Rob Beardsley is the founder of Lone Star Capital, which focuses on Texas workforce housing through vertically integrated operations. In this episode, Rob provides observations, insights, and practical examples of debt and equity from his latest book, Structuring and Raising Debt & Equity for Real Estate.
Rob Beardsley | Real Estate Background
- Founder of Lone Star Capital, which focuses on Texas workforce housing through vertically integrated operations.
- 2,500+ multifamily units
- Based in: New York, NY
- Say hi to him at:
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Joe Fairless: Best Ever listeners, how you doing? Welcome to the best real estate investing advice ever show. I'm Joe Fairless. This is the world's longest-running daily real estate investing podcast, where we only talk about the best advice ever. We don't get into any of the fluffy stuff. With us today, Rob Beardsley. How are you doing, Rob?
Rob Beardsley: I'm doing great, thanks for having me on the show.
Joe Fairless: Well, I'm glad to hear it. It's my pleasure. We're going to be discussing structuring and raising debt and equity for real estate. And oh, what a coincidence that is the title of your book that you recently wrote and published... So first off, congratulations on that.
Rob Beardsley: Thank you very much. It's really exciting to be releasing my second book now. So far, the response has been very positive. I was a little bit nervous about this one, because it was hard to top the great feedback I got on the first one, but I wanted to give it a shot and write another book. Writing is a lot of fun.
Joe Fairless: Well, that's your opinion, that writing is a lot of fun... But I'm glad that you did it, and I know personally, after I get done writing, I am satisfied, fulfilled by doing it, but it is a challenge for me. Rob is the founder of Lonestar Capital, which focuses on Texas workforce housing through vertically integrated operations. Their portfolio consists of over 2,500 multifamily units in Texas. He's based in New York City. So with that being said, let's talk about structuring and raising debt and equity for real estate. Obviously from the title, we know the focus of the book. But can you just take a step back a moment and just give us a little bit more context for why you wrote the book?
Rob Beardsley: Yeah, so for those that aren't familiar with myself and what we do at Lonestar, as you mentioned in the bio, we're focused on value-add acquisitions in Texas. And the key to that business, as most real estate businesses, is the underwriting and understanding what you're buying, what you're paying, and the business plan in order to get the returns that you're seeking. So the first book that I wrote was "The definitive guide to underwriting multifamily acquisitions", which lays out our full underwriting process and methodologies. So it's great and obviously critical to know how to underwrite and identify a good opportunity, but I thought to myself, what's the next step after you find a good deal? And the next step is actually structuring the deal. There's three elements to a good deal: it's buying at the right price, it's structuring correctly, and then it's going out and executing. So I wanted to talk about that middle piece, which is structuring the deal correctly, and then another hot topic, which is actually going out and raising it... Because just because you find a good deal, it doesn't mean you're going to close it; it takes a lot of work to actually build relationships with lenders, and get the debt. And then same thing on the equity side, build relationships with investors, and raise the capital.
Joe Fairless: Makes sense; very logical progression. So what is something that after having written the book, when you talk to people about it, something that surprises them, that perhaps isn't common knowledge, or isn't something that is commonly practiced?
Rob Beardsley: Well, focusing on the debt first, I think it's a bit surprising, and we've all been there, but when you're casually looking at deals, it's easy to overlook the debt, when in reality, debt is the greatest source of risk, and it's really important to understand what those risks are and how to get comfortable with them, or if needed, making adjustments to the debt so that it is more in line with your goals. And your goals may be to maximize cash flow, or your goals may be to minimize risk, or to hold long term versus short term. So figuring out what your goals are and what your investor's goals are, so that way you're structuring the deal to appeal to them - I think that's something that we miss, because oftentimes we're kind of going through the motions and just thinking "Well, let me just pick the option that has the most loan proceeds." But in reality, taking a step back and getting more clear on your goals can really help you in getting a better debt structure.
Joe Fairless: What are the common debt structures that are used in your world?
Rob Beardsley: In our world, I would say broadly speaking, the debt structures are batched into two different types, which would be bridge debt and then permanent debt... Permanent debt being 5, 7 and 10-year loans, and then bridge debt is 2 to 5-year loans, which are usually floating rate, and they're usually at a higher leverage point. So both have their moments, and again, it's all about making the right match. If you are buying a deal, that's, let's say, very low occupancy, it's underperforming, and it needs a lot of renovation work, that is the perfect fit for a bridge loan. However, if let's say you're trying to buy a brand new class A deal that's fully leased up, that may actually be a bad fit for a bridge loan, and you're better off looking at a longer-term loan. So that's just at a very basic level the two themes and the different ways that you may want to apply them in your strategy and your goals.
Joe Fairless: Why would that be a bad loan for the class A property that's fully leased up to get a bridge loan?
