Park Place Investment Interviews Kirkland Capital Group's Chris Carsley & Brock Freeman
Watch Brock Freeman and Chris Carsley of Kirkland Capital Group discuss their approach to investment in the Kirkland Income Fund with Park Place Investment.
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Transcript
Investment Cubed Episode #7 - Kirkland Capital Group
Park Place Investment welcomes to you to another episode of Investment Cubed, where we talk about the world of commercial real estate and real estate financing, Silicon Valley and technology startups, and investment and personal finance.
Hi, everyone. Welcome back to another episode of Investment Cubed. Today. We have two great guests here from Kirkland Capital Group to discuss their real estate debt equity fund. First, we have Brock Freeman, the COO and Managing Partner of Kirkland Capital Group, a commercial real estate debt fund with consistent equity like returns, and a focus on capital preservation. His career spans technology, finance and real estate in both Asia and America. He runs the PropTech Seattle open house events and is the Seattle Regional Chair for the Foundation for International Blockchain and Real Estate Expertise. He started his career as a Taiwan stock market analyst in Taipei, later moving back to Seattle and joining a mortgage bank as an underwriter where he built the industry’s first web based end-to-end loan underwriting, processing, and secondary marketing platform. He is a member of the Cascadia Blockchain Council, and has testified on behalf of a number of blockchain bills for several Washington state house committees.
Next we have Chris Carsley, the Chief Investment Officer and Managing Partner at Kirkland Capital Group. He brings over 25 years of investment industry expertise, specializing in corporate and venture finance business, valuation, business operations, efficiency, regulatory compliance practices, securities research, portfolio management, arbitrage trading, and hedging. Previously Chris was responsible for the creation of the business risk and operational due diligence program as a senior member of the investment research and analysis team at Benchmark Plus Management. Chris is currently a member of the Charles Wright Academy Endowment Committee serving on the board since March, 2017.
He co-founded the Northwestern Hedge Fund Society. Now the Seattle Alternative Investment Association in 2004 and is the co-head of the executive board of the Seattle CAIA chapter that launched in 2017. He earned his CFA designation in 1998, Chartered Alternative Investment Analyst in 2011, and holds a BBA from the University of Portland.
Question: Tell us about yourself and how you got into real estate.
I'll go first. My name is Brock Freeman. I'm the Chief Operational Officer for the Kirkland Capital Group. And I have a long background in real estate, mostly on the debt side. I spent years in underwriting, everything from building up underwriting teams, underwriting market loans myself, as well as auditing other underwriters.
And then on the tech side, building underwriting systems, loan processing and underwriting systems as well. This was early on in the residential mortgage space, and then later on now in the commercial space. But that's my specialty, really understanding what drives risk and how to understand underwriting and due diligence around both the loan, the property, as well as the borrowers for a real estate loan.
Chris Carsley: Hi, I'm Chris Carsley. I'm the Chief Investment Officer for Kirkland Capital Group. Most of my background within real estate originated on the investment side. I was manager for a number of different accounts that had a real estate exposure, specifically on the private side, so I did a lot with walking those investors through that investment and also understanding the valuation metrics behind those investments. Then on a personal basis having been directly involved with some equity investments in the real estate space and now heavily involved on the debt space in micro-balance commercial real estate.
Question: Tell us about your company.
Brock Freeman: A couple of years ago as I was looking out into the real estate space once again, after taking a turn for several years in corporate IT working for some of the largest Fortune 1000 companies. I wanted to come back into real estate, and one of the opportunities that came up was in the space of commercial micro-balance loans, these are loans under $1.2 million.
Of course, no one just starts up a fund out of nothing. I explored it, and then one of the best people I knew that had such a long period of experience in fund management was one of my friends, Chris. I went to talk to him about that and we started really examining whether this was something that had really the depth of opportunity. Not to just to make something that would be a flash in the pan, but something that we could really build a very strong, risk averse, fund around that could serve both investors and borrowers alike.
One of the things in talking with Chris over the years is that with his experience as a fund manager, he had been approached many times with building all kinds of different funds. So, one of the things I knew was that if I came to him with this idea he wouldn't simply just let us go crazy on something, but he would really cause us to do the due diligence.
Chris, one of the things that you had told me in the past was in making those decisions around what to accept or what not to accept in building a fund, you would really start to narrow down [opportunities] very heavily, but maybe you can talk about one of the reasons that you thought this was a good opportunity in this micro-balance commercial loan space.
