In today’s episode of the Actively Passive Investing Show, Travis Watts details how investment firms and investors are approaching multifamily post-pandemic, and strategies that are going to stick around from now on. He talks about how multifamily held up during the pandemic, how millennial lifestyles are affecting the future of multifamily, and moves investors should be making to prepare for the next recession.
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TRANSCRIPTION
Travis Watts: Hello, everybody, and welcome to the Actively Passive Show. I am your host, Travis Watts. I’ve got a really exciting episode for you guys today; it’s a topic that I’m actually going to be covering at a online webinar series, but I want to pull some bullet points out, make it a little more fine-tuned to this show and highlight some of the passive investing elements. So the title is How Investment Firms And Investors Are Approaching Multifamily After The Pandemic.
As always, some quick disclaimers – this is obviously for educational purposes only, I’m not giving any kind of financial advice/ I’m not a CPA, I’m not a lawyer, attorney, so please, always seek licensed advice. But with that said, I think you guys are going to find some really good takeaways from this. But I really want everybody to understand what happened in 2020 with multifamily, what’s happening right now, and kind of what’s that forecast look like moving forward.
So I’ve put together a little bit of an agenda, a couple of bullet points that I’m going to be covering in this episode is why multifamily is an important asset class before the pandemic, during the pandemic and post-pandemic, who’s the right fit for investing in multifamily private placements. It’s certainly not for everyone. What due diligence a passive investor should be doing before investing in this type of asset? How investment firms are focusing on risk mitigation today and moving forward? Lessons learned from the pandemic, pros and cons of investing in a multifamily fund versus individual deals throughout 2020 looking forward. And moves that investors should be making to prepare for the next recession, when that comes.
With that said, I will start with why multifamily from a macro level? We’ve hit on these topics before on the show, but I really want to give you at least my version of a pretty all-inclusive list as to why multifamily.
Number one is, the whole reason I got in this asset class in the first place was because of cash flow, and more specifically, because of monthly cash flow. And plenty of investments out there that will distribute on a biannual basis or maybe even a quarterly basis. But for me, the objective initially was to replace my W-2 income that I had years ago and the job I disliked, with monthly passive income.
And number two – this is something I didn’t realize till a few years in, but the tax advantages can be absolutely tremendous. So always work with a licensed CPA, and hopefully even a strategist, someone who can proactively help walk you forward to your goals. But a lot of people invest in multifamily and I should just say real estate in general, for the tax advantages – for the depreciation, for the cost segregation studies and the bonus depreciation that’s available right now in the tax code. These things change year after year, but if you really go back and you look at the history, there’s always been advantages to investing in real estate throughout the history of the United States.
Third, it’s an inflation-resistant asset class. I hate using the word proof so I always say resistant, but what I mean is when the cost of materials goes up, as we’ve seen recently with the price of lumber earlier this year spiking almost 300% – actually, it was a little bit more than that – and/or the price of wages increasing, which we’re seeing nationwide as well, that’s lifting the value of real assets like real estate. It’s not just applicable to new development and new construction, it’s also lifting the values of pre-existing real estate. I’m sure you can attest to that if you just take a look around in your own market, look at what’s happening with single-family homes right now, look what’s happening with multifamily if you’re tuned into that asset class… We’re definitely seeing that type of inflation happen right now.
Number four is diversification. I’ll share a quick story with you. When I used to invest in single-family homes, I had 100% of my portfolio in about a 30-mile radius; one market, one asset class — I won’t say one business plan, because I did different things with my properties… But I really wasn’t diversified and it started freaking me out because as I was projecting forward, as I’m saying, “Hey, what about in 10 years from now, 20 years from now, do I want to have 50 or 100 single-family homes in one location?” There’s political risk in that. What if there’s tax changes in the state that I was in? What if a natural disaster comes through? …a flood or a tornado, and wipes out all or half of my properties? You just never know.
And one of the biggest benefits to passive investing has been, over the years, to be able to partner nationwide on different apartment communities, different regions, geographic diversification, asset class diversification, sponsor diversification, meaning that I’m working with different operators… It truly is, in my point of view, even though I have a lot in my own portfolio allocated towards multifamily, I still feel like I am diversified. And of course, I invest, as I’ve said before, in self-storage, ATM machines, note lending and other types of investment models.
