Bulletproof Cashflow Podcast | Building a Real Estate Development Empire, with Scott Choppin

Welcome to the Bulletproof Cash Flow Podcast. The go-to place to gain financial freedom through real estate investing. Here, we interview investors, mentors, and entrepreneurs. Who share their secrets and advice to help you build passive income. Well, today’s guest is no stranger to real estate development. His family has been in real estate development since 1960. Creating such projects as the World Trade Centre in Long Beach, California.  He first entered the business in 1983, working on a multi-family development project and serving as director of land acquisition for a multi-billion-dollar company. In 2000, he joined the founded his own firm the Urban Pacific Group of Companies.  Which designs and builds urban housing throughout the west.  He’s been featured in Forbes, Housing Wire, and Globe Street. Where he talks about real estate development and offers insight into everything from real estate development economic cycles to building in opportunity zones. Now, with all that I’d like to welcome Scott Choppin to the show.

“So, the way I’m looking at it is that you got three components that are involved in the real estate development space. One is that you have to underwrite rents and operating expenses and—-like you guess normally do in your value-add deals. Two, the second part which I’ll come back to is the design, portion build, portion zoning, portion land assessment.  and then the third is ultimately at the end of the day we want to exist this property and produce yield to our investors. You guys in the value-added section do that also. So, it’s that middle component where I see the vast challenges.” – Scott Choppin

Intro: Welcome to the Bulletproof Cash Flow Podcast. The go-to place to gain financial freedom through real estate investing. Here, we interview investors, mentors, and entrepreneurs. Who share their secrets and advice to help you build passive income.  Let’s get into the show.

Augustino: Hey, every one it’s Augustino. When the real estate market heats up multi-family investors start looking to new developments as a way to keep pace with demand. The key is to understand to nuances on how to build new projects from concept to completion. And there are many items to consider including design, permitting and construction management and this is all before it’s even ready to be leased up.

Well, today’s guest is no stranger to real estate development. His family has been in real estate development since 1960. Creating such projects as the World Trade Centre in Long Beach, California.  He first entered the business in 1983, working on a multi-family development project and serving as director of land acquisition for a multi-billion-dollar company. In 2000, he joined the founded his own firm the Urban Pacific Group of Companies.  Which designs and builds urban housing throughout the west.  He’s been featured in Forbes, Housing Wire, and Globe Street. Where he talks about real estate development and offers insight into everything from real estate development economic cycles to building in opportunity zones. Now, with all that I’d like to welcome Scott Choppin to the show. Hey, Scott thanks for coming on man. Appreciate it.

Scott Choppin: Hey, Augustino great to be here. Appreciate the invite and happy to be here with you.

Augustino: Yeah, it’s going to be great. So, before we go on, I think it is [inaudible 1:28] to say you can reach him on via his company website at urbanpacific.com. All right, Scott maybe tell our listeners how you got your start.

Scott Choppin: So, like you referenced in the introduction—and I appreciate that great introduction by the way—it really comes from the family business and what that did was gave the advantage of knowing what a real estate developer does. You know, the offer and how one produces economic benefit to investors through the real estate development process. And so that gave me my start and then from my early days I made a whole plan for my career development to educate myself outside of the family business. And so, I worked for companies such as [inaudible 2:10] bros or what now everybody knows as KB home. Working for a multi-family division of theirs. Which was a major apartment development shop plus syndication—equity syndication shop. And so, through working in those types of environments, I got a lot of really good training from a lot of good highly competent professionals in the real estate development business. Which gave me the base of my knowledge and to some degree my networks. Which allow me to transition into forming Urban Pacific and to ultimately now on a 19 year stretch of real estate development projects.

Augustino: Awesome. Awesome. So, now that you’re focused on specifically on moderate-income, workforce housing. That kind of thing.

Scott Choppin: Correct. Correct. So, if you look at our track record which last we added up we’ve exceeded nine hundred million dollars of the capitalized value of the total pipe of projects that we’ve completed. In 2016, we finished up a couple of major assets. A four hundred and fifty-three-unit project that we completed in Westminster, Colorado on a joined venter with Lennar–what’s called Lennar Multi-families Unit Investment group–That was a joined venture with them and it gave us the opportunity in the market place  in 2016 to look around and see what was happening. And what appeared to us was that everybody, correctly, was focused on podium projects. So, high density multi-story urban infill type projects and specifically in the demography Gen z, Millennial, demography. Which was perfectly appropriate but given our history we always want to be contrarian. And looking for new niches to exploit. So, that we can be away from the crowd. Everybody’s crowding into the millennial podium style projects space. We wanted to be somewhere else. So, we created a new project called UTH. Which is a three-story urban-in-fill townhouse rental product. With some pretty unique characteristics but we made the decision at the time to focus on an urban infill think of it as working-class family demographic. And so, all of our units are on grade three-story townhomes with five bedrooms, four bathrooms intended to serve working families in urban in-fill environments throughout the western United States.

Augustino: So, maybe quickly just explain what urban infill means. Just for the listeners who maybe don’t understand what that means.

Scott Choppin: Yeah, good question. Urban, obviously, that’s already self-explanatory. So, we’re in the cities. But infill is a particular type of development. Where we’re building in already existing neighborhoods. So, we might find a vacant site that’s in a neighborhood that has not been developed or maybe the building was demolished in the past. Or we might actually build it or buy an existing building and then tear it down and then build new units there but that in-fill is differentiated from what people called green-field. So, greenfield would be developing on a site that has never had development. Maybe on the periphery of an urbanized area or maybe even suburban or rural. So, we are sticking really directly in city environments, not necessarily hard CBD or downtown locations but think periphery around downtowns or just generally urbanized areas. We’re looking for sites that inside those of in-fill properties that are not developed presently.

Augustino: Interesting. So, would you say that the in-fill properties then they offer then they offer —I’m not going to say stability because to me all new buildings offer some level risk. Right? But because there’s traffic already there you are able to draw from that traffic. Is that the reason why you focus on those in-fill type of scenarios?

