Owning & Operating Multifamily Real Estate Through COVID-19 with Daniel Shaeffer

Daniel Shaeffer, CEO of Cottonwood Residential, discusses how the outbreak of COVID-19 has impacted multifamily real estate.
Daniel Shaeffer, CEO of Cottonwood Residential, discusses how the outbreak of COVID-19 has impacted multifamily real estate. He also delves into the reasons why the market is relatively stable despite the historically high unemployment the nation is currently facing. Prior to the pandemic, multifamily real estate experienced five years of rent growth and two to three years of development growth. Development growth was worrisome to players in the industry due to the belief that it would dilute supply and put downward pressure on demand.

Shaeffer’s properties are concentrated in the higher end of the sector, attracting white collar millennials who are at less risk of job loss than their less institutionally educated counterparts. This debunks the theory that, in a time of crisis, Class-A tenants will migrate to Class-B properties and Class-B tenants will migrate to Class-C properties because Class B and C assets have been impacted more in the current crisis than Class A assets, just as they were in 2009.

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Ryan Morfin:

Welcome to NON-BETA ALPHA, I’m Ryan Morfin. On today’s episode we have Daniel Shaeffer, the CEO of Cottonwood. He’s going to share some of his thoughts and insights about owning and operating a large multi-family portfolio due to the Coronavirus crisis. This is NON-BETA ALPHA.

Ryan Morfin:

Daniel welcome to the show, thanks for joining us.

Daniel Shaeffer:

Glad to be here. Perfect day to talk about real estate.

Ryan Morfin:

So Cottonwood is a large owner and operator of multi-family across the country. Multi-family has gone through a little bit of a volatile time, but it is a pretty stable asset class. Would you mind sharing a little bit of your thoughts of where you thought the forecast was for 2020 prior to the Coronavirus shock and then how it’s changed and what your outlook looks like going forward?

Daniel Shaeffer:

Yeah, great question. So as we rolled into 2020 the market was very, very strong. It was strong in terms of occupancy, it was strong in terms of rental rates. We really were on the back of five straight years of really, really strong rent growth. Driven mostly by incredible demographics. I mean both the Millennials and the generation following Millennials are the biggest size wise of any generations in the US history, and for a lot of cultural reasons and I think cost reasons, tons of those people are delaying home buying and they have been. They delaying marriage, they’re delaying having kids, so they tend to be apartment renters for much, much longer. That trend has been like this wave that’s been washing over the entire industry over the last five or six years, so all of us have had just unbelievable rent growth.

Daniel Shaeffer:

In our world we typically model a 2% to 3% annualized rent growth, and probably over the last five years we were averaging 4% to 5%. Some years better than others, but it was a very, very strong period in the industry. We’re not like tech companies that have crazy growth, I mean it’s still very stable, but because these numbers are big and they move very slowly, it’s just this wave that’s slowly just washing up over the industry so it was very strong. What had been happening, particularly in the last two or three years though, was a lot of new development was starting underway. So pretty much in any city we operate in, and our business operates in the largest of the Sunbelt cities, so we’re in places like Raleigh, Charlotte, Tampa, Orlando, Atlanta, Nashville, Dallas, Houston, Phoenix, and all great cities but everyone of those cities had cranes in the air building apartment buildings.

Daniel Shaeffer:

There for a few years I was really worried about over supply, but what’s been happening is there’s been so many people in this demographic that all of us have been filling up new units. I think there was some concern that the number of new units going into 2020, and ’21, and ’22 really next few years, was going to be more… It was going to be enough that it was going to start putting some pressure on rent growth. So that was a concern hanging out there, but otherwise, other than that concern financing was cheap, you could get plenty of leverage on deals in the capital markets, and I think all of us felt like 2020 and 2021 were going to be pretty solid years. Maybe not the 4% to 5% rent growth we’ve been seeing but probably still very solid 3%, 3.5%. Even with all the new supply coming online.

Daniel Shaeffer:

COVID threw a wrench in it. However, when the dire forecasts were starting to roll out in early March and everybody started talking about hey who’s going to pay their rent in April? And you heard things about national rent strikes and you heard about all the job losses coming. We were all, as owners and operators, taking bets on what we thought the collections would be. Not only do we own a very large portfolio, we also manage a separate account for a very large institutional partner. Our institutional partner, they were predicting 50% to 60% of the people would pay rent. And we did all sorts of calculus on our own portfolio and we needed about 70%, 65% to 70% of the people to pay rent for us to cover not only our mortgage expenses, but all of our operating expenses and our people.

Daniel Shaeffer:

I felt pretty sure we were going to be in that zip code but you just didn’t know. Low and behold in April we collected 98% of what we collected in the first quarter. That is a little higher probably than the industry average. I want to say the industry average probably ended up at 95% or 96%, but the whole industry did really well. Now nobody wants to be down 4% or 5%, but relative to where we could have been things were much better, much more stable than we expected. And so we didn’t know if it was only going to last a month. Well low and behold in May also we collected 98%, and so far in June, the month isn’t over, today is June 23rd. We’ve collected 96% already for June. Literally I mean with each month has been within a few thousand dollars of the prior month.

Daniel Shaeffer:

I think part of that and when you think about multi-family you have high grade, really high quality stuff, and then you have kind of really, really basic housing. The guys that manage more basic housing stuff have been hurt harder because the people who’ve lost jobs tend to be lower on the wage scale and so they’re renting cheaper apartments. Our apartments are what I would say A, A-, so we’re generally have working professionals, young working professionals in our units, but we’re not the highest end but we’re closer to the high end. I think our demographic of renters has been less impacted by COVID. You see them a lot more, and the things that really worried me and concerned me is virtually every municipality we worked in, we also have a few properties in Boston, we have one in Portland, Oregon. Some cities are more liberal than other cities and were much more aggressive of not allowing us to evict people during the pandemic.

Daniel Shaeffer:

Anybody who came to us and said, “Hey, I lost my job because of COVID,” we have tried to work out payment schedules. Hey pay this much this month and we’ll let you pay us back around three or four months. We’re not charging people late fees, we’re not aggressively pursuing anybody. But then the CARES Act came out and the CARES Act basically said anybody who has mortgages that are financed by Freddie Mac or Fannie Mae you have a moratorium on any evictions. A huge portion of the multi-family market is financed by Freddie Mac and Fannie Mae. I would say probably more than two-thirds of our properties have that kind of financing on them, and that moratorium goes through July 27. I know you’re based in Dallas. Typically in Dallas if somebody doesn’t pay us we can evict them within three or four days for non-payment once we’ve gone through the rent.

Daniel Shaeffer:

Now under the CARES Act you have to give people a 30 day notice, and so realistically if somebody is living in one of our units today and is not paying, for any reason we can’t move to evict them until the end of July and we have to give them a 30 day notice, so they can really live in our apartments through the end of August. And so when all these regulations were being thrown on the industry nationwide, I think we were all pretty nervous. But low and behold our worst fears just haven’t played out. People still pay their rent. People don’t want to get behind on rent, they don’t want to have their credit impacted, and I think the social contract of paying your rent, paying your bills as Americans is still largely intact.

Daniel Shaeffer:

Yes we have properties that you have a few people who’ve wanted to have a rent strike and wanted to make an issue out of it but haven’t, and haven’t been successful. Generally speaking we’re trying to work with people. Where do we go from here? What’s going to happen for the rest of 2020? What’s going to happen in 2021? I’m going to roll the tape back about a year and a half ago. We began thinking about leasing units differently than the rest of the industry. Thinking about leasing units differently than we’d ever done it and different than anybody else had ever done it. So for anybody who’s listening and you’ve gone into a large apartment complex or a high rise and wanted to rent, you typically will meet a leasing agent who’s effectively a sales person who will then take you on a tour of the property and try to get you to sign a lease.

