A note to Insiders: On Thursday, we published Pt. I of our conversation w/ Naftali CIO David Hochfelder, which focused on scouting some of the country’s highest-profile development sites and locking in an equity partner at a time of extreme dislocation. Today, we dive deeper w/ him into a couple defining themes of today’s market: the changing nature of the capstack (David provides a super-revealing example), and the depth of the ultra-luxe buyer pool. I wanted David for this because he sits in a fascinating seat, and because he was willing to get specific – which is our whole thing here at The Promote. Hope you find this valuable. And if you know someone who would benefit from reading this and might want to become an Insider, forward it along – they can get 10% off here. - HS

800 Fifth, Williamsburg Wharf, these are big swings. But let’s talk about the opposite. There was a period where Naftali wasn’t buying anything, while a lot of Miki’s [Naftali] peers were going haywire buying. You’d hear stuff like “Are these guys still in business? Are they frozen out of equity?” 

Many in our audience, particularly those in multifamily, are dealing with this right now. If you're not transacting, are you even alive?

I joined in ‘16. We didn’t buy anything from early ‘14 till ‘17. And even then, it was not a target-rich environment to buy at attractive prices. But the fact that Miki had been sitting on the sidelines was very appealing to me coming in to help run the investment side. When the market is all screwed up, we go on buying sprees, and when the market is filled with tons of liquidity, we sit on the sidelines because we can't buy assets at prices that we agree with for the equity capital markets. But we had 7 [ongoing] projects. We always wanted to be doing more, but there was a good amount to keep everyone busy.

The biggest evolution in the business wasn't on individual deals. It was moving from smart investing to real company-building. When I arrived, we were a well-respected boutique condo developer. Very good business, profitable, but inherently cyclical, and you have to reinvent yourself basically every project. It's also extremely tax inefficient.

Since then, we've formed four distinct verticals: The condo business, a credit and fund management platform, a very big Florida operation, and then we have a large-scale mixed-use build-to-core division. The profits and fee streams of the business as a whole are diversified and predictable. 

Back to your point about periods of inactivity. We bought a handful of asymmetric deals pre-2020. Then in 2020, right after the pandemic, we went on a crazy buying spree. We bought what's now Williamsburg Wharf. We bought what's now the Henry on the UWS, a large condo project. We bought 255 East 77th St., another large condo project. We did the Willow in Gramercy. We bought 2 very large projects in Florida. In 16 months, we bought 6 deals totaling billions of dollars. And we were willing to have that conviction. On the first deal, which was the Henry, my view was, “we're buying this really, really cheap. I have no clue where the equity capital markets are going to be between negotiating this deal and going hard and closing it.” I went out pretty wide on that deal, because I wasn't sure how the LPs would react, and we got a bid from every single LP. That's usually a good sign that you've probably created a good deal, but we went in with no visibility on that. 

Is there a risk of running out of buyers for the product you’re looking to build?

[The buyer pool] is a lot deeper than many people realize. Betting on the ultra-luxury market is one of the best bets you can make right now – not just in real estate, but in luxury fashion, art, hospitality, timepieces — look at the [latest] Sotheby's results.

I'm distinguishing between ultra-luxury and luxury. I don't know where you quite draw that line. The Bellemont on 86th and Madison, which we sold out for $4,000 a foot, that's at the very top end of luxury, but not necessarily ultra-luxury.

Ultra-luxury buyers are structurally insulated from the macro cycle. Mortgage rates really don't matter. Wall Street bonuses on a seasonal basis don’t drive purchasing decisions. CPI inflation is background noise. Wealth at the top 1% in the U.S. has more than doubled [since ‘17]. This might not be a politically savvy statement for me to make, but the number of billionaires keeps growing. That's not a trend, that's a structural reality. If you take 800 [Fifth], we're going to have 50-some-odd apartments. 220 [CPS, Vornado] had over 100; 15 CPW [Zeckendorfs] had over 200, and they sold swimmingly well.

The demand is more than sufficient. Barriers to new supply are essentially permanent. So pricing is remarkably inelastic, and as a developer, you're a price maker, not a price taker. At 220, the original sales were $8,500 a foot. The resales, on average, are over $12,000 a foot. In new development, look at 80 Clarkson sales relative to 150 Charles.

