#27: Navigating Real Estate Investing amid COVID-19 with Timothy Wallen

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. Today's gonna be a great interview. We're so lucky to have Tim Wallen. He is the CEO of MLG Capital. If you've been part of my world for any amount of time, whether you've been on the blog or the Facebook groups, there's no doubt you've heard of MLG Capital. But we're gonna talk a little bit more about what it is today. I mean, I can tell you that currently they own and operate over 20,000 units. They've been in operation for more than 33 years, and the market value of the properties is over two and a half billion. So they obviously know what they're doing. But we're excited to have the head honcho here right now, Tim. How you doing, Peter?

I'm doing good. Thanks for getting together.

Yeah, I mean, we've talked before, but it was in different times. But I'd love to kind of talk a little bit more about the perspective you have right now and what's going on. But let's start from the beginning. Tell us a little bit about your background and ultimately how you ended up at mlg.

Well, I've been living and breathing the real estate thing for, my gosh, about 30, 30, 32 years now. They're actually really 35 years now with my public accounting experience. But I came in the real estate world through Pricewaterhouse. I was a tax manager with Price out in San Francisco. I grew up in Wisconsin, did that rubber band thing, went to California for a number of years, then moved back to Wisconsin. But when I came back from San Francisco back to Wisconsin, I had MLG as my client, and I spent about a year working with them, and then I joined him as the CFO and a smaller partner back in 1989, and then I took over the leadership role as a CEO in the year 2000. So I've been with MLG for roughly 31 years again, living and breathing real estate and tax and all the things go with it for that whole time.

Now. What did it look like back there in 89 when you took over to what it looks like now? I mean, how have you seen it grow and change?

Yeah, you know, it's obviously very different. I was a very entrepreneurial company when I. When I came back from San Francisco. They had like 10 to 12 people at the time. Today we're roughly 500 people in the organization. Now today we, you know, we have, we have eight CPAs and staff, four attorneys, land planners, engineers, accountants, all the people that work super hard on our properties, and all the local regional managers and all the maintenance guys. And we very deep bench of talent, you know, throughout our organization now.

And just tell us a little bit about what you focus on and who are the people that you actually serve and help.

Well, we're very unique in our industry. Most real estate guys, they have their niche. They might be a multifamily guy in the upper Midwest or just Milwaukee, Wisconsin, or they're in the Southeast, or they're in Texas or they're in Arizona, or they're maybe a retail guy doing stuff. Very niche. What makes us unique is we're an operator in Wisconsin, Texas and Florida. You mentioned the 20,000 units that we manage and oversee. But we also are what I would describe. Let me clarify that. We also, you know, we fix toilets, we shovel snow, we cut grass, we deal with all the tenant complaints and all the opportunities to make places better, a better place for them to live. But we're also unique in that we really are like a private equity firm. We actually proactively invest with other real estate operators around the country. So to bring that home to you, there's roughly 60 different real estate guys, say, for example, in Minneapolis that we talked to about their deals and, you know, a couple guys in Minneapolis, and we're willing to invest in that local guy. So around the country we have well over a thousand real estate companies that we talk to about their deals, and we're looking to invest in one or two of those a month. We see about 60 or 70 opportunities a month from other real estate operators. So in addition to being a vertically integrated real estate operator, we're really a JV equity partner for other real estate guys around the country. And we did that. You know, we could have opened up other offices around the country. But my viewpoint is so hard to get talent and so hard to get somebody say I'm going to have all these great relationships in Nashville or Minneapolis or Denver or Phoenix and all these markets. And somehow I'm going to be an expert in a matter of seconds by hiring one person, you know, my viewpoint, we were better off to partner with the local guy that's been there for 10, 20, 30 years and parlay off their strengths and their relationships. So. And then we look at investing in Deals that we think make great sense. So our investors get the benefit not only of our direct markets, the Wisconsin, Texas and Florida, we get the benefit of us traveling the country late nights, planes, hotels, trying to find the best deals possible for our investors nationwide.

