Why Real Estate Development Deals Fail to Get Financing

John Friedrich (00:00)
when people people always think what i would like if i just have the money i would be able to do this you know it’s like no it’s like you know so so much of it especially with cover earlier stage stuff or the higher risk stuff it’s it’s about working with the people that already have the asset and finding you know the highest and and best use of the super efficient with like how you deploy your your

Cody Crabb (00:05)
Right.

John Friedrich (00:23)
your own cash right

Cody Crabb (01:57)
Welcome back to the Real Estate Pros podcast by Investor Fuel. I’m your host, Cody Crabb And today I’ve got John Friedrich with LFB Ventures. John helps developers and builders secure large scale financing for major real estate projects. And today we’re going to get into how lenders actually judge a deal, the sponsor, the asset and the market. John, thanks so much for hopping on today. I really appreciate it.

John Friedrich (02:18)
Thanks so much Cody, it’s a pleasure to be here.

Cody Crabb (02:20)
So to start out, I love getting a little origin story. Where did your radioactive spider come from? How did you get into the business?

John Friedrich (02:28)
Yeah, yeah, well so I started my career actually in the Mining sector if you can if you can be leave it my father was an investment banker in kind of gold mining sector mainly in South America things like that and you know, I Joined him at the end of his career ⁓ and didn’t really you know

Want to get into the mining sector was you know, it was a little bit kind of old school I guess and You know, I’d always kind of admired Architecture and design and like how do cities work and you know all of those types of things So I thought that getting into the real estate arena would be would be you know a lot of fun So, you know joined kind of a small-scale developer ⁓ Back in

was it 2015 or something like that, so about a little bit over 10 years ago or so, doing kind of luxury single family homes in Los Angeles, town homes, all that sort of thing, and had a lot of fun. But slowly, know, learned that I wanted to focus more on the financing side. Both my parents were investment bankers and things like that, so it’s just kind of a language that makes sense.

And ⁓ yeah, joined LFB here about three years ago or so. You know, done a little bit over 250 million ⁓ in transactions ⁓ over that time. You know, worked with a great team and kind of here I am and there I be, kind of in this crazy market of ours.

Cody Crabb (04:07)
Yeah, yeah, I’d love to get some thoughts on that from you later, by the way. ⁓ so before we started, you mentioned you said every transaction kind of has three pillars. Go ahead and kind of I love that analogy. Can you go ahead and kind of give our audience a little peek at that?

John Friedrich (04:22)
Yeah, totally. I mean, I think a big part of the way that I look at the market and the way that we look at the market here at LFB is that every transaction is pretty much grounded in objective truth, not just what the sponsor or the lender or one vantage point kind of sees. It’s like what’s happening holistically. And that…

Cody Crabb (04:46)
No matter how much you don’t want

it to be that way or yeah, that’s it sometimes is the hard truth, but yeah

John Friedrich (04:51)
Yeah, Yeah,

especially when like, you know, when people start trusting you with their money and you know, you’re trying to make to make a project or a business plan work, you know, like you can’t can’t force it. You are, you’re, you’re held to the laws of nature for lack of a better sort of phrase. And you know, the, you, you really have to build off of that foundation.

I to overly do the analogy here with.

real estate but yeah so you know I think you know the way that we look at objective truth is we break it into three basic pillars you know one is sponsorship you know who’s the team that is ⁓ building the project you know who’s putting up a know a portion of the equity who’s managing the team who’s taking it through entitlement who’s taking it through permits and construction and who’s ultimately going to execute the business plan that’s that’s pillar one

What’s their experience, know track record all that sort of thing? The second pillar is the asset, know, what are you gonna build? We focus only on land and housing So like, know, is it gonna be a single-family home? It’s gonna be a town. it’s gonna be mixed uses could be in a apartment building And what are the general? Economics of that like I’m missing how much is it gonna cost to build how much are you gonna sell it for? Is there is there enough margin? And then that kind of segues into you know, the third pillar which

is what’s going on in that particular market. Is the market going through expansion? Is it going through contraction?

