WS1925 Preferred Equity in Real Estate | Highlights Paul Moore

In this insightful highlight episode, we had the pleasure of reconnecting with Paul Moore, a long-time friend and the driving force behind Welling's Capital. Paul shared his journey from writing "The Perfect Investment" to recognizing the need for a more robust acquisition strategy in multifamily investing. He detailed how his team expanded into various asset classes, including self-storage, mobile home parks, RV parks, and more, ultimately transitioning into a fund manager role.

Paul explained the concept of preferred equity, a topic that has generated significant interest among investors. He broke down the capital stack, illustrating how preferred equity fits between senior debt and common equity, offering a blend of immediate cash flow, future upside, and payment priority over common equity. He emphasized the importance of due diligence and the unique opportunities presented by preferred equity, especially in the current economic climate where traditional lending has tightened.

We also delved into the world of RV parks, an asset class that has seen tremendous growth, particularly during the pandemic. Paul categorized RV parks into four types: overnight, extended stay, workforce housing, and destination parks. He highlighted the profitability potential of each type, with a special focus on destination parks that offer a range of amenities and activities.

Listeners can expect to gain a deeper understanding of the nuances of real estate investing, the benefits of preferred equity, and the burgeoning RV park market. For those interested in learning more about Paul's work or exploring investment opportunities with Welling's Capital, visit wellingscapital.com or follow Paul on Twitter at @PaulMooreInvest.

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Transcript

Whitney Sewell: 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. You and I were playing music together. The listeners probably don't know that, but they, 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.

Paul Moore: 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?

Whitney Sewell: 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.

Paul Moore: Okay. Well, you, I think you really are.

Whitney Sewell: So. I appreciate the kind words. Well, Paul, you are, I mean, you have pushed forward in many ways 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 Welling's and you're all's focus and, and then let's dive in.

Paul Moore: 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 to 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 some 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, you know that I read the book, The One Thing by Gary Keller and Jay Papasan, 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 or 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, 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 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 rate ups and downs, and all that.

Whitney Sewell: 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. It's so much easier. So I love that. So, but 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?

Paul Moore: 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.

Whitney Sewell: 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 or 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 we'll specifically dive into preferred.

Paul Moore: I sounded, 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 parks, so. Anyway, I was being silly. But yeah, so we as a fund, we're 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, I'm thinking of a couple self-storage conversions near Boston. They didn't even hit the public at all. They just went to friends and family. We were one of those friends. 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.

Whitney Sewell: 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.

Paul Moore: 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% in 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 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, which would be like a second loan, a junior loan, or it can be filled by preferred equity. 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, 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. It 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% common equity, if the cap rate expanded or net operating income dropped, and 25% 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, like I mentioned. We still negotiate depreciation benefits. We still get paper losses from depreciation passed through to us. In fact, in one case, we got 100% 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 forced 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 forced 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 100% whole in the sale. So that's some of the benefits of craft equity in general. I'll take a breath, Whitney.

Whitney Sewell: Yeah, no, that's great. I just appreciate 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 a 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 or the other?

Paul Moore: Yeah. So typically the, some people, by the way, think this is, oh, they think, oh, I'm a, 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. So in the deals in pref 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. I want to point out too, that 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, and that is a deal's 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 and says, okay, we're going to give you egregious terms and we're going to possibly have forced 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. And we're also not doing development pref 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, back in my capital stack, if there's a 15% pref 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's stake in the deal. And so it's really good for everybody if it's done right.

Whitney Sewell: Yeah, I think it's, 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. Cause I think there's definitely going to be a need for that to more and more, unfortunately. But you know, on the acquisition side, you said most of the time, that's what you all are doing. Value add types of deals. Are there other types of deals that this would be considered for?

Paul Moore: 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 gonna be like four or five more year term. But one of the parts 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 PREF equity when that debt's gone, just to be the only, in other words, we would be in first position in that case. We would just be they'd have pref equity and common equity only or possibly GP equity on that deal. So that's another type. Another one would be to 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 pref 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 adds, 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.

Whitney Sewell: 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 on this fund should be asking an operator or fund manager like yourself, knowing that this is the piece of the stack that we're investing mostly in?

