1102: Special Guest Interview (Trevor Calton - Part 1)
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00:01
Welcome to Episode 2 of Season 11 of the Growing Empire Show. Today I'm here with my special guest, Trevor Calton, from Evergreen Capital and we're going to talk about how to secure the right type of leverage for your investment property purchases. So stay tuned.
00:16
Welcome to Growing Empires. Hosted by real estate entrepreneur and trusted investment advisor, Jennifer de Jesus. Growing Empires provides insight to building wealth through passive income producing real estate investments for those who want to build and manage a more profitable real estate portfolio.
00:36
Welcome, Trevor, to the Growing Empire Show. I'm so glad that you're here. Let's kick off this episode with you sharing a little bit about the work that you're doing now with Evergreen Capital.
00:46
Jen, thanks for having me. I'm happy to be here. I am the owner of a boutique commercial mortgage company. I've been in commercial real estate, the industry, for about 25 years, and started out working with a mortgage bank doing distressed asset acquisitions. Which was probably the best education anybody could ask for if they wanted to get into commercial real estate investing. Because we learned the ins and outs of not only the financing, but the properties and what causes them to become distressed and then what the workout solutions are. After spending several years as an analyst, I was, tried my hand at commercial real estate sales. As a broker. I did that, for several years, I was licensed for about 15 years. And through that time, I also did a stint as the director of asset management for the housing authority of Portland, overseeing about 300 multifamily properties. And shortly thereafter, I became a professor of real estate finance and the masters of real estate program at Portland State University. And about five years ago, decided to start my own mortgage company. And now we specialize helping investors to get commercial loans over a million dollars. But I do a lot of sort of strategic consulting along with that. Since I have worked in asset management, I understand property management, sales, negotiations, due diligence. So wear a lot of hats in the industry. And I'm one of those people that loves real estate, so much I'll talk about to anybody who will listen.
02:19
I hear you, I could do the same thing too. So I'm sure we're gonna have a great conversation. Today, we're going to talk about sourcing debt and equity capital for investments. And I've asked Trevor to join me to share his wealth of knowledge he's gained throughout his years in lending, as well as his background in real estate. And today we are going to talk about different things you need to know when using debt and equity. We’re going to cover what questions you should ask when you’re searching for a lender. I definitely will have Trevor elaborate more on distressed property acquisitions as well. So I'm going to just jump right into our very first question, how should investors go about sourcing debt for investment purchases?
02:44
It's a great question to start out. And I tell clients the same thing, every time, the best place to start when looking for a loan is with the bank where you already have a relationship. And that is for a variety of reasons, but primarily because that bank does not want to lose you as customer. But I make the analogy that, you know, going and sourcing debt and is sort of like finding a law firm for if you were gonna go to court. And you you know, if you were gonna go to court, and for a lawsuit, you would first call your own attorney. But if your attorney didn't specialize in that, then you would go and you would need probably need some help finding another attorney. And in the capital markets, it's the same thing. Most banks, especially retail banks, they only allocate a certain amount of capital, if any, to any particular product type. So you know, some might do multifamily loans, some might only do say, you know, retail, or SBA loans. But most banks don't do everything. So if an investor is going to find a loan, the first place they should go is talk to their bank. But then from there, what I always say is, unless you're very familiar with the various lenders out there in the market nationwide, the easiest thing to do is to engage a commercial mortgage broker. And the reason for that is the process of getting quotes and term sheets from lenders, especially on a commercial deal. It's far more complex and in depth than getting, say, like a residential loan quote. And I recommend that people use commercial mortgage broker because for a variety of reasons. But one, they do it every day, we are talking to lenders all day every day, and we work with borrowers of all types, different, you know, levels of capital to put down different levels of experience, and of course, different investment types that they're working on. And it's a lot more efficient and faster for a company like us to help a borrower find the best loan with the best rates and terms for their project. And the nice thing is we you know, in addition to sort of offering a broader scope of options, we are more efficient. We understand the process, we know the questions to ask, and typically we are able to get the lenders to reduce or waive their origination fee. And so we can charge the fee. So, most times, hiring a commercial mortgage broker doesn't cost the borrower any extra money. It's roughly the same. And yet, it's sort of like going in, you know, you wouldn't go to court without an attorney. And you shouldn't go to the capital markets without somebody looking out for your best interests. And so we, you know, we always emphasize, we work for the borrower, not for the bank. So, that's, I think, the best road for most people unless you have an established relationship with a lender.
05:53
Right? So would you say in that particular scenario, our suggestion that the broker is acting more like a an advisor, who the broker is essentially looking out for you as an advisor, and then they're going to source out your deal to a variety of banks potentially right to actually fund the purchase?
