Building Affordable Urban Multi-generational Housing with Guest Scott Choppin | Host Allen Lomax

Today’s Guest is Scott Choppin. He is the founder of the Urban Pacific Group of Companies, a Long Beach, CA based real estate development company, founded in 2000, that focuses exclusively on urban infill and affordable housing communities throughout California and the western US. Over the last 18 years, the company has developed nearly 1,700 units of unique to market urban housing communities throughout the Western United States. Presently, Urban Pacific has created a new housing innovation called UTH, which provides middle income multi­generational housing to urban families, while producing market superior yields on invested equity. Historically, Urban Pacific’s UTH projects have delivered 29% IRR yields on equity. As well as real estate development, the company provides project and development services to major commercial businesses across the nation through its subsidiary, Urban Pacific Realty Advisors.

For full transcript click here Expand Ep#56 Building Middle Income Multi-Generational Housing with Scott
Choppin
Duration: 54:15
Two Speakers
Host: James Kandasamy
Guest: Scott Choppin

Infomercial: Welcome to Achieve Wealth: Through Value-add Real Estate Investing. This is the show where the guru hype is banned, and you get direct insights from commercial real estate operators. If you are a passive investor, this show can help you better understand investment opportunities. And if you are an active investor, the lessons from each episode, can help you to become more effective in your own deals. Now here is your host, investor and author, James Kandasamy.

James: Hi, this is James Kandasamy. Thank you for listening to this podcast. I appreciate you. I know I can provide a lot of value to this podcast, and I want you to share it with your friends, your families and anybody else you know, that could benefit from listening to this kind of content. Go share it on Facebook, LinkedIn, Twitter, Instagram, or any other channels that you want to share because sharing is caring. Thank you. Let us go on with the show. Hi audience and listeners, this is James Kandasamy from Achieve Wealth Through Value and Real Estate Investing podcasts. Today, I have Scott Choppin from Urban Pacific Group of Companies, which is based out of Long Beach California. It’s going to be a very interesting topic that we’re going to discuss, because I think this call is focused on workforce housing development. Hey Scott, welcome to the show.

Scott: Yes James, thank you for the invite and glad to meet you and glad to be here.

James: Scott, can you tell me which markets are you focused on right now?

Scott: For our workforce housing model, which we have given the name Urban Townhouse or UTH, for short, Southern California is our home base. This is a new innovation. We are really bringing this business plan to life in Southern California because we know the market so well, it’s our backyard. We actually do have a strategic plan presently in place that would take us through in other markets and in California, San Diego and the Bay area, and then we have underwritten this product in several Western marketplaces, think Portland, Seattle, Denver this workforce housing model works in all those markets. And then recently we’ve been exploring the Dallas-Fort Worth marketplace. Presently active projects are all in Southern California, being LA and Orange County.

James: Let us go back into the details when you say workforce housing development. This is different from what people like me would buy, class B & C workforce housing and we rehab them. So, you are basically a developer? I am very curious on how this developing versus buying rehab and much together in terms of price point, but you are saying is workforce housing is not, it’s not the normal class A housing that’s being built everywhere. Can you explain the difference between Class A new apartment building versus your product classes and what do you target for in terms of the quality of the construction, the price and all that?

Scott: Sure, happy to. The way we think of it, a UTH really is a middle market product. You might describe it both in the context of the level of the build, our finishes would be in the middle of the market. We are not luxury, but neither are we true affordable housing where you would really try to keep costs ultra low, where we are sort of in between those two. The families we serve are middle-income families or modern incomers, is another way to describe it and our predominant tenant avatar would be a large family I’m in California. You would think like Hispanic families, Asian families, and certain micro-markets and these families would be working families. I think blue collar would be another way to describe it. They are generally making between 80 and 120% of median income for whatever location we are building in LA and Orange Counties for the product that we are building presently. The reason we are focused on that market is basically, in the development marketplace, you have the luxury end of the marketplace, where it is high amenities, very nice finishes, high end products, high rents, urban locations downtown or other high-income marketplaces.
Then the other end of the spectrum, you have what I call true affordable housing, that would be government subsidize, low-income housing tax credit projects, true affordable serving families that are below 60% of median income is how we typically think of it. We built it to the middle. We built to the space in between those, and so UTH or Urban Townhouse is our model and that is intended to basically bridge the space between luxury and true affordable to serve families. That again are in these 80 to 120% of median income and really a marketplace that nobody is serving. No developers, or very few maybe is the way to say it, really are intentionally looking to serve these working families and that is important because basically these are the families that incomes are stagnant. Generally, they are going to be service workers, service economy and that they do not make necessarily enough money to afford the luxury product or more importantly for us, the demographic profile. These are large families, think six to 10 people in a family that would be mom and dad, maybe an adult child, or two in-laws older, maybe grandparents, and then younger kids, either of the parents or the adult kids.
But more importantly, they have two to four wage earners and that is the most important part of this demographic; that is, they have already the lifestyle of sharing incomes and expenses across the family group with multiple wage earners and so serve that by building a five bedroom, four bath rental product. Middle-market specifications, if you would walk into these units, you would think it is pretty standard apartment finishes, but we’re at every part of the development cycle looking to simplify. We have a simpler build process and we do a three-storey on great product. We keep the finishes moderate or middle market, so we can keep costs down. We buy land in markets that are low and lower middle income neighbourhoods, think B and C neighbourhoods, if you can put that designation on it and across the whole development cycle, we are able to simplify really at every possible place that we can with the net effect of reducing costs, which helps us basically keep the rents generally are between 3,000 and 4,000 a month. Remember that is a five-bedroom, four bath unit, 1,750 square feet. It is a combination of the way we say it. James, we are pairing private capital with a workforce housing model and the way that we make that feasible and produce yields to our private equity investors is that we have this vast simplification and this particular model of the five-bedroom, four bath unit.

