Ep #315 – James Kandasamy – Author of Passive Investing in Commercial Real Estate
Here is some of what you will learn:
Types of deals to consider
Understanding Yield deals
Understanding Value Add deals
Understanding investor life cycles
Difference between Passive Investor & Key Principle, General Partnership roles
The value of stress testing
How to avoid bidding wars
Proper due diligence
The danger of emotional buying
Keys to successful investing
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Full Transcript Below:
James Kandasamy – author of Passive Investing in Commercial Real Estate (Ep315)
Intro: Hi! I’m Rod Khleif. Each and every week I record an interview with a thought leader that I know you’re gonna get a ton of value from. Now here on YouTube are the video versions of my podcast, Lifetime Cash Flow through Real Estate Investing. Now to make sure you get the latest information please subscribe and hit the notification bell. Let’s get started.
Rod: Welcome to another edition of “How to Build Lifetime Cash Flow through Real Estate Investing”. I’m Rod Khleif and I’m thrilled you’re here. And you guys are gonna get tremendous benefit from the my friend who I’m interviewing today. His name’s James Kandasamy and he’s my friend because he’s a member of my multi-family boardroom mastermind. Were actually in a deal together. He’s just a great guy and I’m really blessed to have him on the show today. He’s got a you know over a thousand doors, 65 million dollar portfolio. He’s a real hitter in this space so we’re gonna have a lot of fun today. James welcome to the show my friend!
James: Thanks for having me here Rod
Rod: Absolutely. So you know the topic of today’s show is going to be passive investing in commercial real estate which I know you wrote a book about which we’ll talk about at the end but you know let’s talk about how you know let’s say you know you’re an accredited or a sophisticated investor and you want to invest passively in a syndication, in somebody’s deal. And guys I’m here to tell you that you shouldn’t invest in anything unless you know this business a little bit okay, that you’ve done some homework, you’ve looked into the operator, you’ve looked into the unit you know a little bit about the deal structure and understanding you know what’s a good deal and what’s not a deal before you get in bed with somebody. And so we’re gonna talk about all that today. So James, you know I guess let’s just get right into it. I mean we don’t have to you know normally I would say tell us about your history and how you got in the business but I don’t think we have to do that today. I think let’s just go right into some questions about passive investing. So you know let’s say someone’s thinking about it you know what would you recommend they do to get started?
James: Well I mean I mean there’s a lot of conservation when you want to invest passively especially with now the password is syndication right where anybody can invest passive in any syndicated multifamily deals and I think the key things that they want to look at is you know how do they consider deals right and what are the sponsors that that they want to invest with right. As you mentioned I know who do you want to get in bed with right. So let’s go through each one of those and other two big things that I think we should be covering as part of our discussion here. One is the concerning deals right. What kind of deals do you look at? right I mean there are three types of three primary types of deals that that exist in the market right now. One is call or something call it yield where the deals are stabilized and you get cash flow from day one. And the other one is something called value add and the third one is called a deep value add. And value add is more of a combination of between yield and a deep value yet whereas deep value adds wherein it’s very very opportunistic and you get the highest equity appreciation compared to a cash flow right. So if you look at yield plays or card deals you get cash flow from day one but there’s not much of equity appreciation unless the market appreciated right. So I’ve seen many many times where people buy a car deal and they said oh we made three hundred percent in the last three years but actually they didn’t do much to the deal. Actually the market appreciated right so same thing on the value add deal where you know there’s
Rod: Hold on hold on. Let me stop you for one second. So guys a yield deal you know like an A-class property would be a yield deal okay. Well you know it’s a property where there really isn’t much opportunity or it’s a property that’s already been repositioned, you’re just taking it over in collecting rents and banking on appreciation. So that’s a yield deal. The most common deal in multifamily is a value add. So let’s talk about a value add now James
James: So value add is it’s a combinational where you get a cash flow at the same time you also get equity appreciation. It’s a I would say is a better in terms of safety wise in terms of margin for error because you have that buffer because you’re adding value to the NOI right. We got to push up the NOI and that’s the powerful force appreciation in commercial real estate. But value add there’s two types of value add. When you go more into the deep value add you have to do bridge loans, you have to short-term loans and you may not get paid for the next 2-3 years because you know the sponsor is trying to stabilize the deals that’s more with it
Rod: Right so let me dig in there for a minute James coz you’re saying some things that might go over the head of some of my people. So in a value add, you know maybe you go in and you would put in new plank flooring and maybe put in new fixtures and paint the outside and do some landscaping and resurface the parking lot. In a deep value add you might have a property that’s you know if you’ve got to by the way if you’ve got a property that’s unstabilized, if the vacancy is high enough you can’t get regular Fannie Mae and Freddie Mac financing which is why James was talking about you need to go out and get bridge debt. You’ve got to get a bridge loan then you go in and do you know a deep value add could be a complete remodel in an apartment. I mean I know you know sometimes you can spend as much as ten to even $20,000 per unit in a deep value add if you’re doing massive remodel work. And they are they are riskier for sure especially if you’re not an experienced operator but you know there’s an opportunity to really massively force appreciation and that’s the term he used guys, is forcing appreciation. That’s what’s beautiful about this space is that you have the ability to do that by adding value to a property. So you know go ahead and dig into deep value adds a little more than that James
