Investing in real estate can be a risky business. Scott is a real estate developer of highly undersupplied, multi-generational urban housing for families. He is producing investor opportunities in long-term hold new construction investments, which is a little different from what we normally talk about and he focuses on high demand urban metros.
"I still have to basically convince investors that the risk mitigation or risk profile is worth the investment.
And so generally, we're going to need to be at higher cash on cash return or at least equal on cash on cash. Once we're stabilized relative to other competitive offers in the value-add space and so generally for us, you look at it high teens low 20s on a 5-year investment for an IRR. An IRR is a good indicator although it's very sensitive to how you underwrite and particularly any underwriting is a function of how well are the projections that you make into the future. Am I trending rents? Am I trending operating expenses? Am I doing it appropriately? We don't trend rents but I know lots of people who are in a new development that hey, I'm going have you know 5% bumps for the next three years while under development so my rents will be 15% higher when I get there." Scott Choppin
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Introduction: Welcome to the DJE Podcast where you will learn about real estate investing from real life examples. Here's your host, Devin Elder.
Devin Elder: Ok, welcome to the show. Today I’m very glad to have with us, Mr. Scott. Chopin Scott is a real estate developer of highly undersupplied, multi-generational urban housing for families. He is producing investor opportunities in long-term hold new construction investments, which is a little different from what we normally talk about and he focuses on high demand urban metros. Scott, welcome how are you?
Scott Choppin: I'm doing well, I appreciate the offer to join and happy to be here.
Devin Elder: Yeah, great to have you on. So let's kind of kick it off. Where are you, where are you based out of and where do you live and do you operate there?
Scott Choppin: Based in Southern California. I'm actually a native of the city of Long Beach, where I live and raising my family which is the 4th generation of our family and here in the city of Long Beach, we have work all over the western United States. Although right now we're very focused in California just given the demand characteristics for new construction in Southern California we have plenty of work to do here and stay local.
Devin Elder: That's great and that nice.
Scott Choppin: Which we always love, being your backyard, if you could.
Devin Elder: It's not always the case for everybody but that's nice. So how, what was your journey like to kind of this investment space that you're at? How'd you get started?
Scott Choppin: So, I actually have a family background in real estate development so I'll differentiate for, for myself, our company and my family's background predominantly development versus investment, although they go together as everyone well knows. So I grew up around uncle and my dad who are in the business in various forms and so gave me a background on what is a real estate developer do? Why is that a good career choice? And most importantly how can you make a career out of it and make money? So I actually spent from about the time I was 18, numerous years basically going to school and working for companies to get training in what is ultimately a fairly complicated business. Zoning and construction and sort of things that differentiate new construction from existing assets.
So, I have worked for major fortune 500 companies, I've worked for a company that's now known as KB Home used to be Kauffman and Broad and I worked for a division of theirs that built multi-family new construction. Basically apartment assets for their own corporate investments and worked for a couple of other companies but always in that vein of new construction ground-up multi-family.
Devin Elder: That's great. I appreciate that. There seems to be kind of two separate camps and whether its development ground up and redevelopment. Like stuff we have historically done with my company and a lot of people, we have on the podcast. So I'm excited to kind of dive in on some of the differences. Obviously, they are very different worlds one of them you know B and C value-add multi-family kind of has cash flow from day one and you're hoping to find something broken and come in and fix it and prove net operating income. Whereas, on the new construction side, it's a different deal. A friend of mine that does development we were having a conversation the other day and he said I'm trying to have the conversation with all these value-add people about new construction it's the ultimate value-add we're taking hurt [right] turning it into you know the this this new stuff so you know they kind of made sense. But maybe you can dive in a little bit on and educate our audience that might have some understanding of what kind of a B or C value-add deal looks like in a repositioning and cashflow and compare that with how do you talk to your investors on a ground-up project.
Scott Choppin: Sure and just by way of example, Joe Fairless, in his book, he uses the term forced appreciation. That's what development is, so your friend's exactly right. I mean, it's the most challenging, high-level forced appreciation. But in essence, you're taking a raw piece of land and turning it into a brand-new asset. So, the way I like to think of it is really in three buckets.
So the first bucket is what everybody knows, is how to underwrite apartments, how to find rent comparables, how to produce operating expense budgets and manage that. So you can build NOI, increase NOI, so the normal multi-family apartment underwriting. The second component is the development characteristics, which are zoning, construction, land acquisition. Which we can talk about in more detail later.
