Episode #106 - 9 Ways to FINANCE Your Next CRE Deal!

Today hosts Braden Cheek, Brian Duck, and Joel Thompson discuss 9 of the most effective ways to finance commercial real estate deals.

All right, how's it going? And welcome back to how to invest in commercial real estate. And we have an awesome show mainly because I think it's Super Relevant. Super relevant. Tell us about it, Braden. Yeah. Well, I mean, anything we need to open up the the show on, you're, you're doing an awesome development at Bigby. Tell us something new. Well, uh we just got done meeting on that project. We are uh unless they lied to me, we're on budget and on schedule definitely. And we're getting ready to bring the peers uh out of the ground and pour the foundation so nice. Yeah. All right, lumber prices are coming down. Hopefully other things start coming down as the economy slows and that'll help us build it for a little bit cheaper. Be nice and we hope we feel it that'd be different different than what we did. Yeah, I wanted to actually, I wanted to show you a graph because I looked it up in our meeting of what lumber prices have done over the last few years. And you know, we made the decision to go to steel on the criteria building because lumber was so high and it's done nothing but fall like a rock since, uh, we decided to go with expensive steel. That makes me feel great. I just wanna let you know that, that they could, could they pour foundations on sand?

Yeah, we peered, we peered all that interesting. Yeah. Anyway, uh, so one of the biggest drivers for buying commercial real estate is the leverage that you can get on it and you don't want to use all of your own money if you can help it. And so today, we thought we'd mention or discuss nine ways to go about financing your commercial real estate deal. Hold on my notes. But, you know, we've talked about how leverage is, is the name of the game to maximize your returns, right? But I don't know that we've ever talked about all the different ways. We've talked about them maybe at one time or another, but not all in the same show. Yeah. So I, I think I'd like to start off with some sort of analogy, right. Joel's talked about the money sheen analogy, money, money machine analogy before. But it's basically this idea that if you could go buy a machine that made $100,000 a month and it only cost you $50,000 a month. The, the only question you would ask is how many can I buy, right. And that's essentially what we're doing here. We're talking about the spread between the cost of capital and what your investment is actually making.

So in a real estate investment, you know, you may evaluate that on a on a cap rate that's super common. So an eight cap deal that year, assuming no income growth is gonna make you 8% return on your equity, um assuming you bought it in cash. But if you can go borrow the majority of the the funds from a bank or some sort of other institution at half of that, let's say 4% properties making eight, you borrow the majority of the money and they only want four. Now, the, the lower money you put in, right. If the bank's taking 80% of the deal, you're only putting 20% in and you're making your 8% right? Because the property made 8% on leverage. So you're making 8% on your 20% down, but you're also making the 4% on everything the lender is putting down. So, really, you're, you're making almost 12, right? And that's the idea that we're talking about today is how to, how to maximize and generate positive leverage. Right. Yeah. And so the first one is the most simple that we'll go over and it's uh local, regional banks and we, we like to use local and regional banks.

A lot of people don't. Uh but the banks are easy to work with and they're uh they'll leverage up to 75 to even 85% on a deal, which is great. Uh, the, the positives are you, you know, them, you can, if you have a problem, you can go to them. Uh, they don't want your property, they're less likely to take it back. They'll want to work with you before they foreclose. Um, so all of those things are positive, the rates are generally low. They may, they may not be the lowest on the list that we have today, but they're generally pretty low. The negatives for a bank is that you have to sign personal guarantees and, and so you're putting the rest of your assets on the line. And so if the deal doesn't work, let's say you just catastrophic, you have to hand the keys back. Uh If they sell that property for less than what you have owed the difference, they're gonna come after you for, in the form of a judgment and that'll hang over you for a long time until you pay it. So, uh but we've been successful in utilizing banks, especially when buying uh multi retail. Do you, do you think uh private bank or, or banks are the most common way?

I mean, that's what we do. We seem to have it down. Uh We know a lot of banks that we can go to so it seems fairly easy to us and, and everything else that you talked about is that you think that's the most common way uh that people um are buying real estate statistically. Yes, that's the most common way. Like I forget this statistic, but it's like two thirds or something is lent out by local and regional banks in the United States. That's like 22 3rd of the lending in the economy. I, I think it may be more. I'm just, and if I had to guess why, that is uh my thought would be this, that there's so many, there's banks in every single local market, especially the smaller local markets. If you think about uh a small town near you, uh Oak Mogi or mcallister, I'm talking about towns around Tulsa, but everyone has them big institutional lenders aren't necessarily going to be favorable on lending in those markets. But local bank will always lend in their local market. That's number one. Number two is that most borrowers are not sophisticated enough to know uh what all the options are available to them.

