The IDEAL Investor Show: The Path to Early Retirement

Skip the bank - Use this Game Changing Opportunity Instead

• Axel Meierhoefer

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In this episode, we interviewed the man who funded over $2 billion in loans, helped over 600 clients, and performed over 40,000 hours of underwriting of commercial real estate - David Kotter is the CEO/President of the Hybrid Debt Fund, as well as Integrity Capital, LLC. Integrity Capital, LLC focuses on proactive commercial finance services for clients throughout the United States. 

Interview Notes:

[00:00-02:27] The trouble with Real Estate Lending

[02:28-05:15] Private Credit Funds

[05:16-14:48] Why skip the bank

[14:49-20:34] Benefits of Hybrid Debt Fund

[20:35-24:22] Game-changer

[24:23-29:20] Exploring Build-to-Rent Opportunities

[29:21-30:10] Learn more about Private Lending

[30:10-31:31] Investor Q&A

Special mentions: Chris Botti, Arizona State University, Utah, Salt Lake City


Any questions?

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David: [00:00:00] So if you're trying to go get a loan from a bank right now, they're gonna mandate that you put in 10 to 20% of the loan amount of deposits in the bank. That's a pretty big hurdle, hence forth. Why we love the private debt markets, because it allows for more flexibility. We just don't have the same amount of red tape of things that really are non-essentials to make sure that an investment is appropriately done.

Axel M: Welcome to the Ideal Investor Show. This is the podcast where we help you. Challenge your mindset and discover where you are. Let's go. Hello and welcome to another episode of The Ideal Investor Show, where we bring you great guests around the topic of passive investing, getting earlier to retirement, and learning good ways on how to do this.

Axel M: And today we have another one of those episodes where we have a great guest and I want to welcome David Coder to the show. 

David: Thank you so much for having me, Axel. It's a pleasure to be here. 

Axel M: Yeah, absolutely. Wonderful for you to make the time. Uh, before we dive in and learn a little bit about [00:01:00] this kind of interesting way of lending money and what you're lending it for and so forth, tell us a little bit, how did you get to where you are today?

David: Yeah, well, I'm originally from Utah, native of Salt Lake City, and ended up coming to Arizona. 98, went to a SU in my junior year. I started buying and selling commercial real estate loans from banks with a really wealthy guy who took me under his wing and learned a ton about the industry. And so I decided after a couple years that I wanted to spin out with a partner of mine and start a direct commercial real estate.

David: Uh. Origination firm. And so we began originating loans back in June of 2003. And here we are today having done about $2 billion of originations ourself. And couple years ago we decided we wanted to start our own fund, which is now called Hybrid [00:02:00] Debt Fund, and we saw a huge gap. Within the industry and we just decided we were gonna capitalize on it.

David: And it's been a wild ride and a great journey of really understanding how to underwrite, how to look at risk and how to really build a foundation of, of providing passive investors opportunities to make good income while minimizing their risk. So that brings us up to today. 

Axel M: Yeah, that's very cool. Now, you said you guys created a fund.

Axel M: For people who are not that familiar, the only thing they ever heard is a mutual fund. Can you, can you describe a little bit what is the fund and how does it function? 

David: Absolutely. So it is a. Private credit, commercial real estate fund. So it's a Reg D offering that we provide to investors that come into an equity pool.

David: And what happens is we lend money to developers. So apartments, [00:03:00] retail, industrial, self storage. They need to get a loan. Well, they're going to either go to a bank. Or they're gonna go to a private group or you know, life insurance company. What we've done is we provided a nichey product where we do a first deed of trust.

David: So we have the security instrument against the property, and we do a stretch senior loan, so we go a little bit higher. Then a bank would go. And in return for that, we actually take a participation. So we take 30 to 35% of the net profit and 30 to 35% when they sell in three years. And so what happens from an investor's perspective, they come into this pool within our fund, they'll make five point a 5%.

David: Per annum paid out quarterly. And then what happens is they will go ahead and participate in that reversion. And so when we sell or get the NOI, we're gonna be lifting them to get to about an 11 to [00:04:00] 13% net internal rate of return for the investors. And so what happens is they'll get. 80% of that profit participation until we get to 13 and then we split it 50 50.

