WS533: The Importance of Sticking to Your Guns on A Deal with Sam Rust

[INTRODUCTION]

[00:00:00] ANNOUNCER: Welcome to The Real Estate Syndication Show. Whether you are a seasoned investor or building a new real estate business, this is the show for you. Whitney Sewell talks to top experts in the business. Our goal is to help you master real estate syndication.

And now your host, Whitney Sewell.

[INTERVIEW]

[00:00:24] WS: This is your daily real estate syndication show. I’m your host, Whitney Sewell. Today, I have a special guest. His name is Sam Rust. Thanks for being on the show again, Sam.

[00:00:34] SR: It’s a pleasure to be here, Whitney. Thanks for having me.

[00:00:37] WS: Now, I’m honored to have you back on the show. As a listener, if you haven’t heard of Sam before, you should have encouraged. I encourage you to go back and listen to show WS196. It came out May the 5^th of last year, and Sam and I discussed numerous things then. But today – Up to this point, Sam and I – He’s my business partner if you didn’t know, and we are partnered on a few deals now. I’m excited about just the future of our business and what’s happened there and just how we’ve grown since partnering.

Very briefly about Sam, 450 units, $60 million assets under management and growing. Right, Sam?

[00:01:13] SR: That’s right. That’s right. Ever upward.

[00:01:15] WS: Yeah. Why don’t you give the listeners just a couple minutes of your background, and then let’s dive into a recent deal that we closed. We’re going to go in-depth on a specific property.

[00:01:25] SR: Awesome, yeah. I live here in Denver, Colorado, so I’m a product of the Rocky Mountains. I don’t want to go any further east. I always need a mountain on the horizon, so I know how to orient myself against the compass. But I’m married. I’ve got four wonderful daughters and a boy on the way, so we’re excited to get some diversity at the Rust family home.

I grew up in Idaho, just outside of Boise on a family farm there. I graduated college from Thomas Edison State University back in 2009 with a degree in business. From there, I went to work for a family business that focuses on B2B sales in the industrial automation realm, so I held many roles in that organization and most recently as business development and a product specialist.

I got into real estate back in 2017, wanting to grow some capital that I had. After doing a lot of different research, I landed on syndication as the niche that really spoke to me and felt like fit my gifts and my abilities. I syndicated my first deal in 2018. I met you at the Best Ever Conference 2019. Then together we closed a deal, a 180-unit deal in 2019. Then we just closed Stratus, the deal that we’re going to talk about today, in March 2020. It’s been a real fun journey along the way. I’ve left my full-time position at the family business and I’m focused full-time on what we’re doing here at Life Bridge Capital.

[00:02:47] WS: Wow! Well, thank you again, Sam, and I’m thankful that you’re going to start getting some blue in the house in the near future.

[00:02:55] SR: I am too. I am too. The girls are always good for a wrestling match or playing Frisbee or throwing a ball around, but I think we’re all excited to add a little bit more diversity to the mix.

[00:03:05] WS: They’re some amazing young ladies. It’s been great to get to know them as well over the last year and a half or so.

But, Sam, I’d love for us to just express to the listeners a little bit about this property that we just closed on and just go back to even finding that opportunity. I get the question often about finding this deal or how we’re finding properties and things like that. I’d love for you to elaborate a little on Stratus, even back to when it was first presented to us, and let’s walk through that process a little bit.

[00:03:33] SR: Yeah. Personally, as I’ve grown in my knowledge in the syndication business, I’ve really benefited from other people sharing their stories and how they found deals, how they underwrote them. A lot of times, we think that this is a fast-moving industry and that, man, you just decide to syndicate. Then four months later, you found a property. As you and I both know it, and many of our listeners know, it’s just not the case. So, I love many aspects of this story and excited to dive into more detail here.

It really starts with our property we closed on in 2019, Lincoln Springs. On that deal, we had a buy side broker that had brought us the deal, but there was a sell side broker that had the listing. And we had a great transaction on Lincoln Springs. We were an easy buyer to work with. We accommodated. There was even a fire on the property a couple of days before closing, and we were able to work through that. Generally, the listing broker appreciated working with us, and we had done the financing with the listing broker as well. They have a debt arm, and so we went that direction.

