The Exchanges

Q Have you thought about adjacencies? So you can stick to your knitting, but maybe there's another group you can teach to do this in a different set of geographies. Just kind of curious the internal discussions you have about scaling laterally.

A It's interesting. We don't want to be complacent, but we also think there's just a lot to do where we are. I think you look at Essex, large public REIT, they are in our geographies doing what we're doing, and they're 20 times our size. So there's plenty of opportunity to do more significant work within our sandbox. We've had some investors ask us, can you pick up five more states and go do this in those five states? That's for the experts in those states. We're here doing this. We have thought about owning longer In our geographies, because a lot of the brokerage relationships and the region and the location understanding we have could lend itself to acquiring newer product. And I think that could be interesting or owning things for a much longer duration on the side. But now we're really laser focused on working with the folks who put us in business. We have a core group of about 10 investors that have been in all of our funds. If we do well for them, it's profitable for us. We're hungry to make that a good bet for them.

AI assessment note: “there's plenty of opportunity to do more significant work within our sandbox.”

Q So you mentioned, okay, your parents had bought a couple of rundown apartment buildings, got some of their friends' money. This had been going on for like, 25 years. So what was Interstate Equities when your sister and you stepped into it?

A So I remember showing up to work the first day a week after my father's funeral. I didn't have a key to the front door. I was sitting on a stupa outside the front door waiting for somebody to show up. We had five or six people in corporate. They really cared a lot about taking care of our high net worth investors. We had 10 small properties that we owned and we had no one on the investment team. There were a couple of people in property management and a couple of people in accounting and somebody that ran the office and then Julia and myself. So we're very fortunate to have a playbook to work on, but it was bare bones at that point. And it was unclear where it was going to go because James Boyd, my father, he was a force. And so the business without him was not going to exist any longer unless somebody came in and reinvented it. So there's a little bit of a turnaround element to it.

AI assessment note: “We had five or six people in corporate... We had 10 small properties”

Q When the ownership is that fragmented, how do you find these properties to buy?

A So we're a small team. Having steak dinners with the family for 10 years is not a great use of our time to unlock deals, because you don't know when they'll trade. What we do do, though, is we keep a very close tab on the brokerage community. We have folks from East Hill Secured, which are the real estate investment banking folks, all the way down to folks with a Gmail account that have a broker license, and those folks are paid as they find deals. Those are the individuals who are having Dinners with a family for 10 years, and then a generational transfer occurs, or a tax bill happens, or the family decides they want to move into retail, or they want to move out of state, or something happens, and then they want to meet the market, and at that point, the broker says, gosh, I've had a relationship with this family for eight years, 15 years, I have one call to make to try to make this transaction and finally get paid, and so then they have a choice on who they want to work with, and that's a call we want to get. And so we'll get the call from the broker saying, you know what, they've been very challenging. I know somebody who's a quick yes or a quick no, and we'll get on a plane and come and see this asset and underwrite it accurately and quickly. And so then we want to get that call. Having capital, but being easy to work with, being a quick yes or a quick no is just super impo…

AI assessment note: “What we do do, though, is we keep a very close tab on the brokerage community.”

Q Well, why don't we go back to your initial background and start of your career?

A I run Interstate Equities. We're probably a little different than Starwood. They're fancy guests that come on this show. We have about a billion dollars under management. We're a real estate private equity firm. We buy and operate apartment buildings on the West Coast of California and in the state of Washington. That's the flavor of what we do. I grew up in Palo Alto. I was a public high school kid. I worked at a sneaker shop. My father was a professor of economics, so he didn't look kindly on being asked for cash. After high school, went to Middlebury College, wanted to do something really different, and ran cross country and track there, so I got to see the East Coast, and then learned along the way what investment banking was. A lot of folks at Middlebury who grew up in New York, just a big industry there, and as I learned about it and thought, this sounds really interesting and something I could go into, it turns out in Palo Alto in There was a lot of tech investment banking going on, and so found one Middlebury grad who was in that office and worked my way into an internship and then being a financial analyst at the CSFB tech group for Frank Quattrone's group. Remains one of the more famous investment bankers, so it's really fun to watch him as a practitioner, but then also be there through the upswing and then the downswing of the tech environment. Honestly, that really …

AI assessment note: “I grew up in Palo Alto. I was a public high school kid.”

Q How did you go about that process? You're talking post-financial crisis. Even if the investment opportunities are good, it's notoriously the hardest time to raise capital. What were those two years like?

A They were humbling. We always say at some point in your career, you have to burn the lifeboats. There's no going back. My friends at TA that had accepted my resignation and they'd invested with us. So there was no going back. And I had this fancy private equity job and now I had no salary. So we needed to figure things out. And so we took out somewhat of the TA playbook and we started calling investors. We started getting in front of people and we'd have little lights in the tunnel along the way when I'd be sitting and talking to a partner at Sequoia who was looking from a high net worth standpoint and investing with us. Gosh, if this partner thinks this is interesting, there must be other institutional folks globally who have interest in this that have a bigger capacity to invest. We were taking meetings. We must've done 150 meetings, cold calling, looking through the newspaper at names and who we should get in touch with. We had never done a fundraising meeting in our lives, and at TA, I had no exposure to that. Maybe another way to put it is pressure creates diamonds, and there was pressure. We did not want to shut this business down on our watch, and so my sister and I, we were all in.

