Anna Kelley  0:00  

And so when we hit the peak, because when money is cheap asset values go up, if you can borrow more cheaply, you can afford a bigger house and you know, a nicer lower payment, and you’re going to go buy and invest in more things that you’re going to try to generate a return. Well, that created this asset bubble. And when values started to come down a little bit, and these loans start to reset, it became evident that many people were going to walk away from their properties upside down and declare bankruptcy. And when that happened, essentially, all of the financial institutions booked asset values went down, their ratings declined. And they many of them, you know, as you know, went under so I think there’s a lot to learn from that. The mortgage world got tighter and better. So the loans issued since then have been much more stable, fixed loans, higher credit quality, so we’re better there. But the variable debt in the commercial real estate world and the commercial lending world, I think, is still a lesson that we haven’t learned, and it could cause some future pain as well.

Announcer  1:07  

Welcome to CRE PN Radio for influential commercial real estate professionals who work with investors, buyers and sellers of commercial real estate coast to coast whether you’re an investor, broker, lender, property manager, attorney or accountant we are here to learn from the experts.

J Darrin Gross  1:27  

Welcome to Commercial Real Estate Pro Networks, CRE PN Radio. Thanks for joining us. My name is J. Darrin Gross. This is a podcast focused on commercial real estate investment and risk management strategies. Weekly we have conversations with commercial real estate investors and professionals who provide their experience and insight to help you grow your real estate portfolio. 

Today’s program is sponsored by Building Insurance and Risk.  When you invest in real estate, it pays to work with a real estate investor protection specialist to protect yourself and your investment from catastrophic loss. The experts had Building Insurance and Risk focus on real estate investor protection. They provide you with multiple insurance coverage offers and a side by side coverage comparison. To learn more, go to BuildingInsuranceRisk.com. 

Today, my guest is Anna Kelley. Ana is a former top ranked financial relationship manager for Bank of America’s private bank. She also worked for AIG for 20 years in the corporate and affluent Markets Group focused on creating products for ultra high net worth individuals, banks and institutions. Anna has been investing in real estate since 1998, and has held active ownership of a rental portfolio valued at $300 million across Texas, Pennsylvania, Florida, Tennessee and Maryland. As a sponsor, Anna seeks strong multifamily investment opportunities to help her partners and investors meet their financial goals and grow wealth on a tax preferred basis. She brings her decades of experience with both traditional investments and real estate to help others overcome fears, increase knowledge, mitigate risk, and make wise investments in real estate. Anna is passionate about creating a meaningful impact in the lives of her residence and communities. And is also a sought after speaker real estate coach and a four times Amazon number one best selling author. And in just a minute, we’re gonna speak with Anna about real estate investing through market cycles. 

But first a quick reminder, if you like our show, CRE PN Radio, there are a couple of things you can do to help us out. You can like, share and subscribe. And as always, we encourage you to leave a comment, we’d love to hear from our listeners. Also, if you want to see how attractive our guests are, be sure to check out our YouTube channel. You can find us on YouTube at Commercial Real Estate Pro Network. And while you’re there, please subscribe. With that, I want to welcome my guest Anna Kelley, welcome to C R E PN Radio.

Anna Kelley  4:10  

Thank you so much Darrin, it’s so great to be here with you today.

J Darrin Gross  4:13  

I’m I’m delighted to have you and looking forward to our conversation. I gave kind of a little bit of your background there. But I’m curious if you could share any insight with listeners. Take a minute and share a little bit more insight with listeners.

Anna Kelley  4:30  

Sure, so one of the things that makes me a little different than maybe some people that you’ll hear on on commercial real estate is I really didn’t get started investing in real estate. I started my career out in the financial world in the institutional investing world. And I realized very quickly working with ultra high net worth investors that if you have a lot of money to begin with, it’s pretty easy to find investments to grow your wealth pretty rapidly. As long as we’re in an upward economic cycle, but if you really don’t start with wealth, it takes a very long time to grow wealth in the traditional investing arena, investing in your 401 K and stocks, bonds and mutual funds. And so I recognized that I didn’t want to have to wait until I was 65, to create a million dollar net worth and to live on $40,000 A year after that. And so I had a very wealthy client, who, when we mentioned back in the late 90s, that we could get him a CD at about 8%, he laughed at me and said, Honey, I make way more than that on my real estate investments. And I realized that in all my training in the financial world, and investment advisory classes, and all of that, I never learned anything about real estate. And so it piqued my interest to say, I might want to check into this and see if there’s a way for me to grow wealth more rapidly through real estate. And that put me on a path of interest in real estate. But it wasn’t really until 2009, the great recession, when I worked for AIG, lost the majority of my 401 K and was told every week, we were probably losing our jobs, that I realized that, that putting my entire financial future in the hands of the stock market, retail investments, or a corporate job really wasn’t wise over the long term. And that’s what got me to really escalate my level of real estate investing to create financial freedom. And it’s the best thing that I ever did.

