[Part 1 – 3] How to Source the Ultimate Deal… (A Wall Street Pro’s 5 Best Experiences Over 17 Years)

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I’ve said it before and I’ll say it again — the best opportunities are those that are not widely marketed.

In industry speak, if the deal has been “shopped around” a lot, it’s a dud. No one wants to see it. It’s been passed on.

Where do these deals go to fester? Craigslist. Facebook. It’s a digital sewer of desperate and clueless brokers looking for any way to get a deal closed.

LinkedIn,® too – if not used properly…

So the question remains, “What have been your best deal sourcing experiences?

This is a great question you’re going to want to pay attention to closely if you’ve ever thought about starting your own real estate investment fund or joint venture. As I’ve mentioned before, your investors are going to want to know what your “edge” is…

Your special sauce that makes you different than all the other guys out there with a tin cup in hand asking for money.

As someone who has been around the block a fair few times with deal sourcing, I have plenty to share. But in this 5-part series, I’m going to share my — you guessed it — five best experiences.

And if you follow this correctly — actually follow through — you’re going to see quality deal flow. And no one ever went broke who could source meaningful deals.

…And I don’t mean the marijuana farm in Searchlight, Nevada nor the dilapidated manufacturing facility in Flint, Michigan.

The name of the game here is relationships. I’ve talked about it before here. If you’re not good at relationship building, that’s not a problem. So relax. Just make sure you have your intern or domestic VA shake the trees for you.

Before we go deep, you must understand where pressures come from in commercial real estate. It’s not the same as in residential. Once you know that, this exercise becomes much easier for you and your staff.

Priming the Pump

Before we dig into the details here, you’re going to watch these 3 short and right-to-the-point Five Minute Fundamentals videos that explain how waterfalls work in commercial real estate.

Video 1: The Senior Loan

 

Video 2: Mezzanine Financing

 

Video 3: Preferred Equity

 

Now let’s get to the fun stuff…

Commercial Pressure Points

….Where All Problems In Commercial Real Estate Can Be Linked Back To

Part 1 – Equity Investors Want To Be Taken Out, Haven’t Been Paid, and/or Have Faced Capital Calls

Generally speaking, when a fire occurs in commercial real estate, stress comes from the top down at first. The top meaning the top of the capital stack.

And at the top of the capital totem pole are the equity investors.

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In the smaller balance commercial space (meaning assets less than $30mm in value), you’re going to see a lot of syndications and partnerships start to feel antsy. Most of these equity investors are retail investors, meaning moms and pops, who haven’t gotten paid or are looking to invest in the next shiny object.

Regardless of what they are — they want out.

What also makes this interesting is that depending on how this asset had been managed, their manager or owner-operator may have just made a capital call.

In short, this means that the investors, or Limited Partners (“LPs”), have to come out of pocket to pay for things like…

  • deferred maintenance
  • taxes
  • debt service…

You get the idea. So they’re antsy.

Antsy, but really not in so much control as they don’t really know what their rights and remedies are: some of these are friends and family of the owner-operator who invested in the operator and not the fundamentals of the deal, or they may not know the owner-operator and these equity investors were merely just pooled together by an RIA or some other mechanism such as a crowdfunding platform.

Whenever you hear of a “partnership blowup”, you usually think of 2 guys who are fighting like cats and dogs, right? No. This is exactly what it means most of the time.

The investors are frustrated and angry. They were promised one thing and the reset on that promise has been extended several times.

Strategy: Capital Formation, Capital Placement

Capital Formation

In a prior post, we introduced the methods of how pros quietly assume loans…

  • without pledging their credit and personally guaraneeing a loan…
  • with very little – if any – of their own money…
  • without paying superfluous bank assumption fees that range from 1-2%…

If you’ve not read that post, I would strongly urge you to go back and familiarize yourself as to which assets you’ll want to portfolio and where to find them and the reasons why they must be assumed.

Capital Placement

The only capital providers who would like these are those who are discretionary, smaller-balance to middle market private equity firms.

They are not permanent lenders like life companies, banks and other portfolio lenders. They structure and customize the financial product around the problem.

