Ep. 6 Why Invest in Commercial Real Estate Private Credit?

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Welcome to the My Private Network Podcast!

Interested in learning about private market investing concepts and opportunities available to you?

This week's episode features our co-founder and host, Bob Simpson, who gives you, the investor, a chance to hear from industry experts about why you should consider investing in commercial real estate private credit?

Today's Expert Guest

Harley Gold
Managing Partner
Peakhill Capital

Today's Questions of Interest

1:44 Harley, tell us about your journey to build your private credit firm.
Could you explain the investment concept Commercial Real Estate Private Credit?
What prevents somebody to go directly to CMHC instead of waiting a year?
For individual investors or family offices looking to diversify their portfolios, how would you recommend using your strategies in their portfolios?
People are flocking to the GIC market but what's the historical return differential for GICs?
19:09 What would you say is a major reason that your fund and your firm have done well over the last few years?
Where do you see your firm in five years?


Bob Simpson: Hello, everyone, and welcome to another episode of our podcast. We have a treat for you today. A special guest, Harley Gold, a distinguished expert in the commercial real estate private lending.

We last heard from Harley in episode three, where we asked him a few questions. For example, given concerns about commercial real estate, what kinds of deals are you focused on today? And how are you assessing risk differently today rather than a couple of years ago?

Our podcasts are all about education. So if you want a broad overview about private real estate focused private debt, feel free to revisit that podcast. So today we're thrilled to welcome Harley back into a more in depth discussion about commercial real estate private credit.

This intriguing concept is listed on our platform privatedebtandequity.ca under concepts for those eager to explore its potential. Now to quote Private Debt and Equity, something that we have up on that website, this limited partnership is managed as a yield based partnership with capital protection backed by income producing first mortgages secured by commercial real estate.

So to get things kicked off here, Harley, before we dive into specifics, let's allow our listeners to get to know you a bit better. Tell us about your journey that you've been on to build your private credit firm.

Harley Gold: Sure. Thanks. So I've been in real estate finance for about 23, 24 years. And, I got into the business just after 9/11, when I was looking to get a job in wall street inequities.

And the investment baker I was looking to work with said, when times are bad, you should go into real estate. And so, after I did my MBA and I was going to internship in the U.S. I got into real estate just from his advice because it's a hard asset. And from there forward, real estate has been an exceptional investment returns since that point in time, given the hard asset in uncertain times, people feel comfortable with a hard asset.

And obviously a cash flowing asset is even better and so forth today. Sort of a hedge against inflation to some degree. As well, that historically has taken place over the last number of years. But how I started in real estate and I started in real estate lending right away, working with lots of different lenders in the United States and Canada.

Prior to starting Peakhill, I was with a larger firm that, that had institutional backing, where it was pension plans and endowment funds that were invested through, RBC's platform with a company called PHN, which is Phillips Hager North. And I was helping originate loans into those products. So first mortgages and so forth.

When RBC bought that platform, I wanted to create my own platform. I would have multiple investors, retail, institutional, and family office investors that would have an opportunity to participate in deals that I've historically done throughout my career and have exposure to clients and borrowers across the country that I've been doing business with for 20+ years.

Bob Simpson: So like many entrepreneurs, you sort of had that aha moment where you said, you know what, this is okay doing what I'm doing, but I think I'd better try to do something on my own. Is that kind of where your head space was at the time?

Harley Gold: Yeah. I invested my own capital over the years into the space and returns were strong and family and friends always said, well, is there ways I can participate in the space?

And I said, well, banks had an investment vehicles, life insurance companies invest in the mortgage space, institutional investors have some exposure, but a lot of retail doesn't have exposure to the space. And so, you know, it made sense to start a new platform where we would, we would accept some of that money into the space, give people opportunity to get you know, very strong risk adjusted returns for people that are looking for, for nice income streams with good protection.

From the investment side, it was always something that I did, but really thought it would be good to bring our fund and sort of create our fund a little bit better than other funds out there.

