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Every Friday, join us as we dive into the latest in real estate multifamily with David Moghavem, Head of East Coast Acquisitions at Trion Properties. David invites top experts who know the ins, outs, and trends shaping the real estate multifamily market across the nation!
Whether you’re a seasoned investor or just curious about where the next big opportunity might be, Deal Flow Friday brings you the weekly inside scoop on what’s hot, what’s not, and what to watch for in today’s ever-evolving real estate scene.
David Moghavem (01:30)
All right, everyone. Welcome to another episode of Deal Flow Friday. I'm your host, David Mogavum. And today we got Michael Khalilzad, the founder of Castle Square. Michael is super active, super on top of it. ⁓ Michael and I have been working on a few deals and
Michael Khalilzad (01:33)
Okay.
David Moghavem (01:49)
He's always been super responsive, super helpful, super knowledgeable. You've also probably seen him on LinkedIn. love Mike, I love your takes on the equity conversations you have, what equity is out there, what they're looking for. And I would love to bring some of that into here as well. So I'm looking forward to this conversation.
Michael Khalilzad (02:07)
Well, I appreciate you having me David it means a lot I'm not one to really go on Public platforms, you know, it's kind of funny a few years ago I did run a podcast but I was on your side of the seat and it's been a lot more comfortable and the only reason I actually
David Moghavem (02:17)
Heh.
Michael Khalilzad (02:25)
I joined us today just because of ⁓ our personal relationship. I just think you're genuinely a great guy to work with and I was excited to be a part of something that you're personally spearheading. So thank you for having me.
David Moghavem (02:38)
I appreciate that. you know, for me, it's actually to have you on the pod who spoke to Sam Zell, to just have someone on the pod who spoke to him really elevates my pod. So selfishly, I'm happy you're on mine.
Michael Khalilzad (02:52)
I appreciate that. That's funny. I have so many jokes about that, by the way. I don't know. I've been talking about it. know, people have been asking me as well to relaunch because they did enjoy the prior series. What we did was kind of unique, kind of going back to 2021 with that series. It was kind of fun. The whole genesis there was I wanted to try to inspire students in university.
David Moghavem (02:53)
And I don't know why you haven't started a pot. Yeah, what's that? ⁓
Michael Khalilzad (03:20)
to have a live conversation as well. those podcasts that were publicized were actually live, live with college students sitting in the room where they had, Yeah, because I thought that would give them a good opportunity to feel inspired to say, wait, I just sat in the room with this type of executive. I feel like I could do anything, right? That it ⁓ of takes that separation of I'm just some young kid. What am I getting?
David Moghavem (03:29)
Wow, like a live stream.
Michael Khalilzad (03:48)
How am I ever going to get to the top of the corporate ladder if that's the path they want to take and now, I'm in the same room with them. Maybe anything is possible. It was just kind of meant to inspire ⁓ young students, but also to educate or enlighten folks who are actually playing the everyday game, right? Real state for my goals. Yeah. So yeah, I have a joke for you only because you mentioned Zell. He was one of like ⁓ one of the folks we were grateful.
David Moghavem (04:05)
And were they like interacting with the speakers as well, like live feed? That's pretty cool.
Michael Khalilzad (04:17)
I'm humbled that folks like that are willing to even join a platform that I was a part of, meant a lot. anyway, I thought you'll get a kick out of this. So yeah, the format we did there was where we would run a proper, true, ⁓ straight keynote panel, me and the speaker, for about an hour. And then at the end of that, because that was the value proposition for everybody in the industry, at the end of that hour, then I'd open up the floor for students, professors, et cetera.
⁓ to answer questions and the thing that you just get a kick out of them saying this so one thing people learn about me right now is i i'd to be myself and i'm i'm just a straight shooter i talk to you like i'll talk to anybody right so we'll just see where this goes but anyway so david you'll get a kick out of this when i ⁓ when i did the sam zell podcast in particular out of everyone we ever conducted that had the most rules associated to it by that by his team ⁓ and one of the
David Moghavem (04:58)
That's why I love you.
Makes sense.
Michael Khalilzad (05:14)
Yeah, and one of the key rules is nobody is allowed to type in the chat. Nobody's allowed to interject. Nobody's allowed to ask any questions. Only Michael and Sam could speak. And it was a strict rule because they, for obvious reasons, they were a bit uncomfortable having a live audience and this being recorded. They wanted certain things vetted and people can take professors were trying to break the rules every five minutes, like screaming, I need to talk to this guy. And they were getting so ticked off.
David Moghavem (05:39)
Yeah.
Michael Khalilzad (05:44)
but they were such good people. Yeah, it was funny. Believe it or not, this is in public information, but halfway through that podcast, because he's an inspiration for me as well, let's be real. If he's not an inspiration to you, then you're not a real estate guy, right? Halfway through that podcast, the fire alarm went off in my building. Yeah, so, we...
David Moghavem (05:44)
They just want acknowledgement from Sam Zell, just like knowing that they exist.
Of course, yeah, of course. It's a legend. Exactly.
Oh my God. I don't think I
remember that. I watched the episode. don't remember. Did you like edit it out or? Uh huh. Uh huh.
Michael Khalilzad (06:12)
Yeah, yeah, we cut it out and I went downstairs and
I say to the fire department, I what's going on here? Because I'm like, are you kidding me? Yeah. And they, you know what they said to me? ⁓ we're just doing a fire drill. So we have to come out for an hour. You know what I did? They wouldn't know who it is, but I was so into the moment. I said, excuse me. And I'm not being cocky because I don't mean it. I'm just so into the moment. said, I'm on a zoop call with Sam Zell.
David Moghavem (06:19)
I'm on the phone with Sam fucking Zell. Huh. ⁓ my god.
disaster.
