September 3, 2021

JF2558: 4 Challenges of Today’s Market with Spencer Gray

Indianapolis investor Spencer Gray is telling us all about his multifamily ventures as well as his experience as a GP and an LP. Spencer talks about why he chose multifamily over other asset classes, the recent challenges he’s faced in today’s market, and finding the right balance between being aggressive vs. overly aggressive to ensure you’re participating in the market without overpaying. 

Spencer Gray Real Estate Background:

  • CEO of Gray Capital and full-time real estate syndicator/investor
  • 16 years of RE investing experience
  • Primarily focused on 150+ unit stabilized multifamily in the Midwest, with Indianapolis being the most active market
  • Invests in industrial and medical office CRE as an LP as well as multifamily as an LP with other operators
  • Portfolio consists of about 5,000 multifamily units as a GP with control, 4,000 units as an LP, 12 medical office buildings, and 2 ground-up industrial developments as an LP
  • Based in Indianapolis, IN
  • Say hi to him at:
  • Best Ever Book: The Hands-Off Investor: An Insider’s Guide to Investing in Passive Real Estate Syndications


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Joe Fairless: Best Ever listeners, how are you doing? Welcome to the Best Real Estate Investing Advice Ever Show. I’m Joe Fairless. This is the world’s longest-running daily real estate investing podcast, where we only talk about the best advice ever, we don’t get into any of the fluffy stuff.

With us today, Spencer Gray. How are you doing, Spencer?

Spencer Gray: Hey, Joe. I’m doing great, I appreciate you having me on.

Joe Fairless: Well, I am glad to hear it and it is my pleasure, and looking forward to getting to know you and learn more about what you’ve got going on. Because Spencer has 16 years of real estate investing experience and he’s the CEO of Gray Capital, and he’s a full-time real estate investor and syndicator. His business is primarily focused on 150+ units in the Midwest, with Indianapolis being the most active market, and coincidentally, he is based in Indianapolis, Indiana. And as an LP, he’s got experience; he invest in industrial and medical office, commercial real estate mentor, as well as multifamily. So he’s got some LP experience, but his focus is on being on the GP side. His portfolio consists of 5,000 multifamily units as the general partner, with control over 5,000 units as a general partner, and 4,000 units as a limited partner. He’s got — I assume that’s 12 medical office buildings as an LP. Is that correct?

Spencer Gray: It’s around 12. We’ve invested in several medical office building funds, and each one of those funds has a handful of properties. So it’s around 12, but it becomes a little bit harder to keep track when they kind of keep adding assets to that.

Joe Fairless: I hear you. There’s no need to keep track as an LP, right? Which is the beauty of being an LP.

Spencer Gray: It is. You have to pay attention, make sure that people are doing what they say they’re going to do. But when you have a good relationship and things all check out and keep performing, it’s just another way to leverage your time while you’re focused on everything else.

Joe Fairless: And he’s participated in two ground-up industrial developments as an LP.

So with that being said – there’s the intro, now let’s learn more. Spencer, can you tell the Best Ever listeners a little bit more about your background and your current focus?

Spencer Gray: Yeah, so I’ve been pretty much a serial entrepreneur since I was in high school; I had the opportunity to flip a house with a buddy of mine when I was a senior in high school. So I kind of got the real estate bug at that point. But I didn’t really think that that was going to be what I was going to do as my career. So I went off, I started several businesses. I went to school to be a recording engineer, and loved music, loved recording music. I did that for a while, worked independently, worked for… Eventually, I started another business in the craft beer industry, selling hops to craft brewers. Eventually, I built one of the fastest-growing hop distributors in the United States. I sold that business and kind of went all-in on investing into multifamily real estate. Really, I was fortunate I was able to partner with a syndicator here in Indianapolis who I was able to really learn from, co-sponsor quite a few projects… And then after I had done that, I started investing as an LP, and once I really felt like I had not only a track record, but I really understood the business, and there were things that I thought I could do – not always better; some things better, but some things just different from my current partner. I started building a team and started syndicating our own projects, and being the lead sponsor in multifamily acquisitions, mostly in the Midwest.

