Episode 4 of the Fundamentals of Commercial Real Estate Investing is now available on your favorite podcast listening platform. In this episode, RealCrowd Co-Founder & CEO, Adam Hooper, discusses how to evaluate real estate sponsors with Paul Kaseburg at MG Properties Group.
In this episode listeners will learn about:
– How to evaluate the executive team
– Is there a point where a good deal outweighs in-experienced sponsorship?
– The importance of local market knowledge and relationships
– What to look for in a sponsors track record
Paul Kaseburg joined 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 12,000 units totaling $1.7 billion in total consideration. Paul has 17 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.
Paul is also the author of the book: Investing in Real Estate Private Equity: An Insiders Guide to Real Estate Partnerships, Funds, Joint Ventures & Crowdfunding (available on Amazon).
Adam Hooper – Hey, Tyler.
Tyler Stewart – Hey, Adam, how are you today?
Adam Hooper – I’m good, and welcome RealCrowd listeners to podcast number four. Tyler, who do we have on today?
Tyler Stewart – Adam, today we have Paul Kaseberg. Paul is the chief investment officer at MG Properties. Today Paul is going to walk investors through how to analyze the various real estate sponsors they’ll come across.
Adam Hooper – Good, and Paul is actually, he’s also an author, so we’re now two for four,
Tyler Stewart – That’s right.
Adam Hooper – We’re batting 500 with accomplished authors. Paul wrote a book called, Investing in Real Estate Private Equity.
Tyler Stewart – Yeah.
Adam Hooper – Which we’ll talk about in the podcast. But Paul’s principal at MG Properties Group. Joined there in 2010. Since then, he’s been involved in the purchase of around 12,000 apartment units, totaling a little over $1.7 billion dollars of value. Came to real estate from kind of an interesting background. Mechanical engineer by trade, and then got into M&A and venture capital investing, which we’ll cover how that informs his approach to real estate now, which is pretty interesting background, in transition to real estate. Tyler were are some of the things that listeners should be taking away from the podcast today?
Tyler Stewart – Yeah one of the keys was the importance of a sponsor’s track record and reputation. And it goes much deeper than just building comfort with investors. Paul described how a strong track record and reputation can have a very tangible impact on the metrics surrounding a deal.
Adam Hooper – Especially, yeah when we were talking about looking in a new market. So if a sponsor is established in a market they know all the assets, they know the deals a trade, they have those relationships. And oftentimes, with that intimate market knowledge, comes with the ability to find a deal that someone coming to that someone coming to that market for the first time might not uncover, or they might not know some of those pricing nuances. And so, that track record and experience really does matter beyond just again their historical performance, but also directly relates to the kind of deals they have access to.
Tyler Stewart – Yeah, and another key from today’s podcast was when Paul jumped into how to limit the sponsor-related risk investors are exposed to by identifying sponsors with a healthy income stream.
Adam Hooper – Yeah and also he mentioned, and we’ll get into the end of the conversation there which is really interesting part, we started talking about fees and alignment and how if a sponsor might be too in incented by those backend promote fees, maybe that pushes him to take a little bit more risk. And so that alignment of fees can also play into the amount of risk that a sponsor is willing to tolerate when they go out and look at new acquisitions. That was an interesting point.
Tyler Stewart – Yeah, and the final point, or really theme of this podcast was would you rather invest into a deal that targets great returns with a moderate sponsor or a deal that targets moderate returns with a great sponsor? And Paul said he’s going with a great sponsor every time.
Adam Hooper – Yeah, and that’s being the theme of today’s podcast is what you should look for when you’re starting to examine sponsors. I agree completely. The sponsor is very important when you look at deals and as we’ve talked on prior podcast, and will continue to talk about, it’s not all about just the highest number. You have to look at all the other components that go into that, and arguably one of the largest components that go into that is the sponsor.
Tyler Stewart – Yeah, exactly. Paul’s approach was to evaluate the sponsor first. And once there’s a sponsor that you’ve identified as a group you want to invest with, that’s when you began to evaluate the opportunity itself. And to learn more about how the experts evaluate opportunities, stay tuned. We’re going to have Paul on the podcast again, and that will be the topic at hand.
Adam Hooper – This is the first conversation with Paul in a line of many podcasts with him to cover all the ins and outs that he wrote in his book, and a lot of great information today. Again, touched on fees at the end, so definitely listen through for that. We’re excited to have Paul back on our next few episodes as well. So as a reminder too, since this is a multi-part series, if you have any questions or comments, or suggestions for future content, please email us at firstname.lastname@example.org. And also a heads up, Tyler and I will be in the Seattle area April 19th to the 21st. Might be throwing a little investor event, so if you’re interested send us another email, email@example.com.
Tyler Stewart – It would be fun to meet as many of our listeners as possible while we’re up there in Seattle. And even if you can’t make it to the event, let us know if you’re in the area, and you’d like to meet. Adam and I would be happy to go grab a cup of the famous Northwest coffee, and get to know some of our listeners.
Adam Hooper – And with that Tyler, let’s get into the show.
