Mortgage Trends in the Wake of Rising Interest Rates with Eric Stewart

When interest rates go through what they have over the last 18 months, the biggest concern for investors is how that will impact their ability to borrow money and raise capital.

If you look at loan amounts, it might appear as if borrowers don’t want to lend, but the truth is funds are still available, we just have to have clarity around what we want to achieve.

What are some of the changes that interest rates have brought to the marketplace? How do we make sure we still reach our goals?

In this episode, commercial mortgage broker, founder of Atlantic Investment Capital, and the author of “Borrow Smart!” Eric Stewart talks about the state of loans in the way of interest rates.

Three Things You’ll Learn In This Episode

-Buffer your borrowing
With interests changing frequently, how do we build flexibility into the loans we take?

-How navigate multiple lenders
Is it better to deal with a mortgage broker, or should we just go directly to the lender?

-Non-recourse vs. recourse loans
What are the options we have for loan structure?

Guest Bio

Eric is a commercial mortgage broker, founder of Atlantic Investment Capital, and the author of “Borrow Smart!: Learn The “Not So Secret” Weapons Of Successful Commercial Real Estate Investors”. Buy the book here, to reach out to him send an email to erics@atlanticic.com or call/text 800-916-9005.

Scroll to read the transcript.

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Voice-over:

Welcome to Raise Private Money Legally with your host attorney Kim Lisa Taylor. If you’re a real estate investor trying to avoid the legal traps that come with raising private money, then this podcast is for you.

Kim Lisa Taylor:

Information discussed during this free podcast is of a general educational nature and should not be construed as legal advice. Today, our topic is “Mortgage Trends in the Wake of Rising Interest Rates.” Here we are in 2023 and we’ve seen a whole flurry of activity by the Feds, so we decided we would bring on an expert. Eric Stewart is the expert that we selected. We love Eric. We’ve known Eric, I don’t know, probably 10 years, maybe longer, for a very long time.

Eric is like a magician when it comes to mortgages, and I just tell you this story firsthand is that my husband and I syndicated a property one time and it took us two years to get it refinanced and Eric stuck with us for the whole entire time and it was just a crazy story and he finally found somebody who would finance it for us when we were down to the wire stressing out about it because we had a private loan on it and we got it done. So as far as I’m concerned, he’s a magician. He helped us get it done. I don’t think anybody else would’ve stuck with us that long. So he’s been around the real estate investment circuit for a long time. Very, very much in tune with the kind of things that our clients are trying to do. So Eric, tell us about yourself.

Eric Stewart:

Yeah, thanks for the intro, Kim. I really appreciate that and definitely thanks for having me on and letting me talk to your listeners. My name’s Eric Stewart. My company is Atlantic Investment Capital and I’m a mortgage broker, so I don’t actually write the checks, but I’ve got a stable of lenders that do write the checks and that allows me to serve individual investors that are looking for short-term debt, long-term debt, small loans, large balance loans for all different types of industries. It just gives me a lot more options than being a “one-trick pony” with one bank, one credit union, or even one agency lender that may have one or two products. So it’s been wonderful to connect with folks like you that also share and serve that same client base. And we’ve got that back-and-forth, those open lines of communication where we’re all here to help these clients succeed.

And that that’s been wonderful. I mean, I think you and I met, it had to have been around ’08, maybe ’09 even, something like that. So it’s been a long time, a lot of deals funded and it seems like no matter what the time was, what year it was, there was always something exciting to talk about. There was always some uniqueness to what’s going on with interest rates, what’s going on with property values. You can’t find a deal, you can find a deal, what’s hot, what’s not. And that’s always been what’s created the opportunities are the folks that had clarity for what they wanted and had clarity on how to get it aligned, their interest with the right industry professionals, and they were able to take advantage of the opportunities. And I don’t think that’s going to change going forward, especially not between now and the next couple of years. I don’t think you’re going to see it settle down.

Kim Lisa Taylor:

Well, I know that we had a very slow end of the year. (In) December things cooled way down. January was a little bit light for us. I think everybody was just reeling about what’s going to happen, but now this month we’re going gangbusters again. So people are finding deals again, people are managing to find deals that make sense. So maybe the sellers have started to adjust their prices or maybe other people have exited the marketplace, competitors have exited the marketplace because they think it’s a bad time or whatever, but our clients are finding deals and they’re coming back into the game. So what do you see happening in the commercial marketplace in the wake of these rising interest rates?

Eric Stewart:

Well, funds are still available. Rates have increased, and we all know that prices have increased, cap rates have compressed, and a lot of borrowers look at the end result or that the net loan amount as an indication that lenders don’t want to lend or they’re interpreting that as something negative from the lender’s side where they’re not looking to get involved or there’s a major concern with the market. The reality is lenders want to lend that they’re using the same underwriting metrics that they always have. The difference is that it’s with a higher interest rate. It’s with right now lately much higher expenses, especially on insurance, and that same loan amount is in conjunction with a higher purchase price. So it results in lower leverage. So it’s not as though lenders are saying, “Hey, we’re not going to do more than 60% leverage.” It just means the property won’t cash flow for more than 60% leverage.

So that standard underwriting that they’re doing, they really haven’t changed. It’s just producing a lower loan amount. So what we’ve seen happen since then, to your point, is cap rates have risen. We have seen prices pull back a little bit and that we started to see that the middle of Q3 of last year. We did see a dip actually, which you were talking about, say Q4 of last year. We did see rates pull back a little bit and in the true spirit of volatility here, they have recently jumped back up. We’ve got the 10-year Treasury that’s now above 4%. We’ve got a two-year Treasury in the high 4’s, most impactful to our multifamily rates in the long-term term debt, that 10-year Treasury note when it broke that 4% barrier again.