Right after we closed Lincoln Springs, which is in South Colorado Springs, he saw – The broker brought Stratus, which is a property built the exact same year as Lincoln Springs about a mile away in the very same submarket, great unit mix, and gave us the financials. He wanted us underwrite and put a bid in on that property. This would’ve been in June of 2019, so you can already see that it was a nine-month process from when we first saw the property to when we closed it in March.

But a couple of things that stood out to both you and I at the beginning of this process, one, great unit mix. 90% two and three-bedrooms, which is highly desirable here in Colorado Springs. Good vintage for us. It was a property we had some familiarity with. And then our property management team that was on the ground, their headquarters is literally 200 yards away from this property, and they had managed this property back in the late 2000s, so they had some good history on site.

We took the financial data. We did it, our underwriting. We went toured the property, took our property management team in with us. We’re able to look at some of their old records and figure out some of the things that we felt we would need to address. There was some deferred maintenance on the property related to a couple of the property systems, and there was some foundation work that needed to be done and some sewer work that needed to be done. We were aware of those things going into the initial round of bidding.

We completed our underwriting in July and ended up assigning in our estimation, because the property was worth somewhere between 28 and 28.5 million. We’d be willing to pay up to 28.5 for it, taking into account market factors, cap rates, all of that good stuff, but also recognizing that there was some deferred maintenance that needed to be done. At the time, the property had great occupancy. It was 95%. Delinquency was relatively low. It seemed like it was being relatively well-run, although there was a couple of warning flags in the T12 about nine months prior. In late 2018, that would’ve been it looked like they had struggled with some delinquencies. We wanted to keep an eye on that as we’re going through the process.

Anyways, to sum up a lot of details, I went to the broker. I told him, “Hey! Here’s where we’re at,” and he told me that they already had several LOIs. This is before their call for offers at 29 million or above, and he said, “I don’t think you can remain in the bidding if you don’t get to at least 29 million.”

I mean, you and I, we’re really gung-ho and anxious to get that next deal going but we did not want to sacrifice on our underwriting. I think that as tough as it was, it seemed like such a great fit for us on many different levels, we had to pass on. I just told him, “At this point, I can’t get above 28.5. I don’t feel comfortable underwriting to that. Here’s why.” We wrote up a couple of page summary on why we were at 28.5 and hoping that would earn us some goodwill.

But ultimately, after trading some figures and going through all the due diligence that we had, we just decided to not submit an LOI. We felt like it would hurt us to submit an LOI that was potentially $1 million under what our competition was at.

The whisper price on it was 31 million. It just seemed like it was going to get into a bidding frenzy, and we didn’t want to participate at that level. We wanted to stay true to our foundation.

[00:07:44] WS: But that’s not easy, Sam, to walk away, right? I mean, we wanted to put an offer, and on it we wanted to do another deal, and I think a lot of the listeners are in the same boat.

Maybe they haven’t got their first deal done yet or maybe they’ve done one, and you’re itching to get to another deal. Everybody is, right? Where’s the next deal? Where’s the next deal? It’s hard to have the patience to say, “Okay, this is what we know it is worth, and we’re going to walk away, ultimately.”

[00:08:07] SR: That’s so true. It’s – Still being on the front-end of our real estate careers, I think that need for discipline, it’s harder. It’s harder to be disciplined when you’re on the front side but it’s all the more necessary, because there’s so many unknowns that can trip you up. You’ve already established with your property management team that this is an acceptable amount to pay. And anything beyond that, even if you can convince yourself that it’s just how the market is rising or this, that, and the other, it just is not worth compromising to a significant degree on your underwriting. That was difficult because we had invested a lot of time, a lot of effort into this project, and there wasn’t a lot else trading.

In Colorado Springs, the market that we focused on to date, properties over a hundred doors or between 10 and 13 transactions a year on average, with a high of 18 transactions in 2019, I believe, so there’s just not that many available properties. When you find one that checks a lot of the boxes, the temptation is to just pay whatever you need to get it done. But the math is the math, and we just couldn’t justify going out to our investors and trying to pitch a project that had all the margin for error sucked out of it.

[00:09:19] WS: Something I would like to highlight as well and give you some credit here, like you sent me the email when we’re talking about why we weren’t interested in Stratus at that time and the email that you sent to the broker. But I just thought it was extremely professional. I wish I had brought it up before the interview. I didn’t think of it but I just thought you did an amazing job of representing to the broker why we’re not interested in a very professional manner.

