YFP REI 102: Navigating Today’s Market with Economist Alex Cartwright, PhD

Alex Cartwright, PhD, an associate professor of economics and managing partner at Vilicus Capital, discusses strategies for navigating today’s real estate market, why he is making a move toward syndication, and why clenching onto tools won’t necessarily help you get to where you want to go. 

About Today’s Guest

Alexander Cartwright is Managing Partner at Vilicus Capital where he is responsible for managing the firms’ strategy, market analysis, and underwriting. Alex has completed dozens of multifamily real estate transactions and has overseen dozens of complex rehab projects.

Alex is also an Associate Professor of Economics & Chair of the Management Department at Ferris State University where he teaches classes on Managerial Economics, Economic Growth, and International Business. Alex has published many peer reviewed papers in leading economics journals, law journals and national newspapers. Alex is an affiliated scholar with multiple think-tanks and has served as an Economic advisor to congressional candidates in Peru.

Previously, Alex was a consultant to Open Door Capital, one of the largest owners of mobile homes in the United States, where he oversaw construction, infill and capital improvement projects on multiple communities and provided underwriting on outparcel development projects.

Alex received a B.S. in Mathematical Economics from Hampden-Sydney College where he graduated Phi-Beta-Kappa, Summa Cum Laude and first in his major. He earned an M.A. and PhD in Economics from George Mason University where he was the F.A. Hayek Fellow in the program for advanced study of Philosophy, Politics, and Economics at George Mason University’s Mercatus Center.

Episode Summary

The tools and skills that got you where you are today won’t necessarily take you where you want to go. You have to invest in yourself, so our guest today strongly believes. In this episode, we wanted to bring an economist on to talk about what the market is doing from a global standpoint and we promise it’s not a boring economics lecture! Our guest today is Alex Cartwright, a Managing Partner at Vilicus Capital. He is an Associate Professor of Economics and the Chair of the Management Department at Ferris State University, and on top of that, he is also a real estate investor. He’s the type of guy who has done some really interesting things and has a unique way of diving into complicated topics and breaking them down. In our conversation today we talk about the training wheels of investing in real estate and everything that encompasses. We hear why Alex is making a move toward syndication, and why clenching onto tools won’t necessarily help you get to where you want to go. He does a deep dive into understanding cap rates and NOI and shares his opinion on the multi-family cap rate drop. If you want to hear more about hotel conversions, and so much more, don’t miss out on this episode.

Key Points from the Episode

• Alex gives listeners a background of who he is and where he is today.
• He tells us more about the training wheels of investing in real estate: the duplex.
• Benefits of the FHA loan.
• A few common objections to the duplex.
• Understanding syndications and Alex’s moves in this direction.
• He talks about holding onto tools; what got you to where you are won’t get you to where you want to go.
• The most important thing you need to understand for evaluating different kinds of commercial real estate.
• He does a deep dive into cap rates and NOI.
• Alex shares his opinion on the four things that caused the multi-family cap rate drop.
• Alex talks us through how he converts building uses and the back story. 
• Why Alex feels good about a free-market capitalist-oriented solution to provide affordable housing. 
• Where things are heading with interest rates and cap rates; and what we might expect.
• How to evaluate an operator.

Episode Highlights

“Everybody can start educating themselves, no matter where they are on the journey.” — @AlexCCartwright [0:08:30]

“If it’s got one front door, at some level, it’s a liability. Meaning it doesn’t put money in your pocket every month.” — @AlexCCartwright [0:08:48]

“The number one cost in all of real estate is a vacancy.” — @AlexCCartwright [0:10:24]

“I decided that what got me to where I am is not going to get me to where I want to go.” — @AlexCCartwright [0:19:51]

“What a 10 cap means is that if you bought the property in cash, you would get a 10% return.” — @AlexCCartwright [0:26:10]

“Sometimes I say to my students like, if you want something pretty, then go buy it at Nordstrom – we’re not trying to buy things that are pretty. We want to buy things that make money.” — @AlexCCartwright [0:37:19]

“The best investment is what you can make in yourself.” — @AlexCCartwright [0:46:40]

Links Mentioned in Today’s Episode

• Alex Cartwright on LinkedIn
• Alex Cartwright on Twitter
• Vilicus Capital
• Open Door Capital
• Bigger Pockets Podcast
• Brandon Turner
• Apartment Investing Podcast
• Range
• Episode 26 Senate Eskridge
• Episode 53 Senate Eskridge
• Episode 24 Savannah Arroyo
• Epiosde 21 Ketan Patel
• Robert Kiyosaki
• Grant Cardone

Episode Transcript

[INTRODUCTION]

[0:00:05] NH: Welcome to the YFP Real Estate Investing Podcast. I’m Nate Hedrick.

[0:00:09] DB: I’m David Bright. We’re both pharmacists and real estate investors that believe that real estate investing does not have to distract from a meaningful career in pharmacy. 

[0:00:17] NH: Each episode we share stories that educate and inspire pharmacists to leverage real estate investing as a part of your financial plan. 

[EPISODE]

[0:00:25] NH: Hey, David. How’s it going? 

[0:00:26] DB: Hey, good. Thanks. How are you doing, man? 

[0:00:28] NH: Good. It’s springtime. It’s been busy, though. It’s been awesome. We had a chance to get away. Me and the fam went off to Florida for about a week, which was really nice. We just sold a house. We got a lot going on. It’s been really good. What about you guys? 

[0:00:40] DB: Yeah. It’s been wild. The real estate market for sure. Now, we did not get a chance to go to Florida. We’re still here in cold Michigan. There was hail this week. It’s like, yeah, it’s still wild up here, but it’s a strong season in the real estate market. That’s for sure. We’ve got a few flip projects finishing up. We’re trying to buy a couple of properties right now. I’m really hopeful that as we see the trends in mortgage rates like, I don’t know if you see mortgage rates in the last couple of days, but they’re coming down quite a bit compared to the early part of March. We’re recording this in early April 2023, trending in a lower direction, which is nice for buyers and sellers. 

