Carson Faris On Maximizing The Rewards Of Commercial Notes

December 24, 2020




GDNI 32 | Commercial Notes


Commercial notes can be truly rewarding and worth the shot, but only if the investor knows the right strategies to use. Without proper planning, such notes may only go to waste. Chris Seveney and Jamie Bateman go deep into this topic with Carson Faris, the Founder and CEO of Phoenix Investment Funds. Together, they discuss the specific asset classes to target, the best timeline to follow when dealing with commercial notes, taking advantage of performing and non-performing spaces, and a lot more. Carson also shares his own strategies when it comes to commercial notes, as well as some tips on the ups and downs of the industry.

Listen to the podcast here:

Carson Faris On Maximizing The Rewards Of Commercial Notes

We have a special guest. We have Carson Faris who is the Founder and CEO of Phoenix Investment Funds. Phoenix is a firm that specializes in the acquisition repossession of debt secured by commercial real estate. In the past, we’ve been wanting to have people come on to talk about that commercial space. Carson has been in the space for many years and Phoenix has been around since 2014. Carson, how are you?

I’m doing fantastic. Thank you. How are you doing?

I’m good. We were talking a little bit about how our day was going and I was talking about a crazy foreclosure sale that we had and stuff which shows about procrastination stuff. We don’t need to dive into that. It will be something I will dive into in another episode from that perspective. Carson, why don’t you tell us a little bit more about yourself and what Phoenix does.

Chris, let me ask a quick question. How far back do you want me to go?

Why don’t you start with how you started Phoenix? What got you interested in the goals from Phoenix, and fast forward from how you started to where you’re at, and where you think you’re going to be in the next twelve months? Right then and there, that’s going to take up this entire show because I’ve already got about ten questions backlogged in my head. Why don’t we go from there?

After a lot of years of working in the commercial real estate space, I was a retail developer and I had a national development manager for a larger retail firm. In general, we were operating in about thirteen different states and we did a lot of shopping centers. On average, we would be rotating about 4 million square feet which equates to hundreds and potentially thousands of small shop tenants to large targets house tenants. Our goal in that company was to purchase properties that we knew we could turn around, and have a lot of tenant relationships that we could put in there and help them roll out. It was a good journey. I started there in 2006 and we were on a big growth path at that point. The company continued to grow and double. I got to learn and have a lot of roles in that firm.

In around 2009, when the whole world had a conundrum, we had a large portfolio. We were knee-deep in about four projects. We’re in the $100 million to $300 million range each and heavy in debt. As part of those, the world shuts down. The bank started acting funny. I had a great experience of learning banking internally on the borrower side. Our relationships with a lot of those lenders during that time, we got our books cleaned or worked through and the relationship is built. We found ourselves getting a lot of calls or at least I would get calls from the people I’ve talked to. They are like, “What do you think about this deal? What do you think about these guys?”

All of a sudden, it turned into me learning how the bank was looking at these deals, what they needed, and what they were trying to accomplish. I found that interesting. I left that firm that I was working with and started Western Bay Group in about 2013. Western Bay Group was an independent development company outside of my old firm. I did some deals there, but I found my eyes wandering notes again. I had a friend and all he did was invest in notes on a very complicated, smaller transactions.

I was a partner there but as I would lean into the projects and analyze the commercial real estate aspect, what it could be, where it could go, and how you build it, I discovered that we’re able to expedite the timing associated with his deals and also improve the returns substantially by shoring up the business plan as it relates to the commercial side, knowing what to do with it, how to do it cheaply and efficiently. As everyone in notes knows, time is the number 1 or 2 factor. Get yourself a good basis and make sure you understand the timelines.

After doing 3 or 4 deals with that company on the side, I was asked to come in as 50% owner and combined some of my skillsets with that note platform. That started going fast. It grew quickly. Our capital relationships were blended in from my old world. I was able to translate the end game of a retail property through the note process and educated myself in the details. I started from the bottom again and went all the way to the top to get a horizon picture of what the scenarios would be in the events that you could get hurt. Also, the number one thing to realize is don’t lose money. That takes a lot of precautions, understandings, and building yourself a good team. Hopefully, a good outsource team. Bringing in all the labor when you don’t know necessarily when notes will come isn’t always the best move, just a free tip.

Phoenix did about 40 transactions at a time. We’re located in Newport Beach, California. That was rotating through the years until the distress started to wind down, the deals were stretching, and the pricing got too high. We had multiple funds open at that time. We had a blind fund model. It’s a rare one to be able to accomplish because you write general perspectives, aim at what you’re going for, the partners fund blind and you have total election and choice on that capital. You are paying for the use of their capital from the time they sign on. You have a cash drag issue or another way to put it is you have to transact quickly enough to make sure that that preferred return to investors does not eat up your overall return for all the work that you’ve done. There are a lot of learning lessons in that how to stage that and set that up.

We did about $200 million in transactions over the last 4 or 5 years. Most of that in those first three. The rest of it was fixing the things, finishing them all out and selling them off. As I sit here, I’ve wound down that entire portfolio. A few assets are kept in a company but for the most part, we’ve all transacted, moved out, sold, refi-ed or whatever they needed to do. I went into the environmental space for a while. It’s an expertise that we have. To get into that profile, I’ve been to different podcasts, but now it’s back. Defaults are up. I’m tracking the forbearance and defaults by state. They’re rising long-term, 90-plus days are increasing. It’s a little bit more difficult in the space that I play on larger transactions.

Where the people are getting hit, this might be valuable to your audience, is in the smaller community bank world and smaller regional bank world, they don’t have a special asset department which is the department that works on this stuff normally. They generally don’t have the sophistication to deal with what goes into the commercial process. They’ve never even sold the note before a lot of the time. This is an interesting time for people looking for a smaller size deal. In commercial, that can mean $300,000 to $2 million or something like that in terms of a note purchase depending on where you live. There’s going to be a lot of that coming up with not a lot of resource.

