Real Estate Risk Management, Recessions, and Survival Strategies with Luis Belmonte

Luis Belmonte (00:00)
your entire assumption in your business is there will be a recession and I need to live through it and I need to have as much capital as possible or capital I can raise from reliable investors that will allow me to buy because in the immortal words of my former boss, the recently retired CEO of Prologis,

Big money in real estate is made by those who have cash when nobody else does.

Scott Bursey (02:11)
back to the real estate pros podcast. I’m your host Scott Bursey. And today we’re diving into strategies for navigating complex markets and identifying emerging value. I’m excited to speak with Luis Belmonte, the head of Seven Hills Properties, a firm known for its surgical approach to investment. Luis, thank you so much for joining us today.

Luis Belmonte (02:35)
Happy to be here.

Scott Bursey (02:37)
This is awesome. For those of our listeners who may not be familiar with your world, please fill us in on how your career began and where you’re at now.

Luis Belmonte (02:49)
My career began totally accidentally. I came back from Vietnam at the end of 67 and got a corporate job. And I was ⁓ sharing an apartment with a friend of mine from high school who ⁓ agreed in a moment in a saloon to invest in a little real estate rehab. And it was not going well because his hippie partner wasn’t showing up to work. ⁓

My corporate job was boring and the pay was lousy. So I said, well, if you pay me $3 an hour, I will strap on my tool belt and help you finish this thing up so you can get your money back. And which I did. And we, we finished the rehab of this little two flat building in San Francisco and sold it and made a little money. And then we did another deal and made a little money. And then we did a deal that was screwed up. We

We made every classic mistake possible and although we did buy it right, thank the Lord. So we got out in one piece, but ⁓ we didn’t make any money. And by then I got married and my wife got pregnant. That’s kind of an obsolete concept, but that’s the way we did it in the old days. And so there was pressure for ⁓ regular income and I went to the headhunters and I ended up getting a job ⁓ with a company.

out of New York City that built warehouse buildings all over the United States. And so I became the operations manager of their San Francisco branch. And for the next 30 plus years, I built warehouse buildings, financed them, managed them, leased them, rehabbed them. So I was one of the biggest developers of warehouse space in the United States. And then along comes 1986 and the company I was then working for.

went de facto broke. So I ⁓ went to the other side of the equation and went to work for an investment advisory firm. ⁓ I was working as their pet developer for the account of the partners. And then we went public and eventually became Prologis, the biggest REIT on earth.

And I was one of the founders and I ran their development program.

until I was 64 and we were building in the United States, Mexico, Europe, China, Singapore. And it was decided by the powers that be that I was too old to be an international road warrior. And I agreed. So I got a very nice handshake on the way out. And then I founded Seven Hills Properties, which was a little side business I was running on behalf of the partners. And my partner and I ⁓

then went out and basically did merchant building for a few years to build capital. And then we ⁓ ended up with a lot of excess land on our Walgreens sites that we built out and we bought some more shopping centers and we built 500 units of low income housing, ⁓ which is brain damage in the extreme, but it doesn’t involve much capital. And eventually you make money if you hang in and you really manage aggressively.

So we now have a nice system that gives us a nice living and pays our employees and gives them a bonus and a 401k and we’re on down the road. And we’re actually really developers because it’s our own capital. Most people in the commercial real estate development business these days are indentured servants to the money. So when the development business collapsed after 1986 tax act,

Property all went to the institutions, the insurance companies, private equity, that kind of thing. So the people who call themselves developers today have a financial source, know, one ⁓ financial source or some several financial sources, and they build on behalf of those sources and they work for what’s called an earn out. So the investor gets ⁓ Kuhn Preferred IRR.

And then there’s some kind of split above that. Typically these days it’s a seven or eight IRR and the developer gets maybe 20 or 30 % from seven to nine and maybe 40 or 50 % from nine to 11 and maybe 70 % over 12 or something like that. But it’s basically a fee and earn out business. We’re not in that business. We actually invest money. We have a few investors in some of our deals, but we’re the controlling partner.

like it was in the old days. So we’re actually developers, but we try and stay below the level where people are writing checks with other people’s money. I never wanna be in any competitive situation where somebody’s writing a check with somebody else’s money. And every deal we’re in, I’m writing the check with my money. So I have a more ruthless assessment of the risk reward involved.

