Ashcroft capital: Additional 20% capital call

[Jon Zhou]

After many of the Ashcroft capital syndications paused distributions, I get this surprise email this morning saying all LP investors need to pay additional 19.7% of invested capital call  

anyone have experience with capital calls and syndications? Is there ever a position outcome to these or are we putting more money into a failing syndication?

“Thank you for your patience as we continue to navigate our way through this current economic cycle and unprecedented time in the capital markets. We recognize that this email contains a substantial amount of information, which is why a member of our Investor Relations team will be contacting you shortly to address any questions.

We need to solve for three major factors as it pertains to Elliot Roswell:

1. Allow the multifamily market time to stabilize.
   
2. Meet liquidity needs for the rate cap, capital expenditures and unexpectedly high debt payments.
   
3. Resume renovations which have been temporarily paused.
   

How do we achieve this?

Based on feedback from our existing lender, other potential partners, and the significant capital requirements to potentially buy down the loan to refinance, we determined the best path forward is a successful LP capital call of 19.7%. This will allow us to maintain flexibility to potentially sell the property within 24 months.

This is Ashcroft’s first capital call, and while it’s regrettable to take this step, our primary focus remains safeguarding your investment. Therefore, all LPs must participate 

Elliot Roswell is a strong asset that is poised for a strong rebound in value as markets improve. This is due to the property’s institutional quality and the continued growth within the Atlanta market. Moreover, demand and absorption rates are currently at 25-year highs and are continuing to trend in that direction with a 70% reduction in new construction permits and drop off in deliveries in early 2025.

We will maintain flexibility to sell Elliot Roswell as markets improve and anticipate doing so within the next 24 months. In the meantime, we need to cover rate caps costs and resume renovations so that we are best positioned to maximize your potential return.

Why is a capital call necessary?

• Preserving Capital: If this capital call is not successful, we will have to sell Elliot Roswell in an inopportune market. This would result in selling the asset below our basis and incurring a significant loss of LP-invested equity. Specifically, if forced to sell now it would be a total loss of capital for both Class A and Class B.
  
• Replacing Rate Caps: Our rate cap is expiring this year, and the projected replacement cost is $736k.
  
• Resuming Renovations: Given rising inflation and labor costs, our capital expenditure exceeded initial underwriting. This prompted a temporary pause to renovations. However, resuming renovations is essential to increasing revenue, and a capital infusion allows us to resume both interior and exterior renovations. We will consistently evaluate the cost vs. benefit, adjusting the renovation scope as necessary.
  
• Maintaining Lender Requirements & Loan Covenants: We (Joe & Frank) will consistently support you and our other investors through both favorable and challenging times. We’ve already extended a $2.9M interest-free short-term loan to cover various unexpected expenses, including the replacement rate cap over the past 12 months. While this was meant as a temporary solution, it must be repaid promptly to maintain compliance with loan agreements and ens

[Carlos Ptriawan]

Quote from @Paul Azad:

Many experienced GPs and investors did see in late 2020 and throughout 2021 that massive inflation was on the way, which then began in mid 2021 and ramped up to 9% by mid 2022. All from the 27% increase in global US Dollar M2 money supply in 2020, the largest ever in US history. So many GP's did avoid variable rate debt and short term maturity loans requiring RE-FIs at predictably much higher rates. But there are many GPs that would buy at any inflated price as they had no skin in the game and even fewer neurons under the scalp :)

The US has now shrunk the M2 money supply by 4% in last 18 months, which has brought inflation rate down, This decrease in M2 has only happened 4 x in US history and every time caused a recession. Let's hope this time is different. 

 well the holy cycle :

QE Started(2009)--->all asset pricing spikes--->first attempt to rate hike(2019)--->covid-->massive M2 print (March 2020)--->rate cuts to zero and print more (until Q2 2022)--->all asset peaked--->all residential and CRE Fomo buyers activity escalted---->CPI rising(Q1 2022)--->Fed do nothing-->Inflation--->Fed Rate Cuts(Q2 2022)----->Asset dis-inflation/Recession/Stagflation-->cap rate decompression--->capital call (2023/2024)--->Office price falling/MF cap rate squeezed--->Capital Call on the rise/Prefs

Next: regional banking crisis/pension fund crisis------>liquidity crisis------> Fed bailout---->JP Morgan/Citigroup/Goldman would save everyone----> and then We restart QE Again (yayyyyy) 

Been like these since 1993. 

[Jason Piccolo]

Well this is great news for LP’s. 

1. We are making the waterfall split more favorable on AFAF1. Instead of the 85/15 (LP/GP) that we previously communicated, we are changing it to 90/10 (LP/GP)
2.  We are about to be under contract on a Class A community at an excellent basis. Those of you who have fully funded the capital call are invited to invest and receive GP-carried interest. This is an excellent opportunity in today’s market, and we will be able to provide you with more details in approximately one week.

