assets
will deliver faster than othersand, and others may take a
(05:10):
longer period of time. And tosome degree, we're actually
returning back to somenormalcy. I think with a zero
interest rate environment nomatter what asset class, it
seemed like everybody was awinner effectively. But in
today's higher interest rates,you're going to , you're going
(05:30):
to have differentiated assetclasses and differentiated
business plans there . There'llbe more winners and losers in
today's higher rateenvironment. And to some
degree, we'll, we're g onna,we'll be migrating back to, I
know it seems like a long timeago, but we'll be back to
(05:51):
between 1995 and 2000 when t heFed funds rate averaged f ive a
nd a q uarter interest rate. Investors at that period of time
had to buy assets at a goodbasis, had to execute a
business plan a nd had toopportunistically exit a ssets
in order to gain a return. Andso today's investors will
(06:22):
really have to sort of earntheir return and the free ride
that I think a lot of peoplehad over the last decade is a t
hing of the past.
Beth Mace (06:32):
Yeah , that's, I guess that's a little scary
thinking about that in terms ofbeing able to really manage
your properties better to gainNOI, you can't just benefit
from any kind of cap ratecompression anymore. You're
gonna have to really do yourhomework to grow NOI to
maintain your values. So how doyou think this period of
capital market turmoil willplay out ? And how do you think
(06:55):
this compares to past cycles.
Al Della Porta (06:57):
In terms of how it turns out? I mean, it
depends on a number of factors,right? It depends on inflation.
And whether or not the Fed hasinflation under control,
depends on how high interestrates will rise, depends on the
recession, whether we will havea soft landing or prolonged
recession. And depends onwhether or not today's credit
(07:21):
environment spreads into othersectors and spills over into a
broader credit crunch, right?
So those are all variables thatI can't predict but they all
impact how this c o rrectionwill play itself out. Ho w i
t's different this time around.
From my perspective compared tothe a great financial recession
(07:45):
f o r example is at t his timelast time it was certainly a
balance sheet issue, right?
This time around the banks haveplenty of reserves. They're
solvent and any of the recentbanking issues that we've had
have been idiosyncratic. Butoverall, particularly the money
center banks are pretty wellhealed with their balance
(08:07):
sheets whereas they weren'tduring the great recession. And
the other difference as well,this time around is , capital
formation continues tobasically take advantage of
opportunities that thiscorrection may present itself.
(08:27):
Whereas during the greatfinancial crisis that capital
formation happened afterwards,not like , not beforehand. So
there's a lot of proactivecapital formation that's
happening, happening today thatwill be used to address any
issues during this correction.
And then the other differencesthat I see from , the Great
(08:51):
Recession and today, obviouslythe interest rates are far
higher than they were duringthe Great recession, and
therefore the ability to sortof kick the can approach on
loan modifications will betested certainly during this
during this correction comparedto last time. And so it'll be a
(09:14):
question of how patient is thatcapital, whether it's the
equity capital or thedeposition. That'll be
interesting to see how thatplays out during this
correction and depending on howsevere and how long this
correction will last.
Beth Mace (09:28):
Interesting. Okay, so let's stay on banks for a
second. We know there wascertainly a lot of discussion a
few months ago about what wouldhappen to banks with some of
the regional banks like SSVBand others had challenges. And
I think, I agree with you,they're idiosyncratic, but I
think that the overall scrutinyby banks towards borrowers is
much deeper than it had been.
So who steps in to take thatposition that some of the banks
(09:55):
had had? Certainly regionalbanks are really important for
commercial real estateborrowers in general, more so
since than some of the othergroups. So any sense of who's
stepping in are some of thechallenges. I know that the
GSEs, Fannie Mae and FreddieMac are having any view on that
in terms of, will that just bea dearth of lending capital or
(10:15):
debt funds might step in, butwill that be sufficient?
Al Della Porta (10:19):
Sure. I mean, the banks went through a
tremendous growth period overthe last couple years. I think
the tally that I saw between2020 and, and 2022, they grew
their balance sheets orexposure to CRE by $200 billion
, um, in a pretty short periodof time. That was due to the
(10:39):
fact that the public marketswere virtually shut down
because of the fed rate hikes.
And all those borrowers pivotedtowards balance sheet lenders,
including the banks ,specifically the banks, which
at the , at that point in timewas the cheapest cost of
capital. Today those banks arenot seeing the payoffs, right?
(11:01):
So transactional activities areminuscule compared to years
past. And so I don't see thebanks returning in a meaningful
way anytime soon.
Unfortunately, I think they'llstill have to wrestle with
their existing book and focusinternally and externally, but
there is private capitalforming around these
(11:24):
opportunities to completelyreplace that void is not
realistic. So I think thatcapital i s going to be very
selective in terms of itsstrategies and opportunistic as
well. And frankly, I think thereality is is that even though
maybe the kick t he c anapproach i s not as prevalent
(11:48):
this time around, I am seeingit make a little bit of a
return to the marketplace andI'll just use office as an
example whereas 18 months ago alot of lenders were taking a
little bit of a harder line onth e o n office transactions,
whereas today, I think all ofthe, th e m arket participants
(12:10):
are realizing that forcingissues a sale or no te s ale or
some sort of liquidity eventtoday will realize losses to
whether it's the equity or thedebt position. And so I've seen
sort of the kick a can approachreturn a lot of lenders in
(12:34):
today's environment. And Ithink that will probably
continue. But in the meantimethat capital formation will
pick off some reallyinteresting deals in this
marketplace. And so will itcompletely fill the void,
probably not, but it'llcertainly , m ake up some
market share o ver time in thenext couple years.
