Gabe Bodhi Taking Advantage of Market Inefficiencies in Sub-Institutional Real Estate

7th October, 2021

Episode 18 Show Notes

With real estate values soaring to new highs, it’s common to wonder how to incorporate the risk of a potential market correction while still participating in property appreciation over the long term.  Our guest today, Gabe Bodhi, is a Denver-based professional real estate investment manager who shares insights learned through previous market cycles.  Gabe discusses the various inefficiencies of the non-institutional real estate market and how value-add and mismanaged real estate can present attractive opportunities for savvy investors.

Key Points in This Episode

  • Gabe’s depth of experience in the financial markets and how he came to found Tekton Group
  • How markets are cyclical and tend to overshoot on the way up and down
  • Why he is a value investor and how he weaves value into his investment strategy
  • The view that leverage is beta and not alpha, and how to employ leverage in real estate transactions
  • Important areas for due diligence, and how physical due diligence can uncover potential red flags
  • How he looks for value-added and mismanaged real estate as investment opportunities
  • The inefficiencies that are prevalent in sub-institutional real estate investing, and the enhanced return opportunities
  • The metrics he employs to value and transact real estate, including unlevered yield to total cost
  • Compares real estate to public stocks, and how REITs and private real estate are similar and different
  • Why Colorado is an attractive market and why he invests predominately in that market
  • How to find the right investment manager and the risks to watch out for when selecting a private real estate manager

{01:05} Andrew 

Hi, this is Andrew from PitchBoard. I spoke with Gabe Bodhi, founder, and CEO of Tekton Group. He talked about a pricing inefficiency in sub institutional real estate. What he looks for when considering a property and why he’s a conservative investor. This was a great chat. You won’t want to miss it. Gabe, welcome to the podcast. It’s great to have you on. 

{01:26} Gabe

Thank you so much, Andrew. I’m excited to chat with you today.

{01:29} Andrew 

Yeah, I’m looking forward to this discussion too. You spent a long time on Wall Street, and now you’re in the real estate business. Can you give our listeners a bit more about your background?

{01:39} Gabe

Absolutely, I grew up in a small college town in western Massachusetts called Amherst. My parents, oddly enough, were and still are hippies, and there was a TV show in the 80s when I was growing up called Family Ties, and Michael J Fox was a character by the name of Alex P. Keaton was kind of an investment oriented/conservative business guy, and his parents were hippies, and my parents started calling me Alex P Keaton during high school. I always had a desire and interest in being an investor—that kind of guided me where I went to college. I went to the University of Pennsylvania in Philadelphia for undergrad and then spent the next 20 years in the financial services investment. The world as both a consultant and in investment management, most recently before my real estate career well. Was as you said, as the head of the financial services sector at Janus Capital.

{02:36} Andrew 

I’m too curious not to ask this question.  Do you think that you got in your interest in investments in business in a way to rebel against your parents?

{02:49} Gabe

Of course, isn’t that what almost all kids do, especially teenage kids? Yeah, yeah. I mean, I took to math, and it was very interesting to me. Me, I just sort of fell in love with the concept of investing. I bought my first stocks when I was in high school and had $0.00. I don’t think my parents could spell investing; I guess because of that; it became natural to me. Ah, invest.

That said, they’ve been nothing but supportive to me throughout my entire career and were both awesome parents when I was a kid. And still are today.

{03:21} Andrew 

What was that like in high school? You know you’re buying your first DOG in your and subsequent stocks. Did you tell your friends about that and were they interested in the market at that point.

 {03:33} Gabe

Not really, you know, and frankly, I don’t think I knew what I was doing either. I bought Microsoft in the 80s, which obviously worked well, but sold it to pay for college. But no, I don’t think any of my other friends were super interested in it. And frankly, I didn’t know a ton about it. I read the Wall Street Journal when I could get my hands on it. This is pre-Internet pre-email. This is, you know, there were no stock chats or anything like that. This was just a kid who was interested in economics. Mix in, and the world of finance and just started going down that path.

{04:04} Andrew 

I was in high school-like which is when I really started to learn about it: the market, I guess. At that point, we, you know. We were living through the tech bubble, to your point that you know you when you’re early on, you don’t really know what you don’t know.

 I didn’t realize the history we were living through at that point. It’s only in hindsight when you read more, and you learn more, that you appreciate what was going on at that time, right?

{04:34} Gabe

Absolutely, and I think there are many people who will tell you this, but there’s no substitute for experience. And I have lived professionally through—two significant downturns. One was the tech bubble that you talked about in 2000 to 2002 Ish, and the second was the great financial crisis in ’07 ‘08 ‘09. I say, the latter was more impactful to me, but both were quite impactful in how I view capital markets and investing.

