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Welcome to Episode 16 of Offshoot with Kristian Peterson.
Kristian is a seasoned commercial real estate entrepreneur with over 20 years of experience in the institutional investment space. As a managing partner at Catalyst allocating joint venture equity into real estate development deals, and raising capital for the fund, he has a refined sense of what it means to be an impact investor. Catalyst pursues market equity returns while creating measurable impact within their investment communities. These dual mandates co-exist, and one does not dilute the other.
Kristian’s expertise comes blasting through in our conversation.
Listen in as he covers:
- Being intentional about investing and making an investment.
- The polarizing response that impact investing gets from the marketplace and the community.
- His description of the generational challenges that have come to the real estate industry since 2019 in terms of Covid, supply chains, inflation, high interest rates, higher op. ex., and soon enough, higher property taxes.
- The value of a good local development partner when allocating joint venture equity into development deals.
- How Catalyst’s impact scorecard allows them to objectively quantify social impact independently from financial analysis.
- How Catalyst has successfully formulated and closed a fund with two classes of investors, one class that accepts a lower return in exchange for social impact, and another class that is market rate.
- And finally, Kristian’s mindset as a fiduciary in both the short and long term.
Transcript
Announcer:
Welcome to Offshoot: The Fident Capital Podcast with host Kevin Choquette. Offshoot is a curiosity driven conversation that features a wide range of real estate business professionals. In each episode, we unpack the knowledge, vantage point, and domain expertise of our guests. Then we move beyond the facts and figures and dive into the personal habits and mindset which allow them to be high performers in their respective field. This podcast objective is simple, supporting entrepreneurs, fostering relationships, and uncovering meaningful conversations that positively impact business.
Kevin Choquette:
Welcome to episode 17 of Offshoot with Kristian Peterson. Kristian is a seasoned commercial real estate entrepreneur with over 20 years of experience in the institutional investment space as a managing partner at Catalyst, allocating joint venture equity into the real estate development deals and raising capital for the fund has refined sense of what it means to be an impact investor. Catalyst pursues market equity returns while creating measurable impact within their investment communities. These dual mandates coexist and one does not dilute the other. Kristian’s expertise comes blasting through in our conversation. Listen in as he covers being intentional about investing and making an investment.
The polarizing response that impact investing gets from the marketplace and the community. His description of the generational challenges that have come to the real estate industry since 2019 in terms of COVID, supply chains, inflation, higher interest rates, higher opex, and soon enough higher property taxes. The value of a good local development partner when allocating joint venture equity into development deals and how Catalyst Impact Scorecard allows them to objectively quantify social impact independently from their financial analysis. How Catalyst has successfully formulated and closed a fund with two classes of investors, one class that accepts a lower return in exchange for social impact and another class that’s market rate. And finally, Kristian’s mindset as a fiduciary in both the short and long term. I hope you enjoy the podcast.
Hello, everyone. Thank you for tuning into another episode of Offshoot. Today Kristian Peterson, a managing partner at Catalyst Opportunity Funds is joining us. I’ve known Kristian for just a short period of time through introduction of a mutual friend Peter Kleinberg. However, in much the same way a five-year-old can ascertain musical virtuosity as easily as a PhD in music. It didn’t take long to realize that Kristian’s incredibly sharp and capable. He’s also thoughtful about the impact his professional actions have on the broader community. And you need look no further than Catalyst, a double bottom line investment firm to see evidence of this. Kristian has a rich background in commercial real estate that spans over 20 years. Just before Catalyst he spent 11 years at Fortress as a senior vice president working on private equity and credit funds. While there, he led several investment initiatives including securitization of over a billion dollars in middle market commercial real estate mortgages and the management of over 3.5 billion in assets.
Before joining Fortress, Kristian worked as a director of consulting for a sustainability advisory firm providing original best practices and decision support to portfolio managers at global real estate companies. He also worked as an advisor within a private real estate syndication firm, underwriting over $2 billion of commercial real estate acquisitions, assembling a due diligence team and developing their processes to evaluate acquisition and development opportunities. Kristian holds a BS from BYU and an MS in real estate from MIT. He also has some pretty unique credentials on blockchain and sustainability. Outside of the professional, Kristian is a skier, which he gets to do from his home in Sundance, Utah, and an avid outdoorsman. He’s also a freak of an aerobic athlete. He was recently telling me of his resting pulse of 65 and an OSAT of 85 while he was hanging out at the 17,000-foot base camp of Everest. That’s 100% not normal as there’s literally 50% as oxygen up there. Translation, don’t think you’re going to keep up with him on a bike ride. Kristian, welcome to Offshoot.
Kristian Peterson.:
Yeah, thanks, Kevin. And I’d reciprocate some of the positive things you said about me having skied with you a time or two. You are a force to be reckoned with yourself on the mountain as well as you know your way around mountain bike trails, so I’m not sure I’d go head-to-head with you, but I appreciate the generous [inaudible 00:05:01]-
Kevin Choquette:
Maybe on the downhill that’s true, but I know you’d smoke me on the up.
