Retaining Flexibility in Real Estate Investing: A Podcast

26th March, 2021

Retaining Flexibility in Real Estate Investing with Hussain Nathoo, OrangeStone Capital

Staying diversified and flexible is almost always a good thing with regard to your real estate investments. Here on the show today to talk about his approach and fund is Hussain Nathoo from OrangeStone Capital! Our guest is based in Houston, Texas and we get to hear from him about managing the fund, how he got into the real estate game, and some of his thoughts on the market in Texas currently. We delve a bit into his focus on the state of Texas and how he has diversified within this geographic location, before getting some insight into the particulars of the fund, how he manages it, and how to make the most of good opportunities that present themselves. Hussain offers some great thoughts on prioritization, how this can simplify decision-making, and we also talk about what makes the top of OrangeStone’s list! The conversation covers the impacts of the pandemic, leverage and loans, and differentiating a fund from competitors. For all this and a whole lot more, be sure to tune into The Pitch Podcast today!

Key Points From This Episode:

  • Hussain’s professional background and his entry-point into investing and starting a fund.
  • Some thoughts on the power of real estate assets as a safe investment.
  • The key elements to Hussain’s approach to investing: ‘Utilizing the underlying dirt’.
  • The range of deal-sizes that OrangeStone Capital generally looks for.
  • Creating an edge and differentiating from the array of other funds in the market.
  • Leverage in deals; OrangeStone’s philosophy towards underwriting and loans.
  • Assessing the right moment to sell and why Hussain bases this on risk.
  • Hitting the right level of diversification across the industry for a good level of exposure.
  • A good example of an OrangeStone deal in Texas from a couple of years ago!
  • Concerns over inflation rates and where the market may go from here.
  • The effects of COVID and how things have played out across Texas for Hussain.
  • A stand-out investment lesson that Hussain learned from a failed deal in 2012.
  • A quick breakdown of the setup at OrangeStone; employee numbers, asset value, and more!
  • How Hussain approaches balancing the different aspects of his role and pursuing the right deals.
  • Closing thoughts from Hussain; fostering continual evolution for growth and longevity.

Transcript:

“HN: Real estate is kind of an industry of dinosaurs. So, I think the first to adapt and adjust and grow their company, embrace technology, embrace scale, while having the flexibility to continuously pivot are going to do pretty well in the next 20 years. So, we’re about that. We want to continue to pursue that. And again, flexibility to us has infinite value as the options just allow for you to do just some creative things.”

[00:00:26] JM: Hi, I’m Jenny Merchant, co-founder of PitchBoard, and welcome to The Pitch Podcast. We’re here to have thoughtful discussions with forethinking managers for taking unique approaches to professionally investing capital. Through these conversations, we hope to introduce you to new ideas and strategies that will help you better manage your own portfolios.

Before we begin, we want to remind our listeners that everything in this podcast is for educational purposes only. Nothing here is tax, legal or investment advice. We don’t endorse any products, services or opinions made by our speakers. Some statements in this podcast may contain forward looking projections. These projections do not guarantee future performance, and any past performance does not guarantee future results. Finally, nothing in this podcast is an offer to buy or sell securities, speak to your own advisor before making any financial decision.

[00:01:30] AH: Hi, this is Andrew from PitchBoard. I had the pleasure of speaking with Hussain Nathoo of OrangeStone Capital. Hussain is based in Houston and manages a real estate fund. We talked about how he got into investing, how he sees the Texas real estate markets, and how he manages his fund to take advantage of the opportunities he spots. I think you’ll enjoy the conversation that follows.

[INTERVIEW]

[00:01:51] AH: Hi, everyone. This is Andrew Hepburn from PitchBoard and I have the pleasure to introduce our listeners to Hussain Nathoo, Founder and Managing Partner of OrangeStone Capital. Hussain has tremendous experience in investing and everything real estate with a particular focus on the Texas markets. He’s a Houston native and attended the University of Texas at Austin. We’re very excited to hear some of his wisdom today. So, with that said, welcome, Hussain. It’s great to have you on the show. To kick it off, do you want to give our listeners a sense of how you got into investing and sort of just a broad overview of your fund?

[00:02:24] HN: Sure. I was working in energy PE back in 2010 and generally, learned a lot about the business of professional investing. Subsequently, an opportunity came up with some friends and family to pursue a substantial portfolio deal in the real estate world. And at that point in time, the market was pretty soft, I think 2010, post GFC. And I was young, I was about 25 years old. So, I thought it made sense to go ahead and make the leap.

