Episode 12 | Build to Rent

*The following transcript is auto-generated.

craig fuhr:
Well, hey, everybody. Welcome to Real Investor Radio. I’m Craig Fuhr, and I am surrounded by experts, experts today. Jack, good to see you.

Jack BeVier:
Absolutely, YouTube Boss.

craig fuhr:
Fred, great to see you as always,

Fred Lewis:
Always

craig fuhr:
sir.

Fred Lewis:
good to see you.

craig fuhr:
Jack and Fred, both, Fred is obviously the founder of Dominion, the Dominion Group here in Baltimore. Jack is a partner at the Dominion Group. And we have Dennis Cisterna today on the line to talk all about Build to Rent, everybody. So obviously Build to Rent is a hot, hot topic in the real estate investing space, both from a sort of a mom and pop standpoint all the way up to Wall Street. We’re gonna be talking all about that today with Dennis. Dennis runs a successful business in the space. And Fred, why don’t you go ahead and introduce Dennis if you would. And we’ll learn as much as we can from him today.

Fred Lewis:
Sure. So Dennis has been a friend of the Dominion Group for well over a decade. We met Dennis when we were trying to get financing as we grew the business. Dennis has tremendous expertise in fundraising capital markets and built his own builder and fund under his Guardian brand. So did extremely well, very experienced. And Dennis is also my partner in a Sentinel net lease. fund that we’ve built over the last five years.

Dennis Cisterna:
Thanks

craig fuhr:
now

Dennis Cisterna:
for having

craig fuhr:
I

Dennis Cisterna:
me, guys.

craig fuhr:
can. Well, it’s good to meet you, Dennis. Thanks so much for taking the time to speak with us today. Hopefully we can pick your brain over the next episode or two and really sort of learn more about Build to Rent, where it’s been, and some of the headwinds that you might be facing right now. So why don’t we just jump right in, guys. Just taking a look at some of the news that’s been. on the internet lately. I think the common theme that I’m seeing is media seems to be hot and cold on Build to Rent. If you listen to, like Jack just sent me a news piece from the Today Show, and it was pretty fluffy, a lot of happy talk, and it was this notion that, you know. We are living in a time where the cost of home ownership and the cost of renting is sort of at parity, tough to get a loan, most people can’t afford the down payment, a lot of Gen Zers are really not that interested it seems. I read a report the other day where it said 44 percent, they surveyed, real page, surveyed 2,000 multi-family renters ages 55 and younger. And they found that… those with incomes between 20 to 200,000, more than two fifths of them, 44% of them, said they’re pretty darn happy. They’re really good with renting. And if you talk to Gen Zers, they’ll tell you that 51% of them will say that renting is the best choice. And I think that’s sort of what we’re hearing in the happy talk, the CNBCs, the CNNs, you know, they wanna tell us that bill to rent is really the magic pill to solve all of our housing woes right now. Dennis. Why don’t you jump in here anyway and help us out. What’s been your experience? Tell us about your experience thus far.

Dennis Cisterna:
Sure, sure. Well, my background, I started my career as a housing market analyst. So I’ve been long in housing and residential investing for my whole career, worked for Toll Brothers and Lennar for a number of years, and have been involved in the build for rent sector since 2017, which frankly doesn’t seem like that long ago, but it’s eons compared to a lot of the new entrants in the space. So, you know, our first experience with it was buying 40 inventoryed houses from a home builder. and just operating part of that subdivision as a rental community. And then over time, we expanded that business to buying entire subdivisions and then buying land and having builders fee build for us, and then ultimately developing our own communities as well from the ground up, including entitlement. So I’ve kind of done and seen it all as it relates to the bill for rent sector and how to enter that market. you are right in the sense that there is an extremely strong amount of demand for rental products across the country. A lot of that has to do with some of the macro trends overall, because we have a housing shortage and we have had a housing shortage for a long time. And it is quite easy to say that I prefer to rent when I can’t afford a mortgage. So I think there’s some conventional wisdom in there where people say I’m very happy to rent. And ultimately people would be happy to rent or buy because they just like to have a house, but we’re not really producing enough housing for the population overall. I will tell you, although it’s against my, I guess my, my nature, because obviously I run a for-profit business. I don’t agree that renting is always the best way. If you look historically at wealth creation for the middle class in America, it’s through owning your own home. And

craig fuhr:
Mm-hmm.

Dennis Cisterna:
with the advent of Bill for Rent, you are taking a lot of entry level supply away from first time home buyers, and you’re putting it into the rental market. Now, there’s an opportunity there financially, but from a socioeconomic impact, I think it’s actually negative as you see income disparity grow greater and greater across the different quintiles of the market. But. The demand is there. I think the problem that you will see in this sector, especially now that interest rates have gone up, yes, interest rates have gone up, so it eliminates people to be able to buy their home, but it also makes it much harder to go fund these bill for rent communities because your interest rate to borrow as an investor is much higher as well. So yields have been compressed in this ultra low interest rate environment to a point where People were expecting that to happen forever. Now that interest rates have doubled in the span of 18 months, it makes a lot of these bill for rent projects financially unfeasible unless you are literally OK with clipping a very low coupon and kicking the can down to an environment where interest rates are low again. It just depends on what kind of investor you are. But for investors looking in the bill for rent sector now, if their strategy is I’m going to I’m going to go clip a 2% or a 3% coupon because I have to use negative leverage and I hope that one day interest rates come down so I can make a good profit. It’s a freaking pipe dream. I think you…

craig fuhr:
So, so my job on the show here, Dennis, is to slow it on down, you know, for the folks that don’t speak Wall Street and sort of all those things. So

Dennis Cisterna:
Sure.

craig fuhr:
you gave us a lot to digest there. One one question I had was what markets are you currently in?

