No Tenants, Toilets, or Trash? It’s Possible, Through Self Storage w/ Paul Moore

David Greene:
This is the BiggerPockets Podcast show 533, where we talk about self-storage strategies, super charging NOI and saving taxes with BiggerPockets, author Paul Moore.

Paul Moore:
This is very powerful and the point is in all of commercial real estate, you have an asset, and if you can find a way to significantly increase the income by extracting that extra value, you can get great return.

David Greene:
What’s going on everybody? This is David Greene, your host of the BiggerPockets Podcast, where we teach you how to build wealth through real estate. We dive in to the tactics and mindset of our guests who have been successful in specific niches of real estate and break down their strategies, so you can follow them and have the same results, as long as you take the same consistent action. Today, I am going to be speaking with BiggerPockets new author, Paul Moore, who wrote the book for BiggerPockets on self-storage. This is a fantastic conversation. It is literally one of the best ones that we’ve put out. Paul goes into incredible detail about just how you can get into the self-storage game. I know after listening to this, I was thinking this doesn’t seem so bad. I think I could get into it as well.

David Greene:
Paul does a great job of highlighting just why you would want to. A Lot of the things that stop people from investing in real estate traditionally, Paul calls them toilets, trash and tenants, they’re not a problem in the self-storage space. It’s much easier to add value in these ways than it would be in traditional residential real estate in many cases and one point that came up during this conversation that I didn’t think of, the contractors that you need to add the value you in the self-storage space are more readily available than they are in the residential space. This is a way that you can go left when everybody else is going right, and it might be the most informational interview I’ve ever done on a specific topic. So make sure you listen to this one, all the way through and take some really good notes because by the time this is done, you are going to want to invest in self-storage, just as much as I do.

David Greene:
Okay, guys, buckle your seatbelts because this is an awesome interview with Paul Moore. If you like what you hear like I did, please go to biggerpockets.com/storage and grab a copy of Paul’s book, where he shows you how you can build big wealth through self-storage and without any further ado, let’s get to Paul. Mr. Paul Moore, welcome back to the BiggerPockets Podcast.

Paul Moore:
Hey, it’s great to be here, David. Thank you.

David Greene:
Yeah. I’m glad to hear that. We had you on back on show 285 where Brandon and I interviewed you, and I believe at the time you had sort of started the transition from residential investing in sales, into the commercial side of it. Can you give us a quick recap on of what we talked about on that show?

Paul Moore:
Yeah, so I started … I sold my company in 1997 to a public firm. I started flipping houses, before flipping was a thing. It was called fixer uppers back in those days, if you remember that and then, I started flipping waterfront lots. I started building some homes around Smith Mountain Lake in Virginia, to a small subdivision and David, I learned something amazing. I found out that you shouldn’t actually try to build homes ground up, if you don’t know how to change the door knob on your own home. It’s just a little piece of advice for anybody who might want to benefit from that. At any rate, I went from residential, I ended up writing a book on residential real estate. We talked about that briefly before. In 2010, I found myself investing in oil and gas in North Dakota.

Paul Moore:
While I was there, I realized there was a huge housing crisis. So we talked about on the last show, how we built a multifamily asset and then another one next door to it in 2011 and we operated that multifamily quasi hotel during the oil rush, during the Bakken for a number of years, and then I wrote the book called, The Perfect Investment, about multifamily investing. So commercial level multifamily is what we talked about on the last show for the most part.

David Greene:
How is that investment doing with some of the changes we’ve seen in the recent administration and the policy regarding like oil production in America?

Paul Moore:
Yeah, well, we bought … we built these facilities when it was said that oil would never go below $90 dollars a barrel again, and it was like 90 to 110 if I remember right when we were operating the facility and we sold it and then oil plummeted to about $30 a barrel within six months of us selling the facility. Our goal was to build the nicest facility in that part of North Dakota, and I think we did. So, the buyer of that, the guy who’s operating it now is still doing pretty well because there’s still a lot of oil production people in the area, they need housing and this is a great solution, but from what I understand, it’s going pretty well.

David Greene:
Okay. That’s awesome. Now, what inspired your shift out of residential investing and into the commercial stuff?

Paul Moore:
David, I don’t think I knew at the time how true this was, but I’ve observed over the years that the wealthiest people in the world, the Forbes 400, almost all of them own commercial real estate. I think that there’s a couple reasons. One, they want to write large checks and it’s easier to do that in commercial real estate. That’s pretty obvious but another reason is math. Now, your mom always told you to be good in math and thankfully I went to math class and I learned something that has been very powerful for me, and that is that the commercial real estate world operates on math. Now, when I was flipping houses, we flipped dozens of houses, if we put $100,000 into the purchase of a house and then we put in … let’s say we finished the basement, finished the attic, put on additions.

Paul Moore:
We put in gold plated fixtures. I never did that, but let’s say we added $200,000 to the bases in that house, so we got 300,000 plus in it but it’s in $150,000 neighborhood. Well, that’s not going to make sense because residential real estate is based on comps, comparables and we all know that. Commercial real estate is entirely different. It’s based on math. In fact, it’s based on a value formula and the value formula is that the value or the change in value is based on the net operating income divided by the rate of return, also known as the cap rate. So, if you can increase the enumerator in that equation, the net operating income or if you can compress the denominator or keep it constant, you can force appreciation.

Paul Moore:
Forcing appreciation means that you can increase the NOI or like I said, compress the cap rate and have a significant increase in the value of the asset. When you sprinkle in a little safe debt with some leverage, it is very, very powerful. So, that’s one of the reasons, that’s one of the major reasons I and a lot of other people love commercial real estate.

David Greene:
So, if I’m hearing you correctly, what you found was I have more control over increasing the value of commercial real estate than sort of the wild grab bag of results you can get in residential.

Paul Moore:
Yeah, I think that’s true. I think especially for an experienced operator who can recognize intrinsic value, and what I mean by that is recognized value that’s inherently locked up, but not being drawn out by a mom and pop operator. It’s a very, very powerful strategy and especially in days like this, when you can put together a lot of these assets into a portfolio and sell it to an institutional investor at a compressed cap rate, which means lower denominator, means larger sale price. So, these guys are looking for stabilized assets and the opportunity to put together a portfolio is a very real and very profitable strategy.