So we’re sitting at just over 4% and that is what in the short term is going to create some turmoil. Folks that have already been … moving through their loan process, they have locked their interest rate, and they’re going to have to deal with those changes during the process. And I know you see a lot of that because that’s when you get involved. Right now that’s what we’re working through. When you structure these loans, you give yourself enough of a buffer in the interest rate. You don’t underwrite the current market rates, you bump that up a little bit so that you have some flexibility as you go through processing.

Kim Lisa Taylor:

So what kind of interest rates is this translating into for our clients?

Eric Stewart:

Well, great question, and it’s a moving target, but I like to focus on that foundation. The 10-year Treasury yield is a really, really solid gauge to keep an eye on because as that increases, that is what your interest rate is based on. Now again, I’m using an agency permanent loan, let’s say a 10-year loan or a 12-year loan, something like that as an industry standard because there’s so many different loan types, so many different lenders that we can talk about in a whole ‘nother podcast. But for just to standardize, the 10-year Treasury yield, which is right around 4% right now, is a good industry standard base. I like to plan on 2% above that.

Kim Lisa Taylor:

2%.

Eric Stewart:

Yeah. 200 basis points above that. Now, that’s very general. There are certain loan terms and certain loan characteristics that could put you at 215 basis points or 2.15% over. There’s also some scenarios that can put you at 1.75% over. So there is a range there, but focusing on the one in the middle and just kind of standardizing it, I like to say 2% over the 10-year Treasury.

Kim Lisa Taylor:

So if I’m understanding this correctly, then it sounds like if the 10-year Treasury is at 4%, then we’re looking at interest rates of 6% for these commercial loans. Okay. So that’s not so bad. I mean, I think that people were imagining that it’s like 7% to 9% or something like that, but it sounds like that’s not the case.

Eric Stewart:

Not right now. And if you’re looking at today’s rates, again, that’s what we have to give ourselves a little bit of a buffer. So if you’re underwriting your deal and you’re planning on closing in 60 days, which is a standard timeline, then I would really ask you to dial in six and a quarter, 0.35, something like that, because we’re going to see … another Fed meeting here mid-month. Realistically, market sentiment comes out based on the Fed’s minutes more so than what they do because they’ve already priced in the two more quarter-point increases and they’re looking at what they’re going to say or the market looks at more about what they say than what they actually do. But I think it would be wise to plan on higher rates at least through middle of this year.

Kim Lisa Taylor:

Okay. But that’s still reasonable. I think those deals are still doable first. So for the listeners, if you’re underwriting your deal, then you want to put in maybe the six and a quarter percent just to be conservative as far as what your interest rate is going to be on that deal. Now, are we still seeing the same terms? Are we seeing options for five-, seven-, 10-year maturity rates on these loans?

Eric Stewart:

It’s a great question. And those terms are available. They haven’t restricted the availability of them. (What) most clients do is modify their loans based on current market conditions. And to your point on that five-year deal, some clients, they’re taking the strategy of doing a five-year term and then refinancing once that loan matures, thinking there’s going to be a lower interest rate. What I would ask them to do is look at the premium that they’re going to pay. Because right now we have what’s called an inverted yield curve, meaning the yield on the 10-year Treasury is lower than the yield on the two-year Treasury or even the five-year. So you’re going to pay a higher interest rate for that five-year than you are for a 10-year fixed period. I saw one the other day, it was almost 7% for a five-year deal where you could save a hundred basis points to take a 10-year term and fix it for 10 years.

Kim Lisa Taylor:

With those 10-year terms, there could be a prepayment penalty, right?

Eric Stewart:

You’re absolutely right. And that’s the nuance. You look at the prepayment penalty and we have the ability to pay a little bit higher interest rate, but get a softer prepayment penalty. So we’re going to compare the difference between just doing a five-year term and paying a premium for that relative to a 10-year term and pay a premium for a softer prepayment penalty and see which one benefits us the most.

Kim Lisa Taylor:

Well, and then are there seven-year terms available?

Eric Stewart:

There are, yes.

Kim Lisa Taylor:

Somewhere in the middle, so maybe pay less for seven than five.

Eric Stewart:

Exactly.

Kim Lisa Taylor:

And it’s also a trade-off you’re gambling that in five years there’s going to be better interest rates, which may or may not be the case. What if they’re worse? Then you’re forced to read finance in the shorter term.

Eric Stewart:

You’re exactly right there. It’s an educated guess. I try to keep my opinions out of it and I try to follow the money and I look in the industry about who is betting the most on future interest rates. And there’s two players in the industry that have the most to lose based on short-term future interest rates. And that’s bridge lenders and rate cap providers.

Rate cap providers, they price their cost of their caps based on where they feel rates are going. And they look at the forward curve charts.

Bridge lenders, they have maturities that are coming up in two to three years. I mean, that’s a short fuse on those firecrackers. So I look at where they underwrite their exits, which is, historically it’s been around five and a half to 5.75. I can almost assure you they’re going to bump those up now based on the last couple, well two weeks that we’ve had rate increases. But looking at what the rate cap providers are doing, really those guys, they price based on future rates. And so rather than try and reinvent the wheel, I go in and look at what they do.

Kim Lisa Taylor:

Okay. So … the rates we’re talking about, these are Fannie, Freddie, CMBS, or is it across the board, kind of the same?

