WS1852 The Benefits of Preferred Equity in Real Estate Investing | Paul Moore

Discover the secrets of successful real estate investing with Paul Moore, the mastermind behind Wellings Capital. With a diverse portfolio encompassing self-storage units, manufactured housing, and multifamily properties, Paul has become a leading authority in the industry. In our exclusive conversation, he shares his journey from Ford Motor Company to real estate mogul, unveiling the strategies that have propelled him to success.

Learn about Paul's ten-year hold approach and how meticulous diversification across geographies, asset classes, and the capital stack can secure your investments. Delve into the fascinating world of acquisition equity and discover its growing importance in the market. Paul provides invaluable insights into the types of deals that benefit from rescue capital and the considerations that are essential when investing in a fund focused on acquisition equity.

If you're considering a career transition into real estate, Paul's experience with pre-equity will inspire you. Explore how this strategy maximizes returns on value-add deals and facilitates a seamless shift from the corporate world. Don't miss out on this opportunity to learn from a true expert in the field. Tune in to our latest episode and unlock the secrets of successful real estate investing with Paul Moore.


Connect with Paul on LinkedIn to stay updated with his latest insights and visit his website for more information on how you can take your real estate investments to the next level. Get ready to elevate your investment game!
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Transcript

00:00 - Paul Moore (Guest)
But one of the things we're doing that I like is we're a 10 year hold. So while a lot of people love the idea of doubling their money in a couple years and that's great when you can do it but the 10 year hold is allowing us to relax and not be so concerned about the cap rate expansion, interest rates ups and downs and all that. This is your daily Real. 

00:23 - Whitney Sewell (Host)
Estate Syndication Show. I'm your host, Whitney Sewell. Our guest today is Paul Moore. He's founder and managing partner of Welling's Capital a 17,000 plus self storage, a union's manufactured housing and multifamily units over over half a million and assets under management. As a degree and MBA from Ohio State, entered the management development track at Ford Motor Company in Detroit. After five years started a staffing company with a partner, sold it in five years, began investing in real estate in 99. He's 85 plus real estate investments and exits. 

01:03
He's appeared on HDTV, house Hunters and a number of different places and Paul's been a friend of mine for many years, which many of you may know. You'll hear us talk about it a little bit, but he's going to share some insights to actually the next two days that I know, whether you are active or passive, you're going to learn a lot. Paul, it's always a pleasure to connect with you. You're somebody I've known for a long, long before I ever got in the syndication business that you and I were playing music together. The listeners probably don't know that, but they should know it and so grateful for having your time and having you on the show. Congratulations to your success. I'm looking forward to diving into a few topics today, actually over two days, a series of shows and highlighting some expertise you've gained and sharing it with us. Thank you so much Welcome. 

01:47 - Paul Moore (Guest)
Oh, it's great to be here. Whitney, Thank you so much. And yeah, people don't know that I mean, aren't you like, didn't you study under Neil Peart to like the greatest drummer of all time? 

01:58 - Whitney Sewell (Host)
I'm still giving his family lessons for his son, and I'm just kidding, no not at all? Not at all. I do enjoy playing drums, but I've never claimed to be that good. 

02:07 - Paul Moore (Guest)
Okay, Well, you, I think you really are so. 

02:10 - Whitney Sewell (Host)
I appreciate the kind words, paul you are. I mean you have pushed forward in many ways with welling, with welling's capital. I know we've had you on in the past, but it's been a bit. Give us an update on what's happening, or maybe what's happened most recently with wellings and your all's focus, and then let's dive in. 

02:29 - Paul Moore (Guest)
Yeah. So welling's capital Just kind of a background here. I wrote a book called the Perfect Investment Humble Title back in 2016 about multifamily investing and then I got really concerned. I really felt like that honestly, our team did not have a great acquisition strategy. We weren't finding off market deals. We were competing with people who, honestly, were willing to overpay, over leverage and do all kinds of things too that just kind of drove the prices through the roof in a lot of cases and a lot of multifamily investors were doing a great job, but the sum who weren't doing such a great job made it really hard for us. So we expanded into other asset types Back in 2018, we added self-storage, then mobile home parks, rv parks, light industrial, open air shopping centers still doing multifamily Whitney. 