Scott Choppin: Yeah, it’s a great question. When I started the company in 2000, we were specifically focused on in-fill. That’s even why we named the company Urban Pacific. Because we knew we were going to be building in urban areas and the influence for building in-fill locations or in even urban areas came there’s a guy named Bob Gardener. He used to be one of the managing directors at a company called Robert Charles Luzern And Company—a national level market research, market study company. That was focused on real estate and had some expertise on residential. Bob Gardener at the time and in like 1999 was evangelizing about the movement of new demographic trends into cities—into the city centers—Years before it was even happening. So, at the time it was Gen X starting to move into urban locations and then it’s just continued Millennials, Gen Z they want to be where there are cultural amenities, Where there’s transit. It’s close to their work. So, they are not getting on the freeway. The idea that of getting on the freeway particular in southern California, particularly in the newer generations, the idea of getting on the freeway is an anathema. People are like I don’t ever want to do that. So, I’m going to live close to where my job is and so, we were just serving a new developing demographic trend. It just happened to be really early. I would say, we started that thinking in 99, 2000. (We) Formed the company around that because we were bullish on that. We were like we get this. We ourselves could see…at the time we lived in these places. You know, Cool downtown lofts next to the light rail. You know, I can walk the across the street and go to the basketball game in Down Town, LA. That stuff just resonated with us and then by 2003, 2004 that trend had blown up big and everybody was focused on that space. Recession came and obviously that depressed production of new development projects but then since then let’s say since 2010 that urban infill trend has just gotten even bigger particularly with the new Gen Z, Millennial demographic wanted to live in those locations as well.

Augustino:  Now, it sounds to me like those infill projects are going to be less risks. Because again, all those people want to be there and the infrastructure is already in place. If you’re going to go to a greenfield type of area where there isn’t usually a lot going on out there. There might be a road leading out there. But that’s about it.

Scott Choppin: Yeah, correct. You’re exactly right. So, the risks have lessened because of the demographic pull. These generations want to live in this location. That was one of the first one that we focused on, but there are other ancillary risk mediators. So, One of these is zoning. So, we’ll talk a little bit more about zoning later as we talk about transiting from the value added to the real estate development space. But zoning and getting governmental approval—what we called entitlements—is one probably of the biggest challenge that developers have and what you get as an advantage in urban in-fill is that there is already build out city fabric, right. You’re not building in a new on a site that’s never been developed and then the neighbors or the politicians or city council members say, ‘Oh my gosh! You’re going to be building apartments on this site. It’s beautiful. It overlooks this. It overlooks that.’ And so, you have a lesser entitlement risk on our infill locations.

Now, that’s a generalization. It’s not for each site true but as an example, in our UTH model in our business plan, we only buy sites that already have zoning. Now, that’s for the purposes of just lessen complexity and producing more velocity in the projects. But on a general basis zoning is going to be… at least the idea of a building going where a building was before isn’t a totally a change.  Now, some people will argue I want to build greenfield sites on the outskirts of Huston or some major Metro area. There is certainly stories, there as well but we have really cut our teeth over the years on becoming experts and on producing new opportunities for real estate development in these urban environments. And we found that the acceptability by cities and neighborhoods is generally better than most cases on green-fields.

Augustino: And that’s actually huge. I mean, in our world where we buy value add type of deals. We always consider the political climate—I mean, hate it or not eventually we have to evict people.

Scott Choppin: Yeah.

Augustino: And how easy it is for us to turn a unit—hopefully if someone is not in there it makes our life a lot easier. But the same thing, I would imagine, the same thing goes for you but I imagine the same thing goes for you. But being in California how do you navigate all that?

Scott Choppin: Meaning the eviction process?

Augustino: Not just the eviction process. The permitting side of things. So, I have to imagine that things out there are not very easy. That’s what I think But I mean you’re in the game that’s why I’m talking to you.

Scott Choppin: [laughs] Yeah, I think that’s exactly right and I think one of things—or many of the things we’ll talk about today is differentiating between value add, buying existing assets and getting into the real estate development space. I mean, I have already talked about many people are starting to look at that as a space to move into. Because assets are too expensive and I get the story of existing value-add projects. If, you can them at the right price to produce the yields you need. And so apart of my purpose in talking with you and talking about this is sort of highlighting the differences. And that what you described of the political environment or the political process, as I call it, is probably the most difficult challenge of what’s different between these two product types. So, California, as you have assessed, is almost just on the level of insanity regarding the political process. We have the most regulation for zoning. We have the most stringent levels of zoning, environmental review, SEQUOIA. Which people have talked about. So, we’ve done all that and we’ve come from that place. So, we know it well. So, we see that as a barrier to entry. If somebody’s coming from Houston or somewhere out of the market, California does appear as a challenge.  And so apart of our thing is to use that as a competitive advantage to know that but it also informs us that maybe there are some types of entitlements that we don’t do.  Like earlier, we said that ‘Hey, we only buy by the right site for UTH. Well, that’s because we know the difficulty of entitlements and government approvals. And we say, ‘we don’t do that.’  In this business plan, we actually go the opposite direction and that is informed by the fact that we have been through that challenge so many times. In many cases, we’ve lost. In many cases, we’ve won but if you want to up the ratio of success and reduce risk and what I say is ‘reduce complexity, increases profit.’ Then we would choose now to go to a simpler model by right. Which means the zoning is already there and all you have to do is design a building and submit the plant check.

Augustino: Right. Nice. Nice. Okay, let’s talk about that then. What other considerations would an investor that wants to get started doing—a aside from the zoning aspect, which is important, but let’s say there’s a deal. Actually, there’s something that we’re kicking around right now. We can get a nice, good piece of land. I think it’s just over half an acre. Almost An acre of land for about a million. A million five. Something like that. What other things do I need to consider if I want to put up like say a twenty-story building or something?

