SIH Capital Group – Investing for the Upside of Downturns

with Denis Shapiro

Investing for the Upside of Downturns with Denis Shapiro

by Denis Shapiro | Patrick Grimes

Transcript

Denis Shapiro:

Hey guys, welcome to SIH Capital Group monthly webinar series for the December edition. I have Patrick on. I’ve done a few panels with Patrick, I’ve gotten to know him about a year ago. We were introduced by a mutual contact and we stayed in touch here and there. I wanted to get Patrick on to get his take on what’s going on. There’s a lot of pessimism in the market today and I think Patrick has a interesting interpretation of what’s going on in the market and how you could keep a cool head about yourself and which areas that he’s looking at in investing. I’ll pass it on to Patrick. Well I let him introduce himself and then we’ll get into Q&A about a really free flowing conversation of what’s going on today.

Patrick Grimes:

All right, sounds good. And I actually also have some slides that do a combination of both of the introductory stuff, so is it okay if I float through some slides or is this meant to be purely a-

Denis Shapiro:

No, go ahead. I’m going to make a co-host right now. So you got… It’s all yours.

Patrick Grimes:

You’re the guy that wrote the book on the alternative investing almanac, and I was going to wave that around, but I’m actually on the road visiting family right now, so I figured I better be prepared for this one.

Denis Shapiro:

No worries, go ahead.

Patrick Grimes:

I appreciated you joining the panels that we were on before. Can you see the screen there?

Denis Shapiro:

Yep, looks good.

Patrick Grimes:

There. All right, so I’m not going to go to presentation mode because I want to go back and forth to, I got a website here or two I want to look at, but… And I’d prefer some very much like an interactive type of exactly what Denis Shapiro was talking about. This is really for you guys. Cyrus, Dean, Gary, Ryan, just throw out questions. I’m going to keep this chat open so I can see it. And Denis Shapiro, we see some come through that I missed. But yeah, we’re going to talk a little bit about investing for the upside of downturns. I think we have 40 minutes, but real quick about me. I started back in machine design automation and robotics in 2000s. And I was in fact right in front of my head here back when I had hair. This is a robotic assembly for the Tesla rotor, rotating part of the motor.

And behind here is a Lockheed satellite solar cell assembly. And this is a flu test machine. I did automation assembly for all kinds of stuff and this was actually converted to a COVID test later on. So I was systems, processes, automation, sky, all one of a kind builds. And that was mostly my career. Early on I got some advice from the founder of the company saying, “Hey, you should invest in real estate.” And I was shocked. He was very wealthy doing incredibly… He was like my idol in the high-tech space. And he meanwhile informed me that him and his pals are all investing everything they make high-tech in real estate. I went real heavy real soon, invested in a pre-development back in 2008, lost everything or it was before that, but I lost everything in 2008 and that’s the way it sat. Just some roads with some plots and no humps. And took about 10 years after the financial collapse. We’ll talk a little bit about lessons learned through that, which is why this topic is very near and dear to my heart. I lost everything once already.

I started high tech again. I’ve got master’s in engineering and business. Was doing well, needed a place to dump cash, followed the breadcrumbs of the wealthy and it led me right back to real estate. And so I did a bunch of single family stuff. Buy, renovate, hold, and I was doing great but I was moonlighting it was exhausting and it wasn’t scaling to the level that I wanted. And so that led me to invest on Main Street where I founded a private equity firm, met Denis Shapiro, read the book, which everybody else should read. And then we started trading up partnering and doing larger multifamily, and that’s one of them right there. Invest on Main Street, primarily real estate scaled about 600 million. It’s about 5,000 units right now in the Midwest, southeastern states. Write for Forbes. I’m a speaker, I’ve got a couple books out now and we diversified into oil and gas.

And then from there we realized, well, we’re doing oil and gas now and a real estate company. And so we founded a firm called Passive Investing Mastery that does more alt asset and essentially growing into invest on Main Street coming out of the loss. The question was where and how, where do I learn from, back from that 2008 situation? And in 2008, which we’ll look at some graphs to kind of show the dynamics of how debt and equity investments have waned and different markets have waned over time and which one’s more recession resilient. But I was all in one investment and I was looking for the highest returns. I was really aggressive. I didn’t understand risk adjusted returns and I was buying something that I had to pay payments on that didn’t cashflow. And so I learned a lot. I started doing existing construction things that are there already that cashflow quickly or on day one. Much lower leverage, meaning high down payments that are more manageable and can be paid by the property’s cashflow instead of doing variable and balloon payment interest.

