#135 Find Investment Opportunities In A Recession, ft. Nathan Clayberg

Welcome to the Passive Income MD Podcast where we talk about creating your ideal life through multiple streams of income. I'm your host, Peter Kim. If you enjoy hearing about this stuff, make sure to hit subscribe so I can bring it to you every week. Now let's get on with the show. Hey everyone. We're back with another real estate segment. I'm really excited to introduce our next person here. He's someone that's been well known to this community. I've known him for years. He's just a great person, super knowledgeable in the space of real estate. Extremely successful, he and his company. I'm talking to Nathan Kleberg. He's the assistant Vice president of MLG Capital. They're based in Milwaukee, Wisconsin. If you don't know who they are, you've probably heard their name everywhere at this point. But they are a company. They're Real estate investment management company, which is with a 35 year track record of delivering awesome returns for their investors. They built up some amazing funds. They're all diversified well over the United States. They're a company that I've invested with personally. Nathan's someone that I've gotten to know over many years and he's just been. He always delivers in terms of education and just leading with really that caring attitude first. And so we love having him as part of our community. Nathan, how you doing?

Great, Peter. Thanks for having me on and thanks for the intro. We're excited to be here.

That's awesome. We're going to be talking about some really cool things. I mean, this is a very interesting time in the market right now. A lot of fear, a lot of anxiety. But a lot of other people are looking at this time as a time of opportunity and especially your company. I know the way you guys see things. So we're going to be talking about where are the opportunities in this period? Where are some things that maybe you are concerned about, how investors should be thinking about this period, how to be smart with their money, maybe even some of the tax benefits that people should be thinking about. Thinking about. We're going to talk about all of those things, but really quickly. Do you mind just sharing a little bit more about yourself? Like tell us, how did you actually get into real estate? Let's go with that story.

Yeah, yeah. So I actually fell into real estate somewhat accidentally. I studied accounting and finance in college with the intention of doing something in the investment world, but not sure exactly what. Ended up connecting with the CEO son of mlg. He was a football teammate of mine. In college, we became good friends and then Tim, the CEO ultimately came and encouraged me to come work for him. And, you know, four or five years later, here I am. But it's been, it's been a great experience. You know, a lot of smart people at mlg and I've learned a ton in that time. And having the background of finance and accounting building blocks has really been able to accelerate my learning. And it's been a really fun ride so far.

That's cool. I mean, what position did you play?

I was a defensive tackle. So trying to look less and less like a defensive tackle these days, but it was a good time.

That's awesome. All right, so I mean, in terms of real estate, these last five years that you've been working with MLG Capital, you've done this. You've probably seen the market change and shift quite a bit over the last five years. Where do you think we are right now in the market overall? Like your overall impression of what's going on?

Yeah, it's an interesting time. You know, though, we've kind of seen over the course of the last two, three, four years, probably one of the hottest real estate times that even people who here have been in the industry a lot longer than I have have ever seen. And now over the course of the last six months, it's been a pretty dramatic cooling off in a very short period of time. And a lot of that is fueled by what we're seeing in the interest rate environment. That's kind of a byproduct of the inflation that we're seeing in the broader economy. So, you know, some people have worried that the real estate market is overheated now. Now we're starting to see, okay, what does it look like in an adjusted world and is there opportunity? We think that there is, but you got to be disciplined. And that's always true. But it's especially true in times like this where, you know, the next, I would say 12 to 24 to 36 months are a little bit uncertain.

I mean, you guys have a 35 year track record. Tell us a little bit about your track record real quick. And then I want to ask you, like, what are the things that you guys have learned over that time that's really allowed you guys to have that success during that period? But do you mind just sharing a little bit about that 30, 35 year track record and what you guys have been able to do?

