Robert Boucai & James Broyer – Tax-Efficient Multifamily Real Estate at Newbrook (EP.475)

0:00When I started looking at my own returns and my investments in 2020, I invested in a bunch of real estate general partnerships over the last 10-15 years. My best after-tax returns were coming from real estate because of the depreciation shelter and the growth in income. I was getting attractive returns on an after-tax basis. We came to the conclusion that we really needed to create this ourselves and we couldn't invest more with other GPs because the other GPs don't have the things that we were looking for. We needed to reverse engineer the optimal solution for ourselves and find a partner to help us implement it.

0:44I'm Ted Seides, and this is Capital Allocators. My guests on today's show are Robert Bukai and James Breuer, co-founders of Newbrook Capital Properties, a multifamily real estate investment platform built to generate optimal, long-duration, tax-efficient income. Robert is also founder of Newbrook Capital Advisors, a hedge fund he launched 20 years ago that today manages a billion dollars across long, short, and long-only strategies. He was born with sensory neural hearing loss, and today serves on the board of the Hearing Health Foundation, which is dedicated to preventing and finding cures for hearing loss.

1:24Our conversation covers Robert's path from real estate to hedge fund investing and back to real estate. We discuss the real estate strategy he designed with James, including alignment, market and asset selection, property improvement, and supply demand drivers to create durable rental growth. We close with risks, synergies with Newbrook's public equity business, and plans to scale the real estate platform. I hope you enjoy the show. And if you do, this week, why not reach out to that friend of yours? You know, the one I'm talking about. There's someone you've known forever and trust and love so much.

2:01You probably only see each other There may be every year or two these days, but whenever you get together, it's like no time had passed at all. Go ahead, reach out to them and just say hi. When it comes up what inspired you to reach out, just tell them you thought of them while listening to the Capital Allocators podcast. And maybe they want to have a listen too. Thanks so much for spreading the word. Please enjoy my conversation with Robert Bukai and James Breuer. Robert, James, thanks so much for joining me. Thanks for having us. All right, Robert, let's kick it off with you. Take me back to your upbringing that led you to get into the investing world in the first place.

2:39I grew up in Boston. Parents were immigrants from Lebanon. I had the fortune of growing up in the 80s and 90s. I enjoyed reading things like the Wall Street Journal, business books, wanted to go to a business school for undergraduate. When I saw Wharton in the summer of 1992, I said, this is really where I want to go to school. I applied early. I got in. I was thrilled. And I spent four years there from 93 to 97, majored in real estate, majored in finance. I was great at math. I loved playing with numbers. I loved reading stories. I invested in the stock market when I was a teenager. That's really what I wanted to do.

3:17I had done two summers of investment banking in California, came to the conclusion that investing was what I felt would give me control of what I could do and where I could live. The best real estate job coming out of Wharton was at Blackstone. So that's where I started in 1997. I worked there for three years. There were very few investment jobs coming out of Wharton that were available. Most of them were banking. Private equity didn't really exist for an undergraduate. Blackstone was a great place for me to learn. I joined the group when it was on fund two. The group only had 12 professionals.

3:53we had a portion of an office floor on 345 Park Avenue. A lot of the people that are there today were very low in the totem pole back then. And it was a great learning experience. I got to travel a lot, Europe, Asia. It was a real amazing education experience. But while I was there, besides learning about building a business and investing in real estate, a great friend of mine from Penn, who was an engineer, had opportunities to invest in technology and telecom equipment startups. This was the beginning of the build-out of the internet. We invested in a bunch of these startups together. Some of these companies went public and did quite well.

4:35So it brought in my horizon investing beyond just real estate. I loved real estate. That got me interested in investing in, at the time, venture capital. I left Blackstone in 2000 to do venture capital investing. In that one year that I did it, I quickly realized that the opportunity was on the short side, not on the long side, because that bubble burst pretty quickly. A lot of these companies were funded by the debt capital market, didn't have sustainable earnings and ability to pay the interest on their borrowing. So I realized that the opportunity was on the short side. I joined a hedge fund in 2001 that had a small amount of assets, worked there from 2001 to 2005.

