WS1920 LP Investing Insights | Aleksey Chernobelskiy

Welcome back to the Real Estate Syndication Show! I'm your host, Whitney Sewell, and today we had the pleasure of speaking with Aleksey Chernobelskiy, an expert advisor for LP (Limited Partner) investors in the real estate syndication space.

Aleksey brings a wealth of knowledge from his experience managing Store Capital's $10 billion commercial real estate portfolio and his impressive educational background as a quadruple major from the University of Arizona. He now shares his insights with nearly 2000 investors through his Substack and assists GPs (General Partners) with various aspects of LP relations.

In our conversation, Aleksey emphasized the importance of LPs taking their time to understand deals and maintaining a healthy dose of scepticism when evaluating potential investments. He also highlighted the need for LPs to be sensitive to the GPs' position, as they manage inquiries from various investors.

We dove into Aleksey 's article on the top 15 syndication mistakes, discussing how LPs should approach deal splits, preferred returns (PREFs), and IRRs (Internal Rate of Return). Aleksey stressed that LPs should not focus solely on IRRs, as they can be misleading and often depend on aggressive assumptions. Instead, he advises LPs to understand the risks and the factors that could impact the deal's success.

We also touched on the topic of fees, with Aleksey  explaining the rationale behind acquisition fees and the importance of transparency from GPs. He pointed out that while fees are necessary for GPs to operate, LPs must understand how these fees impact their investment from day one.

For those interested in learning more from Aleksey , you can find him on  LinkedIn, and his Substack, where he regularly shares valuable insights into the world of real estate investing.

Thank you for tuning in, and don't forget to like and subscribe for more expert advice on real estate syndication. Share the show with your friends and help them become better investors too!

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Transcript

Aleksey Chernobelskiy: First, I'll just comment that as you're starting as a new LP investor, you should tend towards spending more time on everything and giving the GP the benefit of the doubt on everything. Until, of course, you have to ask and see what they say and sort of have a healthy dose of scepticism, which is what I always call it, which is good for investors.

Whitney Sewell: This is your daily real estate syndication show. I'm your host, Whitney Sewell. Today our guest is Aleksey Chernobelskiy . A leksey, is advising LPs on investing. He writes weekly to almost 2000 investors on his sub stack. He helps GPs on matters relating to LPs such as capital calls or feedback on investment decks. H e previously ran Store Capital's $10 billion commercial real estate portfolio and oversaw the firm's underwriting team. A quadruple major from the University of Arizona in finance, mathematics, economics, and accounting. So Alexa is just a value, such a large value of information here. And this, we're gonna do a couple of segments with him, but we're gonna dive into something he wrote around several topics that make you think, right, as an LP. And we're going to go into a number of those today. And then another segment, most almost completely focused on capital calls. It's a very big thing that's unfortunately happening right now that you're going to want to stick around for. You're going to, because of these two segments, you're going to be a better LP and GP. Lexi is honoured to have you on the show. I've heard many great things about you, your skill sets and your, ability to advise LPs, even , on what deals to invest in. And we're going to jump through a number of things during these segments. I know and highlight your expertise that I know are helping many, but before we do, man, give the listeners a little bit more about this background of yours, which I feel like I'm a little bit jealous of because you have some skill sets that, uh, man, I wish that I had as well.

