Construction Loans and Opportunity Zones: How to Get the Highest Leverage for OZ Projects

Kevin Kim:

Good morning everyone. Welcome to another Geraci webinar. My name is Kevin Kim, and today our special guest is Amil from Forbix. So Amil, please introduce yourself and the company to the audience.

Emil Khodorkovsky:

Hi Kevin. Hi audience. I'm Emil, I'm a partner at Forbix Capital and Forbix Financial. We're both a lender as well as a, I guess a broker or raiser for capital. We raise capital and syndicate deals. So I've been doing this for about 20 years both on the lending side as well as in different partnerships. We've developed and done different partnerships all over the country, mostly for multifamily development for last 10 years. And I think we built about 600 units in the last 24 months. And in different partnerships we own and control in some way shape or for about 1100 units aside from doing a lot of volume in terms of commercial debt, mostly on the multifamily side. So about 65% of the loans that we do are apartment buildings. The rest is other commercial types, all sorts office retail, well when it was still popular to do retail. And we also have the residential side, which is a Forbix capital side, not Forbix Financial where we do all the agency stuff, non QM debt private debt. And so we're kind of a pretty versatile mortgage bank with an equity arm.

Kevin Kim:

And Emil, so the webinars kind of concentration today are topic is about structuring debt and capital stacks for the qualified opportunity zone program. And I've been working very closely with you guys and trying to get some deals over to you guys for our developer clients who are doing ozone projects namely and typically in ground up construction but also those who are kind of prime candidates for the HUD program. And so they're very few lenders that I know that are HUD lenders. And so please tell us a little bit about the HUD program that you guys offer and we'll get into the actual webinar itself after that.

Emil Khodorkovsky:

So yeah, I think I could speak to the topic only because I've raised the equity side and we have a project in an op zone and in San Francisco. So I know enough about it to at least understand when it works and sometimes when it doesn't. Our background in terms of the HUD side, so we've been a HUD lender we've done the HUD debt for a lot of other clients as well as for ourselves where we essentially so we, we've experienced it both as a lender as well as a client. And the cool thing about HUD debt, whether it's for construction and or permanent debt, is the fact that the rate is locked in from day one for the entire term. So whenever you're doing typical construction loans, you normally have a one or two year window or three year window to on a variable deal, and then they have to search the market for a permanent loan thereafter.

And you don't know what the rates will your two or three years when you're ready to go perm. And with HUD, you locked in for a decent rate from day one. So today's construction rates around three to three and a half percent roughly depending if you qualify for green or if you're going non-green, and it's a 40 year term plus the years that you need to build. So essentially it's fixed in for 42 years. So that's the biggest difference HUD versus non HUD. Now there's some pros and cons going HUD, it doesn't work for every project, and we can discuss that in more detail. We will.

Kevin Kim:

So just a little bit of an intro intro for myself, for those of you who do not know me, my name is Kevin Kim, partner here at Geraci Law Firm. I manage the firm's corporate and securities division. So opportunities on fund opportunity zone fund formation is really we do a lot of it here at Geraci. We do a lot of fund formation in general at Geraci for real estate and for private debt. So the ozone program is kind of one of those hot topic questions right now because we have a new administration coming in for the uninitiated in the audience today, I want to give a brief, very brief introduction to the program. If you want to know more details about it, just feel free to call me. I can give you a much more detailed explanation for real estate focused only. So there's another component to ozone that has to deal with businesses and startups and the like.

We're not talking about that today. We're talking about real estate. So when it comes to the ozone program itself for investors, investors can invest their capital gains into an eligible ozone project and defer their gains until 2026. We have a discount. It's no longer 15%, now it's 10%. We missed that, we missed that after last, last year actually. And if you hold the investment for 10 years you will be able to waive the additional gains created from your investment. So you'll pay your taxes on your capital gains in 2026, but any additional gains derived from your investment is waived if you hold it 10 years. So ideal for a lot of real estate investing, long-term projects, long-term holds for real estate to be eligible, the real estate must be located in the opportunity zone. These are predefined zones by the states and the counties you can go online and find out where if your property is in a zone or not.

It's all based on census tract and all that. Every state has their own map and there are a couple options to see if you can use it. The primary method in which we see it is we call it the substantial improvement test. And that's basically you're going to double the value of the property. Now, typically you can use the land value, but the common strategy is to double the adjusted basis of the property. And that's very useful for heavy rehab, without the reuse, we've got the construction, and the like depending on where you're located. But it can also be used for original use. Original use, meaning that it's never been advertized or used as that type of property before. It's typically useful for vacant land and raw land. It can also be used for vacant properties. Vacant properties must be a vacant for a significant amount of time, typically five years to be considered useful for the zone for the ozone program.

But as you can see, the program is really attractive for investors and that's why they garnered a lot of attention in the real estate space. You saw a lot of past two years, you saw a lot of developers utilize the program to build anywhere from small as small multi-family to large hotels and even some sporting centers. So we see this being used across the sector and one of the most important things that we think is overlooked and needs to be discussed in much more detail has been the stack, the capital stack for your project because it's oftentimes overlooked. Underestimated. And who better talk about that than someone who works on both sides of the coin on the equity and the debt. So I want to talk to you, Emil about this because one of the things that we oftentimes kind of come up with in this space we see a lot is the client will come to us, Hey, I want to do an ozone fund. I want to do an ozone project. Here's the project, here's how much we're going to put into it, here's how much we're going to raise. And it doesn't really seem like it's kind of well thought out and we have

Emil Khodorkovsky:

The same problem stack.

What happens is oftentimes, like you mentioned, people come and they say, Hey, I'm going to do this project. And they think of financing last. They think they know what they're going to get, but because they don't really know the details of how it works per se with op zone fund, I think that the dialogue with the finance person, whether it's us or somebody else, should begin really early in the game for any project, not just op zone, especially for op zone. So you and I touched on it before, we've talked a lot about these deals. There's a non-recourse component that is required from these kind of deals. And given when we are in the middle of a pandemic, a lot of lenders that were doing construction financing, let's say six or nine months ago, may not be doing it today. So you have to focus on, hey, well first who's lending?

