Private Credit Masterclass – Part 2 feat. Anton Mattli | Aspen Funds
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Private Credit Masterclass – Part 2 feat. Anton Mattli


Join us for Part 2 of our Private Credit Masterclass podcast series, where we dive deeper into seizing unique opportunities in private credit investing. In this episode, we continue our discussion with special guest Anton Mattli, CEO of PEAK Financing, exploring strategies like bridge financing and loan assumptions. Discover key underwriting factors for assessing risk, understanding sponsor strength, and ensuring financial stability.


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Introduction and Welcome

Ben Fraser: Hello, Future Billionaires. Welcome back to another episode of the Invest Like a Billionaire podcast. I’m your host, Ben Fraser. Today, we have part two of the Private Credit Masterclass. So if you haven’t watched last week’s episode, you definitely need to go check it out because this is a continuation of a webinar we recently hosted all about private credit.

So last week we really laid the groundwork and the support for what’s happening right now, specifically in multifamily, is creating a very unique opportunity in the world of private credit. Today’s episode is part two. We’re going to really get more tactical and practical. About what is the universe of private credit, all the different options available.

How do you take advantage in this market right now? And really several case studies that put a lot of color around what is actually possible in the space. And I think you’re really going to enjoy it. If you have any interest at all in private credit, now is the time to be paying attention to this asset class.

And again, hopefully you enjoy this educational content that we try to put out whenever we have a lot of investors interested in something. So With that, please enjoy today’s episode and if you are enjoying the podcast, always appreciate your feedback, ratings, reviews, and shares with friends. With that, enjoy the show.

The Invest Like a Billionaire Podcast

Ben Fraser: This is the Invest Like a Billionaire podcast, where we uncover the alternative investments and strategies that billionaires use to grow wealth. The tools and tactics you’ll learn from this podcast will make you a better investor and help you build legacy wealth. Join us as we dive into the world of alternative investments, uncover strategies of the ultra wealthy, discuss economics, and interview successful investors.

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Exploring the Universe of Private Credit

Ben Fraser: What is the universe of private credit, right? Because we’ve said this term a lot. You probably heard this as a buzzword because it’s very popular right now.

There’s a lot of people jumping into the private credit space, but What does that mean? Because it can mean a lot of different things. So at its most basic level, private credit really is anything that’s outside of banks, right? Because it’s private and these are not regulated banks. So that can include bridge loans, CMBS, which is a commercial mortgage backed securities agency.

And so there’s a lot of other well known funding sources that are not really what we’re talking about that could be classified under that category. And then you have distressed situations distressed debt investing. And then a whole gamut here. We’re going to get to, but.

What we’re focusing on and talking about is what we call non institutional opportunistic private credit. So this is being able to invest opportunistically lower on the capital stack through either being preferred equity or second position debt, mezzanine debt. And being able to get into a good deal with a lower at risk basis and help that deal make it through to the next kind of turning point or new deals that are requiring additional funding because of the things that are going on where the credit is tighter.

Understanding Debt Funds and Their True Nature

Ben Fraser: So talk about all those here in a sec. Debt funds are not created equal. So this is a little bit of a poke in the eye to some people that are using the word debt. You’ve seen maybe a debt fund and an income debt fund. People throw the word debt out pretty aggressively.

A lot of times it’s not true debt, right? So a traditional debt fund is something that is secured by the subject property and has a lien filed against it. And Anton, you mentioned the other day, you saw someone talk about they have a new debt fund that they’re launching, but the underlying strategy and what they’re making, the investments they’re making within the fund.

Was not actually debt, right? You want to just share that real quick? 

Bob Fraser: They meant the investor, they were, they were loaning the fund money. So that was the debt instruments. 

Anton Mattli: Yeah, that’s right. So it’s turning it upside down. And because they are borrowing as a fund, they call it a debt fund, but then they would invest in equities and everything else.

Bob Fraser: Yes. So you want to make sure. You don’t. 

Anton Mattli: Understand what they mean with that fund. 

