Mike Zlotnik 0:00
I grew up being a mathematician. So we’ve looked at risk too. And I’ve learned there’s two elements to risk. Number one, it’s likelihood. Number two is impact. So what what, what I do is I look at risks and try to figure that figure that out. So likelihood and impact are the two key variables that drive all the decisions. And I would say the number one risk on a grand scale of things, and for the entire real estate market, and I think about it, it’s not necessarily my biggest fear because I feel that the the impact is huge and likelihood is low, very low. But the interest rates going up a lot.
Announcer 0:43
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J Darrin Gross 1:02
Welcome to commercial real estate pro networks CRE PN Radio. Thanks for joining us. My name is J. Darrin Gross. This is the podcast focused on commercial real estate investment and risk management strategies. Weekly, we have conversations with commercial real estate investors and professionals who provide their experience and insight to help you grow your real estate portfolio.
Today, my guest is Mike Zlotnik. Mike is known in real estate circles is Big Mike, due to his stature. But more importantly, He is known for his personal integrity, and for having a keen understanding of the financial aspects of successful real estate investing. Mike is the CEO of TF Management Group, LLC, and is a real estate fund manager. And in just a minute, we’re going to speak with Mike about the best commercial real estate investing opportunities coming out of COVID-19.
But first, a quick reminder, if you like our show, care, pn radio, there are a couple things you can do. You can like, share and subscribe. And as always, we encourage you to leave a comment, we’d love to hear from our listeners. Also, if you want to see how handsome our guests are, be sure to check out our YouTube channel. And you can find us on youtube at commercial real estate pro network. And while you’re there, please subscribe. With that I want to welcome my guest, Mike, welcome to CRE PN Radio.
Mike Zlotnik 2:35
And thank you very much appreciate the opportunity to join your podcast radio show. And delighted It’s a small world we chatted about this a little bit. You’re in Portland, where New York and close with some friends with folks that live in your neck of the woods. So yeah,
J Darrin Gross 2:54
and I you know, my neighbors. That’s awesome.
Mike Zlotnik 2:57
It’s kind of a small world. That’s so thank you for having me.
J Darrin Gross 3:00
Now. Glad to have you. Here. Before we get going, Mike, if you could take just a second and share with the listeners a little bit about your background.
Mike Zlotnik 3:09
Sure. So I grew up in the former Soviet Union. And but people asked me, where are you from? I call I say From Russia with love, like James Bond. Originally, actually from Moldova, not Russia, but I my native tongue is Russian immigrated from the former Soviet Union to the United States in 1989. As a political refugee, so I’m a US citizen at the end, the US patriot. And so that’s kind of the origins. I live in Brooklyn, New York, married to my lovely wife for 21 years, I have four kids, and a cat, the fifth child, those of you who have a path can appreciate what I’m talking about. And previously, I had a career almost 15 years as a software executive mathematician by education and spent years in that industry. But in 2000 I discovered real estate, made my first purchase and continued acquiring assets from there and discovered that’s the best asset class and never looked back 2009 I quit my last it job I went real estate full time starting managing my own investments as well as investor capital. And been it’s been a journey since then. And today we invest broad range of commercial and residential assets from performing to distress that from multifamily Self Storage conversion of hotels to affordable multifamily housing, industrial even cannabis farms, how about that? part farms we have debt on land. Well, not conversion, but permitting for cultivation. So it’s a strategy and pretty flexible, dynamic looking for greatest copywriters and greatest opportunities. And that’s what’s what we do.
J Darrin Gross 5:08
Awesome. Well, I I’m impressed with the kind of the width of your, your different asset classes, I think so many times I find people that are kind of, you know, they’re married to one, and we’ll write it up and write it down as opposed to recognize the opportunities that are in other asset classes. Can you speak a little bit of that how you how you are comfortable with with all the different asset classes?