We did a lot of fixed rate, in fact all fixed and multifamily and only a couple in single and multi and only a couple were variable rate, but we bought rate caps. And then we bought things that we could add value to and that helped because we could buy something that was already cash flowing, but we can make a systematic improvement and not try to create something from nothing. And with operational reserves and interest rates and insurance, I mean, and keeping workforce housing, we built a recession resilient portfolio and we’ve got all these multifamily, beautiful apartments. We got at a discount and we renovated and we did great and as a result we’re in both debt and equity and all kinds of different assets and that’s kind of our mission is to provide those path of investments. But we decided to get into alternative investments when we started seeing another recession come.

And why is that? Well, that’s because the wealthy have a diversified portfolio. And even since I started in this business, I’ve had a download. It’s a free download, it’s an investor guide, and at the front of it I put this graph, I don’t say invest everything in real estate. I’m actually a high tech guy learning to diversify. That’s been my career, right? And if you look at the asset allocation of the upper income and ultra wealthy, they have 25 to 50% of their wealth in alternative investments. They actually, the middle class has 8% of their wealth and alternative investment and that’s business equities and real estate. They also have things in liquid assets, assets that are not locked up over time in fixed income assets. There’s a diversified portfolio here and if you’re heavily indexed in one asset class, it can not serve you too well.

And we’ll talk a little bit about that. The Tiger 21 diversification of the wealthy actually shows a very similar… Tiger 21 being I think you have to be over 20 million net worth, you have to prove you’re over 20 million net worth and they publish right all of the allocations of each of their members. And so you can see here’s an example of how the ultra wealthy are allocating and you see very clearly you have, again 50%, that’s actually a 53% in alternative investments, a combination of private equity and real estate, right? 27% in real estate, it’s very similar. And then they have fixed income on the left side. So that we’re going to talk about because that has to do with debt for example, that’s one of those or bonds those, one of the ways that you can get fixed income. And so a lot of this has to do with how to seek those diversifications and within real estate, dive into that 26% of the allocation.

It’s going to give us the opportunity to invest in a couple different ways and we’ll look at the risks of rewards of those. And then we’ll circle back to the resilience, the recession resilience of those. If you look at real estate, how to capitalize or how to invest in real estate, what we have is what we call a capital stack. And in the capital stack, the most common things are the senior secured debt and the common equity. Senior secured debt at the bottom and the common equity at the top. And if you’re buying a single family home, this is really understandable because you have your loan and then you have your down payment and that’s your equity, your common equity. Now maybe one day you’re going to buy it and then you’re going to need to renovate your kitchen and you want to get a second. Well, maybe you’re going to get a second loan, which we also call mezzanine debt.

That’s as complicated as single family gets. When you get to commercial, you have potentially lots of investors on the common equity side, hundreds slicing of that common equity side, pooling capital together through things like syndications to come in. And when you do that, some of them say, “Hey, I want a preferred position over the rest of the common equity guys.” And then you have this idea, this notion of preferred equity, it’s still equity, it’s not a second like mezzanine debt or a second on your home, but those are ways you can invest in real estate. Now, what’s the effect on the risk and reward? The lower you are on the capital stack and senior secured debt, the higher your payment priority is you’re the first person paid. And in a senior secured, meaning you’re the first position, you just can take the asset if they don’t pay you.

The potential return is lowest on the bottom of the capital stack. Why? Because you’re capped, there’s really no upside per se in debt, you’re just about downside protection there. Once the cash that comes in from the property, the first thing it has to do is fill up the debt cup. Once that debt cup is full, then it fills up a second position. Once that full, then it waterfalls to the common equity. But the common equity can keep going, you can make a lot, you have a lot of upside. However, that also means that in recessions, the recession resilience of the common equity is lowest and the recession resilience of the senior secured debt is highest. The lower you are, the more protected you are in a recession. Your position on the capital stack definitely determines your risk. A lot of investors right now are choosing to invest in lower risk assets for capital preservation and not taking the higher gamble on higher common equity.

