063: Understanding Debt and Credit Funds with Michael Episcope

00:00 - 00:29 | Michael Episcope: There's so much money out there in credit right now that you have to be careful about people who especially don't have a long track record or a dedicated team to source. Like, where are they getting their deals from? And hopefully they're not reaching and just trying to put the money out for the sake of putting the money out. Because let's face it, especially in these closed-end funds, managers don't get paid unless they're actually investing the capital in those instances. So it's just something for investors to be aware of out there.
00:35 - 01:28 | Christopher Nelson: All right. Welcome to this episode of Tech Equity and Money Talk. I'm excited to bring back Michael Episcope from Origin Investments. He is the co-CEO and founder. Origin Investments has 1.7 billion assets under management, a large multifamily shop. Michael started his career as a trader. and is a lifelong Chicago citizen and lover. Welcome back, Michael. Thank you for having me back, Christopher. Yeah, and so in our last conversation, you know, we touched on a little bit, you know, credit and debt funds. And I think that this is something I think we're seeing right now in the market, in the private equity market, you know, debt funds, you know, credit funds are popping up everywhere. I'd love to just get educated on it real quick. What truly are debt funds, credit funds, and the combination?

01:28 - 03:02 | Michael Episcope: Yeah, so the traditional, if you're looking at any credit fund out there, essentially they're investing in a part of the capital structure that's more protected than equity. Generally, they're not going to be the senior debt. And if they are making senior loans, they're usually leveraging those up in some way, shape, or form. And the intention is for a credit fund to return stable income and 99% of the return is Generally coming through through some sort of yield rather than appreciation in the asset itself They are an alternative to you know, certainly some real estate funds. There are real estate credit funds as well we have one where we're investing in that part of the capital structure, so we're both a you know on the equity side in some of our funds but in other funds we're actually the lender as well and it's been a fantastic strategy you know depending on where you are in the cycle you might want to be in equity or you might want to be in debt and I would say that really depends on where you believe the best risk-adjusted returns are. Today, you're probably being overcompensated for being on the credit side, just for where we are in the capital structure today. But it's a great way to invest, and I think credit funds have a place in the portfolio, certainly. So credit, even if the underlying widget, how you're managing or generating the returns, is real estate, don't confuse that with actually being exposed to real estate on the common equity side. So there's places in a portfolio for both.

03:07 - 03:32 | Christopher Nelson: Investors who start out and they say, okay, I'm owning a portion of the equity. I'm going to get the appreciation. I'm going to get the depreciation. I'm going to get some type of cash flow. Now, when they're investing, let's say on the debt side, they have moved to that other side of the capital stack where they're going to get the return. but no appreciation and no depreciation. Did I get that right?

03:32 - 06:16 | Michael Episcope: That's right. So the equity is going to be your first loss, but it also has unlimited upside, where if you are more interested in principal protection and current yield, you're going to want to be in a debt fund. And typically, the way debt funds work, and we'll take a capital structure, if equity is trying to earn 15%, that equity owner, and you're leveraging this property up to 65% or 70%, The debt in today's market might be six, six and a half, seven, depending on the project. If you're doing, I'll take a construction deal, you might be paying eight and a half, even nine percent. Well, what happens is if we're making a loan like this as a senior lender and we're loaning zero to 70 percent at nine percent or eight and a half percent, we are going to do what's called a leverage loan to generate our returns because nobody is going into a debt fund to earn 9% gross, because after your fees, everything else, you're going to be down at 6%. You can go buy a muni bond and do better than that. And so the way it works is that really what we want to do is we want to occupy that space between 50 and 70%. And you can get there in a few different ways. You can issue the senior loan from zero to 70, and then you can do what's called a note-on-note execution with a senior bank where you're selling off zero to 50. But $0 to $50 is a much lower risk part of the capital structure. So if the overall loan is generating $8.50, and you can sell $0 to $50 for $6.50, you're creating arbitrage within that loan. So now $50 to $70 is paying you closer to $14 or $15. And I'm just making up these numbers, but that's essentially how loan-on-loan execution works. And then you can also issue mezzanine debt, you know, that just occupies 50 to 70 that might pay similar. Or you can originate preferred equity in that same structure in 50 to 70. No matter what it is, you're getting to the same place. And I see a lot of you know sponsors out there talking about how they're investing in you know senior loans yes you have to be careful with that because i even hear investors who echo this and i said look it's impossible for you to generate a 13 percent in a senior loan position. There is leverage in that structure whether or not you realize that, and I say it in a nice way, an educational way, but that's the truth behind it, right? And all of us are trying to get to that same leverage. You want to be in that mezzanine position and depending on what the underlying widget is, you're going to be generating somewhere between 13% to 15% gross return and sort of in that 10 to 13% net return range to investors.

