January 24, 2022

JF2701: Uncover the Value-Add Potential in Class-A Properties with Jonathan Nichols


For many commercial real estate investors, C-Class and B-Class properties are almost synonymous with the term “value-add.” But for Jonathan Nichols, he’s found that there’s still value-add opportunities in Class-A properties that investors might otherwise miss. In this episode, Jonathan reviews his recent deals, including a Class-A student housing property, and why value-adds can also apply to Class-A properties.

Jonathan Nichols | Real Estate Background

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Slocomb Reed: Best Ever listeners, welcome to The Best Real Estate Investing Advice Ever Show. I’m Slocomb Reed. This is the world’s longest-running daily real estate investing podcast. Today we have Jonathan Nichols with us. How are you doing Jonathan?

Jonathan Nichols: Great, Slocomb. Thanks for having me on the podcast today. Excited to be here.

Slocomb Reed: Jonathan is a full-time syndicator at Apogee Capital, which helps people passively invest in value-add multifamily real estate. He is the GP on 200 multifamily units, 18 short-term rentals, and LP on 250 units. He worked for 10 years as an aerospace engineer and went full-time in real estate in October of 2021, just a few months ago. He’s based in Arlington, Texas. Jonathan, reading your bio, I have to ask, your 18 short-term rentals – is that a deal that you syndicated?

Jonathan Nichols: Well, it’s actually a mix. We have a few different genres of short-term rentals; we have some residential properties that my wife and I own, which is how we got started in real estate several years back. We have a few arbitrage units which is where we rent and then re-rent the units on Airbnb. And then finally, this past year, we did an eight-unit JV property. Not a syndication, but a JV property; that’s short-term rentals. That’s kind of our hybrid between multifamily and short-term.

Slocomb Reed: Gotcha. What does your joint venture look like on that eight-unit with STRs?

Jonathan Nichols: My wife and I, as we started scaling up in short-term rentals, we really spent a lot of time developing our team, our business structure, and stuff and got it to where it was fairly efficient. So I had this idea, “Hey, I’m jumping into multifamily world, doing syndications, JVs, and stuff like that now with multifamily. What if I could buy a small multifamily property and convert it to a short-term rental, and thereby get higher cash flow, higher returns for the folks on the deal?” I had a few partners who were on other multifamily deals with me that were interested in that business model. Basically, I took over the role of managing… Rather, my company took over the role of managing the short-term rental side of the project. Of course, I put together the deal itself as far as… Not the syndication, but just the transaction, the rehab, and all that necessary to start doing short-term rental.

Slocomb Reed: The other deals that you have syndicated, those 200 units – where are they?

Jonathan Nichols: We have one deal, which was the first deal that we were co-GPS on, up in Tulsa, Oklahoma. We did that one early part of last year, and it’s taken off and doing very well. Then we have another deal that we just closed on in College Station, Texas towards the end of last year; it’s actually an A-class student housing type project. We were the lead syndicators on that deal.

Slocomb Reed: Tell me more about that class A student housing syndication. You said you bought it late last year. What did that property look like when you were proposing it to potential investors?

Jonathan Nichols: It was really interesting, because the first question that I got asked of it is, “Okay, it’s A-class, so there’s no value-add; it’s not a value-add deal.” Well, in fact, it is a value-add, because value comes in a lot of different ways. The story behind this property is that it had been owned by a mom-and-pop owner for quite a good bit of time. Their primary interest in the property was just having it 100% occupied and easy to manage. So while they took good care of the property, they didn’t necessarily push it to its potential. We took over the property; it’s only eight or nine years old, it doesn’t need any type of major rehab on the units as of now, and basically, we’re starting to implement professional management, professional marketing that will drive rents up to market, in a tertiary market in Texas that’s actually rather strong.

So  the value on this is just a management play where we’re able to hit market rents that the previous owner was not seeing on that particular property. So far, it’s off to a good start; we’re really excited about it. But it’s definitely a little bit different than a lot of the typical C-class value-add syndications that probably investors are used to coming across.

Slocomb Reed: Yeah. C-class and, to some degree, B-class has kind of become synonymous with that term, value-add. Let’s talk about value-add for a moment… Because when you boil down the definition of value-add, you’re talking about increasing the value of the property, which at the end of the day comes down to one of two variables, or both. Value-add is either increasing the NOI, or decreasing the cap rate. And there’s no reason why that can’t be done in A-class the same way it can be in B or C-class. Yes, a higher percentage of the operators in an A-class situation are going to already be performing optimally to the market. But you’re talking about an ownership situation that is very familiar to C-class operators, the mom-and-pop who wanted to be stable and safe and low hassle, instead of pushing income. They were primarily concerned with a lifestyle for themselves that resulted from the property more so than the NOI, which left an opportunity for you to increase the value and syndicate an A-class student housing deal. Am I missing anything here?