Dennis Cisterna:
So our portfolio is in Texas, Florida, Georgia, and the Carolinas.

craig fuhr:
sort of the very, the most popular states for Bill Durant right now,

Dennis Cisterna:
Yeah, but I would also

craig fuhr:
with the exception

Dennis Cisterna:
caution,

craig fuhr:
of Detroit.

Dennis Cisterna:
I would caution you to say that the majority of that portfolio was tied up before the middle of 2021.

craig fuhr:
Mm-hmm.

Dennis Cisterna:
Those markets became ultra competitive during that period of time and the barriers to entry became much higher. So I actually think there’s a good runway in a lot of secondary and tertiary markets. partially capitalized by a large private equity firm who doesn’t wanna go into those secondary or tertiary markets, but there’s a number of operators that I know and I have worked with in the past that are having great success in more affordable Midwestern markets where the barriers to entry are lower, but there’s still a good amount of housing demand for rental products.

Jack BeVier:
Hey, let me jump in with a question. When we’re talking about the build to rent spectrum of stuff here, when you’re talking about the investments that you’ve typically seen, are you talking about single parcel of land that’s multifamily and it just happens to look like single family townhouses? Or are you talking about individually deeded lots where the developer has the optionality of selling off one at a time in the future, or

Dennis Cisterna:
Yeah,

Jack BeVier:
both?

Dennis Cisterna:
that’s a great question. So everything that we’ve done to this point has been individually deeded lots where there’s a tentative tract map and every home is individually recorded. There are obviously investors out there that focus on single plat transactions where it is similar to an apartment building, right? You’ve got essentially 140 units on a single parcel. And both work in Build to Rent. I think when you see that type of product on the single plat, it’s typically more of a kind of villa, fourplex, army barrack type of product as opposed to more traditional townhomes or even truly single-family detached homes or even duplexes.

Jack BeVier:
So my understanding is that whether it’s individually deeded lots or a multifamily parcel, the financing for the developers doing those deals, looking at those deals, you can take advantage of agency multifamily financing. So

Dennis Cisterna:
That’s right.

Jack BeVier:
you get kind of a little bit of this best of both worlds, right? Where you have the optionality of an individually deeded lot that could be sold to a homeowner in the future, but you get the rates of Freddie Mac multifamily financing. That’s

Dennis Cisterna:
That’s

Jack BeVier:
a big leg up though, right? Versus a scattered

Dennis Cisterna:
it.

Jack BeVier:
site

Dennis Cisterna:
It

Jack BeVier:
approach.

Dennis Cisterna:
is. It is. It is. It is a big leg up to have that agency debt. I will tell you, however, if you do have the individually deeded lots, you can’t sell off one or 10 of those houses. So there are loan covenants within there when you’re using agency debt saying, OK, you’re going to use our paper. If you’re going to do that, you have to keep this as one completely connected community. You can’t sell off bits and pieces of it. So that is the restriction you have is you lose that flexibility of selling at one off. But I will tell you, most investors, that’s kind of a worst-case scenario that you’re going to go sell it off one by one anyway. In this day and age where you’re getting kind of greater premiums for selling them in bulk to begin with, and you would on a one by one basis, it’s a highly unlikely scenario where you’d break part of it out anyway.

Jack BeVier:
So one of the things that I’ve always heard at conferences where build to rent’s a common topic these days is that this may be a new market, right? It’s historically unserved, I guess you’d say, because in the past, folks went from renting an apartment, getting married, and then they go buy a house, whether they’re ready for it or not, whether they wanna be in that area or not. And with kind of like the changing social structures, people getting married later, having kids later, the opportunity to rent in a location while you’re, and have a single family lifestyle is something that previously wasn’t as much of an option for folks. And so maybe even the rents that you can get for those, have you seen developers being able to push rents even above from a. even above where, you know, I guess kind of market expectations because they’re offering a product that really wasn’t available to the rental market before.

Dennis Cisterna:
Yeah, I would tell you there’s definitely a, obviously there’s a premium for new housing and new construction versus existing product. That’s number one. Two, it really, it depends on the location where that product is being offered. So if it is the only game in town where it’s the first time there’s been new product available in 20 years, yeah, you’re probably gonna push it well beyond what the comps are gonna show you in that market. And that happens a lot of places that have been built out for a long period of time. So if you go into an area like Cleveland, Cleveland doesn’t have exactly a ton of new housing permits to begin with. And you put a community in there that’s 30 years, it’s been 30 years since anything’s been constructed. You’re going to be able to push rents, even though it’s an affordable market to a greater degree. Same thing with areas that are up and coming, where you see a lot of job growth. Maybe it’s close to a lot of commercial services and amenities. The demand for that is going to be greater and allow you to push rents a little bit more than maybe you anticipated. In addition to the absorption being greater as well, that’s another big part of this, is understanding how long it takes you to go and actually stabilize that community.

