Real Estate Investment Opportunities Series - Origin Investments

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Welcome to another Great White Coat Investor Real Estate webinar. I'm here with Michael Episcope. He's a principal with Origin Investments. Michael, thanks for being with us again.

Thanks for having me, Jim.

All right. We're going to talk a little bit about real estate in general. We're going to talk about Origin specifically and what investment opportunities are available there. And then we're going to do some key Q and A at the end of the presentation. So why don't I start by turning some time over to you, Michael, I know you have some slides prepared. Let's go through your presentation to start with.

Great. I am, yeah, I'm going to present for about 25 to 30 minutes. I think it'll take that long. And then we'll open it up for Q and A. But Jim, I thought I'd start with maybe a little bit of background about me, kind of my how I got here today, really. And, and I'll start maybe later in my career because I, I was a commodity trader, the ripe old age of 36 years old, and I had a what I'll call a first world problem. And that was I had made some wealth, and now I wanted to protect and grow that wealth and replace my income. And I was a bit paranoid at that time. And, you know, like many people who have built wealth at an early age, you want to make sure that you retain it and you grow it and that it does all the things that you need it to be. And I've known a lot of people in my life, unfortunately, that have made wealth early on, they've lost it later. And that's a hardship that's tough to go through. Nobody else, nobody wants to say, I used to be rich. And so for me, it was about how do I invest that money prudently? And I got a lot of my deal flow and information from advisors, friends, my network, and people who, I think at that time really, I really thought understood investing. And I never had any real success, though. It was always two steps forward, one step back, sometimes two steps back, sometimes even three steps back. But I learned a lot. And I think one of the biggest lessons I learned was that no one would be a better steward of my money than I would be. Maybe this is a little bit about my paranoia as well. So I decided to retool from my commodity trading days, go back to grad school and get a master's in real estate and really learn and retool about real estate investing. And at about that same time, my partner and I We formed Origin, at that time was called Origin Capital. Today we're called Origin Investments. And it was more like a family office. It was not the vision that we're sitting here today and realizing. We syndicated some deals, we hired some people along the way, we developed our phone business. And it all sort of came organically, but it was really about just creating a company for investors like David and me and to invest our money. And that resonated, I think, with a lot of of other individual investors. And Jim, your story really resonated with me for a lot of the same reasons when we met about six, seven years ago about your trials and tribulations in the investing world. And that's what really attracted me to you and the white coat as an investor. Now, today's presentation, it really, when I was putting this together, I was like, what value can I provide for this audience? And I thought about just the general arc of our decision making at Origin. Why real estate, right? Some of this is even me. Why do I want to be in real estate? How does that help grow wealth? And then it comes, once you make that decision, well, where do you invest, what do you invest in? And what does it good deal look like? And how do you create good deal flow? And so my goal today is really to share some of the basics about real estate investing with the audience and with the hope that I be. I hope that you become a smarter investor as a result. Then take away a few nuggets and if you don't, then Jim will tee me up in the Q and A and something will happen there, hopefully magically. So let's jump into the presentation here. Jumping into the presentation, I have to show these disclaimers first. This is everybody's favorite part. There's a picture of me, always an old LinkedIn picture that shows up there. And again, the first question you have to ask is, why private real estate versus all of your other available opportunities? Why not just put your money in the stock market, go other places? And so it's always looking for asset classes that are complementary to your existing portfolios, and then also asset classes that exhibit high risk adjusted returns and low correlation as well. And when you're looking at real estate, this chart I think sums up a lot of it. It's the S&P 500 versus the NCREIF index, which the NCREIF is the national Council of Real Estate Investment Fiduciaries. And these are all institutional investments. And you see this over 25 years. And this chart shows private real estate that it's Returned actually higher returns and lower volatility than the S&P 500 over the last 25 years. And generally that has followed suit over the last five, 10, 20, 30 years that real estate has actually produced higher returns with lower risk. And to me, what I find interesting, I heard somebody speak a long time ago and said the same thing. But real estate in many ways, if you know, kind of the efficient frontier, it tells you that for every level of risk that there should be an equal level of return. And in many ways private real estate, it's defied the investing laws. It's the. It's produced higher returns than riskier assets. And you just don't find that that often. And really what real estate is when you think about it, no matter what it is, whether you're talking about multifamily, industrial, office, retail, self storage, it is a hybrid between a bond and an equity. And it has characteristics of both. Long term leases, they create stable cash flow. If you're in hotels, they're overnight leases. And then you have growing rents that really create appreciation in the asset class. But when something sits between the risk of a bond and equity, it should have returns commensurate between a bond and equity. And it doesn't. It's actually outperformed equities over the long run. And I believe that'll continue to be the case. So the next thing, as an investor, at least some of our decisions and we used to invest in a lot of things back in the day. We were formed out of the 08 financial crisis. @ that time the world looked very different. Everything in the world was on sale. But over the years we had to make a decision where do we want to focus our efforts. And so here what you see is the performance by sector. As an individual you may choose to go in a particular vertical or if you're investing as an lp, you might choose to invest in a lot of different asset classes. And what you see here are the returns on the left axis and the standard deviation is on the lower axis. And over on the left hand side is the multifamily sort of sitting all by itself. And that's easily generated the highest risk adjusted returns over the last 30 years. And this is an asset class, we only do multifamily. It's not a disruptible asset class. We don't see the Internet doing things even during COVID This has shown its resilience. It's a need based asset class. People always need somewhere to live. It's also been proven to be a hedge against Inflation. And we saw that firsthand. In fact, I guess in many ways it's the reason for inflation. Because when housing prices and multifamily rents, they go up by 10, 15, 20%, that is going to show up inflation and in other areas. And it's also, especially in multifamily, it appreciates over time. I can't say that for every single asset class out there and even assets in certain cities. So it does depend where you invest as well. And I'll get into that in a few different slides. What I love about multifamily is that a single asset, it also has built in diversification. A building can be 200 to 400 units, whereas in office, retail and industrial you have more concentrated risk. And there you should invest, or you should at least consider investing in these other asset classes. But you need to understand the risk of the asset class to invest in it. And if you have the choice, when you're looking at something like this, between investing in a multifamily deal and an industrial deal, well, the industrial deal really should produce a higher return because you're taking on more risk. If it doesn't produce more return, then you should invest in the multifamily deal. So understanding the characteristics behind each and every asset class is important. Now, I'm simplifying this because it's not as simple as buying a core multifamily or a core industrial building. Generally you're going to be investing in some strategy, whether