True wealth is having assets that produce cash flow – cash flow is they key to sustaining that wealth. In this episode of Passive Investing from Left Field, Paul Moore, the founder of Wellings Capital, joins Jim Pfeifer to share his secrets on how you can keep your wealth growing by investing in cash flowing assets. Paul also shares his strategies for creating wealth and explains the difference between speculation and investing. He also talks about how you can vet sponsors by following the principles from Brian Burke’s book, Hands-Off Investors. Listen to this episode and hear Paul’s strategic plan to create wealth with cash-flowing assets!
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Creating Wealth With Cash Flowing Assets With Paul Moore
I’m excited to have Paul Moore with us. He’s the Founder, and Managing Partner of Wellings Capital, a real estate private equity firm focused on mobile home parks, self-storage, and RV parks. He’s an author, a podcaster, a regular contributor to BiggerPockets, and an experienced real estate investor. He was a guest on our show on episode 24 and is going to be the keynote speaker for the upcoming in-person Meetup in the Left Field in October in Columbus, Ohio. Paul, welcome to the show again.
It’s great to be here. What an honor.
We are pleased that you’re here again. Usually, I ask for the full backstory, your financial story, and how you got to where you are. Readers, if you want the full story, go back to episode 24, read that, and then come back here. Can you give us a brief background of how you got into real estate and syndication? How do you get to where you are?
I sold my company at age 33 to a public firm. Very fortunate to do that in Detroit in ’97. I started investing in real estate to protect and grow my own wealth. As I talked about on the last show, I thought, “I’m a full-time investor now,” but I really wasn’t. I was a full-time speculator, and I didn’t know the difference years ago. I lost a lot of money and made a lot of money as well. It wasn’t as fun as I thought to get fun, excitement, a thrill, and a charge, all those antonyms or synonyms, I should say, out of my investing the same way I did as an entrepreneur. I found that there’s a big difference between investing and speculating.
We talked about that at the last show. After a lot of pain and over several years, I worked my way from all kinds of residential deals into commercial. I ended up writing a book called The Perfect Investment on multifamily. I found that it wasn’t perfect, at least for me, because we found a lot of people were outbidding us by 10%, 20% or even 30% on deals that made no sense to us. They made millions of dollars while this rising tide has lifted all boats these last few years. We expanded out into self-storage, mobile home parks, RV parks, and some multifamily in our funds. We are on our sixth fund now at Wellings Capital. That’s the whole journey in two minutes.
If someone wants to know the whole journey, we can go back to episode 24. You mentioned speculation versus investing. This is a critical topic. We talked a little about it last time, but I want to dig in a bit more. What types of assets do you see as speculation and as investments? My feeling is that an investment is something that produces cashflow for you. You are not just banking on the upside and speculation produces almost nothing. You get no current benefit but you are hoping, crossing your fingers, “This is the big payout.” Can you talk a little bit about the assets you put in each category?
I don’t know if it’s an absolutely perfect analogy in every case but I completely agree with you. True wealth is having assets that produce cashflow. If it’s predictable cashflow, growing cashflow, and appreciating, all the better, investing in those types of assets. Paul Samuelson was America’s first Nobel Peace Prize winner in economics and he said, “Investing should be boring. It should be watching the paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”
Another famous investor, George Soros, said, “If you are having fun, you are probably not investing.” I’m not saying it’s not fun to invest but honestly, it is sometimes a little more boring. I agree that cashflow should be the key to that. Warren Buffett said, “This is going to offend a lot of people but I bought a little Bitcoin myself as a flyer but I wouldn’t give $20 for all the Bitcoin on the planet.” The way he thinks is, again, if it’s speculative, he wants nothing to do with it. If Buffett Law, if Berkshire Hathaway lost 99.4% of its value, it would still beat the S&P 500 over the last many years. He’s done pretty well with that investing versus speculating mindset.