That's like when I started, I, I had no idea. Some of the, the, the sophistication of the lenders on this list. Lastly is I think that a lot of commercial deals are not big deals. And you know, if it's a half a million dollars here, there's no credit to the deal. It's a warehouse over here. Those are always gonna be local banks because the other people on this list aren't interested in things without credit or if they're below a certain size, you're not gonna get them interested in lending on your deal. So, those are kind of three reasons why banks are probably the most common. Yeah, you can. I mean, we found a property in Louisiana and the first question we asked is, what's the debt look like? We, we found a, a local bank who's got a branch a few miles away from the property. We went and bought in Louisiana and they were ecstatic to give us a loan on a retail asset. They'd drive by every single day. So, I mean, it's, it's as easy as Googling banks, right, in that local market. The next thing I would say is, and I, I know we're not rating them, but would this be probably the cheapest easiest, you know, generally most favorable terms on, on the real estate we buy?

Would you say that's probably from banks? I mean, out of the nine, it's cheapest, friendliest, easiest. It's gonna be close to the cheapest. Ok. Not, not necessarily the cheapest because government backed loans tend to be the cheapest. Sure, but the dock prep fees and the hassle and the time and you know, the legal cost of closing the loan, the hassle of closing the loan. This is gonna be on the low end of that for sure. Yeah, that, that might take us to our number two way if you guys are, are done with that again. And that's, that's hud Right. And I don't have any experience with that. Um, I know you've been working on a hud loan for what, two years or? Well, no, we did, we kind of gave up on it because uh interest rates spiked and cost spike and we got debt constrained on our leverage. So we ended up bailing on the hood loan, but I have had a loan before. It's uh housing and urban development and they have specific programs, especially for lots of different programs that I'm not educated in to discuss. But they do loan on multifamily. Uh and they are very strict and they're multifamily or, or, and only multifamily or at least related.

Well, the program I'm thinking of is only m uh multifamily. I don't, I'm not aware of any hud programs for loans for retail, but they do have farming and agriculture and other things that they loan on you. So hud there's a couple of positives. First is there's uh they're very low rates uh compared to maybe the lowest. Um the second is that you can, you, you can typically get higher leverage, not always, but 90% on a multifamily development or a multifamily deal is possible. Uh And I'm not sure of any other lender that that can do that on like a uh a development project, you can get a 40 year fixed 40 year. So we were late to the game if we would have got that hud loan started and done while the rates were 2.8 can you imagine having a 2.8% fixed rate for 40 years. I mean, you're guarantee, virtually guaranteed cash flow for decades. Uh, and so they're the longest, and they're the longest fixed period. It does come with a lot of upfront fees. What's the downside? It sounds great. Uh, there, there are downsides. I'm not gonna get them.

All right. We're gonna stay pretty high level here. Uh, but the, the downside is, is there's, there's prepaid penalty. It can be assumed. A lot of people don't like to assume hud deals. They have relaxed this, but in general, in years past, you could only take funds out of the investment like twice a year and they had to be approved through an auditing process from Hud. So Hud's gonna audit it and make sure that you have enough reserves and that you're keeping the property pristine. Uh And then only then will they allow you to take, to take money? Is it easy to go get one of these loans you just call Hud up and say, hey, Hud. No, it's, it's quite difficult because all the government uh bureaucracy boxes have to be checked. So this is one, we definitely want to find a mortgage broker expert. Yes, you're gonna want to find someone that in your market that facilitates hud borrowing that knows people at Hud that can push this through because it takes, it can take a year or two to get it all the way through. You have to first time. No, it's a, uh, yeah, a forward looking we're developing, we're planning on developing this a year from now.

