Guest Michael Thompson, Vice Chairman CB Richard Ellis

 

Host: Trey Stone

Co-Host: Michael Thompson with CBRE

 

Resources:

Michael Thompson’s Contact Information:

Ph: 713.787.1926

E: Michael.Thompson3@cbre.com

 

 

Michael Thompson’s Background

 

Trey has known Michael for over 17 years. Back then, Michael Thompson worked for Keith Van Arsdale at BMC mortgage. Now, Trey and Michael are much further along in their careers.

 

Michael Thompson is with the debt brokerage side of CBRE which is the largest real estate firm in the country and one of the largest in the world. If Trey has a deal that needs financing or refinancing, he works with Mike. Trey also considers him to be a trusted advisor when he is considering a property. 

 

Mike’s primary function at CBRE is to analyze investment properties. If you’re considering a commercial property investment, his team at CBRE factors in the historical data and provides an indication of what type of financing the property might qualify for. They look at the property but also the deal as a whole- they consider the partnerships, sponsorships, qualifications for financing, etc. Mike is a native Houstonian who grew up in the Sugar Land area. He has many close friends from his childhood and college years who are in different facets of real estate and through them he networked and landed at a boutique lending firm. He grew his business there and moved into CBRE in 2012. 

 

 

Commercial Property Lending

 

Many people assume that you have to qualify for a loan based on what you can afford as an individual. On the commercial side of lending, your loan determination is not based on individual status. The vast majority of loans that Trey has obtained with Mike have been non-recourse loans. A non-recourse loan is not dependent on the individual’s ability to make the payments on the loan. Instead, they consider the income that the apartment complex produces.

 

The apartment complex will already have a certain amount of income when you buy it and a certain amount of expenses. The lender looks at the current income, expenses, and your plan for the property when determining the loan amount. Your plan could include upgrades that will increase the value. From there they determine what type of income is reasonable to assume the property will produce and that is the determining factor for your ability to finance the deal.

 

The pro to this is that it can be easier to obtain $100 million dollars worth of debt in non-recourse Fannie Mae loans than a loan for a single-family home. With a single family home, the loan determination comes from what the individual can afford rather than the income it will produce. If Mike has a borrower who does not have much financial depth, he can still help that borrower get a commercial loan in many cases where they would have a hard time securing a loan for a single-family home.

 

The con is that it could be frustrating when you have a tremendous amount of net worth and liquidity but if the bank does not agree with how the deal will perform in your budget then you may not get a loan. Individual qualifications do not factor in and lenders know that the tenants at the complex have to be paying enough in rent to cover the operating expenses and the mortgage.



Depreciation Tax Credit

 

The depreciation tax code can be a huge benefit of investing in multi-family real estate. On paper, due to depreciation tax code, even if your property has produced an income it is considered to depreciate as it ages. The tax deduction you receive for the depreciation of the property offsets the income of the property and investors often do not owe taxes on that income because of this tax deduction. For example, the tax code can show that a property has depreciated in 19 million dollars in a single year. If the income from the property does not exceed that depreciation amount then there is no requirement to pay taxes on the income. In actuality, many investors improve properties with upgrades and renovations to increase the value of the property. This is Trey Stone’s investment style. Even with those upgrades, the depreciation tax credit applies. The depreciation amount becomes a paper expense that doesn’t affect the income on the property. 

 

Trey received feedback from a listener and often receives similar feedback stating that this sounds too good to be true so he asked Mike to weigh in. Mike confirms that this is accurate and it’s the primary reason some of their clients invest this way. 

 

“It’s one of the beautiful things about investing in multi-family real estate.” Michael Thompson

 

 

Notes for Inexperienced Investors

 

Mike works with certain clientele who are well versed on these processes. They’ve also worked with plenty of first-time buyers in multi-family properties. There are certain metrics that lenders look at on the sponsorship side as far as net-worth, liquidity, etc. Partnerships can combine net-worth and liquidity to qualify for loans that would far exceed what a single investor would do on their own. The non-recourse nature of the loan is key in a lot of cases because the investor is not providing a personal guarantee and the lender is more reliant upon the underwriting of the property.

 

This is where CBRE comes in to line out the underwriting for the lender to show them all of the metrics: debt service coverage ratios, debt yield, loan to values, anticipated CAP rates, etc. Mike’s team at CBRE will tell you what you can qualify for as a sponsor and then if you have partners they can show you what you can qualify for on a combined basis. When they lay out the general metrics for investors, they then have a clear understanding of how to get there and what they need to afford the particular loan amount they are looking for. 

 

Trey explains that debt service coverage ratio comes from the plan for the property and the historical data on the property’s performance. The lender considers how much income the property produces and the operating expenses to see the net operating income or profit it has produced in previous years. That profit has to be greater than the amount of the debt service which is the payment on the loan every month.

 

For example, if you have a 1.0 debt service coverage ratio you would be collecting exactly enough money in profit to make the mortgage payments. The problem with that is any hiccup in operations could make you unable to make the payment. Mike’s team at CBRE typically looks for a minimum debt service coverage ratio of 1.25. This means 25% more income than the mortgage payment needs to come in each month. The 25% cushion protects the borrower if there are unexpected costs. Sometimes what the bank requires is actually for your own good.

