With inflation, rising interest rates, and a looming recession, how do you invest in this volatile time? Right now, fixed Debt, stabilized deals and longer term holds where you can ride out the volatility might be options to investigate. But most importantly, you need to find partners or sponsors that align with your investing strategy and goals. If you are not aligned with the operator’s business plan and assumptions, you probably don’t want to move forward with them. It’s important to find the right deals and partners for you and to define your buy box. Join Jim Pfeifer as he talks to the President of the Roll Investment Group and full-time passive cash flow investor, Jeremy Roll. Listen in as they talk about the possibility of rent decreases, matching your investment philosophy with those who you are investing with and how to build long term investment relationships. There are many ways to invest, Jeremy encourages you to find what’s right and comfortable for you and then work to implement your strategy.
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Finding Your Investing Strategy in Uncertain Times with Jeremy Roll
I’m super excited to have Jeremy Roll with us. He started investing in real estate in 2002 and left his corporate job to go full-time passive investor in 2007. He’s an investor in over 60 deals and more than $1 billion of real estate and business assets. He is the Cofounder of For Investors By Investors, a community he started in 2007 with the goal of facilitating networking and education for real estate investors, which sounds very familiar because that’s what we do at LFI as well. He has been a big supporter of the show since the beginning. He was one of our first guests. You can check it out on Episode 6 of the show with Jeremy. Welcome back. We are glad to have you.
Thanks very much for having me back. I appreciate it. I hope this is helpful for your readers.
It will be. It was the last time, and I’m confident it will be again. The way we like to start is to get your financial journey. We have a lot more readers than we did in episode six. If people want to read the full story, they could go back to episode six. Can you give us a little shortened version of how you got into passive investing, how you got into real estate, and how you became a full-time passive investor?
Thanks again to everyone who’s joining us. I will try to keep this one short. I’m on the past investing side. I was investing in the stock market prior to the dot-com crash. When the dot-com crash occurred, I was sick of the stock market from a volatility perspective, even more importantly, frankly, a lack of predictability perspective. I’m a low-risk, slow, and steady guy. I like to be planned out, and not knowing whether the stock market would be up 30% or down 30% in the year was not a good strategy for me in terms of predictability for my retirement account, 10, 20, 30, or 40 years down the road. I started to look at different ways to invest in 2001, and I came across the concept of passive cashflow because I was working in the corporate world back in Disney headquarters at that time in Los Angeles. I was way too busy to do anything actively.
I came across passive cashflow in the syndication. They are pulling other investor models, and I dipped my foot in it starting in early 2002. I ended up rolling all my savings from stocks and bonds into cashflow from 2002 to 2007. Honestly, I wanted to have the paycheck and the cashflow. The whole point of the cashflow was more predictability for my retirement account. I wasn’t looking to leave the corporate world, but I had the last straw moment with the manager. I was working at Toyota headquarters in Los Angeles at the time. I decided to take a risk and leave because I had enough cashflow built up to live off of. I left the corporate world in June 2007, so I have been a passive cashflow investor for several years, but full-time for a while now.
There aren’t many people that have a track record that long. That’s why we appreciate you sharing your knowledge. I’d like to dig right into it. I’m sure you are getting a lot of questions about the economy and where things are going. It’s impossible to know for sure, but I’d like to know what your outlook is for the last couple of months of 2022 and then heading into 2023 and beyond. What do you see as some of the things that will affect real estate investors, specifically those of us that invest passively in syndications?
I was on a macroeconomic panel, so this is very salient for me. It’s great timing because we are having a session on a day when the CPI was released for the month of October, and it was higher than expected. To give people an idea here, it was at 8.2 and went up to 8.3, now back down to 8.2, but basically going nowhere. I will get into that in a second because it’s not surprising for a specific reason, but what I’m anticipating is more inflation. This is going to signal that the Fed has to keep being aggressive. I suspect that now there are some predictions that the 75-basis point increase in early November is pretty much a high probability 98% chance lock.
People are now anticipating a 75-basis point increase in December, which wasn’t the case before it was 50. The Fed is looking to end the year probably at about 4.5% Fed funds rate, give or take, where it was originally, when it started in March, it was predicting 3.25 if I remember correctly. We are way ahead of where the Fed thought we were going to be at this point. That means that there’s been worse inflation. When they started, they were hiking. For 2023, there are going to be two very salient things. One is that it takes 6 to 12 months lag from when the Fed typically starts to raise rates until it starts to have an impact on the market and everything as far as inflation goes. Also, once we cross across 5% inflation, it takes, on average, three years to come back to normalized inflation rates.
