EPISODES
Episode 50.
Andrew Shook, Head of Commercial Real Estate Capital Markets at Lima One Capital
I love this guy to death. My dear friend and colleague, Andrew Shook, get ready for a full on multi family education in this week’s episode. Inverted yield curves, cap rate’s all good stuff. I’m Dalton Elliott, UH and. Fun fact, I was born in Hickory, North Carolina, raised in Merles Inlet, South Carolina. Carolina boy, UH and. This is the real estate of things podcast, brought to you by lean one capital, the nation’s premier lender for real estate investors. You’re listening to the real estate of things podcast, Sir Andrew shook. Thank you for joining, my friend. You got five, four, three to one. Here we go. We’re live, we’re going live and moving color. I say sorry, Andrew shook, because I only know you as shook, shookie bear. Mr Shook, well, I didn’t know that your parents gave you a first name. I thought I thought stoke was hit so good day. It was a great dea, to be honest with you, but they ultimately decided on something that started with a so there, that’s fair. That’s fair, that makes sense. I get the full picture now, but thank you for joining. I uh you are again. I know you as our multi family guru, in house. But tell me a little bit about what you do at Lemo in capital and your background in the space. You have been uh, you know, you’ve you’ve run some shops. So you you have quite the pedigree here. Well, that’s kind but I have been at it for more than a minute, there’s no doubt. Um. But yeah, my responsibilities Um at Lema one are to really, you know, look after the capital markets function for multi family, help with UH, product development and price ng Um, and it’s a it’s a bit of a, you know, dual role. Um. I work with a lot of the sales people on structuring transactions and trying to, you know, make sure we can get them organized in a way that puts the right risk on the balance sheet and gets a deal done. Interface a lot with our credit partners, Um, and make sure everything is addressed and, you know, and pricing. So Um. I mean it’s not literally my title, but almost like a product manager kind of role. Um. But technically I’m had a commercial real estate capital markets for the front. Got It, and I want to dive right into the multi family and commercial world. I was walking on our sales floor earlier this week and, uh, CNBC was on one of the TVs and you saw just a bunch of news. Inverted yield curve. Uh, what in the world does that mean? What is an inverted yield curve and why does that matter in…
…the multi family and commercial space? Doesn’t matter. And if so, why? Oh, it matters a lot. Um. Yeah, for sure. So a normally shaped yield curve is a yield curve where the longer maturities have higher yields. So the yield on the ten year Treasury note is greater than the yield on the two year treasmy now, Um, and you know it’s this year in the markets has been so tumultuous. Um, you know, two years ago into you know and a half, we had the covid outbreak and all of the UH, tumultuousness and and unsurgery that was created from that. Then everything is settled down from a financial market’s perspective in two thousand and twenty one and then, Um, you know, with all of the stimulus and the printing of money and other factors that were in play, we’ve had this massive spike in inflation and as a result, the Fed has had to raise rates significantly. You know, just you know, looking at a couple of quick charts before this episode. And just twelve months ago the two year swap rate was thirty basis points, you know, a third of a percent, and right this minute it’s at six. So the you know, it’s more than tenfold higher than it was. And currently the ten year swap rate is right at three point three five. And so when you have this relationship where the two years that you know call it three and the ten year UH is at three thirty five, that’s an inverted yield curve where the shorter maturity instrument has a higher yield than the longer maturity instrument. And just for multi family operators, you’re looking at right just short term duration versus longer term duration financing. So it it really makes you go back to the drawing board in some cases on what kind of debt you’re gonna take down on properties. Right. Yeah, well, I mean it’s all about the business plan. Like it’s. It’s really a very you know, the multi family business is a very common sense business. It’s not super complicated, it’s not differential calculus Um, but you’re you’re in in in a bridge lending context. You’re buying a property and you’re gonna fix it up some way, somehow. It could be Um, like physical rehab new countertops, new cabinets, new appliances, landscaping, you know, that sort of thing, refreshing the units and taking a thirty year old property that’s maybe lower class, beep, Pretty Class C property…
…and given it a nice refresh amenities that are, you know, popular and in demand from the tenant base. Dog Parks is a big thing now, Um, and other types of amenities. Um, and and then re tenanting the property, you know, at higher rents. Um. or it could be Um, you know, just a sort of a property management play to something much more heavy, where you need, you know, windows and roofs and HVAC systems and something that’s a lot more structurally involved. Um. And so it’s just it’s a variety of things. But the other dynamic that’s going on now that’s really interesting is with the market volatility. The business assumptions that you made, call it, you know, fourth quarter last year, January this year, are probably not valid anymore. So what’s with, you know, again with all this inflation? Construction costs have gone through the roof. That’s been on the news, you know, left Ring Center. Um. What what are you gonna do, you know, the in