Lessons Learned from the Most Recent Downturns | Durable Value Ep 85
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Ryan Swehla: So today we're gonna talk a little bit about the real estate downturn that we have just experienced, and hopefully are at the bottom of. Uh, and just for a little bit of context, we saw the largest rate hike in, um, Fed history, and that rate hike in- resulted in an immediate decline in real estate values because real estate is a levered asset, uses loans, and because cap rates, uh, fluctuate with interest rates.
And so as cap rates go up, values go down. So over the last, call it three years, we've seen about a 15 to, uh, 20% decline in real estate values, which equates to about a 30 to 40% decline in the equity value in real estate. Mm-hmm. The largest decline we've had since the Great Recession. So we're fra- just framing our conversation here today, uh, we've gone through a pretty significant market decline, and, uh, what are some of the key lessons that we've learned from that?
Joe Muratore: Yeah. There's a bunch, and it's mixed. We'll talk about it a little bit later, but it's, this is almost like a series of 100-year events. And, um, it's caused a, a s- a bunch of distortions, um, that are different from the GFC. But I'll, I'll start by one that's similar in that downturns take longer than you think.
Yeah. Like, like the real estate, real estate cycles are a thing, uh, five to eight years. Uh, during the la- during the GFC, the downturn was from about 2007 to about 2011, four to six years. In our case it was, uh, it feels a little compressed in that it, it seems like this started about mid-2022. Today we sit near the end of 2025.
Ryan Swehla: Yep.
Joe Muratore: Um, it seems like i- we, we mostly invest in apartments and multi-tenant industrial, and it feels on the apartment side that we've, uh, bottomed and recovered and, uh, began, uh ... Maybe we're 10% off the bottom in, uh, the markets we serve. And frankly, this is, I think, common throughout the US. And on the industrial side, things still seem to be settling out.
Maybe we are 10% the other way. We're not on the recovery part, we're, we're just before. What's interesting is, uh- Well, that, that cycles take longer than you think. And while you need to plan for those, uh, as we'll talk about, pencils down isn't always the approach. Uncertainty creates opportunity.
Ryan Swehla: Yeah, it's interesting because, um, as y- many people say, if you could predict market cycles, you'd be a billionaire or a trillionaire.
Uh, because, um, being right but being wrong on time is as bad as being wrong.
Joe Muratore: Mm-hmm.
Ryan Swehla: You know, you can... If, if we attempt to time the market, uh, we end up with lost opportunities on the one hand, and we end up with, uh, you know, opportunities we wish we hadn't purchased on the other hand. So there is some wisdom to that kind of almost dollar cost averaging, uh, where, you know, during market cycles, we are aware of the market cycles, we are factoring in the market cycles, and we're using that to make the best decisions in any moment in time.
Joe Muratore: An interesting, uh, piece of that, though, is that this market cycle acknowledged its distortion in some way. Uh, this was a sort of an artificial cycle. It was a, a COVID-driven, uh... Money went in, uh, and now we gotta recover from it. When you look at the real estate charts from 2011 to today, you often see, um, you know, an inflation level up and to the right kind of growth in value in line with, with rents.
But when you look at the, uh, charts in COVID, values flooded up, and then interest rates flooded up, uh, as well, and then values went down to match interest rates, but it wasn't a one-for-one. Uh, interest rates went from three and a half to six and a half, sometimes seven and a half percent. Um, and yet cap rates moved, you know, 1%, one and a half percent, which is still, you know, a 15 per- to 20% value decline.
But there's this, um, secular trend, or there's this, uh, y- yeah, secular in that it's unattached, which is that America's chronically undersupplied for apartments. Uh, there are, uh, millions more apartments needed than exist, and so there's a, there's a durable demand line that is there and continuing to grow.
Uh, also on the industrial side, uh, distribution and e-commerce, uh, continue to be major trends driving need for that. So unlike the GFC where it was kind of like Uh, values collapsed and buildings were vacant and businesses were falling apart, the need for these two asset classes was still high. So you had the mix of demand was, was still a thing-
Ryan Swehla: Yeah
Joe Muratore: but risk adju- adjusted returns, uh, reacted in a muted way, uh, because of the, I guess, the durability of the asset types, um, even, even with interest rates being higher. It, it's a mixed bag is the point.