Scott Bursey (08:45)
That is a great journey. And thank you for sharing that with us. I know you’re an accomplished author. Could you elaborate on some of your books that you’ve published?

Luis Belmonte (08:58)
Well, after I retired from corporate life, ⁓ I still had some energy. So I decided I would try and write a book to teach people about the real estate business. And I wrote one which was okay called, ⁓ Get Rich, Slowly, Invest in Real Estate. And then ⁓ after a few years, I decided that I could do better. So I tried again to do a primer on all kinds of…

commercial real estate, multifamily, retail, industrial office, nothing about hotels, resorts or single family because I didn’t do that. But I have built, managed, financed virtually every other kind of real estate over the course of 55 years. So I thought, well, I can kind of distill the essentials and talk about the mistakes and teach some person who’s starting out kind of the essentials of the business. So I wrote Real Estate 101.

And then ⁓ then I decided, well, what what my strength is is telling stories and distilling lessons.

So I wrote a street dog MBA ⁓ and to say to people, if you can afford to get an MBA, go ahead and do it. If you can’t, I’m going to try and teach you some things. And I go to I used to go to Stanford twice a year and Berkeley once a year to the business school. And my job there was to talk.

to the students about things they weren’t learning otherwise. Kind of the emotional aspects, a more cynical view, as I described it, poisoning young minds. And so what I’m trying to do in Street Dog MBA is experiences I’ve had and lessons learned there from, a whole lot of which were unpleasant experiences. And ⁓ I start out with the motto from… ⁓

I can’t remember who the author of this was, but the line, it goes something like this. Some people learn by listening to others. Some people learn by reading, but most men have to go ahead and pee on the electric fence. I’m trying to tell people, okay, here’s the times I peed on the electric fence and you can avoid this with the other two alternatives here. So, and then after that, I started to try and distill

Scott Bursey (11:48)
You

Luis Belmonte (12:00)
⁓ the things I’d learned being a manager, how to appropriately manage an organization. And the theme is you are not the boss of the team. You are the servant of the team and your rewards come if the team succeeds. So you spend your life attempting to support the team, get the right people who have the appropriate strengths in the right roles and get the team to pull together.

and continually emphasize the goal that we’re attempting to reach as a team and that if we do that, all of us will prosper. And if anybody goes the other direction, our chances of coming unglued are very great. as much positive reinforcement as possible, 95 % positive, 5 % negative behind closed doors and brief and without emotional content. And that’s how you

have a superior organization. ⁓ Street Dog Negotiator is all about indifference. And my motto is, he or she who cares least wins. If I walk into a negotiation with you and you need the deal and I don’t, I’m home free. And get your ego out of it. So the theory is you…

Scott Bursey (13:21)
Yes.

Luis Belmonte (13:21)
write

a short list of what you need out of the deal, what you absolutely have to have in order to make the deal worthwhile. And then a list of things you’d like to have. You go into the negotiation, if you get what you need and a few of the things you like, stick your hand out, tell the other team how skilled they were, they kicked your ass and walk out the door. This is not win-win, this is not win, this is just get what I need and get on to the next deal. ⁓

my need and your need are not compatible, then we haven’t got a deal. And I need to just get up and walk out because ⁓ either they get what they need and I don’t, or I get what I need and they don’t and they’ll be pissed off forever. ⁓ if it isn’t gonna be there, then forget about it. But the important thing is just get what you need and get the hell out.

Don’t worry about winning, don’t worry about looking good, don’t worry about the power struggle. I’m always willing to negotiate on the other guy’s turf. I’m always willing to put up with whatever negotiating fault or all they have, any of that crap, as long as I get what I need. So that’s kind of my literary universe right there.

Scott Bursey (14:42)
Absolutely, some great golden nuggets there, Luis. And this has been on my mind since we bought you. With current high construction cost and low inventory, what’s Seven Hills Properties’ approach to finding value in acquisition today? Given all your experience.

