June 13, 2023

JF3204: Pros and Cons of Value-Add vs. Ground-Up Development ft. Christopher Stout



Christopher Stout is the principal at StoutCap, which acquires high-performing assets in growing Southern markets. In this episode, Christopher discusses how he leveraged his experience in construction to garner success in value-add multifamily investing. He also shares the biggest struggles he’s encountered operating in a landlord-unfriendly market as well as advice for investors looking to get into development or bring construction in-house.

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Christopher Stout | Real Estate Background

  • Principal at StoutCap
  • Portfolio:
    • 479 units 
  • Based in: New York, NY
  • Say hi to him at: 
  • Best Ever Book: $100M Offers by Alex Hormozi
  • Greatest Lesson: Keep your foot on the gas as if it’s the hottest real estate market ever. That way, when deals start to pop up, you’ll be in line for them.

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Slocomb Reed: Welcome to the best real estate investing advice ever show. I'm Slocomb Reed and today I'm here with Chris Stout. Chris is joining us from New York City. He is a principal at StoutCap, which acquires high-performing assets in growing Southern markets. His background is a full-time career in construction. His current portfolio includes 479 units. Chris, can you tell us a little bit more about your background, and what you're currently focused on?

Christopher Stout: Absolutely. So my main focus is apartments. It always wasn't my main focus, but I've been in apartments for a long time. So I started buying apartments in my early 20s, and I did that through prophets of construction. So I started my construction company, doing remodels, kitchens, baths grew it to be a custom home building company, and then grew it to be a development company within the city.

So in order to grow it to that level, I needed investors. Obviously, everyone knows development is a very capital-intensive business; a lot of money needed to build homes. So I leveraged the relationships from my remodeling and custom home building business into investors. The investors knew that I took all the profits from all the business I did in my life, and I put it into apartments. I single-handedly acquired apartments up until about four or five years ago, I was buying apartments completely by myself, and my investors were on my development side.

One of my investors said, "Why don't you let me enter your apartments?" I'm like, "Yeah, that's for me. That's my family. That's for future down the road." I went home that night, I was like, "I think that was a mistake." So I had a deal going on at the time, and I was like, "You know what - jump in this deal." It was me and him. He was an LP, and I was the GP. And grew it from there.

So I still have a development company in New York. My main focus is the apartments and the syndication business. So I basically just took what was second, put it first. And the development, I have a pipeline of homes that need to be constructed within the area; it takes a long time to get all these things approved, so it is a fairly good lag on development. Kind of why at this time today we're not ultra-excited about getting into apartment development, just because of that lag time between the acquisition and the last lease being signed. But as far as development to sell within New York, just because of the pipeline, I keep it going. But apartments are the number one concern.

Slocomb Reed: That's awesome. Chris, a couple of questions here... You said you took your profits from your construction company and were buying apartments with them. You were buying existing, you weren't building apartments?

Christopher Stout: That's correct. Yeah. So I bought value-add properties within the New York City market at the time. When I started investing in New York City - and for anyone who's listening that is from New York, when you're brought up in New York, you think that New York is the only game in town, it's the only place to be putting money; nothing is happening anywhere else in the world. And then you start doing some traveling -- actually, what starts to push you out of New York is the terrible laws that are linked with this specific business. The specific business of renting apartments and the laws within New York City do not get along. It is not a good place to do it. I think you come back to New York when you could be renting apartments for North of 10,000 a month. When you're in ultra luxury in the absolute best locations within the city, that's a different ballgame. But when you're renting workforce or affordable type $2,500, $3,000/month apartments, you're in a real difficult zone, where if someone stops paying you, you're out of business for eight to nine months. And we're not even talking about COVID. We're just talking about regular non-COVID days. So it's a brutal environment to do business.

So it pushed me out, and now I'm out. So I still have some holdings within the city, but slowly exiting as good seller opportunities come along. But 100% of the future purchasing for me, the foreseeable future will be out of state buying, in places where we could do good business.

Slocomb Reed: And you're not building apartments currently, not due to lack of expertise. Clearly, you have that. It's because of how long it takes to get through apartment development?

