Real Estate Development Basics Class - Part 1 Overview of the Real Estate Industry

Summary

In this introductory video, Michael Schwartzman, principal of Develop Incorporated, delves into the foundational concepts of real estate development. Aimed at anyone new to the industry or keen to deepen their understanding, the class covers the general landscape of the real estate sector, from its economic cycles to the nitty-gritty of investment risks and returns. Throughout, Schwartzman shares insights based on his 30 years of experience, providing viewers with an engaging and informative overview. The session explores various asset classes, investment strategies, and macroeconomic factors affecting the industry today.

Highlights

• Michael Schwartzman shares 30 years of experience in real estate development from construction to teaching. 🏗️
• The video outlines the basics of real estate development, offering insights and tips for beginners. 🎓
• An engaging discussion on risk versus return using a stair analogy, explaining why higher returns demand higher risks. 📉
• Exploration of various real estate asset classes and their market dynamics, including multi-family, office, and retail. 🏘️
• Michael discusses the impact of global economic cycles on real estate, emphasizing the cycle of boom and bust every 10 years. 📉

Key Takeaways

• Real estate development is a multifaceted process that spans from entitlements to leasing. 🏢
• Understanding investment risk versus return is crucial for making informed decisions in real estate. 📈
• The real estate market consists of different asset classes like multi-family, office, and retail, each with varying degrees of risk and return. 🏠
• Economic cycles and macroeconomic factors significantly impact real estate investment opportunities. 📊
• Familiarity with terms like cap rate and NOI is essential in the real estate realm to assess property value effectively. 💡

Overview

Michael Schwartzman kicks off his real estate basics class by diving into his extensive career journey. With a construction background, Michael brings seasoned insights into the complexities and thrill of real estate development. From foundational elements to nuanced market dynamics, this video serves as a thorough primer for enthusiasts and newcomers alike!

Delving into investment strategies, Schwartzman introduces the crucial balance of risk versus return, using a fun stairway metaphor to underscore the varying degrees of financial daring required. His lively explanations help demystify the critical metrics of real estate such as cap rates and NOI, empowering viewers to make savvy investments.

The video transitions to exploring different real estate assets, highlighting how various economic cycles have historically influenced market opportunities. Insightful and informative, Schwartzman ensures you step away with a deeper understanding of how diverse factors come into play in this dynamic industry.

Chapters

• 00:00 - 02:00: Introduction Michael Schwartzman, principal of Develop Incorporated in Los Angeles, introduces his real estate development basics overview class. With a longstanding career in the real estate industry starting at age 17, Michael has accumulated extensive experience in construction and development across various projects. His insights and expertise form the foundation of this introductory chapter.
• 02:00 - 10:00: Real Estate Investment Fundamentals The chapter titled 'Real Estate Investment Fundamentals' provides basic information about the real estate development process. It was created to assist a commercial broker in gaining a better understanding of the industry, aiming to improve the broker's ability to support clients in making better deals. The chapter serves as an educational resource for individuals who are new or young in the real estate industry.
• 10:00 - 19:00: Economics and Real Estate The chapter titled 'Economics and Real Estate' explores the extensive facets of the real estate industry, including roles such as lenders, construction superintendents, and interior designers. It highlights the diverse aspects of the field, aiming to provide a comprehensive overview beneficial to those involved. The content will be made available in a format allowing for self-paced learning, emphasizing the enjoyment and educational value of engaging with the material.
• 19:00 - 30:00: Understanding Market Cycles and Risk The chapter is based on 30 years of personal experience in project development processes. It highlights that while every project is unique, the fundamental development process remains constant. The process typically starts with securing entitlements, followed by creating drawings, obtaining permits, building, and finally leasing. The author believes that understanding this consistent process of project development will be beneficial to everyone.
• 30:00 - 40:00: Asset Classes and Investment Strategies The chapter introduces the structure of the class which is divided into three main parts: an overview of the real estate industry, the development process from concept to completion, and pro forma analysis and deal structure. The instructor thanks contributors from LinkedIn for their suggestions on topics to cover, expressing hope that all addressed topics will be beneficial to the audience.
• 40:00 - 51:00: Value, Valuation, and Financial Metrics This chapter introduces the concepts of value, valuation, and financial metrics, particularly in the context of real estate and alternative investments. It aims to help individuals improve their understanding and advance their careers. Key topics include risk versus return, real estate's position in the investment world, and the influence of macro and microeconomic factors. Additionally, the chapter discusses real estate asset classes, and the intricacies of debt and equity sourcing.
• 51:00 - 59:00: Equity, Debt, and Arbitrage in Real Estate This chapter begins with a discussion on the fundamental concept of opportunity risk in real estate, which is likened to a monumental staircase where investments at each step carry varying degrees of risk. The analogy is used to explain how different levels of investment require different levels of return, prompted by the challenge of determining the amount of money one would need to jump from varying heights of the staircase. It underscores the principle that risk and return are inversely related at each level of an investment decision, not just in real estate, but in stocks, businesses, bonds, and other investment vehicles.
• 59:00 - 60:00: Conclusion The chapter titled 'Conclusion' uses an analogy of climbing stairs to convey a message about taking risks and the associated challenges at different levels. It describes the progression from simple, low-risk steps that one is accustomed to, to progressively higher steps that require more skill, preparation, and resources. As one climbs higher, the potential risk and reward increase, necessitating greater effort and caution. The narrative suggests that as challenges grow, so too does the need for planning, resources (like money), and careful execution, encapsulating the themes of risk management and growth in a familiar metaphor.

