1. What should we focus on during economic uncertainty?
Given the potential recession on the horizon, it’s crucial to shift our strategy from offense to defense. This means emphasizing capital preservation and cash flow. These two aspects should be at the forefront of our investment decisions.
2. What are the prevailing thoughts about the economy for the next 6 to 12 months?
Many experts and analysts predict challenging times ahead, with a consensus suggesting a tough economic climate for the next 6 to 12 months. While it’s important to be aware of these predictions, it’s equally crucial to remember that every market operates in cycles, and opportunities can arise at any point in the cycle.
3. How can we take advantage of the current market cycle?
Understanding where we are in the market cycle is key to seizing opportunities. It’s normal to feel fear and anxiety during uncertain times, but the resilience and the ability to identify opportunities can lead to significant wealth creation. History has shown that downturns often present prime opportunities for those who remain steadfast and adaptable.
4. What should we look for in investment opportunities?
When evaluating investment opportunities, it’s essential to ask critical questions. First, assess the narrative behind the opportunity. Why does it make sense to invest now, considering the current circumstances? Second, consider how the investment is positioned for the future, both during the potential bottoming phase and when the market begins to recover. Evaluating the story and long-term potential will help guide your investment decisions.
5. What factors should we consider when looking at deals?
In the current climate, three factors take center stage when assessing deals: purchase price, cash flow, and debt. The purchase price should reflect the changing dynamics of the market, with potential discounts of 10% or even 20% compared to previous years. Cash flow becomes paramount as cash reserves and positive returns can ensure stability in uncertain times. Lastly, understanding the type of debt and its terms is crucial for managing risk effectively.
6. How does debt impact investment decisions?
Debt is a significant source of risk in any deal. By evaluating the downside and how operators manage risk, you can make more informed investment choices. It’s important to be aware of the current interest rates and the debt structure, opting for longer-term fixed rates when possible. Interest-only payments can also alleviate short-term obligations. Additionally, being cautious and factoring worst-case scenarios into your strategy is a prudent approach.
7. How does our approach differ from others?
Our approach emphasizes risk aversion and thorough analysis of worst-case scenarios. By partnering with experts and carefully considering potential outcomes, we strive to mitigate risks and ensure long-term success. Our current deal, for example, involves a five-year fixed loan with five years of interest-only payments. And our property’s energy efficiency qualifies us for a green loan with reduced interest rates.
8. Why not just keep my money in a high-yield savings account?
High yield savings accounts are a vital piece of someone’s portfolio. You should always have some cash to be able to use if there is an opportunity. They, however, are not an investment vehicle.
Rates are great now, but just last year they were yielding sub-1% and may be back there if the federal reserve drops interest rates again. They are also very tax-disadvantaged as income from interest payments gets taxed on your marginal rate. Distributions from syndications are tax-deferred until the sale of the property. Real estate investments offer the opportunity for both ongoing cash flow and long-term appreciation. By diversifying our portfolios with real estate assets, we can achieve a balance between immediate cash flow and future net worth growth.
9. I have a substantial amount of cash sitting in a savings account. Should I invest it all or leave it as is?
Determining whether to invest your cash or leave it in a savings account depends on your individual situation and financial goals. It’s wise to always keep some accessible funds in your high-yield savings account regardless of the economic climate. To make an informed decision, consider your desired lifestyle, future plans, and risk tolerance. If you prioritize long-term wealth accumulation and are comfortable with potential fluctuations, allocating some of your funds towards investments, such as retirement accounts or real estate, can be extremely beneficial.
10. How will the rapidly changing interest rates affect Encanto?
Encanto has a 5 year fixed loan with five years of interest only. That means no matter what the interest rate goes up to, our rate stays the same. The five years of interest only also give us extra cash flow to send to our investors. The downside of this type of loan is that they assume that we will hold the loan for the full 5 years. Most of the risk and work done by the lender is done on the frontend so they impose a prepayment penalty for those that sell or refi a property early. This may still make sense if an amazing offer is given to us, but likely we will hold the full 5 years.
11. Will there be depreciation (bonus and cost segregation)?
Yes, we will have both cost segregation and bonus depreciation. We are estimating there will be 50-70% of your investment in depreciation in the first year. If you have passive gains that you can offset (K1s from elsewhere or rental income), then off a 100k investment if you are getting 70k in losses in the first year and are in the top bracket (37%) you are roughly saving 25k in taxes that you would have paid. That’s a 25% return in the first year before you get a dollar from us. It’s very important to remember that this is only for people that have K1s with passive gains, and not typically available to W2 employees.
12. What can go wrong in the deal?
This is a great question and one that all potential investors should be asking. It’s good to know that the sponsor has thought of the different factors that could go wrong in the property and planned around it. The biggest risk in real estate right now is interest rates. It’s impossible to know which way they will go. We’ve taken care of that by getting a fixed rate loan. Another possible issue is that there is other new construction that will come live in late 2023 and 2024 and will be direct competition. The reason we are not worried about them is because of the amazing price per unit we are getting. We are basically buying the property at the cost and other new construction will have to have rents significantly higher just to break even.
13. Are you worried about other new construction in 2025 or later?
We don’t think there is going to be much new construction after the current in-progress stuff is built.
That is for four reasons:
1. Construction costs are insanely high right now (supply chain issues, high cost of materials and labor).
2. The banks that typically lend to development deals are small regional banks because those loans are considered too risky for larger groups but the small regional banks are busy not failing.
3. Even if someone was able to get a construction loan, it would be 12%+ and it is impossible to make the numbers work right now with that expensive of a loan.
4. Finally, there is a new law in Phoenix where new construction projects have to prove that they will have enough water for 100 years. We think that’s going to completely freeze the new development market for a couple years until people figure out how to comply with the law.
14. Are you worried about water in Phoenix?
In the short-term, the water situation will help the property because it will limit any new construction starts. The issues with water are longer term at the earliest 10-20 years and we will be well out of the property by then.
15. You’ve told me what could go wrong, but what can go right?
We are buying this property for 222k a door, someone has already bought the same property in a worse area for 326k a door last year! Our pro forma only has us selling at 307k a door. So if the economy improves even a little bit, this will be a homerun. We have no idea where the economy is going in the future (we think better) and want to prepare for the worst.
16. What role will Sunrise have and what role will Ascent have in the deal?
Commercial real estate has three separate but important parts.
1. Acquisitions: finding the deals, negotiating and flattering the seller to get them to sell to you.
2. Asset management: running the property and enacting the business plan.
3. Capital raising: raising the money for the deal.
Sunrise is great at the first two. They found the deal and have run the other deal we have with them very well. Most people in our shoes will only do the capital raising. However, we do capital raising and asset management. We think asset management is important enough that we double up on it. Sunrise focuses on the day-to-day of the property and managing the staff, while we focus on the bigger picture on how to maximize profit.
17. Why do you prefer real estate investments that offer both cash flow and growth potential?
Real estate investments that provide a combination of cash flow and growth potential offer several advantages. These properties generate regular cash flow that can supplement your income or be reinvested for future ventures. Additionally, if structured correctly, real estate investments can provide tax advantages, safeguarding your income. Furthermore, as the value of the property increases over time, your initial investment grows, resulting in a larger pool of assets. By carefully selecting properties that align with your financial objectives, you can achieve significant cash flow and build long-term wealth.