Sure. So using the Wall Street term, we are allocators, the way to think about what we do is where allocators of capital into the best opportunities different during different market cycles. And so I think of myself as a diversification manager, and the capital allocator. That’s primary strategy kind of what we do, as far as building expertise in various verticals such as self storage, multifamily, industrial, as we make investments, we’ve been learning over the years, what works, what doesn’t, obviously, commercial underwriting has a lot of stuff in common. Obviously, cap rates, interest rates, sensitivity to over noi to, to the top line to the bottom line expenses, all this stuff is sort of similar in nature. But knowing a specific industry is important. And we’ve focused on picking the right sponsors. So the The game has been having a vertically integrated sponsor, so someone who does distress that in New York City, and that’s all they do. So we’ll allocate capital to that to the extent of the diversification strategy, as well as, as the deal flow gets better or worse with the market cycles. Similarly, as I mentioned, the cannabis farms, the only reason we invest with that in our industry, because we know a very competent operator, who figured it out, build the connections in Lake County, California, and they’re able to get their permits done faster than the rest of players. So that’s the way to think about this. pick the right operators, specialists, if the if there were few people that you can know, like and trust, you can execute the strategy with them. And then we have this to learn as we go, we adjust to observe. So that’s been kind of the approach. The way to think about this, everyone loves Warren Buffett, well, I don’t know if loves them, but he knows who he is. So Warren, if you read what, what, what he does, he’s only only about three things really, obviously, companies he wants to buy or what investments he wants to make, right? The dollars, he wants to put in those investments, and then the people to run them. We use the same basic methodology in the reverse order. We start with people, then we decide what dollars we can write into strategy within our diversification. And then obviously, the project so it’s projects, and then and then dollars. So as we know, we have a $2 million bucket in distressed debt. And we look for projects. And if the water projects come along, can we get it to the right economics? At the right, waterfall? There are plenty of great operators with soso deals, it has to be a great operator. great deal. And then the right, obviously, dollar amount. So I don’t think that helps, but at least that’s how I think about the whole exercise.
No, I think it definitely, you know, it clarifies it, as opposed to you know, those that are focused strictly on an asset class, you You said you start with the operator. I mean, knowing knowing that the operator but also understanding the the opportunity. And then getting into the if I understood right, getting into the the details on the project. So you have to have a good operator and a good a good project for for something, you know, for, you know, something that you would be interested in investing in if that’s kind of what I understood, right?
Yeah, exactly. So if we start with the relationship I’ll give you, I’ll give you an example. We’re working on the new opportunity, kind of while new, I mean, it’s been around that the concept is all but I go to number of masterminds, one of the masterminds I go to call the collective genius. It’s kind of very interesting, very cute name, but it’s movers and shakers in real estate. Some guys are residential. Some guys are commercial. Make long story short, I met a couple of new guys there. And their whole strategy is they buy land for cash, and then they sell it with seller financing to people who pay them on a credit card. So they’ll buy a lot for three, four or $5,000, they’ll sell it for 18 to 20,000 bucks on a payment plan 250 bucks a month for 72 months. It’s a massive receivables business. But they’re real businesses is a technology, business and marketing. But it has real estate as the product. So when I looked at this stuff, what’s really interesting is this was new. And we’ve never done anything like this. First thing we did, and you and I both know very best. So I send those guys the very best to get very verified because I have great relationship with with with very Western lens. And once they got very best verified, I knew these guys are clean, and they’re good guys, then we underwrote them, we gave them a hard money loan effectively secured by that portfolio off of all these massive receivables. So yes, the different strategies knew, but I thought it was a great deal, because they could afford to pay us better than market rates while the market is over subjective, but it’s a niche product. So the way to think about this, it’s a niche loan. And we found and we working with them, we’re working with expansion, their strategy continues to grow, we’ll continue to invest more capital with them. But this is an example of kind of discovering a sort of new to our strategy, whether the good operator, so we started with due diligence on these guys, to we gave him a small loan and they’re performing. And as they continue to grow, we’re looking to do more business with them. So the strategy is fairly straightforward. Is this a commercial real estate, in my view, it is it’s almost it’s a, this is an example of real estate mixed with a business, right, you have self storage, you have senior living, you have sell my operating businesses real estate component, but it’s all separation. And it’s critical to pick the right people who know what they’re doing. Right, I mean, we can talk about senior living, you could buy a bunch of senior living facilities, if you have a terrible operator the business falls apart, same is true with self storage, this gets a critical operating business. So
So let me ask you, I mean, knowing that the operator is the key to all of this, what are some key, you know, indicators that you look for? When when assessing a an operator.
