Debt-Free Real Estate Investing, With Chay Lapin

Real estate investors are conditioned to the use of leverage in their investments, but a debt-free strategy can open up surprising opportunities for CRE investors.

Chay Lapin, co-founder of Cove Capital Investments, joins Andy Hagans to discuss the unique advantages of debt-free real estate investing.

Episode Highlights

  • An overview of Chay’s career, and how his interest in real estate started as a “side hustle” while training as an Olympic athlete.
  • The advantages of debt-free real estate investing, including the ability to move quickly when desirable opportunities arise.
  • Why being debt-free can allow an asset manager to take on certain types of risk (and be compensated accordingly).
  • The pro’s and con’s of DSTs compared to investing in NNN properties.
  • Where Chay believes the DST market is going, and which segment will see the highest growth.

Today’s Guest: Chay Lapin, Cove Capital Investments

About The Alternative Investment Podcast

The Alternative Investment Podcast is a leading voice in the alternatives industry, covering private equity, venture capital, and real estate. Host Andy Hagans interviews asset managers, family offices, and industry thought leaders, as they discuss the most effective strategies to grow generational wealth.

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Show Transcript

Andy: Welcome to the show. I’m Andy Hagans. And today we’re talking about debt-free real estate investments. Not a typical, you know, product segment, typical strategy, but it’s actually a really important strategy that a lot of high-net-worth investors are finding very, very valuable. Joining me today is Chay Lapin, co-founder of Cove Capital Investments. Chay, welcome to the show.

Chay: Yeah, thank you, Andy. We appreciate the opportunity to speak with you and your listeners.

Andy: And I love it because it’s unique. It’s so much of…I’m thinking of the bookstore with almost self-help type books about real estate, and it’s all like, “How to buy a duplex with 1% down,” and it’s the sort of general trend of using as much leverage as you can and every… You know, to me it’s almost refreshing when I hear of sponsors or fund managers who are thinking about, you know, limiting leverage. And then I was researching Cove Capital. I’m like, “Whoa, debt-free. Well, that’s really unique. You know, I gotta learn more about this.” And then I was reading about it, and it made a lot of sense, but I think a lot of our audience is probably not even aware that this exists. So, we wanna jump in and talk about this strategy and where it might fit in investors’ portfolios. But before we jump into that, could I ask you, Chay, about your background? You know, how did you end up co-founding Cove Capital?

Chay: Yeah, so I’ll try to keep this within reason, but, you know, it stretches all the way back just to me getting in real estate, I’d say is kinda how this started. And I’ll tie that in in a second. But I came from, I played water polo at a pretty high level. I went to the Olympics for that sport. And most people haven’t heard of water polo, and you definitely don’t make any money playing water polo. And so, you have to make a decision once you graduate college. You know, if you have admirations to go to the Olympics, you gotta be all in because of your training regimen. And a lot of times we have to compete in Europe, so we don’t have the opportunity to necessarily take the investment banking job here out of college, or a lot of the traditional routes that you may do if you were trying to get into finance or real estate or something along those lines.

So, I realized that really early in my career when I was a freshman in school and someone had advised me to look into the real estate sector at different areas because that could be something I could do while I trained. And I was fortunate to find an alumni at my school that brought me under his wing in his real estate firm in Los Angeles. And he got me my license when I was in college. And at that particular sector, I was more focused on, I mean, everything from leasing to property management, to asset management, to brokerage. And I kinda learned all those different areas and segments that ultimately ties into what we’re doing today, what got me here.

But in that time, I also was always networking, you know, who could I find in different…? You know, I learned about new sectors in real estate all the time. There’re so many different directions. And you were saying this before we started the podcast, that there’s always something new to learn. So, I was always out there trying to find mentors. And ultimately, I ran into Dwight, who is… Dwight Kay, who’s my co-founder for Cove Capital. And he was working in the DST space, the DST offering space at a different company. And through that ’08 cycle, when we were coming through the recession, he broke off to start out…to start another company, which still exists today, but more of a capital markets company where we’re raising equity for other DST issuers.

Long story short, I came on board with him about a little over a decade ago when I retired officially out of water polo to be on that capital market side. And then we evolved what we are today with Cove because we saw the missing piece in the institutional world. We were raising hundreds of millions of dollars for institutions that utilize debt. And not that that’s bad. We’ve had a lot of success using debt, and if you use it correctly and conservatively, you most likely will be okay. But a lot of times that’s not the case, right? A lot of times it’s used very aggressively. And so, that’s how we saw the niche.

And we had three things in mind when we started what we are today. And that was one, we were working with the end user, the retail high-net-worth individual. So, a lot of institutions don’t get to work with the actual end user. They’re working through a capital markets desk or a financial advisor. So, we got to see the eyes of the retail investor early in our career. We raised close to $2 billion of equity through the retail channel. And so, and we got to see how institutions interacted after the end user became an investor. And we took all that feedback to try to create a better product. And again, not to say those institutions are bad. We have great relationships with them, but we just try to fine tune that. And then, so that was number one, the end user who’s ultimately our end user because we work with high-net-worth individuals.

