In this episode of The Agent of Wealth Podcast, Marc Bautis has a conversation with Abel Pacheco about investing in commercial real estate. Abel discusses what sparked his interest in commercial real estate and how he took the leap to move from IT tech sales to becoming a full-time real estate investor. Abel speaks on some of the challenges that may come with the profession and how he has found success in commercial real estate.
In this episode, you will learn:
- Where to start your real estate investing journey, with different market and asset classes.
- The difference between investing actively versus passively.
- The three things to consider when evaluating real estate investment opportunities.
- Tips for raising capital and building trust with investors.
- COVID-19’s impact to the opportunity and investor side of commercial real estate.
- And more!
Resources:
5tcre.com | Bautis Financial: (862) 205-5000
Welcome back to The Agent of Wealth Podcast. I’m you’re host, Marc Bautis. Today I’m joined by Abel Pacheco, President and Principal of 5 Talents Commercial Real Estate, a private capital group that identifies, acquires, rehabs and improves then sells multifamily commercial properties for profit. I talked about the benefits of adding real estate to an investment portfolio in a previous episode of the podcast, and I’m looking forward to talking to you about the details of how to do it.
Can you give us some background on yourself and how you got into commercial real estate?
I am originally from Corpus Christi, Texas. I grew up there near the beach. I now live in San Antonio, Texas. I’ve spent the adult part of my life here after graduating from the University of Texas at San Antonio. I’m married with kids — I have a one-year-old and a three-year-old. They’re my world: My wife and my kiddies.
I’ve been involved in real estate investments since 2008, but I also had a full-time, W-2 job up until this year. Over the years, I’ve taken everything that I earned in my W-2 and put it into passive investments in real estate. I invested in single-family houses for about 10 years, and got up to about eight properties in my portfolio. Then I transitioned to commercial real estate. In less than two years, I went from 8 to 800 doors, including commercial and multi-family. I’m a passive investor, an active investor and a general partner in 5 Talents Commercial Real Estate. I do a bit of development too.
How to Transition From a W-2 Job to Passive Income
You mentioned that you switched from a W-2 job to investing full-time. That’s got to be a tough decision to make. How did you decide to flip that switch and transition to full-time investing? Did you set some kind of goal or or target?
I would like to say I was a strategic about it, but I wasn’t. I worked in tech, IT tech. The business had a lot of success and did well, but none of that success was for me or my family. So I had a mindset shift.
The switch from W-2 to full-time investing came from my wife and I having a conversation. I had wanted to pull the cord two years prior, but somebody talked me out of it. I’m really glad they did. They said, “Wait. You haven’t thought about your credit. It’s easier to get a loan or mortgage on property because you have a W-2. All of that is going to be harder the moment you leave the W-2 job. So ride it out as far as you can.” But a couple of years later, once I had enough holdings and enough maneuverability with cash and assets, I pulled the cord. I knew, at that point, that I would be able to withstand a longer period time without an income check.
I would love to say I was more strategic, but it was really just dissatisfaction and being ready to make that exit.
You mentioned you started in residential and then moved to commercial, which is a typical path. When you started in residential real estate, were you doing single-families and flips, or were you holding them as rentals?
The first property we bought was one that we lived in. We bought a $116,000 three bedroom, two bathroom house in San Antonio, Texas. It was somewhat new at the time and we bought it with our FHA loan. I think we put 3% down, and that was my first property. Then we moved to a second house, which wasn’t a flip or rehab. I wasn’t that comfortable with rehabbing anything — I really liked buying houses that looked nice and were move-in ready. I realize now that I paid a premium for those.
We got into the second investment property with making a very low down payment. It was another three bedroom, two bathroom house. Every time we would move out of one house, we would keep it, rent it, and buy the next one. We did that several times until my wife said, “I’m not moving out of this house, I really like this one.” That’s when we started saving up a little bit more, to put down on the investments.
Our strategy was pretty much to buy, hold and rent them. We managed it with our income from W-2 jobs — my wife was in tech also, so we both had jobs during the daytime. Nights and weekends were devoted to finding the next property, or educating ourselves more about real estate.
We would analyze properties using spreadsheets and try to figure out what was the best cash on cash return we could get. We’d buy the deal and then we’d go back and analyze it. We were doing it backwards, but that was how we became educated — through doing the process.
After the third or fourth residential property, you’re expected to put 20% down and have at least six months worth of reserves. Lenders will add up your properties, add up the mortgages and multiply it by six — that’s what they want you to have in reserves (in the bank), to make sure you’ll sustain payments for six months should something happen. The down payment and closing costs plus the reserves were just too tight. I couldn’t scale. That’s what led us to raising capital.
Scaling You Investments: Residential versus Commercial
Is that when you began to transition into commercial real estate?