Christopher Stout: Yeah, when you do the numbers, and you take into account what you can make on a development project, what you're able to do on a value-add... Because we're buying businesses, right? We're buying businesses in the form of real estate. So we're looking for good real estate, poorly managed, or someone who wasn't operating the business. There's always going to be an endless amount of people who do not have their eyes on their business. So to think that every single building that's owned within this country is being properly managed and the eyes are fully on it is a big mistake; there's always a void in the market, so it's our job to find that void. So no, I'm not building apartments, and I've looked at building apartments, we've gone deep into negotiations to purchase land for development... And the deeper we get, and when it comes time to actually pull the trigger, we stand back and we look at all the work we just did, and we're like, "This isn't going to be worth it." It's so much better to buy the apartment community down the block, that is still in a great area, and the owner, or the current sponsor, hasn't had his eye on fully. We pick that up, do a little change, and we're cash-flowing from day one.

So 18 to 24 months is still a very conservative number for apartment development, by the time you sign that last lease, or that last batch of 10 leases. We take all the time value of money into consideration, and it usually turns out for us, at this time, with construction [unintelligible 00:07:20.25] sellers expect to get for their land, it's still better to buy value-add, in our opinion.

Slocomb Reed: I want to dive into this a bit deeper, Chris, because typically when someone has a very highly valuable expertise to real estate like you have, they're looking to find ways to deploy that expertise to increase profitability. And you basically just said that you aren't doing that. Another way to put this is find the hard work that most people can't do, that you want, and you'll be able to find profitability there. You're not doing that either. You're buying the same thing that everybody else is looking to buy that doesn't have your expertise. Can you put some more numbers for us behind why the value-add deals have made more sense for you, then deploying expertise you already have to do more complicated deals?

Christopher Stout: Yeah, I could hit that in two angles, Slocomb. The first angle is I actually use my expertise to save us from making mistakes, more so putting us into a position where we have to do deeper work. So I am no stranger to work, and by no means am I afraid of going deep into something. But what I've typically seen as valuated deals, I could tell from a group of photos - because we obviously look at photos first, then we go tour a property... I could tell from a group of photos what kind of shape that property is in, and how the previous ownership or the previous couple ownerships have taken care of it over the years. I could tell if this asset has been lipstick on a pig three times over, and then they're trying to sell it, or it's been well maintained over the course of its ownership.

And what I've seen is when I'm trying to acquire an asset, the construction experience helps me bid properly on it. So after we acquire it, I'm not into a CapEx circle that I can't dig myself out of, where all of my cash flow is getting eaten up by work that I didn't notice when I went into it. So I think just by having the expertise that I have, it keeps us out of trouble more than getting us into a higher profitability situation. We just know what deals to attack harder; that everyone might be scanning all deals, and attacking them all with the same energy, we go after the ones we want with high energy. So that's the value-add side.

Then the development side, what we've noticed is with the construction costs the way they are today - and something that might be hurting us as our underwriting. Since I've began in business, I've always outperformed by underwriting. And sometimes I think I lose deals because of it, because I'm overly conservative on my underwriting... But typically,

when we look at development type deals we're building now today, with what sellers are trying to get for their land, and what it costs to construct them, we're in the neighborhood of a six and a quarter, six and a half cap on a really, really good day. And my opinion is, if we go after a really good value-add deal, so a deal that the structure and the bones of the building are good, that hasn't been endless amounts of renovations stacked on top of one another, that we could go in and we could be in business at a 7+ cap in a great market by the time we would even get permits approve on a new construction deal.

So by the time that we signed that last batch of 10 leases, we might have an asset that's worth five and a quarter to five and a half cap nowadays, we would have a good asset touching an eight cap that would be worth just south of a six cap, or right at a six cap. And we were cash-flowing for that period of time, and we were taking advantage of depreciation during that period of time, when our investors are almost more than a quarter way through the cycle of the deal.

