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Posted Mar 2, 2023

An Interview with Jason Kern, President of Investment Management at Cortland

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In this conversation, Managing Director Brandon Sedloff sat down with Jason Kern, President of Investment Management at Cortland, to discuss how the current macroeconomic environment compares to The Great Recession, dealmaking in 2023, and the longevity of multifamily properties.

Here is a portion of that conversation, edited for clarity. Watch an on-demand recording of the entire back-and-forth here.

Brandon Sedloff: What’s your take on the current market environment?

Jason Kern: As you have seen, there has been a freezing of deal activity in all property types. In 2021, we did $350 billion worth of multifamily transactions as an industry, which would have been a large number for all property types combined back in the day. At Cortland, we did 70 new apartment building acquisitions in 18 months, from 2021 to the first half of ’22. We invested $7 billion in apartments during that time, and then we've done nothing since, just to give you a sense of how dramatic a change we’ve seen.

Someone like Cortland is in an enviable position in the sense that we still have access to debt and borrowing from some of the big banks who certainly value us as one of the more active borrowers and big institutions that they deal with. I fear that some of the smaller players in our business may not be getting their calls returned quite as rapidly as we are, given these large banks dealing with their own capital constraints that are either being forced upon them, or them being conservative and waiting for the next shoe to drop, so to speak. But it is making development numbers hard to pencil out, and it's making acquisitions hard.

Brandon Sedloff: How will that evolve over the next six months? Are you waiting for some sort of market correction?

Jason Kern: You've got that classic scenario where buyers smell blood in the water, looking to get some distressed deals at discounted prices. But at the same time, well-capitalized owners and sellers don't want to take a mark down where they're holding their assets on the balance sheet. And if they're not pressured into selling–either because of liquidity issues with the fund, because they're getting to the end of a debt financing, or caps are expiring–you're going to have fewer sellers willing to sell into a distorted market.

It’s a matter of discovery. As we go into the first half, and especially the second half of 2023, I think it will be pretty slow as things work their way out. But those of us who are more optimistic expect a clear end to the interest rate rising policy moves by the end of the first half of this year. Even if people think interest rates will stay the same, much less get cut, that can bring more certainty into the equation and get people making decisions and doing deals again.

As I said, more motivated sellers will largely be motivated by debt that is maturing that they can't or don't want to refinance. There are so many small partnerships in this business where the equity partners would have to cut an equity check to pay down a loan with new debt service coverage ratios with higher interest rates, and they're not going to want to do that or not be able to do that. These interest rate caps are incredibly expensive now, and replacing those can be prohibitively expensive. And so, as time goes by, you'll see more and more of those pressures building up and more and more assets coming out to market.

That's all you need in a market like this–a little capitulation from sellers. And remember, if they've owned the asset for more than a couple of years, their rents have increased dramatically, even with the recent deceleration in rental growth in multifamily. I don't think many people will be taking a huge hit to their equity or walking away from equity. They can exit at a discount but still get out with a return that won't be the end of the world. There's a lot of liquidity in multifamily, and we'll see some better numbers coming through, especially in the second half of this year.

Brandon Sedloff: How does this current macroeconomic environment compare to what we experienced during the global financial crisis (GFC) based on where you sit today?

Jason Kern: It's surprisingly painful to me in terms of just investor sentiment. One of our investors proposed to me that the investor sentiment right now is more negative than it was during the height of the GFC, which makes no practical sense to me. We don't have anywhere close to the structural issues that we had, none of those existential threats Yes, we’ve got inflation, which I know hits investors and consumers directly in their pocketbooks. But at the same time, there are worse things than inflation–like the cratering of the whole global financial system when Lehman and Bear Stearns and others went bankrupt.

Inflation does raise the cost of materials and labor. It could hurt our residents in terms of their ability to pay rent, but many of our residents are experiencing their own wage inflation and are keeping up. Our portfolio is affordable in the grand scheme of things. We like to be in these Sunbelt markets that, by their nature, fundamentally have a cost of living advantage over the big gateway markets, even for Class A properties.

The big concern in a recession or stagflation scenario would be job losses. And clearly, losing your job is not good for multifamily. But we've seen that movie before, and there is a flight to quality during those times.

Want to get the rest of the conversation? Watch a recording on demand now.

Watch now.