Multifamily Loans and Lending with Rob Beardsley
Rob Beardsley from Lone Star Capital joins us to teach us about the detailed reality of loans for commercial real estate. Rob is a multifamily real estate expert, and will give you an insider’s look at the best debt vehicles out there today for multifamily real estate investors.
Debt taken out on cash flowing real estate is what we call “good debt” - not all debt is created equal. Consumer debt costs you money, where debt on cash flowing real estate can drastically amplify your return and allow you to acquire large assets that essentially manage themselves.
This is a nuts-and-bolts conversation. If you’re looking for actionable information, look no further!
“You should go a step further and look at what is the loan to cost. also, what is the loan to value based on pro forma valuation.”
“Everything checks out, and then the lender comes back and says, “Yeah, well, we can't get to that number, it's going to be 9 million” that could change up the deal completely.”
“If we have 200 unit property, we can actually in a day or two, walk every single unit and assess the condition of the critical components and interiors.”
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Email [email protected]
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With a background in business and computer science from Carnegie Mellon University, Rob leads the underwriting and structuring function for Lone Star Capital Group. Prior to co-founding Lone Star, Rob had extensive real estate experience through his family's numerous real estate businesses including development, construction, sales, and investment. Additionally, Rob enjoyed a data analytics stint with a global retail company in NYC with annual sales over $50,000,000 where he implemented database and reporting solutions. Rob also actively publishes articles and whitepapers about real estate capital markets, multifamily strategy and deal structuring.
Rob Beardsley 0:00
Right, you have to be looking at a business plan where it makes sense, you can get a lot of bang for your buck. at a minimum worst case scenario, every dollar you put in and capital expenditures would get you $1 increase in valuation. Typically this is not we're looking for we're looking for a 123 benefit, or you know, or even more.
Welcome to Passive Wealth Strategies for Busy Professionals. Today our guest is Rob Beardsley. Rob has acquired over $40 million of value add multifamily real estate, and he is the founder and principal of Lone Star Capital Group, and New York City based private equity firm. He writes and buys deals in the Houston area.
this is a great conversation about debt on multifamily. We haven't talked about multifamily loans yet. this is important for sponsors, the passive investors to understand me, the sponsors have to know it up and down.
Passive investors as you'll see throughout the discussion, don't take on as much risk as the sponsors do. we'll get into why that is. But it's still good to know so that you understand the plan. you can evaluate the deals that you're looking at more thoroughly. really vet whether the sponsors plan fits what you believe to be true about a particular deal area, what you think is going to happen in the future. whether or not the team works together and everything. it's a fun discussion, a lot of really information dense.
pull out a pen if you're sitting somewhere, you're not driving, pull out a pad of paper and a pen, and start writing some stuff down. Because we're really going to go through a lot of dense information that might you might have to go back and re listen. thanks again for tuning in. without further ado, here's the interview. Rob from Lone Star capital. Thank you for joining us today.
Rob Beardsley 2:14
Thanks for having me.
So I'm excited to talk about the debt aspect of investing in multifamily real estate and this is important for active and passive investors alike. can you explain to us from a high level, what's available out there for multifamily investors from the debt side of things?
Rob Beardsley 2:43
Absolutely. there's a whole ton of liquidity in the debt market for multifamily real estate because it's a historically and lately well performing asset class. many lenders are in the business and interested in putting capital, but primarily the most competitive and best terms are available through Fannie Mae and Freddie Mac.
these are normally called agency loans. people are typically using these loans. For longer term financing like 10 year papers, what is most commonly seen for debt terms for multifamily syndications and multifamily acquisitions in general. interestingly enough, also, the agency's Fannie Mae, Freddie Mac, they also push borrowers into what seems to be longer maturity, or at least 10 years of term. they, they prefer to see their borrowers take longer term debt, rather than their five year and seven years. you'll see their pricing. It'll even though typically on a on a standard yield curve, the more term take on, the more expensive the debt becomes.
However, for them, you'll often see that five year debt could be much more expensive. they're pricing themselves out of that duration, and really looking for really pushing borrowers to take on 10 year debt with yield maintenance. I think that is another interesting point that we could talk about next, which are prepayments and for agency loans.
