Dave:
Hello everyone. Welcome to On The Market. I’m your host, Dave Meyer, joined today by James Dainard. James, how are you feeling about the multifamily market these days?
James:
We’re feeling pretty good. I mean, our portfolio’s pretty balanced out. Our stabilized portfolio is doing well. Now, we just got to find the margin, but the deals are creeping through here and there. They’re sneaking through, so as long as the numbers make sense, we’re all about it.
Dave:
Well, I’m super excited for today’s episode. I don’t personally sponsor multifamily deals, but I invest in multifamily deals and I think this asset class is one of the most interesting ones in all of real estate. If you look at commercial real estate and residential combined, multifamily is in a really interesting space right now, and we have brought on honestly two of the most experienced multifamily operators I personally know. We have Brian Burke coming on, who is the CEO and president of Praxis Capital. He also wrote a book for BiggerPockets on investing in syndications, and we also have Matt Faircloth who is the president of the DeRosa Group. He’s also been a multifamily investor for almost 20 years now. And knowing these guys, I think we’re going to hear some interesting opinions that you might not be expecting about the multifamily market. You don’t know either of these guys, do you?
James:
I know of them, but I’ve never got to meet them, so I’m very excited.
Dave:
Well, I think we’re going to have a lot of fun today because they’re both very entertaining and really know what they’re talking about. And don’t beat around the bush at all. They’re going to give it to you straight. They’re going to tell you what they like about the market. They’re going to tell you what they hate about the market. So if you were interested in investing in multifamily or you’re just curious about what’s going on with this massive, massive asset class, you’re definitely going to want to check out this episode. So with no further ado, let’s just get into it. I’m going to start this interview with an apology to Mr. Matt Faircloth because I am a little bit embarrassed that I have known you and worked with you at BiggerPockets for eight years.
Matt:
Well.
Dave:
And this is the first time you’re on On the Market, and that is completely my fault and I’m sorry, but I’m very glad to finally have you here on this show.
Matt:
I accept your apology, Dave, and it is an honor to be here. Thank you for having me. And I, of course, did not take it personally and thanks again and I’m looking forward to today’s conversation and mixing it up with Brian Burke a little bit. I’m going to try and disagree with everything he says.
Dave:
Okay, good. That’s going to be fun.
Matt:
I’ll make it a saucy conversation to make it up.
Dave:
Okay, good. Yeah, just be a contrarian to everything Brian says.
Matt:
Absolutely.
Dave:
Before we get to Brian, can you just introduce yourself for those in our audience who don’t know you yet?
Matt:
Absolutely. Guys, my is Matt Faircloth. I am the co-founder of the DeRosa Group, and you better have heard of me through BiggerPockets through my book that just had a revised edition release called Raising Private Capital. New version has a foreword written by Pace Morby. I’m also one of the leaders of the BiggerPockets Multifamily Bootcamp that just launched another cohort with hundreds of people. We’ve had thousands of people, Dave, through the program, and I’m really grateful for those that have gotten the multifamily education we’ve been able to deliver with BP through that. So that’s a bit about me and my company is a multifamily operator in multiple states across the United States.
Dave:
Awesome. Well, welcome to On The Market. Brian, you were here I think in the beginning of this year and beginning of 2023, you were a guest on On The Market, but for anyone who missed that show, could you introduce yourself, please?
Brian:
Yes, my name is Brian Burke. I was On The Market podcast before Matt Faircloth. That is my claim to fame. I’m president and CEO of Praxis Capital. I’ve been investing in real estate for 34 years, multifamily for about 20 years. Bought about 4,000 multifamily units around the peak of the market a year and a half ago. I sold most of it, sold about three quarters of my portfolio, and then came on your show and talked about how I thought the multifamily market was going to go down and it since has, I’m also going to be the chief disagreer with Matt Faircloth today since that’s how he wants to play it. That’s how we’re going to play it. But I’ll start out with, you might know me from BiggerPockets through my book, which is the opposite of Matt’s book, which is Raising Private Capital. My book is investing private capital, but it’s not called that. It’s called the Hands-Off Investor. And it’s written to teach passive investors how to invest their money into the offerings from the readers of Matt’s book on Raising Private Capital.
Matt:
Absolutely. They’re good pairings those books. And I’ve had many investors come to join us on our offerings that we’re armed with that book. And so I think it’s a great book to tell passive investors how to approach the investments they want to make.
Dave:
Matt, you were supposed to disagree with Brian and right off the bat you’re just agreeing.
Brian:
He already failing.
Dave:
Yeah, you’re failing here.
Brian:
He had one job. You had one job.
Matt:
Yeah, it’s not as good of a book. How about that?
Brian:
Okay, that’ll work.
Dave:
I like how both of you are basically assuring our audience that they’re going to learn nothing because they’re just going to hear polar opposite opinions from both of you.
Matt:
We’ll just give other perspectives, Dave. We’ll give other perspectives. How about that?
Dave:
Okay.
Brian:
We’re not here to teach you anything, we’re just here to present our thoughts and let you draw your own conclusions. How about that?
Matt:
Right. There you go.
Dave:
All right, fair enough.
James:
Well, I am very excited to have both of you guys on here. I’ve been actually waiting to get to interview both of you. So you guys have a great reputation and I’m excited to chop it up. But to get things started, I think what I’m really curious about, you guys have been a multifamily for a really long time and we’re getting all these nasty headlines right now that it’s just about everything’s coming to doom and gloom. The rates are high, things are resetting, and I think it’s making people pretty unsettled right now. Are these headlines in this fear and this doom and gloom, what are you guys doing right now with the multifamily space? Are you guys getting bullish on it right now? I know we’ve been looking for a lot more new projects or are you starting to take a step back and seeing where the chips lay right now?
Matt:
I mean, Brian and I are actually very good friends and we’re in a mastermind together as well. So I could say that for us, and this may be what Brian will say as well, that my company hasn’t bought a deal in a year and a half, and we’ve bid, we’ve underwritten something like 350 deals. We’ve written dozens and dozens of letters of intent, none of which were accepted, of course. And it’s because just the numbers don’t pencil any more based on what people are asking for. There’s the widest gap that I’ve ever seen between bid and ask, meaning what a seller is asking versus what a buyer is willing to pay for a property that I’ve seen.