Luis Belmonte (15:00)
⁓

mismanagement or distress.

I’m looking around for somebody who really needs to sell. I’m looking around for someone who’s been neglectful of their asset. ⁓ I’m looking around for a place where I can add value and ground up construction today in most things doesn’t really make much sense.

warehouse sector’s a little overbuilt and it’s only for people with very long pockets, because when a warehouse is vacant, it’s vacant. And I was in the business for 35 years. That’s a sector. We have one little multi-tenant industrial deal and I do more of those and I’ve looked to acquire them, but we can’t find one at the right price. But for big ticket warehouse, small shop like mine doesn’t belong in it. The office market is in the toilet and will stay there for a while.

The retail sector is just getting to equilibrium just barely after seven years of getting its brains beat out by Amazon and company. And so ⁓ the stuff we have and the basis of which we have it makes decent returns, but attempting to stick new construction up at this point, the numbers don’t work. ⁓ Multi-family in the Sunbelt is overbuilt. Multi-family in the high barrier locations.

still doesn’t pencil because the construction costs, the interest costs, and the government load are so great, the numbers don’t work. So I gotta look for a deal that’s screwed up, where we can come in and clean it up, upgrade the tenancy, put lipstick on the pig, and move the yield from ⁓ seven where we bought it to nine or 10, and ⁓ everybody lives happily ever after.

Scott Bursey (17:35)
That focused approach makes all the difference in the world. And Luis, many investors are…

Luis Belmonte (17:39)
You make all your money when you buy whatever you’re doing, you make all your money

when you buy and, and then you perfect the money by by aggressive, ⁓ continuous grinding management expertise. And if you combine those two things, then you have created value. And, and the trick is, there’s only two ways to make money in real estate. One is to create value and the other is arbitrage. So when

My company, which became Prologis, went public. We had 105 investor clients and we sent them a 300 and some odd page agreement saying, give us the deed to your property and we will give you stock in our company. Now that doesn’t sound like much of a bargain on the surface, but the public markets were paying 15 % more for real estate than the private markets.

So by doing so, the pension fund managers got an immediate 15 % write-up. So that’s why they gave us their buildings in return for our stock, because the stock, and we had a kind of a 24-month window to perfect that arbitrage. ⁓ And another great example is in addition to operating and owning the buildings ourselves, we also had private equity funds.

And so we were still working as advisors for some of the clients 85 out of 105, something like that came in and the rest, many of the rest stayed with us as an advisor. So we got a fun say, and people who run those funds get fees and, and they cling to those fees with a death grip because that’s, you know, that’s what pays their bills. So typically the deals are seven years with

two or three one year extensions, which are always exercised so you can keep the fees coming. And so we’re like, I don’t know, four or five years into one of these funds and the market is very frothy for the product type in those funds. So my boss, a financial genius, sold the whole thing and sent the money back to the investors and they got a 20 IRR. Magically, they were happy. So we walked away from all these fees, but we had very happy investors.

guess who invested in our next fund? And so he was able to see past the immediate to the ultimate. And the same thing happened when we went public. We had tied up a big portfolio of R &D buildings in Santa Clara County at incredibly low prices when the market was in the toilet. I mean, we had bricks and sticks tied up at 25, 30 cents on replacement dollar.

None of the pension funds wanted to invest because they’d been burned. so, you know, human nature is if you got burned an asset A at a high price, you’re uninterested in asset A at a low price, you know, which is just the way the human head is. So, you know, he said, this can’t happen to us. We need to go out and raise our own capital so that when we see arbitrage, we can jump in. Right now in San Francisco,

the people that got in early bought office buildings for 15 cents on the dollar. And they’re gonna make great money. It’s gonna take a few years, but their basis is so low that they don’t need very high rents to flow cash. And as they roll leases over, if they bought a building for 150 bucks a foot and the replacement cost is 900, in the due course of human events, nobody’s gonna build an office building until…

the numbers justify 900 or whatever it is then. So that means the office buildings you bought for 150, even if you spent 100 to get them released, you’re gonna make a pot full if you have the audacity, the huaraches, to make the investment.

