Could Build-to-Rent Investing Deliver a Deathblow to Multifamily?

Dave:
Hey, everyone. Welcome to On the Market. I’m your host, Dave Meyer. And I am joined today by James Dainard. James, what’s going on, man?

James:
Just grinding out deals, Pacific Northwest, trying to get more inventory in the door.

Dave:
How’s that going? You pretty active right now?

James:
Yeah, we are staying fairly active right now. What we’ve been doing is fixing all of our systems, pivoting all our systems. And we’re wrapping up all the inventory we’ve bought over the last year. And then we’ve been aggressively … actually, we’ve gotten contracted over on $16 million in deals the last four weeks. I just closed on two fix-and-flips. And they’re all sizes: fix-and-flips, small guys. One big one, I paid 400 for, one, 1.5 for. I just got a duplex for 1.1. And then we locked in a pretty big deal for little above 10 mil, so moving things along.

Dave:
That’s awesome, man. Well, keep it up. That’s great to hear. Today for the show, we have Ben Miller, who is the CEO of Fundrise. And full disclosure, Fundrise is a financial sponsor of this show. But Ben is an incredible wealth of knowledge. It was so fun having him on. I feel like you guys have a lot in common. You’re both deal junkies and just love talking shop about individual real estate deals and strategies. What’d you take away from the interview that you think the audience should listen for?

James:
He definitely is a deal guy, which is always good to invest in a deal guy, because when I said I stayed at the office till midnight, his eyes perked up. He’s like, “Yes, I get you.”

Dave:
He’s going to make you a job offer after this interview.

James:
Hopefully not. I don’t know if I can take on anymore. But it was just nice talking, because as small investors, we go toe-to-toe with some of these big guys. And just to see where their strategy is and how they’ve pivoted out and are doing things, I was really excited to hear about their efficiencies and how, basically, they make the return by being efficient. And that’s the kind of product they’re looking for. They’re not just looking for the best deal, what fits inside the box. And that’s so key in today’s market right now. As the market flattens out, you have to be really good at what you’re going to do to hit your return. And that’s the same with these big guys. The small guys are no bigger than the big guys. They’re doing the exact same thing. How can they be efficient? How can they deploy the money and deploy it in the right area?

Dave:
Yeah, absolutely. And Ben, in addition to talking about these efficiencies, gives some really good advice about what markets he’s investing in, a whole new asset class in buy-to-rent. We had a really good conversation about that, that I was super interested in. And just shares his thoughts on where the market’s going over the next couple of years. So definitely stick around for this interview with Ben. And we’re going to invite him on in just a minute, but first, we’re going to take a short break.
Ben Miller, CEO of Fundrise, welcome to On the Market.

Ben:
Thanks for having me.

Dave:
Thanks for being here. We’re super excited to have you. Before we get into some of the market conditions and what’s going on in your business, would love to just hear a little bit about your background and how you got started in real estate investing.

Ben:
All right. Well, so I’ve been in this business about 23 years. I started out in real estate, private equity, and then moved to the real estate development sponsorship side. So worked for a large mixed use development company in DC. We were building about half a billion of real estate right when 2008 financial crisis hit. And so I have scars and burn wounds from that experience. And after that, I came out of it thinking, “Well, there’s got to be a better way,” and conceived of the idea of raising capital through the internet for real estate. And we essentially invented that concept in 2012. And Fundrise was birthed with the idea of basically creating a future of real estate where individuals can invest in real estate the same way institutions or high net worth investors can. Before Fundrise, large real estate was only available to large investors.

Dave:
So yeah, you have experience, obviously, on the large institutional side of things. And I’m curious, what sort of advantages do institutional investors like private equity or these developers that you’re working with have that retail investors like myself don’t have?

Ben:
I think there’s two. I mean, one is just the type of products you can buy. So if you thought that skyscrapers were great investment, only institutional investors can do that. So there’s certain types of asset classes, like data centers, that basically are only institutional investors. And the separate is just the type of financing you can get, the type of operations. There’s a lot of economies of scale. So from an operations point of view, let’s say we own 20,000 apartment and residential units. That’s very different than owning three.

James:
So Ben, when I was looking at your guys’ fees and structure, because you guys are large and you’re deploying out so much and buying, is that how you guys can control your fees so much throughout, is because you’re just doing the bigger skyscraper deals, the larger deployed capital? Is that how you guys are so competitive in what you charge?

Ben:
I think it’s a combination of things. We definitely operate at scale. And that’s something that we are now. In the beginning, we had to grow into that. And in the beginning, we basically were just subsidized by our investors. So we had lower fees and we were losing money in order to basically get to scale. So our fees are super low, much lower than other institutional. If you were comparing us to Blackstone or Starwood, their fees are five, 10 times higher.

James:
Is that your typical competitor on a deal, like Blackstone or one of the bigger, bigger institutions?

Ben:
Yeah. On the buy side, when we’re buying apartment buildings, we saw Carlisle a lot. Yeah, those types of institutions were … not so much Blackstone. Blackstone buys platforms, but so other private equity funds.

