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Legacy Wealth Episode 3 | Commercial Financing with Chris Lichter
Chris Lichter knows capital markets. Over the years he’s arranged debt and equity for commercial real estate transactions. In 2018, his Cleveland firm closed more than $1 billion in commercial mortgage financing, and 2019 is showing no signs of slowing down.
In this episode, Chris shares insider strategies for gaining high-value commercial financing. From why you should—and shouldn’t—work with banks and community lenders, to understanding what funding sources are looking for to confirm you and your deal make sense, this episode digs into the financing landscape to help you better understand what’s what and how to structure the right funding, right now.
After that, Chris says, look to refinance. His model involves finding an investor, finding basic funding, then stabilizing the property, renovating it, staffing it was good people—and that’s just the beginning.
What You’ll Learn:
Ultimately, Chris explains, anyone can accumulate legacy wealth—provided they hold the right properties and let them appreciate over time. This market, he explains, isn’t one for speculation—but, if you understanding it, you can focus on long-term amortization and wealth preservation, ideal for getting you through the market’s natural ups and downs.
Tim: 00:12 Hello everybody. Tim here with the Legacy Wealth Show Podcast excited to be here and excited for our guests, Mr. Chris Litzler.
Tim: 00:20 Chris is a huge a longtime friend of mine and a huge asset to our team. He handles all the commercial finance side of things with Marcus & Millichap’s commercial finance division. He’s been doing all my loans for several years and knows the ins and outs of commercial finance better than anybody else I know. And just a really, really good guy to be working with and a huge asset to our team. So Chris welcome to the show, brother.
Chris: 00:47 Thanks for having me.
Tim: 00:48 So, you know obviously the name of the show is the Legacy Wealth Show and we’re talking about how to build legacy wealth. You know I’m not only just making money but keeping money and then getting your money working for you and you’re in the industry obviously, being commercial real estate and commercial finance and seeing a lot of legacy wealth built. So maybe you could just give a high level what you do how you do it and then let’s dive into some of the questions that I have for you that I know other people are going to have for you then I want to talk a little bit about some of your client tell and what you’ve seen just from a mindset perspective across everybody that you do business with people that are worth multiple figures, like eight figures, nine figures, 10 figures. So tell me a little bit about what you do.
Chris: 01:35 Tim, thanks for having me on. And yeah, I’m happy to share a little bit of our experience in the capital markets recently. We arranged debt and equity for commercial real estate transactions, typically loan sizes between 1 million and up. We did about one billion dollars worth of commercial mortgage financing out of our Cleveland office last year and we’re well on pace to hit that again in 2019. So what we do is a agency debt and equity primarily with banks like insurance companies, CMBS, Wall Street money, Fannie/Freddie, all the agencies; whether that’s short term money or long term non recourse permanent financing we have relationships with all of those institutional lenders across the across the United States.
Tim: 02:32 You guys are obviously doing some big things. And as you mentioned you do debt financing anywhere in the country. So essentially if somebody wants to go buy a property they would come to you could help them set up the loan which typically obviously rates vary in terms of that kind of stuff. But for a lot of my loans for instance it’s 75 or 80 percent loan to value. And then I go out and I raise equity, meaning I raise the down payment from my investors. You can actually help with that too. You’ve done that with other investors right?
Chris: 03:01 Yeah absolutely.
Tim: 03:02 It just depends on the terms of what all that needs to shake out as, and then you can sign up the loan and then help them out with any future loans, either refinancing or whether this is a bridge loan or permanent loan or permanent financing, all those kinds of things. So talk about the different types of loans just for anybody from a high level. You know you mentioned the agency debt. What is that? What kind of terms what are the benefits of that? You mentioned life insurance companies and local banks. There are some benefits and some costs and disadvantages to using each one of those. Talk a little bit about each one of them just from a high level; take couple minutes on that.
Chris: 03:42 Sure, sure. Two different lenders are going to be better at different types of loan products right. When you think about a bank, you think about matching your assets to your liabilities. So banks have deposits coming in every single day and they want to put their money out shorter term to match the duration of those deposits. So when you think about shorter term floating rate under five year loans, you think about traditional banks. So that’s construction loans and that’s bridge loans. And that’s typically smaller commercial properties under a million dollars. That’s really where the banks are going to want to. They are almost always full recourse; full recourse means a personal guarantee of repayment of the loan. So they’re looking at not only just the collateral of the subject property but they’re also looking at the warm body behind that loan.
