composer-nuqpghx2y_editor-clip_clip_sam-dogen-financial-samurai-ben_2023-jul-14-0436pm_financial_samurai_p
00:00:00.000 | Hello, everybody. It's Sam from the Financial Samurai podcast. And in this episode, I have
00:00:04.960 | a special guest with me, Ben Miller, co-founder and current CEO of Fundrise, my favorite private
00:00:12.420 | real estate investment platform. Welcome to the show, Ben.
00:00:15.280 | Hey, Sam. Thanks for having me.
00:00:18.160 | You know, about a year ago or a little bit over a year ago, I think it was early 2022,
00:00:22.300 | we had a long hour conversation about the future of inflation and interest rates. And
00:00:29.040 | I clearly remember early 2022, I was thinking to myself, there's no way the average mortgage
00:00:36.540 | rate will reach 6% again. And you at the time were adamant that inflation was going to rise
00:00:43.700 | beyond 7, 8% and mortgage rates rise beyond 6% over the following 12 months. And you proved
00:00:51.440 | to be correct. Can you go through your thought process now that you have been correct? How
00:00:58.200 | did you get into that thought process? And how did you make such a strong determination?
00:01:02.280 | Oh, man, it's so hard to put yourself into the seat you were in, like in the past, because
00:01:09.480 | you have so much, you know, retrospective knowledge. So, gosh, early 2022. Yeah, I mean,
00:01:18.560 | I had been in the firm camp of hire for longer. Inflation was a serious problem. How did I
00:01:27.440 | get there? Because you were spot on. And you had a more bearish outlook, which turned out
00:01:33.160 | to be correct as well in 2022 as things softened. Right, right. No, I mean, it's one of those
00:01:40.080 | things like, and I wish I'd doubled down even more into those positions, because I guess
00:01:45.120 | much as we were right, I wish we'd even, like captured more of that. Because it's been a
00:01:50.800 | rough 18 months for real estate industry and the stock market sort of was rough. And now
00:01:59.120 | it's a sunnier day. So how did I get there? Well, I think it was a combination of two
00:02:05.680 | things that I typically do. I'm doing now, I think about the next 12 months. It's a combination
00:02:13.760 | of like things on the ground. So sort of microeconomics, stuff we're seeing firsthand. And then I look
00:02:19.920 | at the history. Like I always say, like to understand the future, I look at the past.
00:02:25.800 | And so, you know, at the time, on the ground, we were seeing I think 20% rent growth, something
00:02:32.880 | just, you know, stratospheric, like typically rent growth is 3%. We saw rent growth explode
00:02:39.520 | starting May 2021. So that was like some on the ground, like sort of obvious, like, well,
00:02:45.840 | how does that not translate into huge inflation? And then the historical side of it, you know,
00:02:51.080 | I went back and read some books from the 70s. And, and there's a really good book actually
00:02:58.680 | called what's it called? The Secrets of the Temple.
00:03:05.400 | Hmm. Never heard of it.
00:03:07.600 | Yeah, it's about the Fed in the late 70s and early 80s. And it's basically like a sort
00:03:13.400 | of almost, it's not autobiographical, but it's like a deep story from Paul Volcker about
00:03:19.440 | sort of what happened. And a lot of the stories we hear now are not exactly what happened
00:03:24.240 | back then. And so you sort of put these pieces together. I want to last on the last piece,
00:03:31.320 | the third piece of my, my model, my mental model, is I look at what people want to believe,
00:03:38.160 | especially the stock market. And, and if you see the market really resisting information,
00:03:46.480 | that's typically a tell that, that like, eventually, like sort of hope will not triumph over experience.
00:03:57.400 | Mm hmm. Well, well, you were proven spot on correct on terms of inflation and the mortgage
00:04:04.400 | rate. And just to rewind a little bit for new listeners who don't understand or know
00:04:08.920 | what Fundrise is, can you just provide a brief history and description of your company?
00:04:13.800 | Yeah, okay. Well, let me start with me just so because I, I, so I, I come out of college
00:04:20.640 | in the late 90s. And I work in real estate, private equity, and then get the bug, do work
00:04:28.000 | in tech. So I work in tech during the tech bubble. So 99, 99 to oh two, I worked in tech,
00:04:35.280 | maybe even 98 to 02. And so I really saw that world. I was a financial analyst at a startup
00:04:42.360 | and we raised money. And then I went and that obviously everything blew up and I went into
00:04:46.480 | real estate. I was in real estate till, you know, through a real estate blew up. And then
00:04:52.840 | in 2012, I started co-founded Fundrise, sort of combining some of my, my background in
00:04:59.240 | tech and real estate. And in real estate, I worked at a, I was a president of a large
00:05:05.180 | real estate development company. We're doing large mixed use complex real estate projects.
00:05:10.400 | Like we built this like $350 million development in downtown DC and this urban development
00:05:16.960 | was complicated and advancing and in '08, my capital partners, my big, you know, $300
00:05:24.120 | million, $300 billion capital partners went bankrupt.
00:05:27.280 | Wow. Just like that over leveraged?
00:05:29.400 | Yeah. My, so my, the biggest partner was coming called GMAC Commercial, General Motors, Sepsons
00:05:35.480 | Corporation, and they had spun themselves off and they got bought by KKR, Goldman and
00:05:44.480 | Square Mile, I think. And the three of them over levered it. And, and I had a half a billion
00:05:50.480 | dollars with GMAC. They changed their name to Katmarc and then they went bankrupt in
00:05:57.680 | 2008.
00:05:58.680 | Sure. Okay. So you were, it was a scarring experience.
00:06:02.080 | Definitely. 2008 made me such a, such a skeptical, jaundiced person. Like people, people, you're
00:06:11.360 | so, you're just, somebody see even like pessimistic, but I would just say more like really, really,
00:06:16.560 | really skeptical, especially like the, the more, the bigger the institution, the more
00:06:21.560 | I like, wow, I behind the scenes, I don't believe it. So anyways, I came out of that
00:06:25.800 | being like, well, this is just, this is just terrible. The system, '08, people who weren't
00:06:29.440 | to go through '08 don't realize like how, how much the system just became, Emperor's
00:06:35.240 | no clothes. You know, it's just, it was a deep distrust of institutions. I mean, a little
00:06:41.920 | bit what happened with sort of American government probably the last few years, like absolute
00:06:46.360 | loss of faith in the system. Right? You were there. I mean.
00:06:49.960 | Oh, I was in the front lines. I was on the training floor at Credit Suisse, which ended
00:06:54.000 | up going under this year by taken out by UBS. And it was unbelievable. I remember Friday
00:07:01.000 | betting with my buddy sitting next to me that Lehman wouldn't go under because I thought
00:07:04.920 | the government would save the company. And so I bought shares and I bet him a hundred
00:07:09.440 | bucks and then went under and then I lost everything. So I was right there and it was
00:07:14.200 | more devastating than I have ever experienced. Even the pandemic, that was only like one,
00:07:20.680 | two months of scariness going down, but then we rebounded. But the financial crisis was
00:07:25.560 | three years of pain and wondering what the hell would happen to us next.
00:07:31.240 | Yeah. That's what people don't realize. And this is also like, I feel like I like to read
00:07:35.600 | history that it's like you, it's really hard to put yourself into the historical events
00:07:41.560 | and that '08 really was in many ways worse than the pandemic, worse than 2020 financially,
00:07:47.280 | like no question. And like the way to think about it, maybe it's like, if you weren't
00:07:52.400 | there, it's a little bit what happened with Silicon Valley Bank. Like, oh, it's every
00:07:56.140 | bank going to go to zero. And then basically all my savings go to zero and stock market
00:07:59.760 | went down, had gone down 50%. Everything was all that you would sort of take for granted
00:08:06.760 | from a financial economic point of view just went away.
00:08:09.480 | Yeah. And so the financial crisis, 2008, 2009, 2010, things started getting better in 2011,
00:08:16.240 | 2012. How did you say, well, after all that scarring and the destruction in housing, because
00:08:21.520 | over lending and over leverage, you say, I'm going to start Fundrise.
