Brian Adams, Excelsior Capital | Real Estate vs. Buyout: Private Equity Investor Perspectives
2023-05-09 00:35:06
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Welcome to the Karma School of Business podcast. In this episode, we have a fascinating conversation with one of the very best in the real estate private equity world. My friend Brian Adams, founder and president of Nashville-based Excelsior Capital. This episode is brought to you today by Blue Wave. I'm Sean Mooney, Blue Wave's founder and CEO. Blue Wave is the go-to expert of those with expertise.
Blue Wave connects proactive business builders, including more than 500 of the world's leading private equity firms, to the very best service providers for their critical variable, on-point and on-time business needs. Enjoy.
I'm very excited to have my friend Brian Adams on here today. Brian, thanks for joining us.
Yeah, man, thank you for having me. I think I'm the first real estate person, so hopefully I won't screw this up too badly.
You are for people listening. Brian is not only an incredibly excellent real estate investor, but he's also an incredibly excellent person. So if you hear some familiarity here in our voices, Brian is probably the first people I met after moving to Nashville to go on this crazy entrepreneurial journey. And I'd say also one of the most generous people, kind of inviting me in and introducing me to people. So I think if you have the privilege to know Brian, you'll know this.
If you haven't met him yet, you'll see why. I'm so excited to speak with him today.
I appreciate the opportunity to come on. Thank you, Sean.
Right, so, if we want to jump in here, maybe a good way to start off would be just to get to know you a little better. And I'd love it if you could share a little bit about your own journey. How you got into the real estate private equity world, what led you to getting into this industry, with all the choices you had in life?
Yeah, so I'm from upstate New York. Originally, I went to a very small private military school there, and then went to a small liberal arts college in Connecticut, and that's where I met my wife.
So she's from Nashville, we met in college, we did the Northeast thing for a little bit. We both went to grad school in Boston and like every Nashville woman, she wanted to move back home.
And once things got serious, it was non-negotiable. That we would kind of start a family and live within, like, five miles of where she grew up and et cetera, et cetera. So I moved to Nashville, and my wife's family has a family office that's based here, and my father-in-law. And our CIO had been involved in private equity across a pretty broad range of asset classes for 25 35 years, and real estate just. I had an affinity for it off the bat. And we had been co-GPs, we had been LPs in funds, we had been doing direct co-investments.
And so really got exposure to a lot of the investments we were making. We can get into kind of, like, why real estate, maybe, but that's how I initially got kind of into that world. And then I met my partner and we started our business 11 years ago now.
That's great, and real estate industry, I mean, it's a trillion dollar private equity industry, plus, and it's this massive industry. And as we go further in our conversation, I'd love to dig deeper. Because it's something I've always been fascinated about and know absolutely nothing about other than the homes I've purchased over time. And so I have a feeling there's a little more to it than the little bit that I know. But maybe before we jump into that, maybe dig deeper into you.
One of the questions I really like asking is, Brian, we'd know you better if we knew this about you. What's kind of an interesting, maybe, tidbit or trivia about yourself?
I never actually practiced commercial real estate law. I was actually a prosecutor in Davidson County and I worked in the vehicular crimes unit. So I was doing everything. From open containers, which is a CMS demeanor in the Great State of Tennessee, all the way to vehicular homicides, which can be an a felony. And so I cut my teeth out of law school being a vehicular crimes prosecutor, which was. I did a lot of DUI work, which is a very interesting way to learn about the city and to meet some colorful characters, for sure.
If you had stayed in that line of work, I imagine you would be 24-7 busy. Given a just the masses of people have moved here, b Nashville's a pretty boozy town, and then c the multitude of driving styles, given this melting pot that's occurred.
We don't need to go down this rabbit hole. But it's interesting if you think about DUIS. And driving. Offenses in general are one of the few criminal acts that are really applicable across socioeconomic spectrums. So even if you are affluent, everybody drinks and drives and everybody gets into wrecks. And so it really was a very interesting gig for a while, compared to doing just kind of homicide or something else.
