10 Questions with a real estate executive
Interview conducted by Andrew Killian (FT '21) and Tucker J. Rhodes (PT '22) on 3/23/2021
1. How did you get your start in Real Estate?
My start in Real Estate was a bit unconventional but I think you'll find a lot of people fall into that category. When I graduated undergrad from Harvard in 1993, I was offered a job at a hedge fund in Chicago. While I didn't know anyone in Chicago, I still moved here for the job. I wound up staying in the hedge fund space for 11-12 years. After the firm that hired me was bought by BNP bank in '94, I left and joined a much smaller firm where I was made a partner in the late 90's.
My first experience in real estate investing was just personally investing capital that I made through my career. I bought my first home in '96 and then I bought a six-flat in '97, all in Chicago. That was my first experience being a landlord, which was interesting because I was much younger than most people renting from me. At the six-flat, I was making the repairs and doing the credit checks, so I was essentially an operator, which is one of the common mistakes made in real estate investing. As a real estate operator, you really need to know what you're doing. A lot of investors acting as operators don't and as a result the property may not perform at its highest and best use.
In 1999 my business partners at the hedge fund brought forward an opportunity to invest in farmland. I was 27 at the time and agreed to invest. That was my first experience as an LP and not as an operator. It wound up being a significant investment because it kept growing, so it became something that was a significant part of my portfolio. In that sense I was a little bit lucky. I identified, I think correctly, a high risk-adjusted return relative to the opportunity set, but I didn't see what was coming, which was all kinds of tailwinds. A lot of the tailwinds were driven by the secular move in interest rates. As interest rates kept going lower, yield was chasing that lower rate environment. Ethanol subsidies also became a big unexpected benefit.
In 2003 I decided that I wanted to leave the hedge fund space. I then started seriously asking myself what I want to do next. I was lucky in the sense that I found something I was good at and I was able to build wealth during my time working in the hedge fund space. I learn by doing, so I immersed myself in real estate. It's a blessing and a curse if you have enough capital that you don't need to work for someone else to gain knowledge. At the end of the day, anyone can do a real estate deal if you have the capital. However, if you haven't accumulated the domain knowledge it can yield a negative outcome. I did a lot of things right, but I also made mistakes in my first deals.
Along the way I met my business partner Michael, who was in a similar place as me: Very successful in the 90's, still young and wanted to get into real estate. We began exploring the space together. It took us a long time to figure out we wanted to institutionalize Origin, which we did in 2007. This was a dangerous time because it was the eve of the Great Recession. The best thing we did in 2007 when we started the firm was to not immediately jump into doing deals. We spent time studying the markets, figuring out where we wanted to position ourselves, what we wanted to specialize in, and where we wanted to hire people. All those things distracted us from doing deals at the worst time we possibly could have done deals. As a result, we were fortunate coming into 2008 and 2009. We had a very strong cash position and not many residual assets, which wound up being a good position to be in.
2. In what ways did your MBA experience at Booth contribute to your professional success?
I didn't get my MBA until 2012 or 2013 so by that point we had already raised and invested 'Fund 1', and we had raised most of Fund 2. The real reason I went back was to gain knowledge. When I completed my undergraduate degree, Harvard didn't have a real estate or finance program. You couldn't major in business at Harvard when I attended either. While Harvard is amazing in other things, especially in teaching you how to think critically, the skills you would associate with a nuts-and-bolts business education weren't offered, so I went back to fill these gaps. I had already been in real estate private equity for four to five years and hedge funds for 10-12 years prior. I wanted to test assumptions of what I was currently doing to see if there might be a different or better way. In terms of what it provided, there were certain areas where I learned unique knowledge but often it filled in gaps or further solidified what I already was doing.
3. Did you always envision yourself as a CEO? What attributes do you believe have made you a successful leader?
We built the company from the ground-up, so initially it was myself, my partner Michael and two analysts. Then we made our first acquisition officer, then our second, then our third. After a few years, we realized we needed a lot more capital than just our own. To get clients, you need marketing, sales, capital raising, infrastructure, accounting, information technology, general counsel, etc. Over time we grew from four people to 12 people. Then it was 20 people and after that it was 30 people.
What you find is that as you grow, you gain talented people and you can start delegating certain things. The flip side is that your job becomes much more about managing people, and talented people can be very difficult to manage because they're highly motivated. They want to move forward with their own careers and constantly want to be challenged. You want to provide such opportunities in their roles, but they may leave to start their own businesses. We want to provide something great for these individuals at Origin or they might leave. Of course, if they do, maybe you work with them externally and you're always rooting for them. Nonetheless, it's still a challenge. I spend more and more time managing my teams, hoping that we provide the culture and the opportunity to retain talent. We've been very successful in retaining our key people, which I think is a main reason we're one of the stronger-performing managers over the past decade. The average tenure of our key leaders in management is seven to eight years, providing crucially important continuity.
I always tell people who are selecting a manager in anything, there are three things I would ask:
1. What their debt to equity limits are because it says a lot about their risk management.
2. More of a governance issue around American vs European waterfalls, to make sure the fund isn't structured with a non-cross-collateralized promote.
