Evaluating Real Estate Debt Structures

Kirkland Capital Group COO – Brock Freeman and CIO – Chris Carsley join Leftfield Investors to discuss Evaluating Real Estate Debt Structures. This topic is more important than ever now that interest rates are rising, and many operators are still subject to adjustable-rate bridge debt or valuations based on future values (ARV).
Risks are higher and investors need to better understand the debt component of the real estate investment.

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Transcript

Jim: Welcome everybody to the April meeting of a left-field investors. We are happy you are here. And I do have a few more announcements than usual because there is a lot of stuff going on in our community. There are a lot of new opportunities that we're working on and new features that we're trying to highlight.

I'd like to announce some of those, but first, before I forget our next meeting, I know we haven't started this one yet, but our next meeting is May 23rd, and we're going to have Paul Moore from Wellings capital. I'm not exactly sure what he's going to talk about, but he has a fund. Many of us know that the self-storage and mobile homes, but he's been in the industry for a long time, and he has a lot of stuff to talk about.

So I'm letting him choose the topic. A couple of other things. So we are; ' been a lot of talk about Spartan fund. They are a Spartan is coming out with a. And there's two share classes, one minimum of 50 grand, and then there's one with a minimum of a million dollars and you get an extra percent on the prep and a little bit extra on the split.

And they are allowing us as left-field investors, anybody who is affiliated with left-field investors, you can invest individually, but they will pool all of our capital to see if we can get to that million. So if you're interested in self-storage and you're interested in Spartan I will be sending out an email, hopefully, this week with the details, there will also be a webinar that they're putting on just for left field investors.

Just keep your eye out for that.

Brock: These are the guys out of Seattle, right?

Jim: No, I think they are. That's where you guys aren't you, now that I can recall.

Chris: Yeah.

Brock: We always want you to selfishly invest with us, we don't do any self storage yeah. I've actually met with some of the principals.

They're great guys have been around for a long time. I was fortunate to invest to meet with them earlier on yeah. Great, good

Jim: guys. Yeah. Yeah. That's a good endorsement. So thank you for for that. So our survey, I sent out a survey a couple of times, this is the survey where we're trying to figure out where everybody's investing.

This will allow us to form partnerships and to work with with people that you know, to, to show them how much we're investing, really. And when you talk to a sponsor and you say, Hey, we're from a group and we're able to put together a million dollars here, or, we already have $2 million invested with you.

It really can help us bring better benefits to everybody in the left field. So I strongly encourage you, if you haven't done that please do that. As soon as possible, I have a ton of syndications including in tribes and it took me 10 minutes. It was so much quicker than I thought.

So please do that. That will help us all out. There are a number of new things that we're launching. One, we're having a we have the podcast passive investing from left. We are going to have a new episode or not really an episode, but a new series that will be hosted by Chad Ackerman, our one of our founders, and it's going to be called the infield or spotlight.

And he will be doing short interviews with with various infielders, just to share your story of how you're searching for financial freedom and what your investing journey was. So he's going to be reaching out to people slowly to to get that going. And we're hoping to launch that in may.

We're really excited about that. We are also starting a lunch and learn program in may where there'll be lunchtime somewhere in somebody times that will not Sammy's times on, sorry, Sammy he's in China, but some of them will be lunchtime, Western time or Pacific time zone. Some will be lunchtime Eastern time zone and maybe even a lunchtime in between.

And we'll just, it'll be all content. So we'll have somebody on to talk about. Self storage. The first one actually is mobile homes. So the first one we're going to have some people on to talk mobile homes. Then we have a couple other scheduled. So a schedule will come out. I don't have it yet. I think the first one is May 10th, but we're still noodling that around.

So lunch and learns are coming. You gotta bring your own lunch. Sorry about that. It's going to be on zoom so we cannot provide food for you. Not yet. And then we are starting a crypto group. So I will ask Pat Wills to unmute and give us a two minute overview on what the crypto group is about.

Wills: Thanks Jim. Hey everybody. So yeah, there's been a lot of interest in crypto both in the news and in this group on the forums as well, over the past couple of months. So Eric Ward and I decided to start a group called the crypto bullpen. You don't need to have any type of technical knowledge, nothing preexisting.

That's perfectly fine. It's for everybody to learn and grow together. We're trying to explain cryptocurrencies in a non-technical way to a non-technical audience to bring people up to speed on how you can use this in your business and your daily lives, everything along those lines we're looking at doing monthly meetings might have a bit of central education on a certain topic right now.

I think taxes would probably be the most relevant topic for us to cover. We can go through highlight some of our favorite projects that are up and comers, best practices, and actually using your cryptocurrency on a daily basis and then ask and answer questions from the group. So if you're interested in joining us swing by the kickoff meeting, which would be May 2nd, it should be next Monday at 7:00 PM. Eastern.

Jim: Excellent. Thank you, Pat. And I will be sending out a zoom link and some additional information on that. Also this week, probably tomorrow when the when I send out the recording of this meeting. So we're really excited about that. This is not a crypto group, but we it's an investing group and we have to have a couple of crypto experts and they volunteered to help us all out, understand this stuff.

And so we're really excited about that. So we also launched our preferred partner program. I think you've gotten some emails on that, but I just wanted to mention it briefly preferred partners. These are, they've been voted on essentially by this community based on where you've invested your dollars.

And we've gotten this information from several surveys. We've done conversations we've had. And so we have we've reached out to a few partners and so we have accountable equity, Aspen funds, Mag capital partners, the real asset investors. Spartan investments, Western wealth, Tribe Vest, and then Bush Tax Company.

We are probably going to add maybe one or two more, but that's a, that's where we have now. And we're pretty pleased that these sponsors are supporting us financially. And they're also going to give us some great content and be part of our, be a little bit more into our community. Do you have any questions on that?

Please? Let me know. Finally, yes. Finally, we are we're doing some networking, right? 2022 is the year left-field investors really keeps, the marketing going and increases opportunities. So there's three ways we do networking. The first is tonight after this meeting, we're going to go to wonder me.