Ben Fraser: It’s really important to understand the headline names, the debt fund, private credit fund, to really understand what that means, are you going to be secure? Are you not going to be secure?

Are you going to have any priority interests? And the actual investments that you’re making is, are you lending money to a fund or is the fund actually investing in debt? And then another kind of big category, like you don’t think about that because private credit encompasses both business loans as well as real estate loans.

And so there’s a lot of credit funds out there that are also capitalizing on a unique credit market in businesses. And that’s, Yeah. A lot of times called venture debt venture credit, and these are loans to businesses. And so again, there’s a risk spectrum across all these things.

So if you’re investing in, non distress situations backed by real estate, that’s on the lower end of the risk spectrum all the way to. Investing in debt vehicles to businesses that are not secured by any collateral, but just the hope that the business makes it is on the other end of the risk spectrum and kind of everything in between.

So it’s important to understand what the underlying strategy is because. The potential rates of return are very different and they’re not equal opportunity risk here, right? It says you have to understand the risk adjusted returns that you’re going to be earning in any of these types of deals.

Another example that I’ve seen recently is a cannabis private credit fund, right? So cannabis is that you cannot get traditional financing because of the regulations. And It creates an opportunity for private lenders to lend to these types of businesses. But again, not real estate.

It’s a business. It’s an emerging industry. Don’t really know where it’s going to go from a regulation standpoint. And so it’s a very different set of risks. All that to say, it’s very important to understand What are you talking about when you’re saying private credit? And so for us, we’re going to make it very clear.

Our focus is real estate, private credit. 

Diving Into Real Estate Private Credit Opportunities

Ben Fraser: These are investments either through preferred equity mezzanine debt or second position loans, which we’ll talk about the difference there in a minute into real estate, right? And this is going to be the kind of the next stage here of the presentation, just explain all the nuances around this.

Capital Stack and Investment Strategies in Private Credit

Ben Fraser: Anton, let’s talk a little bit about the capital stack, right? This is a concept that you may have heard about, you may not be familiar with, but what does the capital stack mean and, what are some of the benefits here of investing through private credit? 

Anton Mattli: Yeah I would say everyone probably understands that you have a senior lien and you have equity in a property, right?

So that’s through additional financing whether it’s for a single family or a multifamily or retail strip office building, it doesn’t really matter. And that is the most traditional way of investing with debt, right? And naturally, senior debt, because it’s secured by a lien on the property, is at the highest priority.

get paid back. And it’s also the easiest to actually get a hold of the property because of that lien and one can foreclose very easily. Now what is very often the case though is that particularly when you are a developer and more recently also with value add deals that the senior that was not high enough to justify To bring in all common equity and generate the return for the common equity also.

That’s why mezzanine debt preferred equity is being added in some transactions, particularly in the development space that has been around for a very long time. 

Ben Fraser: Some of the benefits of this is if you’re investing at this position of the capital stack, you’re not the senior lender is always the first one in line to get paid, but you can come in even after the fact when a property has already been purchased, already has equity in place, and come in with a priority in the repayment structure.

And so you actually have a priority of payment before the common equity. A lot of times, if it’s an operating deal that has strong cash flow, You’re actually getting current cash flow, you’re getting paid a current portion of the return that you’re putting out there and contracting.

You’re lowering the capital stacks, you reduce the risk of your capital loss, so if a property value drops, say, 25, 30% or even more your capital is still in a position to where you’re not necessarily at risk of a loss. And then many times depending on how you structure these, you can take over, The property operationally or force a sale if the property is not meeting the expectations that were originally agreed upon at that time from the infusion.

Anton Mattli: Yeah, good point there. Maybe one more point I want to make is the right mass and breath equity. Obviously it has priority, but it’s not always making sense as a breath equity mass investor. If the senior debt is already a very high leverage, right? When we, particularly when we look at 2021 2022 with a lot of these bridge loans, where bridge lenders went at 80% to sometimes 83, 85% loan to cost.

