The Housing Crisis, Rising Interest Rates and What's Next for the Fed with Rob Beardsley

Interest rate cap at 5%, which means that if SOFR continues to climb up to 5% and above, you would be protected.

Welcome to the Next Level Income show where it's our goal to take your income, your investments and your life to the next level. I'm your host, Chris Larson. If you haven't yet, get a copy of our book for free at our website, nextlevelincome.com. that's www.nextlevelincome.com. just click click on the book link and I'll even send you a copy if you put your address in. On today's show, we welcome back Rob Beardsley. Rob oversees acquisitions in capital markets for Lone Star Capital as it acquired over 300 million of multifamily properties. He's evaluated thousands of opportunities using proprietary underwriting models and published the number one book on multifamily underwriting, the definitive guide to Underwriting Multifamily Acquisitions. And today, Rob is going to join us to talk about his new book, structuring and Raising Debt and Equity for Real Estate. Rob, welcome back to the show.

Glad to be here.

Yeah, man, I feel like I've seen you a lot lately. Saw you in person here a couple weeks ago. Got to see you on one of your recent presentations and here we're fortunate to have you back talking to the audience about your new book. So welcome.

Yeah, let's stay busy.

Yeah, man. Quick recap, Rob. Tell us a little bit about yourself, your company, you know, Lone Star, and we'll talk, we'll talk about your prior book as well as your current book and what you got going on.

Sounds great. Yeah. So I, my business partner and I, we started Lone Star Capital almost five years ago. Which Lone Star is a family owner operator in Texas. We're actually company is based in New York, but our entire portfolio is in Texas. We also launched our in house property management firm, Radiance Living, which is a Houston based management company that manages our entire portfolio and does no third party assignments. So we stay very focused and you know, are really looking to optimize the performance of our portfolio. Prior to forming Lone Star with my partner Kent, I was studying computer science in college and Kent was a tax attorney at MetLife. And so we both found this kind of entrepreneurial opportunity. We both had a passion for real estate and we took a leap of faith by putting our first deal under contract together. And then, you know, so far so good. The rest has been history. We've acquired over 350 million in multifamily properties in Texas and Have had a couple good exits. So we're just looking to grow, grow the team, grow the portfolio and continue our good performance.

Yeah, no, that's awesome. For those that are, that are listening, you've probably heard Rob on the show before. Rob's super smart guy. He's got a great underwriting model that we actually have in our course that Rob was gracious enough to include in there. So if you're, if you're a nerd like me and you want to have a really great underwriting model, you can, you can access that model in our course. You can reach out to me and have info. It'll also be here in the show notes. And Rob, that was the topic of your first book. So if you don't mind, I mentioned it in the intro to us a little bit about why you wrote that first book that you wrote on, specifically on underwriting.

Yeah, so the first book that I wrote is called the Definitive Guide to Underwriting Multifamily Acquisitions. A bit of a mouthful, but it's all geared towards the financial analysis of acquiring multifamily properties and we call that underwriting. And so underwriting is kind of what I took to in the business first because I have a math background, computer science, I love spreadsheets and I really wanted to understand the business and, and for me the key to understanding that this wasn't necessarily the, you know, the bricks and, and everything of that sort. I kind of like the spreadsheets and the numbers side of things. So dove into that, really became an expert just through the course of underwriting. So many deals, getting feedback, talking to brokers, lenders, investors, and developed this expertise in underwriting. And one thing that I had wished when I was going through that development process was that there was a, have a resource like this book that I wrote which is just a straightforward guide that there was nothing really out there and there still really isn't out there. So I wanted to fill that void in the market by giving back and writing just a really straightforward step by step guide. Because you know, there's textbooks that are kind of theoretical and don't really feel applicable and then there's also maybe multi thousand dollar weekend courses. So I just wanted to give thing super simple and make it kind of clear the air because there's these ideas that, well, underwriting is just for people who are really smart or experts. And I wanted to kind of bring it down to the ground and let people make it more accessible.

