Dave:
What’s up, everyone? Welcome to On the Market. I’m Dave Meyer, joined today by James Dainard. James, what’s going on, man?

James:
Just up in Seattle. I got snow on the ground a little bit. It’s chilly.

Dave:
Seriously?

James:
I’m missing my palm trees in California.

Dave:
Doesn’t it never snow there?

James:
Yeah, we get that wet, cold snow that’s just everything’s slushy. It’s like a snow cone, basically. We got a snow cone streets.

Dave:
That sounds miserable. Yeah. Well, hopefully, James and I and the rest of On the Market team are going to be in Denver next week, hanging out, so hopefully we’ll get some better weather there. Usually it’s nice in Denver. Even in the winter, it’s at least sunny.

James:
Oh, yeah. I like Denver. The few times I went, I love that city. You got sun and cold. That works. Just the wet cold’s no good for me.

Dave:
Absolutely. Yeah. It’s going to be nice. We’re going to be doing a meetup with Bigger Pockets. By the time this comes out, it’ll probably be too late to actually attend that meetup, but Bigger Pockets is doing a bunch more meetups this year, so definitely check that out. We post them on Instagram and on the website. I know there’s one in Salt Lake City coming up in March, so if you are in that area, or want to join a Bigger Pockets meetup, you can definitely do that. Today, for this episode, James and I have the third part interview with Ben Miller, who is the CEO of Fundrise. We have him back. You might remember, right around the new year, we did a show with him called The Great Deleveraging, which is fascinating, just talking about liquidity issues in the banking system. We also had a great conversation with him about build-to-rent. This episode, honestly, went a direction I did not expect. We usually plan out the questions we’re going to ask, and this just totally went in a different direction, but I thought it was a fascinating conversation.

James:
Oh, it was really fascinating. It gets a little bit complex, but at the same time, it’s that core same principles of evaluating, predicting, making sure you’re not sitting on the sidelines, and spreading things out. As long as you predict and you underwrite correctly, you can invest in any market, is really still what it comes down to.

Dave:
Yeah. Yeah, it was really cool. So basically, we tried to ask Ben what he thought was going to happen with the economy. And he basically said, “That’s a bad way to think about it. You should be planning for different scenarios and basing your decisions on the different scenarios that can happen.” And so he sort of walks us through how he thinks about scenario planning and how you can make real estate decisions based on these scenarios. And as James said, just as a warning, he does talk about some investing options that are complicated. I honestly didn’t know all of the stuff he was talking about.

James:
Neither did I.

Dave:
Yeah. So just if you get a little confused by some of the terms he uses right at the end, it’s just for like three minutes. We were a little bit too. But the rest of the episode is just fascinating. I just love the idea of thinking probabilistically, planning different scenarios. It just helps you make confident decisions if you think through all the different things that happen and stop pretending that you know what’s going to happen, because none of us really do.

James:
Yeah, there’s always that one guy who said, “I told you so, [inaudible 00:03:16].”

Dave:
Yeah, of course.

James:
I was guilty. I remember in 2018 people were like, “You keep saying the market’s going to come down. You’ve been saying that now for four years,” and it becomes this cry wolf thing. They’re like, “Well, if the market comes down, we’re not giving you any credit. It’s been too long.”

Dave:
Yeah. You didn’t add a time frame to those predictions, like, “The market’s going to come down in a year” or “the next six months.”

James:
Yeah, corner.

Dave:
Yeah. Eventually, like they say, the broken clock is right twice a day.

James:
Exactly.

Dave:
All right, well, let’s get into it because we had a really long conversation, but it’s great. Definitely stick around and listen to this conversation with Ben Miller who’s the CEO of Fundrise. But first we’re going to take a quick break. Ben Miller, welcome back to On the Market. Thanks for being here.

Ben:
Thanks for having me.

Dave:
Well, in previous episodes when you’ve joined us, we’ve talked a lot about real estate. We had a great show about deleveraging, and we’ve talked a lot about rent to own. But today, given what’s going on in the world, we’d love to just pick your brain a little bit about the macroeconomic climate. I know it’s a very broad topic, but we’d love to just get a sense of your read on what’s happening with the US economy right now.

Ben:
Well, so that is a very tough question. I just feel like-

Dave:
I’m just going to let you talk for 45 minutes and just-

James:
We want to stay State of the Union on the economy right now.

Dave:
James and I are going to leave, and you carry this entire podcast for us. Let me just start with this. Are you bullish or bearish on the US economy right, right now, how about that?

Ben:
Yeah, it’s funny because I feel like not only are we having this question, but everybody is. So, normally, internally we have sort of strong conviction for one way or the other. And I think generally what happens is that the market has conviction about something, and then it tends to be it overextrapolates that conviction. It gets overbought. And that has happened, man, pretty consistently my career. And so then we’re usually contrarian into that because it’s, essentially, like the market sort of gets momentum around an idea that is probably something they want to be true but not necessarily true. But at the moment, I don’t feel like I have a strong conviction one way or the other. I think almost nobody I know does. We’re in this place where we should be in a recession. We’re not in a recession. The market and the economy is kind of waiting on pins and needles for something to happen, and nothing has. And at some point, people will start saying, “Well, no, maybe nothing will.”

Dave:
Yeah. It’s super confusing. You just said that we should be in a recession. And I think that is a prevailing belief. What makes you think that we should be in a recession right now? Just the tightening, the monetary tightening that’s going on?

Ben:
Yeah, I mean just take the idea that Charlie Munger has, which is when you’re trying to apply your reasoning to, or if you’re trying to think through a problem, you can try the inverse of the problem. Flip it over, inverse it, and see what the inverse looks like, and then you come back to the one you’re looking at. So if you flipped it over and said, “Okay, what if interest rates were really low, and what if they were doing quantitative easing, printing a lot of money?” And we know what that looks like. Right? We know that looks like.

Dave:
We’ve seen that game a few times.

Ben:
Yeah. We know that’s prices go up, and economy gets hot, and there’s inflation and all these things that we’ve just seen. So now the policy playbook they’re running is the opposite. Right? Interest rates are really high, and they’re doing quantitative tightening, which is they’re burning money. They sell their assets off their balance sheet and then they eliminate the money. And that should be having the opposite effect on the economy, which is that it’s a recession. It’s a down. Prices go down, right, not that Nasdaq went up 11% so far this year. I saw a great guy from Odd Lots, Joe Weisenthal. He put it perfectly. He’s like, “We’re seeing it in practice,” right, “but we can’t figure out how it works in theory.”