 But to your point, there’s no replacement for experience. And one tiny little concern I have is how many of the market participants today are bidding up asset prices. Whether it’s real estate, the stock market, crypto, NFTs, have lived through capital market cycles because I’m a firm believer that the capital markets are driven by fear and greed and that the human condition is never going to change. And what that means generally is we’re going to overshoot on the way up and probably overshoot on the way down as well.

{05:44} Andrew 

I think it’s often said, particularly in recent years, that there’s this huge cohort of traders and investors that haven’t lived through a meaningful bear market. I think that goes to your point about as many people who are bidding up. Asset prices right now they’ve only known.  The good times I mean with. Some very big jolts, right? But no long pain, is that fair to say?

{06:15} Gabe

Yeah, I mean that that’s certainly my impression.  I have developed an awesome circle of real estate friends that I can talk about a lot of things. Many of that’s actually come through Twitter, which has been an amazing outlet for me. I’d say, on average, there are a good 15 years younger than me. Therefore, they probably have less than a decade of investing experience and may or may not have been impacted by the last major downturn.

Hard for me to say exactly what’s going through their minds, but when you lose 25 to 35% of your net worth in about three weeks in the fall of 2008 that sticks with you pretty significantly, certainly stuck with me, and I’ll never, never forget  that feeling and always will be. Investing with a margin of safety because things can change so quickly.

{07:07} Andrew 

Would you say you were a conservative investor? Before 2008 and did it just reinforce it, or did it really did it cause a sea change in how you viewed investing?

{07:20} Gabe

No, I’ve always been a conservative investor. It’s kind of taboo these days. But I am certainly in the classic definition of a value investor and looking for a margin of safety and buying things at a discount to their intrinsic value, so that’s sort of always been part of my ethos. But like many people in my generation, I was huge and still am a huge Warren Buffett fan. And many of my favorite investors are, whether they’re in hedge funds or the mutual fund world, or our typical value investor. And so, while that’s out of favor at the moment, I think investment styles go in and out of favor. And if you’re going to evaluate an investor, whether they’re in real estate or the stock market, you want to look at their through the cycle returns.

{08:09} Andrew 

So, let’s talk about real estate and, in particular, the genesis of Tekton. What can you tell us about how you decided to found it and an overview of what it invests in.

{08:20} Gabe

Yeah, absolutely! So my first rental property I found in 2013.  I kind of backed into it. I had really gotten into woodworking, and I had bought a series of woodworking tools that were occupying the garage at my house, and my wife at the time strongly encouraged me to move them somewhere else.

 I found a rental house with a detached garage. The primary reason was to house my woodworking. It was a student rental at the University of Denver. Four-bedroom student rental when I. Bought it had rents of $1975 a month, and I was cash-flowing after debt service about $200 a month.

The next summer I marketed the property, I leased it to a new group of students, and I increased the rents from $1,975 to $2,475. So, a $500 increase, and my monthly cash flow went from 500 to 700 bucks a month. And I said, “Whoa, there’s something interesting here”. One thing led to another, and I started buying real estate in earnest. Around that time, the genesis of the actual name of Tekton. When I got around to naming my company, Tekton is the Greek word for the woodworker, and that’s ultimately how I decided to name my company because woodworking is in a securities route the way that I got into. Real estate and you do it.

{09:45} Andrew 

Did you enjoy being a landlord?

{09:47} Gabe

That’s a weird word, not the word I would use “enjoy”. It is an opportunity to. Separate yourselves, there are many landlords who have earned a bad reputation, and I think in many. Instances rightfully so. When I was a very hands-on landlord doing everything myself or with my partner, I did take tremendous pride in separating ourselves from many absentee or less involved landlords.

But I enjoy the business. Tremendously, but the actual aspect of being a landlord and what goes into that? No, I wouldn’t say those are my favorite tasks. I do think, and this is something I say to anybody starting out in real estate. It’s important that you do everything at least once.

So when we were starting out, I did leasing. I did maintenance. I did a collection. I even went to the courthouse and did a full eviction on a bad tenant. Once I did all her accounting, I helped my property. My partner does gut renovations on our buildings, and while I don’t do many of those things today, the fact that I did them from soup to nuts. At one point in my career has been incredibly helpful to me as I work with partners and vendors, and employees to affect all of those workflows.