Not bashing the property or them in any way, but here’s the evidence of why we’re not interested. Ultimately, it just shows how important the relationship is and that we can be honest but still be very professional and ultimately still win the deal.

[00:09:57] SR: Yeah. We want to make sure they we’re operating in integrity and that does mean speaking the truth. I mean, that doesn’t always go over well, but you don’t have to speak the truth in the most blunt way possible. And sometimes couching it well, just being professional is really helpful, and the broker definitely appreciated that. He said, “If something happens, we’ll circle back around.” Well, they had to call for offers in August and went through their best and final, and I got wind that by the end of August. I may have gone under contract for almost 31 million, which is obviously quite a bit higher.

I frankly couldn’t understand how the project was worth that much, particularly with the level of deferred maintenance that had yet to be done. Ultimately, it was proven right by the marketplace. During their due diligence, the first buyer found some things they didn’t like. One of the horror stories that you hear from time to time. The model unit had a sewage issue the day that they came out to do their in-person inspections, and they had the entire capital council out, and so they ended up pulling the deal right before their money went hard at the end of September.

Then all that work that we had put into our broker relationship and into underwriting the property really came to play and part of that is just understanding broker motivations. They don’t get paid until the property closes. Every time a property falls out of contract, one, it’s a big headache for the broker just because they had done all this work to get the transaction lined up. They had found the buyer.

Also, it adds many, many, many hours to that transaction for the broker. I mean, it’s hours that they’re not getting paid. They’re in a sense losing money the more time they spend on this, and so they were in a position where they were looking for certainty of close.

They called us back up in early October and told us that we were the only group they were shopping it to. I’m not sure if that’s true or not. We didn’t act as if we were the only ones bidding on it, but our pre-existing relationship and the fact that we transacted before, we had kept our word, we had worked through some difficulties on our prior transaction, really stood in our favor. So, we went back to the drawing board. They knew where we stood. They communicated to their client ahead of time that we were at best going to give them 28.5 million.

Well, we got updated financials, and they were not getting 28.5 million. Performance had deteriorated over the summer. The seller clearly had assumed that they were going to sell, and occupancy was below 90%, which took us out of running for agency debt, which obviously was going to increase our costs of debt and just make the process a little bit more difficult. Then delinquency had taken a turn for the worse.

We were pretty certain that these issues could all be turned around with good management. The current ownership group had their own management arm, and they were in the process of liquidating all their assets in the Colorado region.

So, we felt like there was a good story there. That was not just something we could sell to investors but was very believable. We’re operating a property right around the corner, same vintage, similar unit types, and we were getting rents higher, and our delinquency was 10%, 5% of what this property was. But it’d be a matter of could we negotiate the upfront costs?

I’m sure you remember, Whitney, but we went back and forth for, man, almost eight weeks, October and November. Trading numbers, going back and forth. We originally offered them 27.5 and –

[00:13:14] WS: There was a lot of Zoom calls.

[00:13:16] SR: Oh, my goodness! Yeah, I remember agonizing and reaching out to a couple of people that we both know and just getting input on the situation. I mean, ultimately, we wanted to land this at a sub 28 million number. But to get control of the deal which we felt like was vital at that point in time, they stood firm at 28 million, and so we went under contract the first week of December at 28 million and immediately started into our due diligence period which involves all the typical stuff, getting underneath, doing all your inspection, your sewer line inspections, your unit walks.

We had you come out. We had a couple other partners come out and do those unit walks with us. Help us with some of that due diligence along the way. Yeah, I mean, really got off and running. But I think that was a pivotal point for you and I was deciding to come up basically 300,000 there at the very end.

I just always remember one of the gentleman that we spoke with. He’s like, “Does the deal work at 277?” which is where we were at. We’re like, “Yeah, it works.” We kind of outlined. We were looking for a 17+ IRR, 8% cash-on-cash plus, so some of the typical figures that you’ll see in a value-add syndication. He’s like, “Well, if I were in your shoes, I wouldn’t let 300,000 stand in the way.” Now, obviously you can take that wisdom too far. You can always say, “Well, we’re only 300,000 away.”

But I think there is something to that, that when you get so close to the finish line and if it really is – I mean, we’re talking less than roughly 1%, a little bit less than 1% of the overall purchase price that to gain control of the deal, to get to the due diligence phase, sometimes it may be worth paying just a little bit more than you want to to gain control of the deal.