Tim: 04:43 So for anybody listening, the local kind of community banks that’s who I use in order to go and get financing as Chris mentioned on some of those smaller type deals and on bridge loans bridge loans, kind of like short term loans for commercial real estate construction loans although it’s not new construction. It might be new construction or it’s something that is usually a little bit more distressed to maybe an agency or life insurance company. The banks will touch stuff with maybe a 60 or 70 percent occupancy versus something needs to be at 85 or 90 percent that a traditional agency kind of lender institutional lender would lend on. So the thing is, the banks are not only looking at the property; they’re looking more at the borrower and the borrower’s ability because the property sometimes is performing and sometimes it’s not performing right.
Chris: 05:35 Yeah, that’s correct. So the banks are going to be able to take a little bit more risk because in addition to the collateral they’re also getting a guarantee. So there are sponsors, global cash flow total, liquidity. Total net worth. I’m kind of saying well we’ll take a little bit of risk on its construction loan because we know that they have the financial horsepower to carry this thing. In the event that something does go wrong you know that’s the opposite really of the life insurance companies or the agencies or CMBS. Those typically are non-recourse loans. So you’re only guaranteeing a loss in the event that you trip; that’s what they call a “bad boy” clause. So a non-recourse loan is going to be made really 100 percent based on the based on the durability and the stream of cash flows of the collateral. As a result those lenders are going to take a little bit less risk. They’re not going to want to make a loan on a super distressed assets because they’re saying, “Well if this doesn’t work out for Tim and he hands me the keys back, I don’t really want to take back this type of this type of product.” So the agencies and CMBS and life insurance companies generally speaking are only making loans on stabilized assets and agency is like Freddie Mac or Fannie Mae.
Tim: 07:00 Those kinds of lenders. Right.
Chris: 07:02 Correct. And I would probably add in HUD to that category.
Tim: 07:06 So, for anybody who is listening there’s something called a bad boy clause. So essentially if you lie, if you cheat, if you steal, if you’re grossly negligent, if you’re fraudulent, if you take a loan and you never make a payment, then those loans through these life insurance companies and through the agency lenders can turn into recourse loans. But one, you need to default. Two, you need a trip one of those clauses and three, they need to take back the property; four, they need to sell it at a loss. So there’s a lot of different dominoes that need to go down. And one of the things that I know we always talk about is you know as my net worth increases I want my safety net to increase with it to make to make sure that if something did shift to something outside of my control happens I’m not personally liable.
Tim: 07:56 All right. Very minimal liability in that long term. So that’s why I like it once a property is stabilized. A lot of times what we do is we’ll buy a property with either some sort of bridge loan or construction loan through a local bank typically which is recourse. But my model is to buy it stabilize it renovate it stabilize it put good management in place and then refinance it into this agency debt long term to hold the property that way I can cash out my investors and then we just have you know essentially agency money in play and it’s a longer term usually fixed interest rate. Longer amortization schedules and and it’s not recourse. So that’s a way that we are working really hard on pursuing that angle to make sure that we do reduce our ongoing liabilities. So tell me a little bit. I mean and you’ve gotten a couple of these for me. If it doesn’t fit into either those buckets of either agency or life or traditional bank like we’ve done some pretty distressed deals and there’s debt funds out there that do that. So tell me a little bit about what the debt funds do.
Chris: 09:02 Yeah sure. So our goal of course is if you’re kind of a consultant or broker is to kind of put you into the right product that fits your long term objective. So it doesn’t quite fit where a bank would play or and it’s not quite stabilized for some longer-term money. There are some debt funds out there that are traditional real estate lenders that will come in and offer you what we call a bridge loan. So that’s Fuller leverage. Call it 75/80 even up to 85 percent loan to cost, anywhere between a one and three year deal can be recourse can be non-recourse usually a 1 percent origination fee and then exit fee depending on who you refinance it with. And it gives you that that capital and flexibility to be able to get in, handle your stabilization efforts and then refinance out pretty cheaply and efficiently with a long term product.
Tim: 10:06 Love that. So for anybody who’s wondering when Chris says you know what the exit costs would be…what he’s talking about is any sort of prepayment penalty. Maybe you could talk a little bit about the different types of prepayment penalties that we need to be aware of in the commercial sector.
Chris: 10:23 Sure. So when you when you buy assets your intent is to always refinance into a longer term product.
Chris: 10:31 So we want to be very conscious about the acquisition and stay with the acquisition and renovation loan to make sure that you’re not being constrained when you stabilize this thing in 12 to 24 months. So, a bank that’s floating rate or a bridge lender that’s floating rate is going to have no prepayment penalty, credit union, you know, across the program. The programs don’t typically have prepayment penalties.
