Patience and discipline are critical for successful investing, and passive multifamily investment is no exception. Effective due diligence is at the core of selecting quality assets and deals to pursue.
On this episode, Paul Moore, Managing Partner and Founder of Wellings Capital joins the show to share how his company approaches due diligence, his investment thesis, and more.
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- Why the margin of safety, and particularly the Debt Service Coverage Ratio (DSCR), is so crucial in any multifamily deal.
- Why conservative due diligence, and saying “no” to most deals is a strong approach for passive investors.
- What separates overpriced multifamily assets from those that may offer value, even in a market with compressed cap-rates.
- Key questions to ask and factors to consider for effective due diligence.
- The investment philosophies, including those championed by Warren Buffet, that can help passive investors choose quality deals.
- Current trends in multifamily, self-storage, and other asset classes that investors can benefit from.
- The continued impact of rising interest rates on real estate.
Featured On This Episode
- The Perfect Investment: Create Enduring Wealth from the Historic Shift to Multifamily Housing (Amazon)
- The Hands-Off Investor: An Insider’s Guide to Investing in Passive Real Estate Syndications (Amazon)
- Fed Lifts Interest Rates by Half Point in Biggest Hike Since 2000 ( Wall Street Journal)
Today’s Guest: Paul Moore
About The Multifamily Investor Podcast
The Multifamily Investor Podcast covers trends and opportunities in the multifamily real estate universe. Host Scott Hawksworth discusses passive investment offerings in the space, including direct investments, DSTs, opportunity zones, REITs, and more.
Scott: Hi, and welcome to the The Multifamily Investor Podcast. I am your host, Scott Hawksworth, and today we’re going to be talking about multifamily, due diligence, self-storage, and a whole lot more, and joining me to offer his insights is Paul Moore who is the managing partner and founder of Wellings Capital.
He is also a published author and he wrote a book called “The Perfect Investment: Create Enduring Wealth from the Historic Shift to Multifamily Housing.” So, a lot to dive into. Paul, welcome to the show.
Paul: Scott, it’s great to be here. Thank you.
Scott: Well, thank you for being here. I always like to kick it off with, sort of, a high-level question. You know, you have a number of funds that you’ve launched, and closed, and successfully funded, and they’ve done well. Can you tell us, I guess, your overall investment thesis?
Paul: Yeah. Well, you know, I think that… So I started out in 1997. I sold my company to a publicly traded firm, and I thought, “You know, I’m a full-time investor now.” And I jumped into investing. And you know what I found out?
I found out I was not an investor at all. I was a speculator. I was a full-time speculator. Investing is when, you know, your principal’s generally safe, and you’ve got a chance to make a return. And speculating is when your principal is not at all safe, and you’ve got a chance to make a return. And the problem is a lot of people confuse the two. There’s nothing wrong with speculating, but the problem is, you know, those people become really famous because they’re the exceptions typically.
The best way, you know, to build enduring wealth is by being a boring investor. In fact, Warren Buffett’s one of the most boring people on the planet. Hardly any of us could endure one week of his life and yet he’s done pretty well for himself, I guess. You know, 30…
Scott: I think so, yeah.
Paul: Thirty million percent return.
Scott: He’s had a few investments hit, I think.
Paul: Yeah, yeah. If you invested $100, if you had skipped an expensive dinner in 1965, invested $100 with him, it would be worth almost $4 million now. And so he’s done pretty well. But he’s a boring guy. And so, you know, the first economist to win the Nobel Peace Prize from the U.S. said, “Investing should be boring. It should be like watching paint dry or watching grass grow.”
He said, “Hey, if you want excitement, take $800 and go to Las Vegas.” And so I spent years trying to… I made a lot of money, and I lost a lot of money. I even had a podcast for four years, Scott, called “How to Lose Money.” And basically we interview people about, you know, their mistakes on the way to becoming a great investor.
And so our overall investment thesis is, you know, value investing, investing like Warren Buffett, and Howard Marks, and Benjamin Graham, which is basically not just buying a market valued asset but finding an asset type that’s predisposed this way but then specifically an asset that has something really wrong with it.
