March 3, 2024

JF3468: The Rise of Preferred Equity and What’s Really Happening with Multifamily Distress ft. Vicki Schiff




Vicky Schiff, CEO at Avrio Management, joins host Joe Cornwell on the Best Ever Show. In this episode, Vicky — a CRE entrepreneur and Adjunct Professor of Real Estate at Pepperdine Graziadio Business School — discusses preferred equity, its place in the capital stack, and the opportunity it presents for investors in the current CRE landscape. She illustrates this by breaking down a specific case study and goes on to discuss how rising interest rates have given rise to pref equity, all while explaining what’s really happening in the world of multifamily distress.


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Vicki Schiff | Real Estate Background

      • AVRIO
      • Hires and trains virtual assistants, primarily for real estate companies.
      • Based in: Los Angeles
      • Say hi to her at: 
      • Best Ever Book: Greatest Salesman in the World - OG Mandino

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Joe Cornwell (00:04.65)
Best ever listeners, welcome to the best real estate investing advice ever show. I'm your host Joe Cornwell. And today I'm joined by Vicki Schiff. Vicki is the CEO of a real estate debt company, Avrio. They're based in LA and she's a returning guest on the show. Vicki, how are you? And thank you for joining us today.

Vicky Schiff (00:25.313)
I'm great. Thanks for having me, Joe. I really appreciate it.

Joe Cornwell (00:28.874)
So we just talked a little bit about your company and the services that you guys provide. So tell me a little bit more about it, define it and give our audience a gist of some of the things that your company does.

Vicky Schiff (00:42.389)
Absolutely. So we have a firm called Avrio and a company below that called Avrio Real Estate Credit.

It was formed last year in the middle of the year after I had co-founded another firm called Mosaic Real Estate Credit. At Mosaic, we originated about 2 1⁄2 billion of real estate credit up and down the capital stack all the way from first mortgages to construction loans to mezzanine to pref equity.

And we sold that company to a public company in 2022. So this is iteration number two of my debt business. And I think today there's a lot of opportunity in the market based on rising interest rates and borrowers at times needing to restructure capital stacks, needing to pay off their construction lenders. If there's a freshly constructed project, most likely they went over budget. So they need some help with taking their construction lender out and just getting more time. We also can invest higher up in the capital stack, meaning we can provide more proceeds to a borrower.

And we're very entrepreneurial, so we will look at anything, any kind of asset class, with the exception of office today in really any geography that makes sense to us, that has macroeconomic drivers that speak to the viability of the real estate itself over the long run. And so that's, in a nutshell, that's what we do. We have a website, People can learn a little bit more about what we do on that website, but we're seeing a lot of, lot of, lot of, lot of deal flow right now. So it's an exciting time.

Joe Cornwell (02:46.634)
Yeah, and we had another guest recently that talked a little bit about the preferred equity or they called it investing in it. I guess you would call it lending into that section. Can you tell me a little bit more about that specific strategy?

Vicky Schiff (03:02.857)
Right. So if you look at a, if you think about a capital stack and borrowers could think about it a little bit different, but at the top you have the first mortgage, right?

So within that first mortgage, you can get a loan from a lender like us or a bank, and sometimes the lender will split that loan into two pieces and retain either the senior or the junior piece. And so that's a part of the capital stack. You could be the senior or the junior in a first mortgage. Then after that, the next level can be either pref equity or mezzanine goes to about, you know, from 60 to perhaps even 85% of loan to cost. And so that is junior to the first mortgage and is more aligned with the borrower themselves.

They're basically in partnership with the borrower and they're helping that borrower execute the business plan by providing capital. The difference between that and straight equity is either mezzanine or pref equity will be preferred, so it will get paid first prior to the equity, but it also most likely has fixed upside. So there could be a fixed rate, perhaps even a fixed rate with a little bit participation, but if the deal works out the way that the sponsor wants it to, then most of the money will be made by the equity. Does that make sense? So that's the way... There, yeah, there at the bottom.

Joe Cornwell (04:37.874)
Okay, and they're Yeah, and they're and they're at the bottom of that. They're at the bottom of that capital stack, right? Okay.