Michael Khalilzad (06:39)
Please let me go back upstairs and they shut the whole fire drill down said my god we're sorry so I just thought that was kind of ⁓ a funny sound I know I forgot about that too you just reminded me but anyway
David Moghavem (06:45)
⁓ that is so funny. my God. Well, listen, luck wasn't
in your favor, but that's why we have editing and you cut everything out and you're good to go. And the only thing I know take out of that is, hey, amazing conversation that was and you spoke to a legend, you know, so God rest his soul and ⁓ listen back to business. Michael, I would love for the audience to hear.
Michael Khalilzad (06:58)
Yeah.
Appreciate it. I appreciate it.
David Moghavem (07:14)
what you're up to, what you're busy with. ⁓ Again, one of the things that I really enjoy is on LinkedIn, you and Alana and your team, you guys post like, hey, I just had a conversation with this equity group and this is what they're looking for and this is what they're targeting. You guys also do a great job of saying, hey, I get a lot of deals sent to me from sponsors and they're underwriting like this, this is why that's not gonna cut it. So give me a little bit of like, what are the type of products that you've... ⁓
Michael Khalilzad (07:39)
Yeah.
David Moghavem (07:43)
been active with and sourcing and getting your clients capitalized for.
Michael Khalilzad (07:48)
Yeah,
yeah, so a few interesting things. One, I believe we're in an environment right now where it's more challenging than almost ever, at least in my shorter career than some folks with more gray hair. But in my career, it's been probably the most challenging time over the last two plus years to get right to get deals capitalized. I don't I don't know how certain sponsors are still hyperactive who don't have discretionary, pretty committed funds.
David Moghavem (08:09)
100%.
Michael Khalilzad (08:17)
It is a tough environment. Although, yes, retail capital is probably a big part of that and people have a loyal investor base and it helps, but overall for folks, yeah, it's drying up big. It's drying up big for most sponsors. There are anomalies that I'm speaking about, right? When I mentioned retail, where there are some syndicators,
David Moghavem (08:27)
Yeah, but retail is pretty tough too right now. I mean, on all spectrums it's tough.
Michael Khalilzad (08:42)
It's an interesting word to be using as well after the, you know, after looking back over the past cycle, but some syndication platforms, they do still have very reliable capital. It's almost hard for me to believe I've seen syndicators primary experience in my day to day business. I've seen syndication platforms come in and capitalized common equity behind high octane preferred equity with a large amount of profit. And I said, that is insane how somebody has to act this. Yeah.
David Moghavem (09:09)
even post-rate like in the past couple of years, like even
in this cycle or are you talking about pre-
Michael Khalilzad (09:12)
Yeah,
in this current cycle, but this is rare. These are anomalies, right? So this isn't market themes. These are anomalies where I feel like some, it's either you're one of the few platforms who do have that reliable, still liquid investor base who is willing to back the deals you're doing, but that's definitely not ⁓ a normalcy in this market, right? What we're experiencing right now is an environment where
more times than ever. People are putting deals under contract and not making it over the finish line. That is becoming a common theme. It's, know, it's tough for our team too, even where you may do everything, you know, everything somebody ⁓ wants from you or needs from you. And then for some reason they have, dropped the ball as well on their side, even a week before a closing table. So that, yeah, it's tough to navigate. But anyway, with that being said, I, I'm a big believer in
creative financing as being a pivotal part of how you get a deal done today. And one good example of that is we recently just signed up a $9,400,000 joint venture equity commitment for a deal in the Midwest, contrary in play to the market. I'm actually, I surprised myself a little bit on this execution to be real.
It's a 1920s vintage townhome component plus a 1990s high rise component and a more secondary slash maybe even tertiary market. That is not where common equity typically is flowing. That is a very, very contrarian strategy and request. On that deal, the investor ended up formally saying no to us in the process. They liked everything about the deal.
David Moghavem (10:56)
Mm-hmm.
Michael Khalilzad (11:05)
And the only complaint they had is, which they overlooked, they didn't realize it, it was easy to miss, ⁓ there was an HOA component because of YMCA. ⁓ But it made no impact to the operational efficiency. It was not a nuisance. was just a fact of the matter. There's an HOA component here. But it made zero impact to the operational efficiency. And as a result, we believe it's not going to be too big of a deterrent for future buyers.
to create liquidity issues because that was the main issue the investor had was, Michael, our committee was ready to do this deal. We love it, but we have to pass purely because we have concern around exit liquidity given an H &A component. And instead of letting that deal die, I listened to their concern ⁓ and I got a little bit creative and I just countered them. And I just said, hey, based on everything I've heard, based on our experience thus far,
You guys love this deal. You love every single fact about this deal. You'd have a single complaint and you are comfortable with last dollar risk. Now you just have one minor concern about this HOA component and how it may poise, you know, a challenge around liquidity. So what I did is I said, I want to do two things for you. I want you to meet with the investment sales broker who could tell you about how many buyers, including institutions, were looking at buying this asset in this immediate process, because that does prove liquidity.
And then two, I like to propose something where you still do the equal amount of proceeds. still a traditional joint venture equity position from a equity ratio standpoint, from a prorata cashflow standpoint, from a waterfall standpoint. But if you truly have a liquidity concern, we could directly help mitigate that a little bit by putting you in a second loss position. So the sponsors, not material. It's not like you're going to 80 % last dollar loan to cost like prep.
David Moghavem (13:00)
Right.
Michael Khalilzad (13:00)
It's still a true equity ratio. You're not getting materially insulated. You're getting slight insulation where the sponsor's equity is first loss and the sponsor is very comfortable with that given how strong their basis was in this opportunity. And as a result, they came back into the deal. said, Michael, I'm not saying I'm smart because this is not genius, but this investor who is sophisticated, they came back and said, Michael, to be honest with you, I've never thought of that. And that is genius. Let me go back. We'll meet with investment committee on Monday.
David Moghavem (13:16)
Interesting.
