103. Debt and Structured Financing in CRE Deals with Derek Fasulo

Connect with the host:

LinkedIn: https://www.linkedin.com/in/brandon-e-jenkins/

Website: https://www.birchprosper.com/

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About the guest:

Derek Fasulo is a Senior Vice President on CBRE’s Debt & Structured Finance team in Houston, TX.  He joined CBRE Capital Markets in 2013 and specializes in the advisement of multifamily and commercial assets.  His primary focus is sourcing capital for acquisitions, developments and refinances and keeping existing owner clients informed on the state of the capital markets.  Derek has been recognized on the Top Producer list for the Houston office since 2019 and the Top Producer list nationally in 2021 & 2022. Prior to joining CBRE’s Debt & Structure Finance group, he started his commercial real estate career in 2010 with CBRE’s Valuation and Advisory Services division as a commercial real estate appraiser. Mr. Fasulo holds a Masters of Real Estate degree from The Mays Business School at Texas A&M University.

Connect with Derek Fasulo: 

LinkedIn: https://www.linkedin.com/in/derek-fasulo-1aa3b421/

Website: https://www.cbre.com/

Episode Highlights:

✔️ Mechanics of deal structuring for newcomers

✔️ Career shifts within real estate

✔️ Asset valuation in finance

✔️ Importance of realistic underwriting

✔️ Strategies against rising insurance costs

✔️ Sellers adjusting to market conditions

✔️ Lenders as partners in financial challenges

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Transcript

SPEAKER_01 0:00

I agree 100% with you. I think if you're investing in real estate, whether that's GP or LP side, I think you need to understand the basics of underwriting. Um, if you're an LP and you're putting money into a deal and you're reviewing these packages on potential investments, you should know how those numbers work and you should know how to underwrite it.

SPEAKER_00 0:23

How successful would you be if you had the blueprint for building wealth as a real estate investor or as someone who acquires small businesses? If you want to move the needle financially in your life, then you need to understand one thing the capital stack. I'm your host, Brandon Jenkins, and this is where your journey to financial freedom begins. Hello everyone, what's up, and welcome back to the Capital Stack. I'm your host, Brandon Jenkins. And speaking of the Capital Stack, it's my pleasure to introduce someone who is very much in the business of structuring the capital stack to ideally achieve the objectives of his clients. So we're going to be digging into um debt and uh finance, structured finance today, which is a fascinating topic to say the least. And it's something that is um vital to the success of anyone in this business, certainly operators who um uh are are working with kind of a larger assets. And so our guest for today is Derek Fasulo. Derek, how are you doing today, sir? Good, sir. How are you? Thanks for having me. I'm doing well. Thank you so much for being here. And uh, I'll give you a quick run through of uh Derek's uh background here. So Derek is a senior vice president on C Bar CBRE, excuse me, CBRE's debt and structured finance team in Houston. Um, he joined CBRE Capital Markets in 2013, specializes in the advisement of multifamily and commercial assets with a primary focus on sourcing capital for acquisitions, developments, and refinances, um, and keeping existing owner clients informed on the state of the capital markets. So a vast experience and background there. Derek has been recognized on the top producer list for the Houston uh office since uh 2019 and the top producer list nationally in 2021 and 2022. Prior to joining CBRE's debt and structure finance group, he started his financial, um, his commercial real estate career in 2010 with CBRE's Valuation and Advisory Services Division as a commercial real estate appraiser. Mr. Frasula also holds a master's of real estate degree from the Mays Business School at Texas AM University. And I'm gonna give you you guys a quick little um update here or or um, I guess a little bit of background. So my first interaction with Derek was actually years ago um when I still lived in Houston and I attended one of Shane Thomas's uh meetups in Sugarland. And that was the first time I heard Derek speaking. That was um, boy, that had to be back in, I don't know, 2017 or something.

SPEAKER_01 2:45

Yeah, it had to be 17 or 18.

SPEAKER_00 2:47

Yeah. And so um, like I said, just a wealth of knowledge, a wealth of experience. And so, Derek, welcome to the show. Why don't you kind of share just a little bit about your background if I've missed anything in that intro there?

SPEAKER_01 2:58

No, it was a good, uh, good, good broad cover. Yeah, so I, you know, went to Texas AM for undergrad, uh, majored in political science with uh aspirations to go into law school, took a year off, uh moved to Houston, worked for an attorney, and just wasn't wasn't for me. I worked for a real estate attorney and then and uh I do not envy those guys, uh, especially in working with them. We worked hand in hand with those guys uh on in what I'm doing now, coincidentally, and uh reading loan docs and and structuring uh entities was not was not for me. So I decided instead of go to law school to go to business school, and so I went to Texas AM with uh um to the Mays Business School with a focus on real estate and specifically real estate finance. So did that over two years, graduated, and that was about the time, right, 2010, where we were coming out of the recession. There wasn't a lot of people in the commercial real estate industry hiring at that time because it was just starting to get, you know, climb out of uh out of the recession that that was in. And and my options were basically go into leasing, uh, so retail leasing or office leasing and cold calling and and doing stuff like that, because that that uh type of position was hiring, or go into commercial appraisal. So I was fortunate enough to be able to land with CBRE. Uh I moved to Houston, worked as an appraiser for three years, just learning how to value assets, um, you know, which is you know, it was a huge strength and propelled me kind of to where I am today, but learning how to underwrite, learning how to value assets, learning how to put performance together, do rent comp analysis, sales comp analysis, kind of everything that I mean, frankly, a lot of the the sponsors on your side of the business are are doing. And so I did that for three years, mostly with retail, industrial, and office assets. And then in 2013, I transferred internally uh to our CBRE structured finance group, um, was an analyst for four years and and uh thinking about 2015, uh started focusing more on the multifamily side. Um, you know, as it became more and more active, especially in Houston marketing, kind of 13 and 14, and a lot of people and a lot of sponsors, a lot of new investment groups jumping into the business, saw the potential there. So I wanted to focus more on that side of the business. So I started focusing full-time on multifamily, and then in I think it was 2018, uh jumped into a production or origination role, uh, which is where I've been ever since. So then again, all pretty much all multifamily. Uh 90, 95% of my business is that, but we have started to expand my partner and I to more industrial and alternative type assets, um, just trying to kind of expand our bandwidth a little bit, but still primarily focused on multifamily.