And then a sponsor was adding breath equity on top of it that breath equity, yes, it still had priority, but it is so high up on the capital stack where the risk is much higher. Why? So now the question is why would, why is it a good time now? Because senior debt lenders, so only banks but also agencies, they have been coming down on the leverage sides.

They’re still going up technically up to 80% but on a programmatic basis, but in reality, very often they are at 65, 70, maybe 75% LTV. With the lenders tightening their credit, coming back overall with their loan to value ratios, that creates an opportunity to come in with preferred equity and mezzanine debt without really getting into the riskier portion that is almost quasi common equity.

Ben Fraser: Great point. 

Bob Fraser: So just to summarize, we’ve seen, traditional credit leave the place. And so now there’s an opportunity for This opportunistic private credit to fill the gap and to be safer down the capital stack. But because there’s such a shortage of capital, they actually can get very good returns. So this is the upper term. 

Ben Fraser: So I’m going to break down now the different types of situations that it makes sense or maybe it doesn’t make sense to bring in preferred equity or mezzanine debt, right? And so you might’ve heard, Distress situations, distress deals, and there are funds that are focused on that.

But to Anton’s point, it can be very risky because a lot of the distressed deals are distressed because of their extremely high leverage. 

Bob Fraser: And there’s no way to fix it. And there’s no way to step into them. And actually rescue these deals. 

Ben Fraser: So there’s two big categories here. I’m gonna break it down into their existing deals that have already been in operation, they’ve already been purchased maybe a few years ago, and they’re trying to get through to that survive 25 and can make it to that next step. The next start kind of new acquisition. So the first of the existing deals, again, the goal is just stabilize the property and hold it until the market improves. In a distressed situation, there’s a lot of reasons they need it.

One is they have an interest rate cap that’s expiring and they need to purchase it, that their lenders are requiring them to purchase a fixed rate cap. And that’s expensive right now. Sometimes lenders are saying, Hey, you need to boost your reserves, your capital reserves, because you’re.

You’re checking the accounts low and you’re had a cash burn. Or they need to finish the renovation program. So a lot of times because of some certain situations that we already talked about. It may have taken longer to stabilize, longer to absorb the new units that they’re renovating.

And so they’re running out of equity because of their cash burn. And so the goal is to protect equity in the situations and this is the most difficult. Type of situation to make work. Because what I have been saying recently is most of these deals have a basic problem, meaning they just purchased it at too expensive of a value with too high leverage, and there’s not really any way that they can make it out.

We looked at one deal the other day that they’re looking for about a $3 million injection on a property that is worth roughly $60 million and. At today’s value, that 3 million would actually be, I think it was 110% loan to value, meaning that the, all the obligations that they had with their senior debt and the new not even the equity was more than the value of the property at today’s value.

And three years down the road, they could hit their business plan, which was aggressive. It would just be enough to barely pay off that, that new injection of capital. That’s a very risky situation and it’s very important to understand if you’re looking at a distressed debt fund, they have a really good strategy going in because it’s very difficult to make those work.

Another way that it might work though in an existing situation, we see this fairly frequently. They actually have really good in place senior debt, right? So it’s the opposite of the distress situation where they have bridge debt, but it was floating rate, very high leverage. It’s difficult to make work.

This is the opposite. They actually have good low rate debt that’s fixed currently and they don’t want to refinance, right? Because say they have a 3% loan on their senior mortgage that still hasn’t three to four years left till maturity. But they do need a capital injection for finishing renovations or increasing reserves for one of the same reasons, but they’re in a much better position.

A lot of times it could even be cash flowing. And the goal here is not to necessarily just protect equity, but actually keep the debt in place and It’s, increasing the leverage slightly, but you have really good in place debt that can help support it. So that’s a common scenario. I have an example here.

I’m going to share on that in a minute. The other kind of set of opportunities and uses of private credit, and this is really where we think the bigger opportunity is on new deals. And the overall goal here is to increase leverage. So as Anton mentioned, because of the credit tightening, banks are pulling back, equity is hard to raise.

