263: Real Estate Investing for the Long Term

SHOW NOTES FOR EPISODE 263: REAL ESTATE INVESTING FOR THE LONG TERM

Some say the multifamily real estate market has cooled but you wouldn’t know it by looking at one Virginia-based real estate company that acquired $100 million in assets in 2018 alone.  In this podcast episode, Chad Doty, managing partner and CEO of Richmond, Virginia-based 37th Parallel Properties Investment Group, shares some of his inside secrets and successful long term strategies that have generated over $400 million in real estate transactions since his company’s inception.

What You Will Learn

• What where the 5 key criteria that motivated Chad to quite a lucrative consulting practice to pursue real estate investing full-time?
• Why multifamily investing is the best commercial real estate investing niche
• What historical data is critical to helping determine multifamily investing strategies
• How a M.A.C. Profile can help you determine a good investment market
• What are the two main things you must do to insure your investments will survive a recession
• Why it’s better to look at demographics over economics when assessing viable investment markets
• What are the 3 steps to successful passive investing?

About Our Guest

Chad Doty

Chad A. Doty, is a managing partner and CEO of 37th Parallel Properties Investment Group, LLC (“37th Parallel”) a Richmond, VA-based multifamily acquisitions and asset management firm he co-founded in 2008. With 12 years of multifamily real estate investing experience combined with 10 years of management consulting experience and close to $415 million in real estate transactions, Mr. Doty is a proven multifamily veteran. He currently oversees strategic partnerships, capital development, and platform development for 37th Parallel and its affiliated companies.  Originally from Kansas City, Chad now resides in Richmond, Virginia with his wife of 23 years and their son.

More About Chad

• Currently, 47 years old
• 85% of their clients are 55 plus
• Started in technology and office improvement
• Worked with 2-5 companies a year off and on for 10 years
• Quickly learned what works and what doesn’t, which companies will be around and which will disappear
• Was a couple years away from Partner at Arthur Anderson when Enron happened and melted the company down from $9 billion in revenue and 80,000 employees to “60 attorneys in Switzerland” in 6 months
• Started working with some smaller consulting firms where he was placed in various companies as a director to help fix the companies but did not like that work
• Started his own consulting company
• It was kind of like the quote – “You can only connect the dots looking backward” by Steve Jobs
• Two things that saved him:
  • His dad was a Navy pilot in the 70s who was gone 5-7 months at a time when he was deployed
  • He didn’t want to be the same kind of dad and didn’t want to miss the important things happening in the lives of his kids.  He wanted to be part of their lives
  • He was 4 hours away when he received a call from his wife when their first child was about to be born
  • He was trading time for money and it was good money but it was capped by the number of hours he could work and he didn’t want to start hiring other employees and be stuck doing that on top of his hourly consulting

Choosing Real Estate

• He started looking for a profession that had the following criteria:
  • Evergreen
  • Tax efficient
  • Barriers to entry
  • Annuity plus spike income
  • And something he could do for the rest of his life
• Even though he had no experience in real estate, he knew that real estate met all of his criteria
• Initially, he didn’t want real estate because, as a kid (19 to 20 years old), he had a bad experience when he was helping his dad renovate a duplex while living in the other unit because he was the laborer and not the asset manager
• He bought a 6-unit in Richmond, Virginia
• Then was going to buy a 12-unit but wanted to go bigger
• Then partnered up to form 37th Parallel and bought a 112-unit apartment
• Continued buying a deal a year every year to reach a really good scale point in 2013
• Since then:
  • 100% profitable track record
  • $400 plus million transaction volume
  • Inc 5000 four years in a row
• Richmond, VA has strong real estate base
  • Home to primary legal teams who do most of the transaction volume for Fannie and Freddie
  • Was largest hub for TIC (Tenancy-in-Common) investments
  • He had real estate auditing clients in the past

Finding His Real Estate Niche

• There are a million ways to make money in real estate but he wanted to get something that made sense for the long term
• Even if he made less money, he still wanted to know he could still make money on every deal (“kinda like Moneyball” – singles and doubles are fine, like basing it on batting percentages, not slugging percentages)
• It comes down to preference
  • What are you trying to create in your life and what business model you would need to achieve that?
  • What can you offer to your clients and know you can be good at?
• There wasn’t a single “aha moment” that convinced him that real estate investing was it but, instead, it was a series of things he tried as he went along
• His company had a 100 single family cash flowing homes at one point but he found that it was “3 times as hard for half the money” when he compared those homes to apartments.  Single family was too hard to scale
• He’s now all multifamily properties