Yeah. And it's great. And look what I, what I love about Your books, Rob. And I'm gonna, I'll grab my book here so you guys can, you know, so most of you that are listening have got my book here. Rob's books are about the same size. And what's awesome is Rob has taken this, this complex topic as he was talking about underwriting, which again, I'm a spreadsheet guy too. I love it, but it is, it's overwhelming. If you're, if you're an investor, you should understand underwriting, but maybe you don't need to go through, you know, the, you know, the dozens and dozens of pages on a spreadsheet, but you want to understand the fundamentals. And Rob, you do a phenomenal job of, of breaking it down into bite sized pieces. It's very understandable. You know, it's worth reading through that book whether you're an investor or you are actually interested in going out there and buying properties yourself. And look, I'll even say, Rob, and you can tag onto this even if you're not buying commercial properties. I think it's great to understand the thought process that goes into underwriting a commercial deal.

Absolutely. Yeah. If you're going to be making an investment of any size, it's worth it to put the little extra effort to really understand the mechanics.

Yeah, no, it's fantastic. So let's talk about the application of that. So you, I love the markets you're in down Texas, Dallas, Houston. Tell the audience a little bit about why you've picked these markets which have, you know, I think you've done a pretty good job. We've seen some significant growth in the Texas markets here. You know, not, not just over the past, you know, over the past 10 years, but really it's exploded here since COVID Why is that?

So? It's, it's the, the recent explosive growth has just been a continuation of the long running trends in Texas such as population growth, job growth, affordability. And Covid exacerbated those trends, such as affordability. You know, people flock to more affordable places to live and I think that trend is only going to continue. So the smile states, Republican states, those have been really benefited from kind of the new new world we're in. And also something that we talked about before recording is just the, the nationwide gap of affordability, rentership versus ownership. Right. And unfortunately that gap is being exacerbated and the recent rise in interest rates, this truly unprecedented rise in interest rates have been the fastest and most dramatic increase in affordability of homeownership and in history. So that does, what that does is that benefits landlords of multifamily because it increases the stock of renters and that demand. So we've seen very strong rent growth across not just Texas, but many other similar cities and states across the country. And I think that is a trend that will continue. Another thing that we really like about Texas is a landlord friendly state. So it allows us to operate our business more efficiently. And yeah, I mean, at the end of the day, it's no, Texas is no secret. Right? Everybody knows Texas is a great market. Investors want to be here. And that has positives and that has negatives. The positive is it's easier to raise capital. Right. You're not kind of selling something that's really tough for investors to wrap their head around. It's something that they already want. But on the negative side, there's a lot of competition.

Right.

There's a lot of other buy in the market, and that's what keeps prices high and keeps cap rates low, which reduces the opportunity to generate outsized returns. So, you know, there's no perfect market, no secrets out there. So you just, in my opinion, need to pick your market and make it yours and become an expert, and that's how you create the most value.

Yeah, no, I think that's a great point. Like, you don't, it's, this isn't, this isn't magic. There's no, like some secret bag of deals. You know, it's floating around out there. But you got to focus on the fundamentals. You got to focus on, on purchasing good deals, structuring good deals, which we'll talk about a little bit more with your new book. But I do want to revisit that. You know, we need over 4 million units still in this, in, in this over the next 10 years to really catch up to where we need to be in this country. And I think the, the rise in interest rates has, it's really, you know, kind of startled some people, both investors as well as home buyers that are out there. And what we've seen is that there's been record cancellations. You're, I know you're out west here, you've been doing some traveling with some of the, the recent meetings here. And you know, where you're, where you're sitting today, there's been, I just saw like 70% of new construction contracts are being canceled. And a big reason is because they're, they're not as affordable as they were a year ago. So what we're seeing now is an affordability gap from between buying and renting at the largest it's ever been. And I'd like to get your perspective on this, Rob, because what's happening is now we're slowing down building again at a time when we were just catching up to the point where we, where we were delivering enough units. What's happening? What's the effect going to be over the next two to five years on the housing and both the residential housing as well as the commercial housing markets?