And then the third, which is ultimately what we are all after, is having an asset that's worth more than what you paid to produce it and selling it at some point. Whether it be immediately in a merchant build model or hold it and rent it and then sell it for appreciation down the road. And that last characteristic is the same for you guys and value-add as it is for us in new construction, we're looking to produce value above our cost structure. So it's really in the middle, the second bucket, that is the most difference between value-add and new construction and that's whereas I talked to people like yourself I say, "hey look, it's not insurmountable the knowledge that's there needed to produce those new construction assets". It's not rocket science, anybody could learn it except it is more obscure so most people who buy existing assets don't think too much about zoning because guess what? It's already multi-family, you've got a historical use, you don't care at some level that it's zoned X or Y or Z. You just know it's multifamily now, so those kinds of questions just disappear for you when you buy an existing asset.
And then in value-add, you have construction challenges as well except the challenge of construction is now more because instead of doing paint, carpet, cabinets, countertops, you try to have weight systems if you can. Sometimes, you get into it and value add and if you're doing it well, don't ever touch structural issues in an asset, you probably go away. So, in new construction, we build all those systems, foundations, framing, what we call MEP or mechanical electrical plumbing, all that's built new. So, different set of subcontractors, more sophisticated construction people, needed both on the people to do the work and then those who of us who manage it. And then, you're working with more sophisticated vendors, architects, civil engineers, etc. and so, those who I think would be the key differences: land acquisition, zoning in one category and then the build process. I'd add a third, which is just the comfort level you have and your own underwriting and execution as a developer because you brought up a key point as you, let's say, you have a two-year build process on a significant institutional great asset new construction. You're going to have two years of money going out and no money coming in, in fact, you have the budget for the money going out and borrow it and raise it in equity. And so, I think that what I talked about, you add people who are looking to move into California can't find anything that makes sense from an economic standpoint because everything's too expensive. They start looking at new construction and I, actually it's funny, I say, "are you prepared to have two or three years of no cash flow coming in?" And that usually stops about 80% of the people dead in their tracks because you know it is a very fundamental difference and some people just can't get comfortable with it and I don't dispute that their logic for themselves is appropriate it's just one of the key differentiators.
Devin Elder: So much has to do with comfort level and people say I'm not comfortable with this and well, lots of people are doing X, just because you're not familiar with it doesn't mean it's not prudent. It's just a comfort level thing and a lot of people come up and under a certain, they started investing with this one guy years ago and they did it this way and that's the box and I think there's a lot of validity to that. It's staying with what you know and do what works but really there are different approaches, you are approaching a capital stack on let's say... Well, first of all, let's paint a picture on what is a typical project? Is it 200 units? It's going to go in A, B area? Or am I way off base?
Scott Choppin: No, so we in the introduction, you talked about the multi-generational what I call, workforce housing. So, we have a track record of doing many different types of projects anywhere from small to very large. About three years ago, we developed a 400 plus unit asset in Westminster, Colorado that would be institutional-grade, large institutional equity and debt. But in 2016, as we watch the market mature we started to want to differentiate so everybody was doing a certain type of urban housing particularly where we are, and we have always been a company that wants to be making an uncommon offer, think contrarian, not being where everybody else says.
So in 2017, we created a program called the UTH program, which is just our brand of a townhouse rental product. Which is a three-story on-grade townhome, garage on the ground floor but with key differentiators that we are building a five-bedroom, four-bath townhome rental product. So, think of it like your standard townhouse model that most people would buy in most traditional urban markets instead we are building it to rent it to multi-generational families.
And we have picked that space particularly because it's not well competed for, nobody's really building in that space. And we see it, particularly where we are in California, is a vastly undersupplied market high demand, low supply which is the sort of characteristics that we want to see. Those projects, when we did the demonstration phase in the beginning, we actually purposely did small projects to prove the model and so those were actually small as you know; two duplex, four-plex quads and that kind of thing. To make sure that we could deliver the cost and rents and values for sale that we projected which we did and we've completed that. Now we've moved up into the production phase, which is projects that are in between 30 and a hundred units and particularly we're limited at a hundred right now because when you build a five bedroom, four bath product and have families moving into these units, you have a different characteristic than your normal management of a standard one and two and three-bedroom multifamily product. So, we're just being conscious about that making sure that we're producing a good lifestyle for the families that live there and particularly also for us in the infill environment. Meaning, in existing neighborhoods it's hard to find 10 acres to build your large projects those land assets are just less available generally.