03:30
You know that I read the book the One Thing by Gary Keller and Jay Papazon and I realized we can't be an expert in I'm not sure we'll be in the top 10 or 20% of multifamily ever, but we'll certainly not be a top operator in four, five, six different asset types. So we decided to pull back and become a fund manager and our goal was to go out and find suitable investments from top operators in these different asset types. So that's what we've been doing for years. Now we're on our sixth fund and we've raised about $127 million total, and about 40% of that or so is in this current fund. So we're having the time of our lives doing this and really enjoying, even though it's a tough time in the commercial real estate realm right now. 

04:22
We're still doing the same thing we were before. We're investing with operators who often find mom and pop deals off market and by finding those types of deals, they're sometimes getting owner financing, or sometimes they're paying cash and they're able to make significant operational improvements to increase the income and, hopefully, to maximize value to investors. So one of the things we're doing that I like is we're a 10 year hold. So while a lot of people love the idea of doubling their money in a couple of years and that's great when you can do it but the 10 year hold is allowing us to relax and not be so concerned about the cap rate expansion, interest rates ups and downs and all that. 

05:11 - Whitney Sewell (Host)
Love that. I also like the longer hold periods like that. I've heard a few operators talk about man, just the the bliss, almost, of having a 10-year hold right and you can weather those ups and downs right so much easier. So I love that. So you all are focused in a big way on a specific asset class. Now, right, I mean or or I know you talked about you all are partnering with some specific operators finding those mom and pop deals. But is that a specific asset class or are you still doing some of different things? 

05:43 - Paul Moore (Guest)
No, we're doing all those six asset classes I mentioned. In fact, we're even diversifying not only across operators, geographies, asset classes, strategies. We're also now diversifying inside the capital stack, and so we're actually doing a little bit of debt, a lot of common equity, but we're also doing preferred equity right now and hopefully we'll get a chance to talk about that sometime. 

06:06 - Whitney Sewell (Host)
Yeah, of course let's do that. Let's jump into what that is and and even why that versus debt or the different types of things you're doing, why you would consider one of the other. But then I want to dive into the preferred equity and what that is exactly, but talk about those three things kind of high level a little bit and then specifically dive into preferred I sounded. 

06:26 - Paul Moore (Guest)
I sounded so sarcastic when I said hopefully we'll get to talk about that sometime. I forgot we were talking about that on today's show. I thought we were talking about RV Park, so anyway, I was being silly. But yeah, so we as a fund were investing in other people's deals and so we're coming in as a large LP investor typically. So usually we're getting we're often getting better terms. We're often getting access to deals that they don't even go public. Some of them like thinking of a couple of self storage conversions near Boston. They were. They didn't even hit the public at all, they just went to friends and family. We were one of those friends. 

07:09
But there's always a concern that investors are thinking well, I don't really need you, I can go straight to the operator. And I'm thinking of another operator, a self storage operator in West Palm Beach, florida, that has the $5 million minimum. So most of our investors couldn't get into that. But I can tell you for sure that I can't think of any way for an individual investor to get into preferred equity unless they're doing it through a fund or another operator. Can I show you a picture of preferred equity just to give you an idea of what I'm talking about, please? 

07:42 - Whitney Sewell (Host)
And just so the listeners know, you can see this video on YouTube, but Paul's going to talk through it in a way, too, that if you can only listen, you'll still understand. 

07:50 - Paul Moore (Guest)
Yeah. So imagine a capital stack that has debt and equity. So the bottom of the one I'm looking at here has 60% senior debt, and you would expect that the top would have 40% common equity, and that's what a lot of deals look like something like that. But right now, a lot of operators are finding that it's hard to get as much debt as they used to. They might have expected to get 75 and raise 25% common equity, but now they're getting only 50 or 60% senior debt. That might be constrained by the debt service coverage ratio. It might just be because the banks are tightening their standards and so and if they're only able to raise the 25% common equity that I mentioned already, that's leaving a 15% gap in the middle. Now that gap can be filled by either mezzanine debt or which would be like a second senior, a second loan, a junior loan, or it can be filled by preferred equity. 