Kristian Peterson.:
Maybe so. We’ll have to put that to test this summer.
Kevin Choquette:
There you go. Well, hey, to get us started, can you just tell me about Catalyst and maybe what does a double bottom line investment firm or an impact investor do?
Kristian Peterson.:
Yeah, no, I’d love to share a little bit about our organization and what we do is we do feel like we are unique within the marketplace and in offering double bottom line investing without having any compromise or trade off in the return profile that we seek. And as you mentioned, my path to get here brought me through the private equity world and through Fortress Investment Group where I had a great career and learned a significant amount of commercial real estate, really across the entire capital stack, whether it was debt and structuring and organizing, debt security offerings through CLOs or whether I was working on the equity book. Just had an array of experiences there. And Catalyst came to me somewhat in a traditional Utah kind of a way. At the time I was living in Dallas working for Fortress and was out here. As you mentioned, I’m an avid skier and was on one of my ski vacations out here with a friend of mine who is a large developer in the Salt Lake region.
And we were having a bluebird Alta day with some fresh powder and he looks at me on the chairlift and says, “Hey, have you ever thought of moving back to Utah?” And I thought, what a day to ask me, fresh snow on a clear day at Alta. Of course, the only answer is yes. And just as life evolves and the way things happen, it was maybe a day or two later where I got a text message from him and he was wanting to connect me with one of my current partners, Jim Sorenson and my other partner Jeremy Keele, who just so happened to have been launching a real estate fund and neither one of them had really come from a fund management background. And so very fortuitous that the three of us got connected and started Catalyst. Now we’re about hitting our fourth year mark at the end of this month.
Catalyst, our tagline is we’re a transformative real estate investment firm that focuses on superior returns and measurable impact. And we believe that those don’t need to be mutually exclusive. It’s been an interesting journey to get us here. And how do you thread, and we’ll get into it a little bit later, but how do you thread what measurable impact is and what does that look like in the context of a real estate project? One thing that I probably never accounted for in my journey here when we had formed an organization around capital doing good is just how polarizing even the idea of doing good with capital is and how it has become over the last several years. I think from a political perspective that we’ve gotten to the place in our own democracy where even the doing good and impact investing can be a polarizing topic.
Kevin Choquette:
What does that look like? How do you mean? I just want to jolt down on that, do you get negative reactions from people who hear that you’re seeking returns and having impact?
Kristian Peterson.:
Yeah, we do. And I think there’s a lot of misconceptions in the marketplace around what it means to be an impact investor and it is distinctly different from what we probably hear more of in the news media around ESG investing or environmental social and governance investing. And they are related in some ways and distinctly different in others. And I think it’s really the ESG element of it that has become so political and polarized over the last several years really both from the right and the left. And there is a, I think a misconception in the marketplace that when you’re investing for good, that trade-off has to be made for your other fiduciary responsibilities of generating market rate returns. And Catalyst really set out on a mission to prove to the marketplace that it doesn’t have to be an either or. And in fact, often it’s an and, and there is a virtuous cycle of when you are investing intentionally, there can be additionality that’s added to your return. And it’s not always in the negative in the way that I think the news media tries to paint it.
Kevin Choquette:
So, on the, let’s just say diehard capitalist side, maybe there’s an orientation that your value proposition is being diluted by including this social impact component. And then on the naysayer side, let’s just call them the anti-capitalist, they just are completely skeptical about it and think you’re, if you will, greenwashing the whole thing.
Kristian Peterson.:
Yeah. You nailed it. Those are the two opposing views that we often find ourselves in the cross-hair of. And I’d like to say obviously from a biased fund manager perspective, but over the last four years I think we have proven out that it isn’t an either or and you can be a capitalist while doing good. And certainly my partner Jim Sorenson over his career has made that his mantra and has really spoken not only nationally but all over the world on this concept of impact investing and how there is and how there is not a trade-off with return.
Kevin Choquette:
What about the opportunity set? I would imagine it has to change, the things that you guys would look at as an unfettered, if you will, opportunity fund would include, let’s just say the entire universe of real estate. Well, you probably would fence it in and get into certain product types and geographies, but you’re putting another layer over it. So, how does that change the opportunity set for you guys?
Kristian Peterson.:
Yeah, and it’s a really good question that I think we have to grapple with as we look at new funds and new fund strategies that we put out there. And it really centers around the idea of what is doing good. And I think you could make an argument and you hear arguments made, and I’m not going to attack anybody’s viewpoint on what is doing good, but on the one side of the scale, you could take the most liberal view and say building a hotel is an impactful project because you’re creating jobs all across the economic sector, whether it’s service jobs or professional jobs, and therefore it’s an economic development for that community. And that certainly is a viewpoint that somebody can take. We tend to be more programmatic about how we define what good is. And we do this through a proprietary impact scorecard that we’ve developed that really categorically puts to a quantitative scale where we see an impact being made within a traditional commercial real estate project.