that's ground up development, value, add something that the sponsor is presenting or you as an investor are engaging in if you're kind of a do it yourself or an active real estate investor. So I like to also talk about tax efficiency. I think tax efficiency and strategy, they go hand in hand. And I'll be talking about strategy at the end of the tax efficiency here. But I don't believe. Right. And I'll just speak for myself because in the early days I really didn't focus on the tax efficiency of real estate investing. And I don't think that individual investors often do a good job at looking at returns on a pre and post tax basis. And real estate, it has built in tax advantages over other investments, depreciation, that's a huge tax advantage that you can actually generate tax free or tax deferred income. I would say you also have the ability to refinance tax free over and over and over. And then there's the 1031 exchange where we can take an asset, sell it, and then roll those proceeds into another asset and and defer taxes indefinitely. The chart in front of you, this is an example of depreciation. And kind of here's how it works. What I've used here is I'm showing large deal, it's $100 million deal. You can do this at a $10 million deal. It's kind of linear no matter what you're looking at. But this would be based on today's cap raise for a multifamily property. It's about a 5% cap rate going in. And what you get there is you get net operating income of around $5 million, then you have to pay your debt. So in this particular example, I've leveraged this property at 60%. So your debt costs are going to be $3.3 million. And then you get your total cash flow there of four and a quarter percent. Nothing to write home about. When you're looking at it today, you actually get more than that on your bank account. But if we keep going and you look at the advantage of depreciation and in an asset like this, you can depreciate the physical asset but not the land. And I've taken liberty here, but you depreciate it over 27 and a half years. And so that gives you about two and a half million dollars of depreciation. That is a tax write off, a tax loss that shows up. So your cash flow, and I call it cash flow, not income, because income is taxable, is $1.7 million, but you also get depreciation of two and a half million dollars. So your taxable income is actually a loss in this case of about $845,000. If you have other income that you can from real estate that you can offset that against, you either a carry that forward or you offset it against other income and you keep that. And so what that equates to is a tax savings of around $312,000. So let's just, for example, if you had $850,000 in income that you could use this depreciation to offset, you wouldn't pay any taxes on that income. So there's a real savings there. And so what happens is your savings is around $312,000. You get an after tax cash flow of $2 million when you add the benefit together. And so your yield goes up to about 5%. Again, bank accounts today are sort of in that five, five and a quarter, five and a half depending on where you are. So doesn't look great. Now that is your sort of what I'll call after tax yield on equity. And if you go over to the left hand side, I want you to pay attention to the bottom because what the bottom number says that 8% is that in order for you to achieve a 5% after tax yield on equity, you would have to generate an 8% pre tax yield on equity. And so you start to see the way the pre tax and the post tax and looking at this a little bit differently, and when you're comparing investments that have these protections and these shields and you have to drill all the way down and really look at an apples to apples comparison because most likely everybody on this webinar is taxable. Now if you're using post tax money, it's very different. There's probably better opportunities for that. And I'll get into that in a few slides. The other massive benefit of real estate when it comes to taxes is tax free refinancing. That you can refinance an asset over and over and over as many times as you want without paying taxes. And I have friends, actually investors at origin who have done this, people's dads who have owned real estate for 30, 40 years that they bought for 2, $3 million that's now worth 60, $70 million. And not only have they gotten the benefit of the depreciation and the cash flow and tax free refinancing, they've never paid a dime of income on the property over the years. What you see in front of you is just the same example I was going into. This is $100 million property that you purchased it for. Today we as an, as a sponsor would do an investment like this. And then let's say you held it for 10 years. And by the way, 10 years, the property value doubles in 10 years. That's only about a 7% return. So this isn't out of, out of left field or crazy when it comes to returns. What happens is that your debt obviously is going to remain the same. I'm just assuming that we paid interest only, but your equity is going to grow from $40 million to $140 million. So massive equity increase. And the next bar over is you're resizing the capital structure again. You're now leveraging IT up at 60%, optimizing the capital structure, but still at a moderate level, I would say. And so you're replacing the $60 million debt with $120 million. You get to pull $60 million out of the property tax free. You paid no taxes on it whatsoever. And then you still have $80 million as sort of net asset value. And so that creates a significant amount of wealth for the investor. And that wealth is created at an after tax basis. And it's very difficult to do that in other asset classes like this. And the advantage of using leverage on real estate is that the cash flows are generally not always, but they're more predictable than many other asset classes. So the next tax advantage of real estate is the 1031 exchange. This is also known as the like kind of exchange. And many of you have heard of this, but this gives you the ability to defer gains indefinitely. If you have a property that you bought, maybe you have a surgery center or a business or something, or building that you've owned for many years, if you bought that for $3 million and now it's worth $10 million, when you go to sell that, you. There's rules around this, I'm not going to go into those. But generally you can sell that for $10 million and roll that into another property. Now this word, this term like kind, has a lot of different, has I guess, a wide definition. And it doesn't mean that you have to sell an industrial building for an industrial building or land for land. You can sell your land and roll that into a cvs, a triple net or chick fil a or whatever you want to buy or other different properties. And so there's a lot of latitude around the 1031 exchange, but it allows you to defer those gains really forever. And so that's pretty straightforward. Now, what many of you may not have heard, and Jim, I'd be curious to know if you've heard about this too, but is the next phase, and this is really becoming popular today, but it's the ability to, to have a 1031 exchange roll into a fund. Many sponsors are doing this, we are actually doing this today. But you can roll those proceeds into a diversified fund via a 721 exchange. And the way you do that is that a DST is created by a sponsor. I'll just use us for an example. We would create a dst. We would go out and find a deal. You would then roll in your 1031 exchange proceeds into that individual deal. So then you would satisfy all of the 1031 exchange requirements in there. And what happens then is that after two years, this is called a seasoning period. This is required by the irs. The fund that has already been identified would acquire this asset and you would then be upbreighted into the fund and you would exchange your interest in an individual property to partnership interests in the fund. And I think there's a lot of advantages to that. We're seeing people use it for a couple of reasons. Number one, to simplify their lives if they don't want to be a direct real estate operator anymore. The second would be for diversification. You can go from a single asset into a diversified fund. And the third is really about estate planning. And so it's, as we're working with older individuals who don't want to leave their family, a headache, and they have multiple properties, they say, hey, it's time for me to actually roll all this into a fund. And it's much easier to separate operating partnership units in the fund when you have, let's say, 100,000 of them across your heirs than leaving five or six sort of disparate properties. So it's a great, great, great program that's becoming, I think it's probably more popular than any other real estate program today, and it's really taken off.