Sometimes they are:

  • bridge debt
  • preferred equity (“pref”)
  • mezzanine
  • common equity

These are called structured products.

The only thing you need to know is that it is shorter term, and will cost more.

Many times, an owner-operator can negotiate with their current mom and pop LPs for a discounted equity repayment if they relieve them of their capital call obligation.

Bonus: In an upcoming blog post we’ll be discussing the growing market for LP Secondaries, which is buying equity interests in funds and joint ventures for a fraction of their value.

(NOTE: Want access to my business vault? Right now I’m offering access to my systems, strategies, templates, trainings, and recordings. It’s all included in The Investor’s Syndicate, and is available to you here.)

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How To Find These Deals

Some of my best deals – and investors actually – have come from busted partnerships.

Here’s how this story usually goes…

An inexperienced (and usually financially weak) owner-operator finds something interesting to buy. Almost always, it’s at the top of the market. So they syndicate the equity capital they need in smaller $50,000 – $100,000 chunks from friends and family. It is a stabilized asset, meaning it’s throwing off cash today.

Lending is loose, and the banks will extend him a loan. He has the debt, and he raises the equity around it. In my experience, this owner-operator syndicates almost 100% of the equity he needs. (I’m purposely keeping this simple so you can see how you can search for these opportunities.)

Fast forward to a point later on in time and a different point in the cycle and now he can’t sell it. Lenders have turned a cold shoulder to him; the capital markets are very volatile (sound familiar?) and any offers he has is not at the same level he got in at with his investors. He may not will not be able make his investors whole.

Now stay with me here as this is how this whole thing goes down in real life.

Who is the first person these investors usually call? Take a guess, I’ll wait.

If you answered their attorneys, the answer is a resounding no.

Why?

Because the attorney will want a $5,000 retainer to dig into this deal after that same attorney reminds them that the docs they signed stated that they were grownup investors who were sophisticated and knew what they were doing and understood the risks.

And by stroking that check, the investor is putting $5,000 to…

  1. “Save” his or her $50,000 equity investment.
  2. Admit that they are not sophisticated. As you can guess, not many people can emotionally do this.

So the only thing the attorney could possibly do is to read over the Subscription Agreement — oh, and the 120-page Partnership Agreement to look for any technicalities that could be challenged.

Also, right about after $4,000 of the $5,000 retainer is eaten by the attorney, that attorney could find out that the docs read that the LPs must have 51% majority control to force the owner-operator out as manager to liquidate the holdings, and now the same investor would have to take their time to hunt down the other investors to find out who they were (assuming that this LP didn’t bring his friends and family into this deal, very awkward…).

Very time consuming.

So who will talk for “free”?

Their accountant. But not just any accountant, no.

Meaning not “Pistol Pete,” the W9 tax preparer at the H&R Block next to the yoga studio, but those who specialize in partnership accounting and do file Form K-1s for partnerships.

A simple Google Search will bring this up. Unless you live in a place where there ceases to exist United States citizens who don’t have to file tax returns, you can find this in your hometown, too…

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Now my story goes a little deeper. I was looking for assets in a particular area, and I knew that most of these investors had retired to Palm Beach and Miami. So now I targeted larger deals, and presumably wealthier investors.

What did I do?

I simply called some of those who had paid for the Google Ads you see (I’ll explain why in a second) and gave them my Elevator Pitch.

“Hi, this is ____ from _____. We’re a discretionary capital provider for commercial real estate. We specialize in providing equity for partnership buyouts.”

Now, the last thing that CPAs want to deal with is anything that gets in the way of being able to spend time on a Disney Cruise with their family after a tax filing deadline. They want their fees, push their paper and that’s it.

So imagine how a CPA feels — who bills by the hour — listening to one of their angry clients calling them and looking for a way out. They want nothing to do with it.

These guys, if you court them well, will also love you. Meaning, “Just send me an email and I’ll see if I can dig into this.”

I didn’t stop there.

After about a month or so of talking and him feeling me out, going on to my website (because you’ll never get this kind of credibility using your IFLIPHOUSES69@AOL.COM email account), I sent him an email that sounded like this, purposely in August ahead of October’s filing deadline, that sounded something like this:

“Hey Frank, hope you’re summer is going well in Boca. NYC has been sweltering.