SPEAKER_00 6:10

Awesome, awesome. Well, thank you so much for sharing that background. I think I think one thing that's kind of um interesting about that is that for people who don't realize, I mean, CBRE is one of the largest, if not, if not the largest, I think, um kind of uh brokerage uh firm in this business in the certainly in the country, but maybe all over the in the world. I'm not sure what the last time I checked. But um, so so one thing that for me is very fascinating is that you have the ability then, because it's a a large organization, to move within within the organization and to give vastly different um types of experiences along the way. Um, and so what what role would you say kind of maybe impacted or benefited you the most in your current role? I'm sure, I'm sure each one kind of played a role, but which which one would you say is kind of the one that really, really benefited you in your current position?

SPEAKER_01 6:58

You know, I would say actually the appraisal role. Um, and it set an incredible foundation on learning the basics of real estate, right? You're learning what creates value, you're learning how to underwrite deals, you're learning how to put proformas together, you're learning how to analyze rent comps versus your property, sales comps versus your property, putting market data together, understanding employment trends, population trends, demographics, and what influences properties. And so I would say like it was kind of a blessing in disguise. I never wanted to go into an appraisal position. It was just a position that was hiring at that time, looking for a job out of college. And it turned out to be like again, the foundation that kind of propelled me to where I was today. Because when I dropped, when I jumped into this position that I'm in now in the in the analyst position I was in before, that's all I was doing. It was a very easy and seamless transition, you know, a little bit different with you know the debt aspects of it and learning, you know, things like debt coverage and debt yields and what influences lenders to lend on deals. That was a different side of it, but the the foundation of it came all from appraisal. Um and and myself, along with two of our other producers, started in those positions as well, uh, started in the appraisal position as well. And again, it I mean, it sets an incredible foundation, just learning the basics of of real estate and how to underwrite.

SPEAKER_00 8:32

Yeah, and I would imagine it it kind of um, you know, after seeing so many deals, it would it would also kind of give you um that that refined perspective to where you know exactly like your eyes are now trained to say, okay, that doesn't look right, you know, and so you can immediately pick out things that um, you know, because that's one thing that you mentioned um that you got to see a lot of what operators are doing um kind of on my side of the table. And the thing is that's that's where many operators fall short is not having some data to back up the numbers that are on the spreadsheet and not having an understanding of you know uh when when rules of thumb are okay and when they're not okay, right? Um so kind of you know, if you could even I I know we're gonna talk about the kind of the the state of the economy in a in a moment here, but I'm just curious, like right now, what are you guys seeing in terms of you know, when you take a first glance at someone's underwriting, and if they if they're still projecting, hey, we're gonna see double digit, we're gonna see 15% rent growth in the, you know, what do you what are you guys kind of cutting down to say, you know, this is how we're looking at the deal?

SPEAKER_01 9:33

Yeah, I mean, I think you can, and you know, some of my clients, and and you know, you mentioned Shane earlier and he still works with them and Jade, I know you know well, and we work with them and have worked with them in the past. You know, if you talk to them, they'll tell you, I'm I'm pretty honest. If I if I see things and holes in your underwriting, I'm gonna question it and I expect you to have an answer for it, right? Because you're sending me a deal to look at to underwrite. I want you to know before I underwrite the deal, I want you to underwrite it. And I want you to know how to underwrite it. And I want you to be able to not just use, you know, a template that came from one of these syndication platforms where you plug numbers in and it spits out an IRR and it spits out an equity multiple. Like I want you to understand the ins and outs of that. So when we do have the conversation, I ask where your assumptions come from, right? We can have an educated, you know, conversation. And I may not always be right, but I can point out things that I see. And you mentioned kind of you know rent growth. And we saw, you know, in 2021, every pro forma we saw, you know, over three to five years had exactly what you said 10 10 to 15% rent growth every year. And you know, that that lasted for about 18 months and then it went back. I mean, historically, like sponsors were underwriting two to three percent, right? And so everyone was basing their pro forma on 15 or 12 or 10 percent, and it was just it, it's not sustainable. It's it was you know a unique situation coming out of COVID where every market, large and small, for the most part, was experiencing significant rent growth. But I mean, those trends could could not continue. Right. So, so when we look at deals today, um focusing on on your rent assumptions, focusing on if you're doing a value add deal and you're renovating your plan is to renovate 50% of the units, which is fine, you leave something you know on the other end for the next owner, but I don't want to see pro forma rents at 100% of those units when you're only renovating 50. And and that was a that was a piece of it that I saw quite a bit back in 21 and 22, where these groups were going in, they were buying a deal with the aspirations of renovating 50 and bumping rents$100, but then they would continue to bump rents$100 and 100% of the units, and I would question it, and I would also often get the feedback well, we're gonna be painting the exteriors and putting landscaping in. I'm like, okay, well, does that justify like 100% increases on the units you aren't renovating? Like, because if you don't get that and you're underwriting for that, you're gonna be in a position two years down the road where you're not gonna be hitting the NOI that you need to exit that loan and creating the value that you need to exit that loan, right? So different things like that. So we we focus on on the income side on that regard, making sure that your assumptions are sound. Um, and then on the expenses. Look, a lot of people got caught in ways that frankly they had no control over, right? You have your controllable and uncontrollable expenses, and uncontrollable is your your taxes and insurance. And unfortunately, especially with insurance, um, if you're buying on the coast in Texas or Florida or anywhere like that, you're just you're getting hammered right now uh with insurance. And it's frankly, it's something that no one could really print. I mean, some could say, you know, hindsight with with all the des natural disasters we've had, that hey, you you know, insurance was expected increase, but I don't think anyone expected, you know, two X type increases in insurance, which are which are just killing people. So, right, we we try to take a little bit more conservative approach. We don't want to put our sponsors in a position to where we provide aggressive advice um that's gonna get them in a situation later that they may not be able to get to. So making sure assumptions are sound on real estate taxes, making sure that you're applying the, you know, not just assuming they're gonna stay flat or five or ten percent. In reality, if you're in Dallas or Houston or San Antonio, you need to be bumping that up to 90% of purchase price on a conservative basis and then growing from there. Um and so, right, there's a little bit, and I think people are now focused more on having more realistic um assumptions and proformas, you know, with with things that happened in 2021 and 2022 that are not, you know, just kind of it was an it was an anomaly situation with rent growth, and that could kind of bell you out, but now that that's stopped, um, it's kind of back to reality at this point.

