fbpx
Global Investors Podcast
GI60: Underwriting Multifamily Properties with Robert Beardsley
August 12, 2020
0
Underwriting Multifamily Properties with Robert Beardsley (Youtube)

Rob Beardsley oversees acquisitions and capital markets for Lone Star Capital and has acquired over $100M of multifamily real estate. He has evaluated thousands of opportunities using proprietary underwriting models and published the number one book on multifamily underwriting.

Watch The Episode Here:

Listen To The Podcast Here:

Transcript:

Announcer:
Welcome to the Global Investors Podcast, a show that focuses on helping foreign investors enter the lucrative US real estate market. Host, Charles Carillo, combined decades of real estate investing experience with a professional background in international banking to interview experts in all areas of US real estate investing. Now here’s your host, Charles Carillo.

Charles:
Welcome to another episode of the Global Investors Podcast. I’m your host Charles Carillo. Today we have Rob Beardsley. Rob oversees acquisitions for Lone Star Capital and has acquired over $100M of multifamily real estate. He has evaluated thousands of opportunities and published a book on multifamily underwriting. So thanks so much for being on the show, Rob.

Rob:
Yeah, thanks for having me on.

Charles:
So you’re quite the underwriter for what you’re doing with Lone Star and you also work with raising money for them. Can you kind of go through your background prior to starting to invest in real estate?

Rob:
Yeah, absolutely. So I had an interesting path into real estate because I grew up in a real estate family, but my parents who ran a real estate brokerage firm in Silicon Valley, they pushed me towards tech, you know, growing up in Silicon Valley, seeing all the startups around us, all the, you know, really prosperous tech companies, they thought that was the dream for me. And you know, so I went to college for computer science and I was studying and going down that path, but you know, some time around in college, I just circled back to real estate. And I was thinking to myself, you know, well, at the end of the day, if I go through this tech route and I make a bunch of money, what am I going to do with it? I’ve got to invest it. And so I started just looking into, you know, investing in that led me back to real estate and realizing, yeah, real estate is the best path. It’s the best way to, to create and build upon your wealth. And you know, then eventually just through, through more research and you know, discussions with my family, it just made sense for me to not pursue a career in tech and go into real estate and I started working with my parents and then as you know, went out and founded lone star capital shortly thereafter. And it’s been a great ride ever since.

Charles:
What were your what was your parents? Were they involved with real estate? Cause you said you partnered with them.

Rob:
Yeah, so like I said, they came from the single family residential world. So running a residential brokerage firm, as well as doing their own investments construction, development, rehabs and things like that. So it’s interesting because it takes somebody younger without those limiting beliefs and a new way to look at the world to be able to say, no, let’s go out there and let’s go look at those bigger deals. Let’s, let’s make something bigger happen. And obviously that’s the natural transition from single family to multifamily.

Charles:
So they never got involved with multifamily or anything like this. This is all new on your generation.

Rob:
Yeah.

Charles:
Nice. Nice. Okay. So for, give us a little background on what Lone Star is, what you guys, what’s your strategy when you’re looking to invest, what are the markets kind of like an overview here?

Rob:
Yeah. So Lone Star Capital is a owner operator focused on suburban multifamily across Texas. Our primary markets are Houston, Dallas, and then secondary markets throughout throughout the state. And we do look at some surrounding States, but you know, our, our business plan, we have two strategies. One would be, we call core plus, which is we’re looking for better assets and better locations. And we’re looking to hold those for longer term. And more of the return is generated from current yield or the cashflow. And then our value add strategy is, you know, we’re typically looking for deeper value add than the typical deal. You know, we’re not looking typically just for the, the lipstick value add, we call them where we’re just, you know, doing $4,000 interior unit turns and calling it a day, we’re really looking to fix issues and, and really get paid for that risk. And so we’re looking for poor management down units deferred maintenance, things like that, where we can really come and create outsize value. So that’s our two strategies. One is, you know, come in, buy it, fix it and likely sell it. And the other one is, you know, we believe longterm in the, in the asset and location and we, and we, and we like the cashflow that we’re getting from it.

