Understanding “Micro-Balance” Bridge Lending

Lance Pederson, the host of the Real Estate Risk Report podcast, Founder and Managing Partner of Verivest, interviews Brock Freeman and Chris Carsley.

Most lenders do not consider commercial real estate bridge loans under $1M. That’s where Kirkland Capital Group enters the picture. They’ve leveraged this opportunity by building the Kirkland Income Fund, delivering a “micro-balance" commercial mortgage option. Chris Carsley and Brock Freeman of Kirkland join Lance to talk about the ins and outs: how the Fund offers investors lower risk and consistent annual fixed income returns, how they approach the underwriting process, commercial mortgage brokers, and assessing borrower risk.

Don’t miss the first few minutes where Lance starts off by using Kirkland Signature, instead of Kirkland Capital.

Access more episodes of The Real Estate Risk Report and Lance Pederson, Straight talk for savvy investors.

Transcript

Intro 0:00
Real Estate Investing can bring big reward and big risks. So know your risks. Welcome to the Real Estate Risk Report, the show for real world insight on real estate investment risk. Now, here's your host, Lance Pederson.

Lance Pederson 0:21
Thank you for joining the real estate Risk Report. I'm your host, as always, Lance Pederson. So today I have with me the fellows from Kirkland Signature, Kirkland Capital Group. 

Chris Carsely 0:36
We would love an affiliation with Costco.

Brock Freeman 0:38
I know where you spend your time in the off hours. 

Lance Pederson 0:42
I've got five kids and a wife gets like most of my paycheck, I'm even sporting the Costco wedges, I've got Costco golf wedges, and the putter. You know I've so Kirkland is always on my mind every time I think of you guys, Kirkland Signature. But you know what, I think so highly of the Kirkland Signature brand. These guys carry the banner well, at Kirkland Capital Group. So we've got we've got Chris Carsley and Brock Freeman, these guys are based up in Seattle area. I've been connecting on and off with these guys for years. A very interesting, as you'll you'll you'll find out here as we get into this a great duo and pair. But Chris, why don't we start out with as we as we always do, sort of getting the backgrounds of how did you guys get in sort of the real estate business. And in this case, you guys are operating a debt fund and you know, kind of on the lending side of things. But Chris, I know you've got an interesting background, kind of from financial services, and then we'll give Brock a chance to sort of share, you know where he came from. And then, you know, Brock, I guess you can kind of bring it together as to why you guys ended up deciding to form Kirkland Capital Group.

Chris Carsely 1:52
Yeah, sure, I'll get I'll get started. Yeah, my background was in investment management. I started off managing high net worth family office money. Early on, did that for a number of years. And then my career transitions pretty quickly into alternative investments where I had an opportunity to join a group, and was a hedge fund trader for a number of years, then took that career and that knowledge, and started deploying on the buy side for a large fund to fund within hedge funds and other esoteric strategies. And then, after that, went in and started doing direct and indirect venture seed Angel type work. So I've been able to kind of touch a number of different things. But oddly enough, throughout all those different pieces, I was always involved in some level of real estate, whether it was assessing and valuation and risk of someone else's real estate or looking at something for myself. And that kind of came to a head my knowledge of how to operate and build funds and run a portfolio. Very risk minded. So risk is always first on my mind. And then Brock came to me in 2019, with an idea and here we are, we put together Kirkland Income Fund,

Lance Pederson 3:03
Yeah, and you in your as your CFA to right like the,

Chris Carsely 3:06
CFA and a CI. So yeah, I used to, I used to have about seven numbers behind my name, but no longer out there selling security. So they all go away.

Lance Pederson 3:16
Which is good. But the CFA, I think it's I don't think people enough people realize and understand one, how difficult of a designation that is to attain it's, it's, you know, but it really does put you through the paces to really become a professional investor in my mind. And I think that, yes, 

Chris Carsely 3:35
It's three years, your life. And I basically tell people, yeah, I guess it's a certain indicator of intelligence. But really, what it is, is an indication that you're the type of person to take on a daunting task, mostly by yourself and complete it. Yeah. I mean, it is really quite difficult. And the CAI for people who don't know what that is, it's really kind of the CFA program, but for alternatives, so it focuses on everything else that's kind of outside of portfolio management, traditional investments.

Lance Pederson 4:01
So yeah, so Chris, Chris is a professional investor, I think that's what's important to understand is that he did, his brain is wired for this. Like I said, the real estate Risk Report in everything we're about here is that's how, you know Chris looks at the world. So, Brock, how about you, man? You know, how did you kind of get from, you know, from where we are today and go backwards? How did you get into this business and what attracted you to it? And why did you have the idea that to do Kirkland Capital?

Brock Freeman 4:27
And before I dive into that, I'll give kind of for people who are not from the financial world, probably a good way to think of Chris's background with his education and the CAI and the CAIA is really, we should be saying, thing, Dr. Carsley, I mean, it's really the equivalent of a PhD or as much time as he spent studying and getting an education plus on top of that the real world abilities and experience that he has, which was really is why I was excited to have him as a partner. So I've known Chris for a long, long time. Before we got together as partners, I started out actually not too dissimilar. I also have a background in finance, as far as degree in finance, but I kind of went a different route early on. My first role was actually in Taiwan, I'd gone over there and taken up a role as an analyst for the Taiwan stock market wrote stuff about that for institutional investors. But then, when I came back to the US, I actually hooked up on into the real estate and in became an underwriter. And it did a number of things for a mortgage company, a lender, and then took a turn into technology building systems, because I quickly discovered I got irritated at just the repeated stuff that we would do. And I found that I had a knack for building things. What using tech. So that's sort of where I took a turn, and sort of my careers since then it's kind of bounced between those two. After the big crash, in 2008 , I actually took a break from real estate went into corporate finance ran systems for Microsoft, mostly internal stuff with their, with their finding their finance and accounting, which was great, I, you know, learned a ton about how corporate finance works, etc, etc. But then I decided, you know, what, I wanted to go back to real estate where I had a lot of fun. And so in 2018, started exploring that, again, saw that it was probably a good time to come back with, with what was happening really with technology and, and commercial real estate, and seeing how that would affect both things in the real world with real estate, and both in the finance end of real estate. So just networking, exploring again, found that there was a real need in the marketplace for what we call microbalance bridge or hard money for commercial real estate. There wasn't many companies out there who were willing to do that kind of thing. And so when we talk about microbalance, we actually are talking about under $1 million loan amounts. That's a difficult thing, because in the commercial world, because a lot of times it takes just about just as much due diligence on these deals, yet, obviously, you're not going to make as much money. But there are some other things that that are really great about this space. And we can of course dive into those. But with my technology background and building systems before an automated underwriting and processing and secondary marketing systems for mortgage, it made sense. I felt like hey, there's this is a place where we can pick up things and make an outsize return, and yet lower risk for investors across a number of areas, use technology to really overcome what previously made this sort of an untenable space to be in and operated on a regular basis. So Chris, and I came together, it was great to have him because of his background and understanding how to build really what we would call an institutional level fund from day one, which was great because I didn't have that background. But what I brought to the table was this background and having been an underwriter understand the real estate, etc. So we felt like together, we'd really be able to fill each other's gaps from very, very well in creating this fund and launching it.