00:08:26.280 | So I came out of that experience, again, skeptical and not really wanting to go back
00:08:31.880 | into institutional world, like not looking at institutional world as like, oh, like I
00:08:37.720 | wasn't enamored by it or somehow impressed by it. And so when I was looking at buying
00:08:44.560 | a city block in Washington, DC for $4 million, which is a really good deal in 2010.
00:08:51.240 | The whole block?
00:08:52.240 | Huh?
00:08:53.240 | The whole block?
00:08:54.240 | The whole block. The whole block.
00:08:56.240 | Sounds like a great deal. Okay.
00:08:57.240 | It sounded like a great deal. And it was in this emerging neighborhood, which at the time,
00:09:02.360 | anybody who was young, everybody went there. You knew it was just blowing up, right? Just
00:09:10.240 | absolutely blowing up. And I went to raise money for institutions and they're like, oh,
00:09:16.360 | I don't really know where that neighborhood is. Back then, real estate was still very
00:09:20.000 | suburban. And also they're like, well, $4 million is too small. It's just too small.
00:09:26.040 | We'll do $50 million.
00:09:27.040 | Okay.
00:09:28.040 | I was like, what are you talking about? And so I was talking to a lot of people who were
00:09:34.040 | in the neighborhood and people who were my age and people who were like basically got
00:09:37.720 | it and they're like, oh, I can't believe you're buying that. What a steal. I wish I could
00:09:39.920 | invest in it. And I was like, wait a second. Why can't they? Like, why can't ... I sort
00:09:47.840 | of skipped this institutional middleman who's to me basically flawed and probably not nearly
00:09:53.880 | as smart as they say they are. And so that was like the genesis of like trying to just
00:09:59.480 | connect the dots between like what I was seeing in real life and how the world used to work
00:10:03.560 | and how the world I thought should work.
00:10:06.320 | No, that makes a lot of sense. And maybe you can talk about your family's background because
00:10:13.240 | I feel you come from a family of real estate investors. Your father has a long history
00:10:20.000 | in investing in the DC area.
00:10:21.840 | My father's a real estate developer. It's what makes me understand real estate developers
00:10:26.440 | who are a handful. And so he's built tons of real estate, mostly retail. He built malls
00:10:35.480 | back when malls were like ... everybody building. He was building malls in like the 70s and
00:10:42.280 | 60s. And so it's actually one huge benefit of that other than obviously getting a decent
00:10:50.600 | amount of exposure to real estate was I was in ... was I in high school? Maybe I was in
00:10:57.320 | high school, early high school when the SNL crisis happened. And the SNL crisis, I mean
00:11:04.200 | so many things are different back then. But the 1992 savings and loans crisis, that was
00:11:11.960 | actually the worst real estate crisis in American history. Maybe worse than the depression,
00:11:16.360 | up there, way worse than '08. Most people today don't know anything about it. It's not
00:11:21.720 | like a part of history that most people in business or finance know about. And I'll just
00:11:30.200 | give you some sense of it. Something like half the real estate in America I got foreclosed
00:11:36.440 | on.
00:11:37.440 | Wow.
00:11:38.440 | Yeah. Just like really just crazy numbers.
00:11:41.880 | And your father was right into it, right in it.
00:11:44.840 | Well, back then this was so ... I mean there's so many differences and people don't even
00:11:48.440 | know what a savings and loan is. And I've wanted to do a whole ... almost like produce
00:11:55.160 | content around this era. It's such a fascinating period because what happened is the SNL crisis
00:11:59.920 | was this sort of cleansing. It destroyed the financial industry, real estate industry.
00:12:04.840 | And then it got rebuilt. Everything we take for granted as normal today, REITs, public
00:12:09.200 | REITs, and private equity funds, and securitization market, all of those were birthed like a phoenix
00:12:16.560 | in the 1992 SNL crisis. So yeah, and so basically I feel like I have a longer view, the long
00:12:26.620 | view in a way because of that, my sort of family background.
00:12:31.280 | And then how did your ... did your father survive? I mean, I guess he must have lost
00:12:35.480 | a lot of money during that time, but how did he phoenix recover it?
00:12:40.280 | It's actually funny. I was just with this real estate dinner two nights ago and it's
00:12:44.160 | like something similar is happening. So what happened was ... so back then, this is going
00:12:48.840 | to blow people's mind if you're in finance, but back then most loans were demand loans.
00:12:53.960 | What does that mean?
00:12:55.640 | So if you had a hundred million dollar loan from a bank, whatever, this is going to be
00:12:59.560 | a large one, they would just call it. They would just demand their money back.
00:13:04.920 | Money back, but what if you can't pay the money back?
00:13:06.960 | Oh, then you're in big trouble.
00:13:08.720 | Well, isn't there that saying, something like if I borrow a thousand bucks, it's my problem,
00:13:14.920 | but if I borrow a hundred million dollars, it's the bank's problem?
00:13:17.640 | Yeah, so what the banks did, because the banks basically were going bankrupt, I think 8,000
00:13:22.040 | banks went bankrupt in that period, is they would call the best loans. So what happened
00:13:28.320 | was the better the borrower, the more liquidity crisis they had because they had their loans
00:13:35.320 | called, the bad loans. They didn't call the bad loans. What's the point?
00:13:37.760 | You can't get it back anyway.
00:13:39.240 | You can't get it back. So that's why a lot of these big real estate portfolios, mostly
00:13:44.800 | owned by families, ended up going public in order to get liquidity to pay off the banks.
00:13:50.600 | So that's happening now because basically if you have an office building, the bank's
00:13:54.680 | not going to foreclose.
00:13:55.680 | Okay.
00:13:56.680 | Because they're like, "Well, I don't want this office building. If I foreclose, then
00:13:59.600 | it's my problem." So they're actually starting to work with the borrowers on office because
00:14:04.000 | it's so bad.
00:14:05.000 | Which is good.
00:14:06.000 | If you have a good asset, they actually will foreclose. So it's like, yeah, there's this
00:14:11.520 | weird whatever the opposite of adverse selection is. The worse your property is, the nicer
00:14:16.440 | they are to you.
00:14:18.120 | Interesting. So you have basically about 31 years of experience, collective experience
00:14:24.960 | in real estate trauma, ups and downs. But over time, over that 31-year period, things
00:14:31.480 | have moved upward. So I think that's really important for listeners to understand that
00:14:36.320 | your background forces you to look at things in a much more critical eye than I have seen
00:14:43.400 | any other CEO or real estate investor look at who is in your field.
00:14:49.960 | So that's a really good competitive advantage. On the downside, I would say is that maybe
00:14:55.520 | you might be more too risk-averse in going after those home runs. So how do you balance
00:15:01.280 | that more cynical outlook with the desire to grow your company and make returns for
00:15:07.320 | your investors?
00:15:08.320 | Yeah. I mean, I feel like what happened in the last 15 years, I was scarred from '08.
00:15:16.520 | Yeah.
00:15:17.520 | I feel like my lesson is when it gets good, it gets better than you thought it could get.
00:15:23.520 | Because my other lesson was when it gets bad, it gets worse than you thought. So I had really
00:15:28.360 | seen it gets worse. But I'd previously in my career really never seen it gets better
00:15:33.840 | than you could imagine. And so I started Fundrise 2012. We grew from whatever, three people
00:15:42.620 | to 300 people. We have like 20,000 residential units. We have $3.3 billion of equity, $6,
00:15:51.400 | $7 billion real estate. We have 400,000 active investors, 2 million users, blah, blah, blah,
00:15:57.200 | blah.
00:15:58.200 | That's great.
00:15:59.200 | All this stuff. So it's just insane. So the sun does rise again.
00:16:04.680 | I mean, anybody listening to those statistics going from basically nothing in 2012 to 10,
00:16:09.960 | 11 years later would say that's a huge success. And does the cynicism decline over time?