Eric Stewart:

If we’re focused on the multifamily industry, then Fannie Mae and Freddie Mac are really the, they’re the go-to lenders. They’re the ones that are going to get … they’re going to offer you the lowest rates, the best certainty of execution. And once we get into self-storage and some of the other commercial components, that’s where CMBS really comes in and they’re the ones that can make it happen. The rates that I’ve been talking about are our Fannie Mae and Freddie Mac. When we get into the CMBS market, you’re going to see a little bit higher rate. They’re probably in the mid to high sixes and they’re looking at 10-year terms.

Kim Lisa Taylor:

Can you explain to us what a rate cap provider is?

Eric Stewart:

Oh, absolutely. Yeah. You’re most likely going to see these rate caps and deal with rate cap providers on your bridge debt. And when you are taking out, let’s say a three-year bridge loan, a lot of times that lender only offers variable interest rates. Well, if you get into a scenario where that rate has no cap on it, you can get into a situation where you can’t make your mortgage payment. The cash flow from the asset doesn’t service the debt anymore. So what they do, and what you can do is buy a rate cap. It’s almost like an insurance policy, and it says that if your interest rate goes up above a certain point, then this company will reimburse you for any amount, any mortgage payment above that rate.

And it’s really a nice tool to have. And it was reasonably priced as of two years ago, but once the expectation of rate increases started to kick in, then those rate caps started to, they got really, really expensive. And they actually pulled back Q4 last year. Rate caps were pulling back because the expectation of rate increases wasn’t as great. And I have a feeling over the last two weeks, they’re starting to price back up again.

Kim Lisa Taylor:

Okay. So yeah, there’s always a trade-off. What do we want to pay up upfront for this insurance policy versus do we want to take the risk and not get that insurance?

Eric Stewart:

Kim, I have to say, it’s really an insightful thing that you bring up there because I’ve looked at that scenario and I’ve been in that scenario with clients where we’re just comparing notes on it and almost always, nine times out of 10, my recommendation is to pay a slight premium for a fixed-rate loan rather than come out of pocket for a couple of hundred grand at closing. And then hope, I mean, you just bet $200,000 that your rate’s going to go up. So why not just pay a little bit more in the interest rate, sleep at night, you know where your rate’s going to be, it’s not going to change. And then you don’t have to buy the rate cap. I really feel like that’s a more conservative play. And then you offer your investors a much more conservative structure.

Kim Lisa Taylor:

Yeah, I like that. I mean, certainly that’s a tool that’s sometimes useful, but if the fixed rates are available for a comparable premium, then yeah, you have to look at that, I would imagine. Okay. So I guess you have a lot of clients that are thinking buy now (and) refinance later.

Eric Stewart:

Yes, that was the thought. I mean, it’s a common… I don’t necessarily agree with the structure, but it is common. I talk to a lot of folks that consider just doing shorter-term loans now so that they can refinance later. What I ask them to consider, though, is the premium that they’re going to pay for that rate. When they do that five-year term, they’re going to pay a premium for it. They’re going to pay a higher interest rate. So they have to look at the overall yield for their investment. And then something that’s not really quantifiable is the interest rate risk or the refinance risk that they’re subject to. So anybody that plans on a short-term maturity and then a refinance, I ask them to really look at that specific deal. Look at the merits of your rent lift, how you’re going to force appreciation, make sure you protect your exit.

Obviously by not over-leveraging, but also not putting together a business plan that’s this artistic operational lift rather than just market rents. On my bridge loans, I say throw money at the problem, keep it simple. If when you get into, “Well, rents have been rising by X and this company’s coming in and job growth is great, so I’m really comfortable, we’re going to be able to refinance out.” I get concerned about that. If you come in and say, “I’m going to improve units, I got $500,000 in the bank, “that makes me more comfortable.

Kim Lisa Taylor:

So just in case anybody’s just new, really new to this and you don’t understand what a maturity date is, can you explain that, Eric?

Eric Stewart:

Yeah, absolutely. When we talk about a loan term, the loan term is the length of time that that loan is outstanding. Well, at the end of the term, that loan matures, that means it needs to be paid off. And sometimes if the loan is amortized, meaning the payments are spread out over the full term, they call it fully amortized. So on your home mortgage, you usually have a 30-year term and a 30-year amortization. Well, on these commercial deals, the term is usually shorter than the amortization. So we’re going to spread the payments out over 30 years to give you a lower payment, but it’s probably going to be due and have to get paid off or mature in 10 years, five years, 15 years, something like that. So that’s where that term balloon comes in. It’s a lump sum payment that needs to be paid off.

Kim Lisa Taylor:

And I’d just like to point out that when I started as a securities attorney in 2008, the financial crisis was shortly thereafter, and there were a lot of people that had really short-term maturity dates on their debt at that point that got left holding the bag when all of a sudden the values dropped, the value of their property dropped. So they were at a point where they couldn’t refinance because their property wasn’t worth the loan amount that they had on it. And so those were the people that ended up losing their commercial properties to foreclosure or short sale. Am I correct on that, Eric? Is that an apt description?

Eric Stewart:

It is. It is. And it was a different lending environment. It was a lot more aggressive, sometimes irresponsible, shortsighted. Because of that debacle, regulations have been put in place to help prevent that. And one of the biggest things is the level of recourse that these lenders have on the notes they originate now, that wasn’t in place … that the accountability wasn’t there way back then.

Kim Lisa Taylor:

Yeah. Somebody who got a bridge loan two or three years ago that’s now coming due could actually be in that situation now, right?