Next, let’s talk a little bit about volatility. So the private placement real estate or buying your own actual real property is a lot less volatile compared to the stock market. Some people will talk about investing in REITs (Real Estate Investment Trusts) that are publicly traded, and there’s nothing wrong with that strategy, and there’s definitely some pros to doing that, like liquidity, for example. However, you are subject to the volatility of the stock market in general. When the S&P falls, when the stock market in general is down 2-3 percent in a day or in a week, it’s not a guarantee, but it’s a high probability that your REITs are too, meaning your real estate. And there’s not a real good reason for that if the underlying portfolio is still performing and cash-flowing and rent’s still being collected. So you have to ask yourself that question, it’s really a question of risk tolerance – is that something you’re willing to tolerate? I came to the conclusion years ago, “No, that’s not something I’m willing to tolerate.” It bothered me enough when I had a small portfolio and I lost $1,000 in a day, but having a much larger portfolio and seeing a $20,000 loss here and there – I can’t stomach it, and that’s just a personal thing, but it’s something you should ask yourself if you’re comfortable with.
Private placements are also a hands-off investment, as in being a limited partner investing in a real estate private placement. My biggest problem when I was a W-2 worker and I was doing 100 hours a week consistently was, “Hey, I don’t have enough time to be flipping properties and taking all my spare days to go round up some new ones to close on, and to always show up to closings, and to be managing tenants or property managers.” It just wasn’t very scalable to me. And the most beautiful appeal is that this is a hands-off investment, so no matter what you do with your time full-time, this is something you can do on the side. It’s just about as hands-off as it would be to go buy stocks in a retirement account.
To that point, managing tenants was just, quite frankly, not my thing. I’m just not a very good manager of tenants, I don’t have a lot of patience. I don’t like to listen to excuses. I don’t like procrastination. I just was very frustrated and stressed out over managing tenants. Even when I had property managers, the issues are still there; they may be handling the phone call, they may be handling the email, but at the end of the day, what happened? Well, the rent didn’t come through this month; that’s a fact and the bottom line. That still stressed me out. And just having one tenant and one asset was kind of scary to me… Versus having, let’s say, a 400-unit apartment building that I’m invested in, and 50 tenants decide they’re not paying rent – it still isn’t making a major impact to the bottom line of the performance on the asset. We may have a little bit lower cash flow or something, but I’m not going from 100% occupancy to zero, and I’m not going from cashflow positive to negative, where I still owe HOA dues and property tax and insurance and maintenance et cetera, just because the tenant decided they weren’t going to pay, or they wanted to move out all of a sudden and break their lease.
I think we all know that baby boomers and millennials both are choosing to rent; this is really a lifestyle choice, and that’s something we hadn’t really seen historically, per se, and those numbers are really increasing. There’s so much—I could make a full episode on just the reasons for this, but you think about some of these baby boomers who maybe have these very large homes, these four or five, six-bedroom houses, had their kids there, their kids have now moved out, gone to college, and they’re selling these homes and they’re saying, “I don’t need all this space. Maybe I’ll just rent a place with a nice workout facility and a gym, maybe on a golf course, a little patio home.” There’s more single-family homes now that are becoming rentals, as in, master-planned communities that way, which is really a cool concept. I went to go look at a couple of those just from an investor perspective. They’re building right now – in over the last three years give or take – these master-planned communities that look, on the outside, much like a traditional neighborhood, but each of these single-family homes are actually rented out and owned by one asset or one management group.
Additionally, millennials are renting by lifestyle choice, just because job flexibility – maybe you’re starting a new job in New York, but you don’t know how it’s going to go, maybe you get laid off a year later and you don’t want to plop down all the fees to go close on a home and have an illiquid investment. My wife and I fit in this boat, where we just like to move just for the sake of moving sometimes, every two or three years. And it’s kind of fun to travel around, try different lifestyle types. We did a whole skyscraper downtown living, we’ve done the suburb living; we’ve lived in some really cool locations, and that experience was made possible by choosing to rent. I’m certainly not opposed to owning, I’ve owned a lot of different homes over the years, but I’ve also rented a lot of homes over the years. So you’ve kind of got to weigh that out for yourself, but it’s certainly a trend, not to mention the affordability crisis right now that we’re in, with millennials having student loan debt, getting married and not having enough for a down payment on a home. Home ownership is actually on the decline as we speak.