David: And so they're in this pool, uh, of deals that they can offer to their bottom line for passive income. 

Axel M: Very cool. And to become a member in this pool, do you need to be accredited or not or Yes, partially, or can you say a little bit about that? 

David: Absolutely. Yeah. It's a 5 0 6 C, and so it's allowed for everybody, but it's accredited investors only, so you have to have obviously, a net worth requirement.

David: Of at least a million dollars minus the house and, or, you know, made 200 plus thousand or 300, uh, combined for the last couple years. So people do need to be accredited to come in and it is [00:05:00] what would be considered an alternative investment. So they might go to their financial planner and find this as an opportunity on one of the platforms that they could invest in.

David: It. 

Axel M: I think that's an important distinction for our audience to know about. Now the other thing is, and I'm thinking about an actual example, um, because, you know, we have friends and, and people in the industry and one particular one I was pretty surprised about is, um, a group of guys got together to do a syndication for a new build.

Axel M: Pretty good size. I think 200. About, don't quote me on the number exactly, but something like 200 unit apartment complex. And they had originally, when they started the, uh, syndicate, every indication that the bank would do the financing, so they bought, bought the land, they got the permits, they got the, you know, all the utility and whatever per permission [00:06:00] stuff and layouts and so forth.

Axel M: And then, and they had investors, you know, so the, that. Limited partner money collection part worked, but then they went to the bank and obviously all that took a while. You know, you're not just turn on your syndicate and then tomorrow you have everything ready. So by the time they were actually ready, um, the bank was hesitant to land.

Axel M: Would that be a scenario where you would be coming in and potentially helping out or is that too far of a stretch? 

David: There's a couple of different scenarios. First of all, if you're a developer and trying to go in and get a loan for banks today, and look, I've dealt with banks for years. They're great. The challenge is right now they are completely constrained.

David: Because the interest rate went higher, they have to pay that on the people that put deposits in there, and they're not getting payoffs right now. And so they're in this liquidity [00:07:00] crunch. So if you're trying to go get a loan from a bank right now, they're gonna mandate that you put in 10 to 20% of the loan amount and deposits in the bank.

David: That's a pretty big hurdle. And not to mention that they're not going to lend you anywhere close to what they would just because the underwriting's not the same. Henceforth, why we love the private. Debt markets because it allows for more flexibility. You don't have the regulatory environment that you need to, and obviously we still underwrite with as much strength and mitigating risk.

David: We just don't have the same amount of red tape of things that really are non-essentials to make sure that an investment is appropriately done. And so it is a great environment and opportunity for all developers right now to use someone like our particular product, which again goes stretch senior end.

David: We participate because it allows them not to have as to raise as much equity and they don't have to give as much up as well and [00:08:00] have it in one central place. So that affords them the expeditious nature and the centrality of it. 

Axel M: Yeah, that's very cool. And, and, you know, maybe I should make a connection.

Axel M: The other thing that I'm wondering is you mentioned three years, which to me, in my little brain not being an expert on multifamily sounds like, okay, that's about the time period from the moment that you have either strong indication or already permit in hand for a developer to actually finish, unless it's a monster, um, deal that you want to do.

Axel M: Compared to something where if you do multifamily, I know there's a long, uh, a strong demand, but I also know of quite a few locations where if you really want to make money at the end of construction without any kind of stabilization period, um, it's tricky because even for rents, it's not so [00:09:00] easy to qualify the people anymore.

Axel M: Right. For a new build, I mean, if you renovate something existing, it's probably a little easier. But I think on a new build construction in like, um, even in a semi metropolitan area, the rents are at pretty, pretty tricky levels for people to afford them on a new build. Right. So I'm just wondering, when you say three years, is that the maximum you would go?

Axel M: Or do you, can you go longer? 

David: Yeah, it's a great question. I would say coming out of the gate is three year notes. And the reason we do that is because we're really a bridge or a short term. Lender. We're not a long-term lender for developers in the community. With that in mind, we feel like a partner with them, even though we're not in their limited partnership, or even in their general partnership, we're truly their lender.

David: So there is an option to extend, which we have full rights to decide whether that happens or not, [00:10:00] and if we don't feel like it's at the optimal time to sell. Then it's more than likely that we're gonna extend that loan out another year just to give the appropriate time. So for example, if we would've done a loan back in, you know, call it 2019, I.

