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How To Invest In Apartment Buildings with Michael Becker

We are talking to Michael Becker. If you’re just getting to know Michael Becker, he’s a Principal at SPI Advisory and heads the Dallas, Texas office.

What is SPI Advisory?

It is an Advisory that specializes in repositioning multi-family assets. What that means is they find underperforming apartment buildings in their target areas and they put their special sauce on it for increasing that value from all the creative things that they do. For certain investors, they are able to participate in this opportunity.

This is an interesting episode because this one was an introduction from one of our partner companies, FortuneBuilders. In this show, you’re going to hear about how do you find underperforming apartment building in your neck of the woods, how do you raise capital whether you’re doing it for a business, you’re doing it for a residential deal or you’re doing it for a big commercial. Also, you’re going to discover about the fire that almost wrecked it all. With that said, I can’t wait for you to learn this show.

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Dustin
We've got an incredible conversation for you. It is with Michael Becker. He's the Principal of SPI Advisory. We're going to go behind the scenes and talk about how this big apartment multi-family, these typical deals go down and how you can participate in them. Michael, welcome to the show.
Michael
Thanks for having me. I appreciate it.
Dustin
I want to start off with something that I call the car chase, which is always the getter of someone's attention. I want to go back a little bit in your career when you're starting your business and money is good, but you're looking at every deal and you're worried about every cent. You're stepping up in the world and you're looking at a deal and you've got a quarter million into this deal. As the deal progresses, you got to put more into it. Now, you're over a million dollars. This is a substantial amount of money no matter how you look at it, especially when you're first stepping up to that next level. You put that extra $250,000 into the deal and the next day you get a phone call.
Michael
The property is on the news. That's never a good sign when someone tells you that your property is on the news and it's on fire. We had done six or seven deals at this point. This is the first time we've stepped up. We went up to a much larger 350-unit deals. We're buying 100 to 200-unit properties, which are fairly large-scale properties in their own right. The dollar amount is a little bit smaller and this one was a $28 million purchase price. To get the deal, we're buying from a very large Wall Street firm. Blackstone was the seller. To get the deal, we had to put up some significant amount of non-refundable earnest money out of the gate because we didn't have quite the track record of some of the other people we’re bidding against. That's how we differentiated ourselves and made them feel comfortable that we'd close on the deal.
When you do a large apartment deal, you tend to rate lock your loan. We ended up rate locking our loan. We have to post another $250,000 on the deposit up and then 23 hours later, the property was on the news and it was on fire. It was the lowest at the moment and we panicked and scrambled. It turns out, it all worked out fine. It was a nervous week. We ended up getting the seller to sign their insurance claim to us. They credited us the deductible that they would have to pay at closing. We ended up closing a deal a couple of weeks later. In the meantime, the first time you ever go through anything like that, it's a little nerve-wracking when it's the unknown for sure, especially we have a lot of hard money up on top of it.
Dustin
You seem calm now. It’s easier to look back, but were you going to demolish the whole place anyway?
Michael
No, we're just going to do a renovation. We're going to change the flooring and appliances and light fixtures and that's about it. Luckily, it was contained to one building. Luckily, no one was hurt. When you see it on the news and there are four or five fire trucks out at your property and helicopters flying over, it was a little bit nerve-wracking for sure.
Dustin
It's interesting to think what you would think, but what about from the other person's perspective? The people involved in this deal. This catches on fire, the deal is not close. Even though you put the money into it, you could back out. What did that person think?
Michael
The seller is a big emotionless Wall Street firm. They couldn’t care less. That's the one thing that I've learned. If you do have apartments, three things are going to happen to you. There'll be fires, your tenants will sue you and people will die in your property. If you can't deal with those three things, you shouldn't be doing multi-family. That's a lot of large numbers and you have tens of thousands of residents as we've had in my career. It happens. You’ve got to realize that you have a structure in place, you have legal structure, you have insurance and you have all those things for a reason. Those are there to protect you for stuff like this.
Dustin
You took on the insurance claim essentially. When you say emotionless, I'm sure they would have a team that has been dedicated. Had this been a smaller group of people, I would think that would be a value add, essentially you're handling the hassle and the paperwork. Did they see it like that even though this was big?
Michael
The larger the organization, the more layers and structures they have. They have a team that just handles stuff like this. They have an emergency response team. They have a vendor there within less than a day to clean it up and securing the site. They’re making sure that they find placement for all the people that were displaced with the fire and other units in the property and etc. It was a mini-response team that deals with the crisis. Those are good things. As a smaller organization trying to scale up, you can take little bits and pieces of that and try to apply it to what you do going forward. It’s some of the best practices.
Dustin
I just can't imagine going through that and thinking, “We just put a million dollars into this deal. What is going to happen now?” You are a specialist in a lot of different things. Let's talk about finding the deal. We're going to talk about all the different parts of this process. The first one is, you have this gift of finding underperforming assets. How do you find these deals, these multi-family or these bigger deals out there in the market?
Michael
There’s a variety of ways, but most every deal has a broker involved in some form or fashion. It's a little different than the single-family space. It's not like the large-scale multi-family at least. If you’re doing eight or ten years, you could mail a letter and then maybe get a response back. If you're trying to buy a couple hundred-unit property, the sellers got a certain level of sophistication. They're not going to go for that. To get these deals, it’s a completely unfair business as well. It's who you know, what you know, what chips you can trade or what you can leverage. You got to use all of these things to try to get a little bit of an edge along the way. There are a couple of different ways. You can either be a property that's listed for sale with the broker. He goes to market, you can bid on it and go through the competitive process. We've done a handful of deals that way. There are some other deals where the broker will bring us a deal because we own property of a similar village and similar area in town. Those sellers are thinking about selling, but not sure if he wants to market the property so they'll just bring it to us. Either we can make a deal or we can't.