Eric Stewart:

It is possible.

Kim Lisa Taylor:

Well, I guess they don’t necessarily, it’s not that the property value has dropped, but now they have to actually refinance it in an interest rate that’s higher than maybe the bridge debt was or that maybe was available to them previously.

Eric Stewart:

You’re exactly right. And that comes, it’s a lot of components that go into that. Number one, and it all starts with, and you’re very familiar with this, the projections. When they dial in these short-term notes, there’s folks that may have pitched a value-add deal as though it is a stabilized momentum play and just a cash-flowing deal when in fact this short-term note means you’ve got to have a distinct value-add plan. You’ve got to throw money at the asset. You’ve got to make sure that when you assess your exit, you use a higher interest rate than where rates were at the time. And that has a lot to do with being able to refi out, is projecting your terms as much as the value because the lender’s going to do a two-valuation approach. They’re going to look at as value, and then they’re going to look at it as stabilized value or as completed.

And a common metric from bridge lenders is that not only are they going to base your loan amount on your total cost, meaning purchase price plus improvements, but in the fine print on your term sheet, they’re going to say proceeds not to exceed 65%, 70%, maybe 75% of stabilized valuation. So they’re going to protect themselves by a leverage-based approach saying no more than, say 70% of the stabilized value. And they’re also going to run exit tests and look at the NOI, projected NOI in Year Two or Year Three and bump that rate up and make sure you can capital that deal.

Kim Lisa Taylor:

So I know I’m running completely deviating from the prepared list of questions that we have, but I’m just going to…

Eric Stewart:

That’s good.

Kim Lisa Taylor:

… chase in these rabbit holes because I think these are things that people want to know. People want to do these bridge debt because, or have to do bridge debt sometimes because they don’t have the right occupancy rate. Is that the driving factor you’re trying to get into a deal that doesn’t have 85% occupancy or is there more to it than that?

Eric Stewart:

That’s a huge component. That is a primary driver of why you do bridge loans just because it won’t qualify for permanent debt right now, another reason is that a bridge loan will include and they’ll lend on renovations, and we’ve got some lenders that’ll do 80% of your purchase price and then 100% of your renovation cost.

Kim Lisa Taylor:

I see.

Eric Stewart:

It really is. But again, we’ve got to look at that exit value because now we’re levering up based on improvements and we don’t want to over-leverage going in and not be able to refi on the way out or not be able to refi the whole unpaid balance on the way out. So you’re right, occupancy is a big one. Cash flow is another one because there’s, well, coming off of the pandemic issues, we’ve been dealing with squatters and all these tenants where you’ve got your physical occupancy, but your collection loss is through the roof. So there’s also those issues because the relief programs have worn, most of them have worn off now, and we’re trying to wean these tenants back on supporting themselves. So there’s a few other concerns in addition to occupancy, but you’re right, that’s a huge one.

Kim Lisa Taylor:

Okay. So bridge debt, what kind of terms do we see on bridge debt? Is it just two or three years and that’s it? Or are there three years with one- or two-year extensions? What’s available?

Eric Stewart:

And I’m glad you mentioned that and here’s why. Well, first let me answer your question. The answer to your question is yes. Bridge loans are usually anywhere from one year to three years. Once you get above that three-year mark, you’re mini perm to perm, three to five years and greater. So one to three years, that’s your core term. That’s when you’re expected to make your improvements, stabilize the asset, and then refinance out. If that doesn’t happen, let’s say something crazy would happen in the world like a pandemic or something ridiculous like that and you’re not able to refinance out of that deal, then they offer you extension periods. There’s usually a 1% extension fee or maybe a half a percent extension fee. And usually they’re a year. So it’s like 1% for 12 months. And then it’s kind of like the doctor, if you can’t pay your bill, they’ll give you another six months. Well, there’s usually two extensions, so they refer to that as a 311. And what I’ve seen investors do is consider that a five-year term and they plan on going into those extension periods.

And I caution against that because those extension periods are not part of the initial term. They’re not part of the initial plan. Those extension periods are just there in case you need them. And what happens is lenders will incentivize you to refinance, meaning those extension periods may not be the same interest rate as your one- to three-year term, or they may start to amortize the loan because those bridge loans, they’re one to three years interest-only. They’re only collecting interest. They want you to increase the value of the property to protect your exit and increase the income to protect your exit rather than pay the loan down to protect your exit. But if you’re in a scenario where, “Hey, we weren’t able to hit in three years, we need to use this extension,” the lender’s most likely going to say, “We’ll give you the extension, but we got to start paying this loan balance down because we’re getting nervous about this now.” So those extensions are not as attractive as your initial one to three years.

Kim Lisa Taylor:

Well, and some of them, don’t they also make you start providing some metrics on your property and if it doesn’t meet the metrics, they can refuse the extension?

Eric Stewart:

Absolutely, they absolutely can.

Kim Lisa Taylor:

Looking at debt service coverage ratio, well, I mean what kind of metrics are they looking at?

Eric Stewart:

DSCR is real standard. They do want to see that. They also want to see a debt yield, which is comparing your NOI directly to your loan amount. They’re also going to look at how much money you have spent and they’re going to watch your CapEx schedule. If you are over budget on a number of items, some lenders go back in and ask you to rebalance that CapEx budget and put more money in. Real standard. It’s something that we negotiate in the beginning of the term is let’s say you sent your CapEx schedule in and the lender has a team that reviews that and they say, “Look, based on this structure, we want to set a rebalance point at 12 months.”

