Commercial Real Estate Podcast

JF3321: Aaron Saunders: Maximizing Returns in Ground-Up Development

Written by Joe Fairless | Oct 8, 2023 8:19:51 AM

 

 

 

Slocomb Reed sits down with Aaron Saunders from Spartan Construction Management, a company specializing in ground-up construction, particularly in the self-storage sector. Aaron shares his background in construction and real estate investing, discussing his transition from single-family homes to multifamily limited partnerships. He also talks about the challenges and lessons learned from ground-up construction projects, including issues related to scope changes, material costs, and regulatory requirements from different municipalities. The conversation highlights the importance of due diligence in real estate investments and the need to plan carefully when embarking on ground-up construction projects.





Aaron Saunders | Real Estate Background




 

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Transcript

Slocomb Reed:
Best Ever listeners, welcome to the best real estate investing advice ever show. I'm Slocomb Reed. Today we are joined by Aaron Saunders. Aaron is joining us from Golden, Colorado. He is with Spartan Construction Management, which is the ground up construction partner of Spartan investment group, long time friend of the best ever podcast. Spartan construction management also builds for other investment firms. They focus on self storage. They started in July of 2021. They have six completed construction projects, four actively being built and another nine projects in the entitlement and design phases. Aaron, can you tell us a little bit more about your background and what you're currently focused on?

Aaron Saunders:
Yeah, absolutely. So welcome. Thank you for having me on the podcast. Grateful to be here. And along with Spartan, I'm kind of a longtime listener and follower of Best Ever as well. Going back to 2017, I attended the first Best Ever Conference in Denver, Colorado. And that's where I met Joe from Best Ever. And then I met Scott Lewis and some of the Spartan investment team there. And that kicked off the transition. my real estate investing career and the initial change in my construction career. But backing up before that, I went to school for construction management. When I got out in 2006, you could really buy a house with just your signature. And I think that's what a lot of people were doing. And I jumped on that same bandwagon. So I bought as many houses as the bank would allow me to and moved into my construction career full time and then had real estate on this side, but as my career continued to grow, I got plugged in. with the best ever podcast and then attended the best ever conference. And that kind of changed things and kind of shifted things in my investing career. I was at this turning point of should I continue to focus on construction or should I make a hard pivot into real estate? And for me, I just absolutely loved construction. So I decided to stick with the construction role and I transitioned all my real estate assets from single family to multifamily limited partnerships. And can have continued down that path since then, but kind of backing up a little bit, or I guess moving forward from there, we had sold my company a few years later, I had moved into a director role. I was overseeing a pretty big portion of work and construction there. Always continuing to buy into limited partnerships and work with teams like Joe and his group and quite a few other operators in the space, but still had that passion to get involved and do a little bit more in real estate. So when we ended up selling the company, I went from being one of the owners to the company to back to a W2 employee. And for me, I really loved that ownership portion and being involved in the really leading and driving change and growing the organization from the construction side. So that's where the relationship that I started and fostered with Spartan Investment Group back in 17 had started to grow and Scott Lewis, the CEO of Spartan Investment Group came to me one day. And Today we're looking to start a general contracting company inside of Spartan Investment Group. And would you be interested in joining the team and partnering with us and the rest of the leadership team in that new endeavor? So for me, it was perfect. It was an opportunity for me to join an operator in the real estate space, as well as continue my construction career and get to start a company from the ground up. So since then we've grown the company. Pretty substantially, we have 13 people on the team now, quite a bit of work in the pipeline that's coming up and a handful of active projects right now. And then as things continue to go, I continue to invest in limited partnerships. So I've invested inside of Spartan as one of the owners of the organization. And it's been really fun to see that full cycle of getting to know Joe at that first best ever conference, getting to know Scott and Ryan and Ben there, and then joining the Spartan team. And now being on the best ever podcast, which is kind of where it all started for me.