[Chris Seveney]

Quote from @Jason Piccolo:

Well this is great news for LP’s. 

1. We are making the waterfall split more favorable on AFAF1. Instead of the 85/15 (LP/GP) that we previously communicated, we are changing it to 90/10 (LP/GP)
2.  We are about to be under contract on a Class A community at an excellent basis. Those of you who have fully funded the capital call are invited to invest and receive GP-carried interest. This is an excellent opportunity in today’s market, and we will be able to provide you with more details in approximately one week.

Just remember 90% of 0 is still zero. My question is why the sudden change? I have seen people do this because they did not have enough investors do the capital call. Not saying this is the case, but since they are raising $ for other deals selling would probably be their last resort, especially when they show those fancy FB ads noting 32% historical return...

[Jay Hinrichs]

Quote from @Chris Seveney:

Quote from @Jason Piccolo:

Well this is great news for LP’s. 

1. We are making the waterfall split more favorable on AFAF1. Instead of the 85/15 (LP/GP) that we previously communicated, we are changing it to 90/10 (LP/GP)
2.  We are about to be under contract on a Class A community at an excellent basis. Those of you who have fully funded the capital call are invited to invest and receive GP-carried interest. This is an excellent opportunity in today’s market, and we will be able to provide you with more details in approximately one week.

Just remember 90% of 0 is still zero. My question is why the sudden change? I have seen people do this because they did not have enough investors do the capital call. Not saying this is the case, but since they are raising $ for other deals selling would probably be their last resort, especially when they show those fancy FB ads noting 32% historical return...

Drown them in futures.. 

[Joel Owens]

Typically higher exit splits are given to investors who throw in lots of their capital with class A shares.

We usually have 70/30. 70 to LP and 30 to GP. If someone is investing many millions to tens of millions and up then can have a different conversation.

Some syndicators starting out might give away the farm to just get going but if they start showing success their cost of capital usually goes way down.

So their are some LP's worth 50 or 100 million that know how to evaluate deals and might take a cheap flyer like 50k or 100k into these newer GP's if they feel deal on its own strong and the new GP just got lucky to find great property at great price. They get high equity upside split that way. To them the LP it's often fun money. They might double the 50k or better or lose it all but can just get tax write off and then make it back in one month or less. They might put a few million each year into higher risk investments just to gamble.

It's all about the level of the LP and their sophistication with portfolio and investment strategy.

[JD Martin]

Quote from @Chris Seveney:

Quote from @Jason Piccolo:

Well this is great news for LP’s. 

1. We are making the waterfall split more favorable on AFAF1. Instead of the 85/15 (LP/GP) that we previously communicated, we are changing it to 90/10 (LP/GP)
2.  We are about to be under contract on a Class A community at an excellent basis. Those of you who have fully funded the capital call are invited to invest and receive GP-carried interest. This is an excellent opportunity in today’s market, and we will be able to provide you with more details in approximately one week.

Just remember 90% of 0 is still zero. My question is why the sudden change? I have seen people do this because they did not have enough investors do the capital call. Not saying this is the case, but since they are raising $ for other deals selling would probably be their last resort, especially when they show those fancy FB ads noting 32% historical return...

 I don't get it either and also suspect there's not enough current investors willing to make the capital call. They are probably labeling it as a show of good faith. Or maybe they're getting a lot of pissed off investors over the loan and repayment setup relative to the cap call.

[Carlos Ptriawan]

Quote from @JD Martin:

Quote from @Chris Seveney:

Quote from @Jason Piccolo:

Well this is great news for LP’s. 

1. We are making the waterfall split more favorable on AFAF1. Instead of the 85/15 (LP/GP) that we previously communicated, we are changing it to 90/10 (LP/GP)
2.  We are about to be under contract on a Class A community at an excellent basis. Those of you who have fully funded the capital call are invited to invest and receive GP-carried interest. This is an excellent opportunity in today’s market, and we will be able to provide you with more details in approximately one week.

Just remember 90% of 0 is still zero. My question is why the sudden change? I have seen people do this because they did not have enough investors do the capital call. Not saying this is the case, but since they are raising $ for other deals selling would probably be their last resort, especially when they show those fancy FB ads noting 32% historical return...

 I don't get it either and also suspect there's not enough current investors willing to make the capital call. They are probably labeling it as a show of good faith. Or maybe they're getting a lot of pissed off investors over the loan and repayment setup relative to the cap call.

I have high-level questions from  from all these conversations in this thread. I especially want to ask Chris as he's the debt expert and also Brian as he seems direct straightforward GP, but don't want to hijack the thread. Maybe I can start several new threads.

The question I have is bit too advanced in CLO origination.