I put a link in the chat. That link will take you. You have to get off a zoom copy the link closed down zoom when we're done, not now. And go to wonder.me. Or to the internet, paste that link in there. And you'll the password is L F I 22, the numbers two, two LFI two, two. And that will get you in.

And it's basically a room and you can cruise from table to table and chat with people. We also have four infielders. We have the mound visits, those have been going great. We started off with four people, I think, and 10 people. And now we're getting 20 people meeting and all of the founders, the five founders, except for me, you guys hear me talk enough?

The other four leave these and there's one every week. And I send out the schedule pretty regularly. The next one is Friday, April 25th with Sean at 12:30 PM Eastern. So that's a lunchtime for the east coasters and it's just a casual, there's no agenda. Or there might be one agenda item, but it's just a talk network and talk investing.

And then finally. Available for everyone is the intros. If you haven't done this yet, I highly recommend it. It's basically a, you sign up on an app and every Monday you get an email, it says, do you want to participate? If you say, no, you're done. If you say, yes, it'll connect you with one other member of our community and you'll schedule a call with them.

And we're actually one of the biggest communities that intros has. They've been looking for feedback. So there'll be contacting a few of you with your permission to to get some feedback on the intros, but that's been going really well also. So that's all the announcements I have. I want to thank Brock Freeman and Chris Carsley for coming today.

They're from the Kirkland Capital Group. They are the provider of commercial real estate financing. And they're here to demystify everything about debt, bridge debt, agency debt and answer a lot of questions. Because a lot of us these days are rightfully a little bit nervous or curious about interest rates going up and how is that going to affect our current investments?

And what do we do with new investments that have bridge debt or non permanent debt and how do we deal with that? So I'm going to turn it over to Brock and Chris, and thank you for coming and we will see you. If you have questions, you can put them in the chat or Brock. I don't know. Do you want people to throw them out while you're talking or wait until the end?

Brock: Oh, just throw them out while you're talking.

Jim: Yeah. Okay, perfect. So I'll turn it over to you Brock.

Brock: Thank you for that intro. I will say though that, will strikes a little bit of fear into my heart because with that intro and the broad topic about everything you wanted to know, that sounds more like a university course lasting over at least quarter an hour, five days a week, a five credit course.

We have 40 minutes with Q and A, so I'm afraid of it's going to be far smaller than that, but we hope to at least answer your questions and do some of that justice. Perfect. Also real estate depth structures. I'm going to quickly flash on the screen for legal reasons. All right. So here's a question to get your juices going.

I think where does most of the money come from in an apartment syndication, lot of those going around super popular I'm in them. We offer them somewhat through Kirkland Capital Group. We partner with others, but the reality is most of the money that comes from an apartment syndication comes from debt.

Yeah. There's a lot of forms of real estate debt out there. We don't, as I mentioned earlier, we really don't have time to go deep into a lot of them. We're going to talk about two forms of debt that we're more familiar with because we offer it as hard money and bridge financing. That being said though we're happy to go and answer your questions as much as possible between Chris and I about different types of debt out there.

So what are the types of debt listed a bunch here? There's and some of them overlap. So, there's not like a full on punch list of all unique types. You could probably come up with more than this here. There's Fannie Freddie, of course. Does that fit into what's long-term and there's midterm dad. I run in, I talked out all day every day to brokers and there's all kinds of how to say terms around debt.

So it's important to get a handle on these things. Now we won't cover everything today, but I do hope to really cover two things and really understanding bridge and hard money and how those are used in the marketplace. And of course, as I mentioned, we can have a Q and A to, to talk about anything else, including interest rates.

That's where I probably going to let my partner more jump in as he's more familiar with how those affects debt, in the wider marketplace. All right. So without too much I do, let me jump and talk about.

Chris: But one of the things there, as some of you may have mentioned seen that there's a box on the other was preferred equity.

We went ahead and threw that in there because although it is equity, it is not debt. It is used as that surrogate, especially, you'll see it very commonly in a lot of syndications where if your primary lender won't allow a second lender, that's that middle ground of that preferred equity. It functions much more like that, but it is classified as equity and it won't have a, it's obviously preferred over equity and sits behind any other form of debt that would be added, but we threw it in there because most of you will probably see it.

And if you have any questions on that, and it is historically was very hard to find labor people who do that. It is cyber. But we're starting to see more and more people come forward with platforms in preferred equity, knowing that's something that's needed for these ever growing and larger syndicates.

Brock: Yeah, it's the old rule that if you make a rule, someone's going to find a way around that.

All right. Let's talk about hard money for a moment. This is classically probably heard of it. Many of you, fixing, flipping, this has been the poster child for real estate investment over the past. I don't know, 20 years or maybe I've been involved with it for too long. It's that classic thing you go, you want to do a fix and flip, you go find some hard money, someone to help you buy the home get some renovation, money as well.

And you're paying, you used to be paying 18 sometimes 19% per year for that money in order to do fix and flip. Now with wall street money, having injured in that's come down tremendously. But that's not the only place for hard money. Hard money can also be used for what we call the burn method.

And maybe if you're not familiar with that stands for Buy, Rehab, Rent Refinance. And then the reason I put that last hour in there is that's repeat particularly in the commercial arena where this is a far more common type of a framework or method that's being used. There's not always the repeat, at least not right away.

It doesn't go so fast because you're talking about larger amounts of larger projects, a quick purchase or access to capital, and other reason maybe there's hair, we ought to talk about hair on the deal. What's the hair on the deal? Is it hair on the property? Is it hair on the borrower? I've got hair, but we're talking about problems with maybe credit where their money comes from.

Maybe they borrowed the money for the down payment. There's a lot of different reasons there around why someone would need to use hard money. Now, sometimes that has a bad connotation in the market. Particularly for investors like hard money, when you had to use hard money, you must be really hard up yet.