Dave:
For those in our audience who aren’t really familiar with the traditional real estate private equity business model, like Blackstone or some of the people you used to work for, can you just explain how they make money, what their objective is, just in a general sense how this sort of market of raising money for private investors to buy large scale real estate works?

Ben:
Yeah. I love that question. So I put a lot of thought into that because to understand how to disrupt an industry, you got to understand how it works. So there’s really a lot of value chain in the industry. So you start with large pools of money, typically pension funds, so maybe California State Teachers, they run $20 billion … sorry, $200 billion. They have all these advisors, all this bureaucracy. They basically allocate money to private equity funds, or private equity funds raises money from those big pools. And then private equity funds turn around and invest it with real estate companies in local markets.
So there might be a local developer in Seattle who knows all about office or apartments in Seattle. And that private equity fund will back them in sort of a 90/10 deal, 90% from the private equity fund, 10% from the local sponsor. And so it’s really like the whole industry is made up of sort of three major players: the funds that allocate the money, the real estate operator who runs the deal, and then the actual large pools of capital, like the Norwegian sovereign wealth fund, for example, trillion dollars. They have to put that money to work. So it’s actually really a lot of it’s about getting those flows into real estate.

Dave:
And what are the sort of benefits that either an individual investor like myself or James, or someone as large as the Norwegian sovereign wealth fund, why would they choose to allocate funds into real estate private equity when they have every option in the world for where to invest their capital?

Ben:
Yeah. Well, I mean, okay, so these large institutions will allocate their money everywhere. So they typically diversify across every single asset class. And so, real estate typically gets about 10% of all their assets. And so, it’s really about diversification. So that’s how these big institutions think first. First, diversification. And then once they get diversification, they go inside of a subsector, like real estate, or maybe it’s venture capital, and say, “Okay, I’m going to allocate X percentage to this sort of asset class. And inside that asset class, I’m going to find experts who are best at investing in real estate or infrastructure or green power,” whatever the asset might be.
And so it’s a very special problem having to invest a $100 billion. It’s hard for most people to imagine, how is that a problem, right? It doesn’t like a problem. But when you get into it, typically, private equity is achieving pretty good returns. It’s usually beating the stock market, for the last 30, 40 years. And so, that’s why they invest in it, right, because it’s been historically better outcomes than public stocks.

James:
So on BiggerPockets, there’s a lot of active and passive approaches to how people want to invest in real estate. And obviously, on BiggerPockets, there’s a lot of new investors or people like me that we’re trying to grow our portfolios. And we’re very active. It requires a ton of work on our side. I know I was at my office till midnight the last three nights, just getting my hands dirty, getting things done.

Ben:
My kind of guy.

James:
Yeah. I will put in the hours, but it does have some wear, right? And a lot of investors are more passive where they don’t want to stay at the office till midnight worrying about their construction budget or crunching numbers and getting that next deal done. Is your typical client mix more of a passive larger fund, or these bigger institution, or do you have a lot of smaller investors too, that just are … For me, after a certain amount of years, I will be sick of keeping my hands on everything. And I just want to put the money out, right? But we’re just trying to build that huge [inaudible 00:11:08]-

Dave:
No, you won’t, James. You’re addicted. You know you’re addicted.

James:
Probably not. I am a true deal junkie [inaudible 00:11:15].

Dave:
You keep telling yourself that.

James:
That’s the theory, right, the whole financial freedom I’m chasing. Who’s your typical client that goes … is it larger funds, or is it smaller investors also looking for that passive income?

Ben:
Yeah, so we have 350,000 active investors. So we have a huge number of people. And so, that basically it’s hard to describe any one persona. There’s all different kinds of people. There’s a lot of software engineers who want to invest in real estate. There are a lot of financial professionals. I go in to meet investment banks. I was meeting with some investment bank before COVID. I was sitting in the room. And it was their investment banking group. It had the real estate group and it had their tech group. And the older 60-year-old managing partner was trying to ask me about Fundrise. And I was like, “Well, who in this room are investors in Fundrise?” Everybody under the age of 40 raised their hand, so half the room was actually my investor.
So it’s a lot of different kinds of people, but I find the thing about real estate, there are new real estate investors who are interested in learning. They want to get their feet wet. Maybe they want to take a small amount of capital risk. So maybe they’ll invest a thousand. They don’t want to go put $50,000 into one deal. But you know who loves to invest in real estate? Real estate people. So you have all these big real estate people who also like to say, “Well, I have my real estate where I’m active, but I have also other real estate I invest in. Sometimes I invested in Fundrise. Sometimes I help other people in the industry that are rising stars.” So it’s so diverse. And that’s one of the interesting challenges, because we have this range of people who want tons of information and are really sophisticated, and people who don’t know what a cap rate is.

Dave:
That’s a really good point. We talk about on the show a lot about diversification. And I think a lot of people assume that means diversification between different asset classes, like stock market bonds. But I at least, I think James is a living example of diversification between real estate assets, right, like being able to buy single families and short term rentals. And so it sounds like a good portion of the people who are investing in these passive deals might also have an active portfolio and are just trying to balance how they’re spending not just their capital, but their time, right? Because probably people don’t have unlimited time to go acquire deals at the rate James does.