RealCrowd – This podcast is brought to you by RealCrowd, a leader in online real estate investing. Visit realcrowd.com to learn more about how we provide our members with direct access commercial real estate investments. Don’t forget to subscribe to the podcast on iTunes, Google Music, or SoundCloud. RealCrowd, invest smarter.
Adam Hooper – Alright Paul, thanks for joining us this morning here. Paul, where are you joining us from today?
Paul Kaseberg – I am in San Diego, California.
Adam Hooper – Beautiful, hopefully getting some sunshine down that way.
Paul Kaseberg – A little rainy, but we could use it when we get it.
Adam Hooper – Good. So Paul joined MG Properties in 2010, but that wasn’t your first start in real estate, right? You came from the real estate background. Why don’t you take us a little bit back to your career before the real estate space, and how that influenced what you’re doing now with MG?
Paul Kaseberg – Yeah so like you said, I didn’t start out in real estate. I came from a family of engineers, and I was an engineer in undergrad. I started out working for TRW in on-orbit spacecraft operations as an engineer, so.
Adam Hooper – Wow, so literal rocket scientist?
Paul Kaseberg – Yeah indeed, indeed.
Adam Hooper – Good.
Paul Kaseberg – So, you know it was fun, but I knew early on that I liked the finance world. I kind of got the bug and went back to business school, and switched over to the in-house venture capital group. And this was before the dot com boom when things were really getting going. We had a lot of interesting intellectual property to license, and we invested in some technology start-ups. And so, I just, you know I loved that. It was exciting. And then the dot com bust happened. And it became pretty clear that if I wanted to go into venture capital, I was going to have to wait a good 10 years or so before that really started opening up as a career opportunity. So, I switched over to corporate M&A, and did that for a couple of years. After doing that for a while, I kind of felt like we would do these huge transactions and no one would notice. And it was hard to feel like I was moving the needle. I had a lot of friends who went into real estate, and obviously a much more entrepreneurial. More more, you can really see the needle move when you do a deal, and so I like that. They talked me into giving it a try, and I made the switch over to real estate, and ended up loving it. So, I started out in the real estate space, doing mortgage making equity and debt deals. There’s certainly the equivalent of doing an investment banking financial analyst position I guess. Just seeing a lot of deals, seeing what works, seeing what doesn’t, seeing how different people handle different situations. So, that was a good way to learn the basics, and I went from there to a family office where I was on the LP investor side looking at other people’s transactions. And so, spent a while doing that, which was helpful to give me some perspective. And then, before right going into the downturn, started up a hedge funded by nonperforming mortgages which was a great space for a little while. It was exciting there for a bit, but then the big investors got in. And once Blackstone and Carlyle start buying in the billions, it’s pretty touch without scale to be efficient in that business. So the trade kind of went away, and that’s when I got into multi-family. I started MG in 2010. And things were still kind of bottoming out in the multi-family space at that point. And so we were just getting going investing again after the downturn. And that’s when I joined the company, and we’ve had a great run. We as an industry, I guess have had a great run for the last seven years or so. As rent started to bottom out and stabilize, and then recover. I mean, multi-family was definitely one of the first asset classes that came out of the downturn, and I think it handled the downturn a little better than some of the other asset classes. And so, it’s been a good solid run for the last few years.
Adam Hooper – And so as a mechanical engineer, one of my best friends and roommates in college is a mechanical engineer, that’s a very different mindset than what we typically see in the real estate world. So how has that training I guess, and education as a mechanical engineer, how has that shaped your approach to looking at real estate do you think?
Paul Kaseberg – Yeah , yeah it is and I mean it’s definitely a different mindset? And you know it’s funny kind of coming from originally being trained I guess, as a venture capital or corporate investor. As well, that’s kind of a different mindset. I mean, you know engineering is extremely precise, right? And so, in engineering school we were very careful about the uncertainty going into a calculation, and the number of decimals coming out of that calculation. Being very practical about you know and what you don’t know. And the finance space is a little bit more about sales, and you know we always kind of joke that there’s a little bit more precision in marketing materials than I think is probably realistic, given the uncertainties of all the assumptions going in. So coming from that engineering background, I guess what it did is… I love numbers in the first place, and so I’ve always had that kind of the propeller beanie mentality a bit. There’s plenty of opportunity for that in real estate, so if anything it was for me, the practice was moving away from the numbers a little bit and just seeing all the other aspects of an investment that come into play to make it succeed or not. And on the corporate side, there are just so many uncertainties and types of things that can make a deal blow up. You know, everything from, just the things that you never saw coming about a company can ultimately lead to its demise, right? And with real estate, you know for medium to longterm investing, it’s really rent, growth and exit cap. For the most part. There a lot of other things that happen in the mean time, but they’re a lot fewer in terms of the number of knobs that you can turn in a deal, and so it’s really much more about the capital stack. The risk that you create through your financing and your structure. And then your business plan, and finding deals that are going to tolerate upside and downside, and looking for the risk-adjusted strategy,
Adam Hooper – Right.
Paul Kaseberg – As opposed to just the highest return strategy.