David: And it was for three years and we got up to that time period, chances are we probably would've extended it or tried to figure something else out just because it wouldn't have been the optimal time because interest rates went higher, which means cap rates started to go higher. There was just a fundamental issue in the economy to where it wasn't the optimal time to sell.

David: We do put that in there from an investor's perspective to protect them, to say, Hey, look, we, we have a, a fuse, and so you need to work diligently to get this leased up and get us taken out. And they have the incentive to do so as well, but we do have that ability to extend. 

Axel M: Yeah. Well, I'm also asking the question because that might be a distinction [00:11:00] between a developer and a syndicator, because at least the syndicators I know in this space.

Axel M: I believe rightfully so, argue that there's a higher value when you can say you have like a 98% occupancy, all said that everything is there. Not only build the thing and now you have to turn it over to somebody else who wants to actually operate it. But if you think, you know, realistically to build, it takes two and a half, three years where it typically takes at least another year to get it even, you know, everything being assumed perfect until you have it fully rent, fully rented.

Axel M: You have the full rent roll with some proof and all that, which is, if you know, again, not the expert, but that's basically what makes the the price right. And if, if you just finished it and you have no rent roll, you can do speculate. The value, but you don't have proof, you know. 

David: Well, and a couple of things, I agree with you.

David: Here's a few things to notate. One, we do five to 15 million. So if you start doing the math, we're, we're dealing with things, especially apartments [00:12:00] that might be, you know, 20, 30. Maybe 40 units tops. Okay. Depends on where it is so you're not having the same, uh, abundance of lease up that you would naturally have if you're doing a hundred or 150 unit apartment complex.

David: That is just a lot more lease up that takes place. So here we're dealing with projects that might be a little bit more truncated, a little smaller and quicker lease up. The second thing is. We don't really get involved until someone is literally ready or has pulled their permits so they're ready. They have their budget, they've got their hard bids, they're ready to go.

David: They've got their GC contract in place, and so now they're in a position where they're actually going to pull the trigger right out of the gate, deploy their capital, and start doing. So you figure it might take someone in our space because of the size, you know, call it. 10 to 12 months to build the facility.

David: They're probably gonna do a little bit of pre-leasing prior to that, but [00:13:00] you know, realistically, let's say it hit the ground in month 12. Chances are they probably takes them a year to lease it up. And so now they have a full additional year of time to, you know, get it stabilized, have some history, and have a permanent lender be able to come in and then obviously have plenty of time to be able to sell.

David: That's generally our thesis on it. Again. Does it always work like that? No. Uh, some of that depends on the economic cycle, but we think three years is at least a, a general talking point. 

Axel M: Yeah. That's very good. And, and that's a really super important distinction because, you know, the friend that I was talking about, I think it the total is 180 or 200 units.

Axel M: Yeah. Right. And the other thing that makes me chuckle, um, like I mentioned before we started recording, I live for a while in Santa Barbara and the businesses now in San Diego. Um. There's not even a chance in hell that you get a permit even for a 20 unit in three years. 

David: No [00:14:00] way. 

Axel M: So, 

David: so no way. You know, 

Axel M: like if you wouldn't, you would have to wait for the permit, for the environmental, for everything literally to be absolutely buttoned up before you can actually get going.

Axel M: Even on the 20 unit, let alone anything a hundred, you know? So 

David: yeah, we don't, we don't take on entitlement risk when someone's gonna. You know, buy that piece of land and go through all of the headache and nightmare, especially if you're trying to do California or anywhere else for that matter. 

Axel M: Yeah. And it's not their fault, right?

Axel M: I mean, we both have to acknowledge it's not the the developer's fault, it's just all the rules and all that other stuff and you know, so, okay, cool. Yeah, that makes a lot of sense. Now, we touched on a few things. We talked, talked about the size, we talked about comparison to syndication developers and so forth.

Axel M: Um. If you were to put in, in your own words a little bit, what is kind of like the, the unique selling proposition compared to similar products in the marketplace? [00:15:00] Some of which we touched on, where you would say, yeah, but you have to consider this, this, and this, and that's why for certain kind of people that have certain intentions, that's the perfect product.

Axel M: Can you describe that a little bit? 