Yeah, and how has that worked out for you, especially in this time right now, having that diversification of kind of where your investments are not fully localized in one area. How have you seen it now that's spread all across the country?

Well, I mean, I think, I mean, like anything in life, diversification is big to managing risk. And so if we build this basket, typical fund will have 30 to 35 properties in it. So if we build this basket of assets around the country, much less risky than finding some crowdfunding deal on the Internet in one location and you put your money into one deal in Phoenix, and it might be a great deal and it might work out great. But just like stock markets, right, right now, you know, individual stocks are more risky than buying a basket of stocks. And our belief is, many people in private real estate, they make that mistake of not getting diversified. I myself did all individual syndications and I changed that in 2012 and started rolling into the fund structure because I thought that was a better structure for the investors. It's actually worse for us economically. We made more money on individual syndications than we do in the fund structure. Because any deal that underperforms the good deals have to pay for the deals that underperform in a fund structure. Whereas individual syndications, that is not the case.

Okay, now that I have you here, let's dive into some of the specifics because I think there are a lot of people here who are listening to this for the first time. They might understand the concept of investing in a single apartment. You see, you can touch it, you know exactly what you're investing in. Let's talk about how it works really quickly in terms of your investment. When it goes in, what does it look like overall, structure wise?

So in a fund structure, and they all can be structured differently, but I'll talk generically how most are structured. Most funds are structured with a real estate company like MLG has the discretion to decide what to invest in. So you're saying, hey, rather than me make the decision to invest and pick assets, I let you, real estate guy, go pick the best deals possible. I'm going to trust you to do that. Now we have the benefit of having over 30 year history of performance that we can demonstrate and we can show the discipline that we've had over a long Long period of time. But again, you're giving that control just like, you know, having a money manager or buying a mutual fund or you're giving somebody else the ability to make that decision for you versus you making it yourself. So you're trusting that expert to make wise choices on your behalf.

So how do you know how to trust somebody in that protection? Let's say somebody's coming into this pretty fresh and new. How do you do the proper due diligence to make sure that you're investing with the right person?

Well, you know, for the average person coming in and looking at investing in funds with real estate folks, I mean, you should ask for the performance history. You should ask, and we're transparent. We'll show you every deal we've ever invested in if you want to ask. And we have that track record available. For example, in our history, our average return $1 of equity turns into $2.30 on average. That's before promotes and fee structures. But in general, we have a long history of taking $1 and growing it to over $2 and have a history of doing that very consistently over a long period of time. So, you know, most guys should be willing to give that to you. If they're not willing to give it to you, that's a red flag for you.

Yeah. So what other questions can we ask besides the track record? I'm sure that when you deal with all these operators in different areas, you're doing your due diligence right on our behalf.

That's right.

What are the things are you asking for besides track record?

Well, I'm sure we dive a lot harder than any investor normally would. We almost look at when we talk to a real estate sponsor, almost like a bank would underwrite somebody. So we get their whole portfolio of real estate owned. Now, most real estate guys aren't going to want to give you that. But because we're typically 80 or 90% of the equity of a deal, we do get access to that. But we ask for all the current portfolio. When we're looking for is there any problem spots, do they have any troubled assets? Because, you know, when people are in trouble, you know, people tend to make poor decisions. And so we like to see if there's trouble spots and understand that. So again, peeling back the onion. What exactly do you have? How the assets performing and really understanding the team. I also think it's really important to look at the management team and the depth. We look real close at all the different functions. There's all the reporting functions like the Controller function, the treasury function, where your managing cash, you're overseeing the financial reporting. You know, what does that reporting look like? Okay, who actually in your shop actually does that? And we've had real estate deals that we invested with where we peel back that onion go. These guys do not have the strong financial strength. They're smart real estate guys, they're savvy, street smart, but they really lack that deep controller function of watching over the books and records and stuff. So we've had deals where we actually let the real estate guy do the property management side, but we retain 100% of the treasury and controller function because for US nationwide, the 20,000 apartments that you mentioned that we manage, we do the accounting nationwide right here in Milwaukee, Wisconsin, for all those assets right here and do centralized accounting. So, you know, I have nine CPAs on staff now. That's not normal. Okay, that most firms don't have that. And that's more driven by the fact that we're really an investment banking firm. That's private equity firm investing other folks. I need to have that depth of talent. It also allows us to do some pretty great tax stuff. So you have to look back, who's doing asset management, what's their policies, what's their process, Are they reviewing the financials monthly? How are they tracking their capex budgets, their operating budgets, just disciplines of operations and understanding the people that are responsible for that. So we do that kind of dive when we're investing with a real estate guy trying to understand their team. We also look at what's the risk of departure of key talent and understand what's the depth if one or two people leave, do they have much of a bench behind them overall? And also we also look at the amount of leverage people take on. Our belief is lower leverage is smarter. Our target leverage was 65%. Many guys do max leverage. And again, you go through something like Covid here recently. Can they withstand a Covid impact or if things got really bad, how is their portfolio going to look and how are they going to perform? So we peel back that onion farther than I think the average investor would really be able to, just because of our position of being 80 to 90% of the equity in most deals that we invest in Now.