And so one of the features that we have is we take a loss up to 15 million of our own capital. If there's any losses in the fund. Or loan defaults and so forth. So that's kind of unique in the space that we operate in that, that we're putting our money ahead of any investor. And that's something I want to do because I felt it was the right thing to do.

And I felt that if I was going to invest with someone, I would want their money at stake because they're the manager. They're the one running it on a daily basis and making the selection of the deals and underwriting the deals. And that's something that I was passionate about to create that investment vehicle where investors could be comfortable that I have my money at stake and making good decisions.

Bob Simpson: Yeah. And I think that's a big decision for you, isn't it? Is that in all cases, when you're trying to build a business, you need to have some unique features. And that in the private credit space, that really the ultimate goal is protection of capital first. So by adding an extra layer in there, it gives investors a better feeling about the work that you're doing, that you have confidence in the work that you're doing in managing the fund.

Yeah. So Harley, let's jump into the heart of the matter, Commercial Real Estate Private Credit. Could you give us and our listeners a clear explanation about what this concept entails? Moreover, why should an investor consider allocating funds to this type of investment?

Harley Gold: Sure, thanks. So Commercial Real Estate Private Debt is, would be a, us doing a first mortgage as an example, an apartment building, which would be the asset class we do the most of today.

Someone's buying a building as an example for 10 million. We would look at doing a 7 million. First mortgage, secured by the property that apartment building would be a cash flowing building where there's, there's rents and expenses and kicking off an N-O-I. Typically, it's a situation.

Someone needs to close on an acquisition quickly, typically would come to us over over a bank just in terms of our responsiveness and customer service levels and competitiveness and so forth. We've got equity protection, so they're putting 3 million of cash equity into that acquisition. So we've got that as a cushion in terms of if something were to happen to the property, if rents were to fall, or if values were to decline in the marketplace and so forth, they at least have 3 million of cash equity in.

We also have guarantees, personal guarantees, so we would review the guarantees, meaning what else do they own, what other savings they have, what other cash they have, what other properties they have, where their cash flow from those properties. We'd look at that, what other debt do they have, what their credit score is like, social media background checks and so forth.

Criminal litigation checks, all that sort of thing would be part of our analysis. And so, you know, our $7 million would be secured by the real estate. We'd also have the personal guarantees from the sponsor or sponsors. Sometimes there's multiple partners in a deal as well. That would be a first mortgage.

Typically we would do it for 12 months. And after 12 months, the strategy that we're running is we would move that to a long term CMHC loan. So typically a 5 year or 10 year deal at a much lower interest rate. And we've moved that loan over into a long term program. So our strategy is doing that interim bridge loan.

Why it's attractive to investors is you're backed by an apartment building and a first mortgage basis. You've got an income stream that could support the debt payments on the loan. So you've got the cash flow as well as you have personal guarantees beyond the real estate where people are on the hook.

That is something didn't worked out that you could realize on and do something about as well. So you got that coverage all the way. But for us, the most important thing we do look at is how we're getting repaid. So in the case of strategy that we're running, we're looking for a long term CMHC loan, 5 years and 10 years.

And that's our take out loan that our borrowers are encouraged to move over to because it is a much cheaper rate. So that's the strategy we run. If we were doing another asset class, as an example, as an industrial building. An industrial building could be a situation where someone's buying a building, same situation, 10 million, we're giving them 6. 5 million, maybe we do a lower loan to value for industrial. And it's a situation where rent on the property might be 6 or 8, and those leases are coming due in a year or two and the market rents are say 12 or 15. And so there's a lot of value creation there from the customer and the borrower, we would look to take out that loan in a year or two with a bank and so forth.

And so that's kind of an interim stage of the loan that we have. But like I said, we would have a cash flowing property that supports the debt payments. We have a guarantee from, from a sponsor and a borrower could be multiple guarantees as well as we have a first mortgage on the property. And then we focus on the markets we lend in.