Yeah, so I mean, why is that? Why would they be pushing borrowers into longer term loans,
Rob Beardsley 4:34
right to the to turn combination is they want 10 years going to put out 10 year money with yield maintenance prepayment clauses. what that really does is it locks in that debt for at least six years, maybe seven years. Because yield maintenance is a calculated prepayment penalty, that is very steep,
Rob Beardsley 5:00
it'll be very unlikely a borrower will be interested in prepaying the loan early within, like I said, the first six or seven years. I think their goal there is they want to put out debt capital and not have it quickly returned to them know that it's going to be out, and it's going to be earning that fixed rate of return just as they push borrowers into their longer duration debt, and also push borrowers into fixed rate debt rather than floating.
If you ask Fannie Mae for a fixed rate loan, they'll say, depending on the market, and depending on the size quality of the sponsor and asset, you could get, let's say 80% leverage, which is great, and you'll get a couple years of interest only. However, if you want floating rate debt, which would flow over live more, which is how most typical floating rate paper works, which is alive work plus a spread rate, they understand that now you're taking on interest rate risk, which is out of their control out of your control of the borrower, and you may only be able to get 65 or 70% leverage. they're going to heavily curtail leverage if you're taking on floating rate debt.
personally, I don't think floating rate debt, is it necessarily any worse than fixed. there's lots of research out there showing that in the long term, letting yourself float with ebbs and flows going up and down on your floating rate is actually in the end, saving you money, then locking in fixed rate that all the time. but in any event, they are pushing for fixed rate, interest rate loans, 10 year debt, and you'll maintenance. that's really kind of the safest place for a borrower to be.
So a man a lot of terms in here that you've dropped, and a lot of things that we've gone over that I think it's important to go back and talk about and define. going all the way back to the beginning, more or less, the term of the loan versus the amortization.
I mean, you're talking about the term of the loan, but you haven't mentioned the amortization. can you talk about the differences between the two? And then what you're seeing out there? And in terms of what lenders are looking for, and we're kind of the best deals so to speak is?
Rob Beardsley 7:40
Right? Yeah, good point. most commercial real estate loans have a shorter duration than the amortization. in a, it on the other hand, if you were to take on a fully amortized loan for, let's say, 15 years, like a personal mortgage, the payments would, you'd be paying interest in principle, and in a way that after the 15 years of the loan, you would now have paid off the loan and there would be no balloon payment.
Leaving the asset free and clear. This almost never happens in multifamily or commercial real estate, where let's say you have a 10 year loan on a 30 year amortization schedule. typically, you're going to get a couple years of let's say, 123 years of interest only payments for the for the first three years. you'll begin amortizing on the 30 years schedule three years into the loan, you'll have seven years of paying down the loan on that 30 year schedule. then when the duration of the loan is up in 10 years, you'll have a balloon payment, which will be materially lower than the original loan balance.
So I mean, you mentioned interest only there. you're you're just paying the interest on the loan for a couple of years. What are the upsides and downsides to interest only loans? I mean, it sounds almost too good to be true, right?
Rob Beardsley 9:12
Yeah, I think the goal, if you could pick here, just, if you could, Mr. Potato Head your debt, you just always pay interest only and you never have to deal with amortization. this is because you know, there's a school of thought that you would like to pay down your principal. the faster the better, right, so the 15 year mortgage is better than the 30 year mortgage. But this really doesn't take a deeper look at opportunity costs and discount rates. for example, for an agency loan that let's say is I mean, right now rates are really low. using an example of 4% is not unrealistic. 4% loan, that is amortization on 30 year schedule, that cheap money. I mean, debt is always key relative to equity.
But even right now, I mean, right now, especially, it's such a painful idea to think paying down a loan that's at 4% is a good idea. Because what I mean is, it's really not a good idea, because you can achieve a higher rate of return in almost any risk asset, right? stocks, bonds, real estate, real estate, especially more than 4%. if my debt is costing me 4%, I would like to only pay interest on it, and never have to pay down because essentially, what you're doing when you pay down, the principal is you're earning that you're building up equity, which a lot of people will talk to the selling point of paying down principal, but you're essentially earning yourself a 4% return on the principal that you've paid down.