Real Estate Development Basics Class - Part 1 Overview of the Real Estate Industry Transcription

• 00:00 - 00:30 hi there my name is michael schwartzman i am principal of develop incorporated located in los angeles and this is my real estate development basics overview class i have been in the real estate industry since i was 17 working construction i have worked for many companies worked on a variety of projects including decades of development experience a friend of mine
• 00:30 - 01:00 asked me if i would put together some basic information about the real estate development process to help a buddy of his who's a commercial broker who wanted to know more about the process so he could be better with his clients understand more about the industry make better deals help his clients make better deals etc i have always enjoyed teaching and i thought i would put this together if there's somebody out there that this helps you're new to the industry young in the industry
• 01:00 - 01:30 maybe you're a lender or a construction superintendent somebody interior design such so many facets of this business i think there's a lot that can be learned from this overview it will be a couple hours long so i will turn this into youtube videos so you can start and stop at your leisure and it's um fun for me to do so i hope this helps i hope you all enjoy it so we're going to get right into it i as i said i have been in this industry
• 01:30 - 02:00 for a very long time i have 30 years of experience this coursework is based on my personal experience the projects i've worked on the process i've worked to create over time every project is a snowflake yet the process on how you move a project through the development process is the same starting the presumption is we're going to start with entitlements we're going to work through drawings we're going to get permits we're going to build we're going to lease up etc and i think this should be quite interesting for everybody
• 02:00 - 02:30 so we're going to look at three basic parts of this class the first one will be the overview of the real estate industry then we're going to look at the development process from concept to completion and we're going to end with pro forma analysis and deal structure and i would be remiss if i did not help thank everybody on linkedin that threw me ideas of topics they'd like to see covered i think i've addressed everything and as i said i hope you find this
• 02:30 - 03:00 interest interesting and i hope there's someone out there that this material helps move to the next level of understanding and maybe get to the next level in their career so let's look at the first part here we're going to look at risk versus return the real estate and alternative investments that'll help us understand where real estate falls in the investment world macro and microeconomic factors i see today the real estate asset classes and then debt and equity sourcing so if we're going to get into anything
• 03:00 - 03:30 we're going to get into opportunity risk that's what real estate really comes down to really any investment you make in a stock in a piece of property in a business in a bond et cetera it all comes down to risk and i have one way of looking at that if i showed you this monumental staircase which we're going to assume is quite tall if i asked you to jump from the first step how much money would you need to do that um it's only a couple inches
• 03:30 - 04:00 you've been doing this since you were probably two years old you are not really risking much danger you're not going to hurt yourself you might need a dollar or two but if we start climbing we get up to the fifth step um we're getting a little higher we've got to we got to make a bigger jump uh we got to really work on our landing uh you may say to yourself now i need a little bit more money if we get up to the 12 step and given the size of this all marble with metal railing staircase this is quite the jump you you may land
• 04:00 - 04:30 on a step you may fall down you may break your nose you may break a kneecap um got some danger you're gonna want more money and finally if we put you up to the top right at the top landing and now i ask you to jump straight down or down the stairs now you have a good chance you're really going to hurt yourself so we are looking basically at risk versus reward and it's a natural graph the further we go out on the risk profile the higher we go on the staircase the more money we're going to
• 04:30 - 05:00 want to make in the in the investment or in this case the jump uh and that goes right to the investment world if we continue and stay on that graph and we look at just general investment risk and all the different asset classes we could start really with the safest perceived investments savings account bank cds put your money in you're definitely going to get your money out with a teeny little bit of interest federal government bonds municipal bonds
• 05:00 - 05:30 then we get into the corporate bonds mutual funds and dividend stocks where you're taking a little bit more risk corporate bonds you know ibm or large corporations you're still going to pretty much get your money back you're going to make your interest mutual funds a little bit more diversified but you're going to get your money back dividend stocks in being that you're in growth stocks dividend stocks you're going to be able to put your money out you're probably going to get your money back dividend stocks tend to be real estate investment trusts utilities things that
• 05:30 - 06:00 are well established and really good for people who are looking to earn some kind of income from their stock investment then you get to grow stocks that's where you're buying something where you want the price to go up you don't really care about dividends you want the money to go back in the company you want that company to grow earnings you want it to grow its value et cetera gold is always a commodity because our entire financial system is based on gold these days with inflation and everything
• 06:00 - 06:30 going on in the world we're seeing a lot of commercials on tv for gold funds gold stocks commodities um whether it's corn copper is huge now with all the electric cars um commodities are anything we use to as a natural resource that we have to turn from one form into another that then serves our economy and then we get to the high end of the risk chart which is real estate international funds international investments and
• 06:30 - 07:00 derivatives which are derivatives are where you take one investment and you turn it into a second and third investment et cetera um the big short the movie uh involved derivatives and the whole crash of the 2007-2008 economic cycle it's a great movie if you haven't seen it recommend it if we then look at investment risk by real estate asset class looking at current environment we can start at the bottom with triple
• 07:00 - 07:30 net government buildings are triple net credit tenants and in this case as you see in the little box to the lower right a triple net building is one where the building tenant pays real estate taxes insurance and maintenance the landlord owns the building and the site but they really don't do anything and a good example of this would either be a building that let's say i own but i leased to the federal government they really take care of it i don't need to do anything i can drive by whenever i want and they're just going to mail me
• 07:30 - 08:00 my my monthly rent checks and that's why we call it mailbox money a credit tenant is someone like fedex amazon cbs ups someone who is a major corporation billions of dollar corporation and um they take care of their buildings and they're going to be there for potentially decades as we move into this to the more presumed riskier investments today based on what we've been through over the past couple of years dealing with
