Welcome to the Real Estate Espresso podcast, your morning shot of what's new in the world of real estate investing.I'm your host, Victor Menasche.This is the weekend edition where we interview notable people from the world of real estate investing.
Today is no exception.We have a great guest all the way from San Diego, California.Welcome to the show, Andy McMullen.
Yeah.Thank you so much for having me, Victor.Big fan.
Well, great to have you here.Now, Andy, you're in a beautiful part of the country.San Diego is a wonderful place.You used to have an office there.Not a great place to do business, certainly in real estate.
And so you're active in many other parts of the country.Before we dive into the details, maybe give a little bit of your backstory and how you got to this point in your journey.
Yeah, sure.So I've been in this game probably about 25 years.Victor, I started off on the commercial real estate brokerage part of the business in Los Angeles, mostly Venice Beach.
And then we started to develop some projects, believe it or not, in that very difficult neighborhood.Neighborhood council was probably as difficult as some of the the council folks there.
And then we started to buy after the 2008 crash, we started to kind of buy again, maybe 2011, 2012, more in apartments, Central California, Southern California, Texas.
And then I would say about six years ago, we kind of stumbled upon the built to rent idea, building communities of 100 to 300 homes and renting them out to residents there. in secondary tertiary markets.
So that's kind of what our focus has been over the last six years or so.
It's funny how sometimes what is old is new again.
That used to be a thing back in the early 1970s and then it just sort of fell out of fashion and disappeared and it's started to come back and where I think a lot of folks that are building in that realm are able to almost have a wide open field because there's so little new products.
So even if that's all you do, you're still only making a tiny dent in the market.
Yeah.And I think that's the biggest part of this is that if you just kind of think in round numbers, 55% of the multifamily market is kind of controlled by Wall Street, right?
And so you've got all the big players in the multifamily market or apartments, but there's really only about 6, 7% of that control in the built to rent community.So you can kind of see the early innings.You are seeing quite a few funds now coming in.
Blackstone just invested a ton of money
recently in the bill to rent and so that's been going on for a while you know the same guys that were buying up scattered sites decided you know after 2009 when our market crashed a little bit and all of the capital dried up and debt dried up where the same guys say let's start to build things next to each other so we can manage them more efficiently and that's kind of when we started to get involved.
Yeah, that makes a lot of sense.And when we think about the build to rent community, people who might have grown up in a detached single family home, that's what they want to live in.That's part of their vision.
They may not necessarily be able to afford ownership of a detached single family home, but that is the living experience that they want, whether it's ownership or renting.Many people don't want to necessarily
hear their neighbors through what sometimes are paper-thin walls, although the technology's gotten a lot better for acoustic isolation.And we see that people want that ground floor, maybe two-story living experience.
They don't want to carry their groceries up three flights of stairs.
Yeah, what's interesting is we kind of had the thesis that it would be younger families in their kind of family formation years.
And that makes sense because the American dream that I had for owning a home is not necessarily they can buy businesses on their phones, et cetera.
But what I was kind of really surprised by, should have been smart enough to know, is that the kind of empty nesters that were active much longer now, even since COVID,
that they would love to have, like you said, kind of this, their backyard with their barbecue that they've been accustomed to with having us cut their grass.
So that's been kind of, you know, some of our projects really cater towards the younger and the family formation years and then a lot of kind of empty nesters and veterans and seniors as well.
I remember back in the early 2000s, there was a billboard on 101 in Silicon Valley and the billboard said, my house is worth a million is not a retirement plan.I don't know if you remember. that billboard.
They were around California and a bunch of different places.And yet for many, it was a retirement plan.
So what many people did is they cashed out of their detached home and became tenants by choice, deciding to live off of the equity and, and spend that down in their retirement years rather than keeping that money trapped in equity.
And so there is absolutely demand in the built to rent market that is lower maintenance.It's maybe not quite lock and leave, but something approaching that.And it's lower maintenance than a detached single family home.
So I think that's absolutely an astute observation that the market does segment that way, absolutely.
Yeah, it's interesting you said about that sign.It reminds me kind of of what we're seeing with this, the economic data that we see, you know, this kind of what they call owner equivalent that just makes up this large number of the CPI.
I think it's like 25%.No one can really explain it.You know, the idea that if I was asked by a census, what would my house go for to the rent, right?And that's kind of controlling a large part of the CPI.
these kinds of almost paper millions that have been accumulated over time and a lot of it is just arbitrary that's a huge makeup in our economy so what we try to focus in as well we can control is.
Supply and the fact that mortgages are about a thousand dollars more than they were in rent.
And that they're catering to not just that gentleman that you referred to, maybe the one renter in the homes years ago that didn't cut his grass like you should, and the neighbors gave him a side eye.
Now that's kind of the community of these younger families.So we can really only control the construction part, which I know you speak a lot about in your business.
Absolutely.One of the things that we see with many of the built to rent communities is that they offer often many of them are amenities rich, much like you would have in a, in a classic multifamily apartment complex.