Jack BeVier:
So a couple of years ago when interest rates were a lot cheaper, these projects were a lot easier to pencil because the refi debt was so cheap. And then rents went up like frickin’ 20% in a 12-month period. And so a lot of folks who were in prior to 2021 did very, very well.

Dennis Cisterna:
Yes.

Jack BeVier:
If you got stabilized by 2021, you knock the cover off the ball. And so what’s your view now? dead model for the first in this higher interest rate environment, lower projected rent growth environment. Do you think it’s a dead model right now? And these folks are just like, Hey, you were, you know, you’re pregnant, you know, there’s no such thing as half pregnant. And so they’re just like, waiting it out. Like, what do you think? Like any anyone entering this market today is a fool.

Dennis Cisterna:
I would not say anyone is a fool. I would say a lot of people are fools. But I think it also depends on what, A, what your investment objectives are, right? So if you are a legacy investor that says, I have a macro bet on rental housing in the United States, I don’t know if the debt is the driver of your business to begin with anyway, because the next two to three years is just a short snippet in your overall investment horizon. So for legacy investors, I get it, because if you can buy at a discount today versus what you bought a couple years ago, and you’re just gonna weather the storm of affordability, not as big of a deal. So those are the people that I totally understand them continuing to enter into the market. Could they get a better deal two years from now? Sure, they’re probably banking on it, but if they can add an extra 1,000 or 2,000 units now, They will. I think for groups that are more IRR driven or operators that are working off some type of promote structure where they need to clear hurdle rates in a short period of time to gain profit, that is a highly speculative bet right now because you cannot generate those terms now. There is no imputed equity on day one from a current acquisition. If anything, you’re probably losing equity, you’re diluting that equity over the next 12 months. So there are a lot of projects out there that are currently being developed or capitalized with what I would consider to be more short-term capital, opportunistic capital, and those folks are gonna need a lot of help. They’re already needing help. And to give you some color even on our own, some of our own portfolio, although we absolutely hit it out of the park. I will consider that to be more luck than skill, just because we got lucky on the timing. But even on our own, there’s a project we have in Florida where we did it as a fee build, but it wasn’t even finished being entitled yet. And with delays through COVID and everything else, by the time we were ready to actually break ground on construction, our construction costs have elevated, the interest rate had gone up. The deal was going to… yield on cost that was around a 6.5% cap rate, 6.5% yield on cost when we were borrowing it at 3.5%. And we weren’t really taking the construction risk because there was a completion guarantee by the builder that was involved. Well, now the yield on cost is under 5% and my cost to borrow is 7%. So are we going to go build? No, we’re not going to build. You know what we did on that? We sold it to a publicly traded home builder because that was the best exit. So, and I think what you’ll see right now, it’s weird. We kind of originally thought that home builders would be a great partner in the build to rent space. And ultimately they will. But right now, because interest rates are so high and overall housing inventory is so low, most home builders are selling gangbusters right now because they’re really the only inventory in town, especially in a lot of these hot markets that Craig mentioned. What are they doing? The hardest part of home building is always replenishing your land supply. So they’re going back to these, these build to rent guys that are now underwater and saying, Hey, I’ll, I’ll pick this up from you. And if, if the bill to rent guy bought it right, maybe he can make a few bucks. If he bought it wrong, he’s selling at a loss.

craig fuhr:
Hey guys, before we roll on here, can we sort of break down the players in a typical deal? It sounds like there’s the builder, there’s the aggregator, there’s the guy who, you know, the funding.

Fred Lewis:
Yeah.

craig fuhr:
So maybe you could just speak to some of the moving parts there, Dennis.

Fred Lewis:
Yeah, before Dennis jumps in on that, I was going to go right there, Craig. I think it’s interesting because it used to be, it didn’t matter as much. You could be a fund investor buying into Builder Rent. You could be the money side. You could be just the guy that bought the lots and you hired a builder. Money was cheap. Cost of goods were lower. Things were more plentiful. But I think what, as Dennis alluded, I guess it depends on where you are in the food chain, basically.

craig fuhr:
It, it, and not, not to mention that Fred, but it’s, it’s the, the unbelievable maturation of this industry in just a few years that I think we’re really seeing this, um, a lot of these players who, you know, there used to be guys wearing all the different hats and now I find that like, it feels to me like it’s, it’s consolidating very quickly. Is that right Dennis?

Dennis Cisterna:
There has been quite a bit of consolidation and maturation. And I will tell you, it’s because everybody in this market is chasing yield in a competitive landscape. Right. So this will paint a very good picture for your viewers, listeners. When we did the first, our first bill to rent deal, I did that because when I started my business, I did not want to go be a one by one. acquire of houses in some random market and have 30 construction crews going, having a background in home building and knowing how

craig fuhr:
I know some guys in Baltimore that have that business model, but.

