Andy: Well, welcome to the Speed, Skill and Stewardship podcast by Cypressbrook Company. I'm Andy Dolliver, and with me is Mike Novelli, CEO and founder of Cypressbrook. And Mike, you kind of have an interesting seat as part of your job. You have over 300 investors in your program today, so you've been at the beginning of a lot of people's real estate journey. And so today we're going to talk a little bit about how someone overcomes the hesitancies or uncertainties of entering into real estate. We're going to start that off by talking a little bit about our own experiences of what interested us in the asset class, and then share a little bit about what it looks like to enter into the Cypressbrook real estate program.
Mike: Right, well, thanks, Andy. Well, for me, my journey is probably a little different than many folks, because I got interested in real estate when I was working in the private equity business in Dallas in the early 1980s and read an article about the Trammell Crow Company. And frankly, I went to that company because they offered a career path where you started out selling for them, really as a broker, and then eventually worked your way into an ownership position in your projects. And I had the wonderful opportunity of working for Crow in Austin and Chicago. I learned a lot about the business, but it was through that experience that I realized what an important asset class real estate was. You know, for probably most families in America, their single biggest asset is real estate, their home. And of course we really try to encourage our investors to think more broadly about the asset class. In fact, a significant piece of overall American wealth is in real estate. Of course, much of it is in the single-family homes that people own, but also in rental properties and things like we do in apartments.
Andy: Yeah, that's great. Well, Mike, thanks for sharing a little bit about your story. I had a slightly different path into the real estate industry. For me, we kind of started off really as a way to supplement my income. I was working for a nonprofit organization, was recently married, trying to start a family, and wanted to be able to provide more than I was able to in that role. And I think something that's foundational in my experience was some earlier experiences from childhood, really three things that laid the foundation for why real estate investing and owning assets was an important part of what I wanted to be involved with in my career. The first one was actually with my grandparents. They gave me $100 when I was 10 to invest in the stock market, and I held that asset, Dick's Sporting Goods, for 10 years. I ended up selling it to go on a college ski trip with some buddies, but I really got to see the value of appreciation in an asset. Second, my other grandparents happened to own a small portfolio of single-family rentals, and so I saw the benefits they had from the cash flow from those assets. And then lastly, a foundational thing for me was my parents. They bought fixer-upper homes, they would renovate them, and they really made them places where it was enjoyable to live. And so I was able to see that if you have a vision, there's a lot of opportunity to create value through real estate. So those early years were impactful for me.
Andy: Now, moving to the early part of my career, trying to figure out how to supplement income, I'm listening to all these podcasts and YouTube videos about how you flip a house, how you buy your first rental property. And eventually I had a partner at my company who was in a similar situation, trying to supplement his income. We went in, we bought a house through a wholesaler, and we had a good amount of success. The challenge, though, is I really bought myself a second job. I was working nine to five at the office, at that nonprofit, and then in the evenings we were going out and managing this construction project. So there were some difficult things in that, and it wasn't the most convenient, but it was my start into the real estate industry. I ended up finishing some additional school and transitioning into a finance job at a boutique investment bank. And while I was there, AI starts to show the potential of being a predominant part of that service industry. And so I was just thinking to myself, man, I need to be in a position where I can own assets and not be in a role where I could potentially be replaced by AI.
Mike: Well, and of course, I observed much of what you described there, certainly when you did your single-family deal up in Dallas with a partner. And you were in an unusual situation in that you didn't know you were getting sold, but I was selling you for several years there, because I saw you as a young man that was numerate, literate, and well informed, the three characteristics we look for in all the people that we would like to bring on to our team, and I thought you could do very well in our business. It's a very effective tool to sell somebody on something when they don't know they're getting sold. And so that's what we did for a number of years, telling you about how good it was in the real estate business. And once you did your single-family home deal, I kind of said, well, wouldn't it be a little bit more fun to do something with a little more scope, and not necessarily buy yourself the job?
