Recently, there have been a lot of questions about what’s happening in the market and how VonFinch is managing the current economic climate. In this episode, Steven breaks down VonFinch’s view of the market and highlights some of the strategies that they are targeting in order to maintain their success.
- There is a movement towards hard assets that will be able to hedge against inflation.
- The smartest investors are going to accept the lower returns today rather than dwell on what they were in the past.
- There are fewer buyers in the market which means you may be able to get a little bit better of a deal than you would have gotten recently in this highly competitive market.
- Some of the biggest Ups come right after those times of great economic pullback
- Steps you need to follow to also get risk-adjusted returns:
- Get crystal clear on what you’re looking for in an investment and what’s important to you.
- Work with true experts who are living and breathing this every day.
- Be clear on your buy criteria so you’re not passing on opportunities out of fear
Interested in connecting with other like-minded individuals? Then join our VonFinch Private Capital Network. Learn more at http://www.vonfinch.com/invest.
Steven Pesavento 00:05
This is the Investor Mindset podcast and I'm Steven Pesavento. For as long as I can remember, I've been obsessed with understanding how we can think better, how we can be better, and how we can do better. And each episode we explore lessons on motivation and mindset for the most successful real estate investors and entrepreneurs in the nation.
Steven Pesavento 00:31
Investors welcome back to another episode of the investor mindset podcast. I'm your host, Steven Pesavento. And today, we're going to be talking about VonFinch's view on what's happening within the market and what strategies are we targeting based on the current economic climate? It's been great talking to all of all of our investors and you know, 50 plus conversations last week diving in, and understanding how our current clients are looking at the market. If you're one of our clients, and we haven't yet spoken, I encourage you to schedule some time. So we can dive in and understand exactly how you're looking at the market. One of the questions that came up often was, you know, what are you seeing in the market? what's currently happening? And how are you reacting to it?
Steven Pesavento 01:16
Well, one of the things that we're noticing is that with the change in the equities market, obviously, many people have been following closely, the stock markets have gone down 15 to 20%, depending on what day you're looking at. And there's a lot of movement towards real assets towards hard assets that will be able to hedge against inflation, but have, you know, intrinsic built in value or are creating income, as well. So there's a lot of interest moving towards the real estate market, in particular, because of some of those changes that I talked about, during uncertain times people are looking to be in hard assets. What we're also noticing is that there is a lot of uncertainty within the real estate market itself, that uncertainty is really coming from the Fed raising interest rates, and with the banks themselves, not knowing how high those interest rates are gonna go. And also not knowing what impact that's going to have on the products that they're investing in, or that they're lending on. So what we're seeing is that we're seeing a lower loan to value. And when you have a lower loan to value and you have higher interest rates, what that does is it ends up reducing what the overall return profile of that deal would be. So what we're seeing in the expectation that we're setting and SMART operators are setting as well as that what once was a 17% IRR return last year or the year before, that same deal purchase today, and today's that environment is likely closer to a 14 or 15%, same risk, same product was a 17. Now as a 14 or 15, it's important to accept the market that we're in and not think that I wish we could go back to the market that we previously came from. Because what we're also seeing is on those same deals if cash flow is projected at six or 7%, we're now seeing cashflow at four or 5%. So it's important to accept that these are the returns that are available today. And many people would say hey, well, I liked the old returns, I'd prefer to have those maybe I'll wait until I can see that again. And the smartest investors are going to accept it. And they're going to move directly in to the type of opportunities that are available.
Steven Pesavento 03:42
Rather than wishing or trying to search out deals that maybe have a higher return. without necessarily knowing the difference between those products, you could end up getting into a little bit of a sticky situation. The reason for that is some sponsors and operators will continue to project returns that are higher, although their ability to hit those returns are going to be significantly impacted. And here's the reason why this is what's really important to understand is that when interest rates go up, the cost of that debt goes up. When loan to value goes down, more equity is required. And so when you pair those two things together the debt the bank is the biggest partner on these individual real estate transactions. So if they are bringing 60 to 70% of the the the money that's needed to purchase that property, and the cost of that capital has gone up by 2%. You can imagine that the available capital available for returns is going to go down. And that's further exacerbated when you look at loan to value going down and needing more equity meaning those returns that are available need to be spread out amongst more dollars. Right. So that's one thing that we're seeing we're setting a new expectation about what the return profile is today. We absolutely are always looking to be able to exceed expectations being able to exceed pro forma. And we've done that on every deal that we've done going all the way back to the von Finch home days, we've had a lot of success and being able to be conservative going in. And that's really important. And if that's important to you, then you should know that when you look at our opportunities and compare them to others is that we're setting an expectation that we believe we can achieve, and then we believe that we can exceed as well. So that's one thing we're noticing the market.