Dave:
Yeah. It’s [inaudible 00:07:43]. That just inspires so little confidence. We know what’s happening, but we have absolutely no idea why it’s happening. But it makes sense, right? Yeah. Everyone would think that we’d be in a recession or at least the labor market would’ve cracked a little bit by now or something would start pointing in that direction. Do you have any speculation or thoughts on what is holding the economy together right now?

Ben:
Yeah, in situations like this, we have a practice internally which is called scenario planning, which is a structured approach to forecasting. I’ve been doing it for years. I mean, I read this book in probably 2000 by this guy named Peter Schwartz. He wrote it. It’s called long-term scenario planning. It’s a business practice of how you do rigorous forecasting. Right? And that is a great book and is a great chapter in the book. He was involved with Shell, and Shell Oil ran this practice with him, I think, in the room back in… God, it must’ve been like 1986 or ’07. They were sort of trying to figure out what was going to happen, oil markets. And they ran into this in scenario planning process he recommends, which I also basically recommend, is that when you’re trying to think through the future, there’s like you have to move to multiple scenarios.
And so having like, “What’s going to happen?” is like you’re asking the wrong question. You want to have sort of different scenarios, and you want these scenarios to be different, to be contrasted, because you want to get your mind out of this idea of a fixed future and work and think probabilistically. And so the scenario structure he recommends are basically, a natural extrapolation of the present to the future, which is generally, there are sort of cognitive bias that we fall into. We think about the future as if it’s more of the same. It’s because of the way we perceive time as a sort of continuity. And that’s useful to sort of say, “Okay, well, let’s just play it out. Actually let’s do the work and really play this out, put some time into it.” And then the other scenario we’d naturally do would be like, “Okay, things get a lot worse. Things break. There’s a negative scenario.”
And then the third scenario would be something strange or unexpected. And the point of the scenario planning is not necessarily that you’re right about any one of those things, but it’s basically, it gets you much more prepared. You’re looking for certain indicators in the market in a way that you weren’t looking for them before. So you’re able to move sort of faster, or you may change some of the things you’re doing. You say, “Oh, well, if this thing happened, it would be a disaster for us, so let’s like fix this thing ahead of time.” So it just gets you in a much better position. It’s a better way to approach that question than, I think, a lot of other ways you hear generally out in media.

James:
Yeah, so when you’re in this market right now, that’s we’re all thinking a recession’s coming. Even the housing market, I’ve seen drop pretty suddenly throughout that last quarter, three and four. And now we’re kind of leveled off, and things are transacting. We’re seeing a lot of buyers in the market, and it’s like, “Oh, okay, the fall has kind of stopped, and we’re just kind of there now.” I like investing. I actually like stable markets. The last two years were a little too nutty for me. For what you guys do, how do you mitigate risk? Because that’s that a unknown, right? I’d rather invest in deep recession or in appreciation where you can kind of guess and predict a little bit more.
But when you have this prediction… Like for me, yes, I think a recession’s coming. It all says it’s on the [inaudible 00:11:31], but we’re not seeing it, and you don’t want to sit on the sidelines too long. How do you implement these predictions into your investing today with that kind of mindset? Because we’re all kind of stuck in the middle right now, but we want to put our money to work. So when you guys are forecasting, what are you guys really looking into, and then how do you actually put that in a tangible use to earning a yield?

Ben:
Yeah. Well, so I think it might be fun to do some scenario planning together, actually.

Dave:
Okay.

James:
Dave piped up.

Dave:
I love this idea.

Ben:
But to answer your question specifically, tactically, what we are doing and what we do right now is you go into credit. So credit, actually, has been really well priced, and now credit in the bond market has rallied a lot. I think I told you about this last time, but we went into the credit markets starting in the summer, and we started buying asset-backed securities. We’ve been really active buying different kinds of bonds and busted convertibles. I mean, just the credit markets were really, really interesting. We were getting super high yields, and we also started lending kind of mezzanine debt or rescue capital. I love being in different parts of the market because that gives me a sort of broader understanding of what’s happening. When I was just a real estate guy, I knew a neighborhood in Washington DC better than anybody, but I missed the big picture, and I got hammered by 2008 financial crisis just absolutely. I didn’t see it coming. I didn’t know what a subprime mortgage was.

James:
I relate with this.

Ben:
Yeah. So I came away from being like having the big picture is so essential, and I get to operate across a lot of different sectors now, and that’s been really useful as I think about the tactics down on the ground, as you’re saying. What do you do? Credit, credit, credit. And that’s starting to go away. That sort of excess yield’s starting to go away. And then, after that, I don’t know what we’re going to do, but I think we have at least another month or two before that happens.

James:
Yeah, that’s a hard part too. In 2008, same thing. I didn’t even know what subprime mortgages were, but I knew the market was good. And we were doing a lot of work during that time, had a lot of business going, and then it kind of hit us out of nowhere because we weren’t looking at the big picture. And then, as you’re trying to invest today, you get this whiplash from 2008, and then you get the memory that you didn’t have your eyes wide open to what was going on. And it kind of locks you up a little bit where you’re like, “What’s the right move?”

Ben:
Yeah, it’s paralyzing. Totally.

James:
Yeah. We’re just slapping every type of mitigation of risk on a deal, and if it hits all these boxes, we’re like, “Okay, we can make that good investment.” There’s been plenty of times I’ve sat out when I shouldn’t, and there’s been plenty of times where I dove in too hard when I shouldn’t. And so it’s like you’re trying to find that perfect median. I think that’s where we’re all at. We don’t really know what the next engine is. It’s, I guess, whatever opportunity comes in front of us.

Ben:
Yeah. My first recession, or whatever you want to call it, was 2001. Basically, it made almost no impression on me. I was just really young, and I was like, “Oh, there’s a recession, I’ve heard,” and I just went out with my friends and stuff. I feel a lot of my people I work at Fundrise with, that’s sort of how ’08 hit them. It kind of didn’t really leave a big impression because they were just coming out of school or something. And then, for me, the second recession was 2008 and left a deep impression on me. And the problem was it left scars, and I sort of overcorrected around it.
And so now we’re in, I think, the third one, and I’m like, “Oh. The third one, I get now.” I sort of was too unconcerned before, and I was overly concerned on the second one, and now I sort of have a really rich understanding in a way that I think it’s hard to get without going through three, essentially. And yeah, it was like this sort of self-reflection around like, “Okay, I feel really uncomfortable but I’m going to act,” where before I felt really comfortable when things were good, and I shouldn’t act. Right? It’s learning to calibrate to your own handicaps, your own biases, your own that emotional state. That’s what the third recession… You’ll come out of this one with that, and that’s like, you’re going to look back and be like, “I should have done that deal, but I didn’t because I was freaked out.”
Maybe, James, you’re old enough. That’s definitely a gift with age. So there’s not very many gifts. Right? Mostly-

James:
Mostly very sore mornings now.