It’s either undermanaged, undervalued. A lot of these investments, Scott, come from mom and pop operators. These mom and pops typically don’t have the desire, or the resources, or the knowledge to increase income, maximize the value. And if we can find one of those, you know, formerly owned mom and pop assets and then increase the value…I should say, first, increase the assets operation, second, increase the income, third, increase the value, and then of course, if there’s safe leverage on it, dramatically increase the value of the investors’ equity.
The first thing we get from that is actually a higher margin of safety. Warren Buffett, “My cornerstone to investing success is a high margin of safety.” And then the second thing we get is obviously higher income. And then the third thing we get is higher value at the time of refinancer sale. So that’s what we believe.
That’s, kind of, the road we’ve taken. It’s been a painful road, you know, over 24 years, but it’s been a fun road as well.
Scott: Absolutely, and I love that overall philosophy and, kind of, talking about the assets themselves that you’ve invested in. I know, looking over your funds, you’ve had funds that have included mobile home parks, self-storage facilities, some multifamily that some, you know, folks would consider mobile home parks part of that as well.
Why do you like these particular asset classes?
Paul: Yeah. So, specifically someone did a study, and the study said that 93% of multifamily assets over 50 units, so 93% of the assets over 50 units are owned by companies with multiple assets. It doesn’t mean they’re well-run, not at all, but they tend to be.
Multifamily, you know, where a company owns it tends to have a very clear path to value-add. I mean, they know about how to do the countertops, and flooring, and park parks, and all these things to raise income. And multifamily has done very, very well. Like I said, I wrote a humbly entitled book, “The Perfect Investment,” about multifamily.
But only 50% of self-storage is run by single asset operators, so 50%, I should say, you know, are, kind of, ripe for the picking as potential mom and pop assets. And everybody can look around and see how many self-storage facilities there are out there.
There’s 53,000 or 54,000 in the U.S. now, which is the same as approximately all the Starbucks, McDonald’s, and Subways combined. And so three out of four are owned by independent operators and two of every three of those, 50% of the total, are mom and pops. And so there’s a lot of opportunity there.
Mobile homes parks, much more. There’s about 43,000 assets out there in the mobile home park space. It’s the only asset type than we know that has an increasing demand and a decreasing supply every year as far as parks. And we believe about 85% are owned by mom and pops. Again, these guys don’t have the desire or knowledge or resources to upgrade them and maximize value.
Hey, Scott, they don’t need to. I mean, the cap rates have already compressed by about 50%, meaning the value of these assets have already doubled even if they’re just still mediocre assets.
Scott: So for a lot of them, well, why would I need to try to optimize the operations? Why would I need to invest more in this one? I’m just kind of thing on this asset that’s just worth way more than it was when I bought it, you know?
Paul: Yeah, that’s right. That’s right. It’s funny. You know, self-storage owners, a lot of them, a lot of the mediocre asset owners, they feel like, yeah, I’ve got these little metal boxes that spit out money. That’s the story they tell at the country club. And now the mobile home park guys that finally got into the country club are saying, “I’ve got big metal boxes that spit out money.”
Scott: So actually I’m glad you mentioned cap rates because we have over the last 18 months and really even longer, depending on who you talk to, we have seen cap rates compress significantly. And I’m just curious, you know, are there any segments among these that you feel are overpriced right now? And why or why not?
Paul: Yeah, you know, I would say that everything is, you know, hyperlocal to the point of right down to the asset. And so we just invested in a pair of large, newer multifamily assets near Houston. And then we’re about to do another one likely in another place in Texas. The owner of this, the syndicator, has a inside track on reducing property taxes, which is a high property tax state of Texas, to zero and actually getting an agreement to do that for 99 years.
And so while they’re overpaying maybe at 3.9% or 4% cap rate, I think that’s too much. By the time the property taxes are abated, it’s actually a steal, and it’s actually quite a good deal because the net operating income is so much stronger and they value so much higher.
So back to your question, do I think any are overpriced? I think a well-run, you know, fully optimized self-storage, mobile home park, and multifamily asset at around a 4% cap rate is overpriced. In other words, if you can’t significantly improve it, I think they’re all overpriced.