Yeah, it's going to be more of what you're describing and what I was mentioning as far as increasing the stock of renters, which.

Right.

More demand, less supply, cause rent growth. So rent growth, I think, is just really well positioned in multifamily. The concerns about that, however, are just the increasing percentage that rent is going, that rent is related to income, household income. Right. You can only go so far, and that is a concern. For example, and this varies across markets. Right. In Miami, for example, the average is 50 of your income goes towards rent. And that's true for coastal cities. Right. New York City, you have to be, you know, the average person is pending a ton of money on their rent. And for those types of markets, I have concern because how much further can you go? Right. You can't really go much further. You have to purely rely on income increasing in order for rents to increase to some extent. However, other markets, and this goes back to the affordability argument, such as in Texas, where, you know, Houston, for example, is very affordable market.

Yeah.

And also a very low market. So that provides some comfort where you can actually get some rent gains not just from income growth, but also just from taking up of a share of the total income towards rent, which is kind of just where things are naturally trending. And then as far as homeownership goes, kind of a cynical viewpoint or just an unfortunate reality where a lot of people look at the 50s and the 60s and they look at as when America had a very strong middle class. Many people own their own home and they look at that and they say, well, we need to get back to that. That's normal. Let's get back to that. But the, the cynical or maybe more realistic point is actually that was an aberration and that was a unique moment in history which an extremely prosperous time post World War II. And in reality, if you look at economies throughout history, most people don't own land, they don't own property. Right. There's usually the few landowners and. And then the rest of the people that don't own land. So unfortunately, I think we're kind of reverting more towards that as the wealth gap has been exacerbated and that's going to lead to a lower percentage of home ownership. Do I think that's good for the country? No, but it is, it's good for multifamily.

Yeah. And I think it's again, whether, you know, whether it's good or bad, you know, it's. We have to kind of examine what the reality is. And you made it, you made a very interesting point there, Rob. If we look at historically among developed countries, that period in the 50s and 60s, specifically in America, and really American general is, is a bit of an aberration as a bit of an anomaly is probably a better, a better way to describe it. Whereas, you know, there are higher percentages of renters, you know, in developed nations. So yeah, we kind of are reverting more back to that in this country. And you know, historically I've written, you know, blog posts on this, I've had, you know, podcasts on this. But historically it's usually about 30% cheaper to rent than it is to own. Now obviously we have, you know, we have equity, we have forced savings, you know, that comes with, with homeownership. But yeah, you're right. So what is your company doing to take advantage of these trends? I know one of the things that you, you mentioned is you now have vertical integration of property management. You know, I'd love to hear a little bit about that and also some of the other things that you may be doing to take advantage of some of these trends.

Yeah, so you can take advantage of these trends in both directions. So obviously with the idea in mind of strong future rent growth, buying property and benefiting from that rent growth, which results in appreciation is, is a wise thing to do. So that's been our business plan. We've continued to do that. More specifically, value add plans are, have been very successful and I think they'll continue to be successful where as incomes rise, there's a demand for properties to be upgraded. So, and that can happen every three, five, ten years. And you can buy a property that hasn't really been upgraded in a while and you can bring it up to par and command a rent premium. For us, we don't really like making a new market. You know, we don't really like taking something that's at the market and then doing a substantial renovation to re tenant and try to change, let's say a B class property. A. We don't really like that. We need to find lagging properties and then bringing them up to the market where there's a proven in there so that we're a bit conservative in those sorts of plans. And then in the other direction, because of these affordability crises, essentially around the country, there's opportunities to actually create affordability. And so that's something that we're doing actually in Texas with affordable housing where we're actually restricting the incomes and the rents at our properties and that helps provide housing to those who otherwise wouldn't be able to access it in those, in those markets.

Wow. So yes, I guess just to be clear, you're focused more on which, so just focus the audience that may be new to this or they may be hearing this for one of the first times. You know, typically we have class A properties, these are newer properties. We have class B properties which maybe say what, 20 years old, class C which are going to be, you know, maybe 30, 30 plus years old. And then, you know, the class D are going to be more, you know, properties that, you know, probably aren't as desirable, may not even be safe as well. And you guys focus on which, which one of those classes specifically.