Adam Hooper – That’s something as we touched on our last episode. This concept of risk-adjusted is something we definitely want to get into with you, and is something that we’re always looking at. How can we better educate our listeners and ourselves as to the whole theory of risk-adjusted right. It’s not about just chasing that highest number as you look at a construction group portfolio, you need to have some of those deals that are going to offset the risk of those higher returns, right? And that’s again, I think a whole series of podcast we can get into. But, so you joined MG in 2010. Since then, at MG you’ve been involved in about 12,000 units purchased there? You know, a little over $1.7 billion of multi-family properties. And somehow in that time, you managed to write a book, Investing in Real Estate Private Equity: An Insider’s Guide. How in that acquisition time did you find time to write a book, and why ultimately did you decide to write a book?
Paul Kaseberg – Yeah so, the book was… So it really didn’t start out as a book. You know, I’m sure you guys have been the same way. Over time sort of being in the industry your friends reach out with deals, and they email you a deal and say, “Is this a good deal, should I be investing in this?” And I look at some of these deals, and my response would be, “No, you should absolutely run from this deal.” Everyone once and a while it was a good deal, right?
Adam Hooper – Right.
Paul Kaseberg – And so I started kind of responding and having a bullet point of things for me to, you know just a list of things that people should look for. And that list sort of grew over time into like a little bit of a mini-white paper, and different people told me, “You should just turn this into a book.” And when I went out, I looked for a book for a website, or something that people could go to to learn about how to invest in private real estate, and I just couldn’t find anything that I liked. I mean if you go on Amazon, and you search for investing in real estate, the list of things that comes up is every person who’s trying to sell something to you, or sell their own investment and pitch their own strategy. And there just wasn’t anything that was really just a basic overview for investors about how it works, and what to look for, and what to watch out for. And so, I just kind of felt like that needed to happen and it just wasn’t out there. So I spent a lot of time flying. And to entertain myself, I just pulled out my laptop when I was sitting around at the airport, and that was what I would do when I was airplanes, and over the course of about two years the pieces just kind of came together and I ended up putting it together. So really it was more to take care of my own boredom than anything, and just sort of a bizarre little hobby.
Adam Hooper – Good. Well I was going to say the good thing is you put down a pretty good outline in that book for our conversations here. So thank you for making our work a little bit easy here on hosting this podcast.
Paul Kaseberg – I do what I can.
Adam Hooper – So I do have to ask also, you wrote that under a pseudonym. Is there any relevance to the name that you chose for the pseudonym Sean Cook?
Paul Kaseberg – Oh yeah, so not a lot. Sean is my younger son’s name, and Cook is my grandmother’s maiden name. So it was, that was the background behind it. And really, I didn’t write it so that no one would ever know it was me as much as, again I felt like almost everything that was out there was somebody trying to sell something. And of course, easy for me to say now that I’m on this podcast. But I didn’t want it to be about me selling something.
Adam Hooper – Right.
Paul Kaseberg – I just wanted it to be about…
Adam Hooper – The information.
Paul Kaseberg – Just a fun excuse to put the information out there, and hopefully people find it.
Adam Hooper – Good. So we’re going to do a pretty deep dive with you here on all things real estate, but let’s start with the basics and lay some groundwork. Today we’re talking about obviously, what is a sponsor or manager. You know in RealCrowd we call them sponsor, and sometimes they’re called an operator, sometimes a manager. Let’s get really basic, what is a sponsor?
Paul Kaseberg – A sponsor is someone who has the job of going out, finding a deal, putting that deal together, raising the equity, ranging the debt, and then once you close it, you’re taking care of that property and making sure the values maximized. And you know, sponsors can be anything from a vertically integrated company, that handles everything from the property management, to construction management, and the leasing in house to a couple of people who just have an office, and a cellphone, and a copy of Excel. There’s a really wide range of what it means to be a sponsor in the industry. But really it’s that person who as an investor, as a passive investor you’re trusting to handle your money for you.
Adam Hooper – They’re the ones, like you said, they’re the ones when you hand them the money, they’re the ones that are actually going to execute the business plan, and make sure everything at the property level, or the fund level in that case…
Paul Kaseberg – Right.
Adam Hooper – If it’s a fund. They’re the ones that you’re trusting to actually do the work and be that manager of your money as it relates to those deals.
Paul Kaseberg – Exactly.
Adam Hooper – Now on the last podcast with Michael Episcope he mentioned you pick the jockey not the horse, which basically means you’re looking almost as much to the manager, if not moreso than the property itself. When you look at a sponsor, and investors are looking at sponsors, what are three or four items you should always look for, just very high-level when you’re looking at a sponsor that you might be interested in doing business with?
Paul Kaseberg – There are definitely some key items. One thing I would say about evaluating sponsors is I wouldn’t necessarily start with an offering. In terms of building a real estate portfolio, I’d probably start from the top and say, number one, what’s my allocation to real estate? Number two, what kind of product is that going to go into? Is it a REIT, is it a private real estate investment? And then where do I want to be in the capital stack, equity, mezz, debt, preferred equity. And then strategies, do I want to be core, development. and where does that work? And then food group, how do I allocate across office, multi-family, retail? And then, once I get all of that then I would say I am looking for an equity investment in retail in the Western United States, right. You kind of work your way down to that point. And then you go out and look for the sponsors that you think are going to be the best at that. And you try to dig those up from the bottom up, and find the people given what your looking for who are best qualified to execute it, and then once you find those people, that’s when you really dig and say what is their experience in that food group? What is their track record? What is their platform like? And I’d say when evaluating a sponsor I think really the most important things you want to look for are the track record, and then what do they bring to the table beyond their track record in terms of their organization and their deal volume? ‘Cause that’s really what’s going to set them apart.