And those categories that we have really fall into five key areas, we look at things like housing affordability and we’ll take a project and as we do a financial underwriting, we’ll do an impact underwriting. And one of the metrics we might look at there is how many units of this particular project are delivering to the missing middle or the workforce housing, which is somebody who’s earning somewhere between 60 and a hundred percent of the area median income. We’ll look at in a second category revitalization. What is this project doing for a distressed neighborhood? Is it bringing in new economic development? And is that economic development being done in an inclusive way including the community that it’s being built in? We look at access to services and these are things that I think most of us listening to the podcast probably take advantage of in our own daily lives, but in a lot of our communities across the country, things such as access to healthy food options through grocery stores or medical services by having a urgent care clinic in the community.
These are things we’ll refer to as food deserts or medical deserts. And there are large swaths of our population where have been underserved in these very basic necessities that I think many of us take for granted. And then we’ll look at things like environmental sustainability. Every project we do, we try to hold to the highest degree of environmental sustainability that we can, whether it’s through water conservation or energy conservation. And then the fifth category that sort of overlays on everything is diversity and inclusion. And I think as many of us know, and I think is well understood by those both inside and outside the industry. The commercial real estate sector is not very diverse whether you’re looking at people of color or women owned owned firms. And so we try to address that and everything that we do, and I think we take a lot of pride in the projects that we’ve done to date.
Over 60% of our partners come from a diverse background. And when we take that whole scope of those five key areas, we translate that into what we call our impact scorecard and we score a project in each one of those and there’s baseline impact profiles that we need to achieve in order for us to move forward for that second bottom line piece of it. So, it has to make sense from a market rate perspective on a return profile and then it has to make sense from an underwriting on an impact profile as well.
Kevin Choquette:
And you guys, you’ve had considerable success. I think you’ve shared with me in the past the size of fund one, and I think you’re rounding out fund two, this message that you just shared is a little bit nuanced and I can imagine speaking to LP investors who might be handing over discretion to you guys that, well, let me ask it this way, how is that message received?
Kristian Peterson.:
I think that message has been received very well. We champion ourselves as, or we think of ourselves as champions of this message of being more intentional about the investments that we’re making and for our particular firm doing that within the context of real estate. And we really have two investor classes if you want to think about them that way. One is a group of investors that probably weights the impact nature of the projects that we’re doing. And so they’re investing with us because we are developing in communities of color because we are bringing services into underserved areas.
And then we’ve got a group of investors that may be a little bit more agnostic towards the impact investing but are investing because they like the markets that we’re in and they like the return profile that the project is generating and their preference for the impact may be secondary to what it is on the return. And this is really, I think an outcome of the balance that we’ve always been trying to strike at Catalyst that we are a market rate non-concessionary fund that is trying to deliver an impact. And I think it might help to paint just to put a little bit more context and definition around it to paint a picture of what one of these projects looks like that we think is a good showpiece for that.
Kevin Choquette:
Yeah, that’d be great.
Kristian Peterson.:
So, one of our first investments in the fund one, and we closed out fund out at around 250 million and really did the bulk of that raise in the middle of the pandemic while sitting in our attics, which was an interesting place to launch a new fund working from home. But one of the first investments that we made out of that fund was in a project in Tacoma, Washington with a female led development firm. And she had really spent the last several years and had track record of delivering workforce housing in that 80% of AMI range without having to take any LIHTC or other federal government subsidy. And through her efforts, she was able to obtain a TIF from the state of Washington that helped abate some of the real estate taxes over a period of time in exchange for delivering it for the state of Washington.
The requirement is 20% of those units at 80% of AMI. And put this project in a distressed community in the hilltop neighborhood of Tacoma. And at delivery we were actually able to lease those units at about 70% of AMI and had about 160 units. Because of the acute need for housing meeting that level of income demographic, the first month alone, we received over and executed over 80 leases and had 50 move-ins and were able to basically fully lease that building within about a two and a half month period. So, it really proved out to us, if you go back to those five pillars of impact that we were addressing a housing need in the greater Seattle area. And then on the ground floor space, and this is where I think what we bring is a new way of thinking to a very traditional model of commercial real estate instead of building a business center that would likely never get used or lightly get used at best, is we held back about 3000 feet of ground floor space for community services.
And we went and approached the city of Tacoma who had a co-op grocer that was looking for space in the neighborhood. This is in one of those food deserts that I identified earlier where people living in this neighborhood historically had no access to healthy food. So, we leased about half of the space to them. And then the other half of the space, we were approached by a credit union based out of the Seattle area with a strong credit rating behind them that came to us and said, there’s things such as financial deserts, just like we have food deserts and medical deserts where there’s a significant portion of our population that doesn’t have bank accounts, that has never had a debit card, that has low financial literacy.
