Slocomb Reed sits down with seasoned commercial real estate expert J.D. Schmerge to deep dive into the dynamics of the ever-changing market from decoding property valuations to the art of bridging sellers and buyers.
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Transcript
Slocomb Reed:
Today's episode is brought to you by Presario Ventures, a private equity real estate firm based in the booming Austin, Texas market. To learn how you can invest in the future of Texas with Presario Ventures, visit info.presarioventures.com forward slash best ever. That link is in the show notes.
I'm Slocomb Reed. Today we're joined by JD Schmerge. JD is a friend of mine here in Cincinnati, Ohio. He's a multifamily broker. He's the director of multifamily with the brokerage Si Vales Vallejo. I'll let him explain what that means. He also has a short-term rental, I believe, in Northern Kentucky here in Cincinnati. How long have you been focused on brokering multifamily, JD?
JD Schmerge:
About six years now. Why don't you tell us a little bit more about your background and what you're currently focused on?
JD Schmerge:
I come from a non-real estate background, was in the IT staffing and consulting industry prior to real estate. And about six years ago, decided to make a transition and dove right into multifamily brokerage at Marcus and Millichap and joined a great team over there and got up to speed and learned the ropes there. Had a great five and a half year run and actually just about six months ago for a number of reasons decided to make a change over to where I am now more of a startup boutique brokerage in SVV. So that brings us up to speed here. Still doing the same thing, predominantly 50 units and under multifamily here in Crager, Cincinnati, Northern Kentucky area.
Slocomb Reed:
Quick question, JD. Thinking about our listeners who are service providers and vendors in this space why move from a name that every single one of our listeners can recognize in Marcus and Millachap to a name that none of them have heard of and most of us can't pronounce?
JD Schmerge:
Yeah. Great question. So it was a couple of things, but ultimately I wasn't using the platform that is advertised with some of the larger firms, if you will. Everyone kind of creates their own client database, if you will, after a number of years in the industry. And those are the clients you prefer to work with. And we're doing most of our transactions through our own database. We're not throwing deals up on the MLS or other listing sites and waiting for the market to come to us. Most of the deals that we're doing are with clients who we have established relationships with. So I feel I could do that just as well or better and have a little bit more flexibility with our business at a smaller firm.
Slocomb Reed:
That makes a lot of sense. JD, 50 units and under multifamily is a segment of the asset class that the vast majority of our listeners either invest in currently and actively or pass through on their way to larger multifamily deals or other asset classes. So it's interesting in that light to be asking you what's going on in that space, at least in Cincinnati, though I expect that what we're experiencing here will translate to many other markets, of course, Midwestern markets, but possibly markets all over the country. So what I want to ask, which I'll go ahead and ask is what's happening with transactional volume right now? And what are you seeing with your opportunities to transact? My expectation is that you're going to say that sellers aren't as interested now because they locked in low interest rates, their cash flowing, and they still only want to sell if they can get the sky high prices of 2021, but I'm assuming I'm correct. And I see that you're nodding. I'd like for you to go beyond that into what's actually happening in the market.
JD Schmerge:
Great question. So there's a lot of factors at play and 2021, 2022, or outliers, I think, in the number of transactions that were done. Those were not only fueled by the low interest rates, but also the pent up demand coming out of COVID when transactions weren't getting done, or maybe they were put on hold for six or 12 months, and then they finally got done in 2021 or 2022. So while 2023 transaction volume, while it's down from the last couple of years, I wouldn't say that it's far below the average or there's not deals happening.
But from our standpoint, we're taking a little bit more cautious approach in trying to assess motivation and having more in-depth conversations in regards to value than we were the last couple of years when we were at record low interest rates and rates had moved down so quickly that it was hard to tell what the market was going to be willing to bear. So Mr. Seller, if that's the price you want, we'll go out and try to get it. And more often than not, we were able to achieve that.
That hasn't really been the case through 2023. Obviously rates have doubled, nearly tripled from where they were the last couple of years. So it's definitely slowed things down, but there's still deals getting done. We just got to work a little bit harder to find them.
Slocomb Reed:
Yeah. The thing you have a seller's motivations to sell the motivation of valuation or a sale price that they would never have even fathomed now being real is no longer the case. So it makes sense that a lot fewer people are interested in selling.
I just interviewed someone who said it was a make me retire number. There aren't make me retire numbers anymore.
So what I want to ask here is how are deals getting done? What is it about a seller that is motivating them enough to sell currently? We're recording at the beginning of Q4 2023. And what is it about those listings, those properties that are bringing in the right kinds of offers to get them sold?