06:16 - 06:23 | Christopher Nelson: And so that's on the debt side. And then on the on the credit side, that's where then you would be placing preferred equity.

06:23 - 08:11 | Michael Episcope: I use credit and debt synonymously. So either one. But And it just comes in those three forms, whether it's mezzanine debt, whether it's preferred equity, whether it's a senior loan that's a note on note, we call those AB note executions. And then you also have CMBS loans out there. You have Freddie Mac, we do K-series, so securities on that side as well, which are pooled loans that are all against multifamily as well. So there's a lot of ways to kind of play the space and generate yield. And I think in today's environment, I alluded to this in the beginning. This is a place where you're truly being overcompensated for risk because capital has fled the system. Asset values have come down. The cost of capital has gone up. So the new lending environment where banks are only going up from kind of zero to 55, well, sponsors can't come up with 45% equity in a deal. And so they need somebody to bridge that capital structure up to 70. So now we can go 55 to 70% command maybe a 14% yield in that position. And we're at very, you know, kind of low risk. And if you take this back two or three years ago, you had lenders, senior lenders were willing to go up to 70. So then your mezzanine, your credit, your debt lenders who were kind of in that next layer were going up to 85% of the structure and they were only getting paid 12%. So it's been a massive shift where you've had a devaluation of assets. You're lower in the capital structure, but you're actually getting paid more in an environment. And that's why we love, you know, the lending side. And every time I get the question by investors, you know, somebody asked me, like, well, what keeps you up at night about your strategic credit fund? I said, well, on the long list of things that keep me up, that's not on it. So not today, at least.

08:11 - 08:43 | Christopher Nelson: Right. Well, let's talk about this. From a personal portfolio perspective, how do you think about this versus your equity investments? Do you think of your debt investments as, okay, this is just a core piece of income that's going to cover core expenses for my portfolio and then I'm adding more risk as I sort of move up equity. How should investors think about this when they're thinking of coming into this year portfolio allocations and seeing different investments in front of them?

08:44 - 10:55 | Michael Episcope: I see credit as part of your bond portfolio. That's really where you should be taking out of. So if you have a, I'll make it up, you know, you're getting older and 60% of your portfolios and bonds are fixed income, you might want to take 10, 20% out of that portfolio and direct it towards higher yield. somewhere else, you know, like in a credit fund, in a debt fund, and then it becomes evaluating the debt funds out there because as you talked about in the beginning, Christopher, there is a proliferation and there are a lot of them out there and how kind of the sausage is made is really about the manager, it's about the widget underneath that you're using to create the yield, what you're lending to, and then the sponsor's experience as well, and what their track record is to be able to pull those yields up, and then how much leverage and financial leverage they're using within the structure. Because one thing about credit funds This is a notorious business for financial leverage. And if we go back and study history a little bit and you go back to the 08 and 09 crisis, debt funds actually did worse than equity funds. So before we were talking about how equity is the first loss and you scratch your head and you're like, well, how can that be? Well, That can be because it was a house of cards, because these credit funds, they leveraged up, they weren't diversified, even though they had a lot of loans, because they were getting line of credit after line of credit after line of credit. So when one loan failed, they all failed, and the banks started calling their money in, and they just had no, they had no say within the capital structure whatsoever. So I always think that's an important place for people to really, or maybe questions to ask about how the returns are actually made. And you have to ask the question, well, if your senior loan is paying 8%, how are you delivering 13 to me? Let's go through this so I really understand the math. What are you doing here? Are you cross-collateralizing loans? Are you using subscription lines? Are you using other warehouse lines? Where is the leverage? It is there. You just have to find it. And that's how you understand the risk ultimately.

10:55 - 11:11 | Christopher Nelson: So are there a few key questions? So let me actually take a step back. What are some of the assets that would be the widgets in these debt funds that you would see have better historical performance?