Jonathan Nichols: No, I don’t think you are. Honestly, I think your best point is just that flaw that a lot of people have tied value-add specifically to B and C class. Most of what I look at, to be clear, is B and C class properties, like everyone. But I get a lot of deals across my table that are C-class, and it’ll be marketed as a “C-class value-add deal.” Well, really what it is, is another syndicator who bought it five years ago, they’ve taken most of the value out of it, and it’s a turnkey property. And there’s nothing wrong with that at all; there is a right buyer for that property, but it’s no longer a value-add deal, because most of that’s been squeezed out.

By the same token, you go look at an A-class that has value-add on it; it’s going to look a little bit different as far as the return structure and such, but the reason that A-class typically sells for higher is because it’s lower risk. When we are talking to investors, one thing we explain to them is “You probably can go find 10 C-class deals that would have a lot higher returns than this deal. But this is going to be a lot lower risk deal, that’s more likely to appreciate.” On top of that, we’re in a market that has strong economics behind it, so I do really believe in this project. Of course, that’s not even considering the tax benefits that went along with it.

Break: [00:08:00][00:09:38]

Slocomb Reed: Are the tax benefits anything beyond the ordinary?

Jonathan Nichols: I would say not, because the property by itself, yes. But if you have a true C-class with value-add on it, you’re going to get a lot of tax benefits from that value-add if it’s executed properly and all that. So you’re not going to see as much of that. So it’s probably pretty much in line with what you see on most syndications. We definitely had investors who, because we’re approaching the end of 2021, are concerned about their tax bill in the upcoming year, and said “We need to put money in a good project.” So we had a low-risk project with great returns and the normal cost-tax benefits, so they were sold.

Slocomb Reed: College Station, Texas makes me think of the Aggies. Are there any other major employers in College Station outside of Texas A&M?

Jonathan Nichols: That’s a great question. First of all, my wife and I – we both went to Texas A&M, that’s where we met. So we’re very familiar with the market, because we’ve lived there for several years. Historically, Bryan-College Station has been, I would say, outside of the school, somewhat of a flat market. But in recent years, there are a number of large, well-known companies that are putting tremendous amounts of money, in the order of hundreds of millions of dollars, in a market with a quarter million people. So the job growth that you see, the employment growth, the population growth outside of the growth of the school itself – it hits all the metrics that most syndicators look for in a solid market. That’s something that’s come to play, I would say, in the last two to three years, particularly. I think it’s a market that’s well positioned for success in the near future.

Slocomb Reed: I am in Cincinnati, Ohio. We have a couple of great universities here, and very solid student housing markets within Cincinnati, but I’m not in them yet. When you were evaluating this deal in College Station… I say that because I’m really asking out of curiosity here… College Station, a quarter million people, relatively flat outside of the university… When you are underwriting the area, knowing that this is going to be dedicated student housing, are you weighing the growth of the university against the other economic factors affecting the market?

Jonathan Nichols: Well, that’s a good question. First of all, historically a bit of a flat market; now it’s actually growing rather rapidly. So outside of the university there’s population growth, because of these new employers that have come in the market.

So when it comes to the student housing side of it, you do want to look at the university as well. The largest public university, the largest university in Texas, the student population growth is extremely high, and has been for a number of years. So I think it bodes well with property performance.

This particular property, once again, remembering that my wife and I are very familiar with the town, it’s really an impeccable location. It’s very desirable for students who want to live, because it’s within biking distance, walking distance of the university… And for anyone who’s familiar with very large universities, not every school that you have the ability to live and walk to your university. In some of the larger schools, you may be riding a bus for a while, or have to drive, etc. So that benefit of the locational alone was something that we took into consideration.

