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Achieve Wealth Through Value Add Real Estate Investing Podcast

May 6, 2019

Jeff Adler, Vice President of Yardi Matrix share his view of the latest state of Multifamily commercial asset class.

Show: Achieve Wealth Podcast 

Guest: Jeff Adler 

Title: Multifamily State of Union with Jeff Adler 

Host:  Hi Audience, welcome to Achieve Wealth Podcast, a podcast where we are tuning in to learn as much as possible. Today, we are bringing in an awesome guest, who is the keynote speaker at many conferences, many high-level conferences, so was able to get his time to spend with us today to go to as what I call the state of the Union of multifamily real estate. So today we have Jeff Adler who is the vice president of Yardi Metrics. Yardi Metrics is a US multifamily office, industrial and south storage as an information toolset in coordinating underwriting and asset managing commercial real estate investment.  

So if you have subscribed to Yardi metrics report, which is awesome, very, very data rich and I think it should be part of your decision making in selecting markets and looking at trends in terms of a commercial real estate, especially on multifamily. Your mail would have come from Jeff Adler. So I'm very pleased to bring Jeff on board. Jeff, why don't you tell my audience something about yourself and your company that I would have missed out? 

Jeff:   I'm based here in Denver. You already made fixes. Basically the data division of Yardi systems, which is well known in the property management sphere, across all different asset classes, we cover the multifamily office, industrial self-storage in all those different other asset classes. But my background was primarily in multifamily. I was the chief operating officer of a [01:49unintelligible] in Denver,  for about 10 years from 2002 to 2009 and I joined matrix about five years ago. So that's kind of what we do. And some of the work that I do is the basic products, the tool kit that helps you identify opportunities under find deals, underwrite deals, understand markets, understand entities and players in those markets. And then on top of that work, I have a team along with Jack Kern that talks about investment strategy, investment themes and the overall economy.  

And so we try to put everything into context from kind of what's going on in the global economy, straight down to which deals should you buy that fits your investment strategy. And that's kind of what we do. So happy to be on the podcast and give you any information about what it is we're thinking. 

Host: Yeah, I'm really excited because I read the reports that are created by Yardi Metrics on whenever you guys send by-market, by-economic at high levels so it's very, very informative and I love it. 

Jeff:  As a part of what we do to get our name out, you can go to and for free, sign up for our [03:16unintelligible] reports where we do those 10 multifamily markets a month, six office markets a month. We also do a monthly report that's free on the multifamily market nationally, the office market nationally and self-storage market national. So there's a lot that you can plug into that kind of can set a context so we provide free. And then if you want to learn deeper then you can talk with us and go deeper into the data service. So that was the resources that are available to all of your sort of listeners. 

Host: Yeah, yeah. I would encourage all your listeners if you want to do commercial real estate, especially multifamily or an office or self-storage, go and subscribe right now. It's an awesome, awesome tool and information is free and it's really good.  

Jeff: What else can I do for you? Let's get in there and let's start talking. 

Host: Yeah, yeah. Correct. I mean I know we talk a lot about multifamily because I'm a multifamily operator. We own 1400 units in San Antonio, Austin, Texas. But I want to always understand about other asset class. I mean, recently I launch a book, it's called Passive investing, Commercial Real Estate, which I also talk about other asset classes. So I'm very happy to ask you questions about other than multifamily, you know, as a start. So compared to multifamily office and self-storage, what are the good and bad about each one of this asset class from your perspective since you look at all of this? 

Jeff: Yeah, personally, I think multifamily is in an incredible sweet spot. So let me take a multifamily and we can compare it to other asset classes. The reason is is that there is an overall shortage of housing in the United States, which to a greater or lesser degree in different markets. And then it's really kind of an overhang from the kind of the crash. So we had a surplus of housing in going into the crash. But really now we have deficits, on a cumulative basis since '06, we've got a 200,000 unit multifamily and single family deficits. If you go from the bottom of the crash, it's about 2 million units. So how is this being expressed? And we also have, we have a number of demographic trends; people getting married later, having kids later, having fewer children, having student debt. 

 So if you look at all the divorce rate, look at all of these demographics, we seem to have like a secular shift in the number of renters and the renter households population in the United States overall. And you see that expressed in very high occupancy rates since the crash that are still hanging in the 95, 96 level at the national level, which is very, very high and rent growth that historically if you look at, and I've done this back in 1970, CPI and the rent growth are very, very tightly coordinated. Since the crash, the rent growth has been about cumulatively five to 600 basis points higher than CPI, it is an anomaly so it's not like the normal cycles you can go back to, this is fundamentally different. You can look at the extent that there is new supply coming on, about 300,000 units a year. 