Mike Zlotnik 12:09
So we always start with obviously, the basic background checking, I mentioned will relying now on very restaurant is for us, right? So as long as there the history is clean, or they can explain what has happened in a succinct manner, at least it’s a start to look for is well organized. documentation. They can’t can’t understate this. If they give you great documents, underlying spreadsheets, with KPIs and they know their business, you know it immediately. So in that business, one of the critical KPIs new lots acquired versus new lights sold on this financing, that tracking that they don’t have getting stuck with inventory. So getting well organized. The KPIs and data is very valuable. You get a sense whether they know their business, and how well, right. And obviously understanding how they make money, pretty obvious. Running the math. So what I do want to see is a business model that has pretty strong foundation. So risk levels. So the other thing is we’re looking at I mean, you we talk pre qual you’re, you’re the master of the risk assessment, the risk is probably one of the most fundamental things, what can go wrong with the strategy. So I looked at this, and lamp is not going to have a problem or it’s not going to depreciate, you’re not going to have buildings, it’s going to crumble, the strategy doesn’t have a lot of downside, other than these guys turning bad, and somehow disappearing with a bunch of cash, which is a risk, right? But if you can eliminate that risk, through the background check and understanding who they are and having some controls. But then have a day if the operator is high integrity, and that risk goes away. And the asset class itself works. And they don’t run into a problem with too much inventory. The business feels very solid from the investment perspective. So I would say fine, fund the fundamentals of the business, that’s the way to think about it.
J Darrin Gross 14:11
Is there any kind of a timeline of experience the look for him? I mean, all these things that you’ve mentioned, suggests that they’ve been in, you know that they’re a proven entity, is there any kind of a minimum years of experience that you would look for?
Mike Zlotnik 14:25
So that’s, that question is a part of this week. I’m not looking for somebody who’s 20 years of experience in this if they have 20 years of experience in this, they shouldn’t need my money. Right? But they just shouldn’t they should have built a great business and were bankable financeable. So these guys have a couple of years of experience to me. They have two strong years and these guys are young. So I see the path if they’re on the right trajectory. We’re catching them before they’ve gotten too big, too strong and they’re fully bankable with traditional money with a with a bank with a bank capital. So Couple of years, I would say, have general experiences sufficient. Obviously, they’ve not seen market market cycles. So what is important is more monitoring. But they’ve agreed to this. And they’re providing more reports. And they’re demonstrating what, what’s happening as long as that’s in pretty good shape. I don’t necessarily need 20 years of past experience and a resume that that has, you know, worth called in the paper. But can they still operate as he is, you know, you could have been great 10 years ago, and now things are falling apart. So let’s just call him like, you look at trailing 12. When you’re acquiring anything, that’s the key. What is the trailing? 12? The trailing 12 looks good. That’s an indication.
J Darrin Gross 15:46
Gotcha. Well, I appreciate you kind of diving into that a little bit. I think that, you know, the operator is clearly kind of the integral piece or I mean, the the kind of the tell of whether or not at least what I’ve seen, and an insurance if the, if the operator has their act together, things usually run pretty smoothly. If they’re always trying to shade things in a particular way, or make things fit in a particular way and ignoring, you know, the facts, it makes for a difficult go. And, I mean, I’m sure that’s, that kind of plays out in your business as well. Let me ask you so so, you know, in your experience with the different types of investments that you are placing in the capital that you’re placing. Right now, we’re in the middle of the covid 19 pandemic, if you were to compare your experience and what you guys were doing, pre COVID, as opposed to what you’re looking at, going forward? Can you kind of make a comparison for us based on you know, asset classes and strategies and where the opportunities are?
