June 20, 2023

JF3211: Why Diversification Is Your Key to Survival | Beyond Multifamily ft. Ash Patel



The Beyond Multifamily series is hosted by non-residential commercial real estate investor and Best Ever Show host, Ash Patel. Ash’s goal for this series is to introduce you to the world of non-residential commercial real estate investing and teach you how to look at and underwrite different commercial asset classes.

In this podcast episode, Ash Patel discusses the state of the economy and real estate. He mentions concerns about banking collapses and the need for diversification. Additionally, he highlights oversupply in the multifamily market and the resilience of suburban downtown shopping centers.


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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 this is an episode of Beyond Multifamily, where we dive into topics other than multifamily investing. Today we're going to dive into the current state of the economy, the current state of real estate, and a lot of elephants in the rooms.

I just got back from the Best Ever conference. If anybody's never been or if they are on the fence about going to the Best Ever conference, anybody who's been there will unanimously tell you, it is the best networking event ever. The mood was a little bit different this year; there was a bit of doom and gloom and cautiousness, whereas in the past it was unicorns and rainbows and the arrow moving to the upper right corner. And this year, people were told, "Survive 'till '25. Neil Bawa had an incredible keynote speech, along with Joe Fairless. And Neil's speech was, "If you can make it through 2025, the seas will open up and opportunities will come back again to the market. However, there's going to be turmoil." His opinion on the Fed was if they stop raising around the June timeframe, we are good; we can take a deep breath and we can start looking for deals again. However, he cautioned everybody very strongly, if the Fed continues to raise in June and beyond, there's going to be blood on the streets.

We ran into a lot of syndicators who have paused preferred payments, and there are capital calls on the horizon. And paused prefs were almost normalized when you talk to people at this conference, and when you talk to multifamily people in general these days. And Best Ever listeners, I will again make the case for looking beyond multifamily into other asset classes, but I also want to share that it's only real estate people in finance people that seem to think the arrow always goes up and to the right. And I can't tell you how many people I've ran into that are telling me "Don't worry rates, will be back down by the end of 2023", and it blows my mind. I know we want rates to come down, but there's no evidence to suggest that.

Just yesterday morning the Producer Price Index came out, and it was a little bit negative, which is good. The Fed is trying to slow down an overheated economy, and each time we get the jobs reports, it's like a kick in the pants to them because they're trying to slow things down. But the economy continues to add jobs. The PPI, the Producer Price Index, which is the cost at which producers or businesses buy their products - that's taken a bit of a hit, which is possibly a sign that all of the rising interest rates are working in the Fed's favor. However, Jerome Powell came out and said, "We are going to continue to increase rates."

Even in the wake of the SVB collapse, these banks that are collapsing, last week the Fed did something very interesting. As soon as news hit about the bank failures, they said "We are not going to backstop the banks. We are not going to do a bailout like we had in the past." And then very quickly, just a few hours later, they announced that no depositors will lose any money, regardless of the amount, whether it exceeded the FDIC insurance limit or not. And they announced this on Sunday. As of Monday morning, all depositors will have access to their funds, which was shocking. They did a very quick about face. My opinion - and again, prediction pond has very thin ice... My opinion is that this will become systemic. We will see more of this, and people will start to panic. My wife called me while I was at the Best Ever conference, and my wife has very little to do with our finances by choice. I share with her our net worth once a year, and some big deals that I do, but for the most part, what I do is kind of in a silo. Nonetheless, my wife calls me at the Best Ever and says, "Hey, do we need to look at moving our money from one bank to another or spreading them out?" So it has hit mainstream America; this banking collapse is hitting everybody. And when I say hitting everybody, I mean, it's hitting their mindset, it's hitting their decision-making.

I know my lenders - I'm going to meet with them tomorrow, but they're going to be a little bit skittish. I have a vacant 30,000 square foot office building that they were excited to lend on two weeks ago; when I have the conversation with them tomorrow I wonder if they're going to pull back a little bit, pull their enthusiasm back at least, and be much more cautious on giving me a million and a half dollars for a vacant office building.