One thing that I figured it out, from all these "syndication games", it seems to me, that the perpetual winner of all these game would be the lender only. But I want to ask this in certain way so not to be misunderstood.

[Carlos Ptriawan]

There's very interesting "twist" in how the bridge-lender that originally approved this floating-debt bridge loan, although knowing the borrower (GP/LP) would be bankrupt in the future, but they can somehow, trick the system somewhat, so they can continue making the loan modification and these foreclosure event doesn't seem to cause a dent at their book.

[Frank Sichelle]

According to someone in another forum, the funding deadline was 5/20 and only 49% of the capital call has been funded.

[Carlos Ptriawan]

Quote from @Frank Sichelle:

According to someone in another forum, the funding deadline was 5/20 and only 49% of the capital call has been funded.

 One thing that I found very bizarre in the GP MF world is that, there're extremely very little data where an LP can analyze the legal document/data between the lender and the borrower/GP.

For example, in residential we can check the actual funding between the bank and homeowner, but in this case, how do we know ? if bridge lender is asking for 3 mil for SOFR+2% for 3 3-year extension, does it mean if GP can only give 1 mil, then the loan extension would be for 1 year only ? Then what happens in that case, what other contingency and deals between the two parties can be analyzed further ?

I read information from the bridge lender earning report, other than saying "lender able to do loan modification for SOFR + certain rate ; for x number of months", there's not much information.

It's almost like writing a "blank cheque" to someone on the street.

[Carlos Ptriawan]

for example, the following are the sample request from GP to LP when they ask loan modification to occur :
I changed some word to make this remain anonymous
********As GP we had negotiated the following loan modification conversations with the mortgage
lender spanning the past year that successfully reduced the accepted principal repayment from the
original $2X million loan balance to most recently to $1 million.

Fortunately, based on our leasing and sales assumptions,
we believe will recover 50% of original LP equity:

** Existing investors will be asked to contribute their proportionate share of a XXX million recapitalization,
The mortgage lender will officially write its loan down to $X million. $1 million of the recapitalization funds will pay down the mortgage loan,
with the lender staying in the deal at a principal balance $X million and new maturity date of January 2028.
** The remaining XX million of recapitalization funds will be placed in a reserve to fund future
tenant improvements and lease commissions.*

------------------------------------
My question to @Brian Burke and @Chris Seveney and @Scott Trench :
1. Don't you think the lender is playing with free-wheel assets (for lack of better word), lets say borrower use 80%LTV and cap rate went down 20% so now it's 100-110%LTV. What's really the math logic for the lender to charge the LP $20 million, $40 million or even $1 million ? it seems for me the asset (as long as the valuation remains between 100-110%LTV) becomes a hostage at certain times.

In residential, it's easy to understand that the bank could help the situation because the gov. is intercepting and giving help to the borrower so loan modification is possible, but what's the mechanism in CRE case?

2. If that's the case, then.... as LP we donot care about who is managing the asset, but don't you think it's always safer/better to invest directly to the lender? with their reserves, their risk is very minimal (especially in multifamily asset class).

[Scott Trench]

Quote from @Carlos Ptriawan:

for example, the following are the sample request from GP to LP when they ask loan modification to occur :
I changed some word to make this remain anonymous
********As GP we had negotiated the following loan modification conversations with the mortgage
lender spanning the past year that successfully reduced the accepted principal repayment from the
original $2X million loan balance to most recently to $1 million.

Fortunately, based on our leasing and sales assumptions,
we believe will recover 50% of original LP equity:

** Existing investors will be asked to contribute their proportionate share of a XXX million recapitalization,
The mortgage lender will officially write its loan down to $X million. $1 million of the recapitalization funds will pay down the mortgage loan,
with the lender staying in the deal at a principal balance $X million and new maturity date of January 2028.
** The remaining XX million of recapitalization funds will be placed in a reserve to fund future
tenant improvements and lease commissions.*

------------------------------------
My question to @Brian Burke and @Chris Seveney and @Scott Trench :
1. Don't you think the lender is playing with free-wheel assets (for lack of better word), lets say borrower use 80%LTV and cap rate went down 20% so now it's 100-110%LTV. What's really the math logic for the lender to charge the LP $20 million, $40 million or even $1 million ? it seems for me the asset (as long as the valuation remains between 100-110%LTV) becomes a hostage at certain times.

In residential, it's easy to understand that the bank could help the situation because the gov. is intercepting and giving help to the borrower so loan modification is possible, but what's the mechanism in CRE case?

2. If that's the case, then.... as LP we donot care about who is managing the asset, but don't you think it's always safer/better to invest directly to the lender? with their reserves, their risk is very minimal (especially in multifamily asset class).

