FCP 127: Advanced Real Estate Investment Strategies & Structures – Featuring Scott Krone

Jack: Hello and welcome. This is Jack Bosch speaking, and welcome to another episode of “The Forever Cash Life Real Estate Podcast” where we talk about all things cash flow and real estate. And, today, we’re going to go into a little bit more different subject about conversions, like, about self-storage about SBA loans, and all kinds of things that we haven’t really talked ever about. So, stay tuned and we’ll get started right away.

Man: Welcome to “The Forever Cash Life Real Estate Investing Podcast” with your host Jack and Michelle Bosch. Together, let’s uncover the secrets to building true wealth through real estate and living a purpose-driven life.

Jack: All right, and here we are. So, our guest today is Scott Krone. Scott is the managing partner of… I have to put on my glasses to actually read his company name, of Coda Management Group, right? Coda Management Group. Scott, how are you doing today?

Scott: I’m doing well. Thanks for having us, we appreciate the opportunity.

Jack: Wonderful, Scott. So, tell us a little bit about you, tell us what you do, tell us a little bit about your background. We’d like to jump into things right away, but just give us a little bit of a background of what you guys do, how did you get into that line of business, and just those kinds of things.

Scott: Well, upon graduating from college, I decided to pursue a Master’s in Architecture, and there was a new program that you didn’t have to have a bachelor’s degree in architecture, you could just go right to your Master’s. And so, it was a three and a half year program. And, I was fortunate enough to get connected to a professor that was also a real estate developer, architect, and builder. And so, I worked for him for six years, three while I was in school and then I continued that. And so, I began really immediately involved in real estate because he was one of the few professors that was practicing as a developer as well. And so, since my background was non-architectural based, when I was working in the office, he had me doing office, you know, development stuff, and when I went to school, I was doing the design stuff, and so I got the best of both worlds there.

Jack: Okay, very good. So now, today, what is your main lines of business?

Scott: Well, we have two businesses, one is Coda Design Build, which is a retail client-based driven work or clients hire us to develop properties for them. We just finished up a church, Church of the Redeemer where they’ve been searching for a property for 20 years, and, we helped them acquire it, we got them the zoning, the entitlements, we got them through the financing, we did the design, we did the build, so we really helped them throughout the entire process. And then, the second business that we have is Coda Management Group which is our investment side where we’re actively, at this point in time, taking warehouse or other commercial buildings that are non-performing and converting them into self-storage facilities.

Jack: All right, wonderful. And, where are you mainly located, and where are you mainly operating?

Scott: Well, we’re located in just north of the city of Chicago, but we are operating throughout the Midwest. So, right now, we’re in Wisconsin, Illinois, and in Ohio. And, currently, we’re looking in the Michigan area and also Kentucky, and as far out as North Carolina. Those are the areas the we’re currently located.

Jack: All right, very good, so that covers a good part of the country. Okay, so walk us through a typical kind of, like, I mentioned in the intro that we’re going to talk about conversions. So, what do you convert, what do you typically look for, how does the process typically works?

Scott: So, we’re looking for buildings that are between let’s just say 70,000 and 110,000, 120,000 square feet in urban settings, that are either non-performing, or underperforming, or not being utilized to its efficient which I guess is underperforming, and then we convert them into class A self-storage facility. And, class A means fully enclosed, climate-controlled, and has the lockers inside the building compared to what is known as Class B or C, not that they’re in bad neighborhoods but it’s more of generational, third generation where, you know, it’s the old self-storage, you know, rows of garage doors that you drive down an isle and there’s garage doors on both sides, and they may or may not be conditioned. Ours are all in, you know, either large commercial buildings, you know, multiple stories or single stories where you literally can drive your car into the building, the garage door comes down and then you roll your stuff to your locker.

Jack: All right, that’s beautiful. Okay, so these are found basically in…they’re not like many self-storage facilities are, either in, let’s say, not the best location sometimes or they’re buildings mostly, the most new builds are, like, on the path of growth and the outsides, a lot of that is built there. So, yours are right smack off in the city, right?