• 08:00 - 08:30 covid multi-family properties have been kind of the investment sweetheart because they are still you can still receive financing on them a well-established well-located multi-family building 50 100 300 units well established the rent years of history of of uh stabilized cash flow very easy to finance because we're still in a market where people are trying to put money to work and they're trying really hard to put money to work industrial properties have become very
• 08:30 - 09:00 very popular they have always been but i think it's been covid and our life cycle right now where we order so much product delivered to our house that industrial properties especially uh those locations where it's the last stop in the supply chain in the distribution chain so as you know something a facility that's very close to los angeles as excellent distribution routes to the washington dc area something just outside of atlanta something just outside of chicago
• 09:00 - 09:30 something downtown in houston very very well placed industrial properties very sought after obviously with covet and our knowledge of how important medical facilities are today medical offices become very very popular and then we get into office retail hotels these are the kind of three other basic food groups in the real estate world office has been kind of a question mark because we really don't know what office is going to be like moving forward there was a time when office buildings were just completely vacant
• 09:30 - 10:00 in early 2020 and luckily thank god we're moving we're moving through that retail obviously taking a hit because of the internet uh effect on the retail industry yet there are still retail assets grocery anchored retail shops uh looking at outdoor malls that became very popular because it covered because people could basically be outside go in and shop and return outside versus being an interior mall for example hotels we are waiting to see if
• 10:00 - 10:30 business travel returns where's i'm zooming with you right now and zoom has become quite popular business travel is going to be probably cut down i think moving forward i think that unless you really have to see somebody which will be so much more enticing moving forward now that we're getting back back to some bit of normalcy uh hotel business travel will come back gradually hotel destination travel in the right locations
• 10:30 - 11:00 has kind of always performed a matter of fact if you tried to get a hotel room in hawaii in early 2021 you're gonna pay three four times the asking rate of 2019 period and then we get into land speculation oil drilling and gold mine now oil drilling and gold mining you're basically taking a huge risk you don't know whether you're going to get it or not a lot of money goes into those processes land speculation definitely has some risk attached to it trying to
• 11:00 - 11:30 develop a new property whether the government will allow you to do what you foresee as that opportunity however it is it involves the public process and you don't really have a time period you can't really put a bracket on how long it's going to take to move from one end of the entitlement process to the other so land speculation and development always seen as a risky endeavor looking at the economy we are still paying the price of the 2020 global
• 11:30 - 12:00 pandemic shutdowns around the world material production kind of stopped ceased just distribution we're still dealing with those supply chain disruption issues the price of lumber still skyrocketing steel etc if you've tried to order new appliances a new frigerator a new microwave that can take weeks or even months now because we're still just losing people in the process however hopefully that's coming back in line and these shortages um
• 12:00 - 12:30 are basically exemplifying the supply demand uh balance is way out of whack it still is and it probably will still be for some time so costs are rising as a result uh inflation has kicked in that's really been the news the gov the policies of the new administration have been doing great in terms of jobs and our economy yet even though people may be making a little bit more money with gas and food costs more it still feels like we're getting kicked in the teeth
• 12:30 - 13:00 so we have seen that hard hit industries developed nations kind of dealt with this around the world with losses unemployment and just general civil unrest which has just been very unfortunate unfortunate and we can't just flip a switch and and turn the whole world back on like a car it just doesn't work we need to ramp this back up and it's probably going to take time and i think expectations for most well-noted economists as this could take all the way through this year looking at
• 13:00 - 13:30 statistics is very important in the real estate industry you always kind of know where you have been so you can kind of project where you're going going through grad school i always thought that studying demographics and statistics was kind of ridiculous it's like hey let's just go build that office building it's going to be great well there's a time you need to know hey how many people are working in this area how many office buildings are there what is vacancy what do things look like so one of the biggest things we can look at of course i think is very important is
• 13:30 - 14:00 where are we on the overall economic cycle and that we can do by looking at the united states uh gross domestic product uh growth rates and here i've just looked at a chart um that demonstrates from where we were in 1950 to kind of where we are today and hitting in my lifetime i'm 56 years old i was born in 1965. the oil crises going through the 70s uh in 1989 we had really huge inflation inflation rates got up to
• 14:00 - 14:30 17 18 21 at one point very quickly the dot-com bubble that we hit 2001 and obviously as we all know most recent history is both the great recession that we had in 2007 due to the subprime mortgage and the housing bubble and then where we are just through covid now with that we can then look at these various points of the rates of unemployment and as that unemployment sign curve flips up and down it's demonstrating our
• 14:30 - 15:00 economic cycle and if you just kind of look at this carefully if we had the crisis in 73 then let's call it 79 to 82 89 2001 2007 2020 we pretty much have an economic recession in this country about every 10 years so we hit rock bottom we have good steady growth it kind of tips up we get over the tips of our skis and something causes a pin to pop the balloon and down
• 15:00 - 15:30 we come obviously where we were after the great recession of 2007-2008 and i would candidly say that stretched into 2010 before people started really picking back up so 2010 as we got in 2020 the economy was rolling everybody's feeling good it kind of led you to believe based on previous history it's been about 10 years something's gonna happen in this case who would have known it would be a medical issue that would cause our downturn and and as a result
• 15:30 - 16:00 of that as the graph shows we tipped almost 15 and what i want to make the point i want to make about this and studying these type this type of information is i've worked on two major projects in my lifetime that showed the different parts of the economy and with that i worked on the investment building which is in washington dc in 1999 as you can see from the graph we were coming down unemployment was very low the economy is cruising when we started that project our pro forma office rents
