An in-depth look at office and industrial properties with Danny Mulcahy of Northstar Commercial Partners on The RealCrowd Podcast - The Fundamentals of Commercial Real Estate Investing.
Danny Mulcahy serves as the Director of Equity for Northstar. In this capacity, he is responsible for leading all equity offerings, investor relations, and helping to guide the evolution of the firm’s capital raising and investor relations infrastructure.
Danny brings more than 20 years of experience in leadership and management experience to Northstar. Most recently he was a managing director with Tripoint Global Equities and ZacksInvest, both being boutique investment banks focused on providing early and mid-stage companies with advice and guidance in corporate finance, corporate structure, corporate governance, mergers and acquisitions. Prior to Danny’s roles in investment banking, he was an advisor for Merrill Lynch and Managing Partner of DM Hollo, a commercial real estate asset management and development firm. He has been the broker of record for more than $1 Billion in commercial real estate transactions, assisted with the development, sales, and leasing of more than 1 Million SF of industrial properties along with acquiring and divesting more than 1000 acres of land throughout the southwest United States.
Adam Hooper - Hey Tyler.
Tyler Stewart - Hey Adam, how are you today?
Adam Hooper - Great, and welcome, listeners, to another episode of the RealCrowd Podcast. Tyler, who do we have on tap today?
Tyler Stewart - Adam, today we have Danny Mulcahy, Director of Equity from Northstar Commercial Partners.
Adam Hooper - Yeah, Danny's really deep background industry, been in it since early 2000s, been through a market cycle, seen some things.
Tyler Stewart - He has seen some things and he gave us a general broad take on his view of both office and industrial properties.
Adam Hooper - We talked about a lot of good stuff today, basic diligence items, some underwriting issues. You know, Northstar, they have a pretty unique approach to how they build community and embrace some of those intangibles around property ownership beyond just numbers.
Tyler Stewart - It's the whole big picture, it's not just the property in the community, it's how can this property help grow the community around it.
Adam Hooper - Good episode today, we even got Danny to forecast a little bit for us.
Tyler Stewart - We did.
Adam Hooper - Do we give a little insight or shall we wait for this episode?
Tyler Stewart - I think we got to listen, see what he says. As always, if you have any questions, comments, concerns, or feedback, please do send us an email to firstname.lastname@example.org and we'd love if you could head to iTunes, SoundCloud, Google Play, wherever you end up listening to this and give us a rating, we'd really appreciate it. 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 at iTunes, Google Music, or SoundCloud. RealCrowd, invest smarter.
Adam Hooper - All right, well, Danny, thanks for joining us today, excited to have you on the podcast and talk about all things office, industrial, jobs, and everything else we come up with.
Danny Mulcahy - Well, thank you for having me and I appreciate the opportunity.
Adam Hooper - Good, we were talking a little bit before here, in Denver, you brought up the Amazon expansion thing, looking at a few cities, sounds like you said January is going to be the announce date potentially?
Danny Mulcahy - As far as I understand, January is their target date to select a city.
Adam Hooper - Yeah, we were talking, our last episode, we had Adam Fountain on, he's out of Seattle, we didn't get any great insights from him in terms of early indications, you have any inside dirt on where they're looking?
Danny Mulcahy - No, they've kept this very close to their chests. I even know people at Amazon and nobody has a clue.
Adam Hooper - Yeah, so what would your take be, good, bad, indifferent, if Denver was the one?
Danny Mulcahy - I think it's great for Denver, I think it'd be great for Amazon. I mean, this is a young city, vibrant city, has a lot of youth and millennials, has a great education base and health base, I think it fits perfectly with the culture that Amazon is trying to promote.
Adam Hooper - Denver's seen a tremendous amount of growth, it's been a pretty hot market last five, six years. I was out there, gosh, a couple years ago, I think it was a ULI event, and just tremendous changes that are going on there, a lot of really good activity, good absorption, new developments, housing, seems to be somewhat affordable compared to some of the other cities they're looking at, but still a bit tight there. Why is Denver doing so great right now?
