We Build Great Apartment Communities Presents: Creating Intelligent Underwriting in Uncertain Markets with Scott Choppin

With so many market forces to consider, it may seem impossible to protect your business from upcoming changes that can potentially ruin deals.

Although you cannot control market changes, one way you can insulate yourself is through protective underwriting.

In this episode, we have a very special guest. Scott Choppin, Chief Executive Officer and Founder of The Urban Pacific Group of Companies joins us. He’ll be sharing his experience and knowledge on how to create protective underwriting with enough room to maneuver for mistakes since as we all are familiar with, there are no perfect deals in the world of real estate.

If you want to learn how to overcome market changes through insulative underwriting, what the emerging housing demands are in the market today, priceless leadership advice, and other real estate tips and tricks, then this episode is a must for you!

John Brackett: Welcome to We Build Great Apartment Communities. The only show dedicated to the process and strategies for transforming apartment buildings to thriving communities. I am your host, John Brackett, and welcome to the show. All right, folks, welcome to We Build Great Apartment Communities. I have a very special guest Scott Choppin. Did I say that right?

Scott Choppin: Correct.

John: Okay. And so a very unique opportunity that we have because Scott is someone that’s been in this space for quite some time, so he carries with him a lot of very unique experiences and perspectives. And in the world of investing leadership now, people are starting to look at leadership a lot more seriously, especially investors because they’re looking for folks to follow in a market with a lot of uncertainty. And I think Scott is someone who has a very unique background and who understands the value of leadership and taking everybody to the finish line. So without further ado, Scott, welcome to the show.

Scott: Great to be here. Appreciate the invite very much.

John: So tell our listeners and our viewers a little bit about your background. I typically introduce folks and share their background, but I think you have a very diverse background and a long history in development and acquisitions. So can you share with our audience your background?

Scott: Yeah, sure. I appreciate that John. So try to give the shorter version. So a couple of main things. One is I grew up in a family that was in the real estate development business. So my Uncle Mike and my dad, Kerry each ran their own respective development companies developing assets like commercial office, apartments, some infill, for sale product. And so it really gave me a chance to growing up being an observer of the business. Although when I was young, it wasn’t necessarily going to be my career choice. Once I got to about 18 or 19 years old, I got out of high school. I didn’t necessarily have a plan to go to college. And so spent a handful of years working in the construction trades and worked in the field as an electrician. And that really basically opened my eyes that I needed to work in a professional career and that I wanted to be an entrepreneur. Like in these things, I knew sort of fundamentally that I wanted to work for myself, that I wasn’t going to be a corporate guy. I didn’t necessarily; at that point in time know that it was going to be a real estate development career. So as I got into a handful of years into the construction business, it really showed me what the environment was like, what it was like to be around construction sites.

And then a couple of key things happened for me that really informed me for the rest of my career to be a real estate developer. One was, I was working on an apartment project in Long Beach doing electrical work, nothing to do with my family, no connection there, and the real estate developer showed up. And this is after I’d been in the field for a couple of years. And I go, “Oh, I see. I want to be this guy wearing a suit, driving a nice car, clearly was the leader.” Right? To use language that we’re using today. Somebody who is in charge, the man, maybe, right. Like the guy. And I knew who he was or she was because of my background, right? As real estate development as a career is like sort of an odd non-obvious choice, right. Most people don’t even know what it is. And then the other part that informed me in that same era, I’m a heavy-duty reader. And I happen to pick up one of those famous fifties-era books of, you know, How to Make a Million Dollars Investing in Real Estate on the Weekends. Right. You know, if you read it today, it would be one of those sort of overly simplistic books that you see from the fifties.

What it did, John, was it really informed me. This is what deal-making is, right? This is how to be an entrepreneur in real estate. They didn’t describe it that way. It was just, “Hey, go find a site and buy it low and fix it up and sell it high or hold it and rent it.” But it really sort of opened my eyes. I go, “Oh, this is what my dad and my Uncle Mike are doing. This is how they make money. This is how they build companies that do this kind of real estate work.” And so really from that point on everything I did was geared towards building my career in the real estate development business my choice of college, my choice of college major, the first few companies that I worked for. So I graduated from college and then to just to put the final closing thought, I worked for a guy named Mike Costa at a company, at the time it was called Kaufman and Broad Multi-Housing Group. That was the name of the division. This was a subsidiary of what people now known as KB Home. But it was very unusual that we were an apartment syndication and development operation that was a subsidiary of this Big Fortune 500 home building company. Nobody knew about us. We were like the skunkworks of the company. We made them a ton of money. And I worked for Mike and the people that were in the senior executive positions. And I learned an absolute ton about how to be a real estate developer. In fact, that was why I chose to be there. I spent at least a couple of years trying to get the job. And I knew it would be the place where I could learn how to be a real estate developer and then basically worked for one more company after that Sares-Regis. Then in 2000, went on my own to form what is now the Urban Pacific Group of Companies.

John: Well, I really appreciate the background. I think it’s important that our listeners, our viewers understand that history because we’re going to get into some things today that I think are going to give our viewers or answer a lot of questions out there and a lot of uncertainty, right? You said a lot of things that stood out in that summary. You got one thing in particular there, which was deal-making right. You used the words deal-making. And I really liked that. So I’m going to touch a little bit on what you do as a company, which is workforce housing. We’re going to get into what is deal-making looks like for you in this market?

Scott: Yeah.

John: Because I think that’s really a big deal. I think leading into that space will help answer a lot of questions that people are asking right now, which I’ll ask you some of that. But can you tell us a little bit about Urban Pacific and why workforce housing, I know that’s your specialty, that’s where you spend your time and energy and resources, you know, it’s a great niche. Can you maybe explain in summary to our audience what workforce housing is? And why have you decided on making that your niche considering that you came from a luxury development background, which I find really fascinating?

Scott: Yeah. Great question. Actually, just to change slightly what you said there. So Kaufman and Broad Multi-Housing Group was actually a syndicator developer of affordable housing communities.

John: I remember.

Scott: So low-income housing tax credits and Sares-Regis was luxury.

John: Right.