Charles:
Yeah. That’s great. I think a lot of syndicators and investors, because there’s so much buzz around the value add, they’re kind of missing the whole bowl on the actual repair and upgrading of the bones of a property. And because there’s no rent increase there. So it’s something that kind of gets patchwork, I think. And when you’re looking at a deal years back when I would look for like passive investing in deals and it was something that you always saw, you never saw anybody. Well, I’m like, well, there’s nothing here about any of the true mechanicals or roofs or anything like this. It’s just like, we’re going to do this, but then we’re going to put grant it in. And that’s, it’s great that you focus on that. Cause that’s not something that I think most investors or syndicators are really focused on.

Rob:
Yeah. It’s a great point. And I, and I wrote an article about this awhile ago, talking about how everybody’s talking about the, they want to look at the sexy before and after pictures of the kitchen renovation and you know, the new flooring and things like that. Right. And, and for people that are, you know, visual or not, you can just see it. And it’s so straightforward to be able to picture and understand how you’d be able to charge an extra hundred to $200 of rent with an upgraded unit, right. It’s a very straightforward business plan. That’s easy to buy into what’s, but when you’re separated from the numbers and this, we can tie into underwriting, you know, as somebody who’s deep in the numbers, when you, you can look at a business plan that includes, you know, the, that granted like, as you talked about the granite countertops and getting a $200 rent premium, but the problem is if you paid upfront a four cap, you basically overpaid up front for the opportunity to create the value in the backend. You’re not really number one. You’re not being compensated for your risk. And number two, your returns aren’t, aren’t where you thought they were just because you’re able to raise rents $200. It doesn’t mean that you’re actually hitting the return that you’re looking for. And then on the flip side, it’s a lot harder for people to understand how they’re actually creating outsize value for doing things like roof repairs or mechanicals or the foundation and curing other deferred maintenance. Because as you said, there’s no rent increase for that necessarily. So, and, but the, but the answer to that is the way you’re creating value in, in those circumstances is actually by lowering the risk of the asset and thereby lowering the cap rate in which your asset is valued. So you’ve actually seen a lot of investors over this last cycle. What they, what they’ve done is they’ll come in on an untouched property and they’ll completely redo the clubhouse. They’ll, amenitize the property, dog park, everything they’ll you know, cure all deferred maintenance and then just leave the interiors for the next guy. And they’ll sell that deal for an extremely low cap rate because the next is willing to pay up for the opportunity to complete the programmatic interior value add. So, that’s something, a business plan that people overlook but it has been very profitable.

Charles:
The other thing too is where we are now with COVID people aren’t going to be getting these rent increases that they previously thought. So now it’s like, Oh, we’ll just hold on. And we’re going to cash flow it, well, you also have to do now, your hole is going to be longer. And this property you have is also going to be older. So now that’s something else that a lot of these operators that we’re looking for really aggressive rent bumps, I don’t think they’re going to be able to really achieve, and there’s going to have to be something that gets changed, because at some point you’re going to have to do this maintenance, especially before, or it’s going to be discounted when you sell it. And so,

Rob:
Yeah, totally agree. And I, and I think the, we were very COVID or not. The cycle was very long. We were, we were at the tail end of the cycle. Evaluations are getting stretched and, you know, rents could have, could only grow so much more. You know, we had this long 10 year run of, of rent growth and rents were increasing as a percentage of income. And you know, that can’t last forever. And so we were already seeing that get stretched and, you know, people were pulling back you know, even lenders and investors were pulling back and their willingness to pursue and finance value add deals where you were taking the interiors up a notch charging an even further premium. And, you know, eventually you’re starting to get to a level where you’re competing with new construction and that’s something you never want to do because new construction will always win. Right? It’s going to have higher ceilings. It’s going to have, you know, everything, the latest and greatest. So, you know, having your rents as a class B asset compete with an a, that was recently developed you know, it’s recipe for disaster. So really the, the business plans that of, Hey, this property is in great shape. It’s performing nothing’s wrong with it, but we could still think we can raise another a hundred bucks on the, on the units. You know, we shied away from those. And we really chased after deals that had management upside. Like, let’s say, for example, the property is already renovated. There’s really not much you want to do in terms of pushing the finishes and the rents, however, it’s 80% occupied. Can we get it to 95, right. Looking for real deferred or, or issues like that.