08:55
We really like preferred equity, and there's a lot of reasons for that, but I did want to show this. So again, if you're listening, there's imagine a three-part capital stack instead of two the bottom being senior debt, the middle being preferred equity and the top being common equity and, of course, the top, the common equity that's actually at highest risk, as it always is, in case there are losses, but of course that is the place of highest gain in an asset that performs as expected or profitably. So we really like preferred equity because, first of all, it provides immediate cash flow just like debt, has a future upside, just like equity, and a shorter hold time, and at this point in the cycle a lot of people are a little nervous about the long hold times that I mentioned earlier. It has payment priority ahead of common equity. So if, in the example I use with 25. Percent common equity, if the cap rate expanded or net operating income dropped and 25 percent of the value was wiped away, that would all be in the common equity realm, in that example at least, and so the preferred equity would still be made whole as well as the lender. There's no lien, which is that's a benefit of senior debt. There's typically a lien on the property, but in this case sometimes we're often getting personal guarantees from the sponsors for this. There's lower downside risk exposure than common equity. 

10:32
Like I mentioned, we still negotiate depreciation benefits. We still get paper losses from depreciation pass through to us. In fact, in one case we got a hundred percent of all the depreciation because the operator didn't care about it for some reason. We can negotiate control rights in case something goes wrong. We can negotiate for sale rights. We can be recognized either officially or unofficially by the lender like Fannie Mae or Freddie Mac, and what that could mean. That for sale provision especially could mean that the lender wouldn't foreclose if there was a problem. They would allow us to force a sale and make sure we were made a hundred percent whole in the sale. So that's some of the benefits of preff equity in general. Take a breath, whitney. 

11:20 - Whitney Sewell (Host)
Yeah, no, that's great. I just appreciate you thinking through that. Even seeing the slide, I encourage listeners to see that. I think it's helpful to see the visual there. However, I think Paul laid it out there from senior down at the bottom, you think the higher you get on the ladder, the riskier. It is right, so, as you go up, but maybe just on an elementary note here on this, for our maybe newer passives or actives, who are the investors that are in the common equity versus the preferred equity and how would they be in one of the other? 

11:51 - Paul Moore (Guest)
Yeah. So typically the some people, by the way, think this is oh. They think oh, I'm an investor in a certain deal, I get preferred because there's a preferred return of 8%. That's not this. This is something completely different. So this is closer to a different type of equity. Well, it is a different type of equity. It's closer to mes debt, like I said. 

12:14
But if the LP? So in the deals in preff equity we've invested in the LPs in one case were a bunch of LP investors, just like you would typically see. And then another deal it was actually the sponsor equity. Everything behind us or above us in the capital stack is actually it was 25%, I believe it was all GP equity, so their own skin in the game, which we thought was even safer, and so that is typically where the LP money is coming from. 

12:47
I want to point out too that there are there are at least three types of preferred equity. There's probably more. One would be development, like somebody's building a building, and they've got so much potential upside that, the high cost of preferred equity. I didn't mention that yet, but the high cost of preferred equity right now is definitely within their budget If they make a big sale. Another type is rescue capital. There's a couple kinds of rescue, but I'm just going to go with the most obvious one. 

13:19
That is a deals in trouble. They've got to pay for new rate caps and it's really expensive. They've got to refinance and the lend, the new loan, is going to be a much higher interest rate. So a rescue capital might be somebody who comes in says, okay, we're going to give you egregious terms and we're going to possibly have for sale rights, we'll take this over, and if it goes bad, we're okay with that. And so that's not what we're doing. 

13:48
And we're also not doing development prep equity, though I think that's a fine thing to do. We're doing the third type, which is acquisition equity. For the most part not exclusively, but for the most part we're doing acquisition equity, which would be buying a value add deal, and for the operator it's a great benefit to have this, because think about it with back in my capital stack if there's a 15% prep equity in the middle, they could refinance and take us out, or they might have. Maybe the GPs have profit from another deal they're about to close on and when they do that, cash will come in and potentially take us out and then they can buy that effective 15% of ownership, which could potentially maybe even double the GP stake in the deal, and so it's really good for everybody if it's done right. 