00:16:21.000 | I would say it's a team. I did this. I was a small part of that success. I guess I exist
00:16:30.600 | often at the margins, both good and bad. So whether it's the team, I'm pushing them actually
00:16:38.480 | out to be more ambitious, more risky, so to the extreme. And also on the negative, sometimes
00:16:44.560 | I'm pushing them to be more conservative. Because what happens is mostly organizations
00:16:48.000 | sit in the middle. There's an organizational bias towards this middle position. And again,
00:16:54.080 | I said sometimes it gets way better than you imagine. Sometimes it gets way worse. So of
00:16:59.800 | a 15-year run we just had, mostly it was better. And then we'll probably have a couple years
00:17:07.120 | where it's way worse. We had it in 2020. And so what is sort of like a little bit dispositionally,
00:17:16.560 | but also the role you end up in as a senior executive is to be pushing on the margins.
00:17:25.280 | When I used to work in other organizations, that wasn't my job. Essentially, that's the
00:17:31.840 | work I have to do is to drive change. How is the investment decision decided in terms
00:17:40.160 | of is there an investment committee? Is there unilateral decision making? If you identify
00:17:45.960 | a choice piece of property in, I don't know, Mobile, Alabama, how do you decide whether
00:17:50.840 | this is the property that's going into a particular fundraise fund?
00:17:54.800 | Well, it's changed over time as we've grown. So we have an investment committee. We always
00:18:00.400 | had a committee. You always want a team. A good team always beats an individual. And
00:18:05.480 | so I have phenomenal people I work with, people so much smarter than me. It's just awesome.
00:18:11.160 | Working with people smarter than yourself, it's just such a joy. And so in the beginning,
00:18:18.200 | it was a small investment committee. And basically the mistake we made was not taking enough
00:18:25.320 | risk in 2012, '13, '14.
00:18:27.320 | Yeah, it was bottom of the market 2012, yeah.
00:18:29.840 | Yeah, we did a lot of MES, preferred equity. So like I have a great deal example. So we
00:18:35.440 | had this deal, Bend, Oregon, 2013, '14. It comes to us. They go, "Okay, we're going to
00:18:43.680 | buy this apartment building. We need $4 million equity. We'll put up one, you put up three."
00:18:50.920 | And we said, "Nah, I don't know. Bend, Oregon, apartments. How about this? We'll put in one,
00:18:56.120 | you put in three, and we'll lend it to you. We'll get a 12% current return." And anything
00:19:01.400 | above, we'll be senior. We'll be like MES.
00:19:03.160 | Okay.
00:19:04.160 | They said, "Okay, so you'll put in a million and get 12 on the downside, but also 12 on
00:19:09.880 | the upside."
00:19:10.880 | Okay.
00:19:11.880 | More or less. And I was like, "Yeah, let's just do that."
00:19:13.760 | It's capped, yeah.
00:19:14.760 | Yeah, cap return. But you know, capped, but more protection on the downside. And we did
00:19:22.520 | 40 of those types of deals. We did 40 MES preferred equity deals before we changed in
00:19:31.400 | late 2015, '16, we started doing equity. But that deal in Bend, Oregon, we put in one,
00:19:39.040 | you put in three, so four total. They sold it, I think 24 months later, for $20 million.
00:19:45.080 | $20 million? Oh my God. So your 12% is like whatever compared to the-
00:19:50.720 | So they made $16 million plus three. So they made $19 million on three and we made 12%.
00:20:01.520 | So that's the downside of being too risk averse. So we started investing in equity and that
00:20:10.080 | was one of the reasons we started going heavily into multifamily back then. But they did buy
00:20:15.480 | us a bottle of wine. They came to DC just to basically rub it in our face and take us
00:20:19.080 | to dinner.
00:20:21.760 | Well you know, it's interesting as, let's say, individual retail investors, I personally
00:20:27.480 | struggle with this as well in terms of investing to improve and then to sell as a flip or to
00:20:33.560 | just buy and hold and just generate the cash flow. Because for me, I left my job in 2012
00:20:39.280 | and I needed cash flow to pay for my living expenses and I needed to grow my cash flow
00:20:42.960 | as my living expenses increased with the increase in the number of family members I had. So
00:20:48.280 | in the long term, it seems like real estate has outpaced inflation by 1% or 2% and in
00:20:54.720 | 10, 20 years, your value of your real estate holdings is going to be greater than it is
00:20:59.320 | now. It's almost like a war of attrition. So how do you think about doing that flip
00:21:04.400 | or the improvement or just buying and holding forever?
00:21:08.640 | Yeah, so that's a great question. So I have another mental model. I call them like operating
00:21:15.960 | principles. And so I always like to think of things like from top down and then I think
00:21:20.480 | of things from the bottom up. So like top down, you'd say, okay, like real estate, that's
00:21:27.200 | a decision because you also could be in tech or stocks or something else. So the real estate,
00:21:32.400 | that's an allocation decision. Underneath real estate, you really are picking geographies
00:21:37.600 | and you're picking asset classes. And that's might be like, we've been huge investors in
00:21:44.200 | residential and the Sunbelt. Now you're multiple levels down from where most people are making
00:21:49.920 | decisions. And then inside of that, you're making like the very tactical decisions of
00:21:54.760 | like which apartment building in Tampa, what's the basis, what kind of operating expertise
00:22:00.640 | can you bring to bear and what kind of leverage. And so from the top down, I believe that's
00:22:08.040 | 80% of returns is like all these are allocation decisions. If you think about like the counterfactual,
00:22:16.080 | if you'd gone real estate, office, San Francisco, it doesn't matter how good your tactical decisions,
00:22:24.840 | your operations were, you're wiped. You're wiped out. And that was my 2008 experience.
00:22:30.920 | Like the big, big things, the big decisions are basically like 80% or 100% of outcomes
00:22:40.440 | and they sort of operational excellence like that. That matters. Obviously you want that
00:22:45.120 | to be true. But man, if you don't get the big things right, it doesn't matter.
00:22:50.360 | Small things don't matter. No, that's really true. And it's sometimes hard to get the big
00:22:55.640 | things right. I mean, I guess long-term, the big thing is there will always be inflation.
00:23:01.320 | Generally there will always be population growth.
00:23:03.200 | Wait a second.
00:23:05.200 | Well, global, I'm talking about the world. The global population growth is inevitability.
00:23:10.480 | Now, I don't know about America's population growth given the replacement rate is what,
00:23:14.680 | one and a half? It's like under?
00:23:16.200 | No, it's plummeted.
00:23:18.200 | Right. But yeah, investing in long-term trends is definitely, I agree with that. I wrote
00:23:24.280 | a post about that, invest in long-term trends and then like the minutiae stuff, it's not
00:23:29.080 | as important.
00:23:30.840 | So in terms of the long-term trend of investing in the Sunbelt, I believe in that because
00:23:37.360 | we're work from home, telecommuting, technology, the acceptance of work from home. And I talked
00:23:44.160 | about that in 2016, which is why I started focusing more and more on Sunbelt and Fundrise.
00:23:50.520 | But what do you say to the people who say, well, one of the downsides of the Sunbelt
00:23:54.600 | and the Midwest region is that there's endless supply. Whereas if you invest in the coastal
00:24:00.840 | cities of New York City, San Francisco, Seattle, whatever, there's just limited supply. It's
00:24:05.760 | really hard to build.
00:24:07.760 | Right. Right. Well, so like to invest in the right long-term trends, you sort of skip the
00:24:13.980 | question of, well, how do you do that? And so I took this great class years ago about
00:24:21.240 | the sort of the five major like fundamental drivers of society. So you're talking about
00:24:27.000 | when you're talking big, really big, major drivers are technology, demographics, war,
00:24:33.320 | disease, and I think the last one, globalization, where those were the five. And you might throw
00:24:39.360 | like culture in there, which you can really, it's a little more squishy because like culture
00:24:43.360 | Japan, not in the culture of America. And it's, you know, if you take those five, right,
00:24:50.480 | all five of those hit in the last 36 months. Right. War, disease, globalization, demographics,
00:25:00.240 | and technology. I mean, those are the, it's just, it's uncanny how much those are the
00:25:04.640 | fundamental drivers of long-term trends. And so if you just sort of parse that, like, you
00:25:11.560 | know, so yeah, real estate, you can think of real estate as like a levered return on
00:25:17.160 | GDP. And so, and so where the GDP growth of, of like Youngstown, Ohio is like negative.