Sometimes we’ll give brokers potential lists like, “Here are ten apartment complexes or twelve apartment complexes.” We subscribed to a bunch of data services. We're looking for properties that are underperforming compared to their competitors in the marketplace and those are the ones we're targeting. We try to target those. We'd give them a list, they start calling on the ownership group and sometimes those deals hit. Those have been some of the more successful ways that we've seen on. The reason why I'm here in person is because the largest apartment conferences are going on in San Diego right now. All the owners from across other larger scale ownership groups and all the brokers across the entire country are here in San Diego. It's about who you know building relationships and working and leveraging everything that you have. People do business with people they know, like and trust. That's just a lot of it. It’s getting those little edges with the brokers and trying to get that piece of information that the next buyer group doesn't have.
Dustin
I can respect events and wanting to get deals at events. Is your expectation to walk away with a deal? Is it to walk away with a couple of follow-ups that look like deals? Is it just to stay on people's radars?
Michael
A little bit of both. You come here to be seen. We had a dinner and another dinner. The brokers will be there and you want to stay top of mind. Hopefully, you'll come away with a handful of deals you can underwrite and then maybe one of those will turn into something you end up buying. If we can pick up four or five properties out of this event that had potential, that fit the size and location that we want, then we'll go back and try to do a little bit more due diligence to see if they fit. Once I get back home in my office, we'll do a little bit more follow up on it. If I could ultimately buy a deal out of coming to the conference, that would be very successful for us.
Dustin
I want to take a step back. Why does someone want out of a deal? We're all at a certain level of sophistication when we're looking at these deals. You say underperforming. To the person that's operating it, maybe it's not so underperformed. Maybe you have access to some information. Take us back a little bit. What are some reasons why someone wants out of a deal? Why would they want to sell?
Michael
There are a variety of reasons. Some reasons why we sell those is because we bought property. We had a business plan. The value has gone up and I have a bunch of investors in a deal unrelated to each other who have may be invested $100,000 or $200,000 in my deal. We've owned it for three or four years. I could double their money and it's a good return for everybody. It’s time to return the capital. There's that reason or you have a mom and pop type of guy. Some guys ran the deal for twenty years and he passes away. The kids inherit it and they don't know what they're doing. They want to go spend the cash instead of running a class C apartment complex.
That could be a reason why they do it or these larger institutions, they raise funds. These funds have defined lifecycle. It’s a three-year fund or five-year fund. At year five, they're selling that deal no matter what. It’s just time to exit the deal. It’s a variety of things. One of the biggest reasons why people consider selling is to have a loan maturity. These loans have hard fast maturities. Usually, they are five years or ten years long and when it's over, you have to refinance it. It's not like you get an extension for the bank because they're a securitized loan so you have to pay it off. It’s either you've got to go through the expense of refinancing it or it's just a natural time saying, “What's the value of my property? That's gone up quite a bit. Let me go out and sell the deal.” Those are some of the reasons why people sell.
Dustin
Is there extra motivation for a seller if that window is coming up and maybe they just haven't been paying attention or it's another property in the portfolio? Is it like in residential where sometimes you can catch it at the right moment and then people become extremely motivated?
Michael
People are people. They have the little emotions and things coming along. If you happen to be there at the right time and maybe they had a bad day or some tenant sue them or they had something and it was the third time that happened in the recent past and they’re just done with it. You might be able to catch them at the right moment in time. There's always the greed factor too. We'd been in a good environment and they flipped the switch for five years. The market has been going and going. They haven't paid attention to it and you catch them and they realize what the value of the property is now and it’s a lot more than they thought they would ever be worth when they bought it. That could just be that moment where you catch them where they’re like, “How much can I make on my property? It's time to sell it.” They still haven't quite fully optimized the property. For the next buyer sub-group, they can inject some capital, do some renovations, increase the rents and buy an extension to value. It's a win-win scenario.
Dustin
I want to get into the plan for the value add and how you can extract maximum value. Where are you looking? Where are the deals? Are they in one specific part of the country? Are there little markers that you're looking for in terms of geographic?
Michael
I'm based in Dallas, Texas. As of the end of 2018, we closed on our 33rd property. We've done almost 7,000 units and now we own about 4,500 units and the vast majority of those units are in Dallas–Fort Worth. That's where I'm based. I'm based in Dallas and my business partner, Sean, is based in Austin. We have about 600 units in Austin and about 3,900 units in North Texas, Dallas–Fort Worth area. Those are the two markets I’m focused on. At some point, we'll go to Houston and San Antonio and then maybe eventually get a little bit wider. There are nine or ten of us in our company. We're a small firm and we're not trying to take over the world.
We're just going to make sure that we're buying in good markets that have good demographics, population growth, job growth and a landlord and business-friendly environment. That's of our little recipe on the market that we want to find. In Dallas–Fort Worth, there's about $800,000 market rate apartment units and in Austin, there are about $200,000 market units. That’s the two market we focus on. We have about a potential of about a million units that we try to work at. For a company of our size, that's a good pool to go fishing. At some point, we'll be buying in Phoenix or Atlanta or some other market. Right now, it's going to be Texas for the next year or two then maybe we'll expand out a little bit.
Dustin
That's a good lesson for everyone. Everyone’s eyes are on the sky when there's a lot of opportunity in your own backyard. I can appreciate you understanding that. Are there any cities in Texas or around that just does not meet your criteria?
Michael
San Diego is above the sea. It’d be a very tough place to be a landlord because it’s more pro-tenant than pro-landlord with your state local laws. If you can't evict somebody for six months or something that are living in your unit, it’s hard when you got to pay bills and your mortgage every month. We try to find landlord to business-friendly states that have population growth and job growth. I want the wind to be in my back instead of my face a little bit. You can do that and then you can do the other stuff right like buy in the right specific location, find the underperforming deal, have a good management plan and have a good capital plan, you could do well. In the meantime, if the wind is in your back and you make a little mistake here or there, it’s a forgiving business if you have enough time. If there is enough people keep moving in, the rents have to have to go up. It forgives some mistakes you could make along the way as well.