Devin Elder: That makes sense. So, what is your capital structure and stack look like going in? Is it per project varies a lot? Or do you have a repeatable model that you use?
Scott Choppin: We definitely have a repeatable model, in fact, this UTH model is the most production-oriented design and build process we've ever had. In fact, I compare it to a home building model, so in Texas, you'd have the Beazers and the Tolls and the KBs, the RayCos, if you're in San Antonio. Although I think RayCo is gone now. We purposely want to build the same unit over and over again because what that does, that drives cost efficiency. We can use the same subs over and over again and in most markets, you are, I think, experienced in Texas. In California, that very high increase in construction cost both material and labor as the markets return and we've up production so we have to be very careful and manage that for simplicity. So, our capital stack generally looks at, pretty typical development model would be a 75/25. So 75 percent would be debt, construction debt in the beginning, 25 percent would be equity. That's a rule of thumb, there's no standard to that but you know most lenders are at somewhere between 65 to 75 percent loan to cost so we have to plug in the equity. That is, the amount to make up the full capital stack. And we try to use the same lenders and investors deal after deal because, you alluded to if somebody's comfortable with an investment model and it's proven, of course, that attracts returning capital as well as new investors.
Devin Elder: Yes, that makes sense. A really straightforward debt plus equity model similar to what those of us in the value-add multi-family space do. Are you structuring...I love these details on how people put deals together and so, are you structuring just one equity set up for investors? Or are there hurdles that you're hitting? Or how do you set that up?
Scott Choppin: Well, so as far as the equity, how we produce returns for equity, I mean it is almost infinite. We have some projects where it's a single high net worth investor or a family office but generally we're anywhere between if we can get 50/50 on the back end for a profit split after pref we would always choose that and we have some investors that will do that with us. I think the market for your standard investor and new construction or even in your space might be 70/30, 80/20, 80 to the investor and 20 to the sponsor.
So we're really, in fact, as we were prepping for this interview you got me to thinking that we really do compete amongst investors with people who are producing like yourself, value-add projects and we get compared all the time to that and it's right. We're in a competitive market and so it's our job as a developer and sponsor of these projects to produce both the compelling story about why these project makes sense, why somebody would make the move to new construction. There are some story about our product and a defensible category and a recession that's probably out there fairly soon. But in, in many cases, because we ask people to take a higher level of risk ostensibly, while you have that two years of no cash flow and no building at all, going to an empty building then, to a full building and lace up and stabilization. We are having to pay generally, a market superior return as how I describe it, for development projects that would be low 20s and up on an IR basis, on a two to three-year merchant build model. So in other words, merchant builders build it, rent it and then sell it immediately as soon as you reach stabilize occupancy.
Devin Elder: And is that the model for you to go with that merchants build exit? Or are you ever looking at, "hey can we take out our investors, hit our IRR and hang on to this thing for a decade?"
Scott Choppin: So, it's a great question and actually we find ourselves today in a changing situation with the economy. I mean, you're tracking it I'm sure as closely as we are. We're seeing the yield curve is inverted three months, ten year inverted a while back and we're now at the two-year ten inverting, at least playing with inversion. So, we're looking forward to 12 to 18 months out some change in the market, downturn, recession, however, you want to describe it. And so, what that's had us do is basically leave the merchant build model we're finishing, we have one project that'll start this month in Los Angeles and we'll build that and sell it probably sometime early, so it would be probably spring of next year. And then, all the other or projects that come after that will all be long-term hold capital raises.
So, we're really looking for five to ten year hold periods, same asset style, same UTH, same workforce, multi-gen. But now we say, look let's see if we raise five your money or ten-year money, we're bullish on the on the undersupply story and when researching rents in the, let's say, Los Angeles market, through 2007, 2008, 2009, 2010. We really had almost no lowering of average rents across the market. In other words, very stable under-supplied rental market and right now we're more under-supplied now in rental housing than we were back then. And so, we look to the right kind of product being stable in a recessionary environment and that's not your big projects that are renting to millennial and Gen Zs. I think those projects have pressure meaning, lowering rents, maybe oversupply. And so, that was exactly why we shifted to this UTH model was that we want to be in a space that's under-supplied and vastly under-supplied if we can find it. Of course, anybody would do that if they could and in this particular market we see that. So we look to stable incomes during a recession and then in five, seven or ten years when the capital is ready to be paid back either we sell the asset or as you say refi again or maybe just raise new equity and payout. We as a company and me personally, as the owner of the company, I want to hold assets long term.