Vicky Schiff (04:44.025)
you have to think about, you know, a borrower could get crushed by their lender. So they're always sitting on the bottom, whereas a lot of borrowers like to think of themselves at, at the top. But when you're a lender, you think about it in the opposite direction. So, um, and the opportunity there is just really to support borrowers that need additional capital to get through business plans. And that is happening a lot right now.

Um, based on the slowdown of leasing, perhaps some reversal of leasing rates or increases, and certainly the increase in interest rates for borrowers that are on floating rate debt or floating rate loans has really slowed down the business plans of a lot of operators around the country in all asset classes. So that's what we're here to help with.

Joe Cornwell (05:42.13)
Okay. And so I guess maybe to help the audience understand, give me some examples of the right type of deal maybe where a bar would come in and work with your company.

Vicky Schiff (05:57.961)
Right, so we were working on something earlier this year, well actually later last year, that was a freshly built multi-family asset in a very, very urban market, very dense market, hard to build in. The construction loan was due, so the bank, which was a bank loan, they wanted to get paid back the borrower went over budget by about 12% and that borrower had investors.

So in order to satisfy that bank, to have that bank extend the loan and reduce its loan amount, because now the asset was worth less because the cap rate rose in the market, that borrower had to bring in mezzanine. They needed about five or $6 million of mezzanine to sit behind the construction lender to make that, to allow that construction lender to extend the loan. And then that mezzanine would be senior to the existing the existing equity.

So that is a prime example of where a deal's just capital starved, they need to bring somebody in, but that new capital wants to be senior to the existing equity holders. And what that does for the borrower, it gets them through a period of time where they can lease up their asset, get it to stabilization, and then go out and get a cheaper agency fixed rate loan.

Joe Cornwell (07:34.862)
Got you. Okay. Yes.

Vicky Schiff (07:36.399)
If that asset was already eligible for a fixed rate loan, they would just take that because it's cheaper and it's less hassle. But it wasn't ready yet.

Joe Cornwell (07:42.43)
Yeah, I see. I see. Yeah, so that makes sense. You know, I'm wrapping my head around some of these situations, you know, investors, syndicators, funds, whoever's putting these deals together could be in today's market, as you mentioned some of those factors causing, you know, the opportunities for your company. And if the asset, if the deal itself fundamentally is still good, you know, all the underwriting, the potential of it is still there. But as you mentioned, you're just, you know, trying to get them from A to B, so to speak, with the capital.

And because otherwise, obviously, no one's going to want to potentially put capital into like a sinking ship, let's say. But in this case, the deal fundamentals are strong, but it still has a ways to go for whatever reason and then to get to the finish line.

Vicky Schiff (08:30.689)
Yeah, we want to see a path for our borrowers and our partners to make money. We want them to win as well, and sometimes they just need more time.

Um, the other situation we're seeing every day is requests for construction loans. There is just a really, um, deep lack of construction capital in the marketplace right now. So, uh, we're seeing requests every single day for construction loans, for multifamily, for example, or hotels. And, um, we look at a lot of them. I mean, obviously, there's a lot more moving parts to doing a construction loan and to lend on something that's either freshly built or needs to be restructured as far as the capital stack.

And it also, the construction loan itself, the total project costs have to make sense. So that builder has to be building to a return on cost that's higher than, or a cap rate that's higher than it was two years ago, because cap rates have gone up. The takeout on that construction loan is going to be more expensive than it used to be. So a lot of those deals don't make sense. We look at them, they're so thin, and we don't see a way to get out to have the right debt yield on the way out so that another lender can take us out. But the banks and other debt funds and other lenders have pulled way back on construction.

Joe Cornwell (10:04.434)
Okay. And I know in the intro, you talked a lot about how the market changed, obviously, the last couple years and some of the opportunities you're seeing. What are your thoughts on the market as a whole, meaning, you know, commercial or investment real estate? You know, where are we at today? And where do you think we're headed in the next six to 12 months?

Vicky Schiff (10:24.961)
Well, I think, you know, I teach real estate finance class at Pepperdine and we were having a discussion with my class yesterday and I asked the class what's one of the most important things to consider when you're looking at investing in real estate and I waited and they thought a while and one guy after a few minutes said, interest rates, and I said, bingo. What's happening in the market today? The person said, well, interest rates are high. I go, well, they're not high.

