All Forum Posts by: Bobby Larsen

Great topic and one that I think is very helpful to many LPs on BP today. 

However, I do disagree on preferred equity. When used correctly and in moderation, it can be an effective tool at times. The first sanity check is if there is a sizeable spread between preferred rates and rates of return that LPs should be expecting on value-add projects. On small balance preferred equity, rates are 15%+ so this fails that test in my opinion. However, with larger balance preferred equity ($5m+), rates become more interest. Typically between 12% to 13%. If it passes the first sanity check, preferred equity should be viewed akin to debt and be analyzed with a blended rate with a potential loan.

Example, Property A was acquired with a loan from a debt fund at 3.75% + SOFR and a 3% interest rate cap that is expiring. Property A does not have reserves to buy a new rate cap or maybe it just doesn't make sense but at the current 3.75% + 3% (rate cap), Property A is cash flowing 1-2% a year. They have the option to do a capital call or preferred equity.

Capital Call - to either buy the rate cap (likely a bad decision) or a capital call to buy down loan principal and execute a fixed rate loan at 6%. Investors need to pony up additional capital and investors that don't, will be diluted. Property will cashflow at 3% with an expected total annual return of 13%.

Preferred Equity at 12% - to either buy the rate cap (definitely a bad decision) or preferred equity to buy down loan principal and execute a fixed rate loan at 6% for an all in (loan + preferred) blended rate of 6.6%. Investors do not need to provide additional capital or be diluted. The property will cashflow at 2.25% with an expected total annual return of 15%.

I don't view either of these to be the right or wrong answer but I would expect different LPs to have different preferences here.

This approach can also be used on new acquisitions. It's very surprising to me that investors will often rather see a property purchased with a 75% loan to cost debt fund at 4% + SOFR (all-in rate today of 9.33%) than a 60% loan to cost agency fixed rate loan at 6% combined with 15% loan to cost preferred equity at a rate of 12% (7.2% blended rate). Both sound risky to me and we're a sponsor that typically executes with 65% agency debt, but if I were choosing between the two as an LP investor, I would be choosing agency debt + preferred.

Two different topics, in my opinion. I was just commenting that a 0.88 DSCR doesn't indicate the value of a property is underwater. There's a higher likelihood but it could also just mean the sponsor made a poor decision on the type of loan they put on the property and it could make sense to restructure the capital stack with a new loan and a capital call and/or preferred equity.

@Carlos Ptriawan I understand your point of view but DSCR does not indicate value. A sub-1.0x dscr indicates poor financial structuring which can still be corrected with a capital call or preferred equity IF the value still justifies that approach.

 The investment would either need to have A) collected a significant amount of distributions (cashflow) or B) had a lower basis from one or more previous 1031-exchanges. A is unlikely given GVA's value add approach. B will likely depend on if this was your initial investment with GVA or from a prior investment that sold and 1031-exchanged.

Looks like there are two letter floating around, one for Fund I and the other for a specific syndication. Both would need to be evaluated differently and the answer to contributing to the capital call is whether you believe in the financials projections which should likely be viewed with a bit more skepticism. We are in a real estate recession and while I do think we have seen most, if not all, of the pricing declines, markets do not rebound quickly. If anything greater than 100% of equity is wiped out today (values less than loans) then the quick answer is not to contribute because you'll be met with immediate dilution of your new equity.

Also, these Class A and Class B (common and preferred) equity structures can become really messy when times are difficult. It is impossible for a sponsor to act as a fiduciary to both. According to the fund letter, Class B is wiped out and Class A is at 71% of initial investment. My immediate question is: Where will the new equity sit in the capital stack? If new equity has priority over Class A then this capital call is diluting Class A's remaining 71% and Class A should be pushing for a sale. Class B likely won't want that because it means a full loss of capital. Both classes are represented by the same sponsor, how does a sponsor act in the best interest of both share classes? Review the PPM with an attorney to see if Class A has additional control rights. Additionally, how does dilution work between class A and class B if they don't participate in the capital all?

Lastly, I take issue with the "All LPs must participate language" which is likely incorrect but I recommend reviewing the PPMs with an attorney. 

Have them sign a new lease. Agree with all of @Kevin Sobilo points above with the largest being the legal aspects of using an unfamiliar lease in court. If applicable, it also gives you the opportunity to update language regarding utility reimbursement methodology in the lease. If you want to keep them month to month, you could also issue a change of terms.

Both are useful to know but GRM is really only helpful comparing opportunities within markets whereas cap rates are useful comparing opportunities across multiple cap rates. Don't rely on anyone else cap rates, everyone calculates them differently.

Follow long term migration and employment growth and combine that with current cap rates. And, as always, have a long term investment mindset.

All of the markets that you mentioned, aside from Albuquerque, have the growth. With that said, Albuquerque is home to the best investment I’ve ever done but that was when cap rates there were 100bps higher than other markets. Today, they basically the same so not sure the draw other than just being affordable.

Dallas has the growth but remains the most aggressively priced market in today’s environment. There will be distress there so be careful.

Las Vegas and Phoenix also have some near term distress coming (and supply in Phoenix) but pricing has softened quite a bit which could provide good entry points over the long term. The next 12 months will be difficult though.

Other areas to consider are the Mountain West (Utah, Idaho) and the SouthEast (Tampa, Atlanta, Charleston). Both of these areas have strong growth forecasts and are prices less aggressively than Dallas and better near term fundamentals than Phoenix. Except for Atlanta- plenty of distress coming to that market as well.

@Chris Webb I think that was the second capital call as well.

We’re going to see quite a bit of this in 2024, most thought it was going to come in 2023 but foreclosures take awhile. Most of the loan modifications that sponsors are touting almost assure this outcome as well. That should translate into 2024 being a good year for new investments.