Obviously we want to lend in markets that have a lot of liquidity. That if something didn't work out, we could sell that apartment building or we could sell that industrial building. So we do focus in the primary markets, Toronto, Montreal, Vancouver, for the most part, more selective in other parts of the country, but typically those are the markets where you have the most investors.

That is something didn't work out. You could sell that property in 30 days, 60 days, or 90 days that you'd have a lot of interest to buy that property.

So back to the example I gave someone bought a property $10,000,000, we're doing a $12,000,000 loan. It's very unlikely we're going to walk away from $3,000,000 as well as it's unlikely that property is going to sell for less than $7,000,000 over the next 12 months, even if even if values were to fall we'd feel comfortable that we could sell that property for eight, nine, 10, 11, 12, whatever million dollars it might be, we'd have that, that protection.

So it's a good risk adjusted returns today that we're running are like 10, 11 percent net, which are quite attractive relative to, you know, GICs at 5, 6 percent relative to investing in the equity world where you're kind of at those returns, but you're getting paid on a monthly basis is really attractive to investors today.

Bob Simpson: Yeah. So I guess the, the question that comes to mind as you went through that is, so you're bridging a loan to CMHC. What prevents somebody to go directly to CMHC instead of waiting a year?

Harley Gold: Yeah, so we're a CMHC lender. So there's about a dozen CMHC lenders in Canada. We're one of them. There's banks and other companies that are CMHC insured lenders.

So someone has to come to us or go to a bank. They can't go to CMHC directly. CMHC insures a loan, but it's our loan, so we run that process. But the process with CMHC can take three months, six months, nine months, 12 months. It's a government agency, so it's not a very fast process. You can imagine it takes some time, typically in the apartment space, a market moves pretty quick in terms of if something comes on, there's not a lot of apartment buildings in Canada, as you know, it's a scarce asset.

And so when it does come to market, there are lots of buyers. We see, you know, typically if it's 20 unit building, there could be 10, 12 buyers lined up to buy that property. Typically have to close in 30, 60, 90 days. Don't have a lot of time to arrange the CMHC financing and so that's a matter of it.

The other factor would be in terms of apartment buildings, people do want to improve the building. So you have a lot of older stock buildings where you have tenants that have been there for 20, 30 years, and there may be opportunities to turn over some of those units, fix them up, new flooring, paint, new appliances. Sometimes you'll add laundry rooms or laundry and suite. So certain things you may add value to the property that you can also get higher rents.

And so some clients would buy properties, renovate them, spruce up the lobbies and try to attract higher paying tenants potentially on turnover. And so that would be another opportunity that people run.

Bob Simpson: When does the, you know, my next question was going to be about risk and where does this CMHC guarantee kick in over that 12 month period prior to exiting?

Harley Gold: Yeah, so it'd be at the end of our loan term. So we do, we make the application like upfront, typically. Our application to CMHC is for more money than we're doing. So back to that example on that $10 million apartment purchase, if we're doing a $7 million CMHC for $8 million or eight and a half million. CMHC, you can go up to 85 percent loan to value as well.

So typically we have that buffer that we know we're going to get a higher insured loan amount that gives us that protection as well. So that's another protection that we have is that, is that we have a takeout loan that's going to pay off our loan.

Bob Simpson: Right. So really you have 30 percent equity as a cushion, but you also have personal guarantees, so, you know, that 30 percent number might actually get ballooned up a little bit, right?

Okay, so I think that covers the risk side that I really wanted to focus in on today. Let's look at from an investor point of view. For individual investors or family offices looking to diversify their portfolio, this is something that I found, Harley, that through discussions. Is that you know, firms like yours, you've got the product, but you leave it to an advisor to make a decision as to how they use it in the portfolio.

I'd like to hear from you if you were a portfolio manager and you're working with individual clients or family offices, how would you use the strategy in their portfolios?

Harley Gold: So I would say I could speak to myself personally. So personally. I have 80 to 90 percent of my investment money in this strategy for a few reasons.

