In today’s Syndication School episode, Theo Hicks is going to go back to cover some of his favorite presentations at the best ever conference 2020. We’ll be talking about Jillian Helman of Realty Mogul. Realty Mogul has purchased over $2.8 billion in real estate. Jillian provided tips on things you learned managing a large portfolio during COVID.
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Theo Hicks: Hi, Best Ever listeners. Welcome back to another episode of the Syndication School series, where we focus on the how-tos of apartment syndication. As always, I’m your host Theo Hicks. Today, we’re going to go back to cover some of my favorite presentations at the Best Ever conference 2020. A few weeks ago we covered one speaker, today we’re going to cover the second speaker. Today we’ll be talking about Jilliene Helman of RealtyMogul. RealtyMogul has purchased over 2.8 billion dollars in real estate. Not sure if that’s how much they have under management currently or total, but regardless, a massive portfolio.
During her presentation, she provided tips on things she learned managing such a large portfolio during COVID. These lessons really apply to any economic recession, most of them apply to any economic recession. The examples, obviously, are pretty COVID specific. But the theme you’ll notice from a lot of these tips is that about half of this stuff is done before an economic recession even happens.
That’s kind of a theme that I’ve learned from interviewing hundreds of people on this show, is that the people who are successful, or at the very least maintain their business during economic recessions, are the people – which kind of brings us into lesson number one from Jilliene – play the defense before the economic crisis even occurred, rather than once it actually occurred. Making the proper preparations before an economic crisis occurs is really the most important takeaway that she had and I’ve personally gotten as well from, as I mentioned, interviewing people on this show.
The single most important defensive tactic thing you can do to prepare is to make sure that you’re underwriting conservative. So again, this lesson is play defense before an economic crisis, not during. So you don’t want to only be conservative during economic crises, or during recessions. You don’t want to be conservative when you’re looking to buy deals when the market is not doing very well; you want to always be conservative. If you find a deal, no matter what time of the market cycle we’re in, and it doesn’t meet your investment criteria, don’t adjust the numbers to make your work. It seems simple, but it’s not that easy to follow in practice. For example, don’t make aggressive revenue growth assumptions based on historical trends, like five-year average rent growth, or the five-year projected rent growth… Because some of these markets were growing 5% to 10% in rent every single year. So if you bought a deal, say in 2019, assumed that rents would continue to grow by 5% to 10% for the next five years, and you underwrite that in your deal, and based your purchase price on that rent growth assumption… Well, since rents actually dropped by about 0.1% a year into the pandemic, they drop 0.1% or increased 0.1% – anyway, basically no rent growth at all – well, that deal is probably not doing very well. Whereas if you made a conservative rent growth assumption of say 2%, and even if rent didn’t grow, you’re in a much better spot than you were if you assumed rent will grow by even more.
Similarly, cap rate assumptions – we talked about this on the show a lot… Making sure that you’re not assuming the market is better at sale than at purchase… Because again, if that doesn’t happen, you’re in a bad spot. So this is kind of the main example of what ways you can do aggressive underwriting. We’ll go over a couple of other ones a little bit later on, but the whole point here is that be conservative with your investments during times of economic expansion. That way, you are able to maintain or still do well during recessions.
Two other defensive tactics – she talked about the property management company. We’ve got plenty of episodes on how to find property management companies, information on when to bring them in-house… I’m not going to talk about that one too much.
Break: [00:04:59] – [00:06:05]
Theo Hicks: [unintelligible [06:05] interesting, making sure that you’re having open conversations with your lenders during a period of economic expansion. Don’t only communicate with them when you need to get a loan. Think of ways to stay in contact with them, stay top of mind with them, as well as make sure that you set expectations for what happens when a recession happens. That way, when a recession does happen, you’re able to still get loans, you’re still able to get them to answer the phone if you need to, say, delay a payment or something. You want to have them on your side before the crisis occurs, because then once a recession happens, everyone’s calling their lender. So that’s lesson number one.
