Financial workout specialists, CWCapital’s James Shevlin and Goodwin’s Minta Kay, join Spencer to explain why commercial real estate has been more resilient during the pandemic than previous downturns and offer insights on creative moves that property owners facing potential distress can make to mitigate financial pain.
We Can Work It Out: Financial Workouts Amid the Pandemic
January 18, 2022 37 Minute Listen
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Spencer Levy
I'm Spencer Levy, and this is The Weekly Take. Many of you in the audience know how much I love pop culture from the 1980s and in thinking about the topic of this show, I was reminded of a line from a classic movie sequel from that era, that movie Rocky three. The line comes from Clubber Lang, played by Mr. T, who was asked to predict the outcome of his fight against the Italian Stallion prediction. Kluber growled Pain. The point is for the real estate industry. Economic downturns traditionally follow the clubber lang prediction recession, financial pain. But on this episode, we'll look at creative solutions that help some to lessen, if not to avoid a painful punch.
Minta Kay
There is no one playbook for what's happened in 2020 and 2021
Spencer Levy
That’s Minta Kay, a partner at the global law firm Goodwin and co-chair of its real estate industry group for more than 30 years. Minter has advised investors, owner/operators and more on all aspects of their real estate dealings. Working out of Goodwin's offices in Boston and New York City, she also leads an emerging practice. The PropTech initiative, which is focused on supporting the intersection of real estate and technology.
James Shevlin
This crisis is really a liquidity crisis and liquidity crises typically you recover quicker, which we have seen. But there's still some concerns out there.
Spencer Levy
And that's James Shevlin, the president and CEO of C.W Capital, also a veteran of the business for more than three decades. Based in Washington, DC, CW Capital uses data analytics and technology to provide a range of services on the financial side of commercial real estate, advising some of the top institutional investors in the world. We'll talk with our guests about their observations and analysis of the financial challenges caused by the pandemic. We'll discuss defaults and foreclosures, and why the level of distress wasn't as bad as it could have been. But also where there are still signs of potential danger on the horizon. We'll look at evolutions in lending and other practices in real estate, with insights and recommendations for working out financial troubles in any industry. Coming up, the potential pain of our epic bout with the pandemic and solutions worked out to soften the recession's blow. Financial workouts.That's right now on The Weekly Take.
Spencer Levy
Welcome to The Weekly Take and this week we're going to be talking about financial workouts, a topic that a lot of people thought we could be talking about a year ago. But here we are now into 2022, and this is our first one, in part because the economy has done so much better. Real estate has done so much better. Is that your perspective from being on the front lines in the legal field? Are those things behind the scenes that are maybe not quite as rosy as I'm suggesting? Minta, what do you think?
Minta Kay
Well, I would say that I think there is no one playbook for what's happened in 2020 and 2021. The economy has certainly supported ongoing investment in real estate, but it is without a doubt that there's a tremendous amount of default on the debt side and that there is stress in the industry. One of the interesting things to think about is the difference between what we're experiencing right now and what we saw at the global financial crisis. And I think the fact that the distress is driven by a health pandemic as opposed to a pure financial crisis has really changed the attitude and the ways that constituencies have behaved. Courts are behaving differently. Lenders are behaving differently. Landlords are behaving differently. There has been a level of patience this time around that we didn't necessarily see last time.
Spencer Levy
James, what's your perspective on that same opening statement of it's a lot better than we thought it was going to be.
James Shevlin
Well, I mean, yes and no. You know, we compare this back to 2009 when we saw a very similar type crisis, but in different aspects of it, it was a valuation and a real estate fundamental crisis. This crisis is really a liquidity crisis. And liquidity crises, Typically, you recover quicker, which we have seen, but there's still some concerns out there and probably lingering effects of COVID. We will see for years to come.
Spencer Levy
Well, I'm going to modestly disagree with you because I think there is a tremendous amount of liquidity out there. Certainly from the equity side, we didn't overlap this time as much.
James Shevlin
Yeah, I agree with you. I mean, it started out as a liquidity crisis. But what we found is, values have really held up. In the last crisis. It took multiple years to get to a recovery period. We're here. It's happened much, much quicker. And, you know, there's been a ton of money raised to support these declining assets and really rescue them from the initial trouble.
Minta Kay
And I would say Spencer, that's because values dipped dramatically but have held even in the most hard-hit asset classes like hospitality. Hospitality values are coming back up, delinquencies are going down. And from my perspective, what I see is that there's been a lot of dual tracking in dealing with distress in that space. So you've got lenders who are thinking about pursuing remedies. Some wait too long while before they do. Some wait a year and a half – in stuff that's been publicized, you know, your listeners will know – but some progress along that path while negotiating potential modifications and workouts, as you will, moving forward. So I think there's been a double trajectory, a dual path that has led to more creative solutions than there has been enforcement, frankly. And some of the enforcement’s been stalled and stopped.
James Shevlin
Well, we tried. You start with 2020, March of 2020. Who knew how long this was going to go on, right? We all thought a couple of weeks and then all of a sudden it didn't happen. And the first class that you mentioned was hospitality. It's a daily lease. No one came in the door the next day. So right away, we're getting calls. And before we know it, over a few weeks period, we've gotten $20 billion of relief requests come in our shop with their hand out. Hospitality was probably the hardest hit. No one was traveling and we had to step in to provide relief. So we did. We suspended replacement reserve collections. We switched some deals over to IO just to try to help them get through the crisis. And then you saw it in retail, too. Tenants stopped paying. So there was a little bit of crisis there. But beyond that, it wasn't as bad as we thought it would be. Now, our special servicing book grew 500 percent in just a few weeks, but we were able to handle all those requests. Some deals did need relief, some deals needed a little help, and then there's some deals where people just handed us the keys.
Spencer Levy
So for the purposes of our listeners, there are going to be a few technical terms used on this show and others define them as they come along. So James said IO means interest only. Most people who have a loan will have both interest and amortization just like your home loan, and it's one way to save people some money. But what James also mentioned was that some of his book moved from regular servicing to special servicing, and that is a feature of conduit lending, of securitized lending. And so, James, I think most of your loans are securitized, but just talk to us about some of the nuances of how a securitized loan might be dealt with differently than a balance sheet loan.
James Shevlin
Absolutely. So our name book, overall name book is about, $20 billion. So just to put it in context here. And as a special servicer, we deal with situations where there's a trigger event. The borrowers either defaulted and typically that is after a 60 day period, they haven’t made a payment and it would automatically be transferred into a special servicing type situation. Otherwise, the deal would be sitting with a master servicer who would handle the day-to-day loan servicing. So there's triggers – you know, a big tenant leaves may be a trigger that may move a deal over. So the first thing that we do is we contact the borrower and try to figure out what the story is and see if we can quickly resolve it to move it back into a performing situation. Not easy. And as you can imagine during COVID because it started out with no liquidity, not being able to make the payment, we had to quickly react and try to right-size the ships.
Spencer Levy
Minta, so from your perspective, why don't you also talk about some of the remedies you've seen and maybe some distinctions between the securitized world and the balance sheet world?