Number two, protecting the financial advisor or the registered investment advisor, because that’s a big risk too. As an advisor, you are placing, or your client is placing their trust in you and putting in something that hopefully is not gonna lose all the money. And so, that debt-free protected the retail investor, the advisor.

And then third, our company. You know, we wanna be around for a long time, and by having a debt-free approach not only corporately, but in our offerings, we’re able to sleep at night when coronavirus happened. We’re able to sleep at night when all this, you know, turmoil that we’re all experiencing now. Yeah, capital raise slows down in environments like this, but again, we could push forward, and we can sustain our current investors. So, that’s kinda how we arrived at that debt-free approach. And that was a thesis, right? That was something that we got a lot of pushback early in our career pushing debt-free by other institutions and other competitors and things like that, and I think people are finally realizing it.

Andy: Well, it’s interesting, Chay, you know, you mentioned getting pushback earlier in your career and seeing where, you know, interest rates have gone. You know, and it’s interesting that you’ve built your business up and founded it in this very low interest rate environment. And it’s kind of like, you know, if I’m in your seat, I’m probably thinking like, “My, how the tables have turned,” you know? Like it’s…

Chay: Yeah. Because you…

Andy: …it’s our time to shine. But even before this higher interest rate environment, obviously, Cove Capital was growing, you know, you have an incredible growth story. I think it’s really interesting in your story, you know, how many people get into real estate as, you know, I’d almost call it a side hustle or side gig, and then it becomes their main thing. I don’t think I’ve ever heard of an Olympic athlete getting into real estate as a side… That’s a new one, but I’m like, “Well, it’s the side hustle. It’s, you know?” So, that makes sense.

Well, zooming out again to the debt-free thing, because I think this is the most unique aspect of Cove Capital, the fact that you really own that, it’s front and center, and you’re marketing, and you’re attracting investors on this concept. Why debt-free real estate investing? You know, aside from just lower risk. So, I think it’s gonna resonate with some investors just from the standpoint of, you know, that lower risk profile, but what other, you know, I guess, what other avenues does that open up when you’re debt free?

Chay: Yeah, so you take away the obvious mitigating risk by being debt-free, but then that also gives you a lot of flexibility. There’s about half of the equation that is we don’t have the catastrophic loss. Now, I’m not saying there’s not risk on a real estate. We have cash flow risk, you know, if a tenant goes bankrupt, or doesn’t pay their rent, or we get affected from eviction moratoriums. That’s uncontrollables we can’t control, but what we can control is we don’t have that loan pressure, right? The loan modifications, the workouts, all of that. So, that’s your obvious that you’re talking about, but what is the other side of the equation? It’s flexibility.

We’ve been able to exit deals in opportune times when we were planning on maybe holding the deal for five years and an off-the-market offer came to table in year two or three. And if we had a loan, a defeasance or prepay or whatever may be in that loan structure, we may not have been able to take that exit. On the flip side too, we’ve had situations where we evaluate our portfolio and we go, “You know what, we could get out of this deal today with a good decent IRR for investors, but we’re seeing a change in the market.” You know, a big employer left or, you know, something’s changing in that region where get out today. But again, if we had a loan, we wouldn’t be able to do that without taking a big hit from the defeasance or the prepay.

So, the flexibility there, the flexibility in changing, pivoting business plans, flexibility in pivoting an asset. A lot of people don’t realize once you’re in a certain loan structure, it’s not like the mom-and-pop loan, you know, that we go get, me or you get from the bank. You have to ask a lot of permission to do certain things. You have to ask permission to restructure leases. You know, even if you’re extending the lease and it all is gonna be good, you still have to go through that red tape. And I’ve seen stories with other institutions where they’re going down that road and the bank is being slow for whatever reason, or asking additional questions, that’s red tape and they miss that lease extension, that kinda ends up getting, you know, a better offer down the road.

So, it gives us a lot of flexibility, and I think that flexibility’s gonna be to our advantage in today’s market because we’re starting to see exposure and people having to fire sell assets. There’re certain asset classes that are very much not financable, so it takes out a lot of buyers. And so, we can get into that potential low hanging fruit, get in there and reposition the asset, and then, you know, cash flow and wait for the opportune time when lending comes back in the favor. So, risk mitigation and flexibility, I think are our two biggest components in that debt-free approach.

Andy: So, you know, you’re talking about commercial real estate. It almost reminds me of the strategy that some individual investors have that are flipping houses or whatever, which is they’re not using debt upfront, they’re targeting foreclosures, or just total dives, or assets that are “problematic” or “distressed” or whatever, just but individual houses and they’re purchasing with cash up front and then they refinance out the backend. But you guys aren’t doing a refinance, right? It’s just, your point is just on that acquisition side, you have more options, more flexibility, you can move faster, right?