Yeah. So there is a lot of wisdom gained over that amount of time of investing for MLG. That's looked like we've done 89 transactions that we bought and sold and I think the number of total transactions over 200, but 80 that have gone full cycle. If you take an average of how long we held each of Those is about 4.87 years. And we've turned $1 into $2.60 in just under five years during for a 35 year period. That's pretty good math. It's an average annual return about 39%. We're proud of that. What we've learned though is we spent the first 25 years or so of our company history doing individual syndication deals. Probably a model that you and a lot of your listeners are familiar with where you're into one opportunity at a time. Following the great Great Recession in 2007-2009, we pivoted to our fund structure, really trying to get people diversified across different asset classes and across different geographies. So that was a pretty significant strategic shift for us. But it's really all of the same fundamental principles of investing in real estate. But now instead of just, you know, you're spreading out your risk across the basket of assets. So I think that right now, in times of uncertainty, that strategy really flexes its strength. Diversification is critical. Another thing we've really learned is the importance of how you're using leverage. We like to be very moderate leverage, 60 to 65%. And we like long term fixed rate financing, which people probably talk about this a little bit more later, but people who have been floating a lot of their deals at high leverage points in the last few years are potentially in for some pain here in the next 12 to 24 months. So I'm excited about our strategy. I think now is really the time that you lean towards a diversified moderate leverage fund.

Give us a little peek into the back room there at MLG when you guys are having discussions around this period. What's the overall sentiment for everybody in the company in terms of the leadership? Do they see this more? I mean, obviously, are they more concerned about managing risk at this time or are they more like thinking like this is an opportunistic type time for them?

Yeah, I think overall this is an opportunistic time and never excited to be in a recession. But there are real opportunities that are created in times like this. You may have heard the old Warren Buffett saying, to be fearful when others are greedy and greedy when others are fearful. Right now the market is a little bit, a little bit apprehensive and we're starting to see some really Unique opportunities spring up already and think that over the course of the next six to 12 months, there's an opportunity to deploy capital at a time where pricing is pretty attractive. And we believe in the long term outlook for the asset classes that we're investing in. And so we believe that there's going to be an opportunity to sell these in the future at a time when it's better to be a seller than a buyer.

I mean, I think people understand the whole residential market pretty well in terms of they see home prices and they see demand. And probably in their own neighborhoods right now, if I'm guessing, they're starting to see prices either plateau or even you'll see big price drops. And I think people understand that pretty well. But when it comes to like apartment buildings, industrial, office, whatever, people maybe not understand how like the needle moves like that. I mean, it's not like somebody just wants to come in and buy. Why would some of these properties, why are they being sold at like lower prices? And why does that create opportunity for you guys to come in at this point? For those who don't understand, maybe you can explain a little bit better.

Yeah. The broad concept is that real estate valuations are generally driven by cap rates. So a cap rate is a multiple on the operating income that a property earns. So it's referenced as an inverse multiple. So let's say a property generates a million dollars of operating income every year and someone pays a 5% cap rate for it. That's basically saying 20 times the million dollars is a $20 million valuation. Over the course of the last few years, because interest rates and debt constants have been lower, people have been willing to pay more and more and more for that same million dollars of operating income. And that drive cap rates lower and lower and lower. What we're seeing now is that is starting to head back in the other direction. As interest rates have moved pretty dramatically, we're starting to see cap rates move in the same way. And what's exciting is when we're buying now, we're paying less for that million dollars of operating income than we were 12 months ago. And we still believe that there's room to grow that operating income. And then we think that there's actually a real opportunity that when we go to sell these properties that we might be in a more stabilized world where people are willing to pay higher, higher valuations at that point in time. So it's really all a matter of how much are people willing to pay for the income that a property is able to Produce.

Why would some of these companies sell right now though? If they know that the market is kind of in a bad place, why wouldn't they just hold it through a certain period? I mean, do you have any idea why some of these properties might be going up for sale?

Yeah, no. 1. I would guess very few people who don't have to sell are selling right now. But I think that over the course of the last few years we saw a lot of groups using high leverage floating rate bridge debt and those. The problem with that debt structure is one, it's floating, so you're subject to movements in the short term rate indexes and two, the short term nature of it means that you've got a looming expiration date that's probably coming up here pretty soon. As interest rates have spiked so dramatically so quickly, you're very likely that certain buyers are going to find themselves in a position where they can't afford the debt service with the income that the property is actually producing right now. And their only options will be to capital call their investors or to go ahead and sell the property. The challenge with selling the property right now is because interest rates are moving around. There's a lot of uncertainty in the buying market. There's a smaller pool of buyers that are out there actually being active right now and so they're not getting the same 30 offer sales scenario that they were 12 months ago. We think that we can be a buyer that comes in and picks up some really nice deals during this time because there are people who need to sell, some motivated sellers and limited buyers.

