Want to learn what is currently happening in the New York real estate market and how to apply quantitative analytics to real estate buying?
Eric Malley, Founder & CEO at MG Capital, joined us on the podcast to discuss what he is currently seeing in New York and how he has applied his background in the financial services industry to real estate.
In This Episode You’ll Learn
– How to use data and analytics to make acquisition decisions
– What areas of New York are cooling off
– Where the opportunity is in New York
*If you like this post, be sure to enroll in our free six week course on the fundamentals of commercial real estate investing — Enroll Now.*
Tyler Stewart – All opinions expressed by Adam, Tyler and podcast guests are solely their own opinions and do not reflect the opinion of RealCrowd. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. To gain a better understanding of the risks associated with commercial real estate investing, please consult your advisors. Hey listeners, Tyler here, before we start today’s episode, I wanted to quickly remind you to head to realcrowduniversity.com to enroll into our free six-week course on the Fundamentals Behind Commercial Real Estate Investing. That’s realcrowduniversity.com, thanks.
Adam Hooper – Hey Tyler.
Tyler Stewart – Hey Adam, how are you today?
Adam Hooper – Tyler, I’m great, who’s on tap?
Tyler Stewart – On tap, we have Eric Malley, CEO of MG Capital.
Adam Hooper – We’ve worked with MG for a while now. They’ve got fund live on the platform. Interesting approach, I think we had a good conversation about the New York market, that was what we’re hoping to get to his kind of his take on what’s going on in New York, some of the fundamentals, how they approach it which is interesting. They play in the residential real estate space but they have a unique approach to it and how they actually do it.
Tyler Stewart – Eric comes from the financial services world, where Eric would analyze investment opportunities on a quantitative model basis, and he’s applied that to real estate which is pretty unique.
Adam Hooper – It is, again specifically to residential real estate in Manhattan. So they’re focused exclusively on Manhattan, so there is a lot of really good statistics in there. I think you’ll find an interesting answer about Eric’s mentors, which I thought was a pretty unique take on that. And we also talked about their transition from historically being a fund that raises capital from institutional sources. To now raising capital almost exclusively, and in this fund exclusively through retail investors like listeners of our podcast.
Tyler Stewart – They saw a shift in how capital is being raised and yeah, Eric had an interesting answer on what’s it’s been like to go from institutional investors to retail investors.
Adam Hooper – Again really the base of that is opening up these opportunities and providing access. So not only just in the US, they also have a very large international investor base too which was surprising. He said 70% of their investor base is international which is a lot.
Tyler Stewart – That is a lot, and I’m still blown away by how quickly they can transact on a deal.
Adam Hooper – So another really good episode, good insight into the mind of MG Capital and how they view the New York real estate market. So I think with that, let’s get to it.
RealCrowd – This podcast is brought to you by RealCrowd, the leader in online real estate investing. Visit realcrowd.com to learn more about how we provide our members with direct access to commercial real estate investments. Don’t forget to subscribe to the podcast on iTunes, Google Music or Spotify. RealCrowd, invest smarter.
Adam Hooper – Alright Eric, well thanks for joining us today from your office in New York. We’re just talking before we started covering, you’ve been on a bit of a whirlwind of travel lately, we appreciate your time, taking to come chat with us today.
RealCrowd – It’s a pleasure, it’s terrific to reconnect with both you guys, Tyler and Adam and excited to share a little bit more about MG Capital, what’s going on in our marketplace and what we’ve learned from traveling the world and talking to our retail investor base.
Adam Hooper – So we’ve had the fund live on the platform for a while now, but for listeners out there that maybe haven’t seen it or have had a conversation with you, won’t you take us a little bit back to your start in real estate, maybe go through kind of your history background, what got you into the space and how you kind of ended up where you guys are at with MG.
Eric Malley – Sure, so while we invest in real estate, we’re really considered more of a financial services shop in that we manage a myriad of real estate private equity funds and special-purpose vehicles that invest in real estate. So my career dates back to 2000, roughly 18 years ago when I started our vertically integrated platform known as MG Capital today. Today we operate MG Capital Realty which is our acquisition and dispossession organization as well as our asset management. And we operate MG Capital which is the vehicles that enable global retail investors to gain access to our investment strategy. We also license title agents, so we provide our own title insurance and a myriad of other things, all in an effort to reduce the costs associated with operating our investment funds to produce better returns for our investors. And of course, by being able to operate a vertically integrated platform, we reduce the need for third parties to participate in our strategy which inevitably enables us to, perfect our performance overall. So we got started in 2000 primarily as a result of demand for what we knew back then as investors looking to invest in real estate as a way to preserve and protect their wealth. And so we started our advisory practice back in 2000. That grew rather rapidly and we added property management a couple years later. And then in 2006 we launched our investment platform and our first year of reporting was 2007. So we’ve been at this quite a while and we’re really proud of the work that we’ve created and the relationships
Eric Malley – that we’ve built across both the real estate industry in Manhattan as well as the financial services sector globally.
Adam Hooper – And so you’ve been focused exclusively on New York for pretty much your entire real estate career.