For anyone who is hoping this is going to be done in the next months or it’s going to be half in the next few months, if you are looking at probabilities, which is what I try to do for myself to understand where I should invest, the probability is not much in your favor that’s going to happen. I am fully expecting that the interest rate increases that the Fed started in March are going to impact the market starting in the second half of 2023, and that’s going to push us potentially into a recession. If not by then, then most likely. It’s hard to time that.
Unfortunately, I believe, and I hate to say this, but it’s true that a recession is the Fed’s best friend now because what it will do is increase unemployment, reduce spending, and therefore reduce inflation. I think that the Fed is going to push until we get major changes in the employment rate data, and we are far from that now. Unfortunately, the inflation rate is giving the Fed the green light to keep going full steam ahead. That’s the economic side.
A recession is the Fed's best friend right now.
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From an investing perspective, what that means for us is that there is still a tremendous risk for interest rates to continue to go up, which means there are tremendous risks and probability for asset prices to continue to go down. They have already started depending on the asset. As an investor, you have to be very cognizant of the fact that the probabilities are in favor of interest rates going up and asset prices continuing to go down. Keep in mind that asset prices typically move slowly in real estate, and that process takes a good two years to get to the bottom.
That process arguably started between March and May, depending on who you ask. Some say it’s January. It’s sometime in the first half or toward the end of the first half of 2022. I don’t think we are going to see anything close to the bottom until we hit at least 2024. I could be wrong. I’m using probabilities now. Anything could change. The big thing that can happen to change things is the Fed or the government with stimulus or interest rates because things have been so artificial for so long now that you could take all these probabilities and do the best you can with them as an investor, but then the federal government comes in and says, “Screw the probabilities. Here’s what’s happening. We are printing $3 trillion.”
I’m hoping that’s not going to happen, and I can’t operate as if that’s going to happen, but those are the things that can derail all of this information. I got concerned at the end of 2016 from a cycle timing perspective. We would have had a recession in 2018 or 2019 had it not been for Trump having stimulus at a very unusual time when the economy was still pretty hot. That stimulus, which was unusual at the time, then pushed things further back as far as how long this recovery was.
With the pandemic, we were about to have a recession. We had the inverted yield curve, we were about to go into recession, probably right about March of 2020, and then the government printed trillions of dollars and said, “Screw the recession. It’s going to be a couple of years from now.” As an investor, I have been concerned for many years following these probabilities, and the government has said, “Screw your probabilities,” for a long time now. I’m hoping they will let this cleansing happen as far as an end-of-cycle reset to put us back into a starting position for another cycle.
You covered a lot of things there, and that’s fantastic. I want to go back to interest rates because you mentioned they’d be about 4.5% at the end of 2022 with the Fed charges. Isn’t that still historically low? Is there potential for a lot more raises? The other question is if it stays at that rate, as a real estate investor, you can still make money and figure out ways to get cashflow with interest rates at that level.
There are always ways to make money. Frankly, I tell everybody, “If you offer me your house for a dollar, I will make a lot of money off it.” If you buy assets at the right price, you’ll always make a lot of money off it, even if interest rates are at 20%. Price is key in terms of that equation. You are right. It’s still pretty low historically. Since the ’70s, the Fed has been pushing the rate down for half a century, and now it’s going a little bit in the opposite direction. My personal opinion is, in longer-term talking, the next ten years are still going to go in that direction. I don’t think they can afford to keep the interest rate high because the debt service rate is 125% of GDP now.
I don’t think they can afford it to be very high for a long time. Eventually, they will pivot and go down once they cause the recession and get some of the inflation in check. They will probably then start typical QE and lower interest rates, but at a much slower pace, so they don’t get all this inflation happening again. That’s what they are trying to hit now. If you look back in the early-’80s when Volker was dealing with this, the numbers of the following which is shocking, the Fed funds rate went all the way to 20%, but inflation was at 13%. That’s published inflation at the time. If you measure inflation the way it used to be measured, we are at 16% to 17% at the moment, but we are at 3% to 3.25% Fed’s fund rate or whatever we are at.
We are so far off from what the Fed is probably supposed to be doing but can’t afford to do and may get a lot of help from an economic downturn. They are probably not going to have to go all the way up there because they are going to accomplish some of it from a recession and from employment going up. I want to point out that anyone thinking that they are going to stop at 4.5% and then start their reviews quickly, another thing you should know is that normally in these situations, when they stop, they go flat for a while to see what’s happening. Part of that reason is because there’s a delayed effect, and they have to see what’s happening from that delayed effect and measure it correctly. I know that’s a lot to unbox, but the bottom line is that we are way low compared to where inflation is now as far as them truly dealing with it.
Inflation is a big issue or big problem. Inflation starts slowing down as supply chain bottlenecks get cleared up as companies start onshoring production in the US. Are there other things that could affect the inflation print, so we don’t have to keep increasing the interest rates?