SPEAKER_00 14:40

Yeah, I think I think so as well. And you know, um, I think the way that you phrase that is important for people to kind of understand, too, is that really what you're trying to do, like you mentioned, is to make sure that there are realistic assumptions in place because, you know, so if you were to, you know, uh operator comes and brings an underright deal to you and it has these lofty um projections that really don't make sense. And if you were to just say, Oh, okay, cool, let's let's roll with it, okay. Well, they're operating the deal, they get to year two, and they uh will not be able to achieve the NOI that they need or whatever, it could, it could, their debt service coverage could could drop because they you know thought that they would get more rent coming in than they than they have, or whatever it is. So you it's almost like you're you take it in and you're saying, okay, well, you know, first of all, hey, do you have a uh an actual what's the basis behind these numbers? Okay, you have a base. Sorry, it sounds good. Uh, but but listen, you know, you need to need to be uh based in fact as well, based in reality. You know, who have you had a conversation with to vet some of these numbers out? Um because it's about protecting, you know, but kind of both parties, right? If you're going to represent that, hey, this is a deal that we can actually reach out, reach out to our network and uh to start shopping uh uh for some capital and and to to help these guys out, well, it needs to be clean, it needs to uh fit you guys' criteria as well. Um, and so you know that's why I always tell people that look, underwriting is is extremely important. And I think the reality is there are a lot of operators that don't that aren't comfortable with underwriting. Um, and especially now when when you're talking about digging into the specifics um uh of it and what's really driving the numbers, I think that um it that's something that I'm not sure how, but it it seems to have sort of dropped off and things like raising capital and and other things have really sort of taken the fore uh forefront. Yeah, but but underwriting is still absolutely critical. And and you know, for my my take on it is I think everyone needs to understand underwriting. I I don't care what your role is on the GP team, I actually think you do need to understand um underwriting. Uh that's that's my take on it. But uh 100%.

SPEAKER_01 16:41

And you brought up a great point, and it was a situation where in the past couple of years was capital was easy to raise. And I, you know, and I I attend conferences to try to network, and there's always things, and people are always the most interested in how do I raise capital. And it's great to have someone on your team that can do it, and because it is an important piece of the capital stack, you need equity. But to your point, like I think a lot of people were focused more on how do I raise capital instead of how do I underwrite a deal. Um, and I agree 100% with you. I think if you're investing in real estate, whether that's GP or LP side, I think you need to understand the basics of underwriting. Um, if you're an LP and you're putting money into a deal and re and you're reviewing these packages on you know potential investments, you should know how those numbers work and you should know how to underwrite it. Right. And that way you can you can vet the deal. You don't just trust the numbers that are in the package. Um do do your own homework, right? And know how to underwrite. So I think that's a great point that you that you pointed out right there.

SPEAKER_00 17:48

Yeah, absolutely, absolutely. And so um, so so let's talk a bit about um kind of what's at the core of of your focus now. And this is for so for people who are maybe not familiar with what it means to have a conversation with you and with your team and and and to bring a deal to you for uh uh uh for for advisement and and and your the services that you all offer. Kind of what what do you do for operators for clients that um that are uh uh present a deal to you?

