August 6, 2025 • 66 mins
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Joe Ryu, manager of Prospect Capital's private real estate credit fund, shares his journey from investment banking through the Great Financial Crisis to his current role in real estate credit investing. He explains how private credit offers attractive risk-adjusted returns through specialized financing structures that combine agency lending with subordinated positions.
• Real estate private credit involves loans on commercial properties that don't freely trade, typically accessed through institutional investors
• Private credit investments often offer higher returns with less volatility than public market equivalents, though with reduced liquidity
• Prospect Capital's strategy creates value by partnering with Freddie Mac to provide borrowers with competitive financing while maintaining conservative risk profiles
• Unlike many competitors who use fund-level leverage, Prospect's approach avoids taking on additional debt at the fund level
• Private credit valuations are more straightforward than equity valuations since loans are only impaired if property values fall below loan amounts
• Focusing on stabilized, cash-flowing multifamily properties reduces risk compared to development projects or challenged office assets
• The real estate capital stack typically includes senior debt (60-70%), subordinated debt/preferred equity (10-15%), and equity (25-30%)
Join us for our next episode as we continue exploring alternative investment opportunities that can help diversify your portfolio while aligning with your financial goals.
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Steve Davenport (00:03):
Hello everyone and welcome to Skeptic's Guide
to Investing.
Today we're fortunate to have aguest.
Our guest is Joe Ryu fromProspect Capital.
Joe is the manager of theirprivate real estate credit fund
and today we're going to talkabout Joe and how we got into it
(00:23):
.
First of all this is a new thingfor us we're trying to bring in
other asset classes and otherideas on investing so that
people who hear private creditwill have an idea now what it is
what you're investing in andhow it might work for them.
I think that we can spend a lotof time, clem and I, talking
(00:46):
about these things, but Ifigured why not bring in an
expert?
And Joe has been doing this fora while and he's got a great
fund and I think it's worthhaving his perspective versus
just Clem and myself.
So, again, we're doing thiswith video so that people can
enjoy the banter and the facesand the hand motions that we're
(01:09):
going to do to each other, someof them involving fingers, which
may be, you know, less thanpolite, but that's the way it's
going to be sometimes.
So, joe, if I look at yourresume and your career, it seems
like you took a different paththan a lot of people who
typically want to work for.
(01:30):
You know the private equityfunds and the private or the
equity management of individualnames for investment banks and
other places.
Can you talk a little bit aboutyour background and?
Joe Ryu (01:46):
how you got into private credit.
Sure, absolutely so.
I graduated in 2000 and, in amarket where the idea was, you
know, try to survive in thedot-com boom, get a job anywhere
you could and you'd probably bebetter off than a lot of people
(02:08):
suffering from where the marketwas, my desire was to go into
finance.
It had always been thedirection I wanted to go, so
thankfully I wasn't competingagainst a lot of my computer
science colleagues that couldn'tfind a job.
Ultimately worked in investmentbanking for many years and at a
(02:34):
middle market shop called Duffand Phelps for the longest
period of time, right throughthe great financial crisis, and
it was in that organization thatI got my first kind of flavor
for real estate.
And there was an IPO that weworked on of a office REIT in
(02:59):
Santa Monica.
They're still publicly traded,it goes by the ticker DEI,
douglas Emmett, and they were atthe time a public REIT manager.
We had taken them public, butpreviously they had about nine
private funds from primarilyuniversity endowments and
(03:21):
invested in core officeproperties in markets such as
Santa Monica, hawaii, west Coast, oriented Through the GFC and,
working in banking, worked withvarious clients that were trying
to raise liquidity andoftentimes the value of their
(03:42):
real estate was worth more thanthe value of the going concern,
and so they tried to monetizereal estate holdings through
various, say, leasebackstructures, often bankruptcy
processes where they wereselling assets to try and
resolve creditor issues.
(04:04):
And so that's where I reallystarted to see real estate and
really get enamored with theasset class.
And then I decided I would gointo business school.
I had seen where my career hadtaken me at that point and
wanted to pursue a career inreal estate.
(04:25):
But at that point in time theonly real way to go into real
estate was either as aentrepreneur yourself and invest
in real estate, or to become onthe institutional side to work
either on Wall Street as aanalyst covering publicly traded
REITs, which I didn't find asvery appealing, or work for a
(04:50):
REIT itself, and that I can getinto more detail.
But to tackle getting into realestate, private equity or real
estate credit, a lot of thosemanagers still to this day are
very selective because they'revery focused on hiring generally
(05:13):
, like they try to say,individuals that have a strong
background in real estate, thathave already done it before, and
so if you haven't done itbefore, it's really hard to get
into that career path unless youtry and use relationships or go
through an MBA route, which iswhat I did.
(05:34):
I went to the University ofChicago for my MBA full-time and
there I did a MBA internshipwith the related companies
during the summer.
They famously developed theTime Warner Center in Columbus
Circle and the Hudson Yardsproject in the west side of
(05:54):
Manhattan, along with numerousother projects largest
multifamily operators across thecountry, including a very large
affordable housing component,which is actually where they got
their start.
The founder, steve Ross, was inaffordable housing, was a tax
(06:16):
attorney.
Now he owns the Miami Dolphins.
That's how lucrative it can be.
Then I had an opportunity tothen decide do I want to go into
real estate development, um, orI had an opportunity to work
part time during my second yearof business school, um.
Trying to recruit for a job, um,during school.
(06:39):
Which is the primary goal of anMBA is you can take all the
classes you want, but you reallyare spending two years to
intern and recruit, network andget a job offer that you really
want to pursue full time.
And on the investment side it'svery less structured.
So if you want to go intoconsulting or marketing or
(07:01):
investment banking, thosecompanies, those big brands.
They come on campus and theytake you to dinner and they take
you to a ball game and thenthey put you through a very
structured recruiting processand they fly you out to their
offices and then they take youthrough numerous super days and
(07:21):
interviews and tests and examsand then they get an offer to
you very quickly.
But if you want to be on theinvestment side and something
that's a little more niche-y,you have to really be
entrepreneurial and figure outhow to get an offer.
I mean, there are programs forsome large firms like Blackstone
(07:45):
that might come on campus andsay we have one job for this
school and we have one job forthat school and one job for this
school, and you can imaginesome feeding frenzy.
So for everybody else, you knowI networked and I found the
opportunity to work part-time mysecond year of business school
at Aries Management in Chicagoand I was doing that during the
(08:12):
day and at the same time I wasstill working part-time for
Related Midwest because they hadsaid hey, you're great to work
with over the summer.
We'll pay you $25 an hour to doyour analytical work and for us
(08:32):
it's free labor.
None of these internships camewith any guarantee of an offer,
but it's the way to kind of getyour foot in the door.
I had to pivot all my full-timeclasses to the evening classes
in downtown Chicago, so it waskind of regrettable it sounds
like a lot of fun, like a goodway to spend it.
Steve Davenport (08:52):
It was pretty regrettable.
Can you just go back to thepoint about real estate, because
it feels to me like if themarket is collapsing in 2008
around you with all of thisextra debt and leverage and all
of the things with problems withindividual structured products.
I mean, do you like workingwith things that are chaotic or
(09:14):
like why?
Why was that attractive to youversus you know a good old, hey,
let's study.
You know corporate bonds andyou know see if the J&J bonds
are better than the IBM bonds.
Joe Ryu (09:27):
Right.
Well, I'll tell you somethingelse that's funny after this.
But during that RMBS crisisthat really we all famously know
blew up on residential mortgagebacked securities up on
(09:50):
residential mortgage-backedsecurities it was very
interesting to study it,particularly also in business
school, to see how the sausagewas made and how it blew up and
how Wall Street will always findanother way to create a product
to sell to investors andgenerate fees.
A product to sell to investorsand generate fees.
And in this interim period ofholding the risk and balance
(10:15):
sheeting some of these loans,you can famously get caught.
And underneath all of that wasthe idea that you can diversify
away your risk or you canstratify the risk away into
certain tranches of debt capital.
That, okay, this is AAA riskand this is risky, and we are so
(10:35):
smart we can tell you what youcan buy and what return you're
going to get and how safe it is.
The theory was fascinating.
Now the execution of it wasreally greedy and so, looking at
how it was done and thefundamental analysis that should
have really dominated over theconversations about how to
(11:00):
execute this, they really weresometimes really disjointed, but
the fundamentals of it, whenyou think about it, they should
actually work to a certainextent.
And so the real estate creditaspect of that blow up really
(11:20):
fascinated me.
And although I never got intoresidential mortgage-backed
securities, which is where thatcatastrophe unfolded the
commercial real estate market,the CMBS market and CMBS 2.0,
having learned from theirmistakes in the past, was really
fascinating to me.
(11:41):
And getting into real estatecredit in business school, um,
was an opportunity to not justtake okay, you can be an
investor in real estate, butthen take approach where again,
you're not the first lostposition, you, you have a little
equity cushion and you cangenerate a pretty attractive
(12:03):
return was where I was reallyfocused on.
Hey, this could be a reallyattractive market.
And sure enough.
As we all seen, the privatecredit space in corporate
lending has blown up.
It's just been a darling andcontinues to be.
And when I was with Aries Ijoined Aries full-time out of
(12:25):
business school that was theflagship business, private
credit business and it kept ongrowing, and so the mantra from
management was hey, real estateprivate credit should be just as
big.
Why can't we make that?
What private credit in directlending is?
(12:45):
And now it's really caught upand it has a lot of learnings
from what we've seen in GFC andCOVID.
So it's been a long road to gethere, but I think all of that
helped form who I am and how Ithink about real estate credit.
Clem Miller (13:07):
So, joe, I've got a few questions and they're more
motivated by, you know, sort ofthe part of our audience who may
be, you know, very unfamiliarwith this particular asset class
, and so so keep that in mind asyou answer some of these
questions.
So, first of all, privatecredit for real estate.
(13:30):
Can you just sort of definethat area?
I mean, what are, what do youmean by that?
Where do the you know, where,who, who originates private
credit?
I think is a a question that,uh, that some might ask you know
who are the typical investors,uh, in private real estate
(13:51):
credit?
You know, how would you, youknow, how would you pair this
with other types of assetclasses so that you're not, so
that you're, you know, amplydiversified?
You know questions along thoselines.
I got more questions than that,but I'll leave you to start.
Joe Ryu (14:07):
Yeah, sure.
So private credit iseffectively a loan that's
originated on typically acommercial real estate property,
and so it could be as simple assaying there is an apartment
building in Brooklyn and thereis a mortgage on it for about
(14:32):
$100 million building and a $60million mortgage.
That mortgage is a privatecredit instrument because it
doesn't freely trade.
It doesn't freely trade.
So when you think about thepublic credit in real estate,
where can you find publiclytraded real estate?
(14:52):
And that's typically in thebonds that are issued by owners.
So publicly traded real estateinvestment trusts that issue
bonds, real estate investmenttrusts that issue bonds or they
issue preferred equity or theyissue any type of term loan
facilities and anything that youcan get that you can buy and
(15:14):
sell freely.
You might have a QSIP, you canbuy from your Schwab account and
say, okay, this REIT is payingme 5% on these bonds and these
bonds mature in 10 years.
They're trading a little bitbelow face value.
I'm getting a little bit morejuice on that return.
(15:36):
So I'm going to buy this bondbecause I think it's money good.