One is the duration is short, which I like. Short duration. The risk adjusted returns, as I mentioned, 11 plus today is quite attractive. And that's kind of at the level of equity type returns within the S&P over a historical period of time. Without the same type of volatility because we have a flat nav.

So people can come in and out at the same investment level and not have the risk of being in a public vehicle. So we've got that. So those are the main reasons why I like it. I mean, I think historically, if you look at pension plans, life insurance companies, family offices, they're sort of in the 10 to 30 percent percentage of assets that might be in credit.

And some of that might be in fixed income where they can trade in and out of bonds on a daily basis. Some of that might be in private debt, commercial real estate loans and so forth. Where you may have quarterly liquidity, depending on the duration, you may have yearly liquidity, or it might be longer term investments on private debt, depending where you're playing at.

But I would say today that 10 to 30 percent should probably be a lot higher because the risk adjusted returns are there, relative to other asset classes today, from my perspective. I think it should be, you know, it can be a lot higher. It also depends on what you're looking for. Are you looking for income?

Are you looking for growth? Obviously, this is a nice income play. But today you're actually getting growth type returns. So today, that's why I would say the allocation should be a lot higher than it would historically be. And I would normally say in the space that we're in, typically you're probably more in an 8 to 9 percent historical net return space.

Today, as I mentioned, 11. So you're, you're, you're higher than you have been historically. And that's because obviously prime and interest rates are quite higher today, which makes it an interesting investment for everybody today, even if they are looking for sort of growth equity type returns or getting that in this product today.

Bob Simpson: Yeah. So for people, Harley, who we used to call them GIC refugees, right? GICs just got to a point where they weren't making enough money. So they turned to equity markets as an alternative, looking at the S&P 500. My sort of favorite metric that I like to share with people is if you took the S&P 500 from December 31st 1999 to current that the returns about 6. 5 percent per year over that period.

But you have, you've lost 40 percent of your money twice on that path. You had a period of 10 years where you didn't make any money. You lost another 25 percent over a couple other periods. So you could almost make a case that at current levels that for equity investors that this might be something they want to look at to de risk their portfolio.

Harley Gold: I agree for sure. You know, myself personally, I moved out equities into this product and I think it's makes a lot of sense today for people for sure. Yeah.

Bob Simpson: Yeah. The other thing that we're seeing is people are flocking to the GIC market because, you know, five was like a bit of a magical number, maybe not quite as magical as 10, but you know, compared to where rates have been, five looks pretty good today.

What's the historical return differential for a strategy like this over GICs?

Harley Gold: I would probably say if I were to pick a range, I would say that, you know, if we're, if we're at 11 net today and GICs are at five. You're sort of, you know, 500 plus over GIC's so when GIC's s were, you know, at three, two or three, you're sort of in that eight plus, eight to nine.

So five, 600 over, I would say, would be sort of the range that we would see over GIC's s, which is good, which, which I think is, which I think makes sense for people. The other thing too, people have to consider is their tax consequences. The particular LP that we're talking about, it's a limited partnership.

We do have a lot of family offices that hold it in their corporations and they do treat as active business income. So from a tax perspective, it's 26 percent active business income as opposed to 50 percent interest income. So from a total return perspective, it's better than owning a GIC as well.

Bob Simpson: Right. So you're getting double the return plus you're getting almost double the benefit of taxation. Correct. So yeah, and that's what investors should be looking at, especially if they're trying to compare it to their bond portfolios or their GIC portfolios, is what's that spread? How much more are you getting?

And you know, double is a pretty good spread compared to things like buying junk bonds or some other things where, you know, the risk and volatility is quite high.

Harley Gold: I mean, I've seen, I like, like a lot of fund managers we've talked to who, who, who compare our products, sometimes they are looking at, investing in the bond market.

The issue with bonds is yes, there will be a time where you will get capital appreciation on the bonds if rates fall. But you're basically betting that rates are going to fall. And so that obviously hasn't been a good investment for the last few years because rates have only gone up. And so I think it's hard to pick the point in time to know when rates are going to fall.