David: Yeah. I'll speak on two fronts. One is gonna be. Perfect product with respect to the end user, meaning the borrower, and then I'll go ahead and touch upon a perfect product for the investor coming into the pool. 

Axel M: Yeah, right. 

David: The first one is, if I'm a developer, I walk into the bank, I'm gonna have to put a lot more money down and I'm gonna have to jump through a ton of hoops.

David: So that developer who's willing to do that, that's great. But for most of them, or a lot of them, especially right now. They might not be in a position of being able to have that much equity to in infuse, and so that's probably an option that's not optimal. They could then also go to a private money lender.

David: Well, if they do that, [00:16:00] they're still gonna have to put a reasonable amount down. They might get it done quicker and not have the same hurdles, but they're still gonna pay a higher coupon. On the loan themselves upfront. So for our product, what we love about it is, number one, we're gonna go higher. So maybe the bank says, Hey, we're gonna do 50, 55, maybe 60.

David: We're gonna lend 75, 80, 85, potentially 90%. So a lot more on the capital stack, which means less equity they have to put down, right? So that developer that says, Hey, I wanna preserve equity and I don't wanna put that much down. And the second thing is we're gonna charge a 7.5 to 8% rate, which in today's environment, the bank's probably pretty close to that anyways.

David: Yes. The private money lender, quite frankly, is gonna be higher. They're probably nine, 10, 11%. And so we're now in a position to say not only are we gonna go higher, it's a fixed rate. [00:17:00] And it's a a great option for them to be able to utilize that as an instrument for them to get the deal over the finish line.

David: That's the reason why people come to us and they don't have to try to toggle between. I tied the deal up. I'm running to get equity, I'm running to get debt. How do I keep those all together at the same time? It's very, very stressful for the developer to try to manage all those pieces, let alone everything else they have to do.

David: So that's the probably the perfect situation. And the other thing I would say as well, axle, is that the people we work with, they're seasoned. They know their craft, they know their backyard. They're very sharp. They have had to have gone full cycle at least two to three times, and they have to have a net worth that's equivalent to the loan amount and liquidity that's 10 to 15%.

David: So we're pretty picky about the developer knowing their craft, but if we do, that's great for them. So I'd say that's the first strand of the ideal [00:18:00] optimal situation for the target audience, for the investor. Why this is such a great thing is look, if they go to private credit, you hear this word private credit, it really blankets a huge area of credit cards.

David: Or business loans. And so there's this strand of private credit, which is private credit, commercial real estate. What we love about it is we're getting a first deed of trust against the asset. Okay? If somebody goes into just a private equity deal, which is fine, they're in a pool of equity investors, but there's really no security.

David: It's just you're in a pool. If the equity gets lost, which happened a ton through, call it 2022 to 2024, a lot of people lost the equity. That's gone. In our situation, if things go haywire, we can foreclose on the asset. We, we have tangible rights to that, to be able to get that asset back and at least preserve what was in there originally.

David: So that's the first thing we love about it, is [00:19:00] you actually have an instrument that has a deed of trust against physical, hard real estate. And then the other part that we love too is you're getting an ongoing coupon. Out of the gate. Plus you're not just getting the coupon, but you get to participate in the upside as if it was equity, even though it's not.

David: But it has an equity feel because we're getting 30 to 35% of the upside. So the investor gets security, they get the downside because we underwrite things really tight. They also get the ongoing income, plus they get that kicker on the backside that lifts their returns at the very same time. And so it's this, it's this instrument that's very nichey.

David: It's very unique and I think it affords someone the ability to say, we're lowering the risk, we're getting ongoing returns, and we really get the benefit of that upside pop. 

Axel M: Yeah. Very good. Very nice explanation. David. Um, [00:20:00] I'm also assuming, I, I'm basically sure that you have a draw schedule, right? Like even if you say, okay, we, we willing to finance, but on a draw schedule, so with a, with a deed, if for some reason something happens and halfway through construction, the GC falls even with best due diligence.

Axel M: You only out the money that was actually spent minus the down payment, I'm assuming. Right? So you should actually almost always be on the safe side for your investors. Um, you know, that's at least, is that about a fair description? 

David: Absolutely Axel and what we do, we have a whole due diligence list that we walk through.