Joe Fairless: So why did you choose multifamily over different types of properties that you can invest in, in commercial real estate?

Spencer Gray: That’s a good question. I think it was something that I understood. I had flipped single-family residential houses and I had always liked the idea of buying duplexes, buying smaller multifamily to create cash flow and passive income. So I think it was really just being stuck in kind of the residential real estate world, not really thinking of there all of these other asset classes. So once I really decided I really want to start scaling this thing, it was kind of where I was and what I knew, and learning another asset class like industrial or medical office or self-storage – it seemed a little too foreign to me at that point.

Now going back in time, would I have chosen another asset class? Probably not. There are other great asset classes;  industrial is doing so well right now, self-storage is doing really well, I had a lot of success in medical office space investing as an LP… But at the end of the day though, looking back, multifamily has been such a strong performer and it is such a scalable business. I don’t really know that I would have done anything really differently, but it was honestly just kind of what I knew, and I kept moving forward.

Joe Fairless: Let’s talk about your deals as a GP. What is the largest deal that you’ve done, in terms of unit size?

Spencer Gray: Largest deal as a GP in terms of unit size would be a 360-unit B Class apartment community in Carmel, Indiana, in terms of unit size; not necessarily purchase price. We’ve done another larger deal, it was an A class deal, that was a little bit higher purchase price… But certainly unit count, that project in Carmel is the largest one I’ve been on the GP.

Joe Fairless: When did you close on that?

Spencer Gray: That was in 2018.

Joe Fairless: Alright. And do you still own it?

Spencer Gray: We do. We’ll probably own it for the next couple of years. We have a joint venture equity partner in that project, and the prepayment penalty on the loan that we assumed is probably going to have to let it season for another year or two, until we look at actually selling it.

Joe Fairless: Approximately or precisely, depending on your memory, what number deal was that as a general partner?

Spencer Gray: That was probably number seven or eight, I would say.

Joe Fairless: Okay.

Spencer Gray: I had done a handful, but it wasn’t too recently… So yeah, it’s kind of in that 7-8 range.

Joe Fairless: The reason why I ask that question is if you have a joint venture equity partner on it, and that for syndicators who are starting out, especially, could be very appealing… Then once you grow, it’s great to have multiple sources of equity; you can have individual investors at 50k to 100k chunks, and then you can have a joint venture equity partner separately, and kind of have two paths there.

Spencer Gray: Yeah.

Joe Fairless: So how did you get introduced to the joint equity partner? And was that the first deal you did with them?

Spencer Gray: Yes, it was the first deal that we’d ever done with them; it’s the only deal that we’ve done with them since then. We were co-general partners on this project, and our partners had identified them. It was a bigger deal than we had usually had taken down; it also had a loan that we would have to assume. And so that was going to make the leverage relatively low. I think made the leverage come out to be about 60% LTV. And so it was going to be an equity check that was a little bit larger, that we were comfortable raising ourselves.

So we spoke to different equity brokers and kind of played that speed dating game of trying to find the right match for the deal. And then, as you’re familiar, Joe, it’s not necessarily “Can you find the equity?” but what strings come along with that? What strings are attached? And you might have somebody that, yeah, they’ll write the check tomorrow, but getting into a long-term partnership — and one, they’re not going to provide millions of dollars for free, just because they’re nice guys. They’re going to typically want some kind of control, major decisions, as well as charging their own fees. So we haven’t done another joint venture equity deal really since then. Not that they’re not good partners, not that the deal’s not going well, but it’s not the cheapest equity. And when you can’t control your own project, I believe that there are risks in that.

You can have a great partner that has some control that brings something to the table and it can be a creative, but when you’re getting into a relationship with a group that you don’t know that well, and they may have some ability to control the deal, whether it’s vetoing a sale or triggering a sale, you have to think a couple times before you sign that term sheet and get too far down the road.