Well, the nice thing about this one, Michael, as Opposed to other 721 upREIT exchange programs I've seen, is that it doesn't sound like the fund has to actually want your property.

Yes, you are correct. So by IRS rules, the fund cannot guarantee a purchase. And so there's an IRS seasoning period there that has to take place. Now, I can tell you that inside origin, because we are actually going out to acquire our first deal. We put our hats on for the Income Plus Fund, and we say, hey, what does the Income Plus Fund need in terms of portfolio construction? Where do we want to be, what cities, what type of asset class, et cetera? And then we go out there and we look for that deal for our 1031 exchange investors with the intention of buying this in about two to three years. And so ultimately, that will roll into the Income Plus Fund, but by law, you cannot guarantee a purchase, but you want to definitely create a path to the fund itself. Does that answer your question, Jim?

Yeah, I mean, I've seen this with some other fund providers, but basically it only worked for them. There wasn't the mid single stage of the dst. Basically, it was only possible for properties that the fund wanted in the fund.

Exactly. Yes. Right. These are. And some funds do it. Some of the larger funds, they drop properties down and they syndicate them to buy them back later. And so that's why I said, you know, as a portfolio manager, when we're looking at these things, we have to put our Income plus fund hat on and then go acquire deals that we truly truly want to own in that fund long term because that's an open ended fund and we're looking out 10, 15 years into the future. So I started out like talking about tax efficiency, how it was really hand in hand with strategy. And I think that when we first started out we adopted the buy, fix and sell strategy, much like private equity. The challenge with that is when you're buying and fixing and just selling an asset, you're not taking advantage of, of any of the tax breaks that I just went over. Depreciation, tax free, refinancing, the ability to use 1031. And I think real estate, it does have an unfair advantage. But if you're not in it for the long run, you're not taking advantage of those benefits of the tax side and it creates great income, but you aren't building real wealth. And to me, real wealth is built and created by buying great assets, building value and holding them for the long term and enjoying the benefits of the income and the appreciation and the tax free refinancing and using all of those things together. And I think it's really important for investors to think about as they're investing in deals and they're getting out in two to three years and churning over money, but paying taxes and doing it again and taking more risk. Are you better off just buying a really high quality deal and being in it for 10, 12, 15 years? I've done the math. I think that you are, that's a decision that you'll have to make for yourself. Because for me, if I can take less risk and make an equal amount of wealth, I'll do that all day long. And that's kind of like as the evolution of origin. This is something that we're constantly evolving and improving on our strategy and we've moved from the buy, fix sell to more open ended funds that take advantage of the tax benefits I just talked about. So I'm going to talk about a little bit about growth and strategy here because investing in growth markets is really, really important. And the chart in front of you, what this shows is really a simplification is comparing two properties where the only variable that I change is the growth rate of income. One property, the income grows at 1% and the other property, the income grows at 4%. And you can see the difference in value creation. After 10 years, a property that grows at 1% will be worth around $33 million. Again this is super simplified, but just that little delta creates a huge difference in wealth. The property that grows at 4% is worth about $55 million after 10 years. And if you're using a moderate amount of leverage, the outcome of wealth creation, it's going to be substantial. Now, the reality is that the property that grows at 1% would actually look a lot worse because your expenses are growing at 3%. So if you're only growing it at 1%, chances are this might be worth 20 to 25 million dollars. Because your expenses are eating into your margins. And the growth rate of income, it really needs to keep pace with inflation at a minimum. Historically, it's done that. Multifamily rents have grown at about 3% per year. And I tell you this because when you're looking at markets, and I'll take Chicago, for example, right, I don't want to pick on any markets I out there in Iowa or these other places, I can pick on my own market. This is where I live. We don't invest here anymore. But investment performance, it's highly correlated to population and job growth. And it should make sense because when you have population growth, when you have job growth, that's going to bring more people in, it creates demand for space. And the more demand you have, the higher the rental rates you can charge and you're just less likely to get appreciation in a city like Chicago versus a city like Nashville or Austin. In the long run, there are challenges that those cities are working through. In real estate, you get an oversupply, you get an undersupply, you get boom bust periods. And so you have to be mindful of those. And this is a really interesting story that I told somebody, a friend of mine here in Chicago, he bought a townhome 29 years ago. He just sold this recently. 29 years ago, he paid $500,000 for this townhome. And it was in a growing area in Chicago that eventually filled in. It was south side, south of Roosevelt Road, if you know that area. And over the years, he put about 3, $400,000 into it. Most of it happened when he was moving and he was selling it and he decided to upgrade it. And when I asked people, what do you think he sold that for? 29 years later, I hear, well, 2 million, 3 million, 5 million, right, all kinds of stuff. But generally I'm in these cities that have experienced enormous growth. Well, the punchline is this. He sold that property for $750,000. And that is sort of the punctuation of why you have to invest in cities that have a growing population, that we are only in the Sunbelt for that reason. And I think over the long run, these cities that we're in will outperform the northern counterparts. Could it play out differently over a short period? Absolutely. And Chicago is, you know, doing, doing okay today, but I'll bet on a Nashville or an Austin over the long run because those cities have just, I mean they're attracting population like, like never before. So. Okay, I'm going to move on to investing. You have choices. Where do you want to invest? Do you want to play on the credit side or do you want to play in the common equity side? And so to keep this simple, I only have one slide on the credit. I am going to focus more on the common equity side. When you're investing in debt, you are giving up upside for downside protection, meaning that your range of outcomes is generally going to be somewhat fixed. You're also, you don't get the benefits of, you don't get the tax benefits as you would in common equity. But it is a lot of sponsors who are diversified, have bigger platforms, generally run a debt platform and they run a common equity platform. And we do the same. And you're going to be in this kind of 55 to 80% range. Today we're seeing incredible opportunities in the credit space. 