Lance Pederson 8:30
Yeah, that definitely. And it's interesting, because I, I've, I met Chris and Brock separate and apart. I mean, Chris and I have been talking on and off for a number of years. And we always hit it off because we are kind of as well, we're fun nerds like we're, we're structured with what it is like so we speak each other's language, right which, which, for me, and no offense to the clients I work with and things but sometimes I do feel like I'm teaching like fifth grade, like all over every day, again and again. And then when I when I would speak with Chris, it'd be like. Alright, we're speaking the same language like we it's two colleagues, like you said, it's the PhD or whatever, don't give myself too much credit. It's It is very esoteric, random stuff. So it's like, oh, yeah, not that exciting, very interesting. But and then and then Brock to from the tech side, and, you know, blockchain stuff, and that's sort of where him and I had connected and then to see these two, sync up was kind of cool. And obviously I'm the Pacific Northwest. Kirkland Capital Group is a member of the of the verify sponsor network. So we're super excited to have these guys especially if there is they're, they're launching the venture, just the types of guys that we want, you know, in our club, so to speak, and so it's been fun to get them there. And it really our roots to in my roots, at least on the real estate side, whereas as lenders, so you know, in more small balance microbalance side, I completely hear you, which is why I think we're gonna dive in today is just talking about. Why that need exists. And I think that it's interesting when you think about it for, for, for guys like Chris and Brock, they really have, unlike like commercial real estate acquisition, guys, really, they're out there and they're just trying to find stuff to buy now that they have to maintain relationships with brokers, and so a lot of the similarities, but really, they have this investment product. And in their case, it's a 506 c offering the Kirkland Income Fund. So you've got this financial product you're trying to sell to accredited, you know, high net worth individuals, and thereafter yield and, you know, and risk adjusted a good risk adjusted return, and, you know, cash flow and income and that kind of thing. But they also have to go out and compete, you know, for borrower attention, right. And as Brock alluded to these, you know, it's still the same amount of work to determine whether or not you know, how much you're willing to advance or lend to somebody. And, you know, you have to assess, you know, figure out what, what the property's worth, and, you know, all those sorts of things, but you, you need to attract borrowers money's fungible, right. And obviously, if they can, you know, get it cheaper someplace else, they, you know, they may do that. So that means that you have to have really two different, you're trying to get the attention of high net worth investors to sell this, this financial product, but you're also trying to get the attention of those who need to borrow capital. 

Brock Freeman 11:23
So maybe classic, two sided marketplace,

Lance Pederson 11:26
 It's a two sided marketplace, which is the same problem that, you know, we have, you know, Veribest now to like, we got sponsors, we need to attract them in as members, and we've got to get the investors. And so it's really double the work, that you have to have to have a different message to the different people. So maybe because of this tech background, and I know you guys, in this case, you know, you're comfortable lending, not just in, you know, Washington State, but you guys, you know, originate loans and other states and maybe share with us like, how do you go about getting that lending product? That micro balance sort of bridge type of stuff? How do you get that out in front of people so that they know that? You know, think, you guys potentially could land on their project? What do you what is it good?

Brock Freeman 12:11
That's a great question, Lance. So in my career, I've actually built loan broker networks two times before, and this will be the third time. So I was pretty familiar with the loan brokers, how they work, how they think, I had spent quite a few years both in the field building that. And then later on managing for a lender managing other salespeople who had built those networks as well. So for me, it was okay, you know what, we can either go out there and try to contact all these 1000s of commercial real estate brokers, and maybe they have a deal once every couple of years to send us. So staying top of mind is gonna be really difficult. Or, you know, you can directly reach out to borrowers and try it that way. But in the end, really, it's like, wow, there's a ready to go Salesforce out there. They're called commercial loan brokers. They're the ones that if you treat them, right, if you protect them, if you know how they think. And you can, you can tap into that, it's like you, you're going out there and recruiting your own Salesforce. And so that's what that's what we've done. 

We started out, doing outreach, just talking to them kind of understanding from their perspective, okay, what are the difficult things? How do we make some changes, and I made several changes upfront to really attract their business by appealing to what what matters to them. And there's a number of things that we do, and that don't really lower, increased risk for us at all. Number one is just look, they want to be protected, they want to make sure that their borrower isn't going to go around you, around them to us directly. So one of those things is we just, we just don't do any direct loans. It's always there a loan broker, so that helps make them feel confident. Number two is, you know, they have their fees, they're the points that they charge, we put that right into the documentation that we send them, we make sure that that's in the loan docs, make sure they're paid out of closing, we've heard enough stories about brokers who were, you know, particularly from the private lenders, who were, who were spit who were cheated on fees. And so that leaves a bad taste in their mouth. So, you know, those, those are some of the things I do, we set up. 

