WIN188. The Fund of Funds Strategy - Diversify Your Real Estate Portfolio with Mark Khuri

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AJ: Alright. Today we have Mark Khuri with SMK Capital Management coming to join us on the podcast. Mark, thanks so much for coming on the podcast with us and you know we usually get started by just why don't you just tell us a little bit about yourself and kind of like how you got into real estate in the beginning and kind of what brought you to where you are now?

Mark: Yeah, thanks for having me AJ. Good to be here with you. So how I got started? Gosh, twenty five years ago, give or take. Was in corporate finance for a number of years working in a cubicle with another coworker, you know, a lot of spreadsheets, AJ.

And he pulled one up that was a pro form a of a fourplex that he was looking to buy and manage and renovate. Gosh, he had like such amazing projected returns on that spreadsheet. I still remember today and I'm sitting there like, what is this? Can you really make that much money just by

AJ: is this really is this really real?

Mark: Yeah, exactly. So that was one of my earlier memories. But yeah, essentially started investing in real estate at the age of 25 and that was 2005 and while working full time, you know, very active real estate agent buying, renovating myself, managing everything myself and doing it after work and on the weekends, of course. So, yeah, that was the early days, partnered with my family for the next several deals after that. Brothers, parents, aunts, uncles, cousins.

There's a lot of Khuri's involved. That's our last name. And so we did about a dozen different acquisitions, predominantly all single family, small multifamily, distressed buying from the bank, all cash, boarded up type houses for pennies on the dollar from what they were being sold at just a few years prior. And so by 2010, I was hooked and left the W-two and formed our company, SMK Capital Management, partnering with my father at the time. He's since retired really to create syndications and funds and invest in a lot of different stuff.

And so over the years, we've essentially, I think we've created and managed over 70 different partnerships with investors. We've invested in over 150 different properties across three dozen states with different sponsors, operators, and also being a sponsor and operator ourselves in single family and small multifamily. So I'll pause there, done a lot and learned a lot over the years too.

AJ: Yeah, that's pretty cool. So with the corporate finance, did that kinda give you a background into how to start setting up funds or, like, do the syndications? I know that I mean, for for us, we learned about syndications on bigger pockets, but it was, ten years later from what you're talking about. So I'm just kinda curious about that. Yeah,

Mark: not directly. Corporate finance was a good stepping stone in analysis, budgets planning. I was an internal auditor for several years and so these kinds of roles really helped with more on the spreadsheet analysis projection side, AJ. Operations, I learned a lot of that through owning and operating 60 of our own properties over the years in multiple states with team members. And so a lot of hands on through also my father was a real estate investor since the 1970s.

So it's kind of been in our family for a long time. But really to get to the answer to your question is like how do you learn some of the technical aspects of creating a fund and managing it and syndications? It was a few ways. One, paying expensive attorneys to teach us. That's what I would call the hard way of doing it and learning directly from the legal aspect, which is important.

Of course, you need to know the laws, you got to know how to structure things properly. And so the first, I think, formal fund we created, you had a pretty big ticket upfront to get that created properly informed. But that was sixteen years ago. And so at this point, you learn a ton through doing, you also learn a ton by investing in other operators' deals, right? And so as an LP, we've been an LP personally in over three dozen deals as well, just through my personal family investments and my retirement account as well.

Was that that was

AJ: that something you did before you started doing your own funds or was that something that kind of came afterwards?

Mark: Yeah. I'll I'll kinda share a little bit of the progression. So when we first left the w two, we went out to our local friends and family, you know, had them over to our home and our basement and a PowerPoint presentation and food and drinks about a blind pool fund that we were creating to basically piggyback off of what we were already doing as a family for the last five years, buying some of those deeply distressed assets I mentioned earlier. And so that essentially was our first formal capital raise, AJ, in our basement in Upstate New York where I'm originally from. And it didn't go great, to be honest with you, we didn't raise that much money and

it was 2010. So I think a lot of people were just, know, hesitant. The world was upside down, right? Yeah. So, but we dove in and we just kept going, but we were essentially an operating partner for seven years from that point till 2017 in all of our deals as, picking the paint colors, financing, determining when to sell, when to refi, managing everything from A to Z.

But at the same time, the reason why I mentioned this, when I left the W two, I had a four zero one k sitting idle and I transitioned a lot of those dollars into a self directed IRA and I started networking my tail off. You know, back then it was all in person. There wasn't really Zoom and the Jobs Act hadn't passed yet and so you had to shake hands and listen to people speak. And so I had notebooks full of notes of information and just a sponge for for learning and education. And that was a big part of, hey, I wanna invest as an LP, some of my retirement dollars into these other real estate sectors that we're not experts in or don't necessarily know how to operate.