[0:01:14] NH: Yeah. It’s definitely heating up the market again. We’re seeing more and more properties here, at least locally, that are coming on the market quickly, selling quickly. That inventory problem is still persistent. It’s making for an interesting spring real estate market, but it’s good. It’s nice to see those rates coming down. 

[0:01:30] DB: Yeah. In keeping with our push in season two of the YFP Real Estate Investing podcast, we’re focusing much more on current events and changes to the real estate landscape, referencing back to a lot of earlier episodes. We talked about in the first 100 episodes, but many folks that have been tuning in for years have probably been hearing us talk about rates in threes or even the low fours for even investment properties. That’s certainly not a thing right now. 

We’re seeing some major shifts to much higher rates compared to that, although historically, just a lot more normal, much more wild than they were during the first little bit of COVID there. Really those big market shifts, that’s a good time to bring an economist into the show and talk about what is the market doing from a global standpoint. 

[0:02:14] NH: Yeah. I don’t want anyone to panic, right? You’re an economist and you start to think like boring economics lecture, here we go. I promise, it’s not that, right? We’ve brought on Alex Cartwright. Alex is a Managing Partner over at Vilicus Capital. He is an Associate Professor of Economics and the Chair of the Management Department at Ferris State University. He’s done a bunch of really interesting things in the real estate market. He’s been a consultant for Open Door Capital, Brandon Turner’s company that you may have heard of. 

He’s a guy that has done a lot of interesting things and he has a great way of diving into some of these really complicated topics and trying to break them down. Again, on top of all those things, he’s also a real estate investor himself. It’s not just theory. It’s really based on reality and actual experience too. Again, the perfect person to bring on for our next episode of season two. 

[0:03:00] DB: Yeah. I his perspective too, because he got started with single-family rentals. He got started – and he’s got some fun stories about getting started, even smaller scale and a different business, entirely. He’s jumped all around and been just very entrepreneurial in his journey and growing through all of those stages. He can talk about the “getting started” and gives great advice for getting started with the markets doing there. He’s also giving great advice for larger projects and conversions. On his end, he’s working on a syndication project. He talks about syndication and what’s the market doing in that world too. With the big picture economics hat on, the market shifts over the last couple of years, I found the conversation really helpful for a lot of those stages and a lot of those concepts. 

[0:03:45] NH: Yeah. I completely agree. I think, again, just some of the ways he breaks down these topics that are really relevant to what’s going on today. Super, super helpful. Hopefully, you guys enjoy the interview we did with Alex. As always, if you have questions or if you want to hear more interviews like this one or the topics you want us to cover, please head on over to yfprealestate.com. You can connect with David and I there. We can find ways to make the podcast more for you guys. Hope you enjoy this interview. With that, enjoy. 

[0:04:15] NH: Hey, Alex. Welcome to the show. 

[0:04:17] AC: Glad to be here. Good to see you guys. 

[0:04:19] NH: Yeah. Thanks for joining us, man. This is going to be really fun. Why don’t we jump right in and give everybody a little bit of background on you and why you’re here today? 

[0:04:26] AC: Sure. I’m an Economics Professor at Ferris State University. Before I was an Economics Professor, I was a poor graduate student. I led to school in a very expensive city, Washington DC. When I was looking for a place to live right after graduation, it dawned on me that I could buy a house and rent out the rooms to other people in my program. I was amazed at how lucrative that was. That is what really got me interested in real estate in general. 

As a poor grad student, the bank just didn’t have enough faith in me to give me a mortgage, so after several attempts and saving up lots of money to put down, I was unsuccessful in securing a property, but took that love for real estate and decided that what I would do instead is buy cars to rent out on Uber to other drivers. This was right when Uber was becoming a big deal. UberX, the platform that most people are familiar with had just come out. 

I bought a car and again, just taking the concept of buying an asset, chopping it up into little pieces, and renting it to people. I bought a car. I created a website where people could reserve a car for hours at a time. I took a percentage of their earnings. Then I leased out a parking spot in the center of Arlington, where people could come on public transport to use their car for Uber. The sales pitch was, if you don’t have a car that’s Uber approved if you don’t have a hybrid if you don’t want to use your personal car, you don’t have a personal car, whatever the story is, you can come and use my car. There is no minimum amount of time or maximum amount of time, reserve it for a half hour at a time. I don’t make money if you don’t make money. 

I get the car, it’s on the road 24 hours a day. Then I get another car and another car. Then I figured out how I could sell some minor damage insurance on my cars, but the whole time I’m thinking about my cars as if they are little pieces of real estate. Now, unfortunately, you can’t cost-segregate cars. Cars don’t appreciate their value. Cars need repairs. As soon as I graduated and got a real job, I took my W2 income down to the bank and secured my first FHA loan for a duplex, which is how a lot of people get started. That’s how I encourage all my students to get started in real estate. 

We can talk about how, and why that’s just a great path like landlord training wheels if you will. I lived in a duplex for a couple of years. Got another duplex. Got another duplex and tried to build my portfolio from there. Then for the last two years, I have been working on syndication deals. 

[0:07:08] DB: Yeah. I love that natural transition to from just being a little bit scrappy, getting in where you can, doing what you can to get started, and then just growing from there. I feel like that’s a very common thread of people starting off with, well, and maybe not starting off with cars, right? But at least starting off with the single-family house duplex, something a little more achievable there and then growing in bigger investments. I think the bigger investments are really impressive. I want to get there, but can you talk for a minute about that single-family house or duplex? As people are trying to think that through, where do I get started? Tell us a little bit about the training wheels of investing there as you said. 

[0:07:44] AC: Sure. Let me just one point about that slow start. Like a lot of people are ego to get started, but they think, wow, I’ve got to pay down some debt or I’ve got to get a higher paying job like, there are a lot of barriers. This is the thing that for a lot of people getting started, you got to plan a good 12 to 24 months out sometimes to put yourself in a good position. You just use that time to get yourself educated. That whole time I was driving for Uber, I was listening to the BiggerPockets podcast. That’s one of my favorites. 