It’s starting to come down a little bit, but the sellers, and most importantly the brokers, I think they’re really culprits here, have not come down to the acceptance that rising interest rates are going to pinch a bit on what we’re going to be able to pay for properties. But a lot of properties are being sold in the four to 5% cap rate range or offered up at that range and they’re coming back on, they’re going under contract and they’re coming back on the market. So I’m starting to see a little bit of slippage, which we can talk about, but there’s, up until recently, a lot of stuff we’ve looked at, it’s been drastically overpriced.
Brian:
When I was on this show back in January, the title of this show, and if you didn’t see it, look it up, it was called The Multifamily Bomb is About to Explode or something crazy, some kind of crazy catchy title like that. And I had predicted some chaos in the multifamily market. And so yeah, I think James, to your point, there’s negative articles out there and we’ve earned every one of them. There’s a good reason for these negative articles, that’s because there’s really not a lot of good news to report. It’s just being frank. That’s how it is.
Somebody asked the other day to use a baseball analogy, what inning are we in? Are we in the first inning, second inning, eighth inning, ninth inning? And my answer was, to use your baseball analogy, I’m on the team bus sitting in the parking lot waiting to get to the next venue and we haven’t even gotten on the freeway yet to get to the next park for the next game. I’m not buying anything. I haven’t bought anything in two years and it might be another year or two before I do buy anything. So there’s not a lot of really good news to report, I’m afraid.
James:
And do you guys think that you guys haven’t bought anything in the last year or two just because the opportunity’s not there? Or you just want to see where it’s going because we’re seeing the same thing, we look at hundreds of deals and then we find one out of a hundred that will actually pencil really well, and typically it’s value add, but are you waiting for a better return or is it just because the math’s not working?
Matt:
I think this is where we differ a little bit because we’re still looking at deals. Brian, you’ve told me that most of the time you’re just deleting emails as they come in from the broker. His finger can’t hit the delete button fast enough. He’s like, “Why are you clocking my inbox with this garbage?” So for us, we still do underwrite deals and we still shop and we’ve come very close on deals and I’ve actually seen more and more distress come in, people that have to sell versus folks that want to sell. So I think that’s going to be the next opportunity. We’re trying to catch something like that for somebody that’s looking to sell for a reasonable number versus selling for some astronomical, somebody trying to sell it for double what they paid for it a year ago. And we’ve seen quite a bit of that, by the way. We’ve seen multiple deals that are literally double what the seller paid for it two years ago, and they’re just trying to pass their problem that they bought.
It wasn’t making money when they bought it two years ago. They’re trying to pass that problem up line to me. So there’s a lot, there’s more of that, but we’re seeing more and more distress. So we are actively bidding. We just submitted an LOI yesterday on a deal, but it was a good deal. I mean, it made money, this magical thing called making money the day you buy it instead of being negative for a couple of years, crush your fingers and hope that it makes money later. We’re seeing more of that. Maybe not a torrent or a flood or a bomb just yet. So if there is a bomb, as Brian predicted, I don’t think it’s exploded yet, but the fuse is short if there is one. Brian, am I right? Are you still deleting emails as they come into your inbox and not even [inaudible 00:11:01]?
Brian:
Finally, I get to disagree with Matt because-
Matt:
Oh, please do.
Brian:
… he’s right that in the beginning, I’d say the beginning, when was the beginning? Let’s say late ’21 to early ’22, I was literally doing that. I’d get an email of the new deal coming in, I would just delete, I didn’t even care. You could send me what looked like the greatest deal in the world. I didn’t even care, delete. I couldn’t delete them fast enough. Now, I’m actually underwriting them, but I’m not underwriting them because I want to put in an offer. It’s more like if you’re seeing two cars about to collide, you just can’t take your eyes off of it. You have to watch the accident happen. And so I’ve got to underwrite the deal so that I can see where is the market, what’s really happening, how far apart are the buyers and sellers? What number am I coming to versus what number are other bidders coming to? And I’ll have the conversation with the broker like, hey, where are you coming in on pricing? Oh, our offers are in this range. And it’s like, really? Yeah, just lose my number.
Matt:
Well, at least you’re reading the emails now, Brian.
Brian:
Yes.
Dave:
Yeah, just to make fun of people though.
Brian:
There’s got to be some entertainment. I’ve been doing this for so long, I got to change it up and have some fun. Come on.
Dave:
Right. Yeah. There is some data that supports what you’re saying, Matt. I think the gap between buyer and seller expectations is something like 11% I think I saw last week, which is one of the largest it’s been in several decades. And I just wanted to ask you, Matt, as you’re doing this, you said you’re offering, are these properties selling just for more than what you would pay for them and you disagree with the other investors underwriting or are they just sitting?
Matt:
Yeah, sometimes yes. Sometimes yes, they are trading and we do monitor. We have CoStar, which is a software you can use to monitor transactions and that kind of stuff. So we do see some of these properties, believe it or not, our trading, and I’ve even through our investor base, believe it or not, it’s a bit of a small world. So folks that do invest with me will email, and they say, “Hey, I’m looking at this deal in a market that you do shop in, would you be open to take a look?” And darn it, if I didn’t already bid that deal, and this is a deal that we lost on, and I’m looking at the proud new buyers offering memorandum, and there’s a lot of things that they’re having to do to make the deal make fiscal sense for their investors.
Things that we wouldn’t do necessarily cooking their books, but they’re using a certain crystal ball, looking into the future, hoping that things go well, hoping that rate increases stay great, and hoping that cap rates go even maybe even lower than they are over the next five years. Those deals are closing, but they’re closing with a lot less debt. I mean, Brian and I can remember a day when you could buy a property where 75, 80% loan to value on a mortgage. Those days haven’t been around for a little while. Now, you’re talking 65, 60, even 55% loan to value. And you could present to investors, “Hey, it’s low risk, it’s low debt,” not true investor, what really is at risk is your money.
It’s more risk for the investors because there’s a lot more equity that needs to go in and make these deals work. So those are trading, Dave. But the other thing that I’m seeing as well is we’re also seeing deals come back on, saying, oh, that buyer couldn’t close or that deal fell apart, saying it nicely, but they either couldn’t get financing, couldn’t raise the equity, couldn’t something, and so they ended up backing out. And so the deal comes back on at less than what they were asking before.
