Real estate is often considered as an alternative investment – and rightfully so. Today’s guest, Harvard Grace Capital CEO Stewart Heath, takes issue with that. He argues that real estate is the only alternative as far as Wall Street frames it as such. To him, real estate is the original investment. Whichever way you look at it, real estate is certainly a great way to boost your portfolio with recession-proof assets – if you do it right, at least. In this episode, Stewart tells us the lessons he learned from his 35-year career in real estate, particularly during the 2008 recession. He shares with us his thoughts on the current economic slowdown and how this differs from the one he experienced more than a decade ago. He also shares a bit about the Nashville and Huntsville markets, which are the closest to him. Tune in for some great insights on how to effectively navigate today’s market challenges!
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I’ve got a great guest, Stewart Heath of Harvard Grace Capital. Stewart and I are in a mastermind group together. We’ve got to spend some time together at various conferences. Stewart is a 35-year professional. He runs a company called Harvard Grace Capital, which does fractional C-level engagements for businesses.
Stewart has also been a real estate investor for more than twenty years, with experience in commercial multifamily development, construction management, and investing. One of the things I like is that Stewart has learned a lot of lessons from 2008, which is something I have also been through. You only know it if you’ve lived through it. We are going to have a great episode here. Stewart, thanks. Welcome to the show.
Thanks, Jack. I appreciate you having me. It’s quite an honor.
Given where we are in the world economy here, I would like to start talking about how we think this compares to 2008. If you could, share a little bit of what your experience was with 2008 and how you think this compares over the last few months or so.
It’s a topic that associates and I talk about quite a bit. I don’t think this looks anything like 2008 or 2009. It’s hardly comparable at all. 2008 was a genuine financial crisis that occurred from market conditions of easy credit and a bunch of people, including yours, truly getting way too much credit that was offered by banks. There was a slowdown. Warren Buffett is the one that said, “We are going to see who’s swimming with their trunks off.”
When the tide went out, everything was flowing back in 2008 because there was lots of credit. All you needed to do was get another loan. Asset prices were going up. You went and refinanced the deal you bought and got more money to buy the next deal, and then it stopped. Wiser heads were less foolish but I was doing everything 100% finance. Banks were all game for it.
That’s not the case here. I would describe our situation as an artificial economic slowdown. There was going to be an economic slowdown after all the money that flowed into the economy from the pandemic. You couldn’t go on vacation. What did people do? They spent money on their houses, sold their house, bought bigger houses, bought cars, and did all kinds of stuff other than travel. A lot of that was with free government money.
There was going to be a slowdown. You pulled a lot of demand forward. We knew things were going to slow down. What’s happening here is the cost of energy. The current administration put massive restrictions on our ability to generate our oil and petroleum here in the United States. That shot up fuel prices. The cost of fuel and energy is built into every product and service, especially food and anything that has to be delivered.
I call it artificial. It’s not artificial to us who are paying $450 a gallon at the pump but to me, it’s very reversible by the same stroke of a pin from which this was somewhat called. We have a genuine slowdown in the economy because of multiple things. There’s no more new free government money. The price of goods is going up. People have finite resources.
We hadn’t seen much happening in the job market, but now, we are starting to see that too. The world was shaken by Walmart’s earnings release saying, “We didn’t have such a great quarter.” Walmart’s customers are everyday folks. They are being significantly impacted by Walmart. It is in every business. They are in groceries, consumer products, and fuel. They are one of the largest fuel distributors in the country.
Artificial triggers are causing a real recession. They may be hard-pressed to say it’s a recession but we should find out if we had two-quarters of declined economic activity, which would meet the definition. This, to me, is nothing like 2008. Most of the businesses didn’t do anything to create this one. The Fed has one tool in its arsenal. I don’t know how raising interest rates is going to do anything about supply chain issues and fuel costs. We need policy changes without going too far down the political side. Both sides do stupid things from time to time.
I agree that it’s 100% different this time. The other key thing that I tend to look back to is in a lot of the residential houses, people got in trouble with these option arms where the rates were locked for a year or two and then doubled in some cases, whereas a majority of people in this case locked in 30-year fixed at 2.5% or 3%. They are not going to be forced to sell. They are locked in at a nice low rate. Those who didn’t buy may end up renting longer because the houses are now unaffordable, along with a lack of overall supply. I would like to think we are much more protected for those of us who focus on multifamily and other niche alternative classes.