Minta Kay
The balance sheet world has the ability to – use my word from earlier – be a little bit more patient and at times a little bit more creative because they are more in control of their destiny around the debt that they hold. That's not to say that they will choose to exercise remedies on a differential basis than the securitized lenders and certificate holders might. So there have been situations where either type of lender has ultimately decided to pursue a remedy. Commonly, it's been in the time period that you mentioned, UCC foreclosures because it's usually the junior lenders that are seeking to take over. And borrowers have gone in to try to impede the exercise of those remedies, and they have achieved some success in this period. That success has been attributable to the assertion that the pandemic has made the exercise of remedies unreasonable. People can't go inspect assets they might buy. Time periods for bidding procedures are too short, given that everybody has been stuck at home. There's just a whole procedural aspect to that type of remedy that the pandemic has opened the door on discussions around. Early on, the lenders were quite receptive. There were numerous foreclosures that were stayed, at least temporarily, on the basis of the need for pandemic relief. That's changed now that we're living in circumstances as we are, you know, for quite such an extended period of time.
Spencer Levy
Let's go back now – just again, some of the technical terms we – UCC foreclosures. Essentially the way that it works, correct me, if I'm wrong, Minta, is that you have the senior lender that will typically go up to, say, 50, 60 percent of the capital stack. And then below that, you'll have different forms of junior lenders, mezzanine lenders or other forms of lenders. Those are the ones that would (a) have these UCC filings and (b) those are the ones that actually, James, you specialize in, particularly when you get all the way down in the stack to what's known as the B Piece. Is that correct Minta? And then I'll come to you, James.
Minta Kay
That's absolutely correct. They're the ones that are more at risk, obviously, because the senior lenders have secured mortgages. They've lent at a lower threshold than you've articulated. It's when you start layering on the debt to get to loan to value – another term of art. But to get closer to approaching the actual value of a property on the lending side that there are riskier positions, and that's where people are forced to act more quickly and earlier when there's a dip in the market.
Spencer Levy
James, you specialize actually in those riskier areas not only to take that extra yield, but also to get some of the servicing rights. Can you explain some of that to our listeners?
James Shevlin
Certainly, certainly. So actually, we handle, really, mostly the senior debt, but we also handle some of the junior debt pieces as well. But on the senior debt, the way it works, it's, you know, a Wall Street firm will accumulate a bunch of loans and they will sell them off in the form of a bond structure. And the bonds are rated from less risky Triple-A down to non-rated, non-investment grade. And the lowest holder is known as the controlling class. And they are deemed the decision-maker for when a deal gets into a workout type situation. So getting back to like the UCC foreclosures, typically that's a positive thing for the senior lender. You'll get a new borrower whose hope, you know, you're hoping that brings that loan current. That's typically the only way they can step into the shoes is to bring that loan current. Probably they're a little bit stronger than the current senior holder, and the loan will become performing. And that's the goal of all these workouts, right, is to get the loan back to performing.
Spencer Levy
So, James, let's talk relative to the GFC, when we saw the amount of loans that were moved to special servicing go up to significant numbers. Just just give us a sense of comparison. How many loans were troubled then in the GFC versus today and why there might be a difference?
James Shevlin
You know, at the start of it – 2019 into 2020 – very, very few defaults. Pretty much selling off what we call the legacy book, which were deals that were originated in 2005 through ‘09. People were accumulating what they call the 2-0 book, which were deals that were originated in 2011 and ‘12. Very few of those deals were in a workout type situation and then all of a sudden overnight just exploded to having to deal with all these requests and deals moved into servicing. Now that has declined to where we are today. Almost two years later, we're able to dispose of some of the deals, but still it's a fairly healthy book from where we were. It just takes a long time – as Minta will all probably back me up on this – to go to a borrower and say, OK, what do you want to do? And back and forth trying to make a decision to the point of maybe putting in a receiver who, you know, watches over not just the borrower's interest, but also the lender's interest. And then getting to the point of making it REO – real estate owned – via foreclosure. It's not that quick. And we touched a little bit upon earlier, there were certain moratoriums out there. In Oregon that we couldn't do anything, we couldn't enact any remedies, and there's certain states that are quite difficult, even in non-pandemic times, to take control. Not every state is Texas, where you can just go in and fairly quickly get control of that asset.
Spencer Levy
But also there's that wild card at sort of the end of the line, so to speak: the bankruptcy judges. And the bankruptcy judges, notwithstanding what the documents say, have great flexibility in what they can and cannot do to help your borrower. So Minta, let's assume that some of our listeners are borrowers that have troubled assets. And they're maybe just squeaking by on payments. They're not sure what to do. How do you advise borrowers in that situation?
Minta Kay
That's a difficult question because the bankruptcy code is not designed to really handle single purpose entity, single real estate asset cases so they can be filed to buy a little bit of time, but they are usually dismissed. Thrown out is the word that's commonly used. So for your standard SPE real estate borrower, it's not a really good strategy. It's not something that is commonly used. Now with organizations that own many assets that have portfolios that do have the potential to really restructure into ongoing concerns with certain concessions on their debt and on their other vendor obligations and third party liabilities – you know, then that's an option that people do consider, and we advise people to consider. The bankruptcy courts were very sympathetic to the distressed borrowers early in the pandemic. And a lot of waivers were granted. Time was given. As I mentioned before, I think that is starting to tighten up a little bit because we're living under conditions that have extended for quite a long period of time. So we're we're feeling that shift now
Spencer Levy
And again, for the purposes of our listeners, SPE stands for special purpose entity. Most individual assets are owned in an LLC of some sort that keeps the actual borrower one or two steps removed from that asset.
James Shevlin
Spencer, one thing I want to add which is interesting on these SPEs: The one bad trigger if you file bankruptcy is personal recourse. The benefit of a securitized loan and even a balance sheet loan a lot of times is non-recourse. That is the one thing you don't want to trigger. That's a fight that we will fight. If you're going to play ball, then you're going to have to deal with the ramifications of it.
Minta Kay
There are nuances with that. Obviously, the party to whom the recourse extends in the event of bankruptcy is sometimes itself judgment proof, right? There's a lot there, but it's a very good point to make. Sometimes that's really painful, sometimes not so
Spencer Levy
Well, to your point, once again, and having gone through the GFC, even the personal guarantee, the springing personal guarantee or what I used to call when I was practicing law many moons ago, the quote unquote bad boy guarantee is what we said. You do a bad idea of some sort.
Minta Kay
That’s the reference.
Spencer Levy
Is that still the term, Minta? I'm not sure.
James Shevlin
Oh, yeah.
Spencer Levy
Yeah.
Minta Kay
It is. It doesn't say bad person. It's still “bad boy” in quotes in all the docs. Go figure.
Spencer Levy
Is that right?
Minta Kay
Yeah.
James Shevlin
But you know, you need those triggers. You need those triggers in place that people have to be reminded that even though it's a non-recourse loan, do not divert funds, do not steal money, work with the lender. And a lot of times we see in these workouts the, you know, the borrowers try to do everything, not to work with the lenders. And of course, then as a result, we're going to have to battle to fight for the collateral.
Minta Kay
Spencer, maybe it's just because there can't be bad women.
Spencer Levy
Maybe, maybe. Well, you know what I'm going to say, I'm going to say something for the record here, even though I don't want any women, men or otherwise to go into foreclosure, get in trouble. The more women we have in the business, the better.
James Shevlin
But women do default on loans, too, Minta.
