Robert Boucai & James Broyer – Tax-Efficient Multifamily Real Estate at Newbrook (EP.475)

This Sponsored Insight features Robert Boucai and James Broyer. They are the Co-Founders of Newbrook Capital Properties, a multifamily real estate investment platform built to generate optimal long-duration, tax-efficient income. Robert is also the Founder of Newbrook Capital Advisors, a hedge fund he launched twenty years ago that today manages $1 billion across long-short and long-only strategies. He was born with sensorineural hearing loss and today serves on the Board of the Hearing Health Foundation, which is dedicated to preventing and finding cures for hearing loss. Our conversation covers Robert's path from real estate to hedge fund investing and back to real estate. We discuss the real estate strategy he designed with James, including alignment, market and asset selection, property improvement, and supply-demand drivers to create durable rental growth. We close with risks, synergies with Newbrook's public equity business, and plans to scale the real estate platform. Learn More Follow Ted on Twitter at @tseides https://twitter.com/tseides?lang=en or LinkedIn https://www.linkedin.com/in/tedseides/ Subscribe to the mailing list https://capitalallocators.com/ Access Transcript with Premium Membership https://capitalallocators.com/signup Editing and post-production work for this episode was provided by The Podcast Consultant (⁠ https://thepodcastconsultant.com/https://thepodcastconsultant.com https://thepodcastconsultant.com/⁠ https://thepodcastconsultant.com/)

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Speaker 00

  When I started looking at my own returns of my investments in 2020, I'd invested in a bunch of real estate general partnerships over the last 10, 15 years. My best after-tax returns were coming from real estate because of the depreciation, shelter and the growth in income was getting attractive returns on an after-tax basis. We came to the conclusion that we really needed to create this ourselves and we couldn't invest more with other GPs because the other GPs don't have the things that we were looking for. We needed to reverse engineer the optimal solution for ourselves and find a partner to help us implement it.

• 0:44Ted Seides?

  I'm Ted Seides and this is Capital Allocators. My guests on today's show are Robert Boucai and James Broyer, co-founders of Newbrook Capital Properties, a multifamily real estate investment platform built to generate optimal, long-duration, tax-efficient income. Robert is also founder of Newbrook Capital Advisors, a hedge fund he launched 20 years ago that today manages a billion dollars across long-short and long-only strategies. He was born with sensory neural hearing loss and today serves on the board of the Hearing Health Foundation, which is dedicated to preventing and finding cures for hearing loss. Our conversation covers Robert's path from real estate to hedge fund

• 1:28Ted Seides?

  investing and back to real estate. We discussed the real estate strategy he designed with James, including alignment, market and asset selection, property improvement, and supply-demand drivers to create durable rental growth. We closed with risks, synergies with Newbrook's public equity business, and plans to scale the real estate platform.

• 1:51Speaker 02

  I hope you enjoy the show. And if you do, this week, why not reach out to that friend of yours? You know, the one I'm talking about. There's someone you've known forever and trust and love so much. You probably only see each other maybe every year or two these days, but whenever you get together, it's like no time had passed at all. Go ahead, reach out to them and just say hi. When it comes up, what inspired you to reach out? Just tell them you thought of them while listening to the Capital Allocators Podcast, and maybe they want to have a listen, too. Thanks so much for spreading the word.

• 2:22Ted Seides?

  Please enjoy my conversation with Robert Boucai and James Broyer.

• 2:28Speaker 02

  Robert, James, thanks so much for joining me.

• 2:30Speaker 00

  Thanks for having us.

• 2:32Speaker 02

  All right, Robert, let's kick it off with you. Take me back to your upbringing that led you to get into the investing world in the first place.

• 2:39Speaker 00

  I grew up in Boston. Parents were immigrants from Lebanon. I had the fortune of growing up in the 80s and 90s. I enjoyed reading things like The Wall Street Journal, business book, wanted to go to a business school for undergraduate. When I saw Wharton in the summer of 1992, I said, this is really where I want to go to school. I applied early. I got in. I was thrilled. And I spent four years there from 93 to 97, majored in real estate, majored in finance. I was great at math. I loved playing with numbers. I loved reading stories. I invested in the stock market when I was a teenager. That's really what I wanted to do. I had done two summers of investment banking in California, came to the conclusion

• 3:22Speaker 00

  that investing was what I felt would give me control of what I could do and where I could live. The best real estate job coming out of Wharton was at Blackstone. So that's where I started in 1997. I worked there for three years. There were very few investment jobs coming out of Wharton that were available. Most of them were banking. Private equity didn't really exist for an undergraduate. Blackstone was a great place for me to learn. I joined the group when it was on Fund II. The group only had 12 professionals. We had a portion of an office floor on 345 Park Avenue. A lot of the people that are there today were very low in the totem pole back then. And it was a great learning experience.

• 4:04Speaker 00

  I got to travel a lot, Europe, Asia. It was a real amazing education experience. But while I was there, besides learning about building a business and investing in real estate, A great founder of mine from Penn, who was an engineer, had opportunities to invest in technology and telecom equipment startups. This was the beginning of the build out of the internet. We invested in a bunch of these startups together. Some of these companies were in public and did quite well. So it brought to my horizon investing beyond just real estate. I loved real estate. That got me interested in investing in, at the time, venture capital. I left Blackstone in 2000 to do venture capital investing.