That must have been a fascinating kind of first career for a whole host of reasons. I'm sure the stories that you could tell that we'll save for a beer after this. But then it seems like then you got pulled into real estate for all these great reasons. And maybe what I'd love, just given my little knowledge on this space. What are some of the reasons why investors like to invest in real estate? What are the advantages above and beyond?
You can put your money in public markets and private equity buyouts. Why is real estate private equity so highly sought after?
Yeah, I mean, despite what you said, it's a pretty basic, straightforward investing strategy. One of the things that people love about investing in real estate in America is. Over the last 200 years, it's pretty consistently gone up 2 to 3 year over year. There are some years where it's more less, but on average, it is a very methodical appreciation strategy over time. So if you have a long enough time horizon, there's really nothing that you can beat other than owning domestic real estate and holding it for a long period of time.
And that's been played out over and over again. We all know those stories about somebody who bought this corner property and held onto it for generations. And it then became kind of this cornerstone piece of a portfolio. So I think that's one aspect, and the other is, to your point, about owning homes. There's familiarity there. People have typically rented an apartment, owned a home, worked in an office building, frequented a retail location, stayed at a hotel. And so you kind of understand basically what the drivers are for that growth.
And I think there's just that appreciation for it. Whereas private equity can depend maybe on the industry or the focus, and that can be a little foreign or esoteric. Real estate is pretty broadly known as an asset class. And then the third thing I would say is I often tell investors the I.R.S tax code and bear with me. I got a C in basic federal income tax, so I've got a COO who's a CPA and they do all this.
But the tax code is a series of incentives and disincentives to encourage or discourage certain behavior. And if you look at the tax code as it stands today, it is encouraging you to get married, have children, own your own home, and to own commercial real estate. They're just massive tax incentives to try to get more and more people to own commercial real estate. And we could get into some of the particularities, but from a taxable investor standpoint, very few things better than owning commercial real estate today.
And why is it? Do you get to roll your basis into new properties or the things that you can do? That? Unlike maybe owning stocks and even companies where you're taking your tax hit after every sale. What makes the real estate industry special?
Yeah, I mean, there's the basis, there's the 1031 optionality to defer taxes, which is hugely powerful, right? And a lot of people take advantage of that. The biggest thing, especially under the Trump Tax Act, is the ability to depreciate that asset. So that bonus depreciation right off the bat, where you can push through that depreciation. Like me, as a sponsor, I can give my LPs within an SPV setup. I can give them the benefit of that depreciation to show on their K1 that they can offset gains elsewhere in their portfolio. So that ability to just take advantage of that massive depreciation, especially the bonus depreciation early on, is just hugely powerful for investors.
That is really unique as I think about my career in private equity. I only received income, I never received any kind of depreciation. So I ended up filing in a wide number of states every year and my tax guy loved it.
I love when I get an email from an investor once the K1s are uploaded to our investor portal in a timely fashion. Always we're never late. They email me and they say, Hey, there's something wrong with the K1.
I'm like, Oh God, so I get my COO and we look at it. He's like, I don't understand, I got 10 on my deal, but you're showing a loss. I'm like, Oh, no, no, this is a very good thing for you.
You don't need to call me, you should call your CPA. You should be very happy with this outcome.
That's phenomenal and stuff that I wasn't familiar with, so I'm glad I know that. Like everything, the Cobbler's kids often don't have shoes on.
So I'd be really curious as you think about it. Looking at opportunities from your lens as a private equity real estate investor, what are some of the things that you look for in a property? Some traits you say this has the makings of being a potentially good investment.
Yeah, and this is really a function of what you're solving for. Much like private equity, real estate comes in a lot of different flavors, right? You've got core core Plus, value add opportunistic development. And those risk profiles are going to have different return profiles that are correlated more or less with that strategy. We're value add core Plus investors.
