Would you invest in real estate in today’s market? There are people who tense up at this question, their thoughts focused on a looming housing crisis.
Investors know better. They know that portfolios are not built overnight. They have a strategic long-term plan in constant action, one that dictates what to do and how to do it when the markets turn. One man’s crisis is another’s opportunity.
Adam and I recently sat down with Paul Kaseburg of MG Properties Group to talk about how to create these opportunities. As Chief Investment Officer at MG, Paul’s been involved with the purchase of over 12,000 units totalling $1.7 billion in total consideration. He emphasized that it all came down to strategic planning.
Develop the Mindset of a Healthy Investor
Paul’s first piece of advice for investors is to stop chasing the one perfect deal and start developing a personal plan that fits your own tolerance for risk.
“Investors must first talk to their financial planner, their accountant, and their attorney to make sure they understand their own situation before going out to make investments,” Paul says.
Real estate must be seen as an allocation and not necessarily as a way to go in and pick the highest returning deal you can find. 7 years since the true recover of the 2008 financial crisis, short-term strategies have become a bad habit, where we got used to pumping money into the highest yield deals without any real appreciation for risk tolerance or risk capacity.
Instead, Paul wants us to consider the following questions:
- What does my current investment portfolio look like at the moment?
- What is my overall timeframe to invest?
- What is my need for liquidity during this timeframe?
The answers to these questions will help you decide which investments make sense and how much money you have to allocate. It becomes crystal clear where to put your focus, whether it’s core, core plus, value add, or opportunistic deals.
“Once you decide how much money you have, start breaking it up across different parts of the capital stack,” Paul says. “The more you can diversify your product type and location, the less concentrated you are in one area, minimizing your overall risk.”
Your Risk Profile Determines What Asset to Invest In
Once you know where you stand on risk and available capital, decisions become easier to make. Paul says that most institutional investors categorize deals into the following 4 risk profiles:
- Core plus
- Value Add
Core investments are the least risky of the bunch. They are well-located, newer buildings that attract high-quality tenants. “We’re talking major metro markets with very high household incomes ,” Paul says. “Generally the buildings have been built recently so you’re not risking major repairs.”
Because these buildings attract ultra high-quality tenants with great credit, you get consistent cash flow, but not so much appreciation. “Typically for core investments, we see lower leverage, in and around the 50% mark with yields hovering between 6-7%,” Paul notes.
“They tend to be low, long term return deals,” he adds. The risk with core are the interest rates. “When they go up, you can have an impairment to value, for sure.” Core deals check all the boxes—Good location, good product, good tenant.
Core Plus starts to erase one or two of those checks. “Perhaps a deal is in a great location, but maybe it’s 30 years old,” Paul says. This allows for the cap rates to increase slightly and as a result, you get slightly more leverage.
Paul typically sees Core Plus deals with “6-8% cash-on-cash return over a 10 year period, depending on how the debt shakes out, and IRR is in the 9-11% range,” he says. Core Plus deals are fairly stable opportunities, in stable markets, but are a little bit higher risk than a core deal.
In both core and core plus deals, investors can expect to go long-term. Deals can be held anywhere from 10-20 years. “If you have a deal with an expected low return, there’s no real incentive to get in and out to maximize IRR,” Paul says.
Value Add deals are where sponsors start to play a key role. “Value add, for the most part involves some heavy lifting from the operator. At MG, we deal with apartments, and that’s where we go in and renovate units, replace kitchen flooring or lighting, or tackle the common areas,” Paul says.
Beyond physical changes, the building may be mismanaged. These deals require an operator who has a solid vision for the outcome and the business plan to accomplish their goals. Because of the added risk, the returns are also better.
“We start to see the shift over in terms of composition of those returns from cash flow to appreciation,” Paul says. These deals also allow lenders to make decisions based on the investment plan of the sponsor, and not just past performance.
Opportunistic have great returns and great risk. “Development tends to fall in this category. So do unusual product types or use of real estate like a land entitlement play, ” Paul says. This is where GPs really add value.
It’s all about the vision of what can be created. “Maybe GPs are using their contacts with municipalities to get something approved or relying on their expertise in construction to build something unique.”
It’s really all about appreciation for the most part for those deals. But you can’t really lever as much either. Sometimes there are capital structures where you can go out and get hard money loans or unique lenders to really put a lot of debt.