The answer is yes. I haven’t analyzed how much of an impact that could have on everything else, to be honest. One of the reasons why I haven’t done that is because demand is slowing. Look at FedEx. They removed guidance completely and said there was going to be a global recession. Clearing up the supply chain at that point may not be helpful because demand’s going to be lower. It’s almost like clearing itself, but this goes back to the recession taking care of some of these problems. To me, what’s going to have a much bigger impact than that is the recession, unemployment going up, and consumer spending going down. In addition, the Fed funds rate continued to be increased, but if you are talking about not that piece, that’s going to be the biggest other piece.
We are investors. Whatever happens in the economy happens. We can’t affect it. We have to go on and figure out how we are going to keep investing. The last time we talked in episode six, you said you are mostly on the sidelines regarding new investments. I have a couple of questions relating to that. You didn’t want to wait on the sidelines because you have this cash and need to start your journey.
You need to get it going. You have to take some action. Not any action, but smart action. You didn’t want to wait on the sidelines for 12 to 18 months. What asset classes do you think you would be looking in? Before you answer that, I’m also going to ask you what your personal favorite asset classes are. Those are two separate questions, but let’s start with someone getting going. What should they be investing in now if they don’t want to sit on the sidelines?
To be clear, I am not a financial advisor. I’m giving you my opinion. I am personally sitting on the sidelines, so it’s not what I would tell people to do. The one thing I want to point out before I answer the question is we have been through a decent amount of Fed funds rate hikes already. There are a couple more coming. My suggestion would be that we have a short amount of time to wait to see the impact of all of these hikes as far as how much our price is going to adjust, especially in the first half of a year with the negative sentiment in the market versus risk being high.
Short timeline for me to wait, the risk is high. If I’m new, I would tell people. There’s a short timeline to wait, and I don’t mean 12 to 18 months. You can wait 3 to 6 months and see what happens at the beginning of 2023 on how much prices are adjusting as people are now digesting what’s happened in 2022 and realizing prices are going down. Everyone’s accepting it, and the sellers are going to start to accept it much more readily. That’s a great equation. High-risk short timeline, that’s a very good risk-reward equation for an investor as far as I’m concerned for people to wait. If you have to put in the work or money now, there are two things I would say. One is if you could find assets where you don’t have to worry about the prices going down or them depreciating, that’s one possibility.
High risk, short timeline. That's a very good risk-reward equation for any investor.
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My biggest concern is when asset prices will go down into the future and you are investing at the wrong time. Assuming you believe that cashflow is going to be steadying isn’t going to be too much at risk from a recession. The answer you are looking for me is that I would tell people that if you are helping on getting money to work, don’t mind if an asset price goes down and think it will come back up over time, which a lot of people believe and is probably theoretically true, I would strongly recommend looking at something that has a ten-year fixed rate loan that is highly occupied, is known to weather a downturn reasonably well, and that you are fairly confident in that the cashflow is going to continue and you are going to benefit from the cashflow, so you are getting money to work.
There are two quick examples that come to mind, probably even three that do well in a downturn. Mobile home parks do very well in a recession typically. It depends on the recession and so many factors. What percent of owner-occupied homes are there? There are some, but I’m giving you a generalization. That’s number one. Number two is apartments can do well. I think we are going to see decreased rents, which probably no one’s ever said on here before because no one can even envision. I’ve fully convinced because that’s what happens in a downturn, and that is coming up. All these asset classes are at risk of reduced rents in a recession, but these will do okay during a recession, relatively speaking.
There are apartments with longer-term debt. That’s stabilized. I wouldn’t necessarily go into a value deal that depends on all these things happening, like increased rents. Self-storage as well can do well in a recession. People sometimes will have to go back home, they will have to bunk up with somebody else, and have to store things. Storage did very well in the last recession relative to other asset classes. None of these are perfect. All of them will probably have a rent increase, but these are better if you are hell-bent on putting money to work.
Let’s go back to episode six. That was March of 2021, roughly. You were still thinking the recession was coming or something was happening. You had said you were focusing on short-term investments, such as hard money loans, flips, and assets that don’t rely on appreciation, such as ATMs. Is that still the case? Is that still what you are looking at if you were to invest? For an investor who is already established and can wait a little bit, would those still be good investments?
In 2021 when the interest rates weren’t hiking like crazy, I was looking at three buckets concerned about a recession coming up. 1) A short-term opportunity where the risk was relatively low, and I thought the predictability of getting your return was high. 2) You can then cash that out and have money to deploy at a better time potentially. Those were unusual opportunities, and 3) Opportunities like the ATMs where we don’t have to worry about the asset prices going down.