 It's Class A, kind of an urban core or in places that are sort of urbanizing notes. There's the big opportunity for, I'll call it non-institutional investors, it's been in class B and Class C I would probably say 50 unit to 100 units where there's not a lot of institutional competition. There is a deep need for housing and the price umbrella of the new supply is so big; I mean the new stuff that's coming in is five to $600 a month different that is coming from the masses, sort of majority of the workers and renters can afford and are paying so you're really insulated from new supply pressure. And so again, if you look at the demographics in terms of the demand and job formation is really pretty good and then you look at the fundamentals of supply, it’s very expensive to bring new supply to market. There is a labor shortage, material costs are going up, impact zoning fees are high so you have the kind of the recipe for a great demand-supply balance and multifamily and this severe problem is happening on the coast.  

So just talking to your maybe constituency in Texas, right? You can look at the severe problems that are occurring in California with job growth and affordability, there is a significant out-migration from New York, New Jersey, Illinois, and California. They're moving into all of the markets in North Carolina, in Texas, in Arizona, in Nevada and so you have in addition to the tailwind of organic economic growth happening throughout Texas you have relocation; and in a relative business-friendly environment  with a very high level of supply response relative to other parts of the country. So you have a lot of very positive things. So I'm very, very positive on multifamily as a sector, particularly class B and C assets; C is a little tougher because only just until recently you began seeing finally a wage growth at the bottom end of the skill sector, people would traditionally go into a C class asset.  

B class asset, in my mind, is a little bit better because there's more income growth there and there's more sort of to work with. C class assets, generally speaking, you make your money on having very low expenses, very low turnover by picking your customers very, very carefully so that you get a community that's going to stay there and can tolerate maybe 2% rent increases, but you really can't push rent five, six, 7% in that group, they just don't have the income. Whereas in class B, you can push rents higher, expect a higher level of turnover because there's a deeper pool of people who can kind of pay the rent. Those strategies, particularly for the non-institutional investor are very attractive. And I really find there's a deep market in terms of demand and I view the economy as in pretty good shape.  

There are some pressures; we're late into the cycle here so the biggest issue I see short term is that potential end version of the yield curve. Long-term rates are two- sevenish, they were at three- two and now they are two-seven again, short term rates are at two and a quarter. There's not a lot of room between the 10-year and the overnight rate. The importance of that is, is that if the short term rates go higher, bank lending will pull back, the data has been historical and you're 12 to 18 months from a recession; we're not there yet, but it's a tight rope.  

 My best guesstimate right now is we probably have another, I think in 2021ish is when it's likely to have a recession. I don't think it's going to be a big one, I think it's going to be kind of a mild one and the reason I think that is we did a big blowout in '09. And if you go back historically, and I'm bouncing around on you a little bit, but if you go back historically, the best analogy is what happened in the 1930s versus post role, World War Two recessions, they're different animals. So I think we're coming off of a big blowout, really a depression we got through very quickly because of great action on the part of the Federal Reserve. 

So I do see a recession coming up, but I do think it's going to be a mild one. So really multifamily is best positioned, in my view, to serve right through this recession. And so I think, again, multifamily is a great asset class; its guard a tremendous amount of institutional and investment capital and will continue to. There are other asset classes out there. So office has traditionally been, I would say a big kind of institutional asset class requires tremendous amounts of capital and it's really viewed as a bond alternative. If you think of that as a bond alternative, it's bought largely for cash; if it yields 4- 5%, that's great. Again, we're viewing it relative to bonds and it requires a tremendous amount of capital to keep those assets fresh. 

If you're an opportunistic office investor, you really have to take something like a suburban office, which is really beat up to hell and change its fundamental character connected to transit, make it into a canvas, and create a place. Now that has tended to require a tremendous amount of capital in order to play there. So I kind of view office is just really more of an institutional capital play because of all the capital requirements that are required for it. And it's hard for a non-institutional player, in my view, to have success in office unless you are riding off the coattails of a smaller building attached to these other investments; it's just a very hard thing to make work.  

Now, the big playing industrial, you know, and I'll slip over to storage in just a second is really kind of what's going on with e-commerce. I mean that's what's driving industrial is the commerce need and really the pullback and retail. So retail is littered with strip malls that we just don't need or it can be repurposed to other uses. So what I do see often is people who are opportunist to be looking for sort of beat up retail assets that are distressed and changing the nature of that asset or for industrial what's driving the market is not knowing so much manufacturing, which really isn't driving space requirements, but it's really ecommerce and those tend to be very large facilities. I mean like 500, 300,000 square feet, a million square feet that are in near population centers to handle the demand. So there's active development pipelines and industrial. Again, it's very hard I think for a non-institutional player to sort of access the action because of the capital requirements that are needed in the industrial. 

 Self-storage is very much a different place; it is historically owned mostly by small owners and non-institutional players. The capital requirements to get into the sector are, generally speaking, much lower than multifamily or any of the asset classes. Right now, the issue at the moment is that there's been a significant level of development. Self-storage to the sector did incredibly well during the downturn. And the reason it did was that most of the people who have stuff and only about 10, 11% of the population use storage but most of the people who did use it, needed it to store their extra stuff; in a downturn, they didn't stop using it. In fact, in some cases, people use more of it because if they were going through struggles in their homes, downsize in their homes or apartments, they moved their stuff into a self-storage facility. 

