Step 8: Reposition the Property

Welcome. This is the Insider's Edge to Real Estate Investing with James Nelson, the principal and head of Avis and Young's Tri State Investment Sales Group. In this program you'll learn game changing strategies to outperform the market. James will teach you how to source, execute and capitalize on the best real estate opportunities in New York and around the world. Now here's your host.

Welcome to episode number 125 of the Insider's Edge to Real Estate Investing. This is your host, James Nelson. I am principal and head of Tri State Investment Sales for Avison Young. Thank you as always for joining. I really, really appreciate it. Love the comments. For those of you who subscribed, thank you. It's what helps others find the show. The whole purpose of this program is to help give you the inside edge to real estate investing so you can outperform the market. And that is also the main driver and point behind our upcoming book that is coming out early next year. And I am writing this with my writing partner Rachel Hartman, who will be joining us shortly. She's incredible. She's written for Fortune 500 companies and is a regular contributor for US News and World Report. And today we are going to be talking about step eight, repositioning the property. And if you're just joining for the first time, we are in the midst of this series. It's a ten step series. We also had an introduction as to why invest in real estate as opposed to other asset classes. And I also had an episode where Rachel interviewed me on my story not only as a broker but also as an investor. So for today we are gonna be talking about how you improve a property. For most of you investors out there, you're not just looking at buying stable cash flow and holding. You are looking to add value, improve that bottom line. So we're gonna be talking today about how you go about that, looking into the construction projects and how to go about getting the best team to accomplish that, keeping cost control. So a lot of great content that we're going to be talking about today. So we're going to have a brief word from our sponsor and then we are going to get right into that discussion on repositioning the property.

A different approach to putting our clients first. Avis and Young's Tri State Investment Sales Group sells multifamily office retail development and specialty sales throughout the New York metro area. As experienced thought leaders in our industry, our 35 member group is available to help you make informed investment decisions by advising you on your current holdings or identifying new opportunities in the marketplace. Our one unified team is built on an industry unique platform which promotes unparalleled collaboration and teamwork. We share core values of hard work, integrity and expertise. We put our clients first providing tailor made strategies to achieve superior results. Please Visit us at aytristateinvestmentsales.com and follow us on Twitter LinkedIn and Instagram amesnelsonnyc to learn more.

Welcome back everyone. James Nelson here, your host of the Insider's Edge to Real Estate Investing. And here with my guest co host, Rachel Hartman, we are collaborating on an incredible new book that's going to be out next year. Cannot wait for you all to check this out. I mean, it's a lot of hard work that's going into this, but this story needs to be told. You know, I can't tell you and maybe I relayed this on one of our previous shows, but you know, I do a lot of guest lecturing all over, you know, the kind of tri state area actually, beyond nyu, Fordham, Columbia, Wharton, Cornell. And you know, I asked these professors, I asked them, I said, you know, what recommended reading do you have for your students? And you know, you'd be very hard pressed to get recommendations, you know, and I'm sure some of you have maybe been out there searching for books. You're learning how to invest. Maybe you're sitting in your dorm room right now in college and looking for a side hustle or a way to get into the business. Or maybe, you know, you're a successful entrepreneur who's just sold their business and is looking to diversify into real estate. And you're learning, you want to learn and figure out how to do this and, you know, really go beyond the, you know, fix it, flip it, you know, you're ready to do some serious investing for cash flow and all the benefits. So yeah, we've been working away and if you haven't heard our show since we renamed this podcast, we started with my story talking about how I got into the business and my experience not only as an investor, but more importantly as a broker because I see so many transactions work with hundreds if not thousands of investors. So I have this great vantage point where I can sit and I can see what works. And I want to share that information with you. I want to help you avoid the pitfalls. But I also want you to know what's going to make you the most successful. So we did that. We then did a show on why real estate. And then Rachel, maybe tell us what the other seven steps maybe you can give A quick run through. Which brings us to today.

Yes, let's do that. Because what we're going to be talking about today actually makes some assumptions. For instance, it assumes that you have a property. So you've already gone through a lot of these initial steps. You've looked at different options, you've built up an amazing team, you, you've secured the financing, raised capital, you've gone through the underwriting process, you've closed on the deal. And so now it's that idea that you have it in your hands, which is a super exciting step. I think it's one of the reasons a lot of readers are actually going to pick up this book. It's kind of that idea. When you think of real estate investing, you've got a building, you want to do something with it. But this is really where a lot of the things you've been doing up to this step start to come into reality, so to speak. So we've talked before about ways to add value to the property and we're really going to dive into those aspects here. With that in mind, I'd love it if you could actually start us off by talking about different ways that you can actually add value to a property.

That's great as always and perfect lead up and yes, but by now, congratulations, you own a property now what are you going to do with it?

Right?