J Darrin Gross  6:35  

Alright, I love it. Love the history there little backstory, and how you get started? You know, it’s funny, I just had coffee with a couple of investors, little Meetup group we do. And I’m based here in Portland, Oregon. And you mentioned that the, the, where you were in ’09, with AIG, and kind of the the sense of like, you know, are you going to be able to keep your job? I just learned this morning that Intel, the big chip manufacturer, has announced salary reductions for all of its workforce. And I think the front line is like 5%, management, maybe 10%. And if you’re vice president, it’s, you know, 20%. And I thought, wow, I mean, that’s, that’s not the head doesn’t necessarily jive with the, the inflation inflation, you know, you hear about wage increases is kind of the one of the things that that is, you know, hanging out there kind of thing. But yes. You know, on the flip side of that, I’m also talking with the guy who’s in sales, he said, sales are way down. So, you know, it does kind of offer an entree into kind of the the market cycle conversation I was hoping to have with you today. Absolutely. And I just kind of curious that, you know, if, if maybe the best place to start would be to maybe go back to kind of the oh nine, because that’s the most recent cratering of the market. What was what was in place at that time. And I think, you know, one of the one of the things that I’m a big believer in is that whatever the cause of it, was, has likely been tweaked. So that it won’t likely happen this time. But I think that people are looking for that, you know, like, oh, it’s gonna make everyone happy. But the reality is, is that, you know, where it comes from, isn’t always easy to identify. But the results are very similar. Right? And that, so maybe if we could go back and just kind of reset, you know, what was going on and in, you know, the capital markets, the job markets, and, you know, real estate back in the day, oh nine, and then kind of look, from there forward, and then see where we’re sitting right now, that sounds like a

Anna Kelley  9:08  

Absolutely? Yeah, absolutely. I’ll say this. You know, one thing having been in, you know, really the elite areas of Bank of America and AIG and when I say that, we had a lot of information on every type of investment available to us, and where, where can we find the best returns? And how can we mitigate risk with those returns? Right, I worked at AIG. So we were in the business of creating returns and mitigating risks together as much as we could primarily through private placement, life insurance, where investors, banks institutions could park their money in just about any investment they wanted to as a private placement and put that within a life insurance policy so their wealth could grow tax free within that plan, or if you’d invested directly in a stock or you know, private place meant outside of insurance most of the time that that that’s taxable. And so, having had such great training and these, you know, increasing roles where we were looking at more and more products, I have to say, looking back that I was naive to think that I knew as much as I knew, I kind of figured if you understand investments, well, the risks are generally the same over time. And you can make a pretty informed decision based upon looking at history and looking at the things that are going well. And when I was really blindsided by, you know, late 2008, early 2009, completely blindsided by the collapse of the financial system and the real estate markets, I realized that you can know a lot about your chosen investment, whether that’s you know, multifamily, or the stock market, gold and silver, you name it. But if you don’t understand the forces that are happening in the economy that impact asset values, the impact your cash on cash return and your income, that impact interest rates, you can be blindsided, again, by anything that can disrupt asset values, interest rates, cheap debt, et cetera. So my biggest lesson from 2009 Was that it’s not good enough to know your one or two or three chosen niches, well, you really need to become a student of the economy and watch the macro economics, watch the real estate and the economic cycles and say, Are we in an expanding cycle? Is that expanding cycle likely to continue? Or other signs of it cracking and heading back down toward a decline or a recession? And what are those signs? How do we know how to recognize when things might be shifting so that we can understand that there might be new risks that could impact our returns, or even wipe out our retirement plans like, like, it happened to me in 2009. So I really didn’t study the economy at a high level before I only really studied specific investments and historical returns. So that was my biggest lesson. And since then, I’ve become a student of the economy. So I’m watch macro economics like a hawk. And I understand I watch rates, I watch what’s happening in the currency wars between countries in trade wars between countries, because all of those things, impact currency values, and ultimately impact how the Fed reacts to changes in potential global issues. Where before 2008, we really were mostly focused on national economic health. And we were focused on real estate as a major asset that had been increasing for such a long time, that I think we got lazy in the financial system. And we just assumed that things were going to continue to get better, the economy was going to be different this time it was going to continue to expand. And a lot of the signs that there was unhealth in the mortgage industry, and an asset values and in the collateral that was used, you know, for financial assets and derivatives and things like that. They assumed that things were going well, and they ignored all the negative news. So when I look back on 2008, and nine and say, How could all of these really smart, large financial institutions with well paid, you know, actuaries that mitigate risk? And you know, financial engineers that understand all this? How can all of us be so blindsided and in hindsight, you know, appear to be stupid and not know what we were doing? And the reality is that there were signs There were articles written, you know, starting in 2006, saying, beware there’s problems in the mortgage market, there’s there’s rougher worse debt worse, underwritten loans than what we think they are. And there’s way too much collateralization of that debt backing many, many, many obligations and and loans, and that if the bubble pops, things could collapse. And it did. So, you know, I think we’ve learned from that in terms of the some of the problems with the mortgage market that brought down the system was that rate, loans were easy, they were easy to get, you didn’t have to have a great credit score, you didn’t even have to prove your income. They had no dock loans, and they were filled, the economy was filled with those types of loans and variable rate interest loans where, you know, adjustable rate mortgages would reset. And so when we hit the peak, because when money is cheap asset values go up. If you can borrow more cheaply, you can afford a bigger house and you know, a nicer lower payment and you’re going to go buy and invest in more things that you’re going to try to generate a return Arne well, that created this asset bubble. And when value started to come down a little bit, and these loans start to reset, it became evident that many people were going to walk away from their properties upside down and declare bankruptcy. And when that happened, essentially, all of the financial institutions booked asset values went down, their ratings declined. And they many of them, you know, as you know, went under. So I think there’s a lot to learn from that. The mortgage world got tighter and better. So the loans issued since then have been much more stable, fixed loans, higher credit quality, so we’re better there. But the variable debt in the commercial real estate world and the commercial lending world, I think, is still a lesson that we haven’t learned. And it could cause some future pain as well.

