AIPIS 49 - Property Management and Market Update with Justin Ford

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Hey, it's my pleasure to welcome Justin Ford to the show. He's the founder of PAX Properties and he's an active investor in real estate and global stock markets. He has published, edited and written for over a dozen investment newsletters and launched the US Version of the Fleet Street Letter. And he's got some great information and advice to share with us today. Justin, welcome. How are you?

I'm doing great, Jason. Thank you very much for inviting me.

Good. Well, it's good to have you. So tell us a little bit about your sense of the market.

Now my sense of the market is that there are pockets of value. You can find a good deal of value throughout a lot of the country, but many markets are already fully valued and some are approaching overvalued territory. And whether that's on the residential side or the commercial side, I think that's the gist of it.

Right, right. And I would agree with that, by the way. So what markets do you in the US we've got about 400 individual markets. It's a huge country. So when you see these talking heads on CNBC and so forth, it just drives me crazy because they talk about the housing market as if it's some national thing. But what markets do you like?

I like still a few in South Florida. I live in Southeast Florida, Jason, and back in 2004 through 2006, I wrote a small real estate course. It's called Mainstream Millionaire. And I was probably the worst marketer in the entire world because though I sold the real estate course, I told people it was a bubble back then. And I put out in 2006, I think I published something called Secret Value and growth cities and identified what I thought were the best value cities and were the most overvalued cities. And I stopped buying myself in southeast Florida as a Multiple buyer in 2004, 2005 I bought one. 2006 I bought one. There were special deals. Both those special deals, if they were fish, I would throw them back in the water. But I did find everything always washed its faces. And I did very, very well. But I followed my own advice. In 2006, I went to some of the value markets. I moved away from the bubble markets. Like Phoenix was a bubble market. I identified that southeast Florida was a bubble market. A lot of the coastal markets were bubbles. And I went to some of the value markets. At that time, my number one value market was Austin. And when I could no longer find cash flow in southeast Florida, I made a few hundred thousand dollars in Austin. I went to Jacksonville. That was a market my best coastal value market. Austin has never fallen even since the peak. It never crashed. Jacksonville did take a hard tumble, but it was a great value even before the bubble so that I could hold onto my properties. I'm about to sell one of them for probably a $250,000 profit. I give that background to you just to say that I'm not a Nostradamus or anything else, but there are real legitimate ways to identify which markets offer a value and which are overvalued. Talk about.

Yeah, I want to ask you about that, but Justin, what types of properties are you investing in? Because those numbers are all relative. If you tell me you made 250 grand on a large deal, I would think, eh, no big deal. If it's a little tiny deal, I would think, hey, that's pretty great. So give us a sense of that, your average deal size.

Yeah, that's a good point. Back then I was doing smaller deals, typically one to four unit deals. So when I made $200,000 in Austin, it was $100,000 each on two four unit properties. So that was a very n. Investors more than doubled their money when they couldn't. Anywhere else in Jacksonville, it was a small 14 unit building. So that was also a very nice return for looking at about a quarter million dollars in profit and basically a $400,000 purchase price. So that was a good return as well. Especially investors will More than double their money on that one too, because we use leverage on that. So now I'm doing deals. My last deal was about almost $3 million. And we're in the market now for up to $10 million. Because I've done 35 deals through the boom and the bust. And through it all, I've never been late on a single mortgage payment, not one. And it's all because I follow very fundamental, value driven principles. So to answer your original question going back to today, I think southeast Florida, it's tough to find good deals in a lot of the most popular markets, but you can in some of the fringe markets. If you're talking about small properties, there's a lot more deals. If you're talking about commercial properties, larger commercial properties, Southeast Florida is very hard to find a decent deal right now.

Okay, so define commercial, because that could mean a property, apartments, or it could mean industrial, office, retail. What do you mean when you say that?

I use the definition typically used by banks. So when they talk about residential loans.

They'Re talking about over four units then?

Correct. So residential loan is one to four units, and then a commercial is five units and up for apartments. And then it's everything else that's not apartments. It includes industrial and retail and warehouse and office and that kind of thing. So in the multifamily space that became very popular in southeast Florida, and I bought after the crash, I was fortunate to buy a lot of very inexpensive stuff near the ocean, near downtowns. Well after the market crashed, I started to look for properties again about 2009. By 2010, I was an active buyer and I was able to buy some properties at pennies on the dollar near the beach in Florida, near central down areas. But in the last year or so, it's gotten fairly expensive. And I was at a commercial real estate conference yesterday with many large national firms and a lot of experts. And a lot of these guys, guys are resorting to what I consider rhetorical hocus pocus to justify crazy prices and very minimum yields. These guys, they're trying to justify five caps, four and a half caps.

Unbelievable.