Scott Choppin: Right. So, the way I’m looking at it is that you got three components that are involved in the real estate development space. One is that you have to underwrite rents and operating expenses and—-like you guess normally do in your value-add deals. Two, the second part which I’ll come back to is the design, portion build, portion zoning, portion land assessment.  and then the third is ultimately at the end of the day we want to exist this property and produce yield to our investors. You guys in the value-added section do that also. So, it’s that middle component where I see the vast challenges. So, we talk a little bit about zoning but other things that would be different and new challenges to investors would be now you have to find a piece of raw land—in your example, you’re buying this half-acre site—you have to make assessments about the land. Does it have environmental issues? Did there used to be a gas station there? And you have to assess that and say do you want to buy this land or not? Then you have to check the zoning. You have to understand the underlying zoning. Can we build what we want there? And even before that what do we want to build? This a challenge that I see in the people I talk to that are making the transition. They are like, ‘I don’t even know what I want to build.’ and I go it’s a great question they’ve sort of come upon that challenge. And now you have to become expert in making assessments about the market. Similar, to how you guys do in value add.

Except, you’re given a certain unit mix. I’ve got so many ones and twos and threes and how does that fit the market and where do I set my rent? And how do I compete in that space? Now, you’re further challenged of creating that program. How many ones and twos and threes do I do? I got a guy the other day. He’s like, ‘I got my designs down.’ And I go, ‘What did you do?’ and he goes, ‘Two bedrooms,’ and I go, ‘Why’d you do that?’ and he goes ‘Well, that’s sort of what I think is the right thing.’ And I was like, ‘Did you do the market research? To see what the market housing stock has a predominant of?’ and if you look at most Metro areas in the United States the predominant unit type is two bedrooms. I knew this when he had given me the answer. And I go, ‘You’re going to build more two bedrooms under the most competitive stock of units in your city that exist? Why would you do that? Go to studios. If that’s appropriate go to threes. Go to one-bedrooms.’ So, now you’re challenged with this assessment of the market in a different way. In fact, I describe it as where is the gap? Where is the design that’s not being met? And let’s produce units in that and then you have the sort of design and permitting challenge. So, you have to hire a good architect, good civil engineers. You have to know those people and in the value add space maybe you know a little bit of those people but you want to know and have people in your networks who have done that.  and then the last is the build challenge called it construction management.

To me, this is, where I see people run into the biggest walls is picking the right construction team and let’s just be honest the construction business is fraught with peril. I mean are people good? Are people bad?  And the good people—the good GCs and the good subs are in high demand. They’re busy and they’re not necessarily going to take your project on. And so, there are different ways to resolve these challenges but that, in a nutshell, is where I see in the value add to real estate development is both the scariest part for people who have observed this and go, ‘I don’t know anything about those things.’ And then there is a process of building networks and knowledge that one needs to go through. None of it is rocket science. I mean, zoning is a complicated and obscure and a wholly different weird space of new regulations that you don’t normally have to deal with. But that’s where I see where people get hung up most often and that’s where the big risk is. And so, in highlighting that you say you don’t know how to —apartments you know how to sell apartments. We don’t challenge that you know that inside out. Now, we just have to get you comfortable and up to speed on this middle place and that’s really our big message out to the market place, right now. Is invest in your education of transiting from existing assets to new construction and sort of being a good source of learning. So, people can look at that and say, ‘Yeah, that’s possible if I do it the right way.’

Augustino: Right. Right. Because I was just going to say doing what we do as far as buying a value-add asset. We know for instance that the property has already been there as long as fifteen, twenty, thirty years… Whatever it is. However long it’s been there. We know it’s been cash flowing. We know what the market comps are going to be as far as rent is concerned. We know what expenses are. I’m not going to say it’s risk-free but there is some level of understanding. So, we know what we’re dealing as opposite to new construction you mentioned those three things. That thing in the middle is where the question marks are and that’s the risk that you have to somehow measure. It’s understanding those comps but down to the level of you better be damned right because if you not you’re going to put up a twenty-story building. [laughs’] that you can’t fill.

Scott Choppin: Yeah, right. A see-through building, we call it. Yeah, so you’re exactly right and you mentioned something interesting because I get the comfort level that comes with those types of historics. You know, I got trailing twelve up ‘x’ in rent, right. That is a database of information that exists and give people some comfort that it’s not zero right. And a new construction this is where I see many investors, they become sort of like challenged in their thought process and they go, ‘I got to have zero income for one or two or three years while you develop the building?’ Because of course, you’ve got no units rented. You don’t even have a building, right. You have a piece of land that’s got a vision of what you want to do.  And so, the underwriting of those rents and those operating expenses have to come from some other place than historics that you have. Now, as a value add person, who is good, you’ll identify ‘Hey, I see that rents are low or I see that operating expenses are too high or it’s being badly managed.’ And that’s sort of the art and where to me the most value and profit is produced is the recognition of those off the market too high, too low whatever it is operational expenses.

Now, put the additional challenge of assessing that from no historical. Now, I say it that way as if it’s scary because me as a developer we create system and practices of how to overcome that. Because we’ve been doing it for so long, we know that. Now, we assess the market the same way you do. In other words, we go out and ‘I’ve got a three-bedroom unit. I’ve got a two-bedroom unit. I’m going to go pull comps. What are my rent comps? I’ve got to pull sales comps like what is project so and forth. Now, we pull land comps that a new one that value-added guys wouldn’t do. So, we are using some of the similar practices but then there is a certain interpretation that you need to make. In the old days, when I worked for guys like KB it used to be that I was at five-cent premium per square foot new product over existing. You know, that was just a rule of thumb. I could get five cents of square foot more at my own rate than in a five-year-old product for an example. Which at the time was probably appropriate. I always remember that but we don’t really use that. If anything, when I go in to assess a new building, I want to look for producing better value to the renter in some way of design, amenities, the unit type. Like our five-bedroom, four-bath is one of those advantages.