Ben:
Yeah. It’s actually the easiest people for me to talk to is a real estate person. And they get comfortable with investing in things they know. So a real estate person can underwrite real estate, like, “Oh, I get this.” But if I were to bring you machine learning, “Do you want to invest in machine learning?”
They’re like, “I don’t know. I’d have no idea how to make that decision.” So a lot of times people invest in things they understand. And so, a real estate person would start with us and say, “Oh, hey. Actually, you guys really have a deep specification here. I’m interested.” And they might want to invest in a geography they’re not active in, or a product type; as you said, they’re an office guy and they want to go invest in residential.

Dave:
I invest passively, I mean, primarily at this point. And one of the things I like most about it is being able to get into geographies that I’m not in currently. What markets are you heavily invested in? Geographically, are flooding the Sunbelt, just like a lot of people are on this show, or-

Ben:
Like everybody else?

Dave:
Yeah, exactly. You don’t have to give away your trade secrets, but are there any geographies you’re particularly interested in?

Ben:
Yeah, it’s funny. So Fundrise has been around since, as I said, after the financial crisis. And we were all in on urban infill in 2012 and ’13, ’14. Anybody who was in real estate knows that the emerging neighborhood was where everybody was investing. And then 2016, we pivoted and started really investing in the Sunbelt and selling all this stuff in Brooklyn and DC, and so we went heavy Sunbelt. Our 20,000 residential units are all Sunbelt.
And so now, I still think Sunbelt’s where it’s at. It’s just I think it’s all about build-for-rent rather than multifamily. I mean, I think both are good. But yeah, I still think Sunbelt’s got the runway. I still think that an Austin or a Nashville will just keep on building. The only place I’m interested now is new. And really, Columbus is interesting. I think Columbus could be … I mean, not interesting to go to [inaudible 00:16:15] not. I work with somebody from Columbus, so I always like to tool on Columbus. But yeah, I think Columbus has got a huge amount of growth coming that’s really going to be interesting, because of the Intel chip plant they’re going to build there.

Dave:
Oh, okay. I’ve been to Columbus once. It was pretty fun. I had a good time.

James:
Hey, Ben, how often do you guys analyze that strategy and look at pivoting? Because I mean, at some point you made a pivot in 2016. Do you guys audit that once a year for your strategy, or how far down the road are you forecasting when you’re looking at making that … That’s a big change, right, going from what … that’s a totally different type of market, emerging cities to Sunbelt. How often do you guys do that in forecast?

Ben:
Yeah. I mean, back then we did it because we were investing across the country, but mostly in urban infill. And we were learning from doing deals. One of the things you do is if you invest in a deal, let’s say in a new market, you learn a lot. And if it’s going well, then you can actually double down. And so, we were invested in a few emerging markets, which at the time … I remember actually I had a person who used to work for me. And they were like, “You got to sell everything in Florida, because the next recession, Florida’s going to get killed, and New York’s going to basically do great,” because that’s what happened in every other financial … Every other financial crisis, going ’08, 2001, the sort of Sunbelt got killed. And this was totally upside down of how it normally happens.
So if you like an intuitive answer and an analytical answer, analytically, we have a hundred software engineers. So we’ve been building software into our system so we actually start getting real time data from all of our properties and also, I don’t know, like 14 million other properties, some huge number. So we can really see what’s happening on the ground and have a good sense of where growth is, and essentially where rent growth is, and occupancy delinquencies. So, that’s a huge part of it.
And the other part of it’s what I call is top down. It’s really easy to see that when something’s getting really expensive … like if you’re in New York and there was a two and a half cap back in 2017, people assumed rent growth had to go to like $8 a square foot. They just don’t believe that, right? So at some point, the Sunbelt will get too expensive relative to the gateway cities, to the New Yorker and LA. And that’s when it’s over. That’s when it’s topped. And so it’s really a question of, you do bottom up analysis in the weeds, and you do top down analysis, looking at the big picture. You have to do both.

Dave:
And how do you make decisions about that? Do you have an investment committee? I guess I’ll say I hope you’re not just making algorithmic decisions like Zillow was doing, and failing out for a while.

Ben:
Yeah, yeah. Right, right. So Fundrise is 325 people, and so we have a lot of real estate people. And we’re in a lot of markets. So it’s driven by the people first. The software just makes it easier to see the information. But the idea that software is going to replace people in investment decisions, I think that’s a big mistake. That’s not where our software will make improvements. Our software can make improvements on the operations. It’s really the operations where the software can improve, basically all the work that’s done after you buy it. But whether or not you buy it is a human decision.

James:
So you use the software to increase the return, but not analyze the return?

Ben:
Yeah, and manage it. I mean, we actually intend to roll the software out to third parties, probably in about a year, because there’s actually nothing really like it out there. But we built it for ourselves. And we know it’s good. We know it works. And so, we’ll make it available more people, but it’s like, this is going to take time. We just don’t have the bandwidth.