[laughter]
Spencer Levy
So on the topic of personal guarantees, even there – Minta, correct me if I'm wrong – the bankruptcy judges or other judges have some flexibility there. Say if it wasn't, if you had clean hands, right – I guess clean hands could mean a lot of things – if the pandemic took you down. Not because you were a bad operator, the judge might be more sympathetic. Would you agree with that, Minta?
Minta Kay
I would agree with that, and we've seen that play itself out. Although as I mentioned that flexibility and that sympathy is starting to fade a little bit as we wear under the ongoing impact of the pandemic. The business world and the real estate world just can't stop for such an extended period of time. So the constituencies who have a real role in deciding how it operates are moving much more quickly now.
Spencer Levy
Sure. Well, now as all of us have been in this business for a while, you know, I vaguely remember the RTC days in the early 1990s, as I'm sure you do as well. RTC stood for the Resolution Trust Corporation, was a government formed entity when we had the demise of the S&L savings and loan industry in the early 1990s due to some over lending and maybe a little bit self-dealing. The banks basically took the S&Ls, took the bank's assets back and then sold them for a song to many of the large real estate companies that exist today. And that changed materially over time, where people did their best not to take them back, not to sell them for a song. And I guess my question, I'll start with you, James. Are we a better place today or in the RTC, clear the books and move forward period.
James Shevlin
I was an employee of the RTC for four years and lived through it. All the chaos. Worked in the Inspector General's Office, dealing with some political issues. There was no structure in the loans back then. I think that was probably the one common theme. And today structure is much, much better. I think leverage is better. But there's still concerns out there. And we have to always remind ourselves as we go through things like a crisis – step back, you know, do we have triggers in place or just a loan made sense? Is the coverage adequate? Even today, we're sitting here today – and we talk about our hospitality; it's recovering everything. – I looked at our book and 49 percent of our hospitality assets have debt coverage today below one point out. So even though they're performing and someone's getting that check every month to meet the loan payment, there's going to be a time where at maturity or even further down the road, if we go through a, God forbid, another crisis that they could potentially default agai. Or how do they refinance out? If your coverage is that low, that means someone has to write a check to bring the leverage down and will that happen?
Spencer Levy
Well, one of the things for folks that are considering different forms of real estate hospitality, which is great form of real estate, is a operating business. And if you have no tenants coming in or occupants coming in, you’ve still got to put the money into the foreigners that some people have said. It eats every month. Unlike some other forms of real estate.
James Shevlin
That’s why it's so different. And I get a lot of questions about why hasn’t office defaulted yet? No one's in the office. Why aren't we seeing it? The big difference is it's a daily short term lease versus a longer term lease. And depending upon when that office lease matures, that's when you have to deal with the issue. We're really not seeing it in CBD office right now, the defaults in office. Will it happen at some point? Maybe. The bigger concern is probably more suburban office as there's a flight to quality now. That's the first thing we should look for to see how suburban office performs. But our office book, our delinquency rate on the performing deals right now is zero point three-three percent. There's virtually no –
Spencer Levy
Can I just emphasize that point I'm turning right to you Minta, right now, but I just want to double down on that point for a second: point three-three percent of one of the biggest special servicers in the business book on office is in default. That's how office has been resilient during the crisis, though I think we'll all agree that may come to an end. Minta, what’s your point of view?
Minta Kay
A couple of points here. One, I think we should watch that because I think we may see some changes. I think we may start to see more stress in that sector, not if they're going to go into outright delinquency so they hit your quote unquote book, but I think you're going to see more difficulty there. Certainly, there's a tremendous amount of subletting going on now. But that goes into my point earlier. I think we have a very mixed bag here. I don't think we have one playbook. So I think office – flight quality is happening, but I think suburban – I would take issue with you – is growing dramatically. We work with a lot of clients who are really developing different kinds of hub and spoke models, different kinds of sites, Main Street office sharing, that are really going to allow people who are working on a hybrid basis – some in some out of the office – to access professional working space. So I think office is TBD. We'll see. But I think this is going to be the year that that's very tested.
James Shevlin
Yeah, I agree with you, Minta, too. I mean, there'll be some downsizing. I think we're all looking at efficiencies right now. Corporately, everyone's looking at that. How much space you need? Law firms specifically. They probably don't need as much space as they take. And you know, can you sublease that space? It'll be very market driven, too. I'm very concerned about, like, Chicago, where you've got older buildings, very expensive to improve that space and very large block space that has to be subdivided Almost it doesn't make economic sense and some of those buildings.
Spencer Levy
Let me jump in there for a second because next week's show is on Chicago. I'm going to have to take exception with James and say that yes, Chicago has its issues. It's got a lot of office space, a lot of older space. But the beauty of Chicago – like L.A. with the Bunker Hill section, like different sections of New York – is that those cities are reinventing themselves, and the reinvention in Chicago may not necessarily be in The Loop. But there is a lot of capital going into the loop, as we had a guest on the show talking about one of her assets where she was putting $500 million into it. But the other place it's reinventing is the Fulton Market. The Fulton Market in Chicago is one of the most vibrant submarkets in the United States. And that's in Chicago, notwithstanding its issues. That's an opportunity.
James Shevlin
I think just look at population trends.
Spencer Levy
Well, that's where we can differ again, James, because I think when you look at population trends, you have to segment it. So we actually did a study on this last year, when we looked at population trends in New York and San Francisco. And you know, those trends showed? An outflow of people. And you say, Oh, that's the end of the world, right? Well, no, because, you know what? It showed an inflow of the most highly educated, highly talented and dare I say it, highly productive people. And you know who drives real estate demand? Those people.
James Shevlin
Spencer, I will tell you those people do not want to be in the office five days a week. Those people want to be in the office two or three days a week. So what do you do?
Spencer Levy
Well, let's talk about this. And Minta, I think it's fair to say that of all the industries we've seen, the law business has actually shrunk more from a footprint per average employee than other industries. And the reason I've given to that is No. 1 law firms are a little bit of a laggard behind other industries because of law libraries, because of copy rooms, but also because what we're dealing with today isn't a real estate crisis. We're seeing a shift in the labor versus management equation, where management had more power pre-COVID. Now labor is growing, and I think young lawyers understand that of you have any point of view on how you're changing Goodwin's space.
Minta Kay
Yeah, absolutely. First of all, say we pay all the rent in every location, even though we're seriously looking at the shifts that we need to handle. We are reshaping our space. We are creating different uses of space. We are looking at ways to facilitate sort of the hybrid way of working. And we're in early days. Some in-house meetings coupled with folks, you know, outhouse, if you will – or on Zoom or on some other LinkedIn connection – don't really work very well. Like you guys have all experienced that. I'm sure it's hard to make that all work. So we're investing a lot in technology that will enable us to have some people in the office, in a conference room, some people out. We expect hybrid to be the new norm. We're trying very hard to get people together again because we recognize the value in that. But we're looking at reshaping our spaces. We're looking at reshaping our technology and expect that to continue.
Spencer Levy
Well, Minta, I think that's a great segue into something that both you and James have great expertise in, which is prop tech. And I know you have a big practice there. And James, you've been investing a tremendous amount in that project. So maybe James, why don't you start with your prop tech and how it's helping CW Capital. And Minta, I’d love to learn more about your practice. James?