Because if you’re a big family you don’t have any choice of a big units in the regular apartment rental markets. Nobody does that it’s totally just unheard of. And so your only choice is a house. I always say our families they if had the choice will always rent a house. I mean, who doesn’t want to have the white picket fence and the backyard. You know, The American Dream. I also know that in our environment and these Metros that we work in the house goes for four thousand dollars a month. And so, we come in and we’re going to supply a townhouse with a two-car garage, five bedrooms, four bath, brand new and it will be at thirty-five hundred. So, we want to have better or equal value or lower rent or we may be similar rent but we’ve have better value. So, another example would say we’re competing with an older four-bedroom unit in downtown Long Beach: No air conditioning, no parking, a really small kitchen, small bedrooms. Well, our big units seventeen fifty square feet, five-bedrooms, it has a garage and it has air conditioning. Right, that’s a thing. I mean, In these days of climate change….So those are added competitive advantages. In fact, what I tell people you know think of it this way we’re the very rare instances of a rental product that provides a two-car garage direct access private garage like a house. If you think back and I think back to the apartments that I rented no one ever had a garage.

Augustino: No.

Scott Choppin: You hiked out to the parking lot. You know, how many ever yards away or hundreds of feet away and so particularly in the neighbor hoods that we’ve built. In which are middle- or lower-income middle-income neighborhoods for working-class families. If you’re a mom who works the night shift as a nurse you and you come home at three in the morning or five in the morning or whatever. You can drive on our site. Gate opens up. Garage door rolls up and drive in close door and now you’re in your bubble. And now you can live in neighborhoods that you might not otherwise feel safe in. So, when a family looks at that they are ‘Like holy moley I’ve got a garage. It’s my space. I don’t share it with anybody.’ And so those are always the advantages that we’re hoping to produce as renter look at our unit and you know the garage and the air conditioning are sort of like the top ones that we think of.

Augustino: Nice. Nice. So, what other considerations should I be considering then if I’m going to be—What other things should I be looking at then you mentioned environmental. You mentioned some of the zoning aspects. What other things should I be considering aside from the unit mix things like that too.

Scott Choppin: Well, I think going back to what we just mentioned in passing before. You know, a lot of it is about the build process right. So now you’re going to have a much more complicated build. Most value adds. You’d know, you would be paint carpets cabinets, countertops, maybe some finished carpentry doors.  You know case base. Now, you have to take a raw piece of land pour foundations you know frame the new building put all new systems in and I think that just requires a certain amount of education and what is that process? How does that happen? and I think that most people if they thought about it they go, ‘Oh, yeah. I’ve seen houses being built and I watched framing, Right.’ So they may know at a superficial level but as a person moving into that space, you need to be as knowledgeable in the sequence of a build as the contractors are. Because now you need to watch how they do it. You as the manager of your development or your partnership you need to be able to say it should happen in this order. And it’s not always the same. Because each project has its own sequence. But you want to be able to know how it should go. So that when you’re talking to your general contractor and he’s like, you know I’m being ridiculous here, ‘oh, I’ve got to frame the building before the foundation has gone in.’ I’m being extreme in my example and you go ‘Oh, I don’t think that’s the case. So explain what you mean.’ So that you’re knowledgeable be enough to be able to know what should happen.

Think about it this way, a conductor in an orchestra, right? They’re the leader of the group. They may pick the music and the ultimate performance is up to them but they’re not playing the violin, but they know what the violin should sound like. Now, he can’t or she, the conductor, play that thing but I go, ‘I’m going to watch that and I know what I should hear because I picked the music and I know what the results should be and I need to watch this person actually do it.’ Now in our example here you want to have a correctly finished, hopeful under budget, under schedule building. Now, that is a process like you can’t know that but there are resources in the market place to get that education. Or you build networks of people around you that know that so maybe you hiring a project manager to work on your team and they know that stuff inside out. That’s a powerful way to move. You can buy their experience in essence so…

Augustino: Yeah, because that sounds like a risk. Really getting the right management to manage the whole, not just the construction, but everything else that goes along with that whole project.

Scott Choppin: You need knowledge in each of those. We talked about the middle domain but its land assessment, zoning, design, and construction. And by the way zoning and construction are two entirely different universes are knowledge. Right, your construction guy doesn’t know zoning and you’re architect may know zoning but maybe architect might have an overview of zoning and design and build but most architect that I work with aren’t as the entrepreneur and the principal of the project and most importantly they don’t have any risk in the deal. I mean if it goes badly—I’m sure they would be if they are a good person, a good self they would say, ‘hey, look…I don’t wish that for you.’ But ultimately at the end of the day guys like us we have recourse through the constructional lender. If the project goes bad or doesn’t  go well we have personal financial or cooperate financial risk through the recourse guarantees and so that becomes real very quickly, ‘Like oh boy it didn’t go right.’ And so I’m not saying there is an easy way to do that or try to play it down the risk but I think today is to say ‘There are ways to mitigate that risk. If you’re looking to move into that space.’ And in some cases, people are being almost driven into new development. Because they can’t find value add existing assets to buy appropriately and by the way that’s where we are in the cycle. Development tends to a rising market and a peak market business or the type of economic activity that takes place in that.  Even the way I describe it I say ‘ development above replacement cost’. You know, if you’re in a downturn buy an apartment asset for eighty thousand, and I’m using California numbers here, and the replacement cost is a hundred if you had to build it new. And that’s in a downturn scenario. So dropping market trough maybe the beginning of the rising market, right. But the flip is let’s say that my bill cost is still a hundred but in a development scenario now it’s worth a hundred and twenty. So, I build at a hundred and I sell at a hundred and twenty. That’s the development model or above replacement cost math or Metrix. But that doesn’t exist in a downward market. Now, that that value is dropped. Build cost is still the same. It’s just now the value is moving because the economic activity is shifting.

Augustino: So, would you recommend for value-add guys to get out there and consider building. I mean, it seems to me that many of my friends anyway are considering building as a way to fulfill that gap. You know, there is demand out there right now. It seems to me that there is a good level of risk, but at the same time too there seems to be plenty of demands. I mean, what are your thoughts around that.

