Our guest Shahin Yazdi breaks down each piece of the capital stack and what it means for investors.
Shahin Yazdi is a Principal/Managing Director of George Smith Partners. Since starting his career at GSP in 2007, Mr. Yazdi and his team have secured over $1 billion in financing for all asset types including Multifamily, Office, Industrial, Retail, Hospitality, Self-Storage facilities, Land, RV Parks, Assisted Living, Skilled Nursing facilities, and Student Housing projects.
Mr. Yazdi’s clients include private individuals, family offices and institutional investors. He is recognized for his expertise in underwriting and negotiating complex transactions, which include mezzanine financing or private equity for bridge, permanent, and construction loans. Mr. Yazdi has received awards for his debt/equity placements, spoken at large conferences, and has been interviewed on national media broadcasts.
In 2009, at the height of the recent economic down turn, Mr. Yazdi played an instrumental role in establishing George Smith Partners advisory services arm to assist borrowers and lenders with troubled
loans and distressed assets. Prior to GSP, Mr. Yazdi worked at a major commercial bank, which gave him in depth knowledge and understanding regarding the intricacies of the banking system.
Mr. Yazdi is an active member of the Jewish Federation Real Estate & Construction Division, ULI, ICSC, PREA, NAIOP, and CoreNet Global.
Mr. Yazdi possesses a Bachelor of Arts Degree from the University of California, Santa Barbara. He is an active Real Estate Investor, enjoys playing basketball, rooting on the LA Lakers, traveling domestically and
abroad and most importantly spending time with his wife and family.
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RealCrowd – All opinions expressed by Adam, Tyler, and podcast guests are solely their own opinions and do not reflect the opinion of RealCrowd. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. To gain a better understanding of the risks associated with commercial real estate investing please consult your advisors.
Shahin Yazdi – In every deal there’s different layers of capital that’s basically used to acquire or build an asset. This will be a combination of basically equity and some type of debt. The capital stack in every deal is important because ultimately that’s going to tell you what the returns on the deal are.
Adam Hooper – Hey Tyler.
Tyler Stewart – Hey Adam how are you today
Adam Hooper – Tyler, it’s another good day.
Tyler Stewart – It is it’s a nice day here in Portland, Oregon, huh?
Adam Hooper – It certainly is and another great day for a podcast.
Tyler Stewart – That’s right, we had Shahin Yazdi, Principal and Managing Director over at George Smith.
Adam Hooper – Yeah, so we talked today about something pretty core to every deal, but I don’t think we really dug too deep yet on the show, so we talked about the capital stack today. Different portions of capital stack, debt, equity, mezzanine, preferred, different pricing, different rates, different loan-to-values. Pretty good overview of, as an investor, of what you expect to see when you look at the capital stack.
Tyler Stewart – Yeah, we did a deep-dive on the capital stack starting from the bottom of the capital stack and worked our way up and Shahin was great he just broke it down for us and for our listeners. I think this will be a good episode.
Adam Hooper – Yep, talked about kind of what the goals and you had the question in there where the goals of the different parts of the capital stack, you know, how to arrange a capital stack, where that art comes in and really what makes a, what makes the right capital stack for that deal, so.
Tyler Stewart – Yeah, hopefully should be another good informative episode for all you listeners out there. As always, again, every rating we get gets us in front of more listeners and we can bring better content to you so we appreciate those ratings and reviews on iTunes and wherever you listen to us. As always if you have any questions or comments please send us a note to email@example.com, and with that let’s get to it.
Adam Hooper – Well, Shahin, thank you for joining us today. Excited to dig in on the capital stack and learn a little bit more about an area we haven’t really talked a lot about on the podcast, super fundamental to our space, so we’re excited to have you on the show today.
Shahin Yazdi – I’m excited to be on, thanks for having me.
Adam Hooper – Perfect, well tell us a little bit about, you know, maybe your current role at GSP and maybe how you got into the real estate space and what you’re up to these days.
Shahin Yazdi – Okay, so at George Smith Partners we’re capital growth advisors where we help our clients raise debt and equity for their various commercial real estate projects. I’m one of the Principals and Managing Directors of the company so along with all my partners I help oversee the direction of the company and help assisted grow. I also am responsible for bringing in production for the company and new deals and along with my team of five we do all asset-types, all loan types across the country and all pieces of the capital stack.
