February 14, 2022

JF2722: 3 Benefits to Investing in Mixed-Use Developments ft. Sam Bates


In this episode, Sam Bates—CEO and Founder of Bates Capital Group—shares the advantages of investing in mixed-use developments. He also walks us through the details of his first commercial development deal, the challenges he’s faced, and how he scaled his business to $190M in AUM.

Sam Bates | Real Estate Background

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Ash Patel: Hello Best Ever listeners. Welcome to The Best Real Estate Investing Advice Ever Show. I’m Ash Patel and I’m with today’s guest, Sam Bates. Sam is joining us from Dallas, Texas. He is the founder and CEO of Bates Capital Group, which has $190 million of assets under management. Sam has a 12-year track record of real estate investing experience. Sam, thank you for joining us, and how are you today?

Sam Bates: I’m doing great, Ash. Thank you for having me. Looking forward to discussing real estate with you.

Ash Patel: It’s our pleasure. Sam, before we get started, can you give the Best Ever listeners a little bit more about your background and what you’re focused on now?

Sam Bates: Definitely. From an early age, I was always intrigued by money and started investing when I was 11 or 12 with the help of my grandpa. I went and got my undergrad in finance, worked at UBS as an investment analyst, and thought I was going to do that for the rest of my career. I decided to go back and get my master’s in personal financial planning, and I got an MBA during that time period. I quickly realized that the financial planning route – they said they’re fiduciaries, but they aren’t. They just stick people in the same investments, or at least back then, if they had 250,000 or 10 million. After the stock market crashed in ’08, I realized I needed to find another avenue and I started investing in real estate. I love real estate, just because you can truly add alpha. People in stocks and equities talk about adding alpha, but I feel like buying assets or developing assets so you can surely add that return that people can’t get in an investment. I think that’s why syndications and private placements are so great.

Now we’re focusing on acquisitions, developments on multifamily, we develop single-family, we do lot developments, we do a lot of different things. We’ve owned some commercials, RV parks… So just anything where we can find value, we’ll look at it.

Ash Patel: That’s a lot of ammunition you just gave me. Can you explain to our Best Ever listeners what adding alpha is, or chasing alpha?

Sam Bates: Chasing alpha is basically providing more return than what the index or the market can give. The higher the alpha on a stock, the higher the return probability is, but also the higher, essentially, the volatility is. I think with real estate, you can correlate it — especially if you have a stock portfolio, you can correlate it where it’s actually more diversified and create higher returns than you might just with a regular mutual fund or ETF portfolio.

Ash Patel: Thank you. Sam, can you give me an idea of the timeline from when you got into the finance industry – how many years later was it that you got into real estate?

Sam Bates: I started in 2005 at UBS, and then I got my master’s, and I was in consulting actually, doing tax consulting and optimizing business operations for a few years, and I started investing as a limited partner in 2009, then did a lot of single-family homes on my own, the BRRRR strategy, fix and flip… I did a development, and I realized that you couldn’t scale in single-family as you can in multifamily, so I transitioned to multifamily as a general partner in 2016, and have been doing it for six years.

Ash Patel: Got it. Sam, you walked away from a pretty lucrative future in banking, being a personal financial planner, very well-educated. Was that a hard decision, to leave all of that behind?

Sam Bates: It was, but at the same time, I didn’t feel fulfilled, honestly. I knew that there had to be a better way to, I wouldn’t say make a living, but just to enjoy life and to make an impact. Ever since I was little, I’ve always wanted to make an impact. I grew up on a farm, where everybody in the community was farmers, or very blue-collar people. I didn’t quite understand business at that time and I always thought you only could make an impact being in the medical field. For a long time, I thought it’d be a doctor. But now I’ve realized that the US, and really the world in general, needs a large helping hand with financial literacy. We don’t get that from our educational systems. Luckily now, with podcasts like yours and all these other podcasts that have popped up on educational platforms, people are getting more educated on how to invest. But the mass majority of people still have no clue on how to invest. I love being able to share my wisdom about real estate or other private placements that they don’t know anything about.