So what I personally like to see is in-place cashflow, existing properties and the ability to. And I think we're going to get into this a little bit. But create value without having to take an outsized risk. So if I see in-place rents at $10 a square foot. Because the property is being currently managed and owned by an individual who's not a real estate professional. And we can go in there and we can push rent rates to just what market is, and if market is 13 14, $15 a square foot over the course of one or two years, as that rent roll turns over, if I can increase rents 50 without having to take on the risk of doing development or having to pay a lot of tenant improvement dollars or leasing commissions. And just bring it to market. And not have to be above and beyond in terms of really smart real estate people who are great asset managers, which we hope are those things, but they're hard to do right. So if I can create that kind of value by just doing what I think the market does. That's obviously a great outcome and something that we look forward to. Plus, being able to give people kind of day one cashflow, that's generally our strategy.
And maybe just a basic question, Brian, When you say core plus, what does that mean?
So that's the spectrum of risk and return. So, a core asset would be a fully occupied apartment building in a great suburb of Dallas, right? Excellent demographics, killer location, brand new construction. It has no risk associated with it if it was done properly, right? So that's a core asset.
Your yield is going to be commensurate with that core strategy. So you're looking at two to 3 returns on your money because there's not a lot of risk. That's like the most conservative real estate investments that you can do. And then it goes through the spectrum, it gets riskier as you go through core plus, value add, opportunistic, and then obviously development.
So then your idea is, we're going to take a little more risk. And then let's talk about what you do. And then move it from Core Plus to core. Is that the idea?
Yeah, exactly. Value add to core. And then you have different buckets of capital that want to seek different strategies commensurate with what their allocation is.
You can have different strategies for different investors. That makes a ton of sense.
It's like any ecosystem, right? I mean, a private equity group that's doing a lower middle market buyout aggregation play is going to sell to a larger conglomerate. And kind of get that delta between multiples, same concept.
Yeah, that makes a ton of sense, so let's maybe talk about that. So you said you're starting at one part of the risk profile and you're hoping to make some enhancements. How does your firm approach this whole idea of value creation and your portfolio of properties? And how you can make a difference and make it something more than what it was?
Yeah, there's a lot of cliches in real estate because it's been around for a long time. And the longer I'm in the business, the more I realize they're all true. So in our world, people say that you make the money on the buy and that the three most important words in commercial real estate are basis, basis and basis. And so we're very thoughtful about our per pound purchase price, what we're buying at per square foot. Because once you get married to that basis, you can never really divorce it, right? It's kind of living with you forever. And so when we think about value creation, you know, for us on a risk reward basis, we think if we can go in there and buy something that is existing.
So it's a property that was built 10, 20 years ago. It has proven cash flows, we can really get in and comfortable with what the expenses are. We've got historical financials, T12 financials, and we can kind of compare them over time. And what we'd like to see in terms of a fact pattern is the current ownership group is unsophisticated.
Maybe it's a group of individuals that aren't real estate professionals. What you often see in our business is a high net worth individual or family who is managing the property themselves and leasing the property themselves. Because they want to get those fees, or they don't want to pay what would be market fees? So we come in and we bring in professional property management, professional leasing. We manage the asset ourselves. And we think, okay, if day one it's giving us a 6 yield and it's got in-place cash flow. Maybe a little bit of vacancy if we just bring it to whatever the market is in terms of rate, credit, term, etc. On the rent roll side, we think we can end up somewhere in that 10 to 20 total return scenario.
And so that's our strategy is two to three years we can bring it to what market is backfill some of that vacancy, improve the rent roll. Obviously, we do all the other things in terms of depreciation, etc. If there is deferred maintenance or capital expenditures that need to be done, we reserve for those.
And then we turn around and either refinance it, give the cash back out to the investors, or we sell it.
Yeah, that makes a ton of sense. And as I thought about your kind of point about cliches in real estate, I realized, as I reflect on my time in the private equity industry, we had cliches like crazy. But they were all probably from the real estate industry. So we would say, oh, we're going to come in and we want to buy a house on a good block. And we're going to do the kitchens and bathrooms and then sell it to the next. And you're just literally doing the exact same thing.
And we even borrowed your cliches, so that's good. Now. I need to know more of the origin story of the industry that I was in for a long time. And I think your business has been around a lot longer, so that makes a ton of sense.
