Episode 96: Red-Hot Real Estate with David Steele

Announcer:
This is The WealthAbility® Show with Tom Wheelwright. Way more money, way less taxes.

Tom Wheelwright:

Welcome to the wealth ability show, where we're always discovering how to make way more money and pay way less taxes.

                Hi, this is Tom Wheelwright, your host, founder, and CEO of wealth ability. We are in a hot real estate market. Most of us remember 2006 and 2007, and that hot real estate market. This feels at least as hot, maybe even hotter, due to the low interest rates. The question is ‘are we so hot we're going to bust. What's going to happen with evictions? What's going to happen with pandemic? Are we going to continue to have this evictions keep going out and out? What's going to happen with the rental market? Are we going to raise interest rates? All of these are questions and I'm fortunate to have my good friend, Dave Steele. Dave and I have known each other a long, long time. We run in similar circles and Dave is an expert in multifamily real estate. I'll let Dave explain exactly who he is, but he's with a company called Western Wealth, and they do a lot of real estate, particularly in the Southwestern United States. So Dave, welcome to the show.

Dave Steele:

Thanks a lot Tom, great being on your show.

Tom Wheelwright:

If you can, just give us a 30 second synopsis of your background.

Dave Steele:

I've been in the multifamily real estate business for both 30 years, and about seven years ago, partnered up with Janet Le. Paige, was a brilliant 40 year old computer scientist, female, just a rock star of an entrepreneur. She came to me with the idea of ‘Hey, we should buy these apartment buildings' and I thought to myself, there's no return on apartment buildings. They don't make any money. We had been buying a foreclosed houses on the courtyard steps and she said, ‘well, just take a look at this one deal.' We looked at this one deal and I went, ‘wow, this is, this is amazing'. And so we did the first deal together. She asked me to put up 300 grand. I said, fine. I'll put up the 300,000. She called me back later that night and said, well, Dave loved it.

                You're doing the 300 grand, but would you do me a favor and go and get two of your friends, cause we're going to make so much money on this. That when we do the next deal, I'd like to have three of you to invest alongside of me. So I thought, wow, that's pretty gutsy move. And that was the first deal we did and we've since done 102 deals. The last seven years, Dallas, Phoenix, Houston, San Antonio, and Atlanta, we're now the second largest multi-family owner in Phoenix. The model has been very, very simple by the 1980s product, fix it up, do the value, add we do it really, really fast and move the rents. That premise has been very, very successful and there's just a huge demand right now in the value add space, which continues.

Tom Wheelwright:

So let's talk about this. So let's start with, there's no question. I mean, we've never seen prices. I was looking frankly, I was looking at your most recent deal and I'm going that the unit price is $166,000 per unit. And I remember if we saw a hundred thousand dollars per unit, we gulped, okay, at a hundred thousand dollar per unit. How is that possible that real estate can be this high, and is it really possible that this is still an okay market in which to invest? Or are we going to, is this a bubble? We know it's a bubble. The question is how much bigger can this bubble get?

Dave Steele:

Well, I think you got to go to two premises, which you either need to believe or not believe if you believe them, you should invest. If you don't believe them, you shouldn't invest. Number one is, are we building enough new housing? And right now the US needs 350,000 plus new housing units a year, which we've never been able to meet. We were supposed to start meeting that in the early 2000s and we fallen short every year. So every year there's this gap that's growing. And guess what happened during the pandemic? That gap just got bigger and bigger because trades didn't want to work, people were scared to build new apartments. So that gap just got built, just got bigger. So in markets like Phoenix and Dallas and Houston and these real growth markets, the number of new buildings isn't happening, but the number of new people is moving at a pace way greater than has ever been expected. So if you said to me..

Tom Wheelwright:

So let me stop you there. We got the demand, but what about the price? I mean, it can, the prices continue to go up? Can you, I mean, yes, there's demand, but at some point there's got to be a price situation saturation on the rents. At some point you got to believe the Fed's going to raise interest rates. So talk about that. Talk about what, first of all, what's the impact that the fed and the interest rates have on the multi-family business?