Demographics Over Economics

• He views this type of investing through a demographic lense — He sees the primary driver of multifamily as household formation and household psychographics, meaning what’s happening to populations that want to rent a home/unit and what are their preferences in terms of geography, lifestyle, amenities, retail, etc.  and what do they prefer
• Prior to 2005, it was 60% homeowner and 40% renter, which brought us to the housing bubble.  By 2010, home prices went up and the numbers flipped to renter 75% and owner 25%, according to joint housing study done by Census Bureau and Harvard
• Add to that that US population has rapidly increasing with 1/3 immigrants
• He saw a giant opportunity
• He didn’t start buying value-add.  In the beginning, he just wanted to buy a safe asset that would cash flow
• But as time went on, between 2011 and 2012, they saw rent growth grow significantly and continue to grow
• The largest renter group is 18-35 year olds, echo boomers, 78-80 million strong
• Fastest growing rental group – 55 and over.  They rent for many reasons:
  • Economic need
  • Economic preference
  • No yard maintenance
  • Geographic
  • And, once the move, they never own again
  • And lifespans are increasing
• It was the demographics that caused them to move into multifamily

Finding Markets

• They love research and have done lots of it
• They look at
  • What’s happened in the past
  • How companies grow – how they scale from 1 deal to 10 deals to 100 deals and how they hire and scale staff
  • They look at your MAC Profile (Market, Approach and Capability)
    • There’s no approach above that’s right or wrong
    • One of those factors has to be fixed variable
      • Market-Centric approach
        • I’m going to work in Atlanta, Chicago or Richmond
        • They have to deal with the ups and downs of their particular markets of focus
      • Chad’s company wants to be a multifamily specialists
        • B- to A- operators
        • Middle of the household income curve ($57-58,000) – largest U.S. income group
        • They want to serve that resident type well no matter where they go
        • They were capability-centric first
        • Then they found markets where that approach was favored at least for the next 20 years
        • Texas was one of those markets
          • They had state constitutional amendment in the 80s that disallowed them to take more than 80% LTV on mortgage loans so they missed much of the disaster the rest of the country experienced 2006-2010
        • They have focused primarily on the Texas triangle – Galveston-San Antonio-Huston since 2008
        • Have also done deals in Austin, Kentucky, Carolinas and Atlanta
        • Nothing in Virginia

How He Buys

• Looks for stable market anchors
  • Major governmental job footprint (very dependable jobs)
    • State and local government
  • Higher education
  • Healthcare (especially hospitals)
  • What’s going to be there forever
  • Solid economy in last 5 or 10 years, looks to do good for he next 20 years
  • They utilize the “grandma rule”
    • If they wouldn’t put their grandma’s last $100,000 in that investment/market, then they don’t do it
  • What he does when he buys
    • 6 months of reserves for debt service that they don’t touch 44:49
    • Raises, upfront, for CAP-X for first 5 years
    • Doesn’t over-leverage
    • Measures “break-even occupancy” (BEO) – Ray Acorn “Dealmaker Guide” book on commercial real estate.  How occupied to break even.  Buy in a market where you can get a double market
  • He also looks at household trends and projections for the next 30 years
    • The over 55 group is increasing it’s renting percentages, every year, for the next 20 years
      • There’s the demand
      • Where is this group going? What MSAs are they moving to?  Why are they moving there?  What are the characteristics of those markets? This data is publicly available
      • You have a demand curve
        • But there are still imbalances at the MSA level, neighborhood level, and with supply and demand.  You still need to figure out:
          • Who are we serving?
          • What’s the local competition
      • There’s no national real estate market.  (There’s a national finance market but not a national real estate market)
        • Everything is at MSA, state and sight level
      • He doesn’t buy in areas that are retirement-centric
        • It’s harder to grow income in those locations
        • Renters’ choices can vary
          • They are sensitive to things outside of market cycles
        • But Chad wants predictability
          • So he goes where the jobs are
          • They look at properties within a certain distance from job centers
        • Renters go to the “best place they can afford based on their lifestyle
          • Single people look at places with
            • Amenities
            • Entertainment
            • Close to transportation
          • Families look at
            • Schools
            • Crime
        • It’s not difficult to find this information but it is a process and you have to go through it if you are doing your job for your investors.  You need to create systems
          • The creator of the Dilbert comic strip, Scott Adams, wrote a book called “How to Fail at Almost Everything and Still Win Big” in which he asserts that Goals are for Losers.
            • In the book, Adams points out that, unlike goals, a system is something that you’re doing every day to improve your chances of success. Everything that you do in your systems approach will help you achieve success in the long-run.
          • Chad says systems are crucial because they allow your to serve your clients well in what you do
          • He shares their systems with potential investors so they can easily decide if their approach meets their investment needs
      • Chad’s buying Criteria
        • Garden style
        • 2 or three story
        • No high rise properties
        • Less about style
        • B- to A- properties
        • Resident type over building type