Adam Hooper – The sponsor then as you said, you’re already five layers deep, you know you want to invest in real estate. You know you’ve got this kind of particular strategy to find. And then you want to look at the sponsoring. You said obviously track record is pretty big. In the book you mention that even the best real estate can’t overcome the damage caused by a bad sponsor. As you’re looking at track records, how do you kind of peel back those layers and try to figure out, how much of their success can you attribute to market or to timing or to the overall, again the overall real estate cycle versus the actual activities of that sponsor, just based on the track record, or what you can see from your research?
Paul Kaseberg – I think to answer that it’s important to talk about why you hire a sponsor in the first place, and what value sponsors bring to a transaction, because I think it’s a little less obvious than it seems. And that is, first of all, in almost every part of our world we hire experts to do things. We hire attorneys, we hire tax advisers. You don’t build your own toaster, and you don’t write your own software, and so real estate’s no different, right? Sponsors bring a level of expertise. I think in general there’s a misconception about real estate that it’s really about the deal. And if anyone finds the deal, and they go out and do it, they’re going to do well. And I think there’s a lot more to it than that. And so the reason sponsors exist, because any sort of intermediary does in the world, is that they add some value. So there are different pieces to that right? So, the first thing they add is there’s a level of detailed knowledge in relationships in the industry, and so doing the same type of deal over and over, like anything there are just a million tiny details to the underwriting and the operations and the relationships that are involved in that. And so that could be you happen to know the local fire department, and there’s an issue with your fire system, and so you can go down and deal with that in a way that’s going to be much less expensive than it would be if you have no exposure to the people involved. Perhaps you know a seller who you’ve closed a transaction with, and you come to there’s a contract dispute about something. You’re trying to work out a purchase contract. You pick up the phone and give him a call and work through it. You know, just even something as simple as I need to put down another roof overlay, and it’s windy here, and what nail pattern do I need for that? And so they’re just a million of these little, little issues that can crop up, where you can incrementally be a little bit better in your decision making if you have the base, and the platform and the experience. So that’s kind of one way I think that sponsors add value. And then obviously there’s the actual transaction part of it where sponsors who are specific to a product and geography are tracking essentially every deal that comes to market.
Adam Hooper – Right.
Paul Kaseberg – There’s really a deep historical knowledge of deals that transact, what the evaluations were, what the moving parts were, and the issues associated with those. And so there’s a lot of knowledge that contributes to valuing a deal in the first place. I mean, a lot of the deals that we look at, we looked at the last time they transacted. And so…
Adam Hooper – Right.
Paul Kaseberg – We are very familiar with them. We know the history of them. They’re probably comps to some videos that we own. And so there’s a very textured I guess, understanding of the market. And that’s important to being able to value a deal beyond just putting the cash flows in the model, and seeing what comes out. And then, I guess to kind of add on to that is because I think a good sponsor is someone who is active in the market too. Because the activity in the market, and that track record in the market creates a reputation. That reputation, doing what you say you’re going to do, and relationships with brokers, relationships with sellers, that is really important to being able to tie up deals, right? Because if you sort of switch hats, and you put on your seller hat, and think about why do I pick someone to buy my property, you know from the seller’s prospective, they’re going to sell a deal that, you know. Let’s say this is a $50 million dollar deal. The debts coming due in a couple of months. If you put that property under contract for somebody who doesn’t execute, then that could end up endangering your partnership.
Adam Hooper – Right.
Paul Kaseberg – So you really have to have some trust in that other group. And so, if it’s someone who you’ve never dealt with, who doesn’t have experience in the market, and doesn’t have that track record, than really the only way for that buyer to tie up the deal is to offer more, and maybe to put up some non-refundable money, right? And so, paying more for properties is not necessarily the best way to make money in the business. And so there’s a, you know having that reputation is really what allows you to sort of hit. You just have that advantage on every deal right?
Adam Hooper – Sure.
Paul Kaseberg – Because you get a little bit better price on everything, and you get the deals when it’s a tie. So that’s an important factor.
Adam Hooper – That gets to one of the other questions that we have is when you’re looking at a sponsor, are you looking for sponsors that have a very narrow focus in terms of geography or product type, which would as you suggest, having that narrow focus means you know everything that’s going on in that market. You have those relationships, you know those transactions. Do you have a preference for kind of a jack of all trades sponsor, or someone who focuses on a specific product type in a specific market?
Paul Kaseberg – I think that having specific focus is really important. Kind of for all the reasons I talked about. There are, I think there’s a pitch to be made that having a jack of all trades sponsor does add some value and that they can go out and find opportunities wherever they are. My experience is that it’s hard to be expert at all things all the time.
Adam Hooper – Right.
