Brennen Degner is a real estate investor, operator, and CEO of DB Capital Management, LLC, a vertically integrated organization focused on value-add multifamily investments. In this episode, Brennen discusses why his ideal deal size is $30 - 35 million, key things to consider when purchasing older properties, and how he plans the management needs of properties with triple-digit units.
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TRANSCRIPT
Slocomb Reed: Best Ever listeners, welcome to the best real estate investing advice ever show. I'm Slocomb Reed, and I'm here with Brennen Degner. Brennen is joining us from Denver, Colorado. He is the operator and CEO of DB Capital Management, a vertically integrated organization focusing on value add multifamily investments, with a portfolio of around 3,000 units. Brennen, can you tell us a little bit about your background and what you're currently focused on?
Brennen Degner: Yeah, so starting with what we're currently focused on, because it relates heavily into my background. We're currently focused on value add multifamily, really Texas West, so we own assets in San Antonio, Austin, Denver, Salt Lake City, Las Vegas, and then we have a presence or a target presence in Phoenix; we don't have any assets there currently. And historically, we've owned in both Portland and Los Angeles, but in the last five years or so, or four years or so, we've made kind of a thematic exit out of those coastal markets.
So going back to how that relates to my background, prior to starting DB, I ran asset management for a group called NJW Investments, and we were primarily a multifamily value add shop, with a heavy concentration or focus actually in student housing as well. So we really targeted student housing across the country, and then multifamily value-add. So when I left, that was primarily what my background was in, and it didn't make sense to reinvent the wheel; I didn't really think I could raise capital around any other asset class, given that's where the predominant amount of my experience was.
So that's what we focus on today, and we've built a pretty cool machine; we've got a construction company based in Dallas, that services all of our assets on the construction side, and then we just did a joint venture with a property management company that's based in Utah, that has 30,000 units outside of us, but we did this kind of cool joint venture with them on our assets, to really help them grow more into multifamily. They were predominantly student housing before. And so that's kind of how my background led into what we're focused on today.
Slocomb Reed: Value add multifamily investments; that's a very commonly used term. Let me make some assumptions here, tell me where I'm wrong. You buy properties that are going to cash flow day one, but leave room for improvement. You target a roughly five year hold period with likely a sale afterwards, a preferred return to passive investors, and a targeted internal rate of return on that five year period?
Brennen Degner: Yeah, so I would say over the last few years we've seen a lot of our deals exit well under the five-year mark, just because the market was on such a tear. I would say most of what we're underwriting today is back to that five year period. So we would usually do a three to five-year underwriting. Most of our investors are funds or institutional investors that are pretty IRR-driven. So that's kind of pushed us a little bit more towards three-year investments. But on average, we're usually valuing deals on a three to five-year hold assumption.
I think right now with what we're seeing in the market, we're going to see that push [unintelligible 00:03:53.17] most of what makes sense, on the debt side, is a minimum of five years with the agencies right now. So five, seven or 10-year lifespans are probably a lot of what we're gonna see in the pipeline today.
Slocomb Reed: [unintelligible 00:04:08.24] 10 years?
Brennen Degner: Yeah, we're seeing probably the most of creative money on the agency side be 10-year -- like, we have a quote right now for a deal we're recapping in Utah, that's a 10-year term, full-term interest-only. And it's sizing well, and all in rate with a 10-year, because the yield curve is inverted, the 10-year is actually lower than the shorter options. So like you're all-in the rate is in the low fives, and probably a month ago it dipped into the high fours, but as the 10-year ticked back up, it's gone back to low to mid fives. And that same loan on a five-year would be in the high fives, low sixes. So I might get a little bit of spread relief on the five-year but not a ton.
So we're just seeing, for deals that are a little bit more stabilized, that you're buying at a good cap rate, that the 10-year money right now for us is where we're finding a unique opportunity to push cashflow a little bit more, and value deals a little bit more aggressively on the five-year money.
Slocomb Reed: Does that 10-year money also come with a steeper prepayment?
Brennen Degner: Yeah, I guess every positive has a negative to it. But yeah, you're pretty much locked in. We looked at doing a structure that has an open prepay; I think it was after five years. And the break relief that you end up getting by going with the 10-year essentially gets washed away when you start, because all that happens is they start to charge you more in spread, or make up for it somewhere. So the couple of deals that we're looking at that structure with, we have to look internally and say, "Are we ready to hold this thing for 8 to 10 years?" Because you're pretty much locked into it for that timeframe.