Beth Mace (12:57):
Okay . So let's talk a little bit about pricing and,
and what you're seeing inpricing and sort of bid-ask
spreads and how pricingcompares to return on costs. In
your observations right now arethere a bit where starting to
come a little bit closertogether in terms of values or
where do you see things playingout right now? I know that we
(13:18):
certainly have seen, accordingto Green Street, we've seen
like a 12% average drop inpricing in July. From your
earlier levels , earlier ,MSCI, CPPI is showing a 10.2%
drop. So what are you seeing interms of price drops in terms
of the transaction market morebroadly?
Al Della Porta (13:36):
Sure. I mean, in today's world where you have
such uncertainty , andvolatility pricing is not the
risk of , pricing is notefficient, right? So, and I'll
just use the example on asimple 50% stabilized
(13:56):
multifamily , scenario whereyou would look to finance pre
covid , we would see 10 to 15bids, and that pricing would
range within a pretty from highto low within a 25 basis point
range. In today's world, eventhough it's a stabilized 50%
(14:20):
levered deal, you would onlysee five bids and you could see
as much as a hundred basispoints difference in spread
between the high and the low.
And so that tells you that themarkets are not efficient. And
because of that bid ask spreadsbetween buyers and sellers and
(14:41):
what we're carrying orsomeone's carrying on, I think
on your books carrying valuesversus appraised values,
there's a pretty, pretty bigdifferential. And so I think
that gap will likely continueunless participants are forced
to transact whether it's debtrelated or not. I think that
(15:07):
bid ask gap will, will justcontinue for the foreseeable
future until there's greatervisibility in the capital
markets.
Beth Mace (15:14):
So is that related to if you have such different
pricing between a bid and anask related to on how people
underwriting it related to howthey're looking at exit cap
rates, when you guys look atdeals in your win or that you
lose, what are you seeing interms of some of the different
assumptions that people aremaking?
Al Della Porta (15:34):
Yeah, I mean, we're, we're bidding, but we're
obviously being fairlyconservative. I think the
reality is that folks arebuilding in conservative
assumptions In today's world,if you just look at, at
interest rates for example, andrelative to cap rates, it
doesn't take much for someoneto fall into negative leverage
(15:57):
territory, right? The 10 yeartreasury blew up 40 basis
points just within the lastthree to four weeks. The five
year did the same, right? Soit's really difficult to hone
in on a ssumptions u nless youbuild in a lot of cushion a nd
those assumptions. And hencethe reason why there's a huge
(16:20):
difference between what buyersare willing to buy and sellers
a re willing to sell. We AEWand t hen a lot of investors
are we're not underwriting.
We're looking sort of what's inplace and what we can get done
today whereas in bettermarkets, people a re
underwriting growth, right? Andso you can only, you can only
(16:43):
underwrite what you're seeingin today's t oday's world. And
y ou taking that risk on futuregrowth assumptions is probably
not something that you wouldsee in today's world.
Beth Mace (16:55):
So are you guys looking at a lot of new
construction or is that sortof, when you look at their
replacement costs versusbuilding? I think at least in
the senior housing sector, forexample, there's very limited
new construction going on. Andis that the case with, are you
guys looking at newconstruction.
Al Della Porta (17:11):
Generally speaking across the firm
seniors, multi-family,etcetera? We're not looking at
new construction. I think thereare , there are potential
potentially better deals tobuy. It's basic reprice core. I
think we're watching corevalues, adjust based on higher
(17:32):
cap rates. And so we thinkthere could be some
opportunities just to simplybuy, r eprice core. And in some
cases these might begenerational t ype assets that
only come to market. A ndduring these types of cycles to
go out and put a shovel o n theground i n a construction d
(17:55):
evelopment project today is apretty relatively risky
proposition. I think finding aconstruction financing would be
very difficult, particularlywith t he, the banking C RI
crisis that's still prevalent.
So, and that cost , and if youdo find a construction loan in
today's world, that cost ofcapital can be pretty expensive
(18:16):
and, and pretty conservative ona LTC basis and probably pretty
full recourse. And then you addin the factor of your
underwriting assumptions, whatthe forward curve looks like on
interest rates and whatinsurance costs could be a
year, two years from now. Wewould rather pivot towards core
(18:36):
, strategies on the equityside. And reprice core would be
very much along that, alongthose lines.
Beth Mace (18:48):
Let's look a little forward. What do you think will
be the catalyst that will getthe transaction market moving
again? Is it will be until theFed has declared, we're done
inflation's under control,we're not raising interest
rates anymore, or what are theother sort of indicators that
we need to be watching? Or doyou see any green shoots?
Al Della Porta (19:07):
Yeah, I mean, we need some stability, right?