The truth of the matter is particularly since 2008, that banks have really curtailed and been limited in what they can use or what kind of property they can lend on there. There's a lot of limitations. Chris, do you want to talk about that for a moment? Cause you're a lot more familiar with all those restrictions around bank lending.

Chris: Yeah. If you're not aware of a little history lesson, 2008 occurred in 2009, you had the Dodd-Frank rule come out. And there was a lot of stipulations on the amount of leverage that could be used. And then there was a lot of stipulations around the parameters in documents that could be used for lending.

And really what it caused is a lot of the lending that banks were involving themselves in the early two thousands was now no longer part of them. And a lot of the banks actually took even bigger moves than what Dodd-Frank required because they had their hand cut off in many ways with a lot of the loans they had done.

That's one of the big inefficiency and hard money really, as Brock has said, it's really gone from, that stigma of, you're going to a loan, shark type shop now don't kid yourself. They still exist out there. Please read your documents very carefully because there is one aspect of hard money that I'll when I finished this thought, I'll come back and mention it has migrated to a lot of that entry level, smaller deals, secondary tertiary markets.

It has been very key for a number of people in the small commercial space. And it just kinda got bucketed in hard money, even though. A lot of hard money is really just falls in the same bucket as bridge financing. That's literally what it is. It's a short-term loan to get from a point where your property is not stabilized.

A bank will not cover it under their current mandates and hopefully within 6, 9, 12 months, maybe longer 18 months. We've seen a few people who want 24, but it's much more common to see people right around 12 months coming in and saying, Hey, this is my business plan. I can turn this property around in 12 months and I can go get a conventional loan.

That's really where this all stemmed from. And this has really become a key element in private debt at this point. Yeah. Oh, and the other way that I did want to finish that one, thought around when I say read your documents, the old hard money game was yeah. They charge you rates and they'd be really light on the paperwork and maybe they don't even do a credit check.

If you're talking to a shop like that, be very careful. Read your documents and make sure they don't have language in there that allows for, a quick trip wire where you make one mistake and they're filing to take your property because the old game of hard money was, yeah, I'm charging you a big rates and I'll make money no matter what, but my real big money was I had a low LTV on your property.

And when you make a mistake, I take it. And then I make that big equity boost. That was where your old school and some of your current hard money lenders still make a lot of. Yeah.

Brock: As a borrower. Yeah. That's definitely what he want to make sure. Or even if you're, let's say a partner or maybe a silent partner doing a fix and flip with somebody or even a commercial property, you want to make sure you're you understand what is being done there on the loan side from the lender there are still private individuals and private funds out there.

These are all non-bank Lin lending facilities that have some pretty incredible terms there. Now let me talk a little bit about how you should approach this. If you want to look at investing in a debt fund as an investor. Okay. A couple of things to consider here. You want to ask yourself, okay.

So for that debt fund, What are they lending on? Are they lending to the fix and flip arena? Are they lending to commercial property? What is their maximum LTV? How do they consider how they make those LTVs? What do they, what does that LTV, what does that the V the loan to value? What does that value based on?

Is it as is value? Is it ARV, which is the after repair value that matters. These things matter greatly. If, generally on funds or at least in the past, the fix and flip, the reason they were able to get those high rates was because they were lending off ARV some future estimated value after repairs that they thought. Hey, this is going to make it, but the challenge with that is that introduces a tremendous amount of risk into the deal because you're based on a future value. Yes. I realized that they're going to only do a draw schedule. They're going to hand out money as you did you do those things? However, it still introduces lots of risks because it's not based on as is value.

There is hard money lenders out there or bridge lenders like ourselves. We don't go off ERP. We simply go off as value. So based on your purchase price or as is, that's what we lend off. So therefore, if something goes wrong with that property, you can run it in your own mind about if you're based on a future value and something goes wrong during that renovation, or even on a construction loan during construction, what are you doing?

Because now you've lent your way out over maybe what the value is, what the loan amount that's out there that you've already lent. How are you going to get that back versus principal protection or principal focused debt funds, which are lending off as is, and if something goes wrong with it, because you're based on asset, your chance of getting that principal back as well as maybe all the interest code, et cetera is much higher because you're based on that asset.

So something to really consider with that, the other item that I would and Chris, feel free to jump in here on this particular topic where some debt funds you're part, you're basically an LP and some debt funds. You're actually a ball, sorry, a lender to that fund. So th that, we've seen that in that structure too.

So again, go back and read your PPM, read your investor docs to understand, am I an LP? Am I getting, what are the fees on that? Am I, if the ball, I'm sorry, if the debt fund or the manager is taking more risks on a particular loan in my, as an investor being rewarded for that risk. So the way the better funds are structured is that, that there is a fixed fee or a fixed percentage there of whatever's the interest rate being charged to the borrower.

Therefore, if the manager decides, Hey, this is a more risky loan, therefore I want more interest on that. Your being rewarded as well for that extra risk versus some funds that we've actually seen out there. You're getting a fixed 8% and 7%, whatever, and banners are going out there and oh, Hey, I can go do I can get 18% on this loan.

Hey, I'm going to take this huge risk, but they're not paying the borrower or I'm sorry, they're not paying the investors for that risk. You're getting the same, no matter what, they're getting the huge spread. Chris you might want to talk a little bit more about that, cause you've seen, you've read a lot more PPMS for debt

Chris: funds.

Yeah, no, Brock, I think he covered most of it, but simply put, and you'll see this they'll come in with an enticing level and this is, there's an there's good and bad to, every fund structure. I'm not poo-pooing in any one particular fund structure, but this one being a very risk centric person I've been in investments for better part of 25 years and I've always been part of risk groups.

And one of the things that I've seen that you should be cautious of is that come out and say, Hey, we'll give you a 9% return. You really want to ask the question of what type of loans are they doing? What rate are they getting? Because one of the classic things you saw over the last decade was a lot of construction loans.