Scott: So you interpreted it correctly, just that I have these bookends of the beginning of my career working for Mike and the senior executives at that division at the time, all affordable housing deeply ensconced in the development of true tax credit oriented affordable housing. And then Sares-Regis was a luxury developer. So I got the spectrum and that really informed what ultimately became our choice of product originally. And then as it’s evolved into this workforce housing space. So really quick Urban Pacific is a development company. We’re a real estate developer. Well, you know, it’s all real estate developers do. You find deals. We find land, we acquire it, we entitle it, we design it and we build it, rent it, and either sell it. Or all of our sites, all of our projects, we now keep long-term hold. So that’s fundamentally what the real estate developer does.

And so started the company 2000, having left Sares-Regis group and at the time in that era, urban housing wasn’t really what it is today, right. It’s much more well known. A lot of people, different demographic groups want to live in downtown locations. We’re talking in July of 2020 that may be evolving a little bit in the era of coronavirus, but in 2000 urban housing and living in downtown locations wasn’t really a thing. You know, it was very obscure. You know, your artists took an old loft space and converted it into housing, like that was what was happening at the time. You know, very quiet, very backwater if you will. So I, through my work at Sares-Regis Group the company at the time, it hired a company called Robert Charles Lesser and Company to basically tell them, “Hey, what’s the future, right?” This is the question that they were addressing for the next three to five years. And RCLCO’s as they’re now called, came back and said, “You have to do urban housing.” And I’m paraphrasing. They didn’t say it that way. But they’re like you’re got urban housing. There is that. This is the future demographics coming. You know, this was sort of Gen X and then future or what became Millennial and Gen Z. They were anticipating many years ahead and saying, this is the environment that’s going to grow and so that’s where you should be.

Well, the guys that Sares-Regis were just super smart guys, brilliant developers, but that wasn’t their flavor. Like urban housing wasn’t really what they wanted to do. So they just made the choice not to do that. And I was like, “Man, that’s where we got, I want to be doing that.” And like that to me, I was 32 at the time, totally resonated with me. I’m a Gen X-er and at the time I was like, “I could see that.” I wasn’t going to necessarily make that choice at the time I had a young family. So I was looking at a growing family.

So we basically launched Urban Pacific in 2000 to pursue urban infill assets and in fact, hence the name. So we’ve been doing that for now 20 years. And in 2016, 2017, we were finishing some projects that were like early projects coming out of the recession.

So starting in 2012, 2013, the market was coming back up. We captured some really great land opportunities and we bought really well-meaning inexpensively stuff that already had entitlements in place. So a lot of good math, meaning low land price, shorter time periods because the entitlements were already in place. And we executed on a bunch of those deals, did really well. But in 2016, late 2016, early 2017, the market was starting to mature to the point where there’s a lot of product coming online in various markets that we’re active in. So think like Downtown Long Beach, Downtown LA, really any major Metro market in California and that was a lot of podium buildings. So think mid-rise, four and five stories over a parking structure, a lot is all studio and one-bedroom product. Perfectly aligned for the demographic cohort that was ascending at that point, which was millennial and Gen Z, right. Really millennials at the time and great cohort, largest single cohort in US history, right, demographically.

But also we were reading that there was a lot of competition. And for me, that was a signal that we had learned going through the 08 recession that we really needed to be very, very savvy and nimble when oversupply started to be a story in any market that we’re active in. So we made the choice to basically finish out all of our projects that were in that podium studio one-bedroom domain and really look for something that was contrarian, right. So we created what’s called now Urban Town House or UTH. That’s a specific product category, a product type that we innovated. We’re building a three-story on grade townhouse with five bedrooms and four bathrooms as the unit design, two-car direct access garage on the ground floor. You might think of it like this is commonly a condo product, this three-story garage on the ground floor product, but we’re specifically purposely designing and building it to rent. What we were after was to house middle income working families with the logic that these families were resilient because they had multi-earner households, right. They classically, normally live multi-generationally and they live in an economic sharing environment, which is that they have multiple earners in a household that share incomes and expenses across the larger family group.

John: Sure.

Scott: We made the decision at the time to completely go into that marketplace fully. Like we don’t do any other product type at this point in time and don’t expect really in the long run.

John: So Scott a really quick question for you.

Scott: Sure.

John: Has that thesis has been proven out in this market?

Scott: It has. Yeah.

John: Can you talk a little bit about that because I think it’s great information to be able to share about why the product that you’re building out and you focus on there’s a lot of stability, especially in a market like this, where usually everything can be relayed back to employment.

Scott: Yeah. It is, right. Yeah. Population growth or not or the opposite of growth, shrinkage reduction, and job growth or reduction. So yeah, we always anticipated and my background from my work at Kaufman and Broad really informed my knowledge of working families, right? Because at the time we developed, you know, when I worked for Mike in that group, we only developed for low-income families. Think 60% or below of median income, those were the incomes and the rents that they paid. Well, the supply of those families needing housing was very large and we were never supplying enough housing demand, right? And so as we start to formulate the UTH model, I go, “So we’re not going to be true affordable housing. It’s a great space, but it’s also very competitive.” A lot of great developers in there. Non-profits for for-profits, highly competitive market with a lot of good developers. And we just didn’t want to go in and try to contest that space. But neither did we want to be the luxury studio, one-bedroom podium, like we described before. So we started looking at this middle space, right. You can call it middle-income housing, call it missing middle moderate workforce housing. We’ve sort of used those terms interchangeably. But what I did know was that there was a sector of the marketplace, working family that was not being served by the development marketplace. And that was because I’d seen both sides of the spectrum through the different companies. So we went into that space in a broad sense.

So I give for the background now to answer your question, we always knew that these families would be resilient in a downturn. And there are two things that make them resilient. One is the multi-earner household like we described, right. They naturally live multi-generationally and they naturally live this economic sharing lifestyle. This is how they’re able to afford housing in California, generally, which of course we have the highest cost housing marketplace in the United States relative to incomes, particularly right. And incomes are flat and housing prices are rising in almost every major Metro marketplace. So we knew there was a story there. And so as we started to develop this product category, we knew these factors of the multi-earner household were going to make them resilient. But the other part and this is sort of the second part of the answer is that these families are very what I call sticky. And what I mean by that is they have very strong social networks that tie to the location where they live.

John: Interesting.

Scott: So think extended family.

John: Right.

Scott: [Inaudible 00:14:01] are close by. These are not long commuter families, right. Churches down the road, kids are in school because they’ve got kids. You know, millennials and Gen Z are young and their lifestyle and life period don’t have them to have kids yet, right. And so nothing wrong with either of those demographics. We just say, we choose to rent to this working family where our housing can actually benefit them because it’s coherent with their lifestyle in the number of bedrooms and bathrooms, lives multi-generationally, and is in the infill neighborhoods where they already live and work and have families.

