JF2097: Insight in Development Deals With Preston Walls

Preston is the CEO and founder of Walls Property Group, he currently manages a portfolio of 70 buildings valued over $300MM. Preston shares his experience through starting in residential to now development deals. Joe asks Preston to explain some different challenges he has faced in the development world so you can be better prepared if you choose to venture on this path.

 

Preston Walls  Real Estate Background:

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“It was helpful to move forward with something in the face of somebody you respect and trust pointing out the reasons you should not do it.” – Preston Walls

TRANSCRIPTION

Joe Fairless: Best Ever listeners, how you doing? Welcome to the best ever real estate investing advice ever show. I’m Joe Fairless. This is the world’s longest-running daily real estate investing podcast where we only talk about the best advice ever; we don’t get into any of that fluffy stuff. With us today, Preston Walls. How you doing, Preston?

Preston Walls: I’m doing great, Joe. How are you doing?

Joe Fairless: I’m doing well and looking forward to our conversation.

Preston Walls: Hey, likewise.

Joe Fairless: A little bit about Preston – he’s the founder and CEO of Walls Property Group, currently manages a portfolio of 70 buildings valued over $300 million, he’s got 16 years of real estate experience, located in Seattle, Washington. So with that being said, Preston, do you want to get the Best Ever listeners a little bit more about your background and your current focus?

Preston Walls: Yeah, I grew up in a real estate family. My grandfather was a professor and started a student housing business on the side, and my father’s a real estate developer, so I grew up with it in my blood. I went to school on the East Coast and worked in Manhattan for a few years; I thought I’d get away, but they called me back and I’ve been working in industry since 2002; moved back to Seattle, I worked with my dad for six years, we did some ground-up together and some renovations, and the downturn came, and he said it’s time for him to move on, and I’ve been doing it on my own since then.

Joe Fairless: Well, what did you learn from your dad? I know that it’s such a open-ended, broad question, but just some highlights.

Preston Walls: Two things come to mind. One, just the practical skill aspect of being a developer and what it takes to put a new construction development together. That was really valuable, just as a skill set. The other, he’s been a critic of mine as well, and if there’s ever a reason not to do a deal, he’s the first one to point it out. Especially in the early, early years, where you’re trying to get over the hurdle of, “Should I do this? Does it make sense?” Just trying to get the conviction and the confidence to do it, it was helpful to move forward with something in the face of someone that you respect and trust pointing out the reasons you should not do it.

Joe Fairless: It was helpful to move forward in the face — so going against what someone who you trusted said not to do? Did I hear that correct?

Preston Walls: You have to be really committed and feel really strongly about the deal to move forward with it, to purchase it, when someone is pointing out the way that it could go wrong.

Joe Fairless: Someone with more years of experience, someone who is very familiar with you, and you’re familiar with them, and you know likely he has the best intentions for you. So how do you ultimately – and if you have a specific example, even better – come to a realization that “You know what, I know he has the best intentions and he has more experience, and he’s saying I shouldn’t do it, but for XYZ reasons, I’m going to move forward”?

Preston Walls: One deal comes to mind. I was living abroad at the time, but I’d managed to put this building under contract. I had done my due diligence from afar as much as you can do without seeing the property. He was in Seattle and attended the walkthrough inspection, and–

Joe Fairless: What type of property?

Preston Walls: It’s a 26-unit multifamily building in Seattle. And his report was there are five active leaks in the parking garage and it wasn’t raining out. So you’ve got water issues, there’s a lot of deferred maintenance, the tenant quality in some of the units is fairly poor. He said roof needs to be replaced, “You should not buy this building. I would not buy this building.”

Joe Fairless: Very good summary, yup. Okay.

Preston Walls: He got caught up on all of these– maybe multiple plumbing leaks are not cosmetic things, but he got caught up on what I viewed as resolvable, fixable items, and the price that we were under contract at was at discount enough for fixing everything that could possibly be wrong with it. So I moved ahead anyway with that property and I still own it today; it’s been a great investment. What number transaction was that in terms of your transaction history?  It was probably in the 12 to 15. But even the first transaction that we did, this dynamic played out the same, same way.

Joe Fairless: Really?

Preston Walls: I remember it was a triplex in Seattle, and the first deal you do is the hardest one to get over that hump, and I had created so many models of so many properties that were listed, and I had done the architectural work, adding another unit to the building and doing some work in the existing units… I had bids from contractors, I had all of these variables ironed out, and he was still telling me of all the things that could go wrong and the reasons not to do it. And I moved forward with that one as well, and I still own that one today, and ultimately, he was supportive of my decision and congratulatory of how the deal played out, but it was hard getting there.

Joe Fairless: You mentioned number one, that the thing that you learned was the skill set required to put a development deal together. I’ve never put a development deal together. I have a lot of respect for developers, because of all the stuff that they go through, and some of it I’m not even aware of. What are the skill sets or some important skills that are required for being a developer?