• 16:00 - 16:30 were 39 so we were expecting 39 a square foot when we delivered that building by the time we actually did deliver the building we were clipping close to 51 52 a square foot that huge growth in the office rental rate was pure profit for the for the owners who invested in that project unfortunately i also worked on a project called rockville town square in 2006 we
• 16:30 - 17:00 started basically in 2004 we're working the market is just crazy we were selling it was a condominium project is how we started we were selling tons of condominiums we could sell multiple condos a day everything looked awesome unfortunately we then got in 2007 2008 we delivered the project and there was nobody to buy a condo because nobody everybody was scared people were losing their jobs it was crazy so the big
• 17:00 - 17:30 lesson here is you cannot control the economy and in real estate development when you start what might be a five six seven year process you are crystal balling that out number of years beyond the tips of your skis and that's why statistics like this are very important if we look at where the economy is today and what opportunities that might provide for real estate let's start right here the federal government put out huge stimulus stimulus packages obviously it worked we've got very low unemployment we've got we've created
• 17:30 - 18:00 millions of new jobs now as as a as a watcher of the economy i think that our economy was pretty much in the toilet as a result of covet coming out of 2020 everything was terrible as we just discussed unemployment was 15 people weren't working across the country things were just terrible so when you used that that point as a measuring stick from 2020 to 2021 and now 2021 in 2020
• 18:00 - 18:30 everybody's like oh wow we're doing so great let's keep a mind on where we were and what we're projecting today so yeah we increase jobs et cetera but um where are we really in this case because of the the decision by the administration to write checks to people instead of corporations demonstrate a lot of uh interest because this time we bailed out our people not our big companies
• 18:30 - 19:00 also the federal reserve has been holding interest rates historically low at started in 2008 2007 uh it's continued for to give us just that whole decade of growth but that's probably coming to a stop we've already seen in the past six weeks indications from the fed that the federal reserve is going to start raising interest rates we're probably going to see a quarter of a point in the first quarter second quarter whether we get up to three quarters by the end of this year anybody's guess the 10-year treasury
• 19:00 - 19:30 which is a good marker on where the economy is going with regard to interest rates and one way that a lot of banks and lenders provide loans it could go from about 1.7 up to about two and a quarter by by year end which historically is still dramatically low you have to keep that in mind our interest rates are ridiculously low um but when they take up a point and you're paying you know interest in on your
• 19:30 - 20:00 credit card or you want to go buy a new car you especially want to go buy a new house every quarter of a point takes away your buying power and we also have inflation that is what everybody's talking today inflation's up seven percent because you basically have too many dollars chasing too few goods there's only one thing that can happen uh where prices are going to go up because demand is so high and supply is so low but i do believe things are going to lighten as the supply opens up inflation will decrease
• 20:00 - 20:30 a number of economists that i listen to you know that are work for top tier organizations and they're just crystal balling it let's keep everything in perspective expect that we'll we're gonna we're gonna roll through 2022 uh but you know it might might get down to about five percent at some point then it'll work its way back down meanwhile when people get increases in their salary they don't go back down so we're hoping for that point when inflation starts going down but uptick in wages works and then people are going to really start seeing more money in
• 20:30 - 21:00 their chat paycheck and returning to office unemployment's down below four percent right now we're learning to live with covid hopefully we're stepping into the endemic instead of the pandemic and we're going to just deal with it like we deal with the flu and other things and personally i'm back on parking on level d in my office building i've got to go down a couple of floors now because there are so many people that have returned to my office building where i work so we look at basic lines everybody always wants to talk about housing
• 21:00 - 21:30 we still have supply shortages basically nobody did anything in 2020. demand continued to grow because with covet people were like hey instead of living in an apartment with the rent i pay with interest rates so low i might want to move to the suburbs or i'll drive until i qualify for a mortgage and i'm going to go get my own house so i don't have to be in an elevator i can go outside i can get a barbecue whatever at the same time what's interesting in this economy that really rolls back to about 2004-2005
• 21:30 - 22:00 as we moved into the the previous great recession that was caused by the housing bubble when condominium buildings went back to be rentals they were called rondos instead of condos they were rondos and people started to rent buildings where they had marble countertops and they had gorgeous bathrooms four fixture bathrooms with a tub and a shower and beautiful plumbing fixtures beautiful electric fixtures tvs mounted on walls gorgeous hardwood
• 22:00 - 22:30 floors amenities that were like living in a hotel everybody started saying you know hey especially i think younger generation i'm starting to make money i could rent because i don't have the money for a down payment for a house i can live in this gorgeous apartment building with a pool and a theater and a club room and a fitness room etc and i'm just going to be a renter by choice i'm going to i'm going to invest my money in other alternatives than buying a home which seems to take you know 30-year mortgage
• 22:30 - 23:00 30 years till you pay it off 30 years till you own it outright so the cost of goods and construction costs will hopefully stabilize as the supply chain eases i do expect that in this year although it's been wicked scary when the price of lumber has gone from 200 to 600 to 1800 aboard foot and hopefully now it's working its way back down as everybody deals with cove it gets over covered you know just with regard to lumber all of the people who work in that industry truckers especially getting goods to
• 23:00 - 23:30 to our points of acquisition hopefully everything gets better there's still lots of pent-up demand institutional capital is still sitting on the sidelines people are making large transactions if there's a fund when people raise money and we'll get into that people raise 350 million dollars when they want to make an acquisition they don't want to buy something that costs two million dollars that's almost a rounding error on their accounting statement what they want to do is buy
• 23:30 - 24:00 something for 20 30 50 100 million dollars something when they put out a news brief says you know hey so and so capital just spent 50 million dollars on this acquisition or they just bought a portfolio for 250 million dollars that's what everyone's trying to do so as we look here just locally and i know anybody could be watching this around the world los angeles is still one of the largest economies in the world with a diverse workforce multi-faceted economy with entertainment of course technology
