Maximizing Opportunities: Expert Insights for Investors in a Shifting Economy with Dakota Brown and Alex Zapata, Ep 115

Welcome to the Journey to Multifamily Millions podcast, where we speak with professionals on financial topics!

Dakota Brown and Alex Zapata examine the quickly evolving loan and equity markets in commercial real estate in this talk. Bridging loans, the effect of rising interest rates, financing and underwriting difficulties, and investor strategies for navigating market volatility are the main topics of debate.

In the face of economic turbulence, they explore the ramifications of rate increases, bridge loan methods, insurance and tax issues, and new trends in asset classes.

They emphasize the value of being both cautious and opportunistic in the current environment while offering a critical perspective on market dynamics and helpful underwriting advice. They also go over the prospects for 2023, pointing out areas that might give chances despite the difficulties brought on by an unstable economy.

Episode Topics

[00:41] Meet our guest, Dakota Brown and Alex Zapata
[02:56] Current Market Volatility and Trends
[04:56] Understanding Debt and Equity Transactions
[10:43]  Impact of Federal Funds Rate on Treasury Yields
[19:43]  Inflation, Labor Markets, and Economic Outlook
[26:241] Buyer and Seller Expectations
[31:18] Underwriting and Rent Growth Challenges
[37:42] Debt Strategies and Investor Returns

Notable Quotes

• "Rates are composed of two metrics: an index and a spread." – Dakota Brown
• "Banks are hedging their risk... no one’s really sure where rates will be." – Dakota Brown
• "We arrange debt and equity transactions, not direct lending." – Alex Zapata
• "Debt service coverage ratio is the biggest constraint as rates move, impacting leverage." – Alex Zapata
• "Multifamily operators are using bridge loans to acquire, but it’s becoming less attractive right now." – Tim Little
• "I've seen price drops of one to two million because debt has gotten so expensive that the seller has to acknowledge that." – Tim Little
• "This is a really crucial time that not a lot of people have experienced in their investment careers. It's been about 11, 12 years since we've had a similar style economic volatility"  -[Dakota Brown]
• “Hotel to multi-family conversion is a very popular concept. I think it's a lot more conceptual than it has been executed in certain markets.”  -[Alex Zapata]
• “We always talk about multifamily being recession resistant, but I think it's important to note that it's not recession proof. It doesn't mean we won't get impacted  by a recession, we will, and we need to think about that.” - [Tim Little]

👉Connect with Dakota Brown

• Linkedin: Dakota Brown
• Website: www.FranklinSt.com

👉Connect with Alex Zapata

• Linkedin Alex Zapata 
• Website: Barclay Gro

👉 Connect with Tim

• Linkedin: Tim Little
• Instagram: @tim_at_zana
• Email: tim@zanainvestments.com
• Visit www.ZANAinvestments.com for more info on Tim and how you can passively invest in multifamily real estate
• Get your Passive Investor's Cheat Sheet FREE

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Transcript

[00:00:00] Dakota Brown: I'm heavily advising all of my clients right now to, if they are taking a bridge loan, take out a fixed rate bridge loan, the really the Delta between a floating rate and a fixed rate bridge loan right now isn't extremely large. It's well worth it to pay a little bit more for a fixed rate bridge loan right now than it is to take on the risk. of a floating rate bridge loan. And, as far as the rate cap goes, it's almost next to impossible to put a price on those in today's environment with how volatile everything is. those are changing, literally on a daily, if not more than a daily basis.  

[00:01:08] Tim Little: All right everyone and welcome to the journey to multifamily millions. I'm your host, founder and CEO of ZANA Investments, Tim Little.  We have the tag team of Dakota Brown and Alex Zapata, both from Franklin Street. Dakota is a senior associate with Franklin Street where he works in debt and equity for commercial real estate acquisitions, refinances, and developments. Alex is a senior financial analyst responsible for underwriting debt and equity transactions across all asset classes, analyzing financial statements, creating waterfall models and performing cash flow statements.  So please briefly introduce yourselves and let us know what is going on. 

[00:01:51] Dakota Brown: Yeah, Tim, first of all, appreciate you having us here. and I think you're absolutely right. This is a really crucial time that not a lot of people have experienced in their investment careers. It's been about 11, 12 years since we've had a similar, style, economic volatility time period. so this is quite new for everyone. And I think the timing is great here. We, Alex and I live in this environment on a daily basis. and we're quite excited to get into the meat and bones Of what's going on here. but with that being said, as you mentioned, I'm a senior associate moving into a director role at Franklin Street. I've been there for about two years now. I have a background in private equity, and worked for Jeff Vinick for a couple of years. And,now switch over to the broker dealer side of the business, and work very closely with Alex, who is an analyst on our team, and I'll let him introduce himself as well.

[00:02:40] Alex Zapata: Appreciate it Dakota. And yeah, Tim, thank you for the introduction and the opportunity to be here. Tim said I am a senior financial analyst at Franklin Street on Franklin Street's capital markets team. Like we talked about, I'm responsible for supporting all the originators like Dakota across all of our different offices throughout the southeast and we have a national focus. A lot of my time is spent, underwriting and researching different asset classes, from multifamily in Tampa to office in Fargo, North Dakota, self storage in Clayton, California, really just understanding our deals and making sure that the acquisitions that our potential clients are making are financeable and make sense.

[00:03:16] Dakota Brown: Awesome. Thanks, Alex. And I'm going to share my screen here just so we can bring up our presentation. we've put together. Okay. So we'll start to get into the meat and bones here. I think the title is very applicable, rapidly changing debt and equity markets. There's a ton of volatility in the market right now on both the debt and equity side, on the investment side as well. and we'll discuss a little bit more about that here.