Adam Hooper – Perfect, and then tell us a little bit about your entrance into the real estate space. I know you had a background in banking before then so I’m curious how that background in the more traditional banking environment might, you know, pushed you into commercial real estate maybe and formed what you’re doing today on the capital market side.
Shahin Yazdi – Sure, so I always had a passion for finance and real estate. I realized after college that the best job for that would be in banking so I could get a good strong foundation, understand the principles of underwriting and just how the banking system works. Within a few years I eventually moved to George Smith Partners and I think a lot of what I learned in banking helped. First and foremost I think every credit committee likes a detailed story and as a banker you kind of learn to address issues with credit before they even become an issue. You start to think like a credit officer, underwrite the way that you know they like to see deals underwritten. And then the other thing I learned is that there’s always exceptions to be made. We had a lot of polices at the bank, you know, if you were able to sell your story well enough the bank was willing to make an exception to make the deal happen. So it was a lesson that I really carried into what I do now and in everything that we do we try to be as detailed as possible, address problems, and figure out solutions, before the lender even thinks of it and we understand that if we do a good job kind of laying out the foundation of the deal that every lender would want to be able to do it, or at least we can find the right one for it.
Adam Hooper – And now for our listeners out there that maybe aren’t as involved, or in tune with what goes on in the kind of mortgage world. Maybe spend a minute telling us your role as a, or what is the banker’s role versus your role at GS, George Smith Partners, where you guys are out, you know, effectively canvasing the survey, or canvasing the scene of lenders out there as a mortgage broker per say. So how do those roles differ, right, when you’re helping a borrower find that loan versus you’re actually at the bank and looking at those loans? How do those, you know how do you look at the deal differently?
Shahin Yazdi – That’s a great question and it’s actually one of the reasons I left the bank. I think even though every bank can make an exception ultimately they all have a box. Our job as real estate, as capital advisors, is to find the best deal for our clients and to help them get what they want. So we really have no obligation with certain lenders. Ultimately our job is to underwrite the deal, to create that package, and to basically speak to every lender, or capital provider out there, to find the client what they’re looking for. Whether that’s a bridge loan, a perm loan, a construction loan, or a mezz piece to get them the leverage that they want.
Adam Hooper – And so when you say you’re trying to uncover those issues before it becomes an issue that’s in when you’re doing your work and you’re out there telling that story on behalf of the borrower to these different perspective lenders. You’re kind of helping address what some of those risks might be or how the manager, the borrower, is going to mitigate those risks?
Shahin Yazdi – Exactly, so we’ll underwrite it and if there’s a shortfall, for instance, like if we’re doing a bridge loan and we realize there’s going to be a shortfall in the cashflow, we’ll make sure to underwrite the deal, do a cashflow model that looks at into the next 24 months and then figure out exactly what that interest reserve needs to be rather than have the lender guess it, right?
Adam Hooper – Getting it easier to get to a yes versus a, letting the bank come up with the reasons no.
Shahin Yazdi – Exactly, that’s right.
Adam Hooper – Perfect, well, you know, because we said we would kind of transition to the main topic today which is the capital stack and that’s something that obviously is very crucial to every deal, there is a capital stack and structure for every deal, but like we said, we haven’t really taken too deep of a dive on the show before so why don’t we start with just very simple high-level capital stack. What does it mean? What is it comprised of? And what does it tell you about a deal?
Shahin Yazdi – Okay, so in every deal there’s different layers of capital that’s basically used to acquire, or build an asset. This will be a combination of basically equity and some type of debt. The capital stack in every deal is important, because ultimately that’s going to tell you what the returns on the deal are. So how that’s structured, what the rates are, what the returns to investors are will tell you what the returns that basically the sponsor is going to be, does that make sense?
Adam Hooper – Yeah that does, yep. And so depending upon what each rate required essentially for each portion of the capital stack blended will tell you kind of what the total, you know we call here, cost of capital is for that particular deal structure.
Shahin Yazdi – Exactly. And most importantly, what the returns are going to be.
Adam Hooper – Right.
Shahin Yazdi – Otherwise it’s like why are you doing this deal, right?
Adam Hooper – Right.
Shahin Yazdi – You want to make sure the returns make sense.
Adam Hooper – And now are all capital stacks static? Is there variability in every deal, and every deal has a different capital stack, every deal has a different kind of ideal structure? Where does the art of arranging this capital stack come into play?