Is there a net migration in or out? What type of people are coming in or out? Is it retirees? Is it young people? Is it young professionals? Is it working class? What are all those sorts of things? So all three of those pillars have to kind of come together to identify what is happening holistically with the project. And then financing effectively is layered on top of that in terms of what’s the risk reward? How are the parties aligned?

And once you kind of find that alignment, you can typically find a way to make a deal.

Cody Crabb (07:44)
And I think along with that alignment, it kind of implies that you have a clear goal. You know, it’s not just about doing the deal and getting through with it. It’s like, are you doing it? What’s the benefit for, you know, what are you aiming for? Anyway, the reason I say that is just because the, you know, if everybody’s not aligned, then you’ve got that kind of misaligned pillar. And as your analogy says, that’s probably not a good idea.

John Friedrich (07:59)
Yeah, yeah.

Yeah, well, and I think what’s also challenging is the…

real estate operates within the greater capital markets, right? So, if you look at something like what’s going on with inflation or bond prices or like what’s the return on the stock market, all of those things influence what the expected returns are for everybody in the cap stack, whether it’s the person providing the debt, they’re tying to treasuries or trying, they’re floating on sulfur or prime or.

types of things. like you’re operating within that that constraint and then with you know

equity investment like you know if you’re dealing with family offices or institutions or all those types of things you know like you’re you are bound by the performance of everything else that’s going on in the capital markets like so for instance you know this is no longer necessarily the case right now but like you know if you were you know getting into multifamily investment right you you would think that like okay like you know you’re just operating between like what’s the multifamily expected return you know across the nation and

as long as I’m operating within a reasonable band of that particular group, then I have pretty good chances. Well, we’ve seen kind of almost a, not necessarily an exodus, but the yields on multifamily are not where they were. And the yields on stuff like corporate bonds have gone…

have gone up pretty high. And so, you know, if you think about it in on the kind of a global or a holistic standpoint, if I’m a family office and I’ve got $100 million, right? I can either, you know, doesn’t make sense for me to take on construction risk for a multifamily asset where I’m going to make, you know, seven to eight percent yield on cost.

⁓ and it’s going to take me two years to see a return or should I park that in corporate bonds that are AAA rated and highly liquid and those can you know and those can give me a similar yield and I’m getting cash flow right now.

you know, like it’s just like those types of constraints are just kind of the, again, kind of like the objective truth of what’s going on within the market. And if you can’t hit these particular returns or be competitive in that greater landscape, then the project probably doesn’t pencil and you might want to consider whether or not you should do it or not.

Cody Crabb (11:13)
So one question I’d have for you is, because there is like quote unquote safer investments and things, what projects still make sense if you can still get some yield from those? What is it about this specifically that makes you stick with it?

John Friedrich (11:27)
Yeah.

Yeah, so I mean think you know we do probably you know this year we’ll probably do probably 750 million in transactions at LFB and probably about 75 % of that is going to be lot development for the public home builders. So you know I think what’s interesting about that sector is you if you look over the last kind 24 to 36 months

especially post 2022 rate increase. going back, I guess, four years now. Well, time flies. But if you look post 2022, when inflation was running…

the Fed starts to jack up rates, all those types of things. Effectively what happened is everybody that had gotten a mortgage before that year, before 2022, they’re effectively locked into their home because their buying power has been so greatly diminished over the last few years. So the existing housing inventory is effectively locked in place. Nobody’s selling, so nobody’s buying, right? And you would have to sell at

a higher price.

⁓ In order to compensate for recapping into a into a new home So that that that inventory is locked so that’s cause you know kind of a real kind of bull run if you will in new production single-family homes think the art Horton think the Nara think and be are all of those kind of big public home builders because they can Because they they can build new homes and then they can do something called a rate buy-down so, you know

If the face rate on a new mortgage is 6.5%, D.R. Horton can say, we’ll buy down your rate down to the threes if you buy this brand new home. And then they just work that into the margin of the sale of that home. So everybody that’s been wanting to get into home ownership over the last three, four years pretty much has been going into new home builds.

Cody Crabb (13:24)
Hmm.

Hmm.

John Friedrich (13:37)
And for us, know that that means that you know a lot of those home builders don’t hold they don’t develop the land themselves they rely on kind of a regional developer to go out and acquire the land put in the roads the Infrastructure all those types of things get it to something called finish lot and then the home builder comes in and purchases a lot

Cody Crabb (13:52)
Mm-hmm.