At the moment, I pulled the short-term one to me because it’s very hard to find short-term stuff that is predictable in an environment of highly increasing asset prices. I have done hard money lending for many years every year. I pulled my hard money lending. It was either January, February, or March, given that the interest rates were about to go up. That’s a huge risk to me for someone who has to either refinance or sell because now the asset price is decreasing, selling into that or refinancing at a much higher rate. That’s the vertical I pulled. I don’t think that’s easy to achieve at the moment. The other two verticals still remain. It is still hard to find stuff. As investors, there are always unique opportunities out there but still hard to find stuff now.
If you are sitting on the sidelines now, is there any place you can put your cash to get some yield, or are you sitting on cash and waiting?
I’m still trying to figure out what to do with some of my cash. I’m on the cusp of buying treasuries. What’s happened is that as the interest rate increases went up so much, I should qualify this. I wanted something that had three-month liquidity. I didn’t want to go into a year into an inflation-protected tip. That is very good, I believe.
If you can get that, that is a great risk-reward if you can park money for one year now, but I don’t want to wait that long for liquidity. Those are short-term, three months or sooner. The highest probability of what I’m going to do now is buying a three-month treasury at 3.5%. I haven’t looked at the rates, but they have been between 3.25% and 3.5%. It’s not great, but better than nothing. Good short-term liquidity and risk are pretty low. I was planning on speaking to my broker as far as the fixed income side of it, but there are other better suggestions. That’s the one I came up with. I was not able to wait on hold long enough to figure that out. That’s my current thought, but we’ll see what happens.
I want to pivot to some other specific investing-type topics. The first thing is a lot of operators, specifically in multifamily over the last few years, have used bridge debt, especially for their value-add deals. How do you see that panning out? Do you think there’s going to be a lot of operators or deals that people got in with bridge debt that end up struggling and maybe having to sell early or capital calls? What do you think is going to happen with all that bridge debt?
From a pure numbers perspective, if you were in a strong market with very large rent increases that you were able to achieve in that model, you are going to be okay up until deploying the capital or starting that project and getting some of those new rents achieved towards the middle of 2021, plus or minus. Assuming you were in the typical model of an 80% LTV that I used to see all the time, I have never invested one of these just so you know, but I have talked to people about numbers and run some numbers. Impossible is a bad word, but at the moment, it seems almost impossible, if not impossible, for those deals to ever be okay.
With the amount of interest rate increase, a bridge loan at the moment seems almost impossible if not impossible to ever be okay.
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Certainly, now, with the debt coverage ratio problem, and let’s not even talk about rents eventually going down, they will have a problem getting sufficient refinance terms to be able to cover the original debt. I have heard anecdotally that some of the deals are already starting to try to short sale or trade in anticipation of the math doesn’t work. Anyone before then, if they achieve 20% plus rent growth in a lot of those deals, the math will work for them, and some of them have already refied. We are going to see those opportunities come to market sometime in the next 1 to 2 years, if not already. They are starting a little bit. Those will be good examples of a deal that could make sense in a challenging time, but that’s all going to depend on the sale price.
What happens if they can’t service the debt? Are there buyers out there that are going to sell? Are they going to have to lower the price? From an investor perspective, if I invested $50,000 in a multifamily deal with bridge debt at the end of 2021, which is speculation we are talking about here, am I going to lose money? Am I not going to make as much money?
I have not invested in one of these, so I have only done so much number crunching at a very high level. I haven’t analyzed that exact scenario, but I believe the most likely scenario, in that case, is going to be either the owners are going to be able to short sale and essentially get less than what they paid, and the lenders will okay that in lieu of foreclosure.
The investors will probably not be going to cover either most or all of the debt, and the investors will get nothing, or the property will get foreclosed, and the investors will get nothing. I don’t mean to be the bearer of bad news, but that’s the reality of the numbers. If you are reading this and invested in one of these states from the beginning of 2021 and on, I would strongly recommend that if you want to understand what’s going on, you sit down and run the numbers with the sponsor. Get them to estimate what they think is going to happen because they understand a deal better than anybody if you are concerned about understanding where you can end up.
Perhaps they have to sell those deals or get out of those deals. Is that because they can’t pay the mortgage, and so then they end up having to sell?
There are a couple of different things going on. First of all, rent increases have decelerated tremendously in some key markets now and, in fact, are running negative month over month in some key markets. It all depends on when you invested and started your value-add plan and when you were able to do these rehabs and get people in. There are some other clauses that exist in some of these that may put someone into default well before a refinance event. That’s what I’m talking about with a potential short sell or even foreclosure because, at that point, you are breaching the terms of the debt. You are in default already. That’s going to happen to these deals much sooner than the 3 to 5-year refinance period.
The refinance isn’t possible because interest rates have gone up so much, and you can’t find the fixed-rate debt you are hoping for. That was the whole point of the bridge debt. It’s a bridge to fixed debt, and that is not going to work in the business plan.
