An In-Depth Look at Real Estate Investing

By Stephen Rosen on December 22, 2022

There are two ways to invest in real estate: for income or for growth.

When we talk about investing for growth, there may be many unknowns about the risk, the return that these can have, and how to execute them to maximize returns.

In this episode, Stephen Rosen continues the discussion on why investing in private real estate is so valuable to an investor’s portfolio, this time focusing on the growth type of investing and explaining some fundamental aspects like risks and strategies involved.

Stephen discusses:

• The several ways to approach a growth strategy in real estate investing
• Why growth shouldn’t always be associated with high levels of risk
• The importance of patience for general land developments
• Examples of properties that had to be redeveloped for a more lucrative use
• The power of re-energizing a used or old property
• High-interest rates making income investing less attractive
• And more!

Connect With Stephen:

• srosen@hightoweradvisors.com
• Hightower Bethesda
• LinkedIn: Stephen Rosen
• 301-202-3582

Publishing Tags:

Approach Investing Differently, Hightower Bethesda, Stephen Rosen, Investing, Real Estate, Investing, Growth Investing, Income Investing,

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[00:00:00] You invest your money strictly in stocks and bonds. If so, it’s time to change that. Welcome to Approach Investing Differently with me, Stephen Rosen from Hightower Bethesda. I’ve been advising clients for over 20 years on how to invest in alternative investments, and I’ll explain why you should dedicate a percentage of your investable assets to hedge,

[00:00:23] private equity and real estate, in order to maximize returns and create a more efficient investment portfolio. Now, on to the show.

[00:00:37] Stephen Rosen is here to continue his discussion on why investing in private real estate is so valuable to an investor’s portfolio. Now, last time around the focus was on income generation. This time Stephen will explore the idea of growth in real estate. I’m Patrice Sikora. And Stephen, you told me there are several ways to approach growth in real estate.

[00:00:59] [00:01:00] Yes, there definitely are, Patrice Thanks for hosting again and I hope that our listeners are back and enjoyed the income portion of this conversation and we’ll turn it to growth. One thing to keep in mind, and we talked about this in our pre-meeting notes, is that growth doesn’t necessarily mean you’re taking on massive amounts of risk.

[00:01:16] So I want to kind of get that out of the way for people. I think a lot of times people think about growth and they think about risk. And at the end of the day, we are utilizing risk in clients’ portfolios in a very different way. Particularly when we bring in the alternatives and the real estate, we’re trying to minimize.

[00:01:34] Okay, so there may be more risk in a growth oriented real estate investment, but it’s definitely not on the higher level of risk. Because at the end of the day, and this is something that’s very important for investors to recognize, you still have an asset. Whether or not you meet all the targets for this potential investment, or whether their fund manager meets all this, all the targets for the investment,

[00:01:59] at the [00:02:00] end of the day, you still have an asset. Whether it be a building or a piece of land to eventually sell. And so therefore, in general, your asset, your risks and your potential losses are mitigated dramatically by that. But the time factor here, the time factor, that is a huge risk. Yeah. Again, huge is all relative.

[00:02:19] We’ve seen equity markets decline 50% in the span of six months. So, I always look at risk, and we talk about this with clients all the time as far as standard deviation is concerned, and where do we kind of, what do we consider risk? Risk to me is your potential to lose money and sometimes how quickly can you possibly lose it.

[00:02:40] So when I take a look at risk, yes, there’s different levels of risk within growth real estate, and we can start talking about that now. But again, I always put that in the context of what are your other options for investing. We’ve had a long period of low interest rates. Yes. They’ve started to go higher and they’ll probably be [00:03:00] higher for the foreseeable future and maybe normalize, but again, that’s only moderate levels of return.

[00:03:06] And equity markets, regardless of the year that you’re in, always carry a general level of risk, both to the upside, which is great, but let’s not forget all the downside that we experience and that volatility and the angst that it causes to the average person. Hence why we use alternatives all the time.

[00:03:23] So, but let’s turn the conversation back to real estate per se and kind of the growth component of it. So, when we take a look at how we can, sort of, target growth. There’re a few different kinds of general components of it. You’ve all seen what we would probably call general land development. In this case somebody buys a piece of land or a parcel of land, maybe they want to build

[00:03:51] some mixed use facilities there. Maybe you can have some commercial and some residential use. There can be office buildings and apartment buildings. [00:04:00] Could be stuff for retail or restaurants, sort of these mini cities that are getting built all over the country. You could also have just pure residential.