• 24:00 - 24:30 professional services los angeles is a great place to invest everybody thinks that everyone's starting to migrate out of los angeles trying to go to texas florida other places with low taxes no personal income taxes et cetera maybe better places to work but i don't know los angeles weather is pretty cool it's pretty awesome out here i grew up on the east coast i like living with palm trees and hummingbirds better than snow um so let's look at the asset classes that we're going to talk about through
• 24:30 - 25:00 the course of this of this class here are basic food groups multi-family residential industrial office retown hotel these are commercial properties single family homes is just a part of the housing market that is not considered commercial uh property now you may own a house and you may invest in another house and you rent it out and that's your rental property and that's your investment that doesn't necessarily make a commercial grade property in the multi-family world we have mixed
• 25:00 - 25:30 use multi-family ground floor number of stories above that's been going on really as as mankind has has moved forward and developed we also now see although the single family a single-family house is not a commercial investment commercial great asset what's happening now is that large investment funds based on covet and that idea where people would rather not be in an elevator maybe they want their own individual house they're literally buying
• 25:30 - 26:00 neighborhoods or let's say a large home producer like envy homes builds a little neighborhood with 225 houses a major investment fund may buy that entire neighborhood and then they use it as rentals so i kind of call it horizontal multi-family everyone has their own individual house but they're paying rent they don't own it and there's a there's an equity team investment team that benefits student housing is tremendous in the market it's
• 26:00 - 26:30 really grown uh because either people developers are either ground leasing property on campuses or they're buying property immediately adjacent they're building gorgeous buildings and they've got you know put two three four beds in an apartment unit uh with a small kitchen maybe or just like a living area and bathrooms and then on the ground floor you've got a huge cafe and a place for first for um study uh different you know where it might be nooks for studying or where you get
• 26:30 - 27:00 tables and have groups et cetera affordable housing always very popular because the government is always putting out programs that fund affordable housing however i must tell you affordable housing is its own animal you have to know that business you have to have experience in it there are a lot of rules how there's low income tax credits it's a it's a whole it's a whole production i have very little to no experience in that and i will not be addressing that
• 27:00 - 27:30 in this course manufactured housing mobile home parks uh trailer parks as some people refer to them which is really kind of a slander because mobile home parks and manufacture housing are actually one of the most important aspects of the of the real estate industry because it is the least expensive way for somebody to get into their own home what you're doing typically in a mobile home park is you are renting the ground or the the stall where you would be
• 27:30 - 28:00 parking your trailer or your manufactured house you pay rent on that land but you own the house so you might have a mortgage um but typically a manufactured home you know three bedrooms two baths nice living area kitchen dining um you know might sell for anywhere from 50 to 100 000 i mean except you're in the you know outskirts of some place in a rural area you're not really gonna find something for a hundred thousand dollars um so
• 28:00 - 28:30 still a very a very very desirable aspect being that everybody thinks it's a cash cow business even though it's a very heavy operational business senior housing rounds out this this division in my opinion which goes from see independent living where people are let's say hate to say it because i'm 56 55 years and older uh where we're independently living and then maybe it might be a facility that offers the different levels of care as somebody ages 65 75 85
• 28:30 - 29:00 to the point where they're really being taken care of all day so um very popular because hey when you retire people want to do cool things um and they want a nice place to live and it's a very interesting investment opportunity and we talked a little bit of about industrial but warehouse distribution centers that support the supply chain are huge anything that has to do with manufacturing and of course industrial really is primarily it's a triple net building operation but somebody may own a 75 000 square foot facility that's
• 29:00 - 29:30 broken into five or six different um rentable areas and uh where somebody really does operate the building so not everything in industrial is triple net it's just very typical because of the size of facilities that that industries need office urban versus suburban locations is always the big battle here um everybody thinks that you know your suburban office building someone vacates you're gonna you know you're gonna lose money all the time not really true because most suburban office buildings
• 29:30 - 30:00 typically cost less for rent than urban locations where you're in a downtown heavily trafficked area and that's where in the suburban locations when you tend to have your back of house space your accounting department may be a facility that is just a support to the main business so we can have a real nice sales and real real slick office downtown but then most of the work is done in the suburbs maybe 20 minutes away i've always found that wherever the ceo or the cfo lives or the top guys or gals
• 30:00 - 30:30 making the decisions that's where the office building is going to be so medical office we said just coming really great uh investment because as you guys probably know once a doctor opens up an office somewhere and they build out five six exam rooms or a dentist has four or five chairs or something they're not going to go anywhere they want their clients their patients to know exactly where to go where to park how to get in there into their office and their very long-term
• 30:30 - 31:00 tenants data centers is really something that kind of falls in between is it office is it industrial i think because it really supports the economy and what we do i i consider data centers kind of in line with office it relates to technology increasing online activity it's really a business oriented aspect so i call it into office but again this whole course is based on my experience and what i think so maybe you think different that's fine retail grocery anchored strip centers
• 31:00 - 31:30 where do you go to get your shopping done and maybe it's where you get your dry cleaning and maybe it's where your pharmacy is and maybe some fast casual restaurants that has demonstrated to still be popular whether you were using an online app to get your groceries or whether you were putting on your mask and going out and getting them yourself it really showed how important grocery anchored strip centers are power centers and outlet malls now this is the branch that really took it on the chin because all of a sudden i don't
• 31:30 - 32:00 need to go to some big power center to go to best buy to buy my tv matter of fact most people are just ordering online and the tv is being delivered to your house and you can order white glove service where they bring it right in and or install it for you and outlet malls with the way people can shop i think i think online shopping is our new outlet quite frankly and there's been a lot of investigation is okay now that we've got all these malls and retail is kind of dying a little bit as a result of online shopping that's just growing