I don’t think it’s wrong to speculate about building a ground-up self-storage facility, ground-up multifamily or a ground-up light industrial park. They have a sense of speculation but also have a much higher reward in the end. I think of speculation more as assets that have no tangible cashflow to create value. I don’t mean to knock Bitcoin but it was up to $62,000 at one point, and in the last several years, it has been as low as $3,000. I hear it’s hovering around $20,000. I don’t pay much attention to it. It has no tangible cashflow to create value. Therefore, in Buffett’s mind, it’s pure speculation. I have to say, I agree.True wealth has assets that produce cashflow. Click To Tweet
I agree with that as well. I’m not going to say invest in Bitcoin. I speculate in Bitcoin. Part of it is that it’s fun. I have a small portion of my capital that I reserve for fun speculation but that’s swinging for the fences. I loved how you said, “If you want to create wealth, you need assets that produce cashflow.” Maybe investing speculation, they aren’t asset class dependent. If you invest in Berkshire, even though you’re not getting cashflow, maybe that might be more investing.
Whereas if you invest in the meme stocks, that’s the speculation. It’s the same as if you put money into a development deal, that’s speculation on some level but if you put it into a deal that’s already cashflowing, there, you’re investing. It’s not maybe asset class dependent. It’s what the project is or what the actual deal is.
I want to point out Berkshire Hathaway, last I checked, has about 115 investments in every one of those cashflows. Even though Berkshire is not cashflowing net to the investor, they’re reinvesting. In fact, Buffett made one distribution in 1967. It was $0.06 a share or something. He regretted it ever since. He feels like he can better reinvest that money than hand it to investors to reinvest. That’s one of the reasons we added a distribution reinvestment plan to our new fund but that’s another story.
I liked the way you think of that with Berkshire. Thinking of the entire economy, I want to switch a little bit and talk about inflation. You said that can be an advantage to investors. Can you explain how inflation can help real estate investors?
I remember 1979 and 1982. I remember when in December 1980, Paul Volcker from the Fed pushed the prime rate to 21%. Ronald Reagan partly got elected based on his campaign platform that inflation is always evil. It’s a thief, a robber, and destroys people’s retirements. There were people who were getting pension checks, as they used to call them back in the late ’70s, that would cover two months of their mortgage or rent, and all of a sudden, it was covering two weeks of their mortgage or rent. It was horrible, but honestly, for real estate investors, it can be harnessed for good.
There was a great economist from the 1600 or 1700s who said, “If you can figure out who is creating the cashflow, the currency, and has got the power, that would be the Federal Reserve and the US government. If you can figure out how to be on their side, how to harness what they are doing, and you can be on the same side as them, then you can create great wealth.”
If you can lock in to low fixed interest rates, and let’s say it’s a 10 or a 30-year deal, at 4%, 5%, even 6% interest rate but you can allow inflation to run up those rents and, therefore, revenues and net operating income by what’s it running now, 8% a year, it could create massive at least paper wealth for you. It may be that you are keeping up with inflation but that’s a lot better than falling behind every year. A lot of other asset types do that. Real estate has this amazing ability to keep up or stay ahead of inflation for the most part.
Is it too late? Our interest rates have already risen so much that now you can’t get in there and be on the same side of the government as far as getting that long-term fixed interest rate and then writing out the inflation as it comes. Are there still opportunities to get in there and get some fixed rate in? It used to be that interest rates were 20%. I don’t imagine we’re going there, but historically, we are still at pretty low-interest rates.
I can, and any of us can only answer that in a rear-view mirror because somehow or another if interest rates fall back to where they were, the effective rate in the 3s, 2 years from now, which I cannot imagine. If it happens, maybe we did miss the window this time or at least for a short time. Overall, as you said, we are historically low-interest rate times. If you can find deals with a significant amount of intrinsic value that’s not tapped or harvested however you want to look at it by the current owner, you can significantly outpace any interest increase or any other cost increases you might have.
That’s more important than where we are in the cycle. It’s finding that value out. Warren Buffett, Charlie Munger, Howard Marks, and Ray Dalio made a fortune in value investing. If we can value invest in the real estate world, honestly, whether the interest rate is at 3% or 8%, we can often outpace that significantly, and the deals we invest in are what we see all the time.
Talk a little bit about intrinsic value. That term is thrown around a lot. It’s the value-add stuff, mostly. Can you talk specifically, maybe even by asset class, about what you mean by intrinsic value and how do I recognize that when I see it?
I could talk about this all day. You are going to have to reign me in, probably. If you can acquire an asset from a mom-and-pop operator, then you will often find that the mom-and-pop operator doesn’t have the desire, the resources, or the knowledge to improve the asset, create more revenue and net operating income, and therefore create more value.