Ben:
Yeah. So we could talk about credit, or we can talk about scenarios, or we can talk about something else, whatever you want.

James:
Dave wants to go through the scenarios.

Dave:
I love the idea of scenario. I do because I was writing and filming a YouTube video today, trying to explain what might happen with mortgage rates, and I was thinking through what are the different scenarios, or what are the variables at least, that will impact mortgage rates over the next year or two. And so I was just thinking about that. I don’t know if either of you have ever read the book Thinking in Bets by Annie Duke. She’s a professional poker player.

Ben:
Love her.

Dave:
Yeah. She’s phenomenal. I just love what you said earlier, Ben, about thinking probabilistically, that’s the only way you can really approach these types of environments. No one knows. So you just have to think about what are the different outcomes. Assign some probability to each of them and act because doing nothing, like you were just saying, is not really an option, especially for you Ben. You have large assets under management. James, you have big business. You have to do something. So you need to think through the scenarios and try and make the best decision you can. So I’d love to learn more about Ben. How would you approach scenario planning, given the context that most of the people listening to this are retail investors, people who are running a small business? How could they go about doing some scenario planning for this economy?

Ben:
Yeah, I love that because I learned it and I feel like it really works. It really helps you get out of sort of the paralysis or the moment you’re in where you feel like you have to pick a choice. And again, I took this whole cloth from Peter Schwartz and maybe refined it by doing it.
And let me just give you the example of Shell Oil for a second because that’s a great example. So they did this scenario planning. They did the three scenarios. And their third scenario in 1987 or something was this crazy scenario. They’re like, “What if the Soviet Union fell? What if it collapsed?” And 1987 or ’86, whenever they did that scenario, that was crazy. The CIA didn’t see it coming. No one saw that coming except for Shell. And Shell said, “If that happens, all these things will happen. We could probably get ahead of it with very little effort.” And they put a few things in motion that, two years later, when Soviet Union fell and Berlin Wall and everything, right, that they ended up making like $100 billion, something, absolutely killed it, because they were prepared for something that just seemed so outlandish to them at the time and anybody at the time, including the CIA.
And so there’s a lot of power in the scenario planning because it’s like, yeah, okay, there’s a 1% chance of it, which means probably it’s actually really easy to get ahead of that thing. But the pandemic, right, that 1% thing does happen, and being prepared for the pandemic or not being prepared, or interest rates going up from 0 to 5%, the inflation hedges you could have bought ahead of time were really, really cheap because it was so unlikely. So the great thing about sort of doing the scenario planning is that the unlikely thing is actually easy to get ahead of early and basically impossible after.
So if you take the moment, right, and you say, “Okay, we’re at this moment in time where we, basically, feel like it could go into recession, or it could not. Those are the two easy scenarios. Right? So why wouldn’t it, or why would it? And we spend the time thinking, “Okay, well, why would it not go into it? The main reasons, in my view… And I’m interested in yours… essentially are the labor market stays healthy because there, essentially, is a demographic shortfall. We’ve closed off immigration, and the baby boomers are finally retiring. And so you end up with just not enough workers to support a 350 million-person country. And so you have more demand but less supply of workers, and that’s good for workers, and that’s also inflationary. That’s one, probably the most likely, reason.
Other possible one that I feel like I haven’t heard anybody talk about is productivity. The X factor is why all these things aren’t causing inflation is, basically, real productivity, that the pandemic shocked sort of the system and sort of stirred it up, all the sort of static complacency. Tyler Cowen calls it “the great stagnation.” Right? There was this period where just people weren’t moving. People would stay in the same job. Telehealth, all these things were sort of stuck, and the pandemic just caused a lot of change. And all that change now is being picked up as productivity growth, but productivity growth is extremely difficult to measure, and we won’t know it’s productivity growth till years back. So in a way, I think about could this be like the 1990s? And if you go back and look at the 1990s, Fed funds were at 5.5.

Dave:
Right where we’re heading. That’s what [inaudible 00:21:54]-

Ben:
Yeah. So, there was a recession at beginning of the ’90s, that’s why George H. W. Bush lost the election. Clinton comes in, and there’s this productivity boom. There’s a combination of technology, and also the biggest generation at that time was boomers, and they sort of enter into their 30s and 40s in the ’90s. So it sounds like the millennials now, right, to have big generation driving productivity growth. You have technology, and so you have high interest rates but high growth. And people look back at the ’90s being this amazing period of American growth. And so that’s a possibility I think most people, including myself, hadn’t really deeply considered. And what does that mean for asset prices is it’s a derivative of that scenario. That could be the case. You can be persuaded that there’s a lot of good things happening in the country, and that’s why we don’t have, and aren’t going to have, a recession.

Dave:
Interesting. So, I mean, just for everyone listening, basically, when you talk about economic growth, at least in terms of GDP, there are really two ways to grow an economy. Right? It’s the number of people working and their productivity. And so because people continue to work, and maybe, as Ben is saying, productivity is going up. That is a reason why GDP is continuing to grow. We saw, I think it was at 2.9% annualized rate in Q4. So by the traditional definition of a recession, which is two consecutive quarters of GDP contraction, we are definitely not in a recession by that definition. And maybe this is why.
And I just want to also get back to something you said, Ben, which is really interesting, which is that maybe the labor market is so tight because there’s just not enough people, and that’s just never really happened before. Or do you know of any instance where there’s just some slack in the labor market, where there’s so many extra jobs available that even if the total number of jobs goes down, like it probably has, the unemployment rate doesn’t actually fall because it’s so easy to replace a job? Is that sort of what you mean?