You mentioned the time of COVID How's MLG doing right now in the time of COVID dealing with all of this?

I think it's just about being smart, being real, about what environment you're in. Overall, we're only off about 3% in collections from COVID impact So we've been average about 90, I'd say 2 to 3%. So we're averaging about 96% collections. When we say collections in the real estate business, even last year we might have been at 98% collected. Because you also have some people that don't pay, right? I mean, in any environment you have people that don't pay. So we're really talking about a chance 2% increase or so of non payment impacted from COVID which honestly is less than I thought. When we underwrote, we actually looked at what if we don't collect 20%? What if we don't collect 25% because of COVID Back in April we were running those kind of math gymnastics. Cause we understand in our portfolio, because of our lower leverage point, we could handle collection drops of 25, up to 30% on the assets and still pay all of our bills just fine. Again, because we have lower leverage than much of our industry.

Do you see, right now, obviously we're still in the thick of it. And I know that people are talking about all sorts of things or stimulus money might run out. We're still going to be going for a while. Do you think that there are things to be even more cautious about in the future, in the next six months, 12 months?

Well, I will say in general, I view it to be a temporary condition. I do think there's permanent job loss here. Okay, so I don't want to understate that. We're already back to like 8.4% unemployment here. We snap back pretty quickly from, I think they got up to 14% at its peak. I just have some reference. 2010, your unemployment got up to 10%. So we went past the Great Recession unemployment numbers, but we're already back below that 8.4. So the way we're looking at stuff, we're expecting recovery in general by the end of 2021. So we expect a bit of a slow grind between now and then. We gotta get through the COVID issue. We gotta get through the COVID scare. We gotta have some vaccines, we gotta have more therapeutic type stuff. So when you're doing your planning and you're doing your underwriting to buy stuff, right now we have roughly almost 55 million of deals to acquire right now. But all those deals, they got off market. The key to that is, are you being real about your assumptions? You know, if I was believing by the end of 2021 and three months from we'd be back to normal, I'd be nuts. So you just got to be real about what you're assuming, whether it be from an operational perspective or from a new acquisition perspective. Just be real. It will pass. It's a challenging time for many, but it will pass. And it does create opportunities that you can take advantage of.

Now, what are you telling investors right now when they're thinking about investing with you? When you mean setting expectations correctly? What are you letting them know that returns just might be a little bit less than maybe they expected a couple years ago? Is it going to take longer to get your money back? Is it, you know, what are you telling them in terms of expectations for how to invest during this time and what it'll look like?

Well, it's kind of a really interesting environment because what you're navigating, there's so much money out there right now. And with all the government stimulus, the stock market growing, there's just so much money out there. Interest rates are near zero. But you can buy real estate and you can buy multifamily real estate and produce, let's call it A. I'd say 4, 4.5%, 5% is probably real. There's some deals we look at we can get produce a six. But I say right now the expectation is more 5 or 6% cash on cash yield, something like that. I think that's a deliverable. But I tell you it's competitive out there. When people are out trying to buy stuff and competing against other buyers, it is really competitive. All five deals that work on right now are all off market where we didn't compete against anybody to buy those assets. We've been having a hard time competing on market deals just because it's just so much money out there overall. So I would say the bottom line of what to expect more modest cash on cash yields in the context of multifamily. And it will be more modest, but it will get better. And I think there's opportunities. You do have to be cautious on the buy side. And you got to be real assumptions if you're real. I think things can work out well for anybody buying multifamily.