Dave:
You said something earlier, Ben, about build-to-rent and liking it better than multifamily. We just did a show with the national … God, I’m going to butcher this. It was Multifamily Housing Council. And they were talking about just huge demand for multifamily units. And that, I think, bodes well for the future multifamily. But I’m curious if you have a different take. What do you like about build-for-rent as an asset class, going into the future?

Ben:
So we got into that build-for-rent around 2019. We’ve been trying to get into single-family housing since 2017. We couldn’t find a way to do it at scale where it was efficient. And the reason we went into it was we saw our office is made up of mostly millennials. And the millennials are turning 30, having kids, leaving cities. They need more space, and a house. They want a house. And the second thing that happened that we didn’t expect was work from home. And work from home, I think, is the biggest social revolution happening. If you go back a hundred years, people used to work on farms. They moved to cities to work in factories and office buildings. Now, they’re leaving cities and they’re leaving office buildings. It’s that big a social change. And so work from home, I think, is going to drive residential value. It’s going to take a trillion dollars out of office and put it into residential value.
And so if you’re going to work from home and you have kids, are you going to do it from a one-bedroom apartment downtown, or are you going to do it from a house? So I think the house is a better consumer product. It has a backyard. It has light. It’s actually cheaper per square foot. And you’re willing to basically commute, because you don’t have to commute as often anymore, because you’re working from home. So basically, it’s like an iPhone is a better product than Blackberry. The home is a better product than the apartment.
And so we said we wanted to invest in that, but we didn’t want to go buy single-family homes, because basically that would put us in competition with our customer. Our customer wants to buy a home, and they don’t want to compete with a billion dollar institution to buy it. So we said, “Okay, well we can’t compete with our customer. Well, let’s build it.” And if we build it from scratch, we can build it designed to be this new thing. So it’s like an apartment building laid down on its side. It’s got amenities like a swimming pool and a clubhouse, and all the things you would have in a really cool apartment building, but instead in a hundred-unit community where you have a dog park, running trails, all these cool neighborhood features. And we run everything. You don’t have to deal with lawn care. You don’t have to deal with maintenance. So it’s like a really cool product. And I think it’s just going to become a big part of the industry.

James:
Did the build-for-rent have anything to do with implementing the plan, too, and efficiencies? Because we build 50 homes a year in Seattle. We renovate about a hundred homes a year. And I can say renovating is substantially less systematic than building. Building, you go through the plans, permit, you’re hiring professionals. It’s managed all the way through. And you can actually control it a little better. Whereas remodel, every house is so different. Does it have anything to do with that and keeping your deferred maintenance down? Because I know on our new build apartment buildings or rentals, we have way less deferred maintenance and way less issues, because the remodel, there’s always those trades that do things a little bit different, a little bit wrong. And then you have to come back and fix those things. Does that have any impact in making that decision, remodel versus … or was it all about who your consumer was and what they were trying to do?

Ben:
Yeah. Yeah, totally. So you know more than most people about this. So we started out in the remodel. We bought about 50 homes in LA. And it was a nightmare. Every home was different. The permitting was just horrible. We constantly had squatters breaking in. It just didn’t scale it. We couldn’t pull it off. And we were like, “Okay, well, we still think this is a huge macro trend.” And so we went to home builders. We actually also bought land and said, “Oh, this is zoned for 400 suburban apartments. Let’s build 200 single-family homes instead.” And so we went to a home builder and said, “Hey, we want to build 200 single-family homes here.”
And they’re like, “Oh, interesting. You want to buy homes? We build a lot of homes.” And we found that the home builders can build homes for way cheaper, because they build 10,000 homes a year. So they can build homes way cheaper than even if I sat down with a development company and did it. We might build for $200 a square foot, and they’ll build for 150 a square foot. So we partner with home builders. And those home builders basically build us. We’ve built like 5,000 homes so far. And we’ve really built a lot, and we intend to build more. And so the home builder at scale can deliver basically a bespoke product that’s designed for long-term ownership rather than, as you said, the renovations, which are mostly like, make the renovation and sell the house before the deferred maintenance comes home to roost.

Dave:
The type of development you’re describing sort of reminds me of some of these planned communities that honestly I’m more used to seeing older people, retirees live in. Are you appealing to the work from home demographic and younger families? You were talking about the impetus for this being millennials buying homes. Is that who you’re building the product for?

Ben:
Well, that’s who we thought we were building it for. It turns out it’s like everybody. It’s so diverse. Here, here’s one interesting stat. A typical apartment building, 25% to 30% of people have a dog. And in build-for-rent, 70% of people have a dog.

Dave:
Whoa.

Ben:
Right? Because you have a backyard, right?

Dave:
Yeah.

