WHITE BOARD WORKSHOP
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219 Max Sharkansky, Managing Partner, Trion Properties
Max Sharkansky’s firm, Trion Partners, is in the business of value-add multifamily residential real estate. They started out around 2005/2006, right before the recession. Prior to that Max was a broker at Marcus and Millichap and his partner, Mitch Paskover, was working on the debt side at HFF in mortgage banking. They started buying deals towards the end of 2005 and as Max had been brokering multi-family deals in the San Fernando Valley at the time, they naturally started buying multi-family in the San Fernando Valley. That is where they had access to off market deals and market knowledge, and then from there it just snowballed.
From Trough to Peak
They bought two deals in 2005, a few more in 2006, and then at the end of 2006 the partners formed Trion. They continued to buy through the last cycle in 05, 06, 07 and sold most of their portfolio in 2008 prior to the crash. They saw what was happening with Mitch being in the capital markets and Max being in the transactional markets. Their properties when they saw vacancies starting to tick up, and rents starting to tick down. They saw what was happening to the market and so they sold out in 2008. As they were selling in 2008 they changed their acquisition strategy from a value add multifamily. The old model no longer worked so they started targeting non-performing debt secured by multifamily, even though at that time in 2008 there was a logjam in the market and nothing seemed to work. Lenders wanted to sell non-performing debt at 90 cents on the dollar irrespective of the value of the underlying real estate, and Max was looking at deals based on the value of the underlying real estate.
As the market slowly changed, they were able to buy from one local banks and from there they ended up doing about 20 deals during the downturn in 09, 10, 11, 12. About 15 of these were note acquisitions and deals and five were REOs. By that time they had a fully built out their management infrastructure and while their competitors were straight buy the note/foreclose/sell because Trion were operators they were buy the note/foreclose/renovate/lease up and then sell. And it was in having this infrastructure that allowed them to buy the REO products as well. Coming out of the downturn in 2012 they just went back to the value add business and [as of date of podcast call] had approximately 17 properties in their portfolio with an 18th in escrow. Their aggregate portfolio value is around $240 million and they have a gross track record of over $300 million on over 40 deals.
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It was a wild, wild west especially during the downturn. Trion grew very organically during that time. They bought their first few properties with their own capital. Both Max and his partner had been pretty strong producers at their respective firms so they had some dry powder and bought their first few properties using that. Then they started to syndicate out to friends and family and colleagues. Mitch reached out to some of his HFF folks to some of Max’s Marcus folks invested and it grew very organically.
During the downturn it became extraordinarily difficult to raise money so they bought a lot of stuff with high octane debt and their own capital. As they got a little further along and developed a track record and more of infrastructure it became a little bit easier to raise money. At the time it was still all friends and family and introductions through referral. They had met some family offices who were able to write larger checks and they were using a lot of expensive debt. Indeed, they were buying notes with other debt, putting debt on debt which was very helpful in allowing them to close.
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Two Models of CFRE
Max heard about CFRE through the news when the JOBS Act passed. They started calling around. They did some deals with a RealCrowd, RealtyMogul, RealtyShares and have found them all to have been great to work with. The whole process has been very successful and it has been a large boon to their business. It has provided access to capital that they would not otherwise have had access to, and it has allowed them to supplement equity capitalizations when they very much needed the capital.
Max has found that there are two basic models by which the CFRE websites operate. There is the LLC model which would be like RealtyMogul and RealtyShares where you interface with the platform directly. This model is more like dealing with an opportunity fund, where the sponsor interfaces with one originator, call it, or a deal guy. With that person, the sponsor does a walk through, the deal guy does their own underwriting, there is a lot of Q&A back and forth and the process is not dissimilar from an opportunity fund. In this model, there is no interface with their investors as that all happens behind the platform’s own curtains. Sponsor does not know who the investors are, they do not interface with them before the acquisition, and neither do they interface with them after the acquisition as they are operating: All communication is with and through the platform.