[00:04:09] Okay. We’ve seen golf communities down in Florida, how, you know, dotted with homes all across, or even just communities, in general. No golf courses across the country, but just large residential homes. These are all land development deals done correctly. They are insanely lucrative, but there’s a lot of time involved in that because if you think

[00:04:33] driving by any one of these potential construction sites, we know that those construction sites are active for years. Yes. And so, you have to have patience. From an investment standpoint, you have to have the ability to have long staying power because sometimes you go through economic turmoil in that process.

[00:04:54] And for those who live in the Washington DC area, I can point to what’s gone on behind, [00:05:00] around the Nationals Park downtown. That park was initially, that stadium was initially built around the 2008 timeframe, during the global financial crisis. There was a lot of land that was left vacant for an exceptionally long period of time.

[00:05:15] Remember that, years upon years. Yeah. Years upon years upon years until all that land can be developed. Well, now you go down to a Washington Nationals game. Uh, it’s beautiful. There’s a lot of buildings, both residential, hotels, commercial properties, and it’s a vibrant, thriving area. And I promise you the people who have the ability to stick with their land purchases and hold out and had the ability to see through all of their construction, made a lot.

[00:05:44] So you need to be able to withstand that. The economic changes, particularly when you’re looking at development deals, particularly if you’re starting from scratch, then you’ve got your redevelopment deals. People are always looking at, again, we can be looking at [00:06:00] commercial or residential, there’s no one way to skin that particular cat.

[00:06:04] Sometimes it can be as simple as taking an apartment building and for those who are in New York or visit New York, you can many times stay in a hotel and you’ll feel that it was once an apartment building. And you’re right, it was once an apartment building, but somebody bought it. They felt that there would be more money to be made as a hotel.

[00:06:25] Whether or not that’s the case in today’s world anymore, who knows. But at the end of the day, somebody once thought that, hey, we should take this apartment building, we should convert it to a hotel. And there’s something that’s, you know, redeveloped. Other times you’re taking commercially used buildings and maybe converting them into residential buildings or vice versa.

[00:06:45] One of our investors took an old theater in the Silver Spring area around here and converted into a property that’s being used by Children’s Hospital. So, there’s endless examples that we can provide as far as what [00:07:00] redevelopment looks like. And again, a lot of it is time intensive, labor intensive, and we’ll talk about some of the risks that are out there.

[00:07:07] You could also take a look at what I’d probably call maybe a refurbish, re-energize and grow philosophy. Okay. In there you might be taking a look at, a multi-family home, for example. And we’ve talked about multi-family investing in our last podcast because it’s something that we use for income generating purposes.

[00:07:25] And it’s been a very, very, very popular investment thesis for individuals, family offices, as well as private funds and the ones that we access over the years because they’re very consistent and they’re very stable, but they’re also, and sometimes because of that, maybe they get run down. Maybe they’re in an area that was once economically depreciated and now maybe it’s starting to make a comeback.

[00:07:51] But you’ve got a multifamily building that maybe doesn’t have the 90 plus percent occupancy that the income guys are looking for. Maybe [00:08:00] it’s a 60% occupancy rate. And so, someone will come in again, dedicate meaningful capital, clean up the property, clean up the apartment building,  invest in the apartments themselves, whether they need to be refurbished, new kitchens, new baths, whatever, and reenergize that property.

[00:08:20] Take that property from a 60% occupancy, bring it up to 90%, and then stabilize. Then they’ll turn around and sell it to the income generating people. Because traditionally the growth investors are not looking for the same things that the income investors are looking for. So, the growth investors are looking for different things than the income investors are looking for.

[00:08:44] The growth investors are looking for higher levels of return, sometimes in a shorter period of time, but clearly when we’re talking about large development deals, those clearly take a lot longer. But when you’re taking a look at a refurbished, [00:09:00] re-energize and grow type of deal, or some type of conversion, you’re generally looking for those to happen over a couple of

[00:09:07] years, two, three years maybe four at max. But generally, you’re looking for some significantly higher returns versus the income people who are really looking for good, steady income. Maybe they’ll get a little bit of appreciation due to the increase in cash flow that you’re getting, which will eventually make the property more valuable.