J Darrin Gross  15:53  

No, I appreciate you kind of going through that. Because, you know, that whole time with, you know, running up to, oh, 809, there were were, you know, the rates were so cheap and easy, or money was easy to get. And the fact that so many people have multiple properties or had very little skin in the game. You know, I think the the notion of, of Safe, safe loan or a safe investment from a lender perspective, lost sight of, you know, there’s no skin in the game, there’s no, you know, what’s the incentive to to make the payment? What’s the incentive to, you know, you know, keep the, you know, the home a roof over your head, right. And, you know, you know, the, the fact is, is that underwriting has tightened up significantly from then we just went through a huge wave of refinancing, where people have like locked in low interest rate, debt, fixed rate for for a long runway. But, you know, as you were saying that everything like Wayman, this is exactly what’s been playing out in the commercial here. The, you know, whether it be just in, in commercial real estate investors in general, or a whole, a, you know, crop of newer investors that found commercial real estate, that maybe just thought it was like, you know, like, oh, eight or, Oh, 607 in the residential, where you could decide to get a get a loan, you buy a fix that you sell, you buy a fix, you know, kind of that kind of thing, not to realize that or not, you know, having thought it through that, you know, what happens if, if I can’t sell it? What happens if the market changes? Right, How well am I prepared to weather the cycle? Right. And so, tell me a little bit I mean, your background and with your experience investing in a lot of the the oh, 809 crash? You mentioned it before here was the debt was not fixed, it was some sort of variable product with with less than capable buyers to absorb that change in the, the the loan. Right, you look, look at the commercial debt, and the way most commercial deals are, are structured. Do you see a parallel that’s playing out or that’s about to play out?