• 4:50Speaker 00

  In that one year that I did it, I quickly realized that the opportunity was on the short side, not on the long side, because that bubble burst pretty quickly. A lot of these companies were funded by the debt capital market didn't have sustainable earnings and ability to pay the interest on their bonds. So I realized that the opportunity was on the short side. I joined a hedge fund in 2001 that had a small amount of assets. Worked there from 2001 to 2005. We did really well in oh one and oh two, taking advantage of the bursting of the TMT bubble. That's what got me interested in the hedge fund business. When I left in 2005, I wanted to start a firm around the best practices of public and private equity. The things I had learned at Blackstone in private equity, having an investment committee,

• 5:34Speaker 00

  having a standardized memo model with the best practices of public equity, which were the ways to ask company questions, the ways to go about research, the ways to build conviction and ideas and build a firm around those best practices. I started Newbrook in February of 2006, well, been 20 years starting this February. We started that business with $9 million of AUM. Three months after I started, my father told me, you should go back and get your old job, but this isn't going to work. I didn't get the most encouragement necessarily at the beginning, but I stuck it out. And at the end of the first year, we had about 200 million of AUM. So we were big enough to seed and scale and we grew the business. Today, we have about a billion dollars of AUM between our hedge fund and the long only fund.

• 6:20Speaker 00

  That's how we got to where we are today on the liquid side of our business.

• 6:24Ted Seides?

  When you look across that set of experiences, early private equity, real estate, a little bit of venture, shorting, a hedge fund and long only today, what are the common threads you took away that helped you, say, over the last 20 years at Newbrook, take all those lessons and bring it into your investment style?

• 6:43Speaker 00

  It's always to keep your eyes open for opportunity, to be aware of what's changing in the equation, where we are in a cycle. Some things can be good for one sector and not be good for other sectors and to be aware of that. When I was at Blackstone, what had happened in technology came to the detriment in the public markets of real estate companies. REITs would be trading at a significant discount to NAV because people were selling public real estate stocks to buy the technology stock. Conversely, those stocks did better when the technology stocks blew up. These things can work in reverse. When you look back at the last 20 years as an example, cycles can happen in different asset classes at the expense of one another. It's important to keep sight of that.

• 7:27Speaker 00

  And as I look at where we are today, there are assets that are at all time highs and there are assets that are 20 to 30% off of their all time highs and that creates opportunities. That's one of the most important things I've learned from that perspective.

• 7:39Ted Seides?

  What's that trajectory been over the last 20 years in the hedge fund business?

• 7:44Speaker 00

  The hedge fund business in the early 2000s when I started was a terrific business. It was less mature, less developed. Broadly speaking, the markets were flat in the 2000s and in the hedge fund business on the long short, you could make 10, 15% a year. There were sectors that went up when other sectors went down. Correlations were low, competition was low. You didn't have people that were using credit card data and satellite data and analyzing the number of words were used in a conference call the way they are today. So the competitive field was a lot easier. The business was less mature. You didn't have the number of multi-strat funds and the credoring that you do today. It was a great area and a golden era, as some people have referred to it. Very different today.

• 8:28Ted Seides?

  How's the business evolved to get you back to thinking about private real estate?

• 8:34Speaker 00

  When I started looking at my own returns of my investments in 2020, I'd invested in a bunch of real estate general partnerships over the last 10, 15 years. My best after-tax returns were coming from real estate because of the depreciation shelter and the growth in income. It was getting attractive returns on an after-tax basis. It was effectively double because you're getting a tax default on the income. I saw that in 2020. I said to one of my partners, we should be doing more of this because the returns are much better than liquid returns on an after-tax basis. We came to the conclusion that we really needed to create this ourselves and we couldn't invest more with other GPs

• 9:15Speaker 00

  because the other GPs don't have the things that we were looking for, which was they're not necessarily benefiting from the income shield that they're getting from real estate because you need to own it long term. You need to use fixed rate financing to do that. They are generally using short-term floating rate financing and they have shorter term hold because they're trying to generate carried interest income to pay themselves. And then lastly, I would say they don't have as much personal capital invested. So the alignments are not there. There are some other intricacies around taxes and bonus depreciation that we did not see that other GPs were necessarily solving for. We came to the conclusion that we needed to reverse engineer the optimal solution for ourselves and find a partner to help us implement it.

• 10:00Speaker 00

  That's how we got to where we are today. So carry that forward into what you're doing.

• 10:04Speaker 00

  So I spent 21 and 22 trying to find someone to partner with, coming to the conclusion that we needed to find someone to do that in the construct that we wanted. I met about 50 potential partners and came across James Broyer, who was running the multifamily business at J R K. And they had the same goals that I desired, which is fixed rate financing, long-term hold, alignment of interest, value investor and contrary in the things that they chose. This is exactly what we wanted. 95% of the people that I met wanted to use floating rate financing. The reason I want to use floating rate financing is there's no prepayment penalty. So they can buy an asset, they can fix it and they can sell it and not have a repercussion

• 10:47Speaker 00

  of paying down the treasury maintenance penalty on the debt. I get that and almost all opportunity funds in the real estate will use floating rate financing. It makes sense if that's your construct. But at the same point, all of these funds have primarily tax-free investors. They're servicing endowments, foundations, sovereign wealth funds that don't care about taxes and that's great, but we care about taxes. If you care about taxes, the advantage of investing in real estate is that you're getting this tax-sheltered income stream. The only way to benefit from that is if you hold it for a long-term hold and you can only finance it with fixed-rate debt if you're going to value that. So that's what we did. James and I met in January of 2022.