So hopefully by now, and if you've listened to our previous shows, especially listen to that one step two, assembling the right team. Because it's not like you're going to close. And now we say, oh, I just bought this building, now what am I going to do with it? You know, hopefully you've assembled your team before you even signed a contract to purchase the property. So your architect has already gone in to make sure that you can do what you want to do. You've got your contractor, you've spoken with leasing brokers, so you understand, okay, this is how I'm going to reposition the property. Maybe you're going to turn a one bedroom into a two bedroom. Maybe you're going to, you know, create some additional retail space. But again, having this idea up front is going to really help you. So when you close, you hit the ground running. So that being said, and I know I really want to get into this conversation today, but I also want to take a step back because, you know, you brought up something really important which is, you know, look, we're making the assumption here that you are buying a property which is what we call value add. Okay, Value Add is when you are going in to improve the property. Okay, now that's in contrast, and I think we talked about this on an earlier show, the different types of investments, right? So in the institutional world, what you would call a core investment, that's like buying a bond. That's those CVS's, Walgreens, you know, McDonald's triple net lease, 10 year, you know, new lease, where basically you just get a rent check every, you know, the first of every month. And, and they handle everything, right? They handle the repairs and look for some people that works. And you might say, james, Rachel, I don't want to go in there and renovate and have to deal, you know, with dealing with tenants and new leases. So, and that's okay. I mean there's, that's one of the questions you have to ask yourself before you go into this is, you know, how hands on do I want to be, right? And we've talked about earlier shows and that again in that episode about the team, you know, can you hire third party professionals to do this for you? And we're going to be talking about that today. A managing agent, leasing brokers, contractors, you know, of course you can have, you don't have to physically swing the hammers and do this, but you know, for a value add property, you are the one that's overseeing this. Think of yourself as the general manager, right? You're watching this. And so, you know, it is important to ask yourself, you know, do you have the time to, you can make available to do this? Because especially if this is your first one, you really want to get, if it's a value add, you really want to get hands on because you want to learn every step of the process. Of course you can always build a team, you can always delegate in the future. But understanding, you know, what it takes, how to control costs, staying on top of things. You know, there's that old adage, you know, squeaky wheel gets the oil. You know, even my clients, when I'm out trying to sell properties, you know, I've got clients who call me, you know, every other day, James, what's going on with my listing? And you know, do they get a little extra love? You know, they probably do, right? Because it's like, all right, I got to get this thing moving, right? So I know, Rachel, I just threw out a lot of things. But I think it is important for our listeners to first really think about, you know, and that, that is that that step one of what to buy, you know, how much am I in for? Because Today's show is going to really talk about what I think is the true value and opportunity for real estate, which is to reposition taking assets that have been, you know, mismanaged. Long term ownership, that's what my investors love.

Right.

You want to look at a situation where they did not maximize rents, they haven't renovated the property in 20 years. Because look, this is a cyclical market, right? The market goes up and down. You hope you buy it a low, you hope you sell at a high. But let's, I mean, no one has a crystal ball, right? And so if you are in a market where, you know, let's say right now we're at a point in time, we're recording this in May of 2022, where, you know, we just got a 50 basis point rent rate hike, you know, so now there's a risk that rates are, it's going to be more expensive to borrow. That should push pressure on pricing.

Right.

So I better not be relying on my business plan to. That pricing is just going to keep going up and up and up and that investors are going to continue to accept low returns that we can sell to. I need a more stable plan, which is I'm going to actually increase the bottom line by raising rents and controlling expenses. And so that's what we're here to talk about today.

Perfect. And I know from your experience in New York, you've seen this done so many times. And this is actually a main part of the book as well. I mean, the subtitle is Strategies to help you outperform the market. So here we're looking at ways that you can do exactly that. I'm curious, Rachel.

They're not just strategies, they're game changing. We are changing the game right now. As you're listening, it is happening. These are game changing strategies. So, you know, picking a name for a book is actually, you know, you want to get it right. So. Yes, yes. The insider's edge to real estate investing. Subtitle Game changing strategies to outperform the market. That's, that's what we're doing here.

Yeah, and I love the title and it really, you know, the whole book outlines what to do in this real tangible way, which is one of the things I love about this project. This is not one of these lofty books where it gives you great concepts, not a lot of practicalities, and it also helps you avoid things like Googling every single step so that you're spending literally hours trying to do all the research yourself. You can just grab it and Go. So I'm curious, when you have first time or beginning investors come to you and say, I'm really interested in taking on a value add. What can I do? What do you see? Are there some types of value add projects you suggest for first time investors or. Not necessarily.

Right. So I love mixed use, retail on the ground floor, apartments above, because, you know, multifamily is still the safest investment out there.

Right.

People always need a place to live. You know, the office market, you could say is the riskiest investment right now. I mean, again, you know, after this pandemic, you know, what's the return to the workplace going to be? You know, like, so having apartments there, especially ones that are, you know, picking the right cities, neighborhoods where you are seeing a upward swing. I mean, right now we are seeing, you know, people, you know, picking up, leaving, saying, hey, if I can work remote, I can live anywhere. And looking at these areas where, I mean, look at the, it's supply and demand, right? So you're looking for markets where, you know, the type of product that the tenants are demanding is not available.

Right.

And that's happening actually right now in New York. We do not have enough apartments. We are so undersupplied. And that's why we've had a 33% rent increase in the last year. Now that's great. So again, if you were an owner who bought in, an investor who bought in a year ago, did some work and now the rents are a third higher, you're doing really well right now. Okay, now is it going to continue to go up a third every year? Of course not. But again, really trying to find out, okay, what does this market demand? Okay. Because you don't want to be a pioneer, you don't want to be the first person to deliver condo level finishes only to find out that no one's paying for it.

Right?

