Apr 28, 2022
Are increasing rates putting
pressure on your business? CRE investor, entrepreneur, and innovator
Rob Finlay joins the podcast to talk about inflation and share
strategies on how to navigate the variables that come along with
it. He also discusses his company, Thirty Capital, and the work
they do to guide loan borrowers through the complexities of the
transaction.
[00:01 - 04:38] Forecasting Inflation
- His take on inflation and what he sees coming in the future
- This is what they’re doing to be inflation-proof
- Inflation and real estate
- Should you raise rental rates?
- Considering the constraints in the market
[04:39 - 10:22] Actionable Steps to Protect Your Portfolio
- Finding opportunities in different asset classes
- How to use leverage to your advantage
- Looking at the future of your finances
- How to optimize your debt
[10:23 - 16:51] Defease With Ease
- Comparing SOFR and LIBOR
- Rob explains defeasance
- Here’s what Rob and his team are doing to help borrowers
[16:52 - 17:57] Closing Segment
- Reach out to Rob!
- Links Below
- Final Words
Tweetable Quotes
“So that's going to really separate the real operators… being able to see that incremental return above what everybody else is doing is really going to be down to the operator.” - Rob Finlay
“Appropriate leverage is that you have enough leverage on the property to meet your financial objectives. But you don't have too much so that when there's sensitivity in this market, you're not going to get crushed.” - Rob Finlay
-----------------------------------------------------------------------------
Connect with Rob! Visit Thirty Capital’s website if you want to learn more about the solutions they offer.
Connect with me:
I love helping others place money outside of traditional investments that both diversify a strategy and provide solid predictable returns.
Like, subscribe, and leave us a review on Apple Podcasts, Spotify, Google Podcasts, or whatever platform you listen on. Thank you for tuning in!
Email me → sam@brickeninvestmentgroup.com
Want to read the full show notes of the episode? Check it out below:
Rob Finlay 00:00
I've always been a big proponent of leverage, leverage, leverage. Being appropriately levered. And that's a good word and a bad word, right? So appropriate leverage is that you have enough leverage on the property to meet your financial objectives. But you don't have too much so that when there's sensitivity in this market, you're not going to get crushed.
Intro 00:19
Welcome to the How to Scale Commercial Real Estate Show. Whether you are an active or passive investor, we'll teach you how to scale your real estate investing business into something big.
Sam Wilson 00:30
Rob Finlay is a CRE investor and entrepreneur based in Charlotte, North Carolina. He spent the last 20 years bridging the gap between innovation and technology. And he's built a portfolio of CRE assets, a financial advisory and services firm, and 10 technology platforms. Rob, welcome to the show.
Rob Finlay 00:46
Thanks, Sam. Thanks for having me.
Sam Wilson 00:47
Hey, man, pleasure's mine. Three questions I ask every guest who comes on the show: In 90 seconds or less, can you tell me where did you start? Where are you now? And how did you get there?
Rob Finlay 00:54
Okay, well, I started I grew up in real estate. So that's how I started. So since I could walk, all I can remember is commercial real estate. Second question, where are we now? We're in Charlotte, North Carolina. We have a portfolio that spans across the United States in highly-structured products, as well as direct real estate ownership. And where we're going, we're big believers in innovation, technology, and staying ahead of the curve, looking around the corner.
Sam Wilson 01:18
Well, let's talk about looking around the corner. What are you guys doing right now to fortify your portfolio against inflation, the coming changes from the Fed give us the breakdown on what you guys are doing? And what do you see coming?
Rob Finlay 01:30
I think you don't need to be much of a fortune teller to see what's coming, right? We've held off for a long time with our policies. Now we're looking at Fed is raising rates. We're looking at basically a flat yield curve. So basically, you can borrow two year at the same rate as you can 20 years. So we're definitely seeing changes in the market. Inflation is going to be a really interesting thing and a really tricky thing. People who have purchased assets in the last probably 12 months forecasted big rental growth. You might be okay because if the market can support it. Otherwise, I think if you're buying properties, right now, you really have to look at two things. One is, can you... And with the volatility of rates right now, if you think about this, you're buying properties where 10-year treasury in the last 30 days has gone up 50 basis points. So you adjust 50 basis points on your cap rates. Look what happens to your view, in order to make that work. So I think you're going to be looking at affordability, and really trying to figure out if your rental increases that you've performed are going to meet that.
Sam Wilson 02:32
What would prevent... So my small mind I see with inflation, obviously, people's ability to spend has to increase in order to meet those rental rate increases. But if everything is increasing in price, I mean, it seems like at some point that rental growth just has to go up organically if there's more money in the market. Is that a poor summary?