And that location is…whatever

The sales at 80 Clarkson are more than double [150 Charles] on a per-foot basis. I don't like talking about competitors' projects, especially 80 Clarkson, where we were the cover bid, but the trajectory of price growth is dramatic. Outside of New York, look at resales of homes in Aspen or waterfront homes in Miami. Those prices have tripled in the last 4 years. And Manhattan is still relatively inexpensive compared to some global cities.

[Readers: Go check out my Bloomberg Odd Lots pod on this ultra-luxe thesis.]

You’re developing top-tier product in the midst of peak rhetoric against it. We’re talking just a couple weeks after the whole Mamdani-Ken Griffin fracas, stemming from the revived pied-à-terre tax. Do you find any of the ongoing chatter about legislation – or even just the vibes – concerning?

I'm not going to speak on Ken, because he's a friend of mine. But I'll say this on the pied-à-terre tax — it's bad policy. It's a terrible precedent. It's basically a wealth tax, and wealth taxes have no place in a capitalist system. Those making these decisions don't seem to understand that a buyer who creates jobs, pays real estate taxes, and creates zero strain on city services is not the enemy – it’s exactly the kind of person you want in your tax system.

That being said: I think the impact is being overhyped, and the actual effect on ultra-luxury is going to be more marginal than the headlines suggest. To take 800 Fifth, for example, those buyers aren’t going to be deterred by a slight carrying-cost adjustment.

You mentioned vibes. That's where it has a more deleterious impact. We're now sending a message to people that are spending a lot of money in the city, creating jobs. They're not necessarily asking for the red carpet, but telling them they're not welcome is not a good message to send.

I do want to emphasize one thing: I have never wavered, and we will never waver, on our commitment to New York. New York is the most important global center for commerce, ideas, and culture. That doesn't change because of who's in Gracie Mansion. I think to suggest that Mamdani can unilaterally alter the fabric of the system is giving him – or anyone else – too much credit.

Let’s talk how the capstack is changing.

The market looks completely different on the surface than a decade ago, when everything was done by a syndicate of commercial banks, usually with some recourse. That syndicate market is basically nonexistent today. Borrowers now prefer single-source execution, but embedded in almost every one of these deals, either directly or indirectly, is some level of syndication. It's just done horizontally rather than vertically today with senior and mezz. So I don't think it's as different as people make it out to be. Every Apollo or JPMorgan financing, even if they sign a term sheet solely with the borrower, has other participants embedded in it. It's the same capital markets story; it's just different packaging.

We don't rely on financial engineering to make the math work. If you are relying on a construction loan to be priced to perfection as a borrower in order to make the math work, then there's probably something wrong with your investment thesis, or at least the asset price that you're buying it at. Miki and I draw a line in the sand between equity risk and debt risk. We've never been big on exotic structures – we've never done EB-5, we've never done Israeli bonds, rarely do we borrow mezz. We're plain vanilla.

You had a $75M slice of mezz from Barings on the Williamsburg project.

Most of the things that we've done, at least non-recourse in the last 3 or 4 years, have had a sliver of mezz, but that's mezz to get to where traditional bank leverage was 5 years ago, not mezz to get to 85% financing. And when we're borrowing mezz, it's SOFR +600/700.

The initial financing on Phase I came from Bank OZK, a prolific construction lender that seems to have pulled back from New York. On Phase II, the financing came from JPMorgan and Goldentree, also your lenders on 800 Fifth.

OZK was supposed to be the construction lender. We actually had a windfall from City of Yes, where we got a bunch of excess [Zoning Floor Area]. So we were about to close that construction loan 2 years ago, but we put it on hold with the plan to just bring it back to OZK. And they couldn't get to the same place. So, unfortunately for them, JPMorgan swooped in and won the deal in less than a week.

Is that a regional fear they [OZK] have, or do you see it as a broader pullback?

It's a regional one. They're still very active in Florida. They're going to recalibrate and they'll be back in the market in other places. They've done very well in New York. There's no reason for them to be out of the market.

The mezz space is a red ocean. There's a lot of capital on the mezz side. There's actually not as much capital on the senior side for construction. You look at the banks, it's basically JPM, maybe OZK, Deutsche, and Axos, and a couple others in other regions. And then it's all private-capital debt fund contribution from there, and the debt funds that do senior debt are also few and far between. So that's a great place to be in the capital stack on a risk-adjusted basis.

You mentioned to me another deal that’s illustrative of today’s capstack dynamics.