100%. We were wondering, ‘How do people buy 100 properties in a year?’ I went to networking events, real estate conferences and seminars. I traveled to many cities and took over 200 hours of coursework. I saw that there are people that have thousands of doors: Literally, 2,000 or 3,000 or 4,000 doors worth hundreds of millions of dollars.
When you added everything up, I owned around $1 million worth of assets. Then I traded or transitioned to almost $100 million of my portfolio asset value. Seeing other people do it opened my paradigm.
Then I found out about things like:
- Regulation D.
- 506B and 506C investments.
- Private placement memorandums.
- Investing passively as a limited partner.
I really felt like my money was earning a faster, better return with less of my time, effort and energy. That’s what led me to commercial real estate.
Did you wind up keeping the single-families, or have you sold them over time?
I’ve sold some of them, I’m down to about five. The most I had at once was 10. Now, I still buy one every once in a while, because I think of it as active capital. How do I get my next $50,000 seed investment? That leads a lot to doing a flip or a rehab on a property. We recently bought a foreclosure and did a short sale deal. Those properties started as active and then turned into passive.
Have you focused on one type of asset class, or are you diversifying out amongst different types of projects?
I started with heavy focus in one market and one asset class. I would recommend anybody that’s new to the space to do it that way, because the real estate world is huge. Even when you narrow it down to residential or commercial, the world is still really big. I chose multi-family properties because I liked the fact that it was ultimately residential but there was less risk. If you rent a single-family or two-family house and one person leaves that month, you’re losing a lot.
The geographic area is also important. I live in San Antonio, Texas. It was easy for me to choose my own backyard. You want to look at the demographics, job growth and what’s happening overall in the area.
Active versus Passive Investing
You mentioned that the real estate industry is big. Can you go over the the difference between investing actively and passively?
Sure. When I’m an active investor, I have to do the following:
- Find the deal.
- Speak with the property’s broker.
- Do the analysis.
- Complete the underwriting.
- Write the letter of intent.
- Get the deal under contract.
- Put the legal agreement together for the syndication.
If needed, I also:
- Raise capital.
- Work with investors.
A passive investor is really just one of the individuals that they’re still part owners. They’re actually real estate owners to the IRS, they are partners in the deal. You have all the tax benefits of being an owner. However, they’re along for the ride and they don’t have to do all the work. They could look at the team’s monthly or quarterly notices, whether they open the email or not, the checks are still going to come in, they still get a piece of the deal.
I’ve heard it explained really well on one of my podcasts when I was interviewing somebody and they compared it to flying on an airplane. They said, “There’s the flight crew and pilot that are leading the deal. They’re the active people that are taking you from San Antonio to Vegas. Everyone else that’s on the plane, they still get there but all they did was pay for a ticket and they can enjoy the ride and not have to worry about the ups and downs of anything that happens on that flight. They arrive safely.” So that’s a good high level comparison between an active and a passive real estate investor.
I see a lot of investors who want to invest in real estate and they start out thinking that they want to be active investors. It’s sexy, they own real estate, they’re doing everything. Then you realize the time commitment and the education knowledge that it takes to do it. You went over everything that goes into active investing and it takes time to do all that, but it also takes knowledge. You can really screw something up and lose money if you do something incorrectly. I see a lot of people flipping back to that passive side and there’s nothing wrong with being on the passive side because like we said earlier, real estate’s a great asset class. Even if you’re a passive, you can see great success in the real estate space from the passive side.
100%, yeah I’m active now. I started passively, I took some 401K money and used to invest in our first 400 doors. It was a great learning experience, I got to earn while I learned… and I moved to the active side to try to make as much as I can. This is now my new full-time job, but ultimately the goal is to go back to 100% passive at some point. You call it full circle at the end of my investing career. I’d love to be passive only and just have somebody else go do the work and maybe I can sign as a key principal and be a little more passive in this.
How to Evaluate a Commercial Real Estate Investment Opportunity
I see a lot of passive investment projects that come across my desk covering different asset classes and locations. How should they start to evaluate a commercial real estate investment opportunity. Are there certain things to look at to help determine that if something would be a good investment?
Yes, there are. It’s funny you ask, during COVID this year I went full-time into real estate. I thought I should probably put some thoughts together and I wound up writing a short e-book. It’s about 60 pages and it’s the guide that I use to invest in $93 million worth of commercial real estate. So that’s on our website, 5tcre.com
The first thing you want to do is decide whether you want to be an active and passive investor. You really want to start with your risk and reward mindset. Do I like a risky investment? Am I young enough to put a little extra risk or as I’m getting older, no, I want a little more conservative? You start to write down your goals. Visualize your success, and then that’s the most important part. Write down what you want to accomplish? I think it’s been said a lot but it’s really understated because a lot of people I work with, they’re just like, “I want to make as much money as possible.”