Dustin
You mentioned some of the factors, job growth being one of them. When you hear Amazon announcing a new city or Google opening a campus or whatever, is that something that goes into your equation? Does that excite you at all in your business?
Michael
We were fortunate enough in 2018 with Paul and Than, we ended up doing our second property with them. We bought a property in North Austin. It was about three or four weeks after we closed that Apple announced that they're going to drop up to 15,000 jobs about three or four miles away from our apartment building. That was just dumb blind luck. At the end of the day, we were focusing on Austin because Austin is a dynamic metro that's growing. It’s got all those things I mentioned and it's a mecca where they're tracking these large corporate reloads to come in there. Dallas is the same way.
We put ourselves in a position to have some good fortune because we're in an environment that's conducive for that to happen. I tried not to pick on my favorite city. I was going to pick on Detroit, but if Dallas ever turns into Detroit and people move out of your city. It's a hard environment to be successful and you have to do everything right and you still have a bunch of winds in your face instead of your back. Trying to just focus on the basics and the high-level demographic growth and things along those nature. Those are good stories and it makes me feel good about putting our capital at risk and our investors' capital at risk in environments like that.
Dustin
I have a personal curiosity. I was in Austin on business and I had to get from one part to the other and I didn't time it. I didn't know. I didn't have situational awareness. I ended up getting into a car and get shuttled across and there's massive traffic. Does traffic play any role in your calculation? Great growth is a good problem to have, but it's going to take some time to fix the traffic problem. Does that play at all into what you're thinking?
Michael
That's a big concern about that market in particular. That a challenge. If you time it wrong, then you could be sitting in the car for 30 to 45 minutes and go three to four miles on the road. That's certainly a challenge that the regional planners have to get on top of. You need to pay attention to where people live. You'd buy a house and you drive 30 or 40 minutes to your job, but if you live in an apartment, you want to be close proximity to their employment center. Trying to find multi-family products and properties that are close to the employment centers and destinations, that’s something we pay a lot of attention to. We try to be within a few miles of some very large employment base. It’s one of the key factors of why we like this specific part of the submarket over not liking it. That's something we pay attention to and traffic would certainly compound in that issue.
Dustin
Is it possible to time it with the announcement? You said that you had all the factors, you had the window working with you and it just so happened that a couple blocks away, they plopped down the center. Is it possible or is it too late when a big company makes an announcement to be able to go and buy up some stuff?
Michael
Anyone that is paying attention will see that announcement and then they would want more money for it or they buy one away for those jobs to deliver and wait for that to be absorbed in. I’m not saying this is too late, but it'd be much more challenging to come in. We made money the day they made that announcement. We haven't realized it yet but it's certainly helped us out.
Dustin
If I think I have a potential property for you, whether I'm either a bird-dog or maybe I own a unit, how do I bring that deal? Is there a scenario that it happens?
Michael
Once in a while that happens. It would be a little bit more challenging. These aren't like of some size or some scale. For a company like our size, I can't go buy 30-unit or 40-unit deals all over the country. That had to be in a market that I want. That's a good way to get a start in the business. If you get these smaller deals and you want to bird-dog and you want to wholesale them, that is a good way to learn a little bit and make a little bit of feel on the way. If you start doing stuff aside, most of these ownership groups are sophisticated. They're not going to let you tie a deal up and go try to flip a contract because that's not going to be what they want.
They’re going to want to have control of the deal and they want to know the capacity and ability and track record to execute on one of these deals because they're tying it up. It's a business to all these people that own these things. If you have a 200-unit property and you have 45 employees on site that worked at the property alone full-time so they don't want to disturb the staff. It causes these people to maybe move away by having a bunch of random people walking over the property. As an ownership group, you got to be sensitive to that and make sure you don't have a lot of operational disruption by having a bunch of yahoos trying to tie your deal up and flip a contract.
Dustin
I'm curious as to your criteria. When you see a property, what makes it underperforming in your eyes? What are some of the criteria that you're looking for?
Michael
The real high-level pitch. We're targeting 200-plus unit deals in suburban Dallas–Fort Worth and Austin that are 10% or more below market rents compared to the competitor properties on the same market. Those deals have either a physical issue or a management issue or some combination of those two things.
Dustin
What would be a physical issue?
Michael
When we come with these deals, we come well-capitalized. We’ll cure it for deferred maintenance that might exist. Maybe some wood dry so you need to do an exterior paint job because it hadn't been painted in seven or eight years. More likely than not, the office and many sets are outdated. It looks like it’s built in 1997 and it looks like it's from 1997. It's twenty years old and you come in, you upgrade the office area, you upgrade the pool area or add a fitness center because it didn't it have it or maybe a dog park. We'll go inside the unit. We'll change out the flooring and light fixtures and plumbing fixtures and cabinet fronts, add a backsplash and from the white appliances to either stainless steel or black. We make it a little bit more contemporary to what the newer product is doing. By spending the money and putting capital in a deal, we would come in and get the rents up to what the competitor properties are charging down the street. The way the multi-family or any commercial real estate’s value is based on the income it produces. You increase the income, you increase the value and that's our basic business model. What I like about this business is it’s simple. It's not always easy to go out and execute but at its core, it’s like you buy a place, you make it nicer, you raise the rent, you raise the value and you returned capital. That’s what I do for a living.
Dustin
You may have answered this, but I want to make it real clear. Why wouldn't an existing operator do this themselves other than they're frustrated with the tenant lawsuit thing?
