What is something that we should think about if we are continuing to acquire more assets directly? Given that we are investing in uncertain times, these assets are associated with legal and financial risks. In this episode, Patrick Grimes, the CEO and Managing Partner of Invest On Main Street, talks about his journey when he started becoming an investor. He also shares his experience pivoting from single-family to multifamily, its pros and cons, and the benefits of shifting. Tune in to this episode, and together, let’s venture into investing in uncertain times!
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Investing In Uncertain Times With Patrick Grimes
I’m super excited to have on the show Patrick Grimes, the Founder and CEO of Invest On Main Street. He has several years of experience in active real estate investment, purchasing distressed assets, renovating, and stabilizing for long-term cashflow. His portfolio includes controlling ownership of over 2,729 units in the emerging markets across Texas and the Southern United States.
He’s also the co-author of an Amazon number one bestselling book, Persistence, Pivots, and Game Changers. He’s inducted into the Forbes Real Estate Council and contributed to Forbes Thought Leadership articles in investing and commercial real estate. I’m so super excited to have you on the show. We are going to be talking about the topic of investing in uncertain times. It’s quite timely for where we are. Welcome to the show, Patrick.
I appreciate it, Lisa. It’s been great getting to know you. We’ve been in masterminds here for many months and see each other almost every other week. I enjoyed very much your contribution to the group. I’m glad that I get to be able to join your show.
I’m happy to have you on. As we’re talking about investing in uncertain times, I want to share a little bit about your story of being in real estate and in a time like this many years ago. How does that impacts your decisions as you continue to invest in real estate?
Many years ago, it made me feel like I didn’t have hair on my head, which I now no longer do. Back in the early 2000s when I graduated college, I very quickly got some advice, “Engineering is great. It’s cognitively rewarding. I have a lot of fun doing it, but it’s not going to provide the financial future that you need. Invest as much as you can as soon as you can into real estate.”
I was a researcher. I did all kinds of research. I dumped a bunch of my earnings, almost all of them into a pre-development. It’s super high returning and leverage, and this was back in ‘06 and ‘07 when the market was never going to go down. I did personally guarantee all those loans and those properties to take a big hit. I learned early on what it’s like to speculate and gamble versus the calculated investments that I do now.
I learned about buying for cashflow with low leverage instead of leveraging to the health and personally guaranteeing everything and hoping for new developments and pre-construction to pan out. That led me towards a path of doing that in single-family, very calculated renovations, bringing them up to the nearby comparables, which naturally led to larger multifamily investments and learning about recession resilient markets and how to do it to ride out downturns.
You mentioned a couple of things. The first one I want to dive into is the single-family to multifamily transition. Some investors who might be reading this are investing in single-family, and you’ve decided over the years to pivot from single-family to multifamily. Can you talk about some of the benefits, pros, and cons of doing that for yourself?
Me having done it before and seeing the way of thinking and listening to the books, the gurus, and then what people say about it, I beat my own path doing the single-family thing too. I figured it out and ran it down. I didn’t know what the BRRRR Method was or Buy, Renovate, Refi, Rent, Repeat. Now that I see the more sophisticated low-risk multifamily, I try to get the message out. I wrote two articles in Forbes. One was about how multifamily can meet and see a family on the race to retirement, but as part of that, it was asset protection and how you have less liability, most legally and financially, in larger multifamily in doing single-family.
It comes down to a lot of most single-family people who don’t even know there’s another path. All they see on TV are these fix and flippers, so they’re drawn in and see a quick win on the end of a rainbow of buy distressed, renovate, and then sell. They don’t realize that they’re personally guaranteeing all this, which means there are so many trips and falls. You can get sued. If the market has a downturn and the bank’s going to come after you, the legal and financial risk associated with those assets. I didn’t know that I was even taking them. Most single-family guys take a blind eye to it.
Given that we are investing in uncertain times, that is something that people should be thinking about if they’re continuing to acquire more assets directly. You also mentioned taking a more calculating investment approach as opposed to speculating. Can you also elaborate a bit on what those entails?
There are maybe four components to it. Some of you might wrap it together, but first, take a look at the prior trends and you see what markets and composition were in terms of employment. Which ones fared well in recessions? What was the big boom, and why? The Las Vegas, the two songs they did, why did they grow and fall? It took several years to recover. Why was that?