Example of this is say hypothetically we had a $10 million property. For that, we’re going to put 4 million down and we’re going to get a loan for 6 million. That capitalizes, we have 6 million in debt investments, we have 4 million in equity investments that capitalize the purchase of the property. What happens when the market fluctuates and reduces by 15%? Well unfortunately that drops the common equity from 4 million, but now the equity they have in the deals link two and a half, a 15% reduction in market valuation of the property. In fact, around the nation right now we’re seeing fluctuations. 10, 20 and 30%. But so 15% is right on par. What happened to the common equity guys? Well, they lost 37%, but what happened to the debt? They didn’t lose anything. And so that is a quick example and please ask questions. There’s a lot of people out there sitting quietly, spying honest. Denis Shapiro, if you have any questions, Denis Shapiro, please chime in. Yeah,

Denis Shapiro:

I’ll watch out if there’s any questions in the Q&A or the chat, I’ll definitely shoot them out.

Patrick Grimes:

All right, and I want to share. Each market actually can behave a little differently and if anybody’s invested in different markets, feel free… And I can pull this up, but I wanted to share my whole screen so I could share this graph with you. Now, with this graph is the Fred data and it suggests that the transaction home value prices in different metropolitan areas, right over time. And as you can see, there’s just steady growth. But when you get towards 2005, you see this huge bubble. And then in 2000 quarter one, in 2007, we reached the peak and then some of them plummet. We see some of the ones like this first one here that’s in Orlando, and the second one that’s in Las Vegas, the two highest ones here, those medium home value prices are in that range of 257 and 278. But just a couple years later, they plummeted to all time lows of a 100 to 140. They lost almost half their value. And that’s just in a couple years from that 2007 quarter one to 2012 or 2011.

Now other markets that are more recession resilient, and so we’ll look at this blue line, or the green line, which is Dallas and the purple line, which is Houston, which is actually the majority of our portfolio with, and actually where I did my single family investing comeback into real estate because of this, it actually stayed steady and it only lost or flattened out for just a couple quarters before they began to go up again. Now why is that? Now think about it. If you invested in Houston as an equity investor, you’re just sitting pretty, hanging out during the 2007 eight financial crisis. If you’re in diversifying of course throughout the market. But if you’re in common equity in a position in Las Vegas, you’ve lost everything. In a position in Orlando, you’ve lost everything. And I’m really picking on hospitality. But it’s important to know that when you’re investing in, and I’ve got some other ones like New York, which also made some swings, but it’s important to know that when you invest into equity, you’ve got to be very careful what markets you do it in.

And the diversified makeup of the industries within those markets need to be heavily indexed in recession resilient locations. If you invest in the right kind of markets and the right kind of assets, that cash flow, you can actually build a portfolio to survive recessions, to ride them out. And that’s part of the journey here that we’re on today. Now what happens when the interest rates rise in these situations? Which this is different, we didn’t have this in 2008, we didn’t have interest rates rising, we didn’t have inflation skyrocketing. This was the largest situation of financial fraud in the country’s history. What’s the effect of interest rates rising, which can cause a recession? And it looks like it is in some industries here on both the equity and on the debt side. The capital stack returns during high interest rate environments. Higher interest rate payments reduce the profitability for common equity.

They decrease valuations, they increase debt service, they decrease income. And because of that people will pay less, if the debt costs more, they pay less for the properties. If you’re holding an asset, interest rates goes up, it’s not a good day for you. What about in the debt? Higher interest rates actually mean payments that are higher to you, returns that are higher for you. All things considered the same, the same property at the same leverage and a higher interest rate environment is more profitable for the debt people than that same property in the same environment in a low interest rate environment and dramatically so because their returns go up.

Properties, for example, that were on the market for six or seven or 8% interest loans just a year or two ago are now nine, 10, 11% interest loans from banks. But as we’ll talk about later, banks are pencils down. Sometimes those loans just because of the demand are 13%. And actually that’s actually what we’re lending at right now. The returns and debt today can actually be somewhat analogous to equity of a couple years ago at the lower risk premium in this particular type of recessionary environment.

Denis Shapiro:

Patrick, can I jump in before you go on, to slide 19? I think this is a great slide to show how dramatic the losses can be when you’re on… One more. 19. Yeah, that’s the slide. There was a recent example, I’m not sure if you’ve heard of it, where a syndicator had private equity and the private equity last minute came in before they closed and basically put a provision in there that allows the private equity to come in and convert the entire LP shares to a ludicrous $10. There was a $6 million of LP equity and there was a provision in there and then there’s a little controversy if it was declared or not, whatever it is. But the LP investors though, at least the ones that I talked to, were blinded by this because that conversion basically turned into a hundred percent loss on their principle.