Eric Malley – Absolutely, I mean long enough to say that we could be deemed experts in the marketplace for sure. We’re pushing 18 years. Or some might say two decades.
Adam Hooper – I mean are you from the area, New York how did you get immersed in that world?
Eric Malley – Well, New York is a really exciting town. What’s amazing about it is some would say that it’s the global financial capital of the world or many would say it’s a cultural capital of the world or a lot of people would even say it’s a hub of attracting today’s youth to come here and work. I was drawn to it because well, I am from New York and I kind of got the New York real estate and investment bug really early on and couldn’t imagine doing anything else. And as we started to look back then at the demand for housing in the Manhattan real estate market, we realized that this was going to be a forever circumstance, right? So Manhattan is 13 miles long at the widest, it’s a mile and a half wide. It’s geographically supply constraint and over the last 18 years that we’ve been in the marketplace, we’ve seen redevelopment and some new development. But it’s not like areas, other areas around the United States where you have large slots of land that you can just continue to expand. So this is a marketplace that is really uniquely positioned to attract the financial services industry, the media industry, technology, pharmaceutical, the law industry, the media and marketing industry. And so what happens here is that we realize that, there’s such a demand for companies to be in Manhattan that there’s got to be a need for housing for them as well. And so, basically very early on we realized that if we could provide long-term housing to what we deem is today Fortune 1000 firms, then we’d be very well positioned for growth
Eric Malley – and providing an essential services to those companies. So, that’s really what we saw early on and that’s kind of what we’ve been doing ever since.
Adam Hooper – Yeah, and that’s the strategy of the current fund and you’re on your fourth fund now that’s on RealCrowd. Same strategy, right? Kind of providing this long-term–
Eric Malley – This is our fourth fund, our sixth investment vehicle and our strategic relationship with you guys has been terrific. I think you’ve experienced some impressive success with our investment products, and we’re really pleased with the relationship and the number of investors that have allocated through your platform. And what I would say is that, what we did actually about two months ago is we did a focus group on the investors that allocated through your platform. And we basically talked to about 10 of them, and we used a third party to do it and they had these discussions about, why did you allocate to MG Capital, what was important to you? And what we discovered from the investors on your platform is that they really genuinely appreciated the uniqueness in the strategy, and that they were very much interested in the fact that we offered distributions and that we were a private equity fund that had a shorter-term that was really designed for retail investors. But they also appreciated the fact that what you guys are giving them is access to high-quality investment products on the platform. So everyone had great things to say about RealCrowd, and we’ve really enjoyed the relationship so far.
Adam Hooper – Yeah, that’s mutual and we were just talking before we started recording, this is a fairly new capital raising avenue for you guys. Historically, it’s been all institutional capital and now you’re branching out into the more direct individual investor world. That’s a pretty big transition, and had to be I’m assuming a fairly big leap to go from the institutional capital world down to the individual investors. Maybe you can talk for a minute or two about what that transition has been like, what precipitated that transition and kind of where you guys see capital raising for your business going forward.
Eric Malley – Yeah, that was a big transition for us. The last fund that we raised that was exclusively from institutional investors was our second fund. Adam, what we decided to do with our third fund which was closed out about a year and a half ago, is we wanted to enable retail investors, of which there are approximately 12 million accredited retail investors in the United States. We wanted to give them access to the same institutional quality products that the big endowments and pension plans and investment banks have historically had access to. And since we were among the likes of investment managers that were the beneficiaries of those allocations, we had built the internal infrastructure and transparency and oversight associated with what those organizations required. And we thought this is a great opportunity for us to do something wild and crazy and have some fun with it. But really, to really change the way that retail investors build their investment portfolios. The challenge retail investors today have is that they are predominantly subject to what gatekeepers are thinking and selling. And what we thought would be a really great idea is to enable retail investors to come into our investment products direct, and to bring about some stability within their portfolio that also gave them diversification to real estate in a passive and professionally managed way. So this was a big transition for us. We went from a minimum investment of a million dollars and launched five new investment products. And as of interestingly enough, just last week,
Eric Malley – we launched a new investment product called the MG Preferred Plus. It’s a minimum investment of $50,000 and what we have found is really remarkable, is that by opening the door to the retail investor who is now empowered to make investment decisions from the privacy of their home or their office, that if they can come in at $50,000, they actually choose to come in at higher amounts. And what we have seen across the platform this year is that many people like to come in, open up an account, kick the tires, spend a quarter with us seeing how we perform and then they grow their relationship. And they end up having very significant relationships with us that we almost didn’t anticipate. And this year, we’re on track to do a distribution in July that’s, first year of fund fours operating of about four-and-a-half percent which is, a partial year of performance plus a partial year of capital raising and acquisition. So that’s really tremendous from the perspective of what retail investors are thinking about. What we built with the institutional guys is still there, right? So we allow institutional investors to participate in our strategy. Our maximum investment size is $25 million but what we’ve done is we’ve said to the institutional guys who were previously allocated to us, “Well, why don’t you be the conduit for the acquisition of our portfolios after they’ve been professionally put together and the performances perfected.” So what we’ve done is basically just moved the institutional investor out of the first position
Eric Malley – and put them into the second position creating liquidity for our retail investors, five and six years down the line. So in a way everyone’s having some particular advantage by us doing this. The retail investors are having access to the investment products and the institutional investors are still having access to our strategy but on a much larger scale.