They'll go out and charge, 16% on hard money and they're paying you nine. And often not these funds will be charging you a management fee as well, and maybe even an incentive fee. So when you start adding up all these fees that are not really obvious to see right off the top, you're there, they're getting paid 16 on their loan.

They're making 7% effective. Off the that. So just, it's just something to be aware of. You're seeing less and less of this, but there are funds out there that realize, Hey, if I just really go out and promise someone a big interest rate and it's fixed it, that'll capture a lot of people because in this world that we fall into where everyone's looking for yield.

Everyone wall street all the way down to us individuals everyone's looking for yield. People can be easily drawn in by large returns. Just make sure that the risk is commensurate with the return you're making. And in one of the counterarguments to that as well, you wouldn't be able to get access to those loans.

So being paid nine is a fair price because they're giving you access to a set of loans. It's up to you to make that decision. If that is a fee structure and a risk you're willing to take. We, when we built our fund, I didn't like that idea. We passed directly through. So if I go write a 12% loan minus my management fee and fund expenses is your guys' return.

It just made it much more simpler to explain, and you didn't feel like, I didn't feel like I was unduly putting anyone to risk that, they weren't being rewarded for. So something to think about there's a lot of stuff that goes on in these, hard money bridge financing, and sometimes even larger commercial.

I know billion dollar funds that did this and then you ask them a question. Do you have any institutional investors? And the answer will be no, because your large pension endowments would never agree to that fee structure should tell you something. If the big money's not agreeing to it.

Should you be?

Brock: Yeah. If there's, you know what, we'll take questions as we go along too. And since I can't see the questionnaire, feel free to pop in or just. Yeah, ask away.

Chris: I've got chat up as also, if you want to write a message and I'll see it in chat. Yeah.

Brock: So let me, I'll talk quickly. I'm going to, I'm going to spend too much time here, but I'll talk about this as a loan.

We wrote last month, this was a 17 unit mixed use. Sorry. My tombstone couldn't quite fit correctly on there, but so it cut off the top, but 17 units mixed use Winchester, Kentucky. You might ask where that's at. It's a tertiary town. We liked it because that there was, so we look at a lot of metrics trying to make an objective decision around where we make loans. This was a place where on the mixed use, those are apartments above, this classic mixed use, where there was a retail, it could be one or two units downstairs. And there was a 16 units upstairs. And so what was nice about it?

So there's a lot of renovation that could be done on it. A bank of course, was not going to take it because the renovations hadn't been done nothing's really been done to the building as far as upgrades or anything in 25 to 30 years yet. The rents they were getting were pretty incredible for, what they were, there was hardly anything for rent in the entire, within 30 minutes drive.

There was just, there was a lot of reasons to like this. The borrowers, this is their first commercial deals. So that's another reason why you don't see banks willing to make deals for someone doing their first, but they were young, but they already had several rentals and fix and flips that they had done over the last three to four years, very aggressive.

We liked their approach to it. One of them had a construction background, so they were able to save money that way by, basically doing the, being their own GC. Again, that's one place that banks don't lie. They don't like it to be your own GC. They want you to get someone to expensive. Whereas we see, Hey, if you've done some fix and flips, you've been your own GC.

We think that you can probably handle that. So there was a number of reasons we liked as a deal for that and the borrowers as well. So this is a bridge or, you call it hard money. Deal where once this is stabilized we don't think that there's going to be any problem for someone, a long-term lender, whether it's institutional or a bank, maybe even a local credit union to pick this up and run with it.

Once it's stabilized. The nice thing as an investor for investors on that, again, we only do it an as-is loan. We went 70%, I believe on this. So 70% LTV that's as is value based on the purchase price. And we got, a third-party evaluation. So let's say that these guys really screw up and the renovation doesn't go as well as they want it.

Generally they don't kick everybody out and renovate. They renovate a couple of apartments at one time. I think there was maybe five vacancies. So what happens there? We know that. 30% down. That's a lot of skin in the game and we liked that because that means that they're going to move hell and high water to make sure that this makes it, they don't want to lose that skin in the game, that money.

So that's one, one thing that's protecting us on the risk side. The other is, again, just because it's as is value, something goes wrong. We take the building back. We're going to get that money back for our investors. We're going to get all of that plus some. So that, that's an example of one of the deals that we did.

That's, quasi hard money slash bridge loan.

All right. Let me talk now. Broader about bridge financing. Obviously Fard money is a former bridge loan. It's not the only type. There can also be gap or interim financing. There are generally short term up to a year. Sometimes, maybe two years is still called bridge. But the whole idea is that it's a temporary financing until long-term financing can be put into place.

Sometimes it's because of the sale of an existing property it's used on both residential and commercial as well. The biggest thing there for bridge in, in, in what in the commercial site particularly is that there's either very low or no pre-payment penalties. I can say for us, we generally put in a three month minimum interest payments.

But we just don't want to, we want to make sure we collect at least enough to make it a worthwhile for us to do, but it's very low verus on agency debt on long-term financing, you have some pretty long and pretty honorous prepayment penalties in there. And some of that's because of the way they'll even have.

What's called YSP or yield spread premiums that go back to the broker or orchard their internal compensation commission to their own salespeople or our loan reps internally where they're paying basically out of future interest rate payments to out, out the door in the beginning while then of course, you're going to have a prepayment penalty because if you got prepaid earlier, they would actually lose a lot of money.

So that, that's a reason for that. So that's all I'm going to say here about that bridge. I'm going to go back to this sort of types, I guess I'm going to throw that up there and let's talk about one more thing that was thrown up in the introduction, Chris interest rates. So we're seeing interest rates rise, the feds pushing them.

Let's talk a little bit about how that's affecting debt in general. But particularly, probably on that long-term debt and maybe what we're seeing with some of the apartment syndication debt, or even maybe what you might see on long-term debt for other property types, such as what was mentioned earlier, which is a self storage.

