#233 How to Choose the Right Real Estate Fund

Hey, everyone. I'm excited about today's talk. There's somebody that's actually really well known to our community. He's been part of our community since, I would say, the very first pimdcon we've ever done. He's been part of this community and he's helped so many of you out there actually navigate this whole space in terms of commercial real estate, multifamily, in terms of education and getting people connected to great opportunities. This is Nathan Kleberg. He's the vice president at MLG Capital. He leads the fundraising business development team. He manages joint venture acquisitions, all especially in the Midwest area. Again, someone well known to our community. If you haven't heard of MLG Capital, they've been a partner of ours at PIMD for, for quite a while now. It's actually one of the very first real estate investments that I've made in terms of investing in a fund has done extremely well for me and I know it's done really well for so many members of our community. And they're currently raising money for Fund 6. It's actually near the end. We're going to talk about this, the fund mlg and why Nathan thinks that, you know, this fund in particular is poised to take advantage of what's happening in the market today. Welcome to the Passive Income MD podcast where we talk about creating your ideal life through multiple streams of income. If you enjoy hearing about this stuff, make sure to hit subscribe. Now, let's get on with the show. Nathan, how you doing?

I'm great.

Now I'm excited to talk to you because I think more than almost any other group that we talk to, you guys have a really great pulse on, on what's going on in the market today, especially when it comes to commercial or multifamily because you guys have a good size fund, your assets are all over the place, you talk to so many different operators. You, you know, obviously with, with your CEO and you know, being well versed when it comes to finances and in that world too as well, especially when it comes to taxes. You guys have a great understanding of what's going on today. So if it's okay with you, I'd love to talk about what's happening in the market that you're seeing and how to take advantage of these opportunities. Does that sound like a good way to start?

Perfect. Let's do it.

Obviously, everyone knows that when you know, people that are listening to this, what's happened in the market over the last couple years, they've all heard of inflation. They've heard of interest rates skyrocketing and they probably heard of like, honestly, some multifamily opportunities and deals that haven't gone that well in terms of, you know, there some apartment buildings are having some challenges with these rise in interest rates. So groups are having challenges. They probably heard of all these kind of things. But what are you guys seeing today when it comes to the market and when it comes to opportunities? Is that what you're seeing as well?

Yeah, absolutely. There are some real challenges going on in the market today. But there those challenges are what are creating a lot of opportunities. If you think about what's happened over the course of the past four or five years, there's really been kind of a wild ride in the real estate world. You had a global pandemic that caused massive supply disruption. You have historic inflation, then you have historic interest rate movement. And now what we're seeing in multifamily, that's, I think the most important headline is historic levels of new supply that are being delivered. And they're really being delivered because of what happened previously. All the projects that started in 20 and 21 and 22 at a time when debt was very inexpensive, you could borrow money at 3,4% for your construction loan. And all those projects kind of got lumped together because there were so many delays in new construction because of COVID during that time. So if it takes about 24 months to build new apartments, fast forward to 23, 24, in the first part of 25, we're seeing all of these new apartments hit the market in a way that's causing some real challenges on occupancy, causing some downward pressure on rents, causing concessions to hit the market. And it's been a really interesting time, especially when you combine that with really high interest rates relative to where we were three, four years ago, not that high in the grand scheme of long term interest rates, but, but high relative to what people have seen in the past few years. So it's been an interesting time. The impact of that has been a lot of the institutional investors that were bidding up pricing in real estate are now on the sidelines. Largely they have to maintain an asset allocation in their funds or in their, in their models. And when their interest rates ran in 2022, their bond portfolios got absolutely crushed. And, and as a result, they've been allocating away from private real estate back into bonds. Over the course of the past couple of years, you've probably seen in the headlines larger private REIT players are satisfying redemption Requests being forced to sell and meet the market at a time when maybe it's not the best to do so. And then there are a lot of syndicators who are struggling right now. They bought deals with high leverage, floating rate debt and you know, hopefully none. No one listening to this is in any of those deals. But the, the deals bought in that fact pattern, especially in 21 and 22, are experiencing some challenges. So the, the interesting thing amidst all of this supply, temporary excess supply is that on the buy side, the competition is greatly reduced today. And we think that there's a ton of opportunity, as you look out over the course of the next three to five years to buy today in a period of temporary softness.

