Deidre Woollard: Hello. I'm Deidre Woollard, an editor at Millionacres, and thank you so much for tuning into a Millionacres podcast. Today I'm talking to Michael Episcope, one of the co-founders of Origin Investments, founded in 2007. Origin Investments is a real estate investment firm that acquires multifamily properties in a lot of the fastest-growing markets that we've been talking about lately, like Atlanta, Austin, Charlotte, Denver, Raleigh. It's raised multiple funds for investors. We're going to talk today about real estate investing, about the current market, about the multi-family boom, and so much more. Welcome, Michael.
Michael Episcope: Thank you for having me, Deidre.
Deidre Woollard: Let's get right into it. Your primarily investing thesis, as I understand it, is about multi-family and some of the fastest-growing markets. That's definitely one of our investment thesis, investments things that we think about with our premium services, Mogul and things like that. What are you seeing right now in the multifamily space?
Michael Episcope: So a lot. Certainly with COVID, having happened last year and a lot of the demographic shifts going on, you're starting to see the migration changes that really started last year. But I'll caveat this by saying two things. You had a lot of one-way or what we thought were one-way moving trucks going down to the Sunbelt markets. We think that this trend is going to prevail for definitely the next decade, and this has been happening that the Northern cities have been losing population to the Sunbelt. Southern cities for quite some time, especially the high-tech city is going to the low-tech cities. COVID only accelerated that trend that we've seen. We've been in these markets certainly. Before COVID, these were the fastest-growing markets. Pre-COVID, low taxes, affordability, just areas that are truly lifestyle markets where people want to live and work. Those are the areas that have been benefiting for the last 10 years, and COVID only accelerated that. What's interesting though is we've also seen what we thought were those one-way moving trucks, they're not one-way, they're coming back. We've seen a lot of strength in the Northern cities as well. We're looking at the overall growth of the market and the demographics and everything going out there. There's a housing shortage both on the for sale and the multi-family side in many of the markets we're in. But it's interesting to see strength everywhere as we're looking around.
Deidre Woollard: Interesting. I wanted to ask you about types of multi-family, because one of the things I'm seeing a lot right now is that garden-style apartments, smaller communities, those are selling well, they're also commanding higher rents. Seems like some of the really high towers are not doing as well. Is that something that you're keeping an eye on?
Michael Episcope: Yeah, 100 percent. We focus primarily on garden-style apartments. It's really for that affordability component of it, as you mentioned. The reason why, when you are building high-rise and podium, the cost to construct those projects is so much higher that you really need rents that are approaching mid two dollars per square foot, three dollars per square foot, and the place is so many people there gets really thin up there. But when you're looking at garden-style apartments, especially in some of these markets, even as you factor in some of the cost increases that have happened across the market in the last few years, we can still deliver apartments at what we call affordable prices. The apartments, they are much different than they were three, five, even 10 years ago, there's shrinking where the average unit used to be about 900 square feet in size, today, they are 750. Your units are getting smaller, but your chunk price, which is the most important thing, how much you're paying in rent is staying about the same. When we're looking at our markets, I would say that brand new product, garden and wrap is what we're really focusing on, but that affordability component to it. We're able to deliver in the market about a dollar-forty per square foot, all the way up to about $75-$80. We're really looking to hit that bulk of the market where people who are making $60-, $70-, $80,000 can afford a beautiful classy apartment unit in a nice community. That's really, I think where the crux of the market and where a lot of the deliveries are going to be happening in a lot of these Sunbelt states, especially with this migration happening.
Deidre Woollard: Absolutely. The projects you're looking at, are they mostly value-add core or opportunistic?