So one of the things that I'd love to get your perspective on Brian. This topsy-turvy world that we've lived in really since 2020, where it feels like we've lived in a washing machine. Just kind of going back and forth, but not necessarily finding kind of a new normal. And a steady so, lots of churn, lots of change, but without maybe a lot of steady kind of progress one way or the other. So when you look at the economy, the interest rate environment, kind of the hybrid slash, virtual work, postures, and how that's impacting the real estate world, what does that hold for the real estate industry, particularly this year?
Yeah, so I'm not sure if I'm allowed to swear on this program. But I would use something that my wife uses when she talks to students at her school. Which is kind of like a shit sandwich. So I'm going to say some kind of tough things and we'll talk about some good things and with some tough things. So right now, a rising interest rate environment is probably the worst thing possible for commercial real estate. If you look at multifamily, we'll use that as an example because I think it's the most acute.
Or office? You've got a situation where buildings are coming up for refinancings. You're going from borrowing costs at Call it 4 to borrowing costs that now can be something like 8, so you're 2x-ing your borrowing costs. You've got a world where rental rates, both on the office and the multifamily side, are largely decreasing.
Meanwhile, you've got pretty intense inflationary pressures that are causing operational expenses to increase. This is about as bad as it can get for commercial real estate when you put all those three things together, right?
And I don't think there's going to be a huge amount of systemic pain, like we saw in 2008 with the housing crisis. I think the banks were actually much better behaved and tighter. From a regulatory perspective. I think leverage ratios are fairly manageable, I think reserves are pretty deep. And I think operators and GPs and sponsors and fund managers were just better equipped to handle it. Because they lived through 2008, and they were just forced to by both their investors and the lending environment itself.
So I think there will be pockets of pain. I would not want to own an office building in midtown Manhattan that was a class B product. I don't see what's going to happen there. I think there will be some apartment deals that get brought back to the market.
So kind of big picture. I'm not hugely concerned, but I do think in the next 12 to 24 months there will be some pockets of real pain and distress. And I was talking to somebody at this event last night. I think, similar to your industry. For the first time in a long time, I think mezzanine debt and private debt and credit are going to have their day. I think there'll be huge opportunities the next 12 to 24 months for those guys to come in and make some really good money on some of these deals. Because the financing is in, the lending environment is so tight that I think going to private debt makes a lot of sense for a lot of groups.
So there'll be some Bridge capital that can come in, and really the thing that I'll look for, and not only real estate, but the buyouts, is will the Mezzanine Debt Group see the opportunity? Because historically, when times were great, they get priced out by the lower cost capital. When times are awful, they circle the wagons. I think they're learning the lesson now and going to be piling in.
And we're seeing that certainly in the buyout space as well, so that makes a lot of sense. So this year, certainly, I think a lot of places is challenged, and certainly, whether it's buyouts or real estate. We're seeing these kind of impacts systemically across the economy. But one of the other sayings that I think is so telling and so true is this great phrase. This, too, shall pass.
Most recessions, whether we're declining at 0.
5, or growing at 0.
5. They both feel pretty bad. So even the delineation, are we in a recession? It's kind of a silly point. But one of the things that you mentioned earlier during our conversation here is that we have these bumps in the road. But over the long term, this asset class is steady. Eddie.
So how do you think about as we get through this kind of fever and maybe shake off some of the malaise? How do you think about this? Not just over the next 12 to 18 months, but the next 12 to 18 years?
Yeah, and this is where for folks that have the ability to talk to international LPs, it can be really powerful. Because if you take a step back and you look at the world globally and you think, okay, if I was an allocator and I had a 100-year time horizon, where would I allocate my capital? Today, Southeast Asia has got some real challenges.
Western Europe does not look that attractive, South America looks like a mess. So you start zeroing in North America and you run the numbers and you look at things demographically. GDP, technology, safety, security, domestic U.S. operating companies and real estate look really attractive, I think, to a lot of groups. And there's no reason that I can see a catalyst for that to go to the downside, especially when you run a comparison analysis to other geographic locations.
I mean, would you really want to be participating in operating companies in Japan today? would you want to be buying commercial real estate in Western Europe? I think on a comparative basis, the U.S. real estate is still the best, and operating companies, honestly, are the best place to be today. And that's in a 25 50-year time horizon. I don't think you're going to be able to beat it.
