Forward Thinker: Richard Litton Discusses Multifamily Investments

In the exclusive circles of commercial real estate investment, Richard Litton’s name stands out. Litton serves as president of Harbor Group International and chairs the firm’s investment and credit committees, where he oversees a portfolio with $12 billion in multifamily assets, $3 billion in office assets, and a $5 billion credit and alternatives vehicle. 

What makes Litton even more interesting is his previous life as a corporate law partner in commercial real estate finance, and his prescient decision more than a decade ago to slowly extricate HGI from the office sector and move the firm’s investment capital into multifamily. 

Litton sat down with CO to discuss his career, the last 20 years at HGI, and how CRE investment strategies require constant reevaluation. 

This conversation has been edited for length and clarity.

Commercial Observer: How has Harbor Group International’s investment strategy evolved over the last 20 years? 

Richard Litton: There’s just been geographic growth for us from less than $1 billion assets under management (AUM) to $20 billion AUM, so growth has come a couple different ways. First, we’ve significantly grown geographically. When I joined it was very oriented to the mid-Atlantic and the Southeast with some isolated investment in the Midwest, and over time we’ve become truly national. The other thing that’s been important is our different investment strategies and products. When I joined we weren’t making any debt or credit investments. We started that in 2007 with preferred equity financing and mezzanine loans, we started investing in bonds on Wall street during the Global Financial Crisis (GFC) and have steadily built out a variety of different credit strategies. So we’ve both grown geographically in terms of where we own real estate and we now have a $5 billion credit business, which didn’t exist for us before 2007. 

Another great change coming out of the 2008 financial crisis, and it was a very good decision, was to orient ourselves more and more to multifamily. Back in 2009, we were 50 percent office and 50 percent multifamily, and had a heavy position in multi-tenant office buildings in a lot of midsize markets. Heading into the GFC, we sold down those assets, and decided to invest much more in multifamily, build out multifamily credit, so today out of our [$20 billion AUM], 83 percent is related to multifamily and to housing, either directly owned or through our credit business. 

And how has your credit strategy evolved in this time?

We decided, as longtime owners and operators of multifamily, that we could invest smartly with other sponsors with preferred equity and mezzanine loans and provide different types of risk-adjusted returns through that strategy. We started that in 2007, and became one of the first providers of preferred equity behind Freddie Mac mortgages. So that was an important evolution of our business strategy.  When there was dislocation in bond markets during the GFC, we raised capital to buy bonds collateralized by real estate where we felt we could underwrite and understand the underlying collateral and take advantage of pricing mismatches in the market to take advantage of the distress. We bought them at big discounts, they snapped back to par, and we sold them. 

The next evolution of credit was in 2015. By that time, Freddie Mac started securitizing their loans and selling off certain bonds to private investors. So we already had this previous bond experience and had built out certain aspects of our credit strategy and had a tremendous relationship with Freddie Mac, as we were so often a borrower from them, so we were part of a small group that had access to the B pieces in their apartment loan secularizations. So we became one of a select few that got regular access to those bonds. We were able to raise capital from foreign institutional investors to take advantage of those opportunities and so that Freddie Mac bond business — we’re in our 11th year with it — have been the largest single purchasers of those types of bonds in the U.S. So it’s a very important part of our strategy. 

What are these bonds like?

It’s cases where securitized loan pools are collateralized by 50 to 60 apartment properties across the country, and we think we have a very good ability to understand and underwrite that collateral. But the last piece of credit business growth came during COVID, when a lot of liquidity drained out of the market among debt fund lenders and other private credit providers. We implemented a whole-loan business where we started originating floating-rate senior mortgages for other sponsors, successfully raised capital around that strategy, and we’ve been in that business into our fifth year and made billions of dollars of senior mortgage issuance or originating our own whole loans. 

It seems you’re very comfortable in the multifamily space. How have you seen it evolve?

One on a macro level, it’s much more of an institutional product class that attracts a lot of institutional capital. If you look by 15 years, or even 20 years ago, the mega-managers wouldn’t be as heavily invested in multifamily as nearly as much as office, shopping malls and hotels, but because rental housing dynamics have been strong, and the supply-demand metrics have generally been good for landlords, you see a lot more institutional capital also investing in multifamily, so that’s led to situations where you have multibillion-dollar deals that occur in the sector that were rare to none 20 years ago. The other overall trend that has emerged is a general housing shortage out of the Great Financial Crisis and given the difficulty of those times, housing wasn’t being built, we created an overall housing shortage in the U.S. And in the apartment market, even though we’ve had a lot of supply that’s come into the Sunbelt, that has come into the market since COVID, we are under supply in U.S. housing. So the overall supply-demand metrics from an investor perspective have been very positive to landlords. 

How were you able to disassociate yourself from the office market so safely?

It’s been an assessment for us where the fundamentals will be and where we can best utilize our skill sets and assess investor appetite and where investors are comfortable. We didn’t go from 50 percent office holdings to 10 or 15 percent for no reason. I was concerned 15 years ago about the lack of prospects in growing rents. When we had 50 percent of AUM in office, we’d own multi-tenant offices in markets like Cleveland, Cincinnati, Orlando and Jacksonville and Baltimore and Norfolk and Nashville and places like that. We owned some in Chicago, as well. But as we looked back on the years leading up to GFC, and coming out of GFC we just weren’t seeing any rent growth. You’d invest in an office in 2003, in some of these markets, and in 2008, even prior to the crisis, rents weren’t moving. We just didn’t see underlying drivers to really move rents, so you were really relying on cap rates to compress to make money. And that’s not a place you want to be. You want to be in sectors where you feel good about the underlying fundamentals, and we had a conviction it would be much more in housing.  

How have you applied your legal expertise and legal career to investing? 

It’s important because every investment is a transaction and there’s a counterparty, whether that’s a buyer, a seller, a lender or an investor, and that has to be carefully documented and to carefully reflect the business deal. You have to think about all sorts of contingencies that might occur as a business matter and address those in a legal document. So there’s a lot of important overlap between business decision-makers and what lawyers have to think about when you’re bringing a deal to a closing table. And what’s important as anything is how risk is allocated. Is it appropriate for buyer to bear the risk? The seller? The borrower or lender? It’s a combination of legal analysis and business judgment. 

What’s your best investment strategy and advice

First and foremost, go work with a firm where you are working with the highest integrity people, with the highest ethics. Go and work for firms or businesses that are growing and trying to be creative about finding different ways to invest in the sector. But also always think about the fundamentals of the real estate: What are demand drivers? What are the factors in the economy that influence how the real estate performs? Don’t get too caught up in the Wall Street trading of bonds and structuring and leverage and financing without understanding the fundamentals at a property level. 

Brian Pascus can be reached at bpascus@commercialobserver.com