In last month’s newsletter, we took a detailed and pained look at which sectors of the economy were hit the hardest by the pandemic along with the difficulties that many businesses and industries are facing as a result.
[Part 2] A Look at Potential Investment Opportunities on the Horizon
Since that time, we’ve seen glimmers of optimism offset by reason for continued pessimism: while some states entered into phase one re-openings, we’ve also seen recent COVID spikes in areas where social distancing measures were lessened. In summary, there remains a lot of uncertainty about the stability and ultimate recovery of the economy.
With that in mind, we’re taking a look at where investors can begin to look for opportunities in the midst of and in the hopeful wake of the pandemic, the importance of patience in such an environment, and specific examples of distressed deals today.
Driver of Distressed Deals – Debt Issues
There’s a vast number of properties currently under forbearance as we mentioned in the previous newsletters. Banks are granting forbearance on any residential property. If it’s a multi-family property backed by Fannie and Freddie, they’re straightforwardly and automatically granting forbearance. If it’s commercial paper, banks are also doing it; although private lenders are not required to, they’re granting forbearance because they want to stay in good standing with their regulators.
Forbearance typically ranges from three to six months. When it comes to an end, usually at the end of the sixth month, it will result in some serious issues. At that point, there may be extensions, but I don’t anticipate that commercial deals will be extending; rather, they’ll be looking for a work-out or something. If the sponsor can’t pay at that point, the assets are severely distressed. That’s issue number one.
A second factor is technical defaults when debt service coverage ratio cannot be met. In other words, the rent collections for property owners are too low to pay the debt. At that point, in order for loans to be reinstated or brought current, there will be requirements for the cash infusion by the owner of the property to reduce the mortgage balance and to get that service coverage ratio into a manageable level. Below is an example situation with a 10% rent drop:
The next consideration is liquidity reserve requirements. Currently, banks have been requiring six to 12 months of interest reserves on any new loan funded by Fannie-Freddie. They’re requiring this because they’re just not sure of what’s ahead, but previous transactions will have similar concerns. They will have all kinds of shortage of liquidity in reserves and technically may be failing loan covenants. As a result, there will be defaults related to non-payment issues.
Lastly, commercial mortgages will start trading at a discount once defaults set in, and the lenders will have technical defaults on their books which would mandate lenders to increase their own reserves. As a result, they’ll be motivated to sell the paper. It’s an interesting concept that they can sell a mortgage at a discount lower than the reserves they have to allocate in order to support the loan.
Many banks will be motivated to do that because it would essentially have the same impact on their cash position having cash coming back instead of allocating significant loss reserves to cover the risk associated with a defaulted paper. Thus, it will be a pretty interesting situation when technical defaults start to kick in or when the end of forbearance occurs.
Trends and Recovery for Quarters 3, 4, and 2021
The big question will be concerned with trends in Q3, Q4, and 2021. At a certain point, the economy will most likely open back up, but when it does restart, at what level will things stabilize? What will rent rates look like, and what will the occupancy trend be? It’s anyone’s guess, but it’s probable that different types of assets will have different patterns in terms of behavior, collections, and overall data.
The recovery shape could be a V-shape, U-shape, L-shape, or a swoosh shape like the Nike logo.
A Game of Specialists: Investment Opportunities on the Horizon
Let’s talk about opportunities. Expect these to come in different shapes and sizes. Look for distressed and discounted commercial debt to be opportunity number one. Our group is already seeing these types of deals and are looking to avail ourselves of them. I expect we’ll see more and more opportunities arising in the upcoming months.
Paper will trade first, well ahead of assets. Once the situation comes to a head and banks recognize the extent of their stressed situation, perhaps they’ll sell paper instead of foreclosing. This could lead to significant opportunities to buy paper from banks willing to pull out rather than having to deal with onerous sponsor work out scenarios. This won’t be for the faint of heart; rather, it will become a battleground for specialists who are adept at working out assets with sponsors.
In terms of existing distressed and discounted equity in private deals, at the moment, private deals are frozen. Real estate investment trusts (REITs), on the other hand, have a market price, and you can participate by purchasing REITs if you feel like you’re getting a better deal. You can also get into private deals which have both advantages and disadvantages. There will also be newly acquired distressed and discounted deals.
So, instead of coming into an existing deal and taking on some private capital injection to salvage a deal at a better price you can come in and basically invest into a new deal light of debt or equity.