Ben:
Yeah. If we were doing this exercise as a business, we would then go off and look for periods where that has happened, and we’d try to see, “Okay, what was happening?” So the first one that comes to my mind, this is a extreme example, is Europe sort of after World War I or after World War II, basically a lot of change because everything was destroyed. So they had to build a new manufacturing base. In World War I, a whole generation of men were just killed, gone. So there was just not enough population available do the work. That’s an extreme example. I have to go back and look at that period, but I’m pretty sure Europe went through a period of tremendous growth. I mean, it started from a really low base because of all of the destruction.
And you’d to go back and look at after World War II in the United States as maybe a similar parallel. And I think we were also closed to immigration for a long time, running into that period. So there are historical parallels. You need to go spend some time to do a robust… Whole point of the exercise is do the work, right, because you’re looking for patterns. You have to understand the data to really understand the patterns. And so you can’t get there just from sitting around. But scenario one is something like that. Right?
I think there’s also sort one other thing I’m seeing in the market that’s also part of this sort growth story, is onshoring. We have stuff in Phoenix, and there’s just so much growth happening from the onshoring. I mean, the government passed a new industrial policy, which they’re going to spend money to bring chips and green power and infrastructure, and it’s causing a lot of deficit spending. And you can debate whether that’s good or bad in the long run, but it’s causing huge growth. We have a industrial part of our business, and [inaudible 00:26:16] industrial today… Our industrial portfolio is actually the best performing of all the assets we have. Six months ago we thought, “This is scary. What’s going to happen?” And instead we’re leasing way above market, tons of tenants want leases. Everybody said Amazon left the market. It was going to get bad. And instead we have had like TSMC, which is a big chip manufacturer in Phoenix, they came to us for one of our buildings. Really, really, really active market. And I think it’s because of onshoring.

Dave:
That’s super interesting. So basically, these combination of things, like we’re getting onshoring, meaning jobs are being repatriated, people are bringing them back to the United States that maybe were offshored, entire industries. Chip manufacturing comes to mind. The reduction of immigration over the last couple of years and the, yeah, productivity of workers could all be one scenario. Right? So that’s why that the economy is still growing. What about the other side? We haven’t seen a recession yet, by a traditional definition, but do you also do scenario planning to think through what might come down the road that will lead to a recession, and try and scenario plan how deep that recession might be?

Ben:
Right.

Dave:
You own real estate in so many different asset classes. Do you try and forecast how each asset class might be impacted?

Ben:
Yeah, so, just to finish scenario one, so you can see that it was mostly an extrapolation of stuff we’re already seeing. Right? You’re just trying to play that out. And the thing about a scenario I just want to refine here is that it’s really almost like you’re writing a book or a movie of the future. It’s not just a bunch of data. You want to build a story, and stories are how we actually understand information, not data. Data is not how we understand the world. So you want to make it until they imagine a script.
And so scenario two is, the story you would tell is something like, “I’m a year from now.” And I said what happened, actually, it turns out, is that even though information technology and the Internet made data moved quickly, the real economy still moves slowly. And all those layoffs and all those problems were building up. It just took longer for it all to sort of culminate into a recession. And recessions are vicious cycles. As you cut people, then you buy less stuff. And you buy less stuff, the supplier then has to cut people. So it’s just a lot slower than we imagined. In 2001, the tech bubble collapses in March 2010. Sorry. March 2000 is when the tech bubble collapses. Oracle didn’t have their down quarter and their earnings miss till one year later. And that’s like… doesn’t seem that disconnected [inaudible 00:29:27].
So when bad things are happening, everybody’s trying to stop them from happening. You’re trying to delay the bad thing, kick the can. The lender wants to extend. You don’t want to do the layoff. And so there’s a lot of reasons why that it takes a longer time for down to happen. And then, you say that’s what’s the background context. And then, in the sort of scenario two, there’s some catalyst that causes everybody to sort of break to the negative. And that catalyst could be the government just shuts down for half a year or four months because of the debt ceiling, and there’s defaults, and then they cut all social suspending, and then all of a sudden, now all the spending that we thought we were going to have goes away. And that’s, basically, causes a recession.
And maybe something happens in the world unexpected, somehow you wouldn’t think is connected to it. But China decides to sell all their Treasuries. Right? There’s just some strange catalyst that breaks to the negative. And then everybody finally, “Oh, it’s a recession.” And then people really start pulling their money out of the stock market. They’ve really stopped doing business activity, business risk. And that just starts to feed on itself. And so it’s like you point at a catalyst as the reason why it happened. But it’s really, it was already happening slowly and just needed some narrative shift.
We just saw this. Last year, January 13th, I think it was, when Russia invaded Ukraine, right, we already had inflation. Background context was there, but that catalyst really just tipped it to the inflationary market. That was something that just was all of the last 12 months. It’s easy to imagine sort of the inverse of that happening. You’re not trying to predict the catalyst. You’re just trying to tell a story, imagine a catalyst. And the point of it is that if you can imagine it, you say, “Oh, well, then I wish I had done these things.” You’re putting yourself into that scenario. A year from now, if this is what’s happened, I wish, in retrospect, I did whatever. “If I had liquidity for this lender, they’re going to basically end up in trouble. I better be ready to pay them down,” or whatever the things are that you look back and say, “In that scenario, here’s a checklist of things I wish I had done in retrospect.”

James:
Yeah. And I feel like in today’s market, you just have to. We’re having to do that on any kind of deal we’re doing. And what Ben’s talking about is you can get locked up. You have to find the opportunity that works in [inaudible 00:32:11] your checklist. Because sometimes, when you think about with these big funds and the economy, it gets very overwhelming. Right? So for us, in our basic day-to-day, we’re just trying to go through a checklist of each deal. What’s the risk? What’s the predictability? Where do we think rates are going to go?
What we did know is with rates keep going up, the affordability is coming down. We saw that happen. We also saw that happen 2018, when rates kind of went up a little bit. We saw the market kind of come down a little bit. And so it’s just about taking those day-to-day steps because it gets so overwhelming with the amount of information. You just kind of go through a predictable checklist per deal that you’re looking at or investment engine. Ben’s in a way bigger field, but in real estate you’re like, “Okay, at a certain point, an asset class is going to hit the checklist a lot more.” And then that’s where reshift our focus as investors, at least. Like we were talking about, we bought a lot more larger multi-family because it’s hitting our checklist every time. Whereas fix-and-flip is only hitting it 50% of the time now. And so you just have to kind of predict what’s going to happen and then really put that into your day-to-day underwriting and mitigate the risk that way.