Michael
There are a couple of reasons. Some might do it themselves and some of them are like, “I've owned it for eight or ten years. I've been returning money every month. I'm doing well, so I don't want to stop doing distributions to retain capital to do this. I don't want to go to my investors and raise $1 million to come in and spend all this capital to fix it up. I'll just go ahead and sell it and give it to the next person.” One of my mentors told me when I got early into the business was, “You own apartments in dog years. Every year you own it feels like seven.” That is a true statement. If you owned a property for a period of time, sometimes it's time to sell it and move on to something else after a while. There's a variety of reasons, but usually it's because they don't want to defer distributions currently and/or take a big capital call in from their investors to put more money in. It’s better off to sell and take that money somewhere else.
Dustin
I want to go back to something you said. Raising rents is a touchy subject to the masses. The one thing that you communicated was you're adding value, you're painting, you're updating things. I can see now how that can be less touchy of a situation. I'm curious as to how you also improve the lives of the renters or the people that are there. What are some other things that you're doing to add to that?
Michael
Not so much anymore. When we first started out, we'd buy a smaller, older and tougher properties. You get it in place and if you don't have proper staffing on site, some of the offices are always shut so you don't provide your basic services or the amenities are down half the year. The pool is green and you're not keeping the chemicals on the pool balance or there's crime because they didn't do proper screening of the tenants. There are some bad actors on your property and they’re breaking in cars and do whatever happens when you have a lot of people living in close proximity to each other. Things like that and just basic level of service. Getting rid of any crime when there are certain people that shouldn't be on your property. On top of that, the biggest value proposition though is we're taking something that's old and outdated. We're providing them with a better product. In return, we get higher rent for the better product that we provide. That's our basic value proposition. Unfortunately, it's tough.
You hear all these affordability crises all across the country and it's real. I feel bad because these tenants have been seeing in Texas 5% to 8% rent increases year over year and it's slowing up a little bit here. Their incomes aren't rising at that same rate. We’re the affordable workforce housing space so there's not a whole lot of alternatives. If you don't live here, you're going to go to a trailer park or you’re going to be homeless. There’s not a whole lot of options. It’s housing by necessity more than a luxury housing by choice. These people just have to take it. They double up, they get roommates and it's a real problem out there in the world. What we're building as an industry is top of the market luxury apartments.
We’re not building workforce housing just because the labor land costs and materials are so expensive. You have to pencil out higher rents to make that economically viable anymore. It's a real challenge. I don't think we have a good answer for it in our country. If anything, they're taking away the workforce housing space, knocks down old buildings and builds something new on top of it. What we have and what I do for a living is becoming more and more scarce. It’s seemingly is a good place to invest your capital and provide a good, clean, affordable, and safe housing. There are great tax benefits and debt and all these great things that go along with it. It's one of the multifaceted investments in class that has been great. It seems that it's got a lot of legs ahead of it for many years to come.
Dustin
There's always a certain segment that is going to be beyond budget. Do you find most of the folks that are there want to stick around when the plan is presented or if they have some knowledge of what's going to happen? Do you find most of the people stay or is there a big turnover in between?
Michael
The markets we're in at Texas was a little bit more transitory of a market than where we are in San Diego. In Texas, you have a security deposit. It's $200 or $300 for a security deposit. In California, it should have one month rent plus up front. You have larger security deposits. That's part of the function that is easier to get someone out of your unit in Texas. If you don't pay, your stuff is on the curb and in 30 days, you could be evicted, where it could be many months in different parts of the country. We tend to be a little more transitory. On average, most of our apartments have 40% to 50% turnover every year no matter what happens. People moving from this part of town to that part of town. They’re moving up and down the quality depending on the personal financial situation.
If you come in, we can control that to a certain extent by how aggressive we want to get and how early and hard we want to raise rents as we do the renovation. It's like a gas break type of thing when we're going in these deals. We want to come in and start doing the renovations early on within a couple of months of owning it. I start providing that better product to then justify the higher rent. Sometimes you come in there and we hit the gas a little too hard and all of a sudden, the occupancy backs off a little bit and then you're like, “I didn't want to go to 85%.” Then you back off and hit the brake a little bit and then you catch up. You constantly do the gas break along the way. It's never a perfectly smooth line on the way up. There’s a whole bunch of that on the way up and down. We're just trying to make sure that we're providing value and we're giving a better product. We’re a lot more sophisticated as an industry than what we were a decade ago.
We're taking a lot of stuff from the hotel and the airline or rental car industry. They have revenue management. If you go look at this airline seat on this flight this one day and you go back the next day, the price can be different and fluctuate depending on their availability and how many seats are sold. I take that same concept and apply that to the multifamily industry. Everyday our price changes on these units and it’s based on our specific availability, how long that unit has been on the market and the surveys. All the competitor Compset, the competitive properties are and what they're charging. It comes into an algorithm and it tells you what your price should be for that unit on that day and that rents will good for one day and the next day it can be something different. We’re trying to be a little bit more sophisticated the way we go about and operate as an industry in whole. It’s trying to optimize your rent roll to help push your revenue up along the way as well.
Dustin
It rolls into my next question. It's easy to justify an increase in rent when you're adding value. What are some things that make the property more valuable that you do behind the scenes? Whether it's tax deductions or tax strategies or other things that you do that may not be so visible. You can't give us trade secrets here, but what would be some examples of the things that you do when you come into that?
Michael
You need to either raise income or cut expenses. Those are two things that you need to do. The way the value deals or your net operating income divided by capital rate. You've got to increase your net operating income. The revenue is straightforward. Most of it comes on rental increases by providing a better product, but we do little things. One of the best return on investments we could do is if you have a garden-style apartment complex, which is very common in Texas. It’d be a two or three story walk up stick frame building, not with the parking structure, not high rise. If they have some land, then you could do on your ground level is to add a more extended patio like a backyard. Fence it in by a 10x10 backyard and you could charge $50 or $75 a month by having a little yard for your kid or your pet. It can cost you $1,200 or $1,300 to do and you get $50 to $75 a month. You could add a more covered parking, that's a good way to charge $25 to $30 a month for a couple of parking spot that might cost you $1,000 or $1,200 to install. Those are good return on investments.