They also tend to be shorter term, although there’s situations, for instance, land entitlement, that can take a long time. While these are rare, investors in the opportunistic deals are looking for IRR, so the goal is to get in and do whatever you’re going to do, and then get out.
Narrow down deals by product, sponsor, and location
When you first join a crowdfunding site or attend a local investment group, it’s easy to feel overwhelmed by the sheer amount of deals available. Besides knowing your risk tolerance (discussed in part 1), here are few other strategies you can use to build a well-rounded portfolio.
Build a portfolio by product type
The first decision to make is what kind of product you’re after. “Let’s say you have a $4M portfolio, and want 25% of that in real estate,” Paul says. “$1M in available capital can get you at least 10 deals at $100K each.”
“One way to look at it, is to select two multifamily deals, two office, two retail, two industrial, two self-storage, and disperse the remaining capital across various other options,” Paul says. This level of diversification limits your concentration risk, negating the pressure to select the one product that will beat all the rest.
In the private syndication space, spreading $1M is easy to do. Deals range from as low as $25K all the way to $100K or more. There’s no reason to limit yourself to one type of asset.
Choose a sponsor who shares your vision
Once you know what product you’re after, it gets easier to have conversations with prospective sponsors. Paul highlights that in the current market, investment profits depend more on strategic execution than market forces.
“At MG, it’s really been about the micro strategy in each market, and what’s happening with that specific property, as opposed to just a bet on a larger metro area,” Paul says. This is especially true for value add deals, where opportunities lie in the relationships sponsors have with other industry professionals.
Look for sponsors that view real estate as a long term asset. “That doesn’t mean that you can’t go in and create value. We’re value add players, we do physical improvements, we do operational improvements, but we’re also here to hold real estate for the long term and generate income and capital gain for our investors,” Paul says.
Rely on your sponsor’s expertise about a certain area
“Not one manager is going to be the best at office in core New York City locations and also suburban multifamily in Tulsa, Oklahoma, right?” Paul notes.
Those are generally not the same group. And so, if you’re diversifying, you’ll want to leverage the expertise of respective teams. This can be a relief for busy professionals who don’t have time to visit development sites, and it really is the whole point of investing through a syndication in the first place.
“Part of the fun about real estate is going out and seeing the buildings you are investing in, but ultimately, you are paying the sponsor to know the real estate better than you,” Paul says.
What is your staying power?
If you can avoid the need to sell when the markets are down, the risk of loss goes way down. “As you start to get later in the economic cycle, there’s more of a chance that there can be a downturn,” Paul says. At the moment, we are about 7 years into the true recovery of the biggest economic collapse of recent times.
Having a plan keeps you disciplined in the face of fear. It also prevents disasters. “If you’re over levered or if you have short term debt and the economy takes a dip, you could end up being forced to sell at a time when the market doesn’t have much liquidity or values are down, and that’s a situation we aim to avoid,” Paul says.
That’s why it’s so important to avoid short-term gains. That is a strategy that can end up getting you in trouble. “One of the ways we look at it is, in real estate, you want to really make sure you have staying power. Staying power means if the market is rough, you can ride it out and wait for a better day,” Paul says.
How to find deals that survive a downturn
The trick is to find sponsors who make it their strategy to find investments that are robust in downturns. “We’re seven to 10 year holders for the most part. Our assumption is there’s going to be a downturn at some point in those 10 years, whether it’s year two or year seven, it’s probably going to happen,” Paul says.
With the disposition volume down, there’s a lot of competition for new deals among sponsors. Sponsors are having to rely on their reputation to close on deals. “There’s a lot of preparation to get those deals awarded, and you need a solid reputation to get them. Then, you really have to follow-through on your plan,” Paul says.
Make it your goal to find sponsors who have a track record of experience. While surfacing their respective websites is a great start, nothing beats a personal conversation where you can ask your most pressing questions.
Investing in real estate is a long-term game. Unlike the stock market, big capital is used to secure, improve, and dispose of high-value assets. This takes time and meticulous planning to be execute well.
Taking the time to develop a plan narrows your focus and allows you to perform the necessary due diligence on individual deals. That’s when you can start interacting with sponsors and professional advisors to mitigate your risk further.
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Tyler Stewart is VP of Investor Relations at RealCrowd. All opinions expressed by Tyler and interviewees are solely their own opinions and do not reflect the opinion of RealCrowd. This article is for informational purposes only and should not be relied upon as a basis for investment decisions.