The data suggests that there is a shortage of safe affordable workforce housing nationwide. I think many of us are aware of that. What I’m talking about is not the term “affordable housing”, but the term “workforce housing”, so a Class B property, a 1980s, 1990s, where you still have maybe a pool and a gym and things like that, but it’s not luxury, it’s not the highest-end product type that you can live in. We’re talking about rents that are maybe $1,000 to $1,200 per month, not $5,500 in a downtown skyscraper, or something like that. There’s definitely a shortage, both in new construction and pre-existing product right now, for that type of housing.
There’s still a very high demand, both from Wall Street and what I refer to as main street investors. A main street investor is just an investor like myself, an investor perhaps like you. So yes, everybody’s chasing yield, everybody wants cash flow. We’re in a very low-interest rate environment, Treasuries are around 1%, corporate bond are around 2-3 percent, so real estate is still providing a very healthy yield for everyone.
Here’s a big one – the ability to leverage other people’s time, expertise and networks. After doing single-family for so long, I just one day had to look in the mirror and get serious with myself and say, “You know what – you’re not that great at what you’re doing, Travis. You’re not that great at these fix-and-flips, you’re not finding the best deals, you don’t have great profit margins… It’s just really competitive and really tough”, and I just, quite frankly was not a key player in that space, nor did I really want to be. At the end of the day, I was after cash flow and tax advantages. So investing in real estate private placements – you get to find groups who are dedicated and passionate on a full-time basis to doing what they do best – finding these properties, underwriting, raising capital, asset management, turning these things around. And that was a tremendous epiphany for me, around 2014-2015, to realize this was a real thing that I could do.
Investing as a limited partner can also mean limited liability, it’s something to definitely consider, when I was buying single-family homes, I’m the one signing the dotted line for the loan, recourse loans. These banks can come after me individually, they can take my assets, they can dig into my bank accounts, that kind of stuff.
When I’m investing in a syndication, I’m usually looking for a non-recourse loan. So if I go put $50,000 into an investment, I’m limited in my liability to the $50,000 that I put into the deal. So even if all hell breaks loose and everything in the world goes wrong, the max loss I’m looking at is $50,000. I don’t think a lot of people are tuned into that concept or that idea; I think it’s one of those things kind of like maybe with driving a car – we’re not thinking day to day about the liability that’s associated with that. It’s not until you get in an accident that you say, “Holy crap, I didn’t realize all the ins and outs of my insurance policy, or that this wasn’t covered, or that this could be considered my fault.” So it’s very similar to that, and it’s worth considering long term about your liability exposure.
Travis Watts: Scalability – huge. I talked a little bit about that example of investing in a 400-unit apartment building versus, let’s say, buying 400 single-family homes; that’s obviously a lot harder, you’ve got 400 different roofs and 400 different HVAC systems, and everything else. It’s much easier to invest with scale. Whether I’m in a limited partner investor in one deal or 100 deals, I’m not managing any of them, okay, I’m just scaling up my cash flow. Whereas before, every single-family home that I would acquire was taking that much more of my time, even if that only meant one or two hours a week, times that by every single property and all of a sudden, I’ve created myself a full-time job I didn’t intend to have.
Last but not least, this is an important one for some people – you don’t have to rely on your own credit or your debt-to-income ratio when you’re investing in real estate private placements, for the most part; there’s a few circumstances that may not apply to what I’m about to say. But in general, whether I invest in one syndication as an accredited investor, let’s say, in a 506(c) offering, or whether I invest in a 300, there’s nobody there saying, “Hey, look, you’ve got a lot of these investments, you need to stop; we can’t let you invest in this one.” So it’s very scalable in that way. And unlike when I did single-family and I ran into roadblocks at property number 5, 6, 7, because the banks were looking at me and saying, “Hey, guess what? You’ve got an awful lot of debt on your books, and we’re not going to give you a loan for this next property.”