I mean the reference point that a lot of people have is 2008 to 2010. They talk about that recession and how it was so bad for real estate, all these prices drop, A lot of people lost a lot of money. How do you see today different? Because you guys have been through multiple cycles. So how's this one different from 2008 to 2010 is the same type of sentiment?

Well, The Great Recession, 2009, 8, 9, 10, that was a slow grind down. You had true fracturing in the banking industry. The banking industry was in trouble. You had true fundamental challenges. So you had this slow grind from is about 4.4% unemployment by 2007 and you bottom about 10% unemployment. What's crazy about this cycle, we had 50 year lows of unemployment back, you know, just eight months ago. Right. You're at three and a half percent unemployment and you catapulted up to 14% unemployment in a matter of months. So it's a forced government shutdown, forced government recession. And so it's very, very different fact pattern. You came into this with a lot of strength, so it does give you a better cushion. And the banks were very healthy and less leveraged coming into this as well. So much more able to see a snapback being quickly. I still think it's going to be relatively modest. It's not going to be a slow grind back like it was from 2008. 9. Because there were systemic problems in the financial industry and we had to work through that and we had to strengthen the banking system. And we don't have that fact pattern right now. So just a matter. When people get past the fear of COVID and live life again. Good reasons to have fear, but we have to get through that as a country. And once we get through that as a country, I think things will snap back. I think people start traveling again. It'll recover quite quickly. At some point. Our underwriting, we're looking at 2022 for that to really start happening.

I mean, you guys invest in not only multifamily, but in some other sectors as well, right? Other fields. And so how have you seen the difference between multifamily and maybe something like industrial or something like that?

Sure. Well, when we look at all asset classes, there's a fundamental concept of the basics of demand and supply. And sometimes people can overcomplicate it or overthink it. But let's talk multifamily once real quickly. So you know multifamily story. Anything you do, right, if you have too much supply versus demand or whatever, you're gonna be in trouble. If you have too much supply versus demand, your prices are gonna fall. Basic economics, right? Whereas if you got great demand versus supply, things are gonna be really good. You got pricing power and all that kind of stuff. So you got to just keep it simple from that perspective. So if you look at multifamily, the fundamentals of demand supply are very sound. If you look at the demand side, you get aging population, student loan housing prices are up 57% in the last eight years. Rents are up 38%. Affordability is an issue, unfortunately. You have higher divorce rates, you have people getting married later in life. You have pure population. We talked earlier that you're in the OB area of medicine and people keep having babies, right? The population growth. So we average about 7, 10 of a percent population growth every year. So you get a built in demand center. That's real. And the interesting thing is household formation, which is all those things I just talked about, aging population, student loan debts, all those kinds of things that impacted people's ability to go into housing. Household formation is at 1.09% whereas population growth is at 0.7%. So what that means is you're actually creating new homes, home demand housing, single family, multifamily at 50% higher than population growth because of all these other factors. So the demand side of multifamily is super intact. Supply side. The interesting thing here, one impact of COVID that people don't think about is that you're going to have less supply created because banks are getting tighter, right. When you have a Covid environment, they fear. That fear means the lenders aren't going to lend as much, the developers are going to take as much risk. So you're going to have all these things, slower supply growth. But yet that demand side, everything I mentioned, none of that stopped. Frankly. People probably have more babies right now, right? All this time alone. And so you have demand side of this thing is fully intact and yet supply side is going to be slowed. So when this does snap back, multifamily solid industrial has major things in its favor as well. United States has low energy costs, which is big. You're seeing this trend for jobs repatriating back to the United States. We have jobs coming back to the States, so there's good things happening there. This e commerce trend in retail is a big demand generator for industrial. A lot of these companies, like think about Amazon, these massive warehouses are being built and logistics spaces, a lot of demand space on the industrial side. So the demand side of industrial is very much intact. I will say you, you have to be a little careful on the supply side of industrial. It is not hard to buy land and slap up a building and say here building they shall come in industrial development. So you do have to watch when you're buying industrial, what's the risk of new construction around you now Multifamily is like 95.5% occupied nationwide. Industrial is about 94.5% occupied nationwide. So both pretty solid. Industrial and multifamily are our two favorite asset classes. Very investable. But you have to be careful about the supply side growth on a local, local basis. Overall, I'll do a quick snip on office and retail. We do invest in office and retail. Unfortunately we have none in our current fund number four because it's been hard to find those deals that make any sense when we buy retail and we buy office. Let me just talk one time because I'll confuse the market. So let's talk retail first. Now I'll surprise you by the statistic retail. Actually I'll have fun with you. So what do you think retail is occupied nationwide? Peter, you said Multifamily. Industrial. Multifamily 95.5% multifamily, 94.5% industrial. What do you think retail is occupied.