James Shevlin
Sure. So one of the things I was tasked to do when I got this see five years ago was How can we grow beyond being a special servicer? And, you know, two areas that really came to light were how we sell our assets, how we dispose of our assets. And we developed an online commercial real estate auction platform, really to sell deals on our own book. And four years later, and three plus billion dollars in sales, we've been very, very successful doing it. Really flipping into selling just our own book to selling for third party sellers. And it's been really exciting growth there and excited to see where it's going to go in the future. The second area is something called real insight. It's asset management software covers data management, role-based workflow and custom reporting. It's unique in that it has the flexibility to handle any commercial loan product and financing structure. We talked about it really handling the loan from cradle-to-grave. So we we take the loan in and it's originated variable to underwrite through this software. You can surveil through the software. You can special service through the software. And then you can dispose it. And it's been a really big game changer. And has taken off during COVID for some reason, as institutions are looking at their book and instead of people just providing reports, let's consolidate all together into a database. We're excited to see where that goes as well.
Spencer Levy
So that particular tool, it can red-flag an asset before it falls into default. Is that one of its functions?
James Shevlin
That's exactly right that you can watch trends in terms of payment and debt coverage. Occupancy trends anything that may be a trigger to suggest an asset may be in trouble – and do it fairly quickly versus having a few analysts having to crunch numbers. And this puts everything in a cloud based system right at your fingertips.
Spencer Levy
Well, I think that's a great tool because we have tools like that on the front end as well for AI. A lot of our clients underwrite assets trying to get to what to buy using similar programs. And certainly nothing is 100 percent, but nevertheless, we're seeing on both ends. So Minta, I’d love to turn to you now because prop tech’s a huge part of your practice. Let’s hear about it,
Minta Kay
So a lot of this conversation has been about debt and about debt default and managing debt. But I would like to bring everybody back to the fact that there is no one, whether they realize it or not, who's not impacted by the built, the hardscape in which they work and which they live, etc. Real estate is ubiquitous and it is everywhere. So whether you understand it or not, you're in it and it is impacting you. So the hard escape, I think, is something that has the opportunity to be fundamentally changed coming out of this crisis. I'm not just talking about better HVAC. I'm not talking about touchless this-and-that. I'm really talking about ways that we see coming up now through our practice to make more efficient, make more cost effective and make quicker changes to the built environment. It is creating new products to build, new ways to build, new ways to shape communities, new ways to expand, improve the lives of people whether they are in their personal life space or their professional life space, or somewhere in between. So I think that opportunity on the equity side to focus on adaptive reuse, I think is another space that's phenomenally important in the hardscape. There's some really interesting changes going on now. Some of the more mundane are office conversions to apartments. And that's happening across the country. Some of the more interesting are old antique mills and factories converting into community hubs with event space restaurants and all that other stuff. There are old retail spaces that are converting into medical facilities. There’s a lot of that going on, and I think it's very important during this time for the real estate community to be thinking about that and to be exploring opportunities to tie back to this topic. Lenders are open minded, equity investors are open minded around this stuff. I'm not saying they're jumping in, you know, in the deep end, but people are beginning to think about this much more seriously. And even the CMBS lenders are starting to learn how to underwrite some of these different kinds of uses and different kinds of revenue streams.
James Shevlin
Well, I would agree with you. I mean, I think adaptive reuse is definitely a strong trend. But I think sometimes it's like a little bit more talk than action right now. And that's really tied to volatile material costs and labor costs. And then there's also zoning. You know that who knows what you can do with this stuff, right? That's probably more your area, but a huge amount of money has been raised for the purpose of chasing these deals. I don't know if there's enough deals yet out there that we can say it's a trend.
Spencer Levy
I actually agree with both comments. We are seeing a lot of adaptive reuse, but it's really expensive. And so you don't see quite as much of it as you'd like to see, but you are seeing a changing landscape of the issues of why you would change your use. And the reason why most real estate investors want change the use is to make more money. But there's also –
James Shevlin
Or maybe because it doesn't work anymore, right? So you take your Class B office and you want to convert it to multi because there's stronger demand for that than Class B office. You can't compete with Class A office. There could be older hotels, which we see all the time. They convert those to multi or assisted living senior living. That is a big trend that we are seeing the full tear down and rebuild right now. It's expensive. You're not seeing much new construction.
Spencer Levy
OK, well, I'd like to get some final thoughts from both of you. I'll start with you, Minta, why don't we take out your crystal ball maybe three or four years from now, looking back, how do you see the real estate landscape evolving with a particular focus on how the workout environment is going to shake out?
Minta Kay
I think we're going to go through a period of workouts now. I think we'll come out of it. Four years down the road there may be another one triggered by something that I don't have in my crystal ball, but I think that the real estate industry is cyclical and it is very, very nimble and adaptive. I am very confident and I believe highly that innovation is going to drive a lot of how the hardscape is shaped and how the community invests and chooses to place its money going forward. I don't think we're any more old bricks and mortar and that's it. I think we've hit a tipping point and that's only going to accelerate over the next few years.
Spencer Levy
So, James, how do you see the workout environment shaking out? And how do you otherwise see the real estate space changing?
James Shevlin
You know, with our declining delinquencies the real estate market's going to be strong. It's resilient. I think technology will come into play in a more and more things will be developed and a more efficient and transparent industry will be as a result. So. It'll be good. I think loan structures will – with the crisis that we have now, I think people smarten up and make sure things will be strong. They won't be as liberal and throw things out there, given the world we're in today. But the one big area I think will see to explode will be data. We initiated a huge data project where we want to gather and structure and standardize all our unique and private data that we've collected through the years as part of our due diligence that we do on deals or underwriting our asset management or disposition services and share that with the world. So there'll be a huge explosion in that area.
Spencer Levy
Great. I will sum up our episode on financial workouts with optimism. Because what we heard from James was that point three-three percent of his book in office is in default, which is a surprisingly low number. The second thing that James said was that the real estate industry is going to be strong, and James is in the special servicing and servicing business. So that's, I think, another optimistic sign. And Minta of course, showed great optimism about how real estate continues to evolve through adaptive reuse and other things that are going to make us a strong industry in the years to come, even if it isn't the same asset mix. So on behalf of The Weekly Take, I want to thank Minta Kay, partner at Goodwin for joining us on today's show and sharing some just unbelievable insights.
Minta Kay
Spencer, thank you for having me.
Spencer Levy
And then I want to thank James Shevlin, the president and COO of CW Capital. Also great insights today. James, thank you.
James Shevlin
Thank you, Spencer. It's been great.
Spencer Levy
For more on our show visit CBRE.com/TheWeeklyTake. You can find out more about the topic we just discussed, as well as share the episode. We look forward to discussing more issues, sectors and markets, including, of course, an episode on Chicago coming up next week. In the meantime, don't forget to subscribe rate and review us wherever you listen. Thanks again for joining us. I'm Spencer Levy. Be smart. Be safe. Be well.
Spencer Levy
I'm Spencer Levy, and this is The Weekly Take. Many of you in the audience know how much I love pop culture from the 1980s and in thinking about the topic of this show, I was reminded of a line from a classic movie sequel from that era, that movie Rocky three. The line comes from Clubber Lang, played by Mr. T, who was asked to predict the outcome of his fight against the Italian Stallion prediction. Kluber growled Pain. The point is for the real estate industry. Economic downturns traditionally follow the clubber lang prediction recession, financial pain. But on this episode, we'll look at creative solutions that help some to lessen, if not to avoid a painful punch.