 So the sector did incredibly well in the recession, has attracted a fair amount of capital and now more and more institutional capital is trying to get in. There's been a lot of development that's been going on and so the big issue in self-storage is finding an asset that's not under supply pressure or finding pockets. And then self-storage is a very local kind of asset class but the bottom line is the world is within three to five miles, that's it. Somebody could use somebody across town and it just doesn't matter. It's really that three-mile pocket or like a 10 to 15 minute drive time because people are using storage only to the extent that is near them. So a lot of storage developers basically track new development in multifamily and will plot the deal down close by or they'll look for new home construction and plops something near there. 

They will look for pockets where there is less than about seven square feet per person and that's the tools we provide, where you can actually find the pockets of population that are not currently served. It is a good asset class for a non-institutional investor to get in and it does complement very nicely with multifamily because they're a complimentary kind of asset classes. I would say though, that we don't necessarily cover single-family rentals per se, but I would say, again, single family rentals along with, kind of 50 to 150 unit multifamily in self-storage, they're all complements of each other. They were around people who need space to live but don't have the capital to actually get into buying a home. And so I find we kind of track, we cover self-storage, we cover multi-family and we track single-family rentals because I view it as a complementary asset class. 

 I know a lot of people in that sector; I actually was in that sector myself for a year and I just knew that entire space is very good for, kind of the smaller institutional player and the non-institutional investor. Kind of a long expedition but [18:27unintelligible]  

Host: Yeah, I didn't know that you guys have some tools to look at the self-storage demand analysis, which is very interesting so that's a really good explanation. So coming back to multifamily, so what you're saying from what I heard from you is the 2008 crash, the whole crash is equal into 1930s crash and that's a huge crash and we don't expect to see that in the next coming crash, right? Because a lot of people have that short-term memory about 2008 and everybody's like, okay, I'm not buying it. It's going to go down like what 2008 happened, is that correct? 

Jeff: I mean, 2008 was an 80-year event. We're not going to see something of that magnitude in our lifetimes. What we're likely to see on a go forward basis, is something akin to the recessions that occurred prior to 2008, 2001 recession, the '91 recession even further back. So these were typical kind of recessions that we're not driven by debt blowouts, but what connotes a depression is that they are fuelled by overleverage in assets classes. A typical recession is where there's inflationary pressures and goods and services, which then lead [20:00unintelligible] kind of cooled by rising interest rates and it's kind of a minor. deleveraging.  

So if you want to kind of get deep into this, for anyone who's on this, Ray Dalio, who's the CEO of Bridgewater Associates, has a great video on YouTube, a 30-minute video on how the economic system works. And he pretty much lays out basically the notion of a minor debt cycles, which occur every seven to 10 years and a major debt cycle which occur every 75 to 100 years. We just went through a major kind of blowout so we're unlikely to see a major blowout again in our lifetimes. We'll now do normal minor recessions and so you've got to be forward-looking as opposed to sort of backward-looking. 

 So with that in mind, right, the debt position of households and businesses are actually in pretty good shape. The issue we have is that the debt position of the federal government is the thing that's a concern. Now, fortunately, and again, I'm taking a bit of a tangent, our debt is denominated in our currency. So the debt really isn't going to be a problem because it can get inflated away. Other countries don't have that luxury and if you're worried about potential inflation, well you want to be in real estate because it basically marks to market on inflation and our debt is denominated in $6.  

So paradoxically in a weird kind of way, real estate is very attractive because it's yield relative to current interest rates is high. But even if, God forbid, we had inflation, a recycle that came back, if your debt is denominated in $6, you make money because your debt depreciates and your income goes up nominally because your rents are sitting in nominal dollars. So I would say, real estate is kind of like, it's a win-win. Like if there's no inflation, it's good; if there's lots of inflation it's still good but I wouldn't do it, make sure your debt is in fixed. It's fixed versus I wouldn't go with a floater right now in terms of floating rate, interest rates, that wouldn't be a good idea. 

Host: What about floating rates with hedge? I mean some people they say there's a cap on the floating rate. A lot of people do bridge loans or short term loans or they do a hedge. 

Jeff: Again, I'd say, a bridge loan is designed because you have a value-enhancing program that you're going to execute. It's usually a  one to two-year bridge loan and for that purpose, it's just fine, right? Because you're going to do something different; you're going to create value, you're going to add cap or you're going to reposition the property so that makes perfect sense. And then you want something that gives you your payments as low as possible while you're executing your value-add. 