An example of that would be a super simple one. Let’s say I have a self-storage facility. I acquired it for $3 million, and it happens to be in a great location. I borrow $2 million on that, and I have $1 million in equity on a $3 million self-storage facility. If it’s in a great location to add U-Haul. This is one simple example out of dozens. I add U-Haul. Let’s say I can make a $3,000 a month commission on that. You can do much more than that. I know people making much more than that and people making a lot less than that in U-Haul, to be clear in self-storage.
$3,000 a month is $36,000 a year. Backing up the commercial real estate formula for value is the net operating income divided by the cap rate, which most of your readers know. $36,000 a year divided by 6% or 0.06, you created $600,000 in value from one thing you can do. That’s an intrinsic value. That opportunity was there for the previous owner but it took the new owner to unlock it.
$600,000 in value on a $3 million facility, which was at 20% ROI on day one but a 60% ROI on the equity. That equity holder now, instead of having $1 million in equity, has $1.6 million. Let’s say that operator added a retail store with locks, boxes, tape, and scissors. They raised rents to market levels. It was 20% higher. There were 6 acres out back, and they could add an RV and boat storage. That’s huge.
Adding a billboard, filling 40 vacant units at $125 a unit, that’s $60,000 a year but divided by a 6% cap rate. That’s a million-dollar increase in value from 40 vacant units. Lots of mom-and-pop operators have much more vacancies than that. Those are some examples in self-storage but there are examples in every asset class that we know about.Investing should be boring. If you want excitement, take $800 and go to Las Vegas. Click To Tweet
There are a couple of things in there. One part of the reason I’ve found that the mom-and-pops, a lot of times, don’t do this is maybe they are not sophisticated enough but also, they might’ve owned it for 30 years to pay down their mortgage and don’t even need it. They are fine to let it go, and someone like you or the operator can come in and do that value add.
The other thing you mentioned is leverage. That increases your returns significantly. I’ve heard people say, “One of the negatives of syndications as a passive investor is you can’t use leverage.” My point is that the leverage is in the deal. You are not going to get the leverage at the bank. The asset manager is going to get the leverage, so you still have the leverage.
Using the Buffett mindset, hopefully, a professional investor with their own skin in the game, a team, and a track record knows how to leverage that better than most of us would on our own. We have an operator we invest with who comes in at 65% leverage less than my example but, within a year, they usually have a 35% LTV, Loan to Value. How do they do that?
They might pay the loan down a tiny bit but they mainly do it by increasing the value, the denominator in the loan to value equation. Think about what that does is more important even than that. Not only is it increasing the value and making you feel better. It’s increasing the debt service coverage ratio and, therefore, increasing the margin of safety.
What I mean by the DSCR is that 35% LTV guy, his Debt Service Coverage Ratio is about 2.5. That 2.5 means there’s a 2.5:1 ratio between the net operating income and the debt payment. On a given month, to make it simple, they might be making $25,000 net income after all their costs but their debt payments are only $10,000. In a terrible economy, a pandemic, or a 9/11, they could lose a whole lot of occupancy and rent and still be way above their debt payment. That’s what we love about real estate to survive and even thrive through a recession.
The way you explain the DSCR is well said. That’s awesome. How many times can the net operating income cover the debt service? The way you explained that was perfect. That shows you the security of your investment. If you have all this income, even if your income goes in half, you are still going to be able to pay the mortgage. If you can’t pay the mortgage, that’s when you get into trouble, especially with adjustable interest rates.
We typically invest with operators who have fixed interest rates but there are some components or sometimes they do have an adjustable rate, especially if there’s a lot of value add. That’s true. Even if, with an adjustable rate, let’s say that the $10,000 a month payment went to a horrible level, which is $15,000 or $18,000, you would still have more than enough to cover it. You would be adding that value and, hopefully, wouldn’t be forced to sell.
I heard about a guy who owned a Walmart or a strip center around a Walmart. The value of that building or the strip center went down significantly since interest rates went up. We are not seeing a lot of this yet, but we will. He’s like, “Why do I care? I’m still making $20,000 a month free and clear. What do I care with the value goes down? I plan to hold it long-term.” That’s one thing we love about real estate, especially commercial real estate.