The long-term housing supply outlook has been pretty rosy for the housing sector for 10 or 15 years. We’ve got people coming up. They are going to need apartments and houses. We can’t keep up. That’s good if you are on the investment side of housing.
Tell me more about your path. How did you get started in real estate investing? Did you migrate into syndications?
I’m a CPA. I became a CPA because my dad was a CPA. He was your very traditional, conservative, and stoic guy. He was a partner at Ernst & Whinney until the day he retired. The only job he ever had out of college was Ernst & Whinney. It sounded good to me but I’m a little bit more entrepreneurial than he was. I’m still a CPA. I still do CPA things from time to time but I’ve always loved real estate. Early on, I had exposure to several clients who were flipping houses before it was called flipping. They would build a spec house. I was fascinated to learn how they did it.
In about 2001, it’s an interesting story. There used to be a guy who had an infomercial named Carleton Sheets. I’m sitting there. It’s in the middle of tax season. I’m up at 2:00 in the morning doing tax returns. His infomercial comes on. I’ve probably seen it a hundred times. I started listening. It was a $199 money-back guarantee. I thought, “Screw it. I’m going to do it.” I started reading it. It was pretty good stuff. How do you do this? He was very practical about it. He would tell you how to go through the classified ads back when there were still newspapers.
I started doing it. Within a few months, I did a seller-financed deal on my first duplex in 2001. A month after that, I found another guy who was selling fourteen duplexes. We did a similar thing. I was able to get mortgage finance on the part of it. I got him to take back seller financing on most of the rest of it. I put $10,000 into it. I was a landlord. I had 30 rental units. I loved it. From there, I partnered up with a guy in Franklin, Tennessee, and started building houses. We turned some of those into rentals.
From there, I was still pursuing rentals. I ended up buying a small block of condos in one development. Two years later, I owned the whole complex of 70 units. We are renting them but I wanted to renovate that one. Condos were hot. This was 2006. We got those rented and brought those back on the market to sell in January of 2007. I sold 26 of them in the first weekend. I was like, “That’s great. I’m going to be out of this by Memorial Day.”
The world started to change. In March of that year, Lehman Brothers and Bear Stearns started having issues. I might be off a year there. That might have been 2008. I didn’t sell another one of those condo units for another twelve months. We were doing marketing every weekend. The world stopped. All of those 26 closed. The world slowed down. All of this was cross-collateralized against everything.
Long story short, in 2008, there was the presidential election. That was when Countrywide Mortgage informed the world on July 27th that they couldn’t close any of the loans that they had agreed to fund on July 31st. They were strange times. Everything came crumbling down. Ultimately, I was able to stay afloat for about twelve more months and ended up having to give everything back to the bank. I declared bankruptcy in ’09, went back, and got a job.
I never lost my passion for real estate but the way I have done it was stupid. I should have brought in partners. I learned the value of equity and having a cushion and reserves after all of that. I had appraised the values of everything I had put together. I was partners in some things with $20 million of real estate. If I had even $300,000 of reserves, I would still have some of those assets. Some of them were worth holding on to for a long time.
Learn the value of reserves, which is something we do now. We build in reserves because you don’t know what’s going to happen. When you build your empire on how asset value is always increasing, then you are never prepared for the day when it crashes. Nevertheless, that’s what led me to syndication. I’ve had several CFO executive positions in between but then, in ’17, I came out with Harvard Grace from the consulting side. In 2020, we formed Harvard Grace Capital. I have partners there.
We have closed one deal. We’ve got two in the works, which should close in October 2022. Reserves, equity, and raising capital, most of which we have raised from friends, family, and closed-end networks. I found out about RaiseMasters in early ’21 and joined in April of ’21, which opened, “This is how you do it. How do you reach people?” I knew the JOBS Act, SEC, and 506(c). I was aware of these types of things. I didn’t know how you would go about and find investors. That helped me with what you said earlier. That’s my story.