Danny Mulcahy - I came to Denver probably 10 years ago. I'd lived in Denver earlier than that, but I started looking at Denver, and I've lived a lot of places in the country, and it provides a really high quality of life. 300-plus days of sunshine a year, good public transportation, plenty of outdoor activity, good school system. The populace itself is healthy compared to other states, had the infrastructure. All things combined, the emptying of the Rust Belt over the last 20 years has pushed a lot of youth and people out of that part of the country, taxes and overcrowding on the coasts, and prices for that matter have also drove me here. To a certain extent the last five years, a lot of that growth was initially spurred by changing in some of the marijuana laws, but that's much less to an extent now with all the other states adopting similar laws. But we've had an explosion in financial services, an explosion in tech, we were always a big energy producer, in nat gas and with the advent of fracking, that certainly added to it. There's a lot of good reasons to live in Denver.
Adam Hooper - Yeah, so just, the legalization, I know that's had a huge impact in the industrial space, and that was one of the things that was talked about, again, last time I was out there for that conference, was how that is impacting the absorption and availability of what was traditionally kind of bulk industrial space. You guys are obviously very involved in the industrial world as well, what have you guys seen from that industry's impact on traditional use of industrial space and rental rates and just availability?
Danny Mulcahy - The Denver market, the Denver metro area is, I want to say, less than 5% vacant in the industrial space. A healthy industrial market in first- or second-tier cities is probably considered between 7% and 9% vacancy. The marijuana users really took out sort of the bottom rung of property, sort of the lower-end industrial space, which certainly put pressure on everything else. We just started a project in Broomfield, actually, I'll take a step back. Along with some of the anti-growth measures that communities in, say, Boulder have, have also pushed cramped supply. We're doing a project outside of Boulder in Broomfield, and Broomfield and the two surrounding sub-markets are less than 2% vacancy on industrial space. But not only that, it's not only the marijuana users, but to a certain extent retail's pain has been industrial's gain. I didn't mean for that to rhyme. But because the brick and mortar footprint of retail has been diminishing and industrial has picked up that slack.
Adam Hooper - If they're absorbing the lesser-tier space, that pushes everything up-market, that increases rental rates across the board, tightening for existing space, so it's interesting, that's been a comment not just in Denver but other areas as well have seen a pretty big impact from that industry. That just wasn't a thing before, right, that wasn't a use that was even thought about before, and now it's a pretty big shift of how that landscape looks.
Danny Mulcahy - It absolutely is. And you know with industrial, drive times become very important for those users with not only service and delivery expectations of their clients but also from a gas and energy usage, the centrally located industrial even has more pressure on it.
Adam Hooper - I'm sure we could talk a lot about that, but let's take a step back here and talk a little bit about your background and how you first got into real estate. What have you done in the last 10, 12, 15 years, how did you get into that space, what brought you to it and what's getting you excited about where we're at now and where things are going?
Danny Mulcahy - Well, thank you for asking. I've been doing commercial real estate now since 2000, so almost 18 years, and I started for an industrial developer in Las Vegas, and ultimately built about a million square feet of industrial in various forms from mid-bay distribution space, small buildings with yard, and everything in between. In total, I've brokered more than $1 billion in transactions and sold, leased and bought well over 100 buildings at this point in my career. I've done everything from retail, office, apartments, billboards, cell towers--
Adam Hooper - We haven't done any episodes on billboards or cell towers yet, that might be another one we can, we can explore.
Danny Mulcahy - Yeah, billboards, car washes, mini-storage and cell towers are great little investments that just churn out cash--
Adam Hooper - Just cash cows, right?
Danny Mulcahy - And very low maintenance to them.
Adam Hooper - Long background, seen all sides of the business, now with Northstar, Denver area, I think you said you have about 7.5 million square feet total office, industrial, you guys have a pretty broad footprint right now so you're looking at a lot of different markets around, correct?
Danny Mulcahy - We have assets in 15 states, essentially coast to coast, in the whole range of product types, from multi-family, retail, office, senior living, and industrial, and a smattering of other things such as charter schools and daycares. We have a presence in quite a few places. We typically stay away from the first-tier markets, the gateway markets such as New York, Miami, San Francisco. There's just a lot of competition in those markets from equity that's not wholly focused on return but more looking for just a safe haven.
Adam Hooper - Listeners to the podcast out there know a lot of what we do around these episodes is education on how to look at different asset classes or some different ways to look at due diligence. You've written some articles historically on due diligence, whether that's in the traditional private equity on the company side, but also real estate. How did you get into that, what was your training and diligence processes, or was that just from hard knocks of going through it all and experience?
Danny Mulcahy - Well, a lot of it, certainly the most valuable part of my experience and education came from the hard knocks and on-the-job training, but it's been a lifetime of learning in the various areas. I am a licensed, it's inactive currently, but I am a licensed investment banker also, and financial advisor, along with taking other formal education in real estate finance and other finance for that matter.