I never in my life would like to earn 4%. I would much rather be alone and keep going on the interest only train. with that in mind, there are ways to structure your debt to really stay on interest only and get the max leverage from the agency. this would be something like you could take on a more expensive. a lot of lenders will put side by side quotes, okay, here's your 10 year debt with your maintenance, and then here's your 10 year debt with a step down and the step down on a 10 year schedule would be the first two years would be 5% exit fee, which no paying 5% of the loan balance could be a huge number, and obviously, prohibitively expensive.
you would go the first five years, or the first two years at 5%, then the next two at four, and then the next to it three, and then you end up at one one and then you're in you can prepay a car with no penalty out in the last six months.
Oh, no, you have to pay 1%. the step down, you have to pay 1% out even then, but the point is, is if you can get let's say 10 year debt with four years of interest only, then you let the four years run out of interest only payments and then you refinance. you pay (what would that be) 543. so then you pay 3% out and put on fresh, four years of interest only again. so that's one way mean, that's a bit costly, because obviously, paying 3% on the loan is still expensive. it has to make sense. But based on how much additional proceeds able to get if you're adding more value, and the noi is increasing, but then there are other ways to structure it. that's that's my take on the interest only.
So if you're wondering what's the risk there? I mean, if you're not making the investments, not making the projected rent increases, or not performing quite as well as expected, then that's going to be more difficult to do that refinance strategy. Right? Or am I way off base there?
Rob Beardsley 13:16
No, yeah, I mean, people definitely look at refining, as you know, banking on it is not prudent. I agree. I think the, the difference in this scenario is that you still have your 10 year debt turn. therefore, if your interest only runs out and you and the markets not there for you, you are in a deep recession or your properties and why is gone down, and now you can no longer support full proceeds Rifai, then you have the option to hold your debt for additional six years, and you should be able to weather that economic storm.
if you were prudently leveraged from the beginning, and I think that's the point A lot of people make is, well, I'm paying down my loan, and therefore I'm reducing my risk, as, as I go further along the business plan, and the longer I hold the asset, I would say you're held, your leverage point is held to a debt service coverage ratio constraint from the beginning of the loan.
based on the full balance, and this debt service coverage ratio is calculated based on the principal and interest payment, so amortizing payment from the beginning, so whether or not you're taking on any interest only payments, you'll be constrained to a principal plus interest payment. basically,
if your, depending on the market, depending on the asset, if your income cannot support 125%, a fully have a principal and interest payment, then you won't be able to get the loan, you think you can't. they'll cut your leverage down to a point where you're able to have 125%. of income to debt service ratio. I think the point is that you want to be prudently leverage from the beginning and not bank on paying down principal along the way to reduce your risk and get to a place where you want to be and, obviously we're in the business to add value and buy deals and create big increases in income and valuation.
for us, if we're taking on a 10 year term loan in reality, if we succeed in our business plan two to three years down the road, that 75% leverage loan is going to really be 60%. if you do a good job 55% leverage. we want to take as much leverage front, knowing that we're still going to be constrained to that 1.25 or 1.25, debt service coverage ratio.
Rob Beardsley 16:10
Which means you'd have to see a from from
the beginning, even though you're going to increase income from the beginning, you'd have to experience a 20% decline in NY in order to be cash flow, breakeven. that would be that would be an enormous hit to your property if you take that big of a cash flow reduction. what to avoid that particularly right.
Rob Beardsley 16:37
That's not an everyday occurrence. Exactly.
Yeah. Right. Okay. Great. you mentioned, you mentioned leverage percentage, I think it'd be good to address that in terms of 65%, LTV, 80%, LTV, what does that mean?