Anna Kelley  18:36  

Absolutely, I do. And, you know, because I lost so much in 2009, really, we had started a business at the height of the economy in 2007, with a significant amount of debt. And so, you know, when when everything collapsed, not only did I have to, you know, provide for our family, but part of my salary went to cover my husband’s staff expenses, because he had a new business, and then I lost most of my 401k. So I never wanted to live through that again. And so I’ve been very, very conservative as a commercial real estate investor, you know, since 2009, with the types of debt that I take on because really, most people can survive a recession or even a financial crisis that last 10 months to a year and a half, which is about how long most of them last, if they can continue to cover their debt. So your debt payment as a percentage of what your income is, through all sources, is really the thing that you’ve got to be very careful of, and if you don’t know what that debt payments is going to be into the future, when you’re at the cusp of the end of an expansion period in the economy and starting to head downward really is what I see the greatest risk to all investors regardless of what type of debt you have and what that particular asset is so specific to multifamily. Right before things started to get really crazy, I’d say before the pandemic, and even through the middle of the pandemic, most multifamily investors, which is all I invest in actively, I’m passively invested in lots of other commercial real estate. But my active investments are buying and syndicating and operating large apartment complexes, these value add deals where we buy them at a good basis, and then we increase the value, increase the rents and sell them for a profit. Typically, that process is about three years. And so the great thing before the recession is most syndicators, were using Fannie and Freddie backed mortgages. And so we got, you know, five to 10 year fixed rate loans. And those that did do bridge that they only did it when they bought properties that couldn’t pencil with Fannie and Freddie. So bridge debt, temporary debt, that’s variable rate really always has some risk. But in an expanding economy, where you think things are just going to keep expanding over the next three years, rates won’t go up significantly, we’ll be able to roll that new debt, if we have to refi or if someone buys the asset from us, they can get a low rate mortgage, then it keeps you pretty comfortable that your asset values are going to keep going up, because of the fact that the economy is going up. Well, the pandemic kind of was the first major shock that said, Wait a second, now we have all these tenants that don’t have to pay, at least the media’s telling them that the government’s not going to make them pay. And now you’ve got debt that you have to maintain, even with potentially a 3040 50% cut in income. So I thought during that crisis, while we are in in big trouble, and we got through it, and we got through it really well, because we had cash reserves. And because we had a fixed debt payment, we did not use bridge debt. So after the pandemic, I became more resolute in my decision not to do deals with any kind of variable rate or bridge debt loans, because I had experienced the pain of that during the pandemic. But what happens is we quickly forget, you know, we had this pandemic, we had a recession, the the government stimulated the economy, we had all this excess cash, and rates, you know, came down and everybody says cheap money. Surely, we’re out of it, we’re back up into expansion, we’re not going down. If we can get through this, we can get through anything. And so they they bought more property values continued to push up in commercial real estate because of the cheap debt. And essentially, most syndicators, were using bridge debt. Now, instead of the Fannie Freddie that meaning they had a year, maybe two with an extension to get the renovations done, to sell the property for a high value or to refi. And they estimated that their mortgage payments would be about the same and rates would be about the same when they had to exit. And that’s where the real risk is today. Because as you know, and all of our listeners, if you’ve been watching the news at all, you can see that we’ve had mass inflation that that many people didn’t expect. And that’s caused the Fed to raise rates at the most aggressive rate since I was a child in the 1970s. And so when you don’t think that things could get worse, you make decisions based upon the assumption that things get better. I didn’t do that. And I don’t do bridge debt, because of those lessons I learned in oh nine, because of the fear that we wouldn’t be able to pay on mortgages during the pandemic, I said, my kind of foundational, you know, debt paradigm is that, generally speaking, I don’t do bridge debt unless I have many ways to mitigate the potential for the asset value to fall cap rates to rise interest rates to rise and need to be able to afford a much higher mortgage payment.

J Darrin Gross  23:52  

Yeah, no, I, I, I like your, your thought process there on, you know, locking in the debt. And also, it just, it, it’s more about you being able to weather that whatever that cycle, whatever the future is, because, you know, as we’ve we’ve kind of alluded to, and kind of look back, things happen. And, you know, while it’s it’s popular to believe that it’s just everything’s gonna go up and up and up and up, there is a limit, even though a lot of people can’t see it. It’s kind of like on a roller coaster, you can’t see the the vertical or the drop until you’re right, all the way over the top there. Right. But that it sounds like that, that for you is kind of a rule of investing period is that lock in that debt and know that you can service the debt from now, till the till the end of the loan? There’s because I kind of,