Chris: Yeah, no, simply put an interest rate is your cost of capital. Obviously when the fed increases interest rates, what it's adjusting is the short term the front end of the curve as they will call it. And you'll see what we're experiencing now is a flattening of that curve. And some people are worried about an inversion because historical data of inverted yield curve usually leads to a recession.

We're not sure that's going to happen. And I'll tell you that the I was on the phone what a couple of weeks ago with Morgan Stanley and Goldman Sachs, and they have a plethora of data going out there saying, listen, even if we go into an inverted yield curve, it's been an extended period of time up to 30 months before you start seeing recessionary type implications to that move.

But the key aspect, interest rates are your cost of capital. Now, listen, if you're in a long-term debt and it's fixed and you've managed to lock in a cheap rate then you're sitting pretty you, the value of your overall trade as a package becomes more valuable because of your debt. If you've got variable component, this is a winner again, hopefully you've maybe put it up, there's something that you can, if you've got variable debt, which a lot of your big loans on multifamily does do a variable components to it.

You can go out and purchase a Reiki. So whoever's ready. The debt will be more than happy to sell you a form of insurance called a rate cap where if interest rates increase above a certain level, they will not move your debt. Any higher will people want to dive into that later or understand more of that?

We can talk into that, but that's just an equation of saying listen, I need, my cost of capital would be at a certain point to make this deal viable. If you guys are modeling. Various deals. You need to start making adjustments to your model and estimates of saying okay.

If I think, I'm not into my deal yet, or I think my debt could increase by a certain amount, it should be in your documents, you should adjust your models and understand what is that going to change? Cash flows and the profitability and future IRR of your project. And and one of those things also is if you're not done with your deal and you're still negotiating rates you need to seriously adjust and make sure that the price you're paying is gonna work out for you with a larger cost of debt.

I had a question a couple of weeks ago. From one investor and they said how does this really affect say, like our fund? And I said we're on average. Our gross yield in our portfolio is a little over 12%. So it's not like we're being hurt by inflation. And we work in an inefficient space where, and I'll use a term here it's called volatility of money.

You don't see large cash flows of money like wall street when they came in, most of that money went to very large commercial and they went to, the single family, residential fix and flip, or, the rent to own a single family, massive track projects that people are building all over the place.

When you have that type of volatility of money and that kind of impact the interest rates will have a bigger impact to you. You'll have an interest rate change. Now what's funny is everyone in the single family, residential space saw last year rates fall from nine to 10% down to. Seven to eight, unless it had a lot of hair on it.

You were still getting out your hard money loans and nor borrowing money at 9%. People are now wondering, okay we're going to recapture and is there going to be a price move to be seeing how rates are going up? Are we going to be able to charge more? I always like to say the single family, residential, especially the fix and flip model, it has huge volumes of money moving through it.

It is literally that Canary in the coal mine keep an eye on those rates because it'll give you a view into. What is going to be the impact, obviously there, but elsewhere that might be a more inefficient space. And the timing of that your guess is as good as mine. No one knows exactly how fast inefficient sectors will capitulate to rising rates.

So it's something that a lot of people haven't seen in their lifetime and their investing. No, one's seen rates go up in very long time in a material way. One of the things that I think seeing how has those areas with large volumes of money I don't think you're going to see a massive, boost in interest rates or cost of capital without seeing property values fall.

And one of the, one of the investors I was talking to, I said one of our worst case scenarios is if you're coming in and you're doing syndicating deals that people still want a premium value to their property, but the cost of capital is going up. Eventually you're going to have a second.

To where you're not going to see interest rates full anytime soon, if they just raised them. They don't tend to go back that quick. They'll pause for a while and see what happens because raising interest rates has an immediate impact on the stock market, obviously, but you gotta remember when the stock market price is everything, it's always future expectations.

So the actual impact to interest rates in calling inflation, it takes months if not years, to actually have that impact. So you don't really see the fed turn around right away and you say, oh, we were wrong and switch back because there is a delayed effect. And I think you'll see that delayed effect in, a lot of real estate, but like I said earlier, adjust your models, things they're going to get more expensive and hopefully we will start to see.

Owners who are looking to sell, realize that they're not going to be able to command the huge premiums they've been able to get for the last decade or so. Or they're just not going to sell their property or they'll sell it to somebody who's going to run on really thin margins.

Brock: Like first question here. Let's see. Yeah. Great question.

Chris: Yeah, it was, I read that out

Jim: loud, real quick. Just so learn in the chat question from Steve. Most of us here invest passively in syndications. What debt structures should we be aware of in today's rising interest rate environment, pros and cons of different structures.

Chris: Like I said earlier, one of the things that most of the debt on these big syndications has variable components, has the, does, did the sponsor put in a rate cap?

Did they buy something earlier to mitigate any kind of upside cost of that debt? What are the terms of the debt? What kind of traunch moves and increase in costs? Can you have you already experienced or can experience in a max? So when you're rerunning valuations and you're investing passively, one of the solid questions you should be asking your sponsors is, oh, Hey, can you run me through a scenario of interest rate changes in cost of our debt?

And how does that impact cash flows? How does that impact the overall profitability of this project when we went into it? That would be a key due diligence question to make sure that you're throwing out there.

Brock: I think one of the other things to be aware of too is when you have. Pref equity in there now, depending on how that was structured out there.

So just again, questions to ask your sponsor on private equity was, when the model that you're presenting that I'm going to make X dollars, was that based on two years into the deal that you're going to see this huge rise in value, we're going to exit out of that pref pay them off. And all of a sudden I'm going to get cheap financing, which is going to bump my returns and bump my cash on cash returns.

It's just something to be aware of out there. What does that model based on that you're looking at what those IRR is that were promise to you on that syndication deal.

Chris: Yeah. If you're in a relatively new deal and you're planning on that classic three-year refinance will, where will rates be?

Maybe that won't be the best.

Brock: And I'm not saying anything's wrong with prep. We're, we have a deal right now that is open that has private equity. But the key is here is how does that model structured is that there had they gone and over promise based on the model they put together, that's the key.

