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Reonomy Executive Chairman Rich Sarkis on the Future of CRE in New York and Beyond

Jun 17, 2020 by Deidre Woollard

Rich Sarkis has a long history of entrepreneurship. He founded Reonomy about eight years ago. As he puts it, he didn't really know much about commercial real estate, other than it was a huge asset class. But what he discovered was that it was pretty bereft of data and analytics solutions in a modern sense. He created the business along with a couple of co-founders in order to basically bring that modernity that Zillow (NASDAQ: Z) (NASDAQ: ZG) had brought to the residential side to the non-single-family side.

The company started with one product in New York City. That product enabled lenders, brokers, and developers to basically search for opportunities for refinancing sales redevelopment, etc. Over the years it has been scaled into a broad suite of web-based products, data products, and analytics products that serve a broad swath of users in the U.S. Reonomy has raised over $120 million in funding. In February it announced a partnership with Infogroup, adding 315 million individuals and 24 million businesses to its existing database of commercial properties.

Millionacres sat down with Sarkis over Zoom (NASDAQ: ZM) to talk NYC, machine learning, and how the current economic situation differs from what we've seen before. Since this interview took place, Sarkis announced that he is stepping down as CEO but will become the executive chairman. Bill Okun will take over as the company's chief executive.

Right now, with everyone needing to make decisions without touring properties and trying to get as much information as they can, are you seeing an uptick in interest and in business?

It's been interesting. When the national emergency and national lockdown was announced, there was a little bit of a dip where people just, I think, were literally sheltering in place, homeschooling, and just didn't have time. Since then, certainly April and into May, we've seen an uptick in folks turning to data and the web applications to basically do that research, do that pipeline building, and become local experts so that when the economies do open up, and they're starting to open up, they're going to be on the front foot and not on the backside.

On the residential side, we're starting to see a lot of search, but it's not necessarily turning into action quite yet; that's probably an inventory problem. On the commercial side, are you seeing the same thing where there's a lot of searches?

It's the same thing. We tried to figure out, you know, why that is, and it's kind of intuitive because when all these counties and states were shut down, what happened is literally the local tax assessors and the county clerks offices were closed for business. I've spoken to a lot of our clients on the debt and equity side who had a number of large [transactions] in some cases; I was talking to one of the big mortgage bankers and he said he had a billion-dollar deal that was on the one-yard line and didn't close -- they just couldn't literally file the transactions.

The good news is, that's starting to lift and folks are starting to go back to local tax assessors and county clerk's offices are opening back up for business. So hopefully in the next couple of months, certainly in Q3. Q3 will definitely be one to watch to see if we see that uptick that most expect, especially on the debt side with historically low interest rates, obviously.

So you're in New York, the hotbed of everything, but I'm also hearing that some of the real estate investment trusts (REITs) are already starting to consider picking up office space or trying to figure out if there are deals to be had. Are you seeing that kind of activity?

New York City has been disproportionately affected, as you mentioned. We were, and we made the decision to start to work remotely over two months ago now. In mid-March we had one office with 150 people across three floors in a midtown office building, and we actually made the decision to terminate our lease. We had some flexibility, and we just didn't see a world in which, certainly this calendar year, pre-vaccine, pre-therapeutic, etc., it would be safe or prudent for people to be crammed into an elevator or a subway.

To your point, whenever there is duress and distress, there's also opportunity. You don't need a recession for that. One of the most popular search features on our site is around pre-foreclosures and foreclosures because folks want to see distressed assets that they can reposition, hold for a long term value, etc. So yes, we are seeing search activity, even in New York City. Office, though, not so much to be perfectly honest; what we are seeing is more so warehouse, industrial, data centers.

And it's also starting to sort of bleed outside of the core five boroughs, right -- we're looking at Westchester County, Northern New Jersey, even areas of Connecticut, etc. And that's more of the activity that we're seeing. And I'm hearing a lot of REITs on a national level looking to gobble up and buy up data centers, as I mentioned, industrial warehouses. Surprisingly, there's been a lot of retail activity in New York City, even in Brooklyn.

I wanted to mention the report that Reonomy put out looking at all of the different recessions. Which type of recovery seems most likely?

It's a good question, and part of why we did the research. Just to summarize, we looked at the last seven recessions going back several decades literally to the late '60s, early '70s. We looked at the duration of the recession, what the overall response and impact were from a U.S. macro perspective around interest rates, GDP, and unemployment, and then looked specifically at commercial real estate and the impact around price and volume of transactions in terms of the trickle-down effect.

It was a little bit all over the place. The 2001 recession was a sort of double whammy of the dot-com bubble bursting, as well as 9/11. It had a very strong impact negatively on the economy, but it had a massively positive impact on the commercial property market in terms of volume of transactions up 80%, counts up almost 20%, and an overall price increase over 10% year over year on the back of that recession.

However, when you look at the financial crisis of 2008 and 2009, you see a very sharp downturn from an economic perspective, unemployment, GDP, down 5% or a little over 5% actually, but then when you look at what that did to commercial property values down over 15%, the volume of transactions down by half year over year. I mean, think about that. That's a huge decline.

So now when you look at the here and now and say, Well, what can we learn? Our perspective is it's going to be a little bit of a hybrid because you do have this one very defined cause in the virus, etc. But as opposed to 9/11 and the dot-com era, which was very finite, and you knew that, okay, 9/11 happened -- it was obviously a terrible and senseless tragedy. But then the recovery literally happened the day after, right, as you think about it, and even in terms of people's mindset: We're going to resist. We're going to show them that we won't be cowards, etc.