Michael Episcope: I was going to say that at the beginning. What we're seeing, we're focusing on building and lending in the market. Our three strategies are really building, buying, and lending. The challenge in today's market, and one of the things that we've really been keeping an eye on is that you had a tremendous amount of pent-up demand in 2020. People who wanted to invest a lot of funds out there, they couldn't invest, and they are all investing in 2021, and a lot of them are chasing momentum down into the Sunbelt, the Southern markets and the Austins, the Nashvilles, the Tampa. Tampas in the world. What's happening is you're getting older product that is just trading well above replacement cost. To us, we're stepping back a little bit. Even though we have those three strategies of building, buying, and lending, it's more of a barbell today. We're choosing to build and lend and staying out of that mill portion of the value-add because if we can build a brand new product for, let's say, $220,000 per unit and that's going to be delivered in two years, that's a much smarter move for us and our investors than buying something that's 12 years old, that we have to value add that we will be into for 250,000, $260,000 per unit when we're done. A lot of people see development as a more risky proposition, we actually see it as a lower-risk proposition in today's market because you're still able to get that spread between the cost of development and the market value. If these value-add buyers are correct in today's market and it continues to go up, the spreads on development will only get better. It's just a matter of how do you want to enter the market in an already built project that you are paying above replacement cost, or do you want to do it by building brand new? For us, it makes a lot more sense to build. It's also, there's so much capital in the markets right now that to compete and go to the bidding process, you might get 20-25 buyers, and that's just not how we want to compete. We swim upstream, we're willing to go where others aren't. To gain penetration in some of these markets, it just makes a lot more sense to build and compete against all the hot money that's out there.
Deidre Woollard: That's really interesting because I think you've mentioned something really important there, which is there is so much capital, I'm just seeing transactions left and right and I know some, people have to be buying for more than they should be. In terms of the building and the lending, and that strategy, is that by market strategy or more of a by project strategy?
Michael Episcope: The 14 markets that we cover, we utilize those three strategies in every market. We like to think of ourselves as a solution to the market. Our model is more of a joint venture model, so we're working with sponsors on the ground and whether they are selling a deal, whether they need capitalization for ground-up development that they've been working on for two years and a lot of times, if we can't meet terms on the equity side, then what we do is we talk about, well, if our equity doesn't work for you in the cost of our equity, and sometimes it doesn't, what about a preferred equity loan? Almost all of our deals that we're lending to, are deals that we want to do common equity on as well. I would say 90 percent of our preferred equity loans are in ground-up development, but in deals we really believe in, with sponsors who we believe in, and in markets we know. It's not as if we're lending to certain markets or a certain product types and we're buying certain product types. Everything we do is really in the Class A garden and ramp multi-family in our 14 target markets. Now, I will say that those markets are always moving and evolving and we're looking at the data and information because Chicago, for example, where we're located today, this was a market that seven or eight or nine years ago we were heavily investing in, but it was a very different time and today, you can't ignore the fiscal situation in Chicago. With taxes going up and what's happening from a political situation, it's very hard to make sense of investing here when you have more of a national view. I'm not saying Chicago's bad, it's just you have to rank your cities and look at them and make choices based on your capital. We have the choice between developing a property in Phoenix, or Nashville, or Chicago. Phoenix and Nashville are going to win all day long because the fundamentals and the runway for the next five, 10, 15 years is so much better then the unknowns in Chicago now, I've said I love Chicago. I live here, my family's here, I raise kids here, but my investment dollars are elsewhere.
Deidre Woollard: Interesting. About finding sponsors, what are you looking for? Are sponsors approaching you with deals? Are you just active players in the markets that you're invested in? How does that part of it work?
Michael Episcope: The way our model is set up is that we're headquartered in Chicago, but then we have offices in Denver, we have an office in Nashville, we have an office in Dallas, and we have an office in Charlotte. Those serve as regional hubs and it's our deal officers out there who are creating relationships with sponsors proactively going out, they're building relationships and this market really is about people, and who you know so we're not looking to be transactional, we're looking for long-term relationships with repeat partners. Because when you're in this business long enough, what you realize is that deals that go bad or not about the deal or the real estate or the time, it's about the people who you invest with and that's the biggest thing. So when you can have a good partnership and find people to do repeat, if things do go wrong and you're both reasonable and like-minded, and you can work through these problems together, you can get to the other side intact. If you end up doing a deal with a bad partner, no matter what happens to the market, things can just go rye on those sides. So a lot of our time is spent really building those long-term relationships repeat, getting to know people, understanding their track record and that's how we've always believed, even with our investment partners to us and us to our sponsor, partners on the ground, as well. It's just building long term relationships and that's what matters in this business, it's about people.
Deidre Woollard: Totally agree with that. It's one of the things we've noticed inside our Mogul services that sponsor communication is pretty much everything and track record, and all of that stuff really matters when you're talking about investments. I know that Origin is for accredited investors so far. We've seen the SEC make some changes in opening up the rules for accreditation, how closely are you watching that? Are you ever thinking of going into other options for investors like having like a reggae plus or anything like that?
