Why Messy Real Estate Deals Often Deliver the Most Asymmetric Returns | Ep 113

James: Today I want to explain why I intentionally run towards messy deals and why some of my best performing deals actually turned out is like pretty complex and pretty crazy that nobody else wanted. Today on the Furlo Capital Real Estate podcast where we dive into the intricacies of real estate investing including complex, messy deals, and our mission is to equip people to invest wisely, no matter the level of complexity.

So that. We can invest wisely in both property and people so that together we can build wealth while improving housing. I'm James. I can see you mouthing along Jessi, my wife. How you doing? Good.

Jessi: I know, I'm trying to, I'm trying to remember it too. I'm like, Hey, how did it go? Oh yeah. And I like, I like the hooks.

Insert it in. It just makes it hard because you memorize it a certain way and it's like, wait, that's different.

James: I know, I know.

Jessi: Uh, I dunno. You just talk about messy. And it makes me think of hair for some reason. Like I got my messy bun in.

James: Yeah.

Jessi: Messy hair.

James: It's all right. You want a lunch

Jessi: tank? Why am I think about hair?

I know

James: some other people who had messy buns in

Jessi: it's messy bun day.

James: I know what that is.

Jessi: Yeah. Yeah. My bangs were not playing along, so I was like, okay, fine.

James: Sounds good.

Jessi: So it pulled back.

James: Well, we're not gonna talk about messy hair. We're gonna talk about some messy deals.

Jessi: Messy deals, yeah. Which, I don't know, that sounds scary to me.

James: I know.

Jessi: I, because my Oh,

James: I know. That's why we're gonna talk about

Jessi: it. I'm glad you're going to define it. Because I think other people too, you say a messy deal and they're like, oh, no, no, no, no, no. That's, it's like, that's a bad deal. Yeah. It's like, no,

James: but ideally ones that are messy with some asymmetry because, and we're gonna dive into this.

Problems create pricing errors and creative finance thrives on urgency and underoptimized assets. Age better than perfect ones if you know how to solve what others. Choose to avoid.

Jessi: Mm-hmm.

James: Okay.

Jessi: That makes sense.

James: Yeah.

Jessi: Yeah. You're, you're accepting a problem, but you have a solution.

James: Yeah. So that's actually reason number one.

Problems break price, discovery.

Jessi: Yeah. Tell me more about

James: that. Yeah, yeah, yeah. So there are, uh, there's like, we're gonna call them clean assets, not so messy, right? Well put together ones, right? Those are put into efficient markets. Think like the MLS, LoopNet, Zillow, those kind of things.

Jessi: Like a, like a standard deal.

Where you're like,

James: yeah,

Jessi: it's nice. Everything's fixed. It's cookie cutter. It fits the

James: price

Jessi: range that

James: you

Jessi: would think.

James: The price is kind of what it is. Yeah. The market really determines what it is. However, messy assets. They don't have that. Like they might have expired leases that are on there. Like, okay, how do we value this?

Or there might be some like mixed use confusion. Oh, what is the true value of this thing? Okay, there might be a lot of deferred maintenance. How much will it actually cost to bring this up? What will the value of it be once it's actually been repaired? And oftentimes there's just no good comps to go with it, and so you can't just look at those other properties.

So what that means typically is that there are fewer buyers, and that means there's a wider range for what the price could be,

Jessi: right? Because if you can validate one reason or another why it would be that way, then

James: yeah.

Jessi: Yeah. People will have to take it. 'cause it's like, well, we don't have any other

James: comparison.

Well, I'll, I'll often look at deals, especially on the commercial side. Where there's a big difference between an owner operator, someone who's gonna move into it and rent it themselves. Yeah. Or you know, own it themselves, versus someone like me where I'm like, well, I'm gonna own it, invest it, and I'm looking to get a return.

Sure. You lot of times you get people who, they'll just pay more because they're like, I have a totally different use for this. I don't actually care about the ROI, I'm just trying to save my rent, and in 20 years I kind of care about what the value is.

Jessi: Because

James: not really

Jessi: when they resell, but, but

James: it's more like, I don't wanna have to ask permission to do all the repairs and stuff.

Yeah. I just want do it myself.

Jessi: Yep.

James: And that has value, which I totally get true out of it.