David: It's very comprehensive and we make sure that we've dealt with the borrower in their background, their financial strength, and making sure that there there's no fundamental issues in their past, and if so, that we've addressed them and feel comfortable with them. We deal with the asset itself, meaning that we're looking at the location, [00:21:00] demographics, geography, rents, comps of sales.

David: We wanna know that that's a great piece of real estate, that if we ever really did have to take it back, that we're comfortable. With our position in it that we know that we're okay to get out of it as well. When it comes to construction, we're very tight about making sure that we know the contractor, their background, their finances, that they have, the bonding appropriately as well, and that when we're looking at their budget, that we've scrubbed the budget.

David: We came up with our final budget and made sure that we're not gonna run into an issue where there was an expense overrun, that there's enough contingency in the budget, all those things that we do to make sure that everything has been dotted and checked off, so that Lord willing, if we ever had to take it back, that we're already in a position with our, uh, backups to just step in, finish the project off.

David: That's why we have completion [00:22:00] guarantees and bonding, and that we could just finish the project off, take over it, work it out, lease it up, and sell it ourselves. So again, all those are part of the experience of, you know, 21 plus years, as well as making sure, you know, each one of these gray hairs has a story.

David: So I see that's why when, when we look at a project, I can see already. Hey, this is probably going to be an issue and we need to deal with it. So we get to mitigate each one of the risks through the process so that we feel comfortable, which therefore means the investors confident as well. Right, 

Axel M: right.

Axel M: Well, I mean, I was just asking that question mainly because I was like, a little while ago, had nothing to do with, uh, our upcoming interview. I was thinking, okay, if I were in, in construction. Some guy comes around and says, the main source of my lumber is gonna become the 51st state of the country. You know, then [00:23:00] how do you mitigate that?

Axel M: So, I mean, there are certain things you can think about inflation, and maybe you can nowadays think about COVID, but there are some stuff where even the, the best preparation seems to be really tricky. Or, I mean, with all this stuff, right? Like I, I remember that it was easy. For six to $800 to get an appliance in a kitchen, you know, and then you got terrorists and inflation and all that kind of stuff.

Axel M: Now, if it's gradual, that's one thing, and I think you can kind of plan for it if it's like. One day you have April Fool Day, and the next day you have Liberation Day. What do you do? Yeah. You all of a sudden 

David: the, you know, COVID just happened or you know, there's a major catastrophic thing which can happen.

David: Yeah. Is that's why you have to think through those things. Obviously have a process and a system, but to your point, there are just some things you go, okay, that w we did not see that henceforth. [00:24:00] You have to be prepared to say, what, what are the primary, secondary, even tertiary things that you're doing to think through risk, because some of those things are uncontrollables, you know, nobody.

David: Yeah. I mean, I, 

Axel M: I don't, just, like I said before, I don't think you can. Expect any GC to know any of those kind of semi political things, you know, so, yeah. Okay. But the last thing, and I want to just ask this because I've been looking into this in our part, as we mentioned before we started recording, we are more on the non-commercial traditional residential side, but we also recognizing in a similar vein, like you keep pointing to that, um, built to rent.

Axel M: Um, is probably the longer term future since we try to help our clients to build legacy, right? So if you really never have the stated intention. Like you said, three years, right? Like in our case, we don't really have a stated intention to sell the property. If we did all the [00:25:00] things right upfront, we bought it.

Axel M: Now if you say, okay, I want to keep this as a legacy in my family, I want to keep it for a hundred years. It's better to buy one that's brand new than one that's 50 years old, right? So, um, but what, what that triggered to me is that we have a few partners who do build to rent, but in phases. And I was wondering.

Axel M: If that would also apply to your model where somebody says, okay, I'm a gc. I'm trying to cater and, and cover everything, and I want to do this 20 unit thing, like 10 in 10 maybe. And we get this done with David Carter's organization. And when that's done two years down the road, we start phase two and then we start phase three and so forth.

Axel M: And you know, ultimately 10 years later you have like three or four phases completed and you do it, keep doing the same thing, and you just, instead of doing these huge projects with 200. Units all at once. Is that a realistic game plan or 

David: Yeah, the short answer is yes. To follow up on that, I'm a [00:26:00] big fan of BTR, which is Build the rent.

