Recession Proof: Building a Defensible Portfolio Through Social Impact

Location: Flint, Michigan — Handing out water bottles to Schafer Square residents with the Ruff Rider Motorcycle Club (Flint water crisis).

Real estate investing is my calling and being able to impact lower income neighborhoods (in partnership with nonprofits and community organizations) has been an amazing experience that I can only be grateful for.

Picture: Flint, Michigan (1Q2016)

In just 2016 alone we created over 50 jobs in three states across the USA (not to mention the indirect ways we supported these communities).

Our inclusive strategy helped house political refugees by working with Washington and the Office of Refugee Resettlement.

It also allowed us to impact the homeless veteran community by working with the VA.

All of this is quantifiable by the alpha we capture.

Ergo, it is possible to do good by doing well.

It’s challenging but someone has to do The Hard Thing About Hard Things.

‘’As a startup CEO I slept like a baby. I woke up every 2 hours and cried.’’ — Ben Horowitz

I will admit, I am still getting used to putting social good and private equity side-by-side.

Our conservative nature drove us to seek out risk adjusted returns, so we specialized in becoming THE category kings of affordable housing.

Having grown up in the ‘hood I find it extremely rewarding to apply the institutional framework I learned at Goldman [Sachs] to the neighborhoods I grew up in. In communities that I still live in.

The ability to scale both environmental and social impact in our community is work that actually matters.

I feel our conscious capital approach to investing has been an amazing experience as we have catalyzed change in communities from California to Washington, and from Washington to Michigan.

We employ a multigenerational outreach program.

As we engage all levels of the community through our workforce housing platform.

From millennial’s to those on fixed incomes, we provide high quality and affordable housing solutions to all members of our communities*.

*Research has proven that when we commingle our 55 and over residents with the younger population- we decrease depression and turnover, all the while increasing resident satisfaction.

Our opportunistic nature allows us discretion to be tactical investors.

It is in our nature to selectively, and responsibly employ, leverage.

While we have the ability to enhance our returns, we are not reliant on these factors to exemplify how our triple bottom line framework works as a standalone unlevered strategy.

There is a misconception in this industry surrounding our investment strategy. The feedback we hear is as follows, “we prefer to invest in xyz high grade luxury assets as opposed to the inner city given our preference for risk adjusted returns. This archaic thought process is terrifying (especially as a fiduciary) given where we are in the economic cycle.

Here is an example of how the math shakes out- if we acquired an asset that generates a 4% yield or capitalization rate, this is the equivalent of a 25x Net Operating Income multiple (or in the case of Corporates: EBITDA). Let’s suppose the seven year bull market does not continue and we face some headwinds.

For hypothetical purposes what if the unemployment rate climbs upwards due to the automation of service jobs due to self driving cars, robots in manufacturing facilities, machine learning, artificial intelligence, automated fast food facilities, etc.

What happens if the 4% cap rate decompresses to 5%?

The answer is- the NOI multiple drops from 25x to 20x. That’s a 20% reduction in value. Let’s compare that to assets that we are acquiring in the “riskier” urban markets in the Southwest at a 6.5% cap rate, if that decompression take us 100 basis points higher to a 7.5% risk adjusted yield the change to the NOI multiple is from 15.38x @ a 6.5% cap rate to 13.33x @ a 7.5% cap rate. That’s a 13.33% reduction of value.

Secondly, what I love about this asset class is that being in the lower tier of Maslow’s hierarchy of needs- we are able to have more consistency in our operating models as our cash flows are driven by needs and not by wants.

As we enter this next stage of the economic cycle, and we are subject to the whims of the current administration, I feel the most defensible strategy is to be invested in the top quartile of non-cyclical businesses.

As we trend into this next stage of the economic cycle, our strategy will not only continue to outperform the market- we will thrive as we continue capturing alpha by being present in the most rudimentary levels of Maslow’s hierarchy of needs.

The outlook for Luxury housing is looking pretty gloomy and I would be very scared about entering that asset class at this stage of the cycle (there are a few exceptions to the rule that are more driven by local market supply and demand economics).

We see this clearly in the primary markets where publicly traded institutions are witnessing a larger outflow of turnover as millennials chase the new-NEW thing meanwhile concessions are making a come back in gateway markets.

So how do we build a defensible portfolio that can both outperform and weather even the worst of the economic cycles?

The answer is to find a strategy that can capture alpha, all the while mitigating downside risk.

We do this by rebuilding our inner cities.

As a family office operator, I recall the lessons I slugged through prior to and during the Great Recession.

I dealt with three fires then three reconstructions while commuting to and from community college.

Then Indy Mac called one of our loans.

That’s where we learned about the importance of operational efficiencies.

We restructured our internal operations by bootstrapping a lean procurement and in-house supply chain management strategy.

As we collapsed value chains by going global- we weathered the financial crisis virtually unscathed given the margin of safety we built around our investment philosophy.

We are real estate people doing a fund, not fund allocators doing real estate.

Our operational background allows us to mitigate the risk of any transaction given our deep understanding of all things concerning workforce and affordable housing.

As value-added/opportunistic investors, we exploit idiosyncratic opportunities where we can add significant value.

With our discretion we capitalize on tactical opportunities by collapsing the value chain in the operations by using in house supply chain management and lean procurement strategies.

Our social driven approach feels good which is extremely important for my long term engagement.

I am just happy that we are able to continuously outperform the financial markets by capturing alpha that puts food on our plate (farm to table preferred).

Long story short, I would be extremely worried about entering into risky assets like Luxury housing at this stage of the cycle.

While the economic narrative does not signal recession in the immediate turn, I feel we are witnessing a micro-paradigm shift as concessions pick up in the primary markets.

I would be worried as I think about how I would protect and ensure the sustainability of my cash flows.

This feels like an opportune time to cross-collateralize our portfolios and even consider hedging (via derivatives, swaps, and structured equity strategies) to diversify and mitigate our operational risks.

Our story is simple- we have dedicated our lives to the business of Impact Investing since the early 90s, about a decade and a half before the term became popularized in 2007.

We mastered this space before it was even marketable.

We are in a hurry Impact our communities. If this resonates with you — join us as we grow our platform to more than just the underlying alpha but towards actual lasting change.

@Forbes Contributor | Former I-Banker at Goldman Sachs and Morgan Stanley | Impact Investment Expert