Historically, they're high compared to a three cap someone paid a year and a half ago or two years ago for multifamily asset. So it's not that they're high, it's that they're too high for the prices that people paid for assets. And I think within your ecosystem you have a lot of multifamily and self-storage syndicators who perhaps bought things on floating rate loans that now their debt coverage ratio used to be one to when their interest rate was four and a half, and now it's not even one one, when the interest rates have now gone to six or seven, and their interest payment has gone up by 50 to 100%.

Now they're not even covering their interest, right? What's the lender telling them? You're out of a covenant, pay us down or pay us off. And so that is a function, that is something that's happening in the market right now. That's a really important thing to focus on. We all know the office story. Office is worth 50 to 70% less for certain assets than it used to be because of the demand, supply demand, supply demand. There's still demand for multi-family.

On the construction front, a lot of assets that got approved and in the ground a couple of years ago are going to be delivering in the next 12 to 24 months. So we're going to have, in the short run, we're going to have an oversupply of multifamily, which creates a lot more competition, even with the older products against the newer products, because newer products, they want to get filled up so they can refinance.

But eventually, there'll be a lot of competition lag in new construction, so we'll be undersupplied again. With respect to industrial, that's slowing down a little bit as well, and hotels are kind of have and have not. So it just depends on what markets, what asset classes, the age of the property, how it's structured from a capital standpoint. If somebody has a fixed rate loan for a long period of time, they're good.

That's a very different situation that if someone has a floating rate loan and they bought an asset at a three cap hoping it to add value to get it to a five and sell it at a four, you know, they're not generally going to sell it at a four anymore. Does that make sense? Joe, the way it explained it. I'm trying to be overly complex, but it's trying to be some of the situations I've seen out in the market.

Joe Cornwell (14:28.694)
So back to the comment you made about the market specific oversupply issue, because I've heard some, some concerns from, from other guests we've had and I'm in the Midwest. So I'm based in Southwest Ohio, Cincinnati, uh, Metro market. And we've had like almost no new to construction. You know, there's a very, there's like a couple of projects that, you know, city wide and you know, the suburbs are not allowing any multifamily development of any kind basically in the entire kind of greater tri-state area. So it's interesting when I hear that comment, and obviously as you did mention, it's market specific, but do you think that's going to be something that's kind of a local phenomenon or are your concerns more broad with the national market?

Vicky Schiff (15:20.717)
I think real estate is a local.

The real estate question is local. I think you have to look at specific markets and say how much supply and demand is there in that market and how long does that market take to absorb based on migration patterns, based on job creation and other things, and certainly the economy. People, when they can't afford an apartment rent, they'll just double up. They'll move back in with their parents. Sometimes, unfortunately, they have to find alternatives or, you know, we have a massive homeless problem in this country, obviously, so we all know about that.

But I think it is a very, very local question, but I don't have the stats in front of me, but I'm looking right now at an email I just got from Alan Mackin, which is a big law firm, and the headline is the industrial sector is going to be a mixed picture over the next three years while development activity remains strong. Supply is expected to grow faster than demand, signaling the new development will eventually begin to cool.

So that's actually what I would say for multifamily as well. Demand will, I think, demand will level off, build back up again in the future, supply will start to level off based on the fact that there's very few new housing starts and in the multifamily space and a new cycle will begin. But people have to have staying power. That means they have to be at least well capitalized enough to get through a storm if they believe in their asset and if they paid the right price for it. Some people just pay too much.

Joe Cornwell (17:12.278)
Yeah. And so, you know, for those people, let's say in those kind of worst case scenarios, what, what is the, uh, end game for them? And I'll preface that question by saying that we haven't seen the big run of foreclosures that everyone predicted, you know, in the last two years, uh, we haven't seen a ton of kind of desperate motivated sellers selling for pennies on the dollar, just trying to get out of deals.

So, uh, you know, at least what I've seen in the Midwest, that whole kind of, uh, prediction that a lot of people had flooding the market with inventory hasn't, you know, came to fruition. So what are your thoughts on that? And you know, what are those worst case scenarios going to do here in the next year or two?