Okay, let me see if I can summarize this in a way that I can understand real well. I mean, you do such a great job of explaining this from real estate standpoint. I think that a lot our listeners at this point have, have listened to a lot of talks in terms of real estate. So they, you know, understand you well. For just to kind of simplify a little bit, let me if I see if I understand these factors correctly based on what you said. A lot of apartment buildings were started about two, three years ago when interest rates were in a good place. So a lot of those apartment buildings now are finishing up and, or they finished up and now they're trying to find new renters. What's happening is that now, because there's so many more options for people, especially in certain areas, that it's hard for even some of these apartment buildings to fully get rented up. And so there's probably at this point, there's a lot more vacancies that you're seeing mean that there's a lot more unrented apartments. And so that's one, one issue. Right. The other issue I think you said, is that these institutional investors, which means that these big buyers out there that have a ton of cash, they've been trying to stay away from this market. I guess they've kind of withdrawn some of their investments or not been super excited about that. So a lot of money is not flowing into this space, at least from the big players and not moving the markets there. Do I have that correct?

Yep, that's right on.

You have that. And then also at this point, obviously interest rates have been high. And so it's caused some problems in the marketplace with people who currently own where some of these investors, whether it's REITs or like smaller syndicators or partners, they've actually had to sell some of their properties too, when they haven't wanted to sell. So usually that means that people are selling at prices lower than they want. And so that's happened as well too. So all of these things have happened at the same time. And so what does that exactly mean for you? I know that you guys are very active buyers in the space. What does that mean for price, for competition and opportunities? Just so that I can hear that again from you.

Yeah, yeah, that's a great summary. And I think we should hit each of those components individually. So pricing cap rates are how we value real estate. Cap rates are the income that an asset produces relative to its, its purchase price. And cap rates are higher today. Cap rates are generally correlated with interest rates. So if interest rates have moved up, cap rates have gone up as well, which means we're paying lower prices today. What's interesting about that is we think we're capping a temporarily lower income because there's a little bit lower occupancy, a little bit higher concessions, a little more muted rent growth. And so we think that's a really compelling opportunity to buy a lower income at a higher cap rate that results in a steep discount in pricing. And in some cases in certain markets we're seeing that can be 20 to 40% depending on, on the fact pattern of, of where we're at. So that's a really exciting opportunity competition. You'd think that everyone would want to be jumping in and buying these types of, of opportunities, but for the reasons we just mentioned, there's less competition in the market today. And it's not because people don't want to. If you hear some of the larger CEOs of these big, big private rep players that normally are, are buying up the market, they're actually saying that now is the time to buy. But their investors are wanting out because they're, you know, whatever, whatever their individual circumstances might be. So greatly reduced competition for lower pricing. And in our mind, those two things really combine well for, for significant opportunity that we can capture in our fund. And I'll also add, you know, we have properties in our fund that we bought in 21 and 22 that are having some challenges. No doubt. Every, if you buy we own 160 properties in MLG, you're going to have challenges and you have to know how to run Adam and fix them. But that's why you have to also get yourself diversified. You have to buy with modest leverage. We have saved ourselves so much pain. We've saved our investors so much pain that, that a Lot of the market is feeling right now because we bought in the right structure and with the right risk mitigation forces in play.

So when, when you're seeing these, these market forces and all of these things happen, like the end result is, if I, if I'm hearing it correctly, is you're just buying these properties that maybe would have been you, you would have to buy for a certain amount two, three years ago. You're buying them essentially at a discount today to where they were. Am I hearing that correctly?