David Greene:
So if you’re looking for somebody to exit, you’ve built up some revenue producing assets and you’ve added value to them, you want to … to sell to sort of like a hedge fund or something like that, what’s some advice you have for how people can get in touch with those acquisition managers of those companies?

Paul Moore:
Yeah. Well, first of all, I would recommend that you put together a franchise type operation, which means that you’re putting together standard practices, policies and procedures, standard management, a web presence. You’re doing all kinds of things that mom and pop operators don’t do because they don’t have the desire or the knowledge or the resources typically to do it and hey, David, they don’t have to because the cap rate compression we’ve seen over the last decade has already doubled the value of their facilities in many cases. They can go on being average and still make a huge profit. So putting together a portfolio of similarly run assets with similar marketing, similar management, et cetera, would be something you could do.

Paul Moore:
Then if they’re in a similar geographic region, they’re under one flag, you can approach an institutional buyer like a life insurance company, a hedge fund, someone like Sam Zell or Blackstone. You can sell this for a very, very nice premium because of your efforts in putting together the portfolio.

David Greene:
Now, my understanding is you’ve actually written a book for BiggerPockets with some of these strategies you’re talking about now, is that the case?

Paul Moore:
Yeah, we’ve got a new book coming out in November on self-storage investing. It’s called Storing Up Profits, Capitalize on America’s Obsession with Stuff by Investing in Self-Storage.

David Greene:
Okay, so if somebody is to get this book, what are some of the things that they can expect to learn from it?

Paul Moore:
Well, first of all, the first third of the book is dedicated to why we love self-storage, and one of the reason I changed over since the last podcast from multifamily to self-storage is the fact that multifamily has been a very, very popular asset class. In fact, Chris Bennett has done some research on this and he said that 93% of multifamily over 50 units is owned by companies that have multiple assets, which means they’re typically run better, they might have squeezed the value add out of these assets and they’re already at a premium price and let’s face it, a lot of single family and multifamily assets are selling at a premium.

Paul Moore:
We were looking for asset types that were recession resistant, but also had a lot of meat left on the bone, like Brandon’s found mobile home parks. When we first stumbled into self-storage, we realized that those two asset types both have a lot of mom and pop owners, which means again, they have not significantly increased income and maximized value. So the book talks about some of the things we love about self-storage. Some of the things we love are, that the tenants are typically pretty sticky. It doesn’t mean they wear Velcro suits but yeah, they might, I don’t judge. These are tenants who actually stay around with a price increase.

Paul Moore:
I mean, think about it, if you had a multifamily lease and your landlord raise the price from … let’s say you raised it by 6%, well, you might move out rather than pay 60 bucks extra month. In a self-storage facility renting at a hundred bucks a month, you’re probably not going to spend a weekend, get your friends together, rent a U-Haul to move your treasure out of your unit down the street just to save six bucks a month. So self-storage is done very good in all types of different recessions, in good times, in bad times. Good times, people are filling up their Amazon carts. Bad times, they’re storing stuff as they downsize. There’s the four Ds that play into this, downsizing, dislocation, death and divorce. Bad times people have where they need to store their stuff.

Paul Moore:
So the first third of the book is dedicated … talking about why we love self-storage and why we recommend people look into the self-storage asset type. The second third of the book is about four different strategies to build a self-storage empire, and we can talk about that if you want. Then the last third is about seven different paths to get into self-storage from wherever you are now.

David Greene:
So why don’t we start with those four strategies that someone can use to build a self-storage empire, what’s the first one?

Paul Moore:
Okay, so one, I didn’t talk about a lot was the momentum play. The momentum play would just be buying an existing self-storage facility that’s already stabilized. The income is already where it needs to be. The marketing is already good, everything is already dialed in. That’s probably not a strategy that most people getting into self-storage would want to do, but it is a potential strategy. A second strategy is buying a value add asset. This is where you can … like I said earlier, you can extract a lot of intrinsic value. There’s a lot of value add opportunities in self-storage that I never would’ve imagined.

Paul Moore:
When someone first told me about value add and self-storage, I kind of laughed because I was used to apartments, where there’s carpeting or hardwood floors and lighting and countertops and cabinets and lots of things you can upgrade to add value. Self-storage has four pieces of sheet metal, a floor and a door and some rivets and it’s really hard to imagine how to increase the value, but there’s a lot of ways. For example, you can add U-Haul truck rental, that can add thousands of dollars a month to your income and hundreds of thousands to the value of facility. You can add tenant insurance or late fees, administration charges.

Paul Moore:
You can bring the rents up to market levels. You can increase occupancy. You can pave an acre or two or put gravel down outside in rent to boats and RVs and other things like that. So there’s a lot of ways to add value to a self-storage facility. We’ve seen lots of value ads that have allowed investors to increase their equity by literally two or three fold, and if you want, we can do an example later where that exact thing happened. There’s a lot of great ways to add value to a lot of mom and pop self-storage facilities.

David Greene:
That makes a lot of sense. Yeah. What’s the third one?

Paul Moore:
Yeah. I love this because … I mean, this is something a lot of people could do. I mean, you might have a hundred unit self-storage facility down the road from you and you could put a U-Haul out front of it and potentially significantly increase the NOI and the value as a result. The third strategy is ground up development. This is the riskiest and it also carries, I would say, the highest potential return as you bring an asset out of the ground. You go through all the hassle of building it and then bringing it to a stabilized state and then potentially either refinancing it or selling it to a larger buyer. So the ground up would be the next strategy and then, another one of my favorites is the retrofit and repurpose strategy.

Paul Moore:
AJ Osborne was on show number 286 in July of 2018, and he talked about taking an abandoned Kmart, selling off the parking lot, cutting it in half and turning that into a beautiful self-storage facility in Reno, Nevada. We all remember that story because he was in a coma a lot of the time while he did it and he turned that into a beautiful self-storage facility. After that show, he and I were on the phone one day and he got an offer from a large institutional buyer for that facility for many times, literally many times what he had in it. He was only 40 or 45% occupied at the time, in the fall of 2018. So repurposing could be taking an old Kmart, a Sears building, a Toys “R” Us and I even heard the other day of somebody doing this with an office building and repurposing it as a self-storage facility.