Adam Hooper - A lot of investors that listen to the podcast have experience either starting their own companies or investing in companies, whether it's venture or private equity, maybe not as much experience in underwriting real estate. Why don't we start with, what are some differences when you're looking at investment metrics or analysis of a public or private company, verses some of those similarities or differences that you're going to see when you're looking at real estate as an asset class?
Danny Mulcahy - Yeah, that's a good question. From my perspective, underwriting real estate... is a lot more simple, to be honest. Most of the variables, when you're looking at a real estate investment are easily defined. Your risk factors are easily defined. When you're looking at a private company, especially early and mid-stage growth companies, there's a lot of variables that you just cannot account for, from increased competition to management team to market adoption, availability of financing. There's uncertainty in intellectual property, research and development. There's a lot of cash spend that ultimately goes nowhere in early and mid-stage growth companies. From 2012 to 2016, I spent the majority of that time in investment banking for early and mid-stage growth companies, helping them secure growth capital, and I met a lot of fabulous teams, certainly way smarter than me, with great ideas, good intellectual property, but they were always essentially 50-50 guesses.
Adam Hooper - Right, it's hard, right?
Danny Mulcahy - It is.
Adam Hooper - Speaking as the CEO of one of those companies right now, there's a lot of stuff that can go wrong.
Danny Mulcahy - There is.
Adam Hooper - Yeah, coming from a real estate underwriting background myself, I would tend to agree with you. There's a lot of kind of rational assumptions that you can go look at when you're trying to underwrite a real estate asset, right? You know what historic market trends are, you know what rent growth trends are, you know what vacancy and absorption is, you know what you're paying on an acquisition basis compared to replacement costs. There's a lot of fairly standard rational metrics that you can look at that just flat out don't exist in the private company world.
Danny Mulcahy - That's absolutely right. I mean, your biggest risk in real estate really comes down to your assumptions on your absorption and your lease rates. To a next extent would be your construction costs. But a lot of those things, you are making educated guess, as opposed to, if you're developing a stem cell therapy, the guy in the garage next door to you could be developing something that leapfrogs your technology and you're not even aware that it was an idea.
Adam Hooper - And so as a non real estate expert listener of this podcast, how can they either gain access to that information or are there resources out there that you'd maybe recommend, is it trust in the sponsor, you know, how can a non real estate expert that's looking at some of these different investments, how can they start that process, what are maybe some ideas around that?
Danny Mulcahy - Well, fortunately, there's a lot of information available in the market, from everything from market demand reports, it's all freely available, typically distributed by the big real estate shops like CBRE, JLL, Colliers, etc. You can figure out, just do a simple Google search, you can look at the most recent industrial vacancy report, you can look at, in any market, certainly any first-tier market, but pretty much any market in the country, you can get data on it. You know, traffic counts and patterns, etc, whether it's available through commercial real estate firms, research firms, or for the city and state counties, all that information is readily available. It's not hard to research that, and then ultimately you can always hop in your car and go kick the dirt yourself, you can visit the site and make your own instinctual assessment of that opportunity.
Adam Hooper - We do have listeners who will go visit a property just to check it out, to check out the market. What are top three things you would look for when you're looking at a property as an investor who can't necessarily get a tour, but what would you look for in that market?
Danny Mulcahy - "Location, location, location," right, the cardinal rule of real estate. Fortunately we all live in houses, we all work at businesses, we typically all drive cars, so we do have some ingrained knowledge to be able to assess something. You're looking at traffic patterns, you're looking at conditions of the roads, you're looking at growth areas, the property itself, is the property well-maintained, is it well-located, what are the surrounding areas like it, will the surrounding areas encumber the property in the future, the uses of that property in the future, i.e. if you're building an industrial building, is there residential going up across the street which could later restrict the uses that, say you have loud noises, pungent odors and other things that residential people would fight against. And ultimately residential occupants are voters. They'll typically get their way sooner or later.
Adam Hooper - Now Danny, you said you guys are in 15 different states, you're looking at the markets that you're currently in, to acquire new assets, you're looking at new markets to expand into. What do you guys identify as a good market or a market that would warrant interest in either expanding into with your existing assets or looking as a new market to get into from your first purchase?