Shahin Yazdi – Every deal is so different and unique and ultimately the needs of the sponsor is always so different, right? And so some sponsors need less equity than others. Some sponsors need help raising the equity. Some sponsors prefer more debt and want to put in less equity. Every deal is always different too, the numbers aren’t always the same, right? Every cap reads different, every market is different, and every business plan is definitely very unique to the different sponsors that we work with.
Adam Hooper – Okay, and then most of the times investors are going to see capital stack in a fairly consistent format, you know, it takes the shape of a bar graph essentially with the bottom most portion of that being your most senior and then working your way up the capital stack as you get towards common equity and the sponsorship kind of co-invest capital. So why don’t we start at the bottom, start at the debt portion of the capital stack and maybe give us kind of, you know, what does it mean to be in that position if you’re an investor, either in that debt piece, or in an equity piece and you see something that’s more senior on the capital stack to you?
Shahin Yazdi – So the debt piece I think is the most important it’s what pretty much outlines with the initial returns to the sponsor are going to be and it also tells you how much equity you need for the project. It’s the least risky portion because it’s obviously at the bottom, if anything goes wrong they’re in the position to basically foreclose, wipe out anything behind them. I think when you think of debt you could think of traditional banks, insurance companies, debt funds, securitized lenders like CMBS, those are all the different debt options that a sponsor can look for.
Adam Hooper – And now when we talk about, you know, seniority on the capital stack that’s basically what you just said there, right? The ability to, you know, at the end of the day who has control if something goes wrong somewhere further above the capital stack, whoever is in the most senior position kind of drives the boat, right?
Shahin Yazdi – That’s right.
Adam Hooper – Yep, and so there’s a trade-off, right, for being that most secured position obviously, it usually comes in the form of a lower rate. So how does the profile of debt investors differ from equity investors necessarily?
Shahin Yazdi – So debt, depending on how much leverage they’re offering and how risky the deal is. For instance we’re doing a deal now where it’s a construction loan and the sponsor doesn’t want to provide any guarantee, even a completion guarantee, which is very, very rare, especially for a construction loan. That deal on the debt piece, because it’s so risky, and they’re going, you know, it’s a pretty high-leverage loan, that’s going to be around eight to 10%, right, that’s where most of our quotes are coming in at. On the other hand when you’re doing equity, and that’s typically the range of debt will be anywhere up to 10, 12, but it’s always a fixed return. You’re going to get your interest, you’re going to get your fees and then you’re done. You don’t get any of the profit or participation above that. Equity, when you’re participating in the deal as equity you’re taking a little more risk, but you’re also going to get the returns that the project gives off. So you’re typically looking on an equity deal, depending on how risky it is, if it’s a multi-family deal in a prime location, you might be looking to get 12% on your money. If it’s a little bit more of a risky deal you might be looking for northwards of 20% IRRs, and a 20% return on your money.
Adam Hooper – And then on just a pure kind of traditional senior loan piece what kind of loan to values are you seeing typically, how far up the capital stack does that usually go these days?
Shahin Yazdi – So, depends on the deal, it depends on the debt-type as well. If you’re looking at perm loans, a permanent loan, and that’s for an asset that’s basically stabilized, you want a good longterm, fixed-rate loan, or even a short-term loan, but it’s a stabilized asset. You’re going to get somewhere up to 75 to 80% loan-to-value. In core markets where cap rates are suppressed, and they’re lower, you’re typically going to cap out around a 65 to 70% loan-to-value. Even though the lender can go higher they’re typically tapped out by other metrics which is the cashflow more or less. So the DCR is one of them that every lender looks for and the other one is debt yield, which is basically the NOI of the property divided by the loan amount of the property.
Adam Hooper – Basically what’s the lenders return if they had to take it back, right?
Shahin Yazdi – Exactly.
Adam Hooper – Yep.
Shahin Yazdi – Think of cap rate, but it’s for the loan instead of the value.
Adam Hooper – Right, and now how have you seen that change over the last maybe 12, 18 months? Have you seen loan-to-values, or rates, move dramatically in relation to any market shifts, or kind of what’s the overall take there?
Shahin Yazdi – Oh definitely. In the last four months rates have dropped significantly and I think in the last 12 to 18 months you’re just seeing more and more lender, you’re seeing more lenders get more competitive. There is so much capital out there chasing deals that, it’s a very good time to be a borrower.