I’m a little bit more focused on the larger transactions. We try to stay under the big institutions. We’re aimed in 2021 for that $5 million to $25 million mark. We’ll do smaller ones if we need to. The volume of deals when they’re smaller can take up all of your capacity. At this stage, with where the market is, I’m a little bit more focused on waiting for opportunities that are genuinely worth our time and then executing on those business plans very efficiently. My experience has shown me doing less well provides a much better return from all than doing a lot of deals well.

You mentioned distress coming to pipe. Is your focus going to be on one asset class, whether it’s office or retail? You mentioned you’ve got a strong retail background. I know office is struggling. A lot of retail is struggling especially food service. Multifamily in some locations are struggling as well or is going to struggle. Is there a specific asset class that you’re looking to target or is it more opportunity based on location, deal, what the metrics and numbers fall into?

I would say it’s a little bit of a mesh. There are certain things that we look to avoid and that changes as the market changes. For example, I don’t care what deal it is. I’m not doing business in New York, Chicago or New Jersey. We moved down a lot in Phoenix. The legal system there is frozen. I have a deal where the person is not paying their mortgage in eleven years. I’ve spent $400,000-plus just in legal in the last few years. Right before we were finally able to get them out, two days, we had the COVID restriction came on. They can’t get evicted and I have to start everything all over again. There are certain places where we found it inefficient to work and be able to reliably get information on timing that we don’t.

To answer your direct question, we are focused on three main areas which are going to be industrial. It’s a hot market but that’s where you’re going to find your owner users. That’s a great category if you can find them. You can help people out. You can work with them. They usually have a story. They know they’re building their business. There are a lot of options with those folks. Be very aware if it’s going to be an SBA loan because that gets much more complicated. Overall, those are good interesting places to play. In retail, it’s going to be a cluster, but that is a place we’re going to look and be very careful. There will be a lot of stuff coming out in there.

GDNI 32 | Commercial Notes

Commercial Notes: Doing fewer deals provides a much better return than doing a lot of them.


The third one is multifamily. That’s going to be tough to find. You’ll find some small stuff. I see it all the time, but it’s the people who believe that they’re no longer supposed to be paying rent. What they do and what your legal rights are to remedy that? Do you have the capacity for the holding cost on that? Overall in the marketplace, I’ll look at stuff, no matter what it is because it’s a relationship business. I’m sure yours is, but if a lender has some issue on a property, and they need to get it off so that they look great in committee or it’s important to their bank. If we have a relationship with them, we’ll look at it and we’ll see if we can solve it with them and for them.

We try and do that. That’s where our business is aimed. It’s not even so much on the assets. We know we can take that without looking at them and what we want. It’s a relationship-based business where it takes a long time to build and establish relationships with special servicers, lenders, attorneys or whoever it is that is someone’s main focus of deal source. We help them in their job and help them to succeed because they are going to have a heck of a job in front of them over the next two years.

Carson, I was curious if you could try to highlight some of the differences between the space that you play in, and more of the residential space depending on your experience there. Obviously, that might be 2 to 3 more zeros in the transaction. How might the timeline or the pieces that are moving compared to your typical single-family distressed note that someone is trying to turn around and resell or exit through the property. What are some of the key differences there?

One of the first things were people that get used to the laws. The Homeowner Protection Act and such related to residentials are not in place for a commercial. On the other side of that fence, commercial people like to say, “It’s a big boy’s game.” They don’t mean that in a derogatory sense. What they mean is you have to watch absolutely everything. Pretend it’s an entity in Delaware. What it says is what it is. You have to protect yourself much more because in the residential side, there are so many forms and natural protections. What has to go for a consumer and the lender has to quantify and live with by the time they’ve originated that note. Residential investors are generally much safer in what they’re buying is going to be a real first trustee, and there’s not a lot of hair on it. It’s home. There are a lot fewer parties involved.

On commercial, that document can say anything. If you don’t know what you’re doing, you can give away a lot of rights or they’re not going to stipulate to a lot of the conditions that you were used to automatically in residential. You could find out the next day that they don’t have the paper note. The courts aren’t going to allow that mortgage to be live unless you can show up with a paper note. The bank is like, “Sorry, you signed it. Commercial big boy rule.” I’ve seen almost all of it in one way or another. You got to watch yourself a lot more.

Another thing to keep in mind is there are a lot fewer commercial properties than there are residential properties. The volume, size and skills that it takes to unload one. In this market especially, if you are in a commercial space, you need to know that there’s a tenant or someone that can use it. With what’s going on in the business environment, that can be a little tricky. The depth of knowledge to feel confident in that and know what the pricing is deep. The two main sources for that in commercial are LoopNet and CoStar. LoopNet is a little bit more free. CoStar is quite expensive but it houses a lot of data. Now, LoopNet is owned by CoStar. It’s the mergers world.

That’s one thing to take in mind and borrowers are a lot more sophisticated in commercial. They’re going to do strategic bankruptcies on the last day. They’re going to file lawsuits that are somewhat frivolous because they know that there’s a lot of guys that do this all the time. They do it to know exactly where the pain points are and how to utilize the legal system. It’s not in a moral or a good way, but they’re working the system. No judgment on anybody, but they’re more apt to do that.

In residential, you’re tending to deal with the homeowner and this is hopefully, the first and only time that they have to go through this. You guys can work something out a little bit more simply without having to have so much strategy in mind before you ever talked to them and a lot of things in place. Legal is much more expensive in commercial. You have to review a lot more documents depending on the asset. You’re also bound by the existing leases and agreements if the lender did an SNDA, which is a big thing in commercial.