Alright, switching gears a little bit – I want to talk about who is the type of investor that’s right for multifamily syndications. Well, [unintelligible [00:18:06].29] a lot of corporate professionals in my experience, right now I’m pulling from my investor relations side here and my knowledge there over the last several years, but you’ve got CEOs, VPs, presidents of company, you’ve got sales reps, you’ve got IT engineers and technology people… You’ve also got medical professionals; you have doctors, you have dentists, you have surgeons, you have anesthesiologists, you have radiologists, and the list goes on.
And then you have the other category – this is kind of where I fell into play; I was a highly paid W-2, I worked in the oil industry. So you’ve got those folks, you’ve got lawyers, professional athletes, business owners, entrepreneurs, that kind of stuff. But all of that to kind of wrap up in one box, to say, in general, accredited investors are high net worth, high-income individuals. Not every syndication deal, not every private placement is only available to accredited investors, but a lot of them are, and generally speaking, that’s who’s investing in these types of assets.
There were some changes to the definition of accredited investor in 2020; the SEC added a couple ways to qualify. But in general, from a high level, some of the common ways to qualify is if you’re an individual making 200,000 per year for the last two years, with the expectations to do the same or greater in the current year… If you’re single, one person, or if you’re married, just bump that up to 300,000, for the last two years, expectations to meet the same in the current year. We’re talking about gross combined income.
The other way you qualify is by net worth. So if you’re not the high-income earner, scrapped that, and you say, okay. If you’re a homeowner, just forget about that, push it to the side, exclude your primary residence. If you have a net worth of $1 million or greater by tallying up all of your assets minus liabilities, then you can be deemed an accredited investor, and that’s whether or not you are single or married. Some people confuse the two and think maybe it’s double if you’re married; it’s not true, it’s just $1 million total net worth, married or single.
What the SEC changed in 2020 is they extended this definition to say, “If you have a professional financial license, something like a series 7, series 82, series 65 license, you could be deemed accredited,” because you obviously have the know-how of the risks and the structure and what private placements are, and how they work. In most careers where you’re holding those licenses, you may even be selling those products. So they went ahead and extended it to have more people be able to qualify under the definition.
Last but not least, if you have a trust or an entity or an LLC that has $5 million or more in assets, then the actual entity itself could be deemed accredited just based off of that, even if some of the investors inside that entity may not be accredited. And if the assets are under $5 million, then generally speaking, each of the owners of that entity need to individually be accredited investors to participate in an accredited offering.
Alright, I know we’ve covered a lot, but a few more things that are critical here – how did multifamily hold up through the pandemic or through 2020? And I just want to kind of go over a general timeframe of what I found the psychology to be last year. I’ll start with the spring, so I’ll start from March of 2020 through maybe May of 2020.
The focus for a lot of us whether we’re investors or whether we were active is safety, number one, of course. Everyone’s concerned about safety. We’ve got this virus going around, we don’t know what that means… So we paused our renovation projects on these value-add properties temporarily, one for safety; two, because we didn’t know what kind of liquidity we were going to need in these projects to maybe offset any dips or catastrophic events that may or may not happen.
Communication was key; that would mean, from an asset manager perspective, communication with your property managers, and from your property managers to your residents. Collections were top of mind, making sure that rent was still coming in. I think a lot of us thought, initially, everyone’s going to quit paying rent or everyone’s going to move out, so resident retention was top of mine; how do we keep people in these properties? How do we work with our residents, so we don’t have to deal with an issue like that?
Now I’m going to skip into the summer, let’s say June through August, kind of the bulk of the summer. Well, we had safe reopenings, following all the CDC guidelines and the mask mandates. But hey, it’s the summertime, we want to open the pools for residents, we want to have barbecue areas, no one wants to sit cooped up all summer in their home… So where applicable, that’s what we decided to do. And simultaneously, we were able to safely resume the renovations on the properties, still with an emphasis on collections throughout that period.
