Today we are covering what is the difference between cash on cash, what is IRR, what are REIT's (Real Estate Investment Trust), and what are the pros and cons from an investor's perspective.
We're interviewing Jason Ricks, a professional real estate investor focusing on acquisitions, leasing, construction and development. He has a background in retail leasing and asset management working on premier properties worth hundreds of millions across the country. He also oversaw a 2.2 million square foot value add retail portfolio throughout Texas and Oklahoma, and most recently he was featured in the number one Amazon best selling book "Desire, Discipline and Determination".
Tell us a little bit about you
I grew up in Austin and I got into the business at the perfect time, 2008! Everyone's hiring, people are doing deals. No, it was a real challenge and I ended up interviewing with just about every commercial real estate firm under the sun in Austin. I had a lot of people throw me offers at minimum wage and say "Hey kid, see what you can do, come in here, cold call and get a deal done".
I ended up partnering with up with a company called Tarantino Properties which was a boutique firm. We had exposure in Austin, San Antonio, and Houston, I specialized as a broker in shopping centers, specifically Class C, and Class B shopping centers. I did that for four years, learned a ton about how to get a lease done, listings, brokerage, did some tenant representation, and got acclimated in the business, it was a great move as they threw me into the deep end right away: "Here's a desk, here's a phone, go after it".
It was a lot of fun, but I really wanted to pivot my career and go into the asset management realm, so I ended up having an opportunity to work for a private investor who had a pretty substantial portfolio. He had about $3 million of NOI in a portfolio in Texas and Oklahoma. He was looking for some young guy that he could whip to death and work to death and to add value. And it was a lot of fun. So we ended up doing some really unique things. We would buy really difficult shopping centers like a former Walmart that was vacated. Imagine 400,000 square feet of vacant retail space. We would chop it up and subdivide it and make the outside exterior look really good, work on lighting, parking lot repairs, exterior facade improvements. And we would end up leasing to a bunch of junior and anchor tenants. And then potentially we would look at building what we call a build a suit on an out parcel that's closer to the road. We would do free standing fast-food drive through restaurants, we would do 9,000 square foot buildings, and then once we maximized the value, we would end up trading that asset and disposing of it. So I did that for a while.
And like any good asset manager, when you enhance the value, the owner is going to liquidate the portfolio. At the time I was ready to make a move and I really wanted to go towards something more institutionalized. And one of my mentors got me connected with AMLI Residential, a multifamily developer that specializes in mixed use properties, with ground floor retail and apartments on top. We were in nine major metros. It's a private REIT and it feeds into the Morgan Stanley Prime Fund, which is a very large institutional fund of around 24 billion in size. This got me a lot of exposure to the REIT world, all the fun reporting that you have to do and keeping everyone happy. But it was a great opportunity because they hadn't had anyone with retail experience come in and steer the ship, get familiar with different types of developments, construction, working with different cities, and making sure that we can get the management and leasing just right for Morgan Stanley. That has been a really enjoyable ride, a great company, I learned a tremendous amount, but ultimately where I'm going in my career now is more towards the general partner side, or the GP/Sponsor side.
I had a chance to interact with Michael Flight and we recently decided to partner together, and I could not have asked for a better partner. He has been doing this for 30 years and I couldn't be happier with that partnership and where we're taking it. I'm back to my roots of value add shopping center investing. We're looking at secondary and tertiary markets that have a good growth story and provide liquid returns for LP investors.
One thing that caught my attention was when you guys were buying centers with tenants that went dark, the the big national tenants. What did you do with those big buildings, where you subdividing them into smaller units?
We ended up buying, and at the time it made sense, on a per pound basis, or a per square foot basis. We went to a group and bought nine of their former regional super centers at one time, they were scattered throughout the United States. They had CCNR issues, and when you have these giant Walmart centers, most people stay away from them. The other issue is how do you get debt on a vacant building, right? You have to find the right operator with the right level of background. And we had strategic relationships. I'll talk about a specific shopping center in Waco, TX. We ended up carving up the space in four different ways. We ended up leasing a large chunk of space to Tractor Supply, Planet Fitness, and to Dirt Cheap (a concept that's in the Southwest), which is just a discount retailer. We also leased the backend of the shopping center to group called CSL Plasma that occupied the 300,000 square feet. And on top of that we were also successful in working with the city in developing the 9,000 square foot pad where we were able to put Firehouse Subs, Brighton Dental and a nutrition store.
We had so many awkward, and unique situations. We had a bad shopping center that was built in the 50's and it was in Del City, Oklahoma, which was a tough market. The ceiling height were 11 feet, 10 feet, and that's not big enough for a grocery store to come in and do stacking. So, what am I going to do with this thing? The owner told me "Get it leased, Jason, go figure out how to get the ceiling height increased". They needed the ceiling height to be 16 feet. So I worked with a structural engineer and I looked at the numbers that it would take to do that, and my eyes would glaze over. It was "Oh my God, how are we going to get this one?". I ended up knocking on the city's door, hat in hand and asked them to help me out, and we ended up negotiating a TIF (Tax Increment Financing), which is just a fancy way of saying a "tax abatement" program over a period of 10 years to help us reinvest into the shopping center, and let them try to literally raise the roof on a 50's building with all kinds of hazmat issues. It was a joy.