That makes a lot of sense. And to what degree are you seeing? Given some of the topsy-turviness? And the fact that most people, when things get dangerous and fear pervades, they get very conservative and circle the wagons and they miss opportunities. To what degree are you seeing buying opportunities that relate to your business and your fund, and how you're deploying capital for your investors?
What I've been telling people is, so you've got kind of three main components for real estate, not different from private equity. But you've got to source the opportunity, you've got to source the debt, and then you've got to raise the capital, right, the equity. Right now, all of those things are just harder than they were a year ago, they're not impossible. But what used to be an email or an inbound is now you picking up the phone and making 10 phone calls. You're getting on a plane and going to talk to somebody, or seeing something, working your network harder, putting in more hours. And so we have not seen. And this is where there's, frankly, a bit of a disconnect between the LP community, the GP community today. Because we've got a lot of family offices or larger groups who are saying, Hey, we're the screaming hot 2008 deals.
And I'm just saying, you hear about people giving the keys back on some of these assets in the Wall Street Journal or whatever. But I'm just not seeing that distress in the market right now, certainly on a one-off basis. But in terms of if you want to go out and raise an opportunistic fund and be ready to deploy a lot of capital, I'm just not sure it's there. And frankly, given the rate environment we might be coming into in the next 12 months, it might not be there. I think for a lot of sponsors who are in distress, they're saying, stay alive till 25. And if they're able to do that, those buying opportunities might just not be there today.
And so I could be proved wrong. We could have kind of a drastic shift, but I'm just not seeing it or feeling it, especially compared to what it was in 2008..
So, Brian, as you think about your firm and viewing the world in a very kind of thoughtful and sober way. How are you working with your team and finding ways to be a custodian of the capital that you're managing?
Yeah, and this is where being a fundless sponsor is really powerful. Because I don't have discretionary capital, I can't just do a capital call and have money come to my inbox two weeks later. So I've told the team. We have to really sharpen our pencils. And we have to have a better value proposition today than we did a year ago, when money was pretty easy. And I'm sure your industry is facing this too. I think the smartest question investors are asking today is if I can get 5 in a three month t-bill, why am I locking up money with you for 10 years at whatever percent?
And so we have pivoted to shorter duration, higher IRR, bigger multiple uninvested capital opportunities to justify the risk and the liquidity premium. And I think that's a healthy thing for sponsors and GPS, and where my LPs have really done a good job. I think of informing me what makes sense for them today and what would justify them, kind of picking up the phone and writing a check. So that's the dynamic is, we're obviously always stores and fiduciaries, but it's really what's the value proposition that makes sense for LPS today? And finding those type of deals just takes a little bit more work than, frankly, before we could capture an arbitrage between debt and cap rate. Give people a nice, healthy yield.
That's great, you need to do more as a sponsor in today's environment.
We're seeing that, I think, everywhere, across any of the investment spaces. You got to be more, you got to bring more, and that's in some ways the evolution of industries and businesses, but particularly now. And it's the thoughtful capital like yours, that I think finds ways and pockets to be successful when others are kind of seeing maybe greater challenges. So, like you said, you're working harder, you're getting on planes, you're finding other things. And that I think is a good lesson really for any business builder, whether you're a private equity investor, a real estate investor, or an operator of a property or a business.
That kind of mindset goes a long way.
And I don't want to age you, but you've been through a couple cycles.
Yes.
So have I, and I think this whole idea of unprecedented is just wrong. The world blows up every three to five years like it just does. And so as a manager and as a sponsor, you need to be able to kind of roll with that change and understand that. There's no 10-year calm period, at least not anymore.
And volatility is just with us for the long term, I think. And so you'd have to have a playbook where you can pivot towards doing things that make sense for your company and for your investors.
Absolutely, and I think that's another kind of great perspective to have. This is just part of life and part of the world. And you can get upset about it. Or you can just play the game or play the hand as the cards are dealt. And just know that's what it's going to be.
And this is the industry you chose, right? I mean, this is what I tell my team is like, nobody sentenced you to go to private equity.