• 11:33Speaker 00

  We agreed that this would make sense to do, but unfortunately at that time, the math didn't make sense. Cap rates were below borrowing rates. There would be negative leverage, not positive leverage. One of the cardinal rules of real estate investing that we have at New Book is we want positive leverage to happen from day one. That's a great form of self-discipline because by definition, you're financing at a lower cost than a cost to buy the asset. So if it costs 5% to borrow against an asset and you pay 6% cap rate, you're getting 100 basis points of positive leverage, you're making 6% on your unlevered capital, you're making 100 basis points of spread on your levered capital. Hopefully you can increase your 6% cap rate to 8% over the hold and you're getting even more spread over the hold.

• 12:14Speaker 00

  That creates a very attractive income stream and return stream for the investor. If you get an income stream, let's say over a hold of 8%, that means that if the asset does not appreciate over, say, a 10-year hold period, that you're getting an 8% IRR. The probability in my mind of an asset not growing in value over 10 years is low. It can happen, but it's low. And if that's your left tail in your income distribution, that seems to me to be a pretty good risk reward. That's how we came across and that's how we decided to work together. Fast forward to August of 23, we were having calls monthly. We had met Adam Donahue, who decided to join us and help us with organizational matters and has been a real asset to the group.

• 12:59Speaker 00

  We decided to start in October of 23 because in August of 23, James came to me and said, you know what, we can get 6% cash on cash on deals today. I said, okay, that's attractive. Finally, that makes sense. I remember a sixth to a California New York taxpayer asked at the 12% or 13% bond. That's pretty good. So we started in October 23. Since that time, we have acquired eight assets, about 2,100 units. We've made a lot of progress since then, but it was a long time coming.

• 13:31Ted Seides?

  So James, let's turn it over to you. I'd love to hear more about your path up until the point where you met Robert.

• 13:37Speaker 04

  I grew up in Massachusetts, similar to Robert. Coming out of college, I was graduating in 2008. First job out of school was pension consulting. I did that for about a year and a half before getting into investment banking. I realized pretty quickly that I wasn't particularly passionate about investment banking. I'd been reading a lot of real estate books at the time. And something that clicked with me and was interesting to me was real estate. So I joined a company called Boston Capitals. At the time, they owned apartments in the country. It was a large affordable component of that company where they owned about 200,000 units across the country. I was in a smaller division within there buying market rate communities. That was my first steps into multifamily. I loved everything about it. I love traveling the country. I love finding it new opportunities,

• 14:19Speaker 04

  figuring out ways to operate more efficiently and love the transaction aspect of it. After about two years there, I kept on coming across a firm called J R K Property Holdings. They were expanding rapidly and they were in Los Angeles. My girlfriend at the time, now wife, had also been born, raised, went to school within about 25 miles and we thought it would be an exciting opportunity to go and live somewhere else. So we ended up in Los Angeles. I ended up spending 12 years at J R K. It was a great experience. Came in as an analyst and ultimately ran the investment division as the president for the last five years while I was there.

• 14:52Ted Seides?

  What led you to leaving and joining Robert?

• 14:55Speaker 04

  When I met Robert, we had a cycle that was ending. I saw the opportunity that sounded amazing. At the same time, Jerkay had evolved into more of a family business with the founder being close to 70 years old and his children coming into the business. It makes sense for someone who had an entrepreneurial aspect that they were looking for and looking to start their own business. Robert was a great partner and viewed the world through a similar lens. All the aspects that he likes about real estate, whether it's the tax efficiency, the distributions, it also aligns perfectly with my investment strategy, which is de-risk assets when you can own them for longer, when you're employing fixed rate financing. So it blended very well and we knew very early days after meeting that this was going to be a great partnership.

• 15:38Speaker 04

  When I met Robert in January of 2022, multifamily, the acquisition volume had doubled since 2019. It was just an incredibly compressed market where you had tight cap rates, incredible volume of deals selling. But the playbook had, to Robert's point, switched for a lot of groups where they began doing three to four year hold periods. Everyone was utilizing floating rate debt. You had all the non-traded REITs, which were raising a tremendous amount of capital. So you had these non-traded REITs that were actually buying about $20 billion worth of multifamily in 2021. About 10% of all transactions in the multifamily space were being traded to these non-traded REITs. You had these cap rates that had compressed. There was a ton of capital chasing these deals, but there was rent growth there.

• 16:21Speaker 04

  But for someone who only employs fixed rate financing, it was not an attractive time to be deploying. The values didn't make sense, where these things were trading on a per unit basis. There was no discount to replacement cost. Felt really risky and it didn't feel like we could get the right cash on cash returns that could justify buying these assets. We met in January, after about a year and a half, to Robert's point of getting to that 6% cash on cash, finally saw these values drop about 30% from peak. And then we were able to start buying below replacement cost. I felt that there was very limited downside from that point. There was enough people that are on the sidelines. There's enough groups that had taken on floating rate debt. They weren't buying, they had

• 17:01Speaker 04

  Legacy portfolio issues. We knew that there was going to be some sort of correction from when we met. We just weren't sure when it was going to happen. After about a year and a half of a lot of conversations. Okay, this is an attractive entry point. We're going to have this business for 30, 40 years. We're believers in multifamily. But this is an outsized period of time for us to take advantage of the opportunity. That's when we launched.

• 17:23Ted Seides?

  There are a couple of aspects of the strategy that you've intimated at. The first, obviously, multifamily. Why focus on multifamily real estate?