Ash Patel: Sam, I’m glad you shared the issue with being a fiduciary. I’ve had the luxury of interviewing a number of former financial advisors and planners, and I always ask them, “When you were in the finance industry and you found out how great real estate investing is, why didn’t you recommend that type of investing to your clients?” Most of them, right off the tip of their tongue, will tell you, because there was no way for them to make money on it. There are no kickbacks, there are no instruments where they get bonused on how many real estate investments they put their clients in… So what a huge gap that they have there.

Sam Bates: Yeah, that’s exactly the case. I think they don’t get compensated, so they aren’t going to recommend clients into that. Also – and this was myself when I was a financial analyst – most of them don’t understand real estate. Financial advisors are glorified salespeople, and they’re trying to push a product, sell a product, and every sales position has numbers they have to hit, and financial advisors have to hit different numbers. I saw 15 to 20 people will get fired because they weren’t hitting numbers in a couple of years. So it’s more about meeting those goals and objectives than truly doing what’s right for the client, unless you own your own RIA or small investment firm; but the big brokers, it’s all about numbers.

Ash Patel: Just churning and burning.

Sam Bates: Exactly.

Ash Patel: Did you leave your career after you became successful in real estate, or were you in the beginning phases of it?

Sam Bates: I spent 12 years basically in corporate America, and I was doing it in tandem. After grad school, I worked at a consulting job for five years, then I worked at an energy company for five to six years, doing tax planning, tax strategy, business optimization. Concurrently, I was invested in real estate, because I didn’t want to stay in tax for the rest of my career. I saw how lucrative real estate could be, and I saw the freedom it gives… When I say freedom, I don’t necessarily mean time freedom; I spend as much time working in my business now as I do than ever. But I’m spending two months in Colorado, where if I had a job, I couldn’t do that. It just gives you a lot of flexibility, and you get to make an impact. Hopefully, the investors that you bring up, and essentially create a better life for them, will also help invest in different organizations, charities, or whatever that they think is worthwhile and suits them.

Ash Patel: Sam, a great little nugget of knowledge there. A lot of people might have the misconception that if you get into real estate, you can work a lot less. But most of the people that I know work a lot more than they did in the corporate grind. But it’s just a lot more fulfilling, a lot more satisfaction.

Sam Bates: I completely agree. I think a lot of the “gurus” or people that are trying to sell a program say you just have to work two hours a week, five hours a week, or whatever. And maybe you can do that if you have a portfolio and it’s stabilized. But I feel like if you have investor money, it’s your fiduciary duty to make sure you’re getting the best return; and I also want to grow the business and grow the company. I’ve worked a lot, but I enjoy it. I’ll tell anybody that if they’re wanting to get into real estate, don’t get in it for just the money, because you aren’t going to make money right away. You should follow your passion and follow whatever you like and enjoy, because you’re spending 50, 60, 70 hours a week maybe on working whatever business or career you decide.

Ash Patel: We’ve both been in real estate for over 10 years, and we’ve seen those people that did it for the wrong reasons not have the staying power. You truly have to be passionate about this to make it a success. So yeah, great point. Did any of your former financial colleague’s defect with you into real estate?

Sam Bates: Not to my knowledge, but I’ve had quite a few different former colleagues and clients invest with me as a limited partner. They’re still doing their W2, in either a finance job or accounting tax job, but they’ve started to invest with me. I think it just shows… It’s interesting how some financial advisors will invest with me, but they’re telling their clients to invest in the stock market.

Ash Patel: I introduced a really good friend of mine who is a very successful financial advisor… And I told him about Joe Fairless and these syndications that I’m investing in – this was years ago. I just made an introduction, they had a meeting, and then my buddy calls me and he says, “Wow, what an incredible opportunity.” I said, “Are you going to put your client’s money in it?” He says, “Ash, I have no way to get paid on these deals, but I’ll put my own money in it.” So yeah, good point.

I’ve got to ask you, you have $190 million of assets under management, and all we’ve talked about is you investing in a couple of single families and one syndication. So if you don’t mind, give me the journey of how you got here.