Michael Episcope: Today we serve about 1,800 investment partners, so we have quite a bit. We've talked about how do we scale up our organization to lower our minimums because today, we're operating for funds and one of them is actually for qualified purchasers only because that's a credit fund and there're securities and it, and that's our multi-family credit fund. It is real estate bank loans on that side. But our other funds, our QZ fund that has a minimum of $50,000 and then our income plus fund has a minimum of $100,000. So we're not talking about opening up a reggae plus fund. I don't want to complicate matters, but if we can serve the needs of more accredited investors by lowering our minimum and figuring out how to scale, that's a conversation that's been ongoing for a long time, but it really takes a technological solution. I think we're there today. There's some things that we have to straighten out. We just we got onto a new system recently. It seems to be going quite well, and then in the future, if we can find a way to be lower touch, if you will, on investors who want to put it in $10,000, $20,000, $30,000, we absolutely love to do that, but really our model is a high touch model. Today we have eight people in our Investor Relations group, which is probably bigger than any other IR group out there for a company our size, even 10 times as big as us, and it's that personal relationship and having that contact that matters so much. We don't want to necessarily lose that, but we also want to be able to share our funds with the people who need them most. Because early on when my partner and I, when we started this company, it was really about building an institutional platform for the high net worth investor, giving them all the benefits of real estate. We're using all the institutional trades, and what I mean by that is the service, what I just talked about, are the fees right, keeping the fees at a minimum, and also delivering returns, and we've been able to do that in our fund. There's nothing more that we like than to bring minimums down to even service a bigger swath of people out there. It's been fantastic. We're adding about, I would say, 50 new investors every month and certainly raising a lot of capital. But there's always that challenge between raising capital, the demand on that side, and prudently investing it in deals. Like right now in our income plus fund, we actually just started creating a queue because we have too much cash in there to put out and so once we are able to invest that over the next few months, we'll open up that queue and let that money back in. We also just closed down our QOZ fund one, we topped it off at around $270 million for the same reason. We had a tremendous amount of demand for QOZ and looking at our pipeline, we actually cut off the funding last month. We'll be opening up QOZ fund two in probably the next 30-45 days, as soon as the pipeline builds up enough to make sense of that.
Deidre Woollard: That's fantastic. Obviously dealing with high net worth individuals, I'm sure one of the biggest questions you get is about taxes. I've noticed that inside our services, investors want to use that SDIRA capital. Seems like you're doing that at Origin Investments. How does that process work for your investors?
Michael Episcope: I will just talk about taxes in general, how we view them. Our entire base is the taxable investor. Every single product that we think about and how we structure them. I will talk about the evolution here a little bit. When we started in this business, our Fund 1, 2, and 3 were all closed-ended funds. Meaning, we raised a committed amount of capital, we found yields, we called that capital, it was a buy, fix and sell model. The challenge with that is that when you look at things over time, real estate is no different than stocks. The key to getting wealthy is buy great real estate, buy great stocks and hold them forever. Because the upside is going to take care of itself. All you have to do is put yourself in a position to win in the long run. When I look back at Fund 1, we did extremely well. That was a top decile performing fund. But some of the deals that we sold, you look at them and they've doubled in value. The same thing in Fund 2. You look at those and the ones we've sold, now we generated great IRR. But also what you realize is that from talking to investors, they are like, "Hey, that's awesome, what do I do with my money now?" Our new evolution of funds is really looking at how do we build a better structure and a better fund? It's looking at how do endowments invest, how to pension funds, how do the most sophisticated family offices invest? They invest by really having a tax strategy around their investment strategy. All of our new funds are really buy, fix and hold, with the option for the investor to get out on an appraisal-based NAV. When we're thinking about QOZ, qualified opportunity zone, that is a development fund that is all about tax strategy and saving on money on the back-end. I am sure we will get into it a little bit. IncomePlus Fund is an open-ended fund where we're doing development and we're doing lending within that fund. We own some properties as well. But that is an appraisal-based NAV fund where investors can get out when they want to. But it's not us actually selling properties. If we do sell a property in the fund, we can actually 1031 exchange it underneath the saved taxes. I'm a taxable investor. My partners are taxable investors, we've invested more than any investor in our funds. We're always looking through things through our lens and how do we want to manage our own money and tax strategy has to be part of any investment strategy. Our funds have evolved and even one of our funds coming out, it's a pure multi-family development fund called Growth Fund forward and we're going to be launching this next month. It will have about 10 different development deals diversified around the country and it will have a short time horizon of about five years. But if you want to stay in, you can, if you want to punch out after five years, you can. If you're a growth investor on our after IRR and want to maximize it, that five-year punch out period is for you. But what we found is most people are like look, after I take the risk with my capital, I just want to enjoy the passive tax-friendly income for a long time. That's how we've evolved by listening to our investment partners, but also just managing these around our own capital and it makes sense. I really wish more sponsors would think about long-term wealth creation than rather generating short-term IRR. Because I think that's a huge mistake that both sponsors focus on and also investors as well. I mean, if you make 15 percent IRR, you can't measure the wealth creation of that because of the time-base of money can't spend IRR, is the famous saying in our market. It's really an educational process, but something we firmly believe in. Deidre, I hope that answers your question.