Now, private credit how does anindividual investor get access
to that mortgage on thatbuilding in Brooklyn?
They say, hey, that mortgage inBrooklyn is actually paying 6%,
but I think that's a betterinvestment than giving it to
(15:57):
that REIT that owns officebuildings across the country.
But I can't get that creditinstrument in my portfolio For
that reason.
It's private and it's typicallybeen the domain of institutional
investors like pension fundsthat would invest into whether
(16:18):
they're separately managedaccounts or in real estate
private credit funds to getaccess to those private loans
backed by hard assets.
And because these are largeloans, it's typically the domain
of the institutions that aresupposed to be smarter and say
(16:39):
well, we'll allocate some of ourportfolio to real estate
private credit to get somebetter returns and less
volatility, because in thepublic world you'll see a lot of
fluctuations based on marketsentiment.
So a really strong office REITin New York City is going to be
much different from an officeREIT that has suburban office
(17:02):
properties across the country.
But all of them are going totrade down together in sympathy.
So there are pluses and minuseson each side.
But the private credit spacehas really drawn a lot of
attention and a lot of retailinvestors are now, furthermore,
thinking how can we get accessto this market, and a lot of the
large funds have createdproducts for retail investors to
(17:25):
get involved with here.
Steve Davenport (17:30):
Is there a way to do you look at the like a
benchmark in this space and sayI really hope this property
gives me, you know,benchmark-like performance.
And the benchmark for privatereal estate Southeast would be,
you know, 4.6.
And we're looking at a propertyand that credit is 5.2.
(17:53):
Do we have that kind of detail,or is that kind of where the
magic is in private credit?
Joe Ryu (18:01):
It's a little bit of both exactly.
So you'll want to benchmarkagainst other fixed income
substitutes.
And then, when you saysubstitute, you're going to say,
okay, if I'm going to put mymoney in a private real estate
credit investment on a officeproperty, that fixed income
(18:23):
equivalent is going to be a veryrisky bond the high yield junk
bond, right, because who knowswhat the value of this office
property is.
But if you then are investingin real estate credit backed by
stabilized cash flowingmultifamily investments, that's
pretty strong.
So you'll then benchmarkagainst fixed income equivalents
(18:43):
, whether they're BBBs orslightly higher, depending on
where your leverage is in thereal estate portfolio.
And then, on top of that fixedincome equivalent analysis, you
look at real estate propertyindices and there are numerous
indices published by varioussources that benchmark how real
(19:08):
estate equity funds have, andnot every fund is included in
these indices, it's selected.
(19:32):
So you want to benchmarkagainst two types of competing
products.
There are the real estateindices, which a lot of
institutions might follow.
But, moreover, everyone'slooking at benchmarking against
fixed income equivalents Likewhere can I get that return,
(19:55):
that kind of yield, on a bond,and do I feel that my credit in
the real estate product isbetter than the credit backing.
Product is better than thecredit backing, whether it's a
company in pharmaceuticals or acompany in technology.
(20:19):
You probably look at somethinga little bit more conservative
in terms of their risk,something less volatile.
Probably compare real estate tosomething more of a staple in
consumer products and look atthe pricing of those bonds
versus the pricing of the fixedincome equivalent real estate
credit product that you can getin private credit.
Steve Davenport (20:37):
That's great Thanks.
Clem Miller (20:38):
Yeah, so basically it's income investors who are
interested in this primarily,correct.
Joe Ryu (20:48):
So that goes back to Steve's earlier question about
real estate equity and realestate debt.
Yeah, as I mentioned, anybodycan get involved in real estate.
Everybody who owns a home isinvolved in real estate.
That's a large part of a lot ofhousehold balance sheets and
when you own your own home,you're an equity investor, right
(21:10):
?
So if the price of your homegoes up, you've made an equity
return and you haven't made acurrent income investment.
However, unfortunately, you'reactually paying your mortgage,
so you're net negative on acurrent income basis, but your
expectation is in 30 years ifyou pay down your mortgage.
(21:30):
If you sell your house for aprofit, you've made a gain.
So equity real estate investorsare looking less for a current
income.
They're looking for capitalappreciation and those funds are
geared toward a total returnthat is driven by really selling
(21:52):
an asset for a profit.
Now some funds will advertiseand say, hey, we're an equity
fund and we can still pay acurrent distribution of 3% to 4%
and target an all-in return ofsomewhere between 12% and 16%
once we sell all theseproperties.
In this environment, if youdon't think that real estate
(22:15):
valuations have bottomed, a lotof investors on the equity side
in real estate are sitting onthe sidelines and saying, well,
we're not quite ready yet tojump into real estate equity
because they're uncertain aboutvaluations and interest rates
are high, so borrowing costs arehigh.
There's all these headwinds, andthen the real estate credit
(22:38):
investor says today hey, I likethis landscape, interest rates
are high, I can get paid a lotof money by lending on it and I
don't have to take the risk ofthat equity investor and hope
that the value of this propertyappreciates.
I have an equity cushion behindme so I can lend Steve $100 to
(22:59):
go buy a building that he'sgoing to pay $150 for, and I
feel a lot better about thatbecause along the way, every
month he's paying to pay $150for.
I feel a lot better about thatbecause along the way, every
month, he's paying me a currentdistribution.
Now there are some hybrids thatgive you a mix of appreciation
and current income and we canget into this later.
(23:20):
But we have developed astrategy that does that, but
it's certainly focused ondelivering capital preservation
for investors and delivering acurrent distribution that is an
attractive yield versus what youcan get in money markets and
(23:41):
treasuries, but delivering avery conservative credit product
that has very little volatility.
Clem Miller (23:50):
So, joe, I've got a few questions.
So first question is valuationIs the lower?
You know, one of the obviouslybiggest complaints about private
equity at least, is thatvaluations are.
You know they're thought to besometimes manipulable, right?
(24:13):
Sure, because they're, you knowthey're done infrequently.
There's less transparency aboutit because there's no market
equivalence.
So my question is is that anissue in private credit?
Let me give you my second issue, which is liquidity.
(24:34):
On these private credit funds,is there any gating, which means
for our listeners it means thatyou know you can't.
You can invest, but you can'tnecessarily pull out your money
all at once.
You might have to stay in therefor a certain time.
The second one or the thirdquestion I have I don't know if
(24:57):
you're writing these downs Oneis valuation, second one is
liquidity with the gating.
And the third one is how manyproperties are typically in a
private credit fund?
And I guess the broaderquestion is how diversified is
an individual private creditfund across industries, types of
(25:22):
properties, etc.
Joe Ryu (25:24):
Yeah, all great questions and these are all very
relevant.
The first on valuation.
So private credit whether it'sreal estate, private credit or
direct lending to companies thatare private, not listed has
always had this debate onvaluation and it continues to.
(25:48):
And it will continue to because, as you said, it's not
transparent.
What happens is the manager ofa private credit fund either
uses a third party to value alltheir assets or they have some
(26:10):
internal methodology that'sreviewed by an auditor, some
formulaic type of process thatthey outline and say this is
what we're going to do on aquarterly basis or a monthly
basis, and then true it upannually on a quarterly basis or
a monthly basis, and then trueit up annually Now, because
you're not investing in publicmarkets where you can see the
(26:31):
price of a security every second.
An investor gets a statementthat says here's the value every
month and in between that therecertainly are going to be
differences in variation inprice, right, so it's a
double-edged sword, and this iswhy it's typically been an
(26:53):
institutional market in the past, where institutions say okay in
exchange for having lessinsight into I'm locked into
this.
I'm going to trust this managerto deal with the valuations on
(27:18):
a process in a manner that I'vereviewed and in exchange I'm
getting a higher return.
So there should be a trade-offright.
If you can get the same thingin the public and you feel like
you're getting the same amountof risk relative to your return,
then certainly go to a low-costETF.
(27:40):
But the private credit fund issupposed to give you more
stability and a higher return inan equivalent fixed income
product with less volatility.
So in exchange you're getting abetter return and less
volatility, so that you're notdeciding I want to sell this
(28:01):
month, but I want to sell inabout six months or maybe in 24
months.
And so long as they continue toinvest in similar types of
underlying assets, there shouldnot be much volatility to the
price, and so you can plan as alife insurance company or a
pension plan and say I canprobably redeem this investment
(28:25):
in about 30 months.
It should be around this NAVand along the way I've collected
an 8% distribution and I don'thave all of this vol on a
publicly traded stock price thatI have to manage.
So for institutions that arenot looking for liquidity
(28:47):
they're not looking for a dailyNAV it's a perfect trade-off and
that's why it's typicallyperfect trade-off and that's why
it's typically been theuniverse of institutional
investors.
But now you know the retailuniverse is waking up to say,
well, I want those benefits too.
Now going back to the valuationfront, the valuation one is
(29:09):
tricky because, let's say, themanager bought a property for
$100 and it was an equitystrategy.
That valuation is determinedeither by a third party or
internally every quarter.
And who's really looking overtheir shoulder to say that, oh,
(29:36):
each quarter that valuationseems to be going up 10%.
You know, really, thebenchmarking there is where the
policing gets involved, right.
So it's more a matter of youknow, these third parties look
and say, well, does that lookreasonable compared to the
(29:56):
overall market?
And if it is, they don't sayanything really.
But there's a lot of discretionthat does get involved in
whether even it's a third partyor in-house that is ascribing a
value to that asset.
And so a lot of the critics ofprivate investing say, hey, it's
(30:18):
good when things are going up,right, and I get a statement
every month that says myinvestments are going up in
value.
But when you get hit with ablack swan event and your
statement still says it's up150% and the public market are
down, there's some dislocationthere that you have.
(30:40):
Investors say how is thispossible?
And then they all demand theirmoney immediately and they can't
get it out because they're thegates that you had just
mentioned and those valuationsdon't reflect reality the gates
that you had just mentioned andthose valuations don't reflect
(31:02):
reality.
So one way to mitigate that is,if you don't believe right now
in valuations, then investing ina more conservative portion of
the capital stack.
Real estate credit or privatecredit is where a lot of
investors have parked theirmoney and say, if these
valuations are too high, I'm notgoing to go into a private
(31:25):
equity fund, I'm going to gointo a private credit fund and I
am going to take a lowerconservative basis and get a
distribution on that and investin this fund that has an equity
cushion above it.
That's one way to do it.
Now, even with a credit fund,there could be a valuation
(31:45):
concern similar to what we justdescribed.
So a real estate credit fund,let's say, put its money across
10 different loans and each onewas made at, call it, $10
million, each period, monthly,quarterly.
The asset management team hasto look at the balances of each
(32:09):
one of those loans and say arethey money good or are they
impaired?
One of those loans and say arethey money good or are they
impaired?
The analysis, however, is alittle bit easier because you're
not looking at the value of thebuilding right.
So say we take that Brooklynexample and say here's a $60
million loan on a $100 millionproperty.
The asset management team atthe real estate credit fund says
(32:32):
every period is this $60million loan impaired?
And they would only be impairedif the value of the building is
only worth less than $60million.
So there would have to be asignificant decline in that
property's valuation for thatteam to say, well, we've got an
impairment issue.
So that's why real estatecredit or private credit is more
(32:54):
attractive, because you knowthe valuation is set by a third
party or some team that says,okay, that building's still
worth $100.