One of the markets that did well is Houston, for example, which is why I was drawn to originally build a single-family portfolio there. It only took a few quarters of strong growth and a plateau for it to start growing again. What you find is that there’s a diversified employment-based that is of a nature and recession resilient and that balance is something we look for in both the employment base and the proof through recessions and the properties we invest in throughout the Southeast in Texas. That’s one side.Interest rates are a risk for all deals unless you're managing them. Click To Tweet
The other side is the buy for cashflow immediately. I’m not hoping and praying that I can buy land and title it or improve it, that I can buy a construction that one day we’ll be there and leverage it to the health. I’m buying day one cashflowing assets, which also are low leverage, so we’re using very low down payments in a way where the breakeven occupancies are low enough to where they cashflow and be potentially in a downturn.
You can look up the data for remote workforce housing multifamily, and it only dropped at the end of the ‘80s in occupancy in nice single-family homes and apartments. People move into the workforce housing and existing construction. They still stay busy. If you put enough down so that your breakeven is well below that, even in a downturn, you can ride it out. It’s then about making sure that you can ride it out, locking in long-term debt, or getting a rate cap with extensions for your debt products, so that when you’ve looked at the peaks and valleys, you can bridge that gap in the future.
Before I move on to that, one more thing is coming back to the leverage. You talked a little bit about the ways in which people can structure that leverage, either locking in that long-term debt or getting the rate caps. Can you talk about you mentioned having lower leverage? That’s loan-to-value as people continue to go into more investments. Is there a rule of thumb that you’re looking at as well when you are assessing deals in terms of a threshold for which you find is acceptable?
The combination is how much you put down on the property, which is what most investors think of as a down payment. In multifamily, we call it loan-to-value. It’s the reverse down payment, but then there are other things too to your improvement because we buy properties that are under market, so we can force appreciation.
We can drive those rents up and create value by going to work instead of hoping that the market goes up. We want to start out cashflowing, but then with upside. We want to have an improvement budget, but we’re not going to get a loan for that improvement budget because that would affect our breakeven occupancy. If the market made it down through that, we’d raise that. We want to keep that low. We’re going to raise all of that. A lot of syndicators get a loan for that.
We then have closing costs, but then what about your reserve account? A lot of syndicators are like, “I’d rather have an 18 or 22 IRR. I’d rather leverage at 80% to 85% or 15% to 20% down payment. I’m going to second because the bank will loan it to me.” That doesn’t make it right for your investors. It means a bank will loan that to you. What we’re trying to say is, “Let’s keep it low. “ The deal we have right now is a 68% loan-to-value to the total cost of the project, which puts us at a 75% breakeven occupancy. Even as ‘08 and ‘09 happened again, we should still be cashflowing. We’ll be fine.
You brought up a good point here because sometimes, as investors, we’re looking at, “What’s the IRR? What’s the return going to be?” Looking underneath the HUD at the reserves and the CapEx, “Are they taking a loan for those? Is that included or wrapped up in the loan? Is that something where they’re raising capital for?”
If they are raising capital for that, it’s going to impact their returns, but investing in uncertain times can make it a more conservative play going forward into that particular investment. Can you talk a little bit about rent growth and the supply chain? As investors think about continuing to invest, whether real estate is a good play for them right now, they think about rent growth in the supply chain.
To fully answer that question, let me tack on a little bit to the last question. What I didn’t say was that other little bit that we raised, which is the reserve account or capital reserves like your safety. What does that mean? That means, what if it drops to 75 occupancies, and then we drop below? If we keep six months’ worth in reserves, that’s $1 million extra sitting on the sidelines. What if a tornado hits one of the properties? What if that happens during a downturn and you don’t have the funds and got to float the capital to your bills while it’s being rebuilt before you can exercise your insurance. What if you’re not insured fully?
What the insurance is for is the replacement cost of the billing as well as loss of rent. We’re made entirely whole as long as we have the capital to ride it out. That’s why we raised an extra six months’ worth in reserves in these uncertain times to tackle it. What are the what-ifs? The what-ifs are, “I don’t want to be in the situation that the people are in that I buy deals from.”