Anna Kelley  24:52  

I’d say yes, but there’s always exceptions to every rule, but if you make an exception, it shouldn’t then And quickly become the rule because it worked out once or twice, right. So there are situations and I’ll use right now, for example, now we’re at the point where commercial real estate values haven’t come down significantly, yet rates have gone up significantly, and lenders have cut quite significantly the loan to value they’ll actually give you for that debt. And so it’s much more expensive to buy properties today. And so, if I were to lock in a rate for 10 years today, when I believe that rates won’t be this high for 10 years that wants, you know, the Fed has been successful, hopefully, in killing inflation. And we have a little bit of softening in the economy, the hope is that they go back and reverse rates, I’d say in the next year, I don’t count on it till 2024. But if I think rates are going to come back down, you know, even a point or two or three, I might not want to lock a rate for 10 years today with a prepayment penalty, that could be pretty stuff, this might be one of those only periods when I say, because of how high rates are today, if I think that history is gonna repeat itself, and the Feds gonna lower rates within a year or two, or we have a deep crisis or a deep recession, that will definitely necessitate them cutting cutting rates, I might go ahead and take the risk of a variable loan, because it might be actually less risky today than a fixed loan with a multimillion dollar prepayment penalty. So I’m not going to do that on all of my deals. But if I find something with a strong enough basis, Darren, and I can hold enough cash reserves that I can whether a rate going up even more, you know, after a year, and that I have enough upside in that property to really create massive income to offset potential cap rate changes or interest rate changes, then I might do a variable loan or two today. And if it’s a development, which I do, then most of your loans are variable. So you just have to find different ways to mitigate that interest rate cap insurance, things like that.

J Darrin Gross  27:03  

Right. And I’m just curious with the development, it seems like that’s almost it’s a, like an entirely different animal from like a value add, and a value add, you release, you know, whatever the income stream is. And I’m assuming that you’ve got a pretty good idea what the market can bear as far as additional rents in you’ve got a little bit fewer variables there. I mean, there’s still obviously a material supply chain kind of stuff that could happen and, and, you know, create a situation but development I mean, that that to me, is kind of the the original value add, starting from a piece of dirt to something that that you know, something that sell eventually or do you do you build whatever you’re developing to to keep buying all or you know, building hold, are you are you in your developments of is it more of a for for sale,

Anna Kelley  28:01  

it is really more for a sale. But the great thing about multifamily development. And again, this is very regional specific, so I only invest in markets that have extremely strong resilient economies, with lots of new companies moving in lots of jobs, the things that are going to keep an area resilient, and where there’s really minimal supply for the demand of the population growth. So when you’re in that type of market, and you know that there is a lack of housing, that there’s going to be an extra three 510 1000 people within two or three years, then you can feel pretty good about what you can get for rents, how full you’ll be able to be. And so you know, we’re we’re building those for the upside. On the positive front, you know, we do hold a lot of reserves, and we have to because again, those those loans are a bit variable, and we don’t have income coming in to service that debt. You know, which which makes it a little bit tougher. But on the positive side, we really don’t have a lot of expenses either other than the building. And so if we raise enough money and have enough money to develop the project between our capital stack our equity, private equity lenders, you know, different kinds of, of lending programs that might give us credits and things of that nature, then we can pretty well bank on what our exits going to be. Now, with that said, a typical development project, we’re developing large apartment buildings, you know, 500 to 1600 unit complexes, they’re going to take two to three years to complete and fill. And so our exit is similar to a syndication about you I deal with three years. But if the economy doesn’t give us what we want, and this is what everybody doesn’t know the answer to is where is our economy really going? So we can tell that it’s on a downward trend, we’re probably likely in a recession or very close to and will be in 2013. But if the recession goes longer than the average of 10 months, and if the recovery lasts longer than the average of 18 months for recovery, rates were right close to that three year mark. And so the beauty of development is, you know, if you have the right economic fundamentals locally where that asset is really needed to provide housing and affordable housing for people, then if we had to at that point, we would refinance and keep the property and go into a Fannie or Freddie fixed rate product. Rather than sell it if the economy didn’t give us what we thought we would have yet. And upside. We can hold that asset for a few more years, and then sell it at the optimal time during an expansion period of the market cycle.

J Darrin Gross  30:35  

Love the multiple exit strategies. That’s, that’s, that’s great. wants to touch her ask you about this. So that you mentioned kind of the normal duration of like the peak and the trough. I thought I heard you say 1018 months? It? Is there a time between the top and the bottom? That’s a normal cycle. I mean, that I was that seven, eight years was kind of the the, the timeline, but I don’t know that that’s necessarily the case.