So those two together really make for a very resilient model. And in fact, now to answer your final question, we’re actually accelerating in this marketplace. So we continue to rent at or above the levels that we have set in our pro forma as leasing activity for the projects that we have and leasing is going very well. Even during the worst, the lockdown, we were still getting good traffic, having open houses, leasing units. In fact, all the units that we lease during the downturn now are all above pro forma. And then the last part of what makes it resilient and accelerating is that we continue to deliver this product to these families in these marketplaces at a time that they really need it more right now they need to combine even more.

John: That’s a great point.

Scott: Right. And then the final two pieces are that we should expect land prices to decelerate and we’re already seeing that at some of our newest deals. We’re able to negotiate land price reductions, but also we’re anticipating cost decreases in the construction markets. We haven’t seen it yet and everybody’s telling a story. Well, maybe it comes back, but we certainly have seen a lot more labor availability, which has sped up the projects we’re in the construction in. And I expect that to turn into some cost reduction in the near term future.

John: Well, Scott, I really appreciate the summary and I can see that, you know, the demographics extraordinarily well. And so I’m going to shift a little bit and we’re going to talk about demographics, but we’re going to talk about it, I think a little differently. We’re going to send you back into more of the life cycle of a project like this.

Scott: Sure.

John: Give our audience a pretty good understanding of what goes into the acquisition, financing this, and of course managing this. I’m not going to talk about disposing of the asset, but spend a little bit of time talking about the strategy behind those first three because they’re critically important to your success. And also it sounds like you have partners and the folks that are participating with you in these projects.

Scott: Right.

John: So we’re going to talk a little bit about that. So in this market, how are you adjusting your underwriting models for some of the uncertainty or some of the risks? Because I do agree with you. A huge opportunity I think for folks that understand how to measure risk, right? Because the greatest challenge is not knowing how to measure or anticipate risks in an uncertain market, right? So what adjustments are you making right now? And how are you approaching that as the leader of your company?

Scott: Yeah. So it’s a great question. We’re actually not adjusting our underwriting much. We were always a cautious underwriter. I mean, again, another lesson that the 08 recession taught us is the assumptions that you make at the beginning of a deal you’re going to have to live with for several years, depending on the size of the project. And so the way I put it, John, is that when I was a young project manager working for others, man, there was no deal I couldn’t do. With every most complicated deal, I can solve those problems. I’m a great problem solver. Let’s do it, right. Now, I’m the opposite. There’s almost no deal that can make it over the hump, right? Like for if there’s any little wind of some issue or friction in the process or much higher levels of complexity, I’m like out, man, like immediately.

And in fact the saying I have, and I think your listeners will appreciate this is that in real estate development, complexity is the enemy of profits. So the more complicated your deal in any way, right, land acquisition, entitlements, construction style, capital markets, the market itself, like right now during the coronavirus, we have complexity in the marketplace. So the more you can simplify your deal, the more friction you can take out of your deal, the more quickly it’s going to go, the easier it is to execute, the less mistakes you’ll make, and the better you’re going to be profitable, right. And for us as fiduciaries for investors that ultimately that’s what we have to do. We have two main things we’ve got to do. We’ve got to house tenants appropriately, successfully in the neighborhoods, and at the rent levels that are appropriate and coherent for their lifestyle. And we’ve got to make investors’ money. That’s the second one.

John: Absolutely.

Scott: First really ultimately, right.

John: So you know it’s really interesting that you say that. So I communicate that differently to our teams. It’s really a balance of time, energy, and of course money, right. Time, energy, and resources and that’s the balance that we try to play.

Scott: Yeah.

John: Which of those do you are at this point is weighing a little bit more heavily…

Scott: You’re talking about in this part of the cycle?

John: In energy. Yeah. Because the way you put it like that you communicated that in terms of complexity. So the more that we can simplify the project or get down to the top three things that will allow us to get through this and execute on this. Great. Now we know where the money is and we can move forward, right.

Scott: I think to answer your question by the fact that we design for less complexity from the get-go means that any disruption or breakdown that we experienced in whatever part of the deal that happens to be disrupted by itself doesn’t wreck the project. In fact, we do that by design and that was the lessons I learned from 2008 are that you have to be conservative in your underwriting everywhere. Like there’s no place that you can’t be. Now, you can be so conservative that the deal doesn’t work anymore. Right. You’re so conservative that you can’t make a profit and I’m not meaning that. I’m just saying that relative to the understanding that we have and we can make sure we have a good understanding. So before we started this interview, we talked about San Diego, right and needing to know, get really grounded in construction costs. So I know construction costs are important, right and it’s a fundamental tenant of real estate as it is for everybody, right in real estate development. I just go in there and don’t say, “I think I know what it is.” Gosh, it’s X in Southern California. So it should be X minus or X plus in San Diego. I go, “I don’t know.” So I’ve got to do something that proves it up. I’ve got to ground that assessment.

And that’s a really key thing is you want to do that in every variable of your project. Like you want to do that as many variables as you can, right. Like, let’s say we have a hundred variables in a project. I’m just making that number up. You really need to get grounded on the predominance of that. At least enough that you know you can be protected so that when something does break down. So in this era, the market rents are decreasing, right. When it was I was reading, Yardi has a report, Orange County was down 5% and San Diego was down X percent. I don’t know. I can’t remember what it was. I look at our numbers to answer your question, like what’s changing? Nothing is changing other than we’re anticipating some reduction in construction costs. I’ve already negotiated land costs lower, right. We’re seeing that in actuatable.