Let's start the hud process today. So this is someone you pay to help you through the process. They, yeah, they will take a fee, just like a mortgage broker will take a fee. But then there's also just a lot of other fees and expenses. So this is a very upfront, uh very expensive upfront process. Um And so some of that you can build into the, into that high LTV. Um But, but still we add cost to your deal. So the the amortization and the rate I have to make up for that. So real quick who's, who's backing the loans and, and their amazing terms? So what's the incentive, I guess for hud to, to do this? What are they looking for? What areas? I mean, I, I think the idea is kind of affordable housing, right? Yeah, I think they, they want market rate there, there's a couple of different pro uh products out there uh as far as affordable and how, but if you're just doing a market rate deal, they will want to do a, a complete study on the market and they'll want to make sure that this area of town down, uh given all the other units that are coming online needs uh housing units, there's a demand for the unit. So they're just doing all of that in the background to say, ok, this area is gonna be deficient over the next five years of multifamily units.

And so we're gonna go ahead and, and land here. Now, guys, you know, if you're an expert on hud lending, you probably are gonna butcher everything we said, but we're just trying to be high level for some of our investors and, and so we can move on to the next one. All right. Well, let's stay with the departments, Brian, take it away. Fannie Freddie. Fannie and Freddie. Yep. So if you play in the apartment world, obviously, you're, you're super familiar with and the value add multifamily game, it's typically going in with some sort of bank debt completing your renovation, stabilizing it and then your take out is taking it to market to sell. But if you want to keep it or if you just want to lock up good loan terms, you're taking it to, to Fannie Mae or Freddie Mac to get permanent financing and just like hud um when it comes to existing apartment units, probably some of the best long term financing options you can get on, on multifamily. Yeah, and you will need to consult with a broker. I highly recommend you use a broker that does this for a living because it's, it's not an easy process. It's not as cumbersome as hud. Uh but we really have had good luck with Fannie Freddie loans.

Uh we have a great mortgage broker. We've had him on the podcast before. Uh, but these loans they're gonna be advertised most likely for 30 years. They're most of the time fixed for 10 years. Although they do have seven and five year fixed deals. Um, they're, they're not, they're more expensive than a bank with legal and, and things and inspections and reports, but they're not near as expensive as hud and maybe 60 to 90 days instead of, you know, I would say 60 days, uh 60 to 90 is probably a good ballpark from start to finish. And their rates would be, how would their rates compare to, to hud? They're gonna, I think most of the time they're gonna be slightly higher. I don't know what they are today. But an example, we have a loan right now now with uh Fannie that is, I think two like 2.83 fixed or it was a ten-year fixed deal that we put on a year or two ago when rates were really low. So that's a great product fixed for 10 years. Averts for 30 years. Sometimes you can get I O for a year or two. The LTV is really good. It's up to 80%.

They've backed off of that some lately, but typically 75 is not too hard to do in a, in a decent market. Uh It's a great option now, if you've never done a Hut deal and this is your first multifamily property? Oh, sorry if you've never done a family, uh, Fannie Freddie deal. And, and this is your first, uh, property. It's gonna be tough. A little bit of heartache from Fannie Freddie. They want repeat, they want, they like repeat borrowers and they also like to see a net worth in excess of the loan amount. So, if you're gonna get a, you know, $4 million loan amount, you have to, you have to show a net worth of a four million bucks. That's not easy to do full background check, full, you know, kind of not audit, but they're, they're digging in to who you are late on payments. Have you ever been foreclosed on? Have you ever, uh, had a judgment against you in a lawsuit? I mean, they're gonna get into it because the same thing if you default, uh, they only get the asset and so they want to know what kind of person they're, they're going into business with. So non recourse, not uh fully, non recourse. Yep. Ok. And like, um, your comment on hud Right, this is a lender that's very involved and sophisticated in running this asset.

They require financial reporting. They require reserves on and interests and in taxes and in, in capital expenditure, they'll require an inspection every so often and they'll require repairs be made based on the findings of that inspection and they'll make you do it or else you can't withdraw all the money out of your escrow account. So, I, you're dealing with a sophisticated lender who doesn't have any recourse except the property. So they're making sure that property is accurately being taken care of and, and reserves are being built up and repairs are being made. Yeah, I think, um, they're kind of quasi in between a Hud and, and a bank and that they don't, they don't force you to do an audit like Hud does and they don't, they don't restrict you from using the money where they, where they do, what they want to see is your tax returns monthly and yearly P and L s and they're gonna, um, withhold reserves, uh, of several 100,000, let's say on a property and they'll, and every month they'll, or every year they'll take additional reserves and then, uh, at the end of the year they may give you a list of things they want you to repair.