James: How many of these products have you guys built and sold? I mean, is it a proven concept, but that is a completely new concept, right?

Scott: It is a new concept, but to answer your question, it is a good question, by the way. When we created this product about three years ago, we made the intentional decision to do what we call it, demonstration phase of projects. That was actually four original projects that we kept sort of small and midsize on purpose so that we could prove the model really. The way that we think of proving the model is really in three places. One, can we rent it for what we say? Very few developers, in fact, almost none are doing five-bedroom, four bath townhouse, rental units. Second, could we build it for what we projected? Bill costs and development being ever, ever important and that is never a factor that you ignore. And then third, and really most importantly is, can we value it at its completion and stabilization at a value that is appropriate in a sale if we sold it or in a refinance, say we get a permanent loan to take out the construction loan and import more, most importantly, are we producing yields to our investors? We have actually of the four original projects in the demonstration phase, we have finished three and sold those and produced a 22.6 6% IRR across that original three-project portfolio. We sold our last building actually in January and then the three projects sold. The fourth project of the demonstration phase we actually are completing now. We have actually switched now to a long-term hold model.
The first three were merchant build, that is build it, rent it, sell it. But we believe in the product type so much that we are actually going to keep everything that we build, now is going to be long-term hold oriented and that is because of the belief, but also having a long-term orientation actually gives us a more defensive positioning relative to a recession, which, in today’s interview is important relative to this coronavirus economic situation that we find ourselves in because these families, these multiple wage earner families are really when hard times come, they tend to batten down the hatches in place, that is the way we call it. We like that profile versus other profiles, which, nothing wrong with a gen Z renter. It is just that the gen Z renter is very mobile, so when their job situation changes, which is not a very important thing today, coronavirus for the shutdown that they can move very quickly. They have nothing to tie them down. They do not have kids in school. They don’t have church close by. Their extended family is probably in another city where they grew up. Our families, basically these middle-income families, kids are in school locally, churches close by, extended families close by, and most importantly, their job is usually somewhere close by. They choose their housing location to be coherent with their job location. What all that does that makes them very stable in turbulent times, because rather than trying to move across the country, because they have such a strong social network locally, that has them stay. And we don’t say that staying or leaving is wrong, or right. Everybody’s choice will be right for themselves. We just say for our demographic profile, we want to rent to families that we know are going to be generally stable and that will stick around and stick around for a long time.

James: I am not sure I am in five-bedroom; four-bathroom is definitely catering to what’s. I wouldn’t say niche because a lot of demographic that you talked about to stay in groups or to stay in families and there is multiple, which so that’s very exciting to see someone really catering to that, the need of that demographic. Because a lot of people, as you mentioned in Asia, and even in the Hispanic community, they like to stay within the families, that is very important. How did you come up with this concept? Is it something that you saw somebody else doing or did you guys see that as a need and what were you doing before that and how was the aha moment to come to this model?