Mike Zlotnik 17:05
are so? Yeah, it’s a great question. I would say that the time horizon is changed when everything is running well, and we were a little bit more aggressive. In as COVID hit, it’s a wake up call. And what does it mean? It means we’re looking for strategies where we can get to the value of phase over a shorter amount of time and getting to civilization faster. Now, it’s not the only strategy will obviously invest in deals that have great fundamentals, but they take longer to execute. But in general, I would like to see faster path to cash flow, because one of the variables or uncertainties of COVID is the cash flow. If tenants are not paying, what’s the what’s a big risk? And the other adjustment is what is the risk to the cash flow related to COVID. dynamics, so specifically cannot evict cannot foreclose? Right. So we’re making loans we’re trying to be extra careful now. We’re going to have difficult time with foreclosure if is a default, obviously, picking the right operators. We can’t understate that that is the most fundamental thing. If you pick good people, you don’t have to worry about the foreclosure risk and so on. It starts with high integrity. Obviously, if you pick shysters doesn’t matter what I mean, they’re gonna figure out a way to cause grief. So I would say COVID risks obviously come into play. How is this asset specifically impacted? So multifamily investing today? Has that risk? For sure. But what asset class? They you know, is it the Class A Class B, Class C? section, section eight, one investment were made in the middle of COVID. We’re very comfortable with it. We invested with another member of the collective genius mastermind, who is I call him the biggest shark in Mobile, Alabama. So forgive me, I’m out of New York. I don’t know. I didn’t know where my bill Obama was on the map. So my ignorance, but obviously, I know now, and he was, was buying a portfolio of 93 single family residential properties. Right. So I looked at it as a commercial project. It’s basically a package and they all within 15 minutes drive from his office, and he owns hundreds and hundreds more. So you can manage the portfolio. And 90% of the portfolio was section eight, right? And so the the safety of the income stream was related to the the government payments, that’s why we invested in it’s cash flowing like a monster today. Because he bought a less than 50,000 a door and they’re, they’re renting 150 and 100 bucks a month. So from that perspective, you can get pretty good yield in a portfolio instead of multifamily go find multifamily. Yes, it’s harder, but this exercise was a precision of doing it with the right app. Raider, and in the market that case cash flowing substantially. And then obviously doing the due diligence on the project and the deal. So here’s an example of a justice strategy in the middle of COVID. The other strategy, we did make another investment in a substantial value of multifamily in Indianapolis, almost 1000 doors with a very, very competent sponsor. And we were nervous about where things gonna go. But the sponsor experience and the track record and ability to execute strategy in the rents below the market kind of helped us to clear that bridge. So if you have a very competent operator, they have a good track record of executing a similar strategy and you picking the right asset in the right location, then you can you can go with that. And the deal obviously had great economics and the right type of a waterfall and right depreciation benefits. So was it that unique thing about that deal? On top of all this, it was a value a strategy that had cash flow from day one. So if he asked me what has changed in the past, I wouldn’t care about the cash flow. Now I do, I would like to have the safety margin of some cash flow from day one as a buffer against problems. So that’s a COVID. Investing. So
J Darrin Gross 21:24
now that that makes a lot of sense. You know, and I’m just kind of curious, you know, you’ve emphasize the the quality of the the operator their experience. Is there. It sounds like you maybe answered the question with just saying the cash flow is more important now than it was historically. I know, like, I’ve heard multiple times from from investors, how the lenders are acquiring additional capital and reserves kind of thing. Is that, is that factoring in anything that you’re doing? Or when you’re underwriting deals? Are you? Are you looking for more cash, in reserve to weather any kind of storm that might still be on the horizon? or lack of income? or?