Danny Mulcahy - Well, we like to consider ourselves opportunity focused, as opposed to just purely being asset class or geographically focused, we try to focus on opportunities. There's good and bad deals pretty much in every market that you go to. Certainly going to markets that we enjoy being in ranks high up in there. If we're going to spend time managing an asset, we don't want it to be in an environment that we don't want to spend time in.
Adam Hooper - The gut check factor.
Danny Mulcahy - Yeah, and just the quality of life factor. And it runs to a pride of ownership. You can make money in a lot of ways in real estate, from low-income housing to a dirt parking lot that you lease out to trailers. You have to assess what your own preferences are and make your decisions accordingly. But when we go to a market, obviously we're looking for the growth of the market, the stability of the market, the business climate of the market, from a tax perspective and a regulatory perspective.
Adam Hooper - And so with those similar factors, again you said you're more opportunity focused, where you're looking at similar factors, if you're looking at an office deal or industrial deal or a development deal, are those different factors that you guys will weight or look at differently?
Danny Mulcahy - To a certain extent they're the same. There's going to be some markets that are better for industrial and some markets that are better for office and retail. It's all the same things, we want there to be a consistent regulatory environment, we want there to be consistent growth, and we want there to be, from a tax perspective, consistency in the taxes. The market analysis from the top level, 30,000 foot, are very similar regardless of the product type that you're looking at.
Adam Hooper - And then you mentioned before, having a centrally located industrial facility is more beneficial than something that's way out, just in terms of freight and gas and energy, transportation costs. Office, suburban versus core, how are you guys seeing that? You see much of a difference? There's obviously a big shift away from the suburban office model into more urban core, creative, adaptive reuse projects. Where are you seeing that dynamic now? Are you seeing some movement back out to suburban, or are you seeing more consolidation into core?
Danny Mulcahy - No, I still think the core consolidation is going to continue, the urban core is going to continue to trend that way. With the advent of the location-neutral workforce, the suburban office, you had to be very very particular about your suburban office. We are currently doing a couple things where we're completely reprogramming what was suburban office that performed well for years and years and now you couldn't lease it at all on an office perspective. We're converting buildings to self-storage. That trend is not going to dissipate any time soon. There's just not the need.
Adam Hooper - And do you think that's a demographic-driven trend, is it a transportation-driven trend? Why is that?
Danny Mulcahy - It's a technology-driven change. A lot of the people who were in suburban office in the past, you know, your architect, your lawyer, these more service-providing organizations, they can do everything from their home at this point. They don't need to drive down the street a half a mile now to do it. You don't need to have the face time that we once needed with all of our clients. The computer has taken that away. Now your office space, I mean, you've seen the advent of WeWork and Regus, the shared, Executive office has been around forever, and executive office was big in the suburban area. Sorry, that distracted me--
Adam Hooper - That's fine, yes, the executive suites being--
Danny Mulcahy - Yeah, executive suites's been around forever, they were big in the suburban office space, and now what we're seeing is the suburban office is going away, there's migration to the core, and then within the core we're finding more and more of these shared office locations that are providing more of a community for those users, it's more office on-demand as opposed to what we used to do.
Adam Hooper - Traditional sense, and even just within the use, you said you're converting some of your suburban office to self-storage, just the floorplates and the build-out and the use within traditional office space has changed dramatically. Again, a lot of that was driven by technology, open office, not even necessarily cubicles, but just kind of cooperative workspaces, that's a huge change, right, that dramatically, as an owner of a building, dramatically changes what your costs are to operate that, to rehab it, to put a new tenant build-out. How have you seen that dynamic shift, how you might have looked at a tenant retrofit or build-out five, six years ago?
Danny Mulcahy - If you were looking at, well, staying on the shared office space concept, instead of having the four walls and the separate bathrooms and the like, you are saving a lot of money. And what I like, I think, the best about the shared office space is their ability to adjust rents almost in real time. People sign more of a membership agreement as opposed to a lease agreement, and those membership agreements could be one month or three months, or for that matter a year, but it gives the landlord a lot more flexibility to adjust their rents according to demand, and they can do it more frequently. I really like the shared office business model.
Adam Hooper - And how has that changed underwriting going in? That's a very different, again we talked about a little bit ago the ability to kind of make these rational assumptions of office and these different rent trends and absorptions, vacancies. If you're going from, historically, looking at a three-to-five-year lease for an office space to this now shared... We had an episode a couple episodes ago about this fracking concept, being able to split it up and have a more real-time adjustment of some of these rental rates and lease agreements. How does that change how you look at building a model or some of these assumptions, or does it?