Adam Hooper – Good.
Shahin Yazdi – Definitely.
Adam Hooper – Well, now let’s move a little bit further up on just a very simple capital stack. So we’ve got our loan piece figured out, now we get into the equity piece, right? And you know we were talking before we started recording, sometimes referred to as common, most of the time on our platform LP equity, limited partnership equity, or JV equity, joint venture equity. Let’s talk about kind of of where that fits in the capital stack, how far the stack goes up the, up the stack, and what some of those basic attributes of a common LP, JV equity are?
Shahin Yazdi – Sure, so JV equity usually is going to be, and it could really be anything, it’s such a fluid product. It could be a 50/50 split, it could be 90/10, 95/5, with the sponsors bringing in 5% and their JV partners bringing in 95% of the equity. I think this is an area where crowdfunding and, you know, your platform is great because it’s filling the void for smaller deals where sponsors that are doing deals around five to 10 million, and typically would go to friends and family for their equity, and this kind of equity can now go to your platform, or other crowdfunding platforms, to kind of raise that money. If it’s a larger deal there’s definitely institutional equity partners that would want to come in and can participate in those deals. And this is an area where obviously they’re taking more risks so they’re going to look for returns on their investment.
Adam Hooper – Perfect, and then how far, what portion of the remainder of that capital stack say where maybe 60% loan-to-value from the debt piece, how much of that are we filling up with this kind of common equity piece?
Shahin Yazdi – So at that point the 40%, a sponsor, depending on how they want to structure it, if they do 90/10 that 40% is going to be split up with 90% to the equity partner and 10% to the sponsor.
Adam Hooper – Perfect, so in that case, again, 60% loan-to-value, and if it’s going to be a 90/10 structure for the equity piece, you’d have these limited partners, the LP equity coming up to, that would be what, 96%, and then you’d have the sponsor coming about, so it would be that remaining 4% which would round out that capital stack?
Shahin Yazdi – Exactly.
Adam Hooper – Perfect, and now on the sponsorship, on the co-invest side and the GP capital, tell us a little bit about how that differs from the common equity, or the LP equity, and maybe what those return profiles look like?
Shahin Yazdi – So the sponsor and the GP are basically the ones managing the deal so they may put in five, 10, even up to 50% of the deal. They’ll start with a certain return and then basically, again, this can be structured in so many different ways, but typically there’s a waterfall where eventually as the common equity, or JV equity partner, gets their certain return hurdles, they get more of the participation and they get more of the profits. So they may start with 95/5, or 90/10, but then as the common equity hits certain hurdles and IRRs, they’re just going to make more, you know, they’re going to get more of that profit. And they can eventually move up to being 50/50, even 75/25, where now they’re getting… I’ve seen situations like that where they’re getting 75% of the profit because they hit certain metrics.
Adam Hooper – And that’s kind of what we commonly refer to as the promote, right, that’s the sponsor promote?
Shahin Yazdi – Exactly.
Adam Hooper – Yep.
Shahin Yazdi – Exactly.
Adam Hooper – Have you seen, you know, current market, we see kind of what we do on our platform and I’m curious in your world, are you seeing a typical, I guess this is kind of a loaded question, so I’ll ask it anyhow. Are you seeing structure. I mean they come in every shape and flavor out there, but are you seeing any kind of common themes in terms of simple promotes, or multi-tiered waterfalls, or what those structures are looking like these days?
Shahin Yazdi – I think all of it is pretty negotiable and I think they all differ per deal. Most of the time on larger construction deals, if we’re doing equity, investors want 20% IRRs, or better. Sometimes you’ll get down to 17%, or better. If it is a rehab deal you can get down to 15% IRRs. Sometimes it could be slightly less with specific family offices and I’ve seen it as low as 12%. And I think the best return to the GP are always going to come from friends and family, or now I’m even seeing again, crowdfunding. A lot of crowdfunding sites kind of have friend and family returns where it’s around 10 to kind of 12% IRRs.
Adam Hooper – Yeah, I think that’s also been just the shift in the market, right? I think a lot of the early deals that were done in our industry in 2014 through 2016, 17, there were a lot of those user deals out there where you could get a lot of those higher IRRs and just the kind current niche in the market we’re seeing that kind of come in and tighten where those deals are a little bit harder to find so those returns are definitely compressed a bit, much harder to find those 20 plus IRR deals anymore.