Who's doing construction two, does it fit my needs? Three, what's my plan with this property, and am I comfortable taking this kind of a loan? Because you don't want to be stuck in the end creating all these ideas, getting the tax benefit, et cetera, and getting into a loan that's bad and it's not good for the project, especially in many cases, you and I both know with the op zone, there's a lot of upside in the future because you're investing in areas that are underdeveloped now and in the future they'll be more developed. So in two or three years, if the rates are a little bit higher, will you be able to refinance out of your construction loan or not? And that's where we're starting to, we're getting into the stress game. You're not getting into a lot of that with FHA only because the loan is fixed for 40 plus years on a construction deal. But on a typical deal, you're absolutely right. People get into loans and then they try to figure out how to get out of 'em in two or three years. And sometimes they haven't really done the math properly to how a lender would stress their rates for a construction loan and then they realize that they're short 5 or 10 million in equity and now they're coming in with mezz financing that's a lot more expensive than they really wanted to commit to.

Kevin Kim:

Yeah, we've seen that a lot. It's the client, typically as a securites attorney, the client overestimates the ability on the equity side and then they're forced to go mezz. But when a product developer comes to you, is there anything different when it comes to, okay, so you've got your conventional ground construction or developer non ozone versus an ozone project that comes to you. Is there anything different? Does ozone play a factor? I mean you mentioned it a little bit, the long-term aspect, the non-recourse aspect. Is there anything else that you evaluate when you look at a project that comes to you for financing or even for equity and that's different when it's ozone? Because to me, typically ozones a huge complicator when we're dealing with a offering document set,

Emil Khodorkovsky:

Two questions, two part question. One was financing. No financing is treated the same way. Meaning that from our perspective, debt service is debt service. And by the way, because I sit on a non-profit board, so I'm involved with a non-profit financing where you're going with low income housing tax credits, it's typical to get into a deal that doesn't cash flow because you're getting grants and all these other things that you're doing to compensate for the lack of debt service, you're allowed. So typically when you're doing a non-profit deal with low income housing tax credits, it's a very similar structure. You, your senior debt still has the debt service to a certain number, then you've got the soft debt and all those other things in the capital stack. So the debt part is the same, there's no question about it, meaning that you're qualifying it based on a certain rate, based on a stress rate if it's not going to be a per loan from day one, that's the same, the non-recourse component, that is a challenge, right?

Because typically unless it's HUD a HUD loan, non-recourse is a lower loan to cost than a typical deal would be. So it's more like 50 to 60% loan to cost instead of 75 to 85. And because of that reason, you have to either come in with more equity or you have to get me financing, well then me financing is more expensive. And you have to calculate that in two, three years when you're finished with a project and you're able to stabilize it, is there going to be enough dollars you're going to be able to get from a refinance to pay off the senior and the MES debt? And we're seeing a lot of this right now where clients got stuck after the pandemic. So March, april, may, clients finished their projects and their absorbency isn't the same that they thought it was going to be, right?

And we're doing a lot of bridge debt for those clients and me temporarily until they get to a stabilized number where we could refinance 'em and pay it off. And everybody is lucky because their rates are low. Rates are right now from the high twos to the mid threes for agency debt. And because of that reason, they're lucky they refinance out of their senior debt and meds. But in three years from now, are the rates going to be the same? Who knows? And so that is one thing that everybody needs to consider and stress the rates a little bit and make sure that if they cannot figure out a way to refinance debt, that they'll be able to find some other means of getting cash from somewhere to pay everybody off. Because the worst thing you can do is you created this amazing tax strategy, put all the pieces together, and in three years the lender takes your property because you can't figure out a way to pay 'em off. That's a problem. So that's not why you do what you

Kevin Kim:

Do. And from an ozone standpoint, you run a ton of risk mean while you do have an incentivization to hold, stay in for 10 years, like Kenny, you made a point with on the equity side, the plan has to be very, very sound right? And the ozone investors are coming in as equity investors and your other non ozone investors, whoever they may be, if they're coming in as equity investors, they're going to want to make sure you got a solid plan and they're going to want to stay in. Some investors I've spoken with have said it needs to stand on its own ozone cannot be ozones like a cherry on top. It doesn't make a difference to us whether we get the benefit or not. What matters to us is that the project of sound, we don't care. We'll pull the money out if we have to.

And so to your point is planning seems to be a major, major impact reserves and all that kind of stuff. And what we've found was a lot of clients you, you're hitting nail on the head in my opinion is a lot of my clients underestimated, number one, the amount of capital they're going to be able to raise from ozone investors. Number two, their ability, their ability to get the appropriate financing in the long term, their refi plans don't make any sense or are illogical or overestimating the possibility for refi. And we saw the same thing in e B five, right? Well,

Emil Khodorkovsky:

You hit a nail in the head about one thing. You said the deal has to stand in its own two feet. And it's funny, a couple years ago I got so many opportunities. Oh, ozone, ozone, it was so let's call it hot, right? Yeah. Everybody had an ozone deal. But it was a lot of people that had a lot of low income housing tax credit deals that tried to modify 'em to make ozone deals. And then they wondered why they couldn't raise money for it. Because the deal pencil to a five cap and all the ingredients on the soup based on a 10-year projection of upside, but on its own two feet, it didn't make sense. So the people that invest in low income housing tax credit deals because they're trying to get a tax benefit, are not the same. Investors are going to invest 10 ozone.

They're just not. These are opportunistic or listed investors that want to make money and if they're going to put money into a deal, just a tax benefit is not enough. It adds a couple 2% to your yield as a formula, but at the end of the day, it doesn't make or break your ability to invest. So the point is that, like I said, you hit the nail on the head, the deal has to stand on its own two feet for normal ozone investors and frankly for customers that are creating the opportunities on, because how are you going to make any money for yourself if you're building to a cap rate? That is the value of the property. Because with cost overruns, whatever you're projecting today, I could just tell you, having built a bunch of units and invest in a lot of projects, you're project a six, you hit five and three quarters.

Kevin Kim:

I mean CASA runs a G hit, especially in these markets, CASA runs a guarantee. Oh yeah. But lemme ask you this. Let's talk actual figures on a successful financing side. I guess from a stack perspective for a successful single project, ozone ozone fund that's doing one project, it's just where do you like to see the equity position be? Where do you want to see it? Is it 30%, is it 40%, is it 50%? Where do you want to see that

Emil Khodorkovsky:

As an investor or as a lender?

