329: An Insider’s Guide to Investing in Private Real Estate Deals

SHOW NOTES FOR EPISODE 329: AN INSIDER’S GUIDE TO INVESTING IN PRIVATE REAL ESTATE DEALS

Real estate investing can take many shapes and forms but, for passive investors, one of the most appealing is investing in private equity.  Paul Kaseburg, otherwise known as Sean Cook, the author of Investing in Real Estate Private Equity, has been involved in the purchase of approximately 22,000 apartment units valued at over $4 billion dollars.  In today’s podcast, Paul shares practical tips and strategies to help you build a profitable real estate portfolio, manage risk, avoid common mistakes, hopefully make lots of money and have some fun along the way.

What You Will Learn

• Is it possible to create a real estate analysis model with a high degree of precision?
• A good “risk proofing” investment strategy that will do well regardless of the economy
• Is it better to buy now for the short term or for the long term?
• Key funding strategies that buffer negative economic shifts
• Best types of deals to buy for today’s economy
• How to find the best real estate investment or syndication companies
• What are the key things you know to assess if the real estate property is a good investment
• What to look for in a new offering PPM

About Our Guest

Paul Kaseburg

Paul joined San Diego-based MG Properties Group in 2010 and is responsible for the firm’s acquisition, disposition, and capital markets activities. At MG, he has been involved with the purchase of approximately 22,000 units totaling $4 billion in total consideration. Paul has 20 years of experience in real estate private equity investment, capital markets, and corporate M&A. Prior to joining MG, he held various roles in commercial real estate debt and equity acquisitions, development, and financing. He has a background in corporate M&A and venture capital investing at Northrop Grumman (NOC). Paul holds a Bachelor of Science degree in Mechanical Engineering from the University of Notre Dame, and an MBA in Finance and Entrepreneurship from the UCLA Anderson School of Management.

More About Paul

• Grew up in Hawaii
• Went to college at Notre Dame and got a degree in Mechanical Engineering
• Loved quantitative things, numbers and analysis
• Got a  job with Northrop Grumman
• Worked on on orbit operations on satellites
• But, later on, got more interested in the finance world
• Went back to school at UCLA Anderson School of Management, gor MBA in Finance and Ertrepreneurship
• Ended up transferring over to Northrup’s Venture Capital Group
• Was now licensing technology and investing in start-ups
• Loved the transactional side of the business and financial analysis
• Then the Dot Com bust happened and venture capital opportunities were limited
• Ended up getting involved with corporate mergers & Acquisitions (M&A) at Northrup
• Had some friends in real estate business and it appealed to him

Transition to Real Estate

• Wanted to learn real estate, so moved into commercial mortgage banking
• Was able to see how deals unfold, how different asset classes work, and learned what he liked and didn’t like in the commercial real estate business
• Worked in-house at a large Family Office that had a real estate group, working in LP (limited partner) real estate investment analysis side
• Reviewed lots of different offerings
• Learned what’s a good offering, what’s not a good offering and who to invest with
• Before the downturn, he was working with a group that started a hedge fund that bought non-performing residential debt
• It was a lot of fun for about 18 months and then the downturn happened and a lot of the institutional players got in that space
• He saw that as more of a trade than a business

Focusing on Multifamily

• In 2010, was hired my MG Properties Group, a multifamily owner and operator that only works with apartments – only existing products, no ground-up developments.
• They buy, rehab and hold apartment communities
• Medium to long-term holds.  Median hold is about 8 years
• 1,000 private investors, including some family offices
• Does some family office and institutional joint ventures
• Has partnered with Blackstone on some deals and other large institutional groups
• Has been at MG for 10 years
• Enjoys being an acquisitions person because he gets to work with a great team that includes:
  • Construction team – can walk through a property to give him feedback on roofs, plumbing, siding
  • In-House Operations Team – Review pro-forma budgets and give feedback on payroll, marketing strategy and rehab strategy
  • Having teams like that, all in-house, has been a valuable learning experience for Paul and helps them to make good decisions
• As an engineer, he enjoys the quantitative analysis aspect of the job, even though real estate is hard to quantify in many aspects
  • You can model real estate, looking like you have a high degree of precision, with the way that they analyze real estate, but the reality is that there is a lot of uncertainty in the assumptions that they use
    • “Garbage in.  Garbage out.”  If you don’t have good assumptions going in to your analysis (i.e. rent growth, value-add, rents, exit cap, etc.), it can blow your whole model and it’s not accurate any more
    • That’s why a lot of engineering is about
      • “What is the level of accuracy on my assumptions?”
      • “How to I think about an uncertain system?”
      • “How do I put some numbers around that?”
      • “How do I make good decisions in light of the fact that I have imperfect data?”
    • There’s an art and a beauty to that — it’s one of the things he loves about real estate
      • There’s definitely a quantitative side to real estate but it’s not just running math numbers
      • You have to combine that with some practical judgement and experience, knowing what’s worked in the past and what hasn’t worked and what your capabilities are and what you’re not good at and trying to put that all together to make a good deal
    • It’s fun.  It seems like it’s just a math problem but there’s some much more that goes into it – it’s relationship oriented with other principles, analysis oriented, management oriented
    • Even the narrow niches of real estate can be a lifetime of learning