5:17We did really well in 01 and 02, taking advantage of the bursting of the TMT bubble. That's what got me interested in the hedge fund business. When I left in 2005, I wanted to start a firm around the best practices of public and private equity. The things I had learned at Blackstone in private equity, having an investment committee, having a standardized memo, model, with the best practices of public equity, which was the ways to ask company questions, the ways to go about research, the ways to build conviction and ideals and build a firm around those best practices. I started Newbrook in February of 2006.

5:51Well, it's been 20 years starting this February. We started that business with$9 million of AUM. Three months after I started, my father told me you should go back and get your old job, but this isn't going to work. I didn't get the most encouragement necessarily at the beginning, but I stuck it out. And at the end of the first year, we had about 200 million of AUM. So we were big enough to seed and scale and we grew the business. Today, we have about a billion dollars of AUM between our hedge fund and our long-only fund. That's how we got to where we are today on the liquid side of our business.

6:24When you look across that set of experiences, early private equity, real estate, a little bit of venture shorting, a hedge fund and long-only today. What are the common threads you took away that helped you, say, over the last 20 years at Newbrook, take all those lessons and bring it into your investment stuff? It's always to keep your eyes open for opportunity, to be aware of what's changing in the equation, where we are in a cycle. Some things can be good for one sector and not be good for other sectors. And to be aware of that. When I was at Blackstone, what had happened in technology came to the detriment in the public markets of real estate companies.

7:05REITs would be trading at a significant discount to NAV because people were selling public real estate stocks to buy the technology stocks. Conversely, those stocks did better when the technology stocks blew up. These things can work in reverse. When you look back at the last 20 years as an example, cycles can happen in different asset classes at the expense of one another. It's important to keep sight of that. As I look at where we are today, there are assets that are at all-time highs, and there are assets that are 20 % to 30 % off of their all-time highs, and that creates opportunities. That's one of the most important things I've learned from that perspective.

7:39What's that trajectory been over the last 20 years in the hedge fund business? The hedge fund business in the early 2000s when I started was a terrific business. It was less mature, less developed. Broadly speaking, the markets were flat in the 2000s. And in the hedge fund business, in the long short, you could make 10%, 15 % a year. There were sectors that went up when other sectors went down. Correlations were low. Competition was low. You didn't have people that were using credit card data and satellite data and analyzing number of words were used in a conference call the way they are today.

8:13So the competitive field was a lot easier. The business was less mature. You didn't have the number of multi-strap funds and the crowding that you do today. It was a great area and a golden area, as some people have referred to it. Very different today. How has the business evolved to get you back to thinking about private real estate? When I started looking at my own returns and my investments in 2020, I'd invested in a bunch of real estate general partnerships over the last 10, 15 years. my best after-tax returns were coming from real estate because of the depreciation shelter and the growth in income.

8:53I was getting attractive returns on an after-tax basis. It was effectively double because you're getting a tax deferral on the income. I saw that in 2020. I said to one of my partners, we should be doing more of this because the returns are much better than liquid returns on an after-tax basis. We came to the conclusion that we really needed to create this ourselves and we couldn't invest more with other GPs because the other GPs don't have the things that we were looking for, which was they're not necessarily benefiting from the income shield that they're getting from real estate because you need to own it long term.

9:26You need to use fixed rate financing to do that. They are generally using short term floating rate financing and they have shorter term hold because they're trying to generate carried interest income to pay themselves. And then lastly, I would say they don't have as much personal capital invested. So the alignments or not that. There are some other intricacies around taxes and bonus depreciation that we did not see that other GPs were necessarily solving for. We came to the conclusion that we needed to reverse engineer the optimal solution for ourselves and find a partner to help us implement it.