Lesson number two is also her lesson from 2019, which is the conference presentation in 2019, which is that the pro forma is always wrong. So when I did the underwriting series, we talked about how you don’t want to trust the listing brokers pro forma; you can use it as a guide, but ultimately you want your underwriting assumptions to come from the actual T12, the actual rent roll, and then conversations you have with your management company to determine exactly how the property will operate. Not exactly, but assumptions about how the property will operate after acquisitions. So obviously, that pro forma is always wrong. But what Jilliene is saying is that your pro forma is also always going to be wrong. So you underwrite your deal and you’re really making some pretty high-level assumptions on your pro forma, on your income and expense statement… And then once you’ve actually gotten the property under contract and you’re doing your due diligence, then you can confirm some of your assumptions, you can adjust some of your assumptions, but there’s always going to be unknowns, which means that your pro forma is never going to be 100% accurate. So in order to account for the fact that that it’s not going to be accurate, then you need to have some buffer room.
She gives four examples of ways that you can, again, prepare yourself for the pro forma not being right. If the pro forma is right or pro forma is better, then you’re fine; you’re actually going to exceed your projections. But if your pro forma is incorrect in the wrong direction, then you want to make sure you have these buffers in place.
The first example – we’ve talked about this, having a contingency budget. Jilliene recommends 10%. We’ve talked about 15% in the past, so 10% to 15% is a solid number. For example, if you expect to invest about $10,000 per unit in renovations, then you want to also include a contingency budget of at least $1,000. Assume it’s going to cost $11,000 per unit; have that $1,000 buffer. Because at the end of the day, if you don’t use that money, it’s not like it disappears; it’s not like you no longer have access to that money that you raised.
The second is to scale back the number of units you expect to renovate and lease. It’s a big one during a pandemic. She talked about this a little bit, one of the things that they did was stop doing renovations. So if you assume that you’re going to renovate 20 units a month, what happens if a recession hits? It’s going to be zero per month, or five per month, or 10 per month; the demand for those goes down [unintelligible [00:09:15].00] your cash reserves. Well, you assumed that you would renovate units faster, which means that your income would increase faster, which means your return would increase faster… And since that’s not the case when you had a super fast timeline, you might not be able to hit your returns.
She didn’t give any specifics on this, but my advice would be to stick to a timeline that your property management company and whoever is doing the renovations. So if your property management company does renovations, then make sure that they are in agreeance with that timeline, and maybe make it a little bit longer too. So a six to a 12-month timeline where you’re doing 20 to 25 units a month probably isn’t the best idea. Probably under 10 is more realistic.
The third example is going to be — we kind of talked about this earlier, it’s assuming an exit cap rate that is 1% greater than the cap rate at purchase. This means that you’re assuming the market is worse at sale than at buy. 1% is pretty high; we usually recommend 0.1% per year, but still, 1% is a really solid conservative assumption. If the deal still makes sense, if the cap rate goes up by 1%, then it’s a really good deal.
The fourth thing that you’re going to want to do is make sure you’re doing sensitivity analysis. When you do a sensitivity analysis, you’ll vary certain metrics on your underwriting model and see how it affects the returns. The two factors that Jilliene talks about were vacancy and bad debt. So all else being equal, if a vacancy goes up by 1%, 2%, 3%, 4%, 5%, or more, or it goes down by a similar number, how does that affect the overall returns to investors? Same with bad debt – bad debt goes way up because you have a lot of skips and evictions during a recession; how does that impact your return? So a 2% bad debt, 3%, 4%, 5%, bad debt. It’s a function on Excel that you can do and you could do this for really any data points you want – cap rates, rental premiums… So kind of just pick a few of these metrics that are impacted by recessions and then shoot them up really high and see how that impacts your returns.
Something that is common now is the base case and then an upside and a downside case. So three different cases with three different metrics saying, “Hey, here’s what we think is going to happen, but here’s what we want to have happen, and the stuff that’s possible to have happen. But also, here’s something else that we wouldn’t want to have happen, and it’s also possible to happen, and here’s how the returns would be affected.”
Those first two lessons are the longest ones, and they are the ones that are done before a recession happens. Once the recession hits, you really can’t do any of those things. You can’t change your underwriting or your pro forma; all you can really do is take a look at these next four lessons.
Lesson number three, once a recession does hit, is to take a breath and be deliberate. Even if you’ve done a bunch of preparations before a recession, it still might be a stressful experience. So it’s very important to relax. When you relax, also use that energy, rather than stress out, to focus on what your priorities need to be. Once you know what those are, focus on them.
Jilliene said that for her properties, obviously, the health and the safety of the residents and her team was important, but on the operational side, keeping up occupancy and shoring up cash reserves were her two main priorities. They came together and determined what they needed to do in order to make sure that they could focus on these two priorities. So occupancy stayed up and they could shore up their cash reserves, so they stopped renovating units, they stopped increasing rents, and they stopped all non-essential repairs to accomplish those two tasks. So not spending money on renovations or repairs to shore up cash reserves, not increasing the rents in order to attract more people to the property. So calm down when these things hit, and then make sure you’re figuring out exactly what you need to do in order to, in this case, keep your occupancy up, make sure you have cash reserves.