Shahin Yazdi – It is really hard.
Tyler Stewart – Could you break down for me, so we’ve looked at debt, equity, and co-invest. What are the goals of each investor in that portion of the capital stack? So you already mentioned debt, the investors are looking for a fixed return, but could you break it down for us for each element of the capital stack?
Shahin Yazdi – Sure, so the goal for the debt is really to put out the money, get a fixed return and then eventually get paid back. I mean they’re not trying to take high-risk deals, they’re trying to do deals where they’re in a position where they know they can get taken out, right? Equity, I think ultimately their goal, is to hit a certain return. If you’re investing equity in a deal, just as you would whether it’s real estate, or the stock market, or a company, you’re looking for a certain return on your money and you have those targets. And I think with real estate versus other product, it’s a little bit easier to kind of calculate ’cause you could see where market comps are, you could see where they’re projecting to, and then get comfortable with that transaction assuming everything stays on course.
Adam Hooper – And so now when the sponsor’s looking at capitalizing a deal what are they trying to solve for, right? Are they trying to optimize one portion of the capital stack over another, are they trying to get to that kind of most efficient blended cost of capital? Where, how does that decision-making process unfold in terms of what the ultimate capital stack looks like?
Shahin Yazdi – So, that’s a great question and I think that can kind of lead us into talking about mezz and pref equity as well. Depending on the sponsor it’s a function of looking to obviously get the best return for themselves but obviously having a capital structure. For some sponsors they don’t want to give up control so they may not want to bring in a JV equity partner ’cause ultimately that partner, that equity, is going to have some control rights as well. They’re not going to just get to hire whatever management company they want, they’ll have sell restrictions on the property and the sponsor may decide, hey, I don’t want to do that, so either I’m going to do an equity source where they’re not going to require those control rights, or, I’m just going to layer in debt. And then that’s where you can get a bank loan and then mezz or pref equity on top of it too, where none of those sources, both of those really function as debt and they’re not going to come with any control rights and it will lever up the deal. So I think for every sponsor when you’re looking at what they’re going to look for it depends on their needs and it’s so different. Some sponsors are flush with equity, they’re lucky enough to have a lot of money and they’re never really out to the market for equity. So what they’re always looking for is the best debt and they’re looking for the best rates.
Adam Hooper – Right?
Shahin Yazdi – Right. Other people are looking for the most leverage and so that’s why I think, you know, the first goal is to always understand the needs of the sponsor. And no sponsor, no two sponsors ever have the same needs, it’s always different.
Adam Hooper – So basically cost and control are the two big levers, I guess when you’re looking at capital stack, what is the cost of both debt and equity and then what are the controls that as a manager you might need to give up to get to that different portions of the capital stack?
Shahin Yazdi – Absolutely.
Adam Hooper – Perfect.
Shahin Yazdi – And control with debt can come in various forms as well ’cause some debt providers, if you’re getting a bridge loan, for instance, they may have certain cash management accounts that as a sponsor you’re giving up some of that control, right, but in return you’re going to get more leverage and you get nonrecourse money and so it makes sense you decide to do that, right, you make that choice.
Adam Hooper – Yep, and so now just to two things you just mentioned there, just for our listeners. Cash management which, well they have a sweep account basically, some kind of ability for the lender to have some control over where the cashflow from the asset is going so it doesn’t just immediately go out to the sponsor. That lender will actually have some, a lockbox, right? They have the ability to maybe get to that cashflow before the sponsor does. And then the other piece, cash management, and…
Shahin Yazdi – And in return you get leverage, right?
Adam Hooper – Okay, yeah.
Shahin Yazdi – When you do those kind of bridge loans.
Adam Hooper – Perfect, thank you. And then why don’t we just talk a little about recourse versus nonrecourse loans and what that might mean for listeners on the show here that are investing as LP investors, not the manager, how does recourse versus nonrecourse loan impact them maybe?
Shahin Yazdi – Sure, I, you know typically for the LP, it will not really affect them, because they’re not signing on the loan. But as a sponsor and even something that’s telling about it and just so you know when you see, hey, this sponsor is getting a nonrecourse loan, that means that they’re not personally guaranteeing the loan. There’s no guarantees to that lender getting their, there’s no personal guarantee to that lender getting their money back, all they’re signing for is bad-boy carve outs where they say, hey, I’m not going to commit fraud, I’m not going to contaminate the property, and then if I do any of those, you know, bad-boy, bad-boy things, right, I’m going to, the loan would be recoursed to me.