You can do water conservation programs. The way the utilities on these deals, most of it is where the tenants will pay directly to the electric provider for their electric bill but there's one big master build of the property for the water and sewer. It’s called RUBS, Ratio Utility Billing System. What the property will do is take that bill and allocate it and bill it back to the resident. If you could come in and reduce the water bill, that's a good way of saving some money. You could get a better electric contract or trash contract or some of the services you have to do on the property.
Those are some other things. We're always looking for other ways to add ancillary income like pet rents or valet trash where they pick up the trash from the front of the tenant's doorstep versus them taking it to the dumpster. Maybe you pay the service provider $10 a month and then you could charge the tenant $20 a month. You make the spread between it or something like that. There are all these little ancillary incomes because of the dollar of revenue, whether it comes from rent or other incomes. We're just trying to find ways we can come in and tweak and push it up.
Dustin
They say that you make your money, when you buy it, it's not when you sell. Do you agree with this statement?
Michael
Yes and no. Good deals are made more than found in a lot of ways. You want to come in and buy the property for a little amount of property as possible. In this environment we've been in, it's a competitive environment at this point. We're just trying to find something that is underperforming and through our efforts, we can force value into it. It’s a different mindset. That's why a lot of people have a hard time when you go on from the residential single-family or flip a house via landlord and buy something and fix it up. The mentality is the property has got an ARV, the after-repair value of X. It's going to cost me X amount to renovate it, so I got to buy it cheap enough to then renovate it and then have enough profit margin in the middle, but that’s not necessarily what you need to do in multi-family.
If I'm finding something that I know the rents are about $100 below market rent, the cost will be $4,000 or $5,000 a unit to go in and renovate all these units. It increased my income by $100 times twelve months times however many units I have. I could control my own destiny and force that value in. If you do a little single-family house, the house is only going to be worth with all the competitor houses in our markets sell for. You don't control your own destiny as you do in the multi-family space. You’ve got to buy right and not try to overpay. At the same time, if you can force value until a little bit more, you control your destiny quite a bit.
Dustin
When you go into a deal, do you have an exit in mind? I know you have a game plan for increasing value, but are you putting, “We’re going to be out in three to five years.” Is it hard fast? “We have to be out in X years.” What's your thought process there?
Michael
When we do deals, we always try to have a primary strategy. If someone invests money with you, what they want to know is, “How much I'm going to get my money back and when?” There’s some money along the way and there's a big pot of gold at the end of the rainbow. They want to know when and how much and how long is it going to take to do that. If you're going to be in these deals for perpetuity, most people don't like that concept in general. We’re targeting about a five-year hold period. One of the things I like to say is every projection and every pro forma I've ever done has always been wrong. I either do better or I do worse. You'd never hit exactly what you think you're going to do. When you get into these deals, you need to have a plan A, plan B and plan C because stuff is going to happen. The only thing I know is it’s going to be different in the future than what it is right now. You’ve got to adjust along the way and use your experience and expertise to make the best of whatever the situation is along the way.
Most of these deals, we're projecting to hold for about five years and hopefully have a little bit of some cashflow along the way that's paid out monthly. Some of the deals we’ll reject then we’ll do refinance in the middle or some of them we’re just going to sell in five years. When we get into it, we’ll just constantly reevaluate what's going on the marketplace and maybe now is the right day to sell it. It's only three years in this plan, but we think we get out early and that's great. Maybe in five years, there’s a big recession and it's not the right time to get out. Hopefully, we have a ten-year loan.
We have a little bit of time on the backend and maybe we’ll wait a year or two and wait for year seven when the market is a little bit more advantageous when you go out and sell it. That's something that you're just constantly reevaluating twice a year or once a year, “Where are we at? Where are we on a plan towards projection and pro forma? Are we off on something? How can we correct that? What's going on in the marketplace? Is now the right time to sell or should we own a little bit longer?” It's a fluid thing and we're just always on top of it. We’re always trying to evaluate the right moment is to exit the deal. If you understand what the property is worth and you choose not to sell it, you're effectively buying it at that price. We're just trying to make sure, “Would we buy at this price or are we not buying at this price?” If the price is so high, that doesn't make sense to me. It was time to sell it and find a more attractive place to put your capital.
Dustin
Refinanced versus sell, what enters into your thought process when deciding what to do?
Michael
When we first started out, we bought the 1960s and 1970s vintage C class apartments. About four or five years ago, we went over to the B class in Texas like the 1980s. The last couple of years, we buy anywhere from B to A-minus to late ‘90s and all the way to about 2008. What would you do to these large apartment building? There's this concept of operating expenses and capital expenses and this either above or below the net operating income line. The whole point is that these old buildings have all these nonrecurring expenses that occur all the time on them that are below than NOI line that doesn't necessarily hit that, so it doesn't impact value. You'll have an old building that has a sewer system that has a big chunk of it collapsed. You've got to spend $10,000 to dig it up and replace that section. That doesn't impact NOI so it doesn't impact the value, but it's a real cash expenditure that I had to pay my plumber with and I can't distribute to my investors.
If I own an older building, I'm more likely to want to get out of that a little bit quicker and I'd want to sell it. If I own a newer building, I would be more opt to hold that a little bit longer. If it’s something built in 2008, I'd be more likely to refinance that deal and want to own it a little bit longer. They don't have all these nonrecurring items that recur all the time that use cash that are below the NOI line. That's one of the reasons. Another thing is if I'm bullish on that location and I feel that there's a lot of job growth in that area and I feel that we have more juice in the deal. That we're going to be able to continue to push value, that's something I want to own a little bit longer. If we feel that we’ve extracted the vast majority of the value of this deal and the progress can be a subject to what the market is going to do, that's something that I’d be more likely to sell. If they're still more upside in it, we still feel that we can continue to push, but I want to own that a little bit longer. It’s a multifaceted approach but those are some of the things that we take into account on whether we want to sell it or refinance and hold it for a bit longer period of time.