00:25:26.120 | Okay. And the GDP growth of like, of Dallas is, is way above our national average. So
00:25:34.240 | by doing, by picking the right region, what you can do is take US GDP growth and then
00:25:39.280 | get the top end of it, right? Hopefully top quartile of it. And that's, and that happens,
00:25:44.200 | that happens to be, you know, these Sunbelt cities, but we, if you'd asked me this 10
00:25:49.280 | years ago, I would have said New York, San Francisco, LA. And we were, that's where we
00:25:53.360 | were investing. We were heavily invested. We were not invested in the Sunbelt before
00:25:56.880 | 2016. And that was because the levered GDP growth was in those cities and the cities
00:26:01.920 | were having huge population growth. So, so like, okay, follow people that's demographics.
00:26:08.280 | The second is technology and technology is, I mean, so obvious in retrospect, but man,
00:26:15.160 | is it, people seem to miss it. I actually think people miss the big things more than
00:26:18.800 | the small things. And so you look at like e-commerce, cause you and I basically watched
00:26:26.880 | e-commerce go from nothing to basically dominant. And it was so obvious that in retrospect,
00:26:32.760 | retail would get destroyed by e-commerce and industrial would then of course, like
00:26:38.520 | rise. Nevertheless, like, and I, my, my father was a retail developer. He built malls. Yeah.
00:26:44.080 | Right. It was like, it was invisible to the retail industry for sure. Real estate industry.
00:26:51.960 | And but it's been, you know, the biggest or top three biggest drivers of real estate growth
00:26:57.920 | and returns or losses in the last 20 years. So that's a mega trend. I think remote work
00:27:04.240 | is sort of the next it's obvious, but I, again, I was at this dinner with like 10, you know,
00:27:11.240 | big real estate people and they're like going on and on how to go back to the office and
00:27:15.960 | the office is more productive. And, you know, they're just, I mean, and they're all basically,
00:27:20.480 | I mean, it's in tech, I go in the room and I'm the oldest person and in real estate,
00:27:24.880 | I go in the room and I'm the youngest person. So look at all these people who are, you know,
00:27:31.200 | I mean, they're older than me. Right. So like there, I'm like, well, I don't think you know
00:27:35.640 | very much about the future maybe because what you're up against, what I think the pattern
00:27:41.520 | they're missing is that e-commerce in 1997 is nothing like e-commerce in 2017. Like the
00:27:51.000 | technology improved enormously. And so it's not like you're competing with the technology
00:27:57.880 | of the present, you're competing with the technology of the future. And so I think remote
00:28:03.080 | work technology is like, it's just getting started. And between VR and God knows what
00:28:09.180 | else in AI and other things they invent, like the office industry is fighting, fighting
00:28:14.720 | technology industry now, like head to head. I'm like, well, I have a firm opinion who's
00:28:19.400 | going to win that. And that's technology. So these mega trends, I think of the mega
00:28:24.960 | trends and when I go read about it and I like, and you think about these really basic, big
00:28:31.520 | frames, because it's easy to get lost in the details. And that's like, I once said I was
00:28:37.760 | going to write a book. If I write a book about the companies I've been involved with, I was
00:28:43.200 | going to call it Into the Weeds. Because everybody just goes straight into the weeds. And for
00:28:51.600 | lots of reasons. And it's so easy to miss then. Well, you're like, here I am in 2008
00:28:58.800 | and I'm working on getting sure that this wall is properly positioned so that the apartment
00:29:04.480 | unit is going to be really efficient. And in the meantime, everybody in the world is
00:29:08.440 | going bankrupt. Like it's, you know, these small things like they matter, but they just
00:29:15.640 | they if you don't get the big stuff, right. You get wiped out. Right, right. You get wiped
00:29:21.320 | out. And we're trying to avoid the wipeouts here, folks, the 35% to 50% declines. And
00:29:28.440 | these trends that you talk about, they sound I hear a bullish bullishness in your voice
00:29:34.400 | in terms of investing in the Sunbelt, residential, industrial, driven by technology, work from
00:29:40.400 | home, demographic changes, and so forth. So that's why it's actually particularly fascinating
00:29:47.840 | when I hear your bearish outlook on a potential recession on the horizon. On the one hand,
00:29:53.160 | I think a lot of us have been talking about a recession for the past 12 months, because
00:29:57.640 | of the inverted yield curve, which has always preceded a recession. On the other hand, we're
00:30:03.120 | seeing June CPI come in at 3% below expectations, PPI coming in below expectations. It seems
00:30:10.680 | like the labor market is still very strong, real wage growth is declining. So it could
00:30:16.440 | be there's a greater and greater chance that the Fed will engineer a soft landing. And
00:30:22.680 | it won't be as catastrophic as it once was during the global financial crisis. So I'd
00:30:29.120 | love for you to share with listeners your view on why we could go to that catastrophic
00:30:34.360 | level once again. Okay, well, so I do think there'll be a recession,
00:30:40.840 | but I don't think it'll be catastrophic. I'm saying sort of halfway between a soft landing
00:30:45.120 | in 2008. So exactly what does that mean for people like what is a recession? Partly we
00:30:50.600 | we debate debate, whether or not we'll have one we have to have definition of terms. And
00:30:56.920 | so like somebody when I heard somebody say like a recession, it's a soft landing when
00:31:02.800 | your neighbor loses your job, their job is a hard landing when you lose your job. So
00:31:10.440 | so like, let me here's my argument why I think we'll have a recession, it's going to be a
00:31:14.160 | recession, it won't be as bad. Oh, wait, not even close. But it's going to be a real recession.
00:31:19.800 | Is that like, it's almost like the argument has to be that this time is different, because
00:31:27.240 | all of the fundamental pieces that lead to a recession are in place. Right? So like,
00:31:35.140 | I've done this analysis and saying, you've probably heard it, but like, just to give
00:31:38.440 | sort of some of the main parts of it is that, so every recession in the last 70 years since
00:31:45.840 | 1954 was preceded by interest rate hikes. So you have nine recessions, and every one
00:31:53.520 | had interest rates go up significantly, you know, so this time, we went from zero to five
00:31:59.680 | and a quarter, approximately right, like, like, in 2005, went from one to five and a
00:32:07.320 | quarter, right, and that led to the 2008 financial crisis. So, okay, so there's, they're always
00:32:12.840 | preceded by interest rate hikes. And then the part that I think is tricking everybody
00:32:16.760 | is that there's always a long lag from the interest rate hikes to a recession. And the
00:32:22.720 | lag is like, you know, two years, basically, it's, it's, it takes a long time for those
00:32:29.520 | high interest rates to basically kill economic activity. But they, they do and they are,
00:32:37.200 | I mean, I'm seeing it on the ground, there's no question that, you know, Fed fund rates
00:32:41.040 | at five and a quarter, which means you're borrowing at seven, 8% is, is just putting
00:32:48.760 | a halt to a lot of activity, a lot of activity, and also draining liquidity from the system.
00:32:56.680 | And so like, so the lag of 24 months, or on average, it's 10 month lag from peak interest
00:33:03.520 | rates. So as average, so like, if peak interest rates are July, let's just say the Fed says
00:33:10.720 | we're going to stop raising rates in July, which I think 2023. Yeah, next month, I think
00:33:16.360 | there's a good chance of that could be they go a little higher, they could go higher.
00:33:19.880 | I don't think that's like, I don't know how to call that. But like, let's say, let's say
00:33:24.120 | July, August, September, somewhere at peak, 10 months from there, basically, almost a
00:33:30.920 | year is a year from now. So you're basically a year from now having a recession. And that's
00:33:38.600 | why that matters is that if that happens, that's the 30 4050% loss. Right? So if you
00:33:46.440 | care more about the wipeouts, then about the incremental short term gains, then you worry
00:33:51.320 | about that 30 4050% loss, you know, if you focus on the long term, you don't lose, say
00:33:58.200 | the long term, because there's a lot of like, excitement in the short term about AI or,
00:34:06.600 | you know, a soft landing. Well, what do you say to skeptics of that 30 to 50% potential
00:34:13.600 | loss in the second half of 2024? Who say, well, let's say job growth is still good,
00:34:19.440 | unemployment rate goes to 4%, from three and a half percent. But the mortgage rates, so
00:34:26.720 | the demand for Treasury bonds goes up, mortgage rates go down, the 10 year Treasury bond yield
00:34:30.440 | goes to two and a half 3%. So barring costs go down to five, five and a half percent.
