Today we are reviewing how to make investments with a possible recession coming up, and how do you underwrite deals with that in mind. We are interviewing Hunter Thompson, the founder and managing principal of Asym Capital. Asym is a private equity firm based in Los Angeles, California, which helps accredited investors passively invest in recession resistant real estate. They have purchased more than $75 million of commercial real estate with the help of more than 300 investors of theirs.
I am personally very excited about this topic, from my observation living in Silicon Valley, I think that the signs on an upcoming recession are everywhere:
1. One of the companies that I used to work for is currently losing $130 million per year, and they’re valued at almost $10 billion in the stock market.
2. I dabbed into angel investing, and so much money being thrown at startups that don’t have any customers
3. There’s a lot of money being thrown in real estate. Cap rates are very low, interest rates are at an all time low, and the government is not raising rates for some strange reason.
These signs all happened right before 2000 and right before 2008, and now is a great opportunity for us to jump into why we should be looking at session proof properties and how you underwrite these deals.
Can you give us a little history about your background?
My entire investment thesis is really born out of the most significant downturn in recent history, with the great recession. I’m the type of person that was very inclined to go left when everyone was looking right. When 2008 happened, I was very drawn to financial markets and the first thing that I started looking at was stocks and bonds just because that’s what I was most interested in there’s so much marketing to help people focus on stocks that you can’t help but be interested in it. When 2008 happened, I jumped all in to financial assets, started studying the stock market, really focused on value based investing, similar to a Warren Buffett style of investing and for a lot of people, 2008 was their last straw moment. 2008 for me was a green light.
I didn’t really realize the challenges with the stock market until about two years later, and this is something that I talk about a lot but almost no one else talks about which was the European debt crisis. The reason for this is that I had spent so much time studying the stock market, reading charts, understanding how to do technical analysis and a variety of other metrics. And then something happened with Greece, and many European countries where there is a complete lack of liquidity in the market. Very similar to what happened in the US in 2008, but it was with markets that I had absolutely no insight into. I could never have predicted that the Greece bond yields would be one of the most important predictors of my entire portfolio. And all of a sudden it was what everyone was talking about on CNBC, out of nowhere, as if this was reasonable.
When I started to understand that no matter how much research I did, no matter how much of a market advantage I thought I had, or even how large my team was, a stock market is so correlated and interwoven with each other that I can’t mitigate the risks that are taking place all over the world in the global capital markets. So I started to look for investment vehicles that were well positioned to the downside, but that even more importantly, the problems that could potentially come up were mitigatable. That quickly led me to real estate, and because of that experience with 2008 and 2010, I built an investment thesis entirely around recession resistant real estate. In the stock market as a small company, or a small family office, I felt completely powerless, I felt like I had zero market advantage. But with real estate, a small team can have a tremendous market advantage even over some major players in the space. The thing at the time was, they were saying that if the Greece bond yields went above 7%, the S&P 500 was going to be fine, but if they stayed below 7% the S&P 500 was going to collapse.
I remember waking up everyday in market timing, just looking at this and finally realizing, what am I doing? Waking up at five in the morning, looking at the Greece bond yields. I’ve got to find something that’s actually going be able to be predictable over the long term. And as any listener of the show knows, real estate is just an incredible wealth for protecting and growing your own net worth. But more than anything, that predictability of outcome is much higher through cashflow. And then when you compound that with the recession resistant component, you’re starting to get the best of both worlds. You’re getting the leverage, the tax advantage, and also that predictability of outcome through the inverse correlation of the demand and the overall economy. And that’s really where our investment strategy has been focused over the last 10 years or so.
How do you prepare for a potential downturn and how do you underwrite real estate deals with this in mind?
My thesis is that all types of real estate are going to perform if the capital markets are booming and the economy is really heating up. If you can raise rents aggressively, you can fill occupancy, you can complete capital expenditure and expect to be able to raise rents, etc. But only some types of real estate do well when the economy is contracting, so even if you have a portion of your portfolio that’s focused on the types of real estate that do well when the economies are contracting, it really significantly increases the overall risk profile of your portfolio and increases the favorability of the risk profile.