Kevin Kim:

Let's say both. Let's say both.

Emil Khodorkovsky:

I don't care. You want to put in the money and the deal makes sense for you. No problem. My constraints are my debt service. So the point is that the difference is, for example, if we end up going HUD, I can get you to a pretty high loan to cost 75, 80% even if the yield on cost is not that great because my rate is three and a 5% and it's a 40 year loan, so my amortization schedule's longer, I can pencil you to a much higher loan amount. Let's say I'm going with the traditional financing non HUD. Well now I'm using a stress rate of 5% and a 30 amortization. And even though today's rates are three and a quarter for a non FHA loan, well that is a problem. Why? Because if you're building to a five or five and a half cap, we need 30% of equity minimum.

Yeah. Now let's talk about the capital stack of senior debt versus me. Well, depending on your firepower, your client's firepower and your ability to have borrowed money in the past, your history how many units you've been built in a particular market, et cetera, et cetera, you may not get the prime loan to cost that you would get from a bank who you have a long-term relationship with. You may not get 65% loan to cost, maybe you only get 55 and you have to get 10 or 15% of meds. So then we get into the higher dialogue. How do you pay off the meds? Do you have a contingency plan B and C if things don't work out according to your plan? And those are the hard questions we have to ask. But generally speaking, I think you have it on one of the slides, roughly 20 to 40% of equity slash meds.

How much of it you're going to take will depend on the structure of the project, the yield you're building to. So if someone is building to a 7% yield on cost, so on a 50 million project they're going to make three and a half million. Well, really it doesn't matter what the capital stack is because even if the rates go up to five and a half percent, you'll be able to refinance. But because most clients in an op zone are building to a five and a half to a six cap, the rates have to be low enough to be able to pay off if you're over leveraged. So those are the mean, without giving you an exact answer based on real math. If you want to give me a math problem, I'll solve it. But just high level, that's the high level answer

Kevin Kim:

That's important. I mean, one additional component to that, and you mentioned it earlier, is the low income house. The low income housing tax credits and other tax credits. We do a lot of projects that come with the client has this glorious business plan saying they're going to do ozone, they're going to get a construction loan, they're going to get new market tax credit, they're going to try to qualify for other ancillary tax credits. Some say we'll do eeb five on top of all that, a very, very complex structure. Let's talk about tax credits really quick. So as on both sides of the business, let's look at it from a lender and from an equity standpoint. Do you require that the tax credits be applied for pre-approved, be at least eligible? What is the eligibility requirements you see if they come to you claiming I'm going to also file for these tax credits?

Emil Khodorkovsky:

I think it's all, I mean, it's kind of like when people come to us, they don't always have the full equity raised. You don't. So we always have to take a good hard look at the people and really get to know them, especially if they're a first time client to understand, Hey, where are you raising the equity from? What are you putting together? Because when you get into a project with somebody, and let's say they've raised 20 million out of 30 and they're 10 million short, we're like, okay, well if they can't figure that out, we can come in with a mess piece or something like that it it's okay. But if they're coming in with a first 2 million out of 30, we're going to take a really, really hard dive into who they're planning to partner up with and get comfortable because time is money in this market.

We're all very, very busy with financing needs from other people. So if we're going to dedicate our time toward underwriting and funding alone, we want to make sure the money's ready. And it doesn't matter. I I'm answering your question in two parts. One is it doesn't matter to me whether it's equity coming from a private equity source, a fund or a tax credit, and then understanding how tax credit works and understanding this limited amount of allocations and knowing how competitive that tax credit space is, right? If they're not partnered up with it with a heavy hitter who has been awarded tax credits in the past, it's going to be really difficult. I mean, I sit on a board for a company for a nonprofit called Ski Housing Trust in downtown la, and I see kind of firsthand how we're competing for the same tax credits and many of them are getting awarded and the stack are getting more and more complicated between grants and tax credits. And the timing of everything has to be just reported requirements. So it isn't for the faint. And if we don't believe that the team that is going out to raise tax credits is partner up with somebody who is likely to be awarded those tax credits, we frankly will not want to work on the

Kevin Kim:

Project. So it's not necessarily the, you don't need to have them, but you also, you need to see that they have the right team in place to maximize the success. That's important. I've seen a lot of people just say, oh yeah, we're, we're going to get XYZ tax credit. Okay, well if it's like for example, new market tax, well what tax firm are using, what attorney are using for the

Emil Khodorkovsky:

Hundred percent?

Kevin Kim:

Where is your application ready? All that kind of stuff. So what's your stack? Is it even eligible? Where is it? Where's it located? All these things. E five is, I have much more experience with e B five than tax credits. And we've done the same thing is we had clients come to us with this grand scheme and the first thing I see is you have no plan for your E B five, right? Everyone's going to reject you because you have e B five on here, right? And you combine ozone Eeb five and tax guys on the same project. Your lender is going to ask you a ton of questions based on your track record, your experience, and your vendors. I mean, they're not going to just accept it.

Emil Khodorkovsky:

Just having, I'll give you an example. There's a lot of clients again, going back to Skidro housing for a second. Lately there's been a lot of clients who initially were developing land for profit and they got into deals, not necessarily zone deals, but they got into projects that they were going to do as a market rate deal. And then after the cost. And a lot of these land developers, they're in these deals for five, 10 years, they're land bankers. And when they pencil a deal and they realize that they're not going to get the opportunity for a premium for that kind of a deal, then they're like, huh, maybe I should partner up with a big group like Skid Row. We can do some sort of a gym venture contribute to land for whatever my basis is and do some sort of a upkick and then we can keep it for a long, long time.

So there's been a lot of opportunities lately where skidder housing is joint ventured with developers where the deals didn't quite pencil for them to go market rate, but they did pencil to go affordable. And so sometimes it makes sense to partner up with somebody's experience, whether it's a lawyer or a nonprofit to run your project for you. And I can't stress that enough that people think they can do it on their own. But until you've dabbled in zones without you, I wouldn't get into it. Because when I read the hundred page docs <laugh> or hundreds and hundreds of pages of docs and the 3000 revisions of those rules, it's not for the faint. And I think when you can simplify it, you guys do from the perspective of, Hey, here are the bullet points of what you can do and what you can't do. Just trust me, this is it. Right? And that's a huge part of this.