Devin Elder: Absolutely. So, I'm in San Antonio we've got certain market conditions here. So thinking about Los Angeles one thing comes to my mind, what's a cap rate on something you guys are [inaudible]?
Scott Choppin: So, great question.
Devin Elder: I'm ready.
Scott Choppin: You guys are going to laugh at this, we're hearing stories. I mean again we're not in the value-add space per se, but I am hearing stories of people buying sub 4 regularly like that's the average. And then, if you get into very, very tight markets like West Los Angeles, Santa Monica and those kind of markets even as low as 3, sub 3 and I've even heard a couple stories of somebody buying a 2 cap. Which I said, "prove it to me!" Right? Show me, they couldn't so... but it's not out of character when you're at a 4, sub 4 or a 3. And I mean, maybe there's a story there for somebody as a buyer particularly if they're a really long-term hold buyer and say, "hey I have a great asset in Santa Monica". It's really hard to build there, there's a limit on supply story politically in California generally and then some of these markets that's almost impossible to build anything new it's very, very difficult. So you can organize around that but, I also go look, if you are wrong in the way rents are trending or the way the interest rates are trending it's really easy to erase that 3%. I mean...
Devin Elder: Right
Scott Choppin: Just in an instant you could be upside-down, now again if you are long-term hold maybe go find my values below what it was when I purchased but in 10 years or 15 years it'll come back and maybe even exceed, and we certainly saw that in the recession. Southern California, although for sale housing was more critically hit than multi-family was, we had stable income but lowering value. So, we anticipate some version of that from the family and so hence, the preparation of long-term hold. We don't have to sell in four years when we're still in a recession coming out where seven-year money, ten-year money and then we think we're going to be fine there.
Devin Elder: Yeah, that makes a lot of sense and cap rates just one piece of the puzzle, it doesn't tell the whole story. It's just always interesting for me to hear these different markets especially something that's so radically different than...
Scott Choppin: Yeah...
Devin Elder: a [inaudible] market
Scott Choppin: Yeah... no, no three cap deals in San Antonio, probably.
Devin Choppin: That's right we might have bought some three cap based on actuals but that's not...
Scott Choppin: Right, but then you, you know you're delivering it at a six or seven or eight when you're done right?
Devin Elder: We are seeing some compression though, it's interesting and you know kind of surprising too. So we'll underwrite for expansion it is just nobody knows how...
Scott Choppin: Yeah, but you guys are probably, the term I use is vigilant. In other words, we are still entrepreneurs in real estate, we want to produce prudent projects, you have to be watchful and vigilant and prepare. And that's why we have converted now to all long-term capital raises and no short-term money or short-term deals, projects, schedules.
Devin Elder: So what does it, what does a lifecycle look like forgot a project where you've identified a piece of dirt and you're kind of kicking it off, are you guys kind of sourcing these the infill lots from brokers? Do you have somebody in-house sourcing it?
Scott Choppin: We do both. As anybody the same as you guys in your market, you're having every source that can possibly be found to try to deliver deals to your front doorstep. We have, we do have relationships with brokers from my institutional days, I have got a lot of those relationships. I will tell you though, that our UTH model really is better serve to be in low and lower middle-income neighborhoods. So think blue-collar neighborhoods is where our tenant base is and also where we like to develop because the challenges are less from any sort of political kickback, for zoning or other moving we may need to make. But really the two purposes for being in those neighborhoods, one is that's where our tenant base already is, they already live in these neighborhoods we just happen to be giving them a 5 bedroom, 4 bath unit with a garage to live in, which is not a space other than the house that is available to rent in the apartment world. But also, a key advantage is we're able to buy land more cost-effectively, it's not as high demand, we are not competing with luxury for-sale builders or even luxury multi-family guys. So what that does it really takes a lot of the mainstream brokers out of play. They just don't track deals in those neighborhoods and that's fine.