Ben:
Yeah, tactically, yeah, you’re totally right. What’s interesting about a downturn like we’re talking about, where maybe it’s not like ’08, maybe it’s just things don’t pencil. There’s no growth. It’s not a great way to make money. In your underwriting, you’re not likely to lose money either. Right? If you’re buying in this environment, you’re trying to figure out like, “Okay, do I think this is going to be profitable?” But you’re looking at the numbers, and you really position yourself to protect the downside. And if you’ve done it right, especially in this environment, I really think you’re just looking at basis. You’re not looking at cap rates. We’re starting to see you can get, as credit especially, but you can get in below replacement cost. You’re buying something, just you’re buying it cheap, even though on paper it doesn’t look like it’s going to make money because you can’t forecast interest rates. You can’t forecast cap rates. You can’t forecast rent growth. But man, it’s cheap. It’s not expensive.
The way I think about it is, then it’s just about time. It’s just at some point, whether it’s five years or two years, some point that will be a good investment. We have a lot of people on our team who used to work in big financial institutions, and they like to do big, complex financial models. And I’m like, “Well, I hate those things.” And they’re always wrong. They told you not to deal today, and they told you to do the deal in 2021. They overextrapolate the present into the future. And so 2021, everybody overextrapolated high growth, and now people are going to over extrapolate low growth. If you’ve protected the downside, the upside will take care of itself. But that’s not how the model… The model’s not contingent. That’s why we’re talking probabilistic thinking. You want contingent thinking, and then, if there’s a few different contingencies, you don’t know which one is going to be, but you have good basis, and you have time. The world will recover.
If you look at Sam Zell or anybody from the ’80s. I’m obsessed with the 1990 collapse of the real estate market, and I’ve actually done a ton of interviewing people from that period, talking to people who worked for the government. So just to give you a sense of how bad that was, 8,000 banks were foreclosed on. And then all those banks foreclosed on all their borrowers because, basically, you can’t get money. When your loan comes due, you’re going to get foreclosed on. And so then the government ended up owning $1 trillion of real estate, and there was just no money.
And all the people that I’ve been interviewed, like Larry Silverstein… Well, what is he worth? 5, $10 billion. Or Steve Ross, who’s from Related, worth $10 billion. All of them, basically, were wiped out. They were bankrupt in 1991, and all of them figured out how to buy in that period. And the people who survived were people who, basically, were able to go back in and buy in that period. And that period was, I mean, it was so much worse than we’re talking about right now. But at the same time that they were bankrupt, they were buying. And it was horrible. It was brutal.
Everyone used to borrow money back then, and the lender, which is savings and loans, an S&L, the loan was structured as a demand loan, which meant that the bank could say, “I’m calling your loan” at any point. They demand the money back. So when the S&Ls got in trouble, which loans do they call first? They call the good loans first because they know the bad loans aren’t going to pay them. So everybody got taken down back then. The only way you could survive was you could roll up your assets into a public REIT and go public through an UPREIT structure. The guy who took everybody public back then… His name’s Richard Saltzman… I interviewed him on Friday, just like, “Hey, I got to him.” Took me a while to get to him. And I was like, “Tell me what happened back then.” He created the first real estate private equity fund in 1986 or ’07, with Sam Zell. And so hearing these details, it gives me so much color about, “Okay, what are the lessons here, and how does it apply now?”
And I asked him that, right, like, “What do I do now? What do you think I do now?” It’s looking at the past, really in detail, talking to people who were there, not just reading about it. That is such a good way to really get your mind around the acting right today, in this environment.

Dave:
So what’s going to get rolled up next? So Ben-

James:
Hey, I want to get in that roll-up.

Dave:
… what scenarios are you playing?

James:
He had [inaudible 00:38:32].

Ben:
Oh, and in scenario three, scenario three is the hardest one because you got to do something less like the, “What’s the 1%?” If we did this in 2019, and I said let’s do a pandemic, you would’ve been like that-

Dave:
Ridiculous.

Ben:
“That’s ridiculous.”

James:
Yeah, we all learned lessons. Yeah, if the pandemic happens again, I’m buying assets in mass droves. I mean-

Ben:
What’s like a 1% chance of happening? Because the thing about probability is you have to do the chance that it happens times the magnitude.

Dave:
It’s expected value, right?

Ben:
Yeah. Magnitude’s often left out of the… I have [inaudible 00:39:09] and like, “This is a big risk.” I was like “Okay, so you’re saying it’s a big risk, but what’s the downside if it happens?” Like, “We could pay a $100 fine.” And you’re like, “Well, I don’t understand why we’re talking about this.” They’re like, “But it’s really high likelihood of happening.” Anyways, it’s a tax thing or a [inaudible 00:39:25]-

Dave:
So this is like a black swan event kind of thing, if you’ve heard that term.

Ben:
Yeah, at some point now, “black swan” has become… It lost its meaning because it became so popularized.

Dave:
Yeah, so people know, the idea is an unexpected event that you can’t really forecast. Like Ben said, the pandemic is an example, unless you disagree, Ben. I think that’s an actual black swan, as it was originally conceived as something really no one sees coming but sort of changes everything.

Ben:
Yeah, that’s definitely how I define it. But Nassim Taleb, who invented black swan, he’ll say that pandemic wasn’t a black swan, because some people saw it coming. I don’t exactly know how he actually defines it, even though I’ve read bunch of his books. He’s like, if you want to figure out great place to go think about this stuff or learn about this stuff, is read… I think the best book’s called Antifragile. That’s my favorite of them. But all of them are good. I read them all. His thinking is very similar to this. It’s a little bit more theoretical because he’s a trader and a thinker. He’s not a business operator, doesn’t run a business. So his advice is a little bit harder to apply to someone who’s got employees and operations and stuff.
But anyway, sorry, that digression. So not that their black swan is always a bad thing, but you could say the Internet was a good version of that. No one sort of saw it coming, and it caused massive growth. Year ago, AI, you would’ve been laughed out of the room, and now like, “Maybe it’s actually within this decade transformative to American productivity.” So it’s usually a bad thing. Usually black swan’s a bad thing, but it doesn’t have to be a bad thing.

James:
All this fork modeling you’ve done, what have you predicted of where you think the opportunities are? Because that’s essentially what you’re doing. You’re going through the models. You’re looking at the history. And then that’s going to leave you a certain amount of items left over, right, or assets you were going to want to look at. Where are you looking?