James: Yeah I mean the so deep value that you have a lot more equity appreciation right. So your equity might be doubling in the 2-3years time frame whereas on the core yield site though you get a lot of cash flow, you have a lot more thin equity appreciation. You may not have any equity appreciation unless the market appreciates right
James: So what I’m saying is any passive investors really need to look at their own life cycle, how much money they have, where they are in their investment cycle of their life right. So let’s say for example if you’re very young you need it you only have like two hundred thousand to invest you know you can’t really you put that 200,000 into a cash flow deal and expected to you know sustain your life and you can retire or you can achieve financial independence right. So what I’m saying is for people like that where they have limited amount of money their early stage they have a W-2 job which K which is not taking care of them in terms of income. They can take a bit more risk and invest more into the deep value add or value add space compared to you know yield deals right. Whereas someone who’s who has a lot more money who have like one or two million dollars to invest and they are more in the later cycle and they want to retire and they do not want to do work, they don’t have any job, they want more stable less risk, they can invest more on the yield type of deals and so the alignment of deals with the investors life cycle is very very important and a lot of people don’t understand that because
Rod: Yeah let me enhance what you just said just a little bit because guys you know you really should have, depending upon where you are in the cycle of your life like you just said James, you really you’ll find that your investment’s strategy is going to be different like you said if you’re younger you know you can take more risks and you know I like to equate it to buckets you should have a risk bucket you know that your money that you risk you should have a you know a risk or growth, growth bucket then you should have maybe a security bucket you know money that you don’t spend and then of course a bucket for your lifestyle but you know it really depends on where you are in your you know at your age your tolerance for risk and you know the only thing I would add is yes you know you can do a deep value-add deal but just a word of caution you really know the operator because that you know if the operator is undercapitalized, if they don’t know how to do a heavy reposition they get into something they haven’t done before, and you know you can have cost overruns and you know they can get in financial trouble especially if they’ve got high vacancy. And so would you agree with that James?
James: Oh yeah absolutely is one thing that I want to mention is you know I’ve seen operators who have done core deal type or yield deal type in two or three times and then the fourth one they suddenly want to do a value-add or deep value add and they fail miserably just because these are different skills right. Buying a stabilized property was just turning around a demographic or turning around tenants running out of property is completely different skills right. So you need strong property management, you need strong people manager, you need strong you need control over the property manager
Rod: Strong organizational skills I mean if you’re managing a big project a multi-million dollar reposition you better be great with project management you better know how to sequence the work you know. So you’re not in there you know putting in carpet before you paint or you know I mean that’s an extreme example but you know you really need to you know so the point here is if you’re gonna invest passively in somebody’s deep value add make sure you check out the operator. Look at their history what have they accomplished in the past to make sure you’re not getting in trouble. Now what do you suggest James as far as you know enhancing their skill sets I mean do you think it makes sense for them to learn the business a little bit and really understand how to you know even do a cursory evaluation of a deal to make sure that they’re checking the operator, they’re checking what they’re doing
James: Well I mean there’s many ways to check the operator right now but the best thing I would say is just talk to the current passive investors who have invested with that operation see whether they have come, that’s the best way to find out because there’s no other way to really find out about operators-writers really any operators publish all their track record right. A lot of times they just show the current deal and this is what we’re doing and a lot of times operators use whenever they are the KP for other deals so they invest in passively. In some other deals and they take that unit count and add into their unit counts. So a lot of times I see operators claim they have three thousand units they have done thousand units or they’re done five hundred units but actually when you dig deeper actually they were just investing passively. So keep in mind passive investment is completely different scale from a sponsor skill
Rod: Right you know there’s the passive investment and there’s a KP Key Principal of the GP the General Partnership and those are syndicators like yourself and I that put these deals together and yeah very big difference, very different skill set. I will say this though. I will say this though James is that if you invest passively in someone’s deal, it does enhance your experience because you’re seeing you know what’s happening in the back. You’re saying you’re getting some additional experience the banks will look at it as a level of experience and you know and I know in my deals you know when we when we bring in passive investors we I make a conscious effort to do some education as part of that process you know so that you know it’s like anything. Anytime you add value and you educate it comes back to you and if you do that with your passive investors, if you’re a syndicator you know it’s a really smart move you’re bringing them along, you’re raising their level of competence, would you agree with all that?