Unfortunately, we didn’t end up landing the deal. But going through the process with these guys was a great learning experience and that was able to earn their trust on other deals. I’ve been following a couple other decent sized real estate funds in the Texas market and one particularly caught my eye. Their name was an Amery, and they since been acquired by a company called Edens. They focused on purchasing irreplaceable retail corners in dense urban areas, and given how successful they’ve been doing that, I didn’t really see a point and trying to recreate the wheel and I really just decided to follow them and follow that strategy.

Over the years, as dense areas have kind of become more urbanized, land values kind of shot up. So, generally, if a site works for retail, it can generally work for any other use. I think if you’re going to go to Starbucks, I mean, why wouldn’t you go to an apartment or an industrial building or an office building. Those locations are generally widely universally acceptable for almost any other use.

So, over the years, we basically adapt to that model to begin also purchasing great infill office, industrial, and other kind of special use sites. For the most part, we just want to continue focusing on these urban areas, and they’ve been really good to us. So, we will continue to buy them as these areas continue to densify.

[00:04:12] AH: We’ll get into more of the particulars of the markets that you invest in Texas. But I guess from a high level, how would you make the case for real estate as an asset, and why it’s something that investors should own?

[00:04:27] HN: From an overall perspective, I think you have to allocate some of your dollars to real estate, just you know, it’s kind of traditional, economics and asset allocation. I think that you have to have diversification within real estate. I wouldn’t go all in on retail, hospitality, multifamily, industrial, there’s so many different industries and they’re effectively a derivative of the common economy, when you get some exposure to real estate assets and the industries back those assets just by owning it. So, view it almost as like a bond for particular companies and getting some of that real estate appreciation that comes with it. So, it’s almost a good hedge and it allows you to have some type of coverage in case something were to go wrong within that industry and it allows you to give it to another company or another industry to allow you utilize that space. So, a bond with upside characteristics is what I look at real estate as.

[00:05:20] AH: Sort of like a hybrid between an equity investment and a fixed income investment?

[00:05:25] HN: Correct.

[00:05:27] AH: Do you want to describe the key elements to your investment approach? How do you decide what to invest in? And how do you go about assessing opportunities? And then what are the criteria that you’re looking for, as a real estate investor?

[00:05:43] HN: Over the years, we’ve kind of refined our model, and now we really just focus on the underlying dirt. We care a lot less about the improvements. So, whether it be a retail building, office building, industrial building, whatever it is, we’re really just underwriting to that dirt. It’s important to us to have that optionality at the end of the lease to effectively do anything else. And it goes back to that retail strategy whereas if you buy a site that works for retail, it effectively would work for anything else, this is putting that to practice and actually being able to convert those assets to other uses.

On one end, it eliminates a credit risk. I wouldn’t say eliminates, but it it just mitigates the credit risk. We’re really just trying to find assets where we can almost care less if the tenant stays or leaves. We’ve got good underlying dirt there that could be utilized for something else in the future.

[00:06:35] AH: So, really, it’s any piece of land that you’re buying could be a substitute. It’s industrial, it could be commercial or vice versa. Is that sort of how you’re looking at it?

[00:06:43] HN: Correct.

[00:06:43] AH: And what sort of size of deal, just to give the listeners a sense, what sort of size of deal do you tend to look at?

[00:06:52] HN: So, we’re pretty much sub $20 million and our sweet spot is that $5 to $10 million number. And I think a lot of people will say that, it’s too big for mom and pop, it’s too small for the big institutions. But institutions are definitely getting into the space. So, I wouldn’t say that there’s no competition from those guys. It’s just been a good sweet spot for us. And traditionally, there has been maybe a little bit less competition, but it’s definitely heating up as well.

[00:07:21] AH: And I guess that leads into my next question, which is, there are so many funds out there. How do you differentiate your fund from everyone else? What would you say is your edge? Is it that particular size of deal that you specialize in or something else?

[00:07:38] HN: So, we’re generalist by nature, just by the various real estate assets that we own, but we’re hyper focused on land. So, we’re always engaged with developers and trying to get a pulse on what’s going on in their world. Our model kind of allows for a higher probability of closing and generally a faster process than others that are focused on either just the improvements or just the credit or just the development side of a deal. We rarely ever dropped deals, because we generally identify everything we need to know, prior to putting a deal under contract. Developers that we might compete with, they’re looking to do high rise, apartments, office building storage, et cetera. They have to design a project and generally raise their funds, whether it be equity or debt prior to closing. If a deal is subject to leases, then we’re competing with credit investors who really have a threshold that, “Hey, is this a 5% cap, 6% cap, we can buy it, or we can’t buy it”, whereas we’re kind of the hybrid. We see where what the developers see. We see what the credit guys see, and we try to find a sweet spot between the two.