[00:09:28] And those people are generally looking to hold onto properties for a lot longer period of time, because they really like the cash flow. So, it’s different, yeah. Say it sounds like a very symbiotic relationship here between the growth and the income growth. Does it, income buys it 100% because again, you have different pools of money who are looking for different things.

[00:09:52] They have different objectives at the end of the day, and their investors are looking for different things. And that’s why it’s so important [00:10:00] to understand where you’re investing, why you’re investing, and who you’re investing with. And you really want to make sure that there’s a matchup between what your objectives are and what the objectives are of the actual fund that you’re looking for.

[00:10:18] And that again, comes back to making sure that you’re using people who know what they’re doing in this space. Thankfully, I believe we do and have an understanding about what our objectives are, what our clients are looking for, and you don’t want to put a client in a growth-oriented investment when they’re looking for income.

[00:10:40] They’re not going to. And even though some of their properties inside their fund may get that income flow, most of the funds are not paying it out regularly because they’re taking that income, they’re reinvesting it in the properties and trying to speed up the process by which they can turn things around [00:11:00] in this kind of economy right now, where hopefully we have, or we’ll see the bottom pretty soon, where do you see most of your fund investors wanting to?

[00:11:11] Again, I think it’s very specific to the investors themselves. I think the issues that we’re starting to see right now in real estate is that everybody’s been able to live off of cheap money, right? Interest rates have been low for an exceptionally long period of time, and the conversations that we’re having right now is the difficulty in purchasing, particularly for income, because most income purchasers are utilizing some form of leverage.

[00:11:51] They, let’s say historically you could have maybe have a property that is yielding 7%, all right? And you borrow at 3%. [00:12:00] Say you borrow half the money to purchase it, and you use equity for half the money. So, you’re getting a 7% yield on your equity purchase. Then you borrow at three or 4%, and then you’re earning another three or 4% above your borrowing cost, and now you’re getting, you know, it’s very difficult to do that in the environment that we’re in right now.

[00:12:23] And because what we’re seeing right now is borrowing costs are based upon where pricing is right now. Borrowing costs are very much matching cash flow from a lot of properties, so the benefit of leverage on an income producing property doesn’t really exist. Right. Or at least it’s a very small spread, right?

[00:12:45] And so people are having to adjust right now in their purchases to a lower income or prices are going to have to change. And so that’s one of the things that we’re looking at right now is that there needs to be probably some reset.[00:13:00] People who are looking to sell properties as to what the value of their property is because people can’t generate the income that they could.

[00:13:07] And we’re trying to focus on growth, but it does kind of understand what’s going on in the income world maybe gives you insight into why, maybe we’re looking at growth a little bit more right now. But when you take a look at the mismatch on the income side it gives you a little bit of a pause because you have to see some price.

[00:13:28] Somewhere, something has to give. Now the rent people will tell you, the income. People will tell you they’ve received a benefit over the last  year or so because they’ve been able to raise rents so dramatically high. And yes, that is true. But at the end of the day, if you can’t borrow at a rate that is substantially lower than the cash the property is running, it doesn’t really make sense to borrow.

[00:13:52] And so from a growth stand, you want to take a look and see, okay, well here, where are we in the economy? Because to your point, are we [00:14:00] bottoming? Who knows? I’m not sure what anybody’s crystal ball has out there. They’re a lot of crystal balls. Oh, trust me. I get emails from clients every single day asking me about what this guy said, and that guy said, and this girl and that girl.

[00:14:14] And let me tell you something, all four of those people have a different opinion. And they always ask why. Why do they have an opinion? I said, they’re paid for the opinion. And they say, well, what if they’re wrong? I said, no one remembers if they’re wrong. They only come back if they’re right. That’s right.

[00:14:27] And that’s their true. And that’s the reality. So, on the economic front I think it’s very important when you’re looking at growth investing that you have variables in place that you understand, or at least again, the average person isn’t really needing to understand this, but understand the risks that are involved for the funds that they’re working with, is all the different factors that go into getting a return on a growth investment.