John Friedrich (13:57)
⁓ And the great thing about that business is that the public home builders will actually give you something called an earnest money deposit ⁓ upfront. So they’ll come to the table with 10, 15 % of the total project cost, say, okay, if this thing is entitled and ready to go, here’s 15 % of the cap stack. Go talk to somebody like myself, go and get an acquisition and development loan.

And that’ll infill the rest and then that that developers only come into the table with kind of a small sliver and the equity multiple on those On these projects are fantastic. It’s like, know, two to four two to four X for the for the sponsor for a prep for relatively low risk because you have a You already have the home builder Putting up money and saying that we’ll buy these lots at you know XYZ cadence over the next two to

Cody Crabb (14:38)
Mm.

John Friedrich (14:56)
three years.

Cody Crabb (14:57)
⁓

So I’d be curious, you are on the lending side, so who do you deal with the most in your day to day as far as people that you work with?

John Friedrich (15:49)
Yeah, totally. we cover everything from the senior part of the stack through kind of mezz. if, just in case, if you were still not so…

doesn’t mean financing sits between the senior senior loan and the true equity part of the staff so talking to you i can also be structured as preferred equity with with certain payout structure at waterfall but it is it is typically secured by some type of a jr that’s that is subordinate to the senior that the bank of the private credit fund takes off

so you know our our financing sources have run the full game will deal with regional banks deal with asset managers with private credit funds with family offices so it really depends on what the size of the project is what the profile of the sponsor is what market it is you know all those types of things and you know once we have all those three pillars kind of all lined up in terms of the profile of the deal we know it’s sort of capital

to show them too.

Cody Crabb (16:56)
So,

because you’re on the finance side, I expect to hear that you deal with some people that maybe are not fully aware of what they are doing, maybe what they’re sitting on and things. One thing that I always like to ask in situations like this is, so what makes you look at a deal and be like, brother, this is not, you know what I mean? Like you say no when they think.

They bring it to you thinking, obviously, yeah, this should be fine. This should go through. So what do you see that makes you immediately like a huge red flag that people might not spot?

John Friedrich (17:30)
Yeah, yeah,

I think, you know, if somebody doesn’t…

I think there’s, wow, there’s so many layers to that. I think a big, big part of it is, you know, if somebody comes kind of looking for pursuit dollars, where it’s like they just want to buy raw land and it is unentitled, ⁓ they don’t have their permits and it’s kind of like way out in the sticks. But it’s like, I know that I can do a really great project out

It’s like well, you know, it’s to to do pursuit dollars that you you you typically do that sort of stuff like under something called a purchase and sale a agreement right where you know, let’s say, know, you want to you want to do, know 20 homes outside of Houston, Texas But the land is is raw. I don’t have any utilities You don’t have a plat map all those types of things and you know, it’s a it’s a two million dollar

⁓

Take down for that for that parcel You know somebody sends me a package and they say hey, I’m looking to raise You to two million dollars I can can I get a loan on this?

You know like that that to me it’s a fundamental misunderstanding of how the system works, right? If you if if you want to get financing you need to come to the table with with entitlements and and permits and like and then the counter to that is like well You know like how am I supposed to take down this this this two million dollar parcel? Well, you you structure your PSA in in a way where the seller is effectively is effectively carrying you through the entitlement and permit process

Cody Crabb (18:48)
Yeah.

John Friedrich (19:11)
So you go to the seller and you say hey seller. I’ve only got two two hundred grand I’ll give you the two hundred grand right now, but I want a you know one year escrow or two year Escrow so I can go and spend the $100,000 on entitlements to get it to the point where it can then be taken out by a horizontal development loan so

Cody Crabb (19:35)
Hmm.

John Friedrich (19:37)
when people people always think what i would like if i just have the money i would be able to do this you know it’s like no it’s like you know so so much of it especially with cover earlier stage stuff or the higher risk stuff it’s it’s about working with the people that already have the asset and finding you know the highest and and best use of the super efficient with like how you deploy your your

Cody Crabb (19:43)
Right.