Ryan Swehla: You know, one of the other things that we saw during the downturn is really a preference toward cash flow, which is not surprising.
This is typical during downturns in that as we're going through the upcycle, we are more and more willing to bank on the future-
Joe Muratore: Mm-hmm ...
Ryan Swehla: and less and less need to have return now because we get to this kind of exuberant stage. And so then we're much more focused on, well, if I add value, I can create this value.
If I add value, I can create this, and if I don't have as much near-term cash flow, that's okay. As we've seen through this downturn, our, uh, the- collectively, the market's preference for current cash flow has increased significantly. Not to diminish the value add because we are still seeing today, uh, you know, value add returns that are very strong, stronger than they were three years ago, but on top of that, you have this, um, cash flow component that has, that really it adds safety to the return that you didn't have when you were in this more exuberant phase.
Joe Muratore: I think it was a r- you know, uh, firms are a collection of their people. They're a collection of their lessons learned, both from the people and as a firm. I think this was a real chance for our firm to mature or l- learn a new series of lessons that will endure with us. But, you know, as you said, prior to, um, 2022, you know, cap rates didn't, uh, value.
Cap rates were very low. I mean, things were trading in the fours and es- especially on the, uh, value add side, maybe high fours, but you weren't buying stabilized properties. You were buying, you know, an opportunity set, and the seller was participating in some of that value, and the market allowed for that.
You know, the lesson learned in this is that cash flow endures and that, well, you know, it's that, uh, Warren Buffett idea of when the tide goes out, you see who's wearing shorts. But, uh, the point is, you know, value add is amazing, but it's also very cyclical, and cash flow is an You know, I, I, I strongly believe that, um, it will be much more, cashflow will be much more value in this firm for the long term, even as we go through the next, uh, next cycles.
Ryan Swehla: Yeah, and cashflow brings safety.
Joe Muratore: Mm-hmm.
Ryan Swehla: I'd say one of the other lessons learned, um, fortunately not as hard of a lesson for our firm, but one of the other lessons learned is the value of fixed-rate debt. N- none of us expected the magnitude and swiftness of the interest rate hike. And so even we as a firm are, are dealing with the fact that w- as assets refinance, the interest costs are significantly higher than they were-
Joe Muratore: Yeah
Ryan Swehla: you know, prior. But then obviously the firms that, uh, used more variable rate debt, they saw that almost immediately. They were
Joe Muratore: blasted.
Ryan Swehla: We're, we at least are sheltered in the sense that, you know, the duration of the loan allows for a little bit more of the market to settle out To be able to accommodate that higher interest rate.
Joe Muratore: Mm-hmm.
Ryan Swehla: But certainly, um, debt and debt structure becomes amplified when you're in an environment where interest rates are elevated.
Joe Muratore: One new phrase that came out of this, uh, downturn was that, you know, I don't hear it anymore, I haven't heard it in about a year, but pencils down. Everything was pen- I kept hearing pencils down.
And first I'm like, "Who writes with pencil?" I mean, I don't know. But I- pencils down. Everybody was pencils down for, for a couple years. And, um, two parts. Uh, number one, i- it speaks to the herd mentality, and how in uncertainty, um, you know, there's, there's some famous sentiment about letting things settle out, and then letting things start again, which is about where we're at now.
But I look at the Elk Grove deal, I look at the Los deal, I look at, uh, Tilly Lewis deal. I mean, frankly, all, you know, we're, we're sitting out on fund four, but I look at the eight deals in fund four right now, all bought during pencils down, and think, "Thank goodness we bought during pencils down." Yeah. I mean, uh, pencils down also means uncertainty.
In the markets we serve, we were liquidity at a time when some needed liquidity. And, and w- frankly, i- i- now is a magic moment. End of 2025, we both have clarity, we have a sense that in 2026, the, you know, the market's gonna- going to firm up. I listen to other firms' podcasts, some large firms. I hear sentiment echoing this, and I'm thinking like, "We- let's keep buying while we're in this, uh, this trough, while there's a lack of liquidity and, uh, we're able to execute because, um, i- increased activity is coming."
