In todays email:

• 🤑 Note Income Masterclass - see details

• 🤓 Bridge Lending History

• 🤔 What Changed?

• 😬 Packaging Loans - Securitization

• 😅 Rate and Rate Caps

• 😕 I Am A Genius Mentality

• 🙃 Summary

Note Income Masterclass - Thursday Dec 14, 2023.

The Note Income MasterClass will be held Thursday Dec 14, 2023 at 2 pm Eastern.

In the class we will discuss the following:

• Note Overview - Why notes? Discuss types of real estate notes, how it works, where to invest, etc.

• How Profit - Income sources. Discuss what are the profit centers in note investing.

• Buying Process - Steps to buying notes. Discuss the process and due diligence for buying a note and the note sale agreement.

• Team Needed - Outsourcing. Discuss who you need to get on your team to be able to properly underwrite, value, buy, service, mitigate, etc your notes.

• Critical Docs - Due diligence docs. Discuss the important docs like the note, mortgage, assignments, allonges, title policy, etc.

Click Here for the details of the masterclass. 

Bridge Lending History Lesson

What we are seeing now in the multifamily space resembles to some degree what happen in the Great Financial Crisis in 2007-2008. This time the excess exuberance is in the multifamily space instead of the single family space. Many new sponsors and operators entered the market with little to no experience and many will lose it all due to the excessive speculation.

Whether you're a sponsor or a limited partner, it is important to look back in history and see how we got into this situation and make sure that we learn some lessons and some takeaways for the future. As a limited partner investor myself, I think it is important to learn the lessons of history and continually educate myself on what are the critical questions to ask the sponsor in order to increase your probability of not only return on capital but return of capital.

So first let’s go back in history. In 2015, the majority of the multifamily sponsors/syndicators were doing agency loans. Agency loans are loans from Fannie Mae and Freddie Mac. These were fixed rate loans with 5, 7, 10 year terms and it was pretty stable. The rates back then were around 4.0% to 5.5% and you could get 75-80% leverage with maybe a year or two interest only, and that's how people bought deals. The agencies required 90% occupancy for the last 90 days and that's how you got an agency loan.

Back then you would do a shorter term bridge loan if the property did not meet the agency loan requirements or if the property was just broken, or mismanaged. It was a higher interest rate and it was a shorter term.

And then boom, COVID hits 2020, all the bridge lenders go away. The only thing you can do is agency loans and they made you put up huge reserves. So if your loan was, let's say 10 million, they were like, we'll give you the loan, but we're going to need 5-10% set aside as reserves. So not only did you get a lower leverage loan, but you had to put up a big reserve. And so that was the only lender in town. So majority of volume in 2015 to 2019 was fixed rate agency loans and in most of 2020 more of the same.

What changed?

Then the Fed took the rates down to zero by mid 2020 and the 10-year treasury went down below 1%. You then had the option of going and getting an agency loan or you could do a floating rate bridge loan.

And this is where the math all changed. Let's say a deal was $10 million. The sponsor would ask his lender to get a loan from Fannie or Freddie and the lender would say we can do a 6 million loan on this deal. So 60% leverage. Then the sponsor would ask about a bridge loan for that same 10 million purchase and they would give 8 million. So they were at 80%. Fannie and Freddie were at 60% and the bridge lender was at 80%. That was huge!

Then the sponsors would go to tour the property and put in an offer at 10 million. But now there is 20 other sponsors looking to buy the property at 10 million and then goes to the next round best and final 11 million, then 12 million, then 13 million. Okay, it's 13 million. But the agency loan is still at $6 million and would not lever up with the price. However, the bridge lender would increase the loan amount and lever up in approximately the same proportion to the increase in price.

So now the bridge lender would say “Ok your at a purchase price of $13 million and we will come up to 10.4 million (80%)”. So your equity check was the same even as your price was going up. The bridge lender was looking at pro-forma. However, on the agency side, they were saying, you're at 13 million but the loan that we can give you is still 6 million because it's based on in place cash flow. So now, every time you went up in price, you had to raise more equity and no sponsors wanted this and the agency loans volume dropped dramatically.