Rob, same around the B's. Yeah. You know, sometimes to be a little bit kind of in the B plus, A minus and then sometimes down to the C plus with a hope of renovating it and bringing it up to a B minus. So the B for us is a sweet spot because is great workforce housing where people are renters by necessity as a sticky tenant base. And there is just growing demand for that. And we see, we see strong there.

Yeah. And I think that's awesome. And if you can, if you can capture tenants that are looking for more affordable options, you know, maybe as they move up or like you were mentioning, taking advantage of some of the programs that are out there, these private public partnerships where you can take advantage of these residents that are looking for a more affordable option and giving them that while still making it advantageous for, you know, the, your, your investors in these properties. I think that that's fantastic. And look, I think we have to continue to look for these options out there because, you know, we just, you know, I was with Ken McElroy a few months back and you know, we were having a discussion about affordability and he said, and for those that you don't know, Ken McElroy works with Robert Kiyosaki of Rich Dad, Poor Dad. And Ken said, look, there's only, only one way to solve this. We just need more units. Right. In your mind, is There any other way to solve this problem, Rob?

That's certainly the best way. I mean, other ways to do it, but I don't like the ways because they are a little bit too.

Mark.

Interventionist, you know, and we've seen those sorts of programs not do well in markets like California and New York.

Yeah.

So I just would hate to see more policy like that where, you know, it's kind of short sighted. Rent control which stifles new supply.

Right.

New construction. So yeah, adding new units is absolutely the best way to go. And to the extent the government is willing to, which obviously they're willing to help in this solution, they be subsidizing new development rather than just restricting rents because it really just stifles capital. What you need is you need encouragement of capital to flow into new supply.

Yeah, now I think that's a great point. I think, you know, there's a lot of debate around this, clearly, but I think the challenge is when you, you have rent controls in place, you discourage capital flowing into those markets. You know, when you discourage development or you, you demand, you know, these options that may not be economically viable. You see what we've, we've seen happen here in Asheville, North Carolina where basically the city council said, you can't build unless you build with, you know, basically these, these affordable options that are below market rents. And developers said, well, we'll just go to Charlotte. Well now Charlotte has seen a massive increase in new supply. Asheville was one of the top, I think it was number three in, in the United States last year in, in competitiveness because rents have exploded so much. So, you know, we see that in California, for instance, when we have the, the government get involved, we've seen costs go 3, 6, $800,000 per unit to create a quote unquote affordable unit. Whereas, you know, we could build for a quarter of that price most likely. So yeah, I think, you know, if we, if we let the private markets do what they're good at and let, you know, let the government agencies encourage that. I agree. I think that probably is the optimal way.

We can move on.

Is.

The problem that any new supply is going to be built to cater to class A because developers need to get an roi. And so why would a developer build property that is, you know, not seeking top dollar rents?

So that's really good point.

And that's where the government can get involved and help subsidize essentially new development of Class B.

There we go. Yeah, I love it. I love it. So, yeah, I guess so the bottom line is we, we need more supply, we need policies that are going to encourage that. So you mentioned this, Rob. We've seen rates explode at a rate we haven't seen interest rates explode at a rate we've never really seen historically. And that's caused pressure on buyers. It's also caused pressure on buyers of commercial properties as well. So I think you really hit it and I really appreciate it. I got your book in the mail here with a little note. Read it right away. And we have a link here in the show, Notes Structuring and Raising Dot com. If you guys want to get a copy of Rob's new book here, Structuring and Raising Debt and Equity for Real Estate. And I would love to hear your perspective, Rob. What, what are you seeing in the markets right now? What are some of the strategies that you're employing as you look at deals, as you purchase deals, and as you figure out, you know, what's the best way to make these work for, you know, both yourself, your company and by and investors as well.