Um, so that, that's gonna real quick if they want to see that. Um, back to number one real quick. Private bank. What or, I mean, AAA local bank, what do they want to see in terms of reports? Good question. They want to see your tax returns. Yeah, they'll email you every quarter and, and that's it. And you may get your local banker that you have a relationship with. They may, uh, email you and say, hey, how, how's the property doing that? That's, that's, that's local bank hud has, has a full blown com a third party company doing an audit on every dollar that you took in and you spent. So. All right, let's keep going. Uh C M BS is the next one I did uh live company. So, uh interestingly enough, I've never done a life uh company loan myself, but just think we all know what life insurance is. Those companies take your premiums and in order to uh produce returns or dividends, uh uh they invested in commercial real estate and other investments. And, and so like, uh I met with a lender yesterday Protective uh life insurance company out of Birmingham.

And, and so they, they have their premium dollars and they wanna go invest those somewhere and they want to get a safe secure return and, and so life companies, good things about life companies and, and this kind of comes from my meeting. But I knew some of this before that uh they will lock the rate uh at application, they haven't even committed to do the loan and they'll lock your rate and that rate lock is good for 100 I think at least 100 and 20 days for free C N Bs. Uh we, we're not there yet. So I'll leave that. Uh the other ones though. They, I don't think they lock, they lock the rate that, that soon you have to wait and you have to put a deposit down at rate lock, once they commit to doing the loan, I think like in a, on a Fannie Freddie deal, you have to, you know, maybe two points of the loan you've got to put up. So if they go lock the rate, you have to put up this cash. So if you, if you bail after that, then you lose that $200,000 deposit, let's say. So life insurance company free rate lock at application, no deposit necessary. Also non recourse um way easier to deal with than uh C N Bs and, and in some instances, Hud and Fannie Freddie, typically they want uh nicer commercial real estate typically.

So good markets. Uh class A class A class B uh type assets. They're not gonna be just throwing their money at, at older shopping centers or C class apartments. That's not gonna be life insurance's game. They do, they do new development. One thing I thought was interesting. Uh Typically they're a 65% LTV deal, but they have AAA program where they'll participate in the profits and they can loan all the way up to 100%. That's insane. And I've, I've never uh I've never done that, but it was very intriguing to me. We need to send them our Starbucks Marine Creek deal. Yeah. Uh So we'll see if they, they have interest and the uh life insurance companies have complete flexibility so they can do uh a 30 year fixed 30 am, they can do 15 year, fixed, 15 year a and, and many combinations in between. We, we're just a private company giving a loan essentially. And so like Fannie Freddie, they're pretty much ten-year treasury type loans. Well, those are strict guidelines. Same thing with banks, like banks are, have to lend on a very certain guideline based on the fractional regulations.

Yeah, another thing we didn't talk about with, um, with the first few is that there are prepaid penalties on some of these loans. I think I mentioned it on hud. Well, most of all of them except your regional bank has a massive prepayment penalty. Yeah, the longer you, the longer you fix these deals, the, the more expensive that prepay is. So if you get in a situation where you want to sell, it's gonna cost you quite a bit of money and I don't want to get into how to calculate that because it's a little bit messy. Fannie Freddie though we didn't touch on, um, is, is fairly easy to assume. Again, if you're a repeat borrower of, of Fannie Freddie, it's way easier to assume if it's your first one, you're trying to assume a Fannie Freddie loan, probably gonna run into some challenges but definitely not as difficult as hud or maybe a uh maybe AC M BS loan. And by prepayment, all you're saying is if you decide to pay off the loan or, or even a portion of the loan, maybe they're gonna charge you some percentage or some fix. Yeah. Whereas a local regional bank, even if that, which is a big, if, if they have a prepayment penalty it's on, if you refinance it to the bank down the road and they just lose out on the interest if you sell the asset.

