Time horizon plus strategy, during times of economic certainty, are key pieces that you need to look at in order to find investment success. Join Steven as he takes a look at those key components and why it’s so absolutely important to consider them as part of your investment strategy so that you can reduce risk and still achieve your financial goals.
During times of economic growth, we can be focused on opportunities that have a shorter time horizon, and therefore have a shorter debt schedule.
You can flip multifamily properties or flip houses in a growing or declining market; you just have to be able to anticipate how much that decline is going to be or you have to anticipate when that growth is going to taper off.
A long-term strategy has a lower risk profile, but also a lower return profile, and works very well in both markets, but is extremely beneficial in markets of decline.
Reduce risk by being lower in the capital stack.
Invest in very high-quality assets that renters are very interested in renting, even during times of economic change.
Interested in connecting with other like-minded individuals? Then join our VonFinch Private Capital Network. Learn more at http://www.vonfinch.com/invest.
Steven Pesavento 00:05
This is the Investor Mindset podcast and I'm Steven Pesavento. For as long as I can remember, I've been obsessed with understanding how we can think better, how we can be better, and how we can do better. And each episode we explore lessons on motivation and mindset for the most successful real estate investors and entrepreneurs in the nation.
Steven Pesavento 00:32
Investors Welcome back to the investor mindset podcast. I'm your host, Stephen Pesavento. Today's passive investment conversation comes down to a very important thing for this time in the market right now is understanding the importance of matching strategy with the right time horizon of an investment. time horizon plus strategy, during times of economic certainty are key pieces that we need to look at in order to find investment success. So let's take a look at what are some of those key components that end up going into this and why it's so absolutely important. So the first piece here is understanding strategy, we often are looking at strategies that fit different types of economic environments, and that are great in different types of markets during economic growth or economic decline. Where we're sitting today, it's the end of August of 2022. We're looking at an environment where interest rates have been going up and are expected to continue going up, at least for the next quarter, if not longer, where loan devalue on projects has gone down, banks are offering less money. And as a result of both of those things, return profile on deals has been reduced, or it needs, the expectation needs to be reduced. Because when those first two happen, that service is higher and more equities require, therefore returns are split across more dollars, therefore reducing the return per dollar. Great. So we've got that out of the way. This is the environment we're in right now. We're an environment where we may come back to seeing a growth focus environment, we may see a stabilization of interest rates and of growth. Or we may be in a stagflation airy environment, where we see interest rates going up, and we see inflation going up. And that is what has happened in the past, we may end up going in an environment where inflation stays high. And we see a stabilization in the rest of the economy. Or we may end up going into a full blown recession.
Steven Pesavento 02:38
Many including myself believe we're in a recession, it's not something that we need to be in fear about. But what it means is that there's been two quarters of economic decline of GDP. And that's where we're at today. So what does that mean? That means that during times of economic growth, we can be focused on opportunities that have a shorter time horizon, and therefore have a shorter debt schedule. When I say that, let me show you an example of two different examples that are very different, that I think will really set us up to talk about this. So back in 2016, when VonFinch had flipped 200 homes between 2016 in 2019, and it built a sizable portfolio, we were buying houses, renovating them and reselling them during this period. Buying and operating that many properties with debt and equity being the funding source is a very highly leveraged experience a highly leveraged process, and it works very well during times of economic growth. So on those opportunities, you typically had six to 12 months that we were fortunate because of our track record and experience to get 12 month that, but oftentimes, you'll see flippers who have 90 day, maybe only maybe even six months, in order to complete that project. What that means is they're going to buy that property than to renovate it, and they're going to sell it on the multifamily equivalent of that. We may buy a 200 unit property, we may renovate half or all of those units, and we may plan to sell that property within 12 to 24 months. Both of those are short time horizon projects that are focused highly on renovation and forcing appreciation on the property through renovation. They're great strategies. Redevelopment is a phenomenal strategy to make great money. We love that strategy. But when focused in a growing market, they work really, really well. Now, on the flip side, is a project that has a 10 year time horizon with long term debt that has a 10 year debt schedule, and has the ability to add a supplemental which is essentially a second loan from the same supplier of that first loan. That is going to equities the project after the value has been brought up going into that project renovating those 200 units, stabilizing, adding that supplemental and holding for 10 years, knowing that that debt window is 10 years long, and cash selling the property on the back end or the beginning of that project.