Back to speculation versus investing, if you have been in the stock market over the last few months, you saw your statement might be down 20%, 30%, or something like that. I have no idea the value of all my real estate holdings, and I don’t care because I’m still getting the same cashflow that I got months ago. A few months from now, perhaps that cashflow will go down a little bit. My friends don’t work out or there might be some troubles but it’s not going to drop 20% or 30% overnight like the stock market is. That’s another reason for investing in real estate.
I want to talk a little bit about a multi-asset fund. Your fund has several asset classes in it, mobile home parks, self-storage, RV parks, and maybe a little bit of multifamily in there. That gives built-in diversification to the investor. That’s easy to see. What are some of the other advantages and reasons for investing in a multi-asset fund besides the, “You get a couple of different flavors of ice cream there?”
I’m going to come at this from a slightly different angle. If Michael Phelps, as a kid, would have decided somehow magically that he wanted to get 28 medals, 23 gold, and 5 more in the Olympics, he could have and probably would have thought, “I’ve got to go learn to do high jump, long jump, javelin, 400-meter, shot put, pool, and who knows what else.” Instead, he hyper-focused on the swimming pool. We all know the book, The ONE Thing by Gary Keller and Jay Papasan. He was able to have much more success.
I don’t think we would’ve ever heard of Michael Phelps if he had tried to do what Jim Thorpe did 100 years ago and have 6, 10, or 20 different events. By being a multi-asset fund, we are able to find operators who are obsessed with one thing, whether it’s RV parks, self-storage, mobile home parks, and light industrial. We are able to diversify and put them together in a fund that allows investors to make 1 investment and get in perhaps 100 different assets.
If you wanted to get in 100 different assets with 8 different operators across 20 different states in 6 asset classes, if you want to do a $50,000 or even a $25,000 minimum across 100 assets, what would that be? Millions of dollars you would need to put in. Most people don’t have that or don’t want to put that much in. With a multi-asset fund, you can put in $50,000, for example, and can be spread across all that diversification.
Comparing it to the world that most people wander into, which is the stock market mutual funds, it seems like you are describing almost a mutual fund. It’s like an index fund almost but it’s not an index fund because you are specifically picking operators. They are not taking every operator. What does that do to the returns? If I was to pick one really awesome sponsor, am I going to get better returns than going with you where you are doing blended through different sponsors and different asset classes? Is that going to double my returns?
Let me answer that in two ways. Number one, yes. It could double your returns, and that would be what I would call the diversification tax. I’m saying that loosely but you get my point. You are paying maybe a small percentage, 1% of your return, to be diversified across these different asset classes. The 1% was a complete example. I just threw that out. The offsetting factor to that is that we get better deals.
For example, my business partner, Ben, was in Nevada doing due diligence on a self-storage fund. We are excited to invest if they’ve passed through all our due diligence screens. We are still working on it. They offered us a much better deal than a retail investor would get. We are getting a piece of the general partnership. We have another operator with a 65/35 split but they gave us an 80/20 or maybe a 75/25 split, much better than the investor would get. That’s an offsetting factor. I can’t say that everybody’s returns will be better with us but that’s not nearly as costly as you might think at a glance.If you can acquire an asset from a mom-and-pop operator, you'll find that they often don't have the desire, resources, or knowledge to improve the asset, create more revenue, and therefore create more value. Click To Tweet
When you diversify inside the fund, we’ve talked about the asset class as one of the big ways you diversify inside the fund. Do you also look at the market and geography? What other things do you look at as you are trying to build that out? Do you go after quality sponsors and let them pick the ways, and you get natural diversification? Do you target certain markets or sponsors?
Warren Buffet and Charlie Munger for Berkshire Hathaway find durable assets or durable asset classes, whatever you want to call them. They go and look for the best management teams they can find that do those durable assets, those great assets well. That’s exactly what we do. We don’t focus on geography. It’s not like we are trying to get more in New England, Florida, or Texas. We let the operators pick that. We feel that having the best sponsor far outweighs being in the best geography. That said, we love it when sponsors avoid California and a few other locations that are harder to operate in.
We talked about asset classes and RV parks. This seems to be something that is becoming more popular now than it was a few years ago. A few years ago, I didn’t even know it was possible to invest in RV parks. I didn’t think about it. Similar to car washes are both the new asset classes that are popping up. Why are you looking into RV parks? What do you see there? Talk to us about the asset class.