I was also listening to Apartment Investing with Michael Blanc, another one of my favorites. I’m constantly, I’m educating myself so that when the time came that I could afford to get a property, I was ready, not just financially ready like I was mentally and emotionally ready for it. Everybody can start educating themselves, no matter where they are on the journey. I’m shifting gears to thinking about a duplex. Here’s my quick sales pitch to all my students versus a single-family house. I’m sure you’ve had a lot of other guests that have said the same thing. I can’t take any credit for coming up with this, but I agree with it. 

If it’s got one front door, at some level, it’s a liability. Meaning it doesn’t put money in your pocket every month. You buy yourself a single-family house, and hopefully, that’s cheaper than renting. That’s absolutely an empirical question. It really depends on if you’re going to live there for longer than four or five years in most markets, just because there’s maintenance, there are closing costs when you buy and when you sell. There’s no shame in renting. I don’t want there to be any shame in renting. This is number one. It’s got to actually be worth it to buy a single-family house. If it’s got one front door, it takes money out of your pocket every month. Hopefully, you’re gaining some appreciation, but you can’t bank on that. 

Some people in the industry, I think rightfully call waiting for appreciation as smoking hopium, right? We’re just hoping, hoping, hoping that it’s going to go up in value. We can talk about it later. It’s one of the things I like about commercial real estate, the more I get involved in it, you don’t have to smoke hopium. You’ve got a lot more control over the value of your asset. When you get a single – now a lot of people will get a single family and think, I’m going to live here a year or so and have a nice low-down payment, then I’ll be able to move out and use it as a rental. There are absolutely benefits to renting a single family. 

One is you’re usually able to offer a yard and that attracts young families, and people with pets. Those are amenities that you can’t get in a larger apartment building. You’re competing with apartment buildings on things other than price, which is nice. Those families do tend to stay longer as tenants. That’s good, of course, because the number one cost in all of real estate is vacancy. At the same time, though, I think that’s an excuse for a lot of people. Yeah, I’m going to buy this house that really my wife or husband really likes and we’ll turn it into a rental someday. It’s rarely the most profitable path. 

What you want to do is get a duplex. Think of it this way. You can get an FHA loan, an owner-occupied loan for three and a half percent down. That’s the only loan that you can get on a multifamily property where you put less than 20 percent down. You put three and a half percent down. That’s only seven grand for a $200,000 asset. Now, let’s set all other benefits aside. If that $200,000 asset just appreciates 3% a year, this is not smoking hopium, 3% is quite reasonable. You capture all of the upsides, by the way. You don’t have to share any of that appreciation with the bank. This sucker appreciates by 3% for two years. You’ve already appreciated $7,000, right? That was your down payment. 

Also, what’s very achievable in most markets, and like where I am in grand rapids, you can find a $200,000 duplex where you can rent one unit and that will cover the entire mortgage payment. Maybe you’re not putting, not just the mortgage payment, but the taxes and insurance also. I understand you’re not putting tons of money in your pocket, but as I’m sure you guys talk about, you want to have your money in something that’s compounding and most people’s biggest expense every month is their housing. Average American housing is over a third of their income. 

There’s almost nothing that most people can do to raise their income by a third, except by a duplex, because by making your housing expenses zero, you’re raising your disposable income or the income that you can put in something that compounds by one-third. There really is nothing you can do to raise your income by a third. That doesn’t require a license and doesn’t require any more of your time. You don’t need anybody’s permission to do it. You need to get out there and make that your first investment, also because you’re two, or $300,000 duplex, it probably only has two bedrooms per unit, max, maybe three bedrooms per unit. 

As people get a little bit older, they get married, they have a family, and inevitably what school districts you’re in matters. How many bedrooms you have matters, if the tenants are next door making noise here and there, that matters. When you’re young, you can afford to put up with those inconveniences or maybe you’re single and can put up with those inconveniences. You need to take advantage of having that in life. 

The last thing I’ll add is with the FHA loan, once you have lived there as your primary residence for 12 months, which in order to put that three and a half percent down, it does have to be your primary residence. Then you can leave. You can rent both units. You can live wherever you want. You’ve got that asset that mortgage is getting paid a little bit down a little every month. You’ve got income that you’re not trading more time for and you’re at some level, you can always move back in there. Your housing is covered, no matter what. That’s great peace of mind. You got somewhere to live, no matter what happens. 

There’s the long and the short of it. Everybody needs to do that at least one time. It sounds big and scary. Let me just — here are a few common objections to it. I hear people say, “Well, what am I going to do when the toilet overflows in the middle of the night?” Everyone says – by the way. I’ve never had any toilet overflow in the middle of the night. I’ve got dozens of units. Have you guys ever had a toilet and ever flow in the middle of the night? 

[0:14:05] NH: No, but now that you’ve asked, it’s going to happen, right? 

[0:14:07] AC: It’s going to happen. 

[0:14:08] DB: Everybody’s knocking on wood. Yeah. 

[0:14:10] AC: What everybody forgets is, if you buy a single-family house, stuff can break in that too. It’s not like duplexes are necessarily more susceptible to having problems. If something breaks, what do you do? You call someone and you fix it. Like if you own a house, stuff is going to break. It’s like owning a car. Stuff’s going to break. Well, I’d rather own a house where at least I’m staying there for free, okay, or at least I can rent both of them out someday. 

Then I also hear, “Oh, my dad.” I get that a lot because I’m talking to undergraduate students, or my cousin, or my rich uncle, or somebody told me, they don’t invest in real estate, because what happens if the tenant doesn’t pay? That’s just really hard. You got to leave that real estate game for the rich professionals. Guess what? You are never getting that advice from people that own duplexes. No one that owns a duplex ever said that. Ask the people that actually use this, they call it the house hacking strategy. If they regret it, you’d be hard-pressed to find one person that’s telling you that this didn’t work out for them. Take advice from people that have actually done it. 