I think Patrick makes some excellent points on knowing where you are in the capital stack. I just had Jeremy roll on and he says there’s a time and place for all types of investments and in raising interest rate environments, he believes in certain principles. And I think this is a great example because a 15% reduction doesn’t seem like a lot, especially when you’re looking at these investment offerings and they give you these matrices and they say how conservative they are because even if they’re off by 10, 15, 20%, they’ll still make money, blah, blah, blah. But at the end of the day, if that capital stack is positioned a certain way and you’re not asking that question to figure out exactly where that common shares are, you’re not only in a position to lose 37%, you’re actually in a position to lose a hundred percent of your money. And then what good is those 20/30% IRRs if you’re putting your capital in danger?

Patrick Grimes:

I appreciate you bringing that up and all of that is so valid. This piece right here, which is the preferred equity piece, is killing a lot of common equity folks and the SEC recently pushed out new regulations that require transparency for preferred equity positions when there’s a preferred position over the common equity. There’s a lot, there’s probably half a dozen times that I’ve heard recently just in last year, LP investors come to me and they find out that the sponsor didn’t raise all the capital, they back filled it with a preferred equity piece, equity that is before the common equity, and they never disclosed that to the common equity guys and materially increasing the risk. But somewhere in their PPM, they had this thing in there saying that they could do it. And so what’s happening now is because the valuations are lowering and income is getting hit, which we’ll talk about in a while, the preferred equity people are often able to just come in and take over management.

And the reason why is because they write, when they put up a $5 million check, they write those requirements within those investments saying that if you don’t reach your debt coverage service ratio or the business plan doesn’t work out or something happens and you fall under certain parameters, we can take over management. What happens? They do crazy stuff. Maybe they have a clause like what Denis Shapiro just suggested or maybe they don’t because when they take over management, it means they no longer care about common equity since they get the first dollar after the property sells into their paid back, they just want to sell the property for their investment amount and they don’t care about your return. It’s happening a lot right now, unfortunately. And the SEC is working towards trying to get more transparency on preferred positions and side letters that they put in place with preferred equity. Side letters specifically is a big target because of how proliferate it’s being. I’m not actually-

Denis Shapiro:

You want to discuss what a sidecar letter is just for a brief second.

Patrick Grimes:

Yeah, so if all you have in your debt structure is a common equity piece and maybe you have a mezzanine or maybe just a common equity, and this is most of the cases. You have senior debt and common equity. And what typically happens is maybe the sponsors… Two scenarios. The sponsor needs to bring in a big capital piece, a large capital piece, but that large capital piece is like, Hey, I don’t want to be treated by all the other people that are investing a hundred thousand because bringing in five or 3 million, so I want to be in a preferred position. Well, where are those rights spelled out to that larger investor? Traditionally, if you look in the PPMs sometimes it’ll say we allow side letters. The sponsor can just create a side agreement with this other investor and give them this preferred position, this better split this whatever it is to try and get them to come in.

And oftentimes side lighters are used for that. Or if you have the property in an LLC and you’re thinking that you’re actually investing directly, the property’s being bought by that LLC and you’re actually investing directly in an LLC to get around side letters, what preferred equity people are saying is, “No, no, we’re going to create another LLC and we’re going to joint venture with you where we have real ownership and you have real ownership, but we have the right to take over.” And so oftentimes common equity guys don’t even realize that they don’t actually have, the manager doesn’t have control over the asset too, kind of entangled web. But in all of those cases, there’s some site agreement or like a JV agreement, co-management agreement oftentimes isn’t disclosed and you want to ask these questions. And oftentimes it happens at the very last minute. Sponsors worried about losing their million dollars of hardness money or somebody pulls out and they have these kind of sharks have a lot more leverage, fortunately.

Denis Shapiro:

Thanks Patrick.