How He Sells

• He buys with the long term in mind
• They “strategically sell” – buy, renovate and sell in 5 years – only if it makes sense
• As he has studied some of he more successful real estate investing companies, he has seen certain attributes
  • The companies that are the wealthiest aren’t the ones buying and selling every couple of years
  • The wealthiest companies are the ones who have “accumulated” properties and were the long term holders
  • They buy initially thinking they will love the property in 20 years
  • They only sell if
    • The market fundamentals are shifting in a way they don’t like, or
    • They get an offer that has out-sized their current projections, which means they advance 2 years ahead and needs to make for the long-term
• Chad’s company bought a $10.5 million project in Louisville, KY
  • 2.5 years later, received an unplanned offer from a 20,000 unit buyer, moving from another state
  • Buyer was persistent and wanted Chad to give them a sell price
  • Chad came up with a very high price to scare the guy away and the buyer said he would buy it at that price
  • Chad’s company decided to go for it because of the tremendous value and return for their investors and because the investors would have thought them crazy to turn down the overly generous offer
  • Sold it, did a 1031 exchange into a 419 unit building for $30 million in UT Dallas area where they jumped their cash flow by 30%
• They will do the sell if it makes sense and it:
  • Escalates income
  • Escalates equity growth
  • Or both
  • It must be optimistic from a sales perspective and then a long term cash flow hold
  • It works well for their clients too because
    • they can invest first and watch their money grow
    • they don’t have to worry about where the money’s going to go right away, they just want to know the address
• They do cash-out re-fis for investors when it makes sense for the long term
  • It’s their primary liquidity strategy
  • As a long term holder of cash flow producing assets, that is looking to optimize that cash flow, they are going to grow equity and that equity has no way to return, so once they get to a certain point, they will get a supplemental loan with Fannie/Freddie at a slightly higher fee, that allows them to extract capital, they will “re-reserve” for Cap-X for the first five years and the rest they can look at another project opportunity for investors who want to take advantage of that opportunity
  • When they do a cash-out re-fi like this, they always provide another opportunity for their investors should they want to keep growing their investments.  This is more tax-efficient for investors who may not want to deal with the capital gains

Biggest Mistake

• On mistakes – “Everyone’s going to be an idiot.  Just try to keep it to 5 minutes a day.”
• His two biggest mistakes:
  1. Partnering on deals with someone, unless you know them like family
  2. Assume the seller is not giving  you all  the information you need for success
     • Make sure your due diligence includes factors affecting tenant sources
     • Invest as if you are investing your grandmothers last $100,000
     • Bought a deal next to a University – 80% international students (Second deal they bought)
     • Seller had relationship with International Student Board at the university
     • After it was sold, all the international students left and stopped coming

Biggest Success

• Big believer in “Kaizen” (Japanese business philosophy of continuous improvement of working practices, personal efficiency, etc)
  • Every six months his company looks at things like:
    • What are we doing in regards to capital development?
    • What are we doing in regards to asset management?
    • What are we doing in regards to expense management (at the asset and company levels)?
  • Treats each apartment complex as if they are individual franchises for the long term
    • It’s kind of like a food franchise
      • Has a defined customer area –  lives within 5-7 miles of asset
      • You know their preferences by where they live: their preferred amenities, retail, grocery stores, employment hubs, schools, crime rates
      • Then you look at how you should perform in that marketplace:
        • If my property was a restaurant, am I a Quizno’s, Subway,or  Applebees
        • Know which niche or set of niches you want to own in that location to do well?
        • It’s much easier to do this in a B class asset because it’s less likely that a brand new building will be built to compete with you.  Totally different renter profiles