placed rents or nine fifty dollars? I was gonna push them to well, that’s a lot. You know, three d bucks on is kind of a third, roughly speaking. Right. So, but can that happen now? You know, if, if unemployment, you know, creeps up, is the tenant base going to be there? Twelve fifty? Well, the you know, the optimists of the world, say, of course they are. You know, I’m a great sponsor and I’m gonna have a wonderful property and people are gonna want to live there, and I’m sure that’s true. They can only live there if they can actually afford to pay the rent. All right, shook. So, to use your words, I’m gonna make a gross over simplification and tell me true or false on my gross oversimplification. So it would it be fair? False? That probably probably, but, knowing it’s a gross over simplification, let’s see is it would it be safe to say? Would you agree with the statement that you know you have Class A, top class B, Middle Sixty, Class C, lower twenty? Is it a fair statement that your safest investment on a risk reward calculation is going to be in that middle six, the Class B property. Well, Um, I all can decide. I wouldn’t classify it as you safest for lots of reasons, Um. But I think what’s what I would agree with wholeheartedly is, you know, look, sponsors of of the really high end class a buildings, you can do fabulously well. It can do fabulously well, and their beautiful properties, Um, but they are in fact, by definition, Um,…
…uh, addressing a relatively small slice of the market, right, because it’s this layered effect of you know, someone has the ability to pay and they’re willing to pay. And what might you know? We’re we’re all emotional beasts as as human beings, right. So when we signed up for that least two years ago or a year ago or whatever, we might be feeling great for whatever reason. And now, if we have more uncertainty, even though we could pay, we we may be like, you know what, I’m gonna move into a lower dollar price place because I just, you know, something unsuspected happens, I just I just feel a little better, you know. Um. But certainly, and when you’re when you’re you know, addressable market, if you will, if you’re horror, Um, tennant base represents that, you know, middle six and of the people that can pay right you just got a lot more people and most markets are not heavily overbuilt. Um and UH and in Class B apartments, um. So you don’t have this worry that you know supply is going to outstrip demand and put red pressure on you from that regard. But you get, you know, you get to address that, that middle and some piece of that, you know, higher end market that you know people, you know, voluntarily or non voluntarily, Um, will shift out of that Um, you know, higher end, highly amenetized class a property into a class B property. So you’re the and the objective right is to fix it up, get it, you know, Um, which is both physically, at least physically, and economically occupied for ninety days consecutively, and then now your property stabilized from from an agency loan underwriting perspective, and then you can go refinance your bridgeline into Um, you know, Fannie may or Freddie Mac, multi family loan or bank financing or life company or whatever the case makes makes sense. Makes Sense. So let’s keep it moving. Talk to me about cap rights. This is always a fun multi family topics. So I’M gonna I’m gonna throw this underhanded softball at you and take a swing at that, however, which way you would like? Sure. Well, again, you know, just to sort of level set um information for the audience. I know that we have a lot…
…of very sophisticated people that enjoy the real estate of things, uh, and some people that are learning more. So just a level set um cap rate is, you know, sort of functionally the dividend yield, if you will, on the property. So strictly speaking, at your net operating income Um, which is your collected rents, effective gross income Um, the you know, minus the total operating expenses of the property Um. And then so it’s that net operating income and o I divided by the purchase price of the property. Um. And to put sort of you know, common sense Um, you know, range around that Um. Some of the gateway markets, particularly on the West San Francisco, L A, San Diego, east coast, you know, Boston and the Greater Metro New York area, D C, pockets of DC and the surrounding areas, have gotten really low like, you know, three odd percent. I’ve seen a couple of two handle cap rates and that just like blows model understainment. That’s yeah, it’s just, you know, it’s that’s a very technical bid. You know, a lot of money chasing a small number of assets. Um, but you’re unless you’re, you know, paying cash. And even if you are paying cash for property, you want it. You’ve got to have risking just to return. I mean we’re all, whether we’re doing it professionally or personally, we have a responsibility to Um, you know, make good risk based investment decisions. So why would you buy, you know, any asset that was yielding less than the tenure trade inasury? Right, because you should. It’s got operational risk associated with it. So cap rates are generally looked at versus the tenure treasury and you know, hey, what’s my what’s my you know, pick up what is my incremental yield versus the tenure and cap rates are frequently Um, you know, a cap rate over seven percent and most markets Um is considered pretty high. Again, in the major markets they’re frequently in the threesum or low fours. Uh. And there’s, you know, lots of sort of common markets where that cap rate, on a stabilized basis, will be in that five to seven, you know, upper fours maybe out to seven and a quarter, seven and a half Um percent range. And so you know that makes a lot of sense. You want some buffer over the tenure.
