Ted Martell – Empty Rooms: Commercial Real Estate Non-Performing Loans in NYC at Maverick Real Estate (EP.349)

0:04Hello, I'm Ted Seides and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can join our mailing list and access premium content at CapitalAllocators.com. All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions.

0:44Clients of capital allocators or podcast guests may maintain positions in securities discussed on this podcast. On today's Sponsored Insight, we'll discuss another empty room, an opportunity ignored by most investors because they either don't want to or can't participate. It's real estate NPLs in New York City, a niche opportunity requiring a high degree of specialized expertise. My guest on today's show is Ted Martell, the co-founder of Maverick Real Estate Partners, the leading investor in commercial real estate NPLs and distressed loans in the New York City market. Maverick manages$500 million focusing on the specialty since its launch in 2010.

1:28Our conversation covers Ted and David Averam's path to bootstrapping the business, the nature of the opportunity, and the blend of data science and analysis that makes it work. We also discuss the wide open landscape of opportunities on the horizon in the New York City commercial market. Before we get going, there's a lot of serious heavy stuff happening in the world. Without making light of any of it, these Spread the Words are intentionally just the opposite. They're my attempt to provide a little comic relief in what can be a very difficult world. So this week, I thought I'd talk about another travesty of sorts.

2:07The World Series finished up last week with the Texas Rangers defeating the Arizona Diamondbacks. In case you missed the whole thing, yeah, that's called parody in Major League Baseball. These underdogs not only weren't the New York Yankees, they weren't even portfolio companies of my favorite and most passionate investment in Arcto's sports partners. Adding insult to injury, both teams actually beat an Arctos portfolio company in Game 7 of their League Championship Series. And there would have been just a little more money in it, well, for me. And last week, just when you thought it couldn't get worse, the world-famous New Zealand All Blacks had a heartbreaking loss in the finals of the Rugby World Cup.

2:52So when all your expected sports results fall by the wayside, I suggest you clear your mind with a riveting edition of, you guessed it, the Capital Allocators podcast. Thanks so much for spreading the word. Please enjoy my conversation with Ted Martell. Ted, thanks so much for joining me. Thanks for having me, Ted. Why don't you take me back to the beginning, wherever that starts for you in the path to starting this business? I grew up on the South shore of Long Island with a family of musicians. My parents were from Northern Minnesota, moved to New York after they graduated college and got married because my dad had to fulfill his ROTC requirement and joined the army band.

3:36And he was stationed in Fort Hamilton in Brooklyn. And so they both became teachers. Ultimately, my dad was a high school orchestra director and my mom was a elementary music school teacher. And so music and education in my family were extremely important. What was that like growing up with two musicians? It was challenging. My parents were my music teachers. There was an expectation around practicing. They instilled in me the quality that you should practice daily, that you should perform repetitions. As I grew older, I was more interested in athletics than I was music. And I think that was difficult for them to understand how could they possibly have an athlete as a child.

4:22I continued with music through high school and sports. I played soccer and lacrosse. I was the kid that went late to practice because I had orchestra rehearsal. And I was the kid that went late to jazz band because I had a game. And so I was constantly juggling these two disciplines. And while my parents saw them as extremely different, I saw them as extremely related, certainly in retrospect. Practicing or repetitions, just as important in sports as in music. Being part of a team and collaborating with people, just as important in sports and music. Making sure that you're aligned with each other, sports and music the same.

5:03And so after high school, I went to Princeton University where I studied architecture. And architecture for me really touched on a lot of the things that I had grown to love as a student, using my analytical and creative skills together to design solutions to problems and then create visual representations of them, generally around the built environment. I was fortunate to also be a lacrosse player in college. And here again, I was juggling two extremes, explaining to my teammates and my coach why I was late to practice because I was an architecture studio or explaining why I was missing an architecture studio event or why I wasn't there all weekend working on my project because I had games and practice.

5:50It was very difficult and challenging to organize, but both were extremely important to me. I had to figure out how to reconcile those things, particularly because the lacrosse team at Princeton was extremely successful. While I was there, we won three national championships my freshman, sophomore, and junior year. I was an active player on the team. And I think some of that experience has been really influential on some of the things we've done at Maverick today and on my business career as a whole. Whether it's sports, music, and then architecture, there's this artistic quality in what you're doing.

6:29And I'm curious how you expressed that once you left college. It's a very good question. And it's something I struggled with along the way. My first job out of college was working in construction as a site super, a project manager and a project executive, pretty non-traditional path for a Princeton grad and very mechanical in nature. You're managing projects. You're doing a lot of analysis. The creativity there comes in finding better ways or cheaper ways of building, but it felt like there was a gap. And so after a couple of years of working in the construction industry, I really wanted to understand the capital behind the projects.