David Greene:
That’s pretty cool. Those are actually some really good practical examples of ways that people can get in and add value, and I like that you mentioned they don’t involve a traditional rehab. You’re not looking for a contractor to come in there and put in new cabinets and put in new flooring. Maybe you’re looking for someone that can lay concrete, level the ground. It’s a different type of contractor you’re looking for and my guess would be some of those people are actually easier to find than the people that are doing cosmetic rehabs on single family homes. Am I close to being accurate there?

Paul Moore:
No. These days that’s exactly right. One thing I failed to mention was just adding climate controlled self-storage. We looked at acquiring a self-storage facility outside of Raleigh, and the lady was a mom and pop seller. She said, “Everybody has to bring a check in every month to pay for their facility.” Well, think about that, that’s reminding them that they have a unit every month and it’s reminding them that they’re writing this check and reminding them that they probably need to clear that out. I said, “Where’s your website?” She said, “I don’t have a website.” I said, “Oh.” She said, “Why would I need a website, I’m a 100% occupied for years.” Of course that reminds me that she’s probably … it tells me that she’s probably under a market with her rents than she was.

Paul Moore:
There was about an acre out front of her facility that would’ve been a perfect location on this well-traveled road for a climate control old self-storage facility. So, if we would’ve acquired that facility, we would’ve put a nice three story climate control building out front, in front of these couple hundred old tired units in the back where she was. So that’s a great value ad. Think about it, the land is already paid for, it’s in a great location. You’ve already got a business and hopefully, you’ll have a website and a marketing presence. It’s a great way to add value, to add income and to really significantly increase the investor’s wealth.

David Greene:
Now you mentioned earlier a little known strategy used by operators to generate over 40% annual returns. Can you share what that would be?

Paul Moore:
Yeah. So this is a little bit crazy, but I wrote about this in the BiggerPockets blogs a number of times, Michaelangelo was a great sculptor and he made a weird statement. He said, “When I look at a block of marble, I already see an angel that’s inside the block. All I have to do is chip away the superfluous material to get to that angel.” I thought that was kind of weird myself, but there’s a lot of truth in that. There’s a lot of intrinsic value locked up in mom and pop assets and they can be all kinds of different assets. It could be single family home, sometimes, if you can convert them to a commercial or an Airbnb. It could be self-storage.

Paul Moore:
It could be mobile home parks, apartments. There’s a lot of value that’s locked up and that it takes a trained eye to see. So sometimes I was talking to a great operator yesterday, who said … I said, “What cap rate do you acquire these assets at?” He said, “Well, that might be a three and a half or 4%,” which sounds terrible, that’s really expensive, but if you see tremendous upside that nobody else could see, if it’s like being run terribly, like we know one asset in Colorado that was acquired, had 80% occupancy, that sounded okay, but they also had 80% delinquency. So, 64 of every 80 tenants were not paying or were paying late. So, that thing was not making anywhere near the profit it could have been.

Paul Moore:
So the strategy is whatever asset type you’re in to find intrinsic value and extract that value. I like to call it intrinsic value extraction. So, my company looks for operators that are experts at extracting intrinsic value out of assets and significantly increasing the income and therefore the value. I mean, just simple examples would just be the stuff we already talked about. Adding a website, adding a web presence, finding a way to lease units, site unseen through an iPhone. Just adding a U-Haul. If you can add U-Haul that’s … you can add $3,000 a month, if you’re in the right location, 3000 a month is 36,000 a year using our value formula, 36,000 divided by a 6% cap rate, 0.06. I believe that’s like $600,000 increase to the value of your asset.

Paul Moore:
Think about it. If you bought a million dollar self-storage facility, a small one, you put 500,000 down, 500,000 in debt, you added 600,000 to the value, you more than doubled the value of the equity by just that one simple contract you signed with U-Haul. This is very powerful and the point is in all of commercial real estate, you have an asset, and if you can find a way to significantly increase the income by extracting that extra value, you can get great returns. One of the operators we invest with has over 60% IRR, 60% average annual returns because he does this strategy over and over David.

David Greene:
Well, you’re certainly making a compelling case for why someone would want to get into it, what are the seven paths someone can take if they want to get into this asset class?

Paul Moore:
Yeah, when I thought about getting into commercial real estate, I had no idea where to get in. I mean, I looked at storage facilities or large commercial strip centers or whatever and I couldn’t figure out, would I need millions of dollars, the ability to get millions of debt, convince a broker? There’s a lot of barriers to entry. So the last third of my book has seven paths on how to get into the self-storage business, but this is applicable to lots of different commercial real estate. It applies to mobile home parks and data centers industrial, et cetera. So the first path, I call it the long and winding road.

Paul Moore:
The long and winding road basically means that you buy something small, you improve it, you go out and lease it up to its capacity, then you either refinance it or sell it and then you repeat. I think somebody called this the BRRR strategy. I heard that somewhere, David. So it works with commercial too, but a lot of times, people find that the BRRR strategy works better in commercial when you sell the asset and jump up to a higher level. So in 2015 or 16, I was in Arlington, Texas. I met with a multi-family owner who was selling his apartment complex. He’d start out with a thousand dollar bonus from his job as a mechanic. He bought a duplex.

Paul Moore:
He Fixed it up, rented it, sold, it, bought a fourplex, did the same. He did this from 1993 to 2015 and he was selling this asset, 132 units for 11.8 million dollars. He was jumping up to a 15 million asset. So I know it’s possible, it’s a long and winding road because it took him 22 years to pull that off, but he was doing quite well in that path. So that’s path number one, the long and winding road. Some people refer to it as Brandon’s stacking strategy. I don’t think it’s exactly the same as stacking, but some people might call it that. The second path would be a capital raiser. Now raising capital is fraught with challenges and SEC potential violations, so don’t just run with this.