Mike Zlotnik 22:13
Yeah, for sure. So I’ve developed educational methodology called the four quadrants, a lot of people have four questions, or Robert Kiyosaki has four quadrants, I have my own four quadrants. So what I like to focus on what I call in quadrant one, and two of these are sort of investment grade quadrants, and I’m not selling this methodology. It’s simply the way to think about this is buffer reserves, though, if you if it’s an equity investment, is there substantial debt service coverage ratio, and then obviously, reserves. So the quadrant one deals are the deals that have a cash flow, have substantial reserves, healthy dscr. And a little over capitalized project, with, with extra cash always helps. Now, the bank’s requirements sometimes help, right? If the bank says, Hey, you need six months of interest reserves, and I’m keeping it well, that’s great that that, in fact, requires over capitalization because that cash has to be in the reserve account. So I don’t mind that at all. In fact, I like it. Lower leverage is one thing that I’ve looked at recently, most people want to get the higher leverage more than happy. So this trend, the aggressive operators will go to a bridge lender, and they’ll get at 85% leverage, while the conservative lender will say 70. But the effective benefit of a lower leverage is you can actually get a lower rate. So there’s two way savings. Looking at the max leverage, you know, it’s a two way sword. If things don’t go well, you can get wiped out faster. So I would say, yeah, looking for lower leverage, maybe a little bit lower target ROI, as long as the safety of the of the income is, you know, feels feels better just feels what I call the quadrant one and two deals, the speculation element is lower and it safety which can cash reserves, lower dscr simpler strategy to execute. is what I look at what I look at,
J Darrin Gross 24:18
have your time horizons changed at all as far as pre COVID. Now, I mean, I think you did hint at it. You’re looking for quicker cash, cash flow, are you even kind of said cash flow? I mean, day one is kind of what you’re looking at. Are you looking for deals to go full cycle faster? Or what is your is your expectation for a deal cycle? changed at all?
Mike Zlotnik 24:45
Yes, another great question. I would say that the path to civilization, you know, he can monster two years if you can execute that full strategy. Now if you’re innovating a lot of units, can you do it during that timeline. We haven’t talked yet. But I do like the hotel conversions to affordable multifamily. This whole strategy is pretty pretty healthy, generally extended stay hotels that are easy to convert that look like apartments, most of them can get to the stabilization point within 18 months. Now, can you enter into a similar asset class on an existing multifamily, it’s harder, because you have an asset class that’s distressed, now you can you can pick it up at a better price. And it’s an easier conversion path. So I would say that, because you gave a get through, you have an empty, empty future apartment complex. So you can execute the strategy versus you have a full apartment complex, we have to gradually do it. And I don’t mind the gradual strategy, which has better cash flow from day one. But sometimes you can go into more value add more speculative, as long as there’s a very competent operator, fairly straightforward conversion process, right. And obviously, sufficient reserves to be able to pay for the budget overruns, budget has to be conservative, too. If those elements are good, you can run into sort of value strategy faster, basically, you entering the strategy, without fear of something getting stuck, the the risks, what can go wrong. So even this project, the risks of things going wrong are lower than infest a path to a civilization. I like those projects more today. So that’s, that’s the kind of the way the view of the world what else can be done to reduce risks?
J Darrin Gross 26:38
I like that the conversion strategy, are you seeing a lot of that? And if so, are there any particular market characteristics where you see that playing out?
Mike Zlotnik 26:51
Yeah, it’s a it’s a non major MSA. Right, you could do it in New York, but I don’t know I would want to do it in New York is a massive oversupply of condos in Manhattan, why would I want to take a hotel in Manhattan and try to convert to more apartments not a good market, but if it’s a project somewhere in Midwest southeast, secondary MSA, smaller market and the key location of that property if it’s fits right into residential neighborhoods, and it’s a good location, but I do like a proximity to universities see if you have universities you could have potential for off campus student housing. So instead of paying paying on campus price, they could pay off campus have the privacy have a better living conditions and a pretty easy commute so that these are the kind of the characteristics it’s the location within the city in the town. And then obviously easy conversion you don’t have to do extended stay you could do a tour of a traditional one, but extended stays ideal kind of candidates.
J Darrin Gross 28:00
Right Well I know I’ve talked to other guys that have done that you know, he wasn’t exactly their first idea but it just it made sense. But I would think with the extended stay you’ve already got some sort of an assemblance of a kitchen in a lot of those were some of the smaller traditional motel kind of a thing you may you may not have you know a kitchen as much as you just have kind of a bathroom and some of the the you know the the capital expense required to add the kitchen I mean I guess if you buy if you buy it right and like you said if you get an if you starting with an empty property there’s not going to be any resistance to to moving through it versus a full property kind of thing but it I can see it both ways I guess
Mike Zlotnik 28:49
Exactly what you said. If an extended stay hotel has a kitchenette installed that’s a massive help right i mean saves quite a bit of money it may look a little bit you know if the hotel is not new it may look a little little age all its its antique it’s lovely to see
J Darrin Gross 29:03
the kids behind the walls I mean I guess you your guts bombing everything. Yeah, you can. You can hook up new fixtures and make it look all pretty but just the behind the walls kind of thing gets kind of expensive.