Ben:
So guess what? People who have dogs want to live in a house rather than apartment. So there’s all sorts of drivers for why you want to live in a home with a backyard and more light. So when we compete on apartments.com for renters, you’re selling basically a different experience. And I think for a lot of people, they didn’t even really know that was available, the idea of renting a home that’s not from some random mom-and-pop who’s not going to have that good of a property management capability. So it’s a new asset class.
Real estate, if you go back 20 years or longer, as long as I’ve seen, right, real estate actually births new asset classes every decade. So 20 years ago, there were zero data centers. Now, data centers are a huge part of the business. 20 years ago, cold storage wasn’t a thing, self-storage wasn’t a thing, cell tower rates weren’t a thing. Single-family rental as an asset class got birthed by Blackstone, with Invitation Homes. So these new trends show up, and the old trends like retail and office die. So it’s a key part of real estate, is being part of the new trends.

Dave:
That’s very interesting. James, I’m curious, would you ever build for rent at your scale, or does this only work at scale, like Ben is talking about?

James:
I think it works more for large short plats, because the larger the plat, the cheaper it gets. It’s like when you build a home, if you build a 4,000 square foot home versus a 2,000 square foot home, your price per square foot’s going to be a lot cheaper on the large, because your core areas are still the same. But when you have these big plats, they can really cut the cost down. So we build infill. Our largest sites’s probably 12 units, 12 town homes. We do all town homes, mostly four to 12 unit sites, because that’s what you get in infill. Our build cost around Seattle’s about 275 a foot, from development to finish. And it’s getting you a higher end product, too. But if we look at our tract home, like my clients that are tract homes that are buying more like hundred plat sites, they’re building in the low 200s.
And so it makes a huge difference in your bottom line when you can get scalability. Plus, you get the efficiencies out of the renting, the property management, the maintenance. Everything’s in one central location. And so yeah, the larger the plat, the cheaper it’s going to be.
And the other good thing about the building to rent on these large plats is the typical timeline for purchasing these is to close on permit. When you’re negotiating a lot of these deals, you get a close with the permits, and it could be a year or two down the road. But you can get building day one, whereas in infill, on the smaller stuff, it’s such a hot market that sometimes we have to close half the time that we would need for the permits. And so, you can systemize out the bigger plats just substantially better. But the downside is you’ve got to have Fundrise money. You can’t go buy it. I’m not going to go buy a 100 unit plat, because I’m going to be putting everything into one pot. And so yeah, the bigger the money, the bigger the scale.

Ben:
Yeah, that’s exactly what we found, because we have a mentality we hate to outsource anything. We always do try to do things ourselves. And we started out trying to build these things with our own capabilities, and the home builders just crushing our execution. So they’re building $150 a square foot. We couldn’t build for less than 200 a square foot. And they’re building for 150. I mean, we’re literally buying homes right now in Austin, above Pflugerville, for 130 a square foot. They just have such scale. And they buy like 10,000 countertops. They just have such control over their supply chain.
Now that I understand that business, it’s really a factory. It looks like a real estate company, but it’s actually a factory. And everything is about how something moves through the factory floor. The plumber is coming exactly on time. If you’ve done renovations at home, like one project, there’ll be this massive downtime between when the electrician is supposed to come and when the guy’s supposed to close it up with drywall. And then people won’t come, and it’ll be delayed. You can’t actually close up the wall because the electrician hasn’t shown up. And so, it’s all about coordinating the trades. And you can do that with a home builder in a way that you just can’t do that as … Even a hundred homes, it’s not scale.

James:
Yeah. It’s like the whole premise of the Toyota manufacturing plan, where they build the cars that are constantly moving; or Boeing, same thing, where you get so much more … Because your labor guys go, “Here’s my house. I got to walk next door. Here’s my next house.” Whereas with remodels, you got to drive an hour down the road, and you don’t know exactly when it’s happening.

Ben:
Right, right. So a lot of times people ask me about cap raises and stuff. And we buy on basis. If we can get a C of O for $150 a square foot in Tampa, I’m feeling pretty good about that. And exactly what cap rate it’ll end up leasing up to is … cap rates come and go. I mean, when I started in the industry, you’d be like, “Okay, we build to a 12?”
And I was like, “What? A 12?” Now, people are building to a five, maybe four, maybe a six. So cap rates will come and go, but your basis is forever.

Dave:
So I mean, just for people listening to this, it sounds like there’s not really a good way for a retail investor to go out and get into this asset class of buy-to-rent, with the exception of Fundrise, I guess, they could get in it. Or are there other ways that people can hop on the build-to-rent bandwagon?

Ben:
I mean, it’s really new. It’s a new space. I mean, seriously, there are probably 50,000 units across the country. I think there’s like 50 million apartments. I mean, this is really new. I mean, I’m talking institutions, because they want to do it too, they can come in and co-invest with our customer. I love the idea of a multibillion dollar institution investing next to a $10 investor. That doesn’t happen in normal life. But the platform we built basically is a platform that they want.

James:
And what kind of investor … for the smaller investors, they have to be accredited to invest in your-

Ben:
No.

James:
No?

Ben:
No, no. Anybody can invest, yeah.

Dave:
Oh, cool. So how does that work? Because normally on a syndication, you have to be accredited. There’s a minimum of, I don’t know, usually 50 or 100 grand. How do you get around that?