But we do have a key set of brokers that do travel in those areas, we have our own ongoing, just weekly practices of our research, co-star and loop net and those kinds of sources where we find stuff. And then interestingly enough in California, is a lot of cities are mandated to produce a certain amount of housing production under some rules that we have at the state level. And so cities have sort of become an advocate for us to try to produce housing in their own cities and so they might call us and say, "hey, I've got a piece of ground and city of Southgate and we want you to take a look at it and see if it makes sense for your program." And then a brand new one for us in California is, school districts now are allowed to transact some school district land if it's to facilitate teacher housing, and our UTH model and teacher housing actually go together perfectly. Now it's a very cutting edge, brand new, but I think in the long run. In California particularly, if we're going to produce the amount of housing that we need to even remain remotely affordable, which we're not now, then I every private sector employers, public sector employers, school districts, cities are all going to have to be producing as much velocity and transactions and new build housing as possible. And so you know, normally cities are against development in many cases or at least critically they are, now we're starting to see with the force of new laws at the state level that cities are starting to go, okay I guess I got to begrudgingly get on board with this and so we see those areas two long-run future resources to produce more deals.
Devin Elder: Yeah, well that's a good thing for sure and you're supplying a product that is absolutely under-supplied so they should be getting on board. Once you've contract a piece of dirt you're looking at, just for some perspective here for me, this is kind of unfamiliar territory. You contract a piece of dirt January one, when's the first tenant moving in?
Scott Choppin: We're generally underwriting for your average size project so let's pick one now. We have a fifty-three unit project we're working on right now so I give that about fourteen to sixteen months to build it. Okay and then your absorption, I might do six to eight a month. So that plus... just to line it up linearly. So we would get a piece of land under contract, do our due diligence, that would be forty-five, sixty days. Let's say we're comfortable, we buy the land and then we start producing the plans. Plan productions probably two months, plan check is probably four, six, eight months, then the build twelve to fourteen to sixteen months and then absorption. So, you're really not getting a tenant in your leasing operations for minimally two years and some cases three years on average.
And that, I think, that's a key difference between you in the value-add space where you would turn units as you could. And that's really where that risk profile for investors differentiates itself because they go wow, I've got all these different new components, I never had to do full architectural plans and civil and MEP, I never had to do plan check. I'm speaking as if I'm the investor assessing that risk and am I investing with a competent sponsor, operator, developer? Do they have a track record of doing that? And then unfamiliarity with those processes. So what I encourage investors to do is use their networks of people like you, have your friend who's a developer and I'm sure you have these conversations with that person as well.
And I also encourage people that either want to get into the real estate business or are investors that are looking at transition to partner up. We do joint ventures all the time with people that are like, let's say, they want to come to California and they have no experience although they're a developer from Florida. That is a real key differentiator in pairing down the schedule, assessing and mitigating the risk correctly, in California the politics of rezoning and general plan amendments. What I call entitlements, this is a huge challenge and it eat keep people alive if you don't do it. In fact, that's why for UTH we really predominately buy zone sites meaning, buy a right so we don't have any rezone or anything, that kind of thing. So, in the beginning, I think I would always encourage people to joint-venture or hire somebody or whatever I mean there's lots of knowledge of people that are in the real estate developments basic you know can essence be brought to the team in various different ways to make that transition more smooth.
Devin Elder: That's such a great point I always advocate that too on these larger projects, whether its value- add, new construction, etc. You talking about millions of dollars, there's nuanced components the whole way through and joint ventures are great, figure out a way to add value and get in the game and don't worry about necessarily your ownership stake when you're starting out, I think it's a great way to get started.
Scott Choppin: Well, in your space, would be somebody who's raised equity and bought
smaller value add assets and they all of a sudden want to move into that I want to buy a hundred units, one hundred and fifty, two hundred, different set of investors, potentially different set of lenders, different underwriting process. I mean, that the technical characteristics of underwriting rent and operating expenses, NOI are the same. Obviously, the numbers are bigger but I've seen many people that were moving into that bigger project space which you always would do, as you become more sophisticated. Guys like myself get into bigger projects you don't want to mess with 20 units after you've been doing it long enough. Unless it drops in your lap and it costs zero or something like that.
