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March 6, 2023

A LP's Guide: Navigating Through Uncertain Markets

A LP's Guide: Navigating Through Uncertain Markets

In this podcast episode we interview Paul Moore, Managing Partner and Founder of Wellings Capital. He advises limited partners (LPs) on what to look out for in the current market when investing in real estate deals. LPs should look out for for low leverage, high skin in the game, and operating expense ratios below industry norms. They should also be cautious about reversion cap rates, which may not work in all cases, and inflated rent growth assumptions, which can be misleading. LPs must scrutinize the sponsor and the deals and avoid confirmation bias while investing in real estate. Apart from that he also discussed the opportunities to navigate through the uncertain markets.

LPs Should Be Wary Of These!

  1. Low leverage -  Low leverage is preferred in general, but investors should be careful when there is preferred equity in line ahead of them. This means that preferred equity will be prioritized in the capital stack ahead of the investors, which could be a disadvantage.
  2. High skin in the game - Investors should look for high skin in the game, but they should be careful if the sponsor's upfront fees are the only source of skin in the game. Sponsors should also have a personal stake in the game and be willing to invest in the deal.
  3. Operating expense ratios below industry norms -  Operating expense ratios below industry norms are a red flag. Syndicators sometimes lower their operating expense ratios to get to the IRR for investors, but this could be problematic in the long run.
  4. Reversion cap rates much lower than the current cap rate - Counting on reversion cap rates much lower than the current cap rate to make a deal work could be speculative. Investors should carefully examine sponsors and their track records to determine whether their value-add upgrade program is likely to work.
  5. Inflated rent growth assumptions -  Investors should be wary of inflated rent growth assumptions. Syndicators often stretch their assumptions too far, which can cause problems in the long run. Investors should look for sponsors who are realistic in their projections and avoid those who rely too heavily on inflated rent growth assumptions.

Opportunities in Uncertain Markets

Paul Moore discusses the opportunity for investing in preferred equity deals during a downturn, citing Warren Buffett's successful $5 billion investment in Goldman Sachs during the 2008 financial crisis. He emphasizes the importance of being prepared to invest when opportunities arise and caution against waiting too long as deals can move quickly and quietly. Jake also acknowledges the potential risks involved and expresses empathy for those who may lose money in a downturn. Overall, they suggest that now is a good time to prepare for potential investment opportunities, as the market is likely to present deals in the coming months.

What is Preferred Equity?

Paul shared the concept of preferred equity (pref equity) is discussed as a potential solution to the challenge of obtaining equity financing for real estate deals. Pref equity is a type of equity that has current cash flow and sits behind debt in the capital stack but in front of regular limited partner common equity. It offers a fixed coupon rate of 8% and has limited upside potential of up to 6-8% more, totaling to a 14-18% coupon rate. While pref equity may not have unlimited upside potential, it can be a more attractive option for investors in times of market uncertainty.

Who is Paul Moore?

Paul Moore is the Managing Partner and Founder of Wellings Capital, a private equity real estate firm that focuses on acquiring, managing, and growing commercial real estate assets. With over 20 years of experience in the industry, Moore has been involved in the acquisition and management of over $500 million worth of real estate assets. He is also a published author and speaker, and has been featured in various media outlets, including Fox Business, Forbes, and Entrepreneur. In addition to his work in real estate, Moore is actively involved in charitable organizations and serves on the board of directors for several non-profit groups.

If you'd like to say hello, you can find Jake at @JJakeWiley on Instagram and Twitter, and on LinkedIn.