[00:14:55] So yes, number one, if the economy is stronger, it’s going to [00:15:00] drive demand traditionally for whatever that real estate development or refurbish is trying to create. Okay? If you’re trying to create a better multi-family home and increase vacancies, well, you better hope that you’re able to, you know, be cost effective in how you are refurbishing the place, and you better hope that the economy is strong and stable, particularly in the environment that you’re refurbishing this building.

[00:15:26] Okay. Are there people there who are going to be able to migrate and move into your building that was one 60% occupied and you wanted to get to 90% occupied for your development people? Okay. COVID has changed a lot. It’s, you know, slowed the supply chain down, as we’ve talked about, so it takes longer to get things.

[00:15:46] And because it’s taken longer, it’s also increased construction costs. We’ve had properties within our funds, somebody bought a deal, took them a while to get it zoned.  By the time they were able to get it [00:16:00] zoned property, construction costs increased for what they wanted to do. They looked at the deal and they’re like, we really can’t make the money that we wanted to make on it, so we’re just going to sell the property.

[00:16:13] When that happens, does the property go with all the approvals that it already has, or do the new owners have to go through the whole process? Well, I think a lot of times when that occurs, the new owners are potentially looking to do something different. Okay, because now sometimes they might be looking to do the same and they can probably sell it with the zoning approved, because that’s the property itself is what has the approval to be owned, not I think, the individuals themselves.

[00:16:36] So it becomes valuable because you’re further along in a process. So, the time delay isn’t there. And also there’s sometimes that look, there’s many times, and we see this with our funds because we have great conversations with them where they’re looking at a particular property and they’re only willing to bid X on it and they’re bidding X on it because they’re super [00:17:00] conservative with what their estimates are for their construction costs for the time it’s going to take.

[00:17:06] They want to make sure that they get a return that is commensurate with what their expectations are. And so, they underwrite their bid based upon their assumptions. There are other people who say, nah. Number one, they might make more aggressive assumptions, okay? Or they might be willing to make less of a return.

[00:17:27] So that’s also where you have to have an understanding about how detail oriented are the people who are investing your money and how frequently are they willing to stick to their guns? And again, it’s a dual edged sword there because sometimes you might be right in your assumptions, sometimes you might be wrong.

[00:17:48] I can tell you we’ve had funds who were probably a little too conservative in a period of time that maybe they didn’t need to be. They ended up taking a little longer to get money to work than one would like. And while some of their [00:18:00] competitors were maybe willing to pay up for properties, they were rewarded.

[00:18:04] But if you were disciplined and you stick with disciplined people,  you may not always get the upside, but you’re certainly going to find yourself protected on the down. And for us, whether or not it’s income producing real estate, or particularly growth real estate, we want to make sure that it falls into what we’re always looking for, which is great risk adjusted returns and making sure when things go sideways, because they always go sideways, that’s just the reality.

[00:18:38] Stock market goes sideways. Bob Market, as everyone is seeing goes sideways, things go sideways. How do you handle it? Okay, how bad is that sideways move? And if we can minimize those downward moves when things go wrong again, you don’t have to make as much on the upside. It’s the whole thesis behind every single thing that we do.[00:19:00]

[00:19:00] If you protect the downside, the upside will always take care of itself. So, you know, when it comes to the growth investing, you’re right, the economy definitely plays a role in it because you’re not getting the cash flow to sit around while you, okay, it’s a very different process. So there are more risks that are out there from an economic front supply chain, front construction, cost front, cost of capital, sometimes, but, you know, other times the cost of capital in those scenarios is not necessarily as important because the turnaround of the projects is usually faster than the return is, and so therefore you might start to see, when we see some confirmed stabilization of the economy, you could see a reinvigorated interest in more growth oriented real estate because the numbers just might add up better.

[00:19:55] Right now, the numbers on brand new income producing real estate are [00:20:00] not a hundred percent in investor’s favor. They’re still, but they’re definitely not what they were. Over the course of the past 10 years, as interest rates were declining and cap rates were declining, and even in those instances, you might not have high levels of inflation, but everyone’s still able to raise rent a couple of bucks.