[0:15:19] NH: Yeah. I love that. That was just the primer on why somebody should consider real estate investing. I think that was awesome. The way you walk through all that. Again, we still encourage people to get started in the exact way that you’re talking about, right? Buying a single-family home, buying a duplex, running out half, buying a triplex, running out two of the units, and living in one, right? That’s awesome. 

I know you have started the shift away from that more toward this syndication commercial space. Maybe just tell us a little bit about one very briefly, and we’ve covered syndications in the past on a bunch of past episodes. If you’re looking for those, you can go back to our core season. We’ve got episodes 26 and 53 with Senate Eskridge, in episode 24, we talked to Savannah Arroyo. Then even in episode 21, we talked to Ketan Patel all about syndications. Maybe give us a super quick like this is what syndication is. Then what you’re doing with that. 

[0:16:06] AC: Yeah, sure. I’ll tell you a story about syndications and why I’m making the move for it. Syndication just means you got a group of people coming together and they’re buying a property as a group. Now that we call it a syndication instead of a partnership or a joint venture because in a syndication specifically, people within that group are passive investors, meaning they’re just fronting capital and they don’t have any hand in the day-to-day operations of the property. 

It doesn’t mean they don’t have decision authority or they don’t have a say, they can’t vote on what should happen, but they’re not responsible for the daily activities of a property. Whenever you invest or make decisions — financial decisions on behalf of someone else, in other words, you take their money, make decisions with it and promise them a return, in the United States, you’re selling a security. That’s regulated. When you syndicate something, what you’re doing is you’re selling people shares in a building. They call it a syndication as opposed to just a partnership or a joint venture. It’s a fancy word for a partnership where some people are completely passive. 

[0:17:16] DB: With your economics hat on as well, can you speak to what’s going on in the market lately with interest rates and cap rates and how maybe even defining cap rates real fast to talk about how commercial property is valued, what those values are doing right now in the trend of direction and also the trend of the direction of interest rates on loans and how that all comes together. 

[0:17:36] AC: Yeah. I will do that. I’ll talk about interest rates and cap rates. I want to just say about what interests mean in syndication, but I also want to tell you a story that comes out of a book that is, been my favorite book for the past two years. It’s called Range R-A-N-G-E by David Epstein. If you haven’t heard of that, you need to go and get it. One of the stories in that book is about firefighters that would fight forest fires. I think they also mentioned firefighters that are fighting regular fires in buildings. The author describes how firefighters are often found deceased with their heavy oxygen tanks strapped on them. 

An oxygen tank is an important tool, but it begets the question of, if they perhaps could have survived, had they dropped the oxygen tank, which would have allowed them to, I guess it’s quite heavy. That would allow them to be a lot more agile to escape whatever dangerous situation they’re in. People that have studied this believe that if these firefighters would just drop the tanks, they’d be able to get to where they were going and survive. What I take away from that, and what the author takes away from that is we often clench onto tools that are familiar to us and not just that have been familiar to us, but tools that have helped us get to where we are. 

I think for my case, the tool that I was really clenching onto is the duplex and my F-150. Those two things. Wow, they have been beneficial in making me financially free and confident and giving me a lot options, but I realized that – and that I’m sure that if I continue to clutch on to duplexes and my pickup truck, it would continue to produce results for me. I was just on another hamster wheel. We talk about how you want to be financially free, because it’s not scalable to work for money, to trade time for money, but getting duplexes, well, that’s great. I’m not discouraging it at all. It’s not the most scalable real estate investment out there. 

As difficult as it was mentally, I decided that what got me to where I am is not going to get me to where I want to go. I went to this real estate meetup in Houston. It was at a brewery, and I’m talking to different people there. I was in Houston to look at a property that was for sale. It was 120 units, a large property. I said, “Yeah, I think I’m going to put an offer in, on that property.” I’m telling other people that are at this brewery. They said, “I saw that for sale too.” I said, “Well, I don’t live in Houston like I’m becoming an expert on this market. Tell me, what do you think of it?” They said, “Well, it’s five and a half million dollars.” I’m like, “Well, understood, but that’s also $47,000 and change a unit.” They’re like, “Yeah, but it’s five and a half million dollars.” 

I thought to myself like, if you ran a business, and I told you, you could have a billboard on your local interstate, but it’s 100 grand a month. What would you say to me? You might say, a100 grams a month is a lot of money. I would tell you, the 100 grand a month is irrelevant like it depends on what is that billboard going to bring me in terms of new traffic like an ROI, you can’t evaluate the I without knowing the R. You got to know both of them together like, let’s not get hung up on the fact that it’s 100 grand. Let’s look at the return. 

Those guys are like, “Yeah, but that building’s five and a half million dollars. That’s too much.” I’m like, “Is it?” Then I heard all these guys talk about how, okay, got these great deals off market on their duplex and their triplex. They got this appliance on clearance at Lowe’s and that appliance on clearance at Lowe’s. I’m like, “Yeah, I know how that feels. I’ve been there.” They found this contractor and that contractor and they got their system down. I’m like, “Yeah, I’m right there with you.” Then they all went out and they got in their pickup trucks and drove away. I thought I cannot – I need to graduate from this. At the time I was doing some consulting with Open Door Capital, which is I believe the second-largest holder of mobile home parks in the United States. 

I had an opportunity to get some one-on-one time with Brandon Turner, who is the founder of that company and host of – used to be the host of BiggerPockets. He’s like the best decision I ever made is when I put my tile saw on the curb. I didn’t even try and sell it. Just said, “Get rid of it.” I thought, yeah. I got to drop the oxygen tanks. I got to put my tile saw on the curb. The people that go after the five-and-a-half million-dollar buildings, they don’t drive pickup trucks. That’s for a reason because they don’t want to get distracted with that stuff. It’s not. 