00:34:37.520 | Doesn't that bring in demand and keep things kind of alive?
00:34:41.720 | So I Yeah, so I say to you two points, we take them in part. So first was unemployment,
00:34:47.520 | unemployment is low 3.7%. Last I checked, but every recession, there's unemployment
00:34:53.360 | starts out really low, it was 3.9%. In 2007. Right? Yeah. And so that was seems pretty
00:35:00.480 | similar in there. And it moved a ton went to like, seven and a half percent or something
00:35:06.640 | in 2010. So so there's, there's, unemployment basically the lagging indicator is not leading
00:35:14.680 | indicator or coincidental, coincident indicators happening at the same time. So unemployment
00:35:20.640 | basically is, I think, doesn't prevent a recession. And then, you know, if they drop rates, you
00:35:29.520 | know, let's say late next year, that's has a lagging effect on economic activity. And
00:35:37.840 | so it was, it's going to take time to to basically get the engine started again. And if you look
00:35:45.520 | historically, they were already dropping rates in '07. I mean, rates started coming down
00:35:51.200 | August of '07. And they had come down from 5.25 to 2.25 when Lehman went bankrupt, September
00:35:58.420 | '08. So they are already dropping rates. They were also already dropping rates. In year
00:36:03.840 | 2000. They started dropping rates in around, I think, I think it was March around March
00:36:09.920 | when stock markets are falling and started dropping rates. And they dropped rates all
00:36:13.320 | the way through and it still didn't stop a recession then either. So the Fed, the Fed
00:36:18.080 | is a lagging interest rates, and unemployment are lagging indicators. So they, and they,
00:36:24.560 | so they just will not prevent a recession if they are acting like, you know, essentially
00:36:30.200 | at the time of recession is too late.
00:36:32.640 | So it would it be fair to say that the Fed is not doing their job well, then because
00:36:39.000 | you would presumably think these well educated, very wealthy individuals who see the data
00:36:44.440 | and who know that there is a lag would then be more proactive in managing those rate hikes
00:36:51.520 | and cuts because of those lags. So what would you give the Fed in terms of a grade score?
00:36:57.480 | Yeah, it's a mystery to me because you and I could have looked back in 24 months ago,
00:37:04.960 | or when inflation went from zero to 9% in a month or something, right in May 2021. May
00:37:13.720 | 2021, interest rates started, it was the, it was a pandemic back to reality, right back
00:37:22.560 | to normal life in May 2021. People started going back to restaurants, they started back
00:37:27.800 | to start renting and rents and all sorts of inflation indicators started skyrocketing
00:37:32.840 | May 2021. That was when the pandemic ended. And there was an enormous inflation indicator
00:37:41.840 | starting May 2021. They didn't start raising rates till May 2023. Two years later. No,
00:37:54.920 | no, sorry. May 2022. Sorry, it's my fault. May 2022. Yeah, so one year. So there was
00:38:01.560 | tons and tons and tons of obvious indicators. Interest rates shouldn't be at zero. Interest
00:38:06.440 | rates were at zero. They had zero at the same time that inflation was just like, it went
00:38:13.960 | to three, then it went to five, then it went to nine. So why did the Fed react so slowly?
00:38:21.800 | And I'm saying that's just how the Fed behaves. They always do, they always have. And I know
00:38:30.200 | if you go look at the, you go read like the secrets of the temple and other things, there's
00:38:33.320 | all sorts of reasons why, but the idea that the Fed is going to be ahead of the curve.
00:38:42.840 | I think that's not likely because they normally don't institutionally, they're not, they're
00:38:48.360 | not likely to do that. They haven't been at least. And then also in this case, they really
00:38:52.360 | want to bring inflation down. So they're likely to wait till inflation is clearly down before
00:38:58.700 | they start raising again. Sorry, before they start lowering again. They're more worried
00:39:04.600 | about inflation than they are about a recession, according to their own words.
00:39:08.960 | Yeah. I mean, it's kind of fascinating because I've railed against the Fed all the time,
00:39:13.680 | but I wonder if I'm like the armchair quarterback after the Seattle Seahawks throw a pass instead
00:39:19.280 | of running Marshawn Lynch into the end zone, whether we're just kind of missing something.
00:39:25.280 | I mean, we're not, they've got to see something that we don't see. I have to imagine that.
00:39:30.880 | I don't think so. I think it's not, it's not the people, it's the institution. If we were
00:39:36.280 | in the institution, we'd end up doing exactly the same thing. Just like you can be a president,
00:39:41.120 | you can be a nominee running for president, you get in that seat and you're captive of
00:39:45.880 | the institutions as well. So the institutional bias of the Fed and the political pressures
00:39:51.720 | of the Fed, I think are more dominant than the individual actors in the Fed.
00:39:59.680 | It's fascinating. It's kind of another knock against government and big government in terms
00:40:05.120 | of efficiency versus, you know, just being a solopreneur, a private company.
00:40:11.160 | I mean, it's just hard. 350 million person country. It's got a lot of political crosswinds.
00:40:17.760 | I think it's just hard to manage anything that large. I mean, we have 300 people in
00:40:23.840 | the company. I was like, Oh my God, I barely have control of this organization.
00:40:27.560 | Well, hopefully you have good lieutenants who are managing down and well. In terms of
00:40:34.440 | opportunity, because you launched an opportunistic credit fund. Can you tell the listeners what
00:40:43.640 | that is and where's that opportunity?
00:40:47.560 | So we have three strategies. We have a real estate strategy, we have a credit strategy,
00:40:52.080 | and we launched a tech strategy at Fundrise. And the credit strategy is something we've
00:40:58.080 | been doing a long time. As I said, back in 2013, 14, we were doing this MES. So we've
00:41:04.080 | done 87 MES deals like that. 87 different lending to other families. A ton over more
00:41:12.680 | than a decade. And we basically had stopped doing that starting around 2020, 1920. Because
00:41:22.000 | what had happened was, 2014, you could lend at 14% interest rate. And as the market got
00:41:28.360 | hotter and hotter, the need for that kind of funding went away. The banks actually sort
00:41:35.840 | of would fund it instead. So a bank would lend 75% or 80% when in 2014, they were only
00:41:43.880 | going to lend 55%. So there was a gap. And so there was a need for this capital and that
00:41:48.240 | need went away in 2019 and 2020. Or you could do it at ridiculous risk, ridiculous low rates.
00:41:56.480 | And so we stopped doing it. And then basically, in the last 12 months, the need and the opportunity
00:42:02.360 | came back. Roaring. And so there's this gap now in the market. The banks have pulled back.
00:42:09.560 | And you can get 13%, 14% interest rates again for this MES position. It's straight out of
00:42:17.280 | the playbook. It's so funny how it's just completely repeated, gone full cycle. And
00:42:23.480 | I expect basically there'll be a window to do this for three to five years and probably
00:42:28.360 | closes again because the market gets better. In the meantime, especially ahead of this
00:42:34.720 | recession, I think there's a recession. We can debate it. No one's arguing 100% there
00:42:39.920 | won't be a recession. There's more risk on the downside than the upside. So it seems
00:42:44.360 | like a good time to be taking that 13%, 14% yield.
00:42:47.600 | And back when I made the wrong bet in 2014 with that Bend Oregon deal, we were on the
00:42:56.480 | other side of the recession. So that's when there was upside. The risk was on the upside
00:43:03.800 | and not the downside. So right now, I think it's no question in my mind, if you can get
00:43:12.760 | that debt-like risk, I feel like you bank it, you sleep.
00:43:33.320 | Let's help the listeners understand why a sponsor or a property developer would pay
00:43:39.200 | that 12% to 13%. Let's just set up a scenario where I guess things were going well and then
00:43:46.320 | the banks have pulled back and their loan is coming due. Are most of these loans variable?