An SNDA is an agreement between the lender and a major tenant within a commercial building. It says that in the event that there’s a foreclosure, we’re going to honor your lease or your agreements. If they have that, normally when you foreclose, you can wipe all leases and you get a fresh start. If you’re having a subordination agreement between the parties, there’s nothing you can do. You’re stuck with that document and property. Some people miss that. They think they’re going to do all these things and they realize the property is stuck for ten years. You have to go through a whole another court to deal with the tenant issue.

In some instances, it could be vice versa where a default could also give the tenant an out potentially from their lease for early termination as well. That’s something else to keep in mind because you may think, “I’m picking this up. There is an anchor tenant in this location.” Let’s say it’s a CVS and there’s no drive-through. They want a drive through. They’re looking to strike a deal two blocks down the street or something. That happens and they get them out. You’ve got to be very careful banking on your numbers.

Understanding timelines and having a good grasp of finances are the two main factors in the notes industry. Click To Tweet

That hits home too that what people should realize is you’re dealing with an entity versus a homeowner. They’re going to have much deeper pockets, more sophisticated, and they’re going to have a lineup of attorneys most likely, compared to what you deal with the homeowner. You’ve got to be a lot savvier and make sure from the team you put together, you put together an A-squad team that knows what they’re doing, especially on the commercial side of types of defaults. Would you agree, Carson?

I would. I found that there’s a great opportunity in notes that’s not available in development. That is developers are always shaving every dime and I know a guy that can do it for that. Banks don’t have any emotion in the real estate. If you put in your legal team, it’s going to be whatever, make up a number, depending on the deal, $10,000 to $250,000 or you have all of these assumptions that are market normal and make sense for the issue. You point out that the person could go into bankruptcy because that’s probable and here’s all the stuff that means with that. If you can articulate all of that, you can write down the acquisition price for that and share the information with the lender. In a non-emotional way, they will go, “That’s what it would cost us if they did that.”

It supports you in getting a better basis on your acquisition. Even having that team, it’s great to both make sure that you’ve underwritten appropriately so that you have the cash to deal with it. Also to utilize that team, make sure that you’re providing a great proposal to be able to purchase the asset and be realistic. Our job as note buyers, in theory, I can’t speak for you. One of my jobs is to look at all the things that might happen and then utilize all of our skills to try and eliminate them. I won’t know that until after I bought it. I have to take a conservative approach on the acquisition and then a way to improve the deal is to fix things that otherwise will going to happen. How do we build that relationship?

I would say if somebody was going to make a transition between a housing buyer, residential note buyer, and commercial, a great place to start for what it’s worth is something that’s very similar. What’s very similar is a smaller owner user size deal or a smaller deal where the borrower is walking. It’s very clear that they’re walking so that’s great. I’m assuming that it’s the same thing but for the most part, you’re purchasing a note for one of several reasons. It’s a performing note and it provides you a yield. If you are able to get something at a lower cost to your pay off, then it improves your yield or you’re going to do a modification of some kind because the note isn’t feasible.

You’re going to go with the intent of getting a payoff. There’s a balloon payment there and you’re negotiating it down. Your business plan is waiting for time, and then you get this payoff. There are a lot of options. Lastly, it’s someone who’s willing to own the real estate or wants to own that real estate. The mechanisms that you use to evaluate whether it’s a good decision or not has to do with what you want. If you want to buy the building, a great thing to know is that the loan amount is greater than the current market value and replacement value of that real estate.

If the note is $2 million and you’ve got an appraisal that says the building is only worth $1.8 million and you have all this other stuff, you’re not going to underwrite to the UPB anymore or the Unpaid Principal Balance. You start with that collateral, and then you get to reverse that back. When you come into play, what you can do to be a godsend to the borrower is agree in exchange for their friendly foreclosure or their deed in lieu to forgive the difference. Everyone can walk away, which a large commercial bank may not do.

There’s a great advantage to those smaller deals and I think there’s going to be a lot more of them. Those are regional banks and community banks. You’re going to be looking for attorneys that serve them and special asset officers or people that deal with that in the banks. Some of the smaller banks don’t even have that. Community banks are going to be hit the hardest because they stretched the most and there is a lot of those. You can develop a relationship with one or several of those in your local area where you know the real estate and the people, and there’s an opportunity to have a note to review.

Do you all play in the performing space at all or strictly nonperforming?

There are different buckets. In my world, the buckets are you have regular bank direct deals. You have your auction deals which are the bank loans that go through Debt X, 10X, or one of those things that ends in X, or you have the hard money guys. That’s a deal that you can buy for yield. The hard money guys coupons are already written to 9% to 14%, and they have all this stuff. They’re the first ones out usually. There is an opportunity to purchase a note for yield. A hard money lender’s UPB is different than a bank’s UPB. I mean that in the way that each of those groups thinks about it. A bank’s UPB, even if it’s got an accrued interest of $100,000, it’s going to be what the UPB was. That’s how it’s on the books.

For hard money or private lender, their UPB means total payoff with all of your stuff in there. The difficult part about those guys is you might get more yield, but you’re not sure that you’re ever going to get all of this stuff above UPB. The bid-ask spread which is how much people are willing to pay for what they’re selling it for has been large for the last year. It’s starting to get close. I would say by the first quarter, it will be aligned at least for certain deals. The transactions will start coming out. Lenders have been writing down quarter-over-quarter. They’re starting to release assets in early 2021 through the first half of the year.

We’ve seen the same thing on the residential side. There were 2 or 3 months where it was almost a standstill. There’s no agreement between pricing expectations between the buyers and sellers. It seems like it’s picked up a little bit. Chris was out there buying all kinds of non-performers anyway, but I do think it’s going to open up on the residential side as well. You mentioned a few states you stay out of. Are there a few states that you are targeting in particular or not so much?

GDNI 32 | Commercial Notes

Commercial Notes: If you want to buy a building, remember that the loan amount is greater than the current market value and replacement value of that real estate.