Rob Beardsley: That's a great question. So just generally speaking, like we discussed, bridge loans usually come at a higher leverage; obviously, you can back the leverage down, but then you may not be optimizing your cost of capital. But assuming that you are getting a higher leverage loan than a permanent loan, that bridge loan is going to potentially overlever the stabilized deal, because if you are buying a stabilized deal that doesn't have upside, there is no path to value creation except other organic growth. And what a bridge loan's premise is that the lender is giving you a loan on the basis of future value, not in-place income and in-place value. So that can be a mismatch, where if the market doesn't grow at a fast enough rate, you may be in a situation where you are over-leveraged... Which may not be a problem in most times, but if you head into a down market, or if interest rates change on you, it could put pressure on your deal. So it's good to look at a cushion, which is why we focus on value-add deals for the most part, where we can actually increase income actively through renovations, improve management, and other strategies to increase revenue and reduce expenses, so that way we build in some cushion for us on the cashflow side, as well as the value side, because we're able to force appreciation.
Joe Fairless: As it relates to focusing on the debt first, you mentioned the business plan; what are some other questions we should ask ourselves to determine what to put into place from a debt standpoint?
Rob Beardsley: So what I think is also really a big topic that's overlooked are prepayment penalties. This is also a way to match your goals and your business plan to the debt structure. For example, we like optionality, and we like to exit deals quickly if there's a good sale opportunity. However, if we have a long-term loan in place, with expensive prepayment penalties, that actually may make it more difficult to exit in 2, 3, 4 years, hurting our goals. So it's important to understand that if you do want to exit early, you may want to bake in additional flexibility into your loan structure before just jumping at the highest proceeds, lowest rate option, which may lock you into something called yield maintenance, for example, which is the most expensive prepayment penalty, which often forces you to sell subject to a loan assumption... Which can work out well, but it just limits your options. So just as an example of optionality is important - you may want to pay up a little bit through a higher interest rate up front in order to be able to exit for a cheaper prepayment penalty down the road.
Joe Fairless: What other questions should we be asking ourselves, as it relates to debt?
Rob Beardsley: Yeah, as it relates to debt. Well, what's interesting about this whole topic is it just keeps going and going. As you know, there's so many different structures, and I don't know if I should be embarrassed or proud that this book's only about 100 pages. I think it's good to be able to condense it down into the core topics. But yeah, you could just keep on going and going.
One thing that comes to the mind is recourse, and there are plenty of options out there, in our space at least, for non-recourse debt. However, sometimes there may be an option that creeps in that is partial recourse, or full recourse, or some sort of recourse provision, and that's something that is really important to keep in mind. It may not seem like a real risk, but if you don't need to take that risk, you should absolutely avoid it.
I've heard a lot of people say the number one rule of real estate is "Never take on recourse that", which I think for some people in their business plan there may be a time in place for it, but again, it has to be in alignment with your goals and your overall strategy, so for us, we try to avoid recourse as much as possible, as I'm sure you do as well, but we've actually bumped into some difficult times actually last year, where we had lenders who were non-recourse at the very last minute change terms on us, and require recourse, and it was a moment of "Okay, well, do we move forward? Or what are our other options?" So that kind of goes to another topic, which we haven't touched on, which we will for sure, in a moment, which is relationships. So that's another surprise and element to look out for.
Joe Fairless: Well, before we jump into relationships, let's talk about your thought process when it did go from non-recourse to recourse. Will you talk us through that?
Rob Beardsley: Yeah, absolutely. So like most people, we can get away with avoiding recourse. But like I mentioned, in this case, it was a turbulent time for the capital markets, and two lenders, actually, on two separate deals, were threatening to walk away. So we had to get creative and find a way to get them comfortable, and that was one thing that they proposed. So we worked with them to carve out a 25% partial recourse... Which, if you hear 25%, and maybe it doesn't sound like such a big deal, but it really is a big deal; you're still on the hook for the first 25% of the lender's losses. And that's not to be taken lightly. But our thought process was, "Oh, shoot, we have less than a week to close. We need to make this happen, so let's do everything we can to make it happen." And we did, and it was successful, and thankfully, we're actually now in a position to refi out of those loans, which I think is huge. Even if the refi wasn't taking us into a better loan, and just removing the recourse, that would still be a big win. But thankfully, we're getting into new loans that are better, as well as removing the recourse option.
Joe Fairless: What negative consequences, if any, does having partial recourse on your balance sheet have for future loans?