• 17:32Speaker 00

  If you look at the different real estate asset classes, it's the least controversial one. We can debate work from home. As regards to office, we can debate on consumption patterns with retail. Data centers are too big for someone like us to adjust. Multifamily, there's no debate. People need a place to live. That's the most important thing. Second most important thing is it always has access to the lending market. Because of buyers, we can borrow off of family and buddy financing. We always have access to borrow from the bond markets effectively. Whereas the other asset classes have more risk in accessing the debt capital market. This is the easier asset class to own for predictability, for safety, sleep at night, investing money.

• 18:15Speaker 00

  The other thing I would point out is that multifamily is a asset class that has historically had low capex. It lends itself well to making distribution. Whereas things like office or retail are tenant improvement heavy. Therefore, maybe more episodic in its ability to return capital to investors. What we are trying to create is a synthetic fixed income replacement stream for an investor and a tax advantaged one. Multifamily lends itself best of all those asset classes to doing that.

• 18:51Ted Seides?

  What's the subtlety if most of the competition uses floating rate debt? You've mentioned you want to use fixed rate debt. How do you come to that decision to use fixed rate debt?

• 19:02Speaker 00

  It goes back to the income replacement side. If you are trying to get the tax benefit from investing in real estate, you get it from having a long-term hold because it allows you to use the depreciation shield. If you buy a piece of multifamily property, you depreciate most of the assets over 27 and a half years. If we're trying to buy that income stream, goes back to the example of 6% capital with 5% borrowed financing. It starts out as a cash on cash, slightly over a six-year one, and it grows through the hold. Maybe that's 8% over the hold. If you use floating rate financing, that number may not be as predictable. You're subject to the Fed raising and lowering rates. In the fixed income side, if you hold it for 10 years, you have a more predictable income stream. You're less dependent on rates for your return.

• 19:45Speaker 00

  Going back to the example, if you have a 10-year hold and you have an 8% cash on cash over the 10-year hold with a fixed income, debt financing, if the asset doesn't grow in value, you're getting an 8IRR. If the asset grows 2% to 3% a year, which is more likely, you're probably getting something on the low teen because of that. It lessens your risk to rates. It also lessens your risk to exit cap rates on the back end. If rates go up during the hold, if your cap rate ends up being 100 basis points wider, it's probably because there was higher than expected inflation during the hold. If that's the case, you probably had better than expected income growth. You're going to have a higher cash on cash and you're productive, but maybe your cap rate is higher. So your IRR might be slightly lower, your cash on cash will be slightly higher. For us, I view it as a way of de-risking our churns out.

• 20:29Ted Seides?

  When you decide you want to focus on multifamily, it's a lot of markets to choose from. How do you think about where you want to be buying assets?

• 20:38Speaker 04

  We're a little bit unique in this. We end up underwriting about 100 deals a month. It's the best data that we can get out there. We subscribe to a number of different data providers. The best data we can get is from underwriting deals, looking at rent rolls, seeing where the rents are heading, seeing which markets are compressed right now. We focus primarily in landlord-friendly states. That's the Midwest in select markets within the Sun Belt. Looking at about 100 deals a month, five of them might actually be interesting enough where they meet our narrow box. Where they have the right in place performance, we can tell that it's a compressed market and the rents are heading the right direction. And then we can get it at the right price where we can generate the right cash on cash returns. For us, to Robert's point, we look to have about two thirds of our return to come from cash flow.

• 21:23Speaker 04

  That is the best risk adjusted way for us to look at these versus a floating rate buyer that might not care about cash flow and might rely on appreciation at the exit and be relying on what the environment is in three to four years. We want to look at over a longer duration time where we have a predictable revenue stream that we can improve by renovating interiors, figuring out how to operate more efficiently, drive ancillary revenue streams to drive overall cash flow in the asset. And then be able to exit the asset ideally during a compressed period and not be forced to sell when it's not a seller's market.

• 21:56Ted Seides?

  Once you pencil out the math on any one deal you're looking at and it looks good, what are the subtle things beyond what the numbers tell you that lead you to want to buy one asset versus passing on another?

• 22:08Speaker 04

  Looking at such a high volume of deals, we'll dig into the past five years of operating performance. We think the market's fairly efficient from a renter's perspective. If the rents are too cheap, the renters are going to find it and there might be repositioning from a physical perspective. There might be upside there, but you can identify a lot of these compressed markets through occupancy and performance historically. What we gravitate towards is the deals where we know over the next 12 to 24 months, even if we don't have to do anything physically to the community, we're heading in the right direction and then we're going to be able to further improve it. It's finding the deals where we see strong renewal growth, strong income to rent ratio with employers in the market, and then really little supply.

• 22:49Speaker 04

  What's unique about us is that a lot of institutions focus on the highest population growth markets in the country. If you step back and look at the data, you look at over the past 10 years, 20 years, it's not the Austins, the Dalles's, the Tampos of the country that are performing the best because we're solving for rent growth. At the end of the day, we care less about population growth. We want population growth to be positive, but we're solving for rent growth, which is totally different than a lot of people's mentality and investment thesis. They're looking at population and where areas are growing. But if somewhere is growing, that means there's also supply, there's very few barriers to entry, there's probably land available. We look for the areas in the markets where either it's you can't build because it's too difficult and challenging to build there,

• 23:33Speaker 04

  or the rents don't justify it. So you have A solid runway of rent growth that you can achieve before someone's going to come in, build in the market and ultimately cause pressure on the rents that you're charging. It's looking at specific submarkets where we can see there's no supply within 10 miles. There's not going to be supply until we either get rent growth of $500 plus a month per unit, or it becomes much cheaper to build, in which case rates are down, in which case we're happy with that outcome too, where we might not get quite the rent growth we expected, but our value on a capitalized basis is going to be better than we had underwritten.