Nationwide Right now my gut reaction outside the malls. Yeah, my gut reaction is lower. I mean it's. Yeah. I mean especially with what's going on right now. I don't know. Personally, when I'm driving around, I feel, feel like retail's occupancy is low.

Right. So big picture, 95% nationwide outside of malls. And so and that statistic surprises people. But what people don't understand is the supply side. Again, when we talk about population growth for multifamily, we've had that 7, 10 population growth every year people buy stuff, right? So in 10 years time you've had population growth 7% about roughly in the last 10 years. Amazon's only 5% of the retail marketplace now. Amazon's been a monster, right? And everybody knows Amazon's eating a lot of guys lunch. But the reality is the rest of the retailers aren't going to land the back say hey Amazon, you get it all. They're fighting for their lives. So the retail guy is fighting pretty hard. The problem with retail is change is afoot. There's a lot of changes. There's concepts that are failing. There's new concepts coming in. There's existing tenants that have to change the way they do business. And change is expensive for real estate guys. Our viewpoint is you can't buy stabilized retail and make good money. So I don't want to buy a fully occupied retail center even if it's a great location because the market might be point doesn't price in the cost of that change risk. And as tenants come and go, it's very expensive to redesign space and cut it up. So I like buying retail in a great location that has temporary availability of Space because some and it fails. And if it's a great location, I believe we'll lease it back up again. But as soon as we lease that baby up, I'm going to sell it and run anything retail. Buy the problem, fix the problem, sell it, cast a register, bring the register, win, take your win and go and buy something else. So we won't buy retail. Stabilize. Office is a little different. Office has got systemic long term occupancy problems. And it's really because they have problems on both the demand side and the supply side. On the demand side of office, there's trend to less square feet per person, per employee. And certainly with the whole zoom factor and Covid it's accelerated this concept of working from home. Now I do think we are social beings and I do think people want to be together. And so I think it's really hard to build corporate culture working remotely. So I think you have a relationship with your current employees. It's okay to maintain that for a while over time. But you're hiring that new employee or you're trying to mentor some other person, you're trying to grow managers. I think people need and want that social interaction. So I'm still a big believer that the office market is investable asset class and it'll be okay. The problem is more on the supply side is that people keep building it. And even though it might not necessarily be new, for example, I call it the CEO ego problem. And many CEOs will build that new office building because they want the sexy new place to walk into work every day because this is where they spend a lot of time in life. So they want this cool space part of it. They do it because they want to have an attractive place to attract employees. But the problem is they're going to leave some space behind. Some old stuff built in the 80s and 90s and it's not not cool anymore. And so they leave behind supply because they're going to build this new sexy building. They don't necessarily need more space. They might be building a smaller building, they might be doing something different. But so supply gets created even though there really isn't need for that physical space. And so it creates a systemic supply growth problem. And it combined with some fall off in demand. I don't think the demand falloff in office is going to be as great as some people predict because I think we are social beings and people want to be together. So I'm not in the camp that office is dying from the demand side. I think the problem is really more on the supply side. So nationwide office is about 90% occupied and I don't think that gets better. I think it's going to bubble around and I think you're going to have systemic vacancy problems because of people build new and they really don't need to.