SPEAKER_01 18:16

Yeah, so yeah, so from the start, you know, when clients are looking to acquire a deal or even refinance a deal that they currently own, um, our first step is to analyze the numbers. Um, get a rent roll, get a T12, get historicals, understand what your cost basis is in the deal or what you plan to do to the property if you're acquiring it, whether that's a value add plan, capex plan, operation improvements, et cetera. And so really kind of get in there, understand the numbers, understand what the game plan is, and then have a conversation and strategically try to find the right type of capital for your business plan. Uh, because it's gonna be different for everyone, uh, whether it's a short-term hold, a long-term hold, a value add deal, and a cash flow deal, an appreciation play, right? They they all can have different debt, uh, rather short-term, long-term floating fixed, right? Um, that's gonna work better for you in situations, uh, depending on what your business plan is. So getting the numbers, understanding what the business plan is. From there, once we figure that out and we're we're ready to hit the market, so to speak, we will put together a marketing package showing what that business plan is, showing what the numbers are, uh, doing location, demographics, sales comps, rent comps, full analysis kind of from top to bottom and putting a package together. And then we go out and we exhaust our network, right? So we have at CBRE, we're a direct lender for Freddie and Fanny. Um, we have debt fund, life company, banks, credit unions, REITs, you know, you name it, relationships. And so the good thing about CB is we as a as a national platform, we have a database where we see winning deals and we see quotes in real time that come through. So if I were to win a deal now and I enter it into the system, it blast out to every producer across the nation, right? And we have that that wealth and knowledge we can all share. And CBRE is great about creating that platform. So we know about, I'm not gonna say every lender, but we know a lot of lenders out there. Um, and we exhaust those lending relationships and we try to bring back the best quotes possible for your business plan. Um, and from there, it it we're kind of, you know, we're in the customer service business. We're we're helping you um reach a goal, and that's to acquire property to operate it successfully. So our job just doesn't stop there. We help facilitate the closings, we facilitate third parties, surveys, you know, corresponding with legal. We kind of do it all throughout the process. And then even post-closing, we're there to help you. I mean, it's a lot of what I'm doing right now is post-closing stuff. And what I mean by that is that there's insurance problems that arise, or if there's draw issues or the lender is not being as responsive as possible, or if it's servicing issues to where you know you have a rate cap expiring and you want to negotiate things like that, like we're involved still in that process. And I think lenders prefer us to be involved, prefer us to be the spokesperson for that sponsor. Um, because like your relationship with the lender may be new, but we CBRE has that existing relationship. We do a lot of business with these lenders, and so they prefer to kind of keep a front man involved to help facilitate the these conversations. So we're in it from day one on. Underwriting until, you know, in some cases you're completely out of the loan three, four, five years later. So we're we're stay involved in the deal.

SPEAKER_00 22:09

Absolutely. And I would say, would you is it fair to say that um, you know, as an operator, kind of having you guys on their team really sort of gives like a competitive edge, I would say, to saying, hey, listen, we're you know, we're working with someone that you know vets out teams, they're they're not going to just bring a deal that's a piece of junk, you know, to the network. So it's so it does give kind of that competitive edge that someone would need to then uh give confidence to to lenders in.

SPEAKER_01 22:34

Yes, sir, absolutely. Yeah, no, that that's a great point. And you know, we've had some lenders that look, you gotta understand like me to my competitors and and other people that are you know outside of the market trying to come into the market as competitors. We all bate we all for the most part, I would say have similar lender list. Every now and then there's gonna be a lender that I may know that someone else may not. But just like you do with individuals or sponsors that you're acquiring for properties from, just as you do with sales brokers that you're buying deals from, establishing those relationships, we're doing the same thing with lenders, right? It's a relationship business on all fronts. And so if we're bringing a client or a deal that you know may not go well, you know, the the lender may, you know, not give us another look or say, look, I'm gonna be cautious on this next one. And if we have a good, you know, good reputation, uh, you know, like C V does and handle high quality deals, high quality sponsors, and they know that what we're bringing them is a real deal with a real sponsor, you know, they're gonna focus more on that than seeing a random one-off deal from someone that they they may not know. Yeah. And, you know, so it just like again, it's a relationship business. It is for us just as it is for you.

SPEAKER_00 24:01

Absolutely. And so, you know, that kind of begs the question then, like what like what can you know, what can an operator do to sort of make it easier on you, right? So to make it even easier to have clean underwriting, but what are some of the other things that it's like, okay, you know, to make to where you're saying, okay, absolutely, I got to present this guy to, you know, he's have a great his team has a good package, everything's clean, everything's in, you know, we can uh represent this this team and this deal fairly easily.

SPEAKER_01 24:27

Yeah, I think I think on our side, the the number one part is exactly what you said sound underwriting. Um making sure you understand the deal. Um, you know, because there's gonna be questions, you're you should know the deal better than we do to start, right? You're acquiring this asset, you're touring this asset, uh, you're underwriting it. You should be able to help us out, answer some questions on the front end. Underwriting should be sound, your assumption should be sound. Um, we can talk through and walk through all that information. So understanding that piece of it is is key number one. And you know, it's it's something that that we run into often, is where sponsors think that the best approach is to let CV look at it, let a competitor two look at it, let a competitor three look at it, and have all these guys go out and work the market. And it is not, it is just not beneficial to the deal, and it's not beneficial to you. Because I guarantee you, and it happens all the time when sponsors try to do this, lender one will call me and say, Look, I saw the deal from you, but I just saw it from another person. What's going on? Right. And it starts to muddy the wather a little bit, right? It it um it it reduces, you know, the sponsorships, uh, the sponsors' chances of of getting a good deal from that lender. Um, because they don't they may not think it's a real deal if this guy's out here blasting them, has three different or two different mortgage brokers out there blasting the deal. Um, so it helps us. We like to work on an exclusive basis. Um, I understand some lens, some some sponsors don't like to do that, but I truly and honestly feel that is the best way to get the best results. Um and and keep in mind, you know, we ran into it on a deal recently um with Freddie, particularly. Like, if they see deals from from two different mortgage brokers, they won't quote the deal. They're gonna email you back and they'll say, Look, whose deal is this? I need a letter of exclusivity. Whoever gives that to me, I will quote it, but I'm not quoting it for both of you, and I'm not quoting it at all until you guys figure it out. So just you know, I would say that's another piece of it. Like go with the with a person you know and trust. It's not me. Great, use someone you are, but you know, focus on letting them run the process for you, trust them to do that, and and give them, you know, give them the business and the chance to do that. And if things don't work out, you can always shift gears later. But um, I would say that's another piece of it, and that's a piece that we run into too quite a bit. Um, and it's typically with kind of you know, first-time, second-time sponsors that are kind of new to the business. Um, but establish those relationships. And if you want to switch uh gears on the next deal, fine, but let that let that broker run their process.