There are several challenges associated with that. A) The refinance isn’t going to work because a lot of these deals were taken at 80% loan-to-value and had a big chunk of debt that won’t be covered in a current valuation, for example, because prices are already down. B) Before then, they may breach the debt coverage ratio because of the lack of revenue. C) As it stands now, terms for debt are not as favorable as they used to be in refi-ing.
The loan-to-value is lower. There are a lot fewer lenders out there. That’s only going to get worse before it gets better. They are going to have a lot less liquidity available for apartment investors and all of 2023 compared to now. I could be wrong. It’s a big statement, but that’s when a lot of this carnage is going to become much more apparent with the economy.
That’s when lenders are going to get scared. They are going to have to shore up their reserves and all kinds of stuff. That started to happen, but it hasn’t been a complete capitulation event yet. Between the worst terms in terms of the loan-to-value, the higher debt coverage ratio requirements that some of them are employing, the higher debt coverage ratio that results as a result of higher interest rates, and all kinds of stuff. There are myriads of ways that these cannot pencil out any end. That’s why I’m concerned for anyone who’s invested in something in the last few years.
What happens when sponsors say, “Here, the proforma is 12%, 15%, 20% IRR over the last couple of years,” and now they are going to come to you and say, “Bridge debt. We are selling it. You are not getting your capital back.” What happens to those operators? Are you thinking that this is going to affect all the operators, 50% of the operators? Who’s going to invest with those people again?
Not only have I not personally been through that, but this is a unique time with the amount that rates have shot up. I have never thought that I have ever been in a scenario like that. When you asked me that question, what I thought you were going to say is, when investors are going to sue, what’s going to happen? Those are all legal questions that I can speculate on, but I’m not an attorney.
It depends. Those operators may have had 10 or 20 successful bridge loan deals behind them for 2 or 3 years. Investors made a boatload of money, and then the music stopped, and investors lost a little money, but those investors may have made a net amount of a larger amount of money and maybe still willing to invest in a different structure if that sponsor’s going to tell them what they are doing to adjust to the times. Some of the newer sponsors are going to have a big problem and are going to have to exit this game potentially. This is part of what happens in a downturn, unfortunately.
This is where communication is critical because, as I have said before, if the deal’s going south and sponsors explain it to me on the way down and talk to us and give us the reasons behind it, I can live with that a lot better than those that are not responding, hiding, running, and not being communicative. It’s important to get out in front of it and start talking to your operators now.
I agree with you on that, although I will say that even if it’s a new sponsor, be as communicative as possible. If you’ve lost all your money, and no one’s ever made money with them, or very few people have, I’m not quite sure how they are going to raise money. One thing we should be clear about is that the hardest time for sponsors to raise money when the best deals are out there is when people are scared. They are going to have a heck of a time trying to raise money, even if things are going okay in the next year or two. Those sponsors may still end up exiting the business.
The hardest time for sponsors to raise money is when the best deals are out there and people are scared.
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This might be a crazy question, and this is too broad. If you are an operator with bad bridge debt, the interest rates are high, you did a value-add deal, and you try to get as much done as possible as quickly as possible so you can get rents up or get the classic unit turned into a supreme unit or whatever they call it, can you value-add your way out of it?
That’s why I was getting to the exact dates that I was mentioning. The people who executed well from 2019 and 2020 essentially have either already value-added their way out of it or will eventually end up in a refi that will have gotten them to that point. This is a question of the runway. Airplanes are trying to take off. If your airplane tries to take off with a much smaller runway, those people in 2021, at some starting point, won’t have enough runway to evaluate and value-add their way out of it.
Here’s the last question on this topic. Let’s say that you are looking at a new deal that’s coming out, and they have reasonable fixed-rate debt for ten years. They have loan-to-value in the ’60s because I’m seeing some of these deals. I know you are on the sidelines. For the average investor who still wants to put money to work, is that something that seems reasonable that they might be okay?
It’s a good question because I would then turn back to you and say what price they are paying. If the formula is you got a low debt ratio, a ten-year fixed-rate loan, and you are getting a pretty good price for the property so that the cashflow is starting in a good place, the cashflow could go down during a downturn, but you have enough padding there that will probably survive a downturn. I’m making a lot of generalizations. You have to run the numbers. It depends on the expense ratio and who’s managing it. It depends on if it’s a class A, B, or C or how much money is spent. It’s all kinds of stuff like what the reserves will look like. There are scenarios where people could potentially be okay.
The big question mark is going to be if rent goes down, which I believe it will, then how much will they go down and which market you are looking at. I will say this. You have a much higher risk of having a problem in a much more volatile market. I don’t mean volatile historically like LA, San Francisco, New York, and all those. I’m talking about even markets that were crazy volatile, like certain markets in Arizona, Texas, and other places that had huge rent run up, like Boise, Idaho, and all this thing.
