Interview conducted by Benny Kay and Tyler Thornton

1. How did you get your start in the Real Estate industry?

I had my first real estate experience while I was still in high school. I worked for Holiday Inn as a lifeguard and pool manager, and that was really my first exposure to the business. I really liked that job, and, you know, at first I was just a lifeguard but ultimately I ran the pool. I hired the lifeguards, I was responsible for opening it up, getting it ready for the season, closing it up when the season was over, and I did that for eight years during high school and college. I really liked it, and it was rewarding hiring good people and doing improvements, such as staining the chaise lounges and pool railings and painting the pool area.

It was a very rewarding, fun experience, and I made a lot of good friends who worked with me there. So that was really how I got started. Then, in college at the University of Illinois, I had friends who were getting really interesting jobs and internships at real estate syndication companies that were buying multifamily properties. There were big companies in Chicago like Balcor, JMB, and VMS, that were buying apartments and other asset classes using tax incentives that existed in the eighties. Just as I was finishing up college, they were buying huge amounts of property across the country. I enjoyed working at a hotel on the operations side of things, but I thought, "how can I get one of these jobs where I can be on the investment side and buy property?". For me, that was the next step. That's what I really wanted.

I looked for jobs during my senior year at Illinois at all the companies I mentioned earlier and couldn't even get an interview. I just didn't have the connections and didn't have the GPA. I did find a company called AMLI that was interested. AMLI was a newer company. They were a developer and acquirer of multifamily and office properties. I interviewed there and ended up getting an internship over my Christmas break. I worked in their Atlanta office and it was a kind of test drive for them. I didn't get paid much, but they fed me and that was just as good, and I got a free ticket to experience Atlanta so it was a win-win situation.

And that's where I decided to work after I graduated. They didn't tell me what I would be doing, but they said I had a job if I wanted it. When I got there, they said "we need you in office brokerage". It wasn't the acquisition side of the business, which was what I wanted, but I was just happy to have the job.

I worked with a group at the time that was looking to create a tenant rep business. They hired me and one other guy to be the junior brokers, and our job was to canvas all the office buildings in Chicago to find tenants who were interested in relocating. So tenant representation is what I did my first two years at AMLI. I really liked it and got good traction. During those two years, I sat in a cube across from this guy named Pete Vilim who had an office. Pete was in charge of apartment acquisitions and at that point he needed another body. Pete and I were friends and I said I'd like to volunteer for that position. So, I ended up moving over to apartment acquisitions and working for Pete.

That was what I wanted. That's what interested me. But, I had actually really loved the tenant rep business all the cold calling, trying to creatively figure out ways to convince people to move their office space, and those commissions are big. It's a lucrative business if you can get activity going and I did get some big deals done. I had to finish the deals on the tenant rep side before I moved into Pete's group. That was in 1987-88 and that's really when I cut my teeth on multifamily investments. Pete was an incredible mentor, one of the smartest people I know. He's my partner here at Waterton, which we co-founded together. He taught me so much.

Back then, there were a lot of tax considerations and Pete was a tax guy. He came from Coopers & Lybrand which, back then, was one of The Big Eight accounting firms. He has a master's degree in taxation from DePaul and he also behaved like a lawyer, even though he never was trained in law. He knew more about the legal side of transactions such as contracts and loan documents than any lawyer I knew. He was a great mentor.

That was also around the time I started thinking about getting my MBA. I went to Booth at night and did it part time. Two or three years later, after I got my MBA, I ended up at Equity Group Investments to do apartment acquisitions there.

4. When you started Waterton, investing in Class B apartment projects were not typically considered an "institutional" investment. What drove you to "buck the herd" and what obstacles did you encounter along the way?

That is easy to answer. Back then, the Class B apartments were low in price with very high cap rates, and that's how we were going to get these extraordinary returns. The other theory I had when we started Waterton was, as long as I could deliver really good IRRs and multiples, we could raise the money. And so, in that Class B space, we were really yield and return-driven. That meant more risk, but we were comfortable with the risk.

Those Class B properties, at the time, were kind of crappy properties. They were tired, had deferred maintenance and low rents. Those were the risks, but we were comfortable with that because we were getting a high enough cap rate and return for taking that risk, and we haven't pivoted too much from that strategy to this day.

We tend to follow the rules that we started with from day one. One rule is that we need these higher, extraordinary returns. So Waterton always has, in our funds, required a higher return target than many of our peers. Second, we're always looking at our total cost and what is the discount to reproduction cost? We have to have a spread between the reproduction cost and our cost. We always want cash yield, because cash yield always protects you. Even if you have five percent cash yield per year, if you hold the property twenty years, you will get all your money back. That's kind of the worst-case scenario assuming your yield never grows. Yield can protect you if other things don't work out.

We have always followed those rules. There are other things we don't compromise on such as location. The top three rules of real estate are location, location, location. We stick by that, and because of that, what has happened over 25 years is we have a top quartile track record. In some cases top decile for people who do value-add multifamily investments, and that's extremely important for us to maintain.

6. At the 2016 Booth Real Estate Conference, you talked on the panel about disruptors in commercial real estate, or as you called them at the time "micro-disruptors" in the multifamily space, things like the increase in package deliveries, drone delivery, driverless cars, Airbnb, and others. How have your views in that space changed over the last few years and where do you see those disruptors heading in the future?

I remember on that panel there was a retail person who was dealing with macro-disruptors, significant disruption from Amazon and online purchasing which was disrupting the regional mall business. The hotel industry has been significantly disrupted by Airbnb and home-sharing. And office has been affected by co-working and WeWork. Those are more "macro."