Slocomb Reed: You said that your investors are primarily funds and institutional investors. What size assets are you targeting right now?
Brennen Degner: We generally are targeting 100 units and up, and depending on what market we're in, it's probably closer to 200 units and up. So I'd say our average deal size is in the $30 to $80 million range. I would say our sweet spot is probably in the 30 to 50 million. We're actually also a family office; my partner Devin, his family is a group that started VCA [unintelligible 00:06:22.20] so we also come with a pretty strong balance sheet. So I think the deals that are in that $30 to $50 million range we end up being a little bit more competitive, because we're bigger fish in a small pond. Once we go above that, in most of our competitors, similar, we tend to lose some of that competitive advantage a little bit. So I would say our best deals are typically around $30 to $35 million are really where we shine. Once it goes above 50, we become a little bit more of a commodity.
Slocomb Reed: I'd like to hear more about that niche. Niche doesn't feel like the right word here, Brennan, but you really shine on deals that are around 30 to 35 million in acquisition?
Brennen Degner: Yeah, acquisition or total deal costs.
Slocomb Reed: Yeah, total deal costs. Gotcha. A quick jot about my background so that you know better how to talk to me about this, and to our listeners... Active owner-operator in Cincinnati, Ohio; personal portfolio just under 100 units. I have my own management company, I'm very involved in the day to day operations... So to me, a $30 to $35 million deal is so much larger than the stuff that I've looked at that I don't understand what parameters would make that acquisition cost or all-in look ideal to an investor. I've only ever done stuff smaller than that. So tell me what are the factors at play here that make that the right deal size for you guys?
Brennen Degner: When you're in that what we think is a sweet spot is you generally have a large enough asset that you can fully staff it. So you're getting those economies of scale of being able to have at least one in one out, one manager, one maintenance person. Usually, once you're in the 30s, you're probably closer to at least a manager and a leasing specialist and a maintenance guy and a maintenance tech, let's call it. So from just like a time allocation of our internal resources, it's much more efficient than buying sub 100 unit assets, where you have to try and make up a staffing plan sometimes based on aggregation of units in certain areas, and stuff like that. So we've really found that it's really tough for us to buy and do really well and perform really well unless we can have the right staffing plan in place, which at a minimum is really one in one out.
The reason we say that 30 to 35 - and that's very broad; it could be 25, it could be 40. But really, I think the cut-off is when you're under 50 a lot of very, very institutional groups aren't looking at it. So you kind of strip them out of the competitive set. And those are the groups that historically over the last couple years have had the resources to put up multiple millions of dollars of non-refundable deposits day one. Huge, huge amounts of capital that they're just throwing -- they usually have large discretionary funds that they can close a deal on balance sheet and then refinance themselves out if they need to afterwards, so they can really shrink the timetable to close deals. And we've found, and as we were competing more and more - I mean in 2022 we bought a $64 million deal and a $74 million deal. But when we were competing on them, we weren't -- as well-resourced as we are, we weren't willing to put up that extra capital, or move as quickly, so we kind of lost that competitive edge once we got up there. Whereas a $30 million deal, if we needed to close the equity on balance sheet, we could. Same thing up to about 40, 45 million. So that's really where we're competitive.
So we really focus on that segment because it's more efficient from an operations perspective; from a corporate or a company balance sheet perspective, we're much more competitive, we can do a lot more things, we can be a lot more nimble. And we don't have to compete with other groups that can do those similar things on a larger scale. So we just ended up finding that we have a more competitive makeup in that value range.
Some examples are we closed a deal in Denver in 2021 where we had the capital raise, it was a seller that owns a lot of assets in Denver, Colorado Springs, we really wanted to perform for them; we had the capital raised, but the capital that we had raised was not really ready to fund, and so - I think it was like 60 days post PSA, which would have required us to use one of our extensions, and we really wanted to show well for this group, because there was other stuff in the pipeline to buy... So we just closed it without having to use our extension, which I think was like 45 days. And we closed it on balance sheet and just waited a couple of weeks to get our money out from the capital that we had raised.
So we can do that on a $30 to $40 million deal, and we're not even close to being able to do that -- or we could if we wanted to from an allocation perspective, but we're not willing to do that as we move up the value chain a little bit
more.