Deidre Woollard: It does. Actually, I find it really fascinating because I think you hit on something that we've talked about internally, which is that for real estate crowd funding, so much focus is put on IRR as what people should be looking for and people respond to an IRR rate before they even really look at all of the components of the deal. What you're talking about, I think is how you get past that and how you think about not just what your returns are going to be, but what the goal actually is of the money you're putting in and how you want that money to be returned to you and having options about that I think is important.
Michael Episcope: Yeah and I would go further. It's the after-tax return. What people don't measure is they compare, so our IncomePlus Fund for example, it's a 9-11 percent annualized return and it doesn't jump off the page. But the term I use, annualized return is very different than IRR, and yet they look exactly the same. If somebody invests in our funds, they are being diversified. All of their money is going in at once and they're generating that return from day 1. If you invest in a deal or if you invest in a Call Capital Fund, you have to also look at the impact of the taxes at the end when that deal gets sold, you have to look at the impact of cash drag, your money is sitting around, the rest of your capital not being invested to try to build this portfolio. So many people don't see that macro view of how they're managing their money. They're just looking at this one's at 15 percent, that one's at 10 percent, this one must be better and there is an education process. I've actually written a lot on this about the difference between IRR and annualized yield and just how to really use multiple on equity to equate the two and look at it like, what is your end goal? As a taxable investor, you have to start thinking about these things. Somebody told me a long time ago, look, somebody is going to give me 12 percent on my money. Just don't ever pay me back, just keep it coming. That's so true. I don't want 15 percent IRR for four months on my money and to play that game, that doesn't work. Again, this has been an evolution, but it's fantastic and I think our investors really have come to appreciate it and that's why we've been able to attract so many family offices and high net worth to our platform because we're doing it differently.
Deidre Woollard: Interesting because it makes me think also about individual deals. I know especially if you're dealing with ground-up, you have the passive losses and then you have to use passive losses from one deal to offset another deal when a deal comes through. You're playing that game all of the time and that's a lot for the individual investor to think about and try to manage to make sure that they don't have that big tax wallop when a deal ends.
Michael Episcope: I'm a much bigger fan of investing in funds. We didn't create funds because they are better for us. We actually think they are better for the investor. The rest of my portfolio, I only invest with managers in a fund because for me to think that I can pick deals and I can find better deals than they can, that's just ludicrous. What I have done now is I'll invest with the manager and if there's a sidecar opportunity on my investment, that is well, and that's the same way we operate, is that sidecar opportunities that have been vetted by us, that have been screened that have been underwritten. It's fantastic because a lot of our investors have been with us so long that when they see a sidecar opportunity, they'll just make a commitment. They don't need to call. They've seen it, they've witnessed what we can do over and over and we've just built trust over the years with a big group of investment partners. It's been fantastic just watching this evolve because you don't build trust overnight in any financial business.
Deidre Woollard: Excellent. Well, let's take a quick break here and then we will talk about opportunity zones when we return.
I'm back with Michael Episcope of Origin Investments. We're talking about CRE, we are talking about real estate investing. We're going to talk about opportunity zones. But first, I want to ask you a little bit about your personal journey because I think it's interesting. You were a successful trader. You moved over into real estate. You've built this company as a thing. It sounds like as a thing that you wanted to have in your own life. I wanted to ask you about how investors who love stocks, want to have a stock portfolio, but also want to have real estate investments, should think about bringing both into their lives.