 When you're done with that value-add repositioning, if you choose to hold the asset, that's when you have to think about permanent financing and you don't want to be kind of on a floating rate, IO forever, in that case, because you're not getting the advantage of what might happen in the broader economy. You're basically, maximizing current return but you have an exposure. So I kind of view bridge loans as appropriate in the context of a value-creating program. But outside of it, it's very dangerous, you've got a lot of risks you're taking on. 

Host: I'm out of all my short term loan so now I'm on long-term fixed rate loan, all agency loan, which is good but I know a lot of my listeners, have this notion of, hey, let's go do a bridge loan, I mean, it's easy to make deals work under a bridge because you get higher leverage. But there's also a notion of, oh, now we're going to hedge the bets on the interest rate hike by having an edge and there's a cap that they can do. 

Jeff: But I would say here, but if the cap came into play, it's a cap per year. Suppose there is a lifetime cap is at a very high level if you have to get out of a bridge loan, what do you have to get into is going to be very unpalatable at the time. So I do think, again if I was giving advice to an investor is to say a bridge loan is great for a specific objective you're trying to accomplish, but it is not a long-term old strategy or if you're doing it, just understand you're going to maximize current income but you are taking on an asset risk that's rather significant. You know, everyone will make their own decisions and if they choose to do that, then they choose to do that but you should be aware of the risks that you're taking and not kid yourself about it. 

Host: Yeah. Especially on syndication where we are raising money from private investors and we just have to make sure we communicate that to the investors and that he's okay with that, right?  

Jeff: Yeah.  

Host: Interesting. So you're talking about yield curve inversion, right? Where the daily yield curve might be higher than the 10 year Treasury, at high level so what is causing that? 

Jeff: Well, what you have is an interesting kind of situation here and this is more geopolitical if anything, but it has deep implications for us in real estate if you're trying to understand the demands side. So this is the issue of, again, demand looks great, the economy is expanding, jobs are being formed, unemployment's low, wages are rising, all sounds great. So what happens in these periods of time? Well, normally, you would begin to see inflation; it would kind of rear its head and the Federal Reserve executing its mandate to try to kind of make sure the place doesn't get out of line, would tend to be pushing up rates on a short term basis to quote-unquote cool the economy. But what we're seeing very interestingly is, we're having economic growth, but where's the inflation? You're not seeing inflation really be systemic above a 2% rate. Which is what their stated goal for price stability is and why is that?  

 Because growth isn't that great in Europe, growth isn't that great in Japan and the trade pressures that the administration is putting on China is basically hurting the Chinese economy, which is why they're at the table in the first place and so there really isn't the system long-term inflationary pressures. So as a result, long term rates, it's your step in the market, the Federal Reserve has no influence really on long-term rates. They set short term rates but long term rates, they can't set directly. They can try to influence it and they did try to influence it in the past by buying up mortgages and other long-term securities but there's a lot of where generationally, and some folks get it simple and don't quite realize it, we're in a demographic period of time where there's a lot of global savings.  

 And you can look at those global savings, they are going into bonds. And if you look at Europe or Japan, because their economies are actual have declining populations, they're in a saving mode significant significantly. They're not in a consumption mode, they're in a saving mode, and they’ve got a lot of capital to deploy. The interest rates in Germany, for 10-year German government bond, are negative so our 10-year notes, a 2.7, the equivalent of what Italy is paying. So if you're a European investor, do you want to put your money into Italy or the United States? Because that's really the choice so if I had a choice between Italy and the United States, I'm putting money in the United States and so we are attracting a lot of capital on a long-term basis, which is keeping our 10-year rate pretty low. And there's no real evidence of inflation to justify an investor saying, oh my goodness, I need to be compensated for inflation and so I should get out of bonds and other assets that would cause the long-term like [29:24unintelligible]  

 So if long term rates aren't rising that much and there's not a lot of inflation, the Fed pushed up short term rates to the point where the fourth quarter, when the stock market meltdown was really a function of the market saying, well if the Fed keeps raising short term rates, they will create a yield turn version. And what happens is that short term rates are higher than long term rates. Well, if you're a bank, banks are in the business of lending money, borrowing money on a short term basis and lending money on a long-term basis. Well, if there are not enough margins in there for them to do that, they have costs, they stop lending because they would lose money if they borrowed short and lend long, it's not profitable so they choose not to lend money. Well, what you're talking about there is a contraction of credit in the economy. Well, when credit contracts, guess what? You know though it takes a little bit of time, you get a recession, you'll get a recession tomorrow or within 12 to 18 months you get a recession because there's a contraction of credit and that's worked its way through the system.  

So if you think about us as in real estate, we deal in metrics that are rents, occupancies and things like that, our cash flows, those are lagging indicators. So what's happening in the real economy, what's happening in the economy is wage growth, employment. Those are the things that happen in the real economy. I look at the capital markets as a precursor to what's going to happen and then we have an economy which is then a precursor to what's going to happen with real estate operating metrics.  