7:07So I went back to business school. My plan was to become a real estate developer so that I could apply that creative side of my brain to the business. And that's what I did post business school. I worked for a few different real estate developers, managing the construction design and financing of projects. How did you find your way into development at a business school? So most people go to business school, in my mind, for one of three reasons. It's to learn something, to meet people, or to climb the corporate ladder. For me, I really wanted to go learn something. I've always been very driven by this curiosity and this desire to learn.

7:45I wanted to understand capital flows and real estate and buildings and how it all worked. Turned out that was also a great place to meet people. That's where I met David Aviram, who's my 50-50 partner in Maverick. We've been business partners since 2010. We started out as friends in business school. And at Happy Hours, we talk about our entrepreneurial ideas and how we wanted to run our own real estate business one day. We looked at opportunities together. But post-business school, we both took jobs at firms. We were building our lives. We got married. From time to time, we would look at opportunities together.

8:21but generally we had jobs. I was working in real estate development. Dave was working in real estate investment sales at Eastill Secured. And we continued down those paths, watched each other, got married, went to each other's weddings, enjoyed New York City. And the global financial crisis hit in 2008. We knew that there had to be a tremendous amount of opportunity in the marketplace. And those entrepreneurial ideas or those seeds that we back in business school, they started reappearing in our minds. And we decided to quit our jobs and start Maverick full-time. What was it like for you guys taking that leap?

9:00It's a little bit scary. You're giving up good jobs. You're giving up certainty of income. It's also extremely exciting. I was working for a real estate developer. There was no capital available in the market to build anything. And so I wasn't really working on anything meaningful at the time. And that bothered me more than anything. My wife and I were expecting our first child and I asked her, what do you think? And she said, well, if you don't do this now, it's going to be a lot harder down the road once we have our first son. And so I told Dave, I was expecting a child with my wife. He said, let's do it.

9:35I said, I don't know where this road's going to lead, but we've got to make some money and we've got to do it quickly. What'd you decide to do? We found some office space. It was one room and we started going there every day of the week. We felt that it was important to be together. There was a lot of broad confusion still two years into the global financial crisis as to what real estate was worth, where the opportunity was. After a few months, we settled on non-performing loans. We knew that there were a bunch of broken projects all over New York City and we started trying to call lenders to see if we could buy the debt.

10:07And we were a fundless sponsor and we really started focusing on data. Dave's experience before working at Eastdale Secured was at Bloomberg, and he understood the power of data. And we both understood how technologically behind real estate was. And there was a tremendous amount of information becoming more available. What was the first break you had in terms of either an opportunity on the investment side or capital to fund it that made it begin to work? Our first break was a call to a banker who invited us into his office. And he saw us as industrious entrepreneurial guys. And as we were leaving the meeting, we had a nice discussion with him for about an hour.

10:51He threw an appraisal at us, literally threw it to me and I caught it and said, tell me what you think about this. And we went back to our office fast and furiously trying to figure out what the situation was. And And it was a loan secured by almost a full city block of land in a good area of Williamsburg, Brooklyn. The default rate of interest on the loan was 24%. It had been in default for two years. And we perceived the loan to value on the property to be about 40%. So very well secured loan with lots of accrued default interest. And we immediately called some of the private equity managers that we had been talking to and said, hey, we've got this situation.

11:27We want to take a look at it. What do you guys think? and we got to work at underwriting it and putting an investment memo together for it. What happened with that deal? We closed it. That first transaction paid off in the first three months. We made about a 1.3 multiple. So we were into the carried interest. Dave and I made some money. We took a deep breath and we said, now what? On the second transaction that we did, we bought a loan secured by a hotel under construction on the lower east side of Manhattan. There was a mechanics lien sandwiched in the middle of the capital stack. We ended up negotiating with the construction company that had the mechanics lien and bought it for 50 cents on the dollar.

12:04And the light bulbs went on right there. And we said, how do we find a record of every mechanics lien on every property in New York City? And we quickly found out where they were recorded. You had to go to the county clerk's office, 60 Center Street in downtown. Underneath the courts is the clerk's office. And down there was a green screen computer and you could print out mechanics liens one by one. And we printed out every mechanics liens that was over$100 ,000. And then we collated them, scanned them. We sent them to an outsourcing firm in India who put them all into a spreadsheet for us. And we had our first data-driven sourcing spreadsheet.

12:43What happened once you had that data set? Dave and I got to work making phone calls. We called the lenders on which these mechanics liens were recorded. And we said, hey, we noticed that there's a mechanics lien recorded on your property in which you've lent money. We're interested in buying the loan. Many times, they did not know about it. Sometimes they said, don't worry about it. We know all about it. It's not a problem. But hey, take a look at this other opportunity I have. And we learned how to systematically call people to do outreach to find these opportunities. We recorded our progress, we followed up, and we were able to generate a real stream of deal flow using this data.