It changes a lot. The West Coast is easier for us but we have some challenges there. Arizona is great. Here’s what you track and it changes. It’s hard to answer because it changed for me. Depending on the situation, I track how is the legal system there and how confident are we on the track to get to a fee. If you can establish that even if they go bankrupt because of the situation, at least it has the probability for that. That would mean that there is subjectively equity available in the building, then there’s at least an option to go bankrupt. If not, they go BK. They’re going to give you relief from stay anyway, but it still might add 1 or 2 months or whatever it is.

For places where you go BK in that court might be two months. Knowing the legal timeline and environmental liabilities are important. In California and a lot of states, if you end up with something and it happens to have dirty dirt, you are fully responsible for that. They’re going to come after you and your investment, and that’s not great. Arizona has a not your fault, not your issue way about them. Depending on what you’re buying, that’s important.

Where are the people now? Are they leaving? Are they coming? What type of businesses is there? How are they going to get through this recovery? I live in the strangest state that I can think of. California is wobbling all over the place between all the laws on what’s going on here and there, and pricing expectations. We have a very unique taxing system which is constantly trying to be modified, which makes the investment a little bit scarier. The last thing I’ll mention is, because we could go on for this, what’s the income tax?

I don’t know how your investors do things. We set up SPEs or Special Purpose Entities for each acquisition that we do. We try and have offices in the states that we’re doing a lot of business because there’s no need for people that aren’t here. If we ran everything through California and our partner and the deal in Florida that our office in Florida is handling it, California has got a 13% income tax. It’s 12.3% up to a certain height, then it goes up to 13.3%. If you have $100,000 in profit and you got to lose 12% to 13% of it for no reason, then that stinks. Look at those different qualities, but the court is number one. Everything else I can account for, but the timing of what it’s going to take to get there. Anything else, you can analyze and it’s somewhat within your control.

You talked about timing, speed and control. I’m curious and you mentioned hard money in 9% to 14%. On a typical deal, is there a certain type of yield that you look for on these types of deals that you pencil them out from a return’s perspective? On my nonperformance, I target a certain percentage of yield. It’s what I’ll bid based on a worst-case exit strategy. I was curious about how the commercial space numbers jive with the residential side. With a much larger number you’re working with, I’m guessing the overall yield was lower than a $50,000 note versus a $5 million note. I was curious, what you typically target or your ballpark range?

It has to do with which capital bucket it’s being grabbed from. If you’re grabbing it from a capital bucket where the thing about notes is they’re all cash transactions. You’re not financing them normally unless you’re inventorying it differently. You’re looking at that and you say, “What is the partners need?” Depending on the risk of that deal, let’s say your cost of capital is 10%. That’s what they need as a preferred return. If we want the company to work, we’re going to have to be able to look at a deal where you can’t absorb the expenses, you can’t have the fee, and then the partner is working in it. I try and get where the market goes from 80/20 splits, cash-to-sponsor, all the way to 50/50 is where it lands after you have a ton of experience.

The way that we manipulate that is we change the pref. The higher the risk, the higher the risk. If you can get a 20% annualized return, that’s good. That’s not the way it used to be. Some can be in the hundreds and some can take forever and not go anywhere. On average, if you can achieve 20%, that usually allows you to cover the cost of your capital and still have enough money meaningful that goes back to the sponsor and sponsorship group. That’s a nonperforming deal. On the hard money, semi-performing type of deals, you can do a lower one. In my experience, I’ve made a lot of mistakes for sure. One of the main mistakes that I’ve made is not taking into account the expertise that it takes to manage each particular deal, and the attention that each one of those deserves.

When we started doing 40 and I have certain people running things, there’s a wobble there. That wobble leads to much lower returns or they forgot that there were defaulted taxes that were taking up 18% by their local state or something. Until closing comes, your margins are slimmed down. If stuff goes wrong, my partners still make their pref. It’s important to protect capital. I want things to go smoothly so that the company also does well and we do well. I’d say 20% is a minimum threshold for smaller to mid-size deals.

When you get to large deals, it can be less but then we’re looking out forward. There’s a short-term hurdle of 10% cash-on-cash while we’re holding through an issue. A few years later, we might sink an extra million dollars into the thing to rehab it because the lease is almost up, and we’re taking more of a development mindset. When we do that, we can take a shorter return on the front knowing that our business plan is down the road.

There are a lot fewer commercial properties than there are residential properties. Click To Tweet

That answered the question perfectly from that perspective. I see this mistake happen a lot on the residential side. You mentioned the fund and the blind pools or the blind funds, which are what a lot of note investors will do. A lot of mistakes they do is they’ll go out and buy a pool of nonperforming without mixing any performing loans in there, and then get the clawbacks because they take time to buy it then board it. They’re all nonperforming, you had no money coming in the door. All of a sudden, they’ve got this pref that’s due that keeps accruing. I’ve seen it with several investors in our space that do that.

They’re not making any money for the first two years of the fund because they’re finally paying back the clawbacks and stuff. I’m glad you mentioned that when you brought that up about the velocity because that’s important strategy. The other one that I thought was interesting was you mentioned the type of use. In California, if it’s a gas station or a true dry cleaning facility that they have to do it on-site, your risk level in your due diligence has gone up significantly. I’m curious, do you have to do phase 1 or phase 2 environmentals as part of due diligence on any of these? Does it have some type of use that may have higher ramifications on it?

In California, you have to do them no matter what. If you do things appropriately, do your phase one, do your initial studies, you’re not held as responsible especially as a lender. We do them on absolutely everything. The two main reports are going to be your phase 1 and phase 2, whatever that is, and your PCR, Property Condition Report. Those give you the basics even though we don’t need them all the time, they’re helpful. As industrials got more popular, it’s not just gas stations and dry cleaners anymore. First of all, the regulatory standards have gotten to the point where if you do have some issue, it is physically impossible to clean the dirt in California. If you go outside into a park, that’s never been used. It fails.