Brian:
Part of the problem is too, I mean, I see this as an owner. As owner, our operations are fine. So we look at it and say, “There’s no reason to sell at today’s values. The values are way too low.” And then as a buyer, I’m looking at it going, “There’s no way I would buy at today’s values.” So if I can’t get myself on the same page, there’s certainly no way that unrelated buyers and sellers are going to get onto the same page. It’s just simply not happening. There’s way too much of a spread. To Matt’s point about loan to value ratios, you might be paying a fair price for a deal when the max loan to value you can get is 60% or 55% if that income stream is rapidly growing.
But if that income stream is stagnant, because you’re going to grow your way in to more value on the real estate, but if the income stream is stagnant and you can only get 55 or 60% LTV because that’s all the income the property has to support a debt of that size and you’re not growing the income, you’re paying way too much. And that’s what’s happening. If you could start underwriting properties at 75 or 80 LTV right now at today’s debt rates, you’re probably paying a fair price, but that’s not where sellers are.
Matt:
And these deals are going in at 55% LTV, Brian, that I’ve seen, and the cashflow is 2% on equity to investors.
Brian:
How’d you get it that high? I haven’t seen one that high. Most of the ones I’m finding, it’s negative. I saw one the other day, it was a 3% IRR, let alone cash on cash.
Matt:
Right.
Brian:
Some of them are just really, really bad. Now, some of these trades are happening probably because you’ve got 1031 buyers, they’ve got a gun to their head. The tax tail is wagging the investment dog. You’ve got ones where you have funds that have raised a bunch of money that’s sitting there, maybe they’ve got pref burning a hole in their pocket, they have to spend it. There’s some transactions that are happening out there, but transaction volume is minuscule compared to historical transaction volume. I mean, we’re talking about drops of 70 to 80% in some markets in transaction velocity, and there’s a good reason for that. Nobody wants to pay this price and nobody wants to sell at the price where the value really makes sense.
Matt:
Before we move on, Dave, I want to throw an and in there to Brian, we’ll call it a disagreement. Brian, [inaudible 00:16:56], that’s because I remember we’re supposed to disagree, right? So you forgot to say about cost segregation studies, Brian, and people don’t talk about cost seg enough and how it’s become a driving factor in this market. I cannot tell you how many investors invested with us over the years because of the negative K-1 they could get because of cost seg studies and accelerated depreciation, which in essence guys allows investors to write off a lot of the investment that they made into a property to the tune of 30 to 50% of the check that they write to the deal they’re able to show is a loss. Cost segregation studies and…
Well, accelerated depreciation is slowly burning off. You’re only able to write off 80% of it this year, Brian, as you know, it’s going to 60% next year. So I think that that factor has been artificially driving the market a bit because I still get investors that call us regularly saying, “Hey, can you get me a negative K-1? I mean, I need one by the end Of the year.”
Brian:
Don’t you love it when people want to make bad investment decisions to save paying a few bucks to the government?
James:
It’s so crazy.
Brian:
I think some of the worst investment decisions ever made were made for tax reasons.
Matt:
Oh, goodness.
Brian:
Whether it was a 1031 exchange, a negative K-1, whatever you want to call it, forget about that. This is a game of making money, not saving tax. Now, I know that saving a dollar to the tax man is earning a dollar. Okay, fine. But losing $10 to save $3 doesn’t make any sense.
James:
Well, you guys are two of my new favorite people. I think because I’m loving this and I know when I want to practice my sales skills, I’m going to call Brian and try to sell him a multifamily building in the next six to 12 months.
Matt:
Can I listen in on that?
Brian:
I’ve said I’m the worst marketing person ever, and here I am, I’m in the multifamily business and I’m just totally bagging on it. So this is my marketing prowess at its best, James.
Dave:
People always want to give people money who don’t need it, Brian. So I think you’re going to get a couple of phone calls after this podcast.
James:
But speaking of being a little pessimistic, which I think is a good thing, right? As investors, we’re supposed to punch holes in investments, see what happens, and then whether we want to move forward or not. So I’m one of the most pessimistic salespeople there are in real estate, but going back to work through that pessimism and work through these deal flow, getting back to just the fundamentals of multifamily, like how we buy properties or how you guys have bought in properties over the years and just getting back into those core principles, what you were just talking about of people are using cost segregation just to try to get the tax break when they could be giving away money over here anyways, people get blind by certain strategies sometimes. I agree it makes no sense just to get the tax break if you’re losing money. It’s like when you go buy an expensive car every year.
I’m like, I don’t understand that either. You get the tax ride up, but you’re still spending money on the car. So as we get back to, I mean, the one good thing about these rates going up is it is slowly settling down the multifamily market back to where it was 2016, ’17, ’18. You could look at a deal, you can put your numbers on it and try to move forward. What fundamentals are you guys… Like Matt, you’re looking at a lot of deals, Brian, you’re denying a lot of deals. So you’re still going back to the fundamentals of what are you working through and what are you guys looking for in today’s market? So it hits your buy box of, hey, we’re going to move forward right now because it’s a riskier market. So you want to take your time. What makes you push yes on that deal?
Matt:
Yeah, and this is one of these, again, I get to disagree. Brian and I buy in different vintages. I tend to buy more workforce housing, like the 70s and 80s vintage properties. And so I look at ways that I can add value and take a 70s or an 80s vintage and bring it up to today’s standards. So I look for what can I do? What can I roll my sleeves up with our company? Because we’ve got a fairly robust construction initiative in our company. So what’s possible with regards to renovation, construction, revamping, that kind of thing, and be a little careful in today’s market about that. You have to be very uber sensitive to pricing because anything you invest in a property and CapEx goes to your total cost basis. You can’t have the purchase price be too much of that cost basis.
So we look for construction dollars, James, and then I look for a disparity between the market rent and what the actual rent is. Most of the deals that we’ve done that have gone really well were not owned by seasoned operators before us. These are folks that were onesie-twosie operators or folks that were newer to the space that didn’t really know how to manage properly, mismanaged from one reason or another. So those are deals that we really like. And so I look to bottom line at James, I look for rent bumps if I can get them, construction investments that I can make that’ll create real change at the property. And I look for mismanagement that I can easily cure with a better management strategy.