Stability in the treasurymarkets. I think the market has
underestimated how high rateswill have , have gone and what
the fed , will do in terms ofrate hikes. And so once we have
conclusion to the fedtightening, I think that will
certainly bring in somestability in the, in the
(19:29):
marketplace. And then finallyseeing where treasury rates
will end up 10 year treasuriesgiven the last month's runup in
treasuries I think participantsare back on the sidelines.
When, just by example, we'vebeen bidding on a number of
(19:51):
multifamily assets and when thetreasury rates were hovering
around 4% , e ven though weweren't the winning bid, it did
seem like those deals wereactually transacting, but as
soon as the treasury rates ranup to close to 4.5%, then all
of a sudden a lot of folks whow ere selling assets had failed
s ales, sales assignments. Sowe need a little bit of
(20:14):
stability in the marketplace sothat people can feel
comfortable that they're makingthe right assumptions and they
don't fall into negativeleverage. And then they need a
little bit more visibility interms of the overall economic
and capital market environment.
And so as soon as we have thatcomfort, I think people will be
able to transact.
Beth Mace (20:35):
So , not to put you on the spot, but I will, so
probably sometime in 24, so 23,sort of the rest of 23, when
you have three months left,continue to be where we are
right now, which is pretty weaktransaction markets. And in 24,
maybe some stabilization wemight see an improved market.
Al Della Porta (20:53):
Yeah, potentially, yes. I mean, I
think the reality is that wehave been opportunistically
deploying capital in 2023, andI think , we'll continue to do
that in 2024. So we on averagewill deploy roughly 4 billion
(21:13):
of acquisitions or deploycapital roughly in that range.
And this year we've onlydeployed about a billion across
all product types. And thatincludes a couple of
construction loans, industrialconstruction loans so, and so
we're finding uniqueopportunities whether it's
equity investments subordinatedebt some mezzanine or
(21:38):
preferred equity investments orjust stretch seniors or
construction loans. So I thinkthe reality is that 23 and 24 ,
I don't think we'll see, eventhough assuming we have some
stability in the marketplace, Idon't think everyone will be
pivoting to rush back in. But Ithink the reality is that we'll
(21:58):
be opportunistically investingduring that time period.
Beth Mace (22:03):
Well, the fed's goals were really to sort of
slow inflation and by doing so,slowing the economy. So since
commercial real estate is oneof the most interest rate
sensitive sectors, I mean thatwe're seeing the results of
really what the intentions ofthe Fed were. So I guess until
we see a change in theirviewpoint that it makes sense
that things would slow down. Solet's switch for a minute to
(22:25):
senior housing and what's AW'Sview on senior housing? Have
you been doing any deals? Whatlooks good, what doesn't pass m
uster s o forth.
Al Della Porta (22:36):
I mean, we're, we're positive and on senior
housing, We've been in thesector for 20 years and, and I
personally was in the seniorspace earlier in my career and
really enjoyed watching thewhole sector mature over the
past 20 years. So I think it'sa sector that we're committed
to. We have clients now thatare actually picking up the
(23:06):
phone calling cause they'reinterested in the sector and
the reasons why they'reinterested in the sector is
that fundamentally I think thesector i s in a really good
spot. From a demandperspective, y ou w e're really
at the beginnings of an agingbaby boomer population, and
that population i s gonna growfour times faster than the
(23:29):
overall U S population. And so, that will certainly , that's
a great story for seniors and then when you think about it
relative to other sectors,you're starting to see some
headwinds in multifamily, forinstance, that rent growth is
no longer there. That renterprofile is starting to see
(23:52):
some, some cracks and even inthe industrial space y ou're
starting to see things slowingdown. So from a senior's
perspective we believe theworst is over and we're at a
trough, and from a demandperspective that will continue.
And we've seen rent growth inour portfolio between five to
(24:14):
10% o ver the last 12 months.
And we expect that rent growtht o continue and to 24. Then on
the supply side because of thebanking crisis, we're not
expecting s upply to be asrobust as it has been in t he
years past. So for example, in2018, we were adding roughly
(24:36):
43,000 units or 8% of the totalsenior housing supply. And now
that nu mber's d own b e low 20 ,000 by half a n d that trend
is likely to continue in 2024,given what we're seeing in the
banking crisis. So f undamentally I think we view it
(24:58):
very positively and eager tosee what the sector, how the
sector performs ov er t he nextcouple years.
Beth Mace (25:09):
So when you go out to try to finance a senior
housing deal using it more orless challenging or the same
as, let's say multifamily oranother product type.
Al Della Porta (25:17):
It's a little bit more challenging 'cause
there's fewer players in thespace, right? So there's still
a fair amount of liquidity inthe multifamily and industrial
space and right now there'slimited liquidity in the senior
housing space and the majorplayers are obviously the
(25:40):
agencies and a handful of lifeinsurance companies. And we
really need to have a healthydebt market for the senior
housing sector to thrive,right? And I know that the
agencies just like many otherlenders are dealing with some
loan issues but they'llcertainly return. And when that
(26:01):
happens, I think that'll bodewell for the senior housing
credit markets. And the adventof debt funds too into the
space has been welcomedliquidity in that space that
wasn't available when I startedmy career. So anytime when you
see new types of lenders enterthe space and add liquidity to
(26:22):
space, I think that's a goodthing. And it does appear the
debt funds who tend to be alittle bit more I would say
nimble across different assetclasses. I think overall
they're viewing seniorspositively as well.