Paul Moore:
You can’t just go raise money and get paid a commission unless you’re a licensed broker dealer or unless you’re a principal in the deal. So if you’ve got background, if you’ve got access to a lot of people with money, if you’ve got social media skills, if you can blog and write and podcast and do those type of things, you can actually raise money, and if you can become a general partner, a co-GP in a deal or if you can get a broker dealer’s license, you can actually raise money and then let somebody else do the heavy lifting of the operation. So that’s another path in. Some people might be tempted to do that and just try to charge a commission, and that is just not okay.

Paul Moore:
There are some nuances of getting a flat fee, but the gist of this is you really want to be involved as a principal. The third path is being a deal finder. Now a deal finder, you might be tempted to get a commission like a real estate broker, but it’s not legal to get a commission for the most part.

David Greene:
Can I jump in there real quick, Paul? This needs more clarity. I frequently hear people asking for it, they might call it a finder’s fee, they might call it a commission. I don’t think the average listener understands how regulated certain parts of this industry are, when it’s appropriate to ask for that, when it’s not. Do you mind providing a little bit of clarity on both when it’s okay to ask for a finder’s fee type situation and what type of problems you might be creating for the person you’re asking of that from?

Paul Moore:
Yeah, there are, I believe it’s seven things in residential real estate, at least in the state of Virginia where I am, that you cannot do as an unlicensed person. You can’t negotiate a deal. You can’t offer a deal. You can’t write up a contract. You can’t do a lot of things that only a principal or a real estate agent should do. So, if you’re trying to do that and then get a fee as a non-licensed person, again, I don’t know what’s true in the other 49 states, David, I don’t know what’s true where you are but in general, I don’t think you should be charging a commission. Can you get a flat finder’s fee?

Paul Moore:
I think you might be able to but my point in this is you should try to get into the deal, like say, “Hey, give me 3% ownership and let me learn the business. Be my mentor.” What do you think, David? Do you think I’m on track with that or do you see it differently?

David Greene:
I think it can be problematic, like if someone brought me a deal and said, “Hey, I want in on it,” and now they’re wanting my I help with the deal but they’re also trying to negotiate their split of what they think it should be and they have their understanding of what their split should be is based off of sort of ignorance in this industry, and someone like us has a lot more experience, so maybe we don’t value what they’re bringing as much as they do. It opens up the door for hurt feelings. It could cause the whole thing fall apart. There’s also the element of when you’re becoming someone’s partner, you’re getting into bed with them in a sense and it’s often a person you don’t know very well.

David Greene:
So if it’s someone like you, Paul, who has extensive experience with doing this, you probably already have documents drawn up in a very standardized, this is the cut that I would patch out to give to this person and you can present it to them and they can make their decision. For someone who doesn’t do this all the time, I think that could be a little bit trickier. So I do think ideally it’s better to be in the deal, but before I brought the deal to the person and said, here it is, I would probably say, “Hey, hypothetically speaking, if we had a deal that match your criteria, what do you think would be fair to include me in this,” right?

David Greene:
Maybe you give up some of the cash flow to make the deal work and you get equity in the deal. Maybe the person says, “I don’t want you to have equity because I don’t know you but I’ll cut you off a portion of the cash flow and pay you that.” Sort of let the operator decide what they’re comfortable with, then once that’s decided, then you can say, “Well, here’s the deal? Does this work for you?”

Paul Moore:
Yeah. I find the human nature always, each party values their role completely different before and after the deal. So, it’s important to negotiate that up front.

David Greene:
I think the reason I don’t tend to partner with people unless it’s a huge, huge deal and even then, they have to be someone that I know really well, is everything can go great but we could just have a different vision for when we want to exit, how we want to run it. Sometimes it involves capital raising where partners have to bring money into the deal and maybe one of them doesn’t want to put capital in it or one of them wants to sell because they have another opportunity, and the other investors say, “No, we don’t want to sell,” and it causes hurt feelings. When you partner with someone for the first time that you don’t know, it typically needs to be a deal that’s so big that there’s enough meat on the bone, that human beings can be paid to take care of the maintenance of that deal, right, like asset managers and property managers that have experience.

David Greene:
Otherwise, you’re relying on a human, you don’t know what to do part of the job that maybe they don’t have experience doing or the goal is an exit. We’re going to hold it for X amount of time and then we’re going to sell it, like flips, we’re great for partnerships or what you’re describing, we’re going to buy this place, turn it around, and sell it to institutional money. If it’s like no, we’re going to hold this thing together for 50 years. That’s very similar to marrying someone you just met until death do us part.

Paul Moore:
It really is.

David Greene:
Yeah.

Paul Moore:
Yeah. That’s very true. So, I am part of a mastermind with a lot of commercial guys and we talk about this deal finder issue a lot David. One thing we’ve concluded is that we don’t have to standardize it across different companies, but seems like the going rate … and I don’t think this has anything to do with the fact that it’s real estate commissions 3%, but the going rate seems to be for the person bringing the deal to get about 10% of the general partnership. So in a syndication, we can talk about that more if you like, but typically the GP, the sponsor, the syndicator, they’re getting something like a 30% ownership split and giving the cash investors 70. So 10% of 30% would be about 3% of the deal.

Paul Moore:
If you give a deal finder that and they want to get in and they want to hang around and they want to go to the due diligence and sit in on the conference calls and meet the lender, and then as a deal finder, if you do that, you make some money from it and then, you can put it on your resume. In other words, a lot of people out there that say I’ve been part of X number of hundreds of units, a lot of them, they just brought the deal. They were a deal finder and I think that’s a pretty good strategy to get into this business.

David Greene:
Great point. Okay. What would the next path be?

Paul Moore:
The fourth path would be go big. So if you won the lottery or you got a big inheritance or you are an NFL football player and you retire, you might have a lot of money, and this is actually a real situation. I’ve seen this. So, people want to get in and they want to jump in big right up front rather than go through the long and winding road or be a deal finder or whatever and they’ve got capital. So if that’s you, you might want to really seriously think about getting all the training you can, reading all the books, listening to the podcast and then getting a great asset management team around you because this is a great way to get burned if you’ve got millions of dollars, but no knowledge.