Slocomb Reed: Brennan, I want to put my own words to a summary of what I just heard you say, if you could please correct me where I'm wrong, for myself and for the listeners. Your range has a floor and a ceiling; your ceiling is set by your competition. You didn't talk specifically about a need for a lower return than you have, but that's something that I've heard often from people who come up against institutional competition, is that your ceiling is set by your competition needing a lower return than you need, but also having access to greater resources that make them a more compelling buyer to a seller. So your competition is really kind of setting your ceiling. And your floor on what deals make sense for you is set fairly operationally, that you're not going to buy properties that don't meet the minimum threshold of onsite management that you're looking for, which is at least one leasing tenant-facing person, and then one maintenance person. Is that correct?
Brennen Degner: Yeah. And I think on the lower return side, what we typically see is not -- because we look at deals on the JV side with institutional groups all day long, and depending on what asset type you're focused on, or I guess class, whether it's kind of core, core plus, or value-add, the return parameters for most of the institutional groups that we look at deals with for value add, you still have to fit in the same general box that we're targeting for some of our smaller equity checks. It's when you start to get into deals that are more of like the core plus that the pool of capital really widens quite a bit in terms of what is core plus; what are my returns for core plus. Some groups that's a 15, some groups it's a 12. But I think there's just a lot more, because you generally step up in vintage, too. So you just end up getting more and more capital that's willing to do deals like that, assuming just from a risk-adjusted return perspective it makes sense for them. But I would say if you put an '80s deal out to market on the equity side, from what we see, whether it's a $30 million deal or a $70 million deal, you're generally sizing that from a value perspective to the high teens project level IRRs. So I don't know that on the heavier value-add space that you really get much yield compression as you move into larger assets. That's one of the reasons they're willing to allocate money to value-add capital, is just because they need to chase that yield a little bit.
Slocomb Reed: In layman's terms, Brennan, the more work that a property's going to need to achieve peak performance, the less the size of the property matters with regards to the returns that a buyer is going to be willing to take on?
Brennen Degner: Yeah, I think that's a fair statement.
Break: [00:14:21.25]
Slocomb Reed: I'm coming from a market in Cincinnati, Ohio that a lot of non local investors have had serious trouble breaking into or scaling in, and a lot of that has to do with the average property size in our apartment inventory, but also the age of our apartment inventory here in Cincinnati. Maybe -- I hope this is something all of our listeners already know and I'm the odd one out here, but why is it that a 1980s vintage is going to require so much more work than something newer than that?
Brennen Degner: It's just the physical plan of the assets changed quite a bit throughout the 1980s and into the early '90s. So materials used in the construction, especially as it relates to electrical, HVAC, plumbing, kind of your major systems pieces, the evolution of those, especially if you start to dip into the '70s, and just the age, the general wear and tear on the lifecycle creates an environment where it's a lot harder to budget what the costs associated with executing your business plan are going to be, because there's so many more skeletons in the closet, and there's just so many more unknowns that get factored into it.
As you get into the early '90s, the mid '90s, you start to see the general stuff that just help extend the standard wear and tear life of a property; you just don't have as many of those unknowns that pop up. So simple things that we do is that if a deals older than 1990, we use a 10% contingency instead of a 5% contingency, or we've tried to kind of balance it out. But they always just come with more operational risk as far as the construction unknowns.
The other thing is just because of where pricing and rents falls, you're generally more susceptible to inheriting problem tenants, or delinquency, and stuff like that, so on the property management or operation side, there's just more [unintelligible 00:17:17.18] and tackling and heavy lifting that goes into them. Third, final thing that I could think of off the top my head is when you're a property manager trying to break into the industry, the thing you want to do as a good manager is generally not to manage an older 1980s deal with some lipstick put on it; you want to be in that new, nice building. So the talent pool that you're able to tap on the management and personnel side is just a little bit more challenging as well. So you kind of get all these factors that come into play, that make it so that the risk has got to be worth the reward.
Slocomb Reed: That makes sense. As a Cincinnati investor I guess we're just so accustomed to 1960s brick boxes that we all adapt our plans operationally and our budgets accordingly. Recently, I've done a lot of removing walls to make floor plans more open concepts and contemporary; that's just the world that we live in now, I guess. Awesome. Well, Brennen, are you ready for the Best Ever lightning round?
Brennen Degner: Ready. Let's do it.
Slocomb Reed: What is the Best Ever book you've recently read?