There’s a lot of where it makes sense to increase the leverage slightly. to generate what we say, what we think are higher risk adjusted returns relative to the risk you’re taking. And so one of the reasons is a quick close or a funding gap. And we’ve seen situations where either a senior lender falls through at the last minute.

You’re trying to close on a new property, new acquisition, the senior lender backs out, right? They’re saying, Hey, we’re actually not going to do these deals right now. There are appetite changes. We’ve seen that happen. Or they have a senior debt, but they can’t raise enough equity in time to close.

And so those are short term in nature. It’s just a bridge, a gap. And a lot of times, they can raise out of the equity shortfall because they have equity coming. It’s just a timing issue. Another one is loan assumptions. These are really popular right now. This is something that we’ve seen a lot.

We’ve actually done several of these. Where there’s a low interest rate on the senior mortgage, generally agencies like a Freddie Mae or a Fannie Mae or Freddie Mac loan that a new sponsor, a new operator can assume that low interest rate, but a lot of times they’re very low leverage. So it can be 40%, sometimes up to 55, 60%, but that’s pretty low leverage generally.

And so it’s a great time to come in. Behind that low rate senior increase the overall average, but a lot of times they can be cash flowing in a great position and the goal here is to increase leverage and then anti you said one of the most common uses historically and especially now is a new construction because banks are already a little bit reticent to lend on.

on new construction or development, but especially now. And so leverage rates have just plummeted. We’re seeing this, it’s looking at one deal. I think the senior loan is around 45% leverage, it’s very low relative to what it has been. And you can come in and you can increase the leverage a little bit without taking an inordinate amount of risk.

Any general comments on some of these general uses? 

Anton Mattli: No, that’s all great. Again, on the new construction historically. The senior leverage was somewhere around the 60, 65% mark, and then the rest had to be covered with breath equity or mass, but in most instances breath equity and then more recently, everyone was pushing up the leverage all the way to 70, 75%, sometimes even higher.

Obviously there was less need for breath equity there, but now we have moved in the complete opposite direction and now the leverage is actually below the historical average of where the senior lenders come in with their leverage. 

Ben Fraser: So I’m going to share a couple examples here. 

Case Studies: Real-World Applications of Private Credit Strategies

Ben Fraser: So I mentioned the capital injection and so this is one so the multifamily property, you can see a picture of it there.

There is a value add strategy about 75% through the renovation program. The first property manager probably managed the occupancy plummeted in the short term, but they’re back on track and they’ve got it, actually cash flowing, but they’ve run out of funds because they were using their reserves to fund renovations actually to cover their cash burn because of the low occupancy.

And so they needed about 750, 000 to complete the renovations. The in place senior debt was very low, a low rate. And they would increase the funding. And so we put out a Mez loan on this one. We actually are secured on this which can happen sometimes and the goal here is to help stabilize and refine us out.

So we’re maxing out the loan to value at 75%, get a secure position in the property and we’re also charging 15% interest rate plus 2% origination fee. So it’s a pretty, pretty strong return relative to the risk you’re taking. In this scenario, and so this is, current cash flow, have a great path to finish a renovation program, they’re almost all the way done, they’ve proven out of the market rents and it’s a great example of that case where they have the low in place senior.

Here’s another example. So this was a case study of gap funding. So this was because the sponsor couldn’t get the equity in the account in time. They had a short window to close as a new purchase. I was about, they needed 500, 000 to close. And this one we also were able to get secured in and basically it was a 90 day loan to help them close and then get paid off from the new equity coming in to replace that debt in.

From our standpoint, it’s great because it allows us to earn a really great rate of return, but then we get paid off. We can recycle that capital into new opportunities. And a lot of time generates better yields by recycling that capital in a short period of time. This was like I said, 90 day loan.

Made a personal guarantee from the sponsor, experienced sponsor here. And it was a short term thing and I got paid off on this one. A loan assumption. So these are some of my favorites right now because they’re a really great strategy. So this is a sponsor that they’re assuming an agency loan with a 2.