1) I think that a lot of funds and investors will be better off selling at huge losses or handing the keys back and taking a full wipeout, than committing additional capital. Hard to say what the move is in any specific deal.

2) Debt is safer than equity until it isn’t. When I lend Hard Money, the borrower is taking the first 30% of the risk. I am taking the remaining 70%. A complete loss of value is unlikely, but possible. I can lose more than the borrower, technically. 

And, I am unlevered. A levered debt fund multiplies this risk. They only need a small write down to create serious risk to the debt fund’s equity position. 

I am an extreme bear in this market and won't be interested in debt or equity positions against multifamily in most markets until cap rates exceed Freddie debt rates by 100 bps, preferably 150 bps. Oh and I think the 10-year ends the year over 5.5% by EOY. That implies cap rates in the 7s, or higher. Equity is of course long gone in that world. But now your LTV is 150%+ and yes, lenders lose even more per deal than equity in that world. Only way equity loses more than lenders is if they keep meeting capital calls the whole way down.

I’ve written off my investments to zero and have encouraged my GP to sell one unit - at least we’d recover 15% of the initial investment. They won’t do it, of course, and I respect them - I could be wrong. But, I still feel this is the best course right now for many, including me. I count the position in this deal as a $0 on my balance sheet.

[Clark Stevenson]

Quote from @Chris Seveney:

Quote from @Jason Piccolo:

Well this is great news for LP’s. 

1. We are making the waterfall split more favorable on AFAF1. Instead of the 85/15 (LP/GP) that we previously communicated, we are changing it to 90/10 (LP/GP)
2.  We are about to be under contract on a Class A community at an excellent basis. Those of you who have fully funded the capital call are invited to invest and receive GP-carried interest. This is an excellent opportunity in today’s market, and we will be able to provide you with more details in approximately one week.

Just remember 90% of 0 is still zero. My question is why the sudden change? I have seen people do this because they did not have enough investors do the capital call. Not saying this is the case, but since they are raising $ for other deals selling would probably be their last resort, especially when they show those fancy FB ads noting 32% historical return...

 They could promise me 120% and I wouldn't meet the capital call. I gave them my answer on the deadline 5/20 but can confirm, at least from what they told me, that they had 88% committed but a much lower percentage (around 64%) fully funded and were now offering the diluted shares to any existing investor.

What helped me was advice I heard when I had a friend inherit property. An old, wise investor asked my friend if he had inherited cash, would he invest in that property. He said, "if you say yes, keep the property; if you say no, sell it."

I used the same logic so since I had mentally marked my investment in AVAF1 down to $0, I asked myself, if I had the amount of the capital call available today to invest in this as a new deal, would I do it? The answer was an absolute no so I didn't meet the call.

[Clark Stevenson]

Quote from @Frank Sichelle:

According to someone in another forum, the funding deadline was 5/20 and only 49% of the capital call has been funded.

 According to what Ashcroft told me, as of Tuesday 5/21, they had around 64% of the capital call in hand with 88% committed.

[Steve Vaughan]

Quote from @Scott Trench:

I am unlevered...
I am an extreme bear in this market...

Same here, Scott.  Not just RE, but paper securities/equities, precious metals, BTC, etc all at all-time highs.

I'm just glad money market mutual funds are paying me 5% while my equity positions hit their targets and hope your prediction of the 10 yr at 5.5% happens.  I missed the last spike. 

[Carlos Ptriawan]

Quote from @Clark Stevenson:

Quote from @Frank Sichelle:

According to someone in another forum, the funding deadline was 5/20 and only 49% of the capital call has been funded.

 According to what Ashcroft told me, as of Tuesday 5/21, they had around 64% of the capital call in hand with 88% committed.

The one I attach here is the sample of information from lender side.

This one is not related to Ashcroft but this one is related to Tides GP group, there's this information from lender that makes this information public that can show how much DSCR or capital is required for the apartment to be just in break even:

their new debt service increase by 72% while DSCR is 0.10x. Absolutely going for foreclosure.

I think this makes sense, as the interest rate moving from 4%-5% to 8-9%. I am always so surprised by the lack of information that LP has; while from the lender side, they know all very detail what's going on for the same investment.

Based on this information alone we know that apartment that can survive in today's environment is those apartment who has DSCR 1.4-1.5x during loan origination.

Cred_IQ has related information that the there're 40-50% total loan that would mature in 2024/2025 with cap rate 4-5%, that's the apartment that would go either loan modification/capital call or straight foreclosure.

End of this game would be in late 2025.

But there're also lot of opportunity for the lender side (and the bank) that as long as they have very large reserves, the lender can make lot of money acquiring those property in long term.

[Jay Hinrichs]

Quote from @Carlos Ptriawan:

Quote from @Clark Stevenson:

Quote from @Frank Sichelle:

According to someone in another forum, the funding deadline was 5/20 and only 49% of the capital call has been funded.