For example, mobile home parks, we started investing as LPs in mobile home parks in 2012, and then it kind of just spiraled from there. We made over 20 LP investments over the next few years into a bunch of different real estate sectors, oil and gas, senior housing, student housing, vacant land, promissory notes, tried a lot of stuff while being an operating partner and essentially determined, you know, which lane we want to focus in, where's our specialty, where's our risk reward profile that we're really comfortable with that we think can provide our investors with great returns, but essentially lower risk than some of the other areas we tend to avoid. Yeah. So it's a lot of process of trial and error and education along the way.

AJ: So what I'm hearing is you kind of spread spread out far and wide and kind of figured out like what it is that you're good at and then double down on what you're what you're good at.

Mark: Yeah, I mean by 2017, we decided, hey, let's look at the risk and reward of these investments we've been making as a family into these LP deals versus our GP operating partner investments. And we found and again, we were in single family, small multifamily as a GP and the window for deep discounts was closing. We saw that coming for a couple of years and we kind of knew that single family historically has been more correlated to the economy than some of these other sectors. And so we essentially asked our investors like, hey guys, here's what we've been doing as a family in addition to the deals you're invested in. We've also been investing in mobile home parks, self storage, some industrial, these other sectors.

Are you interested in diversifying, getting access to these as well? And everybody pretty much said yes at that point, AJ. So we pivoted and started, more syndications where we partner with other sponsors and operators that are specialists in one real estate sector and raise capital in a fund or syndication style where we manage all of our investors, their distributions, their K-1s, their tax returns, the quarterly updates, bookkeeping. We do everything in house, but operations is on our operating partner side for those deals. And so our investors knew and liked and trusted us and essentially stayed with us and we manage everything for them and they still communicate directly through SMK versus having all these operating partners that they have to learn about and know, like, and trust and of course

AJ: Well, it sounds it sounds like they trust you to go and vet these other sponsors and talk to these other sponsors and do all the due diligence around making sure that they're not gonna walk off to Mexico with your money, right?

Mark: Exactly. Yes, that's a big part of it. We've seen a lot and done a lot. We've got a lot of pretty intricate processes and systems in place to make sure we're picking the right people and the right deals whenever we can, of course, get a special kind of situation where, you know, honestly, like, just to be frank, we look at about 600 to 700 different investment deals a year, all in real estate, and we invest in maybe 1% or so, AJ, and so it's saying no all the time and then just trying to find those handful of deals that kind of you just say, wow, I need to learn more about this, like this is one heck of a story and look at the risk reward profile on this versus the other one. It's gotta have something unique.

And so that's what our investors are relying on us for is to find those special deals.

AJ: Yeah. And I'm not sure I exactly heard, but, like, I think you said you started creating these funds and it didn't go well raising money back in the bottom or the basement in in New York. Like, kinda tell me a little bit more about how that progressed.

Mark: Well, I mean, we, we started out with a blind pool fund, which is very hard to do in 2010. It was a thesis. Right? It's

AJ: it's pretty hard it's pretty hard to do if you don't already have investors that have, like, senior track record and know and like and trust you, they're like, wait a minute, you want me to just blindly invest in in what you're doing? So

Mark: And that yeah, exactly. But we, you know, we dove in head first, I like to say. And so that's what we started doing because we were already buying specific property type in a certain location where we had a team on the ground and we had some case studies, but it wasn't a fully established ten year runway profile track record, etcetera. But that's how we got started. We basically said, hey, we're going to kind of repeat what we've been doing already and you guys want to come and invest with us and created that fund, which again, legal docs, operating agreement, formation, done through quite expensive attorneys at the time.

And you kind of just snowball from there. You do another, do another, do another. We've created 70 over the years of those different types of entities and different investments and grouping of investor capital to go and invest in real estate.

AJ: Nice. And so, I mean, in some aspect, what you're talking about is so you create a fund and have multiple investors invest with you and then you use that essentially capital to invest in multiple different sponsors or do you do it just for a single sponsor for a single deal? I mean, I think that this is like the fund of funds kind of model, from what I understand. But maybe maybe for our listeners, why don't you give a definition of what you believe the, like, fund of fund model is and how it works?

Mark: Yep. Yep. So essentially, fund of funds is where investment manager, let's say it's us, SMK, creates a special purpose vehicle, an LLC, where investors will invest into that. And that LLC has its own operating agreement, its own PPM, its subscription documents, bank account, tax filing, you name it. That LLC will then go and invest in other LLCs, other operating partners deals as either an LP, GP or a JV type agreement.

We're almost always negotiating better terms from our operating partners, AJ, than what an investor would get on their own if they went direct to any one of those deals. And so the economics have to make sense, you know, net to the investor because SMK or the fund manager, fund to funds is obviously not doing this for free. There's gonna be a split into some type of promote structure in addition to the GP's profit share split as well. And so you got to be careful of fees. If you're an investor, make sure you're very much aware of how the net return is being calculated to you.