But I think it's the same thing in development, it's just finding somebody who has that skill set in that particular new domain that you can assess they really have that competence. And then, give it up, piece of the deal. There is a cost to it but what's the vice-versa or the opposite? Which is what? You lose the deal, you piss off investors if you lose money or you don't make money. I mean, nobody wants to do that, no. And certainly in the beginning of my career, we paired up regularly with people who had more you know more liquidity, bigger financial statements for guarantees that you have to do on the construction loans, better knowledge maybe somebody has a site that you covet, you go, "wow I'd love to develop on that site", but you know Joe or Jane they control it. And there's a story there about joint venture, and in fact, we still do it regularly even as seasoned and sophisticated as we are after 19 years of running this company being purely in that space.
Devin Elder: So we've seen in our market, a lot of the new stuff that's been developed and multi-families kind of been this luxury and so I guess that plays well for us as owners and sellers and it makes it difficult as buyers because we're pretty supply constrained. But you've got a certain type of luxury product, what are you guys doing for a finish out on something that is workforce housing? You're not going top in on fixtures but I'm curious to know what does that look like? And I don't know if you could quantify what you're saving versus a luxury product but just kind of ballpark differences there.
Scott Choppin: I think you would find if you looked at, let's say, your standard luxury product for a twenty-something in Austin like we were talking about Austin before. I think you would find that the finishes that we supply are very similar. We use a production grade cabinet, recently we were doing quartz countertops and under mountain sinks. You can buy cabinets for very expensive that have self-closing mechanisms and European hinges, so that's the level. Appliances would be similar, production grade, maybe a stainless insert if you can buy effectively. Carpet, we try to do probably more not hard surface like tile, but like a wood plank, like an engineered product or a vinyl plank product because our units will be used harder. There are more kids, more family members for a five-bedroom unit, we assume between six and ten people. It's one of the reasons we do four bathrooms because, as you know in owning multi-family assets over long run, your kitchens and your bathrooms just get beat to death. Particularly bathrooms and plumbing and showers so, that's one of the reasons we went to four baths set up because we just knew that that would be used, utilized much more.
On the cost of furniture, I would really think we're buying these products in a very similar cost category to your production luxury builders. I think the key differential and our cost savings comes in in our building format. So earlier I mentioned a podium building, a podium building you are familiar with it, would be parking structure below grade or on grade and then the units sit on top of a concrete parking structure and you go up three, four or five levels, would be like a short high-rise. That would be another way to describe it. And then, our model is a three-story on grade so it's like your two-story house except it's got one level taller but our garage is still on the ground floor entry door, foyer, entry stairs. We do make them multi-generational by putting the bedroom bathroom on the ground floor, so if you had an in-law or you know grandma, grandpa that kind of thing.
Devin Elder: Sure.
Scott Choppin: So our big cost savings is in building a different type of building. Meaning, no podium, no parking structures, no complicated mechanical, electrical plumbing, really, really simple. Think you know in the old days we called them dingbat apartments. It would be your most basic production but we can rebuy cabinets like we saw some of our stuff locally or on occasion, we'll buy them from overseas. But you can get cabinets very cost-effective that look good and stand up reasonably well and so our cost savings on finishes it's probably de minimis, compared to other luxury products.
It's really in sourcing our land more inexpensively and then we have a less complicated, faster, simpler build. So that allows us to hire different category of subcontractor where we can drive cost savings you get in these big projects and you don't have union labor, you don't have a tower crane that you have in some of these bigger projects. So simplicity and reduction of complexity is really where I go. Anything I can do to make it simpler, what the saying I have is complexity and development is the enemy of profits. The more complicated your project, and you have the same in value-add, if you have a more complicated undertaking. That's why you would prefer never do structural repairs on an apartment asset because it's unknown, it's more complicated, you need to hire different higher level sub-contractors, so similar choices different domains. But you're still looking to keep it simple, keep it short and sweet on the execution, increase profits, increase velocity.
Devin Elder: Love it, love it. So we spend a lot of time talking to investors and some are seasoned, some are new and we kind of walk through the investment model. If you were talking to an investor and kind of walking him through an investment project, what's the high level on, I tend to think about things in terms of like cash on cash return. If there's distributions, when do they start? Either IRR or average total annualized return over the life of the project. What are some of the conversations you guys have with investors what you're doing?
Scott Choppin: It's always a comparison I alluded to earlier, not that we're talking necessarily the same people that you're talking to but anybody who's relatively sophisticated invest in multi-family assets, has an array of offers that they're looking at and its value-add. I think we show up more often to people with something different and so what we tend to do is, we really tend to focus on the differentiators for new construction versus value-add.