And so they signed a long-term credit lease at two times what our underwritten rent was in the project to bring in banking services to a community that had been underbanked. And so we look at that against those five pillars, we were able to address most of those through housing affordability, bringing access to services, doing it through a diverse sponsor and doing it in a historically under invested in distressed neighborhood. And we’ve had tremendous success in doing that. And that’s pretty emblematic of the projects that we look and that we have done in our portfolio.
Kevin Choquette:
And so is that, I’m listening to what you’re saying and I don’t remember what the old phrase was for the banks and banking where they would, is it redline a neighborhood?
Kristian Peterson.:
Redlining. Yeah, yeah, redlining.
Kevin Choquette:
So, we would say, I’m just going to say 92101 because downtown San Diego. Yeah, look, we’re not making any residential mortgage loans in 92101, which in your sort of comments of food deserts and financial deserts, the reason that was outlawed is because it was a reinforcing behavior. As soon as the capital was pulled out of that market, it imploded. I’m wondering if what you’re explaining is this radical idea or at the same time also incredibly obvious, there hasn’t been anything perhaps brought into markets like this.
You guys come with a new source of capital and surprise, surprise, the market responds. It just seems like it’s not obvious because there are parts of towns and even towns in their totality that capital steers away from. I just wonder what your comments might be on that. Because it strikes me as both very progressive and insightful and you’re a bit of a renegade to do it. And then at the same time when you explain the result, it seems perhaps a little bit obvious that you would get that kind of a result of 80 units a month or on 150 unit project. I mean, okay, then nothing’s been delivered and how long, of course there’s pent-up demand.
Kristian Peterson.:
Yeah, I do think what you see across our urban fabric nationally is a byproduct of redlining. And in addition to that, we find this particularly in areas in the southeast of where infrastructure was used as its own form of redlining where freeways were intentionally put through on a north-south access through Nashville and in an effort to basically create physical barrier from historically African-American neighborhoods from the white neighborhoods on the other side, downtown adjacency. And we’ve encountered this a lot, whether we’re doing this in Nashville, whether we’re doing it in Winston-Salem to some degree this happened in even places in the north like Minneapolis. And I think there is a little bit of shift in mindset when you go into neighborhoods like this. And I’d be probably remiss to say that it wasn’t easy going in the first time into a neighborhood like this, but I’ll share another example, which is in Minneapolis and neighborhood there called the Seward neighborhood, which is historically has been an immigrant neighborhood.
It’s currently dominated by a Somali population. And we had an opportunity in our fund one to look at a project that had been in the planning and development phase for several years and they had put together some tax increment financing. They had gotten some grants from the state and the county and had put together a capital stack and were short on the majority of the equity and they had a hard time sourcing the equity. And they came to us and said, “Hey, would you look at this project?” And so we went out there, this was a neighborhood that had not seen a market rate development in over 40 years. And it’s hard to contextualize that in almost four decades in almost an entire generation, you had not had a new project built that wasn’t done under section eight housing. And we had to get comfortable that in that neighborhood there were community members who would stay in the neighborhood or who might move into the neighborhood if there were quality housing there. And this particular neighborhood was one stop away on the light rail from downtown Minneapolis.
We liked that it was adjacent to the Hiawatha trail. It had a lot of good fundamental real estate characteristics, but for sitting in a neighborhood that had been underdeveloped and underinvested in. And we did our diligence and we take everything through a rigorous institutional due diligence process, which comes from my team’s collective experience at places like Fortress or Goldman or CIM. And we came to the conclusion that we could get comfortable with the potential renter base there. So, again, we built about 140 units in this neighborhood and we leased that project up in about four months at really no compromise and actually at a higher rent than what we had originally underwritten and did this in the middle of November in Minneapolis, which is not a ideal time to be delivering a new project.
And what was really, I think helped prove out our thesis is over 50% of our resident population are Somali, and these are Somali families who had no quality housing in the neighborhood and as they moved up the income scale and could afford better housing, what would traditionally happen is they would leave the neighborhood and basically leave the neighborhood and in a lower socioeconomic way. And we were able to retain them in the neighborhood, retain those families who wanted to stay and live in the community that they were in. And I think that really helped us understand that you really have to do your due diligence and there is a renter base, and I think a lot of traditional private capital groups that may not be the project for them because they may not get comfortable with or maybe wanting to do the legwork to really understand where those renters are going to come from.
Kevin Choquette:
And what does that legwork look like? I mean how do you start with, hey, nobody’s done anything for 40 years in here and maybe we should do our homework and see if there’s a good investment here? I mean, it’d be pretty easy. Well, look, I’ll tell you my experience of capital is with very few exceptions, well, I don’t want to overstate this. There is oftentimes a reluctance to do the hard work of thinking about something that’s not what has been done before. So, how do you approach something like that and go, right, so how are we going to figure out if there’s an opportunity here?