Vicky Schiff (17:53.857)
Well, you've seen it in office. You have seen the pennies on the dollar from even the biggest private equity firms in the world saying, take my building back, right? So you've seen it in that sector. That's a supply and demand issue. What I'm seeing is situations where lenders have made an initial loan of let's say 70% of value.

Now their loan, if they reappraise the asset, looks like it's more like 80% of value, and perhaps they'll put a little prefect equity in to keep that asset going. Now the owner owns really nothing, right? They're getting a little bit of a management fee. They're trying to retain some upside in the form of a hope note, meaning I hope my value goes up and saves some of my investors, and those things are being played out a little more quietly than a big rush of foreclosures hitting the street because lenders still see that there is some value. They might be in the asset now though for 100% instead of 65%.

And so they're going to either say to the borrower, sell the asset or we're kind of now the owner, you can manage it, you can stay in there, but we own the asset. You owe us, you know, $100 million and the property's worth $101 million. And then it just becomes a situation where the borrower is working for free. And that's happening more than the big wave of assets getting dumped into the market.

So there's a lot of recaps going on. A lot of people out there looking for capital to bring in to allow their asset to survive over time. There's obviously some news articles that have come out in the last week or so and have been coming out about these big, some of the bigger syndicators that are having major issues and I won't name names, but I'm sure you've read about some of those. So reading into those articles, you can see that, you know, lenders are putting a little bit more money in, but they just, the lender is now the owner of the property. Now they're the owner.

Joe Cornwell (20:15.786)
Yeah, no, that makes sense. Are there any specific markets that you are most interested in when you look at doing these type of loans? Are there markets you don't, or states maybe you don't wanna invest in? I assume you guys are investing just in the US or you're international?

Vicky Schiff (20:31.117)
Just the US now. You know, it's very market specific. You have to look at the risks within each market. Some markets sound like they have great political structures and are super business friendly, but they're simply not that dense, right? They don't have the advantage of population.

Some markets have the advantage of population, but they have draconian rent control laws that are really hurting owners and developers or in Los Angeles for example voter it was voted upon I think that it was under 55 percent it got passed we have an idiotic new transfer tax called ULA. It's ridiculous. So that anybody that sells a property over, there's two breakpoints, five million and 10 million, has to pay a new transfer tax. There was a transfer tax before of something, but the new transfer tax is 5%. So all the assets just dropped in value by 5% because if, and if a lender forecloses on an asset, transfers title to themselves, they also have to pay that 5%.

Right? That's crazy, but LA is under supplied, and there's 10 million people that live in LA County. So we can think about all these awful things that happen in LA, but your property is most likely going to be full. Whereas in some other markets, you could be facing a situation where there's competition and and just not enough, too much supply for the demand that's there.

So there's, you know, there's trade-offs and you have to underwrite for that risk. So if I'm going to underwrite an asset in LA, I'm going to underwrite that 5% transfer tax as a contingency in the worst case scenario. If I had to own that asset, would it still be worth it for me to own that asset and pay the 5% transfer tax? Now, there's lawsuits against it. Hopefully, it will get overturned at some point.

But, you know, that is, that's a kind of, lens that I need to look through as a lender because I'm not at the bottom of the capital stack. I'm at the top of the capital stack or perhaps somewhere in the middle. So I need to make sure that my basis is justifiable over time. Because I don't have upside generally, right? I just want to get paid back.

Joe Cornwell (23:04.31)
Okay. And I guess my last question on, you know, your business in general is, of all those different types of debt, all those different types of services and options, what is it that you personally like to do? What types of deals do you like to, you know, loan into?

Vicky Schiff (23:24.513)
Well, we're not doing as much anymore, but in my last firm, we did a lot of construction lending. And I am so proud when I walk through an asset that we had a big part of making happen. So one of my favorite assets is we were the construction lender on a project in Park City at the base of the mountain in the canyons called Pendry, which is part of the montage brand. And I'm there all the time and I just it's so wonderful to see people Skiing and enjoying themselves and families there and listening to music outside and thinking to myself I had a big part in my last firm and everybody that worked there had a big part making this happen.