Minta Kay
There is no one playbook for what's happened in 2020 and 2021
Spencer Levy
That’s Minta Kay, a partner at the global law firm Goodwin and co-chair of its real estate industry group for more than 30 years. Minter has advised investors, owner/operators and more on all aspects of their real estate dealings. Working out of Goodwin's offices in Boston and New York City, she also leads an emerging practice. The PropTech initiative, which is focused on supporting the intersection of real estate and technology.
James Shevlin
This crisis is really a liquidity crisis and liquidity crises typically you recover quicker, which we have seen. But there's still some concerns out there.
Spencer Levy
And that's James Shevlin, the president and CEO of C.W Capital, also a veteran of the business for more than three decades. Based in Washington, DC, CW Capital uses data analytics and technology to provide a range of services on the financial side of commercial real estate, advising some of the top institutional investors in the world. We'll talk with our guests about their observations and analysis of the financial challenges caused by the pandemic. We'll discuss defaults and foreclosures, and why the level of distress wasn't as bad as it could have been. But also where there are still signs of potential danger on the horizon. We'll look at evolutions in lending and other practices in real estate, with insights and recommendations for working out financial troubles in any industry. Coming up, the potential pain of our epic bout with the pandemic and solutions worked out to soften the recession's blow. Financial workouts.That's right now on The Weekly Take.
Spencer Levy
Welcome to The Weekly Take and this week we're going to be talking about financial workouts, a topic that a lot of people thought we could be talking about a year ago. But here we are now into 2022, and this is our first one, in part because the economy has done so much better. Real estate has done so much better. Is that your perspective from being on the front lines in the legal field? Are those things behind the scenes that are maybe not quite as rosy as I'm suggesting? Minta, what do you think?
Minta Kay
Well, I would say that I think there is no one playbook for what's happened in 2020 and 2021. The economy has certainly supported ongoing investment in real estate, but it is without a doubt that there's a tremendous amount of default on the debt side and that there is stress in the industry. One of the interesting things to think about is the difference between what we're experiencing right now and what we saw at the global financial crisis. And I think the fact that the distress is driven by a health pandemic as opposed to a pure financial crisis has really changed the attitude and the ways that constituencies have behaved. Courts are behaving differently. Lenders are behaving differently. Landlords are behaving differently. There has been a level of patience this time around that we didn't necessarily see last time.
Spencer Levy
James, what's your perspective on that same opening statement of it's a lot better than we thought it was going to be.
James Shevlin
Well, I mean, yes and no. You know, we compare this back to 2009 when we saw a very similar type crisis, but in different aspects of it, it was a valuation and a real estate fundamental crisis. This crisis is really a liquidity crisis. And liquidity crises, Typically, you recover quicker, which we have seen, but there's still some concerns out there and probably lingering effects of COVID. We will see for years to come.
Spencer Levy
Well, I'm going to modestly disagree with you because I think there is a tremendous amount of liquidity out there. Certainly from the equity side, we didn't overlap this time as much.
James Shevlin
Yeah, I agree with you. I mean, it started out as a liquidity crisis. But what we found is, values have really held up. In the last crisis. It took multiple years to get to a recovery period. We're here. It's happened much, much quicker. And, you know, there's been a ton of money raised to support these declining assets and really rescue them from the initial trouble.
Minta Kay
And I would say Spencer, that's because values dipped dramatically but have held even in the most hard-hit asset classes like hospitality. Hospitality values are coming back up, delinquencies are going down. And from my perspective, what I see is that there's been a lot of dual tracking in dealing with distress in that space. So you've got lenders who are thinking about pursuing remedies. Some wait too long while before they do. Some wait a year and a half – in stuff that's been publicized, you know, your listeners will know – but some progress along that path while negotiating potential modifications and workouts, as you will, moving forward. So I think there's been a double trajectory, a dual path that has led to more creative solutions than there has been enforcement, frankly. And some of the enforcement’s been stalled and stopped.
James Shevlin
Well, we tried. You start with 2020, March of 2020. Who knew how long this was going to go on, right? We all thought a couple of weeks and then all of a sudden it didn't happen. And the first class that you mentioned was hospitality. It's a daily lease. No one came in the door the next day. So right away, we're getting calls. And before we know it, over a few weeks period, we've gotten $20 billion of relief requests come in our shop with their hand out. Hospitality was probably the hardest hit. No one was traveling and we had to step in to provide relief. So we did. We suspended replacement reserve collections. We switched some deals over to IO just to try to help them get through the crisis. And then you saw it in retail, too. Tenants stopped paying. So there was a little bit of crisis there. But beyond that, it wasn't as bad as we thought it would be. Now, our special servicing book grew 500 percent in just a few weeks, but we were able to handle all those requests. Some deals did need relief, some deals needed a little help, and then there's some deals where people just handed us the keys.
Spencer Levy
So for the purposes of our listeners, there are going to be a few technical terms used on this show and others define them as they come along. So James said IO means interest only. Most people who have a loan will have both interest and amortization just like your home loan, and it's one way to save people some money. But what James also mentioned was that some of his book moved from regular servicing to special servicing, and that is a feature of conduit lending, of securitized lending. And so, James, I think most of your loans are securitized, but just talk to us about some of the nuances of how a securitized loan might be dealt with differently than a balance sheet loan.
James Shevlin
Absolutely. So our name book, overall name book is about, $20 billion. So just to put it in context here. And as a special servicer, we deal with situations where there's a trigger event. The borrowers either defaulted and typically that is after a 60 day period, they haven’t made a payment and it would automatically be transferred into a special servicing type situation. Otherwise, the deal would be sitting with a master servicer who would handle the day-to-day loan servicing. So there's triggers – you know, a big tenant leaves may be a trigger that may move a deal over. So the first thing that we do is we contact the borrower and try to figure out what the story is and see if we can quickly resolve it to move it back into a performing situation. Not easy. And as you can imagine during COVID because it started out with no liquidity, not being able to make the payment, we had to quickly react and try to right-size the ships.
Spencer Levy
Minta, so from your perspective, why don't you also talk about some of the remedies you've seen and maybe some distinctions between the securitized world and the balance sheet world?
Minta Kay
The balance sheet world has the ability to – use my word from earlier – be a little bit more patient and at times a little bit more creative because they are more in control of their destiny around the debt that they hold. That's not to say that they will choose to exercise remedies on a differential basis than the securitized lenders and certificate holders might. So there have been situations where either type of lender has ultimately decided to pursue a remedy. Commonly, it's been in the time period that you mentioned, UCC foreclosures because it's usually the junior lenders that are seeking to take over. And borrowers have gone in to try to impede the exercise of those remedies, and they have achieved some success in this period. That success has been attributable to the assertion that the pandemic has made the exercise of remedies unreasonable. People can't go inspect assets they might buy. Time periods for bidding procedures are too short, given that everybody has been stuck at home. There's just a whole procedural aspect to that type of remedy that the pandemic has opened the door on discussions around. Early on, the lenders were quite receptive. There were numerous foreclosures that were stayed, at least temporarily, on the basis of the need for pandemic relief. That's changed now that we're living in circumstances as we are, you know, for quite such an extended period of time.