Daniel Shaeffer:

It turns out Millennials don’t really love hands on salespeople. I mean all the studies say that Millennials like to shop on their own, they’re online people, they do virtual tours. Everybody today who’s signing leases or are doing rents they do it on their iPhone. They don’t want to sign paper leases. They’ve already toured your unit, they’ve already toured your complex online, they’ve shopped all the competitors, they know everything about you when they show up to tour your property. We started thinking differently like we probably should change our model on how we lease. Now mind you our industry is old school, it’s very slow moving, and nobody has really done this. We said, “Let’s maybe move away from the old leasing agent sales model, let’s go to more of a hotel, concierge model.”

Daniel Shaeffer:

You walk into one of our properties into the office. We have a concierge who greets you, and the concierge then gives you the information that allows you to tour the property on your own. If it’s a garden style apartment where that’s more spread out we’ll give you a map and we have bread crumbs that show you signs to how to get to the three or four or five units that are vacant and you actually can see the unit you’re going to live in. No more model units where we’re trying to fake you out and this is beautiful, then you rent something that’s totally different and you’re not happy with it. You actually see and tour the unit you’re going to rent.

Daniel Shaeffer:

Low and behold guess what? People like that more. Our closing rates started going up when we allowed people to start touring on their own. And this is important for COVID, and I’ll come back to it in a second. The other thing that it allowed us to do is to rethink about our staffing model, because now we didn’t need so many people in the office because our concierge was there. You didn’t have two or three people out on site constantly touring, and what happens when you have two or three people touring, a new prospect comes into your office. What do they see? They see a little sign on the door that says, “Hey, be back in 10 minutes or be back in 15 minutes,” because the agents are all out on tours and somebody who shows up to tour can’t get a tour. Well nobody in our industry waits around. The Millennials they pick up and they go to the next property, they don’t sit around and wait for your 15 minute clock to go by.

Daniel Shaeffer:

We got rid of those clocks because there’s always now somebody in the office, and it creates more of a sense of urgency if there’s two or three people touring at the same time on their own. And finally, major problem that’s been happening in our industry over the last five years probably has been packages. If you think about the volume of Amazon packages showing up in an apartment complex everyday when you’ve got 300 units. Everybody’s ordering two or three Amazon packages a day, it’s a major shipping center. People in our industry have thrown out their hands. Some have just let people through the properties, the delivery guys. Some have tried package lockers, and we’ve said what we’re going to do, because we’re not spending as much money on payroll to have leasing units on site, we’re going to extend our hours. So instead of being open from 9:00 to 5:00, which most apartment complexes are to keep their employees happy, we’re now open six days a week from 8:00 to 8:00, we’re open Sundays from 10:00 to 6:00.

Daniel Shaeffer:

We did that because the Millennials who want to tour, they want to tour when they’re not working, they want to tour after hours. We want to be open when the customers want to come in, and because of that we can also deal with packages. So now our office just happen to be package centers, and so because we’re open either before your job or after your job, you can get your packages everyday from us, and if you want to ship something you can just leave it in the office because UPS and FedEx are always coming through. And so we solved a whole bunch of problems at once.

Daniel Shaeffer:

But what happened when we rolled into COVID and this is why when I talk about what’s going to happen this year with rents it’s important. When we rolled into COVID we were able to stay open. Our concierge’s put on masks, we sanitize the offices, and people who wanted to tour during COVID, and believe me there actually were people still touring and signing leases, they still came in. All of our competitors closed down. All they could do was do virtual tours and hope people would lease online. And some people do that but most people actually want to see what they’re going to live in before they lease.

Daniel Shaeffer:

And so we were able to continue leasing during March and April and May, but what happened is a lot of our competitors could not, they shut their doors. The old leasing agent, give a tour model didn’t work during COVID like a self-tour did. And so their vacancy started falling, and when our competitors vacancy started falling they started throwing concessions out there. Giveaway, like hey, we’re going to give you a month of free rent. So what’s happening today is a lot of people, a lot of competitors are finally starting to open their doors again, but they’ve lost 5%, 10%, 15% points of occupancy because people slowly have been moving out and they haven’t been leasing and so now they’re throwing concessions on those marginal units trying to lease them back up this summer, and that’s putting pricing pressure on the whole market.

Daniel Shaeffer:

Now luckily for us, because we were leasing that whole time, we maintained our occupancies high. When we’re competing we’re only competing with our marginal units that are vacant because we’re just a lot more full than everybody else, but I predict that for the balance of 2020 rates are going to be lower because people are going to try to lease back up. I would expect to see rates somewhat down to flat for this year for our business. Some markets are going to be worse. New York City, Los Angeles, San Francisco have actually seen pretty sizeable downdrafts in rents. The Sunbelt markets we’re in have been actually pretty flat. I got a list last week from my team looking at every property we manage and own, and probably 50% to 60% of them are flat, probably a third of them we’re going to increase rents 2% to 3% because there’s still plenty of demand, and probably only 5% to 10% actually we worried about the new rents being a little bit lower than the [inaudible 00:14:51] rents.

Daniel Shaeffer:

It’s going to be a soft year and probably 2021’s pretty soft as well from an operating standpoint. What does that mean? That means valuations are probably down a little bit. If you’re looking at a current NAV on your property or on a whole portfolio of properties it’s probably down a little bit because the net operating income likely will be down a little bit for 2020 versus 2019. That all being said, I mean with interest rates falling and now the fed pumping so much liquidity in the market that Freddie and Fannie have come back to the lending world, we think CAP rates might actually go down from here. Even if you have a bit of softening and NOI, you may have CAP rates going down and offsetting some of that value loss. We’re thinking properties are down 5% to 10%. 10 would be high, probably more like 5% is worth settling out.

Daniel Shaeffer:

Two months ago we all were guessing properties were down 10%, but there’s been such a snap back in economic activity and the collections have been so much more stable than I think any of us guessed, that we don’t think it’s going to be that severe long-term. I’ve been talking for a long time, I’ll let you dive in [crosstalk 00:16:00].

Ryan Morfin:

No this is great. I didn’t want to interrupt you.

Daniel Shaeffer:

[crosstalk 00:16:03] stream of [crosstalk 00:16:03].

Ryan Morfin:

You kept giving me what we were looking for. I mean so the question is values are down 5% to 10%. Would you attribute most of this… Do you think we’re in a V shaped recovery is the first question? Is that what you’re seeing in the market?

Daniel Shaeffer:

A month ago I would have told you there’s no possible way we’ll have a V shaped recovery. Today I don’t think we’re going to have a V shaped recovery, but I think certain parts of our economy will recover quickly. Other parts are going to be hard. I think there’s been permanent damage done to small businesses. I think you’re going to see a third of the restaurants disappear forever. I think the hotel sector’s going to take a long time to heal itself. So I do think airlines, I mean I’m trying to book flights to go tour some of my assets. The availability of flights schedules is way off, though it’s coming back pretty quickly. Even versus July. July there’s a lot more flights available than there were even in June. And so I was very bearish and I was expecting a very deep and long recession. I’m less so today than I was a month ago. I still don’t think it’s going to be V shaped but I don’t think it’s L, I think it’s a modified U.

Ryan Morfin:

Yeah, it’s interesting. I’ve been surprised. I think you hit something succinctly though. I think class C markets, class C assets across the country are getting crushed. This really impacted I think the lower income households more than it did the service economy households.