Now to make matters worse, the sponsors would say they need a million dollars for rehab. Okay, we'll add a million dollars on top of that says the bridge lender. So now the bridge lender is at $11.4 million. And this is what happened in 2021 and 2022 on most deals. There was so much money chasing these deals it was crazy. I spoke to one CRE lender (~1 billion in volume per year) which said during this time period 80% of CRE loans were bridge and of those almost 95% were floating rate and this was going on across all the major markets.

Packaging and Selling

Most of these loans were then being securitized into what is called CRE CLOs or collateralized loan obligations. The lenders would do a billion dollars worth of these loans and then they would securitize it and institutions would buy it because they could get 3-4% rates collateralized on multifamily property or could buy a treasury at 1%…which one would you take?

And so it just kept going on and on. So, from January 2021, all the way up until probably summer of 2022 (about 18 months) the bridge lending environment pushed values up significantly. So very similar to 2007, 2008 in the residential space.

Much of the money came from private equity that had capital from high net worth investors but in addition many of the larger banks were providing lines of credit to these bridge funds as well. So the banks were doing a loan against the loans and there became too many lenders in the space and then a race to the bottom. Each lender would give more money and at lower rates. A classic case of too much money chasing two few deals which ultimately drove the prices sky high.

Rates and rate caps

Now let’s discuss rates and rate caps. In 2021, everybody was comfortable taking a floating rate because the Fed basically said, we're not raising rates in 2021. The Feds were trying to revitalize the economy pouring a bunch of money on it and were not going to raise rates. So in 2021, you could buy 3 year interest rate cap for pretty much nothing. Let's call it on a $10 million deal. You'd chip in $20,000 and you could cap SOFR + 1%. And sponsors thought they were throwing money away. Many sponsors felt like it was a waste of money to buy a rate cap. But in 2022 January, those rate caps started getting more expensive because Feds were hinting at rate increases in 2022. So those rate caps got more expensive. And so most sponsors went from three year caps to two year caps to save money but today those caps are nearing expiration. Now if you buy three year cap it is closer to 9% of the loan amount. So on $10 million it'd be $900,000.  

So people who have maturities or rate cap expirations, they're selling now. And you can now find deals that are at the loan amount and even underneath the loan amount (i.e. ~20% discounts to prior values). Many sponsors have no equity and are in a tough spot.

I am a genius mentality.

Some sponsors in 2019-2021 had liquidity events (sold the property) and made alot of money and many started thinking if they could just do it on a bigger scale. And so a lot of the sponsors who bought a deal in 2019 and sold in 2021 when the cap rates were compressed made a bunch of money, but you only did a $10 million deal, so you didn't make a ton of money. So then they went from the $10 million deal to a 50 million deal and then thinking next deal will be 100 million and I will get rich. It just kept going.

In addition, many syndicators were making money not only on the promote that they made when selling the deal, but also on the acquisition fees and the acquisition fees were based on the purchase price. So why not do a bigger deal? It takes the same amount of work, and a lot of these deals could run better with the management company, etc. But the problem is that these deals, when they're upside down and they are large, a lot of these owners just cannot feed them for long. So if you have a 5 million loan and you can't make the debt service, you can sort of struggle along and figure it out and raise a small amount of money. However, if you have a 50 million loan and it's upside down, it is very hard to service the debt and continue to feed the beast.

Summary

At this point, the jury is not out and we will see what type of stress these bridge loans will put on the market in the next 12-18 months or so. It seems as if many of the lenders are willing to work with the borrowers (sponsors) but how long can you kick the can down the road. The lenders will not want the property back in 2024 with so many coming on the market.

Right now cap rates are lower than the interest rates (negative leverage) and this makes it difficult to buy a multifamily and have it cash flow. Also many sellers are not willing to sell because they would be taking large losses and therefore not many deals are getting done today.

Click Here for the details of the Note Income Masterclass. 

We would love to get your feedback and your thoughts! Let us know which topics are of interest or where you need more clarity. Just respond to this email directly 😌 or email [email protected].