Kristian Peterson.:
Yeah, and I think this comes back to our DNA of being community investors as part of our tagline is there has to be, you’ve got to have a good strong local sponsor. And from Catalyst perspective, we’re LP capital providing equity to local developers and ground up development of primarily workforce housing and in some cases addressing some of those service holes that we talked about. So, it really starts with us by having an underwriteable sponsor. And these are groups that traditionally have track record, they’re well regarded in their community. We did another project in North Minneapolis, which I think had a very similar dynamic to South Minneapolis where we’re one of the first projects in that neighborhood in several decades. And our sponsor in that neighborhood is a pillar of the community in that neighborhood. And he understands what the needs are of that community.
He understands where the demand’s going to come from. We look for additional capital that’s been going into the neighborhood, whether that’s through a nearby hospital system, maybe that hospital system’s undergoing an expansion. There has to be a demand driver just like any other fundamental real estate underwriting that you would do. So, it’s having a good sponsor, it’s understanding the demand dynamics in the neighborhood. And then I think the third and maybe equally or more critical piece is just engagement in that community. And so when you have a good sponsor, they’re fully engaged in the community that they’re in. And we have a project that we just wrote a term sheet on in the Winston-Salem market. I like this example, is a best in class developer who’s really engaged with the community. And so in this particular project, in order to help understand the needs and the demand, and this is in one of those traditionally redline districts where the freeway bifurcated the traditional African American neighborhood.
And here we have a diverse sponsor who’s built a coalition with the local health system in the Winston-Salem area who’s gone out to about a half a dozen other local groups to really understand where their needs were for housing. And these are groups like the school district or the community health hospital that’s adjacent or the fire and police. And that’s really core to what we’re delivering in that workforce housing. And he’s built out a model that basically shows this pent-up demand by understanding the needs of this various group. And that’s one way where we can look at one of these neighborhoods and before we go into it, really understand is the demand going to be there? And I think as we’ve proven out in several of our projects now that this model does work and it does require maybe a new way of thinking as a capital provider, but we see these communities that have been underinvested and you can make money in those communities. You just have to be smart about how you do it.
Kevin Choquette:
Yeah, I love it. To be honest, I didn’t realize there was so much texture to what you guys do. I mean, we’ve had some conversations around it, but you’re definitely explaining with more rigor how nuanced the opportunity set it is and how you go about finding it, underwriting and securing it. If we go to just today in the business, what’s happening with you guys and what are you seeing? What challenges are you facing?
Kristian Peterson.:
Yeah, I’ve jokingly deemed this era of commercial real estate that we’re in as we’re living through the seven plagues right now. And I start that with the pandemic displacement that we had and the pandemic displacement of residential tenants, of commercial tenants and is really my plague number one, which fed into, and I think everybody’s going to be licking their own wounds on many of these points, but fed into the supply chain issues. And we started this fund six months before the pandemic had hit and had to-
Kevin Choquette:
Perfect timing.
Kristian Peterson.:
As I mentioned earlier. Yeah, great. Yeah, don’t follow my career in timing, because I came out of graduate school in 2008 or 2009, launched my first fund and six months before the pandemic came out of my undergraduate basically in the 01 dot com crisis. So, anytime I make a major life move within my career should be an early indicator for the rest of the industry to watch out. And this one was unique and whether it was the pandemic displacement or supply chain issues that were a result of that, leading into the third plague of high inflation that we’ve all been dealing with now for years and now entering this phase of higher interest rates, the fourth wave coming at us, the fifth one being higher opex expenses, particularly across our multifamily assets and acutely within insurance, which is really part of this feedback loop that we’ve been living in because we had supply chain issues and higher costs, now we’ve got higher insurance because the insurance companies have to underwrite higher replacement costs and maybe they’re seeing additional risk because of some of the things that we’ve experienced in the last several years.
And I think we’re entering a phase now in a sixth plague and this one will has a lag effect to it. And that’s that I anticipate seeing significantly higher real estate taxes, whether that’s driven by some of the significant increase that we’ve had in rents in some of our markets and multifamily projects or one that I think that doesn’t get talked about within our urban core that we’re watching very closely. And as you leave, as the office sector largely pulls back from downtown, you’re going to lose a significant of your tax base in a lot of these urban cores. And that tax hole has got to be plugged by something. And I think what that something is, is probably the multi-family that’s come in, in the last several years and this kind of regentrification of downtowns. And so I don’t know that we’re fully out of this feedback loop and I don’t know what the seventh plague is.
I’m sure there’s something out there and it’s required us to be innovative. Launching a business in 2019 and having to live through this. These are issues that are generational issues. And I think anybody who’s been in the business the last four or five years have been having to deal with generational issues and succession and it’s required us to be constantly innovating. And I think our second fund is really a byproduct and an example of how we’re trying to innovate and to remain not only true to our mission of delivering market rate, double bottom line returns through impact investing, but also having to maintain that market return profile. And so maybe if I have just a minute, if I could explain what we’re doing in our second fund.