I traded my pickup truck. It’s not an arrogant thing, whatsoever, right? I was just like, what is going to get me to where I want to go to the next level is not what got me there. In deciding to not do — I did buy one for Fourplex last year, but just because it was a good deal. I thought about whether or not it was a good use of my time to do it, and I just decided that I wanted to move into taking people’s money as investors and using my knowledge to negotiate and acquire larger deals where the returns are larger and where my efforts are more scalable. As somebody doing that like building a brand and doing that at first, that’s hard. That’s going to take time, but that’s what I’m working toward. 

[0:23:18] DB: Well, I like how you talked about the ROI piece there, right? The return on the investment is the investment scale. You’re focused on the return. You, obviously as a professor, as a teacher of this, you can focus on some of the metrics of that. That’s where that cap rate piece comes in, right? That’s how you can start to evaluate some of these larger properties and start to look at that investment. Is that right? 

[0:23:40] AC: That’s right. Let me talk to you about that. This is the most important thing you need to understand for thinking about and evaluating different kinds of commercial real estate. Before I get to the cap rate, let’s just back up one level further. You guys know that when you are looking at a single-family home, the value of the single-family home is primarily determined by the comps, by the neighborhood. The appraisal look at what’s comparable and determines the value of your home based on what other people are paying for similar products in the market. That’s also true for a duplex. That’s true up until five units. 

After five units, it’s considered a commercial asset. At that point in time, the value of the property is totally and completely determined by income. In other words, the location, the amenities, and the features of the property, right? How visually appealing it is, etc. All of that at some level is factored into the rents that that property generates. Appraisers look at the income that a property generates. Then that income is multiplied by some number in order to give the property a value. 

Now, I can’t help but say, this is how every business is valued. Every business even outside of real estate is valued based on the cash flow that it generates. Commercial property, meaning an apartment complex or a self-storage deal or an office building, or a hotel, same story. We look at how much cash it generates. We put a value on the property based on that stream of cash flow. 

On Wall Street, they talk about multiples. How many times am I going to multiply your earnings in order to get there? In real estate, we talk about it a little bit differently. We still talk about multiples, but we talk about it in terms of a cap rate, which is quite literally one divided by the multiple that is being put on those earnings. Now, the reason, so I’ll give you an example. If we say that a property trades or is evaluated, valued is probably a better term at a 10 cap, which means that every $1 of value that that property generates is multiplied by 10. If it’s generating $10,000 a year, the property is at a 10 cap, worth $100,000. 

What that 10 cap means, sometimes you’ll see it expressed as a percent, cap stands for capitalization rate. What a 10 cap means is that if you bought the property in cash, you would get a 10% return. That quick math is, that’s one of the reasons why we talk about real estate in terms of cap rates instead of multiples. Now, just one quick thing to add on to that, the number that gets multiplied by the one over the multiplier or the number that gets multiplied by a cap rate is what’s called the NOI or net operating income. That’s all the rent, essentially the rent minus the expenses, but before any debt is paid. 

It’s done that way, because everybody will have their own different capital structure or debt terms. You take your NOI, divide it by your cap rate, and you get the property. Then the question is, where does the cap rate come from? The cap rate is set by the market. Of course, I can’t help but say as an economist that the market just means buyers and sellers, not like some abstract force, not the government imposing the cap rate on us. For example, hospitality, volatile cash flow, and seasonal, the cap rates tend to be 10, 12, maybe higher, meaning in a higher cap rate, lower multiple placed on the income. 

What tends to have the lowest cap rates, or in other words, the highest multiple placed on their income is what’s considered the safest, highest growth, most desirable real estate. That’s multifamily. Over the past 20 years, we’ve seen cap rates falling for multifamily, but even over the past three years, we’ve seen just a drop in cap rates for multifamily, meaning that people are paying more and more for a dollar of multifamily income. 

Your broader question, David, what is that caused by? In my opinion, that’s caused by three things in rank order. Number one is the low-interest rates that the Federal Reserve has created by expanding the money supply by 40%. Number two is the ensuing inflation that those low-interest rates caused causing building prices to be so high. That’s building prices, both in terms of labor and materials. Then three, a more restrictive regulatory environment for building doesn’t — it never gets any easier to build anything. 

Then I will add in a fourth. That is, we see an acceleration in household formation. Household formation, meaning when do people start living on their own, and have their own address — as marriage is delayed and people go to school longer and become independent a little bit earlier, we’ve seen demographically household formation getting accelerated for many years. 

[0:28:47] NH: It’s such a great perspective on what actually is going on. I appreciate your deep dive into cap rate, because it gets started around a lot, especially by new investors, or like, I’ll hear this on like TikTok thing, right? They’ll throw something about cap rate and they have no idea what they’re talking about. It’s nice to hear it from an economist to actually fully understand that. I appreciate it. 

One of the things you mentioned, which I think is interesting, you mentioned that hospitality versus multifamily like everything has different cap rates. There are different risk levels and different returns based on what thing you’re investing in. I know you have some experience in actually converting building uses, right? You would take one building currently used for X and convert it into something totally different. Can you talk us through a little bit about that? Because I find it really interesting. 

[0:29:29] AC: Sure. A little background on that. Cap rates have become so low, they’ve come up a little bit as interest rates have come up. The people sellers are not able to demand as much of a premium for their apartment complexes, but cap rates were so low for multifamily. Multifamily was so hot that you couldn’t buy anything that generated an IRR north of 20%. That’s my personal metric. I take – we can talk about it if you like, I take what’s called the efficient market hypothesis very seriously, meaning that it is extraordinarily hard to get consistent returns that outperform the S&P 500. 

If people are going to hand me their money, then I need to be really sure that I’m projecting something far north of 8%. That’s the long-run average of the S&P 500 after subtracting out a couple of points for inflation. I couldn’t find apartment buildings where you could conservatively realistically show that your investors are going to get an IRR north of 20, which is really where I want to be. We try and be at over 25 IRR and all our deals for our investors. IRR meaning Internal Rate of Return. 