The other thing that we've set up just in our loan process is knowing that loan brokers will get on the phone, they'll take a call from a potential client, they'll have a sort of a broad idea about what the client looks like, but before they want to put a lot of work into it says, can I even get some traction on this from any lender, so we make it easy for them to come come on our website, or email us but potentially on our website again, too. I use an online method to submit that scenario, they didn't even have to submit documentation will give them what we call a scenario proposal, which is like, Hey, here's, here's what we're thinking on rate. Here's what we're thinking on our points, here's what we're thinking on, on the LTV or whether it be able to meet that loan amount that you want. Here's kind of closing costs, just a broad idea. So they have something to go back to the client say, Hey, is this worth even going further, before we even get into the next part where we want to go additional level and issue a term sheet or something like that? So that that has been a very appealing process for loan brokers and why we've seen a huge uptick and why they will, they'll come back again and again to us.

Lance Pederson 15:38
Yeah, I know, there's certain states that you, I mean, as you guys, you know, really get this ramped up and going, wait, are there certain states that, you know, I know, there's like lending laws or, you know, different things like that. So there's certain states right now that you that you're bullish on or that you're really concentrating your efforts more than others are?

Brock Freeman 15:58
Not really, we really just reached out to commercial loan brokers in particular, as a matter where, however, it's interesting to see the states I mean, from a, if you're just doing commercial lending, there's very few states that you, you really need to be concerned around with licensing. As long as you're not doing that one to four unit. Really, the the world is your oyster. And that's one of the reasons we don't do one to four at all, we don't touch it at all. And I feel quite confident about that. Because actually, you get into that there's a lot of other lenders who are doing funding, fix and flip and in that area, so I feel like look, we don't need to try and compete with that, let's let's really focus in our niche and and get known for our niche. That being said, like, you know, there's not a lot of stuff that comes out of California, there's just a ton of lenders, I mean, that's California seems to be the home. I mean, even when I worked in the industry before, that was the home of so many different lenders. And so it's similar, like, you know, the tech industry with Microsoft here or San Francisco with so many people who went to work for that and then spun out on their own deal. Same thing for California. So we haven't seen stuff much from there. And that's okay. There's plenty of other markets where we feel comfortable about and we've seen a lot of deals per se in the south, the Midwest, where we really like actually these secondary and tertiary markets that have shown consistent economic either solids, you know, economic returns in that marketplace because of the broad employment factors or have even seen slight upticks. But there's still a need for a lot of housing, workforce housing, etc. 

Chris Carsely 17:37
And those markets is when you look at it from a nature from a trade standpoint, I mean, a lot of these borrowers that are coming out, they're not going to find something in a gateway city or say on I five, is there opportunities for their value add and their gain is in the secondary and tertiary markets. So we're naturally gravitating to the geographical areas, that they're finding the opportunities, which, you know, may not be the states that some of the big funds are focusing on trying to do the large commercial projects. And that's fine.

Lance Pederson 18:06
Yeah. And is that what you've you've heard from your your borrowers? Is that, that they really struggled to find that sort of bridge product, like, is it? Is it really that bad? Like there's this from the brokers? Yeah, yeah.

Brock Freeman 18:20
I in general, they can. There is something I hear almost on a daily basis when I talk to new ones who, who submit deals to us, or I'm just doing cold reach out. Cold outreach, is, yeah, I can maybe find someone to do that 750 to 1 million, or they'll make an exception for me as a broker. But below 750, and especially below 500. Just forget it, you're just you're just not gonna find a hardly. You might find some local private lender who does normally the one to four who will consider that but then because your consideration of how you underwrite a commercial deal versus how you might underwrite a one to four unit or a single family residence is so completely different that they struggle they struggle with well, wait a second, you know, this guy's buying this seven unit in in Texas. Well, you know, their DTI's don't line up. Well, you know, underwrite for DTI on a on an apartment complex, you're looking at DSCR you're looking at other factors. And so that whole concept, the whole how you approach a deal as an underwriter is very, very different. So they're happy to be able to talk to someone who actually understands, hey, here's how we approach commercial underwriting, we approach it from an income standpoint, we approach it much differently than a lender will approach a single family investment property. 

Lance Pederson 19:43
Yeah, and yeah,

Chris Carsely 19:45
You know, I have one other point I wanted to mention, too, that it was kind of, you know, some exact statements. You know, we were talking to a broker, and he was like, Well, you know, the other trend we usually see is in funds. They'll they'll work with us at a certain point in, they have good rates and everything else. But when they raise a lot of money, and they get big, they look down at this small amount that they have to write. And all of a sudden, they're like, hey, yeah, we can give you the LTV you want, but we're not going to be able to give you that 11 or 12, we need to charge 14 or 15. Now, because of the size of the loan that you want to do to make it worthwhile for us, and he was very it obviously, that had happened to him multiple times. And I was like, Well, listen, the nature of our fund, what we're doing is we're going to stay in this space. And we're okay with that. We're naturally going to stay in the it's a capacity constraint that basically we have to deal with. But it's something we want to be that consistent institutional level, you know, fund that is going to be the provider for loans in that space. And he was excited. He was like, that's amazing. Because most people the lifecycle of funds is I get really, really big, and then I have to move up. And that's not what we're gonna do.

Lance Pederson 20:54
Yeah. And then that source is shut off. It's like it because it doesn't pencil out in these projects. I'm assuming if it's some sort of, like you said, seven unit 10, unit 16 unit, value add play. C to A B sort of deal. They, I mean, 14, it doesn't, it's sort of like the deals dead. Right? Like, I mean, that's,

Brock Freeman 21:17
I mean, you could maybe, I mean, I think part of it is just, you know, look, does anyone want to pay the you know, super high rates, I mean, look, even even on the most deals were were doing and they 11 or 12. It's not like they love to pay it. But Lance, honestly, one of the things that we look at very closely, is when they come back and say, Oh, you know, I can't make this deal unless you make it a 10. Well, that's a red flag cross because that means that they're running their margins so closely on the deal that if you something, something goes wrong on it, and you're not going to make the make the make it work, because you couldn't get that that 1% less on the loan, that that's probably not ideal you should be doing and it's not that we want to I mean, we want to send some outsized returns, and we have on most of these projects, let me tell you about one in Texas, they love to talk about it. We even made a blog post about it.