Though, I think that takes on more risks than people understand relative to having a flat nav, whereas bonds, you know, it's a price. The bond value can go up and down.

Bob Simpson: Yep.

Harley Gold: Right.

Bob Simpson: Yeah. Bonds last year, if you took the XBB, which is an ETF that is a pretty good range of bonds was negative 11 percent total return after you received the interest.

Harley Gold: Wow.

Bob Simpson: Umm in a bond fund. Right. So, you know, there, you're looking at a major spread over that. And I think one thing. Harley that investors need to look at when they, they look at this sort of thing is the idea of certainty versus potential return. So we could look at rates, you know, when bond yields hit five, the, yeah, maybe rates like they just did drop to four and you made some money over the short term.

Are you better to take five with the, to take risks to try to get 10, or are you better to take 10, which is, you know, a much more achievable return over that period. So, you know, I think there's a lot of different ways that people can look at their fixed income and compare it to an asset class like this, but I think they can also look at equities as an alternative as well, that this might be a way to get equity returns with much lower risk than, than they've been experiencing.

You will miss out like in 2021, the S&P was up 30%. You wouldn't catch that in this, but then again, over time, it all smooths out. So your firm's done really well, what would you say is a major reason that your fund and your firm have done well over the last few years?

Harley Gold: We're specialists. So we're specialists in the apartment space.

You know, we've got 60 plus people in the company now. We're all across the country. We have a direct relationship with our borrowers. There are so many funds out there that they don't have their own sales team, meaning their own originators that are originating loans, even in the private debt or even commercial real estate lending, they would use mortgage brokers intermediaries or even use other companies like ours to originate loans.

But we have our own direct sales force. And so we're getting the best deals that we can get out in the marketplace and having that direct relationship with borrowers and having a lot of repeat business. A repeat businesses is what we look for to build long term relationships. You know, as I mentioned, 20 plus years of the business, I'm doing loans with lots of people today.

I've been doing loans with for 20 years and their track record has been great. I know them intimately. I know their business strategy. I know what they're doing. I know how they operate and we're transparent and they're transparent. And so even if they have to pay a little bit more to do a deal with us over a bank, they're dealing with us over a bank just because they know us.

We've done business and have that history. People at banks move around a lot more, right? And so in our organization, we have very little turnover. We've got great customer service. And I think that's been, been our strength is our customer service levels, our responsiveness, being available for our clients and helping our clients along the way, even in a higher interest rate environment where some of our customers today are paying a lot more than they've expected to pay.

We work with them and help out in terms of long term plans and so forth. With their assets.

Bob Simpson: Yeah. So if we were doing a job interview right now, I'd probably be asking you the question, so where do you see your firm in five years?

Harley Gold: I think that in terms of personnel, probably double. The particular fund that, our peak only opportunity fund will probably be three or four times the size from the origination side. We did 3. 2 billion of loans this year. Probably around 5 billion in Canada would be a normal stabilized, origination amount that we would expect, over a long period of time within the apartment space and, the industrial space. And a little bit of retail where we're active as well.

Bob Simpson: Yeah. So the future looks rosy for Harley gold in your firm.

So that's, always a good thing to see. Now, I just want to put out a, you know, big thanks Harley for sharing your valuable insights today, this podcast. Episode will be available on privatedebtandequity.ca as educational content for incorporating Commercial Real Estate Private Credit in portfolios.

Now to learn more about this asset class, please visit privatedebtandequity.ca click on concepts and look for incorporating Commercial Real Estate Private Credit into your portfolio. Before making any investment decision it is essential for you to consult a professional advisor to determine suitability.

Full disclaimers are available on privatedebtandequity.ca. Now also, please don't forget to follow us on your favorite podcast platform. Subscribe to our YouTube channel to stay updated on new episodes. I'm Bob Simpson. It has been a pleasure guiding you through. This informative discussion. Remember that knowledge empowers you to make informed investment choices and reach your financial goals.

So until next time, have a good day.

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