Scott Choppin: Yeah, I mean it’s definitely a place to be cautious but we need to be cautious and discipline in any real estate transaction or opportunity. So, the answer is yes. I see the value there.  But it has to be under certain conditions. And in fact, we’re changing our methodology of how we invest. And so where I go with it is two places for new construction: One is we have changed our orientation as a developer from a merchant build model. Which is basically build it rent, it sell it, right. So we’re just building the project to immediately sell it.  Verses now we’re are changing to a long-term holding scenario. Which may be more like standard in the value-add space if you’re holding three, five years. Although, it depends on the principal and the investors, but we are now raising capital for around a five, seven and ten year hold period. And the reason we’re doing that at least in estimate in our read of the tools we use for assessing the market cycle. Obviously, we’re in the longest expansion in US history from an economic activity standpoint. And so the “u” curve is inverted and you know we’re in a good mood about it.  We say we’re anticipating. We’re being vigilant.  And we are revising the way we invest to basically have capital and ownership of the deal at seven or ten years to go through that economic cycle.  So, market will go down. Values will go down but we’re still holding a brand-new asset and that’s fully occupied at a basically still below market rent compared to houses. And given what we see in California rents were very stable during through the ’08 through the 2010 period in the recession that we can expect particularly in our demographic of environment working families that they’re going to be very stable generator of NLI for properties and so we are owning a new asset with stable population and infill working communities. Then we can have a higher confidence level that we will basically not have a significant drop in rental income. And NLI through that downturn and then we come out the other side and we’re okay. We either come back to value or I think over the long run value will go up.

So, how I differentiate that between value add model and a new construction model is a few things one is you get when you invest in a development and you hold it for ten years, you get a brand-new asset. Low Maintainance in the beginning with a longer-lasting positive maintenance and upgrade environment. Two is you have fit your design into a part of the market place that’s not oversaturated. You didn’t build two bedrooms into the massive market place in the city. And so you’ve differentiated likely to some degree or hopefully, you think that way and you do that and the third is that we’re going to be building buildings in areas that are more defensible in a down turn. So, when you buy value add you have certain market, submarket or micro market that you developed in but we’re also choosing to build in areas that we chose. I mean, there are some neighborhoods that we can’t get into because there are not land available. But we’ve had more choice in where we place locations of our new developments to be sustainable in that recessionary environment. And for us that’s working-class neighborhoods and think of it this way your working-class family, individual we call these demographics ‘sticky’ and what means is that kids are in school close by, social networks are strong, church is close by, family’s close by. And then more often than not our families are not commuting long distances to their job far, far away. They usually work close by. Although, their working-class environment. And so what that does is that harkens back to stability that I described that is positive in the recessionary environment. And I’ll differentiate it let’s say that you have a high-density podium building in an urban environment that has Gen Z and Millennials demographic as your focus. My internal joke is that those folks in those demographics if they have a job change, they are very mobile and they can leave tomorrow. They can move cross country and they got another job. They can go to Austin. They got a job. You know, housing’s more affordable there. They can be gone. There is nothing to tie them to that location and appropriately so. That’s the life cycle or part of they’re in. They don’t have kids. They don’t have other things that tie them to the community and neither is right or wrong. Both are correct. It’s just that the orientation is different and we’re looking for our tenants to have a certain orientation that helps protect our asset during the downturn.

Augustino: Right. Now, you mention podium buildings…mainly for the listeners to clarify what a podium building is.

Scott Choppin: Yeah. Thank you. Thank you. That’s a question that comes up often. A podium building—everybody knows a podium building—but the best way to describe it is got a concrete parking structure at the bottom floor. Maybe it’s underground. Maybe it’s above grade. But you drive into this concrete parking structure and then there is something between three and six stories of wood-frame apartments sitting on that parking deck. The deck is the podium. Whence why we call it a podium, right. You know, it’s a flat surface that you build your units on top of it. And they tend to be middle density and what I mean by that is it’s not a high rise. A high rise has the same parking structure. In fact, It usually has more levels below grade but it’s twenty stories high. So, you stack a lot of unities on top of it. On the other end of the spectrum is your single-family house with the garage and a driveway that’s the lowest density.

Our UTH product is sort of closer into the lower and then podium is between twenty-five to the acre to let’s say two hundred to the acre. That’s a podium density. Those are dwelling units per acre. That’s the Metrix I’m giving you and then in a high rise environment you maybe a  hundred and fifty to almost infinite of units per acre depending on how tall you can go. High rise is how we differentiate that. So, think of units stacked on a parking structure but no taller than six, seven, eight stories that would be a podium.

Augustino:  Okay. All right. Good. I know that your focus is on that urban in-fill. Many people that are transiting over to building. They’re doing really, class A, high end, pools on the rooftop all kinds of crazy stuff.

Scott Choppin:  Luxury product. We call that.

Augustino:  Luxury product, yeah. Because I guess they feel that that’s where the bulk of the money is to be made. How do you differentiate from that with the product that you guys are developing?

Scott Choppin:  Well, I mean look the typical move is to do just what you described. In other words from an economic stance if you’re going to be doing a development you will always maximize rents. In [inaudible 37: 20] and therefore value. You’re always going to try to maximize or work to maximize that and that’s perfectly appropriate. Now,  people that are in the value add might appropriately argue that if you’re a developer of that super luxury class A product. That’s called a core product. In a downturn scenario, those very, very high income people lose their jobs or get pay cuts and people start to move out of that A product into a B or a C product. So there is the argument for value add as a defensive recessionary protection environment. And that’s true like people they move down and so that’s why we formulated this UTH model. I mean, We have social impact purpose and my affordable houses background at some the companies I worked for informed me of the need and the demand for those type of units. But I also need to take care of my family and make a level. So we need to produce a profit. So we just innovated in the space in between luxury and true affordable and we’re able to produce yields to our investors. But by certain strategies of simplification and by buying land less expensively of having shorter bill period, and short no zoning periods. Because we bought by right. So all the tactics within the business plan all orient to lessor focus on production of yield and producing units that are in demand and not oversupplied.