JD Schmerge:
Great question. The four D's of motivation, death, divorce, debt, and dissolution is a little trick that I learned when I was early on in the business. If there's one of those four factors that are motivating a sale, chances are higher you're gonna get to the finish line than if it's simply for money, just because prices might be sky high. Not that we go and seek out necessarily sellers that are in trouble experiencing one of those four D's. But if you can make sure the motivation is there and they're going to be realistic with pricing, then I think it's worth everyone's time to try to pursue it. So, you know, I thought seller financing would be a little bit more prevalent in trying to get deals done and maybe that will over the next six to 12 months, if rates stay where they're at or keep going up, but really we haven't had to do any crazy creative financing to get deals done. At least personally speaking through 2023, it's been all traditional financing deals or cash deals in a couple of cases.
Slocomb Reed:
What you're saying could be construed to mean that we've returned to a regular market. The regular motivators are back into play the way that they always are, that we're not seeing dramatic spikes or dramatically high inventory right now because prices are not that high.
But would you say that we're seeing below average inventory now compared to not two, but four or five, six years ago?
JD Schmerge:
It's hard for me to gauge. My gut answer would be yes. We're probably at about the normal transaction level of looking at a longer sample size than just the post COVID era of 21 and 22. I'd have to do a little bit more research and find some hard data to really validate that and coming in at the end of 2017 in the real estate, I don't have a huge sample size to really go off of, but to me, it seems like it's about what it was pre-COVID.
Slocomb Reed:
That makes sense. I want to talk about seller motivation a bit longer and then transition the conversation about JD. It has become very common in the last 10 years or so to the value add syndication model of apartment investing specifically.
This episode is not a deep dive on how value at apartment syndication works, but I will say that when that is your model, you are highly incentivized to sell sometime within years three through seven of ownership and operation of your portfolio because you need time to drive the NOI, force the appreciation you need to sell for the profit that you need in order to deliver the return to your investors that you projected when you acquired. A lot of people bought apartments three to seven years from now. Are you seeing that they are selling the way that they planned currently or are most of them holding on dealing with the interest rate market, whether or not they bought rate caps and are those people who are timed to sell their value add syndications selling or are they continuing to hold waiting for a better market to sell in?
JD Schmerge:
Great question. I would say the short answer is a lot of people are waiting a little bit longer to try to get out of this uncertainty. I don't think that anyone has really caught themselves just completely failing to hit their pro forma rents in their NOI, but I think it's a matter of strictly the interest rates that are something that nobody could have forecasted them going as high as they are now into almost 8% territory. So I think a lot of sellers feel they'd be leaving money on the table if they sold now versus maybe try to wait out another 6, 12, 18 months and see if rates do come down a little bit to help them achieve a higher price.
Slocomb Reed:
Let's talk about what is getting deals done right now. JD, you said you anticipated that seller financing would be more prevalent. That's one thing that could be quote unquote getting deals done.
Is it that sellers are less interested than you were expecting or is it that buyers and their lenders are less interested than you're expecting? What are the other things that are actually getting deals done right now?
JD Schmerge:
I've yet to do a transaction this year that involve seller financing. I am in talks with a couple that have said that they're willing to entertain that idea. So a couple sellers. Correct. So the fact that there are some people open to it, I think to me, that could be construed as maybe they are motivated if they're willing to do that, or maybe they like the idea of it because they don't necessarily need all their cash up front, but they want to defer some of those capital gains over multiple years. So for those sellers that understand the nuances of seller financing, there are some benefits to it. But to answer your question, as far as getting deals done, like I said, it might have been pretty straightforward so far throughout 2023, so they've all been pretty much conventional financing with bank debt. We're just making sure we're doing our due diligence on the front end to make sure that the lenders understand the deal and the whole story. And even if it is a value add deal where maybe the day one NOI is pretty tight as far as that coverage ratio that we've got a strong borrower that the lender understands is going to be able to achieve that pro forma NOI within the first 12 months or so to help put the lender at ease because there's really not many deals getting done right now where that debt coverage ratio is not razor thin.
Slocomb Reed:
J.D., are you saying that sellers are still getting the price that they want?
JD Schmerge:
Ultimately, if we're making it to the finish line, then yeah, I guess the facts would say that sellers are getting the price they want. But I think there's a lot of deals being listed out there that are not selling. I always try to do a deep dive and review of every deal I know of in the market at the end of each year and try to put some stats together. And I'll be curious to see what that looks like in a couple of months as to how many deals, at least that I can find that I know were personally listed or even marketed offline that actually transacted because I'd be willing to bet it's a fraction of the number of the list of close ratio that we've seen the last couple of years.
Slocomb Reed:
That's interesting. So it's not a question necessarily of when properties go under contract, do they get to the finish line or for the properties that receive offers, are sellers getting their number when they close? It's more about the listings that go to market, whether or not they are attracting the attention that the sellers require in order to transact.