Ben:
By going through it. So our vehicles are publicly registered. So we actually go to the SEC say, “We’re going to have a strategy to invest in build-for-rent. And we’re going to basically allow the public to invest in it.” They work us over, to no end. And then we get it cleared. And so that’s why anybody can invest in it.

Dave:
Oh, so basically the reason you have to be accredited for a syndication normally, correct me if I’m wrong, Ben, is because they’re unregistered securities, right?

Ben:
Right.

Dave:
It is not vetted by any government entity, like stocks, for example, which are regulated by the SEC. And so you’re saying you register your investments with … is it the SEC, or is it a different-

Ben:
Yes, the SEC. Yeah.

Dave:
It is the SEC. Wow. Are you the only people who do that?

Ben:
I mean, it’s-

Dave:
You don’t have to tell me your trade secrets.

Ben:
No. I mean, I don’t want to say categorically there aren’t people who doing it. But I mean, yeah, the idea of going direct to consumer, registering the funds … I mean, again, that’s a scale thing, right? You’re not going to do it for a 50-person syndication, but with 350,000 investors, the cost to do it is significant, right? I mean, we have 50 accountants in house. We have five in-house attorneys. There’s a lot of grind on it. But across enough people, the marginal cost is almost nothing.

James:
Yeah, because they look under your hood a lot more at that point, right, the SEC [inaudible 00:35:46] the big difference is-

Dave:
You’re feeling violated, Ben?

Ben:
Yeah.

James:
But that’s why so many people set up these syndications with unregistered securities, because I mean to Ben’s credit, that’s a lot of work. And if it’s not worth the headache if you’re doing a 50-unit apartment building, because the cost and the audits and the qualifying is pretty good. But that means that your investor can feel pretty good about putting money with you though, because I mean, it’s getting an extra pair of eyes in audit, compared to a lot of other syndicating platforms.

Ben:
Yeah, yeah. I mean, we’ve been doing it for a while. And our CFO, my CFO was chief accountant at the SEC. So we have expertise. After a while, you know what you’re doing. And just like anything, I’m sure with real estate when you first started … You talked about doing an 80-unit apartment building before we started this show. When you started, you were like, “How would I do that? I wouldn’t know how to do that.” But once you know how to do it, it’s not that complicated. It’s just knowledge. And so, working with regulators, understanding what they care about, giving them what they need. Once you understand it, it’s not rocket science.

Dave:
I can’t imagine what the SEC would do if they looked at my personal real estate investing and the way I’ve kept my books over the last 12 years. I’d probably be in jail. Not that I’m doing anything illegal. I’m just a little disorganized, okay?

James:
We’re going to have to edit this part out. Hey, Ben, have you guys had any problems with inflation and supply chain issues in this build-to-rent? Because obviously that’s been tough for us as builders, controlling our cost. Actually, randomly, it’s been easier for us to control our costs more as a builder than a remodeler. The remodeler has been tougher, because I think the labor market’s less experienced, and so they charge more. But what’s inflation been doing to your returns if the build cost goes up, or how do you mitigate that, or how do you deal with inflation?

Ben:
Yeah. There’s a lot of complexity in what you’re asking, so let me just pick a few things because, yeah, it had a huge effect on everything. I mean, everything was going crazy last year, especially. So I’ll just give you … so the reason we broke through with build-for-rent is we went to these home builders in 2019. And we were talking to them and they were maybe interested, but mostly they weren’t interested. Then March, 2020 happened. If you remember March, 2020, when the stock market collapsed 40% and people were locked down, guess what people were not doing in March, 2020? Buying homes.

James:
Except for me. I was buying.

Ben:
Most people were not. So the home builders had all these homes. And all of a sudden, the industry just stopped on a dime. And they turned around to us and said, “Do you want to buy these homes?”
And we said, “Yes.” So we went under contract for half a billion dollars of homes that summer.

James:
That was a good month.

Ben:
Yes, because then they had to deliver them. We’d go under contract, and they’d deliver … You know home builders, we go under contract, and they deliver them over the next … It took them like 18 months to deliver all those homes. And so yeah, our contract price was like scorchy. And they would come back and they would be like, “I know we’re under contract, but every single cost is going up. Can we talk about this?” So we had a lot of complexity there.
And then they’d deliver … we’re talking about delivering 100 homes a week. We were buying a lot of homes. And they’d deliver them without refrigerators, without a kitchen. We’d go in for the inspection and it’d be missing a kitchen. They would just not be able to get certain things, like in Texas, we couldn’t get door hinges. They would deliver the home and be like, “We put these hinges on,” but you knew the hinges, the hinges opened out. And so you can’t have the hinges open out because then somebody can walk up and just unscrew the hinges and take the door off the house. So there was just all these little things that they had these problems around. We had a person driving around buying refrigerators at Costco so we could actually rent the houses, because we had these houses without refrigerators. So yeah, there was all sorts of chaos happening.

James:
When they say timing is everything, that’s the best time. So you bought it cheap. So the build costs were locked in too, when you committed to that?