Charles:
Yeah, that’s great. So when evaluating a property or an area, what are some of the main determining factors you want to see?

Rob:
So one of the first things we look at is median household income. I think that just paints a picture. I mean, it just gives you a number to work off of right away. And we look at it at a very granular level. And then we go out to the census track one mile, three mile radius. And you know, that has to be in line with the tenant you’re trying to attract and the price that you’re paying for the property and the rents that you’re charging. Right? So, so median, household income, number one, very big other things would be the single family home values. So, you know, you definitely want a nice Delta between your cost basis in the deal and single family homes. It depends on the class of asset and then the overall neighborhood makeup, but, but really strong opportunities that we’ve seen, you know, the, the property will cost, let’s say a hundred thousand per unit and single family homes in that neighborhood will be 400,000. So that is, is a very, you know, that makes you feel very safe and comfortable, and you’re, you’re less likely to lose residents you know, to single family, unless they they’ve got a raise and they’ve got the money for a down payment. So same thing with home values, meaning household income, very big in terms of, you know, market level metrics.

Charles:
Yeah. That’s great that it’s not as easy for them to make the jump into that single family house from where they’re renting. So you kind of have like a little bit of buffer zone there because that’s one of the things too, I’ve spoken to places investors before, and they say one of them in particular was saying, you know, we don’t go anywhere with you’re having a meeting or a medium house, a price, I guess you would say that’s under a hundred thousand under 150,000, which I feel is really low, but if you’re buying units 40, $50,000, it’s different. But yeah, you really have that you have that buffer zone, which makes it, you know, you can retain your, the renters in that area much easier. So when I speak to underwriters and I’ve never spoken to an underwriter that says they have like aggressive underwriting, right. And it’s always something funny because I know you guys have different models, which is great because you usually, when you talk to underwriters, they have a value add model. There’s not a different as you consider core plus, but when you’re, what are the rules or principles that you employ to achieve an accurate, but conservative underwriting when looking at deals?

Rob:
Yeah. So, yeah, it’s a great point. And I think it’s a funny thing. It’s a joke that, you know, I’ve never met an aggressive underwriter, right? Everybody’s conservative, but the reality is we’re all aggressive underwriters. That’s the truth of it because whoever buys a deal, most likely, especially if it’s been marketed to any degree, that’s the person simply who is willing to pay the most. Right. And the way that you pay the most is by looking at your numbers and seeing where you get comfortable by pushing and squeezing, to be able to come up with that highest valuation possible. So it’s a delicate dance of pushing and squeezing, get not going too far to put yourself at risk of, of losses and, and severe under performance. And so I would, I would put not to get too far off track, but I would put, you know, risk of loss at a much greater importance than under performance. I think it’s a win. If we thought we were going to hit a 16% IRR and we only had a 14, you know, I consider that a win as opposed to, you know, we squeezed and pushed and we went after a more aggressive deal and we thought we could get an 18, but then we ended up losing money. Right. So I think there’s a balance of pursuing the right deal on a risk adjusted basis. So, you know, you have to so one, so to kind of get into it. One thing that we’re very focused on is, and I was actually rebuilding our chart last night, but we have a chart that goes across all different market types and property types and business plans. And we actually assign a return requirement. We have various return requirements for each type of property type market business plan. And that way we always know what type of returns we should be seeking, given the risk of the asset. So for example, if we think we’re buying in a B location in a major Metro, and it is a, you know, modest value add, we know exactly, you know, what return we’re seeking there and, and we can solve the price to account for that return appropriately. So, so that being risk adjusted, I think is one way to, you know, be a conservative underwriter and really most accurately pursue deals. Because what you want to do is you want to know when it’s right to get aggressive, you want to realize, okay, well, I am a, you know, let’s say I am in a better market. It’s a class, a location, and it’s a core plus. So it’s very low risk, you know, we’re really not raising rents. We’re, I mean, look at our performance or we’re gradually raising NOI over time. You know, we should be able to accept a lower return for this low risk. So, so that would be one, one big thing that I don’t think many people talk about, which is explicitly looking at your return hurdles you know, to help you really get aggressive when necessary,

Charles:
What is your, what is the timeframe usually on like core plus? I mean, every deal is different, but

Rob:
So I think five to seven years is, is what we typically underwrite on a core plus.