But really, at the end of the day, there were two things that we were evaluating in order for us to feel comfortable signing the PSA on this property. One, what was the lending environment? Who was willing to lend on the project? We found a couple different good options, and one that we were particularly happy with. And two, who was going to manage it? To back up a step, I have folks come to me on the short-term rental side of things all the time and ask me questions about buying a short-term rental. The first question I’ll ask them is the same, which is who’s going to manage it? You need someone that is a professional in that specific type of environment, so we found a local management company who is headquartered in College Station, has been there for 20 years; it does not only student housing, but also manages a few hotels as well. So when it comes to the intensity that comes with the turnovers and the schedule that you see with that, they were very well prepared to take on this project. So those were kind of the two things that led us to believe we were going to be successful in this project.

Slocomb Reed: Jonathan, I want to ask you a little more about the debt that you got for this deal. But first, a frame of reference for the debt conversation. How big is this property? How many units? How much did you pay? How much were you looking to get? Did you have a value-add budget?

Jonathan Nichols: The property itself is 75 units, they’re all townhome style, so the units are very large.

Slocomb Reed: Is it a rent by the bedroom situation?

Jonathan Nichols: It is not. That’s another thing that made us comfortable with it. It’s not rent by the bedroom, and it’s also 12-month leases. So while the percentage of students living on the property officially made it a student housing project from a lending perspective, we do have a lot of full-time professionals that live on the property. Professors, or even graduate students pursuing PhDs that are going to be there for a long time. It’s really a lot different than a straight student housing project, to be honest with you. So there’s a component of both in there. But it’s 75 units and… What else did you ask me about it particularly?

Slocomb Reed: How much did you pay for it and what was your projected rental budget?

Jonathan Nichols: It was an 8.5-million-dollar property, which was like a 5.5 cap for this market, which is really incredible for A-class, honestly. The rental budget – there’s really nothing on the interiors that needs an upgrade. It’s a new enough property that just the finishings, the flooring etc., is all in great condition. It’s more of just kind of minor exterior things. We had a pretty light budget just for a little bit of deferred maintenance on the outside. But I wouldn’t even call it a full CapEx budget, to be honest. It’s probably what most people would just put into reserves. But it’s stuff that we identified going into the project was going to need to be repaired.

Slocomb Reed: What kind of rent growth potential did it have when you bought it? This doesn’t sound like something that’s going to get a big bump in rents… But like you said, previous mom-and-pop owners who cared more about making things easy than profitable. What were you looking at?

Jonathan Nichols: What we needed was to be able to get 5% to 7% rent growth in the first year in order to hit our proforma. What we’re seeing is that we’re somewhere around 10% to 12% below market rents as of today. What’s interesting is that Texas A&M is home to a Real Estate Research Center in Texas. So they do research on real estate all across the state, and obviously, are well versed in their local market as well. They released an article here within the last month or so basically stating that 2021 properties had seen 10% to 15% rent growth nominally across the board. So we’re talking properties that were already at market rent seeing those kinds of rents…

Slocomb Reed: This is at College Station?

Jonathan Nichols: That’s correct. And they’re expecting that again in 2022. So for us going into this project, that was something that really made us comfortable with it. Because the rents that we were needing to hit to hit our proforma were well below what’s projected just from nominal rent growth, outside of properties that are at below market as is.

Slocomb Reed: Yeah. The rising tide lifts all ships, for sure. It’s a good time to be taking advantage of what’s happening in the market when it comes to rent rates. So 75 townhome units, technically classified as student housing, but you have a mix there of tenants, professional as well as student. 75 doors, 8.5 million, pretty stable, a little bit of rent growth potential… This sounds like a dream for most lenders. What kind of debt structure were you looking at?

Jonathan Nichols: One of the things important to our team was to find non-recourse lending. That was probably the most challenging. You have to go back to the history of the market there, in College Station. Agency was not particularly interested in this project, because one, they’re not big fans of anything that they would identify student housing. But more so, if you look back at the history of the market several years back, there was a lot of development of new A-class student housing between, let’s say, 2012 to around 2016 in this market. And for a brief time period, the market was even a bit oversupplied on student housing. So I think that some of the lenders were concerned about that, and not looking at some of the metrics… Because what really matters in a market, if I tell you, “Hey, Slocomb, I’m going to buy a property in Austin.” You immediately think, “Oh, that’s a great market.” But why do you think that? Likely, it’s due to what it’s done in the past.

Slocomb Reed: It’s because of how many people say Austin all the time. You hear it everywhere.

Jonathan Nichols: Exactly. But what we really care about is what is the market going to do in the future. So while we don’t have a crystal ball, there is a lot of research and data that can give us an idea of what it’s going to do in the future. Some of that I already mentioned. Companies coming in and investing enormous amounts of money, job growth, population growth, low unemployment. Particular to this property, a university that also has population growth, a subset of students who have no issues paying rent… Presenting all that to the lenders, once we’ve found a group of lenders who were interested a) in student housing, and b) in non-recourse lending, it was actually a pretty easy sell. So it’s just finding the people who are interested in that kind of project.