10:00That's how we got to where we are today. So carry that forward into what you're doing. So I spent 21 and 22 trying to find someone a partner with, coming to the conclusion that we needed to find someone to do that in the construct that we wanted. I met about 50 potential partners and came across James Boyer, who was running the multifamily business at JRK. And they had the same goals that I desired, which is fixed rate financing, long term hold, alignment of interest, value investor, and contrarian in the things that they chose. This is exactly what we wanted. 95 % of the people that I met wanted to use floating rate financing.

10:39The reason they want to use floating rate financing is there's no prepayment penalty. So they can buy an asset, they can fix it, and they can sell it and not have a repercussion of paying down the treasury yield maintenance penalty on the debt. I get that. And almost all opportunity funds in the real estate will use floating rate financing. It makes sense if that's your construct. But at the same point, all of these funds have primarily tax-free investors. They are servicing endowments, foundations, sovereign wealth funds that don't care about taxes. And that's great. But we care about taxes. If you care about taxes, the advantage of investing in real estate is that you're getting this tax-sheltered income stream.

11:21The only way to benefit from that is if you hold it for a long-term hold and you can only finance it with fixed-rate debt if you're going to value that. So that's what we did. James and I met in January of 2022. we agreed that this would make sense to do. But unfortunately, at that time, the math didn't make sense. Cap rates were below borrowing rates. There would be negative leverage, not positive leverage. One of the cardinal rules of real estate investing that we have at Newbrook is we want positive leverage to happen from day one. That's a great form of self-discipline because by definition, you're financing at a lower cost than a cost to buy the asset.

11:57So if it costs 5 % to borrow against an asset and you pay 6 % cap rate, You're getting 100 basis points of positive leverage. You're making 6 % on your unlevered capital. You're making 100 basis points of spread on your levered capital. Hopefully, you can increase your 6 % cap rate to 8 % over the hold, and you're getting even more spread over the hold. That creates a very attractive income stream and return stream for the investors. If you get an income stream, let's say, over a hold of 8%, that means that if the asset does not appreciate over, say, a 10-year hold period, that you're getting an 8 % IRR.

12:30The probability in my mind of an asset not growing in value over 10 years is low. It can happen, but it's low. And if that's your left tail in your income distribution, that seems to me to be a pretty good risk reward. That's how we came across it. That's how we decided to work together. Fast forward to August of 23, we're having calls monthly. We have met Adam Donahue, who decided to join us and help us with organizational matters and has been a real asset to the group. And we decided to start in October of 23 because in August of 23, James came to me and said, you know what, we can get 6 % cash on cash on deals today.

13:09I said, okay, that's attractive. Finally, that makes sense. And remember, a six to a California New York taxpayer acts like a 12 by 13 % bond. That's pretty good. So we started in October 23. Since that time, we've acquired eight assets, about 2 ,100 units. We've made a lot of progress since then, but it was a long time coming. So James, let's turn it over to you. I'd love to hear more about your path up until the point where you met Robert. I grew up in Massachusetts, similar to Robert. Coming out of college, I was graduating in 2008. First job out of school was pension consulting. I did that for about a year and a half before getting into investment banking.

13:48I realized pretty quickly that I wasn't particularly passionate about investment banking. I'd been reading a lot of real estate books at the time. and something that clicked with me and was interesting to me was real estate. So I joined a company called Boston Capitals. At the time, they owned apartments in the country. It was a large, affordable component of that company where they owned about 200 ,000 units across the country. I was in a smaller division within their buying market rate communities. That was my first steps into multifamily. I loved everything about it. I love traveling the country.

14:18I love finding new opportunities, figuring out ways to operate more efficiently and love the transaction aspect of it. And after about two years there, I kept on coming across a firm called JRK Property Holdings. They were expanding rapidly and they were in Los Angeles. My girlfriend at the time, now wife, had also been born, raised, went to school within about 25 miles. And we thought it would be an exciting opportunity to go and live somewhere else. So we ended up in Los Angeles. I ended up spending 12 years at JRK. It was a great experience. Came in as an analyst and ultimately ran the investment division as the president for the last five years while I was there.