[00:08:43] AH: How much leverage do you tend to use in your deals and how would that compare to some sort of an industry average, would you say?

[00:08:51] HN: It’s tough to say it, because we do, again, so many different asset types. So, we’ll do generally as much leverage as we can get for any specific asset type in which allows for it. So, in retail, you might get 65% LTVs. In multifamily, you might get a 75% loan to value, it really just depends. But again, we look at our underwriting as being really conservative. So, even if we can take on a full amount of debt, generally speaking, if everything were to go wrong with the asset, we can bulldoze it, and go back to square one and be in a better position than we were when we bought the asset. So, we’re less concerned about leverage. We’re ultimately just trying to find a way to get from point A to point B. It’s carry, carry pop. That’s really our motto is carry as long as you can and, and hope for the pop at the end of the day.

[00:09:40] AH: I guess that brings up the issue of when do you know when to sell? To make that decision to to exit one property and move on to the next?

[00:09:52] HN: Generally, it’s when you can be able to de-risk it yourself, meaning if I’ve got a lease on a property, and it’s about to roll or a tenant is saying, “Hey, I need to get out.” At that point in time, we might engage with the developer to ask them to say, “Do you want to take down this property?” Because the timing is right. I mean, the yield is about to burn off for us. And it’s right for a developer to take on so he can go develop his project.

So, we generally kind of wait for those circumstances. Sometimes the market is so hot and heavy, that there’s effectively an opportunity to buy out your tenants and give them a pot of gold to get out of the deal and those opportunities, if it makes sense, we take them as well. I don’t think there’s ever really a perfect time to sell or to buy an asset. It just depends on the circumstances for any particular asset and the criteria that surrounds that

[00:10:42] AH: I mean, that’s a good point. I guess no one really buys at the absolute bottom or sells at the absolute top, right? I guess it’s an art form, as much as it is a science.

[00:10:54] HN: Yeah, hit 300, 400 baseball throughout the good times and the bad times, we look at that just like real estate. We’re always trying to hit singles and doubles and occasionally hit a homerun, occasional strike out, but we’re just trying to maintain the process.

[00:11:09] AH: Sort of onthat note, from a risk management perspective, do you prefer to be concentrated in the investments in the fund? Or I mean, how do you look at what’s too much diversification? Or would you rather be concentrated in just a handful of ideas or would you rather spread things out more for risk management purposes?

[00:11:32] HN: We’re diversified and that we’re in a couple of different key markets, Houston, Dallas and Austin. Additionally, we’re diversified through the assets that we own and that they are – even though we’re underwriting to land, we view ourselves as the land fund. We have exposure to retail, multifamily, industrial, special use parking lots, golf courses, you name it. And I have exposure to all those different asset types. But having the diversification of being in multiple different markets in multiple different asset types, almost lets us have more exposure to an asset than anybody else possibly could from risk management perspective. We’re hyper focused on urban properties in those three markets.

So, if you were to say, “Hey, you know, you’ve got too much land exposure in any one of those Texas markets, I would say yes, but we’ve got components to offset that risk.” And that is just by having assets that are generally earning income or exposed your different asset classes. So, I like having kind of that hyper focus and since I know the market, probably better than most people do, but I also like that I am exposed to a couple different worlds at the same time.

[00:12:45] AH: Is there is there a deal that you’ve closed, either recently or in the past number of years, this sort of highlights your approach to real estate investing?

[00:12:54] HN: Yeah, we bought a big box retail center in Austin, Texas. I’m going to say about two years ago. It sits on about eight and a half acres. The asset was subject to a lease with a credit tenant, albeit relatively poor credit. With only four years remaining on the lease, the asset was priced at, call it an 8% to 9% yield or cap rate. The tenant had multiple five-year lease renewal options remaining, but generally pretty modest rent bumps. That made the deal unattractive to both credit buyers due to the short lease duration and the associated credit risk, as well as developers because they had no assurity that they’d ever get control of the asset due to the options, because he asked it was priced significantly below land value and carried in a kind of an above average coupon. We love the deal. We closed on a deal in 45 days of contract execution.

