Someone tell me why you enjoy working in HY RE Debt?
I've been on the sell-side for 3 years, and I'm looking to make the move to the principal side. I have a strong preference for being on the equity side given:
- More granular underwriting associated with equity side
- The implementation of value-add plans / asset management side of the business is a big part of what makes RE interesting to me (would like to see the actual execution of these plans, not just the underwriting)
- The higher risk is more exciting to me
However, there seem to be a plethora of high yield debt jobs out there. There's a new analyst / associate opening every week and it seems like a new debt fund pops up every 3 months. But for some reason, I can't see myself enjoying these jobs.
In theory, you're doing the same underwriting, structuring debt terms, pref terms, etc. So I should enjoy it just as much, but I can't warm up to the idea. My experience with debt has been that it's very process oriented. Since it's lower risk, it's more about sizing loans as fast as humanly possible, getting all the CYA docs together asap, putting together a credit memo / closing ASAP. It seems less about finding the best opportunities, and more about finding as many opportunities as possible, collecting fees, and even in the worst case scenario you should be made whole by selling the property to a distressed buyer (in todays climate). Every investor is a sales person, but lenders seem to be way more salesy than equity folks.
I guess the point of this post is for some experienced posters here to tell me why I'm an idiot to think this way. Do any of you at RE Debt Funds really feel like investors? Do you not just feel like you're going through the motions of pulling together the required documents to close?
Disclaimer: I did an internship in lending and this is where my negative bias comes from. Don't intend to trigger any lenders here
Following - I am currently interviewing with a couple debt funds
Equity and debt are both ‘salesy.’ The equity teams suck up to the brokers and their LPs or GPs. They also suck up to the PM firms to get better costs etc. the debt teams suck up to the mortgage brokers and appraisers.
In terms of deals etc., I’ve noticed equity people prefer and like to think about and do asset management while debt people generally prefer deal process and legal work.
Additionally, as you noted, it seems debt teams just want to get terms sheets out etc., in my humble opinion, it’s less about term sheets and more about the credit. Depending on the type of loans you’re doing, you may lend on a value add deal that is a terrible bet, but....when you analyze the credit entirely, the borrower is a strong credit with a large balance sheet. So you may not care that the real estate is bad because you know this borrower won’t default. It’s a major strength to the credit. So a lot of times, instead of thinking, wow this deal isn’t good but we are doing it because we quote every deal. Step back and think about the strengths of the credit. The borrower may be so strong you don’t care about the real estate business plan.
On the equity side from an institutional level, I’ve also found the business moves a bit slower than the debt side. Reason being investment sales brokers will market most deals (not all) for 4-6 weeks. This means you have a lot of time from when the package comes in to when bids are due and you can work through the deal slowly. On the debt side, you only get the package after the buyer has been chosen, so may only have 30-45 days to close the deal. Much tighter timeframe so it’s imperative you underwrite the deal quickly and quote fast. Once you quote, be ready to sharpen your pencil, win the bid, and close. A lender will have been working on the deal for 1-2 months while the equity teams have been working on it for 2-4 months at that time.
I’m not quite sure why you think that underwriting is less granular on the debt side than the equity side. Our job is to evaluate a business plan and decide for ourselves if it has merit or is total bullshit. Yes, lenders take a slightly more conservative approach to modeling assumptions and tend to think in downside, tail risk scenarios, but it doesn’t change the level or quality of the modeling itself. And when you are talking about high yield, riskier debt pieces, debt can actually be more complicated than equity because beyond structuring the loan to protect the downsides as best we can, we also have to be prepared to possibly own the project. If that happens it is because the original business plan went to hell in a hand basket and we have to either fix it or come up with a new business plan quickly so that we can recover as much of our investment as possible.
Yes, there is a lot of process involved. Yes, there is a lot of legal and tax and operation type of stuff to deal with that most equity guys get to bypass because they have finance people doing it for them. Yes, you are further away from the day to day of a property. I like to think of a building like a mini company. Equity guys handle the day to day management of the company. They are the CEO, CFO and COO. Debt is like the board of directors. We don’t get into the weeds of the day to day, but we do expect quarterly updates on how things are going and at the end of the day, if there is a proposal we don’t like, we have veto rights.
To your question about feeling like an investor: A lot of debt is a volume business (life cos, cmbs, banks), but funds are slightly different in that you raise money based on your track record and returns. Nobody will reinvest with you if all you did was use their money to juice fees or if you have multiple losing investments in your fund. Do I feel like an investor, yes, because we are literally investing billions of dollars on behalf of investors that entrusted their money with us. Also, probably because I invested my own money into the fund and have carry. We are very selective in deals we chase (part of this is being a lean team, part of it is not wanting to lose money) and even being in AM I have a seat at the table when everyone is discussing risks and mitigants of a deal.
Can you elaborate on what carry looks like at a debt fund compared to an equity fund?
Pretty much the same between debt and equity funds: there is carry over a hurdle (usually lower than equity). You get a % of the pool, if there is anything earned.
Does your shop typically meet those hurdles? I’m trying to understand how you beat the hurdles if you know what your interest payments are and stuff like that. Do you guys set your hurdles lower then the interest you charge? Also what’s your carry valued at ?
The hurdle is set when the fund is created. So when you raise money, you set it at an achievable hurdle. However, if rates drop from when you raise the fund to the time you’re putting the money out, and floors drop with it, you’re missing the hurdle. Or at least you spread between what you thought you would get any the hurdle will be slimmer.
The same thing can happen on the equity side. Returns compress and you need an 8 pref. When you raised money, you thought you could get a 12% IRR. Well now it’s 10%. Your pool won’t be as large.
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