Allowing for the Economy

• Many people in real estate, like many other industries, would like to know what will happen with the economy
• Even at his company, they pay very smart economists’research that will try to give them some understanding on what will happen but, at the end of the day, there’s not perfect information on what will happen with the economy
• That’s why it’s important to not take at face value what assumptions are being used with whatever model is being used to evaluate a deal
• You always need to ask, “What’s the upside and what’s the downside scenario on what the economy will do?”
• His company spends a lot of time on “risk-proofing” deals and thinking about their downside scenarios by asking “What can a deal tolerate before they have a problem?”
  • Because they tend to invest in long-term deals (7-10 year holds) which may include some good years and some bad years
  • They don’t know when the bad years may hit but they just want to make sure, going in, that they are capitalized in a way that they can ride out smoothly and try to get through to the other side
    • To reduce risk, they make sure they use an appropriate amount of debt, if possible, and cash flow that and 10 years from now, they’ll be glad they own that asset
  • It’s easy to read economic analysis and become over-confident in your understanding of what’s going to happen but that’s just the business of forecasting economics
  • Most investors underestimate the uncertainty in the economy
    • For example, you may assume rents will grow 3-4% on average over the next couple of years
    • Sub-markets volatility, over short periods of time, either over-perform or under-perform, but, if you look at history, over the last 30 years or so, you’ll see that they all converge to historically reflect steady growth
    • If you have a short-term mindset, there is a bit of “Russian roulette” involved
      • If the market does great, you’ll win
      • If it does poorly, and you don’t have an exit plan, you may have to give a property back to a lender
  • We are currently in the longest growth expansion in history and real estate investors have greatly benefited
    • It has not been as large as previous expansions because he rate of growth has been a little lower
    • Most groups believe we are late in an economic cycle
      • What it means for Paul’s company, regarding the way they approach their business, is that they are trying to be real appropriate with the way we use leverage
        • Practically speaking, that means they are in the “preferred borrower” channel for Fannie Mae and Freddie Mac
          • They get the best possible pricing – Just recently locked in a 10-year deal at 3.23%
          • They use lower levels of debt (60-65%)
          • 10 year, full-term
          • Interest only
          • Fixed-rate debt
          • This helps drive cash-flow to their investors
          • It also creates extra cash coming out of an investment that they can use to address capital problems or just solve issues if there were to be a down-turn
          • It’s a good defensive strategy to approach the business considering where capital markets are right now
  • In summary, their strategy in dealing with economic uncertainties is:
    • Use less debt
    • Get very attractive long-term fixed-rate interest-only debt to avoid risk during the hold period
    • Buy good real estate
    • In 10 years, they should be fine
  • He anticipates a down-turn in the next 10 years
• Because MG did not lose any properties in the last downturn, they were in a good position to take advantage of the upcycle

Paul’s Acquisition Criteria

• Has not changed much since 2010
• 1980s and newer properties
• Larger properties (because they self-manage and want to be efficient)
• Very set target markets
• Expand incrementally into newer markets, one at a time

Learning From Investing in 2010

• People back in 2010 were still terrified
  • Especially on the institutional side
    • Very difficult to find institutional partners for deals
  • Private investors
    • Were in “risk-off” mode
    • Had denominator approach
      • Stock market was down
      • Made them feel over-allocated to real estate
  • Capital raising was trickier (the opposite of today)
  • Cost per unit and cost per foot was great
    • Investors thought “I’m getting an amazing discount on this!”
    • But cap rate was terrible because rents and NOI were down so much
• Everything looked great on paper
• You had to believe that there would have to be significant upside
• If you approached investing conservatively (I’m only estimating 3% rent growth”), you would not have invested at that time
• A lot of groups missed out on the opportunities in that recovery
• There wasn’t the distress from the RTC days with so many deals come to the market and prices were really distressed
• Prices didn’t go down as much in the multifamily space just because lenders and other owners didn’t have to sell for the most part.  There wasn’t as many distressed sales
• Transaction volume went way down in the institutional apartment business, while everyone rode out that tough time
• It was a good “defensive” place to be compared to other asset classes
• But was tricky to take advantage of because you had to be really aggressive to buy deals in 2010
• However, in retrospect, you could have bought anything and done well
• They did a few short term “opportunistic” deals, but mostly stuck to their long-term strategy
  • They used higher leverage when they were further back in the recovery and felt that there was more certainty in terms of where the economy was doing in the median term
    • They had a few deals that were in the 70-80% debt range that worked out well
    • They tried to match those with deals that had very high cap rates where they felt there was a lot of downside protection even though the loan-to-value was higher
    • It was more deal specific