Multifamily is so hot, I thought to myself, how am I going to get a smoking hot deal on multifamily? There are lots of big groups out there that have hundreds of millions of dollars. They can throw around. They can put down non-refundable, $100,000 earnest money on day one. They can close in 30 days like, they’ve got so much experience getting loans from Fannie Mae and Freddie Mac, they can get the best rates. They’ve got in-house property managers like, why should people invest with me versus going with the big dogs who have a lot of experience and buying power? I couldn’t come up with a compelling answer to that. 

I started looking at alternative strategies. I heard a lot of people talking about hotel conversions, which is where you buy a hospitality product and you do some work to the building to convert it into workforce housing. Conversion there is a little bit ambiguous because the conversion refers to making physical changes to the building like in the case of a hotel, perhaps adding kitchens, but it also refers to making a financial change to the building, namely buying something at a hospitality cap rate, where you’re paying maybe 10 or six or $7 for every dollar of income, and then converting it to multifamily, where maybe you’re going to get 15 to $18 for every dollar of income that you generate. 

You’re converting it to something that has a much slower cap rate. I thought that all sounds good, but what a pain in the butt that must be like, I’m thinking to myself, first of all, a ton of construction and a ton of construction means unknowns, right? It also means it’s expensive in terms of dollars and the time it takes to get that stuff done. Then also, you got to find a city that’s open to rezoning a property or at least allowing you to change the use. Then you’ve got to find a seller that’s willing to let you put a property under contract for not two weeks or 30 days, you might need 60, 90 days to go to the city and say, “Hey, what do you guys think of allowing us to change the use of this asset?”

Then maybe you have to hire an architect to pull that off. Oh, and by the way, a lot of these two-star older hospitality buildings are franchises like a motel six or a holiday inn. Those are franchises. For the seller to take the franchise off, they’ve got to pay some pretty hefty, they call [them] liquidated damages. They’re essentially fees for leaving the franchise. I thought, wow, that’s a lot of hurdles to overcome, but in having that mindset, I made a mistake. That is, I didn’t just put numbers on those problems. 

That’s what all good entrepreneurs do, especially in real estate. There’s a problem, put a number on it like, this house has a crappy location. Great, put a number on it. House needs a bathroom, put a number on it. Needs a new roof, put a number on it. All these problems just put a number on. I went – and I started looking at these hotels. I started putting numbers on those problems like big exaggerated numbers. Without getting too much in the weeds, I just said, “Wow, figuring out how to solve these problems is just worth it.” 

It’s just worth it, because for example, in Texas, class C, which is workforce housing trades for around a low 100,000s per unit, whereas you can buy hospitality for 35 to 45,000 a unit. Sometimes extended-stay hotels that already have kitchens in them. When you’re in one of the hottest markets like a great location, hotels also happen to be in great locations, right? They also happen to have really nice amenities. 

By the way, old hotels, they’re not that desirable. People don’t really remodel two-star hotels, maybe once. Then they just build new ones. I was, okay, that is worth figuring out how to do. I’ve been studying that for over a year, put different hotels under contracts, found out, and learned all the different complexities. I’m trying to build a brand around being the person that knows a lot about hotel conversions. 

[0:34:43] DB: Well, and I like that. The big picture, if you’re buying at 45,000 a unit. You’re selling at the six-figure price per unit. Then by converting the purpose of the building without even necessarily a lot of physical change, but by just getting in, managing it differently, converting the purpose, you’re able to double your money then, essentially. Save for some of the expenses, but just to very oversimplify, you can go in and double your money just by changing the purpose of a building because you’re understanding some of the market forces and how the cap rates are driven. 

[0:35:15] AC: That’s right. I also think to myself like, why do I want to be a multifamily in the first place? Well, here’s why I like real estate in the first place. It’s scalable like, we’ve all agreed there. Also, we like that it’s relatively safe. Meaning — and safe in the sense that it provides cash flow every month — I don’t know what technology Apple, Amazon, Google, or Netflix is coming up with that’s going to destroy demand for $1,100 a month apartments and people at essentially every income level, at some point in their life need $1,100 a month apartment. There’s a need for that in every city. Guess what? The supply of eight to $1,100 a month apartments is not going to expand. 

There’s likely more demand for that product as interest rates rise and more people are crowded into the rental market. Arguably, even as the economy overall shrinks, there’s more demand for that product. I thought, hotel conversion, it’s not just a better deal financially, but the macroeconomic fundamentals make it less risky. If I’m buying things at a lower price point, I’ve got lower taxes than my competitors. I got more pricing power than my competitors. I got a lower break-even occupancy than my competitors. I don’t have to lease as many units to get the bills paid in a worst-case scenario. 

It’s not just like, okay, here’s a different strategy where there’s not a lot of competition like, it’s better. It’s better than the B at A class stuff in a lot of ways. Now, just one comment on that. When I first started looking at real estate, and you guys know, when you go out and look at a $100,000 house, it’s not fancy. It’s got some stuff that you probably don’t like. A lot of people that are not really analytical, they can’t imagine themselves living there. For that reason, they don’t want to buy it. I’m not that direct when I’m talking to investors, because I only want to talk to people that want to invest, right? I don’t want to twist their arm. 

Sometimes I say to my students like, if you want something pretty, then go buy it at Nordstrom like, this is – we’re not trying to buy things that are pretty. We want to buy things that make money. I don’t want to live in a hotel room. Some people don’t want to live in a hotel room. But guess what? When you’re making 30, 40 grand a year, the difference between a $700 a month hotel room, and a $900 or $1,000 a month apartment, that’s a big deal to somebody. There’s demand for that product, so we want to provide it. 

I feel good, not to sound ideological, but because I’m an economist, right? I’m all about markets. I like free markets. I feel good about using a free-market capitalist-oriented solution to provide affordable housing. I don’t want young people to be burdened with debt and get out of school, have to put a third or more of their paycheck toward their rent, and think to themselves, gosh, I just can’t get ahead. The system is rigged against me. I worry that biases them against free enterprise and free markets. We feel good about being able to provide a solution that fights against that sentiment. 