Yeah. And if your listeners don't know what a cap rate means, it's basically the net operating income typically divided by the purchase price or the total deal cost. But just to give you an example, if you have a million dollar property and it generates $200,000 in rent and you spend $100,000 on expenses, you have $100,000 in net operating income before your debt service. That means as a percentage of your Purchase price, you're making 10% cap rate. And that's a very, that's a huge number. You're not going to find that except in marginal properties and marginal areas, but that's fine. But the prime properties used to trade the last year or two at 7,8 cap. Now they're trading at 5,4.5. And these guys are trying to find all sorts of ways to justify it. They're talking about really buy homes again like they did in the past. They're talking about new lifestyle buyers, you know, the guys who live in a complex next to a rock climbing wall. So that's why they're paying 5,000 a square foot. And I'm saying to myself, are you telling me that these 28 year olds who are living in this complex with three pools and a rock climbing wall, they're going to live that lifestyle forever? They're not going to have kids one day and do math and go, you know what, honey, we can't pay $5 a square foot anymore. We better buy a house.

It's just, it doesn't it amaze you, Justin, how people can rationalize the stupidest things? The nice thing about getting a little older is you see this, you've seen it before and there's always the rationale. This time it's different, right? It's not different, okay? These are just crazy things. I mean they're, they're saying, they're saying an apartment renter will pay $5 a square foot per month.

Right? Exactly.

Because of the high amenity. You know, that's just insane. And these cap rates are joke. I mean, when you get into institutional side, the deals get so much worse. That's always perplexed me a little bit. The common thinking is, hey, look, if you're a volume buyer, you get a better price, right? If you're ordering printing for your business and you print more copies of newsletter, you get a lower price, right? But when you buy bigger real estate deals, oddly, you actually get a lower yield, not a higher one. Yes.

There are two inherent problems in many businesses, especially in real estate business. First one is brokers are a big part of the business. And you know, God bless, many brokers are excellent, many are so so, and quite a few.

And many just suck. Let's just call it.

I was going to try to be more diplomatic because I don't actually, actually.

We'Re going to say most of them just suck. Okay?

But here's also even a broker who let's say is earnest and wants to do well, there's a genuine conflict of interest. If you come to me, and I'm a broker and I'm not very well steeped in things, I want to sell you a property, and if you come to me, I want you to do a deal because I get paid by the transaction. I'm not the guy who's going to pay your mortgage for you. I'm not the guy who's going to find some tenant to pay these crazy rents for you. All I got to do is get the transaction done and I get paid and then I'm good, and then I go on to the next deal. And that's the problem. In fact, I get paid. The more you pay, the more I get paid as your representative, which is ridiculous. But that's the way it works. At the same time, you have the same problem on the money side. Now money's coming back into the market. You know, lenders, they should have been in the market three years ago when stuff was cheap. But lenders do everything backwards, let me tell you. Most of them do. They're crazy. But in any case. So lenders now have all this money coming because now, of course, real estate's the hot thing again. And so they're trying to push out all this money. So you have all this money that has to be placed somewhere because people want their yields, they demand their yields, these billions and trillions of dollars from funds. And they have all these broker who are transaction driven, and then you have the poor new investor who thinks these people are experts.

It's a recipe for disaster.

Unless you yourself come to understand how to evaluate properties and to go back and answer your question specifically, I think overvalued markets right now. San Francisco again, Asheville, Savannah. And those are really beautiful cities, but it's very hard to find good cash flow and good deals there.

By the way, you said Asheville. Are you talking about Oregon?

No, no, no.

North Carolina?

Yes, correct.

Yeah, yeah, Great place. Biggest house in the country there. The Vanderbilt Mansion. I've been there.

Right, right. No, I've been to all three of the cities and they're beautiful cities, but they're tough to find cash flow there. And that measurement's on a residential basis. There's small residential properties, but I tend to find that the commercial follows the residential. But I can tell you that real markets that have real value. Now, for me, there's a lot in Florida in the secondary and tertiary markets. Tertiary simply means third markets. And those would be things like. Like for instance, Orlando is a secondary market. Tampa, Naples on the west coast. Jacksonville in the north still offers some decent value, even though it's on fire. For the last year and a half, the recovery has been extremely strong, but it still offers some decent value. And then there's even tertiary markets like Huntsville, Alabama, stuff like that. But I think San Antonio is a compelling story. I've never been to San Antonio yet, but from what I see about it, I like it for a lot of reasons.

I.

It has good value characteristics, it has good growth characteristics, it has a decent economy, and it has a good reputation. It's one of those Sunbelt cities that has culture and that is driving a lot of boomers that way and even some Gen Xers that way. So when you have value and growth combined, that, to me, is an interesting market. So those are just a few examples. To answer your original question, you know.