And then the team says, great,our loan, is money good.
Next period they move on and saywait a second, there was an
earthquake or there was a firein Maui and our building is gone
(33:17):
, right.
Then that building's no longerworth $100, it's worth zero.
And then that's when thatcredit fund takes a full
impairment right.
There's no reason to keep thaton the books at part value,
(33:37):
reason to keep that on the booksat part value.
But what they will do is saywhat is the insurable value of
that property and, by the way,we're the first ones to get paid
.
So with that insurance policy,the owner of that building file
a claim, get the money from theinsurance company, and it comes
in two forms.
It comes in either the money torebuild the property or, if
it's a complete loss, the moneyto, you know, pay whatever their
(34:01):
maximum liability is, and thatmoney goes to the lender and
whatever's left over after theloan is paid is goes back to the
owner of the property.
So there's a lot of.
Clem Miller (34:12):
So, joe, let me ask you about the stack OK.
Refer to it especially in abankruptcy context or, like the
Maui fire was, I think, is areally good example that you
raised.
So you're in the top stack, ok,the senior secured, it sounds
like.
Sounds like you are, and so Igot two questions.
(34:35):
One is are you in that seniorstack alone or is there some
kind of syndication process?
And then the second question Ihave is who's in the stack, like
the mezzanine I don't know,mezzanine might not be the right
word, but who's in the, oh, thesubordinated stack just under
you but above the equity?
Joe Ryu (34:56):
Yeah, that's actually who we are.
We're actually in thesubordinate.
Oh, you're in the subordinated.
Clem Miller (35:01):
Okay.
Joe Ryu (35:01):
Correct, correct.
And so here's how it's easy todescribe.
You have a $100 millionbuilding and we're only
providing this capital toexisting cash flowing properties
that are what we callstabilized, meaning they've hit
their market level of occupancy.
(35:21):
These are stabilized propertiesthat qualify for government
agency senior mortgage financingand that's like the best you
can get in market because it'sthe cheapest, highest quality
financing and you can be aninvestor in real estate credit,
either in the senior or thesubordinate side or the equity.
(35:45):
And we've created a strategythat likes to be in that
subordinate tranche, but onlywhen we're behind an agency
senior loan.
And that's because the FreddieMac and the Fannie Mae senior
loans on cash flowingmultifamily properties it's very
(36:07):
low leverage and it's very lowcost.
So you can get right now a 5%mortgage on a high quality
apartment building and this isthe government kind of business
and preserving housing andcreating liquidity in this
market.
You try to get a home loan atthat rate and you're not going
(36:30):
to qualify for something likethat.
So when we can go let's say inthis example there's a $60
million mortgage on a $100million property we can provide
$10 million above that 60, sothat the 60 plus 10 equals a $70
million total debt package.
(36:51):
Alternatively, the owner of thebuilding can go straight to a
bank or a life insurance companyor a debt fund and get that
entire 70 and call it a seniorloan.
So although we're subordinate,we're actually not hired in any
leverage than what you can getfrom any other institution.
(37:16):
We're just splitting it in twopieces, sourcing that bottom
stack from the cheapest providerin the market because we're
approved to work with FreddieMac and it's very difficult to
get that approval and we canissue the subordinate preferred
(37:37):
equity very debt-like, verymezzanine debt-like preferred
equity behind Freddie Mac.
And when we provide that to theowner of a building at a
combined $70 million it'sactually cheaper than what they
can get from a debt fund atBlackstone or KKR or Apollo.
(37:58):
Now those debt funds can offerthat $70 million in a single
stretch senior loan and give theborrower the convenience of
only having to work with oneparty because in our structure
there's Freddie Mac and thenthere's Prospect Capital, so
there's two parties that theyhave to deal with.
(38:20):
But we kind of make it seamless.
Everything is coterminous,everything has the same maturity
date, everything has the samerights, everything has the same
offensive defaults, so the sameprovisions they have to abide by
.
But negotiating thedocumentation upfront is a
little bit more laborious, butthat's my job.
(38:42):
To get it done and for that,for instance, the the first two
deals that we did, the blendedcost of capital was roughly
around 6%.
Once you put in prospectcapital's preferred equity
investment, the equivalentpricing you would get from a
(39:04):
commercial real estate seniorloan debt fund that gave you the
same amount of proceeds but allin one nicely wrapped package,
would be roughly 7.4%.
So we have a value propositionthat owners of properties would
like.
We're providing the same amountof total debt, we're not
(39:27):
providing any higher risk andbecause we structured it this
way, I can get the benefit andactually profit off of Freddie
Mac.
Because their rate is so low, Ican charge a pretty high rate
for my paper sitting behind itand Freddie Mac gives us that
right because we are also anowner and operator of
(39:50):
multifamily properties acrossthe country and currently we
have 22,000 apartment unitsunder management and they don't
allow anybody to issue thatpaper unless they can step in
and correct a problem that'shappening at the property.
So if there's a broken roofleaking and the owner of the
(40:11):
property refuses to fix it, wecan default them and then
Prospect will go in and fix thesituation.
So we're kind of the first lineof defense for Freddie Mac.
It's a really mutuallybeneficial arrangement that in
the real estate credit worldonly works because we have an
(40:31):
actual real estate equitybusiness where we own and manage
properties.
But we can use that advantageto make our credit fund really
provide a compellingrisk-adjusted return for
investors.
These senior debt funds that Imentioned they're using a
(40:53):
levered that I mentioned.
You know they're using alevered return to generate, call
it, 11 to 12% levered returns.
We're not using any fund levelleverage and we're generating
right now 13.5% IRRs and we haveno leverage.
So you know we have kind of aresource non-recourse debt from
(41:17):
Freddie Mac and provide that tothe borrower.
And because we're doing it inthat fashion, our fund has no
liabilities.
We are not on the hook to repayFreddie Mac.
That's a borrower obligation.
We are not on the hook to repayFreddie Mac.
(41:39):
That's a borrower obligation.
So a more, we would say,thoughtful mousetrap to generate
better returns on real estatecredit investments like in Maui
or there's, you know, any otherkind of uh diminution of value.
Clem Miller (41:58):
Uh, freddie Mac gets paid out first, that's
correct, and you get paid outsecond.
Joe Ryu (42:05):
Yeah, yeah, that that is correct.
We are subordinate Um.
Clem Miller (42:17):
So you're not leveraged.
Joe Ryu (42:18):
You're not leveraged at your level in the stack, but
you are subordinated, correct,yeah, but what investors should
parse through is, if you look atthe commercial real estate debt
fund universe today, I thinkthere's over 100 funds, but
(42:38):
they're all advertising thesenior loan strategy and they
all use fund-level leverage.
So when I was with AriesManagement, same game you use
fund-level leverage and theyadvertise senior loans because
it sounds great First mortgage,first lien, senior secured Okay,
(42:58):
sign me up.
But if you read the fine print,every loan that is originated
from that senior debt fund usesborrowings.
So let's take that Brooklynexample.
Right, that owner in Brooklyngets a $70 million first
mortgage from a debt fund.
That debt fund gives them that70, but behind the scenes only
(43:24):
contributed 10 million from thefund and then went to the credit
facility and borrowed 60million your credit facility and
borrowed $60 million.
So then they issue the loan atthat rate, 7.4%.
But yet they borrowed $60million at 5% and they lever
(43:45):
that return to make that $70million loan, which has a base
rate of 7.4%.
It now generates, for the fundthat only contributed $10
million, 11% to 12%.
So let's take that wildfireexample in Maui.
Who gets paid first in thatcommercial real estate senior
(44:06):
debt fund?
It's the credit facility.
So all of those senior debtfunds are also junior, but they
don't tell you that until youreally figure out wait a second
what does fund level leveragemean?
And it means you're notactually senior, because in
(44:26):
order to get that $60 millionadvance from a credit facility,
that fund actually has toexchange the mortgage to receive
that advance rate.
So the senior debt fund isactually a junior debt fund and
that's happening in front ofeverybody's eyes.
Now, when we were advertisingthese funds to institutional
(44:50):
investors at my own firm, theyall understood yeah, there's no
way this mortgage that youoriginated for 7% is going to
give us a 12% return on this.
Yeah, some pokey pokey, right.
And in the prior payments, yes,all of those lenders that lend
to the fund, they're paid first.
So it's the same amount ofexposure.
(45:14):
So it's the same amount ofexposure.
However, the added advantage wehave is this let's say we have
that Maui example, right.
And let's say the insurance wasinefficient, insufficient.
So the insurance company saysoh, you know what?
This was an event that was anact of God, it's not covered
(45:38):
under the policy.
So you get zero from us.
So normally, the insurancepolicy might come back and give
us $70 million, right, becausethe lenders all review the
insurance to satisfy the amountthat we've lent.
Right, we don't care about theequity, we just really wanna
make sure that we get our moneyback, but if it's an act of God.
(46:01):
You know insurance companiescan be very difficult to work
with.
They say we're not giving youanything.
Here's what happens Freddie Macgets zero, we get zero, the
sponsor's wiped out, but FreddieMac still has a claim against
(46:22):
this borrower.
Right, and Freddie Mac can'tcome to our fund.
There's a clear distinction.
We were never the borrower fromFreddie Mac.
Freddie Mac can't come after ourfunds now how, if you go to a
commercial real estate seniordebt fund and the insurance
(46:43):
claims resulted in zero return,the credit facility is going to
say, hey, you still owe me 60million dollars, right?
And that's what happened incovid.
When everyone left Manhattanand these office buildings were
vacated, all of these creditfacilities called on the credit
funds and said you need to payus back in two days.
(47:03):
And you know what happens.
The owner of those propertiesthat were lent the money said,
hey, we're gone.
Sorry, but who is liable?
Who is responsible for payingback the credit facility?
First?
It's a fund, right?
So we prevent that fromhappening in our structure so
(47:24):
just just one more question, uh.
Clem Miller (47:27):
that, I think, will round out my understanding of
your business model.
Sure sounds to me like, ineffect, you're operating as a
kind of sourcer and agent forFreddie Mac.
You're like going to FreddieMac you're saying here are some
properties and Freddie Mac andyou, or you on behalf of Freddie
(47:50):
Mac, are then going to buy theproperty.
You're going to take thatsubordinated or junior position.
Freddie Mac takes the seniorone.
Freddie Mac is probably relyingon you for the credit analysis,
I would imagine.
Or maybe you're relying on them.
Probably more likely they'rerelying on you for the asset
(48:10):
analysis, but you're sort ofoperating on their behalf or as
a, you know, as a partner, as apartner.
Joe Ryu (48:22):
Yeah, we're really a partner because, you know,
freddie is such a massiveorganization and they have their
very rigid underwritingprotocol, which have gotten very
strict particularly under thisnew administration, and so they
don't just lend to anybody,right?
So if you've had a default,bankruptcy, fraud, anything,
(48:45):
good luck.
You're not borrowing fromFreddie Mac or Fannie Mae.
That helps us, because we don'twant to lend to anybody that
doesn't meet their standards.
Weeds out all the chat.
Steve Davenport (48:54):
Where do those problems go?
Can I just finish this Mauiexample, out all the chat?
Where do those go?
Can I just finish this mauiexample with the?
Because the one part I don'tunderstand is okay, you, you
presented the worst casepossible where the insurance
plays zero.