Moving from more of the fall until – I’m just going to skip all the way to the present here, so almost the last 12 months, we’ll call it the last 10 months or so, return to normalcy. Well, returning to the new normal, let’s say, I don’t know that we’ve quite returned to normalcy. But collection’s still being a high priority and we’re able to push rents, because we’ve now seen the massive demand for both people needing a place to rent that’s affordable, and also with the housing crisis and the huge influx and inflation we’ve seen in single-family homes – it has pushed a lot more people into needing to rent, so we can conservatively bump rents.
So that’s just a really quick recap of 2020 through present and what I’ve experienced myself with my own portfolio across different operators, my general perspectives. You may have experienced something different, but in general, that’s what I’ve seen.
So let’s talk a little bit about what due diligence a passive investor should do before investing in multifamily here in 2021, and looking forward. First and foremost, it’s always been important, and it remains important to research the sponsor. What we’re looking for there is track record, experience, consistency in business model – are they doing the same thing over and over? Asking the difficult questions, running Google searches, background checks if applicable to you, if that’s important… Just getting a really good feel, does this operator know what they’re doing? And the more they know and the more track record they have, the more likelihood that their deals are going to succeed.
Understanding the risks – this includes reading the PPM, the Private Placement Memorandum associated with this type of investing, the operating agreement, the subscription agreement, talking with the general partners and the operator about the risks, maybe even leveraging your own legal team or your own attorney or lawyer to talk through what these things mean, how these apply to you and making sure you’re comfortable making an illiquid investment.
To that point, there’s obviously pros and cons with this kind of investing; we’ve outlined that numerous times throughout the show, so check out almost every previous episode we’ve ever done here on the Actively Passive Show, but I’ll give two examples – a pro, the tax benefits. So you’ll want to get with your CPA, and how does that affect you? What does that mean for you? Is that helping you achieve your goals? And maybe a con is that this is an illiquid investment, so you know, you have to put your money in and let’s say you don’t get that money back for five years, are you okay with that? What if you have an emergency come up? Do you have cash reserves to bail you out in those situations? You never want to be putting your last money or your only money into deals like these.
Last but not least, does the business plan and the philosophy of the operator align with your goals? And I want to talk about this, because it’s so important. Everybody’s got their own criteria, everybody’s got their own goals. What’s important is you want to try to reverse engineer. You want to first say, “What is my goal? What is my long-term objective? And then how do I get there through investing?” And let me give you two examples of two types of investors I come across on a weekly basis.
So we’re going to take two examples here, Sally, and John. So Sally is, I don’t know, let’s call her an IT professional. She works 60-80 hours a week, she really enjoys her career. However, she doesn’t enjoy working that much; maybe she’s got kids at home, etc, and it’s just a big workload to have. So her goal is to generate $10,000 per month in passive income, to allow her to switch from that full-time work schedule to a part-time work schedule. So her goal is $10,000 a month passive income.
Whereas John, on the other hand, let’s say John just says, “Look, I want $3 million as a net worth so that I can retire at age 50.” And let’s say John is 40 right now. So these are going to be completely different objectives, with different criteria, and there’s going to be different business models that are perhaps suitable for either of these folks, I want to highlight that for you.
Again, just to reiterate, these are example purposes only, this is not financial advice to you or anyone else, these are made-up characters. But let’s say that Sally given her goal of $10,000 a month passive income; she likes multifamily and self-storage as far as sectors or asset types. Maybe she likes value-add and core plus business models or risk profiles. And then as far as her criteria, maybe she likes monthly distributions, she’s cashflow focused, she prefers syndications over the stock market or publicly-traded REITs. She likes B and C class assets in the suburb markets, in the Sun Belt regions, for example. That type of model would allow Sally to accomplish what she’s looking to accomplish, in that she wants to build passive income on a monthly basis.
Whereas on the flip side, John – he may be completely different; or maybe he’s not completely different. Maybe he does like multifamily. But let’s say John works in the hospitality sector, so he wants to invest in some hospitality deals as well, maybe some hotels, for example… And he likes new development, new construction; opportunistic risk profiles, meaning maybe you’re going to do a hotel-to-condo conversion, or something like that. He might not care about distributions, because he’s got a 10-year horizon, he doesn’t need the cash flow right now, he has an active job, so maybe he’s just in it for the equity. He wants to buy low and sell high and higher risk, higher reward kind of stuff. Maybe he likes A class, luxury, high end units. Maybe he likes the urban and the downtown environments, not the suburbs, and maybe still like Sally in the Sun Belt region. So we’re all different, and what matters is your goal at the end of the day, and what’s going to help you achieve that.
