What to do if your property is in trouble? If your interest rates are doubling? What will save your deals? This is a step by step guide on what to do if your property is in trouble, from managing your bank all the way to getting multiple bids from all of your vendors. Ken McElroy, CEO and founder of MC Companies, shares this golden guide with us.
For some of these deals that LP investors are in, where GP's are operating, there is a challenge, especially in multifamily bridge, or anything value add, or even construction loans to work through a modification or to go to a lender. Some lenders will say, you're going to make this payment, and until you're short on the payment, here's 80% of the amount, and you say, here's what we've got to pay, then they may workout something with you, have you walked through that process before?
Here's the truth: the lender does not want the property back. They're supposed to create the resistance back to the sponsor, but at the end of the day, the foreclosure process, the default process, etc, it's legal, but they are going to have to take that, then package it up with some broker somewhere and take a write-down from somebody like us, that is going to buy that at a deep discount. It's a poker game. Unfortunately, they have a straight flush, and you have an offsuit, but it's a dance, it's part of the dance, and what's going to save people right now is cash. The way to do it is to go find that cash if there's value in the real estate. What happens is, there's an ego, an emotional attachment involved, there's LP money, or maybe your money, there's all of that to consider but if people can hold these deals, for the long term, they're going to be fine.
A couple of examples: in 2005-2006, I bought some things in Austin, Texas. In 2007- 2008, I looked like an idiot, my loan was more than the property was worth, and what saved me was occupancy and cash flow. People buy things for cash flow, or they buy things for capital gain, but you should be buying them for both. A lot of people were saying, oh, there's little or no cash flow or negative cash flow on day one, they're waiting on this big value add, and there's no cash flow, so they run out of cash. The strategy started at the buy. Everything we do cash flows at day one, so in that scenario, all I had to do was focus on management. How do I keep this place full? How do I manage my expenses? I had fixed rate debt at the time which not a lot of people have right now, and I just rode it through and then lo and behold, by probably 09, 10, 11, I was right back to where it was, and then it punched through.
You have to think long-term. If you get enough cash today, and you have a really good asset and you have equity, then you should be preserving the equity, your investors, and the LP's and trying to figure out how to do that first, and then work through it. You need cash first, you need to show the lender that you have a plan (again, the lenders don't want these assets back because having them back is a pain in their butt), and then do the loan modification, and long-term hold. It's different from what the business plan said, but if you're trying to preserve the investor LP money, and the asset is worth it, then it's worth it. Time will heal this. The next 18 to 24 months is going to be rough. But if you go 30,000 feet, there's a massive shortage of housing. There's a lot of new construction, that's all going to be gone by, let's say 2025 and we're going to have a massive rent growth again in 2026, 2027, 2028 because nobody's building, and there's a lag in and of all that new supply as well. If you just get through the next couple of years, that's going to require money, you're going to do all kinds of creative things and this is when you learn. Going through this, as painful as it is, that's where all the lessons are. There are no lessons at all when you're an influencer raising money, things are going up, and you're trading it out and you're buying new crap. They're actually all bad lessons. This is the time where you can absolutely preserve the asset, the LP equity, and preserve your relationship with your lenders, you can do it. If you bought the asset right, and if the asset is worth the loan, otherwise, it's a different path.
What are some of the things we should be doing if our properties are in trouble?
The first I always look at is what's within your control. One of the things I've started to do is really dial in on my operations. Now, I have a massive advantage because I started in property management right out of college. For the first 10 years of my life, I managed 20-30,000 units. When I step on a project, I have a checklist in my mind that I've been through 100 times. The first thing I've done is scrubbing each one of my assets. I want to make sure that my expenses are completely in order, everything's been bid out multiple times, and that my market rents are exactly where they should be. I make sure that I have the right teams in place, that I'm maximizing my revenue, my other income, and my expenses. That requires a fairs amount of work. That's super important because no matter what, that is going to determine your next loan, your next investor, they're going to look at the operations.
I looked at a building yesterday, a brand new construction, under in lease-up, it stagnated at 60% and I thought, okay, that's awesome, that's an opportunity because they're going to take a haircut, they're trying to get through lease up so there's a strategy around that. And because I'm strong in operations, I know that I can bring my own team in there, top it up and make the deal work. When you have that kind of confidence from the operations, it gives you a lot of power, those are controllables, those are things that you can do now.
The second thing is you have to dig into your partnership agreement with your LP equity and your prefs, and all of that, and you need to take a look at your stress points. And then you can start to bring in other sources to top it up, whether that's asset management, it could be family office, institutional, or a number of things, you can give up GP equity, you can bring more LP equity, you can come up with a loan, all of that should be fully transparent to your existing deal. You can't just change things and tell them later. You have to paper up and make sure it's all correct. That's the area that people are going to be in trouble on, thinking that this will be short term, I only need this for six months, three months, one year, whatever. If they're right, they're probably going to be okay but if they're not, people are going to wonder how they got squeezed out.
You need to go out and get other opinions from brokers, opinions of values, people are doing that all over the place. Brokers aren't listing deals right now, they're actually giving everybody BOV's. That's really important because that substantiates what the thing is worth. Then, you have to look at your debt, and see how much equity you have, and if you have equity, even if it's half, or 2/3 or 1/3, of what it was, that's still okay, you're in the money. Now, it doesn't really matter today because you're not selling, If you're selling today, that's exactly what would happen. You're playing the long game here so you need to have all that information and then you can go out and make good decisions on the asset, preserving the equity. I've been in a situation where we bought things and equities went down, probably everyone has, a car, a house, things depreciate, things go down in value, but over the long haul, especially with this inflation, you're on the right side of it, even though you might be feeling a little bit of pain. I want to be in hard assets during high inflationary times, because we all know, you can't build a home or apartments affordably right now, so if you own them, you're actually in that category. That's good, even though it might not feel good, if you can hold on to it, I truly believe that real estate is going to really skyrocket based on all these crazy things that are going on globally.
Ken McElroy
www.kenmcelroy.com
www.mccompanies.com
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