And so the amenities in the community are part of the attraction.People are not going to afford $300,000 swimming pool in their backyard, but if they're part of that community and there is a $300,000 swimming pool amortized over 150, 200
detached homes, they have access to that amenity without necessarily having to shell out the capital for that.So that can be part of a very attractive lifestyle choice.
Previously, they would have thought they needed to go into an apartment complex to gain access to that kind of an amenity.When you're building, are you going amenities light?Are you going amenities rich?What's the what's the thesis?
Yeah, it's interesting.What we've kind of discovered is that some of the projects that we can build in Lafayette, Louisiana, for instance, in good schools in that particular, probably the best in the state.
But a lot of those communities really care more about the walking trails, the playgrounds, the kind of open space, the green.Now, we have built clubhouses and pools, and certainly there is a market for that.And I'm thinking of a Broussard
project that we've got not too far from their kind of the youngsville area of lafayette louisiana and alabama and baldwin county i think the market does command those kinds of amenities but.
What you can't get as reference before is maybe the people above and people below.We're building these for homes people are walking in their senior neighbors in the open spaces the dog yoga all that stuff is kinda what they care about more so than.
you know, having that pool.In some cases, that's a big deal for the kids, but I was kind of surprised to learn that that was not as much of a factor as we're surveying our residents.
It's interesting you mentioned that project.I'm going to go out on a limb here and guess that I may have actually seen it.It's just north of Interstate 10, correct?
You may have, yeah.Yeah, you may have seen it.Interesting.
It's such a small world, isn't it?
So you've, well, you've seen everything.So it really, you're, you're, you're, you're looking at, you know, sideways building in San Francisco and, you know, sideways buildings in New York.
And so it's businesses in, you know, under the airport of Miramar.So you've been everywhere.It doesn't surprise me.
That's funny.So as we look forward, obviously, there's three main variables that determine the viability of any of these projects.
There's how much you're going to get per square foot in rent, what's your cost to build per square foot in the market, and then the cost of capital.Everything else is a rounding error by comparison.
Property management might be 1% more, 1% less, but at the end of the day, it's those three main variables.A lot has been dominated by cost of capital over the last little bit. construction costs has come way down, especially in the South.
And with the number of projects that have been canceled, there's a lot of labor available at very respectable prices.People are willing to compete for business again, as they should.
It's now the big question is, what's going to happen with the cost of capital?We've got a big election coming up over the next few days.We don't really know what the outcome is going to be.Maybe we'll know by the time this
podcast airs what the outcome of the election is.
But the feeling is that whoever ends up in the White House, whoever ends up dominating the Congress and the Senate, they're going to spend money like drunken sailors, because that's what politicians do, which at the end of the day is inflationary.
And at a certain point, you can only go so far holding interest rates down at the zero bound when you're printing money that fast.
Yeah, so this is kind of interesting.I've heard you talk about this.
I think that my view on the inflation is a little bit different in the sense that really if we were to stay kind of on trend here, and I think most of the inflationary struggles that we had were supply.The Fed's much smarter than I, but I think about
maybe we'll have two more cuts here.And I think if you're considering the questions that are asked to the Fed, they don't want to seem to answer if we're in a recession or does it really matter if we're dropping rates, right?
Because by that time, it's kind of too late if you've got jobs data.So from my perspective, what we can control is I think almost every lender that you've talked to over the last two months says, well, wait till the election, right?
We're not doing anything till the election, which is kind of silly if you think about it, because it doesn't really matter.As you said, the money's either going to move or it's not.
And usually when there's a new president, in this case there is, the money's going to be starting to open up and move a little bit.So my feeling on it, whatever this election goes, that I think there is going to be more money moving.
And I was kind of surprised that so much capital sitting on the sidelines.
It does make sense, though, Victor, if you kind of think about it, the people that were kind of sitting on the sidelines, you say, well, of course, there's going to be money coming out even where interest rates are.
But the risk that they're taking to get that money out. when no one else is lending or no other private equity is too great.And so now perception with interest rates falling a little bit, I think you start to see the flow of money.
And even if the economy does dip a little bit, I'm pretty bullish on the real estate part of it because of the supply. and the movement of money, which affects cap rates and all of the rest of it.
So I'm curious your take on the inflationary pressures and how that would really affect the economy, but specifically real estate, which may even be different.
We have a narrative, certainly in the mainstream media, that it's all about the Fed.And the Federal Reserve dropped interest rates in the middle of September.At that time,
Towards the middle of September, the yield on the 10-year Treasury was below 4%. even as low as 3.7 some days.
And since the dropping of the federal funds rate by 50 basis points, we've seen the yield on the 10-year Treasury go up by almost 60 basis points.The Fed has had nothing to say about that.
It's all the market, bond markets specifically, making a determination about what the cost of money might be in the future, and maybe to some extent worrying about inflationary pressures as time goes on.