Anyway, I spoke to the partners here at the firm and we would be interested in covering your hard postage costs for you if you can send a flyer out with your client’s K-1s. We would cap this at about $5,000 for now; anything over than that let’s discuss.”

Not only did he agree, but it was a raging success. He had 400 clients. That was about $1,000 including printing and postage — to recipients who absolutely had to open his letter for statements. Much like when I was younger and report cards were sent home to mom and dad.

Frankly speaking, we weren’t equipped to manage all of the calls. We got about 80 call backs before we got smart and initiated what is now known today as the Dandrew Answering Service.

And people will hunt you down. They are motivated. They want out.

In one instance, someone sent their daughter-in-law to our office at the time on Fifth Avenue, unannounced. Because they didn’t get a call back fast enough. And she lived in Connecticut. (Imagine that. Someone driving a Crown Victoria with Florida plates complaining about something not happening “fast enough”…)

Now, why I targeted the Google Ads is because these accountants are spending money on new leads for new clients, and Google isn’t cheap; these guys are bidding on specific keywords. They understand the business and would probably be willing to make a deal to offset their hard mailing costs.

That was an ace in my pocket.

These guys were a little savvier and probably willing to wheel and deal a bit.

Comparatively speaking, the guy who is listed on Page 15 probably doesn’t want any new clients, and is happy with those same clients he’s had since the Kennedy Administration and just wants to retire soon.

Now here is how you put this together.

Like Lay’s Potato Chips, no investor can invest in just one deal. The exclusivity of these “golf and cigar guys” investing alongside other allegedly “sophisticated” investors in “hot deals” was too much for them to resist. And, based on our experience, it is more than likely that they have other deals they are looking to unwind out of.

(We’ll talk more about my experiences with loan issues in Part 2 of this series, so make sure you’re bookmarking it and are subscribed to our list.)

But that’s beside the point. You want to know who the other owner-operators are who bought at the same time, as those owner-operators may have other issues, such as their loans being called.

  • Take their calls.
  • Talk to them.
  • Ask them about this deal.
  • Ask them if they are involved in any other partnerships.
  • Ask them for the name and contact number of the owner-operator to see if you can refinance them out.

“Refinance” is a word they will understand. But you’re not looking to refinance anyone or anything yet. You need to get to the ring leader and find out if he has any stresses. Remember, if he doesn’t now, he will later. Make sure you check in every once in a while.

When you get to the ringleader, tell him what you do and to see if he’s buying anything.

Here’s how that conversation may go:

“Hi, [Owner-Operator], my name is _______ from _________. We’re a discretionary capital provider. Sometimes we’re debt; sometimes we’re equity.

Our core sponsors are people like you who have found something interesting to buy but don’t have all of the capital they need.

On the other side, for those looking to get out of current loans, we can provide short term debt or equity for those sponsor’s facing balance sheet challenges.”

Then shut up for a moment and see what they say.

You’re not going to hear their problems first. They want to get to know you. Also, you’ll want to ask this very important question:

“What other assets do you have besides this one?”

You may not get a kiss on the first date, and that is fine. But you are planting the seeds for a follow up. They will want to – again – check you out. They’ll go to your website, LinkedIn profile.

These seeds will be harvested later when any of the below happens:

  1. The lender pressures the owner-operator to pay off the loan.
  2. The IRS does the heavy lifting for you via a vicious depreciation recapture.
  3. The operator decides to cut costs by firing the management company (novice move).
  4. Tenants are complaining because their roofs are leaking, and there are no reserves.
  5. All the above.

We’re out of the gate with part one of my best experiences and trust me — I’m just getting started. Remember what I said, if you follow through, you’re going to see quality deal flow like you didn’t think was possible.

(NOTE: Want access to my business vault? Right now I’m offering access to my systems, strategies, templates, trainings, and recordings. It’s all included in The Investor’s Syndicate, and is available to you here.)

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Part 2 – The Senior Loan 

Let’s paint another backdrop here.