Yeah, I mean, I've usually seenin these situations that they
usually pay pennies on thedollar for some of the stuff.
And let's just say they paid,they had a 60 million insurance
(49:16):
and they got paid 30 as 50%payoff on it, but you still own
the land.
So you can Freddie Mac can turnaround and sell the land to
someone else to get up, becauseI guess when I think about a
property, I think about its landand then the improvements to it
(49:37):
.
Sure Is it?
Usually the land is about athird of the value and the
improvements are two thirds.
Isn't that the?
Joe Ryu (49:45):
It depends by market, but that's not a bad benchmark.
Steve Davenport (49:48):
Right, right.
So when in reality you'regetting 60 plus, you know
somewhere around you're gettingfully paid back because half of
it is coming from the land andhalf is coming from the
insurance.
And if you got fully insured,you would have you know there'll
be money, even for some of theequity holders, right.
Joe Ryu (50:08):
Yeah, now that's.
That's typically the case,particularly in Maui and in the
Palisades, where the land hasincredibly strong.
The problem is, it's just beena, it's been a catastrophe that
nobody can then see thecommercial viability of
developing there.
Steve Davenport (50:26):
Uh, because of all the toxins in the land and
city constraints and well plusif they can't insure it now,
exactly because once you, I meanI don't know when these
policies, like it feels to melike the whole space around
Florida and some of these fireareas is really, you know, like
I noticed here, and you know,every time I look at my
(50:49):
insurance bill, it goes up, yeah, and I sit there and I say,
well, we're worried abouthurricanes affecting roofs.
I'm saying my roof is six yearsold.
What are you talking about?
Oh no, we can't, you know, andI just, I find the.
I mean, I like the fact thatProspect Capital is in the
middle, with more experience inthese and more ability to act
(51:12):
than if I was to try, moreability to act than if I was to
try, Like, I think thatsometimes you and I look at
things Clem, as how could I dothis myself?
And this is one case where Ithink it's very hard for us.
You know, first of all, wedon't have access to the deals.
(51:33):
Second of all, we don't havethe full understanding of how
all the different machinationswork.
And thirdly, you guys arerunning properties, so you have
that.
You know.
So when somebody says, oh, myproperty is 85% rented or 90,
what is the number Like?
Because I think that we'retalking about the property
(51:55):
itself.
But if the property was notwiped out, but it was mainly
damaged by a storm, the cashflow that you're getting from
the property still covers thenote right, when somebody is 95%
rented, does that mean it's a1.2 coverage?
1.5?
Like what's a standard coveragewhen you've got something
(52:17):
rented.
Joe Ryu (52:18):
Yeah.
So Freddie Mac uses a benchmarkwhere they're 1.25 on a
amortizing debt service, whichmeans when you buy a home, your
standard mortgage paymentincludes principal and interest
payments.
It's not just a interest onlypayment, that payment.
(52:40):
Freddie Mac takes the rate thatthey give you and say, if your
monthly payment includesprincipal, pay down and interest
, I need a one, two, five, x.
That's why they're so, you know, conservative.
Steve Davenport (52:56):
Right Leave this really thick cash stack 20%
of the property were damagedand weren't able to be drawn.
The residents weren't there.
You would still have fullcoverage from the 80% of the
residents who are stilloperating.
Joe Ryu (53:15):
Generally so.
Most of the deals we're closingon are probably 95 to 97
percent at least, so you know wecan provide.
Steve Davenport (53:27):
Yeah, there's more cushion there than other
right I'm just saying that, yeah, it's another form of cushion
if the property has first of allthe insurance being payable as
one big item.
But again, we're only talkingabout a case where an item is
completely annihilated, as in aMaui versus Right.
Joe Ryu (53:47):
Yeah, we were given some really draconian examples
just to underscore.
But to your point, there iscash flow every month coming
from all the tenants they direct.
You know we direct them whereto pay their rent every month
and that keeps the lights on andthen some.
So in real estate there's aspectrum that we define as core,
(54:10):
being stabilized properties,cash flowing, fully leased, and
that is where most institutionalinvestors have typically
resided.
They want to invest in corereal estate, which means fully
leased, cash flowing and inprime gateway markets.
So New York City, boston, losAngeles, san Francisco used to
(54:33):
be one, but, as you can see,real estate also has some
transition.
And then core, core plus valueadd and opportunistic.
And the further you get fromcore, the less cash flow comes
off of a building.
So at this end of the spectrum,opportunistic, is your classic
(54:53):
development story.
Let's go buy this piece of land.
It's not generating any income.
In fact, we have to spend moneyon it, we've got to pay taxes,
we've got to pay insurance,we've got to pay security and
maintenance until we get itdeveloped, entitled, first
permitted, approved and thendeveloped, and so for three
years or more you're not gettingany cash flow.
(55:15):
And then, once it's built, youget a certificate of occupancy
and then from there for the nextcall it two years you spend to
lease it up and you finallygenerate cash flow.
That's an opportunistic type ofplay where you're not getting
any cash flow.
The deals that we're looking atare all on this side cash
(55:35):
flowing stabilized.
We're not looking atconstruction.
On this side, cash flowingstabilized.
We're not looking atconstruction.
You can make a lot of moneylending on construction but
there's a lot of execution risk,particularly with all these
tariffs and particularly withbuying out construction costs.
Labor costs are skyrocketing.
There's a lot of risk.
(55:55):
So we're looking at this side.
Core we're looking at maybecore plus in terms of quality,
but all cash flowing, because wewant to target the lowest
volatility asset class withinreal estate and go to the most
conservative type of asset,that's cash flowing, and deliver
(56:20):
the best risk-adjusted returnto our investors.
And we're providing thatcapital preservation, we're
providing an equity cushion sowe're not in the first loss
position and we can generate anequity-like return at 13.5% IRR
(56:41):
without having to do all thiswork.
And this one area called thevalue add.
So there's opportunistic andthere's value add, value add
strategies right now in realestate equity they're marketing
12 to 16 percent returns.
Uh, and you're in the first lossposition yeah we're in real
(57:04):
estate credit and we'redelivering right down the middle
of that fairway and we're notin the first loss position, we
get a tractual coupon, okaylet's go around and kind of
finish our comments and we'llstart.
Clem Miller (57:18):
I have one more quick question.
Sure, no more questions for you.
Steve Davenport (57:24):
One more quick question.
If you call it a comment, I'lllet it go, but if it's a
question you can't do it.
Clem Miller (57:32):
So let's say you've got three elements in the stack
, you got equity at the bottom,you've got your position in the
middle, and then you've gotthree elements in the stack.
You've got equity at the bottom, you've got your position in
the middle, and then you've gotFreddie Mac at the top.
What are the typicalpercentages of each?
Joe Ryu (57:44):
Freddie Mac's somewhere between.
They're going to top out atabout 60%, maybe as high as 70.
They'll advertise going to 75,but generally you don't see that
as often.
And then we're the next kind of10 to 15%, maybe sometimes 20%,
but because we're expensive,generally the borrowers don't
(58:06):
like to have us as a very bigpart of the stack.
So we're typically in our dealsending at 75%, deals ending at
75%, and then 25% is the sponsorequity, common equity.
And what's great is and thisalso goes to your prior question
(58:30):
is a lot of these deals arecoming to us from institutions
that own real estate,multifamily properties, and say
hey, property values havedeclined over the past three to
five years because rates havegone up and so we paid 193
million for this building.
It's now worth 170.
And we're actually saying yeahwe agree with you that value has
(58:52):
declined but even at that resetvalue we still have in our
analysis and the appraisal thatwe order at least 25 to 30%
equity value behind us.
It's not like we're reachingand saying yo, that valuation
from five years ago.
Let's continue to hold on tothat.
We're saying we're getting anew valuation today and we make
(59:14):
sure that we have 25 to 30%cushion behind us.
Evaluation today and we makesure that we have 25 to 30%
cushioned behind us.
And then that agent thequestion you said about agent
agented activity with Freddieit's actually it's a two way
street.
A lot of times we have FreddieMac senior loan originators
(59:37):
calling on prospect because theywant to do business with
Prospect and provide seniorloans on the properties that we
own.
So we're primarily all agencyfinanced.
We were blessed by borrowinglong-term fixed rate during
COVID, so we have no realmaturities coming up until 2029.
(59:59):
A lot of commercial real estateowners borrowed short-term
floating rate and they're now ina pickle.
But we have Freddie Macoriginators calling on us
because they want to do businesswith us and say, hey, we want
to give you a new loan on thatproperty.
And we say why would werefinance.
We're locked in these low rates.
But they continuously stay infront of us because they want to
do business with us and we say,well, you know what, we have
(01:00:23):
our new fund.
And when you go to anotherborrower and they actually need
10 million more or 12 millionmore, you know that we are
approved by the agency to issuethis paper.
So we'll consider you guys onthis deal.
(01:00:43):
But call us whenever you havean opportunity.
So it's kind of this two-waystreet.
They come to us and bring usopportunity.
We come to them and bring themopportunities, come to them and
bring them opportunities and,having worked at a large real
estate credit fund in the past,we, you know, had to compete
(01:01:06):
based on our reputation and ourpricing right.
So we would say to an owner ofa building say, hey, you know,
we know you got 10 quotes fromyour real estate broker at CBR8
for a mortgage.
We are a very well-known creditfund.
We assure you that we can closewithin 45 days.
(01:01:27):
And they say, fantastic, butyou need to lower your rate by,
you know, 50 basis points.
Our channel is you know,there's still some competition.
But we actually have the agencycalling on us too to say, hey,
we want to do this loan withthis borrower, but they need 10
million more and because we haveto size at a 1 to 5x coverage
(01:01:51):
ratio, there's plenty of roomhere.
Can you do this together andit's like a funnel that comes in
this way and that's been agreat source of our business
that a lot of commercial realestate debt bonds won't get
because they're not part of thisecosystem with Freddie Mac, and
(01:02:12):
that's really one of ourcompetitive moats that we're
really proud of.
Steve Davenport (01:02:18):
Thanks, joe.
I mean I think today was agreat discussion but we didn't
get to half of the questions Ihad because Clems Les jumped in
front of me.
We didn't talk about the Fed.
We didn't talk about regionalstrengths of the South versus
other areas.
We didn't talk about you knowreal estate and how you know.
(01:02:41):
AI usage and all the parts therewas 15 better topics we could
have covered, but we'll, we'll,we'll have to, that that just
means that we'll have to haveyou back.
I think there's a lot going onand I would love to get you know
more perspective on how muchinterest rates move and
influence what you do in termsof your being more aggressive or
(01:03:02):
less aggressive, or do youthink that we're going to see a
recovery here with you know thelower rates and any?
Anyway, I really appreciate youcoming today and I think you
did a great job.
Joe Ryu (01:03:16):
Um, thank you for our listeners I understand a lot
more about this business thatyou're in well, I I, as I was
saying, I can talk for hours, soI'll have to come back on um
when I'm on the road meetingwith investors.
Uh, my, my sales team has tocut me off because I just keep
talking.
Um, I'm pretty passionate aboutit.
(01:03:37):
I've been doing it for a while.
I like that.
Steve Davenport (01:03:42):
Yeah, I think it's been great.
I look forward to our listeners.
I would say you have control ofyour finances and your
investments.
You can make a difference andyou can invest according to your
values and according to yourgoals.
So this is an idea.