Scott: More times than not. I mean, one in Milwaukee is not in the heart of downtown, you know, it’s still in the city of Milwaukee but it’s outside the downtown area. But, the ones in Ohio are, you know, three blocks from the center of downtown.

Jack: Okay, wonderful. Great. And, just out of curiosity, what’s your typical customer there is like, especially in those central locations, is that is that the mom and pop that need a place or is this more companies?

Scott: In those locations, it’s probably going to be about 50/50 between residents as well as businesses, and businesses, you know, just need a little bit of extra, you know, storage and square footage to warehouse stuff. And so, what we’re expecting in both of those locations is a combination of both commercial and residential [crosstalk 00:05:46].

Jack: Okay. Does that change if you go to the outskirts of town?

Scott: It does, not necessarily just the outskirts, but the demographics. So, wherever we’re considering a property, we study the demographics. And, it’s not just how many people or how many square foot of lockers there are per person, though, which are major demographics for us, we look at the income level because that dictates what sizes we do, and also, how many people are in the area. So, we really study the demographics very thoroughly, and that will determine whether or not we go into a community. In fact, I was just having that conversation with a person from a local city that we’re working in, and, you know, I was making the point that first and foremost, the reason we’re buying that building is because of the fact that the demographics warrant our use and if it didn’t, there’s no way I’m buying that building, you know…

Jack: The demographics weren’t what?

Scott: Warrant. If it…

Jack: Oh, warrant that use.

Scott: You have to have that demand. If the demand is not there…

Jack: What’s the perfect demographic for you?

Scott: Well, in our setting, we want to be, you know, over 100,000, 150,000 people within a 3-mile radius. And, it’s not so much the type of person, it’s how many other lockers are there compared to the number of people? So, the metric is 7 square feet of lockers per capita, and if we’re above 7 square feet, then we will not even touch it. And, you know, a lot of places out east Florida, South Texas, a lot of communities are, you know, around 9 square feet of lockers for capita, which is still very high density of self-storage. The markets that we’re going into, were typically between 1 and 3 square feet per capita.

Jack: Okay, that makes perfect sense. That’s a very good analysis. And then, you were talking about the drives that, the, kind of, the demographics drives, the sizes. Can you give us a little bit more detail on that?

Scott: Well, the more affluent the community is, the more desire it is to have larger lockers. So, we have one facility which is in a very affluent community, and we couldn’t rent out the 10 by 10s, but as soon as we converted them to 10 by 20s, then they rented. Because, you know, they wanted a bigger space because if they’re renovating a house, they want to pull all their furniture out and then, you know, people come in and rent four or five lockers at a time for nine months to a year.

Jack: Okay. Yeah. That makes sense. Yeah.

Scott: The less affluent the community then the higher the premium for smaller lockers. They’re not going to, you know, rent a 200 or 300 square foot locker, they want to rent a 25, you know, 35, 50 square foot locker.

Jack: Right, right, right. Okay, that is really good information. So, now, you take old warehouse buildings, have you taken office space because, like, have you looked into office space because for example… Or, not office space but retail space?

Scott: We have, and some of them have been a combination of office and retail. The biggest challenge with the retails are, communities that we’re looking in or, you know, considering, they don’t want to de-zone it from retail into self-storage, and so they really want to hold on to that retail component. But, there are examples where a big, you know, car dealership or a big box Kmart, we actually looked at a Lowe’s building which is retail, and we bid on it and we didn’t get the bid. So, we have looked at areas that are big box retail as well.

Jack: Okay, makes sense. So, now, that’s really cool. So, you’re taking these buildings, very creative, and… I’m looking out the window and there’s a big fat coyote walking by right now. And, that’s what happens when you live in Arizona.

Scott: Well, it happens here in Chicago. We have coyotes right here in my community as well.

Jack: Oh, wow. Yes, yes, yes.

Scott: They just attacked two people, unfortunately.

Jack: Oh, I’m sorry to hear that. Yes. So, again, back to the subject matter here, but that’s what happens when we’re live, right? So, you’re converting these deals which is really cool. Now, how do you typically finance them?