Danny Mulcahy - Well, I don't know if it changes a lot of the underwriting look at it. You're still going to make your assumptions on an annualized basis. We don't do shared office at this point, so we haven't really dug too far into operating a property like this ourselves. If we were going to operate it... And I don't actually even know how to answer that question.
Adam Hooper - It's just very different business, right, to operate that?
Danny Mulcahy - Yeah, it is. As a landlord, who owns the whole building, who puts a shared office operator into it, I'm going to get a master lease from them, and then their dynamics of how they manage it will be their concern. I'm probably not the best person to answer that question there.
Adam Hooper - Building off of that community type environment, Northstar very involved in job creation, job growth, and community support around where you guys do own assets. How do you see that, as one of those intangibles, playing into performance or the health of the area that you guys are going into? I know that's a big key point for you guys in how you approach investing.
Danny Mulcahy - It is. We were just talking about the other day in one of our all-hands meetings. We had a construction camera on site and trying to relay to the rest of the staff the good that they are doing for the community, when you see 200 construction workers and realizing that you're responsible for creating all those jobs, and then the exponential effect of that, the sandwich shop down the street and the Uber and Lyft riders giving those workers rides, it has an exponential and multiplying factor every time we do a project. Additionally, on a couple of occasions now, we have bought a really distressed and vacant asset, and while we are figuring out what we want to do with the property and marketing the property, we've essentially created incubator spaces and provided the space to non-profits to operate as an incubator to a certain extent. And so we give back to the community that way, which is also creating jobs and lifting people's lives up. And so it comes back to pride of ownership of things. We're all professionals here, we've been doing this a long time. Just as I mentioned wanting to spend our time in locations that we want to spend our time in, the same thing goes for the real estate that we go for. It's nice to know that we're creating jobs, it's nice to know that we're removing blight from a community, tearing down an old building and putting up a new building, or fixing a building that's been sitting there vacant and looking like an eyesore, improving the quality of life aspect also. Those are the intangibles, but they are important to us.
Danny Mulcahy - Because we can make money in real estate a whole lot of ways, so we choose to do it where we think we're also helping the community, whether it's through jobs or better quality of life, etc. It is an intangible that we enjoy thinking about.
Adam Hooper - That's great. How do you go about finding those communities?
Danny Mulcahy - Well, a lot of times the communities even approach us. Because we've been doing this for 17 years and we are heavily involved in philanthropic efforts in every different direction, a lot of times those opportunities are being presented to us by either the non-profits or by the city and counties themselves. The project we mentioned in Broomfield, we had bought a vacant building and leased it out, or essentially gave it out to a non-profit for a couple of years while we were coming up with a plan for it, and it was so well-received by the community that the county actually approached us on another piece of property that says, "Hey, this is essentially the only blighted property we have in our community, would you like to do something with it? We like you guys," and ultimately they partnered with us and gave us tax increment financing and the like to help improve the community.
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Tyler Stewart - That's great, and then to bring it back to our listeners and the investors out there, so when you're looking at a market, it's "location, location, location," it's "is this a community I want to live in," you're looking at the growth of the market. Now as an investor, once you've identified those things and you're looking for sponsors, what are the kind of things you would look for in a sponsor of industrial or office?
Danny Mulcahy - Good question, and it might be a cliche, but people do business with those they like and trust. And so as with most things in life, you're backing the jockey more so than the horse.
Adam Hooper - You must have listened to our prior podcast episodes, Danny.
Danny Mulcahy - I have, but that's sort of the methodology that we approach in finding our investors and our JV partners also. There's a lot of opportunities out there, but do you really want to be talking with that person every day, do you trust that person will behave ethically and morally and honestly with you during the course of it, not just in business but in their own personal lives, also. Danny, personally, I focus on only doing business with the people that I believe I can trust and I enjoy talking with and being around. Even though a lot of our investors are very detached, they could be all over the country, the assets could be in completely a separate state, we still try to develop a personal relationship. Even through, you know, we've had great success working with you guys at RealCrowd. You guys have done a fabulous job and I'm really impressed not only with your guys' performance but the investors that have found us on your website. But we still try to build a personal relationship with each one of them, even though it was all done electronically. There's very few investors that I don't reach out to personally and want them to know who I am and I want to know who they are.