{10:59} Andrew 

In hindsight, “enjoy” was probably not the best word choice, I think. I think what I think what I. Meant was, was it worth the hassle? Because I think you often hear about people who, they become landlords, but they don’t maybe appreciate the effort required. Or some of the unexpected expenses that can come about and just look at. Just look at the top line and forget that there’s a lot of time and money that can happen that they didn’t expect.

 {11:29} Gabe

I think that’s absolutely true, and I can’t tell you how many people I meet who try and be a part-time landlord, and there’s a lot of wealth that’s been created in this country over the years by professionals who were very successful in their chosen field and invested excess cash into real estate.

You go to any city in North America I’m sure you’re going to find it. A large number of very wealthy families started out buying real estate as a hobby. That said, the last three, four, or five years I think, has made a lot of people overconfident in how easy it is to be a landlord, you know you buy a deal at a 4 1/2 cap. You don’t do anything to it. Your rents go up, and then you sell it at a 3 1/2 cap two years later, and you think, wow, this is easy. I just keep printing money. I can promise you. It’s not that easy. Or any normal business cycle, which I think we will enter at some point. I don’t know when. I would not even begin to pretend to predict that. I think there’s going to shake out a lot of part-time landlords.

{12:31} Andrew 

Do they tend to be from what you know over-leveraged?

{12:35} Gabe

Gosh, I hope not. You know that that is certainly something that is going to make it acutely painful if they are.

I really don’t know what their capital structures are, but we have a saying that leverage is beta, not alpha, meaning it will amplify your returns both on the upside and the downside. But it’s not going to be the source of yours in a market that you keep going up when unlevered returns might be high single digits a year, but your level of returns are in the teens or 20s.

You start thinking, wow, this cheap debt that I can get on multifamily because it’s supported by the government is a massive source of value and I would just caution to say that it works both ways. If things were to come down and you only have 10 to 20% of the capital stack in equity, that can get eaten up real, real, real quick.

There’s a lot of operating leverage in the real estate business, meaning when your top line goes up, a large percentage of that top-line falls to the bottom line. It works both ways. You have decremental margins on the downside where if rents and collections fall, the vast majority of that downside is going to directly impact. The bottom line, so you don’t have a very variable cost structure. Having your revenue get hit. Maybe 10-20% can have a 40-50% impact on your bottom line.

{14:00} Andrew 

Right, and I guess if too big a group of people are in the market. Are we leveraged and then that kind of a spillover effect into the real estate market, as a whole.

{14:10} Gabe

It absolutely can I. I will say, having watched the great financial crisis up close and personal, that lending standards are certainly. Much, much, much tighter now than. They were in ’05 ’06 ‘07, whether it’s residential or commercial.

Obviously, there are people who are over-levering in. And finding ways to get that leverage in development, you’ll see a lot of mezzanine debt packages that will increase the effective leverage to 75, 85, 90% loan to cost? That’s a really scary place to operate on and something I don’t think we would ever participate in.

{14:46} Andrew 

For Tekton what’s the ideal leverage to use on a deal?

{14:54} Gabe

Sure, so we think about leverage in two stages. Our core business is buying mismanaged assets that have a clear path to add value. And when I say add value things, we can do that to increase cash flow of the property. The most straightforward and almost every deal we’ve ever done, path is to renovate the units.

Most people like to live in new modern, renovated units, and we’ll pay a rent premium for that. When we go through the renovation process, and we add value, oftentimes, our cash flow will be depressed during that rehabilitation stage, and so we’ll generally go into a deal with 50 to 70% loan to cost.

And when I say cost, I mean the total cost of buying and renovating that property.  And then we’ll generally. Refinance out the original loan and as much of the equity as possible with a stabilized loan. Our traditional, typical stabilized loan is going to be coming out of the agency world, and we don’t really think about that on a loan to value perspective; we think about it from a. Debt service coverage ratio, which is how much NOI profit is this building going to generate and how many multiples of our debt service is that cash flow going to be? So, we’re generally using stabilized debt around 130 to 135% debt coverage ratio.

{16:20} Andrew 

And what? Would be the typical kind of building that you would buy.

{16:25} Gabe

It’s a good question. It’s generally 1 to $10 million in value, kind of 10 to 50 units built sometime between the 60s and the 90s, been owned by somebody who certainly in Colorado has made a lot of money because real estate’s gone up so much and instead of reinvesting that money in the property, would rather just sell. And so, the units have been neglected. The outside has been neglected. The management has not been super awesome, and so we come in, and the first thing we do is install professional management. The second thing we do is what we call—curb appeal work. Even before we start renovating the units, we want to make the building inviting for prospective renters.

And then we’ll go at the deep value add. Work and that you’ll. Generally, will take us anywhere from 12 to 24. Months to stabilize the building, refinance out the equity, and go from there. 