Dustin
I'm interested and intrigued by the behind the scenes of the business, but I want to shift our conversation. What potential investors getting into a deal looks like, whether that's with you or on their own? How do you hedge against economic downturn?
Michael
I was a banker. It’s how I got into the business. I came into this business by underwriting loans and making loans to other people who own apartment buildings. When we’re in the economic recession, I was the grim reaper for a couple year period. I took a lot of lessons away from that. I found four things that happened to people that got them in trouble. I try to structure my deals to avoid one of these four things. First and foremost, people who got in trouble bought properties in the hood like high crime areas and lower socioeconomic areas. Those tend to be harder hits in the recession. We're trying to buy well-located deals and good better school districts. That's a good thing for us. Near your employment, near your retail and major thoroughfares. It’s the 101 on real estate which I take seriously and buy at the better-located stuff. It doesn't have to be in the Beverly Hills, but nicer suburban market.
Two, I saw people come to these deals under capitalize. They didn't do a good physical inspection on the front end. They did not set aside enough money to cure the deferred maintenance that exists instead of signing up for money up front to implement at the capital plan to upgrade the unit or upgrade the exterior common areas. They are undercapitalized. I’ll use Texas as well. Texas in the summer it gets hot. They had a unit that's occupied. Their AC unit goes out on the outside and they don't have a thousand dollars to change out the AC condenser. They go to vacant unit and take that condenser or put on an occupied unit. Now they've got a non-leasable unit over here that snowballs on them. Come on these deals well-capitalized. Third, not having proper management in place. I inherited a loan. It was a classic story from thirteen or fourteen years ago. This UPS driver from Los Angeles had a house in LA. He sold it and made $500,000 on it. He did a 1031 and buy a 30 or 40-unit property in Dallas and try to self-manage it from LA. He didn't know what he was doing.
The end of that story wasn't very good. Make sure you come in with a proper professional third-party management company that ask you to scale and have a back office and accounting and they know what they're doing. If you have properly managed it in place, they're likely not to screw it up and make some very simple mistakes. Finally, a lot of people got in trouble having low maturities at a bad time. If you happen to have a low maturity in 2009, the capital markets are frozen and your values are temporarily down. The baker's playbook is to re-margin my loan or pay my loan down so I can then refinance you. If you don't have the money and your partners aren't willing to give you the money because you lost a bunch of money in the value, then you're forced to sell it when the prices are down. That's a bad thing. We buy well-located deals. We have proper manager employees. We come into these deals well-capitalized. If we have a five-year plan, I want to have seven or ten-year loan to give me a little bit of margin on the back end. If in five years from now is a recession, that's not the right time to go out in the marketplace and sell it, I have time on my side. I can hunker down and operate and just wait for a better time in the marketplace to go sell it. Those are the types of things we're doing.
When we first started out, we bought our first couple of deals and we would do about 80% loan to value. Now, most of these deals are about a third down. You’re talking somewhere between 65% to 70% leverage. That's what we're doing now to give us a little bit more margin for error because trees don't grow to the sky. At some point, you're going to have some leveling off or softening in the real estate market. It's a cyclical business. We haven't seen one of those in years at this point. At some point, that's going to happen. The worst thing you do is to lose your deal. You can always not pay out as much as you think you are, but you got to preserve that capital at all costs and make sure you have enough time. Real estate is forgiving and you're going to make more money as long as you have enough time along the way.
Dustin
Why apartments as an investment vehicle?
Michael
I can give you a laundry list of reasons why I don't like office and retail in particular. Some of the main reasons why is, those are capital intensive. If you do office buildings and retail, there are two things. In multifamily, you have tenant improvement allowance and you have lease conditions. To sign a lease, you’ve got to give the tenant $20 or $30 a square foot to reconfigure your space so they can get it to be whatever their use is. You've got to pay 6% of the life of the lease payments as a leasing commission to the broker that brought you the deal. That's when you got a frontend of the deal before you start getting your rent in. The vacancies tend to be a lot longer in the retail in the office space. You could be six months or a year or more vacant in your space.
While in apartments, once you get the deal, you still don’t have the turnover costs as long as you're not coming in and have a big value at play. If your deal is good, you just want to keep your units. We call it classic. It means that you're not upgrading them, you’re just maybe changing the flooring out, put coat a paint up, clean it and lease it out to the next person. You’re talking about a 30-day vacancy and it's not so capital-intensive along the way. By necessity, there are more favorable tax treatments with it as well because you'd depreciate commercial buildings over 39 years. You can depreciate residential over 27 and a half years. Some multifamily is treated as a residential part of the IRS. You’ll get little bit better tax advantages. There's much better debt available.
Fannie Mae and Freddie Mac are not the two largest lenders on the residential, but also on the commercial side as well. You get this great nonrecourse debt that is more available and cheaper on the multifamily space compare to office or retail. It got a lot of scales. I started out like a lot of people. I did a bunch of rental properties on my own. I ended up doing sixteen rent houses and it wasn't scalable. Having 100 units or 200 units in one location with professional management, with onsite staff, you could scale that so it doesn't take a lot of my time on day-to-day like it would be if you had 100 houses scattered all around. Trying to go collect rent and do work orders and stuff like that. Those are some of the main reasons why multifamily makes sense and why I think it will be a good asset class for many years to come.
Dustin
This may be a mind twister for you but why not apartments? Why wouldn't someone do apartments?