Scott Bursey (21:42)
Absolutely. Vision and execution. Luis, many investors are worried about recessionary risks right now. What is the most critical risk mitigation step you would advise for a portfolio right now?

Luis Belmonte (21:59)
So our industry is delusional. We think good times are the norm and recessions are the exception. It’s the other way around. Recessions come. So you should plan your entire business around recessions. means you have exit, that means you look at the worst.

thing that happened in your sub market in history and say, okay, if that happens tomorrow, can I live through it is my level of leverage. And I used to have a lecture on a flip chart before there was ⁓ a computer crap. And I had lists of ⁓ real estate organizations that had gone broke and I’d flip the pages and you know, like five names on each page and page after page.

virtually every single one of them went broke because of too much leverage. So you look at your leverage and you say, can this level of leverage stand ⁓ a 10 % drop in rents and a 20 % increase in vacancy? And if it can’t, you better change it. So if you own a ⁓ suburban office building in the middle of nowhere, you better have zero leverage. Cause when that sucker goes vacant,

you’re gonna have a hard time. And the way it works in recessions is the periphery empties out and comes in toward the middle and refills from the middle back out. So if you’re on the periphery, you better have very low leverage. If you own an apartment building in Manhattan or San Francisco, you’re probably safe with 80 % leverage because you can lower rents and still make debt service. When you do your financing,

Get it out as far as possible. If you use variable rate financing, just shoot yourself because you’re done. ⁓ know, capital will disappear. You can’t replace the loan. You’re going to get your brains hammered out. So if you’ve got a long loan and you’ve got renewal options on that loan, then when the capital strike comes, you’re OK. You exercise your option. You live to fight another day. So you.

your entire assumption in your business is there will be a recession and I need to live through it and I need to have as much capital as possible or capital I can raise from reliable investors that will allow me to buy because in the immortal words of my former boss, the recently retired CEO of Prologis,

Big money in real estate is made by those who have cash when nobody else does.

Scott Bursey (24:50)
Absolutely. ⁓ A sound defense is the best offense.

Luis Belmonte (24:54)
Absolutely. And you better dig that trench deep and ⁓ you you better get your counter battery in place because it’s coming.

Scott Bursey (25:05)
Luis, what is one specific non-traditional asset class like short-term rentals or manufactured housing perhaps that you’re most bullish on right now?

Luis Belmonte (25:17)
Well, I have watched the manufactured housing business for, I don’t know, 40 years. I’ve toured plants. ⁓ I’ve thought about investing a couple of times. I tried to build a little manufactured housing subdivision one time, but the fees that the government entity was going to charge me just made it impossible. ⁓

I mean, it makes all the sense in the world, but it’s like a fusion energy. You know, it’s the wave of the future that hasn’t ever happened to come. So I think at some point in the next few years, especially when you get additional robotics in the factories and apply AI to the planning process ⁓ and the organization of the construction.

you’re going to be able to reduce the prices enough of manufactured housing, both for multifamily and single family that will make it so compelling it’ll get across the finish line. The other thing is this, ⁓ people need meaning. That’s one of the things that I talk about in my management book. They need to feel they’re important. And so the average person who’s protesting a development of any kind uses that opposition.

to find meaning, make, that they feel important by shutting something down. in ⁓ environments like California, with CEQA, it’s always very easy to stall a deal, shut a deal down, bring environmental criteria in that make it impossible to get anything done, get extortions that kill the numbers, all that stuff. And people feel good about themselves. Well, that is passing.

So opposing housing now is no longer a virtue signal. We’re opposing data centers and warehouses, God bless. Since I own a lot of stock in a warehouse company, anytime you constrict supply, you know, it makes me wealthier. So that’s why I a few apartment buildings in San Francisco. When I first bought them, my rents were $125 a month. They’re now 4,000 in the same unit because of rent control, God bless.