Now obviously we have these risk characteristics of a two or three-year build process, we have to lease these up from zero and we have to build it and acquire land. But on the flip side, some of the advantages we see is one when we do finish the asset and stabilize, we have a brand new asset. Literally, brand new HVAC, brand new systems, all the things that when we own apartments that are older in the long-run tend to break down over time, so that's one key differentiator. The other thing that I look at is when you buy an existing asset, you're always buying what is available in the marketplace. In other words, you can't go to a neighborhood and say I really like that neighborhood now let me produce an asset in it. Now, you would track the neighborhood but still ultimately you can't force the property to come to sale you either have convinced the seller and so or owner to sell or it's on the market. We now have this choice of going to a particular area or city or neighborhood and looking if we can find under-utilized land or vacant land, now we can produce an asset in that market that didn't exist before.
So there's this unique way used to produce new opportunities that come out of thin air all extensively. And then the other one I really focus on is really a differentiator on that product type. What I call the unit design and so, like for us this five bedroom, four bath is a very key differentiator. We say, "hey that makes us different than everybody else", really we're on the extreme end of that spectrum but there's high demand, low supply. One of the other things we talk about our units is, all of our units have a two-car, ground-floor direct access garage. So it looks like a townhouse, think of it, think about any asset that you own. I own assets too - you know I've lived in apartment assets, I never had a garage. That was my own two-car garage that you could shut the world out and unload your groceries at your leisure, so those become key differentiators but the attract renter is that the rents that we want which produce the returns.
But also when I talked to investors, I highlight these key differences because they go in the long-run, you still want to differentiate enough so that you don't have the problem with owning any multi-family asset, like in Texas, you guys particularly have this experience in any market that's easier to build in, you could buy an asset and then Trammell Crow could land next door and build you know 500 units of brand-new housing. And that's possible in California too, but in the neighborhoods and locations that we're in generally not and if anybody is, they're certainly not building five-bedroom, four-bath. So again, uncommon offer, differentiator, what I call margin utility, what is different about our product, that makes it different. Now having said all that, I still have to basically convince investors that the risk mitigation or risk profile is worth the investment.
And so generally, we're going to need to be at a higher cash on cash return or at least equal on cash on cash. Once we're stabilized relative to other competitive offers in the value-add space and so generally for us, you look at it high teens low 20s on a 5-year investment for an IRR. An IRR is a good indicator although it's very sensitive to how you underwrite and particularly any underwriting is a function of how well are the projections that you make into the future. Am I trending rents? Am I trending operating expenses? Am I doing it appropriately? We don't trend rents but I know lots of people who are in new development that hey, I'm going have you know 5% bumps for the next three years while under development so my rents will be 15% higher when I get there.
Devin Elder: Well, you can make the argument that's very interesting, I never considered that.
Scott Choppin: You can make it and I think anybody who's relatively seasoned wouldn't do that if they could shoot. So, in other words, if you could not trend and still produce good yields to investors and make your project feasible, you would always do that. So it gets into the slippery slope but particularly as markets heat up and construction costs go up, land becomes more expensive, labor's harder to get, so timelines extend on construction schedules that starts to be this pressure on returns. And it happens in the value-add space too, right? As people compete, lots of capital competing for deals. That's why you get into those three cap, stabilize purchases in Santa Monica because everybody's beating each other up to try to get that deal because there's nothing else to buy, very, very little.
So you know we're always looking to produce conservative underwriting but an edge and that's why we go to these different locations, different tenant profile, different construction type. And for us in the UTH model we really like the story and a downturn scenario our tenants tend to be already from those neighborhoods, working-class families and the way I describe is they're sticky. In other words, their social networks are strong, their kids are in school, their church is down the road, their family lives all around them, more often than not. They're not long-distance commuters, for us like in Long Beach, our typical tenant would be dad drives a truck at the Port of Long Beach, which is three miles away and he doesn't get the need to get on the freeway and commute. So they tend to be like a localized sticky and the joke I make is you know if you rent to Millennials or Gen Z.
And although it's perfectly logical for them in their life cycle, if they lose their job, they can move away very quickly there's nothing keeping them local, they don't have kids, they don't have any network, other than maybe what they built at work so my joke is you know that millennial renter can move to Austin yesterday. They just can scoot and so not that we advantage ourselves related to our tenants being sticky we just serve that family for the need that they have and just know that their lifestyle will be more stable for us in a downturn scenario.