Dennis Cisterna:
Yeah, I know. I know. They’re great guys, but it’s not for me.

Fred Lewis:
Yeah, and they did okay.

craig fuhr:
It did alright. It all ended up well.

Dennis Cisterna:
I’m too lazy to go do that heavy lifting if I think there’s a quicker way to make a buck. So on the home building side, and knowing how home builders are structured, they have a lot of cost centers that go away when they sell in bulk. And they sell much quicker. So when we bought our first 40 houses from a home builder, we were able to get about 10% off of the retail price. So I’ve got 10% equity in on day one because we’ve eliminated sales and marketing costs, we’ve eliminated some of their financing costs by taking down a third of the subdivision in a day. And doing that makes a lot of sense to me because number one, You’ve got a brand new house, so you have less repairs and maintenance as an operator, right? You’ve got a new product to offer into the market, which is sometimes a little easier to lease up than a house built in 1970 that’s renovated.

Jack BeVier:
Hey, Dennis, to that point, so what’s the difference between typical single family scattered site expense ratio versus what you were seeing from an operator’s perspective as an expense ratio for a built-to-rent community?

Dennis Cisterna:
Yeah, so obviously the biggest factor in most expense ratios are property taxes, right? So it really varies market to market on that front. Like you go into South Carolina, you’re going to get absolutely killed on your expense ratios generally. But let’s say overall, you could probably expect to knock your, if your operating ratio on existing single family is 40%, it’s probably 35, 34% on new houses.

Jack BeVier:
Yeah, that’s helpful.

Dennis Cisterna:
And it could be lower than that, depending on how sticky your tenants are. Obviously single family has a huge competitive advantage over multi-family in the turnover department for tenants. Build for rent communities have even better stickiness than existing SFR. So it could easily be 20% or more of a discount from an Ombax perspective. And then so looking at the fundamentals of why this made sense, initially it was like, oh, well, I can go do all this work and go buy houses one by one and renovate them. And hopefully I can get to like a at the time a five and a half to a six cap in a primary market. Or I could go buy houses in bulk on a brand new house, take no construction risk and be at a six plus. So for me, that was kind of the no-brainer as a way to scale the business efficiently with brand new product and be able to control my pipeline a little bit easier. And

craig fuhr:
What’s

Dennis Cisterna:
then…

craig fuhr:
that conversation sound like to a builder when you roll up and you’re like, we’d like to buy a one third of your development here.

Dennis Cisterna:
Well, I will tell you in the early days, a lot of them were saying, what the heck are you talking about? No way we’re going to do that. And there’s a lot of natural, there were a lot of natural obstacles to this, right? Because it just really depended on what the homebuilder’s culture was, what their mission was. Some homebuilders said, no, our business is to provide housing to people and be the primary owners or… Some of them will have covenants in their CC&Rs or HOAs where there’s a maximum amount that can be rentals. So objections all around. But there was a number of builders early on that saw the light. Dream Finder’s homes out of Jacksonville. Lennar is another one. A number of groups that really. got it kind of early on and said, hey, this is a great way for us to kind of make sure we continue to hit our quarterly or annual numbers. We’re at the end of, like if we’re at the end of a quarter, because when you’re booking the sale, you’re booking the sale on all those units at once, right? So it’s a good way to kind of even flow your revenue numbers for the builder as well. And they’re still able to get the exact same margin, if not a slightly better margin than selling retail with a lot less friction. You know, when you’re selling… 100 houses to someone at once, there’s no change orders. I’m not going in there with my wife to change the backsplash on one of the houses. It’s just a much more frictionless process. But then as more people entered the market, it got, two things happened. Number one, people said, well, if I go and build this myself, Or if I go buy the land, I can make, I can turn it from a six into a seven or a seven to an eight or whatever, right? So there’s just more juice there the earlier you got into the development life cycle. And.

Jack BeVier:
And to your point, and the back end is de-risked. So take a little bit more risk on the front end. Know that your back end risk is already mitigated because of the, you’re just going to refi the whole thing. You don’t have to do 75 sales. So the total risk profile for the deal may be about the same, but the return’s 100 and 150 basis points higher.

Dennis Cisterna:
Yes, yes, for sure. So it made a lot of sense to go earlier into that development cycle. However, as per most things, everything looks a lot fricking simpler on the cover than it is in reality, right? So you have a bunch of, for lack of better terms, single family rental yahoos that all of a sudden thought they were home builders, tying up land here and there, had no idea how to build a house. And so you had a lot of deals that were tied up.

Jack BeVier:
What year is this?