This is all about education,and we're here to try to help
(01:04:03):
you understand what's availablein the market and what's
available for you to consider asyou look to allocate some of
your funds, and I think thatthis is a great example of that.
So, everybody who's listening,we appreciate you and we want
you to realize we're here foryou and if you ever have
(01:04:24):
questions, please reach out andcontact us and we'll try to get
Joe back again in six monthswhen he can tell us you know how
the new Fed of the Fed is goingto have lower rates and that's
going to even be better for someof the real estate investments
that we have.
So thank you everyone.
(01:04:46):
I appreciate you listening andshare with others, okay, thank
you.
Hello everyone and welcome to Skeptic's Guide
to Investing.
Today we're fortunate to have aguest.
Our guest is Joe Ryu fromProspect Capital.
Joe is the manager of theirprivate real estate credit fund
and today we're going to talkabout Joe and how we got into it
(00:23):
.
First of all this is a new thingfor us we're trying to bring in
other asset classes and otherideas on investing so that
people who hear private creditwill have an idea now what it is
what you're investing in andhow it might work for them.
I think that we can spend a lotof time, clem and I, talking
(00:46):
about these things, but Ifigured why not bring in an
expert?
And Joe has been doing this fora while and he's got a great
fund and I think it's worthhaving his perspective versus
just Clem and myself.
So, again, we're doing thiswith video so that people can
enjoy the banter and the facesand the hand motions that we're
(01:09):
going to do to each other, someof them involving fingers, which
may be, you know, less thanpolite, but that's the way it's
going to be sometimes.
So, joe, if I look at yourresume and your career, it seems
like you took a different paththan a lot of people who
typically want to work for.
(01:30):
You know the private equityfunds and the private or the
equity management of individualnames for investment banks and
other places.
Can you talk a little bit aboutyour background and?
Joe Ryu (01:46):
how you got into private credit.
Sure, absolutely so.
I graduated in 2000 and, in amarket where the idea was, you
know, try to survive in thedot-com boom, get a job anywhere
you could and you'd probably bebetter off than a lot of people
(02:08):
suffering from where the marketwas, my desire was to go into
finance.
It had always been thedirection I wanted to go, so
thankfully I wasn't competingagainst a lot of my computer
science colleagues that couldn'tfind a job.
Ultimately worked in investmentbanking for many years and at a
(02:34):
middle market shop called Duffand Phelps for the longest
period of time, right throughthe great financial crisis, and
it was in that organization thatI got my first kind of flavor
for real estate.
And there was an IPO that weworked on of a office REIT in
(02:59):
Santa Monica.
They're still publicly traded,it goes by the ticker DEI,
douglas Emmett, and they were atthe time a public REIT manager.
We had taken them public, butpreviously they had about nine
private funds from primarilyuniversity endowments and
(03:21):
invested in core officeproperties in markets such as
Santa Monica, hawaii, west Coast, oriented Through the GFC and,
working in banking, worked withvarious clients that were trying
to raise liquidity andoftentimes the value of their
(03:42):
real estate was worth more thanthe value of the going concern,
and so they tried to monetizereal estate holdings through
various, say, leasebackstructures, often bankruptcy
processes where they wereselling assets to try and
resolve creditor issues.
(04:04):
And so that's where I reallystarted to see real estate and
really get enamored with theasset class.
And then I decided I would gointo business school.
I had seen where my career hadtaken me at that point and
wanted to pursue a career inreal estate.
(04:25):
But at that point in time theonly real way to go into real
estate was either as aentrepreneur yourself and invest
in real estate, or to become onthe institutional side to work
either on Wall Street as aanalyst covering publicly traded
REITs, which I didn't find asvery appealing, or work for a
(04:50):
REIT itself, and that I can getinto more detail.
But to tackle getting into realestate, private equity or real
estate credit, a lot of thosemanagers still to this day are
very selective because they'revery focused on hiring generally
(05:13):
, like they try to say,individuals that have a strong
background in real estate, thathave already done it before, and
so if you haven't done itbefore, it's really hard to get
into that career path unless youtry and use relationships or go
through an MBA route, which iswhat I did.
(05:34):
I went to the University ofChicago for my MBA full-time and
there I did a MBA internshipwith the related companies
during the summer.
They famously developed theTime Warner Center in Columbus
Circle and the Hudson Yardsproject in the west side of
(05:54):
Manhattan, along with numerousother projects largest
multifamily operators across thecountry, including a very large
affordable housing component,which is actually where they got
their start.
The founder, steve Ross, was inaffordable housing, was a tax
(06:16):
attorney.
Now he owns the Miami Dolphins.
That's how lucrative it can be.
Then I had an opportunity tothen decide do I want to go into
real estate development, um, orI had an opportunity to work
part time during my second yearof business school, um.
Trying to recruit for a job, um,during school.
(06:39):
Which is the primary goal of anMBA is you can take all the
classes you want, but you reallyare spending two years to
intern and recruit, network andget a job offer that you really
want to pursue full time.
And on the investment side it'svery less structured.
So if you want to go intoconsulting or marketing or
(07:01):
investment banking, thosecompanies, those big brands.
They come on campus and theytake you to dinner and they take
you to a ball game and thenthey put you through a very
structured recruiting processand they fly you out to their
offices and then they take youthrough numerous super days and
(07:21):
interviews and tests and examsand then they get an offer to
you very quickly.
But if you want to be on theinvestment side and something
that's a little more niche-y,you have to really be
entrepreneurial and figure outhow to get an offer.
I mean, there are programs forsome large firms like Blackstone
(07:45):
that might come on campus andsay we have one job for this
school and we have one job forthat school and one job for this
school, and you can imaginesome feeding frenzy.
So for everybody else, you knowI networked and I found the
opportunity to work part-time mysecond year of business school
at Aries Management in Chicagoand I was doing that during the
(08:12):
day and at the same time I wasstill working part-time for
Related Midwest because they hadsaid hey, you're great to work
with over the summer.
We'll pay you $25 an hour to doyour analytical work and for us
(08:32):
it's free labor.
None of these internships camewith any guarantee of an offer,
but it's the way to kind of getyour foot in the door.
I had to pivot all my full-timeclasses to the evening classes
in downtown Chicago, so it waskind of regrettable it sounds
like a lot of fun, like a goodway to spend it.
Steve Davenport (08:52):
It was pretty regrettable.
Can you just go back to thepoint about real estate, because
it feels to me like if themarket is collapsing in 2008
around you with all of thisextra debt and leverage and all
of the things with problems withindividual structured products.
I mean, do you like workingwith things that are chaotic or
(09:14):
like why?
Why was that attractive to youversus you know a good old, hey,
let's study.
You know corporate bonds andyou know see if the J&J bonds
are better than the IBM bonds.
Joe Ryu (09:27):
Right.
Well, I'll tell you somethingelse that's funny after this.
But during that RMBS crisisthat really we all famously know
blew up on residential mortgagebacked securities up on
(09:50):
residential mortgage-backedsecurities it was very
interesting to study it,particularly also in business
school, to see how the sausagewas made and how it blew up and
how Wall Street will always findanother way to create a product
to sell to investors andgenerate fees.
A product to sell to investorsand generate fees.
And in this interim period ofholding the risk and balance
(10:15):
sheeting some of these loans,you can famously get caught.
And underneath all of that wasthe idea that you can diversify
away your risk or you canstratify the risk away into
certain tranches of debt capital.
That, okay, this is AAA riskand this is risky, and we are so
(10:35):
smart we can tell you what youcan buy and what return you're
going to get and how safe it is.
The theory was fascinating.
Now the execution of it wasreally greedy and so, looking at
how it was done and thefundamental analysis that should
have really dominated over theconversations about how to
(11:00):
execute this, they really weresometimes really disjointed, but
the fundamentals of it, whenyou think about it, they should
actually work to a certainextent.
And so the real estate creditaspect of that blow up really
(11:20):
fascinated me.
And although I never got intoresidential mortgage-backed
securities, which is where thatcatastrophe unfolded the
commercial real estate market,the CMBS market and CMBS 2.0,
having learned from theirmistakes in the past, was really
fascinating to me.
(11:41):
And getting into real estatecredit in business school, um,
was an opportunity to not justtake okay, you can be an
investor in real estate, butthen take approach where again,
you're not the first lostposition, you, you have a little
equity cushion and you cangenerate a pretty attractive
(12:03):
return was where I was reallyfocused on.
Hey, this could be a reallyattractive market.
And sure enough.
As we all seen, the privatecredit space in corporate
lending has blown up.
It's just been a darling andcontinues to be.
And when I was with Aries Ijoined Aries full-time out of
(12:25):
business school that was theflagship business, private
credit business and it kept ongrowing, and so the mantra from
management was hey, real estateprivate credit should be just as
big.
Why can't we make that?
What private credit in directlending is?
(12:45):
And now it's really caught upand it has a lot of learnings
from what we've seen in GFC andCOVID.
So it's been a long road to gethere, but I think all of that
helped form who I am and how Ithink about real estate credit.
Clem Miller (13:07):
So, joe, I've got a few questions and they're more
motivated by, you know, sort ofthe part of our audience who may
be, you know, very unfamiliarwith this particular asset class
, and so so keep that in mind asyou answer some of these
questions.
So, first of all, privatecredit for real estate.
(13:30):
Can you just sort of definethat area?
I mean, what are, what do youmean by that?
Where do the you know, where,who, who originates private
credit?
I think is a a question that,uh, that some might ask you know
who are the typical investors,uh, in private real estate
(13:51):
credit?
You know, how would you, youknow, how would you pair this
with other types of assetclasses so that you're not, so
that you're, you know, amplydiversified?
You know questions along thoselines.
I got more questions than that,but I'll leave you to start.
Joe Ryu (14:07):
Yeah, sure.
So private credit iseffectively a loan that's
originated on typically acommercial real estate property,
and so it could be as simple assaying there is an apartment
building in Brooklyn and thereis a mortgage on it for about
(14:32):
$100 million building and a $60million mortgage.
That mortgage is a privatecredit instrument because it
doesn't freely trade.
It doesn't freely trade.
So when you think about thepublic credit in real estate,
where can you find publiclytraded real estate?
(14:52):
And that's typically in thebonds that are issued by owners.
So publicly traded real estateinvestment trusts that issue
bonds, real estate investmenttrusts that issue bonds or they
issue preferred equity or theyissue any type of term loan
facilities and anything that youcan get that you can buy and
(15:14):
sell freely.
You might have a QSIP, you canbuy from your Schwab account and
say, okay, this REIT is payingme 5% on these bonds and these
bonds mature in 10 years.
They're trading a little bitbelow face value.
I'm getting a little bit morejuice on that return.
(15:36):
So I'm going to buy this bondbecause I think it's money good.
Now, private credit how does anindividual investor get access
to that mortgage on thatbuilding in Brooklyn?
They say, hey, that mortgage inBrooklyn is actually paying 6%,
but I think that's a betterinvestment than giving it to
(15:57):
that REIT that owns officebuildings across the country.
But I can't get that creditinstrument in my portfolio For
that reason.
It's private and it's typicallybeen the domain of institutional
investors like pension fundsthat would invest into whether
(16:18):
they're separately managedaccounts or in real estate
private credit funds to getaccess to those private loans
backed by hard assets.