SPEAKER_00 27:23

Yeah, yeah. I kind of wonder where that where that comes from too, because I I um, you know, I can't I can't help but think it maybe comes from sort of the single family side, you know, that that that approach of having you know shopping certain things around and think and thinking that in that arena it it makes sense, but in this space it just does not, and it doesn't serve either party well. Um, but uh yeah, I don't I don't know. It's just I wonder if that's kind of where it where it came from. Who who knows? But um you know, um, so you you mentioned um a couple of times, you mentioned the platform at CBRE. And that's one thing that a lot of people may not realize, but you all have a great sort of techno uh technological sort of backing to what you do as well to give you that up-to-the-minute information. Um, and is that kind of is something that CBRE focuses on quite a bit to kind of give you and your team kind of like, okay, we we can see deals as they come in, we have access to our network um through our platform. Is that is that something that you were kind of tying uh uh uh uh that you were speaking on there?

SPEAKER_01 28:19

Yeah, absolutely. So CB has been done a done a great job at at investing in technology and investing in collaboration and investing in networking, not not just externally, but internally within within CB, because so we have we have offices in every major market in the nation. We have debt guys, investment sales guys in all those markets. Most of them know each other. Um, we have you know internal CB conferences that that we go to where we focus on this type of type of stuff and focus on how to grow business internally and collaborate with our investment sales teams as well. Yeah, I mean, but you know, I kind of hit at it earlier, like it's about sharing information and it's about gathering information that someone else, you know, whether it's a lender or terms or or whatever, that I may not know that a guy in you know the Carolinas is doing and it's with a bank that can then lend nationally, but they're located in that market and may have never heard of them if it wasn't for the platform and and those real time quotes. Because I mean, it and it is real time from the moment it hits internet. I mean, it blasts uh every email. Um, and so we get these quotes real time every single day so we can see which lenders are active in the market, who's quoting the best terms, what leverage, what type of I.O. what type of rates, what type of deals are looking for. And um, so we yeah, CB's done a great job creating that platform internally.

SPEAKER_00 29:44

No, that's that that's outstanding. Yeah, because I because I know I I'd heard quite a bit about um that as well, like you mentioned from some of the uh the folks, uh other other operators that I've um that are in my network and that I work alongside. And so um, so yeah, I just think that um that that's a powerful tool. And it kind of really speaks again to the benefit of hey, having that exclusive relationship because really all the data is at your fingertips anyway. And so it's yeah, it just makes a lot of sense. Um, there's something else that that's um I wanted to kind of to touch on that you mentioned earlier, right? And this is around sort of uh uh CB's mission to um provide kind of the ideal uh solution from a debt and structure finance perspective, depending on the business plan. So if I'm coming to you and say, hey, Derek, look, you know, I have a deal, you you know, you've underwritten the deal, um, but it's a long-term business plan. Kind of what's what's your approach to then finding the right structure for that, say the seven to 10 year business plan versus one that's say three or five to uh three to five years?

SPEAKER_01 30:40

Yeah, so longer-term business plans, I think, are better suited for for fixed-rate deals, right? It's one that you can kind of close, you put to bed, you cash flow it, like you said, over the next seven to 10 years. And you know, the best fit for that could be agency, it could be life company, depending on the leverage. Um, but yeah, typically longer term fixed rate deals try to max or terms, try to maximize your I.O. so you can cash flow the deal, your your interest-only periods. Um, and then you know, agency loans for the most part are are structured with the feasance or yield maintenance. So you gotta, if you're going to fix the rate and you're gonna plan to be in the uh into the into the deal long term, then you're not gonna have those stringent prepayment penalties. But right, what you don't want to do is, and I'm kind of seeing it with the way that the market is fluctuating right now, and guys start to get nervous, and guys start to say, look, I want to get out of my floating rate deal as soon as possible, and I want to put it into a fixed rate deal. Um, and they're locking 10 year, seven or 10-year deals at 6%. And with the aspirations of not holding it and getting out of the deal in the next three years, I mean, you're gonna be in a tough position. And something that I saw in 2019 and when when rates were kind of running up and guys were locking deals at five and a quarter, and then right, no one could foresee COVID and everything that would transpire after that, but they're locked into a 10 or 12 year deal at five and a quarter, and then rates come down to 275.3, and they're like, What am I doing? I I can't get out of this without paying a crazy expensive prepayment penalty. So if you just gotta, you got what I was alluding to earlier is you gotta find strategies and you gotta find debt that's gonna fit towards your business plan. Um, and so on the long term, again, that's probably agency. HUD is also a great uh debt tool if you're acquiring newer assets. I don't think it works well on assets that are 70s, 80s, you know, maybe even 90s. I think it works well on deals that are kind of 10 years and newer. Um, because HUD looks at it on a 35-year schedule and they're gonna base your replacement reserves on that 35-year schedule. And if you're trying to put a 70s or 80s deal into a HUD loan, instead of paying the traditional 250, 300 in replacement reserves, you can pay upwards of a thousand, uh, a thousand a unit replacement reserves because they're looking at it on that longer-term schedule and what's expected to be needed uh as far as deferred maintenance and capital improvements over those next 35 years. So I think people need to understand that. We had a, you know, there was a period earlier this year when rates were running up. We had a lot of clients inquiring about HUD loans on 70s products, and it just we had to advise them like in a lot of cases, unless your property is super clean, it just does not make sense. Um and rates are slightly better, but prepayments are typically stepped down 10, 9, 8, 7, 6, all the way down to one. So again, if your plan is to get out in three years and you're trying to save the deal because it can underwrite more aggressively on a HUD loan and get you more proceeds, you're you're you're you know fixing a short-term problem, but creating a longer-term problem with a high prepay penalty in the next three to four years. So you just gotta you gotta understand the different pros and cons of all the debt instruments out there. And then if you're on the flip side, if you're looking, you know, if you're two, three, four-year old, um, floating rate tends to work better, even at the elevated levels they're at right now, but buying a cap. Or um, you know, Freddie and Fanny have come out with uh with a five-year and with three years of yield maintenance with one percent after that. Now you're gonna pay a little bit more rate, but it does give you the flexibility to get out after three years. So, right, and that's the type of stuff we can help you with, understanding what your business plan is, putting the right debt on the property. Uh, so if you want to get out sooner rather than later, we can structure the debt around that um to be able to achieve that goal.

