Pearlstone sees opportunities in underwriting

NEW YORK—Due diligence consultancy Pearlstone Capital recently launched for the commercial real estate sector to help provide both lenders and owners third-party evaluations of properties.

The business includes forensic diligence, underwriting and feasibility studies for all commercial real estate asset classes.

“We are a third-party diligence company that banks, lenders, investors, the buy-side and equity-side hire to do certain underwriting diligence,” said Jacob Margulies, founder/principal, Pearlstone Capital. “It has become very popular over the years to let those people focus on the originations and then they outsource different components of the underwriting. There are certain things about my company that are unique, especially with regard to hotels. That is our core business.”

He has a 15-year career in real estate, with the last 10 years focusing on hospitality. “I worked for two different companies over the last eight-plus years. About six months ago, I left my last company and recently formed Pearlstone, which was something I have always wanted to do—I have always wanted to run my own company,” he said. “Based on certain things lining up for myself personally, it was a great time for me to go on that venture. So far, it has been great.”

The main clients for third-party underwriting diligence companies are lenders, whether traditional banks or non-banks. “All of these companies have underwriters and originators,” he said. “Originators are trying to bring in the business and the underwriters are trying to make sure that whatever loans that the originators find meet their guidelines. Certain parts of the underwriting at each of these different banks, whether it is a CMBS loan or it is a balance sheet loan, or a bridge loan, mezz loan, etc., have certain criteria for their underwriting. There are different components of it.”

For hotel lenders, Pearlstone will prepare agreed upon procedures (AUPs) for the properties they are backing. “Basically, it is a deep dive into the historical financials—checking boxes off a list of testing procedures to ensure that the cash flow that is represented and the financials that are represented are accurate,” said Margulies. “If there are issues with it, [we work]to get those issues identified and rectified so that the bottom-line cash flow, the bottom-line net operating income, is supportable.”

He said that hotel lenders like having AUPs because hotels are an operating business with fluctuating revenue. “Traditional real estate has leases, and you read the lease and they have to pay rent of $120,000, plus their proportionate share of XYZ,” he said. “You know that revenue went up from here to here because you know there was a rent step or there was something tied to the agreement. With hotels, it is a different story. You could have the rates change every day. There could be things like a Super Bowl, or there could be a PIP or upflagging or downflagging. There are so many market-related and operational things, like a GM leaving or hiring a new revenue manager. All these factors impact the P&L of hotels, so you really need to dig in and understand, not just from a pure numbers standpoint, but also from a hotel standpoint. I have the numbers kind of experience and also the hotel operations type of experience. The clients I have really appreciate that level of diligence, that AUP for their underwriting purposes.”

An AUP can provide comfort to a client with regard to bottom line NOIs. “I will present them with an AUP, which is a financial model that shows all of the historical cash flows, plus cash flows that are current today that could be based on franchise agreements, etc.,” said Margulies. “They can use that and input it into their financial model and have it as an extra source that they can go to their investors. They have a third-party AUP on it and it gives them supportable NOI of XYZ.”

Pearlstone also offers more traditional underwriting—an asset summary report. “It is a memo to their credit committee that shows the market, the property condition, a review of the appraisal,” he said. “It is basically a whole memo that the credit teams at that bank will then use to approve or not approve that loan. It can be anywhere from five to 50 pages that highlights all of the aspects of the deal—the property, the market and other third-party reports like appraisal or environmental. That is more traditional and some banks or non-bank lenders either don’t have the teams to be able to put something like that together, or don’t have the expertise, or they are just too busy and they need some help with sections of that credit memo or the whole credit memo.”

The company also works with hotel owners to create AUPs when they are looking for financing or to sell their properties. “Let’s say there is a family that owns a hotel in some market in Minnesota and they want to put their books together correctly with the proper chart of accounts,” he said. “When they go to a lender or investor, they then have something that they can present their financials in a historical fashion with testing procedures done so that there is a supportable cash flow. That investor will be very impressed versus them sending their very rough P&Ls that look like chicken scratch—which people might laugh at. That is the longer game in that it takes time to get these hotel owners to understand why this could be beneficial for them. A random hotel owner only needs to do this once every few years, whereas a lender is constantly lending X amount of deals per month.”

The company also does feasibility/market studies in the hotel space. “A bank may call me up…and tell me they are looking for a loan in Minneapolis and that they are concerned about the supply,” said Margulies. “They want me to do a report on the supply there and some aspects of the market. It is not a full report, but it is more boutique, a niche one that a bank may be interested in.” HB

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