I've never seen a prepayment penalty on selling an asset from the local bank and I've done a lot of bank deals and here's the power of that real quick. On our local bank. You have a, you have a loan, it's at 5% rates, dive. Uh, there's no prepay penalty. Uh, and so you can get them to lower that rate for you sometimes in the middle of the loan and not always, but that's a great option to have. It's an interesting conversation, you know, I'll be the first one to admit, but it is what it is. All right. Let's keep going. Yeah, we gotta roll through these. All right. Next one. Um, commercial backed securities loans. So these are typically made by your massive banks. Um, your Goldman, your barclays, your, um, JP Morgan Chase. You know, I'm, I'm running out of massive banks, but there are these massive loans. So they go make 100 million, hundreds of millions and they'll make these tranches of loans based on credit ratings and, and very strict parameters. You know, we're gonna invest in these markets with these type of shopping centers and they'll bundle up a massive amount of these loans and then they'll sell that loan tranche on Wall Street.

Right. So this is a commercial backed securities loan. It's very, not very, you know, not as complicated and difficult and timely as hud, um, maybe more complicated and timely and costly than Fannie and Freddie. Um, they're typically not doing apartment deals. You know, they're kind of playing in the retail space when they're out there dealing apartment deals. It's just hard, it's depending on market conditions, whether they can outperform Fannie Freddie, because Fannie Freddie is just so good. Well, and they're selling these in the open market, right? So, like Goldman, all these companies are only gonna go make this massive tranche of loans if they know these assets are being traded and they know somebody's willing to buy the bond on Wall Street because that's literally what they're doing. They're, they're selling this got totally blown up uh in 08. But they're, they're back now. Well, they kind of, they kind of went, they were back and, and then now they're kind of going away. I, I uh I apologize to all of them. I don't like these loans. Uh I don't like him for several reasons, but I'll give you a couple real quick. Uh Number one, um we have a loan through Goldman Sachs and we had a mortgage broker that was like, hey, I know Goldman, they're the gold standard.

Goldman it's in their name, man. And uh and they're like, you, they don't re trade the rate that they, they do what they say they're gonna do. And I'm like, guys, I, I really don't want to do C N BS. No, we got this. So we went out and got a $10 million loan. The spread was already high uh at the time and they knew we were on a 10 31 trade and then at the last day of my trade, like we're closing this loan. So on the, on the spread, you meant they probably gave you some market li to watch or something like that. It's like it was like a 2 30 over the 10 year treasury at the time or whatever. Got a spread. And so we get to the closing date. They don't fix the rate, ok? The other guys, you know, fix the rate 320 days. Fannie Freddie, fixes it before the closing date. They wait till the very end when they've got you fully pregnant and they go out to the market and they're like, oh man, things are crazy. We're, we can't get the spread and, and you got to do this deal, the market, we're gonna lose this. We're gonna go up even more and, and they changed the spread on me. They added like 20 or 30 bits and we're talking, I mean, put that over 10 $10 million for 10 years it's a huge amount of money. I don't think people appreciate it either.

It's like the day, like, you've been working for months to get this deal closed. You've got hundreds of thousands of dollars in earnest money that you're gonna lose. If you don't close on the deal, you've spent tens of thousands of dollars. You spent all of your time, that's for free. But it's got some sort of value and then you're on the phone to verbally lock your rate the day of closing on Wall Street. And you've got a number in your head because you've got the freaking 10 year treasury pulled up in front of you and they're like, yep, spread move to 2.5. We clear to close. You're like, it was terrible. And I was so mad if I had any ability to tell them, uh, to take a hike, I definitely would, but they knew that, which is why they did it. That's why they did it. And so I don't, I hate being in a position to be taken advantage of and, and so I, I'm not gonna put myself in that position again. Yeah. Well, let me ask you this, uh, criterion, you know, the largest deal and the most money we've had to borrow is I don't know what, what if we went out and bought a $200 million retail center? And we needed to borrow 100 and 50 160 170 million.

Is that what we'd have to do? I mean, local banks aren't going to give us that much money. Right. Uh, yeah, C N B loans are they're gonna be, they're gonna play in that really big space if it's not multifamily, you like that space. So, well, let's not, let's not stay on it. Uh, one other thing that I don't like about them is that they're sharks and, and so if you get in trouble and you need to, you know, like COVID hit, I had banks calling me asking me what they could do to help, help me with the situation. C N Bs didn't call. And if I called them, they'd go back and look for something I missed so they could just take the property. They, they do not care about you. Uh They are gonna take advantage of whatever situation that you allow them to. And so that's another reason why I don't like them. Let's let's move on. All right, we're getting back in the flow here. We are. All right. This next one is actually kind of exciting. It's sometimes referred to as hard money. Uh but it's private equity, right? So this is, this is high net worth individuals. This is family offices. This is, you know, the rich guy down the road is giving you a loan for your first fix and flip. It's a guy who says, hey, you've got this uh rehab project bank maybe won't give you any additional funds, I'll, I'll loan you the 105 100,000 or a million dollars to do that rehab.