It's a really interesting time to be doing deals and there's been a lot of changes. So it's a less forward market to, to be structuring deals and making things happen. So particularly the debt is very interesting because we have a market where there's a lot of divergence in opportunities and terms. Because if you rewind that year ago there was so capital and competition in the debt space. All lenders were kind of looking the same. They all had competitive terms and even whether it was a bridge loan or permanent loans, all similar interest rate. And now you have divergent interest rates from, you know, fixed rate, floating permanent versus short term debt. And in our opinion, the best way to approach the market is to be focusing on deals that are financed with permanent and I would say still today, fixed rate interest rate, fixed interest rate. You know, that is a bit more of a tricky situation today because some people may be looking at the market and thinking, well, rates are currently high and they're projected float down lower. So maybe it's actually worth it to float today and then get the benefit of floating lower over time. And that could be very well true, but you're going to deal with a lot more volatility and you currently have to deal with very high interest rate cap costs. So for those that aren't familiar, an interest rate cap hedging product where the lender most often makes a borrower buy a hedge or an interest rate cap which puts a ceiling on their floating rate debt exposure. So what's interesting is you have a situation today where floating rates are pretty high. The Fed is expected to raise rates maybe once or twice this year. And then actually the market, Mr. Market is already projecting the Fed to cut rates in September. So that is very soon. So the idea of paying up big leaf for super expensive interest rate cap which puts a ceiling on your rate and then you just float below that and this just becomes worthless. Right, That's a waste of money. Obviously it's an interest, it's an insurance product at the end of the day. So it's not a waste of money.

So if you don't mind, Rob, just explain for the audience real quick in 30 seconds if you can, what is an interest rate cap.

So an interest rate cap puts a ceiling on your floating rate debt. So let's say for example, so for today is around 4.6%. You could buy a interest rate cap at 5%, which means that if SOFR continues to climb up to 5% and above, you would be protected, your interest costs would be fixed and you wouldn't pay anything more than that 5% limit there. So, so it kind of allows you to both float but then also have a ceiling. So if it ever breaks that ceiling, you're protected.

Gotcha. It's essentially insurance on your interest rate, Correct?

Yeah.

And for those that so SOFR S O F R for those of you that may be hearing that for the first time, it's essentially the new metric that we use instead of Libor, which is the inner the London Interbank Overnight rate, SOFR is now the secured overnight financing rate. Just as a quick aside there. So okay, so you think that it's better to put fixed rate debt, long term debt, it's going to be a little bit more stable, give you more security going forward on these properties.

Yeah. And it's also a matter of optics, comfort, sleep well at night, you know, just eliminating as much variability from your deal as possible where it very well may be the case that if you lock an interest rate today or in the next couple months, it may prove to be a, a relatively higher interest rate than what could you, what you could have lost later. So, but at the end of the day, if you can make the deal work right now with your interest rate today, then you can lock it, live with it and still strong return. So that's what we're focusing on and that's what we're looking at. With that being said, we want to retain flexibility and that's one of the things to watch out for. When you're looking at fixed rate debt. Because when a lender is willing to offer you fixed rate debt, it often comes with a more onerous prepayment penalty. And we want, and let's.

Again, you're hitting some really great points here. So I want to underscore them and also make sure the audience understands these things. So I have an interest rate on my home. If I want to refinance, I can refinance basically at any time. But if I buy an apartment building and I put fixed rate debt on, the bank says that's great, but if I pay it off early, I have to pay a penalty.

That's right. It's much less flexible than your home mortgage. So it's, it's something to be aware of because it doesn't show up in your typical metrics of LTV interest rate. Right.

It's.

Yeah, you have to look out for that prepayment penalty. And so like you said, typically if a lender is going to give you a fixed rate, then they want what is called call protection, basically. And if you prepay it early, they don't want to have a situation where let's say you're paying them 6% and then you prepay that loan early and can only loan out that new money at 4%. Right. So they want to be protected in that event. So, so for us, we're focusing on loans that are kind of in the middle, which would, which are for us, seven year loans.

Right.

