February 4, 2022

JF2712: Lessons Learned Managing $2+ Billion Portfolio During COVID

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We’re sharing the top ten sessions from the Best Ever Conference 2021 as we gear up for the next Best Ever Conference at the Gaylord Rockies Convention Center in Colorado this February 24-26th.

In this episode, Jilliene Helman—CEO and Founder of RealtyMogul—shares seven lessons she learned while managing her real estate business during the pandemic.

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Joe Fairless: Welcome to another special episode of The Best Real Estate Investing Advice Ever Show where we are sharing the top sessions from the Best Ever Conference 2021. This year, the Best Ever Conference is back in person, February 24th through 26th. Come join us in Denver, Colorado. You’ll hear all the new keynote speakers, you’ll meet some new business partners, you’ll learn some insights from the presentations and from the people you meet, that you can apply to your business today. Here is an example of a session from last year that is still relevant today and will be beneficial for you.

Jilliene Helman: Perfect. I’m going to go ahead and kick us off. I’m Jilliene Helman and I’m the founder and CEO of Realty Mogul. Realty Mogul is an online marketplace to invest in commercial real estate transactions, sometimes known as real estate crowdfunding. We connect investors to real estate investments around the country. Since its inception, Realty Mogul investors have invested in over $2.8 billion of real estate through the Realty Mogul platform. I thought it would be fun today to talk through lessons learned with $2.8 billion of real estate during COVID. I can assure you it was more fun to have a $2.8 billion platform pre-COVID. But we learned a lot during COVID and I thought that it would be helpful to share that and share some of those lessons learned. I’ve got seven lessons to share today and then I’m going to give you a little bit of insight into where we think the market is headed, the types of deals that we don’t want to do, the types of deals that we do want to do.

Lesson number one is you play defense before an economic crisis, not during it. What do I mean when I talk about playing defense? First of all, underwrite well and don’t do deals that don’t meet your underwriting criteria, don’t stretch to do a deal. I sometimes see real estate operators changing assumptions, trying to make deals work, convincing themselves that this deal will be different than the last one, it’ll have better tenants or better collections. That’s just bad news, that’s incredibly important to play defense before an economic crisis. The second thing that we learned is that you have to have a strong property management team in place. During a time like COVID, we saw strong management separate the property’s performance compared to comparable properties. Our best property managers were proactive, they were working with tenants on payment plans, they were helping our tenants to complete rent assistance applications, and they were incentivizing tenants to pay rent online. These all had really positive effects on maximizing collections and occupancy right in the heart of COVID. There’s no such thing as “set it and forget it” with management companies, you have to actively manage them. That was even more true during COVID when so much was changing so quickly.

The other one around playing defense is having open conversations with your lenders. It was absolutely critical to our success in managing through COVID. COVID has caused lenders to take an increasingly proactive approach in managing properties. Having open discussions with your lenders as to how COVID is affecting the property and the steps that you’re taking to mitigate those effects is incredibly beneficial for your lender. But you have to have those relationships pre a crisis like COVID. At the end of the day lenders are made up of people, which means that you have relationships with those individual people, and those are absolutely critical. Now, why is it critical? There were times during COVID when we needed the lender to do a draw request for construction expenses that we’d already spent pre-COVID. Or maybe there was an extension on a loan that needed to happen or a payout of additional proceeds for good news money. If you don’t have strong relationships with your lenders, in times of crisis, it’s really challenging to get them to do what you want them to do.

Lesson number two is the proforma is always wrong. I shared this on stage at the Best Ever conference last year and I’m repeating it this year because I just think that is such an important lesson in times of crisis and not even in times of crisis. But knowing that the proforma is always wrong, what are some ways to combat that? First and foremost, it comes down to underwriting. Underwrite a minimum 10% budget contingency, scale back the number of units that you’re planning to renovate and release per month, slow it down, use a cap rate at exit that is at least 1% greater than your cap rate at purchase, and increase vacancy and bad debt to stress test your pro forma. If your stress test financials are still acceptable to you from a risk-return perspective, that’s probably a deal that you want to do. But it’s impossible to predict, in good economic times and particularly in bad economic times like COVID.