James:
Yeah, that value add makes a huge difference in your performa, Brian. So are you more pessimistic about the market just because salespeople are trying to pitch you bad deals? Or is it just because you just don’t think it’s the time to be jumping in right now?
Matt:
Brian’s always a pessimist.
Brian:
Yeah, I’m already pessimistic. Both of those are true, actually. I owned this one property that was a complete and utter dog. I mean, there was nothing I could do to get this thing to perform. So this guy, somebody owned it, tried to get it to work, lost it in foreclosure, somebody else bought it, tried to get it to work, couldn’t get it to work. I came in and said, “I can fix this problem.” So I go in, I tried to get it to work, I can’t get it to work. I literally had hired the sheriff’s department to have a full-time deputy on the property to try to control the crime. It was that bad. Finally, I sell it to somebody else because it’s like we got to get out of this thing. We earned a little bit on it, but it certainly wasn’t a smoking deal.
It was probably one of our lower performing deals. And then a year later, somebody’s pitching me the deal to buy this deal and they’re like, “It’s a proven value add strategy with upside potential.” And I’m like, “That thing is a dog. There’s nothing you could ever do other than burn it to the ground that will improve that property.” And so it’s just absolute broker hype and never ever believe it when they say these proven value add strategy, it’s a 100% BS. But at the same time, now, we’re in this market where the market also sucks. So I don’t like where interest rates are. I don’t like where cap rates are. I don’t like where things are going. And then somebody wants to sell me a crap property that proven value add strategy in the middle of a crappy market. So it’s a double negative and that’s not a thing.
Matt:
I’m going to go give Brian Burke a hug right now. I think he needs one.
Dave:
So Brian, you’ve cited a couple of reasons. I just want to make sure we understand. So you’re saying you don’t like where cap rates are, so you still think they’re too low, at least on the buy side. You cited earlier, sluggish rent growth, high capital costs. Is there anything else we’re missing there that you don’t like?
Matt:
Insurance.
Brian:
Oh, yeah.
Matt:
[Inaudible 00:24:05], Brian.
Brian:
I don’t like expenses. Insurance rates are going up, payroll is going up. So all your operating costs are increasing. So now, you’re in this weird position where operating costs are increasing, cost of capital is increasing, income is decreasing because rents are falling, the stats are showing rents are falling, especially in markets that had big increases. Now, you could say like, “Oh, well, they had big increases, now, they have a decrease. No big deal. You’re still up from where you were a couple of years ago, yada, yada.” Great. But that doesn’t help you if you just bought six months ago because that was your starting point. So you’ve got all those factors are problematic. Now, to make matters worse, we’re investing in these assets to do what? It’s to earn a return, right? We’re putting money into a deal with the hope that in the future you’re going to get more money back. That’s the only reason that we’re doing this.
And in order to quantify how much money we’re going to get back, we have to do financial modeling. And when we do financial modeling, we’re using assumptions to determine what the income is going to be in the future and what the property’s value will be in the future so we can see how much we’re going to ultimately sell this property for and how much we’re going to earn along the way. Now, if I can’t quantify the inputs going into this mathematical equation, I can’t quantify the output. And that’s the problem I’m struggling with right now. I don’t know where interest rates are going to be six months, one year, two years from now. I don’t have a lot of confidence that they’re going to go in the direction that I would find favorable and certainly not the direction where I think it’s necessary at today’s values.
So that one’s out the window. I can’t quantify where rent growth is because predictions are all across the map and they’re not what they were. And you can’t look in the rear-view mirror and say, “Well, it was 10%, so it’ll be 10%.” No, it won’t. So that one’s out the window. And then on top of all that, you don’t know where cap rates are. So how do you calculate your exit price if you don’t know the cap rate? And I think cap rates are still too low. I mean, it was one thing to buy four cap properties in a 3% interest rate environment when you had 10% or 15% rent growth, but four cap does not work in 0% rent growth, even if you didn’t change the cost of the capital. Four cap also does not work with increasing rents, but high interest rates. Now, you have decreasing rent and high interest rates and four caps are just a total joke.
Dave:
All right, well, let’s just end now. I think the episode is over. It’s over now.
Matt:
If you were an animal, you would probably be a bear right now, right?
Dave:
An angry bear.
Brian:
It’s realism. It’s demanding some realism in this market. Everybody wants to be rosy, like everything’s going great.
Matt:
Don’t you think there’s going to be opportunity though, bear man? You think there’s going to be opportunity coming down the pipe here, right? And this is like your bull optimist buddy over here talking, right?
Brian:
I was going to say, is this where you say moo or something like that?
Matt:
No, I don’t say moo. I say, right opportunity because I think that I’ll give you a few things that are on the other side of the coin. Equities expectations has not changed. I don’t know if the folks you’re talking to have or whatever. Yes, debt cost of capital has changed, but even though you would think that it would because an investor could just go popping their money into a mutual fund or a CD right now, whatever, and make themselves four and a half, 5%, their expectations on pref or expectations on IRR or returns on a deal have maintained somewhat realistic. It hasn’t changed. They’re not expecting to make… You would think that investors made 20, 25% IRR with syndicators getting lucky and selling deals to the market being really hot the last couple of years.
Investors were not seasoned by that and that’s not what they expect anymore. Investors still, I think I’ve seen investors expect 12, 13, 14% IRR on deals and they’re also willing to be even more patient, right? I think that in addition, everything you just said is right. I’m not disagreeing anything you said, but I’m just giving you another perspective. So I think that there is also opportunity to acquire deals for people that have to sell. There are maybe opportunities and this wave hasn’t come through yet because it just takes a while for distressed properties to work their way through the system to get… I know you were around in 2008 like I was. When the market crashed in 2008, the distressed deals weren’t on the market a month after that.