00:43:51.200 | Is that why? They're like, "Uh-oh." How does that work from the buyer's point of
00:43:55.080 | view?
00:43:56.080 | I've done a lot of it, so I have a pretty good idea. There's two actual sub-executions.
00:44:03.240 | One is a construction loan and one is a refinance. And so I'm going to do each because what's
00:44:08.640 | happened is the phase we're in is actually about construction loans and the next phase
00:44:13.880 | will be refinancing. So what happened was if you're a real estate developer and you're
00:44:19.200 | building a 300-unit apartment building in Tampa and you've basically been working on
00:44:23.960 | it for probably two years, maybe three years to get your permits, you've got your architectural
00:44:28.840 | drawings, you've got your lender lined up, you've probably spent millions on it, you're
00:44:34.480 | a breaking ground. The lender comes to you at the closing table and says, "I know I was
00:44:39.920 | going to lend you 72% but now I'll lend you 52% or 55% or 60%."
00:44:46.120 | Where do you come up with that shortfall of 20%?
00:44:47.760 | You have a shortfall. It's a shortfall, say 15% of that project and that's maybe a $10
00:44:53.680 | million hole. And you just don't want to go back and raise that money. You go back to
00:44:59.640 | investors and say, "Actually, I need twice as much money." And so a lot of investing
00:45:09.760 | is about actually understanding where somebody's got momentum. Knowing what they know at the
00:45:20.080 | moment, they probably wouldn't have even started the project but they've got to carry it to
00:45:24.080 | the term. And so they'll come to us and basically that's where we'll go. We'll go in this up
00:45:31.680 | to 72% or something like that in the loan to cost.
00:45:37.240 | You think about that as like, "Okay, this building may cost $200,000 a unit to build
00:45:43.080 | and I can be in this building for whatever $135,000 a unit. I feel super good about that.
00:45:52.640 | I couldn't buy that in my dreams if I were on the market and I can lend into it. So I
00:45:57.240 | feel really good about the basis. I know the sponsor. We've done a lot of deals with the
00:46:03.480 | same sponsors over and over again, repeat sponsors over a decade. So that's the first
00:46:10.960 | and that's the most common today. We've done six deals like that in the last 90 days.
00:46:18.320 | How did you source those deals? Was it like a blast email saying, "Guys, we've got $100
00:46:22.520 | million for you to vent," or did they come to you?
00:46:25.600 | Typically, you're already known. You already work with these people. You have relationships.
00:46:34.320 | Part of it is just you know it and then there's brokers who know you do it. It's always brokered.
00:46:39.720 | Everybody just uses capital brokers. There's only maybe 20 brokers in the country that
00:46:45.520 | do 80% of all of the financing for this stuff and they know you and they say, "Oh, we do
00:46:51.760 | this deal," and typically we're like, "No, we're not going to do that deal." So it's
00:47:00.320 | very informal. The real estate industry is such an inefficient market still, how people
00:47:06.600 | find money, how people raise money. It's a broker transaction. A broker is like, you
00:47:13.640 | know, it's not a rigorous process.
00:47:16.600 | Interesting. So once you get sourced that deal, how long does it take for you guys to
00:47:20.440 | analyze the deal and say yes or no? Or to say yes, I guess.
00:47:25.960 | Yeah, I mean that process, it's weeks and weeks and weeks. From the first time they
00:47:31.200 | touch us to when we're closing, I mean you're talking about like two to three months. We
00:47:36.640 | can get the yes pretty fast. Basically, you want to get to a signed term sheet. You want
00:47:41.880 | to lock up the deal. The funny thing about deals, I think it's true with most deals,
00:47:48.520 | is you can know right away. It can know within five minutes. It's so funny. Where is it?
00:47:56.160 | Who is it? How much do they need? Why do they need it? What's going on? Okay, that's a good
00:47:59.840 | deal.
00:48:00.840 | That comes from experience.
00:48:03.840 | Yeah. I mean I'm sure it does, but I always talk to people and I'm like, "Yeah, but look,
00:48:09.080 | so obvious. Look at this. It's where it's like you have to sharpen your pencils or you're
00:48:15.880 | like, "Just don't do it. Don't bother." Sharpening it, you're like, "Oh, it's this new sponsor.
00:48:20.960 | They just left a big firm. They had friends and family, they need more money." It's like,
00:48:27.840 | "Ah, forget it. Just no way. Just too hairy."
00:48:30.760 | On this one, this is actually the lesson, probably not as intuitive. The risk is on
00:48:36.360 | the sponsor, not the asset.
00:48:39.800 | Okay.
00:48:40.800 | Right? The basis we're in at and the type of asset, multifamily, it's not the asset.
00:48:47.800 | It's just the sponsor is dishonest, is incompetent, gets over their skis, whenever they get in
00:48:55.720 | a fight with their partners. It's always been for us on the 100 plus, whatever, 90 plus
00:49:01.040 | deals we've done, it's the sponsor, the real estate developer. That's the one. And real
00:49:07.280 | estate developers are a handful.
00:49:09.280 | Yes.
00:49:10.280 | They're a handful.
00:49:11.280 | Sure.
00:49:12.280 | So that's actually, that is experience. I've had team members bring me deals, like, "This
00:49:19.160 | is a great deal." I'm like, "Tell me about the sponsor." "Great sponsor. They have 5,000
00:49:24.520 | units."
00:49:25.520 | "Well, where'd they come from?" "Oh, he was the biggest originator of subprime mortgage
00:49:30.040 | in 2008 or 2007. And then it blew up because the mortgage business blew up."
00:49:36.840 | Yeah.
00:49:37.840 | "And he was the biggest originator of subprime mortgage in California in 2007."
00:49:41.720 | Yeah.
00:49:42.720 | "Don't do the deal."
00:49:43.720 | Why? What do you mean?
00:49:47.520 | Maybe he learned from it. Maybe he learned from his blow up.
00:49:50.160 | No. Don't do it.
00:49:51.160 | No? No. Okay.
00:49:52.160 | And they're like, "Okay, fine. Then get a hold of his lenders from 2007."
00:49:58.720 | "How do I do that?" "Just find them." And weeks go by, they're like, "I still can't
00:50:04.480 | find them." "Then we're not doing the deal."
00:50:06.800 | Okay. It's not worth it.
00:50:07.800 | And they finally, finally found the guy. They're like, "I got a hold of this person. I called
00:50:10.680 | him five times. He finally called me back." And he said, "I wasn't going to call you back,
00:50:15.280 | but I felt so bad for you. So I'm telling you, don't do this deal." The lender of this
00:50:20.320 | guy is like, "We foreclosed on this subprime mortgage originator. Literally, his computers
00:50:27.200 | were at the bottom of the pool."
00:50:28.200 | Oh my gosh. All right. Don't do the deal.
00:50:32.800 | Don't do the deal.
00:50:33.800 | A little too shady. Too shady.
00:50:34.800 | Yeah. Yeah. There's lots of things that shady people do. And that's where if they have a
00:50:41.760 | trust and the investor is a trust rather than a person, that's often a bad sign because
00:50:48.320 | they're trying to shield the person.
00:50:51.160 | Issues.
00:50:52.160 | I had a person that did a deal where Mark Anthony was the equity. Mark Anthony, the
00:50:58.400 | singer.
00:50:59.400 | Okay. Singer. Yeah.
00:51:01.400 | And the sponsor I was going to trust. And I was like, "Hmm." After a little bit of digging,
00:51:08.720 | sponsor, been in jail, insider trading.
00:51:11.400 | Okay. So why risk that? Yeah.
00:51:14.520 | But Starwood was the lender.
00:51:16.160 | Well, it's tier one.
00:51:18.600 | Yeah. It's amazing to me how many of the big private equity funds will look past that stuff
00:51:23.480 | actually.
00:51:24.480 | Interesting. Interesting. So I cut you off there. You were talking about two lending
00:51:29.600 | scenarios like the construction and refinance.
00:51:32.320 | And the other one, refinance. Yeah. So that's the wave coming.