Beth Mace (26:37):
So A l I know that w hen you and I w orked together
(27:34):
closely, we used to look at therisk profile, for example, o f
senior housing versusmultifamily, and y ou c ould
measure that b y looking at the premium to the U S treasury
or t he premium againstmultifamily. So in the time
that you and I w orkedtogether, we certainly saw that
risk premium decline o r seniorhousing. Do you think that
that's, where are we today withthat? Do you think that t he
(27:56):
risk premium has changed m oreinstitutional investors, a s y
ou p oint out, a re coming toyou actually looking for
possible opportunities insenior housing? So from my
perspective, it seems like thatr isk p remium has continued to
decline. It's becoming senior housing becoming more of a core
l ike product at least. And doyou think that t he capital
market conditions t o now h avechanged that or given the
(28:19):
demographics a nd the positivemarket fundamentals that will
maintain a pretty tightpremium?
Al Della Porta (28:24):
Yeah, given where we are today, having gone
through Covid and, and nowdealing with a higher rate
environment, we did see thosepremiums increase, right?
Probably more than multifamily.
I agree with you. Like over theyears that premium did decline
for a number of reasons. Butgiven today's most recent
(28:46):
today's world, I think thatpremium did increase. So
historically, senior housingcap rates would trade at a
premium to multifamily andjust, just generally just say
it was a hundred basis pointsor so depending on the asset
and market, etcetera. In thetoday's world, I think that
differential is probably closerto 200 basis points, but I
(29:08):
think that trend probably hasmoderated and likely to tighten
going forward, given the growthprospects and the real estate
fundamentals for seniorhousing. That said overall cap
rates are still highlycorrelated and contingent upon
how high treasury rates go,right? Right . So we're , and
so if treasuries continue torun up, then obviously those
(29:32):
cap rates will make anequivalent move as well.
Beth Mace (29:37):
Alright , well this has been great. Is there any
thing you wanna sort of wrap upas a summary statement for
where you think we're incapital markets trends and what
would be the catalyst to changethings, especially as it
relates to senior housing?
Al Della Porta (29:50):
Yeah, I think for me it seems like the sector
has gone through some prettytough times and finally it
feels like the light is sort ofat the end of the tunnel. And
seniors is personal to me,meaning I've been in seniors
for 20 plus years and I'veworked with you and a number of
other folks and developed a lotof relationships. So I'm eager
(30:14):
to see seniors recover intoday's world. And I think the
pieces are there for growth.
And so like I said, AEW'soptimistic on the sector
fundamentally and we're formingcapital around it. And so we're
looking forward to the nextphase of our this in this new
(30:38):
world basically of deployingthat capital .
Beth Mace (30:42):
So Al thanks so much for taking time to talk to me
on this NIC Chats capitalmarkets focused podcast series.
I really appreciate your time.
Al Della Porta (30:50):
Thank You.
Hello, and welcome to the NIC Chats Market
Conditions podcast series. Myname is Beth Mace and I'm
currently a senior advisor atNIC focusing on the economy and
capital market trends andimplications. Thank you for
joining us today. The focus ofthis series of NIC Chats
podcasts is talking to expertsand industry leaders impacted
by today's property and capitalmarket conditions and trends as
(00:26):
they pertain to the seniorhousing transaction market,
property, pricing, deal flow,and market sentiment. As you
listen today, I hope that youwill find some insights and
ideas that are relevant to youin your business, be it as an
operator, developer, banker,private equity provider, public
entity, or other capitalprovider. Today's podcast will
(00:47):
be a free flowing conversationwith my guest Al Della Porta.
Al is a managing director atAEW Capital Management and head
of the Capital Markets Group.
Al and I have known each otherfor many years as we worked
with one another for nearly twodecades at AEW Capital
Management when I was adirector in the research team
at the firm. Hey Al, and thankyou for joining me today on our
(01:07):
NIC Chats podcast seriesfocused on capital markets.
Al Della Porta (01:10):
Hi, Beth.
Thanks for having me. Pleasureto be here.
Beth Mace (01:13):
Great, thanks. So Al, tell us a little bit about
AEW Capital Management and yourposition.
Al Della Porta (01:19):
Sure. I've been with the firm for 25 years
and head of capital markets.
And our primary responsibilityis to manage our financing
strategies across the firm,across all accounts and
property types. And thatincludes senior housing ,
additionally, that alsoincludes some of the
(01:39):
alternative investmentstrategies such as cold
storage, medical office, andlife sciences. The firm
currently has roughly $40billion of assets under
management here in the UnitedStates. We manage roughly $16
billion loan portfolio withlongstanding relationships
across all lender types,including the life insurance
(02:01):
companies, the agencies, thebanks, debt funds, etc., etc.
And our senior housing exposureis roughly three and a half
billion over 70 properties andover 9,000 units. Historically
speaking. We've averagedroughly two to three billion a
year in financings across allof those product types. But
(02:22):
obviously this year thosevolumes will be significantly
less than that. But given ourlongstanding history and track
record and our relationships wehave pretty good insight into
the broader credit markets andcapital markets which can be
proven to be sort ofadvantageous specifically for
senior housing.