13:21Around the same time, we started raising discretionary capital. We lost a lot of transactions along the way because we didn't have money. Buying non-performing loans requires you to have capital and the ability to move quickly. These transactions can close in as quickly as five days. But lenders want certainty of closure, and they want to know that you're going to do what you say you're going to do. We needed capital. We raised our first fund from friends and family, and we're extremely successful with that first fund. That investor group introduced us to other investors, and we kept going down this road over the years.

13:53We're presently investing out of our sixth private equity-style fund, which has about$317 million in commitments. And 80 % of that capital is institutional, limited partners, foundations, endowments, and pensions. In the meantime, we've really doubled down on data and building out systems in order to achieve our goals. So as you've gone from that first fund to the most recent one, how have you articulated your strategy? Maverick buys non-performing loans secured by real estate in New York City. We make money by buying those loans at a discount to the underlying collateral value and then encouraging repayment from the borrowers.

14:39The profit is made up of any discount to the principal balance that we are able to negotiate with the lenders as well as the collection of accrued default and contract interest plus fees. So if we break down that process, you started with this mechanic liens database. How do you think about where you're going to find these opportunities to buy the loans? Today, we are ingesting many publicly available data sets. These data sets come in different forms and formats. They come from city, state, federal level. And we are first cleaning that data as we ingest it. And then we are connecting that data through similar fields.

15:18And so this process has yielded a very sophisticated data resource and team that can develop leads for our sourcing team to identify opportunities, as well as market knowledge that can help us underwrite and think about how we are doing. So as you run through all these data sets and work through these screens, what is it that you look at when you come in on a Monday morning to say, oh, here are the potential opportunities we want to go try to source directly? Our sourcing team is given lead lists that are generated by data strategy. And these lead lists are organized by these indicators of distress.

16:00And the sourcing team is going through these lead lists one at a time, making their phone calls doing their outreach and sourcing opportunities. They're calling banks, they're calling private lenders. Naturally, after doing 185 of these transactions, we've also built some relationships. Maverick has become the number one buyer of non-performing loans secured by real estate in New York City. And we get inbounds regularly. We have banks and private lenders calling us and asking us to tell them what we think about a given loan opportunity. What would we pay for it. What is the sweet spot of the non-performing loan you're looking to buy look like structurally?

16:40Our average loan size is$7 million. The majority of the loans that we're buying are$2 to$20 million. That middle market space, there's a tremendous amount of opportunity for us to play in it because it's complicated, because the material is complex, and because there's not a lot of other capital pursuing those opportunities, not in a systematic way, the way we are at Maverick. The loan we're looking to buy is that the underlying collateral has cash flow, that it's an extremely liquid property, meaning there's lots of demand for it. So it should be very financeable. I think those are primary on the collateral side.

17:14From the loan side, the lower the LTV, the better, because that encourages that fast payoff. If you think about the loans that we buy, a loan that is, say, 20 % LTV has a lot more equity for a borrower to refinance the property and pay us off. Naturally, those aren't the ones that tend to be in default. It's the ones that are much closer towards that 70 % edge, but those are the things we're looking for. What does that diligence process look like to see if it's a transaction you want to undertake? Due diligence includes reviewing the credit file, legal review internally and externally. We have legal staff on the team, ordering a fresh title report, collateral valuation, the credit or loan valuation, as well as a guarantor analysis, and ultimately a site visit before we close on the transaction.

18:03How do you go about pricing these? So our mandate is to deliver high teens net returns to our LPs. So we're underwriting the collateral and we're underwriting the loan documents. These are non-performing loans. So updated rent rolls, expenses, problems, things of that nature, are not necessarily provided to the bank, so they can't necessarily give them to us. But we are looking at collateral valuation in a number of ways. We're looking at discounted cash flow analysis, comparable sales analysis. We're looking at old appraisals in the credit file. We're calling brokers and getting broker opinions of value.

18:37And we're using these different data points to triangulate to some sort of valuation on the underlying collateral. Once we get comfortable as to where we think from a conservative basis value is, That goes into our loan underwriting model. The loan underwriting model generates a series of probability-weighted cash flows based on a series of qualitative and quantitative inputs into the model. How competitive is it once you've determined there's a loan that you want to put an offer onto in going from that to acquiring the loan? I would say it depends. There are many transactions that we do directly with banks and private lenders where there is no broker or middleman marketing the loan.

19:21So those I would say are not competitive. I would say that's the majority of the transactions we've closed where we have identified the distress, we've contacted the banker, and we've bought the loan. That is more typical in a healthy market where it's a good loan gone bad, meaning LTV is good and you can pay up to the principal balance of the loan. Today, we're in a very distressed market. We have rising interest rates, inflationary pressures on expenses, decreasing cap rates, general uncertainty around valuation in certain asset classes, demand questions, and loans and their values are far more uncertain.