Wow. Market summer. Yeah, that's it in a nutshell. Thanks so much.

Yeah, that's a high level overall. So I mean the COVID impacts I think are all temporary impacts in those asset classes, but those are how we look at stuff. So office and retail are merchant asset classes. Buy a problem that you think you can fix, lease it up, sell the asset, don't buy stabilized office and retail. That's our viewpoint now. Many people buy that stuff and it works out. It's high risk. If you buy a office building, retail building, and the anchor tenant leaves, it is super expensive and very difficult to recover from that loss.

I mean, one of the things I want to hone in on because you mentioned it and you're considering your background in tax, you mentioned you have all these CPAs on staff and you said so you can do some really cool things with taxes. I think with a lot of the people that are investing in this, you know, high net worth individuals, especially physicians, they really are concerned about the tax benefits. That's a big issue for them. They want it, that's a big benefit. So what are some of those tax benefits that we can take advantage of when investing in private real estate? What are you setting up through having all these CPAs and what does that look like for the average investor?

Well, again, I was a tax manager Pricewaterhouse and I've been living and breathing. I hate paying income taxes. I like paying cap. I don't mind paying cap gain rates, but I try to minimize any ordinary rates overall. So anybody who's highly compensated, they can capture and have incredible tax benefits from investing in private real estate. However, there's something called the passive loss rules, meaning that for example, in our fund last year, someone who invested a million dollars in Fund 4 in 2019 received about 600,000 of ordinary losses allocated to them. Those are all paper losses. We still sent out a 5% rate of return that money and on that million dollars, but yet we still created 600,000 of losses. There's things that we do and I could send you an article sometime on that if you want, Peter. But the big thing is we do cost segregation studies, which means when we buy an asset, we go there and we analyze every piece of that asset as far as what the depreciable life could be or should be. And so most real estate guys actually you think they would, but they don't. Most real estate guys don't do that because by the time they try to do their tax return and they give their K1 stuff, the tax stuff to the CPA to prepare the returns, it's February, March, whatever, and there isn't time to do a cost seg study. You need to do a cost seg study close to when you buy. So like we're buying a deal in October, we're doing a cost seg study in November, we're not waiting to the spring to do it. So cost segregations are critical to achieving the max tax benefits. That's a question that you guys can ask the real estate clients you invest with, do they do cost segregation studies? But that's a big driver. It allows things like bonus depreciation of the shorter depreciation life assets. That's where we get to expense bonus depreciation. All this is a simple word too is that we can expense that purchase overall. And so you want depreciation lives that are shorter in nature in that I can expense that cost over a 5 year, 7 year, 10 year, 15 year period or even faster using bonus depreciation and overall. So the trick though, for highly compensated people, called people in the medical field or anybody else who's got a big W2 of some sort, the trick to capturing that if we give you losses, you're actually not allowed to offset that against your medical income unless you have other passive income. So the art of our business is one thing that we do which is unique and people don't understand this, is that the triggering of capital gains, that is selling assets. If I sell an asset and I trigger capital gain, that capital gain will be used as passive capital gain income. And the power comes for highly compensated folks is when I sell an asset, when we sell an asset now, if I trigger a million dollars of cap gain, I have a neurosurgeon has this exact fact pattern triggered a million dollars of cap gain income, have more than a million dollars ordinary losses sitting there that a million cap gain million ordinary nets to zero, right? So zero impact on your taxable income. But because I gave you a million passive gain, you're now allowed to use a million dollars of passive ordinary losses. If I didn't sell that asset, if I wasn't willing to sell that asset and I never triggered the cap gain, the passive capital gain, you never really use those passive ordinary losses until some day long into the future. So to get that current benefit of that, the fact that we sell assets, ring the register, take our profits, actually enhances the after tax rates return. And a lot of real estate guys will talk about buy and hold, buy this asset, hold it forever kind of thing. You miss the opportunity to capture the maximum tax benefits if you do that. Plus you miss the opportunity to take your capital, redeploy it into better, smarter assets going forward. So I'm not a big buy on the hold forever guy. I believe we create value. Take your gains, take the money and go buy something that's a good investment again and that creates the max benefits to our investment clients and to me personally. So that's the art of how we do it. And again, it takes a long term program of investing in private real estate. Like if somebody's investing for the first time today, you're going to build up a bunch of passive losses and there'll be available use in the future, but you won't really be able to use much of it until we start selling assets. Or if you invest with some other real estate guy and he's giving you ordinary gains that you really shouldn't be because he hasn't done cost seg studies, you could use our losses, offset his passive income, ordinary income that did, somebody wasn't disciplined, you know, using all the max tax benefits, but so you can offset passive losses against other passive income, whether it comes from somebody else. But in all of our funds, you know, we have zero, less than zero, ordinary income in our funds because of being proactive and using every tool possible overall. So the tools are available if people take the time and effort to do it. And it can be done if you're disciplined in how you approach it.