Lesson number three, take a breath, be deliberate. In times of crisis, things can feel really, really crazy. Many people forget to plan and forget to prioritize. When COVID hit, we took a breath as a company and we came up with a plan. We reassigned folks who were working in the originations team onto the asset management team. We drafted communications around that plan and we came up with two priorities, limiting the priorities and measuring them because what you measure gets done. The number one priority was the health and safety of our tenants and our team. The number two priority was keeping occupancy up and shoring up cash reserves. That meant immediately halting renovations, halting rent increases so that we could keep people in their units, and cutting all non-essential expenses and repairs. When you’re looking at an economic cliff, cash is king, and we took deliberate actions across our assets to ensure that we shored up cash. That’s it, two priorities and a plan.

Lesson number four, don’t be afraid to innovate. Going back to our priorities, the first was the health and safety of our tenants and team. In the very early days of COVID when it was still unclear how dangerous it was, it was still unclear exactly how it was spread, we didn’t want the property management teams interacting with the tenants. This led us to use software to do virtual leasing and self-guided tours. It’s still shocking to me how many units were leased via self-guided tours. At some properties we measured the data, the conversion rates were higher through a self-guided tour than they were when a property management professional joined the prospective tenant in the unit. It was pretty remarkable and amazing and it’s something that we’re going to continue to use post-COVID. I think it’s a real lesson of not being afraid to innovate.

Lesson number five, do experiments and test the market. Lesson number five was a big one for us in the face of the pandemic. We decided to start testing the market and the appetite for renovations back in June 2020, just a few months after the pandemic started. Sure enough, we were able to keep hitting renovation premiums in many of our assets. Step number one was making sure that we shored up cash and shored up capital so we stopped all the renovations. Then we got back in the market and started testing. It turns out, as more and more people were stuck in their apartments, a nicer apartment was even more important than before. We approached the first renovation post-COVID that every property is an experiment. When the experiment worked, we doubled down. We had one property in the height of the summer, which was the height of COVID in Texas, where we leased over 40 renovated units over the summer using virtual leasing and testing the market. It worked very, very well.

Lesson number six be a stellar communicator. This is particular for all those sponsors and all those operators who are in the audience today. But providing detailed updates to investors is critical in good times and in bad times. Investors are reading the news and wondering how the pandemic has affected their investments. Providing detailed transparent and regular updates eases uncertainty and increases confidence. We increased the frequency of our updates to monthly from quarterly and we were available and receptive to questions, calls, comments, and ideas from investors.

Break: [00:09:07][00:10:46]

Jilliene Helman: Lesson number seven, which is my last lesson here, is to take a position. There’s a lot of fear in the midst of an economic crisis and in the midst of not even an economic crisis, but a global medical pandemic. It’s really important that you can overcome that fear, and the only way that you can take a position is by overcoming that fear. I want to share an excerpt from our June 2020 investor communication. “Choosing to invest in today’s market means two things. One, you must assume the world is not ending, and two, you believe the country will recover in the future.” I’m reminded of Warren Buffett’s quote from his recent Berkshire Hathaway shareholder meeting in which he said, “One of the scariest of scenarios when you had a war with one group of states fighting another group of states, and it may have been tested again in the great depression, and that may be tested now to some degree, but in the end, the answer is never bet against America.”

That, in my view, is as true today as it was in 1789, and even was true during the Civil War and the depths of the depression. We do not believe we are in for depression, namely, because of recent massive government intervention. The US has never seen the extent of monetary and fiscal stimulus that we are seeing today. As a reminder, this was June 2020, 90 days after COVID hit in full swing. We decided in June 2020 that we wanted to play on offense, and we assumed the world was not ending, and we believe that the country would recover. Data told us that supply and demand fundamentals, particularly in apartments, made it such that investing still made sense. In the ’08 and ’09 crisis we had an oversupply of housing, today we have an undersupply of housing. That, coupled with low interest rates, made us get back in the market. We decided to get back to finding real estate investments that met our due diligence criteria and we based it off of a deliberate assessment.

I’m going to share that assessment with you completely transparently. Here are the things that make us afraid in today’s market and made us afraid in the height of COVID in June, in March, in April. Unsurprisingly, most of these were on our list well before COVID. I gave a presentation at the Best Ever conference last year, you can go back and you can look at my list from last year, and there are not that many that are that different on what makes us afraid. There’s one in particular on what we’re excited about and I’ll talk through that one in a minute. But let’s talk through first what makes us afraid. There are a ton of landlords who got sucked into the WeWork craze or the Silicon Valley craze. That’s doing master leases to tenants with no credit quality like WeWork, that’s something that we’ve avoided since inception, and we will continue to avoid. The next one is office with significant rollover. We’re not afraid of office today and we can talk more about that, and why we’re not afraid of all office. But we’ve been afraid of office with significant rollover for years. What tenants are going to come in and replace those tenants? We’ve questioned that for a long, long period of time.