RV camping increased five times as much in 2020. Remember that was right in the middle of COVID, five times as much as it did in 2019. Twenty six percent of new RV campers were new to RV camping in 2020 during the pandemic. Now, 11 million households or a little more than that own RVs but here’s the amazing statistic, 9.6 million plan to buy an RV within five years.
If that plays out, you are talking about maybe an 80% increase in RV ownership but there’s something that’s more powerful than all that, in my opinion, at least. The Airbnb model or the sharing economy model that’s popped up so rapidly within RVs has turned any RV into a mobile rental unit. Let’s play this out. If you own an RV, instead of using it 4 weekends a year, you can now rent it out for 20 weekends a year, as an example. That’s five times as much use.
Not only are sales going up of the RVs but the usage is now potentially going up much higher. Who’s that going to put a strain on or a constraint on? It’s going to be the RV parks because that same RV pad might be used in my example, 3, 4, or 5 times as often. That’s exactly what we’re seeing. My neighbor has one of those huge, expensive RVs. It’s a Winnebago or something. He said he has to look a year out or more to book an RV space.
COVID massively increase this trend, and you can imagine why. A study before COVID said, “It’s 47% less expensive to take an RV and camping trip than a comparable car, hotel vacation, and 62% less expensive than a comparable air flying and hotel vacation.” We are excited about this asset class. I will take a breath. You can ask me more questions. We love RVs.
Is this like mobile home parks where they are not building any new ones? If you say they are going to be 80% more people out there going around in motor homes, you can add all the amenities and make current places nicer like value add, as you talked about any other asset class. Are they building the space, so there’s more capacity?
They are. One of the good things about RV parks is that a lot of them are remote. The top RV park in America, according to USA Today, is in Pelahatchie, Mississippi. That’s one we did not invest in but we invest heavily with that operator with his other deals. It’s remote, yet it’s only a couple of hours from a lot of major cities. Another one that my wife and I stayed one way outside of Fort Worth, 45 minutes West. I felt like it was in the middle of nowhere. I was driving there at 11:00 at night, feeling nervous like, “Where are we going?” Once we got there, it was like a resort. They had a $2.5 million water park and a $600,000 lake they added.
They had Wibits, a $200,000 feature where you put an obstacle course out on the lake, and kids rent it for $17 an hour. That’s a total of $1,000 an hour, by the way, in the summer that those things rent for in the season. They’ve got a drive-in theater, face painting, and rodeo stuff. They’ve got human foosball, jumping stuff, an amusement park, and putt-putt golf. They have T-shirt painting and gem mining. All these different things are added as value adds. They took a $3.5 million RV park they bought and added space out behind it. They added 100 acres to add a lot more sites. It turned out, in the end, to be an $18 million park but the value based on cashflow once they are up and running is over $30 million.
How does a passive investor like me know what metrics I’m looking at when it’s a multifamily property and want to see what are rent increases pro forma going to be? What’s the tax situation? Are they putting an increase in taxes in the pro forma? What’s the vacancy and the economic vacancy? Those are some of the factors I focus on. What do I focus on in RV parks? I have no idea. How does a passive investor analyze that?
It depends on the strategy. One strategy is to get an RV park like Smith Mountain Lake here in Virginia, the RV park that sold for $7 or $8 million. It’s not even a very large park and doesn’t have hardly any amenities but it’s at this awesome lake in the Blue Ridge Mountains. A lot of those RVs sit there all year. The strategy with that one is lower rents but very high occupancy. Another strategy is like the one I described where you have a resort-type destination location, and the occupancy might only be 3 or 4 days a week, 6 months a year like Zion National Park or Grand Canyon would be year-round probably but you get the point.
It has lower occupancy but much higher rates. They have golf carts that rent for $75 a day. There you go. It doubles the revenue right there. Those are two completely different strategies. You would have to figure out the strategy first and then dial in to see how well that operator is doing within that strategy. You want to ask detailed questions. We have a person on our team who nails or understands all those numbers and takes a look at them. It’s still pretty new. There are probably lots of other strategies. I didn’t even mention it in between those two.
How many operators are there or how many have taken an RV park, full cycle, done all the value add, and sold it? Are these hold forever? What are the operators like? How many people are there gobbling up all kinds of mom-and-pop things? Are there a few big operators out there?