14:51What led you to leaving and joining Robert? When I met Robert, we had a cycle that was ending. I saw the opportunity that sounded amazing. At the same time, Jericho had evolved into more of a family business with the founder being close to 70 years old and his children coming into the business. It didn't make sense for someone who had an entrepreneurial aspect that they were looking for and looking to start their own business. Robert was a great partner and viewed the world through a similar lens. All the aspects that he likes about real estate, whether it's the tax efficiency, the distributions, it also aligns perfectly with my investment strategy, which is de-risk assets when you can own them for longer, when you're employing fixed rate financing.

15:32So it blended very well. And we knew very early days after meeting that this was going to be a great partnership. When I met Robert in January of 2022, multifamily, the acquisition volume had doubled since 2019. It was just an incredibly compressed market where you had tight cap rates, an incredible volume of deal selling. But the playbook had, to Robert's point, switched for a lot of groups where they began doing three to four year hold periods. Everyone was utilizing floating rate debt. You had all the non-traded REITs, which were raising a tremendous amount of capital. So you had these non-traded REITs that were actually buying about$20 billion worth of multifamily in 2021.

16:11about 10 % of all transactions in the multifamily space were being traded to these non-traded REITs. You had these cap rates that had compressed. There was a ton of capital chasing these deals, but there was rent growth there. But for someone who only employs fixed rate financing, it was not an attractive time to be deploying. The values didn't make sense. Where these things were trading on a per unit basis, there was no discount to replacement cost. It felt really risky, and it didn't feel like we could get the right cash-on-cash returns that could justify buying these assets. We met in January.

16:41After about a year and a half, to Robert's point of getting to that 6 % cash on cash, we finally saw these values drop about 30 % from peak. And then we were able to start buying below replacement cost. I felt that there was very limited downside from that point. There was enough people that were on the sidelines. There's enough groups that had taken on floating rate debt. They weren't buying. They had legacy portfolio issues. We knew that there was going to be some sort of correction from when we met. We just weren't sure when it was going to happen. After about a year and a half of a lot of conversations, okay, this is an intractive entry point.

17:14We're going to have this business for 30, 40 years. We're believers in multifamily, but this is an outsized period of time for us to take advantage of the opportunity. That's when we launched. There are a couple aspects of the strategy that you've intimated at. The first, obviously, multifamily. Why focus on multifamily real estate? If you look at the different real estate asset classes, it's the least controversial one. We can debate work from home with regards to office. We can debate on consumption patterns with retail. Data centers are too big for someone like us to address. Multifamily, there's no debate.

17:48People need a place to live. That's the most important thing. Second most important thing is it always has access to the lending market. Because of buyers, we can borrow off of Fannie and Freddie financing. We always have access to borrow from the bond market effectively. Whereas the other asset classes have more risk in accessing the debt capital market. This is the easier asset class to own for predictability, for safety, sleep at night, investing money. The other thing I would point out is that multifamily is an asset class that historically has low capex. It lends itself well to making distributions, whereas things like office or retail are tenant improvement heavy.

18:33Therefore, it may be more episodic in its ability to return capital to investors. What we are trying to create is a synthetic fixed income replacement stream for an investor and a tax advantage one. Multifamily lends itself best of all those asset classes to doing that. What's the subtlety if most of the competition uses floating rate debt? You've mentioned you want to use fixed rate debt. How do you come to that decision to use fixed rate debt? It goes back to the income replacement side. If you are trying to get the tax benefit from investing in real estate, You get it from having a long-term hold because it allows you to use the depreciation shield.

19:13If you buy a piece of multifamily property, you depreciate most of the assets over 27 and a half years. If we're trying to buy that income stream, it goes back to the example of 6 % cap rate with 5 % broad financing. It starts out as a cash-on cash slightly over 60 or 1, and it grows through the hold. Maybe that's 8 % over the hold. If you use floating rate financing, that number may not be as predictable. You're subject to the Fed raising and lowering rates. In the fixed income side, if you hold it for 10 years, you have a more predictable income stream. You're less dependent on rates for your return.