[00:03:42] Alex Zapata: Yeah, like we mentioned, there was even a rate hike today. So we're going to cover a bunch of different topics. we'll do some macro with a little bit of micro getting into the nitty gritty we're going to, like we talked about, we give a quick background about ourselves, the type of lenders and equity providers that we work with. What people are probably really here for, which is the current market update, where rates are, what impacts rates, where inflation and how it affects commercial real estate financing, and just some of the current trends that we're looking at for the first half of next year, And, where are we headed and how can people continue to acquire deals and build wealth outside of traditional stock markets, bonds, those things, We're also going to touch on some of the concerns. Because not everything is looking super rosy right now. And we have to acknowledge where some of the shortfalls are. And we'll get into some of the underwriting tips to mitigate those risks and how to navigate underwriting and financing in today's environment. Wrap it up with a short Q& A session and we'll go from there. Thanks, 

[00:04:35] Dakota Brown: Alex. Okay, so a brief summary on who we are. We just gave you backgrounds on ourselves. But to provide a little more context around the company that we work for, Franklin Street. We're a full service commercial real estate firm nationally. We're based out of Tampa, that's where our headquarters is. We have several lines of business debt and equity origination. That's where Alex and I live, eat and breathe. investment sales, selling multifamily retail, all the major food groups, all the different asset types. We have tenant and landlord representation, we have a huge insurance team, we have a property and project management team, and we all work very closely together. We were founded in 2006, to date, or I'm sorry, in 2021, our total transaction volume was just shy of 1. 5 billion dollars. and as I mentioned, we're headquartered in Tampa. Yeah, it's a great overview Dakota. Now 

[00:05:23] Alex Zapata: Let's talk about some of the lenders that we work with and the equity providers that we work with. We are not direct lenders. Just want to put that out there. We are a commercial brokerage firm arranging debt and equity transactions for our clients, And on the debt side, we work with anyone from Small community banks and credit unions all the way up to the bankers of banks of America's and Wells Fargo's of the world's work with agency lenders, Fannie, Freddie. affordable housing HUD type lenders, bridge lenders that are both DSCR driven and non DSCR driven, which we'll get into some of those specifics. Private debt funds, hard money lenders, commercial mortgage backed securities, or CMBS lenders. On the equity side, we have a diverse pool of investors, including private equity funds, family offices, and high net worth individuals. And even, we started to dabble in EB 5 investors. Some of the typical deals we work on. Dakota and I typically are seeing deals in that 1 to 15 million space. And we're asset class agnostic. We have experience underwriting, not only multi family, single tenant, multi tenant, retail, industrial assets, self storage, even cannabis dispensaries, which is a very hot topic recently. And, we're again, location agnostic. Our focus is the Southeast in the Sunbelt States, which is typically where most of the investment is coming from. Like I mentioned earlier, we've underwritten an office deal in Fargo, North Dakota. I've underwritten deals in Clayton, California. and then we've also written underwritten deals in Manhattan. So we, we know a lot of people were here to, make sure that we're providing the best financing terms that are available for you and make sure you guys can deliver your returns to your investors. 

[00:06:58] Dakota Brown: Thanks, Alex. All right. So this is getting a little more into what everyone's here for a current market update. so we're going to touch on a few things here and the first thing that I'm going to touch on are our rates, and starting from the floor up. when we're quoted a rate from a bank or a debt fund,or whoever it is, rates are compromised. I'm sorry, composed of two, two different metrics. It's going to be an index and a spread. so we're in most cases on the permanent financing side. We're using the five year, five or 10 year treasury. and then on the bridge loan side, we're using SOFR, which could be fixed or, a spread that's fixed or floating over SOR. So an example right now, the five year treasury, is 3.75. I think it's actually lower than that today. It might be 3.6 something. but each bank is gonna use a spread of about 170 to 230 basis points. over that index. So currently, the five year Treasury is around 3. 75 percent and banks are using 170 to 230 basis points over that spread, we're seeing rates in the mid fives to around 6%. And we've added a very worthwhile website here to keep in tune with market rates. And that's Chatham Financial. We use that on a daily basis. They have a lot of great other tools and market trends on their website as well. So banks currently are increasing their spreads. A lot of this has to do with uncertainty. a year ago, we were seeing anywhere from 150 to 200 basis points over the treasury. Now we're seeing closer to 200 point basis points over the treasury. And the banks are really doing this to hedge their risk moving into the new year. No, one's really sure of where rates are going to be. and banks are, they don't take on risky investments. so they're going to do everything they can to make sure that they're not losing money right now, current permitting, permanent financing terms that we've been closing deals at. are between five and 10 year terms, we're seeing leverage anywhere from 55 to 65%. a couple of years ago, we were able to get up to 70, 75%. We haven't really been seeing those types of deals lately, just with how, how compressed cap rates are. so most deals are being financed in that 55 to 65%, leverage point. As I just mentioned, current rates are, And they are really in the low to high fives with treasuries, just taking a dip recently, treasuries were about 60 basis points higher, in the preceding weeks where we were seeing rates closer to six and a half. amortization, depending on the asset type, where we shouldn't have an issue getting to 30 years on multifamily industrial, newer built retail, in some cases, 25 years. and very rarely we'll have to dip down to 20 years. So the biggest limitation on limiting proceeds is the debt service coverage ratio, or your DSCR, which is equal to your NOI over your annual debt service. So most banks are typically requiring anywhere from really 1. 2 to 1. 25 times. Your idea, your DSCR. So that's the biggest impact on leverage right now. So at the current cap rates that properties are being purchased at, NOIs in comparison have been, lower percentage of that purchase price. So that's really squeezing leverage on a lot of these opportunities. And with that, Alex, I'm going to pass it back to you. 

