This episode was recorded using CallIn, which gives me the chance to take questions from and talk with listeners live on my podcast.
It’s a stressful time to be a capital allocator. At Bolt Storage, we have over 290 active LPs, $30M out in capital under management, and close to $80M in self-storage, and it’s stressful when interest rates go up. Stocks have been tumbling down and unless the Fed reverses course we’ll likely see that drip down into the real estate market. That’s what’s on my mind right now, thinking about what’s on the horizon and protecting the company in the worst-case scenario.
Q: In this environment, what are you watching out for when you’re buying?
A: I sleep well at night knowing that we don’t have crappy deals in our pipe or on our books. We underwrite 20+ deals and send offers on 5+ facilities a week, and we lose most of them. It takes extreme discipline to lose out on deal after deal and watch other people pay more than we will, but in times like this, it makes me glad we prioritize cash flow and good deals.
I’m watching out for the right deals at the right price, same as always.
Specific to this period, debt yield is key. Debt yield is how much net operating income the debt is yielding, so if I have $1M of debt on a $100K NOI property that figure is 10%. It helps you figure out what interest rates you can absorb without putting your business at risk. With a 10% debt yield we would have negative cash flows at 8.5% interest, and with a lower debt yield that breakeven point would decrease as well.
I spend almost all my time protecting the downside, asking in what scenario our deals or our properties go wrong. Management is a risk; lately some organizations have cut management fees to 6-7% of revenue, but I know that even with an affordable team we need 10% just to break even at 13% to keep a healthy business. My job as an operator is to make sure the management company is a standalone business that has a profit so we can afford people if we’re not making deals, which will be the case if things turn south.
Q: Starting out, do you recommend forming a small PE shop allocating capital towards multiple deals or shooting for one home run deal a year, similar to the Real Estate God?
A: Start out by doing one home run deal a year that can change your life. Effectively deploying capital at scale is almost impossible on day one without a track record, portfolio, banking relationships, or network to raise capital.
We did just one deal in 2017, one in 2018, and three in 2019. It’s a process. Start small and get a few great deals that can change your life.
Q: What should you focus on in the structure of your first deal as an LP?
A: As an LP you need to have a nose for what assumptions are being made. A GP can make a spreadsheet and pro forma look however they want it to with all sorts of crazy assumptions about revenue, expenses, growth, exit cap, etc.
Ask yourself, what is the sponsor thinking they can do with revenue? Does it make sense? If a sale is modeled in, at what price and cap rate? How likely is it that we all lose our money?
Aim for a 10%+ debt yield, as mentioned earlier. Check the expense ratio, which is total expenses dived by total revenue. Anything under 30% is a red flag, it’s incredibly difficult to operate a self-storage facility under that mark.
Q: With rates rising, what kind of industries do we think will get hurt a bit and may be good to buy into?
A: Nobody really knows, there’s so much nuance. Any industry can be a good deal and work out well for an investor. The data from the last recession says home builders and contractors took the biggest hit, but some people say that won’t happen this time around.
It’s all about risk-adjusted returns. I think there will never be a bad time to get into sweaty home services businesses, as we’ll continue to have a shortage of them and they won’t go away.
Q: What are your thoughts on landscape lighting as a sweaty service business?
A: I love it. It’s a low-risk play, what’s the worst that could happen? You can work your way into more specialized and higher-skilled verticals, and make great money even though the business doesn’t scale.
P.S. If now is the time to start your own journey, the real estate community is for you. I weigh in on almost every post, and there are a lot of people smarter and more accomplished than me.
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