The other thing that we’re afraid of is retail unless it’s Main and Main. We’re not afraid of retail the way a lot of investors are, but the reality is that retail is significantly overbuilt. We just have way too much of it around the country and we have a lot of big-box retailers like the old K-Mart, the old Sears boxes that are not functionally working, they’re functionally obsolete. But we do like retail in Maine and Maine. Given that it’s out of favor, cap rates are higher and given where interest rates are, retail can be a great place to find strong cash on cash returns. But you have to be very, very careful about where it’s located. The next one is hospitality. We hate hospitality. Hated it before the pandemic, certainly hate it during the pandemic, and I expect that all hate it after the pandemic. Clearly, there are deals to be done today, given just how much distress there is in hospitality. If you’re willing to stomach that risk, if you’re an operator in hospitality, there are certainly some amazing operators. But I still believe it’s the worst risk-adjusted return in any real estate asset class that you could think of. You have nightly tenants in hospitality, it’s an operating business, and I don’t think that you’re paid for the risk of that operating business generally. Thankfully, we had almost no exposure to hospitality when COVID hit, and it’ll go down as the worst-performing asset class during COVID. Even though there are a ton of investing opportunities in it today, I still don’t like it.

We’re also worried about the impact of insurance costs rising in markets like Florida and Texas, predominantly due to climate change. You look at Texas right now, I just got a note this morning that we had a pipe burst due to the cold freeze that’s happening in the Texas market. You can underwrite for this. But when I see standard 3% increases in insurance expenses year over year, this is a red flag for me. Insurance costs are going to go up until there is government intervention. I think that if we can’t get control on climate change, we will see government intervention. But for now, we want to make sure that insurance costs are being modeled appropriately.

The other red flag is modeling a refinance with Fannie or Freddie that is less than 4.5% or 5% interest, two to three years out. I wish I had a genie bottle to know where interest rates are going to be, but I don’t. In the absence of concrete data, we don’t think it’s prudent to guess where interest rates are going. I don’t like business plans where it’s a value-add business plan, it’s being acquired with bridge debt, and then there’s an assumption in three years that you can replace that with Fannie or Freddie debt at 3%. That’s just not going to fly, even if we get lucky. That’s where interest rates are three, four, or five years out from now; not something I’m comfortable seeing in underwriting.

The other thing that makes me really afraid, is sitting in cash when inflation starts to rise. That is the single best way to lose purchasing power. Personally, I’m trying to get capital out, I don’t want to be sitting in cash; of course, I always have cash for a rainy day, but that’s something that makes me afraid. It makes me afraid for a lot of Americans and a lot of investors who are going to see their purchasing power decline when we start to see more inflation, and the Fed has said that they want to start to encourage inflation; they’re actively trying to encourage inflation.

Alright, switching gears to be a little bit more positive here. Where do we think that there may be an opportunity? Well-occupied apartments with reasonable bad debt, financed with long-term, fixed-rate debt. This has really been the bread and butter of how investors haven’t used the Realty Mogul marketplace to invest, pre-COVID and post-COVID. I’m a huge believer in apartments, I think that they are some of the best risk-adjusted returns in real estate. Even though the pricing has been bid up, even though cap rates have come down, I think that it is one of the safer areas to invest in commercial real estate. But you have to look at the bad debt. We sometimes will see operators bring transactions that they want to use the Realty Mogul platform for, and it has terrible bad debt during COVID.

There’s an expectation that with better property management it’s going to get better, with the rent relief bill we’re going to get that money back… I don’t like that story. I’m not afraid of bad debt today, 2% to 4% bad debt is kind of where our portfolio is running. The economics of that portfolio still work even with that kind of bad debt. Hopefully, you can get a little bit of a discount off the pricing because of that. But I am very cautious of bad debt today and where that property has performed during COVID. We’re big, big believers in long-term fixed-rate debt. Debt is incredibly cheap today compared to where it’s been historically. We don’t know where it’s going to go, but if we can lock in that interest rate and we know what the underwriting is on a long-term fixed rate debt, that gives me a lot of comfort.