Scott: Great question. Since I formed the company in 2000, we have really been an urban in-fill, developer that builds in already existing neighbourhoods and cities that are urbanized, so think urban metros. We have always been oriented around demographic profiles that exist in a city which can be very vast. There is obviously lots of different demographic niches inside there. There is a couple of ways that we came up with the UTH innovation. First, really is my background. Originally, when I came into the development business, I worked for a company that developed affordable housing projects – think true government subsidized, affordable housing. From that, I got background in basically serving lower income families and some of the projects that we built, we would do even three- and four-bedroom units on occasion. I always knew fundamentally that there was a very, very high demand in that demographic and also very low supply. Remember a government subsidized housing is always limited by the amount of government subsidy that is available, which is not endless. It is a finite resource and there is always more demand than there is supply in that marketplace. That is one end of the spectrum and then for several years, I worked for a market rate development company that basically did luxury product. From that, I learned what the luxury marketplace was, but that also is the market where there is private capital not unlimited, but certainly as much capital is available generally in a marketplace where there is good projects to invest in and they can make money, that attracts capital, and so in 2016, a couple things happened.
One is, there was a slight flattening in the marketplace in Southern California and what that meant, basically, was that equity and debt thought that there was a large amount of new supply coming online, which there was, they were right. That had them being a little bit more cautious at the time and it gave us a chance to start a look for something different from what everybody else was doing, which was predominantly high density studio and one bedroom mix projects that serve gen Z and millennial demographic, which is a perfectly appropriate market, biggest demographic cohort in US history, kids, baby murders, the millennials generally, but we have always been a niche player. We have always been looking for something that is contrary or uncommon. That is why we started doing urban in 2000, which was not really a thing at that point, nobody was doing that. We were early adopters in that space. We have always been oriented that way. Then what happened is because we started to look around, we started looking at different sites and different locations, and we actually bought a site in downtown Long Beach, which is my hometown city and where we’re based as a company. We bought it really, really well, very inexpensively on a per unit basis and that gave us the capability to experiment. One of the interesting things about the site is that it was limited on the unit count that we could build. We can only build so many units on this land area, but it was not limited in the type of unit or particularly the unit size that could be developed. What that gave us was this interesting idea of let us expand, I can’t do more units, but I can expand the size of the unit and to maximize that project at the time, we went to a four bedroom, three bath, two-storey townhouse product, and the story we had about that was, that we can’t do more units, but we can make the units bigger. That will produce the capability to rent more on a whole dollar basis, like we could charge a higher rent and that project, that first project was exceptionally successful, James. In fact, we underwrote rents for these four-bedroom townhouse units at 2650 and when they finally went to market, they were basically up at 3250. This is downtown Long Beach in Southern California and that really, for us, that was the aha moment we got, oh, there is a lot of value there or we can basically achieve more rents than what we underwrote. We were being conservative, which is our natural inclination of course, but that gave us the idea and then we started to basically evolve the product. We went from a two-storey townhouse, four-bedroom, three bath and we sort of rest on the idea that we could add more bedrooms that would produce more rent. We sort of toyed around with the five and six-bedroom concept and settled on a five- bedroom product for bath, which we described earlier. Then we did what other changes, went from a two-storey model to a three-storey model, still two-car garage on the ground floor. What that did is that shrunk the footprint, so we could fit more units on a given piece of land and increased our density. In the development world, producing more density on a given piece of ground, as long as the bill costs are appropriate, we will just generally, have it been a more profitable, more productive project. From that first project, we created the demonstration phase, went and acquired several more sites and that have continued.
So, we are now through where it let us see, where are our sixth and seventh projects on this model and we finished the demonstration phase that proved the model with this IRR that we have produced or converting to a long-term hold. Now what we are doing is we are growing in project size, as we have mitigated the risk and now have a clearer understanding of the product type, because nobody is doing this and certainly nobody is doing this at scale. There is a handful of people around the United States that we can see that are doing little small projects are very small, micro market focused. We are the only one that I can tell that is bringing large amounts of middle-market or institutional capital to larger projects really scaling the model. Recent projects would be, we have an 85-unit project in a city called El Monte, which is in Southern California and we will do that in two phases. First phase will be 54 and the second phase will be 31. You can see we have sort of marched up the food chain, both in project size, as well as project volume. We are always conscious of the market cycle in today’s environment with this coronavirus recession, we are going to probably end up calling it that we are always tracking that in a way always have and so now we are in that mode of being very cautious on acquisition of new projects we are underwriting more defensively really testing rents much more often. We now find ourselves in that part of the market cycle, although we do think this product performs well because of this defensive family demographic that we talked about.

James: What kind of zoning does this kind of dollar needs? Is it single family or is it multifamily?

Scott: Great question. What we did when we first put the plan together is because we are from California and California is very difficult, entitlement process, I think rezones site plan review, conditional use permits. We basically made a rule that in all the projects that we purchased or developed would be Bi-Rite zone, meaning it already had the zoning that work for the product type.

James: What is the zoning?

Scott: As an example, our three zone would be what we typically look for now, every city has a different version of our three zone. But it is a product that basically develops at about 20 to the acre. We are a three -storey product.

James: That is obviously multifamily Commercial three multi family, right.