• 24:08Ted Seides?

  I'd love you to walk me through a deal that you've done, through the actual property, number of units, all the characteristics that led you to want to buy the asset.

• 24:17Speaker 04

  We bought a deal in suburban Charlotte, North Carolina. It was June of 2024. We identified the asset. It was 96.5% occupied. They were achieving 8% increases on new leases that had moved in. They were getting strong renewal growth as well. The rents are about $1,200 here, so it's 30 minutes outside of Charlotte. It's not downtown Charlotte where you have a lot of supply. There was no supply within 15 miles and the rents were just too cheap. It was an asset that largely hadn't been renovated. So we could go in, renovate the community. We knew the comps were $400 to $500 above us. So we had a healthy spread where we could improve the asset, but still be below them from competing.

• 25:00Speaker 04

  We were able to buy the deal with eight years of financing in place at about a 4% rate, and we bought it around a six cap. So it's about 200 basis points of positive leverage. We put a small supplement alone at closing. That was about 150 basis points of positive leverage by the time we had closed the deal. Today, we've had 13% rent growth in the past 16 months on that asset, and we've only renovated 20% of the community. So we know that we have rents that are heading in the right direction, and we have strong tailwinds for the next 12 to 24 months as we continue to. Increase the rents, get them closer to market. But we're also offering a product to these renters that's superior to what they had lived in before. Most of our residents are staying at the community and upgrading to the renovated units.

• 25:45Speaker 04

  That's a perfect outcome for us. We don't have to displace any of the residents and we've been operating at 96% occupancy since we bought it. That's a good example of a deal that's down the fairway for us where positive leverage at the beginning, we have that eight years of fixed rate financing and we have an opportunity to reposition the asset.

• 26:03Ted Seides?

  What is the actual process of renovating a unit look like? The dollars you put in, what you're doing to the unit and what you get on the backend?

• 26:12Speaker 04

  Most of the properties we buy typically underwrite somewhere between 12,000 and 20,000 per unit for renovations. We'll do this all at the onset of the investment. So we call all of the capital upfront. We have a large contingency fund for anything that can come up, given our longer duration hold period. We'll give ourselves sufficient buffer, but we are going to look to renovate the community over the course of four years. We'll look for high ROI items that are going to drive leasing and demand for the community. I think fitness centers, pools, curb appeal from landscaping, signage, anything like that. I would say 70% of the equity allocated for rehab is going to the interiors. Kitchen and bath upgrades, it's flooring, it's things that are going to help us operate

• 26:56Speaker 04

  it more efficiently over the long haul. We don't want carpet in the units. We want wood plank flooring. We want stone countertops. Anything that's going to help reduce our capex spend down the road and enable us to charge more for a rent premium versus what's in place versus the comps is a good outcome for us. We'll end up renovating any given community, 10 to 20% of the units. We'll increase renewals to create a little bit more vacancy if we don't see that we're getting units back where we can renovate them. We're typically renovating anywhere from four to 10 units a month at most of our communities.

• 27:30Speaker 00

  We're doing things to improve the quality of the tenants, like adding dog parks, pools, gyms. So all the things that would get positive feedback from the tenants preparing the driveway. It's important for us to provide a good experience for the residents because it pays for itself.

• 27:46Ted Seides?

  How do you think about the diversification aspects of a portfolio of these properties?

• 27:52Speaker 04

  It makes most sense for us to continue to be focused on the Midwest and the Sunbelt. We want to eliminate as much risk as possible. We do not touch California. We don't touch New York. These places where you don't know if there's going to be restrictions put in place that are going to impact our ability to manage the assets the way we need to, or that are going to increase taxes on the sale. We look for states where we know they're going to be landlord friendly, they're going to enable us to run the business the way we historically have and know we need to in the future. We don't expect to be outside of 10 to 12 states ultimately, but we do look at diversity. It makes sense to be across a variety of states.

• 28:31Ted Seides?

  With the intent of having a long duration hold, how do you think about the exit strategy on an asset?

• 28:37Speaker 04

  In a perfect world, we would be selling during a compressed period. It makes a lot of sense for us to hold these and to sell inevitably if we're able to get interest rates coming down, or if we see that the market compresses and we can sell them during a compressed period. That's a benefit of the longer term fixed rate financing. Ideally, we could put together a handful of deals and get a premium, and that'd be a very good outcome for our investors. For us, we underwrite that we're going to be selling them in an environment similar to today, which is largely a buyer's market. There's not a great time to be selling, but we think that we're going to have an opportunity to sell during ideally a compressed period, either as a portfolio with a handful of the deals, or a larger transaction if it makes sense. And there's equity out there that wants to pay a premium for portfolios.

• 29:20Speaker 00

  It's important in our business to under promise and over deliver. You have to delight people. You have to give them a better experience than they're expecting, and that keeps them coming back. That's what we try to live up to as a team, where we under promise and over deliver, that we project lower than we think we can get. And as James mentioned, that we're selling our cap rates where we are today, where we think we're probably going to do better than that.

• 29:43Ted Seides?

  What does the competitive landscape look like when you're looking at an asset that you find attractive?