Spencer Levy
Let's go back now – just again, some of the technical terms we – UCC foreclosures. Essentially the way that it works, correct me, if I'm wrong, Minta, is that you have the senior lender that will typically go up to, say, 50, 60 percent of the capital stack. And then below that, you'll have different forms of junior lenders, mezzanine lenders or other forms of lenders. Those are the ones that would (a) have these UCC filings and (b) those are the ones that actually, James, you specialize in, particularly when you get all the way down in the stack to what's known as the B Piece. Is that correct Minta? And then I'll come to you, James.
Minta Kay
That's absolutely correct. They're the ones that are more at risk, obviously, because the senior lenders have secured mortgages. They've lent at a lower threshold than you've articulated. It's when you start layering on the debt to get to loan to value – another term of art. But to get closer to approaching the actual value of a property on the lending side that there are riskier positions, and that's where people are forced to act more quickly and earlier when there's a dip in the market.
Spencer Levy
James, you specialize actually in those riskier areas not only to take that extra yield, but also to get some of the servicing rights. Can you explain some of that to our listeners?
James Shevlin
Certainly, certainly. So actually, we handle, really, mostly the senior debt, but we also handle some of the junior debt pieces as well. But on the senior debt, the way it works, it's, you know, a Wall Street firm will accumulate a bunch of loans and they will sell them off in the form of a bond structure. And the bonds are rated from less risky Triple-A down to non-rated, non-investment grade. And the lowest holder is known as the controlling class. And they are deemed the decision-maker for when a deal gets into a workout type situation. So getting back to like the UCC foreclosures, typically that's a positive thing for the senior lender. You'll get a new borrower whose hope, you know, you're hoping that brings that loan current. That's typically the only way they can step into the shoes is to bring that loan current. Probably they're a little bit stronger than the current senior holder, and the loan will become performing. And that's the goal of all these workouts, right, is to get the loan back to performing.
Spencer Levy
So, James, let's talk relative to the GFC, when we saw the amount of loans that were moved to special servicing go up to significant numbers. Just just give us a sense of comparison. How many loans were troubled then in the GFC versus today and why there might be a difference?
James Shevlin
You know, at the start of it – 2019 into 2020 – very, very few defaults. Pretty much selling off what we call the legacy book, which were deals that were originated in 2005 through ‘09. People were accumulating what they call the 2-0 book, which were deals that were originated in 2011 and ‘12. Very few of those deals were in a workout type situation and then all of a sudden overnight just exploded to having to deal with all these requests and deals moved into servicing. Now that has declined to where we are today. Almost two years later, we're able to dispose of some of the deals, but still it's a fairly healthy book from where we were. It just takes a long time – as Minta will all probably back me up on this – to go to a borrower and say, OK, what do you want to do? And back and forth trying to make a decision to the point of maybe putting in a receiver who, you know, watches over not just the borrower's interest, but also the lender's interest. And then getting to the point of making it REO – real estate owned – via foreclosure. It's not that quick. And we touched a little bit upon earlier, there were certain moratoriums out there. In Oregon that we couldn't do anything, we couldn't enact any remedies, and there's certain states that are quite difficult, even in non-pandemic times, to take control. Not every state is Texas, where you can just go in and fairly quickly get control of that asset.
Spencer Levy
But also there's that wild card at sort of the end of the line, so to speak: the bankruptcy judges. And the bankruptcy judges, notwithstanding what the documents say, have great flexibility in what they can and cannot do to help your borrower. So Minta, let's assume that some of our listeners are borrowers that have troubled assets. And they're maybe just squeaking by on payments. They're not sure what to do. How do you advise borrowers in that situation?
Minta Kay
That's a difficult question because the bankruptcy code is not designed to really handle single purpose entity, single real estate asset cases so they can be filed to buy a little bit of time, but they are usually dismissed. Thrown out is the word that's commonly used. So for your standard SPE real estate borrower, it's not a really good strategy. It's not something that is commonly used. Now with organizations that own many assets that have portfolios that do have the potential to really restructure into ongoing concerns with certain concessions on their debt and on their other vendor obligations and third party liabilities – you know, then that's an option that people do consider, and we advise people to consider. The bankruptcy courts were very sympathetic to the distressed borrowers early in the pandemic. And a lot of waivers were granted. Time was given. As I mentioned before, I think that is starting to tighten up a little bit because we're living under conditions that have extended for quite a long period of time. So we're we're feeling that shift now
Spencer Levy
And again, for the purposes of our listeners, SPE stands for special purpose entity. Most individual assets are owned in an LLC of some sort that keeps the actual borrower one or two steps removed from that asset.
James Shevlin
Spencer, one thing I want to add which is interesting on these SPEs: The one bad trigger if you file bankruptcy is personal recourse. The benefit of a securitized loan and even a balance sheet loan a lot of times is non-recourse. That is the one thing you don't want to trigger. That's a fight that we will fight. If you're going to play ball, then you're going to have to deal with the ramifications of it.
Minta Kay
There are nuances with that. Obviously, the party to whom the recourse extends in the event of bankruptcy is sometimes itself judgment proof, right? There's a lot there, but it's a very good point to make. Sometimes that's really painful, sometimes not so
Spencer Levy
Well, to your point, once again, and having gone through the GFC, even the personal guarantee, the springing personal guarantee or what I used to call when I was practicing law many moons ago, the quote unquote bad boy guarantee is what we said. You do a bad idea of some sort.
Minta Kay
That’s the reference.
Spencer Levy
Is that still the term, Minta? I'm not sure.
James Shevlin
Oh, yeah.
Spencer Levy
Yeah.
Minta Kay
It is. It doesn't say bad person. It's still “bad boy” in quotes in all the docs. Go figure.
Spencer Levy
Is that right?
Minta Kay
Yeah.
James Shevlin
But you know, you need those triggers. You need those triggers in place that people have to be reminded that even though it's a non-recourse loan, do not divert funds, do not steal money, work with the lender. And a lot of times we see in these workouts the, you know, the borrowers try to do everything, not to work with the lenders. And of course, then as a result, we're going to have to battle to fight for the collateral.
Minta Kay
Spencer, maybe it's just because there can't be bad women.
Spencer Levy
Maybe, maybe. Well, you know what I'm going to say, I'm going to say something for the record here, even though I don't want any women, men or otherwise to go into foreclosure, get in trouble. The more women we have in the business, the better.
James Shevlin
But women do default on loans, too, Minta.
[laughter]
Spencer Levy
So on the topic of personal guarantees, even there – Minta, correct me if I'm wrong – the bankruptcy judges or other judges have some flexibility there. Say if it wasn't, if you had clean hands, right – I guess clean hands could mean a lot of things – if the pandemic took you down. Not because you were a bad operator, the judge might be more sympathetic. Would you agree with that, Minta?
Minta Kay
I would agree with that, and we've seen that play itself out. Although as I mentioned that flexibility and that sympathy is starting to fade a little bit as we wear under the ongoing impact of the pandemic. The business world and the real estate world just can't stop for such an extended period of time. So the constituencies who have a real role in deciding how it operates are moving much more quickly now.