Jim: And what are the questions you would ask a sponsor to make sure that debt is, or the, the debt is in the right place. The preferred equity is it's just passive investors, because part of this is, we don't want to reiterate the deal from scratch. We found a sponsor.

We know and trust and we've vetted them. We think they know what they're doing. They send us a deal. We're looking at the debt. We don't get all of the deep underwriting details. So how can we, and this will go to the next question too, but how can we figure out is this a deal we want to get into?

They're doing a bridge debt for three years with a two year option and it's interest only. And they got all these bells and whistles. May maybe we ask them if they have a rate cap, what else should we be asking?

Brock: I think what you should ask is, okay, so you gave, let me just throw up an example.

Let's say that you're looking at a deal and they're saying, oh look, it's w we think that it's gonna deliver, 9% cash on cash returns with a 7% preferred, but we're overall looking at delivering, a 20% IRR, the question you want to ask, is that okay, based on what, what does that 20% based on, is that based on a refi in year three, is that based on interest rates not going up?

What exactly? What was your model here? They should at least be able to provide you a file-level model where you can see what that was based on it. Bottom line. You want that to be a conservative? You want to say no, actually that 20 IRR is based on the fact that we won't be able to do. A refi where it's based on rates going up another one or 2%, then we're going to be able to, and if we can, if all goes well and we're able to get that refund, actually we're able to deliver a 25, that's the kind of conservative underwriting, but that's some of the questions you want to ask around.

How is your model based on isn't it? What assumptions are you making around that model?

Chris: And one of the keywords there's stress tests are run in multiple ways. One of the stress tests you want to make sure that they've run is, will the impact interest rates. A lot of people will run stress tests on vacancies.

They'll run on rent increases. They'll run all kinds of different factors, but, make sure they've run in. They understand what's going to happen to their project. If that revise not going to happen and they are going to, or they're open, they didn't put a cap on, and what's our worst case.

Our debt goes to the max. How does that impact the project? It's one of those that, I don't know if there's a top 10 questions. I saw somebody. There's probably more than 10 questions, but with regards to specific debt, it's one of those things of get your transparency and see if they can share some of the loan document aspect and read through and understand.

What are some of the terms? What are our ranges? Where do we get hurt? What trip wires do we have in place? When did, what is the equilibrium. If we can't refi and we get in, one of the questions that came in also is, what if a, you did a bridge loan and you now you're not able to maybe get long-term financing.

What's what does, that was one of the questions. Yeah. Run that scenario, run that test

Brock: as well. And that could happen if you've got someone that's put on a too high of loan to value based on their purchase price. So maybe they ran it all the way up to 80. And now they're relying on refinancing, but then let's say interest rates rise.

And so that they're not getting the DSDR that's required for refinancing that into agency debt.

Jim: So what happens if they can't get agency debt and they have a short-term bridge loan and that's not working out anymore, what they can't refi do they just have to sell or.

Chris: Oh, you can, you could extend the bridge loan if that's a, an available option, but that's going to cost the project.

There's usually a certain number of points on the value of the loan that you'll be charged for an extension. So obviously you're now paying money that was not expected. That goes back to another question as well. How much buffer has put in place, day one in the project, how much money did they buffer in the res and in their first expectations of four things you just didn't.

Yeah, did they go thin and say, Hey, we don't really need much. And I'm just going to have, a couple of hundred thousand sitting around or did they say listen, this is a larger project. And I think we need to have, eight, 900,000 sitting around, for incidentals

Brock: and easy way to bump returns is not raising enough so that you don't have that cushion in there.

Correct.

Chris: It can be, it doesn't mean, if you have the ability to sell, but let's just walk through the scenario. You're now on a timeframe of, you want to sell, you want to get out of a project. It's not going to return what you thought. Hopefully it's not going negative. But you're also selling in a market that, like I said earlier is probably not going to be commanding the premiums that you were expecting.

Brock: The next question is can the cost of an existing rate cap rise with interest rate hikes? Not that I know of. Basically when you do a, it's an insurance, that's a, it's a little bit different than doing car insurance or something like that. That's an ongoing thing. Your interest rate cap is for a specific time period.

So when you purchase that interest rate cap, you're you have a choice at the beginning? Is it a one year? Is it two years? Is it a three year, et cetera, and you're paying upfront for that interest rate cap. So it's fixed either. They're not going to change it on you now, if you only purchase the one year and they need to go roll it and then go purchase another one, of course, then it's a gamble on what that's going to cost you the next time around

Chris: yeah. And obviously the tighter, the cap. It's just a derivative product. Someone's writing you an option. We won't go into too much of that, but the basis of they're just writing an option based on the term. What's your time value of it and what is the strike price? And the strike price is well that gap.

And if the tighter, the cap the more you're going to pay and you want to stay at that cap and you went with a short-term period and something went against you. It's going to cost you a pretty penny, but they usually don't. I've never run into one, but let's just be honest as a derivative product, anybody can write whatever they want into those things.

I'm not saying someone hasn't tried to do that. I just have never seen one that had a variable component to it. Yeah. But the only, I used to work on wall street, so I've seen a lot of wonkiness in my day. And the people will try to write all kinds of crazy things into derivatives.

Brock: How frequently our interest rates adjusted in the typical 3, 1, 1 multifamily bridge loan or the ratio is equal to, or more than credit hikes.

First of all, most agency loans are not based on the fed rate. Okay. They used to be based on labor now there Chris helped me out here. Maybe you can answer this question. I'm less familiar with the agency than you are probably.

Chris: A lot of it they're basing, they're going to depends on the document, but almost people are trying to peg to something that's right around, your 10 year.

Brock: Yeah. Okay. Yeah. And then usually those adjustments, that's, again, it's going to depend on who it is, but I believe that they're quarterly.

Chris: Yep. Usually

Brock: that's the key usually. And again, you can ask that question in there

Chris: and often not there again, it depends on the lender, but it's not lockstep, the fed raises by 1%.

