80 Million Net Worth Multi-Family Investor Buys... Muni Bonds?

Question

Thought this was interesting and worth sharing. I have a personal mentor in my network worth approximately 80 million. He primarily invests in multi-family real estate; however, I recently discovered that he holds nearly 40% of his portfolio in tax-free municipal bonds. Upon learning this fact, my first thoughts was...why invest in an asset that yields 3% when you could invest in real estate and potentially have a much higher return? Then he explained the lesson. In summary, the lesson was about capital preservation, NOT potential equity upside or seeking the highest yield. In other words, this is a risk mitigation strategy in his mind. After all... 32 million x 3% = $960,000 a year in tax-free income - Not bad

Most of us in this forum love multi-family real estate, myself included. Here are some questions that came to mind:

1. How do you rank the importance of capital preservation (protection of your initial investment) when it comes to investing in multi-family? #1, #2, #3?
2. Do you diversify in any other asset classes? If so, feel free to share which ones
3. How do you evaluate risk vs potential return when making an investment?

Most of us in this forum love multi-family real estate, myself included. Here are some questions that came to mind:

• 1. How do you rank the importance of capital preservation (protection of your initial investment) when it comes to investing in multi-family? #1, #2, #3?
• 2. Do you diversify in any other asset classes? If so, feel free to share which ones
• 3. How do you evaluate risk vs potential return when making an investment?

Bobby Larsen · Answer

@Travis Watts

1. #1, especially for our long term strategy.  Every investor is different and the shorter the hold, the more an investor should accept the reality of volatility.  For our long term 7-10 year strategy, our overriding principle is to never lose initial capital.  If the Great Recession were to happen again (and it will eventually), our goal is to once again not lose a single dollar of investor capital.  This means withstanding a 30% decline in rents and having debt in place to wait out a significant decline in value.

2. Stocks, real estate and venture capital.  The greater the net worth, the more an individual will want to be in capital preservation mode investing in more core real estate, bonds, muni’s, gold, etc.  It’s the reason why core LA real estate sells at a 3% cap rate. There is an endless amount of ultra high net worth individuals that can buy a $25 million property with only an expectation to park cash.  Same as true today, despite the pandemic and terrible political climate.

Taylor L. · Answer

As far as capital preservation vs net return goes, I'm at a point where I'm still focused on base hits & producing overall return. Haven't hit the $80MM net worth point quite yet :)

I diversify into self storage & stock index funds. I consider self storage to be recession resilient and I have a sponsor I trust quite a bit, so I'm happy to invest with them. Index funds have the upside of being highly liquid, so I consider them a good place to park capital in between real estate investments (not counting cash reserves)

Evaluating risk v return is an interesting question. Risk is both qualitative and quantitative.

It's qualitative in that the business plan for a particular investment needs to make sense. If the plan is to raise rents at the property, why would a tenant want to pay more to live at our property vs our comps? If we have a good answer for that, great. That's a qualitative gut feel - do the neighborhoods feel comparable? Do the properties feel comparable, or could they be made to feel comparable when we update our property? If those things are off, forget hitting the rent bump numbers.

Quantitatively, is our underwriting really conservative? After all, everyone says they underwrite conservatively. But how do we know we're really being conservative? My answer is looking at lots of deals, history, and data.

Paul B. · Answer

This year cities and states have seen their tax revenues drop significantly, to the point that some want a bailout from the federal government. I wonder if that changes the approach for Munis right now, or has this level of default risk always been there.

Jay Hinrichs · Answer

I had  business partner who sold his garbage company to Waste management for ALOT of money like what your talking about here.. and thats exactly what he did double tax free muni's

One of his favorite things to do was when some stock broker or other person wanted to talk about investments he would drop that pearl.. and they would say what the HECK  your not making much return..

He would then say.. well it depends on how many bonds U have.  LOL  granted if you only have 100k in bonds making 3%  but when you have 30 million plus well thats another matter.

And this individual owned a ton of other property ALL free and clear.. when he would present his balance sheet to our bank.. It was all Assets and basically ZERO debt..  Most of the really wealthy folks I know unless they are syndicators  dont have any or a much debt..

John Spurlock · Answer

First of all, this is great post. Your mentor's strategy is probably tempered with real life experiences that give him a roadmap for the future. At his level (and probably age) there's no reason to expose all of his wealth to market uncertainty.

In terms of preservation, I try to build a motte around my investments to protect them from the market and potential liability exposure.

I hold my properties longer than most of other investors that I know, this helps insulate my properties from market fluctuation. As you know, you make your profit upon purchase. I try to have my lease agreements shift most of the responsibilities from my companies to the tenants, make sure my LLCs are sound and that my commercial insurance policies cover the "unexpected" events that could go wrong.

That being said, every plan has a weak point. You need to be flexible enough to adapt to the situation to overcome it. I like having a couple contingency plans in place. My favorite contingency is you can never have enough cash on hand.

-John

Bobby Larsen · Answer

3. It’s difficult to exactly quantify and everyone will have a different opinion of what’s “safe” but we evaluate historical cap rates and the volatility of those cap rates as well as run a sensitivity analysis with changing rent growth and cap rates.

Travis Watts · Answer

Thank you @Bobby Larsen and @Taylor L. for your perspectives

80 Million Net Worth Multi-Family Investor Buys... Muni Bonds?

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