And that means they’re going to go in, look at what you planned on spending, what you actually spent, and if you need to bring in more money, you sign that you will. And that’s usually included in the carve-outs. And then what we’ll say is, “Look, that doesn’t really align with our plan because of the seasonality of it. We bought this property in Wisconsin, we can’t do a roof in February, so we’ll have to push this out. Let’s make that rebalance point 18 months,” something like that. So those are the types of things that we negotiate upfront so it aligns with the plan.

Kim Lisa Taylor:

So I think that the audience is starting to see why it’s so important to work with a mortgage broker like yourself that’s going to help them understand all of this. And because there’s so many variables here that they have to consider that unless they’ve done this a zillion times before, they’re not going to know or understand that. Let’s spend just a minute talking about a mortgage broker versus going directly to a lender. What are the advantages of going to a mortgage broker? I mean, other than knowledge, which we’re seeing here.

Eric Stewart:

It’s a great point and it has a lot to do with relationships. If you haven’t dealt with a lender before, each one has their own proprietary methodology, their own proprietary guidelines that they underwrite to, even though they may all sell their loans to Fannie Mae, they each have their own methods, and some are more conservative than others. Some want their deals presented a certain way and some will give you certain concessions, but that’s lender-specific. So that existing relationship is priceless. It has somebody that you can go to that knows what that lender’s looking for, knows who to talk to. I mean, it makes all the difference in the world.

Kim Lisa Taylor:

And I liken it to, you can go to a store online and buy something directly from that store, or you can go to some aggregator like Amazon and you can compare five different sellers of that product. With a mortgage broker, you’re getting their expertise listening to what you are saying about what your needs are for the project, and then in their mind going, “Okay, that would work good for this lender or this lender or this lender,” or maybe you need to consider bridge debt. Maybe you need to consider this before we get to agency. Eric’s going to be thinking about all that stuff as he tries to direct you to the appropriate lender, which may not be your local credit union or bank. I can tell you that I’ve had clients come to me before that are like, “Oh, well we talked to this lender and these are the terms they gave us.” And I always encourage them, talk to a mortgage broker so you can get their wealth of knowledge of what other options are available out there.

Eric Stewart:

It’s kind of like a tailor, because it’s not just about the deal, it’s also about your investment strategies and your individual plan for this asset. So you go to a tailor. Well, if they’re talking to me, they’re going to say, “Look, you’re really short, so you need to do this and this.” So the deal’s no different. We’re going to discuss it. And the first thing I like to do is just listen. Have you tell me your plan for the asset, how you’re going to raise the capital, what the overall structure’s going to look like from a hold period standpoint. Tell me about the market, what your connection is there, and then we can walk through the best debt structure for you, but it’s got to start from the borrower’s plan and then we find the right loan to fit in from there.

Kim Lisa Taylor:

Yeah, I think that’s really wise. So how about qualifying for loans. People… Well, let’s talk about this first and then let’s talk about qualifications. Recourse versus non-recourse. Can you explain that?

Eric Stewart:

Yeah, absolutely. It’s one of the big drivers for a lot of my clients that are converting from single-family into multifamily. Everybody wants to do non-recourse debt, and the neon sign for non-recourse debt would be “no personal guarantee.” That’s what everybody likes and hangs onto. Some of the real fundamental benefits of it is that you’re unlimited on the number of loans that you can do because the guarantee and the borrower is with the property itself, number one, that it’s not hitting your personal credit. Number two, that loan is getting sold off to investors. So when you are dealing with, let’s say a depository lender, a bank, they hold that loan on their books, doesn’t get sold off. And the more debt you do, the more loans you do with that lender, the higher that exposure is to you. So a lot of times they’ll say, “Hey, no more than $7 million, no more than $12 million,” and then they cap it.

Well, when you work with a securitized lender, a lender that sells that loan off in a group, they pull it with a bunch of other loans and they sell it off. Well, now it is an investment on its own. Your second loan comes in, your third or fourth or fifth is a separate securitization, so it’s not a total exposure thing. Each loan is securitized and its own package. And so it allows you to keep borrowing. I’ve done, I’ve sponsored deals and had this more than one loan request going on at the same time, and they didn’t overlap as far as my net worth liquidity and all the borrow requirements, you’re able to do that because they’re separate buckets, they’re separate securitizations.

Kim Lisa Taylor:

So it’s not like it’s cumulative. They’re saying, “Oh, well your net worth is this, you can only guarantee up to X amount dollars worth of loans” and then you’re done. It’s more like you could borrow against that same net worth again and again and again.

Eric Stewart:

Exactly. You’re exactly right. So that’s one of the benefits. And I use that example to the non-recourse question because most of your securitized lenders are non-recourse. So I try to… I mean, I have to compartmentalize that. When I say recourse lenders, I’m usually thinking depository lenders like banks and credit unions. A lot of your alternative lenders in that one-to-four space, they’re usually recourse.

Kim Lisa Taylor:

And you mean one-to-four-unit space?

Eric Stewart:

Yeah, yeah. I’m sorry.

Kim Lisa Taylor:

You’re talking one to four units?

Eric Stewart:

Yeah.

Kim Lisa Taylor:

Okay. So small properties, the smaller the property, the more likely you are to get into recourse debt. Is that an apt statement?

Eric Stewart:

That’s exactly right. And if you had to put an industry standard on it, if your loan request is below $1 million, it’s probably going to put you in a bucket where you’re doing a recourse loan. Now there’s some alternative to banks. We’ve got no-doc or low-doc programs where you pay for a little more privacy and things like that. So they are available where they’re not looking at your tax returns and doing this global debt-to-income ratio like a bank is. But that $1 million is the threshold for say, Fannie Mae’s small-balance program and Freddie Mac small-balance program.

