Tom Carroll, founder and CEO of Ballast Rock Capital, joined the Thought and Action podcast to discuss real estate investing with a positive social impact.
The thought for the day is how investment real estate can have a positive social impact and how that fits into a portfolio. The action is deciding how to apply this if you’re a direct owner of real estate yourself or looking to add real estate to your overall investment portfolio.
Real estate investing is a broad subject, so let’s start with Ballast Rock’s area of expertise within the real estate market, the origins of the company, and what is fueling the company’s success.
Ballast Rock was founded in 2018, and it was built out of experiences at a prior real estate private equity firm. Ballast Rock focuses specifically on workforce multi-family housing across the Southeast.
Because real estate is a very, very broad asset class, Ballast Rock has a dedicated geographic focus and a dedicated asset class focus. We have a niche focus and a niche specialization in workforce multi-family housing.
Dynamics of Workforce Multi-Family Housing
This niche has a very unique demand and supply dynamic in the United States. Ballast Rock is acquiring assets typically at one-third to one-half the cost of construction. As a result, we never need to worry about incremental supply. So supply is not a concern.
Let’s talk about what workforce housing means. It that residents have jobs that earn between $25,000 and $65,000 in gross household income. So our residents are typically police officers, teachers, nurses, junior doctors, and people working in the service industry across the board.
There’s a highly, highly limited supply of workforce housing. And at the same time demand is if anything increasing for workforce housing.
We focus exclusively on small to medium-sized cities in the Southeast. Columbia, South Carolina; Fayetteville, North Carolina; Macon, Albany, and Valdosta, Georgia, are all examples of cities Ballast Rock invests in.
We have two corporate offices, one in Atlanta and one in Charleston, but we do not invest in Charleston or Atlanta. Those are the two big hub cities for the Southeast, and there’s just too much capital chasing deals in those locations.
Investing in Durable Workforce Communities
We don’t generally invest along the coast. All of the coastal cities, such as Savannah, Charleston, Hilton Head, and Myrtle Beach, have a heavy focus on food and beverage and hospitality. Those industries have a significant downside in any economic downturn, and we concentrate on workforce groupings with a higher gross household income for real estate investing.
The proof is in the numbers, and in 2020, our revenues in the Southeast went up by 10% across our portfolio. So that focus away from the coast has paid off.
That said, no one saw COVID coming. We won’t pretend to be clairvoyant, but we did know that the next economic down-cycle would hit hospitality and food and beverage particularly hard. We wanted to avoid cities that have employment concentration in those areas, and that’s a play that worked out extremely well for us.
It’s also worth noting that our collections were unchanged for any months in 2020 versus pre-COVID, even though there was an initial moratorium on evictions and a CDC moratorium on evictions is still in place.
We’ve been unable to evict in most circumstances, which is an important tool for landlords — not one that we turn to first, but it is an important tool. Despite that, our collections have remained unchanged versus pre-COVID and our occupancy actually is now higher than it was pre-COVID. And that speaks to the demand in the Southeast, as well as the ongoing wage growth.
A Growth Location
Historically, the Southeast has had lower average wages than most of the US. But the level of wage growth has been very substantial over the last 10 years. And generally, unemployment in the Southeast is lower than in most of the country. So it’s a growth location.
If you live in this area, you know that there are cranes on the horizon constantly, which is always a sign of development and growth. And so our focus on the Southeast has paid out. Our focus on workforce housing and the demand-supply dynamic has paid out and been very successful.
Last year, in 2020, we paid 9% cash-on-cash to our investors. And in 2019, we also paid 9% cash-on-cash to our investors, which is extremely healthy. And that’s just on the income side.
We believe we’ve meaningfully created capital appreciation as well. At the moment, we think it’s somewhere in the context of 2-3x on equity in two years in the first fund. So, you know, we created a huge amount of value for investors and I think that’s really ultimately our success.
Advantages of Indirect Real Estate Investment
In addition to the numbers, there are advantages for investors who go this route beyond indirectly investing in real estate or managing it themselves.
First and foremost, Ballast Rock is taxed as a partnership. In other words, you get all of the same benefits from a tax perspective of depreciation and shielding of your income from income investing. You get all of those benefits even though you invest with a professional manager who does the work for you on a daily basis.
Also, it’s worth noting that there’s no difference between investing in real estate directly and investing indirectly from a tax perspective. We use things like cost segregation, however, that a smaller group or individual investor would probably never use.
On a smaller scale, investors use rule of thumb depreciation, which is much slower. We use cost segregation, which enables us to create very sizable passive tax losses upfront. Those passive losses can shield the income that we pay you as well as any other passive income in your portfolio. So it’s very advantageous to work with us on real estate investing from a tax perspective.
