Deal Financing 101: How to Thrive in High-Interest Environments, Real Finds Podcast #19 Transcript
Gordon Lamphere: Hi, I’m Gordon Lamphere with the Real Finds Podcast, the podcast series where we interview key entrepreneurs, scientists, and activists shaping the real estate industry and, as a result, our world. On today’s podcast, we’ll be speaking with Culby Culbertson. Culby is founder of Culbertson Holdings, a commercial real estate firm focused on development and investments in the Southwest, Sunbelt, and Midwest. On the podcast, we discuss the state of deal financing, best practices for navigating the high interest rate environment, and how to get more out of your next investment. It’s well worth a listen. Culby, thank you so much for hopping on the podcast today.
Culby Culbertson: Absolutely. Thank you, Gordon.
Gordon Lamphere: Can you start by telling us a little bit about yourself?
Culby Culbertson: Sure. I was born and raised in the Dallas, Texas area. I went to Texas Tech and spent about five or six years in West Texas. Back when oil was cool, as I like to say, I spent a couple of years working for Halliburton in Midland. Since then I’ve come back to Dallas and been in the financial services and real estate space ever since, about six to seven years now, and the last five years specifically in commercial real estate and real estate financing.
Gordon Lamphere: Oil isn’t too different from the real estate world, but what got you into real estate? We all have our journeys.
Culby Culbertson: Texas always has a big presence for folks interested in real estate. Friends and family were involved, I saw it firsthand, and very good friends of mine were already in construction, sales, and wholesaling and finding success, which piqued my interest. It snowballed fast. I got my start swinging hammers doing demolition on single-family houses, found higher ground quicker than most, got my license, flipped a couple of quick houses, got enough cash in my pocket to quit my nine-to-five, and it snowballed into what I do now. It happened relatively quickly, but I had a real passion and a knack for it.
Organizing Debt and Equity
Gordon Lamphere: Real estate isn’t all about swinging hammers. What do you do now?
Culby Culbertson: I primarily organize debt and equity for commercial transactions. My focal asset classes are multifamily, self-storage, and the core commercial assets, as people say. A lot of folks have trouble identifying the best product available, because it’s not something you pull off the shelf. You need to work through it, understand the numbers behind it, and understand the end goal, and all those variables tie in when you’re organizing the financing.
Gordon Lamphere: Can you walk us through how you tie a deal together and finance it? Even within real estate, as soon as you start talking numbers, some people’s eyes glaze over. What does a typical deal look like?
Culby Culbertson: When people categorize commercial real estate, the first thing they do is categorize by asset class, and the same goes for how you finance it. With multifamily, for example, there are government-regulated programs like Fannie Mae, Freddie Mac, and HUD, conventional products like banks, and unconventional, non-QM products from debt funds. So first, identify the asset class. Based on that, you have a path forward through the products available, whether the agencies, Fannie and Freddie, or debt funds that are more construction or value-add focused, with bridge loans and so on. Once I know what asset class the borrower is interested in, I organize a few documents: profit and loss statements, the rent roll, any capex that’s been completed or is anticipated, and a pro forma, which shows how the property will perform once your project is done and you’ve worked out the deferred maintenance or operational deficiencies. From there, you can identify how the property is underwriting and what you need to do to get it stabilized.
Reading a P&L
Gordon Lamphere: You mentioned P&L sheets. What are you looking for? Are there particular red or green flags?
Culby Culbertson: The two biggest indicators are income over expenses, but that’s a broad way to put it, because there are many ways to make money on the income side, especially in multifamily. There are different revenue avenues: reimbursement of utilities, or RUBS, parking income, laundry income, application fees, pet deposits. The list goes on. It comes down to what your management company is comfortable doing, the size of the asset, and the profile. On a Class C property, you’re not advertising 5G internet and a trash valet service the way a Class A multifamily would.
Then break down expenses: property taxes, insurance, R&M, which is repair and maintenance, contract services like internet, landscaping, and security, G&A, which is general administration, and payroll. I could go for days. The top five I typically look for are property taxes, insurance, R&M, G&A, and contract services. If you can outline those expenses, where you are today and where you should be, and couple that with income, you can understand where the property is performing against a market expense ratio, which you typically want between 30% and 45%. If you’re above that, there’s likely something to tweak with your management company.
How a Deal Gets Done
Gordon Lamphere: How do you actually get a deal done? An investor says, I want this deal, and reaches out to you. How does the process work?