Partly driving that or maybe it's just a question of supply and demand for that that paper maybe we're in a moment where Demand for that ten-year papers has dropped and so so the yield has had to go up in concert We often think that there is one central arbiter that is setting a rate and it just doesn't work that way there are many many many rates you're gonna pay your construction loan as An offset from the secure overnights fund rate, so it might be so for plus five
year 35 or even 40 year fully amortized loan is going to be indexed to the 10 year Treasury and so on.And the Fed doesn't set either of those.So as real estate investors, our capital costs are determined by other market forces
How are we able to make determinations about where that cost of capital is going to be and how do we underwrite that?How do we forecast that in the future?What's the price of a rate cap?
All of those questions come front and center, at least for us as we do our planning.
And I think the big part of that is that flow of capital, right?
Which to a certain degree, even if interest rates are a little bit higher, and I've been through multiple cycles and as I know that you have, sometimes you've got interest rates that are in those fours, fives, but you've got this... There was a certain time in the 2000s, early 2000s where that was maybe high, right?
But you had this flow of capital, which compresses cap rates.And if people are moving, they're making it a lot less.The hinge is much less on the actual rate itself than the movement of capital.
And I think that's what I do believe will likely happen in either administration.So I'm a little bit more bullish on the real estate side than I am the economy, because you certainly see some of the jobs data being revised.
It's very hard to pinpoint where that's going. But I think if you think about just manufacturing, auto, and real estate, which are a large part of the effect of real estate flowing capital, those have all been relatively strong.
I mean, the idea of healthcare and some of those, that doesn't matter, whatever interest rate, if you need your surgery, you need your surgery.So I think real estate's an okay place.
I'd be curious if what you're underwriting, some of your developments now on cap rates and yield on costs,
Yeah, we're typically looking for a spread between yield on cost and the cap rate.So for the listeners at home, when we make that distinction, the cap rate is what the market offers when trading a piece of real estate.
The yield on cost is the NOI for that property divided by the total investment.So because it's not trading in the market, we would have built it at that project cost.So we want to spread between those two.If I go back
mid-teens, 2013, 14, 15, we would have been very happy to build at a seven and a half percent and see it appraise at five, see a point or two or a point and a half or two points of spread between those two numbers.
Today, it's more difficult to achieve that spread.We've seen cap rates elongate a little bit, but not that much. Now, if you're in C-class apartments, prices were bid up to insane levels.
There's no way a C-class apartment should be trading in the fours.That makes no sense.That's not an A-class property.So yes, those cap rates absolutely are going to elongate as they should, because they were well overheated.
But if we're building new product today, in many markets, you know, good locations, it's a struggle to get a point and a half spread between yield on cost and cap rate.
It's really, you have to focus, really sharpen your pencil on cost, make sure that you're not overpaying for capital, make sure that you hit your schedule, my goodness, because time can eat you alive if you've got the meter running on an expensive construction loan.
those are the things that we focus on making sure that we can hit those timelines.And if we are working on a project that where the timelines are less certain, try and minimize the debt, if not zero it out altogether.
Yeah, I think, I think the part that we hear not enough about is, especially in the markets that so I'm in San Diego, we developed in LA, the time with which you can build, it's just part of the reason the Southeast so attractive one land is relatively inexpensive.
And that Every market is localized, but the land is inexpensive.The labor, as we talked about, has improved a little bit, the cost of labor.But the speed with which you can get things done is so crucial.
So from that entitlement phase through that kind of horizontal phase where you do need a lot of the municipality's help,
We typically put our own money in through that first entitlement phase and then at the horizontal phase, we might bring that out to the market.
You need a lot of municipalities help, cities, consolidated government, all of that is really the speed with which you can build is so important.That's probably you hit that part on the head is that all of this other thing, what we can get for rents.
you know, what our interest rates are going to be and, you know, what our costs are.That's, that's all kind of secondary if you're, you know, two years behind schedule on your construction.
Well, there's that and the other thing to remember, of course, as well, is to really pay attention to completions that are in the marketplace, because there's many fabulous markets right now that are oversupplied, at least for the time being.
And how long is it going to take for that new product to absorb when you've got the majority of new leases being signed with rent concessions or some kind of incentive?That does put downward pressure on rents.
And so you might not even hit your numbers as you aim to lease up your building quickly, because it's more important to get it leased up than to get the last 50 bucks.But then you're not hitting your numbers.
So we pay very close attention to that, make sure that we're not going into markets that are oversupplied, because that could be that could be painful.Well, Andy, if if folks want to connect, if they want to learn more, what's the best way?
Yeah.Legacy acquisitions.Please take a look at our website.We've got some resources for experienced and newer investors or real estate operators.So and always find me on LinkedIn.I know Victor, you and I have been helped by a lot of mentors.
So if we can help somebody as a resource, we'd love to be able to do that.
Love it.Well, Andy, great to connect.And for the listeners at home, definitely reach out to Andy McMullen at Legacy Acquisitions.The link will be in the show notes.And in the meantime, have an awesome rest of your weekend.
Go make some great things happen.We'll talk to you again tomorrow.
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