Chris: 11:04 Now once you refinance into this longer-term product whether it’s CMBS. Whether it’s a life insurance company or an agency , the words you’re going to hear quite often are “yield maintenance”. So, when you get into this longer duration product, this 10 year fixed rate loan, the lenders are able to offer extremely attractive rates in terms because they intend to put their money out for 10 years. If you go ahead and you pay this loan off in year 4 or year 5, the lenders you would say that’s okay to do so but you need to maintain my yield for the rest of the loan term. So I anticipated 10 years of interest you can pay me off early, but you need to maintain my yield over the next four years assuming that I only reinvest in the corresponding Treasury; that’s yield maintenance.
Chris: 11:54 Now we can always for some sort of premium say if the if the coupon on the loan was four and a half percent yield maintenance, say we pay for 60 for the next 10 years but instead of having to be yield maintenance, there’s a declining scale prepayment penalty.
Tim: 12:12 So let’s talk yield maintenance real quick.
Chris: 12:15 So if I have a four and a half percent interest rate on my loan as a 10 year loan and I paid off in in year five, over the next five years I have to maintain a four and a half percent on 10 million bucks. That’s a sizable amount of interest that I need to catch up on. But it’s not just about that. It’s what would they. It’s the difference it’s the delta that you would owe if they took that money and they put that 10 million bucks into the U.S. Treasury. And what that bond would yield, right? That bond would yield a 3 percent and you’re at 4 and 1/2 percent essentially you would only a one and a half percent on that for five years and that would be your prepayment penalty. Is that correct?
Chris: 12:59 Every year for five years discounted back because there are some amortization in there, and then it’s kind of back again for the present value of that. Yeah. So you can take the corresponding U.S. Treasury. So that’s five years left; you take a five year U.S. T, take that difference. This kind of back forth amortization and a discount rate and that’s going to be approximate.
Tim: 13:23 So, you do some math on this on that side of things. And then the other one is the declining scale prepayment. So talk a little bit about that.
Chris: 13:32 Sure. So your typical bank loan that’s on the balance sheet that’s a five year duration would be 5 percent year 1, 4, 3, 2, 1 percent decline scale over the life of the loan. Now if you wanted a life insurance company loan, these guys are holding on the loan on the balance sheet. You could pay a little bit of a premium to gain yield maintenance for, I’m making up an example, for yield for the first five years and then and then a five four three two one percent decline scale on the back half.
Chris: 14:04 You can do the same thing with Fannie Mae. You can do the same thing of course with the life insurance company.
Tim: 14:11 So if it’s a 10 year loan term…do most have this or do most have yield maintenance?
Chris: 14:20 Most years you’re taking the lowest possible rate because, again we’re always coverage constrained quite often. So you’re going to take the lowest rate with the yield with the yield maintenance for the life of the loan. Some 10, some twelve…it just depends on the objectives of that particular transaction.
Tim: 14:39 So, conversely this the step down if you have a 10 year loan term. Essentially in that first year, it’s usually 5 percent for the first two years, usually 5 percent of whatever the principal balances is what your prepayment penalty is.
Tim: 14:55 So your 1 and 2 would be 5 percent; your 3 and 4 it would be 4 percent, your year 5 and 6, it might be 3 percent, year 7/8, it would only be 2 percent prepayment penalty; and then year 9 and 10, pretty much up to what the last 90 days the loan. There’s a 1 percent premium prepayment penalty and then the last 90 days there’s no prepayment penalty open at par. So it steps down the longer you own the loan while you’re paying on it. It’s a step down how much you owe, based on the principal balance of that loan.. Good stuff man…this is like nerdy math stuff but it’s like really important especially when you’re doing commercial real estate commercial finance; like everything’s run by the numbers here.
Speaker 2: 15:41 So this is like absolutely critical information and really, really good stuff. So again I appreciate your sharing. Tell me a little bit about what. What are the top don’t know few things that somebody can do to make themselves super bankable? I know that in residential real estate it’s maybe only 10 percent property and 90 percent on the individual and commercial real estate. It’s conversely only about 10 percent on the individual and about 90 percent on the property. What is the bank looking for one in in the sponsor or the borrower and then what are a couple of things that that borrower can do to make himself look amazing on paper?
Chris: 16:25 Sure, yeah. Good, good question. I would say that that loan requirement that borrower specific requirements vary from lender to lender.
Chris: 16:34 But I would always tell your listeners and your investors that we generally look for as a rule of thumb net worth of the loan amount and post closing liquidity of 10 percent of the loan amount. So what does that mean? So, let’s say we’re doing a five million dollar loan, we would want to have the person signing the non-recourse carve outs be worth collectively if there’s more than more than one sponsor five million bucks. So that’s net worth which is total assets minus total liabilities. So, you own 10 million dollars of real estate you, owe $5 million bucks. You own 100 percent of that five million dollars that’s left, that’s equity… that would be network of five million bucks. And then we need post closing liquidity of 10 percent of the loan amount. So that’s half a million bucks. So that can be stocks, bonds, mutual funds, cash collectively making up five hundred thousand dollars.