A significant portion of our business is focused exclusively on things that cater to people that are making $35,000 – $55,000 a year, somewhere in that range. The mobile home park business, for example, is probably the most clear example of a recession resistant asset because the worst the economy does, the more demand there is for the product. Think about it like this: if everyone that’s making $100,000 moves down to making $60,000, and everyone that’s making $60,000 moves down to $40,000 and everyone that’s making $40,000 moves down to $30,000, there’s always demand for that bottom product. Now that doesn’t paint the whole picture, which is something we can get into from a big picture perspective, though the mobile home park business is very compelling because the demand is stable.
A similar case can be made for something like self storage where people use the product when they’re going through some kind of life change. Let’s think about things like downsizing, which is very common during recessions, people change jobs, people have to move in order to stay employed, things like that are all very common during recessions, and also you have people moving home from college unexpectedly, but all of them spur demand for the product of self storage. From a downside protection standpoint, it’s very compelling. And also looking at the historical data, this isn’t something that just sounds reasonable. This is actually very well backed up by historical data and decades of research on the topic. If you Google recession resistant self storage, you’ll find an article on as the recessions from 2001 and again in 2008 took place, rents were stabilized, occupancies increased while the self storage vehicle was doubling in size. There were 20,000 self storage facilities in the United States around the year 2000, and now there’s about 45,000, and while it doubled, occupancy rates remain high and increasing rents were taking place during both recessions. So it’s very compelling and not just something that makes sense from a big picture.
I don’t know much about mobile home parks, but what I have heard is that a lot of cities are prohibiting them from being built mainly because of tax purposes. The cities and states are not getting a lot of tax revenue from mobile home parks. How do you find these deals? And is that true?
Oh yes, it’s pretty remarkable actually. You have this incredible supply demand disequilibrium, which is further expanded by government regulation. To your point, one of the reasons is that the tax revenue for mobile home parks is very low compared to, let’s say, an apartment building or a hotel. Because of this, it’s basically impossible to get the zoning that allows you to create a mobile home park, and each year there’s less and less and less mobile home parks, even though there’s a tremendous demand for the product. There are about 10,000 baby boomers hitting the age of retirement every single day. Many of them are relying on social security as their only source of income. The average social security check is about $1,300 a month. The average two bedroom apartment rents for about $1,300 a month. So you have all this demand and at the same time a contracting supply.
In terms of how to find them though, five years ago when I was talking about this topic, most of the time I’d be talking about it, I would be explaining what a mobile home park was, and how it was possible to invest in them, but now it’s become somewhat in trend. More and more people are talking about it because of how favorable the cap rates have been over the last years comparatively to other cap rates. But the way that you identify them is you look for significant mismanagement, most notably in the sense of overpaying for expenses and undercharging for rents.
You can find a mobile home park, let’s say with one hundred lots, that is $75 under market rent. That’s very significant because that’s $75 per month times one hundred, times 12 to make it annual, divided by a seven cap or so. You’re talking about hundreds of thousands of dollars of value added to the property, or millions of dollars of value added by simply raising rents. Now, you have to do so in a way that’s conducive to, say, a $25 rental increase and then six months later at $25 annual increase, because the tenant base is very sticky but also they’re in a low income situation so you don’t want to have a PR nightmare in your hands by just bumping up rents by hundreds of dollars. But you can bring them up to market rents in a way that’s appropriate and produce millions of dollars of value for your investors.
How do you underwrite deals for self storage for example?
I’ll start by giving you a look behind the curtain so to speak, with a metric that you almost never hear anyone talk about. In the self storage business, in the multifamily business it is very common to refer to replacement cost. And it’s very compelling if you can buy a product significantly under replacement cost because how is someone going to compete with us if they can’t build that? Or build it for more expensive than we can buy it for? You’ll almost never hear anyone talk about that in the self storage business. Why? Because they’re very inexpensive to build. So what that means is you have to be very cautious about buying in markets that can be oversupplied quickly.
One of the first things we look at is that we have the national average of about 7.7 square feet of self storage per person. If we have a radius of let’s say five miles, we look at the number of population and look at the number of square footage, and if the ratio is out of whack, either under supplied or oversupplied, it gives us a good sense of where the supply demand room is within that radius. That doesn’t paint the whole picture, but it’s definitely something that’s compelling. For example, if there’s only four square foot per person in a geographic location in a radius, that means that there could be an increase of three square foot per person before you start to have a challenge with being able to raise rent. So that’s one thing we’re looking for: mismanagement.
