All Forum Posts by: Brian Burke

Quote from @Amit M.:

Unfortunately LPs, in addition to being in bad deals are also deciding on capital calls. Personally I think more often than not it will be throwing out good money after bad, but seeing which capital call end up saving the day and which won’t will be interesting. 

LPs in this position have some factors they can consider when evaluating the chances of a successful outcome.

1. An incompetent sponsor—good outcome unlikely.
2. A loan maturity in the next 3-5 years—good outcome unlikely.
3. Primary financing is bridge debt with a wide spread—good outcome difficult.
4. Capital call just to buy the next one-year rate cap—good outcome unlikely and expect another capital call.
5. Capital call to pay down the loan a little so the lender will extend the maturity out another year—you are back in #2.
6. Capital call is just to plug holes for a year or two and by then the market will come back and we can sell and get all our money back—good outcome not very likely.
7. Competent sponsor, no loan maturity for at least 5 years, not bridge debt with a wide spread, property generally stable, and capital call anticipates several years of liquidity—good outcome more likely than not.
8. Competent sponsor, capital call large enough to completely escape existing toxic loan with cash-in refinance to a lower-balance loan with a long maturity—good outcome possible, even probable, if there is no other “hot money” in the deal such as preferred equity or priority share classes.

There are surely other nuances I’ve missed here, but this is a start.

I think a lot of people would categorize a sponsor as “good” if they delivered a fair return. Many people would label a sponsor as great if they exceeded the projected return.  They would label them as bad if they paused distributions or issued a capital call.  And if all or most capital was lost, many investors would label the sponsors as crooks.

But these labels are all wrong, which is why the idea of a ranking list presents problems and could lead to poor sponsor selection.  The problem isn’t the list, the problem is “garbage in, garbage out.”  Smart LPs need to look deeper if they are to make good selections.

The sponsor’s number one job isn’t to buy real estate—it’s to not lose people’s money.  For the last decade we’ve been in a continuous bull market, so most sponsors would get a good or great rating if they are any good at investor communication and accounting. 

But today’s market is one where real assessments can be made.  Tough times show who people really are.

Assuming great communication, I’d label a sponsor as “great” if they get through the next couple of years without losing investor’s money.  “Good” if they lose some money but are very transparent about it as @Scott Trench mentioned in his post.  “Bad” if they lose all money, or if they lose some money but fail to communicate.  And “crooks” if they misappropriate funds or lie to (or conceal facts from) investors.

Quote from @Carlos Ptriawan:

1. Is it possible for these loan to be refinanced with CMBS loan ? But how it can be approved if their DSCR is 0.6-0.8 while agency loan is asking 1.25 DSCR/75%LTV ? It would also dilute all prevs. investors.

2. So all these capital call/13% prefs are basically paying 9% loan while their DSCR is 0.8, how is it possible ? this is more like debt paying debt over debt to 

3. So these bridge loan is acquired through CLO with aggregated rate of 7% ; their profit spread is 1.7%; leaving 8.5-9.0% total interest to be paid by the GP/LP syndicators. In other words,they now have to pay 400-500 bps for asset that's only having 0.6-0.8 DSCR. It all seems very bizarre to me.

4. What's more interesting is that that bridge lender is still able to generate profit and 10% dividend (whether there's accounting cookbook that I don't understand I don't know) but seems they are having a clever way to avoid losses. But beside that what intrigue me is that if I am just investor and I want to have sustainable income why don't I just purchase those CLO at 7% or their notes that's also at 6.5% ; compare to riskier LP position.

5. Also in theory, due to large reserves of the bank/lender, I think if I'm the lender, I would just choose to bankrupt all these GP. The lender can take over these apartments without causing problem in their book, create their own own GP and run/service the apartment with the reserve that they had. In fact, this lender is doing the similar thing when they "switch" the ownership of one apartment from one GP to another GP (of their friend perhaps).

 1.  Sure it’s possible, but “easier said than done”.  Some borrowers would likely have to pay down their principal 20% to 50% to refinance some of these loans into agency/bank/lifeco debt, which would require a mountain of new equity which would absolutely dilute investors.  But if existing equity is worth zero, dilution amounts to what?  The bigger problem is getting the new equity.  Unlikely.

2. I suspect deals with that structure will end up in foreclosure or other forced sale eventually, unless a quick market reversal bails them out.  Unlikely.