Culby Culbertson: A lot of our business is either direct with owners looking at refinance options, or owners working with a real estate broker trying to agree on a price. How a deal underwrites is a big indication of how it will sell. Say Gordon is the seller and comes to me and says, I’m working with GREA, and they’re looking to sell my property at a five or six cap. I’ll underwrite the deal based on the P&Ls, and based on the price they want, we can back into how the property underwrites against the expected sale price. Then I can take the financials and market data, all the information helpful to a lender, and give an indication of how it will be financed in the marketplace, which is also a big factor in how it sells.
If you can get Fannie Mae or Freddie Mac, it’s a much easier process going to market. That’s a streamlined product: 30-year amortization, fixed rate, interest-only, often higher leverage. If the property is underperforming, the debt service coverage ratio is a good indication. A 1.25 is the benchmark. If it’s below that, especially significantly below, which is common given the gap between seller expectations and borrowability, it’s very difficult to go with an agency product at the leverage you need. The less leverage, the more cash you put in, and the more cash you put in, the lower your cash-on-cash return. If your DSCR is 0.86, you’re very limited. So I’d go to a variety of lenders, a bridge lender, a bank construction product, or a low-leverage agency, and come back to Gordon and say, because of your debt service coverage, your debt yield, and the products available, here’s where your selling price is and here’s the lending product you should pursue or advertise to your buyers.
How the Debt Market Has Changed
Gordon Lamphere: How have you seen the debt and leverage markets change in the last 36 months?
Culby Culbertson: That’s the golden question. Here’s some perspective. In 2018, when I started focusing specifically on the debt markets, I was getting rates in the high fours and mid fives, and if I got you a sub-five rate, I was a hero. Come 2020 and 2021, if I wasn’t getting you a sub-four rate, I wasn’t in the picture. That drastically changed. What goes down must come up. I think we’re getting back to normal. The utopia of two and three percent rates is likely behind us, at least for a significant period. But we can play ball with rates in the high fours and mid fives. People have been doing it far longer than you and I have been around.
Rates do affect underwriting. The higher the rate, the less leverage; they’re inversely related. You’d have to be really humming operationally for a higher rate not to hit your bottom line. But there are ways to offset it, especially with agency lending. The ten-year treasury today is around 3.5% or 3.6%, and most agency lenders are doing about 200 basis points over the ten-year, so 5.5% or 5.6%, a little lower on larger loans, coupled with interest-only. Lenders are savvy. They’ve seen the ups and downs and know how to weather them. They’re doing longer interest-only periods and longer amortizations. Fannie Mae has a 35-year amortization, and you can do five, seven, or ten years of interest-only depending on the deal.
It really comes down to borrower strategy. If they’re getting in with a purpose, capex, deferred maintenance, and they’re confident they’ll get the job done in 24 to 36 months, my recommendation is probably a five-year deal or less, or a bridge loan, which is a temporary product, or a bank loan, where you accept that it’s recourse. But here’s the secret sauce, Gordon: there’s really no such thing as non-recourse. From a balance sheet exposure standpoint, sure, you’re protected. It’s asset-based lending. But if you don’t do what you say you’re going to do, they’re going to take your keys. So recourse or not, borrowers need a purpose in mind. It may be a higher rate, but if you believe in your project and your pro forma underwriting makes sense, based on how you lay out your interim bridge financing and your expectation on the exit, that’s the golden ticket to the buying process.
Financing Self-Storage
Gordon Lamphere: We did some financing in 2021 and got some crazy rates. One building of ours was financed at 1.9%, which is nuts. But we’ve done deals recently, and the price of money is still trailing inflation, so it’s not a ridiculously high rate environment. The money just isn’t as free as it used to be. There are a lot of different ways to finance different products. Some recent guests have been in self-storage, which I think is a little more akin to the commercial industrial product I’m familiar with. What are the pain points and unique aspects of financing a storage deal?
Culby Culbertson: For storage, it really comes down to management. A reason a lot of folks love self-storage is the lower barrier to entry from a cost perspective. At the end of the day, it’s walls and garages, and self-storage thrives off displacement. You get fired, self-storage. You get a job, self-storage. You get married, divorced, have a kid, self-storage. As long as you find a good area with a need for it, and you have good management, you can do very well. Climate control is something people are becoming more attuned to, because it opens doors to a lot more customer types.