Kevin Choquette:
Yeah, absolutely.
Kristian Peterson.:
Because it addresses your question about how we’ve had to innovate. So, going back to the beginning of the podcast, one of the five pillars of addressing social impact that I think we have almost permeating throughout our entire book is really this idea of workforce housing. And anybody in the housing sector, I think it’s well understood that the federal government has had a decades long program now within LIHTC or Low Income Housing Tax Credit that has been inefficient in terms of its tax efficiency in delivering housing to the population that’s making between 60 to call it 80% of the area median income. And it’s never enough. And so I don’t want to pretend that it’s a sufficient amount of housing, but there is a delivery mechanism there for that income demographic. And I think we’re all well aware that market rate housing to the income population that’s making a hundred to 120% of our immediate income has its own efficient delivery method.
That’s I think what general multifamily housing development will do, but there’s this cumulative housing gap that according to the last study done by the National Association of Realtors in 2021 was that 5.5 million housing units short across the country. And that because of these pressures that we’ve had from higher costs higher now borrowing costs and has slowed down the delivery and has priced many people out of housing, that housing gap now has grown to about 6.8 million. And when you look at who is that group of 6.8 million that doesn’t have housing, the bulk of that group is this income demographic between 80 and 120% of AMI. And that particular segment of the population is really the backbone of our community. That’s the police officers and the teachers and the nurses. And while there are very good housing preservation funds out there that basically buy class B product and maintain that within the overall housing supply, there really has not been many innovative approaches to creating new housing for that income demographic and really addressing the supply shortage.
And what we’ve done is we’ve looked at that problem and through most of the call it 20 deals development projects that we have going right now are addressing some form of that housing. But as the pressures of borrowing and as the pressures of higher cost and construction materials have really put pressures on the model of delivering in that 80 to 120% even with having some public subsidy, whether it was a TIF or abatement or other programs. And so when we’ve had to address this problem, we looked at it, we said there’s, there’s still work to be done on the equity side. And so when we went back to our investor base, we found that we really had two different classes of investors. We had, as I mentioned earlier, a class of investors that was driven more by the impact profile of the project but still needed to make positive return.
And then we have the class of investor, which is your traditional real estate investor that wanted to see a market rate return profile. And so when we took the problem of delivery of workforce housing and the pressures and we looked at our own portfolio and our own investor profile, we came back to the drawing board and said if we created a fund structure that basically blended down the overall cost of capital that’s needed for these projects in order to unlock more of that project in an affordable price point, that we could do that through a fund structure. And so we’ve, in our second fund offering, we have two classes of investors, a class A investor, which is a traditional market rate investor and a class B investor, which is a lower yielding, generally more institutional investor that will take a reduced spread relative to the market in order to deliver those workforce housing units.
And when we run this through our fund structure, we are now able without any compromise of return to our class A investor and without any compromise of return to our developer partners, but taking that return difference between the A and the B class and putting that back into making these projects more affordable, that we have a structure now where we can take most traditional market rate projects and create 50% plus of those units being at an 80% AMI. And that’s really the focus of our second fund is focusing on that supply delivery of workforce housing and doing it through capital stack innovation at the fund manager level.
Kevin Choquette:
At the asset level or the pro forma associated with the asset, does that translate into accepting a lower cap on cost or a lower spread between the pro forma terminal cap rate and your cap on cost?
Kristian Peterson.:
Terminal cap rate remains unchanged. Most of these rents will probably get marked to market, but by bifurcating out the return profile from the project level down to the class A and class B, there’s no impact on the class A return. The overall IRR of the project is blended down lower, but when you split that blend down between our A and our B, the class A investor is still getting what they would expect in a target multi-family return from any other, the Class B investor is basically absorbing the difference of that return in order to enhance the affordability of the project.
And we have now field tested this on projects and have built a core investor base around this, and it was really listening to what the needs of our investors were and taking the needs of those investors and applying that to projects to solve a problem while still maintaining an underwriteable able deal. And it was a journey to get there, but we think that this really could unlock a lot of opportunity in building workforce housing and because we are headquartered here in the Intermountain West and much of this housing affordability has probably disproportionately hit many of these communities in the Intermountain West and west coast. A lot of the focus of our fund capital will be in delivering these 80% of AMI projects within the Intermountain West and west coast region.
Kevin Choquette:
I love it. It’s super innovative. I haven’t heard anybody trying to do it, but my world is sort of asset level. You’re running the fund, so let’s go with the geographic thing. You had mentioned previously where there’s a freeway separating the good part of town from the bad part of town. We got two 100 unit projects that are identical and for the sake of making this simple, the rents are the same, useful fiction. One of them is targeting, say 80% of the units, or sorry, some large percentage to be 80% AMI. The other one is market rate.