Doing Business in Light of an Impending Market Correction

• Two parts:
  1. Recession Prediction
     • He is active in the National Multifamily Housing Council
       • Gets their research
       • Attends their events
       • At their meetings, they will say:
         • We are at a historically long bull market
         • Consistent job growth – peak employment
     • No one knows when it will happen
       • Economists, housing developers and lenders are not good at predicting recessions
       • Are we 2 years away or in the 9th inning?
       • Are we in extra innings or is it a double-header?
     • If you look at:
       • Demographics
       • Job growth
       • Wage growth
       • Job diversification
       • We are not at where some of the recession indicators say we should be to be close to a recession.  There are too many uncertain factors:
         • Bond yield formation?
         • Market does have some volatility
         • Political environment is messy
         • Tax cuts during a growth period
           • Great for real estate investors but what do we do with that if we don’t make up for it in a debt perspective
         • Renter formation – still there
     • Paul goes back and studies failure
       • Looking at it from a historical perspective
         • The Paul Volcker years (chairman if the Federal reserve under Carter & Reagan)
           • Interest rates went up to 15-16% in early 8o’s – Why?
             • What did smart owners do in that time period?
         • What happened to the B grade renter market in 2008-2010?
           • Unless you were in coastal cities or what he calls ‘the sand states” – California, Nevada, Arizona, Florida,  B grade rents did not really go down.  They went up.  C grade went down and A grade tanked!
           • By serving a more stable group, you are less likely to fail
  2. What you do to be less sensitive to economic cycles
     • Have a “rainy day reserve” of 6 months of debt service that you never plan to touch
     • Raise the cap-X funds needed for the first 5 years going in
       • Lowers return slightly but it’s a necessary margin of safety
       • If they have a $20 million dollar deal, for example, they may have to raise another $2 million for cap-X expenses up front
     • Build in safety and good economic factors as part of their model
     • Break-Even Occupancy
       • Measures “break-even occupancy” (BEO) – This comes from Ray Acorn who is the author of “Dealmaker’s Guide to Commercial Real Estate” book on commercial real estate (no longer in print).
         • Chad determines how occupied a building must be to be at “break even.”
         • He buys in a market where their asset can handle a “double market vacancy” (even though they have never experienced this yet).  For example, to calculate the BEO
           • If they are in a market which has a 7% average vacancy
           • Double that = 14%
           • BEO = 100-14 = you would need a 86% or higher occupancy rate to break-even or make money
     • Doesn’t over-leverage an asset.  Typically does not go over 75% LTV
     • These things create resistance
     • Is it bulletproof?  No.  But if you look at what Chad and team are doing in historical perspective, they would have survived 2008-2010 based on the markets he is in