We bought a property at a 19% bad debt in Houston. The owner neglected the tenants. He didn’t know how to manage and didn’t have the working capital to survive COVID. He didn’t collect well, and so we were able to get it at a crazy good discount. We have management vertically. We manage it better and we have reserves in place, so if there is a dip, we’ll be able to ride it out and don’t lose the building. We have reserves so that if there’s a natural disaster or a property on fire, we’ve got that under contract now, a new deal, and they didn’t have the reserves floats. They were forced to sell where all the investors took a big hit.
In the uncertain times and investors are looking, “Who’s got that fortified shell? Who’s built in enough reserves. Who’s built-in enough lifeline to even survive a disaster and a downturn?” I’m talking to hundreds of investors all the time. For the last several years, I’ve been saying, “I’ve been through a downturn. I know it’s going to happen, so this is how we structure our deals. This is where we invest. These are the cycles we invest in. These are the neighborhoods that we invest in. This is how we debt-leverage ourselves. This is the capital reserves and how we construct them so that you’re protected in case there’s a downturn.”
Some of them are like, “My brokerage accounts and stocks are going up. I’m going to stay there.” Here we are on the other side of it, and I’m like, “You should have invested in our investments because they’re stable, cashflowing, and appreciating.” They’re like, “I can’t if only I could. My brokerage account is down 30% right now, so I can’t invest.” I’m telling you what that cycle does. The cycle means their basis is down about that much.
In those investments, they’re not only now going to be affected by inflation, which is north of 5.8%. They’re going to be hit by inflation. They’re trying to get 20% or 30% back of their brokerage account. Even if they get to that breakeven point, the dollar amount, the value of that, and the spending power of that dollar will be much lower.
In addition to that, they’re going to be paying taxes on every single piece of income that comes in from that, but in our investments, we’re the perfect place to be right now. In fact, the smarter, more intelligent investors that come to us are trading millions of dollars in our investments. Why? It’s because it’s a hard asset. It’s a cashflowing asset on day one. Our rinse, which is another article I wrote in Forbes, is how multifamily, income-generating real estate is a hedge against inflation.
Our rents track with inflation. In fact, our expenses are lower. They don’t grow at the same rate. In an inflationary environment, at the very least, hedge if we don’t make money on inflation. If you want to ride that 8% or whatever curve that we’re looking at, we’re the right place to do it. If your operator has all the fundamentals, locked in that interest rates, and has these reserves has low breakeven occupancies, you can get into havens where you can make money.
Can you recap there on the importance of the operator and their structure? Someone who’s reading is like, “I could see the benefit of investing in real estate.” As they’re continuing to look at so many different deals, they’re like, “I’m jaded by the returns. What are some of the things I need to be looking at underneath the HUD to make sure that this is a good deal that I should be investing in?”
One of the soft topics is I asked them. We’re they investing during a downturn? What does that mean? It’s not dissimilar that I came from the high-tech machine design automation and robotics space. I was educated in Silicon Valley with my Master’s in Engineering and MBA. The executives out there are looking for people that failed and how they responded and reacted to the failure.
A lot of venture capitalists won’t invest until you fail, maybe once or twice. I’m not saying that that is what you want to do as a requirement, but when I fly around. I talk to different groups and they show me different deals and look at underwriting. I ask questions about stress testing and things. They don’t even understand because they don’t understand why I would think that way because they’ve never gone through a downturn.
My recommendation always is to find an operator that has gone through a market correction and ask them, “What it took to survive that? What you’ve learned on the other side of that?” These investments are long-term investments. You want to have somebody that knows how to ride out a time and knows how to ride out an investment that can withstand the cycles of time because it will happen.
That’s generally what I say. Vertically integrated property management is important. When they say conservative underwriting, ask them what that means. Ask them if their interest rates are capped or fixed or if they’ve figured out what the maximum tolerable interest rate is. Ask what their exit projections are and try and get a feel for if they’re articulating responses like they’re going into battle.