Aleksey Chernobelskiy: Yeah. Hey, thank you so much for having me on in terms of background. I, you know, I think there's a lot to discuss, but I think the most relevant was the experience of store capital, which is a public reach. I led the underwriting and portfolio management teams there. So. Um, on the one hand, the job was to run a 20 person team that runs the existing, uh, at the time, close to $11 billion, uh, portfolio, all commercial real estate assets in, um, in the U S so close to 3000 properties. Um, and I also ran the underwriting team, which essentially means that, you know, on any given week, would look at a dozen or so, sometimes more, sometimes less deals. And we had to sort of very quickly decide whether something met the risk reward parameters that we're after, or we needed to ask some clarifying questions. And, you know, that was an exercise in its own right of sort of just understanding how risk reward works, how to sift through deals, how to be really nice to the people on the other side, right? Like you don't want to drag people along with a bunch of questions that are irrelevant, right? So yeah, I'm happy to kind of address any questions in terms of my life, so to speak, after the REIT world. I left two years ago, have tried several things and most recently decided to start a venture on the LP advisory side. So right now, I guess the easiest way to explain it is advise existing LPs, mainly today that's capital calls, right? People that don't really understand whether they should invest in capital calls or not. Um, future LPs, in other words, you know, uh, someone wants to place a hundred grand, 500 grand, a million. Um, and it helps them look through a deck, uh, and or supporting materials and come up with, um, a better understanding of, of the risks involved in the deal just so that they don't, don't go into it blind. And then the third thing is, from time to time, GPs will reach out, and I help them in some ways as well, with the exception of raising money, because I think that would sort of like impair my independence. Yeah, so that's a little bit about me.

Whitney Sewell: No, that's awesome. I love the background. And not just everybody has led a underwriting team, you know, that with a portfolio of 11 billion or 3000 properties, so grateful for your expertise and, you know, and how you're even using it now to help others in their investing and And, you know, one thing I wanted you to be able to elaborate on, you talked about, you know, quickly decide, right? You know, if something fit or not, even appreciate how you said, you know, how to be nice to the folks on the other side, right? Not every deal is going to work, but even respecting their time, like, what are the questions that we need to know about this opportunity that's going to help you understand that risk reward, you know, ratio there. But, you know, How about we dive into that exercise a little bit? I'd love to know, uh, you know, I know the listener, I probably call it the listener's attention as well. You know, the exercise that helps you do that. Uh, and then I know there's a number of things we're going to, or a few other things we're going to talk about, but thankfully we have Alexa for a couple of segments here at least. Um, and so the listeners know, but elaborate on that, the exercise, right. Uh, and, uh, you know, so you can make some of those decisions, uh, quickly.

Aleksey Chernobelskiy: Sure, so I'll tell you two things. First, there's a reason why the exercise I think is important. Even though I advise LPs, I think LPs would not be in a good place without happy GPs and incentivized GPs, both from a fee structure and a promote structure. Now, you know, something I firmly believe in is being able to ask questions and the idea that if you're not getting good responses, then you should not feel pressured to sort of give in and just invest. The flip side of that is also really important because LPs need to be sensitive to the fact that, you know, GP has many investors and all types of investors are asking different types of questions. And so, you know, you sort of need to do your homework. before realizing whether you want to ask questions or not, right? In other words, many times you'll look at a deal and you'll just know that it's not for you, whether that's because there are way too many questions and sort of like the probability of getting good answers is low, or perhaps it just doesn't meet your goal. For example, if someone wants a cashflow deal and this is a development and cashflows won't start for a few years, So like, you can just pass immediately and not ask them any questions about the deck. Right. And I mean, that's just a simple example, but there are many sorts of similar but not as extreme examples that apply. So just to start the conversation, I think it's important to be sensitive to both sides. In terms of the actual conversation, what I think a part of the discussion today will, I think, be an article that I put out, which is called the top 15 syndication mistakes. What I would recommend that everyone do, and the reason why I put this together was I sort of, see the good and the bad from the LP side. When you see a deal go sideways, you can almost always go back to the original deck, to the original model. discern the questions that you could have asked, but didn't. And I'm not talking about, you know, predicting COVID or something crazy like that. But there are certainly things that should have been in your due diligence that weren't. And I think it's really important to simply look at all the factors of a deal together, right? And not pass too quickly. That's also really important. So meaning, On the one hand, you want to do this quickly, right? As we pointed out, Whitney, at the beginning of the conversation. On the other hand, you can't do it too quickly based on a variable thinking that it means something else. So I'll give you an example of both. First, I'll just comment that as you're starting as a new LP investor, you should tend towards spending more time on everything and giving the GP the benefit of the doubt on everything. Until, of course, you have to ask and see what they say and sort of have a healthy dose of scepticism, which is what I always call it, which is good for investors. But I think it's really important because investments are tricky, right? So I'll give you an example. One thing I hear all the time is, Hey, you know, isn't it crazy that I got a deal from a GP and there's a 50- 50 split? Um, I couldn't believe that, like, what were they thinking? I passed immediately. And I speak to the LP and I say, well, like, so in other words, you, you didn't tell me enough information to know if that's good or bad. For example, you know, let's say a standard breath. split is like 78% preferred, 70 to 80, and then the remainder in terms of the split. But let's say that the 50-50 split, I'm just making this up, but if someone says 50-50 split, I pass, but then you realize that the pref was 10%. It's like, oh, well, I probably should have looked at that. Or perhaps it's a 50-50 split, but the GP is contributing 50% of the co-invest and typically it's way less. So all of this is part of what I would call sort of like a slow and steady investment process. And I think it's very easy to find reasons to pass on a deal, but it's just not the way of the investor. Yeah. Yeah. So I think going back to your example, it's a holistic approach, right?