There’s no way to get out of your cleanup. People who are smarter than me in this space are yelling at the senators, doing the things that they do, and work with the agencies. For the last few years, you have not been able to clean up a site especially about vapor intrusion and things related to dry cleaners. As industrials become more prominent, what happens is you’re going to have a phase one done, and it’s going to tell you that microchips or aerospace company, something has been there in the last 100 years that none of these rules applied for. That phase one is going to tell you that you recognize the environmental condition on the property is historical use, we recommend more testing.

If you were to do phase two, they’re going to tell you where it was. They’re going to tell you that you have to do hundreds of thousands of dollars in drilling or testing. There is a way of having the information that you need for your understanding and use, and then knowing the risk because the way that the system is set up, it’s not that easy to get a clean report in certain asset classes. For the most part, they’ve been used and utilized. In California at least, we have something called Geo Tracker. It will tell you if any state agency has any reporting on this particular site or if you’re in trouble. You can do Envirostore and that one to get a feel for, are the regulators going to be involved or is this something you’re doing for paperwork?

For our audience, a lot of them might be on the residential side of things. I want to explain that phase 1 and phase 2 are environmental studies that you do on the property to see if there are contaminants or what are the soil characterizations. We use the term dirty dirt, which is it’s got things in there that shouldn’t be or it’s above reportable limits. You may have to remediate and clean those out. I’ve done work up originally from the commercial world up in Boston and DC. You’ve got the other thing that throws a curveball in you, which is archeology because a lot of these sites might be historic. I was working on a site in Downtown Alexandria that they were pulling a boat that was a few hundred years old because of the way the shoreline moved out of the ground and stuff.

It’s cool, but the amount of money on a development that you can lose because archeology steps in literally with the little brushes and finding things out. There’s insurance for that, believe it or not. For our audience, phase 1 and phase 2, another thing that’s part of a commercial that you get to focus on is, what was the use and was there any type of contamination on that property over a span of time? There might not be the store there. It might have only been there twenty years, but you have to backtrack and make sure what was there prior to that as well.

GDNI 32 | Commercial Notes

Commercial Notes: Community banks are probably going to be hit the hardest because they’re stretched the most.


If you’re a residential person next to an industrial site or next to a retail site that used to have a dry cleaner, that spreads in a plume underneath. It can drastically change the value of your home. You might have a lawsuit on your hands, but you’re going to be spending years dealing with that. When evaluating even a house, I would take a look at what used to be there. Now, you can go back on Google Earth in whatever year, and see what used to be in place. It’s nothing that you need to worry about overly, but it doesn’t hurt to put that on your sniff test if anything used to be around there that could cause me a big issue.

I’m laughing because the house I live in now, we built it. When we were getting under agreement, we knew we going to knock the existing house down and build it. As part of the inspection, the lender required a home inspection. I said, “We’re going to get a boring rig in here. We want to do test borings because we’ve got a lot of soft clays in this area and stuff. I want to make sure it could support foundations and stuff for the house because we also have high water table.” The seller was like, “What are you talking about?” I was explaining to him I want to get a boring rig and started taking borings and stuff. It reminds me off in my head when you’re talking about the plumes on property. A lot of residential people sometimes a lot of stuff is new to them so you got to explain it.

I was curious if you have a favorite deal or worst deal that you wouldn’t mind talking about whether that’s with Phoenix or before that.

I can give you 30 seconds on the Brooklyn deal that I talked about earlier since I’d mentioned it. That was a note that was done appropriately but it was during the high times that everyone is pressing out loans. This particular borrower has chosen to come up with anything they can. One of the first lawsuits that took a couple of years to deal with was they had said that the party at the title company had forged the initials of the manager, and that wasn’t his signature and stamp. This is eleven years of legal. As a commercial property owner, you have to put the receiver in place. If you have a trustee when you get to that stage, but you have to pay the receiver every month which is not cheap to manage things by the court ruling. You have to cover the insurance. I’m supposed to be fixing it up and I’ve got to pay the taxes.

For eleven years, there’s no legal recourse for this deal. That is, by far, the longest one I’ve ever heard. They’ve gone BK now twice. They never changed the BK plan from the first one that got shut out. The court still has not dismissed it with prejudice, so they could even do it one more time. Be very aware of your borrower, their personality, and their traits as best as you’re able to. Look at their history if you can. That’s important. On a good deal, sometimes we’re able to save some companies and I liked that. There was a deal in California where a long-term family company, 100-plus years, had some financial challenges associated with their contracts with the government and whatever they were doing.

The lenders are coming down on them and it got bad. We looked at them. We liked them. We purchased their note for not a great price but we understood the building and what it could be. You have a choice to try and go down one road or the other. We met with these people and they were great. It’s like, “We have this giant contract and they’re not paying us. Here’s what’s going on.” We facilitated a side loan for them. They have a company that saved 64 local jobs there. Everyone got to stay. It got down to two days and payroll couldn’t be met. We floated until the government came in. We built a great relationship with them. California then continues to put more regulations on, so they then moved to North Dakota.

We ended up taking over the building at that point. We worked something out with them, purchased it and repurposed the building. They called me a year later and the government had been delayed. It’s hard if you’re in the Department of Defense world to get a building cleared. You have to build everything and have it there before they’ll even get an inspector and it can take a long time. They had a very similar situation. I had no relation whatsoever to this new thing but we met up, we found a solution for them and they’re great people. I got to know them and their family well. There are certain things about this job where there’s an intimate space created between a lender and borrower. You have an option to create an intimate space.