Multifamily has not had macro disruption yet, but I am a cautious warrior. I think, "What's going to bite multifamily? What's going to be our Amazon? What's going to be our macro-disruptor?" In 2016, all I could see were the micro disruptors and these are ankle biters. Packages are a pain and we have had to add man-power. For example, during the holidays at Presidential Towers, we had six people dealing with all the packages and we needed more space but that really is a micro disruptor. Airbnb is a macro disruptor for hotels but in multifamily it's micro.

Now we're in to 2020 and it is more apparent what could disrupt our industry. I don't know if I was predicting this in 2016, but I'd say our number one disrupter is Government. Government disruption is a result of our success in a ten-year run of rent growth run that has created a housing affordability crisis across the country. It's in the papers every day and for the first time it's part of presidential debates. Bernie Sanders, four days ago, tweeted about national rent control.

Now rent control is being discussed at some level in more than seven states. It's been implemented in Oregon and California. There's a new California referendum on the ballot in November. New York passed a very draconian rent control bill in June of 2019. Regulation by government is not just rent regulation. All kinds of regulation are potentially macro disruptors to us and that is a result of our success. That's number one.

Number two is technological innovation, which our industry is behind on. That will impact us in good ways but also negative ways. That's why it is important for our industry to be at the forefront of innovation. The positive impact will be that we're going to become a lot more efficient in operating, we'll be more profitable per employee on a property, and we'll be able to automate more processes. There is already self-touring technology available, so maybe you don't have to be open on the weekends. I think that's a positive disruption. There is other technology that could create more revenue at our properties by selling more things to our residents because we technically control the last mile.

The negative side of technological innovation is the potential for data breaches. We have highly sensitive information - social security numbers and other personal information on our residents - to protect, but fortunately our industry has not been materially breached yet. Lastly, on the communication front, with 5G and what happens with data getting in and out of our buildings and how the FCC controls that and regulates that.

Then we have the environmental disruption that worries us. More frequent storms, more frequent fires, that result in higher insurance costs. We've seen massive increases in insurance premiums. Is there a scenario where certain types of events can't even be insured? Do we want to own those properties? Are there certain properties in locations that will be underwater by 2045? It's a sustainability and resiliency issue that we really have to be careful about.

There's a lot of these disruptors out there and we have to be very vigilant as owners and as an industry on behalf of our investors, because we do not want to be the next Class B regional mall business.

8. You touched on the topic of housing affordability and things like rent control a few questions back. How are you approaching those risks specifically from a strategic perspective?

The first thing is, companies need to understand those risks and where they exist. They are local, state and federal, so having an understanding of the regulatory environment is important. We have a legal department here and we do spend a lot of time understanding that regulatory environment. I think it's complex and I think certain investors underestimate that complexity and potential risk.

We've been buying rent regulated buildings for 15-20 years, and we've actually done very well with them. We have no problem buying rent regulated buildings, but you have to buy them at the right price so you can get your returns, that's the key.

What we don't like are buildings that are unregulated now, but have high risk to become regulated and it's not in our assumptions. That will be the challenge potentially with California and certain municipalities there. You could buy an unregulated building in Santa Monica today and then Prop 10 passes in October and Santa Monica's going to say no more rent growth, even on your vacant units. Those are risks that you have to be very careful with. It's the uncertainty.

Chicago has some risk right now too. It's well known we have property tax risk and that we don't know where the property taxes are going. So, how do you underwrite that when you don't know how high the property taxes will be? Our view is you just have to figure out a level that you're comfortable with that is conservative. That's more art than science in a lot of cases, and we have to make a lot of those risk-reward decisions.

9. Several of our students recently attended an event with Maurice Cox, the new commissioner of the Department of Planning and Development, where he stressed the importance of linkage between public policy, development plans, and private investments. What impact does the new administration have on Waterton's investment strategies locally in Chicago?

We're not really developers, so for us it wouldn't have much impact. My only comment on that is there is inclusionary zoning, which basically makes developers build affordable units along with their conventional units. The more you increase that requirement, the more it's going to be a hindrance to making new deals pencil. With public policy, I think you have to be careful, because unless there's an economic benefit for the developer to build those affordable units, It's going to be an economic detriment to their modeling and they can only handle so much of that.

I think there's inclusionary zoning and then there's harmful inclusionary zoning, and the more you push it, the more it becomes harmful, and that shuts down development. That's what this administration has to be careful with.

I know everyone's complaining that all the new development is super luxury, Class A, high-rent development and that's very true. But the more of that product that's put into the inventory, the more edge it takes off the rent increases on the older product. That's kind of Booth Econ 101. No matter where the supply falls, that supply is going to impact price because the demand is what it is.

Trust me, developers will overbuild if the municipalities don't put so many restrictions on them and the capital is flowing. Right now the capital is flowing, and it's the municipalities that are slowing it down and that's what keeps the rent increases from getting out of control.

We've had good rent growth in Chicago, but it would have been much worse without all this new supply. People move out of the Class B to upgrade to the Class A, and that creates more Class B inventory. That suppresses pricing, so let the builders build.

If Chicago wants to incentivize developers to build more affordable units, then we should give them economic incentives like bonus density. That doesn't cost the city anything. Something like, you can go up ten more stories if you build thirty more affordable apartments. Give some more liberal zoning or other benefits like tax abatements. New York, given all its problems, is great at providing tax abatements in exchange for providing more affordable units in developers' buildings.

I'm okay with some level of inclusionary zoning, because all municipalities have something like that. Whether they call them impact fees or inclusionary zoning, they're trying to get something out of the developer. But this administration needs to be careful or they're just going to shut down the pipeline.