Slocomb Reed:
That's an awesome full circle story. Yeah. And shout out to Spartan investment group, of course, and their role in the best ever conference and Ben and helping run it. Shout out to the best ever conference as well. You can go to besteverconference.com and see that we will be reuniting in 2024, April 9th to the 12th in Salt Lake City, Utah. And if you all want to have the kind of career trajectory and investing trajectory that Aaron Saunders has had, you want to meet the kind of people that he met that led him in this trajectory, you should be there in 2024. We've added all the value that we can, Aaron episode over. Thank you. That's a joke, but definitely I'm a big fan of the best ever conference as well. I've gotten to go the last couple of years. So I don't have a question for you yet, but I'm going to just ramble for a moment and see what question comes from it. There are a lot of real estate investors who are drawn to the idea of building ground up instead of buying, especially in assets that are structurally and mechanically more simple like self-storage, the simplicity of self-storage along with the returns are what attract a lot of investors to it in the first place. Ground up construction draws the attention of a lot of investors. because the returns can be significantly greater than purchasing existing supply. It's also way more complex than just buying something that already exists, that already has a client base or a tenant base in place. You can improve the tenant base, increase the rents, improve the condition of the property. Building ground up is more complex than that in a lot of ways. So let's start here, Aaron, where do you see the most mistakes made? in ground up construction of self storage, both from other firms, but also within Spartan.

Aaron Saunders:
Yeah. I appreciate the intro and the question there. I think the biggest mistake that I see is having a very clear scope of work on what the want is and what the final product should look like and taking that very clear scope of work on what that final product is and should be based on the investment thesis and then building the team around that. A lot of times it'll be a napkin sketch of what if, can we do this? And then we start with a conceptual estimate and we start to go down that path and it morphs and changes into this modification of what the original idea was that may not fulfill the investment thesis or the expectations or the investor's expectations on the back end of the project. So as your listeners are looking at. ground up development, whether that's storage or multifamily or anything else, thinking through exactly what that finished product looks like and then working backwards, I think we'll go a long way to the success of the project. And that's one thing that's challenging because we see them GCR projects. So in that CM role, the design is constantly morphing and changing, and we're trying to coach that project along. And those designs can change substantially. So that can change price. and lead times and a lot of different variables in there. So just having that clear scope of work and that clear expectation for what are the main drivers for you as an investor in the beginning, when you're starting that project, can go a long way to the success of the job.

Slocomb Reed:
Aaron, your answer there makes a lot of sense. And we have a very sophisticated listener base. You'd know you're one of us. I think we can all intuit that beginning with the end in my is critical to success in delivering the right final product. But can you give us some examples from your experience with your own projects or the other projects that you've seen be constructed where that wasn't followed?

Aaron Saunders:
Yeah. We're working on a project about say a year and a half ago or so it was an expansion to an existing facility. And the initial idea was we're buying a property that has good cashflow. there's a lot of demand in the market. We're going to go ahead and build just a small expansion on the available vacant land here. We started down that process with the team and as we started to look at the numbers, we realized it makes a lot more sense if we start to build on this project and grow the square footage a little bit. So it moved from single story to two story. And when you go to two story, you now need to add an elevator. which not only takes up a little bit of your rentable square footage, but increases the cost for the equipment as well. So when we looked at that, we went back and ran the numbers on the demand again and said there's enough demand here to go to three story. Well, what's the maximum height that we can build this facility at? Okay. Well, it's 34 feet 11 and that's what the AHJ is going to allow us to build. Well, if we're buying the elevator already, let's make it three story and really try to maximize our dollar per square foot by adding another level. to the facility. After going through all those changes in design, getting ready for permits, and then going back to the bank, over that timeframe, interest rates had started to change and increase. And as those interest rates started to increase, the feasibility on the project started to get worse and worse and worse. And our pro forma started to get closer back down to, it's better not even to expand at all, and our investors are still gonna get the same return. Or we take out this additional loan and expose ourselves to quite a bit of construction risk. And ultimately that ended up killing the project when we could have moved forward with that initial small expansion and we would have been able to execute that. Right out of the gate and complete that project and have a little better returns. Instead of shooting for a home run, it would have been a solid base hit. And ultimately it was a strikeout.