Beth Mace (02:43):
That's terrific. So this is exciting 'cause I think
you're gonna give us a sort ofunique view on the capital
markets from your perspective.
Being in charge of thefinancing at AEW. So a lot has
happened in the capital marketssince the Federal Reserve began
raising interest rates in Marchof 2022. Today, the Fed funds
rate is in a range of five anda quarter to 5.5% up from
(03:06):
virtually zero 18 months ago.
As the Fed has hiked interestrates 11 times, the Fed acted
quickly to raise interest ratesto slow overall economic growth
to take the steam out ofinflation. Now, there's been a
lot of debate as to the causesof inflation that was as high
as 9% as measured by the CPI inJune of 2022. Since then, the
rate has slid down to 3.2% inJuly before advancing to 3.7%
(03:30):
in August on a year-over-yearbasis. According to the most
recent measure of consumerprices just last week, the FOMC
met again and kept interestrates flat for now, but it did
indicate that the Fed wouldremain data dependent in making
its decisions until inflationactually comes down and until
inflation comes down, the Fedhas said that it will do
whatever it takes. Fedprojections released last
(03:54):
Wednesday suggested that tobring inflation down to the
target of 2%, the Fed mightneed to move the Fed funds rate
up to 5.6% by the end of theyear, and hold rates above 5%
in 2024, higher for longer is aWall Street summation of the
Fed's current interest ratepolicy. Now , I know you
tracked this pretty closelybecause of the interest rates
(04:15):
and the impact that it has onthe financing. So what's your
view on Fed policy and thebroader economy and what the
fed's recent actions last weeksuggest?
Al Della Porta (04:23):
Certainly , I mean, there's no question We've
seen the fastest rate hikesprobably in our career, right,
since the early eighties. Andso we're going through a
transitional period of timeright now. Effectively all
risk-based assets are migratingfrom a low interest rate
environment into a highinterest rate environment. And
(04:45):
effectively we're going througha de-leveraging process. We
were the beneficiary of zerointerest rates for a good
portion of the last decade orso. But now it's time to sort
of deliver those assets. Butunfortunately it's not a smooth
transition and that's gonnatake time and certain assets
will deliver faster than othersand, and others may take a
(05:10):
longer period of time. And tosome degree, we're actually
returning back to somenormalcy. I think with a zero
interest rate environment nomatter what asset class, it
seemed like everybody was awinner effectively. But in
today's higher interest rates,you're going to , you're going
(05:30):
to have differentiated assetclasses and differentiated
business plans there . There'llbe more winners and losers in
today's higher rateenvironment. And to some
degree, we'll, we're g onna,we'll be migrating back to, I
know it seems like a long timeago, but we'll be back to
(05:51):
between 1995 and 2000 when t heFed funds rate averaged f ive a
nd a q uarter interest rate. Investors at that period of time
had to buy assets at a goodbasis, had to execute a
business plan a nd had toopportunistically exit a ssets
in order to gain a return. Andso today's investors will
(06:22):
really have to sort of earntheir return and the free ride
that I think a lot of peoplehad over the last decade is a t
hing of the past.
Beth Mace (06:32):
Yeah , that's, I guess that's a little scary
thinking about that in terms ofbeing able to really manage
your properties better to gainNOI, you can't just benefit
from any kind of cap ratecompression anymore. You're
gonna have to really do yourhomework to grow NOI to
maintain your values. So how doyou think this period of
capital market turmoil willplay out ? And how do you think
(06:55):
this compares to past cycles.
Al Della Porta (06:57):
In terms of how it turns out? I mean, it
depends on a number of factors,right? It depends on inflation.
And whether or not the Fed hasinflation under control,
depends on how high interestrates will rise, depends on the
recession, whether we will havea soft landing or prolonged
recession. And depends onwhether or not today's credit
(07:21):
environment spreads into othersectors and spills over into a
broader credit crunch, right?
So those are all variables thatI can't predict but they all
impact how this c o rrectionwill play itself out. Ho w i
t's different this time around.
From my perspective compared tothe a great financial recession
(07:45):
f o r example is at t his timelast time it was certainly a
balance sheet issue, right?
This time around the banks haveplenty of reserves. They're
solvent and any of the recentbanking issues that we've had
have been idiosyncratic. Butoverall, particularly the money
center banks are pretty wellhealed with their balance
(08:07):
sheets whereas they weren'tduring the great recession. And
the other difference as well,this time around is , capital
formation continues tobasically take advantage of
opportunities that thiscorrection may present itself.
(08:27):
Whereas during the greatfinancial crisis that capital
formation happened afterwards,not like , not beforehand. So
there's a lot of proactivecapital formation that's
happening, happening today thatwill be used to address any
issues during this correction.
And then the other differencesthat I see from , the Great
(08:51):
Recession and today, obviouslythe interest rates are far
higher than they were duringthe Great recession, and
therefore the ability to sortof kick the can approach on
loan modifications will betested certainly during this
during this correction comparedto last time. And so it'll be a
(09:14):
question of how patient is thatcapital, whether it's the
equity capital or thedeposition. That'll be
interesting to see how thatplays out during this
correction and depending on howsevere and how long this
correction will last.