Mike Zlotnik 29:14
Yeah, that’s an ideal setup. The the secondary opportunity becomes like you mentioned hotel, it looks like a motel. These these are sort of studios. And what’s really interesting years ago when I was when I was in college, I lived off campus. This is many, many years ago, in a in a motel right next to the university, and essentially, they weren’t missing. They were missing kitchen kitchenette, but students still live there because it was better for privacy. So if you can install small kitchenette, and you can cook it works, it absolutely works. It comes down to the price folks who rent in these these type of assets are very price sensitive. The price makes a big difference. So the product has to be extremely common. petitive
J Darrin Gross 30:02
gotcha. You mentioned some of the asset classes you had touched on storage, or self storage. Are there other asset classes that you see are are potential opportunities coming out of COVID.
Mike Zlotnik 30:19
Office conversion to multifamily. Pretty obvious that some office buildings are dysfunctional as well, at least they’re not, you know, they’ve lost at least some number of tenants. And it’s a good conversion consideration if it’s got the right location. So I would say, that’s all local mean, if you find the right asset, if the conversion path is cost effective, I think there is an opportunity there also is a lot of retail space that needs another home, for sure. So the classic big box retail conversions to self storage, that strategy has been around for a number of years, it may still make sense in some markets. The cities don’t want it anymore. But it is a creative repositioning of, or retail into some housing, which is said it’s hard to play. It’s not designed for that, but it’s a possibility people can potentially find, you know, economically feasible projects. And then the rest is really our world is very opportunistic with people we know, it’s like it’s not a necessarily a massive opportunity in a given sector. It’s more that I like the the cannabis play, with the land conversion to land permitting for cultivation, if you’re in the right market, the whole country seems to recognize that and it’s no longer taboo, it’s very friendly topic. Like that strategy. I mentioned to you some of the newer things we’ve been doing with land kind of interesting play if you if you can buy the right at the right price. The reason I say that, because it’s it’s really marketing and technology business, getting to the sellers, and getting them to sell you the land is a skill. And if it’s the right operators, you may be able to make money in that field. That strategy has been around so people have done this for years, and it comes around in cycles again. And if you buy it right, almost hard to go wrong. infill, obviously. So getting back to the land there. This continues to be interesting strategies in cities, if you find the right type of location, and you can redevelop or develop ground up for affordable. I have a I have a friend who he’s a pastor. He’s a pastor in Los Angeles. And he his strategy is pretty interesting. He goes around the city and finds other churches that have land that they’re not using. And he basically offers them to develop the land into affordable multifamily housing. And he figures out the economics. And generally the churches, kind of like they do now is this post pandemic pre pandemic. He had the strategy before before COVID. But now it’s even more relevant again, housing seems to be the need for affordable housing is accelerating. So that’s kind of what what I see today.
J Darrin Gross 33:27
And that’s that’s, I know, here in Berlin, we’ve certainly got our share of housing issues. Let me ask is there a particular size of range? Or can you identify what what’s a range of opportunity for you as far as dollar size?
Mike Zlotnik 33:48
Sure. So we are relatively small, I mean, institutional players who write bigger checks. But today for us, the sweet spot that we write today is between half a million to a million dollar project. There’s no right or wrong, we can write a bigger check. We’ve done projects we’ve written bigger checks. that give you example, the project we we did that in Indianapolis that the big 90, almost 1000 doors, were over a $3 million check. And we sold off the rest through a sub syndication we had we spun out a separate deal. The deal was just so good. We couldn’t pass it. So we wrote it a bigger check. And it helped negotiate the terms, obviously. So we’re open to the idea to write a big check, from a diversification perspective would probably want to have less exposure than then I’m out. So today, as I mentioned, half a million to a million. We’re writing some bigger checks. But what’s the sweet spot today? No, we were pretty pretty happy to take a piece. We this hotel conversions, very few are leveraged. And you’re all in 6 million bucks, your four and a half million debt debt one and a half million dollar equity. We happiness. It’s almost perfect match for us. We’ll take a good chunk of it, if not all of it. So that’s kind of the way to think about small hotels, just kind of that whole space whether your equity raise anywhere between, you know, from, let’s say half a million to 5 million, this is where we are we happy to participate
J Darrin Gross 35:18
in Do you, do you like coming in on the equity side? Or do you like doing the lending or both? Are you? You agreeable?