{17:23} Andrew 

Is there a considerable due diligence process that happens before you sign the deal is particularly given that some of these buildings have been neglected.

{17:33} Gabe

Absolutely, I think due diligence is mandatory in this business. We break our due diligence into three buckets, financial due diligence, physical due diligence, and legal due diligence.

And we have a checklist. I think it’s up to about 100 items that we go through on every property within those three categories. The biggest one, of course, is the physical inspection because, to your point, roofs, boilers, foundations. Those can be massive dollars, and if you haven’t figured that into your investment you can quickly turn what looked like a good deal on paper into a—bad deal in the real world.

 {18:08} Andrew 

Yeah, I guess especially if. Not only are your costs higher, going to be higher, but that you’re, it’s possible that the rent you’re going to receive could actually be lower if the building is in worse shape than you.

{18:21} Gabe

Could be, we’re always going to get it to the level we want it to get to. It just may cost us more to get it there in what we call the rehabilitation phase. Rents could be lower because of some of those deferred maintenance items, but we’re going to take care of them. It may cost us. What it costs us to get there but. We will take care of them. And won’t stabilize it and refinance out our equity until we’ve done that.

 {18:46} Andrew 

Are there any particular red flags or even green flags that you look for in a prospect deal?

{18:51} Gabe

Big deal. I mean, the green flags are kind of the things I talked about. Well, located, mismanaged real estate that is obvious ways to add value.

I think red flags are. We’d almost prefer the units to be worse than better dirty trashed-out holes in the wall. All that’s fixable, I think—the major dollars from a red flag that we worry about is. Roofs, boilers, foundations, and mechanical systems.

When I say mechanical systems, I mean electricity, plumbing, and HVAC, and so those are the major red flags that we have, and we look at a building.

 {19:30} Andrew

Do you sometimes think about buying these like unloved buildings a bit like buying a stock that’s out of favor?

{19:36} Gabe

Of course. You know you would ask a little bit about kind of what I learned in public equities versus today, and I’d say they’re very similar in the fact that I’m looking to buy a stream of future cash flows at a discount to intrinsic value. 

 I’d much rather compete in a less competitive world, whether it’s a market or an asset size that doesn’t have. Tons of capital chasing those deals.

I do think there’s a couple of really important distinctions between my career and public equities and what we do now. First and foremost is that we can add value. You know if you go buy  Apple Stock Tim Cook is not going to take your call and accept your suggestions as to the features needed on the iPhone13, but when we buy a building, we can dramatically change that building and change the Trajectory of the cash flows. Associated with that building, so I think adding value is.

A very unique aspect to what we do, and then I’d say there’s a real market difference in efficiency. I covered large-cap financials. One of my favorite stocks a decade ago, and I still hold some. Is JP Morgan stock trades roughly $2 billion a day, and last time I checked there’s 35 sell-side analysts that cover?

 I think it’s. Really hard to argue that you have an edge as a Reg FD investor in pricing. The JP Morgan secure. Parties, when we’re looking at deals that are brought to us by brokers in an off-market transaction that maybe nobody else even knows, is available to buy.  We think there’s a market difference in efficiency.

The second thing is there are always people selling sub-institutional scale real estate for weird reasons. It could be getting too old. They could have co-ownded it with sibling, and the sibling moved away and stopped managing it, and now they want to sell it. And that happens in good markets and bad. And our job is to provide liquidity to those kinds of sellers when the opportunity arises.

{21:32} Andrew 

Do you have a sense of it? What the yield pick-up is when you’re in the sub-institutional market versus the institutional market?

 {21:43} Gabe

Yeah, that’s a great Question Andrew, I can give you, my guess; I don’t have a specific mathematical answer to that. We underwrite every single deal in our market that comes out in our space, and we underwrite it to what we call stabilized yield or unleveled yield to cost.

Right now, just talking with my analyst this morning. We haven’t underwritten a deal north of five north of a 5% yield in two months in Denver.

We are seeing, I was told that we are no institutional assets have sold. Over a four cap in the last year to date in Denver, that would indicate something like a 75 to 100 basis points spread between where we think we can get a sub institutional scale multifamily value-add property to and where institutional buyers are buying turnkey properties in Colorado.

{22:40} Andrew 

One of the things I find fascinating in markets is, I think there’s this widespread assumption that the bigger players necessarily have an advantage over smaller players in terms of maybe information and access to deals but. There are examples, and I think I think you’ve described one of them where being a bit of a smaller fish actually does give you some upside right?