Not all lenders are equal in commercial real estate and this is where a lot of aspiring – and existing – owner-operators get lost, confused and waste a lot of time.

Remember here, we’re targeting those lenders who are more motivated than others as defined by the risks that they have. For this, we have put together a blueprint to reference called The Commercial Real Estate Matrix of Capital Providers.

Commercial-Real-Estate-Contunuum-of-Capital-Providers

 

 

 

 

 

 

 

 

 

 

This blueprint will give you an industry-wide orientation as to who does what across the capital structure.

For the purposes of this post though, we’ll only want to focus on the banks for the following 4 reasons:

  1. If the lender is regulated (meaning FDIC Insured), they will be forced to take a larger write down once the property becomes REO. Lenders cannot sustain large REO portfolios, as they will require greater amounts of capital.
  1. If a lender is non-regulated, or private, they do not have capital charge issues, but they will have non-earning asset on their books.
  1. The amount of REOs a lender can afford to have is directly related to the lender’s net worth and liquidity. In other words, a $10,000 loss means a lot more to you than, say, Warren Buffet…
  1. Most lenders seek to sell their REO assets quickly, in order to free up cash.

Now let’s briefly touch on defaults. You’ll see why in a moment.

By and large, a mortgage of trust deed is an….

 Enforceable lien, meaning the remedies in the case of a default is foreclosure of the secured asset.

There are two types of defaults: a monetary default and a technical default.

A monetary default is seen as being the most severe. It means that the owner-operator has stopped making principal and interest payments. The lender will probably start filing legal notices and that may or may not result in the owner-operator filing bankruptcy.

How this happens?

Simple.

An inexperienced buyer comes in and overpays for something. How were they able to overpay?

Again, simple.

They got the “reach” financing to stretch the value of the deal to get it closed from a lender who – at the time of purchase – cared more about their profits than the risks they would have to deal with later. Think of getting a loan based off of the pro-forma NOI.

A technical default is more common than you think. In fact, whenever you get a permanent commercial loan from a lender, you’re already in default on Day 1! See, the covenants in the loans docs may be structured so that the lender can call the loan due at their whim. It happens a lot and mostly when the capital markets dry up and lending isn’t as lose.

The same banker who took you out for a $200 tomahawk ribeye and creamed spinach closing dinner is now not your friend. He or she is cold.

…And wants their money back.

An example of a technical default would be that a loan is maturing and has a balloon that needs to be paid off. It is past its maturity date, the owner-operator is probably still making principal and interest payments (depending on the terms) but the lender is breathing down their neck.

Every loan has a….

 Cure period, meaning all defaults will typically have time for the owner-operator to fix or cure the problem.

Strategy: Capital Placement

Now that we got that out of the way, let’s look at the numbers. Approximately $1.3 trillion in smaller balance loans are coming due soon. Regulators have already put the brakes on those “reach” loans and it will be the private, boutique capital providers and private equity firms to the rescue.

Not another bank or conventional lender.

The scenarios you’ll see are Discounted Pay Off (“DPOs”) opportunities where an owner-operator may have the opportunity to buy his or her note back at a discount. Placing bridge debt (like hard money) or equity from qualified institutions is the play here for you.

Other more severe defaults on over-leveraged properties where the bankruptcy is the last gasp for the owner-operator. Here, arranging and placing Debtor-In-Possession (“DIP”) financing is where you’ll add value.

Often more complicated, these are super-collateralized first trust deed loans at very low LTVs that are ahead of all others in the capital stack as mandated by a Federal Bankruptcy Judge.

If you want to know who the most power people are in America, they are the Bankruptcy Judges.

How To Find These Deals

Monetary Defaults

Personally, when I was starting out, and I badly needed deal flow, I would call real estate attorneys.

Here’s the interesting part: lawyers know law, but they do not know structured commercial real estate finance as well as you do (or will after reading this blog). The smaller attorneys do not understand that there is specialized financing available.

They are merely just trying to stop the bleeding and stretch out the time the owner-operator has to scramble together financing (often to the benefit of their billable hours, but that’s a whole different conversation…maybe we should have it).