Paul Kaseberg – And if you’re spread too thin, it’s hard to, you miss things on the details of whatever product you’re working on. And so, I think there are benefits for the sponsors to being diverse, right? Because from a platform perspective you can sort of move between investment types based on what you think is the most attractive one at the time. For investors, for the most part, they can make that decision because again if you’re going from the top down you’re saying, “Oh, well I think office is a good place to be right now.” For instance, “I’m going to look for that sponsor.” So investors can make that decision, the sponsor doesn’t have to. And I think, I guess an exception to that is if it’s a really big group, they’re going to have the depth to be able to…
Adam Hooper – To have discipline.
Paul Kaseberg – Maintain the organization, right. In each of those. And so, if you have enough money, then you can have a multi-family team, and a retail team, and an office team too.
Adam Hooper – Right. So then for sponsors that are going into new markets, I mean obviously if you’re trying to expand and grow your business, and you need to look into a new market, there’s going to be a time where you do your first deal in that new location. As an investor, should you be looking at that with any different kind of a lens if it’s a sponsors first acquisition in a new market, or new a new product category? How do you look at that if a career multi-family sponsor is making with their first hand full of acquisitions either in a different geography, or an office property, or retail property. How should an ambassador look at those types of opportunities?
Paul Kaseberg – That’s always a trick from a sponsor’s perspective, is how do I grow my organization through geographies? We tend to be very careful about that, and I think if you look at what these sponsors bring to the table in the first place right, which we sort of talked about it’s, number one, they have better deals coming in. Number two, they get better prices on deals. And then once you own the deal because of your organization, you execute better on it, right? In all those things are a little tougher when you’re in a new market, so you don’t necessarily have that track record of underwriting. You don’t necessarily have the relationships, although some of them may cross over. And then, you don’t have the expertise or the organization that’s as effective in that new product. So, I think it’s always a little bit of a disadvantage when you’re going into a new market, or a new product type. And I think investors should take that into account. I think, at the end of the day that’s just one factor.
Adam Hooper – Right.
Paul Kaseberg – But, we try to be really careful about that. For instance, if we’re going to grow our geographies, we pick a geography that’s sort of the next city over, and we can take our same regional manager, and maybe they have some experience there, and they can oversee that property. It bolts on to what we’re already doing. We only do the West Coast because we want to be really careful that we keep a close eye on our properties, and if we were to do one property in Florida, not only do we not have a high level of expertise there, operationally it’d be hot. And that property, it might just be, it wouldn’t get as much attention as some of the rest of our portfolio, so.
Adam Hooper – Sure.
Paul Kaseberg – We try to be careful about that, and I think it’s worth paying attention to as an investor.
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Adam Hooper – Is there ever a time where a good deal would outweigh, not necessarily poor sponsorship, but maybe would a deal be good enough as an investor to look at that you might have some more leniency if it’s a new market, right? If you’ve got a good sponsor that’s looking at maybe a 15 or 16% return, and you’ve got a lesser experienced sponsor that’s targeting a 20% return. Would you ever see a situation where the deal is just so good, that you can forego some of the issues with the sponsor?
Paul Kaseberg – So, perhaps, but really at the end of the day, I think the sponsorship is absolutely the most important factor. And perhaps it’s not a simple spectrum of good, to medium, to bad sponsor. You know, I think there a couple of aspects to that. You know, there’s good and bad in a normative way right, where you’re saying is this a person or a group who will do the right thing for investors, and when there’s a downturn, are they going to treat their investors the way they should be treated? Are they going to act in everyone’s best interest? And then there’s the question of is the sponsor weak or strong? That is for the most part a network and liquidity question. So, if there’s a cashflow short fall, is that sponsor going to be able to step in and deal with it? Are they going to be able to keep deals solvent in a downturn? And that could… That issue could come not necessarily from the deal you’re investing with, but perhaps the sponsor has personal recourse on a variety of loans. And one of the other loans throws them into bankruptcy. That’s not going to be good for your investment. And so, the financial weakness or strong-ness of an investor is important in the downturn scenario, but also in the, just when you buy a deal. The stronger investors tend to get better loan terms. I mean right now, the difference between a strong and a so-so sponsor is easily 25-30 basis points for longterm debt, which is really material over the course of 10 years. So, that’s indefinitely important, and then there’s the effective and ineffective aspect of being a sponsor, which is once you buy the property, do they have the team in-house and the organization that’s going to do a good job with that investment?
Adam Hooper – Right, to actually execute on the strategy.
Paul Kaseberg – Yeah exactly. When you take all those into account, you know, I think it’s really more important to focus on the sponsorship even if it is a little bit lower return. And the other factor to take into account with that decision, because that’s something that everyone has to deal with right is underwriting isn’t necessarily apples to apples between different sponsors. So the reality of the business is the most established sponsors with the best track record, tend to be the ones that don’t need to work as hard to find investor capital. And so they don’t need to promise high returns, or they don’t need to underwrite high returns to go out and get a deal fully subscribed. And so, there’s an aspect of the business where startup sponsors tend to be a little more aggressive,
Adam Hooper – Right.