Dennis Cisterna:
This is like right. just after COVID, everyone, the home builders thought the world was over. We got some of our best deals out of the panic of home builders, which literally lasted like eight weeks, right? And then everything’s back to normal. So we got very lucky in that eight week period. And after that, and everyone said, Oh, okay, well, the world’s not actually over. It’s just kind of a new paradigm. And now the, now the entire universe is flush with cash. You saw people go in and tie. I saw single family operators. bidding home builders by 30% on land purchases. You have to be out of your mind, because home builders are pretty aggressive to begin with when it comes to buying land, because they’re in a very competitive market. To be able to outbid someone by that means you are underestimating and overestimating on probably a number of key variables. And that’s what a lot of that was happening. And a lot of those deals, the only thing that saved those projects was the rapid rent appreciation. And some of them still, that

craig fuhr:
It’s

Dennis Cisterna:
was

craig fuhr:
been

Dennis Cisterna:
not.

craig fuhr:
a business model for many over the last several years.

Dennis Cisterna:
It has, it has, you know, it’s market timing is certainly, you know, luck has a lot to do with it. But right now, I think you’re kind of seeing you’re kind of seeing exactly how much proper underwriting was done. over the last 18 months as you see deals kind of desperate for rescue capital now or being sold to builders or just getting handed back to the bank.

craig fuhr:
Can we drill,

Fred Lewis:
So, so…

craig fuhr:
I just want to drill in on Fred’s question one more time. So you were in the business, you make a decision that you want to buy houses in bulk, rather than one at a time. You go meet with a builder. The builder says you negotiate a deal to buy one third of that builder’s basic inventory in this neighborhood.

Fred Lewis:
or the whole community

craig fuhr:
and

Fred Lewis:
in

craig fuhr:
kind

Fred Lewis:
their

craig fuhr:
of shifts

Fred Lewis:
case.

craig fuhr:
on you a little bit. Now you’ve got to find a, so tell us sort of then what happened after that.

Dennis Cisterna:
So, you know, when I did my first deal, I worked for a large publicly traded company. And about eight months after that, with some prodding from Fred and a couple other friends, they said, why don’t you just go start your own firm and do this? And so, so I did. And so we, you know, I, I closed on my first community, probably. I don’t know. three months, four months after I started my firm on another deal in Florida. And went to go raise money for that, brought in an LP equity partner. We hired a third party property manager to lease it up the property, stabilized it, refinanced it. And now it’s, that one was actually in an opportunity zone. So it’s a little bit different. But beyond that, everything after that was, I partnered with another long-term friend in the industry. Tebow Adrian, his company is called Lafayette. So we started Lafayette Communities, which was a joint venture between my firm, Guardian, and his Lafayette. And so we said, hey, let’s do this, let’s build it, let’s scale it. So we started underwriting deals together. We went out onto Wall Street. We got a big private equity firm to back us as our LP investor. And he was already, he already had internal property management. So we really had the infrastructure in place there to go get it. And I already had great relationships with home builders, spending the last 20 plus years in the industry. So we were just out there hunting and we were not competing against very many people at all in 2018, 2019, and then the first part of 2020. But like I said to Jack, after COVID kind of settled the housing market down, everyone and their mother came 500 million, a billion, some crazy ass number that if you actually look at the total scale of the build for rent sector, there’s no way they could deploy the capital. But yet here it is, one group after the other that’s somehow going to build 10,000 houses in the next three years.

Fred Lewis:
So let me ask a question because I think that segues a little into all that happened. There were a lot of folks who got into deals they shouldn’t have got into because money was cheap and they had to deploy. And as you just said a few minutes ago, there’s going to be rescue capital for guys who should never have bought what they bought and assumptions that were off the fricking wall. So I think that’s a thing. But then there’s also who does it work for today?

craig fuhr:
Hmm.

Fred Lewis:
There’s still a slice of the market. And I’ll pose an example or pose a question, actually. Jack and I were talking with a pretty significant kind of midsize small builder, guy, entrepreneurial builder. Out in the Midwest, he’s able to buy lots aggressively. He’s able to kind of come and maybe finish the development side on something that’s broken, get it to finish a lot, and then do a 20, 30, 40 unit. Development and he’s a builder at heart. He’s able to buy well. He’s not looking at yield He’s looking at basis and he’s looking to put it down at a basis that he thinks from a replacement cost Makes a lot of sense so that he can his issue is yeah, but cost of funds are high Like he’s not a he’s not a capital markets guy, but he’s a builder So I guess the question is you got two things that have been said here is what’s gonna fall apart? And how do you act on that if you want to and then who’s it working for?

Dennis Cisterna:
Yeah, well, I would say to answer the second question first, the people it’s working for are really the groups that do have a good land basis or are creating value in the deal from entitling the land or ultimately really controlling costs. You know, building a home might sound like it’s commoditized, but there are levels of value engineering that some groups are much better at. And with scale, there also comes… a lot of potential discounts when you’re building to help improve your basis. So one of the reasons that I wanted to partner with some of the large home builders at first was because I knew they could build my product cheaper than I ever could. Even if I started my own home building firm, there’s

craig fuhr:
Hmm.

Dennis Cisterna:
a big difference between a group that builds 50,000 houses a year and a group that builds 50. And that percentage discount. They could make their margin and still sell them to me substantially cheaper than I could build. So, so, Fred, I think the people that are going to be able to continue pushing in this environment are not only people that are focused on that basis and able to build and develop efficiently. It’s also people that are willing to go to markets that have higher natural yields, but maybe not the growth. that you’re gonna see in Orlando or

craig fuhr:
Mm.