{23:12} Gabe

Absolutely, and I don’t think that’s just real estate, but without a doubt, you have less competition. In this world that I’m talking about sub institutional scale multifamily value add in Colorado, then you do an additional scale.

There’s no bright red line that delineates, hey, this is a sub institutional asset, or hey, this is an institutional asset. Still, in general, fifty million and above on the value of a building is going to be institutional. Ten million and below, there’s not going to be an institution playing there, and between 10 and 50, it’s going to be a sliding scale.

We believe that being able to build a business around writing 2 to $3 million equity checks into a deal gives us a competitive advantage. The people who are more sophisticated than us have a lower cost of capital, more resources. They will never write a 2 to $3 million check.

I have a friend who works at a billion-dollar real estate private equity firm their average equity check needs to be north of 50 million bucks. They’re never going to compete against us. Can they borrow cheaper than us? Absolutely! Do they get cheaper equity than us? Probably do they have more resources than us, without a doubt, but they can never write a 2 to $3 million check into a deal where that’s kind of our bread and butter is in the 1 to $3 million equity check sizes.

{24:38} Andrew 

And you’re focused on multifamily Colorado, as you mentioned. Is there something in particular about that market that you find attractive? And would you have you considered expanding into other areas?

{24:52} Gabe

Great question, Andrew, and you know, I’ll say that We started, and we continue to grow in Denver because we live here, and we live it day in and day out. I feel like we have a really good sense of the submarkets both in Denver and across the Colorado Front Range. We know the renters what matters to them and what doesn’t, and I’m A huge believer, always have been, in returns on the scale, meaning the longer you’re doing something, the better you’re going to be at it.

 If I got on a plane and flew to Salt Lake City and try to buy a deal there where I don’t know the vendors. I don’t know the property managers, I don’t know the brokers. I think my chances of success would be lower. That doesn’t mean I couldn’t do it, but my chances of success would be lower, and so we want to give ourselves and our investors the best chance to succeed in the deals we do, and we want to invest in what we know. And that’s Colorado real estate. Specific to Colorado, why? I do find it compelling is it’s got a relatively unique combination of high quality of life, great weather. People are somewhat surprised about this because they’ve watched a Broncos game on Monday Night Football, and it was snowing, but we have more days of the sunny year in Colorado than San Diego. So, we have irreplaceable natural beauty.

The Rocky Mountains are right in our backyard, and I think they’re just absolutely stunning. Every time I drive up to the mountains, I’m blown away by the natural beauty and I think this is somewhat of an underappreciated element to our economy. And really, something every real estate investor should be thinking about which is, we have a very diverse economy.

No single sector represents more than 18% of the employees in our economy, which means each of the sub-sectors of each of the sub economies kind of works on its own cycle. And when one’s down, another one might be up. We’re not like Lake Houston, I’m going to use it as an example, even though I. I don’t know that much about it. Which is probably higher.

 It is levered to the oil and gas industry and if oil and gas are down, real estate values are going to be down. So those are the main reasons that we like Colorado multifamily, which is the high quality of life, great weather, diverse economy, and irreplaceable natural beauty.

Those factors have manifested themselves into higher job and employment growth and national averages about 50% faster for growth, then the national average over the last ten years and one of the four fastest-growing cities amongst the top 20 in the United States.

And Denver is still a relatively small city. I mean, the metro area is somewhere between three and three and a half million people, and it’s one of the smallest cities. I always use this statistic. It’s one of the smallest cities in the United States with all four major sports teams. I think there’s. Right? Only 11 cities. And Denver is one of the smallest, and I think that’s kind of interesting ’cause it’s big enough to be cosmopolitan enough to have. Hockey fans and football fans and baseball fans, and basketball fans. But it’s still a. A relatively small city that can grow dramatically and so. So I think. Colorado probably is.

 Denver will probably be a 5,000,000 person MSA by 2040 or 2045 and real estate if you have a long enough time, horizon is going to be worth more than it is now. We’re just incredibly picky about the real estate we’re willing to buy and at.

{28:09} Andrew 

What price have you noticed any? The effect of the pandemic on Denver real estate or migration to Colorado, and what I’m getting at here is, there’s obviously been a lot of people working from home and more of a realization that many jobs can be done remotely, and I’m wondering if people look at a picturesque city like Denver and say, well, you know if I can do an IT job or another job from there rather than a much larger city, then that’s something. I’m willing to do.

{28:43} Gabe

Andrew, kind of without a doubt. We’ve seen that come. We’ve had what we call migration, meaning more people moving here than moving away from here since I’ve been in real estate for the last eight years. But that trend absolutely, without a doubt, accelerated during the pandemic.