Ben:
I mean, credit. And we can talk about what that means. Credit, basically, means lending, and you can do that as a direct lender, actually be the lender who lends to the building, or you can do that in the bond markets, or you can do that in the sort of asset-backed securities markets, which is the market where you’re… have to be a large investor. And that’s all sorts of structured things like CLOs and lever loan market, lever loans. And things that I used to read about, now I’m seeing it. Some of the stuff I look at, I’m like, “Why does anybody want to buy this? Oh, my God, it’s horrible.” I look at the CLO market. I started seeing the CLO deals. So a CLO, it’s collateralized loan obligation, which to me, doesn’t mean anything. I don’t know what that means.

Dave:
Good, me neither.

Ben:
Yeah. And I’m like, “What is this thing everybody’s talking about?” And so I saw this deal, and it was big sponsor, big group, and they gathered up, I don’t know how many, let’s say 300 or 500 loans they made to small businesses. And the loans were on average like $2 million loans to like a warehouse that sells granite in Montana and just all sorts of small businesses where they borrowed $2 million to run their business. And I look at that, and as a mostly real estate person, I’m like, “Oh, my God.” That doesn’t seem very attractive to me because that granite company, if they go out of business, that $2 million goes to zero. Who’s going to go bother trying to go get $2 million from hundreds of borrowers? That’s a very inefficient process. It’s amazing that those companies can borrow from securitization market through the CLO structure. But I can’t believe that it’s attractive.
But I mean, I’m not an expert yet in it, or maybe I’ll never be. But there are parts of the market that are just really interesting. I give you one that’s not, another negative one, and I give a positive. So last time we talked about this public company called DTLA, Downtown LA, and it’s a office portfolio of five or six towers in Downtown Los Angeles, like the Gas Tower. They call them trophy assets in real estate. And I can’t remember if we talked about this on the podcast or after, but essentially, they’re part of the great deleveraging, their loans coming due, their cap rates, interest rate caps expired, and they defaulted yesterday on, whatever, a billion dollars in real estate, and the whole thing’s going to go sort of into a workout. That’s interesting. Going and looking at that is a really interesting… It gives you sort of a little bit of a glimpse into the future because I think that’s going to happen broadly. ]
But the part that I got to see, too, is that I could see the bonds underneath of that real estate, the CMBS bonds underneath of one of those $350 million towers. And they were still trading at 94 cents on the dollar. And I’m like, “This should be trading at 32 cents on the dollar.” Some of those tranches go to zero. So the bond market in what I think of as the real economy, the bond market, its points, is so abstracted from real life. That’s why it was part of my thesis of Great Deleveraging. It’s why sometimes it can be so mispriced. You can go in there, and we did and bought a lot of really good bonds because we could think about it differently. And so we’ve been doing that.
So asset-backed securities of single-family rental, non-QM, so non-conforming mortgages, where… We just saw a portfolio recently, last week, and it’s a bunch of loans, and they were all originated in the last five months, five months ago. So that’s like September. And the average interest rate’s 8% on that portfolio because that was a horrible time to borrow money. So you say, “If a borrower could make it work at 8% in September of last year, that’s probably a pretty good loan there.” And everybody was underwriting as if the world was going to end. So there’s parts of the market that are really attractive.
And same thing with tech. There’s a bunch of busted convertibles, they call them. They’re big tech companies that borrowed money back in 2021. This went away, but Roblox, which has a couple billion dollars in debt, so maybe they have like 10% debt on the company, and the bond was at 8%. You can take that bond and lever it at… That’s a 15 current on a super low risk credit. You can take debt and borrow against debt. That’s what the Great Deleveraging’s all about. The best way, only way to really make big money in debt is by levering it. And so levering it when it was 2%, not a good idea. Levering it when it’s 8%, that sounds pretty good. This is also true with the REITs. Sorry I’m going on here. But the REIT mark, here’s something that’s really, really interesting. So, we track public REITs’ equity and public REIT debt, and we have a list of the companies we think are good companies. And their bonds are trading at a higher yield than the equity.

Dave:
How does that work?

Ben:
So, they’ll take a company like Essex or Invitation Homes or American Homes 4 Rent. The cap rate for those companies are like 4.5, 4.75. They’ve really rallied in the last 30 days. And the bonds are 5, 5.1, 5.2. So basically, the bond yield is higher than the equity cap rate. And so I look at that and say, “Okay, well, either the bond price is too cheap, or the equity price is too expensive, because you shouldn’t be able to get the debt at a better yield than the equity. That doesn’t make sense.” There’s something happening in the market that’s either it’s not efficient, or some part of the market’s wrong. And I’m going to say, “Well, I don’t know if the equity is expensive.” So we’re buying that bond. I bet the bond market’s right and equity market’s wrong.
I mean, and not just bet. We’re doing that. But seeing that insight of, I buy that asset as a building, I buy that asset as a public REIT, I buy that asset as a bond holder or an asset-backed security. And you can see, along those that chain, where the pricing just doesn’t make sense. Right? If you can buy the 65% tranche, you can be at 65% of replacement costs as a lender and get an 8% return unlevered, right, because your equity is levered too. Right? You could lever your debt and get a 15 or a 12. That sounds a lot better to me than being in the equity and getting a levered 5.

Dave:
Right. Yeah.

Ben:
6. What are you levering into now? 7 if you’re lucky.

Dave:
Wow. Well, let me just say this. I think most people who listen to this probably are interested in getting into debt, but probably lack, maybe lack the sophistication to do this sort of… And I mean no offense to anyone listening to this. I also lack the sophistication to do this, to get into that kind of betting. I think most people here are looking at either individual notes or note funds or just traditional real estate assets. So I guess what I’m curious about is, if people go ahead and do the scenario planning, and they go through in their mind and say, “One scenario is things keep going well. We avoid a recession. One thing is where things break, and we go towards recession. Another one is really unknowable,” how do you get from that… for just an everyday investor… how do you get from that to, “Here’s what I’m going to do with my money next month”? How do you make a plan from those scenarios?

Ben:
In some way, though, it’s like it’s actually not that complicated. So you have a scenario where you make that investment in that building. Things go well, you do well. Things go poorly, you don’t lose money. And if there’s a black swan, it’s either really good for you, or you’ve protected yourself from it.

Dave:
Right, right.