 In I think it's pretty typical for for the borrowers that we're doing these loans for, they took a 16 unit, boardinghouse downtown San Antonio, all you know, is conversion from an old home originally and 16 units. And they're gonna convert it to a 10 unit. So he's in the middle of this conversion, there was there were some minor foundation issues a whole lot, a whole bunch of reasons why, of course, they couldn't go to a traditional lender, we love the deal, because he was he was taking a 16 unit boarding house, converting it to a 10 unit, one bedroom, one bath, it was perfect for the area, there was this, these catching this nice rise in this neighborhood, classy neighborhood walkable. And by the time he gets done with it, he's going to almost double the value within one year of that place. And then on top of it, he'll take us out with a revive get some of his money back that he's using for renovations. And he's looking not just at a a huge return on his initial investment from a from a value standpoint of the property. But when I did the calculations, he's he's looking at something like in the 30s or even below 40% cash on cash returns once he does a refinance. So is he gonna really quibble about I think, the 11.75 that we charge them on ideal? No, he's super happy to simply have a lender, that's that says, Look, I see your vision, and I'm willing to lend on this. And But for us, since we're only going on as value, we're not taking an outsize risk either. Yeah, for us, but but it's those, we're super happy to see that our borrowers are making money hand over fist on that. And, and also on the on the other side, providing much needed middle market Class B housing to two places that are in such need of it.

Lance Pederson 23:59
Yeah, that's exactly right. And that's a big thing is it's I mean, it's, you know, right now, the construction costs are just through the roof. And, you know, it's so these are the things is just reusing the spaces that we have. And, you know, essentially, I didn't realize that there was such a dearth of financing options for that size. And I guess that does make it hard because, I mean, doing the show, it's like everyone's story, it's like, started out with single family went to a duplex, then a four Plex, then a 10 unit, then a 16. Unit. Now I'm buying 100 unit. Right. So it's really, that's kind of in the path of, of, you know, how people you know, often that's their trajectory. Right, but it's difficult if the financing options are, you know, there aren't many on that path that makes it that makes it difficult, especially now with the housing shortages that we have. I mean, we really do need it with the interest especially with multifamily in particular, I mean, there's all sorts of people that are that are interested in getting into the space and wanting to be operators? Right and doing these things. Now, the flip side of that given to us is the Risk Report. Do you find that that is a hard part sometimes for you, is that that the track record of the experience of the borrower? Maybe not be as is, you know, as great as is? I mean, it's, is that a bit where the risk premium comes in as well? Because I mean, if you're, if you're doing it on as is, what's your advance rate, like 70?

Brock Freeman 25:27
 Now we'll go up to 80 to 80,

Lance Pederson 25:30
So go up to 80. So, you know, they've got they've got something in it, it's on price, basically. Is that right? 

Chris Carsely 25:36
Yes,

Brock Freeman 25:37
Yes that's right. So they've got to have some decent skin in the game. So that means that they're bringing in not just at least 20, and usually much more than that. I mean, our quote, Chris, what's our portfolio, weighted lp

Chris Carsely 25:48
69, our portfolio is about 69%, LTV, on average. So yeah,

Brock Freeman 25:53
So they're bringing skin in the game. And on top of that, they've got to bring in the money to do the renovations as well. So, you know, you know, you talk about track record, what we want to see is not necessarily that they have commercial real estate investment experience, but they definitely have some experience doing the fix and flips single family, one to four unit type of stuff. So they know how the game is played, because that's what we want to see, they know how the game is played. We have made an exception on that one time, and that was where they had a tremendous the wife's a doctor. And so they just they had a tremendous amount of money in the bank, lots of money to, you know, coming in on a monthly basis, the husband decided he was going to do this full time, we made sure that they had professional management, for the rental, the property management. So you know, we mitigated a few things on that, I think on that one where maybe 70%, LTV, but they were bringing in a tremendous amount of money to put into that. So we felt like from a risk standpoint, for our fun, look, even worst case scenario, they walked away from it, we would be able to go in there, and we'd have a nice asset that we bear very easily be able to get everything back for our investors plus some. So we felt very comfortable with that.

Chris Carsely 27:12
But I think one thing you mentioned there, Brock, that's an important aspect is, in general, you might not have someone Oh, this is my 20th commercial deal. Yeah, you're just not going to see that at this level. But one of the things that is usually already in line, and we haven't had to really push that hard is a lot of these guys, they have property management that has experience in the geographical area. And we actually do verification on that. So who's your property manager? Let's get on the phone with them. Let's verify their background, we'll do the operate heavily within this area. And can they actually, you know, complete the goals you're going to need for this new property. So I mean, that's one of the the extra steps and due diligence that we actually have to do.

Lance Pederson 27:50
Yeah, cuz I mean, ultimately, in order to in order for the refi to occur, they're gonna have to the NOI is gonna have to be there, because that's what that's right. So it's really, it's that execution risk that you guys have to deal with like, Okay, what do you need to do the property? You know, where are those rehab funds coming from? which we'll get to in a second? And then, and then are you going to be able to stabilize this asset? 

Brock Freeman 28:11
Yep. 

Chris Carsely 28:11
Correct. 

Lance Pederson 28:12
You know, are really, that's your path now? I mean, are you really trying to stick as much as you can to sort of multifamily or we are? Are there other property types that you look at? Or? It just depends?