Dave Steele:

Well, let me, let me back off first to the rent, because I think it's critical to the rents, right? What you're really looking at is you're looking at, for easy math, there's a classic unit that you can rent as a two bedroom. That's a thousand, $1100, $1,200. So if you walked in that market today and you said, ‘Hey, I'm in Phoenix and I want to send my kid to school, to university, there's a pretty good chance you would not rent that classic unit for your kid. You'd look at it and you'd go ‘this just isn't nice enough to send my daughter to university, right? But if you renovate that suite and you put in stainless steel appliances and hardwood floors and redo the bathrooms and you renovate that suite and you put in a washer dryer, now you look and you say that two bedroom suite would I pay $1,400 there isn't there isn't price resistance on the renovated suites.

                So the new stuff that's coming online is coming online at $2100, $2200, some of it is high as $2500. So there's still this huge gap between what it's costing for brand new construction. There's all these people moving there because Intel is adding, spending $20 billion and that's triggering, all these other jobs, Amazon is adding jobs and there're just jobs after jobs, after jobs, just follow the announcements of the California companies that are pulling shoot in California, because it's so expensive and saying, we're making our next regional office in Texas or in Phoenix. And so, so that's really what is triggering the growth. The growth is the growth that is really what's triggering. The growth is the growth is that the affordability is still so much more significant than..

Tom Wheelwright:

There's this big gap between the coasts and the center of the country is going to continue to happen, and of course, what we learned during the pandemic is that people are comfortable living even someplace where they don't work. Right. So, and they don't want to want to be on the coast because the taxes are so high that, there's so many problems on the cause. Now you've got so many people moving to the middle of the country and they're not just buying homes, presumably some of those people are renting, and the tech people, they may be renting even though they're working in California. So given that we've got interest rates at historic lows. I mean, I'm looking at, I was looking at a 15 year conforming long $560,000 loan is 2 and half percent.

                So what happens with interstates? Because as we know, a lot of our listeners, they're pretty sophisticated real estate investors. And you know, that the most important number when it comes to investment real estate is cap rate. Right? Because it, so if you're cap rate goes down, then your value goes up, your cap rate goes up, your value goes down. It's a very specific and, and very direct formula, basically. So if interest rates go up, obviously cap rates go up because people are expecting a higher return. How do you see the fed? What do you see from the fed? I mean, do you think interest rates can continue to come down? You think they'll go down from 3% to 2%, to 1%, or do you think they'll start going back up because we've got this 5%, which is actually in the grocery store, 30% inflation.

Dave Steele:

Well, where do they go? Where do they go to Tom? That's the real question is, I mean, do they go up a quarter percent? Did they go up a half a percent? I think that's a possibility. Do I think they go up one or one and a half percent? No, I don't see anything in the future that shows that huge pop in, in interest rates. But I do think there is some risks, sure. There's some risks that they're going to go up because we're having inflation, but we're having inflation because in the old days we said,'wow, we got a $40 increase in our rental rate and now we're getting a $200 rent increase on our rents,' so we're getting a $200 rent increase, the cost of the utilities, which is going up, but that's being borne by the tenant, right?

                So you're seeing these increases. So there's certainly some room down the road in the deals. But this gap, this growth of what you can get right now in renovating a suite on the value add side, this is, I've been doing this for 30 years. This is the golden days of our business right now, because, we're seeing, we're seeing rents turn. We turned to rent the other day that had a $630 rent increase. Right? So you just look at it and you go, why? And a big part of that is there's old inventory that has not been treated properly, and so if you go in as an owner today and you, now, you don't get that $630 just for free, right. You've got to go in and you've got to do the leasing office, and you've got to put in a fitness center and you've got to put pool furniture around the pool where you sit in a lawn chair, you don't fall all the way through the lawn chair.