Rob Finlay 02:52
I think inflation and real estate has always been considered a great inflationary hedge, right? It's like, yep, rental rates are gonna go up, everything's gonna go great. There's a point at which though. Here's two things, how much can it go up? So there's rental rates based on a value add strategy, right, and which comea in improving this property. It's a B minus, and I'm going to make it a B plus, I'm gonna get my value add that way. The other way is, you're right, just organic inflation, normal CPI. Problem is your normal CPI now is 10%, right, it's seven, half a percent think we're forecasting it. So I think that's where you're going to start to see, can these properties meet 10% per year increases, when real wages aren't increasing 10%. Then you start to add in the complexity of companies. I don't think we're going to be booming here. There's a lot of constraints in the market. So now, are employers going to be able to increase wages by 10% in order for people to be able to afford rent? So affordability, which is here in Charlotte is a huge factor and having kids who just graduated from college and are trying to find places to live is a huge factor when looking at real estate right now, especially in multifamily.
Sam Wilson 03:58
Yeah, especially in multifamily. And maybe this was a bad statistic. So you know, somebody could listen to this episode come out and say no, you're completely wrong. But somebody told me and I haven't looked this up, in the Charlotte market, so they looked it up and there's less than 1000 houses for sale on Zillow? Some crazy number. It's like in the entirety of the Charlotte MSA, less than 1000 houses for sale.
Rob Finlay 04:15
Yeah, I think I heard a statement actually even better than that. That there's, I think, there was a million and a half real estate agents or brokers, and there's only 600,000 homes for sale in the United States or something crazy like that. Absolutely. The supply of homes is very small. And being able to build that was also very difficult as well, right? Because you have all the commodity price increase, and there's a shortage of labor.
Sam Wilson 04:39
How do you take all of these variables, put them in the mix and come up with a reasonable move forward solution?
Rob Finlay 04:46
There's a couple of things one is real estate people tend to be pretty quick thinkers sometimes. And I think the things that I look at first and foremost is... I am agnostic to property type, right? I've invested in senior housing, assisted living, industrial office, you name it, we've invested in it. And so I think from a real estate investor standpoint, it's to maybe open up your horizons of opportunities, right, and look at things that multifamily people have done the same, they started looking at home parks and RVs and open up your horizon. The second thing is really look at the buy, right? It's now this is about the buy, how are the assumptions? I still think there are opportunities. There's pockets of opportunities. There's locations of opportunities, but you've got to look far and wide to find those opportunities, and they might not be in Charlotte, North Carolina, they might be in somewhere in the middle of Stanton, Virginia, right? There could be in different areas. That's where you need to be looking.
Sam Wilson 05:43
Got it. That's interesting. What do you, guys, I guess, when you say, look in those different areas? Yes. Okay. You can look in different areas. But are there specific steps or actionable things that you guys are doing to prepare your portfolio for maybe, you know, decreased rent growth? Or maybe inflation above rent growth? Or what are some things you guys are doing strategically?
Rob Finlay 06:03
Yeah, well, I think because of our background in capital markets, and debt advisory, primarily through our defeasance and derivatives business, we focus on appropriate leverage. I've always been a big proponent of leverage, leverage, leverage. Being appropriately levered. And that's a good word and a bad word, right? So appropriate leverage is that you have enough leverage on the property to meet your financial objectives. But you don't have too much so that when there's sensitivity in this market, you're not going to get crushed. We think look at same thing, you still have interest rates that are fairly low, the capital markets, your Freddie's and, and some of your CMBS lenders have widened out a little bit. But there's still as a great time to lock in long-term rates, especially if short-term rates have just gone up. So appropriate leverage means getting the right amount of leverage that will support your property for this near and foreseeable future and be able to get some a decent return out of that. So we've reallocated our portfolio from leverage. That was number one thing, that's easy to do.
Sam Wilson 07:03
Easy to do. Could you define that?
Rob Finlay 07:05
Sure. I mean, you look at your portfolio, look, it stress it, and analyze. That's a nice thing. Real estate, for the most part, and especially with debt optimization, it's all about numbers, it's got to pay off an existing lump, it's going to cost me something to pay off that existing lump, I'm going to get a new loan, and the benefit of having that new loan is going to be something and it's going to be for a period of time. And so calculating that is really just simple math. Now, it gets a little bit more complex when you start looking at forward curves, and what interest rates are going to be like in the future, and so on and so forth. But for the most part, that's what we look at. So we try to tag and look at our future growth of our cash flows from our properties, and sort of tie that back to debt. Do we have enough debt that's going to last us for the next five to seven years, and will provide sufficient leverage on our property, depending on whether or not the market goes great, or more importantly, to prevent its downside protection, right? If the market goes crazy, again, hey, I can refinance, get out and go. If I'm stuck with zero or negative rental rate growth, where we might have in some markets, I need to make sure that I can cover my debt.