Anna Kelley  31:10  

Yeah, it’s really interesting. So I’ve studied this pretty extensively, going back to all the data that’s been available since about the 1930s. Multifamily data has come a long way, since about the 80s. So some of the data prior isn’t, isn’t great. But what I can say is that in a recession, in general, on average, since they’ve been tracking since the 1920s, the average recession lasts 10 months. Now, not every recession is average, right? So 2008, clearly lasted a lot longer. And the recovery period was much longer, the average recovery period after a recession is 18 months beyond that, before you start getting back into an expansion or growth cycle. And then the average peak to trough is actually five and a half years. So from, you know, recession to recession average is five and a half years. But if you look back in the last period, since the global financial crisis, the Great Recession in 2009, we had about a 12 to 13 year exit expansion period, so much longer than the averages. But the reason for that was extremely loose monetary policy, significant monetary supply into the system to encourage borrowing to encourage investment to encourage stimulating that economy. And that that stimulus, the volume of money supply into the system, as well as the extremely low interest rates allowed us to continue to move up, up up up up, the consequence of that is the the massive amount of debt. I mean, we have a quadrillion dollar debt derivative market. So if there’s any risk that I’m a little nervous about in the next year or two, especially if the Fed does continue to raise rates is more that we have a derivatives or a credit crisis, you know, related to this debt that we’re talking about. And if that happens, and it happens, not only in the US, but globally, our recession could last much longer than 10 months. Again, it could be a deeper recession, and it could take a lot longer than 18 months to recover from. But if we don’t have a crisis, and the Fed is able to kind of engineer this miraculous soft landing, if you will, or recession may not be as deep or as long this time. And so what I’ve learned is averages help us kind of have an idea of what to look for, what direction are we heading, are we heading in a positive expansionary direction or a negative contractionary era. But then we have to look at what are all the other kind of pins that can pop the external factors that could make something much more quickly go into recession be much deeper and be much longer. And it’s infinitely more complex today than it was in 2009 2009 was infinitely more complex than I ever realized. Until then, because I didn’t understand that the entire financial system was so intertwined with credit default swaps, essentially insurance on the value of of all the other companies they were investing in. And now we’re substantially more complicated than we were there with with global trade. Globalism over this last decade has really expanded the supply chain issues, potential escalation of war with Russia and Ukraine. So those things, the health of our global alliances over overseas, all of those things can impact our economy and the health of our currency, our interest rates and ultimately our asset values in a way that we’ve never had to really think about before. And so I think there’s more risk and more things that could tip us into deeper and faster recessions in the near future than what we’ve experienced in the recent past.

J Darrin Gross  34:56  

Ya know, that that you know, Free Money has a price. And it’s not always recognizable at the front end. But, you know, in insurance, I mean, this is a, a, just the thing I’m dealing with with my clients. And that is just how reinsurance has been so affected by a lot of the global stuff and, and or the the, whatever global warming or whatever, however you want to phrase it, the insurance companies are a big believer in. But the, but what I’m seeing is like, they’re setting the price, which is increasing the price to the insurance companies, which increases the price to the retail buyers. But I’m seeing now that just yesterday, I had one where the buyer, we had had a claim a couple of years ago and had to raise, the price went way up. And last year, the deductible went way up. And this year, he took even a larger, you know, to x of a large deductible. So I went from my, you know, $25,000 deductible to a $50,000 deductible, and just his kind of ability to try and reconcile that. And I guess my question is, is, you know, when, when we go through this kind of adjustment phase is 1018 months, or however long it takes for buyers and sellers to recalibrate as to what is the market, you know, as prices keep going up. There’s not likely that prices are going to come back down. I mean, that’s kind of the hope. But I think that after a point, if everybody’s been paying the price, and that’s the cost of whatever it is you’re used to buying, it’s done all of a sudden, there’s not. There’s not like an endless supply and no demand, because the market is proved out there is demand and the price to support it. So, you know, I’m kind of curious, in your thoughts on that, as far as is that part of the trough? Is that? Or are we in kind of a new territory be based on the the increase the inflationary element? You know, because I think normally when we when we think about like the cycles, I don’t know how much inflation is built into the those cycles, whereas this inflation element, does it create a new element to to? You know, I guess, take stock in or to ponder? Sure.