What I found with this in doing business all over the country, Justin, for about 10 years now, actually. 10 execs. Exactly. It is not just about the market, of course. It's about the deals and the properties you're able to source in those markets, but it's all about the team you can find there. You've got to have a good team. And I have many times told our investors that, look, we'll turn down an otherwise good market. There are markets we want to be in, but we haven't found the team. I would rather have a mediocre market with an A team than a mediocre team in an A market, because I don't know if you share that philosophy, but that's a big part of the equation is that the people and the resources you have in that market.

I would agree with you entirely that your team is paramount. However, I would say that I find it hard to imagine that some cities that in every city, you can't find a decent team. And what I mean is, you know, you come down to South Florida. I'm originally from the New York area. I've been in south Florida for 22 years, and I speak to people from New York all the time. Who they go, I can't believe the guys, the workmen, especially in South Florida, they kind of show up whenever they want to. They're not reliable compared to New York and might be a little biased, but I think that's probably true. I mean, the stuff people, workers pull down here, they would never pull in New York, it would seem to me, from my experience. But I have more experience down here as a.

When you say New York, where are you talking about? Are you talking about New York City?

Well, I lived in New York City, I grew up in Long Island. I'm talking about the whole tri state area. But I'm not trying to pick on southeast Florida. I'm just saying that I've heard that type of quote unquote prejudice before. You know, I've heard New Yorkers talk badly about the reliability of contractors here. And I'm saying that there might be some basis to it when you're generalized. But obviously this is a large state, there are good people here, you can find them. Maybe you feel you might just have to work a little harder to do that, but you can find them. So the way I would approach it, Jason, first of all, you know, I used to do small residential. I am teaching another residential course now. So I also talk to people about buying in foreign markets. And I do tell people I think it's easier to manage 100 unit property 1000 miles away than a 2 unit property 1000 miles away. The reason for it is if you have a duplex and your manager is doing a crummy job, you don't have that much leverage over them. You have to fire them and find someone else. You have to make sure you have the right contract that lets you fire them. Because for them, if they lose a duplex, it's not the end of the world. They lost maybe a couple hundred dollars a month. But if you have 100 unit property, you probably have two to three full time people. There's their jobs and their bonuses depend on them doing a good job. So as long as you have good accounting, you can put a good team in place.

I totally agree with you. You just explained one of the reasons for the success of my business model. I don't know how much you know about it, but we help people acquire properties in several markets that we like all over the country. And one of the things we say to them is, look, you could do this yourself, certainly you could research markets. You could even find a good provider of properties. Okay, which was that second issue of VA Team and the mediocre market. Right. Or vice versa that I mentioned. But even if you do that, you're not going to have any leverage over them because you're not a big enough fish, you're just not a big enough client to really matter that much. And what we do is we aggregate that we might have, for example, in Austin. We've done hundreds of deals in Austin. And you know, some of these are just single family homes. They're nothing big, right? And our investor will buy two properties in Austin, two in Houston and two in Indianapolis and two in Atlanta. Right. So they've got a little, little eight property portfolio, no big deal. You know, that could be an investor that did five in each of those markets. Doesn't matter. The point is the same, but they're not a big account. And so like one of our Austin property managers, for example, he has about 320 doors under management, single family doors, and half of them are from us 160. So he's going to do a good job because we've aggregated that business to that provider. So we like to say if you have trouble, contact your investment counselor at my company and we'll contact the manager for you. And if we say jump, they better say how high? Right. Because it's a big account for them, it matters to them and that's the important thing. It's got to matter to them.

That's a very good point. I think that's basically the next thing we're trying to do. That what I'm considering doing is I have a very good team here in Florida and when I go to a foreign market, I would consider putting a replacement in for them and then putting my person in that property. I'm talking about a larger property while it's being stabilized. You uninterrupt. So incentivize my person, give them sufficient bonuses and everything else so they don't mind going living in another place for three months or so and then have our established team grow a new team and then have our established team come home. So that's one of the approaches we'll be taking. But you're absolutely right, Jason.

You need leverage, you need for your phone call to matter, right?

Yeah, absolutely, I agree with you. So Justin, when you set up an LLC and you're out there raising capital from investors, that minimum of 25,000 per investment share and the maximum can be quite a bit higher than that. Do you have any cost built into the deal or you know, for example, you'll probably have travel expenses, do you take a salary or any pay for yourself or how do you, how do you work that?