If I was going to put a fundamental thing on it. In your class A space and even in the podium millennial business that I described that is also luxury. Just a different format of your building and where it’s located right. So, you’ve got your podium Millennial in downtown Long Beach and then you’ve got your suburban two- or three-story model in the outskirts of Denver, let’s say. Both are class A. Both are still looking to maximize rent per square foot and hold all the rents to produce maximum economic benefit but they also happen to be, guess what, where all your competitors are in that space too. And that’s the real trick and that’s what differentiate development from value add. Although, you can still have supply-demand issues in a value add environment that markets get overbuilt. And if you have a brand new building and your trying to rent units into an overbuild market you’re going to have to reduce rent. Which reduces NOI. Which reduces value. And that’s where that become a challenge in some cases you can’t rent the units at all. I mean, you usually drop rents and that’s the strategy to fill up your units, right? And so again like I said earlier we’re always looking for a niche to exploit or to be contrarian or an uncommon offer that I call it. Something that is scarce relative to what everybody else is doing.

Look, those market-rate developers that are serving the Millennial and Gen Z demographic are perfectly logical in their choice. Because it’s the biggest cohort in the history of the United States. Second only to the baby boomers. These are the kids of the Baby Boomers. Right, and that’s exactly the place to be except that that is where everybody competes. And big players with lots of cheap capital and huge financial resources you the [inaudible 40;39].If you are person who is looking to transition and you are not [inaudible 40:38] which none of us are. Then you have to make a different choice which is you compete head to head with the best in class. You know, cheapest capital sources and we’ve done those kinds of projects but we’ve specifically moved away because so many people were moving into competing in that space.

Augustino:  Yes. Yes. Now, you’ve mentioned investors maybe give us quick rundown as to how does that work? What are the expected returns? What’s the upside in one of your projects?

Scott Choppin:  So, there’s a couple of different ways to answer it and you guys have the same in the value-add space and we’re really differentiated in timing.And so true for value add and construction is the merchant-build model. Which is you buy it. You upgrade or build it. You up the rent or you lease like we do and then you sell it and that a very short window. Let’s say two, three years, maybe four years depending. And let’s cashflow the deal for seven to ten years and then come out the other side and see what our value is. And an NOI as gone up and you know market values have hopefully gone up over a long period. And then we sell for appreciation and collected the cashflow in between. As you well know between a short-term hold and a long-term hold IRI are will always degrade over time. The longer you hold an asset the more likelihood that the IRI is going to be lower. That’s just standard what happens when I think high-value money is put into it.

So, we’re oriented the same way that the value-add guys are except for the advantages we talked about. So we’re approaching investors in a similar capacity that you guys do in the value add space. We obviously have a different sales conversation or orientation around like why would somebody invest in a new asset? So expensive. That’s one of the rejections we get regularly. So, that’s a part of the conversation.  So, we’re having to compete in the market. That’s why value add and construction together. Because we realize we have conversations with investors all the time and somebody say ‘Hey, I’ve got a value-add deal and they’re buying really cheap. And I’ve got really low value add upgrade cost.’ and we go look if that’s what you’re looking for then our offer is probably not coherent with what you want to accomplish. And that’s totally fine. That’s totally expected.  They’re being logical for their choice. Which is absolutely correct. So generally, on a merchant build right now. If we build it, rent it and sell it. We’re achieving anywhere from twenty to thirty-five percent rates of return.

On a long term hold we’re generally on a ten-year hold, we’re looking at around fifteen to twenty percent [inaudible 48:28] return and lower because it’s a longer time period and then if you look at five-year hold then we’re probably in the low twenties on an IR basis. But again I’m orienting everybody I told to—like I have people who go,  ‘I want to be in the deal for five years’. I go, ‘great’ I say, ‘how do you plan for the recession?’ because if at five years we got to sell that asset because you need to get your money out of the deal and the markets down. What do we do? The answer is that we stay in right don’t we sell. Or we sell and have a lower value or a loss. Those really the two main choices. So, it’s not for anybody. But anybody that is listening to this we are all oriented the same way. Nobody wants to be caught short in the downturn and values for multi-family assets will go down. Cap rates will go up. Interest rates will go up. But I don’t want to sound like I’m locked into this like I guarantee that this will happen but I think we have a high confidence level that those changes will happen. But we don’t know when the recession will be. And we don’t importantly how much of an effect it will have on the real estate market. Given 2008 was real estate centric downturn radically so.

This new recession people are anticipating that it won’t be real estate centric and then within residential you have for sale houses and that will affected a certain way and then you have multi-family and then inside that, you have value add and new construction.

In my opinion, my assessment is the multi-family will be affected less so. Because and particularly in the markets that we’ve developed in.  We are so undersupplied in California and that’s why rents are so high. I mean, out of the top twenty-five markets in the United States I believe that the top ten or twelve out of that are all in California. And so we are in a vastly undersupplied market place anyway. Which just firms up the protective cushions of a downturn. Right, now downturns will lower rents but we’re looking always to mitigate when a recession comes and which know eventually it will happen. What are we doing in the design of our financial structures? The type of buildings we design. The assets that we acquire and how can we anticipate those to perform in a recession and through a recession with ultimately to protect the investor’s dollar and produce a yield. Does that answer your question?

Augustino:  [laughs] Yeah.

Scott Choppin:  Sorry, I went off on there I got to make sure that I bring it back full circle.

Augustino:  Yeah, it’s very, very intense. It’s a lot of information. I’m going shift gears is because something I do know you know a lot about are these opportunity zones.

Scott Choppin:  Right.

Augustino:  So, maybe just for the audience describe what they are and what is the actually opportunity and maybe some of the hurdles around developing on that kind of land.