Slocomb Reed: What terms did you get?

Jonathan Nichols: We were able to get 75 LTV, which is pretty right down the fairway, I would say, in Texas. Don’t need any CapEx money, because the repairs are minimal, so that’s not really much of a concern. 30-year AM, low DSCR… So it all worked out pretty good, honestly, in the end. A lot of it was just really being clear on our business plan, on providing evidence of the property’s current performance… As I said, because it was a mom-and-pop owner, they had done all the right things as far as screening tenants and running the business well, but it just wasn’t the most organized. So we as the sponsors of the team had to do a lot of that organization and then present that information to the lender. So at the end of the day, you think that the lender is trying to sell you a product, but it’s really you trying to sell them a property. You have to approach it in that manner if you want to be successful.

Slocomb Reed: Yeah. I know that 30-year amortization is going to help your cash flow a bunch.

Break: [00:20:45][00:23:41]

Slocomb Reed: Did you underwrite this to the five-year hold? Is that the plan?

Jonathan Nichols: That is the plan. We’re seeing in the Texas markets a lot of sponsors are choosing not to hold properties for five years. Just when you look at cap rate compression, combined with rent growth, a lot of them are not having to hold properties that long to hit the equity multiples that they’re projecting to investors. My hope would be that we would see something similar on this project, because it’s more of a management play than a rehab play. It won’t take us long to implement our value-add strategy on this project. But at the end of the day, we want to be conservative. It’s a five-year business plan, it’s a five-year note, so that’s what we’ve underwritten it as.

Slocomb Reed: Awesome. Well, Jonathan, are you ready for our Best Ever lightning round?

Jonathan Nichols: Better now than never. Yup. Ready to go.

Slocomb Reed: What is the Best Ever book you’ve recently read?

Jonathan Nichols: Well, that’s a great question. I’m going to name a non-real estate related book and say The One Thing. The reason I like that book is that when I was trying to lock down our first multifamily project, it really helped me with just not only the mindset, but the organization behind trying to accomplish what to me seemed like a very large goal. So for any listeners that have a big goal going into 2022 and haven’t read that book, I would definitely recommend it.

Slocomb Reed: The One Thing, it’s phenomenal, for sure. What is your Best Ever way to give back?

Jonathan Nichols: That’s an incredible question. A couple of years back, actually several years back, my wife and I were privileged enough to go on a trip to Tijuana, Mexico and build a house there for a family over an extended weekend. Then we made it basically a family tradition of ours to go back every year up until COVID hit. Honestly, it’s been one of the most impactful things that I’ve had the opportunity to participate in. So we’re hoping to get back into that this year, but I really enjoyed that a lot.

Slocomb Reed: Nice. What is your Best Ever advice?

Jonathan Nichols: It sounds really generic, but what I would say, especially to newer real estate investors, is just to have that never-quit mentality. It amazes me how many people come into this industry with maybe minimal experience or a resume that doesn’t seem to suggest that they’re going to be successful, but then they wind up being incredibly successful. I think the one thing that ties the people that succeed is that they all are very committed to the outcome. It’s not about saying, “Well, I’m going to give this amount of effort. If it doesn’t work, then whatever.” They just have this attitude that they’re willing to write a blank check, and whatever it takes, they’re going to get it done. That would be my advice, is figure out what it takes and work hard until you succeed.

Slocomb Reed: That’s awesome. Jonathan, where can people get in touch with you?

Jonathan Nichols: As you already mentioned, the name of our company, my wife and I’s syndication company is Apogee Capital. We have a really great website, which my wife actually built, called apogeemfc –as in multifamily capital– .com. It’s got all kinds of resources, typically targeted towards passive investors who are interested in multifamily commercial real estate. We have a free eBook. So that’s definitely a great way to get in contact with us. Also, I’m rather active on LinkedIn. If you search for me there, I’d love to connect with you if you have any questions or just want an introduction.

Slocomb Reed: That’s great. Jonathan, thank you, and Best Ever listeners, thank you for tuning in. If you enjoyed this episode, please subscribe to the podcast, leave us a five-star review, and share this with someone who could benefit from what Jonathan shared with us. Thank you and have a Best Ever day.

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