Dennis Cisterna:
an Austin or somewhere else. Like going, I’ve always been a big believer in secondary and tertiary markets. There are gold, and in fact, this is part of our investment thesis at Sentinel is I like to go into Midwestern markets and other secondary markets that have a cool narrative. They’re not big enough markets to go attract institutional capital. But that doesn’t mean that you cannot be highly successful in those markets even today, because those are markets that maybe you were doing a yield to cost on of 8, 9, 10 percent before and it was kind of through the roof. You didn’t know who you’re going to necessarily sell that product to. You just knew the cash on cash would be strong and you could refinance out of it. Now I think you still get a very good yield for yielded cost in those markets, but your cost of capital is more expensive. Can it still be accretive? Yes. And I think that’s all you’re looking for in this market is

Fred Lewis:
No.

Dennis Cisterna:
don’t go negative leverage. That is investment 101 because as soon as you go negative leverage, that means your entire investment thesis has become speculative to actually earn profit beyond. Otherwise, don’t use that at all. And I think

Fred Lewis:
Okay.

Dennis Cisterna:
that’s part of it, too. You’re seeing some guys that are just cash buyers that are saying, look, I’m going to go earn even in a primary market. I’m going to go earn a five, six, a seven. And that’s okay for now because I’m a long-term investor.

Jack BeVier:
I think

Dennis Cisterna:
And,

Jack BeVier:
that’s

Dennis Cisterna:
oh sorry, just to answer

Jack BeVier:
no good.

Dennis Cisterna:
the second part of Fred’s question in terms of how do you participate in the distress, you know, it’s tough for your average investor to go in and take like a preferred equity piece or a mezzanine debt piece on a large $40 or $50 million transaction. But a lot of it will go, will be going and pursuing some of the people that are operating in a market. Like, you know, let’s say you’re in Kansas City. Go to the building department for the city of Kansas City or some of the outlying suburbs, and you’ll know what the build to rent project pipeline looks like. You can contact those sponsors and say, hey, you know, I noticed your project got a building from it six months ago, but there’s nothing in the ground. What’s the status? What are you guys trying to accomplish? I will caveat all that though by saying, some of these deals don’t have a place for rescue capital right now, because they are so far underwater, because there is no exit. that makes sense if your basis is too low, or your basis is too high, excuse me.

craig fuhr:
too high.

Jack BeVier:
Yeah, I think something that, what are you Googling, Fred? If the,

Fred Lewis:
Dennis Success

Jack BeVier:
I think.

Fred Lewis:
Stories.

Dennis Cisterna:
Fred’s giggling building permits in Kansas City.

Fred Lewis:
I just did. I’m already putting an order in the by.

craig fuhr:
I’ve already started a mailer.

Jack BeVier:
What’s something that I think that we’ve seen from some bill to rent folks that we’re financing is that they think that they’re pinching pennies on the construction costs because they’re project managing the thing themselves. They’re doing it more on an infill basis because they’re able to find that one-off lots, you can get a cost basis and one-off lots at… where, you know, where utilities are already at the street, right? They don’t have to take a subdivision, you know, where, where they may even be buying it at a discount to replacement costs. When you define replacement cost is taking raw land and entitling it and putting, and putting horizontal development into the ground. So they’re, they’re right, right there, or even below the replacement cost of a finished lot, uh, as a starting point. And then when they refinance, they can get a, uh, You know, their yields, their net yields are not going to are not strong, right? Like, I don’t think anyone’s fine in, you know, building to a seven or eight. That’s I think that’s very, very difficult to find. But if you can build to break even, maybe have a look and minimize your equity stock, it’s a way to and you have, as you mentioned at the beginning of the conversation, a long term view of American housing. It’s a way to add units to the portfolio that you don’t think and you don’t think they’re going to appreciate the next. couple years, but you know, either the Fed is going to get inflation under control and rates are going to come down or the Fed’s not going to get inflation under control and rents are going to go up. And so it’s a heads you win tails I lose or sorry, heads I win tails you lose, you know, hedged bet, I guess, on just American housing period. And as you mentioned, you know, an easier to operate than easier to scale and easier to operate than doing it a bunch of one at a time.

Dennis Cisterna:
I look, I would agree that it’s I think it’s better to break even in this environment and grow your portfolio than just sit on the sidelines and you know, pick up a new hobby.

craig fuhr:
Hmm.

Jack BeVier:
Yeah, I think that’s a significant question right now, right? Where it’s so hard to make deals pencil right now. Am I gonna go back to… And they could flip them one at a time, right? And just be… But then you’re just a straight up home builder in a probably untested tertiary new construction

Dennis Cisterna:
At least you

Jack BeVier:
market.

Dennis Cisterna:
have optionality, right? You’re creating value in that you’re creating product that you’re adding to the market. As long as you’re not having to stroke a check every month to own that house, then I can understand the value in that for people to build their portfolio to stay busy. Maybe they have employees they want to keep active. The real estate investment cycle is not made of just home runs, right? There are singles and there’s doubles and there’s some.