Best Ever listeners, whether this becomes systemic or not, the damage is already done in people's hearts and minds, eroding people's confidence, eroding lenders' confidence, eroding our opinions of how viable these banks are. We've always heard that they've been able to pass a lot of these stress tests since 2008, but then we have banking collapse. The next couple of weeks of market news will tell us what direction we're heading in, and my fear is it's not going to be good.

In the news we have Blackstone, who about a month ago had a $270 million fund that was comprised of New York City apartments go into receivership. Best Ever listeners, just this morning they announced they have another $325 million CMBS loan comprised of Las Vegas real estate going into receivership; they are dumping $350 million of Chicago apartments. Things are not looking well for Blackstone, and these guys are the financial heavyweights, right? They should have seen turmoil coming, they should have seen interest rates going up, just like a lot of us should have seen it, but we chose to ignore those warnings.

In other news - and this was talked about at the Best Ever conference - we have between 500,000 and 800,000 apartment doors coming online this year. There is already pricing pressure on multifamily, and there's talk about oversupply in certain markets... An additional 500,000 to 800,000 will certainly fill any supply gaps for most metros. Here is a crazy statistic that I had to do a lot of research on, because I didn't believe it was true, but the Dallas Fort Worth area - they are opening 175 hotels. Now, when I read that I thought surely this was miswritten, and it is 175 rooms, not actual hotels. But that's not the case. Several sources have cited this. Dallas Fort Worth, 175 hotels are opening in 2023. They are going to add 20,000 hotel rooms. So anybody in the short-term rental space in that area I think should heed that warning. They are going to have boutique hotels, new hotels, hotels that cater to a lot of different needs and wants. So anybody in the short-term rental space in DFW, make sure what you're providing is unique, and there is going to be a continued demand for it.

On the positive side, I also want to share that retail sales are up 6.9% year over year; retail is still healthy. Again, retail vacancy is at 6%, the lowest it's been since they started recording that metric, CBRE that is, back in 2004, I believe. So retail vacancies are very easy to fill these days. We have plenty of operators opening stores. Ross Stores is opening 100 new stores in 2023. Dick's Sporting Goods, their year-over-year sales are up 7.3%. And I think this is monumental, because Dick's was one of those stores that was hurt by the Amazon effect. A lot of people started buying their wares online instead of going into the store... And now I think we're finding people are returning to their suburban stores.

We also have a lot of discount stores. We have two tenants in a strip mall that we own that are big-box discount stores. One is a TJ Maxx type boutique store. Another is a 30,000 square foot furniture store where they take returns from Wayfair in overstock and sell them in this store. So all those products that we return are ending up being purchased by the truckload and then being displayed and sold in these boutique stores that are popping up.

We also have Walmart and Target and Home Depot that have missed earnings. What's happening, folks, is the middle class is getting pinched, they're getting stretched too thin. Credit card debt is higher than it was pre pandemic. The middle class has already voted and stated that they will not spend much more money on discretionary goods; they will reduce their spending.

So Ash, you're talking out of both sides of your mouth; you stated that retail sales are up year over year, but the middle class is being pinched, and they're not going to spend money on discretionary goods. What does that mean? Folks, it's what I've stated from the very beginning - one thing that is internet resistant and recession resistant are those suburban downtown shopping centers; the place where there's the dog groomer, the nail salon, the barber shop, the insurance place, the pizza place, the deli. Those things that we've been so accustomed to post COVID to visiting frequently, because we never go to city centers anymore. We choose to go to our suburban downtowns, and that's where a lot of shopping has popped up. A lot of eateries and bars and restaurants are popping up, and that's where you want to invest. Those are internet-resistant, recession resistant, and even COVID-resistant, because COVID is what drew us away from city centers, and we got used to just driving to a suburban downtown, instead of taking an Uber or a 30 minute cab ride to a metropolitan downtown.

So I want you to underwrite some of those deals that you see in your suburban downtowns. If you see a For Lease sign, I want you to pick up the phone and call them and say "I'm a commercial real estate investor. I'm interested in buying your building."