And from there, we essentially, what we do today, AJ, and have been for many years, we don't create a blind pool fund anymore. We did that once and we learned our lesson, not the best way to do things. So we will create a fund when we see two or three investments that we really like and want to invest in right around the same time and then that'll snowball. So for example, we just recently closed our Alternative Fund IV, which was opened twelve months ago. And we, at that time when we opened this fund, AJ, we had identified three investments that we wanted to invest in.

One of them was fixed income debt fund. Another one was a mobile home park income and equity, excuse me, income and growth, and then the third one was an industrial portfolio. And so we put those together, launched our fund, started raising capital so that way investors knew, hey, you're already gonna invest, your capital is gonna be spread across these three first deals and then over the next six, nine, twelve months, we're gonna keep the fund open and we're gonna continue to raise and deploy into what we hope to be more amazing deals that we can source and find And that way, in investors, capital is spread across all of the deals in the fund and they get diversification, income, growth, tax advantages. They can avoid high minimums because we're aggregating capital and we do the math like if somebody had access to all of the deals in our fund today, there's nine of them that we invested in, AJ, over the last twelve months. They would have had to have 1,200,000 just to hit the minimums on each So that's kind of how we look at it and essentially our investors rely on us for quarterly updates, communication, progress reports, tax returns, distributions, k ones, you you know, you name it.

They just deal with with us and not all of the nine operating partners.

AJ: So they get a bunch of the benefit of diversification, in the investments without the kind of essentially initial upfront capital, and then also without the initial, like, upfront due diligence. Like, that's you guys are really doing all the due diligence on these sponsors. I mean, you talked about, you know, back before, Zoom, you were shaking hands and and doing that marketing, like that's a significant amount of knowledge that you've acquired over the years, You know, that if someone's a doctor's working forty, eighty hours a week or something like that, they just don't have the time to go do nor necessarily do they want to, right?

Mark: A 100%. I mean, not all of our investors are passive. They're busy. They've got too many things going on in their lives. They want a portion of their portfolio to be allocated with a fund manager that knows the space really well and can, of course, vouch for investments, do enough due diligence where we're passing on almost all of them and just cherry picking the few that we think have a high likelihood of meeting or beating the projected returns.

That's always the goal of any due diligence of any investment that you're going to make. And so that's what they rely on us for. It's very passive for them and essentially providing them an investment vehicle that they can't create on their own and maybe don't have access to most of these deals either as well. I mean, some of them are relationships, They've been in the business for sixteen years formally. So a lot of our deal flow is, hey, Mark, we got one in LOI, take a look at a pro form a.

Do you want to jump on a call next week? Tell us what you think if you guys want to get involved. That kind of relationship really is where we get a good number of our deals from.

AJ: Yeah. I mean, you know, as a sponsor ourself, I'd much rather just come to one person and do a JV, partnership on a really good deal as opposed to talking to twenty, thirty investors. So I I understand where the the benefit comes in. Can you talk a little bit more about I mean, I get that, you know, the minimums is a kind of a hurdle for investors, but, I mean, with investing more money from a fund to with a sponsor, you said that you get some other, I guess, kind of benefits or preferred pricing. Like, you expand on maybe not exactly, but like kind of a range of what that maybe looks like?

Mark: Yeah, I mean, it's essentially through over time, relationships are formed with other operating partners where we are investing multiple $6.07 figures with them. Right, AJ? So they look to us as more of an institutional partner that is going to deep dive on due diligence much more than any individual investor would do, at the same time write a bigger check, right? That's just be transparent, that's how we help our operating partners. And so for doing so, we're often able to negotiate more favorable terms than what an investor might get on their own.

So I'll give you an example. One of our operating partners, really good at what they do, mobile home parks and self storage, they've got almost 1,000,000,000 on assets under management, AJ, and they provide their investors a 7% preferred return and a sixtyforty split above that. We negotiate a 9% preferred return and an eightytwenty. And so that's what our fund receives. And then we add in SMK a again isn't doing this for free, so our investors at SMK's entity level will get an eight or 9% preferred return and 70 to 80% profit split above that.

And so the net return to our investors is the same, slightly better coming through SMK than what they would get if they went direct to the operator. So that's one example. Sometimes we will negotiate lower management fees, sometimes we'll get favorable voting rights depending on how much equity we are for the whole deal. We might have the ability to say yay or nay to an exit strategy, a refi, a capital event, they might have to come to us first to get that approval. And then throughout the whole process, access to financials on a regular basis.

We are on asset management calls with our operating partners monthly or quarterly, depending on cadence needed and just essentially managing it in much closer than what an individual would be able to do on their own.

AJ: Yeah, well, and, you know, from your guys' standpoint, you've got significant more capital than just a regular investor normally would too. So there's a fiduciary responsibility that that needs to take place and again, it's your business. So that's like where, you know, what the investor that's investing with you is essentially paying for is like, you know, the peace of mind that someone's watching it and knows what's going on all the time.