11:11 - 12:48 | Michael Episcope: That comes down to the manager, candidly. Real estate is obviously what we use. This is what we know. We are, I would say, an inch wide and a mile deep, so all we do is multifamily. We are equity owners. We're also lenders on this side. It's the asset we know. We don't look at these things like a traditional bank who would be an asset-based lender. And I think the first thing you want to look at is the underlying collateral, right? What am I investing in? Ultimately, what is creating the cash flows that are going to move up the chain and how safe is that? Am I investing in some ice cream shops that are supposed to do that? I don't know. People have crazy things out there. And then how much of that is flowing up and how much leverage is being used throughout the structure, especially at the fund level. But other credit funds, they go into operating businesses. So when you have your big players like Blackstone and Aries, they have credit funds out there and they're loaning money to businesses. And they've done quite well in those loans doing that. And you have some diversified funds. I think Cliffwater is a big one out there. They used to be consultant and now they have a big you know kind of a fund of funds if you will they invest in a lot of different managers across the board so it can be a number of things so wherever there are industries borrowing money you can pretty much guarantee that somebody is taking that debt and creating some sort of credit fund or collateralized loan obligation that is being then sold to a fund manager that is ultimately generating income for investors. So the list goes on and on.

12:48 - 13:35 | Christopher Nelson: And so it sounds like if the manager understands and knows the asset, and you as the investor can know and understand what they're investing in, and that's part of your thesis, at that point, you're starting to get some level of alignment. But you did talk about earlier that There are some – it sounds like there's some no-nos and some credit funds, right? And I remember – because both you and David know the space so well and I think for somebody like myself who's learning, I think sometimes trying to figure out how to ask the question is, He mentioned that you can actually then start getting leverage on your particular fund and that's something that you don't want to do. You want to have no cross-collateralization between the loans. Is that right?

13:35 - 16:14 | Michael Episcope: That's exactly the word I would have used, Christopher. Yes, no cross-collateralization. It comes down to common sense. Take us for instance. We're doing loans against multifamily real estate, right? And let's just say we're generating, on average, 11%. But then there's another manager in multifamily real estate who's generating 14%. Well, they're not finding better deals. We're finding just as good a deal, so how are they doing that? And these are the questions people have to ask. And then you might say, when you learn about all the risk, you might say, I'm comfortable with taking that risk for that incremental return. But you should know the risk you're taking, and what happens is people usually find out the risk they were taking after the fact when things go wrong. And you might say to yourself, look, I don't think there's a chance in hell that multifamily real estate is going to be impacted from here on out. We're at the bottom, we're this, so I want to use a lot of leverage, I want to maximize returns, things like that. But you should know that before you go in there, because what happens a lot of times is, especially with some managers, and I hear this all the time, well, how much money do you need to make? Because, oh, if you just need to make 13%, we'll take a ton of risk, we'll scrape off the top and just give you 13, and nobody's the wiser on that. You have to watch out for that as well. But it's understanding that financial leverage and cross-collateralization is a big thing. And for those of you on the podcast who may not understand that, it's basically saying, look, if we make one loan and have it in a special purpose entity and we only have that loan and that goes bad within the portfolio, we only lose our money on that loan. But if we make 10 different loans and then we say, look, we've got this loan pool of $100 million and we take this to a bank, And we say, would you loan against this? And the bank will say, yeah, we actually, you're from 60 to 75% on these loans, and that's where you occupy in the capital structure. And we will give you $50 million against these $100 million of loans. Well, now you've leveraged that pool up 50%, but now they're all to this bank. So when one of those loans goes bad, because the bank is going to be watching this like a hawk, The bank is going to have covenants and they're going to say, hey, one of your loans went bad. You're no longer covering. We're calling our loan. Fifty million dollars. What are you going to do? Right. They own your loans. Right. And now you're forced to sell these loans, get out, do anything. You're beholden to the bank. You're working for them. And so that's what happens. Right. So you've you've created incremental return, but with exponential risk.

16:14 - 16:39 | Christopher Nelson: Oh, that's cross collateralization in a nutshell. I'm gonna rewatch that myself. That was a very, very nice summary. Excited about that one. Debt funds though, they are a little different than like a traditional equity investment because many of them do offer, once you have your capital in for a year or 18 months, that then you can actually get liquidity out of them.