JD Schmerge:
Exactly. So, yeah, sellers might be willing to list at a price that they would be willing to sell at, but is that where the market's actually at? Ultimately, the market and buyers are going to dictate the price of the asset. I tell sellers a lot that we can talk to or blew in the face about the value, but at the end of the day, it's worth what the market's willing to bear, not what you and I decide based on an NOI and a cap rate and a cash on cash and IRR, what the value is.
Slocomb Reed:
A couple of questions here, JD, about your practice as a mortgage broker. How much of your time is spent in lead generation for seller clients? Has that changed over the last couple of years?
JD Schmerge:
Are you talking about lead generation trying to find listings and find sellers or find buyers for active listings?
Slocomb Reed:
Yes.
JD Schmerge:
Okay. The first. So when you first start out, it's 100% of your time. You've got nothing in your life. It's a real relationship. So it's just smiling and dialing, if you will. So as the years go on, it's a little bit less each year, but it never goes away. We're always trying to drum up new business, trying to find owners that we've not been able to connect with. So I would say right now, probably a quarter to a half of my time, it is trying to drum up new business. And the other large balance of that being actively trying to sell deals that we've got available, which sometimes they coincide, obviously.
We've got a deal we're pitching to investors more often than not. They already own some properties here in town. So it's always an open dialogue as to how things are going with their properties. If there's anything in their portfolio that they would also entertain offers on or might want to at least see our opinion of value on.
Slocomb Reed:
JD, how much of your time is spent looking for buyers for your listings? Are you just tapping into your current list of investors or other activities that you're doing to increased your buyer's list right now in order to get your listing sold?
JD Schmerge:
So I've done a pretty good job at keeping buyer's list of every time I connect with a buyer, whether it's at a meetup event or they saw a listing that we have online or referral. I always try to get those into my buyer database. And obviously I can't keep in touch with every buyer on a weekly or even monthly basis, but I'm not spending a ton of time actively finding buyers right now, because obviously after six years in the business, I've created relationships and contacts with a lot of investors, but it never ends. You can never have too large of a network. So while there's not time actively spent going to find new buyers, certainly when we have active listings, there's probably owners within a two mile radius of a property we might be selling that we haven't connected with. So yes, we're always seeking out new buyers, investors that we haven't worked with before.
Slocomb Reed:
But it sounds like specifically seeking out buyers to get your listing sold is not necessarily something you've had to do. It comes down to whether or not your sellers are willing to sell for what a buyer is willing to pay for in today's market. Is that fair?
JD Schmerge:
Yeah, absolutely.
Slocomb Reed:
Last question here, JD. With regards to what is selling right now, what buyers are willing to pay the seller's price or close to the seller's price for the things actually transacting. Is it the properties that have significant value add opportunities or are underperforming right now that are selling or is it the ones that are more stabilized? I've heard that lenders are much more interested in properties that are already fully stabilized so that they don't have to worry about the fluctuations of cashflow in the coming years and whatever they might bring recession, increased interest rates, decreased increase rates, what have you. But that doesn't necessarily mean that's what buyers want to buy. So are you as a broker, what is it that you're pitching to investors and to lenders with your listings right now? Is it the turnkey ishness of a property and is it the more stabilized already up at market rents properties that are selling? Or is it the ones where work renovation, capital expenses are needed in order to achieve market rents. And therefore they can sell a little bit cheaper. Which one of those is selling more right now?
JD Schmerge:
Good question. I would say it's still both. I think it's more buyer driven than it is market driven. There's always going to be those buyers out there that they don't want a project. They want something low maintenance turnkey that they can cashflow day one.
And I think there will always be those opportunities out there. I think from a lending appetite, I would say that lenders, especially if they've been burned by some of these investors that maybe aren't hitting the numbers, they thought they would. But there's always those value-add buyers out there that no matter what the market is, they want to be able to create their value. They don't care if rates are 3% or 9%. They're going to come in and do their renovations, increase the NOI and sell. So I would say it's more client driven than market driven.
Slocomb Reed:
Real last question here, JD, we're in the habit of asking our guests for their best ever advice. What I want to hear from you is the advice that you wish you could give to all of your seller clients. Pretend that the best ever listeners and I are all of your listings. What is it that you really want us to say and do?
JD Schmerge:
Only sellers?
Slocomb Reed:
Just the sellers. The people who want to sell their properties right now, what is it that you wish you could actually tell them to do that they would do it?
JD Schmerge:
Be realistic on expectations and trust that the market is going to dictate the price.
Slocomb Reed:
That makes a lot of sense. Where can our listeners get in touch with you?
JD Schmerge:
Email, cell phone, call, text, LinkedIn, whatever you prefer.
Slocomb Reed:
Awesome. And those links are in the show notes. JD, 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 that you know we can add value to through our conversation today. Thank you and have a best ever day.