Michael Episcope: Yeah. That's a lot of questions. I'll start with the background question and I'll take you back. This is my second career. I was a commodity trader in my first career and that is where I built my wealth and I retired from that career in about 2005, right around 2006. I knew I wanted to get out of that business and do something else. I just wanted to transition. I've been in that business since I was nineteen years old, and it was time and I'd always loved real estate. I was exposed to it as as a young kid when I was 12,13,14, I used to go work with one of my really good friends, literally building projects, swinging hammers, going, helping his dad. I was labor, but it was fun and that's what we did on our summers. Also my grandfather was in real estate, so I used to go to his buildings and he was in multifamily, really rough stuff on the West side of Chicago. I saw the lifestyle that he afforded and what he did, but also how to do it, right. From managing the pennies, the nickels, the dimes, and being hands on in stock. I think that got into my system at a very young age. But it was really when I retired from trading, I needed to take my assets and turn them into income. As I was investing out there, even during my trading career, it always felt like two steps forward, one step back. I had, had some good success in real estate, but I had a couple of deals that literally just blew up and it wasn't they blew up. There's a difference between making a bad decision or having a bad vintage. '08 was bad for everybody. Then it was just getting, making stupid mistakes. Because you have, good decisions that can lead to bad outcomes and you have bad decisions that can lead to good or bad outcomes. While there were a couple of decisions that will go bad decisions and bad outcome.
I just realized that that time that I needed to educate myself, I needed to take control and there was nobody who is going to be a steward of my money more than I was going to be. I went back, I got a masters in real estate from DePaul University. I enrolled in 2006. I was the old man in class, if you will. I was about 35-36 at that time. It's interesting looking back and my partner and I, we had a very similar background in need and he was also high net worth investor we working on and non profit together. I'd known for five or six years. We were just like-minded creatures. We decided to start Origin together in 2007 as a means of investing our own capital. I wish I can see here today and tell you that we have this vision of what it's going to be today, but the reason and the purpose of why we started it is sort of the same. Then we wanted to share that with our friends, our family, and have a platform where people could realize the full benefits of real estate. You got to understand this is pre JOBS Act. When I'm talking about a world before, there was this proliferation of real estate companies and all this transparency in the market. Prior to that, these were all closed or meetings, these were all individual syndications. You couldn't really do a lot of due diligence or compared deals for the market. A lot of the non-traded private REITs were out there just charging enormous fees and we were like, ''There's got to be something better.'' We set out to build it and that's really what we did in those early stages. Then it was only in about and 14 or 15 that we started to use marketing as a means of attracting new investment partners to our platform. Because by the time 2014, '15 rolled around, we had already been through Fund 1. We had round trip that was a top decile Fund. Fund 2, shaping up to be top-decile. We said, ''Look, we have a great product. All we have to do is getting in front of a lot of people and they'll buy it.'' That was the simple thesis and staying true to our philosophy, what we believe in building the team, building the operations around this, and being an investor in our funds. That alignment I think, is what attracted so many people to our organization. One thing that my partner and I, we talked about a lot is risk management. We view this in such a comprehensive way in everything we do. It's not just about the deals we buy and how we manage them, and how we capitalize them. But it's also about how our team and how we compensate them and how we keep them and all of the structures that you can think about aligning people together. That is the genesis of how we grow in the ethos of Origin. That message, it's still true today. Our goal as a firm is always to generate returns in the top quartile, that top decile. What was really, I think one of the metrics I'm most proud of is that; we were just ranked recently as a top one percent manager by Preqin. We found out from one of our investment partners. We always ask the question, how'd you hear about us? They said well we were actually doing a manager rank in Preqin, and you came up as number 15/2,000 and we said, ''Oh my god.'' We subscribed to Preqin, we give them our data and information. We went in there and took a look at it and we ran the queries and talk to Preqin ensuring of there we were. It's that consistency over time that has really helped us and we don't want to grow for the sake of growing, but we want to grow in a responsible way to continue to generate those same returns, at the same level of service, or even better, because we're an organization that wants to win and we want to continue to put out the best product we can in the market.
Deidre Woollard: Interesting. Would you say that most of the investors that come to you already have an interest in real estate or do they have an existing investments, maybe stock portfolio and they want to get into real estate, what's their level of acknowledge?