Those are the ones who are going to have the highest risk of the pendulum swinging the other way. If you are getting in and your rents are going down quickly because you happen to get into the wrong market, that could cause a big problem. You are still going to have to hit debt coverage ratio or being default on a loan and stuff. There’s still a lot to consider, not, “Are you going to be cashflow positive?”
The counter to that, and I don’t know if it’s true or not, is markets like Phoenix, Dallas, or some of those, there are still a lot of people moving there. They still don’t have enough housing. How can rents go down when demand is still going to be there?
This is the same argument I heard. There’s so much liquidity in the market. Do you know how much liquidity there was in the market in 2007? A boatload of liquidity in the market. How did that happen, then? The way that rents go down is a domino effect. Rents go down because people lose their jobs, can’t afford to pay rent, and have to pair up with somebody else or move to their house. Demand goes down, and then supply goes up as a result, and then there have to be concessions or rent reductions.
There was a shortage of supply of housing in 2007 and 2008 as well, and we had rents go down. I would tell people out there to be very careful with the whole assumption of, “There’s so much liquidity.” This stuff that’s always the same at the end of a cycle until it isn’t, and it goes bad because dominoes fall, and these dominoes that fall cause these other things to happen. If you are going with probabilities as I do, probabilities are that we are going to see rent reductions and probably higher or worse rent reductions in areas that had much higher rent increases.
That makes sense. As you said, we’ll see what happens. There are patterns to the cycles, and that’s what’s happened historically. There’s no reason to think that won’t happen again. I want to pivot to a different topic a little bit. Are you still evaluating and looking at deals? If so, have you seen any red flags, things that concern you, and things that people should stay away from that we haven’t already talked about?
I have been very concerned about these bridge loan deals for myself in the way that I invest. I haven’t done any of them since I started. I still see some people doing them out there. That is very concerning to me because if you are going to look at one of those deals now, you need to tear apart the proforma and understand what’s going on before you consider it at this particular point with everything we have talked about.
As far as other deal types go, I have the same concern across everything, which is asset price decreases. The other thing we haven’t talked about is if rent goes down in an inflationary period from an expense perspective, you are going to have a greatly decreased NOI, and there are two challenges and concerns I have investing now versus 2023 or the year after, which is not just asset price is decreasing because of interest rates going up. It is asset price decreasing because your NOI is lower than it was a year ago.
You have a compounded effect one on the other. That is what is the realistic scenario from a probability perspective. You are going to have both compoundings on each other. If you are looking to get into a deal, it’s important to model that out and take that into consideration. It’s a short-term deal that’s a much higher risk. If you don’t care if the asset price goes down in the meantime, then make sure you look at the rent side of the equation and not necessarily the value side of the equation. I’m concerned about having both of those. The good news is if you wait, you can potentially benefit from that compounded effect if that’s what you believe the right thing is to do.
I imagine that you get a lot of operators and syndicators contacting you wanting to share deals. I know I get a lot, and you must get even more because you’ve been doing this for so long. How do you sort through that? How do you determine if a syndicator that’s new to you is worth putting through your vetting process?
I’m going to put aside timing because I’m on the sidelines for normal deals anyway. I’m going to answer this high level because it can end up being a very long discussion. What I’m trying to do is find someone who aligns with my personality, who’s looking to underpromise and overdeliver with their assumptions, is very conservative and detailed, has a high probability of overperforming, and is trying to build long-term relationships with investors by using conservative numbers. I’m trying to avoid someone who is being very aggressive with their numbers, making those numbers look good, having some other probability of coming through, and underperforming but not caring as much because they are a marketing machine and they are going to find other investors anyway.
That’s the highest-level response I can give. I’m a conservative person, so for me to know that someone’s conservative is good because I can also sleep better at night knowing that their reserves are probably going to be more conservative. They are probably going to be more cautious about what they are spending. They are more interested in overperforming for investors in general, and they are trying to line the whole thing up to do that by buying the right deal to make that happen. That’s a high-level answer.
Do you respond to every person who sends you a deal? That seems impossible because I know I don’t. How does an operator get with you? How do they get you to respond and start the process?
I’m on a lot of lists. I’m not going to invest in what I don’t respond to. That’s why I’m laughing because I get so many deals every day. If someone’s new and randomly reaches out to me, I will dig into a combination of who they are and how long they have been doing this. Is there some track record I can see? What is their background in the industry itself?
Those are important pieces. There are these other assumptions like purchase price, cap rate, or type of debt they are using. Are they using conservative debt or not? Is their business plan aligning with what I look for in a ten-year or longer-term hold? Is all that aligning? There’s no point in me finding the best person and match for me if they have a completely different business plan than I’d want to invest in.