Daniel Shaeffer:

It did for sure. Also the other asset class you’re seeing getting crushed are people that were buying class B deals and overpaying for them in the hopes that they were going to do this massive value add and were going to increase the rents and turn over the rent roll. It’s really hard right now to increase rents in existing place and turn over the rent roll. Because there’s just not enough demand with nicer guys like us now competing for those tenants. However, we’ve done a ton of research on this. If you look back to the Great Recession, and I’ve heard guys out marketing. Hey, in a recession people move from A to B and B’s move down to C’s. People say that because it sounds logical, but it actually doesn’t happen that way.

Daniel Shaeffer:

And if you look at the data it’s all about employment. And so if you look at during the Great Recession, people with college degrees, when we went into the Great Recession the unemployment rate was 2% for people that were college educated. It got all the way up to 5% unemployment for college educated people. For people who didn’t have a college degree and there’s a couple of different categories, people that had just high school, people that had some college. The unemployment rate for people with just high school spiked all the way to 17%, so it was three times as great as the unemployment rate for people who had a college degree. Now it started higher, at 5% or 6%, but the spread was so much wider.

Daniel Shaeffer:

What we learned actually is that people who owned A class apartment properties, their tenants were much more likely to keep their jobs. So people weren’t just looking to save money to move down. If they kept their job they kept their apartment. People did not want to change their lifestyle, so what happened is the B and C properties actually got hit a lot harder during the Great Recession and the exact same thing is happening here. We used to own a bunch of B properties, and that’s why we did this research and over the last decade we basically sold pretty much everyone of those properties and rolled in the newer class A deals because we wanted that demographic, we wanted that college educated higher workforce demographic to protect the portfolio. And that’s kind of what’s been happening I think.

Ryan Morfin:

Yeah, no I think that is absolutely what’s happened. I think the data about jobs though, I think we had great numbers in May but we dropped a lot of jobs. And so I guess the question is, is your outlook on jobs do you think we’re stable or do you think there’s going to be another wave now that the PPP program rolls off in the summer? Will there be more unemployment? What are you guys thinking? How are you forecasting that?

Daniel Shaeffer:

Well I mean you can call me a cynic but I’ll be very, very surprised if we don’t extend unemployment benefits, at least through the election. This is so political, and I don’t really want to get into politics here because I’m not a political person, but those unemployment benefits, more than even PPP, I think are underpinning economic activity in this country. And so somebody who is one of those B or C renters, they may not of yet had the full transition to unemployment that will happen at some point. And so depending on how we manage that and how much of our fiscal budget we want to throw at that will determine the severity of the recession.

Daniel Shaeffer:

There’s another problem obviously, which is that the more money we print effectively to cover these problems, at some point the pothole we’re filling in gets to a fill and creates inflation. But we all said that in the Great Recession and we never had any inflation, so I don’t know if we’re going to have it this time around either. But I think the fiscal stimulus today is helping us not go into as deep of a hole, and so what I don’t know, we’ve tried to get data but it’s really impossible. What I don’t know is what percent of my own tenants have lost jobs. Now my tenants generally are college educated, they work in higher quality job sectors that haven’t been as hit by COVID, but there’s still companies scaling back. I mean we haven’t laid off anybody in our company because we’ve needed all of our employees, but a lot of people I talked to have used this as an opportunity to cut back anyway.

Daniel Shaeffer:

It’s very, very hard to say what’s really going to happen with jobs. I think the $600 a week per person is masking the true unemployment and the filing. I do think as long as that’s out there those continuing claims are going to stay very high. I do think the worst of it’s behind us, but I don’t know how quickly it rebounds. But you’re seeing more and more calls for a V type recovery, so honestly I don’t know what to tell you. I’m not an economist, I’m just looking at my own business, and I am really surprised at how stable our business has been.

Ryan Morfin:

Well your former employer and mine, Morgan Stanley, has called for a V shape, Wells Fargo has called for a V shape. I mean it’s interesting and the jury’s going to be out, but I do think yeah, a lot of young people right now are saying, “Please fire me, because I’d rather stay unemployed because I’m getting more money than you were willing to pay me,” which is ludicrous incentive but I think that’ll eventually run out and it’s going to then start to have some ripple effects. Hopefully we can get the economy rebooted. Your comment on inflation’s interesting. I don’t disagree, CPI’s been low, but I think there has been inflation, I just don’t know how we measure it and I don’t know what the real estate community talks about. Hard assets, the stock market, it seems like the central banks have surgically injected steroids into certain hard asset classes. Is that a conversation that you guys are worried about or have you guys had that thoughtful conversation with the V industry is how much of this is central bank tinkering versus real value appreciation?

Daniel Shaeffer:

We do talk about that. I mean if you’re an apartment person inflation’s generally good if you’re properly capitalized. But real inflation, that means rent’s increasing, which they have been. If real inflation is there and you have an accommodative fed, that means your CAP rates are going to stay low, you’re going to make a lot of money. The inflation that is dangerous, of course, is just asset bubble inflation. When you don’t have any real incomes because we could find ourselves in a situation where incomes are not rising so we’re not able to push rents and CAP rates kind of stay flat.

Daniel Shaeffer:

Now if there’s even more inflation you could actually be flat on rents and incomes and still make money if you believe CAP rates are going to continue to go down, and for us CAP rates are effectively they’re a yield on cost. And so if the fed is pushing down interest rates and assets are in a bubble, that means our assets are appreciating, our yields on costs are getting lower and lower and lower, and we’ll still make money in that situation. The trickiest situation is when interest rates rise and you have actual… No inflation or deflation, kind of a stagflation scenario is what is the killer for our industry.

Daniel Shaeffer:

Most people I talk to actually believe that we will have continued pressure, downward pressure on interest rates and continued stimulus from the fed from now through eternity. I mean I say that, I’m 50 years old this year.

Ryan Morfin:

Infinity QE, yeah.

Daniel Shaeffer:

So I’m saying, “Hey, for the next 20 years of my career, by the time I’m 70 what’s really going to happen?” Nobody I talk to thinks we’re going to have massive spike in interest rates or CAP rates during that time period. We all think yields will stay low, which is going to basically put an anchor on values for us to the downside, which means we’re all probably going to do pretty well. At what expense? At the expense of our children’s generation because they’re going to be loaded with so much fiscal debt? I mean at some point we got to grow the economy to at least have the output equal to GDP at the debt equal to our output. I think it’s going to be tricky because we push through that debt equal to 100% GDP issue. That seems to be a weight on growth for any industrialized economy, so I do worry about that in our country.

Ryan Morfin:

Yeah, no I’ve been telling people it’s got to be productivity enhancing growth, investments, plus classic core hard assets is a pretty I think sound strategy. As it relates to the Millennials, why do you think people are waiting longer for household formation? What’s driving that trend?

Daniel Shaeffer:

You know I have my own personal theories on it. I don’t totally know, but if you go back to the late 60s, early 70s, it has been a steady increase. I have this chart I show people, I don’t have it in front of me, but it’s right around the year 1970. The average age a man was getting married was 21 and a woman was 19. Maybe that was in the mid 60s, let’s say 1965. Well today the average age now is 27 and 29, and it’s always been this two year difference in age, which is interesting but it’s continued to increase and increase and increase. I think part of it is lifestyle honestly. I think people are playing longer and wanting to enjoy their single years more. I think it’s a lot more difficult today.

Daniel Shaeffer:

If you live in a city, one of the major cities I invest in or one of the coastal cities, it takes a long time to save enough down payment to buy a home, even with rates as low as they are. Home prices are very high. I mean we track home prices to rental rates kind of on a parody. When you look at adjusted mortgage versus rent ratio, and it’s continually been more expensive to own than buy for the last two decades. There was one little blip during the Great Recession where they averaged out for a year or two, but now it’s right back up. I think it takes a long time. I mean I don’t think we’ve had tons of wage growth, so I think because of that it’s hard for people to be in a position where they’re comfortable buying a house.