[0:38:25] DB: I like that a lot. I like the very different strategy that you’re giving us a deep dive into versus what a lot of syndicators are doing by doing this use change and by leveraging that. I know we’ve talked with other syndicators in the past that speak about value add and other things within an existing space. 

I think particularly over the last couple of years as you mentioned, as cap rates have come down, meaning that property values have gone up, I think we’re in this season where everybody looks like a genius that’s been in the syndication space because the market has just really helped a lot of people out. As we look ahead into the next couple of years with where things are going with interest rates and cap rates, can you give us a little preview of what we might expect, and does past performance guarantee future results? 

[0:39:11] AC: Of course, past performance doesn’t guarantee future results, but let me put a little bit of meat on that bone. Let’s say cap rates fall from a six to a four, all right. A cap rate at six means that for every dollar you take one divided by 0.06, that means every dollar of income or net income that comes in is multiplied by 16, all right? If a cap rate goes to a four, that means every dollar of income that comes in is multiplied by 25. That’s $9 for 25 over 16. That’s a 56% change in the valuation. If the cap rate goes down two points, all right? 

Let’s say you’re a crappy syndicator, and your business plan wasn’t any good. You underestimated your expenses. You didn’t get very competitive debt terms. You overpaid for the property. You recycled through three property managers. You’ve got a ton of tenants that are delinquent on and on and on. Every bad thing in the book happens, but all of a sudden, the property that you have gets valued 56% higher. 

It’s hard to lose like if you lost, I’m sorry, but you’re just a fool. By the way, the S&P 500 goes up high 20% in those couple of years when the interest rates are low. It’s like, yeah, you generated 20% on your real estate deal, but what risk did we take and what lack of liquidity did your investors have being locked up in your apartment deal versus just sitting at home and investing in their Vanguard S&P 500 on e-trade? 

Here’s how you would evaluate a syndicator, I would think. It’s not to say that their track records don’t matter, but you have to look at what they predicted would happen. Just like step back for a second. If I asked you, David, do you think it’s going to – if you told me, “Yeah, it’s going to rain tomorrow, Alex.” I say, “How certain are you, it’s going to rain tomorrow?” You say, “I’m 99% certain.” David’s really certain it’s going to rain. 

Then, of course, as an economist, we know that asking someone to bet is a tax on their BS. I would say, “David, are you $10,000 sure that it’s going to rain tomorrow?” He says, “Yes.” All right. Then let’s say tomorrow comes and it rains and David’s like, “You see it? I was right.” Let’s say David’s right like five days in a row. Well, that doesn’t mean that it was 99% likely to rain. Maybe it was only 5% likely to rain, and David happened to be right. 

The confidence of somebody’s predictions doesn’t say anything about how good those predictions are. Just because their prediction happened to be right, doesn’t say that they’re going to continue to be right at all. They may have been wildly off. How do you evaluate a syndicator with that in mind? Go to that syndicator and you say, “When you guys bought that property three years ago, the one you just sold, show me the projections that you gave to the investors.” Right? Did you project occupancy to be, where? You projected the expenses to be rare and you expected to sell it for what? Which one of those targets did you meet and did you not meet? Because maybe they sold at a low cap rate and everybody got a whole bunch of money, but they might have missed all their targets along the way, right? That would indicate to me that they’re not such a good operator. 

[0:42:22] NH: I really like that, because I feel like we’ve talked to others about how to evaluate operators, but rarely have we talked about going back and looking at the actual operation, right? We talk about results. We talk about it, you’re completely right. If the market is giving you a cheat sheet, basically, the results may not be the thing to watch. It might be the actual operation itself. I really, I really appreciate that. It’s a really good dive into that. 

Alex, I want to get your take. We do three questions with every guest on the show. We call it our final infusion questions. I want to get your take on these, see where you’re at. The first one we always ask is what’s one tangible strategy that you use to make sure that you’re investing works hand in hand with your career, right? Is the economist professor? How do you do all of that at once? 

[0:43:03] AC: I’m lying if I say that it’s not a struggle what to prioritize. As an economist, I’m the first one to tell you that trade-offs are real. I do two things with various degrees of success. Maybe these are not the right two things. One is that I make sure that I’m integrating my professional research agenda with my entrepreneurial interests. I’m doing research right now on affordable housing and the regulations that surround affordable housing. Also doing research to try to understand exactly what predicts economic growth at the city level. 

We hear a lot of things about you want job growth, you want population growth, these everyone’s got like the same four or five criteria. I’m doing research about historically how well do those hold up and actually predict different amounts of appreciation and what drives rent growth, things of that nature. Try and integrate those two, but on the trade-off point, we’ve got this concept in economics called the production possibilities frontier. I know this sounds so boring. Maybe this is not a good idea of me to try and describe a graph via audio. I think you can get it. 

All that we say in economics, if you do more of in a world of scarcity, that’s why we all trade with each other. We live in a world of scarcity. We got scarce resources and scarce time. It’s not to say you got a scarcity mindset and you don’t believe you can grow, but it is to say that we face some constraints. Well, if I do more of one thing. I’ve got to do less of another. Maybe you remember from your econ class, they threw up some examples the first day and said if a country produces more guns, then they got to produce less butter, okay? 

[0:44:42] NH: Guns and butter. 

[0:44:43] AC: Guns and butter, right? 

[0:44:44] NH: It’s classic, right? 

[0:44:45] AC: More of one, less of the other. All right, that’s right. You only have to produce fewer guns if you want more butter unless you are unable to push the curve out unless you’re actually not able to do more of both. I believe that I got imperative to ask myself like, am I on the curve? Am I at my limit? Is it actually true that I can’t do more of both or is this just some story I’m telling myself or someone else has told me? Is there a reason why you can’t do these things? 