Rob Beardsley 17:01
Yeah, so I think that a lot of these numbers, unfortunately, can be manipulated. taking something at face value is risky, and to the passive investors that are in the favorable or envious position to be able to sit back and put their money to work and let other people you know, create value with it and things like that, you need to still be hands on at the beginning to obviously, like we spoke before we recorded betting the deal, the market, the sponsor. certainly, these are some of the key aspects of vetting a deal specifically are the numbers side of it, which, like, we're going to talk about now that the leverage point, so the loan to value or LTV is typically related, or, which is the debt amount, divided by the purchase price. I think this is a good metric to look at.
it's pretty standard. But then you should go a step further and look at what is the loan to cost. also, what is the loan to value based on pro forma valuation. let's say, a year or two into the business plan, and based on your predetermined assumptions, what is the loan to value then, but so loan to cost, the difference between loan to cost and under value is a loan to cost lumps in additional costs into that denominator, which would normally just be the purchase price. But now you're let's say, you're having an interior next year renovation budget, you could lump that into your costs there. be your debt divided by the purchase price, plus your costs to renovate.
that is, to me a much better indication of leverage, because typically, you're going to get a in order to actually want to spend money on renovations, right, you have to be looking at a business plan where it makes sense, you can get a lot of bang for your buck. at a minimum worst case scenario, every dollar you put in and capital expenditures would get you $1 increase in valuation. Typically, this is not we're looking for, we're looking for a 123 benefit, or you know, or even more.
But if you're only getting a one to one increase in value, that is a better representation of your leverage point. Because if you have a 75% loan to value loan, what it cost, it's only 70%. that means in the near term, as you're implementing your business plan, you should be leveraged at 70%.
For those out there who have bought their own home and everything like that are investing in the past, you're probably they're probably familiar with closing costs and the costs of getting your debt. In this commercial world, the numbers are bigger, so we expect bigger closing costs. what are your closing costs, and like cost of financing look like in these types of deals?
Rob Beardsley 20:12
Yeah, so it's pretty standard for lenders to charge a 1% origination fee. that'll be your single biggest expense. let's use a $10 million loan as an example here. you can expect to pay that 1% origination fee. there's $100,000.
The next thing would be the lenders. when you actually sign a commitment letter, and be ready to begin the process with the lender, you'll wire anywhere from 30,000 to $75,000, to the lender as a good faith deposit, and they're going to now begin the process with this money to one, they're going to charge their underwriting fee, which is just basically, you know more about fees to them on top of their 1% financing fee, and then you're going to pay for their legal bill, which for a $10 million loan. and really, it's it doesn't change much. It changes a little bit depending on the type of loan between, let's say, an agency loan or a bridge loan. but you know, let's call that legal $25,000. then you're also paying for their third party reports.
there are all these deals, if you're getting a loan, you'll typically have a lender mandated third party reports, which are in appraisal, phase one environmental report, and a PCR, which is a property condition report. that those three reports typically cost $25,000 in total. already, we're here at $160,000. those are typically and then on your side, you're going to have our legal. that could be another depending on the type of loan could be 15 to $25,000. just there on the loan side of things, your closing costs are on a $10 million loan, nearly 2%. then, on top of it, if you are using an intermediary to access the debt markets, you could expect to pay a half a percent in additional broker fee on top of it. now you could be looking at 3%.
Wow the numbers are much bigger than when you buy your own home. But I guess that's not too surprising. what is the most as your you've gotten deeper and deeper into this world of multifamily investing? What is the most surprising thing that you've learned from a debt? Something that just came out of nowhere? And you're like, Oh, well,
Rob Beardsley 23:04
that's good to know. Yeah, that's a really interesting question. I think learn this very early on, I think it's a really strong lesson, and you hear people talk about it, but until it hits you right in the face, it's hard to really heed the comments fully. But that is you really need to have trust in your lender. because there's so much trust that you end up having to do, because there's a lot of time in between. When you pick a lender and sign that engagement lender letter, or letter of intent to closing, right? That could be two months could be three months. a lot can happen in a lock and change. although all that print that time the lender is going to be performing due diligence and underwriting the property, and collecting personal financial information.
there's pretty much nothing stopping a lender during that process after you're very deep in your your money is non refundable in escrow with the seller. at any point, the lender could say, oh, that $10 million loan we talked about? Well, we actually think it's only going to be not. you need another million dollars of equity. rry. that's never fun situation. that's why people call that example very ugly, we're retraining, right, nobody wants to hear that word. Nobody wants to talk about it. how do you protect yourself, right? You want to you know about this, and so you want to be smart up front. there's really no way to protect yourself, I think the best way to protect yourself is through relationships, and trust. it's, that's been a really interesting dynamic to learn about.