So look at what is the best in class product in your market and study it. I think we talked about on one of the earlier shows, go walk the comp set, go, go shop around and say, hey, I'm a tenant, I'm looking to rent apartments, right? And go see what the other buildings look like and see what works, right? Also speaking to the rental brokers, residential brokers and saying, hey, what's the demand in this market? Is this a, a shares market where, you know, is my target renter? Are the young professionals who want to share a two bedroom, you know, or is it a family and I need to have, you know, larger bedrooms, larger living area? You really Want to understand who is your target market and then build according to that, right? And then same thing with retail. You know, what is, you know, who are the tenants who are growing, who's doing great business, what do they want? You know, who knows, it might be, you got a sleepy old hardware store and you know, you want to build this out for a restaurant, right? You might have a garden space where they can have seating in the back. I mean, again, you got to speak with the architect to understand can you do it. Obviously, if you're going to build out a restaurant that's very expensive, you have to figure out how to vent it, you know, so you have to make sure that you can do it. There's also considerations. I mean, I have some clients who say I don't want a restaurant on the ground floor because it's going to bother my tenants up above because the noises and the, you know, everything else. So, but I think it's really looking in the neighborhood, seeing what is doing well and then really trying to replicate that, right. And deliver, you know, that, that kind of at that top level where you can really generate outsized returns, right? It always amazes me. And maybe, you know, maybe it's the same in your market in Miami, but here, here in New York, you know, you can have two buildings that are right next to each other and in one building, the one bedroom is renting for 3,800 and next door it's running for 5,000. I mean, the both buildings are built at the same time. What's the difference? You walk into the apartment for over 5,000 and you've got, you know, a beautiful well lit lobby. And you know, the apartments have washer dryers, granite, stainless steel appliances. You know, tenants, especially in the right markets, will pay up for certain finishes, right? But there's other markets, you know, whether secondary tertiary markets where they're commodity markets and no one's going to pay you for that, right? So it's, you're doing that analysis on the return on your investment, right? So if I'm in New York to gut renovate a one bedroom apartment, that could cost anywhere from 50 to $75,000, right? So if I can get a lift of $500 a month, and again, not that $6,000 is going to go directly to my bottom line because as I raise the rents, you know, there'll be, you know, taxes and expenses. But you know, bear with me another $6,000 a year at a 5% return. I just increased the value of my property by $120,000. So I just spent 50,000 to $75,000 to make my building worth $120,000 more. So that's how you really create value. And I'm not again, going back to what I was saying earlier, my exit strategy is, hey, I got a great buy. I bought this building for a five and a half cap. I'm going to turn around and sell.

It for a 5 cap, right.

And try to get more money. No, what's really going to make that investment, a double, a triple, a home run is really increasing that bottom line, which has to do with driving that top line, those rents.

Exactly. Great explanation. So I'm curious, when we think about the investor's role in this, I feel like it sounds like a huge time commitment. We've talked about this a little bit before too. How involved do you get in the project? Who do you turn to for help along the way? So I'm curious if you can talk about the managing agent. So I don't know if you see, first time investors usually take on this on their own. If you usually advise against it and then how you go about picking out a great managing agent.

Yeah, I would say for starters, oftentimes we see investors self manage, right. They figure I can't afford to pay a third party manager. Managers charge, depending on the size of the transaction, anywhere from 3 to 6%.

Right.

So on the gross revenue, right. So if you're running a building that has, you know, a $200,000 rent roll, you know, and if you're paying your managing agent 5%, it's 10 grand, you know, a year. So you might start by asking yourself, you know, is your time worth More than 10,000, you know, a year? But I think it's also, you know, there are clearly there's advantages and disadvantages. Okay, so let's try to, let's try to spell this out. Okay. First of all, if you're new to the game, having an experienced manager, right, who knows what to do, how to run these properties, really on the expense side, super important they have those relationships with heating, whether it's gas, oil, repairs, the superintendent, it could probably even be helpful with an insurance provider. They're going to really, the hope is they're going to really save you money, right. On, on the expense side of the equation. So that's pretty invaluable, especially if you don't have connections and you don't know if you're trying to go figure it out on your own. Also keep in mind, if you're just one person who's got one building, you don't have a lot of bargaining power. If I'm a managing agent and I run, you know, 1,000 units over, you know, 50, 60 buildings, I'm probably going to be able to negotiate the best pricing with these service providers because I'm giving them volume.

Right.

And I've also probably tried out a lot of these service providers and know which ones aren't great.

Right.

So that's certainly some of the advantages, I think, on the, on the advantages of self managing. Look, no one's going to work harder for your building than you are.

Right.

Just like I said, okay. That manager, it's benefit that they've got 50 or 60 buildings, you know, they get kind of that, that, you know, collective bargaining, if you will. But the flip side is they're running 50 or 60 buildings. So you know, your building's not the only thing they have going on. And you need to make sure, like who's watching this to make sure that things are happening in a timely fashion. If there's a tenant complaint, you know, is the repair person going out there. But also there's a difference between being a managing agent and an actual asset manager. Okay, Think of a managing agent is really someone at the property level. Again, they're collecting rents, they're paying expenses, they're filing your paperwork with the city, you know, but asset manager is the person who's looking at the whole thing saying, now wait a minute, why are we only getting 3200 for this one bedroom when the next door property is getting 5200? You know, is this really the highest and best use? You know, you know, a lot of these managing agents will also do leasing.

Right.

So some of them are good at it. Some of their, you know, it's not their core business. So you might be better off hiring a residential brokerage firm.

Right.

So again, I think for a first attempt, I like the idea of having a third party manager. Yes. You know, you're going to have to pay them that 4, 5, 6% of your revenue. But if the deal doesn't pencil with paying 3%, 4% or 5%, it's probably too tight of a deal and you probably shouldn't be doing it anyways. And by the way, for your first deal, you could also be showing it to the managing agent and say, hey, what do you think about these expenses? What do you think about these rents? What do you think about how we could improve the performance of the asset? So once you have a large portfolio, most of my, you Know, my largest clients, they all self manage once they get to a certain point, you know, and I'm talking about kind of the more hands on operators, right. Who have, you know, 20, 30, 50 buildings. Now once you go a step higher in the institutional world where you've got, you know, REITs operating tens of thousands of units, sure. Of course they use professional management, especially if their portfolio is national in nature.

Right.

Whereas if all your buildings are within, you know, a mile or two of each other, again, it is easier for you to self manage and keep an eye on that yourself.