Sam Wilson 08:13
Right. And so what does sufficient debt mean? Is there a certain fixed number you guys are looking for? Are you deleveraging? Are you leveraging higher? What does that look like?
Rob Finlay 08:22
That's a great question, but almost impossible to answer. It's all case by case, right? So if I have a property that I've owned for a long period of time, I've got low leverage on it. And I think I'm in a fairly stable market, I might increase my leverage. If I'm in a market where, hey, you know what, we've had a pretty good run, let's make sure that we're at the right amount to show some of that downward pressure. It's all about downward pressure. That's where, I think right now, it's probably you're at the last inning, to be able to get some appropriate leverage on your property for this probably 12 months or so. That's really where we focused on, making sure are we appropriately levered to come into in weather, maybe some flat rental growth, some tougher markets.
Sam Wilson 09:05
Yep. Absolutely. And I've heard, you know, it said that real estate investors inflation hedge is borrowing money at long term fixed interest rates. I mean, if you're borrowing money at three and a half percent, it's going up, you know, inflation is 10% a year. I mean, you're basically getting paid to borrow money. I mean, is that kind of part of the equation as well?
Rob Finlay 09:22
I think so. As long as, once again, it comes down to as long as you're realizing that 10% increase, right? That number only makes sense as long as your rental rates are increasing to that level. Otherwise, you're going to be on the negative side, because your expenses might be going up to 10%. Are your rental rate? And I think that's really the key. And I think that's where real estate operators, that's going to separate the real operators from the partial operators, and that's going to be in this market. What can I do to really add value and increase rental income to my properties? Because in the past few years, it wasn't that hard. Let's be real. And I, myself included, I own property. He's buying them. Yeah, put them in. And yeah, I've done some stuff, but nothing to achieve the kind of results that we've had today, right? Now, you're going to be in a situation where it's not as easy to get that income. So that's going to really separate the real operators, being able to really determine alpha and really being able to see that incremental return above what everybody else is doing is really going to be down to the operator.
Sam Wilson 10:23
Yep. And certainly, we've benefited from the tailwinds as well. I've looked around and said that to many of my investors, it's like, you know, we're not geniuses here. It's just a sign of the times, and we're along. We're riding the wave, and it's great. But you know, that's just a sign of where we are right now. Will it always be this way? Probably not. So, talk to us a little bit about your capital markets company. And then, you know, I'd love to hear about your defeasance company.
Rob Finlay 10:47
Well, so the capital markets is the defeasance company. So I started the company back in 2000. So CMBS loans, loans that had been securitized and sold off, don't allow for prepayment, typically, they need to stay in order to be able to sell the bonds. And so we created this process called defeasance. And defeasance, has been around since 2000. And that business is also corresponding with our derivatives business. So we do a lot of hedges swaps, things like that, which is actually very exciting. Now, since LIBOR has gone away and LIBOR has always been the standard index for which floating rate loans have been priced. Now, LIBOR has gone away and you now have this SOFR, and SOFR in itself has a lot of complexity. So if you're a borrower, and you're going to go get a floating rate loan, your index that's base rate could be priced off of something that is not easily understood, as LIBOR was. There's a lot of complexity in that market, it used to be you, hey, my LIBOR is this, my spread is this and that's what it's going equal. Nowadays, if you're a borrower who borrowed under LIBOR, a year ago, basically, you're going to fall back to a different language, you're going to be converted into a different index. So you had LIBOR, you're now going to have SOFR or something else. So there's gonna be a lot of complexity and a lot of interesting things that are going on in the market coming up next year when these loans have to be converted into SOFR. So any borrower that's one thing for your listeners, any borrower out there that has a floating rate loan, you should probably look at your documents, and figure out that that rate, that index that you have, will change.
Sam Wilson 12:24
Do you think will go up, like this will cost the borrowers more money?
Rob Finlay 12:28
Oh, it could very well, it could be substantial. Because what's happening right now is when they did this fallback, and when they said LIBOR is going away. A lot of people got together and said, Okay, well, what rate do we take and put in its place? Right, LIBOR, London Interbank Offered Rate, and that's gone. So now, we have this SOFR, which is basically a secured overnight funding rate. And, and this rate, though, they try to make it fair. So there's actually a term SOFR rate, there's a fallback SOFR rate, and length, and sometimes your loan documents might be silent, to what actual rate or index that you will fall back to. So any existing loan that has LIBOR, the government has said LIBOR is going away. So LIBOR will go away. And then depending on your documents, that written several years ago, have no concept of SOFR or anything else. There's BSBY other rates out there. So there is some complexity, and then very well could increase the borrowing costs for a borrower.