AI assessment note: “They were humbling... We must've done 150 meetings, cold calling”

Q When one of these deals finds you, you have a small team, you're hopping on a plane. What is your underwriting process look like?

A So there's always a danger of falling in love with the real estate. It's quantitative first. So we want to see the model before we ever even look at a photo or anything. We're looking at the model and does this make sense financially? Then we'll start looking at the block by block nature. We only underwrite things in towns that we have interest in investing in. So the town usually has already been underwritten. And so then it's, Hey, what part of town do we want to be in? Is this in between the church that most of Community goes to, and the school, which is outrageously good, and is this the path that the families take every morning, or is this in the tartar part of town, and there's a bar that has a really bad reputation that's behind it, and there's always going to be a bad element coming and going from that bar next to the asset. Should we price the rents differently because of that? It comes down to a real block-by-block sense of it. You get at the property level, and I mean, it's colorful. Not every institutional teammate loves what they see when they get to the property level of it. There'll be a single mother of three doing a fantastic job raising her family in unit one. And unit two could have a hoarder in the unit with magazines piled to the ceiling and a small pathway in between next to another family that might have seven cats and seven litter boxes. And it makes you…

AI assessment note: “It's quantitative first. So we want to see the model before we ever even look”

Q you would describe your investment management tech, request a demo at ridgeline.ai. And now, back to the show. When you put the numbers together, right, so first you're talking about renovation of common areas, fixing the problems in the building, then you've got these individual units. How does the math work on either a unit basis or a building basis to get to the types of returns that you're targeting?

A So when we're renovating, we want to keep ourselves to a high standard of about a 20% return on cost. We want to make sure that we're making returns that are accretive to our aggregate returns for the deal, at least that we originally underwrite, that we're clear of that. We really test ourselves at each feature. A fun example is we'll go in and renovate an entire unit for 20,000 dollars and we'll say, actually, that stone counter costs 2000 dollars. We could have done a laminate counter for 1000 dollars. On unit one Oh three, let's actually pull back the stone and put in the laminate. And if you can get the exact same rent, we may pull back that feature and we'll say there's actually no return on cost for that additional feature. Another way to put is some people, if you build it, they will come. That's part of real estate is if you build a building, you got to deliver the whole building, whether people like it or not. For us with each unit, with each feature within a unit, we're iterating and constantly looking at that. And that's Where we can be very careful not to overspend into a unit, which is a huge risk modulation approach. So when downturns have happened in the past, even when we went into COVID, And the same thing in oh seven, before we really knew what was happening, we knew our return on cost wasn't quite working. Despite what we were trying to figure out in the pub…

AI assessment note: “we want to keep ourselves to a high standard of about a 20% return on cost.”

Q Which two people have had the biggest impact on your professional life?

A I think my father, just his academic approach, I got to hand that to him. Being a professor is very strange to have a professor of economics be running a real estate firm. This idea that there's somebody always smarter in the room, I think is something that I definitely appreciate. And then Frank Quattrone, it was a long time ago I worked for him, but I learned a lot watching him operate and then continue to track his career. And then ultimately I got laid off by him in late Like I said, I don't deserve anything. Got to go out and create value. Got to create opportunity. The cycle can move on you. Things that you think are not movable are movable. It turns out in life, that was a gift to get that gift at the age of 23 or whatever you are at that age. That was something that I'd definitely thank him for.

AI assessment note: “I think my father... And then Frank Quattrone”

Q I'd love to turn to the investment process and maybe you start at that top of the funnel. So how did you decide where to focus? This is real estate. So got to start with location, location, location.

A It's as important what we don't do as what we do do, and so we're very careful about where we spend time. There's a lot of ways to do well in investing, but what we believe makes the most sense for us on a risk-adjusted basis is to invest in apartments in areas where the schools are fantastic, the jobs are outrageously good, homes are very, very expensive, so folks who want to be in that market in order to have their kids attend these schools and work at Silicon Valley companies or these powerhouse employers, They will be renting for the time being. And those renters, a lot of times, maybe they're making a fantastic salary, and they're sending their money back home, or they're paying off business school, or they're trying to make the next leap so that they can buy a home. There's a huge opportunity to provide housing for those individuals. This could be somebody, a fresh MBA, but it could also be somebody who's a groundskeeper at the local golf course, and their significant other works at a restaurant, and they could also be living in our building, one unit over from that MBA grad. That's the opportunity. To be in these infill markets. Maybe another way to frame it is where we're not. So we're not in the Inland Empire. We are not in Sacramento. We're not investing in areas where you can build a ton of new product. And we like these markets where nothing new gets built. And the …

AI assessment note: “invest in apartments in areas where the schools are fantastic, the jobs are outrageously good”

Q Once you've gone through a building over a couple of years with this turnover, you've got it mostly renovated. You mentioned you then look to sell. A lot of people, particularly in families, think of real estates as just the yielding property. I'd love to hear, how did you come to this time horizon that's a little bit shorter than what someone might expect from a real estate investment fund?