94% interest rate, but the LTV is very low at 45%. And so they’re layering in preferred equity investment of a million dollars that brings up the LTV slightly. It actually helps their returns to their equity investors. And the LTV on this one is only 55%. And so this one is structured as preferred equity.

So it’s different from the last two that were structured as loans. And so there’s differences we’ll talk about here in a minute. And so this one, how preferred equity works most of the time is you have a current portion and a back end accrual. And so the current portion is actually paid out of cash flow.

And while the loan is paid out. And then once you have paid off that remaining back in accrual accrued annually and then gets added to the balance and gets paid off. And in this situation we’re coterminous with the senior meaning we’re at the same term as the remaining maturity in the senior, which is about three years.

So three years, we’re gonna get paid off in this one. And at a. 55% LTV with a new acquisition. This is, I think the in place cap rate on this one is in the 6% range. That’s really strong. It’s very strong cash flow. It’d be very likely that we’re going to get paid off pretty comfortably with the refinance.

And so we’re earning a 14% annual return on this with origination fees. And we have a huge equity cushion to cover our position. So now we’re going to talk a little bit about the different structures here. 

Differentiating Between Mezzanine Debt, Second Position Mortgages, and Preferred Equity

Ben Fraser: And Anton, do you want to give a little bit of context for what’s the difference between mezzanine debt traditionally and second position mortgages, which I’ll share after this one.

Anton Mattli: Yeah it’s a good point to highlight because there has always been a lot of confusion, I think, among EME syndicators, is it, what is a mezzanine debt, what is, what’s the difference to second lien. Very often it’s being used in the wrong term. So the second line is pretty clear, right?

So it’s a second lien on the property secured by the property with a lien on the property and which is really the right after the senior lien. That’s the most preferred option that you can have as a lender, right? Or as an investor But very often you cannot have that because the senior lender does not allow to have a second lien in place.

So that’s where the mezzanine structure and in addition to that then behind that also breath equity comes into place. Compared to the second lien that is secured by the property itself, the mezzanine that is not secured by the property directly. And I think there is a lot of confusion when it comes to that, it is secured by the equity pledge in the borrowing entity, right?

This obviously is not like a single family home where someone buys that property in. His or her own name. The borrowing entity is typically an LLC. It can also be a corporation, but in 99% cases, it’s an LLC. So this is an actual entity that is the borrowing entity. And as a mezzanine lender, You essentially instead of the property itself, you have a pledge in that entity.

If the borrower is not performing, you can foreclose. On that entity interest and ultimately you will own that prop, that borrowing entity at the end, the senior loan is still there, but now you are the equity holder of that property and that essentially is your security in it. 

Ben Fraser: Yep. Makes a lot of sense.

And so it’s very similar to the security loans, but the security. Yeah. Is not in the property itself, but in the entity that is the borrower that owns the property that you can foreclose on and execute your rights. And so the difference here is the collateral on second position loans actually secured by the property.

Sometimes it’s difficult to get a second line behind. Firstly, in most cases, it’s only going to be allowed with traditional banks and traditional banks that are comfortable with that. And we’ve seen in most cases, probably what we’ve underwritten so far, 30 to 50% of the cases, you actually can get a second lien on the property.

But again, it’s not all the time and it can be structured a little bit differently. And then you have preferred equity. And so this is This is different than the mezzanine debt or second position lows in that your collateral is you have no recourse to the property, but a lot of times you can either negotiate a pledge of the sponsors equity, which kind of then blends into the meds that mezzanine debt type, or you also get personal guarantees from.

The operators are sponsors and how this works a little bit differently. I mentioned before that there’s a contract rate of return and it’s split into a current portion, a current pay portion and a back end accrual portion. And so you can continue to get cash flow from the operations of the property and you can also accrue a back end profit for once that.

Property sells or as refinances and pays off the preferred equity. And so the capital protection here is different in different cases. If you are not behind an agency lender which I’ll talk about in a minute, many times you can negotiate certain takeover rights. And you can actually if the operators are not hitting certain metrics hitting certain things that are required by the agreement, then you actually can take over the operations of the property, take over control and decide what to do from there and become the operator.