I mean we talk a lot about, in our community about taking advantage of, you know, when times kind of reveal itself to be opportunistic. Right. We talked about this point of maximal financial opportunity when the market kind of resets and things like that. I know that so many people are, have been talking and they've been saying, oh, I wish I was there in 2009, 10, 11. To be able to buy at the beginning of this peak. Do you feel like that's kind of where we're coming to? And how long would that period again, according to you and the smart people at your company, how long would that buying period be open for? You say?

Yeah, it's really hard to say. No one knows exactly. And we can look into our crystal ball and make some long term prognostications. But here's what I like about our structure. We're going to be deploying our current, our current offering fund fixed capital over the course of the next 18 months. I think during that period of time we're going to be experiencing at or near that, that point of maximum financial opportunity that you're talking about. One thing that was interesting is I referenced that 89 transactions full cycle in MLG's history. There are two other times in the last 35 years where we've been in a significant extended period. Bear market like we're in right now, stock market's down greater than 20%. We've seen GDP decline for the past two quarters. So we're in a recession. Two other times where you can point back to and see, okay, well how did we do last time? This type of market we saw this type of environment. The first was the dotcom bubble 2000 to 2002 and then obviously the great Financial or the Great Recession in 2007-2009. I was pretty proud to talk about 39% average annual return over the 35 year track record. There are 16 deals of those 89 that we bought just in those two two year windows. And we actually beat our 39% average during those times. Weighted average, it was like 40% average annual return. Now what we did see was the hold period was a little bit longer. It went from just under five years to just over nine years. But the multiple and overall return was still there. I think that really speaks to times like this are where you got to be out there and you got to be investing, you got to be smart. But I think a fund structure is the perfect way to do that because you're investing through a cycle and you're having the chance to still spread out your risk in a really responsible way.

Yeah, I think that speaks to how smart you guys have been and how you guys done in the past is that you've been able to buy through these periods, have the investor capital to go out and take advantage of opportunities. And that's amazing. And my, my hope is that people who are listening to this, that they see this time a little bit differently than the whole general population sees it. Like you mentioned the whole Warren Buffett be greedy when people are fearful, fearful when people are greedy type thing. I think that is a great principle for people to live by in this community. We've educated ourselves, we've been smart about our investments, we've gotten our capital together. And I think that this is an opportunity that I would say most of us only get once, twice, probably in our lifetimes. And I'm excited for this opportunity. I'm excited for people to take action and make things happen during this period. A question that I have about fund structure that I've gotten quite a bit is that is there any advantage for people to invest in a fund on the earlier side versus the later side? Because I think you guys are like a fund typically for people who don't know many of these fund structures, you're able to invest throughout a long period of time where it's open through maybe something that. Something you could tell us, for example, just so we have some exact numbers, how long is your fund open till for people to invest? But what is the advantage of people investing on the earlier side?

Yeah, so we launched this fund in May. We're raising 450 million. We're probably about 90 million raised right now. And I would expect that we'll continue to raise this same bucket of capital for probably the next 12 to 18 months somewhere in there. It's kind of whenever we get to that 450 million or the end of 2024, whichever comes first, there are some real benefits to coming in on the front end. The first is we have an 8% preferred return with our investors. And that means from the time that investors come into the fund that they're accruing an 8% annualized rate of return, which is pretty attractive in the market that we're in right now. And if we don't pay 8% current, the unpaid portion. So let's say we've had a 4% starting off that other 4% that we owe them earns 8% compounded interest until we pay that back to that. So investors have a really nice kind of built in downside protection when they come in early into the fund and they start the clock on that accrual. The other benefit of coming into the fund is early is a little bit unique to this tax year. 2022 is the last year of 100% bonus depreciation. And that means that the ability to accelerate passive losses and pass those back to investors is at its maximum point right now. And over the course of the next five or six years, it's going to slowly be phased out. It's not to say that there won't be tax benefits to investing in real estate at that point, but right now and for the past few years, they've been on steroids and starting in 2023, that they're going to start to be phased out a little bit. So what that practically means is if you invest in 2022, you're probably looking at passive losses out of our fund. And the 50% of what you invest range next Year, it might be closer to kind of 40%.