Rob Beardsley: Yeah, it is something that you need to disclose. I think it's not a deal breaker, and it's not something that is viewed as terribly negative. I think lenders understand it. Something that is much more serious would be something like a construction loan that has contingent liabilities; that is something that all lenders really want to get a good handle on and understand. And this actually opens up another topic as far as debt structures and nuances, is what is the lender requiring of you? We talked about recourse, but there's other simple reporting requirements and net worth and liquidity requirements, and it's good to understand what those are before you go too far with a given lender, because you may be attracted to working with a certain lender, but then the further you go down, they spring on you these terms and requirements that maybe you and your team aren't willing or aren't capable of. So it's another part that you may not necessarily see in the model, because we're not talking about dollars and interest rates, but it's very still important to the deal.
Joe Fairless: Not willing or not capable of - can you give an example or two of what a lender might require that would fit into those categories?
Rob Beardsley: Let's talk about the not willing first. For example, I would say this is pretty rare, but you could have a situation where a lender is requiring the sponsor and the people who are actually guaranteeing the loan to put a certain percentage of the equity into the deal. That might be 5%, that might be 10%. And if it's a big enough deal, you could be talking about hundreds of thousands or even millions of dollars. So as a sponsor, you may have that cash, but you may not be willing to, because frankly your money may be better spent on growing your business, or spreading it around more of your deals.
Now on the not capable side of things, most lenders, their kind of basic requirements are net worth of the sponsor or principals that are guaranteeing the loan to equal the loan amount. And then 10% of the loan amount, they're seeking for liquidity; basically, bank statements showing 10% of the loan amount. So for many sponsors, especially early on, that could just be not possible. So that will either force you to negotiate and try to find lenders that are willing to make an exception, or you can bring on a loan cosigner onto your team to sign the loan with you in order to satisfy those requirements, which I think is actually a great way to go, rather than trying to find that one off lender that may work with you... Because then you're probably going to take a step down in terms of terms or quality of lender partner. Instead, giving away a little bit of your piece of your pie away to bring in a sophisticated, experienced individual who has the net worth and liquidity to satisfy the loan can get you an even better loan potentially than you were originally looking at, and really improve your deal for your investors.
Joe Fairless: From a reporting standpoint, what do lenders typically require?
Rob Beardsley: From a deal standpoint, you have to provide monthly financials for the deal. From a sponsor or principal standpoint, lenders are different. Some of our lenders, they want to see quarterly personal financial statements. I'd say mostly though, lenders want to see your personal financial statement and schedule of real estate owned on an annual basis... Because, hey, it's fine that you showed us a certain amount of liquidity at closing, but that's actually a covenant that survives the entire duration of the deal. So they don't want for you to show them $2 million at closing, and then you spend it all, and then a year later you don't have anything in the bank. So that's why they want to keep up with those annual reporting requirements.
Joe Fairless: Let's talk about relationships. You mentioned that earlier... Can you elaborate more?
Rob Beardsley: Yeah, I think a lot of people mistakenly treat lenders as commodities, because there's a lot of lenders out there, and a lot of them may look the same... But really, there is quite a bit of differentiation, and relationships are the key. Finding good people to work with is number one, but number two is actually building a relationship so that there's a level of trust, and you're putting yourself in a situation where they want to pull for you, they want to make it work for you, rather than them just kind of pushing papers and sizing up deals and sending you feedback. So for that reason, I think it's valuable to try to do two things at once, which is -- they're kind of at odds with each other. On the one hand, you want to build a network, and you want to have many lenders that you have relationships with, so that way you can pick between the best options. On the other hand, you want to go deep and have strong relationships with a few lenders, where you've done multiple deals, and they pull strings for you, because they actually have confidence in you and they know you through more experiences.
So we've been through, as I'm sure many people have, through difficult times with lenders, where there's certain issues as far as closing, or a title issue pops up, or terms change, and working through those issues builds trust, to where they've seen you prevail over a difficult circumstance, and seeing you work hard and make things happen, and that can lead to getting a better deal than if you're just to throw your deal out to 100 lenders and see what the best deal comes back for. So yeah, building relationships - we always talk about relationships when it comes to investors and equity, but on the debt side it's really important as well.
Joe Fairless: Why did you mention relationships when you were talking about the 25% partial recourse?
Rob Beardsley: Well, because, frankly, it could have been worse; those closings were happening right when the market was totally flipping on its head during 2022, as interest rates were changing and lenders were backing away from the market; they could have just pulled out completely and just been done with us less than a week before closing. Very unprofessional, but it's well within their rights.
So when you're talking about lenders, even though you're signing papers, and term sheets, and things like that, they don't really have much of an obligation to perform. So you're putting a ton of trust in your lender as a real partner in the deal, especially when you're talking about putting up earnest money deposits that are non-refundable to the seller, and you're raising millions of dollars from your investors, all banking on a closing occurring. And a lender - it's rare, but again, they have the power to potentially pull out in a difficult circumstance like that. So if there's a bigger relationship there, then they're obviously going to be much less likely to do that.