Preston Walls: One of the biggest ones or probably the hardest one for me is capacity to take risk, because you’re in markets where entitlements take a long time. The soonest you can acquire the land and deliver the product is probably five years in Seattle. So you’re looking at a really long timeframe between when you start spending money and when you eventually see a return on that investment. So a lot can change over that course of time and you need to be able to withstand financial– your balance sheet needs to be able to withstand that, and you need to have a pretty accurate idea of where things are going to be. And that’s rental market, that’s construction costs market, that’s cost to get there, that’s carrying costs, all of those things that go into it. That’s probably the most challenging one that I face.

Joe Fairless: High level, you said the soonest is five years. What is that timeline and just walk us through high-level steps from day one to year five?

Preston Walls: I’d say, three years for entitlements. So you purchase property, you need to get a master use permit, which is the permit that allows you to apply for a building permit; get your master use permit, then you can apply for the building permit. So roughly three years for that. 18 months for construction, six months for lease-up and financing.

Joe Fairless: Got it. You’ve gone through the entitlement process. What are some things that surprised you when you first went through it?

Preston Walls: Wow. There’s so many unknowns and uncertainties, and you’re continually learning new ones. Environmental risk is big. I’m building a site now that’s on a steep slope. Just to get the variance to build in an environmentally critical area added probably another 18 months to the process. Historic risk is another one that you don’t really know when that’s gonna pop up. So there are historic zones and historically designated buildings, but there can be historic aspects of a building, a facade that the local jurisdiction wants to keep, and that can significantly hamper your project or the scope of what you want to do.

Joe Fairless: Have you come across that?

Preston Walls: I have. I purchased a building in a historic district. The structure itself separate from the district had a historic easement on it, which meant that I couldn’t alter the exterior facade of the building. Didn’t say anything about the interior; the interior is essentially open for redevelopment, whatever you want to do. But ultimately, the combination of those two, having to get approval and sign off in order to get a permit from both of those entities was painful and time-consuming, and ultimately, I moved on to a different deal.

Joe Fairless: Do you currently do ground-up development?

Preston Walls: I do. I’m building a 60,000 ft building right now and I’ve got another project that should break ground later this year.

Joe Fairless: So you love the pain. You’re in it and–

Preston Walls: Well, I feel that ground-up construction is really fun. It’s really challenging, it’s exciting. I love the vision component of seeing a site, seeing what it can become and producing something there, but it’s hard from a risk standpoint, it’s hard from a balance sheet standpoint, it ties up a lot of liquidity and it ties have a lot of risk on your balance sheet. So I use it sparingly and I do the projects relatively infrequently. The value add syndication is my bread and butter, and there’s a lot less risk in taking an existing asset, making it better, repositioning it and turning it around more quickly to stabilize it.

Joe Fairless: So just from an internal assessment standpoint, whenever you’re looking at an opportunity, what must be in place in order for you to do ground-up development, since as you just mentioned, value-add, lower risk and less headaches– you didn’t say that, but I’m assuming that’s the case. So what’s gotta be there?

Preston Walls: There has to be a really good opportunity and a really compelling reason. The reason is usually a vision component that the market hasn’t seen. So the building I’m working on now that’s under construction, I bought it on a cap rate because a previous developer had tried to entitle it and did a half-assed job with it with the city, and the city responded with a public record notice that said, “You cannot build on this site.” So the broker that was selling it was hamstrung by that. He couldn’t market the development opportunity with this knowledge from the city, or with the city’s decision ruling on it. So it worked on a cash flow basis, and I got the development potential as a zero cost option to work on. So that became a side project in parallel to operate in the units that were there. And you go one step down the road and if you’re successful, you go to the next step, and all of a sudden, I had variants from the city to build a building there, and then I could move forward. So I’ve got to have a strong value proposition that gives me a cost advantage over the rest of the market. That helps me feel more comfortable on taking the risk of going into development site.

Joe Fairless: So tell us about the deal that you’ve lost the most amount of money on.

Preston Walls: Probably the worst deal I did was the historic one, and part of the reason I bought it was the purchase price was really low.

Joe Fairless: What was it?

Preston Walls: It was $450,000 for this commercially zoned retail property on a main street in Seattle. So I sold it for 20% more than that, but I lost a year and a half of time, opportunity costs that I could have been doing something else. So that was frustrating.

Joe Fairless: That’s pretty good though, if you haven’t lost money on any deal, and the worst deal is that you made 20% on the purchase price. I understand opportunity cost is in play, but from a dollars and cents standpoint…

Preston Walls: Well, the other factor that goes into it is I’m typically not a seller of buildings. I’ve only sold three or four properties over my career. So my goal is to own properties for long term, not sell them and hang on and realize the cash flow that they produce.

Joe Fairless: What are your thoughts on selling them and then doing a 1031 and going into a larger deal with more cash flow? I know you’ve thought about it.

Preston Walls: Oh, I’ve definitely thought about it. Every time I think about that, every time I’m tempted by it, my mind goes back to Robert Kiyosaki and the question of whether you want to carry buckets or you want to build a pipeline. And it’s tempting to carry some buckets and make some money, hire some bucket carriers, but ultimately, the pipeline business is holding on to assets long-term and getting the cash flow from them.