Adam Hooper – Yeah, we just had Matt Sorenson on our prior episode talking about self-directed investing, and similar sentiment; the gatekeepers, the traditional asset managers where people would have their retirement accounts. It’s not that you can’t invest in other projects and other investment opportunities with those accounts, it’s just that those gatekeepers, they don’t allow it. And so I think just the awareness and giving people access to this, this type of investment and these opportunities is very much core to our mission, and I think that resonates for sure with giving people a full menu of options to be able to choose from verus just the traditional assets that they, are presented from those gatekeepers.
Eric Malley – I would agree with that. The one thing that I find in talking to retail investors about their individual retirement accounts is that they don’t necessarily realize something that’s very important which is that that account can go down even though it’s professionally managed by a very large global brand, at the institutions if you will. There are circumstances that drive performance within your IRA. I find that those investors who have their IRAs set up with large institutions aren’t thinking about them in the same way that they really should be in particular, because most people don’t realize that their IRA can change in value and actually go down. And so it behooves them to begin thinking about how to diversify their IRA investments and to have a very fair balanced portfolio. Some riskier investments, some less riskier and then of course certainly a diversified professionally managed real estate strategy is important. Without suggesting that they allocate directly to us, but of course having exposure to a professionally managed real estate fund is a healthy way to bring stability to your portfolio.
Adam Hooper – And then to again kind of ducktail on to that, your strategy is debt-free. So acquiring all cash without any leverage for the retirement accounts, that helps avoid some of the… Do you guys see a lot of retirement account activity into your vehicles from the fact that it is a debt-free fund or has that been a big impact for your capital raising?
Eric Malley – Well, from a capital raising perspective, the fact that we’re debt-free has definitely been very positive but we aren’t debt-free so that we can raise capital. We’re debt-free because I fundamentally believe as the chief investment officer, that it’s in the best interest of our investors to have access to our high quality investment products at the lowest risk ratio as possible. So, we like to prioritize distributions to investors as opposed to paying down debt service. We look at sort of what happened in the 2007/8/9 financial crisis. Those were very telling times that were not that long ago that a lot of people still have strong memories about. And the big drivers in all of that economic downturn was really the fact that a lot of these firms were heavily levered. But most importantly, I think that our investment management team and investment committee likes the fact that we are unlevered so that we can all sleep at night. And if we’re sleeping at night our investors are sleeping at night. We believe that because we are unlevered, we are mildly impervious, almost completely impervious to interest rate sensitivity. Of course we don’t have any debt service but… I think it’s refreshing for retail investors to think about an investment strategy and a real estate private equity fund that is debt-free. We would go so far as to say that we’re the only real estate private equity fund in the world that’s following a completely debt-free strategy. And yes, it would be much easier for us to go and have a half a billion dollar line of credit
Eric Malley – from any one of the big institutions that sit near to our office but we would much rather allow the retail investor to allocate to our strategy so that they can have stability in their portfolio, and we have the opportunity to build long-term relationships with them as opposed to providers of debt.
Adam Hooper – Okay, well so let’s get back a little bit into just the New York market. You said again this was kind of early 2000s you identified this need for the housing side. How did you get into that specifically? Did you have any mentors? Was that just an area that you were focused on? How did that thesis kind of develop within the Manhattan market?
Eric Malley – Well, my background prior to that was financial services and so, one of the things that I realized very early on is that individuals think about real estate in a very emotional way. Investors when they’re professional, they think about investments objectively and they think about how best to produce the highest returns with the lowest volatility. And I began to think about residential real estate in the same way. Which is that it’s not about the personal particulars that drive an individual’s interest or the actual ownership of the asset but rather, the use of the asset in its highest and best manner. So, I began to apply some of the fundamentals that I utilized in my financial services career prior to launching MG Capital, and started looking at residential real estate the same as you would any other investment, free from emotional bias and gut instincts and really started looking at the analytics and algorithms associated with it. I didn’t have any specific mentors, but I would say that, some of the big drivers are the importance of having residential real estate be looked at as not only as a place to live but as a viable means for investment. And so my mentors have really been the spectacular architectural structures that have been built across New York and how to take those assets and convert them to revenue producing long-term investments for our investors. So, in a way the buildings themselves have become our mentors.
Adam Hooper – Hmm, that’s an interesting take. I don’t think we’ve heard that one before, I like that.
Tyler Stewart – No, and I’m curious, what fundamentals from your financial services career have you taken over to real estate?