Chris, correct me if I’m wrong, but that’s why you called it the Good Deeds Note Investing Podcast. Trying to come up with these win-win scenarios is not always possible. You can’t control everything, but that is a feel-good story.

It’s similar in commercial. If the person wants to play ball, we try and play ball and work with them. We’re not heartless individuals. We have a fiduciary responsibility to our investors but in the same token, in many instances, keeping somebody in a deal a lot of times is also most lucrative. On a nonperforming asset to get it reperforming, get it right back to where it needs to be, and then turn around, flipping it later on down the lines. It’s a win-win for every party involved. It sounds like it is on the commercial side as well.

I pulled up a flyer from one of our last funds and the big thing on the bottom of it was, “Profitable investments make a positive difference.” In that quarter, we had turned a burnt down apartment in Northern California where there was nothing to do. We got that thing all fixed up. We took an old plating facility that was unusable. We have these great stories of turning stuff around. It’s possible to do it anywhere but in notes, there are none of the parties involved. It’s two individuals or groups trying to work something out. There’s a legal process but there’s a real opportunity to build relationships.

A lot of my borrowers or tenants that were in the buildings, I had one from years ago called me and told me that everything is going great. Their business plan succeeded this 2020 and they crushed it. He’s so excited and curious about what I’m up to. If there’s something we could work on together because the relationship is so deep when you’re in the trenches like that. I’ve been on both sides of the fence throughout my life. I didn’t grow up with money and things were tough a lot when I was young. I remember them shutting the water. I remember all of these things. I try and bring that into my business and take the human approach, and buy things that allow me to do good deeds when they’re available.

That being said, I will say this as one of the key rules. As nice as you want to be, which I’ve learned over time isn’t always great, take your legal actions immediately, and then be nice after it’s set up so you’re not waiting the 90 days. That was a lesson that took me a long time to learn early on. It worked out sometimes, but when the times that it didn’t, do I regret not making that small investment and taking those steps because I wanted to be nice. Be nice after it’s set up.

You could apply that to your newfound role as a father as well. I definitely agree with that. Do you ever play in the second space or is it strictly first? I know that second lien commercial notes exist.

I’ll buy any part of the stack. I’m generally in first, but the second has a lot of strategic advantages at times. Generally, it has a good coupon. It depends on who the lender is on the first. If it is Chase Bank, they’re not going to do it. They want their mortgage paid off. I can work with them. I can call them and say, “I’m foreclosing on my second.” It’s subject to their mortgage but that’s fine. That’s a great mortgage. That would save me a lot of time to go get it. Those ones are okay. I don’t play in them a ton only because the amount of equity in those deals tends to be tight. You never know what the first is going to do.

Banks don't have any emotion to real estate. Click To Tweet

A lot of the times, you’re not dealing with Chase or somebody like that because they don’t allow the second. I’ve had multiple circumstances as things have changed in the market where the deals are available as the 2nd and 1st because they never told their lender they got the second. There are a lot of seconds going on that we’re never notified. Now people started paying attention as the market tightened up and they are not happy. To be fair, some of those borrowers don’t read that stuff. Commercial documents are crazy long and they’re like, “I got plenty of equity. Why couldn’t I get a second?” It’s not how it works. To look at Chris’ face, he knows that’s not how it’s works.

I work for a commercial developer and we’ve been through many deals. There are things, especially now, where they’re monitoring your debt service. They’re looking at it. If you’re going below a certain debt service, they’re like, “You got to pitch in. You got to put more in the reserves.” The whole putting a second on, I’m laughing because I’ve seen that. People do that before and then they get caught and it’s like, “I didn’t know.” As you said, the documents are extremely thick and it’s not 30 days to get these types of loans. There’s a lot of underwriting and due diligence that’s involved in them. If you’ve ever seen a loan application for a commercial, it’s an interesting feat to complete one. It’s a completely different type of application compared to the rest.

There’s the initial application without the documents. It’s the app process. It’s real fun, but do you know who’s great if you ever have a chance to step up? It’s life insurance company. They’re great to work with. I’ve had a great experience with them.

Can you be more specific on how do you work with them?

GDNI 32 | Commercial Notes

Commercial Notes: Be aware of your borrower, particularly their personality and best traits.


In terms of getting financing, if you get to that level, life insurance company are great to work with. They have no post-closing covenant precedent a lot of times. In relation to a lot of banks that did track everything, it’s a lot of work. I don’t mean this to be true everywhere, but in a simple form. If you make your payments and you remain financially healthy, they let you manage your property and do your thing. You don’t need to go back and ask them a bunch. They’re like, “It still has its equity. It’s still good. You lost your big tenant. You’re going to keep paying us.” It minimizes a lot of the strain associated with the larger bank deals. For me, that works well. There’s a guy named Antonio Hachem at George Smith Partners. He’s the best in the business. If you ever have a chance to get a large commercial loan, the stuff they can do is unreal. I’ve been blessed to have them on our team over the years. Life insurance is a good deal.

If you were to give and you’ve given a lot of great information and feedback already, as we wrap up this episode. You talked about relationships, community banks and starting small. I’m guessing similar to a typical deal, due diligence is one of the number one priorities. A question I was going to ask was, I know you’re buying 30, 40 at a time or whatnot, but what is the transaction time to close a deal? Is it similar to the space on the residential where you put in an indicative bid, get it accepted, do the due diligence over a course of 3 to 4 weeks, and then close on the deal? How does that process work on the commercial side?

I can tell you my experience. Depending on what trench you play in, they all work a little different. I’ll say it’s unlike anything I’ve seen in regular real estate. The way that our relationships are working these days, the relationship is direct with the person at the bank. That’s the way we prefer it. You can do all the options and they have all those timelines that you discussed. A direct deal with a lender is, a lot of the work that we’re doing goes like this, “We got something. It’s interesting.” “Send me over what you have.” They’ll have a few documents. They look at it if they’re interested or not interested. They push that back. If we are interested, we’re going to have a list of questions and we’ll have a list of documents we’re asking them to get. They’ll send them to us again.