It took like a year or so for that distressed to work its way through. So that being said, I think we’re going to see maybe some more bank loan foreclosures come onto the market. I think we’re going to see owners that are going to get realistic that they’re going to realize they can’t sell for their number that they need to sell for and they’re going to get more in tune here. So I’m starting to see more of that, more distress in the market, more people that have to sell versus those that want to sell. And I think that in line with equity, in line with really good underwriting and factoring in everything you just said, I think will create opportunity and is beginning to create real opportunities that exist today.
Brian:
Well, I do agree with you that the investor’s return expectations haven’t really changed much. That part, I’m on the same page with you. The difference that I see is that two years ago, we were driving a Corvette en route to that destination and now we’re driving a Tercel and so with a quarter tank of gas. And so we’re still trying to get there, but it’s just difficult to get those mid-teens returns at where prices are today.
Matt:
I’m starting to see broken down Corvettes on the side of the road. And also I’ll give you one more. We don’t invest in top tier markets and that’s something you and I have always differed on that one, Brian, we invest in sub-tier tertiary markets like the Piedmont Triad in North Carolina is one of our markets. I have a joke, if the city has a major league anything, I won’t invest there, major league football, baseball, maybe hockey, but not baseball or football. [inaudible 00:30:33] if major league baseball, major league football’s made a big investment there, not me. I’ll go for where a minor league team is because the cap rates didn’t push down as far as they did in say Greensboro as they did in Raleigh or in Charlotte or something like that.
Brian:
Yes, I call those high barrier to exit markets.
Dave:
No one wants to buy. Yeah.
Brian:
I suppose that makes it easier to buy [inaudible 00:30:55].
Matt:
Something we’ve debated on a lot, Dave, is that it’s easy to get into but hard to get out of those markets.
Dave:
That’s right.
Matt:
Believe it or not, there are people that do want to buy in the tertiary markets.
Brian:
Yes, there is. And there’s arbitrage. There’s arbitrage you could play, I don’t care what the market looks like, you can play arbitrage. I could literally buy a deal today and it would work and I would confidently buy it and I could confidently pitch that to my investors, but it would be at a certain price. And the problem is that no one is willing to sell at that price right now. They will be when their back is against the wall, they will be. I just haven’t seen it yet.
James:
But it does feel like it is coming down, I mean, things are moving downstream right now. We’ve seen some syndicators that maybe are a little bit newer to the market. They’re getting caught with some bad debt right now and it’s causing some issues or their midstream and a value add and their costs are out of control. Maybe their vacancy rate was a little bit higher than they expected during that transition, the turn, their debt has crept up on them on the bridge financing. And so Brian, the one thing is yes, nothing’s making sense, but sometimes that’s the best time to buy a deal because things start falling apart and breaking down.
I feel like these opportunities are starting to come up. We’re starting to see some stuff that we can stabilize out at seven and a half, eight cap in there, which we would not be able to touch two years ago. And so as these things are transitioning though, does it also make you put your deal goggles on? Because when I see those things being able to buy that one rare deal needle in the haystack, I get excited and I’m like, okay, cool. We got some movement coming this way.
Brian:
Yeah, I mean, that’s the beginning of it. That’s the spark lighting the fuse. But for me, our scale is a little bit larger. We need to see that I can’t just buy one needle in one haystack. There needs to be a few needles in there to really make it worthwhile because that one needle in that one haystack is being chased by anybody that’s going to try to find it. Now, you can always find that one that nobody else had their eye on. And I’ve done really well over the years doing that, getting that one deal nobody knew about, but I just don’t think that they were there yet in enough quantity where it makes a ton of sense and I think we’ll get there and time will allow this to wash out. But I just think there’s another six months to a year of chaos that needs to play out before we get to a point where we can confidently say there’s going to be enough deal flow at a fair enough valuation to make the effort worthwhile.
Dave:
So Brian, if you’re not doing multifamily, are you doing anything else instead?
Matt:
Golf.
Brian:
Yes. I’m trying to improve my golf game. Actually, I just got an in-home golf simulator and I have my own driving range in my garage.
Dave:
All right, what’s your handicap done in the last year then? How many strokes have you shaved?
Brian:
It’s absolutely terrible. Absolutely terrible. I cannot break a 100 to save my life and it’s just because I’m not really good at sports and never have been. So yeah, literally nothing. It’s like I sold three quarters of my multifamily portfolio right before the market started to tumble because I saw this coming and I’m like, “We got to get out of all this stuff and sell it all while we still can.” I sold one of my companies and so I don’t have to do anything, so I’m just waiting for the right time. Now, when I was younger and broker, I was out hustling and trying to find deals and I looked for any little pocket I could find that little shred of opportunity. I totally get it. The people that are listening to this podcast, they’re like, “Hey, I’m newer in this business. I don’t have the luxury of being able to sit there and not work for a year. I need to do something.”
Get out there and do it. That needle in that haystack that James talked about is out there if you can find it. I think you’re going to find it probably in small multi. I think that’s where the opportunity is right now. I’m too lazy to do it, but I think if you have the energy for it, go out there and look for your duplex, four-plex, 10-plex because that’s where you’re going to find the quintessential tired landlord or that’s where you’re going to find the undercapitalized, unsophisticated owner that wants to get out of landlording and all that kind of stuff. That’s where you find those deals. You don’t find those in 250 unit apartment complexes. People that own that stuff are generally well capitalized, professional. They do this for a living. They have resources and ways to weather the storm. Now, that doesn’t mean they all do. There are certainly a lot of syndicators that gotten this business over the last few years that probably never should have. This market will clean them out, but the deals are going to happen behind the scenes.
You, casual investors, are never going to see them. There’s billions of dollars. In fact, I think I just saw an article the other day, $205 billion of capital sitting in dry powder on the sidelines by large PE waiting to buy distressed debt packages from these deals. And so what they’ll do is they’ll buy the debt at a discount and then they’ll foreclose. But when they open the foreclosure bid, they’re going to open it at full principal and interest, which will be more than the property is worth. So they’ll get the property back and they’ll buy the property before you ever see it. So I don’t think we’re going to see this big wave of foreclosures, all that’s going to happen in so-called backdoor deals that aren’t going to be out there on the forefront. So it’s just going to take a while for all this cleanup to happen. That’s all.