Michael Khalilzad (13:29)
and I'll give you an answer, but this could work and it did. So that just shows you it's not a black and white market right now. If somebody says no, listen and think about how could he be creative to get deals done? And that is a really important, a really important factor in my career experience right now to getting things over the finish line.
David Moghavem (13:33)
Wow.
Yeah, so
so just unpacking that a bit, they were concerned about the liquidity on the back end, like like, know, how many buyers on the back end would buy this. And what they did to mitigate that is say, hey, by putting you in a second loss position, you know, if you can't sell it or have to sell for less, like you'll you'll still be covered. And maybe. Yeah, yeah.
Michael Khalilzad (14:11)
Potentially, right? It would help, right? It would help. Because you're not like
dropping now your equity ratio to something more like prefect equity, where you have a huge amount of insulation, but you were really comfortable with last dollar. So now I'm giving you a little bit even better basis, right? Just a minor, which yeah, yeah, exactly.
David Moghavem (14:18)
Right.
Yeah. Yeah.
And it does feel like equity at this point, common equity has the power, right? With how tight liquidity is and just the frustrations you were just talking about, how it's so hard to raise capital that when someone's kind of getting in bed with the deal, like, you know what? This is a little uncomfortable. They kind of have leverage in that regard. Have you been seeing that often or is that this was kind of a one-off?
Michael Khalilzad (14:52)
Charm.
Yeah, that's a good question. We're seeing a lot of different things. Now, I wouldn't say that's a typical theme because a lot of investors don't want to so-called take advantage of a sponsor given an e-liquid market. That's not the right partner to have. That's not the right partnership to go into. So we're grateful to not experience people trying to take advantage of an e-liquid market with the type of terms you're proposing.
David Moghavem (15:12)
Of course, it's not the right way to be doing business.
Michael Khalilzad (15:26)
We rarely see it, is a good thing. But what I'm seeing that is a bit interesting right now, and I'm working on navigating, is where I listen carefully to investor feedback, and then I think about ⁓ pipeline as a result. Where do we want to spend time? What could get across the finish line?
But like, for example, what we're seeing right now is a really common theme with investors is a lot of people want immediate yield day one. So going in high cash on cash, and they also want a strong per unit basis. They don't want to overpay for immediate cash on cash. They want high yield.
David Moghavem (15:54)
Mm-hmm.
Discount to replacement
costs and strong cash on cash day one.
Michael Khalilzad (16:07)
Yes, those are two massive things. And what's really interesting though, so we just ran a deal in Western US. I love the opportunity to be honest. It was a 7.1 year one cash on cash. The building was built in the 1990s, sponsor has experience in the local market. Good story. But not every, some people, we did have an investor step up who wanted to put in a common equity. was a RIA who's done 57 investments to date. They loved the opportunity.
But not everybody did feel the same way about that basis. They felt like the basis was a little bit too expensive for that immediate cash flow. So it was interesting. Shortly after we ended up getting a really strong pipeline that fits these themes of what everybody wants to write a check for. Very good discount on a per unit basis standpoint and strong immediate yield. And right now we have
David Moghavem (17:00)
And what's sorry
to cut you off, what's like a strong yield when you say that? Is that like, yep.
Michael Khalilzad (17:03)
6 % year-on-cash on cash depending on vintage
if it's like a if it's like an a-class property core location Somebody would love to take a 5 % cash on cash going and that's a great coupon, right? But if you're buying a bit of an older property, maybe more secondary market you want to you you want to be closer to like a 6 plus if yeah, and we're seeing that by the way last year I didn't see much of that. That was a really high bar where it was almost awkward to tell clients that that is what we want to see
David Moghavem (17:14)
Sure. Sure.
You want a six.
Michael Khalilzad (17:32)
⁓ to be excited to try to help procure equity. Yeah.
David Moghavem (17:35)
But enough people have said it now, where now
you're starting to see the market correct and then you're also starting to see, at least on agency, you'll start to come in a little bit where you can do a buy down and kind of get there with some financial engineering.
Michael Khalilzad (17:40)
Yeah.
Yeah,
yeah, what's really interesting right now is we have exclusive mandates on a handful, a handful of opportunities that all mimic these type of these type of returns or deal metrics. We have a deal right now that we're extremely excited about. Love the client. He's bought 25 assets to date, full cycle 13. He's really active. just has he just had a deal in Salt Lake City spoken for with an equity partner in the closing process.
He just had a in Ohio spoken for. We were a part of that, Grateful Eight spoken for. And now he has a third opportunity that we are drooling over at our firm. From every single factor about this opportunity where he is under contract formally to buy this at a per unit basis, that's 27.8 % lower than every single relevant trade in the market. That is a phenomenal basis. His year one cash on cash.
David Moghavem (18:45)
Post-rate hike.
Michael Khalilzad (18:47)
What did say? Yeah, no, right now, this is live, live. Yeah, right now, is pretty... Yeah, yeah, sorry. So, yeah, yeah. So, like, there was a trade,
David Moghavem (18:48)
Like post-rate hike or we saying, yeah, yeah, yeah. Discount to bark it today. Yeah. Yeah.
Michael Khalilzad (18:58)
there was a trade end of March of this calendar year. That ⁓ was 30,000 plus per unit more than what he's buying it for. And that was of an older vintage. So he's truly buying based on relevant recent trades, almost a 30 % discount on a per unit basis.
If you go and speak with local developers, he's buying at a 35 % discount to replacement costs. If you look at his immediate year one going in cash on cash, conservatively speaking, it is well past the 6%. And it's a privilege to be a part of that opportunity because it's 1990s vintage. That's new enough for a lot of the market to like. That's a liquid enough, you know, uh, yeah. Yes, it's, it's, it's a 6.35 using agency.
David Moghavem (19:30)
Yeah.
North of a six cap, I'm assuming, right? If you're getting to that cash on cash.
