Video: Value-Add Real Estate with Bill Shopoff
Greg Mausz, ADISA’s immediate past president and chief operating officer of Preferred Capital Securities, interviews Shopoff Realty Investments president and CEO Bill Shopoff on value-add real estate investing. Shopoff, whose company specializes in opportunistic investments, explains the differences between opportunistic, value-add, and income-based real estate investing, the internal rates of return typically associated with each strategy, and how financial advisors can evaluate viable value-add/opportunistic investment sponsors.
Video Transcript
Greg Mausz 00:09
Welcome to another edition of Focus on Alternative sponsored by ADISA, the Alternative and Direct Investment Securities Association. My name is Greg Mausz, I’ll be your host today and we have Bill Shopoff, with Shopoff Realty Investments. And Bill, to get us started can you walk us through what is opportunistic investing what is value ad investing and what is more income-based investing when it comes to real estate?
Bill Shopoff 00:32
Certainly, I appreciate being here. So opportunistic investing would be something on the higher end of the of the perceived risk spectrum. Typically, in the 18 to 20% internal rate of return and up, and it’s generally defined as something where there is is an opportunity to create value that doesn’t exist otherwise. I call it making the invisible visible. Which is which is somebody goes by a piece of property every day sees one thing there and then along the way another developer goes by and sees something completely different and goes and seeks a rezoning, maybe he saw an industrial facility there but really what he saw was a future residential community. He went goes buys that site he gets it rezoned and then he either builds it out or sells it and achieves what I would think would be more opportunistic types of returns. Because he sought out something that others didn’t see, they weren’t looking at it for the income stream of what was there he was looking at it for the income stream that what could be there. How you add is something where somebody’s doing some improvements to a property, I would call it a heavy lift to a property but perhaps they are buying an older apartment building and renovating it in getting significant increases in rents. The the terminology we use is you know is there a is there a classic unit or an upgrade unit a classic unit Is a nice way to say is that that dumpy old unit that was built 30 years ago…
Greg Mausz 02:07
Right.
Bill Shopoff 02:08
And the upgrade unit has got the new countertops and the new vinyl tiles and you know cabinet fronts. and in an upgrade where people would pay perhaps you know they might pay $100 or $200 more a unit a month. So, a developer might go spend $10,000 to renovate a unit, if he gets $150.00 a month it’s a pretty good return. That’s going to put him in more of the value add space, and I would say typically I would put the value add space as kind of a mid teens maybe 12 to 16% internal rate of return is where the where the industry kind of sees that space. And then core or or really income focused is single digit IR’s it’s buying that Class A building typically in a major market not always but typically in a major market. They’re buying a relatively new building being mostly new, you can’t have Class A with age on it there are some Class A graceful office buildings. But I think generally people are thinking of that building is something that’s newer vintage it’s got the right floor heights it’s got the you know the right electricity if you’re an office user because today office uses much higher electric consumption than it used to be. But those but those investors are typically seeking a you know an internal rate of return that’s going to typically be in the single digits.
Greg Mausz 03:27
Thank you for walking us through that. There’s a lot of the investments and funds that I see out there more focused on core the core investing that you kind of just walk through but your specialty is more in the opportunistic and value add. Can you give us some further examples of what those properties and or situations would look like and and and is it dependent upon an asset class or geography?
Bill Shopoff 03:55
Well, I think that’s a great question. I think that it works across the asset classes and geography, but by virtue of being opportunistic it’s not like I walk into my office every morning and there’s a plethora of opportunities. You have to dig through a lot of things to find that gem. And so, somebody that was focused on this space is going to look at a lot of opportunities a lot more than it would take to go by not to pick on them but if you’re buying triple net lease deals. It’s relatively straightforward business, you’ve determined what your credit risk that you’re willing to take and you and your release duration and then you want to yield. You you find a property that meets that you know, say I only want ten-year term I only want Walgreens credit and you know I want a 5 cap and if those deals show up, you’re a buyer. Well, the opportunistic business is a little different because it’s I I call it story investing. Where when a broker calls there needs to be some kind of story why is this for me and why can I why could I or some other sponsor solve the problem and achieve that you know 18 or 20% IRR instead of you know investing in safer things and making that you know 8 or 10% IRR.
