Power Player: Walker & Dunlop’s Susan Mello Shares Her CRE Investment Wisdom

As executive vice president and head of Walker & Dunlop’s capital markets division, Susan Mello knows a thing or two about structured finance. A former adjunct professor of law at Rutgers University, Mello practiced real estate development law for more than a decade before spending 16 years as a managing director at PGIM Real Estate, where she oversaw the investment strategy of multiple closed-end equity funds. 

Mello now advises Walker & Dunlop’s team of brokers, and their many clients, on complex CRE transactions and their accompanying investment theses. She sat down with Commercial Observer to discuss her career, the current investment landscape, and how both office and multifamily are adjusting to the changed capital markets landscape.  

This interview has been edited for length and clarity.

CO: What’s it like leading Walker and Dunlop’s capital markets division and what’s your history in the industry?

Susan Mello: I’ve been at Walker & Dunlop since July 2021, so I’m relatively new. I oversee our national debt and equity brokerage business. I also oversee our non-agency debt and equity business, where we’re acting as advisers to our clients and capitalizing their real estate assets, whether that’s debt, preferred equity, mezzanine debt, we go across the capitals stack, as well as all property sectors. The brokers and bankers on my team can do retail, hospitality, etcetera. I came from PGIM, formerly Prudential Real Estate Investment Management, where I was on the equity real estate side, investing equity on behalf of clients for 16 years, before joining Walker & Dunlop to run the brokerage. So I have a background as an investor across all property sectors from the investment management perspective. 

In that case, what’s your best piece of advice when it comes to CRE investing?  What’s the secret to a good deal?

People used to tell me, “It’s not rocket science.” It’s good advice in that it’s more about your experience. It’s more about understanding the property type, the cash flows, where it’s situated. That’s what it’s most about in commercial real estate: understanding your asset and the cash flows and how that impacts your investment. Because we’re investing in an asset where its value should come from how it will operate, and that comes from experience. 

What is your read on the CRE investment landscape today? Is credit more popular than equity? 

I would tell you that credit is still a very popular investment choice for capital flowing into commercial real estate. Credit is still in demand with investors giving money to debt funds to manage it. There is liquidity on the debt side, on the credit side, more so than traditional common equity — that has been a little bit more challenged in the past two years, as valuations have been uncertain. We had an increasing interest rate environment, and that gave equity investors a little bit more pause on where valuations were. Whereas, on the financing side, there was still a lot of liquidity in financing but there were more conservative underwriting standards which led to liquidity being available, but at higher pricing and lower proceeds. That’s what has been going on. 

And what is your take on the phenomenon of debt getting equity-like returns? 

If you’re going higher up in the capital stack, as a lender, and maybe you’re doing a stretch senior [loan] or you’re doing mezzanine [debt] or preferred [equity], it’s because you’re getting returns like equity, but you’re not getting as much risk. So that’s been very attractive in terms of capital falling into this space. But it’s put a damper on equity.

Returns have to be higher for equity for investors to want to put it out, but with higher interest rates and higher costs your returns won’t be there, so that’s been the challenge on the equity side. When equity has been starting to flow into the market, especially over the last eight to 10 months, equity is saying “I don’t’ know where values are going, and I might not be underwriting returns, but I can buy a discount to replacement cost,” so there’s been a big focus on equity, as it’s deciding, “Do I want to move? What’s going to make me comfortable?” You’re underwriting returns and that goes on your assumptions, but your cost basis, people should know how much an asset costs. So if they think they can build something at a discount to replacement cost, that’s where equity has gotten more comfortable coming back into the CRE space.

So if that’s the calculation that investors are making, are we seeing a lot less new construction, or renovations, or purchases with the idea of renovations in mind? Are we simply seeing a resizing of capital stacks with this equity rather than traditional construction financing?

What we have seen, definitely on the equity side, when we’re raising equity, or common equity, for our clients, is that it’s much more scarce on the development side for exactly that point. If your traditional equity investor thinks “I can buy it at $100 per square foot rather than building it at $150 per square foot, I don’t need to take risk of development — the cost overrun risk during construction.” And second is the time. On a development, nothing goes according to a straight line. If there’s a delay in the supply chain, if there’s a delay in getting permits, time is money. And so it’s much easier to buy today, and it’s immediately cash-flowing if you’re buying a stabilized asset. You don’t have that time until you can potentially get cash flow in as you do on a development deal, which might take two years to build. 

That’s interesting. So which asset classes are generating the most investment dollars among your clients, as an underrated asset class?  What is being avoided?