Daniel Shaeffer:

I also do think there’s a cultural motive to being closer to the cities. I think the Millennials they care more about their lifestyle necessarily than hey I’m going to work super hard and buy that house and start the mortgage. I don’t think they care as much about their parents life as maybe we did, our generation did.

Ryan Morfin:

Yeah, no and that’s interesting. I mean do you think that… I mean places like New York City you’ve seen a lot of an explosion of interest to move out of the city and less dense environments. Do you think that’s short-term or do you think that some of these mega cities… Now you guys are in the Sunbelt so those development pathways are more spread out and less dense, but do you think some of the highly dense places like San Francisco, LA, Chicago, New York, are they going to see reduction in demand due to the pandemic going forward?

Daniel Shaeffer:

I think the short answer is yes, but I think if there’s a vaccine or the pandemic effectively disappears I do think there will be… I think those people will come back. I think one of the reasons those cities have performed so well… Maybe not Chicago. Chicago’s a bit of an exception to the rule only because of it’s own fiscal problems it’s created that made it hard, and Chicago’s still a great town. I mean I lived in Chicago, I love that place. But it’s own fiscal situation’s made it tough to attract new businesses. You look at the coast, they have done very, very well. They’ve had outsiders return for a long time because people want to be there, and they want to be there because there are great jobs there, there’s great cultural life there, there friends happen to be there.

Daniel Shaeffer:

I think the work from home thing and the get out of the city and have space is nice and it may, even on the short term, you may have family formation happening more rapidly for a while, but I think that unwinds itself once the pandemic goes away. In the assumption that there is a vaccine and this isn’t something we’re living with forever. If this is sort of a new normal and we’re distancing forever I think people are going to think twice about being in crowded spaces. But the youth don’t seem to care. Everyplace I go and I’ve been anybody below 30 no face mask, they’ll hang out with their friends, they don’t even care about COVID. It’s the rest of us and I’m not that worried about it. I’m 49 turning 50, but I think people who are in their 40s, 50s, and 60s seem to be more concerned about it, probably more aware of the risks maybe than the 20 something year olds are.

Ryan Morfin:

Yeah, no are you guys changing maybe your future CAP X plans given that people are not working more at home, higher speed internet fiber. Are there CAP X decisions that are going to change given people’s work posture?

Daniel Shaeffer:

You know a little bit. I think one of the trends that we were seeing in new developments is a push to a lot of co-working areas in your own complexes where people were [inaudible 00:30:22] work, and I don’t think people want to use those as much anymore. So the whole co-working concept may not be as important for a while. People I think want to be in their own space. I do think having high speed data’s important. We have really high speed data in most of our properties already. That’s something you have to have to keep the Millennials around anyway. Our investment philosophy this year has changed a little bit because it’s really been pushed more by the capital markets.

Daniel Shaeffer:

When the pandemic first started happening there was a complete short-term collapse in the capital markets for real estate funding, and the mortgage REITs who were always the lender of filling in the marginal gap, I would say, totally imploded. I’m sure you guys have followed that pretty closely, and their lenders were basically liquidating their own collateral as fast as they could, so there are all these secondary impacts. Well long story short, that basically caused most construction lenders, traditional banks, to pull back on what they were willing to lend on. They got much more choosy about where they would go, much more choosy about what types of developers they would work with, and then they all pulled back on leverage. A typical lender that would loan you 65% or 70% of the costs of a new development now are saying, “Hey, I’ll give you 55%?” And so we’ve seen a huge hole open up in the capital market for developers and institutions looking to build deals that now have a gap, they have a funding gap somewhere between 55% and 65% to 70% of the capital stack.

Daniel Shaeffer:

And so overnight we started getting phone calls from people who needed to fill that gap. That gap before was never as wide, it was more people would get a construction loan and then they were just trying to fund… They’d maybe split the equity in two pieces. A piece from 70% to 80% of the capital stock or 85% and 85%. 100% would be the common equity. Before people were pricing that preferred equity security, that mezzanine slice, 11% or 12%. And overnight that market went to 15% to 16%. And so when you can put capital in a new development and you’re only 80% of the capital stack so you have a bunch of equity cushion behind you and you can still make a 15% or 16% return, I mean we were pricing developments before, you were only making 18% or 19% on the common equity with a lot more risk. And so we’ve been able to de-risk our investments and increase the yield at the same time, and so we’ve been aggressively pursuing those types of situations.

Daniel Shaeffer:

I don’t know how long that window will be open, maybe a year. After that probably things start tightening back up. There’s just a lot of cash on the sidelines, right? So once people get comfortable investing and the capital markets start healing themselves again, those really sweet opportunities will disappear. I just don’t want to be kicking myself a year or two years saying, “Now why didn’t I buy every one of those I could have?”

Ryan Morfin:

Yeah, no that is a good risk adjusted return. I think the question I have for you then is how has the pricing on the debt changed? Is is flat? Are credit spreads gapped out a bit for the construction financing?

Daniel Shaeffer:

Credit spreads to construction lending have gapped out a little bit. Before you could borrow LIBOR plus 300 on a construction loan. LIBOR plus 285, that’s probably now LIBOR plus 350, but LIBOR’s basically nothing and so you’re only talking about half of a percentage point increase in rates. It’s really not that dramatic. The rates on the Freddie and Fannie stuff gapped out initially but have tightened right back down, and so it’s more just a willingness for a lender to take risk right now. I’m sure they’re calculating their own books. Hey, what’s going to happen with all these retail centers where the restaurants aren’t paying, what’s going to happen with our hotel clients? They’re trying to reserve capital to deal with. Real estate deals up for certain will be a problem.

Ryan Morfin:

Yeah, no we’ve talked to some bank CEOs recently on the show and they’ve got their corporate credit books now. It’s not the real estate causing the problems, it’s the tenants so it’s going to be very interesting. Well I know that I was talking to some former colleagues that are at Wells Fargo now and the CMBS program. I guess the multi-family, CMBS programs are going to come back this fall. Is that what you’ve heard as well?

Daniel Shaeffer:

I mean I’m hearing some rumblings about that. I mean CMBS is usually the first thing to go and the last thing to come back. I would say this, people who’ve done CMBS loans and then lived through when the CMBS market has a crisis, probably will opt to never do CMBS loans again. I only say that because in our early days of our business we did CMBS. It was cheap debt and readily available and was easy to get. But the problem is when you’re in a recession and anything you need to deal with at a problem at a property you have to go through… Because the whole thing’s been securitized you end up having these servicers and special servicers, and it’s really complex web of individuals you have to work through to get approvals and everybody wants to charge you a toll through every gate for every response.

Daniel Shaeffer:

Well when you have a single lender or you work with one of the government agencies, Freddie or Fannie if you’re in the multi-family business, obviously if you’re in another business that you can’t use those guys, it’s much easier to service those loans and issues than it is through the CMBS world. We’ve avoided CMBS in the last cycle. Most of the people we know and work with have as well, but there is a place for them. They’ll do higher leverage, riskier deals, and it will come back. There’s a demand for that paper.

Ryan Morfin:

Yeah, no the servicers are interested in prolonging conversations, not expediting them because they make their ticket every month they charge the trust. That’s a [crosstalk 00:36:24].

Daniel Shaeffer:

Yeah, I mean once the deal goes to special servicing it’s really hard to get it out.

Ryan Morfin:

Well it seems like there’s not going to be a lot of distressed debt though. You speak about equity gaps in construction financing, but we haven’t seen a lot of people saying to lenders like here’s the keys, we’re done. I don’t think we’re going to see that in this recession.

