The views and opinions expressed in this article are those of Chief Financial Officer Derek Evans, and reflect his personal perspective as of the date of publication, informed by professional experience, ongoing market observations, and qualitative assessments developed over time. This commentary is not intended to be, and should not be construed as, investment advice, a forecast, or a prediction of future performance. The observations shared do not rely on or present specific statistical analyses. Actual market conditions, outcomes, and performance may differ materially. Past experience is not indicative of future results.  

Summary: 

Debt and equity are both critical components of commercial real estate investing, but the way they are balanced can significantly affect risk and potential returns. Realberry takes a conservative-to-moderate approach to leverage, evaluating debt levels, interest-rate exposure, asset type, investment strategy, and expected hold period on a deal-by-deal basis. The company also co-invests alongside its limited partners, typically contributing 5% to 10% of the equity, to align interests between Realberry and its investors. 

Q: Let’s start with the debt piece, which will naturally lead us back to equity. How does Realberry use debt in structuring commercial and multifamily real estate investments, be they acquisitions or new development?

Derek: At a very macro level, debt for real estate is a critical part of most sponsors’ capital stacks and how investments are capitalized. 

There definitely are some investments that pension funds may hold without leverage, for example, including core or core-plus assets that generally perform like bonds. But, broadly speaking, given the capital-intensive nature of real estate development and the size of acquisitions like the ones we make, debt is almost always a part of the capital stack. 

As you think about how sponsors including Realberry use debt, there are a couple different variables that drive decisions. The first is risk thresholds. There's a lot of different thinking around risk and the amount of leverage that groups are willing to take on. On the one hand, sponsors use leverage to boost returns, but it also goes the opposite way too. More leverage means more borrowing cost, which can lower returns if things don’t go as planned. Then, there are product-type considerations — whether it’s an office, retail, industrial, hospitality or multifamily property — and then whether it's an acquisition or new development. There are considerations around each of these factors. 

Q: Please elaborate on that approach, and how it works in practice.

Derek: On all of our transactions, whether it's an acquisition or new development, we always start by looking at what the unlevered returns would be; that is, the investment returns without any debt. Then we assess what the levered returns would be at various debt levels including with the associated borrowing costs. 

From an overall philosophical standpoint, I would say two things. First, we look at leverage holistically across our entire portfolio and balance sheet and have a philosophy there. Second, we have a philosophy at an individual product level and as an acquisition versus new development. Speaking with broad strokes, I would categorize our leverage philosophy as being conservative to moderate in our use of debt. We are not users of high leverage. That’s not to say there couldn't be a unique transaction or circumstance where we look at taking mezzanine debt or preferred equity, but generally we try to be fairly conservative in our use of leverage. A lot depends on the strategy around a particular asset including how long we plan to hold the asset. 

I won’t go too far down the rabbit hole except to say that we’d be inclined to have a different point of view on a triple-net-lease investment with an investment grade single tenant versus an office building with multiple non-credit tenants, as one example. The office building in that comparison is the higher risk, so the inclination would be to have less leverage. Conversely, the triple-net-lease investment is the lower risk, so more leverage may be justifiable. 

I think of conservative leverage as about 50% to 55% of the asset value, and moderate leverage as more like 60% to 65%, with the range in between. If you were to ask people across the industry, that would probably be pretty consistent with the way others think about the levels of leverage relative to equity.

Q: Talk about loan terms. Does Realberry generally have a preference for fixed-rate debt versus floating-rate debt, or shorter-term versus longer-term debt?

Derek: Big picture, our philosophy as a firm is generally to have more fixed-rate debt than floating-rate debt, because real estate is cyclical, the performance of assets can change, and interest-rate volatility is a very identifiable risk to real estate. Quite frankly, as you know, we have seen that over the last four years, beginning in 2022.  

Previously, there was a 15-year period where everyone in our business got used to lower interest rates. Then in 2022, rates started to spike. I would say most people in real estate investment were not immune from that. So, our overall, general philosophy is to be 75%/25% fixed-rate versus variable, or even 80%/20%. 

Now, when you drill down and look at the different types of activities and investments we make, some essentially require floating-rate debt because the results and the timeframe in which they can be realized are either short or somewhat unknown. That basically describes new development. It’s typical to carry floating rate debt on new development for either construction or on a bridge basis until the point at which a property has stabilized and you're able to either put longer-term mortgage debt on it or some sort of hedging in place to synthetically fix the rate. So there's always going to be a portion of our portfolio that is subject to interest rate risk by virtue of the nature of the debt. 

With regard to acquisitions — when we look to buy, renovate, and then stabilize and sell an acquired asset — the length of the debt term would depend on where we think the market is from a rate perspective. I would say right now given where rates are, we're probably more willing to take variable-rate risk because we see the likelihood of rates coming down over the next two to three years versus going up as being more likely. 