16:39 - 17:23 | Michael Episcope: Yes, certain funds. It really depends, but even, what a manager depends on the strategy but usually those loans they're making short-term loans of two to three years because the loans that we make or other managers are making especially in the real estate space are generally to transitional assets assets they're in value add or development or in some phase where they're transitioning to permanent debt because a lender who's part of a credit fund is not going to be your lowest cost of capital. We're high cost of capital out there for this and then you're going to have your traditional lenders coming in. So we would not be the, you know, kind of your first stop in the process there.

17:24 - 17:41 | Christopher Nelson: So if you are looking at a debt fund, what type of diversification – I mean obviously we don't want cross-collateralization but are you also looking for or should you as an investor be looking for a diversification of geographies?

17:41 - 19:13 | Michael Episcope: Yeah, I think that's important. I mean again, it comes back to the underlying widget but yeah, I mean, it's always good to have geographic diversification. I can never argue against that. And it's about having, you know, how many credits do you have in the fund as well? And we talk about that in terms of if you're running a $500 million fund and you have, you know, 10 loans in there, that's going to look very different than you have 200 loans, right? Oh, and I'm sorry, Christopher, I want to get back to your liquidity question because I think I kind of blanked as I was going through the answer. on that particular fund. But a lot of times with these debt funds, you have loans rolling off after about a year and a half or two years, or you have liquid securities in those funds that do provide some liquidity in the fund. And I think it's great to get capital back, but it's also great to be compounding capital and to be in a fund where that manager, when one rolls off, they can just go into another fund. Because let's be honest, as an investor, if you're earning 10, 11%, you kind of don't want your money back. And if that manager can put your money back to work in a great asset, then it saves you a lot of time from getting that capital call back. and then going to find a new fund or a new deal or sending it back to that same manager to do the same thing over and over. But liquidity, it's a lot easier in a credit fund than it is in a common equity fund where generally your equity's locked up for three, five, seven years.

19:13 - 19:38 | Christopher Nelson: Yeah, and I just wanted to label that as an advantage and just an educational point because I just thought that was interesting. The other thing that I think is interesting too that I think is a real viable strategy for people that you know, are building a private equity portfolio that they want to get income from eventually is that in a lot of debt funds too, you have the ability to reinvest until you actually need the income.

19:38 - 21:24 | Michael Episcope: Yeah, a drip is a very common thing, especially in the open-ended funds. There are both closed-ended funds and open-ended funds and some people like closed-ended funds and I think most of your listeners would probably be familiar with that. I think, you know, in a closed-ended fund, you're making a commitment. The investor calls it as they invest. And then when those assets roll off, they're sending your money back. In an open-ended fund, you invest all of your capital at once. You know, you're investing into a diversified pool. The manager keeps the capital. and then you take it out. Generally, there's a lock-up period, but then you take it out when you want to. And the one advantage of that is the simplicity. All your money is working at once. It's not IRR-driven. It's more than multiple-driven, and that manager just continues to reinvest that capital, and that's where you can do the drip, is in the open-ended funds, which means you're reinvesting the distributions rather than taking those. And we hear this from a lot of investors, and it's so ironic that we have You know, people want income funds, but then they opt in for the drip, and it's just counterintuitive. But in our one fund that has income, it's a common equity fund, about 63% of the investors opt in. Now, that has a growth component, too, and that's sort of industry standard. They're opting into the drip. But even in our credit fund, which is 100% income, this is why people get into this, 52% of our investors opt in for the DRIP. And I think one of the reasons is that people want that growth profile, but they also know they can, you know, click a button and say, I don't want to be in the DRIP anymore. I want that income. So we see many people in sort of their 40s and 50s, like sort of preparing for retirement and just knowing that they can click that button and start taking the income stream.

21:25 - 22:13 | Christopher Nelson: Well, and, and that's, that's one of the things that I, you know, usually share with people has been my strategy is if I don't, I want to find, I want to start training my portfolio now for how I want it to behave in five years. So if I want to have 50% of it being income generating, then I need to be finding those assets now, investing in those now. And if I don't need the income, I either do two things. I aggregate the income and make more investments, or I press the button, as you said, because I know many people who are working in tech today that are getting equity, getting a great salary, and they want to, to your point, Michael, be ready for when they want to step away and replacing those checks. And I think a vehicle like this, this is why I'm excited to share this with people, is super valuable.