Michael Episcope: Yes, that was your second question about the investors portfolio. Thank you. Most investors, because what we don't want people to do is call us up and say, ''Tell us about real estate.'' If you go to our website, we have more than 400 pieces of original content. We believe strongly in educating and for people to do the research and for people to understand what we're doing. By the time they have a call with somebody in our Origin or our Investor Relations department. They've done their homework and we like investors to come in educated understanding, knowing a little bit. But if it's there first time investing in real estate, we will hold their hand through that process because it's very different than pushing a button at Schwab and TD Ameritrade or calling your wealth manager. Real estate should really be part of everyone's portfolio out there, whether it's five percent or 30 percent, that's up to you to decide, but it's too big of an asset class and it has performed too well to ignore it. Whether it's public REITs or private real estate or a combination of both, real estate belongs in every portfolio out there.
Deidre Woollard: I would definitely agree with that. Let's get into Opportunities Zones. I think it's the question that I get all the time. People got very excited about the tax breaks. We saw so much activity in the beginning. As things change, as things evolve, the rules and the benefits are shifting. Who knows what's going to come next with some of the legislation. What are you thinking now about that and you mentioned earlier, it sounds you already have a lot of people interested in a second Opportunities Zone fund.
Michael Episcope: Our Opportunities Zones, I think its the greatest gift to real estate investors in 50 years because of the tax benefits. You take something that's already tax efficient and you add on these benefits to the QOZ and I'm assuming the listeners have a basic understanding of what Qualified Opportunities Zones are and the benefits. You want me to go over that at all?
Deidre Woollard: Let's go over up real quickly.
Michael Episcope: Quickly three benefits qualified Opportunity Zone, investing in one of them disappears this year. The first one, if you have a capital gain from any source out there, whether you sold art, whether you sold your home, whether you sold stocks, bonds, it doesn't matter. If that shows up on your tax return as a capital gain, whether it's shorter, long term, you can invest that money into a Qualified Opportunity Zone projects or fund. You get what's first call at 10 percent step-up in basis if you invest in 2021. To make the math simple, if it's a million dollars that you're investing, then you will only recognize $900,000 when you go to pay taxes. The next benefit is when you pay the taxes. Your tax instead of it being old or payable next year. When you go to pay your taxes, you won't pay that until tax year 2026 payable in 2027. You get basically an interest-free loan from the government. But the last benefit, which is the most important and the most beneficial, if you hold onto your investment for 10 years and one day, you pay zero taxes. So that $1 million becomes worth two million, three million, five million, eight million. It doesn't matter. Once you take that out at 10 years in a day or 20 years however long you want to stay into the program, you pay zero taxes. You also get depreciation the whole time you get the advantage of refinancing proceeds tax-free. It's taking again in an already tax efficient investment and just supercharging and even more. It's something that I personally have been pushing as much money as I can into and so is my partner.
Deidre Woollard: Well, the other thing about Opportunities Zone too, is they were designed as this project to encourage investment in areas that were economically depressed. There's been a lot of criticism about how it's been used about it being in urban areas versus rural areas. Little bit of talk about how it's going to change. Are you involved in keeping track of some of what's happening with Opportunities Zone, potential legislation or things like that?
Michael Episcope: We're keeping track. But there's not much we can do about it now and we're not lobbying or doing anything on that side. I will tell you there has been a lot of controversy around it because the Qualified Opportunities Zones they're low-to-moderate income zones. This goes way back all the way to the Obama days, trying to get this past into some sort of legislation. The nice thing is it was bipartisan accepted by both Republicans and Democrats we're not worried about this going through. But the big caveat to this is that the zones who are based on the 2010 census tracks. If anybody thinks about the world in 2010 versus where it is 11 years later. Some of these cities look totally different. If you went to downtown Denver 10-years ago, that city looks completely different than it does today. Nashville, the same thing. There's been a lot of urbanization that has happened. The thing about this though, is the program in the way it was designed, it wasn't designed in a way that the money would have ever found its way into the truly bladed neighborhoods. Because the benefits happened on the backend for investors once they make a profit. For a company like ours we're fishing along the edges, looking at the transitional areas, looking at areas that we would invest anyway, because our primary responsibility is to make a profit for our investors. We don't look at Qualified Opportunities Zone any different than we would a normal development deal. When we're talking about we just tied up a deal in Nashville. It's one of the best development sites in the country, not the best QOZ sites in the country. It's just hands down. When we're competing, we're talking to sponsors out there about a QOZ site. We're not competing with other QOZ capital. We're generally competing with the institutions and market rate capital out there. For us, we know we're doing something right, because this is market rate capital. But what Qualified Opportunities Zone with the law it doesn't do, it doesn't supplement the capital structure so that we can go into an area that otherwise we couldn't build and build and charge less rents and get less money in revenue, or we would do is lose money. There are some flaws in the program. I think the most notable change that will come in the next quarter of six months to a year is they will update this to the 2020 census, which we're looking forward to. The 2020 census is probably more likely. We don't know what that cutoff line, what that transition will be. But given the fact that the 2020 census was just finalized, it makes a lot of sense. We're keeping an eye on that and that will be more true for fun too, that we're going to be launching in a month and it's for Fund 1, which we just closed.