                Right? You've got to have a nice barbecue around the pool. You've got to have a dog park. You've got to paint the building. So, so you've got to take this 1980s building. You know, if you think of the old, you know, turquoise, toilet and shag carpet, right? If you think of that, that's not what people are prepared to pay virtually any money for right now, there's enough people coming in with money and jobs, renovate the suites, make it a groovy building, and people will pay the price and they'll, and they'll rent the buildings. So what we found in our model is the magic isn't just doing a little bit of these, you've got to go in and you've got to go POW! And you've got to do a whole bunch of it very, very fast. So that the tenants, the residents actually believe they don't believe you're coming in to charge a higher rent. They can't believe you're coming in to make a better community, and they're more than willing to pay in a better community.

Tom Wheelwright:

Hey, if you like financial education, the way I do, you're going to love Buck Jeffrey's podcast. Buck's a friend of mine. He's a client of mine. He's a former board certified surgeon and he's turned into a real estate professional. So he has this podcast that is geared towards high paid professionals. That's who he's geared towards. So if you're a high paid professional, you're going, look, ‘I'd like to do something different with my money than what I'm doing. I'd like to get financially educated. I'd like to take control of my money and my life and my taxes.' I would love to recommend buck Jeffrey's podcast, which is called ‘wealth formula podcast with Buck Jeffrey.' I hope you join buck on this adventure of a lifetime.

                So one of the things I liked about watching what you've done over the years is, it's very much a formula that you've got, right? So you've got a very specific, you got very specific criteria for your building. Very specific criteria for your investing. You only do the same type of building in the same type of markets and you do, and you do the same type of renovations and you do it over and over and over again and I'm a big, big fan of that focus.

Dave Steele:

CPA's tend to like it because it's repeatable, and when its repeatable and it's scalable it reduces a lot of the risks.

Tom Wheelwright:

That's right, exactly. That's what happens. So, what about these evictions though? So we've got these eviction order. I actually am not convinced that the administration isn't going to win this because, even though Justice Kavanaugh said that it was illegal, he still sided with the rest of them. They have a majority opinion saying it was legal, that it was okay. So what happens? Do these evictions go on forever? And then that's question number one, then question number two is what happens when they stop? When that eviction order stops, are you guys going to evict a whole bunch of people? Or do you think they're really, what are we going to have a whole bunch of homeless people? What are we going to have?

Dave Steele:

Well in our world? & I can't speak for everyone else in multifamily, but in our world, it's a crazy, it's a crazy circle. So the circle is you have tenants that haven't paid, and a lot of them aren't that aren't that educated on the process, and in another world and another building, you have funds that are available, that all they have to do is go and fill in an application, and if they fill in an application with one of the relief agencies, that relief agency will give them the money to pay all of their past rent. So we have full-time people knocking on doors, going to the people who are three months, six months, nine months behind, and by the way, the number's fairly low because we've done such a good job knocking on the doors. But, if you think about it, the only people that aren't paying their rent or the ones that are too scared to answer the door, to let us help them fill in the forms.

                If we can knock on their door, get them to fill in the forms, get the rent relief money, they're all paid up in full, but some of them they're just uneducated, they're scared. So what they do is they just think, ‘oh my gosh, I'm going to lose my home. I'm going to lose my home.' And they don't pay, and they don't pay until one day, they skip out in the middle of the night, right? Because eventually the stress of it, unfortunately, the stress of it is really bad. So, what we found is as much as it's an eviction, don't get me wrong, There are clearly people that are out there that are flat out cheating the system, and to me, I put those that those people are in a different pot and you just treat those as whatever the law allows you to do.

                But there's clearly, I believe we have a very empathetic approach to running our business and treating our residents the way residents should be treated. So part of that process is just how do we take our on-site leasing team and really help them facilitate? And we have literally got a couple of million dollars of rent relief has come in across all our different properties, to bring a significant portion of what would have been bad debt up-to-date. So, it's this very clunky system here. The government gave all this federal money to, to all these rental agencies, and now you just have to work it through the system. And it's…

Tom Wheelwright:

I think it will work its way through the system. You don't think you're going to have a whole bunch of people on the street that aren't going to be able to rent anything because they've got horrible credit scores.