Sam Bates: Well, I started looking for multifamily back in 2014, and for the first year and a half or two years, we weren’t winning any deals. We were told that we were too young – because, at that time, I was in my late 20s to early 30s or something like that, and they didn’t trust that we could close. After about two years of banging my head against the wall, I partnered up with a couple of guys. One had development experience, and our first syndication was a mixed-use development of 60 apartment units and 10,000 square feet of retail space. That went really well. Since then, I’ve been a general partner on 14 projects, mainly multifamily, but some, as I mentioned earlier, just different asset classes, mainly in Texas and throughout the Southeast.

Ash Patel: What types of asset classes?

Sam Bates: Mostly apartments and multifamily. I have 1025 units of multifamily throughout Texas and the Southeast. But we have done commercial development, and we’ve done some lot developments. I just bought into a company that they build about 150 homes a year, and we’re going to try to scale it to 1,000 homes over five years. So just dipping my hand in different pots to diversify and hopefully give myself and investors more diversification than just investing in the standard B or C class multifamily acquisition.

Ash Patel: Well, let me play devil’s advocate. What do you say to those people that tell you to be hyper-focused on one thing? You’re all over the place.

Sam Bates: Yeah. Well, I think real estate, especially multifamily acquisition development is very similar. If you understand the details, you can understand it from a high level. But I’ve always surrounded myself with great partners. I have four partners, one’s been a developer for almost 30 years, one was [unintelligible [00:15:06].11] and worked in tax with financial institutions, one is an attorney and used to work in private equity, my other partner is an investment banker… So we bring a wealth of knowledge, and I feel like there’s not one thing we can’t figure out. I know it’s good to focus — they say the riches are in the niches. But at the same time, I feel like we can look at other asset classes. In one of our developments, we 4X-ed our money, and on an acquisition you aren’t going to do that in today’s day and age.

Ash Patel: I agree with you 100%. I will look at anything that makes money. I don’t care if it’s real estate, a startup, or anything. I agree with you. You mentioned that in 2014 you weren’t winning any multifamily deals. Looking back, with all of your experience now, why was that? What were you doing wrong?

Sam Bates: Two things; they always say the first deals the hardest to get. I will say that, because if you don’t have a track record, brokers are going to take a chance on you. Also, back in ’14, the masses were saying we could have a correction in ’16 or ’17. So I’ve always been conservative, and that’s why we only take down a couple of deals a year. But my underwriting was very conservative back then, and if I just knew what from ’14 to now would have held… Hindsight is 2020, but we were looking at deals in DFW for 30,000 to 50,000 and we thought that was high. Now those same deals are probably showing at 150k.

Ash Patel: Well, you weren’t alone; a lot of people had the same fear of an economic collapse a recession. But you got over that. If you were to give some of the Best Ever listeners advice, that are looking for their first deal, and you don’t want them to repeat what you did, what would you tell them?

Sam Bates: I think you need to be obviously tenacious, because you’re going to have pitfalls and you’re going to have struggles that you have to jump over. But what we didn’t do and I wish we would have done was to talk to experienced people. We were doing a lot of underwriting with rule of thumbs, and it just wasn’t working. If we could have tweaked our underwriting, reduce expenses, or increased income a little bit more and not be as conservative as we were, we probably would have got several deals that year. But I’m glad, because I’ve been able to get into development. I think if I would have gotten a few acquisitions, I would have never gotten into development, and I would have never met a couple of partners that has changed my work life, by far, for the best.

Break: [00:17:44][00:19:54]

Ash Patel: Sam, your first deal was a big development deal. Can you walk us through that?

Sam Bates: Yes. We did a 60-unit apartment and 10,000 square feet of retail space. We sold off the retail space pretty much a year and a day after it was occupied, just to pay long-term capital gains instead of short-term capital gains. But we still have the 60-unit apartment. It’s in Kerrville, Texas and it’s been a phenomenal deal.

During the development process, there were a lot of struggles; that year, during the development phase, it rained a significant amount, so we postponed some of the development timelines we had. We had to fire a contractor, we had to fire a property manager… There were just a lot of hurdles we had to cross. But once we provided a great return to our investors on the commercial side, we refinanced and provided our investors over 100% of their initial capital back, now it’s cash flowing. We’ll probably hold on to it for another 10 or 15 years and just continue to cash flow. It’s in a very stable market, it’s in a market that has a high demand for apartments, so we’re always that 98% to 100% occupied, and it’s a very easy asset to manage.