Steven Pesavento 05:43
The second thing we're noticing is that we are seeing a lot less buyers in the market. And one of the big reasons for that is we talked about lower loan to value. When that's also paired alongside many of these buyers don't have great equity relationships, they don't have the ability to raise capital, well, or some of the institutional capital has pulled back as their reallocating their funds in some of the directions I'm about to talk about. But because of that less buyers in the market is meeting there can actually be an opportunity today to get a little bit better of a deal than we would have gotten recently in this highly competitive market. So that's one thing that's really great about what's going on is that when you can capitalize a deal. And when you can set conservative expectations, you can do deals today, that really make a lot of sense. And it's important to stop for a moment. And to acknowledge that you might ask yourself, Well, why not wait to find deals that could be stronger, or why not wait it out a year or so and just kind of see what happens, you know, seeing what happens can make sense. But what I would like to remind people about is that if you would have waited to see what happens post 2020 locked down. Version one, if you would have waited to invest in the end of 2020, or in the beginning of 2021, you would have missed one of the largest run ups in real estate values in history. If you would have waited to invest in equities during that same time, you would have missed one of the biggest run ups in history. So the point being is that what ends up happening is that in any given day of the market, you want to have exposure to what's happening in the market so that you can participate in those ups, because some of the biggest UPS come right after those times of great pullback, economically.
Steven Pesavento 07:46
The second reason why you would want to really get a clear understanding of what you're looking for in an investment and still deploy capital in opportunities that fit that is because we're in a high inflationary environment. You've heard this for months, but month after month, we've seen high inflation, we're in the eight to 10% range currently, of course, I think the most recent read was about 9.1. So what that means is that if you're sitting on a million dollars, you've just lost 9% of that value. Meaning your ability to go purchase something today versus a year ago, is less, and therefore you're actually losing buying power by letting that sit on the sidelines. And that's why it's so important to be able to put that money into assets that actually hedge you against inflation. And when I say hedge, what I mean is that when you invest in real estate, for example, your equity goes into real estate, alongside debt. And as inflation continues, rents go up, as rents go up, net operating income goes up, and net operating income is what leads into the value of that commercial real estate. And so therefore, the property goes up and your investment increases in value, therefore hedging you against inflation. So that's why it's really important. Yes, during times of uncertainty, it makes sense to be able to, you know, create your your emergency fund, maybe extend that a little bit further than you normally would if you're someone who would keep 90 days available. Maybe you move to six months. If you're someone with six months, maybe you move to nine, you have to understand your risk profile. You're where your income sources are coming from and what is going to best fit into your portfolio at Von Finch. We've increased our reserves by about 90 days. And we're in the process of increasing them to about 120 days so we have cash on hand that we will need for operating our business and for you know, paying for personal expenses that are needed for our staff, right we need to make or we can pay our people. However, every other dollar, we're rolling directly into opportunities, because if we're sitting on another half a million or million dollars of cash, again, we're losing value. And we don't want to do that. And therefore, what we're seeing is we're seeing a great opportunity in the market to continue to look for single asset opportunities that will directly own operate and manage and will partner with LPS just like you to go and buy the same type of products and properties that we've been buying.