And then I need to be really cautious of rents. Right now in what we’re renting, we’re actually above performance. So our project in Fullerton, we underwrote 3,500. We’re leasing at 3,800, even in this environment. I say that’s a home run, right. Great. But I also say if on the next project I use that same logic and I underwrite 3,500 and I really could get 3,800, but I go, oh it’s going to reduce 5 or 10%. Well, that just takes me back to my 3,500, right? So that’s a specific idea of what we’re doing differently. So generally we’re very bullish. Like you described early on in this, the housing undersupply story in California is decades in the making and it’s going to be decades in the fixing, right. It’s not happening anytime soon. We still have middle-income families that need this housing. We just need to be cautious in the near term and continue to ground our assessments. We have to get bids on construction. We have to negotiate reductions in land costs. We need to avoid a long entitlement process. We won’t do any rezoning except in special cases. Right now we only want to buy to reduce time. Then on rents, we’ve just got to be cautious, right. We’ve got to go. We can anticipate, we’re already seeing reductions in rents but it happens to also be in all the A luxury product in Orange County. And the 5% is predominantly in that brand new unit that just delivered in Irvine or some stuff that’s still over in Santa Ana. That’s really where that, and that happens to be the product type that we got out of, right, into this workforce housing model.

So I think we’re still insulated, but I’m not sitting here going we’re bulletproof. We just have to be really cautious and not bet on any extra special, magical, positive events happening, right. This is what happens when you’re a young underwriter or new.

John: I liked how you put that answer. So no magic.

Scott: No magic.

John: Scott’s magic.

Scott: No magic. My point is when you’re young you probably have this or new in your career as a real estate deal-maker or a developer, you go, “Oh man, rents are 900. I think I’ll probably get a thousand.” Right. We know new should be a premium to old. We know that generally. But is that real? Should you really get a thousand? I don’t know. I’ve got to go look at the market and I have to make an assessment of the market. And if I realize I can’t have a story about our rents being a thousand, when the market’s 900, then I can’t do a thousand. And if that breaks the deal, then we don’t do that deal.

John: Yeah. You know, it’s really interesting. So someone was asking me a question. This is probably about six months ago and I think it’s a marketing term, right? Forced appreciation. I keep hearing that. Someone finally asked me this question about forced appreciation, man…

Scott: What is that?

John: I was confused. I don’t know. But I think what they were saying was, I understood what they were asking me.

Scott: Right.

John: My comment is there really is no forced appreciation, right. The economics have to be there. Now, you can influence appreciation, right. If the economics are there, as a leader or a company, you can execute and influence that appreciation. But the economics have to be there, right. I mean…

Scott: Yeah. There are no foreseen market forces, right. So if you think of forces like politics, demographics, economics, right. This is a market place to be in the economics. Nobody’s forcing anything, right. I’ve heard that term and I had the same gut-level reaction, but you actually put it well into words. What we do is capture appreciation.

John: There you go.

Scott: By being [inaudible 00:23:59] in underwriters and good risk mitigators and good deal selectors and good execution, right? You have to have all those things go well. What I call practices or the actions you’re in to like move a deal from beginning to end. Right?

John: Right.

Scott: And in fact, I will think of it, the opposite. It’s the appreciation that is there to capture if you don’t make mistakes along the way, that’s what ruins people. That’s what ruins deals and mistakes on the way could be the market changes against you, which you don’t control either. But the way you overcome that is you don’t underwrite your deal so aggressively that it either depends on very much large amounts of appreciation that may or may not arrive when you get to the end of the deal. Or the way I described it earlier is you assume that your deal could take some backtracking on rents. Or maybe the other way is your construction costs, “Hey, I think it’s going to be X and I should maybe assume that we’re 10% over that, right.” That was our metric for years and years as construction costs went up. You know, I’d add five bucks a foot to our number on every new deal, every six months, whatever. That was sort of my math. And then when it goes against you, you don’t fail right. When your underwriting is done correctly, you’ve got room to maneuver. You’ve got enough contingency to overcome mistakes. There are never any mistakes. Or say it another way, there’s always friction in the deal process.

John: Right.

Scott: The question is, are you a good enough deal underwriter and risk mitigator that you’ve built the protection into the underwriting? And if you can’t have a story about the protection, then you don’t do the deal. And that would be really the fundamental way I look at it if I can’t see that protective part of the underwriting, I won’t do the deal.

John: I think you put that so well. I love how you expressed that very clear in a language that anyone can understand. Right. So in this market, where are you running into the greatest friction? Or I like how you put that friction.

Scott: Yeah.

John: What friction or what potential challenges are you anticipating the most?

Scott: Yeah.

John: And what are some things that you’re doing to mitigate those challenges? And I’ll probably put this because it’s so true. In every single deal, no deal is perfect. I’ve never been in a deal that has gone perfectly.

Scott: Right.

John: But what I have been in our deals were accounted for mistakes and we’re still able to maneuver through them.

Scott: That’s right.

John: Because we priced for that.

Scott: Yeah. Your deal takes abuse is the way I put it, John. It can get beat up and not fail, right. Or it can get beat up and still keep going, right. You know, if that’s the takeaway that when you set your deal up to be able to take abuse, take friction, take breakdowns, right that’s what a smart, intelligent, seasoned underwriter does, they know that. You can’t know the friction of your deal, not exactly. You sort of know the fundamental categories, the right market, financing, city. You know the fundamental categories, but you never know what quarter that damage is coming from.

John: Right.

Scott: Maybe things went up. Oh gosh, man, framing lumber went up 10 bucks a foot or whatever, you know. And you go, okay, well, but I’ve got that covered. And I don’t know, what’s that thing covered. Like I couldn’t anticipate lumber, but I do know construction costs can do that. And if I make protective mechanisms in my deal for that so we’ve covered that. So I think your question is what frictions…

John: So obviously construction costs are a big one, right? I mean, because that can make or break your deal all the time especially if you’re buying right and you’re buying land at a great value. I think in this market, we’re going to see more and more of that.

Scott: You think more construction costs increase?

John: No, I think construction costs are going to come down.

Scott: Yeah.

John: There’s just less demand for labor right now. But I think what we are going to see, and we’re starting to see that right now, is that the asking price of land or real estate, in this case, especially multi-family product, there’s a lot more flexibility right now because of the uncertainty, right.

Scott: Yeah.

John: The more uncertain the market, the more flexibility there is, especially when those assets have been probably slightly over-leveraged.