Chris Carsley: I remember the day Brock said, “Hey, I have an idea. We can build a fund around investing in micro-balance commercial real estate bridge financing.” And I was like, okay, give me the rundown. I have a knowledge base of what you're talking about, but why now?
It was kind of a loaded question. You'll find that I often ask questions where I kind of already know the answer to them. Being in the investment space and following up on research and hearing the demands from a number of different of my networks in the RIA and wealth manager space was the common, constant demand for yield. I mean, long before COVID-19 actually occurred and drove us into 150-year lows on the interest rate scales, we were already at low interest rates.
You already had a number of investors, a lot of retirees that were wondering, where am I going to capture yield and have it in a risk adjusted space. By looking at the nature of where you could come in and capture an excess return versus comparative investments, and really still have the risk controls in place around being first lien, full recourse against an income producing property, resonated heavily. It put me mentally in a place where we want to be on the risk curve. The returns are extremely competitive across a number of different profiles. It really puts you in competition with, and able to consistently beat, a number of different investments, both traditional and alternative on the investment side.
So, that was a huge component of coming in and being able to create and build this fund. Then having a relatively small team giving me the capability to deploy knowledge of a number of different funds that I'd built: seed angel, venture, managed futures, long short, equity funds. Being able to take sort of the best of the best of having built a number of those types of funds and deploy that here was going to move us quickly to where we were truly going to have institutional level operations, regulatory capability and compliance in place regardless of size.
Real estate is very different than some of the esoteric trades where they were a little bit more black box. I liked the idea of being able to approach investors for this fund and be able to offer them full transparency, which is important in today's world. I think it's important for investors to want as much transparency as they can possibly get, because that's what I always want.
So there's a number of factors, not only on the investment side, but on the operational build of what the Kirkland Income Fund has become. it was a combination of driving forces that led us to be where we are today.
Question: What’s the objective and strategy of the fund?
The way I like to really go into that is our mission statement of why we were creating this fund. There’s no better way to put it than just to simply read through it: delivering an opportunity to invest in micro-balance commercial real estate bridge financing that provides consistent returns through scalable cash flows at lower risk levels to investors while offering a superior platform for select commercial real estate buyers to source funding.
And the reason that became our mission was there are two folds to this fund where we want to not only bring a great investment to investors is are going to allow them to capture consistent yield while controlling risk, we also understand that those trades come from a number of different networks. Brock already had many of them, and we continue to develop them. We need to be a platform that's going to have them in mind as well, because that's going to really help build that consistent deal flow from those brokers and other people looking to go out and purchase commercial real estate.
Question: What type of investments does the fund make and what is the due diligence process?
Brock Freeman: We are very niche in the type of loans that we do. We've chosen that due to research that we did at the very onset of establishing where the opportunity in the market was. Due to some interesting things that happened post 2008 there's not a lot of banks that can participate in the type of debt, particularly bridge or short-term debt, the 12-to-24-month debt, that now has seen the rise of a lot of private debt providers be able to offer.
Now within that, of course everybody wants to do the huge deals. Everybody wants to do the $20, 30, 40 million or higher deal and deploy that much capital and make a whole bunch of money on one deal. The challenge is that everybody's doing that. What we wanted to do is leverag a couple of things that we saw were opportunities for us in particular.
I have a background in finance and had a lot of that finance experience in the area of automation, using systems to automate things and lower costs. I first did that in residential mortgage, building some of the first systems out there for the underwriting, processing, and secondary marketing of those mortgage loans. I don't see that there's any difference in being able to apply that to what we call micro-balance loans, for commercial property or multifamily five units and above that are under $1 million. The reason that we can apply some of that technology and systems here is because there's a huge amount of opportunity out there with the number of loans for properties that fall into that space.
There's not a lot of other bridge lenders that are offering that because it takes a lot of work still to do that due diligence. A lot of them don't have that information technology background. They don't have that tech background in order to lower their cost of doing the due diligence on each one. By doing larger loans they sort of do an end run around having a need for that technology. Whereas what we've chosen to do is deploy technology from the very beginning to keep our costs low.
Now that does a couple of things. First, it allows us to capture an outsized return. Our loans are typically in the elevens to twelves [percent], once in a while in the thirteens. What that means, and Chris will talk about this a little bit more in a bit around how we structure our fund, but that really gives 8.5% to 9.5% target net returns to our investors. That's really difficult when you're start talking about the larger deals because there's so much more competition. But in order to do that, to make that run, we had to apply technology, which is what we've done. That's why for me having that background and being able to automate those systems that we have for the due diligence and information was super important.