In this case, you can actually force a property. You can try to default the interest rate. If you’re going behind a loan assumption, so with an agency lender such as Fannie Mae, Freddie Mac, PUD, you’re more limited in the rights that you can that you have. But in most cases those are much lower risk investment opportunities because the leverage rates are usually much lower.

But you also still have certain rights and primarily what’s called drag to market. So you may not be able to take over the operational control of the property. But you could actually force it. A requirement to sell the property at any point in time if certain covenants are not being met. And so you still have kind of an ultimate trump card so to speak to execute your interests in that.

And they also want to add on the PREF equity side Anton. 

Anton Mattli: Yes so maybe like you mentioned Fannie or Freddie they will not allow a mezzanine debt, right? So they do not allow a second lien other than their own supplemental loan that they might be granting. But so only they will not allow a mezzanine debt.

That’s why in most instances then breath equity is the option there. There is some breath equity that also has a hard pay element to it. Naturally the agency lenders do not allow that. So it’s really the traditional breath equity. As long as the free cash flow is available, then you get paid.

If the cash flow isn’t available, then You are not going to get paid. So it’s, you solely do not have the same hard pay as what you would have with a mezzanine debt or with a second lien. But as you have mentioned before, typically you would not want to come in with a high leveraged breath equity anyhow, but particularly when it comes to these loan assumptions where the in place senior loan might be 45 or 50%.

In your case, it was 45% LTV. And you add another 10% of breath equity, you have still a 45% cushion in that example you have had. So yes, you do not have that hard pay, but you have a significant cushion there. So that’s your primary protection on a day by day basis to get paid. In addition to all the remedies that we have talked about.

Bob Fraser: Let me just summarize here too. So we’re talking about three areas that we really like, where we think there’s a lot of opportunity, it’s It’s a second mortgage debt. It’s a pref equity and it’s mezzanine debt. All of them are lower in the capital stack. So much lower risk. And all of them have different ways of protection where you’re actually in the driver’s seat.

You’re not directly in the driver’s seat, but you can make things happen. You can protect your investment and by, by forcing the borrowers to do something or by taking over the property. So they all, and the mechanisms are all different, but they all have mechanisms where you’re in the driver’s seat.

So all of them are great opportunities and just, it really comes down to what are you able to do? What will the senior lender allow and what will the borrower accept, to pick which one of these will work? But all of them can work to different degrees in different situations and all of them are lower risk and all of them are protected.

Ben Fraser: Okay. Final section here. 

Keys to Effective Underwriting in Private Credit Investments

Ben Fraser: And this is what are the keys to good underwriting? Because we’ve talked a lot about the differences in the different risk spectrum of. Super distressed situations versus a new acquisition with a loan assumption, a low interest rate, right? Those are two very different types of deals, but across the spectrum, there’s some standards that you want to look at and the keys to underwriting.

This is not exhaustive, but these are what we feel are the most important thing that you want to look at when evaluating whether something, an investment in this type of vehicle makes sense. And so the first and foremost and anytime said it several times throughout today’s presentation but cushion margin leverage ratio, talk a little bit about that and why that’s so important and how also debt service coverage ratios come into play in this part of the underwriting.

Anton Mattli: Yes sure you also have mentioned the word basis and that’s why a lot of sponsors are now in trouble. Because of the high basis that they bought at. 

Bob Fraser: They paid too much. 

Anton Mattli: That’s right. They paid too much combined with too high of a leverage, right? We know of several deal sponsors that also paid maybe on the high end, right?

And it’s always, looking back, hindsight is always 20 20. But they came in with a much lower leverage instead of 80% LTC plus breath equity on top, they meant when with 65 to 70% LTC. So they are still in a position to service that debt and also refinance out of that debt. And when it comes to underwriting for breath equity mass or second lean, The same principle applies, right?

So we always need to think of whether we have the ability to actually get out of this loan or prefacuity down the road once the refinancing or a sale takes place. And that assumption obviously has to be really important that it’s correct. So when we look back to 2021, everyone assumes That you will be able to get out at a roughly 4% interest rate agency loan.