14 plus percent returns, it's almost equity like returns, but in a very, very protected position. A lot of what we talk about, I always get this question, where is it a good place? I'm like, credit is great. I think there's too much uncertainty on the common equity side. If you have non taxable income, if you have an IRA, a 401k, something that you can invest in alternatives, it's a great place for that. And I think the common equity side over time will right itself. But today we as a company are definitely favoring the debt side or the credit side over the common equity side. And we've seen the market already come down from its peak around 15%. And when we can make loans at, you know, and occupy the part of the capital structure between 55 and 80%, that means that values have to come down another 20% before we risk $1 of equity. And I'll make that trade all day long. Right now I don't believe that multifamily, especially in the institutional side, is going to slide another 20% from where we are. There's some good things happening on the horizon. We definitely have some tailwinds in front of us, but also some headwinds on the other side. But that's a choice debt investing for sure. And then the other choice is Common equity, and this is really more typical in real estate investing. And so I'm going to focus here quite a bit. And common equity, it occupies the first loss position. So you're going to have greater risk and a greater reward. And in the example I'm showing in front of you, this particular example uses around 65% debt, which I would consider that sort of moderate, moderate risk taking anything above 65% and you're sort of in the higher risk. Anything below 55, 50 is in the lower risk column. But that really does enhance the returns. Again, the cash flows are more predictable and it also enhances the tax benefits as well. But that's for another time. Typically, if you're going to be in the common equity position, you're going to want a required return here between 15 and 20% over around a three year hold period. It's the minimum you'll want for entering into this position. Now that said, you have to evaluate the risk, right? Are you going into a stabilized deal, it's going to be below that risk level. Are you going into a value add deal where the units are going to be taken offline, they're going to be upgraded, or are you going into a ground up development deal which would be at the higher end of that return spectrum? And so you have to understand not only the asset class you're going into, but also the risk of the business plan to evaluate whether you are being compensated for that risk. And again, the question I get a lot is is it a good time right now? And I'll say that timing, it's nearly impossible because there's just too many variables out there. But there are factors to pay attention to today in the market, we haven't bought a deal in four years. There's negative carry and what that means, and it's a very telling sign about future investment performance. But when you have your borrowing costs that are above cap rates, which is what's happening right now, so your borrowing costs are between five and a half and six. And on institutional, multifamily properties, your cap rates are somewhere around five, five and a quarter, five and a half depending on the market, you actually have negative leverage where the more debt you put on the property, it's not accretive, it's actually dilutive to returns. And when you get to a scenario, and historically we've been in these, where you can actually borrow for less than the cap rate, for every dollar of debt you put on the property, you're actually enhancing returns, you're generating higher absolute returns and you're actually generating a lot more cash flow as well. On top of that, we have an overhang of supply. We've got million units that are going to be delivered this year in markets that already have quite a lot of supply to absorb. That will happen, that supply will get absorbed, might take longer than we expect. But the nice thing is going kind of in 2025, the supply is largely muted because not a lot of shovels went into the ground in 2023. And, and typically it takes about 24 months for a community to be built. On the positive side, the tailwinds, we have a housing shortage. Owning a home has never been more out of reach for people right now as well that mortgage rates, the rise in prices is just creating this huge gap between owning versus renting and historically that Delta people will pay more to own. And, and these are charts we always look at. But it's about 150 to $200 per month right now. It's never been wider in the history of this country where owning a home is over $1,000 more per month. And so it's really forcing people into more properties. And that's why when we're looking at this supply, it will get absorbed. There are some tailwinds and some good things on the horizon. And my opinion is that it was, it's a better time today to invest than it was six months or even a year ago. And we'll know a lot more in the next six months. So last thing, last section I should say that I'm going to cover is evaluating common equity deal. I think this is a useful exercise because how do you know a good deal when you see it? And I know that when I was an individual investor and people used to show me something, I'd be like, great, I'm not a professional real estate investor. How do I know if this deal is good or this deal is good? And there's hundreds of variables. And I'll tell you, as a manager, understanding this, most people, 98, 99% could not figure out from sort of the highest level if a deal will work. Right. I get to see a lot of these deals. We go through this exercise all the time. And so I'm going to give you five or six that should get you 80 to 90% of the way there. And it's really in the interest of trying to determine if an investment will work or the likelihood that it will work. I don't think that sponsors are genuinely nefarious and trying to pull the wool over your eyes. But I do think that there are some sponsors and you have to look at this. Are they being really aggressive or are they being incredibly conservative on their underwriting? And the one that I really want to focus in on here before we jump into maybe this exercise, just common sense at the bottom. And that's your gut. Do you like the sponsor? Do you feel good about them? Did they come from a good referral? You have to ask yourself this question. How did the deal get to you? Is it complex or is it simple? And if you find yourself asking the question. Yeah. Or stating, well, it could work. Right. That's not a good place. Right. You want deals that are going to work that have kind of an asymmetric return profile where the downside is protected and you can make a lot more than what even the pro forma is showing. And that's the magic when you're looking at a lot of deals. And I think the best word that somebody can say or learn, especially when it comes to investing, is no, let it go by. There's always another bus that will come by in another deal and a better one. And don't be afraid of missing out on a deal. Okay, so here we go into sort of the exercise. And these are two ground up development deals. I made them very simple that I'm gonna compare side by side and you can sort of make your own judgment about which one you might want to invest in at the end. I'm gonna equalize these two. And we have a saying in this business that the pro forma is wrong. No one can predict the future, but we can definitely put ourselves in a more favorable position to win. And a lot of what I'll call sponsors and people who are out there who are soliciting deals, they tend to see the world with rose colored glasses on. And it's your responsibility to protect your own investment and at least be able to ask the right questions. And so there are, in this example, I want to take you through this. So we've got a few variables and I put them on here. So the first thing you want to look at is sort of the manager experience, right? Are they experienced in this asset class? Have they done things here before in this market? How's their track record? And in this particular example, you've got one with 10 years, one with seven. You want to evaluate their infrastructure, the rest of their team look at their track record. And again, simplified. So these are two deals in the kind of the same area, different sponsors. You know, that's not that big of a difference. 