Tim: 17:43 Is there anything that doesn’t count in that? Your personal residence counts, and your retirement funds count, like Roth, like all those types of accounts?.
Chris: 17:52 The answer is it depends. It depends on the lender and it depends on the account. So if it’s a true retirement account that you can’t really get at except for massive penalties, a lot of lenders aren’t going to count that. But a lot will. So I would say 50 percent of the lenders are going to allow retirement accounts and 50 percent not. They’d probably allow it for net worth but maybe not the liquidity. Absolutely for net worth, but they wouldn’t count that as true liquidity.
Chris: 18:25 So I think I think that’s the first thing that we’re looking for is let’s just make sure that on paper we’re hitting those minimum those minimum requirements depending on the lender, there’s not as much scrutiny given to personal tax returns as you would with the residential mortgages. But we want to make sure that we at least have all of those items in a nice complete package, including the K ones to be submitted to the lender so that the institutional lenders are more worried about network liquidity and real estate ownership experience and then a global cash flow. From a property development standpoint, the actual commercial real estate cash flow then the actual personal tax returns.
Tim: 19:17 Yes. I mean I mean we’re doing commercial real estate right. So even though we have cash flow a lot of times, we have depreciation that year that could offset a lot of that cash flow and a lot of our earned income. So that way, as real estate investors our tax liability might be a little bit lower than that and on paper we might not look bankable.
Tim: 19:36 Right. But these commercial institutions these commercial lenders know the game. They know how the game’s played and they can see past a lot of that stuff, so when talking about net worth, that’s important. Equal to loan amount liquidity equal to about 10 percent of the loan amount. How does how does credit score come into play and maybe past credit issues? I mean obviously there’s still some people out there with lingering maybe foreclosures or short sales or things like that on the record from the last downturn. How does how does that affect or adversely affect the loan the lending environment for those folks?
Chris: 20:14 We’re always going to run credit. And I would say we don’t need 750/800 credit scores. You think of real estate owners as really wealthy guys. We don’t need to see perfect credit…in the high six hundreds, it’s still going to be acceptable. So credit is just something to be aware of. Be transparent with your scores, be forthright with your information…just disclose everything upfront. That’s the same with previous credit blemishes. If you had foreclosures, if you had modifications, if you had bankruptcies…none of those are non-starters. We just want to really understand what led to those instances and put together a nice, clean, right-up-front explanation of what happened so that everybody knows you’re not trying to hide anything. They will inevitably come up. So let’s just walk through the front door with them. Explain what happened…this is how we play nice in the sandbox, this is how this is how we how we dealt with this stuff, and nobody took a loss and we all we all moved on.
Tim: 21:26 So, a big picture what’s the story behind it. Right.
Chris: 21:29 Yep. So let’s just put together a nice, clean story upfront to submit that on day one instead of day 44 when we’re trying to close.
Tim: 21:40 So, all right–good stuff. What about this scenario…what if I’m an entrepreneur in a traditional business, not real estate related. I make a lot of money or I’m a doctor or an attorney, or something in a white collar profession or an entrepreneur making a lot of money outside of real estate. I don’t know anything about real estate but I have the net worth, I have the liquidity, I have the credit score…will the bank still lend to me on a $10 million dollar apartment building that’s 250 units? So the bank knows that I don’t own anything other than my primary residence.
Chris: 22:17 Depends on the leverage, right? It depends on a lot of thing…it depends on the lender. Depends on the leverage. Depends on where it’s located. I think, first things first is the lender’s going to say who’s going to manage this. We want competent local third party management put in place who are going to run the asset. Now I also think that on a loan that size, for your first one, you’re going to want to bring in a a partner. So somebody who has experience that if decisions need to be made, if we need to replace the management company somebody that can get the new group. I think the first one’s going to be important to bring in an experienced and experienced partner from a net worth liquidity standpoint. This guy is going to be strong enough. So he’s there. The lender is going to want him to sign on the non-recourse carve outs. But I think from an experience perspective, you’re likely going to want at least for the first one to tab somebody on your team.
Tim: 23:23 Absolutely. I mean, you’ve seen the deals that we do. We buy a lot of distressed properties with buying for pennies on the dollar. And the reason we get those is I’d say a good chunk of those people are usually mom and pop owned and managed and, you know, they sucked all the cash flow out of the property they never put anything back into the property and they painted themselves into a corner over the course the past 20 or 30 years and now they don’t have any money to put back into the property so they’re forced to sell.