Paul Moore:
I’ve run into people on the BP forums where they’re saying, “Hey, I actually don’t know anything about self-storage or mobile home parks but I’ve got an opportunity to buy one from my uncle,” and I’m just thinking that’s fraught with trouble. I mean, it’s one thing to buy a flip house and maybe you’ll lose 20 your $30,000 in your learning process, but if you’re buying a two or three or five million dollar property, especially if you’ve got other people’s money involved, not a good path in my mind.

David Greene:
I think there’s a lot of wisdom in that statement. The reason I’m highlighting this is when we’re discussing it from the perspective of the person looking at the deal, they’ve never bought it, it seems obvious they shouldn’t get into that, but it never gets presented to the investor from the perspective we’re talking about. All that they see is, “Hey, I’ve got a great deal. It’s self-storage. It’s a farm. Here’s my idea of what I’m going to do,” and they hear people on the podcast say, “Oh, self-storage is great. It makes all this money,” and the investor is like, “Oh, I’m investing in self-storage.”

David Greene:
No, you are investing in an operator that has never done a deal like this before, and would frankly just have to get lucky for it to work out, right? So that’s why I want to highlight this, when we’re talking about it now, it’s with clear vision of this person doesn’t know what they’re doing, but when the PPM gets put out and the memorandum goes out where, “Hey, here’s the deal? Do you want to invest in it?” So many investors look at the asset class or they look at the returns and they don’t look at the person who’s actually flying that plane.

Paul Moore:
Yeah. David, I’m writing another book for a BiggerPockets. It’s supposed to come out in a year and a half about Warren Buffett’s principles for real estate investors and one of those principles is sure, a rising tide raises all boats, but someday the tide is going to go out and then we’ll see who’s skinny dipping. That’s a loose quote from Buffett and that’s what we’ve been experiencing since the great financial crisis, for about the last 11 or 12 years, the rising tide has made a lot of newbies look amazing. Some of them have become overconfident, maybe overpaying for assets, charging. A lot of fees. Investors are happy but someday that tide is going to go out. Howard Marks reminds us that everything is cyclical.

Paul Moore:
Trees don’t grow to the sky. So, you got to look at the track record, the team, all that stuff you mentioned David. So yeah, thank you. That’s good stuff

David Greene:
Well, when you described your value formula, let’s see if I could break down this and make it as simple as I can, there’s two ways that you add value to a property because there’s a numerator and a denominator, right? The numerator in this world is the net operating income and you can understand that as the profit, what the thing is going to make in a year. The denominator is the cap rate and that would be how the property is valued loosely based on like how much demand is there. If it’s at a three cap, there’s a ton to people that are all trying to buy that asset class. If it’s at a 12 cap, they have to make it more appealing to somebody because there’s not as many people that want to buy it.

David Greene:
So the price is going to come down and it’s very similar to what I talk about with the BRRR method where you have … the numerator there is also like the yearly profit, what it makes in a year and the denominator is how much money I put into the deal. If you understand that there’s two components that make up that formula, you know that there’s two levers that you pull on to increase the value. The denominator is always the stronger lever, right?

Paul Moore:
Yes.

David Greene:
So as cap rates are going down, you are now dividing your profit by a lower number, making it a better deal. That’s a much more powerful lever than if you can get the numerator to go up. I remember Jay Scott and I were having a conversation with … I think it was Jay Martin, maybe at an event in Washington the Toro Yarbrough prod and we were sort of going over how so many people are focused on that, Jay had brought that up like, “Well, I can make the NOI go up.” We were describing and I’m like, “Yeah, that’s cool, it’s nothing like when you can make the cap rate go down. They just don’t compare,” and because there’s been so much demand for income producing assets by institutional capital, by hedge fund people, by regular investors like me that sold my property in need, the 1031 into something that gets cash flow.

David Greene:
I’m willing to pay more than somebody else would to protect the money. There’s a lot of demand. Those cap rates go down and as they go down, it makes the operator look like they’ve done a much better job than they really have, right? Just the wind’s been at their back. So, that’s what we’re trying to highlight is just because someone’s done well for the last three years, four years, five years, doesn’t necessarily mean they’re a great swimmer. The tide has been really strong pushing people in that direction, and when the tide stops and it comes back the other way, that’s where you find out who’s actually operating in good business, who swims well and who’s going to be drowning?

Paul Moore:
Yeah, that’s right. So, we talked earlier about putting a portfolio together and that’s one way to impact the compression of the cap rate. In other words, increasing the value, like you said. If It goes in the other direction and it will, you’ve got to have a numerator, that’s strong enough to overcome that expanding denominator. That’s why I love that strategy of buying intrinsic value.

David Greene:
Yes. The numerator describes how well the swimmer is. The denominator describes what the tide is doing. That’d be the best way I can describe it. So, that’s a great point is if your numbers are strong and you’re running a good business and your net operating income is healthy, those businesses will survive regardless of what the cap rates do.

Paul Moore:
Yeah, it’s true, and we have seen lots of opportunities where again, we invest with these experts at extracting intrinsic value that … where their NOI goes up so much that even if the cap rate went up by a point and a half, heaven forbid, but it will, at some point, I’m sure that that numerator still overtook that denominator, but when it moves in the same direction, it’s incredible.

David Greene:
Yes, and that’s what we look for, right? We’re like, “Okay, where’s the tide the strongest? Where do cap rates compressing? Where can I expect to get a little bit of bonus?” Then when we find the area, the location, the asset class, whatever it is, we say, “Now who’s the strong a swimmer that I can get in there to manage this thing.” That’s a sound strategy. You don’t have to pick between the two. You look for ways that you get both working together.

Paul Moore:
Yeah, that’s right. That’s absolutely right and the problem with the cap rate though, is a lot of those factors are way outside our control. The cap rate, might be based on interest rates, national demand, the economy. I mean all kinds of things in the region and nationally that we can’t control.

David Greene:
I look at cap rate in the commercial space as very similar to comps in the residential space. When the market is doing great, other houses are selling for more, it naturally elevates the value of your house because the other ones did it. Then, when market drops, all those other houses sell for less, your property loses value, you can’t control it. Just like commercial investors can’t control the cap rate, but if you are investing in residential real estate and the comps drop, it doesn’t matter as the long as your property is cash flowing. If it’s making money, you can wait. It’s very similar in the commercial space.