10 years, 7 years. The location on the left, it's a minus. On the right it's B plus, sort of a tie. Not a big difference. And then the leverage, this one jumps out at me, right? One deal is using 85%, the other deal is using 65%. So the one on the left uses higher leverage. Now that's not a big deal if you're getting compensated for that risk. So as soon as my I goes to that, I go right down to the return and I say, okay, am I being compensated for that risk? You might be somebody who says, hey, I don't ever want to take more than 65% leverage. I don't want to work with sponsors who have to do that. Fine, there's nothing wrong with that. We as a company, when we're doing common equity deals, we don't use preferred equity in our deals. We typically leverage 65% on those deals. But you have the next column or the next line item which is your net IRR. So the deal on the left generates a 20% IRR over this hold period. The one on the right, 16%. Okay, so you're being compensated for that leverage. Net multiple, same thing, that's gonna be a function of the irr. Now, net multiple who, for those of you who don't know it, I actually prefer this metric more than even irr. IRR is a time based metric. And when you look at these together, right, and a time based metric can be manipulated. If I give you a lot of money back earlier, that IRR is going to go through the roof versus later. But the reality is that sometimes you want all of your money working for a long time and it shows up in the net multiple, which is the metric about wealth creation and what that means. On the left hand side, if you put in a dollar, you're going to get back $1.72 after fees, and that is very important. On the right hand side, you're going to get back $1.57 after fees. And so below that you see the exit cap rate. And this is sort of a metric we look at, okay, are they being aggressive, are they being conservative? And in a world you have to understand where existing cap rates are to know if that's aggressive or conservative. If I told you that cap rates were four and a half, they're both extremely conservative. If I told you that the cap rate today was five and a quarter, well then the one on the left I would absolutely just throw out the door. Because any deal will work if you have an exit assumption. In the future where you have lower cap rates, I wouldn't even look at that. So for this exercise, we're going to assume that cap rates today are about 5%. And so the one on the left is basically underwriting that. We're going to exit at 5% in three years. And the one on the right has a little bit of a cushion. Five, three. So if cap rates go up, they're protected and then you have the fees in line, those come out to the net carry. So, okay, so let's go to the next page. So we have two deals. We're looking at these things and then we go out and we say, okay, well these are in the same neighborhood, so it makes it very easy. And we go out and we get what are the market rents for this property? And we go on apartments.com and we look and maybe we make some phone calls even and we start evaluating what we think rents are in this particular area. Because mind you, again, going back to people aren't doing this in a nefarious way. But if your rent range is A$80 to $2 and $0.10 per square foot, you have the choice, do you want to use the upper end or do you want to use the lower end of that to make your deal work? But we go out and we do our own analysis at $1.90. We look at and we say, okay, that makes sense, we're going to use that and equalize these two. And then we also look at comparable sales. And whenever we look at comparable sales, we're looking at both a cap rate and we're looking at comparable sales on a price per unit. So if you have a 300 unit property sell, you look at that and say, okay, well that trade at $320,000 per unit because that's what we call chunk price. And you're looking at those things together. And then you look at deal A and you have some adjustments to make and you look at deal B and you have some adjustments to make and you equalize those assumptions. And that's what this next chart does. And so with dla, we're actually going to bring down the rents down by 20 cents. And that doesn't sound like a huge adjustment, but. But I will tell you this, that if you're starting to get into big numbers and you look at a 300 unit multifamily and what this means, I'll break this down. If you have a thousand square foot apartment that is going to rent for $2,100 per month, that is $2.10 per square foot. Well, if market rents are only $1,900 and you wipe out $200 out of all your rents times 300, times, times, times, you're going to take out about $700,000 in income off the rent roll, and that'll equate to close to $14 million in value just with that one adjustment. The exit price per unit, it's probably already adjusted when you bring the rents down, especially if you use the same cap rate. So the cap rate, we adjust that up to 5.3. And so what happens when you run this through this new underwriting and you say, okay, here's the exit assumptions. This is what we think we can build it for. Do this, you actually get an IRR of 6%, which is an adjustment of 14% lower significantly, right? We had 20%. Now it's only 6%. Looking at it from a different lens, and your net multiple has decreased from 1.72 to 1.19. If we go to the other sponsor on the right, you had starting rents at $1.85. Here they're $1.90. We can actually bring those up. You can leave them the same because the deal works at $1.85. So you leave yourself a cushion there. Your exit price was 310, a door, but the market is probably 320. So this is a very. We're starting to see that this sponsor is extremely conservative. And your exit cap rate is in line with what we would expect in three years because we want to leave a little cushion for those things that we can't control. And we can't control interest rates, cap rates, et cetera. So 5.3 is a more appropriate cap rate for exiting. And so what happens here is you actually have a higher IRR than what you originally pro form. So there's a 20%. And then your net multiple has gone up significantly, too. So when we think about this asymmetric risk profile, in dla, you would have asymmetric to the downside, meaning there's more to lose than win. And in deal B, you actually have asymmetric to the upside. Well, if you underwrite this and you're like, okay, if this deal works at $1.85 rents, but we believe we can get $1.90 or above, we have a lot more upside, and if they go to $1.80, then we're still going to be okay in a deal like this. And that's sort of the mindset of an investor and how we look at Deals. And this isn't just a theoretical exercise. We underwrite a lot of deals on behalf of joint venture partners, sponsors who bring us deals and they come in the door at a 20% IRR and they leave the door at a 6% IRR and they're not even investable. And we constantly go through this all the time. So this is, you know, whether you're an LP and you're investing passive and you're looking at syndications or you are an active investor, it follows the same sort of methodology. If you're looking at an individual deal and you're underwriting it, you just don't want things that are priced to perfection. Again, back to that, it could work. That's not a good starting place. So your job is to figure out and look for deals that have more upside with downside protection. This is on that list of things that I showed you in the beginning, sort of the five or six things. We went over many of them. I would say that this one matters the most, the manager. And if you're wrong picking a manager, let's say you decide, you don't take Jim's advice and you go into active managed funds out there in the S and P. Well the difference there is maybe you'll underperform by 1%, 2% at the most. It's not catastrophic. You can change, hit a button, switch into the S&P 500 and you'll be fine. In private real estate investing, what this is showing you right here is the top quartile managers produced two to three times the wealth of bottom quartile managers during this period from 2012 to 2023. And this is actually in prequent. So that's one of the most important decisions because the other decisions, even though like you have the basic building blocks for how to evaluate a deal, but really in evaluating that deal you're trying to understand what is going through the manager's mind. How are they dealing with risk, how do they view the world? And if you can find a manager like manager B that underwrites the world conservatively and looks to protect downside, the upside is going to take care of itself. Unfortunately, that is the rare instance out there. Deal A probably more common than what you think that are out there, that's probably 80 to 90%. And those deals, when people view the world with rose colored glasses and everything can work. You want to just be very careful about those deals. So hopefully that was kind of what or the end of the presentation. I have some things on origin Jim, but I'LL save this maybe for a little bit later, but I hope you are able to take something away from this and use it when you go to invest, look at deals, look at real estate, and more than anything, just understand the benefits of investing in real estate. So thank you very much. Appreciate your time. Jim, we can jump into the Q and A if that works for you.