Yep. Yeah. And what area you said? What or what area? Sorry. Yeah. So, you know, one of my previous pods, we were someone brought up the analogy of of like a Kool-Aid and he brought a six pack of Kool-Aid because of a six cap. And he brought a ⁓
Michael Khalilzad (19:46)
It's not bad, it's good metrics, so we feel great about this one. But you know what's funny David, we haven't seen any of your re- what? Uh 1990s. Oh it's in the Midwest.
Yeah.
David Moghavem (20:12)
a Kool-Aid pack that was made in the 90s because the 90s in New York. And he's like, I'm drinking the Kool-Aid, six cap 90s in New York. And he's like, and we're finding bees in the Midwest. And he brought out a corn.
Michael Khalilzad (20:16)
Yeah.
Yeah. Yeah, it feels good. Yeah, yeah, it feels good.
They think that they like what I'm talking about, by the way. It's a good play. It's a big deal, But the fundamentals are there. That was a funny podcast, by the way. I teased him about it jokingly. But you know what's crazy, David? So it wasn't too common to see a lot of this last year for me, at least based on our pipeline, right? Yeah. Right. now.
David Moghavem (20:28)
Yeah.
Yeah. Yeah.
It was tough. It was tough for sure. mean, especially,
especially in the Sunbelt, you know, with if you want to like a true six cap was very tough to find in the Sunbelt with supply glut concessions. You started seeing some bad debt and then, you know, we own a lot in Colorado. You started to see some operational challenges in the coastal markets. You didn't see it yet. So I think a lot of people flock to the Midwest because you can buy kind of better vintage six caps and there's a lot of diamonds in the rough. ⁓
Michael Khalilzad (20:54)
sharp.
sharp.
time.
David Moghavem (21:14)
I think you were about to go say right now, it's starting to become more common because why? think to me, this is the year where sellers are really capitulating. They really are making a move and they can't just kick the can down the road anymore. So they're meeting the market and there's enough trades where you see that this is the new reality.
Michael Khalilzad (21:14)
Yeah.
Yeah.
Yeah.
sure it's it's the first time I could say this in a long time where we have a very full pipeline of live exclusives where these deals all meet these type of requirements right where I feel very good about saying I will get common equity across the finish line we have a deal right now in East Dallas the spot if you're if you know East Dallas the sponsor has a has an asset under contract at eighty nine thousand per unit
His all-in cost basis is 103... It's a little older. It's 1980s, but Class B real estate. It's a good-looking asset. He has this under contract at 89,000 per unit. His cost basis is 103,000 per unit. If you analyze the sales comps in the neighborhood, the only thing that's ever sold even recently for 103,000 was a fire sale of a guy in distress. Everything else is selling 120s and up.
David Moghavem (22:01)
Wow, what's vintage?
Mm-hmm.
Yeah.
Michael Khalilzad (22:29)
So we feel good about that basis. It's well over a 70 stabilized yield on cost. It's a good story. So we're really excited with a lot of what we're seeing. We have another deal in tougher market. Okay. Let's be real because of tenant and landlord laws. The tenant laws are making it a bit tougher equity. So we don't love the market, but we love this local sponsor and this basis play as well.
David Moghavem (22:29)
Yeah.
Michael Khalilzad (22:54)
They have an asset under contract in a phenomenal neighborhood of Washington DC. They're buying this thing at a per unit purchase price. Well over six figure, like a hundred plus thousand below where other ⁓ comparable ventages have traded recently. It is a phenomenal discount. Their year one cash on cash skyrockets above a six and they're also taking advantage, which I really love, of an accretive seller press.
David Moghavem (23:14)
Yep.
Michael Khalilzad (23:22)
It's not high leverage, it's only 8 % coupon with a 5.0
David Moghavem (23:26)
It's a seller carry
to kind of bridge the gap to get the pricing that they need to get to.
Michael Khalilzad (23:30)
It
wasn't, yeah, it was just a tool to make the returns even more juicy without having some high octane piece of preff because JV equity doesn't sit behind preff. That's not a, that doesn't sit behind preff. But guess what? They're comfortable with that. This is super soft, super friendly. It's 8 % all in with the 565 current. It's great. So this deal is pushing north of a 20%. It's a net 19 IRR.
David Moghavem (23:42)
for sure. But they'll sit behind a seller carry that's in the market.
Michael Khalilzad (24:00)
That's not that easy to find. So it's like we're seeing, we're seeing a widespread, you know, widespread deal flow that underwrites Wells. That's the whole point. That's why I'm like, I'm so excited right now. It's this is, it's wrapping up.
David Moghavem (24:02)
For sure.
Yeah, Michael, let me ask
you on, you you guys, have some great clients and some great repeat clients and it sounds like they're finding some really solid deals. If I talk to most sponsors, think sometimes that's probably not as common as maybe you're seeing on your pipeline, right? Because you get all the good deals to get capitalized. How do you think these sponsors are sourcing deals or, you know, you don't need to give up their...
their secret sauce, but what are some common themes that you're seeing that the story that you're hearing from the story that's getting to where it is? All these good deals have to have a story. So what are those stories you're hearing?
Michael Khalilzad (24:53)
Sure. one story on a deal we're doing right now, the sponsor has a... So this isn't the founder of the firm there. They're looking to grow their presence in a certain pocket of the country and they hired a great boots on the ground team. So highly experienced guys with a great local reputation. ⁓ There's an opportunity right now that they're under contract in where the seller is a bit... Not literally distressed financially.
David Moghavem (25:10)
Mm-hmm.