And I need, you know, 10% interest. I need it minimum guaranteed for a year. And I want a, uh, a point of origination and I want a point when you pay me off, like that's typically what a private, uh, equity loan may look like. Yeah, I mean, I think you're thinking of the, the bridge, a bridge portion of the private equity. Um, because yes, if you, if you want private equity, uh, or, uh, there's also, you know, Fannie Freddy has a bridge program as well, but bridge loans are typically you want it quick and, and easy and, you know, maybe the, the deal has some hair on it and needs some stuff. Yeah, they're gonna charge you a point or two on the, on the entry, a pretty high interest rate and a point or two on the exit and it's for, for a short period of time. So that's not all of private equity because there are certain private equity that will go alongside, let's say a bank or Fannie Freddie. And they, and they'll just be the equity portion of the deal that, that's a different, um, that's a different deal. Then they're gonna want an A P P F, uh, they're gonna want, you know, 70% of the profits, that kind of thing.

So that's a little bit of a difference. But, yeah, that's the next one on our list. Yeah. Preferred, preferred equity. Isn't that more of like the, well, so, uh, kind of similar private and preferred equity. They're very similar preferred equity. Let's say I'm gonna syndicate a deal and I've got a, a primary loan and, uh, I'm gonna raise two staunches of, of, uh, equity capital. One is preferred equity and then, then one is investors, the preferred equity, they'll get a really high interest rate like 12% let's say, but they don't get any of the backside uh profit, then the investors, they will get an, let's say a lower eight pre and maybe uh 60 40 or 70 30 split of, of whatever's left. So you pay now in exchange for higher upside. Yeah. And so, and, and so as it goes, the first lender gets paid first, preferred equity gets paid second and the, the investors get paid third. So where do you see private equity? More of a long term situation outside of a bridge loan? I let's get back to that. Yeah. So, um you know, if we were going to go buy an apartment complex and I was gonna get a Freddie loan for 75% the, the private equity, I could go to a family office and I could say, hey, I got this great deal and they'll say awesome.

We're gonna write you a $10 million check. They may or may not require me to put equity in. Some do, some don't care as much. And in that 10 million bucks they're gonna give me which is 25% of the total they're gonna say, ok, I want an eight pre and a 70 30 split. So I mean, after I get my, I want 70% of the profits. Uh this is good, this is good. So this is essentially a sponsor going out buying his own deal, essentially finding the money from a Wall Street family office. Basically with one sophisticated investor that will dictate the terms to you with like one person, I, I would say that's the biggest differentiator between the two, right? And so essentially, you're saying indicator wouldn't need to come up with any of their own money unless they required a little, they may say a 10% co coves maybe 10, so 2.5%. But if they don't, if they don't, then they don't. Here's the kicker though, with private equities, they typically want their 8% preferred return, then they want 100% of the capital paid back. Then you do a profit split. So if you have a, if you have a normal apartment deal as a sponsor, you're not, I mean, it, it may take 68 years or more, maybe longer to get the 100% of their capital paid back because you have to make an excess of 8%.

Correct. Anything over 8% return, cash on cash return goes to pay back the sponsor equity sponsor equity. But the preferred equity, these multifamily syndicators that are, you know, buying these massive apartment deals with private equity equity, right? They're living on acquisition fees is what you're saying because all of the money has to be returned and the upside has to be returned before they get a share of the promote. So it's a completely different structure. It's a completely different structure. It's not a bad structure. Uh And if you're in the long game as a, as a sponsor, uh you start, you know, you're building these at you, you know, 8 10 now. So you've been every dollar, you pay down that huge mortgage. Uh You're getting a share of, uh you know, as long as you're cash flowing over that 8% and you can pay back their equity over time, eventually it's gonna really pay off for you. Uh But you're, it just takes a while and it's a, it's a different game than what we play. Ok, let's keep going. All right. We did private and preferred equity, good distinction between the two. Um ok, let's use one. It's called mezzanine debt, mezzanine debt.