Beth Mace (09:28):
Interesting. Okay, so let's stay on banks for a
second. We know there wascertainly a lot of discussion a
few months ago about what wouldhappen to banks with some of
the regional banks like SSVBand others had challenges. And
I think, I agree with you,they're idiosyncratic, but I
think that the overall scrutinyby banks towards borrowers is
much deeper than it had been.
So who steps in to take thatposition that some of the banks
(09:55):
had had? Certainly regionalbanks are really important for
commercial real estateborrowers in general, more so
since than some of the othergroups. So any sense of who's
stepping in are some of thechallenges. I know that the
GSEs, Fannie Mae and FreddieMac are having any view on that
in terms of, will that just bea dearth of lending capital or
(10:15):
debt funds might step in, butwill that be sufficient?
Al Della Porta (10:19):
Sure. I mean, the banks went through a
tremendous growth period overthe last couple years. I think
the tally that I saw between2020 and, and 2022, they grew
their balance sheets orexposure to CRE by $200 billion
, um, in a pretty short periodof time. That was due to the
(10:39):
fact that the public marketswere virtually shut down
because of the fed rate hikes.
And all those borrowers pivotedtowards balance sheet lenders,
including the banks ,specifically the banks, which
at the , at that point in timewas the cheapest cost of
capital. Today those banks arenot seeing the payoffs, right?
(11:01):
So transactional activities areminuscule compared to years
past. And so I don't see thebanks returning in a meaningful
way anytime soon.
Unfortunately, I think they'llstill have to wrestle with
their existing book and focusinternally and externally, but
there is private capitalforming around these
(11:24):
opportunities to completelyreplace that void is not
realistic. So I think thatcapital i s going to be very
selective in terms of itsstrategies and opportunistic as
well. And frankly, I think thereality is is that even though
maybe the kick t he c anapproach i s not as prevalent
(11:48):
this time around, I am seeingit make a little bit of a
return to the marketplace andI'll just use office as an
example whereas 18 months ago alot of lenders were taking a
little bit of a harder line onth e o n office transactions,
whereas today, I think all ofthe, th e m arket participants
(12:10):
are realizing that forcingissues a sale or no te s ale or
some sort of liquidity eventtoday will realize losses to
whether it's the equity or thedebt position. And so I've seen
sort of the kick a can approachreturn a lot of lenders in
(12:34):
today's environment. And Ithink that will probably
continue. But in the meantimethat capital formation will
pick off some reallyinteresting deals in this
marketplace. And so will itcompletely fill the void,
probably not, but it'llcertainly , m ake up some
market share o ver time in thenext couple years.
Beth Mace (12:57):
Okay . So let's talk a little bit about pricing and,
and what you're seeing inpricing and sort of bid-ask
spreads and how pricingcompares to return on costs. In
your observations right now arethere a bit where starting to
come a little bit closertogether in terms of values or
where do you see things playingout right now? I know that we
(13:18):
certainly have seen, accordingto Green Street, we've seen
like a 12% average drop inpricing in July. From your
earlier levels , earlier ,MSCI, CPPI is showing a 10.2%
drop. So what are you seeing interms of price drops in terms
of the transaction market morebroadly?
Al Della Porta (13:36):
Sure. I mean, in today's world where you have
such uncertainty , andvolatility pricing is not the
risk of , pricing is notefficient, right? So, and I'll
just use the example on asimple 50% stabilized
(13:56):
multifamily , scenario whereyou would look to finance pre
covid , we would see 10 to 15bids, and that pricing would
range within a pretty from highto low within a 25 basis point
range. In today's world, eventhough it's a stabilized 50%
(14:20):
levered deal, you would onlysee five bids and you could see
as much as a hundred basispoints difference in spread
between the high and the low.
And so that tells you that themarkets are not efficient. And
because of that bid ask spreadsbetween buyers and sellers and
(14:41):
what we're carrying orsomeone's carrying on, I think
on your books carrying valuesversus appraised values,
there's a pretty, pretty bigdifferential. And so I think
that gap will likely continueunless participants are forced
to transact whether it's debtrelated or not. I think that
(15:07):
bid ask gap will, will justcontinue for the foreseeable
future until there's greatervisibility in the capital
markets.
Beth Mace (15:14):
So is that related to if you have such different
pricing between a bid and anask related to on how people
underwriting it related to howthey're looking at exit cap
rates, when you guys look atdeals in your win or that you
lose, what are you seeing interms of some of the different
assumptions that people aremaking?
Al Della Porta (15:34):
Yeah, I mean, we're, we're bidding, but we're
obviously being fairlyconservative. I think the
reality is that folks arebuilding in conservative
assumptions In today's world,if you just look at, at
interest rates for example, andrelative to cap rates, it
doesn't take much for someoneto fall into negative leverage
(15:57):
territory, right? The 10 yeartreasury blew up 40 basis
points just within the lastthree to four weeks. The five
year did the same, right? Soit's really difficult to hone
in on a ssumptions u nless youbuild in a lot of cushion a nd
those assumptions. And hencethe reason why there's a huge
(16:20):
difference between what buyersare willing to buy and sellers
a re willing to sell. We AEWand t hen a lot of investors
are we're not underwriting.