A Partially informed by insecurity. You think of these young kids trying to build a track record that we could show people and do well for them. And really it's all talk until we deliver cash back to somebody's hand. The mark doesn't mean much, especially in today's environment. What's a mark? It's all changing very fast. What matters is your returns. And so for us in the early days, it was all about, Hey, we approved the thesis, sell the deal, show the folks the return on cost or the ROI and the IRR. And so it was all about building the track record that way. What was exciting as we got to know the institutional community was that most of our friends are not taxable. So foundations, endowments, they're not paying tax. And so while we do have debates about how short to hold the deal, and obviously we want an ROI that's high enough, we don't want a one three and a 50% IRR. That doesn't get the job done. We need ROIs that are much better than that. The idea of selling a building is a less painful to an endowment or foundation because they're not paying tax when we send it back to them because basically charitable things they're doing with it in the world. But we debate it. I think as well, we take on risk by buying old buildings, by doing renovations, by handling the residents, and just doing all the things we're doing. I think real estate in general underestimates how much more ri…

AI assessment note: “Partially informed by insecurity. You think of these young kids trying to build a track record”

Q I'd be remiss if I didn't ask you about risks, and the first obvious place to think about is the macroeconomic environment and what we're seeing with rates and the potential for recession. How do you think through risk in the strategy?

A We want to have as few variables as possible. We talked about new supply. We like markets where you can't build anything, even though it's frustrating as a resident of some of these towns, things like earthquake risk, that's a risk. And so we have earthquake policy on the entire portfolio, which most groups don't. We just say, let's just solve for that. Obviously nothing's ever solved. Look, the interest rate environment, you'd be remiss not to mention interest rates have effectively doubled for our product. The good news for apartments is we can still get loans. We can get really nice loans still. But if you're in Retail or office. There's just no loan. You've got to do all your deals, all equity, which is pretty wild. The effects on us have been much less than others, but the doubling of the cost of the capital is no small thing. There's a resetting of pricing going on right now, which is very interesting. And so we're paying attention to that. I think there's physical plant risk for certain, especially late in the cycle. So we've been very cautious of this over the last few years. If there's an environmental risk or there's a fire risk, Or there's a foundational issue at the property, real infrastructure or site issues. We really steer clear of that because when you're doing meat and potatoes investing, there's no way to smooth that over. There's no 10 X deal in our world. I…

AI assessment note: “We want to have as few variables as possible. We talked about new supply.”

Q What are some of the other leadership lessons you've learned along the way?

A In real estate, there's a lot of hubris. And so we see a lot of people that get over their skis in terms of taking themselves too seriously. There's a lot of people using the word I too much. We've got a 110 people and most of my job is just taking care of them and keeping them empowered. The idea of have a broad team, have a team that's empowered. We have five people on our investment committee. We have press releases that don't include my name and they shouldn't because there's other people that made that outcome happen. I really think there's benefits in terms of returns. To having a team that's empowered and not having it be this one person show. We can all name a lot of private equity firms where there's really just one name that's talked about. And I think that's a real fault. A nice thing with Julia and I co-leading this business is one of us gets over our skis. We'll trim each other back pretty quick as would our other investment committee members. And so that's a good thing too.

AI assessment note: “The idea of have a broad team, have a team that's empowered.”

Q What kind of cap rates do you underwrite in these models?

A The deals we really love are operationally distressed. So if there's a family who's running a deal and their property may be a hundred percent full, but if they're asking half of what market rents are, so the revenue is broken and will take several years to get that back up to where we believe it should be as residents move. It turns out about 50% of residents move every year in America. And so that's a real opportunity in our space is that as somebody gets a significant other, changes job, they move. And then at that point we can go in Renovate the unit and then bring the unit to where we think the market should be. You could be buying something if the revenue is half of where it should be. The cap rate could be a two and a half cap. But we believe that just with normal operations, this property is somewhere between a four and a five percent cap rate. That would be our view on the going in. And that's shifting today with interest rates moving up considerably. But a nice thing in our markets is we can look back to the We can look back to 2007 and we can get a real sense of where cap rates peaked out in a given town. And we like these rich markets where the cap rates really never blew out. And so that gives us some sense of safety in that town. So you pay for safety, if that makes sense. Whereas in other markets, cap rates double every time in 2002 or 2007, if their cap rates do…

AI assessment note: “this property is somewhere between a four and a five percent cap rate.”

Q So how do you go about making that renovation happen at that cost and on time?

A Comes down to just being good to people. So we're very focused on being good to our vendors, paying them on time, doing what we'll say we'll do. Most vendors pay their teams every week, but then they have a net 30 to charge us. It's a really tough industry. They get paid every 30 days if we pay on time, but they have to pay their teams every week. So us being able to deliver them consistent work to keep their teams busy, but also paying all our bills on time and being good to them, not having them bid endlessly on projects they don't get. So we have to earn it. Nobody has to work for us. I believe in that in the firm. I believe in that with our investors. We have to earn it every single day.

AI assessment note: “we're very focused on being good to our vendors, paying them on time”