22:13 - 23:17 | Michael Episcope: Well, that's I mean, financial independence is all about creating passive income for yourself. And that's why I got into real estate is that I wanted to protect my wealth. I also want to grow it. And I wanted a tax efficient passive income streams. And that's what real estate can offer you, whether or not you can be in the equity or the debt and get both of those. The debt is obviously not as tax-efficient as the equity side. But I will say this, one thing that if people are evaluating different credit funds, if you're in real estate and there's a REIT blocker, you're going to get the 20% tax deduction. So if you're in the upper bracket, the most you'll ever pay on the federal level in a product that is manufacturing its yield through real estate is 30%. Whereas when I was talking earlier, some of the competitors, if you're investing in companies and things like that, you're going to be at the upper bracket. So you also have to take that into consideration. So you might see one that, you know, so a 14 and a 12 are actually the exact same on an after-tax basis once you apply that re-tax deduction.

23:17 - 24:31 | Christopher Nelson: Oh, that's great. That's another gem. So we've talked a little bit about some of the operational risks. We've talked about some of the advantages of debt funds. One of the things I wanted to touch on is when you have real estate in your portfolio, because one of the things I think it's important to call out, because we're talking a little bit about taxation, is Sometimes if you're not able to find, you know, because I know you have the income fund, which is also you get equity and you get income. So you're able to get then appreciation, depreciation and income. The income is not. as significant as like something from a credit fund. But this is where as people start thinking about managing it as a portfolio, you can have maybe even things in a growth fund or a growth asset that are kicking off heavy depreciation that then balances out that you know, and is able to provide coverage for the income that you're getting off of some of those debt funds. And this is one of the things I like people to understand is you're trying to aggregate in your portfolio, you know, the, the income, the appreciation and the depreciation. So then you're passing it over to your tax guys, and you're looking for it to come out more depreciation than income.

24:31 - 26:55 | Michael Episcope: Yeah, that would be one of the best advantages of even getting into existing assets. Now, in our fund, any excess depreciation in our equity fund I'm talking about gets captured at the REIT level. But one of the reasons, like when we think about tax efficiency, so ironically, both our funds, the Strategic Credit Fund and the Income Plus Fund, are designed to create sort of nine to 11% per year. So you look at them, but the difference is on the Income Plus Fund, It's very tax efficient and tax deferred, whereas on the strategic credit fund, you're going to be paying taxes on that every single year. So, you know, all things being equal, if they were both to generate the returns, you're going to build a lot more wealth through real estate by deferring those taxes and the depreciation and rolling that income back into the projects. But depreciation is a huge tax advantage. And to the extent that you maybe have individual syndicated deals and things like that, that you can use that to offset, that's a bonus. But I will say that you don't get depreciation until the asset comes online and is stabilized. And most investors, they wanna invest in the ground-up development and the value-add phase. To us, we've sort of changed our philosophy and really, in the beginning, we were buy-fix-sell investors and we sort of changed our the way we think about building wealth, because that sounds great, and I think in some areas it makes sense, but the problem is that you're doing nothing but generating taxes over and over and over, and you're not really building long-term wealth. In real estate, especially on the common equity side, I know we're talking about debt today, But real wealth is created by building value, holding assets for long term, no differently than in tech, but enjoying the cash flow, the depreciation, all the tax benefits. You can refinance real estate over and over and over tax free 20, 30 years. And if you're only buy, fix, sell, and you're doing that all the time, you're not really taking advantage. of being in real estate. So in our income plus fund, we do have debt in that, and the tax disadvantage of that debt is offset by some of our more core plus properties that are in that fund that come into that bucket through our ground-up development projects.

26:56 - 27:16 | Christopher Nelson: Well, and I think what we're also getting to here is that the advantage of being diversified in multiple funds that provide you these different benefits into your portfolio is ultimately going to get you the goals that we want, which is protecting our wealth, being able to grow, and doing that in a tax-efficient manner.

27:16 - 27:21 | Michael Episcope: Yeah, financial independence. It's what we're all striving for. You got it. Mailbox money, we call that.

27:21 - 27:35 | Christopher Nelson: So let's talk a little bit about what is the structure, because I know that your credit fund is a completely different company than Origin Investments. Is that correct?