Paul Moore: Yeah, I mean, I think I get, 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 person before you invest, 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 going to 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, just because it's in a safer place in the capital stack, you still want to see all the due diligence you would any time you make any investment. Truly, it's less likely to lose money, but it still could lose money if the deal goes south entirely. 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, and most of them don't want to mess with it under $10 million. So a lot of the shops out there, as they're called, or investment funds, they want to go from $10 to let's say $100 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 10 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. There's so few people out there wanting to do this right now. I mean, we're seeing coupons 10%, nine or 10% current pay. plus another 5, 6, 7% on top of that. So we're seeing total coupons in the 6, 15 to 18% 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 pro 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 adds really work, well, they can confidently say, hey, it might cost us 16% for two and a half years, but we'll be out, and then we'll acquire that, or we'll distribute it among the whole equity investors, depending on how we go about taking the pref equity people out.

Whitney Sewell: 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 and say, Hey, we got the, the 7 million you need tomorrow with everything checked out. Right.

Paul Moore: Right.

Whitney Sewell: 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 given 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.

Paul Moore: Yeah, I mean, 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 add. 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 GP capital. And they paid us 15%. And that was like, rather than split it into 10% current and 5% upside, they just said, well, let's give you 15% right up front. And they gave us a whole year in advance. And so at closing, instead of giving them 5 million rough numbers, 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 in treasuries, and we're feeding it out one month at a time out of this reserve account into our fund. 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. This guy is the boss. 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 tightened 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. 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 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.

Whitney Sewell: Yeah. Yeah. No, I think that's a, it's an interesting point to think about that a developer or somebody like that would pay more, but why is RV parks one of those you're considering?

Paul Moore: Yeah. So we actually wanted to invest in RV parks for a couple of years and we didn't have an operator that we really knew, like, and trusted. Did I say that right? And we were, we finally found one and we're really surprised that, I mean, COVID has just accelerated a long-term trend. I mean, RV park ownership had already risen over 62 percent this century so far, since 2001, and there are 11.2 million U.S. households that own an RV as of a year and a half ago, and 9.6 million more said they wanted to buy one. 20, over a quarter of new campers, RV campers were new in 2020 alone during the pandemic. I mean, when a lot of people were hiding in their basements, a huge percentage of people hit the road with RVs and The RV park, the demand on RV parks was enormous. RV parks have continued to experience growth since then. The rate of new campers has just, I mean, in 2020, 21, and even into 22, until interest rates started going up. The demand on parks was significant, and we really believe that this is a trend that even though it's slowed down now with the interest rate rise, those RVs are still on the road. Those people are still using the RVs, and for a couple reasons I'll get into later, we think that the demand on RV parks will continue to increase for a long time. Wow.

Whitney Sewell: And so I've experienced those things firsthand. And so RV developments speak to that. And, and is that a growing trend? It probably is. I would imagine.

Paul Moore: Yeah. Well, let's start by talking about the four different types of RV parks. First of all, you've got overnight parks and those are light on amenities, heavy on convenience. There might be right by the highway. And it's a place that people stay on their way somewhere else. A second type you just mentioned, and that's what reminded me, and that's the extended stay RV part. Now we both know where Smith Mountain Lake is. If you haven't been to Smith Mountain Lake, you need to come. It's the Tahoe of the East. Uh, Whitney, you live right next to Smith mountain Lake or right near it. And am I supposed to say that on here? They can never like it. Okay. I didn't think so. So there's extended stay parks there at Smith mountain Lake that have like a seven year waiting list. People build decks around their RVs and they actually stay there permanently. I, my cousin had a place for like 20 years at an RV campground. They had a permanent place set up that that was permanent. A third type that's not really well known is workforce housing. We saw a lot of this in North Dakota during the oil boom. And then the fourth part, the fourth type is destination RV parks. Now there's two types of destination parks. One is near a like Branson, Missouri, or Gatlinburg, Tennessee, or one can be the destination, and some are both. And so being the destination means the park has a lot of amusements, it might have limited food service, It might have cabins set up. A lot of people come in their RVs and they want their extended family or their in-laws to come, and they don't have an RV, so they might want to stay in a cabin. Some of them have swimming lakes, fishing lakes, water parks. drive-in like a drive-in theater screen putt-putt golf might have golf cart rental all kinds of things a lot more than that face painting and gem mining and t-shirt painting and hayrides all this kind of stuff some of that's paid some of them even have wibbits

Whitney Sewell: I don't know what that is.