The other part is, I've built up a couple of times in my career, networks of loan brokers. We've done the same thing here again. There's a lot of very good loan brokers out there that operate in the commercial loan space. We reach out, we let them know about what kind of program we have, and there's a lot of deal flow out there.
That brings me to the second part is what of our investment screening process or due diligence looks like. Because of the number of loans out there in this space, and because there's not a lot of other lenders, we can really pick the cream of the crop. We probably only choose around 10% or even less of the loans that come across our desks. We look at a ton of stuff, but we turn down a lot because we don’t feel like we're in a position that we have to deploy capital for these types of loans because there's a scarcity of trade deals. The thing is that there's a ton of them out there.
We can pick up the cream. We can really pick up the ones that are not high risk to deploy our capital and our investors’ capital into those trade deals. On top of that, because of the fact that they're smaller deals, we can spread our investment capital among more of them. Now it means that if any one of them has an issue, it means we're putting less of our entire portfolio at risk.
We can also apply a lot of both internal and paid information that we get from private and public sources and use that to make determinations. That gets us away from what happens with a lot of private large debt, the more anecdotal “I need boots on the ground to really understand does this look good or not”, where you run against human biases. We've tried to, along with automation, eliminate that sort of human bias by using both public and private data sources to do our due diligence.
Then we also take and roll that up and Chris takes a look at it from across the portfolio on whether we should deploy capital in certain places so that we don't get too much concentration. Chris, you might want to talk a little bit about that sort of due diligence, that extra level of due diligence we do not just on an individual deal, but how do we look at that across the portfolio?
Chris Carsley: Yeah, definitely. When we're filtering through one of these in the aspects of building out the portfolio one has to understand dollar allocation to a loan. We do see a lot of loans that come in, in the millions of dollars, which would be a concentration in our portfolio. It may be a great investment from first glance, but from a concentration standpoint wouldn't be an intelligent a way to build a portfolio.
But there again we started this fund and we thought we're going to work across a lot of different sub sectors within commercial real estate, but with COVID most of our portfolio became concentrated in multifamily. We didn't really view that as a risk, we viewed that as a risk mitigate given the current environment and the uncertainties around retail and office. Now I'm not saying those are bad trades and I'm not saying that in the future we may not have some of those in the portfolio. I'm just saying right now that one of the things that we did in structuring the portfolio is to really focus on and really capture those income producing multifamily properties.
And although they have their own fears around rent collections and eviction moratoriums, there again we restructured the portfolio and added factors into our due diligence and our underwriting requirements. One of the things that we added was the ability to obtain prepaid interest payments. When we write a loan, to help mitigate some of that risk around are these people going to collect rents and be able to make interest payments to us, let's give ourselves a window to where that's not an immediate concern. A lot of the borrowers were totally okay with moving forward and prepay three to six months of interest. That allowed us a window to watch them perform, deploy out on their business plan and the betterment of the property that they had planned, to get us to the point where we're going to be in the right place for conventional conversion.
We also look nationwide. We want to develop a portfolio that is not going to have some idiosyncratic event to a certain geographical area. A tornado or flood or something like that, and all of a sudden our entire portfolio takes not one, but multiple hits.
We want to be in a variety of areas that capture different socioeconomic impacts, different employment impacts and different exposure to different companies that are helping build those geographical areas and they need housing. Those are all the things that we consider when we might have a couple of different loans that pass all the initial filters. How does it really impact the fund? And what's the value add to the diversification of the portfolio?
Question: Let’s talk numbers...
Chris Carsley: The way we built this fund out our expected returns are really arranged because there are a number of factors that's going to create dynamic impacts on the movements of rates. Some of it may be that the loan is a little more risky, so we might capture a higher return. Some that we assess might justify a lower gross yield on a loan. But for the most part right now we're seeing everything that we're writing in the 11 to 12% gross paper, and we think that will continue for some time.
We're looking at record year lows, but you're also looking at a current monetary regime. Our government, they need to keep money cheap, so we don't see that changing. And if it does change, it'll be gradual and something that we will be able to adjust to. But like Brock said earlier, there's a supply and demand factor of why we want to stay in this micro-balance space. It really gives us the ability to capture efficiency and pricing power. We don't have a lot of competition in the loans that are shown to us.