Daniel Shaeffer:

You’ll see some of that I predict and it’s going to be very localized to hotel operators and to retail operators who can’t stomach it, can’t make it through. There was an article in the Wall Street Journal a couple weeks ago about hotel owners who were largely CMBS were not getting forbearance agreements, were not getting any action. The CMBS guys were taking action and foreclosed, where hotel operators who had traditional banks as lenders, or life insurance companies, were easily getting forbearance agreements. It’s a strange world of haves and have nots in the hotel world. Retail was already struggling because of the Amazon effect, and now you have multiple bankruptcies as all these bankrupt tenants are renegotiating their leases it’s going to have substantial impacts on owners of that retail, both the mall people and even a lot of the strip center guys.

Daniel Shaeffer:

I think guys who are in the grocery anchor are probably in much better shape, but how many of those small businesses in those centers are going to go out of business permanently? I think there’s going to be some pain in those two sectors and there may be some really good buys there. There’s so much money they’re waiting around for it, but I think that stuff’s going to get overbid pretty quickly.

Ryan Morfin:

Yeah.

Daniel Shaeffer:

If you’re owning office buildings or multi-family or storage, there’s just not going to be any distress most likely. I haven’t seen one deal trade hands in the last quarter. Nobody really knows where the market is and everybody I know is just saying, “Let’s just hit pause, let’s just wait until we have some price discovery.”

Ryan Morfin:

Yeah, and I think people are going to amend their exit horizon just because they’d rather wait it out versus get liquidity at 5% to 10% below proforma. Any things that you’re reading right now or any books or podcasts you follow or people that are influencers that you’ve been keeping tabs of that not only track your industry but just the markets in general?

Daniel Shaeffer:

I’m a little more of a history reader because I like to think about how things today rhyme with things that happened in the past. I’ve finally, this books been a long time, but I’ve been reading the book about Truman, it’s a pretty big tone and it’s just so interesting to see what was happening back in that time period. You see parallels about what’s happening today, what happened in our Great Recession, what happened now. A book I read during the last recession, which I refer to a lot was a book called The Panic of 1907, and it is an unbelievably well written book on economics. Basically the cause of the panic in 1907. The underlying cause, it was a credit crisis, and it seems like every one of these financial crisis that at least I’ve lived through there is some type of credit crisis. There was a short one now, we’re still living through it. There was a massive one in the Great Recession. There was even a credit crisis during the dot com route. There’s a credit crisis in the late 80s, early 90s.

Daniel Shaeffer:

The panic in 1907 was brought on basically by the great San Francisco earthquake, and when the earthquake happened it caused massive fire, and when the fires didn’t get put out for weeks in some places there was basically a liquidity trap because there was so much gold tied up in the vaults of the banks in San Francisco that they couldn’t settle payment across the United States with the gold, underlying gold because the safes were so hot from the fires it took months for them to be able to open the safes and get the gold out. And so it caused this liquidity crunch and that was before the Federal Reserve was formed and JP Morgan himself had to pump tons of liquidity in. Then there was all sorts of structural issues that caused this cascading liquidity crisis in our country, and really precipitated the founding of the Federal Reserve.

Daniel Shaeffer:

Super fascinating book. I do like economic history as well. There’s a book called Keynes Hayek and it’s about the two different philosophies and they were contemporaries with each other and the book talks a lot about the two of them in World War II on the roof of a church trying to fight the fires as the bombs were being out. Then the book goes into talking about their different economic theories and it’s really fascinating to watch. We live in a Keynesian world, right? Our world has gotten so far away from free market economics, but I think we still have to study economics to understand where we’re headed as an economy and make good decisions. Obviously we all became Keynesian’s the second the COVID thing hit because we wanted the government to start throwing money and resources at every one of our businesses to keep us afloat during a pandemic.

Daniel Shaeffer:

I guarantee it, every decade there’s some crisis that’s going to hit us and like clockwork, if you look back all the way to the early 70s it’s been every decade some new crisis hits us and it’s some new black swan.

Ryan Morfin:

Well Daniel I won’t tell the folks at Hyde Park or [inaudible 00:42:00] that you’ve become a Keynesian, but I do appreciate you joining in and sharing your insights, it’s been fascinating conversation. Would love to have you back in the months ahead to share more thoughts and thank you so much for joining us.

Daniel Shaeffer:

Yeah, love to give you an update in a few months and thanks for having me on the show. I really appreciate it.

Ryan Morfin:

Absolutely, enjoyed the conversation. Thank you so much.

Daniel Shaeffer:

You’re welcome.

Ryan Morfin:

Thank you for watching NON-BETA ALPHA, and before we go please remember to subscribe and leave us a review on Apple Podcast or YouTube channel. This is NON-BETA ALPHA and now you know.

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Ryan Morfin: Welcome to Non-Beta Alpha. I'm Ryan Morfin. On today's episode, we have Pini Althaus, CEO of USA Rare Earth, talking to us about the supply chain glut in rare earth minerals. This is Non-Beta Alpha.

Ryan MorfinPini, Welcome to the show. Thank you for coming on today.

Pini AlthausThank you for having me, Ryan. Good to be here.

Ryan Morfin: So you're an investor and a miner in rare earth minerals. Can you share with our listener base, what are rare earth minerals? Why are they important and why is there a geopolitical race going on globally?

Pini AlthausYeah, I mean, rare earths are an extremely ubiquitous part of all advanced manufacturing or technology manufacturing today's day and age. Several years ago, I had not heard too much about rare earths myself. I was not that familiar with it and being involved in this sector, in this company, for the past few years has given me an education of course. And I mean, I was sad to hear that 50% of all imports into the United States contain are earth elements and it runs the gamut from consumer electronic devices that we use every day. Our cell phones, our laptops, most communication devices, medical equipment. So there's a tie with COVID, which we can touch on at your discretion. Electric vehicles, defense equipment. So pretty much anything or everything high tech today has a rare earth element or critical minerals contained within them.

Ryan MorfinAnd what are some of the names of some of the more important rare earth? I know there's lithium for batteries, but what else is considered in this category, critical?

Pini Althaus: Yeah, so lithium is a separate category to battery material. The rare earths are 17 rare earths. The four, let's call it, key rare earths that we're focused on at our company, the four rare earths that go into the permanent magnets. And these are the magnets that are found, there are a number of them in your back of your cell phone or an iPad. But if you look at an F35 striker jet, you've got about a ton of rare earth magnets in those. And we've got two heavy rare earths and two light rare earths is part of the permanent magnets. You've got dysprosium, ytterbium are the heavies, and then you've got neodymium, praseodymium as the two light rare earths. So those would be key rare earths that are the focus.

Ryan MorfinAnd you use these in, I guess, in military applications as well, but historically, where has the United States sourced the rare earth for supply chain?

Pini AlthausYeah. And that's the shocking part. We've been securing those materials from China. So China controls the rare earth sector and has done so for the past 30 years or so. And it was a significant misstep on the part of the United States, allowing China to have this control. And actually this wasn't a question of China coming in and doing anything nefarious as far as stealing IP or anything. The US government made a conscious decision about 30 years ago to allow China to come to the United States and acquire the processing capabilities for rare earths. So just as part of some background, you've got the rare earth materials containing various mining projects, but once you extract them, you have to then process them and they go through certain phases before they get to the magnet phase. And China, the thought process was let China do the mining, let China do the processing.