So I think housing will get a little easier to build. The standards will get a little more flexible and manufactured housing might come into its own in the next few years. ⁓ Aside from that, ⁓ know, the bargain I see is ⁓ A, A minus and B plus office buildings in good locations. ⁓ You know, when that market stabilizes three, four, five years from now, you’ll make a lot of money. ⁓

We’ve tried, well, mobile home parks, if you’re really hard-nosed, are a good investment. I lived in one when I was young, and we’ve looked at them, but we never could get one that had the right risk reward. So one of the things I talk about is you need to balance risk and reward. So when you’re looking at a deal, you say, how much risk am I taking?

how much work do I have to do to perfect this thing? So if I’m buying a brand new building at Maine and Maine with a AAA tenant on a long lease with inflation built into the lease, then maybe a five, five and a half percent return, something that beats inflation is okay. If I’m buying a pool hall, cum Meth Lab in Barstow, I need a 20 % return because

You know, I’m going to have to, I’m going to have to go out and buy a firearm and hire a bodyguard to collect my rent and the meth lab might get busted. And so I need to get a return of capital real fast. So in a trailer park, you need, you know, 10, 12 % return going in, and then you manage aggressively. You’ll do just fine. You know, we haven’t found one with the right numbers. I looked at Marinas. ⁓ you can, you can do business in Marinas, but the same thing. It’s a lot of work.

And so, and you need to really assess the competitive situation. Where are all the other Marinas, all that stuff. So ⁓ we, at one point we had a great deal doing a wrecking yard. We were going to actually construct a wrecking yard for somebody who did insurance salvage in Texas. And we had everything teed up and the city council drop kicked our deal. So, but I would have done that deal. one of the

most lucrative deals that we ever owned was a pornography shop. And we bought it because we were going to build a Walgreens on the site. And magically enough, nobody in the city was against our deal. But it took us like a year to get it all teed up. And in the interim, the porn shop was paying great rent. Now, the internet kind of killed the porn business. you know, what I’m saying is, if you’re looking for cash flow and you get it at the right price, you know, that’s it’s just

the risk reward thing. What’s my going in free and clear yield and does it justify the time and the work? Zero time, zero work, I’m in the fives. A lot of time, a lot of work, I’m in the fifteens.

Scott Bursey (30:42)
Luis, interested to know what is the biggest mistake you see experienced real estate investors making when managing cash flow today?

Luis Belmonte (30:53)
So the biggest mistake is assuming that because you’re good at thing A, you’re good at thing B. And so that’s why the average big acquisition fails is some fool who was really good at doing A decides they’re gonna be good at doing B. Anytime you do something new, you’re gonna pay a stupid tax. So I tried, when I was working for as an investment manager, ⁓

I never did a deal anywhere without a local partner. ⁓ And so I needed local knowledge. And that was the biggest thing going on. Cause you go into a strange market, whether it’s a product type or a geography, you’re gonna get your ass kicked. And so when we built our first low income housing project, ⁓ I mean,

We really struggled because of all the things that we didn’t anticipate, all the cons and all the inspections and all that stuff. And it took us several years to get all the lessons to pay all the stupid tax. And now having paid it, we’re good at low income housing. The second one we built, we did a lot better. We got it fixed a lot sooner. So…

I went to build buildings in Mexico and thank the Lord. And the guy who was my project manager spoke fluent Spanish, but we never said that to anybody. So he could assess the conversations by perspective Mexican partners were having with each other without them knowing it. And as a result, I picked a partner who didn’t know squat doodle about the warehouse business.

but who appeared to be honest and a ⁓ straight dealer and who had great political connections. So the trade-off was, I’ll teach you warehouse business, you teach me Mexico business. And when we did our first big deal, the president of Mexico came to cut the ribbon. So I figured I’d pick the right partner. But I find out in Mexico, there’s no title insurance. So I had to research title on the parcels we bought.

to the cooling of the earth because there just is no title insurance. There are no testing labs. So you’ve got to bring your own soils engineer and materials engineer to the site to test that you’re getting the right concrete and you’re getting the right rebar. ⁓ And in America, you just hire a testing lab. There aren’t any testing labs in Mexico. On the other hand, there are civil engineering skills. ⁓

And soils engineering skills are better than the United States because they have so many issues. So ⁓ and I found out that they do everything by hand. So, you know, on a warehouse project, you know, you’re building a couple hundred thousand feet. There’s maybe 20, 30 people on the job site, a lot of machinery in Mexico. There’s very little machinery and several hundred people. And instead of pumping concrete, they’re hauling it in five gallon buckets to pour in the footing. So.

you know, just a different world. Same thing in Japan, same thing in Singapore, same thing in Europe. ⁓ You’re going to pay a stupid tax anytime you try something new. So number one, start small. Number two, hire a local partner or local expert because ⁓ what you think you know, you don’t know.