• 32:00 - 32:30 uh incrementally by multiples every year what is the new use what do we do at the 200 000 square foot mall and there's there's a couple great examples here in los angeles where they took where we've taken 400 000 square foot malls chopped out 300 000 square feet to either be residential or some kind of new office for a major tenant without a lot of outdoor space and then you just condense the retail to maybe the best hundred thousand square feet or
• 32:30 - 33:00 fifty thousand square feet and that's where you that's where it begins and end and then outdoor entertainment centers uh in los angeles we're lucky we have beautiful weather and with that we've had the opportunity throughout the real entire pandemic all throughout the year to be outside and in these really kind of entertainment venues where there's large walkable area fountains you know music being played there are some really some lovely things that can be done with
• 33:00 - 33:30 outdoor retail centers and i i see that as the way things are going to go really everywhere it can be possible uh except for you know northern locations and hotels we kind of touched this on on this already uh you got vacation destination locations hawaii florida california texas anywhere it was warm arizona anywhere it was warm we couldn't travel internationally because of covid so we start looking internally and maybe as a result people start rediscovering america because we do have a beautiful country and then work related versus extended stay
• 33:30 - 34:00 and will that actually work moving forward what is the new um office look like so what does the new business travel look like etc getting into value and valuation so every business is based on profit it's an entrepreneur's goal to make money we're capitalist nation everyone does get a chance to work hard and succeed and i realize that while watching the news uh over the especially over the past two years with kind of all the craziness going on
• 34:00 - 34:30 in our country it is obvious that some people in our socioeconomic scale have a much easier path to success but never said the great thing about this country uh is that you can come to the united states with nothing and you can work your butt off and you can succeed i have had a number of clients that have arrived here from other parts around the world and i have designed and built some very large homes for them or built out very large offices they started with nothing and
• 34:30 - 35:00 they have built their way up and it is it is very possible so let's look at what business is it really comes down to revenue how much money do you earn and expenses how much does it pay for you to earn those or earn those dollars and that gets down to basically your net operating income so i take all my money in i pay all the suppliers and everybody i need to put those goods in place and that gets me to net operating income or noi and
• 35:00 - 35:30 that is before debt service so taking to the next step if we do have a loan for what we do and that's a business loan uh or it's a building that we bought and we'll get into that deeper soon but if i have a loan i've got to pay my loan interest maybe it's an amortizing loan so i pay interest and principal and then whatever i'm doing i'm gonna have capital reserves to make sure whatever i'm doing if i'm making plastic cups and i've got big machines that crank out those cups every day but one of those machines may break so i better
• 35:30 - 36:00 save some money every single month or every year a certain amount for capital reserves so when that machine goes down i've got the 10 20 30 50 grand that it's going to take to fix it so after i've accounted for net operating income pay off my loan interest take handle capital reserves that gets to net profit that is your cash available for distribution before depreciation and taxes and that's basically your pocket money that what is really going into your pocket and that's an interesting evaluation we'll do when we get into pro
• 36:00 - 36:30 forma analysis so this formula applies basically to any business it could be a commercial real estate investment it could be a startup technology it could be a dog grooming business a restaurant coca-cola or pepsi or any major corporation at the end of the day they still study these few line items especially the further you get the top of the organization the smaller the income statement gets to where they just want to know how much do we sell how much does it cost how much do we make do we
• 36:30 - 37:00 pay our loans how many reserves do we have what's our net profit what money am i putting in my pocket or distributing to shareholders now using leverage or loan debt will affect your return on equity and that will be discussed in the third lecture i want to make that point in case you're raising your hand right now questioning that so value and valuation the capital markets match sources sources or providers of debt and equity with users of debt and
• 37:00 - 37:30 equity in a variety of forms it could be a direct investment i want to open up a lemonade stand and my father is going to invest 10 and that's the deal it could be that you buy stock um which could be common or preferred shares bonds which are actually rated in tranches from aaa which is like the most reliable that if i put in my million dollars i'm going to get my million dollars back plus my interest and then as you go down that scale double a a triple b double b b and
• 37:30 - 38:00 unrated my risk profile goes up my reward is higher but there could also be a chance i don't get anything because when everything starts to get dissolved they start at the bottom and work from the unrated up of who doesn't get paid which leads my to my comment the triple a always gets repaid unless everything goes to hell in a handbasket and if we then go to look at loans because hey whoever puts debt on a property or any kind of uh investment is
• 38:00 - 38:30 also making an investment they're just doing it through the debt side and we'll get into that as well there are general obligation bonds which come out as a you know typically done by jurisdictions or the government and then really anything that you can produce that can be sold to another party is really an investment so with that we look at what's called a capitalization rate or a cap rate now this is typically related to real estate but it's and it's because it shows what
• 38:30 - 39:00 your return on investment will be or you're going in yield you're going in return it's applicable to all all investments now a cap rate might also be equivalent to uh like a p e ratio price to earnings ratio on a stock so every different asset class um has their different metric that is a way to easily communicate between investors and i'm not going to get in deep to stock bonds and all that kind of stuff
• 39:00 - 39:30 i am this is a real estate um this is a real estate show so uh so using a cap rate or that going in yield going in return so i'm gonna buy that building at a four percent cap rate i can then know i can evaluate investors can evaluate one value property against another one it's a way to simply assess risk and projected return i can buy an office building at a four percent cap rate i can buy a retail center at a six
• 39:30 - 40:00 percent cap rate i can buy a um industrial building at eight percent cap rate et cetera so it's a very easy way to communicate across the board so as i said it quickly displays investment risk potential return to a potential investor so let's look at how we actually get that this is going to be where we start getting into some math so value and valuation is derived from a very simple formula if you take net operating income and you divide it by the market value