Charles:
Okay, cool. So with the country starting to open up cause of COVID, how did your underwriting change when you been reviewing deals all through the beginning of 2020, mid 2020 now?

Rob:
Yeah. So the biggest change, was the financing. The lender agency lenders were requiring and they still are reserve hold backs which, which greatly increased how much equity you needed to bring to the table day one. And then you’d hope that all goes well in your property’s performance. And you’d be able to have those reserves released roughly after 12 months. So that was something that we had to just factor in and be cognizant of. And, and it did, and it does affect your returns, you know, having to front cash day one to then get it returned back to in year two, that that does create a drag effect on your returns. But aside from aside from the debt changing, the way that we adjusted our underwriting for the native effects of COVID, which I would say, you know, being less willing to pursue rent increases and value add, and obviously taking organic rent growth off the table, you know, pre COVID, we were rents nationally, we’re growing solidly somewhere around 2%. And, you know, looking at NMH C’s last report this week you know, it runs in may when we’re down, you know, negative 0.1% or something like that. So, what we, what we did is we took any rent growth off the table for the first 12 to 24 months. We increased our hold period, generally speaking to account for, as you said, you know, early on, sometimes you get stuck and you just have to hold a deal for longer because you don’t have the opportunity to either implement your business plan or seek an exit because you don’t have, you know, the optimal capital markets environment. So you know, for those couple of factors, you know, you might have to wait to implement your business plan and you might have to wait to get the best price on a sale. We lengthened our whole period, which as you know, when you lengthen your whole period, your IRR typically goes down you’re, you’re, you know, you’re spreading the value, add aspect of the deal over more years and that’s diluting your returns. So, you know, just by taking rent growth off the table for the first 24 months and increasing your whole period and stressing your going in vacancy, that right there is going to, you know, take your deal. That was an 18 IRR, you know, down to maybe a 12 and so we were adjusting our pricing by roughly, you know, a 10% discount to, to get back to our 18%, for example.

Charles:
So what do you see over the next few years, obviously you’ve changed around your rent growth over the next 12 to 24 months. What are you seeing for let’s say next year, the year after going forward with multifamily in, I mean, with everything that just happened with all the printing of money, with the new regulations with agency, which will probably not be as stringent years to come after this passes, what do you, what are you seeing?

Rob:
It’s a really interesting time. I think all in all people are very bullish about multifamily. The longterm demographics are only improving. And I think so the going back to how we change our underwriting, if I think if you noticed there was nothing that we really changed in terms of terminal evaluation. For example, we didn’t increase our exit cap rates thinking, well, the world, you know, the sky is falling and, you know, investors are going to hate multifamily and discount it with a higher cap rate. We don’t believe that’s going to be the case. You know, things are gonna get better and get back to where they were. So, you know, we’re optimistic about the future for multifamily. And in terms of all the money printing that you mentioned, you know, obviously that has to show up as inflation at some point. We have no idea when, but, you know, real estate has historically been a strong hedge to inflation. So you know, it’s not a multifamily is not a bad place to be, especially with yearlong leases, turning over, you can adjust your rates, you know, with inflation, you know, hotels are the best, right? You have daily changes in your room rates. So that is actually the best inflation, hedge real estate asset. But you know, multifamily is, is pretty strong as well.