Patrick Grimes:

Yeah. Okay. All right, so we have about 20 more minutes here. So I think I talked a little, I think this slide’s a little bit out of place. What went wrong in 2008? This was supposedly I had a balloon debt, I had a second, I had a first and I had a second right in 2008. And so moving forward, I think I talked a little bit about I was personally guaranteed all in one investment, focus on high returns, not on risk. Today’s challenges are a little bit different than 2008. I think Napoleon said, “I never won a war that went to plan, but I never won a war that I didn’t plan thoroughly.” Coming out of 2008, if you zoom out, we saw there was a major financial disaster and we needed a lot of operating reserves, we needed a lot of things to keep us afloat during that time.

If you had a lot of those similar things, you can potentially write out this financial disaster as well. Now this financial disaster is a bit different. Interest rates are up, meaning valuations are down. That’s painful. We have 50 years of US inflation versus interest rates. And so I don’t want to go too deep into this, I’ll lose everybody, but so even though interest rates are up, it’s not the only issue. A lot of people are really hyper-focused on that. It is one thing to say interest rates are up, but interest rates are up because inflation is high and it’s the government trying to fight inflation that really the root causes that inflation. But inflation isn’t just driving interest rates. It means your rents are going up potentially, which is great, but unfortunately rents are staying flat in most areas. Meanwhile it’s driving your maintenance costs, it’s driving your renovation costs. Not only is it more expensive to renovate, the materials, it’s taking longer to get them. And the great resignation coming out of COVID affected labor, the ability to hire, so it’s driving payroll costs.

Inflation is also arguably hitting other aspects. We have insurance premiums. Whether you’re a believer in global warming or not, this isn’t a political discussion. There has just been more natural disasters in a lot of the favorable markets. In fact, I’ve had two 500 year floods and one property within just a handful of years. A lot of carriers are just picking up and leaving. So you’ve got interest rates, you’ve got payroll, you’ve got material costs going up, affecting your CapEx ability to renovate. Now, insurance premiums, which we would usually put a 5% escalator, now they’re up 30%. 30% nationally this year. 30%. Other than tax, that’s your biggest one. And taxes are going up. A lot of states are hurting with COVID. They’re working for where they can rebalance out their balance sheets and taxes in a lot of the favorable markets, including some places like in Texas.

And if you didn’t buy a cap rate, of course your interest rates is going to grow to meet that cap. Those are all major, what we call financial disasters. And coming out of COVID, rental assistance ended rent payments didn’t resume in a lot of markets and delinquencies skyrocketed, which caused the eviction courts to be backed up. And for example, where we used to be able to evict in two months, one to two months in Atlanta, it’s 12,000 evictions that are backlogged. It’s 15 months, 15 to 16 months for the whole process to get somebody out. Let me just put a little analogy behind. Say you own a store, all right? And for 16 months people come in every day, fill up their basket and walk out. And for 16 months you’ve been going to the court and you’ve been telling them, or sorry for… It takes 10 months, you’re going to the court and you’re telling them, “People are stealing from me every single day. There’s a whole building of people stealing from me every single day.”

And then finally after 10 months, the court creates a date for you saying that they will see your case in 10 months and then after 10 months they say, “Yep, you know what? All those people are doing something illegal. You’re right. We’re going to notify the sheriff’s company to stop them immediately.” Six months later, five to six months later, the sheriffs show up and they tell those people to stop stealing from you every day. And that’s essentially what’s happening in Atlanta right now. And there’s 12,000 evictions. There’s more than just interest rates and so there’s a lot of distress in the market.

Investing in downturns right now, it’s harder if you weren’t hedged in a combination along the vertical of the capital stack and real estate. If you weren’t in the more recession resilient markets with diversified employment and you weren’t in places that were landlord friendly that allow you to evict, all these things are going to hit you. That’s why we talk about diversification. Timelines is a part of it. Unfortunately, the material supply issues and backlog and then the loans are coming due during this time. It’s actually a trillion and a half dollar in commercial bridge loans coming due by 2025. Everybody should go crawl in a hole and hide and be fearful. What’s interesting is that billionaires were made in 2009 and 10 because they chose to invest when there was opportunity. And I really don’t like this quote by Warren Buffet, I don’t like it at all.