Greg Mausz 05:14
So, as you come across these deals. How are you evaluating the risk of any given deal, I mean how are you looking through that story as you mentioned and and and sifting through and saying oh that could be a good story that’s going to have legs and that one, we’re just going to avoid that story?
Bill Shopoff 05:31
Well, I think you’ve you’ve got to look at both your upside. Look if if you’re doing an appropriate underwriting of an opportunistic deal, you get the upside pretty easily if you’ve got a decent deal, now it’s how do you figure out how to protect your downside. So maybe that’s buying what we would call a covered land play. Where I’m buying something where there’s an existing use where I’m at least covering downside, or at least most of my downside. But I’ve got a substantial upside from the change in use. That might be a good risk mitigating factor. But I think the other way to do it is by building a portfolio of assets, by not going on in in and saying great I got this one great deal and I want to bet all my money on that one great deal. I I think that’s not the way it should be done. I think you build a portfolio of assets whether they’re core assets for that investor in core. But for us as you know as opportunistic investors we think you’ve got to have more than one to create a portfolio, and then you want to allocate your capital appropriate across that portfolio in the event that one of your ideas doesn’t hatch you’re still doing OK.
Greg Mausz 06:41
So, Bill financial advisors broker dealers registered investment advisors they believe in growth they believe in diversification, but what advice could you give them on how they should evaluate or pick a real estate manager that’s focused on opportunistic investing?
Bill Shopoff 06:59
Well, I think it’s part of their diligence and they should run diligence in any advisor any sponsor that they’re gonna do business with. But as part of that they should be looking at track record and I think part of track record is does that sponsor have longevity through cycles? Have they managed through one or more cycles and they’re here to talk about it today? I think the other part is did they learn maybe you could focus when you were questioning them. Pick what what what deal did you do that went great and tell us everything went great and then what deal did you do that didn’t go so great and what did you do about it maybe what did you do to mitigate your loss maybe you lost less and what did you learn from it?
And I think those are good questions look it’s not like real estate is a perfect science even core investors could lose money. And I could point to a number of examples of really smart money losing money on what we’re perceived to be safe investments. But clearly in this space things do not always work to perfection. You count on doing some things and they’re all not necessarily within your control. So, then I think it’s what have they learned from their mistakes? And how are they how are they going to manage that going forward? Did they adapt to it? Did they maybe they changed their leverage components other things that work in their business so that they’ll be better geared towards you know recession or some other blip in the system that they have to manage through.
Greg Mausz 08:25
Thank you. Opportunistic investing generally has a little more risk associated with it. We spoke about kind of mitigating some of that risk by investing in a portfolio of deals. But getting down to a specific per deal basis, what are some of the tools or tactics you use to mitigate risk on a per property level?
Bill Shopoff 08:46
It all starts it pre acquisition diligence, much like the sponsor doing you know the the Rep doing diligence on a a sponsor. We spent an exorbitant amount of time doing diligence on each asset. We understand the asset we understand the physical properties of the asset, whether there’s environmental issues, what the geology might be what land use issues are. And then we evaluate our primary business plan. I use the analogy, once Upon a time I was a flight attendant on a corporate jet fleet, and so when I get on an airplane, I actually still look for the exits. My intention is like yours to go back out the way I got in, but you know in my real estate deals I look for alternative ways to get out of them. And so maybe we buy an office building that we think we’re going to rezone as condominiums, but we can’t get that done so we got to do the lease up on the office and sell it as an office building. So, we want to know more than one way to get out of a deal not just the way we’re thinking about getting out of it. And I think that’s what any opportunistic or value add investor should have is is multiple departure strategies should the original plan not work.
Greg Mausz 10:03
Makes a lot of sense. Bill thank you for walking us through some of these details when it comes to opportunistic, and value add real estate investing.
Bill Shopoff 10:11
Happy to be here thanks for the time.
Greg Mausz 10:13
And thank you for watching another episode of Focus on Alternatives. For more information about real estate investing or alternative investments please visit adi.sa.org, thank you.
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