So you know, now let’s think about the last year. So you bought a property at a at a four percent cafreight in some market. And now the two year treasuries rather swap rates at five and the ten years at three thirty five. So you know, if you’re looking at the tenure now, you’re you’re just sixty five basis points of incremental yield premium over just, you know, buying a regular eight fixed income instrument. So, Um, that’s not a particularly you know, I would respectfully submit that’s not a particularly healthy risk position to be put in. Um, the if you’re in a you know, six cap, you’re still, you know, at least you know, at least a hundred fifty basis points to the good. Um, and that’s in the context of historical ranges. Um, you know, four under basis points of cap right spread historically would be very wide. Um. And you know, less than a hundred basis points is is definitely tight from an operator standpoint. You know, when covid broke out and through today, it just feels like we’ve seen a bigger number of SFR investors moving into the multi family and commercial space, I think, at least from the day to day on the sales side at Lema one, I’m kind of see that. What, off the top of your head, uh, you know, some of the key points of advice, tips watch out for, the nuances for someone who is moving from the SFR space into the larger unit multi family space? Yeah, well, Um, it makes a lot of sense. Um, you know, in a in a multi family property, all of your doors are on the same tax parcel right. You don’t have to drive across town to Um, you know, fix a leaky faucet or or do whatever. So multi family properties are much more operationally efficient. Um. That said, they are, you know, a little bit of a different animal. So, depending on the Um, the magnitude of of your, you know, Sfr, your existing kind of SFR business, Um, I think you would be, you know, uh well advised to spend a good amount of time interviewing property management companies that have expertise in both the local market that you’re investing…
…in. Um, most lenders, including ourselves, require third party professional property management. If you don’t live very close by and, Um, you know can demonstrate that that that that you have the capability to do so, um, but also the that the type of properties that you manage or that the property management company manages. So, you know, it’s it’s a different thing to manage uh high end, expensive, very customer service driven, you know, Class A property than it is to manage the garden style apartment. It’s kind of right down the middle, UM, which is very different than managing uh, section forty two property or a section a property. You know, those those properties have a lot of regulatory and reporting requirements, Um, and they’re they’re they’re all Um, you know, if you have students in your property, you know, all of those things are present unique property management profiles and you want to make sure that, Um, you’ve got a good property management company that’s got a demonstrated track record in both the market and the property type that that you’re buying the very sage advice. I was at a Multi Family Conference, UH, both at the end of last year and the beginning of this year, and property management was a massive topic. It’s an area that if you’re not if you if you don’t do your due diligence, if you’re not thoughtful about it, it will just be a nightmare for your entire life. So good, yeah, it’s it’s a problem. And then, you know, with no disrespect of the property management companies of the world, but just because you hired a property management company doesn’t mean you can set it forget it. I mean you have to manage them the way you would manage your own property. So you know, as they’re submitting you know, repair bills or whatever, make sure they make sense, double check them, Um and and really stay on top of it. So, Um, and then you know, if you grow more and you want to set up your own property management company, then, depending on on your on Your Business Plan and how densely populated your your properties are, you know, maybe you can do that, but property management is really key for the long term holder. Sure you’re in this special bucket of people to me, and I truly mean this, uh, like I know every time I have any lengthy interaction with you I’m gonna Learn something, uh, and that is very exciting and valuable to me, uh, personally and professionally. And so I truly thank you propping on this episode but more broadly, thank you for being you. Oh Man,…
I appreciate you. Well, that’s very kind. Um, I love working at Lima One and, Um, it’s a great team, you know, and we’ve had a lot of success. We’ve been blessed. You know. We’re up, you know, over quarter over quarter in the multi family business alone. Um, we’ve got, you know, really compelling, uh, you know, t twelve origination numbers. So Um, I appreciate you having me on and look forward to doing some more of these with you. Absolutely we’ll have you back on the sooner than later. For Lima one, visit Lima one DOT com. L I M A O N e. you’ll find our great multi family product offerings there on the loan program page. In addition to Sfr, Rehab, rental, new construction, H bridge, we do pretty much everything here big tent. So thank you again, sure, thanks to everybody for listening. All right, thank you. Are you a real estate investor looking for the right lender that can finance all your deals and help you scale? Lima one capital has the best suite of loan products in the industry bar none, whether that’s fix and flips, fix and holds, building new construction or buying rental properties. They have incredible financing solutions for it all. A reliable, common sense lender is one of the most important parts of your investment team, and that’s exactly what you get with Lima one. Let Lima one capital show you how they’ve helped thousands of real estate investor scale and increase their wealth. CHECK OUT LIMA ONE DOT COM or call eight hundred to five nine zero, five nine five to speak with a consultant and preparation for your next project. Thank you for joining us today on the real estate of things podcast. Subscribe and tune in weekly for new content for the industry’s best while we continue to unpack the nuances of this dynamic market. Follow US across social media for additional insights and analysis on the topics covered in each episode, and remember to rate, review and share the show.
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