Scott Choppin:  Sure, so just generally opportunity zones are a tax incentivized investment vehicle. In the 2016 Tax Act, this was a provision inside the tax act That basically gave an advantage for investments with a certain kind of capital that was invested in certain geographic areas. Right now, I’ll explain a little bit more about what that means. So opportunity zones are basically geographies or let’s say parts of cities that are across the entire United States that the Local Government and the State Governments and the Federal Governments basically decided that met certain criteria for these investments go into. Right, like investment in this neighborhood or that neighborhood and they are called opportunity zones. Hence the term zones and they actually like a census tract. Which is a type of geographical area think of it like a zip code but it’s more around demography and the census. And they had certain poverty rates that existed in these geographies and those were what people indicated are appropriate or qualified and that’s were the investment than would get a tax advantage, okay.

So let’s talk about the tax advantage and I’ll give it to you in a nutshell. So basically if anybody has a capital gain so let say you sell an apartment asset and you’ve got a huge capital gain. Which you’d normally pay tax on or if you did a 1031 it could do that to roll over your tax basis and do another property. But let’s say you had to sell it and you had no exchange property. You have a ten million dollar capital gain whatever you’re tax rate is you would pay that tax. Very basic. The opportunity zone the investment vehicle says that ‘if you take that ten million and you roll it into either a fund or a property or it can go into businesses also but if you invest it into that vehicle. Let’s call it a real estate project because that’s coherent with our conversation here. And you do it in a period of time, which I recall is a hundred and eighty-day, then immediately you defer the capital gains tax payment. So, it act like a 1031 that way but then on top that there is an additional tax advantages. So, in the fifth year if you hold the investment in that property or fund then you have, I think it’s a five percent or maybe it’s a ten percent relaxation basis. I’m going to get people call me telling me I should know this inside out. And then in the seven years, you get an additional step-up in basis. So, by the time you get to that seventh year then it’s a full fifteen percent step-up in basis, meaning fifteen percent reduction in your basis and in your taxable or you know what your ultimate tax is, but the main thing that everybody’s focused on is that if you hold your investment ten years or more all the gain on that investment or in that fund is completely tax-free. Which is huge and that’s what everybody is focused on.

And so 2016, it took almost two years for the IRS to promulgate regulations which are the law itself is pretty basic in the description of it. These areas. This is your basic tax advantage. These are the types of investment dollars meaning capital gains that you can invest. So it’s left to the IRS who oversees tax advantage you know investment vehicles they need to promulgate regulations so that everybody knows how to do the thing. So those regs are out. I think they went through maybe two comment rounds. I think, everybody I think at this point is being to be comfortable that they understand all the details on how to do the investment so that you keep the text advantage. And I would say you know we’ve been tracking it for probably two years. And I would say for us, at least in the last year, the market has started to coalesce to have really identifiable capital sources funds. Meaning funds, fund managers, family offices that have these kinds of capital sources. And then also additionally market started to coalesce although it’s not complete. In what are the attractive investment for these funds or fund managers and for this capital because it’s completely broad. It doesn’t need to be industrial or houses or this or that. So it’s completely open. So that caused it to be wild west. Everybody’s just shooting in all their options just trying to figure out how to go.

And also at the beginning for us, one of the issues we ran into was most of the early funds were very, very large. You know. Fund Raise had I think their first OZ funds was a billion dollars. I think they may be going out to as much as five billion. Of course, when we have funds that big any equity check for any deal can’t be too small. It’s institutional size capital. And they’re like I don’t even want to look at a deal unless it’s a twenty-million-dollar equity investment. Which is great we love that but ninety million-dollar deals are floating around the US. There’s a fair amount but they are highly competed for.

Augustino:  And it may not be an opportunity zone either. To boot right?

Scott Choppin:  And yeah right and to your point, it’s even more restricted. So, you’ve got to have a deal and in that qualified census tract. It’s got to be of a certain big size. Right, for these early capital sources. And for the new one which really the one that I’ve been focused on is ultimately the deals got to be feasible. And my broker friends are going to hate me for this but a lot of brokers will just throwing stuff against the wall to see what sticks. Or rising the price of land because now it’s an OZ and it’s tax advantaged so it must be more valuable. And really what I’ve seen is the more disciplined players in the market place they are realizing or they’ve been focused on the fact that they need to make investment in deals that ultimately work. Whether they have the OZ capital or not. Like the OZ capital just doesn’t anoint your project with instantaneously with double returns. It just doesn’t happen that way. Yes, it is a cheaper cost of capital? Generally, as we have observed.

So, we’ve focused on basically feasibility first. Right, so we identify the site. It’s in an OZ and then we underwrite it and if it’s just squeaking on returns, you know low mid-teens IRR for new developments. We’re like ‘pass’. And so what we’ve basically postulated which turned out to be true. Is that, in the beginning, there was no OZ capital and the regs just came into place and there were no deals yet. My perception, in the beginning, is there going to capital that attractive to space. That’s turned out to be true. There’s plenty of capital.  And now we started to go now the constraint is going to be deals. Just like what we said. Is it in the right area? Is it the right project type? Right size? And then ultimately is it feasible? And that’s what we’re seeing right now is that there is a lot of capital in the space. But very few real well-underwritten projects that you can look at and say this makes sense. And that’s not to say to people won’t do bad deals or they won’t find great deals. I just see it as the fundamental challenge of that business is finding good deals. And then for us what that turned into is that we are not going to chase any deals. It’s like you get the shiny object, ‘oh, we’ve got this new source of capital. Let us go after these deals. And we started to underwrite and we go that one doesn’t work. That one doesn’t work. That doesn’t work.’ Okay, so we go back to basics. which is our UTH model and we’re just having it be as an ancillary part of our business.  Although, I know it will grow.