Michael Khalilzad (25:23)
but distress because she just went through a process with an alternative buyer who dragged her drag this thing along for so long, so much diligence, took so much of her time and they failed to close. And it was a lot on her mentally. they, this is a truly really actually drained her. She did not want to go through this process again. So she put it back on the market. It was not fully on market, but they talked to key people and our client was awarded the deal.
for millions of dollars below the next buyer in line millions of dollars below because their reputation this guy in the local market his reputation is phenomenal at the brokers but the seller they knew they were not going to cause headaches they knew they they're good for their word they're going to close this deal and they can move quick and that got them a substantial discount because she didn't want to go through another stressful process and yeah ⁓
David Moghavem (26:18)
Yeah,
that's soup. By the way, that that's a story that is definitely a common theme. It's not an anomaly. Like there's a lot of seller fatigue right now from just being in this choppy environment and sellers that need to make a move for liquidity purposes are in a bind. They need a surety over anything like price. Obviously, people want to get the highest price. But at the at some point, you just got to say I need to go for the sure bet.
Michael Khalilzad (26:28)
Yeah.
Yee-haw.
David Moghavem (26:48)
And I think you're starting to see that. so reputation, staying around the rim. I've said this before. I think the broken sale processes, you're starting to see a lot of good value where you're not the highest bidder, but they go for you because of reputation and, just the process playing out.
Michael Khalilzad (27:06)
Sure.
David Moghavem (27:07)
I would say a couple of years ago when people were having low maturities, you still had a little bit of, I guess, outlook that things are going to get much better later on. So they would say, OK, let's wait another year. Let's buy another recap. Let's do our capital call. I think we're out of time now where the capital calls are over. ⁓ If you haven't done a capital call up until now, you know, then your time is up and
Michael Khalilzad (27:27)
Sure.
Sure.
David Moghavem (27:34)
And lenders are also kind of agreeing that things aren't going to change much from where they are today. So I think the motivation, like you're saying, is actually now starting to translate to sales more than we've ever seen it.
Michael Khalilzad (27:41)
chart.
Sure.
You know, could I semi-pivot the topic for a sec because you mentioned capital call and it just reminded me of something that I would love the opportunity to take advantage of this time together on a live podcast to just throw something at the audience. People learn a lot about my personality quick. I am very opinionated, but I'm a good guy, but I love to say crazy stuff, right? Because that's how people learn.
right? It makes my team laugh. People love when I say something insane because then they just think it's funny. I'm such a... I say it as it is. If you're watching this podcast and you're new to the business and you have a property under contract where you're assuming a floating rate loan and you tell me or any investor that you're very good at finding good deals but to make it pencil you leave key things out of your budget such as funding a rate cap for the entire life of your old period
You're not good at finding deals because it doesn't pencil and you should not be buying a deal with investor capital where you don't have something like a rate cap fully funded for the life of your investment period because you're a fiduciary to your LPs and that's inappropriate. So you...
David Moghavem (28:54)
Amen.
You've, you've,
it feels like you shouldn't have to say that, but with some of the bad buys that you've seen and just the people out there, you gotta say it. Yeah.
Michael Khalilzad (29:09)
No, no, David, it's not the bad boys! I see stupidity
where people are buying tomorrow! Who haven't learned from the bad boys! And I'm like, are you kidding me?
David Moghavem (29:18)
Yeah, it's crazy.
It's crazy. It's crazy. Michael, you probably see some pretty bad underwritings. I could feel it. You have some good clients, but then you probably have some people that are just coming out of the woodwork and saying, hey, I'm under contract, I'm hard, I close in 20 days, I need capital. And then they're like, well, no wonder why you haven't raised capital. Look at how you underwrote this deal. So how do you vet that? How do you vet that?
Michael Khalilzad (29:21)
And I swear I say it because game is crazy.
It's crazy!
For sure.
For sure. But you know what's really concerning to me though? Yeah.
David Moghavem (29:48)
Let me
ask you, how do you vet that in the beginning? Like how do you vet the guys who are for real versus the guys who just need to get some capital quick and might get wiped?
Michael Khalilzad (29:59)
To be honest, I don't believe in speculation because I'm conservative. We worked on launching a bucket of capital back in quarter one where we were looking to deploy 900 million into ground of development projects. And that changed my whole philosophy as an intermediary for advisory side of the business on how to analyze a deal.
When we launched this program that we were looking at doing back in January, we had a ground lease component. ⁓ And then we'd pair that with a non-recourse construction loan. The reason we did it is for a few things, right? If we go back to Sam Zell's podcast with us, right? One thing he said is to make real wealth, you need to have a monopoly. You need to be contrarian. You don't want to jump on the bandwagon.
Why would I want to be a prep allocator? The whole country is allocating prep. I'd rather try to do what nobody's doing. And I understand why nobody's doing senior debt behind ground leases. It's very challenging thing. There's a lot of risk associated to it, but we think there's actually a of benefits. So anyway, when we worked on launching that program to put out 900 with a read and a conglomerate, I had to really start thinking a lot more conservatively as well, because brokers could be aggressive.
right, and just trying to push, push, push. So when we did that, because of the ground lease component, I built a higher level of discipline. Because if I have a conglomerate partnered with me to go allocate construction financing, where we're originating a ground lease alongside our product, business plans need to go according to plan because of the elevated risk of being on a ground lease. If something doesn't go according to plan,
you're in a very scary position so with all that being said i don't like to believe in speculation when i when i evaluate a deal and most investors don't like to do that either
So if a sponsor's never done something, for example, that's not a very good story to me. If it's a new business plan for a sponsor, how do I get comfortable? Okay, I'm not just gonna shut you down. My job is to help be valuable to you. Let me try to help come up with a story here that actually is credible that we're comfortable with and see if we can do something. So when we think about sponsorship, ideally the best story that people wanna see is a sponsor
who has at entity level has done what they're looking at doing again but if that story is not there we're definitely gonna wanna analyze a sponsor's prior track record who's on the team what is their actual involvement what is their skin in the game how much money is coming out of your pocket what are you netting in this deal after fees in terms of skin in the game we look at all that if a sponsor says he's done a bunch of things great but let's analyze that srto
make sure his portfolio is not in shambles. If he has one jail that went bad, I want to talk to him about it. And I want to hear how he responds. he ⁓ an honest guy? You want a critical...