That was one of my big takeaways personally from this whole experience is learning how the industry negotiates, when you can really apply pressure to the buyer or the seller, and when you have to recognize that maybe you don’t have the strong hand and act accordingly.

[00:15:13] WS: Sam, I get asked all the time and I know all the listeners that are operators get asked too, “Well, how are you conservative?”

I’d love your take and just talking about this deal specifically how we are conservative, because we talk about this to people all the time, and I hear it from – Everybody’s going to tell you they’re conservative, right? Especially in these times, the way the market is right now and things that are happening in our country, we’re going to see – We may see pretty soon who is actually conservative and who is not. But tell us some measures that we take to be conservative and we’re conservative in our underwriting on this deal.

[00:15:46] SR: Yeah. I think the first thing that we did and probably the most important is we had a significant reserve budget. This was a project that had some hair on it. It does have some major sewer line issues and some minor structural work that needs to be done. We went with a bridge loan, and that wrapped all of our renovation costs into the loan. But you still have to float those costs. We still wanted to be able to pay out our investor-preferred returns and we did not want to get close to under capitalizing on the deal. That’s really the number one reason that syndications fail is that you’re undercapitalized. You’re not equipped to handle an unforeseen shock like a coronavirus or some of these other things that have happened on 9/11.

We came in with roughly two and a half years of investor payouts in cash liquid in an operating account, and that’s how we like to think about our expenses. It equates to roughly a year and a couple of months of debt service, so we’ve got a very, very healthy emergency fund. Honestly, I anticipate being much higher than we need, but that’s the point. You don’t want it to be exactly what you need. You want it to be more than you need because you may need more than you think, to overuse the word a little bit. But that’s one way that we’re conservative.

Another way we were serving some of our biggest competitors in the area that we’re also looking to acquire properties and looking at their expense growth assumptions and rent growth assumptions. Then we were assuming 25% higher expense growth and we were actually assuming nearly 35% lower rent growth than some of our competitors. Just trying to be as close to – But the market – There’s a fine line between being too conservative and underwriting yourself out of deals and yet still being conservative. But we felt like we were able to strike that balance here at Stratus.

Then obviously, a revision cap rate is really important and then making sure that even though cap rates had compressed pretty significantly over the last 10 years or even 2 years that we’re baking in a significant amount of cap rate expansion to accommodate for environment such as we find ourselves in today.

[00:18:05] WS: Nice. Moving forward with Stratus, any details you want share before we have to wrap up?

[00:18:11] SR: Yeah. We are excited to take possession. Obviously, the environment is a little bit different than had we banked on. Another way that we’ve been conservative is we had 30% vacancy in year one with the level of delinquency that we have, the level of vacancy upon takeover. We felt like we had to account for that, and so that’s baked into our underwriting. We plan to do much better than that but we have margin for error there, and so we’re focused on really changing some of the exterior things on the property. Just bringing a pride of community, a sense of community into that apartment complex and really revitalizing a small corner of Colorado Springs.

We’ve got a great team identified that’s hit the ground running. We’re already knocking stuff off of our required repair list. We’re lining up a bunch of contractors for work to done this spring and end of the summer and hopefully take advantage of some of this coronavirus scare and be able to get the work done for less than we had originally budgeted.

[00:19:07] WS: I meant to highlight earlier too just the relationship that you’ve built really and that we have now with not only the broker but also the management company and just how important that relationship is and even how they managed this property years ago one time and just the insight that they have provided by having that relationship.

[00:19:25] SR: Yeah. At Life Bridge Capital, we firmly believe in third-party property management, and part of that belief is informed by our experience with Dunmire Property Management. We’ve just been thrilled with them and our partnership with Crystal and the team that she’s assembled. They’ve been in the market. I try not to bring this us up too much to Crystal, but they’ve been doing this longer than I’ve been alive, which is pretty amazing and gives them just a wealth of experience to draw on.

I mean, obviously particularly to Stratus, they had been on this property that helped us be conservative in our underwriting the first time around and account for the deferred maintenance that need to be done.

Then going forward, they control a large share of the market down there and they’re open to trying new ideas. We’re trying innovative strategies for driving more traffic to our properties, whether it’s new marketing campaigns or different amenities that we’re trying to install to draw more tech savvy younger generation to our properties. They’ve been really receptive and been fantastic in their execution.

[00:20:23] WS: What about something you learned through this process that you didn’t know before Stratus, this specific deal?