So long term enough to be low risk in our opinion, but then couple that with a five year yield maintenance period. So basically the prepayment penalty is only for five years. So if we hold the property for five years, we could actually pay off the loan for no penalty.

Gotcha.

That works really well for our underwriting. That works really well for our conservative five year business plan. Do we want to sell sooner in let's say two, three years and have a higher return? Yes. But do we want to plan for it? Right, we want to be more conservative and have that. And in the event that the market is hot and we can actually sell for a great price in a shorter period of time, then we can do that and afford to pay the prepayment penalty.

Gotcha. So you're giving up, you're giving up a little bit short term for that, for that longer term, both longer term flexibility as well as that longer term stability. Right. When it comes for these things. And yeah, it's interesting, we've had some exits with investors and one of the things, when you Sell after a couple of years is some investors are disappointed because they're like oh man, I, I, I don't, I wanted to just keep holding this property, you know, for another, another couple of years. So yeah, it's always, it's always kind of balancing that risk there. So last point here as, as we before you share a little bit more about, you know, where people can get in touch with you. Rob, is that real interest rates? So today, you know, interest rates are you mentioned SOFR is about 4.6. Right. So we're looking at interest rates maybe in the fives 5 to 6% range when it comes to lending for you know, multi family product. But what are, what is inflation at today in your opinion?

In my opinion. Well, I would say and I mean that's just, it's so funny because we made this so complicated because we certainly did, you know, month over month or trailing months or you know, inflation expectations for the next 12 months. Personally, just without getting too much into numbers, my opinion is that inflation has materially come down and that all of the Fed's actions are working. In addition to the actions working, I think the supply chain issues and the structural issues from COVID that had caused a portion of the inflation have now been rectified. So I think there's a few forces that are really alleviate inflation. So I think inflation is coming down a lot and it's moving forward not going to be a principal concern. I think the concern will be deflation recession and re stimulating the economy. So I would say we're somewhere around, you know, by the numbers we're somewhere around, you know, high twos, high 2% inflation. And so the Fed is staying strong with their goal of bringing inflation down fully to their, you know, two, two and a half percent target. They really want to bring it down to 2%. So you know, they're kind of rattling and making sure the market fears them and that the market doesn't brush them off and believes that they're going to continue to raise rates and really pressure inflation. So that's, that's where I, I think that we're going to over hike as we do because the, the data lags and then they'll lower rates and re stimulate and we'll be back on the, the debt train.

Yeah, I mean it really for better or worse, it seems like the Fed always seems to overcorrect, you know, overshoots as you said. And then, you know, we come back and they certainly don't want to say oh we're good, we're going to start lowering rates here next quarter. So nobody, nobody sweat it too much. But really interesting discussion, Rob. Hopefully we, we didn't get too two in the weeds for people because as you know, I love to talk about this stuff. But one more time here. If people want to get a copy of your book, if they want to learn more about what you're doing at Lone Star, some of your, some of your upcoming acquisitions here, what's the best way to get in touch with you? Yep.

So for the book, you can head to structuring and raising.com and then if you want to know about, if you want to learn more about Lone Star and what we're up to, you can head to our website lscre. Feel free to get in touch with us there. And if you want to connect me on link post daily there as well.

Awesome, Rob. Thank you. And if you want to get Rob's spreadsheet, if you want to learn a little bit more about his underwriting model and how you can apply it not only to your, your own properties, but also any investments that you're looking into, it's baked right into our course. You can also check it out on Rob's website there and I'm sure we'll be having you back here in the near future. Rob, thanks so much for sharing again with the audience.

Yep, great to be here. Thanks for having me on.

Hey Chris, here again. I hope you found this episode valuable. Now I have one more thing to gift you. We have a page for my coaching clients where you can get a free copy of my book as well as much more from previous guests on the show. Just check out nextlevelincome.com coaching to get a free copy of my book, audiobook and much more. I'll send you a copy of my book and cover all the shipping costs as a thank you for listening to the podcast. Also, please like share and take just 90 seconds to give us a rating on Apple Podcasts.