Anna Kelley  37:26  

Yeah, it’s interesting, because typically, when you’re nearing a top at the peak, there generally starts to be either a slowing of GDP, or an increase in inflation, that kind of tips you over from peak to heading down into the trough. We haven’t seen inflation like this, really, in my lifetime. I was born in 1974. And as you know, Volcker was you know, aggressively trying to kill inflation through most of the 1970s. And so this time, and again, the complexity of our economy is so much different than what it was 40 plus years ago, that it’s really hard to to say, what’s the norm and what’s going to happen, we really haven’t had this particular type of thing that’s pushing us over the edge. I mean, some of it was clearly pandemic spending, pandemic stimulus, pandemic supply chain issues. And so when you look at inflation, there’s really four key components that the Fed looks at, and the National Bureau of Economic Research that dates recessions, they look at core goods, in a core Energy for Food and core services, and poor energy and core food went up significantly when Russia invaded Ukraine, because they’re a major exporter of energy, of fertilizer, and quite a few crops as well. And so you know, that is a piece of the inflation that over time, we’ve seen start to come down a little bit. So food was very inflated, it’s coming down a little bit. Energy prices were, you know, really massively impacted by the war between Russia and Ukraine as well. And so when you have elevated energy costs and and or elevated oil costs, that means that transporting everything is more expensive. And so goods and food are gonna go up just by nature of energy going up. But then you add the COVID, supply chain issues, and there were back logs of goods and supplies for a very long time. And when there’s a lack of supply and a huge demand that creates this massive inflation. So the good news for us is all three of those have come down quite substantially. The piece that stickier that I’m a little bit concerned with is the core services and that is things you know, that we use as day to day services, it’s eating out its restaurants, it’s doctor’s visits, it’s all kinds of things. And so essentially, those core services have a lack of skilled workers and lack of workers for the number of jobs available, which is really caused wages to go up. So wage inflation is primarily related to core services. And so that’s why the Fed is trying to now really create enough pressure and make the costs of doing business, the cost of servicing debt, the cost of borrowing higher, so that companies have no choice but to start lowering wages, and reducing, you know, demand for jobs. So they’re trying to do that to bring inflation down. And if they bring inflation down successfully, without going into a deep recession, this next cycle may not be nearly as long or as bad. The thing that I worry about a little bit, and this is again, where we really don’t have precedents is that if the war escalates, you know, Russia’s invasion of Ukraine, the US and Germany are now sending in tanks and, you know, Russia saying, this is an act of aggression, et cetera, if this gets worse than energy prices, and food prices could come back up again. And regardless of what the Fed does, what they can really control is employment and wages and the amount of our debt, but they can’t really control prices of energy and food. And so we could have an escalation of inflation again, which could keep us you know, with the Fed having to continue to keep rates up to control what they can and be in a longer period of some type of recessionary decline. And then the last thing I’ll say is that a lot of this code, both COVID, and the war with Russia and Ukraine, is causing countries to really relook at how and where they distribute really items of national security, food, semiconductors, energy. And so I think there’s this D globalization and shift to let’s bring things back on shore, that is going to have a cost to it, that could keep inflation higher for much longer than what we anticipate. And so you could have an environment, this is what I actually think we’re going to have. That’s not really in a clear place in the cycle. It’s not really a deep recession, because there’s still some growth and there’s still inflation, it’s not really a peak, like inflation. In a healthy economy. It’s more akin to stagflation, where you have this declining growth, a stagnating growth, at the same time that you have elevated inflation. And if that happens, it’s really tough for us as investors to gauge where is it going to go and for how long? How long is it going to be, you know, negative, but I tend to think that we really can’t look at history and say, based on this, this recession is going to last this long, we’ll be out of it, this quickly, rates will go back to this cap rates will be you know, here or there, because there’s so many factors that are converging at the same time to make today’s market much more inflationary. And ultimately, the only way the Fed can do that can kill it is to create stress and deflation and decelerating growth or recession for a longer period of time.

J Darrin Gross  43:05  

No, you clearly made the case for studying more than just the real estate market. I mean, there’s, there’s a lot to pay attention to a lot a lot of balls up in the air. And, you know, the hope is that they stay in the air, you know, and that there’s not a a somebody dropped the ball and, or crash kind of thing. And, and we keep this thing going. But

Anna Kelley  43:32  

I think the thing, you know, the other key takeaway is that since we don’t know where these things are going, you really should be looking at your investments for more of a longer term strategy, you know, the days of value add, sell it in a year and a half or two years, because the economy’s booming, those days are over for now, you know, you’ve got to be really a resilient and very strong operator. Because if you can’t control the things that impact interest rates, which do impact cap rates and values, you’ve got to get really good at increasing noi on your assets. And you’ve got to have great debt that you know, you can basically know where your debt payments are going to be, and the reserves and the wherewithal to hold properties longer. So that if we don’t bounce back in two years, like we you know, have in the past, that you are very resilient and that you can hold these assets and wait several more years to have that kind of growth that we saw before to really boost asset values. So you know, there has to be a little bit of a shift from value add as the norm to more value add with the longer hold period, generate cash flow while you’re holding it and have have much more stable assets with stable debt until we can kind of see when we’re close to being on the other side of of this pain.