 According to what Ashcroft told me, as of Tuesday 5/21, they had around 64% of the capital call in hand with 88% committed.

The one I attach here is the sample of information from lender side.

This one is not related to Ashcroft but this one is related to Tides GP group, there's this information from lender that makes this information public that can show how much DSCR or capital is required for the apartment to be just in break even:

their new debt service increase by 72% while DSCR is 0.10x. Absolutely going for foreclosure.

I think this makes sense, as the interest rate moving from 4%-5% to 8-9%. I am always so surprised by the lack of information that LP has; while from the lender side, they know all very detail what's going on for the same investment.

Based on this information alone we know that apartment that can survive in today's environment is those apartment who has DSCR 1.4-1.5x during loan origination.

Cred_IQ has related information that the there're 40-50% total loan that would mature in 2024/2025 with cap rate 4-5%, that's the apartment that would go either loan modification/capital call or straight foreclosure.

End of this game would be in late 2025.

But there're also lot of opportunity for the lender side (and the bank) that as long as they have very large reserves, the lender can make lot of money acquiring those property in long term.

Lenders if they foreclose can only recoup whats owed to them on the note..

[Carlos Ptriawan]

Quote from @Jay Hinrichs:

Quote from @Carlos Ptriawan:

Quote from @Clark Stevenson:

Quote from @Frank Sichelle:

According to someone in another forum, the funding deadline was 5/20 and only 49% of the capital call has been funded.

 According to what Ashcroft told me, as of Tuesday 5/21, they had around 64% of the capital call in hand with 88% committed.

The one I attach here is the sample of information from lender side.

This one is not related to Ashcroft but this one is related to Tides GP group, there's this information from lender that makes this information public that can show how much DSCR or capital is required for the apartment to be just in break even:

their new debt service increase by 72% while DSCR is 0.10x. Absolutely going for foreclosure.

I think this makes sense, as the interest rate moving from 4%-5% to 8-9%. I am always so surprised by the lack of information that LP has; while from the lender side, they know all very detail what's going on for the same investment.

Based on this information alone we know that apartment that can survive in today's environment is those apartment who has DSCR 1.4-1.5x during loan origination.

Cred_IQ has related information that the there're 40-50% total loan that would mature in 2024/2025 with cap rate 4-5%, that's the apartment that would go either loan modification/capital call or straight foreclosure.

End of this game would be in late 2025.

But there're also lot of opportunity for the lender side (and the bank) that as long as they have very large reserves, the lender can make lot of money acquiring those property in long term.

Lenders if they foreclose can only recoup whats owed to them on the note..

There's an interesting twist here from what I read,  the "lender" becomes the new gp/servicer that's operating this apartment. Free money for them,they form their own GP/LP group. They don't need to sell soon so they can recoup the "paper losses".

 Or another tactic they use they re-sell the asset to another GP. Another tactic is to manipulate the CLO books (this is the one that I'm about to ask Chris).

Those lenders are so smart that they can delay the foreclosure and hide the losses, it's almost like an asset robbery by the lender. It was discussed in one of the lender earning call but I still can't get the substance how they able to change the books.

[Chris Seveney]

Quote from @Carlos Ptriawan:

Quote from @Jay Hinrichs:

Quote from @Carlos Ptriawan:

Quote from @Clark Stevenson:

Quote from @Frank Sichelle:

According to someone in another forum, the funding deadline was 5/20 and only 49% of the capital call has been funded.

 According to what Ashcroft told me, as of Tuesday 5/21, they had around 64% of the capital call in hand with 88% committed.

The one I attach here is the sample of information from lender side.

This one is not related to Ashcroft but this one is related to Tides GP group, there's this information from lender that makes this information public that can show how much DSCR or capital is required for the apartment to be just in break even:

their new debt service increase by 72% while DSCR is 0.10x. Absolutely going for foreclosure.

I think this makes sense, as the interest rate moving from 4%-5% to 8-9%. I am always so surprised by the lack of information that LP has; while from the lender side, they know all very detail what's going on for the same investment.

Based on this information alone we know that apartment that can survive in today's environment is those apartment who has DSCR 1.4-1.5x during loan origination.

Cred_IQ has related information that the there're 40-50% total loan that would mature in 2024/2025 with cap rate 4-5%, that's the apartment that would go either loan modification/capital call or straight foreclosure.

End of this game would be in late 2025.

But there're also lot of opportunity for the lender side (and the bank) that as long as they have very large reserves, the lender can make lot of money acquiring those property in long term.

Lenders if they foreclose can only recoup whats owed to them on the note..

There's an interesting twist here from what I read,  the "lender" becomes the new gp/servicer that's operating this apartment. Free money for them,they form their own GP/LP group. They don't need to sell soon so they can recoup the "paper losses".