Next thing I want to cover is what has changed since the pandemic? Well, the biggest thing from my perspective looking at deals is everybody pre-pandemic was talking about the deal itself. “Here’s the age of the deal, here’s the paint color, and here’s what we’re going to do with the roof, and here’s the amenities that we’re going to upgrade.” Well, that all shifted to a focus on the renters. Who are my renters? Where do they work? What is their income? Are their jobs recession-resistant, we’ll say? Are our tenants working in the medical industry and local hospitals, versus are our tenants working on cruise ships, part-time or seasonally? That’s going to make a very big difference on whether or not your tenants can actually pay the rent. And to that point too, a lot more shift and focus on the market. People leaving California – where are they going? Well, a lot of them are going to Texas, some to Nevada, some to Arizona. Okay, let’s go to the East Coast; people leaving New York, and New York City specifically – where are they going? Well, the Carolinas, Florida, Georgia, etc. So there’s been a lot more emphasis on renters and the market, and a lot less on the deal itself.
The last thing I’ll say on this topic is, is the property you’re buying conducive to work-from-home situations? In other words, are you buying a multifamily project that it’s all studios and one-bedrooms? Or are you buying two-bedroom and three-bedroom units, with maybe a den or an office space, or maybe a co-working space that’s on-site? These are things that you want to think about; maybe even a value-add plan that you want to implement on the property you’re purchasing.
So how firms are focusing on mitigating risk for investors?
I’m going to go portfolio-wide again, speaking with a lot of operators that I work with; I’ve done a lot of phone calls with them, watched a lot of their presentations, webinars, monthly updates, quarterly updates, etc. The first thing is, as we talked about, you still want to focus on location. That’s the name of the game with real estate, always has been. I think we all know the old adage, “Location, location, location.” But also quality. What I saw in my portfolio is the Class A properties actually performed the best throughout the pandemic, as far as collections and occupancy. The class B, as you take a step down to those older properties, not quite as nice, that had more of a delinquency. And as you step down to class C – and I only have a couple in my portfolio – they actually performed the worst of all. So your tenant demographic makes a big difference, and to focus on the quality of the asset would be the best advice I can give.
Financing strategies, when you’re looking to do loans or you’re looking to invest in a deal. Understand the difference between an agency loan and a private loan; there’s pros and cons to both, but I can tell you, if you go with an agency loan, like a Fannie Mae, Freddie Mac, that kind of thing, there’s often really high prepayment penalties, so whether you want to refinance or sell early, it could make it very difficult to do that. So you want to be aware of if the general partner is getting that kind of loan – that’s a possibility – versus a private loan, which could have a lot more flexibility. But they both have pros and cons.
Another risk mitigation strategy that I’m seeing groups do is just taking chips off the table; properties they may have bought three, four or five years ago, and maybe wanted to keep holding for cash flow, they’re saying, “You know what, the market’s up, the markets hot. Let’s go ahead and sell. We can give our investors a nice solid return right now.” So that’s been nice. I have several properties this year, 2021, that are selling, and it’s nice to have those equity pops.
Travis Watts: The last thing I look for as a passive investor, generally speaking, is a group that’s vertically integrated, meaning they’re doing their own property management on their own assets, and/or doing their own construction on their own deals. It’s not always the case, I can’t always make that my criteria, but if you can find groups doing that, it’s certainly a cost savings, both on the GP and the LP side.
I’m going to cover this next one quickly, because we actually did a full podcast on the pros and cons of investing in a fund versus individual deals. But quite frankly, over the last 12 months, I have seen a lot of general partnerships move towards a fund model, and that’s why I want to address it. In fact, just this week, there’s two more funds with groups I invest with that have launched a fund model.
One is the time commitment – again, who’s investing in these private placements? Busy professionals; let’s just sum it up as that. Do you want to have to do due diligence individually on each property 5-7 times per year if that’s the amount of deals you’re doing, or do the due diligence once on a fund that’s going to acquire 5-7 properties? One investment, one time, and then being diversified that way. That’s a huge one.