Ryan Swehla: Well, and I think that goes back to the idea of instead of we're on, we're off, it's much more around the idea of a lever. When we perceive that, you know, borrowing from Howard Marks, when we perceive that the probability of further downward is low, that's the time that we should be more active buyers.
When we perceive that the probability of downside is high, uh, as we get higher in the market, that's when we should be less active. But there are opportunities all along there. And, uh, I would say even some of the assets that, you know, in hindsight we say, "Man, we shouldn't have bought that asset at that time of the market"- Um, we still bought well relative to that market.
The challenge that we're working through is that that asset now has to go through this decline, and then we have to get back up to, you know, a better market cycle. But, um, I think the key is to be buying the right assets and at varying velocities depending on where the market is in its cycle.
Joe Muratore: If I were to generalize, it would be do the opposite.
In 2022 when everyone was chaotically buying, bought at a discount, we followed our process, but those prices have come down and are going through a trough and a recovery. But during the pencils downtime, we got smoking deals. And, um, almost always the answer is don't do what everyone else is doing in investing 'cause almost always that's, you know, that's, that's beta.
Alpha lives in uncertainty. Silence equals alpha. So I mean, there, there's a very powerful lesson there about if you feel a little nervous, you know, break that down and ask why. And if you feel a little safe, break that down and ask why.
Ryan Swehla: What are some other lessons that we've l- learned during this, uh, downturn?
Joe Muratore: Uh, the ability of, uh... What's, what's that old saying? Uh, never underestimate how long the, uh, market can outlast your good idea. Mm-hmm. Well, the, the point is in a downturn when you think things are difficult, expect a pile on. There, when, when bad things pile on, they do. I suppose the, the reverse is true also.
But in a, in a negative situation you have, uh, debt cost spiking. Guess what? Then insurance.
Ryan Swehla: Mm-hmm.
Joe Muratore: Then labor, then materials. Mm-hmm. Uh, then you have this wall of maturities. I mean, it's like, uh, w- y- you know, c- in capitalism or, or in w- in market forces where there is a opportunity for anything, it w- it will move.
Ryan Swehla: Yeah.
Joe Muratore: And add in now, uh, potential stagflation or recession or- Yeah ... a sustained, um, you know, a, market rates higher for longer. It, it, it feels like the tide is turning, but never underestimate the, the ability of all market forces to converge right at once.
Ryan Swehla: Yes.
Joe Muratore: Because they will. But any thoughts on that?
Ryan Swehla: It, uh, reminds me of thinking about how assets, individual investments respond to those market forces because, um, I think we've also developed a sentiment over time where we don't wanna be owning assets that- It ca- can be more, the, the magnitude of the problem can be amplified.
And one thing I'm thinking of is, you know, the move away from single-tenant assets, large, uh, anchor tenant assets because those are the, those are the assets that can be most impacted by, uh, changes in, in tenancy. Whereas the as- the, the assets that have broad diversification, um, they have a general ability to maintain cash flow, to maintain occupancy better than where we need to have that anchor tenant.
Joe Muratore: That might have been the biggest lesson learned, to restate what you said in my own eyes. Um, it was avoiding, it, it is avoiding binary outcomes and creating optionality. It's not cash flow or value add. It's cash flow and value add. It's not, uh, you know, y- your debt needs to have, uh, if, if you have cash flow, you have debt optionality.
The point is, uh, be in a location where you have multiple groups that could take you out, the private owner, the syndicator, the institutional. But in everything we do, seek to have optionality and, you know, then you have, you have time optionality, you have capital optionality. Uh, then you can scale. There's, there, th- there's no crises when you have options
In this episode, we break down the recent real estate downturn, what caused it, and the key lessons for investors. We cover interest rate impacts, the importance of cash flow, fixed-rate debt, and how to find opportunity in uncertain times. Whether you’re an experienced investor or just curious about real estate, you’ll find actionable insights here.
Timestamps:
00:00 – Introduction & Market Overview
02:00 – Lessons from the Downturn
05:00 – Cash Flow, Value Add, and Investment Strategy
08:00 – Debt, Risk, and “Pencils Down”
11:00 – Building Resilience & Optionality