Matt:
If I may offer a alternative, my way to look at it, first of all, the needle on the haystack is never on the market. The needle on the haystack gets found behind the scenes and the way you’re going to find a needle in a haystack right now, and I’m talking to those listening on how to get going or how to scale up in today’s market. One thing I teach in the BiggerPockets Multifamily Bootcamp is about being market centered, right? You are not going to find a needle in the haystack if you’re just sitting around surfing LoopNet and waiting for a 8% cap rate deal to show up on LoopNet. But you might find a deal that pencils out and is a good deal if you pick a market, not seven, not 10, certainly not any more than one market that you want to become an expert in, and then drill into that market and get to know the brokers.
And then yes, you could start small, as Brian had said, if you’ve got the management equation figure it out on how to manage a 10, 15, 20 unit that you may find. Go for it, right? You are going to see more distress on the small side. Brian is right about that. But if you drill into a specific market, the brokers Will Certainly put the fancy pants, 95% occupied, 50% renovated apartment building with lots of value add, 1992 vintage. They will gladly put that all over the market and blast it to everybody. But what they’re not going to do is they might not put the 75% occupied property where the person’s run out of gas and true story guys, property where the syndicator themself has fired the construction crew and is in the units themselves painting the apartments. We saw that deal.
That’d be like Brian or Matt painting the apartments and doing the renovations on their own because they couldn’t get anybody to work for them anymore, couldn’t afford to pay the labor so that the operator decided to be the labor. Those opportunities are out there, but you’re certainly not going to see a broker mass marketing that opportunity. They’re going to walk around and make that a pocket listing or just find somebody who’s willing to give a good number for that deal because the broker’s not going to put their name on it or do a big blast on it or anything like that.
Deals like that, maybe seller’s a little embarrassed about what they’re dealing with. They don’t want 30, 40 different groups tramping through the property, maybe don’t want to tell their onsite staff that they’re selling. So deals like that are going to get sold more behind the scenes. And if you guys want to get plugged into those needle in a haystack behind the scenes deals, you got to become uber market centered. And they’re starting to happen now. We’ve seen them and there’s going to be way more of them soon. And I also agree with Brian on the foreclosure thing, he’s probably right. Private equity probably is going to buy up a lot of that and then we probably won’t see it, but there’ll be some distressed seller to owner stuff that will happen too.
Dave:
So Matt, you’re just out there looking for deals and not pulling the trigger. Are you actually doing anything, shifting any of your money out of multifamily into other asset classes?
Matt:
Making a lot of offers, but you don’t make money making offers, do you?
Dave:
Doing a lot of podcasts.
Matt:
That’s it. I know. This is a lot of fun but doesn’t pay well. So what we are doing is yet again, like I said, I want to be Brian. I do respect Brian quite a bit and I do follow a lot of what he’s done. And so he’s done very well with hard money and so we have launched a fund that puts money into hard money assets, which hard money gets used during times of distress. If you could borrow money from a bank, you would, you get money, hard money because you have to because you’ve got something that needs to go from A to B, call it bridge capital if you want to call it something nicer than that. But there’s becoming a lot more hard money that’s going to be used to take things to transition assets that maybe need to get around second base, so to speak, and get brought home.
So we’ve launched a fund that’s doing very well, that’s just deploying capital into bridge deals, smaller stuff, not big, big, big multifamily stuff. These are little duplexes, triplexes. We’re doing an office building, hard money loan, that kind of thing. But it’s a great way to create cashflow now because multifamily has gotten away from cashflow over the years. It’s more of an appreciation game or it has been recently. But the fundamental of multifamily used to be cashflow. And what’s great about hard money is that cashflow is day one. And so we really have been pushing that hard while we still bid, I don’t know, we might underwrite, we probably get to between 10 and 15 multifamily deals a week that our team is underwriting as well, hopefully to catch something.
Brian:
And Matt, you’ve brought a good point there about the hard money thing. The other advantage of that is it allows investors a place to invest capital in this market and earn a return. I mean, we’re doing the same thing. We started a debt fund a couple of years ago and it was a follow on. The company that we sold was a loan originator, a hard money loan originator. And so we flipped to the other side and became a debt buyer a couple of years ago. We got about 50 million in our portfolio, but we’re able to get investors an immediate return versus with multifamily ownership, it just takes so long to get there. And right now, we can give more cash on cash return with debt than we can with equity. So it gives investors a place to put money while they wait for the next multifamily cycle to come back.
And I just think right now, I’m more focused on risk than I am on reward because I think in order for us to earn a return in the next market upcycle, we have to survive the market down cycle without losing principal. So if you could put your money into a debt vehicle, I just think somebody else’s money is in first loss position. Our average loan to value ratio is 65%. That means somebody else has 45% or 35% equity in the deal that they can lose before we ever get touched. And so to me, that’s a downside risk protection. So I think people need to think about containing their risk first, finding avenues for cashflow with good risk management and forget about your pie in the sky, double-digit, mid-teens returns for now. Those days will come back, and in fact when they do come back, they’ll probably outperform.
It’s like three years ago, four years ago when we were projecting 15% IRRs on our deals, we were delivering 20s, 30s, 70 in one case. So those returns are really good when the market is really taking off, those days, they will be back. I’m not long-term bearish on real estate, the market or multifamily. I’m short-term bearish. And that’s all going to change. The problem is I don’t know when. Is it going to change next week, next month, next year or two or three years from now? I can’t call it yet. You’ll have to have me back on the show before you have Matt come back on. I don’t want to have him beat me the second time around. Then at some point, I’ll be able to figure out when that’s going to happen, but I can’t figure it out just yet.
James:
No, and I love the debt model. I’ve been lending hard money for a long time and I remember when I was 20, it was 2008 and the market just crashed. I met this private moneylender and he had a gold chain and he would charge us four points in 18%. And I remember I was like, “I want to be that guy when I’m older,” like lending out the money. Because it is, you’re right, it gives you a much safer loan devalue position. We do a lot of private money, hard money loans out in Washington, as debt becomes harder to get, it’s a great engine because you can get a high yield. But going back to the multifamily conversation, the good thing about it is you don’t get taxed at that same rate that you get as ordinary income coming through, right? It’s a high return, high tax.