Ben:
Right? This is hyperlocal. If you were saying, “Will Intel put a $50 billion factory in Columbus, Ohio?” I’m going to buy there. There’s a 1% chance that happens, and then I’ll buy it in a way where my leverage can, basically, withstand a black swan or a down market. And then if everything goes well, I could, basically, have three ways to play it out. So you can just apply those three scenarios to the investment. And basically, in the downside, you’re not going to make money on the downside. That’s not realistic. But you’re not going to lose money. Or you can basically weather the storm, and then you said, “Okay, I’m good. I can, basically, act.”

Dave:
So basically, as long as your downside is breaking even, right, you treading water for a little bit, something like that, where you can withstand the scenario where things break, then your worst case scenario is you tread water for a little bit, but you’ve put yourself in a position to capitalize on at least one of the other scenarios, and potentially the third scenario, depending on which way it breaks.

Ben:
Yeah, I mean, for me, because I exist in a world where I’m expecting everything to go wrong, always-

Dave:
Just business wise or just always?

Ben:
I mean, it’s kind of personality and kind of from my experience. I mean, the pandemic, if that didn’t teach everybody that a lot of things can go wrong all at once… Right?

Dave:
Mm-hmm.

Ben:
But if you can get to a place where you’re like, “Okay, well, I’m prepared for that scenario,” then you can just have a lot of confidence. You can act.

James:
You’re basically swinging for base hits, hoping that one turns into a home run because of whatever. Yeah, I mean, because you can shift that. Right? I mean, that’s where we’re seeing the demand from investors right now, too. They want flips. They want cheap properties, just in case they can break even on them later. And that’s where kind of everyone’s going. And we kind of rushed to buy a bunch of properties like that too because if the market does rebound, then we got nine base hit deals out there they can turn all into doubles, triples, and home runs. It can make a big impact. I think chasing a home run right now is a dangerous thing, though. Don’t swing too big.

Ben:
Totally. I always say, “We’re the tortoise, not the hare.” I’m all about singles. Because the thing about it is that the way the world works is when you hit one of those singles, sometimes like just, “Zoop,” it just shoots into outer space because you just didn’t predict that they’d open a Whole Foods next door, or some big company decided to buy that asset. It’s not predictable in a way that sell models pretend it is. And the point of the singles is just, if the option price is priced at 0 with a single, right, it’s like if you hit enough singles, one of those will be a home run. But if you just waiting for that home run pitch, probably you’ll never have it. And if you do, you’re not going to be a good hitter because you just haven’t been out doing the reps.

Dave:
That’s so true. Yeah, I think that’s a really good point. If you never swing, you’re just never going to have the opportunity to even get the ball in play or to take advantage of what happens. Just the natural things that happen in economy that you can’t participate in if you’re just on the sideline the entire time.

Ben:
And the people who get the home run options are the ones who are in the market. They see that you’ve bought five houses in a row, and they call you up. They’re like, “Hey, I’m going to do this thing that’s really ill-advised. It seems like you’re active in the market. I’m going to sell you this deal because I need, basically, somebody who I know is going to close. I’m looking for certainty, and I saw you close five singles.” So you just get way more opportunity by being in market. Predict the home run or the white swan or whatever, the outsized opportunities… In my experience, all the great things we’ve done, they didn’t happen on purpose. They happened by accident.
Now, we were in the right place, and we were doing the right thing. For example, for Fundrise, I raised a Series A from this guy who wrote a $27 million check to us, clean round, just incredible terms. And he just came out. He came into the office. I was like, “I don’t know who this person is.” He liked my dog. I chatted with him for an hour, and he just offered me, basically, a blank term sheet. There’s no way I would ever have forecast that in my life. “Hey, we’re going to raise a Series A two years from now.” That was just unpredictable. But if we hadn’t launched the company, we hadn’t been in market, we hadn’t, basically, been doing it, we wouldn’t have gotten the shot.

Dave:
Totally. It’s like thinking probabilistically, right? If one of 100 of those meetings might turn into your grand slam, you need to take 100 meetings. That’s easier to say about a meeting than it is about purchasing real estate. But the idea is still the same there.

Ben:
Right. And you couldn’t predict which of those hundreds going to be that one. And trying to is thinking about the world the wrong way. It’s nonlinear. The world works non-linearly, and our forecasts are usually linear.

Dave:
Yeah. It’s like dating. A lot of people say it’s a numbers game. If you want to meet someone you’re compatible with, you got to go on a lot of dates. You don’t know which one’s going to be the right one, but you just go on a lot of them. And then ultimately, you might find the proverbial home run. I think it’s very, very sound advice. And James and I were on a show a couple weeks ago. We were talking to a couple former NFL players, and we were saying that, personally, for me, I like to forecast or underwrite deals very pessimistically because it puts me in a position where if I’m wrong, it’s great. If I’m right, so be it. I’ll eke out a return. But if I’m wrong, then you’re just happy to be wrong because you actually wind up to see something that has much more upside than you originally intended or thought possible.

Ben:
Yeah. Our team had a sort of consistent mistake in the way they underwrote. We were doing a lot of this pref/mezz investing back sort of after ’08. We’ve done 77 pref deals, or it was like 78 because then we closed one. We’ve done a lot. And we were getting like 12, 13, 14% yields. And so we were really happy because we looked at the equity analysis, and we said, “They’re not going to make more money than us.” But where they were wrong is they priced the volatility at 0, the option value at 0. So the thing about equity is that sometimes it goes up in value more than it should. It goes up, and you’re like, “What the hell’s going on here? Why is that person, why is Starwood, willing to pay me a three cap? That doesn’t make any sense.” Right?

Dave:
Take it.

Ben:
Yeah. And this is not in the model. And so that the value of sort of this 1% is mostly how most, I mean, big money is made. I hate Excel. I hate Excel because it becomes how we think. The medium becomes the message, if you know that reference. And so-

Dave:
Totally.

Ben:
… it overly constructs the way the future works, and it just doesn’t work that way. And so the underwriting becomes the decision, rather than a support of the decision.