David Greene:
Yeah. It’s going to be hard to exit, if cap rates increase a lot and your property value goes down, but your net operating income will keep you alive. You’re not going to drown as long as you can swim. I’ve never really put an analogy like that together. Paul, I think that that’s a pretty sound one.

Paul Moore:
I like that. I like to blog on that with your permission. I love that. The tide and the swimmer, that’s excellent.

David Greene:
Absolutely. Okay. Where are we? What path are we on now?

Paul Moore:
Well, we talked about going big and now, I’m going to talk about something that people aren’t going to want to hear, get a job. Now, a lot of people are listening at BiggerPockets Podcast because they don’t want to get a job. They don’t want to work for the man anymore, but there is a sound strategy to get into self-storage or other commercial assets by getting a job. Gary Keller, Jay Papasan’s partner, of course, he started out by getting a job as a realtor. The top multifamily … one of the top multifamily guys in America. Rick Graf started out as a porter at an apartment building and he worked his way up to CEO of Pinnacle. So, there are great ways to get a job.

Paul Moore:
One would be getting a job as a commercial property broker. Another would be a lender. Another job would be working for an asset manager, property manager would be a great one. I know a guy who ditched $120,000 a year mortgage loan officer job to work for 60,000 a year as a property manager at a Dallas self-storage, and his goal was to do that, to learn the business, to buy a self-storage facility and then operate it. So that’s his way of working his way into the business. Getting a job means you get the terms right, you meet the people, you understand the lenders, the math, all those things and you might even end up getting to partner with your boss someday, who knows?

Paul Moore:
So getting a job is the fifth path. The sixth path of the seven is taking the passive path. Now the passive path in my mind is a very good path for people who have a full-time job, a career, they’re making a lot of money, they might be enjoying their retirement and they are not in a position to really focus on this. It’s one thing to own some single family homes or an Airbnb on the side, but to buy a large commercial asset in your spare time, that’s a little dicey to me. It seems a little risky to say the least, especially if you’re using other people’s money. So the passive path allows people to find a sponsor or a syndicator, vet them really well and then, go invest with them.

Paul Moore:
One of my favorite books on this is Brian Burke’s, The Hands Off Investor. I know you had him on the show before and his book, The Hands Off Investor, I keep right here by my desk because he’s got lots of strategies to vet sponsors. So, that is a fabulous path for a lot of people as well. Now, of course you could also be the sponsor, but that would be more of another path but that would be something you’d want to do after you’ve done a lot of this other groundwork to learn the business. The seventh path is finding a mentor or a paid coach. Now, a mentor would be somebody where you might go in and say, “Look, I’ll work for you, evenings and weekends. I’m really good at this, whether it’s spreadsheets or web design, social media, podcasting.”

Paul Moore:
You go in and work for them and in turn they train you on the business, so that’s one way to do it. No money often changes hands. Often, if you do a fabulous job, if you find yourself being indispensable to them, they’ll hire you because they’ll feel guilty. One of the top realtors in San Francisco, commercial realtors started out this way. She quit her job in 2008 as a CPA and she actually began working for free as a mentee, under a commercial real estate firm, and she worked her way up to being one of the top brokers in San Francisco. The other way is a paid coach and a paid coach, of course, is hiring somebody to be your paid mentor.

Paul Moore:
I’ve paid $25,000 or more, two different times in my career to get a paid coach, and I find that this is a fabulous way to jumpstart your career and the paid coaching route, David will also sometimes fold in to some of the other paths. For example, if I have a paid coach, I might be able to be a deal finder for them or a capital raiser, as long as I’m a legitimate co-GP for them. So the paid coaching route and the mentor route will be the seventh path. These are the different ways I find that people get into self-storage or other commercial real estate asset types.

David Greene:
All right. I mean, that’s pretty detailed analysis there. That’s really good stuff. All right. You talk about the power of a dollar when it comes to real estate investing. Tell us what you mean by that.

Paul Moore:
David, I never dreamed what the value of a dollar could mean. Jeff Bezos tied practically for the wealthiest guy in the world, went around the Amazon facilities and he took the light bulb out of the vending machines. Now, why would he do that? Well, he reasoned that the light bulb was taking up electricity and it needed a maintenance person to change it out, and there was a cost of the light bulb itself. All the, advertise some snack company like Lance snacks. See, he realizes that a dollar a month saved is $12 a year and Amazon’s PE ratio, their price to earnings ratio right now is about 56. So a dollar a month saved, $12 a year that translates to $672 in his wealth and in the wealth of his shareholders.

Paul Moore:
Well, the value formula in commercial real estate is quite similar because if you can … and this is why I think most of the Forbes 400 invest in commercial real estate, David. Imagine this, you add a dollar a month to the bottom line of your multifamily or your self-storage mobile home part. Okay. That’s $12 per year. Mama told me I was good in math. So $12 a year, that doesn’t sound like much but divide that by the cap rate, and there’s typically running like 5%, let’s say 6%. So $12 divided by 6%, 0.06. Now, it’s getting into real money. It’s $200 added to the asset value, but it’s even better than that, because if you have a leverage, let’s say 60% leverage, then the value to you as the investor could be two and a half times as much.

Paul Moore:
So that $1 saved or gained per month in that asset could translate to huge dollars for you. I already used U-Haul as an example, adding U-Haul can add $600,000 to the value of your facility, but just raising rates, just raising rents. Let’s say you’re 20 or 30% below market. If you can raise rents 20 or 30%, in many cases, you can almost double the value of your equity or just adding a climate controlled building or graveling a parking lot. I heard of a story where somebody graveled … I think they actually paved an acre out front of their facility and they set it up for boat and RV storage and they added 120,000 a year to their income.