A lot of people will tell you that you’re doing fewer, you need to be doing fewer things, you’re busy, etc. I know this sounds a little bit arrogant, but that advice always comes from people that are doing less and are just not where you want to be. I’ve learned to tastefully ignore those people. How you balance a busy schedule, what I have no secret sauce for that, right? We do the best we can. 

[0:45:42] DB: I’ve heard you hint at a little bit of Robert Kiyosaki and other things as you’ve talked. I’m really curious now, what’s one resource that’s been most helpful to you in your real estate journey, whether that’s a book, podcast, person, author, website, or whatever that would be? 

[0:45:56] AC: Wow. One person. I would say listening to Grant Cardone, just mindset-wise, even though a lot of the, he’s pretty bombastic and pretty arrogant. I think there’s a lot to be learned from the mindset there. I really like the BiggerPockets podcast. I like the Michael Blank podcast. In terms of resources, I would tell everybody, you should drop some money to go to a conference and just be around other people that are trying to do what you’re trying to do, feel that energy and you’ll be totally present and listening to those speakers. Remember that, that truly is, it’s cliche to say that the best investment is what you can make in yourself, but just break that down for a second. Buying, The 10x Rule or Rich Dad, Poor Dad, or any of these really popular books you can get for literally less than $5 used on Amazon. 

What is the ROI of reading those books? Just enormous. Incalculable. The best investment you can make. Therefore, when we’re running around and talking about being financially responsible and making your budget, which I’ll save some comments on that. But let’s set budget minimums, not budget maximums and at $3, $4 a book, if you just say, I have to spend $100 a month on Amazon buying books like, who cares if they all pile up in the house? Just give them away, right? Or just read half of them like the ROI is that high. You ought to be buying that stuff all the time. You ought to drop some money on going to conferences, that ought to be in your budget. You ought to have a goal to spend so much on that stuff. 

[0:47:36] NH: I like that. That’s new. Our parent company, Your Financial Pharmacist is like, oh, I don’t know about this, but I liked that advice. I think it’s good like tap into that ROI, spend the money, make it happen. That’s cool. All right, good. Then our last question. What’s one piece of advice that you would give to somebody, a pharmacist or a young professional contemplating a start in real estate investing? 

[0:47:55] AC: Contemplating a start really depends on your goals. There are a lot of people that – like, I like my job, right? I’m not trying to stop being a professor. I don’t know what it’s like to be a pharmacist. Maybe some people love it. Maybe some people don’t. The degree that you’re studying and what you’re studying and what you’re thinking about doing and who you’re around, at some level is driven by your goals. If you’re trying to make yourself a little bit more financially secure, then maybe a couple of duplexes are right for you or a couple of rentals, you don’t need to have 50 of them, or maybe you want to invest alongside someone else. 

If you’re trying to quit your job, you need to approach this with a different sense of urgency and a different level of energy. That requires some soul-searching. I guess my one piece of advice, I guess, it would be, I really want people to understand that all financial decisions and all financial questions are fundamentally empirical questions, meaning they’re not answered by logic alone. We don’t need to measure anything to know that the three sides of a triangle add up to 180 degrees. We know that a priori by logic, is that a good idea or a bad idea? Should I rent? Should I buy it? Should I buy a used car or a new car? Should I max out my 401k or not? 

I don’t want to – you shouldn’t be answering those questions with principles, right? Those are empirical questions. They’re not yes or no like, if you’re answering them with principles, that’s fine. If you don’t like, you’re just following a heuristic, because you don’t know how to estimate the cost and benefits but learn how to estimate the cost and benefits so that you can get yourself closer to your goals. Don’t just follow the blanket rules that everyone else is following, they’re likely wrong, and they may not be for you. 

[0:49:36] DB: I love it. I love it. If people want to find out more about you, where can people get in touch with you or learn more about you? 

[0:49:41] AC: My email address is on my syndications website, vilicus.capital, V-I-L-I-C-U-S, Vilicus stands for Steward in Latin. We’ve got an email list on there that people can sign up for. Of course, you can email me directly. My email is listed there. I’d love to hear from you. Connect with me on LinkedIn. I post stuff there occasionally, but I found that – there’s another tip. In real estate, wow, people use LinkedIn. There’s just great stuff on there all day long. If you’re not on there, it’s – you ought to be spending some time on there. A lot of great stuff I read on there every day. 

[0:50:18] NH: Wow. Awesome stuff, man. Obviously, a wealth of knowledge and somebody I hope we can have back on the show sometime. 

[0:50:22] AC: Been a ton of fun. 

[0:50:23] NH: Yeah. This has been great, man. Thank you for spending the time with us today. Again, hopefully, we’ll reach out if you’re interested in learning more about the syndications that you’re running and just appreciate all your knowledge. 

[0:50:33] AC: Yeah. Thanks, guys. It’s been a great time. 

[0:50:34] DB: Thanks so much. 

[END OF INTERVIEW]

[0:50:36] NH: Thanks for listening to the YFP Real Estate Investing podcast. If you like what you heard on today’s show, please leave us a review and subscribe to the show so you never miss an episode. If you have a question, know someone that would make a good guest or want to connect with us, head on over to yfprealestate.com and join the growing YFP Real Estate Investing Facebook group. 

As we conclude this week’s episode of the YFP Real Estate Investing podcast, an important reminder that the content of this podcast is provided to you for informational purposes only and is not intended to provide and should not be relied on for investment or any other advice. Information in this podcast and corresponding materials should not be considered as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with their financial advisor with respect to any investment. 

Furthermore, the information contained in our archive newsletters, blog posts, and podcasts is not updated and therefore may not be accurate at the time you listen to it. Opinions and analyses expressed herein are solely those of your financial pharmacists unless otherwise noted and constitute judgments as of the dates published. Such information may contain forward looking statements which are not intended to be guarantees of future events. Actual results could differ materially from those anticipated in the forward-looking statements. For more information, please visit yourfinancialpharmacist.com/disclaimer. 

Thank you for your support of the YFP Real Estate Investing podcast. Have a great rest of your week.

[END]

 

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