[00:10:21] Alex Zapata: Thanks Dakota. And like you said, the biggest constraint right now is debt service coverage ratio as rates move. you have a month, a larger monthly debt service and it's impacting leverage. We have to be honest with ourselves and the days of 3 percent money and 75 percent lender value are far behind us. But what really impacts these rates, right? So the federal funds rate, otherwise known as the fed funds rate, it's currently the main tool that the Fed is using to kind of battle inflation to give you a perspective. We've had I believe this was our sixth or seventh rate hike this year. And the fed funds rate went from, a quarter of a 0. 25 percent all the way up to what is 4. 5 percent after today's rate hike. And that causes changes in, in treasuries, right? Dakota said, your rate is the five year treasury rate or the seven year treasury rate, or the 10 year treasury rate plus. spread spreads haven't really changed too much. they've widened a little bit, but it's really the change in treasury yields that has really affected, why rates have gone from three and a half to four up to, now five and a half to six. And what does that really mean? Treasury notes are supply and demand driven, right? When investors are pessimistic about the economic outlook, treasury yields increase because they have to make those fixed rate bonds. More attractive to investors because if the cop, the fed is printing trillions of dollars a year and there's no one to take on those bonds from them at a, 1 percent return or a 2 percent return, then maybe they try to entice them with a three, four or 5 percent return, right? And it's a fixed rate product that provides risk free, investing, but. at two or 3%, it's hard to get some people to invest in that when you can go buy a multifamily deal that gives you an 8 percent return year over year or something like that. And then just, again, general supply and demand of money, people who have, and I think the residential market is a good case study for those people who have low interest rate mortgages. Are not really interested in selling or refinancing right now. So that outstanding paper on the balance sheet is just out there. No, there's no payoffs coming in and new money being put out because that's generally slowed down with transaction volume slowing down. And when there's dry powder or hundreds of millions of dollars sitting in banks, they. They've got to do something with it. And it's definitely impacted rates and made them even more risk averse than they already were. 

[00:12:41] Tim Little: Yeah. And guys, I'll just say I'm a perfect example of that. I refinanced my house at 2. 65. And I think I can confidently say that it's not going to get any better than that. So you're right. The incentive to sell at that point is virtually gone. And even if we do move, I would much rather just rent it out because I know the rental rates here in South Tampa. but two, because it's such, Cheap debt that what I'd be incurring by, getting a new mortgage and everything else, 

[00:13:16] Dakota Brown: it 

[00:13:17] Tim Little: just doesn't make sense.

[00:13:17] Dakota Brown: Yeah. A hundred percent. Yeah. Yeah. and Sam, that's such a good point. a lot of people are looking at how competitive it is. the market's been as far as people wanting to buy, the supply is not being as much as the demand, which really pushed down cap rates. This is an issue behind the scenes that not a lot of people see that aren't, living and breathing the debt and equity markets on a daily basis. This recycling of cash and banks are in the business to, to lend. and if they don't have enough money to lend, that means their supply is shrinking. And if anything, I understand investors, the demand to buy these properties may be slowing down, but that demand is not necessarily going to be going anywhere. so this is going to be really important moving into the new year. Making sure that, if you're constructing a property or acquiring a property, the bank that you've worked with for 10, 15, 20 years, they may not be able to lend anymore. And there may not be any local banks. And it's important to be in tune with who's staying active and how much cash is on their balance sheet.

[00:14:16] Tim Little: Yeah. can I, go back to something that you talked about earlier, which was the, You were saying that you had, you could get fixed or floating for bridge. and I think that's a really important piece to talk about because so often, multifamily operators are using bridge loans in order to acquire. it's becoming less attractive. right now I would say and you guys can probably talk a little bit more about that but i'm curious as to Rate caps if you guys are privy to them, to what that looks like from your side in terms of the cost of those rate caps. Cause I remember, back in, I think it was 20, 20, 21 or 20, 2020, we got a rate cap and it was only because the bank required it. and we were like, whatever, it was like 150, 000, and this was for, A relatively large property. And nowadays that same rate cap would cost like 800, 000. And that's exactly what we're paying on some of our more recent deals. So if you could talk about that a little bit, as much as you're comfortable talking about it. And the impact that's having on investors as well and how that may just kill deals. 

[00:15:33] Dakota Brown: Yeah. Yeah. Really good question there, Tim. And I, it's, I'm heavily advising all of my clients right now to, if they are taking a bridge loan, take out a fixed rate bridge loan, the really the Delta between a floating rate and a fixed rate bridge loan right now isn't extremely large. It's well worth it to pay a little bit more for a fixed rate bridge loan right now than it is to take on the risk. of a floating rate bridge loan. And, as far as the rate cap goes, it's almost next to impossible to put a price on those in today's environment with how volatile everything is. Those are changing, literally on a daily, if not more than a daily basis. With that being said, We're working on a specific opportunity right now. This is 110 units in Daytona Beach.an investor who's looking to, he was looking to refinance out of his loan, and unfortunately refinancing out of a bridge, a floating rate bridge loan. He couldn't hit the senior permanent loan proceeds to fully refinance. So he had no other option, but to either sell or purchase a rate cap. and on a 14 million loan, he bought an 18 month rate cap. I believe it was a 50 bringing down his index, 50 basis points, or putting a cap. Around 50 basis points over his current index. I forget exactly what the specifics are, but on a 14 million loan, it was about 850, 000 to purchase that recap. 