19:57And so what we've been experiencing in the market for the past 12 months, and really even further than that, going back to the beginning of interest rate hikes, is a bid-ask gap in the market. And so we've never been busy or underwriting or looking at opportunities, but we are not closing a lot of transactions. So when you do purchase one of these loans, they're non-performing by mandate. What happens in your process once you've acquired the loan to try to collect more than had been collected before? We use two means to encourage repayment by borrowers. Number one is to reach out to them and talk to them to try to understand what their perspective of their situation is and what their plan is to repay us.

20:42Number two is all of our remedies that are within the loan documents and exercising them. And we have found that over time, that deploying both of these things at the same time is the most successful means towards facilitating a fast resolution. In other words, you're talking to them, but you're also enforcing your legal remedies. How does that go? You can imagine you're reaching out to someone who is already in some distress and you're the new kid on the block who now owns this loan. Feels a little sharp elbowed to also be doing this legal process at the same time. That can be a difficult discussion, but these are commercial borrowers.

21:21These are borrowers who are using leverage as a tool to generate a return who have gotten a little bit over their skis. Most of them are rational players who understand the position they're in, who are willing to have a rational discussion and seek a quick resolution with us. So those conversations are fine. They're very clear. They're very direct. The rules of the road are laid out before everyone and everyone operates as they see fit. What do you find that's different when you step in to make that call than what the prior owner of that note might have? A big difference between us and say a bank or even a private lender is that we're not in the business of lending.

21:59Banks and private lenders are in the business of lending and being good lenders and working with their borrowers. When they are selling us the loans, it's kind of the last stop. The bank or private lender has decided to terminate that relationship. When we've stepped in. We're not looking to make a relationship. We're looking to resolve a problem. I think Maverick has developed a reputation as being tough but fair in the marketplace. And I think borrowers many times will abuse that relationship with their banks. How do you think about your exit strategy? So when we think about it from an underwriting perspective, the short-term resolutions tend to be very high IRR, lowish multiple, whereas the longer term are higher multiple, lower IRR.

22:42And lower IRR tends to be that high single digits. And so we're really trying to stay in that first bucket. We want fast resolutions. And so we work very hard with our borrowers to find ways to exit quickly. We're very happy to get that higher IRR, lowish multiple, and then to redeploy the capital again. The deal flow and the pipeline are plentiful. And we see that as being a great outcome for our limited partners. How do you think about when you're holding, when it comes time to potentially have to take back the keys and own the properties? So we don't actively seek to own the properties. If we end up owning the properties, there's really significant friction cost on the transaction due to transfer taxes at broker fees and carrying costs.

23:29And so we've found historically that you're better off settling with the borrower before it comes to that. We are willing to take back the keys and we've done so about 10 % of the time that we've made investments in non-performing loans. And so we've taken back the keys about 20 buildings. We presently own about four properties and we seek to sell them immediately through a broadly marketed process. Occasionally, there are small things to do to those properties to clean them up to maximize price, but we're generally not seeking to take on ownership or development risk. We don't find that that is the risk that our limited partners are looking for.

24:07And we don't think it's risk that's appropriate for us to take on. There's somebody out there that's better at doing that than us. What we're great at is finding complex situations where loans are in default and realizing the value from the loan side. How do you think about as you're negotiating with an owner, you need to be able to have the stick of taking on that building, but at the same time, you ultimately would prefer not to for the reasons you just said. I think we proceed full force to take back the keys, despite the fact that it's not an outcome that we want. When we think about the stick and litigation, we don't stop.

24:45We don't let up. It would be perceived as a weakness. And it's important for us to push from that side hard. We think about any settlement discussions that are on the table from a very rational perspective and an analytical perspective to determine, is this actually the economically best decision to take it back. And so it's really about making the decision if something's on the table, as opposed to, I don't really want to take this back. What team do you have in place to conduct all of these different aspects of the process? Today, we are a team of 20 people. We're divided up into three different groups.

25:21There's data strategy, there's the investments team, which is managing the sourcing and the asset management of our deals. And then there's the finance team. As David and you have grown this organization from just the two of you to what it is today, what is it about your partnership that's made that work? So when I think about partnership, I think about alignment. David and I are 50-50 partners. We're extremely aligned. We have equal decision-making. We have the same level of capital invested in all of our deals and vehicles. And I think that first five years in business, we learned a lot about what that really means.

26:00It was just Dave and I in a room trying to figure out what we're doing, trying to figure out how to do it better as we uncovered it. And it required a certain way of being, being very transparent with each other, being very direct, providing feedback as to how we are doing. We knew very early on that we were committing towards a long-term relationship and we wanted our decisions to be aligned for the long term. And that's really how we thought about our partnership. But I think that partnership extends beyond just David and I to how we interact with our other partners. And by other partners, I mean our limited partners, I mean our employees, I mean our third-party service providers.