I can’t remember who said it now, but one of my favorite quotes is I never won a war that went to plan, but I never won a war that I didn’t plan thoroughly. That’s part of the essence of being an analyst and being a multifamily survivor. You’ve got to have that plan in place and the experience to know what that plan needs to be.Don't sign up for a business plan that's too aggressive. Allow yourself time and flexibility to execute all parts of the business plan over a more extended period, and you should be fine. Click To Tweet
Especially in the times that we are in because it’s more important than ever. One other follow-up question on the loan and cap rates. As investors think about investing, the investment might be a bridge, and they’ve decided to purchase a cap. The Fed is continuing to say that they are going to continue increasing interest rates throughout the rest of 2022. Are there scenarios ever where that rate increase could hit or surpass what you’ve paid for a cap? Is that a risk?
Interest rates are a risk for all deals unless you’re managing them. It always has been a risk for all deals. It was people who considered it a reasonable risk. Even on the best days, we were doing long-term fixed interest or buying a rate cap. Rate cap means that even if you have a floater rate, you’re buying an insurance policy that maxes out your rate so that if it ever gets there, that’s as high as it’ll go. It’s another insurance policy.
It’s similar to spending an extra $1 million, which is six months’ worth of expenses. In fact, rate caps in 2021 used to be $400,000. In 2022, it’s $1.4 million. Those numbers seem big but these are current deals that are around $50 million. What are the numbers that we’re looking at? It’s a lot, but it’s an insurance policy.
If you buy that policy, then there are two things you want to look at. A lot of the deals have a refinance and then a sale. You want to understand that the refinance may only work if the interest rates are a certain number. They’re not buying a rate cap that applies to refinance. For example, right now, we have a 4.25 interest rate and we bought a rate cap that’ll max it out at about 5.25, but we looked at the deal and said, “We need to have an assumption for an interest rate and refinance so that we can still make our returns.” That needs to be conservative enough so that even if the interest rates do grow, we can still meet our projections. If they’re projecting the same interest rate, that doesn’t make sense.
We said, “We plugged in 8.25. We stress-tested our deal, which is very conservative.” The residential world has much higher interest rates than us in the commercial world. You may be thinking, “We’re already there.” In the commercial world, our assets are a lot lower risk. We get a lot better rates than you do, which is part of the benefit of being multifamily. What we’re saying is, let’s make sure that we rate capped it. If we’re assuming a restructuring of that, let’s make sure that we have a high enough interest rate to plug in for that.
You may say what-ifs scenario like, “What if you don’t get to the refinance? If interest rates go high and you can’t refinance.” Is your debt extendable? You want to make sure that they have extensions built into the long-term so that they can keep carrying it forward because nobody wants to be caught without a seat like I was in 2006, when all of a sudden, the interest rates were high. There’s a recession. You can’t sell the property.
You’d ended up selling it at a discount, which guts the equity of the property. Go to an operator that understands things don’t always go the plan and locks in enough of a runway to ride out that dip. We have extensions built into our debt products so that if we need to exercise them, we’ve pre-negotiated our extensions.
Another hot topic is executing value add in an environment where you have inflation and supply chain struggles. What are you saying to an investor in that area?
We like to buy properties that cashflow and keep in that way, which means we’re not going to empty out any buildings, destabilize the income, and start paying out of pocket for our expenses. We very slowly renovate. Typically, it’s over a 24-month period, which means we’re renovating 5 for 10. They supply units a month.
The supply chain issues that are very challenging are potentially much more critical for new construction. In new construction, you may need 300 appliance sets all at one time because you’re building and you’re going to build it all. You’re going to come and attach them all, but we can buy ahead and from different suppliers.
We can work towards bringing containers of things like hard countertops. We can be very agile on our feet because we’re not in a race to make an occupied building. It’s already occupied and income-producing. We’ve executed our renovation plan all, except for the floorboard kickboards, the range hood, or the backsplash.
We have the ability in our market because we’re doing it slowly and over time. We’re able to do what we want, coming back and fill the easy pieces that we can do while the tenant’s still in the building. That’s been helpful for us. In general, the advice that I give is don’t try and sign up for a business plan that’s too aggressive.
Allow yourself time and the flexibility to execute all that’s part of the business plan over a longer period, and you should be fine. We used to say basic in Southeast Texas, and when you’re doing it at scale in hundreds of units, our budgets were $4,000 or $6,000 to do an entire kitchen, and $8,000 is max. Sometimes, now we’re putting in $10,000 and $12,000 because we know things are going to cost a little bit more. Things are changing. All of a sudden, finances are the same cost as black appliances. How did that happen? Quartz now is a little more expensive, so we’re getting containers from Vietnam. Where did that come from?