[00:16:58] Alex Zapata: Yeah, I think, we're seeing it too, obviously. I, we recently priced one on a 33 million, bridge zone out in the, out in South Atlanta, and it ended up being, the rate cap costs that right now is close to a million dollars, right? And that's additional costs that you have to underwrite, and that's going to heavily affect your bottom line and your alternate net levered cash flow. And. Even people who bought rate caps two years ago, with a two year term, and maybe they need to trigger their extension or something like that because of supply chain issues. And they really haven't finished fleshing out their business plan. They're having to reprice those rate caps. And now those rate caps have doubled, tripled, five X didn't and cost. It's definitely something that, like Dakota said, we do recommend a bridge loan if it's a heavier premium up front. and even more so than that, I think we're trying to get our clients to move into the mini perm space with a bank. If that's a viable option, I know Dakota has done two or three deals that probably last year would have gone high leverage bridge and, They ended up going low leverage bank with a couple of years interest only to facilitate that business plan because it just made more sense.

[00:18:04] Tim Little: Yeah. And the last thing I'll say on that, just,to educate the audience in case they're not familiar, what we're talking about when we say a rate cap is that, if you have that floating rate bridge loan, it basically protects you. Think of it like an insurance policy. if you, if your floating rate is, say two two points if it goes over whatever that cap is Then it kicks in like I said like insurance and pays out Whatever that difference is and gentlemen, please add more context to that but that's basically my understanding and I think it's worth explaining to people because honestly, like three years ago, I didn't know what a rate cap was because I, it's just not something that was talked about because rates only went in one direction. And that was down. So I think it's something you have to know now. 

[00:18:54] Dakota Brown: Yeah. Yeah. And you're spot on there, Tim. Raycap is putting a cap on the index. and depending on what kind of cap, if it's, do you want to put a cap on where it is today, or if you want to cap it off at a certain loan amount, the pricing on that is going to change drastically. and you can even buy down the index slightly. which is surprising. So it's technically buying down your rate, but you're sure going to be paying for it. 

[00:19:17] Alex Zapata: Yeah. I think we also, one thing that's very valuable to our clients that I think most people need to be in tune with is on the shorter term bridge loans. That index is SOFR, right? It's the one month term SOFR, which you can find on Chattanooga financial that Dakota mentioned earlier. And if you look at the projected curve over the next,you're probably looking at that index, which is currently four and a quarter almost. It was probably closer to zero 12, 18 months ago. and it's probably going to approach five at some point. So when you use that index plus a spread, call it two 50 over term. So for today, you're looking at 6. 6, 6. 8%, as opposed to,12, 18 months ago, you're looking at barely 3 percent floating rate deal. And as you're transitioning a property and cash flows are affected, it'll definitely affect that bottom line.

[00:20:09] Dakota Brown: Yep. Thanks, Alex. Okay. So briefly getting into inflation and labor markets, everyone's aware that inflation is on the run. It's been on the run. and another thing I want to touch on is the labor markets as well, but the annual inflation rate decelerated, to 7. 1 percent in November, of 2020. Of this year, compared to 9. 1%, which was the highest since 1981. And that 9. 1 percent was in June of 2022. It's good to see that inflation just started coming down. and these numbers are run from the consumer price index, the bureau of labor statistics. You can look this up online. We can start to see that the Fed's rate hikes have been slowly taming. Inflation and the biggest goal that we're going for right now is to have a soft landing. The Fed caught inflation quite late, and they're battling it, very aggressively. and the last thing that we want to do is freeze up the economy and put ourselves into a recession, which is not the plan, obviously. So the Fed is playing a fine tuned game of, how much do we have to raise interest rates? Okay. to level inflation to our standard, which is between two and 4%. and then, labor markets. So we're starting to see inflation come down just a little bit, which is great. But we're also going to need to see labor markets ease up a little bit as well. I believe our current unemployment rate is around 3. 2 to 3. 4 percent currently. And really, we should be seeing between five and 6%. unemployment on average. So we're going to have to see both inflation and the labor markets continue to cool down before we really see a bigger light at the end of the tunnel.