It's not like magically your loan just goes up by 1%. It's yeah. There's usually steps three steps and net. It comes out less because of the time factor of when the steps. Yep.

Brock: Okay. And the typical short-term loans with two, when your optional extensions, how certain are the extensions in practice, for example, to the terms of the extension, typically give the lender most of the discretion to extend or not?

So yes, honestly, almost, I don't think I've seen it where the lender doesn't have complete discretion. Over that. I know in our loan docs, if you go look at them, we typically clearly because of the size we do what we call micro balanced loans. So our max loan is 1.2 million. So our max time period is 12 months with two, six month extensions.

Of course, if you're doing a larger loan amounts, let's say, two, three, 4 million typically then the renovation or project that's going to be a little longer, let's say an 18 to 24 month. And maybe you have one year extensions. So yeah, they're almost always at the discretion. Sometimes lenders will do them for free.

Most of the time lenders charge we charge for the extension. That's usually either a fixed fee. Excuse me. And Chris and I were just talking about this or it's a percentage of the loan and you might, of course at the time period, it's funny. We see people not even questioning what the cost of that is, but then of course, and then they come 12 months later and say, oh, by the way, I need an extension.

I can't get, I'm waiting for the refi to happen or, whatever it is it's going to cost me. Y cause they just don't read the loan docs, but usually it's anywhere from 1% to one and a half or with our cannabis, it's 1.7, 5% of again, you basically paying points to extend the loan.

But there's work to be done. It's not just oh yeah, you're extend. There has to be a Reese. You have to go back and do a title search again and make sure that there's no additional liens or changes on the title. You have to have that title insurance extended. You basically have to have a modified, even though it's called an extension, it's actually an extension.

It's a nice term for it. But the reality is it's a modification of the loan terms. So you have to have a go do a sign up an actual signing again with a modification of those loan terms. All this time takes time to put together the loan. You have to draw those docs again for that mod.

But hopefully that answers your question around the extensions is just, it depends on how long that loan was to begin with.

Chris: I love the next question. The basis I'll read it. Some syndicators are claiming if you invest in areas such as Texas, the market is so odd, the cap rates won't really matter that much and they can sell it to the next buyer.

I believe in your second sentence. Full-heartedly I would not believe them either. There's way too many factors in potential events that could occur. Yes, there is factors that I think all of us know Californians and anybody on the coast is moving to either Arizona or Texas. Yes, that is totally correct.

That probably will continue to be a trend. Will you see an immediate adjustment in cap rates? Probably not. Is it something that in a longer term trade, which if you're there again, you're in a brand new syndication in Texas and you've got an exit in seven years. You're now trying to forecast what the economy's going to be in seven years.

Good luck with that. There's a famous quote of if someone can give me an economist with only one hand, I might actually get a real answer. But there again, run your stress tests, understand because it understand why the cap rates are that way and the individual factors that are occurring to create that dynamic.

And what do you think the stability is of that particular factor? Because there's more than just migration going on there. There's business there's education growth one of the things we just did a property right in Tempe, because it's right next to ASU. If, for people who don't know this on the phone call, I know this is not standard knowledge unless you're in venture and startups.

ASU for two years in a row, has. National entrepreneurship awards over Stanford, MIT and other colleges. There is a huge explosion of entire campuses all centered around entrepreneurship and growth in that area. Not students are rolling out of college and staying local and building their startups right there.

Just like you see in Silicon valley, same thing we see up here in Seattle, tons of people coming out of UDaB and, just going, right across the street and getting, the cheapest office space they can possibly get. I would not believe you, that cap rates won't matter. Cap rates definitely matter.

It is. It's a relational, it's the time point of what's my exit. And if you don't get the exit, it doesn't mean you've lost money, but if you're someone who's hunting IRR, one of the key aspects of that equation is the duration of the time of the return. So if all of a sudden you're now in a trade that was supposed to be seven years and you're going to be there for 12.

Your IRR is going to get smashed. And that's just a fact math is one of those wonderful things being a universal constant. So I agree with you in short,

Brock: one of the things I want to bring up here, Chris and I, again, I think this is an excellent question, as an. Even for myself, w my primary career has been in lending or on the lending side.

And one of the things that when I teach new underwriters, as I say, look for the red flags first, why? Because you start picking up enough of those red flags. It's just basically look, I don't need to even examine this loan anymore. It's just, it's done it. Doesn't move on. I think you can take that approach also with your investments, whether it's syndication, whether it's investing in other funds or whatever is as an investor, you start to keep along, Hey, here's the things that I learned to watch out for.

And so that you can actually look through when you become quicker and quicker to look through a deal, look through the PPM, et cetera. And you're looking at your eyes go right to those red flags. And I think this is one of those red flags. If you've got a syndicator or a sponsor, who's trying to pull the wool over your eyes and say, oh, cap rates don't matter.

That's a huge red flag because cap rates and considering what cap rate you buy, and then once you sell is going right to what they're going to try and promise you, or at least tell you is their IRR that you're telling you for the deal. So that worries me a bit because on a good underwriter for a syndicated deal, a good sponsor who's underwriting conservatively says, oh okay, look, I'm buying us at a forecast, but you know what?

I want to actually underwrite at a 5.5 cap. And that's the amount that I want to use because if cap rates go up, I want to make sure I can still deliver what I'm telling investors. I'm going to deliver. Not that on buying in the poor. I think it's going to go down to, I'm going to get you a 25 IRR. No, that's huge red flag right there.

It's just one of those things as you look at, or are they not being realistic with that? I with that capital.

Jim: Hey Brock we're running up against eight o'clock. I got one more question and then maybe a small follow up question. You mentioned red flags and I think that's great. A great way to look at that.

So just to summarize it, if we're looking at a multifamily deal and they have, probably bridged debt, like most of them do these days. And so it's adjustable and all that. What are the red flags that we need to look for? Would it be, for example, they don't have a rate cap. Is that a red flag?