Perfect. Just a couple of things that we can clarify before we move on. I love that you brought up asset manager. Maybe just for clarification, if we can talk about what the asset manager does, where they might come into the project and what you can expect from them.

So an asset manager, that's really for an institutional type transaction, for the type of investing, private investors, first transaction, second transaction. I mean you are the asset manager, you're the one who is watching the performance of your asset. If we were talking about a fund, what does the asset manager do? They are the ones who are managing the manager, Right. They are overseeing the retail leasing broker, they are overseeing the rental broker. They are communicating to the investors. They are most likely putting together quarterly reports. So we've had Derek Aiken on this show, who, you know, we raised two successful funds together. In addition to being the cio, the chief investment officer, he was our de facto asset manager. We had a portfolio of investments, right. 33 investments that we did. And as the asset manager he was overseeing and some of those we had with multiple, the same sponsor multiple times, but he was overseeing each investment. So he was speaking to usually the sponsor, the person who was running the deal. And if we need more information, hey, let's get the leasing broker on the phone. I want to find out what's going on. If we're selling the property, hey, let's get the sales broker on the line, let's get a report, let's find out what's going on. And he was taking that information, putting that in a nice report and presenting it to our investors so they understand how the portfolio is doing. So yeah, I mean, I think for most of our listeners they're not going to have the luxury of having a full time asset manager. But I call it out as a distinction on the difference between a managing agent who again is just there to deal with the physical day to day operation of the property as opposed to kind of that big picture person. And it's not just, you know, hey, are we going to reposition the property? But it could be, hey, when do we refinance? You know, your managing agent's not going to say, hey, rates are about to spike, you got a year left, you know, on, on your loan. You should probably start thinking about refinancing. Look, when you want to sell, that's, that's your call. Not, not the managing agent. So you know, you need to understand when you are going to, you know, what is your business plan, what is the timeline, when are you going to be taking these steps?

Great. That's a great explanation. So when we, so getting back to managing agent, we've talked a little bit about what they do. I'm curious from an investor expectation point of view, you know, what should we be looking at getting from the managing agent? For example, on a month to month basis, should we be seeing certain reports continue to flow through to us, anything that we might want to be aware of so that we know what to look for?

Absolutely. They should 100% be giving you monthly reports which are, you understand, you know, this is the basic accounting, right, that you want to understand what rents have come in, you know, what expenses have been paid. And sometimes it doesn't all add up until you look at it. You know the snapshot that the T12, that trailing 12 months because you know, taxes might be paid quarterly, they might be paid, you know, twice a year. And then also you're watching when the rents, when they're using a cash method of accounting, you're actually seeing when the rents come in, they should also be having an aged receivables where they're actually showing where, you know, if a tenant gets behind in rent. So, you know, hopefully, I mean, if you got a problem where a tenant hasn't paid you for a month or two, that managing agent should be all over that. And you know, after a certain amount of time, if it doesn't look like that tenant is going to make good, I mean that, that's when you need to bring in, you know, your L and T council. But yeah, they should be giving you monthly reports. They should also be giving you, you know, updates and hearing what's going on at the property. If there's any issues, things that you need to address, they should be keeping you posted. But again, it really depends what kind of arrangement you have with the managing agents. Some of the managing agents say, look, will collect, we'll collect your rent. Will, you know, you'll pay, we'll pay your expenses. You know, we'll file the paperwork with the city. But, you know, any improvements on the property, that. That's on you. Some of these managers also do construction management, right? So, for example, you know, in New York, there's all these local laws where, you know, you might have to do facade work or you get a violation because you have a crack in the sidewalk. You know, the managing agent, you know, should alert you when there's a problem. When you get a violation on the property, you know, they should let you know, hey, look, I mean, there's an issue with the sidewalk. You go in and do the repairs, but they're going to look for you to go find the contractor to deal with that sidewalk. Unless if you have them retained to do that type of work, then they, in essence, become the GC to oversee that work.

Okay, great. This is all really good to know. So I'm curious about part of this process as far as when you know how tenants are treated, so to speak. So the property passes from one owner to another. You're looking for ways to add value. Are tenants informed? Not necessarily. I just feel like this is good for listeners to know so that they know how tenants should be treated.

Rachel, it's great that you ask these questions because, you know, sometimes I think, oh, it's just this is the way it works, and this is. And. But you don't know what you don't know. So, first of all, when we're selling properties, it's a big no, no as an investor to talk to the tenants. Okay, let's start there. If I'm trying to sell you a building and you're going in talking to my, you know, retail tenant, hey, how's it going? You know, are you thinking of staying or, you know, what's. How's business here? Well, why are you asking? Oh, I'm thinking of buying the building. What? My landlord's selling my building. But you. A lot of the times, you know, the tenants are not going to know the property is for sale. You know, landlords, you know, sometimes they'll say, hey, look, you know, it's time. Everybody knows I'm selling. I've told them, obviously, their leases will be honored. But, you know, a lot of times landlords don't want their tenants to know because they don't want tenants to. Some think that the tenants might take advantage of the situation, say, oh, this guy's selling, so he's not going to chase me for my rent. I'm going to stop paying. Right? So, yeah, rule number one, don't, don't Talk to the tenants. You know, that's really frowned upon.

Right.

And so assuming now you've made it past this stage, you sign a contract, you're getting ready to close. Now, I think we talked about this on the last show, but the tenants are required to certify. It's called a tenant estoppel. So the estoppel is where the tenant reconfirms what's going on in the lease. They're going to say, okay, this lease is true and accurate. This is the, this is the lease. This is the whole lease. There's no amendments, no side agreements. Okay, great. Because what you don't want to do when you're buying a building is you show up and you thought the tenants leaving next year and they got a sweetheart deal, and then they show some, you know, something on the back of a napkin saying they can stay for another 10 years. So again, part of this is making sure that, you know that the leases are what they are. So. But on the day of closing, that's when the tenants find out, you know, letters are slipped under the doors, they're emailed. This is your new owner. This is who you, you know from current ownership. This is the new ownership. This is where you send your rent payment. And the tenants don't really know until, you know, that day of closing when title actually transfers.