Two is what I talked about earlier, diversification. Sometimes it’s regional asset type, sometimes it’s sponsorship type, but it’s very nice… Let’s say I put $100,000 into a fund that’s going to have five assets in it; I’m really allocating approximately $20,000 per property in that scenario, and not having to do $100,000 investment in five individual deals where I’m half a million out of pocket.
More consistent and stabilized returns. I tell you, you guys, sometimes you just got to let go of that ego. I used to think I could pick stocks that were going to outperform, and I lost money. I used to think I could pick individual real estate assets that were going to outperform, and thankfully, I haven’t lost money, but not everything has really panned out the way I thought it might, so I’m really not as good as I thought. And just quite frankly, it’s not even about being good, it’s sometimes things are out of your control. You bought a property and there was some foundation issues that popped up, there was a hurricane that hit the property, or a flood… We’ve seen the freeze out in Dallas, Fort Worth, the flooding out in Houston… These are kind of unprecedented natural disasters that really haven’t happened in a very, very long time, if ever, and sometimes that just happens; it’s the real world.
So to the point of some assets in a fund maybe outperforming projections, while others may be underperforming, but if you mesh the two together, you kind of get a more aggregate and stable consistent return that way. And you could again, draw the parallel between stock investing – it’s like buying an index fund or an ETF that owns a bunch of stocks versus trying to handpick which ones you think are going to do great.
Last but not least, I don’t know about you guys and your CPA, but I have a fairly expensive CPA, and every time I get a new tax form like a K-1, for example, which is common for these private placements, I have to pay another $200 approximately for every single K-1. So in a given year, if I go invest in five deals, that’s a lot of extra cash; I’ve got to fork up another $1,000 for my tax return. When you invest in a fund, usually, but not always, you’re getting what’s called a consolidated composite K-1 tax form; so even though there’s maybe five properties in the fund, I’m getting one K-1 tax form at the end of the year, which really helps offset those costs.
Last thing I’ll say about funds is if you’re going to launch a fund or you’re looking at a fund, it’s usually an experienced operator that’s doing that, someone who has the ability to raise a large amount of capital. It’d be awfully difficult to go read a book or attend a little bootcamp over the weekend, and then the next Monday say, “Alright, I’m going to go raise $100 million and launch a fund.” Very difficult to do that. So these are usually groups that have experience and track record, and now are confident that they can go raise that $100 million, for example.
Alright, moving on to the cons with a fund, because there’s certainly cons. First of all, you’re placing a lot of trust in the operator; the operator is going to tell you up front, “Here’s our fund, this is what it is, these are the markets we intend on purchasing in, these are the assets we intend on buying, this is the size, these are the debt terms, etc.” But really, you’re going to have to trust that the operator can do that and will do that for that fund.
So it can be what’s called a blind pool fund sometimes, where you or I have to put in money upfront, and then we just have to wait and see what actually gets put into that fund. If the fund’s going to be open for six months to a year, you could maybe wait six months, see what’s been happening, if things are going well and according to plan, if you like the deals that are being acquired, and then decide to take the leap and invest at that point. Sometimes the cash flow in the first year especially could be lower than doing an individual asset, because it’s what’s called a rolling close. So investors are putting in capital, but maybe the deal is not purchased yet, so that’s kind of dwarfing the cash flow a little bit, because they’re sitting on more cash than they have assets. So you might be looking at 4% or 5% or 6% year one cash flow, instead of maybe 6%, 7%, 8% or 9% cash flow year one, something like that. This is not always the case, of course. These are questions you need to ask the operator, there’s other things you need to look for in the overview; I’m just pointing out a few things to consider.
And because it is a fund model and it may take six months to 12 months, sometimes even longer to launch and get stabilized, the timeframe or the hold period may be longer. Some individual deals I invested in said, “We’re going to have a five-year hold period”, but they ended up selling in 18 months. Well, that’s not always going to be the case with the fund, because you have other assets to consider. So you may have to wait till all the assets are sold to be exited from the fund; that could actually take more than five years in some cases. All things to think about, these are questions you need to ask yourself about your own risk tolerance and goals, criteria and see what meets your objectives.