Scott: not a single-family zoning cause that’s not, but with this caveat, James, which in California, and some other markets like Minneapolis and some cities like Oregon, they’re starting to convert single family zoning where you can build like triplex and quadplex apartment projects on single family lots with single family zoning as sort of a zoning overlay and that is starting to become a new trend. In fact, California is working on a new law to potentially convert all single-family zoning across the state, into this triplex quadplex. And if that happens that is going to be a game changer for us now. We are not necessarily wanting to do three- and four-unit projects. We want to work on bigger stuff, but we might be able to go into a neighborhood and buy three or four or five or 10 or 15 houses possibly or maybe undeveloped lots. There are one. And that case when that law, if that law passes and we could use single family zoning in that way, now that does not exist today in California. I am speculating on the future, but we do have the capability to be flexible dynamic within the zoning story and we do not want to do major entitlements. So, anything with a heavy lift entitlement process will usually pass on.

James: Yes. It is too much headache for in California, right?

Scott: Yes. And again, back to this idea of simplicity, right? The saying I have, James, is complexity is the enemy of profits and real estate development. The more complex your project that’s billed that’s market, that’s underwriting, that’s the cycle. Like we are in a complex environment now with coronavirus, those are all going to degrade your profitability. Our job is to look for a combination of all the hottest, the maximum simplicity in all the different development steps that we can produce, and zoning is one of those. We avoid a complex zoning process means we save time, energy, and money, which drops to the bottom line of the development project.

James: Got it. Why did you move from, originally developing all these big town-homes and you are selling them but now you said you recently changed your strategy to want to keep it for a long time, which has become the community of apartment units? You moved from condo selling, to a building, the town-homes and selling a condo. Now you move into an, a common concept where you are going to give it up for long term rental. Do you think your demographic buyers or renters would be different or be the same because previously they were buying for them to stay and they do not mind paying mortgage? Now they have been having renters. You have to find them with a group of family. The second question to that is, is there any law that allows how many people per unit that can stay in terms of renters?

Scott: Yes. Great question. So just to clarify a little bit, so when we did the early demonstration projects that we sold, we did not, we never sold the individual units. What we would do is we would have a group of 15 units in an apartment project and we sold that as if you sold any other apartment project. Let us say you bought 200 units, value add, and you did your work on the project and you sold it to an investor. Good. We did the same thing. The reason that is important is because we are really apartment developers, not condo developers and nothing wrong with that market. It is a viable market, but particularly in California, a condo development has construction defect liability, a long tail of risk in that and so we have done condo projects in the past, but we have not done that for probably a decade plus.

James: It was sold as an apartment building?

Scott: Market apartment. So we would develop an apartment project with 20, 30, 70 units, whatever the size of the project would be, we would lease it up and then we would sell it to an investor either a high net worth investor, maybe a family office or institutional buyer flow is big enough. But now what we are doing is we are just, instead of selling that apartment project, we are going to keep it ourselves, raise long-term oriented equity. When we finished the project, lease it up, we will fund a permanent loan and pay off the construction loan, and then just hold it for we want to hold it in perpetuity as a company, and my family as the owner of that company. So that is the main difference is instead of renting it and selling it, we rent it and hold it.

James: You basically build it, lease it up and you refinance it, go to a long-term it’s like BRR method. You are doing a hundred percent value add. Right?

Scott: Right. Yes. Well, in fact, I say, development’s the ultimate value-add because we have the land and we built the new building now has more complexity than your standard value add deal. Of course, because we are building new and we have zoning issues.

James: Yes. A lot more risk because you are dealing with a lot of permitting city issues and like right now that is happening. You might have a construction loan, which can be complex to manoeuvre in this kind of period, right?