[00:13:49] AH: I guess, sort of fast forwarding to today, what’s your sense of the Austin, Houston and the Dallas markets in which you operate?

[00:14:00] HN: They’re all really good markets. Austin has probably gotten a lot of attention due to all the tech companies expanding over there. So, it’s a pretty hot market and very competitive deals are moving pretty quickly in that market. But again, if you’re tied in, you still get some exposure to it. So, we love the market, we’ll continue to do deals over there, but it is a very competitive market.

Dallas has the benefit of just having the infrastructure of a gigantic city, but having kind of a small-town cost of living, so you’re going to see people continue to move over to Dallas, and they’re going to grow and it kind of has more of a macro pulse as far as how the city is built, their core competencies are Telecom, transportation, they’re real estate. It’s a very much kind of global city in the heart of Texas.

Houston has had probably more hiccups in any other markets due to commodity volatility. But the city has done a good job and really trying to diversify. The city, in my opinion is reaching critical mass because population continues to grow, even without all these big energy companies, doing hiring sprees. So, we’re growing on our own organically. It’s been great and the volatility as an investor has been awesome for us, because we’ve been able to kind of take advantage of kind of the ebbs and flows in the market. We think that the market will continue to do well in taxes, frankly. I mean, in all those markets. They’re kind of unique quirks. But over time, just the cost of living, the warm weather, the loose regulation over here, all really benefit Texas.

[00:15:34] AH: And what would you say to investors that are worried that real estate in general, might be at a peak? And I guess, maybe a related question to that is, you know, we’ve obviously seen long term interest rates recently started to go up a fair bit. And is that something that you’re worried about? So, it’s sort of a two-part question, but do you worry at all about the general real estate market, I guess, is what I’m getting at?

[00:16:01] HN: So, going back to my point earlier, we’re not really trying to time the market. We feel like there are deals to be add in both good markets and bad markets. And over the long run, if you just maintain your discipline, things should generally work out. So, we’re not really following the noise all too much. As it comes to real interest rates, we are very cognizant of that and we think that rising rates will be more of an opportunity for us than anything. And I say that, it seems almost counterintuitive for real estate guy to say that, but we’re more focused on the underlying land and we are the income of these assets.

So, there less competition if interest rates are higher, because everyone else has to kind of – any credit buyer that we’re competing with effectively has to underwrite those higher interest rates. So, we view that as a great opportunity in the coming years, as interest rates pop up a little bit to get a little more competitive on assets.

[00:16:57] AH: In the sense that there will be less competition from other investors?

[00:17:03] HN: Correct. Their hurdle will just be naturally higher, because rates are higher.

[00:17:07] AH: Right. Has COVID and everything that’s come with it, has that affected the markets a lot that you focus on, or for sort of business in general?

[00:17:18] HN: For the most part, we’ve been okay. Texas, for better or worse, has kept the economy open throughout most of the pandemic. We’ve been the beneficiaries of that. We haven’t had too many hiccups. We do have some kind of CBD type parking lots where the income is not nearly where it was before. But again, we’re long term guys who believe in the value of the land. So, you know, losing a little bit of cash flow for a few months isn’t really going to impact us and really, only allow us more opportunities as it does impact maybe other guys.

[00:17:51] AH: It’s easy for investors to talk about their successes, not as easy to talk about the things that didn’t work out. But I think it’s always interesting to hear about failure that a fund manager had an ideal or a situation and what they learn from that. Can you think of off the top of your head about about a failure you’ve had over the years and investing and what you learn from it, and how you apply that today?

[00:18:16] HN: I did a deal, maybe in 2012, or 2013, subject to multiple leases with a shopping center, fantastic real estate, ideal development site. In my mind, I thought this is going to be perfect for a six-story, midrise apartment deal. It shaped right on a corner, it has a land acreage that we needed, good density around us. But we had leases in place with multiple different tenants and we knew that going into it, but I guess we didn’t allocate the proper amount of risk to having those leases not roll off simultaneously.

So, a bit of a drag as we had some leases rolling, and then some tenants staying, and some tenants exercising their options. So, at the end of the day, that is still a retail Center today, because we just had too many problems, getting those leases to align and getting the tenants to kind of get on board with being bought out from their leases. So, this made us a little bit more cognizant about going into deals where there’s effectively too many parties involved. So, now we try to focus on deals where there might be one or two parties at most. And at those few parties, we better have a good grip on what they’re thinking. Whereas if there’s one, it’s kind of an all or nothing approach. It’s either you’re getting 100% of the income or getting 0% income. So, 100% credit, and then it turns into 100% development. We like those situations. But again, we’ll occasionally pivot to do deals with more than one tenant if the situation behind it makes sense.