Whitney Sewell: I mean, you're looking at many other aspects as opposed to just having a hard and fast thing that, Oh, nope, the prep wasn't this, or the split wasn't this, or the fee was this. Well, there may be something else that's good about this or compensates that completely. Right.

Aleksey Chernobelskiy: I'll just add again, that the way that I started this was over time, you get much better at this and quicker. Right. So the reason why I wrote this list is. As you get quicker you sort of realize, Oh, maybe it's a 50- 50, but let me look at the prep. Let me look at the co-invest. Let me look at a few other things. And within a minute, you might be able to be like, well, okay. I know that it's not a 10% prep. I know they're only contributing 2% of the co-invest, et cetera, et cetera. And then you, you pass within. I mean, it could be a minute, right? But, it takes time to develop that skill set and reps . being able to see the deal from a holistic perspective.

Whitney Sewell: Yeah, you know, and I think that that goes right along, along with, uh, obviously this, you know, the top 15 reasons to stop and think, you know, like the, the article that you wrote, uh, because the very first thing is a syndicated real estate deal, lower than 65%, uh, per cent split to LPs. Well, that's one thing, right? You know, and the next one, social proof, the next one, uh, talking about typical IRRs. Well, again, if you're looking at one of these things, right, well, we need to ask some questions, right? But, that may lead up to your second or first topic or point, right? Uh, to ask questions about some other things.

Aleksey Chernobelskiy: Right. And, and quickly, I'll just add, there's a reason why I call it stop and think I wrote a little bit about that in the article, but for the benefit of the folks listening, um, it's precisely for that reason. In other words, if something, if, your split is 50- 50, it doesn't meet my first criteria. But there might be a reason for that. So it's a reason to stop and think, as opposed to just freaking out and saying, oh, red flag, I pass. Like, that's just not how investments work.

Whitney Sewell: Let's hit a few of these points, and we'll have to do it kind of quickly, unfortunately, I know we could talk a lot about each of these in detail, maybe you highlight a few of these, and then I would love to talk about, you mentioned it actually, currently advising on capital calls. I know many listeners or LPs listen who would have several questions about that, so maybe we talk about that too in another segment, and we'll dive a little more into those, but let's talk about a few of these, at least at a high level. And so the listeners have a better understanding from your article, but maybe hit splits for just a moment, you know, like, you know, the typical, obviously 70, 80%, but you know, when, when would you be okay with that being different? Or what are some things the listener needs to be aware of?