Scott: Well, I think whether it is value add or new develop new construction always will have that I am in a project at the margin of the change from a good economy to a bad economy. Now I will say, as you may be observing this March 2020 time period that we are in is the most rapid deceleration of an economy I have ever seen and we will obviously day by day, figure out what, how that’s going to affect the market. In fact, I’m tracking, I probably in the last two weeks, I have probably been on 30 you have different webinars, CB Richard Ellis, Capital Markets, Cushman and Wakefield, Walker and Dunlop, which you are going to, what’s going to happen, George Smith partners. Like everybody is trying to figure out what is going on. We have that risk and I think a value-add person would have it the same as new construction.
Really what happens for us is there are two main points that we have to worry about that the cycle changing. When we are in a lease up and perm loan funding scenario, and that we have either started construction or not started construction. On the latter example, if I talk to people, I say if you have not started construction yet, then don’t, sit on that land. You may have bought the land and hopefully you can work out a story with your investors, but arguably right now actually some people and, we are in that camp, actually think that this may be a good time to start new projects, the right type of project when they get completed. Like our UTH model, we still are firm believers in that demographic, because guess what, even though we have this coronavirus recession that we are going to have to deal with for the next several quarters, economic consensus is two to three quarters of recovery to five to six quarters of recovery and the consensus actually has a recovery in Q4 of 2020.
In California, particularly we went into this recession already in an under supplied, residential marketplace. If you are affordable housing or middle-income workforce housing, you already were serving new units into a vastly under supplied marketplace, high demand, low supply right now, demand is falling. At least that is the story we are hearing but we are not seeing it in our portfolio. Of units that we are leasing, we seem to be doing fine. I do not sit here and say we are bulletproof. I just think our model of serving middle income families and particularly giving them the capability to group together in a larger unit, five bedroom, four bath actually is a special sort of advantage now because now people will come together in family groups, maybe if they were not already, and then they would come back and live together. I think of like roommates coming together. That would be an example. I think we are generally feeling neutrally positive, cautiously optimistic. We have not seen drop-off in leasing rates is what we are seeing as of today. We still have to be conscious of where we are. We have a project under construction and one of the consequences that I have seen, James, is that we have significantly more labour available in the marketplace than we had three weeks ago. And that is because people are getting laid off from their jobs, which has no positive. We do not say that’s a good thing, but a net consequence to our construction process is that we have had a flood of labour come back. I do not know if they were working in other types of jobs and came back to construction.
Our subcontractors, the story is that other people have shut their projects down, like they are not constructing which people may be doing for like a defensive choice, but our project in Montebello is actually speeding up surprisingly enough. And we won’t be done with that until the end of this year or early next year. From a leasing standpoint we are not going to lease until I think we are out of this at least the immediate threat of coronavirus and then recovering basically and Q4 2020 and Q1 2021. In fact, there is an old saying that some people say build through the recession like an old developer builder rule of thumb is, construction costs should drop. We have not seen that yet. But I think the pickup and available labour will make you know, subcontract in more competitive and drop labour costs. I don’t say that’s a positive, the environment of job layoffs at the huge levels that we see are, and I think we will see on a go forward basis is incredibly discouraging we are in the United States to me we are the most innovative, resilient country on earth. I always like to use Warren Buffett’s saying has never bet against America. We are fully prepared for a recovery. It is just functionally, how long does it take? What is the depth of the economic downturn that nobody knows today? We will continue to basically look forward to serving middle income families and what, it’s still an under supplied marketplace even today.

James: Got it. What about the second question? How many people are allowed to stay in one unit? Is it based on number of bedrooms?

Scott: Yes, that is a great question. There is no rule per say. Each city may have occupancy limits, although that’s probably rarer than not, we have never run into that issue. So functionally, what we see in our tenant profile is 6 to 10.
Although that’s probably rarer than not, we have never run into that issue. So functionally, what we see in our tenant profile is 6 to 10. HUD, the Department of Housing Urban Development, has a rule that basically says that occupancy is how can they put it; they say the unit is over occupied and there is a terminology I am not remembering right now, but there are too many people in the unit if you have more than two per bedroom.

James: Yes. I think that its two heartbeats per bedroom.

Scott: Right. We only do the five-bedroom UTH unit, four bathrooms. So that would be 10 people. We generally don’t see 10 people though. Usually it’s six to eight would be the sort of average family size that we see. I mean, we have people renting right now and in our Orange County project that are four people we have a family, that is a mother and two daughters, both the daughters are in college, one in JC, locally, one at Cal state Fullerton. Initially they are going to bring their grandmother from out of state to come live with them. They are going to use the fifth room as a study room for their daughters who are in college. Now we are in flux right now with schools being out from coronavirus. But I think the consensus is that most schools will return in August and September, at least that is the thinking right now. Although, we do need to anticipate that there may be disruption in that this family is still going to rent the unit. We have that even smaller families that will run a five bedroom.

James: Yes. How much is the construction cost? How much does it come up to?

Scott: Yes, confidential events up to about two weeks ago, we were averaging about $375,000 to $400,000 per unit of cost all in, that will be land hard costs, city fees, soft costs. I think that will change. I do think construction costs may at least plateau we are not planning for any reduction in construction costs, although that would be one potential effect of a recession a particularly deep recession, I think would certainly adjust construction costs downwards, but let me put it this way, in the residential environment, the residential apartment development sector, generally going to have a range of product densities from your walk up to storey with surface parking, your garden style walk up all the way to the other end of the spectrum would be Highrise apartments in the market like New York City. We are right in the middle at 20 to the acre, that is sort of the middle, again you see this concept of middle income, middle density, that kind of thing.