Mike Zlotnik 35:28
Yeah. So, we actually we execute the strategy as we have a few funds. So the the tempo Growth Fund is a growth fund, it basically takes growth positions generally. So it’s equity. Typically, temp Opportunity Fund is more of an income and Growth Fund. So we like as much as we can to take that position. We’ll take that with an equity kicker if possible, or, you know, primary debt or mass debt. But we need that because the fund has more of an income focus for tempo Growth Fund, it doesn’t care. As long as the risk adjusted return is healthy. It’s fairly flexible either way. So there is no right or wrong. It really depends on the project. The again, the cannabis farms, the pot farms, that’s what I call them the the land conversion, the owner is not willing to give enough equity on the project. So he’s perfectly happy. We’ll record firstly mortgage and have hard money terms on that, then we have an equity kicker. It worked for the sponsor, it’s really negotiation, right? That depends on what you can work out to the right sponsor, and what are your kind of risk adjusted return dynamics
J Darrin Gross 36:31
Got it. Hey, Mike, if we could, I’d like to shift gears here for a second. By day, I’m an insurance broker, and work with my clients to assess risk and determine what to do with risk. And there’s three strategies we typically consider, we look to see if first we can avoid the risk. If we’re not able to avoid it, then we look to see if there’s a way to minimize the risk. And if we can’t avoid nor minimize the risk, then we look to transfer the risk. And that’s what an insurance policy is. I like to ask my guests if they can look at their own situation, your your business, your clients, investors, the market, however you want to identify. But if you can take a look in and at your situation, and identify what you consider to be the biggest risk. And for clarification, while I’m an insurance broker, I’m not necessarily looking for an insurance related answer. But if you’re willing, I’d like to ask you, Mike Zlotnick, what is the BIGGEST RISK?
Mike Zlotnik 37:40
So great there. And thanks for that. Three, three ways to manage to kind of risk avoided. mitigate it and obviously transferred. I when I grew up being a mathematician, so we’ve looked at risk too. And I’ve learned there’s two elements to risk. Number one, it’s likelihood. Number two is impact. So what what I do is I look at risks and try to figure that figure that out. So likelihood, and impact are the two key variables that drive all the decisions. And I would say the number one risk on a grand scale of things, and for the entire real estate market. And I think about it, it’s not necessarily my biggest fear, because I feel that the the impact is huge, and likelihood is low, very low. But the interest rates going up a lot. So take a look at what has happened to the 30 year bond, where we are recording this February 10. I don’t know when it’s gonna come out, maybe it’s live. But I looked at the data since the beginning of the year, and the 10 year Treasury and in a 30 year Treasury moved quite a bit. The yields have gone on on a 10. year from from point 94, up to 118. If I if I’m committed fluctuating obviously on on a 30 year from 1.66 to 1.9697 in that range. And these are very substantial moves. If you’re a bond investor, you lost 20, maybe even more percent of your investment in 30 days. This is how sensitive this stuff is. And the whole real estate industry is heavily dependent on low interest rates. It’s like a fuel when the rates drop, it’s a fuel for real estate fire. When the rates climb, cost of capital goes up cap rates go up now. This is directional moves. But what the United States is doing, they’re printing huge amount of debt basically borrowing and spending the money for the stimulus and everything else. So our debt to GDP ratio is getting out of control. Nothing new here, right? We’ve known about this, but it’s getting progressively worse, it’s that the risk is accelerating. So there’s only one solution, unfortunately, that we’ve seen it in the world out there to Japan model there is going to go negative. Now, as crazy as it sounds, it’s the opposite of the risk that I’m talking about. So the rates go negative probably will be pretty good for a lot of real estate investors, as the cost of capital will drop. But there’s also a possibility of effectively runaway inflation, as the government continues to spend without the brakes, unless fat comes in, that’s basically manipulation of rates, that the Fed has unlimited checkbook, and they can buy all the bonds that are issued by the Treasury and push other rates down. But at that point, what do we have, we have a central bank that buys everything, just to get the rates to the point where they can service the debt on, you know, one, the liabilities of the United States government, unfunded liabilities plus the real debt. So the problem is, this could turn into a runaway hyperinflation. And the rates will actually jump substantially. And it happens, it will be essentially devaluation, massive devaluation of the dollar. And it can happen, I’ve seen other countries do this. So your strategy of artificially keep the rates lower and lower and lower. It works until it doesn’t. And if it doesn’t, that becomes a cliff. And that cliff triggers hyper inflation. And it could cause substantial grief on the on the older all the lines, everything rolling the debt service, it’ll be massive squeeze, because of the debt to GDP ratio is so out of control, that if rates climb, we have a massive collapse of the of the of the over oversized debt portfolio, the whole the whole national debt plus all the private debt. So it’s a possibility to risk, what can you do about it? It’s hard, it’s hard to come up with a great strategy, obviously. likelihood is, is pretty low, I do think that the Fed will not let that happen. In the long run, it’s just they can’t, I mean, we’re gonna have a bigger crisis, a different type of crisis than we’re dealing with now.