David Moghavem (32:59)
That's key. I would say that's even more
key, right? Like how are you handling these deals like in and out of this cycle? if someone's been in the game for, you know, they started their company 10 years ago, they had a, you know, a seven, eight year bull run, right? So, you know, in this cycle, exactly.
Michael Khalilzad (33:07)
100%.
100%. Yeah, how were you performing when shit hit the fan, right? When everybody
was in, not everybody, you could almost say that metaphorically, when everybody was, you know, was struggling a bit, right? What did you do to navigate that market, right? And it's not just about how they navigate though. I'm also curious as to your character. What are you gonna tell me about those tough times and about your portfolio, right? Are you an honest partner?
Or do I think you're not being transparent? So it's a holistic approach is the point, right? On how we think about sponsorship. But the theme here is we don't want to speculate.
David Moghavem (33:58)
One thing like I know you're talking about,
ground up, it's tough to make ground up pencil right now in general, because unless you're in markets that are super supply insulated, and you're still seeing rent growth, like maybe parts in the northeast or like just just different supply constrained areas. It's really hard to make these type of construction costs, borrowing costs, basis pencil when you can buy below replacement costs. So like, how are you making
Michael Khalilzad (34:18)
I'll go ahead.
⁓
David Moghavem (34:31)
those because I know you were saying like you were putting out some ground up construction money. ⁓ How are you making that pencil? And I think you were saying offline maybe that you guys were pivoting strategies or coming up with something. So I'd to hear a little bit about that.
Michael Khalilzad (34:35)
Yeah.
Yeah, yeah,
for sure. ⁓ Believe it or not, I love the ground up business. it's tough to make work right now. But where I think I'm the biggest nerd is definitely when somebody says, you look at my ground up deal? I always smile knowing I'm about to look at the Excel sheet out of curiosity.
David Moghavem (34:59)
Yeah, but the ground up developers
don't know how to underwrite usually. think, you know, like they're usually, to be a ground up developer, you gotta have balls. Like you gotta, you gotta, you know, and like if they, there's a joke that like ground up developers, if you haven't filed for bankruptcy, you're not a real developer. Like that's like the joke, cause they just, there's so much risk. There's no cashflow. Your first dollar is when you finish lease up and then you have to flip out of it. It's very tough.
Michael Khalilzad (35:03)
Yeah.
He's sharp. Sharp.
Sherman.
Strongest
David Moghavem (35:28)
Like I'm not talking about like the related groups and like the institutional ones, but.
Michael Khalilzad (35:29)
Sure. Sure, you know what I think is actually really insane
when it comes to being a developer too? In certain cities, depending on what you're doing, having these assemblages. I've seen crazy things from smaller guys who are in almost over their head to get their deal to actually get a shovel in the ground. Just getting through the assemblage of all these parcels, depending on how the type of project profile or location, the carrying costs, the pre-development process, and they sweat.
It's like it's been a year, it's been two years, it's three years in some markets, four, right? And that to me is also pretty crazy when it comes to the grit you have to have as a developer. It's nuts, right? What we're trying to do though, right now to help smaller developers, right? Smaller players is bring in a joint venture partner who is actually a blue chip developer, one of the largest in the United States of America. We have a phenomenal relationship with them.
one of the largest affordable housing developers in the US. They've been around for countless decades, but they're also active in other resi food groups, right? So traditional market rates, student. They're comfortable as long as there's not entitlement risks, I will say that, but they are comfortable buying land and going through. Yeah, it could be, it could even be a little bit ahead of shovel ready, but there's no like, ⁓ call it just like zone. Yeah, yeah, exactly. ⁓ And
David Moghavem (36:41)
Mm-hmm. Shovel ready.
Bye bye, right.
Michael Khalilzad (36:55)
What we're essentially doing for smaller sponsors now, we actually are in the middle of one right now, is bringing this blue chip developer to come in and partner with a small little developer.
And they'll fund 75 % of the GP.
equity in the deal. In this case, the GPs want a promo, meaning they're not putting in all the LP equity, right? But there's still value here and I'm going to get to it, right? So.
David Moghavem (37:17)
Mm-hmm. Mm-hmm. Yeah, so
like if on like the equity side, let's just dumb it down. Let's say you're gonna go vertical, the construction loan is 60%, LTC, the other 40 % is equity, and then the GP is gonna be probably 10 to 20 % of that 40, right? And then what you're saying is they're coming in for 75 % of that 20.
Michael Khalilzad (37:34)
Right. Correct.
What's really exciting about this is that not only will they contribute 75 % of that capital, they're going to sign any loan guarantees, meaning that's essentially unlocking financing you probably wouldn't have had access to without that guarantee, without those guarantees and that partner. So now you get way more to creative financing, way more creative financing. You now have a balance sheet that you could do these bigger deals that you wouldn't have had without that partner. Right.
And not only that, now you also unlock equity because they're truly a development partner. They're a code development partner. They'll let you do whatever you want to do that you're good at. They're comfortable with you doing GC work if that's what you're good at. They're comfortable with you doing whatever you're good at. They're not here to step on your toes. They're true partners, but they are a code developer.
And that unlocks the equity as well, because it's so tough right now. If you're the biggest developer in the country and you're a co-developer in this project, I probably will have a easier time bringing in a joint venture equity partner. And we work really well with them. They're a capital markets team. We could collaborate. They can help bring in a joint venture equity partner. So I think that's a really good tool that we're using now to unlock capital stacks.
for development projects in this tougher environment because we do hear this theme. There's a fund in New York City. They were founded by former Carlisle executives. They manage a quarter billion. They're only targeting maybe four MSAs, Atlanta, Boston, and two others, right? I think Seattle. And we have a live deal right now. And they said, Michael, I love the project, but this developer's an in-house GC and he's only done a few smaller deals. I won't touch this with a nine foot pole.
purely because of that. So now by bringing this one partner in, overnight interest, right? So we see lot of value there.