Yeah, that doesn't sound like a fun situation. I don't know, I guess we'll work on our lender relationships. hopefully, we can avoid that situation. they can help us see that coming and help us stay away from having to, I don't know, invoke the word retrading, because that can really mess up your relationship with your broker, and potentially just completely ruin the deal.
Rob Beardsley 25:35
well, just going to add to that, the retreating number one, it's a risk really not worn by passive investors. Right? It's, it's really, truly all on the sponsor. if a sponsor has a deal lined up, they put it under contract, and they are operating under the assumption that they're going to get $10 million loan, as we discussed, and they're pitching the deal that way. investors say, Oh, yes, this deal looks good. everything checks out, and then the lender comes back and says, “Yeah, well, we can't get to that number, it's going to be 9 million” that could change up the deal completely. and really make it from a deal that looks pretty good to a lot of a deal that a lot of investors wouldn't be interested in.
Well, it's an unfortunate, passive investor in LP at that point could simply not commit to the deal, or if they were already committed, they could back out. that is definitely one benefit of being on the passive side.
Yeah, absolutely. I think there's a very good point in that, that's a little bit deeper, that, at least up front, in the very beginning of till the deal comes to the table and everything. as passive investors, we don't have any risk in any of these deals, unless we're specifically looking for for looking to be that risk capital.
as passive investors, we don't have this risk of really any of these things that this sponsor takes on, they have to put down an earnest money deposit with the seller that's on the sponsor to do themselves or find an investor that's specifically interested in being that risk capital person. passive investors out there don't need to worry about a lot of these things. It's good to know. But a lot of these problems up front are problems for the sponsor to worry about and not for the passive investor to worry about. Yeah, absolutely. we're going to take a quick break for our sponsor.
So we've got three questions I asked every guest here at the end of the show. Are you ready? I am. First one. First one, what is the best investment in real estate that you've made?
Rob Beardsley 28:08
Can you go a little bit deeper into that? What is there a specific relationship that comes to mind?
Rob Beardsley 28:15
There are certainly a couple. But I think in general, it's the mentality of seeking relationships and, and building that, that strong network of people that you can count on, right, the lenders that will provide honest feedback, and not betrayed and investors that believe in you, and believe in your deals and brokers. I think everywhere you turn, in the business, there's a pivotal relationship, and building up strong ones, and all those aspects is super important. I think that that's what's going to carry you through a career in real estate rather than trying to find that perfect deal.
Yeah, you look at it in the long term view, where you have a long term view about it. Great. On the other side of that, what is the worst investment that you've made in real estate so far?
Rob Beardsley 29:13
This is so funny. It's a, it's the classic buying out of state single family home. What happened? I mean, luckily, nothing too bad, but basically, learned my lesson quickly. That you can't just think, think you know it all and think that if the price is low, it's a good deal. what happened is, we bought a single family home out of state, and thinking that there, there was already a tenant in there, and we'd be collecting checks, clipping a coupon. But quickly, after we bought it.
Tenant was paying rent we had to evict, and then we had a single family home sitting bacon. and not only that, it was trashed by the previous tenant. then we had to go through that trouble to fix it up and then put on the market, and it was sitting on the market, and so ended up finally selling and taking a loss. But that is just, in my opinion, very, a good example of why single family homes are just really terrible passive investment, because you're relying on that one stream of income.
it you know, if there is a headache, which there always are, it ends up being a massive one, because it's the whole business plan. I think it's just far less work and far better to not have to rely on one tenant in your single family home. Hmm. in hindsight, you know,
assuming that, I don't know, in hindsight, like, what could you have done on the front? And they're like, what's it like the one of the biggest mistakes that you made in picking that deal? and not the others? Assuming, you're still looking at other than the fact that it's a single family? You know, was it? Did you go look at the property, and you said it was out of state?
Did you look at it before you bought it? Did you send somebody look at it? Did you audit the lease? What? What do you do?