Steven Pesavento 05:24
Both are very different. Both are great strategies both can work in any type of market, right, you can flip multifamily properties or flip houses in a growing market, you can flip them in a declining market, you just have to be able to anticipate how much that decline is going to be, or you have to anticipate when that growth is going to taper off. On the alternative side, the long term hold the 10 year debt with the 10 year business strategy hold period is much more secure, it's typically going to offer a lower return profile. And it's typically going to be focused on creating cash flow after that initial renovation. stabilization period because remember, on value add projects, typically, projects don't heavily cash flow upon purchase. If there's a heavy value add components, sometimes it's possible. Sometimes it's possible to pay preferred return right from the beginning. Sometimes it takes a few months or even a year or longer, depending on the project the market and specifically that Proform every deal is different. So we've got these two different types of deals, I told you that on one hand, we absolutely can make money in a declining market or growing market with a short term strategy. But I also share that a long term strategy has a lower risk profile, but also a lower return profile, and works very good in both markets, but is extremely beneficial in markets of decline. Because it doesn't matter what happens during a declining market, as long as you can continue to pay your debt service. That's the most important thing about real estate, the ability to pay debt service. When you've selected a good property. As long as you have a long enough time horizon, you won't lose money in real estate, so long as it's being operated well and the property is not being run into the ground. Typically the only way. Typically, the only way that you lose money in real estate is when you can't pay the debt service or when the debt service is expiring, and another lender is not interested in coming in. So during 2008 during other recessions that negatively affected the real estate market in particular, the reason that those developers or redevelop errs lost money was because their bank note became due. And they couldn't refinance, or they didn't have the cash flow or equity to in order to keep feeding that mortgage during the period where the economy was down. And that project was not able to be completed. Now the same is true of long term projects, the only way they lose money in a economic decline is when they don't have enough cash flow to support the long term debt note. Okay, so we've got that out of the way.
Steven Pesavento 08:21
Why is this important right now, because we're in a time of economic uncertainty, no time in the last 10 years has it made a lot of sense to be focused on opportunities that reduce risk. Most for the most part, we've been in a high growth market. And although it makes sense to have different types of assets in your portfolio, most operators and most investors have been focused on driving returns. As Blackstone recently said, up until just recently, it hasn't made any sense to take a lower return profile in order to greatly reduce risk. We've talked about the VonFinch preferred equity program that we are in the process of inviting investors to participate in that fund. And the reason for this program is specifically because of that reduced risk by being lower in the capital stack. In other words, having 20% of pref equity above 60% of debt with another 20% of someone else's not VonFinch investors equity sitting above that investment, therefore reducing the risk. Another way to reduce risk is to take lower loan to value loan on a investment, specifically that has strong cash flow and ability to pay. And that has a strong ability to pay even with greatly reduced occupancy or renters that are paying. It's another great way to reduce risk. Another way to reduce risk is by investing in very high quality The assets that that renters are very interested in renting, even during times of economic change, and that the renter profile is typically part of a group that is not as negatively impacted as other groups, you can sometimes see this in what's called Workforce Housing in some areas of the country. And you can also see this in certain areas of the country with certain demographics that happen to be high income earners, that are not being impacted currently in today's market.
Steven Pesavento 10:30
So there is different types of benefits towards different types of assets. So why am I sharing all this? Why is it so important to understand is that during times of economic change like this, it can be very beneficial to invest in longer term investment, windows, looking at longer term debt with a longer term business plan. What the exchange off of that is, is that the investment capital is in that opportunity for a longer term period than it would be if you were going to do a short term redevelopment of a large multifamily project. Instead of it being one to three years, maybe you're on a five to seven or a seven to 10 year hold. Or perhaps you're investing into, you know, a five to seven year fund that's going to go invest into preferred equity, or potentially you're invested into a 10 year income fund that's really focused on the long term time horizon, because as a reminder, that time horizon allows more time for economic uncertainty, to avoid negatively impacting the investment that is being made in that deal. Because when you're in a short term renovation of a project, going back to the old single family example, when you have 90 days to execute a plan, and if it takes 30 extra days, but you only had 90 to complete it, then you're past your debt window, and you're in bad shape. It's bad news bears for you. And it's bad news bears for the sponsor that you invest in it. When you've got a 10 year time horizon, and the economy goes down for 12 to 24 months, then not great. Maybe cashflow is impacted, maybe your preferred return accumulates a little bit longer, maybe distributions get reduced. But in the long run, as long as that investment opportunity has the ability to weather that 12 to 24 month storm.
Steven Pesavento 12:39
In the long run, it should not negatively affect the entire project itself, you should be able to see that project restabilize and see appreciation continue to happen at that project. So during times like today, it makes a lot of sense to look for opportunities that can create current cash flow today, that can create a strong overall return but with much reduced risk. And it makes a lot of sense to invest with a longer time horizon. So if you're someone who's looking to get involved in the same type of deals that we do here at VonFinch, and are interested in investing in both deals that have both long and short time horizons, depending on when you're coming to us, and what type of deals best fit the market, because that's exactly what we're focused on doing is understanding how can we create the best return profile for investors, reduce risk, and fully manage and execute those investment partnerships? On behalf of our clients, then head over to Vonfinch.com/invest. To get registered to start seeing access to the same type of deals that I personally invest in, you can schedule a time with me or a member of our team. So that we can get to know you and understand if this truly is a good fit for you. And if it's truly a partnership that we're looking to get involved in. So appreciate you listening. It's always a pleasure to be able to dive into investment knowledge and be able to share that knowledge with each and every one of you guys, thanks so much. See on the next episode.
Steven Pesavento 14:27
Thank you for listening to the investor mindset podcast. If you liked what you heard, make sure to rate review, subscribe and share with a friend. Head over to the investormindset.com to join the insider Club, where we share tools and strategies from the top investors and entrepreneurs and how to take it to the next level.
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The Investor Mindset Podcast & President VonFinch Capital
Steven Pesavento has always been obsessed with understanding how we can think better, how we can be better and how we can do better. He is an active real estate investor who curates Commercial Real Estate Investments for clients.
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