Ben:
Yeah. There-

James:
Oh, that hurts.

Ben:
Yeah, yeah. There was one deal we were under contract with, and the builder had a $5 million liquidation. To break the contract with us, they had to pay us $5 million. And they literally just broke the contract: “We’re just breaking this contract. We can’t”-

Dave:
Whoa. It was that bad? Oh, my God.

Ben:
It was that bad. It was in Austin. And the price of the homes had inflated so much, they’re just like, “We’re just walking away from this contract. Forget about it.”

Dave:
Wow. That’s insane. Are you starting to see that level off now? Are things getting better in terms of supply?

Ben:
Oh, yeah. Well, supply chain’s still a little messed up, but the home building industry’s now flipped again, and sales are falling. And I’m like, “Oh, I’ve seen this movie before.” But this time, like last time, there was nobody doing this. Now there’s more money now chasing build-for-rent. So we’re not the only sort of buyer in the space. But yeah, as you know, the market is shifting a lot right now. There’s a lot changing.

Dave:
I know you don’t have a crystal ball, but where do you see things going over the next year or so?

Ben:
Yeah. I mean, in some ways, the next year’s easier than the following. We’ve been saying since January that interest rates are going to be higher for longer. And Powell last week at the Jackson Hole meeting said 4% Fed funds rate for all of 2023. So that means basically you’re going to be borrowing at 6% or more, where you used to borrow at 3%, or at least that’s where we were borrowing.
So I think the industry’s going to grind to a halt. I think most things don’t pencil at more than 4% interest rates, I mean, base interest rates, like the Fed funds rates. And our expectation is the surprise is going to be that inflation doesn’t come down as much as people expect, interest rates stay higher for longer. And it’s almost like people are like, “Well, how can that happen? That’s so bad.” And it’s like, “Because it doesn’t care how you feel about it.”

Dave:
Sorry, but that’s the truth.

James:
Well, and it’s also history repeats itself. That happened in the ’70s, right? It just stuck, and then they had to get it worked through the economy, and on to the next thing.

Ben:
Yeah. I mean, I don’t know what you’re seeing, but we have 300 people, wages. It’s super competitive for labor; food, everything. =I’m not seeing inflation come down in any meaningful way. So why do I think it’s going to all of a sudden just shift? It just doesn’t seem likely to me. So the thing we did, we really slowed down investing back in January, and we started building up cash. So we have like $700 million of dry powder right now. So we were ready and fairly ready for the shift. And then the shift’s going to be you need to go and to invest in credit. That’s another learning, because I’ve been in this for a while. In a financial crisis, all the action happens in the liquid credit markets. Like in 2020 or 2008, you couldn’t really buy properties, but you could buy the paper. And so the paper is where the pricing shifts a lot faster, and you can get way more distress. But that’s a whole different part of the real estate industry that most people don’t see, CMBS, RMBS, asset-backed securities, that kind of stuff.

James:
Oh yeah, because they’ll dump that paper cheap. I remember one of the best deals I ever did in 2009, I didn’t even know how good of a deal it was when we did it, someone came to us … they had a 10-unit in foreclosure, and it was a private lender. And they’re like, “Hey, we want out of this.” They sold it to us for 50 cents on the dollar. And then we were running it like, “Oh, okay, cool. We’re going to be able buy this. We’ll foreclose it. No one wants it.” And it ended up getting bid up.
We bought it a week before the auction. We bought the paper. We took it down to the auction steps. We foreclosed it. And then it got bid up. They were stepping it against us, because we wanted to keep the building. We had no intentions of selling it. And we made like a 300% return on our investment in 10 days, because someone really wanted it. And we had no intentions of selling it, but we’re like, “That was the easiest.” We didn’t have to touch it. We didn’t have to do anything. The guy gave it away. We got it escrowed, and it was just a win all the way around. It’s amazing what that can do.

Ben:
Yeah. So we’re all in the real estate business, but there’s this shadow real estate industry that you don’t know about, where all of the things you do where you borrow money, you buy an apartment building, you buy a house, eventually, most of that asset’s actually financed. And then there’s this whole parallel real estate world of credit markets where people are buying your paper and levering it up too, right? So actually, when you buy a house, you buy an apartment building, you’re borrowing maybe 75%. And somebody behind the scenes has bought that paper and levered it up 10 times as well. And then somebody bought their paper and levered it up 10 times more. And so, the shadow industry of trillions of real estate, just the debt, it’s become much more attractive than the equity.

Dave:
That’s super interesting. Yeah. I actually was just looking last week at investing into a note fund. It seems like a really good place to be investing right now. Ben, I know we only have you for a couple more minutes, so maybe we’ll have to bring you back to talk about note investing and [inaudible 00:46:04] the credit markets. That would be super interesting. But before we go, can you just tell our audience about where … obviously they can find you on fundrise.com, but if anyone wants to connect with you, what’s the best place that they can do that?