14:42 - Whitney Sewell (Host)
Yeah, I think it's so helpful to think about it that way. I appreciate you laying out a few different types there. We've heard often lately about this rescue capital. A lot of people are talking about creating rescue capital funds and whatnot as well, because I think there's definitely going to be a need for that more and more, unfortunately. But on the acquisition side, you said, most of the time that's what you are doing value add types of deals. Are there other types of deals that this would be considered for? 

15:11 - Paul Moore (Guest)
Yeah, another one would be. One we're looking at right now is a five mobile home, five part portfolio mobile home parks, one of the deals. They're all funded individually and they all have their individual debt on them. Of course, one of the most of the debt's going to be like four or five more year term, but one of the parks is the debt is coming due, it's terming out in like March, and so they're talking to us about possibly coming in with preff equity when that debt's gone, just to be the only. In other words, we would be in first position. 

15:46
In that case They'd have preff equity and common equity only, or possibly GP equity on that deal. So that's another type. Another one would be for an existing operation that doesn't necessarily need rescued, but they really want to have some working capital to either go maybe buy more land next door let's say it's an RV park that wants to acquire an extra 100 acres next door and so they might use preff equity to do this, and then they would refinance us out in two years or it could be a multifamily operator who has a fabulous history of value ads, but they don't have any extra cash available right now and they want an extra $3 million, let's say, to do value add on 100 or 200 more units and that money would be again likely refinanced out in a couple years. 

16:42 - Whitney Sewell (Host)
What are some of the downsides? Or, even better, what are some of the things that an investor that's considering even investing with you all in this fund should be asking an operator, fund manager like yourself, knowing that this is the piece of the stock that we're investing mostly in? 

16:58 - Paul Moore (Guest)
Yeah, I mean I think I get a lot of comments on Twitter where people are like wait a minute, isn't this rescue capital? Isn't this just throwing bad money After bad or good money after bad, I guess? Or isn't this a dumpster fire, followed up by they use all kinds of words on there and that I won't repeat? But at any rate, that's just not like. That's something I would definitely ask. I would also ask to make sure that the the person before you invest, that if they're coming in behind Fannie Mae or Freddie Mac, that it's coterminous with Fannie or Freddie and that Fannie and Freddie's gonna approve them Make sure they've done all the due diligence that you would want to see. We've actually Two or three deals in a row, one at the closing table I mean literally at the closing table. We'd already wired money we pulled out of because of Just last-minute shenanigans by the operator that we weren't willing to tolerate. I mean, don't just cuz it's in a safer place in the capital stack. You still want to see all the due diligence you would. Anytime you make any investment, truly, it's likely that it's less likely to lose money, but it still could lose money. I mean, if the deal goes south entirely. 

18:14
There's a lot of things to look for. One of the things we're doing right now is we're actually so there's a lot of folks actually out there wanting to do preferred equity. Most of them don't want to mess with it under ten million dollars. So a lot of the shops out there, as they're called, or investment Funds, they want to go from ten to, let's say, a hundred million and after seeing the amount of due diligence and Legal structuring and work and NOI audits and everything else that's going into this I'm talking a lot of work and a lot of money spent on legal I can see why they want to be at ten million or above. But we're actually Doing, we're looking for deals in the two to seven million range and the reason is we can get a much higher coupon. 

18:59
There's so few people out there wanting to do this right now. I mean we're seeing coupons 10%, 9 or 10% current pay Plus another five, six, seven percent on top of that. So we're seeing total coupons in the six, fifteen to eighteen percent range. That won't last forever. I mean that's partly a function of the fact that interest rates themselves are so high right now and Lending has tightened up right now and there's so few people wanting to do profit equity. If they've got a really good team and a good plan and a good track record of upgrading these deals and making these value ads really work Well, they can confidently say hey Well, it might cost us sixteen percent for two and a half years, but we'll be out and then we'll acquire that or we'll distribute them on the whole equity investors, depending on how we go about taking the pref equity people out. 