Yeah, let's go ahead and take some questions. Great job on the presentation. Thank you for that. You know, recently my state legislature wrapped up their session and like many other areas of the country, we have a serious housing crisis in Utah. We're now the 8th most expensive place to buy housing. You know, we're not on either coast and we're the eighth most expensive state. And so there are political changes that are being implemented in various state governments and federal governments, et cetera, to try to solve this housing crisis. Housing, how do you view those as affecting investor returns?

Wow, those are almost. I view two. One is like a social issue, one is an investing issue. I will say this, that what the Fed is doing today with interest rates is a policy that generally works in a more normal environment. The challenge we have today is that we have a distorted environment, and the Fed really hasn't impacted the velocity of money that's going into housing. We have the largest demographic that's moving through the economy right now, the millennials, who are all coming of age 32, 33, 34. And the housing shortage is actually a result of what happened back in 2008, 9, 10, where banks stopped lending and a lot of people just left the market altogether. But we didn't have enough speculative housing to. So we find ourselves in sort of this conundrum today where the Fed is using tools from the past to try to control an issue today. But you have this weird demographic that just can't. The Fed can't. The same tools don't work today because people are finding a way to buy these homes. And I would have told you two years ago if you would have told me the Fed was gonna raise interest rates to know, five, five and a quarter, five and a half percent. The long end was going to be four and a quarter. I would have said, yeah, there's going to be a huge housing recession. We just haven't seen it. Housing prices have sort of flattened. It's definitely impacted. I think the multifamily side for owners, not renters, owners have really borne the brunt of this because we are the ones who. Who own the asset itself. And the higher rates and cap rates and interest Rates are really impacting us as owners and the investors and funds. And this is a true real estate recession right now. This won't last forever. I think we'll be out of this soon. And it's good to have real estate in your portfolio. Cause S&P 500 is having its day, but eventually this will reverse. So I don't have the exact answer you're looking for, Jim. I think the housing shortage and the affordability is an issue there. There are choices, right in today's world. People can find a way to buy if they can afford it. If they can't, they can rent. If they can't rent, they can choose to stay at home, they can double up, they can do some things. But I just think from a social perspective, this is the most unaffordable time to own a house in the history of this country. And in fact, I was reading an article the other day that said this was by Zillow, so take it for what it's worth. But it was before the pandemic. In order to own a home in this country, you could, your earnings had to be around $60,000 today for you to be able to afford a typical home. You have to make over $100,000, right around $105,000. So you can think about that gap and how many people have been priced out of home ownership. It's definitely an issue that needs to be solved. I don't think interest rates are the job, but certainly we need to build more. Yeah, yeah.

I've been talking to lots of docs, young doctors coming out of residency and fellowship making $300,000 in relatively high cost of living areas that literally cannot afford to buy the average home in that market despite an income that's well above average. It's pretty impressive. And if it's affecting doctors that way, you've got to imagine how it's affecting households with more median income than that. Speaking of interest rate changes, you know, a few months ago, kind of the markets and were predicting that there'd be maybe three interest rate cuts on the short term interest rates that the fed controls in 2024. More recently, they're talking about maybe not being able to cut rates at all in 2024. Do you expect that to have a negative effect on real estate returns in 2024?

Yeah, I do. On the common equity side. I don't. On the credit side. And that's why investors have choices and we really see opportunity on the credit side. And it's hard not to root for a great economy I can't find myself doing that. I mean, if the Fed can magically engineer a soft landing, that would be absolutely incredible. We would love that. But I don't know if that will happen. I feel like the Fed always does something until we figure out where the risk out there, then something breaks and then we go into recession and. But I do believe that the Fed is going to do their job. They're going to get inflation down, we're going to start to see this rates come down by the end of the year. And one of the big components I mentioned this earlier in inflation are housing costs. And part of the housing costs are rent. And you're seeing single family homes at least stabilize in some areas, but rent's actually coming down significantly depending on the market you're in itself. But that takes a while to run through the inflation numbers. But we're going to start to see that and even the Fed is waiting to see that take place this year. So I think rates will be lower by year end and it should help alleviate some of the interest rate costs and cap rate expansion that we've seen the last couple of years. Whether or not there's a complete turnaround for real estate. The only thing I look at to get a great indicator of that is I watch a lot of the public REITs. Public REITs tend to be great leaders of what's going to happen in the future. So we look at these public REITs in the multifamily space that overlap our areas and so far they're just sort of sitting on their 52 week lows right now or very near them. So that could change quickly though.