Paul Moore:
Well, there was no increase in cost once they’ve built that, which was about $100,000 to build it. So 120,000 a year, that’s an additional two million dollars added to the value of that facility. In fact, it practically doubled the equity. Just adding that boat and RV storage. The previous owner could have done that, David. They easily could have added boat and RV storage, but they didn’t do it for whatever reason. This is the power of seeing the intrinsic value as an expert in being able to extract that, which we talked about before you,

David Greene:
I heard someone say something the other day, I don’t remember who it was and it’s such a simple statement. I was almost embarrassed, I never thought of it on my own. They were talking about … I’m going to ad lib a little to their point. They said, most of us would do … like we give our right arm to add 15 to 20% of increased revenue in our business. We would work so hard to bring in extra money to the top line, but taxes come right out of the bottom line. We often don’t even think about ways to save money in taxes, but generating 20% additional revenue is probably going to be less savings when it’s all said and done than saving just 10% in taxes. So can you share a little bit about the way that real estate helps you save taxes and how important that is when it comes to accumulating wealth?

Paul Moore:
Absolutely. So I think another reason, the Forbes 400 generally invests in commercial real estate, there are so many tax benefits. The tax code is written to incentivize investors and business owners to do what the government wants people to do. So, it’s written actually to favor real estate investors. It really is. So there’s a lot of different ways, strategies and tips you can use to save money on taxes. The first one is kind of funny. It’s hiring a tax strategist. Now I know a guy named Ed and Ed was paying about 120,000 a year in taxes and he stumbled into some of these strategies I’m about to talk about and he went to his CPA and said, “Hey,” he met him for lunch and said, “Could I do this?” The CPA said, “Yeah, Yeah. You can do that. You probably should.”

Paul Moore:
He got kind of irritated and he said, “Okay, what about this?” He said, “Yeah, that’d be a good idea too.” He said, “You’ve been doing my taxes for like a decade. Why didn’t you tell me this?” The CPA said, “You pay me to do your taxes not be your tax strategist.” Well, as you can imagine, that was their last lunch together. He went out and found a tax strategist and he said he hasn’t paid a dime. He hasn’t paid a dime in taxes since that and he’s talking about legitimate tax savings now, not just something under the table. So hire a tax strategist first. The next thing would be, have a direct investment. If you get a K-1 from your commercial real estate deal, then you are getting the pass through savings, and we’re going to talk about some of those from the asset.

Paul Moore:
So the asset passes through the savings to you as an effective partner, if you are getting a K-1. Another strategy is return of capital, and this is kind of obvious, but one of the waterfall methods, and a waterfall is the repayment to investors from a syndication, is to pay back the return of capital first and by giving them back … let’s say they invest $100,000, and they’re making, let’s say 8,000 a year. Well, that 8,000 here comes back tax free because it’s a return of capital first and we all know the time value of money, if you don’t have to pay taxes. In the early years, that can be a significant opportunity to reinvest that money and pay the taxes later. Another strategy and the big one I want to highlight is accelerated depreciation through a cost segregation study.

Paul Moore:
Without getting into a lot of detail, I’ll just tell you that assets commercial and residential assets have building structure, but they also have personal property. The government allows you to segregate those and extract out the personal property. So like in an apartment, it might be lighting and flooring and cabinets and countertops and even some electrical and the appliances and the roofs. Those can all be depreciated much more quickly than the building itself. So because of the 2017 tax law changes, a lot of that, at least right now, as we’re doing this show can still be depreciated or counted as a paper loss, if you will, early on like in year one.

Paul Moore:
So by doing this, investors can have … they can be getting a return, they can be getting cash in their bank account but they can have a loss on their tax return for many years. This is a really powerful strategy, and this is one that surprises me sometimes that people don’t use, but they could. Another strategy is to correctly classify fully deductible repairs. So you might have an accountant over there, who’s just counting something as maintenance when it can be a capital expense or capital expense when it could be maintenance. Just make sure you’re classifying all those well because in the 2017 tax law reform, they also broadened the section 179 rules, which means basically for example, a roof, instead of taking it as a cost over 15 years can actually happen … can all be compressed into year one in some cases.

Paul Moore:
There’s all kinds of other things that can be done like that. Of course, refinancing is another strategy. You can free up some or all of your equity, you can refinance, let’s call it lazy equity or gains, you can refinance it and there’s no tax on that to the investor, just like refinancing your house. So commercial operators and self-storage and otherwise can refinance back some or all of the equity to the investors. The investors can go put that back into use without paying taxes on it. Of course, another strategy we all know is the 1031 exchange and that’s exchanging one property for another of so-called light kind. The 2017 tax reform eliminated the 1031 exchange for all kinds of different asset types, but not for real estate. Thankfully.

Paul Moore:
So the 1031 exchange, I have a friend who invests with me, he’s been kicking the can down the road since the 70s on some money he invested and he keeps re-upping his 1031 exchange, every time he sells an asset and it allows him to continue not to pay taxes until he dies. Well, they say death and taxes are the worst things out there. Well, death cannot be a problem for the tax man as well, because under the current laws, you can get a step up in basis. So if the month before you pass away, if you sell all your assets and pay the tax, so you can give your kids cash, that sounds like a good strategy, but you have to pay massive taxes in some cases, especially if you’ve been kicking that can down the road. Under the current laws, you can get a step up in basis, and the value of the assets are actually re-calibrated to the value at your death.

Paul Moore:
So there’s no capital gains and there’s no depreciation recapture to your heirs, if you decide to go that way, another strategy is using self-directed IRAs. There’s Roth IRAs. There’s SEP IRAs. I talked to a government employee the other day who had his retirement plan with the government for decades. He had no idea you could invest in real estate because Wall Street doesn’t want people to know, they can invest in real estate but you can through a self-directed IRA or a 401K. Another powerful strategy is to avoid passive loss limitations by becoming a qualified real estate professional. So if you don’t know about this, if you or your spouse can become a qualified real estate professional by working in real estate over 750 hours a year, and by doing that more hours than anything else you do professionally, you can get massive tax savings.

Paul Moore:
You can even use losses like I’ve been talking about against your active income. So there are significant benefits to this, and this is why a lot of these real estate investors never or rarely pay taxes, at least for many, many years.