Non-Recourse Investment & Diversification
On top of that, investing in a fund means that it is a non-recourse investment. Now, all real estate has risk. Anyone that tells you otherwise is not telling you the truth. We would argue, though, that the risk is far lower than most others in your equities portfolio already.
If you invest, for example, $100,000 in your own real estate, you’re typically putting a personal guarantee on that debt. As a result, you are at risk for much more than the equity you’ve used to purchase the property. You’re at risk for all of the equity and all of the debt.
Again, real estate investing through a non-recourse structure means that no risk in terms of additional guarantees, whereas if you invest yourself, you do take that risk.
The other point is, of course, that it’s diversified. It’s a Sunbelt Fund II is a 50 million equity raise. We’ll be using that 50 million of equity to acquire between 120 and 130 million worth of real estate across North Carolina, South Carolina, Georgia, Eastern Alabama, and potentially Northern Florida.
Our average acquisition is around 10 million, so likely you’re talking about 12 or 13 different assets in that fund. And they’re spread across different states, different cities, et cetera. So you get a level of diversification that you could never create as an individual investor. You probably don’t have the capital for that as an individual. Also, you get a better tax advantage, and there’s no exposure to recourse on the debt.
In addition to the benefits of leverage and diversification, the best reason to invest in a fund generally, and ours specifically, is the deal funnel.
Our team has underwritten hundreds of deals in our space over the last few years. I’ve been on site for 70 or 80 deals just in the last couple of years. At the moment, we’ve underwritten more than 200 deals. We’ve high-level analysis on 200 more than that and we’ve actually only acquired 10 deals in total.
Our deal funnel is exceptionally broad. We have contacts throughout the seller and broker markets in our niche asset class and in our specific geography that individual buyers don’t have access to.
We get all of our deals off-market before they’ve ever been blasted out to a larger audience. In other words, guys like us have already trolled over the deals before you even see them. We are able to separate the wheat from the chaff and acquire better deals and get better portfolios.
It should be no surprise. This is an illiquid market. It’s actually one of the unique markets where insider trading is perfectly legal and perfectly normal. And so that access to that deal funnel is probably our largest single value add for real estate investing.
Investing in Property Management
Ballast Rock has a big team. We have 65 employees on the property management side. All of our property management is done in-house. We do not use third parties. You don’t need to worry about unplugging some residents toilet at 2:00 a.m. or communicating with a property manager that’s unplugging their toilet at 2:00 a.m. because we handle all of that.
Further, be cautious working with an organization that does use third parties for property management. I have direct experience with that, and we’ve learned the hard way that using third parties does not work. It certainly does not work as effectively.
In this field, we strongly recommend seeking out and working with the most professional team that you can find. And I would argue at the moment, we are the most professional guys in the Southeast doing what we do. My partner is ex-Goldman, and we have a bunch of ex-Wall Streeters that have brought a higher level of professionalism to a price point that is typically for modern-park type investors or individual investors.
Professionalizing the Asset Class
The core of our strategy is that we are professionalizing the asset class. We’re professionalizing management by delivering safe, clean, and affordable homes. And that speaks to our social impact. We provide safe, clean, and affordable homes to working families.
At the same time, we also provide high performance, high levels of communication, and access to the management team for investors.
We provide monthly reports and quarterly financial reporting on a basis. Our accountants and third parties also prepare annual financial reports on an annual basis, which is an incredible level of reporting at our size as a manager. And that’s just based on our experience coming from a big institutional shop.
Investing for a Positive Social Impact
Finally, a lot of investors will find the performance very compelling, but the positive social impact is the cherry on top.
When we step in, we’re often buying from modern park owners that have, in many cases, run properties very poorly. They’ve tried to improve performance by reducing expenditure. We find that that’s not the best way to do it.
One of the commitments that we make is investing in the amenities, quality of living, and safety of these apartments and properties. You’re able to create a better community, and that better community develops in a virtuous cycle. You reduce the amount of turnover, and you improve your capacity to generate rents over time.
Delivering on Community Promise
Also, when we acquire these properties, we do not go in and evict everyone and start fresh with ground-up redevelopment. It’s quite the reverse. We’re investing in the properties, in the exterior, and slowly, as there’s natural attrition, we renovate units, and those renovated units rent at 20 or 30% above the classic units.
But we are not kicking out existing residents. That’s our social compact. We are focused on maintaining the existing resident base and slowly and steadily renovating as there’s natural attrition. And three to five years out, this property will be radically different from what we’ve acquired. And all the while, we’ve helped reduce crime, we’ve improved security, and we’ve delivered safe, clean, and affordable homes.
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The views expressed in this commentary are subject to change based on market and other conditions. This podcast may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.