19:54 - Whitney Sewell (Host)
Yeah, definitely some benefits in Managing a fund, like, like you have where you can negotiate, you have more negotiating power, right when the capital's there, you can go to somebody say, hey, we got the the seven million you need tomorrow if everything checked out right, right, yeah, so that's helpful for investors. I mean they may not know the exact deal up front, but but they know that, man, that's, that's giving you so much more power and giving them more benefits by having that all up front. No doubt about it. Anything else about the, the pref equity that people are asking about, paul, or or that maybe you've got questions about, I mean, from investors that you want to share before we end this segment, yeah, I mean. 

20:35 - Paul Moore (Guest)
One thing that people would ask is somebody on Twitter blasted me and they said I just reported on a deal and one of the deals we did was the kind where we were actually providing additional capital for them to go out and buy more or upgrade some value at, and we got personal guarantees from two brothers with a combined total net worth of $300 million, and they were the only capital in these deals. There was no LPs, it was all capital, it was all GP capital and they paid us 15% and that was like, rather than split it into 10% current and 5% upside, they just said we'll just give you 15% right up front and they gave us a whole year in advance and so closing, instead of giving them 5 million rough numbers but we only gave them 4.5 million because we kept the $500,000. I didn't do the math right on that, I just realized. But we kept the rest, the whole 15% of one year. So we just kept that $750,000 in our bank account and that's now earning money and treasuries and we're feeding it out one month at a time out of this reserve account into our fund. 

21:48
Well, somebody on Twitter blasted me and said there's no way. This is ridiculous. This is not true. Nobody in their right mind would do that and that's a question we get. Why would people pay so much? Well, honestly, the most successful real estate developer I know personally I mean he does like 8,000 lot subdivisions, seriously like at Myrtle Beach and in that area, like this guy is the boss, he he sat down with me recently for lunch and he said I am done with lenders. I said what he said. I've been working with this lender for 23 years. Our kids are friends, we're friends and they just totally tighten the screws down on me. He said I would rather work and this was a bank, I shouldn't say with lenders. He said I would rather pay two or three or 5% more to a private. I would rather pay hard money rates to a private lender that didn't treat me this way. In fact he's since did that. He actually went out and found a private lender, and so that's part of the draw here. 

22:56
Banks, when they tighten down, sometimes they have requirements, sometimes they have reserve requirements. My son, who you know is doing real estate deals where they're asking him now like one of the banks, is saying that he should put 10 or 20% of the loan amount in a cash in cash in a bank account, he's like, wait, I'm just going to leave it there in a bank account and not use it. Yep. Well, they're just sick of this stuff, and so they can do a lot more and they can be a lot more flexible with pref equity or private debt than they could going through a bank, and that's one of the reasons they would do this. I will point out one more thing this opportunity is not going to last forever. When interest rates go down and when banks loosen up again, the pref equity opportunities we're seeing now will probably not be here. At least they won't be as profitable as they are now. 

23:52 - Whitney Sewell (Host)
Yeah, yeah, no, I think that's a. It's an interesting point to think about that. A developer, somebody like that would pay more right, but it's more for the flexibility, I think, and the knowing that there's not going to be some kind of requirement like that upfront right and maybe get draws on time and with less requirements or things like that that could delay a process, you think you're getting a better interest rate but, man, if it delays you six months to get the money, that's a problem, right For a developer. So, paul, grateful for your time, and just laying out, man, what is a preferred equity of the capital stack? Where does it live in there? Some questions that investors often have about this type of investing, some pros or cons and whatnot. Tell the listeners how they can get in touch with you and, before you do well, remind them. Paul's going to be back for another segment. Tomorrow we're going to dive into another topic. He's definitely an expert in Paul. Where can they find you? 

24:47 - Paul Moore (Guest)
They can follow me on Twitter at Paul Moore, p A U L M O O R E, at Paul more invest, or they can get more information on prep equity or many other topics at our website. It's wellingscapitalcom, that's W E L L I N G S, wellingscapitalcom, and if they want to do wellingscapitalcom slash resources, we can get thema free special report on all kinds of different topics. Thank you for being with us again today. I hope that you have learned a lot from the show. 

25:19 - Whitney Sewell (Host)
Don't forget to like and subscribe. I hope you're telling your friends about the real estate syndication show and how they can also build wealth in real estate. You can also go to lifebridgecapitalcom and start investing today.