That's right. A discount to what they were trading at a couple years ago, but also a, a material discount to what it would cost to build the new today. Because construction costs amidst all of this have continued to run. So now you want to build a new apartment building. Not only do you have to do it with higher interest rates, you have to do costs.

Are you targeting some of these newer type builds? Are you targeting properties that are already in the marketplace that you're able to go after that maybe you can add a little bit of value to?

Yeah, I would say both. We're not generally buying, we're not doing the development ourself, but we found some really unique opportunities where we can buy in a pocket where there's been a lot of excess supply. So you pick it up at a great price and buy a property that's just recently leased up. So it's kind of right in the middle of that, that what we think is a temporary supply and demand imbalance. Now it's important to buy at the right basis and it's important to buy in locations where you have real conviction in the long term job and population growth in that market and more specifically in that submarket. So we've definitely bought that type of deal in Fund 6, but we're also buying is more traditional value add deals where you're buying something that was built in 2000. It looks not that dissimilar from the new stuff, but you can go in, fix it up, make it feel a lot similar to the, a lot more similar to the new stuff, and you're still at a 3 to $400 discount to where you know the new stuff might be renting for, for the average renter.

So explain how that works for me then. If I, if you guys are buying at a discount, like how does that ultimately translate to, to better returns for investors? Just at a simple level, let's say today everything you're buying, you say you're, you're buying at a discount, a percentage. How does that translate to A better return.

Yeah, well, I mean there's. You make money in real estate in three ways and we're going to talk about two of them. You make money by paying down debt, but you also make money through cash flow and appreciation. Right. And today the cash flow that we're buying these properties at because of the softness and occupancy is a little bit lower. But we think there's significant appreciation potential if you look out three to five years. And the reason we think that is because while we're dealing with this historic level of supply today, and if you look at the data on what's new, new starts that are being put in the ground today that will be delivering in the next couple years, the numbers have decreased dramatically. People could build when debt was cheap and construction costs were lower, but the forces have turned against those developers and it's a lot harder to make the numbers work today. So if you look out three, four, five years, there's going to be significantly less supply. But the demand is still there, right? There's still 120 million households in the US and that number is growing at north of 1% per year. We need to be creating new single family homes and new apartment builders, buildings for people to live in. And the math is it's just hard to do that. And we're not, we're not on pace to deliver at a, at a rate that keeps up with what demand is predicted to be. So what that means for investors is we're expecting to see stronger occupancies, more rent growth and more demand from the capital side which is going to result in strong sale prices down the road. So if you can afford, if you're a doctor that doesn't need significant cash and cash returns today, we're still producing some, you know, 3, 4%. But if you can stomach a little bit lower yield today, we think the long term appreciation potential in properties we're buying in 2023 and 2024 and 2025 is going to be really, really exciting.

Over the last 35 years, MLG Capital, they focus on making smart investments in real estate and building relationships with their investors. They call it an investor centric fund structure. That's what they focus on where accredited investors, they can invest their money with confidence in funds that target diversification. They prioritize cash flow as well as low leverage with a what they call a unique dual sourcing strategy. So if you're unsure about investing due to rising inflation or volatility in the stock markets, well, I want to let you Know that investing real estate, it's been historically one of the best hedges against inflation. In fact, I've been investing with this company for years. So if you're a medical professional and you'd like to learn more about investing with MLG Capital, make sure you visit passiveincomemd.com MLG Again, that's passiveincomemd.com MLG now back to the show. Can I talk to you a little bit about the fund structure? I'm trying to, for, for people that are out there, we talk a lot about investing in single properties versus investing in funds. And I, I think you're a great example of a fund that knows what they're doing and they do it well. And so I'd love to explore a little bit about how the fund structure works specifically for you so we can learn from it. And so for a fund, you said that this fund, there's $400 million that you're raising for this fund. I mean, that's a huge fund. How does that translate to like properties? How many properties do you typically buy for 400 million? And then as an investor, to clarify, do they essentially own a piece of all of those properties that are within that one fund for that investment?