Aleksey Chernobelskiy: I think the first thing is just understanding why it's important. Right. Um, so. When you invest as an LP, you're a silent partner, and you're essentially giving your trust to the GP to do the best job possible on a given deal. The reason why this matters is because any profits, assuming things go well, any profits are split, and therefore, the lower the split to you, the lower the overall returns. And at some point, the returns get so low, so to speak, in the probability that you might as well sort of invest in an index fund or put it into treasuries or whatever, meaning you need to be compensated as an LP for the fact that you are putting your money in a fairly illiquid asset. um, you are a silent investor. In other words, the GP has more or less full control over what happens. Um, and so because of that, there has to be sort of what's called a risk premium, right? Like you, you need to, um, expect more of a return to compensate for that. Um, so that's the basis of why it matters now. Um, I think The most important thing to discuss here, I think, is the relationship between the PREF and the split. It's pretty simple, but many times people miss it. You know, I think 78% is a pretty market in terms of the PREF for the benefit of the listener. And I'll just remind everyone because conversations I have almost every week. A PREF is not a guaranteed return. It can be stopped at any point. In some cases, it doesn't even get paid when it's accruing. So don't just assume that this is something that will get paid. A s an example, I always give the example of a development deal that will accrue a PREF, but it will not be paid current because there's no cash to pay it, right? Until they can pay it. So keep in mind that the PREF is, it's exactly what it says. It's a preferred return. but not a guaranteed one and not necessarily paid in cash up front.

Whitney Sewell: I try to make clear to every investor that it's the first portion of any cash flow.

Aleksey Chernobelskiy: Exactly. Yeah. Yeah. And then, you know, in terms of the split, I think they're related. In other words, that's another thing that I think companies need to understand Generally speaking, and this is sort of in a vacuum, ignoring everything else in a deal, is just a little hard to do, but as the PREF goes lower, in other words, your preferred return to the LP is lowered, you would expect the promotes to you as the LP being higher, right? And that's an important relationship. Again, going back to our example, if you see a deal that is, let's say a 10% PREF, you're like, oh, okay, that's above market. Then you look at the split and it says 50-50. So then you're like, okay, that's below market. But now it makes sense why it's below market because the pref is above market, right? So these two variables sort of coexist, right? And I would also say that it's important, I think, to know, especially over like, a short- duration deal, right? And by that, I'll say less than five years, right? It's incredible how much people overweight breathe where the additional 1% kind of doesn't matter. So in other words, don't be the person who says, oh, I'm getting, instead of an 8% PREF, I'm getting a 9% PREF. And because of that, I'm willing to give up 50% of the promote. The promote in the majority of deals, especially anything value-add related, is where all the value is held. And so your extra 1% is not that significant.

Whitney Sewell: Yeah, no, I think it's, it's, yeah, we can't look at any of these things in a vacuum. Right. It goes back to your very first point. Uh, but you know, even with those things in mind, you're talking about split, you talked about the pref, um, you know, I'd love for you to dive into, you know, even your third topic there on your paper, which I would also encourage listeners to, uh, to look up. We'll have a link in the show notes as well, but IRR. Right. And, you know, I hear some, some passive investors or LPs say, you know what, I don't look at IRR and some of them are like solely focused on it or, or, you know, I've heard a lot of different trains of thought behind, you know, what they feel like IRR should be or whether they should, you know, they focus on a completely different metric. Um, but I would love your thoughts behind, you know, that typical range there, but then also, you know, how much focus you put on it.

Aleksey Chernobelskiy: Yeah. Um, I mean, I think anyone that has looked at a model, and I always recommend LPs to look at a model, they can, with almost high certainty, understand why I don't recommend sort of basing investment decisions in IRRs. IRRs are typically very weighted towards two or three assumptions in the model. One of the most, sensitive ones tends to be the exit cap rate. In other words, the exit valuation of the property when you sell. And that both depend on sort of market cap rates at the time, but also the NOI that you're able to achieve, which itself sort of depends on your assumptions, right? And, so because of that, actually, I very much, try to tell LPs not to focus on IRR because I think what happens is you sort of self-select the GPs. You're almost like you're biasing your funnel into GPs that across a large enough sample size are somewhat aggressive in their assumptions. R eal estate, generally speaking, is not an asset class that returns 20, 30, or 40% IRRs. And so when you're seeing high IRRs, two things could be true. Either they're conservative assumptions, or they're aggressive assumptions. With high RRs, it tends to be the case that more of them are aggressive assumptions. So if you sort of like have this funnel that says, if something is in a 20% AR, it's not worth it for me to look at it, then what happens is the bucket of things that you look at tends to be riskier on average. Whereas the GPS that thinks about numbers and is careful to, for example, assume capital compression and other things that might umpire are significant, so they sort of get. lost in the tracks because like, you know, their 15% IR isn't high enough, so to speak. Um, but the reality is, is only 15 because they're showing you a conservative case or certainly hope it gets higher. They hit higher than that, but , they're just not comfortable showing that as the base case on slide two or whatever it is. So, I, um, hopefully that helps. I just, I think it's, yeah, it's really important to look at it in a vacuum.