00:51:36.760 | The wave coming. Yeah.
00:51:39.280 | Where basically all these deals were essentially bridging. They're all waiting for interest
00:51:44.440 | rates to come down. And interest rates were basically 3%, let's say, 0% plus 250. So maybe
00:51:56.880 | interest rate previously were at 3%. Now they're at 8%, 7%, 8%. And they need to get to, they're
00:52:03.960 | waiting for it to get to somewhere in the middle, like 5%.
00:52:06.560 | Yeah. Right.
00:52:07.560 | So they're bridging it. And there's just like trillion dollars on bridge loans today. But
00:52:14.640 | the problem is that when they get to the other side and they say, "Okay, now we can go perm
00:52:19.600 | it out, go put it on stabilized long-term financing." They have too much leverage. They
00:52:25.760 | have to de-lever their loan. And so they need MES, preferred equity, recap. And that's going
00:52:31.560 | to be a multi-hundred billion dollar demand. But nobody wants that money today because
00:52:37.920 | nobody wants to perm out their loan yet. They want to wait till-
00:52:43.960 | Nobody as in the companies borrowing the money.
00:52:47.520 | The borrowers, the sponsors, the real estate companies. They're kicking the can. They're
00:52:52.080 | waiting for interest rates to fall.
00:52:54.080 | Yes. I'm waiting too.
00:52:55.080 | That's where they go perm out, put permanent financing on it. And when they do, they're
00:53:01.040 | going to have to raise more money. That's their thinking. And they're just thinking,
00:53:06.840 | "If I kick the can, I'm better off."
00:53:11.920 | Right. Until they can't. Until they're, right? I mean, it's not a marginal-
00:53:17.360 | Until they can't. But that's not in their business plan.
00:53:21.320 | Okay. And so let's say they borrow from you guys at, I don't know, 8%.
00:53:27.880 | No, no.
00:53:28.880 | No. What would they borrow? What rate would you charge them?
00:53:32.520 | Okay. This is a little complicated, but I'm going to try to give you the math so that
00:53:37.080 | I think it's easier to really understand what's happening. So let's say you have a deal that
00:53:41.480 | has $5 million of income. Let's say an apartment building because that's probably the cleanest,
00:53:47.680 | lowest risk deal. So it only gets more risky and worse from here. But let's do apartment
00:53:51.360 | building, $5 million of income. So you thought that was worth $120 million because at a 4
00:53:58.200 | cap, a 4% interest rate, that would have been $120 million. Now it's a 5 cap, so it's worth
00:54:04.720 | $100 million. You'd previously borrowed, maybe it cost you $100 million to build. You thought
00:54:11.680 | you were going to sell it for $120 million. We're only going to sell it for $100 million,
00:54:14.680 | so you're going to break even. And you previously borrowed 75% against that. So that's a $75
00:54:20.400 | million loan. You put in $25 million of equity.
00:54:25.200 | Now the perm lender is going to say to you, "I want a nine yield on my debt." That's what
00:54:31.760 | Fannie and Freddie today are saying. "I want a nine yield on the debt." That's not the
00:54:35.400 | interest rate they're going to charge. They're going to charge whatever today, probably close
00:54:39.520 | to six, but they want to size the loan based on a nine yield on debt. So a nine yield on
00:54:48.760 | a $5 million is a $55 million loan. I was trying to do the math because I feel like
00:54:57.520 | it helps people understand. So the best lender in the world is Fannie and Freddie. They're
00:55:04.280 | one of the cheapest rates. They're going to size the loan based on a 9% constant. And
00:55:12.600 | that means it's a $55 million perm. They previously borrowed $75 million, so they're short $20
00:55:19.240 | million. So they at some point need $20 million when they go do permanent financing. And that's
00:55:31.200 | basically the opportunity that's coming probably a year or so, within a year, I think that
00:55:39.200 | happens.
00:55:40.200 | Right. And what rate would Fundrise charge? And how do you calculate that rate?
00:55:45.960 | I mean, it ends up being very market driven. So it probably ends up being 12%. I think
00:55:52.320 | that's where I bet.
00:55:53.320 | Wow, 12%. And is it callable or not callable? If the sponsor or developer finds that cash,
00:56:00.680 | that $20 million, can they just say, "Here's the $20 million back. I don't want to pay
00:56:04.400 | your 12%"? What's the penalty and how does that work?
00:56:06.720 | It depends on the deal. A lot of lenders, like a lot of MES lenders will actually put
00:56:15.640 | like basically different kinds of call protections on it. It's typically a minimum multiple,
00:56:22.280 | say a minimum one and a half times multiple or something. And we usually don't. We usually
00:56:28.280 | win the deal by saying, "You can prepay us anytime." I'd rather have a 12% that's prepaid
00:56:35.560 | than lose a deal because someone else bid 11.5%.
00:56:39.960 | Yeah, right.
00:56:42.400 | Because my bet is on a portfolio basis, most people aren't coming up with the cash.
00:56:47.760 | Right. Overall, right.
00:56:49.520 | It's just overall. And that's been my... If the market comes back as red hot, maybe three,
00:56:57.800 | five years from now, you start getting called. But I think across the portfolio, it's really
00:57:07.000 | unlikely. Sponsors typically, if they can get more money, do another deal. They won't
00:57:14.240 | go back and use that new equity to recap an old deal. They want to be in motion. They're
00:57:19.840 | like sharks. They have to be in motion.
00:57:22.600 | Interesting.
00:57:23.600 | So it's really unusual. The only way they really take you out is with more debt, not
00:57:29.800 | with more equity.
00:57:31.280 | Wow. What is the average duration of these opportunistic credit fund deals?
00:57:36.640 | Well, so the development deals are short. I mean, they're probably four years. And people
00:57:43.120 | like the idea they're short, but I love the long. So you can get 13%, 14% for three to
00:57:49.560 | four years, or you can get 12% for 10 years.
00:57:52.840 | I'd get 12% 10 years all day. I would invest all my money for 12% for 10 years.
00:57:59.120 | Yeah. And so we still have tons of those deals from 2016, where we just say, we went in and
00:58:06.760 | we went... Because typically a perm is going to be long duration money. And the funny thing
00:58:13.360 | is most private equity funds hate that. They hate the long duration because their fund
00:58:19.880 | doesn't have the life. Their fund life is usually five to seven years.
00:58:23.440 | Oh, but they raise another fund.
00:58:24.440 | And so there's actually not that much money out there available for a 10 year, 12%. It's
00:58:30.600 | a bizarre inefficiency in the market that we've been sort of harvesting for years.
00:58:35.600 | Yeah.
00:58:36.600 | For our investors, most of our investors would... Our investors are definitely a 12% 10 year
00:58:43.000 | investor.
00:58:44.000 | I mean, I would happily do that. So I guess in this scenario, let's say in two years,
00:58:50.720 | 2025, 2026, let's say mortgage rates are down two and a half percent, 3%. If I'm the developer,
00:58:56.880 | I'm not paying 12% though anymore. I don't want to pay that if I can borrow at 7%.
00:59:01.200 | No, because you can't refinance the senior.
00:59:04.400 | Okay. You're just locked in?
00:59:07.160 | The senior is locked in and for you to refinance me, you have to refinance them. And they will
00:59:17.480 | have... I mean, the prepayment penalty on a 10 year loan that was at 6% or 5% mortgage
00:59:25.160 | now is at 3 is going to be 10 million bucks. It's going to be huge.
00:59:30.080 | So basically the senior is sort of blocks an easy refinance.
00:59:34.400 | Okay. Well, I'm excited about this fund now. So for listeners who want to invest in this
00:59:39.560 | fund, what are the criteria for them to invest in this fund?
00:59:45.080 | This strategy, we have two funds investing in it. We have the income fund, which is open
00:59:50.480 | to everybody. And basically we take as much of these deals as we can now. And then we
00:59:57.640 | have the opportunistic credit fund, which is a credit investor fund. So both funds invest
01:00:05.280 | in this strategy now. And I would say that at the moment, just generally in the world,
01:00:10.000 | there's way more opportunities than there are dollars. We're not dollar constrained.