Scott: Yeah. I might just change the language a little bit, John, to say, there is the potential for flexibility. I don’t necessarily say that it’s here yet. And then, of course, every seller and every land seller is different. In fact, my saying about land sellers, like particularly landowners, not cash flowing apartment owner, that’s a different [inaudible 00:28:08]. They’re usually the last to capitulate. They’ll hold on for dear life, “Man, six months ago, my lot was worth X.” And you go, “Do you understand we’re in a different environment? You know, COVID-19, demand for apartments has changed radically.” Now, I don’t how then necessarily that our product is actually performing well. I mean, I don’t hide anything. That’s not my job to convince them that my product is good. It’s just do they want to sell or not? I’ve seen a little bit of capitulation in the land marketplace. And then on construction, I’m still waiting for deducting. I haven’t seen it yet, but we haven’t priced enough new deals. We’re just going to market to bid on a project in Long Beach. I actually have two projects coming up in the next few months to bid. And then you and I talked a little bit about or just exploring San Diego in that way. And that’s really the main variable that we’re left to uncover in San Diego is that construction costs if we can land them generally where we are in SoCal and that’s usually what the subs are telling me, even people are saying San Diego should be a slight discount. I don’t know if I believe that or not. You know, I’d be great if that is true, but I don’t believe it yet.

So really I think to answer your question, what are we planning for? What are we anticipating to have to mitigate for what is the rent? I’m just very vigilant about rents. In fact, this morning, if any of your listeners want to sign up. There’s a guy named Jeff Adler at Yardi Matrix, right? He’s like, I don’t know if he’s the marketing guy, but he sends out their weekly twice a month email blast. Yardi does great free reports. So you just got to sign up for their email list. Great, totally worth the cost. And they’ll do sub-markets. You know, San Diego they did last month. This month, they did Orange County. They got national and they’re seeing rent declines, right in all these markets. Again, as I spoke before, it’s predominantly in the A brand new luxury product. Renter by necessity housing or RBN as they call, it seems to be more protected still it have a little bit of pressure, but it’s much less than the brand new product. And we anticipated that, right? We go new brand new product, just delivering where there’s a lot of competition with the same product that is the normal place where they expect to place that rents would be under pressure. And that’s turning out to be exactly true.

In the renter by necessity, or maybe call it the workforce housing domain that’s where people are leaving the luxury product to go to lower-cost housing, right? So they’re going from A product to B or C to reduce costs. But the other move we’re seeing is what we call recombination or combining, which is where our product really excels, which is a family who’s already living with six people, but the adult child moves home or in-laws move in. And they’re doing that as a defensive measure as I talked about before recombination’s coming back together, right? And then also roommates do that. They go, “Oh gosh, I need another roommate to reduce costs.” And then we’re talking with people that have three, four, five roommates to rent these five bedrooms and they go great because nobody’s building five-bedroom apartments. You’re the only people that we know, particularly, and from our research, we know at scale that we’re delivering these five-bedroom units. And so we’re that place where people go when they leave their one-bedroom because they can’t afford that rent on their own income or their single-earner income. They’re going to our units that’s an advantage. [crosstalk 00:31:17].

John: I want to share something with you that is going to support what you said, maybe a little bit from a little different viewpoint.

Scott: Sure.

John: But I was on a call the other day, it was an interview with the CEO of CoStar. Great conversation, great interview. But he said something that I found really fascinating because now they own Apartments.com. So they’re able to get a very unique perspective into apartment data that most other aggregators are not able to.

Scott: Yeah. I agree.

John: Reese is a great aggregator. We love their data. Yardi same thing, but CoStar is very unique. And one of the things that he said was, let me see if I can paraphrase this the right way. Apartments.com, had roughly 40,000 viewers. In other words, 40,000 people coming in and out, checking out apartments in their listings. Ironically, we have roughly about 40,000 renters in the United States. So their conclusion that was pulled from that, that hasn’t been verified, but more of an assumption is that everybody which intuitively makes sense, the apartment community right now, the tenants, the residents, they’re shopping, right. They’re also positioning themselves, just like we do when we try to look for a better opportunity when we run into times that are a little bit challenging or times that are opportunistic, right? We look for a better deal. So that’s happening right now. And in some of the sub-markets that we’re buying into right now, I have a couple of assets that were in escrow the trending is really interesting, right? Because in March you see a drop-off. April same thing, but everything rebounding back to normal occupancy levels. But what you do see is when we break down the data, you see that when you really look at the unit mix efficiency versus one-bedroom versus two, you have more migration over to more bedrooms.

Scott: Right.

John: So same price, right or improve in price, but we just have more demand for that product.

Scott: Or it could be that they’re sharing. Maybe the rent’s the same from a two-bedroom before to a two-bedroom now, but that single-earner now joins up with another earner. And now they’re dual-earner in that household. So the cost aggregation per person is lower, right? The share that they need to pay is lower. And that logic just continues on a linear path. When you go to five bedrooms, the same basic logic. It’s just that the reality is. And part of the reason that apartments.com and CoStar don’t track it as closely, and this could be the same with Zillow and [inaudible 00:33:43] and Yardi is, you know, there’s just not many four or five-bedroom units and we’re happy about that. Like, we want to be on our own. Like [crosstalk 00:33:49].

John: Right now that’s fascinating to me that you’re building out that type of product. So, Scott, I’m going to transition a little bit and talk about one of our favorite topics and it was one of yours into leadership. But I’m going to tie this into leadership around the capital. Equity capital first and we’re going to talk about debt capital. But you know, in our business, we’re not buying vacuum cleaners, we’re buying real estate and it’s not cheap. So leadership is really important. Can you speak to leadership and why that’s so important when they’re placing capital, especially that of probably underwriter or investor dollars?

Scott: Sure. So in fact, we covered this just a little bit in our pre-conversation. So the way I think of leadership is made up of four distinctions, trust, value, authority, and leadership in that order, right. I think everybody’s used to trust. Like, I think that’s the main part of business transaction and leadership that people think of when they’re going to transact with somebody and take their leadership or accept their leadership as a sponsor in a deal, right. But as the person who needs to sit in that spot as a leader and have identities of trust, value, authority, and leadership, well, then we need to work on our competence and capabilities to actually fulfill all four of those distinctions. Like we cannot be any of those. We have to be competent and even competitive in all four of those distinctions. We have to have higher levels of trust, higher levels of value, money that we make for them, authority or things are required forbidden and allow, right, which is where the developer lives, right. Like what projects do we work on? We do buy the right projects because we know that we don’t want to take on an autonomy process. It’s required that we do that. And we just say, we don’t choose to do that.