Adam Hooper – And why would a lender choose to go recourse versus nonrecourse or vice versa?
Shahin Yazdi – So there a lot of lenders that onLy offer nonrecourse loans, that’s just their program, so any securitized loan is going to be nonrecourse, they’re really looking for the collateral and they’re looking at the asset itself and not as much a sponsor. Other lenders only offer recourse loans and it may also be a function of leverage. Like there are lenders that will offer recourse loans up to call it 75% LTV, but if the loan-to-value is below 50% they’ll offer nonrecourse.
Adam Hooper – So there, in that case again, heavy emphasis on the actual property that they’re lending against because, again, nonrecourse, worst case they take it back, and if you like the asset then they’re at a good basis.
Shahin Yazdi – That’s right, yep.
Adam Hooper – All right, so now let’s talk into some of those, add-ons to the capital stack, right? You mentioned mezzanine debt and preferred equity. We’ve seen a few deals on the platform as preferred equity, we really haven’t seen much mezzanine debt so I’m not sure how familiar our listeners might be, or how much they see those opportunities, either mezz or preferred, but let’s start with mezzanine debt, you now, what is it, where does it fit in the capital stack, and then we can kind of contrast that with preferred equity afterwards.
Shahin Yazdi – Sure, the best way I like to kind of describe mezz and pref equity, think of a hotel, right, there’s always that base level and then the mezzanine level before you get to the rooms, that’s basically what these kind of, this kind of debt acts as. It’s a layer between the debt and the equity that kind of gives you additional leverage. They both act as debt, but they do it a little bit differently. So mezzanine you’re going to have a fixed coupon that you’re getting, they may charge some rate, they may charge some fees, and it is based, it acts as a second on the property. They’re going to have a lean, they’re going to have an inner-creditor agreement with the lender that gives them some rights in case the sponsor doesn’t pay them back they can foreclose and then take over the loan. Pref equity, instead of putting a lean on the property they’re actually going to have a lean in the entity itself that owns the property. Does that make sense?
Adam Hooper – Right, and so again, mezzanine is more, again, they function the same, similar, mezzanine is secured by the property, preferred equity is secured by the borrowing entity essentially.
Shahin Yazdi – Exactly, and then they both get a fixed coupon. Sometimes pref equity may get some of the outside, but normally it’s just a fixed coupon and they may charge some fees.
Adam Hooper – And again, that’s something we’ve seen, we used to call it dequity, right, where you’ve got, participating preferred right? I mean these come in…
Shahin Yazdi – Exactly.
Adam Hooper – Every different shape you can imagine.
Shahin Yazdi – Equity, yeah, I like that.
Adam Hooper – Yeah, and so as an investor if you’re looking at a deal that has either a mezzanine, you know, a mezzanine piece or a preferred equity piece, what does that mean to an investor or how can they learn from a capital stack that includes either mezz debt or preferred equity?
Shahin Yazdi – So some lenders don’t even allow mezzanine behind them and that’s why the investor may do pref equity. I personally think pref equity is a little bit of a better structure than mezzanine because the foreclosure is a lot easier.
Adam Hooper – Right.
Shahin Yazdi – If you’re not getting paid it’s easier to take over versus mezzanine where you have to go through the process. But, you know, different lenders and different investors have different views on it, that’s just my view.
Adam Hooper – And do you see a difference in pricing between mezz or preferred equity?
Shahin Yazdi – Mezzanine typically tends to be slightly cheaper, but a lot of the times, again, it depends on the deal. If you’re doing a cash-flowing property then they’re going to be, I think it’s more about the deal than it is about the product type.
Adam Hooper – Okay, and where are you seeing rates these days for a fairly kind of down the middle either mezz or preferred piece?
Shahin Yazdi – Usually it’s like nine to 10% and up.
Adam Hooper – Okay, and again, obviously varies upon, on many different factors within that deal.
Shahin Yazdi – Right.
Adam Hooper – Okay, so when you’re looking at adding in these different pieces, you know, is there a general rule of thumb in terms of a, a target-blended cost of capital between these components, and maybe what the return profile of the asset is? Or again, so situational that there aren’t really many rules of thumb in terms of what you’re looking at for a cost of capital perspective, you know, blended across these different segments of the capital stack compared to maybe what you’re acquiring in asset, or what that cap rate is?