Kevin Kim:

And we tell clients, listen, ozone is, I mean it's, it's kind of similar to e B five in this regard is it's not a license to print money. It's a very complicated program. You need a lot of vendors in place and it's not something that you can just wing. It's not, it's just some kind of securities program exemption that you can just rely on. Backstop exemptions for this is a tax program and this is a treasury program. There's a lot of different components here, so we got a lot of risk here. So make sure you have that planned out. Same with similarly, B fives. There's a lot of immigration risk attacks or attacks. Tax risk carries risk. So yeah, absolutely. Let's go into the final

Emil Khodorkovsky:

Scene. Yeah, also monitoring, right? Yeah.

Kevin Kim:

I mean the monitoring is for the next

Emil Khodorkovsky:

Many

Kevin Kim:

Years, the 10-year monitoring is where a lot of, I can see it. I'm going to make a prediction year seven, right after the program went live. Any year sevens where just like we did in E five, we're going to see a lot of program a lot of projects have problems and need some rescue. But let's go into the actual financing. Cause we kind of touched on it and I want you to spend some time with, here is HUD financing for the uninitiated who may have a project that is a really great fit for HUD is just they don't know it yet. Give us some information about the HUD program and how it fits into these ozone projects and these construction projects.

Emil Khodorkovsky:

So a couple things I'll tell you about the positives, because there are negatives in anything, right? There's great positives for ozone, there's great negatives for ozone, there's great positives for HUD, there's great negatives for HUD. So it isn't for every project. And frankly, I'll tell you that as a principle in these deals, I don't think HUD is always the right type of loan for people. So just for everybody to get high level, how does an insurance company on the residential side, when you're first time home buyer and you put one or 3% down, that is your fha? Well, it's insured with the same product, except on the commercial side. It's for larger multi-family projects, both for construction or permanent loans. So let's talk about construction for a second and then we'll get into permanent loans afterwards. So pros I told earlier to everyone, 40 year fixed a few years before that.

You've got the construction component, but your rate is fixed in for the entire time. Another rate is low rate is lower than a typical Fannie Mae, Freddie Mac or C M B S loan. The other portion that I think is important is that the prepay is a step down. So after the 40, the two year, let's call it prepaid interest term, you've got 40 years fully amortized. For the first 10 years of the 40, you have a prepay. Then the latter 30 years is a complete open period. So you can refinance, you could sell, the loan is consumable for a half a percent fee, and the rates for a construction loan are in the range of three to three and a half the range. The rate range for a refinance is in the range of 2.4 to three, depending if you go green or non-green for both products.

Now the negative, the negative is a time that it takes to approve an a HUD loan. So if you're a first time HUD loan borrower, so essentially four Bix Financial is a lender. We go to HUD to get a special insurance, and once it's insured, then we can fund this loan in that product. But we're the ones that are underwriting funding it, but HUD insurers it, and then we sell the paper. Now the negative is on a construction deal, the whole process takes 12 months. Now you might wonder why it takes 12 months. It doesn't take 12 months from the time that you're permit ready. But it's important that a developer comes to us when they're entitled before they've done all the full architecture and they have a permit in hand because we'll need a six month head start before they're in a position where they have a permit in their hand.

And from the time that they have a permit, it's about a three month close. So this way it's important that the clients come to us early, whether it's to us as a HUD lender or other HUD lenders. If you're a developer, you got your deal entitled, you know, can build a hundred units. That's when you reach out to a HUD lender, get the quotes, figure this out where, whereas with a conventional lender, you just want to reach out maybe 90 days in advance of you getting a permit in your hand. Now in general, you want to be talking about options for your financing way in advance. A year before, two years before. That's how we started a conversation. The other negative is that when you're using a HUD product, you have to use building prevailing wage. Now there's residential prevailing wage as commercial prevailing wage.

In some areas it won't matter whether you're building prevailing wage or non-pro prevailing wage because the costs are, the costs and the costs are aligned with the market. But in certain areas, a prevailing wage job can cost you more money, especially if it's a commercial prevailing wage. Then it would, if you just built regular with a regular gc just like with the ozone, there's a lot more complexity with paperwork and compliance. There's an annual audit required for every F H A loan. It is something your accounting can do, but it's an added cost that is there as well. So those are the pros and cons on a refi. The other potential issue is the pros of a HUD loan is you can technically get up to 85% loan to cost or loan to value on a construction loan or a refinance. The other interesting thing is if you're a builder owner, let's say there's a 10 million project and you're GCP is $600,000, instead of you having to pay yourself, you can take that $600,000 of a G C fee and contribute that as equity to your project.

You cannot do that on any other product that I know. So that is a huge thing. So in essence, if you count your g c fee as part of your equity, the numbers end up being closer to 90% loan to cost on some of those things. The debt service constraint is less, and because the interest rate is lower, you can cashflow for much larger loan amount. Now, I'm not saying that on every deal you're going to hit 85 or 90%. It really depends on the debt service constraint, but you can definitely get to a much higher loan to cost with FHA versus a non FHA type of loan. The negative is statutory limits. There is a maximum loan amount per unit that were okay funding. It's not meant to be for high-end properties. So typically it depends on the bedroom bathroom count, but it could be four or $500,000 per unit in terms of construction dollars that could be spent.

And some clients that are building really high-end product where they're spending $800,000 per unit per unit, their loan to cost would be severely constrained. So that would not be a good product for that particular borrower. And it's also not meant to be for small loans, the cost of the reports is substantially more. So if a typical lender will charge, I dunno, 15, 20,000 for third party reports. With fha it's 35 or 40, there's more audits. So whenever you're penciling a deal, there is no minimum for hu. Meaning you could do a million dollar loan, but when you count all the dollars, the value isn't there. So typically I tell people that even though there is no minimum or maximum, meaning you can do a 200 million loan or a million dollar loan on a refi, typically you should focus on a target loans of 5 million plus and for construction, 10 million plus for a HUD loan as opposed to other alternatives that are out there.

So again, when I see all the ingredients in the soup, the equity, et cetera, et cetera, you can make a calculation meaning, hey, the equity costs me 20% of my money, for example, but a HUD loan costs me an extra five. Well, I'm okay over paying for fees and the cost because I can get to higher loan to cost. I don't need to raise as much equity or borrow meds. So you can make a justification to use an f h loan for leverage if the alternative is bad. But if you have cash, then it, it's a different conversation. So you have to kind of have all the ingredients for me to truly define the pros and cons. But I think this is a pretty good high level explanation of what you're asked.