SPEAKER_00 35:11

No, that was a uh sort of an incredible uh breakdown right there. My my head was kind of just nodding uh north and south the whole time because it gets sort of a quick little masterclass on that. And I'm gonna um you know, so I I just had a conversation uh um last weekend at my meetup about HUD property, the HUD products. And um, and I've always wondered, you know, HUD has some really, really great uh uh loan products for for the scenario that you mentioned, right? If you have a newer asset and especially if you intend to hold it long term, uh why is it that there aren't many people who actually pursue HUD, even even though some even if they fall into that category, right? They want a seven-year hold. Why is it that people aren't kind of pursuing that option? Because it really is an incredible um option. Is it just a lack of awareness or is there something else that kind of I'm missing that, you know, what's going on there?

SPEAKER_01 36:03

Yeah, I look, I I think it's a couple things. I do think it's a lack of awareness. That there are, you know, and CBA has an incredible, you know, a few incredible HUD originators um across the country that provide a wealth of knowledge. It's a very specific you know, type of debt instrument. So finding someone that truly understands the ins and outs of it um is key. So, you know, educating yourself as much as possible. But I think people are trying to fit HUD and put HUD on deals that HUD, frankly, doesn't need to be put on. Um, and it's going back like older assets just don't work well. Um, and people are trying to do it now because they're reaching, um, because you can underwrite on a 35-year am, you can underwrite down to 1.1, 1.178 or 1.176. And so you can get more proceeds, right? You can get more loan amount on the refi, you can get more proceeds on the acquisition. Um, but a lot of that could be offset by the amount of replacement reserves and upfront reserves you have to put on the property um on an ongoing basis. There's reporting requirements that you need to be aware of. Um, the prepayment penalties you need to be aware of. Um, so I just don't I think people are here, hey, instead of 10 million with a standard agency, I can get you 13 million with the HUD, but not really understanding what the negatives of that and what you're getting yourself into. Again, it works great for there's a development product with HUD, there's a refinance or acquisition product with HUD. Great, great products for the right type of deal. And typically I feel like they work better with newer assets.

SPEAKER_00 37:57

Yeah, yeah, that's right. And certainly, certainly not kind of the right product for the what I would call it is maybe a bit of the standard approach for um, especially for syndication deals, right? Kind of the shorter term, hey, three, five-year-old kind of thing. It's like, yeah, that's probably not the not the right product for it. Um, in in those scenarios.

SPEAKER_01 38:12

Um, yeah, and then another thing is, right, they're just long, like it's not gonna fit on every deal on an acquisition rise. They're long term, like it's a long process to close.

SPEAKER_00 38:21

Yeah, like six months sometimes, yeah, six, eight months.

SPEAKER_01 38:23

I mean, I think, yeah, I mean, could take 12 months. I've seen it take 12 months, right? Yeah, so um, so right right product for right deal, but you got to understand, you know, the positives and negatives of it.

SPEAKER_00 38:36

Yeah, absolutely, absolutely. So, so let me ask you, okay, um, and are you also helped kind of with the equity side um in your current role or or kind of not not not so much or yeah, we we do do equity more, I would say institutional type equity on constructions or you know, large acquisitions where there's you know 15, 20 million dollar type checks.

SPEAKER_01 39:01

We, you know, and just to be honest, we don't do a ton of like the LP equity raises for syndication models. It's just not what our platform is set up for. Um, but we do do some of the JV or large, larger type institutional and and pref equity as well. We we we do quite a bit of that.

SPEAKER_00 39:23

Right. Okay, and and that's kind of kind of what I was wanting to ask you as well, is um, you know, for say for the pref equity scenario, um, what do you typically see as kind of like the minimum where your pref equity connections would want to come in at? Because I know they typically want to be uh, I mean, in some instances, they want to be a uh the majority of the equity um to come in. So what's some of the common requirements that you're seeing?