Scott: Wow, and so then, for you, when you’re going and you’re looking at these assets, your calculation is, okay, that may be overpriced, but then if that’s the case, if that’s what the cap rate is in this market, I’m going to need to find some other aspect that justifies that or can at least make it make sense when you’re going to the numbers, right?
Paul: Yeah, and the issue comes right back to what I said 10 minutes ago, which is margin of safety. If there’s not a lot of… I mean, if everything has to go well to make it work, I’m not really interested in that deal. A prominent family guy that most of us would know his name told me the other day that he has a multifamily asset that just didn’t work out for him.
He still owns it, and it’s barely covering the mortgage payment. So, for those of you who know this number, the margin of safety in this realm would be, in my mind, the debt service coverage ratio, and banks want to see 1.2 or more, we want to see much higher than that. That’s 20% margin of safety.
His was much lower than that, and this is a top operator with a top team. Scott, someone just came in and paid him 50% more than he paid for it. And their interest rate is double what his was, because he hit his interest rates just perfectly, and theirs is, like, around 5% and his is, like, 2.5%. And so how’s that going to work?
Can someone tell me how that’s going to work out? Remember his property management team has already done everything they know.
Scott: Right, they’ve already done everything. They were already, you know, really skating.
Scott: I mean, I think that’s a really good point and it kind of leads into my next question. I’m glad you mentioned interest rates. You know, we’ve seen interest rates rising. The Fed has signaled that there may be more coming. So, you know, there’s not necessarily an end to the woods here in sight. How have you seen this impacting the financing side for your assets, for assets you’re seeing across, whether it’s multifamily, self-storage, mobile home parks?
Paul: Yeah, so I think it probably will impact us a lot more. We’ll probably get two more half point rises this summer. I only know a few famous people in the world, and one of them used to be the head of HUD under Obama, and I had coffee with him a few days ago, and he said that Jerome Powell, the current Fed chief is a Paul Volcker disciple.
Now before your time, Paul Volcker raised interest rates up into the teens and of course the effective rate was even, you know, like, the high teens to eradicate inflation. He said he would stop at nothing to do it, and he did successfully. He said this guy, Jerome Powell, has the exact same attitude. So he said he will absolutely cause what depth of a recession he needs to eradicate…
Scott: To get the inflation in control.
Paul: Yeah, yeah. I mean, I believe him. He seems to know. And at any rate, I think it’s going to have an impact. I think it’s going to have to crack this cap rate thing. I mean, it seems like cap rates haven’t expanded as much as I thought they would the last three months. What do you think?
I mean, I’d love to hear your take on this, but honestly, I just think that the cap rates have to go up, which means the values are going to go down. And I want to quickly point out something. Let’s go way back in time… If you go from a 9% to a 10% cap rate, you have to increase income something like 10%. It’s slightly different than that but let’s call it 10%, 12% just to catch up, to keep the value the same.
If you go from a 3% cap rate, someone paid 3% to a 4%, it’s a massively different story. You’ve got to raise your income at least 33% just to break even. That’s serious, and especially going into a recession, I’m not sure that’s going to work out for some people, Scott.
What do you think?
Scott: No, I mean, I think that’s a really good point. And I think what I’m thinking now is we talked about rent rates, and we’ve seen rent rates just increasing massively. I think last I looked NAR had a report. It was like 11% in February, so a little out of date but, I mean, it was one of those things where it gets people excited but then you just have this question of, how is that sustainable, right?
And so then when you’re talking about those numbers, you might say, “Okay, well, the rents will just keep going up.” Well, that may not be the case. And then we have a recession, and then you have people that can’t pay or, you know, they can’t match that, then things start getting really tricky. And I think these are the types of things that folks looking at these assets really do need to consider.
Paul: Yeah, they really do. I mean, for those who locked in what a 3.25% or whatever percent interest rate for 10 or 12 years with this inflation hitting now, God bless them. I think they’re going to do incredibly, incredibly well if they just sit tight on it. That’s why we have a part of our investment thesis is hold longer.
You know, Buffett says my ideal hold time is forever. Well, a lot of folks that hold these, you know, through an inflationary cycle with low fixed interest rate are going to do really well, I think.