[00:19:45] AH: Just about the the fund itself, what can you tell us about OrangeStone? Do you have partners? How many employees are there? What’s the firm like?

[00:19:56] HN: OrangeStone has about $250 million in assets under management, mostly through syndicating deals. I’m effectively a one man shop from a fun perspective. But from an offloading perspective, we hire the best in class management teams for all of our assets. Again, we view ourselves as the land fund. So, we get the best retail operators to operate or retail assets, best office operators to operator our office assets, and so forth. So, I don’t necessarily have any employees. Through management agreements, we probably work with 10 different management companies of which employ multiple people each. So, it’s an organization built to be very, very, very nimble, to capitalize on opportunities. But at the same time, having the best in class management expertise of the guys that are doing this on millions of square feet of assets.

[00:20:48] AH: So,effectively, the number of people who are working on your behalf is a fair number, you sort of outsource the management of the properties?

[00:20:57] HN: Correct.

[00:20:59] AH: Especially as a one-man shop, how do you balance on the one hand managing investments and looking for new opportunities, and on the other hand, servicing clients and drumming up new business?

[00:21:14] HN: Our investment philosophy is a pretty simple one. It’s almost see ball, hit ball. If the deal criteria pencils out from a land value perspective, I pursue it and everything else is becomes somewhat secondary. So, we begin to identify the risk after that that criteria are met. But it makes underwriting pretty simple, makes the diligence process pretty simple. It makes scaling the platform pretty simple.

As far as servicing, we get third parties to manage the servicing. If I’ve got an investor that wants to reach out to me, they’ve got my cell phone number, they can call me. I’ll answer all the questions I need to answer. But I like the idea that we’re nimble, and we can move and we can pivot as quickly as possible. It just allows for much more flexibility in a world where you need that to be competitive. So, we’re pretty excited about the opportunity to continue to do more deals. I love working my LP base, they’ve been fantastic. The flexibility is so important to me.

Real estate is kind of an industry of dinosaurs. So, I think the first to adapt and adjust and grow their company, embrace technology, embrace scale, while having the flexibility to continuously pivot are going to do pretty well in the next 20 years. So, we’re about that. We want to continue to pursue that. And again, flexibility to us has infinite value as the options just allow for you to do just some creative things.

[00:22:32] AH: Any closing thoughts for listeners who are curious about your fund or your approach?

[00:22:38] HN: We’ve been doing this for 10 years. We’ve got a pipeline to continue to do within doing this over the next 20 years, 30 years, and we’ll continue to evolve. If there’s an opportunity to pursue one of the asset types that we’re in and allows for us to really scale that, we’ve got that opportunity to do that. Ultimately, we’re a land investor, but we kind of have the potential to grow in any particular asset class. So, if multifamily is a flavor of the month, we can absolutely grow and scale that market. If industrial is a flavor of the month, we can absolutely do that. So, we think that the market for real estate will continue to do well. I think people will continue to want to chase that yield and by not having something that’s very much tied to interest rates, like land, we think that they’ll just continue to be opportunities.

[00:23:25] AH: Okay, that’s great. Well, unfortunately, that’s all the time we have for today. Hussain, I’d like to thank you for sharing your thoughts with us. That was extremely insightful and helpful. PitchBoard would to thank our listeners for their attention and interest, and we’ll see you next time. Thanks very much.

[00:23:41] HN: Thanks for having me.

[OUTRO]

[00:23:43] JM: Thanksfor joining us on this episode of The Pitch Podcast. Make sure you check us out online at thepitchboard.com. If you liked our podcast today, please make sure to subscribe to The Pitch Podcast so you don’t miss an episode.

[END]

Tweetables:

“From an overall perspective, I think you have to allocate some of your dollars to real estate. It’s traditional economics and asset allocation. I think you have to have diversification within real estate.” — @hussain_nathoo [0:02:57]

“We’re generalists by nature, just due to the various real estate assets that we own. But we are hyper-focused on land.” — @hussain_nathoo [0:06:07]

“We rarely ever drop deals because we generally identify everything we need to know prior to putting a deal under contract.” — @hussain_nathoo [0:06:33]

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