We’re trying to work through the process of finding a number and creating a range because the underwriting for commercial can get quite expensive and intense. We do a dance back and forth to see if we’re going to be in the range or the ballpark to get all those third-party reports, get the details and the things we want for real offer. Because of the amount of transactions we’ve likely done before, we do the process backwards from development. We get to a place where we go, “Let’s agree that this is an unknown and this is an expense. It’s going to be $1 million. That’s what we can do for it.” They’re going to take that in. They’re going to get that pre-approved by the board if we both find it reasonable or committee or whatever their process is. They’ll come back and go, “They’ll do that.”

If my email is saying $1 million, that’s a deal. After that’s done, they’ll kick that to legal and they’ll do their LPSA, which is the Loan Purchase and Sale Agreement. That’s going to be on a form that comes in and has a lot of stuff in it that you don’t like. In general, you can’t change any of it. It’s one of the risks of doing that deal. That closing time window is fast. On average back in the day, this whole process would have to be in 10 to 15 days because we’re dealing with emergency situations. You do have several weeks or a month in that initial process, but that email is saying we can do $1 million, that’s the handshake in commercial loans as the way we’ve done it. If we write it in an email that will do something, the legal stuff is going to come later, the clock starts ticking and we’re moving forward.

Jamie, any other questions? We could go on for hours.

I’m good. This has been good, Carson. I appreciate your time.

You’re welcome. I have a couple of things to look for if you’re going to start out, a couple of bullet points.

If you have any collateral, any marketing material or anything, feel free to send along.

Thanks. The number one thing that I look at in my personal approach is I look for the issue. In the issue, you’ll find out what type of opportunity it is. If you get the point where you have that lead, start where you’re a borrower, where you have a checking account. Go talk to your lady, your man or your contact. That’s the way to set. See who’s in the bank that does that who walk down the street and do it again. That’s an interesting way to start. When they have a note, identify that issue and genuinely see if it’s something you know how to fix. If you were an investor and you also happen to be a contractor, your brother is, and the issue is beat up or something happened, you can figure that out.

If the issue is something complicated and strange or environment, maybe it’s not a good spot to start. The number one things in the business are the basis, the location and the time. The basis meaning have you done a great job underwriting the risk associated with this deal. If you have, you should be able to get a good basis where you’ve looked at all the scenarios. The location is going to be your absorption. How fast could it move? If it’s a house in a great neighborhood, you can sell it.

The most important things in the business are the basis, location, and time. Click To Tweet

A commercial building in Alabama might be a great price, but the average marketing timeline to put that on the market is eighteen months, and there are only two buyers within 100 miles. It’s not a great place to make sure that your money can move for you. We discussed this a lot with the legal underwriting and understanding they went bankrupt to what happened. You should do a good back and forth on worst-case scenarios with an attorney. You can put all that into your synopsis and try and get a good deal. Your time to fee is the number one question you should be able to answer.

What’s my time to fee? If everything goes wrong, it’s eighteen months and $180,000. If it goes right, it’s going to be four months and $20,000. If you know those scenarios, that makes me feel comfortable as an investor. Costs, expenses and carry. You want to pencil in all of your costs including the carry cost of whatever capital you’re grabbing, so you can see how it works for you. I made that mistake early and I always forgot about myself. When I’m looking at someone to start out, start out thinking about loading in the cost of the capital that you’re planning to use and the return on the deal is a return for you. You can always do a deal level return, but it’s a good way to evaluate the situation of what happens if time happens because you’re the one doing the work there.

Another one is have three exit scenarios. When I look at any deal, the first thing I look at is, if I got it to fee tomorrow and I had to firesale it, what could I get for it, for sure? What is the net result of money in my pocket from that? Taking away commissions, fees and staging costs, whatever it is. What is that number? How does that return go versus these other two exit scenarios I’ll have later if they paid off or if this other thing happened? If you find a scenario in which you can lose money, I would invite you not to do that deal or offer a price in which you wouldn’t lose money because you don’t want to start off losing. That’s the number one rule.

We discussed that even though you’re a nice person, take the legal actions necessary and spend the money to get everything in place. Even if someone’s working with you and they sound great, let them know you’ll be happy to work with them, inform them that you have to make these legal notices and do these other things as part of your role, but you’re still there to talk to them and work on them. That will get you in the front of the line if things go wrong or, God forbid, the borrower has an issue and someone else takes over or whatever happens. It protects you and your investors.

I could go on always for a ton but in this environment, I’d be looking for things that you know and understand that both have an upside potential and they have cashflow. A big empty building in commercial that you’re not sure what to do with is not going to be something you’re going to want to hold because that will drain your dollars quick. If it can at least carry itself while you figure it out, that’s going to be a better deal to start with. Those are a couple of points.

There are two things that pop in my head as you mentioned that. I see sometimes people in the residential space go cheap. They’ll either use a cheap attorney. They try and sell the house themselves. In the commercial world, I would think you can’t do that. If it’s a little retail center, you would want to get a retail broker that’s specialized in that, and not trying to stick a little for-sale sign in front of it. You want to get a top-notch attorney from that perspective. Would you agree with that?

It depends who you are, but in general, I’d say unless you have 10,000 hours of experience in that bucket, you’re great. The good thing is broker is free. They have a lot of information. By free, I mean they get paid when there’s a transaction. They’re consulting doesn’t cost you anything. They likely have good referrals for attorneys and everything else. Managing your attorney and not allowing your attorney to manage you is key. What I try and write out as my best thinking, my objectives, the things that I need to know, and tighten in their frame. Your budget will go from $50,000 to $5,000 if you’ve already put in the thinking, you have very specific questions and you provide them the information they need.