Whitney Sewell: Yeah, something that you mentioned there that stood out to me is, is you must look at what's going to accomplish that IRR for this project. Right? You know, it's like, what, you know, what's the operator counting on to gain that high of an IRR and that one thing alone may never even happen. right? You know, or what's the risk of that one thing not having whether it's a refi, right? Or, you know, big cash payout, right? You know, or they have to sell in year two to accomplish this, this IRR. And that may not, you know, if they bought it last year, well, you're probably not getting that IRR that they projected, right?

Aleksey Chernobelskiy: That's right. And it's, I always tell people you, if you can't find the top three downside catalysts in a deal, you shouldn't invest. In other words, in any deal, you're looking at, nothing is risk-free, real estate is not risk-free, it's not necessarily safe. It can be if it's acquired right, right? But it's really important to understand that even the right investment can have challenges. And if you as an LP can't identify, let's say the top three challenges that sort of have the highest impact on your IRR and get comfortable with those challenges so that you go into the investment knowing what could go wrong, then I just say don't invest.

Whitney Sewell: Yeah, no doubt about it. Y eah, I love that. Just thinking through several things man, what tells us that we shouldn't invest? And you know, anyway, I want to be able to get to a couple other things here before we have to move to the next segment. But, you know, you laid out the area, anything higher than a 3% acquisition fee should be, you know, something to think about, right? I like that. But then just fees in general, right? No clear outline of fees. I could not agree with you more. I want to be extremely transparent about where the funds are going, right? When we do a deal, I want every LP to know exactly what we're charging or what fees the deal is going to have. And obviously an acquisition fee is one of those. And you said one to 2% is common. Maybe elaborate there, you know, on when you see a 3%, you know, when you're, when you're okay with that, you know, when, when is that okay? Or when you've seen higher than that, even.

Aleksey Chernobelskiy: Yeah. Yeah. So, um, actually in the, in the same top of teen syndication mistakes article, I sort of outlined the fact that, um, at some point, a GP has so much experience and success that they could sort of stray away from the pack and charge more. Just because, I mean, at the end of the day, fundraising is a supply and demand story. And if you can charge more and I don't even want to say get away with it like there's nothing. I mean, if you're delivering amazing returns for your investors, you deserve to get paid more than the guy next to you who doesn't have that track record and abilities. T he example I pointed out is Renaissance, which is not in the real estate world, but I think they're sort of a guiding light, so to speak, in this world of extremely high fees, but an impeccable almost track record. In terms of fees as a general point, first, I'll just remind the listeners, especially in LPs, of The reason why fees matter, and I have an article on this, it's called Why acquisition fees in a syndication matter. The reason why they matter is because as soon as you place your money, you're immediately down on your investment. So for example, if, and this is a big misconception that I just don't address right away. Many times people say, oh, what's the big deal? It's just 6%. Well, 6%, in other words, what's the big deal of being 6% down on your investment day one? The reality, however, is if you do the math and you realize that the 6% isn't of equity, it's a purchase price. And that purchase price is levered, right? So for example, if you're investing in a deal, and I have a whole table in that article, if anyone wants to see it, but if you're investing in a deal at 6%, acquisition fee and they're 75% leverage. So that means day one, and I'm ignoring all other fees and closing costs. Sometimes there's like personal guarantee fees, all types of other things. If you're 75% levered, your money is down 24% on day one. So you l ost 24% of your money. And of course, I hope He thought about that and he sort of recovered because the investment is so good. But the impact of my point is the impact of fees is very real when you look at it. And I think you should be aware of sort of. where your money stands on day one as you go into the transaction. And in terms of market rates, as I said, I think one to 2% is common. 3% can be seen sort of like on much smaller transactions. As a percentage of purchase price, the percentage sort of tends to go up a little bit. Above 3% is pretty rare. It happens. And I think generally speaking, Well, one of, one of two things is true. I'll just be candid that either the GP is just like a phenomenal GP that can get away with it, so to speak. Um, and, and, and deserves that. Um, or, uh, to be candid, this is more often the case. Um, the GP is dealing with sort of like a retail base of investors. I just don't know any better. Like they just see it and they're like, Oh, real estate pool opportunity for me. Amazing. And they just don't even understand what the fee means. They just see the IRR, you know, passive income story, retired from your nine to five or whatever, you know, the best slogan is, and they just put their money, you know, without understanding it.