Kevin Kim:

And let's kind of get into the actual practical of this For our listeners who are actually have projects or developers, what's a successful type project that you've seen structured using the HUD program? It we can simplify for the audience a little bit. I mean, we see a lot of concentrations in multi-family, especially workforce housing across the country. My understanding, and we've seen products that use this, is I, I've seen it work very well for workforce housing development, not necessarily rehab, but for development and then also for and for also, I've seen it used for senior housing very popular in the senior housing space when it was booming. I think it's still kind of on its way up again. And then there's a question mark right now that I have for you is one of the trends that we start, we're starting to see is conversions from hospitality to multifamily. And it's going to be a heavy, heavy, it's not construction if you will, it's rehab, but it's heavy rehab. Wondering if these kinds of, I guess, projects would fit under the HUD program, and if you've seen any of them kind of fit

Emil Khodorkovsky:

In what Yeah, we have, and we've worked on 'em actually. So a couple things is just you're asking successes, right? So sometimes I may choose a HUD loan because I'm afraid of exposure on a very, very large loan. So I'll give you an example. There's a project we're doing in Hunter's Point, which is in an ozone, and we're considering whether we're actually going to do an ozone fund for the equity or not. So we're still finishing with the planning commission, hope to wrap it up in the next few months, and we plan to break ground in the next, let's call it 12 months hopefully, assuming everything goes according to plan. So my partners, I took a really hard look and we have to take a consider, hey, are we afraid of the future? Do we think there's potential inflation risk? And in that case, because the cost of construction there, and it's a union city as San Francisco, the cost of construction is so much more.

We think that, and us being afraid of where inflation may take rates, et cetera, we decided that we'd rather come in with roughly or raise a roughly 30 million of equity and get roughly a 70 million loan on that project because we just don't want the exposure in the marketplace in the future, whether it is an OB zone or not. So in that case, I can't get a higher loan amount, not because of my debt service constraint. I can't get a higher loan amount because of my maximum loan amount per unit constraint, that statutory limit. So that is one decision we made that we thought, okay, well it's hold for us. We do think there's a significant upside in 10, 15 years, whether it's a nose on or not. And that's a decision we made there. We're doing another adaptive reuse project in Inglewood that is just outside the op zone.

We probably would've done it. And it's an adaptive reuse of an office space into multi-family units. And you're going to see a lot of that because after what we've seen in the last, let's call it six to nine months, retail, some type of office, they're not going to make it long term. So you're going to see a lot of people trying to reinvent themselves, do up zone changes, et cetera to change those products. So if we're talking up zone, we discussed it earlier that somebody who's buying, let's say a hotel for 20 million and they're going to spend another 20 million to increase the value to 40, could potentially do that in an KN zone as well. So adaptive reuse is something that can be used under the hot product as long as the amount of rehab exceeds, I believe the number is 18 or $20,000 per unit.

So it would work for that construction loan, and it could be permanent financing and treat it like a massive rehab loan. And it would work in some cases when the upside is quite a bit, it may not make sense necessarily to do a HUD loan from day one because remember, it's a permanent loan from day one and it has a pre-payment penalty for the first 10 years of the loan. So if the idea is to refinance, it may not be a perfect product. Now, if you're getting to 85 or 90% older costs, there's nothing to refinance into. But right now what's happened is earlier in the year in March of this year or last year, 2020, I keep forgetting, we're in 2021. So in the beginning of last year, HUD waived an old rule. It used to be that if you did a construction loan not using HUD insured financing, you could not refinance that product for three years.

So what happened is to stimulate the economy, HUD that rule to create more housing. So now let's say a person who built a property using non HUD loan and didn't use prevailing wages, did a regular deal, they're able to use HUD, a HUD loan as a refinance, and HUD does not have the same constraints as other lenders. Meaning let's say typically if it costs me 20 million to build a project agency lenders or normal lenders outside of fha, Fannie Mae, Freddie Mac, mbs, let's say MBS is different, but Fannie Mae, Freddie Mac and other lenders, they won't give you more than 90% of your cost. So let's say you spend 20 million, you can't get more than 18 on every refinance. What's with HUD? There is no loan to cost constraint. So if you spend 20 million and you need to get 24, no problem has to do with loan to value loan. There's no loan to cost issue. So that is another thing that I failed to mention earlier. That was a big rule change that will allow people to refinance the property after using non HUD construction loan. And that product would be fixed for 35 years. And the rates are in the range of two and 5% to 3% today, depending on the loan size.

Kevin Kim:

And that rule hasn't, is that going anywhere or is it this going to be continue to be waived for something For

Emil Khodorkovsky:

Now it's a three year kind of rule and they're going to revisit this and then decide in three years it's two or three, I forget. Right? I believe it's three years. So

Kevin Kim:

That's interesting. Cause a lot of ozone came up, consent saying that they, they're looking for, they did conventional financing, they're planning to refi out. A lot of them don't realize you're plan to refi. If you can get a permanent loan better based off of the way ozone works and the way you don't want, you want to minimize your distributions over a period of time and keep cash flows at a minimum after until a certain date. But the nice part now is a lot of folks who went conventional beforehand without who chose out to go HU or whatever, can now refi into HUD at least for three years. It sounds like that's Oh

Emil Khodorkovsky:

Yeah. For the next, if they finish the project, oh yeah, they finished the project recently. While we know for sure the rules are in play for the next couple of years, they should definitely be doing that. Especially whether, and again, it doesn't matter, it's a non-recourse loan. So at that point you have to just take a step back and see if I get a Fannie Mae or Freddie Mac loan, it's typically a balloon, a maturity after 10 years. And the prepay is for the full 10. With an FHA loan, your prepayment penalties for 10 years, but there is no maturity. It's truly like a home mortgage. It's fully amortized for the entire 35 years. So especially in an odd zone, you've got all that time and you're not in a hurry. And in 10 years if the rates are higher, you said pretty, you don't do anything. But if the rates are the same, then you could refin answer me capitalize and not have an issue at that point, or have that step up basis on a sale. So it leaves you a lot more options.