Jessi: Yeah. That, that could be one way that you solve for a messy deal. You're like, I'll just do it. My, I'm just gonna do it myself. Could you, is another way to say that. Like there are just a lot of unknowns about the property.

Yeah. Mm-hmm. And so it takes a little bit more effort to figure out

James: Correct.

Jessi: What you could do with it or what. The prices or

James: Yeah.

Jessi: What it qualifies for as far as lending or,

James: yeah. Yeah.

Jessi: Whatever

James: they often talk about in real estate, unique is a four letter word. Like you just don't, no one wants to hear that word.

Jessi: Yeah.

James: Because of all those reasons, you're like, man, well, what is the true value of this? Well, what did the one similar to itself for? There was no one similar to it. Yeah. It's, oh, okay. They've semi solved it on the commercial side of the world because you could just look at, well, what's the net operating income?

Mm-hmm. And now let's look at assets that sold for a similar net operating income. Kind of what? But even then, it's like if you have one that's a storage facility versus an apartment unit versus like retail space ES retail, you're like, okay, the net, the NOI might be the same, but. How you got there is different.

The use is totally different. Different. The lease structure is very different. But still it's, it's, it's Anne way that kind of gets you closer. Sure. To it, huh? Yeah. Reason number two, uh, oh out of eight, by the way.

Jessi: Oh, got it.

James: So yeah. So we got a lot. Calibrate myself. Yeah. Yeah. So we can spend forever off one of 'em.

Just threw the other, uh, messy deals, filter out spreadsheet only buyers. Yeah. So many investors they can model. It's funny, I actually took a, um. I don't know. It was like a mentorship course thing when I was first got into syndications. Mm-hmm. And raising funds and, and it was shocking how many people were like, oh, I don't like talking to other people.

I just wanna do the spreadsheet thing. Like, that's what they wanna do. Like, I analyze deals all day long. Interesting. On a spreadsheet, like cool. I mean, okay, that's good. Super good value gets you to a certain point. You sure I'm there too? I get it.

Jessi: Yeah.

James: But, um, but they. A spreadsheet samurai type of person, there's really gonna struggle with

Jessi: Yeah.

James: Like, well I don't, I don't know how to eat these Well, obviously of these things. Yeah.

Jessi: It's like for a spreadsheet you have to have some knowns

James: Yep.

Jessi: That you plug in to the equation.

James: Yeah. And oftentimes messy deals require like judgment. Yeah. And sequencing and just patience.

Jessi: Yeah.

James: It's,

Jessi: it's Or flexibility, the math.

Yeah. Like, okay, maybe, maybe you have to be flexible on timing or you have to be flexible on what type of repairs you're doing.

James: Mm-hmm. Mm-hmm.

Jessi: Whatever it might be.

James: Yeah.

Jessi: The type of tenant that you

James: Yeah. Yeah.

Jessi: Get in there. Whatever.

James: Yeah.

Jessi: Yeah.

James: Reason number three is creative finance only works when someone needs a solution.

Jessi: Hmm.

James: So, creative finance is, you're not just offering 'em cash. I mean, you might be, but you're saying, Hey, uh, I'm gonna do some sort of financing either with you, Mr. Seller, taking over your existing debt, or you're gonna gimme new debt. Stuff like that, that requires someone who's not just selling to, to maximize their, their return for it.

Jessi: Yeah.

James: And so. The reason in that case, the property may not be the messy thing. The person selling might be in the messy situation.

Jessi: So gimme an example of creative financing that makes the deal unique. Like a theoretical or maybe an example of something you've worked with before.

James: Well, yeah, I was gonna say, so like we had one where we bought a house.

It was a guy who was older. And could no longer live there. They were thinking about moving him into hospice. Mm-hmm. They didn't need the cash up front, but they needed to somehow resolve the property. Like they needed to know what its next step was before, uh, before we passed away. Otherwise it was, then it was gonna get really messy on them.

Mm-hmm. And so for them, they were like, yes, we wanna sell to you. But they're like, but we don't need the cash. We would rather collect the interest over the next year and then, and then we'll get the cash plus some interest for it. So it's usually, um, are they looking for greed or speed? Those are kind of the, the ways to think about it.