Yeah, I mean, I think that's. That's great motivation for people who are interested in getting in it sooner rather than later. Again, the thing that excites me the most, I think about, when I think about, you know, real estate funds like yours and other opportunities is again, is that they'll be buying through the next 12 to 18 months. We don't know when that bottom is. I think timing it, people have shown that you really can time it. But if you're able to kind of have the dry powder or the capital buy through an entire period, that's when you're going to really take advantage of everything that's going on. And for people who know me, they know that I love diversification. And you've talked about diversification quite a bit. Tell me really quickly, how many properties, for example, do you expect to be in a fund like this? What kind of asset classes and then what kind of locations? Just for people to understand?

Yeah, so we would expect maybe 30 to 35 properties from the funds fully deployed. We're definitely biased towards multifamily. As far as asset class goes, that's probably between 85 and 90% of what we're going to be putting into these funds. Beautiful thing about multifamily and what we love about it is one, it's really stable cash flow. But two, the supply and demand equation in the broader economy related to multifamily is really intact. Right now. Building new apartment buildings is really expensive, and really you can only build them for class A renters. But there's an entire pool of renters that need to be have quality places to live. And buying buildings built between 1990 and even up to 2018, 2019, where you still can't build for that today, there's really strong demand for that vintage and that quality of product. So we like multifamily, we like industrial. There's still, you know, industrial is 90, 87% occupied nationwide. There's a lot of reason to continue to like that asset class. And then we look at retail and office. We view those two asset classes very opportunistically, but in the right scenario, they can be a good investment. You just have to be mindful of the location that you're in, especially in retail and office, and then locationally, more broadly speaking, across our fundamentals, we're really invested. If you put a triangle over the country, that's kind of the areas that we're in. We're in the South, Southwest, the Midwest, the Southeast and we'll lump the Sun Belt in there as well, Texas and Oklahoma. But those are the markets we want to be in. We're more specifically looking for areas with job and population growth, strong incomes, strong home values, the best school districts. Those are the types of areas that are most resilient in a downturn. Those renter bases have a little bit more cushion in their financial picture to deal with whatever's thrown at them. And I would say right now we're especially honing in on that type of product because we really believe in that type of asset long term.

All right, well, I've learned a lot from this conversation. I know other people have too, about the market that we're in, the opportunity that is ahead of us at this time, especially when it comes to real estate and diversified portfolios of real estate. Nathan, where can people find out more about what you guys are doing and especially this community, they love to know more.

Yeah, we have a landing page for the PIMD investor group, so feel free to. We may put the link in the video here, but then you can also just reach out to us through our website if you're interested in learning more. We have a special deal, special relationship with, with the PIMD Group and if the group exceeds 5 million in total investment to fund 6, then you actually get a better split on the profit share on the back end of our fund, which we're really excited about and really, really thankful for our relationship with Peter and the PIMD team. So if you, if you are interested in learning more, be sure to mention that you're from pimd. We'll make sure you that you're able to participate in that improve remote structure as well.

That's awesome. You guys have been great partners of ours for a while. I've been a personal investor prior to even whatever, you know, this whole relationship with pimd. But yeah, thanks for your hard work. Thanks for the time. Keep, keep it up. I think this will be an amazing opportunity that people hopefully will take advantage of and yeah, let's talk again soon.

Absolutely appreciate it, Peter.

All right, thanks, Nathan. Enjoy the show. Let me know by dropping a review in the podcast app you're listening to us in. And if you haven't already, make sure to hit subscribe. Are you a part of our community yet? Join thousands of physicians who are also on this journey to creating their ideal lives through multiple streams of income. You can join us on our Facebook group Passive Income Docs and you can always learn more at our website, passiveincomemd. Com. Thanks again for allowing me to be a part of your journey. See you next time.