When I was fresh out of Wall Street, I dialed until I smiled and found a 63 unit student housing community in Oxford, Mississippi that was in bankruptcy. And this was in the early 2000’s when lending was getting looser by the day!

That was my first deal as a principal bid and many Intermediaries have used that strategy successfully still to this day.

It’s about finding the deal that isn’t widely shopped where you can provide immediate value.

So where do you find these diamonds in the rough?

Legal filings.

I found a paralegal who had access to the LexusNexus® database to perform searches for real estate-related entities that hold real estate assets who have filed for bankruptcy. It cost me a few bucks and was infinitely valuable.

On each of those filings is the name and contact info for the Bankruptcy Trustee. You now know what to do next.

Remember, you only want real estate assets, not corporations that are over-leveraged.

Only real estate assets. No bankrupt manufacturing businesses, waterparks, or restaurants. Big difference.

Technical Defaults

These are going to be sources more from smaller, regional local banks that have held onto these loans over their term; they never sold off the loan.

Similar to George Bailey’s “Bailey Savings and Loan” in the Christmastime classic movie It’s a Wonderful Life, these lenders keep these loans in their portfolios over the 5, 7 or 10 year term.

Now they have past maturity, and all accounting principles aside, these loans need to be refinanced of sold.

Download the How To Target Smaller Banks Loaded With REOs and NPLS Commercial And Residential Blueprint.

How-To-Use-The-FDIC-Website-Infographic-Resi-And-Commercial

Then call local, smaller banks with – and don’t violate this rule – less than $4 billion dollars in assets.

(No one cares about your brother-in-law who is a teller at Chase or Citi. They are already in a protected class called “Too Big To Fail”, so the Fed Reserve will take care of their own. Got it? Good. Let’s move on.)

Tell them the same thing you would tell other people. That you’re not a buyer but a financier and stick to it. Your lead in should sound something similar to this:

“Hi, this is ____ from _____. We’re a discretionary capital provider for commercial real estate. We specialize in providing debt and equity for smaller lenders such as yourself who may have some legacy assets and borrowers you’re looking to get taken out of. Wanted to see if there was anything on your balance sheet you were looking to move.”

Not much different than what we’ve done in Part I of this series; we’re building relationships by keeping it simple.

See you in Part 3.

(NOTE: Want access to my business vault? Right now I’m offering access to my systems, strategies, templates, trainings, and recordings. It’s all included in The Investor’s Syndicate, and is available to you here.)

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Part 3 – Targeting Smaller Private Lenders

Strategy: Capital Formation

Hard money or private lenders can be a great source for these deals. Many people think that hard money lenders are larger institutions and some are, most aren’t.

Let me tell you a story.

When I had my first fund we were looking for the low hanging fruit and I was the partner in charge of deal flow. When markets are on the upswing, many people get into the real estate business. And out come the private lenders.

What you’ll find is that the private lenders are made up of 2 people: one guy that has the money, and the other one who sold the money guy on the idea of being a private lender.

I affectionately called these smaller lenders with unsophisticated pools of capital the “pinky ring” crowd; all residential mortgage brokers who wanted desperately to manage capital and sourced capital from their friends and family.

The hard money lending business is a very fragmented business with a lack of a centralized knowledge base, especially in residential. If you’re looking to harvest assets, this may be a gold mine.

I wrote an entire book dedicated to starting and managing a profitable private money fund. This was off of all of the mistakes that I mopped up after the credit bubble burst in 2008-2009.

Back in 2007, people were piling in to the private lending business. Doctors and dentists were placing money into real estate rehab deals.

When I was calling on these lenders my lead in was this…

“Hi, this is Sal calling from Dandrew. Wanted to see if you had anything you’re looking to divest of.”

The answers were at times incredulous, but followed this pattern as time went on…

“All of our loans are awesome. They are paying on time and our borrowers are awesome. In fact, I’ll tell you that we’ll never have a default. Our underwriting procedures are on loan from God. Actually, Sal, you should invest with us!”

Now, having grown up professionally in the distressed space, I’ve seen and heard this before. My mentors all knew that this would end in tears. You can’t outsmart Mr. Market any more than you can challenge Mother Nature.