Kevin Kim:

There you go. So I want to start asking you about some kind market trends a little bit. But before we go there, I want to remind the audience there is a question and answer tool in your toolbar for Zoom. So please, if you have any questions, please submit them there and we'll try to get them at the end of the webinar. So moving on to moving on trends. And I definitely want to ask you this because man, the market has changed so much, and we kind of touched on it a little bit. Ozone funds included. One of the things we saw as a trend in the ozone space was when it started was everyone used it to build hotels. And we know now that hotel hospitality is, it's not so good <laugh> right now but let's kind of get into the asset classes. And I want to ask you for qz funds, at least for now, and we can go into the broader discussion for qz funds and for developers who are pursuing them, where have the successes lie lately? Where do you see things going and where should these folks be concentrating? I mean, I would venture a guest. The hospitality is probably not one of them, and they probably should. That's

Emil Khodorkovsky:

An understatement,

Kevin Kim:

Right? So

Emil Khodorkovsky:

I think for deal junkies and people that are kind of scavengers, hospitality would be a great play. What you mentioned earlier, you take a hospitality deal, you repurpose it into multi-family or low-income housing and figure out a way to make that work as long as the zoning allows it. Yeah, hospitality office, retail, I think, let's take a step back and trends. What are people lending on? Even with the multi-family, there's a lot of tenant moratoriums. A lot of the newer product we built we don't have a lot of issues with tenants. It's people that have been able to pay, et cetera. Maybe not a lot in the service industry, and it's also driven by the markets you're in. But for some of the clients I've spoken to, even on the multi-family side, their rent collections are down 20%, 30%. And so with Covid and everything, multi-family is a great asset class that people are still flocking to because I mean, that's the reason why I got into multifamily 15 years ago where I said, well, people got to live somewhere, so let me invest in an asset class.

That's simple. There's a lot of people that have made a lot of money in retail office, industrial, hospitality. I'm not one of 'em. I mean, I own a few commercial buildings, I'm no pro and commercial. And there's a lot of people that have done great in certain retail spaces. So the retail spaces we all can use. Our common sense. The grocery anchors, the pharmacies, those retail spaces are still okay. The seven elevens, people still go in, they get their snacks, et cetera. The gas stations volume is down from my gas station clients, but their profitability is up. So it's more or less the same. But office who needs an office now I'm sitting in my office, in my house, you probably are too. So the point is that the office market is going to shrink, the numbers are going to drop there. So it's not a place that people are going to go in unless they're going to be doing scavenger hunting, stressing the rental rates by a huge number, understanding they'll have to chop up the units into smaller units in order to invite the space. More creative type of offices is that we work, they're not doing great because nobody's showing up. So hospitality, shared

Kevin Kim:

Workspace is even worse, right? Oh, huddled to everyone else. Even worse.

Emil Khodorkovsky:

Yeah. So it used to be that we thought that was the next move, right? Oh, creative office space is the way of the future. Well, not during covid, no office spaces is the way of the future. I think there's probably going to be an uptick in kind of owner user spaces that are smaller. Two story, one story building. I mean, I'm looking for one myself because I don't want to be in an office tower anymore, want something that's easy to park, walk in. So I feel like that trend is going toward industrial. So industrial, the Amazons, you know want industrial space to warehouse product. You want multi-family of course, but all the other asset classes, you're either bargain hunting or you're figuring out an adaptive reuse way to convert into a different use.

Kevin Kim:

And I had a discussion with an ozone kind of colleague of mine, and he was saying the kind of similar echo in the same sentiment is that funds are trending away from what was traditionally being human tradition. It's kind of hard word to say when it's only been around for about two, three years now. But hospitality in retail and office, mixed use, multi-family, well kind of the core asset classes. Now you're right, they're now looking toward adaptive reuse towards residential, toward some multi-family and conversions to, I've heard interesting things about conversion to condos, conversion to townhouses and that kind of stuff. Like more or townhouses, co-ops and that kind of stuff have residential for middle class or upper middle class buyers to take advantage of housing stock. But office has definitely been dead. The retail component has been interesting for ozone because adding the mixed use component and converting over to that direction seems with the right kind of retail tends to make sense for ozone because you have the double the basis by building the large construction projects that require for required for a market or a large restaurant strip.

But then also for the residential component, that adds to the basis value considering the high demand for real residential real estate plays a big factor into the eligibility of the ozone program. So I think that's kind of where we're seeing a shift as well. But let me ask about this. What about geo geographically? Because one thing that a lot of people are talking about right now is the great exodus from the major cities. You're in la I'm here in Orange County, A lot of folks are fleeing actual la la, right? No one's leaving la. Same thing seems to be going from New York, San Francisco. Definitely the truth. How do you see that impacting a lot of these, just development as a whole, but also the ozone program?

Emil Khodorkovsky:

Well, I think if you look at the cycles, there's always exodus and eventually people solely dwindle back and there's another exodus and then people solely dwindle back. So I think everything is if you look at the stock market, why do you people invest a dollar into something that's trading 30 times? Its actual profitability. I have no idea because I'm a real estate guy. But people invest and they have their life savings invested in these things that are all projections and speculation on how far Apple stock is going to go up or where Tesla's going to hit their big mark. Even though a lot of those companies, some of 'em like Uber, they're not profit, they're not profitable at all, but people are betting on speculation. So people naturally are positive thinkers. And I think that eventually people will come back short term. You have to kind of suffer through what it is and how do you attract people?

You drop the rental rates, then what do you, you bring 'em back up, you know, offer concessions to tenants, especially in rent control areas, and they slowly, they come back up. So I think are we seeing a Mac Max exodus now? Of course. Yeah. We're in the middle of pandemic. People are trapped in their rooms and they're getting antsy and they want to get out and have more freedom. And because we're in a temporary situation, we're hoping with the vaccine coming out and with just slow transition into what we would call normalcy, things will stabilize themselves. And then people will go back to maybe a different normal, but some sort of a new normal. And I think that this is all a temporary move. I think people run away from LA come back and things are back to normal eventually.

Kevin Kim:

Fair enough. So I mean, let's talk about the projects themselves now, the actual bones of them. We talked about stack all day long and rise success for both financing and the equity, but we haven't really touched on the intangibles, so we kind of talked about it when we're talking about vendors and experience. What are some intangibles that you like to see when you're evaluating any kind of ozone, an ozone project, but also just a general construction project? What are the intangibles that you want to see when you're evaluating them?