So that's pretty cool. I guess like, you know, other than shaking hands and, you know, I hear that you're looking at like 700 deals or so, like, how do you determine that, you know, I guess maybe going into like the due diligence of the sponsor that you work with, like, what's what sort of like goes into that or what do you look for?

Mark: Yeah, I mean, it's it's a process for sure, AJ. The people are harder to underwrite than any any property, to be honest with you. So we're we're always looking for pedigree, right? Are these folks, this group, this sponsor really good at their specific real estate sector that they're specializing in? You want to look at the credentials, right?

How good are their track record? How long have they been in the space? How built out is their team? What's their AUM? Most of our operating partners are $500,000,000 to $1,000,000,000 plus in assets under management.

Built out teams, track record. When I say teams, you know, that's critical, right? You think about acquisitions teams, asset management, back office, all of that has to run smoothly in order for investment to perform well. And any hiccup in any one of those roles or understaffed in any one of those roles, it starts to show in underperformance. And so all of that's important.

We will oftentimes sit down, interview the asset managers, the acquisition teams, other folks that are in the back office to really try and get comfortable with everybody. Right, AJ? And so it's a lot of interviewing questions, analysis. It takes can take months, if not some operating partners we've vetted for over a year and a half before making any investments with them. And then a big one for us is communication and transparency.

And so right out the gate, I'm trying to feel for how open are these is this group to sharing financials, sharing reporting. Is there a reason they don't want to, a hesitation? How slowly or how quickly do they respond to emails? You know, how easy is it to get them to jump on a call? Like, all of this stuff matters to us.

And so a number of operating partners, you know, may look great on the surface, but once you start to request a lot from them, you find out, you know what? This isn't gonna work for us. If we're not gonna be able to get clear transparency, communications, reporting, financials right out the gates, forget it. It's just not a good fit because we are looking for folks that are really good at what they do and are able to respond within forty eight hours to any type of request, give or take. If we want to see financials, reporting, projections, we'll sign an NDA and show it to us.

Right? And so that's the reality of how it has to work. From there, fee structure, alignment on terms, all critical as well. And so this is a bit of the operator sponsor due diligence that we do and the type of groups that we're looking to to partner with.

AJ: Nice. Yeah. The, I mean, we do mostly multifamily and kind of like small stuff like you had had said. I mean, I think, you know, over the last year we purchased like a 40 unit and a 30 unit, couple 10 units here and there and whatnot. But I'm looking to get to that, like, you know, over 500 AUM, I would say.

So, you know, I guess so what you're saying is you're looking for someone that's like been in the business a long, long time and, with, I guess, kind of like my inclination in the in the market in the last, like, three, four years as interest rates have risen, like, how, I know that in in the market, there's been a lot of kind of turmoil. I mean, how does that kind of factor into the current due diligence and and maybe reevaluating some of your existing partners?

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Mark: Yeah, I mean, obviously, you you and I were chatting a bit before we we recorded and I mentioned that we think this is the best investment timeframe period, time to get in that we've seen since 02/1989. Yeah. And the reason why is because prices are down 30 to 40%. I mean, commercial real estate is on sale. It's having the biggest sale we've seen in a very, very long time.

And so it's a great time to be buying. It's it's like

AJ: the it's like the biggest value add you can get right now because you don't have to do anything. You just have to wait for interest rates to go down and the cap rates to go up. And all of a sudden there's a shit load of equity created.

Mark: If that happens, right? We don't want to underwrite to that, AJ. Yeah. We're always cautious about expecting interest rates to go down and expecting cap rates to go down. So if that happens, yes, there's going to be a flood of money coming into the market.

You're 100% right. And we've seen that in the past. But today it's just it's prudent, very prudent due diligence and asset selection. So we invest in a number of different asset classes, self storage, mobile home parks, industrial, private debt and also some multifamily. Some of the things that we're constantly looking for in a deal, you know, I'll just start with positive leverage day one.

We wanna see the going in cap rate, you know, a 100 to 200 basis points spread above the borrowing interest rate. And so that is really hard to find just in today's market. So that right right away eliminates a lot of deals. And the reason why we like that, AJ, you know this, but it will help create positive cash flow day one. We love cash flow, and so that's a big part of how we try and invest.

Most everything we invest in provides three to 7% cash flow starting in the first year, and then it tends to grow to an average of seven to 12% annually while we're holding. And then we want, you know, average annual ROI, call it in the low to mid teens, equity multiple 1.5 to 2.5 x. So those are our projected returns over about five years, that's what we're trying to find. And also making sure it's somewhat realistic, right? You don't wanna I could take a pro form a tomorrow and change the assumptions and make it look much better in five minutes.