If they look interesting, I will then try to assess this business plan. Does it align with what I am looking for? If it does, I will start to look at some of the assumptions. If those align with what I am looking for, I will start to dig into it further and maybe talk to them. What’s been happening a lot in the past few years is that no one is aligning with what I normally do because that didn’t make sense at the time, and the sponsors knew it, so they went to a much heavier value-add play, but I stay away from that at the end of a cycle. I did that at the beginning of a cycle, and that’s when you build yourself the most runway. We talked about runway before.
The sponsors are motivated at the end of a cycle because the typical cashflow deal doesn’t pencil, and they know they won’t get me because the cashflow won’t be high enough. They pivot and do other things, and those are the higher-risk stuff that I tend to stay away from. It’s been fairly easy to turn down almost everything in the last few years for me.
It’s a struggle for me. I’m in a different place where I’m a different part of my journey, so I get a lot of people coming to me and wanting me to evaluate their deals or operations. It’s always difficult to figure out, “How do I find out if I even want to take that next step with you?” You gave some good pointers as far as making sure that they align with my investing philosophy.
What I would tell you is that whether I get the deal from an investor or a sponsor directly, the one rule I have is that if it’s completely not to type a deal I will invest in, I will reply and say, “Thanks for sending it to me. It’s not a fit for me because I’m not doing value-add or bridge loan deals now. I’m on the sidelines for a regular market deal,” or whatever it is in 1 or 2 bullets. The one thing I won’t do is I don’t have the bandwidth, which is the same problem with you, too much volume. I don’t have the bandwidth to analyze something that I’m not going to potentially invest in. I have to focus on putting the little bit of time I have into stuff that may be a fit. If something isn’t a fit, it’s a very quick and easy response.
That’s where relationships come in because if someone sends me a deal and I don’t know them, it’s almost always going to be, “No, thanks.” If someone comes to me and says, “I want to start a relationship and figure out if there’s a way to do business,” then it’s easier to have a conversation and talk to them and see if there’s a fit there. If they understand, “It’s going to take me a while to get comfortable with you,” then we can move forward. When people are sending deals, that’s an easy no, in my opinion.
Honestly, I’m very prejudiced against it because the first question you ask yourself is, “Why are they sending this to me? How badly do they need investors?” Immediately, you are starting off on a negative foot. I still think it is worth spending two minutes looking at the deal and trying to figure it out, but probably not more than two minutes if it’s not going to be the right fit, which it isn’t most of the time.
We have talked a little bit about this, but I want to see if we can dial in a bit. You’ve talked before about the importance of investment criteria and having a particular to each investor, which you mentioned. As an example, your investment box is different than mine and is different than somebody else’s. How do you define that box? How should an investor determine what their box is? As we were talking about all these deals coming through, it’s a lot easier if you have a defined box because you are like, “That one doesn’t fit.”
I cannot stress the importance of having the most tightly defined box that you are comfortable making if you are brand new or even if you are not new because you will save yourself a ton of time, especially if you are the type of person that will chase things, like a squirrel getting distracted. Let me give you an example. This is very tough for me to do at this moment because I haven’t reset my cashflow targets because I’m waiting for the new cycle to start to do that. In a typical time, I could tell you that I invest in opportunities that are 80 to 100% occupied that are in non-volatile markets with an experienced sponsor, with a diversified tenant base that is typically class B or A minus, and with a specific cashflow target for year 1 and a 10-year average annualized cashflow target from a projections perspective.
If you're a new investor, it's important that you limit yourself to the most tightly defined box that you're comfortable with.
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Stop right there. That will allow you to eliminate probably 75% of what you see, if not more. Those are a few bullets. You can go deeper. You can say, “I’m only going to invest in these states or these cities,” whatever makes sense for you. I’m giving everyone an example. I got the deal, and it was 1970s construction. It was an interesting deal but not for me, and I immediately passed. I can get a deal that’s a five-year or fixed-rate loan or even a five-year bridge loan or storage loan, and I pass. I can get a deal that has 30 tenants for an apartment building, and I pass. It makes it so much easier, and you don’t waste nearly as much time. If you are starting, it’s probably one of the most important things you could do to avoid wasting time on a lot of stuff you didn’t realize was a bad fit for you.
That is such good advice. I have to admit I haven’t done nearly as well as I should have. I am that squirrel you were talking about or the dog looking for that squirrel, however you want to say it. I am chasing shiny objects, and I try to stop, and I’m not very good at it. I need to define that box. Here’s the next question. Is there a different box for each asset class? How do you reconcile that?