We closed a construction loan for our project, the JEM Residences, in downtown Miami a few months ago. That's a 1.5M sf project, mixed-use with retail at grade, ≈ 600 units of multifamily, and then vertically above that, a condo tower, which, for whatever reason hasn't really been done in Miami. A lot of people have done mixed-use with hotel and resi, or even office and resi. Not a lot of rental/condo.

The investment thesis is: If we built it all, and merchant built it, and sold the multifamily, we're getting mega opportunistic returns. But our actual strategy is to build to core, and net of condo sales, we own the multifamily at a 9 yield on cost, and we’d hold it forever. But that business plan didn't gel as much as we thought with the debt capital markets. Because multifamily development in Miami, if you were doing only multi with no condo, does not work today, based on construction costs. So the takeout debt-yield metrics don't work for a lender. On the other hand, our condo portion was only about one-third of the project, so we weren't as focused — we've sold very well – but we weren't as focused on generating pre-sales and deposits, because it was a small piece of the puzzle.

And in South Florida, condo pre-sales is typically the engine.

It's the lender's credit protection, it's the proof of concept, and it's the source of funding. Development margins on condo deals in Miami are much thinner than New York, but you also don't have to put in nearly as much equity if the pre-sales are going well. So many developers – not us, but a lot of developers – treat it as almost an option. Like, “Oh, I’ll track the land, start selling. If it goes well, great. If it doesn't, I'll maybe lose a few bucks or build it in another cycle.” You can't do that in New York, because the land is a much bigger percentage of the total project.

So what we did was interesting. The construction lender there was BHI, an Israeli bank that’s a major relationship of ours. But it didn't get us the leverage we needed – not because they were constrained on leverage, they were just constrained on their position size [Total project cap here is $670M]. So we brought in [$235M] C-PACE financing from Nuveen. It's not the only project that's done that, but it's the only project that's done it in the way in which we did it, where the construction loan was split between the two, but so was the pre-development. So, first we had a land loan — normally you move straight to a construction loan. We had an interim step where we had a “pre-development plus” loan, where our ‘sources and uses’ was to build the podium. And we were able to explain to the C-PACE lender: “Your collateral is, worst case, a parking garage with a lot of development rights.”

The alternative option would have been either to over-equitize the development. So it was an interesting way of getting the process off the ground. It was not easy. I mean, pairing recourse debt and the type of collateral and security that a C-PACE lender has… We ended up dividing up the asset between the multi and the condo in a way that worked for each party. When all was said and done, we got 72% cash leverage at SOFR +325. The non-recourse market would have been at least 150bps wider than that, so it was worth the work.

Let’s talk Naftali as a lender. Not sure how you’re supposed to stand out with so many people wanting the same action.

It's very crowded. One of our key competitive advantages is we know the real estate, we know the values better than most, because we are an equity participant in most of our business. It's not just about picking winners based on that level of perspective. It's also understanding the key risks, structuring the documents accordingly. And then, God forbid, if in the future there's no way to right the ship, we can step in and provide our own credit protection. It's not something we've ever done, but for our LPs and also for the senior lender, it's an enormous advantage relative to other mezz funds trying to win.

Are you exclusively doing mezz?

Not exclusively, but we hold on to the fulcrum position. We usually attach at 40-45% and detach [max] low 70s, at least on a cash basis. There are definitely sub-debt funds that go a lot higher on the V-curve. That's not our business. But right now, a lot of our alpha is just getting better pricing because people want us in the deal. I don't know how scalable that is, but it's a big part of our competitive advantage.

Our 3 core audiences are developers/aspiring developers, brokers who want your business, and lenders who are thinking about how to cater to firms like yours. Any take-home nuggets for those folks?

Long-term thinking is really the only way to look at things. It's not just about the next deal or the next investment, it's about, “how does that fit within the trajectory of the business you're trying to build?” Now more than ever is not a time for amateurs.

There's definitely a blurring line between equity and debt and straight-up asset sales versus recapitalizations. That's not fundamental to our business, but for most deals, that is the case. So, as a broker, it takes a multidisciplinary approach. It's smart for brokers on both sides of the aisle to be working with each other. It's self-serving, but it's smart. 🎙

*Transcript edited for length and clarity

(See highlights from our first in the In Conversation series, w/ Lightstone’s David Lichtenstein)