Paul Kaseberg – Than the more established sponsors in their underwriting. And we see this all the time, because again, we look at every deal on our space. And often, we’ll see the offering memos that go out for deals that we didn’t win from people we know in the industry. And we always kind of, the first thing we do is go to their financial underwriting right, and look at their assumptions and say, “Would you look at the exit cap on this one?” And so, I think it’s important to know that not every, underwriting is as much art as science, and not every sponsor will handle that the same way. And so, a 15 from one sponsor, is not equal to a 15 from another sponsor necessarily. And that’s, from an investor perspective, that’s a really hard thing to evaluate, not knowing the groups involved. And so, again I think by default you want us to really start with the sponsor, and trust that that sponsor is going to be out there finding the best deals they can. Because the want to, too.
Adam Hooper – Right, and so now when you’re looking at the sponsor, some of the things to look for are obviously track record, leadership team, experience. When you’re looking at that first one, the track record, what are some of the things that investors should be looking for as they look back at that sponsor’s scope of work. Obviously, length of time, number of deals, the actual performance of those deals. You mentioned before what happens in the down cycle. Do they stick by their investors and do what’s right? How should investors start to look at the track record of these sponsors?
Paul Kaseberg – Definitely relevant deal experience, like we talked about. You want to make sure that the sponsor experience is the same asset type, same geography. Do they have experience doing whatever they’re proposing? That’s key. Definitely good performance is important over a long period of time. You need to take into account the vintage of the deals that were done too.
Adam Hooper – Right.
Paul Kaseberg – Deals that were done in 2010 should be evaluated based on a different yard stick than the ones that were done in 2007, because that’s just the reality of the business. So I think that’s important. And consistency of returns. You definitely want to look for situations where a sponsor didn’t return investor money. Look for problems, and how those were handled. The reality of the last downturn was it was fairly severe. So I know a lot of sponsors had some issues when they went through that, and it’s important to ask the question about how in that last downturn or previous downturns sponsors dealt with properties that inevitably didn’t do well. Did they give them back to the lender? Did they restructure them internally? Did they feed them personally? How did they handle those situations when they went bad? Because I think one of the things that sets apart sponsors is there willingness to really stick with the deal. Because time will, in most cases time bails you out of real estate problems, if you can hang on long enough.
Adam Hooper – Right if you can, if you can hang on long enough. That’s the key.
Paul Kaseberg – I think that’s important is just to look at how people were treated, because if banks or investors were not treated fairly in the last time, there’s no reason to expect that they would be this time. And likewise, if the sponsor really stepped up, and kept things together and did right by everyone, that’s an important fact to take into account.
Adam Hooper – Yeah and so again, bad deals can happen to good sponsors, and the market can happen to good sponsors. And as you said, the crash of ’08 was a pretty severe one. As an investor, we’ve seen a lot of acquisitions right, from the kind of 2010 onward. And a good market makes every sponsor look good, right? Rising tide, lift all boats. How do you discern as you’re looking at track records, acquisitions that have been done since 2010, ’11, ’12, naturally those have all been in an up market. How do you, what questions should you ask a sponsor? How do you determine did they do right by their investors when you’re looking at maybe a deal that did go South in the downturn? What are some of the questions or things that investors should be cognizant of, or ask of sponsors to get to how they behaved, or how they acted on behalf of their investor capital?
Paul Kaseberg – It’s a great question, and honestly that’s a tough, it’s tough information to get if it’s not provided. And hopefully investors have the opportunity to sit down with sponsors and really talk to them before they make the decision to invest. And so, I think the important things to ask are what were the most difficult deals that you had, and how did they unfold, and how did you deal with them? And what you want to be looking for is how was that problem resolved with a lender? How was that problem resolved with investors? And what was the ultimate resolution to the deal? And really, I think the things to look for there are, because if a deal doesn’t go well, and a property is given back, that can potentially impact a sponsor going forward for the rest of their career. Having a bankruptcy on your background, having a foreclosure in your track record, it’s certainly not the end of a career. I mean, we definitely know that is not the case in real estate, but it impacts the pricing that you’re going to get. It impacts the ability to get other structured products from lenders in the future. And so it’s important to know what blemishes a sponsor has on their track record when they’re going forward. And then knowing how a sponsor dealt with a problem on the equity side’s important. I think probably best case scenario is they… we have to deal with their existing investors. So, unfortunately private real estate is not a particularly efficient structure to raise more equity in, but there are some ways to do it. And partnership agreements tend to have provisions for that if it needs to happen, right. So, usually best case scenario is the investors agree that it’s really just a timing issue, and they put in a little more money to get the deal over the hump, and then it does, and things work out okay. So that’s kind of the best case scenario that you want to look for. And if the sponsor needed to put in a little money themselves to keep things going that’s always a good factor to see in a track record too.
Adam Hooper – And so how should an investor look at a track record for a company that maybe wasn’t formed pre-cycle, if they’ve only been acquiring assets from say 2010, ’11, ’12 onward, how should those track records be viewed given the strength of the market that we’ve seen over the last six, seven years?
Paul Kaseberg – It’s really hard, and we’re at a point in the cycle where I think there are a decent number of sponsors that are in that situation. You know, I guess one way to evaluate that track record is to learn more about the principles history before that particular platform began. So you know often there may be a new platform, those principles may have come from other industry groups in the past,
Adam Hooper – Right.