As a greed, you can do seller financing 'cause you go, hey, you'll actually make more. Yeah. In the long run. 'cause you get interest for it. If you're looking for speed, that's where you can go to seller financing. Like you can, uh, you're doing like a subject to taking over whatever existing debt they have.

You go, we'll just take it over. There's no qualifying, no nothing. Just move on.

Jessi: Just, yep.

James: Yeah. And so, um, kinda depends on what their wants are, but that, that's a situation where like. It was messy. 'cause we weren't actually talking with the seller. We were talking with his, um, power of attorney person who was making all the decisions for them.

Jessi: Right.

James: And so those are

Jessi: cool.

James: That's a messy deal.

Jessi: Helps me wrap my head around it a little bit to have

James: Yeah, yeah.

Jessi: An actual scenario, I guess. No

James: problem. And, and so the big thing there is like, you're not just like, don't think of it as like, oh, I'm buying an asset. I mean, you are, but it's really like you're just solving for problems and constraints and figuring out,

Jessi: and I, I would imagine

James: it's a messy.

Jessi: Like the speed deal is like someone just wants the cash to be able to move or Yeah. Invest in something or whatever it is. And it's like, I don't wanna wait it around. I don't wanna have financing, I just want my, I wanna get rid of this asset so I can move onto something else. Mm-hmm.

James: And sometimes you have someone who, the house itself is in big time disrepair.

Mm-hmm. It's not gonna qualify for traditional financing. Yes. So they can't just put on the MLS 'cause. Yeah, they're not gonna get it. What they're gonna get are cash buyers who go, Hey, I'll give you cash at a massive discount.

Jessi: Yeah.

James: And again, that the greed part comes in to go, well, I don't want to do that.

And so you're like, well, if you're willing to defer a little bit, that has value. And so you play that game.

Jessi: All right.

James: Messy assets also is number four. Uh, hide multiple independent income streams. Potentially. Potentially. Because it's a messy, it's a messy deal. So like when I bought. The baker tower. That was messy in the sense that there was commercial and there was residential.

Jessi: Oh, okay.

James: And

Jessi: I see what you're saying,

James: but there's also a ballroom Sure. That was there. And there's amazing views. And so there's like, there was also like the, there's multiple different

Jessi: for the, uh, towers

James: 10. The towers, right? Yeah. It was like, I totally forgot about that part,

Jessi: huh.

James: Yeah. So those are, so that's usually in the mixed use space.

Jessi: Mm-hmm.

James: Uh, those can look a lot uglier and messier on paper. 'cause like, oh man, I don't really know. And because again, in like storage doesn't equal retail doesn't equal residential doesn't equal industrial, and the demand cycles themselves can all be different. And so how you value those is tricky, which,

Jessi: yeah, and I, I could, I could see wanting to have, not a ton of mess, but some mess because the types of properties do differently in different seasons.

So it's like, okay, your residential might have a ton of vacancies right now, but. Other things might, might be supplementing that income. So it's okay.

James: Yeah.

Jessi: Because your retail spaces keep staying open and whatever it is. So

James: here's a question for you. Would you rather have one amazing tenant or 11? Okay.

Ones

Jessi: 11. Okay. Ones?

James: Yeah. Why?

Jessi: Well, because, because if that's so messy, look at you. It is messy. But if one leaves, I still have 10.

James: That's true.

Jessi: Who's true? Can pay most of the building's mortgage. Yeah, yeah, yeah. As opposed to. If one's gone.

James: Yeah. And you're talking about the vacancy risk, right? So you're willing to vacancy risk, deal with the operational messiness of,

Jessi: yeah.

James: Of more tenants, even if they're not as amazing

Jessi: Right.

James: To, yeah. To take care of.

Jessi: I mean, I, I get it. I guess it depends what you're willing to put up with and if you can float the vacancy risk to have a great tenant in there, maybe that is better.

James: Yeah.

Jessi: I don't know. I

James: dunno. Um, reason number five, this one's controversial.

You may disagree with this one, but operational complexity can reduce financial risk. Okay. Hear me out. So if you have a lot of things that go on with the operation, there's just a lot of components to it, that means that there's smaller failure modes that could happen. Hmm. So, for example, vacancy becomes granular instead of catastrophic.