It’s, be fearful when others are greedy and greedy when others are fearful. And the reason why I don’t like this quote so much is because I don’t think you should be greedy or fearful, but I would definitely wouldn’t put it past Warren Buffett to put this quote out there just so that other people got fearful and greedy. I know that guy was an analyst like me, and I just go back to my math and what my math tells me today, being the engineer analyst is that it’s incredible deals. Right now I’m buying things at amazing basis in our acquisitions funds and we’re originating loans in our income fund, incredible returns. And it’s just an incredible, it’s like second coolest buying opportunity of my life, not because I’m greedy or fearful, but because that’s how it shakes out in the numbers. And it’s opportunistic people right now that aren’t doing the types of investments of yesteryear that aren’t trying to buy things and renovate and improve, but that in a time when costs are high, but they’re doing things a little differently.

And right now you can make your return on the buy just like 2009 and 10. Not value add. What’s broken for me now is if I buy something and then I hold on it for three to five or five to seven years and put millions of dollars to improve it, hoping rent will go up, occupancy will go up, and then I’ll be able to sell it for more. Well, none of that’s penciling right now. What is penciling right now? There’s just a ton of performing assets, great properties that have financially distressed ownership. They just didn’t have the reserves, didn’t have the insurance, they didn’t have the right debt. Their interest rates went to their cap or they didn’t cap, or maybe they just got unlucky and their debt’s coming due now at a time when all their income is squeezed. Valuations are low, people are just not buying unless you come in and buy right.

That gives us the opportunity to swoop in and be the financial relief to operators that are performing assets. These are not un-performing assets either through debt or equity. And that’s where I think right now the opportunity is if you’re in performing assets and recession resilient markets and you’re buying right. You’re making the return on the buy and not hoping, you can’t rely on rent growth, you can’t rely on appreciation through innovations. It’s my take. And I don’t think buying from brokers is the best. We’re going direct to owner right now. The brokers have been whispering unreasonable pricing and still are, and they’re the result of a lot of this. They’re trying to save face with the owners and trying to sell things to higher risk buyers for more than they’ll pay. And most of the assets we’ve bought are things that came back on the market after people failed to perform.

And so we’re doing a lot of talking to the owners directly. Ones that are just willing to say, “Look, they either need a gap transactional or bridge loan,” and we’re originating like 13%, so incredible returns for debt investment debt investors, or I just want out and we’re doing all cash buys. Again, performing assets, cash flowing assets, and then we’re selling them and we’re refining out our capital buying another one’s selling it. And I think that leaning into that take is where it’s at. And because in the debt side that was the acquisition slide on the price side, but on the debt side you have the relatively lower risk, you have higher returns than most fixed. And it’s because you have so much cushion between the waning of the market as long as you’re in those recession resilient markets, even the global financial crisis. If you’re in a 50% leverage position, you’re mostly fine, even in some of the worst markets if you’re in a non-leveraged debt fund and you’re diversified of course, because sometimes the Detroit can happen. And they’re stable.

The reason why it’s so important right now, I think the opportunity in commercial real estate is because banks are under pressure. The regional banks that typically lend on these commercial assets, they’re in a liquidity crunch. We have about eight more minutes, I mean I’ll squeeze this last slide in, but they’re in a liquidity crunch right now. And that means just because some details behind how banks work is that they buy bonds and those bonds that have fixed income are based off lower interest rates. So people don’t want to buy them from the bank because they’re on the, well pay lower amounts and they could buy new bonds today. So the banks are under pressure because people don’t trust them. Deposits are leaving. Their assets, their bond, their bonds are devalued and a lot of their properties that they lent on, people aren’t paying or people aren’t paying off those loans.

So they’re in a liquidity crunch. They’ve backed away, this is creating a lot of distress for performing assets, it’s creating an opportunity for acquisitions buyers to come in and at cap, it’s creating opportunity for debt investors to come in and fill the void. And with the debt maturing through 2025, I think this is potentially, as I said, this second most awesome opportunity for us to put pencil to paper and analyze these debt and equity investments and produce some really incredible returns, focus on financially distressed owners and not distressed assets. And we can reach that higher risk, lower risk premium during a recession resilient time through those methods. That’s really, that’s the slides I had.

Denis Shapiro:

Oh, Patrick, thank you so much for that. I shared a lot of the philosophy I think I’ve been through recent conference said if you could get a direct contact with the owner and do either seller financing or mostly basically an all cash deal or some kind of hybrid in between, you can get some great opportunities. And we are probably towards, depending on who you ask, we’re towards the peak of the rate hikes. You’re going to get a situation where potentially you’re going to get, as long as it’s a nice asset, two, three years down the line, you’re going to be in a way better position. Which reminds me of the whole when I first started investing passively in 2014, but then I went heavy into passive investments in 2018, I remember every single operator I invested in always said, “Oh, we might refi and keep this property long term.”