Paul Kaseberg – You can talked to them about where did you come from? How did those groups do? What was your strategy at the time? How did that history inform the way you’ve set up your current company? And I think that’s one of the few things you can do, right? Because other than that, you just need to take into account that a new platform is a new platform, and that just presents some risks. One of the benefits of a long track record is not just that you have that long track record, because past history isn’t indicative of future results, et cetera, et cetera right? But it’s really that once you get a platform with that kind of 20, 30 years of history, there becomes an even stronger incentive to maintain that track record right, and that’s a really, it’s like a reputation. Once you build that reputation, that track record, that’s your most valuable asset. And so sponsors are incentive wise to be much more careful. Whereas if you’re a startup sponsor, you may not have as much to lose, and you may have more to gain by taking a little bit more risk, and then hopefully if things turn out, that may accelerate your platform faster. So that’s, those are kind of the benefits and drawbacks of being with an established sponsor.
Adam Hooper – You mentioned what the prior experience might have been prior to forming this particular sponsorship entity, and you look at the executive team. What are some of the things that you should look for in the executive team? At RealCrowd, we always look at principal experience, right. And we define principal as having your own capital at risk. So if someone is a career asset manager at a big institution. They don’t ever have their principal capital at risk. Maybe they’re just managing a portfolio, or maybe they’re head of acquisitions for a company. How do you look at that, right? Having your own capital at risk in these deals as a principal sponsor, versus the experience that you can gain through managing maybe a massive portfolio, a billion dollar portfolio, but not necessarily having your own principal capital at risk. How does that play in the equation, and what are some of the things that investors should be looking for in the background and professional experience of an executive team?
Paul Kaseberg – Those are both great points. It is relevant to have experience at a big company, or at least a lot of transactional experience, because that transactional history and asset management history brings up just a wealth of issues over a career that you may not run into if you have just been doing sort of your own small deals here and there. And so, there’s real value to having that type of background. And at the same time, there’s real value to having been out there, putting your own money at risk, and getting deals done yourself. So, I mean I think both of those things are important, and I guess the other thing to look for is, especially a fully integrated company is much more than just the principal or principals, it’s a whole team. And so you really want to look for a depth in the senior management team. Experience on the HR side, and the operational side, on the construction side, because all those things can really, any of those things could pop up to be an issue in the property.
Adam Hooper – Sure.
Paul Kaseberg – And having an experienced team, especially a team that’s worked together for a long time, that’s even better. So, that’s the ideal scenario if you can find it.
Adam Hooper – You mention again this concept of a fully-integrated platform. Which is essentially the things like your property management construction, leasing. All these different components that are required. There are different expertise that are required to execute on the strategy. Do you have a preference for that being fully integrated, or is there some efficiencies to outsourcing some of that work? How do you look at that?
Paul Kaseberg – There are trade-offs to it, and I think that overall, It’s a benefit to be fully integrated, but the benefit is from an investment perspective, if you have a fully integrated platform, typically the operation’s team is in investment committee weighing in on your assumptions. And if you have an unreasonable assumption, you’re going to hear about it on the acquisition side. So, there’s this built-in discipline that you get from having a fully integrated platform, because ultimately the people who are going to have answer to the assumptions are the people who are going to be running it. And if they’re in your company, that’s going to lead to better underwriting. So, I think I mean that’s one important benefit. Another benefit is once you close a deal, and that deals operating, there’s an owner mindset if you are a fully integrated company, because you’re not necessarily just managing another property. I mean there’s a real incentive to make sure that that property value’s maximized, as opposed to just sending out another quarterly report or monthly report. So, I think there’s having that stake in the equity in the deal is an important factor in the performance of the deal. And the other factor that’s a little hard to quantify is if you have a fully integrated platform that creates some, it creates an extra income stream. And we can talk about that too but, it tends to bring in some extra fees. And those fees, well generally you don’t want to be paying more fees as an investor. Having some fees come in through a property management or asset management platform mean that a sponsor is going to have an easier time weathering a downturn. And having a more diverse platform that can make it through good times and bad, that’s a good thing for investors. I mean, I definitely had some colleagues who were at platforms that really didn’t have that fee income coming in in the last downturn, and I saw them shut down. And that was definitely not a good thing for investors, so.
Adam Hooper – Oh, and just to, I would say just to clarify there for our listeners, a property management fee is going to be paid somewhere to someone. Regardless, right? And it’s usually in the kind of 3% of gross rents. Is that typically what you see property management fees?
Paul Kaseberg – It is, yeah.
Adam Hooper – And so that money is going to go to either an outsourced property manager, where that income is going to a third party. Or if there an integrated platform, that income is going to be coming back into the sponsors operations, right? And so the fee that’s being paid is the same, it’s just where that’s going. And that income, as you were saying, can kind of help offset some of those other tightening if you will in down markets, right? That fee income can help keep the lights on essentially,
Paul Kaseberg – Yeah.
Adam Hooper – In a bad situation.