Fast forward two months…

“Hey, it’s Sal, how’s the resi lending going still? You affected by Bear [Stearns] at all?”

They’re reply…

“Are you kidding, we’re not messing with residential anymore. That’s for the little people. We’re now doing development loans! Why don’t you just invest with us?! We can guarantee 15%! Even hot shots like you have to salivate over that one, right, Sal?”

Me…

evil-laugh

About 3 months later, the sonic boom heard around the world called Lehman Brothers rocked the capital markets.

Instead of outbound calls, there were more incoming calls than I could handle. My cell phone would be getting urgent 911 texts. All hours of the day, weekend and holidays.

“What’s going on? How’s the ‘development’ business?”

Them…

“Hey, I know you’re always looking to buy stuff, and now we’re looking to get out of some of our loans.”

This was fun…

“What are your pricing expectations?

Them…

“I need par and I can’t take anything less.”

Oh, really?

“I’m going down into the subway now and I’m going to lose you. I’ll call you later…”

To these guys, the call back later was something that they waited for in earnest like the tax return check from the government. It would come, you didn’t know when, and there was no one else you knew of at the time who was going to send you a check just for waiting.

The reason why these folks needed par is because they didn’t want to have to tell their investors that the ship that God couldn’t sink was sinking. It hit the proverbial iceberg and these guys couldn’t depend on the subprime or CMBS market to get them taken out.

Every time someone told me par, it seems as though my cell phone lost reception.

As a rule: Time and circumstance will change all sellers’ minds.

I knew that all of their investors were calling them wondering about how their deals that they were in were going? About 50% probably wanted their money back.

These “Rolls-Royces” of lenders were now laying in a pool of their own sweat.

And for the next 3 months my cell phone would ring and ping like a Las Vegas casino.

After time, par would be reduced to, “What can you pay for this”?

Without going into too much detail, the only thing these guys were great at were fleecing their investors.

Here’s an example: if a developer needed to borrow $5,000,000, often he or she would be able to get that $5,000,000 – most of the time without ever putting any of their own money in.

The hard money lender would be incentivized to make the loan as high as possible, because right off of the top they would shave 5 points for themselves.

So that would be $250,000 in fees that should have gone into a slush fund for rainy day-related costs such as expensive foreclosure costs. But remember, pinky rings and gold bracelets cost money, too.

The net proceeds to the developer would be $4,750,000, and if anything went wrong with the loan, well the investors would be sandbagged with those issues.

In other words, the persons who made the loan had no alignment of interest with the investors whose money they used to make the over-inflated loan.

They spent their vig, the investors were now on the hook.

Are you seeing where this is going now?

So when I actually drilled down into the Excel spreadsheet that detailed these assets, most of them were undesirable assets like lizard and snake land in rural Arizona, or a small, remote development in Idaho.

This is what happens when you go outside of your core competencies in an overvalued market.

So you can imagine the pressure these hard money lenders are feeling when they told their investors that they would only be lending on single family residential homes and later went into risker deals they didn’t understand the risks of.

To the investor, this is like your foster parents switching in the middle of the night. The industry term for this in the hedge fund world is “style drift”. I call it “bait and switch”.

What does this mean for you? Many times these lenders will sell these assets for a song, or even more interestingly, will allow you to simply take over the payments of the project.

Why?

It’s more important for them to show to their investors that the loan is performing than to have to come out of pocket to pay those prohibitively expensive costs to foreclose that they spent already anyway.

Until next time…

(NOTE: Want access to my business vault? Right now I’m offering access to my systems, strategies, templates, trainings, and recordings. It’s all included in The Investor’s Syndicate, and is available to you here.)

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Salvatore M. Buscemi
A former investment banker for Goldman Sachs in NYC, Sal is one of the nation’s leading authorities when it comes to investing in residential and commercial real estate. He’s raised over $50 Million in capital for his real estate hedge funds.

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Salvatore M. Buscemi

About Salvatore M. Buscemi

A former investment banker for Goldman Sachs in NYC, Sal is one of the nation’s leading authorities when it comes to investing in residential and commercial real estate. He’s raised over $50 Million in capital for his real estate hedge funds.
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