Yeah, good question. So we buy about 25 to 35 properties within these funds. So generally making investments in the 15 to 25 million dollar range per property. And when investors participate in our fund, they own a proportionate share of all the properties that are included. And we do it a little bit differently than some funds. We raise and deploy the capital simultaneously. So we've been raising this fund for about two years now, but we continue to add new investors to the fund and we'll be doing that until we close this fund at the end of this year. What's important to know though is any investors that come in this fall or towards the end of this year still have a proportionate ownership in all the properties that we've previously acquired. So as well as any that we acquire going forward.

So you know, you've been raising this fund for two years. Okay, it's about 15 to 20 million dollars property. So people can have a proportionate piece out of all those. Where are those properties typically located? And again, just to be clear, are those mostly all multifamily properties?

It's about 90% multifamily. That's definitely our bread and butter asset class. We do like to mix in some flex industrial property. We think that there's really attractive long term fundamentals and flex industrial, but we it's generally a smaller portion of our fund that's about 5, 6%. And then about 4% of our fund is in retail. And in retail, we buy very opportunistically. But there can be some, some interesting opportunities long, long term. And, and the vast majority of what we do in MLG and in Fund 6 is multifamily. That's where we see the most opportunity. Geographically. We try and get our investors diversified. We think that's really important way to mitigate risk. But the we like the most are the Sun Belt, the Midwest and the Mountain West. That's generally where we do most of our investing. And that's where most of our properties in Fund 6 are.

You know, one of the things we've also talked about with a fund structure is, first of all, I think you explained it perfectly. You get this diversification right off the bat with one investment, which is a huge plus for investing in a fund. Now, you said you've been raising this fund for like two years. And we always talk about is it better to invest early in that fund cycle or later in that fund cycle. Of course, there's pros and cons to both. I've written extensively about it. You and I have talked about it. But let's talk about this specific fund because again, it is a great case study for us. You're raising capital, I think. When does this fund actually. You think it'll end in terms of you're raising your capital and then what are some of the benefits for somebody to get in now, right at the end?

Yeah. So this fund will be open until December 31st. So we're kind of coming up, down to the wire or unless we hit our $400 million before then, which we actually usually do. But at the Latest it'll be December 31st. But there's some real advantages coming in now at the end of the fund. Even setting aside some of the macro environment conversation, just from a fund fund structuring perspective, there's some benefit. One, you have visibility into what the assets in the fund are. If you're the first investor in the fund, you're trusting MLG as the manager. And I think there's a lot of good reason to trust us as a manager. But if you come in at the end of the fund, you get to see exactly what properties we already own. And you have pretty clear visibility into about 75% of the fund, which is a great thing. The other thing that's nice within with coming in at the end is your money is tied up For a shorter period of time, we're going to be returning capital proportionately over the first six to eight years of the fund lifecycle. So if you come in at the end of the fundraising period, you're going to get your money back faster. And because IRR is a time weighted metric, you're going to have a higher IRR on your investment. Now, someone who came in on the first day of the fund may have a higher multiple on their equity, just more dollars in their pocket. But as a, as a function of a rate of return, end of fund investors have a higher irr. And that can be a really great thing for people who are looking for that type of metric. Great.