3.  Yeah…I don’t know how a deal works with rates like that unless they were bought at about 30% to 50% of the prices they were likely bought for if they were purchased in 2021-2023.  This is another seldom-discussed risk of bridge—the spreads are a lot wider than agency floaters.

4.  Some of these bridge lenders will be in their own world of trouble. Imagine if they have a warehouse line with a rate tied to SOFR at 70-80 percent leverage and the underlying loans stop paying.  There could be multiple layers of unraveling in the months and years ahead.

5.  They don’t even need to force a BK.  Some bridge lenders require equity pledges so they can just do a quick UCC sale and take over the SPE. I think nowadays you instead see can-kicking because as long as the GP has a hope of recovery the lender gets a “free” asset manager and maybe some interest and principal payments. But the moment the GP disengages, or the market supports an exit with the lender recovering their principal, the can-kicking will stop and the action will start. Some of these loans (or even the lenders themselves) have or will sell at a discount, and to the new buyer (maybe a loan to own buyer?) the road to recovery is shorter because they have a lower basis.

Quote from @Carlos Ptriawan:

In case anyone interested to find out how to see this problem from the bridge-lender side intellegently, these information from one of the lender is very informative:

Loan Modifications 

We may amend or modify loans that involve other-than-insignificant payment delays and provide interest rate reductions and/or extend the maturity dates for borrowers experiencing financial difficulty based on specific facts and circumstances. All of the below modified loans were performing pursuant to their contractual terms at March 31, 2024.During the first quarter of 2024, we modified twenty-three multifamily bridge loans with a total UPB of $1.07 billion. These loans contained interest rates with pricing over SOFR ranging from 3.25% to 4.25% and maturities between April 2024 to August 2025. As part of the modification of these loans, borrowers invested additional capital to recapitalize their projects in exchange for temporary rate relief, which we provided through a pay and accrual feature. The capital invested by the borrowers was in the form of either, or a combination of: (1) additional deposits into interest and/or renovation reserves; (2) the purchase of a new rate cap; (3) a principal paydown of the loan and (4) bringing any delinquent loans current by paying past due interest owed. In each case, we reduced the pay rate and deferred the remaining portion of the foregoing interest until payoff. The pay rates were amended to either SOFR, a spread over SOFR or a fixed rate, with the balance of the interest due under the original loan terms being deferred. At March 31, 2024, these modified loans had a weighted average pay rate of 6.95% and a weighted average accrual rate of 1.86%. These modified loans included: (1) loans totaling $712.9 million that were less than 60 days past due at December 31, 2023; (2) two specifically impaired loans with a total loan loss reserve of $7.0 million and a total UPB of $49.6 million; and (3) fifteen loans with a total UPB of $671.0 million that were extended between twelve and thirty months.

During the first quarter of 2024, we also modified sixteen multifamily bridge loans with a total UPB of $692.8 million. The modification terms required the borrowers to invest additional capital in the form of either, or a combination of: (1) additional deposits into interest and/or renovation reserves; (2) the purchase of a new rate cap; (3) a principal paydown of the loan; and (4) bringing any delinquent loans current by paying past due interest owed. The modifications on eleven of these loans with a total UPB of $456.5 million included extensions between two and nineteen months.

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Basically your (LP) decision to invest (on capital call) or not depends on how you calculate the syndication NOI and DSCR when rate reduces by 300bps from now to 2026.

If fund's/unit level DSCR can sustain DSCR 1.0 with 7% rate, then LP money can survive.

These problem is actually easy to avoid if everyone is adding more LPs and reduce the number of LTV and use longer term debt.

Lenders aren’t dumb—they know that as long as the sponsor has any hope of keeping the property they (lender) can squeeze the borrower for money by granting a maturity extension in exchange for a principal paydown.

But the moment the lender thinks they can recover their principal, or that they can’t squeeze any more money from the borrower for additional principal reductions, the cooperative spirit will end and the lender will force a sale.  They won’t wait for the value to allow for equity recapture.

What some borrowers might not realize is that the principal reduction payments may expedite their own demise because the lower the balance gets, the sooner the lender can recover their principal through foreclosure or a forced sale.

 
Instead of paying down a little principal for a little time, pay down a lot of principal and refinance to a loan that allows a lot of time. Easier said than done, however.

@Pedro NA you are starting from a better position from where I started...I had no money and no business experience when I made my first real estate investment.  Having said that, I wasn't raising money from others, either.  It took me almost a decade of real estate investing before I was ready for that step.  