Shahin Yazdi – Yeah, I think it always varies on the asset. Because you could do these kind of loans and the kind of debt that we do can be on an asset that has no cashflow, on an asset that’s just being built, day one, on an asset that’s going to be completely rehabbed and the going-in cashflow doesn’t even cover any portion of the loan. And really you need, a lot of rehab is going to go on, and you need to increase the cashflow to the asset to have it work. You can also do it on an asset that is cash flowing and maybe the first trusteed lender, or the bank, or the CMBS lender, can get that high on the leverage, in the capital stack, and so you layer in a piece of mezz, or pref equity, to kind of get you to the goal that you want. And depending on those things, and it’s really a function of, is cash flow in place today to cover this additional loan, will it trigger what kind of rate you’re going to get?
Adam Hooper – Perfect.
Shahin Yazdi – Because it becomes more appealing, right, if you could pay it on a, if you could pay it current today versus have it accrue and then pay it later.
Adam Hooper – Yeah, no let’s talk a little bit about that as well. So often times when you’re looking at some of these structures mostly in the, well, you can see it more in the preferred equity side, but the current pay versus accrued. So if you’ve got a preferred equity piece that is a, a total rate of, call it 10%, but there’s a split between a current pay and an accrued portion of that. Kind of walk us through that that means or what an investor might learn from when they see that rate, or that word, that a portion of that is going to be accruing.
Shahin Yazdi – So accruing basically means that whatever cashflow can’t cover the interest that you’re paying, and if the lender doesn’t ask you to pay it current it’s just going to get tacked onto your loan and it can start earning interest. So let’s say, for instance, you have to pay a loan, the monthly payments on that loan are $120,000, but you can only cover up to $100,000, so that $20,000 would just get tacked onto your loan.
Adam Hooper – And then I think again, we’ve seen different treatments of how that accrual is accounted for, right, whether that’s just a simple accrual where that amount just becomes a amount payable at a future date, versus compound where, again like you said, it gets kind of rolled into that loan balance and it’s also earning interest. Do you see a standard there between those two kinds of structures, and so we’re getting kind of a little bit in the weeds here, but just curious.
Shahin Yazdi – No, everything, like I said in the beginning, everything is negotiable.
Adam Hooper – Yep, .
Shahin Yazdi – And I don’t think there’s a, you know there’s certain metrics that are always going to be standard, right, you’re always going to underwrite to certain things, but when it comes to something like this it’s pretty much different for each lender.
Adam Hooper – Yep, okay. Well let’s talk about a real-world example. Any assignments that you guys have worked on lately that you think would be good to dig in on and kind of illustrate some of these concepts about the capital stack that we’ve been talking about?
Shahin Yazdi – Yeah, so we recently did a construction loan where the total capital stack was about 60 million dollars. The entire piece was nonrecourse. We were able to get to, basically with that structure we got to 87% of total cost. Initially the sponsor wanted a JV equity partner and we got him quotes for that and we found some equity partners that were willing to do the deal, but ultimately when they realized they had to give up control rights, and they could not agree to those terms, they decided, hey, let’s just go out and get pref equity which we did. The first piece of the loan was about 41 million and then about 18 million dollars of pref. The total project cost was about 87%. The non, so the loan itself was floating at LIBOR plus 400, which is basically LIBOR plus 4%. And then the pref equity piece just had a, you know, a certain return that they wanted on that money and that was pretty much it. And so the blended, and they didn’t get any piece of the upside, and they had no control rights, and it was exactly what the sponsor wanted.
Adam Hooper – So in that case, again, the control sounded like that was a really important piece for that manager, they wanted control, and also by structuring it that way they were able to retain all that upside, right, so this preferred equity wasn’t participating in that. Whereas if they would have had a JV partner, or some LP equity, they would’ve had to share the upside from that development deal.
Shahin Yazdi – Exactly.
Adam Hooper – Yeah, how many, how much of the decision making is, I guess profit driven, you know, control and then also if you can get to that capital stack and not have to get those LP investors and the promotes, I would imagine that drives a fair part of the decision making process as well?