Pini AlthausWe don't need to do that here. And we'll buy the materials from China cheaply and the premier of China at the time, Deng Xiaoping made the comment, he said, "The Middle East has oil. China has rare earths." And unfortunately we weren't smart enough to understand what he was saying. And the Chinese understood that the future of manufacturing is going to revolve around control of the rare earth and critical mineral supply chain. So if you think about it today, Ryan, we cannot build... Forget about consumer electronics and medical equipment. We cannot build the equipment that the US Pentagon or the US armed forces require, whether it's F35 fighter jet, Tomahawk cruise missile, communications equipment, without going to China and obtaining those materials. And it's obvious to all that this should be extremely alarming. We've seen China use this as a weapon, if you will, as far as how it interacts with other countries back in 2010, when there was a dispute between China and Japan on the East China Sea.

Pini AlthausSo China cut off rare earth exports from Japan for 40 days. Japan obviously being a significant user of rare earth elements for their high-tech manufacturing sector, that was stopped after 40 days. But in fact, it was President Obama that first made the United States aware of this, formed a division within the Department of Defense to handle this issue, but not much has happened. And we continue to be relying on China for these materials. And what has been made about trade war with China and whether the trade war is really the impetus for China withholding rare earth exports. And that is a huge misnomer. Whilst China had been talking or implying that they would cut off rare earth exports, the truth of the matter is that China, under it's made in China, 2025 mandate, its belt and road initiatives and others. And you seem to control the critical minerals and rare earth supply chain so that it can continue its dominance as a manufacturer or a global supplier of these materials and finished products.

Pini Althaus: It's the backbone of its economy. And in fact, China has become a net importer of rare earths from different countries like Miramar and others. So with that, they are decreasing the exports to countries like the United States, Japan and others.

Ryan Morfin: And was it ever a risk that the Chinese were going to turn off the exports of rare earth to the US during the trade war? How close were we to that? And was that ever some saber rattling that went down during trade negotiations?

Pini AlthausYeah, I think it was saber rattling. I think it would be paramount to an act of war. I can't say with any authority that that would not happen, but it would be probably, aside from war itself, it would be one of the most significant acts of war cutting the United States off from the ability to procure rare earths. But that being said, I mean, if you look at, as an analogy, the oil and gas sector and the reliance of the United States had for many, many years on OPEC countries to supply us with the oil. And we had embargoes and we had price manipulation by OPEC. This is far more significant given the ubiquity of where these rare earths go. And yes, we're always under the threat that China can cut off exports under the guise of a trade war or for any other nefarious reasons.

Pini AlthausBut I think even more importantly, to just as the natural run of the course of things with regards to their business and their desire to maintain themselves as the global leader in manufacturing and exporting of goods, China is in a position now where it actually requires these materials for their own domestic consumption and can legitimately cut off rare earth exports by stating that they need it for manufacturing and that would actually be somewhat correct. So we're in an extremely dangerous position here with this reliance on China. And it wouldn't just be China. If it was another country, it would be similar issues, not to the same extent, but reliance on one country for these materials is dangerous.

Ryan Morfin: And it's been mentioned in the past that in 2010, China flooded the market to really kill all the competitors in the rare earth mining industry. Where was the World Trade Organization during this period? And how did that play out and how does that set the chess board for China to run the tables?

Pini Althaus:

Yeah. So the WTO stepped in when China cut off rare earth exports from Japan, I think it lasted for about 40 days because the US and Japan protested the WTO, and they stepped in and China resumed exports. While I'm not an expert on these trade matters, one thing that I am aware of is that one of the reasons why China had to resume the export of rare earths was it did not legitimately need all the rare earths for domestic consumption. So therefore it was a nefarious act, if you will, to cut off rare earth exports. Now that has changed, which means China have to cut off rare earth exports today, they have a legitimate case to say that they require these materials. There's a shortage of these materials and they require them for their own domestic purposes. It is the backbone of their economy and there's very little we could do about this today, which is why it's becoming an even more urgent issue.

Ryan Morfin:

And the US government started stockpiling some of these after that incident. Can you talk a little bit about what DOD and DOE has done to start making sure that there's not a critical supply shortage going forward, and is it enough?

Pini Althaus:

Yeah, again, there is a national defense stock pile, and there are materials still that the United States needs to procure in order to shore up its stockpile. There are magnets, the finished magnet products as well, the United States government needs to stockpile. Again, there's a limited amount that the United States government has. It requires approval from Congress, whether it's in the NDAA or other approvals from Congress, to allocate monies for the national defense stock pile of these materials. That being said, there's no endless supply of these materials. And unfortunately, the apparatus, the way it's set up right now with the US government, it's going to continue to require having a secure supply chain of those materials for many, many years to come. So it's not a question of stockpiling for 10 or 20 years, and then this complacency and saying, we'll kick the can down the road. But keep in mind as well, Ryan, that US government accounts for low single digits of overall rare earth imports into the United States.

Pini Althaus:

We're talking about defense contractors, we're talking about the manufacturing sector. The direct impact this has on the economy, jobs, the automotive sector, and others is significant. So it's not just limited to the United States government. If you look at over the past couple of weeks, the sanctions that China have put on Raytheon, Boeing, Lockheed, et cetera. I mean, the question is where are they going to get those materials? And if we go beyond that, you need rare earths for the 5G network. Now that Huawei has been banned from installing the network, not only in the US but other countries, we have to have the ability to get a secure supply of these materials as well. Which currently, again, trying to control the hundred percent. So it runs across the board, both for government, defense and manufacturing in this country.

Ryan Morfin:

Well, and so help me paint a picture for our audience. Does China have all the mines for rare earth, or they're the only ones who started mining it? Or are their mines globally dispersed and nobody's been doing the actual infrastructure to do the mining?

Pini Althaus:

Yeah. So finding rare earth projects or rare earth elements is not the difficult part. It's finding them in significant quantities that makes a project economically viable. And part of that consideration are the environmental rigors that companies in the West have to adhere to. And China, even by their own admission, have had a complete disregard for mining these materials and even for processing these materials. And in fact, just the last week or so, the BBC did an expose on this, 60 Minutes has done an expose on this. But the Chinese have not denied this and have talked about cleaning up their act, but it has an effect on the bottom line for what the costs of mining and processing are if you have no environmental standards to adhere to. So China have exploited those rare earth projects they have, primarily in inner Mongolia, and have brought a number of projects online and quite quickly, and in a significant way, with a complete disregard for the environment.

Pini Althaus:

So it was seen as an environmental no-no in the West for many years. Now, what's happened over the past few years is you're starting to see rare earth projects in different parts of the world sprout up. You've got the Mountain World project in Australia owned by Linus, which is a producer of Nd and Pr, neodymium and praseodymium. So two of the light rare earths. They may have some heavy rare earths coming online at some point in time. And you've got Arafura, which is another company in Australia that we're working with to assist them with their processing so they don't have to send the materials to China for processing. But really these are a drop in the bucket for what the requirements are for the United States. And certainly what the requirements are for allied countries, the EU, et cetera. So there is a race, if you will, worldwide to start bringing projects online. The Chinese are very active in trying to secure assets outside of China.

Pini Althaus:

So in Africa. They have ownership of a project in Greenland. So there is somewhat of a race. The Australian government has stepped in and has started limiting the ability for China to own, or have ownership in, or off takes for the Australian rare earth projects. And that's part of the strategic Alliance between Australia and the US. Canada, similar thing as well. There are a number of projects that are looking to come alive, but these projects are, for the most part, will take many, many years to come online. We have to expedite the process. We have to assist with a [inaudible 00:14:41] supply chain and the domestic rare earth sector, because previously investors have been scared off by things like China flooding the market, which is not a possibility at this point in time, given that China can't actually afford to flood the market. They are already very heavily subsidizing their mine to magnet supply chain there.