Deidre Woollard: I love that you said that you would look at a QOZ deal the same way that you would look at any other deal. Because I think that's really important. It's one of the things that we've talked about, a million acres, it's very important because I think sometimes people just go into an Opportunities Zone deal. But I wanted to ask if there's any other tax credits that you implement because you're doing multi-family, are you looking at low-income housing tax credits or anything like that? Any other programs?
Michael Episcope: We're not looking at low income housing tax credits but certainly within some of the Qualified Opportunities Zone areas. We're breaking ground on two deals in Colorado Springs. One of my favorite markets we're joint venturing with Greystar on these deals and we are getting the equivalent of what I'll call tax increment financing. A subsidy on our taxes on those projects. One has a 75 percent abatement. Which essentially means that if our tax bill, we're going to be $400,000, we're only going to be paying a $100,000 for 20 years. Then on the other one, we're getting a 65 percent abatement. What happens in these municipalities is that in order to attract new development to the area, they provide these TIF incentives to make the economics work. You can see from our first project, we're at 75 percent. Our next project is at 65. This will go down to 50 and then we'll go to zero. Because as you build multi-family in these communities, the community actually benefits, it gets better, it attracts more development. The early adopters, the innovators who are coming into the market, generally get tax subsidies like this. But you are also taking a little bit more risk in Colorado Springs. This is a great benefit to the deal our investors, but we're not looking at any other tax subsidies because low income housing tax credits and affordable housing it's just a very different animal than market rate housing that we're building. Those are a lot of government tax credits that's way above my pay level and we don't do that.
Deidre Woollard: I have to agree with you about Colorado Springs. I recently interviewed a developer there and he was talking about some of the jobs, some of the aerospace technology and things like that in the area it's really fascinating market to be involved in.
Michael Episcope: Well it is and I just read an article the other day, it's the number one housing market for-sale housing in the United States. They measure that by the number of days a home is on the market. These homes are being snapped up like this. We fell in love with the market because Colorado Springs is about an hour South of Denver. Denver is experiencing growing pains. It has the job market that you are talking about. It is home to the front range. You can actually get to some of the mountain areas much quicker from Colorado Springs than Denver these days. The biggest thing that has happened though, is the government there and the view on development has changed. Once that happens, these changes happen really quickly and this happened in Nashville and I went back there. I was there about eight years ago visiting it. You can stand on one side of the gulch look clear across to the other side of the gulch. I was just there six months ago when I was coming up for my son from Florida and we drove through and stop, buildings everywhere. It looked like downtown Denver. The development just really feeds on itself in these markets. We're excited to be down there. We're actually looking for more deals. Where I was going with that story, sorry. The government, as it was explained to me, was a weak form of government. The City Council they actually didn't have a Mayor. About seven years ago they went to a strong form of government and put a Mayor in place so that they can make some of these decisions. They went from being an anti development community to a pro development community. We've seen that happen in the areas of other cities. Once that pendulum flips, things happen fast. We're excited and we're going to be keeping an eye on Colorado Springs and making more investments down there.
Deidre Woollard: I love it. I want to ask you about some of the economic drivers that I think everyone's worried about right now. You've got a couple of, you've got potential interest rates rising. You've got potential for high inflation. Commodity prices. We've seen lumber up and down. Steel has been going up. How are you looking at all of those different things when you're talking about both building and also lending.