Scott Bursey (34:27)
Luis, with all your experience and expertise, I’ve got to ask you, looking five years out, what is the single biggest fundamental shift you predict for the private equity real estate space?

Luis Belmonte (34:42)
Right, I need to think about this for a while. It’s actually a total unknown because it’s all about flow of funds. rates are determined by the amount of money coming in versus the loans expiring. So the net flow of funds and

We need to be humble. are approximately 10 % of the investment horizon. Stocks, bonds, and commodities are the other 90%. Assuming that we perform and ⁓ have our returns decent, we will get our 10%. But whether it’s 8 % or 12 % will depend upon things that we have no control over. And I do not think

that artificial intelligence is gonna have that much impact on real estate. Although I made the mistake during the 2009 meltdown, I didn’t think the rent house business would work all that well because, ⁓ you know, I know how to run a 300 unit apartment building, but how do you run 300 houses that are scattered all over hell’s half acre? I thought, you know, the management overhead’s gonna kill them.

But the fact of GPS, of cell phones, maintenance scheduling, of surveillance cameras, of online rent collection, all those things combined to create an industry that I wasn’t sure was going to make it. So there may be some changes like that, but you aren’t going to change the fact that merchandise needs to sit in the warehouse or that people need to have shelter.

or that people like to go shopping or they need a place to put their computer. So I don’t think there’s gonna be a fundamental change in real estate, but of course I could be 100 % wrong. And I think that we need to think through the possibility of great dislocations like Amazon killing 16 or 17 % of retail.

of Zoom creating a 20 % vacancy in warehouse, I in office space nationwide. There’s something coming along that doesn’t require as much electricity. ⁓ the data center business goes haywire. The frozen food replacing canned food, which changed the whole distribution structure, changed agriculture.

You need to attempt to see around the corner as best you can. But I think human beings are no good at predicting the future. What we predict is the present plus one variable. And so the great thing is there’s a futurist ⁓ book that came out in the 50s and it had a picture of a woman in curlers and an apron.

waxing her kitchen floor and cooking dinner in her atomic oven. ⁓ you know, and look how fast we were supposed to get self-driving cars about 10 years ago. And we’re just getting there now. And they’re turning out to be a little different than we expected. So when the internet came along, I’m sitting on panels that say the internet changes everything. Your business is obsolete. You know, unless you get with this program, you’re done.

And I’m at the end of the panel saying, ⁓ bull bleep. Human nature is human nature. And we aren’t changing overnight. This is going to change things, but we have no idea how. And a few years later, I did a survey just to find out what was really going on on the internet, what was making it. And what was making it was Craigslist, which was the want ads, eBay, which was the garage sale, and pornography. And those were the things that were up.

that we’re going big on the internet. Now today, the internet has changed everything. The cell phone has replaced more things than I can count. ⁓ You know, the local news, the stock market, maps, ⁓ a compass, an adding machine, it’s all on the phone. But there wasn’t anybody predicting that in 1990. So I don’t know what’s gonna happen in the next five years. And nobody else does either. And if they tell you they do, don’t believe it.

Scott Bursey (39:27)
We needed your lens on that. Luis, if someone you wanted to reach out, collaborate with you. What’s the best way for them to contact you?

Luis Belmonte (39:35)
L. Belmonte, it’s 7hp.com, the number seven. 7HP, that stands for Seven Hills Proper.

Scott Bursey (39:42)
Luis Belmonte

everybody. Luis, this has been a pleasure, a sincere pleasure. And you’re welcome back anytime. And for our listeners, we appreciate you. If you got value from today’s episode, please subscribe. We’ve got more conversations coming up with operators just like Luis. Until next time, keep your standards high and your vision clear. We’ll see you in the next episode, everyone.

Luis Belmonte (39:49)
Thank you.