Pini Althaus:

This is more now a case of being able to get production from non-Chinese sources so that the United States and allies have a viable, secure supply chain of these materials. And it's a concern worldwide. We speak to governments all over the world, and we're all facing the same issue. Some more than others, especially countries like Japan, that don't have their own rare earth projects there and are reliant on Australia where they've made some investments there. And in the United States, they've made an investment recently in Africa. So there is this race, if you will. And I think we've got a five-year window here to at least stand up a few projects worldwide. Otherwise we've lost this race and we will be dependent on China for many, many years to come. And Ryan, it's a bit of a hypocrisy. If you look at it where you've got materials going through clean, green energy applications, like electric vehicles, wind turbines, et cetera.

Pini Althaus:

That we're sourcing these materials from China, where they've, again by their own admission, has been complete environmental devastation to water bodies around these mines and processing facilities, to the communities. People have been getting sick around these projects yet we're putting these materials into our electric vehicles or wind turbines. It makes no sense at all. And people are starting to wake up to this. And that's why the sector is starting to see a lot of support come out of Congress and bi-partisan support. And in fact, it's one of the only bi-partisan issues right now in Washington. And it's good to see that some things decided to move in the right direction.

Ryan Morfin:

And is there a special process? You talk about the expense, is it really difficult to mine these? You have to go through a special chemical process to extract and clean and purify. Is it a lot harder than, say, gold or silver or some of the other, we'll call, more traditional elements?

Pini Althaus:

Yeah. It's all about the processing to some extent. So if you look at MP Materials in California, which used to be Molycorp before they went through their bankruptcy. They are a miner of Cerium and Lanthanum, which are two of the light rare earths, the lower valued light rare earths. Given that they do not currently have processing technology, they are sending those materials to China for processing where China is tariffing those heavily. Linus is also, they're doing their processing work in Malaysia and elsewhere. So it's really about the processing at this stage. One of the things that we've done, after we put out our PDA last year with our upgraded resource, which now includes a significant amount of lithium. We make a decision that, based on the test work that we had done around our processing methodology, that we were not going to send our materials to China. That it's paramount for us to do this work in the United States and in a collaborative effort as well.

Pini Althaus:

We've been asked by some of our investors, "Well, why would you be looking to help other projects with their processing?" And the answer is simple. There's no one project or one company that's going to put China out of business or make a dent, or somehow be able to take care of the overall demand worldwide for rare earths and critical minerals. And it's very important for us to have processing capability in the West. So that was the impetus for us opening up our own rare earth and critical minerals processing facility earlier this year, which we did in Wheatridge, Colorado. And in fact, we've made some significant progress on the method that we're using for this. And we're starting to collaborate with Australian companies, Canadian companies. We're currently talking to a group over in Europe as well, because this has to be a collaborative effort.

Ryan Morfin:

How does Europe solve for these problems? Do they have this better under control than the US?

Pini Althaus:

No, they're in a far worse position than we are. The EU commission recently put out a report, I think, a couple of months ago that the requirement for rare earths is going to increase tenfold within a short period of time. Lithium 18 times. They don't really have rare earth projects. Again, there are the Greenland projects, which people have heard in the news recently. Those need to further development work so they don't have rare earth projects ready to come online there. There are a couple of lithium projects that are spread around Europe, but for the most part, Europe is in an even more precarious position. If you look at Germany with the auto manufacturers, you look at the big companies like ThyssenKrupp and others, all these countries and companies are looking for alternatives to China, because we've already seen in the news about China withholding or reducing exports of some of these rare earths that are required for these industries.

Ryan Morfin:

And you mentioned earlier the regulatory posture of the US makes it difficult to mine. Is it becoming a more bi-partisan issue that we need to maybe relax some regulation around the mining exercise, to incentivize private sector to come in and start producing this? Or is the Republican party versus the Democratic party on two separate pages of music?

Pini Althaus:

Yeah. Good question, Ryan. I mean traditionally the Republican party is obviously being more pro-mining and in favor of less regulation when it comes to these things. With regards to our project, we're on Texas state land. So we don't trigger federal environmental permitting at this point in time. And obviously Texas being Texas, a mining state and oil and gas state, things are a lot easier in Texas than they are on projects on federal land where the Bureau of Land Management controls the environmental process around that. But the thing is here, and I don't want to step into what other companies are doing, et cetera, but we do need to be reasonable about allowing projects to come online if they're adhering to environmental standards that are acceptable worldwide. And what we do know, is that China is destroying the environment and cities and water bodies around their mines and processing facilities.

Pini Althaus:

We have standards here in the United States, and I think what we need to do is make it easier for companies to mine, while at the same time protecting the environment. And there are ways to do that. And we're definitely seeing buy-in from Congress, from both sides, with regards to looking how we can stand up a secure supply chain. And, obviously under the Obama administration, they had very strict regulations when it comes to mining. And that's changed under the Trump administration. Hopefully what we start to see is some normal middle ground that'll allow other projects to come online.

Ryan Morfin:

And typically in these rare earth mines, is it amalgamation of different minerals that are all consolidated together and you have to separate them out? Or do you ever find pure play, Europium, I can't even pronounce some of these. Gadolinium, Cerium. I mean, are they all mixed together and you've got to filter and sift them through, or are they pure play mines?

Pini Althaus:

No, they're generally they have a mix. So they're polymetallic projects. They have a number of different materials. Some projects, you more to what we call the light rare earths like MP in California or Linus in Australia. Our project is actually on the opposite end of the spectrum. We have a very high concentration of heavy rare earths. That being said, we do have to go through a process of separating these materials. But the case of our project where we've got 30 materials. We're not going to produce 30 materials. We're not going to market 30 materials. So what we're doing is we're focusing on the key materials that are marketable, that we need for permanent magnets, lithium as well, and working on the separation and the optimization of those materials in particular. But we're all faced with the same processing challenges and that is something that can't be set.

Pini Althaus:

There's no easy way to do this. There are different technologies that have been used in different parts of the world. So predominantly there's a process called solvent extraction, but it's big, it's bulky, it's not benign. It's a bespoke solution for one particular project. So it doesn't work for feedstock from other projects. What we've done is we're using a processing technology that's actually been around since the 1940s. It was part of the Manhattan Project. It's called continuous ion exchange. In fact, the Chinese use it to increase the purities from 99.99 to four nines, five nines, and even six nines. So for some applications you require higher purity levels. It's a far easier processing method to scale up and to take feedstock from other projects. In fact, we've demonstrated for the Department of Energy that we can take coal waste from Pennsylvania and do high purity separation of rare earths using our processing methods. So it's not a step that can be skipped unless one needs to send it to China for processing, which is not going to help us with our objectives here.

Ryan Morfin:

How many other, we'll call it, going concerns on any other businesses that are doing this, that are trying to, I guess, start the development of these mines. Are you guys one of a few or are you one of many? And is it an international or just a US game? Who's leading the charge at going after this?

Pini Althaus:

Yeah, well, I'd say the Australians are leading it outside of China right now. You've got some really good projects in Australia. Again, more skewed toward the light rare earths. There's one more heavy rare earth project in Australia, which is not yet producing. The United States, you've got MP Materials, you've got Ucore in Alaska, you've got the Bear Lodge project in Wyoming, which is also another light rare earth project. So as far as a heavy rare earth project that looks like it will come online in the near term, that would be our project. In Canada there are a couple of projects there as well, and again, more skewed toward the light rare earths. But we really need to get as many of these projects online as possible. Because again, I don't see it as competition. We all have a problem doing supply agreements or offtake agreements for our materials.