• 29:50Speaker 04

  Multi-family is far less crowded than it was a couple of years ago, given the number of people that have floating rate debt, that are overlevered, that are on the sidelines, that can't raise capital. For well-capitalized buyers, it's a good environment to take advantage of that. While other groups are not certain what they're doing with their portfolio, or if they're going to have liquidity events in the future, a lot of times, these groups put their foot on the gas in '21 and '22, when assets were incredibly inflated. There's less competition. Groups need to be nimble, though. You need to have deep relationships and a strong track record of closing and being a good buyer and someone that holds up your end of the bargain for these transactions. Your reputation's critical. You need to know exactly who you're buying and selling from. We'll look at anything from, it could be a broker deal,

• 30:34Speaker 04

  it could be off-market, direct from another principal. We know exactly what our buy box is. We're upfront about that. We're quick to move past a deal if the operations are soft or we don't like the asset or the market, or if we can't get it at the right price. It comes down to a disciplined approach. What we've seen is, for the groups that we buy from, we're typically a quick call to them if they're thinking about an asset that they're going to be selling in the future. Do we want an early look at it and an opportunity to buy it off-market? And do we want to be a repeat buyer from them? It goes both ways. We'll submit close to 200 LOIs a year for transactions. We look at a high volume. We submit these LOIs. If we get a deal awarded, groups know exactly that we have the balance sheet and the capability to take down the deal, that we're signed off internally on it. We don't require outside approval.

• 31:18Speaker 04

  A lot of groups that compete with us, it's inefficient because we're looking at deals that are, call it $30 to $100 million. A lot of our competitors partner with other groups, with other equity providers that require some sort of sign-off and they need to go and find that equity. For us, we have the capability to buy it internally. Most of the time, what we're doing is, we're buying the asset, we're completing due diligence. If it's a deal we want to move forward with, it's exactly what we thought it was. We're going to rate-lock. We're going to eliminate the interest rate risk. And we're on the hook to buy it at that point. That's when we present the opportunity to our network to say, who would like to invest alongside us? Here's our thesis. Here's our internal investment memo. We put some disclosures on there and we share the opportunity and it's resonated.

• 32:03Ted Seides?

  How do you balance the desire to bring certainty to the seller with needing to then either go find equity capital or having certainty of the debt markets?

• 32:15Speaker 04

  Most of our transactions, we're doing fairly quick due diligence. We know exactly what we're looking for. We're very thorough and we can do it in about three weeks. I would say that's not much quicker than what's in the market. But once we complete that due diligence, we're putting up an outsized deposit. Typically somewhere in the range from a million to $2 million. So it's larger than most of our peers. We have a number of programmatic investors that have met us over the past two to five years, sometimes longer, who underwrite us as managers. They understand our philosophy and what we're looking to buy. We have a fairly simple document that outlines exactly what we're buying. If it meets these thresholds, it's non-binding, but we present it to them and they've underwritten us as managers. They don't want to make the decision of, do I want to buy North Carolina?

• 33:00Speaker 04

  Do I want to buy Ohio, depending on what we're looking at? I'm going to sign up for the next five deals, 10 deals, whatever the number of deals is. They're programmatic in nature. So we know that when we're buying deals, we have about 50% to 70% of the equity already raised at the time that we actually go hard on the transaction. That gives a lot of certainty to both the seller and us internally. A lot of times we're buying two, maybe three deals at a time.

• 33:23Ted Seides?

  Once you have the strategy, you've identified a bunch of assets. How did you think about this as a business?

• 33:30Speaker 00

  Going back to the part where I met James in January of 2022. Once we had that meeting and we agreed on it, I mentioned to a bunch of my friends over the following couple of months, I was thinking of doing this and here's why and here's what made sense to me. A lot of them said to me, I would do that too. That really makes a lot of sense. That's when it came to me that maybe this is a business. I was really doing this for myself, but ultimately I realized that this was a need that needed to be provided to other people. What I often say to people who work in our industry and financial services is, what do you think you need to retire? And how do you think about retirement? And I use an example, if you think you need $10 million to retire at the age of 65, let's fast forward to 65.

• 34:14Speaker 00

  So you're going to wake up one day and you're going to start trading in your pajamas and trying to make a living at 65 from that. I said to them, assume you had $5 million in real estate paying 8%. And you're not paying tax on that and that grows at above inflation because you're going to get inflation and rents and with leverage, maybe it's five percent. And then the other five million dollars, you have stocks and bonds and whatever investing you want to do on the side. So you would have four hundred thousand dollars of tax-deferred income that you're getting. And then you have your other five million that you've invested in other things. So does that solve part of your problem for retirement that you're trying to get some income stream that you can then use to plan your vacation and your monthly expenses? The feedback to that was, you're totally right.

• 34:59Speaker 00

  I need to do that. That has been the reception that we got. I understand. So this is what I need to do. If you want to do that, you can't just show up at sixty five and do that. It takes years of planning. And if you want to do it in multifamily, you can't be all in one deal. You need geographic diversity. You need time diversity, depending on the maturity date of a debt that we have. That's how it became a business. We slowly started talking to people when Adam joined in October of twenty three. We started talking to more people and realized that there was a need out there. We came to the conclusion that as investors in the public market, we have great respect for the big alternative firm, but eighty percent of the investors don't pay taxes. Twenty percent do. That's the long part of their business because they're slowly trying to expand to the private

• 35:44Speaker 00

  wealth market. Their products are not optimized for taxpaying individuals the way ours are. The analogy I like to give is they're selling seats on a seven seven seven or an Airbus three fifty. We're selling seats on a Gulfstream. Our market is not as big as their market, but it is much more customized. We cannot deploy five billion dollars of capital a year. We could deploy a hundred, two hundred million type of capital a year. That's what we're capable of. With the discipline, with the buyback, with the limitations that we have and the returns that we're trying to achieve, especially on the cash on cash fund, it is not a huge term. That's how it developed into a business. The investor base we have speaks to the specialness of what we're doing. The investors we have work at a lot of these firms that have these products of the distribution platforms.