And here’s the great thing for us is that UTH already goes into low income and middle-income communities anyways. That’s where these qualified census track OZ’s are. And so actually if you look at our track record in the UTH model, which about two years old, all of our beginning projects were all in opportunity zones already. Now, we didn’t raise capital specifically from opportunity zone and investors. Because it was so early but we’ve already created a track record of delivering good returns in these opportunities’ zones. Which the neighborhood is sometimes decent and sometimes they’re very tough. But we’ve been able to carve out a space where we could be in blue-collar and have a residential product that’s actually feasible. We have a strong track record in production. And we’ve got a story like ‘hey, there’s a model to go into this neighborhood and build a brand new product that’s good in the recession and there you go that’s where we found ourselves today.’

Augustino:  So, these zones you built-in are they designated opportunity zones?

Scott Choppin:  When the zones were finally designated which was I can’t remember the time but let’s say it’s been in the last twelve to 18 months.

Augustino:  Yeah.

Scott Choppin:  They all ended up being opportunity zones.

Augustino:  So, did you get the tax advantages then?

Scott Choppin:  We didn’t if they predated and were under construction. So, we don’t.

Augustino:  Wow, that’s too bad.

Scott Choppin:  That’s why I qualified it because in some cases we had investors that were not OZ investors. I’m just making the point that we’re starting to be in this transition and one of the things that we could do is an investor could buy—lets say you just started construction—and then that OZ investors could actually  buy that asset ant then build the rest of it out and that would have qualified.  But honestly for us in the middle of construction that was too disruptive…To try to switch out old investors and get in new investors and keep going and we had the banks to deal with. And you know it not be done but it just for us in our ever searching for reduction of complicity. Which you know furthers best the execution of the projects. We just made the determination that we would just rather finish the products. Get the investors back their money and their yield—the original investors—and now we’re basically producing new projects that are going out in the market place that are OZ qualified sites. So, for example, on our website, we’re raising capital for a deal out of Northern LA County which is straight out of the get an OZ deal.

Augustino:  Nice. Nice. Excellent.  Excellent. You’ve already touched on this before as far as the economy is concerned but how do you think the next five years is going to look for your business.

Scott Choppin:  So, we’re in this space because we have an absolute long-term belief In the workforce housing model. Again back to the earlier discussion about supply constraint. In any urban Metro market that we observe today…but particularly coastal markets or any major Metro in California…the environment to be able to build enough housing to keep the market affordable has been thwarted or reduced. In most of these areas, zoning became the ultimate constraint and people will argue about that but in reality, I’m speaking from my position as an observer in California from my entire career. We are so vastly undersupplied because we have the most constringent zoning regulations in the entire United States.

And politically California is in for neighborhoods and city councils is very anti-housing. Really from the beginning of my career that’s been the case and then I think it’s become even more polarized and then we have who are very most against development and you have the [inaudible 58:28] universe of people predominantly younger folks who say ‘ I can’t afford to stay in California I would like to but I can’t afford to pay the rent. So either we are going to build more housing or we’re going to leave.’ So workforce housing for us, basically in southern California and the five counties that made up Southern California basically the Harvard Housing Study Group came up with the statistic that we are a million-unit shortfall in housing production in southern California. And predominantly for low and very low-income families.

I look at that stat and I go, in the political environment we are in now, ‘go we are never going to catch up with that.’ And the way I look at it is for the rest of my career we’ll be in this space and don’t think we’ll ever fundamentally catch up the way that we would all say would be most beneficial for housing affordability. So, we’re long term believers in this workforce space. Predominantly because there’s a lot of need, very low supply, high demand. And the other thing I add is that I’ll add and why we focus on workforce like middle income is because over the last thirty or forty years. If you look at middle-class families the income for those families are generally stagnant or flat yet rents and housing cost generally are going up linearly at a fairly good clip.

So, what we have a divergence of this statistic between what income produces and what housing you can afford.  And in the fifties and then we heard the stories of ‘I worked a regular blue-collar job and I could buy a house and I had my family in there.’ Well, that conversation doesn’t exist anymore. Because housing costs for sale or for rent have exceeded dramatically the incomes. Now, In this cycle maybe incomes will start to rise but they catch up in many, many years maybe never particularly if we don’t fix the supply constraint. And so why I’m saying that is that that’s dropping the middle class in America into a housing constraint or a housing challenged space. Meaning their having to pay and more of their income towards housing cost just to stay in California or any major urban Metro area and that’s really where UTA can fundamentally have the most social impact and have a great business plan is coming up with innovations that serve those middle-income populations that have now just recently in the last twenty years become highly challenged.

Augustino:  Yep. Excellent. Great answer and it sounds like you’ll be very, very business then for next little while.

Scott Choppin:  Well, I appreciate that and we’re enjoying the social impact story of this model and developers we don’t always get to say that.

Augustino:  Well then that’s the thing as we said earlier there is this big emphasis on maximizing profits. And getting to the A-class and all of that. Where you’re building homes for the average Joe to and their family to live in and so that also speaks volumes.

Scott Choppin:  Agreed. And also for investors on our demonstration phase of projects, we averaging a twenty-nine percent IOR. There is money to be made there.

Augustino:  You sure?

Scott Choppin:  And I mean profit has to be apart of the model and this the great thing about innovating new forms of housing is that you can produce that. I’m not sitting here saying that this is going to last forever. You know, economics will change and something else happens that causes drift in the market place and we’ll have to come up with a new innovation, but right now we’re like this is a perfect spot. It’s on everybody’s mind. It’s mainstream media. Workforce housing is all over the place. I mean, this is why we got picked up in Forbes and in Globe Street Multi-Family Executive Magazine. Because the story of this middle-income space is brand new or newer and uncontested. I mean, there is not a lot of people in that space and that where we want to be

Augustino:  Yeah. Excellent. Excellent. All right, guys if you want to follow up this guy. You can reach him via the company website at urbanpacific.com. I hope you got a lot of great insight here. A lot of dense information. So check it out again twice. Thank you, a lot, for your time Scot-man. I really appreciated.

Scott Choppin:  Yeah, thanks, Augustino. Appreciated it.

Outro:  Thank you for listening we hope you enjoyed the Bullet Proof Cash Flow Podcast. For more free podcast, articles and videos and resources go to www.bulletproofcashflow.com

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