As we know today, those rates are at five and a half to 6% for a larger loan. So that was a complete misjudgment. And. With that naturally, the debt service coverage ratios that were assumed back then also do no longer work, right? So this is what we talk about. Cushion. We need to do stress testing.

We need to understand what the base case scenario looks like, but also where potentially the worst case scenarios and are still able to get out of it. 

Ben Fraser: Yeah. 

Bob Fraser: What administration on value, meaning if the, if we had to liquidate, there’s a cushion where we’re not going to lose money. And a cushion on cash flow. So meaning they can pay them, pay our loan and have a cushion. Two, so two cushions. 

Ben Fraser: And the other big one here is business plan, right? What is the use of the funds and what’s the likelihood that they’re going to be able to achieve the plan in the timeframes that they’re shooting for?

And to me it comes down to what have they proven the market and the property so far, right? If in the one case I, I shared earlier where they have the in place debt that has a really good low fixed rate, they’ve renovated 75% of the units. And they’re all fully rented. They’ve hit all the pro forma rents that they were expecting.

And it’s just a matter of getting the remaining 25% renovated and rented out. And they’ve seen a lot of market demand. And they’re not trying to be too aggressive on the rates they’re going to hit. So that’s a lower risk business plan when it’s already been proven out versus, Hey, we’re coming in and we actually have to achieve 25% higher rents than our proforma.

And we’re hoping that we can get to those just to get to break even cash flow, right? So understanding the underlying driver of what’s needed to drive that healthy net operating income up is very important. And then you mentioned interest rates are such a key component, these interest rate assumptions.

So what if interest rates don’t go down in the next couple of years, right? We think the likelihood is that they’ll probably start trending down, but if you’ve heard any of our content over the past year or so, we think interest rates will be higher for longer and that’s going to further drive this opportunity for a period of time.

So when you’re looking from a preferred equity position, mezzanine debt position, your primary question you ask is, how do I get taken out? How do I get paid off? And a lot of times the term of your investment from a preferred equity standpoint may not actually match the full term of the business plan that the operator is planning on holding the property.

For example, they might have a five year hold period to operate the property. We might have a three year term. Or so at that point. We’re underwriting a refinance and being taken out and paid off for refinancing into generally some type of agency loan product. And so when you’re looking at those types of products, agency lenders are whenever it’s rated as at that time they’re sizing it, what they call it to the net operating income that is likely going to be generated at that point.

So you want to understand. What’s a realistic net operating income for a stabilized property that an agency underwriter will underwrite to be able to take out. If you want to have a lot of marginally, like you want to stress test it like Anton said and make sure there’s plenty of cushion at that point when you’re planning to be taken out to get paid off.

Bob Fraser: And then let me just add something there, Ben, because I think people may not understand this, but. So a lot of times the operator will send us a pro forma, right? And they’ll say, here it is. We don’t really use that. And you can’t cause that underwriter, right? You’re coming up.

You’re basically in here’s what we think is the realistic business plan. Here’s what we think are realistic assumptions. And we come up with our own kind of secret business plan that we don’t really share with them to make sure. The two, to make sure that we can, to make sure the business plan is realistic and make sure the takeout possibility is actual, also realistic.

Ben Fraser: I’ve talked about this a lot in some of my underwriting one on one. Content on our podcast, but one of the biggest drivers of any proforma is the inflation assumption. And so if you just change your inflation assumption from 3% to 5%, every deal’s great and every deal works.

And so what we want to look at is what’s called trended versus untrended rents. So you want to look at an untrended proforma, meaning You’re not adding in the element of inflation into the proforma, which is going to make everything look better. So you want to look at what is the current state right now.

If you don’t achieve any inflation in the next couple of years in your rents what does that do to the NOI at the day? You want to look at what the untrended proforma looks like. Cause that’s going to give you a much better sense of, if the market just stays as it is, right.