The other model is more of the technological platform model, which is like RealCrowd and CrowdStreet. In that model the sponsor is effectively paying the platform to post their deal on the site. They still vet the sponsor who still goes through a process of sorts, and when a deal is posted on the site there is a flat fee paid to the platform, not a percentage of how much they raise. In this model, the sponsor interfaces directly with investors. Investors, in this scenario, will contact the sponsor based on the posting and with questions about the DD materials. Max has had a lot of dialogue, and Q&A with investors this way, and has even met people on site at properties. Their first property raise through RealCrowd was in 2013and they have investors who have been with them since then doing multiple deals. Even though the process is different, either model works very well.
CFRE Site Input to Operating Agreements
There can be input to operating agreements from the platforms but it generally depends on what portion of equity they are taking. If the deal requires a check of $10 million plus and the platform/investor is taking $1.5 million, they are really not going to have much input into the operating agreement. On the other hand, if they are raising $4 million and the investor is taking $2.1 million then they are absolutely going to have some input on the operating agreement. This is not dissimilar to an opportunity fund or any JV type partner that would go in and mark up the operating agreement and go back and forth before coming to a final contract.
There is a time and place for both models and Trion has used both very successfully. With regard to other sponsors, it really depends on their business as a sponsor and how they want to grow and what they want at a particular time on a specific deal. If they have a deal and do not want the brain damage of talking to a lot of people just do not have the time, then going with the LLC model might make more sense. Here the sponsor will only interface with one person in the raise and the platform gets paid when the money is raised. If the sponsor has a business where they are trying to grow out their Rolodex of high net worth investors and have come to the conclusion that this is the way they want to grow their business for years to come then perhaps the marketplace model is better suited.
In both models, the platforms do the bulk of the marketing. The sponsor does very little. The sponsor might participate in webinars that would be a form of marketing, but these are coordinated and produced by the platforms. In these, the sponsor will discuss the investment and give investors an opportunity to dial in and listen to the dialogue and the Q and A about the investment and then they can submit their questions at the end of the webinar. Beyond that, though, sponsors typically are doing much of the marketing.
Platforms did not start out guaranteeing to sponsors that their raise would be successful, but it seems that the industry is moving in that direction. Fundrise is active in the preferred equity, mezz space and they do guarantee a certain amount but that is a little bit of a different business than the raises that Trion has done.
Max thinks that the opportunity to invest equity in deals through crowd funding is a great improvement for investors over the way it used to be. There is a lot more transparency so some of the more egregious terms that you would see in the old days are not really there as much anymore. For example, back in the olden days you would see much lower preferred returns and much higher promotes. Back when Max started in the old cycle it would not be uncommon to see 50:50 after a 6% pref. and today that is a thing of the past. It is a relic because people have transparency and they have a window into what other sponsors are charging and what is market.
Trion has adopted a cookie cutter approach on preferred returns and promote. For the most part they take a 70:30 split after an 8 pref. and that has worked for them – although some sponsors charge a little bit more. Typically Trion does not do waterfalls but other sponsors will. Other sponsors do but Max and his partner prefer to keep it simple. They do not charge an asset management fee because they self-manage. Some sponsors will outsource their management so they do take an asset management fee. It really depends. It's all case to case, and there is not necessarily a right or a wrong way. There is a very broad spectrum of how to operate.
Platforms do not generally have input into the operating agreements, or attempt to leverage controls that a sponsor has over their deals primarily because, for a sponsor doing a syndication, they need to have controls. In this regard it is very different from the private equity model where the PE firm will have input into key decisions in the deal, and Max has seen some control layers with some of the crowdfunding groups in the LLC model if they have a substantial portion of the equity, say 60 or 70 percent or more of a deal because they own so much of the asset.
The Fremont Deal
Trion purchased a deal that they fully financed and then backfilled using CFRE. It is an 88 unit in Fremont California which is in the East Bay and the Bay Area. Many people have heard of Fremont because it is the home of Tesla auto manufacturing. Tesla is one of the hottest cars out there and it is a rapidly growing car company and because of that there has been an extraordinary amount of growth in Fremont not just because Tesla but also because of AMD some of the other local employers. If you look at it on a map, the town is very strategically located as the gateway to Silicon Valley. The town has an awful lot of overflow from Silicon Valley and the peninsula and Trion loves the market and we love everything about the real estate with regards to the asset itself.