So by paying attention to the capital markets, I tried to keep our clients and our organization two years ahead of what will eventually show up in rents and occupancies and cash flows in real estate properties. So that's why I kind of dwell on the yield curve because if I looked at it, there are five models that we look at in terms of capacity, utilization, wage pressure, and of the five, the one that is, I'll call it the current binding constraint is the yield curve. So it's not the only thing I look at, but it is right now the key thing that I look at. 

Host: Yeah. So that's the best explanation on yield curve and how it's going to impact because I wrote so many reports and listened to so many webinars by brokers and all that, but that's the best explanation, I get it completely. So what you're saying is if there's a yield curve, banks stopped lending bridge loan is more dangerous because if you are predicting that's going to happen by 2020 or 2021 and if you are initiating a bridge loan right now which has three year span, you are going to be landing in a spot where you may not have any funding at that time if the banks stopped lending, 

Jeff: Right. And also you don't the maturities come up in a crash, right? Because what's going to happen, what happens in a downturn, even if it's a minor recession, is people withdraw from the market in terms of transacting, they don't transact. So what transactions do occur tend to be at a depressed level, not depressed level then it's considered quote-unquote, it's a current market value. 

 If you have a bank loan or a line of credit is coming due, they are going to revalue your loan devalue based upon an artificially depressed evaluation. And then they're going to say, oops, your loan devalue is a mess so basically they're going to squeeze you out. They're going to force you to add in more equity or to basically liquidate the line. So you do not want to be in a situation where your debt, if you have a five year term, you're going to see through this problem or seven-year term, but your two to three-year term right now, you bear a risk that you're going to have to come for refinancing when there is an artificial kind of re-evaluation of your assets.  

And what's great about real estate is it really is a long-term value. That if you can last through a problem and not get squeezed out, generally speaking, you're going to be fine. Particularly in multifamily where the cash flows are much more durable, you may see a dip in occupancy of a few points. Your new leases might transact with lower rent, but you've got a lot of existing cash flow; you can always squeeze back on some of your expenses for six months, you can ride through a problem as long as your debt isn't coming due. That's the main thing, don't be squeezed out in the downturn. So you're dead strategy and multifamily is critical to your survival and value creation. 

Host: Absolutely. That's good advice. Coming back to what you call the level of players in the market, right? So if you look at it in the past before coming back, what do you think about the high loan? Because I think in 2015, the lenders have loosened up, giving up more IOs to a lot more people. It is become default to have like three year IO, four year IO. When I started at that time, I know it was hard to get even one year IO and one year IO was sort of attractive because valuable then, but then 2000 was when lenders started opening up the flood gate and now it's like five, six years, seven-year IO kind of thing. What do you think about that? How would that impact [35:19unintelligible]  

Jeff: Yeah, from a cash flow perspective, if you have an IO to an interest-only payment and you can get that for five or six years but it's still fixed; so on the conversion, it's a fixed rate kind of conversion, then great, you just got a great deal. You want your IO to be at a fixed rate and you don't want it to be floating. So if you can get a fixed rate IO for a certain number of years and you're guaranteed to convert to an amortizing loan at the NBIO period at a fixed interest rate, well, you kind of got your cake and eat it too, right? Because you got the benefit of not paying down the principal during the IO period, but you didn't expose yourself to the risk of having to go through a negotiation.  

 So great; if you can get it, go for it, right? I mean, that's fantastic. You guys can put that in your pocket or put that into the property so that you're going to be able to expand your cash flow. It really depends upon who your investors are and what their goals are, whether it's cash now or value appreciation later.  

Host: Yeah. Where I was going with that question was a lot of people have justified the deal, doing deals because the numbers with IO, it looks much better now and it looks really good, right? So a lot of investors are coming in, especially at the level where we are right now, where there's a lot of syndicated commercial real estate deals are happening. There are very less sophisticated people who just look at as [37:18unintelligible] cash and cash, you get 8% cash, they just jump on investing in but that 8% could be IO and in the next three years, let's say rent doesn't go up or you have a deep in occupants, it's what you're talking about that 8% and once the IO kicks in, that 8% becomes 3% right? [37:36unintelligible] become negative so your basic concern is the loan. So I think, I don't know, in my perspective, there's a lot of deals happening right now in the past since 2015 with IO, especially at the less sophisticated level right now. 

Jeff:  I would say, IO, it should be gravy, it should never be the main dish. 

Host: Okay. [38:01crosstalk]  

Jeff: If you're expecting the IO to make the deal work, your betting that by the time the amortization kicks in, the rents will have grown high enough to cover the amortization. I haven't run the numbers on that, but that would be the thinking, you have to get comfortable around is okay, what has to happen when amortization starts since that it actually was a good deal. And then say, well, the rents have to grow at 1% a year or 2% a year, 3% or 4% a year so you really need to stress test that assumption. But you know, this is where people take risk and so if you're taking this kind of risk, understand that in a downturn, that's going to be the first people who will basically get shut out. 