Ash Patel: What was the time difference between when investors funded the deal to when they got 100% of their money back?

Sam Bates: That’s actually a good question. They funded probably in March or April of ’16, and then we sold the commercial deal in July of ’18, and then we refinanced the apartment in November of ’18. So two and a half years or so.

Ash Patel: How did you find tenants for the commercial property?

Sam Bates: Luckily, we had two tenants before we built it out. We built a suite for Keller Williams, it was a triple net lease, and then a gym which was going to be an Anytime Fitness gym, but the owner decided to back out, so we brought in another gym, and it was also a triple net. We had leases and we had gradual rental increases per square foot over every couple of years. We were planning on holding on to it for five to seven years, but we got an offer that met our seven-year projection, so we felt like it was a good time to sell.

Ash Patel: Sam, you guys profited tremendously by selling brand new commercial units with fresh leases in them. Why not do more of that?

Sam Bates: That’s not our bread and butter. The Keller Williams triple net leases – we’ve done a couple of them and those have fallen into our laps. But nobody on our team is out there looking for retail clients or retail land. I’m more of a multifamily expert, so we’ll do it… We’ve built office buildings, we’ve built medical complexes, but it’s usually when the tenants reach out to us.

Ash Patel: And when you say Keller Williams, was it Keller Williams Realty, or did they have a client for you?

Sam Bates: It was Keller Williams Realty.

Ash Patel: Okay. They set up an office there.

Sam Bates: Yeah, they set up an office in the building.

Ash Patel: And right now, while multifamily is trading at very low cap rates, why not consider selling?

Sam Bates: We’ve actually sold four or five deals in the last couple of months. I think it depends on the whole period. We just sold a deal last Friday that we held for two years. We were planning on holding it for five years, but we’re able to do a 54% IRR to our investors, so it made sense. But there’s some other deals we’ve done with joint venture partners that we knew from the get-go they’re going to be legacy assets that will hold 10, 20, 30 years. So I think it just depends on the plan and who your investors are. When you do syndications, it’s harder to hold longer, when you have 30 or 40 investors or 100 investors. Obviously, everybody has different ideas and conflicting ideas. Usually, syndications are being held for a lot shorter duration than maybe a joint venture or something that you do on your own. But I was actually reading an article this morning that’s saying experts are predicting most real estate bills to be held for double or triple the time that they have currently been. This is because of inflation, unevenness, or unknowing of what the future might be.

Ash Patel: Sam, a crazy mixed-use development, a huge project – how did you get investors for that?

Sam Bates: That was, by far, probably the most difficult raise we’ve had. But we went to friends, business colleagues, and a couple of family members. All of us that were the GPs in that deal had a 10-year track record or longer of experience as a professional, and we had built credibility in other industries where they felt like they could trust us with their money. It paid dividends and I think we’ve compensated them, reimbursed them significantly for it. On that deal, we didn’t take any fees, we didn’t even take an asset management fee, the split was 80/20, so it was very favorable to the investors.

Ash Patel: The split was 80/20 to the LPs.

Sam Bates: Yes.

Ash Patel: Was there a preferred return?

Sam Bates: No, there was no preferred return, but there wasn’t an acquisition fee, a development fee, or an asset management fee. We did the construction at cost, so it was very investor friendly.

Ash Patel: Have you continued to use that model in the future, or has it changed?

Sam Bates: Our structures change significantly depending on each deal. We’ve done joint ventures where it’s 50/50 splits, we’ve done 80/20 with no pref, we’ve done 70/30 with a pref, we’ve done 60/40 with a pref; it just kind of depends on the structure of the deal.

Ash Patel: That’s a very impressive property that you guys built. What were some of the hard lessons you learned?

Sam Bates: I think the hardest lesson was — it was five hours away from us, and working with new people that you hadn’t trusted or had a relationship with before… Even though they’re recommended, they didn’t turn out to be what they said.

The first property management company, we fired because we found out she was in essentially embezzling from us. We were going to give her the lease-up bonus, but she took it before we gave it to her and she took it without asking. She just took it from our operating funds. We had to fire her for that. There are just a lot of lessons. The cable issue, the property management company was going to take care of it, but we learned that they didn’t take care of it, so we had to go and reach out to the cable provider. It was probably a 60-day back and forth that occurred during the lease-up, but it should have been done before the lease-up. There was just a lot of things where we learned that we need to have better controls and better checklists to make sure everything was getting done on time and according to plan.