So there are similarities there where there's a very defined sort of enemy and costs, etc. The issue here is that there is still not that finality, pre-vaccine, pre-therapeutic, etc. So the uncertainty, unfortunately, remains. That's the jitteriness that we saw a little bit in the 2008-2009 recession that sort of lingered and had that trickle-down effect.

The other similarity with 2008-2009 this time around is the sort of hand-in-hand of the cause and how it plays with the physical asset, right, because in 2008-2009, the underlying cause was a lot of the mortgage-backed securities, and literally the properties sort of caused the dominoes to fall and almost bring down a banking system.

In this case, the commercial properties weren't the cause. There wasn't a wacky loan-to-value ratio in the underlying assets. The loans are much more secure with all the regulatory stuff that's come down the pipe. Since then the issue is the trickle-down effect of What's this going to mean for office, retail, hospitality? And how that puts downward pressure on real estate assets. So, it still remains to be seen. But we can glean insights, certainly, by looking at the last few recessions.

Long before this happened, everyone was saying real estate was in extra innings. We were in a long cycle, and so it seemed like it would end, but nobody could have predicted this.

You're right. People have been calling the recession for the last couple of years. A lot of folks were pointing to the fact that retail was struggling. Retail pre-COVID was not a pretty picture, and now this has sort of been the coup de grace, but certainly, this is what you find with the recessions.

I don't think it's going to be business as usual, I think that there are two-three distinct phases. There's the phase that we are now starting to emerge from, and let's set aside the risk -- and obviously it's a real risk -- of another big spike in cases in the fall or winter. But let's just assume we're coming out of the first phase, which is the lockdown phase, and literally the economy is shut down. And this is historic, right? And we're seeing the numbers, the unemployment numbers, the month-over-month, year-over-year decline in retail sales, GDP, etc.

But then you enter into this phase, which is the uncertain phase, pre-vaccine, pre-therapeutic, where even as things open back up, then it is not what it used to be. And if you look at restaurants as an example, they have to operate at a 25% to 30% capacity just is not easily imaginable. It just doesn't work. Most restaurants, if not all of them, have to operate at least 70% to 80% occupancy; they need the vibrant bar scene and the liquor, the alcohol sales, to do that. And without that in place, with all the social distancing measures, etc., it's not easy to imagine that it's going to recover.

And so now you think about the third phase, which is post-vaccine, post-therapeutic, etc., which, let's face it, the best-case scenario is still going to be a couple of years away. What does the recovery look like when there is a truly effective vaccine? Then maybe it will go back to normal, slowly but surely, but the carnage will already have been done, right? So you'll be rebuilding, and all those restaurants would have gone out of business. Landlords would have had to adjust the makeup of their building facades, etc. And that's the glass half full.

The other scenario is that it's going to look different, and entrepreneurs will figure out new business models that will thrive in this new normal, and things that you and I don't even enter into our realm of consideration will be normal going forward.

A lot of venture capital was going into proptech, and that's not happening as much now. When is that going to go back up?

Folks were waiting for the shoe to drop on CRE or proptech for a while as well. Our company has raised a lot of money and benefited from that. But there are a number of other companies that, when you examine their business model and look at what they've brought into the balance sheet and then their unit economics, the numbers just don't jive.

And ultimately you can only keep raising money at bigger evaluations for so long until either the public market scrutinizes it or a recession shines a light on it, and investors are now not just willing to give you money because you've put together a really great PowerPoint presentation or you used good marketing lingo.

They will actually peel back the layers of the onion and say, Tell me about your business. For every dollar you spend, what is the dollar that you return? Because ultimately, that's going to build the enterprise value. I think what we're going to see, and we're starting to see -- to your point around the slowdown of the funding in that sector -- is a lot of the businesses just don't stand up to that scrutiny.

People are talking about the death of coworking -- are you seeing that as a concern?

Coworking, it was focused on many humans per square foot. That I think is a thing of the past, but the flexibility aspect and the noncommitment aspects of coworking are huge. And I think that as these coworking businesses adapt their business models to the new normal, they are going to find a very strong demand from individuals and companies for that type of flexibility and for that type of working environment as a complement to the work-from-home movement.

What plans are you and the Reonomy team working on right now?

We are working on systems that allow us to take disparate data sets -- specifically, as they relate to properties, individuals, and companies -- and basically build graphs of how they relate. So things like who really owns a building. Take a company: What is their portfolio of properties? What does that look like over time? Taken individual, which companies are they related to, and how does that relate to real estate? Etc. So we are going very big and building out those graph structures to tie in those three entities and to build a multi-entity-centric model.

And we are on the cusp of releasing a number of new features and products later this year, the second half of the year, that we're going to be bringing to market. And we are very excited about our alpha and beta testers, our clients, including large Fortune 50 banks, insurance companies, brokerage firms, etc. We really doubled down on research and development, and these features and data sets will delight our customers.

Let's end on an optimistic note: What is your most optimistic view of where we're going to be two years from now?

My most optimistic view is that there is a widely used, effective, adopted vaccine that everybody has and is available for all and coupled with a therapeutic, and -- if you read the most optimistic scenarios -- there is a world where that will be the case in two years. There'll be new businesses and new business models that will emerge as part of the entrepreneurial sort of zest created as part of that.

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Deidre Woollard owns shares of Zillow Group (A shares). The Motley Fool owns shares of and recommends Zillow Group (A shares), Zillow Group (C shares), and Zoom Video Communications and recommends the following options: short August 2020 $130 calls on Zoom Video Communications. The Motley Fool has a disclosure policy.

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