• 40:00 - 40:30 that is your cap rate or you're going in yield or going in return and i'm trying to produce in this series a lot of definition a lot of terms it's one of the most key aspects to this business if you go on a conference call with someone and you're talking about an investment are you all talking about the same thing because there's lots of different slang that people look at you know across the board so with that what i would like to show you
• 40:30 - 41:00 back to you know simple math if you know two variables you can derive the third so if we know noi and market value we can get to our cap rate so if we're looking at a business a building that's for sale and let's say it earns 350 000 of net operating income profit or rent less expenses equals noi so noi divided by its potential market value five million dollars i'm going in at a seven percent gap rate or seven percent going in return i'm going to make seven percent on my money
• 41:00 - 41:30 if i know the noi and the cap rate i can then derive the market value so if we know that building has it makes 350 thousand dollars in noi every year and then we know it's as trading as seven percent cap rate then we know that building is worth five million bucks and if we know the market value and the cap rate we can get to noi so if we got a five million dollar building at seven percent we know we can project that noi is 350 000 so if you assume noi is fixed like a bond
• 41:30 - 42:00 payment is fixed uh market value and cap rates are negatively correlated if i know one goes up the other goes down if my market value goes up the price is getting higher the cap rate is getting lower and vice versa as my cap rate rises six percent seven percent eight percent nine percent my market value must be going down because noi is the fulcrum on that seesaw noi is usually fixed
• 42:00 - 42:30 so i hope that helps get into commercial building classifications this is very important when you're hearing about what's trading in the market or what people are trying to deliver you really need to know that there are a number of food groups here as well the first thing is a trophy building or a class a asset this is something that's really going to be something awesome it's usually the newest building on the block it's going to be very sought after by investors and tenants it's said to be irreplaceable highly attractive
• 42:30 - 43:00 number one in the sub market it's setting the bar it's like the smartest kid in class that's who sets the curve so you're going to expect to buy that in a low at a low cap rate because it's going to be an expensive building expense low cap rate um high value low cap rate um and you're going to put in a portfolio you're going to hold it for long term and there's different type of buyers who look for these type of assets so you expect solid year-over-year performance so this might be a gorgeous building downtown location or a premiere in a sub-market in a
• 43:00 - 43:30 suburban location et cetera where everybody wants to be you then get into class b so this might be a slightly older building maybe seven to ten years old it was marvelous when it was first delivered but maybe you know time other new other new buildings on the block so it's still a great asset it's got some upside opportunity maybe through better little better building management maybe minor renovation or maybe you're buying the building like 85 occupied because maybe one tenant moved out and you just
• 43:30 - 44:00 need to do this little bit of leasing and boom you're right back in business you increase occupancy you increase your net operating income accordingly you're all good class c is where you're starting to see assets that are showing signs of age they may be potentially functionally obsolescent and a great way to explain functional obsolescence is always best seen in a office building now as we have advanced um in in the
• 44:00 - 44:30 office environment and now especially where we kind of went through this last phase of people wanting completely open offices with workstations and everybody's going to work together and it's going to be great because you're going to be real camaraderie and what we've learned is everybody really sits around with headsets in because they don't want to hear everybody talking they wish they had their old office back some people love it i think it's pretty cool it's also nice to be in your own office but in those older office buildings what happened in the evolution of our desire to be more open and the ability of structural
• 44:30 - 45:00 engineering concrete steel et cetera the space between columns over time has grown wider and wider wide these are called bays so the column bay or the spacing between columns you know back in the industrial revolution as we you know came into the as america really started producing and we got into the office building and the elevator was introduced um which was you know the greatest thing since sliced bread so maybe we had columns that were 15 feet apart or 20 feet apart so you could have two offices in between et
• 45:00 - 45:30 cetera then we got to 25 30 and then there are things we can span with post tension concrete and different ways to build these days we can make huge spans where there's almost no column column free area so a functionally obsolescent building may be something that's just older and what is it best for either a really good renovation to get it to a class b level and get some higher rents and still something good to hold um probably built very well because it's older and but then again for me it might
• 45:30 - 46:00 be a target for demolitions time for it to go i love historic structures i think everything should should be looked at that something has some benefit but at a certain point you're old you got to go i don't mean to be you know kind of cavalier about it but and then let's look at by classification so a core asset is kind of like a trophy or class a it's sought after it's great as is we're going to buy it at a low cap rate it's going to be high highly priced
• 46:00 - 46:30 and it's going to just be a solid investment we then have core plus which is something where we're going to buy really a core asset but there's something about it that gives us an advantage to do something might be a renovation might be some potential lease up opportunity with some better management again you're always trying to increase noi because the higher your noi the higher your value and value add a lot of people have been talking value add recently and this is where you're looking to buy a building where you can do a major renovation maybe an addition
• 46:30 - 47:00 you know maybe there's a nice suburban office building but it sits with us a surface parking lot that's just huge and we could build a little garage for a couple stories and then we could put another couple floors on top as an example it's a great way we could put in better management turning tenants just just waiting out a tenant to vacate a building at a low rent so you can get them in now after a renovation at a much higher rent and that's always what people evaluate on a per net rentable square foot basis am i able to increase
• 47:00 - 47:30 noi and and corresponding value and then development so that's you know we're going to get into that is the most opportune opportunistic investment vehicle because it involves a public process now let's talk about equity in debt everything that we buy is either 100 equity where you're pulling all the money out of your wallet boom you know or in most cases you're going to do a little bit of equity and some debt either a loan from a bank or some other kind of fund so on the equity side of the register we have