Yeah, yeah, I've definitely noticed, you know, as I look at the quarterly reports from my various investments, you know, multifamily investments are often seen rents going down a little bit lately. Values of those properties, the ones that at least mark them to market periodically, you know, slight decreases quarter over quarter. And so I think you're right, I think we're seeing at least a little bit of a recession for multifamily investors. And hopefully that means we're talking about buying opportunities now and in the near future. But it certainly affects investor returns for those who already own.

Yeah, I think it will. I think that as you know, again, nobody has a crystal ball, but if I'm looking out six months, and the thing I mentioned earlier was negative carry, I do see a world where the carry at least goes neutral, which would benefit investors greatly or even slightly positive, where you can borrow for less than the cap rates. And I think there's a real chance here, and I've said this to a lot of investors in the past, that you really haven't had any multifamily properties sold for two years. And there's a lot of investors out there who want to sell. And I think that what could conceivably happen, and this has happened, in other words, periods like this, this happened in kind of 0, 8, 9, 10, 11. Those periods, is that you have this overhang of pent up sales that are going to happen in the face of improving fundamentals. And so by the end of 2024, if we get lower rates, you're actually going to see higher supply and potentially even lower prices because of the amount of sales, which could create a great buying opportunity. Because when you look at the arc of any cycle, if you have an overhang of people who are selling into improving fundamentals, that creates a great, great environment. And we haven't bought in four years, Jim. You know, any more stabilized deals, we've done a lot of ground up development, but that could be our cue to sort of jump in.

Yeah. You know, when we talk about conservative underwriting, everybody says they're conservative when they do their underwriting. Right. There isn't a sponsor out there that doesn't say they're conservative. How much higher do you think exit cap rates ought to be on the pro forma compared to the current cap rate to be considered conservative underwriting?

So we use a general, what we call drifting of the cap rate. So we look at for exit cap rates. So if you're marking things to market today, they should be marked at existing cap rates. If you're getting into a deal that doesn't, where you don't exit for three, four, five years, then that's the pro forma cap rate. And typically what we do is, is we will look at the in place cap rate price per unit, we back into it and we will drift that by about 10 basis points per year. So if cap rates today are 5% and we're exiting in five years, we will be exiting at a five and a half cap rate during that period. And if the deal can kind of withstand that kind of scrutiny and those filters generally, and meet our cost of capital, a lot of other variables, but generally we're going to do a deal that looks like that. They're just incredibly difficult to find in the world today. But that's what I would say from a conservative cap rate. That's one metric. Again, yes, everybody believes their deal is going to work and Some will and some won't. And I think as an investor we have to figure out, okay, when I look at two deals and they're both look exactly the same on paper, how do I know which one is going to work? And it's yes, it's experience, asking the right questions, getting to know the managers and then, you know, sometimes filtering out, did this manager just get lucky at a great time or, you know, are they really good at what they do? And when you sit down and you've done this quite a bit and you talk to the manager, what kind of vibe do you get from them? Right. Are they investing alongside of you? Why are they doing this? What's their, you know, motivation for this? Are they trying to make a lot of fees or are they truly trying to in the world of making investment returns? And it's an art and science at the same time.

Let's briefly describe the three funds that Origin has open for investment right now.

Yeah, so the ones you see in front of you, I think you're sharing this still, Jim, when we think about this, all of our investors are taxable, high net worth investors and we think about it in terms of a risk return spectrum. So on the left hand side, what you have here is our lower risk or lowest risk fund geared towards income. This is a credit fund, only invests in debt products, so it's going to be less tax efficient. But the interesting thing about when you invest in a credit fund in real estate, you do get the advantage of a reit. Now those benefits run out in a couple of years, so don't do it just for that. But we're also investing only in debt, in multifamily, so it's what we know how we operate on that side. And then in the middle, what you see is the Income plus fund. And I would say this is more for moderate risk investors. We run three strategies in here. We run credit and that fund today is around 60% credit, 40% is common equity and half of that common equity is in ground up development. So in the last few years we really embarked on a barbell strategy of ground up development and investing in credit. And by the way, I should mention these are both open ended funds. So if you want monthly income, if you want to grow and protect and build wealth over the long run, you can invest all your capital and just let it grow. And so what I was talking about earlier about the tax benefits, the Income plus fund takes advantage of, of the tax benefits within the fund. This is an open ended perpetual fund. When we Build a ground up development that sort of moves into what we call our core bucket. We don't sell it. We're not in the business of churning that, building great real estate in really high growth markets and then holding that for the long term and then continually refilling the bucket of ground up development which can be no more than 20% of that fund. And then the QZ fund is really part of our growth series. We don't have a growth fund today because the opportunities aren't out there. So. But the Q Z is a tax advantage fund. If people have long term capital gains, they can actually defer those for quite a. They can defer those and get the advantage. Let me just back up. QZ really hypercharges the tax benefits of real estate investing. So if you invest in the QZ fund today with capital gains, you don't have to pay those capital gains until 2027. So you get the advantage of deferral. But you will have to pay those because they're recognized in 2026. If you're in that fund for 10 years in a day and then sell your interest, you pay zero taxes. So it's a great program for investors who have a very long term outlook, want to be in ground of development and have capital gains to shelter. So that's sort of our mix of products. We also have a growth fund, we just don't have one available right now that will come out. If we see an opportunistic investing come back to the market or if we see a great deal or a great opportunity for ground up development. We'll also have a growth fund but just nothing in the market today that warrants us raising a fund for that.

Yeah. Now the Income Preferred or the income plus fund is over 60% preferred right now. Do you expect that to change long term? Is that kind of where you expect it to be? Could it be 80% in a year or two? Could it be 20% at some point in the future?