David Moghavem (39:33)
Mm-hmm.
And then this other
partner, they got to leverage their experience and their liquidity in a market where capital is only getting placed to few and far in between experienced sponsors. And you're solving the capital dislocation that you're seeing right now, ⁓ where by doing a co-GP, you're giving that capital solution to those people who are in a bind, don't have the liquidity to.
Michael Khalilzad (39:55)
Yeah.
David Moghavem (40:05)
you know, sign the liquidity requirements on a loan or meet the net worth test because they're just, it's a tough market. Why would you sell in this market? So the deals that they were supposed to flip out three years ago, now they have to flip out six years from now, you know?
Michael Khalilzad (40:08)
Yeah.
Yeah.
Yeah,
yeah, no, 100%. We actually ⁓ enjoy, we really enjoy playing in that whole credit enhancement space as well. We really enjoy credit enhancement executions because at least in our experience, maybe others watching have a different experience and they find it to be more liquid. But I personally, David, find ⁓ credit enhancement, getting a loan guarantor ⁓ who is, maybe doesn't know you that well as a sponsor.
isn't that easy. It's not that readily available to have somebody come sign on your loan docs. we do have a... Yes. Yeah. And we have a very reliable solution there, where within maybe 48, within maybe two to three business days, worst case a week, we could turn around and almost guarantee have a hundred plus million dollar net worth.
David Moghavem (40:53)
There's more strings attached to it now, yeah.
Michael Khalilzad (41:15)
and 15 plus million dollar liquidity readily available to come and sign on your loans. Non recourse, but yeah, to come and sign on your loans. Even if it's whether grant development, yeah, that's key. Even if it's a grant development or acquisition or recap. So we're doing a lot of that right now. A lot of lenders ⁓ came to us saying we should partner up where we can bring you all of our borrowers because we really have a frictionless process.
David Moghavem (41:26)
Yeah. Yeah. Non-record. Exactly.
Michael Khalilzad (41:43)
You're not going to have to wait two weeks and I'll figure it out. ⁓ no, no. Like many times I'm figuring out in 24 hours. It's it's it's like programmatic. It's just sure, sure, sure, sure. For the right deals. So that's been a really fun place to play, given for us, it's pretty fluid. It's a very liquid. We could keep doing it for the right deals, right. Sponsors move fast. It's reliable and it's valuable. Right. I'm seeing a lot of deals in limbo because smaller players, right. They don't have that.
and everything else was spoken for and we could come in and they could close. So it's a good feeling. We're doing a few of those right now as we speak.
David Moghavem (42:17)
Yeah, and I think ⁓ you guys serve really well in that space, it seems like, with the middle market, emerging operators, or proven, know, like also, but what I'm saying is like those people need people like you, and it seems like you've had a lot of success with operators like that. I guess, you know, to some closing thoughts, these emerging operators...
there as they're trying to raise capital and they're trying to ⁓ put deals under contract and get them closed. What's like some general advice you would give them? I know you gave some passionate advice already in the middle of the pod of underwriting and things like that, but what's like some general advice you could give like an emerging operator right now looking to raise capital? And then on the other side, and I'll let you start with that, but on the other side, it's also what's some general advice you would.
Michael Khalilzad (42:54)
I would just be inside of you.
David Moghavem (43:09)
give capital because you're matching the two together and marrying the two. So what's some advice you could give to both sides to kind of ⁓ hear what you have to say?
Michael Khalilzad (43:13)
sharp.
Sure. When it comes to sponsor advice, think transparency is key. Be somebody who is easy to work with, be somebody who's honest, ⁓ but also know your stuff. Right? Don't send somebody like, it sounds, it's common sense, but I see so much business. I, so I, when I say things that seem like common sense, I'm speaking because I see so much crazy, crazy things from sponsors. Know your stuff.
David Moghavem (43:45)
You see it all.
Michael Khalilzad (43:46)
Don't speculate in your underwriting if you're if you're showing somebody
a business plan where you're like I did there's one thing that I'm comfortable saying this example out loud because I did directly tell the sponsor my opinion a few days ago but if your business plan is literally based on interest rate movement cap rate movement like that's bullshit right you need to be able to find deals with good fundamentals focus on opportunities where you have healthy immediate yield you want to buy assets
with a 6 % year-on-one cash on cash if you're going old pre-2000s maybe, if you're buying newer properties, core markets, great locations, a real class A lot, a 5's fine, right? But if your business plan, this is really good piece of advice honestly for all sponsors watching who are smaller at least, if you're trying to buy an asset where your year-on-one cash on cash is well below like a 5%,
and it's like a 1980s, 1990s property and your asset that you're under contract to buy is like 90, it's stabilized and your business plan is to just push rents. That is a very tough story right now. It is extremely contrary to equity. And that is, you, if I would have a sponsor want to align with where there's the largest box of interest from investors to have the highest probability of getting a deal over the finish line.
David Moghavem (44:58)
Yeah.
Michael Khalilzad (45:10)
I've done deals gratefully that are contrarian. 1920s vintage, population of 50,000, the boondocks, right?
there was a deal where the median household income within like a small radius of this asset was $21,000.
We were just joking back and forth and they couldn't breathe laughing. This is the first time I think in my career I underwrote a deal with this type of immediate household income. know, crazy, right? But so like people don't want to do these type of deals. That is an illiquid transaction profile. I'm not telling you don't pursue if you think it's a good opportunity. I have contrary investors. I've done it.
David Moghavem (45:39)
Yeah, it's slow. That's low.