3. If you're historically a top-performing manager, are you still using the same team? If you build a track record with a team but you no longer have them, it's an issue.
The other important leadership quality is having a sound vision and mission. Mission is the why, vision is growth and how you get there. You then must get down to strategy and tactics, which need to be solid because you can't scale if you don't have a sound process. We made a decision that we wanted to focus solely on the taxed investor because the largest investors in our fund are my partner and I. We believe focusing on the taxed investor is best for our own interest, but also that there are a lot of people like us. A lot of people who have worked hard and want to make good returns but also want to make good after-tax returns.
That was a decision we made, but when we make that decision, we are also deciding we want to have a lot of clients. Pension clients can invest $20 million to $50 million, whereas my average client can invest $300,000. For me to get the scale on the equity side I need thousands of clients, which we have. To have thousands of clients, you must have sound processes to ensure a good experience.
All this is interrelated, but I would say people first, and a strong foundation of process and a clear vision of what you want to be second.
4. How did you know it was the right time to start your own company? What obstacles did you encounter?
It's no different than starting any other business. You need to fill or augment a need in the market. In real estate, there are two critical inputs for what we're doing: capital and quality deal flow. If you're a GP instead, you need to have a thesis for "why you." The real estate space is massive, but you always must ask yourself, "What am I doing that provides unique value to the ecosystem?" If you can't identify what unique value you're adding to the ecosystem, there's probably a good chance that no one else will be able to identify the value either. If you sit down with me and I'm asking question after question, every response must be sound.
When we started, we couldn't answer all those questions, but we had our own capital, so it didn't matter. In this two-sided market, we were only looking for deals. In a normal business environment, you must answer both unless you start out or stay in the service side of real estate. As we grew, we gained a better understanding for where we fit within the industry.
5. How have you led your company through the pandemic? What difficulties did you have to overcome and how have recent disruptions impacted Origin's investment philosophy?
When the pandemic hit, we had a $300 million deal pipeline that we walked away from. That's six months of work. We couldn't close on those deals because we had no idea where valuations would land. While most other firms we know followed suit, we were one of the first firms to walk away from deals.
We then pivoted into preferred equity. I lead our acquisitions and investment management teams, and we didn't want to be the first-loss position. I was more comfortable being in the down 10-15% protected position. Throughout the capital stack from equity to debt, others were retrenching for the same reasons. You could attain some attractive preferred deals done in the 14-16% range in the protected position.
Over my entire 15-year career, I've never seen the amount of capital that's entering multifamily in the last 60 days. What's happened is that all the money that sat on the sidelines last year wasn't being allocated, plus more capital was raised, so there's a lot of buyers that must buy in the growth market we're in. There's, on average, 20 bidders for every multifamily asset. We have an asset we're selling in suburban Denver right now. We received 25 offers, took 10 to best and final, and did two rounds of best and final. It's indicative of what's happening right now. This particular asset we thought would sell between $98-101 million, but it'll end up selling for around $104 million. Those additional few million dollars are all equity. We're first-loss, first-gain, and we generally lever 2-to-1, so those additional few million dollars are 9-12% on your equity.
To summarize, my answer to your question is we blew up the deal pipeline and we focused in preferred equity. This strategy led to not buying into these equity deals that are up huge now. Additionally, I now don't want to buy equity in these deals because I think people are overpaying. So, we'll sell some of our assets. If I'm wrong and cap rates are even lower a year from now, then I'm underperforming. Believe me, investors are equally unhappy in every scenario unless you outperform.
6. What are your opinions on the Chicago real estate market? How does Origin select markets in which to invest?
We've invested in Chicago historically. We are leasing up a QOZ Pilsen property right now. However, we've dropped Chicago as a market. I'm not particularly bullish on Chicago; I don't think the cap rates price in the risk of our fiscal uncertainty, our future tax rates, etc. Additionally, the outflow of our population is significant enough to warrant attention.
When Professor Pagliari was on our Origin webcast last month, he'd done a bunch of research on gateway markets (including Chicago). He's done some amazing research on why they'll underperform. I agree with everything he wrote. That doesn't mean you can't make money in Chicago - you can. But we're long term investors, and we're tax investors (so everything must be tax efficient). Everything we do is buy, fix, hold, refinance, fix again, refinance, fix again. QOZ is even better because we have to hold over 10 years to get the tax incentive. But to invest I need to have a long-term belief that a market is going to outperform.
Sector picks are more important than anything else you can do in real estate. For most real estate investors, moving from hotel and office to industrial and multifamily asset classes recently was more important than anything else you could do because in doing so you got the sector right. From there, geography really matters. If I had heavily overweighted in Phoenix in 2018, instead of Houston or Chicago, that would equate to 500 more bps annualized over the last three years. That's massive.
We spend a ton of time not only with market selection but with submarket selection, which is also important, especially in Chicago. Chicago is a very segmented, submarket-based city. You therefore must study it in that way. There have been recent revival stories around Chicago's South Loop West Loop neighborhoods, but at the same time we had net outflows of people from the city and the suburbs were getting crushed.