27:35 - 30:16 | Michael Episcope: It is. Yes. And we had to do that for for SEC compliance purposes. And the reason is, is that the strategic credit fund is only for qualified purchasers. And the reason is that we have securities in that fund. And I talked about these earlier, but some of the securities we buy are through Freddie Mac program. So what Freddie does is Freddie I'll just use us again as an example. So when we go out and buy an existing asset or have, I'll use a better example, have a ground-up development that's coming to stabilization, we would go out to Freddie Mac to get a senior loan, a senior stabilized loan of 5 to 10 years. They would issue this. This is what we call a GSE, a government-sponsored entity, and they do that around the country and they issue, you know, 80, 90 billion dollars a year or more in loans. And what they do is every quarter they pool up these loans and they slice and dice them into something called a K-series bond and they sell these bonds to various investors, right? Now, there's a lot of barriers to entry in this because you have to be a real estate operator to actually qualify to buy these bonds. Not everybody can go to Freddie and buy these things, not even on the secondary market. We are one of, call it 15 approved buyers in the world to be able to do this. We know the assets, we like the assets, we underwrite all the individual assets underneath the bonds, and then we take what's called that sort of equity slice. And if you go back from the beginning of this program, 25, 30 years ago, the worst loss was 0.6% on the bond pool. So multifamily has historically been one of the safest assets out there. Freddie is underwriting institutional investors, your Blackstone, your Aries, your Carlyles, origins of the world. And they're lending to great quality assets. So you really haven't had any losses in there. So to be in this program, I mean, it's not easy and then it's a privilege once you're in there. So we really have been working hard over the last few years to be in the rotation, to be buying these securities. It's an integral part of us managing this fund and being able to generate the yield on that side as well. But that's why, because those are considered securities. If we didn't have K-series bonds in our portfolio, we could have what we call the real estate exemption and keep this under origin investments. But there's a lot of sharing. David and I are completely disconnected, but we have a great leader on that side, Tom Briney, and he utilizes all of the infrastructure of Origin to run that side of the business.

30:16 - 30:37 | Christopher Nelson: Well, I was calling that out because I'm trying to understand how you're operating your fund versus some of the things I'm seeing in the market to try and educate investors because my understanding is that you know, in your credit fund, you are looking out in the broader market, but you're not looking to leverage any of that credit or debt towards existing origin assets.

30:37 - 31:48 | Michael Episcope: No, we're not. We have a team, though, and we've had a team in our market for the last, you know, 10 years of our existence. We used to be just in Chicago, doing deals here, we'd fly out, but we made this change many, many years ago, and that team is doing a lot of the origination, so they're talking to sponsors out there, they're originating the debt, they're buying deals, they're looking at ground-up development, so they have their hands full with looking at a lot, so we're not only in the K-series, but we're also doing senior loans, originating those directly, and preferred equity on that side, so it's, you know, there's not a deal out there we don't see, at our firm. There's a lot we pass on and I, you know, for better or for worse, you know, we look at these things as an owner and we're not going to do a deal where we think the sponsor is either, you know, doing something close to the margin or it's going to lose money. We want the sponsor to make money because as a lender things just work out a lot better when everybody makes money but where people start behaving badly is when the common equity starts losing money. Some people are fine but generally they don't like to, you know, leave money on the table and will fight, scratch, and claw to do that. We just don't want to be in that position as a lender.

31:48 - 32:41 | Christopher Nelson: Well, I'm asking this question because what I've seen, and we talked about this a little bit in our last conversation, right, is we have multifamily investments that are under duress because of capital stack, because of the current environment. And now we see this proliferation of debt funds. What I've seen, and I think it's important for investors to understand, is if you're working with a syndication team, and they have some assets and they're also standing up a debt fund, you need to be really clear on, are they leveraging that debt because they're trying to service and fix their own investments? Because I think that, as we talked about, even in this cross-collateralization, this could be actually then exacerbating your risk because you're not placing dollars in a different investment with the same manager to get a different result, you're actually tying it all up with your original capital.