Chris Carsely 28:25
Yeah, well, I mean, given our current macro environment, multifamily, was always going to be a good portion of our portfolio. But it became kind of a majority, because the risks and the uncertainty around retail, and in office, it was just something we had the deal flow, we didn't have to take that risk. And so why induce that uncertainty into the portfolio for our investors and ourselves? Because I mean, one of the key things is Brock and I are fairly large investors in our own fund. So it's our own money at stake as well. So we with that, with that deal flow, why take that risk, it was something we were very comfortable working with a lot of the stuff on multifamily. But the intention day one of putting this fun together, was always to take on mixed, use some office, some retail, as things maybe come back to some normal, we'll have to see how that really pans out and how that's defined. And I know a lot of people are like, hey, blood in the street is the time to buy. I mean, I'm a hedge fund trader, no one needs to explain that mentality to me. It's but there again, being risk focused. I don't need to take that uncertainty right now in say, Oh, I'm going to go and you know, do something in hospitality or retail. If Why, why take that risk. We just don't need to and as we see those uncertainties work out, we'll we'll move to step back into that space. And we've already seen a lot of mixed use.

Brock Freeman 29:50
It's not that we're rejecting those deals, Lance. I look at them all the time. But in the end, they've got to make sense from a lower LTV. I'm not definitely not going to do at all But not even not even 75 on on any kind of retail or office, it's in the 60 65 ltvs. And it's gonna make a lot of sense all the way around for it. Mixed use will go higher but all of that is dependent on how much of the mixed use is in retail or office versus the the residential. So we want to look to that residential as Okay, you know, is that carrying things forward? The other places? Where is it? Where's the economy out in that particular area that we're looking at the geographical area that we're looking at that mixed use? You know, there's just a bunch of factors that we're going to weigh to make sure that makes sense. I mean, in the end, Chris, and I look at these as like, what if we were presented with this opportunity, and we're in those buyers shoes? Would we buy this deal? Do I want to own this deal? Because it's a very real possibility in the future, that we own vehicles? Because it goes wrong for the end? If I don't want to own it, why in the world would I lend on?

Lance Pederson 31:02
Yeah. So then, so then, with that said, Are you finding at that you have to do a little more helping with the borrowers in terms of like, their, their pro formas being a bit of a mess? And, and not, you know, like they, how do you deal with that, right? Where they kind of comes to you? And you're kind of like, yeah, I can kind of squint and see it, like, I think I see what you're seeing, but we really need to button this budget up. And, you know, how do you guys deal with? It seems like, I mean, even we feel like that at times. It's just, okay, this is the nature of the random, when you're in the sub institutional space is there, you're gonna have a lack of sophistication in certain areas. And my hunch is that, you know, financial modeling and pro formas, and budgets,

Brock Freeman 31:47
 Not their strong, suit. 

Lance Pederson 31:47
 How do you deal with them. 

Brock Freeman 31:50
It's a great question. First of all, we look at I've got some rules of thumbs that I use internally, in our in our financing model or own pro forma model. And we make sure that those look good. Part of it is what are they making assumptions for for the future rents or even rents right now? Are they in line? Are they are they taking much more? Are they being conservative on what they're looking for, for rents in the future, we definitely will make adjustments down for that. We'll look at what typical expenses are for particularly multifamily where we we've done most of our deals, and we'll make our own adjustments on what those things are. And of course, in the end, we're getting a commercial valuation to from a third party, we generally work through their capital. And those are reviewed, again, with a desktop desktop. Buying a full appraiser, who looks at it twice. And so you know, we're looking at what what they're putting up for, in there as far as rents and expenses that are typical for the area. So I think in the end, we feel pretty confident about even though you might have someone who's doesn't know how to put together a great pro forma. And that's the assumption we make from the very beginning. We're just not dealing with people who have a long experience and that so it doesn't surprise me when those come in, and they're an absolute mess. So we put that together, to the degree we feel comfortable internally for Okay, does this person have enough reserves to make it through the vacancies, etc, that they have? Because that's why they're coming to us, because there's vacancies or they're going to do some renovations that are going to cause vacancies? So, do they have enough reserves for that? In any in the end? Are they do they have that DSCR? And, you know, are they gonna be able to exit us in that 12 months? Do we see that plan? Do we see that the plan has a high chance of being executed? And that's really what I'm looking at very closely as is does that make sense since the end of things, so they can get taken out by traditional financing? And we have an exit?

Chris Carsely 33:57
Yeah, and also getting them to think about exit like day one. Yeah. Also, it's like some of them I imagine, like, actually, a majority of the people we've worked with have been down that path. But there's always a few of like, well, what banks have you talked to talk more, talk to more than one, you know, get things lined up to where, you know, you're not going to get an LOY, but you can have an intention and have a shortlist of people who are going to, you know, do a conventional loan on your type of property if you meet your milestones and your end goals, and just have that ready to go. Because a lot of people forget, like, Oh, I'm going to do a 12 month bridge loan, and in the 12 months, I'll be ready for conversion. Well, that may not work in today's world, that's you got to be thinking ahead on that you got to be thinking in month 10 about what you're going to do in month 12. And that's kind of just making sure that they're, you know, like I said most of them are up that curve, but everyone's while it's good to kind of mention it just to make sure their heads straight.

Brock Freeman 34:48
Today's workers are upfront about that, that look, I need you to tell me and give me in writing what's your exit plan on this thing as and actually that's part of it. As I look, you're gonna make the money twice, you're gonna get double commissions on this deal that roll through your door because you placed it with us. And now you're gonna place it there. But on the other hand, you need to figure out and talk with your client about how you're going to exit right now. And there's been numerous deals where we haven't gone any further because the broker couldn't tell me how they were going to exit. They like, well, I don't know, I don't know where I'd placed this. Well, then I don't see how we could do that. 

Chris Carsely 35:29
Yeah, that's gonna go bad.