Shahin Yazdi – Absolutely, I mean, I will say though that every sponsor is different and for some sponsors they don’t have that choice. In our situation our sponsor was able to come up with that difference in equity, but some sponsors don’t have the equity and they really need a JV equity partner. So giving up some of that control rights just makes sense for them.
Adam Hooper – Right, if that means getting the deal done or not.
Shahin Yazdi – Exactly.
Adam Hooper – That’s probably a good thing to be able to get the deal done and you can capture that value.
Shahin Yazdi – Exactly. But yeah, you always want to go in with the lowest possible costs and the highest upside to yourself as a sponsor, right, that’s how you want to structure every deal.
Adam Hooper – Yep. Perfect, well, so let’s kind of wrap up then and, you know, again, as an investor, most of our listeners on the show here are investors that are looking at equity investments in these with a manager as a nonactive partner. What are some of the key takeaways when they’re looking at the capital stack of the deal? Are there some red flags? Are there some questions that they could be asking of the manager based on a quick review of the capital stack, or is it pretty straightforward?
Shahin Yazdi – I think first and foremost you always want to see how much leverage is behind you, right, because that’s basically going to tell you how much risk you’re taking and the probability of you getting paid whole. The more leverage a sponsor is putting in on the deal the more risk there is to the equity investor. The other side to that coin though is to see the amount of upside to the deal. Sometimes you can layer in a lot of leverage. You could be a, you know, that small piece of equity, but if the returns are significant on the deal it’s obviously a good deal to do, right, and it makes a lot of sense. So you want to look a the leverage, and then you want to look at the final value of the asset.
Adam Hooper – And then in terms if an investor wants to dig a little bit deeper beyond just the, again, that kind of bar chart of a capital stack, what are some of the questions that they can ask of the manager? Are there any documents that they would expect to see, or review, if they want to learn a little bit more about the composition of that capital stack?
Shahin Yazdi – Usually it’s going to be in the entity documents. That’s really where they’re going to get the nuts and bolts of it. So if they could see the entity documents they could look at the closing statement and then always the pro forma of the sponsor is going to lay that out as well. So they want to look at the pro forma, but they’ll also see the projections of the project, they’ll also see how the capital stack is going to be layered in. The other document they can always ask for is the sources and uses. That basically says, this is the source of all our funds and this is going to be the use of all our funds.
Adam Hooper – Yep, and that’s again, that kind of, that’s the roadmap for where the capital is coming from and what it’s going to be spent on which is obviously a very, very important part of every deal.
Shahin Yazdi – That’s right.
Adam Hooper – Perfect. Well, is here anything else you want to add on capital stack or just kind of general take on the market and maybe we’ll ask you to crystal ball a little bit of where is the financing market looking to shape up for the rest of this year?
Shahin Yazdi – Yeah, you know, I think this is obviously a very strong market and the fundamentals continue to remain strong. Lenders in this cycle have not done at all what lenders in the last cycle have done. Even though lenders are getting more aggressive and offering higher leverage with nonrecourse, the fundamentals are still there and they’re definitely making sure to underwrite cashflow and to have an exit in mind with today’s market in place and not really trending rents up. So I think with rates where they are, where, at least for the next 12 months, I think we’re going to continue going on and things are going to continue to remain strong. That’s kind of my take on the market. And then we have to kind of see where the political climate goes from there.
Adam Hooper – Okay, I think that’s fairly inline with what we’ve been hearing from other folks we’ve been talking with as well. So nothing major, nothing major foreseen that’s going to disrupt this, right, I mean maybe not the accelerated growth that we had seen in the last few years, but just kind of a more steady and, steady and strong to round out the year.
Shahin Yazdi – Yeah, let’s all hope for that.
Adam Hooper – Okay. Well, why don’t you let listeners know how they can learn more about what you are up to with George Smith Partners and if they want to reach out or have any more questions for you how might they be able to find ya?
Shahin Yazdi – Yeah, they could reach out to me on my direct line at 310-867-2954, or email me at S like Sam, Y like yogurt, A like apple, Z like zebra, D like David, I like ice cream, @gspartners.com.
Adam Hooper – Okay, and maybe we can try to spell that out with emoji in the show notes, but. We’ll have all that contact info down in the show notes as well so if anybody wants to reach out to you and ask some more questions please do so. And as always we love comments and feedback here and ratings at the show. So if you have any comments send us a note to firstname.lastname@example.org and with that we’ll catch you on the next one.