Eric Malley – Well actually, I think that the most important aspect of what we’ve drawn in and now perfected utilizing our fourth generation analytics is just the proprietary analytical model that we follow. So today we look at 160 unique qualitative and quantitative investment criteria for the acquisition of residential real estate, in particular, on behalf of our corporate tenants. So, it is very unusual to be using an analytical model that looks at so many unique characteristics when making an investment decision. And the goal really is to make sure that we are free from emotional bias and gut instinct, because those are the things that tend to get people in trouble when they’re making real estate investments. So for example, we use intrabuilding arbitrage, which is our acquisition analytic. And it evaluates property specific criteria across neighborhoods and within different buildings. And we use predictive behavioral tenant modeling, and we use our proprietary historical data. So a lot of these things come into play as part of every acquisition to ensure that we are going to produce the highest and best use and profit for that asset.
Tyler Stewart – When did you decide you’re going to build these models and how did you initially start building these models?
Eric Malley – Well, I think these models were at the onset really embedded in my brain, right? Coming out of financial services we used models for everything that we did. We looked at risk ratios for lending or other investments, and I just began to apply very basic models. But over the years, now 18, we’ve developed our proprietary analytics to reflect not only our strategy but what is important to our corporate tenants and also factors that are relevant to say the New York City real estate market. So for example, looking at asset elasticity as it relates to its viability in the marketplace, what does that mean? Well, if you’re acquiring real estate in the Greenwich Village area of Manhattan, you want to be mindful of what the air rights look like. And provided there are, there is the ability to build in an adjacent lot that could close up your windows would render your assets virtually useless, and proportionately their value would go down. So we want to be mindful of things that are very relevant to the Manhattan real estate market like redevelopment and zoning rights and changes in zoning laws and taxation and land leases, and things that most people are not even thinking about. Most investors are interested in tiles and views and ceiling heights. Yes, those things are important to us because ultimately, there’s an end user going to be using that asset for anywhere between three and seven years in our portfolio. But we’re really interested in making sure that five years out that that asset can still continue
Eric Malley – to do what it was intended to do at the time we acquired it.
Adam Hooper – Mm-hmm, and then as an investor that, obviously they’re not privy to all that information, right? As a passive investor, that’s maybe looking at opportunities across the platform like ours, are there any tools out there, or how do you recommend that they maybe get a feel for how some of those finer decisions that are maybe a little bit behind the curtain are thought through?
Eric Malley – So that’s a very fine balance, and how we share and disseminate information about our proprietary investment strategy. One of the things that we have done, Adam, historically is performed exceptionally well. As you know, we’ve outpaced the S&P nearly four to one over the last decade. And we’re able to do that as a result of many of our competitive advantages, but also our proprietary investment strategy. And so, we like to share as much information with our investor base as possible. We disseminate that information in a way that enables them to appreciate what we do and the results of what we do, but we generally don’t dive into the actual specifics with them and that’s why today’s discussion with you is really kind of the first time that we are publicly in a domain like this sharing more information about how we make the investment decisions and how we perfect the portfolio’s performance and how we look at dynamics related to market trends and capital-raising and so forth. So we’re happy to share this with you and excited for the discussion, but there are some aspects of the strategy that we have to keep them close to the hip.
Adam Hooper – Sure, so I guess maybe since you’ve been running these models for the better part of a decade or more now, how have you seen the market change? And if you started again, you said your first year of reporting was 2007. Obviously we went through a pretty good market cycle in 2008/9, I’m just curious, how the market compares when you first started these. Maybe what’s changed, what have you learned, how does the market look today versus then, and maybe even just a couple of years ago?
Eric Malley – Well the interesting thing about the Manhattan real estate market and many people know this, it’s a very elastic market. While there is the opportunity to invest in the residential real estate sector and eke out a marginal return as an individual investor with a single asset, that I don’t think is really the upside in this marketplace. I would say that the changes that we’ve seen in this market are such that, the way that taxes are calculated are very different than say any other place in the United States. So for example, many people don’t realize this is that, real estate taxes are based on a metric of a multiple of the rental market in Manhattan. So New York City determines real estate taxes not based on the value of real estate but on the rental viability of that real estate. And so, these are very complex metrics to evaluate and to look at. There is a lot of changes to those markets depending upon who is sitting in the the mayor’s office. There’s a lot of changes to the way zoning impacts real estate in New York, and there’s certainly a lot of changes to the makeup of the Fortune 1000 firms that now have a presence in the Manhattan real estate market. So, these are all trends that we’ve watched and seen evolve and we’ve been ahead of the curve on them, in particular thinking about the reason why corporate housing is so important to our strategy in that all of our leases are predominantly with Fortune 1000 firms most of which are fortune 500 firms. And if you look back at where we were when we launched
Eric Malley – our initial fund in 2006, the makeup of Fortune 1000 firms that were sitting in New York were not nearly as strong as it is today. So just to give you some overview on that. So there are 12 Fortune 100 firms headquarters based in Manhattan. There are 115 Fortune 1000 headquarters in Manhattan and there are 55 Fortune 500 firms. So there’s a very large presence of the most significant corporations sitting here in Manhattan, and they all have a demand for housing to provide their employees with. So just to give you some additional statistics on that. Like when we launched our fund, Google didn’t have a massive facility in New York. Right now they have 73,000 employees, roughly 6,000 of them are based in Manhattan. That didn’t exist when we launched our first fund. SAP has a massive headquarters here, Pfizer has a massive headquarters here. These are shops that weren’t predominantly that large and/or even in business at that time. so lots of changes not only across the starchitect real estate but the importance of tenancy and long-term leases. And then of course we’ve built a business based on providing housing to a marketplace that otherwise these companies wouldn’t have access to.