And because these are largeloans, it's typically the domain
of the institutions that aresupposed to be smarter and say
(16:39):
well, we'll allocate some of ourportfolio to real estate
private credit to get somebetter returns and less
volatility, because in thepublic world you'll see a lot of
fluctuations based on marketsentiment.
So a really strong office REITin New York City is going to be
much different from an officeREIT that has suburban office
(17:02):
properties across the country.
But all of them are going totrade down together in sympathy.
So there are pluses and minuseson each side.
But the private credit spacehas really drawn a lot of
attention and a lot of retailinvestors are now, furthermore,
thinking how can we get accessto this market, and a lot of the
large funds have createdproducts for retail investors to
(17:25):
get involved with here.
Steve Davenport (17:30):
Is there a way to do you look at the like a
benchmark in this space and sayI really hope this property
gives me, you know,benchmark-like performance.
And the benchmark for privatereal estate Southeast would be,
you know, 4.6.
And we're looking at a propertyand that credit is 5.2.
(17:53):
Do we have that kind of detail,or is that kind of where the
magic is in private credit?
Joe Ryu (18:01):
It's a little bit of both exactly.
So you'll want to benchmarkagainst other fixed income
substitutes.
And then, when you saysubstitute, you're going to say,
okay, if I'm going to put mymoney in a private real estate
credit investment on a officeproperty, that fixed income
(18:23):
equivalent is going to be a veryrisky bond the high yield junk
bond, right, because who knowswhat the value of this office
property is.
But if you then are investingin real estate credit backed by
stabilized cash flowingmultifamily investments, that's
pretty strong.
So you'll then benchmarkagainst fixed income equivalents
(18:43):
, whether they're BBBs orslightly higher, depending on
where your leverage is in thereal estate portfolio.
And then, on top of that fixedincome equivalent analysis, you
look at real estate propertyindices and there are numerous
indices published by varioussources that benchmark how real
(19:08):
estate equity funds have, andnot every fund is included in
these indices, it's selected.
(19:32):
So you want to benchmarkagainst two types of competing
products.
There are the real estateindices, which a lot of
institutions might follow.
But, moreover, everyone'slooking at benchmarking against
fixed income equivalents Likewhere can I get that return,
(19:55):
that kind of yield, on a bond,and do I feel that my credit in
the real estate product isbetter than the credit backing.
Product is better than thecredit backing, whether it's a
company in pharmaceuticals or acompany in technology.
(20:19):
You probably look at somethinga little bit more conservative
in terms of their risk,something less volatile.
Probably compare real estate tosomething more of a staple in
consumer products and look atthe pricing of those bonds
versus the pricing of the fixedincome equivalent real estate
credit product that you can getin private credit.
Steve Davenport (20:37):
That's great Thanks.
Clem Miller (20:38):
Yeah, so basically it's income investors who are
interested in this primarily,correct.
Joe Ryu (20:48):
So that goes back to Steve's earlier question about
real estate equity and realestate debt.
Yeah, as I mentioned, anybodycan get involved in real estate.
Everybody who owns a home isinvolved in real estate.
That's a large part of a lot ofhousehold balance sheets and
when you own your own home,you're an equity investor, right
(21:10):
?
So if the price of your homegoes up, you've made an equity
return and you haven't made acurrent income investment.
However, unfortunately, you'reactually paying your mortgage,
so you're net negative on acurrent income basis, but your
expectation is in 30 years ifyou pay down your mortgage.
(21:30):
If you sell your house for aprofit, you've made a gain.
So equity real estate investorsare looking less for a current
income.
They're looking for capitalappreciation and those funds are
geared toward a total returnthat is driven by really selling
(21:52):
an asset for a profit.
Now some funds will advertiseand say, hey, we're an equity
fund and we can still pay acurrent distribution of 3% to 4%
and target an all-in return ofsomewhere between 12% and 16%
once we sell all theseproperties.
In this environment, if youdon't think that real estate
(22:15):
valuations have bottomed, a lotof investors on the equity side
in real estate are sitting onthe sidelines and saying, well,
we're not quite ready yet tojump into real estate equity
because they're uncertain aboutvaluations and interest rates
are high, so borrowing costs arehigh.
There's all these headwinds, andthen the real estate credit
(22:38):
investor says today hey, I likethis landscape, interest rates
are high, I can get paid a lotof money by lending on it and I
don't have to take the risk ofthat equity investor and hope
that the value of this propertyappreciates.
I have an equity cushion behindme so I can lend Steve $100 to
(22:59):
go buy a building that he'sgoing to pay $150 for, and I
feel a lot better about thatbecause along the way, every
month he's paying to pay $150for.
I feel a lot better about thatbecause along the way, every
month, he's paying me a currentdistribution.
Now there are some hybrids thatgive you a mix of appreciation
and current income and we canget into this later.
(23:20):
But we have developed astrategy that does that, but
it's certainly focused ondelivering capital preservation
for investors and delivering acurrent distribution that is an
attractive yield versus what youcan get in money markets and
(23:41):
treasuries, but delivering avery conservative credit product
that has very little volatility.
Clem Miller (23:50):
So, joe, I've got a few questions.
So first question is valuationIs the lower?
You know, one of the obviouslybiggest complaints about private
equity at least, is thatvaluations are.
You know they're thought to besometimes manipulable, right?
(24:13):
Sure, because they're, you knowthey're done infrequently.
There's less transparency aboutit because there's no market
equivalence.
So my question is is that anissue in private credit?
Let me give you my second issue, which is liquidity.
(24:34):
On these private credit funds,is there any gating, which means
for our listeners it means thatyou know you can't.
You can invest, but you can'tnecessarily pull out your money
all at once.
You might have to stay in therefor a certain time.
The second one or the thirdquestion I have I don't know if
(24:57):
you're writing these downs Oneis valuation, second one is
liquidity with the gating.
And the third one is how manyproperties are typically in a
private credit fund?
And I guess the broaderquestion is how diversified is
an individual private creditfund across industries, types of
(25:22):
properties, etc.
Joe Ryu (25:24):
Yeah, all great questions and these are all very
relevant.
The first on valuation.
So private credit whether it'sreal estate, private credit or
direct lending to companies thatare private, not listed has
always had this debate onvaluation and it continues to.
(25:48):
And it will continue to because, as you said, it's not
transparent.
What happens is the manager ofa private credit fund either
uses a third party to value alltheir assets or they have some
(26:10):
internal methodology that'sreviewed by an auditor, some
formulaic type of process thatthey outline and say this is
what we're going to do on aquarterly basis or a monthly
basis, and then true it upannually on a quarterly basis or
a monthly basis, and then trueit up annually Now, because
you're not investing in publicmarkets where you can see the
(26:31):
price of a security every second.
An investor gets a statementthat says here's the value every
month and in between that therecertainly are going to be
differences in variation inprice, right, so it's a
double-edged sword, and this iswhy it's typically been an
(26:53):
institutional market in the past, where institutions say okay in
exchange for having lessinsight into I'm locked into
this.
I'm going to trust this managerto deal with the valuations on
(27:18):
a process in a manner that I'vereviewed and in exchange I'm
getting a higher return.
So there should be a trade-offright.
If you can get the same thingin the public and you feel like
you're getting the same amountof risk relative to your return,
then certainly go to a low-costETF.
(27:40):
But the private credit fund issupposed to give you more
stability and a higher return inan equivalent fixed income
product with less volatility.
So in exchange you're getting abetter return and less
volatility, so that you're notdeciding I want to sell this
(28:01):
month, but I want to sell inabout six months or maybe in 24
months.
And so long as they continue toinvest in similar types of
underlying assets, there shouldnot be much volatility to the
price, and so you can plan as alife insurance company or a
pension plan and say I canprobably redeem this investment
(28:25):
in about 30 months.
It should be around this NAVand along the way I've collected
an 8% distribution and I don'thave all of this vol on a
publicly traded stock price thatI have to manage.
So for institutions that arenot looking for liquidity
(28:47):
they're not looking for a dailyNAV it's a perfect trade-off and
that's why it's typicallyperfect trade-off and that's why
it's typically been theuniverse of institutional
investors.
But now you know the retailuniverse is waking up to say,
well, I want those benefits too.
Now going back to the valuationfront, the valuation one is
(29:09):
tricky because, let's say, themanager bought a property for
$100 and it was an equitystrategy.
That valuation is determinedeither by a third party or
internally every quarter.
And who's really looking overtheir shoulder to say that, oh,
(29:36):
each quarter that valuationseems to be going up 10%.
You know, really, thebenchmarking there is where the
policing gets involved, right.
So it's more a matter of youknow, these third parties look
and say, well, does that lookreasonable compared to the
(29:56):
overall market?
And if it is, they don't sayanything really.
But there's a lot of discretionthat does get involved in
whether even it's a third partyor in-house that is ascribing a
value to that asset.
And so a lot of the critics ofprivate investing say, hey, it's
(30:18):
good when things are going up,right, and I get a statement
every month that says myinvestments are going up in
value.
But when you get hit with ablack swan event and your
statement still says it's up150% and the public market are
down, there's some dislocationthere that you have.
(30:40):
Investors say how is thispossible?
And then they all demand theirmoney immediately and they can't
get it out because they're thegates that you had just
mentioned and those valuationsdon't reflect reality the gates
that you had just mentioned andthose valuations don't reflect
(31:02):
reality.
So one way to mitigate that is,if you don't believe right now
in valuations, then investing ina more conservative portion of
the capital stack.
Real estate credit or privatecredit is where a lot of
investors have parked theirmoney and say, if these
valuations are too high, I'm notgoing to go into a private
(31:25):
equity fund, I'm going to gointo a private credit fund and I
am going to take a lowerconservative basis and get a
distribution on that and investin this fund that has an equity
cushion above it.
That's one way to do it.
Now, even with a credit fund,there could be a valuation
(31:45):
concern similar to what we justdescribed.
So a real estate credit fund,let's say, put its money across
10 different loans and each onewas made at, call it, $10
million, each period, monthly,quarterly.
The asset management team hasto look at the balances of each
(32:09):
one of those loans and say arethey money good or are they
impaired?
One of those loans and say arethey money good or are they
impaired?
The analysis, however, is alittle bit easier because you're
not looking at the value of thebuilding right.
So say we take that Brooklynexample and say here's a $60
million loan on a $100 millionproperty.
The asset management team atthe real estate credit fund says
(32:32):
every period is this $60million loan impaired?
And they would only be impairedif the value of the building is
only worth less than $60million.
So there would have to be asignificant decline in that
property's valuation for thatteam to say, well, we've got an
impairment issue.
So that's why real estatecredit or private credit is more
(32:54):
attractive, because you knowthe valuation is set by a third
party or some team that says,okay, that building's still
worth $100.
And then the team says, great,our loan, is money good.
Next period they move on and saywait a second, there was an
earthquake or there was a firein Maui and our building is gone
(33:17):
, right.
Then that building's no longerworth $100, it's worth zero.
And then that's when thatcredit fund takes a full
impairment right.
There's no reason to keep thaton the books at part value,
(33:37):
reason to keep that on the booksat part value.
But what they will do is saywhat is the insurable value of
that property and, by the way,we're the first ones to get paid
.
So with that insurance policy,the owner of that building file
a claim, get the money from theinsurance company, and it comes
in two forms.
It comes in either the money torebuild the property or, if
it's a complete loss, the moneyto, you know, pay whatever their
(34:01):
maximum liability is, and thatmoney goes to the lender and
whatever's left over after theloan is paid is goes back to the
owner of the property.
So there's a lot of.
Clem Miller (34:12):
So, joe, let me ask you about the stack OK.
Refer to it especially in abankruptcy context or, like the
Maui fire was, I think, is areally good example that you
raised.
So you're in the top stack, ok,the senior secured, it sounds
like.
Sounds like you are, and so Igot two questions.
(34:35):
One is are you in that seniorstack alone or is there some
kind of syndication process?
And then the second question Ihave is who's in the stack, like
the mezzanine I don't know,mezzanine might not be the right
word, but who's in the, oh, thesubordinated stack just under
you but above the equity?
Joe Ryu (34:56):
Yeah, that's actually who we are.
We're actually in thesubordinate.
Oh, you're in the subordinated.
Clem Miller (35:01):
Okay.
Joe Ryu (35:01):
Correct, correct.
And so here's how it's easy todescribe.
You have a $100 millionbuilding and we're only
providing this capital toexisting cash flowing properties
that are what we callstabilized, meaning they've hit
their market level of occupancy.
(35:21):
These are stabilized propertiesthat qualify for government
agency senior mortgage financingand that's like the best you
can get in market because it'sthe cheapest, highest quality
financing and you can be aninvestor in real estate credit,
either in the senior or thesubordinate side or the equity.
(35:45):
And we've created a strategythat likes to be in that
subordinate tranche, but onlywhen we're behind an agency
senior loan.
And that's because the FreddieMac and the Fannie Mae senior
loans on cash flowingmultifamily properties it's very
(36:07):
low leverage and it's very lowcost.
So you can get right now a 5%mortgage on a high quality
apartment building and this isthe government kind of business
and preserving housing andcreating liquidity in this
market.
You try to get a home loan atthat rate and you're not going
(36:30):
to qualify for something likethat.
So when we can go let's say inthis example there's a $60
million mortgage on a $100million property we can provide
$10 million above that 60, sothat the 60 plus 10 equals a $70
million total debt package.
(36:51):
Alternatively, the owner of thebuilding can go straight to a
bank or a life insurance companyor a debt fund and get that
entire 70 and call it a seniorloan.
So although we're subordinate,we're actually not hired in any
leverage than what you can getfrom any other institution.
(37:16):
We're just splitting it in twopieces, sourcing that bottom
stack from the cheapest providerin the market because we're
approved to work with FreddieMac and it's very difficult to
get that approval and we canissue the subordinate preferred
(37:37):
equity very debt-like, verymezzanine debt-like preferred
equity behind Freddie Mac.
And when we provide that to theowner of a building at a
combined $70 million it'sactually cheaper than what they
can get from a debt fund atBlackstone or KKR or Apollo.
(37:58):
Now those debt funds can offerthat $70 million in a single
stretch senior loan and give theborrower the convenience of
only having to work with oneparty because in our structure
there's Freddie Mac and thenthere's Prospect Capital, so
there's two parties that theyhave to deal with.
(38:20):
But we kind of make it seamless.
Everything is coterminous,everything has the same maturity
date, everything has the samerights, everything has the same
offensive defaults, so the sameprovisions they have to abide by
.
But negotiating thedocumentation upfront is a
little bit more laborious, butthat's my job.
(38:42):
To get it done and for that,for instance, the the first two
deals that we did, the blendedcost of capital was roughly
around 6%.
Once you put in prospectcapital's preferred equity
investment, the equivalentpricing you would get from a
(39:04):
commercial real estate seniorloan debt fund that gave you the
same amount of proceeds but allin one nicely wrapped package,
would be roughly 7.4%.
So we have a value propositionthat owners of properties would
like.
We're providing the same amountof total debt, we're not
(39:27):
providing any higher risk andbecause we structured it this
way, I can get the benefit andactually profit off of Freddie
Mac.
Because their rate is so low, Ican charge a pretty high rate
for my paper sitting behind itand Freddie Mac gives us that
right because we are also anowner and operator of
(39:50):
multifamily properties acrossthe country and currently we
have 22,000 apartment unitsunder management and they don't
allow anybody to issue thatpaper unless they can step in
and correct a problem that'shappening at the property.
So if there's a broken roofleaking and the owner of the
(40:11):
property refuses to fix it, wecan default them and then
Prospect will go in and fix thesituation.
So we're kind of the first lineof defense for Freddie Mac.
It's a really mutuallybeneficial arrangement that in
the real estate credit worldonly works because we have an
(40:31):
actual real estate equitybusiness where we own and manage
properties.
But we can use that advantageto make our credit fund really
provide a compellingrisk-adjusted return for
investors.
These senior debt funds that Imentioned they're using a
(40:53):
levered that I mentioned.
You know they're using alevered return to generate, call
it, 11 to 12% levered returns.
We're not using any fund levelleverage and we're generating
right now 13.5% IRRs and we haveno leverage.
So you know we have kind of aresource non-recourse debt from
(41:17):
Freddie Mac and provide that tothe borrower.
And because we're doing it inthat fashion, our fund has no
liabilities.
We are not on the hook to repayFreddie Mac.
That's a borrower obligation.
We are not on the hook to repayFreddie Mac.
(41:39):
That's a borrower obligation.
So a more, we would say,thoughtful mousetrap to generate
better returns on real estatecredit investments like in Maui
or there's, you know, any otherkind of uh diminution of value.
Clem Miller (41:58):
Uh, freddie Mac gets paid out first, that's
correct, and you get paid outsecond.
Joe Ryu (42:05):
Yeah, yeah, that that is correct.
We are subordinate Um.
Clem Miller (42:17):
So you're not leveraged.
Joe Ryu (42:18):
You're not leveraged at your level in the stack, but
you are subordinated, correct,yeah, but what investors should
parse through is, if you look atthe commercial real estate debt
fund universe today, I thinkthere's over 100 funds, but
(42:38):
they're all advertising thesenior loan strategy and they
all use fund-level leverage.
So when I was with AriesManagement, same game you use
fund-level leverage and theyadvertise senior loans because
it sounds great First mortgage,first lien, senior secured Okay,
(42:58):
sign me up.
But if you read the fine print,every loan that is originated
from that senior debt fund usesborrowings.
So let's take that Brooklynexample.
Right, that owner in Brooklyngets a $70 million first
mortgage from a debt fund.
That debt fund gives them that70, but behind the scenes only
(43:24):
contributed 10 million from thefund and then went to the credit
facility and borrowed 60million your credit facility and
borrowed $60 million.
So then they issue the loan atthat rate, 7.4%.
But yet they borrowed $60million at 5% and they lever
(43:45):
that return to make that $70million loan, which has a base
rate of 7.4%.
It now generates, for the fundthat only contributed $10
million, 11% to 12%.
So let's take that wildfireexample in Maui.
Who gets paid first in thatcommercial real estate senior
(44:06):
debt fund?
It's the credit facility.
So all of those senior debtfunds are also junior, but they
don't tell you that until youreally figure out wait a second
what does fund level leveragemean?
And it means you're notactually senior, because in
(44:26):
order to get that $60 millionadvance from a credit facility,
that fund actually has toexchange the mortgage to receive
that advance rate.
So the senior debt fund isactually a junior debt fund and
that's happening in front ofeverybody's eyes.
Now, when we were advertisingthese funds to institutional
(44:50):
investors at my own firm, theyall understood yeah, there's no
way this mortgage that youoriginated for 7% is going to
give us a 12% return on this.
Yeah, some pokey pokey, right.
And in the prior payments, yes,all of those lenders that lend
to the fund, they're paid first.
So it's the same amount ofexposure.
(45:14):
So it's the same amount ofexposure.
However, the added advantage wehave is this let's say we have
that Maui example, right.
And let's say the insurance wasinefficient, insufficient.
So the insurance company saysoh, you know what?
This was an event that was anact of God, it's not covered
(45:38):
under the policy.
So you get zero from us.
So normally, the insurancepolicy might come back and give
us $70 million, right, becausethe lenders all review the
insurance to satisfy the amountthat we've lent.
Right, we don't care about theequity, we just really wanna
make sure that we get our moneyback, but if it's an act of God.
(46:01):
You know insurance companiescan be very difficult to work
with.
They say we're not giving youanything.
Here's what happens Freddie Macgets zero, we get zero, the
sponsor's wiped out, but FreddieMac still has a claim against
(46:22):
this borrower.
Right, and Freddie Mac can'tcome to our fund.
There's a clear distinction.
We were never the borrower fromFreddie Mac.
Freddie Mac can't come after ourfunds now how, if you go to a
commercial real estate seniordebt fund and the insurance
(46:43):
claims resulted in zero return,the credit facility is going to
say, hey, you still owe me 60million dollars, right?
And that's what happened incovid.
When everyone left Manhattanand these office buildings were
vacated, all of these creditfacilities called on the credit
funds and said you need to payus back in two days.
(47:03):
And you know what happens.
The owner of those propertiesthat were lent the money said,
hey, we're gone.
Sorry, but who is liable?
Who is responsible for payingback the credit facility?
First?
It's a fund, right?
So we prevent that fromhappening in our structure so
(47:24):
just just one more question, uh.
Clem Miller (47:27):
that, I think, will round out my understanding of
your business model.
Sure sounds to me like, ineffect, you're operating as a
kind of sourcer and agent forFreddie Mac.
You're like going to FreddieMac you're saying here are some
properties and Freddie Mac andyou, or you on behalf of Freddie
(47:50):
Mac, are then going to buy theproperty.
You're going to take thatsubordinated or junior position.
Freddie Mac takes the seniorone.
Freddie Mac is probably relyingon you for the credit analysis,
I would imagine.
Or maybe you're relying on them.
Probably more likely they'rerelying on you for the asset
(48:10):
analysis, but you're sort ofoperating on their behalf or as
a, you know, as a partner, as apartner.
Joe Ryu (48:22):
Yeah, we're really a partner because, you know,
freddie is such a massiveorganization and they have their
very rigid underwritingprotocol, which have gotten very
strict particularly under thisnew administration, and so they
don't just lend to anybody,right?
So if you've had a default,bankruptcy, fraud, anything,
(48:45):
good luck.
You're not borrowing fromFreddie Mac or Fannie Mae.
That helps us, because we don'twant to lend to anybody that
doesn't meet their standards.
Weeds out all the chat.
Steve Davenport (48:54):
Where do those problems go?
Can I just finish this Mauiexample, out all the chat?
Where do those go?
Can I just finish this mauiexample with the?
Because the one part I don'tunderstand is okay, you, you
presented the worst casepossible where the insurance
plays zero.
Yeah, I mean, I've usually seenin these situations that they
usually pay pennies on thedollar for some of the stuff.
And let's just say they paid,they had a 60 million insurance
(49:16):
and they got paid 30 as 50%payoff on it, but you still own
the land.
So you can Freddie Mac can turnaround and sell the land to
someone else to get up, becauseI guess when I think about a
property, I think about its landand then the improvements to it
(49:37):
.
Sure Is it?
Usually the land is about athird of the value and the
improvements are two thirds.
Isn't that the?
Joe Ryu (49:45):
It depends by market, but that's not a bad benchmark.
Steve Davenport (49:48):
Right, right.
So when in reality you'regetting 60 plus, you know
somewhere around you're gettingfully paid back because half of
it is coming from the land andhalf is coming from the
insurance.
And if you got fully insured,you would have you know there'll
be money, even for some of theequity holders, right.
Joe Ryu (50:08):
Yeah, now that's.
That's typically the case,particularly in Maui and in the
Palisades, where the land hasincredibly strong.
The problem is, it's just beena, it's been a catastrophe that
nobody can then see thecommercial viability of
developing there.
Steve Davenport (50:26):
Uh, because of all the toxins in the land and
city constraints and well plusif they can't insure it now,
exactly because once you, I meanI don't know when these
policies, like it feels to melike the whole space around
Florida and some of these fireareas is really, you know, like
I noticed here, and you know,every time I look at my
(50:49):
insurance bill, it goes up, yeah, and I sit there and I say,
well, we're worried abouthurricanes affecting roofs.
I'm saying my roof is six yearsold.
What are you talking about?
Oh no, we can't, you know, andI just, I find the.
I mean, I like the fact thatProspect Capital is in the
middle, with more experience inthese and more ability to act
(51:12):
than if I was to try, moreability to act than if I was to
try, Like, I think thatsometimes you and I look at
things Clem, as how could I dothis myself?
And this is one case where Ithink it's very hard for us.
You know, first of all, wedon't have access to the deals.
(51:33):
Second of all, we don't havethe full understanding of how
all the different machinationswork.
And thirdly, you guys arerunning properties, so you have
that.
You know.
So when somebody says, oh, myproperty is 85% rented or 90,
what is the number Like?
Because I think that we'retalking about the property
(51:55):
itself.
But if the property was notwiped out, but it was mainly
damaged by a storm, the cashflow that you're getting from
the property still covers thenote right, when somebody is 95%
rented, does that mean it's a1.2 coverage?
1.5?
Like what's a standard coveragewhen you've got something
(52:17):
rented.
Joe Ryu (52:18):
Yeah.
So Freddie Mac uses a benchmarkwhere they're 1.25 on a
amortizing debt service, whichmeans when you buy a home, your
standard mortgage paymentincludes principal and interest
payments.
It's not just a interest onlypayment, that payment.
(52:40):
Freddie Mac takes the rate thatthey give you and say, if your
monthly payment includesprincipal, pay down and interest
, I need a one, two, five, x.
That's why they're so, you know, conservative.
Steve Davenport (52:56):
Right Leave this really thick cash stack 20%
of the property were damagedand weren't able to be drawn.
The residents weren't there.
You would still have fullcoverage from the 80% of the
residents who are stilloperating.
Joe Ryu (53:15):
Generally so.
Most of the deals we're closingon are probably 95 to 97
percent at least, so you know wecan provide.
Steve Davenport (53:27):
Yeah, there's more cushion there than other
right I'm just saying that, yeah, it's another form of cushion
if the property has first of allthe insurance being payable as
one big item.
But again, we're only talkingabout a case where an item is
completely annihilated, as in aMaui versus Right.
Joe Ryu (53:47):
Yeah, we were given some really draconian examples
just to underscore.
But to your point, there iscash flow every month coming
from all the tenants they direct.
You know we direct them whereto pay their rent every month
and that keeps the lights on andthen some.
So in real estate there's aspectrum that we define as core,
(54:10):
being stabilized properties,cash flowing, fully leased, and
that is where most institutionalinvestors have typically
resided.
They want to invest in corereal estate, which means fully
leased, cash flowing and inprime gateway markets.
So New York City, boston, losAngeles, san Francisco used to
(54:33):
be one, but, as you can see,real estate also has some
transition.
And then core, core plus valueadd and opportunistic.
And the further you get fromcore, the less cash flow comes
off of a building.
So at this end of the spectrum,opportunistic, is your classic
(54:53):
development story.
Let's go buy this piece of land.
It's not generating any income.
In fact, we have to spend moneyon it, we've got to pay taxes,
we've got to pay insurance,we've got to pay security and
maintenance until we get itdeveloped, entitled, first
permitted, approved and thendeveloped, and so for three
years or more you're not gettingany cash flow.
(55:15):
And then, once it's built, youget a certificate of occupancy
and then from there for the nextcall it two years you spend to
lease it up and you finallygenerate cash flow.
That's an opportunistic type ofplay where you're not getting
any cash flow.
The deals that we're looking atare all on this side cash
(55:35):
flowing stabilized.
We're not looking atconstruction.
On this side, cash flowingstabilized.
We're not looking atconstruction.
You can make a lot of moneylending on construction but
there's a lot of execution risk,particularly with all these
tariffs and particularly withbuying out construction costs.
Labor costs are skyrocketing.
There's a lot of risk.
(55:55):
So we're looking at this side.
Core we're looking at maybecore plus in terms of quality,
but all cash flowing, because wewant to target the lowest
volatility asset class withinreal estate and go to the most
conservative type of asset,that's cash flowing, and deliver
(56:20):
the best risk-adjusted returnto our investors.
And we're providing thatcapital preservation, we're
providing an equity cushion sowe're not in the first loss
position and we can generate anequity-like return at 13.5% IRR
(56:41):
without having to do all thiswork.
And this one area called thevalue add.
So there's opportunistic andthere's value add, value add
strategies right now in realestate equity they're marketing
12 to 16 percent returns.
Uh, and you're in the first lossposition yeah we're in real
(57:04):
estate credit and we'redelivering right down the middle
of that fairway and we're notin the first loss position, we
get a tractual coupon, okaylet's go around and kind of
finish our comments and we'llstart.
Clem Miller (57:18):
I have one more quick question.
Sure, no more questions for you.
Steve Davenport (57:24):
One more quick question.
If you call it a comment, I'lllet it go, but if it's a
question you can't do it.
Clem Miller (57:32):
So let's say you've got three elements in the stack
, you got equity at the bottom,you've got your position in the
middle, and then you've gotthree elements in the stack.
You've got equity at the bottom, you've got your position in
the middle, and then you've gotFreddie Mac at the top.
What are the typicalpercentages of each?
Joe Ryu (57:44):
Freddie Mac's somewhere between.
They're going to top out atabout 60%, maybe as high as 70.
They'll advertise going to 75,but generally you don't see that
as often.
And then we're the next kind of10 to 15%, maybe sometimes 20%,
but because we're expensive,generally the borrowers don't
(58:06):
like to have us as a very bigpart of the stack.
So we're typically in our dealsending at 75%, deals ending at
75%, and then 25% is the sponsorequity, common equity.
And what's great is and thisalso goes to your prior question
(58:30):
is a lot of these deals arecoming to us from institutions
that own real estate,multifamily properties, and say
hey, property values havedeclined over the past three to
five years because rates havegone up and so we paid 193
million for this building.
It's now worth 170.
And we're actually saying yeahwe agree with you that value has
(58:52):
declined but even at that resetvalue we still have in our
analysis and the appraisal thatwe order at least 25 to 30%
equity value behind us.
It's not like we're reachingand saying yo, that valuation
from five years ago.
Let's continue to hold on tothat.
We're saying we're getting anew valuation today and we make
(59:14):
sure that we have 25 to 30%cushion behind us.
Evaluation today and we makesure that we have 25 to 30%
cushioned behind us.
And then that agent thequestion you said about agent
agented activity with Freddieit's actually it's a two way
street.
A lot of times we have FreddieMac senior loan originators
(59:37):
calling on prospect because theywant to do business with
Prospect and provide seniorloans on the properties that we
own.
So we're primarily all agencyfinanced.
We were blessed by borrowinglong-term fixed rate during
COVID, so we have no realmaturities coming up until 2029.
(59:59):
A lot of commercial real estateowners borrowed short-term
floating rate and they're now ina pickle.
But we have Freddie Macoriginators calling on us
because they want to do businesswith us and say, hey, we want
to give you a new loan on thatproperty.
And we say why would werefinance.
We're locked in these low rates.
But they continuously stay infront of us because they want to
do business with us and we say,well, you know what, we have
(01:00:23):
our new fund.
And when you go to anotherborrower and they actually need
10 million more or 12 millionmore, you know that we are
approved by the agency to issuethis paper.
So we'll consider you guys onthis deal.
(01:00:43):
But call us whenever you havean opportunity.
So it's kind of this two-waystreet.
They come to us and bring usopportunity.
We come to them and bring themopportunities, come to them and
bring them opportunities and,having worked at a large real
estate credit fund in the past,we, you know, had to compete
(01:01:06):
based on our reputation and ourpricing right.
So we would say to an owner ofa building say, hey, you know,
we know you got 10 quotes fromyour real estate broker at CBR8
for a mortgage.
We are a very well-known creditfund.
We assure you that we can closewithin 45 days.
(01:01:27):
And they say, fantastic, butyou need to lower your rate by,
you know, 50 basis points.
Our channel is you know,there's still some competition.
But we actually have the agencycalling on us too to say, hey,
we want to do this loan withthis borrower, but they need 10
million more and because we haveto size at a 1 to 5x coverage
(01:01:51):
ratio, there's plenty of roomhere.
Can you do this together andit's like a funnel that comes in
this way and that's been agreat source of our business
that a lot of commercial realestate debt bonds won't get
because they're not part of thisecosystem with Freddie Mac, and
(01:02:12):
that's really one of ourcompetitive moats that we're
really proud of.
Steve Davenport (01:02:18):
Thanks, joe.
I mean I think today was agreat discussion but we didn't
get to half of the questions Ihad because Clems Les jumped in
front of me.
We didn't talk about the Fed.
We didn't talk about regionalstrengths of the South versus
other areas.
We didn't talk about you knowreal estate and how you know.
(01:02:41):
AI usage and all the parts therewas 15 better topics we could
have covered, but we'll, we'll,we'll have to, that that just
means that we'll have to haveyou back.
I think there's a lot going onand I would love to get you know
more perspective on how muchinterest rates move and
influence what you do in termsof your being more aggressive or
(01:03:02):
less aggressive, or do youthink that we're going to see a
recovery here with you know thelower rates and any?
Anyway, I really appreciate youcoming today and I think you
did a great job.
Joe Ryu (01:03:16):
Um, thank you for our listeners I understand a lot
more about this business thatyou're in well, I I, as I was
saying, I can talk for hours, soI'll have to come back on um
when I'm on the road meetingwith investors.
Uh, my, my sales team has tocut me off because I just keep
talking.
Um, I'm pretty passionate aboutit.
(01:03:37):
I've been doing it for a while.
I like that.
Steve Davenport (01:03:42):
Yeah, I think it's been great.
I look forward to our listeners.
I would say you have control ofyour finances and your
investments.
You can make a difference andyou can invest according to your
values and according to yourgoals.
So this is an idea.
This is all about education,and we're here to try to help
(01:04:03):
you understand what's availablein the market and what's
available for you to consider asyou look to allocate some of
your funds, and I think thatthis is a great example of that.
So, everybody who's listening,we appreciate you and we want
you to realize we're here foryou and if you ever have
(01:04:24):
questions, please reach out andcontact us and we'll try to get
Joe back again in six monthswhen he can tell us you know how
the new Fed of the Fed is goingto have lower rates and that's
going to even be better for someof the real estate investments
that we have.
So thank you everyone.
(01:04:46):
I appreciate you listening andshare with others, okay, thank
you.
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