And then leadership is really like, you and I talked about isn’t so much like leader and follower in the command and control forum and I think people commonly think of. And like more sophisticated thinkers will know what I’m saying when I go here, but really leadership I put in the form of when you’re an investor and you’re investing money with a sponsor, you are in a way being a follower to their leadership as a sponsor in that market for that product type in that time in the marketplace and that time in general and history, right. And that part of your assessment is that, does that person have the competence to lead us through this process where at the end of the day we make money? So I like to put it that way, because really it’s more like, “Hey, we want to go from A to B. We want to create. We want to buy a piece of land and we want to deliver a completed, leased up a project that has more value than the cost that it cost to build it right. And therefore the sponsor has to know the pathway, know the steps and the mechanisms that are required to step through that path from A to B appropriately and safely, right. This is where that underwriting comes in of doing conservative underwriting, of completing assessments in a grounded way. And so I really like to think of it from the standpoint, and by the way, investors don’t need to be followers, but that’s the choice of investors. They go, “Oh, I could invest in sponsor A or sponsor B.” But I think in terms of our conversation today is really for sponsors, investors to look at the sponsor, in the context of do they have the competence and the background and the capabilities and the team and the knowledge to lead us through this pathway appropriately? And that could be for any deal. It could be a value-add deal. Does this person know how to find them? Know how to execute the upgrades? Know how to increase the rents? Hire the right property manager? Sell it appropriately if that’s the choice that you have at the end of the day. And I think when you think of it from that standpoint, it’s a great way to assess who people are when you’re thinking about investing with them. Even listening to your earlier conversation, people you might partner within the context of, do they know how to do these things?

And by the way, leaders and followers switch all the time. I’m a follower of many people. I’m a leader to some if they choose to accept my leadership offer. I choose to follow people because they have great leadership in another domain, right. I follow people in that strategic knowledge and learning how to be a better businessman. And I have people that are leaders to me in that sense. So leadership and followership are completely fungible interchangeable. And in fact, in the same relationship, one day, the investor might be the leader on a specific part of the deal. I have expertise in this. We’re going to sell the property and I’ve sold a lot more assets than you have in this particular market. I’ve got a great broker. Okay, cool. Right? Like that, I’m a follower.

John: Right.

Scott: And then vice versa, you know, they may have never invested in Los Angeles or SoCal and they go, “I want to be in California because I know it’s so undersupplied, but I need somebody who knows the terrain and how to travel that terrain successfully.”

John: Absolutely. So, man, I love how you talked about being right. Because there a few people have those discussions and I’ve heard that from very few people. I always say, when you go into a community or you go into a business, that business is going to reflect the character of leadership almost nine times out of 10, almost all the time. And I liked how you put that. You have to be what you’re describing in order for that to work, right. Leadership is about being what we say that we’re actually going to [crosstalk 00:38:56].

Scott: That’s right.

John: And so I think what we quantify that to here is our business is going to have a character and that character is going to reflect how we’re being. That’s one of the reasons why…

Scott: Hey, John, I call that culture, right?

John: Yeah.

Scott: Not to use fancy language, but you know, the culture is a reflection of the leadership and the structures and the practices of that group. A company is an organization of people. And it’s made up of all the component parts of people, not to make them sound like widgets. But the leader leads the team and the team is made up of, you know, people that are competent and that grouped together in an organization. And then how they operate and how they are, their way of being is what makes up their culture. Not to get over, you know, theoretical about it.

John: I think it’s great.

Scott: But that so makes a company successful or not. Because if your way of being is that I don’t make good assessments about future rents. And that’s a ridiculously simple example, but there are people out there who do that, right? There’s a whole vintage of deals right now that was made in the last year and certain markets, which I won’t pick any particular market that was underwritten overly aggressively, over-leveraged, over anticipating a rise in rents from a value-add standpoint, or even development for that matter, that isn’t going to make it. I don’t say that it’s not fun. I don’t wish that. It will save time if an investor was with a person who had anticipated and nobody can anticipate coronavirus by the way, and you know, you would agree with that and everybody does.

John: Agree.

Scott: But what you do is you say, “Hey, I do anticipate breakdowns. And I do anticipate that there will be some pressure on my deal.” Like we talked about before. And you know, like you as an investor, need to assess people and really be pretty brutal about it. You know, I always wish that people would just accept my interpretation narratives about real estate development. Not everybody does, in fact, most don’t, that’s fine. That’s their prerogative. They’re smart to make their own assessments for how they need to fulfill their business plan as an investor.

John: Right. So I really appreciate that Scott. And yeah, I think character inside of a company is really important because usually that kind of translates into how you execute. That’s one of the main reasons why we started a property management company is because I wanted to make sure that we control the character on both sides of the fence. Right. But more importantly…

Scott: You couldn’t find people that were going to meet the criteria and standards that you wanted. You probably wish you could find a property manager that would fulfill that but can’t.

John: Actually Scott, I really don’t anymore. And I’m really glad that we worked through some of the challenges that we did. Because I think the big secret if there’s any in this business, is when you get really good at managing you dial in your numbers and that data now you can use to better assess and underwriting new deals.

Scott: Yeah.

John: So when I’m walking a property now, especially one that’s already built, right and leased and maybe underperforming, I can look at a P&L, an Operating Statement while I’m walking the property in a rental and my brain will start correlating that to just the different classifications.

Scott: Right.

John: Right. On a P&L that we can really only dial-in if we’re managing that property. And it’s very unique, especially around turnover costs and around repairs and maintenance, right.

Scott: Right.

John: Because oftentimes I see people group repairs and maintenance in one-line item, and man, it really doesn’t work like that. Especially with turn costs and also with Cap-Ex. So talk a little bit about Cap-Ex because when I was reviewing your bio, one of the areas I believe you noted was your ability to execute on construction costs, right, make capital improvements. And that requires a huge degree of being as you put it, right? So when you’re making these assessments and you’re dialing in your numbers, you’re proofing everything out, when you pull the trigger, how do you rally your team around getting to that end goal?

Scott: So I think, well answered. It’s sort of like your example of being a property manager for your own account and then going out and assessing a new deal and the rental market in comparison, and contrast to that background knowledge that you have as you’re running your own shop for a property manager. We do something similar in construction. So we don’t hire general contractors. We use what I sort of loosely call the home builder model, right. So in the home building world, the KBs and the [inaudible 00:43:08] and the Beazers, all those companies, they buy their construction work direct from the subcontract markets. They act as a general contractor, but they’re usually not legally, they’re acting in that form, but not necessarily in the chain of the contractual obligations. They’re like an owner builder right direct to the subcontract market. So in 2005, we actually pulled in all the construction activities that we had in-house and have been operated like in-house with construction ever since then. If I could not do that, I would choose to, as the property manager, as you did, you made that move to go in the house. We just could never be satisfied that we could do it as well and it does have a cost component. There are a cost and time, energy, and money that we trade for that. But the offset is the protective mechanism.