Scott: Because I think we’re having such a great, sort of, macro discussion here, continuing with that, we’ve talked about inflation, we’re talking about interest rates, we’ve seen supply chain challenges, challenges with materials, you know, I had someone on the show a little while back, and they were just talking about they had a property where they were acquiring wireless units for installing wireless internet across all of their units.
And then all of a sudden, their supplier just said, “Yeah, actually the price is this now, and it’s way higher.” And they, kind of, had to, you know, look at that like, “Okay. Also, it’s going to take longer to get it and, okay, that’s now impacting that value-add strategy, that’s impacting everything.
So, I’m just curious what you’re seeing as we look at those other impacts across, whether it’s multifamily or self-storage. What are you, kind of, seeing there?
Paul: Yeah, so that same HUD guy was showing me why… You know, actually in my book, “The Perfect Investment,” we talked a lot about how multifamily…no, I should say single family homeownership skyrocketed from the mid-90s to 2005 from the historic norm of 63% to 64%. The government said anybody who fogs a mirror should be able to own a home, and it got up to 69.2% and then it crashed again down to 63% from 2005 to ’15.
But that caused a lot of people to rent a lot more rent, and there was a lot less rental supply coming on the market. Well, believe it or not, that rental supply has never caught up. And so my HUD friend says that, even during the deep recession, he says is right around the corner, he said that rental housing… rents might go sideways for a while.
They may not go up a lot, he said, but it’ll be an incredibly high demand while single family, he predicts, will tank.
Scott: And so ultimately we, kind of, are in this situation where, you know, I always, kind of, sight the housing shortage that we continue to have. And then when we’re talking about interest rates, I always think about also first-time homebuyers. It is getting tougher and tougher. So those are folks that they’re going to have to rent longer.
They need housing. People need homes. So, we’re going to see this continue to impact and so maybe regardless of supply chain challenges, there’s still going to be that demand there. It’s just a matter of finding the right assets, yeah?
Paul: I don’t know how people are doing it.
Scott: As though it were easy.
Paul: I mean, how are people doing this? I mean, think about it. The average mortgage payment, I wish I had it on the screen in front of me, so I’m just going to say estimated. I think it’s gone up from, like, 1,100 to 1,800 for people just buying right now, the average mortgage payment.
What? Think about that. And then rent’s gone up, I mean, some astronomical percent. You mentioned 11% in February. Now, it’s even higher than that now, I’m thinking. I mean, I don’t know how it’s working for people, you know, because there’s no way income is keeping up with this. And although I’m not here to pitch mobile home parks, let’s face it.
I mean, even the Biden administration a week ago today, I think, released a huge statement on promoting mobile home manufactured housing, because it’s the best alternative for both these situations. And I think mobile home parks will continue to benefit. A Stanford…not Stanford.
I think it was a Princeton study a number of years ago. People don’t like to talk about this much. It says that mobile home parks rental rates are way behind. They have not kept up at all with other types of housing, so that even makes it…I think it’s going to be painful for mobile home park renters, honestly, tenants with this massive demand coming at this.
Scott: Yeah, absolutely. We’re going to see a lot of that.
Scott: I want to shift gears a little bit and just talk about Wellings Capital and really your guys’ philosophies. You know, I was looking at your about page, and you just referenced the importance of extreme due diligence on operators and properties. Without revealing your secret sauce, I mean, can you talk a bit about some of the overlooked aspects of this due diligence?
Because, you know, you talked at the top about your, sort of, thesis in finding those mom-and-pop type deals, but then when you start digging into it, what does that really involve?
Paul: Well, we start with Warren Buffett’s quote. He says that successful people say no a lot. The very most successful people say no almost all the time. And it can be painful. I mean, sometimes we say no to friends, I mean, quite regularly, you know? People we really like, know, and trust, we dig in and there’s something that we just don’t feel great about.
And it might not be anything bad about their company. It might just be a lack of experience. This is one of the problems right now, and we talk about due diligence specifically. It’s very hard in a great environment right now like we’ve had for 13 years. It’s very hard to tell the experts from successful amateurs. And it’s very hard to tell them from luckily amateurs.