And every single one of them sold the property in three years. Because at the end of the day, if you’re buying it at 3% interest rate, how are you really going to refi? You need the rates to either be the same level or marginally higher, but when you’re buying it at three, 3.1, 3.2, realistically speaking, you’re not going to refi. How? Without putting on significant increase to your cost of capital. However, if you’re buying it now and you’re getting seller financing at six, six and a half and maybe get interest only for a period of five years and you could almost reassuring, you could with some level of certainty, say in five years, you’re going to be able to refi them out because chances are rates are going to be high fours or low fives and you’re going to be in a great position if you’ve done some simple, small value add.

I agree with your thesis on this a hundred percent. Why don’t you talk about a little bit more, how’s your deal flow been with these kind of deals? Has it picked up in the last month two, what has been the last six months for you with this fund?

Patrick Grimes:

Well, so we have not successfully done seller financing. I think that’s awesome if you’re seeing those opportunities. Most of the sellers that we are working with, they need that financial relief because they have to exit their existing debt or they have to pay off accounts payable, large CapEx accounts payable bills, they went way over budget. Typically we’re recapitalizing it. I mean we’re typically buying all in cash and then maybe either seeking a bank or leverage thereafter because we can get at least the best discount. On the debt side, we’re replacing whatever debt that they have. Mostly though the return just comes from a reset of the value of the property. And we’re disabled to be with agility, move quickly and buy after due diligence, we call it in 14 days. It is the case that I think you and I are both in this industry and I’ve been there a while.

We know a lot of people and I saw the opportunity, we posted a 14.98% monthly check in October for our debt fund. I saw the opportunity to be able to provide extraordinary returns with a debt fund and that’s what we’re doing. I leaped on it and it’s almost like a build it and they will come kind of thing because once you have it and you’re kind of a trusted guy, because the interest rates have gone up to eight or 9% and then beyond that we can move quicker, so we can get 10, 11, 12%.

And they trust us and we’re a known entity and we are not a bank that has all this red tape. We can get 13 plus two points on some of these loans. And hard to imagine why somebody would do that. But if somebody’s going to go pick up a property or they need out or they need somebody to move quickly that they can trust and the banks have just been re-trading and re-trading, they’ll do that all day right now because in order for these guys to move fast to buy these assets or recapitalize the assets to them it’s, I don’t want to lose my investor’s capital.

I need a new loan or to them, I can’t go raise equity right now. These payments to the debt are similar to equity payments. So it’s just more expensive equity or maybe it’s a six month or three month loan and they’re okay with 14% for three to six months while they seek more traditional financing. And so what happened is once we built it, we got a bunch of opportunities. We have a huge pipeline now on the debt fund and for us to lend on and we put that capital to work inside. So far inside of about 11 days on average where capital coming in and on the acquisitions fund, it’s a large direct owner outreach. We’ve got half a dozen constant people getting after it talking. We’ve got people flying around. We’ve always had a very strong pipeline.

But now we’re using that same pipeline shifting direct owner and doing the quick acquisitions instead of with debt. And we’re just not doing the renovations, we’re just trading out. And so that’s working. It’s a lot. But to your point, we’re only seeing that pipeline ramp and throttle up right now and we won’t be able to do these deals… That’s why they’re called recessionary funds. We won’t be able to do these deals in five years from now. We weren’t able to do them two years ago. We couldn’t buy deals where you make the return on the buy. We had to hold them for three to five years to get the return. We’re just going to do it as much as we can, as fast and as agile and responsible as we can consume as much of the market as we can during this downturn.

Denis Shapiro:

Got it. And how are you guys structuring your funds? Are you guys doing open-ended funds, closed-ended funds, and what timeframe are you guys looking at?

Patrick Grimes:

Yeah, so the real estate asset by debt fund, income fund is in both the acquisitions fund, recessionary acquisitions fund are blind pool open funds and as we constantly are raising an into the debt fund, but we raise into the acquisitions fund when we have an acquisition. And then since we’re constantly buying cash, refi-ing out and then selling assets within the fund and buying more assets, the first asset was bought, we were able to use the proceeds from the first assets to buy two more assets without another penny. And that’s what we’re doing right now. And then we’re looking at the third and fourth, we have four more assets in the pipeline right now for first quarter next year. We’re going to need to do another tranche and we’ve got almost 2 million funded and 22 million in soft commits for those. So a lot of interest.