Scott: Well, that’s where the art of the deal comes in. And, look, we look at the capital stack. And so, we have our equity component, obviously, and then the next layer is where we get creative. So, we’ve structured it with a combination of either PACE financing, opportunity zones, historic tax credits, and then, obviously, the debt structure. We have done some [inaudible 00:10:31] loans, but for the most part, we look at, predominantly, with the PACE financing and with the opportunity zones are the major components where we like to offer the creativity to our investors.

Jack: Right. So, since you’re buying in opportunity zones, you’re putting a lot of capital into these deals, probably, to rebuild them all or to build them out. They probably qualify for a lot of opportunity zones regulations.

Scott: They do. I mean, the base is, you have to do 50% of what you acquire it for. So, typically, what we’re doing is, we’re putting in an all-new HVAC equipment, you know, electrical fire suppression and lockers, and so those dollar amounts will warrant the qualification for the opportunity zones. And so, you know, on the debt side, we’ve also used credit unions, SBA loans, and traditional local banks as well to [crosstalk 00:11:26]…

Jack: So, SBA stands out of those, for example. Why SBA over, like, a local credit union, or a local bank, or so?

Scott: Well, they do work in conjunction with the local bank.

Jack: Yes, of course, yeah.

Scott: And so, the reason why the local banks prefer, is because it reduces their risk. So, let’s just take round numbers. If we’re looking at a $5 million loan, and the SBA comes in for… You know, it qualifies for the SBA, the local community development center buys that portion of the loan. So, the local bank, if it’s a $5 million, let’s say $3 million is with a local bank, $2 million is through the CDC, which is the SBA. And so, from a risk point, the bank makes money by selling it to the federal government, but it also reduces the credit risk. So, instead, they have a $5 million loan on their books but the risk exposure is only $3 million. And so, they don’t have as much risk in play, and so that allows them to continue to leverage more of their deposits to get more loans.

Jack: And, that makes sense, that makes sense. So, now, also, you mentioned historical tax credit somewhere in there. You mentioned some tax credit. Just in flying by, I heard you say something about historical or something about taxes. Can you explain, first of, all the concept of that, what is that for our listeners?

Scott: Well, basically what you’re doing is, you’re taking an asset, a building and making it into a national park. So, our self-storage facility in Milwaukee is, you know, right up there with Grand Canyon, and Yosemeti, and all the other national parks, so it goes on the historic National Park registry. And, we can’t do that with every building, and, I mean, it has to [crosstalk 00:13:15]…

Jack: A self-storage facility is registered as a national park. Okay, explain that a little bit more on that here. Give us a little bit more on that.

Scott: So, if you want to buy tickets, we’ll be selling tickets to come and view it for…

Jack: Right, that’s right. Well, you can open a [inaudible 00:13:28] there’s going to be interesting stuff in there, right, in those [crosstalk 00:13:31].

Scott: Exactly, lot’s of park rangers and all that. But, it goes through the Department of Natural Resources, and so, you know, each of these programs go under different departments like PACES Department of Energy, opportunity zones, or the Treasury Department. This is under the Department of Natural Resources. And so, the building has to merit, and there has to be some historical precedence or setting for the building, and, there’s a point system. And, if you don’t have enough points, the building won’t qualify. So, what made our building significant was that it was the first fireproof building in Milwaukee, and when they designed it, they did a lot of ornamentation and decorative detailing both in the first floor as well as on the exterior facade. And so, we had to bring in a consultant to first determine if the building warranted. So, conversely, we have a building in Toledo which is predominantly a masonry, brick, rectangular box. And, you know, I was having conversations with the city planner where she’s like, “Well, this is historical because it was built before 1950.” And I’m like, “It’s not on a historical National Registry, it’s not on the state registry, and there’s nothing historical in character about this building just because it was built before 1950, it doesn’t merit it.” And…

Jack: Now, do you want it to merit it or you do not want it to merit it?

Scott: In that case, it wasn’t an expectation for us. So, we went into the deal knowing that it wouldn’t do it, so we structured it and acquired it without those assumptions. The one that we were doing in Wisconsin, we knew that it qualified, and you know, it had a decorative clock tower, the lobby was all this mosaic, had these ornamental columns and plants, and a lot of fancy detail that we were preserving. And so, when we go through the process, we’ve identified the areas that we have to maintain and preserve, and there are specific requirements for that. And so, we first had to get qualified by the state, and then the state sends it to the federal government to qualify it. And then, we have to build it with those terms and then meet those obligations. And, the result of that, we get tax credits which we can either use or we can sell. And, we get both state tax credits and federal tax credits.