Adam Hooper – And I think that’s what’s interesting, is you kind of straddle, looking at this as an investment class but you’re also somewhat competing with residential buyers that are looking for primary residences or other I guess maybe foreign investment buyers. How does that dynamic play out? Where’s the balance of approaching what’s typically a residence model for a personal buyer and then layering on top of that your investment desires for that similar product?
Eric Malley – Well, I think that, we have found a very unique way to lift the personal buyer agenda out of our investment strategy and just rely on our proprietary analytics. But you’re right. I mean there are quite a few transactions that take place in the Manhattan real estate market every quarter. Statistically I know the numbers but, we’re not in direct competition with the individual acquirer of a residential property that’s looking to live in the property primarily because, their decision making horizon is very different than ours. We are a different type of acquirer. So, when we make an investment decision, let me just walk you through that cycle. If on a Monday, we look at an asset for acquisition that’s been presented to us or that we’ve sought, on Tuesday we make an investment decision utilizing our proprietary analytics. On Wednesday, we email a contract. Thursday, that contract is fully executed and on Friday we fund that transaction. So in essence we have created a sub market within the Manhattan real estate market of being able to transact and/or trade your residential real estate and convert it to cash within five days. So, this is very different pace than what your typical residential purchaser goes through. There’s a lot of emotional decisions, there’s decisions related to juxtaposition, to transportation and education and office and so forth. These are not things that we take into consideration. We’re really a very swift and efficient acquirer of residential real estate assets,
Eric Malley – and we’re able to do that because we understand the market very well, because we rely on our proprietary analytics and because we’re not relying on leverage in any way. So, we are a little bit more competitive to the individual seller and/or developer, whether you’re a one-off developer with a specific building or you’re a developer that’s listed on the New York Stock Exchange. As an acquirer of residential real estate assets that can move that quick, we are highly sought after by all of them as a means to sell their assets.
Adam Hooper – Yeah, certainty of closure and quick cash is always attractive to a seller.
Tyler Stewart – That’s for sure.
Eric Malley – It is. If you can take variable out of a real estate transaction which is time, when it’s going to happen and of course then you give the liquidity to the seller to be able to go about their regular business. You’re really unlocking tremendous value.
Adam Hooper – So what are some of the challenges that you guys see in the market right now, and maybe going forward with where we’re at in the cycle, kind of crystal ball if you would where you see Manhattan real estate going.
Eric Malley – Sure, well I think there’s a couple of different challenges. There’s the perception of our investors challenge as it relates to what we can and cannot do and then there’s the real challenges that we face actually as the largest owner manager of one, two and three-bedroom luxury properties across Manhattan which are diversified in 15 different neighborhoods. I think our biggest challenge is the notion that, individuals who live in our properties think about real estate as short-term. And what we have done is really educated these large corporations on the benefit of having a long term corporate contract with us that ranges between three and seven years. Most of them think much more short-term and so that’s always been a challenge for us. As it relates to the real estate, the biggest challenges that we have are variable costs. So what does it cost to operate a building? What are the unions going to do when their contracts are up for renewal in two years? What is heating and oil and electricity going to look like during the tenure of our ownership? What are some of the trends that are happening on various different city blocks across Manhattan and how does that impact the usefulness of our assets? So these are things that we’re always very mindful of. The great thing is is that Manhattan over the last 17 years since when we’ve been running this strategy is really significantly changed. There really aren’t any neighborhoods that are sketchy anymore. There were certain blocks and neighborhoods in Manhattan 17 years ago that you would select to avoid at night
Eric Malley – just because it was not necessarily as developed as it is today. So a lot of that has gone by the wayside and Manhattan is just a terrific place to live. And this is all very new to us as well. So there’s a lot more greenery, a lot more parks and there’s a tremendous civic sense that takes place in New York. People really do care about the city streets and how they live and how their buildings are maintained. So all those are big changes that we’ve seen in the Manhattan real estate market.
Adam Hooper – And now you mentioned that you’re in 15 different neighborhoods. Are you looking at all areas of Manhattan or how do you kind of zone in on specific areas, neighborhoods versus others? Is that all, that’s all just handled in the metrics and the analytics that you guys run?