The reason that’s important is because we are at the equilibrium point of the highest density that can produce the most rent, even though we fit in these 80 to 120 moderate income categories. We are at the maximum density at the lowest cost, If we went up one more storey to four storeys under California code, we would have to do a heavier duty sprinkler system, would put more exits like safety egress corridors, and stairwells, like adding a second stairwell. Structurally that would go into a different structural code environment and so the costs go up without much raising in income. That is one end of the spectrum for us. The other end is let us say you go to a one-storey or two-storey rental product. You much simpler to build lower costs, except now you are not producing as much whole dollar revenue because the unit per square foot rent is going to be less. You are generating less rent at lower costs. In our world, this intersection of three-storey townhouse is the simplest to build yet maximize the capability to generate rent. In our world, that’s the place to be, that’s the sweet spot, which fundamentally to answer your question, keeps our costs low against this idea of removing complexity from the development process. We are removing complexity from the build process; we build a type five on grade products. We do our slab on grade like your standard garden style apartments, or your house. It would be an example. We’re not building any parking structures or high-rise buildings that drive the costs up significantly. Our land costs are obviously more efficient because we are building in low and lower middle- income neighbourhoods. We are basically reducing costs and keeping costs efficient is the answer and that is part of the additive to the formula of what makes these deals work.

James: Let us go into slightly more detail into the cost structure because this is affordable workforce housing. Can you describe finishing off the interior unit that gives you optimum cost compared to somebody else buying, somebody else’s building [inaudible] for them to stay, right. What are the items that inside the finishing that gives you optimum cost for making it a renting space?

Scott: I am with you, great questions. A few things come to mind, one of the things we do is we build an eight-foot plate or an eight-foot height inside the unit. In California, particularly in your luxury product, your luxury rentals ceiling heights would be nine or 10 feet. By eliminating that extra foot, we keep costs, we make it simpler, lower costs, marginally. Each of these the net effect of the cost of that individual move is low marginally, but when we stack them up together, they start to add up. So, we do that, we stick with a pretty straightforward orange peel texture on the dry wall. We are going to use a really sort of base grade vinyl window. Even a little bit like a notch or two below your standard mill guard that you would buy at Home Depot. As an example, we have companies that basically manufacture vinyl windows here locally in Southern California, that we buy in bulk from them able to get costs, you know, benefit is, you know, cabinets are a production cabinet. Now, you know, in this day and age of the disruption from coronavirus, you know, the, the supply chains from China are vastly disrupted and we didn’t do this intentionally, but we actually found more success with the volumes that we build that ex buying materials domestically. All of our cabinets are made at a cabinet shop in Southern California by just a small, medium business here locally and we are able to get, basically it’s a little bit more expensive, but a couple hundred bucks per kitchen is sort of the differential.
We have the guys local; we know when we are going to get the product, there’s no shipping issues, there’s no delay, with shipping, it got stuck in the port of LA and our shipping container. We can’t get it. That would be an example we have converted to, we typically would build with a granite countertop which generally it has been historically the most cost efficient, hard surface that you could buy. Although lately we found Courts to be maybe a little bit more expensive and we have been able to buy very cost effectively Courts. I don’t know that that is not going to change in the next few weeks if materials get used up, as China is not able to deliver the way it was. We may see people going to buy more domestic countertop materials and that may drive the price up. Let’s see what else, flooring is pretty standard like a vinyl plank. We have converted everything to not a wood vinyl plank. But to a basically it’s like a polymer substrate basically makes it waterproof. It looks like a real wood floor and it is plank. It is got that look. But this polymer base this like resin base has bulletproof. You can pretty much put it any liquid on it and it is not going to wear or expand and go crazy liquid floors, do at least like your standard production floor carpet apartment grade doors would be your standard, production home builder or apartment grade doors beyond that in California, we are stuck with certain code requirements. Electrical, plumbing, mechanical, all have California characteristics and mechanical, has to be a certain energy efficiency. We just try to buy the best cost product that meets the base criteria of the code and we are not able to do the extra. In California and many places across the United States doing green code is a movement like people are trending towards that, we love the story of that, except our trade-off is the extra cost of building those green systems in means that we have to raise our rents to maintain a feasible project. Our trade off that we make, is that we say we don’t build those green characteristics, at least the extra stuff, but we are able to deliver a lower rent to those families and we still have the base code that we have to meet. In 2020, all residential projects that are under the 2020 code all actually have to install a solar system, the capacity to install solar, but we actually have to put the solar system in, which is probably, 10 to 15,000 a unit of cost. We still do deal with some things that we can’t get away with maybe in this economic recession, there might be story for relief from some of those extras that California loads up projects with there’s a movement of frat for fees to be reduced, like city impact fees. I think that is sort of the description of it. It is nothing like you wouldn’t look at it and walk into this unit and go, wow, it’s so downgraded that it is noticeable to me. We don’t do Formica tops, like that would be a move you would make to keep really low expenses on countertops, except that the long-term usability of Formica tops, just is not high-performance products. We have gone to hard surfaces on all of our projects probably 15 years ago it was the last time we did any non-hard surface granite or quartz product. I think that is it, I will stop there. I think that is a good description of it.

