Starting from Scratch

It was not exactly how Randall Friend, Kyle Martin, and Kenneth Melton imagined they would be closing their first big real estate portfolio. The trio, who are partners in Eagle Real Estate Group in Anaheim, Calif., had just established their business plan and, almost immediately, made a successful offer for a $40 million portfolio made up of five apartment communities in Ontario, Calif. "It was kind of a spur of the moment thing," says Friend, a real estate lawyer who wanted to try his hand in multifamily housing.

While the new partners were excited to get the portfolio, they were not totally organized – which became apparent as they were preparing to meet the vice president of Pacific Gulf Properties, the seller. Just as they were about to take their first big step into the multifamily business, they realized they were missing one important thing – business cards. So, just minutes before signing the final papers on the deal, they were at Kinko's picking up their newly printed cards.

Fortunately, this last minute hiccup did not cause any problems, and the new company was off and running. After the deal, Friend closed his law practice to focus exclusively on real estate. In the two years since its initial closing, Eagle has acquired more than 2,000 units, totaling $175 million.

Friend and his partners at Eagle are not alone in their experiences. Their story is illustrative of all the minor details new multifamily firms must address before becoming viable players. Over the past few years, a number of multifamily executives have moved on to start their own companies. But this task is not as easy as it sounds. Before they can venture out on their own with any hope of success, executives must know when to start their business, where to find and tap financing and equity, and if their new partners are trustworthy.

Executives starting their own companies have similar stories. They've all been successful and had good jobs, yet there was always something pushing them to go off on their own – whether it was the feeling they had advanced as far as they could in their current job, the desire to run their own company, or the realization they were so well connected to equity sources that they could take their employer out of the loop and begin doing deals on their own.

In June 2002, Kyle Martin, Randall Friend, and Kenneth Melton (from left to right) established Eagle Real Estate Group in Anaheim, Calif. The company acquires multifamily properties in targeted markets.

Matt Perrin, principal of Trillium Residential in Phoenix, reached a ceiling at his old company, Mark-Taylor Residential, also in Phoenix. He knew it was time to move on. In his 10 years at Mark-Taylor, Perrin had grown professionally and developed some great relationships. In 1996, when he became president, the company had approximately 2,400 units and 250 fee-managed units. When he left six years later, in 2002, it had 6,200 units and 2,500 fee-managed units.

But Perrin knew he always wanted his own company. Though he recognized the inherent risk, he still craved the ability to control his own financial future, which he could only get with ownership. "I did not have control over the direction at Mark-Taylor," he says. "Also, I wanted to make sure I was going to be involved in the development side, not just operations."

Perrin began talking to competitor David Dewar, who was a partner at Magellan Residential, another Phoenix-based developer. While their conversations started as general discussions about the market, they soon found themselves talking about their careers and aspirations. They realized they not only had similar goals, but, most important, they had complementary skills. Dewar was skilled in development and financing, while Perrin knew the property management side and how it related to underwriting deals.

In January 2003, Dewar and Perrin thought the market was ripe for a new multifamily business. There was a lull in the development cycle, which Perrin says provided them with the perfect opportunity to position the company when the market turns. "I realized that there were really no other options for my personal advancement, fulfillment, and enjoyment [at Mark-Taylor]," he adds. "When you couple that with the appropriate market conditions, I knew that the time to leave was as good as it ever was going to be."

While Perrin left Mark-Taylor because he felt like he could no longer advance, Stuart Gruendl left his job, as executive vice president and director of development for SNK Realty Group in San Francisco, when he realized that his capital sources were relying on him more than SNK. "It is such a people business that when an institution understands your personal business philosophy, it's banking on your personal talents more than it is on the collective talents of the organization," he says.

Once this occurred to him, the decision to leave was easy. "I said, 'Hey, I can go out on my own and surround myself with good people I have met in business and go out and execute just as successfully as I had in a larger organization,'" he says. "I will have greater financial benefits because I am the owner." And he did just that, starting his new company, BayRock Residential LLC in Emeryville, Calif.

While most executives are eager to get their new businesses started, it's often good for them to exercise a bit of caution and develop a plan before jumping in. One key thing to consider is partners. In the best case, a good partner can help balance a multifamily executive and help a business grow. In the worst case, a bad partner can leave a business stalled at the starting gate.

Tony Zanze, a partner in Hamilton Zanze & Co. in San Francisco, decided on a strategy, product type, and location when he started his own company. But in hindsight, Zanze admits he made one mistake, which almost destroyed his business before it got off the ground – he picked the wrong partner.

He found apartments he liked in the Oakland area and purchased them with a partner and his father. Zanze's father provided most of the money, while the partner served as the property manager and Zanze, the asset manager. The problem was that the partner was not very detail oriented. "It turned out he was more of a big picture guy," Zanze explains. "We were not seeing any books, and the accounting was not getting done. He started producing paperwork that did not make sense. Eventually, we learned the bills were not being paid."

Zanze and his father removed the partner and hired a small property management firm to help them turn their portfolio around, and in the process, found themselves a new partner. Mark Hamilton, the husband of one of the property management firm's owners, owned 10 properties in the Oakland area. He had an office, administrative help, a solid business model, a strong local network of due diligence people and contractors, a good knowledge of the Bay area market, and, most important, the desire for a partner.

The new partners skills complement each other. Hamilton finds the properties and handles management and customer relations, while Zanze focuses on due diligence, capital markets, financing, and investor relations.