 Or another tactic they use they re-sell the asset to another GP. Another tactic is to manipulate the CLO books (this is the one that I'm about to ask Chris).

Those lenders are so smart that they can delay the foreclosure and hide the losses, it's almost like an asset robbery by the lender. It was discussed in one of the lender earning call but I still can't get the substance how they able to change the books.

If it is mezzanine financing that is a different animal and in those situations the lender can step in and take over the LLC during a default, this is what many are most likely doing as they are getting free asset management for a period of time until it fails, then they can come in, bring their own capital, wipe out all the investors and take it over. Its a do not hate the player hate the game, but the GP does not have to sign up for a Mezz loan it was done at their choice.

[Lane Kawaoka]

Current market conditions, especially with cap rates having risen from the low 4s to over 5-5.5%, essentially wipes out LP equity when the value of properties went down at least 30%.

Recent shifts due to 0 => 5.5% Fed Rate in the quickest time in history, has turned cap rates from the low 4s to over 6.5-7% in some markets for Class B apartments. This shift has notably impacted property values, leading to significant downturns. To illustrate, a property initially valued at $60 million might see its worth decrease by 30%, settling at around $45 million. In scenarios where senior debt (and renovation costs) hovers around the $50 million mark, the resultant cause pushes preferred, and LP and GP equity positions below the surface.

Basics on Property Evaluation:

To figure out how much your commercial property is worth, you can use the following simple math equation. You take the money you make (NOI) and divide it by something called the cap rate. The cap rate tells you what people are willing to pay for properties like yours.

So, the equation looks like this:

Value of Property = Net Operating Income / Cap Rate

Imagine your shopping center makes $100,000 a year after you pay all your costs (that's your NOI). And let's say the cap rate in your area is 0.05 (or 5%). You can figure out how much your shopping center is worth like this:

Value of Property = $100,000 / 0.05 = $2,000,000

But here's the tricky part: You don't get to decide the cap rate, it's decided by the market, kind of like how fashion trends decide what clothes are cool. If the cap rate goes up because the market changes, like from 0.05 (5%) to 0.06 (6%), even if you're still making $100,000, your property's value changes.

So with a cap rate of 6%, it looks like this:

Value of Property = $100,000 / 0.06 = $1,666,666.67

Even though you're making the same amount of money, your shopping center's value went down because the cap rate went up. It's important to remember that you have control over making your shopping center nicer and more profitable, but you can't control the cap rate, which can make your property's value go up or down without you changing a thing!

It's a sobering situation that no one has faced since 2009 faced with it firsthand (the dinosaurs who did are out of the game or in the institutional world not working with BP type retail investors like you and I). The stark reality is that a 30% market downturn, again caused by an unprecedented surge in interest rates – the highest in four decades – can profoundly affect market values. Such a scenario doesn't just bring values down by 30% but also places substantial pressure on property holders, especially when debt refinancing looms on the horizon, compelling action at these reduced market values.

Here is the double whammy that increases the cash in refinance needed, the capital markets (bank lending) terrain has tightened greatly. Banks, previously granted loans at 70% of the property's value, are now capping at 50%. This adjustment demands a greater cash input at the point of refinancing. This is the debt renewal tidal wave everyone is talking about and where we will start to see a lot more of.

From a personal perspective, this period has been particularly taxing. Having personally a lot of skin in the game, often being among the first to contribute when things got difficult. Witnessing the dissipation of substantial (multiple seven figures) personal capital, especially in efforts to steer through these turbulent times, has been a sobering experience. It became very apparent in Q4 2023 (point of no return for those in 2021-2022 vintage project) as the market cap rates deteriorate even more as pricing has not found a firm ground, particularly when it seems that additional capital infusion won't bridge the gap to more secure financial footing.

In these moments, the weight of the situation can feel particularly burdensome, and I speak from a place of shared experience. The recent period has been emotionally intense, marked by earnest discussions with investors navigating these very challenges. It's prompted a profound realization of the importance of compassion for everyone involved and those caught in this same situation.

If you find yourself in a similar position as a GP, grappling with the uncertainties and complexities of the current market, know that you're not navigating this alone (unverified data something like 25 million assets with renewing debt situation). In times like these, empathy and understanding are important. If you're an investor or a general partner facing similar challenges, I encourage prudence and reflection before funneling resources into uncertain ventures, building a bridge to no where as something where I did with my personal capital. While I might not be the first person you'd think of reaching out to, I'm here to lend an ear, to engage in a dialogue, I've seen operators commit suicide over this and some flee the country check I don't think either are viable actions. If you're navigating these turbulent waters, know that your experiences resonate, and you're not alone in this journey.