What was your first new deal after restarting? I’m going through what I went through. I also took a job for a year or two. I ended up in the nonperforming mortgage space, which is an interesting pivot. I remember myself and the level of anxiety. I somewhat lost my mojo to quote Austin Powers. How is the mental game there? What was the process to get back and do the first deal post-financial crisis?
I regained my mojo. The first job I took was down in the Huntsville, Alabama, area. He owns things. He develops and leases. He has been through something similar in a previous financial crisis. He snatched me up pretty quickly. We went out. I helped him structure deals. It was almost like going back to school because I could go out and reprove to myself that I still had the skills and the know-how with somebody else’s money.
Other than a couple of single-family homes that we did, which I hadn’t intended to, they were owned by a lady that I had married along the way. In the middle of this, there are divorces. There was a remarriage, which is a fabulous thing. She had some property. I didn’t want to get back into residential but I knew how to do this. We did those.
The first real deal we did was an office building in Spring Hill, Tennessee, which we closed on earlier in 2022. I had taken on a client. It was a not-for-profit that owned it. They owned this building. They didn’t know what to do with it. I said, “I do.” I managed this building for three years and then finally convinced them to sell it, which we closed in January 2022.
If you go back, people are like, “Nobody is going back to the office.” There were a lot of investors who thought, “You are crazy,” but I’m in the South. We pretended there wasn’t a pandemic for two years. Hardly anybody ever stopped going to the office. Everybody has adopted the hybrid model for sure but a lot of people are already doing that. We bought a 100% occupied office building with some expansion capabilities. We are in the middle of that deal. It’s going better than expectation.
I spent a lot of time thinking about the office market. It’s two different markets. I was in Napa. Silicon Valley is still very hybrid. It probably needs a lot less space. At the same time, there are also more people that can work remotely in different parts of the country that may need smaller offices in a secondary or tertiary market. What were the numbers? What’s your take on the office market as far as how to take advantage of it over the next few years?
You touched on it. There are some stats out there that support the fact that all of the movement from population back into downtown areas was slowing and, in some cities reversing. When the pandemic hit, we were already in the middle of a trend to go back to suburban offices. That’s where our focus is. It’s in the Nashville market and even in the Huntsville market, which are the two markets closest to me.
The central business districts are healthy but they are not for offices. They have become more entertainment districts. The office brand in downtown areas is still a bit weak but if you go outside the city centers, the suburbs, Nashville, and most places, there’s hardly any vacancy at all. I will speak for the South because I focus on Southern cities like Atlanta, Birmingham, Nashville, Huntsville, and the Tennessee Valley mainly.
How do you play that? If you can find a good deal on a suburban office property, maybe it needs some work. Work hard and do that deal. We are heavily focused on trying to find medical offices. Medical offices were never impacted. In some states, you couldn’t go to your doctor but all that stuff stopped pretty quickly. There are lots of office uses that cannot be done remotely unless doctors are going to do house calls again, which is unlikely. They are going to have offices, and you are going to have to see your doctor. Medical offices are huge opportunities. Most of them are full and stay full.
Our deal is that we are pursuing cashflowing assets. You pay a little bit more but there’s the predictability and the stability of that asset. What our investor class is looking for is recurring cashflow and the ability to do that. What I have found is that there are a lot of properties. We have put an LOI out on one of them. The visionaries have these, “Let’s put an office building there, which took a lot of risks,” but then they don’t know how to write a good lease.
There’s one that we are in. It’s a great location but he had no rent escalators in his leases at all. All of a sudden, we are in inflationary times. You could get away with that for about twenty years. You and I are of the age where we remember inflation. We were younger then but a lot of people haven’t thought much about inflation for 20 to 25 years because it has been such a non-issue. I don’t understand anybody who wouldn’t put rent escalators in a multi-year lease.
All costs continue to go up. The poor landscapers out there are suffering from gas prices. They are all having to go up. As all of your costs go up, your tenant is going to keep paying the same rent. There are a lot of opportunities out there from poorly-managed assets. It might be great assets, so you have to get in there and suffer but it might take you 2 or 3 years to get all those leases back to be more marketable. Once you’ve done that, you can then flip that office building because you’ve put the leases into a situation that will keep up with any changes.