This next bullet was on my “where we’re afraid” last year at the Best Ever conference, and now it’s on my “where there may be an opportunity.” That is new construction in growth markets with a late 2022, 2023 delivery, even better if the costs are fully negotiated and locked in. We believe that construction costs are going to rise, and we believe that transactions that are just about to go vertical, that already have their costs locked in, are going to have a significant advantage to new construction in 2024, 2025, 2026. We are investing in new construction, we’re investing specifically in growth markets that we believe in, but we’re also investing in some markets that we believe are going to recover in 2022, 2023, 2024 that are hard hit today. Where we wouldn’t want to buy existing apartments there today, but we’re interested in doing construction projects that are going to deliver in 2023 when we expect the market to recover.

I’ll walk you through a couple of examples of those. We also like growth markets – Austin, Dallas, Denver, Raleigh, Charlotte, Columbus, Phoenix, Jacksonville, Salt Lake City, Nashville, growth markets, people are moving, positive demographics, jobs are moving, markets that we want to invest in. I mentioned on the last slide that we’re not afraid of office, so we like office with long term credit tenants, and a functional need to be in office. As an example, we have the DEA as a tenant in one of our properties. It’s hard to imagine that the DEA is going to work from home, so that’s a tenant that we like.

Triple net with great tenants, I’ll walk you through two examples of that. Retail at Main and Main, ideally trading at a discount; and not yet, but NYC, LA, and Miami in 2022 and 2023. These are some of the hardest hit markets during COVID, they are some of the greatest rent declines during code, and yet we believe that people are still going to live in cities. People are creatures of habit, people are social creatures, they’re going to want to be back in cities at some point in time.

Break: [00:20:13][00:23:10]

Jilliene Helman: With that, I thought it might be fun to quickly go through the deals that we’re invested in via the Realty Mogul platform since COVID hit, to give you a sense of the type of deals that we felt comfortable offering up to our members in the heart of a pandemic. To be clear, none of these are available for investment, there’s no sale of securities, you can’t invest in any of them. But I wanted to give you a sense of the types of deals that are sort of — the crystal ball that Ben was talking about. These aren’t even crystal balls, these are deals that we did in the heart of COVID.

The first transaction is a deal called NV Energy. Now, people may think that we were totally crazy, but in the middle of COVID, June 2020, we did an office deal in Las Vegas, Nevada. What could sound stupider? Las Vegas, Nevada, heavy, heavy, heavy hospitality market, very challenging, obviously, for job creation, and for the economy. When travel was getting shut down, when people were not choosing to travel, we did an office deal in the heart of Las Vegas, Nevada. Now, how did we get comfortable with that and why did we make that decision? This is an office building that is leased to NV Energy, which is owned by Berkshire Hathaway. It provides energy in the state of Nevada and elsewhere. There are nine years remaining on the lease, we got fixed-rate debt at 4%, and there’s double-digit cash flow. At the end of that nine years, investors will have 100% of their principal out and will still own the property. Pretty good risk-adjusted return from our perspective.

We did another triple-net deal in the heart of COVID, closing Q2 2020. This was a triple net medical office deal leased to Covenant Health, 10 years remaining on the term, fixed-rate debt at 4.15%, double-digit cash on cash returns, and strategically located right by the hospital. They cannot afford for a competitor to come in and lease that space from us. So it’s strategically located, long term, and leased to medical. As we all know, medical has been doing okay during COVID.

The next one, a two-pack portfolio of apartment buildings in Dallas, Texas. I think that this deal and the next deal are probably the main COVID discount deals that we got, to be completely honest. A lot of uncertainty around apartments in that Q2 timeframe – these close in Q3 – but a lot of uncertainty around apartments. That is not the case today. Apartments are well bid up, it’s incredibly competitive, multiple offers, hard money at the signing of PSA… But I think that this deal and the next one was exceptions. Parks at Walnut, 308 units in Dallas; that’s a growth market, there’s been huge, huge job creations and new companies that have announced that they’re moving into Dallas pre-COVID and even post-COVID, and fixed-rate debt at 3.06%. I think this is one of the cheapest loans in our entire portfolio across 15,000 units that have been transacted on the Realty Mogul platform. This is a value-add strategy, so testing the market with value-add, going in, making sure that the market can bear it even during COVID, and then renovating those units.

Very similar is this transaction, 9944, that was also closed during COVID. A very similar story, right next door to Parks at Walnut, fixed-rate debt at 3.18%. Again, very, very cheap. The ability to generate meaningful cash on cash returns because of how cheap that debt is.