It’s not going to increase and improve. And in some markets, that’s probably going to be the realistic case or in the Midwest. That’s actually probably conservative, but we still want to make sure that we know what is going to happen if rents don’t go up, that’s a very important metric to look at.

Bob Fraser: And we want to underwrite to the exit. So you’ll look at, Oh, if they’re, if they were expected to be taken out in three years, we’ll understand what are the interest rate and cap rate assumptions in three years to make sure that they are realistic, that there is a, there is a. High likelihood that we will be able to take, be taken out at that time.

Ben Fraser: Yeah. So on trend, it just means the inflation rate is zero. So this is as simple as it is. So Anton, what about sponsor strength when you’re looking at placing these loans with the lenders you’re working with, you placed a billion dollars last year. This is a big factor, right? That it’s very important to understand and what do you generally want to look at and see from a sponsor standpoint when trying to help with these situations?

Anton Mattli: Yes so track records have been thrown around a lot particularly during the good times everyone showed. So we doubled the money in two or three years and we had an IRRs of 25% plus. So everything looked great, right? However, what no one really was talking about is where these returns came from.

And when it comes to track record, one of the key pieces is to actually understand the operational track record, right? All these successes are always driven by operational performance and the markets. And over the last few years until the middle of 2022, a lot of deals did not do well operationally, but they still were Blazing successes because of the market.

So it’s important when you look at the track record, what is the true operational track record? So that’s really an absolute key there. And for the similar type of property as what is being discussed, right? So if someone has. Let’s say success with a 20 unit property. It’s very different than if they look at the 200 unit property, that doesn’t mean that they have really the ability to do that, replicate that on a 200 unit property.

Ben Fraser: Yeah. Great. Great point. What about financial strength? 

Anton Mattli: Yeah, financial strength from a lending perspective, we always look at it as a as a base case scenario that the net worth should be equal to the loan amount which is when it comes to the senior debt equal to the senior debt, obviously, if there is an additional debt, whether it’s breath or mess that is being added to it, that should also be taken into consideration.

Liquidity. The sponsorship group should also be around 10% post closing after down payments and excluding acquisition fees, roughly 10% off the loan amount, whether it’s just a senior mess or secondly, and everything combined. So that kind of gives a reasonable question where someone can be comfortable with that.

Obviously it’s important to understand whether these numbers are. Or really readily be available by, particularly when someone has a lot of businesses that may show a lot of liquidity, but if that liquidity is tied up in other businesses, it doesn’t really help. 

Ben Fraser: And then the last one is the skin of the game, right? How much do they stand to lose if they have to hand the keys back to the senior lender. And a lot of times, sponsors haven’t invested any equity of, or any of their own cash into the deal. And. The only thing we have to lose really is the reputation, which. It’s important, but at the same time, there’s nothing that speaks louder than cash that they’re at risk to lose if the property doesn’t perform.

Anton Mattli: Yes. Unfortunately we have seen a lot of games that were played over the last few years when everything goes up. White sole lenders look the other way and very often even though on paper, someone actually invested money they didn’t really invest much. And if you have five general partners in a deal, sometimes even more.

Maybe the combined investment is 5% of the total cash equity contribution, but if you split it up among 7 people, it’s not really enough that it would hurt any of them. So I think one really as a lender or breath equity provider one really needs to understand whether that skin is in the game.

Is making an impact on that individual and is that individual willing, if there are issues, to really work hard to keep that deal alive. 

Ben Fraser: All right. That was a lot of information. 

Conclusion and Invitation to Join Investor Club

Ben Fraser: We appreciate you all sticking around. And this is really great to have you all here. This will be recorded.

And available to watch on demand. And really from here, we encourage you, if you’re interested to learn more about this, sign up for our Investor Club. You can take a picture of this QR code here on the screen. That will take you straight to our Investor Club page where you can sign up to be notified and ultimately get early access to deals.

And there will be a lot of information coming out soon about our latest private credit fund that we’ll be presenting here very shortly. And so if you want to get first notified about that, please be sure to sign up for that and appreciate you all sticking around and thanks so much.


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