If our current view of rates were different, we might say, “Okay, we're going to hedge all or part of that value-add property loan with a fixed rate to carry through to when we're going to sell it.”  

That’s a long way of saying there are a lot of different variables that come into play, but thinking big picture, we're highly aware of interest-rate volatility and length of term, and our preference is to be fixed or be synthetically fixed via hedging to mitigate any negative impacts. It’s the management team that makes the difference and calls the shots relative to risk management. We're thinking about this stuff all the time. 

Q: It sounds like, then, that Realberry is not particularly sensitive to interest-rate risk. In other words, that’s not something that keeps you up at night. Is that a fair characterization?

Derek: I think that's fair. Certainly on a portfolio-wide basis, we're less sensitive to interest-rate volatility, but some assets are more sensitive for different reasons, active development deals as an example. 

Q: Realberry owns a considerable amount of developable land. Is land typically something the firm encumbers with debt?

Derek: Generally speaking, when we have land that's held for future development that one day we could be looking to raise to capital for — whether from institutional investors or high-net-worth investors — we would hold that land unencumbered. 

That said, as we actively develop land as part of our master-planned communities, we do selectively use leverage, but at a low level. We do that primarily because we’re in the horizontal land development business. But if it's a parcel that we're ultimately going to go vertical on, we would hold that land unencumbered until we’re ready to capitalize the development of the property, and then the terms would be very specific to the planned development. 

Q: Talk about Realberry’s historical track record as a borrower, paying off loans, and our relationships with banks.

Derek: As you know, Realberry is a 35-year-old company. So we've been doing real estate development and acquisitions for a long time. I'm a former lender by background. I spent 22 years at Wells Fargo prior to joining Realberry as CFO. In fact, I was Realberry’s primary lender from 2003 until 2011 while at Wells Fargo. So I feel like I have a pretty good history of the company.  

We have a deep bench of lenders. I would say if you were to interview those banks, they would consider us probably one of their top-tier borrowers. Because of that, our relationships run deep. I would say we have — I don't want to call it pricing power — but from a relationship perspective, we have lenders very willing to work with us and provide favorable terms, and sometimes do things out of the box. 

Our partners reflect a mix of large national banks, investment banks, super-regional players and local lenders. That corresponds to the range of deals that we do. We may at the same time undertake a $300-million construction project and a $50-million acquisition. Those investments lead us to different types of lenders who can do different types and sizes of transactions. 

We also invest in many different product types. As an example, about half of our portfolio is hospitality. Not all lenders like hospitality. We do some business with debt funds, many of which are new to the market since the Great Financial Crisis and step in where traditional lenders are less interested. We also have deep life-insurance company relationships. And then we have relationships with Freddie Mac and Fannie Mae, and use our desk lenders at the banks to help outsource their products for us. It's a very deep bench of lenders we have relationships with. 

Q: Shifting gears directly to equity, talk about the company’s history as an equity investor, and why we’re seeking capital now from an expanded platform of additional investors.

Derek: It’s funny. Just to put a bow on the debt piece: there’s no shortage of debt capital. For a company like Realberry or a firm similar to ours, there’s a menu of options. Debt is the easy part of the equation. But as I said, we aim to be conservative to moderate in our use of debt.  

The harder part of the equation is equity. We’ve had a broad network of equity investors historically, but instead of making $300 million of acquisitions and development investments in a year, we’re targeting a multiple of that — in other words, Realberry is scaling up. 

Our need for equity capital has grown just like our need for debt capital. So we’re expanding what we’ve been doing for 35 years now with a new digital platform intended to broaden our reach and provide opportunities for more people to invest alongside us. 

Expanding our platform is one of the natural ways that we can expand our sources of equity capital. 

Q: Realberry invests equity alongside investors, be they institutional, family offices, or high-net-worth individuals. Please elaborate on how that works, and why it’s important.

Derek: Realberry’s co-investment as a sponsor is meaningful. As the general partner, our share is usually 5% to 10%, depending on the property. 

As you know, we’re a large master-planned community developer in Colorado. We have investments, in particular ground-up new developments, that are rising on land that we have owned for a long time. There are certain situations where on top of that 5% to 10%, rather than selling the land into a new venture, we would contribute the land into the venture. So our co-investment could be greater than 10% all-in. 

We assume risk alongside investors because we believe in the potential of the investments themselves or we wouldn’t be sponsoring them in the first place, and to align the company’s risk profile with our LPs (limited partners). From a general partner perspective, we don't make money unless our investors make money. So co-investing with LPs represents an alignment of interests. 

Q: Is there anything else investors should know regarding how Realberry capitalizes investments?

Derek: Investors should know that we are very prudent with the use of leverage, and we're very focused on what the right leverage level is for each investment. Generally, we take a conservative view of leverage, which creates the appropriate risk balance to generate the level of returns that we think investors should achieve relative to the type of investment and the level of leverage. Said more simply, the goal is to set and achieve attractive risk-adjusted returns for investors and the company.