06:11
Absolutely. And most often, you know, I typically work with investors. So the vast majority of what we're working on are apartments, or say, retail or mixed use. And a great example of that would be, if I shop a deal for an investor, and I, you know, I'm going out and trying to find them the best rate in terms of Frequently what we'll get will be very similar quotes from different lenders. But they'll have minor differences that your average investor may or may not understand. The first one that comes to mind would be a prepayment penalty. You know, a lot of people will face step down prepayment penalties. So, you know, the first few years, you might say, have like, the first three years of prepayment penalty be 3% in the first year, stepping down to 2%, and then stepping down to 1%. And let's say that you decide that for some reason you want to sell your property in the second year, and it's, you know, a million dollar loan payoff, you know, you're gonna have a $20,000 prepayment penalty. But a lot of people don't understand that there are different types of prepayment penalties, another one called yield maintenance. And that can be much more arduous the borrower. And so I'll give you an example. We saw a lot of borrowers who prior to the crash in 2008, had pretty attractive loans, but prior to ‘08, mortgage loans were in the six 7% range for commercial properties. And then after the crash, when the Fed lowered rates to zero and most mortgage banks were out there lending, you know, 3%, or three and a half percent. And I use that example before, if somebody had a million dollar loan to pay off and they had a 2% prepayment penalty, they'd pay $20,000 as their prepay. But if they had to yield maintenance provision in their loan, yield maintenance means that the lender gets to maintain the yield that they would have had on that loan if it didn't pay off. And we saw borrowers who just because of that one provision had 300 and $400,000 prepayment penalties instead of just, you know, 20,000, just because of that one provision. And the reason I cite that example is because if somebody is going out into the markets, and they're getting loan quotes for an acquisition or refinance, and you know, the bankers, they work for the bank. They're not going to necessarily go out of their way to tell a borrower what is the potential consequence of having a step down prepayment penalty versus a yield maintenance prepayment penalty. And the impact of that is, is variable depending on what happens in the markets. And typically, yield maintenance would be something that would be pretty impactful if rates have dropped. Because then the lender can go out and get that same yield in the market. And it may not matter as much when rates are going up. But generally speaking, you know, it's best for an investor who, especially if they're not savvy in the capital markets, to have somebody that's out there working on their behalf. And that can help them understand that commercial loans especially, are so much more about the terms than they are about the rate.
09:27
So true, I definitely second that
09:30
One thing I tell people pretty often, because a lot of especially less experienced borrowers will that'll be their first question, well, what are the interest rates? And, and I always say, if somebody quotes you an interest rate on a commercial loan, without taking a look at your property, or your loan package, you should probably run. Because they're not looking out, either they're not looking out for your best interest, or they don't know what they're doing. And it's just literally impossible to, quote, an interest rate on a commercial deal without having at least a first pass at the loan package.
10:05
That's an interesting statement. Because that kind of leads us into my next question. And that's what are some of the key things that you need to know when determining which broker to use?
10:14
The most important thing is experience in the product type that you're working in. So if somebody is borrowing money to purchase an apartment building, they really want to utilize a mortgage broker that has experience closing and funding, similar type of apartment deals. Same thing with a retail center. A huge mistake that I see a lot of people make is they hear mortgage broker, and they think that all mortgage brokers are the same, or mortgage lenders are the same. And they're just certainly not. And having worked in capital markets, I understand that understand how banks allocate their funds, you know, where they get their, their funds from institutional investors or warehouse lines of credits. And, and so it's, it's far more nuanced and complex than most people realize. And if somebody engages a lender or broker that doesn't know the type of property that they've been working on, they could end up getting a far worse deal than they could have gotten if they had somebody that was a specialist.
11:16
Yeah, I definitely agree with you on that. So what kinds of questions should investors ask when searching for a lender?
