Check back as SMC will regularly share our thoughts on the direction of the real estate industry and articles that we believe indicate important trends.
SMC’s Verbal Brand
Two years ago I joined a fabulous networking group called ProVisors where I have met many highly competent “trusted advisor level” professionals. In one of the group meetings about a year ago, I participated in a group exercise on verbal branding. I became intrigued with the concept of messaging and how little time we in have, in this day and age, to articulate our message and to differentiate ourselves from others in our respective businesses.
Recently, through one of our investors, I met a corporate consultant, Stephen Melanson www.melansonconsulting.com, who teaches “Differentiation and Game-changing Simplicity”. Over lunch, Stephen emphasized an extremely critical point – people don’t remember much of what you tell them at all. They only remember a small handful of things that stick out in their minds. Therefore, we all need to communicate our differentiators in 5 seconds or less..!!!
I immediately set off to define our key differentiator(s) at SMC. My conclusion: “SMC reports and pays its investors monthly”. You will see this mentioned throughout our website and our literature. I like to call it “mailbox income”.
I recently explained this to Steve Chapman, our Managing Partner. He responded, “don’t forget that investors and their advisors also love the fact we always put assets into our partnerships “at cost”, taking no money out up front, subordinating our interests to theirs.”
“Not now, I own too much real estate”
“Not now, I own too much real estate” is a statement we hear often from investors who own multiple homes around the world. While second, third and fourth homes most certainly are real estate, they are a completely different asset class from the real estate we purchase and develop on behalf of our investors. Like boats, homes are consumers of income. Direct investments in multifamily residential real estate are generators of income.
Recently, an investor announced to me that he plans to sell his $4MM home and he and his wife plan on investing the proceeds into income producing real estate. Smart move. Let’s do some simple math on their $4MM house:
|Mortgage ($3MM @ 4% simple interest only estimates||($120,000)|
|Total annual cost of ownership||($192,000)|
Estimate with house sold and the $3MM in equity re-invested:
|Annual 7% current yield on the $3MM||($210,000)|
|Rent luxury townhouse in same town @$7,000/mo||($86,000)|
|Annual cash flow swing||($304,000)|
Without taking into consideration modest appreciation, total IRR and tax benefits, that’s a cash flow swing of + $304,000 per year, over $25,000 a month. That’s what I call owning too much real estate!
REITS vs Direct Ownership
August 10, 2015
Many investors choose REITS over direct ownership because of liquidity, but they give up tax benefits and returns in doing so. Curious about the basics, I did a simple analysis on the performance of the top ten rated REITS by thestreet.com and below are a few of my observations:
- Going-in valuation of the top 10 REITS average a PE of 34 which translates to a 3.7% yield to equity. Going-in valuation of direct investments typically average a 7% or greater yield to equity.
- Average annual dividend yield for the top 10 REITS for the last 5 years was 5.34%. Average current annual distributions for direct investments typically average around 8%.
- Average total returns (IRR) for the top 10 REITS for the last 5 years was 9.14%. Average IRR for direct private equity real estate investments averages 12% industry-wide and ours is just over 14%.
- Dividends and profits from REITS are taxed by the IRS using ordinary income tax rates. Direct investment limited partnership income is taxed through K-1 tax reporting, with cash distributions sheltered by depreciation and tax losses due to new construction and/or renovation. Profits are taxed, for the most part, at long term capital gains rates. Tax benefits of direct ownership can add as much as 4% to annual returns.
Of course, past performance does not guarantee future results.
Nothing new; same as last year
While spinning at the gym recently, I observed a commercial on the TV for Reese’s Peanut Butter Cups that said: “Same as last year, no changes, nothing new, perfect.” I was struck by the ad because it reminded me of the consistent nature of what we do year in and year out at SMC. While not perfect, we consistently maintain a culture of discipline, patience and diligence while executing, delivering results, reporting and distributing cash flow to our investors and partners.
SMC is what one might refer to as a “downstream developer” purchasing assets that have most often been painstakingly planned and permitted by highly qualified professionals who have run out of money, experienced bad market timing or both. Stephen M. Chapman, our Managing Partner can often be heard saying, “We are not creative. We acquire great projects from others that have taken the ball down the field as far as they could. Our business template enables us to forecast start dates, cash distributions and eventual dispositions.”
Thoughts on real estate investing
On Mailbox Income:
SMC stands for Stephen M. Chapman, our founder and Managing Partner, who has been in the real estate investment business for over 30 years. Steve’s got a great track record providing something called MBI. What is MBI?
I was introduced to the phrase MBI by one of our investors, who raised a ton of money for Sanford Bernstein back in the 90’s and he was also a principal in a highly successful multi-family real estate fund based in Dallas, Texas. He said that MBI stands for Mailbox Income – income that is regularly delivered to your mailbox. He has since become one of our regular investors because that’s what we do at SMC. We produce MBI.
On similarly attractive cash flow characteristics of waste management and multi-family real estate:
In a former life, before getting into real estate, I owned a waste management business. The waste management business actually bears a very close resemblance to the multi-family real estate business because both have a large subscription customer base paying monthly, generating cash flow that can be enhanced, annualized and resold for a substantial profit. The large subscription customer base is what sets multi-family apart from office, industrial and retail where one vacancy can leave a gaping hole in the cash flow of an investment. The cost of replacing a tenant in the other asset classes can be significant whereas in multi-family for a new tenant you just need to clean, paint and install new carpet, all at an average cost of less than one or two month’s rent.
In multi-family, once you have a property up and running you can take off the training wheels and rely on others to make day to day decisions freeing up your time to source new opportunities, whereas in office, industrial and retail, more owner interaction is required because negotiations often have an economic impact of five to ten years.
On today’s lending environment:
Banks are not lending as freely and loosely as they did pre-2008. A typical residential mortgage now requires 25% to 30% money down with very strict credit requirements making barriers of entry AND exit much higher than just a few years ago. Recently, I spoke with a residential real estate broker who said her appraisal business was out-performing her brokerage business because banks are now requiring three appraisals on many new loans.
On a significant demographic shift:
Over the last few decades our thinking about career and how we live our lives has changed. Our parents taught us to buy a home, have a successful career, pay off the mortgage, save money, and eventually retire with a paid off home and a nest egg. Today’s workforce is much more mobile, and it’s no longer common to remain with a single company for an entire career. To accumulate wealth, many are now choosing diversified investment strategies rather than home ownership.
The largest demographic shift is the growth of Generation Y and its impact on all sectors of commercial real estate. This group lives, works and plays in different ways than previous generations. They are more urban and less suburban, driving less, but still wanting to be mobile.
On the other end of this demographic shift — and an equally important driver — are the aging Baby Boomers who are downsizing, selling their homes and moving to locations with amenities similar to those desired by Gen Y, but with convenient health care. For these reasons, a growing and very successful segment of our population is choosing to rent rather than own.
On the Greater Boston multi-family real estate market
The metro Boston Area continues to rank within the top three multi-family markets nationally, with an annual compounded growth rate of almost 5% since 1995. During that same period, the average annual vacancy rate in Boston has been just under 4%.”