We're looking sort of what's inplace and what we can get done
today whereas in bettermarkets, people a re
underwriting growth, right? Andso you can only, you can only
(16:43):
underwrite what you're seeingin today's t oday's world. And
y ou taking that risk on futuregrowth assumptions is probably
not something that you wouldsee in today's world.
Beth Mace (16:55):
So are you guys looking at a lot of new
construction or is that sortof, when you look at their
replacement costs versusbuilding? I think at least in
the senior housing sector, forexample, there's very limited
new construction going on. Andis that the case with, are you
guys looking at newconstruction.
Al Della Porta (17:11):
Generally speaking across the firm
seniors, multi-family,etcetera? We're not looking at
new construction. I think thereare , there are potential
potentially better deals tobuy. It's basic reprice core. I
think we're watching corevalues, adjust based on higher
(17:32):
cap rates. And so we thinkthere could be some
opportunities just to simplybuy, r eprice core. And in some
cases these might begenerational t ype assets that
only come to market. A ndduring these types of cycles to
go out and put a shovel o n theground i n a construction d
(17:55):
evelopment project today is apretty relatively risky
proposition. I think finding aconstruction financing would be
very difficult, particularlywith t he, the banking C RI
crisis that's still prevalent.
So, and that cost , and if youdo find a construction loan in
today's world, that cost ofcapital can be pretty expensive
(18:16):
and, and pretty conservative ona LTC basis and probably pretty
full recourse. And then you addin the factor of your
underwriting assumptions, whatthe forward curve looks like on
interest rates and whatinsurance costs could be a
year, two years from now. Wewould rather pivot towards core
(18:36):
, strategies on the equityside. And reprice core would be
very much along that, alongthose lines.
Beth Mace (18:48):
Let's look a little forward. What do you think will
be the catalyst that will getthe transaction market moving
again? Is it will be until theFed has declared, we're done
inflation's under control,we're not raising interest
rates anymore, or what are theother sort of indicators that
we need to be watching? Or doyou see any green shoots?
Al Della Porta (19:07):
Yeah, I mean, we need some stability, right?
Stability in the treasurymarkets. I think the market has
underestimated how high rateswill have , have gone and what
the fed , will do in terms ofrate hikes. And so once we have
conclusion to the fedtightening, I think that will
certainly bring in somestability in the, in the
(19:29):
marketplace. And then finallyseeing where treasury rates
will end up 10 year treasuriesgiven the last month's runup in
treasuries I think participantsare back on the sidelines.
When, just by example, we'vebeen bidding on a number of
(19:51):
multifamily assets and when thetreasury rates were hovering
around 4% , e ven though weweren't the winning bid, it did
seem like those deals wereactually transacting, but as
soon as the treasury rates ranup to close to 4.5%, then all
of a sudden a lot of folks whow ere selling assets had failed
s ales, sales assignments. Sowe need a little bit of
(20:14):
stability in the marketplace sothat people can feel
comfortable that they're makingthe right assumptions and they
don't fall into negativeleverage. And then they need a
little bit more visibility interms of the overall economic
and capital market environment.
And so as soon as we have thatcomfort, I think people will be
able to transact.
Beth Mace (20:35):
So , not to put you on the spot, but I will, so
probably sometime in 24, so 23,sort of the rest of 23, when
you have three months left,continue to be where we are
right now, which is pretty weaktransaction markets. And in 24,
maybe some stabilization wemight see an improved market.
Al Della Porta (20:53):
Yeah, potentially, yes. I mean, I
think the reality is that wehave been opportunistically
deploying capital in 2023, andI think , we'll continue to do
that in 2024. So we on averagewill deploy roughly 4 billion
(21:13):
of acquisitions or deploycapital roughly in that range.
And this year we've onlydeployed about a billion across
all product types. And thatincludes a couple of
construction loans, industrialconstruction loans so, and so
we're finding uniqueopportunities whether it's
equity investments subordinatedebt some mezzanine or
(21:38):
preferred equity investments orjust stretch seniors or
construction loans. So I thinkthe reality is that 23 and 24 ,
I don't think we'll see, eventhough assuming we have some
stability in the marketplace, Idon't think everyone will be
pivoting to rush back in. But Ithink the reality is that we'll
(21:58):
be opportunistically investingduring that time period.
Beth Mace (22:03):
Well, the fed's goals were really to sort of
slow inflation and by doing so,slowing the economy. So since
commercial real estate is oneof the most interest rate
sensitive sectors, I mean thatwe're seeing the results of
really what the intentions ofthe Fed were. So I guess until
we see a change in theirviewpoint that it makes sense
that things would slow down. Solet's switch for a minute to
(22:25):
senior housing and what's AW'Sview on senior housing? Have
you been doing any deals? Whatlooks good, what doesn't pass m
uster s o forth.