Eric Malley – Well, it is definitely managed through the analytics but a lot of what we do that’s very different is the acquisitions we make are driven by the mandate of our corporate tenants. So we follow a very different strategy than your typical real estate private equity fund. We don’t acquire an asset and then hope and pray that it will eventually become leased. We acquire assets driven by the mandate of our corporate tenants. So once we have a lease that’s been executed by a corporate that ranges between three and seven years, we actually make the acquisition of that asset, so that it’s added to the portfolio, it’s owned by our investors and professionally managed by us and leased by a Fortune 1000 firm of which we have about 215 in our portfolio today. And so, the selection process fundamentally is driven by our analytics and the demand. But our portfolio was made up of assets that are very different than what you typically see in the rental market. A rental one-bedroom in Manhattan might be 700 square feet, and in a rental building that’s managed like a rental building. Our assets are all in condo buildings, they are, one bedrooms are roughly a thousand square feet. The rental of that is roughly 10,000 a month for the first year with an 8% escalation spanning seven years. Our two bedrooms are roughly 1400 square feet, where a typical two-bedroom in Manhattan might be 900 square feet. Our two bedrooms begin at 15,000, again with the same escalations. And our three bedrooms are also significantly larger than what you’d find in the Manhattan rental
Eric Malley – three-bedroom market, and they begin at 25,000. The rents that we charge are commensurate with the fact that our corporate tenants are leasing an asset from an institution that they know of. So it’s not like they’re renting a property from an individual owner who may or may not keep up the property. And so, what we’ve been able to do and this is something that we’ve seen in the Manhattan Marketplace changed significantly over the last 10 years as well, is we’ve been able to sign very long-term maintenance contracts. So for example, we’re maintaining hundreds of air conditioners a year and so, we get a lot of value out of signing a corporate contract for that and that’s changed within our portfolio. And 10 years ago, we didn’t have that many properties in the portfolio and now it’s changed a lot for us. So our investors are benefiting from those cost efficiencies.
Adam Hooper – So again, you’re going into sub markets where the corporate relationships that you have, say you want to go. They’re kind of driving the demand or the acquisition models for you in terms of where they have a desire to house their employees or whatever their corporate housing needs are.
Eric Malley – To some extent you’re correct on that for sure. But also we are very interested in ensuring that we maintain a very high level of diversification within the portfolio. So having a granular diversified portfolio of one, two and three-bedroom luxury properties that are a 100 different buildings and in 15 different neighborhoods brings about asset diversification, diversification of corporate tenant and revenue streams so that we aren’t concentrated in any specific segment. So for example, just to give you an idea, our corporate tenants are broken up into education and museums, fortune 500 to 1000, fortune 100, even fortune 50 and then within those segments we look at the diversification of the industries. So whether it be technology or financial services or non for profit or, a pharmaceutical. And we’re very mindful to make sure that the tenant makeup is extremely diversified and it matches the same diversification levels that we have amongst the residential real estate properties in our portfolio. And this ensures that if there’s an economic downturn in a specific industry segment, that that doesn’t harm our entire portfolio and our entire portfolio is not concentrated in a specific neighborhood. So for example, when the Second Avenue Subway was coming in, we knew very well that that was going to have an impact on the neighborhoods associated with that subway line. And so, we divested any of the assets that we had near to the Second Avenue Subway early on and concentrated on other markets. And what happened was it was true.
Eric Malley – The Second Avenue Subway Line really drove rents down in the neighborhood where there were significant construction for 10 years. And since, we’re mostly interested in cash flow for our portfolio and for our investors, that would have harmed us. So we really, we’re not just looking for the best deal on the acquisition, we’re looking for the highest and best use of the asset. So these are things that we as an investment manager look out for.
Adam Hooper – And any markets in particular that you guys have seen kind of rising or where do you see the trends of corporate housing going? What’s the hot markets right now or what’s maybe cooling off?
Eric Malley – Well, I would say neighborhoods that are definitely cooling off are north of 57th Street in particular because there is a glut of inventory. There’s also not a lot of corporate offices in those markets so what we’re finding today is that in Manhattan, while a million people a day ride the subway, not everybody that lives in Manhattan wants to ride the subway. So just to think about the statistics of residents in Manhattan, there are roughly almost 1.6 million people that live in Manhattan. There’s roughly another three million a day that flow into Manhattan to work here. And so what we see is the people who actually live in Manhattan want to live and work in walking proximity to their offices. So north of 57th Street is predominantly residential, so there isn’t as much of a demand for corporate housing up there. And what we find is is that north of Wall Street and south of 34th Street is where a majority of our assets are. What we find is are, our corporate tenants would like our assets to be situated in those areas predominantly because their offices are within walking distance.
Adam Hooper – I guess there is a concern around the ultra-luxury development in New York and maybe some over building in the upper upper upper high end of the market. Have you guys seen that at all or is that kind of worked through the market right now, or where do you see that sector?