Something else crazy happened at the Best Ever conference this year. In years past I was kind of like the stepchild that nobody really wants to talk to, because I'm not a multifamily investor... Even though I'm screaming from the mountaintops, "Hey, everybody, look at retail, look at industrial, look at office." And really, nobody was interested in hearing what I had to say. This year, a lot of big multifamily operators are looking to pivot into retail, into industrial especially, and they're asking for help on "How do I learn this?" So we have an opportunity to capitalize on some of these assets. Returns are still healthy in office, in retail, in industrial, versus competition being very high in multifamily.

I'm hearing now of syndicators putting down 50%,; that's the LTV they're getting, and they have to put half of the value of the property in as a down payment. They're offering their investors a 4% pref. We are still finding deals that can afford to pay an 8% pref or a 10% debt deal, because the cash on cash is closer to 20% at purchase.

Break: [00:13:11.05]

Ash Patel: I'm going to illustrate the effects of cap rate expansion on large properties. Let's take a $30 million apartment complex that somebody bought at a 3% cap rate; they bought it at a three cap, and this was not uncommon in some of the Sunbelt hot areas, buying 2.5 caps even. So right now we know multifamily is expanding to four, five caps. They should be a little bit higher, but down from the threes, to let's say the mid fours, and fives, mid fives. A 3% cap rate on a $30 million property yields an NOI of $900,000. Multiply 3% times 30 million, and you get a $900,000 NOI.

Now, if cap rates go from 3% to 4%, what happens to that $30 million asset? The value of that asset drops by seven and a half million. How? You take that same $900,000 NOI, divide it by 0.04% cap rate, and you come up with $22.5 million. A $30 million asset lost seven and a half million dollars from 100 basis points expansion in cap rates. If you couple that with floating interest rates, where your debt service is much higher, there's going to be a lot of pain for some of those operators.

Back to cap rates - 3% to 4% cap rate is a 33% loss of value. Going from a cap rate of 4% to 5% is a 25% loss of value; going from 5% to 6% is a 20% loss in value. So the loss in value diminishes as we get into higher cap rates. But some of those folks that bought at very low cap rates, now that they're expanding, there's going to be a lot of pain.

Alright, Ash, enough with the doom and gloom. This is an episode called Beyond Multifamily. Teach us what to do, what to buy; let's go.

So Office - everybody wants to hate on office. Neal Bawa at the Best Ever conference came out to do some Q&A in the hallway, and he was just barraged by people and questions... So I waited till there was an opportunity, a pause in questions, and I said, "Hey, Neil, why don't you invest in office and retail?" And he said, office is *expletive*, but retail is awesome. But I don't know anything about it. This is where we get an edge. If you can educate yourself on how to take down some of these deals, there's so much less competition.

Back to office - everyone loves to hate on it, right? How do you play that? I will tell you that I mentor a lot of people that are buying small offices; again, suburban offices. If you can find something in a walkable suburban downtown - there's bars, restaurants, even a daycare close by - those are so easy to rent. Everyone I know that has suburban office, there is a waiting list. They're fully leased. They are easy to rent. People have realized they can no longer work from home. Even employers have realized their employees cannot work from home.

Mark Zuckerberg yesterday put out a press release stating employees that are in the office are way more productive than those that work from home. My opinion is office is coming back; the work from home thing will be short-lived. As the economy tightens, employers will regain the upper hand. You will no longer be able to walk into an employer's office during a job interview and demand that you get to work from home, and that you work four-day workweeks. I think that will be a thing of the past.

Nonetheless, let's talk about the present. Suburban office - very easy to rent out. How do you play larger office space? We're buying a 30,000 square foot office completely vacant, one and a half million dollars roughly. And it's in a walkable suburban downtown. Our play is going to be to transition this into a co-working space. "Wait a minute, Ash, you're going off the reservation; now you're talking about starting a business. I am." Allow me to explain.

A few months ago we purchased a co-working space in one of the suburbs of Atlanta, Georgia. My partner brought this to me and she said "Hey, the numbers look great on this." It's a co-working space, it's also a building for sale, and it's advertised on LoopNet for quite some time. So I cautioned her and I said "Realize we're buying a business, right? We're going to be managing employees, and marketing, and payroll." And she said, "Okay, let me dive into a little bit more." She came back and said, "By the way, cash on cash returns on day one with 35%." She also shared that rents have never been raised in the seven years that they've been open, so there's opportunity for further upside.