From a cash flow perspective, a lot of the available financing is very competitive. You can still do 25-year amortizations, some CMBS products still do 30 years, and you can still get interest-only. Self-storage commonly leases up quickly, and unless you’re doing new construction, you’re usually taking over a property that already has some occupancy, so you just fine-tune. I keep harping on management, but there’s no better way to explain it. If you have somebody constantly making calls, watching the market, and bringing people in, it’s very cost-effective. It’s $25 or $30 for a unit. It’s not difficult to convince someone to give up $25 to clean out the garage. So there are a lot of advantages if you have a good location, good management, and your financing in order.
Preparing an Asset for Financing
Gordon Lamphere: Management is probably the most under-discussed part of real estate. We had one of the largest insurers in Indiana on a couple of weeks ago, and he said insurance rates are almost always dictated by management practices. For someone looking to take out financing, what are the best ways to prepare an asset to get the most out of the next deal?
Culby Culbertson: I harp on this on every deal, and with every new investor. The buzzword I say almost every day is organization. Have your P&Ls in order, not chicken scratch from the back of a notebook. Have a good rent roll. Have an occupancy trend, like a box score, as management companies call it: here’s where we were in January, in March, and so on. Have your entity tax returns, personal tax returns, personal financial statement, schedule of real estate, and bio. All of it gives the lender confidence, because we’re in a market with some uncertainty, and lenders are going over every deal with a fine-tooth comb.
If you can make their life easier, that’s the difference. Gordon, you’re the lender. Here’s my personal financial statement, my net worth, my liquidity, my real estate assets and liabilities, my schedule of real estate outlining the seven assets I own with leverage and debt service coverage on each, my interest-only periods and when I go to P&I, my bio and professional background, when I became an investor, who I use for management. That presentation, versus somebody piecemealing it, “I’ll get it to you tomorrow, I’ll get it to you next week,” you can imagine the difference in the conversation. The success I’ve had is because of preparation, organization, being realistic on underwriting, and being able to talk with the lender with confidence, knowing we have everything they need to take it down the hall, as I like to say, and get it approved.
What’s Coming in the Market
Gordon Lamphere: You have a unique perspective, because brokers like me are experts in our domain. I can tell you every deal happening on the north half of Chicago and out into the collar counties. But you’re applying financing across a much larger market. What are you seeing in deal cycles and in the real estate market right now?
Culby Culbertson: Multifamily is getting a little squeezed, frankly. Rates are trying to figure themselves out, and a lot of investors are timid about going in headfirst the way they would have two years ago. I think industrial is going to be a highly sought-after product because of the long-term leases and the high demand for e-commerce, production, manufacturing, and logistics. As those businesses surge, there’s demand for that product. There’s limited supply and nearly infinite demand for e-commerce space, which is a staple of our market now. So keep your eye on industrial. Multifamily will always have its place. And I’ll give you a curveball: I think neighborhood office is going to make a pretty good comeback. The Bank of America and Merrill Lynch buildings, I don’t know who’s going to be on the thirty-sixth floor and up. But two-story neighborhood office, one story with four, five, or six tenants on two-, three-, five-year leases, there’s always going to be a place for that, with limited supply. There will always be small businesses that can’t stand working from home. I’m one of them. It won’t boom like industrial or multifamily, but there will be consistent demand.
Gordon Lamphere: We’re definitely seeing that in Chicagoland. A huge trend toward 2,000-foot offices, family offices plus admins, your classic accountant or law firm that wants a couple of admins, small creative offices, all within a ten- or fifteen-minute commute of where the owner lives. Strategic site location for people who don’t want the long commute. The huge eighties and nineties floor plates are going to die, but the unique small Class A buildings built around the one-to-three-thousand-foot tenant, I think we’ll see a lot of. Before the Final Four, what do you see as the biggest opportunities going forward in your space? We mentioned smaller-scale office and industrial, but are there others, maybe on the refinancing side, that people aren’t taking advantage of?
Culby Culbertson: Two-part answer. From a refinance standpoint, this is a great time to reposition your product. If you have captured equity sitting in your asset, take a look, especially if you want a long-term refi, because you can pull out that cash, which is non-taxable, and get into something long term like Fannie Mae or Freddie Mac. Remember, Fannie Mae is doing 35-year amortizations with five or seven years interest-only. That’s tremendous cash flow. Even if you go from four and a half to five point four percent, the interest-only and 35-year amortization probably offset it. You can likely make more money with that cash today than having it sit in the property.