Slocomb Reed: Unfair summary of what you just said, Chris, but effectively, you're seeing similar returns in the value-add deals that you guys have been getting, that you would have gotten with new construction. The value-add deals have way fewer variables and a much shorter time horizon to get to those returns. Is that fair?

Christopher Stout: Yeah. And we aren't ruling out development in the future. It's just what we've been seeing over the past 12 to 24 months. [unintelligible 00:11:30.15] construction expense rise. Although most construction debt is all floating rate, so we're taking that into consideration, too.

Slocomb Reed: Right. That makes sense. You're calling these value-add apartment deals - are you underwriting to the typical five-year hold, with a preferred return during the hold period, and a targeted IRR for investors?

Christopher Stout: Our investment term is simple - the most ideal investment for us, where we really hit the gas on a deal, is we want to be able to double the investor's money in six years. So our investment term is typically six years, and we want to try to get as close to 100% back at the refi between years two and three. So if we could get north of 80% of your money back between years two and three, and we hit a double by year six, that's a home run for us, and that's a home run for our investors.

And the way that we talk to our investors, and our investors really appreciate, is getting 80+ percent of their money back between years two and three; they're able to take that capital, redeploy it into another deal, whether it be ours or theirs or whoever's deal. Now that capital is working side by side in two separate deals by the time year three or four hits; working side by side, and now they're taking advantage of two assets that are depreciating, on and on. And that's basically our investment model.

Slocomb Reed: Chris, what are the most valuable ways that your experience in new construction has aided or improved your value-add apartment investing?

Christopher Stout: Like I was saying earlier, it actually keeps us out of trouble, and it also puts me into a position that I know not to over-improve. I know the simple things that make a large difference, and when we're getting involved in an asset, a lot of groups rely upon a PCR, Property Condition Report. They look at this report, and they'll either make a good decision or a bad decision based upon it. We get a property condition report for a formality of the lender, but for the most part, I went to the property already and I could just tell by looking at it what shape the property is in, and what it's going to need over the course of our ownership.

So I look at them, and I read them, just to make sure there's nothing that I missed... But for the most part, I'm relying on my visit, my site tour; I know exactly what the property needs. And from what I've seen, the properties that are good for me are properties that were poorly managed, good properties, that I could go and tell that they haven't been dogged by four or five groups that have owned it before me. And I could get involved with deals that will scare other people. So high, high value-add. I'm talking total vacate, empty 100 apartments and let's remodel the whole building. I could get involved on a project like that. But a mid-type remodel, or 50% renovation, or anything like that - we just simply can't pay enough for them, because other groups are underestimating what it takes to bring those communities back up to where they need to be.

Break: [00:14:26.11]

Slocomb Reed: Let's say hypothetical scenario or hypothetical real estate investor who happens to be very similar to me - has a goal of building an apartment portfolio long-term; that's long-term wealth building with cash flow. And this hypothetical investor who is very similar to me is also thinking that getting into construction now as a more active source of income that can be deployed into properties, but is also an opportunity to gain expertise in a very important arena of apartment investing... Someone like me is considering getting into construction or construction management as an active source of income now, for the sake of becoming a better apartment investor. What advice do you have, Chris, for an investor like me, who's thinking about getting a career like yours in construction for becoming a better investor? Is it worthwhile, and if so, what aspects of your construction background should someone like me be focused on in order to be a better apartment investor?

Christopher Stout: So if we're talking about starting to get involved with projects that need a certain amount of value-add, or even getting involved with apartment development; say that's just something you want to do - you have no past or prior construction knowledge, but you do want to develop apartments, so do heavy value-add deals... The largest, absolute light years ahead of any advice I could give, it's going to be make sure that you get involved with the right construction group before closing on the asset. Or before getting really involved in this type, make sure you stick within one market, because then you could work with same construction group; you're not trying to enter a new market every single time and trying to find a new group. So sticking within a market, knowing the construction groups there, and making sure that you do not pick the least cost construction group. So whether it be the value-add group, the guys who are good at remodeling, or the construction group that you're going to pick to actually do a new development for you - make sure you pick someone who has the utmost experience. Yes, their price will usually be a little bit higher than the guy who's just trying to get into it. We've seen it, we've spoken to them endlessly... And listen, I started in one spot, too. But it's not good to get involved with the guy who's just starting, or he just built a five unit and you want it to build 100 unit. His price is more attractive, it looks like the right group to use... Don't get tied up with that guy.