Adam Hooper - The relationship is something, since we started the company, is very central to how we're structured. Real estate, as much as we want to bring efficiency and augment it with this technology platform, real estate's still very much a relationship business, as you just alluded to, and that's something we feel is definitely important, to have that direct relationship between manager and investor. I want to kind of dig in a little bit, couple things on the trust issue, that's key, right, that is huge. If you can't trust the person that you're giving your money to, then you're probably not going to do it. As an investor out there, you're presented with five, 10, 15 different opportunities, what are some of the ways that, either as a manager yourself or looking as an investor, how can you start to build some of that trust? What are some of those questions that you should ask, or what does that process look like, to get that feel of where, "Yeah, okay, these guys are what they say they are, their track record is legitimate and I can trust these guys and I'm ready to make a commitment."
Danny Mulcahy - Right, well, of course it starts with, you know, typically it'll obviously start with more of an online research, but working with somebody who has a track record is integral. Certainly if you don't know that sponsor. Not saying that you can't back somebody that you know is starting a new venture, but expect that you are taking additional risk by doing that. Once you've spoken to them, you've asked them candid questions, you've looked at their track record, you do your own online research, see if you find anything that could cause a red flag, such as bankruptcy, pending litigation, securities fraud, a lot of key words that you can look at. Checking references, if somebody can't produce to you a comprehensive track record forthwith, and they're looking for new investors, that's a potential red flag. If they can't produce current business references, from their vendors, or they can't produce good investor references, that's certainly a red flag. That's where I start, is all those things sort of simultaneously.
Adam Hooper - And so what would be, again, in your interactions with investors, not to put you on the spot here and make you come up with a game-time decision here, but what would be some of those questions that people don't often enough ask, that you wish they would, or things that you have to proactively solicit, kind of engage with them for questions they should be asking that they're maybe not asking or don't have the awareness to ask, what would some of those be?
Danny Mulcahy - I think right off the bat is, "Have you ever declared bankruptcy? Have you ever lost any assets? Have you lost any of your investors' money? What was the ultimate responsibility of the investors? How were the investors treated? What would you do differently?" Put that sponsor on the spot. If they say they've never lost money before, if they've been doing it for any period of time, chances are they have lost money. Not saying that everybody's lost money, but most businesspeople have lost money, whether it's entrepreneurs in business or in real estate. Somewhere along the way, something's happened to cause them to have lost money.
Adam Hooper - To dig in that little bit more, someone that's been operating from early 2000s until now, having been through what was a pretty significant market event, 2008-09, how do you look at someone that maybe has been in the business, maybe they were an executive at an operating company before and maybe they started their own company in 2010, '11, '12. We've had a really really good cycle, it was a really great market the last five, six years. It's been hard to lose money, quite frankly, in these last few years. How do you either handicap that, or how do you look at that differently than someone who maybe has been through a market cycle, like what we saw in '08 to '10.
Danny Mulcahy - If you can find someone who was in operation prior to 2005 that didn't declare bankruptcy, kept the same business name today, that's certainly a--
Adam Hooper - That's a good sign.
Danny Mulcahy - That's a great sign. A lot of guys, if you bring up their names in Google or what have you, you'll see that they operated under a different business name prior to 2009. Now they're doing it under another flag. Ask them about their experience in there, where were their pain points and how did they handle it and what are they doing differently today, if anything. Ask them for a specific example, don't gloss over things and just take sort of top-line answers. With us, we lost I think five assets during the collapse, and I have a perfectly good explanation for each one of them.
Adam Hooper - Unpacking that a little bit further, as an investor, bad deals in bad markets, or a good deal can encounter a bad market with a great sponsor, right, and I think it really comes to what did they do as a steward of that investor capital, how did they try to work that out, did they pony up any of their own additional capital to try to solve it, did they go to bat for those investors and really try to protect their interests, or did they just give up, throw the keys away, and "Well, we'll get the next one." Those character things are oftentimes what can make such a huge difference in a down cycle, and that's when the sponsor's going to really earn their money, how are they going to perform in a down cycle for those investors, that's a pretty big part of the equation that again, we haven't really seen a lot of in the last handful of years. That's something we, again, as real estate people, we value that, right, and want to know those stories around, if there was a challenge, how did that sponsor fight for their investors? Right, I mean that's a really big thing.