Denis Shapiro:

And I’m assuming you guys are doing quick kind of flips on the acquisition side, but you guys are not, aren’t doing cost segments or anything like that. It would make no sense in a situation like this.

Patrick Grimes:

We are because which is why we’re 10, 31 exchanging within the fund to subsequent assets. But because everybody wants, and I do too, I want the tax advantages, so why not? And as long as the fund is growing, we’ll continue to be able to distribute depreciation each year until in which case we wind down the fund and then it’ll be maxed out. But it’s kind of like the gift that keeps giving because it’s not all in the first year. We just keep adding more assets and you’re in a diversified pool and we keep doing the cost tax.

Denis Shapiro:

Got it. Okay, cool. I didn’t think about that, but that makes complete sense the way you guys did it. And how large are these funds in terms of fund size?

Patrick Grimes:

Right now we’re heading towards, in the income fund, we just launched a month and a half ago. We just did our first distribution in October was 14.98. And then this November is a little closer to 16,17. We’re penciling it in right now to our Class A members and I think we’re at 5 million in the debt fund and we’re close, like I said, we’re about 8 million funded with 22 in the acquisitions fund. 22 in the commitments in the acquisitions fund.

Denis Shapiro:

Got it. Okay. I think that’s it from my end, Patrick, I know you have the slide up, but why don’t you say where we can find you and then see if we have any last minute questions that I can help get Patrick to answer.

Patrick Grimes:

Yeah, Passive Investing Mastery, Passive Investing, and then mastery.com. We have all of our investments up there. If you’re interested, go to passive investing mastery.com/book. That’s where you can get persistence pivots and game changers. It was an Amazon bestseller and I’d be happy I sent for people that are interested in the story. In fact, Phil Collin, I wrote it with a bunch of other people, Phil Collin, lead guitarist in Def Leppard is in there. He did a chapter some NFL/NBA players. It really is a lot of cool stories from some amazing people on how they made it through life and the journeys that they took. And I tell my whole story and the ups and downs and pivots from high tech to real estate and losing all. If you’re interested in passiveinvestingmastery.com/book and then use Denis Shapiro’s name and I’ll get a free signed copy shipped out to you just as a way to give back. And I love talking to investors, so my Calendly is always there on my website. Happy to chat with anybody wherever they’re at and get them pointed in the right direction.

Denis Shapiro:

Okay, awesome. I think we are just in time, so we did really good. Love the deck, really beautiful slides. I know the Tiger 21 thing I usually use as well because I have a traditional versus alternative slide where I kind of make the argument of why it’s important to do both. And Tiger 21 I think is a good example of-

Patrick Grimes:

Can I see your traditional slide? I’d really like to see what you’ve got as your baseline for that.

Denis Shapiro:

Yeah, I’ll send you the deck on that specific thing. Yeah, I’d be glad to share that. Yeah, because too many people in our industry just tell you this is the only way to invest and that’s just not the case. There’s just a lot of ways and modeling after certainly a lot smarter people than me and you, they don’t just do one or the other. Yeah, they usually have a niche, but they usually are pretty diversified with traditional and alternative investments as well. Thank you so much for putting together the slides. Thank you for jumping on. And yeah, let’s reconnect. I look forward, I’m probably going to get a copy of your book, so I’ll probably use the Denis Shapiro code.

Patrick Grimes:

Please do.

Denis Shapiro:

Just to get the signed copy.

Patrick Grimes:

Yeah. Yeah, I have a copy of yours, but I don’t think it’s signed. I think I paid for it online.

Denis Shapiro:

We’ll swap the books. Patrick, thank you so much. I’ll have the recording, I’ll share it. I do all the little clips as well and streamline that as well. Thank you guys for jumping on, really appreciate it. Enjoy the rest of your day.

Patrick Grimes:

All right. Thanks so much Denis Shapiro.

Denis Shapiro:

Thanks everyone.

Patrick Grimes:

Bye.

 

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The Smart Investors Guide to Passive Real Estate Investing

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