• 36:29Speaker 00

  We have investment bankers, we have private equity professionals, credit professionals, CEOs, family offices. That have the ability to invest in any of these firms. They're choosing to invest with us for a reason because we have created that seat on the Gulf Stream that they want. They'd rather fly on a Gulf Stream than a 777 and an A380. I don't blame them.

• 36:49Ted Seides?

  It sounds like you've gone about this in a deal by deal basis. Have you thought about the value of doing it that way compared to raising a fund for the strategy?

• 37:00Speaker 00

  It's an interesting question. For starting a business and for where we are, the deal by deal makes more sense. It allows flexibility for the investors. It allows optionality for tax enhancements. We don't take, for example, bonus depreciation, which is very favorable for a lot of the investors in New York. It's not favorable for them to take bonus depreciation. It allows us to have the ability to manage the business the best at the moment. Over time, it's a debate whether the deal by deal versus a fund makes more sense. It's one we're going through. The positives, if we were to have a fund, is perhaps the rates of return could be enhanced because we could optimize the timing of the cash flow. We might be able to take advantage of better pricing because we have purely discretionary money. That could be helpful.

• 37:45Speaker 00

  We could perhaps get better expense management with insurance as an example. It's one we are debating. It also allows us to tap other markets that we may not at the moment be able to access, such as the IRA channel, which would benefit hugely from what we are doing. This is an extremely favorable proposition for taxable investors. It's very much in debate and remains to be seen.

• 38:07Ted Seides?

  One of the big tax efficiencies in real estate is 1031 exchanges. How does that play into the strategy?

• 38:13Speaker 00

  At the moment, it's something we have optionality of doing. Every deal is set up as an SPV, so we maintain the ability to do that down the road. It's an important consideration in the current construct. Each investor will have the option at their discretion to decide. If we go into a fund construct, we think we're able to maintain that optionality. We're still working through that. As I often tell the guys, Warren Buffett made 99% of his money after the age of 50. I turned 50 a few months ago. The important aspect of that for Warren Buffett was the fact that he probably paid minimal taxes. That's one of the reasons why real estate is so attractive is the tax advantages it creates. But.

• 38:54Speaker 00

  Most of the funds that are in the real estate business do not allow you to have those benefits because they're typically using floating rate debt. They typically have a short term hold. Sponsors are typically incentivized by the promote. We have tried to set it up such that we're getting the benefits of all the attributes that the government has set up to encourage investment in real estate.

• 39:15Ted Seides?

  When you have the business in a construct of a bunch of different deals, a bunch of different groups of investors, how do you think about communicating with your investor base?

• 39:23Speaker 00

  When I was an analyst at Blackstone, I was told 90% of my job was formatting, which is a form of communication. We pride ourselves on being transparent, communicative, trying to set an expectation that we can over deliver on. We have quarterly reports, we have quarterly distributions. We are very clear about how our properties are performing versus what we had underwritten. And we're very responsive. Adam does an amazing job as head of our investor outreach in that department. It's an important way for us to differentiate ourselves versus our peers.

• 39:57Ted Seides?

  What do you see as the biggest risks to the strategy not playing out as you expect it will?

• 40:01Speaker 00

  One is higher interest rates. I tend to think that if they were to have higher interest rates, it would likely come with higher inflation, which we benefit from. Population growth, if the United States population growth doesn't grow at the rate it has historically, that could be problematic. And replacement costs, if replacement costs goes down, if there are cheaper ways to build, particularly some of the markets that may have more land than others, that could potentially be a risk. We have never seen that. It's always possible if some form of technology allows you to build at a lot cheaper. The last one would be high unemployment at an inopportune time. For example, unemployment is meaningfully higher than it has been historically. Those are the large risks that I would see

• 40:44Speaker 00

  playing out. If you have a higher unemployment, it likely comes with lower interest rates, means the capitalization rates are lower and the value of the income stream is higher. There are all sorts of offsets to each of the risks that I mentioned.

• 40:55Ted Seides?

  James, are there any additional micro risks?

• 40:58Speaker 04

  One of the things we're very aware of is probably more related to insurance. Insurance wasn't discussed broadly as an industry until 2021, when we saw the amount of replacement costs increasing and then weather-related insurance losses ticking up across the country. We've been very aware of that, and although insurance has come down drastically over the past 12 and 24 months, we're seeing a lot of renewals where we're decreasing our insurance costs across the country. It is something we're aware of, and it does give us pause when we think about certain areas, whether it's close to a flood zone or has cat exposure or Florida, Houston, areas like that specifically.