11:23
The things that I would ask, would, you know, the main thing is, you know, what's your experience in funding these types of deals? And the next thing would be, what are your fees? And the thing that is really important for a borrower to know is, you know, everybody needs to get paid, and a mortgage broker needs to get paid, the lender is going to get paid based on their interest rate. I mean, that's what they're doing is they're in the business of loaning money to make interest. And then they also get paid on the back end if there's a prepayment penalty or things like that. But the question that the borrower needs to ask is, what are the total upfront costs in addition to the interest rate, that they're going to have to incur? What which of those costs can be built into the loan amount would have to be paid upfront? What is refundable versus non refundable? Some lenders will collect, say, a $10,000 deposit from a borrower, and they'll collect the deposit. But they won't reveal that if that loan doesn't close the deposit is not refundable. And there are costs of doing business, even just shopping around for a loan. But then that sort of reinforces the earlier point that having an experienced broker that understands that loan type, they can tell you who already has the best programs, you know. nd there are different tiers of programs, the agency like the government agency loans, those are excellent programs, but they can take a little bit longer to close. And so that's another question people need to ask is, how long is this deal going to take to close? A huge mistake that I see people make a lot in making an offer on a piece of property is they don't get a grasp on how long the financing is going to take. And they sometimes don't give them selves enough time in their purchase and sale contract to get the financing that they need. Especially if they're gonna go after a HUD loan or, you know, Fannie/Freddie loan. And so the upfront costs, the time to close whether or not deposits are refundable. And then, of course, you know, the experience level that that lender has in funding the type of deal that they need
13:39
Would you also agree that at that point, it's also important to know things like, you know, how long is the fixed rate period versus the variable rate period? Right, because that seems to differ a lot amongst commercial loans. Yeah, how many years the loan is amortized over? You know, those sorts of things as well?
13:56
Absolutely. That should be actually given because one thing that I think another thing that's important people do is, you know, compare, compare the offerings that you get from different lenders. And the fixed versus adjustable period in a hybrid loan, a hybrid loan being one that has both maybe a 10 year loan. But it's fixed for the first five years and then it becomes variable for the next five years. That obviously, is it a huge deciding factor in whether or not that that's going to be the right fit? Not everybody wants to take that interest rate risk in that second five years. And so obviously things like, how long is the rate fixed? What is the rate, you know, the amortization of the payment. Most lenders, especially in investment properties are going to amortize the payments over 25 or 30 years. A 30 year amortization is going to give the borrower a lower payment. Because it'll be paying they have longer period to pay down principal. But that's not always something that people understand. So I think, you know, those sort of front end questions like How long is the rate fixed and variable? That should be a given and anybody that's working with a lender who doesn't walk them through those basic steps should really think twice.
15:11
The episode will continue in just a moment.
15:14
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16:13
I've also seen a lot of differences when it comes to and kind of going back to your point about you know, making sure you know how long the lender needs for closing the loan and actually going through the pro. Because I've seen a distinct difference just at least in our marketplace, where, you know, some commercial lenders, it's common practice to require environmental inspections and different things. Whereas other commercial lenders are not requiring those types of things. And again, just something so little, could be a drastic difference in you know, four to six weeks on on a loan at some point.
16:47
That's a great point. Yeah, especially with things like environmental. And the reason for that is, it's all about the lender mitigating risk, what people need to be aware of when it comes to what sort of environmental testing is going to be required. It's really based on the property and how it's being used and how it was used in the past. So if somebody is buying an apartment complex, that is in a neighborhood that's surrounded by other apartment complexes, and that's what it's always been, chances are lenders not going to need an environmental phase one. But if the property was, say, adjacent to a gas station, or was previously on a property that was used for an industrial purpose, the lender is going to typically want to test the soils for environmental contamination. And if anything comes up in the phase one, which is a cursory test, and they go into the phase two, which is a much more in depth test, and those all cost money that are typically paid by the borrower, sometimes that those costs are fronted by the lender, but usually the borrower is going to have to absorb that. And the reason for that is if there's environmental waste on a property, all past present, owner, past and present, owners are equally liable for the remediation. And so a lender doesn't want to get into a situation where the borrower defaults, and they have to foreclose on the property, and then they are now one of the entities that's responsible for remediating any environmental contamination. So, environmental is a huge one. But that's a great question, you know, and, again, something that borrowers should always feel like they have had all of their questions answered, they are familiar with the process, they know the potential speed bumps or obstacles that are going to come up, like in environmental testing. And typically what I encourage people to do, I actually help people negotiate their offers all the time. Based on examples like this, we have, we have some developers that we're working with, and they're next to a gas station, and I said, you're gonna need, you're gonna need the option to extend your contract for 90 days, if something comes up in the environmental testing. And, you know, that can be written specifically like, Hey, we're going to close on this date. But if something comes up in the phase one, everybody needs to understand that that could be a deal breaker. So we're going to need another 90 days to test. And without that option to extend, a buyer or borrower could be put into a situation where suddenly they've invested all this money in due diligence and put earnest money down, and they're not able to close simply because they didn't write in the right contingencies in their offer. So I think it's really important to have a lender on your team, as an investor, you should always have a lender on your team. And I think a broker is just the way to go. Because again, the broker works for the borrower, and prior to writing an offer, talk with the lender or the broker and say, Hey, is there anything I need to be thinking about that might not be, you know, blatantly obvious, that we should consider when we're writing the software, especially for due diligence?