The next transaction, Casa Anita, 224 units, closed in Q4. This is in Phoenix. We like Phoenix, Phoenix is a growth market, testing renovations, renovations are turning, and excited to be in Phoenix. We hadn’t done a lot of transactions in Phoenix, we couldn’t find the right transaction. But we found it in Costa Anita and we like Phoenix a lot. We think Phoenix will continue to be a growth market. I think Phoenix was one of the best-performing markets during COVID from a rent growth perspective.

Next one, Gravity [unintelligible [00:26:47].12] This is a deal a year ago that we wouldn’t have done and, this year, we’re excited about it. It’s a ground-up development transaction in Columbus, Ohio. It’s planned to be stabilized in 2024, so we expect the economy to be in a very different place in 2024. 382 units and mixed-use. We’re very excited about this, we’re excited about Columbus, which is another growth market, and a transaction, again, that we would not have done a year ago, that we are open to doing today, and that we’re excited about doing today.

The next one is another deal just outside of DFW in Plano, Texas, built in 2000, 73 units, stabilized asset, hold it for cash flow. The next one is very similar – Turtle Creek, Fenton, Missouri, 128 units, 2018 build, completely stabilized, 12-year fixed-rate debt at 3.10%. The business plan here is to set it and forget it, generate cash flow, hold the asset, do a little bit of renovation with tech packages, so putting in USB ports, but not a lot of work here. Really hold it, set it and forget it, and take advantage of that long-term fixed-rate debt that is incredibly cheap.

Next one, Toluca Lake Apartments, a ground-up development deal in Los Angeles, California; delivery in early 2023. This is also a deal that we would not have done last year or the year before. Had we done it last year or the year before, we probably would have delivered right in the heart of COVID. That was very concerning to us 12 to 18 months ago. Today, with the delivery of late 2020 to early 2023, we think that the economy will recover, and we think that there will be a good opportunity to get back into primary markets – LA, New York, Miami – for 2023.

That leads me to just reiterating lesson number seven, which is to take a position. I shared at Best Ever Conference last year that the first-ever deal that I did was a duplex in Compton in 2013. I started Realty Mogul eight years ago; had I never taken a position on a duplex in Compton and I had a crowbar in the backseat, I never would be where I am today. I wouldn’t have built the real estate portfolio that I have personally, and I wouldn’t have helped a lot of investors all over the country use the Realty Mogul platform to build their own real estate portfolios. It’s so incredibly important to take a position and overcome your fear.

One of the things that I learned in COVID was it was incredibly mental to say “We’re going to get back in the market, we’re going to take a position, we’re going to take risk. WEe’re going to find transactions that we think are the best risk-adjusted return transactions in the market today, but we’re not going to sit on the sidelines.” In any real estate cycle, including COVID, including the 2008-2009 recession, there’s always an opportunity. Whether it’s distressed debt, whether it’s buying apartments, whether it’s buying distressed hospitality if you have the stomach for that; there’s always an opportunity, but you have to take a position, you have to know that the proforma is going to be wrong, so you want to stress-test it, and you want to play defense before an economic crisis, not during it.

I’ll leave you with the lessons learned with $2.8 billion of real estate during COVID. I hope this was incredibly insightful and helpful as folks look to manage their own real estate portfolios or get into real estate deals today. There will be another economic cycle. I don’t have a crystal ball and I don’t know when it will be, but there’s an opportunity to prepare today, even for the next economic cycle. I’ll leave you with one disclaimer, because I should. Whether you invest directly or indirectly, there’s still a real risk to investing in commercial real estate. Things do not always go right; all proformas are wrong. Real estate companies can surprise you and disappoint you. The Realty Mogul platform gives investors the opportunity to discover investments that used to be out of reach for most, and you can use it to create your own diversified real estate portfolio.

I won’t always be right, we won’t always be right, but discerning investors deserve a discerning investment platform, so we built one at Realty Mogul. I’m so pleased to share some of our investment thesis with you and share some of the transactions that we did in the heart of COVID, that I think are representative of the types of transactions that we’re going to continue to look to do as COVID continues and as the economy starts to recover.

Joe Fairless: Well, I hope you gained some useful insights and actionable advice from this previous Best Ever Conference session. Remember, if you’re looking to scale your investing in 2022, we look forward to seeing you in Denver. Get 15% off right now with code BEC15 at besteverconference.com. That is code BEC15 for 15% off at besteverconference.com.

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