The deal presented an incredible value add opportunity and is very typical of what Trion buys. They bought the asset from the family that bought it from your original developer in 1966. Their basis was nothing; the debt was nothing, and they had been operating the building for occupancy for decades, with little capital put back in. Trion will spend twenty $25,000 per unit on interiors, fully upgrading the interiors. They will tear everything out, and will put in brand new kitchen cabinetry, high gloss very European looking, quartz countertops, stainless steel appliances, full wood vinyl plank flooring, washer dryer in every unit – which is a huge selling point for renters. There will be all new fixtures, all new finishes in the bathrooms, tubs, vanities… basically the units will be like brand new units and they can deliver the finished units to the market place 25% below what a renter would be paying for a brand-new class A property.
The project thesis is to stabilize the building at a low 6 percent cap rate on cost and exit five years from inception at a high four cap which is where properties were trading at time of purchase. The company will grow the rents organically once stabilized at around 2.5% to 3% per year. The project was underwritten to a five-year hold, with a deal level 19% IRR and an investor level IRR around 17%.
Trion paid it $26.5 million for the 88 unit asset, which works out at about $300,000 per unit and $300 a foot because the average unit sizes are right around 1,000 square feet. At time of purchase, the price per pound was one of the lowest that had traded in that market in the prior couple of years.
With regards to the structure with their investors, the deal is a standard Trion formula of 70:30 after an 8% pref. They do not take an asset management fee as they self manage for which they take a property management fee. They have their own crew so they also take a construction management fee.
The minimum investment when they were going directly to their own investors was $50,000 but on the CFRE websites typically that is lower. The Fremont deal was a very large raise for Trion at a total equity of $10.5 million, and they started syndicating the equity with $50,000 to $200,000 investors. They also had a few larger investors who took up some allocation but they were not able to fully fund by closing so the partners put in the shortfall and then went to CFRE to backfill.
It took Trion about 45 days to finance the deal, which included 20-25 investors, and then another few weeks to conclude the CFRE tranche – which, typically in using the marketplace crowdfunding platforms, Trion expects to gets 7-10 investors for a given deal. Max will usually meet the new investors, the CFRE investors, before the close. It can be something as simple as a few e-mails or sometimes he has had them come to his office. There have been times where he has met them on site at the property if it is in L.A. or if the property is in the Bay Area and they happen to live in the Bay Area he might meet them there.
Real estate doesn’t kill people; debt kills people.
One of the things that Trion does that really helps them hedge risk is low debt. They do not put an extraordinary amount of debt on their properties. Fremont as an example is levered to about 68/69% percent of cost. Once they refi out of it they will be right around the same leverage at 65/70 percent of the new value based on the increase in NOI.
Max is a strong advocate of CFRE. He thinks sponsors would be crazy not to do it. Whether they are a young sponsor or an old sponsor, a groups that has been around for a few years doing it, or a group that has been around 25 plus years doing it. It is a phenomenal supplement to a sponsor’s investor base and anyone would be crazy not to do it. It is a win, win, win, for all involved. Max has not personally invested in other sponsor’s deals in CFRE because he needs to use all the capital that he has for co-invest and in keeping their own deals but otherwise would certainly consider such investing.
Easy for Some
Max’s Trion is a very niche investor. They are not jack of all trades and masters of none. They do not buy five different asset classes all over the country, but rather focus on buying value add multifamily 60s and 80s vintage in four markets; San Diego, L.A., Bay Area, and Portland. Their business model is simple and Max finds that he does not have to explain real estate concepts to investors because it is a fairly straightforward business. It is the business of apartments; they are taking an older apartment, fixing it up, and making it like a new apartment. They explain the details to investors and they try to keep it as layman as possible. It is not, as Max says, rocket science.