• 47:30 - 48:00 always in america uh high net worth individuals you know that goes back to the vanderbilts and the gettys and all the very wealthy families that have dominated um the united states for quite some time so these are qualified accredited investors they have a they exceed a minimum net worth threshold they're worth 10 million dollars they're worth 20 million dollars they understand the risk they're sophisticated they know what they're doing family offices is basically you know like the vanderbilts at a
• 48:00 - 48:30 certain point there's so much money and there's everybody in the family is doing so well the family as a collective as a family or a trust goes and makes investments they're qualified they're accredited they know what they're doing everything's good investment funds are where people start to pull and raise money from different sources and then use that to go out and take action and make investments on behalf of their participants pension funds are basically when
• 48:30 - 49:00 everybody who works for a corporation that offers a pension typically like a union like the electrical union or the carpenters union they those those employees uh those union members put a certain amount of their money away like an ira or a 401k and then the pension has to go invest that to make sure that when those people retire and they need their pensions that they're guaranteed they are going to have the money available and then you have insurance companies basically doing the same kind of ideas a pension fund everybody gets insurance
• 49:00 - 49:30 and i don't know the day my car's gonna break down but when i need 20 grand to fix it then the insurance company has to come up with 20 grand so they take all the money from all those monthly insurance payments or premiums and they go invest in usually pretty safe assets and then they have the money available they're growing the money so they're there when somebody needs it and real estate investment trust or reits and they are publicly traded or privately held they are under a certain tax code of the united states tax code where the company
• 49:30 - 50:00 doesn't really pay taxes the reit collects all the money pays the expenses eventually gets down to cash available for distribution but then distributes 95 of it almost all the money goes out the door a reit is a dividend stock so all the money goes out the door to the single single uh shareholders so i as a maybe i own a hotel read or an office read or multi-family read i get this i getting my checks all the time every quarter i'm getting a check from the from the
• 50:00 - 50:30 company as my dividend and i'm getting taxed on that as passive or ordinary income depending on the rest of your portfolio on the debt side of the equation of course we have banks who use deposits to go out and make products to go get higher interest rates and make money basically using your money i'm going to show an example of that soon hedge funds kind of like equity funds they go ahead they pull money they put things they put out loans typically at higher rates because they have less restrictions they're usually more nimble
• 50:30 - 51:00 they're pretty quick hey i need 10 million dollars uh to work on this multi-family building i want to build but you know my blender is really giving me a hard time for a four percent loan or five percent loan and maybe a hedge fund gives me a 10 loan but they're like hey we underwrote the asset we think it works we're great we're in insurance companies again because they've got to have the money there when they need it they go ahead and they lend as well typically on fixed debt i don't think insurance companies really do that much construction lending unless it's really
• 51:00 - 51:30 a solid usually by the sponsor if they know it's a major company etc if i went by myself you know just mike schwartzman going to an insurance company it better be a really good asset but i have a really good story i would typically need to be really one of the companies i used to work for um that have big balance sheets and they know they're going to get their money uh mortgage reits do the same things as equity reads they're they're instead of buying an asset they're buying the debt on on that asset uh which is a very
• 51:30 - 52:00 interesting aspect and hopefully you'll start looking into these various areas of the business because i'm always fascinated by how many different combinations there are out there how you can be involved in the real estate business mezzanine lenders are doing kind of they're a second tier lender so you might get let's say we're building a 100 million dollar building we can get 70 million dollars in a 70 loan on our mortgage from our bank but we'd like to get a hot
• 52:00 - 52:30 higher debt on our capital stack so maybe we go to to a mezzanine lender who takes us up to let's say um to 75 or 80 or let's say we got a 60 loan and we want to go to 75 percent it's coming to come at a much higher interest rate much like a hedge fund mezzanine lenders are out there like 12 13 so it's really expensive but if you need that little piece and it gives you enough juice on your equity side then it's a very interesting component to the to the way to fund a deal and then public bonds and grants which are just
• 52:30 - 53:00 local state federal government for public projects most most commonly and typically if you're going to do something that involves public bonds or grants you're also going to pay a prevailing wage so there are two types of ways to construct a building there's either an open shop where you can use anybody anybody any painter that can paint can come paint this building or if it comes with public bonds or grants it's got you know federally produced dollars it needs to pay prevailing wage well that might be a
• 53:00 - 53:30 very limited number of painters who actually qualify almost and it's very uh well equated with unions so let's look at that when i when i mentioned that banks take money from you and they put money out to make money or pension funds or insurance companies how are they actually doing that and what they're working is called arbitrage or spread they're looking for a play in the interest rate so let's say you know banks for example they use deposits and savings account to create
• 53:30 - 54:00 other products so they can lend at greater interest rates they are using your money to make money so let's say just for example we go down to wells fargo i'm a wells fargo banker so i'm just using wells fargo and i put in a thousand dollars at one percent interest rate in a certificate of deposit a cd so at the end of that one year wells fargo would owe a hundred and one thousand ten dollars guaranteed because it's a bank it's remember it was very low on a risk profile
• 54:00 - 54:30 now as wells fargo pools all of those cd money let's say they take your thousand dollars and they create a mortgage at three and a half percent so uh that three and that three and a half percent on the thousand dollars is going to produce thirty five dollars for wells fargo they only owe you 10 so they made 2.5 or 25 in the spread or the arbitrage and of
• 54:30 - 55:00 course they're going to be some operational uh expenses et cetera so they don't net the whole 25 but they're not a fair amount of it so when you look at that and you can let's say a ground-up development of a new multi-family apartment building if we can say that we've done our whole pro forum we can build that building at a five percent cap rate or five percent yield on total project costs but i can buy a building at three and a half percent right now done stabilized tenants etc that one and a half percent or that 150
• 55:00 - 55:30 basis points is the spread and if there's money in the deal then it's worth the risk you would do it you would go for the higher return so with that let's call that end of part one and i very much appreciate your time you