So I’d say the latest darling is data centers. They are really quite popular with investors, but hard to get into. It’s not like a multifamily asset. In a multifamily asset, you kind of understand there’s lots of different tenants, lots of different demand. But data centers are certainly an asset class that’s in favor with investors, if you can get into it. Taking your five major asset classes — office, residential, industrial, retail and hospitality — I’d say office is still uncertain.Questions around valuations and the future use of office space mean that office is not very popular right now with either lenders or investors. It’s very much a contrarian play, and I’m talking about that as a sector as a whole.  

When you’re saying office is the worst, from an investment standpoint, I feel there are many office recapitalizations being done, considering how upside-down the capital stacks are and how badly in need of debt and equity the sponsors are. So what do those deals look like to you right now?

If an office asset is being recapitalized — think a Class A office asset, well located, in-demand office, something like One Vanderbilt or Hudson Yards — the valuations around that make it an in-demand asset. Commodity office, whether suburban or urban, are where you see more challenges. There are some assets that won’t get recapitalized. People will look at it and ask, “What will it cost me to scrap this building?” So there are some that won’t see recapitalization. Someone will take a huge loss, and a lot of the time it’s the lender. It’s not just the equity owner, the equity is out, it’s how much of a loss can the lender take? How much can the lender recover? So let’s put aside the really high-end, in-demand office. You should assume someone is taking a loss on those recapitalizations, it could be the equity, or partially the equity and partially the lender, especially a bank. A bank doesn’t want to have an asset on its balance sheet, so they may be more willing to take a loss on their loan rather than actually get the keys back and reposition it themselves. So everything has a price, and it will really depend on the price for these things to happen. 

Switching gears, I’m particularly curious about multifamily today and how much capital it has drawn from the investment community, especially as it faces down that proverbial “supply cliff” we hear all about. How are you advising clients on investing in multifamily right now?

We’re big believers in tailwinds behind residential housing here at Walker & Dunlop, as you might imagine. We’ve heavily weighted some of our business to housing and multifamily. But the supply cliff, or what it can do for those investors that can be a little patient, is it allows investors and owners to underwrite what will happen in 2027 and in 2028. When you think today about buying or developing a multifamily asset, certainly, the fact that supply should come down in 2026 and 2027 deliveries should impact your underwriting today on your operating fundamentals. You might have challenges with your operating fundamentals in 2024 and 2025, but if you can be patient capital, and underwrite the supply that’s coming to where you think supply will be more limited, you should see more positive operating fundamentals. You’re underwriting on what will happen in year two or three or four, and whether that works for you as an investor. And for patient capital, it can work, especially if they can get it at a discount to replacement cost. 

In your long career in structured finance, would you say equity transactions are more complex than debt transactions? How have they differed?  

I don’t want to say it’s more complicated. It’s a different decision [when it comes to] equity because you’re an owner. If you’re a lender, you have equity behind you, and so in terms of your risk, you’re in a less risky position. So as an equity owner doing structured finance, you really need to understand the ownership structure, and valuations become very important. If you’re a lender and you lend at what you think is 60 percent of the value, you have a 40 percent valuation decline before you’re at risk. Depending on the property type, you’ll evaluate as a lender whether you’ll see that level of decline. We have seen office assets that were 50 percent decline, but generally that’s a large cushion. As equity, you’re the first dollar or risk, and any valuation decline is eating into equity. So it’s a different risk analysis and it’s a different decision. I don’t want to go out and say equity is harder than debt. It’s different in terms of how you think about the investment. 

What type of impact will the interest rate cut have on the final months of the year and entering 2025?  

What most comes from the interest rate cut is it brings a level of certainty. The rate hike cycle is over. I think it’s OK for me to say that [laughs]. That’s what’s been problematic: it’s been the uncertainty around where rates are going. The last time the Fed hiked rates was March 2023 and everyone kept saying, “They’ll start bringing it down.” When they didn’t, especially at the beginning of the year, many in the commercial real estate space thought that rate reduction would come in March or April. And when it didn’t, people didn’t know what to do. Instability, which leads to uncertainty, came back into the market. In 2023, there was a lot of volatility, transactions froze, and no one knew where valuations were going because interest rates impact value. But we came into 2024 thinking there would be stability and then there wasn’t. So transaction volumes were really depressed at the beginning of the year. So what the rate reduction has done is, hopefully, we’ll start seeing 10-year Treasury come down.

Overall interest rates will go lower and, hopefully, cause people to transact more because the cost of capital is less. But just the fact that it brings stability and people feel like, “We understand where rates are and where they might be going, we no longer think they’re going up,” and I don’t necessarily think they need to go down, but I have some stability, which allows me more certainty into making my investment into commercial real estate. That’s what I think it brings. It breaks the logjam that we were seeing because of that uncertainty.  

Brian Pascus can be reached at bpascus@commercialobserver.com