01:00:14.800 | We're not opportunity constrained. We're dollar constrained. We have tons more of these deals
01:00:19.720 | we could do because there's just so many borrowers need this money. And most investors, I'd say
01:00:25.640 | we still have, I mean, we still, we, we invested $400 million in the last six months. We did
01:00:30.600 | invest a decent amount across all of our strategies, but we last year, this time we invested a
01:00:36.920 | billion and a quarter. Okay. So like the dollars and most of the dollars we're putting out
01:00:43.600 | were dollars where you sat on. Yeah. You and I were, I told you I was conservative a year
01:00:48.000 | ago, so I sat on a lot of dollars. I started putting them out in earnest about six months
01:00:52.800 | ago. Yeah. But it's like most people are, I I'm finding is that the most people are
01:00:58.920 | on the sidelines, they're in money markets. Yeah. That's not wrong. I'm just, it's, it's
01:01:04.080 | constraining though, because I think it's, it's got an exciting time to put money out.
01:01:08.840 | And I think that there's sort of like two investors in the market, the investor on the
01:01:12.560 | sideline and the investor in high risk kind of tech. Sure. And you said there's two ways
01:01:19.600 | to invest the income fund and the opportunistic credit fund. Is that accredited only or for
01:01:24.080 | everyone for that opportunistic credit fund? The opportunistic credit fund is like a, is
01:01:27.920 | a short lived fund. I mean, it should, it's a, one of the things I found is that the operating
01:01:34.720 | cost of a, of an evergreen fund, the funds that like our income fund is like $2 million
01:01:41.120 | a year. The operating cost. Okay. Just third party, just dealing with SEC, transfer agent,
01:01:48.920 | all the regulatory stuff. So that has to be, so you can't, you can't have a small short
01:01:53.920 | lived fund. Okay. That is like, um, that's like then that it doesn't have the regulatory
01:02:00.600 | burden or sorry, that does have the regulatory burden. So it's, so we, we created two ways
01:02:04.900 | to do it. One through income fund, it's liquid every quarter, you know, and then the opportunity
01:02:11.600 | credit fund is not liquid. It's a five to seven year lock at lockup. Okay. And minimum
01:02:17.680 | investment, a hundred thousand on the hundred thousand credit fund and $10 on the income
01:02:23.480 | fund. Right. And you, one would say, is it fair to say the opportunistic credit fund
01:02:28.160 | is a hundred percent these type of opportunistic refinance construction loans, whereas the
01:02:34.120 | income fund is a, is a small, yeah. Um, and, and we, and we, we were sitting in a lot of
01:02:41.400 | cash where we started putting the cash out. Um, and so that, that was like, you know,
01:02:47.640 | see on cash looks smart in retrospect, but at the time when your yield comes down, you're
01:02:53.000 | sitting so much cash people not so happy. Right. So, um, you, you mentioned last year
01:02:58.640 | you're something, was it around 20% of your assets were in cash? Something like that.
01:03:03.480 | We had a huge, huge amount in cash and we, um, yeah. And now we've been putting that
01:03:10.120 | out. It's come down as we basically tried to grab as much of this opportunity as we
01:03:15.360 | can. And it's, um, and so it's the bottom, but it's, it's definitely better than it was.
01:03:23.400 | And so how does, how do you reconcile that with your belief in another recession? Because
01:03:29.400 | I, and I say another, because first quarter GDP, second quarter GP were declining back
01:03:33.660 | to back. So that's a recession in my mind. I think last year there was two consecutive
01:03:37.760 | down quarters as well. So it's almost just kind of like a amorphous word. Um, so I guess
01:03:44.440 | it depends on, so you put in the 400 million to work and you're going to put more money
01:03:47.940 | into work this year, but then you think there's gonna be a recession in the second half of
01:03:51.920 | 2024. How do you reconcile that? Well, so it's funny because a lot of the real
01:03:57.720 | estate we invest in and credit is, um, it's fairly counter cyclical. So, so like rental
01:04:07.440 | residential, I think it's going to do pretty well if there's a recession and like a lot
01:04:11.920 | of the stuff that's like, you know, driven by earnings will get really hurt. And so like
01:04:19.280 | the time to buy often depending on the asset class is like when there's not enough liquidity
01:04:25.760 | in the market. Yeah. I, our operating performance on the, on the, on the ground have been, has
01:04:32.160 | been basically, you know, as if their economy is not in recession, their rent growth, their
01:04:40.360 | occupancy. And I, and so, um, the way I think about it is it's, it's actually more around
01:04:47.640 | certain kinds of investment activity. You want to be in lower risk. You want to be in
01:04:52.520 | credit. You want to be in sort of value. I'm not saying you should, I mean, you can be
01:04:58.000 | on the sidelines too, but I was on the sidelines in 22. We go into value and credit now. And,
01:05:07.200 | um, and then like, you know, maybe distress next year, but it's, it's not that you're
01:05:14.920 | not active. It just what, what the activity is like, I don't, I don't think you want to
01:05:18.560 | be buying risk today. I think you want to be buying value. Yeah. I mean, there's also
01:05:23.200 | a price for everything, right? And you model out and then it depends on how you're, how
01:05:27.160 | long you're going to hold and so forth. Well, Ben, this has been a great conversation. I
01:05:32.480 | could talk to you for hours. I know maybe your kids or someone are like bugging what's
01:05:36.400 | going on dad. But where, uh, for more information, what, what would you recommend listeners go
01:05:44.360 | for? Fundraise find out more. Yeah. I mean we fundraise.com I, uh, I have a podcast,
01:05:51.520 | so I try to put my thinking out there, which is called on word. And, um, yeah, if you,
01:05:57.280 | if you were to sign up for fundraise, you'd get a lot of, you'd get a lot of emails, you
01:06:01.080 | know, good or bad. We've probably sent a fair amount of content to people. Um, but I, you
01:06:07.640 | know, I mean, it's, and I haven't, I even have a Twitter handle, which I think I, I
01:06:13.400 | follow you on Twitter for sure. Yeah. Ben Miller eyes. Yeah. Um, and maybe I'd actually
01:06:18.080 | just sign up for threads. So I gotta, I gotta, I can't do that. There's just too, there's
01:06:21.840 | too much going. You gotta focus, Ben. I had to sign up. Well, I love to talk again and
01:06:28.320 | connect again because we have more things to talk about. Uh, I want to talk to you about
01:06:33.240 | the tech fund that you've launched and how that's going. Uh, but we want to be conscious
01:06:39.120 | of the time limit that you have. So thanks so much for spending this hour with me. It's
01:06:43.760 | been great to understand your thoughts in the future. I really think, um, your critical
01:06:49.280 | thinking and your, your history and your cautious nature of looking at things is really a benefit
01:06:56.720 | for investors. And that's some, that's something that I want to, I want to put my money into
01:07:01.060 | someone who's always looking at what are the downside risks? Where can we avoid the huge
01:07:06.420 | blowups? Because I, you and me, we're, we're the same age and I've gone through the 2000
01:07:11.920 | bubble 2008 and it's just like, wow, I can't believe I lost 35% of my net worth in six
01:07:17.160 | months that took 10 years to build. And if we can sidestep those blowups, I think we're
01:07:22.920 | going to be better longterm. So if you want to sign up for fundrise, you can go to financial
01:07:26.840 | samurai.com/fundrise or you can just go to fundrise.com and you can check out onward
01:07:31.680 | the podcast and I hope to speak to you again, Ben, maybe we should do this, uh, twice a
01:07:36.840 | year. That'd be great if we can connect. Yeah, we definitely are setting ourselves
01:07:40.220 | up to look back and say like, okay, what, what happened? Yeah. What happened? Were we
01:07:45.280 | right? Were we wrong? What happened? What was, what were you writing wrong about? Cause
01:07:48.720 | we're definitely be wrong on something. Yeah. Well, I wish we had the recording in early
01:07:52.680 | 2022 because you were absolutely right about inflation, about the mortgage rates and let's
01:07:58.760 | see if you're right again, uh, over the next 12 months. All right. Thanks a lot. Take care.
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