Danny Mulcahy - Absolutely, and I know a dozen different sponsors, probably, who their investors did lose pretty much everything and the sponsors sort of made it through unscathed, which goes back to the underwriting of a sponsor and a deal, is how much equity does that sponsor have in the deal himself? Are the interests aligned? How is the sponsor making money? If they're charging 3% and 5% on the front end in acquisition fees and asset management fees, how much money of their own equity are they putting in? If I say I'm contributing 3% of the equity into a deal, but I got a 3% commission on the acquisition, well, I'm really in there playing for free--
Adam Hooper - Yeah, net skin is not that much, yeah.
Tyler Stewart - What's the balance to that? Do you want a sponsor to be over-allocated in one asset or would you prefer them to be diversified through multiple assets? What's the balance look like to make sure the sponsor's protecting their own balance sheet as well?
Danny Mulcahy - With us, we have 40-something assets, so obviously we can only put so much money in each deal that we go into, but ideally we always are net positive from any of the up-front fees that we might have collected. It's not always the case, and typically when it's not the case it's because we've just over-subscribed on the deal, but we always have our own equity in it, one way or the other. Our acquisition fees really cover a lot of the overhead that we've spent on, you know, the 10 deals that we didn't move forward on. It's sort of a recapture of our operational cost.
Adam Hooper - Yeah, that's one of the things we've talked about in prior episodes, right, is that mix of fees to keep operations going, to keep the lights on, it either has to be some amount of fee revenue for managers to operate their business, plus that right mix of performance-based fees to keep them incented, plus their capital in the game to keep them motivated to do that. It is definitely an interesting dynamic between, not saying there's a right, wrong, or otherwise, that's always something kind of a deal by deal, sponsor by sponsor basis, how those fees are broken down between ongoing operational and performance-based on the back end.
Danny Mulcahy - Right, in our case, the CEO doesn't take a salary, per se. he up-front fees are what keeps his office space open and guys like me and the support staff and the analyst and everybody else employed, and his real motivation and his livelihood is largely dependent on the performance of the investments he decides to pursue, and having those investments perform according to the pro forma that he produced for investors. And we offer a 10% preferred return and a return of all equity before we have any of our split, so if we're not conservative and prudent in our underwriting, his livelihood is affected and his quality of life.
Adam Hooper - Sure, and that's an interesting, the conservative underwriting versus aggressive. As an investor that's looking at different opportunities from different sponsors, different markets, etc, how can they get an idea for whether someone's underwriting it more conservatively or more aggressively?
Danny Mulcahy - Well, first off you look at the term, all the terms, I should say, what the duration of the investment, the pro forma considers, what the lease-up schedule is going to be in most instances, the lease rates in most instances, and then the selling cap rate that you're assuming. Those are some of the top-line things to understand whether it's being aggressive or not. As an example, one of the assets we've worked with you guys on, in Phoenix, Arizona, we were buying it at a seven cap, and if you look at our pro forma, we looked at it at a 7.7 or 7.5 sales cap. We didn't go into it saying, "Oh, hey, we're going to come here at a seven and sell it at a five." Now we're selling it at a higher cap rate, but ideally that's off of a much higher NOI, so the gain to the investors is still substantial, and if we can sell it off at a seven cap again, well then it's going to be wonderful for everybody. But we didn't go into it over-promising--
Adam Hooper - Relying on that for your assumptions to hit those targets.
Danny Mulcahy - Right, and then looking at the lease-up frame. We're not saying, "Hey, we're going to have all this vacancy taken down in 90 days, six months after we're acquiring it." We're going to say, "Okay, we're going to do a staggered, we're going to take down 10% in this quarter and 10% the next quarter." Even though in our minds we certainly expect to do much better than that, it doesn't do us any good, and certainly doesn't do Brian Watson, the CEO, any good to try to fool ourselves with our pro forma. Because again, his livelihood and quality of life is dependent on this performing at or above what our projections are.
Adam Hooper - As we're kind of nearing the end of the episode here, let's switch gears a little bit and we'll have you put your forecasting hat on. Talking about all these market cycles, we're getting pretty deep into this one. Have you guys seen any indicators out there in terms of how we're going to be looking next couple years? What are your thoughts on where we're at in the cycle? Obviously you guys are covering a pretty big geography, right, multiple states and asset classes. Maybe let's start macro, where are we at, how are things looking for you guys as you forecast where the industry and your business is going?