 

Mike confirms that the debt service coverage ratio is the number one metric lenders consider when reviewing loans for commercial properties. He also stresses the importance of the debt yield metric and sponsorship liquidity. Debt yield is the net operating income (or profit) over the loan amount. Lenders are looking for a certain percentage of debt yield. Sponsorship liquidity is important because if your debt service coverage ratio drastically decreases and the mortgage payment still has to be made, the sponsor could still make the payment if they have enough liquidity from their own pocket or partnership’s pocket. It’s an added safety measure to ensure the mortgage payments will be made and therefore an important underwriting metric.

 

 

Pre-qualification

 

Pre-qualification letters are typically recommended by realtors involved in single-family purchases. This helps when a buyer makes an offer on a property because it shows the seller that they are serious and can afford the offer. CBRE provides a similar process to that for people who are investing in apartment complexes. Mike suggests starting with this prequalification process for commercial investments.

 

CBRE looks at personal financial statements and determines what their net worth would be as well as their liquidity. With that information, they can advise on the loan amount that the investor would likely qualify for as a single sponsor. They can also advise on the loan amount that the investor would likely qualify for with a partner to educate them on what they should look for. This process can also help a seller who wants to know if their potential buyer is actually qualified. Mike’s team can advise on the quality of the buyer. 

 

 

Low Income Property Investments

 

Trey reflects on working with Mike over the years to secure loans on low income properties. In these investments, Trey and his partners completely transform the properties and improve the quality of life for the residents. By adding stadium-type lighting, they are able to reduce crime. They’ve also corrected leaky roofs, replaced air conditioners, upgraded fixtures and much more. The impact that it makes on the lives of the residents is rewarding. Low income properties can serve people if you invest and upgrade them, make them more functional, and make them safer.

 

Mike has helped find lenders to help Trey and his team do this. Mike explained that of course the metrics are important but a big part of these deals for the lenders is the relationship with the investors. When Trey explains the vision and improvements for the tenants, it resonates with lenders. Local, regional, or national banks who will keep the loans on the books for a long time feel good about an investor who prioritizes taking care of the property. It’s not just about the numbers for lenders. 

 

A moderate occupancy rate with low turnover in an apartment complex is going to be much more profitable than an apartment complex with high occupancy rates and high turnover . Turnover refers to the percentage of people who move out of your property each year versus the percentage of people who renew their lease and stay. Trey believes adding value and improving the lives of the tenants reduces the turnover. He goes on to say that not only will the tenants renew, but they will renew at an increased rent because of the improvements. Often, Trey’s properties are the only properties in a particular sub-market with these improvements. This investment style works. Mike’s team at CBRE can affirm this and pull data on similar investments to illustrate the effectiveness.

 

 

Working with A Mortgage Broker

 

Trey is often asked why he works with a mortgage broker when he could go directly to lenders who he has close relationships with and secure a loan directly. Trey sees value in the mortgage broker relationship because Mike and his team tells the story in a compelling way, helps organize the business plan and investment summary for the property. Mike also puts the plan in front of many different lenders who come back with many different loan offers. From there the CBRE brokerage team acts as a consultant and helps determine which is the best loan offer. The consultative approach provides a lot more options. The actual investment summary that Mike and his team put together to present to potential lenders is also a tool that Trey uses to present to potential partners because the plan is so comprehensive. 

 

Mike further elaborates that when you work with his team they put your opportunity in front of a large number of lenders and that the value is in those actual contacts. A lot of those lenders are people or organizations that you wouldn’t normally have access to. 

 

Mike explains that the investment summary is valuable because it’s something that the CBRE team can put together easily with their resources. In this summary, they can provide data about comps to potential lenders. A “comp” is a comparable property. For example if you’re buying a property in a submarket, Mike’s team will pull information about different properties that have sold in that same area that are comparable in a favorable light. If you’re overpaying for a property, the comps will tell you that. This is important information for a lender. It’s also important to the investor who may take that information back to the seller and use it to negotiate the sale price. As an investor, working with a mortgage broker can take away some of the fear because the mortgage broker bridges a gap with valuable information. Mike agrees that he can be a professional resource to make sure investors are getting the best deal in the market. They have the resources to keep up with the market and provide up-to-date information.

 

 

The Time to Invest

 

Mike is seeing many investors move into the multi-family market as a way to diversify and add income. That market remains active. Mike’s personal forecast is that we will see a lot of activity beginning in 2021 as people adjust to the new normal and investors realize it’s a good place to avoid some of the uncertainty of alternative investments or the stock market. 

 

When Trey asked if it is a good time to buy in this current market overall or if we’re not there yet, Mike responds that it’s deal specific. Mike sees some deals where sellers’ expectations are still unrealistic based on what’s going on in the market but he is starting to see their expectations come back in line with where they need to transact. That’s why he believes it will pick up in 2021- we’re getting closer every day. If there’s a deal that makes sense now, it’s a good time to do it because debt is extremely cheap. You can engineer some really good returns just with the debt alone. Mike says it’s a good time to invest and will continue to be.

 

Trey suspects that we should see attractive rates over the next 12-36 months and Mike agrees that we shouldn’t see any rate increases any time soon. Trey explains that the low interest rates allow you to pay a higher price for a property because your mortgage payment will be much lower. You can produce way more income this way even if you would have bought a property at a lower price with higher mortgage interest rates. If you can get a deal with a low price and a low interest rate, it’s a whole lot easier to make money.

 

 











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