Tim: 23:48 But the other side, the other person that we buy a lot of property from, as you’ve seen Chris, are entrepreneurs, people who make a lot of money in their traditional business. They look at apartment buildings they watch on HDTV and they think that they can buy apartment buildings on their own and they make a critical mistake of not having a boots-on-the ground partner, of not vetting different management companies and then just deploying their capital into something and hoping it takes care of itself. This is a business; it’s like starting a restaurant or going and selling widgets, or it doesn’t even matter what it is, but you’re starting a brand new business and a lot of people don’t give it the attention and the detail that it deserves and they get kicked in the teeth because of it.
Tim: 24:32 So a lot of the people I buy my properties from are really smart entrepreneurs who make millions and millions of dollars who needed to deploy their money into something and then got punched in the gut over and over again because they didn’t have a boots-on-the ground partner who had equity in the deal that was compensated based on how well the property performs, or they didn’t vet the different management companies and they were taken and essentially stolen from by the different management company. I see it all the time and so I’m glad you brought that up. That’s a really, really good point.
Chris: 25:04 So I would remind you of the property that you bought just outside of Atlanta. The guy that you bought it from…he was a cabinet builder?
Tim: 25:14 He was in the trades.
Tim: 25:16 He was in the trades, so he went into all these apartment buildings installing these cabinets and said I can do this right. And you know we had to buy it from him at 20 percent occupancy because he really ran into the ground but man, does have some nice cabinets…beautiful cabinets, gorgeous cabinets…I’ve got some in a building I own. The cabinets are unbelievable but that cash flow wasn’t so good for him.
Tim: 25:45 If only you could pay his bills. I mean it’s unfortunate, right? This is a guy who deals with real estate investors works with investors and contractors.
Tim: 25:54 Every management company, every single day of his life…he’s like if these guys could do it, I could probably do it…maybe, you know, let me just go and buy something. Didn’t have a partner. Still had a primary business but got kicked in the teeth so hard that he lost his. Not only his property, but his business. He went totally B.K. I think…and you’ve got to come back from all that stuff. So you’ve got a partner up with somebody who knows what they’re doing, from an operational basis… this is a multi-million dollar investment you’re making. You want to make sure that’s in good hands. That’s important stuff.
Chris: 26:31 The other point that I just real quick before we move on is that if you’re very successful in your widget business and you’ve built a big balance sheet and you’ve built all this cash, why are you trying to spend your time in operating buildings when you can strategically align yourself with any one of successful real estate investors out there, keep making your money, keep growing your business, investing passively with guys that know exactly what they’re doing? Enjoy the cash flow, enjoy the returns, but don’t take your eye off your money-making baby.
Tim: 27:09 Absolutely. I mean why would you try to mess up something…you know your focus, you spent thousands of hours perfecting your skill set. You want to go and start something new. As an entrepreneur, I get it.
Tim: 27:20 You know, we like to test out new things and a lot of times that’s something else that’s fun or exciting or different. But the reality is you want to make a lot of money. If you’re inspired by building legacy wealth, stay in your lane and get really, really good at what you do. Double down on that traditional business; let it be boring. The more boring the business, the more money they make and then invest passively like you’re saying into different operators. There’s guys like me, there’s guys all over the country who are great operators who would gladly partner up pay a solid return and give you equity in the deal in order to do more deals together, build some long term wealth and that way you can lean on somebody else’s ten thousand plus hours of experience without having to go through those learning curves…and by learning curves, I mean lose a shitload of money and get kicked in the teeth for years and years and years. So definitely partner up. I love that advice. We talked a little bit about what somebody can do if they have the net worth and they have the liquidity, on how to partner up with somebody. Great management company or bring in a joint venture partner who’s a great operator. What if somebody has the experience but they don’t have the net worth and liquidity? Like I didn’t even realize that this was out there, but what are what are some resources for those people?
Chris: 28:45 If you have you have experience, maybe doing fix and flips, maybe you want a bunch of single family single family homes. You know how to operate real estate, you know how to find good deals but you just don’t have the balance sheet to get a lender comfortable to use traditional mortgage financing. Well, there are sophisticated real estate guys out there with big balance sheets that would love to partner up with you strategically, and you have good deals right? So just because just because you come across a four million dollar deal that you don’t have the net worth and the liquidity to qualify for doesn’t mean we should pass on that deal. Reach out to guys like me reach out to guys like Tim, because for the right opportunities we can we can partner you up with guys that can qualify without gouging you for the entire deal. There are there are sponsors, there are JV partners, there are guys out there that would love to help you get it going. And you’ll still be maintaining a really fair share of the deal.
Tim: 29:50 What I love is that we’ve tied up big deals…you know, especially with guys who came from the residential investment space.