You could, you could sort of play some, some derivatives to protect yourself, you can build in if you’re, if you’re if you’re an expert trader, you could hedge against that. But in the short run, I would essentially caution people who don’t think the rates can go up, they actually can, and they are showing some movement today.
J Darrin Gross 42:57
Now, I appreciate you, you know, getting into that. It’s, it is something that I think I’m I’m aware of, but like you said, not much I can do about it, but more I guess, you know, be aware of it. And and I would assume is a defensive strategy is is not being over leveraged, you know, or keeping a higher degree of, of, you know, cash in the deal kind of thing as opposed to, like you say, going all the way in on on debt.
Mike Zlotnik 43:30
Well, that’s right, it’s a sensitivity study theory to fly up fast. These assets will be selling at higher cap rates. So just doing some analysis, on sensitivity study, as a sponsor, what you can do is assume, hey, the pro forma sale price is based on a six cap, right? What happens is seven, can you can you still survive? It’s exactly lower leverage. So be more conservative in your investing decisions, and have more cash, the solution when the rates go up, and you got to refi. And the cost of debt is going up is to bring more equity. So not a very popular exercise, but it’s an option, can you deal with that type of situation? We haven’t seen this in a longest time. And honestly, you’re asking about a risk, it’s a risk likelihood, I think it’s slow given where the world has gone. And we’ve seen examples of Japan is a classic model because their debt to GDP ratio is worse than ours. And they’ve had no choice but to go there. So I think us is more likely, from a likelihood perspective, that scenario is a higher likelihood than the scenario of a hyperinflation and the rates getting out of control, you know, on the on the higher side. So both scenarios present different types of risk and different type of problem but As an investor, you have to be sort of prepared and please think about what would happen in either one.
J Darrin Gross 45:09
Well, hey, Mike, I want to say thanks for taking the time to talk today. I’ve, I’ve enjoyed our talk, learned a lot. And hope we can do it again soon.
Mike Zlotnik 45:19
Darrin, Thank you kindly. I very much appreciate have been a guest on the on the show
J Darrin Gross 45:26
Before I forget, Mike, I apologize. I meant to ask you, where can listeners go if they’d like to learn more connect with you?
Mike Zlotnik 45:33
Sure. So it’s a little cheesy, but it’s a personal brand. It’s just people, this whole Big Mike. It came as a suggestion from my mastermind guys in the collective Shinya. They said you’re a big guy here, six, four, and a heavy set. So Big Mike Fund. So Big Mike fund.com is the way to find me. And if you misspell it, and you forget to do it on the backhand, you type Big Mike fun. com, I promise. It’s not a kinky site.
J Darrin Gross 46:05
That’s hilarious. All right, well, hey Mike again, thanks for taking the time today. And for our listeners. If you liked this episode, don’t forget to like, share and subscribe. Remember, the more you know, the more you grow? That’s all we’ve got this week. Until next time, thanks for listening to Commercial Real Estate Pro Networks, CRE PN Radio
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