The last few years have been much more focused on multifamily. I’ve seen the cap rates compress tremendously into 3% in some cases. We sold a deal on Phoenix at a 3.75% cap. With rates moving, we are keeping a close eye on where cap rates are going to stabilize. What does the office market look like as far as entry cap rates? What deals are you looking at now?
In 21021, they were mostly 7% and 8%, strangely. We closed our deal at a 7.6% cap. I’m very pleased with that. Since that time, everybody said, “People are going back to the office.” All real estate is local but most office properties are in the 5.5% to 6.5% range cap rate. I don’t think they are going to have time to compress as multifamily did. Interest rates are back up.
We’ve got a mortgage on the property we closed in January 2022 for ten years, fixed at 3.25%. We knew interest rates were going up at that time but we had that locked. I’m feeling pretty good. My lock is 5.5%. A lot of banks are at 6.5% or even 7%. I don’t think there’s any room for cap rates to continue to compress. I would expect multifamilies to expand a little bit, given the market.
Another big thing a lot of our investors look for, and I assume yours as well, is depreciation, especially through the cost segregation. What does an office generally look like compared to a multifamily as far as doing cost segregation on a $100,000 passive investment? What’s the range that investors can perhaps expect in depreciation benefits?
That’s going to vary depending on the type of office. If you are going to go to one of these glass and steel concrete structures, you are not going to get a lot of cost segregation or maybe 20% of the purchase price. The one we did is 28,000 square feet. It was mainly sticking construction and stuff like that. We are expecting about 35% of the total purchase price to get allocated to personal property assets. Out of $100,000, they should expect a $35,000 write-off in year one for that. That all depends on how they can use that at their individual level but that’s what they should expect. Multifamily runs at about 40% to 42%, if I’m not mistaken.
You are in the market. Nashville has been booming for a while. Nashville and Huntsville are your target markets.
We have defined our target market as what I call the 840/565 Corridor. There’s a loop around Southern Nashville, which is I-40, and then there’s I-565 that goes across Northern Alabama. Our focus is on those two. Nashville is overpriced. There’s too much competition. We like tertiary markets. There’s good value, good cashflow, and more stability.
We are smack in the middle of Huntsville. The other way is the Tennessee Valley. Spring Hill, Tennessee, is part of the Nashville MSA but it’s outside of downtown. Spring Hill is where GM put the Saturn plant in 1988. Even when they stopped Saturn, they continued to build other things. GM is building their EV factory and battery plant on that same campus. They are about to hire 10,000 more people within 2 miles of our facility there. Spring Hill is not going anywhere.
I love the phrase, “All real estate is local.” I say it all the time. You have to get to know your local market. Unfortunately, mortgage rates are nationalized but real estate opportunities are local. There are several great cities where there are manufacturing sectors in Southern and Middle Tennessee and Northern Alabama. Huntsville is booming.
It’s all but beneficially announced that it will be the center or the base of the new Space Command. There has already been a large military and defense contracting presence there. Toyota and Mazda put a new manufacturing plant there and hired originally 4,000 people. They are now hiring 3,000 more. All of Northern Alabama is a fabulous target opportunity for all kinds of assets. We are pursuing a self-storage project. I’ve got a contract on that.
I love self-storage. It’s probably the most recession-resistant asset because if people need to downsize, they need a place for their stuff. Anytime people are moving even if they are moving into an area, it’s often time to clean house and get different types of furniture but they don’t want to throw things out. I love self-storage. I assume you are mostly in real estate like me. Do you dabble in any other alternatives? Where else do you invest your money if there’s anything?
I’ve got a little money in the market. Frankly, I use it as a holding pattern. I keep it in things like Apple but have not done any crypto. Honestly, I don’t understand crypto. It makes me nervous. I’ve always liked real things. I like dirt. I like brick and mortar. I enjoy walking around, talking to the tenants, and finding out what’s going on. There’s a reason it’s called real estate. It’s because it’s real. I don’t want to dissuade anybody against crypto. I’m just saying I don’t understand it.