The last year was a major concessions market, but that stopped overnight. We aren't giving two months free rent to renters anymore. So, there's some stabilization. Long-term, I think we'll see lower rent growth, along with other negative outcomes throughout Chicago. I also must think about NOI and about how we're going to finance deficits. It's a lot easier to tax me, one building owner, than a community. So politically, commercial property owners will probably bear the brunt of what's coming in Chicago.
Lastly, this all must be in the lens of cap rates. You can make more money in a low-growth environment if cap rates are pricing a worse reality than what ensues. The problem is our (i.e. Chicago's) cap rates aren't. I want it to be wrong, but I don't see a good outcome for Chicago.
By the way, here's another problem: A lot of people leaving Chicago are very wealthy. A lot of these people are my clients and they're moving all over, mainly for tax reasons but also weather. A lot of cities in low-tax states are quite livable and offer amenities similar to cities like Chicago has. When you lose wealthy people, you lose tax base and also employers. Wealthy people employ people at their businesses but also their home. I don't like the trend I see (both in the data and anecdotally) from wealthy people. It feels like every single wealthy person is either doing leaving Chicago or thinking about leaving Chicago.
7. What is one of your current real estate investments that you are most excited about?
The two areas of the market that I'm interested in right now are preferred equity and development, which is interesting because those two areas are at opposite ends of the risk spectrum. I believe that development is less risky than core multifamily right now. The last 4-5% that's being pushed right now, which equates to 10-15% on an equity basis, if that reverts back to the mean and you lever it 2:1, you are kind of out 40% of your equity immediately. You bear the brunt (put in 35% and 12-15% is gone), you are taking a bath and I think that is likely. I don't view that as an outlier.
Development has big margins right now because you're still developing in untrended (not trending rents during development). I can develop to a 5.8-6.0% cap rate and its trading sub-4.0% cap rate, which results in a really wide spread. Normally we see cape rate spreads of 150-175 bps, but right now such spreads are a defensible 200bps and I like that margin. However, I don't feel the same way about high rise multifamily developments, and I don't develop high rise properties because it's very risky construction. The garden-style development is easier to build and really that not that complex to execute. You're also going in with GPs, so you've mitigated a lot of your cost side.
My point is that if you take a shock to the market, something happens. Secular NOI moves down, cap rates blow out, borrowing costs go up, and the first loss is the margin. You're building for $200,000 per door, and the spot market is trading $275-280k per door right now. That's a profit cushion. If the market takes a shock, as long as I built the asset, I can probably still sell it for $200,000 a door and cover my cost basis. In today's market I therefore view development not only as more lucrative but also as less risky. We're heavily focused here. We have over 2,000 units in development across our markets and I'm looking to do more.
The nice part about being small, because we're still a very small firm relative to a Blackstone or a Carlyle, is that we can be agile. Whereas I currently favor preferred equity and development now, if I feel differently in 18 months, we can pivot. We can do less development and maybe pivot to a new opportunity in core plus. We have capital for that. Our competitive advantage is therefore not just great people and great process, but also agility.
8. How are future trends of sustainability and social equity affecting your investment strategies?
It's not a huge consideration for us. If the added sustainability and social equity benefits make sense in terms of the overall cost structure of the deal, that's a great bonus, but it's not something that we're focused on.
9. Was there anyone you looked to for mentorship and advice during your time at Booth? Is there someone you look to for mentorship now?
I've only ever had two mentors professionally, and ironically neither of them knew that they were my mentor. One was Jim Tyree who used to be the chairman and CEO of Mesirow Financial. The second is Paul Finnigan, who is the CEO of Madison Dearborn and a double Harvard graduate.
The reason that both Jim Tyree and Paul Finnigan are my mentors is because they're both great examples of super smart, super driven people who have built amazing businesses but are also very down-to-earth and give back a ton to the community. Jim Tyree unfortunately passed a few years ago but was an institution here in Chicago and the city nearly shut down when he passed. Paul Finnigan remains very involved at Harvard, is involved with Teach for America, and is involved with countless other civic initiatives. I didn't really have mentors at Booth, but I do have overall mentors - they just don't know it.
10. What advice would you pass down to Boothies interested in pursuing careers in real estate and/or entrepreneurship?
Everyone at Booth is smart. Everyone at Booth is motivated. At the end of the day, I think people are going to be successful in real estate and in business in general if they achieve the following:
1. Focus and become an expert on some specific element of real estate or your business. At Origin the bigger we get the more we focus. When we started, we were doing multiple asset classes and we were chasing the best deal instead of being proactive about what we were looking for.
2. You can't just be smart; you also must be accountable in the sense that you do what you say you are going to do and then overdeliver. That's how you build trust.
3. You must be a good person. There's not enough time in the day or in the world to not be enjoying the time you have. I'm going to Nashville tomorrow to meet our acquisition partner there as well as some potential partners and I'm looking forward to it because I genuinely like spending time with our acquisition partner and our potential partners. Being a good person sounds easy, but there's an awful lot of people who don't figure it out.