Kim Lisa Taylor:

And that’s been true for a long time, but there have been times in the past where they’ve actually had some smaller balances that they’d offer. Is that not available now?

Eric Stewart:

You’re right. They used to go down to $750,000 based on a relationship, but they really drew a hard line over the last four or five years. They drew a hard line on that $1 million loan amount. They’ll actually price you up. Fannie Mae will price you up roughly 80 basis points or 0.8% if you’re below $2 million. They may have waived that actually now that they’re starting to warm up the smaller deals now, or at least been very open to exceptions on that. The latter part of last year, I did, it was about a $1.4 million loan and they waived it. So sometimes we can get that, we get a pricing waiver, but they do price them up.

Kim Lisa Taylor:

Okay, so guarantors, long guarantors, let’s talk about what that means. So in a recourse scenario or even in a non-recourse scenario, you have to provide a guarantor, right?

Eric Stewart:

Yes.

Kim Lisa Taylor:

Or one or more guarantors. What does that mean?

Eric Stewart:

Okay. So first, there’s a guarantor and then there’s a borrower. And as you know, if somebody doesn’t understand this, that’s the Kim Lisa Taylor questions there, is who’s the borrower? Well, the team is going to form an LLC for you that will be the actual borrower. The guarantor is the warm body that controls or makes decisions for that borrower for that LLC. And most lenders have a typical, they have two triggers that they focus on to decide who’s making decisions. One is a percentage ownership threshold. So an industry standard would be 25% ownership or more of that borrowing LLC, that’s one. The second one would be managerial control that through your title. So if it’s a manager-managed LLC, again, another Kim question. If it’s a manager-managed LLC and you are named as the manager, you’re probably going to have to sign them alone.

Now, this isn’t etched in stone. I’ve done deals where we’ve had investors that own 65% of the deal. They didn’t sign them alone because they didn’t have any control. They weren’t managers in the deal, but they did have to get underwritten. They pulled credit, they made sure they didn’t check any boxes on blacklists for investors and things like that. So that’s the hybrid is where you have a major investor that’s over 25%, they’re probably going to get their credit pulled, but if they don’t have any control of the deal, they’re not running the day-to-day operations, they’re probably not going to have to sign. So those are the two triggers.

Kim Lisa Taylor:

Okay, so that’s underwriting versus guaranteeing. They have to be underwritten because they need… And that’s because of the Banking Secrecy Act, where the lender is required to investigate who they’re loaning money to and to make sure that they’re not bad people. So they need to look at them to make sure that they’re credit-worthy and that they’re not money launderers or something that they’re not allowed to do business with. So let me just talk a little bit about structuring, because we do a lot of structuring around this very issue. So when we create a syndicate, we typically create a manager-managed LLC that’s going to hold title to the property, become the borrower on the bank loan. The manager is another LLC, and that includes the members of your management team.

If all of those members are going to be signing on this loan and going to be guaranteeing this loan, meaning that they’re putting up their liquid net worth to support the loan amount, then we’re going to make this a member-managed LLC. If you make it a member-managed LLC and only some of those members of the manager are going to be signing on the loan, then the lender’s going to start looking at the percentage ownership interest of each of those members.

You can correct me anytime I misstate here, Eric.

One of the things we regularly do is let’s say you only have two people that are going to be putting up their net worth to guarantee the loan, but there’s five people involved in management. Then we would also create that management entity as a manager-managed LLC, and we would identify the two people signing the loan and guaranteeing the loan as the managers of that manager LLC. And then all of the five of them, including the two that are guaranteeing, are the members of the manager LLC.

So I know that’s a little bit more of an advanced concept. Some of you guys obviously have done this before. Some of our listeners have done it before, so they get what I’m saying. Some of you, it might be a little bit more convoluted to think about, but it’s just a matter of the lender. And the way I explain it to clients is that the lender wants the people in ultimate control to be the people that are the loan guarantors so that if something happens and that property starts to fail or their loan is in jeopardy, that they know that they’re dealing with the people that have the most at stake. So one last thing about recourse versus non-recourse. Even in non-recourse loans, there’s a whole bunch of carve-outs that say if you do something illegal, if you violate some law, or if some certain thing happens at the property, we could hold you personally responsible for that loan. Am I correctly stating that, Eric, what those carve-outs mean?

Eric Stewart:

Yes, you are. That’s accurate.

Kim Lisa Taylor:

Have you seen these carve-outs grow over the years? More and more things can be added?

Eric Stewart:

The attorneys stay busy. They’re constantly reviewing the lender’s docs. And one thing to note too, and Kim, I’m sure you see this all the time, when a borrower reads their loan docs, they’re usually freaked out, to put it in the most realistic terms, they are built by lenders counsel for the lender. The lender spends a lot of money to make sure that all those documents are weighted in their favor. They’re never going to say, “We want to make this easier on the borrower in case there’s a dispute.” They just don’t do that. So when you, let’s say for example, you start reading Freddie Mac small-balance docs and you’re like, “Kim, this is a recourse loan. This is crazy. Why are they doing this?” And then you’re going to explain, “Well, here’s the difference between the borrower and the guarantor. You are the guarantor, the borrower, the company is obligated to all of these things, but you’re the guarantor signing on this non-recourse guarantee.”