They can't make their principal, they paid too much and when I had to start amortizing, they couldn't make a go of it. So I view that just as similar as the equivalent of a debt maturity; it's like, okay, if you've got an IO period of two years that you bought the deal on the assumption that in order to get your hurdle, the IO period is what made the hurdle work for you, you're basically are sitting at a two year refi’ and you better understand that what your debt service requirements are when you walk in into that. I know we're spending a lot of time on debt strategy here and I think that's kind of okay because the fundamentals are good, generally speaking. There's not a lot of too much supply so the demand is decent, the supply is decent and your death strategy. So there's one part of this, which is your value added, your value creation strategy; what are you doing to create value for your residents, to make your property more attractive to them and a better living experience so that you'll be at high rents and high occupancy? And that's entirely valid and I think, my view would be in terms of enhancing the resident experience, I think there's a bunch of IOT upgrade packages to existing properties that I think add a lot of security issues that people will pay for, not so much to manage your thermostat, but if you kind of know that your kid can come in and you can see on your phone when your kid came in from school and that they're safe, there's value creation there. 

So I think we as owners have to look critically at how are we adding value to the living experience? Not just the four walls, but stickiness, right? Creating stickiness that keeps people kind of in place and so I think there's a whole set of strategies there. The debt strategy used to make sure it's honestly to make sure that you don't get kind of shaken out. That's really my goal as data strategy is not to get shaken out in a downturn. And if you could protect yourself from being shaken out in the downturn, then the fundamentals will basically bail you out. And so as we're talking about IO, which is people reaching to make the deal work when in some cases, I'd rather you focus on what can you do to add value, you can increase the revenues so you didn't have to go that crazy out financially.  

Host: Correct.  

Jeff: So focus on the value creation part that they had provided the increased rents where you don't have to go five years IO and kind of crazy kind of amortization and you're sort of sitting on a time bomb. So that would be kind of my take is; we're talking about debt, but it's more in the nature of put yourself in a situation where you can ride out a storm. 

Host: Yeah, that's awesome, absolutely the right thing. Just make sure you're on a fixed rate loan, and the other thing that is very subtle is even though you're on a fixed rate loan, make sure if you have IO and make sure you have enough buffer when the principle kicks in. Because from my calculation at 80% leverage, you need at least 5% cash on cash buffer and on the 75, it's like 4%, in terms of return; you need to make sure you're still able to service that debt. Let's move on to a bit more different topic. So selecting a marker; so let's say, someone who wants to start in multifamily, multifamily real estate is very local, at the same time, multifamily is an asset class where it's very, very intensive in terms of property management so how would you recommend, how do they select the market? 

Jeff: I look at a number, I'll call it very basic kind of fundamentals and it's on our website and in our materials, we only have a four-box model and that attractiveness of the city. And first of all, we come from the perspective of, how is wealth created in this economy? And I would tell you that I believe wealth is created in this economy based upon the force of ideas and the creation of new products and services, which tend to have an intellectual capital component. So where and in which cities are new ideas being formulated into new products and services? We call that intellectual capitals notice strategy. So we want to be in cities and within that, in or adjacent to the parts of major metropolitan areas where there's a concentration of people who are doing work with their heads, primarily.  

 And then within that context, we use a four-box model. Well, one is first of all, how business friendly is the state within the United States, in the state, at the state level, and at the city level, how friendly is the environment to the formation and creation and continuance of business. Next, we look at how many people are being educated in this area. So it's universities, community colleges, maybe even trade schools, but we're looking for, where is intellectual capital being created? So basically higher education and also, I focused on the quality of the K through 12 school system as well as alternatives for quality education for the port, like charter schools. 

 A third component is amenities; what kind of amenities and culture is being fostered that will attract and retain folks who are highly creative intellectually? So you're looking for arts and recreation and culture and music and trails and things that sort of like people who are active, healthy and thinking with their mind; where is that in your community or any community? 

 The fourth box is really the quality of the public-private partnerships. They're going on attempting to foster this environment that makes it conducive for the creation of intellectual work and the attraction and retention of talent, which then powers the growth in a market. Well, we have found, we've done this for the top 40 cities metropolitan areas in the United States is that these cases happen inside metropolitan areas and they don't happen everywhere. it's not uniform, there are clusters of them in any particular metropolitan area and we'd gone actually through the work of mapping those. 

 Now all of that is you kind of sort your way through that; we do this all across the United States. I track also very clearly domestic migration; you've seen a tremendous amount of domestic migration out of high-cost cities and into cities and states that our score well on these kinds of, all these four attributes. So for Texas; Austin, Dallas, Houston, and to a lesser extent, San Antonio all score well in these areas. And that is where, if you look at where people are moving from and where they're moving to and where businesses, moving from and moving to, that's why, getting a view of the entire country, that's why Orlando, Tampa, Las Vegas, Phoenix, Atlanta, Raleigh, Salt Lake City, are all doing incredibly well because they have a combination of good governance, good weather, which helps. 