That's what we

Ad speaker: gotta watch out for that and make sure

Mark: that we think there's some realistic assumptions on revenue growth, expenses, value add, NOI, you name it. So there's a lot of underwriting, stress testing, downside scenarios we're constantly looking at. If all hell breaks loose in this market, something happens, how low can it go before you're really in trouble? And so that's how we think about things. I think it's very much risk first is how we look at almost every deal versus upside potential.

And I could dive into any specifics, but let me shift back to you and see what that brings for you.

AJ: Yeah, I mean, risk is definitely something to mitigate as much as possible. Just making sure you get your capital back. You know, I think maybe I'll rephrase my question of like, you know, real estate's on sale now and there's been like some turmoil with some sponsors. That, I mean, is that a red flag, if you're evaluating a new sponsor or is it like kind of understandable or?

Mark: Sure. I mean, it depends, right? Are they are they about to go bankrupt? Like, how bad has it been for them? Yeah.

Versus did they make a few deals in 2021 with a certain type of financing and capital structure that didn't hold up and they don't do that anymore. And they're going back to more, I would say, conservative fundamentals and structure. So there's absolutely a case of, hey, we got stung during the rate increases from 2021, 2022, but here's what we're doing now and we've been doing this for fifteen years and that kind of story. Absolutely, you can overlook some of those hurdles, those underperforming assets or if they have some losses, we'll want to know about them for sure. What happened?

Show us the deal. What did you do to try and solve it? Did you get a loan modification? Did you invest any personal equity into the deal? Did you have a capital call?

Like what have you done to try and solve these problems? And then how does that deal compare to maybe some of the current deals they're doing in today's market, AJ? And so I hope that answers the question like it's Yeah. A red line, like, oh, these guys are out. Unless you've heard and seen, you know, there's just blood in the streets on everything they're doing, then we don't wanna go near those those groups either.

AJ: Yeah, that's understandable. Yeah. Well, what else do you do to, like, mitigate risk? I mean, so I hear a bunch of due diligence on the sponsor, diversifying across, like, different types of investments. Like, is there anything else that you would suggest to, like, mitigate risk?

Mark: Yeah, I mean, for folks doing this, there are some red flags that pop up right away that you can look out for when you're looking at deals, right? And so some of those are obvious, some of them aren't as obvious, but I can give you a couple thoughts on here's a red flag, right? One of them might be a really high acquisition fee. We've seen some groups lately charging 4% on purchase price and then you see a whole bunch of other fees built in, right? So you want you want to look at is purchase price versus all in cost.

If that delta is too big, you know, you're gonna have to see, like, I'll give you an example. We saw a deal recently with a large multifamily sponsor. The delta between purchase price and all in cost was like 35%, AJ. So I'm gonna make up a number, let's say purchase price was 50,000,000, total cost was what's 35%, call it 65,000,000 give or take. Okay.

Means the property needs to appreciate by $15,000,000 just for you to break even, right? That's just your starting base case because the all in costs includes all these other fees and expenses and CapEx and you name it, and so we always pay close attention to that. So if you see a big delta, call it more than five or 10%, you're gonna wanna be a bit cautious.

AJ: So the the overall property's value needs to increase by 15,000,000 to like just to get your money back, right? Like, if you're looking at the end of like what they're gonna sell out in five years, it needs to go even further than that. It probably needs to go up to like 85,000,000. Right?

Mark: Correct.

AJ: So the way one thing that like I do wanna like say to the investors though is like, that doesn't necessarily that mean that your NOI needs to appreciate by that much. Because your NOI is based off your financing and you only have to So your equity is typically like 25 to 35% of the money into the property and then you've got 65% of the bank financing. So that 35% needs to essentially like double. So you you may only need to increase it by, you know, 30% of the actual NOI. So like the the rents and the income coming in.

Right. So it's there's a there's a that's what the I mean, from my understanding and that's what the beauty I think of real estate is that you get this leverage from the bank, that you just don't get in other markets.

Mark: That 100%.

AJ: Mark, do you wanna like explain that again and maybe another way too? Like, it's always good to hear it in a couple different ways.

Mark: Sure. Yeah, I think you're spot on. So as I mentioned, we're talking about asset value going up 15,000,000 in this example in order for you to break even. But what AJ is also adding, which is equally important, is that doesn't mean the net operating income needs to go up by 15,000,000. That would be exorbitant, right?