Steven Pesavento 10:29
For years, you know, the last 10 multifamily projects or you know, the 200 Plus single family have all been product that, you know, we like the ability to operate, manage these, and we know we can create a great return. Now, in the same vein, what we're looking for is we've reduced our growth expectations, and we've reduced the loan to value that's going to go into these deals. And so we're tightening up that criteria, we're being very specific, what we're looking for is we're looking for strong markets that are tier one or tier two markets, a tier one market is a Los Angeles or Chicago or New York. Now, we're not really looking in those markets in particular. But what I mean by that is very strong markets that have good growth. We're looking primarily in tier two markets, that's a Denver, that's a Dallas, that's a Phoenix, and other markets like it. And we're looking in some tier three markets, but that have really great demographic information. Now, why is that key, it's important to look for markets that have stability, of income of jobs of all the things that we've always been looking for. But right now, we're seeing some softening in the lower income areas, people's inability to pay in those lower income areas. And we're seeing some areas that have been overheated, and we're looking to avoid those, we're also looking for product that's a little bit newer, that's 1970s 1980s, or newer, that is in a little bit better condition that we believe is in a great area that is going to continue to appreciate despite any kind of changes that happen in the market. And we're looking most importantly, to structure deals in a way that heavily protect our investors. So in those single asset deals, we're looking to be conservative, we're looking to, you know, continue to make offers until we get deals accepted that really meet that criteria. And simultaneously, we're looking to set up deal structures that put us in a protected position. And what do I mean by that? What I mean by that is that there's a great opportunity today, when loan to value goes down, and operators and sponsors need additional capital to actually be able to infuse capital in a preferred equity position that acts kind of like a second mortgage. And the best way to visualize this as on a bar chart, if you think about 60 65% of the bar chart from the bottom up is the debt above that would be about 10 to 15, maybe even 20%, up to a total of 80%, maybe 85% loan to value being that preferred equity. So that preferred equity ends up being about 15 to 20% above, and then the other 15 to 20%. Above that is the common equity.
Steven Pesavento 13:30
So in that example, 60% loan to value 20% preferred equity 20% common equity. In that example, the pref, equity gets paid back its initial investment first. So it gets a return of capital first. And second, it gets a return on capital first. So it gets its entire return that's projected before the common equity gets paid anything, or the sponsor operating team gets paid any kind of promote. So what is really good about that is that it puts you in a better position. From a protection perspective, you give up a little bit of upside, but in exchange, you get some of that downside protection, you have a little bit more certainty. We like this product right now because we see a great opportunity in the market. And we really like products where we can create about 70 to 80% of the return, but only take about 30 to 50% of the risk, right? So we like things where we can get a true risk adjusted return. You're going to hear that a lot from folks. But it's important for you to understand what that is. And then when you hear that from a sponsor operator, it's important for you then to understand in this particular case, why is it risk adjusted in my favor as the investor? The other important thing that we're looking at is the importance of investing with true experts, people who are everyday living and breathing this who are working with all the public data that's available from economists and Working with all the private data that we personally pay for access to, so that we can make these kinds of economic decisions. Because in times like this, it's really important to understand that we can tell what's going on today, right now in the market. And we can anticipate what we believe are the different scenarios that are going to happen. And we can have different strategies available to fit those different scenarios. And so it's critical to understand that each strategy can fit a scenario better, depending on what that circumstances is. And when you're working with true experts every single day, and every week, we're adjusting what our internal strategies are, what we're targeting what we're seeing in the market. And that real time feedback puts our investors in a much better position, risk adjusted so that they can know that they've got somebody who is taking care of their investment from start to finish and looking to protect not only the company's capital, but of course, all of our clients capital that is in every single deal. So with that, what we're highly encouraging is to sit down and get absolutely crystal clear on what it is you're looking for an investment, what's important to you in the investments that you're making, and that you get a clear by criteria so that when an opportunity comes, you're not passing on it out of fear. You're saying yes, this does fit my criteria, or no, this doesn't fit my criteria. And my criteria is realistic, and matches the current environment that we're in.
Steven Pesavento 16:36
So for all of you who have been investing with us, we're grateful to have you on the Von Finch team. It's great to be able to partner with you on these opportunities, we're so glad to be able to create such great returns on the mini axis and the mini deals that we currently are operating for each and every one of you. For those of you who have yet to invest with us or get involved, I highly encourage you to head over to vonfinch.com/invest. Register. If you haven't spoken with us, you know, absolutely schedule a call, we'd love to have an opportunity to speak with you personally. Majority of our deals are available to accredit investors only. However, if you're not accredited, it's really important for you to build that relationship. And one of the best ways to do that is to register a schedule that call and then you'll be able to get access to the exact types of opportunities that we directly invest in as well. So thanks so much for listening. We'd love to hear what your view is on what's happening within the market. Shoot me a DM at Steven.Pesavento on Instagram or at Steven.Pesavento on LinkedIn, look forward to seeing you in the next deal.
Steven Pesavento 17:48
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The Investor Mindset Podcast & President VonFinch Capital
Steven Pesavento has always been obsessed with understanding how we can think better, how we can be better and how we can do better. He is an active real estate investor who curates Commercial Real Estate Investments for clients.
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