Like I said, it's tough to say, but there are some people in that realm that will perform for you, but we've seen it so many times that they don't, and it doesn't come through, and it winds up being burdensome upon the guy... Because really, remodeling or new construction, switching to that job is basically -- I wouldn't say impossible, but it's extremely difficult, because you need to get into the construction world. The previous contractor does not want to pick up where someone else left off, because now they own the whole job.

So get in and get with the right group, do your interviews, speak to people that have used them before, check their projects... They should be able to bring to you projects they've done, and the total cost of those projects. It's light years ahead of any information I could give you.

Similar to when you're looking for a property manager. A bad property manager could make a great deal go bad, or it could be so labor-intensive for the operator that you're down to making daily phone calls to them to make sure that everything's going well.

If you hire the right construction group, it should be as close as possible to set it and forget it. You tell it "Go build me these 100 units. Call me when they're done." Obviously, it won't go that deep, but you want to hire a group that would have the capability of doing that.

Slocomb Reed: I want to transition the conversation a bit here, Chris... You said you've always outperformed your underwriting, because your underwriting tends to be aggressively conservative. When did you acquire your last deal?

Christopher Stout: We acquired the last deal in November of 2022. And we're working on a deal right now. We will be closing middle of June.

Slocomb Reed: I assume you have that under contract though.

Christopher Stout: Yup, it's under contract. All the capital is in place for it. We raised about two and a half million dollars in about two weeks. Previous to that we closed on a portfolio of three deals, one after another. It was sold from a family in North Carolina, that the grandfather who acquired all the deals, about $70 million worth of real estate, passed away, left it to the family, and we purchased one asset after another. And they weren't selling it as a portfolio. We closed on one in September, October and then November, totaling about $32 million worth of assets; raised about $10 million for that. And then, as we all know, the market is very quiet right now, so we've worked diligently for the past couple of months to get this deal. This deals in Northwest Arkansas, closing on 56 units now; smaller than our typical deal, but that seems to be the deals that are alive right now, deals that you could find, people that have owned it for a long period of time.

My advice right now is to be able to bend from your typical investment strategy as far as maybe asset class or size. I wouldn't stray away from your principles. So as far as where you're flexing your underwriting, I don't advise changing that now, because you could get emotional and say, "We usually don't buy something like this, but let's do it." But I would advise being able to flex in what type of real estate you buy, because that's where you're gonna find the deals.

Slocomb Reed: Outside of finding deals the last 18 to 24 months that pencil out for your underwriting, what's been your biggest struggle in operating the apartments that you've acquired in the past few years?

Christopher Stout: Slocomb, I want to give you a really good answer on this, but I have to tell you that operations for us have been very smooth outside of New York. So I could say personally, some of the biggest operational struggles I've had being in real estate, or operating apartments, was operating in an area where the local government does not help us to support us, and is actually against us. And this is why I took the show on the road. My biggest struggles in operating apartments, and even my small portfolio here - I have about 53 or 54 units here in New York still, and it's slowly getting smaller. Like I said, we're unloading here. My struggle is being able to collect payment in an area that does not have our back. So operating in areas that are landlord-friendly has been a breeze. I guess it's because I started my business in one of the harshest environments to do business. So going everywhere else is a walk in the park. We're very, very on top of it, and we had to be that way, because of where I started. So basically all the assets we have now outside of New York performing wonderfully.

Slocomb Reed: I feel like you already answered the question... I'm going to ask it again anyways. Do you feel like your experience having to navigate the New York market and the complexity and the difficulty of navigating landlord-tenant law there - is that a major factor of what's made you such a good operator in other places, how dialed in you had to be in order to operate in New York?

