Benefits of private capital markets and "negative leverage"

[Patrick Zepeda]

In commercial, institutional players don't touch deals sub $20M due to the lack of scale and unfavorable financing (many banks, debt funds and lifeCos won't lend on small deals, or would offer bad terms and full recourse loans). This means that mostly private capital dominates, making it a more imperfect market. Having that said, there is room for huge profits if done right.

Think about a successful dentist that wants to buy the medical office building his practice is in. He has the money to spend, is not a sophisticated investor and will only look at an in-place or stabilized cap rate based on comps. Say this building is renting at below market rates (mark-to-market opportunity). Once the suites roll to market and you lease up with market rents, the NOI will increase and the value will too. Your exit value will drive your profits. You can do this by looking at your IRR / LIRRs in your valuation.

Nonetheless, with interest rates rising so aggressively, many of these commercial private capital deals have "negative leverage". This means that buying on an all-cash basis would yield better returns than with leverage. This obviously puts a huge strain on liquidity in the capital markets because there is less investors that would buy all-cash, and the few that would buy would require lower pricing for the deal to make sense. And this excluding the macroeconomic issues that asset classes are going through. Food for thought.

[Joe Villeneuve]

Buying all cash just just paying full price for the property and paying all the negative CF up front. Profits come after all costs are recovered. The larger the DP, the larger the cost to the REI, and the larger the number of dollars that must be recovered before any profits are made.

[Ronald Rohde]

Yes, but very few sellers are motivated to sell. They will collect income while their MOB sits at a 6.25 cap...

[Henry Clark]

@Patrick Zepeda

Looking at your background and other post.

Most BP and most Commercial deals are not above $20mm.  You’re a Commercial Financial Analyst for large deals.   The reason the players you’re mentioning don’t look at anything below $20mm is lack of scaling.  If they did $1mm profitable deals they would go broke.   They can’t scale.  

The majority of commercial in the US is mom/pop compared to $20mm size deals.  

As far as funding goes.  That is actually very easy.  Start small and Make Your Big Mistakes Early.  Start to scale.  Spread your risk.  Don’t do one large deal right off the bat.  Develop a team and portfolio of deals.  There are a million small bankers and commercial bankers who would love to loan you money with that track record.

On your other post you want to do SFH. Recommend you use your strength and background and do commercial. I can make $1mm profit on one commercial deal with less effort than doing one BRRRR. In a 2 year timeframe. You're in a great area to do commercial.

Good luck.

[Patrick Zepeda]

@Ronald Rohde Correct. Their investment is merely based on the income rather than the exit. The ones that might be looking to sell today, would mostly be investors in distress with their loan term coming up and can't refinance.

[Patrick Zepeda]

@Henry Clark

Thanks for the recommendation! Commercial is more profitable than resi or multi because of the risk. If you want to hold long-term, I'd rather lease to people in a wildly undersupplied market (~6M shortage of homes in US) which pushes rent and values up, while maintaining a lower risk.  I think I will do commercial eventually, but with OPM, not mine.

And saying "the majority of commercial in the US is mom/pop" can't be further from the truth. Think about all the office buildings in every downtown, shopping centers, industrial and distribution centers. Even residential communities. They are all owned and transacted by institutional capital. Not to mention the entire CMBS market...

[Ronald Rohde]

Quote from @Patrick Zepeda:

@Ronald Rohde Correct. Their investment is merely based on the income rather than the exit. The ones that might be looking to sell today, would mostly be investors in distress with their loan term coming up and can't refinance.

 I've never come across a STNL investor who couldn't refinance their debt. They are typically already coming in with low leverage, plenty of equity cushion. Most investors could also pay off the debt from cash if they were faced with selling at "loss"

I think its more like an investor who lost a ton ofmoney leveraged in the stock market, a business gone south, divorce, or death. Those are the motivated sellers.

[Ronald Rohde]

Quote from @Patrick Zepeda:

@Henry Clark

Thanks for the recommendation! Commercial is more profitable than resi or multi because of the risk. If you want to hold long-term, I'd rather lease to people in a wildly undersupplied market (~6M shortage of homes in US) which pushes rent and values up, while maintaining a lower risk.  I think I will do commercial eventually, but with OPM, not mine.

And saying "the majority of commercial in the US is mom/pop" can't be further from the truth. Think about all the office buildings in every downtown, shopping centers, industrial and distribution centers. Even residential communities. They are all owned and transacted by institutional capital. Not to mention the entire CMBS market...

You do your own thing. If you're in this to make money, go for scale. If you want to hedge risk, slowly build a SFR portfolio, no wrong answers. But we assumed you came here to invest in commercial..this is the CRE forum