Brennen Degner: So historically, I've answered this question almost unanimously as Rich Dad Poor Dad, and I think that's a little redundant. My favorite best ever book now is Shoe Dog by Phil Knight.
Slocomb Reed: I'm really listening to it right now.
Brennen Degner: It's amazing.
Slocomb Reed: [unintelligible 00:18:34.18] means a lot. So well written; being a small business owner and a business builder, your brain and your gut read the book at the same time and --
Brennen Degner: It's like therapy. You read through it and you're like, "Oh my gosh, this guy, who's worth - however many billions of dollars, he's going through the same stuff that I'm dealing with right now", as he walks through the book. And then I still get chills when I think about it. I think it's like the last paragraph after they go -- I won't spoil it for anyone who's not read it, but the last chapter is specifically kind of leading up to when they go public for the first time, and the last paragraph or the last sentence of the book still gives me chills.
Slocomb Reed: For sure. It takes a lot for me to want to read or listen to something more than once, and I'm re-reading Shoe Dog right now. Great book.
Brennen Degner: Yeah.
Slocomb Reed: Brennen, what's your best ever way to get back?
Brennen Degner: I do you have a fair amount of work with the City of Hope in Los Angeles. That's been my one way in the last few years to do so. We did a golf event this last year, I've been active in their Walk for Hope, which is specific to women's cancers; my wife's mother passed away from ovarian cancer, so that's just been kind of something that we like to focus on as a family, and actively trying to find other ways -- I think one of the ways I continue to give back is we have team members that I went to the University of Southern California's master's in real estate development program, and I speak at that usually once or twice a year, and I've hired team members from that program, and continue to try and kind of build them. So from a philanthropic perspective, I'm most of involved in the City of Hope, and then just from a business/giving back perspective, it's definitely trying to stay involved with my alma mater.
Slocomb Reed: Thus far in your real estate investing career, Brennen, what is the biggest mistake you've made and the best ever lesson that resulted from it?
Brennen Degner: We've done a ton of mistakes, so this is always hard to answer... My partner and I tried to do -- I guess it would be considered like a co-GP fund with another family office, and the mistake that we made was we didn't really properly vet their resources and access to capital and what their true discretion was... And long story short, we ended up raising more money; we were supposed to be the operator, they were supposed to be the capital, and it just didn't go the direction that we had anticipated. And we actually raised more money than they did.
So we didn't do a good job of properly vetting our partners, and understanding who's responsible to bring what to the table for the partnership, or to continue to be a partnership, and that just ended up blowing up in our face, and took a while for us to pivot from. So as a best ever advice, I would say, if you're going into, especially an operating partnership, it's very different than transactional partnership on a single real estate deal. But if you're going into an operating platform with someone, you really have to know them; it really is a marriage. You have to expect you're going to be together for the next 10, 20 plus years. And so you have to really know who brings what to the table, and what value can you create together.
Slocomb Reed: On that note, Brennen, what is your best ever advice?
Brennen Degner: I think one of the reasons we -- at least in my line, we've grown so exponentially, so fast, is we're very focused. So we don't try and bounce around from one asset type to another; we try and do a lot of rinse and repeat. It's why we built a construction company that's specifically focused on value-add multifamily. Our management team is specifically focused on value-add multifamily; our acquisitions team same thing. I think that really gives us a leg up when looking at deals, especially because of the way we set ourselves up to only look at a finite number of markets around really trying to enter into new markets, unless we have like a team dedicated to them that's ready to scale.
So I think that level of focus and investing intentionally in these markets is what's allowed us to scale. And then on that note, it allows us to really learn from our mistakes and continue to iterate and get better, because we're not having to dive into a different business plan each time; we're able to take the last one, look at what we did right, look at what we did wrong, evolve from that, and make an execution that much better, and then much better.
Slocomb Reed: Last question, where can people get in touch with you?
Brennen Degner: Best place to go is our website. There's a form you can fill out; it goes to my email. I usually try and schedule some time each week to catch up with inquiries. So visit our website, DBcap.com, and fill out the form, and I'll reach back out to you.
Slocomb Reed: Brennen, thank you. Best Ever listeners, thank you as well for tuning in. If you've gained value from this episode, please do subscribe to our show. Leave us a five star review and share this episode with a friend you know we can add value to through our conversation today. Thank you, and have a best ever day.
Brennen Degner: Thanks, Slocomb. I hope to be back.
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