Advice for Old Dawgs Looking at Real Estate Investing

• Three different situations
  • Passive Investors
    • JP Morgan did a study – stock and bond portfolios with at least a 20% direct exposure to real estate (not REITS) and they found those portfolios did better than other portfolios on yield and return over 5 years
    • REITS are basically “real restate flavored stock”
      • Still subject to the inflows and outflows of the market
      • 82-83% correlated to the stock market
      • Leading indicator of the “tail wagging the dog”
    • Direct Real Estate
      • You are getting a direct percentage of the P&L of the real estate that you own
      • Far less volatile than REITs
      • Far more transparent in terms of what you’re getting, why you’re getting and how you play it
      • Much better tax advantages
        • With a REIT, you may get some deductions but it’s typically not “qualified dividends”
        • In direct real estate, your passive activity gains and losses flow via K-1 to your tax return
          • For example, say you have a 5-7% yield deal, overall return of 12-15%, you can get a ton of tax deferral time on that 5-7% return (15 year plus), plus you can do 1031 exchanges and defer the capital gains
        • You can create an environment where, especially if you’re in a high tax state and you’re a high income retiree, where you can get 5-7% net tax-deductible income
    • Decide what you want to allocate to direct real estate. You have to make your own allocation decisions .  And what are you looking for:
      • Wealth accumulation?
      • Cash flow?
      • Legacy wealth transfer?
      • Next, who are the syndicators and sponsors you want to give your money to.
        • “Money shouldn’t flow to a good deal, it should flow to people who know what they are doing.”
        • Find really well qualified sponsors who have have a business, who have a track record and
    • Three Steps:
      • Allocation
      • Approach
      • Sponsor
        • And then evaluate why that sponsor whats the markets they’re in and what’s their style
    • Crowd Funding
      • Many people want to get in this space
      • Some may go to a crowd funding/sourcing site
        • They look at a Pro Forma that looks good and they invest
        • Chad says, “Pro Forma is Latin for ‘Total Lie'”
        • You really want to look at the experience and track record of the sponsor FIRST!
  • Active Investors
    • Ask yourself:
      • What’s my goal?
      • Do I want 1 or 2 properties to get incremental income streams?
      • What’s You limit?  How much money do I have to invest?
        • $100,000 – smaller multifamily
        • Do you want scale where you have a third party property manager?
          • You might need to pool money together to syndicate
      • Smaller amount?  Smaller property?
        • Stay local
        • You’ll want to maintain close management/oversight
        • It’s hard to get the great property managers on smaller properties
      • You can start faster when you are smaller but when you’re bigger, it’s almost better to go slower and get good and then start
  • Multifamily Partner
    • Jump right in to large asset management
    • Executive MBA in multifamily investing

What’s Ahead for the Future for 37th Parallel

• Has had the business for 10 years and still gets chills thinking about it
• It’s a high level, long term play
• The bulk of his net worth is wrapped up in the business
• He has clients that depend on his company to create legacy wealth transfer platforms for them
• They work a lot but play hard
  • He likes to sail
    • That’s where the name 37th Parallel comes from
    • He noticed on a sailing chart he had on his wall that he and a business partner were at the exact same latitude on the chart but opposite coasts and the name suck
• Wants to consistently want to be acquiring $100 million in assets per year
  • To do this, they need to roll out a few new platforms
    • Creation of a Fund
      • Investors can’t just call up to invest
      • It’s a relationship, not a transaction
      • They take time to get to know their investors
      • Usually the investor picks an address, but now they have the option of investing in a fund
      • Coming out first quarter of 2019
    • DST Offering
      • Still commercial multifamily investing
      • 1031 Exchange investors can get into a stable multifamily asset in a way where they can still exchange out and not be bound to what the asset does
      • Gives investors flexibility that TICs tried to do in the past that can no longer do so in the multifamily lending environment
• Not interested in other commercial asset classes
  • Multifamily still has the best returns/lowest risk of any commercial real estate asset class for periods of longer than 5 years
• Will be purchasing larger multifamily assets in a broader range of markets

Rap-It-Up

• Favorite real estate books: The Deal Maker’s Guide to Commercial Real Estate by Randy Alcorn & The Millionaire Real Estate Investor by Gary Keller
• Favorite business books: The Goal by by Eliyahu M. Goldratt & by The Ultimate Sales Machine by Chet Holmes
• Most valuable web site for success (other than your own): (pending)
• Favorite app: Slack
• Favorite quote: “The heights by great men reached and kept were not attained by sudden flight, but they, while their companions slept, were toiling upward in the night.”  – Henry Wadsworth Longfellow
• If you had to start all over, knowing what you know, and you only had $1,000, what would you do to launch your real estate investing business? He would use the money to get a computer and a phone and a way to keep track of deals he wants to look at and people he wants to call. Leverage the relationships he already knows to re-grow wealth. 

How to Reach Chad

• His website: 37th Parallel 
• Sign-up FREE REPORT on Evidence-Based Investing: https://37parallel.com/ebi/

IF YOU LIKED THIS PODCAST, we would love if you would go to iTunes, Stitcher or GooglePlay and Subscribe, Rate & Review our podcast.  This will greatly help in sharing this podcast with others seeking to learn real estate investing as a means to achieve a successful retirement.

Check out our other podcasts at olddawgsreinetwork.com.

Get a FREE copy of our 3-Minute Rental Property Analyzer at olddawgsreinetwork.com.

Episode Sponsor: Meno Studio – menostudio777@gmail.com