Rob Beardsley 31:23
Right, we did very little due diligence. it wasn't a big investment. that was the biggest mistake. Like you said, we didn't visit the property. We didn't think about any of those things. so was thankfully, not an extremely painful lesson financially. But it was a very strong lesson. Very early on that you can never do enough due diligence.
Good to know, good to know. the last question here that I asked every guest, the end of the show is my favorite one. What is the most important lesson that you've learned in real estate investing?
Rob Beardsley 32:03
Yeah, that's such a tough quote. That's such a tough one. But it would probably be that one due diligence, due diligence, due diligence, or the number one rule is you make money on the buy? I think that's a really good one.
So as you've gotten into your now you're fully into multifamily. Moving out of that, that single family world not addressing single families anymore, what's probably the biggest one or two key differences between single family and multi family due diligence that sticks out in your mind?
Rob Beardsley 32:35
Well, the great thing about multifamily is it's a team sport. you don't have to rely on all the due diligence coming from your and so we're fortunate to be able to have property management company on our team and they can with us deploy their resources to be on site for you know, Now obviously, for, for all our due diligence, we fly out to the property, we spend a lot of time there, we spend a lot of time in the market.
a property management company can deploy their due diligence team, and we can do programmatic unit walks. if we have 200 unit property, we can actually in a day or two, walk every single unit and assess the condition of the critical components and interiors. Similarly, we can walk the exteriors with general contractors, we have relationships with general contractors that are honest with us and competitive with their bids and make understanding the scope of a construction, the construction aspect of these projects, far less ominous, and, and wide ranging in pricing and risk. and then we're also able to perform lease file audits. we're looking at the rent roll and comparing the leases and seeing identifying all the discrepancies.
those are that right there makes you a lot more comfortable in the due diligence side, and you're not left here on devices, like on single family. I think yes, it's a bigger beast, it's a bigger project, but there's just more team players to help you and then your lender, like we mentioned earlier, is ordering those third party reports.
if your lender weren't, you should do them yourself. But because they're forced upon you, it's, it's really Another great benefit. the lender is playing with more money than you there, if it's a, let's just say, 80% leverage, or they're putting up 80% of the capital for the deal, and you're only putting up 20. they have a lot more money at risk. so, to that end, they're going to do a lot more due diligence.
it's kind of a good feeling when a deal checks out by your lender, I mean, obviously, that doesn't mean it's a great deal, but it just further helps that there are any glaring issues, at least hopefully, if there are that the lender is making you aware of them. Hmm.
Good to know. All good to know. yeah, this the scale helps a lot in multifamily. I can see what you said about scale, helping from a due diligence aspect that you've got more team players, I think you put it well, you got more people involved and more people working on the task of evaluating your property, so that that makes a lot of sense.
thanks for everything today. I'm really happy to finally get a chance to talk about debt on multifamily real estate, we just haven't gone over that topic yet here. if folks want to learn more about the deals that you're doing, where can they reach you? Contact Information website, all that good stuff.
Rob Beardsley 35:51
Sure your listeners can head over to www.LonestarCapGroup.com, or email me at [email protected]. We're putting deals together primarily in Houston. More than that I do a lot of thinking and writing on some deeper topics and multifamily and real estate in general. if anyone's interested in those things, feel free to get involved in what we're doing.
Awesome. Alright, Rob. Well, thank you for joining us today. Once again, great discussion. Everyone should certainly reach out to you and hear about what you have going on in Houston. That's a very interesting market. I think there's a lot of opportunity there for the right buyers looking in the right parts of Houston. yeah, once again, very much appreciated. thank you for joining us today. Yeah, thank you very much for having me. It's great. It's my pleasure to everybody out there for to thank you for tuning in. thanks for listening today. If you're enjoying the show, please leave us a rating and review on iTunes. I
it's a very big help much appreciated. if you know someone that could use a little bit more passive wealth in their lives, please invite them to the show, or share the show with them and invite them into our little group here that we've got forming. Thank you for tuning in once again. I hope you have a great rest of your day. Have a great rest of your week, and we will talk to you on the next one. Goodbye