I won’t get into that too much. But you’ve got all these lucky and successful amateurs and then you’ve got the true pros. The problem is when they’re all doing the same, you know, they’re all doing almost equally well, you’ve got the death of experts. In other words, expertise isn’t valued in an environment like this. In fact, experts can sometime do a little worse.
Why? Because they have a higher margin of safety. For example, while a lucky amateur might get debt, somehow be able to secure debt at 78% or 80% leverage, the pro on that same exact deal might only get 60% leverage because they want higher insurance. They want a higher margin of safety for downturn.
So they might actually do a little worse. So what we do is we try to fair it out. We try to figure out who the experts are by looking at a bunch of factors, and we have, like, 27 factors we looked at. Like, you know, we do the obvious things. I do a deep dive on their criminal checks, background checks, reference checks.
We fly out to their headquarters. We see how they talk about their investors, how they talk about their employees, how they talk about their spouse. We, kind of, get a feel for the atmosphere in the office. What’s it like to work there? We try to find people who invested with them and are not happy and try to find out what they say.
We do that, sort of, by a death by Google, we call it, by just Googling every possible, you know, angle with their name, their company, their previous companies. You know, we drop in on their facilities to see if they’re run the way they said they were when we were in their headquarters.
We do a lot of other things. We analyze their debt as I already, sort of, mentioned to see if they’re taking big chances, if they’re rolling the dice, or if they’re really careful. A one big thing is we want to see if they’d been through the Great Recession in real estate. I mean, were they in commercial real estate or were they still in high school during the Great Recession?
There’s nothing wrong with being in high school in 2008, but I’m not sure… You know, we’ve invested up to $46 million now with one operator. I just wouldn’t want that to be somebody who is, kind of, new and hadn’t really experienced the horror…
Scott: Yeah, experience the bad times.
Paul: Yeah, yeah. I’ll just tell you this. We don’t go specifically by this book because we’ve been doing this for a while, but Brian Burke who is a great multifamily investor. He’s an author also at BiggerPockets. He wrote a book called “The Hands-Off Investor.” It’s 300 pages, and it’s full of information on how to do due diligence on potential multifamily operators.
Scott: That’s fantastic. And we’ll have a link to that as well in the show notes.
Scott: I’m curious. You know, our audience is passive investors and, you know, maybe they’ve invested in a few deals. Maybe they’re trying to, you know, get better and just improve their ability to, sort of, suss out, you know, good sponsors to work with. Some of these principles you’re talking about, how can they really be applied to just the passive investor?
They’ve got a bunch of presentation decks coming across their desk. They’re looking. They aren’t sure if they want to go Sunbelt. They aren’t sure if they want to go, you know, somewhere boring like the Midwest or something. How does that sort of conservative due diligence approach maybe translate from that side?
Paul: Mm-hmm, great question. One thing I would do is look at their assumptions. Somebody came to me. They were doing something about investing in this deal. They’re buying it at a 5 cap, but they’re assuming a sale at a 4 cap. I said, “That’s really dangerous. I mean, if you’re depending on, you know, the market to compress, the cap rate to compress further, it could happen.
It’s happened a lot, but I don’t want to depend on that. I don’t want to depend on inflation. Again, that’s out of my control. I don’t want to debt on, you know, I don’t want to depend on, you know…I don’t want to assume that rents are going to go up 6% a year but costs are only going to go up 1% a year. That doesn’t make sense. You kind of mentioned that earlier about the wireless internet installations. It doesn’t work that way usually.
So I would definitely look carefully at the assumptions. I look at their experience. I would, you know, definitely pick something that had a lower potential return over a higher one if the operator’s fantastic. I mean, basically ask yourself this, “Do I want to be in trouble, really want to be in trouble with this person for the next decade?”
because there’s going to be trouble. I mean, I’m not saying that I’m not… It’s not a doom and gloom prediction. I’m just saying there’s trouble with…
Scott: Things happen. Life happens.