Break: [08:24] to [10:25]

Joe Fairless: So you’ve raised money from individuals before, and then after, but this was a one-off thing, because of the circumstances that you just mentioned.

Spencer Gray: Exactly.

Joe Fairless: Okay. What about the Class A project? Why Class A versus Class B?

Spencer Gray: I got into this business really focusing on value-add, kind of Class B being kind of the sweet spot. We had a couple assumptions that we were working under; one, we closed on this project, put it under contract during COVID, just last year, and material prices were already going up. And it was our belief that the replacement costs for new construction in the future would be significantly more than what it would cost to build in 2018 and 2019. But also, the fastest-growing segment of renters – not the largest, but the fastest-growing centers, if you look at Harvard’s Joint Center for Housing Studies, is the renters by choice, rather than by renters by necessity. So in the right market, you have the right demographics, the high area median incomes to support those rent levels, in areas that have relatively low supply of new single-family homes. So if you’re in an affluent area, limited amount of options, having an A class luxury asset, there’s still demand, but the business plan is just different.

So for example, on this deal, it wasn’t about doing a renovation, it was much more about running the property significantly more efficiently than the merchant builder that we had purchased it from. They had $350,000 a year in concessions, $130,000 marketing budget, they had an admin budget of also over $100,000 per year… So we could add $500,000 of NOI. And we’ve already done this, we’ve added a $500,000 to NOI, just by trimming the fat, lowering concessions, and moving rents marginally. But that project, I think most people assume Class A is not going to have cash flow, and the returns are low. And I’m not surprised. I mean, that projects going to cash flow over 10% every single year.

Joe Fairless: What has been some challenges that you’ve come across on that project?

Spencer Gray: That project – we purchased it with a bridge loan, and we’re putting a HUD 223(f) loan in place. It’s a long-term, 35-year term deal, fixed interest rate. And we have had a lot of issues in terms of the reporting and the inspections that we have to do in order to put that in place. Now, we’re through most of that.

But one of the things is we were trying to qualify for a Green Mortgage Insurance Premium program that would reduce our MIP down to 25 basis points from 50 basis points, and also reduce our application fees significantly.

Joe Fairless: For people not familiar with MIP…

Spencer Gray: It’s a Mortgage Insurance Premium. And so it’s essentially an FHA loan; if you were purchasing a home with 3.5% equity down, you have to pay some kind of insurance, because it’s relatively highly leveraged loan. So they want you to pay some insurance to cover it in case something happens.

So by qualifying for this Green Program, we were basically able to cut that MIP in half. But in order to do that, we had to get utility records of every single tenant going back to the previous owner, and then the utility company wouldn’t actually provide us with that information, even though we own the property. Since the utilities weren’t all in our name, they were in tenants’ names, they did not want to provide us with that information; they basically didn’t want to do the work. And it came down to we basically said, “We’ll pay you to do the work.” We basically said, “Here, we’ve just sent you a check for $10,000. We need this done immediately”, and eventually, we got it done, because we were going to end up saving hundreds of thousands of dollars by getting that Green MIP over the course of the deal.

Joe Fairless: Hmm. Thank you for telling that story. That’s an interesting one. When you take a look at the deals that you’ve done, let’s say more recently…

Spencer Gray: Yeah.

Joe Fairless: …what has been another challenge that you’ve come across?

Spencer Gray: Well, right now the biggest challenge we’re facing is being able to win deals and try to understand really where the market is at. And we’ve seen incredible cap rate compression over the past year. But not only that, just the amount of rent growth is far beyond… In most markets; not every market, but many markets. The growth that’s occurring is beyond what we would ever modeled on in the past, but it’s actually happening. And there are buyers up there that are forecasting even more growth.