Again, in other words, we know framing and foundations and installation and windows and doors and all the construction cost down to the penny. And particularly in the UTH model, in the three years that we’ve been executing on that business plan, we’ve really refined our unit type really to where we have really two unit types. They’re both four bedrooms or five-bedroom, four baths, slightly configuration. In fact, one is what we call the regular unit and the other one is turn 90 degrees to be wide and shallow, to be able to better layout some of the sites that we work on. But we have those units over multiple projects, same subcontractors, same designer, same civil engineer, same mechanical electrical, plumbing, right. And we do have to upgrade you know as code years change. And this year we have a big code change for the 2020 code and a couple of major systems. But we have the same team doing this over and over again. In fact, it’s the closest to production housing that I’ve ever had as a developer. And we’re loving that, right? Again, reduction complexity.

John: That’s it.

Scott: One of those examples we’re using the same unit type over and over again. We’ve got the same specs, same countertop, same cabinets, same appliances, same team, right, same subs. And what that allows us to do is one, we have trusted relationships. Back to this, you know, identities of trust, we require that of people who work with us. If they can’t meet their obligations to us, fulfill their commitments, fulfill and hold their commitments, then they don’t stay with us, right. Same with vendors. We use the same architect over and over again. And so that really has us basically refine and always ever-improving the plans and the specs to make it more efficient, simplification.

John: Absolutely.

Scott: Reduction of trades. But also like your property manager, gives us a really good instinct for what the marketplace is, right. And in fact, we keep a database of all our projects in this model over time. So we have a running average of, you know, installation is this much per square foot and we use net lease to able to calculate that. And at the leasable square footage of the units right, for lease. And so a sub comes back and all of a sudden they were at X cents per square foot for installation. All of a sudden they double and triple. Well, hold on. What’s wrong here, right? Or sometimes they underbid it and we go, “What are you missing?” Or like, “Hey, great we love a lower price. We don’t want to fight that, but we don’t want you to get in trouble either, right. You miss a major scope component in your bid. Well, guess what we own that risk. I mean, so I’m just going to go, “Hey, well look, I didn’t bid it, dude.” Right. Not my problem. And we wish it weren’t that case. And our subs generally don’t do that. In fact, we’re now in this standard practice of any new deal that we get the subs involved very early, as soon as we have CVs ready to go into plan check. Then we submit the first plan check. Plans that version plans go to all our sub-base. I tell them, tear the plans apart, tell us where there are holes, where there are mistakes, things we can do better. Hey, don’t use this system, use that system, right. I just tell them, you know, beat us up, right. Because the more I’m beaten up in the beginning, the less cost I have to deal with in the field. In fact, there’s a rule of thumb that the numbers won’t make sense, but cost increases would be 50 bucks a square foot, you know, in design CVs. A hundred bucks a foot cost increase in plan check and 150 bucks a foot cost increase in the field.

John: Right.

Scott: The later you waited to fix a problem, the more costly it was going to become, delays and change orders and not reaching the time for lease-up. And I think that’s true and I haven’t done the calculation, but I just go, I never want to get to the field change. Like just never go there. And it does happen, right? There are things that just weren’t anticipated. The inspector wants this and not that. You know, the code change. Code year changed. We just had a code year change for 2020. But in fact, we are on our first project for 2020. So I just use those as examples. But we’re able to have those conversations directly to the subcontract market and buy. If we had a GC sitting in the middle of that, there are many good GCs, John, right, but there’s just going to be a filter in between us and the subs that we don’t want. I don’t want to have our field staff and project managers and staff managing the framer. But I’ll have a killer framer, good dude, salt of the earth just wants to take care of his family and do good work. Right. And take care of us. I’ve built that relationship over now, several projects. And I know that if there’s something wrong, he’s going to tell me. If I get good pricing from him, it’s real, right. He’s going to tell me if there’s the stuff that we should be doing differently and that can’t last forever. When we go to San Diego that framer’s probably not going to go to San Diego. I wish he would, but I don’t think he will.

But those are examples and back to trust. Right. But I think that those are the kind of practices, actions that we’re in consistently, that we have to always be looking to build that over and over again. And I’m working on several new practices every week, every month that we’re constituting to resolve some issue. Oh, we’ve got friction in the draw process with the bank. Let’s fix that. Let’s figure out a different way to do it. Let’s get a different vendor. You know, that concrete material supplier has awful paperwork to get rid of them. You know, there are people with delays or draws, which delays payment to other subs, which slows the job down, eliminate that guy. Get a new material supplier. You know, [inaudible 00:49:04].

John: So Scott we’re approaching the end of this. But I’m going to summarize a couple of things that we talked about because this was a fantastic show and man, I’m really grateful to have you on. Your wealth of wisdom and I think just as important or perhaps, more importantly, you’re a tremendous leader. And I can tell…

Scott: I appreciate that.

John: A lot of effort and time and energy, and to continue to grow yourself as a leader, I can tell in the language.

Scott: Thank you.

John: It sounds to me like you’ve really figured out a niche and especially in the markets that you’re in Long Beach, LA prices are a little bit higher in those marketplaces. So by building out a product with more bedrooms, it sounds like you were able to create a product that allowed you to be maybe a little bit more competitive in those high-density markets, right? Because you can possibly go up in costs on acquisitions, but now that things are reversing now you’ve created this huge advantage for yourself because you competed yourself into a very unique product in a market where pressures on price are going down, right. You’ve dialed in your floor plan. Sounds like you have some off the shelf models now that you’ve dialed in. So I get the fact that this is really designed more for high density, but here’s the question.

So two days ago I finished a book on Airbnb and they have a massive listing share, constantly growing. They’re also developing or building out a segment-specific to developers and multi-family owner-operators really geared towards exactly what you’re doing, right? So I find it really, I’m listening to you and I’m going, man, this guy’s way ahead of this curve. So I’m going to, when we’re done, give you the link to that book. Fast forward it’s kind of boring until you get to the cool part where they’re talking about some of these things.