SPEAKER_01 39:47

Yeah, so a lot of the pref we're doing is behind Freddie. Uh pref doesn't work very well behind Fannie. Um uh they they can do it, but it's it's tougher to do. So when you're seeing Fred, when you're seeing pref behind agency, most of the time it's prep behind a Freddy one. And Freddie has uh has a list of preferred pref groups they like uh to partner with because they want to know if something goes south and redemption rights kick in and this pref partner needs to take over, they have the experience, the operating experience to be able to run these assets, right? So most of the time when you see these pref groups, they also are sponsors themselves that are lending out pref money. Um, and they own 20, 30,000, 40,000 units themselves. And you know, they're coming in behind a Freddie loan. Um, so they want to see someone, someone very sophisticated and very experienced coming in. Um, but you know, some things you need to pay attention to on the pref side is that again, it's not a fit for every deal and it's not a fit for every sponsor. There are certain things within these prep documents that you really need to pay attention to. And I mentioned redemption rights, you know, their ability to kick you out of the deal, so to speak, if you're not performing, their ability, if you if your management company is not performing, to remove management and put a management company in there of their choice. Um, if you're not hitting certain metrics, forcing a sell. We're seeing that on some assets here um recently here in town, where the sponsor is not performing, the pref group is stepping up and they're basically saying, look, you you need to sell this asset and per the pref docs, we can force that sell uh because you're not hitting certain metrics. So a lot of people think pref is is a good quick solution to bridging equity and debt to the you know to the refinance or to the to the acquisition price and filling that in the capital stack. But I would advise you to understand what you're getting into. It is it is a great, great instrument. You just gotta know and understand the docs and how to read the docs and what the rights are for the pref group for yourself. So you're not put in a position to where you're getting booted out from the GP side and the pref groups coming in and taking over. Yeah, and from what I'm saying, there's and there's lots of great pref groups out there and very, very smart guys, and they work with great sponsors. Um much like anything, educate yourself on it.

SPEAKER_00 42:21

Yeah, absolutely. You know, I um uh it's realistically speaking, it's in some ways it's sort of antithetical to the reasons why uh many of us uh kind of get into the business, right? It's a it's to have uh um a certain level of control over the deal. And so I think you're right. It's like having that understanding, hey, you if if you find a prep partner, um then it and certainly those those that language, that verbiage is likely to be in the documents unless there's some long-running established uh relationship with them, uh, then you have to understand that a potential lack of control is kind of what uh what really kind of you know is uh kind of hangs in the balances. If they if things go uh south a little bit, then they might they might tap you on the shoulder and say, hey, listen, here's what's gonna happen. And so that's just kind of the the reality of of that relationship.

SPEAKER_01 43:11

So absolutely. Yeah, I mean, look, they're they're taking you know the top piece. Um they want their returns first. So it's well, that's preferred return. And so they're gonna do just like you're doing with your money and your investors' money, they're trying to protect their money the best they can, and so they have these rights in there to protect their interest. Um, and so again, great tool, just got to understand it.

SPEAKER_00 43:37

Absolutely, absolutely. Well, um, look, Derek, you know, so this has kind of been uh again, just been a really, really um good conversation um here. And I want to get kind of your thoughts. I know that it's probably not the best thing to bring up at the as we get close to wrapping, but um your thoughts on on kind of where the market's headed, right? Where we're at right now, um, in terms of uh from the capital markets perspective and kind of where we're heading into. Say as we close out the year here.

SPEAKER_01 44:04

Yeah, you know, unfortunately, I don't think there's much light at the end of the tunnel for this year. I think most of that's going to come at some point next year, next summer, second, third quarter. I personally feel that the market, the capital markets that is, is continuing to deteriorate. Um, and is not going to get, I think it's going to get probably a little worse before it gets better. And, you know, you're seeing lenders, a lot of lenders exit the market on the banking and credit union side that were extremely active the past two years and frankly just don't have the capital to even lend. They're not getting paid off from all the construction loans they did over the past couple of years. They don't have deposits. And so they don't have the capital to put out there because they're not getting paid off, right? If you're a construction or if you're a developer and you're, you know, you're you borrowed construction money at 4%. Do you want to refinance into an 8% loan? No, you're going to try to work and extend it, right? And so these lenders aren't getting paid off. The ones that are active are requiring a lot of deposits. So they'll say, look, we'll give you a 65% loan return. We want you to give us 20, 25, 30% deposits to hold at our bank. And so we're seeing a lot of because of that, we're just seeing a lot of their those lenders kind of price themselves out or remove themselves from the market. Um, and so there's been several banks that are just not even currently quoting. Um obviously, the agencies are still providing a ton of liquidity, they're doing their job, they're they're providing debt, and debt is available out there. Is it going to work at the rates um that are achievable right now? Um, with treasuries where they are. I mean, you're looking at high fives to low six percents, depending on on the term and the and the product. And if you're buying a deal at a five and a five and a half cap, your negative leverage, and it's how long can you stomach that negative leverage? Um, so I I think we're still just seeing further deterioration in that in that market. Rates are still moving, there's still a lot of uncertainty as to what's going to happen. And um so yeah, I mean, it's been it's been a very interesting year. And you know, on the sales side, I mean, you're just still sellers aren't willing to adjust at the moment. And I don't you can't blame them, right? They're they're holding on, um, and and and hoping that rates are going to come down and that potentially save the deal, or you know, trying to just you know give themselves more time. Um, but in doing so, there's just there's not a whole lot of transactions occurring. There's a lot of deals being repriced and reset. Um, and so I think we'll continue to see that shift over the next 12 months um until we start to see rates kind of move down a little bit.

SPEAKER_00 47:14

Yeah, yeah, kind of that re-repricing and renormalization. And right, I mean, so yeah, yeah.

SPEAKER_01 47:22

I mean, look, historically speaking, right? If you look back at historical rates, like we're a little high now, but we're like everyone was spoiled back in the past couple years when you could fix rates at 275 to 350. I I don't know if we get back to that anytime soon. Yeah, I mean, it could be year, it could be years before you see anything like that. Um and and kind of normal treasury rates on the 10 years, kind of in that four percent range, which if you figure agency spreads 150 to 175, like I mean, five and a quarter is not all that out of the norm. Um, so I think if if sponsors are out there waiting and banking on rates to go back down to four percent to help them get them out of the, I don't I think that's wishful thinking at this point.