Jack: All right. So, and what percentage of a building without necessarily having to mention, actually, dollar figures, but what percentage of the building value do you get in tax credits? What percentage of your rehab costs does the tax credits? How do the tax credits work?

Scott: They base it upon the total cost of the project, and so, we got credits based upon the total value of the building. And so, then, they give you, then, a percentage based upon, you know, what is merited within that building. And so, you know, they look at our total cost and then say here are the tax values, and then we’re able to… For instance, because we did that loan with the SBA, this is a very complex capital stack, we have the equity, we have historic tax credits, and then we have the SBA financing. So, we could not sell the federal tax credits because of the fact that we were doing SBA financing, so we’re passing those tax credits on to our investors. But, on the state side, we’re able to sell those because only one investor actually residing in Wisconsin, the rest of us reside outside Wisconsin, so it’s more advantageous for us to sell those state tax credits.

Jack: Okay. So, you can sell them but just on a second level, then, basically?

Scott: Well, you can sell them on the federal too, but when you sell them, you are actually… The way the mechanism works is, you have to create another company, and the tax buyer buys 99% of the original LLC, and then the 1% becomes your original entity, all right? So, that way, that the buyer gets the use or the value of those tax credits. If they weren’t 99% of it, then they would have to dilute the value of those tax credits. So, the problem with the SBA is, the SBA has to know who the loan is with, and the buyer would not qualify.

Jack: Right, right, right. Okay, that’s starting to get into, really, more complex advanced, kind of, financing structure which is really, really cool, but we’ll leave it at that for now. Anyone interested? By the way, if somebody is interested in learning more about what you do, and how you do that, or investing with you or so, how do they contact you?

Scott: They can look at our webpage, codamg.com, so codamg.com.

Jack: codamg.com. That’s wonderful, great. So, another question I had is like, one of the, you know, pre-talk before we started this interview. You talked about, it’s actually quite hard nowadays to find true value add self-storage facilities. And, obviously, your solution is to find these warehouses and convert them. But, why is it hard to find true value add self-storage facilities?

Scott: Well, overall, the market represents 10% of the population, so by nature… Self-storage represents, they’re serving 10% of the population. So, there’s a lot of unmet demand out there, and so where they are, they’re performing. So, if they’re performing assets, then it’s hard to find a value add. So, most of the typical value add are smaller mom and pops who would prefer the original generation of self-storage, typical drive up, the garage doors, and no heating or air conditioning in them. And, they’re not fully invested if they don’t have professional property manager, you know, they might not have up to date security and all those sorts of things, or they might have underutilized land. And so, those are harder to find just because they’re small. And, what we do is, we’re not self-storage operators, we are self-storage developers. So, when we’re done developing them, we retain a national REIT, in our case, we’ve signed contracts with CubeSmart, and CubeSmart manages our facilities. So, it’s like, when you go to a McDonald’s, or a Holiday Inn, or a Hilton, you don’t really know who owns that business, you just see the name on the door. And so, you’re going in and you’re buying a McDonald’s hamburger because it says McDonald’s, but you don’t actually know who owns that actual location. That’s…

Jack: Okay. So, you own a bunch of them, you don’t sell the assets after you develop it, typically, or not right away, right?

Scott: Not right away, we lease them up, we get them, you know, stabilized, and then once, you know, the value is there, then we’ll sell them off to the REITs. And so, the REITs are looking for larger facilities, they’re not looking for, you know, 10,000, 20,000 square foot facilities, they want to manage, you know, 70,000 to 110,000 square foot facilities.

Jack: Right, that makes sense. So, you’re buying then you’re operating… You’re not operating them, you’re bringing in a branded company that brands it under their name, runs it under their name, and then, once they, with their proven processes, fill it up, optimize it, you then go sell the underlying assets to a REIT?

Scott: Exactly. They could be the buyer too, so once they get stabilized, they might be the buyer.