There are 1,000 ways to invest. None of them are wrong. It’s whatever’s the best fit for you. The box I told you about applies to pretty much almost any aspect I can think of that I invest in, and that’s the beauty of it. There are tweaks. For example, mobile home parks. In apartments, I prefer over 100 units. In mobile home parks, I prefer over 75 units. In self-storage, I prefer over 800 units, but I will consider 300 to 800 units. You have to tweak each asset class very slightly. For some, you have to add things.
For mobile home parks, for example, I probably won’t invest in something that’s more than 25% max 30% park-owned homes. If it’s a high rental property, high vacancy, or whatever it is, if it’s less than 80% or 70% in mobile home parks and occupied, we will look at it. There’s a slight tweak to each thing. In retail, I prefer to have over 10 and preferably over 13 tenants when I can. It’s the same thing with industrial. I prefer to have over thirteen tenants. In an office, that’s a different story. I’m not considering a retail office now, but I’m giving some people an idea. You do have to tweak it per asset class to an extent, but I still know that I don’t want to invest in a very old office building or a very old mobile home park, as an example.
That is such good advice to figure out. I love how you say each person needs their own box. We are so different. What I love about you is you understand that not everyone is as conservative as you, and so you are able to help people even if they are doing something that maybe you would not. That helps us figure out our own space.
Let me be clear that I am on the sidelines now, but I am 100% adamant in believing that if somebody is deploying capital now into the ten-year fixed-rate method that we talked about that isn’t worried about the asset price going down and just want some cashflow in the meantime, they are going to do better than me in the long term. They are mathematically. It’s that I sleep better not going into that deal. Everyone’s got to deal with what’s best for them.
I want to end with something positive because this has been a downer, at least in the beginning. It’s not your fault you didn’t make the economy what it is, but that’s where we are, and I get it. What’s the good news? How are we going to make some money in the years to come? What are we looking forward to?
The great news, beyond good news, is that we are months, if not more than a few months, away from prices adjusting tremendously. Having a recession, in this case, is good news to help with inflation. It’s also good news for investors because, even though people be very fearful, that is the best time to invest. The good news after that is that when you have the beginning of a cycle at your back, then you can look at all different types of opportunities, and maybe you would be like, “I wouldn’t have done heavy value-add or medium value-add,” but that window opens up. That opens up potentially better returns depending on the risk scale because, in other ways, it’s less risky because of the timing.
There is a lot of good news ahead, but we have to get through the bad news period. I will tell everybody to remember what Warren Buffett says, “Be greedy when people are fearful,” because people will be fearful. That’s exactly what happened in 2008, 2009, and 2010. Do whatever you are comfortable with clearly, but those are the periods that the best buys happen. There’s nothing wrong with waiting a year or two after, getting more comfortable, and then going in because you are still getting to a very good point in the cycle.
That’s all great advice. I’m glad that we have something to look forward to. We got to get through this difficult time, and the good times hopefully will be back. Maybe it will be scary times, but they will be good times for investors. That’s what we are hoping for. I know we asked this the last time, but the last question I usually ask is what’s a podcast that you enjoy listening to?
I honestly don’t remember what I listened to or mentioned last time. There are a lot of them, so it’s not a fair answer. One of the ones I like to mention when I only can mention one is Cash Flow Connections by Hunter Thompson. I say this because I find that he gets a lot of guests who are not on other podcasts. For example, he had Ethan Penner, who pretty much arguably invented the CMBS loan and knew the stuff. He has a lot of experience. He’s a great person to have at this timing with the lending environment the way it is, but you are not going to find him on most or any of the other podcasts that typical people listen to. If you are listening to a lot of podcasts out there but want a little bit of a change or something different, that’s a good one.
The last question, I know you are not doing as many investor calls as you used to, but if people want to connect with you, what’s the best way to do that?
The best way to reach me is always my email, which is [email protected].
Jeremey, I can’t thank you enough. There’s so much good content and so much to learn that I’m going to be reading back a couple of times. Thank you for being such a great supporter of Left Field Investors. Thanks for being on the show.
I love Left Field. I love what you guys are doing. You are trying to help the community, which is fantastic. I have spoken to many Left Field members who get a huge benefit from the efforts you guys are putting in. Kudos to you. You guys are building a bigger base which is fantastic. I’m sorry I won’t be attending the meeting you have coming up very shortly, but hopefully, next time.
We’d love to see you at the next one. Thank you very much, and we’ll do this again soon.
Thanks for having me on.
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I love talking to Jeremy Roll. He has so much knowledge. He’s been doing this for a long time, and he is willing to share his knowledge. You can’t find a nicer guy than that. He will share, and all he wants to do is help others. It’s phenomenal. I love talking to him. I didn’t catch this the first time we had the show, but when he was talking about how he got into passive investing, is because he found that the stock market was volatile. That was one part, but it also lacked predictability, and he wanted predictability in his fin
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