Paul Kaseberg – That’s another good point is when you’re evaluating deals it’s important to think about the apples to apples basis, right? So, even though when you’re looking through a PPM for instance and you’re looking at the fees that one sponsor is getting, the fact that they’re getting a property management fee, you need to take into account the fact that maybe another sponsor who isn’t getting that fee is having to pay someone else for it, so. Yeah, you definitely have to take into account the full scope of the business.
Adam Hooper – And now fees, I know before we started recording, obviously our last episode was a very in depth look at fees. Talked about a bunch of different fees in the book, and the mix of upfront and performance-based compensation for sponsors, and it sounds like I think you have a little bit of a different take on that. Can you spend a minute as we kind of wrap up this episode here, your thoughts on fees and performance-base versus upfront or one time fees?
Paul Kaseberg – Yeah, absolutely. And I guess for listeners who haven’t heard the last episode I would highly recommend you go back. That was a great episode. So definitely listen to that. And most of that I agreed with. There were a couple of things in particular that I definitely think are worth saying again which is, number one, investors should read the PPM. And it’s so boring! But you just have to do it.
Adam Hooper – You got to do it.
Paul Kaseberg – You just got to do it!
Adam Hooper – You have to do it, yeah.
Paul Kaseberg – I mean it’s so, in fact you should go out and before you, if you’re new to it read 20 of them, right. And it’s easy, you can go and download them, and you just, you start to get a feel for the texture of the investment, and the structure, and the fees, and different groups backgrounds. And it’s just, once you look through a couple of them, you sort of, you can whip through them pretty quickly, right? But it’s just, that is just so important to really understanding what’s going on with a deal. And, you know like was mentioned then, a bad structure or hidden fees, you know that’s really, that’s an indicator about the sponsor.
Adam Hooper – Of character, moreso than the particular deal, right?
Paul Kaseberg – Exactly, that’s sort of normative goodness versus badness issue, right? So, those things I definitely encouraged. And I think as far as fees are concerned really, you know at the end of the day, dollars are dollars from a sponsor perspective, and the goal for a real estate company like any company, is to bring in more money than you spend, and hopefully as much as possible right, within taking the longterm approach. And so, there’s just a blizzard of different fees, that are called different things from different companies. It’s very, it can seem a little bit daunting. But, the way I would summarize it is there basically two kinds of fees. There’s the fee that you know in advance is going to be there, and there’s the performance fee. And the fees that you know in advance may not necessarily be upfront. They may be paid over the course of the deal, like we talked about property management fees right? And so from a sponsors perspective, whether or not this particular dollar goes to pay that particular expense is a little bit irrelevant. You just want to make sure that you have enough money coming in the door that you can run your platform, and that you a create structure that allows you to be profitable in the longterm right? At the end of the day from the investor perspective, you really want to look at what’s the net drag on my investment. That’s the most appropriate measure, right? So what’s the gross property level return? And then, what am I getting net as an investor?
Adam Hooper – Right.
Paul Kaseberg – Once you put away all this mix of fees. And a lot of sponsors should be able to tell you that answer right, and hopefully that’s in the PPM, so that you can just look at it and say, “Alright, well the property is an 18 IRR, and I’m getting a 15, and that seems fair.” Or, “I’m getting a 14, and that seems so-so.” So, I think that’s overall the most important thing at the end of the day. And you know, and then…
Adam Hooper – Do you have a range that you typically like to see that gross to net what that delta is?
Paul Kaseberg – It depends on the total return of the deal, right. So, if it’s a lower returning deal, if it ends up being an eight, you know maybe you don’t even hit the pref yet, and so there’s no promote being pulled out of it. And so, you definitely would expect to see a lower drag on that investment. So maybe a 1, 2% right? Whereas, if it’s a 25 IRR, then it’s much more likely that you’re going to have something in the five range by the time you get through a couple of different levels of promo. So, every sponsor has a different structure, but you would expect to have a larger drag on deals that do better, and then a smaller drag on deals that don’t just based on kind of the normal structures out there. At the end of the day I think it’s just important to pick a group that you really believe in, and hopefully a couple of groups, right? You spread out your bets amongst some different platforms, and so you don’t have too much concentration risk. So, those are just, I think it’s important to think through that from an investor perspective, because you don’t want to bank on that alignment of interest to ensure that these sponsor’s going to do the right thing for you. You want to really focus on just having a good sponsor that has a good track record.
Adam Hooper – I think that sums it up well, good sponsor, good track record. That’s a good person to trust with your money right?
Paul Kaseberg – Indeed.
Adam Hooper – Good. Well Paul, I think that will wrap us up for today. Lots of really good information. I know we’ve got a couple more on the schedule. We’ll tease the next one that we’re going to record, It’s where we’re going to dig in a little bit more on the property specific information once you’ve decided a handful of sponsors that you’re going to work with. What to start looking for on the property side. And if any of our listeners out there have any questions, or feedback, or comments they’d like to hear on the next episode, please send an email to firstname.lastname@example.org. And we thank you Paul for your time today, and look forward to the next inner series of podcast with you.
Paul Kaseberg – Thank you so much for having me. It’s been a pleasure.
Adam Hooper – Great, have a good one.
Paul Kaseberg – You too.
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