Ash Patel: Would you develop a mixed-use building again?

Sam Bates: Oh, yeah. At least half of my projects have been developments. We have for developments in our pipeline this year. All of them are multifamily, except one, which is multifamily and single-family subdivision. But if a mixed-use development came open, I would definitely entertain it.

Ash Patel: Alright, Sam. You were skeptical about the economy four years ago; you have to be more skeptical today. How are you preparing for what could come?

Sam Bates: That’s a really good question, and I wish I had a crystal ball. Back then I was probably more skeptical, honestly, than I am now, because I just didn’t know as much as I know now. With the Fed and the other governments around the world printing $40 trillion in the last couple of years, I don’t know how the economy is going to go in the future. I think a lot is going to depend on the midterm elections, and then maybe even the election in 2024. I’ve listened to a lot of experts and some think that we’re going to go through a continued expansion until maybe the end of the 20s. That just seems crazy, since we’ve been in an expansionary time basically since ’08 to ’11. To have 20 years of good times is hard to believe. So I’m not going to predict if it’s going to crash or not. But to answer your question on how to hedge against it, I’ve become very selective in acquisitions.

I think people that are paying three or three and a half caps on the 1970s and ’80s deals, they could get taken out if the tide changes. We’re focusing more on developments. People say that developments are risky, but I could easily argue it’s a lot less risky, and we de-risk the investments when we can build at seven, eight, or nine caps, and sell it at four or five caps, or even three caps in some markets. I think you just have to be cognizant, you have to be a fiduciary, and pay attention to the markets. Each market is different. Dallas is different than Atlanta; those are two of the markets we invest in.

So I think you just have to have intimate knowledge of each market. One thing I’ve learned over the years, and it’s happening a lot now, is people are trying to get as highly levered as possible. They’re taking out bridge loans, putting on pref or mez, and they’re levering up to 90%. I think that could be a monumental failure for a lot of syndicators. So trying to have the right debt and just making sure you can cash flow throughout any correction.

Ash Patel: Sam, what is your best real estate investing advice ever?

Sam Bates: That’s tough. There’s so much. I would say be educated, surround yourself with great and experienced people, and just be passionate and focused. If you stay focused and surround yourself with great people, you can do some great things.

Ash Patel: Sam, are you ready for the Best Ever lightning round?

Sam Bates: Yes, I am.

Ash Patel: Alright, Sam. What’s the Best Ever book you recently read?

Sam Bates: The most recent book that I think changed my life is Who Not How. I’ve always been a person that’s a doer but now I’ve realized that I can’t keep doing everything if I want to grow and expand. We’ve brought in a lot of employees over the last six to 12 months and it has taken a lot off my plate. I can focus on the $2000 an hour task or $250,000 task, instead of a $15 an hour task.

Ash Patel: Sam, what’s the Best Ever way you like to give back?

Sam Bates: There’s a lot of different charities that I like to give back to. I’m a Christian so I support the church I go to. Also, there’s a friend from high school and then some nonprofits that I met in Dallas that focus on a lot of different areas, economic empowerment, child slavery, women slavery, expanding the Gospel. I give back in a lot of ways. I also talk to people who are interested in real estate, I know everybody has to start somewhere. When I started back in ’08 or ’09 reading books, I knew nothing about real estate so I like to help people expand their horizons.

Ash Patel: Sam, how can the Best Ever listeners reach out to you?

Sam Bates: You can reach me at batescapitalgroup.com, or by email at sam@batescapitalgroup.com.

Ash Patel: Sam, thank you again for sharing your story with us. Coming from the financial industry, having your master’s degree, being a personal financial planner, then finding real estate, and having $190 million of assets under management. Thank you again.

Sam Bates: Thank you for having me. It was a pleasure.

Ash Patel: Best Ever listeners, thank you for joining us. If you enjoyed this episode, please leave us a five-star review and share this podcast with someone you think can benefit from it. Please also follow, subscribe, and have a Best Ever day.

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