I know or know of people in your same position (executive level tech experience + capital) who have done well in this business, and also ones that have imploded in a spectacular ball of flames.  Your experience, while definitely helpful, isn't a direct correlation to the real estate space--a space in which your greatest contributions will not only be your business skill, but your relationships in the industry (brokers, lenders, managers, vendors, the list goes on).  These things take time to develop.

Chances are you'll do well, but if I'm a passive investor your deal is a hard pass until you've built a real estate track record.  This is one of the reasons I constantly preach to start small--it requires less capital and you can find investors that already trust you for other reasons (friends & family, etc).  Build off that, and eventually outside investors will take notice.

Over the last several years commercial real estate, especially multifamily, has had a bull run.  Anybody could be successful and investors poured money onto these new operators to fuel their growth.  Now many of those deals are, or soon will be, running into trouble.  When investors lose money, or are at risk of losing money, they pay attention.  One thing they'll be paying closer attention to is the experience of the operator and how that operator has shown to perform.  That makes your battle somewhat more uphill--which circles right back to starting small with your own capital first, then friends and family, then, after developing a solid track record, building from there.  If you are going to do this for 20 years, spending 5 of it pouring a foundation before going vertical is time well spent.

Quote from @Dan H.:

Investors have to do their due diligence.  They have to recognize risk versus reward.  They have to take responsibility. 

Between 2012 enter and 2021 exit or near exit, virtually every RE syndication performed well.  Many returned near 20% annualized returns.  Did you think these returns came without risk?

I am in a syndication that for the first time I am concerned about loosing some of my investment.  Did I think this investments had zero risk?   I posted multiple times over the last few years that the previous returns of RE syndications were unlikely to continue.  Even though I posted this, I chose to enter 3 new syndication (2 fully RE related and one an RE hybrid).   I recognized there was risk.  I thought the reward justified the risk, but it appears one may not preserve my investment (time will tell). Regardless if I lose my initial investment or not, I am responsible.  I analyzed the risk and reward and decided to invest.  I knew the fed had announced intent to raise rates.  I thought it unlikely that any time soon we would see mortgages at or near 3%. I still chose to invest believing in their plan and their ability to still produce an LP return that warranted the risk.  I was not investing in RE syndications that were solely going to rehab and improve management.  I was investing in more sophisticated value add offerings. 

The GPs find the best opportunities they can recognizing that the risk/return outlook needs to be able to get LP investors.  The present their syndication opportunity to potential accredited LP investors who do their due diligence and either invest  or don’t.  The due diligence   The GP then attempt to maximize the profits for their benefit and the benefit of the LPs.

I have little doubt that active RE investors can produce a better return than RE syndications.  However, RE syndications can produce good passive returns, but they come with risks.  LPs need to understand the risks versus rewards and make educated decisions.   They must recognize their responsibility.  

I wish those invested in Ashcroft capital a best case outcome.  

Too bad BP doesn't let you vote for a post twice.  Very well said, Dan.

Of course just like any industry there are less competent operators and even downright fraud actors, but the vast majority of experienced operators (especially the ones that have been around the block a few times and survived adverse market cycles) are working with the investor's best interests in mind and strive to produce the best result possible under whatever circumstances they are dealt, even when the going gets tough.  If that wasn't the case, they wouldn't have survived in business as long as they have, and/or wouldn't have a long future.

Quote from @Clark Stevenson:

Acknowledging with empathy the fresh wounds you are experiencing here, I'll present a devil's advocate position on funds:  This is a feature, not a bug.  

In a different post I saw you say that the fund owns 8 assets in 4 markets.  That's a well-designed portfolio from a geographical diversification standpoint.  If the capital stack is well-designed (I'm not opining on that because I know nothing about how this stack is structured), the feature of the fund is that 2 under-performing properties or one underperforming market shouldn't take down the whole fund, just be a headwind to achieving the desired returns.

Investing in a single-asset syndication isn't a play on multifamily real estate as an asset class.  Instead, you are investing in that specific asset.  If the asset you picked turns out to be the one running into trouble and sells at a loss, you're completely or partially wiped out.  If you happened to pick the one that is doing well, you'll do well.  But you're leaving it up to luck, and luck isn't the best strategy.  And for those who say they'll only pick the winners because they can spot them, I'd argue that your luck will one day run out too--even deals that look great in the beginning can turn on a dime.