Fred Lewis:
Mm-hmm.

Dennis Cisterna:
some other stuff out there. So sometimes it’s just enough to keep the lights on and stay focused on what’s going on in the market.

Fred Lewis:
Dennis, let me ask you, a lot of builders build to kind of an institutional exit, no matter what. They don’t always build so they can hold the inventory. They may hold the inventory temporarily and then aggregate to more of an institutional exit. But that means the money has to have an opinion. Big institutional capital has to have an opinion. And what’s interesting, what we just said is, if it’s just the money. It’s not the land, it’s not the horizontal, it’s not the development, it’s not the building, it’s just the money. The money’s gotta have an opinion not to make very much for quite a while,

Dennis Cisterna:
Well,

Fred Lewis:
and

Dennis Cisterna:
I think that’s

Fred Lewis:
make

Dennis Cisterna:
why you

Fred Lewis:
it

Dennis Cisterna:
see

Fred Lewis:
better.

Dennis Cisterna:
most institutional guys on the sideline right now, right? You look at overall investment volume, not only on BFR, but on the existing home acquisitions as well. It’s down substantially for practically every major investor. One, you obviously have limited inventory on the existing home front, which makes it tough. Fix and Flip guys are doing okay, but that’s a totally different business model. So it’s tough. And to your point, Fred, the opinion of those groups right now is we need to see a little bit of stability here. You certainly know these publicly traded groups are not going to buy anything with negative leverage. They would get absolutely killed by their analysts. So they are pencils down. And by the way, this is not a BFR problem. This is a every fricking piece of commercial real estate in the universe problem. This is why you have overall investment activity down 80% from the first quarter of 2022 to where we are now. And it’s not like the money went away. You know, the printing press that happened during COVID and beyond has saturated the overall M1, M2 money supplies. The cash is still out there. Groups are still raising new funds, but the deals have to make sense. of negative leverage everywhere, a total disconnect between buyers and sellers. And so that’s why you ultimately have, if you’re at the development game, Jack, you are banking on selling it to someone unless you’re a legacy holder. And not that many people are legacy holders. So it’s going to be tough.

Fred Lewis:
Well, you know, which is really curious because I would say up to maybe a month or two ago, the narrative in the markets were, hey, rates are up, rates have been escalating all year, but they’re going to come down and they’re going to come down, maybe not at the end of this year now, but certainly in 24. And just in the last month or so, that narrative has changed quite a bit to, we really don’t know. And the Fed saying, you know, inflation is like a monster. We got to hit it over the head until it’s dead three times. And so who knows? It may not be. We don’t know what it’s going to be. So

craig fuhr:
Problem is, it’s a six-headed monster.

Fred Lewis:
Now,

craig fuhr:
There’s

Fred Lewis:
a

Jack BeVier:
Yeah.

Fred Lewis:
six-headed

craig fuhr:
three left

Fred Lewis:
monster.

craig fuhr:
over.

Fred Lewis:
So that changed, that actually dovetails into the point of the institutional sideline comment. Because if pencils are down for more than a year, or then two or three, then maybe we’re in the earlier innings, and not the later innings of where we actually are in the cycle of this kind of the slow death concept.

Dennis Cisterna:
I agree. This is a very lagging type of, if we enter into the proper recessionary environment, it’s going to be one of the slowest on record to get there. And it hasn’t affected a lot of other industries the way it has commercial real estate. But just looking at it at a bigger perspective, Fred and I talk more about the 10-year treasury than we do about actual real estate deals right now. That just kind of shows you. how important that rate environment is. And we’re not feeling the full brunt of the Fed’s changes yet, right? You look at most commercial real estate, you look at practically every corporate bond, the vast majority of the market has not even reset to these higher interest rates yet, right? The pain has not been experienced in most of the total market activity overall. So that’s gonna drag out further and further. And I think… It’s a pretty easy topic to dismiss when people say interest rates are going to go back down. Why? Why are

craig fuhr:
Yep.

Dennis Cisterna:
they going back down? The only way they’re going back down is if we go into an actual recession. And if we go into an actual recession, guess what? Values are going down much quicker than they are right now.

craig fuhr:
Look, if the Fed believes like what he said the other day that the price of housing has gotten out of control, then isn’t this the way to as Jack said in the last episode to peel off some of those some of that? What did you say Jack was like, when the when the rates go up, we’re sort of taking back wealth

Jack BeVier:
Oh,

craig fuhr:
from

Jack BeVier:
pulling,

craig fuhr:
people.

Jack BeVier:
pulling

craig fuhr:
Yeah.

Jack BeVier:
money off the sideline or pulling money out of the system, you know, getting it literally out of the American economy.

craig fuhr:
Yeah.

Jack BeVier:
The

Dennis Cisterna:
Absolutely.

Jack BeVier:
dentist to your point and I, yeah, I’ve heard this narrative. I’ve heard this narrative is, you know, that, that the once, once things calm down, the fed’s going to lower interest rates as if the fed like as if the fed wants to lower interest rates, as if there’s some like, you know, reversion to the mean that’s going to happen. And I keep thinking, I’m like, dude, why would the Fed want to lower interest rates? The problem that the Fed had for the past 10 years is that it was in a low interest rate environment. And so when something went shitty with the economy, it didn’t have any bullets left in the chamber because it couldn’t lower interest rates anymore.