Charles:
Yeah, no, that’s very interesting. I actually think that the cap rates are probably going to get compressed with people not wanting to leave money in bank accounts. No, it’s always uncertain with the stock market. They can put something that’s actually kind of rides off inflation, which is really how real estate works. And I mean, the cost of debt for deals that we did last summer, versus what we’re doing this summer are 10, 15% less. We’re getting twice as long on interest only maybe two years to 40 years. So it’s just like, it’s, it’s very friendly for purchasing right now. I feel. And I just we’ll see over the next few years how everything works, but I think it’s going to be always a safe Harbor for cashflow, which also hedging against the inflation, like you were saying.

Rob:
Yeah, I totally agree with you about the debt. You know, whether we like it or not, cap rates are correlated to interest rates and you know, it loosely, some people argue, well, cap rates, industry it’s aren’t correlated and, you know, but, but the research shows they’re about 70% correlated and yeah, we’ve seen a, a big drop in, in all in rates for multifamily financing. And that is going to pull down cap rates, I believe in the short run or, you know, maybe the medium term. But as, as I said, you know, when inflation rears its head cap rates will have to, to rise and lockstep to account for inflation.

Charles:
Yeah. One thing I just want to say for the listeners is that Rob and I are usually we’re talking now about agency debt, which is a million dollars plus and loan amounts. I feel that there might be an issue for commercial banks. I know that’s going higher when I talk to people that are looking for loans on less than a million dollars with commercial local banks, it is going up five, 10% on the down payment side and refinancing much more difficult. And there’s a lot more hurdles. So we’re talking about larger multifamily, you’re going to have a different a different situation. And when you’re going into dealing with your local bank or credit union, but that’s, we’re just when we’re talking about that, so what mistakes do you commonly see other investors?

Rob:
Yeah, so a big one is hard to spot sometimes, but it’s being too aggressive in how quickly you’re projecting to implement your value at business plan. So people assume that they can get, you know, they can handle all the exterior construction as well as renovate all the interior units, you know, move in better tenants, raise rents, and they can get all that done in the first year. And you’ll see, you know, they’re simple year by year performance just goes from here and then it just jumps up and now they’re making money. So I think you know, be more conservative and more honest thinking through how long it’s actually going to take for you to achieve your business plan is is something that is a common mistake. And I think one of the reasons for that is not too many models I see have a very straightforward stabilization timeline input, and that was, and that was something that I spent a lot of time thinking about and, and, and building and rebuilding while I was building my underwriting model, because I just felt that this is the most complex and subjective part of the underwriting, you know, everything else pretty straightforward. There’s some leeway here and there, but the thing that you see models differ the most in the way that they stabilize and the way that they get from point a to point B essentially. And so, so just to run through it really quickly, the way that I built our stabilization is we take the in place numbers of, you know, rents are here, for example, they’re $900. And the way that I set it up is it’s a, if are in place, rents are $900 and our performance or a thousand dollars it’ll linearly move towards the stabilization number across the amount of months that you input. So let’s say I input 10 months to get from $900 to a thousand dollars. You know, my rents will just slowly inch up by $10 every month until it reaches a thousand. And, you know, once you understand your business plan and, and you have some experience in terms of how long it takes you to renovate and things like that, and, and what occupancy you want to remain at, you know, that’s another issue is some people assume that they can maintain really high occupancy while they’re turning the rent roll and going through a bunch of unit renovations. So you have to look at a blend of, you know, how fast do you want to renovate? What occupancy do you want to maintain and then fit kind of figure out, okay, well, is it going to take me 12 or 18 or 24 months to achieve, you know, the full renovation cycle.

Charles:
Yeah. Yeah. Because you’re Going to see that the you’re definitely going to see your rent roll in your receivables, just decrease when you’re doing all of these turns, because you’re going to have units, it’s not going to be a perfect two weeks to renovate. Then you rent it. You have other units that are waiting to get renovated that are going to be vacant. You have. So yeah, that’s something that people definitely have to pencil in. How many units they can actually do. And then how many units are still going to be vacant because of this, whether it’s they before they’re getting renovated or whether now I have my leasing person is now trying to at least that, so how many am I going to have here before we release these? So it’s, there’s definitely a lot of factors that people don’t normal underwriting doesn’t, doesn’t bring in, right. They just say, Oh, no, we’re going to go from your 94. We’re going to go down to 90 and then everything’s going to be great still when we’re doing this, which isn’t, isn’t true. But so we both worked with a number of passive investors. So how do you suggest your passive investors to become more educated in real estate investing syndication, when you’re, when you start talking to them?