J Darrin Gross  44:53  

No, no good. Good stuff there. Hey, Ana, if we could like to shift gears here for a second. By day, I’m an insurance broker. And as such, I work with my clients to assess risk and determine what to do with the risk. And there’s three strategies we typically consider, we first look to see if there’s a way we can avoid the risk. And that’s not an option, we look to see if there’s a way we can minimize the risk. And when we cannot avoid nor minimize, then we look to see if we could transfer. And that’s what an insurance policy is. And as such, I like to ask my guests if they can look at their own situation. Could be clients, investors, the economy and political? How are we you would frame your situation and and what you would consider to be the biggest risk? And again, for clarification, while I’m an insurance broker, I’m not necessarily looking for an insurance related answer. And so if you’re willing, I’d like to ask you Anna Kelley, what is the Biggest Risk?

Anna Kelley  46:00  

I think the biggest Risk right now is not knowing how high inflation might get for how long and how that might impact both the interest rates over the next decade and cap rates over the next decade. And so with that risk comes a few things that we really have to look at. One, as we talked about is what kind of debt are you putting on your properties? So the question is, when you when you’re trying to create value for a commercial asset, you’re really focused on noi, and you’re focused on on the cap rate. And so these things that that we can’t control are these factors that impact interest rate and cap rate? And so we have to look at what can we control? What risks can we control? Since we can’t transfer that risk? It’s going to be what it is, what can we do to mitigate some of that risk, one of the things is investing in really strong, resilient markets, right? If you’re investing in a class C property and a Class C town with not a whole lot of good jobs, industry, diversity and not population growth, you know, more demand than there is supply, you’re going to really struggle. So if you want to mitigate risk, you need to be in areas that still need way more product than what there is demand for towns that have lots and lots of jobs so that if some businesses or industries get really hit hard, they’re still resilient, and there’s elevated wages and affordable, affordable living in those areas. So the market in which you invest is critical. And then the other thing is, you need to be able to control your expenses, what other expenses can you cut, or make sure that they’re fixed for some period of time, so that they’re not an additional variable that could impact your noi, and bring your value down as a nature of that? And so, you know, an insurance answer is basically, where do you invest? So I’ll give an example. I’m from Texas, and I’m from from Houston, and Houston has had a significant flood risk over the last couple of years because of hurricanes in certain areas of the city. Now, it’s a 10,000 square mile major metro. So Houston is extremely large. And there’s pockets that do not have flooding, and that are much less risky. Well, I want to buy assets there, because if I buy in an area that has had some flooding, I wouldn’t be surprised if my insurance goes up another 30 or 40%, like it has over the last couple of years. So you’ve got to get really good at where are my expenses? And where can I invest and what assets are going to give me the best outcomes, given all of the uncertainty to increase my noi to bank on where I can increase my noi by increasing income and cutting expenses. While I can’t mitigate, you know, the interest rates and the cap rates that we ultimately have.

J Darrin Gross  48:56  

Yeah, now that that is very, very wise, of you to, you know, consider the flood zone of seeing the flood maps get redrawn multiple couple times here lately. And it’s usually a surprise to anybody that’s trying to refinance or are a

Anna Kelley  49:14  

huge difference in asset values, especially in commercial real estate. So it doesn’t impact single family as much. But if you’re looking at something commercial, and your expenses go up, you know, 10%, it’s it’s hard to make that up, you know, unless again, you’re in an area where you can kind of name the rents or you can continue to increase rents to keep up with the increase in expenses. And that’s where location of your investments is extremely critical.

J Darrin Gross  49:38  

Yeah, absolutely. Jana, where can listeners go if they’d like to learn more or connect with you?

Anna Kelley  49:45  

Great, so you can find me on social media at Anna Kelly Rei Mom on Facebook, LinkedIn and Instagram. And if you are an accredited investor looking for multifamily opportunities in this market, where we also make a meaningful impact on the lives of our communities. You can find me on my website there at GreaterPurposeCapital.com.

J Darrin Gross  50:03  

Awesome. Aana Kelly. I cannot say thanks enough for taking the time to talk today. I have enjoyed it immensely. I’ve learned a lot, and I look forward to doing it again soon.

Anna Kelley  50:16  

 Thank you so much for having me. 

J Darrin Gross  50:18  

All right. For our listeners. If you liked this episode, don’t forget to like, share and subscribe. Remember, the more you know, the more you grow? That’s all we’ve got this week. Until next time, thanks for listening to Commercial Real Estate Pro Networks. CRE PN Radio.

Announcer  50:38  

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