Dennis Cisterna:
That’s right.

Jack BeVier:
The Fed wants to keep interest rates as high as possible, as long as, but just out of recession so that if we go into a recession, it can drop interest rates and get us out of that recession. But it doesn’t want. to go back down. It wants to have as, you know, the higher the Fed rate is, that’s more bullets in the chamber for them to do their job. So this idea that there’s gonna be like some naturally lower interest rate is, I’m struggling with it. Like seriously, it’s a serious question. Like I’m struggling to figure, to understand

Dennis Cisterna:
Totally,

Jack BeVier:
if I’m missing something.

Dennis Cisterna:
totally agree. Why would they lower interest rates to undo the work they’ve just spent the last three years undoing? Right? I to think anything other than we are going to reach a period where they’re going to keep it steady for a while, I think is disingenuous and probably I wouldn’t be surprised if the people saying that it benefits the narrative of whatever it is they’re doing. I hear a lot of that from operators that are, you know, GPs looking for LP capital and they say, oh, you know, when interest rates go down, we’re gonna do great. Yeah, well, let me tell you what’s gonna happen on your shitty multifamily value add property here. You’re not gonna hit anywhere near your IRR projection because interest rates aren’t gonna be 3%. They’re gonna be maybe 5.5%. And in that scenario, you’re not selling it for a four cap. You’re selling it for probably 6.5 cap. And away goes the IRR you think you’re going to generate. Away goes the potential profits for your investors. And so this disingenuous pipe dream that people are selling right now, I get it. It’s not fun to talk about a slow, plotting, painful market. But if anybody kind of forgot from 2011 to first quarter We just had rampant fricking growth nonstop about everywhere in the country, every asset class. So it’s okay if we get punched in the stomach a few times for the next couple of years as the market resets. It’s just a necessary part of a market cycle.

Jack BeVier:
There’s this one of the recent, something you gave me think of as one of the recent announcements I saw was MetLife Investment Management announced that it’s getting into the single family rental business predominantly in the built to rent space. And that just like, it made too much sense to me because we’ve seen as the levered securitization market has gotten out of the DSCR lending business, insurance companies have come in. They’ve got a different source of liabilities, a much longer term view. They can have their own, and they do have, right? They have teams that come up with the MetLife investment thesis across asset classes, across sectors. And so it made sense, and very patient money, right? Because of the nature of their liabilities, you know, life insurance and annuities. And so that they’re getting into this space made it seemed like, you know, that made a ton of sense that it’s a long term, but a long term view of the American housing market where they’re not going to they’re going to not going to put any leverage on it. Right. Like we’ve been talking about, you know, the issue with built rent is that it doesn’t pay for the debt. Well, that life’s like, you know, you know what I’m going to do? Not use any debt. How about that? And just clip a six like a six is only a bad yield when debt seven. But two years ago, six was freaking amazing, right? So like, they just decided, hey, the guy who’s gonna use less debt, right? The money who doesn’t need debt, like smaller operators do, they’re just gonna dominate that space for the next several years and buy up a shit ton of houses, right? Cause they don’t care where the capital markets happen to be right now. As you mentioned, they’re making a much longer bet on this asset class.

Dennis Cisterna:
Yeah, look, and I’m not going to argue with that, because you’re going to put your money somewhere. And it makes sense knowing where the headwinds of demand and supply overall are for housing in the US to put your dollars there. But the vast majority of real estate investors do not have that type of patient long view on where they play. So that’s. That’s the challenge for the rest of us that aren’t endowments, insurance companies, pension funds is how do we make a buck so we can put our kids through college? Because, you know, we honestly don’t have that much time to go run these strategies and go do it in scale. Right. We most of us aren’t sitting on the type of capital necessary to have that patient of an outlook. We need to create value in what we’re doing. I mean, that is really why. I am pencils down on build for rent projects right now because there’s no value I can create today relative to the value I could create in 24 or 36 months from now. So I’m looking for other opportunities in the entire commercial real estate market. I’m looking where I think there’s some type of arbitrage or value creation potential, which it’s challenging right now all across the board. I’m becoming a much better pickleball player. But You know,

craig fuhr:
Hahaha.

Dennis Cisterna:
other than that, it’s, you know, it’s needles and haystacks.

Jack BeVier:
Yeah, what we’re

craig fuhr:
Hey,

Jack BeVier:
seeing.

craig fuhr:
Dennis, it’s been fascinating, guys. We could wrap here. And can you stay with us for another episode, Dennis?

Dennis Cisterna:
Let’s keep going, I may need another energy drink though.

craig fuhr:
may need. I may need to go raid the refrigerator here at Dominion as well while Jack and Fred aren’t here. So, alright guys, why don’t we wrap it here. Thanks everybody for tuning in to episode 12 of Real Investor Radio. We’re going to come back with Dennis in just a bit for episode 13. Come on back and check it out.