Axel M: Yeah, 

David: I think it's, it's newer and so there's a lot of larger institutions that are still trying to get their arms around it. 'cause there's just not a lot of history. And I agree with you that newer is better. The one question everybody is scratching their head When you underwrite A BTR project, most people can run it at about 25 ish, maybe 30% expense ratio.

David: I. Everybody's wondering what's gonna happen in seven to 10 years when you've got more breakdowns of the HVAC units and you know there's more maintenance and things of that magnitude. What's that gonna look like? You know, from an underwriting perspective. But I would say we absolutely like BTR and I would tell you, you have a tenant that's going to probably be better in the sense of, you know, maybe you have a family.

David: They're gonna treat the home probably better and stay longer. And so that just means less [00:27:00] churn that we have seen historically. Rents tend to be higher by about anywhere from 10 to 20%, depending on the jurisdiction. And so I think BTR is great and you can individually plot it to your point. You can do blocks of 'em at a time and then you can roll it.

David: And so we love that because it gives the flexibility to where you could, you know, if you need to sell. Some down the road, you can do that, not have to sell the whole subdivision. So I'm a big fan. 

Axel M: Yeah. Actually, I mean, from a lender perspective, you know, I, I still remember the times when we have the seven plus one, right?

Axel M: That would be kinda, I've, I'm always fantasizing about what kind of new products could I come up with, like, you know, get with the seven plus one, do the BTR, and when the loan is the one year away from, from basically resetting. Offer the whole place or individual parts of the place for um, these to own.

David: Absolutely. [00:28:00] Because 

Axel M: then you have a eight maximum 8-year-old house, which is basically like a new house. It's a huge incentive. It keeps down payments low and you never have to deal with the question of what happens with a 10-year-old hvac. So, 

David: and I think you also axle to your point, which I think is great, you have.

David: An opportunity to address the affordability issue if you're allowing somebody over a period of time, even to, you know, migrate themselves into a home, I think that's a great idea. 

Axel M: Yeah, and I think, and you know, you're basically taking off the fed off the top right in this concept would be to say, okay, the first seven years I'm taking advantage of getting all these benefits that you just mentioned about your better tenants, brand new house, almost no repairs, limited reserves that you need to build.

Axel M: And then when you say, okay, I don't want to wait until year 10 when this start, start stuff starts. A couple years beforehand, I make an offer that a lot of people would be interested in because they would [00:29:00] already own a house if they could afford the down payment. Right. So those kind of combining things for different beneficiaries, so to speak.

Axel M: That's Oh yeah. People have told me. Yeah, it's a great idea. It's a little complex. I always say I like complex. 

David: Sure. Come jump on with us. 

Axel M: Yeah, right, exactly. I should, I'm just not a developer. So David, now. You basically watered our mouth, uh, for like, what, 35 minutes? Tell people how they can get in touch with you.

David: Absolutely. So Hybrid Debt Fund is the name of the company. You can go to www.hybriddebtfund.com or you can reach out to me. Specifically at Dave dot Kotter, and that is K-O-T-T-E-R as we were just talking about@hybriddebtfund.com. Or people can call me at (602) 367-8795 to learn more about investing. 

Axel M: Very good.

Axel M: Thank you so much. And [00:30:00] all that information is gonna be in the show notes for anybody who is. Currently driving ourselves, drive safe and don't write all this down. We put it in the show. 

David: Absolutely. 

Axel M: Okay, cool. Well, um, thank you so much again. Before we close, I always ask one or two questions at the end, unrelated to investing and uh, I would like to ask you if you could meet anybody that are alive, who would it be and why?

David: Oh, that's a great question. I would say for me in today's environment, probably Chris Botie. Uh, Chris Botie is a, uh, jazz musician and I'm a huge jazz fan. Okay. And so I've gone to a couple of his concerts and I just. I'd love to shake his hand because every time I go I'm just like, wow, this guy's incredible.

David: So Chris Botie for sure. 

Axel M: Okay, very cool. And that's definitely a little bit less usual, I think, uh, selection because there's a certain number of people that a lot of [00:31:00] people pick. So I'm glad that you had somebody special. David, thank you so much for making the time. It was made fun and maybe we can do it again at some point.

David: I would enjoy it. Thank you so much, Axel. It was a pleasure.