James: Yeah absolutely I mean you are good in doing that right but I mean not everybody gets that kind of opportunity right. The thing is you have to see what’s behind your operation there’s so much things going on in any sponsors work there’s just too much things that passive investors would not know but if you’re able to share that experience and share their skills and what are the challenges that you’re seeing and how are you all coming it, that’s the best way to learn. But just be just be aware that you know if a sponsor on the deal number one they want to do a value-add deal, on a deep value ideal and they’re buying a large portfolio and that’s basically a red flag right so you want to really really make sure that the sponsor was doing their first deal know what they’re doing you know at least that’s starting something small or starting something on the safer side of it right. I mean market is very hot right now. Everybody want to do and I want to do deals right so I know but not everybody can be a deal sponsor to be upfront with you right a lot of skills behind them
Rod: Sure and you know there are a lot of people out there as operators and syndicators that started after the crash and they’ve not gone through a crash yet exactly and you know we’re seeing when we watch somebody do a presentation on a deal and they debt and we ask the question did you stress test it and they said no and guys if you’re doing a deal you better buy, God you better stress test it meaning you know what does it look like 15% vacant? what does it look like if your rents contract? you know and see what your what your break-even point is and how far you can go and if you’re not doing that or your operators not doing that they’re taking huge risks and I will tell you and I’m sure you have James seen this as well where you bet you you’ve been in the best and final on an offer on a deal and you’re scratching your head when you see what it trades at and you know they’re paying millions more than you thought was as far as you could go and you’re like, what are they thinking? and there’s a lot of that going on right now so you want to be very very careful
James: Yeah especially on the beating wall deals. Actually I mean you basically paid the highest
Rod: Right that’s exactly right. So you know I know that you know you’ve been very successful and I’ve seen some of your turnaround projects and you’ve done before and after pictures very very nice work and you know so you know what are you doing to find deals yourself. Let’s talk about finding deals. What do you do to get you know properties that you can add value to cuz you’ve been very successful at that
James: Yeah so we usually like to look for off market deals right and I’ve been very successful in the early part of my acquisition part where we bought like a couple of deals off market directly from sellers. So we work really hard to find sellers. So once we do that we start getting deals from brokers, by buying deals from brokers we avoid trying to go into the
James: Bidding war right. I mean you know even though there’s a bidding war going on, we have a much more high advantage just because we have our own operation. So we get a lot more loan proceeds from there right. At the same time we have told the broker we have a property nearby take this market take this deal off market and they will do it off market as well even though it’s on the market because they know you are the best qualified buyer so they will do it. So we try to pull everything off market, avoid the bidding war, try to use our operational efficiency to get a much better deal out of a deal right. So the other things that we are doing nowadays just because the market is so hard and a lot of deals we just sniffed us and we said no we’re not gonna look at it because that’s just not much of value add to add in and key thing we look for is what is the buffer that we are getting going in today. So we don’t buy, we may buy it at today’s cap rate but we look for the spread from today until the next two years without any rain growth we look for the spread at least one point five to two percent of cap rate increase or from the cap rate increase based on today’s price without any random appreciation. So that’s what we look for, if we can see a clear trend of upside, we’ll push it aggressively
Rod: So in your definition what’s creating that upside and if you’re not looking at rent growth what’s creating that upside? your operational efficiency? your ability to decrease expenses? your ability to manage it better?