John Friedrich (20:01)
your own cash right

and if somebody’s saying like well I’m going to raise money for pursuit dollars I want to go and raise two hundred thousand dollars it’s like maybe you’re not ready to be in development maybe you need to go and save two hundred thousand dollars of your own money and put that up because it’s the highest risk dollars of the entire cap stack

and part of her proving yourself is the ability to you know making money to save the money and go and go and take down the the opportunity or at least put up the there is money deposit to secure the parcel uh…

Cody Crabb (20:31)
Well, you something you

said makes me like you. It’s kind of like you’re saying, look, there are plenty of opportunities for people that maybe don’t have the don’t have the capital right now. that are. like what you’re saying is like, just don’t try to do this. Like this is not this is not where you should be at least yet, because it’s you have to have some things in place first.

John Friedrich (20:53)
Yeah, you know, think, you know, if you’re, if you’re, if you’re just getting started, you know, like a whole, like there’s, there’s certain sort of sectors or like, or business plans that, that, you know, work in certain markets and don’t work in other markets. Right. So for, for instance, like a wholesaling, right. was huge.

Kind of pre 2022 and like where it were Effectively like you you go you go to a seller and it doesn’t have to be raw land. It could be an existing asset It could be You know putting together and an assemblage for urban infill Whatever right? Saying okay. Hey, I’ll get this under PSA. I’ll do an assemblage of these three urban

in fill lots, right? Because I think I can do townhomes or whatever it is. It’s three different parcels.

and I’ll get those under contract and I’ll just flip it to a buyer. The thing is the margins have gotten so compressed that the sellers really are not willing to do that. So the wholesaling business is really great in times of quantitative easing and easy monetary policy and low rates when there’s lots of margin. But in places like what we’re dealing with right now where it’s,

We’re no longer, the Fed is no longer doing quantitative easing. So it’s a lot harder to get loans, all those types of things. There’s less money in circulation. And you’re dealing with like really tight spreads. Like that part of the business is really quite challenged. So yeah, I think it’s about understanding what you can do.

You know, if you’re just getting started, know, brokerage is a great place to start. But, you know, just try not to get over your skis and don’t force the business plan just because you want to do something.

Cody Crabb (22:40)
That’s some great advice. If people want to get in touch with you, mean, who would you like to get in touch with you? And, you know, how can they do that?

John Friedrich (22:49)
Yeah, yeah. by all means, feel free to shoot me an email. I’ll leave it with you. It’s [email protected]. I’m always happy to kind of give some advice if somebody’s trying to check something out or.

or do something. I do prefer to be direct on a project. I don’t want to talk to a broker or all those types of things. I get those emails all the time and I’ve got my own deal sourcing. But if you’re a sponsor and you’re like, hey, I’m looking at this land A assemblage and I’m.

to see what my options are. know, happy to kind of lend some advice there. If you want to figure out how to get through the pre-entitlement stage and what’s the best way to structure your PSA, happy to provide some guidance on that sort of thing. And also just kind of just general market dynamics, right?

You know the the the Texas Triangle is the hottest place in the country right now. There’s deals are flying left right and center between San Antonio Houston and Dallas but you

Cody Crabb (24:01)
I think I realized that, that’s

good to know.

John Friedrich (24:03)
Yeah, no, totally. the it’s probably it is the growth market in the country. But like, you know, I think there’s really great stuff kind of going on and like the Rust Belt as well like Columbus and Indianapolis is is great. Ogden, Utah has got has got some great stuff. Yeah.

Cody Crabb (24:18)
Oh, cool. That’s interesting. That’s, that’s really

weird to living down the street from Utah. that’s very strange, but that’s cool. That’s awesome. It’s good to know. Yeah. well, thank you so much for all you’ve given us today, John. This has been really insightful. I think, some people really, really like getting into the weeds and we’ve just, we’ve done just that today. So I appreciate it. if, if you like what you heard today, audience, go ahead and give us a like, subscribe, comment, all the things, and don’t forget to follow us. So you don’t miss more great conversations like this one.

John, it’s been a pleasure. Thanks so much for hopping on.

John Friedrich (24:48)
Absolutely Cody, thanks so much. Cheers.