Danny Mulcahy - Everything is pretty positive right now. We've had a sustained period globally of relative stability. It might be inverse thinking but with the current regulatory and political environment that we've had recently, the fact that we haven't fallen off the cliff already is almost a support for, if it didn't crash now, then it can't get much worse. We've got the Fed unwinding their purchases, it's going to be flattening the yield curve out quite a ways. Certain markets are overheated, there's been a lot of foreign money coming into the gateway markets and coming into core assets in multi-family in particular. I don't see really any, per se, correction where it would cause a lot of downward pressure, but I can certainly see a flattening, just as a result of incomes aren't rising accordingly, and so ultimately there has to be a flattening of it. There's only two catalysts that I can see right now for a lot of downward pressure systematically, which would be from an impeachment standpoint or a North Korea standpoint. And then there's always the other acts of God, you know, Yellowstone blowing up.
Adam Hooper - Fingers crossed we don't get the super caldera explosion anytime soon, I don't think that would be good for anybody.
Danny Mulcahy - No, that won't be good for anybody. I feel pretty confident, the system is stronger. I don't think it's perfect. I think, one thing that is still in people's minds is the financial crisis that we went through, and that's made a lot of people more conservative in everything, I think people are sitting on more cash, I mean, Berkshire Hathaway's sitting on $109 billion right now. Dodd-Frank, even though there's been some recent changes into that, it still puts us in a better position than we were. The financial crisis was a result of all three legs of the stool collapsing at the same time, bonds, real estate, and equities. I don't see that happening any time soon. Technology, it's advancing rapidly, it's creating new jobs and making things more efficient. Globally the middle class is rising and demand for products is growing on a global basis. All those things I think support further growth. With that said, I'd look at the equities markets and the main thing I learned from the financial crisis was to trust my gut. My knowledge tells me the metrics still seem to play out in the equities market, but my gut's telling me that something's wrong. I don't know what to do about that. Real estate-wise though, I think we're all, except for those two, the core assets and gateway markets, senior living in certain markets, multi-family in numerous markets, those are definitely going to be flattening. They have to be. I can't tell you exactly when or why,
Danny Mulcahy - but we can look at here in Denver, we can see in Denver on the multi-family, incomes can't support further growth of rates, and we have increased supply coming down the market. There is going to be a flattening here of multi-family.
Adam Hooper - We've seen, certain markets have already started to see some kind of correction, at least in terms of the rental rates. And then, some of the things you mentioned, there's so much competition with capital available out there for these, it's getting harder to find, it seems, at least from the sponsors we're working with regularly, it's getting harder and harder to find those deals that we've been accustomed to for the last handful of years. Some tightening of pricing, some reduction in yields, but still overall, I think it seems, general sentiment that it's a fairly healthy outlook.
Danny Mulcahy - Yeah, especially the uninitiated, the interest rates have scared some people, hearing about the Fed, but I don't see longterm rates doing anything dramatic anytime soon. Inflation's not there, corporations are sitting on hoards of cash, I think the market looks really good for real estate. You still have to be particular about what you're going after, but overall, I'm net positive on the market right now.
Adam Hooper - Good. Well, I think that's a pretty good summary, pretty good spot for us to-- Anything else that you want to touch on that we didn't get to, or anything else you want to discuss with listeners out there, real quick?
Danny Mulcahy - I think RealCrowd has done a fabulous job, I like their due diligence process and their attentiveness to the sponsors and their vetting of the sponsors. I created a platform similarly for a large company so I've been in this space for a long time, and I was really impressed with you and why I chose to work with you guys.
Adam Hooper - Great. We appreciate that, thank you. We didn't even have to plug you for that one, Danny, that was, we appreciate that.
Danny Mulcahy - No, the only reason I agreed to do this podcast was that I do feel comfortable with you guys and I think investors, to a certain extent, can certainly feel comfortable with you guys and the process that you guys go through to put sponsors and projects onto your site, but at the same time I'm telling them ideally to dig a little bit deeper on those sponsors because there is the detachment.
Adam Hooper - That echoes a lot of what we've talked about on here, and you said earlier as well, so much of it is the manager and the sponsor that you're choosing to trust, so thank you for the kind words and I think that's a pretty good spot to wrap it up.
Tyler Stewart - Yeah, thanks for coming on, Danny.
Adam Hooper - Great, Danny, well, appreciate your time again today. Listeners to the podcast out there, as always, if you have any questions, comments, please send us an email to email@example.com. And we'd love if you could go to iTunes, Google Play, SoundCloud, anything else out there you're listening on and give us a rating, we'd really appreciate it.
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