So when we’ve tried to purchase apartments, they’ve gone for 10% over what that whisper price was. And even when we put in what we think aggressive offers, someone’s coming and bidding $2 million over what we thought was aggressive. So it’s trying to understand where the market is, where it’s going, being appropriately aggressive to win the deals, but not getting over our skis and speculating about too much growth; still trying to be conservative. But if you’re really very conservative in this market, you’re just not going to participate in this market. So trying to find that right balance to take advantage of the opportunity that I think is in front of us right now, but not just getting too excited in buying anything, because there’s so much growth and more cap rate compression is going to save us all; that may not happen, we just don’t know.

Joe Fairless: So specifically, what’s something from an underwriting standpoint that you’re doing?

Spencer Gray: The biggest change in underwriting is really trying to determine what rent growth is going to look like, really in the next 12-18, maybe 24 months, where it’s going to be after that, how are expenses and inflation on the expense side are going to be affected… And then when looking at exit cap rates, we’re really not doing anything different than we had in the past, which we don’t really even like picking one exit cap rate; we do it, but we just look at sensitivity matrices instead, just to look at what the range is. You probably do the same thing.

But it’s really trying to get the pulse on where the growth is, because we would have never plugged in 9% organic rent growth in a year, or 12% organic rent growth. But when it’s happening right now, and organic rents have moved 10%, 12% to 15%, then you have a rent roll that hasn’t turned over and cycled into those new rents. It’s hard to ignore that growth at the same time. So you can be conservative and just not factor it in, but it’s also the reality. So it’s being where the market is, but not getting over our skis. So really kind of just figuring out what growth to model, to me, is the most challenging.

Joe Fairless: That makes a lot of sense, and I’m sure you have access to and look at third-party research companies like CoStar and other research companies like that.

Spencer Gray: Yeah.

Joe Fairless: So you have access to it, and so do the others who are underwriting those same deals that are competing against you. So what do you do with that information? If CoStar says, “Projected rent is going to increase 12% in this pocket.” Do you just say, “Okay, 12%”, because that’s what they’re saying? Or do you use multiple sources? Or do you split the difference on what you would typically do? How do you approach that?

Spencer Gray: Yeah. We don’t just put in “CoStar says 12% sub market rent growth.” That would be easy. But that’s not what we do. It’s more about first looking at “Let’s remove all the growth in the third parties. Let’s just look at where the comps are compared to our subject property. And what kind of organic growth do we see without all these other forces going on? …and what that delta is.”

And then looking at what the sub-market is growing at after that to adjust for it. But then still determining, okay, well, sure, CoStar is showing that there’s 12% rent growth. But how much of that is new Class A properties that have new leases that are coming online that are delivering at $1,600, where the average rent in the market might have been $1,200? So that moves that average up.

So you can’t just take the growth rate on its face. But I think using it to influence where the market is growing… Because even if that rent growth is coming from new Class A or renovated Class B, that does affect the market downstream. So it’s a much more nuance, and a meeting of art and science of where that growth is going to go… And a little bit [unintelligible [00:19:07].18] it’s okay, well, markets growing at 12%. The deal looks good when it’s growing at 6%. We don’t need to get over our skis and plug in 12%. But I say that, and we’ve lost out on—

Joe Fairless: And you won’t get awarded the deal.

Spencer Gray: Exactly. You don’t participate, so you don’t get awarded the deal.  Exactly.

Joe Fairless: Hmm. Let’s transition a little bit to a deal that hasn’t worked out. What deal have you lost the most amount of money on?

Spencer Gray: I’m very fortunate… I haven’t lost any money on a multifamily deal. Now, I have lost money when I flip single-family homes. The most I lost was about 50 grand, flipping a house that ended up just running way over budget, and we didn’t hit our sales price at the end of the day. And the biggest reason for that was it was in a historic district of Indianapolis, and [unintelligible [00:20:02].00] I would love to work in a historic district on these old Victorian homes. Well, the Historic Preservation Commission in Indianapolis seemed to have a different opinion of what they wanted to see done and ended up getting in a kind of a long, protracted, I wouldn’t say battle, but just let’s call it a frustrating relationship with the Historic Preservation Commission… And I told myself I’d probably never do a project in a historic district again. I don’t know if that’s still the case, but I certainly wouldn’t flip a house. But it’s easy to say I just want to do something.