Scott: You’re right.

John: Because really they’re spending a lot of time defending the litigation that they’re going through. They have a lot of money at this point, so they’re going to get through it. But if you fast forward to this segment, how they’re looking to expand their share, this is one of those segments, right? So you kind of build that. It’s a very unique opportunity. So my question to you is, is that a potential partnership opportunity that you’ve considered, you know, with these third party suppliers like Airbnb, because they’ll love your product. I mean…

Scott: Definitely, in fact, I’ll just add to Airbnb although what you’re telling me is new. But as you’re speaking, I go, “Oh, they need to increase supply.” Right? They need more new products.

John: They do.

Scott: Brand new or more locations. Maybe professional owners, right in the sense of developers and sponsors and owners, landowners. We’ve also had a conversation in some of the co-living markets. So like a group called Common. We had a long conversation about them. They’re co-living models, almost exactly. In fact, they were doing six bedrooms and we were doing five bedrooms and we liked that model. So I’m always open. In fact, in my role as the CEO of Urban Pacific, John is it’s my responsibility to continue to innovate. Like there’s people are going to come, they’re going to figure out, “Oh, Scott’s doing great. Urban Pacific is doing great with five bedrooms. Let us go do five bedrooms right.” Now we are at the far end of the spectrum. So I don’t expect major institutional competition, but we will get, you know small and midsize players who will get on to that. You know, I think there’s just a general trend towards family-centric rental housing, right. That hasn’t traditionally been a marketplace that’s had much in the way of supply.

I think there are multiple opportunities. I think there are opportunities for us to build these product projects as a teacher and firefighter housing. Those are workforce housing also, but you know, more centric to particular users or employers, right? I think there’s a story around this economic sharing model for middle-income seniors. Like these are the things that I’m just sharing openly what we’re looking at in the future environment, you know, anticipating future threats, obligations, and opportunities, these are some of the future opportunities that we anticipate. We’re not making any moves to fulfill most of these that I’ve described a couple. But here’s where I go with that.

Here’s sort of the final answer. I am so enthusiastic and just such a great space for serving these working families, John. I think that from my days working for Mike Costa at Kaufman and Broad to see the need for these families that need housing that’s coherent with their lifestyle. Clearly that at, or below 60% true affordable housing the need is the deepest. For the homeless and there’s a lot of good folks working in that marketplace. But I’m in a story. It’s a real story that looks like middle-income families in California are under huge pressure and I am grounded that nobody is serving those families. And so I’m both super enthusiastic to be delivering the social impact of housing that’s affordable or more affordable through this economic sharing model. The families that are underserved in this marketplace. And two is like we’re building projects right now in an environment where unemployment is a huge factor. I’m in just tremendous story about us growing our labor base, which we are, right, through our subcontractors to keep people employed gainfully, if not and expanding. So these social benefits, social impact story, I think for me, has to be in a story that I think we are in such an under-supplied part of the marketplace, meaning working-class, blue-collar, middle-income families in California, and this could apply to other major urban Metro markets but California is the most one end of the spectrum.

We have the top 10 least affordable housing markets in the United States, right. Hands down. There’s no comparison. I think that’s a long-term viable defensive space, right. Insulated. Nobody’s going to come in a major way to build, you know, thousands of thousands of five-bedroom units. No institution will. I expect to touch that, maybe wrong in my claim. But it’s too radical for institutional developers and sponsors and ambassadors, right. I don’t say it’s crazy. I think it’s great. I’m encouraged. In fact, I’ve seen the marketplace sort of respond as we talk about this more to folks like yourself and being out in the marketplace, speaking about UTH. People are like, yes, families, middle income, working-class families that’s a space that nobody’s really engaged in deeply. And so we’re just so in wonder and enthusiasm about being in that marketplace and some good business story, right? Defensive, insulated space, good social characteristics, produces profitable projects.

In fact, it’s so much John that I mentioned it just in passing before, we’re not selling a single project that we developed. We’re going to hold everything that we build from here on out that started about 18 months ago. First as a defensive move against a coming recession, right? If we didn’t have to sell in the middle of a recession, we didn’t worry greatly about values. As long as we had stable income-producing renters, producing stable NOI, we’re in a good story about valuations fluctuating. We don’t have to sell. We don’t care so much about that. I mean, it is an important factor, but we don’t have to sell right now.

John: So Scott, how do our listeners get ahold of you? I know, you know, we have a pretty broad listener base, right? We have folks that are looking to place money passively. We have folks looking to co-invest. And we of course have landowners and property owners that are always looking for great leaders to partner with that can take them to a finish line and add some value and help enhance their portfolio. So how do people get a hold of you? What would be the best way for folks to reach out to?

Scott: So I would encourage people to go to our website. It’s www.urbanpacific.com. Go to our Contact Page. Our entire teams’ emails are on there. My email’s on there. Feel free to email me. My direct phone number is there. I encourage people to text me if they want although email’s best. While people are there, I would encourage you to sign up for our Saturday newsletter. We’re always putting out all the tracking I do economically, John, all the articles I read, all the economic tracking tools that I make assessments of weekly to keep as best we can ahead and conscientious of the market, I share that in these Saturday e-blasts. So we’re putting out tons of just good information for investors and people that are on the marketplace. There’s a red button on the right, sign up.

And then the last thing I would just encourage people to go to our Investor Education Section on the website. Tons of articles, blog posts, videos, podcasts. A lot of educational material about being an investor, how to underwrite apartments more effectively, how to assess sponsors, people that are in the business how to do their deals better. So we do our normal marketing announcements about projects where we raise capital. We put those out on that e-blasts and the blogs. So people can find new deals there and we’re putting out stuff almost monthly right now. We’ve got a good pipeline of projects in this acceleration phase, which is counterintuitive in the coronavirus. But we’re fortunate to have a product that benefits from this downturn, which is pretty different, but people can find deals there.

John: Awesome. We really thank you for coming on. It’s been a wealth of information. And really excited about the opportunities that you’re creating for your company, your teams, and we look forward to your continued success.

Scott: John, great to be here. Appreciate the invite.

Outro: Clarity of purpose creates our greatest competitive advantage. When we transform apartment buildings to thriving communities, we improve how people live and create assets with high-profit margins. Don’t forget to subscribe like and share this up with a friend. I’m John Brackett bringing you things you can implement right away.

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