I began investing in 2009 and started out of state turnkeys in 2012 a period that remarkably coincided with a great time to enter the market, I've witnessed the past 12 to 13 years have showcased an impressive and steady bull market. However, it's also clear that markets naturally ebb and flow, and corrections, though challenging, are a part of the investment landscape.

One of the key insights from this journey has been the importance of diversification. Today involved in over 2B of deals or 65 plus projects - most of these ventures are secured with fixed-rate debt or long-term notes, extending beyond five and even ten years, or particularly in the realm of developments through substantial completion. Spreading investments across various sectors and over time has proven to be a prudent strategy, especially for navigating through market corrections. Abet it still sucks.

Another undeveloped takeaway that I have is how influential interest rates are with real estate prices especially when you get such a synthetic change to interest rates we have seen this year, whereas we have seen the stock market react counterintuitively positive (perhaps due to fake money being produced). This as an investor has forced me to look for Alpha in different asset classes potentially outside of the BiggerPockets world of real estate. From late 2022, we did not do traditional value add multifamily deals because we could not make the numbers work due to the distressed capital markets terms that were available in the market... this is essentially why the market came down so much because buyers like us were not buying. There are a lot of operators out there saying that they can get properties at 30-50% off the highs (they are correct on that) but without the debt package, the deal ROI numbers don't work.

[Brian Burke]

Quote from @Carlos Ptriawan:

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My question to @Brian Burke and @Chris Seveney and @Scott Trench :
1. Don't you think the lender is playing with free-wheel assets (for lack of better word), lets say borrower use 80%LTV and cap rate went down 20% so now it's 100-110%LTV. What's really the math logic for the lender to charge the LP $20 million, $40 million or even $1 million ? it seems for me the asset (as long as the valuation remains between 100-110%LTV) becomes a hostage at certain times.

In residential, it's easy to understand that the bank could help the situation because the gov. is intercepting and giving help to the borrower so loan modification is possible, but what's the mechanism in CRE case?

2. If that's the case, then.... as LP we donot care about who is managing the asset, but don't you think it's always safer/better to invest directly to the lender? with their reserves, their risk is very minimal (especially in multifamily asset class).

 @Carlos Ptriawan I’ll answer as best as I can from the perspective of a borrower (I’ve borrowed on bridge debt way back in the day), GP of 4,000+ units (75% of which I sold in 2021/2022), LP (I have passive investments), and lender (a mortgage banker I co-founded did over $2 billion prior to selling in 2022). 

With the exception of a few “loan to own” shops, the lenders don’t want these properties.  They don’t make loans hoping the borrower will fail.  They might not always make the best decisions, resulting in failures, but some of those decisions were driven by bad data (whether from the borrower, appraiser, inspector, or whoever).  And some of these lenders just did a poor job because they got caught up in the same unjustifiable market euphoria as the borrowers.

But now as those bad decisions or incompetence or inappropriate market enthusiasm rise to the surface, most lenders have only one goal:  to get their principal (and hopefully interest and costs) back.

So as it relates to negotiating an extension with a borrower…these are individualized conversations with ala carte selections, not a prix fixe menu.  The lender knows that as long as the GP has some thread of hope in saving the deal, or just saving face, they have a fish on.  What the servicer will do is figure out how much they can squeeze out of the borrower in exchange for kicking the can down the road.  $X principal reduction gets you X extra months.  Both the GP and the lender can tell their investors that they won.

To your question on how this is calculated, there’s no math formula, instead it’s more like that scene in National Lampoon’s Vacation where the Griswold Family Truckster gets repaired at the only gas station in the desert.  When Clark Griswold asks the mechanic how much is the bill, the mechanic looks at the gas station attendant, they both laugh, then looks at Clark with a serious look and asks Clark, “How much you got?”.  Clark says “you can’t do that, I’m going to call the Sheriff.”  The mechanic laughs even harder and whips out his Sheriff badge.

It may seem as if the lender is extending to help the borrower out, but the moment the lender can’t squeeze any more principal reductions from the borrower, or the moment that the principal has been reduced enough or the value has rebounded enough, the lender will foreclose and sell the asset to recover their principal.

As to your question about whether an LP should care who is managing the asset…yes the LP absolutely cares. If the lender takes over, they aren’t looking out for the LP.  If the lender becomes the GP, through an equity pledge sale, for example, their sole focus will be to preserve the asset until such time as it can be sold for enough to recover their principal.  They won’t wait (nor even try) for the value to rise enough for the LP to recover anything.

Bottom line is I think that a large portion of deals that have a loan maturity in the next few years will ultimately result in a wipeout of investor equity if LTVs (at today’s value) are high, unless there is a V shaped recovery in values, which I think is doubtful (but I could certainly be wrong).