Lesson number four is don’t be afraid to innovate. Don’t be afraid to make changes. Whenever really any economic crisis or recession occurs, you’re most likely going to need to make some quick adjustments and quick changes to your asset management strategies, and your acquisition strategies, the type of properties you buy. The faster you can make these changes, the better off you’re going to be. More specifically, to this most recent COVID pandemic-induced recession, a lot of the changes and innovations [unintelligible [00:13:52].27] the way that units were shown; a lot of people began ramping up their virtual tours, their self-guided tours. I think last week, I actually did an episode on some ways to use new technology in multifamily investing, that are currently being used and are kind of on the horizon. We’re not going to focus on this one too much, but the whole point here is that if you have an idea or see an idea that might help you overcome any operational challenges during the recession, don’t be afraid to test that and see if it works.
This brings us into lesson number five, which is to do experiments and test the market. As you’re innovating and making changes, make sure you’re doing experiments to make sure that your innovation actually works, rather than just doing it blindly and then not tracking its results.
For example, Jilliene started doing these virtual tours, realized that the conversion rates she was seeing was higher than the in-person tours she was doing with a leasing agent, so now they’re focusing — I’m not sure if it’s exclusively, but they doubled down on virtual tours, which obviously saves them money as well, plus accomplishes the safety aspect of it too. So don’t be afraid to innovate, that’s lesson number four, but make sure you’re testing these innovations, and then double-downing on what works, and then stopping what doesn’t work.
The last lesson Jilliene learned was to be a stellar communicator. We talked about this a lot on the show. We were talking about, really, the main reason why people are going to invest with you is that they trust you. Ways to create trust is through transparent communication; it’s one of the ways. So making sure that you’re providing consistent updates on the deals, proactively addressing the issues with solutions… So that’s essentially exactly what Jilliene said.
There’s something else that you probably want to do leading up to recession is to always be a good communicator, but it’s not necessary or 100% before, because you might not have a lot of investors reaching out to you when things are going great, when you’re hitting their distributions, and [unintelligible [00:15:54].09] on time. If they’re happy, they might not be reaching out. However, even if your distributions aren’t impacted by a recession, they’re still able to hit the same frequency and amount, you’re still most likely going to have more investors reaching out and feeling concerned about the recession. “What does it mean for the investment? I know I’m making the same distributions now, but what are your future expectations?” Or if you do the pullback on distributions, when’s it going to go back to normal? Are you still going to buy a property? Do you plan on selling? Things like that. So obviously, again, before recessions it makes sense to communicate, but it’s even more important to do so during a recession. Consistent communication is going to be key here.
For Jilliene, they transitioned from doing quarterly updates to monthly updates. In these updates, rather than kind of going over just the operations, they talked about any operational challenges that they had, like dips in occupancy or collections, and then specifically what steps they were taking to proactively address these operational challenges. And also expressing their availability to their investors to answer any questions or concerns that they might have.
In summary for that one, you want to be a stellar communicator just in general, but it’s really, really important to do so during these economic recessions. So increasing the frequency of your communications, proactively addressing any issues you have, already bringing solutions and already having those solutions in place or at least in progress, and then letting them know that you’re here if they wanna talk.
In summary, the six lessons that Jilliene Helman of RealtyMogul, $2.8 billion worth of real estate, learned during COVID was, number one, make sure you’re playing defense before an economic crisis, not during an economic crisis. Lesson number two, the pro forma is always wrong. Lesson number three, take a deep breath and deliberate. Lesson number four, don’t be afraid to innovate. Lesson number five, do experiments and test the market. And lesson number six, be a stellar communicator.
That concludes this episode. We do have a lot of other blog posts related to COVID. We have 25 as of this recording. If you go to joefairless.com and go to our blog topics, you can go to that Coronavirus category and take a look at some blog posts we have on this pandemic. But we also have obviously all the other Syndication School episodes we’ve done so far and all the free documents we’ve given away. Those are always available for free at syndicationschool.com. That ends this episode. Thanks for tuning in. As always, Best Ever listeners, have a Best Ever day and we’ll talk to you tomorrow.
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