And then the last thing I'll mention, is that there is a story for us to have some of our units, small percentage units, to be available to section 8 families and although we do have an asset that I own in Thousand Oaks, it's all section eight. But it's seniors section eights, not for everybody, but we see story there with section 8, as being another stable source of renter's and for us, a very stable income source needs to be the Housing Authority, through the federal government on the section 8 vouchers. So we offer those on a limited basis regularly, but in a downturn scenario, we had a hard time finding renters or rents we were under pressure the section 8 program is actually a good defensive place to go. And interestingly enough, because we do these five bedroom, four bath units, our rents in many cases or the market rents are the same as the section 8 rents for that unit type or unit size maybe a couple hundred above or below but right there. And so that's a good story on top of that for a defense and stance and the units.
Devin Elder: That's great. Well, Scott, this has been really helpful to help me understand and hopefully some of our listeners to understand that the difference is on the new construction side. I have one kind of personal just curious question here,
Scott Choppin: Sure.
Devin Elder: What's the dollar per square foot on, on something you guys are doing I mean or dollar 10 on rents.
Scott Choppin: A great question, so we all focus on the value ratio, how much per square foot am I getting? Interesting enough, when we do these bigger units we really don't focus on that so much, where I basically focus is hold all the rents and I do that because basically, our units set a five bedroom, four bath might be 1750 on average for our standard unit that we like to production build. And our markets vary anywhere from 3,000 a month to 3,500 a month so that might be a dollar $70, $80, $90 a square foot. Which in some markets would be high but in California, like let's pick Long Beach, rents are easily 350 to 4 bucks a foot as for your standard.
Let's say you got a studio or one-bedroom, we're looking at some projects that we're tracking where the two-bedroom, the rents is 2,800 a month and three blocks over I have one of our UTH models, which is double the size maybe more and it's 30 to 50 a month. So comparably, now here's the thing, our families would never rent in that two-bedroom. It's not an appropriate form of unit two bedrooms, one bath or two baths. Our competition really is houses, this is what I tell my people internally if a family could have their choice they would always rent a house. If they could have the right backyard, detached garage, driveway, front yard, the American Dream, white picket fence. Except that the challenge is that either these owners of these homes may be an individual homeowner maybe corporate owner generally, are not going to rent to a family of six or eight or ten.
They wouldn't prefer that so it's a little bit tougher to find but more often that what ends up is, those house rents are above where we're at so, let's say, we're 30 to 50 in Long Beach or even 3500 now. Either you can get a really old tiny house for 2,800 a month, but it's two bedrooms or 3-bedroom 1-bath, no parking, no air conditioning, no nothing new. Or, if you are going to get the bigger newer house with systems, air conditioning and driveway that kind of stuff you know you might be thirty eight hundred, four thousand, forty five hundred a month and obviously most of those homeowners wouldn't ever accept section 8 or it's much more difficult. So we're generally about two to three hundred a month below the closest comparable house is sort of the metric we use.
So when I give you these thirty to fifty thirty five hundred usually we have seen house rents that are four thousand and above in comparison so we're somewhere between three and maybe as much as $700 a month less than. You don't get your backyard, I do have your two-car garage, the play areas are limited because obviously, you don't have the front yard, back yard. But we're finding our tenants recognize what the opportunity is, particularly because our projects usually are closer to what they already know that job, the community, family, that kind of thing and so we're just trying to be coherent with an already existing market. Which is a family that lives in a blue-collar neighborhood, is a working-class family, would rent this or that if they could but no one's offering it and now we're just offering a new type of unit into existing marketplace that never had that offer. There is almost nobody doing these five bedroom, four bath and certainly nobody at scale so we're [inaudible].
Devin Elder: It's a big unit multi-generational, its below what the house is comparable to, it is going to be and it is brand new, what not to love?
Scott Choppin: Exactly.
Devin Elder: Well Scott, this has been really helpful. Thank you for actually adding a lot of value to our audience. If somebody wants to reach out connect, getting your universal, learn more about what you do, what's the best route?
Scott Choppin: For that, they can just go to our website, which is www.urbanpacific.com, and there's a contact page there and certainly people can reach out through that and that will go to our team and they'll get those folks in touch with me.
Devin Elder: Perfect, well we'll link to in the show notes Scott thanks so much for coming, on take care.
Scott Choppin: Thanks Devon, appreciate it.
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