Dave:
That’s a really good point. I do feel personally attacked because I love Microsoft Excel so much, but I get what you mean. It’s so true. Like you said, it’s about a story, a holistic story about underwriting. It’s not just like, “We put together these models.” And models are all well and good, but they’re a function of the assumptions that you put into it. And assumptions come from very flawed humans, who probably have the right intentions and best guesses, but a lot of times, they are guesses, are based on historical precedent that doesn’t turn out to continue into the future.
And I also just wanted to recommend a book. Ben mentioned something about the 1% of outcomes really driving returns. There’s a great book I just listened to called The Psychology of Money by Morgan Housel. I don’t know if anyone’s listened to that. It’s really very easily understandable. But he talks about that. He does this whole study of the stock market, but it’s applicable to real estate as well, where just you don’t know. Even the best investors of all time, these legendary stock investors, if you look and break down their portfolios, it’s like they had a couple of wins, and they just let it compound for a really long time. And so it’s similar to real estate, where it’s like as long as you can stay above water and continue to do pretty well, something’s probably going to hit. You don’t know which one, but you have to have enough skin in the game to be able to take advantage of those once in a life… Well, not once in a lifetime. The 1%, like you said, just taking off.

Ben:
Yeah, yeah. I would just add one additional piece of the equation. When that 1% comes along, I find that when you find the thing that’s like, “Whoa, this is not normal,” you know. Right? I’ve had only a few deals in my life where I’m like, “Oh, my God.” I bought a deal in 2010, before Fundrise. And you knew it was a good deal. And so this is something they say. And among traders, George Soros is a famous trader, and they say he wasn’t right more frequently than everyone else, but that when he was right, he made huge bets. It’s like when you hit see that pitch that’s like, “Oh, my God, this is a good pitch,” you just put a lot behind it. And that’s the magnitude part of it. It’s not just about the frequency. It’s about the magnitude. And most people focus on how likely it is. I’m like, “How likely it is is only half of the equation.”

Dave:
It’s a really good point. All right, well, we’ve kept you for over an hour, so I do think we have to get out of here, but this was a lot of fun, Ben. Thank you. I mean, I love this idea of scenario planning. And especially in this type of volatile market, it’s really a great idea on how to make decisions, is just to understand that no one knows and sort of to play out in your mind or write it down on a piece of paper, the different things that could happen, and make sure that the decisions you’re making are viable in those scenarios. What was the name of that book again, just in case anyone wants to read it?

Ben:
It’s by Peter Schwartz. I think it’s called The Art of the Long View.

Dave:
Yeah. Okay. Yeah, I Googled it. That’s what I thought. Okay, great. It is, yeah, The Art of the Long View. I will put a link to that in the show notes. Well, Ben, thanks for being here. Is there anything else you think our listeners should know?

Ben:
No, this is so fun. This is much deeper conversation than I normally see people have. You guys are really fun to talk to.

James:
Well, that’s good.

Dave:
Oh, well, thanks, man. We appreciate that. Likewise. We looked forward to it.

James:
Yeah, I think the dangerous thing is it’s easy to burn through. We might have to make like a four-part series on a couple of these episodes.

Dave:
This is going to be an audio book. All right. Well, Ben Miller, CEO of Fundrise, thanks for joining us, and hopefully we’ll see you again soon for On the Market.

James:
Thanks, Ben.

Ben:
Yeah, thanks, guys.

Dave:
All right, James, what’d you think?

James:
I think I have some homework to do, when-

Dave:
Yeah.

James:
… [inaudible 01:02:51].

Dave:
Were you also Googling stuff Ben was talking about to try and understand?

James:
Yes, for sure. And it all comes down to the same core principles. We’re all trying to predict how to make money, but when you’re talking about that kind of money and that kind of range of asset classes, it gets a little confusing. And Ben’s a very smart guy. Oh, I was definitely Googling terms, writing things down, going, “What? Question mark.”

Dave:
Totally, yeah. I mean, he’s just at a level of understanding of finance and some financial engineering stuff that I just don’t understand. But I do think the stuff he was talking about with scenario modeling, I love it so much because it really represents, at least the way I personally think, and just think that thinking probabilistically is the only way to be a good investor. If you think, “Oh, the economy’s 100% going to do this,” that’s not true. You don’t know that. No one knows for sure. So you have to really think about all the different scenarios that could unfold and prepare yourself. And that way, honestly, for me, if I take a loss, but I thought about the fact that there could be a loss in the future, it doesn’t sting as much because I’m like, “Okay, I understood the risk. I understood that that could happen, and I made the best decision I could at that time.” And I just think it’s such a wise way to start thinking, especially in this type of volatile economy.

James:
Yeah, that’s how we invested in 2008, when the market was in free fall. It was just like, “All right,” we had to buy this, and if the market dropped X percentage, we were predicting that in there. And we overpredicted. It was like we weren’t losing ever on deals then. It was like we barely made money. But then, like you said, if you spread your chips out, then we’d hit a good one. So just predicting, spreading your chips in a safe way, and then looking for all upside at that point.

Dave:
Yeah, absolutely. I think it’s awesome. I really like talking about that and loved the conversation at the end, where we were kind of just saying what you just said. You got to spread your chips out. You have to be in the game. And I really recommend that book, if anyone wants to listen to The Psychology of Money, talks about how that’s how almost all investors really make it big over the long runs, is they spread their chips out, and something hits, and they don’t know exactly what it’s going to be, but they are consistently in the game, and they play a little bit defensively so that they don’t, like you said, they don’t lose money on these deals, but they give themselves the opportunity for upside. So definitely check that out. Sweet. All right. Well, this was a long one, so we’ll get out of here quickly. James, where can people find you?

James:
Best way to get ahold of me, honestly, is on Instagram, jdainflips, or you can check us out at jamesdainard.com.

Dave:
If you love property walkthroughs, definitely follow James on Instagram. They’re so good. I love watching them. That farmhouse you flipped, I want to live in that house. It looks so cool.

James:
So do I. That’s why I’m like, “I’m not in a rush to sell it.”

Dave:
[inaudible 01:05:43].

James:
I’m like, “I like it.” I was like, “If no one buys this, this is going to be my house in Seattle when I’m in town.” It’s awesome.

Dave:
Oh, it’s so dope.

James:
Yeah, and I’m not even a farmhouse guy, but because it’s on a farm, I’m digging it.

Dave:
Yeah, it’s pretty cool. So yeah, check out James, jdainflips on Instagram. I’m @thedatadeli. Thank you all so much for listening. We’ll see you for the next episode of On the Market. On The Market is created by me, Dave Meyer, and Kailyn Bennett, produced by Kailyn Bennett, editing by Joel Esparza and Onyx Media, researched by Puja Gendal, and a big thanks to the entire Bigger Pockets team. Content on the show On the Market are opinions only. All listeners should independently verify data points, opinions, and investment strategies.
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