Actually it’s even better to say the same. They’re both doing the same rents and they’re both say building to a 575 cap on cost. If Catalyst comes over to the mission-driven side of the freeway and brings this structure, is it probable, possible, even relevant that instead of both of them having to build to that 575 cap on cost that the mission-driven one might be able to underwrite to a 55 because the cost of the equity capital is marginally less and therefore either you could drop rents or you could absorb more construction costs in pursuit of putting products into that marketplace in order to get deals done? Am I thinking about it the the right way at the asset level?
Kristian Peterson.:
You are you thinking of it contextually in the right way and there are, as you know on the finance side of the business that you’re on, is there are favorable debt financing available when you are addressing that level of affordability and whether it’s through regional banks, we have one here in Salt Lake that at that level of affordability will give us more favorable DSCR coverage in exchange for delivering that affordability. They’ll also give us slightly higher proceeds, maybe relative to a quote on a market rate deal. It’s made us more attractive to Fannie and Freddie. It prioritizes us in 221(d)(4) HUD applications. And so we think that not only is there benefit and potentially some lower cost of capital on the equity side, but we’re also seeing some more favorable terms on the debt capital side, which allows us to be equally competitive.
We also think it’s a much stickier renter pool. We think there’s knock on effects and lease up velocity. We’ve seen this across our portfolio, the example that I gave in the greater Seattle area of the velocity we had. I think we had a good product in a good location, but I also think a lot of that velocity was driven by just this absolute dearth of available product within that AMI price point. So, when you factor in both the economic direct benefits and maybe some of these indirect knock-on effects, we think it’s a very defensible thesis to have.
Kevin Choquette:
Yeah, it’s fascinating. I want to be mindful of your time. We discussed that at the outset here and I want to transition towards a little bit of the personal stuff. I love everything you’ve been sharing. What has been your experience of starting Catalyst? You’ve talked to it, but what are some of the takeaways, some of the things you might share for the listener just in terms of if you had known maybe I wouldn’t have done this or things to avoid or any of that.
Kristian Peterson.:
I think in the business that we’re in is being fiduciaries and we take that very seriously. And in terms of the way we approach and manage the business. I like to think of myself as a short term optimist and a long-term pessimist. So, I need to be conservative in my views in the long-term and maybe how things are going to turn out, but in the short term, I need to be optimistic. And we’ve had plenty of challenges thrown our way as I mentioned launching in the pandemic and it was daunting to have left a fairly good position at a large institution like I was at and to six months later be in the middle of our capital raise. I don’t know that we had raised maybe 25 million when the pandemic hit and there was a moment where a decision had to be made and that was we were either going to press on and know that we were going to be successful and do whatever it took to get there, or we could have said timing wasn’t right and we’re going to fold and go our different way.
And I think our thesis, I think our mission resonated. I think it resonated even louder during the pandemic when a lot of these issues about disproportionate health effects of COVID was having in these underserved communities that didn’t have access to services core to the mission that we have or the housing shortage that I think we were all experiencing coming out of the pandemic. And by really sticking true to our thesis and being a daily optimist got us through some very challenging times and a very challenging environment to be an entrepreneur. And we’re still faced with that today.
Our second fund, we’re having good success, we’re going to have our first close in the next 60 days because I think our housing mission resonates and I think our innovation and our capital stack that we’re doing at the fund level resonates and it addresses a problem that didn’t go away just because we’re faced with these other macroeconomic challenges. And so having started this business in 2019 and having all these challenges thrown at us, I think has made us a better organization because we’ve really had to innovate. We’ve really had to take these on with a positive attitude.
Kevin Choquette:
Well, you’ve articulated a lot of objective data-driven processes to assess what you were explaining as impact. I’m curious if you reflect back on it sounds like there was a moment or maybe several where it was like, hey, is this the right time, right place, or should we just hang this up? What was the blend of data-driven analytics that supported the decision to stick it out versus emotion and grit?
Kristian Peterson.:
Yeah, I mean I think just as an entrepreneur problem identification and then finding solutions for that problem. And I think the one data point that keeps coming back to us is, and I probably will come back to the housing pillar, because that’s really where the focus of our current fund is, is this housing shortage isn’t going to go away. And I think it’s one of the largest generational challenges that we’re going to be faced with is our socioeconomic split in such a way that our rich are getting richer and the poor are getting poorer and the middle class is continuing to get squeezed.
And so long as we have a product that’s addressing that problem, whether it was through our first fund, which took advantage of the opportunity zone legislation, whether it’s the second fund that is innovating in a way within our own fund structure, when you’ve got a solution to a problem, which we believe that we have, I think that’s really the drive that keeps us in the business. And I think it’s resonating with the capital markets and I think that’s a good indicator that what we have is what the market needs at this time.