19:45Going back to the example, if you have a 10-year hold and you have an 8 % cash on cash over the 10-year hold with a fixed income debt financing, if the asset doesn't grow in value, you're getting an 8 IR. If the asset grows 2 % to 3 % a year, which is more likely, you're probably getting something on the low teen because of that. It lessens your risk to rates. it also lessens your risk to exit cap rates on the back end. If rates go up during the hold, if your cap rate ends up being 100 basis points wider, it's probably because there was higher than expected inflation during the hold. If that's the case, you probably had better than expected income growth.

20:17You're going to have a higher cash on cash than you projected, but maybe your cap rate is higher. So your IRR might be slightly lower, your cash on cash will be slightly higher. For us, I view it as a way of de-risking our transaction. When you decide you want to focus on multifamily, there's a lot of markets to choose from. How do you think about where you want to be buying assets? We're a little bit unique in this. We end up underwriting about 100 deals a month. It's the best data that we can get out there. We subscribe to a number of different data providers. The best data we can get is from underwriting deals, looking at rent rolls, seeing where the rents are heading, seeing which markets are compressed right now.

20:54We focus primarily in landlord-friendly states. That's the Midwest in select markets within the Sunbelt. Looking at about 100 deals a month, five of them might actually be interesting enough where they meet our narrow box, where they have the right in-place performance. We can tell that it's a compressed market and the rents are heading the right direction. And then we can get it at the right price where we can generate the right cash on cash returns. For us, to Robert's point, we look to have about two-thirds of our return to come from cash flow. That is the best risk adjusted way for us to look at these.

21:26Versus a floating rate buyer that might not care about cash flow and might rely on appreciation at the exit and be relying on what the environment is in three to four years, we want to look at over a longer duration time where we have a predictable revenue stream that we can improve by renovating interiors, figuring out how to operate more efficiently, drive ancillary revenue streams to drive overall cash flow in the asset, and then be able to exit the asset, ideally during a compressed period and not be forced to sell when it's not a seller's market. Once you pencil out the math on any one deal you're looking at, and it looks good, what are the subtle things beyond what the numbers tell you that lead you to want to buy one asset versus passing on another?

22:08Looking at such a high volume of deals, we'll dig into the past five years of operating performance. We think the market's fairly efficient from a renter's perspective. If the rents are too cheap, the renters are going to find it. There might be repositioning from a physical perspective. It might be upside there, but you can identify a lot of these compressed markets through occupancy and performance historically. What we gravitate towards is the deals where we know over the next 12 to 24 months, even if we don't have to do anything physically to the community, we're heading in the right direction and then we're going to be able to further improve it.

22:39It's finding the deals where we see strong renewal growth, strong income to rent ratio with employers in the market, and then really little supply. What's unique about us is that a lot of institutions focus on the highest population growth markets in the country. If you step back and look at the data, you look at it over the past 10 years, 20 years, it's not the Austins, the Dallases, the Tampas of the country that are performing the best because we're solving for rent growth. At the end of the day, we care less about population growth. We want population growth to be positive, but we're solving for rent growth, which is totally different than a lot of people's mentality and investment thesis.

23:16They're looking at population and where areas are growing. But if somewhere is growing, that means there's also supply. There's very few barriers to entry. There's probably land available. We look for the areas in the markets where either it's you can't build because it's too difficult and challenging to build there or the rents don't justify it. So you have a solid runway of rent growth that you can achieve before someone's going to come in and build in the market and ultimately cause pressure on the rents that you're charging. It's looking at specific submarkets where we can see there's no supply within 10 miles.

23:50There's not going to be supply until we either get rent growth of$500 plus a month per unit, or it becomes much cheaper to build, in which case rates are down, in which case we're happy with that outcome too, where we might not get quite the rent growth we expected, but our value on a capitalized basis is going to be better than we had underwritten. I'd love you to walk me through a deal that you've done through the actual property, number of units, all the characteristics that led you to want to buy the asset? We bought a deal in suburban Charlotte, North Carolina. It was June of 2024. We identified the asset.