Perfect. Exactly. This is great to know all these do's and don'ts that will be helpful going forward. So I'm curious, when it comes to repositioning, we talked a little bit about construction. I love it. If you could talk a little bit about the investor's role in a renovation or construction project. It seems like it can be a massive undertaking. If you think a residential place, you know, sometimes you're redoing your kitchen, it seems like a big deal, or transferring that to a much larger building. But I'm curious if you can talk a little bit about that.

Yeah, I mean, look, this is where the creativity really comes in. And a lot of the investors love this stuff. And especially if you have a design aesthetic. And, you know, look, a lot of people get in this business or architects also, and they understand how to reconfigure space and how to make it more efficient and how to, I mean, we haven't even talked about expanding on properties. You know, can you do additions? I mean, these are the kind of things where, you know, you really, you know, you're adding value and you're kind of going from a value add, you know, to opportunistic, opportunistic. Is where you almost get to the point where, you know, you could be building ground up, which, which is something we don't recommend for, you know, you know, early investors. But look, your, your imagination is a great place to start in knowing what you want. You know, again, that goes back to finding out what, what's, what's, you know, the highest and best. I mean, we're going to be selling next. We're going to be bringing to market some assets in soho and their lofts, are they more valuable as office or are they valuable as residential? You might get different. People have different thoughts on that.

Right.

We need to make sure. Or as the investor, you need to first and foremost make sure that you can actually do that.

Right.

So is it according to zoning and residential might have. They have more requirements on light and air. You have to have setbacks if you want to have legal light and air from a window for a bedroom. You know, does it have the right egress? These are the kind of things where, yes, you want to be creative, but it has to fit within, you know, the zoning confines. And then in New York City, the zoning handbook is over 700 pages, right? So, you know, yes, you need to have an architect. And this goes back again to the team. You know, they need to be show you projects that they've worked on in the area, right. Where they've had success. You know, sometimes when I hear clients, you know, especially out of town buyers who come in, oh, yeah, I've got this great architect. We did all. We spec these homes down in the Carolinas. We did great. And they come to New York and they just get crushed because they just don't even know where to start. So, you know, I think again, the creativity, your vision, what you want to see happen, that's the fun stuff, right? That design aesthetic. Hey, let's, let's figure out, you know, I want to go for a modern, you know, design aesthetic. I want to do this with the lighting, I want to do this with the flooring. I want to recapture some of this, you know, the ceiling that's been dropped. I mean, whatever it is. But again, goes back to what I was saying. You got to make sure that you're meeting the market. Just because it's your design aesthetic doesn't mean that's what the market wants.

Right?

That's more important.

Right.

You're not designing a place for you to live at. This isn't your own home.

Right.

You need to make sure that there's going to be demand for what people want Right. And again, making sure that what you want to accomplish is both, you know, possible from a zoning standpoint, but also, we haven't even talked about this structurally possible. You know, like, sometimes I'm walking through, you know, buildings, showing them, and, you know, maybe the broker on the other side is knocking on walls. Oh, yeah, you can take this wall out. And I'm thinking, man, I don't know if I would be, you know, tell, you know, for sure. Especially some of these buildings are over 100 years old. I mean, having an engineer come in and understand what you can do, especially if you're adding floor, is super important.

Yeah, excellent point. I also love that. That idea. Do what you want. Just make sure other people like it, too. Very important in this. In this space. So I feel like when you're planning a project, I wanted to ask if you could talk a little bit about timelines and delays. For instance, you're going to have things come up with 10 and leases, construction projects. I know a lot of things. With COVID you hear a lot of people talking about construction projects going haywire.

Yeah. And that's why you really, you know, time can make or break an investment, you know, and, you know, I'm sure many of you have had this experience before where, like, you see this, you know, you hear this corner property, this parking lot, you know, sells, and it's just sitting there with construction bridging up for like a year. And it's like, what are they doing? What is going on? And the next thing, they start coming out of the ground, and it's like they're adding a floor. It seems like every single week. I mean, a lot of the planning and approvals, you know, can take, you know, months and in some cases can take years. That's why it's very important for you to understand. You know, as complicated as New York City is, for example, with over 700 pages, at least we have 700 pages and we have zoning as of right. They give you a manual on what you can and can't do. And if you want to, you know, build residential in a commercial zone, can you go for a spot rezoning of variance? Yes. Is that going to take you a year? Yes. Is that going to cost you hundreds of thousands of dollars? Yes. So again, for early investments, I would make sure you are doing something as of right. This especially applies some of these suburban markets. Oh, my gosh. Like, nothing's as of right. Like, you have to go to the town and, like, appeal what you want to do, like parking requirements do you have enough parking to do what you want? One of my, you know, crazy ideas. I thought my town needed a taqueria and a tequila bar. I said, wouldn't it be great if we could just open this up on the street? And thank God I knew enough about the business to call land use counsel and say, look, you can't open a restaurant bar without having enough dedicated parking. There's no parking on this street only. So again, understanding the framework of what you can do. And again, these approvals, they take time. So that's why. And again, if you can get a, you know, this goes back to the old, I think it was Helmsley Spear your price, my terms, and go back and listen that podcast I did with Francis Greenberger too, about his stretch deals, you know, who knows, maybe you tell a seller, look, I'd love to buy your property for $2 million. I can close in 60, 90 days for a million five if you want. You want to do two years, though? Look, you're going to have to give me a year, year and a half to close. You're going to need to file permits on my behalf. And I will close once we have those permits. Right, because if you're sitting with a vacant property waiting for approvals, you're still paying real estate taxes, you're still probably paying utilities, you know, you're paying your investors. Again, we talked about that capital stack. If, Rachel, if you've given me your money to go invest on your behalf, you don't care if it's that vacant for a year or two. You just want your 8% preferred return and then you know, the profit afterwards. So you know, as the sponsor, you're making your money on that promote. The quicker you can get to that capital event when you refi sell, the better. So if I can stretch out that under contract process where I only have a 10%, 5% deposit up and I can get all my approvals ready. So the day after close, I'm swinging hammers. That's, that's the ideal, right? And so again, just, I keep saying it goes back to the team because understanding the time it takes, like, look, in New York, if you want to get gas into your property with Con Ed, like, take a number, right? I mean, it could literally take six months to a year, you know, to get gas service if you're looking to switch over from oil, for example, you know, these things, they just, they take time. And that is something that I see in a lot of the pro formas. You know, you always have to, you know, plan for those contingencies the time that it takes. I mean, you mentioned right now, I mean, the biggest issue is with the supply chain.

