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Jonathan Davis (10:54):
Can a fund manager put a freeze on distributions and redemptions?
Bill Fairman (11:28):
One quick thing, there was a house in California, 1,100 square feet. They put it on the market at $899,000 and then it ended up after 23 offers were made on this property, they ended up selling it for a little bit over a million. You think there's a little price bubble out there in California?
Jonathan Davis (11:59):
I remember in a previous life talking with a note trader and they had a note that they were buying and it was secured by, in their words, a crack house. It was in California and it was just right at a million dollars. That's when I knew something was going to happen.
Bill Fairman (12:34):
Yeah. If you decide to stay in California and not move out, it's still going to cost you a butt load of money to buy a house there. That's for sure. In certain sections, obviously real estate is local in nature.
Jonathan Davis (12:51):
Your states and places that have huge upswings in prices are the ones that have huge downswings in prices. They pretty much stay constant, little depreciation, and little appreciation. But like Florida, California, and New York, those areas not everyone, but a lot of people, talk about how they can find. They start noticing the bubble and the real estate market, and it's first noticed in the condos in Miami. So it's one of those I have the big upswing and then the big downswing.
Bill Fairman (13:30):
Typically you're saying states are the ones that are the most volatile, but that's a good thing because most of those things are the easiest to foreclose on. I know it sounds harsh but those are the areas that once they go down, they bounce back the quickest because you're able to move the inventory through quicker and correct all the mistakes. Whereas the states that made it very hard to foreclose on it just took so much longer. Their markets were hurting for a long time because they didn't just pull the band aid off.
Jonathan Davis (14:06):
You gotta let that inventory run through. We talked about the example before, New York is one of those “Kings county” after 2008, there was like a seven year backlog. It was something insane on foreclosures because they just wouldn't push them through.
Bill Fairman (14:27):
Yes, they can freeze and of course it has to be in your documents. It's in our documents that the manager has the authority to freeze all distributions and redemptions. The reason this question came up is I read an article from Djerassi Law and they were talking about this exact thing.
Bill Fairman (15:19):
There was a fund that they had done the paperwork on and it was during 2008. You had the mortgage meltdown and they had a lot of banks, and values of properties that they were going to have to write down. So instead of having all the bleeding happening, they just froze all redemptions. They froze all distributions.
They had enough cash to weather the storm eventually within a year or so. They were able to sell that fund to a much bigger hedge fund and through that turmoil where no one could get redemptions or distributions, they still ended up with an annualized return when they sold the fund to this other hedge fund of about seven and a half percent, which is not mad when you're thinking your fund is going away.
Bill Fairman (16:40):
Keep in mind, this was a fund that was doing a lot of conventional conforming loans. The rates weren't that high in the first place. That was a really good return for that type of fund.
There's some other examples of dirt during the COVID year. If you were heavily invested in commercial property and specific types of commercial property, hospitality, retail, that type of thing, those property types were just beaten up the last couple of years. If your fund has value, add the type of an inventory where they're buying already bang and a discount, the goal is to fix it up, get it stabilized, get it refinanced. And then getting out of that loan or selling it to somebody.
Now, your values are all messed up because you expected a particular value at the end. You're doing your documents based on your expected return. Expectations are completely done. I know some funds that have had the wind down completely.
Jonathan Davis (17:58):
They do a Proforma based on a certain rent roll in a NOI, and then they can't achieve it. You're getting half the NOI that you thought, you're screwed.
Bill Fairman (18:10):
That's one of the downsides of being in a syndication. Now 95% of the time when you're in a syndication, everything's working out like it's supposed to, but occasionally you'll get these Black Swan market corrections that will target a particular property type and then expected return is nowhere near what it was. You don’t know you're locked into one asset right now, if you're in another type of fund that has those same types of properties, but they have more than one asset. It's not a syndication. It's a fund that has many of those types of properties in the fund. You're a little bit safer there because you're not, I always say that you're not investing in a chunk of change in the one asset, even though 95% of the time it's going to work out just fine.
Jonathan Davis (19:08):
Change a little course and explain the whole freezing on distributions or anything like that. We all know it's like a run on the bank. We know what that looks like. This is a microcosm of the same thing. We have an event that happens and all the investors come in and want their money. What happens when you give all the investment? You can't if a fund is doing what it's supposed to 90 plus percent of its money is outworking in assets. You can't give it back. And then you have all these people wanting it back. So, if I give or bill gives one person or two people back their money, then we've set a precedent and we have to start getting everyone's money back. But then we start diluting the value of what we're giving back to people because the cash isn't there. So that's the real root of it is why we want to do that. We want to protect every investor, not just one.
Bill Fairman (20:13):
Do you never want to sell an asset below the market or at a loss in order to give people their money back? The plan B is always to hold on to the answer until the values come back and then you sell them in the meantime, they need to be making an income. So you can at least get some sort of return while you're waiting.
Bill Fairman (20:41):
That's how you have to do that.
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