Tim: 29:57 And when you’re investing in single family houses, you’re looking at a 20 or 30 thousand dollar profit spread right after you flip the house, and you pay for all your broker fees and your commissions, your closing costs and all these things that make you 20, 30, 40 grand and like that’s cool but there’s not enough juice in the squeeze for everybody to get paid. As the operator, you either need to be Superman or Wonder Woman and do all aspects of deal versus in commercial real estate. My favorite thing about that…I mean obviously legacy wealth is a big piece of it, but my other favorite thing is that I can focus on what I’m really good at and my unique ability on my core competency. My team can focus on theirs. I can bring in joint venture partners who are amazing at construction and project management and I can afford to pay Chris his fee and I can afford to pay a broker their fee because we’re talking about not tens of thousands, not even more than hundreds, probably millions of dollars of equity in these projects and millions of dollars of profit that could be carved up amongst everybody.
Tim: 31:01 So even if you have a portion of that…I say all the time is I’d rather have 25 percent of a watermelon versus 100 percent of a grape. You know there’s a lot more juice in the squeeze of 25 percent of a watermelon than there is in a hundred percent of the grape, and it’s a lot more fun to own twenty five percent of a watermelon and just do stuff that you’re good at, and stuff that you like doing instead of trying to do everything and own 100 percent of a grape. So that’s a big deal and a big mindset shift. You know, it takes you a lot from like a scarcity mindset to more of an abundance mindset; that’s a muscle you really have to work out and exercise in order to strengthen that and really understand the opportunity there.
Tim: 31:44 You know in this in this equation, it’s not traditional math. One plus one here equals three. You know, you can do a lot more as a collective group than you could as individual parts. So that’s powerful stuff. Let’s talk about this. Where do you see the lending environment go going over the next 12, 24 months? So you know we’ve seen people talking about this inverted yield curve. We’ve seen people talking about hey we’re at the peak of the market. You see all these different reports from firms like yours, coming out and putting these market reports together saying that we’re at the peak or even over the peak or outside of it. What does all that look like? I know I know the Fed’s been saying the interest rates stay i steady for the next 12 months. What’s going to happen next year, an election year, like there’s a lot of moving parts. What are you seeing from your end on the on the finance side?
Chris: 32:38 So I think the first comment that I’d make is I don’t I don’t predict interest rates. If I could predict interest rates, I wouldn’t be mortgage banking…I’d be making a lot more money. So I want to caveat everything that I know with that I don’t predict. But I will tell you…what I’m seeing with a lot of my guys is they’re taking they’re taking as much money as they can off the floating rate stuff right now and they’re putting it into longer fixed rate permanent financing. So we’re in a really unique time where we’re prime. One of the benchmark interest rates is at five and a half percent. I’m doing 10 year fixed rate loans right now at four point six percent, or even with the life insurance companies down around 4 percent.
Chris: 33:27 So longer money is substantially cheaper than floating rate money today. So I would say that’s step number one is that everybody is taking anything that’s got short duration terms and fixing it out at current low interest rates, which historically has been an indicator of a coming recession.
Tim: 33:49 Right.
Chris: 33:51 Did they say that longer durations of inverted yield curves is a signal of recession?
Tim: 33:59 Yeah. So that’s not to be anything afraid of though, like there. I mean there could be some opportunity; there’s probably a lot of people in real estate who shouldn’t be in real estate right now and it could cool off… a little bit of competition and then at the same time might create some realistic expectations and sellers minds versus them thinking they’re going to get top dollar and above retail price for all these different things.
Tim: 34:21 So for me and my team, we actually see more of an opportunity that’s coming up because we are putting long term debt in place fixed interest rate debt in place long term amortization schedules to allow for more cash flow that way if things do cool down. If things do shift, if the market does change then we’re going to be very bankable when all that stuff happens. So that’s a good insight. What else you got?
Chris: 34:50 I suspect that as the market cools off a little bit…it has to inevitably cool off. The market is extremely aggressive right now. I think you’re going to see a little bit of underwriting tightening, you know. Right now we’re able to do 80 percent loan to value cash out deals. I suspect that if the market cools off a little bit you’re going to see you’re see LTVs come in, five dips, 10 dips potentially.
Tim: 35:21 So, instead of getting 80 percent loan to value, you’re saying we might get 70 or 75 percent loan to value?
Chris: 35:27 Correct that I suspect I suspect that that day could come. And when we when we underwrite our deals we’re always doing that. We’re always expecting that today look probably 80 percent. But let’s underwrite this as if on the refi, we’re only going to take out seventy five percent just to make sure that things are safe.
Chris: 35:44 Sure; so when you and I look at deals together what we do is we say we expect the cash flow to be here in 18 to 24 months based on current deals that have gone down over the last six months at, let’s say…you know 75 or 80 percent loan to value on this comparable product for a refinance…my team and I would cut that leverage back five dips for your models. That’s just a conservative way that we’ve underwritten. We’ll help the interest group a little bit too, right?