James: Yes, that is a really good description to really give detail. Just now you mentioned about the cost could be about 300 to 400,000, let’s say 350,000, what percent of it is the land and what percent of it is the building, because I know California land is expensive, right?

Scott: Yes, up to three weeks ago, we were looking at projects on average that were probably 50 to 80K a door of lands. So out of the 400K or $375, you might have anywhere between 50 to a 100K of land costs inside that number.

James: Let us say 300,000 is the building improvement.

Scott: Yes. Well, let me refine a little bit more. Let us say roughly our bill costs for the actual hard cost of the construction of the building and the site improvement costs, maybe let us say it is 200 to two 50 a door. In California, we have a lot of city impact fees and you could easily do between 10 and 50,000 a door of city impact fees. And then we have a cost. So, architecture, engineering, you do a lot more of that comparatively to a value add deal and I’ve never thought of it on a per unit basis, but we might have architectural fees, soft costs, and that might be 300,000 per project, spread across the number of units.

James: No, the reason why I am going with my question is I am trying to see where is another place other than California, which you can duplicate this model? California has this impact fee, which you say is 50,000 and over. It does not exist in a lot of cities out there. It does not have the land costs that California has. For example, if I want to build this in Austin, I am just trying to find out, would it be like 200,000 per downhill which can be a really, really good price point, right?

Scott: A great question. The way I think about it is you really have to be in a specific marketplace that has a differential between the rents that are charged for an apartment versus the cost to build it. You are on the right track for feasibility generally. But I will say generally, probably 80% of the markets across the United States will not work for this product because they are in a lower cost, lower rent environment, like even in Southern California. There is a place called the inland empire in Southern California. That’s Riverside and San Bernardino counties. It is probably 30 or 40 miles from where I am based in the LA basin and that market doesn’t work for this model because as soon as you get into that geographic region, two things happen, really three things, one is your cost component goes down. Your land price goes down and your build costs goes down. Those two go together and that means housing costs goes down and so to buy a single-family unit or to buy an apartment project per unit that drops and therefore the rents that you charge also drops. They all sort of move downward together. Our product really has to be in an environment where rent costs are high enough to support the higher cost to build, but our strategy or our competitive advantage or marginal utility and others, what do we do that is better than other people that makes our projects more competitive is that we are able through the simplification process, there is reduction of complexity and are generating of whole dollar rents in the five bedroom environment, just able enough to make these deals like superior in yield because we’re dropping costs dropping time enough to make the model work right now, if rents drop enough and construction costs stay static, then the model won’t work anymore. If rent stay static and costs go up well, then, you know, to extreme cost increase, then the model won’t work.
So, we’re in a very specialized environment and I never sit here and say our team to our teams internally that we are bulletproof from this, but that market exists because of the supply constraint that I talked about before, which is a political supply constraint. California is the most difficult entitlement you know, marketplace in the United States, maybe other than maybe like New York city, but even New York city has like better zoning capabilities in a lot of cases than we do in California. Earlier I said, we made assessments of San Diego, Bay area, Portland, Seattle, and Denver and we were able to find in each of those cities you know, neighbourhoods where we could buy land cost effectively enough, and the rents were high enough in surrounding neighbourhoods to that particular neighborhood that, that differential worked. I also said, we looked at Dallas. I think there is a story in Dallas, now in Dallas and the Texas marketplace, my assessment right now is five bedroom, four bath units, the square footage that we built probably don’t make sense because a large family could just drive 20 minutes out and, drive North to Dallas Metro into marketplaces where they could rent a house cost effectively that worked for them. We are in that assessment period for Dallas and then the coronavirus situation came. I think that may dramatically change. A market like Texas, as you know being in Austin or investing in Austin yourself is Texas is a marketplace where the market goes up enough in values, cap rates drop just slightly. Well, then you can build outwards.

James: There is a lot of land out here.