There are 8,750 privately held RV parks in the US. Ninety four percent of them are held by operators who have 1 to 4 properties. It doesn’t mean they are mom-and-pops. It doesn’t mean they are horrible but likely, if they have 1 or 2 properties, they are probably considered mom-and-pops. They don’t have the desire, resources, or knowledge to improve the park and add all those amenities. They don’t need to.
They are getting incredible cashflow. There are two very large operators that operate REITs. One is Equity Lifestyle Sam Zell, and the other is Sun Communities. If there are any others, it’s hard to find. We spent three years wondering if we could find a professional operator that wasn’t a REIT, then wasn’t a mom-and-pop, and we finally found one. We were so happy that we did but we didn’t know of any others.People could lose a lot of occupancies and a lot of rent and still be way above their debt payment. And that's what we love about real estate. It can survive and even thrive through a recession. Click To Tweet
That’s interesting. There are a lot of new ones starting out there. You will be able to find them 3 or 5 years from now but it’s great to get in on the ground floor. I want to switch tracks a little bit and go back to the vetting of sponsors because we talked about this last time, and it’s super important. It’s one of the things that we really concentrate on. Left Field investors are vetting the sponsor but it’s different when we are vetting a capital allocator like yourself who has a fund that you are not the actual operator of.
You are going out and finding the operators, so you are doing the operator vetting. You are doing it much better than an individual would do because you are a company and have more resources and all that. I get all of that. How do I, you, or any capital allocator make sure that we are in alignment, that you are the sponsor that I want to work with? What do you recommend the processes for that?
There are not many out there that do exactly what we do. It’s a little hard to answer in a sense because I don’t know what these other allocators do exactly but I can speak to you for us. If I were looking at investing as a third party in a fund, I would say, “Tell me about their experience, their internal team, who they have on the team, and how they vet the operators.”
We all know about Bryan Burke’s book, The Hands-Off Investor. Are they following the principles of that maybe 300-page book to vet their sponsors? This is a very long list that we covered a lot of last time. How much skin did they have in the game? What type of fees do they have on the front end and the backend and asset management fees? What type of waterfall preferred return? Keep in mind that your hurdle or your preferred return is a split on a split and keep.
If I say to you as a fund manager, “Instead of a 60/40 split like one of our operators that we’ve invested $47 million with, we get an 80/20 split.” That sounds great but keep in mind that we have a split on a split. If we have 80/20, and that operator’s given 80/20, you need to realize it’s 64%, 80% of 80%. You are getting 64%, and 64% is still better than 60% but we have other fees and things too which we are going to knock down to your point that there’s a cost. When I think about that, I think, “What am I getting for that cost?” We mentioned diversification across asset types, operators, and geographies. As an investor, I would better be expecting a much better gross return.
If I’m only going to get 64% minus some fees on top of that if you can picture an 80/20 curve, the 80/20 Rule. It’s fractal and the top 20% of the top 20%, you can prove this Perry Marshall’s great book, 80/20 Sales and Marketing prove this. If you can find the top 20% of the top 20%, which would be the top 4% of operators, they are going to produce perhaps the top 80% of the top 80% of the profits, the top 64% in other words.
They better be doing that and have a track record. They would be able to prove they are doing that because if that operator, that fund manager is able to get twice the revenue and twice the profits, even if there’s a 64% split, rather than a 70% or 80%, which you would love to see, hopefully as an investor, I would see the value in that.
I want to get into the weeds for a minute. Left Fielders have a membership group called the Infield, and we have a forum where people are always talking about deals, sponsors, and investment strategies. In the forum, we were talking about your fund because there are people that are investing and others that are interested in it. People were talking about the preferred return. We had a conversation that it’s not a preferred return we normally think of in typical syndication. It’s a hurdle rate. Can you explain to us what the hurdle rate is? What a preferred return is? What the difference between those two are?
I’m probably being a little technical here but the preferred return is anytime the investor gets paid first. We have, and most everybody else has a preferred return. Where the difference is, is it a cumulative preferred return or noncumulative? Cumulative is better. Let’s say, that the preferred return hurdle is 7%, as an example.
If I hit 5% this year, the hurdle is 7% that I’m banking. The investor is banking 2% for the future. Next year I hit 6%, and they are banking another percent. Next year, we refinance and hit 10%. Now that the first 7%, plus that 3% that were banked, all goes to the investor. That’s a cumulative preferred return. Everything above that split is 60/40 or 70/30.