Michael
Knowledge in expertise trumps a lot of stuff. I talk bad about offices and industrial, but if you know what you're doing, that can overcome a lot of it. If you have specific knowledge in something and you have the expertise, that'd be one way or two if you want to be on your own. You want your own deals and you don't want to have a bunch of investors and partners. There are very great things about that and there are some not so good things about that as well. I don't know if I would have been better off with the benefit of hindsight just having 200 houses all to myself and own them all or have the 7,000 units a day with almost 600 unique investors that have invested with you at this point. It's like a daycare in a certain sense managing all the personalities. The vast majority of people are great, but you have one or two that for whatever reason stick out. That would be it.
If you don't want to do that because most people don't have unlimited amount of resources. If you want to do large scale deals, you're going to have to pull capital with other people. If you just want to own it on yourself, it'd be a little bit simpler. You can do what you want to do and not ask other people. Buying a fourplex, buying a bunch of little rental properties and doing your own thing, that can make sense as well. I don't think there's anything wrong with the residential one-to-four space and being a landlord or flipping houses. It’s just I wanted to scale and I wanted to grow and this wasn't going to be very practical to do it in that investment vehicle.
Dustin
You've raised quite a bit of capital. I want to take a little bit of the context. For those who are reading this that are outside the real estate, maybe give us some boilerplate ideas around that. What's your advice about going and raising money, whether it's for a real estate deal or a business in general?
Michael
Going from zero to one is hard. At that first deal, it’s super hard. Going from one to two is a little bit easier. You don’t know what you don't know. If you don't have a track record, trying to get and overcoming that is challenging. First and foremost, when you're starting out, be realistic about what size you're going after. You don't want to go out and try to raise $27 million as I did on my 30th deal. You don't start there. You grow into that. Firstly, we've raised about a million dollars and I didn't know how we're going to get that million dollars, but we had some money. We put some money in and we just have had faith that we had a big enough network and that we're going to figure it out along the way. We're always going just a little bit past my comfort zone. We try to go 10% or 20% past that. That's the way you grow in the business but be realistic about it.
Don't wait until you have a deal ready to start raising capital. You can start getting out ahead of that. You need to go to a great network, go to great events, meet a lot of people and always talk about it. When you’re starting out, you build your database. Most people start with a database which is an Excel spreadsheet with someone's name and email address and phone number and maybe some notes. Eventually, once you do some stuff, you get a little bit more professional database. Try to be like a thought leader in whatever you're doing. Make sure to put out some content. Go be a guest speaker at a meetup, host a meetup or get guest speakers to come to talk to you. If you get on a podcast, this is a great avenue for people to hear me talk for an hour and either I'm going to make sense and I'm going to seem credible to you or I'm not right. I can tell you how it is.
I'm naturally a shy person but believe it or not, when I go to a big event, I find it easier to be on stage and talk from the stage. When I'm offstage, I can go stand in the corner and people come up to me. What I don't like doing is going up and say, “I'm Michael Becker. Nice to meet you,” and start a conversation. Understand what works for you and what your environment is and start putting yourself out there. Get people on the frontend and you got to do that. Whatever you think you need, you need to raise 20%, 30% or 40% more than what you think it is. Some people will flake out when it comes time to do it. It’s not that they mean bad, maybe they have a life event or something came up and they need that money for something else. Those are just some general tips starting out.
Dustin
We hinted at it earlier and it was this idea of maybe less investors, higher dollar amounts or smaller investments and lots of investors to deal with. How do you think about their requirements when you put together a raise?
Michael
Both are good. We've done deals where we had one investor. They put all the money in with us. The majority put a little bit, they put it the most. We'd done deals where we had 200 investors in a deal. Both have their pros and cons. What I like about the business is it's a feel-good business. We do well financially by doing good for the community at our property. The more people that we can allow into the deal, the more families we can come in and help financially. We help them secure their retirement, pay for the kids' college and stuff like that. We get the money out of Wall Street and put it more in the main street type of investment. One of the more satisfying things is it’s good when we have one large investor.
We make a bunch of money and we sell a deal and they make a bunch of money. It makes me feel even better when it's someone that has a professional job that has a good salary and enough to save up to invest 100,000 in a deal. We can turn that into $200,000 or whatever in four or five-year period. That makes me feel even better because you are more impactful on them. Having both is good. One of the things that I strive to do is have a very diverse investor base. I don't want to be so beholden just to have one investor. If they ever turn and speak it off for me, then I'm out of business. Having a broad pool of people that you can open up opportunities to is less risky than trying to put all your eggs in one or two baskets.
Dustin
It’s easy for me to look at your business in your world and say, “It just comes down to the returns that Michael and SPI are able to provide.” Assuming that you're providing great returns just like some of your other competition out there, how do you differentiate it in this world?
Michael
You’ve got to provide high-quality opportunities on a risk-adjusted basis that have high-quality returns. I see some of my competitors, especially some of the less experienced people, when they’re starting out, I don't think that they quite take into account that there's a return. If you make 15% here or 15% there, there are different levels of risks within that type of investment. If they're buying a lower quality area or you're doing a ground-up development, that you have to buy a piece of land and go vertical on the deal. Get it delivered, get through the city and don't worry about costs increase. You’ve got to lease it up and execute. I'm going to deliver 15% and that's going to deliver an 80%, but there's a whole of different risk profile between a development deal and a deal that's already 95% occupied the day we buy it. We're going to raise rents 8% or 10%. There are two different risk profiles.
One of the things that we try to do is to try to strive on as low of a risk profile of a deal as possible. Every deal has a certain level of risk to it but try to mitigate as much risk as possible providing high-quality returns. When I met Than and Paul, especially Than, he complimented me. We do a good job of communicating consistently on a monthly basis. The best way you communicate with your investors is with a check. That’s the best way to communicate and do that monthly and consistently. That's a great way. On top of that, trying to be as transparent as possible. Providing a very comprehensive management report with some color and some commentary of what's behind the black and white and financial reports as well. Being transparent, when you have good news, you share it and when you have bad news, you share that as well because these deals aren't perfect.