Emil Khodorkovsky:

I think we talked about the math of it, right? Loans to value, loan to cost. D S C R and credit. The intangibles are working with people you actually want to be working with, especially if it's a long drawn out process, them understanding the product type you're going to put him into put your client into. And so it's really about the education. And that usually comes from experience. Sometimes people lack an equity partner that's strong and we can possibly either be their equity partner, introduce 'em to somebody, or they lack their experience. So I, I'll give you an example. We had a client that was a really credit worthy client, but has never built multi-family before, has only built retail deals. So we partnered up with somebody who had significant multi-family experience to get into this thing because that project was too big for a first time multi-family person.

So that person put up money and decided to JV with them and it's relationships. But building these kind of relationships, you kind of have to feel the vibe from the person that the investor you're going to put in with is going to jive with that person. So if I have to pick two, it's experience and personality. And the biggest thing is that sometimes a person has a great personality but is an inexperienced, you're going to run into issues with that person that if that person was experienced, you wouldn't run into like, Hey, what do you mean?

Kevin Kim:

That's important though, right? Because that's very intangible. Because if they're inexperienced and you identify that as, Hey, as your lender or as your partner now in this project we're telling you, you probably don't have the experience you need. And if the sponsors playing in the ego game and say, no, I got this. That's a big red flag from a personality stand. Cause they're not going to mesh well with any introductions that you make.

Emil Khodorkovsky:

But Kevin, you have to establish a trust factor with a person. Sometimes my best clients in my experience are the ones that leave me first and they come back, right? And the reason why is because I tell them everything that we normally tell people from day one, Hey, you've got an issue with this, this, and this and the other. They're like, okay, well the other person's telling me I don't have an issue with this. I'm like, okay. And then they leave, then they get a bad loan and then afterwards they come back, oh, I had to get a bad loan. And then they become your client for life. That that's always been our greatest right client because you tell 'em what it is, you tell 'em the truth. And again, this is coming from personal experience, our own failures. I remember my father told me, make your own mistakes.

Don't make mine. These are the mistakes I've made. And I feel like you want to pass that on to other people. When you see clients do something wrong and then you explain to your new clients, Hey listen, I've had clients went down this path, didn't work out, don't do this. Hopefully they listen because you're coming from a good place. You're not trying to scare 'em away from anything, but you want to tell 'em the facts. And that's our job. So we see some of these gaping holes where sometimes clients are like, oh, I got this thing. I'm like, well, if you have a cost plus deal with somebody and you don't have a guaranteed maximum price contract with the gc, do you have the ability to cover if there's a cost over on here? Have you really done the math on this? So there's a lot of conversations we have that aren't about financing because the product is pretty structured, understanding how to put it in.

Yeah, we get that and we know that really well, both for ourselves and for others. But it's all the other intangibles, like you said, Hey, how well do you know the gc? What kind of track record do you have with them? Are they reputable? Do you know about 'em? Are they bonded? There's so many different variables that we really get involved with because we do want the project to succeed because us as a lender is a reflection on this as well. We don't want them to fail. Yeah. So we really dig in and have these conversations.

Kevin Kim:

Fantastic. Well, Asia, I want to make sure we talk about kind of other areas. One thing that I don't want to spend too much time on this, but I do want to address this, is liquidity. Liquidity, liquidity. Everyone. This past Covid past year with Covid liquidity has been one of the number one topics in the debt space. But for developers and for ozone developers and those who are using the HUD program, all the above. How does the liquidity plan change when you're using for ozone? A lot of folks think, okay, I got to hold onto this property for 10 years. It's actually not true. You've got an ozone fund. Your fund invests in the properties, the investors invest in the stock, and that's the eligible ozone investment they can sell and flip properties as long as the next real estate project is eligible. So from a liquidity, if they have the ability to sell and find a new property, they can continue cycling their capital that way. But the question mark becomes, does that jive with say, a HUD loan? Does that jive with the investor expectations and so on and so forth. So I want to help with you about the HUD loan first. Sure. If the plan is to invest in a pro, I mean, it makes sense. If I'm going to hold onto the property for 10 plus years, it sounds like it works perfectly for that. But if I'm a developer, I plan on selling this thing after a year into stabilization, should they still be considering a hot loan?

Emil Khodorkovsky:

A hundred percent. And I did the math myself, right? Because if I know from day one I'm putting an X amount of cash, and the alternative, if the rate is 4%, is that I won't debt service to a loan amount more than X. So with a HUD loan, I can get to a 20 million loan with a non HUD loan. I'm only at 15 right now. Later on, when I'm able to refinance, assuming the rates are three and a half percent, will I achieve with a regular loan? Because my regular loan has a 30 amortization, not 40, I may only be able to hit that 20, 20 million mark anyway. So if I know that I'm projecting these rents, and likely the rents aren't going to be much higher in a year than what I'm projecting or two, so I know that I'm still going to be at that 20 million ceiling, I'd much rather have a HUD loan that's in place with a fixed rate that someone can assume that I g guaranteed the rate than take a chance that in two years rates are the same, where I'm not going to be able to get a higher loan than 20 million anyway.

And because a loan is consumable, it's a great product. I'll tell you why. So let's say at that point, the rates aren't three, they're four. Well, I'd much rather assume a rate of three than go to the market and get a new loan. 4%. So that becomes a commodity that you're selling to your buyer.

Kevin Kim:

It's a premium.

Emil Khodorkovsky:

The premium, exactly. So you can get a premium.

Kevin Kim:

Yeah.

Emil Khodorkovsky:

Yeah. So that's where it's

Kevin Kim:

Important the audience to know is that these loans are consumable, right? So when I sell the property, this is a small fee for that, but if I want to sell this to a buyer, the buyer can come, the new borrower, now he's got this loan locked in. Now the developer,

Emil Khodorkovsky:

The loan is high, right? But the problem is where it doesn't work as a HUD loan is if we think that in the future for rates around 4% instead of 20 million, we can get 25, then the HUD loan is not for that particular property. Why? Because the person's not going to want to put an extra 5 million, it was down to have a 3% rate versus four, for example, right? Sure. Okay. So in those instances, I'd say, no, that's not the right move because you're going to sell your strategy's different. So then you start kind of playing with the idea, well, how much more equity do I have to come in with? How much more of a premium will I get? So there's a lot of moving parts, and we're happy to dissect them and give our suggestion recommendation, but ultimately the client will make the decision.