Right.

And it's like getting stuff like you might have an apartment completely finished and you're waiting for your stove and your. I remember I ordered a refrigerator, tried to get a refrigerator for a project and they were saying that there are no refrigerators of this size available in the U.S. for another six months.

Right.

And so, which seems crazy to me, but that was really, at one point, that was a real issue. So, okay, do you go back and redesign your whole kitchen to put in new appliances or do you wait for it? You know, it's really important to understand. And when speaking of the gc, like, okay, do you have, you know, are these materials readily available?

Right.

Such important questions to ask ahead of time. Exactly. So you met, you brought up structural issues. I'm wondering if you can speak a little bit to that, how to find out if there are structural issues, if you've seen that those can be overcome during a project as well.

Yeah, I mean, this is really part of the third party reports. So there's, you know, one of my good friends, Josh Simon, works for ebi. They do everything from, I mean, soup to nuts. They'll come and they'll do a property condition report. They'll do environmental reports, they'll do the engineering. They could even give you a cost estimate on what it takes. And there is a difference between cap X capital expenditures. That's when you come in and you have to make, okay, I know I'm going to come in here. The property needs a new roof, it needs a new boiler. I need to upgrade the electric. That's cap X.

Right.

Whereas now I've renovated, you know, and I've renovated the apartments now, you know, the sink breaks or whatever, you know, down the line, that's kind of an ongoing repair number. So. But yeah, they can come in. You need a structural engineer. Again, most of these properties that have been in existence for decades, and I hate to say if it looks good to the visual eye, but the properties I've been in that have structural issues, in many cases you can actually see them leaning from the street or if a floor looks partially collapsed. But I mean, I think it's really super important again, if you're obviously adding square footage, either, you know, above, up top, especially to have that engineer come in and see can the floor loads actually withstand more development.

All sorts of things to be aware of before you put the hammers, you know, get the hammers going, so to speak. So I'm curious if you can speak about any red flags or things to watch for during a construction project. I'm not saying necessarily abandoning everything, although I suppose if that's best for the investment that that could happen, but just things to be aware of.

So we haven't talked much about the construction process, but there's different types of contracts, right, with the gc and I think out of all the pitfalls in investing, cost overruns can crush you. I mean I think where you buy a property, how you finance it, what the closing cost, legal, that is pretty controlled, right? I mean sure there can be some interest rate movement between bidding and acquisition, but knowing the actual construction budget and knowing what you set out to do, I mean there are such things as GMP contracts where they cap and say this is an all in number, this is what it is. And if you're doing that, you know, telling your contractor, look, this is the all in number, you know. And by the way, I had also put a timing provision in there, you know, hey, you're telling me you're going to deliver this by this date? If not, I need to have penalties because if I'm sitting with a vacant building that's costing me more. So if you're going to do that, that's got to swing both ways. I would also reward the general contractor. If you finish a project earlier, I'm going to give you a bonus.

Right.

So you know, other kind, other ways to do it is you know, open book, right where they're going to be showing you the bids, right? Because these general contractors, what they do is they have subs for each of the different trades. And so if they are doing their job, they should be bidding each of these jobs out. Like don't just bring in your go to electrician, bid it out to two or three jobs. I think a lot of these GCs, they mean really they mean well, they got great relationships. They're going with oftentimes their go to sub because they just know, you know that person's going to drop everything for them if they need them to come. They get great service, the pricing's fair. But sometimes when you do that, especially when you're moving quickly, if you're not bidding the job out, you're not getting the benefit of, you know, really that, that, that pricing. So if you go in that open book, you know, format, make sure that you see what are the bids that are coming and make sure that it's competitively bid if you know, subs or you have connections, throw them into the mix.

Right.