So this is the long way to get to your answer. Those carve-outs can house all the exceptions to where the lender can come after you personally if you do things or don’t do things within this list. One of the most recent ones, I won’t say recent, but one of the most prominent ones that they’re using is completion guarantees. So they’ve been doing it for a long time; it’s not new. But let’s say you’re doing a renovation deal, you’ve got a bridge loan and you’ve got a $500,000 renovation budget and you blow your money, you spend it all on something else and you don’t complete the repairs and the deal falls apart because you didn’t complete the repairs.

They include something in those carve-outs called a completion guarantee where you’re personally guaranteeing saying you are going to complete this project. You’re going to do the improvements, not necessarily spend all the money, but you’re going to do the improvements that you say you’re going to do. Another one in there that catches folks is voluntary bankruptcy. So if there’s a trouble at the property and you run and file bankruptcy just to protect yourself, so that lender can’t take any action against you, that triggers a recourse guarantee. So certain things like that, you definitely want to walk through with your counsel and understand what your real exposure is.

Kim Lisa Taylor:

Well, and I’ll tell you where the first thing that you talked about happens where you can’t guarantee the completion, and that’s because you didn’t raise enough money up front. So when we do an offering, we’ll do a minimum offering and a maximum offering. We’ll say you have to raise at least this much in order to acquire the property, but you can continue to raise after closing in order to raise your capital improvement budget, et cetera. And then we give you a cushion that says, if you get into the property and you figure out that there’s some other thing or something goes over budget and you need to raise more money, you can go up to this maximum dollar amount.

So your ideal target is somewhere in the middle of that minimum and that maximum amount. But if you only raise the minimum and you get in there and you close the property and you never raise the money for that capital improvement, that’s where you get into that trouble, where you could experience some liability for that personal guarantee for not being able to complete the repairs. And I have actually had some clients that did that in the past and ended up losing the property because it’s easy once you’re running full steam ahead to get to the closing table, and then the second you get the deal closed, you’ve got a million other things to do to get the property going, but you take your foot off the gas from raising money and you stop raising money. And that is a huge mistake.

You never stop raising until you hit your target. And then you leave the rest in there as a cushion. Not that you’re raising the money, you’re just leaving yourself a cushion in. your offering documents that you don’t have to go do a whole new offering. You can just reopen this offering if you need more money within the first year, and you’re usually going to be able to figure that out within the first year. All right. Well, Eric, this has been phenomenal. Like I said, we completely deviated from the list of questions. I apologize for that, but I think we covered some really great stuff. I do want to talk a little bit about your book, which I happen to have a copy of right here. Tell us about your book.

Eric Stewart:

It’s quick. First of all, I try to refer to it as more exactly as it would be more of like a plane ride kind of read and more of a discussion. And I left out all of the, “Here’s what I did when I was a kid” and all that kind of stuff. It really just gets right into what you need to know, and it’s really born from questions that I’ve gotten over the last 20 years because they’re all so similar. That’s my entire educational platform is built off of the questions that I get from clients because of the repetitious nature of it. This discussion is there to prepare you and help you figure out what questions to ask, help you figure out what rabbit holes to go down to that are going to be the most valuable for you specifically in your investment. I don’t talk about mindset, I don’t talk about your “why.” I hope you start to peel back the “how” so you can make that “why” happen.

Kim Lisa Taylor:

Just for the people who are listening, the name of the book is “Borrow Smart.” And how can people get a copy of it, Eric?

Eric Stewart:

It’s on Amazon. I don’t know how to post the link right now. I don’t know if I screen share and do a QR code or how I should do that, but it’s available on Amazon. “Borrow Smart, the Not So Secret Weapons of Successful Commercial Real Estate Investors.”

Kim Lisa Taylor:

And Eric Stewart, if you want to look him up by author, it’s S-T-E-W-A-R-T. Okay, great. And let’s see, what’s your website? How can people reach you?

Eric Stewart:

Oh, okay, great. The easiest way for you is the way I want you to get in touch with me. So I will give you my email address, which is E-R-I-C-S, erics@atlanticic.com.

Kim Lisa Taylor:

So the name of the company is Atlantic Investment Capital, and so the domain is atlanticic.com. All right, so we’ve got a couple of questions here. Let’s see, an anonymous attendees says, “Which Southeast regional states are landlord-friendly?” and they’re asking specifically North Carolina, Georgia, and Florida.

Eric Stewart:

We’ve had — and I’d have to go back and update on all the landlord laws because it’s not something that I target and keep track of each state — but I have not had had huge issues with the assets that we’ve owned in Georgia. Everything I’ve owned in Georgia, I’ve been a passive investor in, so I haven’t been involved in the evictions, but I know the properties have done well. I’ve never heard any pushback on that. Florida, I do not see that as a tenant-friendly state. So that’s one that I think you would consider landlord-friendly. And then I think North Carolina is the other one that you’d mentioned.

Kim Lisa Taylor:

Yes.

Eric Stewart:

Okay. Once again, I have not heard any issues with North Carolina being tenant-friendly. I think all those three, I would consider them to be landlord-friendly states.

Kim Lisa Taylor:

Yeah. And I’ve had, I mean, not to be political here at all, but I have had some clients say we only invest in the red states because it’s the blue states that tend to be more … actually more anti-landlord, I would say. More than tenant-friendly they’re anti-landlord. And there’s certainly a big push across the country to start instituting rent controls in certain areas and things like that. So you’ve always got to be cognizant of that because that’s going to affect your exit strategy and your ability to sell the property to a new buyer later on and the actual property value itself, because you’re not going to be able to maybe achieve the same rent increases that you were hoping to achieve and it could depress your exit value.