Lance Pederson 35:31
Yeah, that's right. Yeah. And that's good. This is good. Because you do have these, you know, once the loan is made, now, you've got multiple constituencies and stakeholders who are aligned, you guys want them to exit? Yeah, broker wants them to exit double fees. And then of course, the borrower. I mean, they, they'd rather pay 5%. That's right, or 5 or 11 percent 11. Right. So there's, there's good alignment of interest. But once again, it's all comes down to who said it's that execution, the execution risk, that's really applied, you know, that, you know, and that's, once again, that's what they're having to pay you guys for, right? In this case, the fund the lender, for the execution risk, it's, that's why the cost of capital is higher. So let's flip over that in the fund structure. Because, you know, now you've got this, you know, open ended fund that I can invest, you know, equity into, which has, you know, it holds assets that are basically first position loans on everything we've just talked about, right, so you get your mind wrapped around the average loan to value 69%. That means there's 31 cents on every dollar in equity in the deal on day one, as they act as they execute their strategy through forced appreciation, as they de-risk it, you know, that the LTV becomes even greater, right. So as they create more equity, and it's the risk, if they do that, to me, I think that's where you send her on it is on the lending side. It's borrowers who know what they're doing, and can execute their plan to get it to where they're trying to go. If they do that, then this thing's beautiful. Now, on the other side, when I when I make that equity investment into the fund, you know, there's a couple ways to do this. Now, I believe in your guys's fund, right, it's straight equity, there is is that accurate? Or is there some

Chris Carsely 37:21
Yeah, it's just, it's just straight equity, you come in as an LP and you have a membership interest in the fund. And you're just treated pro rata across all the loans. So I rebalance every single month on a pro rata basis for all investors. One of that is is I want to make sure that later investor, and is capturing as much diversification as I can offer as any other investor in the fund. And so what that really means is, if I've got 20 different loans, and you come in, by the next turn of a month, my fund administrator and I have basically readjusted your exposure across 20 different pieces. So you're now capturing the identical diversification is everyone else in the fund? And, you know, it doesn't affect earlier investors, because, you know, the interest rates don't really change that much from loan to loan. So there's no Oh, is there a detriment to earlier investors? No, not at all. But what it does is allow every investor in the fund to have as much exposure across, you know, and control their risk as I mean, diversification, as we all know, is a key aspect to, you know, portfolio risk.

Lance Pederson 38:30
Yeah. So it's getting Yeah, the more the more assets that are in there, and then, but you guys don't, you know, the fund that cited a liquidation scenario, if you go and sell all this paper at par. There is no, there's no one ahead of the members of the fund. Right, because that's no one's I have no, yeah. And I think that that's the sort of thing so when you when you look at debt funds, or underwriting a debt fund as a as an investor, I mean, those are the big the big things in my mind that one would would look at right is one, what are the what is the underwriting criteria? Right, what are what is the mandate for the fund? What what kind of loans can this fund acquire? And what are the criteria? Everything we've just talked about, right? That the big one being loan to value and then digging into? And you've you've, you've answered all these questions about how does one establish the V and LTV loan to value? You know, appraiser, someone else's, you know, appraisal, someone else's looking at it, right, making sure that you get comfortable with the as is it's on as is so you know, that's your cushion. So you look there and then you say, can the fund borrow money senior to my position, right, because then that's, you know, and if it could, once again, some do so those are leveraged debt funds. Some funds are structured out I'm not saying that they're good or bad. It's important that you just understand that there's a difference. Like those are the things that you said before you know, anything else is, what can this thing do? What you know, and in your guys's case, sounds like all the fun can do is what first position

Chris Charsely 38:46
No one is ahead,no.

Lance Pederson 38:46
Cause that's yeah. And I think that that's the sort of thing. So when you, when you look at that debt funds are underwriting a debt fund as a, as an investor. I mean, those are the big, the big things in my mind that one would, would look at, right. Is one, what are the, what is the underwriting criteria, right? What are, you know, what is the mandate for the fund? What, what kind of loans can this fund acquire? And what are those criteria? Everything we've just talked about, right? The big one being loan to value and then digging into, and, and you've, you've, you've answered all these questions about how does one establish the V and LTV loan to value, you know, appraiser, someone else's, you know, appraisal of someone else's looking at it, right.

Lance Pederson 39:28
Making sure that you get comfortable with the, as is it's on as is. So, you know, that's your cushion. So you look there and then you say, can the fund borrow money senior to my position, right? Because then that's, you know, and if it could, once again, some do, so those are leveraged debt funds, and some funds are structured that I'm not saying that they're good or bad. It's important that you just understand that there's a difference. Like, those are the things that you said before, you know, anything else is, what can this thing do? What, you know, and then your guys's case sounds like all the fund can do is what first position loans is that awkward?

Chris Charsely 40:02
Yeah. It's all First. Yeah. We won't make a loan. That's not first position. Yeah. So no one can be in front of us, but while you were also talking about at the portfolio structure is, you know, funds can use leverage. And I know that a lot of people, you know, you pick up too many rags and it's all about how leverage cost a problem. Leverage is not actually the problem. It's the people deploying the leverage, creating an operational risk that's above and beyond what they can control and maybe creates an asset liability mismatch. I mean, there's lots of different ways a fund manager can make mistakes with leverage. And one of them is overleveraging because they think, well, nothing could ever break what I'm doing trust me I've made that a comment throughout my career and I always get proven wrong. U T here's always something that can go, could go wrong even though, uh, you know, the probability is near zero.

Chris Charsely 41:27
But so, I mean, we don't deploy leverage currently at the fund level. But our general plan was to always, once we get to a certain size, you know, have a line of credit for increased capital utilization to really create a better yeah. It's just a cash management tool of where, you know, around ends and, you know, sometimes you'll have cash and you get a great loan, but you don't have as much money. So it creates, you know, cash drag issues. And that's what you're talking about. It's just the operations of the fund is really kind of smoothing that out and creating, increased efficiency from an operating fund. I mean, that's, that's, that's solid use of leverage. That's you know, if I'm going to go out and say, I can get five X and I'm going to lever up that, okay, well, you know, you got to, you got yourself in a very different fund.

Lance Pederson 42:07
Well, you got you, you got it. I think. And that's why I say, like, I'm not a leverage as the devil sort of guy. I, I, I think for me is that when these, when these funds are promoted and marketed, it it's, it's easy to, just to go to what the return is. Right? So like right now, right. Kirkland income fund is generating, you know, near, near double digit return, right. Nines or whatever. Right. So, but it's important to know that that 9% return is different. It's important to understand that what the nine represents. So they generated a nine un-levered, right? No leverage I'm in first position and the underlying assets have an average loan to value of 69% first position. Right. So, yeah. So that's where you say is that, that's how you do it without doing that assessment. You can't just say, well, this one's doing a nine and this one's giving me a 10, the one that's delivering a 10 could have, you know, one-to-one leverage which once again, it might not.