We had multiple friends move here from New York, Chicago, San Francisco. I think they’d always kind of been thinking, hey, we get a little bit older. We have kids. We’re going to want to live somewhere that has a slightly lower cost of living and maybe a higher quality of life. Life Denver is on the shortlist, and then boom, the pandemic hit. They’re living in a 1500 square foot apartment in Manhattan. Can’t go out, can’t do anything. Nothing is open. They don’t have a backyard, and they just said, well, this is enough. I’m ready to, ready to hop, skip and jump.

So, we’ve certainly seen that in the—Denver metro area. A place that is perhaps even more pronounced is in the mountain communities in and around Colorado. I have two friends who moved to Aspen for the pandemic aspens, not a city that I can afford, but they certainly can. Vail home prices are up about 30% in the last 18 months, people to your point are saying. Hey, if I can work from anywhere, at least during this pandemic, I might as well go someplace amazing, and the Colorado mountain towns have absolutely been a beneficiary of that as well.

{30:09} Andrew 

How much would Denver house prices be up in the last 12 months or so?

{30:14} Gabe

I’m going to give you a guess. I don’t have the numbers at my fingertips, but I would say 20 to 25%.

That is just very specific to my neighborhood, we have seen houses increase. There’s one house on the market that they did some work on. But they just listed it for twice what they paid for in 2019. It’s pretty profound.

Now, of course, low-interest rates are a major, major driver of that. I think the government did the right thing in response to providing stimulus, both fiscal and monetary, to the economy during the pandemic. But one of the offshoots of that is low-interest rates have driven the price of real assets up dramatically, and most there’s been a major beneficiary of that.

{30:58} Andrew 

Do you think that that’s sustainable, or do you? Do those double-digit increases? Do they give you as a real estate investor pause?

{31:08} Gabe

Absolutely, they’re not sustainable.

There’s no chance that we’re going to see a 20% average home price increase for the next few years anywhere. I don’t think they’re sustainable. I do think there’s a difference between being a real estate investor who invests in cash flowing assets and values them as such versus a family.

That’s buying a home to live in, maybe moving from new. York, where they sell a 2000-foot condo for a kazillion dollars and can buy a lot of real estate here.

There’s certainly coupling between the for-sale housing market and investment real estate properties, but they’re not directly linked.

{31:47} Andrew

Right and when?  You’re buying a property. Do you look at it? More from what kind of cash flow can this generate on a sustainable basis. Or versus how much capital appreciation can we get out of this deal.

And I realize that those are linked, but are you? Do you see yourself as a yield investor or as someone who’s looking for the growth of your capital primarily?

{32:11} Gabe

I think It’s a wonderful question, and you’ve hit on the two major ways that real estate investors make money, either buying a property with marginal cash flow dynamics, but dramatic appreciation over time or buying a property with great cash flow, but potentially not great appreciation over time.

I doubt you’ll be surprised to learn that we are almost entirely cash flow buyers. If we can’t see significant and appropriate levels of cash flow in the stabilization period, we’re probably not going to buy an asset that means we probably were going to miss out on some. That said to your point about them being linked.

Higher cash flow is going to drive appreciation, and so, in an ideal world, we buy cash-flowing assets that we can force appreciation onto, and we realize that appreciation, either through refinancing out a decent chunk of our equity or all our equity or selling in some instances.

Our primary underwriting metric is what we call unlevered yield to cost. Goes by other names, unlevered yield on cost/ return on cost.

 It’s kind of like a cap rate, but you don’t ignore anything in the denominator. Unlevered yield to cost is your stabilized NOI divided by your purchase price plus? Closing costs plus your rehab costs, and that’s where we look.

Hat tip to a friend of mine that I met through Twitter named Moses Kagan. He and I have always looked at unlevered yield to cost independently. He was able to open my eyes to the fact that in a different interest rate environment, you should be targeting a different unlevered yield to cost.

So, the absolute number you’re underwriting too will change depending on how cheaply you can borrow or how expensive. Your borrowing is in Colorado. We generally shoot to find deals that are 50 basis points or more in excess of their debt constant on an unleveled yield-to-cost basis.

So, what does that mean? The deal we just bought in July of this year that we’re in the rehab stage on, we forecasted that we think will stabilize the NOI to a point that will be about 6% on our unlevered yield or on our cost basis and cost basis again that includes purchase price, the cost to rehab, and my closing costs.

That 6% is about 70 basis points higher than the debt constant at what we can refile that property at. And a debt constant is the principal plus interest annual payment divided by the initial unpaid principal balance alone.