Chris: 36:17 We do. So, if we if we’re doing four and a half percent on a 10 year fixed rate yield, we might underwrite it at 5 or 5 and a quarter as a stress on the refi. We might also say if four or five comparable deals have traded at a 7 percent cap rate in this market, we might bump that up 25 basis points on the refinance.
Tim: 36:47 And you do that because you want to stress the financials you want to make sure that you’re underwriting these things very conservatively especially with where we are in the marketplace right now. You don’t ever want to force a deal.
Tim: 36:57 We try to kill every single deal; if we can’t kill the deal then I know it’s a good deal. If you can stress the financials this way with a lower loan to value and with a higher interest rate… God forbid nothing changes in the markets the strong still twelve months from now. Imagine what the returns are going to look like! So if you can make it work with very conservative underwriting and nothing changes or even if it changes less than what you’re what you’re stressing it at, your numbers are going to come back real, real strong for at least if you follow me and if you follow the way that I structure my deals when you’re turning these things over in 12 to 24 months. That’s a more predictable timeframe than let’s say five years down the road or seven years down the road. It’s hard to assume…I mean we could have two different presidents; in the meantime we could be in war with China, we could have a big wall built…I don’t even know, there could be all sorts of political uncertainty and economic uncertainty all sorts of things going on over the course of five or seven years. It’s very hard to predict out that far. We can have a pretty good indication of where the market’s going to be in the next 12 or 18 months, which is typically what it takes me to turnaround a property and then put the long term debt in place. It offers a little predictability on that.
Tim: 38:12 So we talked about how to minimize some downside risk and capitalizing on opportunities when the market shifts to other things. Is anything else that before we move on anything else that we should be aware of as investors from the financial sector that you can think of?
Chris: 38:28 I would say that the most important thing that you guys can control is basically control what you can. So if we can put long term debt on something and fix an interest rate and fix an amortization schedule and know what the control of all that service is going to be. We don’t know necessarily what the market’s going to do. We don’t know what occupancy in any particular market is going to be, we don’t know what rents are going to be, but if we can take one piece of the puzzle and fix that thing in, we want to be able to control what we can.
Tim: 39:05 Yep. Love that. So Chris, you work with a lot of smart, or perceived smart people right? Real estate investors people who have a lot of wealth, have big balance sheets, have a lot of liquidity, a lot of net worth.
Tim: 39:20 Who are those who are really growing their legacy wealth right from a from a perspective of looking across all your different clients? Are there certain commonalities that you see among different investors that smart investors and the people who really have…I don’t know…short term vision, long term vision, the types of deals, the types of assets they’re buying, their mindset and how they structure deals? Are they more strategic? Are they more tactical? Give me some like insight on maybe some commonalities that you see amongst your different to your different clients. I think it’s interesting to think about the psychology that some of these people that legacy wealth builders have.
Chris: 40:06 Sure. So I want to caveat that by saying I’m in Cleveland, Ohio, so I’m a Midwest guy. Most of my clients are Midwest guys. There’s a different way to build wealth in the Midwest than there is on the coasts. There is there is a ton of rent growth and appreciation on the coasts. We don’t enjoy that as much here in the Midwest. So the main thing that I see from my guys that build, you know hundred million dollar balance sheets, two hundred million dollar balance sheets, is the benefit of long term ownership and amortization. So when we talked about net worth, we talked about the value of the assets minus the amount of debt that’s on the assets. So amortization over 10, 15, 20, 30 years of property ownership really accrues to your benefit. Right. So we start with a 10 million dollar asset that has 8 million dollars of debt on it and it appreciates to 11 or 12 million and that 8 million dollars of debt amortizes down over the first 30 year amortization not too much.
Chris: 41:17 You know maybe we’re only paying down 16, 17 percent of that but then 10 years from now, we refinance and we don’t pull out every last dollar and we start advertising this on a 20 or 25 year schedule. Now all of a sudden, we’re really, really starting to amortize this stuff down and we’ve built a lot of equity in these assets so we see a lot of apartment deals get done with Fannie and Freddie type loans…10 year fixed rate loans, a little bit of interest only, long amortizations, but the clients that are the wealthiest guys convert that stuff to longer term a little bit tighter amortization after they’ve repaid their investors like life insurance company financing guys are the guys that have the strongest, best, most durable balance sheets.
Tim: 42:10 Interesting. So I love that man. I love the idea of you don’t owe anybody anything on your property so they can never take anything away from you. That’s the best case scenario. Like I’m in high growth mode right. So I’m buying I’m putting debt on properties.