32:41 - 34:37 | Michael Episcope: Yeah, Christopher. And you just reminded me of something. I mean, there is this proliferation of debt funds out there. And it's also one of the reasons why we're not going to see this massive distress out there. I mean, There's so much capital out there. I think the one thing you have to be careful of, and we saw this with distress funds, right? Well, distress funds have been being raised for the last year, and we've had this conversation internally, and I told the team, they're like, well, we need to raise the distress fund. I said, well, show me a distress deal. Show me a couple distress deals, and we'll raise the distress fund, but it's not gonna be based on what we believe is going to happen. We haven't seen a distressed deal. Well, we see one, you know, like nothing, you know, that we can scale. But for companies who have built or raised distressed funds. So, you know, a year ago, they'd be like, hey, our cost of capital is X, Y, Z. Right. And then all of a sudden they couldn't find deals that met that cost of capital. And it came down a little bit. Now, well, it's 18 percent. It's now 16 percent. Well, we just need a deal that has a lot of potential. Right. You know, now they're sitting on all this capital because they thought distress was coming and it's not. The same thing applies to the credit industry is that there's so much money out there in credit right now that you have to be careful about people who especially don't have. a long track record or a dedicated team to source like where are they getting their deals from and hopefully they're not reaching and just trying to put the money out for the sake of putting the money out because let's face it especially in these closed-end funds managers don't get paid unless they're actually investing the capital in those instances so it's just something for investors to be aware of out there. And I think it's, you know, it's a good thing that there's credit out there and there's private capital because I think it's going to, you know, put a kind of a normalization on this downturn.

34:37 - 35:20 | Christopher Nelson: I think so too, that it's going to put the normalization on the downturn, but I just try to advise people to really get clear. And I like what you said, understand the track record. If this is something that, especially I know that there's been a proliferation of new syndication teams, especially in multifamily that have come online in the last three to five years, if all of a sudden now this team that was new to multifamily is now being new to debt funds, I just ask a lot of questions because I think there's plenty of opportunities to go to shops that have a ton of experience, years and years of experience that have a totally separate team that can take care of your capital.

35:20 - 36:27 | Michael Episcope: I agree 100%. We kind of saw this in the Qualified Opportunity Zone space when that was announced. you know, kind of 18, 19, everybody started, you know, there was a proliferation. Everybody, I mean, it was actors from MovieStar, you know, they were launching a QOZ fund. And even recently, we had an investor say, hey, can you accommodate me? The fund I'm in is winding down. Well, we're certainly not at the end of the program, but they couldn't make this work because they couldn't build it to scale. And you saw the, you know, now there are certain funds that are just orphan assets within funds and nobody's watching them. And so this can happen also to credit funds or at least people who are launching them. And I would say to anybody, investors, you don't want to be the first investor in a fund, right? Wait till they get to scale and you know they have the track record, the experience, and that they can actually put the money out. And that's easier said than done because everybody goes out with grand plans. Hey, we're gonna raise and deploy a $400 million credit fund. Okay, well, how much have you raised? Well, 22 million. Okay. wait a little while, watch how things progress. And if they don't, there's other opportunities out there.

36:27 - 36:56 | Christopher Nelson: So what are some of the questions that then investors should be asking to operators to vet this? Is it really to understand where they've been deploying capital? Obviously, there's questions of, let me see your track record, and things like that. But I'm trying to say, what are questions you would ask to understand where the capital is deployed today, and what assets, and are they you know, investing or deploying dollars into their own assets to sort of, you know, fix their own problems.

36:56 - 38:49 | Michael Episcope: Yeah. I mean, certainly you want to understand the strategy. You want to make sure that there's not strategy drift there as well. And then you want to make sure whatever their competitive advantage is, that they're using their competitive advantage in this strategy. So whether that's whatever they've been doing for the last 20 years, this is consistent with that. We see, you know, sponsors sometimes. you know, going from assets that maybe rhyme but aren't exactly and, you know, it's kind of a recipe, you know, certainly not for success. Some can do it, but generally most don't in those instances. We talked about looking at How do they make money? Where's the leverage in the structure as well? You wanna make sure, we talked about the fund size as well, and whether they're going to be successful in building a diversified fund, because there's nothing worse than having an orphan fund that's $25 million. Because keep in mind, fund expenses, a lot of times, certain expenses are almost fixed, right? They might be a little bit variable, but grow much slower than the growth of the fund. So a $400 million fund, can have an expense ratio of 30 basis points, let's call it, right? 20 basis points, something like that. That's $800,000, that's a lot. Well, if suddenly you're, instead of paying $800,000 a year, maybe the fund's a lot smaller, you're still paying $500,000 or $600,000, but your fund is now $25 million, it's a lot harder, right? You're creating a lot more expenses and it's harder to get out from underneath that. You know, I hate to say this, Christopher, but a lot of this is just common sense and really making sure that you're getting into something that can truly deliver the benefits that you're looking for and questioning things in a healthy way along your journey.