[00:21:50] Alex Zapata: Yeah, that's great Dakota.  So we're going to dive into some of the kind of current trends that we've been seeing probably over the last 12 months, but really even more so over the last, 60, 90, 90 days. Both lenders and LP co GP investors have uncertainty in the market. It's a wait and see game. a lot of the larger institutional banks, your bank of America, your Wells Fargo, if you're not a parent client and you're not doing a home run deal, they're probably not. Providing anyone with money. and on the LP side, there's a lot of uncertainty around, raising rents and true value added in terms of being able to project a business plan and ultimately hitting the returns that you're promising to these investors. I think on the other hand, the Sunbelt remains probably the King of investment at this point. I think probably the way that Florida and the Sunbelt handled the pandemic really helped them. And people continue to move here every single day. I'm sure Dakota and Tim will tell you, I feel like the traffic has just tripled in the last three to six months. And I know it's snowbird season here in Tampa as well, but people coming down from New York and L. A. and, less investor friendly states to Florida, Georgia, South Carolina, those types of states that want businesses to relocate from Wall Street to Miami to Tampa, we had a big thing for St. Petersburg was getting ARK investment to come. to come down here. Miami had hundreds of Wall Street companies come down to Miami. And that speaks to the strength of the Sunbelt, right? And I think that investor demand is there. And that's why you haven't really seen a ton of value decline yet. because hundreds of people are moving here every single day from an asset class perspective, multifamily. Is probably still king. It's the most sought after asset class. it's the most competitive asset class, I think for us specifically, 50 percent of our business is multifamily, probably even closer to 60 percent over the past two years, because deals were deals, it was cheap to buy deals and deals made a lot of sense. And an asset class that's come to the fore since then is industrial, right? You've got Amazon expanding like crazy and everybody doing these online orders. The days of. Going to the store and spending three, four hours at a retail center at the mall are not gone, but they've significantly reduced. So industrial and storage of being able to put all that stuff in one location with access to delivery and major corridors is incredibly valuable. Like I said, retail has recovered well since the pandemic, I think, A lot of people are out there buying, I think consumer spending for the holidays is probably just a little bit under where it was, three years ago, but it is still probably outpacing what people thought based on inflation and kind of the tightening economy. I think there's a heavy scrutiny on good retail and what does that mean a good tendency people and businesses that have been in your shopping center for a long time. And. have strong financials. I remember the first retail deal we did post pandemic. There were a lot of questions about the owners of businesses, how their financials are, and how long they've been there. And that's something that wasn't really asked pre prior to COVID. And I think the people that are struggling are office owners and hotel owners, right? office with remote work. is struggling. I think a lot of people are coming back to the office and they prefer a hybrid environment. If you're talking about your 55 days a week, nine to five, office day, that's changed for everyone except for Franklin Street. But,and then on the flip side hotels right people are traveling, and I think the. The hotels that are dedicated towards leisure and travel like St. Pete Beach's hotels are full of people. And those asset classes are trading for ridiculous numbers, but your kind of more business class off the highway type of travel and leisure hotels are struggling a little bit. what was once a seven cap is probably now closer to a 10 cap. Lenders have a very strong aversion to financing office and hospitality altogether. they're more interested in multifamily, industrial self storage, retail, those types of things. And that has to do with, Interest rates rising, right? This will drive up the cost of capital for investors, which causes a couple of things, right? Cap rates have to decompress, which we'll talk about negative leverage in the next point. And leverage will have to come down. Sponsors and buyers are having to bring more equity to the table, which can make a deal not really work for them, right? If the cost of your debt service is more expensive and the amount of money you have to bring to the is, is double what it previously might've been. It might not make the deal pencil. And like I talked about negative leverage is when the cost of borrowing money. So if you're borrowing at a 6 percent rate, but the deal you're buying is a four and a half cap rate, that's negative leverage, right? It is more expensive to pay your debt service than it is to just acquire the property and enjoy the yield that comes off of that property. And that's a very popular topic that's come across and especially the multifamily value ad space where people are paying. Enormous amounts of money per door for a multifamily property. When the going and cap rate is two, three, 4%, but you're borrowing at five, six, 7%. And ultimately there's still a gap between buyer and seller expectations. Buyers want to buy at today and tomorrow's prices based on six and 7 percent interest rates. And I think sellers still want to sell. along the top of the market, right? They want to maximize their price and it's hard for buyers to get the type of financing that allows them to maybe potentially overpay for an asset. and gamble a little bit more.

[00:28:06] Dakota Brown: Yeah. Thank you, Alex. And to reiterate there, that's the biggest, one of the biggest, that gap between buyer and seller expectations is the biggest factor right now. Alex. slowing down total transactions. We have buyers and sellers pointing fingers at each other. and they're not on the same page right now. And we're expecting that to change coming into the new year. There's been a lot of disruption. There's a lot of uncertainty, but as we progress through this volatile market, we're expecting. those buyers and sellers to slowly start getting on the same page. And we think a lot of that's going to have to do with cap rate decompression.

[00:28:41] Tim Little: Yeah. And I'll tell you guys, I'm seeing that in real time as we're trying, trying to get deals going back and forth with these sellers who, oftentimes have. What I consider anyways, as the buyer, unrealistic expectations, because we are not in the same place as we were, even six months ago, I'm sorry. And yeah, I think a lot of them are just in denial and I get it, you want to get what you thought you were going to get, but you have to take the current market conditions into consideration and some of them are, and then, there's retraining going on. dropping of prices or at least, changing things a bit. but I've seen price drops of, one, 2 million because debt has gotten so expensive that the seller has to acknowledge that. but it's, yeah, no, nobody likes it, but it's just the reality at this point. 

[00:29:35] Dakota Brown: Yeah. Tim, that's a good point. And, not only is the debt getting expensive, but we're also seeing acquisition, insurance and a lot more expensive. here in florida insurance issue and with the recent becoming even worse issue really impacting this gap. Okay. So where are we headed? No one has a crystal ball and no one could really predict exactly where we're going to be. But, we, I think we have a pretty good understanding of where we stand currently and a pretty good understanding of where we're going to be, heading into 2023. the best part about ending the year, on these rate hikes, I guess you could say is that we've started to see inflation. cooled down a little bit. It came down from June of this year at 9. 1 percent to 7. 1 percent as of November. We had our seventh rate hike today, which was 50 basis points, which I personally think is still pretty aggressive. it's been, I believe it's been 22 years since we've aggressively raised rates this, this much. but that 50 basis points is coming down from the feds. Previous 75 basis point hikes, which economists and the general investment community saw as a positive, coming into 2023. The Fed's goal is to continue taming inflation. So I think we're going to see two, three, maybe four, 25 basis point hikes. If I had to put my finger on it right now, I would say we're going to see. 325 basis point hikes, and the fed's going to hold their rate, the federal rate, steady until we get inflation closer to that two to 4%, that 3 percent mark.there's a lot of investor optimism around our, the recent CPI report. It came back a little bit better, not much better, but a little bit better than what most economists were expecting. And that goes to show that the Fed, the Fed's rate hikes are one working and it gives us a little bit of optimism about a soft landing. Obviously we have a lot more to go through. the Fed, the Federal Reserve still has a lot of work that needs to be done to, to hit that soft landing. But this is, this was a good initial sign, a good starting point of saying, Hey, this might be working.