A well-designed fund that has a couple of losers and a lot of winners has the option to sell the underperforming assets, even if at a loss, and carry on with the winners.  Eventually markets correct and the winners can produce gains that make up for the losing asset's losses and investors can eventually come out the other side whole, and have a shot at a profit, even if the continuation plan requires a capital call.  It doesn't always work out that way, but it can.  With single-asset deals that are losers, this option is off the table, if the deal is sold at a loss investors take a loss with no chance of recovery.

Just food for thought as there are pros and cons to every structure.

Quote from @Paul Azad:

WOW, they had to spend 18.6 million for 12 months of Rate Cap insurance up from 513K they spent for same insurance they got 2 years earlier, 

These syndicators took huge risks in acquiring these MF properties with the variable bridge loans with rate cap insurance in order to buy at lower cap rates than any reasonable investor with fixed agency debt could afford and apparently at LTVs approaching 80% too, in order to drive higher IRR 'projected returns" for LP investors.

Bridge loans are a disaster when the markets shift.  In 2020 and 2021 I was getting outbid by millions of dollars on nearly every property by syndicators using bridge debt. I graciously bowed out. I feel for their investors…

But fixed debt doesn’t solve every problem.  I had a broker bring me an off-market deal in 2020 that required a loan assumption because the fixed loan’s yield maintenance (prepayment penalty) was around $20 million.  The loan had like 10 years left on it. I didn’t want to be locked in like that so I passed. The deal sold to someone else. A couple years later that buyer was trying to sell but that prepay was an obstacle.  Another year later, it hadn’t sold and now they are riding the value down.  They lost tens of millions in value and counting.

My point here is there is no free lunch in CRE finance. LPs in fixed rate deals selling in 2018 to 2022 took major hits thanks to yield maintenance but no one made a big deal of it because that money came out of sales proceeds and even after that everyone made good money (but could have made more, so is not making the same as losing?). Contrast that to LPs dipping into their pockets further to buy a replacement cap, so it's understandable why that gets people's attention.

Don’t get me wrong, short-term maturity risk 10+ years into a bull run is ill-advised to say the least.  But in every deal there are decisions that need to be made on which risk to choose when selecting financing.  Experienced groups that have survived cycles are more likely to make the right call at the right time, but even they don’t always get it right. Neither do the LPs that invest in these deals, even the ones that really know what they’re doing.  

Quote from @Eric Bilderback:

@Brian Burke

In your opinion do you believe the sponsor should return fees etc?

Short answer:  No

Longer Answer:

In the vast majority of cases GPs are under no contractual obligation to return fees in any case.  And contractual issues aside--from a practical standpoint, GPs would have long-spent that money (if nothing else for the taxes on it) and might not have the cash available to return fees, especially if they are not currently transacting.

The dirty dark little secret in the syndication business is it's really a fee-based model.  If the deal is structured right, sponsors likely get little to nothing until the property has sold, aside from some up front fees and some ongoing fees.  Without opening up a whole other can of worms, it's true that some sponsors charge exorbitant fees and don't bring anything close to that value to the table, but that's another discussion.

None of this is to say that sponsors couldn't or shouldn't feel some pain when things go astray.  I know I have--I've waived off various fees and even written checks to cover losses several times over the years when things didn't go according to plan.  But when factors outside of the control of the sponsor derail a deal, that doesn't mean that the services the sponsor did perform and are performing are worthless (if they really are a good operator, etc).  

On the contrary, times of challenge are really when a good sponsor "earns their money."  LPs want and need their GP to stay interested in the deal and not go bankrupt.  If you think a bad market sets a deal off course, just imagine how much chaos stems from a failed GP.  That can be a complete disaster, with no one really in control.  If everyone's interests are aligned, the sponsors and investors are in it together and should work from the same side of the table to solve the issue.  Assuming the sponsor is honest and competent, becoming adversarial really benefits no one.

Quote from @Todd Goedeke:

@Brian Burke please post again the questions every investor should get answers for ( red flags) from the operating agreement and historical experience of general partners.

An investor should not have to read a book to see a checklist of “ dealbreakers” before investing.

You're right, Todd, they shouldn't.  Fortunately they don't have to--for people who purchase the book directly from BP here, they get free bonus content and one component of that is a list of 72 questions to ask a sponsor.

Someone will read this and think I'm just trying to sell books--not the case.  I wrote the book (and the list of questions) but BiggerPockets owns the publishing and distribution rights so I can't just post the list here.  I don't make a living off of book royalties, but I have built my reputation off of honoring contracts.  :)