[00:20:19] So you have declining interest rates and increase in cash flow. It’s a recipe for dramatically increased property values. On the income side, that’s not the world that we’re living in right now. So, I think it’s very important to be very choosy on the income side and if we can get a bottoming out from an economic standpoint, there’s a tremendous amount of growth in a lot of regions and there’s a lot of migration of people from certain states into other states.

[00:20:47] That creates the need, creates a need for infrastructure. It creates a need for hotels. It creates a need for residential buildings. It creates a need for strip malls and parking structures and [00:21:00] everything to accommodate those higher levels of population. And a lot of times those cities don’t have it just yet.

[00:21:06] Opportunity. Self storage units. A hundred percent. And by the way, you know, people sometimes look at self storage units as an income producing asset. They are, once they’re up and running. Okay. But they have to get created somewhere. And so, people buy, you know, a lot of land, build a self storage unit, stabilize it and sell it, and they sell it to the income producing.

[00:21:34] So again, to your point before, it is a very symbiotic relationship. It most certainly is. You can’t, I can’t say you can’t have one without the other. I will say that the growth investors traditionally need the income investors more probably than the income investors need the growth investors because there’s a lot of properties out there in today’s world that are in existance

[00:21:59] that are [00:22:00] cash flowing, that are making money. So, you don’t necessarily need the growth people to build something, refurbish it, and then be able to turn it over to the income people. The growth people do need the income people. because they don’t want to hold properties for a long period of time. The income people could be happy with, you know, returns.

[00:22:19] And we measure everything in private investments from an IRR standpoint, internal rate of return, and that measures the return of capital from the point in time you invest it to the point in time you get it back. Because all of these funds that we invest in traditionally are capital call structure funds, and you’re funding your investment over a period of time.

[00:22:41] And so private real estate on the income side, we can probably see anywhere between nine to 15% IRR. Oh, okay. Which is fantastic. I would probably tell you that most growth investors are probably [00:23:00] looking for 15 to 30 plus range at a bare bones minimum. I’m not saying they always achieve it, and also keep in mind that those are generally gross returns that the general partner or the developer make.

[00:23:13] That’s not always the returns that the investors make because there’s fees and costs associated with all of the investments. But in general, the growth investors are looking for a dramatically higher return than the income investors, which is why they want to unload the proper. Once they’re done with them, they want their money to go work on the next deal because they’re looking for higher returns than the income people.

[00:23:37] It’s also why the income people are traditionally happy holding onto properties for a longer period of time. They just want the cash flow, and if the cash flow is increasing because you’re able to raise rents, they’re super. They don’t have a need to get rid of the investment. They’re very happy holding onto it.

[00:23:55] The only reason why most of them end up finding a need to sell it is [00:24:00] because they have terms on their funds that maybe can only last eight or nine or 10 years, and they’re required to sell the properties and give it back, give back the money to the investors. So that’s kind of the dynamic as to why they end up selling.

[00:24:16] If they didn’t have to sell them. And we know a lot of individuals, and I said families who are large real estate investors here, particularly in the Washington DC area, they buy these multifamily residential buildings. They’ll hold onto them for decades, collect the cash flow and go on their merry way.

[00:24:35] Great discussion. Great discussion, Stephen. I love it. Now the next time we’re going to turn around and talk about private equity. Oh yes, he says with a big smile. We do. And for those who are listening, be prepared. That one might be a long one. I have a lot to say on it. Not that I don’t have a lot to say on everything.

[00:24:53] But at the end of the day, I think there’s a unique opportunity for investors in the private equity market. There’s been a [00:25:00] massive sea change in the public equity markets over the course of the past 20 plus years with respect to companies staying private for longer. So, it makes it much more opportunistic to be private than it is for public.

[00:25:14] And so we’ll get into a deep dive in that conversation next time. All right. Hold those thoughts. Now, how can listeners reach you if they’ve got some really, I’m sure good questions for you, even if they’re bad questions, how can the? As always, and I say this after every episode, please visit our website, hightowerbethesda.com.

[00:25:32] There you’ll see our podcasts, our blogs, some of our research notes. You could always email us through the website, I think that’s always the best way. I think you can get a good feel for who we are and what we do. And follow this podcast to get access to every episode. Of course, please share with others as well.

[00:25:49] And thanks for being with us.

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