And so a quick way to look at that is what's the starting net operating income? We look at the seller's trailing 12 financials, trailing 24 financials of the seller and extrapolate out where we think it can go based on our business plan, what we're gonna do to grow the net operating income, how quickly, and then that's where conservative versus aggressive assumptions come into play. But essentially, if you're looking for a lower risk investment, you're gonna see net operating income starting, you know, at the number pretty close to where it's already been at for the last couple years and maybe just going up a little bit, maybe 10% to 15%, maybe 20% over the next five years. That would be a pretty conservative jump versus other deals, which maybe there's a heavier value add and you're gonna renovate the units and you're gonna do all these other things manipulate NOI growth, you might see NOI growth go up 80% over the next five years. But to get from here to there, you get it, it's a lot harder and you have to do a lot more and there's more execution risk to be able to create that value than maybe the lower NOI growth deal and so if that is the business plan, you should be rewarded with a higher return because you're paving on more risk.

That's what it comes down to for us. Yeah, we always look at risk reward.

AJ: So actually kind of that kind of brings a point of like we stay far away from developments and the the the term that you mentioned there was execution risk and that for us, like, just we foresee developments like the unknowns with the city, the permitting. There's just a ton of stuff with development that that execution risk, just goes absorbently or exorbitantly higher than a purchase and kind of a rehab. And typically, we see on, like, those deals is, like, the the rewards are not compensatory with the amount of risk that's associated with it. Is that kind of like your well, what are your thoughts on kind of development and those deals?

Mark: I think you said it perfectly, AJ. Yeah. Just to to kind of comment quickly, we don't do a lot, very little, if any, development, new construction deals. Again, we like to invest for cash flow and of course there's no cash flow if you have a deal that hasn't been built yet and isn't producing income. Construction costs have gone up.

You know, we've seen, as you have, more deals miss their projections than those that actually hit them or beat them Yeah. From a time delay and a cost overrun standpoint. And then you also have the cost of borrowing on construction loans is really high. And so there's a reason why construction starts are down now, what, 50% on multifamily across some of the Sunbelt regions. This just doesn't pencil anymore, guys.

It's too expensive to build. Again, I'm speaking generally. There's always exceptions where it can make sense. But for me as an investor, those types of deals tend to have a slightly higher projected rate of return, AJ, but they come with, I don't know, three, four times as much risk, maybe five times. So the risk reward is out of line in my opinion, right?

If I'm going to take on development risk, people probably are going to scream at me, but I want to see a three x, right? That's what I want to see. For sure. I don't want to see a two x. Two x is what we're underwriting on some of our value add deals that have cash flow day one.

So

Ad speaker: But I

AJ: I think that investors get caught up with and it's like the sexiness of it. Right? Like, I wanna be in this brand new building that looks, you know, awesome and these architectural drawings that look amazing. Like, oh, of course, this is gonna work. This is gonna be incredible.

So Sure. Yeah. Always I've

Mark: always overruns, time delays, expensive debt. It's it's a tough uphill battle.

AJ: Yeah. You know, one thing we may have not talked about with risk and risk mitigation is what about markets? Like, these sponsors, I'm assuming operate in different markets. I think you said you wanna pick sponsors that are super familiar with their market or have been there a while, but do you stay away? Like if you see a certain market not going in the way that you want.

And the reason I'm asking is we we operate in Portland our market right now is, significantly, you know, nationwide. We're we're probably a little bit down. But again, that makes for a good buying opportunity. But I'm curious kind of your view and how you calculate that risk or how you look at it.

Mark: Yeah. Mean, markets are obviously very important, AJ. We all know real estate is market specific and it can adjust in five miles. We can be in a completely different market, even less, right? So but what we also look at because we invest in multiple real estate sectors.

And so, for example, a mobile home park isn't gonna be in the same type of market typically that a apartment community might be that we're looking at. And so we are a little bit more market agnostic depending on asset class. So for mobile home parks and self storage and some industrial, not all industrial, but some were were typically in secondary and tertiary markets. Why? Because we're looking for cash flow.

We're looking for affordability for housing when it's mobile home parks, for example, or even some apartments. But generally speaking, we are investing in the Midwest, the South, the Southeast. We're looking for markets where, you know, honestly, on apartment communities, AJ, looking at a two bedroom, the rent is usually a $1,000 to $1,800 a month. There's not we're not investing for $3,000 a month type communities. Mobile home parks, we wanna make sure we are within close proximity to a major MSA, you know, usually twenty minutes.

You wanna have a good strong 500,000 ish population center not too far away. You want to be able to make sure that the community you're looking at is affordable based on the local area median income. How much money do folks make in this area? What is the cost of living and the cost of the rent that they're going to pay? And then, of course, you know, look at comps and try and determine supply, right?

That's a big one for us, especially with self storage. You have to be very careful in self storage. If a local community is oversupplied, we'll stay away right away. That's a big red flag for us. We won't we won't touch it because it's gonna put a hamper on rents, occupancy, all your projections.

New supply can crush old supply performance on self storage very quickly overnight, and it could take years to recover. And so that's a bit more, you know, down to the granular micro market, you know, this specific zip code, how much storage supply is there versus vacancy, occupancy, demand and how easy is it to build new. And self storage, for example, is one of the easiest sectors to build new and the new shiny one competes with the old shiny one. Just got to paint it. So there's not much to it from a differentiating factor versus apartments, you'll see a big disparity in price run on a 1980s apartment versus a 2020 built apartment, right?