This is part of the drill and we just got to work harder in today's world.
Yeah, that's something that we've been talking about, our team is. Times like now. It's easy to get afraid. But if you can pivot your mindset and view the world through the lens of opportunity. While others are fearful, great companies are made during these times and time and time again.
Yeah, I mean, I've had mentors and people that I really respect say like, now is the best time to invest in venture capital. Like when people are getting crushed and there's like, you know, people are taking massive haircuts. Venture capital firms can raise no money, banks are blowing up like this is. If you have the fortitude like, now is the time to allocate.
So 100. And as you pointed out, unfortunately, I had a first front row seat watching the industry, you know, and world blow up in 2001 and 2002.
But what came out of that? It was Amazon, it was eBay, it was all these amazing companies that are household names today.
But thinking about, you know, maybe this is a good time to move to. This next question is, you know, kind of going back in time. One of the things that I love about our business here and the people like you. That I get to know is you get to learn something every day that you wish you knew. And for me, every day. I'm like, why didn't I know this before? And in some ways, if I had to figure out these things myself, I would have been in a lot of trouble for most of my life.
And so if you were being, you know, if you think about yourself and all the scars and wounds and lessons that you've learned over time. And you could go into that way back machine and go back to your 22 year old self. What would be one of the top pieces of advice that you would share with yourself then that you wish you knew at that time?
I thought a lot about this question over the last couple of years, and I'm going to give a simplistic answer, which is I wish I had known earlier. To just start owning assets, be it stocks, be it operating companies, be it real estate, residential, commercial, if you just were in the business of owning assets. For the last 25 years, you've enjoyed massive appreciation, incredible cash flow. And I think we're in a world where things are just getting more expensive and pricing is not going to go back now. And the earlier that you can get into the asset ownership business and whatever type of ice cream it comes in, the better off you're going to be. And I wish I had understood that earlier.
I think that is amazing advice and one that I too, think I wish I did. And it's really interesting as you think about people like you and people like me who are in the investment business so often. As I mentioned earlier, the Cobbler's kids have no shoes. And in how I manage my own personal life, which has ended up okay. But still, as you think about the full potential of what it could be. It's just those mindsets of being in the ownership business and having maybe a little bit of delayed gratification, particularly in your younger days. And what that would mean going forward, as things compound and accrue and build and grow? I think we all have stories, particularly those in Nashville, about, Wow, I wish I bought that.
Yeah, I mean, if you look at we live in a part of Nashville called Oak Hill, it's a residential bedroom community close to Green Hills. Belle nude It's a nice part of town. My father-in-law bought 20 acres in 1984, back when this was considered like the sticks, right?
He has taken a company public, he has had massive venture capital exits, like big multiples. We actually ran the numbers. Owning this property has been his best investment he ever made.
That is amazing, and that makes a lot of sense. Just what I've seen in Nashville real estate in six and a half years, I can't imagine since 1984. And I remember when I moved to Nashville in 2016, I was like, Oh, I've missed it.
Yeah, you always think that, but that's the thing is. Like, I would tell my 22 year old self. You read these articles about people flipping houses or buying coastal property or whatever and like, Oh, it's pricing's gotten crazy, I'm out. If you just put the money to work and then forget about it for 20 years, it's unbelievable.
I think that's great advice. I'm going to have some conversations with my kids this evening.
To do exactly this and take some of their savings accounts and put them to better work.
Perfect.
Well, Brian, this has been amazing. I really appreciate you taking the time sharing your perspectives and wisdoms, particularly in areas I just know so little about. And I think all of our listeners will get a lot out of this, so thank you so much.
Yeah, appreciate you having me and thanks for doing what you do, all right.
I look forward to seeing you at the kid's school pickup line.
Yes.
The hookup line, that's exactly it. All right? Thanks, Brian.
Special thanks to Brian for joining. If you'd like to learn more about Brian and his firm, Excelsior Capital, please see the episode notes. That's all we have for today. For more information on this podcast and Blue Wave, go to Bluewave..net Forward Slash podcast. That's b-l-u-w-a-v-e.
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