The real lesson was, if you’re going to do something in an area with special rules, it’s not just enough to follow the rules by the letter, it’s sometimes more important just to get the buy-in from the individuals who are enforcing those rules, because we thought we did everything to the letter of the regulations and their guidelines, but the person enforcing those rules had a different opinion.

Break: [21:00] to [24:05]

Joe Fairless: So 50k approximately on a fix-and-flip loss; nothing on commercial as a general partner or as a limited partner?

Spencer Gray: As a general partner or a limited partner we have not had a deal that we’ve lost equity in. We certainly have had deals that as an LP that didn’t go as planned for a while, and distributions were suspended, and we’ve had a couple deals with capital calls… Yeah.

Joe Fairless: What type of properties were you investing in as an LP that had capital calls?

Spencer Gray: Two deals that I’ve had capital calls as an LP. One was a commercial office project, and the other one was a large multifamily deal that we were an LP in. The commercial office building – they needed to re-tenant the space. It was a Class A office building on the north side of Indianapolis, and they underestimated how long it was going to take to get a tenant to lease the space, and how much money they would need to carry the project. So there ended up being two additional capital calls, about 30% of our initial equity.

Joe Fairless: That’s a good chunk.

Spencer Gray: That was a good chunk. Yeah, now it ended up working out great. We hit about a 30% IRR on that deal. So it ended up being really great.

Joe Fairless: Wow.

Spencer Gray: It was about an 18-month hold, so it wasn’t like a long hold… And it’s easier to get that higher IRR in a shorter time period. And then the second deal we had a capital call for a multifamily deal that we had invested in, in Memphis. It was a huge deal, two properties right next to each other, totaling about 900 units. And it was a very deep reposition, heavy-lift value-add; it was an in-place occupied renovation, so your residents could still be living in the units, you move them out, you renovate the unit in a day, you move them back in… Which is expensive; you know, you’re spending $12,000 to $15,000 per unit.

What we didn’t anticipate was how rough the demographics at the community where and how we’d really have to reposition and hire a new tenant base in. And that’s hard enough at a 200-unit property, but when you’re talking one 700-unit and then a 200-unit that are run together, that’s a very large ship to turn the right way. And credit to the operator, the GP; they’re great guys, they were able to figure it out. They’ve sold off one of the properties and the other one’s under contract right now. So it was, fortunately, able to work out. But we haven’t received a single distribution since we closed, and when you invest in a project with the goal of producing a consistent stream of cash flow… So we didn’t hit the goal of producing cash flow, but we’re not going to lose money.

Joe Fairless: What do you think the return’s going to be?

Spencer Gray: We’ll have to see how it ends up. The real story – cap rate compression, to say the least. So it’ll still probably be a high teens IRR. Was it a successful project? We didn’t lose money, and we’re going to make a high teens IRR. So in one case, how do you say it wasn’t successful?

Joe Fairless: Yeah. Right. Yep. Well, they’re attempting to turnaround not a property but entire neighborhood—

Spencer Gray: Exactly.

Joe Fairless: —if it’s [unintelligible [00:27:04].22]

Spencer Gray: Exactly.

Joe Fairless: So that’s a different task. It goes back to some of the fundamentals – location, location, location. My company has bought a property next to a gas station… And lesson learned. There’s a lot of people hanging around gas stations that might come over to your property, and it’s not the most desirable thing to have next to your apartment community. It’s great that cap rates compress for that deal, and they also rolled up their sleeves and put in the work to turn it around, it sounds like.

Spencer Gray: Yeah, they definitely did. But yeah, the cap rate compression really saved the deal. And I think another lesson is… You’re getting into a new market; that was the first deal we’d done in Memphis.