Every projection I've done, I've been wrong. Fortunately, we've done better more than we've done worse in most of our deals. You need to share some of the challenges along the way. You have to budget for stuff and then have contingencies then have backup plans and all that stuff. You make little minor adjustments along the way. You need to be communicative to the people and explain what's going on with these deals. Some of the feedback I've gotten has been positive is that we do a good job at communicating and trying to be as transparent as possible along the way.
Dustin
You mentioned that you worked at a rather well-known bank and you’ve got to see deals from the other side. Do you feel that gives you an advantage with what you're doing?
Michael
That was an unbelievable perspective to have. I worked for a very large bank and I lead nation three years in a row for my business unit loan production. All I did was a multifamily loan. I saw a deal after deal. I’m closing a large-scale multi-family deal a week. That was a lot of loans. Once you did, you look at more that you didn't even do so you get to see a lot of things. That was a good perspective because if you think about it, when you're putting a deal together, you have your capital stock and a portion of it comes from equity in a larger portion generally comes from debt. Having 75% of the money coming from your loan. Understanding and being on the other side of the desk, originating loans and now becoming on the principal's side, it’s a good perspective to have when your largest investors are your lender. For me, to be able to speak fluent banker with them, I understand their motivations and what's behind them and that helps a lot.
By nature, bankers tend to be a little bit more conservative in the way they go about stuff. Having that background has been invaluable for me transitioning over. I wouldn't have been able to go as quick and as fast as I did if I didn't have that background or that level of experience. I had a lot of knowledge. It wasn't doing it for my own account, I was watching my clients get rich. One of our main motivations to get out was I felt that I knew as much more about it than what they did and I was making a good paycheck, but they were getting wealthy. I wasn't utilizing everything I had at my desk, all my resources and all my knowledge. I wasn't only utilizing a portion of it and that was one of the main things that drove me to get out of the bank and go to the principal side.
Dustin
What advice do you have for those that are interested to go the route that you did?
Michael
Everyone starts with the half and everyone starts with whatever position they have. Some people will have more financial resources than others. Some people will be younger and some people will be older. You have all of the excuses you can make in life, but you start where you start. I had a lot of education and professional experience in a lot of relationships being a vendor and most people won't have that. You got to start by getting educated. That's going to be first and foremost. Go into events and get educated. I recommend you to watch or listen to podcasts. I'm a big podcast junkie. There are a great number of podcasts out there. This is a good place to get started. Get your education then you need to get a network.
You need to find the people that can help you and give you some passive investors. Maybe they can help qualify for a mortgage. We haven't talked too much about financing but qualify for the mortgage is a big part of this deal. You need to start meeting brokers and management companies and lawyers and all the vendors you need to put the deal together. It’s a team sport. You don't do this on your own. You need to have professionals. I know enough about every little thing to know enough to know who I need to go to and get the answer for this thing. I know enough about taxes and law that’d be dangerous. I go to my lawyer and my CPA when it's time to do the actual work and perform.
Those are what you need to do. Build your team out, build your investors out, get educated, get networked and you need to go out and do it. You got to take action to get results. A lot of people have that whole paralysis by analysis. They go to every educational event that’s ever known to man and they're seminar junkies, but they never go out and buy real estate. They were better off going to a seminar or two and save all the money that they spent on the other seminars and actually go buy a piece of real estate and get out there and do it. You’re never get to know everything you need to know. You're never going to be comfortable. At some point, you just got to take that leap of faith and go on and do it.
Dustin
Michael, thank you for being on the show. I’m sure people are as excited as I am. I see you as a credible source or at least an interesting figure to learn more from. There’s a couple of things that I want people to know. Are there any requirements that they need to know in working with a firm like yours and where can people keep tabs with what you're up to?
Michael
If you are looking to invest in real estate and if you have a done list, you could complete a personal financial statement. Just do a basic analysis of yourself where you set all your assets, all your liabilities, what your net worth and equity is. It’s a good place to get started. If you're looking to invest, our typical investment has $100,000 minimum. I know there are a lot of other investors, a lot of the sponsors out there and other opportunities that have lower minimums than that. Most of the deals we do require you to be an accredited investor and a lot of these other deals don't require you being credit investor. If you don't know what that is, you should look up at a credit investor and get educated about that.
Just understand what your situation is, what your resources are and how much you're available to invest and are comfortable investing in any one deal. You need to understand, “Do I want to be active in this business? Do I want to do all the work? Do I want to go out and try to put these deals together? I like my job. I want to focus on my job and I want to invest passively and get a good return and some tax benefits along the way.” Those are the types of things. Figure out what your personal profile is and what your objectives are. If you feel that you want to be a little bit more passive than a deal, certainly, I would appreciate anyone that wants to learn more information. Just go to our website and fill that out.
We'd love to have a conversation with people and start putting future opportunities in front of people. If they make sense and the deal makes sense of them, it's the right time, it's a good fit for their personal situation, that's great. If not, there's always another deal and we'll put another one in and maybe at some future point, there is. If it never is, hopefully, you get some level of education and learn a little bit along the way. If you watch a webinar presentation, we're presenting a deal. I'm starting to become a decent figure within the FortuneBuilders community. I teach the third segment of the Commercial Academy. If you could ever come to that event, that would be a great place to meet me or maybe FortuneBuilders Ignite. I tend to go to that as well. I love to meet people in person or virtually.
Dustin
Michael, thank you big time for being on the show and sharing behind the scenes and give us your wisdom. WealthFit Nation, thanks for attending this special show. Thanks for joining us and we appreciate you tuning in. If there is another conversation that you'd have in relation to this one, if you wanted me to go deeper and I just didn't go as deep as you would like, let me know. Let us know on social. We want to know what your thoughts are and what are you going to do to take action on what Michael shared with us. That is critically the most important. Taking action on these ideas. That's it for now. I can't wait to have you on the next show.
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