Christopher Stout: Yes. So when I started, back when I was 24, I was blessed with some of the best tenants for years. And that's what kept me going, because I'm like, "This is great. I don't know what everyone's talking about. People are great, you just judge them by their personality." And then you start growing, and naturally, you get large enough where you start to slip a little bit... And we were just going by personality, and meeting, and paychecks, and we're not doing too deep of a search on the tenants... And you get that sour apple that is just a complete nightmare, unable to get rid of them. And you're like, "Oh, we've got to change our operations here." Where in other states, we are very diligent in who we pick, but it's not the complete end of the world if someone can't pay. And our unit count is much higher. So if we have 1%, uncollectable, we are okay.

So unit count is another thing that fixes this problem; when you operate with a smaller unit count, any issues are amplified. So absolutely, operating within New York and having to build this beast of an operation system, and taking that on the road has made us wonderful operators in other states, where they're actually on our side.

Slocomb Reed: That makes a lot of sense. Are you ready for the Best Ever Lightning Round?

Christopher Stout: Let's go.

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

Christopher Stout: I just read "$100 Million Offers" from Alex Hormozi. And it's a business book. Like I said earlier, we're buying businesses in the form of real estate. So the summary to Alex's book is you have to make your offers so good the other person feels stupid to not accept it. So in real estate, we're constantly making deals, whether it be with tenants, or we're making deals with property managers, or we're making deals with brokers or sellers to buy deals. And the way that I translated it is we create LOIs with numerous options of different ways that we're willing to buy assets. Just make offers so great that the other side feels stupid to not accept it.

Slocomb Reed: What is your Best Ever way to give back?

Christopher Stout: The way I like to give back is we will occasionally go to our sites and hand people one-month rent coupons. So the way we give back and we kind of double down on it, we're boosting morale in our apartment community. And wherever we visit, I have a book of coupons in my back pocket, and I'll hand out random coupons to people for one month free rent. I really like the way it feels just to see someone's expression when they're just walking out of their car, when they're walking to their apartment and someone walks up to them and gives them 1000 bucks. It's a good feeling for everybody.

Slocomb Reed: That's awesome. Chris, on the properties you've actually acquired, what is the biggest mistake you've made, and the Best Ever lesson that resulted from it?

Christopher Stout: I'm going to keep [00:25:19.11] and I'm going to go back to it one more time. And this applies nationwide. I bought an apartment building in New York with rent control. And I was able to see the outlook and what we were able to get the rents to once they started to turn. But what I realized was a big mistake is we have to buy buildings and units that are not under the control of the government. We want the government out of our business as much as possible. So that's why nationwide we stand clear of assets that have government control built within, whether it be some level of AMI... I can't speak on the LIHTC credits that much, but there are a lot of apartment buildings that have a certain amount of control where you are unable to operate without letting outside agencies know. So that's one of the biggest mistakes I think I've made, and now I stay completely clear.

Slocomb Reed: On that note, Chris, what is your Best Ever advice?

Christopher Stout: My Best Ever advice is you have to stay persistent. The day that you feel you want to quit or the day you feel like this isn't working... Keeping your foot to the floor has worked for me absolutely every time. And now more than ever, while the market is in a "frozen period", I see so many groups who are just out of it; they're not looking, they're letting things pass them, they're not staying in touch with their brokers... Keep your foot on the gas as if it's the hottest real estate market ever, and as soon as those deals start to turn, whenever one does pop up, you're going to be in line for it.

Slocomb Reed: Where can people get in touch with you?

Christopher Stout: I'm on Instagram, @officialstout. That's the probably the quickest way to get in touch with me. The website is stoutcap.com. And a direct email always works, Chris [at] stoutcap.com.

Slocomb Reed: Those links are in the show notes. Chris, thank you. Best Ever listeners, thank you as well for tuning in. If you've gained value from this episode, please do subscribe to our show. Leave us a five-star review and share this episode with a friend you know we can add value to through our conversation today. Thank you, and have a Best Ever day.

Christopher Stout: Slocomb, thank you so much for having me. It's been a great time.

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