Paul Moore: I didn't think you did. So wibbits are a floating obstacle course out on a swimming lake. And so if I. if I could share my screen just really quick, because I know people are going to be super curious. And I know all of you who are listening are going to be so jealous of the people who are on YouTube that you're going to want to go over to Whitney Sewell's YouTube channel right now. That's Whitney Sewell. OK, sorry. Anyway, this is Wibbitz, for those of you who can see that. It's a floating obstacle course. Can you see that, Whitney? I can. And so those are about $200,000 or $300,000. You can see that this is about a half a million dollar lake, including the beach here. It's about a five acre lake. This is at one of the parks that we invested in. And with it are these floating obstacle courses. You can charge the kids or adults $17 an hour. to run and play and jump and splash and all that stuff on these. They have slides and stair steps and places you can climb in and under and around. And an RV park operator can make about a thousand dollars an hour during the high season as a value add from just wibbitz.

Whitney Sewell: So I mean, I could see my kids loving that. I mean, it would be well worth $17 for them to get to run around on that thing.

Paul Moore: Wouldn't it? That's incredible. And you could get some work done.

null: That's right.

Whitney Sewell: Yeah. Yeah. They'd want me out there with them, but anyway, so Paul, you listed out these different types of parks and I didn't realize that there were so many different types or I guess I have a number of these, but what's the most profitable type? Well, I know there's pros and cons, but you got to be more interested.

Paul Moore: I just don't have an answer because I can imagine. So let me just finish the, you asked me about development. So developing one of these destination parks, I mean, one of them we invested in was like three or $4 million near Branson, Missouri. But it had an 18 to $20 million all in budget because they bought land around it. They expanded it from just, I think it was 61 sites to over a hundred sites. They added a whole bunch of cabins. They added maybe, and I'm thinking of different ones we've invested in now. Some of them have like maybe a wedding venue, a camp store, food service, human foosball table. Try that one. All kinds of things that they've added. And so the development's really intense, but so is the labor. I mean, some of these take over a hundred employees to manage in the summer, almost like a little amusement park. So the question, is that more profitable? Well, those are projected to cash flow to investors net really high. Actually, I'm probably not supposed to say how much because I have a compliance person who listens to these and she may want me to cut out projections like that. But the I can say that they cash flow, they're projected, excuse me, are targeted to cash flow in the teens or even higher. I would say it depends on your cost, your operating expenses, your capital, your debt structure, all that. But I can imagine any of the four being quite profitable. I mean, I know that when we were doing some things, we were doing workforce housing up in North Dakota, as you remember, back when you and I first met, we were making incredible profits from leasing spots to oil workers. That was about 12 years ago, and the oil companies were paying a massive amount of money to have their employees stay there.

Whitney Sewell: Yeah, I enjoy the asset class myself as far as going and camping, but we don't own any yet. And so I just, I love the exposure though, that you're offering investors in numerous asset classes and even considering RV parks. And maybe why would you even through your phone consider development versus park that's already operating or are you?

Paul Moore: Yeah, so we're only investing with one operator. We, we are really very, very fixated on finding the right operators with the right track record with their own money in the deals, a lot of their own money. And we, the only RV park operator that we have found that we love is doing either buying cash flowing parks. So they're cash flowing from day one. But they're expanding them dramatically. Like I told you about the one in Branson. And so that's, that's the operator we like. And so therefore we're, we're sticking with them for now. If there are other RV park operators who might be a fit, we would certainly be open to that down the road.

Whitney Sewell: And so just grateful for your expertise, Paul, and your willingness to educate and share with us today. Again, tell the listeners how they get in touch with you and learn more about you.

Paul Moore: Yeah, I'm really doing a lot on Twitter right now, or X. It's at PaulMooreInvest, or you can come to our website, wellingscapital.com. You can get a free special report on RV park investing by going to wellingscapital.com slash resources.

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.