Scott: The zoning is very friendly. Our look at Dallas really is a pure urban infill type of play. So, we’re looking at specific micro markets in and around downtown Dallas that have an interesting story of sort of an up and coming neighborhood where maybe there is a lot of new construction for sale housing happened, but no one is making it urban info rental offer. That maybe in this townhouse model, we think there’s a story around townhouse rental in Dallas specifically, although I won’t go into any more detailed in that just to not give away any of our early, you know, and I like the story of Texas. In fact, before the recession, we had an office in San Antonio for a period and we were looking at San Antonio, new Braunfels and Austin. We had some familiarity with the marketplace, although we haven’t been there since the recession, but it is a much simpler bill process in Dallas the codes are warm and friendly. The zoning is more friendly. The time period to get your projects approved is very short but then there is a trade-off, which is a family can drive you know, how a big house set a lower rent than we would want to charge. We have to look for the niche inside those marketplaces. I am not settled that Dallas works, although I think there is micro markets that work, we just need to wait for this, know this economic turbulence that we are into clear out. And then I think down the road, a hundred people a day moving into Austin, or at least they were before this economic climate.
James: I think it is going to get more. Yes.

Scott: I think it is going to increase. I think so. Yes, by the way, James, for us, who are moving out of California to Texas is middle income families.

James: Yes. They got to come for the high cost of living there.

Scott: Obviously, state income tax, no state income tax in Texas, more affordable housing costs, is not really much, diminution in their salaries and their wages, comparatively, the housing cost is much more cost effective. The logic you see it and we just say, there is a story, some niche inside there that says we have that this correct differential between rents and a neighborhood and the cost to build all the costs of land, build city fees, all that.

James: Yes. Coming back to renters driving 20 minutes away, most of the time they just stay within the same community. They just enable everybody is related to each other.

Scott: Right. There is a summary, there are pockets in Dallas that have certain demographics that have concentrated in those neighbourhoods. For us, this is interesting, James, what we find when we have a project in Fullerton, which is in Orange County close by, or we live in Long Beach, everybody who is coming to rent this project is from around the project locally. We are not even getting anybody from the next city over in Southern California, LA, all the city sort of run together, 10 blocks down a couple miles down and all look the same, but it is a different jurisdiction and surely enough, everybody who is come to rent, which is, I don’t know what the count is from our leasing team, but they are all from Fullerton. I think you have hit on an interesting dynamic that I am not fully settled on, but again, I think it goes back to this stickiness, these strong social networks. If your kids are in school locally, you are not going to move eight cities over to get up slightly better apartment. It is a big pain in the ass to change in schools or like, what we see is extended families local.
These families, because of how they already live, multi-generationally, they’re not going to move 18 miles away from their family group that may not live with them but is in the community. These families, they locate close to their jobs. They choose their housing and their jobs based on where they already exist and live. They may move to where their job is going to be, which sort of negates the extended family. We see families that the patriarch gets a great job working for the port of Long Beach and they may all move along. We should not in our unit necessarily, but they may go, hey, look, this is the center of the family. Is this person working and they are making the best money we should facilitate that. And we’re just all we’re doing James, we are giving them in this UTH model, we are giving them a housing type. That is coherent with the way they already live. Correct. In the neighborhoods where they already live. That is really important. I can’t overstate that enough. We are not importing families to Fullerton. We are serving families that are already there. They have just never had the chance to rent a five-bedroom apartment unit ever because it doesn’t exist.

James: That is completely a new niche.

Scott: Right. Might just serve them.

James: Can you tell our audience how to get hold of you?

Scott: Yes, appreciate that. The best way is to go to our website, which is www.urbanpacific.com. There is a contact page and I would also encourage you. There is a ton of investor education, information, videos, articles. We talk a lot about it. Differentiation between investing and value add versus investing in new construction projects. Talk about workforce housing.
The other place that I have encouraged people to go is to our YouTube channel and just look up the Urban Pacific Group of Companies on YouTube. And we have probably 30 or 40 videos posted now that are also investor education centric. Talking about workforce housing. You can see examples of the projects that we’ve completed or under construction on. We talk about market cycle economics. And if when people go to the website, if they want to subscribe to our weekly newsletter, which we talk about the economic cycle, particularly now we’re talking a lot about that on a weekly basis. And there’s a signup button on the website and you can get our weekly newsletter.

James: Thank you very much for coming. I really learned a lot. This is completely new concept, right? Where you are building a town home and getting big families to stay together and rent building and renting it out as apartment. I really looked forward to learning more and I am sure my listeners learned about it as well. Thank you for coming.

Scott: Thank you, James. Appreciate it.

Infomercial: That’s it for this episode. If you would like to learn even more, check out James’ free audio book. It’s the audio version of his bestselling book on passive investing. You can get the audio book completely free along with other valuable resources by visiting www.achieveinvestmentgroup.com/freeaudiobook. Also be sure to join our Facebook group too, to find it, just do a Facebook search for multifamily investors group. Thanks for listening. Join us again for another episode next week. See you then.
End of Podcast Interview

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