I think you explained it perfectly. For those who are, who have been following along or, you know, with some of these blogs we were talking about it, there's been a lot of debate about going earlier, late in the fund. Again, I think there are pros and cons to both. I mean, the earlier you are the money, you know, the, or your money starts working for you. And later on, though, I think one of the challenges, especially for people when they want to invest in a fund, they're like, what am I exactly investing in? I mean, especially if this is the first time working with you, we know so many people come back and invest in your fund, 3, 4, 5, 6, you know, but let's say it's your first time. People are wondering, well, what am I actually investing in with the property? Like, what am I? It's, I'm just, you know, trusting the manager and I don't know exactly what I'm investing in. The good thing about investing late is that you already know a lot of the properties. You can actually see what it actually is being invested in. Is it following the business plan, where it's at. And I think that, I think Nathan did a great job of explaining why, why that's a huge benefit, investing late. And of course, like you said, your returns are getting started right away, you're putting money in and you're kind of shortening the life cycle of that fund by starting late. So I think it's a great opportunity, if anybody's interested right now at the end of the fund. That's kind of where we are with MLG at this point. Nathan, what have you seen? Now, we've been together in terms of working together as a partner, pimd, and I've been an investor of yours for, for many years now over these last five to seven years. What have you seen and what have you learned about investments from, from the viewpoint of high net worth individuals like doctors have come in and they've invested with you. And constantly we're talking about tax benefits, we're talking about returns, we're talking about all of these. Like what have you seen as the trend in that and how beneficial have you seen it be for the investors that have been with you during that time?

Yeah, that's a great question and actually it's a timely question. We do everything we can at MLG to maximize the after tax return that we produce for our investors. And you know, a lot of physicians listening in today, physicians generally are earning a lot of money, which is great, but they're also paying a lot of money to the government. So we're very interested in figuring out how can we maximize that. And we have the benefit now. We've been doing the funds for about 12 years. We've been in business for about 37 years. But we've recently produced some case studies over the last 12 years of what would it look like for an investor who's taxed at the highest rates to have made repeated reinvestments in our funds over the last 12 years? And I'll have to send over the exact case studies, but the high level punchline is when people invest with us, we pass through the depreciation to them. Those losses, unless you have other passive income, are suspended year over year until you have other passive income that's produced. And that happens as we start to sell properties in our fund and we trigger the passive capital gain. You have passive losses and those two things can net against each other. We ran some case studies on people who have invested repeatedly with us over the past 10 years. And what we found was, was pretty powerful. People's after tax rate of return in some cases was actually greater than their pre tax rate of return. Or said differently, they are making money in taxes by repeated reinvestment with us. And it's a, it's a really powerful scenario, but it's going to continue working this way as we go forward. So I'll, I'll send over the case studies and if anyone wants to learn more about that specifically reach out. But it is a really, really powerful benefit that we provide for our investors. And of course first you have to make money in real estate before you can do good tax planning. But if you can do, you know, make money and then, and then do great tax planning around it, there's a ton of value to be had.

Hey everyone have a question for you. What if there was a way to make Your money work for you instead of the other way around. Let me ask you, are you looking for a way to create passive income and secure your financial future? Or maybe you've stayed away from real estate because you don't have time to be a landlord. Then I want to introduce you to Passive Real Estate Academy. It's the revolutionary platform that we created that teaches you how to invest in real estate passively with little or no effort on your part. In just four weeks, our comprehensive course will teach you everything you need to know about passive real estate investing and help build that confidence in you so that you know that you're making a great investment choice. We created this course for busy people like you, and we're going to guide you from every step of the way, from understanding even the most basic information to understanding the jargon and understanding underwriting so you can make sure that you're making a great investment, that you're maximizing your returns and minimizing your mistakes. And the best part, you can do this all from the comfort of your own home with absolutely no prior experience required. So it's time to prepare yourself and learn so that you can be ready for these deals that you see, because the time is coming. So don't let the demands of your job or the current economic climate dictate your financial future. So join Passive Real Estate Academy and build that confidence to know that you're making a great investment when it comes to syndications and funds. So visit our website@ passive realestateacademy.com to learn more and take your next step to financial freedom. Now back to the show. I think the tax issue for physicians especially, you're right, it's a huge thing. I mean, we get. Sometimes it feels. It feels like we're unfairly punished a little bit for kind of the status we're in right now in terms of our income versus some other people that have a lot of tax breaks available to them. A lot of times physicians. I don't know if anybody listening to this feels this way, but, you know, we make a good earning, we work really hard, but we don't get a lot of tax benefits that seem that other people seem to get, especially in the business world. And it feels, I'll be honest with you, at times unfair. And so finding ways to use the tax code to our advantage has always been a focus of ours at PID and our community. And so many people have found that through real estate, to be able to do that and create really nice returns for them at the end of the day we care about what's in our pocket at the end of the day, how we can utilize that. And so hearing that you guys put a focus on that is really, really exciting. And so I love to see some of that data when you guys get it. I know that people can talk to you about it, but whenever you get those case studies and you guys are finishing that out, really cool. I'm excited to share that with our community and it's something that we can all learn from. So I'm excited by that. Nathan, what else is next for you on the horizon? What are you most excited about over the next year for mlg, what you guys are doing? And again, how can people out there, you know, find out more about it?