Spencer Levy
Sure. Well, now as all of us have been in this business for a while, you know, I vaguely remember the RTC days in the early 1990s, as I'm sure you do as well. RTC stood for the Resolution Trust Corporation, was a government formed entity when we had the demise of the S&L savings and loan industry in the early 1990s due to some over lending and maybe a little bit self-dealing. The banks basically took the S&Ls, took the bank's assets back and then sold them for a song to many of the large real estate companies that exist today. And that changed materially over time, where people did their best not to take them back, not to sell them for a song. And I guess my question, I'll start with you, James. Are we a better place today or in the RTC, clear the books and move forward period.
James Shevlin
I was an employee of the RTC for four years and lived through it. All the chaos. Worked in the Inspector General's Office, dealing with some political issues. There was no structure in the loans back then. I think that was probably the one common theme. And today structure is much, much better. I think leverage is better. But there's still concerns out there. And we have to always remind ourselves as we go through things like a crisis – step back, you know, do we have triggers in place or just a loan made sense? Is the coverage adequate? Even today, we're sitting here today – and we talk about our hospitality; it's recovering everything. – I looked at our book and 49 percent of our hospitality assets have debt coverage today below one point out. So even though they're performing and someone's getting that check every month to meet the loan payment, there's going to be a time where at maturity or even further down the road, if we go through a, God forbid, another crisis that they could potentially default agai. Or how do they refinance out? If your coverage is that low, that means someone has to write a check to bring the leverage down and will that happen?
Spencer Levy
Well, one of the things for folks that are considering different forms of real estate hospitality, which is great form of real estate, is a operating business. And if you have no tenants coming in or occupants coming in, you’ve still got to put the money into the foreigners that some people have said. It eats every month. Unlike some other forms of real estate.
James Shevlin
That’s why it's so different. And I get a lot of questions about why hasn’t office defaulted yet? No one's in the office. Why aren't we seeing it? The big difference is it's a daily short term lease versus a longer term lease. And depending upon when that office lease matures, that's when you have to deal with the issue. We're really not seeing it in CBD office right now, the defaults in office. Will it happen at some point? Maybe. The bigger concern is probably more suburban office as there's a flight to quality now. That's the first thing we should look for to see how suburban office performs. But our office book, our delinquency rate on the performing deals right now is zero point three-three percent. There's virtually no –
Spencer Levy
Can I just emphasize that point I'm turning right to you Minta, right now, but I just want to double down on that point for a second: point three-three percent of one of the biggest special servicers in the business book on office is in default. That's how office has been resilient during the crisis, though I think we'll all agree that may come to an end. Minta, what’s your point of view?
Minta Kay
A couple of points here. One, I think we should watch that because I think we may see some changes. I think we may start to see more stress in that sector, not if they're going to go into outright delinquency so they hit your quote unquote book, but I think you're going to see more difficulty there. Certainly, there's a tremendous amount of subletting going on now. But that goes into my point earlier. I think we have a very mixed bag here. I don't think we have one playbook. So I think office – flight quality is happening, but I think suburban – I would take issue with you – is growing dramatically. We work with a lot of clients who are really developing different kinds of hub and spoke models, different kinds of sites, Main Street office sharing, that are really going to allow people who are working on a hybrid basis – some in some out of the office – to access professional working space. So I think office is TBD. We'll see. But I think this is going to be the year that that's very tested.
James Shevlin
Yeah, I agree with you, Minta, too. I mean, there'll be some downsizing. I think we're all looking at efficiencies right now. Corporately, everyone's looking at that. How much space you need? Law firms specifically. They probably don't need as much space as they take. And you know, can you sublease that space? It'll be very market driven, too. I'm very concerned about, like, Chicago, where you've got older buildings, very expensive to improve that space and very large block space that has to be subdivided Almost it doesn't make economic sense and some of those buildings.
Spencer Levy
Let me jump in there for a second because next week's show is on Chicago. I'm going to have to take exception with James and say that yes, Chicago has its issues. It's got a lot of office space, a lot of older space. But the beauty of Chicago – like L.A. with the Bunker Hill section, like different sections of New York – is that those cities are reinventing themselves, and the reinvention in Chicago may not necessarily be in The Loop. But there is a lot of capital going into the loop, as we had a guest on the show talking about one of her assets where she was putting $500 million into it. But the other place it's reinventing is the Fulton Market. The Fulton Market in Chicago is one of the most vibrant submarkets in the United States. And that's in Chicago, notwithstanding its issues. That's an opportunity.
James Shevlin
I think just look at population trends.
Spencer Levy
Well, that's where we can differ again, James, because I think when you look at population trends, you have to segment it. So we actually did a study on this last year, when we looked at population trends in New York and San Francisco. And you know, those trends showed? An outflow of people. And you say, Oh, that's the end of the world, right? Well, no, because, you know what? It showed an inflow of the most highly educated, highly talented and dare I say it, highly productive people. And you know who drives real estate demand? Those people.
James Shevlin
Spencer, I will tell you those people do not want to be in the office five days a week. Those people want to be in the office two or three days a week. So what do you do?
Spencer Levy
Well, let's talk about this. And Minta, I think it's fair to say that of all the industries we've seen, the law business has actually shrunk more from a footprint per average employee than other industries. And the reason I've given to that is No. 1 law firms are a little bit of a laggard behind other industries because of law libraries, because of copy rooms, but also because what we're dealing with today isn't a real estate crisis. We're seeing a shift in the labor versus management equation, where management had more power pre-COVID. Now labor is growing, and I think young lawyers understand that of you have any point of view on how you're changing Goodwin's space.
Minta Kay
Yeah, absolutely. First of all, say we pay all the rent in every location, even though we're seriously looking at the shifts that we need to handle. We are reshaping our space. We are creating different uses of space. We are looking at ways to facilitate sort of the hybrid way of working. And we're in early days. Some in-house meetings coupled with folks, you know, outhouse, if you will – or on Zoom or on some other LinkedIn connection – don't really work very well. Like you guys have all experienced that. I'm sure it's hard to make that all work. So we're investing a lot in technology that will enable us to have some people in the office, in a conference room, some people out. We expect hybrid to be the new norm. We're trying very hard to get people together again because we recognize the value in that. But we're looking at reshaping our spaces. We're looking at reshaping our technology and expect that to continue.
Spencer Levy
Well, Minta, I think that's a great segue into something that both you and James have great expertise in, which is prop tech. And I know you have a big practice there. And James, you've been investing a tremendous amount in that project. So maybe James, why don't you start with your prop tech and how it's helping CW Capital. And Minta, I’d love to learn more about your practice. James?
James Shevlin
Sure. So one of the things I was tasked to do when I got this see five years ago was How can we grow beyond being a special servicer? And, you know, two areas that really came to light were how we sell our assets, how we dispose of our assets. And we developed an online commercial real estate auction platform, really to sell deals on our own book. And four years later, and three plus billion dollars in sales, we've been very, very successful doing it. Really flipping into selling just our own book to selling for third party sellers. And it's been really exciting growth there and excited to see where it's going to go in the future. The second area is something called real insight. It's asset management software covers data management, role-based workflow and custom reporting. It's unique in that it has the flexibility to handle any commercial loan product and financing structure. We talked about it really handling the loan from cradle-to-grave. So we we take the loan in and it's originated variable to underwrite through this software. You can surveil through the software. You can special service through the software. And then you can dispose it. And it's been a really big game changer. And has taken off during COVID for some reason, as institutions are looking at their book and instead of people just providing reports, let's consolidate all together into a database. We're excited to see where that goes as well.