The second part is starting to realize there are the same steps that you’re going to have to go through and the same with every opportunity.
- Qualifying a Market
- Looking at the team doing the deal
- Analyzing the Investment.
If you can focus on those main key topics, you can’t go wrong as a passive investor.
The due diligence comes down to the market and things like the job and population growth. What are the different industries in the market. What’s the median income. I did that and realized that I liked Texas and more specifically San Antonio. Maybe you’re in the Carolina’s or Arizona. You start to look at those different markets and realize, this is why I want to be here. Or maybe you like living an hour from where you plan to invest and being able to drive to it.
The second thing to focus on is the team. What’s their track record? How have they done in the past? How many projects have they completed? What properties are they currently managing? Who are they partnered with? You want to find all of this out. Do they like riskier or more conservative investments. It’s not that one team is bad because they like more aggressive properties, it’s just the way they do it and may not match with your goals or risk appetite.
You should also try to get to know as many people as you can that do syndications. You want to build relationships with many of them to determine who the best people are for you as an investor. The more syndicators you know that are putting deals together, the more opportunities you are going to look at to find the right one for you.. It’s a lot about timing. Maybe I have the money to invest today but the team doesn’t have a deal. Maybe they have a deal tomorrow and I don’t have the money at that time. You have to find enough teams that you can trust.
Sometimes these deals get filled up in a couple of days. We’re raising a couple million dollars and something it only takes three days to fill it up. Then sometimes it’s the opposite. Sometimes it takes us three to four weeks to put the money together. You really are trying to build a relationship as you’re reviewing a deal. You want to put the relationship in place so that way you’re ready when the deal comes out and you already know how they’re going to underwrite it.
Ask them for some past deals that they have done that you can analyze. Hey, can I see a previous offering memorandum, a previous investment package, so you know what they do. It’s the best time, when I have a live deal, you can look at the past ones and ask them a bunch of questions. I’d be more than happy to talk to you. Our old investments, especially when I don’t have something new going, the moment I have a deal going, my head’s laser focused on raising money.
The third thing to look at is the actual deal. You want to learn about the mechanics of the investment. What’s the business plan? How are they going to increase net operating income? What is the net operating income? What’s the cap rate that I’m buying at? What’s the exit cap rate? Basically, the price that you’re paying at the basis that you buy it in today versus your exit capitalization rate that I’m selling tomorrow. How conservative or aggressive is the project. How much money is being raised from investors? There’s all these finer detail questions like, comps, median income, the market demographics in the area. The renovation, interior unit budget, the outer, the capital improvements to the exterior of the building. All these many multiple questions that you’re trying to figure out.
As a new investor, you can ask the questions, but you may not know what the answers mean. It goes back to taking the time to educate yourself today on the mechanics of a good multi-family offering or good whatever commercial property valuation that you’re doing. When a deal comes across your plate, you already have those things in place and you can quickly analyze a deal at a high level. Do I like the market? Do I like the team? Do I agree with the business plan? They’re going to increase all the rents up to $100 by putting $5,000 renovation per door. They’re fixing the floors, putting in new cabinet faces, replacing the toilets and the tubs, and anything shiny. That’s what they’re doing for $5,000 per unit and for that they’re going to raise the rents by $100 which increases the net operating income by X. Then you can calculate it to a value of Y, which means my returns are Z.
You mentioned that one of the important pieces is the team, and looking at past projects. Does it make sense to look at a past memorandum, comparing the initial projections to the actuals on that project. From there you can get a feel for whether they are conservative with their projections or if they are usually aggressive? If you have experience with a team then you’ll get that information over time but when you’re trying to evaluate a new team it can help. One of the challenges I see with these investment opportunities is that if you look on paper they all look the same. You see this great IRR, this great return rate, they’re doing this, they’re doing that. But obviously not all of them are going to turn out great and not all of them will hit their initial projections. There are a myriad of reasons why they don’t, but going back to the teams does it make sense to conduct some due diligence on how they’ve done on past projects?
The most important part or due diligence that a passive investor should do is on the team. The sponsorship team can have a great market and a great deal but with the wrong team you won’t have success. The flip side is that you may have a pretty good market and a bad deal, but with a great team you can pull off success.
Questions to Ask the Team
What are some of the assumptions that you used to make sure the deal is either conservative or aggressive? As they explain that to you, I’m looking for the answers that just make sense to me. Did you use conservative or an aggressive underwriting? Yeah, well what are some of those assumptions that you made?
You want to see how they’ve done with any full cycle projects. Those are projects where they bought a deal, renovated or improved it, increased NOI, and then sold the property.
I also ask for referrals and references. I don’t just ask them for references because they are going to give me a couple people that will definitely say good things about them.