So I think that is certainly important. And just watching what's going on and staying on site, like that's why this is a hands on business and you know, the whole squeaky wheel gets the oil. I mean, if you're only showing up to the job site once a month, you know, it's going to be a lot different than you're there, you know, once or twice a week. You know, typically for a decent sized construction job, you're going to have, you know, a weekly meeting. I'd have it at the property. Hey, let's go meet at the property. Let's, let's walk the property together. Let's especially down the end that punch list. I mean you'll see when these, when the GCs, when they're moving, they got all the trades on the job, everyone's cranking, a lot of money's being spent to get it to 80, 90% done it. Sometimes that last 10% can take half as long as the whole process because you're waiting for, oh, I ordered the wrong outlet, I got to wait for this, I got to wait for that. And you're going through that punch list and it can just kill you because in most, and again, I would assume pretty much anywhere in the country, if you're going to be inhabiting a place after renovation, like you need at least a temporary certificate of occupancy to say, okay, you know, buildings department's been through, fire department's been through this meets. Okay, these are the things that we need to do to get the final C of O, which is usually, okay, we're going to give you attempt CFO to go move people into the apartments upstairs. But hey, you're still working on the restaurant down below, so we're not going to give you a final CO until the entire thing's done right. So you know, but again, if you're waiting on those punch lists to get that tco, guess what, you're not getting income. Right. So again, that's why having that mechanism where hey, you finish early, I'm going to reward you, but the longer you take, you're eating into my pocket. So you know, I need to have this penalty provision that, that, that might, you know, keep them focused on tasks to finish the job.

Yeah, I feel like you probably seen this done hundreds and thousands of times. I don't know if when you were speaking about those different contracts, the open book versus others, if there's one you typically recommend or if it depends on the project.

I think it depends on the project and also your level of experience. I mean, the all in number seems very, you know, appealing. But look, you know, I once saw a funny picture of. It was like this little dinghy parked next to this or docked next to this giant yacht. And, you know, whoever the builder was thought it was funny. The little dinghy was original contract, and the yacht's name was change orders. So it's like, I mean, again, there are going to be change orders, you know, and a lot of it has to depend with how good the plans are, right? Are these, you know, fully approved plans or are these, like, shop drawings? Like, hey, like, the benefit of doing a shop drawing is, all right, we're moving on the fly. We don't know exactly where we're going to put this kitchen until we get in there and open up the walls. So, you know, we're moving fast. But then there's no way that you can get a firm bid on that because we don't know the scope of the job. So, like, that's where the open, you know, the open shop contract works, right? Whereas, you know, once you have, you know, fully developed plans, you know, maybe you can get that, that, that gmp, that gross maximum price. But then, hey, if you decide, hey, now that I'm seeing these plans, this does not work. Like, this is. We got to change this, we got to change that. Yeah, you're gonna have to pay for that.

Right?

And that also pushes back the timeline where they're gonna say, hey, I told you I could finish this job in three months, but you just gave me 16 change orders. That's gonna push, you know, push it back. So it really does depend on the job, but I think planning it in the right way is super important, you know, and then the last thing I will say is that there are some design build architects, right? And for certain things, it's like, hey, we're gonna actually design this thing. We're going to come in and build and execute on it. And you might say, well, James, that sounds like a great idea, right? The architect and builder, they're all in one. They. They just know how to move through a project. Well, look, an architect can also be a great check and balance to a builder, right? Because the architect saying, no, no, this is what we plan. Contractor is here for really big projects. You have an owner's rep. An owner's rep is actually going in. And Rachel, unless of you, you know, know how to. You have a background or a close friend in construction, you might not Know, like, hey, you know, we said we were bringing in this, we need this kind of power, you know, to run, you know, our H vac units or whatever. I mean, unless if you know how to go in and check the amperage, you know, you might need someone who's actually going in and, you know, verifying what's there. But look, this is a people business. I think going in with people who, you know, trust. And let's also go back to that premise. Maybe for your first investment, you're bringing in a partner. If your partner has done 10, 20 buildings before, those contractors are probably going to give that owner preference because they're going to say, look, I don't want to screw it up on this job because I'm not going to get work at the 20 other buildings. Whereas if this is your first time deal, this contractor says, you know, this person's a pain, whatever, it didn't work out, I'm going to go focus on my bigger projects. You don't want to become a low priority?

No, not at all. One of the last things I wanted to ask you was as we look at the construction process also moving forward. So for example, the renovation is done, the units are filled, tenants are paying. I'm curious if there are some tips we can give regarding how to tell if you're getting that return you want. For instance, are there things you should be looking for in the financial statements coming through? Are there a certain signs that maybe aren't as quantitative, but they're more qualitative.

So just as far as what you know, how are you getting that return on investment? Do these improvements make sense? Yeah, I mean, every single one of these decisions you have to know, are you getting a return on investment? Unless if you just say, hey, I'm going to keep this asset forever. I want this to be perfect, you know. But most of the time that decision, on what level, what budget do you have, you know, if you don't know what the budget is and what that's going to do to your rent, like I gave that example before, you know, you might say 50 to $75,000 is a lot to renovate a one bedroom, but if I can raise my rent $500 and I'm going to go turn around and sell the building next year at a 5 cap and that's going to add $120,000, that's a pretty good return on investment. That's over a 2x return on my investment.

Right.

And so those are the questions you need to be asking yourself for Each of these renovations, am I going to get that return on investment and things like the Capex, you know, replacing the roof, replacing the. Well, let's start with replacing the roof. I mean, again, if you're going to turn around and sell it the next year, you know, look, is the buyer going to re, you know, essentially reimburse you or pay you more for that work? You know, maybe not.

Right.