Mike: And in fact, that characteristic is not atypical of people that come to us. We have a fair number of investors that have come to us that have done five, six, seven, eight single-family homes, and they realize that they've committed the rest of their Sundays between now and the time they leave to fixing refrigerators or dishwashers or whatever it is. And so while they may be making pretty good returns, they realize a lot of it is their time spent. I think a lot of our investors come to us when they've been out working for a number of years and they're starting to generate a little bit of cash flow. Probably our most typical investor is someone that has a private company or has their own medical practice. They're a doctor, they're a lawyer, whatever, and they're generating some pretty good cash flow. They have their home, of course, and usually some publicly traded assets or cash, sort of liquid assets. And they come to us for a diversification piece. That's when they see us as an alternative asset to invest in. Real estate is a very good asset, a meaningful part of where they can get good, consistent returns.
Andy: Well, diversification, I think, can become a buzzword in our culture today. For you, in a broad sense, what's the importance of diversifying a portfolio?
Mike: Yeah, I think the way we would look at the issue is that there was a finance economist in the 1950s, Markowitz, who wrote an article about portfolio diversification. His concept was that by investing in an array of assets, you have your publicly traded assets, you have bonds, you have your own home, you have real estate, maybe you have oil and gas, maybe some other things like that. By investing in a diversity of assets, you're able to build out a curve, a graph created by the rate of return you want to achieve on one axis and the amount of risk on the other. You can either decide on a certain amount of risk you want to take and ask, how do I maximize my returns on that amount of risk? Or, here's the return I want to get, how do I do that with the least amount of risk? And I think he built a very good case that you can do that by building this portfolio of assets. And so we would encourage people to think about investing with us as a piece of their portfolio, complementing some of these other things. Let's say you have your own private business that is generating your main value creation activity, and you have some publicly traded or liquid assets in case you get sick, or you lose the job, or the business goes sideways for a while, whatever it is. Then they come to us with a piece of additional assets that they would allocate to this type of program. That's a very good way to build a long-term wealth profile, and that's, I think, how many of our investors come to us.
Andy: Great. And maybe more specifically, are there ways to diversify within our program? How have people done that historically?
Mike: I think that's another really important element of diversification, because we project finance our deals. And I think one of the reasons we've been able to build a long-term track record that's really good: we're averaging in the low 20s for our program, and if you do similar kinds of deals through REITs or Wall Street deals, you're looking at high single digits or low teens. A lot of that is just far less overhead, because when you invest with us, you're investing with the guys that are running the projects every day. We have our own families' money invested in the deals that we do. We're very aligned with the investors. That's not to say we don't have problems, because we have plenty of problems. It's kind of a messy business. But really what we encourage is for the investor to approach our program by investing in multiple deals.
Mike: Our standard investment book goes out with a $250,000 minimum per deal, but we're pretty flexible on that. What we encourage is for our investors to look at us as an allocation of their overall portfolio. Let's say it's a young lawyer starting to do very well, where he gets pretty good regular distributions from the law firm. He might come to us and over a series of years build a program with us. In fact, a very common lunch that I would have would be with a doctor who's done well for himself, and he might have a half million dollars where he says, hey, I want to put a half million dollars in your program. And for that doctor, I would always encourage him to invest in three deals at $175,000, or four at $125,000, or frankly five at $100,000. And over time, as those deals mature, you'll get some distributions from them in different ways. Maybe some will sell, maybe some will get into a refinance situation where we're able to do distributions. And frankly, many of the $300,000, $400,000, and $500,000 investors we have today started with us at $100,000 and grew with us.