Target Deals and Markets Today

• Today, they tend to be more focused on “bread and butter” type deals
• If you look at a bell curve of “quality of assets”
  • They lop off the low end where there’s high crime and very difficult capital issues that need to be solved and functional obsolescence
  • Also, eliminate the other side that is very new construction, a lot of pipeline and uncertainty
  • They tend to be right in the middle
• Their Markets:
  • Washington
  • Oregon
  • California
  • Arizona
  • Nevada
  • They know their markets very well
• Over 1,500 units
• Regional Management

How to Approach Passive Investing

• He knows the challenge of finding good investments from different groups and different strategies
  • On the venture capital side, he had to find the right companies to invest in
  • Working with family offices, he had to find the best real estate deals for wealthy families
• Today, he is on the other side in that he is putting together deals for investors
• Both sides are complicated in their own ways
• He wrote a book a few years ago called “Investing in Real Estate Private Equity,” written under an alias (Sean Cook).
  • We wrote it under a pseudonym because he wanted to give people honest advice how to invest in this space privately, as a passive investor, not on behalf of his employer.  He thinks there is already a lot of “salesy advice and “get rich quick” schemes out there already and didn’t want to be a part of that.
• How to approach passive investing:  The most important thing is to pick a good sponsor

How to Choose a Good Sponsor

• Not all forecasts and projections are created equally
  • Some sponsors are very aggressive in the way they underwrite and project much higher returns
  • Some sponsors tend to be conservative
    • The conservative sponsors tend to not need the investors as badly
    • Some of the highest projected highest returns on paper tend to come from less experienced sponsors
• Pick a sponsor that has been around for a long time
• Pick a sponsor who is active in the market
  • Will get preferred deal terms
  • Will deals from other principles because the principles want to do good deals together
  • Best debt terms
  • Best analysis because they have a big portfolio that they can rely on to make good projections
• First, talk with your financial adviser or accountant
  • Think about your investment portfolio holistically
  • What percentage of your investments do you want to be in real estate?
    • Do I want REITS (Real Estate Investment Trusts)?
    • Private equity deals?
  • Determine what type of assets
    • Office
    • Multifamily
    • Mobile Homes
    • Self Storage
  • Type Investment
    • Equity
    • Debt
    • Mezzanine
    • Preferred
  • Once you decide, determine the allocation amount to invest
  • Then ask who are the best multifamily, office, self-storage, etc. operators out there
    • Talk to a lot of other investors – especially those in the space you want to be in for recommendations
    • Look at trade magazines, Co-Star, Multifamily Housing Association News
    • Look to see who is in the markets of interest to you
    • Make a short-list of good prospective companies
      • Find a good company
      • Get introduced to them
      • Find out what their track record is
      • Vet them
      • When you receive an offering from them, assess the offering and invest or not
        • Read the detail of the PPM (private placement memorandums)
          • What’s their best risk-adjusted deal?
          • the operator
          • risk profiles
          • deal economic terms
          • compensation, fees, promote and incentives
            • Some investors mistakenly think that incentive bonuses are better when, actually, the deal can be higher risk because the sponsor will go after bigger risk to get higher incentives
        • After you get comfortable reading a number of  PPMs, you will get better
• The “art” of successful real estate equity investing is knowing how to pick the best sponsor

Evaluating the Real Estate

• Underwriting models are extremely complex to evaluate
• Many moving pieces
• Key things to look at:
  • Comparable sales (per unit, per foot prices) for similar asset type on a cap rate basis
    • Do they triangulate with the deal you are looking at
    • Are they setting a new high water mark?  If so, is it, for example, you are buying a property with bigger floor plans or newer deal?
  • Rent Comps
  • Cash Flow
    • Rent comps
    • Rent growth
    • Exit cap
  • Where are the pockets of risk

Where is the Company Going?

• Been doing the same thing for last 27 years
• Mark Lieberman is the founder
  • Started buying smaller apartments in San Diego with friends and family during the RTC days
  • Grew the business over the course of time to 20,000 units
  • Has always had the same focus
    • Buy existing apartments
    • B and A- properties
    • Fix them up
    • Manage them in-house
    • manage for cash flow
• Will continue to do the same thing that they do well
• Lower leverage deals, downside protection and cash flow

Rap it Up

• Favorite real estate book:  Am I Being to Subtle by Sam Zell
• Favorite business book: Extreme Ownership by  Jocko Willink  & Leif Babin 
• Favorite website for success: Look for websites and information from websites that differ from things you already think
• Favorite app: Audible
• Favorite quote: “Try not to be a man of success, but rather try to become a man of value.” – Albert Einstein
• 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?  Buy a suit and go to the most successful real estate and investing groups of high integrity and offer to work for them.  In real estate, it’s important to start with a successful team.

To Order Paul’s Book Investing in Real Estate Private Equity

• To order, click here for Amazon link

How to Reach Paul

• Website: MGProperties.com
• email: Paul@MGProperties.com

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