Joe Fairless: Just help me understand a little bit more, because with the 1031, you are still holding on to the pipeline; you’re just building it out with new parts. So help me understand that.

Preston Walls: Yeah, there’s a leakage from your pipeline every time you transact. So there’s frictional transaction costs. It’s expensive to buy and sell property. There’s overhead on your part as the sponsor to find a new deal. There’s risk of not finding as good a deal as the last one. There’s time involved in creating and reproducing it, all of which is time that you could spend working on another deal, a new deal that’s more [unintelligible [00:17:34].19] to your portfolio.

Joe Fairless: I love it. Thanks for sharing your thought process. It’s good to hear.

Preston Walls: I get a lot of pushback on that one. In my syndications, that’s part of what you’re signing up for with me, is not having an exit timeframe. My LLCs are open-ended and I plan to hang on for a long, long time, and it’s hard to think about assets, real estate that way when the majority of the market is on a five to eight year time hold horizon.

Joe Fairless: What did you do in Manhattan for a few years before you came back to Seattle?

Preston Walls: I was an indentured servant in a couple of different investment banks.

Joe Fairless: Okay. Any takeaways you got from that, that you’ve applied to the real estate business?

Preston Walls: Yes. My breaking point occurred about 7:00 p.m. one evening. My cubicle was across the hall from an office. It was the guy’s office that you want to sit in, it’s where you want to get to, and every night that he was not traveling, he said goodnight to his kids on speakerphone from his office and it tore up my 20 something year old soul that — I hadn’t started thinking about having kids, but I knew that that was not where I wanted to be, a working for someone environment; I wanted the passive income that would allow me the flexibility to work when and as much as I wanted to.

Joe Fairless: How soon thereafter did you quit?

Preston Walls: I think I lasted four or five more months after that. My dad had been working on me for years to come back to Seattle, but I was certain that I was going to work on Wall Street and that’s what I wanted to do.

But ultimately…

Joe Fairless: [unintelligible [00:19:21].26]

Preston Walls: It sure did. [laughter] I moved back and we started renovating apartment buildings together, and I haven’t looked back since.

Joe Fairless: Based on your experience as an investor, what’s your best real estate investing advice ever?

Preston Walls: I would say don’t be afraid to go really deep into a narrow niche. I see a lot of investors that get distracted by the shiny new thing. There are so many different ways to be successful in real estate. Success for me has come from being really narrowly focused and concentrating on a specific niche, which is multifamily in a narrow geography within Seattle.

Joe Fairless: What’s your narrow geography within Seattle?

Preston Walls: There are five zip codes within Seattle that are within a 15-minute drive from my office. That’s my geography.

Joe Fairless: Have you ever bought outside of those five?

Preston Walls: I have not.

Joe Fairless: How many transactions have you done within the five? About.

Preston Walls: 40, 45.

Joe Fairless: So I introduced you “manages a portfolio of 70 buildings” so I’m assuming multiple buildings within one transaction.

Preston Walls: Some of those buildings are buildings that I had managed for my family, and we have a small third-party property management business as well.

Joe Fairless: Got it. What’s the name of that company?

Preston Walls: Walls Property Management.

Joe Fairless: Okay, I understand where the name came from. We’re gonna do a lightning round. Are you ready for the best ever lightning round?

Preston Walls: I sure am.

Joe Fairless: Alright. First, a quick word from our Best Ever partners.

Break: [00:20:58]:06] to [00:21:37]:02]

Joe Fairless: Best ever book you’ve recently read.

Preston Walls: The Snowball by Alice Schroeder.

Joe Fairless: What’s a mistake you’ve made on a transaction?

Preston Walls: Not understanding/respecting historic designations.

Joe Fairless: What about something we haven’t talked about? Maybe on a recent deal where you wished you would have done a little bit different?

Preston Walls: I’d say environmental on an acquisition where a bank was not involved. So a bank did not require– a phase one was paying cash, and that came back to bite me on a subsequent refinance round.

Joe Fairless: Okay, so the takeaway is always get a phase one.

Preston Walls: Yes.

Joe Fairless: What’s the best ever deal you’ve done?

Preston Walls: I’d say it was the first triplex that I did. Just being able to have the conviction to buy something with a lot of reasons not to. I still own it. It feels good to still own that asset.

Joe Fairless: How can the Best Ever listeners learn more about what you’re doing?

Preston Walls: Our website, wallspropertygroupre.com. We’ve got newsletters up there and I’d love to connect with people if you’re ever in Seattle or want to chat. Look me up.

Joe Fairless: Preston, thanks for being on the show. Thanks for talking about your experience, what you learned from your dad who was a real estate developer and you worked with him, the entitlement process, what are the components of that process, and then also why you do not 1031, and why you focus on long term holds and building out, to use your metaphor – pipeline versus having the bucket. So thanks for being on the show. I hope you have a best ever day and talk to you again soon.

Preston Walls: Thank you, Joe.

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