But if you're going to own that building for five or 10 years and you're going to avoid leaks, issues, you know, down the road, that's, that's a smart decision. You know, changing to a more efficient boiler, you know, going from oil to gas, some people are converting entirely to electric. What is that cost today and what is that savings over time? There's also, you need to check, you know, there's a lot of programs out there. And again, if it's going green, going energy efficient, where, you know, you can not only finance a lot of these improvements, but you get tax benefits. You know, certain times you're renovating buildings, historic buildings, opportunity zones. We haven't even, you know, there's a lot of programs out there, you know, for environmental cleanups, brownfield tax credits, historic tax credits. Like, there's, there is money that is available out there when you improve assets in certain locations for certain things. And so, you know, understanding what those are can also help defray the costs. But, you know, a lot of these things also depend on, like, what's your hold pattern, your period, what, how long are you going to be in this for? I sometimes have owners who say, you know, James, I'm going to, we want, I want to sell the property. Should I renovate the apartments before I do it? Should I, you know, do this? Should I do that? My advice, nine times out of 10, is to do absolutely nothing. Why would you, you know, if you're going to sell the building and let's say, okay, the building's been in the family for a long time, you haven't raised the rents. You know, you're doing one apartment to the level you think that you can achieve, you know, is not, you know, is not going to move the needle enough. I mean, that buyer who's going to come in and gut renovate the whole building, they will pay up for that upside. And as the investor, that's why, you know, you can't just look at like, what's the cap rate, what's the return? Because there's deals, you know, that I would buy at a 3% return going in that are way better than a 5 or 6% return.

Right.

Because if I buy a 5, 6% return that someone's already improved and maybe they've already jacked up the rents, hey, I might have downside. I might have those rents come down and I might not be able to grow those rents further. Whereas that 3% deal, maybe I can go in and triple the rents.

Right.

So again, you really need going into these to understand, you know, what is the upside potential? What is the business plan? Because what's the budget? Because these are the things they're going to have to go into your deck. You know, again, if you're raising capital, you need to make the case. Okay. And that goes back to Derek Akin sources and uses. And if you haven't, you know, listen to that episode, go back and do that. Because that's really important to understand what is the game plan going into this.

So true. And yes, I think on the next show we need to do a breakdown of some of these tax credits and incentives. I feel like there's a long list, so we might want to highlight some and speak to ones that first time investors might really be interested in.

That might be a bonus show. I don't know. I mean, look, we're trying to teach you everything you know, but I mean, I tell you, and that's what I love about the business. I mean, we're learning things, you know, I learn things every day. So. But, but some of these topics are incredibly complicated. I mean, if you want to. Opportunity Zones, if you want to learn about that, go back and listen to my podcast that I did with David Coelho, who's the CIO of Bridge Investment. I mean, they are the one of the largest investors in the Opportunity Zone space. But these are like super complicated programs. The timing, what qualifies, how you have to, I mean, so again, that's also where it helps to have a partner who's done this before and understands, you know, what you can qualify and how to go about it. And there are professionals out there whose entire business is to help you identify these types of incentives. So that might, you know, again, it's so Rachel, it's so specific to the market, the type of property, the business plan that it would almost be impossible to cover in one show. Maybe that'll be our next book.

Our next book, all you need to know. Yeah, and honestly, this book is that idea of the Go to resource. Maybe you don't need to know absolutely everything about Opportunity Zones, which is probably a book in and of itself, but you know who to go to who can help you and so on. So it's really that starting point to guide you through which is, you know, very easy to do. Also, we don't necessarily have time to read books about every single code there is out there. Great. So. So to wrap up, I wanted to see if you could share an example or podcast that we might point listeners to that really highlight some of these, this value add discussion we've been having.

So I think I'm going to give a shout out to Eric Brody, who actually now has his own podcast too. I love Eric. He great guy. And not only is he a developer, but he's also a contractor and from Brooklyn. I affectionately named the episode no Sleep from Brooklyn because he's from Brooklyn. Yes, I know the Beastie Boys song is no Sleep till Brooklyn, but go back and find that episode. He really loves talking about the nuts and bolts and how deals are done and what to look for in the construction process. I also, and I got to remember where on one of these earlier shows, but my friend Michael Feldman who runs Choice Property Management, he talks about the management process in the show notes. We'll have to put down what episodes. I think he was one on one of those earlier episodes that I did. But yeah, happy to be a resource. And as always, James, Nelson.com is where you have the podcast, you have the show notes, you have the key terms. You got the video series, we got the white papers. We're constantly putting up new content there. So when in doubt, go there and tell you you've got the book, which again, it is on its way. It is happening right now. So could not be more excited. So, Rachel, I want to thank you again. This has been a really great conversation and I hope that our listeners are just getting a ton of value out of it.

No, thank you, James. Really appreciate all this insight you're willing to share with listeners. And stay tuned. Next time we'll dig into the following step. There's two steps. Step nine is talking all about tenants once you have the place.

Awesome. All right, well, this is your host, James Nelson. I'm principal head of Tri State Investment sales for Avis and Young with the insiders edge to real estate investing. Just want to thank you as always for joining, for telling your friends, for subscribing the ratings, the comments. This is what helps spread the word. We need to get the word out on this. I mean, there is, I mean, and by the way, if you found other podcasts that you like that are teaching you how to invest, tell me please. I follow. I try to listen. I am a voracious consumer of information, so I'm always learning. That's what I love about the business. So, you know, we can all help each other. So let's connect. If you haven't already, James Nelson NYC. That's where you can find me in LinkedIn. You can shoot questions to me. Some of you have been reaching out, saying, hey, James, I'd love to just kind of bounce some ideas. And I said, great. You know, email my assistant, Irene Escato E S C O t o@avisonyoung.com she can schedule a time to speak with me. I'm like a real human being. I'm able. I don't, I don't have infinite, you know, hours upon hours. But hey, if you want to talk for 10 or 15 minutes and I can help you out, just let me know. Be great to connect. Until next week. Thanks again.

Thank you for listening to the Insider's edge to Real estate investing. We appreciate your subscribing and sharing with your friends. If you haven't already, please connect with James at James Nelson NYC on LinkedIn, Instagram and Twitter. Please also visit jamesnelson.com where you can find the show notes and other episodes along with an exclusive video series and other helpful resources so you can gain the Insider's edge to real estate investing. Until next week.