So, in a 3 1/4% interest rate world, your debt constants going to be in the low fives. And so, we’re borrowing at a 3.25% interest rate. But when you are that loan is over 30 years your debt constants going to be something like five-two, or five-three.

 So in that world, we’re buying a property with a 6% unlevered yield to cost, and that’s 70 basis points in excess of our debt constant on the refi, which is a very compelling spread as I was saying earlier, we haven’t seen a deal that pencil to the north of a five in the last two months, so. So, seeing something at a six Is pretty juicy for us.

For those of your listeners who don’t fully live and breathe cap rates all day every day, the difference between a 4% and a 5% might not sound like that much, but a 6% return is 20% better than a 5% return, and so. That’s why I work. Obsessively focused on unlevered yield to cost.

{35:59} Andrew 

And what, what? Are the key factors for again for our listeners that are that drive? Cap rates are primarily long-term interest rates?

{36:10} Gabe

That’s a major factor.

I don’t think anyone has shown in an academic study that there is a direct correlation. But in general, if you think of the duration of a real estate asset is somewhere between 5 and 10 years. You look at the yield curve. The Treasury curve, you know where our five years Treasury’s and 10-year Treasury trading. Do you know? I haven’t looked in the last couple of days, but in general over the last little while, 10s have been around 1.21 point three, and 5s have been in the 75 to 85 basis point range.

There is a long-term loose correlation between treasury rates and cap rates. I think cap rates are driven by supply and demand in a city that is hemorrhaging. People wouldn’t want to name any, but in a city, that’s hemorrhaging people, meaning their renters are leaving that city. Even if interest rates are incredibly low, you’re going to need a pretty high cap rate to justify purchasing a property in that city, and so ultimately, I think demand and supply for buildings are going to be the major driver of cap rates. Cities that are incredibly supply-constrained, like, uh.

New York City or San Francisco generally are going to trade at a lower cap rate, even though they’re in the same interest rate environment as Colorado. I guess my answer is there’s a loose correlation between interest rates and cap rates, but ultimately asset prices are driven by the demand for them and the supply of them.

{37:39} Andrew 

So, when you buy a property, do you have a target for how long you’re going to hold it for, or does it depend on the individual property?

{37:48} Gabe

It does depend.

We had a saying at Janus that “are we makers of money or seekers of truth” and what that means is It’s fun to be right. It’s fun to have a universal set of beliefs about what to do with the property. But at the end of the day, I think my goal is to maximize returns for my investors. A lot of times that’s going to be buying and holding it. 

There are going to be times where it makes sense for us to sell. In general, we go into a purchase with a mindset that roughly 2/3 of our purchases are going to be long-term holds, and 1/3 of our purchases are going to be something that we buy to stabilize, increase the NOI on. On sale Generally, the ones that fall into that latter category are in less ideal neighborhoods, have some significant management issues associated with them, but that’s our general rule of thumb is 2/3 of our properties. We’re going to hold long-term and 1/3. We’re going to sell.

Now with that mindset, it’s said it’s important to make that decision early on in your investment process with that property. And I’ll tell you why. When you invest in a property, you need to match three really important things.

 One is your debt strategy. Two is your equity expectations and three is your business plan and they all have to be aligned.

 If you take out, there’s something in real estate as certainly in investment real estate called a prepayment penalty, and banks who lend you money don’t really want you to give it. Write it back to them very quickly and so they will penalize you. 

Or giving it back to them, the higher your prepayment penalty, the lower your interest rate is going to be. So, a lot of people like, oh, I can borrow at 2.8%, but I’ll take on yield maintenance pre-pay. Well, if your business plan is to buy a property, refinance it, and sell it You probably shouldn’t take out yield maintenance pre-pay. You should probably work your way down. Into the step-down pre-pace pay a little bit more in interest and avoid the yield maintenance prepays.

So, it’s really important that you match up your debt to your business plan. It’s equally important that you give clear expectations to your investors, this is something that we’re going to take your money. We’re going to invest in it. We’re going to rehabilitate the property. We’re going to stabilize it, refinance as much as the equity out we’re going to pay you, all your accrued dividends, and as much of the equity as we can. And then you’re going to go along on a ride with us for a long period of time to earn cash low off that property. So, it’s incredibly important that you are clear in matching your debt strategy, your equity strategy and your business plan.

{40:39} Andrew

Right, you can’t exactly give people daily liquidity when you’re investing in real estate, right?