Paul: Things happen. And so do you really trust this person and to want to stay involved with that person or do you have this funny feeling in your stomach about them? And I want to hit that real quick. I really believe we were created with incredible powers of perception, and we’re able to see things that we can’t identify with our logical mind.
They say there’s 3,000 different, what is the word, body language signals and tone, inflection, all kinds of things that neither the sender or the receiver could identify but subconsciously we can see it. Like, if they shift when they say a certain word, somehow our brain can do, what is it, 30 quadrillion calculations a second, it’s amazing, that our brain can pick up on that.
If you’ve got a gut feel that it’s too good to be true or something’s funny about this operator, look, run away. Like Warren Buffett’s said, in baseball, if you stand there and don’t swing, you’ll eventually get called out, you know, or you could get a walk to first base.
But in this game, you cannot swing for a thousand pitches and you’d never get called out. You know, you’re never striking out for just waiting. And so it’s better to wait if you’re not sure. Look, even if you miss out on stuff, we missed out on so many great deals. If I dwelled on that, it could kill me, I mean, emotionally.
But it’s okay because I don’t expect to also be losing everything if and when the market turns down.
Scott: And then that circles back to what you were talking about is just that ability to say no and it’s better to say no to maybe something that ended up working out than to say yes to the wrong thing, right?
Paul: That’s exactly right. I mean, Buffett says this, I don’t have the exact quote in front of me, but he said something like this. People seem to forget that no matter how large of a number you’re getting profit, it’s always zero when multiplied by one single zero.
An easier way to say that is, if you keep playing double or nothing with your investable dollars, we’ll eventually land on nothing and you’ll have nothing left to double.
Scott: Absolutely. I guess overall I’m curious about just current trends. We’ve talked about this landscape. What trends are you seeing when we’re talking about self-storage, we’re talking about multifamily, mobile home parks?
Obviously, there’s a lot of folks that are saying, “Hey, these are great.” But are there trends within these asset class that you’re really seeing take hold right now?
Paul: Yeah, of course multifamily has already been this way for quite a while, but their self-storage and mobile home parks specifically have a lot higher interest from institutional buyers. And so you’ve got Blackstone making these, you know, $1 to $2 billion purchases of both self-storage and mobile home parks.
Of course, he’s already been in it a long, long time, but you’ve got Warren Buffett, you know, now in the mobile home park space with at least three if not more of his companies even though he doesn’t own any mobile home parks. He doesn’t do real estate for the most part. You’ve got Sam Zell. This isn’t really a trend. I mean, we’re talking decades.
He’s been quietly buying up 155,000 total mobile home park pads, and so you’ve got that going on. I mean, there’s so much interests in these. I’m kind of wondering, you know, if it’s going to come a day when we’re like, “Ugh, it’s sort of like multifamily’s gone. It’s been very, very hard, you know, to find value-add.” And so we’re already looking at the next asset class, which is loosely a type of multifamily, and that’s RV parks.
Did that any way answer your question—what trend?
Scott: I think it did in a way in the sense that clearly the interest is continuing with this, and I always say and if you see institutional interest, that means, okay, you know, there’s clearly something here and clearly the trends are going to continue, right?
Paul: Yeah, absolutely. The simple formula is buy an asset with a significant amount of intrinsic value that nobody else has uncovered, harvest that intrinsic value, turn it into a franchise. What I mean by that is putting a bunch of assets under one flag, similar operations, similar marketing, etc., and sell that package to an institutional investor.
That is a great, simple formula.
Scott: Absolutely. Paul, thank you so much for joining me on the show today, offering so many great insights and advice from your experience with all of these asset classes and just general I think that, sort of, due diligence portion we were talking about, that more conservative approach I think is just a brilliant way to think about whether you’re looking for an operator, or looking for a passive investment, whatever you might be doing.
I think that’s just a really good approach. And then if folks want to found out a bit more, maybe find out about upcoming funds you have, anything going on, where can they do that? Where can they connect with Wellings Capital?
Paul: Yeah, they can go to our website, which is wellingscapital.com. And if they want to get some special reports on commercial real estate investing or any of the things we invest in, it’s wellingscapital.com/resources.
Scott: Fantastic. Thanks again.
Paul: Thanks, Scott.