Yeah, that's a great question. I failed to mention that. But that fund, I love this fund Income plus because we can tactically adjust it as managers. And if we go back sort of pre Covid days it was 30% credit and 70% common equity. Today it's 60, 40. And we see an opportunity which we've been talking about lately about positioning this fund more tilting it towards common equity in this environment we absolutely will. So it's more likely that this is the extreme credit to common equity. But you probably will see this tilting back maybe by year end or in 20, 25, sort of that 40, 60 the other way. Because when, if and when we start to see some positive tailwinds in the multifamily side, we are going to start buying more and more deals to tilt that back towards the common equity and take advantage of that unlimited upside as well. Yeah.

Now, the Strategic Credit Fund is managed by Origin Credit Advisors as opposed to origin investments like the other two funds. Can you explain the difference?

Yeah. Origin Credit Advisors, for all intents purposes, is a sister company of ours. And so this is for qualified purchasers where other funds are for accredited. And the Origin Strategic Credit Fund, it runs securities inside that fund, and securities we are actually overseen by the SEC on that side. So we had to split that off. Whereas all our other funds, we're under the real estate guidance or protected. We're not under the guise of the SEC on those. So that has a very different oversight, if you will. And it's important for us to manage that differently. And that fund is run by Tom Briney, who's been with us for 12, 13 years. He's fantastic. But it's, you know, it's separate and the same at the same time. So it utilizes all of Origins infrastructure and experience to run that fund.

I've been investing with origins since 2017, I think was my first investment in one of those growth funds that aren't currently available. I was invested in Fund 3, which this year may wrap up. By the end of this year, I think it was 17 properties total, mostly multifamily, but also some office properties. I think 14 of those were sold off at, at a gain, some quite large, some of them smaller. And then two of them are still in the fund waiting for an opportunity to exit from those properties. And then one of them, the fund basically decided to mail in the keys to the lender. Can you talk about that decision and how that affected the rest of the fund and, and take us through that moment that the fund manager decided to do that with that property in the fund.

Yeah, 100%. So that's fund three. And in fund three, we were in office and multifamily. So that was a period where, I think, you know, if I look back, I always say, like, did we make the right decision given the information at hand? Right. Because there's a difference between making the right decision and having the wrong outcome and making the wrong decision and having the wrong outcome. And I think our investment was sound. We bought an office in the West Loop of Chicago, one of the hottest neighborhoods in the area. That we knew and Covid hit and office demand just cratered. And we looked at it and we lost some tenants. And then you look at where cap rates and where interest rates went. And we looked and we said, look, do we really want to spend the time and effort and money trying to rescue this property? And when we really looked at the math, we said, look, even if we're right, this is only going to add two to three basis points to the fund. But now are we chasing good money after bad money? And those are the decisions and it's never easy. But I will touch on this. Number one, as a sponsor who only engages in institutional investments, you have a put right on these properties. And I can't emphasize that enough. A lot of times when you're an individual and you're guaranteeing debt, you're on the hook for that debt. Well, we don't guarantee debt at the fund level or at an individual level. So that gave us an opportunity to sort of hand the keys back and said, there you go to the bank. So. So we did that and we took a full loss on that deal, which obviously hurt. There were a couple of things like I wish I had a few mulligans on that fund. When we look back, Jim, that would be one of them. Maybe connect at first creek, the sister property would be another one. And you know, for. For the few things that really, I would say the couple things that went wrong in that fund, that fund will still end up for that vintage being kind of right around the top quartile performer as we look at it in prequin. But that was an unfortunate outcome. And there could be another one. We also have a deal in there, another office deal down in Texas that. It's fine, it's occupied, it's doing all that. But the office market, no other sector has gotten hit worse than office. And we did have some good exits on the office side in that particular fund. And thank God we got rid of those before COVID hit some of them right after. So all in all, that was a lesson that we kind of take home and hurt returns on that particular fund.

Yeah, it demonstrates one of the big benefits of being in a fund rather than individual syndications. Right. If somebody had their entire investment just in that, in that particular property, it would have been a total wipeout of their equity. By being in a fund, you still end up with quite good returns.

Yeah. And Jim, I'm glad you brought that up because I'm on the road right now. I'm doing a road show around the country and talking to a lot of investors and people, they like deals, they like funds, they do different things. But I think what they're really many of them are finding out, I'm hearing sort of the horror stories about these are sponsors who are doing syndications. They're under capitalized. And what happens in a fund, a fund is like a company that you can borrow from one property to use for another. And it's all legitimate. It's underneath the same company, the same owners. You can't do that if you have a bunch of syndications. Right. If you have one syndication losing money, you can't borrow from another syndication. That's called fraud. And so with what happens with these under capitalized sponsors or these deals that are going bad when suddenly you have seven or eight or you need cash in refinances, they're getting capital calls that they would have never expected at this point in time. And they're like, oh, I just got another capital call, I just got another capital call. And so I like funds. We do both. We do some individual deals as well on the side, like if the fund can't take the whole deal. But I think syndications you have to be very careful with because sometimes there is the propensity for the deal goes wrong. It's going to be the bank of the investor that needs to step up and fund that deal. Yeah.

All right. I think our time is now short. Any last words of wisdom you want to share with participants in the webinar before we go?

The thing I'll share, I read a good book that somebody at Origin gave me and it was the Psychology of Money. Have you ever read that book, Jim?

Yeah, Morgan Housel's book.

Oh, I love that book. And I just think it's for one. Each chapter is only about eight pages. And I think he's amazing. I would recommend that book to anybody. And then the punchline is this, that investing, it's not about what you know, it's about how you behave through the years and whether you're talking about stocks or real estate or anything. So I would highly recommend that as a reading to anybody who listens to this webcast. So thank you.

Thank you so much. This has been a webinar with Michael Episcope, principal at Origin Investments. And you can learn more about origin@whitecoatinvestor.com Origin. Thank you for your time and attention in this webinar today.

Thanks for having me, Jim. The hosts of the White Coat Investor are not licensed accountants, attorneys or financial advisors. This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your.