[00:31:48] Alex Zapata: I think there's a lot of optimism, but there's also still a lot of cause for concern. Are we really handling the raising of rates effectively? Are we doing it too quickly? Because inflation is inflation and CPI is technically a six to 12 month lagging. it lags six to 12 months to really feel those effects. So potentially we could be setting ourselves up for a very tough Q1 and Q2 of 2023. But Again, we don't have crystal balls. There's a lot of people, a lot smarter than us who will probably try to figure this out and hopefully it doesn't come to that. underwriting exit values have to be evaluated very closely. I think the days of buying a deal at a three cap and, exiting at a four or five after you've, increased value tremendously is heavily scrutinized, And no lenders and LPs are heavily stress testing. The exit cap rate, because a lot of deals are heavy, that's where all the money is made, right? Is that exit or that refinance, and those exit stabilized cap rates have widened, with regular cap rates. what we could probably test out of exit 5 cap is now being tested out of 7. And that affects, that generally affects, returns and then rent growth, right? A lot of these value add deals are bought on the basis that you can come in and renovate and raise rents to $300 or, maybe the seller's operating the property inefficiently. And you can come in on day one and just raise rents, a hundred, 150, $150, but at some point. Those rental growth rates have to slow down and I think we're seeing that right now. I think the last report I saw was that, rent growth has even gone down, landlords have had to lower rents for the first time in probably two or three years. and that ability for buyers to come in and project that they're going to increase rents, 510 50 percent year over year, is being scrutinized by lenders and investors everywhere. And then, ultimately we've talked about this entire time. It's harder to find competitive loan options to make these deals work. So how do you combat that prices have to come down. And, in general,lenders are very risk averse. They are a bank. They want to be as risk free as possible. And there's a lot of uncertainty around where rates are headed in the next 24 months. We will see some, the diversity between spreads that we're seeing from banks. Is really what's eye opening, right? There are some deals that we're getting a 200 basis point spread and other deals are getting a 300 basis point spread from other banks same deal but seeing that big spread in interest rates is definitely causing some concern and then You know, investors are taking additional time to analyze and under ideals where you could probably get an investor to buy into your business plan is taking probably double the time because they want to make sure that they have every data point that makes them feel like their investment is good. And let's talk about some underwriting tips. Like we've talked about, right? Lenders are not as bullish as GPs and owners due to a strong risk aversion, right? So they're going to be stress testing your deal every single way they can, right? They're going to cut rents. They're going to increase vacancy. They're going to adjust expenses. They're going to go from a 40 percent expense load to a 45 and kind of see how that affects the debt service coverage ratio and how they can make sure that their investment in the property is going to be able to repay their loan. Okay. I think it's really important to understand the story of your deal prior to underwriting. and that's definitely the area that you're buying in. I know Timmy Dakota will tell you South Tampa is very different from Sevenal Heights, Lutes, renting a property in South Tampa for 3, 000. Nobody really bats an eyelid, 3, 000 up by USF or up in North Tampa. I think that property will probably sit vacant for 1, 2, 3 years, right? you have to understand what is, the area median income and who your demographic is, right? So when you're trying to pencil out rent increases and value add opportunities, you have to make sure that you're catering to the right type of tenants that live in your neighborhood. Taking a C class property to a B plus or an A minus is very difficult, but taking a C class property to a B minus or C plus property and increasing rent to 150, 200, that's very achievable. But again, you have to understand all those different factors that you might not see from a CoStar report, or you might not see from an investment sales package, right? They tell you the market rent is 2, 500, but All the comparable properties are 20 miles away in a better sub market. You have to understand and analyze all that stuff. I think, like Dakota mentioned, there's a lot of changes that lenders are going to underwrite to post closing, right? Your taxes are going to readjust, and what that really means is that you are going to be taxed based on the new value of your property. It will be, in most cases, a significant increase. And we have to look at what the property is worth. Can support that adjusted tax number going in day one might not adjust, in the first year based on when you buy your property, but eventually it will adjust insurance. Dakota said in Florida it is very tough to find an affordable insurance policy. That makes sense, right? You have wind coverage, you have properties in flood zones, you haveproperty in general liability and umbrella policies that have probably gone from a thousand dollars a unit to 1, 800 a unit. And, every case is different, right? Newer assets are cheaper to insure than 1970s bill assets, but in general, insurance has increased, year over year by probably 10, 15, 20 percent on most cases and our insurance business allows us to see real time, what those premiums are coming in at, And, if a, buyer has a thousand dollars a unit in insurance, but all the insurance codes we're seeing are 1500, 1, 700 a unit. That's going to affect it. And then management is another one that's pretty popular too. That gets changed by a lender, right? Even if you're buying a three, five, six unit deal, lenders are going to underwrite manager fees because if they have to take the property back, they're going to hire a manager and they're going to have to pay somebody else to take care of that problem. It's usually an expense. Affects the NOI and most acquisition people don't really think about that. Now on larger deals, they usually have management, and you're not really changing too much there. How can you change, how can your business plan translate to underwriting? Like I said, you have to understand the tenants that are at your property. For example, if you have a retail center where you think you can rent the property for 25 a square foot, but nobody's leases are expiring for three years. your cashflow is not really going to change for three years. So is your property, is the debt that you're getting going to cause a problem by the time your business plan has to come to fruition? And I think the biggest takeaway that we tell our clients is to be aggressive, but be realistic, right? We're the ones, Dakota and I, who are a little more conservative, but we, there's hundreds of data points that can support your underwriting and your comps and your rent projections, right? And if you're confident and we're confident in that, usually lenders and investors will side with us. And then finally, debt is a tool, but it's not your knight in shining armor. No, just because you can get 75, 70 percent loan to value at 10%, and you're going to worry about it later. It doesn't mean that's probably going to be the best return for your investors. Sometimes like we've talked about, maybe it makes sense to put in a little more equity and get a fixed five or 6 percent rate. And again, there are multiple scenarios that we specifically try to run through to make sure that you're delivering the best return for your investors. And ultimately you're setting yourself up for success because we want you to be able to sell or refi your property in three years and achieve those returns.

