All Forum Posts by: Brian Burke

If you mean "how often do LPs try to sell their positions," I can count on one hand all the ones I can remember, and that's over more than two decades, $400 million equity, and well over 2,000 investors.  

If you are thinking of creating a secondary market of some sort, you'd be the third person in the last 5 years that I've talked to and answered this exact question.  Haven't seen the other two come to fruition...or if they have, I haven't found out.

Demand might be really high right now, but it would likely be dominated by people trying to find someone to pay the full contributed capital for worthless positions in failed deals. 

@Ronald Rohde I’m occasionally asked to speak at conferences, webinars, and podcasts on the subject of evaluating syndication investments. Suffice it to say that this one gave me reasons to add additional material to these conversations.

@Scott Trench this thread started a year ago.  Parts of it didn’t age well, and is somewhat indicative of how the industry became into the position in which we find it today.

Quote from @Jay Hinrichs:

Now given the situation of NO equity right now to negative equity it seems throwing in more cash would be digging a deeper hole and how is it realistic that these props will go up not only what they are under water today but the added capital JUST to get your capital back forget about any return.

Just curious seems like simple math based on your opinions of current values in the B C class MF in the areas I have to assume these are.. I know its all assumptions ..

 

My opinion of current values could be wrong--hopefully no one makes their decision related to this capital call based on my opinion.  If anything, hopefully my opinions here can be taken as food for thought, and lead to questions to ask of the sponsor, to obtain facts from which a decision can be reached. 

Questions like yours--will the value come back to the extent that everyone gets their capital back.  My opinion is the answer is yes--but when?  Will that be in one year?  Five years?  Ten years?  And does the amount of capital being called get you to that point? 

Quote from @Guy Idan:

@Brian Burke - Dropping a question on you as you are well versed in this world - It seems that Ashcroft has an LTV of about 80% at the moment, or 78% if you take out the $14m loan ashcroft themselves gave. For my personal properties, I like to have 65-60% LTV, so 78-80% LTV during a time when the properties were purchased of record low interest rates, and with fluctuating interest rate, seems extremely irresponsible and almost foolish. 

Do most syndicators use these LTV's and is it common or did Ashcroft make a big mistake on that one?

Appreciate your feedback!


 

I won’t opine on whether Ashcroft made a big mistake—their investors will ultimately be judge, jury, and executioner based on the final outcome.  Even if I did comment, my Monday morning quarterbacking should be dismissed as inadmissible because, for lack of a better definition, I’m a competitor of theirs.

But I can speak to my opinion as an operator, in a general sense, not specific to Ashcroft because I’m not familiar with the financing of these assets.

Borrowing with short maturities dramatically increases risk, always. Ten years into a bull run amplifies that risk. Doing so with a high LTV amplifies that risk even further.

Investing in a syndicate comes with risk and the idea is that investors should seek a risk adjusted return.  By that, I mean that the returns you expected should have been significantly higher than the returns from a similar investment with a more conservative financing structure. Was it?

The problem I see is passive investors frequently don’t invest on a risk-adjusted basis.  Instead, they invest in the deal that projects the highest return.  And how do you get there?  High leverage.  Multiple share classes.  Preferred equity.  Mezzanine debt.

This pushes groups to finance this way because “that’s what sells.”  It’s no accident that many of the groups you see today running into serious trouble are groups that acquired a lot of assets near the market peak using tools such as this that juiced projected investor return. 

And to somewhat answer your question, a LOT of buyers were financing this way. Before I stopped buying in 2021, after being outbid by millions of dollars on a regular basis, I started asking brokers "how many of the other buyers are using bridge debt?" Their answer: "All of them." (I was underwriting to 60-65% LTV with one share class and no subordinate mezz/pref.) So I started selling off my portfolio. Among the groups bidding on my properties, how many were using bridge debt? Most of them.

On the other hand, groups that used more conservative finance structures didn’t grow as fast because, in part, the investors weren’t fueling them to the same extent.  Also in part, because they couldn’t underwrite to as high a price as the higher-risk groups.  And in part because groups that finance conservatively tend to buy conservatively, which doesn’t result in much when a market is topping out.

And just a comment about your statement that the Ashcroft properties have an "LTV of 80% at the moment." Then you said "80% LTV…when the properties were purchased." Depending on when these properties were purchased, along with a handful of other factors, these two statements could be mutually exclusive. Multifamily values have fallen somewhere between 20 percent and 40 percent since 2022, meaning that the LTV today could be greater than 80%, and very easily could exceed 100%.

I’ll begin by saying I have no objective data to support my opinion, but I do have some subjective data, so take it for what it’s worth.

I think the trouble is pretty widespread, particularly among newer syndicators (defining that by less than 10 years in the business, so never having survived an adverse cycle).  Larger, experienced shops likely less so, but with these groups even if they have some problem deals it’ll amount to a headwind to overall performance of a very large portfolio rather than a disaster that brings down the firm.

The 2020 to 2023 period saw several very active “newer” groups who were rapidly scaling and in some cases dominating acquisitions.  I stopped buying in 2021 but when I was still actively submitting offers around 2019-2021 we were getting blown out by a wide margin.  I asked brokers back then, “how many of these bidders are using high-leverage bridge debt?”  The reply, “All of them.” 

That response is one of the catalysts to our decision to start selling.  When we were selling, we asked bidders what type of financing they were using, and the answer among the highest set of bidders was nearly always bridge debt.  Fast forward 2-3 years, about half of the properties I sold have come back around with the new owners trying to get out of them, some to no avail.

Having said that, even though brokers looked at me like I had two heads when I told them we were underwriting an agency execution, someone besides myself must have been using agency debt because agency volume hit caps every year during that period.  Whether that came from earlier deals refinancing out of bridge to roll to long-term debt or if it was for acquisitions, I don’t have data to answer.

To your question about competing against high IRRs when raising capital—you are right.  I built our portfolio slowly, in part because it’s difficult to buy with discipline in an undisciplined market, but also in part because investors didn’t choose to invest with us because our projected returns weren’t as attractive as other groups.  So despite a core team with 100,000 units of experience going back multiple decades, I watched newly-minted groups out-scale us.  But I couldn’t be happier—I’m not in this business to scale, I’m here to last. We’ll see how this all plays out.

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.