From an acquisition standpoint, keep an eye on very distressed properties for a full reposition, or on buying land, especially in Texas, Oklahoma, and the land-rich states. I’ve built four or five homes myself and been part of several multifamily redevelopments. There’s a lot of opportunity to find the cash flow and equity multiple people got used to from 2018 to 2021. It’s harder repositioning 1980s, 1990s, or early 2000s product; the numbers get skinny. But when you develop, there’s opportunity at every stage. When you get land fully entitled, that’s new captured equity. When you finish the horizontal, new captured equity. Go vertical, new captured equity. Stabilize and refinance, captured equity. Sell it, captured equity. You can hit a new payout more than once on a single project. A lot of people don’t understand how to build or develop, and I can help with that: sources and uses, budgets, pro formas, market data, resources. That’s a hidden gem in the market that people overlook because they don’t know how to do it. But if you notice, the real players are usually building something.
Recapturing Equity Through Development
Gordon Lamphere: Can you explain more about how that process works? A lot of people, even some developers, don’t fully understand how you recapture equity.
Culby Culbertson: Here’s a great example. In Jarrell, Texas, in Central Texas up I-35 near Waco, I worked with a group that had unimproved land. Unimproved is exactly what it sounds like: no utilities, no zoning, nothing. To get it fully entitled, you need approved zoning and utilities approved by the city, and a myriad of legal factors. Once it’s fully entitled, you have new captured equity. That land is worth more than when you bought it. Then you do the horizontal: roadways, utility pipes, leveling, everything to be shovel-ready. Now it’s worth way more than unimproved, and more than fully entitled. A lot of guys sell right there, usually at a 1.5 to 2x multiple.
Folks who know how to go further put together budgets and sources and uses, which is just a breakdown of the money you need and how you’ll use it, plus a pro forma. Lenders get very aggressive on vertical financing, some at 80%, some up to 85%, depending on the product. Once you go vertical and finish the product, stick and brick, whatever you want, you slap a sign on it called The Oaks or The Meadows, it’s always oaks or forest or meadows. From unimproved to fully entitled to horizontal to a full building, you’re probably talking 3x, 4x, maybe more. Then you sell. That’s how a lot of folks make a substantial amount of capital, because they stuck it through, put the resources in place, and knew the process. It’s not easy. Nothing is. But working with someone like me who’s seen the full cycle and built it myself helps. I build lakefront short-term rentals here in Texas, still building a few as we speak, and I’ve taken large-scale multifamily through full-cycle development. I’ve personally organized somewhere between $300 and $350 million in closed loans with some construction component. So I’m very familiar with the variables: documentation, the numbers, and the resources, engineers, architects, builders, managers, operators. It’s about keeping people close, and it’s a team effort at the end of the day.
The Final Four
Gordon Lamphere: We’ll have to get you back to explain more of that process. Sadly, we’re at our Final Four, which is always a great opportunity to learn a bit more about you and the future of financing and real estate. First, one of my favorites: ten years from now, what will have changed the most about commercial financing?
Culby Culbertson: No crystal ball, Gordon, but I believe rates will be at a stabilized place, back to the mid fours, give or take. The government-regulated programs will become more competitive, because they’re competing against banks, non-QM lenders, and other products, so you’ll see them playing off each other more. The approval process will become more strenuous, because as things get more competitive, more people come in, so getting approved may be more detailed, which is fine. Working with someone like me, my presentation is the biggest factor in my work. From an asset class perspective, it’s going to be driven more toward residential. Population densities in bigger areas like Texas and Florida are growing fast, and other states are being backfilled by the population leaving. I think the bigger office buildings that are no longer utilized will cost more to knock down than to repurpose, so they’ll be repurposed for residential, or, not to give away the secret sauce, maybe something like vegetation and produce. Who knows, when THC gets going, anything that used to be grown in a greenhouse in Oklahoma or California could be grown in the Bank of America building. It’s going to be about repositioning and finding the best ways to take it down from a financing perspective. Here we are in 2023, and nobody’s going to recreate the wheel. Anything new is a recreation or a fine-tune of something that exists, to be more competitive or to take it down a notch. It’s a parabola. Too hot, it comes back down. Too cold, it goes back up.
Gordon Lamphere: Old is new and new is old, and that’s often the case in real estate. Taking it back, if you could go back to the start of your career and give young Culby a little advice, what would it be?