It is true. You got to plug in more of a safety margin into your expenses. You got to be a little more agile as to what you do. You might as well do stainless now because black stainless is the same. You got to be careful as an operator, but at the end of the day, it comes down to how much you plugged in and gave yourself runway, leeway, and buffer into your budgets.
Given the current market environment, can we talk a little bit about return expectations as interest rates continue to increase? What would you say to investors when it comes to IRRs, cash-on-cash, and those kinds of things? What is the reasonable expectation right now in the multifamily space?
Since we’re so leveraged, we have tons of reserves. We assume on exits property rights. Our interests or returns are not flashy. They’re 5%, 6%, 15%, 16%, 17%, and 18% IRRs. It was more that we had more than 18% internal rate of return or annual average returns on our deals, but now I’m bringing a 15% IRR to the market. Why is that? A lot of things we changed in the underwriting. That is not now, but it’s wondering if it’s going to happen tomorrow.
We want to project now that we still want to be able to meet the returns we’re sharing even if the market makes a correction. At the same time, I’m looking at other deals which are short to a few years’ holes, and they’re much higher returns, but those are structured in a way where you might lose it all too. They’re not underwritten cashflowing. They’re raised to the finish line was short-term debt. They haven’t paid the extra for extensions. They don’t have insurance policies and reserves.
I got to caution you if you’re trying to get out there and get rich quick like I was in 2006, then don’t go with a group like ours because we’re going to give you a reasonable return. If the market goes north, we’re going to give you a much higher return, but if you’re looking for stable, long-term, appreciation, cashflow, and capital preservation, then don’t be scared of the 15% returns. Don’t be scared of the 6% or 7% or 8% cash-on-cash because those operators may have better deals than the flashy ones. They also might be safer and return a lot better. At the very least, you may not lose it all along the way.
This now brings me to one of my final questions here, which is retirement. You did an article about how multifamily syndications beat single-family for accelerating retirement. I want specifically this question, given that article that you’ve written and what you talked about, which is the returns. If people are seeking to invest in multifamily for the idea of being able to retire in terms of timing and timeline, what are some of the level settings of expectations that are necessary given the current return environment?
That comes to a one-on-one conversation. I’d be happy to have that with anybody that wants to chat. With the level setting and expectations with single-family, you often have to trade off your time with your family, friends, and hobbies. The deals aren’t big enough to support experienced operators and third parties to come in, do a lot of the heavy lifting for you to find deals, and renovate deals.
Maybe you found one good deal, which got you excited, but you didn’t realize that it was a job. The minute you did that good deal and you finished it. You have to go back to work and do it again and again because the longer you hold that asset, the lower your return goes. Your IRR goes down over time. You made a big leap, but now it’s following the natural appreciation.
Having a group like ours that can jump in there in 2 or 3 years. We’ve analyzed hundreds of deals, found deals, get them under contract, then asset management, property manage, construction management, and renovations. We get to a point where we can do a refinance and pull your capital out if you can find a group that can continue to do that every 2 to 3 years. By getting the return of your investment through a refi while you were still cashflow, reinvesting that into another deal, the capital you got back, maybe invest with them again and another emerging market. Not downtown, but in another market where people are moving to. It’s tax advantage and landlord-friendly, where they found an under-market deal and can drive it again.Multifamily syndication beats single-family for accelerating retirement. Click To Tweet
By the 3rd year, maybe you’ve got a 2nd property. By that 6th year, maybe you got a 3rd property. Now, you’re cashflowing in three deals. If they’re long-term focused operators, then if they sell, they’ll do a 1031 exchange with you. For example, we bought a property at $27 million in 2021, and then we sold it at $37 million. We had that underwritten and on the deck as a five-year hold and an 18% IRR where we exited in less than ten months, and it was a 100% IRR.
We 1031 those individuals into a Houston deal and they all stepped up their basis without paying any taxes. They collected all the cashflow, and then one day, we took their appreciation. We moved it to another deal. Now, they’re collecting cashflow while we drive that appreciation higher, but their cashflow on a higher amount.