Lance Pederson 43:10
I mean, it is what it is. It's just saying that there's for every dollar deployed into some asset, 50 cents of every dollar is basically it has been borrowed from somebody else more than likely at a lower cost of capital, whatever it is, four, five, six, seven, eight. I don't know. Right. That's the other thing to check in on, is that, how much is that other piece, if you're in the equity slug, right. It's just important to understand that. And then if, if, if all their loans or half of their loans are being, you know, they're second in second position loans are, you know, it's just, it's once again, I'm not saying that it's good, bad or indifferent, it's just, it's important to understand that you can't fall into just calling all things that generate a 9% return the same. They're just not like that.

Chris Charsely 44:37
Right.

Lance Pederson 44:38
And it's just, it doesn't work like that because right when these guys brought this product to the market, they're saying, okay, we're we weren't, we talked a lot about the problem we're solving for the, for the operator, you know, the personnel, the multifamily, whatever. Like that makes a lot of sense. Right. And it's not out there and you can generate a really good return, you know, off of that, to the fund, but then how you invest in the fund and what you're getting into. It's just important to understand that what problem you're trying to solve is that you'd like, you know, income, right. I like to make this investment and they get quarterly. And if I can get 9%, you know, return or 10 or whatever, it ends up throwing out at me on those things like that, that's that you're solving a problem in your portfolio. It's portfolio needs income, and now it comes down to how what's your risk tolerance. Right. Cause that's what I mean, like all these guys like, oh, it's terrible. You know, like leverage and debt. Like I'm tired of hearing it because it's not stop saying that. It doesn't mean that it doesn't mean that levered debt funds are bad. It just means that are you, you understand the risks that you're going to take with the investment?

Chris Charsely 45:40
It's just a different risk profile. I mean, I tell people, it's like, you know, I talked to a lot of investors RIA and I'm like, what we do is not everything you should do. I mean, there's tons of other different alternative income aspects that may fit or not fit your portfolio. I don't know the nuances of their particular portfolio, but if I had to go put something together, I often look across the entire spectrum of risk and understanding, well, how much risk am I actually taking? And the effort of a true portfolio manager is I want to maximize my return for the acceptable level of risk that I want to take that matches myself or my client that I'm managing. That's really your end goal. And that may come in lots of different forms where we put this fund together is we're trying to be lower on that risk curve, both. And this is where it comes in with alternative investments is not only in the investment because everyone likes to jump in and assess the investment.

Chris Charsely 47:14
It's also the assessment of the operational risks that are run because you're investing in a fund. You're investing in a company that manages this fund. There is risks in that, which we, you know, having built, uh, operational due diligence programs for multi-billion dollar shops, that's a risk that's unrewarded. You're not paid. I mean, everyone knows, understands risk and return, and they take a certain amount of risk. I get paid operational risk. And one of the big concerns that people need to be aware of is exactly what you're getting at Lance . There's a lot of other factors that differentiate people and that often not sometimes as an unfortunate risk that you're not compensated for. And so understanding those additional risks, whether it be a leverage component or something else, and making sure you're comparing apples to apples is, is, is the right way to look at it. And we've just kind of chosen to, I'm not trying to knock the lights out here. I'm trying to give you an enhanced return. That is a diversifying component to perhaps the rest of your portfolio that has an income option. Those are the three pillars of what we're trying to provide to investors. And, and I want to do that as with as little risk as humanly possible,

Brock Freeman 48:20
Both sides. And I think that's, what's important here, Lance too, is that not only have we taken a, a look at how do we structure and what kind of debt or what kind of situations do we make loans on and make sure that we're, we're lowering the risk as much as possible in that area. Chris has also concentrated and I've been watching this the whole time and totally agree with him that we also wanted to make sure that we apply that same low risk let's de-risk as much as possible from an operational standpoint. So every way that Chris has put together, and this is where I really appreciate his 25 plus years of institutional fund management, as he's able to bring that to the table and say, well, we need to have these operational controls. We need to have on cash movement. You know, you need to have two signatures. You can't just have someone go to the bank account and, oh, I'm going to throw off a wire. And nobody's going to know, uh, you know, these, these are not that we, we feel like, look, you need to be careful that someone's going to be a criminal here, but you know what things happen? People make mistakes and that's what can really crash. I think, personal, you, you had a, uh, pretty surprising to me, um, statistic around how many funds are crash and burn because of operational risk. Not because of the trades they made. Oh

Chris Charsely 49:37
Yeah, no, it's, it's, uh, it oscillates anywhere between 60 to 67% of failures in funds has nothing to do with the investment.

Brock Freeman 49:45
That's just, shocking.

Chris Charsely 49:45
it's actually the people running. And to me it's pretty pretty, I mean, people make mistakes and, and, you know, hopefully most of them fess up to it, but you know, the big, the big frauds that everyone hears of, if somebody made a mistake, instead of just kind of owning up to it, they try to fix it and they dig the hole deeper and deeper for themselves. And, and I got to see this life, you know, front row. I worked with one of the people that brought down Madoff. So I got to see a lot of stuff from behind the scenes. And there's a general belief that, you know, it didn't start off as like, this is what I'm going to do, but there was just a ton of things that were done wrong. And instead of just saying, Hey, what I thought I was going to do doesn't work and shutting it down. It was ego got in the way. And it just kind of ballooned into its own beast. I know.

Lance Pederson 50:34
I mean, you guys know me like this is, this is why, you know, this is why Vera Vest exists, because I, it drives me crazy that the stat that you just said is not known and everyone sort of downplays it and then I, it just, it, okay. It's, it's, it's real. And this is how it goes. And when no one's looking and there's no oversight and there's not good internal controls, you know, that odd sort of way of the operational due diligence isn't being done and all those things that is where your biggest, I mean, that's, that's the risk you're pregnant with that, that you don't see and you don't appreciate. And I mean, once again, and for, for guys like Chris, that's what I say. Like I get on the phone with him. It's like, just, I mean, we, we speak the same language, but the reality is that most other people they're not there yet.