The rents will be staggeringly different. Yeah. Twenty thirty is always the case.

AJ: Twenty thirty, sometimes 50% different. Can be huge.

Mark: Exactly. Exactly.

AJ: Well, very cool. Well, is there anything else on risk that, you maybe want to talk about or on fund of funds before we move on to the the last four questions?

Mark: I mean, some of the things you look out for, again, going back to underwriting deals, some red flags. I know a lot of our folks like to hear about what we're staying away from, but, you know, capital structure, right? If there is preferred equity ahead of common equity, especially if the amounts and terms are undisclosed or subject to change, which we see on all these deals, We just tend to stay away from that, AJ, because it just acts like more debt and it increases the risk for the common equity, but it also increases the return for the common equity. And so that's why a lot of operating partners will have preferred equity ahead of common, but we tend to stay away from that type of structure. And then as far as, you know, debt goes, you know, sixty, seventy percent max is is pretty good.

We have some operating partners that don't go above 50% loan to value I'm talking about and fixed rate debt, for at least five years is what we're pretty much almost always focused on as well. So that allows you time if something should happen where you're not forced to sell at the wrong time. That's that's the reality of how you lose money in real estate, forcing to sell at the wrong time.

AJ: Yeah. Yeah. If you can stay the course for, wait for the rents to come up or, you know, implement, get some, you know, keep doing your value add plan or whatever you need to do to make the cash flow, like holding on to real estate over the long term is where the benefit is. We mostly operate in like forced value appreciation. So typically our stuff's, you know, six months to two years to kinda get stabilized and then wait it out and then hopefully sell for a good price and unless interest rates keep going up.

Mark: Of course. So we'll see.

AJ: Yeah. We shall see. It's, it definitely seems like inflation is starting to creep up again, so it's, not looking the best. But, I mean Right. My brother and I have always, you know, said, like, as long as you keep buying real estate, yeah, even on the ups and the downs, you'll always hit the bottom.

Yeah. You might hit the top. But as long as you keep buying, you're you're still gonna it's like dollar cost averaging in the stock market. So it's like Agreed. Keep keep putting stuff together, keep doing it, and, should be should be good.

Alright. What do you think? You ready for the last four questions?

Mark: Yeah. Let's do it.

AJ: Okay. So first one, what's one piece of advice you would give to your 25 year old self?

Mark: 25 year old self. So I think it would be start building the network earlier. I know that might sound cliche, but it's so important in our business who you surround yourself with, who your investors are, who your operating partners are. And just build it as early as you can and take good care of those folks throughout the process, right? So focus on people is a big one.

I think I would have started that earlier for sure.

AJ: Yeah, that's that's good. I mean, I know that my brother and I have had several mentors during our years, and then also our dad was in real estate too. So, very similar background story. But, yeah, keeping keeping those people that you can call and you don't have to pay a lawyer to, give you that advice is pretty awesome sometimes.

Mark: Yeah.

AJ: Alright. Next question. What was your first entrepreneurial endeavor?

Mark: Oh gosh. I mean the first one that pops up is, you know, buying a condo in Los Angeles at probate court not knowing what the heck I was doing. So yeah, it's a great story but was very young and didn't know what was going on. I thought I already owned the property and I was there to just get the deed and sure enough, I'm at the courthouse steps and the judge asks if anybody wants to bid higher than what my bid was, and I didn't have any more money. And so two guys raised their hands and they essentially were outbidding me, but something happened, they went up to the judge's desk and their checks were made out inaccurate and so they didn't qualify.

And then I'm sitting in the elevator leaving and I got the title and sure enough, one of the guys is standing right there and he's like, Oh, you're that kid that got the condo. He said he just lucked out buddy. Wow. You're like, my gosh, I don't even know what's going on. I thought I already owned this thing.

AJ: What? So do you have? What do you I can explain to me? How did you think you already owned it?

Mark: My real estate agent didn't know what he was doing either, AJ.

AJ: Yeah. Okay.

Mark: So he said, Oh yeah, we just gotta go to this meeting with the judge so he can give you the title. And so I show up to court and there's like, you know, 20 people there and you realize we were just bidding on it. We hadn't actually won yet. And this was the final process to get all the bids one more chance or something. Again, it's twenty plus years ago.

I don't remember all the details, but he was shocked. He didn't know what was going on either.

Intro speaker: Wow.

AJ: Yeah. I we've we've got a contact that's done a lot of, auction bidding and that sort of stuff. And he buys his his businesses. He buys, like, the first right of, was it redemption rights? So if you pick up a court if you pick up a property on the the steps, the original owner has six months to redeem it for that price.