20:00
You make a really great point. And there's something that's happening, at least in our marketplace now that I find extremely alarming and I'm always on the side of, you know, you got to do things in the right steps. But with our market being so, you know, low inventory, high demand, right? Everybody wants to get their offer and get their offering, get their offer in and it's like a race to the finish line. Because literally as quickly as a property goes on market. It's off the market. It's under contract. So I'm finding that buyers are now or investors I should say, are now going the opposite direction, especially if they're a newer investor. They are so focused on getting the deal that they don't even talk to the broker or the lender first. And then they're under contract with almost like fake terms, right. Because they haven't even acquired any kind of financing or have done any kind of application procedures with those lenders. And then they put themselves in a position where they could be potentially losing money, depending on how that contract is written. Because, you know, I think people forget that, you can't just automatically extend the contract. Like both parties have to agree. So the seller doesn't have to let you to extend because the bank couldn't get the financing done, because you never allow them enough time to do it in the first place. But I find that this marketplace is creating this like craziness, where people are like, trying to jump out of line in the perfect order of things, you know. So it's great that you said that, because I think that that's really key, like you have to know where and how you're doing the financing on the property before you go into the offer step. Because if you don't have that worked out you I mean, it could take weeks to source the right broker or lender for yourself. And to find the best deal.
21:47
You make a great point there. And that's, I think, a common misconception that I get with novice investors, or those who are just branching out into commercial. And they're so used to doing residential where you show up with a pre qualification letter along with your offer. And you know, people are often surprised that when we tell them, there's no such thing as a pre qualification in commercial properties. And so it is really important to understand what the financing process is going to look like, prior to making the offer.
22:17
So what would be your advice to somebody that, you know, feels like their offers not going to be competitive by saying that the closing is going to be 60? Or 90 days out? Which could be a very likely thing? What would you suggest as a way to entice the seller to accept our offer, and still be in a position to give the bank plenty of time to do what the bank needs to do?
22:40
That also a great question. And that goes into the skill set of the selling agent, the buyers, real estate agent should have experience negotiating PSAs on commercial properties. Another really common mistake is Oh, my, my buddy Joe, he's, he's one of the top home sellers in his market, I'm gonna have him represent me on this commercial deal. That's a terrible mistake. Because the processes are different. They might as well be completely different industries. And so having a sophisticated, skilled and experienced broker who's done a lot of transactions in the property type that you're working on, just as you would want with your lender, it's even more critical with your real estate agent. They should understand, if they've done that several times, they should understand how to write that offer. In fact, I was just reviewing a PSA this morning. And we were looking at the due diligence timing, and it was a little tight. But a good broker will say, all right, we can put in extensions for whatever we need. And most sellers provided there's enough information in there for that extension, most sellers will agree. I'll give you an example. If you were gonna say hey, we want 30 days for due diligence, and 90 days to close. But we may need an extension you that you would want the agent to write in. For that extension, it would be if there is a phase where any, you know, any findings on the phase one, then we get, you know, X number of days for the phase two, and then X number of days for that or, you know, then we could walk from the deal. Financing contingencies are a big one right now, in the past, a lot of times, a buyer could go in, they could tie up a property, do their due diligence, go and then find out you know, okay, I want to get 80% financing, which is pretty common prior to 2008. And if they didn't get the financing the like, that they wanted, they would just be able to walk from the contract. Nowadays, a lot of sellers won't accept the financing contingency. And they used to be pretty broad, like at the buyer sole discretion. If they don't like the loan terms, they can walk from the contract. A seller doesn't want to be tied up for very long and then have somebody walk just because rates jumped a quarter point during the escrow process. So the point there is you want to have an agent that knows how to explain the reason for various extensions, and have them be appropriate. So I always tell my clients when they're doing a purchase that they should write, you know, write their escrow period for whatever it's going to be 60/90 days. I usually say 75 But you know what happens on the west coast where we live versus on the East Coast could be very different. It also depends on how competitive the mark work it is. If we're in a pandemic, then you certainly want to go have a longer escrow period. Even things like the holidays need to be accounted for because processes in the capital markets and lending, they slow down at different times of the year or for different reasons. Or they might even slow down because rates have dropped and sudden, the lenders got really busy, and they have stacks of files of applications on their desk. So it's just really important to understand, you know, the whole process and most investors don't understand the financing process, which makes it all the more important to have somebody on their team in their network that does.
26:12
Thank you for listening to this segment with my special guests, Trevor Calton. Please tune into future episodes where Trevor and I continue our conversation about all things related to buying investment properties without using your own money and how to scale that investment portfolio. Until next time, take care.
26:30
For more information about how Jennifer can help you plan, develop and manage a strong real estate investment portfolio visit growingempires.com