Dave Steele:

Yeah, I think at last count in all of Arizona, second largest landlord in all of Arizona, I think we had something like 73 people that hadn't paid that were in arrear in the rents, and the majority were just, some were already in the process getting to the rent relief agencies. Some were having some challenges with the rent relief agencies and some were just flat out, I'll call it, just hiding behind the door.

Tom Wheelwright:

Got it. So you don't see a big fallout once this eviction notice once this eviction moratorium ends?

Dave Steele:

We're clearly more nervous on some properties than others, but as a general rule, I would say, I don't see a big fallout. Now having said that, I don't see a big fallout, assuming this doesn't turn into another year long process. There's a certain, after a certain number of months, then I I'd have to say, don't quote me on what I said three months ago, because potentially all bets are off at a certain point in time right?

Tom Wheelwright:

Let's go to one other thing, which is, how to invest in real estate in this market, because you do have that concerned about interest rates. I mean, I don't know how you not have that concerned about interest rates being at an all time low, so prices that pushes prices to an all time high. So do you invest for cashflow? Do you invest for capital gain? What do you do there? How do you, how do you minimize that risk?

Dave Steele:

Well, I mean, the cash flow in the deals that we have, which are the value add deals, they are what they are, we're targeting, we're targeting 20%, 18%, 16%, 16% to 20% + plus returns, and we've clearly exceeded, our average annual returns on the last 32 properties that we've sold. Our investors have hit 30% plus annual returns. So, we're targeting that. We're also targeting a growth at the end of the second year. We can re-finance and the investors can pull back 50% of their money. And by the end of the fourth year re-finance and pull back a hundred percent of their equity and still own the building.

                So, if they're getting all their equity back, they're much less concerned about what that annual distribution is going to be year one and year two. Right? So the models for us is a little bit different at the end of the day, I always say to people, ‘we've done a good job getting 3%-4% annual distributions to our clients', as you're the expert on the depreciation that's still available, is still an amazing kicker in this process. So for many, many of our investors, that's just a huge win. Well, I guess for all of our investors, that's a huge win.

Tom Wheelwright:

Anybody who has a tax advisor that can get them the losses, that is correct.

Dave Steele:

So, returning the capital quickly, having a model, that's got a clear defined plan, and the biggest thing for me is what do you do in any market where you want to reduce your risk? For me, the risk reduction is go into the deal and look at it and really understand. Do you believe that that the value creation is there without just, wow, I'm picking a good market, and it's going to go up 8% this year, right. I think the markets we're in the Phoenix, the Dallas, the Houston, the San Antonio, the Vegas, the Atlanta. I think those markets are going to continue to be some of the best growth markets in the country, but our model isn't going to change that much, whether they go up by 3% or 5% or 8%. They're going to go up because we can do 10 renovations in a month versus five, because every renovation we do increases the value of that property by somewhere in the neighborhood of $50,000. So all we have to do is just keep cranking those renovations and filling them up with the new rent.

Tom Wheelwright:

Okay that's assuming interest rates stayed the same. So two questions. One is fixed rates or rates that are going to old held for five years. Do you think these rates are going to hold for the next 20 year? Or you can have a five-year fixed, fixed rate, and then you can re-finance, or do you think you need to have a 20 year fixed rate loan?

Dave Steele:

We're tending to stay to the variable rates. Largely because it gives us the flexibility to be able to exit on the deals. The other interesting side is that the phenomena that's coming is that, and if you'd like a prediction, so that if I remember back on your show, you can ask the prediction I will give you is that, watch out, watch out towards the middle 2022, watch out in 2023, the institutional money that is coming into multifamily real estate.

                They always say, if you buy waterfront property, today's high prices, tomorrow's bargain, or I guess the other way around, today's bargain is I don't know which way it is, but the bottom line is, lookout in 2022, 2023, the institutional money that is lined up that is looking to buy particularly real estate that's had a significant portion of the major lift work done, and the money that's out there right now, because think about it. They've just come through this pandemic. They love industrial, they're probably not as thrilled about retail, probably not as thrilled about office and they love multifamily. So, a lot of the last couple of years allocations haven't really been spent, because a lot of these institutional groups haven't been able to travel, and they're not allowed to invest these big chunks of money without traveling to the cities and looking at these deals. So, you're going to see a lot of money, I believe pouring into real estate.