Kevin Choquette:
Yeah, that makes sense. Look, continuing on the personal side, my question to you, I mean we’ve rescheduled this probably three or four times, because you guys are going 60 miles an hour plus sounds like long days and very, very driven organization. I also know you’ve got three kids and a wife, the little league extracurricular activities that percolate with that. Just on the personal level, how do you wrap your arms around those competing mandates? You’ve clearly got the professional pretty well dialed and you’ve got a high level domain expertise that may or may not cross over to the home life, but it seems like from my perspective, you do a pretty good job, but I wonder how you think about your personal life and this which clearly could just consume you.
Kristian Peterson.:
Yeah, yeah, it’s a good question. I think one that many of us probably struggle with, and I try to distill it down to its simplest solution where I think it’s carried me through whether it was demanding positions before Catalyst or starting a business in the environment that we’re in. And I think it boils down to just being present, being at home for those little league games for your spouse when they need it, being present at the business, when the business needs it. And it’s always out there. It’s a 24-hour job when you’re a small business owner.
But the thing that I think has remained consistent in a true north for me is always be present and that that’s easier said than done at times, but it does sometimes mean making some trade-offs. And those trade-offs generally I think come in personal time. And so I may leave work early so I can be present at my son’s baseball game and that trade off may mean that I’m having to work later that night. And that’s how I’ve managed that. And I think it’s equal on the work front as well is you need to be there. And as you get older and mature in your career, I think you get better at doing the triage of where you’re most valuable and when. And that’s how I try to balance all those different areas of my life.
Kevin Choquette:
What about, if you will, the end of the day notion, how do you kick up your feet, find relief and recharge, as Kobe says, sharpen the saw?
Kristian Peterson.:
Yeah, and for me, and I think this is personality driven, but for some people I think kicking up your feet is the recharge for me, it’s generally being outside and that is going to entail a level of activity. So, my recharge is tearing down a mountain on a pair of skis or out trail running or on a bike. And I think maybe it’s a fortunate personal characteristic that my recharge and exercise can align so they’re not competing with each other. But recharge for me, I’m not one that sits well on a beach with a drink in hand.
Kevin Choquette:
Totally. I just have a question, because you guys are Salt Lake and Salt Lake is clearly a major MSA, but it also has all of those lifestyle amenities that you’re alluding to. Just curious, is the home base of Salt Lake a net negative, net positive or a non-factor when you’re out in the capital markets talking to people?
Kristian Peterson.:
By and large, it’s been a net positive factor and there’s a couple of reasons for that, but Salt Lake has been by virtually every economic indicator, whether it be unemployment or GDP growth or diversity of the economy. There’s many accolades I think for the metro area that has made it an attractive place and we were out doing our initial fundraising. We do have a good footprint and a significant footprint here in Salt Lake within our fund that has been by and large a positive factor. There are not a lot of institutional capital managers in the Intermountain West region and so groups that are looking for exposure in a market like Salt Lake or Boise or any of these other high growth Intermountain West communities, there are vehicles, but there’s not a lot of vehicles for them to get access to that. And I think it’s been a significant part of our success.
Kevin Choquette:
That’s cool. We’re coming up on time, so I think I’ll just give you the mic. Anything you want to share with the audience, be they the entrepreneur, the developer, the guy who’s trying to get capital formation underway and maybe is a first time fund manager or maybe somebody who’s just right in the middle of a hard asset and or hard fund that’s turning sideways because of interest rates. I don’t know any sort of last thoughts. And certainly if you want to leave any digital, any sort of contact points for Catalyst, obviously Google will probably cover that, but I’ll give you the floor and then we can wrap it up.
Kristian Peterson.:
Yeah, I would say to anyone out there, we’ve talked about the macroeconomic challenges that we’ve had, we’ve had challenges at the asset level. It’s just part of being in the commercial real estate business. It’s been part of my career for the last 25 years. And whether they’re asset level, macroeconomic level, we’re always trying to problem solve. And I think what’s helped me over the course of my career, and particularly as we’ve been starting Catalyst is it’s easy to panic and now is not the time to panic and generally is never the time to panic. There are solutions to most problems and I think if you go into it with the understanding that you’re going to have challenges and those challenges are going to need to be solved, whether it was like we talked about a few minutes ago, the pandemic, it would’ve been easy and probably a rational decision to have stopped our fundraising efforts and said, let’s go do something else.
Or as costs were going out of control on many of our projects. I think we could have panicked or we’re having an issue with one of our office buildings now where we’ve lost major tenants. But I think maintaining a level head is going to serve anybody well, particularly in the times that we are in now. And that’s easier said than done, but having done this now for a number of years, level heads generally prevail. The sun does shine tomorrow, although it doesn’t always feel like it and just remain true to your principles and I think you’ll find yourself that most of these problems will work out in the long run.
Kevin Choquette:
Yeah, good advice. Kristian, thank you very much for taking the time to speak with me. I appreciate it. Listeners, thanks for listening through the entire pod. My crew always tells me to remind you, if you can put a review up on whatever your platform is, that’s always welcome and thanks again, Kristian. Much appreciated.
Kristian Peterson.:
Thank you.