Michael Khalilzad (45:54)
But that's just you're not aligning with the theme of the market. So your probability of just closing transactions go down if you don't know who those anomalies are. We only take an anomaly transaction because we know exactly who's doing that contrarian play. And it's fairly black and white for those folks. ⁓ And then as it relates to the capital market side of things, I think we're in a time and place where people need to start
being more creative and not following the bandwagon. I have a lot of opinions here, I'll keep it short, but this is a very, I really would like to see more innovative products in the market. When you look at preferred equity, everybody's offering, right? Their current pay, their accrual, whatever, all this crap, that makes it very tough for sponsors to raise equity. So that doesn't feel that liquid to me. How are you putting all these dollars if you're issuing a product where sponsors can't raise common equity? That's tough, right?
David Moghavem (46:53)
behind it you're
saying like like why yeah.
Michael Khalilzad (46:54)
Yeah, it's tough and you're
not speaking for all the equity and you're creating giving a product that makes it almost impossible for sponsors to fill the gap. So that's not that accretive to me. Yeah, 20 % of $50 million for a small sponsor, like it's not easy. And how are you going to raise the money? Right. So we have a lot of thoughts on how to have just better financing options. What I personally would love to see from more investors out there is a solution where
David Moghavem (47:02)
Yeah, it's like we'll get to 80 % last dollar. How are you going to get the other 20, right?
It's not easy.
Michael Khalilzad (47:24)
It's a bit of a hybrid, right? Because you could even be disciplined about the transaction profile where you feel like you're getting all the benefits of preferred equity, but it's really a hybrid of Pref and JV. you're, but again, only doing it on deals maybe where you feel like you're again, getting some of the perks of a Pref position. So what I would love to see from a lot more investors is where you have a second loss position, joint venture equity investment.
where maybe you're not 90-10 JV equity, because that's not a lot of insulation. Maybe you're 80-20 JV equity. So it's still a fair equity ratio. have a little bit of, not a huge, but a little bit of insulation relative to your last dollar exposure, because the common equity will be lost before yours if there was impairment. But on cash flow, you're a pro-ratum. So now all common equity is happy with the deal based on cash flow.
There's no accrual because accrual creates risk. If the business plan goes a little bit sideways and this accrual is adding up, you're really going to damage this common equity. Sophisticated retail investors don't want to sit behind this, right? So this hybrid product where you're a second loss joint venture equity investor, pro rata on cashflow, no accrual, there's no current page as pro rata, at sale, you're insulated.
David Moghavem (48:37)
Yes.
Michael Khalilzad (48:51)
by whatever your equity ratio is. Your principal's paid back first. Any common behind you is paid back second. And then there's a waterfall. That to me seems like a much better product that will be more liquid. A lot of people could close the gaps behind that. It's a lot safer for the sponsor. And it's honestly a good product as an allocator because if you're selective about deals you do this in, you could have an immediate yield day one.
I have a pipeline that's so robust. I can't keep up honestly, David, with all these deals that have a 6 % plus year one cash on cash. The amount of preferred equity investors who say, I could do a 6 % current pay. Well, guess what? You could get a 6 % yield without business plan risk. If you're just selective, there's countless opportunities to get a six or seven, call it a 6 % plus yield. That is your current pay, right? So I like that story. I have a
robust pipeline where people are buying at a huge discount to replacement costs and to recent trades. So if you're a prep product and you're saying 80 % LTC, well 80 % LTC on an expensive deal is the same basis in my opinion as an 80-20 equity ratio if somebody's buying 30,000 per unit lower on a cost basis than everybody else. So that's what I think, that's what I'd love to see.
David Moghavem (50:09)
Yeah.
Michael Khalilzad (50:15)
in equity market. want to see more innovative products. I don't want to see everybody copying all other get off the bandwagon. We need more innovators in this space. That's how deals are going to get done. And I look forward to kind of seeing what's out there, you know, over the coming months.
David Moghavem (50:32)
Michael, think that second point about capital is super important, right? Like when we, I went to NMHC and every institution and their mother is saying, we have this pref product, we have pref product, like we're not putting out common, but I have pref. And on paper, it might seem fair or it might seem even safer. But as you said, like 80 % of something that's overpriced, even like rescue capital, it's the same stuff and not as liquid as you said, like who's gonna get behind it?
Michael Khalilzad (50:54)
It's the same stuff. It's relative.
David Moghavem (51:01)
No one's gonna get behind that. Even on rescue capital, the only way you can truly get prepped to rescue a deal in this time is if you're probably resetting the basis. So at that point, why don't you just do what you said and just come in as common with maybe a little bit of mitigate in risk, like a second loss. I think that's a great idea.
Michael Khalilzad (51:01)
100 %
100%.
You know it's funny
David, I know this is it's over now right we're wrapping up we're literally testing this thesis right now meaning we're challenging a black a blackstone subsidiary company that we have we're we're we love working with them if people don't know them these are class act guys but they've pivoted away from joint venture equity to preferred equity but I just I just sent a very detailed analysis as to why in my personal opinion and I laid out this creative structure.
is far more creative on this deal than if you did a preferred equity, the standard preferred equity on your typical deal, right? So yeah, we'll see. It's something I'm really passionate about as well. I feel like there's a big need for this right now. So anyway.
David Moghavem (52:05)
Yeah, well,
Michael, it was amazing having you on. This was a great time. Every time I talk to you, it's always a great time. You're passionate, you're on the ball, you're just running 100 miles an hour. Your thoughts are all over the place. And when you bring it all together and pitch these products and get ⁓ operators and equity to come together and marry them into a deal.
Michael Khalilzad (52:13)
Like live.
David Moghavem (52:31)
It's a beautiful thing and it's even tougher in this environment, but you do such a good job doing it. So thanks again for hopping on and looking forward to discussing more deals together.
Michael Khalilzad (52:40)
Yeah, I appreciate it, David. Thanks for having me.