Eric Malley – Oh yeah, I think that there’s a significant amount of ultra-luxury inventory just sitting. I think the developers of those assets are wondering and potentially scratching their heads and pondering the highest and best use of those assets. Our investment strategy focuses on one two and three-bedroom luxury properties that range in value anywhere between one and a half and five million from an acquisition price. So we aren’t playing in that field where you’re talking about assets that are ultra luxury, 10 to 20, 30, 40 and even some crazy numbers that are north of that. And I think that what we’re seeing is is that if you’re looking at very wealthy people that can spend $50 million on a property, they have a lot of options today. So New York is a great market for them to have a place in but do they really need to invest $50 million at the top of a building and own something, or are they better off renting it? Or can they buy or acquire that same property in a different city outside of the New York or even outside of the United States? So there is a huge opportunity for people who are writing $50 million checks to choose where they actually want to live and spend their time. And I think that over the last five years, we’ve seen a lot of developers enticed by very large transactions that would produce very high margins on their buildings development projects if they were sold. And a lot of them are sitting with unsold inventory right now that is really, really frothy in value. So, my recommendation to them is that they
Eric Malley – redevelop those properties from 50 million into four, 10 million dollar properties or $4 million properties because the market for those are I think a little bit larger. Still not MG Capital’s market but, certainly there are more acquirers of residential real estate in Manhattan in the $12 million range than there are in the 50. And, one of the things that we have seen is that, since our strategy focuses on assets that are below 34th Street, the skyline in that part of the city has predominantly been the same for the last 100 years, and that’s because of the air rights and zoning that govern that part of the city. So there’s not a massive amount of new developments going on that’s adding inventory to those markets. So that gives us as MG Capital a lot of leverage in how those assets that we hold in our portfolio are valued, utilized and priced from a performance perspective.
Adam Hooper – Mm-hmm, and now again kind of tagging onto that, how have you seen the buyer composition shift or change? What is the typical buyer profile? I know you’re in a little bit of a, kind of a niche space with what you guys can do on the acquisition side, but in the luxury residential space do you see competition from foreign capital? Is it mostly domestic, like what is your typical competition when you’re out acquiring assets?
Eric Malley – Well, I can tell you what we know is the makeup of the buyers in the Manhattan real estate market. I wouldn’t say that they are our competition in particular for a number of reasons. One is, we’re typically acquiring assets that are not on the market or not listed for sale for our portfolio. So that would be a very big distinguishing factor between the acquisition practice we follow and say an individual that’s using an agent to acquire a property. So very different and that’s because the individuals who are coming to us for us to acquire their properties are doing it mostly quiet. They’re looking for very swift and efficient transactions. The challenge I think with the Manhattan real estate market is that most individuals overprice their property when they think about selling it. They think that their property is worth more than what it really is. And they do so because they are emotionally attached to it. “I raised my kids here, that’s why this apartment is so special and you should pay me more money, because my kids grew up here.” Well, that’s not the reality. The reality is is that your property is not worth any more than what someone’s willing to pay for it. And it takes individual sellers some time to really go through that process. When we have a market like we do in Manhattan of a large number of non US investors acquiring real estate here for a myriad of different reasons they’re coming in with their own ideas of what a property should be worth and/or what their willingness to pay for it is. And that tends to drive value.
Eric Malley – It takes some time for individual sellers to wake up to what the value of their property is. And sometimes they wait too long and their properties just sit and sit and sit, and then after they sit for a year they call us and say, “Can you make us a deal?” And that’s a good opportunity for our investors ’cause we really do seize those moments and capture a huge upside there.
Adam Hooper – Good. Well, so I guess back to kind of a little prior question with the crystal ball. I mean are you guys seeing continued growth in the Manhattan markets, or where’s your temperature in terms of market cycle this far into the recovery, how does your outlook feel going forward?
Eric Malley – Well, Manhattan is a really unique market. If you look at the value trajectory since the depression, there has always been growth in the residential real estate sector of Manhattan, whether it be through new inventory or increased sales or valuations, those numbers don’t match what we produce as an investment manager from a performance perspective but there has been steady growth since the Great Depression. I think that for a lot of reasons that I mentioned earlier, we’re going to continue to see stable and steady growth in Manhattan. Keeping in mind that sellers in this market are not living paycheck to paycheck or even month-to-month, the statistical data on residents in Manhattan is that they are usually with at least two years cash reserves. So, if there is some market cyclicality that’s impacting whether or not they can sell their property or not, they have staying power. So it’s really a function of what their individual agenda is. If they’re having a baby and they want to move to New Jersey or Westchester or Long Island, then there’s an external factor there that’s driving their decision to take a lower price. But if they wanted to stay on the market for two years, they theoretically could, and if you look at the Manhattan market today, there’s a lot of properties that are stagnant and sitting for a really long period of time, just unrealistic sellers. So they’re not really genuine sellers. If they were genuine they would list their property for what it’s really worth and it would trade in six months.
Eric Malley – So my outlook remains very optimistic in real-estate market for a million and one reasons, including the fact that roughly 250,000 people a day moved to the marketplace. They want to be in Manhattan. Yes, there’s plenty of attrition as well but Manhattan draws people to want to work here. So if you look at and take a poll of some of the statistics of the Ivy League universities. Just for example, I think it was, I’m going to give you some rough numbers. These are not exact but if I remember correctly, the 2015 graduating class of Harvard Business School, 900 students, roughly 60% of them received job offers from firms that were located in Manhattan, 60% plus or minus a few. So, statistically people are continuing to move here because the fact that they, when they go to school, they graduate, they want to move to Manhattan. No offense to some of the other amazing cities across the United States but most students today decide that they want to take a degree in a specific topic so that they can get a job in the financial capital of the world or the cultural capital of the world which is known as New York City.