Now do you think that somebody needs a specific real estate CPA to understand how to utilize this the best or is this something that's kind of already passed down to the investor?

Any good tax, any tax CPA should know how to follow the passive loss rules. It's fundamental to tax preparation. And if your guy doesn't, you shouldn't be using them. You know, they should understand that overall there's one downside of investing in private real estate and there's the cost of multi state filing. One of the benefits investing diversified is protection of your capital, right? Getting diversified protects your equity. Some things in life counter each other. So diversification now in multiple states gives you safer investments, but now it causes the burden, the tax burden of having to file tax drivens in multiple states. Now most tax software Packages will handle that pretty easily. But there is a hassle factor and cost factor. So you know, we have some solutions on how we suggest that and how to handle that. But you know there's a cost to multistate filing and in some cases that cost of filing could eat up some of the value of those tax benefits. So for example, if you're investing a more modest amount, let's call it 50 to 100,000 in private real estate and it's causing you multistate filing, you're not really investing enough money to really capture a big dollar volume of tax benefits because you're going to lose some of that benefit from the cost of multi state filing because you have to pay for preparing your tax return in multiple states. There's a balancing act here somewhere and you have to kind of figure that out based on your personal tax situation with your tax cpa. But yet you do have to be real about the cost of multi state filing because that is a real cost to consider in this. But there are ways to mitigate that.

Yeah, I've heard from some CPAs that they kind of approach those things differently and I'm sure you guys will talk about it as well too with your clients. But in terms of do you file with negative returns? You file every single year. You stack it to the end. Have you heard of things like that? Maybe you don't file every single time there's a negative return, but you wait till there's an actual return, a cap gains return or something like that. You able to file and offset it with some of carried losses. Is that. Yeah.

And most, some states also won't work. Again, I'm not your tax CPA guys. You got to get your tax advisor. But many states require you to file those loss returns every year so that you can have losses available to offset the gain you when the gainer happens. So my personal opinion is you should be following every year the loss returns in most states so that you protect those losses to be used in the future when you do have a gain year down the road.

No, that's good advice. The other thing I wanted to ask is that I know from what I'm hearing right now from a lot of sponsors and we see a lot of deals and that sort of thing is everybody's calling themselves conservative in this time. So what are some of the measures that you would say that again? I guess indicators that I can use as an investor when somebody says they're conservative. Like what are actually some of those things that I should be looking for you mentioned a couple of them, I think already about loan to value and things like that. But maybe just make it kind of like spelling it out. Maybe two or three things I should be looking for.