 Plus these other condition where businesses are moving and where talent is moving. Now it's not to say that if you're in a core, we call it global gateway city, these cities aren't going away anytime soon, they are major centers of intellectual capital, but they are in places and in circumstances where you're kind of swimming upstream as a real estate investor and there is an increasing level of political risks associated with that as well. So among the core cities, the top six, and usually you can think of these cities as generally speaking--I'm I on the right track, Jim, with what you wanted to hear? 

Host: Yes. Absolutely, go ahead. 

Jeff: I could keep going on this [48:41 crosstalk] the core cities are viewed as Boston, New York, Washington, Chicago, LA, San Francisco, and sometimes I'll cross Miami because it operates as a core city. And if you look among those core cities, Boston and Miami are kind of like the best positioned and the other ones less so because of a very high cost and the tax bill and the tax law isn't helping. 

 So those areas were bleeding people anyway and now they're bleeding more. So Boston is pretty well positioned, Miami is pretty well positioned. But even with Miami, there's significant out-migration from Miami to Orlando and Tampa. So I like Orlando and Tampa in that regard and I know there are certain markets that I think are great markets but there's a lot of supply currently. Dallas is an example in Texas. Houston is how you diversify the economy but there's also a large supply response. So in Houston, I would say you have to be very localized; you want to be in places where there's some traffic congestion and you're very close to places where either the Anderson Medical Center or the energy corridor where people want to be and there's a certain level of stable demand so that's, that's kind of the story of Houston. But there are also other cities, Seattle, Denver, Charlotte, these are great cities; they do have a lot of [50:18unintelligible]  if I was talking to someone in the Midwest, I would say Minneapolis is a really good city because the weather goes against it, but it's a kind of a core, a great market, particularly in the suburbs. 

 Indianapolis and Columbus; their downtowns are sort of emerging and in creating something because of their good intellectual capital and very low-cost position. So they are kind of like the king of that hill as it were and they're getting benefits of outflow from Chicago. Most of the Chicago outflow is going to Florida or the Carolina's not so much inside the Midwest. So this is the way I think about cities;  you want to be in places and so if you're a smaller investor that says, look, I'm only going to invest wherever I am, I'm going to only invest to the extent that I can drive to it and I'm two hours away. Okay, fine, that's great. Go and look for the locations within your two hour driving radius. Go look for those locations that have these conditions, where is intellectual work happening and some of the best strategies are to be in an area and find that area and then find an area that's low cost to rent adjacent to it. 

 So even though you have a cost advantage that's within 10 minutes of drive time of intellectual capital note and intellectual capital notes or sound honestly in most of the top 40 US cities, you can find them, they're there. We do this for our clients, but anyone can do it if they do have the time to spend, and again, if you're investing within a two hour radius of where you are physically located, then your job is to get to know your economy, your regional economy and understand where interesting work is getting done. That's where you would tend to spend your time, that's how I think about it.  

So when I come back with certain cities that are attractive or certain studies that aren't attractive, it's first looking at the basis and its intellectual capital work and then layering supply conditions on top of that. 

Host: So are you saying that an investor in Texas should not go to some of the other cities and look for deals? 

Jeff:  I mean understand that when you sort of non-institutional investor go out of your immediate ability to touch the real estate, if you have to get on a plane and you're a non-institutional investor, you are eroding your returns. So what is your competitive advantage as a non-institutional investor? So you have to be very sort of upfront with yourself and I would say your competitive edge as a non-institutional investor is not going to be necessarily a cost of capital because they're going to low cost of capital. It's going to be that you can have more intimate knowledge and you can get to the real estate more closely and you can provide more attention to it than anyone else can, that's your advantage or investing in assets that a large institution would not attempt to invest it, maybe a 50 unit property because they won't want to touch that. It’s a little subscale scale and you can't have a major property management company manage it; it just doesn't work in their strike zone. 

 So you've got to look for assets that you're not going to have competition from institutional investors and where you can bring a competitive advantage. And if you have to get on a plane to see it and you have to have a third party property manager who you eventually can get to it, where's your competitive advantage?  

Host: Yeah, you're absolutely right. A lot of people think that where they are they kind of start finding deals and they start going somewhere else and they become out of state investor, right?  

Jeff:[54:35unintelligible] out of state investor, I would say if you're at the point of having a big office and a large staff and a big discretionary fund, then you have the infrastructure to go across geographies, across the United States. If you are someone who doesn't have those advantages, well, play to your strengths; which is, go to places that those investors can't go or won't go and focus on your intense knowledge. The local economies that you can get to within two hour drive time and depending upon the cities in the region you live in, two hours is not slim tickets; focus on where you can add value. I think all of us have to focus on where we are going to add unique value and that's what we should spend our time on. 