Lance Pederson 51:22
So that is, you know, there's more risk there because they don't know there's, they're ignorant. It doesn't mean they're stupid or bad or intending to do that. It's that for me, it's all about that. Like, how can we, how can we mitigate that risk? That's what we do. That's what I think we do at Vera Vests that Vera Vest. We run background checks that mitigates risk, you know, who you're dealing with, right? Whatever claims they're making. Th th th you know, they can't misrepresent what they're doing and, or it can be verified. So that way, you know, what you're dealing with, if they're inexperienced in your experience, then you need to be compensated for their inexperience, right. As a, as an example. And then ultimately after you make the, you know, you wire the money in making sure that all the money's go where it should be going, because that risk is there.

Lance Pederson 52:04
And it might not be the guy, but it might be his, you know, his controller or CFO is, is, is cooking the books, or is embezzling money. Like that stuff happens like that. It only happens like, you know, once every 50 years when it may not happen, that's just foolishness. Okay. That's foolishness. Because most of this stuff, you never hear about it cause they never get caught. And because you don't know what you're looking at, you don't know that it happened and maybe they're smarter than Maydoff or some of these other guys who go all out in billions. And they just, all they're doing is raycon, you know, just a little bit, right. And which, which a little bit, all adds up, it could be hundreds of thousands of dollars that don't end up in your pocket that ended up in theirs and they misrepresented themselves and they misappropriated your money.

Lance Pederson 52:48
So it's, this is the thing. Right. And, and, and it's, I'm passionate about it. Cause like you guys to the world, it looks like you just showed up last year. Right. But if you listened to this episode, you'll realize that, you know, Kirkland capital group may have in Kirkland income fund, maybe just recently, you know, had its inception, but ultimately under the hood, you've got it's about the operators. Do they know what they're doing? Does that, does the strategy make sense when you look at those things? You know, and you're always going to be, we all have to earn our way. Right. And so it's, there's always the headwinds of, that, that you have, but it's like, this is the stuff there's, there's thoughtfulness to this, right? Like there's methods to your madness and how you do what you do. Right. And, and, and you're, you know, it's just, so those are the things that are important, you know, for those of you listening to this is just, you have to dig deeper. You can not make rash decisions just based on surface level things. Like I know it's hard cause we're all wired to, to do that. But it's just, that's the stuff that you sort of have to look at, look deeper. Yeah. And

Chris Charsely 51:56
I'll, and I'll throw a bone out to you, Lance. Um, you know, just being a guy who spent most of his career, tearing things apart from a due diligence standpoint, I chuckled and I, I, I brought it to Brock's attention that when we were going through your process, you actually called up and said, Hey, your PPM says, the managers will have a certain amount of money in the fund. And I just started chuckling because that kind of thought process of verification is second nature to me. But I see it so rarely in other people. I, and, and you, you guys came in and we sent you the documents and we, and that, that verification that's, that's, you know, big kudos to you. I mean, cause I, I, I tell people all the time, read your documents. It's like, listen, you want to play a game of monopoly with me, but you didn't read the rules.

Chris Charsely 53:42
Sure. I mean, if I, if I'm a bad guy you're in trouble. Um, but so read your documents, understand that, or find a resource that, you know, like Vera vest or something that can, that can understand that document and match the say in the deal it's important. And I mean, and that gets down to the real key aspect. I mean, we're talking about risk here, you know, if you're finding something that you don't understand and you can't get transparency on it, you should back away. Yeah. You should. I be seriously. I, I, the only time I've ever lost money in a deal was where I didn't get an answer to something. I couldn't get transparency on it, but like nine other stars all worked out and it was that one point. That stabbed me. And I was like, God, I knew it was a problem in it. That's what got me. And, and so I urge people, you know, listen, if you feel uncomfortable and the person you're looking to invest with, won't give you that transparency or explain in nauseating, detail, what it is to make you feel comfortable. You should just walk away because there's plenty of other investments out there. Yeah. You've got plenty of great people doing stuff.

Lance Pederson 53:55
You got It. Yeah. That's exactly right. Yeah. Well, well said, Chris, I mean, I knew this would be great. I mean, a great show and it's been, it's been great to, to, to catch up. And where can people learn more about, uh, Kirkland Capital Group? Not to be confused with Kirkland Signature products.

Brock Freeman 54:10
They can, of course go to our website. It's Kirkland capital group.com. And, really, there's a ton of information, both about Chris and I, uh, other members of the team, uh, what loans we've done, uh, you know, at least the high level details. You can also look at our invest page where we go through and we talk about, the Kirkland Income fund. You can, watch other investor interviews that we've done. There's just a ton of stuff out there to educate yourself. And then, you know, once you feel like, Hey, this is something that fits in my portfolio, I like this. And you want some more information then? Hold on a second,

Lance Pederson 54:57
Reach out.

Chris Charsely 54:57
Yeah. Reach out to us. Yeah. I love, I love talking to people and I love

Lance Pederson 54:58
The phone's ringing.

Chris Charsely 54:58
Yeah, exactly. Brock already super popular, but no, I mean, yeah. Reach Out to them. I loved it.

Brock Freeman 55:05
And I know I was like, oh no, that thing is going to ring for forever.

Lance Pederson 55:06
He stepped out.

Brock Freeman 55:06
Anyway, the shared office. So, yeah. And then, and then once you, once you,

Lance Pederson 55:12
We gave them your, we gave them your cell phone numbers.

Chris Charsely 55:26
Oh, that's exactly what everyone called rock. Right.

Lance Pederson 55:28
Good stuff, guys. It's been great catching up. Yeah, take care. We'll be in touch.

Chris Charsely 55:35
Lance. Thank you very much. Cheers.