Pini Althaus:

In fact, one of the things that we're going to have to consider is looking at potentially scaling up our production, based on the demand that we're already starting to see. And I think other companies would find that as well. So it's all about the economics of the project. You have projects that were economically viable back in 2012 or rare earth prices with 35% or so higher than they are today, and are not necessarily viable today. So that's the challenge as well, economically viable projects. And we've got to get as many of them online as possible. It takes many, many years. I mean, our project has had over $70 million put into it to get to where we are today, and we're close to getting to the production scenario. It all revolves around processing at this point in time.

Pini Althaus:

We'd be very happy to see another couple of projects come online, because this is extremely important for national security and for the economy as well. I mean, if you think about it, Ryan, if you've got a billion dollars of rare earth materials, that translates into a trillion dollars or I should say trillions of dollars of finished product. So you've got a magnet in your phone there that's worth a couple of dollars and the cell phone's a thousand dollars. And electric vehicles and defense applications even more.

Ryan Morfin:

Yeah, everyone has one of these iPhones now, and there's tremendous amounts of rare earth on the circuit boards here. And I think people take it for granted that that supply chain is not secure right now. So one question for you, there's talk of this maybe medium term to longterm, but there's talk about mining in space. Do you think that's a feasible option in the longterm, medium term? What are your thoughts on that?

Pini Althaus:

No, that's just ridiculous. I mean, we're trying to find ways to make mining on earth economically viable. I think the cost of going up to space would be more than what our capex will be bringing our entire project into production. I mean, we've got about a 350 to $400 million capex to bring 130 year mine life into production. I'm not an aerospace expert, but I think sending a rocket, building a rocket ship and sending it up, I think maybe on the fuel alone, you could bring a couple of projects into production. So unless we have a fortunate situation or an asteroid lands on earth, and fortunate if it lands somewhere where we don't care, I don't see how that happens. And if it's big enough, it's a problem as well. It's nonsense. And even, options aside of the deep sea mining for rare earths, I mean, you've got all sorts of environmental issues around that as well. I think we need to look at projects that we can bring online, that can be done so in an economic way, that can be done so in an environmentally responsible way.

Pini Althaus:

I mean, one of the things that we've done at our project is we've got in excess of 60% of the materials that have come out around top, will have a clean green energy applicability to them. So we're using the benign processing method. We're going to be using renewable energy on site. In fact, we will likely be putting a solar farm on site as well. We've talked to a couple of companies that have approached us about that, and we'll be a net producer of power for the surrounding area. So there are ways to do it which don't affect the environment. Obviously if there's a project that's situated on a sensitive area, that's a unique situation for that specific project. We've seen it with the Pebble project, which is not a rare earth project. The Pebble project in Alaska where their environmental concerns is we've been recognized by both Republicans and Democrats, but we have to be reasonable about the projects that don't have environmental concerns.

Ryan Morfin:

So Pini, in season two, we ask all of our guests a series of six questions. They're usually, yes, no questions, but trying to take a survey of our conversations. And if you want to add a little context to the yes or no, feel free, but here goes the first question. If there was a COVID vaccine available today, would you take it?

Pini Althaus:

Yes.

Ryan Morfin:

Who do you think is going to win the election?

Pini Althaus:

Which election?

Ryan Morfin:

The US election.

Pini Althaus:

Well, I think it looks like Joe Biden's going to win it, but I think what happens, if we go past January six from my understanding is that the house will vote on it and it's one vote per state. But I don't know if I see it getting there at this point in time. I really don't have a crystal ball.

Ryan Morfin:

Third question. What type of economic recovery are we in? What type of shape is it taking? A V-shape, W, U, L?

Pini Althaus:

Yeah, I think 2021 is going to be challenging. I think we've been, and rightly so. I mean, we've had no choice as of almost every other country. We've been printing money for the past year because of COVID. And I think we've got to brace ourselves that, at some point in time, the chickens come home to roost. It was a necessary step. People needed it on an individual level. Businesses needed it as well, but I think we've got to do whatever we can to stimulate the economy, give people confidence to go out and work again, employ people. So I think we've got to watch ourselves, especially in 2021. And I have some concerns, but long-term, I think the approach in the United States is a healthy one.

Ryan Morfin:

During lockdown this summer and quarantine, was there anything in particular that you accomplished that you're particularly proud of?

Pini Althaus:

Yeah. A great amount of family time, which, if you would've asked me a few years ago if I could sit at home and be at home for six months, I would have told you absolutely not. I wouldn't be able to do it for six days, but it has... I'm sure it's done this with a lot of families as well. It's brought families together. We had a baby actually last year on Thanksgiving. So I was doing a lot of travel at the time and thought I wouldn't get to see my daughter in her first year or couple of years too often. And being home with her every day is actually been just the most amazing experience. So thankful at least for some silver lining in COVID.

Ryan Morfin:

Are there any silver linings that you see in the economy going into 2021?

Pini Althaus:

Yeah, I think we've gone through an absolute beating and it looks like we've got the ability to come out of it. And I think that's a testament to how strong the economy was built up in the years preceding COVID. So overall I remain an optimist. I mean, we are a country built on opportunity and going out and making it happen. And we're not a socialist country sitting and waiting for people to send us paychecks or wealth distribution or anything like that. I think the American dream still lives on. I think if you go out and you're willing to work and put your head to it and heart in it, I think we do have the ability to climb out of it. So if we look at what the economy is doing over the past few weeks, it looks like it's starting to rebound. And to me, that's assuring because it could go completely one way as well.

Ryan Morfin:

And the last question is, is there anything that you're watching, or listening to, or reading today that has been impactful on your thinking that you'd like to share with our audience?

Pini Althaus:

Yeah, that's a good question. I think it's been more personal stories. The news, I sort of take that in context or with more than a grain of salt. In some cases stay off the news channels for a number of days at a time, it became quite repetitive. But I think on the personal side, talking to friends, my family's all back home in Australia, they've just come out of 110 day lockdown, which we can't relate to that. It's been very trying on them and seeing the fortitude that they've had to come out of that and stay intact. I think the mental health issues that will come out of COVID are going to have a far longer effect than the economic issues. I think we're going to have to focus on mental health issues in this country for a long time to come.

Pini Althaus:

The impact on kids has been significant with regards to lockdown or remote schooling, et cetera. But to see people come through it. I think it's a testament to people in general and to the country and other countries as well, to see got that fortitude and survival instinct to try to get through whatever adversity we can. So hearing the personal stories, the challenges that people have gone through, I think it's made me a lot more aware of things that I have to be thankful for and where we can help out other people as well. I think we have to be united going forward because there are things...

Pini Althaus:

I think one of the things that COVID has shown us is we can get into this complacency and life goes on and we go one day to the next. And all of a sudden we get hit by something that affects everybody equally. I mean, COVID, whilst there were groups of people, whether it was the elderly or people with underlying health conditions, that got hit the worst. I mean, we all got hit in some form or another. So really, this should be something that unites us, not divides us.

Ryan Morfin:

Well, Pini, I appreciate you coming on today to talk to us a little bit about the supply chain crimp on rare earth and we'll definitely keep an eye on it and would love to have you back in the future.

Pini Althaus:

Thank you, Ryan. Thanks for having me.

Ryan Morfin:

Absolutely. Thank you. Bye-bye. Thanks for watching Non-Beta Alpha. And before we go, please remember to like, and subscribe on Apple podcasts and our YouTube channel. This is Non-Beta Alpha, and now you know.

 

The unique history of a Maryland based distillery and craft secrets on how to make great American Bourbon w/ Admiral Scott Sanders Founder of Tobacco Barn Distillery

The unique history of a Maryland based distillery and craft secrets on how to make great American Bourbon w/ Admiral Scott Sanders Founder of Tobacco Barn Distillery

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