Typically what we do is the following. We charge a one time developer's fee and then of course there's a property management fee which is usually about three to three and a half percent. And that's pretty much it right now. When I first started putting together these LLCs, I didn't even charge the developer's fee and that was interesting because I knew that I was participating myself and I knew that the cash flow would eventually be good. And I wanted my investors to know that our interests were 100% aligned. The only way for me to cash flow was if they cash flowed. And the only way for me to make significant money was if they made significant money. All their capital comes out first, of course. But what happened was I realized I would tend to buy non performing properties, properties that have either no tenants in them or very few and need substantial rehab. So sometimes it takes a year to almost two years till the property is what we call performing, certainly performing to an extent where it's actually kicking off cash flow. And that would be fine. My tenants, my investors would be fine because I pressed into the deal that they would get their minimum 7.5% annual yield plus their equity, and they get paid that yield quarterly basis. So they would be getting money, a good return on their money until we could get it full. Then they would get a big chunk of their money back from Refi plus. They would start to enjoy cash flow according to their ownership stake. But I found out that myself, I was all of a sudden stretched very thin because I had all these deals out there, but none were performing yet. So I wasn't paying myself anything. And as I met a few developers who had done a lot of things, they told me that some of these guys told me that this was a mistake that they themselves made when they started. And they said, no, you do have to charge a developer's fee because you have to get paid until the property gets going.

Sure, sure, sure, that's fine. It's got to be a win, win deal. So how much is the developer's fee?

Typically it's 1.5% is what it's been right now. And what I also do is of what of the total deal cost. So if the deal is, let's say it's a $2 million purchase price and it's a $750,000 renovation budget, which is exactly what my last deal was. So the total deal cost is $2.75 million. We charge a one time fee of 1.5% and that's it. Other than that, we charge the 3.5 property management fee and that's 3.5% of collected revenue. So that's based on performance.

And do you take in ownership, do you invest money in the deal or how's that work?

I'm prepared to invest money in all my deals to date. Some deals I put in hundreds of thousands, some deals I put in very little, depending on what's been needed. But to date, I've guaranteed all my capital. So going forward I'll typically put in money into my deals. I don't know if I'll be able to guarantee all my capital going forward because it looks like we're going to. We've had very good success and we may be purchasing 50 to $100 million going forward. And that's just not.

Really practical to have your own personal balance sheet spread out on a 50, $100 million portfolio. But investors will always be prioritize first return of capital and all that kind of thing. But to answer your question succinctly, we'll have a developer's fee and a management fee. And that's pretty much the only fee I foresee going forward on new deals.

What else do you want people to know?

What I want them to know is that we operate very conservatively. Here's the way I look at real estate in a nutshell. There's four ways you make money in real estate. I give them the acronym capa.

Cash flow amortization, positive leverage and appreciation. The only thing you cannot control is the last one, appreciation. Yet that is where most people put their focus and that's why so many people got crushed. That's why banks went out of business, millions of people went into foreclosure and short sale named Freddie Mac went out of business and the government had to bail everyone and their cousin out. On the other hand, if you focus on the first thing, cash flow, amortization and positive leverage, those three things you can control. And if you do those, you'll get consistently good returns. And if you also get appreciation to boot, well, you'll simply turn home runs into grand slams. So that's been our approach always and it will always be our approach going forward. We're very focused on that type of thing, on what we can control.

And I couldn't agree with you more. You know, appreciation is the icing on the cake. But it's got to be a cash flow based investment. That's the only sensible way to do things. It's the good old fashioned Buffett style value investing. You've got to have cash flow. Everything else is gambling, right?

And then we try to put on the best long term amortizing financing we can use prudent positive leverage, use a responsible debt service coverage ratio. We like to be at least 1.3. Usually we're closer to 1.4 and a half, 1.5. So we build in a margin of safety. We never expect things to go perfectly and we're never disappointed. There are always surprises and bumps along the way, but my investors have made very, very good returns. We've never been late on a mortgage payment. We've never missed an investor payment either. So we think that we have reasonable prospects of doing fairly well going forward.

Fantastic. Well, give out your website, if you would, and tell people where they can learn more.

Thank you very much. The website for My business is www.pax-properties.com. pax is the Roman Latin word for peace. P like Peter, A like Apple, X like X ray, and then there's a dash. Not an underscore, but a dash. And then the word properties, that's plural.com. so if you go there, you'll see a bunch of our stuff. There's probably a Contact us. I know there's a Contact Us button. You can also email me. My name is Justin and it's Justin.

And that's about it. And anything else you'd like to know. I'm glad to discuss it, but I do want to pause and say that it's been a real pleasure to talk with you, Jason. You obviously are a person who truly understands this business, and it's my impression I've only just had the pleasure to meet you, but you've been referred by common friends. It's my impression that you really care about the quality of your business too, not just what's in it for you.

Yes, and I can tell you do the same. So thank you very much. Justin Ford, founder of Pax Properties. That Website again is pax-properties.com thanks so much for joining us.

Thank you, Jason. And thank you to everyone listening.

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