Culby Culbertson: If I told young Culby coming out of college to do anything other than what he wanted, he’d probably laugh in my face. I was pretty bold back then. But if I could turn back time, I’d say go straight back to Dallas and get directly into the financial services space, whether real estate or oil and gas, and learn the numbers side of the business first, because everything we do at a high level is driven by numbers. I’d go directly into what I’m doing now. Being in the mortgage space, commercial or residential, sets you apart from your competition, because you understand how lenders make decisions. And the way your financing is structured ultimately dictates how much money you make. If you can’t understand how financing manipulates your product, you’ll say yes to anything. An eight percent rate? Thank you so much, Gordon. But that eight percent rate is tanking your cash flow through the debt service requirement. Instead you say, Gordon, I appreciate your offer, but based on my underwriting, an eight percent rate takes my 1.25 DSCR to a 1.0, and I don’t think that’s best for my investors. Lenders are salesmen too. The higher the rate, the more money for their bank. So I’d tell myself to get into what I do today much earlier. If I’m where I am after four and a half or five years focused directly on this, and I’m 33 now, who knows where I’d be with a ten-year head start.
Gordon Lamphere: One positive we like to take from each episode is a tidbit on a book, real estate or business. What’s a book that’s influenced your career?
Culby Culbertson: I’ve listened to a lot of books, I’ll say that.
Gordon Lamphere: That’s fine. Audible is an acceptable method of literature around here.
Culby Culbertson: There’s an app, if you don’t already use it, called Headway. It breaks down a lot of commonly read books into quick, easy listens for the gym or wherever. Highly recommend it. But a book I really like, and have read more than once, is Never Split the Difference.
Gordon Lamphere: We have that right here.
Culby Culbertson: He was a negotiator for many years and takes that into common practice, and anybody in a person-to-person business would find value in it. Another is Emotional Intelligence 2.0, which gives real-time examples of interactions that don’t go someone’s way, how they reacted, how they should have, and breaks down the mental process. It lets you put yourself in those scenarios, and I’ve found myself many times, professionally or at home with family, able to step back and process in real time. It makes you better on your feet and more fluid verbally. The last is Exactly What to Say, a very quick listen for a car ride, about ten points on exactly what to say in different conversational variations, how to assimilate with somebody, rope people in, or push them back. For anybody with face-to-face negotiation in their profession, those three would be a highly recommended group.
Gordon Lamphere: I wish I never split the difference, had better emotional intelligence, and knew exactly what to say, so those are great for anybody. Our last and most important question: what real estate or business person should we have on next?
Culby Culbertson: A good friend I brought on at my previous company, Cody Baker. He and I started our journeys around the same time and were roommates when we first started. I got him into real estate, and he’s sharp as a nail. He focused on industrial and self-storage, and he was an independent business owner helping organize businesses, marketing, and leads, and he brought the processes and strategies he used as a business consultant into what we do today. He and I together in a room working on something is something special. He’s well spoken, very intelligent, and super friendly. He’d be great to bring on.
Gordon Lamphere: We’ll have to have him on. One final question: what’s the best way for someone to reach out and get in contact?
Culby Culbertson: My email is [email protected], and my cell is 940-594-8839. I’m always happy to help, even if it’s not a deal on the table right now. I love working with folks to get organized and understand next steps and the best path forward, and I’ll tell you directly if I don’t think the deal they’re looking at is what they’re looking for. I think that’s part of why I’ve found success, having a little bit of rawness in my tactics. Shoot me an email, a call, a text, send a carrier pigeon. I’m happy to help anybody looking to get into commercial real estate, build, refinance, reposition, whatever it may be. I’ve personally closed around $300 million in loans and own around $20 or $21 million in assets across multifamily, self-storage, and single-family development, and I’m invested in a few oil and gas ventures. I don’t know everything, but I know enough to be dangerous, and I always like making new connections.
Gordon Lamphere: You gave us some dangerous info today, and we’re grateful for it. Thank you very much for hopping on the podcast.
Culby Culbertson: Thank you, Gordon. Really enjoyed it, and I look forward to doing this again soon.
Gordon Lamphere: Thanks again to Culby. We appreciate his insights. If you enjoyed the podcast, please give us a like, a five-star rating, or a review. Your comments, interactions, and subscriptions truly matter and help us continue to provide quality guests. You can follow us on YouTube, Spotify, or wherever you get your podcasts. I’m Gordon Lamphere with the Real Finds Podcast. Thank you for listening.
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