Joe Fairless: What else that we haven't talked about as it relates to structuring debt do you think we should talk about?
Rob Beardsley: Well, like I said, it can just keep on growing and growing. I don't know if I really touch on this too much in the book itself, but I've definitely talked about the topic of portfolio loans or doing loans individually, and finding the right sweet spot in terms of deal size. There's some kind of [unintelligible 00:19:53.26] deal sizes, where you might get worse terms for a, for example, $5 million bridge loan. But all of a sudden, if you could potentially package a couple of deals together, and you turn that $5 million bridge loan into a $15 million bridge loan, and you could have a completely different set of terms for your deal, which can give you a competitive advantage and dramatically improved terms.
So those are some things to look out for when you're trying to create value, rather than looking at deals on a one-off basis. I know, Joe, you've had a great story where you had a deal under contract, and then you were able to identify a deal down the street, and they were complimentary to each other, and buy it off market. Thinking creatively like that can really create outsized value for your investors. We did something similar, where we had a deal under contract, and we identified the property next door to acquire and merge operations, which has turned out to be hugely successful, and the debt plays a role in that as well.
Joe Fairless: Before we wrap up, equity side. So transition to equity -- we were talking about debt. Now from the equity side, what is something that is surprising when you speak to people about "Yeah, this is what I've found. This is what I wrote about in my book as it relates to this part of equity." Like, oh, really? Can you give us something?
Rob Beardsley: Yeah, what I'd love to talk about is busting some of the myths surrounding institutional capital. And when I say institutional capital, that can mean many things to different people, so I'm referring to professional real estate investment firms that invest as LPs that can look like a family office, or a private equity firm, or something like that. And the big myth that I like to talk about as it relates to these bigger check writers is the fact that they are in fact - not all of them, but a lot of them are, in fact, willing to work with newer sponsors, younger sponsors, less experienced sponsors. That's been true for our journey, and it's been very formative, and I think a lot of people wrongfully shy away, because they think that they don't have the experience or the sophistication, and they're not there yet. But really, if it is something that you want - which, it's not right for everyone, and that's perfectly fine... But if it is something that you want, building those relationships today is absolutely the right way to go, rather than your future self in six months, or a year from now is going to be in a better position.
They're human, just like we are, even though may seem like they sit behind billions of dollars or what have you... They're human, so they work off of relationships, just like we do, and relationships take time. So that's something that I talk about in the book, and talk about, if it is a goal of yours to build yourself and your team up to be really institutional capital-worthy.
Joe Fairless: Who is it not right for? You said it's not right for everyone?
Rob Beardsley: Well, there's a lot of people out there that have a different business model, and they would rather work with individual investors, and educate them on the world of passive investing into real estate through a syndication, rather than doing joint ventures with a larger institutional firm. And there's very legitimate reasons for that. Number one would be, I would say, the fees; you're going to take a step down in terms of your fees, and your ownership in the deal when it comes to dealing with larger, more sophisticated investors.
So if you have a great skill set as far as communicating and marketing and outreach, and working with doctors, lawyers, tech employees, entrepreneurs - that can be a great source of capital that is friendlier to work with, more flexible, they pay higher fees. Both have their pros and cons, which is why we actually focus on both. I think you don't have to pick one and stick to one. It's definitely harder to try to go between both, but I think it's been tremendously valuable for us to do that, because we've learned a lot working with our sophisticated partners, and we've been able to take those lessons and take the feedback and improve and then apply that to the entire business and share that with our retail high net worth investors as well.
Joe Fairless: Taking a step back, what's your best real estate investing advice ever?
Rob Beardsley: My best advice is focus. I'm sure you've heard that before, but we really believe in focus. And that's talking about focusing your strategy, your market, your team, and even on the equity side of things, going back to that to finish up, I did just say that we like to play both ways, and we raise money from institutional investors, and we also partner with retail investors... But focus on the equity side as well as the acquisition side is a huge advantage. If you can get clear on your avatar and really know who your dream investor is, that can do wonders for positioning yourself.
Joe Fairless: How can the Best Ever listeners learn more about you?
Rob Beardsley: If you want to learn more about us at Lone Star Capital, you can head to our website, lscre.com. That stands for Lone Star Capital Real Estate. So that's LSCRE.com. And if you want to check out the book that we talked about today, you can find that at structuringandraising.com.
Joe Fairless: Rob, thank you for being on the show. Thank you for talking about in detail debt and equity; we focused mostly our conversation on debt. Observations and insights, and giving some practical examples along the way. So I appreciate you being on our show. I hope you have a Best Ever day, and talk to you again soon.
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