I’ve got some friends who have made pretty good money in crypto. It has not done so great in 2021 but real estate had its ups and downs in the past too. There is a future for crypto. Ultimately, the G7 countries of the world are going to end up dominating crypto. In one way or the other, there are going to be digital currencies but it’s probably going to be dominated by them because the governments are the ones that are most at risk from that type of asset.
I have been looking at some ETFs. I will have to buy some ETH to buy a particular NFT. It’s some digital art, which I would have never considered but this one particularly captured my interest. That’s interesting. It is a whole brave new world. There are a number of ways that this blockchain technology is going to impact all of our lives, including real estate.
I’m fascinated by it. I’m living down here in Puerto Rico. I’m surrounded by a lot of Bitcoin maximalists and decentralized finance. That’s the other thing. There are the NFTs but then there’s also the entire DeFi market. Those that are building it or trying to build it into an alternative financial system. You saw some major issues where one of the stablecoins collapsed but there are a number of other ones that survived. The crazy thing is that they even have certain coins that could track stocks.
There’s a protocol called Mirror where you could buy synthetic Apple stock using crypto. There are even some options available. At the same time, it’s very much not regulated. I’ve even seen some of the pump-and-dump scams from the ’80s happening with some of these alt coins here too. It’s the Wild West. I’m keeping an eye on it but I share your fear and relative lack of understanding. I know probably enough to be dangerous.
I wouldn’t classify it as fear. One of the things I’ve learned is to invest in things you know and understand. Like my golf game, I’ve never put the time into it to understand. I’m not good at golf because I’ve never put the time into it. I’m not saying it’s evil or bad. I’m saying it’s not something that I do but I will find the time at the appropriate time.
I’m not surprised that there are scams. One of my sons showed me this thing. He was trying to sell a laptop on Venmo. He got this email back saying, “You need to send the seller back $350.” He’s like, “I haven’t even got his money yet.” This is the same old scam from years ago applied to the new digital platform. There’s nothing new under the sun.
Those of us that have had some success too don’t need home runs anymore. You mentioned cashflowing assets. In 80% to 90% of what I do, I focus on principal protection and cashflow. I don’t need the 100X return. I have a little bit of money in ventures if you venture funds because if you are going to do a venture, you should be in twenty different projects as opposed to one.
It’s because nineteen of them are going to fail.
You need diversification. What advice do you have for people getting started on alternative investments?
First, I take issue with applying real estate to a term called alternative investments. Wall Street has done a great job of calling real estate an alternative. I like to refer to real estate as the original investment. It has been around since the beginning of time. It’s my little soap box. For people getting started, first decide how you want to be involved. Sometimes it’s hard to know. Do you want to be on the capital raising side? I enjoy managing properties. I would call that asset management.
We work with property managers from time to time, depending on the property but I enjoy running the asset. If that’s something that you enjoy, get involved in that side but if you are more salesy and you think you could get involved in the capital raising side, then follow Jack and me. Join RaiseMasters and learn what that’s all about. Real estate is not complicated. It’s not a very difficult business to learn.
If you’ve got the skills to raise capital, you can apply that to almost any industry out there. First, understand what interests you. Start small because you can get the same amount of education on a small transaction in a big transaction, although your mistakes will be small. Never question the benefits of actual equity in the asset. That’s the hard lesson I learned. Everything has been going up and up since 2001. It’s like, “Why would things turn around?” They do. A lot of times, it’s for reasons outside of your control and for nothing that you did.
That’s great stuff. How do we get ahold of you?
The best way to get ahold of me is through HarvardGraceCapital.com. It’s all spelled out. There, you can find a link to my Calendly. I would love to talk with anybody who would like to have a conversation. I can talk about real estate and investments all day long. You are welcome to go out there and grab some time. My email is there. My phone number is there. That’s the best way to get me.
Stewart, this is a great conversation. Thank you again for coming to the show. There’s great stuff. I’m going to keep with me that real estate is not an alternative asset. It’s the original asset. I like that a lot. I encourage everyone to please subscribe to us on iTunes, Spotify, your platform of choice or YouTube. Give us a thumbs up. Thanks again for reading, everybody.
Thank you, Jack. I appreciate it.