Tom Wheelwright:

That's an interesting point because institutional investors expect a lower rate of return than the private equity investors.

Dave Steele:

You bet. And again, that's part of why we've stayed in the value add space, because the value add space, a lot of the institutional groups that we talk to we'll tell them, here's what we do. And, and they go, that's great, but man, we would never do that. We just don't have the people or the manpower to put that much energy and resources into generating…

Tom Wheelwright:

So they're more likely to be the buyer once you've done the full renovation, got the rent's up and everything's stabilized.

Dave Steele:

Bingo.

Tom Wheelwright:

Got it. So, final question. What do you say to those people, and there's a lot of them, I was, I heard it yesterday that say ‘we are in a bubble and this bubble is going to burst at some point.' What do you say to those people? We know that and let me just caveat that. So we know that historically real estate has a 10 year cycle and we're 15 years into a 10 year cycle. Okay, so what do you say about that? How does that bubble continue, and how do you continue to push that for significant periods of time?

Dave Steele:

Well, I could only imagine what they've said about the bubble in Seattle, and the rental and the price of rental housing in and around Seattle, and the price that old apartments have gone to and continued to go to, but if Microsoft and the big companies around Seattle keep adding and adding and adding and adding the jobs, is there really an end in sight for how many more rental units they're going to build? And so I'd say the same thing. You look at these job magnet cities right now, you look at Dallas, you look at Phoenix, these are just job magnet cities, and so the question is, I watched the front end and the front end is these companies just keep announcing, we're adding this new facility and this many jobs, this do facility in this many jobs and it's sort of like, well, where are all those people going to live? Most of them are not coming there to buy they're coming there to rent, and there's no new, there's not nearly enough new rental stock being built.

                So I love the idea that I'm sitting there with a building that I'm buying at a price, because the units are mostly classic units, and maybe the market does correct a little bit on us, Tom, maybe that does happen, but I've reduced a lot of the risks, because I still get that value increase by doing the work to renovate the building. So again, like I said, I'm not just buying a piece of real estate in a market that might do okay. I think we're buying real estate in a market that should do really, really well and I'm adding value. I'm forcing appreciation on that building. So as an investor, I like that our investors, clearly like it because they've seen it and repeated it, and then I say, ‘all right, if you're not going to do this, to tell me where else you're going to put your money' we're not going to, we're not, none of us are getting where we want to go by the term deposit I just renewed at the bank at one 10th of one percent.

Tom Wheelwright:

You're not going to cover inflation with that by any means, and of course it would be a whole another discussion talking about the benefits of debt when it comes to inflation, because of course, every year you're paying that debt with cheaper money. As those rents go up, your debt's not going up, as long as you've got your interest rates staying the same. So with that, thank you, Dave Steele, and Western Wealth, if people want to get ahold of you somehow, what's the easiest way for them to contact you?

Dave Steele:

They can connect with Tim McCleary of out of our office, 778 238 3553, Tim@westernwealthcapital.com and many of you know us through, Buck Jeffrey at Wealth Formula, who's our partner in all of these deals as well, so you can connect directly with buck and wealth formula.

Tom Wheelwright:

Awesome. Thank you Dave Steele. We will look for an update, we'll see how your crystal ball works out next year. Maybe a year from now, we'll have this similar, an update conversation. Hopefully the world will be different in a good way, a year from now. Just remember that, whether it's multi-family or single family or it's energy or a business, whatever your particular wealth strategy is, remember that just one of the lessons of this is that when Dave talks about their strategy, they're very, very specific, and they're very good at doing one thing, and they only do one thing, because when you do that and you do it in a place where the government wants you to do it, which is, in Dave's case that says real estate, but we can do it in energy, we can do it in business, a plethora of places, just remember what you're always going to end up with is way more money, and way less tax, I'll see you next time.

Announcer:

You've been listening to the Wealth Ability Show with Tom Wheelwright. Way more money, way less taxes. To learn more, go to wealthability.com.