The idea is that if you get into one of these investments where you constantly have a team keeping the velocity of your capital high, then it depends on how many times you need to circulate a $100,000 investment. If it’s a 4%, 6%, 7%, or 8% cash-on-cash return, you need a cycle that ones. Twice, 3% or 4%, maybe you have another $100,000 you can add to the puzzle. How many times do you need to circulate that?
That conversation, what your needs are, and where you want to be in retirement. At the end of the day, unlike annuities, where they give you cashflow and then one day it disappears, and you don’t give anything to your heirs. What happens is you find you can retire earlier because you’re in these safe cashflowing investments that are growing over time. Instead of dwindling your 401(k)s down, your basis is growing. You can live off that cashflow knowing that you have a safety net for yourself and are leaving something to your heirs. That results in people retiring earlier. In addition to the fact that it’s all tax advantage along the way, it does accelerate that.
One thing I’ll add to it is that I believe that investing through real estate is a multi-year strategy to the extent that you’re not coming in with millions of dollars to invest, which is the case for many investors who can write million-dollar checks. For an investor that’s writing their first $50,000 or $100,000, it’s important for them to recognize that it is a multi-year.
The benefit is consistently investing and working with good operators that have some of the structures and discipline you mentioned here. That can help them protect and grow their capital with time and be in a completely different place much faster than they anticipated. This was so good. Patrick, I finished all my interviews with my level-up of questions that I asked all my guests. The first one is, what are you grateful for in your life right now?
I’m grateful for our new baby that’s coming out soon. That’s going to be the next exciting thing in our life. My wife for her and what she’s bringing to our family.
Congratulations. That’s awesome. What do you now know that you wish you knew at the beginning of your journey?
I wish I knew to take the more steady, tried, and true path than to go the ride the quick wind and high returning, high-risk return trend.
What would you say you attribute your continued success and growth to?
One of my first jobs was at a Toyota plant. I learned about Kaizen, all the Toyota ways, and continuous improvement. That resonated with me and I carry that forward. I’ve been called a high-performer. I worked very hard. I even got two Master’s degrees while I was working full-time, but I constantly think I’m lazy. It’s hard to imagine, but somehow, I’ve got over 3,000 units, $300 million, and I’m somehow lazy.
At this point, how can my readers get in touch with you if they want to get into what you’re doing? You also have an awesome freebie to give them as well.
It’s Patrick@InvestOnMainStreet.com. If you go there on the Contact Us, set up a meeting on my calendar, I’m happy to chat with you. We do have a new investment on the top of the site. You can take a look at an exciting project in Atlanta. I did participate in a book with some great co-authors. It’s Persistence, Pivots, and Game Changers is the title of the book, turning challenges into opportunities.
Some other cool people around here, like Def Leppard, their lead guitarist, Phil Collins, Russell Gray from the real estate guys, NFL, NBA players, coaches, and artists. It was an amazing, fun project. I believe in the content, and there are lots of good stories. I’m happy to provide a free signed copy of this Amazon number one best-selling book to anybody who would like to set up a call. We’ll chat about your goals, what you’re trying to do, and see if I can contribute to your journey. This tells all about that journey from high tech, back and forth to develop pre-development to single-family, and then the multifamily journey as well.
It’s so good. It’s highly recommended. I read it as well, so thank you for that. Thank you so much for coming on the show, Patrick. I appreciate it.
I’m honored to be here, Lisa. I look forward to seeing our next mastermind.
- Invest On Main Street
- Persistence, Pivots, and Game Changers
- Why Income-Generating Real Estate Is The Best Hedge Against Inflation?
- How Multifamily Syndications Beat Single-Family For Accelerating Retirement?
About Patrick Grimes
Patrick Grimes the Founder and CEO of Invest on Main Street. He has over fourteen years of experience in active real estate investment, purchasing distressed assets, renovating, and stabilizing for long-term cash flow. His portfolio includes controlling ownership over 2729 units in the emerging markets across Texas and the southeastern United States.
Patrick has co-authored an Amazon #1 best-selling book, Persistence, Pivots, and Game Changers. He was inducted into the Forbes Real Estate Council and contributed to Forbes thought leadership articles on investing and commercial real estate. Through his other company, Protomation Systems, LLC, he contracts to design and build one-of-a-kind manufacturing automation and robotic systems. Patrick also holds a BS in Mechanical Engineering and a Master of Science in Engineering.
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