That is definitely how we, as an organization, decide how we're going to spend our time. And if I can't find a way to add competitive value to create value, I'm just not going to go do that activity because someone else can do it better. I need to focus on what I can do uniquely better that no one else can do or very few people can do. And that is getting, if you're a multifamily investor is being in asset classes that are smaller, that institutional investors and knowing where the nodes are and being in an adjacent place to those nodes with a class B or C asset and focusing on value creation to the resident that makes your property more desirable, more valuable because you don't want to be just a box. 

 But then you're in a commodity market, you want to create differentiation; either in the living experience, the things that you offered and ideally like IOT upgrades or other sort of a upgrades where people will pay you for these additional services because they add so much value to their lives and that's what you want to focus on. 

Host: Awesome advice. Let me ask you one more question before I let you go. So between the primary, secondary and tertiary marker so I think we have to define primary very specifically; primary means, the entire coastal city that gateway cities, right? 

Jeff: So the way I define primary, primary i snot a good term. We kind of US international gateway cities so there's seven US international gateway cities. There are primary markets, which are really the top 30 metropolitan areas. And primary in my mind would include places like Dallas and Houston and Austin, they're big markets. Then we have, I would call secondary markets where the economies are not nearly as diversified and then you're getting into smaller and smaller metropolitan areas. That makes sense? 

Host: Okay. Yeah, it makes sense. So people go nowadays to look for Yale on the tertiary market, secondary and tertiary markets so do you think that's a good strategy? 

Jeff: I've seen people go to Huntsville, Alabama and they've gone to very, very small markets in a search for yield because their investors are looking for current returns. First, is the metropolitan area you're investing in going through a process where it's changing its fundamental character. So if you were able to identify that Denver 15 years ago was going to go from a tertiary market to a solid kind of viewed as a major metropolitan investment-grade market, you made a lot of money because in that transition of the city, it was able to attract in a new group of investors who had a higher willingness to pay.  

So one strategy if you're going to a smaller city, is the city in a process of changing its fundamental nature? That's a key issue because if it is, then you're going to basically riding on a trail. And I would say there are some cities like believe it or not, Orlando and Tampa and Phoenix that is changing the fundamental nature of their city to be less volatile and have a broader and more stable kind of basis to their employment. If you're going to a really tiny market, and I again, I've seen an investor go to Huntsville, Alabama and buy an asset next to a NASA facility, well that would mean a lot of sense, right? You have found a very interesting special situation in a very small market with good intellectual capital characteristics. 

 But the city, let's say Huntsville, I may be doing dishonor to Huntsville, I'm not familiar with what's going on in Huntsville but if the city is not fundamentally changing, it's character, then your issue is that there's not a lot of other people for you to sell to when it comes time to sell. It's the asset is what it is and you are basing your return on what overall capital market conditions are when you decide to sell. And if you never decide to sell, it may be a great cash flow play; I'm not saying it wouldn't be. You need to be kind of honest with yourself; if you're going to a smaller market than you've been in the past, are you going there because you think that the city is changing its fundamental character and will change to have the characteristic of a bigger city and will grow to that bigger city? In which case, I would say it's a very viable strategy, very worthwhile strategy. 

 If you're going only because you're getting a higher cap rate and that's it and you are taking on a lot of risk and you want to be honest with yourself and not kid yourself. 

Host: Also I've seen in the past when the recession hits, the tertiary market is the first one to get hit as well, is that right? 

Jeff: Because, the exception of this asset that's near NASA, those economies are not broadly diversified. They are generally the basis that local economy, it's usually one or two industries and there's a greater likelihood that one or two industries will get hit and you will have exposure that you can't get around and there's nobody else for you to rent too. So yeah, it is very clear so you do want to understand what's the basis of the local economy and do you understand what that basis is and are you willing to accept the exposure that comes with your renter pool being dependent on one or two industries?  

Yeah, you might pick right and say these one or two industries will not be affected by changes in the broader economy. Okay, but I will say generally speaking, that these other industries in a smaller city will tend to be more focused on manufacturing and extraction, mining, and then some kind of extractive industries, which are generally because the real estate cost is lower. So there's less intellectual capital work being done, it's more extraction or manual or transformation of things and those do tend to get hit pretty hard in a downturn. So I just think you're taking on more risk. 

Host: Got It. I don't want to take up too much of your time, I got so many other questions but I have to respect your time.  

Jeff: We'll have to set up another time and you may do round two. It's been a pleasure being on your podcast.  

Host: Yeah. Do you want to let people know how to reach you or how to subscribe to Yardi? 

Jeff: Sure, the easiest way to do is go to That's one word and on that website, you'll see the publications department, you can sign up for stuff, you'll see my contact information if you want to reach out to me personally or any of my team and that's really the best way to kind of get in touch with what we do. And hopefully, this has made some sense to you and I wish you all much success in your investing. 

Host: Thank you, Jeff, for being with us. Thank you. 

Jeff:  All right. Take care now. Bye. Bye.