Now with regards to the way we built this for investors, we always believe in being very investor focused and one of those aspects is aligning fees to the nature of how we need to run a successful manager. The manager is a business, and that manager oversees the fund; so we have to make sure that the manager can actually run effectively so it can continue to manage the fund in a proper way. One of the things that I realized in my early days of building out a number of different funds, I was only able to take fees from investors, so that implied management fees, incentives, and carries, and a variety of other factors that you'll see in traditional hedge funds and venture.
What real estate allowed me to really look at and better align with investors is there's inherent fees that are taken in the process of the origination of loans. One and 1/2, 2%, 3% in origination, and there's servicing fees, a variety of different things that are inherent in this industry. And that allowed us to really look at Kirkland Capital Group and understand there is a way for us to better align. And what we found was yes, we were able to come in and not have multilayers of fees. We charge one and a half percent, a flat annual management fee that's taken monthly from the investors.
Also one of the things that I love, that most people don't talk about, is fund expenses. Every investor really should go out and really understand what fund expenses are. We actually make it a line item in our statements as we want our investors to understand everything that impacts them and everything that impacts their return. Fund expenses are extremely minimal, as they should be, and it should be defined in the documents what those are.
I get the question a lot, “Why don't we have an incentive fee?” And I was like, “Well, I don't need to take extra fees from the investors.” The inherent nature of what fees we can take from the borrowers, that origination and other underwriting fees, those numbers combined allow us to really look at, when we built out the proforma for Kirkland Capital Group, to really understand that we can build a sustainable business with those two fee levels.
Question: Who is your ideal investor?
Chris Carsley: That's always an interesting question. One of the things of why we decided to put this fund together was it was applicable and appealing to a wide variety of different investors. We would have the investors that need income generation and want monthly payment. We have the individual investors that maybe they don't have exposure to real estate in this fashion and it would be a great diversifier in their portfolio.
We think it would be a good fit for family offices and a number of other larger investors that might be looking for a part replacement to their fixed income portfolios that aren't generating money right now. We've also got real estate experts that can't find an equity deal to dive into. They're realizing and saying, wow, the returns that you guys are able to capture, and from their standpoint of a purely passive play, is not too off what they're seeing in in direct equity. And they don't have to come in and replace toilets and do everything else and wake up at 2:00 AM.
We've captured a number of different investors that have a good background in real estate and own multiple properties. And they've sort of looked at this as a way to continue and they liked the exposure. They don't mind being overweight real estate across their investment portfolio, but this was a differentiated play that from what they were seeing in today's market. It wasn't too different ten the available deals in their geography.
It really is something that if you're investing and you've got a fixed income component to your portfolio or you've got cash, it's a way to say, “I really can capture an amazing risk adjusted return.” Which has really allowed us to sit at a lot of tables and have a conversation across a lot of different platforms, that includes RIAs and wealth managers.
Also, what we've seen is people deploying non-taxable funds. One of the things that investors should consider in what we do is we generate income. It's a short-term income, it's generated monthly, and you should be aware of that and understand how those taxes would impact you. But for investors with self-directed IRAs, or rollover IRAs because they left their company, and they're busy doing a startup, it's something you should consider. Utilizing those funds and capturing compounding aspects of high single digit to low double digit returns for your portfolio.
So almost anybody. I think there's a fit depending on what your investment objectives are.
Brock Freeman: I think to reiterate, Chris said it's not necessarily that there's people that it doesn't apply to. Who doesn't want lower risk, higher return, particularly steady returns that we provide? A perfect place to put in your IRA or your 401k, although we have investors who invest into our fund outside of that. The question is really how much of your portfolio would you allocate, as we tend to see the closer you get to retirement, people take less and less risk. So, that's where they tend to expand the amount of money that's in a fund like our Kirkland Income Fund.
For the younger set though, we're starting to see a desire to have a portion of their portfolio in a lower risk non correlated investment such as the Kirkland Income Fund. That gives them a really nice alternative to their stock portfolio or their VC fund that they're investing in that is much higher risk.
Chris Carsley: A lot of the younger investors and older investors, they like the tangibility of real estate. So this debt fund, if you think about the capital stack of where debt sits, there's a lot of people that like the idea of I'm going to be a debt holder and supported by a tangible asset. It's something that appeals to a lot of investors.