Sam Wilson 13:25
How does the borrower protect against that from a loan written a year, two, or three years ago?
Rob Finlay 13:30
They look at it, they look at their language, and they get with somebody who knows what they're talking about to represent him. I mean, I think that's, it was funny. 22 years ago, we came out with the slogan... And defeasance for anybody who's been through defeasance realize there's a lot of moving parts to it, right? It's a fairly complex situation where you're buying bonds to match the future cash flows and the stream of what the debt would provide. We name this company Defease With Ease was sort of our slogan, a motto, you know, as commercial defeasance. But the slogan was Defease With Ease. We did the same thing and said, Look, we're going to create SOFR with ease, because there's going to be so much complexity, again, with what's going on in the market, where we want to be that advisor to borrowers to help them through the complexities of a transaction. And that's what our Thirty Capital Financial, which is our capital markets arm, we provide borrowers information on whether or not to defease their loan. And if they're going to defease their loan, we help them go through the process, or, Hey, do you need to look at getting a hedge or a cap or swap? Or something like that, and we help them through our hedging advisory, and our SOFR with these products.
Sam Wilson 14:38
Can you define what it is you mean when you say to defease your loan?
Rob Finlay 14:42
So a securitized loan is pre-paying your lump, right? So if you have a Freddie Mac loan, you have a CMBS loan, those loans get packaged up and sold off as bonds, right? bondholders don't like redemption of principal, and so they don't want the redemption of their interest. Defeasance was created to prevent borrowers from pre-paying their loans, right, so in order to get out of one of those loans, or Freddie Mac or a fair or CMBS loan, you have to go to the lender with a basket of securities that will match the future obligations, your basically your monthly principal and interest payments all the way through the maturity. And that's what a defeasance is. A defeasance is basically matching cash flows. But it's a transaction requires somebody actually, whereas yield maintenance is a calculation, right? Somebody calculates what are the others language in your loan documents, and you calculate it, and there you go. Whereas a defeasance, you're actually doing the actual transaction, we actually have to go identify each individual bond, we have to go by each individual bond, we have to go get accounts, reports and create new successor borrowers and things like that. So the transaction itself has is a transaction in itself.
Sam Wilson 15:53
Yeah, so it sounds like it's incredibly complex. And, you know, obviously, these are expensive things to undergo, but other than going through that process, and usually, this happens, either when someone's going to refinance out of that loan or when they sell a property, right?
Rob Finlay 16:06
Correct. Because the only two times you do a defeasance is when you refinance, or you sell. But once again, that comes to the benefit of why you have to evaluate it. You know, people look at prepayment penalties, typically in a negative light, right? Because you have to pay, you have to pay something, but that's the resultant of being able to have lower rates going forward, or more money. So it becomes once again, it becomes this transaction. When we talked earlier about re-optimizing portfolios. That's the kind of analysis that we did. And it's the kind of analysis we do as a company for our clients, which is, hey, I've got this loan, I've got 3, 4,5 years left, I have a 3.75% coupon. I've got this much equity in my property, here are the loans that I can get right now. What do I do? That becomes math.
Sam Wilson 16:52
Right, Absolutely. Love it. Rob. Thanks for taking the time to come on today. And share with us exactly what you guys are doing what you guys see here in the markets moving forward, how you guys are protecting yourselves as well as breaking down some of the more intricate nuances of defeasance, your Defease With Ease company. Lots of fun things you guys are doing. If our listeners want to get in touch with you or learn more about you or your companies, what is the best way to do that?
Rob Finlay 17:14
Yeah, just take a look at thirtycapital.com and you'll see all of our businesses in our portfolio and you can reach me there.
Sam Wilson 17:20
Fantastic. We will put this in the show notes. But does that T-H-I-R-T-Y or is that 3-0?
Rob Finlay 17:25
That's correct. Yes. Thirty spelled out.
Sam Wilson 17:28
30 capital.com. Rob, thanks so much for your time today. I do appreciate it.
Rob Finlay 17:31
Great. Thanks so much. I appreciate it.
Sam Wilson 17:32
Hey, thanks for listening to the How to Scale Commercial Real Estate Podcast. If you can do me a favor and subscribe and leave us a review on Apple Podcasts, Spotify, Google Podcasts, whatever platform it is you use to listen, if you can do that for us, that would be a fantastic help to the show. It helps us both attract new listeners as well as rank higher on those directories so appreciate you listening. Thanks so much and hope to catch you on the next episode.