Ben:
Well, I am active on Twitter, so my Twitter handle is @BenMillerRise, like Rise, @BenMillerRise dot … So you can hit me out there, LinkedIn, contact at fundrise.com. Anytime anybody emails me at the main email address, I always get it. So I’m always interested in hearing people. You learn a lot. Our actual investor base is constantly communicating with us. And we’re always learning about really interesting things. We basically have people everywhere at this point. And they’re really generous with sharing information. So I love to hear from people.

Dave:
Awesome. Great. Well, Ben, thank you so much for being here. This was a lot of fun, and learned a lot. And we’ll have to have you back on the show sometime soon.

Ben:
Great. Excellent.

James:
It was good meeting you, Ben.

Dave:
Well, that was a lot of fun. James, what did you think about the conversation with Ben?

James:
It made me realize how small I am as an investor still.

Dave:
Oh, dude, don’t even start.

James:
But you know what? I don’t get to talk to these big institutional guys that often. And the only time I really get to talk to them is when I get notified their offer’s way higher than mine. And so, it was nice to talk to them and figure out … but it’s very interesting how they are moving things around, looking at things. And it has the same core principles as us, be efficient, buy the right deal, don’t let your procedures maximize yourself out. So I mean, the core principles were the same. I think the money is different, is what I realized.

Dave:
Dude. You talking to Fundrise and feeling small is how I feel every time I talk to you. So now you know what it actually feels like. Yeah, man, I thought it was super interesting. I’m really just fascinated from an economic standpoint about build-to-rent. Like he was saying, it’s this whole new asset class that just never existed before. Previously, you either built multifamily to rent or you would reuse single-family homes that were previously owner-occupied into build-to-rent. And so, it’s a really interesting phenomenon. And you read a lot about it. But to his point, he said there’s only like 50,000 units. So it’s really not like taking over the market, but that’s something I’m definitely going to be watching for the next couple of years, to see if that makes an impact on the markets they’re doing it in.

James:
I think if we go into a little stall too, and dirt gets a lot cheaper … The reason they’re not doing build-to-rent is dirt’s expensive and build’s expensive. But both those are coming down right now. So maybe it hits a sweet spot and they start doing more and more of it.

Dave:
Yeah, that’ll be interesting. For everyone listening, before we record, usually the guests and us just talk for a couple minutes to get to know each other. And James was telling Ben and I about this 81-unit deal he just did. And Ben was completely amazed at what a good deal you got. Can you just tell us quickly about this deal and how you landed it, because I’m very curious?

James:
Yeah, so we’d been looking. We do small syndications, 30 to 40 units in Seattle. And then we’ve been trying to get into 50 to 100, because what he was talking about, the efficiencies of remodeling property management, it really does make a big difference in your bottom line. And recently what we’ve noticed is those deals are now … they were trading at like a three cap, three and a half cap, because of guys like Fundrise coming in and buying them all. And that has slowed down. And so actually, it was a seller that we gave an offer to at 11.8 million about six months ago, and he turned it down, turned it down, turned it down. He went to market, found his new exchange, got tied up twice at 11.8 … or no. He went all the way up to 12 million at the time. Financing blew up both times. And we just kept … well, actually, our 11.8 number dropped to 10.8, because of the rates and the cost of the deal.
And so we just stayed consistent with him the whole time for six months. And we kept updating our offer, too, saying, “Hey, based on rate, here’s our new number.” And we always had that logic of our number has changed only because of the rate with this guy, because he’s a bigger seller. And we ended up locking it in, though, 81 units. About 10.9 million. We have to put about 25 grand, 30 grand into each unit. We’re going to be doing a soft cosmetic with windows, hitting siding, hitting roofs, but nothing too, too crazy. Mechanicals are good. And we’re excited because we have some more opportunity now. But that’s the key right now, is just stay with your numbers. And if you have to change your numbers, just educate the people while you’re changing so they don’t think that you’re just trying to take one over on them. And it all came together. But obviously I was happy to see that it looked like I blew the return socks off him.

Dave:
Yeah. Ben asked James what cap rate he bought at. He said 5.8, which is just unheard of, especially in Seattle, right? You said a couple years ago it was three, 3.3, or something like that.

James:
Yeah, they were down in the low threes. Now, granted, the 5.8 is after stabilization. So after we’ve done the hard work, we’ll be at a 5.8 to six, right in there. So it wasn’t on existing.

Dave:
So that’s where you’re underwriting it at?

James:
Yeah. Stabilized, we’re at 5.8.

Dave:
But still, that’s pretty damn good.

James:
You know what? And I think we could do better.

Dave:
You’re insatiable. You got to do better.

James:
Got to do better.

Dave:
All right. Great. Well, great job today, James, as always. Always asking good questions and telling really very relevant and funny stories about your own experience. So thanks for joining us. Everyone out there, thanks for listening. And we’ll see you guys next time for On the Market.
On the Market is created by me, Dave Meyer, and Kailyn Bennett, produced by Kailyn Bennett, editing by Joel Ascarza and Onyx Media, copywriting by Nate Weintraub. And a very special thanks to the entire BiggerPockets team. The content on the show On the Market are opinions only. All listeners should independently verify data points, opinions and investment strategies.