Mike: But the market cycles. Today in the marketplace, we're in what I would probably describe as the fifth downturn since I started the company 30 years ago, and the seventh since I got in the business. And so we're not realizing transactions quite as readily as we have in the past. But that will change. It always changes. And that will probably be some combination of rents rising and interest rates coming down, which are at relatively elevated levels for my career today. But again, these things always cycle. And our apartment business particularly has always been a very good long-term investment, particularly in periods of high inflation. I mean, we were so happy we had a bunch of assets that we owned before the Biden inflation. If you look at the inflation of '21, '22, '23, every asset that we owned appreciated by 20% just off of the inflation. Very few assets operate like that. But anyway, on diversification, I think what works very well is to invest in multiple deals. It takes a little time. We do our deals when, frankly, the market gives us the opportunity, when the deals make sense. And if we don't see deals that make sense, we don't do any. We can figure out something else to do. But certainly that happens in the cycles. So that's how I would encourage people to think about diversification: both against their overall portfolio, the Markowitz idea, and then specifically across multiple deals in the real estate business.
Andy: That's great. That's great. You did mention one of our key hurdles is our minimum investment of $250,000 per project, maybe with some flexibility there if there's a desire to build a program alongside our firm. What are some other hurdles that people might face? It'd be good to know.
Mike: Well, I do think you need to have a certain amount of liquidity, or a certain amount of investable assets, to participate in our program, which means you have some assets that are liquid for people to rely on. Because in our business, you can go through periods when the assets are very hard to sell, and you want to avoid selling then. In fact, I tease the young guys in the office that I spend half my day making sure we never have to sell into a bad market, right? That way we can time our exits appropriately. So first of all, you should have some liquid assets, and these should be assets that you can afford to have illiquid.
Mike: I think the second thing is that we work under the regulatory auspices of the SEC, the Securities and Exchange Commission. We do what are called Reg D offerings, which are private offerings. We don't really envision these assets ever being publicly traded. And so the SEC has certain guidelines that they want those investors, who are called accredited investors, to meet. There's a variety of ways to become accredited. The two most traditional are a sort of safe harbor, meaning if you meet one of these two criteria, you're deemed to be an accredited investor. That would be that you make over $200,000 a year on an individual return over the last two years, or $300,000 on a joint return over the last two years, and expect that to continue; or a million dollars of net worth independent of your home. And so all of our investors meet that criteria. We take it another step further. Under the Obama administration, they introduced some additional constraints, and we decided to ask our investors to become verified accredited investors. In other words, not just fill out a questionnaire where they self-verify, but rather ask their accountant, their financial manager, or their lawyer to attest to that. There are other ways to do it, but those are the easiest and most straightforward. And we certainly would be delighted to talk with someone about the other ways to do it if they don't have an accountant, lawyer, or financial advisor easily accessible. So that's the second thing, that they would be accredited.
Mike: But I would say the other thing is, again, to approach it as a portfolio. That might be where someone says, hey, I'm going to be using my bonuses or my distributions over the next few years to invest in your program. We have a lot of guys that do that. That's probably where we end up with a lot of folks. And on this minimum issue, we've been blessed enough, and we've been doing this long enough, frankly, that in our group of 300 we have, I don't know, a dozen or 15 that are second-generation investors. And I feel really proud of that fact. In this case, it happened to be the dads that invested with us, and the dad said, hey, look, this is what I found works for me. And so these are all young people that are starting to do well in their careers. They're also probably being taught a little bit about how to invest and how to manage their money, so they will probably be good stewards of that. We've been fortunate enough to pick up some of those guys, and certainly we're very open to them investing at whatever level works for them and their current portfolios. Why? Because we will grow with them. They will be great long-term investors, as we've experienced. So we try to give a little bit of encouragement to the families that invest with us to think more broadly about us within the context of the overall family's investment strategy.
Andy: Yeah, that's awesome. Well, thanks for sharing all that, Mike. I hope for the listeners it's fun to hear a little bit about what interested us in the real estate industry, but also, for those that have never participated in real estate investments, that as they peer into the black box, they see specifically, for our portion of the asset class, how they can participate alongside us at Cypressbrook. So thanks for listening.
Mike: Thanks, Andy.