Tim: 42:30 Sometimes we even do a cash out refinance, where we’re able to take some debt off the plate, putting additional debt on the property even more than what our cost basis just so we can take a little bit of cash out and then redeploy it into other deals because if the money’s at 4.6 percent like you’re saying. I can deploy it over here and get a 10 or 11 or 12 percent cap rate; somebody else might go to 15 16 17 percent cap rates in A and B class areas, too. It makes a lot of sense to do that and I’m you know diversifying the risk, have more cash flow. We’re here now to and we continue to grow. But it’s a big deal and I don’t think people realize how much you can pay down on these properties over time. For me, I put 30 year amortizations on all my properties so as you’re saying, if I just make the minimum payments every single month I can pay down probably you know 17, 20 percent somewhere in that of the total principal loan amount right over the course of the next 10 years until after either refinance or sell the property at that time.
Tim: 43:31 But for me I still like the longer-term amortization. The reason being is because if the market does shift I don’t want to be forced to make a bigger payment than I would on a 20 year loan or a twenty five year one. I can still make an additional principal payment once a year and pay this thing off in 20 years if I wanted to. But I don’t want to have to do that. Does that make sense?
Tim: 43:53 It gives you more options.
Tim: 43:55 Me personally, I just like the idea of putting a 30 year and having more cash flow and then if I have so much cash flow and I’m making like an extra payment or two I can still pay this thing off in 15 or 20 years I wanted to but I don’t have to do that in case the market does shift in case occupancy does drop in case rents drop. Any of those things can happen. I still have plenty of cash flow on the property for where I am right now. Now if I was buying something in 2010, 2011, 2012 after the market already shifted you’re paying 30 cents on the dollar, yep the 15 year am on there are 20 or am on there and it makes a lot of sense because it’s all paid off. You know you’re just every check you write to the bank you’re taking money from this pocket essentially and put into this pocket and pay the principal down.
Tim: 44:43 So, it makes a lot of sense. And I think one of the biggest key factors to building legacy wealth is by holding properties and letting them appreciate over time, letting it naturally appreciate over time and not speculate. Just you know, assuming it’s going to bump up a little bit year after year after year but over the course of 10, 15, 20 years, it makes a big impact on the value of the property and then letting that loan balance get paid down over time and then all of a sudden 20, 30 years from now you’re sitting on hundreds of millions of dollars or tens of millions at least for a property that you own free and clear and you either have a ton of cash flow you can refinance it again you could sell it you can do whatever you want. And I think that’s a major factor of just consistency.
Tim: 45:28 Don’t wait to buy real estate, buy real estate and then wait, and just consistently making payments on the principal, pay down and letting the property appreciate. Powerful stuff man. It’s amazing how that compound effect sets in. So that’s good stuff man. II appreciate you. I appreciate you being here. For anybody who doesn’t know Chris…you guys need to know him and we’ll put his contact information the show notes. And just as a quick aside, do you only charge 1 percent on these loans? So I hope I’m allowed to say that. Hope you don’t mind that. I see you as such an asset to my team that I love paying you and it’s only 1 percent. So do your team takes care of everything. You guys understand me you understand my financials. Obviously the first couple deals, we had to get acclimated you had to understand my business model and how we do what we do.
Tim: 46:21 But now I send you a deal. You guys are essentially my transaction coordinators all the way through. And there’s different ways to have a conversation with a bank. If I was going to go have a conversation versus you going and having that conversation, it’s very important to understand the different dynamics and the posture that you can take with a bank versus me trying to take that posture with the bank and you knowing what the bank is looking for and knowing my story and being able to formulate it and structure it and frame it in a way that is mutually beneficial for both of us. It’s powerful stuff man. So I appreciate everything that you’ve done. And do you have anything else that you want to share? And then I’d love for you to share your contact information with everybody too.
Chris: 47:02 Yeah. Look I can’t thank you and your guys enough. We’ve had a really good run with you guys and we love working with you.
Chris: 47:09 And we’re thrilled to be a part of growing your balance sheet. You guys created legacy wealth for you and your family. So thanks again for having me on again. Any of your clients, your partners can reach out to us. Might the best way to get a hold of me is my email address. [email protected] And our main line you can get a hold of any of us at 216-328-9700.
Tim: 47:34 Awesome dude. I appreciate you…we got a lot of deals in the pipeline too, so I need you to get back to work pretty soon buddy!
Tim: 47:43 I appreciate you. Hope you guys got a ton of value out of this…this is great stuff. Chris Litzler with Marcus & Millichap and I’ll get his information in the show notes. Awesome info on how to build legacy wealth and the commercial finance side of these things, what banks are looking for and what you need to do and how you get involved in some deals, even if maybe you don’t qualify for the financing, you can get involved into building some legacy wealth through commercial real estate.
Speaker 1: 48:09 So Chris Litzler, everybody. I appreciate you bro! Talk to you guys soon…be your best.