And we'll go back to the Baker Tower as an example there. Right. That's operationally very complex.

Jessi: Mm-hmm.

James: But if one tenant moves out, you're like, okay, whatever I got.

Jessi: Yeah.

James: It's

like

James: what

Jessi: you were just describing,

James: it's very similar.

Jessi: Yeah.

James: But even just on the, yeah, it kind of, it's, it's another way of saying for that mixed use, it's, it's, it's slightly different in the sense that it's not just the income streams, but it's on the operation side as well.

You, you get. It's not the vacancy side alone, it's also on the operational side. There's advantages to that. Huh? And there's also potential for doing things better and more efficiently. You can improve the systems because there's a lot of 'em, like for example, if you've got a place that, I don't know, it's all one big shared water thing, Uhhuh, there's an opportunity there to add complexity.

To say, Hey, we're gonna submeter these things out. Mm-hmm. Or we're gonna do some ratio utility building. It adds a lot more complexity, but. It can dramatically increase the revenue. 'cause now you're figuring out, okay, here's how I'm gonna proportion this expense out to that specific tenant or whatever.

Jessi: Huh?

James: Yeah.

Jessi: Wouldn't you think that it would be, wouldn't you think that it would be better to have a building,

I don't wanna say this, that it would be more efficient to have a building that has all the same types of tenants, like what you just described. There's,

James: yeah. There's value that

Jessi: is like. Yeah, there is complexity. However, it's like if all of your tenants are retail, your systems can be overarching. That's true.

You know that with the whole place's as opposed to like, okay, well I have certain systems for these types of tenants, and then different systems for residential tenants and even different systems for like rental type clients.

James: It

Jessi: depends. Maybe that's okay. Yeah.

James: Yeah. It, it depends because you could have, like if you've got residential and commercial, they could potentially support each other.

Sure. It's operationally more complex, but they help each other out.

Jessi: Interesting.

James: Potentially.

Jessi: Yeah.

James: Yeah, yeah. Yeah. Huh Uh, yeah, so I just think like complex doesn't necessarily mean that something's fragile. It can actually. It'd be good.

Jessi: Mm-hmm.

James: Number six, messy deals. Age better than clean ones. It's just a fun way of saying there's more upside on, on messy deals.

Um, because oftentimes the clean deals, they're just fully optimized from day one. Right? Like they're good. You know what you're getting. The cash flow is what it is. The. Everything's set. Whereas with messy deals, you can fix those problems. Mm-hmm. Uh, you can get the leases to normalize. Mm-hmm. You can potentially reset and increase rents on things, and there's just different improvements that you can do that stack over time that makes this property more valuable.

So time actually becomes your ally on a messy deal.

Jessi: That makes sense.

James: Yeah. And you don't necessarily need to time like the, the, the purchase and sale. Perfectly. It becomes more of this inevitable. No, we've added value, we forced it.

Jessi: Yeah,

James: we're good. Mm-hmm. And so that just, it, it just looks better over time.

Ages better.

Jessi: That makes sense. And over time, often a messy property does require more effort or totally. Work.

James: Right.

Jessi: And therefore the upside is bigger.

James: Yeah. Makes,

Jessi: you know,

James: which I think comes back to like, the goal is to solve problems, you know? And if you're doing that, there's value there.

Jessi: Yeah.

James: And messy deals.

Sure problems.

Jessi: Yep.

James: Yep. Um, this one's kind of an interesting one. I think this is true. Uh, number seven, banks only care about the end state. So it's kind of interesting when you talk to a bank, especially in the commercial space. They get it. If there's a property that has issues but you have a solid business plan for how to fix it, they go, cool.

Yeah, we're funding that.

Jessi: Yep.

James: That plan for it. And now obviously they love ones that are also like, yeah, this is full of stabilized, straightforward, we get to go preferable day one. No questions. Yes. Like they get it, but they also get the other stories too. And sometimes they can even charge a little bit more interest.

Because they recognize it's a little bit more risk. Like, yeah, cool. We're in.

Jessi: Mm-hmm.

James: So it can work out there. Cool. Yeah. Yeah. And then finally, and this one's really, this one's a huge one. I saved one of the best for last. You're welcome. Is that local knowledge, multiplies value in messy deals. Mm-hmm. Right?