And that's really cool in contrast to that, anything that I can do to support middle income housing where you're providing, you know, workforce, the workforce, the middle income family with a safe, secure place to live and, you know, live out, be able to go to work and have a safe place to raise their children. That's also super satisfying. So those are kind of two ends of the spectrum. One is a little bit more luxury oriented and the other is, you know, just making sure that people have a safe place to live.

And we look at how an operator operates an asset, what their philosophy is, how they take care of their tenants. You know, we expect the tenants to pay the rent because that's how we get paid back. But at the same time, you wanna give people a good product for what they're paying for. So I think those are things that are important to me personally.

Joe Cornwell (25:12.97)
Yeah, I couldn't agree more. I have a construction background. I own a construction business and definitely one of the most rewarding parts of that process is, you know, seeing a project go from A to Z and, you know, knowing that you built this or you provided, you know, whatever amenity or, uh, residents for somebody is definitely a rewarding part of the business.

Vicky Schiff (25:33.237)
Yeah, you're a creator, right? So much fun.

Joe Cornwell (25:37.762)
So I heard a rumor that you would be a presenter at the Best Ever Conference coming up here in April in Salt Lake City, is that true?

Vicky Schiff (25:45.807)
Yep, it is true. And I came, I was there a couple of years ago. It was a blast.

Joe Cornwell (25:51.554)
Very cool. Can you give us a little sneak peek as to what you will be talking about this year?

Vicky Schiff (25:55.765)
Ooh, I might have some charts. I might have some charts on what's going on in the market and some interest rates and maybe a little bit of personal stories about challenges and getting through challenging times. So something like that. I'm putting it together. I love talking to people on stage. It's like one of my favorite things to do. I get to meet so many amazing people and the crowd at Best Ever is incredible, energetic, passionate, and I'm really looking forward to spending time with everybody there.

Joe Cornwell (26:31.434)
Well, I will be a first time attendee as one of the new hosts and I'm looking forward to it. So looking forward to seeing your presentation when we get there.

Vicky Schiff (26:39.621)
Great, well I look forward to meeting you in person.

Joe Cornwell (27:27.006)
Already ready to transition to the best server lightning round.

Vicky Schiff (27:37.558)

Joe Cornwell (27:39.574)
Best ever book recommendation.

Vicky Schiff (27:42.313)
Okay, last time I said Black Obelisk, this time I'm gonna say San Francisco by a new friend of mine, Michael Schellenberger, who ran for governor of California. And he studied, the subline of the book is Why Progressives Ruin Cities.

I'm a Democrat. So, he really talks about how the overly compassionate policies hurt people. And it's sort of likened to when you don't give your own child guidelines and let them run wild, your house is not going to be in order. So, amazing amount of research, decades of data and I just recommend every real estate person read this book.

Joe Cornwell (28:38.114)
Give me the best of the way you like to give back.

Vicky Schiff (28:42.585)
I mentor women, younger women in my industry, particularly some of those that work for larger companies. I want to see more women leaders in the industry. I have tutored second and third graders online in a tutoring program that a friend of mine runs. And I love teaching about the very basic, basics of financial literacy, particularly the magic of compounding interest to kids. If everybody saved a little bit of money, and that's why people invest in real estate, right, for the compounding interest, then we'd have a much more secure society.

Joe Cornwell (29:26.778)
Yeah, couldn't agree more. That's a passion of mine as well. And where can people learn more about your business or connect with you?

Vicky Schiff (29:35.085)
You can connect with me on LinkedIn under my name, Vicki Schiff, and my website is And please check it out and happy to connect with any of your listeners. And I really appreciate the time.

Joe Cornwell (29:55.35)
And we'll be sure to link to that in the show notes as well as your previous episode. Vicki, thank you so much for joining us and sharing your business and all the insights on the debt and the real estate market.

Vicky Schiff (30:09.706)
Absolutely. Thank you for having me.

Joe Cornwell (30:12.342)
Best ever listeners, well, thank you for tuning in. If you enjoyed this episode, be sure to leave us a five-star review and share this with someone you think could benefit from it. Remember to follow and subscribe to the podcast so you don't miss anything. Thank you for listening. Have a best ever day.

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