Eric Stewart:

One quick note on that too, has a lot to do with the asset class that you’re buying. If you’re buying a high B asset, you may not have to deal with those eviction issues. It has a lot to do with your target tenant base too. A lower C probably going to have some eviction issues.

Kim Lisa Taylor:

I just put the link to Amazon to your book in the chat. Eric, just in case people were not watching the video, they were just listening audibly. What is your phone number?

Eric Stewart:

The phone number is (800) 916-9005.

Kim Lisa Taylor:

Okay, great. And let’s see if we have any other questions. And just so you know, if you want to know information about us, please go to syndicationattorneys.com. There are multiple options for you to schedule an appointment with one of our staff or with me, if you just click the “Schedule a Consultation” button, you’ll get a dropdown that’ll give you some options there. We are always happy to talk to you. I have very skilled staff that can usually answer most of your questions. If you want to schedule a paid consult with me, you can as well. Some of you maybe pre-syndication clients of the firm. If you’re not, that’s another option for you to be able to get direct access to me and Mola Bosland, our other securities attorney, we do hold weekly masterminds for clients only. So if you want to become part of that, those are really, really valuable, especially for people that are just starting out.

But we also get seasoned syndicators that show up on those masterminds and add value to those calls. So that’s something you can do with our pre-syndication retainer, which is just a nominal amount to get a couple of hours of access to us, plus access to our masterminds, and then also discounts off your future syndicate deals. So I think somebody said, Kelsey said, “I just ordered the book. Thanks, Kim and Eric, for the great information today.” Irma says, “Hi, Eric and Kim. It’s Irma.” So this has been super valuable, Eric. It’s way over time that we had you as a guest on our call. We need to do this annually. You’ve got a huge amount of information to share with everyone. I highly recommend, everybody read Eric’s book. It’s only going to take you a few hours; it’s skinny, but there’s plenty of information in there. I don’t know if you felt the same way I did when you did your book though. Once I did my book, I felt like, “Ooh my gosh, that’s my entire brain on 168 pages. I’m kind of depressed about that.”

Eric Stewart:

Yeah. Yeah. That’s why it’s so thin.

Kim Lisa Taylor:

Somebody tried to make me feel better by saying, “No, no, you’re just good at being concise.” I guess it’s your glass half full or is it half empty.

Eric Stewart:

That’s right. That’s right.

Kim Lisa Taylor:

And I think there are people that are watching this on video are just dying to know, is that an actual motorcycle behind you?

Eric Stewart:

That is. It’s an actual motorcycle that is a, that’s a 1971 FX Super Glide. The first year Harley-Davidson combined the two editions. And that is what started that whole cruiser line. And I figured, I love looking at motorcycles as much as I do riding. So that one got put into the office because just makes me feel better to have a motorcycle in here.

Kim Lisa Taylor:

You need to elevate it up on a little platform. It’s your backdrop.

Eric Stewart:

Got you. I’ll do that when I do the podcast. I’m getting a lot of good advice from you, Kim. I appreciate it.

Kim Lisa Taylor:

Happy to have a consultation with you about that. Anytime. All right, so Delroy says, “Great job guys. Hey, Eric. Delroy here.” Robin says, “Thank you both very much. What is the book called? And accessible from again?” Oh, my book. My book is called “How to Legally Raise Private Money.” It’s on the sign behind me and it’s available on Amazon. You can get a free digital copy at our website at syndicationattorneys.com, or if you want to buy the book, you can buy it in Amazon. I am furiously working on an updated version of that that’s going to be coming out soon. And then we’ll be sending out physical copies. But if you get this one first, go ahead and read it. We’ll have some updated content in the new one, and then we’ll be sending you physical copies as well. Once you get into our database, you’ll learn about that. So thank you so much everybody for showing up today.

Really appreciate it, and we look forward to talking to you again, Eric, in the future, and we’ll see everybody else at our new podcast. By the way, we are now doing two podcasts a month. We’ve just had a tremendous growth of our podcast. If you’re not a podcast subscriber, please do (become one). And if you want to hear some of our old episodes, you can hear them at our website. If you go into our library, there’s a section called “Our Podcasts.” You can look at them all there, and there’s a ton of educational information for you there. There’s a lot of little two-page articles, one-, two-page articles that you can read if you don’t want to read the whole book, but the book just puts it all together. So thanks again, everybody have a really great week, and we look forward to seeing you all again soon.

Voice-over:

Attorney Kim Lisa Taylor is a nationally recognized corporate securities attorney, speaker, and the author of the number one Amazon best-selling book, How to Legally Raise Private Money. She’s the founder of Syndication Attorney’s PLLC and investormarketingmaterials.com, whose goals are to provide quality legal advice, plain English offering documents, and professionally designed marketing materials for capital raising clients nationwide. Kim has been the responsible attorney for hundreds of securities offerings and is listed in the 2020 top 100 attorneys and top 100 in finance magazines. Contact Kim at her website, syndicationattorneys.com. Attorney Kim Lisa Taylor is a nationally recognized corporate securities attorney, speaker, and the author of the number one Amazon best-selling book, How to Legally Raise Private Money. She’s the founder of Syndication Attorney’s PLLC and investormarketingmaterials.com, whose goals are to provide quality legal advice, plain English offering documents, and professionally designed marketing materials for capital raising clients nationwide. Kim has been the responsible attorney for hundreds of securities offerings and is listed in the 2020 top 100 attorneys and top 100 in finance magazines. Contact Kim at her website, syndicationattorneys.com.