What is the difference between cash on cash and IRR?
These are both really common metrics that a lot of investors use when evaluating real estate. One of the beauties of commercial real estate, or income producing real estate, is the cashflow. Cash on cash is a snapshot of the percentage return of your cash invested. Imagine that you invested $100,000 into a shopping center. In year one you got a cash flow check of $10,000, so what type of return is that on your investment? That's going to be a 10% cash on cash return and this is usually quoted on a before tax basis. What that does is that it gives you a nice snapshot of the initial return that you're going to get on your investment, which a lot of investors are curious about, especially when you evaluate this against, for example, a stock dividend or a coupon. That's one of the exciting things about commercial real estate - that cash on cash income producing, and cash on cash gives you a nice snapshot of the IRR.
Internal rate of return gives you the full picture, the comprehensive picture. And the way that's done is if you own, let's say a shopping center over a period of five years, you're going to have very different cash flows. And whenever you decide to sell the building, you're going to have a big chunk of sales proceeds. How do you evaluate a return on your investment over a five year period, taking into account the time value of money? That's what the IRR does. It gives you a nice picture of your yield. A lot of times investors will look at IRR before making an investment, and it's primarily a pro forma. So it will say, here's my crystal ball and here's where I think cash flows are going to be, here's where I think we're going to end up going on an exit cap, and this is going to be the sales proceeds. And what's beautiful about it is that it gives you an opportunity to evaluate it against other investment vehicles.
IRR could be shown before getting the property. When you're fundraising, getting the funds to purchase a property, that will be the pro forma IRR, meaning this is what we think your return will be over five years. You can also use IRR to show your future investors your past experience, and the returns that you have given your previous investors. And those are real numbers. A lot of times in the investment world we look at the IRR's on these pro formas and think "That's what I'm going to get". And it's not always the case in private equity. So what you really want to look at from our standpoint is the track record. And that's the beauty because you never really know what it's going to be until you actually sell it. And that's the real number.
What are REIT's and what are the pros and cons of investing in a REIT from an investor's perspective?
REIT's came about in the 60's and at that point only accredited investors were really engaged in commercial real estate, REIT's then allowed non-accredited investors to invest in commercial real estate. This can be done in either debt or equity REIT's, and these can either be private or public. To qualify for a REIT there are a lot of requirements, and a ton of reporting. 90% of its taxable income has to be in the form of shareholder dividends, and you have to invest 75% of your assets in real estate cash or US Treasuries. As an individual investor that's unaccredited, what's fantastic about REIT's is that gives you broad based diversification and exposure to commercial real estate, plus just like any other publicly traded stock, it's liquid, meaning that you can get in and get out very quickly.
For any of your listeners that own a home, they know that real estate is not a liquid asset. There's a lot that goes into selling it. There are a lot of advantages to having a liquid form of investing in commercial real estate. Plus you get exposure to investment grade assets with stable cashflow, and that's one of the beauties of it.
The cons are that, unfortunately, REIT's don't offer much in the form of capital appreciation. They're very dividend heavy focused. And those dividend checks that you do get from REIT's are going to be taxed as regular income. So it makes a lot of sense to keep these in tax deferred accounts, like a retirement account for example. Also, the reporting that they have to do end up giving you high management fees. Plus, they're traded like a stock, and a lot of times it's a lot of emotion that goes into investing in liquid assets, and a lot of times they're traded in the short term. The last thing that always made it difficult for me is, if you're investing in a REIT, they have let's say a hundred properties across the US, and I'm not going to be able to look at each underlying property, and they aren't going to show me that either. So there's a little bit of lack of transparency, and you really have to to make sound decisions based on what you feel like a good management team is, what their philosophy is, and where you see dividends growing in that particular sector.
With REIT's, we as investors don't get the appreciation on the building. Who gets that?
Because so much of the way their stock is traded is based on potential forward earnings on dividends, you're not going to get any of the upside like you would in a traditional private equity transaction that gets filtered back to the REIT's. They're only required to deliver those cashflow dividends and you really don't get the appreciation upside like you would if you were to invest in a private equity transaction.
One thing to note is that when something does happen to the economy and investors want to immediately cash out, the REIT's have to sell these properties in order to give the cash to their investors. And therefore it's another wonderful thing for us as investors to purchase property when there is a downturn. And the REIT's have to sell their properties pretty fast, correct?
Absolutely. Just like any other public traded company, they are at the mercy of their shareholders and investors sentiment. If things do tip, and this goes back to that concept of it being traded on human emotion like most stocks, it's extremely volatile. They will have to accelerate some things off of their balance sheet in order to keep their investor base happy, which from my standpoint, we're looking at shops at that point to come in and acquire these assets and really add some value, and enhance the performance for LP's.
Within how long do they have to give the money back? Is it really fast? Is it within a day or a week?
I don't know the specifics of how quickly it needs to turn. Most of these dividend checks are sent on a quarterly basis. Reporting is very strict and, traditionally, it's done on a quarterly basis.