Joe Fairless: When you say “we”, who’s “we”?

Spencer Gray: We were at an LP; we invested with another syndicator in Indianapolis.

Joe Fairless: Got it. Okay.

Spencer Gray: Yep. So I’ve invested with them in quite a few of their deals; we’ve used them for third-party property management on some of our deals, so we have a good relationship with the guys… And we flew down there on their plane multiple times to look at the deal, see what was going on. So I was more involved than your typical LP on the deal. But I didn’t really know Memphis that well, and I was really relying on their knowledge of Memphis. And we flew in, you know, you tour the market… But you can only learn so much about a market by flying in for an afternoon a couple times. And you can do your research, but Indianapolis is our home market and that’s why we like to invest in Indianapolis. I’m still learning things about parts of Indianapolis I never knew, and I’ve lived here my entire life. I was from here, so I’ve been more or less been here for 30 years, but I still learn new things all the time. So that intimate knowledge of the market – you just don’t know what you don’t know.

Joe Fairless: Taking a step back, what’s your best real estate investing advice ever?

Spencer Gray: Invest in what you know and invest in what you understand. The most mistakes that I’ve made or the mistakes that I see others make is just getting involved in something that you can’t exp—if you can’t explain it to someone else relatively clearly and simply, you really should think twice about putting money towards it.

Joe Fairless: Yep, I hear you. I lost $100,000 investing in a factoring business model, that is still a little fuzzy in my head how it was allegedly supposed to work.

Spencer Gray: Yeah.

Joe Fairless: And it was through a friend, and a very savvy financial person who is my friend — his friend, his contact. So it came from a trusted source, but there was allegedly fraud in the whole thing, and my $100,000 turned to $800 and some dollars that I ended up getting back as a result of it. So there was a return, but it just wasn’t quite what I expected.

Spencer Gray: Yeah.

Joe Fairless: And I didn’t get my original money back. So yeah, invest in what you can understand and easily explain. I kind of understood it, but there was a lot of variables in play that weren’t necessarily fully pinned down, that I should have, so…

Spencer Gray: Yeah. So it’s easy to get excited about something and feed off of the excitement from others. But at the same time, if you can’t really explain it to somebody else… I’ve tried and played around with investing with options and things like that. And I think it’s fascinating more than anything; I just want to educate myself. But man, if I want to lose money, I know that’s—

Joe Fairless: That’s the way to do it.

Spencer Gray: That’s the way to do it. I make more money going to the casino. Absolutely.

Joe Fairless: Yeah. Yeah. And have more fun and get free drinks along the way.

Spencer Gray: Exactly. Exactly. Exactly.

Joe Fairless: We’re going to do a lightning round. Are you ready for the Best Ever lightning round?

Spencer Gray: Let’s do it.

Joe Fairless: Best Ever book you’ve recently read.

Spencer Gray: Best Ever book I’ve recently read… I recommend your book, Joe, but Brian Burke’s new book, Hands-off Investor – we’ve just read that as a team recently, and I thought that was a great book for passive investors, as well as syndicators who want a perspective from LPs.

Joe Fairless: Best ever way you like to give back to the community?

Spencer Gray: Two ways. So one, I love working with other real estate investors who are trying to figure out the whole syndication thing. I’m not a paid coach, I’m not a paid mentor, but then there’s a handful of local charities that my wife and I are really involved with, as well.

Joe Fairless: How can the Best Ever listeners learn more about what you’re doing?

Spencer Gray: We’ve got a great weekly newsletter, I’d love for everybody to sign up for it.

Joe Fairless: Well, thank you so much for being on the show, Spencer. I appreciate you sharing your experiences as an LP and as a GP, what’s worked, what hasn’t worked, and how you’re looking at underwriting during a competitive environment when looking to acquire deals. So thanks for being on the show. I hope you have a best ever day, and talk to you again soon.

Spencer Gray: I really appreciate it, Joe. Have a great one.

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