Spencer Levy
So that particular tool, it can red-flag an asset before it falls into default. Is that one of its functions?
James Shevlin
That's exactly right that you can watch trends in terms of payment and debt coverage. Occupancy trends anything that may be a trigger to suggest an asset may be in trouble – and do it fairly quickly versus having a few analysts having to crunch numbers. And this puts everything in a cloud based system right at your fingertips.
Spencer Levy
Well, I think that's a great tool because we have tools like that on the front end as well for AI. A lot of our clients underwrite assets trying to get to what to buy using similar programs. And certainly nothing is 100 percent, but nevertheless, we're seeing on both ends. So Minta, I’d love to turn to you now because prop tech’s a huge part of your practice. Let’s hear about it,
Minta Kay
So a lot of this conversation has been about debt and about debt default and managing debt. But I would like to bring everybody back to the fact that there is no one, whether they realize it or not, who's not impacted by the built, the hardscape in which they work and which they live, etc. Real estate is ubiquitous and it is everywhere. So whether you understand it or not, you're in it and it is impacting you. So the hard escape, I think, is something that has the opportunity to be fundamentally changed coming out of this crisis. I'm not just talking about better HVAC. I'm not talking about touchless this-and-that. I'm really talking about ways that we see coming up now through our practice to make more efficient, make more cost effective and make quicker changes to the built environment. It is creating new products to build, new ways to build, new ways to shape communities, new ways to expand, improve the lives of people whether they are in their personal life space or their professional life space, or somewhere in between. So I think that opportunity on the equity side to focus on adaptive reuse, I think is another space that's phenomenally important in the hardscape. There's some really interesting changes going on now. Some of the more mundane are office conversions to apartments. And that's happening across the country. Some of the more interesting are old antique mills and factories converting into community hubs with event space restaurants and all that other stuff. There are old retail spaces that are converting into medical facilities. There’s a lot of that going on, and I think it's very important during this time for the real estate community to be thinking about that and to be exploring opportunities to tie back to this topic. Lenders are open minded, equity investors are open minded around this stuff. I'm not saying they're jumping in, you know, in the deep end, but people are beginning to think about this much more seriously. And even the CMBS lenders are starting to learn how to underwrite some of these different kinds of uses and different kinds of revenue streams.
James Shevlin
Well, I would agree with you. I mean, I think adaptive reuse is definitely a strong trend. But I think sometimes it's like a little bit more talk than action right now. And that's really tied to volatile material costs and labor costs. And then there's also zoning. You know that who knows what you can do with this stuff, right? That's probably more your area, but a huge amount of money has been raised for the purpose of chasing these deals. I don't know if there's enough deals yet out there that we can say it's a trend.
Spencer Levy
I actually agree with both comments. We are seeing a lot of adaptive reuse, but it's really expensive. And so you don't see quite as much of it as you'd like to see, but you are seeing a changing landscape of the issues of why you would change your use. And the reason why most real estate investors want change the use is to make more money. But there's also –
James Shevlin
Or maybe because it doesn't work anymore, right? So you take your Class B office and you want to convert it to multi because there's stronger demand for that than Class B office. You can't compete with Class A office. There could be older hotels, which we see all the time. They convert those to multi or assisted living senior living. That is a big trend that we are seeing the full tear down and rebuild right now. It's expensive. You're not seeing much new construction.
Spencer Levy
OK, well, I'd like to get some final thoughts from both of you. I'll start with you, Minta, why don't we take out your crystal ball maybe three or four years from now, looking back, how do you see the real estate landscape evolving with a particular focus on how the workout environment is going to shake out?
Minta Kay
I think we're going to go through a period of workouts now. I think we'll come out of it. Four years down the road there may be another one triggered by something that I don't have in my crystal ball, but I think that the real estate industry is cyclical and it is very, very nimble and adaptive. I am very confident and I believe highly that innovation is going to drive a lot of how the hardscape is shaped and how the community invests and chooses to place its money going forward. I don't think we're any more old bricks and mortar and that's it. I think we've hit a tipping point and that's only going to accelerate over the next few years.
Spencer Levy
So, James, how do you see the workout environment shaking out? And how do you otherwise see the real estate space changing?
James Shevlin
You know, with our declining delinquencies the real estate market's going to be strong. It's resilient. I think technology will come into play in a more and more things will be developed and a more efficient and transparent industry will be as a result. So. It'll be good. I think loan structures will – with the crisis that we have now, I think people smarten up and make sure things will be strong. They won't be as liberal and throw things out there, given the world we're in today. But the one big area I think will see to explode will be data. We initiated a huge data project where we want to gather and structure and standardize all our unique and private data that we've collected through the years as part of our due diligence that we do on deals or underwriting our asset management or disposition services and share that with the world. So there'll be a huge explosion in that area.
Spencer Levy
Great. I will sum up our episode on financial workouts with optimism. Because what we heard from James was that point three-three percent of his book in office is in default, which is a surprisingly low number. The second thing that James said was that the real estate industry is going to be strong, and James is in the special servicing and servicing business. So that's, I think, another optimistic sign. And Minta of course, showed great optimism about how real estate continues to evolve through adaptive reuse and other things that are going to make us a strong industry in the years to come, even if it isn't the same asset mix. So on behalf of The Weekly Take, I want to thank Minta Kay, partner at Goodwin for joining us on today's show and sharing some just unbelievable insights.
Minta Kay
Spencer, thank you for having me.
Spencer Levy
And then I want to thank James Shevlin, the president and COO of CW Capital. Also great insights today. James, thank you.
James Shevlin
Thank you, Spencer. It's been great.
Spencer Levy
For more on our show visit CBRE.com/TheWeeklyTake. You can find out more about the topic we just discussed, as well as share the episode. We look forward to discussing more issues, sectors and markets, including, of course, an episode on Chicago coming up next week. In the meantime, don't forget to subscribe rate and review us wherever you listen. Thanks again for joining us. I'm Spencer Levy. Be smart. Be safe. Be well.
Guests
Minta Key
Partner, Goodwin
For almost three decades, Minta has represented institutional investors, tax-exempts, real estate funds and owner/operators in connection with all aspects of their real estate investment transactions. She co-chairs the firm’s Real Estate Industry group and is a leader in their Proptech initiative, which is focused on supporting the intersection of real estate and technology through thoughtful collaboration across the two practice areas.
James Shevlin
President & COO, CWCaptial
James is the President and COO of CWCapital, a commercial real estate finance and investment management company. The firm offers services to borrowers, investors, partners and clients through a number of vertically integrated companies managing every aspect of real estate finance.
Host
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Spencer Levy
Global Client Strategist & Senior Economic Advisor, CBRE
Spencer Levy is Global Client Strategist and Senior Economic Advisor for CBRE, the largest commercial real estate services firm in the world. In this role, he focuses on client engagement and public-facing activities, including thought leadership work performed in conjunction with CBRE Research. He also serves as Co-Chair of the Real Estate Roundtable’s Research Committee.