Adam Hooper – I think that’s a good look, and again seems from our perspective on the other coast, Manhattan’s always been an attractive place that again has a global awareness, that it seems like it feels, it’s got that safety to it, the desirability of people wanting to put their money into a little piece of New York real estate has always been a compelling opportunity.
Eric Malley – I think that the West Coast is a spectacular marketplace. My son is headed there for school this summer, and I’m excited to to visit him and spend time there and I love it. The real question is, does our strategy at MG Capital work in other markets like say, San Francisco or LA? Those markets are sprawling and massive. Those are automobile markets. Very different than what you have here. The reason why I think Manhattan is what it is is because it’s a walking city, the streets are designed with pathways so people can get around, the stores are situated not in malls but on the street level so that people can interface with shop owners and drop off their dry-cleaning and pick up milk and swing by the meat market. That’s part of a neighborhood and part of a culture that exists here exclusively in Manhattan, and it’s not something you see in other markets the way it is, is situated here.
Adam Hooper – Perfect, well, I think that’s most what we’ve got for today, anything else that you want to touch on or anything we didn’t get to or any questions for us?
Eric Malley – What we are seeing at MG Capital is really interesting as it relates to our relationship with online capital raising and you guys are obviously the leaders in this segment of the market. But just looking at how successful our relationship with you has been and also our relationship from a capital raising perspective this year with retail investors, it tells me that there is a massive trend taking place amongst retail investors, that they’re looking for a friction-free investment opportunity and they are feeling very empowered to take investment decisions individually and personally based on their own interest. And so, I applaud the retail investor for taking charge of the diversification that’s in their portfolios. And I would encourage them to continue to think about stability as they look at the future of how they continue to allocate and real estate is always I think a safer bet than other investment opportunities that you cannot necessarily fully understand and appreciate. But that said, we’re really happy with the nearly 300 retail investors who have invested with us since the beginning of the year. We look forward to continuing to grow our relationship together with you guys and thank you for today’s discussion.
Tyler Stewart – Absolutely, and out of curiosity, has there been anything that’s surprised you about the online investor?
Eric Malley – Yeah, well for one, the fact that there is this terminology, online investor. Let’s back up three years ago. I mean that’s a phenomenon, right? I mean yes, people were buying books and doing Google searches and pricing out automobiles and shopping for real estate. But we are now actually seeing a massive amount of accredited investors making investment decisions online, relying on the fact that we’re an institutional player and we’ve got a very long standing track record. They’re focused on transparency and oversight, they are definitely focused on things that are important like dividends and short-term investment horizons. And the fact that they are actually allocating online is terrific, I applaud their decision to do so. And I don’t think that it was part of our investment thesis to think about capital raising from the retail investor online 36 months ago. But I’m very happy that we’re ahead of the curve and that we’re one of very few institutionally managed investment platforms that have online capital raising capabilities.
Adam Hooper – Yeah, I think it’s a trend and it’s obviously what we started five and a half years ago was to try to give these options to the retail investors and I think it’s encouraging to hear that from you and I think it’s a sentiment that’s growing amongst the institutional sponsors out there that there is a decent base of capital that they can access and to provide those opportunities to investors that otherwise might not have those access points as the institutions, I think is a pretty big shift that we’re still in the early days of. And we’re certainly excited to see where it continues to grow and happy to have you guys as a part of it, and we’ve enjoyed the relationship.
Eric Malley – Likewise, same here. I mean you guys are obviously visionaries five years ago to really step into this playing field. But the one thing that I would also add is is that 70% of our investor base is from outside of the United States and they are also making investment decisions online, which is… These investors are pioneers in their markets, because it is just really not something that’s available to them in their own marketplace. So we’re seeing a lot of pioneering going on from where you guys were five years ago to where we are today. And so the evolution and train of thought of where the retail investor is and what they’re looking for. I’m excited to see where it is next year at this time and 24 months out and I was asked a week ago, during a different interview, where do I see things out 12 months from now. I think that there’s going to be a lot more investor confidence in investing online. I think that market segment is going to truly expand at a rapid rate that is going to make all of our heads spin. And I’ve just encouraged those investors to make choices and investments that they’ve thoroughly reviewed and vetted and made sure that it balances well with their individual investment objectives.
Adam Hooper – Perfect, I think that’s a good place to wrap it up. Eric, we appreciate your time coming on the podcast today. We’ll have your contact information in the show notes and investors out there, listeners if you have any questions send us a note to email@example.com. And with that, we’ll catch you the next one.
Tyler Stewart – Hey listeners, if you enjoyed this episode, be sure to enroll in our free six-week course on the Fundamentals of Commercial Real Estate Investing. Head to realcrowduniversity.com to enroll for free today. In RealCrowd University, real estate experts will teach you the important fundamentals like the start with risk approach, how to evaluate real estate sponsors, what to look for in the legal documents and much more. Head to realcrowduniversity.com to enroll for free today. Hope to see you there.
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