And I guess since we brought up debt, what do you guys suggest? Hard money, people are starting to use it more for these value add multifamily deals too that are a little bit hairier. They got a lot more construction going on. Their commercial debt’s gotten a lot tougher to get. They don’t want to lend you as much money. It costs more. What are you guys seeing on the commercial debt side right now as far as apartment financing? And for people that are looking at buying that 10, 20, 30 unit buildings, because where a lot of the opportunities are, what kind of commercial debt and who should they be talking to? I know we’re doing a lot of local lenders where we’re moving assets over to them to give us more lending power, because the more assets you bring them, the more flexible they are with you. What are things that you guys are seeing as you’re looking at maybe buying that next deal or one day, if I can get Brian a good enough deal, maybe he’ll buy it. What would you be doing to lock down that debt?
Matt:
Well, okay, the deal’s big enough and it doesn’t need that much renovation. The agency debt, Fannie Mae, Freddie Mac are still probably the best out there that you’re going to get because they’re government backed. The yield spread they’re willing to take is a lot less than what you’re going to see elsewhere. So they’re still putting money on the street at like 6.89, I’m sorry, 5.8, 5.9, maybe 6.1, somewhere in there, which is about as low as you’re going to get. But if you need any renovation dollar at all, if you want to renovate the property and do some value add, you got two choices. You can either get that money from your investors and raise it and then hopefully you can recapitalize the property and refinance it or you create enough value add cashflow that the investors are happy with what they’re getting, which that’s what we do.
We just do renovations with investor capital. We just need to just raise what we need for renovations. The other way you can go about it, James, is you could, if you’re buying that 20, 30, 40 unit, a lot of small community banks on the small side would be willing to lend that to you, maybe a fixed rate debt as well. So what scares me is floating rate debt because no telling where it’s going to go and then there’s this awful, terrible invention called a rate cap. Actually, it’s not a bad thing, but they’re just so crazy expensive now that you’ll have to buy to stop your rate from going up. And the cost of those things can really kill the deal.
So if you can get small community bank debt, not a bank that has their name on the side of a stadium, but small banks that maybe has five to 10 branches just in the market that you’re investing in, they might be willing to throw in renovation capital as well and maybe offer to do what’s called rolling up to perm where they can give you acquisition debt and construction debt and then they’ll transition that loan over to a permanent loan and start amortizing it over time once you’re done your work. The only just asterisk put on there is a lot of times almost all the time that debt is recourse, meaning you have to sign off on a personal guarantee. So you have to be okay with that.
Brian:
Yeah, I think Matt’s nailed it as far as most of those financing sources are concerned. I think to that, I’d add that private money is a source to use when you can’t find anybody, any banks or agencies to loan more unique scenarios, heavier lifts, that’s where your private money comes in. It’s a little bit more expensive on an interest rate. It also has a pretty short maturity. There’s unique situations where that works. Now, you really have to be confident that you can execute in the timeframe that you have allotted because I think the biggest killer in real estate in terms of sponsors having a lot of difficulty is in short-term maturities.
And it’s amazing how fast time goes by. And if you take out a three-year loan with two one-year extension options and you think that’s forever from now, well, three years goes by in the snap of a finger in this business. And then if things don’t go according to plan, you might not qualify for those one-year extensions and now you’re completely stuck. So you really have to be careful about loan maturities. Now, in one place, I differ from Matt and I get to disagree with him again, which I love.
Matt:
Please do.
Brian:
Is I like floating rate debt and most people think you’re nuts, why would you want to take on interest rate risk? And the reality of it is if interest rates right now are at a all time high, and when I say all time, I don’t mean all time, all time, I mean, in the last call it decade, interest rates are higher than they’ve been in a decade. Do I want to lock in fixed rate debt at historically high interest rates in relation to this kind of short-term history? I don’t. I want to see it float down. Now, the other problem is when commercial real estate, now, residential real estate, totally different ballgame. I love fixed rate. Any residential property I’ve ever owned has had 30 year fully amortizing fixed rate debt. I wouldn’t do anything other than that.
But in a commercial space, you don’t get 30 year fully amortizing fixed rate debt. You get any kind of debt that you get in commercial real estate that has a fixed rate is going to have some kind of prepayment penalty and it might be a fixed percentage of the loan amount. In which case, that’s not so bad. It might be a concept called yield maintenance, which is astronomically horrible. Yield maintenance means if I take out a 10-year loan, I’m essentially telling that lender they’re going to get all 10 years of interest. And if I have this deal that I’m going to buy fix up and resell in, let’s say three years or five years, I’ve still got to pay the other five or seven years of interest to that lender that I’m not even borrowing their money.
And when you add up the cost of that, it’s enormously expensive. It can cost you millions of dollars. Now, do I want to do that when rates are high? No, because that means I can’t refi if rates go down, and if the property value goes up, I can’t sell either and I painted myself into a corner. Now, I like floating because it doesn’t have that kind of a penalty. Now, floating on the other hand has one risk, and that is if interest rates move high fast, it really sucks to be in floating rate debt. And what just happened, interest rates moved higher than anyone ever imagined, faster than anyone’s ever seen.
And this is the worst time to have been in floating rate debt in probably 20 or 30 years. And I have floating rate debt on the assets that I own, and it sucks. Now, we don’t know yet whether or not fixed would’ve been any better because if I go to sell in a year or two, I might’ve had yield maintenance that would’ve killed it anyway. So nobody really knows. A jury isn’t out until the whole thing is done. But debt isn’t a simple yes or no question. Debt is a very complex question that you have to tailor to your specific circumstance on the deal that you’re doing.
Dave:
That’s fantastic advice, Brian. Thank you. And yeah, I think for all of you who are considering multifamily or are currently investing in multifamily, highly recommend learning more about the debt structures. It’s something I feel still like a novice on, and thank you for teaching us a bit about it, Brian, but it’s a lot riskier and a lot more complex than residential financing. So hopefully you all can take the time to learn it. Maybe that’s what you should spend this time doing instead of buying deals, Brian, is everyone should be learning about commercial debt right now so that they can apply what they learn when the market cycle changes a little bit.
Brian:
Well, I’ve been saying, Dave, for a while, this is a fantastic time to build your business, this is the time where you should be learning everything you can about debt, building your investor base, building your broker network, building your systems. Because you know what? When the market gets really good, you’re going to be busy doing deals and you’re not going to have time to refine your systems and sharpen your tools.
