Building a Mortgage Fund


(upbeat music) – Hi everyone, this is Jillian Sidoti with crowdfundinglawyers.net. This is our segment,
People You Should Know, and before I introduce
our special guest today, I just wanna remind all of you, you’ve gotta go get your tickets to CrowdConverge 2017 right now, before we run out or before
you miss any special pricing. If you are looking to raise
money for your business or build your crowdfunding platform, or you’re a service provider
for the crowdfunding industry, you need to come to this
event, ’cause we’re putting all of you into one room to network, to figure
out what everybody does, to find the resources you
need to be successful in. But today is Mr. Michael Klein
of Freedom Financial Funds. Hi, Michael, how are you today? – Great, thank you, thanks
for having me today. – You’re very welcome. I appreciate you coming, and please tell us about Freedom Financial and what you guys do. – Sure. We’re a debt fund, special accounts that allows us to do more than
just ordinary private debt. We’re focused on providing debt
to real estate professionals that are adding value in
some way to real estate. So our typical scenario is
that someone has gone in and they’re buying a mismanaged asset and repositioning that asset. Maybe they have leases in hand, or they have a business
plan that makes sense given the market that they’re working in, or they’re doing ground-up construction. Most of our commercial
ground-up construction is pre-leased or at least
significantly pre-leased. That doesn’t work in apartments
or single-family homes, so in those cases, there’s
a speculative aspect to it. We are doing this primarily
in the western United States. The more speculative in
nature, the closer to home because the more we
understand our markets. And we’ve raised a little over $50 million in our first five months of existence, so we’re pretty happy about that. Now we have to find homes for it. (laughing)
– That’s awesome. Okay, there’s so many questions in those last couple of
statements that you made that I know our viewers are
gonna wanna know the answers to. So first of all, what made you decide to go into private lending as opposed to a more traditional root
of real estate investing? – Yeah, so I spent about 20
years of my career in banking, both in corporate finance
and real estate finance, in originations of loans,
in working out loans and approving loans, and auditing loans throughout the world, so I know lending really well. And I saw back in the mid-2000s
that this was actually an area where the banks
were really breaking down. The banks had made a bunch of decisions back in the late ’80s to consolidate, to start to call their loans products, and to eliminate training. And so by the mid-2000s I could see the handwriting on the wall that as long as you could
conform your business plan to meet whatever the bank’s product was, you might get a loan. And if you were lucky,
you might get to talk to somebody that actually
understood what they were doing. So I started putting
together a business plan. And back in ’08, with the help of a co-founder, we started a fund in this
space and grew that fund to a pretty good size. We had about $180 million of commitments and had done just under $1
billion worth of financings in a seven-year period. This year, I decided to do
that for my own account, and I was very blessed
that I was joined by an extraordinary group
of senior executives to start the fund with me. So combined we have tremendous
amounts of experience. And I think what borrowers will find is, in our space, which typically’s in the one to $10 million range, you just can’t go to a bank on a consistent basis,
there’s always exceptions, and find people with
our level of experience, and knowledge, and know-how,
and how to get things done, and ability to structure deals to actually match your business plan, versus you trying to
contort your business plan to match some product. – Oh my gosh, I have so many questions. We might have to come back and do another interview. (laughs) So first and foremost, for our viewers out there who are looking for money for their deals and
they would like to leverage, coming to you, am I
hearing that you’re saying you can move faster and you’ll
have a better understanding of the deal than, say, a traditional bank? – Yeah, so our typical turnaround times, if the borrower’s doing everything
the borrower needs to do, because there’s things
that we can’t control, we’ll do a bridge loan in two weeks, we’ll do a construction
loan in three weeks from scratch for a new client. In the past, I mean, our
land speed records are, we did a program with build-to-suits for a particular client,
and he was rolling out a number of them all at once. We closed six construction loans for that client in seven weeks. – Oh, wow. – Yeah, so– – [Jillian] Oh my gosh. – Yeah, so we can move really fast. We have some regulatory oversight, but certainly not the levels that banks are burdened with today. And so if we can make sense of the deal, we’re comfortable with the
people that are executing it, we can move very, very quickly. – That’s awesome. So let’s shift gears for a little bit and talk about the raising of money. You made a profound
statement at the beginning, which is that you raised $50 million in about five months. – Yes. We had a really good track
record at the fund I managed. – Oh, I thought you were gonna say you had a really good securities attorney, but nevermind. (laughs) – Well, we had a very
good securities attorney that was very easy to work with. Actually, that helped a lot,
because we weren’t going back. In the prior fund, we
worked with a much more, big name, you know, firm, the sort of firms that you might recognize if you work at a Wall Street bank. And there was a lot of arguments
about making things work the way we wanted ’em to work, and they had their set ways. We were able to work very well together in getting things–
(laughs) – I was just teasing, but thank you for the interest. – Yeah, no, getting things done. So I really appreciate that. You know, between my colleagues and I, we had a number of relationships already, and so that helped quite a bit. The fund I ran prior to this one, we had seven years of operating history with no loans going past
due 30 days or over 30 days. And we originated over
300 loans in seven years. So we are careful underwriters, and so we had a decent track record and we were able to go
to people that knew us for a long time, decades, and
tell ’em what we were up to, and they were quick to sign up. So that helped quite a bit. And then we’ve also raised
in these managed accounts a fair amount of money to allow us to do high-leverage deals, which is kind of an interesting program, and so I’ll use that as a
Segway to explaining that. Traditional private lenders are staying to 60, 65% of value, and I think that’s prudent, because if you go back in time and look at most losses
in real estate lending, they occur when the lender
goes over 65% loan-to-value. So most private lenders
stick to that 60, 65%. That doesn’t always
work for the developer. If you’re going in and
you’re adding a lot of value and the exit strategy is to sell it, well, maybe higher leverage makes sense. We have the ability, depending
upon the circumstances, to increase that loan-to-value
from, say, 60% to 80%, which usually translates
into 90% loan-to-cost. So we do that with the partnerships that we have in that
capital that we’ve raised, ’cause they’ll take that risk. You know, so. – So what kind of borrower, and I’m assuming you’re
looking for borrowers. What kind of borrowers
are you looking for? – People that have experience
and some track record. They don’t have to have a track record that’s a mile long, but we’re not real interested in the guy who is
building his first house, or the gal that’s buying their
first apartment building. Just, we’re looking for a
real estate professional that has some track record. That being said, they
could’ve stubbed their toes, and certainly in the
downturn that happened in starting in ’08, a lot of people got hurt. So it depends on how they
behaved during that downturn. We have lots of relationships with people that literally got
crushed in that downturn. But when you talk to the people that they were borrowing from back then, they did all the right things and everything they could possibly do to minimize the loss
to not only themselves but to the lenders and
their equity partners. We’ll do business with
those folks, you know. That’s who we’re looking for. – Okay. – Yeah, so–
– All right. That’s awesome. So, well, okay. You’ve said it all, and yet I feel like we need to talk again. So–
– Okay. (chuckles) – Any last advice for our viewers? – In getting a loan,
the number one, for me, and I look at a lot of loan packages. In any given week, I
could look at 15 deals. So how do you get yours
to rise to the top? Well, first and foremost, have a logical presentation
of your information. Have a good deal summary. We often get stuffed with 25 attachments and we don’t even know
if we wanna do the deal. So the best thing to do is to
do like a three-page summary that basically talks about
what you plan on doing. So acquire an apartment,
empty it out, rehab it, and then re-rent it at X rents, increasing the value from X to Y. And then why, why does that make sense? Talk about nearby comps
that support the rents. And then, why is it that you’re
uniquely qualified to do this? You’ve done it five times before, here’s what the results were. Okay, now I’ve got in a
relatively short period of time what you wanna do, why
you think it’s gonna work, and why you’re uniquely
capable of doing it. If all that makes sense,
then I’m still reading, so then you tell me what
he capital stack is. Oh, we need $5 million,
we’ve raised a million five, and we need the other $3 1/2 million. Okay, now I know what you’re asking for. And our ultimate plan is to sell this, or our ultimate plan is to refinance it. So now I know how you
plan on paying it back. So that’s really pretty easy to do. It’s amazing how few people do that well. So it’s just a matter… I’ve told many, many people that I really am looking for
the answers to six things and that’s it. So if you can remember these six things, just write ’em down
and go with this, okay? We always evaluate who the
people are, what their credit is, and then what’s the real estate, okay? And then we’re always
looking at every loan, what’s the money for, how
is it gonna get repaid, and if that doesn’t work out,
how’s it gonna get repaid? (laughing) – Lending’s pretty straightforward. I’ve looked at lending all over the world for all sorts of different
types of companies, and it always really comes
down to those things. It always comes down to who’s
the management team involved, and what are their experiences, and why are they qualified
to do what they need to do. What’s their credit like? Have they stubbed their toes? what did they do when they did? In this case, what’s the real estate, which
is ultimately our collateral? And then, why do they want the money, how are they gonna pay it back,
and then what’s the plan B? As we get late in the cycle
here, seven and 1/2 years, we start seeing that plan
A is the only viable plan and plan B is hope. Hope is a terrible business plan. So, you know, that’s– – You just said something interesting. I mean, here you started this big fund, and now it’s the end of the cycle. – Yes. – How does Freedom Financial adjust towards the end of a cycle? – Yeah, so it means
that we’re underwriting more carefully than ever. That isn’t to say that we didn’t underwrite
carefully before, but we now are looking for basis much more carefully, right. So we’re looking at why
does this particular project have a unique position
in its market to compete if we were to see a 20%
erosion in cash flows. And so we can look at that. Why does this sponsorship have the ability to withstand some duress? So it’s a difficult time. I think real estate investing,
like all forms of investing, is a process of sort of being blindfolded and walking the plank. You know there’s an end to that plank, you just don’t know where it is. I think, was it Yogi Bear that said, “Making predictions is very difficult, “especially about the future.” That’s the environment
that we, all investors, and we’re an investor, we’re investing in the
debt that we originate, are always making. So we’re at a point where we’re trying to get clients money to work on the one hand. On the other hand, we’re making
sure that, when it works, we’re doing our best to make
sure that it comes back. – Okay, I drew a little picture and I want you to analyze
the picture for me. I hope everybody can see this okay. – This is awesome. Okay, so this is… Wait, I see a mountain. No, it’s not one of those pictogram things for psychology tests? – No, (laughs) this is
not a psychological exam. – [Michael] Okay, all right. – Okay, so here we are in 2008, right? Bottom economy, and then
everybody starts buying, and we go up, and then
we hit another quadrant and we go down. Where are we now? – Now–
– Are we here, or are we here? (Michael exhales) – You know, I’m gonna answer that question by splitting the difference. I think, right this minute, we’re probably real close to
that middle line, that top. – Right here.
– Yeah. Sort of that weight. I called it about in November, that weightless feeling you
get on a rollercoaster ride when you’ve reached the top. But what we never know is, is
there another up from here? Is that just one of those
false weightless feelings, or are we on the down side? The economic data is
so all over the board. So one day you read
about something terrible, the next day you read
about something good. Restaurant sales are down. Well, that’s generally
not good for the economy. Manufacturing is down,
not good for the economy. Auto sales, so-so, not
good for the economy. Housing starts up, eh, I’m not so sure that’s
a leading indicator. It does create jobs, but all of us in the real
estate business know that, to be a developer, you
have to be optimistic. But then you read the jobs reports. Overall, they’re pretty good. We’re short on housing
throughout the United States, that’s a good thing. So there’s not a lot of overbuilt markets. There are always micro
markets that get overbuilt. Right now I’d say we’re
kinda in the middle there, and it’s really dependent on
how the next administration creates confidence in all of us to look at the sunny side of everything versus looking at the
downside to everything. Economies are driven
by people’s attitudes, and when in the throes of the downturn I used to tell my colleagues that, not only was it a great time for us, because when everything’s on, when everybody’s running into the streets running that the buildings are on fire, it’s a great time to go into buildings, and you can make a lot
of money doing that. But when people would ask, when do you think there’s
gonna be recovery, and when people got, my answer is always, when people got good and
tired of being pessimistic, because we’re all optimistic. (laughing) At the end of the day, we get out of bed because
we’re optimistic by nature. – Okay, so, fair enough. So do we keep buying? – I think we keep buying carefully. (chuckles) Well, look, you don’t
wanna be a retail buyer. – No. – The people that show up on TV, or the radio guys, or the guys who are selling
some sort of no money down, invest in real estate and make a fortune, eh, I’m less optimistic about those guys, and they all show up
toward the end of a cycle. – Right. – But there’s always interest
in transactions out there. My daughter just uncovered one for me, she’s all over this thing, in the middle part of the
country where she lives. And somebody is under the
gun to make a 1031 work because they wanna get out of a portfolio of rented single family homes. And you know, on the initial look, there’s probably 20% markup if you wanna break up the portfolio. They don’t wanna go through the breakup, because they can’t make
their 1031 change work out. – Oh. – So they’ve got 20-something units that they’re managing and
going crazy with, okay, and they wanna flip into 45
or 50-unit apartment building, which is a better vehicle,
really, for residential renting. So there’s a unique
need at this very moment that allows you to buy at
a wholesale type pricing. – That is so cool that she recognized that this is not where it should be on an individualized basis, because these people need to do this 1031. So those people are not gonna make as
much money as they could, but they’re going to get
the tax, not aversion. Can we say aversion? (laughs) Tax deferral on the 1031,
which will probably help them. I mean, who knows what their
particular tax situation is. Well, I’m gonna wrap it up, because I kept you for way too
long, and I so appreciate it. So tell us, before you leave, two things. One, what books do you recommend, and two, how can people get in touch with you? – Sure. Well, I just happen to have one of my favorite real estate books. Unfortunately it’s out of
publication, however, however, this one was just acquired recently, so they’re out there around
in the used book market. I’m gonna put it on the screen
so everybody can see it. And it’s, can you see that clearly? – Oh yeah, I can, great. – Okay. And so this “Art and Science of Real
Estate Investment Analysis” by Edward John Golden was written back in the ’70s, so there’ll be things in there
that people won’t recognize, like amortization tables,
compound mortgage interest tables, and a whole bunch of formulas that people just use a spreadsheet for. But there are many, many nuggets of valuable real estate investing tidbits in this thing, and shortcuts, because when
Ed Golden wrote the book, there were no PCs, there
weren’t smart phones. There was, you had to do
a deal and make it work on the back of a napkin, probably over a three-martini lunch. – Right. – And so I found it invaluable
throughout my career to have that. And then, in terms of
getting a hold of me, I can be reached at my office,
Freedom Financial Funds, 818-308-3881 or mklein, K-L-E-I-N
@freedomfinancialfunds.com. – Awesome. Thank you so much, Michael. I so appreciate it. – [Michael] Thank you. – Gosh, that was so much information, and I can talk to you all day,
but you don’t have all day. You’re running a $50
million fund, so (laughs) I probably should let you go. I wanna thank everybody
out there for watching People You Should Know segment
of crowdfundinglawyers.net. Do not forget to crowdconvergecalling.com to get your tickets to our
event on February 2nd and 3rd in Las Vegas, Nevada. Thank you, Michael, and
I’ll talk to you soon. – [Michael] Thank you. – [Jillian] Bye. – [Michael] Bye. (upbeat music)

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