David Greene:
That’s a great breakdown of how it works. It’s not … I say this all the time. It’s not … when someone says they didn’t pay taxes, they’re not cheating. They’re not doing anything unethical. There’s actually more risk associated with this because you’re buying an asset that could go bad and there’s more work associated with this. So what you’re describing when you said, “Hey, I’m going to buy a self-storage facility,” then I’m going to pay a contractor to put out a bunch of concrete. Then I’m going to rent out that space to a U-Haul and people can pay to put their boats and their RVs in all those places there. The reason that you get compensated for that from the government, as far as like the depreciation is that there’s some risk. What if nobody puts their boat there?

David Greene:
What if you did a bad job and you didn’t look at the demographics first? The government wants you to, because more people will buy a boat if they have a place to put it, more people will buy an RV. Every time that happens, there’s a sales tax that gets generated where the government makes more money. More people now work at these boat places. More boat mechanics will have a job. More sales people will have a job. Someone will have to build a building to hold all the boats in before they sell them. All of those places will generate tax revenue. It’s often missed by shortsighted people who say greedy real estate investors don’t pay taxes. How much more revenue those investors are creating for the government as a whole, that everybody needs by improving the value of a property and improving … do you have anything you want to add on that concept?

Paul Moore:
No, I think that’s absolutely true. Tom Wheel writes, one of my favorite tech strategists and he talks about this and he said, that the government is actually motivating us to do what they want us to do and that was a light bulb moment for me, and I’m really glad that you brought that out, David.

David Greene:
Yeah, it would be like if I told an agent on my team, “Hey, you don’t have to pay me any of your commission. If you go start a new David Greene team in this area,” and I can collect commissions from those 30 agents instead of the one that was here. It’s very shortsighted of, “Well, they don’t have to pay any commissions. That’s not fair. How come I do?” If you’re going to go build a new expansion partner, that’s going to have 30 new agents that generate revenue for the company, you could too and that’s what investors do, is we step in, in a capitalistic environment and make it better, right? In a socialistic environment, you have less of that.

David Greene:
Now, the government is responsible for making those improvements and most people recognize the government doesn’t do as good of a job as the private citizens do. It’s what I always say is what’s your experience like when you go to the DMV. That’s what happens when the government ends up running the actual experience of what you’re getting versus me, I go to AAA and it’s a privately run company. I go right in there, I get my registration done and I get out. So for all of you investors out there that are hearing this, and you might have a little bit of guilt like, “Oh, I don’t feel good about this.” No, you’re generating so much more revenue than others would be by improving property.

David Greene:
So if that’s what you want to do, you need to go to biggerpockets.com/storage and check out Paul’s book. Paul, I think this might have been the most detailed interview I’ve ever done with an author of a BiggerPockets book. So if anyone is listening, have they already heard everything that’s in the book or should they still go buy it?

Paul Moore:
I think they need to buy the book because there’s a lot of details, including 40 reasons I love self-storage. One of those is that there’s no toilets, tenants and trash to deal with. Yeah, there are tenants but it’s … the eviction laws are totally different and there’s a lot of reasons that I think people could and should by the book, including some of the barriers to entry, to self-storage and how to overcome those and how to get training, mentoring, there’s all kinds of stuff in the book that we didn’t cover on this show.

David Greene:
Well, thank you very much, Paul. This has been a blast. Go to biggerpockets.com/storage. Check out the self-storage book. I’m going to let you get out of here, because we went into overtime already. Is there anything you want to add before we go?

Paul Moore:
Yeah. I just want to say that … we talked about this briefly in the pre-show and that is when I woke up in 1997, I just made a couple million dollars selling my company to a public firm. I wasn’t any happier than I was before. A study I read recently said that if you make over, one person that’s 65, another people person 95, if you make over, let’s say a 100,000 a year, you’re not going to be any happier at 105,000 versus a million and five. So you need a bigger why, and I just want to encourage whatever you’re doing when you’re listening to this, whether you’re an investor, a syndicator or just listening to the show, I want to encourage everybody to have a bigger why.

Paul Moore:
We are meant to leave a mark on history and make this world a better place. When I found out, David about human trafficking, I was shocked. If you took the record profits, not the average, the record profits of Apple, General Motors, Nike and Starbucks, and you combine those together, triple that number. That’s the estimated annual revenues generated by human trafficking every year. So, my company Wellings Capital is trying to do something to use our commercial real estate profits, to fight human trafficking and rescue its victims. I would encourage you to find your big why, something you’re passionate about, something you’re excited about and get behind that, because that is going to be a way that is going to make you happier when you get to your goal.

David Greene:
I love that. Thank you very much for sharing that. As someone who worked in law enforcement, it is a much bigger deal than what people realize, it’s happening around you, the listener right now and you don’t know it. It’s actually very prevalent and oftentimes, even by the time you rescue somebody, it’s obviously a better life for them than what they were living, but it’s in many ways, almost irreversible damage has been done. So being able to stop that from happening before it starts is incredibly important to the people, and it’s one of those things where the victims don’t make themselves known.

David Greene:
They’re not going to get on social media and go say, “This horrible thing happened to me.” There’s so much shame. There’s so much embarrassment. They’ve been beat down so much and their self worth has taken such a hit that they’re not going to get out there and say, I was a victim of something like what we typically see on social media. I remember maybe 10 years ago there was that African warlord that was taken over other villages. I can’t remember his name right now.

Paul Moore:
Joseph-

David Greene:
Kony, was it?

Paul Moore:
Kony.

David Greene:
Yes.

Paul Moore:
Kony. Yeah.

David Greene:
Everyone knew about it. It was just this really popular thing to say. I stand against Joseph Kony. This is not like that. You won’t know it’s happening and so these organizations that are out there, protecting those people are very near and dear to my heart and I really appreciate you, Paul calling attention to this. This is something where your dollars will actually make a big difference. All right, go get the book, biggerpockets.com/storage and Paul, where can people find out more about you?

Paul Moore:
Like I mentioned earlier, I spent years trying to figure out how to get into commercial real estate. So I’ve created a guide for people who want to learn, how to get into commercial real estate. You can get that at my website, wellingscapital.com/resources.

David Greene:
There you have it. This is David Greene for Paul, no tenants, trash or toilets more signing off.