Kevin Kim:

Okay. Alright. All right. So we have a little bit of time left, and I want to, before we ask, open up for questions and introduce one over there, and to talk about that a little bit. I want to get your thoughts on the new administration. There's a lot of discussion about what the Biden administration plans to do about the, I mean, the ozone program, because the ozone program for the uninitiated, the Ozone program was part of the Tax Cut and Jobs Act, right? Initiated by the Trump administration along with a host of other tax deductions and tax programs that were created. A lot of folks are a little bit worried. What's that going? What is the Biden administration going to be doing to this program the Ozone program? And then also whether the other types of financing programs that are available today will be negatively affected. Because in lieu of that, or in line with that, and I'm sure you've, with your network and stuff like that, you had to not think about this. What is your thoughts on the impact of the Zoom administration coming in?

Emil Khodorkovsky:

Well, let's look at it from this perspective. I mean, everybody's got an opinion, right? Yeah. I have a lot of high net worth individuals that invest with us and borrow from us. And everybody's very political and voices their opinion. As you know, there's a change in estate taxes that's coming. And yes, a lot of people rushing at the end of the year to do irrevocable trusts and this and that and all these different things. I always look at things in a very, very simple way. The impact is the impact. It's not something you or I can control outside of lobbying for whatever policy we want. Doesn't matter what side of the coin you're on, you're on the Democratic side, Republican side, it, it's irrelevant. I think people that are on this call are trying to figure out what are the right strategies for themselves to invest in projects and do certain things from a perspective of financing for HUD, well, that's a government insurance.

So nothing is going to change from that perspective. In terms of how do lenders get impacted by this? I don't think they do. I think it's more what is going to be the liquidity requirements within each bank from a banking sector perspective, defaults, et cetera, et cetera. It's going to impact how lenders lend or don't lend. But I don't think the administration really has a direct link to that. But obviously it speaks about the ozone and what rules and regulations are going to be in place for that. Those I don't have the expertise to talk about it.

Kevin Kim:

Fair enough. And just for the audience to know we are, along with the American Association of Private Lenders, going to be on our day on the Hill with Congress and some senators talking to them about making this permanent, along with a few other programs that are tied with this. And so hopefully we will be able to convince them folks, at least to prevent any kind of blockage, but ideally make it permanent. There was some discussion about making this program permanent along with some other deductions earlier in the year, but unfortunately, COVID kind of got in the way of that. So we, we'll see how this plays out. Emil, you're right. I mean, how is this going to play out. It is what it is, and let's make sure we plan around that. And there is a possibility, there's a possibility that this may be eliminated, but I don't think they're going to for the ones that are already, they're not going to cancel out. It'll be unfair for the administration to cancel out the investments benefits. So there would probably be some tapered, there

Emil Khodorkovsky:

There would be a huge backlash if that happened. I mean, that would be, I think, unconstitutional. I mean, if you can't and launch a product and then people spend resources, time, money, invest and then cancel. It may be the future that it won't exist in the future. But I think whoever's invested, invested, and as long as the numbers make sense, I think the op zone is a tool in the arsenal. It isn't the only way to invest. And what we're exploring here is that, hey, as long as you can line up all the right ingredients in the soup, you can cook really tasty soup. But if you don't have all the ingredients, it won't work. So I think the purpose of this dialogue is to make sure that people are aware of all the ingredients and that they figure it out. And if the numbers line up and the structure lines up and the strategy lines up, then it's the right move.

Kevin Kim:

Fantastic. Okay. So that's all for the webinar. Thank you, Emil. So I want to make sure everyone knows the audience. If you have questions, here's our contact information. Mona, where are you at? Would please introduce yourself to the audience and give him a little bit of information on your end so you can make sure we get all the right questions over to the Forbix team.

Emil Khodorkovsky:

Mona,

Kevin Kim:

Mona, I'm have a little bit of, there we go.

There she is.

Mona Elhalwagy:

Hi there. I'm here. So just wanted to give a quick introduction to myself. I work at Forbix and I'm also an attorney. I don't practice. So I did loans before, during and after law school. And when I graduated, I decided to stay in lending because I liked it. But I am a member of the bar and a bit about Forbix, although we are direct FHA lenders and we lend nationwide. We also have a lot of other products nationwide for commercial loans, income projects, like agency debt. And we also offer bridge. And in addition to that, we also do commercial loans in California. So if anybody out there has any questions or if you have a product or a project that

Emil Khodorkovsky:

You mean residential loans in California,

Mona Elhalwagy:

Huh?

Emil Khodorkovsky:

We do commercial loans nationwide. We do residential loans in California.

Mona Elhalwagy:

Yeah, that's what I said.

Emil Khodorkovsky:

Oh, I thought you said commercial.

Mona Elhalwagy:

No, we do residency in California. We do residency in California and Commercial nationwide. And we have other products available other than the HUD, but the HUD we are direct lenders on. So there's my contact information, and if you have any questions, give me a call.

Emil Khodorkovsky:

And so Mona and I have been working together since 2011, and so she's super awesome and extremely responsive. So we kind of work together in teams. So typically Mona will come in gather all the pieces, and then I'll come in and help structure. And Mona and I will work together on whatever questions you might have or deals that you need for us to put together for you.

Kevin Kim:

All right, guys. Well, that's all we have for today. Once again, thank you to the Forbix team for joining us today. Thank you. Thank you, Mona.

Emil Khodorkovsky:

Thank you,

Kevin Kim:

Kevin. And for anyone else who's got questions about Opportunity Zones, who needs a deal, help with the deal, any kind of questions about financing, please give the Forbix team a call on Ozone projects. If you've got any questions, please give us a call. We're happy to help you and get them set up. And once again, this is Kevin Kim from Geraci LLP. Thank you very much for listening in, and this webinar will be available on our website for download. So thank you very much.

Emil Khodorkovsky:

Thank you, Kevin. Happy new year.

Kevin Kim:

Thank you. Happy New Year everyone. Happy New Year to you.

Emil Khodorkovsky:

Bye

Mona Elhalwagy:

Bye.

Kevin Kim:

Bye.