And so he picks up the redemption rights, lets the people go fix it up or do whatever, and then is like, hey, you know what? Look, this looks pretty good. I think I wanna buy it for what this is. It's like,

Mark: woah. Yeah. Yeah.

AJ: So if you're if you're buying auctions, make sure you get the redemption rights from the previous owner.

Mark: Excuse me.

AJ: Alright. Next question. How has your formal and informal training shaped your journey?

Mark: Yeah. I would say, the formal part just being working in corporate finance we touched on earlier. That was a big part of analysis, underwriting, you know, pro form a projections, stress testing deals, sensitivity analysis has all been a big skill that we've learned through some of that formal education, A. J, and working in corporate finance for a number of years. And then informal is just very hands on, also through my family and their experience in real estate, my father specifically.

But, you know, if you own and manage rental properties in your twenties, you're gonna be busy just managing the tenants, leasing, posting them for rent, working with lawyers on the right legal terms, evicting, you name it, right? Posting three day notices, you learn all that stuff. Just dive in and get going and figure it out. Right?

AJ: I mean, back in the time you were doing it, it's like holding open houses and giving it to the most qualified tenant.

Mark: 100%. And one thing I learned, if you have a very small room. Put an air mattress in it. It makes it look much bigger. Right?

Don't don't rent it if it's empty. Put put some some furniture in there. Just it honestly makes rooms and spaces look much larger and they'll rent quite much quicker.

AJ: Interesting. Very cool. Alright. Last question. What was your biggest mistake and what did you learn?

Mark: I don't know if there's a specific one honestly, AJ, that comes to mind. I'll say this, right? Real estate is a hard business. It just is, right? There's always a challenge that we're solving.

Recession in 02/1989 was a big one. There's no financing available. What do you do? Figure that out. Good luck.

And then values and rents came in. They started dropping in certain markets. What can you do? You got to start cutting expenses, right? There's challenges all the time in this business.

We've had a duplex burned down while the tenants are in there. What do you do with that? Property manager calls you and says, hey, we had a fire and you think they're joking, but they're not. It's like a better deal all of a sudden.

AJ: Like, oh, is it just a stove fire?

Mark: Yeah, no, total loss. And so in that case, we hired a private claims adjuster, signed over a power of attorney and had them go fight with our insurance company and they got us a lot more money than we would have gotten on our own. And so these kinds of little things you learn, that was a big problem that we solved and ended up with a really strong return for our investors there. But you know, obviously there's been challenges all the time, AJ, global pandemic, you know, fastest rate increases in forty years, all the challenges today, tariffs, war, inflation. I just think you gotta have a strong spine, you gotta be able to stomach these kinds of ups and downs, and you're in the problem solving business.

And so, you know, if something pops up, just research the heck out of it, trying to figure out who's dealt with this before. Let me go talk to them, hire a consultant, do what you got

Ad speaker: to do to figure it out.

Mark: How do we solve this? I mean, most things that come up today aren't really new per se, right? There's folks that have been there before and try and lean into their experience and guidance whenever you can.

AJ: Yeah. And some people have made jobs out of it too. Like the insurance claims adjuster you were talking about, like that. Yep. Does it so much that he's like, yeah, this is a job.

So a lot more people have some different knowledge and like you have much more knowledge of doing the fund of funds and asking sponsors how to, you know, create new classes and a little bit more preferred returns and stuff like not something we've done. But Yeah. Well, Mark, it's been a pleasure having you on. I appreciate the knowledge that you've shared with us in our audience. If our audience does want to get a hold of you or learn more learn more about SMK Capital, what's what's a good way to get a hold of you or get in contact with you?

Mark: Yeah, I'd say if you're interested in learning about our passive investments, some of the real estate sectors we invest in, go to our website, it's smkcap.com. You can sign up to join our investor network and get access to our offerings when we have some. And if anyone's in Bend, Oregon, let me know. Happy to reach out and connect. Grab lunch.

Go for a hike. Whatever you want to do outdoors. Very beautiful here. This is home for us.

AJ: Yeah. Yeah. If you're in Bend, definitely float down the Deschutes right in downtown, right? In the summer.

Mark: Exactly. Yes.

AJ: That's always fun.

Mark: Lot of fun.

AJ: Oh, yeah. Fun having another person on from Oregon as well. So

Mark: My pleasure, AJ. Yeah. Thanks for having me.

AJ: Yep. Thank you very much.

Intro speaker: Thank you for listening to this episode of the Real Estate Professionals Investing Podcast on WIN, your community of investing knowledge for growth. We hope that this episode has increased your knowledge and added value to your path to freedom.

AJ: If you would, please take a second to

Intro speaker: rate us so that we can get more great investors to interview. If you or someone that you know wants to be on, please visit west side investors dot com and fill out our form to be on the show. Thank you again,

AJ: and enjoy your day.