{40:48} Gabe

There is definitely not daily liquid. And well, that’s not completely true if you Want to buy a REIT, a public publicly traded REIT. You can get daily liquidity, but you’re encumbering yourself with the Overhead of that Structure, so you’re not just investing directly in the in real estate, you’re also paying for the corporate offices and the corporate jet and the corporate executive team, but you’re generally getting really good real estate with low leverage and so that that’s a perfectly acceptable opportunity for a lot of people who want real estate exposure.

In fact, I’d say that if somebody said, “Hey Gabe, I want real estate exposure, what should I do first?”

The answer would be after talking to them would probably behave you thought about. Just buying some REIT stocks that said, I think. And This is why a significant portion of my net worth. As in this, there are benefits to being in sub institutional scale real estate being in what we do as a private investor you would get access to real estate assets that I believe are less efficiently priced.

That potentially may have more upside in a compelling market like Colorado with the trustworthy spot. The answer I think anybody who’s looking to invest in the private market. In the nomenclature, we use GPs and LPs, so a GP is a general partner. That’s what I am. What my team is, and a limited partner would be somebody who gave us capital to deploy.

If I were a limited partner looking at a GP opportunity, I’d be well aware of the risks associated with that. I think there are four major risks. Probably the most important one by a wide margin is sponsor integrity, incredibly hard to judge from the outside, but I would spend it if I were an LP. I spend most of my time evaluating the integrity of the person I’m investing with.

It is a dog-eat-dog world in sub-institutional scale real estate and there are some unsavory characters I would strongly encourage people to beware of before they buy anything. The other three risks I see are  illiquidity, so if you give me some money or give any GP some money to buy an asset. Your mind changes in a year. It’s highly unlikely you’re going to be able to get it. Your money back. There’s an economic risk, which is that we enter a recession.

Cash-flowing multifamily real estate is highly tied to the economic cycle. There are oftentimes multiple economic cycles, as I mentioned earlier that are associated with different economies or different subsectors. At least in Colorado and Denver, you have a diverse set of economic risks.

It’s not just high tech or financial services or oil and gas; it’s a. It’s a broad-based, diverse economy, and then I think it’s execution risk. It’s not like complicated. What is that we do, but it’s not easy. And I am incredibly blessed to have a partner who’s a remodeling contractor who has been doing it for 20 years and runs all our renovations. It’s far from easy, especially in this construction environment where labor is hard to source and is expensive, materials or hardest floors and their expensive.

Those are the major risks.  I would suggest that any LP looking at real estate sponsors consider sponsor integrity, illiquidity, economic risk, and execution risk. 

{44:00} Andrew 

And how can people learn more about your firm if they’d like to go beyond the podcast? How can they? Their website? They can check out.

{44:10} Gabe is our website.

Easiest way to reach me if you ever want to talk real estate is through Twitter, my handle. (I’m 47 years old, so it’s funny to think about a handle) but my handle is @gabebodhi

 {44:30} Andrew 

It’s always easiest when people just have their names there as their Twitter handle, right? It’s very easy to find if you’re looking for a person on Twitter, it’s easy to find them. You don’t have go searching, hopefully too much.

{44:42} Gabe

Thanks so much for the opportunity; what a cool thing to be able to do this and thank you for your interest in what we do?

 {44:50} Andrew 

OK, well we’ll. Wrap it up on that note Gabe Bodhi. Thanks so much for sharing your insights today. I’ve learned a lot, and thanks a lot. Also, to our Pitchford listeners, we. Appreciate your listening to this podcast, and we’ll be back soon with another episode. Bye for now.

{44:59} Jenny     

Thanks for joining us on this episode of The Pitch Podcast. Make sure you check us out online at If you liked our podcast today, please make sure to subscribe to the Pitch podcast so you don’t miss an episode. Share to Facebook Twitter Linkedin Email

Share to


All interviews, transcripts, resources and articles (collectively, the “Information”) presented in this blog are for informational purposes only. Any views or opinions presented in the Information belong solely to the person making such statements and do not represent the view of Pitchboard or any of our employees, partners, vendors and affiliates. Pitchboard does not make any representations as to the accuracy or completeness of any Information presented. Pitchboard shall not be liable for any losses, injuries or damages from the display or use of the Information.

Pitchboard does not recommend or endorse any products or services presented in the Information. Nothing presented in the Information shall be construed as tax, legal or investment advice or an offer to sell, or a solicitation of an offer to buy, securities. Certain Information in this blog may contain “forward - looking” statements or information. These statements do not guarantee future performance. Past performance does not guarantee future results.

All text, images and other content presented in the Information belong to Pitchboard or its respective author, and may not be copied, reproduced, sold or modified without the prior written consent of the appropriate owner. Any quote or reference to the Information presented in this blog must attribute Pitchboard and provide the appropriate link.