Fast-forward several months later - and again, I should have been updating you guys as we've done this, but it's been a long time since I've done a Beyond Multifamily episode... Fast-forward, we fly down there, we look at this co-working facility, and what was very interesting was the person behind this was an engineer, and he studied office, he studied trends, and he studied people working, and he built a bunch of 8 by 10, 8 by 12 offices that were basically built in the middle of this industrial building, and along the sides of it. And I thought, "Wait a minute, co-working is supposed to be open, collaborative, wide open spaces." And I remembered the trend with offices, where 20 years ago it was fun, it was cool, it was hip to knock down office walls. And there will be pictures of CEOs working alongside of new hires, and that was a cool thing to do, where some of those execs can brag that they're on the front lines. Well, over the last 20 years people have realized that it's not a conducive environment to work. There's no privacy, you can't have any quiet time, you're overhearing other people's conversations... We used to install white noise machines in our cubicle farms of our offices. And now, when we're asking younger people to return to the office, they're asking for an actual office; they no longer want to work in an open area.

So this individual had the foresight to realize that seven years ago, and he built a bunch of small offices. Now, there's co working or open spaces all over this building, but it's not one large room. So I want you to remember that as you're looking at different office buildings that are up for sale, or if you're looking to do your own co-working building. So we've owned this co-working space for about three months now. We had a very marginal rent increase; we are still way below the competition, and our cash on cash return just three months into owning this asset is 65%. So whatever downpayment we put in, half a million or so, we're getting 66% of that back every year in profit after debt service. So looking to do that again with an office building that is for sale.

And again, I like this particular spot because it has a bunch of built-in offices already, that are fully vacant. And again - look, office right now is less than 50% occupancy, so you guys can find these deals everywhere. The key is finding them in walkable suburban downtowns. If you're not convinced, if you're thinking "Ash, you've lost your mind. Stick to commercial real estate." Do me a favor, please; go tour a co-working facility or a couple in your area, and just check out the vibe. As soon as you walk in, there's something about seeing people hard at work that makes you think that "I need to get to work." There's just something about the vibe that's created in these co-working spaces, where people are just heads down, headphones on, and they're working hard.

You'll also see that the trend is a lot of offices are being built in them. There's some incredible, very overbuilt co-working spaces that are just the same wide open rooms, different-themed rooms... And I don't know if that is sustainable, if people will continue to operate in those. I think it's hard when you have to make a phone call and you don't want people to overhear your conversation. You also don't want to hear other people's conversation. You can only build so many of those phone booths, those quiet rooms for people to use. I think it's an interesting concept, but from our experience what is definitely working is people renting small offices.

Now, I've got traditional office buildings as well, but anything I look for in the future, I'm going to look for converting into co-working space.

So Best Ever listeners, pivoting into businesses is not that uncommon right now. A lot of multifamily syndicators have pivoted into buying car washes and laundromats, and they're doing build to rent, chasing those yields. My issue with car washes and laundromats is there's a low barrier to entry. It doesn't take a rocket scientist - sorry if I offended some of you guys, but a lot of you could go out, buy a coin laundry place and figure out how to run it. You can buy an existing carwash and figure out the systems and find out how to maximize the efficiency.

So cap rates in mobile home parks, RV parks, self storage, and now coin laundry and car washes have all compressed, because we've got a ton of former multifamily people coming into that space and driving down cap rates. So the only way you're going to find good deals in those asset classes is if you look in tertiary markets, because all the primary markets people are flocking to trying to find those deals. And for whatever reason, co-working just is not on people's radars. There are also boot camps, and there have been for many years, masterminds teaching people how to get into the carwash business, how to get into the mobile home parks, the self storage, how to get into laundromats. There's no boot camps on how to get into co-working.

Best Ever listeners, I'm going to stop the podcast here. I've got a lot more to talk about. I'm going to record another one right behind this and keep going, go through all of my notes. But please email me at Ash [at] investbeyondmultifamily.com if there's a topic you want me to cover. I need some more brainstorming so please throw something at me. And Best Ever listeners, thank you again for joining us.

If you enjoyed this episode, please leave us a five star review, share this podcast with someone you think can benefit from it. Also, follow, subscribe, and have a Best Ever day.

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