The last thing that I want to share with you in this episode is a story of mine from 2015 when I was first transitioning into passive investing, and I did a quick Google search, and I found a very well-known, established general partner operator, and I’m not going to name names just for sake of what I’m about to say, but I had a very good conversation with this individual, and I’m saying, “Please put me on your investor list. I’d love to participate in your deals.”
And three quotes that stick with me from that conversation are this – this general partner said to me, “Travis, first of all, we’re going to see a massive market correction in 2016. We’re not buying multifamily at this time or even in the foreseeable future. In fact, we’re selling most of our portfolio right now, and we’re going to sit on the sidelines and wait for this correction.” Mind you, this is a general partner with 25+ years experience, and I’m so glad that I didn’t take all of that to heart. And this is the lesson in the story, is you’re always going to have people and headlines saying, “Big scary news coming out. Market crash next week”, stuff like this.
In fact, I want to share with you — I wish I could share the visuals with you right now, but I do want to share with you some of these predictions and headlines since the day I had that conversation in 2015. The first was a webinar – I know you can’t see my screen, but this was in 2016; it’s from Robert Kiyosaki, Rich Dad Poor Dad, and it’s sign up for the 2016 predictions webinar in January of 2016. The topic is, How To Profit From a Crisis And a Crash. 2017, David Stockman, here’s the headline, Sell The House, Sell The Wife, Sell The Kids, Sell Everything. 2018, Peter Schiff, headline, “Coming Financial Crisis Will Be Worse Than The Great Depression”, says Peter Schiff. Steve Parcell posts a video, 2019, in July, 2019 Crash Incoming; burning cash in the photo. 2020, Bill Ackman, famous hedge fund manager, Hell Is Coming, America Will End As We Know It: The Great Depression Of 2020. Harry Dent, headline, 40% Stock Market Crash By April 2021. And my favorite, I wish you guys could see this, but he says – Harry Dent, another headline in another podcast he was on, he says, “If I’m wrong this time, I will quit my job.”
And guys, I share this with you, not to make light of the situation; recessions and crashes are very catastrophic things, they wipe out so much wealth, especially from the middle class. But if we look at the stats and facts of what has multifamily done from 2015 through 2021, it is up, up, up and away. Okay, what has the S&P done? Up, up, up and away. Yes, we had a blip in the radar in March of 2020, where we had a correction, which rebounded in a matter of months. And I share that with you because – three things; one, identify your goals. That’s so important. And number two, identify your criteria that’s going to help you meet those goals; and number three, if you’re going to try to time the market, be very careful that you’re not sitting around in cash, getting eaten alive by inflation, as you wait for this big crash that may or may not come. And of course, it’s going to come eventually, we always have these, it’s a cyclical thing. But what if you had to sit on the sidelines, like this individual did in my story for 5-6 years, while you could have potentially doubled your money or something like that. It’s really a tragedy, I hate to see it, but just know that those scary headlines are always going to be out. Even if we have a market crash tomorrow, I guarantee in two months after, they’re going to say, “Oh, it’s going to get worse next month.” So just be aware that that’s a thing. And you can google all these types of headlines, historically speaking, and see what I’m talking about.
Here’s the quote, I’m going to end on; it’s my own quote, and it’s, “Everybody has an opinion, but the only opinion that matters is your own.” And I always come back to that conclusion. I definitely like to listen and hear and learn other people’s perspectives and opinions… But what I do is I’ll listen to, let’s say, 10 different “experts” and their advice, and then I’ll take a step back, and I’ll kind of reflect on that and say,” What makes sense to me?” And based on my own circumstances, do I agree with that, do I not? Or who in particular do I agree with and for what reasons? It’s not easy to do, but it’s a very effective strategy that I’ve never taken one person’s opinion or strategy for that matter to heart, and everything they say goes.
Thank you guys so much for tuning in today. I’m going to go ahead and wrap up here. This has been Travis Watts, the Actively Passive Show. If you have any questions, please reach out to me, I’m on nearly every social media platform and joefairless.com, travis@ashcroftcapital.com. However you want to reach me, I’m happy to help you. And any questions you have, feel free to email or set up a phone call. Until next time, thanks again.
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