Attorneys are whatever, some X dollars an hour between $1,000 and $1,200 depending on what you need. If you can take all that time off their plate, you’re going to save yourself a fortune. When I got started, I would get it to the point where I could be on the phone. I would watch the fifteen-minute mark because that’s how they charge no matter what. I would be like, “If we had 29 minutes, I have one more thing.” I’d be like, “I got to go.” I not paying an extra $200 for one question.

Have you hit $1,200? The highest I’ve hit is $700 an hour. That was a land-use attorney. In California, you do have $1,200 an hour attorneys.

You can tell how much someone charges by how fast they talk.

The other thing is not only them but they have an associate that also is always on the call and they bring a little group. They’re like Smurfs. The Papa Smurf and all the little Smurfs come. You have seven of them on a call, only two of them talk and then you get your bill.

This is legal if you’re going to get into commercial or residential, I can’t speak to that. It is the number one cost-saving skill to develop. I would recommend two things. One, get very clear on what you want to know, what your questions are, open-ended or not. Make sure that they’ve had time to look at that quickly because that might be free. Your evaluation is going to be less. Two, don’t forget who the client is. A lot of people are scared of their own attorneys and they don’t lead them and direct them.

They’re scared of them because there’s an expert in law. You’re an expert in your business and what you need to do is negotiate like you would do with anything else. If they’re telling you that to foreclose on your whatever should be X dollars, see if they’ll do a bulk fee. If something doesn’t make sense to you or didn’t make you any money and they took forever doing something, the number of times back in the day when I got started that there would be a runoff lawyer. I would pick up the phone and be like, “What are you guys doing?” They’re like, “We did stretch on that. Angela had to learn that first and you shouldn’t pay for that.” Those phone calls would be $2,000 difference by asking some common-sense questions. Don’t forget who works for who, respect them, you need them. You start to carry animosity towards an attorney who is supposed to be there to support you when you allow them to do whatever they want, and you’re not clear about what serves you. They appreciate it too.

That’s a good point. Chris has mentioned on our show that there’s nothing wrong with getting a second or even third opinion from different attorneys. We say that in the medical field but people don’t seem to think that. An attorney knows everything. They’re people that are well-informed on a certain topic. Those are all good points.

You can get 2 or 3. I recommend that you inform your potential clients in the form of a question and say, “I have a building that is blank. My goal is to know blank. How would you get me there? How fast and how much would it cost me?” You get to watch their thinking because the styles and strategies of each attorney might be very different. If nothing else, now you have three different versions of what’s possible. You can still choose yours but you can take some of the better ideas from the other two and integrate that in. Maybe the other attorney is better for you on the next deal. I found that to be helpful. As long as you’re meaningful, using them and their services over time, it’s a great way to find what’s best for you.

One last question I had is on the commercial side, if there are tenants and stuff, do you have somebody talk to the tenants to try and get a feel for what’s going on in whether it’s office or retail? Are you allowed to talk to the tenants and stuff?

Not usually. In the commercial world, you can’t speak to the borrower. This is until you close. You can’t have any communication with the tenants in a formal capacity as a potential note buyer. If there’s a Dairy Queen there, you can get yourself a buzzer. You can talk to the staff, you can look around and see if it’s busy. Banks are very sensitive especially on the commercial side of what they’re doing. A lot of times, they’re not notifying anyone they’re selling. It’s something that they need to do for themselves. They don’t want the borrower to have a bad reaction to it or not understand that the bank is trying to sell it to someone who’s going to help them instead of some chop shop or whatever.

It’s similar in residential. When someone asks, “Give me the borrower’s phone number. I want to call them and ask them while they’re not paying.” I’m like, “I’ll cross you off the list from selling you an asset.” You can’t do that. As we wrap up, how can people learn more about your funds, more about what you invest in, what’s the best way for people to learn more?

At this time, feel free as an individual to learn what we’re up to. We’re at www.PhoenixIF.com. It’ll tell you a little bit. That’s a bank-facing website. It’s more for our lender clients. On the investment side, we’ve closed everything down for the moment. I’m not looking to do anything. We’re doing more one-off transactions and we’re not raising any funds at the moment. In the event that anyone ever needed anything or had a question, they can reach me at Carson@PhoenixIF.com, someone will get back to them and answer a question either on investment or if they had a question with the deal. We’ll be happy to do that.

GDNI 32 | Commercial Notes

Commercial Notes: If you make your payments and remain financially healthy, life insurance companies will still let you manage your property.


Jamie, any final thoughts?

Thanks a lot, Carson. It’s been informative and I’m sure our audience will appreciate it and get a lot of value from it.

I hope so. I appreciate it. It’s been a pleasure to be on with you.

Thanks, Carson. Thank you, everyone, for reading.

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About Carson Faris

GDNI 32 | Commercial NotesCarson Faris is co-founder and CEO of Phoenix Investment Funds, a multi-strategy investment firm specializing in the acquisition and repositioning of debt instruments secured by commercial real estate. He is responsible for directing the firm’s investment strategy and is an active manager in all of the firm’s various funds and companies. Carson was also the founder and President of Western Bay Investments, a real estate development firm, as well as Fundamental Real Estate, a boutique real estate brokerage firm.

Prior to founding Western Bay, Carson acted as Director of Development for Red Mountain Group, Inc., where he oversaw the company’s diverse and growing national development portfolio. It was also during this busy time that he was elected President of the Association of Southern California Real Estate Executives and founded the Real Estate Industry Network.

Carson discovered his true passion for business in the late 1990s when serving as a Senator for the University of Wisconsin Milwaukee Lubar School of Business and developing a diverse group of small companies. He credits these first companies—which focused on people, process, and product—for providing him with a deep understanding of business fundamentals, the value of integrity, and the importance of relationships.

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