Key Investment Areas
The greatest opportunities will come in the COVID distressed sectors such as hospitality. We’re currently working on a project with a conversion of an older motel to affordable housing, a trend I expect to see all over the country. The big boys, the big flag hotels–the Marriotts, the Hyatts, the Hiltons–will consume whatever demand there is during the distressed or low demand period, while the weak hotels will completely fall apart. Let me rephrase that to say that there is a strong chance many will fall apart thus becoming great conversion projects to affordable housing (small units, but affordable).
Conversion from retail to self storage has been a trend for a few years now and will continue. Lately, I’ve been hearing discussion of retail conversions to a concept known as “dark supermarkets.” This is when someone takes a shopping mall and instead of having a warehouse somewhere in a bad location, it can be used as a distribution center. For example, it might be the shopping mall that just closed down which provides a great location; it could be re-developed as a sort of “dark supermarket” distribution center. There are also discussions about converting retail to housing but going from retail to housing is a complicated beast.
Lastly, on this subject, there is discussion about converting office or industrial buildings into housing. A developer can receive historic credits, and if there are other benefits available from local governments, these, too, will kick in to allow for the development of dysfunctional assets into functional assets. Look for an opportunity to invest in these types of projects.
Patience is Still a Virtue, Cash Is King Once Again
Look for the best deals to be available 90-180 days from now; in fact, the initial wave might hit even earlier with some instances of distressed debt. I expect the bulk of opportunities to come in the fall and beyond. Therefore, it’s better to have the cash now than have it lose 20%. So although your cash may be sitting in the bank earning nothing but patience, that’s preferable to putting your cash in some kind of risky deal.
Where could you put your cash today? If you can locate opportunities to park your money in senior debt where you get a good yield, that’s a great place to start. Likewise, hard money is a good sector. At this stage, there’s no shame in getting a decent yield and in being very conservative sitting on a capital stack; in our case, we just deployed a couple of significant investments to start generating good cash at a very low risk position.
Tempo Growth Fund LLC
Now is a great time to consider investing in the post-COVID opportunities offered at Tempo Growth Fund LLC. Our fund currently has investments in distressed commercial debt as well as in a value-add multi-family project.
Fortunately, neither of these investments has been impacted by the pandemic nor was there any pre-COVID history of distress. Both were strong value assets purchased at a good price from the start at the beginning of the year. We’re now seeing opportunities to be significantly stronger going forward.
Key Elements of TGF…
The Tempo Growth Fund LLC is ideally set up for the post-COVID environment where distressed and discounted deals manifest. It provides ample opportunity to diversify. As fund managers, our team has great exposure to superior yields via our network of masterminds and relationships around the country. Participants have a single access point into the deal flow which could not be accessed directly in any other way. The fund has an institutional level waterfall with outstanding terms for investors.
The fund is raising a total of $25 million (of which we’ve already raised a significant amount). The fund is growth focused and closed ended. We’re raising money in 2020 and allowed two extensions in 2021. By the end of 2021, the fund will close if we haven’t raised $25 million before that point. The fund’s target return to investors is 12-18% annually on average, most of which comes on the back end.
The fund’s time horizon is five to seven years, it’s IRA friendly, and we do not use leverage at the fund level. It simultaneously creates safety for investors and IRA investors. The fund will invest in distressed and discounted commercial debt. There will also be value-add equity projects, some self storage and multi-family projects.
Finally, the fund has a very professional waterfall with 8% preferred return cumulative, non- compounded in which the class A units getting 80/20% split above 8%. This means that 80% goes to investors with 20% to the managers as a performance fee. Class B units have a 70/30 split with 70% to investors and 30% to the managers.
The waterfall works in a way so that the investors get 8% pref; they also get full return of capital and then they get that portion of the performance split above the pref. Again, we have a fundraising period of 12 months with two extensions of six months provided.
Contact Us If You’re Interested
If you’re interested in investing or want more information, you can contact Mike Zlotnik at Mike@TempoFunding.com or by phone at 917-806-5029. You can also schedule a time to chat via bigmikecall.com
Thanks for reading,
Mike Zlotnik
CEO, TF Management Group LLC
This newsletter and its contents are not an attempt to sell securities, nor to sell anything at all, nor provide legal, nor tax accounting, nor any other advice. The presenter is a private lending and real estate fund management business, and the information represented herein are purely for educational purposes and represents the opinions of the presented. Prior to making any investment or legal decision you should seek professional opinions from a licensed attorney, and a financial advisor.
TF Management Group LLC (TFMG) is an investment fund management company that specializes in both short-term debt financing for real estate “fix and flip” projects, and long-term “value-add” equity deals.