Michael Episcope: Good question and I'll say this in two ways. Number 1, I don't have a crystal ball any better than anybody else does, but with prudent risk management practices, and that's, I'd like to say that we've been thinking about higher interest rates for the last 10,12,14 years since we started. You have to, in this business because, you have to look at, where can you get hurt. Then how do you mitigate that? When we're doing underwriting, I'll just share with you maybe some of the best practices, institutional practices and whether people are looking at our deals or other deals, they should look at these things. What are the variables that move the model the most? Well, growth rate, cap rates. Those two variables will probably move your model the most. When we're looking at a market, we want to be realistic about what we can do, whether it's a value-add or whether it's a ground-up development. Lending is a little bit different of an animal. You have some protection because of the developers equity, and you're also investing with a very qualified sponsor. On top of that, you have the developer profit to fall back on. I'll focus on value-added more and ground-up development. You want to make sure that your growth rates are incredibly conservative. If you believe that the market is going to grow at six percent, if you put six percent in your model, any model is going to work with a six percent growth rate, and the problem is, is that's pricing it perfection. Everybody should look at, what is the growth rate of income over the whole period, and generally that should be anywhere between, I would say two and four percent. We use our own proprietary machine learning predictive model, to factor in these rent growths, but we also put a governor on it. Even if the model came back with seven percent rent growth, we're not going to put that into our model. We're going to be a little conservative. The next thing that we do is when it comes to interest rates, the best predictor is the forward curve on interest rates. We plug those in and look at that. If there are exogenous shocks, we do stress test, things of that nature. I don't think there's many projects today that are going to withstand a shock of 5, 6, 7 seven percent interest rates. You have to look through the world in a reasonable lens and say, what is a 1-2 standard deviation move going to do to our project? If you think that there is a five standard deviation move coming, just hide your head in the sand and stay in cash because there aren't too many investments that are going to withstand that kind of shock to the market. The other thing is cap rates. What are our current cap rates in what is your exit cap rate? All too many times people play the game of look, current cap rates today are four percent and we're going to exit at three and a half. Every model works if you have declining cap rates. But since the risk is in expanding cap rates, what we do is we look at the prevailing market cap rate, and then we put an inflation factor on that cap rate each and every year for our exit strategy or our exit cap rate. Of the four today, we're going to increase that by about 10 basis points per year, so that our exit cap rate is four and a half percent. Deals that can handle up to that scrutiny, are the ones that pass that first test. There's the kick the tire, good real estate, things like that. You don't just want this to be an excel model discussion. But those are some of the little things that we do when we're thinking about risk management, because my background, I've seen a lot of this. I was an interest rate trader, so I've seen interest rates go crazy. I understand, I studied a lot of the firm's, going back to 06, 07 and 08, I was in graduate school watching a lot of these firms implode in just a student of saying, why did they implode? What did they do wrong? It's never about the real estate, is generally about risk management policies that weren't sound, they weren't in place, they weren't thinking about the future, about how these things impacted them. This is also a reason why we've never been a volume shop. Unfortunately, like the modeling I just talked to you about when we were doing this in 2018, when we had a rising rate environment, we did three deals that year. We didn't do a lot of deals because nothing could stand up to our model. I would just say if for investors when they're comparing an IRR of two deals and they're looking at this. Growth rates, make sure those are reasonable. Make sure that there's some inflation to the interest rate side so that when you get through the development phase that you are going into the permanent debt with a reasonable interest rate and then make sure you're drifting cap rates as well.
Deidre Woollard: Excellent, that's fantastic advice. Well just one quick question to wrap up, I saw your article in the Wall Street Journal about you improving your home during the pandemic. I think so many people did that. But you mentioned early on that you had that background in construction. What lessons did you take from that experience coming full circle on that?
Michael Episcope: I had a lot of time on my hands at home. I think that when you find yourself at home, you start to see all the imperfections in the projects and things like that, and so I needed to keep busy. I've always been somebody who's been good with tools and ever since, not only when I was young, but even taking shop class, I've always enjoyed working with my hands and doing projects and from a young age, I guess because I can. I did some fun projects. I built a baseball cage for my kids. Up top on our roof, I built a murphy bed for my son, I put in new windows. It's just been fantastic. But the physical side of doing, there's a satisfaction in it. I enjoyed that during COVID. Some of the projects still need a little bit more to complete, which my wife is talking to me about every day, about getting those done. But I lost a little steam. They're 90 percent there. But one thing I don't like to do is paint and fill. That's where I end. I'm a rough carpenter and trim carpenter.
Deidre Woollard: [laughs] I love that. Well, thank you so much for your time today, Michael. Reminder listeners, you can learn more at arjeninvestments.com. Like he said, there's lots of good information there to learn about and understand really what they do. Remember you could always email us at mediamillionacres.com to share your thoughts. Stay well, and stay invested.