Slocomb Reed:
I get where you're coming from there. There are a couple of different risks involved that you all passed on by not building there. One of them is the risk. Of course, you know what you're doing, but there's the risk that the demand metrics were wrong or the demand shifts in the meantime, of course, and that was avoided. But you also referenced construction risk, which within the construction process, including entitlement and design, of course, Aaron. Where is it that you've... experienced the biggest difference between budget projections and budget reality. You have 18 projects that are either in or have gone through the whole process. Within those 18 projects, where is it that you've seen the biggest difference between what was projected for expense lines and what actually happened?

Aaron Saunders:
A couple of different things that have changed. Obviously during COVID, everybody saw substantial increases in material prices and storage was no different. Steel prices increased pretty heavily over those, but today those prices have kind of settled down quite a bit and we're not seeing any major swings in steel prices. We've seen some actually pullbacks in steel prices as we've gone back to re-quote projects. We've seen reductions in our original quotes over the past few months. So that's been good for the projects. And those are all things that we're aware of and that we can control as far as. getting bids from our contractors and going down that path once the design is in place. If you talk about things that are outside of our control or that we've had the biggest swings on, it's additional requests or requirements from AHJ to AHJ. So just like most projects, we're not building in the same city twice. And if you look at a storage project, you're looking at 5, 10, 15 minute rings or 1, 3, 5 mile rings. And those storages typically that we're building aren't in the same. AHJ. So when we go to another AHJ, we're taking a project through entitlements is what are the requests that they're going to have? Is it an additional facade requirement that may increase the price of the project? Is the fire marshal going to require sprinklers for the whole facility? Is there fire water locally that we can get and bring into the site? Those are some of the things that have the biggest swings on our project. Not so much the individual material prices, but the scope changes, whether that's, like I said, the facade requirements. And obviously the big one is sprinklers and bringing a firewater line in a thousand feet or more to a site can be a pretty heavy line item that when you're first looking at a project may not be included in your conceptual estimate.

Slocomb Reed:
Aaron, what is AHJ?

Aaron Saunders:
The authority having jurisdiction. Sorry for using the acronym there. but it's the planning department, the approval department for each individual municipality that we're working in.

Slocomb Reed:
That makes sense. I didn't want to assume just based on context clues. The two biggest changes from projection to execution, changes in materials cost and unforeseen changes in the scope. I have limited experience with construction. Aaron, with the changes to the scope, including sprinkler systems, like you said, are those not things that the AHJ would have flagged in the plans when they were submitted? 

Aaron Saunders:
Absolutely. They're always flagged in the plans and the change comes before that. The cost increase comes before that. Typically when we're going through due diligence, we'll identify those items then. But when we are in that. conceptual phase when we identify a piece of property and we're going out to get an LOI on it. We're not 100% sure if they're going to require fire at that point. We haven't done our full due diligence on it. So just like when you're buying a piece of property that's existing, whether that's a multifamily facility or a storage facility, you're going to do your due diligence on the existing property. When we buy raw land, we do the same thing. We go through the full due diligence process. Because we want to get those properties under contract as quick as possible, we don't have the timeline to do the full due diligence before we get it under contract. So we do make some assumptions and we use those assumptions in our initial underwriting to see if the project is going to pencil. And then we go through that due diligence process. And that's where we might find out, oh, there's a firewater line right in front of this piece of property, or the closest line is a half a mile down the road. And it's just going to be too cost prohibitive to bring that water line in for the project. And then depending on the number of stories that we're building or the requirements of the authority having jurisdiction or the fire marshal, we may not require sprinkler systems in the building and we can go with what's called just fire breaks or fire walls in the facility. And we'll break the facility up with drywall walls, which creates a fire break and isolates maybe it's a 20,000 square foot building into two 10,000 square foot sections, which would typically be under that 12,500 square foot threshold. So there's a lot of little nuances to their requirements when it comes to fire water, but knowing those things early and just getting the right team on board that can help with that goes a long way.

Slocomb Reed:
Aaron, understanding that you are the general contractor and construction manager and not the investor deploying the capital to make these things happen. Do you know how much money has been spent or how far along the road the deal has gotten before you learn these things when you submit the plans?