SPEAKER_00 48:16

Yeah, yeah, I would agree with that. And and uh, you know, so for the for the ones that for the sellers that are sort of um um holding on, right, and to where that that that bid ask spread is still fairly wide. Do you think that uh is that a mixture of sellers that need to sell and the sellers that are still healthy? Like what's you know, I'm kind of I've I'm kind of wondering about that for the ones that that do need to sell. Are they also holding out? Are you finding?

SPEAKER_01 48:39

I yeah, look, I I think transactions had uh that have occurred have occurred uh for a variety of reasons, whether it was part of a fund that's maturing and they just need to exit. It's they you know, they've they've held it for five to seven years and their funds maturing and they just they need to exit the deal for one reason or another and pay back their investors. Um you've seen some some deals transact uh that were on floating rate agency debt, and these guys are getting hammered um by interest rate cap escros. Um, that has been a common one where they're just the escrow's are so significant and to the point where the deal is not even cash flowing anymore because it's all going in this escrow account. And so uh, you know, their position is well, let's just sell it and move on. Um and then you have the groups that acquired a bunch of deals on three-year bridge notes back in 2021 and 2022 um that that may be struggling. I and look, um anything can happen in the market, market fundamentals can come back. Um, but I think I don't think they're there yet until those loans start to mature. And these lenders have, you know, rather debt yield or debt coverage coming at test tied to extensions. And so we'll see at that point, and I think you'll really start to see it next year if you know if these groups are not able to extend or the lender is not willing to extend, and they're just at a at a point where they're just forced to sell. Or they just don't see look, there's no path forward, right? Any income they have has been eaten up by expenses, NOI hasn't moved significantly. Um, and like right, there's just no path forward to be able to get out of the loan on a refi. And instead of continuing to pump money into the deal, all you know, whether that's an interest reserve or extending an interest rate cap or paying extension fees, they're gonna say, look, let's just let's move on and uh sell it and and and you know move on to the next one.

SPEAKER_00 50:47

Yeah, I mean, you know, and honestly, I I read an article a couple weeks ago where it um was essentially around uh you know lenders who if if they have uh quite quite a bit of of paper that they're holding, where they're in these kinds of situations where the direction in some instances is hey, work work something out because and I said because it it's it's sort of right, they're both both parties are in a bit of a bind, right? As a lender, you know, you you're um your business is still um can be in a bind if your borrower is not able to then cover right kind of their their uh cover their note and things like that. So it's so it is interesting to kind of see, I wonder how things will balance out. You know, this is a bit of a unique period where it just things happen so quickly and that um a lot of the strategies that might have made sense once upon a time really are making sense right now. And and so it's kind of kind of curious to see how things will play out, you know, as we go.

SPEAKER_01 51:40

I have to and look, I mean, that's a great point. I don't think any of these lenders, for the most part, are in the position uh that they want to own these assets, they want to take back these assets. They they they they are your partners and your biggest partner in the deal, right? And they want to see you succeed and they want to get paid back. So and it's it's a it's a thing where as a sponsor, you need to view it as a relationship and as a partner and and work with them and they will work with you. Um, but they want to see you putting the property first, doing everything you can to get to position to where you are cash flowing or can't exit their loan. And look, they'll they'll work with you. We've already started to see it rather see it whether it's negotiating extensions, whether it's negotiating um or modifying terms to the point of you know continuing to waive replacement reserves during CapEx, or if it's hey, instead of requiring you to buy a 12-month cap, let's just put up an interest reserve because cap costs are really expensive right now, and we don't want that money just going to waste on on a really expensive cap when they're projected to go down over the next six months. Let's let's buy a three-year cap or six-month cap, and then let's reanalyze analyze the deal then and see what type of cap is best suited for this deal, instead of just coming out of the gate and saying, well, look, a loan doc say this, you need to buy a 12-month cap. So we've seen lenders work with sponsors and specifically work with sponsors that are are really being proactive and reaching out to their lenders. And I've done a lot of this over the past couple of weeks, setting up calls, discussing the lenders, being very transparent about how the deal is performing and trying to come up with solutions that best suits the property.

SPEAKER_00 53:36

Yeah, yeah, absolutely. Definitely a time to sort of uh, you know, for people who are in a bit of a situation that maybe uh say less than ideal, you know, for the operators out there, definitely a time to sort of uh, you know, try and work a solution up and um and kind of hold on tight and we'll see how things go. And uh, but look, uh Derek, just a wealth of knowledge, you know, man. I I really appreciate this uh very, very deep conversation. And I could keep on going for another hour or so. And uh maybe we'll have a part two where when we're on the other side of some of this uh stuff that we're seeing here. So, but look, always good to see you, man. And like I said, I really appreciate uh appreciate your time. So for the listeners who um are are you know they're hearing this and want to reach out and have a conversation um with you or even uh kind of potentially be a client, how can they do so?

SPEAKER_01 54:18

Yeah, you can look me up on LinkedIn, Derek Fasulo. Uh there's only one of me out there that I know of. Um so you you can look me up that way. My email address is Derek.fasulo at cbre.com. You can reach out to me via email as well.

SPEAKER_00 54:35

All right, awesome. I'll put that in the show notes. Once again, thank you so much um for adding value to the show, to the listeners, to myself. I really appreciate your time, Derek. All right, thank you, Brandon. As always, thank you so much for tuning in to the show today, brought to you by Bridge Prosper. If you enjoyed today's episode and you'd like to learn more about commercial real estate investing, please like, subscribe, and share. And we'll see you again next week. I'm Brandon Jenkins, and this is the Capital Snake, where we help you learn apply in the