Rob:
I highly recommend, you know, looking at it as being an active passive investor. I think if you really want to get the best results for yourself, you know, you need to take it seriously and you need to educate yourself just as you would, if you were, let’s say, in an active investor. And so I think there’s books out there you know, a shameless plug on my new book, the definitive guide to underwriting, multifamily acquisitions. Part of my motivation for writing that book was the hope that passive investors would actually read the book and, and, and feel that the underwriting process is accessible to them. Because I think that’s sometimes portrayed as a black box and that underwriting is this a, you know, dark art that leave it up to the experts, just trust me on this, but no, I really want to empower, you know, the average pass investor to be able to have the proficiency, to underwrite a deal, you know, they can take a lot of the assumptions at face value and, you know, plug in the numbers, but at least they’re there doing it. And at least they’re seeing how the numbers all interact with each other and what the results are. You know, I find it very strange when some sponsors refuse to show their underwriting to an investor when they ask, I mean, I think that should be the first thing you see. Right. Well, let’s talk numbers. So you know, I highly recommend past investors to get my book, dive into it, you know, I’ve, I created it to be open and friendly for the passive investor while still being deep enough for the active investor to glean insights.

Charles:
Yeah. And the underwriting is very important because even if they’re so called seasoned investors indicators, I’ve seen underwriting from seasoned investors that I was just seeing one in January that got closed on and they were saying, they’re doing 60% rent increases. And like, people have to look at if they were in that situation and can the market stand that and how many years are they doing it? And it was over just like three or years, which obviously that’s changed now for them. But you have to review the underwriting for every deal. And you also have to make sure, like, if it makes any sense, I mean, it’s just so how can people learn more about you and your business and get your book? And I’ll put all the links in YouTube and podcast notes.

Rob:
Yeah, I really appreciate that. So to find out more about us, you can go to lonestarcapgroup.com there, you can check out you know, the book, my newsletter, as well as some other articles and insights and find out more about our business. If you want to reach out to me directly, you can do so by emailing, [email protected], you know, happy to you know, answer any questions or get in touch further.

Charles:
Okay. Awesome. Rob, thank you very much for coming on and have a great rest of your week.

Rob:
Thanks so much.

Charles:
Thanks.

Announcer:
Thank you for listening to the Global Investors Podcast. If you’d like to show, be sure to subscribe on iTunes or Google play to get new weekly episodes. For more resources and to receive our newsletter, please visit global investor podcast.com and don’t forget to join us next week for another episode.

Announcer:
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure, subscription documentation, and are subject to all applicable laws. Please consult an appropriate tax legal, real estate, financial or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of harborside partners incorporated exclusively.

Links and Contact Information Mentioned In The Episode:

About Rob Beardsley

Rob Beardsley oversees acquisitions and capital markets for Lone Star Capital and has acquired over $100M of multifamily real estate. He has evaluated thousands of opportunities using proprietary underwriting models and published the number one book on multifamily underwriting. Rob has written over 50 articles about underwriting, deal structures, and capital markets and hosts the Capital Spotlight podcast, which focuses on interviewing institutional investors.

0

About author

Admin

Related items

Running a Multifamily Brokerage While Investing in Apartments with David Childers (Youtube)

GI65: Running a Multifamily Brokerage While Investing in Apartments with David Childers

Read more
Increasing NOI By Focusing On Asset Management with Jason Yarusi (Youtube)

GI64: Increasing NOI By Focusing On Asset Management with Jason Yarusi

Read more
Structuring & Building Your Real Estate Business with Attorney Jeffrey Love (youtube)

GI63: Structuring & Building Your Real Estate Business with Attorney Jeffrey Love

Read more

There are 0 comments

%d bloggers like this: