If you want to reap the biggest profits possible out of distressed assets, creating a concrete business plan with a systematic approach is key. In this episode, Chris Seveney sits down with Jake Harris, an expert in investing in distressed commercial real estate. He explains why small yet consistent strategies can help you win big when investing in this particular asset, establishing a strong passive source of income. Jake discusses the significant change in short-term rental properties after the pandemic and why due diligence is the most critical part of real estate investing.
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The Advantages Of Investing In Distressed Assets With Jake Harris
I have a special guest. We have Jake Harris with us. Jake is an expert in investing in distressed commercial real estate. He is the author of the number one bestselling book, Catching Knives. He also has a top-rated podcast, Passive Wealth Principles. You can also find out more information at CatchKnives.com or PassiveWealth.com. With that, Jake, how are you?
I am fantastic. I had a great mastermind group connection. I’m feeling very invigorated and ready to go take on the world and implement some of these new lessons that I’ve learned.
You’re bringing the energy. I love bringing the energy to these shows. I want to talk to you about investing in distressed assets. We’ll talk about distressed commercial real estate and the opportunities, as well as why passive investors should consider investing in distressed assets. Before we roll too deep into that, why don’t you tell us what you got going on now and circle back to how you got to where you are now?
You mentioned the book, Catching Knives. That is my clever way of playing off the tune of most people saying, “Don’t catch falling knives.” I have found that real estate is a scarce commodity. Whereas most people refer to that in the stock market, your Tesla stock goes down from 420 down to 69 or whatever it is that’s in value. You wait until all that has settled, and then you buy into the market. With real estate, especially commercial assets, there are times in which that asset may only trade hands once a generation.
It only requires one other person to be a bidder or try to buy that asset, and then they buy it because of that scarcity. Whereas with a Tesla stock or something like that, you can buy as many of them as you want that any time, unless there are billions of dollars that you have. If you have billions of dollars, you’re not tuning in to this show probably and that’s not your problem. I was like, “Don’t be taking advice from me.” Nobody should take advice from me in general because I don’t know how to predict the future of anything. That is my grain of salt.
I’ll take you back. Many years ago, I got out of the Army. I read Rich Dad Poor Dad, like a lot of other people on the genesis of their journey into real estate. I wanted to start doing deals and I did. I started and I wrote a very nice wave up in the early 2000s until ’07 and ’08 collapsed. I was caught in that collapse and crushing. I had all these houses and I’d become a millionaire before 30. I had all this success, and then it all crashed down.
I ultimately had a couple of foreclosures on my record. I couldn’t short-sell them. I had a liquidated portfolio. You can get more of the details of this in the book where I illustrate my own personal journey. What happens, and it’s a quote that I put on the back of the book, is that you want to be buying when there’s blood in the streets, even if the blood is your own. In that instance, my blood was in the streets. I was losing on these deals. These assets were falling apart, but that was the best time to be buying because you were getting such an extreme discount. That’s where it came off a long-winded way of saying, “We started buying distressed assets. We started buying them at scale. We started buying them at trustee sale.”
I, because I didn’t have the money at that time, became the workhorse for someone else that had money. I was the one that went into the trenches and started buying, researching, and doing these other things. I had the understanding and the skillsets, and then we leveraged that up. Ultimately, we purchased assets in 23 states, and 1,200 properties. That then is rolled in over several years of commercial real estate. That leads up to what is now. I have boutique private equity, a real estate company that does commercial real estate, some single-family land assemblage development, and other things. These are in different funds based on different investment criteria.
I wrote Catching Knives in 2020. We’re joking about this and you’ve been interviewed on my show where I was like, “I thought this is it. This is the time it’s going to crash.” I sat down during COVID. People weren’t working in the office. I pounded it out and I was like, “This is it.” It came out and the market took off like a rocket ship. I go back earlier. I don’t know if you should be taking advice from me because I was very confident that the market was going to be crashing and it did the exact opposite and it shot to the moon.
I’m sitting there, and then all of a sudden, now interest rates are tripled and construction cost is up crazy high. I’m starting to see, and you probably see more than I do, the tremors of distress are starting to happen. This is why I am very excited-ish because this also means there’s a lot of pain happening and then sorrow. Deals, investors losing money, but there’s a massive opportunity when there’s distress or when people come in.
That’s why you can make generational wealth in one deal in distressed times because everybody gets alligator arms. Everybody pulls back and it doesn’t seem to make sense to them. It’s too scary, but that’s where the best buying opportunities are and it de-risks your investments that you’re investing into because now you’re not speculating on something going right. All the things have maybe now gone wrong, so now you’re just evaluating it and you can buy it under its intrinsic value.
I agree wholeheartedly with everything that you said. It did shoot up. The question I would post for people who weren’t around in the 2005 to 2010 timeframe is, “What was your biggest lesson learned going through that experience many years ago where unfortunately, you were caught where you had the foreclosures on certain properties and stuff?” What would you say was your biggest lesson learned from that period of time?
There are a lot of lessons learned. To boil it down to the one, I would think about this, and this is my story or my experience. I didn’t develop systems. What I mean by that is, and I’ll give you an example, it’s easy to lose weight. Say you want to lose 10 pounds. You can just not eat for two weeks. You probably were not going to die. You’ll be uncomfortable, but you could lose 10 pounds. That’s a pretty easy thing to do if you just had enough willpower. The issue is that not eating for that time period is not sustainable. Maybe you could start eating, but what happens is you didn’t develop a system.You can make generational wealth in one distressed real estate deal because people pull back from things that doesn’t make sense to them. Click To Tweet
This is why I love the book, Atomic Habits by James Clear. It was you default to the level of your systems and if you want repeatable success, you need to have a system. The goals are great for establishing a one-time goal, but a system is something that can get you predictable and repeatable success. That’s where I white-knuckled the ability to have and become a millionaire. I didn’t develop any systems and I didn’t really move the goal line. I became a millionaire and I started sitting on my laurels. I was like, “I’ve done it. Look at me.” I wasn’t continuing on because I hadn’t built this and established this basis.
$1 million many years ago is a much different $1 million than it is now. I don’t know the cost of gas wherever you are, but it’s $5 to $6 for a gallon of gas. Many years ago, it was $2. Everything has been eroded away as the government printed and threw trillions of dollars out there. That for me is understanding how you start leveraging systems. How do you start creating consistency and predictability in the things that you’re doing and your action items? If it is you’re a passive investor, great. What systems can you tap into that allow you to evaluate, do due diligence, and get a certain amount of deal flow, if you’re looking for off-market deals, or if you are trying to generate leads for a marketing company?
I don’t care what it is, there’s a system for that, and then it’s broken down. It’s usually a fairly simple system that you can start following so that you can start tracking and measuring results. For me, I needed to develop those, or at least, I like to call it R&D, Rip-off and Duplicate, other people’s systems. Let’s be honest, nothing is new under the sun. If someone else’s system works, great. Grab that system, take it, adapt it to your circumstance and what you want to do, and then leverage that so that you can get more predictable and repeatable success.
One of the things we’re starting to see on our end because again, we’re usually on the front lines, that is similar but different of course over time goes back to people being over-leveraged. I’m starting to see people trying to do a lot of creative finance where they’re not putting any money down or very minimal money down. A lot of people are first-time investors who don’t have significant funds and don’t realize that it’s great that you can buy a house with no money down or a property with no money down. You have a loan on it that you still have to pay. You may have to pay if there’s no tenant.
People forget how much a new roof may cost or a new HVAC system and end up realizing they have no money to repair it. The tenant moves out and then the house just sits there vacant. They can’t rent it because it’s not rentable, but then they still owe somebody some money on it. Again, not saying that’s going to be a macro issue, but there are a lot of cracks we’re starting to see, which rolls into next.
Let’s talk about the commercial real estate side because there’s so much news out there right now about how many billions or trillions of dollars are coming due within loans in the next few years. Once they reset, lenders aren’t lending because properties with the cap rates are probably worth 50% of what they’re worth. COVID crushed a lot of commercial where offices are downsizing and people are moving to smaller spaces and having trouble leasing the spaces. Tell us a little bit about what you’ve seen, what you think the opportunity is in that space, the benefits for somebody who’s passive, and why it might be something they should look at or consider a fund like yours that invests in that type of strategy.
It’s very deal-by-deal specific. I like what you do as far as you have a fund that you’re targeting these distressed pools of assets or at least mortgages and you’re averaging it out. That’s one of the advantages of being a passive investor or an investor in a fund. You’re getting the advantage of multiple assets. There’s also, obviously in commercial, where you might have just a specific dedicated fund to go off after an individual asset. The timing is one of those most crucial factors. You don’t have typically a lot of time to buy some of these, buy a distressed note, come in and create some rescue capital, or do something like that because the distressed fuse is lit and you need to be able to move in and quickly take advantage of that.
Also, because it is in a distressed situation, you’re not going to have all the information. When you go buy an existing building on the market, you get an offering memorandum, rent rolls, and inspection periods that you can dive into. You can test out all these other things, and then you’re not necessarily getting access to all of that when it’s in a distressed situation. That’s why you’re often able to buy it at such a significant discount because you’re factoring in that risk factor of having unknown information.
I go through the operator’s experience and their ability to understand and at least see some of these red flags. I also tell people, you need to be doing your homework ahead of time because of that limited time period of when it may potentially be going into distress. There are sometimes opportunities to start doing your homework before it’s in that distressed situation. I don’t know about you, but sometimes there are leading indicators that are going to be that something is going awry with this asset into the near future. It could be a maturity of the debt.
People, you can track that. You can get into CMBS or Reonomy. You can get into these software and data programs to see when debts are maturing on commercial assets. If it’s maturing now, in 3 months, or in 1 year, as you said, a bunch of debt is turning over. What’s going to happen? They’re going to be more stressed the closer that gets if they don’t find an option. If you’re doing homework three months before that note is due, then you may have an advantage. You can get that rent roll. You can get some comps on that. You can get market volatility of leasing activity or rental activity if it’s a house, short-term rental, or sober living. All these other alternative ways that you could potentially make some money off of that asset or value-add component to it.
The earlier you get in that process, the more informed that you can be. I’m going to tell you this. You’re never going to have 100% of the information in any deal ever. You’re never going to get 100% and if you add 100%, then it’s too late. You’re going to have to get a certain percentage of it with an understanding of, “Here’s the calculated risk which we’re taking based on this asset.” Oftentimes I talk about this. It’s the intrinsic value of the asset you’re going into, the sticks and bricks.
If it’s a 40,000-square-foot office building and you can go buy it for $50 a square foot, intrinsically, that’s a good deal from a rough order magnitude because you’re buying it at $50 a square foot and right now, it costs you $250 to $300 a square foot to build something of existing of that same thing. No one else could ever build a product at $50 a square foot, and then it comes into your business plan. Are you looking to exit in and out of this in the next 30 days, 6 months, or 6 years? That’s the other important part people need to consider. Your business plan becomes a critical component of how and what you’re investing in these assets.
I have office buildings. I’m not very bullish over the next 6 to 12 months in office. It’s still a very tough market. You’re going to have a hard time leasing it up. There’s more subleasing and that’s where market-specific factors and market velocity are. Tech companies are now putting hundreds of thousands, and in some markets, millions of square feet of office on the market as a sublease. All of that would need to absorb before you could potentially get your office space lease. Unless you’re buying it at such a discount, you’re going to be able to be half the price of anyone else in the office market of vacancy, then that could work for your business plan.
One key takeaway for people that is important is, you mentioned a business plan. A lot of people are so antsy about due diligence and buying asset. They don’t have a business plan for the exit, what that looks like, and what options there are to make sure there’s more than one exit potentially for an asset, or what a sensitivity analysis is to be. “I want to excess this in three years.” What happens if it’s five years? If I’m projecting 80% lease, it’s only 70. What happens if it’s 90%? That’s the thing. I see a lot of people using a calculator and punching numbers to make it look as rosy as possible or trying and working to a number instead of putting in some realistic expectations on an asset to see how it will act.
I see that starting a little bit not in commercial, but in short-term rentals where people are buying assets in the past 12 months in short-term rentals at 2020, 2021 rental rates or post-COVID. Now, it’s 50% less and they’re like, “I can’t do anything.” I’m like, “We should work as a long-term rental,” because that’s how you should underwrite every short-term. They’re like, “It doesn’t work.” I’m like, “I don’t know what to tell you.”
I’ve been a little bit bearish on short-term rentals for a while because there are a lot of headwinds in the short-term rental space in general. I was talking about this. You have a lot of political and potential governmental regulations that can quash an entire market. I don’t know if you saw it. Dallas banned all their short-term rentals. Even though they were licensed, they just decided. Here’s the reason why. It becomes very politically easy to squash the short-term rental because it’s targeting the rich got that has a second home or vacation house. As a council person, if you were, you’d be like, “That guy’s 2nd or 3rd rental property that he’s renting out there, we can ban that.” It’s coming up against a bigger seismic societal issue of a lack of housing.
We are short housing, so then it becomes very easy to go squash the short-term rentals in a market to hopefully, free up rentals for the demand that is pent up. Politically, you’re going to have a lot of support for that. It doesn’t matter if you’re right or left. It’s a very easy thing for politicians to do and to put a regulatory environment on that.
You also have the hotel industry. They’re not fans of Airbnb and short-term rentals, and they have a very robust lobby group. They collectively have 50, 60, 70, or 80 years of lobbying horsepower to go support some of the things that will also undermine short-term rentals and try to drive up taxes and do all kinds of other things on those short-term rentals. There was a post-COVID blip of euphoria when money was raining down and that’s where a lot of people jumped into that. That’s why I think there’s also going to be a lot of people.
You’re seeing that most of the inventory I’m seeing on the market on a single family is Airbnb’s that are not working anymore. People are trying to exit them and you can see the telltale signs of it. They’re all furnished and they got a little neon light somewhere in the background. There’s like a pool floaty and you’re staging photos. They’re taking their Airbnb photos. They’re dropping out of the market. If you have a 3% mortgage rate, you’re not getting rid of a 3% mortgage rate. If you have an Airbnb you bought at peak market value and it’s not renting out anymore, and now you’re having to fork out monthly payments, you’d be like, “Guess what? We’re getting rid of this.”
The other thing I’ve seen is there’s always going to be a short-term rental market in certain beach communities or ski communities. When I see a house across the street from me going short-term rental, I’m like, you’re in a residential neighborhood, so two strikes against you. There’s nimbyism, which most people don’t really believe is true until it impacts them. Everyone thinks everything is great. “We can do this. We can do that.” The moment it impacts you all of a sudden, it’s like, “Stop here.”
I’ll be honest, I don’t want my neighbor to have a short-term rental because I live in a quiet neighborhood with little kids riding their scooters around, and then you got 25-year-olds zipping through a neighborhood at 50 miles an hour or something half-cocked half the time. Is that something that you want? It’s very interesting. I saw that in Dallas. Airbnb just sued New York City or something as well because they’re trying to ban it. I’m in the Washington DC area. Washington DC is extremely difficult to get short-term rentals in. Again, we’re near the lobbying capital of the universe where I am, so it’s very interesting.
Let’s talk a little bit about commercial real estate and some of the deals. When you look at a deal, because there’s probably going to be a lot of commercial assets that are probably going to be available in the near future for you, what are some things that you look for of, “I can make this work?” What are some of the things like, “This asset just doesn’t work no matter what the case is.” Is there a criterion you go that you look at to determine what’s a go versus a no-go?
I would say back to what we talked about earlier. The business plan starts first. Understanding what you’re trying to do, so you can systematically approach some of these assets. There are some that are opportunistic purely. They have an opportunistic fund and they’re just looking for any deal that looks or pencils or makes sense. Previously, and a lot of times I’ve talked about this, I’m very bullish on certain markets that have positive population fundamentals, there’s growth to them, and jobs are coming in. We’re looking in specific markets for deals in those markets. There’s a very small window of the opportunities that lie in those.
Part of it is going to be, “What is that existing asset?” Retail and office, more so office is challenging, so you have to have a better discount. Anything is almost valuable to buy at some price with a very big exception. I talk about this and I have a due diligence course that I teach people. Part of that is from getting kicked in the teeth several times and making lots of mistakes over the last several years of buying things I shouldn’t have bought or not researching, but due diligence.
There are things like contamination. You have a contaminated site because there was a dry cleaner there, a gas station, or some of those other things like that. Now, you’re on the hook for that contaminated dirt. Even if you bought it for nothing, $1, there are sometimes some pieces of dirt that would cost you millions of dollars. There’s also an understanding of zoning, regulations, and property taxes. There are some properties up in Tahoe. A very nice vacation rental and tourist destination and still lots of demand, but the property that was going to foreclosure had hundreds of thousands of dollars of tax assessments against it because of impact fees for a master plan community.
Even if you bought it for $0, you’re going to still have to fork out $150,000 a year in taxes. Maybe you’re okay with that, but understanding that has drastically pulled down the value and you can’t get a permit on it for three years if you’re lucky. Now all of a sudden, “I can’t build anything. I got to pay hundreds of thousands of dollars in taxes. What is my exit plan?” That’s why I say it starts with your business plan. If you’re saying, “We’re specifically looking for San Antonio. We’re looking for an office, or if it’s retail.” The more specificity that you get to what you are looking for, the easier it is to say no to all the things that don’t fit into that box, so you can stop wasting your time.
If you’re just like, “I want a good deal,” then, you’re on looking all over the place, you’re looking random, you’re wasting a bunch of time. If you’re like, “I’m only investing in flex industrial buildings that are worth between $1 and $5 million in this metroplex or in this suburban market, here are the assets that I’m targeting.” It then allows you to start doing your homework on those specific assets ahead of time. You can come up with a price, “Here’s the price on the intrinsic value. Anytime I can buy it under $50 a square foot, I’m good.” With the asterisk of, “As long as it’s not contaminated or some of these other things.”
You have your buy box or business plan. When you start seeing your opportunities or they’re presented to you, it quickly comes in. “Is it this particular asset that I’m looking at? Is it under this price point? Can I buy it for this? Does these things of the due diligence or there’s a risk?” It becomes very easy and quick to make a decision and buy something. That’s where you’re going to get the most profitable deals. Your speed at which you can execute that because you started with your vision, your business plan, and your strategy.
You have also all the resources lined up for that. You have your title company, environmental inspector, and contractors. You know what things are costing or will rent out for. It’s like, “When we buy at this price on this asset and this area, we can move very quickly.” That’s where the most opportunities present themselves.
There are things that you uncorked there that are important. You mentioned with the business plan comes speed and efficiency. Anytime there’s somebody in distress, the quicker you can get the deal close is more important than the number I believe. In most instances, because they’re in distress, they want to get that stress get out from underneath them.
You mentioned contaminated soil sites, we could talk for hours on that. For anybody out there, if it’s a formerly contaminated site, just be very careful because you’re not only responsible for contamination on that site, but a lot of times, it goes to the whole neighborhood and you are responsible for cleanup on every one of those properties. There’s a phase 1 and phase 2 environmental.
I remember back in 2004, we were building 160 luxury condos in Boston and it was a former gas station. We had planned for a certain amount of remediation. In phase 2, I didn’t believe any of the underground tanks were leaking while 3 out of 4 were leaking. You had the guys in the white suits out there cleaning everything up and end up costing an extra million dollars to clean everything up. Contamination, to me and similar to you, is not worth the risk. It’s such an unknown that is not worth it. As we get ready to wrap up this episode, thanks for coming on. Anything you’d like to leave our guests with, a nugget, as well as ways people can reach out to you?
People can reach out to me. I’m active on social media across the board. @Jake.RealEstate on Instagram is where you can find most of me or Jake Harris or Jake Harris Real Estate. I’m not Jake Harris, the guy on the Deadliest Catch show. I’ve never caught crabs. I don’t think I’ve ever been to the Bering Sea. That’s not me. Jake Harris Real Estate, you can find me on those. CatchKnives.com for the book or the due diligence course and other things like that. Passive Wealth is where we talk and help people and guide them through the systems to become more passive investors. That is more critical especially in distressed time periods, vetting out sponsors, vetting out their funds, and vetting out those components.
The last nugget I want to leave with people is due diligence. Due diligence is one of the most critical aspects of real estate. There are so many people that, in the last few years, willy-nilly ran in and got into deals. We even mentioned it earlier, short-term rentals, “The Smoky Mountains are a great place to get in.” They didn’t understand any of the risks. Getting and running through these due diligence components or getting a checklist, we give away the checklist. It’s 74 points that we use on almost every single asset that we purchase.
Why do you use a checklist? Pilots use checklists and doctors use checklists because what happens when these situations arise is you don’t want something very simple to get missed that causes in a plane or a surgery, people die. Your plane crash or heart surgery, you’re not going to die in an investment deal. You may feel like it. Financial stress is real stress. That stress is real. I unfortunately have been aware of people that have committed suicide or attempted suicide because of financial stress.
Understand what you’re getting into and the risk. That’s why due diligence. I keep shouting it from the rooftops, especially if you’re investing in something of distress because there is an inherent risk, but everything in life is a risk. It’s about taking calculated risks and understanding. Sitting around on a bump on the log on your couch all the time has a risk to it, and so does investing. Now, take a calculated risk, understand what you’re getting into, and go take an active role in managing your life and moving forward to your dreams.Always do due diligence especially if you’re investing on distressed properties because there is inherent risk. Click To Tweet
I love that analogy about the checklist with the doctor. One I hear frequently is similar to being on an airplane. Would you rather be on a plane with a pilot who’s been flying for twenty years and been through every type of weather pattern or every incident that could happen on an airplane? Would you rather have the person who’s recently just got their pilot’s license and has only been flying in perfect weather? That’s very important to realize now because the last several years in real estate have been able to hide a lot of errors that people were making because of the appreciation that was being able to gain.
A lot of mistakes were being made, but they could get swept under the rug. Times are starting to change and there’s going to be a point in time where like many years ago, there’s no sweeping them under the rug and they are going to truly show themselves. You want that person who’s been flying that plane for twenty years to the bad weather. Thanks for coming on and thank you everyone for tuning in to this episode of the show. As always, make sure to leave us a review and like us on your favorite station. Thank you, Jake. Thank you, everyone. Take care.
- Catching Knives
- Rich Dad Poor Dad
- Atomic Habits
- @Jake.RealEstate – Instagram
About Jake Harris
Jake Harris is a sought after expert and gifted story teller with a contagious energy he inspires everyone around him with encyclopedic research. He can take complicated ideas and convey them simply and clearly for everyone to understand. Founder of an award winning commercial real estate firm, author of #1 bestselling book (Catching Knives). He has been featured in many publications including The NY Times & Yahoo Finance, host of a Top 100 Business/Investing podcast (Passive Wealth Principles), a frequent speaker, and a highly valued coach.
He uses those superpowers to pioneer cutting edge bold design into exciting hotels, infill, and adaptive reuse projects across the country. To date has purchased and sold 1200+ properties in 26 states and amassed a commercial real estate portfolio of iconic properties. He earned a Master’s degree in International Real Estate, sits on the FIU real estate board, is an accredited CNU-city builder, a member of CCIM, Urban Land Institute (ULI) and holds a CA real estate brokers license.