Self storage business has a reputation of being a very simplistic business. Most people out of the investment community think of self storage as being “Oh look, you just have a bunch of little boxes and you just rent them out. There are no toilets, no trash, and somebody pays you a monthly rent.” There is some truth to that, but that’s where people that are thinking about it as an investment vehicle as opposed to a business. We like to partner with operating partners that have hundreds of millions of dollars under management that have systems and processes in place to truly optimize these facilities. We’ll take a property that is not doing online marketing sales, that’s not doing SEO or have relationships with truck rental companies, or universities, or military bases. They just don’t have the branded merchandise, and the secret shoppers, they just don’t have that infrastructure to them. It’s just an investment, it’s a way to store their wealth, and then we implement that strategy. Our goal is to find ways in which we can generate outsized returns without incurring a proportional amount of risk. And from my perspective, the easiest way to do that is to implement management strategies rather than go through things like unit expansion or taking a C class property and turn it into an A class property, we do those too, but the asymmetric returns are really generated by those strategy differences.
One that I find most compelling is the truck rentals, let’s say we buy a property that has no relationship with the truck rental company. If you’re looking at an excel model, from an underwriting perspective, that one line item is currently $0 a month and we’re buying that property based on in place income. Then the next day after purchase, we call our contact U-Haul, get them to park 15 trucks on the facility, and then we rent out those trucks to tenants as they’re moving in and out and get a commission for facilitating the transaction, U-Haul pays us that, we’re not buying the trucks, we’re not maintaining the trucks, we’re just simply marketing those trucks for sale and getting a commission for doing that. I have personally invested in several properties where that one line item has gone from $0 a month to $3,500 a month directly to the bottom line, multiply that by 12, divided by let’s say a seven cap to be conservative, you’re talking about $600,000 of equity that you’re just turning on by implementing that strategy. And I just view that as being very, very favorable.
You live in Los Angeles, are you an investor in this beautiful state of California?
I love California and the reason I really like living here (there are many), but the weather is number one. Number two, there’s a lot of money in California generally speaking. And number three, there are not a lot of cashflow investments, so it creates an interesting opportunity where there’s a lot of capital and there isn’t a vehicle to facilitate that investment. We have a national outlook to be able to allocate capital all over the country through the relationships we have with our operating partners, which are well positioned. I personally do hard money loans in California to fix and flippers that I have a personal relationship with. That’s not something we do through our company. I just keep my own personal portfolio invested while we are cycling in and out of these other syndications, but it’s a hard business to scale in my opinion, and so we haven’t found a vehicle to do that yet because we’re focused on cashflow since it just creates that predictability of outcome.
And the cashflow is just much better outside of California. In fact, we have a focus on the Southeast of Texas all the way to Florida, and then with the mobile home park business, I really liked the Midwest. You can find properties where a mobile home park may rent for $500 a month where you actually get to own the home if you’re a tenant, or a nearby two bedroom apartment may rent for $1,300 a month. The question becomes: do you want to own your home, have your own place, or do you want to rent for more than two times what you pay? So the right tenants are more drawn to that and I find those geographic locations a little bit more compelling than California for a variety reasons.
Is there anything else that you’d like to share with our audience?
This is an incredible time to be involved in real estate. The business is being revolutionized as we speak and this conversation is a great example of that. I spent at least a year going to networking events, talking to mentors before I was able to learn what someone could learn in listening to 10 podcasts of yours, right? I’m sure you probably had a similar experience. There’s so much amazing content available on the internet, however, there’s also an incredible opportunity for access to real estate deals. You can simply Google good real estate deals and you’ll get access to deals immediately, which again was not the case when I started in the business.
What’s really critical is that people focus on education because, in my opinion, the education has not yet caught up with the access, and so when you’re looking at underwriting, you’re looking at deals, and the way that things can go wrong is almost exclusively around the loan, and it’s almost never talked about. If you think about every real estate deal gone wrong, probably 99% of them, especially those that have to do with a loss of principal, it’s because of something happening with the loan, the interest rate goes up too quickly, and you can’t prepare for that. The loan comes due too quickly without you being able to refinance or add significant value. When you’re thinking about structuring your deals for downside protection, consider the loan terms as being as important, if not more important, as the other underwriting standards. I think that education is so critical right now, it’s readily available, you just have to go all in. That doesn’t mean go all in on a particular investment. That means go all in on education.