And this is exactly what you think of. You know, everyone knows what a mezzanine is. It sits above the ground floor, right? So this is a debt that is above and beyond a traditional mortgage and it is unsecured in the, in the sense that it's not secured by a real asset. And, and Joel brought up a good point before the show, they do typically get their security from some sort of LLC interest, right? Like if you default on this mezzanine loan, they can't go file a, a foreclosure on your property because they're still a primary lien holder that is gonna be doing that. So they will take control of your LLC and they'll try to get that primary loan to not default is, is their sense of security, I guess. So, why would you need mezzanine debt? You don't have enough money, Brian. Well, let's say your, your first loan is 70% and you, and you can't raise 30% equity or uh your equity is really expensive for whatever reason, you know, you're giving away a lot of the ownership. Well, mezzanine debt seems expensive when compared to the primary loan because the primary loan may be at 5%.

Mezzanine might be at 11% and they may have a point in and a point out. So uh so it's expensive but it may not be as expensive as giving equity to investors. And so who is supply, supplying this mezzanine debt? Great question. It's really, it kind of plays in the private, you know, preferred equity space and it, it's just additional debt, right? It's it's not equity, it is still a debt component. So fixed interest rate, they may have some sort of origination. They may have some sort of exit, they don't have a real property collateral, they've got LLC Collateral and it's, it's a loan a little bit. They, they, it's, it's a lender that has the option to convert their debt into equity in the event of default. Ok. So they, it, it is a lender. They're lending you money, correct. Uh, but they can convert that into equity in the business or even just, just all the, the shares of the business in the event you default. So it's really a unique position for them to be in. They underwrite your LLC and your operations obviously thoroughly to make sure there's no other debt because their security is essentially kicking you out of the equation and trying to earn their capital back and uh they're gonna go up to uh they may be 10 or 15%.

So if you have a 70% loan, they go up to 85% you know, maybe if you had a 75% loan, they may go up to 90 but they're not typically going over that. So when would you, I'm asking myself, when would I get mezzanine debt? So, uh a circumstance where we needed additional debt was the trailing 12 month financials on a property were not amazing. They had gotten a bunch of new leases recently. So the forecasting 12 months looked amazing, but the trailing 12 months looked horrible. Therefore, the bank said hey, you know, we'll go to 50% LTV or 60% LTV. So we had to find some sort of mezzanine debt. I think we ended up getting a second mortgage on the deal, which was a pain in the ass because you have to go involve the primary lender and get their approval for a second mortgage and that's a whole deal. But that, that would have been a perfect case for mezzanine debt, right? And the only reason we ended up getting a second mortgage is because mezzanine debt is typically more expensive than a mortgage. It's still a debt instrument, but it's 8 10 12%. Um because they know if you could get the money somewhere else, you would and they're in a sub uh an inferior position in the event that you default.

So that's why it has to be more expensive, but once again, it can be cheaper than equity. Uh and so that people still use it. All right. Last one. Yeah, so the last one is, is really kind of the culmination of all this, right? And we'll just put it in the general bucket of crowd funding and crowd funding is this unique thing to go and see this capital stack, right? And to see these eight options, eight other options we've listed out, you've got all these different types of equity, you've got all these different types of debt, right? So now we use our imagination and say, hey, here's this $10 million property for sale. So I can layer in, you know, a $7 million mortgage. I can put a, a $2 million of preferred equity or, or preferred debt or mez debt and then I can put in 10% equity learning how to build your capital stack in the most profitable way for you as a sponsor, you for, for your investors. That's how these deals are done, right? Is understanding the capital sack better than the next guy. That that's the difference between different sponsors underwriting. We all are looking at the same deal.

Some deal will have 57, 10 different bids you'll bid against other people, right? And everyone's using different underwriting assumptions, your ability to get creative with this capital stack and get a deal across the finish line. The most profitable secure way is, is really a massive key to success in commercial real estate. I just want to add before we wrap up. What is one of our longer shows is that we are definitely not experts in any of these loans. We've done several of them. Uh We were just trying to give you a general idea. So you use Google, talk to a mortgage expert in your industry and get the real details on all the pros and cons of all of these lending uh instruments so that you can be successful. Agree. All right guys. Thanks until next time. Thanks guys.