Whitney Sewell: Yeah, I've seen it both ways as well. And even as a passive investor myself and have questioned maybe a higher acquisition fee, but I figure out, hey, they've done this. You know, they've had 30 successful deals or, you know, I mean, like there's a track record that supports that or builds my confidence in a way that I'm willing to pay it. Right. But I would say that's not always the case.

Aleksey Chernobelskiy: It's not always the case. And I think I would say just from my experience, when you go above 3%, I would say it's more often the case that there are issues with the GP or the deal or both. It certainly happens that there are exceptions to the rule. And while we're on fees, by the way, I just want to mention, fees are there for a reason. In other words, I think many LPs don't understand this. you know, the GP typically puts in months, sometimes, sometimes a year plus of work, deal after deal to get into something that they're presenting to you. Hopefully, this is not always the case, but hopefully, they thought long and hard about this deal and pass on many others in order to get to this one. And so there's sort of like the sweat equity built in. But in the meantime, they have an analyst and an associate or the VP and the CEO and the principal, whatever, like people need to be paid. And so Sometimes you lost money during diligence on a prior property, which you decided to walk away from to be, you know, an ethical GP. Um, right. So, so like there's a, there's a reason for fees. The reality is the GP runs on fees as a company. Um, and so they're super important. It is just the answer is both. In other words, the GP needs fees, but the LP also needs to understand how the fees that are being charged, uh, a, what are they? because sometimes they're not clear and B, how did they impact your investment?

Whitney Sewell: Yeah, I think that's very well said. And I appreciate you highlighting that for the GP as well, because it's so true, right? It's a major investment to get a deal to the finish line, right? Or to the closing ly the starting line, but you know what I mean? To get it closed, there's a major investment that's been made across our entire team and through due diligence and whatnot. and maybe on numerous projects, right? But it almost goes back to the beginning of the conversation, too, thinking about the holistic view here of the deal, you know, and not just looking at fees in a silo either, but stopping and thinking about it, you know, like you're like you're talking about. Let's think about it for a minute in an overall picture. And so I appreciate that in a big way. I like to say we're going to end this segment here. And we've covered so many things already in just a short amount of time here. I'm looking forward to continuing the conversation with the listeners. So now we come back tomorrow. We're going to continue talking about a number of things. I want to dive into some things around capital calls as well, because I know there's many listeners who have questions about those. Also, as that's happened, probably more than the last six months, 12 months than they've experienced in the last many years or several years. And so, Alexa, grateful for your time. Oh, I wanted to mention too, and Alexa brought this up before we even started recording, just said, hey, you know, he's on the shoe he advises passive investors, but that doesn't mean we're endorsing each other in any way. We just met and are trying to learn learn from him and help educate our audience from his expertise. And so I'd like to thank you again. How can the listeners get in touch with you and learn more about you?

Aleksey Chernobelskiy: Yeah, I mean, I think my name is pretty unique and generally not pronounceable. You know, I even Google it. I'm fairly active on both Twitter and LinkedIn, where I just put out free content based on what I see day to day. And I also write twice a week to a bit over 2000 investors on lplessons.substack.com.

Whitney Sewell: Thank you for being with us again today. I hope that you have learned a lot from the show. 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 lifebridgecapital.com and start investing today.