• 41:42Speaker 04

  The insurance risk caused a lot of pain for people in the portfolio. The cost has come down, but it is still elevated, and it's an area where I'm not sure insurance is going to get a whole lot cheaper. It's only heading in one direction at this point. Everyone has to be aware of the risk, and it's causing problems both in the rental space and homeownership space. It's one of those things where we tend to underwrite in a manner that includes more of a worst-case scenario from an insurance perspective. And by default, we end up not being able to pursue those deals because it just doesn't meet our returns threshold. We don't want to take a loss versus our underwriting on insurance costs increasing down the road, so we underwrite it conservatively. And then effectively, it forces us to stay clear of a lot of these deals where it's something that's very top of mind.

• 42:27Speaker 04

  I'd say insurance is a big risk that we think about a lot.

• 42:30Ted Seides?

  Robert, this strategy came out of your own personal need to try to figure out how to optimally reinvest your cash flows. I'm wondering, once you started the investment activity, if you've seen any synergies or adjacencies with your public equity investing?

• 42:48Speaker 00

  Absolutely. We're able to help them on the underwriting side when they're doing rate locks and timing the rate locks. We know what the calendar is for NFP and CPI, and James will get on the phone with our trader when they do the rate lock to make sure we got the optimal outcome. So that's the only way we help them. On the underwriting side... We recently looked at a deal in Norfolk, Virginia, which is a market that has not had historically strong population growth, but is quite levered to the Navy defense spending and the Coast Guard. We spent some time trying to understand the outlook for the Norfolk, Virginia market and did some work around the largest employer, which happens to be a public company. We spoke to some of the sell-side analysts down there. We spoke to the company

• 43:33Speaker 00

  and came to the realization that the real estate market was not aware of that the company was putting in place a 12% wage increase this past July. As we know from COVID, when you got a big wage increase, it typically shows up in events over the following 12 to 24 months. That was something that we conveyed to the real estate team and gave us more conviction in our projections to 3% rent growth. In fact, it's likely to be higher than that. We also learned on the public market side that this was an incredible opportunity because the company was getting a lot of backlog, a lot of business, a lot of contracts because of the spending around the Navy buildup and the competition against the Chinese Navy, for example. It's really helped us and it's opened our eyes to what's going on in the real world and the country. I mean, most of us in our business and the hedge fund side

• 44:16Speaker 00

  traveled to San Francisco and Miami and Los Angeles and Boston. They don't visit the real parts of the country, which James visits all the time in Columbus, Ohio, Charlotte, North Carolina, St. Louis, Missouri, Denver, Colorado. These are the real cities where Americans live.

• 44:32Ted Seides?

  Where do you hope to take this over the next couple of years?

• 44:34Speaker 00

  We would love to continue growing this business. We're providing a unique service to people that need income. We enjoy meeting people. We enjoy going to new markets to find new properties to improve and enhance people's quality of life. We would like to continue to grow ownership of units and make this a great business and try to help all A's that need help with income, retirement planning for people and to continue to expand what we're doing.

• 45:03Ted Seides?

  If you broaden that out to your legacy business, how are you thinking about that over the next couple of years?

• 45:08Speaker 00

  You've seen the trends in the legacy business, which continues to be an increase in allocation to passive investment. There's still opportunity, given where the level of the S and P is and where multiples are, that perhaps the market can be broadened out. If the market broadens out beyond the top half dozen or so market cap companies, that creates opportunities for stock picking. That remains to be seen. The AI revolution is hopefully going to create some dispersion in the marketplace.

• 45:34Ted Seides?

  Before I let you guys go, I want to make sure I got a chance to ask you a couple of closing questions. So we'll start with you, James. What was your first paid job and what did you learn from it?

• 45:42Speaker 04

  First paid job was in sixth grade, I convinced my father to buy a John Deere lawnmower. I started a landscaping business that I ran for three years and I would do landscaping around the neighborhood and fall leave cleanup in suburban Massachusetts.

• 45:58Ted Seides?

  Robert, what was the best advice you ever received?

• 46:01Speaker 00

  The two things that I most valued was hire the best people you can afford to hire and try to make a decision at the last possible moment to preserve optionality.

• 46:12Ted Seides?

  James, what's your biggest investment pet peeve?

• 46:16Speaker 04

  The group think that we see every day within my industry specifically. And it comes down to folks looking at only a handful of markets, these high population markets, where we're a value investor and that's how we've set up our strategy. If you really take the time to look at it, you see that you want to look at the data and look at solving what's actually going to drive the returns of your investment. And that's rent growth. What we focus on is low supply markets. And we've seen that that has outperformed these high population growth markets that come with supply and lack of barriers to entry.

• 46:47Ted Seides?

  Robert, what brings you the greatest joy?

• 46:50Speaker 00

  Besides watching my kids grow up, I love winning. Growing up in Boston, the last 25 years have been a great experience in winning, but also winning and investing in stocks and real estate. I love to be competitive and win.

• 47:05Ted Seides?

  All right, last one, Robert, we'll give it to you. What life lesson have you learned that you wish you knew a lot earlier in life?

• 47:11Speaker 00

  Being in a hedge fund business, I've become cynical. I wish I were more optimistic and believed in human ingenuity and the ability to persevere and solve problems. Robert James, thanks so much for sharing this story. Thanks, Ted.

• 47:25Ted Seides?

  Thanks, Ted. Appreciate it. Thanks for listening to this sponsored insight. Sponsored episodes are paid opportunities for another 12 to 18 managers a year to appear on the podcast. If you're interested in telling your story in front of the largest audience of investors in the industry, please email us at [email protected] to apply for one of the slots.

• 47:52Speaker 05

  All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of Capital Allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Capital Allocators or podcast guests may maintain positions in securities discussed on this podcast.