If you have adjustable and your no rate cap, are you not investing in that deal? Are there some just deal killers for you on the lending side and you're looking at a multifamily or other type of deal?

Brock: That's a great question, Jim. So no right. Cap is not a red flag. If you understand first Wilton to almost every loan, there's already some sort of rate cap in.

On most adjustable rate loans. So what is that and how does that stair step up? So understand that, and then is that considered in the model? So if there's no rate cap, but you're only going on through the rate cap within that loan understanding what that is and how that was modeled out. So if the model that you're being sold on for the returns is, has been stress tested with those maximum amounts.

Great. Wonderful. Then no rate cap, no external or third-party insurance rate cap is needed. So not necessarily a red flag, if they have modeled that. Secondly, there was a question earlier about what if I can't, what if I can't get it refinanced? So that's another thing, is that bridge loan, but what's the extensions in there.

How, what's the chance of getting that extension? Are you dealing with a lender who normally gives extension as long as the loan has been as a performing loan? Those are some areas and if you can't get those questions answered clearly from your sponsor. That's always a red flag too, because they should really understand the ins and outs of that deal.

Or if on the phone, like I get, these, and I've been in this situation too, on some of our deals where the equity deals, they can get very complicated. I'm not saying that they got to spit out the answer right away, but they should be able to go let me double check that. And if they're not able to get back to you in a clear answer, then of course that's a red flag.

Jim: So lastly, before we thank you for being here, I do want to give you the opportunity because I don't think it's clear what the investment opportunity with Kirkland might be. So if you guys could, and again, I apologize we're running late, but if you could just like two minutes, tell us what I know you guys are lenders, but what does that mean for an investor and how if people wanted to connect with you, how do they do that?

And what kind of opportunities are there with your group? Yeah, Chris, you want

Brock: to take this. Sure.

Chris: We are a bridge lender. We tend to target obviously we're private debt, so we've got that inefficiency, but further inefficiency efficiency. And I don't get credit for this Brock does he brought back to me in 2019 and said there is a further inefficient space of where small commercial deals that are sub 1.2 million.

There's just no one sourcing, that debt there's no one providing money for it. And one of the key reasons that we've seen is a lot of the funds start off small. They will get into that situation and they'll go in and say, great, I'll do those loans when I'm growing. And then all sudden they raised three, 400 million, if not a billion, a lot of these funds grew very quickly over the last 10, 15 years.

And so now these small loans are diminimous to them. They're not, it's not worth. So we want to build a fund and stay in that inefficient space. Now, obviously that means, we will be capacity constrained. We're not, we don't have a target to go run, a billion dollar fund, but we want to stay in that space to where we don't have a lot of competition to our loans.

We don't have, we have pricing power and contract power. So we are able to come back and push back on LTVs and most people will accept it or move on. We've had a number of people who say I don't like your terms. Two weeks later, they come back and ask Brock, how do we get this loan done? But the way we structured our fund, as I said earlier I'll just use, certain simple numbers.

Cause it's really that simple, the way we built it as if I go do a 12% loan, we only charge one and a half percent management. And that's annualized. And then we have fund expenses, which I think last year were know targeting at about, 26 basis points or 0.2, 6%. So we actually pass that return on to the investors directly from 12 minus one and a half minus 26 basis points.

And, and then you can get a rough idea of what your net return will be. Last year we had a net return of about 10.1% to two investors. We don't use any leverage. It doesn't mean we won't look at using leverage, but having been someone who has used leveraging a lot of the funds that he's either worked for or built.

I understand that it's a two, it's a two edged sword and I want to be very careful that, and unlike most other real estate. I want to be more like 30 cents to 50 cents on the dollar. No more than that. We don't need to lever our fund to put up really good returns. We're in an inefficient space.

That's already putting up a double digit return net to investors. So it's something that we want to target. As Baraka said, multiple times, we are risk first. We always dive in and assess risk. And then we dry too. And we have a matrix that basically assesses what the cost interest rate of the loan, what the LTV should be.

And then we actually think that's commensurate. And then we look to put that into the portfolio from that standpoint. And one of the final questions that we always ask is, no, it hasn't happened to us in the last two years, but two years is not a very long track record. And especially when we haven't really seen an upset market, although we did launch in, COVID that was it.

Wasn't quite a financial upset in the way that we've seen historically oh eight. But we always ask the question of. Woodbrook. And I want to own this loan because that's really the question. Lenders should be asking if you're thinking about yeah. If we're going to own the property. The worst case scenario is we have someone who defaults and that default leads to a foreclosure and then, we're going to have to take that property and what do we think we want to do with it?

And if the answer is, yes, we want to own that, then we'll most likely put that into the portfolio. We have a lot of our own money in there as well. So we are, we had a lot of skin in the game, so let me a lap

Brock: wrap it up with maybe the 15 second here is number one, you're looking for something lower risk in your portfolio.

That's going to be us because we're that, that senior. You're looking for a decent yield our targets 9%, but we reached to we overshot that with a 10% return last year. You want something that produces steady income. We either pay it out monthly, so you can get a check in your bank account or ACH to you each month, or it can be rolled each month and then reinvest in each month so that's, and it's all backed by income producing commercial real estate.

We don't do any fixing flip commercial real estate. We don't do any

Chris: raw land or construction either. Excellent.

Jim: Thank you guys so much. This was super informative. We really appreciate you being here and can't thank you enough for spending the time here with us today. Everybody on the call, including Brock Chris, if you're interested, we are going to go over to wonder me.

Now you do need to completely close up zoom because you'll have microphone issues and be lost. Like I was last time. Steve put the link in there. I copied the link and put it in again. So it's the bottom of the chat? The password is capital L capital F capital I two two LFI 22. So go ahead, head over there.

We'll do a little bit of networking, but again, Chris, Brock. Thank you very much. And we will see you all next month. Thank you.

Chris: Thanks. Thank you. Thanks.