Yeah, well, we're, we're really excited, like I mentioned several times about wrapping up Fund 6. We think the basket of assets we have already, it's really attractive mix and we're going to add some really nice deals here towards the end of the year and early next year in Fund 6. So we're really excited about that. One other thing, we haven't hit on much, but we have, in addition to our cash funds, we have what's called a legacy fund, which is meant for people who own property and are ready to move on from active ownership in a very tax efficient way. It's a great alternative to a 1031 exchange or a DST. People can contribute their property to our fund in exchange for shares. They immediately become diversified, they become passive and there's a lot of go forward income and estate tax benefits that we can provide in this fund as well. So we're really excited about that structure. We're growing a lot and then we're going to be rolling out Fund 7 early next year and we're hoping to continue to capture this opportunity we see in the market today. It's not going to be here forever. The capital is going to come back to the market, demand is going to catch up to supply and at that time, you know, some of the opportunity we see today will close. So we're excited to capture as much of that as we can in the in Fund 6. Here at the end, in the early part of Fund seven, you just threw.

Something big out there at the very end, this whole legacy fund structure. I think that's something we're going to have to explore in the future. I think that there are a lot of people out there who have over the last however many years got some appreciation from some of their properties, but at the same time feel like maybe active ownership. You know, are they trying to, you know, diversify their portfolio a bit and try to become a little bit more passive? In fact, I think a largest part of our community actually prefers passive versus active. But again, there's a way to do both. That legacy fund structure sounds really fascinating. So if it's okay with you, I'd love to invite you again sometime to talk about the legacy fund. Does that sound good?

Yeah, that. That'll take a full. A full session. So I'd love to share more.

Well, this has been awesome. I mean, it's great talking about the market. We've learned a lot about funds today. I hope people out there have gotten a lot of value from this talk. I think what you guys are doing, again, with your fund structure, creating that instant diversification and taking advantage of, like, the market today. We've talked a lot about that, that there are certain parts of the market and the cycle. We think there's opportunities at every part of the cycle, so you just have to be ready for them. And I. I think without a doubt that you want to be in the buying phase. Right now, we're in the buying phase of the cycle in terms of opportunities. And for every person out there that's interested in real estate, whether you're beginner, advanced, this is. This is the time to at least start to educate yourself, get connected to great resources, and figure out how to take advantage of what's going on now. So I just want to thank you for your time again. What's the best way for people to connect with you, Nathan, to find out more about what you guys have to offer?

Yeah, Feel free to go to our website. You can reach out to our team. We have a landing page specifically for PIMD listeners, so we'll make that available, too. But reach out, we'd love to share more. You can speak directly with any member of our team. You can even talk with me if that's of interest. And we have a lot of exciting things to share, so please reach out. All right, cool.

We'll try to make that link available to everybody so you can check it out. Excited talking. You know, it was great talking to you. As always. Excited for where you guys go from here and, you know, let's talk again soon.

Sounds great. Thanks, Peter. Thanks for having me on.

All right, thanks.

Take care.

Enjoy the show. Let me know by dropping a review in the podcast app you're listening to us at. And if you haven't already, make sure to hit subscribe. Join thousands of physicians who are also on this journey to creating their ideal lives through multiple streams of income. Learn more at our website, passiveincomemd.com thanks again for allowing me to be a part of your journey. See you next time.