Part of the way we modeled this out was because of SEC regulations that we had to comply with. We decided to be a publicly registered fund and a registered investment advisor as well. We have an 80/20 split on the cashflow above a 10% hurdle but that hurdle stands alone every quarter. We expect that our fund will produce roughly a 5% to 8% annual return. If we ever exceed 10%, which is unlikely, then Wellings Capital, my company, would get a 20% split of that cashflow from operations. Anything below 10% annualized, it’s 2.5% a quarter, all goes to the investor.
Effectively, we expect all the money from operations to go to the investor and all the money from refinance to go to the investor. We used to take a split on that. All the money from the principal from the sale of an asset goes to the investor. An 80/20 split on the capital gain or the profit at the end is what we expect. We also pass 100% depreciation to our investors, which is not a question you asked but I’m throwing that in.
Is that why you put the hurdle at 10% instead of a typical prep of 7%? In the typical prep, you get that 7%, and then everything above that is subject to the split. If you have a 10%, you don’t have any catch-up provisions. That’s the main difference. Unless you exceed 10%, you are not getting paid until the end of any of these operations.
That is not something we originally planned but our attorney said that’s what the SEC regs want to see. Our view was that we put it at 10%, so the investor can know we are doing everything we can to take care of them first.
That’s important. That’s an alignment of interests. You are also invested in the fund, but sometimes, the preferred return is always confusing. Most syndicators seem to do it. There are a few that don’t. When you throw in this hurdle of return instead, sometimes it can get confusing because people think, “That’s a pref.” When it is a pref but it’s not the cumulative part. Depending on the backend split, you could end up paying out more to investors at a 10% hurdle than 80/20 than say, somebody who had the same exact results with a 7% pref with a 70/30 split on the backend. It could turn out that yours is better perhaps or theirs is better. It depends on how the deal turns out.
We run lots of models and even included our CFO, a guy who was an executive with Vanguard for many years under John Bogle. We came to the conclusion that it was roughly the same based on the likely returns that we internally believe will happen here. While what you said is exactly right, the bigger factor is what I said. That is if we are good at picking assets and operators and much better than average, then, in theory, the total returns would be so much better that the difference in split, the cumulative versus non, would be almost irrelevant.Multi-asset funds could double your returns. Click To Tweet
That’s a great explanation because sometimes people don’t want to ask the question because they think it’s offensive or the syndicator won’t answer. I know you are not like that but my point is, if you are not going to ask the syndicator, then you shouldn’t invest. If the syndicator operator isn’t going to give you a quality explanation with no defensiveness, then I don’t want to invest with them anyway.
When I reached out to you on this, you were like, “Let’s talk about it. Let’s hammer it out.” I appreciate that. That’s a big deal. The last question I always ask, and you answered this last time, so we get to see if your answers are the same or if you have changed your answers at all. What’s 1 great podcast or 2 that you like to listen to?
One would be The ONE Thing Podcast. That is Jay Papasan’s brainchild. He’s the co-author of The ONE Thing with Gary Keller. I have incredible respect for Jay. The ONE Thing Podcast helps me stay focused on what’s important. Another is We Study Billionaires. One thing I love about that is they will look at Buffet and all these great investors like Howard Marks, Ray Dalio, and all these guys and will study it. I love, in my brain, to transfer that stock, bond, and company investing over to real estate to see how it relates. In fact, I’m writing a book on that.
The ONE Thing is a new one to me. I also listened to We Study Billionaires but I’m going to check out The ONE Thing, and those are different. It means you are adding to your podcast list. That’s fantastic.
Did I say The Hundred Thompson’s last time?
No, but we will add that in because last time you said the real estate guys in BiggerPockets, you were going with the big guys.
I go through cycles. Sometimes I think, “I will never miss a We Study Billionaires,” and then a month later, I miss three of them. I have to be honest. All of our schedules were up and down. When I get on the road, I get more time to listen. I’m looking forward to heading up to Columbus soon.
We are super excited. We are weeks away from the Meetup in the Left Field in Columbus, Ohio. Paul is going to be our keynote speaker. We are grateful that you are willing to do that. We are excited to hear what you have to say. If people want to get in touch with you, what’s the best way they can do that?
I wrote a couple of eBooks. One is, basically, where’s the on-ramp for commercial real estate investing, and others were on self-storage, mobile home parks, and RV parks. You can get all those at WellingsCapital.com/Resources.