Jack: Yeah, whoever pays the highest price of that [crosstalk 00:20:55]…

Scott: Right. Right.

Jack: Okay. Wonderful. Great. So, with that said, I want to ask you just a few other questions, and that is like, unprepared question. I mean, they’re prepared by my side, but you don’t know about them yet. And, that is, just very simply, like, what’s the number one business mistake you have made?

Scott: Well, I think the number one business mistake which was, I picked the wrong business partner. And, you know, he got involved in some things that were not the most healthy for the business. And, as a result of that, it created a lot of, you know, turmoil, and stress, and financial stress when things were not allocated properly, let’s just say it that way. And so, you know, it has been, you know, long drawn out of court and good I’ve worked through those issues. And, you know, obviously, so picking the right partners is a critical component to a healthy business.

Jack: Absolutely, I couldn’t agree with you more on that. My business partner is my wife, she is is as smart as they get and very experienced with finance and so on, so we have a really good partnership on that end. And we can 100% trust each other, of course, and have been married for 18 years. So, great. The other question is like, I’m sure you’re probably a reader, so what is one of the more impactful books that you have read in the last year, I’d say?

Scott: Well, there’s two books, and, they’re, perhaps, related and topic, one is “The Road Back to You” by Ian Morgan Krohn. K-R-O-H-N, so we’re not related. And it discusses the Enneagram, the concept of the Enneagram which is different personality profiles. And, the people who created it are these 4th-century monks which were absolute geniuses. And that, it breaks down everybody into nine different personality types. And, we’ve implemented it through our business in our office, so we all know what our personality types are. And, it’s not like Myers Briggs this or that, but it’s, when you’re healthy, when you’re not so healthy in your things and where you draw from, but it alters the way in which we communicate back to one another, you know, the strengths and weaknesses of what we’re doing.

And, he also wrote a book called “Chasing Francis,” which is about Francis Assisi. And, it’s a very good reminder of a pilgrimage, if you will, and how we’re all on journeys. And, it’s not necessarily related to business but it involves businesses and how people approach business, and how they approach life. And, you know, it’s always, to me, life is about the journey, about the pilgrimage, and the ways in which we can continue to grow, and evolve, and develop. And so, that’s something that we’ve always sought to do in our household.

Jack: Awesome, wonderful. Well, thank you very much. So, with that, again, go to codamg.com to find out more about you guys. I’m fascinated by your approach, it’s different than other guests that we’ve had on the podcasts. And, I love that because I don’t want to have a standard podcast where we just interview all the usual suspects each other, but that we have some very different structures of different kinds of approaches to that. So, that’s that. Do you have any last parting words for, perhaps, our audience that you want to leave us with?

Scott: Well, I’ll just continue with the last topic that we were talking about is, look for ways to continue to push yourself. If you’re not growing, if you’re not learning, then you’re stagnant, and stagnant leads to complacency, and complacency leads to getting caught behind. You know, we’ve been doing this for 25 years, and we have not always been in this realm. But, we’ve been in real estate but the market has changed, so we’ve had to adapt and change with it, and we’ve had to grow and expand. And, each of the challenges that we’ve faced, I think we’ve come away from it in a healthier and more productive manner. So, you know, keep looking to improve and continue to grow.

Jack: Wonderful. I couldn’t agree with you more than more with that. We call it the law of… I forgot it right now. But, basically, it’s a physical law that, if you don’t actively put energy in it… Law of entropy, I think. If you don’t put physical energy in it, it falls apart. So, there’s actually no such thing like stagnation. If you think you’re stagnating, what you’re really doing is, you’re falling apart, and you’re regressing. And so, I couldn’t agree with you more, keep pushing yourself, keep growing, keep learning. And, that’s why I love having guests like you on the show, so we can learn different ways to invest in real estate. So, with that said, that concludes our show. Thank you very much. And, remember to give us a five-star review on iTunes, or give us a thumbs up on YouTube, share the links with that, share the podcast so we can reach more people with this message. And, with that said, Scott, thank you very much for being on the show.

Scott: Thank you very much.

Jack: Thank you, everyone. Bye-bye.

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