Rather use the word conservative. Let's talk about risk. It's like managing risk, right? I mean, you could be conservative in your assumptions. What we talk about is doing smart deals. When I say smart deals is deals where the assumptions that you're making are believable and achievable. You know, you have to ask your question because if you run a pro forma, small tweaks and assumptions will make it look good or not so good, depending on what you assume. So the question is, you guys look at the key things that are driving the value creation in your in the pro forma, and are those assumptions that they're making believable, achievable, and why? And so part of it, when you look at those assumptions, what does it look like compared to the market information? So if I'm looking at rent growth and I'm going to pick up $100 a month in rent by spending, you know, $6,000 in improvements on an apartment unit, are there other assets in that submarket that demonstrate improved units at the higher rents? Yes or no. And that's determinable. You can do that research if you do your homework and the local sponsor should be able to demonstrate to you that they're actually finding those higher rents. Overall, I generally believe in improving assets will improve your rents unless you make really poor choices on what you select. But so again, back to managing risk. Are your assumptions believable and achievable? And again, we talk our term we use internally here is smart deals believable, achievable assumptions. You know, we talked about earlier about diversification that manages risk. You know, I'm a big believer in the fund versus taking individual syndications for most people. Now, you can create your own diversifications by investing in a lot of different syndications, right? That you can build diversification that way. You have to ask yourself what's your skill level to analyze the deal and say, are those assumptions believable and achievable? Do you have the knowledge and experience to make that call? And as an investor, overall, lower leverage is big. Our Target leverage is 65% loan to cost. The industry allows you, from a debt perspective, the 70, 75, 80% loan to cost. I see some deals out there. They even put in a preferred equity piece where they add equity that's ahead of the common equity. And so that is effectively more debt. I saw one deal where the guy gave the preferred equity 16% rate of return. And then the common equity guys, the crowdfunding deal, they were showing these great IRRs. You're going to make 16, 17% on your money was effectively 90% leverage. You had 80%.

So let's explain this for people, just to kind of spell it down. So before right now, normally on a typical deal you have financing from the bank, right? And then you have the equity that comes in from investors. But you're saying now you're starting to see stuff where there's an additional layer in between preferred equity. They call it preferred equity, but it's essentially it's more debt.

You're saying it's essentially more debt because if the thing breaks bad, the bank gets paid first, preferred equity gets paid next, and the common guys get paid last. So if there's only enough money to pay the bank and the preferred guys, you common guys get zippo. So the preferred guy, in the example I gave, they can earn a 16% rate of return before you see your common equity back. And that's a hard bogey to hit 16%. And it made the IRR look good. But again, that's the things. As somebody looking at private risk investing, I don't believe that max leverage is ever worth it. It's just you've worked hard to make your money in life. Preservation of capital is extremely important. And so my viewpoint is I'm going to do 65% leverage, I'm going to make a lower IRR. Who cares? I've saved my. If I end up producing a 15% rate of return versus 17% rate of return, I'm very happy at 15% rate of return and 65% leverage versus taking the higher risk and earning 17%, you don't need it, it's not worth it in my opinion. The last thing that I'd say is anything that we do is we have a proactive strategy to grow our operating income some way somehow. So, so I always call the football analogy. The best defense is a strong offense. If you have an offensive strategy that you're going to grow operating income, I'll take one of our West Grove property where we took rents and we moved rents up roughly 25% in the last three years. Now if we had a fallback and rents dropped 10%, I'm already up 25% because I had a proactive strategy to grow up income. So any kind of downturn, I got additional built in cushion and the cash flows worked the day we bought it. And now I've grown my gross income by 25%. I have that much more cushion for a recession coming along. So my viewpoint is lower leverage, diversification, proactive strategy to grow operating income because that gives you more cushion when the unexpected happens. Like a COVID 19. Those are big. And then on the very beginning of the deal, doing smart deals, deals that have a believable and achievable assumptions, that's going to protect you when the unexpected happens.

All right. Well, I think this has been a quick lesson in private real estate, what to look out for, how to mitigate risk, these kind of things. And I really appreciate your time. I learned a ton. Obviously you guys are preparing and have prepared for this time. Yeah, it's obviously showing now. Wish you continued success and thanks for your time. Really appreciate it.

All right, Peter, thank you for the time and take care.

Okay, thanks, Tim.

Yeah, bye. Bye.

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