[00:20:28] SR: I think kind of finishing the story on the negotiation process, just learning more about how that works. The same gentleman that gave us the advice to bump up the 300 said, “When you go through your due diligence, you’re probably going to find stuff that they didn’t tell you upfront, and the seller is going to expect that you’re going to come back.”

I think if you listen to podcasts of people in the syndication space, a lot of our colleagues that I really respect, something that’s heavily emphasized is avoiding re-trades. You don’t want to re-trade. You hear that constantly. You don’t want to re-trade. Your reputation is everything. I do agree with that, but there comes a point where frankly they just did not tell you or they represented that things were in a certain condition and you get in and you find that they were not.

This gentleman at the same time telling us, “Go up to 300,000.” He said, “You’re going to have an opportunity to renegotiate and make sure that you take advantage of that,” and so we did. We went in and we found that some things were not as they had represented and we were able to negotiate a $400,000 deduct, which got us to our final sales price. It’s just a little over 27.5 million.

So, we came out right where we wanted to be in the end, and I think obviously still many things to learn in this business. I just love getting into the nitty-gritty, but that was probably my biggest take away from Stratus is just recognizing when sellers are okay to negotiate and when they just want to strike a deal and how to take advantage of those moments.

[00:21:52] WS: I know personally I just love going through the process each time. I know we improve and we learn so much every time. I know this time they just – I have an amazing an assistant who has helped so much and she – Going through this process. Every time I could think of a way for us to improve, I would let her know, and we would communicate with her, and she would document these things. I look forward to having this meeting that you and I briefly discussed and her. But just like a post-close meeting and ways to improve every time we do a deal.

But one thing we implemented this time was a portal as well. I’ve learned a lot about that process and how to use the portal and it’s simplified the documents that investors have to sign. It just gives them a secure place to sign documents and watch their investment grow, but just I look forward to just improving and automating some of this every time we do it.

[00:22:40] SR: Yeah, I agree. As we’re growing, we’re finding more and more that systems or how we’re going to facilitate that growth. We need to make sure that we’re doing every little detail correctly the first time. I mean, systems are the best way to do that. I was excited to see the growth in that aspect of our business as we went through Stratus and really excited to put what we learned into action on the next transaction.

[00:23:02] WS: All right, Sam. Great show. I appreciate you elaborating on Stratus. I know a lot of people ask about deals that we’re doing, and so I’m just grateful to be able to put out what we’re up to as well on the show and have you elaborate on that. Tell the listeners how you like to give back.

[00:23:16] SR: Yeah. We’re very involved in our local church, and that’s a great way for us to honor the Lord and what He’s given us, and so we’re very involved there and then, yeah, our family also. We’ve got a bunch of young daughters and trying to raise them well. I think that often that may seem selfish but I think the best thing we can do is pass on our values and what we’ve been taught to the next generation, and so my wife and I take that very, very seriously.

[00:23:43] WS: How can listeners get in touch with you and learn more about you?

[00:23:46] SR: You can reach out to me at [email protected] or go to lifebridgecapital.com. All my contact information is there. I’m active on LinkedIn or BiggerPockets as well, so you can hit me up a variety of different avenues.

[00:24:00] WS: Awesome. That’s a wrap. Thank you, man.

[00:24:02] SR: Yeah. That was fun.

[END OF INTERVIEW]

[00:24:04] WS: Don’t go yet. Thank you for listening to today’s episode. I would love it if you would go to iTunes right now and leave a rating and written review. I want to hear your feedback. It makes a big difference in getting the podcast out there. You can also go to the Real Estate Syndication Show on Facebook, so you can connect with me and we can also receive feedback and your questions there that you want me to answer on the show. Subscribe too, so you can get the latest episodes. Lastly, I want to keep you updated. So, head over to lifebridgecapital.com and sign up for the newsletter. If you’re interested in partnering with me, sign up on the contact us page, so you can talk to me directly. Have a blessed day, and I will talk to you tomorrow.

[OUTRO]

[00:24:44] ANNOUNCER: Thank you for listening to The Real Estate Syndication Show, brought to you by Life Bridge Capital. Life Bridge Capital works with investors nationwide to invest in real estate while also donating 50% of its profits to assist parents who are committing to adoption. Life Bridge Capital, making a difference one investor and one child at a time. Connect online at www.LifeBridgeCapital.com for free material and videos to further your success.

[END]