I go to the internet, search and Google for some of their names, find some of the people that like or review some of their social posts.. See if you can find some kind of information, or you can ask somebody offline, hey, I’ve seen you’re either partners with or connected with XYZ syndicator operator. Have you all worked with them directly? Have you invested with them directly? I’d love to know a little bit of information. That’s probably a pretty slick way to get more information about them, find out a little bit more about their process without having to worry that they’re just giving me the best reference possible. If their investor is like, oh man, I’d love to set up a time with you, I’m thinking about investing with them and I’d love to… have they been delivering on their promises? Then that way you can get a full picture of it. So either one of those two routes will be great.
Have they also had some professional success? I invested with my first partner once, twice, three times but not really because of his expertise in real estate, I knew that but I worked with the guy for 10 years prior in IT. I knew his character, I knew his integrity, I knew the type of individual he was. So that was a big part of the trust factor because he’s educating me through the process. I truly trusted what he was telling me that this was good information, and it turned out to be very true. We went full cycle on the deals, it was the first deal that I went full cycle on.
You’ll start to feel out who you really like and why. There’s a horse and the jockey. Who is running the horse? That’s what you want to bet, you bet on the jockey and the horse in the race.
You mentioned COVID. How has investing been during the pandemic?
I’ll talk about it a couple different ways. From our perspective it was not business as usual. We had a couple of deals under contract early on in March. They were some really good deals that if you rewind the tape. We didn’t know how bad it was going to get mid-March. So we literally walked away from deals, and lose some earnest money. I just took a perspective that we didn’t want to have our investor capital at risk during that unknown period. So we walked away from two deals.
Then nothing happens during March. No deals are getting done, people are walking away from deals left and right. The lenders stopped lending for a couple of big commercial projects. It starts to unfold a little bit throughout the year. Then in April, May, June, July, it comes back to life. The lenders are there ready and willing to help us, but they put a year’s worth of reserves requirements on us. So when we were buying a deal, we usually have to put 20% down into the loan, so if it’s a $10 million property, we’re putting $2 million down. We’re usually raising another, million or so, 10% for capital improvements and renovations. We raise that all up front. Well, the lenders were asking in addition to the 20% down, in addition to the operating reserves, and they wanted a year’s worth of reserve payments in advance. So that definitely meant we had to factor that in. More money had to be raised and it was harder to do a deal.
In addition to that, it felt like sellers wanted more for their property as well. I think they realized the value of their multi-family was probably higher, the stock market was a little chaotic, the market in general was a little chaotic. They had an asset which was generating income. You thought the prices were going to go down, there was going to be these sellers that were distressed, and needed to get out. In fact, it was the opposite. They said, well, I’ve got a pretty good income generating asset. We’re doing well so I’m going to put a premium on this price. That gap between what we wanted to pay and what they wanted to sell at and what the banks wanted to lend, that was very far apart. It was hard for us to go do deals.
Come September of 2020, it feels like the world opened up. The lenders said that they didn’t need 12 months reserve payment anymore, they would take 6. Instead of interest, taxes and insurance, they started saying, okay, we’ll just put the reserves not on PITI but just ITI. So they came down a little bit more there too. I think buyers started saying well, I am willing to pay a little bit more because I realize it is an income generating asset that I want to buy. I think sellers are starting to realize, I probably can’t just sell it for whatever arbitrary price and it still has to be measured off of NOI and the cap rate. Deals are now starting to get done.
I’ll also talk about the COVID aspect for the renters. Our tenants and renters are paying. I think we were very lucky to be in the multi-family asset class or not office space or retail.
I think if you are in California, New York, Boston, or Chicago, those are some of the definitely hard hit markets where they are experiencing a drop in rent premiums. When they rent out a new unit, they’re renting them below what last year’s market. I think that’s probably because probably their urban core areas were probably hit the hardest for COVID and unemployment. Real estate is very local, super micro focused.
It’s very different from single-family. If I was a single-family investor I’d just be cautious. It’s so hard to invest in a different city. But with the right team and right deal I would feel comfortable going into a syndication.
Abel, I want to thank you for being on the show today. You have given us a lot of great information on investing in commercial real estate. How best can someone find out more about you and any projects that you’re working on?
The easiest way is to go to our website 5tcre.com. It’s an abbreviation for 5 Talents Commercial Real Estate. I’ve recorded a number of podcasts. I think there’s like 15 recordings on our website under the About Us page. The book that we talked about is there as well, 5tcre.com/ebook. There’s an educational portion of our website and our fund offerings as well.
We started doing impact investing, Marc, have you guys talked about that on your show?
We talked about it on one of our previous episodes – Episode 21 – How to Use ESG Investments in Your Portfolio. We’re starting to see more and more people interested in it.
We have a non-profit in one of our deal and we’re giving them a slice of the pie. So we want financial returns but we also want to have the social impact. For us it’s social but faith-based driven and it’s really awesome. All of that’s on our website too.