Thank you very much for being on again. We appreciate it. We can’t wait to see you in Columbus.
It’s always an interesting conversation with Paul and this episode was certainly no exception. He talked about how he lost money speculating. Part of that was because he thought that he was investing. That’s how I started out my career because I was a stock market mutual fund guy, and I thought I was investing all this time. I couldn’t understand why my wealth wasn’t taking off like I thought it should. It’s because I was mostly speculating.
I wasn’t getting a benefit in the form of cashflow for my investments or speculations. He came out with this, “Wealth is assets that produce cashflow.” That’s basic and easy, and we all know it but the way he said it made total sense to me. That’s what I’m trying to accumulate, assets so that I have continuous cashflow.
I don’t have to worry about the depletion of my assets, which is what 401(k) and stock market investors have to worry about. He’s right. Speculation is not bad. You just need to know you are doing it, and that’s the key. I speculate on Bitcoin and some of the pre-IPOs and some development deals. I know it’s speculation. I keep it to a small amount of my portfolio and make sure everything else has cash coming in from it.
He also talked about Debt Service Coverage Ratio, the DSCR, and that’s something that we have on our deal analyzer. It’s one of the tools we have for Infielders. It’s hard to understand when you are looking at it but again, Paul has a way of explaining things that make them easier to understand. He used the example that if you have $25,000 in NOI and $10,000 in debt, that’s two and a half times DSCR.
What that means is that you are NOI could decrease quite a bit before you are in danger of not covering your debt. That was a great explanation. He has all these terms that make sense to me like diversification tax. That’s the tax you pay for reduced returns that you get from this hyper-diversification. In exchange, you have less risk, which again makes sense. When you say it that way, it hits me, diversification tax. I liked the way he said that.
We got into some conversations on RV parks, as huge growth is coming in RV parks. A lot of that is fueled by the Airbnb type, where you can rent an RV park or an RV, so it’s not just sitting in your driveway or in storage. It’s used a lot more, which means a lot more RVs are on the road. This is an awesome asset class that is poised for growth. We will see. He’s constantly throwing in Warren Buffett comments, and it’s interesting. Warren Buffett’s stock is publicly traded but he is a buy-and-hold investor of cashflowing assets. Paul is constantly comparing to real estate, which, at least for me, helps everything be a lot more understandable.
Finally, I liked the way that you could have a conversation with Paul about his structure and deal, how it’s a little bit different than others, and people might misunderstand it but he is an open book. He’s willing to have the conversation. He does not get defensive. He explained and even said, “It might be a wash.” He thinks maybe it will turn out better if the deal turns out well but the hurdle rate is different from the standard preferred return. He was happy to explain that to us.
That’s one of the things I look for in an operator. Are you able and willing to explain your deals and structure without getting upset and expecting me to know something that I don’t but explaining it, helping me along, and understanding? That was fantastic. I enjoyed this episode. I cannot wait for our immediate meetup on October 21st, 2022 where Paul will be the keynote speaker. We will learn from him again, but for now, that’s it. We will see you next time in Left Field.
- Wellings Capital
- episode 24 – Past Episode
- The Perfect Investment
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- USA Today – Article
- Equity Lifestyle Sam Zell
- Sun Communities
- The Hands-Off Investor
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- The ONE Thing Podcast
- We Study Billionaires
- BiggerPockets – Real Estate Podcast
About Paul Moore
After a stint at Ford Motor Company, Paul co-founded a staffing firm where he was 2x Finalist for Michigan Entrepreneur of the Year. After selling to a publicly traded firm, Paul began investing in real estate.
He launched multiple investment and development companies, appeared on HGTV, and completed over 100 commercial and residential investments and exits. He has contributed to Fox Business and The Real Estate Guys Radio and is a regular contributor to BiggerPockets, producing live shows, recorded video, and blog content. Paul also co-hosted a wealth-building podcast called How to Lose Money and he’s been featured on over 200 podcasts. Paul is the author of Storing Up Profits – Capitalize on America’s Obsession with Stuff by Investing in Self-Storage (BiggerPockets Publishing 2021) and The Perfect Investment – Create Enduring Wealth from the Historic Shift to Multifamily Housing. Paul is the Founder and Managing Partner of Wellings Capital, a real estate private equity firm.
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