[00:39:20] Tim Little: Yeah, that's awesome. And before I open it up to questions, just a few comments that I want to follow up on, at the top there, you say lenders are not as bullish as. GPs and owners. And it's just funny to me because of our internal conversations. As GPs, we follow the mantra of being conservative, right? and that's for the benefit of our investors so that we're not getting ahead of our skis and we're showing them, Hey, even in a worst case scenario, it still works. but then when we're presenting to lenders, there may be the rosier scenario because you want to show how strong the deal is as well. so I think it's funny that it's not necessarily flipped, but that we as GPs and owners may have to think a little bit differently because the banks are so skittish right now that maybe we should be showing that more conservative underwriting when we are going to get those loans because that's what they'll be asking us to do anyways.

[00:40:22] Alex Zapata: I think. you're a hundred percent, right? if you're showing 20, 25 percent rent growth, a bank's not going to go for that. they're going to go for maybe a three, five, percent rent growth year over year. Unless you're investing real money into the property. what our job is to be that balancing act, right? maybe you come to us with a rosier scenario and we're presenting that scenario. And then we also present maybe a little bit more of a stressed scenario where. Like you said, you're being conservative to your investors. And that is maybe the scenario that we should have lenders was like, look, this is the business plan and this is the model, and this is supported by comparables, but even if they miss their rent projections by 5%, or if vacancy goes from, zero to 10%, what does that look like? And being able to give the lender confidence that one, we have confidence in the deal and to, the deal's already been screened and stress tests. That is incredibly valuable. 

[00:41:13] Tim Little: Yeah, and then the other thing that I was going to mention is, you talk about not expecting those rents to go up as aggressively as they have been. and obviously, there's a lot of regionality. In there, but, I think we have to look at the current trends and say, hey, if we are going into a recession, again, assume that is the worst case scenario, we always talk about multifamily being recession resistant, but I think it's important to note that it's not recession proof, it doesn't mean we won't get, be impacted By a recession, we will, and we need to think about that. We're probably just going to fare a lot better than other asset classes. And then you even have to look at what types of assets that you're invested in. a B class might fare pretty well, because they weren't going to go up to an A class anyways, but they don't want to quite move down to that C class asset. But that C class asset is very price sensitive. And so if you start to hike those rents They may move out and they may just suck it up and go to a D class or move in with their parents or whatever the case may be. So again, while we often tout multifamily as being recession resistant, we have to remember that it's not recession proof and to, Keep those things in under consideration.

[00:42:31] Dakota Brown: Absolutely.  All right, gentlemen, really appreciate this. unless you have some more, No, that's all right. I guess the last thing that I have to say is I'll bring this to a quick conclusion not to drag this on any further is,interest rates, they're going to be rising coming into the new year. and there's a ton of uncertainty. There's a lot of volatility and with that is going to come a lot of opportunities. there's a ton of individuals that just got into this space in the past. 24, 36 months that kind of, everyone was making money a few years ago, but now things are getting a little tougher. And I believe it's going to present a ton of opportunities. and that's, we're staying very optimistic. coming into the new year. Although rates are on the rise, there's gonna be a lot of uncertainty. But, we've seen a little bit of a slowdown in transaction volume, but there's gonna be a little more clarity coming into the new year. We can see inflation starting to slow down. and as I just mentioned with disruption, there comes a lot of opportunities. but we'll wrap it up right there. And I would love to entertain any questions.

[00:43:31] Tim Little: All right. So Does Franklin Street bridge to agency debt? That's something that we've been looking at. It's not quite as common, but we've discovered that it's a thing. that way you can, I don't want to say seamlessly transition. But reduce the risk of what comes after that bridge by having that agency debt lined up. And from my understanding of how it works is you go into it knowing that you want to do that structure. And so both are put in place initially. And so I think something like that would significantly reduce the risk and. Would make investors feel a lot better, especially in an environment like this. So are you familiar with that? And is that something that you guys have seen or actually transactional in? 

[00:44:23] Dakota Brown: Yeah, that's a really good question, Tim. we do quite a bit of a bridge to agency. We also do. Bridge to HUD, bridge to bank style financing, many perm style financing, but coming back to the bridge to agency product. I do agree with you. it puts in a certain level of. return metrics that need to be hit, or income thresholds that need to be hit that you know, and you're aware of, and are black and white. It's not a gray zone that needs to be hit in order to take out that, that agency style product. And, most of the bridge to agency products that were originating the bridge lender,on the bridge side there, they're getting a little more, a little less pricey knowing that, Hey, like they're going to have to hit very specific income thresholds to get into this agency product. So we get very attractive rates on those bridges, current products and bridge to agency products. most recently we've been seeing fixed rate bridge and agency style financing. 

[00:45:21] Alex Zapata: Yeah, to piggyback off that, I agree 100%. We're seeing a lot of that business and it's something that, if your business plan is to potentially hold this asset long term, but you have to do some value add up front, it makes complete sense, right? It's probably a cheaper cost of capital, and you're doing a lot of that upfront underwriting for the PERM program so that when You know, in 24 to 36 months, the refi comes along. You're the lender's familiar with the operations of the property. And, where you need to be and you're able to foreshadow okay, where your business plan needs to be in 24 to 36 months. And yeah, like Dakota said, we do a ton of that business and. It's a very popular thing and I think it ends up being very fruitful for the investors who go through that process. 