[Brian Burke]

Quote from @Lane Kawaoka:

It's a sobering situation that no one has faced since 2009 faced with it firsthand (the dinosaurs who did are out of the game or in the institutional world not working with BP type retail investors like you and I).

 

Um, (insert whatever sound a dinosaur makes here).

Some of us are still around…. :)

[Jay Hinrichs]

Quote from @Brian Burke:

Quote from @Carlos Ptriawan:

------------------------------------
My question to @Brian Burke and @Chris Seveney and @Scott Trench :
1. Don't you think the lender is playing with free-wheel assets (for lack of better word), lets say borrower use 80%LTV and cap rate went down 20% so now it's 100-110%LTV. What's really the math logic for the lender to charge the LP $20 million, $40 million or even $1 million ? it seems for me the asset (as long as the valuation remains between 100-110%LTV) becomes a hostage at certain times.

In residential, it's easy to understand that the bank could help the situation because the gov. is intercepting and giving help to the borrower so loan modification is possible, but what's the mechanism in CRE case?

2. If that's the case, then.... as LP we donot care about who is managing the asset, but don't you think it's always safer/better to invest directly to the lender? with their reserves, their risk is very minimal (especially in multifamily asset class).

 @Carlos Ptriawan I’ll answer as best as I can from the perspective of a borrower (I’ve borrowed on bridge debt way back in the day), GP of 4,000+ units (75% of which I sold in 2021/2022), LP (I have passive investments), and lender (a mortgage banker I co-founded did over $2 billion prior to selling in 2022). 

With the exception of a few “loan to own” shops, the lenders don’t want these properties.  They don’t make loans hoping the borrower will fail.  They might not always make the best decisions, resulting in failures, but some of those decisions were driven by bad data (whether from the borrower, appraiser, inspector, or whoever).  And some of these lenders just did a poor job because they got caught up in the same unjustifiable market euphoria as the borrowers.

But now as those bad decisions or incompetence or inappropriate market enthusiasm rise to the surface, most lenders have only one goal:  to get their principal (and hopefully interest and costs) back.

So as it relates to negotiating an extension with a borrower…these are individualized conversations with ala carte selections, not a prix fixe menu.  The lender knows that as long as the GP has some thread of hope in saving the deal, or just saving face, they have a fish on.  What the servicer will do is figure out how much they can squeeze out of the borrower in exchange for kicking the can down the road.  $X principal reduction gets you X extra months.  Both the GP and the lender can tell their investors that they won.

To your question on how this is calculated, there’s no math formula, instead it’s more like that scene in National Lampoon’s Vacation where the Griswold Family Truckster gets repaired at the only gas station in the desert.  When Clark Griswold asks the mechanic how much is the bill, the mechanic looks at the gas station attendant, they both laugh, then looks at Clark with a serious look and asks Clark, “How much you got?”.  Clark says “you can’t do that, I’m going to call the Sheriff.”  The mechanic laughs even harder and whips out his Sheriff badge.

It may seem as if the lender is extending to help the borrower out, but the moment the lender can’t squeeze any more principal reductions from the borrower, or the moment that the principal has been reduced enough or the value has rebounded enough, the lender will foreclose and sell the asset to recover their principal.

As to your question about whether an LP should care who is managing the asset…yes the LP absolutely cares. If the lender takes over, they aren’t looking out for the LP.  If the lender becomes the GP, through an equity pledge sale, for example, their sole focus will be to preserve the asset until such time as it can be sold for enough to recover their principal.  They won’t wait (nor even try) for the value to rise enough for the LP to recover anything.

Bottom line is I think that a large portion of deals that have a loan maturity in the next few years will ultimately result in a wipeout of investor equity if LTVs (at today’s value) are high, unless there is a V shaped recovery in values, which I think is doubtful (but I could certainly be wrong).

08 to 2011 its was resi market that got slammed and MF and commercial kind of sailed through or did better.. now resi market is doing OK and MF and commercial Office are getting slammed. This was the conversation I had with my Banker at lunch last week  IE how the worm has turned.
AS U state Brian NO lender save those that are basically crooks wants to take a project back that is the thought process of  those that simply have never been on the lending side and simply dont know what they dont know.. thinking the lender is going to get rich taking back these assets its frankly totally naive thinking. Also many of these lenders are using LOC from huge funds and they have their Marching orders all written in their master credit line agreements.

[Bobby Larsen]

 MF got slammed in 08 to 2011, worse than today.

[Jay Hinrichs]

Quote from @Bobby Larsen:

 MF got slammed in 08 to 2011, worse than today.

ya I was thinking the same thing It could be my Banker was being more specific about commercial and Office.. but having lived through that to me it ALL got hammered :( And of course I try to just forget about those terrible years.  I do know clients of mine I sold MF to here in the PDX market though did not miss a beat.