38:51 - 40:35 | Christopher Nelson: Well, the reality is, though, Michael, I think we have to constantly remind people of common sense because when – I've seen this as this proliferation and this exposure of private equity, right? Post-2012 job acts is private equity. We were talking about this earlier, right? It's all of a sudden the crowd streets and the real streets and these things started ripping and people get the understanding. Wait a second. I can invest in commercial real estate passively. I can get appreciation. I can get cash flow and I can get depreciation. And then you have tailwinds in the market so that all of a sudden they are going full cycle. Great things are happening. I think people can easily lose sight of the fact that it's in this type of market that you have to have a due diligence protocol that allows, you know, logic to rule passion, you know, like you want your reason to rule your passion, you know, having a process in the system. I think we just need to remind people of that because I think now when there's distress in the market, there's capital calls, there's anxiety, people want to Do the logical thing. I want to play further down on the capital stack. I want to get a higher return. But again, you have to then ask yourself the question, am I going to be doing it with this operator? I love what you said. Does this operator have the track record, the competitive advantage? You know, those are all important things and we need to make sure that we're taking a breath because, you know, I'd say some of the best investments that I made were the ones that I didn't.

40:35 - 42:48 | Michael Episcope: That's a good point. And I was just thinking as you were talking, I mean, fear and greed is what really, you know, gets people motivated. And then in some of these models, they were forcing people to make decisions in like seconds. Right. And so you're. Really forced to make a decision an emotional decision and like oh my god, this is gonna fill up I don't want to miss it, right? It's that FOMO that's going on. Yeah, and this is something that I learned You know the hard way is that most of your listeners and the people who are on today? You're successful in your business Don't mistake that though for knowing, you know Every other business out there right and there's always this I you know, kind of transitive property, I think that might be the right word, to say, oh, I was really successful and smart over here, therefore I must be really successful and smart over here, and thinking you know everything about real estate, because I don't, you know, your world is technology. I would go out and seek outside advice and help, and I want to say, like, that's, the best thing you can do instead of looking at this and thinking that you know exactly what you're looking for. Reach out to somebody who is truly an expert who does this, wakes up 10 hours a day and has worked on this for the last 25 years, and you'll learn something. I say this out of experience because when I came out of the trading world, I was like, oh, I'm a great trader. I can do investing and things like that. And I got, you know, I had my share of bad investments and learned the hard way, right? And it was that ego that got in front of me. And then I was like, wait a minute, I actually need to go back and educate myself and surround myself with a team and have processes and everything like that. And I think it's only after you've made those mistakes that you realize and pump the brakes. But if, you know, somebody's just starting in their investment journey, I would, you know, that's what I would say is, You know, and also don't make the mistake of following other people into a deal that you think are smarter than you. I've done that, you know, and it doesn't always work. And then you realize how little that person knew after the fact too. So do your own due diligence, reach out to other people, rely on experts in the industry and people who are impartial about this stuff.

42:48 - 43:32 | Christopher Nelson: I'm going to take that as the mic drop. That was good. That was a good roll up. Yeah. Because ultimately, this is why we're here. This is why Michael and I are sharing here today is the fact that we love educating people. We think it's so important that investors are educated. And we've both been on this journey where we've made our wealth, and now we want to protect and grow it. And ultimately, I think we're examples of people who are showing you through action that you can do it. But just be patient. Study the game, know the rules, and be the CEO of your own destiny. Don't default the decision to anybody else. Know the truth, get to know the numbers, and you'll be successful over time.

43:32 - 43:46 | Michael Episcope: Yeah. It's funny because I look at real estate. It's the great builder and destroyer of wealth. I know people who have been on both sides of that equation. You know, it definitely is a great investment to be in, but tread carefully.

43:46 - 43:59 | Christopher Nelson: Yeah, 100%. Well, Michael, thank you so much again for your time. We really appreciate you coming back here to Tech Equity and Money Talk, and I'm sure we'll see you at some point in the future. Well, thank you having me again, Christopher. All right. We'll see you soon. Bye.