Matt:
No.
Brian:
This is when you sharpen your tools and then you use them when the market is really good. So this is an opportunity, take it.
Matt:
Yeah, and I just would talk, I would work really hard on infiltrating a specific market right now. We’re not going wide, we’re going deep as a company. We’re not tip picking new markets, we’re just trying to make new friends in the markets that we’re already investing in because that’s how we’re going to find those needles in the haystack in today’s times. The worst thing I think you could do is to dilute yourself and go wider than you should as this market’s a little squirrely right now.
Dave:
All right, well, we will end on an amicable friendly note like that with you two, agreeing with each other and offering such great advice.
Matt:
Yes.
Dave:
Brian, if people want to learn more about you and what you’re not doing right now, where should they find you?
Brian:
Well, we are doing a debt fund.
Dave:
Yeah, that’s fair, true.
Brian:
You can learn more about us at our website, praxcap.com. It’s P-R-A-X-C-A-P.com. You can follow me on Instagram at investorbrianburke. You can check out my book biggerpockets.com/syndicationbook.
Matt:
Or you can meet him at the top golf down the block from his house, which is [inaudible 00:53:00].
Brian:
Yes, or you can meet me at BP Con where I will be moderating the panel on multifamily. Actually, it’s just on syndication, not specifically multifamily, but the panel on syndication.
Dave:
All right, great. And Matt, what about you?
Matt:
They can learn more about my company, DeRosa Group at our webpage, DeRosa Group, D-E-R-O-S-A group. They can follow me on Instagram at themattfaircloth and they can also see me at BiggerPockets at our booth that we have there at BiggerPockets. They can come see me at the multifamily networking session that we’re running there as well. So we’re going to be all over BP Con with me and my team from DeRosa. So really excited to connect with all the BP people at that event and seeing Brian as well. And Brian and I are actually really good friends. We actually have a lot of fun pretending to disagree with each other, but I am just a little more of an optimist about things, but I really appreciate people like Brian that can give me more of a real perspective on the world versus best case scenario, which is that’s the world I tend to live in my brain.
Dave:
All right. Well, we appreciate both of your incredible experience and knowledge and sharing it with us here today. And of course, we’ll have to have you both back on soon, hopefully when we have a little bit better line of sight on what’s going to be happening so we can start hearing some of the strategies that you’re both employing to start jumping back into the market. But who knows when that will be? All right, Brian, Matt, thanks so much for joining us again.
Matt:
Thanks for having us, Dave. Thanks, James.
Brian:
Yeah, thanks. Thanks guys.
Dave:
We were just completely useless in that conversation I feel like. We did not need to be here for that entire thing.
James:
No, we just need to do the intro and the outro, Dave, and let them go. That was one of the more entertaining episodes I’ve been on.
Dave:
This is perfect. It’s basically just you and I get to invite people we want to learn from, let them talk and I’m just sitting here taking notes not to ask my next question, just for my own investing of just like it’s basically our own personal bootcamp or webinar mastermind or something. Those two, super entertaining but also just extremely experienced and knowledgeable. I learned a lot.
James:
Yeah, that’s a great perk about our gig. We get to talk to really cool people and it was awesome to have both perspectives because everyone has an opinion on what’s going on right now and getting both sides of the spectrum. Brian being very conservative right now, it was nice to hear that it’s okay, right? He’s like, “Hey, I’m good to wait this out. I’ve done really, really well and it’s not for everybody,” but that’s what he’s going to stick with. So it’s just a great perspective.
Dave:
Yeah, I think that the thing that I walked away with is that for someone like Brian, think about his business model. He has been managing funds for multiple decades. The way he makes money is by collecting tens of millions of dollars from passive investors and investing them into multifamily. So his whole point is right now he could probably raise money. I bet he can, but there’s just not enough good deals for him to deploy that capital. So he’s not going to raise the money. For someone who’s just looking for one deal or for two deals, you might be able to hustle into good deals right now. He said that himself. And so I think that was just a really interesting perspective. If you’re a smaller investor or someone like you, James, who just knows your market extremely well and are willing to take deal flow where it’s just one successful deal out of every a 100 deals you underwrite, that’s totally fine. But I think it sort of makes sense to me that Brian, given his business model and how his business operates is being more conservative.
James:
Yeah, and I think that’s the right approach, especially when you’re dealing with that much of investor capital. And then it was good to hear Matt, “Hey, we haven’t bought anything, but that doesn’t mean we’re not swinging every month.” They’re swinging every month and he just wants to make contact on something. And depending on what you want to do as an investor, both, neither positions are wrong or right. You just want to figure out where your risk tolerance is and how you want to move forward.
Dave:
Yeah, absolutely. And totally agree on debt working really well right now. If you know how to lend money or are an accredited investor and can participate in debt funds, it’s a great way to get cashflow right now. So definitely agree with both of them on that. The other hand, I think it’s just a bit more waiting. It sounds like you’re still looking at multifamily deals, right?
James:
Yeah, we’re always looking and we were actually at a fairly good one in Seattle recently, a couple of days ago. So there’s buys out there, it’s good for us kind of middlemen guys that are in that 30 to 50 range. But yeah, if you’re like Brian, the bigger stuff just doesn’t have the margin in it.
Dave:
So 30, 50 units you mean?
James:
Yeah, it’s like kind of no man’s land right now. A lot of people are looking, so the margin’s a little bit better. The sellers are being realistic, but it takes a lot of swings and that’s okay. Just keeps swinging until you make contact. I think the biggest thing is don’t get itchy finger, just be patient and you’ll get what you’re looking for. Stick to that buy box number you need.
Dave:
Yeah, absolutely. Very good advice. All right, well, James, thank you so much for joining us. We appreciate it. And thank you all for listening to this episode of On The Market. We’ll see you for the next episode, which will come out this Friday. On The Market was created by me, Dave Meyer and Kailyn Bennett. The show is produced by Kailyn Bennett, with editing by Exodus Media. Copywriting is by Calico Content, and we want to extend a big thank you to everyone at BiggerPockets for making this show possible.
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