So. Weird assets punish outsiders.

Jessi: Mm.

James: Right. If you, 'cause I've seen some interesting deals that are just even not directly in my area and I'm like, ah, this looks really fascinating. But.

Jessi: Yeah,

James: I don't know anything.

Jessi: You don't know the market and you don't necessarily know potential buyers down the line.

Makes

James: sense? Yeah, makes sense. So if you understand, makes sense. If you understand like what the real tenant demand is and, and, and what the rents are related to that, if you understand like on, uh, for example, for us out on the coast. Like, oh, there are no contractors out there. It's not a thing. Right. Like if you know that it's gonna be expensive, you can underwrite it better and be prepared for it.

Jessi: Sure.

James: Whereas if someone's just like, oh, whatever, it's on the coast, sounds great. Mm-hmm. And then a repair happens. They didn't underwrite it properly. Oh dang.

Jessi: Yeah.

James: You know, and so, so you get advantages. Yeah. Like that, that makes sense. And even if you are doing a project, like I got one, a project that we're looking to do, like I've, I know contractor friends and I'm just like, dude, hey, can you come take a look at this?

I'm

Jessi: mm-hmm.

James: Love to get this thing solved. And so, um, so it's just a huge advantage. Um, for having that, uh, that local knowledge

Jessi: that totally makes sense for messy deals. I mean, even some of the messy deals are messy for different reasons. Like I'm thinking

James: Yeah.

Jessi: A building in a historic district or something is like, all right, that's a little messy.

It's a little different. Yeah. But if you know the town or the commission that's working with it, like. Yeah, you can deal with the mess and it is great. Might have a great upside.

James: Mm-hmm. Mm-hmm.

Jessi: And you know, as some historian will buy it later for lots of money 'cause they loved the restoration you did or whatever, I don't

James: know.

Or you happen to know that there's some development that's coming through,

Jessi: right?

James: It's gonna be there eventually.

Jessi: Yep,

James: yep, yep. All that stuff. Yeah. So if you are, uh, an investor and you're talking to sponsors, like that might be one of the things that you're looking for. Like, hey, where is that mess? Mm-hmm.

Why does it exist and what are you gonna do for it?

Jessi: Yeah.

James: Um, which problems are priced in versus perhaps ignored or not thought about? Um, what must go right versus what must not go wrong.

Jessi: Mm-hmm.

James: I think is a good question. Oftentimes that's around like, how do you think you can actually generate those rents?

Jessi: Yeah.

James: Uh, do you think the rehab cost will actually be that, those kind of questions. Yep. Um. And then just, it's good to know, like, how does the complexity reduce competition here, which oftentimes we're doing off market deals anyways. And so, um, it, it helps, but, uh, yeah, like we're looking at a, a, we just put in an offer.

On a couple houses we're gonna split the lot on again. And, um, it's in Lebanon and it's funny actually, relative to Albany, we're like, oh man, this is actually really straightforward. It's a lot less messy. And, uh, there's, it's

Jessi: because of code or

James: Yeah, they're, they're a lot faster

Jessi: Oh,

James: to process than Albany.

And, um, and a lot of the utilities are already set in. There's no, well there's no shared stuff, so we're like, oh man, this is actually. Like this is really straightforward and there's not a, a manufactured home that you have to get like converted over.

Jessi: Oh, yep.

James: So, uh, things like that. Yeah. So in conclusion, messy deals, they're not just, they're just better by default, but they provide that asymetry where you can.

Solve problems and it creates that pricing distortion just at the very beginning part of it. Um, it allows for some creativity, both in the operations and in the mix and also in the financing of it. And because of those, assuming you're going through and solving them, time becomes your friend because it just becomes more valuable over time as you fix those problems.

Jessi: Cool.

James: So that's why I like messy deals.

Jessi: There you go.

James: Yeah. Yeah. Kind of fun. Kind of fun. Cool. Well, uh, with that we do. Regularly look at messy deals, um, and, and we have people who invest in them. And if you would be interested in learning what that looks like with us, uh, you can check us out at furlo.com and learn all about our investing thesis.

And again, the types of deals that we're doing. And messy

Jessi: ones,

James: messy deals, all rage. It's, uh, it's pretty good. So with that, thanks for listening. Have a great day.