Al Della Porta (22:36):
I mean, we're, we're positive and on senior
housing, We've been in thesector for 20 years and, and I
personally was in the seniorspace earlier in my career and
really enjoyed watching thewhole sector mature over the
past 20 years. So I think it'sa sector that we're committed
to. We have clients now thatare actually picking up the
(23:06):
phone calling cause they'reinterested in the sector and
the reasons why they'reinterested in the sector is
that fundamentally I think thesector i s in a really good
spot. From a demandperspective, y ou w e're really
at the beginnings of an agingbaby boomer population, and
that population i s gonna growfour times faster than the
(23:29):
overall U S population. And so, that will certainly , that's
a great story for seniors and then when you think about it
relative to other sectors,you're starting to see some
headwinds in multifamily, forinstance, that rent growth is
no longer there. That renterprofile is starting to see
(23:52):
some, some cracks and even inthe industrial space y ou're
starting to see things slowingdown. So from a senior's
perspective we believe theworst is over and we're at a
trough, and from a demandperspective that will continue.
And we've seen rent growth inour portfolio between five to
(24:14):
10% o ver the last 12 months.
And we expect that rent growtht o continue and to 24. Then on
the supply side because of thebanking crisis, we're not
expecting s upply to be asrobust as it has been in t he
years past. So for example, in2018, we were adding roughly
(24:36):
43,000 units or 8% of the totalsenior housing supply. And now
that nu mber's d own b e low 20 ,000 by half a n d that trend
is likely to continue in 2024,given what we're seeing in the
banking crisis. So f undamentally I think we view it
(24:58):
very positively and eager tosee what the sector, how the
sector performs ov er t he nextcouple years.
Beth Mace (25:09):
So when you go out to try to finance a senior
housing deal using it more orless challenging or the same
as, let's say multifamily oranother product type.
Al Della Porta (25:17):
It's a little bit more challenging 'cause
there's fewer players in thespace, right? So there's still
a fair amount of liquidity inthe multifamily and industrial
space and right now there'slimited liquidity in the senior
housing space and the majorplayers are obviously the
(25:40):
agencies and a handful of lifeinsurance companies. And we
really need to have a healthydebt market for the senior
housing sector to thrive,right? And I know that the
agencies just like many otherlenders are dealing with some
loan issues but they'llcertainly return. And when that
(26:01):
happens, I think that'll bodewell for the senior housing
credit markets. And the adventof debt funds too into the
space has been welcomedliquidity in that space that
wasn't available when I startedmy career. So anytime when you
see new types of lenders enterthe space and add liquidity to
(26:22):
space, I think that's a goodthing. And it does appear the
debt funds who tend to be alittle bit more I would say
nimble across different assetclasses. I think overall
they're viewing seniorspositively as well.
Beth Mace (26:37):
So A l I know that w hen you and I w orked together
(27:34):
closely, we used to look at therisk profile, for example, o f
senior housing versusmultifamily, and y ou c ould
measure that b y looking at the premium to the U S treasury
or t he premium againstmultifamily. So in the time
that you and I w orkedtogether, we certainly saw that
risk premium decline o r seniorhousing. Do you think that
that's, where are we today withthat? Do you think that t he
(27:56):
risk premium has changed m oreinstitutional investors, a s y
ou p oint out, a re coming toyou actually looking for
possible opportunities insenior housing? So from my
perspective, it seems like thatr isk p remium has continued to
decline. It's becoming senior housing becoming more of a core
l ike product at least. And doyou think that t he capital
market conditions t o now h avechanged that or given the
(28:19):
demographics a nd the positivemarket fundamentals that will
maintain a pretty tightpremium?
Al Della Porta (28:24):
Yeah, given where we are today, having gone
through Covid and, and nowdealing with a higher rate
environment, we did see thosepremiums increase, right?
Probably more than multifamily.
I agree with you. Like over theyears that premium did decline
for a number of reasons. Butgiven today's most recent
(28:46):
today's world, I think thatpremium did increase. So
historically, senior housingcap rates would trade at a
premium to multifamily andjust, just generally just say
it was a hundred basis pointsor so depending on the asset
and market, etcetera. In thetoday's world, I think that
differential is probably closerto 200 basis points, but I
(29:08):
think that trend probably hasmoderated and likely to tighten
going forward, given the growthprospects and the real estate
fundamentals for seniorhousing. That said overall cap
rates are still highlycorrelated and contingent upon
how high treasury rates go,right? Right . So we're , and
so if treasuries continue torun up, then obviously those
(29:32):
cap rates will make anequivalent move as well.
Beth Mace (29:37):
Alright , well this has been great. Is there any
thing you wanna sort of wrap upas a summary statement for
where you think we're incapital markets trends and what
would be the catalyst to changethings, especially as it
relates to senior housing?
Al Della Porta (29:50):
Yeah, I think for me it seems like the sector
has gone through some prettytough times and finally it
feels like the light is sort ofat the end of the tunnel. And
seniors is personal to me,meaning I've been in seniors
for 20 plus years and I'veworked with you and a number of
other folks and developed a lotof relationships. So I'm eager
(30:14):
to see seniors recover intoday's world. And I think the
pieces are there for growth.
And so like I said, AEW'soptimistic on the sector
fundamentally and we're formingcapital around it. And so we're
looking forward to the nextphase of our this in this new
(30:38):
world basically of deployingthat capital .
Beth Mace (30:42):
So Al thanks so much for taking time to talk to me
on this NIC Chats capitalmarkets focused podcast series.
I really appreciate your time.
Al Della Porta (30:50):
Thank You.
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