Others can attest to the importance of a good partner. David Schwartz, managing member of Waterton Associates LLC in Chicago, teamed up with Peter Vilim, whom he worked with at AMLI Residential Properties Trust in Chicago in the mid-1980s. Schwartz not only knew he could trust Vilim, but he also knew what Vilim brought to the table. "My background was in acquisitions, and I thought I could be good at raising money," Schwartz recalls. "But I needed someone who could manage the properties, so I brought in Pete."

Good partners can also give a firm flexibility, such as the case of Friend's two partners, Melton and Martin. Melton's forte is financing, specifically through bonds, which has allowed Eagle to tap into the low interest rates that bonds provide, according to Friend. Martin's strength is in construction, which can help it tackle tricky rehab projects without going to outside contractors.

But, even a solid leadership team will not guarantee success. New multifamily firms must have an equity pipeline. Developing this is much easier when there is already a connection – usually from past jobs. Alfred Pace, president and CEO of Pacific Property Co. in Palo Alto, Calif., was in a situation where the contacts he made during his 17 years with his former company, SSR Realty, helped him out. "There was a significant comfort in the institutional experience I had developed at SSR, where I was investing on behalf of a pension fund," he says. "When that same experience was marketed to private equity and debt sources [as owner of his own company], it was very well received."

Gruendl also courted the private capital sources he had previously worked with. His goal was to have three years of projected overhead, which would keep BayRock afloat during lean times. Gruendl likes to diversify his equity sources. He usually goes to Wall Street and major money center institutions for this equity.

When a multifamily company is starting out and doesn't have a well-established reputation, lenders may not be comfortable with the guarantees a new company is providing, according to Schwartz. But once a firm develops a reputation, things get easier. "Getting the first loan is always a challenge," he says. "Getting the second is easier, getting the third one is a lot easier, and getting the fourth one is a no-brainer."

Since the fall of the stock market, a number of investors are now looking at the multifamily sector as a place to put their money. While this pool of investors can give a multifamily company a larger amount of resources from which to tap, it also can drive up prices. The key to competing in this environment, says Stephen Lefkovits, principal of Joshua Tree Consulting in San Francisco, is to find a way to differentiate yourself from other sources of capital out there. Multifamily firms need a niche, such as being strong in property management, marketing, or having a strong operating strategy, according to Lefkovits.

If they can find this edge, have good financial relationships, come into the market at the right time, and have good partners and a little bit of luck, then they just might make it in the multifamily world. But, as any executive who has made the jump would say, it is not easy. "You are, in essence, living in paranoia," Zanze says. "If you are adverse to risk, forget about starting your own company."

Before starting your own multifamily company, there are a number of factors to consider. Executives who have already made the leap into ownership offer the following suggestions:

Know Your Market. Smaller companies have much less room for failure, so they must have an intimate knowledge of the markets and submarkets they are going into.

Differentiate Yourself. With all of the capital out in the market now, multifamily executives must set themselves apart from their competitors to have any chance of competing for properties.

Look for Deals. Because capital is so abundant and deals can be so scarce, multifamily executives must actively seek out deals. Some start-up executives go as far as to find sellers before properties even make it to a broker.

Find Good People. It's still very important for executives to surround themselves with competent, trustworthy people, whether they are partners, employees, consultants, or property managers.

Manage Your Costs. One way executives can be successful is by controlling development and overhead costs. While there are some market factors that can't be controlled, expenses are one thing that can be.

Don't Have Too Little Capital. New companies need to have three years of capital on hand so that they will not be so starved for money that they'll have to make bad deals.

Don't Leap Without Looking. Before making any deals, make sure they are right for the company. Often times, newer companies have less margin for error than mature ones.

Don't Get Overloaded with Work. With an office to run and deals to make, the demands on a small business owner can be burdensome. It's important to prioritize and focus on what produces revenue.

Don't Go at it Alone. Everyone has a weakness or areas that they aren't an expert. Instead of jumping into something they're not familiar with and putting a business at stake, it's best for executives to look for outside help.

Don't Go In At the Top of the Cycle. Most multifamily executives interviewed said they chose to go in at a lower point of the economic cycle, when multifamily property prices were low.

One of the key decisions most executives must make when they go out on their own is whether to rely on outsourcing because property management and construction can be unnecessary burdens to many multifamily firms. "For many people, the property management process is difficult and time intensive," says Matt Perrin, principal of Trillium Residential in Phoenix. "A lot of people just don't want to deal with it."

Randall Friend, a partner in Eagle Real Estate Group in Anaheim, Calif., is one of these people. He says property management would take away from his company's main strength, which is staying focused on deals and finding opportunities. Stuart Gruendl, founder of BayRock Residential LLC in Emeryville, Calif., also outsources property management so that he can keep his attention on "creating revenue." The high insurance and worker's compensation cost in California and the relatively low cost of property management services also played a part in Gruendl's decision. "If you are starting a business in a down economy, the outsourcing resources are so competitive that they beg for business, so we get great pricing," he says.

But if a multifamily firm has expertise in property management, construction, or rehab, outsourcing may not be necessary. With Pete Vilim's experience, Waterton Associates LLC does its own property management and even has regional offices in Chicago, north and south Florida, Las Vegas, and Seattle. "We look to be as close to the real estate as possible," says David Schwartz, managing member of Waterton in Chicago. "In a perfect world, we would have regional people in every city we are in."

Perrin's background in property management not only helps Trillium, but also it gives him a perspective somewhat different from those offered by Friend and Gruendl. "Property management can be a truly value added process – a way to enhance the value of your asset," he says. "That's the way we look at it. Manage it well, enhance its value, protect your investment, and have control as the developer. I believe that is critically important."