Aaron Saunders:
Yeah, typically they're not getting that far down the road. We're learning those things pretty early, but if you're looking at a lot of projects and a lot of properties, you can get under LOI on a property that ultimately ends up dying less than 30 days later because of... that due diligence process and that happens whether you're buying an existing facility or you're looking at a ground up development.

Slocomb Reed:
But we're talking about issues that come up during due diligence before property is acquired.

Aaron Saunders:
Absolutely.

Slocomb Reed:
So touching on the cost of materials, I'm an apartment owner operator. So coming from a very different position within commercial real estate investing, I know a lot of high level, very large portfolio apartment operators. who are doing their sourcing materials in advance and in bulk and locking in long-term contracts for materials pricing. Some of them are not only sourcing the materials direct from the manufacturer on another continent, but also arranging for the shipment to the United States from that continent. Understanding that there's massive scale required to do those kinds of things. Are there stop gaps for things like? having to deal with the fluctuating cost of steel in this construction for projects the size that you're working on?

Aaron Saunders:
Yeah, there are. And it's similar, but on a smaller scale, obviously. So not adjusted some of our relationships, but built additional industry relationships with manufacturers specifically. So there are a lot of storage. Erectors in the space that can put up a building, but they're buying that building from the building supplier. So what we've done. over the last year or so has started to build relationships with those suppliers. And we're buying doors and metal from the building suppliers directly. And that's helped insulate us from those steel increases. So as soon as we get that proposal, that proposal is good for 30 days. We execute that proposal and that pricing is locked in for that specific project. We have not gone out and bought any additional coil or any additional material to hedge against future. cost changes, but if we would have done that in January, we'd be sitting on a bunch of overpriced material currently.

Slocomb Reed:
Yeah, that makes sense. The business of future speculation is really from the business of grant up construction. Not something I'm an expert in by any means. Aaron, I want to transition the conversation a bit before we wrap things up here. First, I want to say thank you for spending most of our time talking about things that go wrong. Very grateful for that. a breadth of knowledge and experience and a depth of knowledge and experience and success that you've had in multiple stages of your career. The latest one being with Spartan construction management. That being said, specific to people who are looking to get into ground up construction and it can be specific to self storage if you think that makes the most sense. What advice do you have for people who are accustomed to purchasing existing supply? and are considering getting into ground up construction.

Aaron Saunders:
I think the biggest thing that I've seen kill projects is the calendar. Time kills all deals. So when you're buying an existing facility that's already operating and has tenants in place, when you close on that property, you have income from day one. When you're doing ground up development, there's no income until that property is completed, you reach CFO and we start leasing that property up. So that's the biggest thing that I would say to be aware of is, Time is of the essence, no matter what you're doing. So having the right team on, hiring the right team early, and executing that project as fast as you possibly can will help lead to the success of your project. And that's where I've seen projects be the biggest winners is when we can execute construction or execute entitlements and design and construction quickly and then get that property to lease up as fast as possible. The other thing that we've looked at doing on all of our projects that has been successful in the past is we get permits by individual building and we will focus on completing the first building on the frontage before we finish the other buildings and work with the permit office to get CFO on that first building so that we can start renting units in that building and driving revenue to the property as we finish out construction on the rest of the facility. So we'll get a temporary CFO on that first building, and then we'll get our final CFO when that final building is done. But that allows the operator to drive revenue much sooner. It could be a month or six weeks or two months prior to finishing the whole project. And that lease up velocity starts in those two months faster.

Slocomb Reed:
Aaron, that makes a lot of sense. We have run a little bit long in our interview time. I do want to say, I really appreciate you being on the show today. One last question before we exit. Where can people get in touch with you?

Aaron Saunders:
Yeah. Our website is spartanbuilt.com and my email is aaron at spartanbuilt.com.

Slocomb Reed:
Those links are in the show notes. Aaron, thank you. Best of our 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. Thank you, Slocum. I'm grateful to be a part of the Best Ever podcast.