[00:46:05] Tim Little: Awesome. Yeah, that's really good information. Another thing that I've seen is, there's some properties who have recently done hotel conversions, right? And,it's one thing to do the hotel conversion yourself. I've looked at that, haven't followed through with it. but I've seen a couple of properties where they were like, say, 2020 or 2021 hotel conversions. Are there any unique lending requirements associated with properties like efficiencies?

[00:46:37] Alex Zapata: Yes. The biggest one is the first question we always get is do these units have kitchens? Do they have a kitchenette? Because if you're going to go from a hotel to where somebody's going to be living, for a year, you have to be able to provide them, a range, maybe a two stove top or anything like that. And if they don't have it, what does that cost look like? And hotel to multifamily conversion is a very popular concept. I think it's a lot more conceptual than it has been executed in certain markets. I think we've looked at, we've probably looked at 10 of them and only were able to transact on one of them. because the underwriting metrics and, the price per square foot or the rent per square foot that these units command is tough to justify, right? Because if you're talking about 350, 400, 400 square foot apartments, There's only so much that a tenant is willing to pay. And I think it's a good alternative to a lot of the high class stuff that's coming online, even here in Tampa. but it is a product that's been done and there's a lot of intrigue to see that after the properties have been converted, usually with bridge debt, how do they appraise and then ultimately what does the takeout look like, right? Cause that's probably what you're going to be seeing now. Going into Q1 because you need two years to shut the hotel down and convert it. 

[00:47:53] Dakota Brown: Yeah. Yeah. And another thing to go off of what Alex said is, I wouldn't really consider this a requirement, to be run as a multifamily property, but,any lender is going to look for some kind of experience doing that before. Or some kind of heavy value add multifamily. experience. sponsorship is going to be really important to get that lined up on those hotel to multifamily conversions. 

[00:48:15] Tim Little: Yeah. And that, that absolutely makes sense. Alex, you have a question. 

[00:48:19] Alex Tam: Yeah. Hi. thank you guys for providing a lot of value tonight One of the questions I have earlier was mentioned that where the interest rate Becomes a lot higher than the cap rate The problem with that, is it because ultimately you have to bring a lot more money into the table or can you elaborate a little bit more on that? Please. 

[00:48:41] Alex Zapata: Yeah, absolutely. If you think about it this way, if you bought your deal with all cash, and you were getting a 10 percent cap rate, Meaning you, your property's putting off a million dollars in a line, you bought it for 10 million, right? If you're borrowing it. Five, 6% versus a think of your cap rate as your yield. Basically, if you bought this property all cash, you would make 10% on that investment, right? If your cap rate is closer to 4% and you're borrowing at 6%, the cost of borrowing money exceeds your yield, right? Which your yield is basically, your cash on cash return, what is gonna be your net? It's gonna be. A un or an unprofitable investment for you when you get all the way down to your bottom line. So the cost, typically when you see those deals, From a bank perspective, you're probably having to bring 45, 50 percent down where, with a traditional bank loan, you're probably having to bring, 25, 30 percent down, in the bridge space, when you have those deals where the cap rate and the cost of capital are inverted like that, they want you to probably bring more money to the table to get you to a neutral. Leverage point or a positive leverage point where your cost of capital is less expensive than your cap rate. Is that going to answer your question? 

[00:50:03] Alex Tam: Yes. Yes, that does. Thank you so much. 

[00:50:05] Dakota Brown: And just going off of that too, Alex, thank you for the question. So basically if you're buying a property at a four and a half cap, You're making four and a half percent of the money that you invested into the property at acquisition. If you purchase it all cash, if interest rates are 6%, That means you could technically lend money at 6 percent to someone who's running a property and you'll be a lot less hands on. you can make more money, investing elsewhere in a T bill or lending money than purchasing that property. if that clarifies at all. 

[00:50:38] Alex Tam: Okay. So instead of, Okay. I see. This is another perspective. So when that's happening and you'd rather be the lender than the buyer, then the LP investor, is that correct? 

[00:50:49] Dakota Brown: It would depend on your risk profile, but, and there's a lot, it's a loaded question, but essentially, yes. if you want to, for example, if I can lend money at 6%, and if I'm buying a multifamily property at a four and a half cap, I'm going to be putting in a ton of work, a ton of effort. Obviously cap rates, hopefully get an increase as I add value, but year one, I'm only making four and a half percent. Why would I put in all that work when I could go lend money and sit on the sides at, making 6%. there's obviously, there's a ton of more, there's a lot more to it than that. Obviously if you're buying a four and a half cap and you put in the right amount of value, you'd be at a 10 cap in two years. you got to balance it out, but, That's a view that I have on it. 

[00:51:27] Alex Tam: Right, right, right, right. Okay, great. Thank you so much. I never even knew to look at this perspective. So thank you for bringing that. Yeah, 

[00:51:36] Dakota Brown: of course. Thank you for the question.

[00:51:38] Tim Little: All right. Good stuff. any other questions from the audience where we're creeping up? I think we've already crepton eight o'clock. so we're almost at an hour right now. I'll give it a going once. All right. hey, gentlemen, I really do appreciate you coming over here. And Alex said, adding a lot of value to the audience. And this again, all this information is very timely. So I was glad I was able to have you come on and relay your expertise here. I'll certainly have all your contact information. If you know the show notes that I post, I put this on YouTube and then we'll also be sending it out to the list of all those who registered so we'll have all your contact information in there. I think that's it, Tim.

[00:52:23] Dakota Brown: Really appreciate you having us and,definitely looking forward to staying in touch. Absolutely. 

[00:52:27] Tim Little: Okay. Thanks guys. Thanks for coming 

[00:52:29] Alex Tam: on. Thank you. Thank you everyone.