James: Yeah the ability to manage it better by decreasing expenses at the same time ability to put in capital expenses and push up the rent
Rod: Got it
James: These two would increase NOI
Rod: Right right okay you just said without any rent increase so I was just so you know I know you’re great operator and you can you can manage much more efficiently than the average for sure and that’s really important guys. I mean you know any improvement to the NOI is an exponential improvement to the value and you improve the NOI not just by increasing rents by also decreasing expenses. So management efficiency is very important
James: Yeah and also I mean of course you need to have a very strong underwriting skills right when you look at P&L, I mean Robert Kiyosaki say one of the most important skills to read financials yet not many people know how to read financials right looking at rent roll and looking at T2L where do you identify the inefficiencies right. And how do you do market comps? I mean a lot of people like to use costar a lot and they believe a lot in costar but know well let me tell you I don’t have a subscription to Costar
Rod: Well no no but first market comes I mean I’m flying to Dallas tomorrow for a deal we’ve got under contract and we’re gonna go visit every company in the market. I mean you’ve got yeah you’ve got to see who your competition is, you’ve got to see what their vacancy is, what their amenities are, what they’re charging, and that’s how you do market comps. I mean you agree?
James: Yeah absolutely and right now because the market is so hard right now right. So even brokers are telling you even without looking at the property you need to pay me two hundred three hundred thousand a one cash and people find it everybody’s really push to do deals at the same time they are not doing very strong due diligence, their money stuck and even though they find something throughout the feasibility process is too late right. So they just go ahead and do it as I said all this is good when market is good but when market turns around in fact markets already turning around right now right
Rod: Right. Now I was just reading in Business Week that you know that new home sales have fallen off a cliff in some of these hot markets which is a big precursor to you know a contraction so very very good. Well you know I know that you’ve got you’ve got a book out it’s “Passive Investing in Commercial Real Estate: Insider Secrets to Achieving Financial Independence and it’s on Amazon guys and you know James is a friend and it’s definitely got my endorsement and you know I appreciate you being on the show brother you know it’s always fun to talk to somebody that’s making it happen you know let me ask you this if you know what do you think is the most common reason people fail in this business?
James: Buying based on emotion I guess. You have to look at the numbers. And the other thing that I think is very important. Sometimes people look too much into the numbers right so a lot of times if you see a sponsor explaining their deal they just talk about the numbers. Hey what about the demand side of it? you know what about the renter’s? right people don’t talk about household income. What is the household income? how many percent of renters are living there? Nobody talks about that. Everybody just talk about this is what I’m gonna give you this is what it is, this is a great market. What is a great market? Great market’s supposed to be turned into demand right so people talk about the numbers but people forgot about the team on because the renter’s are the ones gonna pay your income and that’s where you’re gonna get the investment returns
Rod: You’ve got to look at jobs, you’ve got to look at median income, you’ve got to look at the household makeup, you’ve got to look at the you know the median home price, and you’ve got to look at the local vacancy rates. I mean there’s some things you got to do it’s this is you know you can’t dabble in this business. So you know a lot of my listeners are aspiring real estate investors maybe they can be passive maybe not but regardless you know what advice would you give them final advice would you give somebody that’s listening this show that knows they want to get into this business. What would you say to them?
James: I would say you know it’s a choice whether you like to succeed or whether you want to succeed or whether you must you must succeed
Rod: Oh nice nice
James: The guy who must succeed is the guy who will succeed. I mean the guy who liked to succeed may do one deal but after that they are done right
Rod: or if they even do one deal. I love the saying you’ve gotta want to succeed as much as you want to breathe
James: Yeah exactly
Rod: That’s the must, that’s the must, you got a must okay love it. Let me ask you one last question if you were gonna talk to your 20 year old self, knowing what you know now what would you do differently anything differently?
James: I wouldn’t held on everything
Rod: You wouldn’t bought more? You would held on everything?
James: Well they you know the skill to really turn around a property comes from, okay where did I learn my project management right learned from a corporate job right? learn to manage people, they learn to how to find, how to underwrite deals. It takes a process to learn all that right I mean you can probably you know find a mentor in the beginning and learn all that in the beginning yeah that maybe is one thing but for me I think I think a lot of experience from the initial part of my life or contributed to quick success in the later part right. I mean people don’t see how much hard work you put in in the beginning oh yeah go to different businesses and we fail so many times and now we have but people just look at now right
Rod: Yeah they look at the success they think it’s all easy. They don’t realize how many failures there were on the way to that success and now I’m really glad you said that and and it all builds on itself you know lost it all in 2008 it was still a seminar. I learned a lot okay and so you know it’s when you look at life that way and you don’t fear failure you realize that we all fail our way to success you know that makes it less intimidating. It was great to have you on the show and guys definitely look for his book. We’ll put the title again in the show notes and James. I’ll see you in San Diego at our next board room my friend.
James: Sounds good
Rod: All right buddy take care see ya
James: Okay bye
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