I mean, how often do you think the timing really plays a part in this where, you know, you’re looking at an asset, you know, you’re underwriting it and you can make an offer, and then maybe competing bidders for whatever reason because of the timeline that it’s being sold. You know, do you see that some of the other parties bidding on assets can’t get financing together in time? Like, does the timing play any part in this?

Chay: I think that it gave us a big advantage in the previous two years, you know, where financing was readily available, so you had way more buyers out on the market. So, that definitely helped us. We won some opportunities over the past two years where there were higher bidders, but, you know, they may have a 45, 60-day runway because of that lending. And we were able to come in on a 30-day, you know, then go hard and close in 10 days. So, yeah, we can lower that. I think in today’s market you’re not seeing 50 offers on every potential property out there anymore, so we’re not gonna put ourselves in a position of an aggressive term or timeline because we don’t have to right now. Maybe that starts coming back again.

I also think a lot of… And we’re gonna see this more. A lot of people don’t realize there’s people out there that are all cash buyers, right? With, like, especially in this home purchasing, we’re not in that arena that you were mentioning. But you have to realize how are they buying all cash? They probably have a bridge line of credit, or they probably have a bunch of investors and their capital stack’s up to here. It’s gonna expose a lot of syndicators because yeah, they’re buying all cash and flipping over here, but they also are, when you look at their capital stack, they’re basically levered at 100%.

Andy: Yeah, you’re talking about so the overall stack of capital. You know, if you look at the number of LLCs, I mean, you know, some people might have 100 LLCs or something. If you kind of get out of the one LLC or get out of the one bank account and look at the big balance sheet, you know, like the real balance sheet, then you find lots of leverage.

Chay: And that’s where we…another area where we wanted to simplify it, again, selfishly for our own selves, you know, not having this crazy daisy chain of like you mentioned different ways you can stack the pile. We have used mezzanine financing in the past and earlier in our career, but we learned we needed to control that process, especially in times like this where you may have bridge, or mezz, or some short-term financing, generally speaking on like a 6 or 12-month term. What if you can’t raise the equity in that amount of time, and that’s coming due, and now that you’re in the hands of some mezz or floating rate situation, which is what you’re reading in the headlines now? We structured our own fund to be able to utilize our own internal, we called it an acquisition fund. So, we raised that capital and that’s what we use when we need to float an acquisition. So, we control that process, right? We’re not controlling…

Andy: Right. So, basically, conceptually, you’re telling me you have like an internal bank essentially, that…?

Chay: Correct. Yeah. Yeah. Correct. Our line of credit basically that we control, right? And we pay our investors well on that, a fixed rate of return. And it works really well because remember the assets we’re buying, we’re not into… I know we haven’t gotten into this, but we’re not into currently flipping or development. Everything we buy is a cash flowing asset today. And as long as that tenant doesn’t go out of business, which again, we’re trying to target investment-grade type tenants, but we have cash coming in the door day one we close. So, if we’re floating the property until we go out and raise the equity, we are able to pay that rent to our acquisition fund, right? So, we’re not getting ourselves way in a hole. So, it’s a unique structure that we found. And again, we learned all that. Both my partner and I came out of the ’08 scenario, and I know it’s different fundamental issues today versus the ’08 in a lot of respect, but there are similarities of lessons to be learned through that, that we saw.

Andy: Totally. Now, in your literature, you know, one aspect that I thought was interesting was the angle on UBTI, right? Where real estate funds that invest in assets with debt, produce UBTI because they’re financed with, you know, equity as well as debt. And then, because of that, you know, some of these funds are not eligible for IRAs or 401(k)s. So, could you talk about that? You know, that’s actually, that’s not something that I’m super familiar with. I mean, generally, I use my IRA or 401(k), those sorts of accounts for kind of the boring stuff, and I have private investments outside of those. Is a significant part of your capital base investing through, you know, these kind of retirement accounts?

Chay: So, I’ll admit that came out of… That was not our strategy. You know, I’m not a specialist in that world either. To be honest with you, a lot of our equity’s just been from pure cash investments. You know, people are liquid, and our demographic is very, very liquid over the past decade. And then also the 1031 side of things. With that said, we naturally stumbled upon that, oh, we structure our stuff debt-free and with certain retirement accounts. It works a lot better that way. I think it’s something that will grow substantially in the coming decade, and we’ve hired people to focus on that, but it hasn’t been our source of equity. It hasn’t gotten us to where we are today. It just happened to.

Andy: Okay, so that’s interesting. I mean, you know, because when I read that, you know, I thought, “Well, that is an interesting hook. Maybe that’s a big driver here.” But it sounds like actually, you know, it is an interesting hook, and it is a driver for some, but it sounds like that’s not the big picture. The big picture…

Chay: It’s not the big picture. It doesn’t mean that it doesn’t…you know, it doesn’t mean that it doesn’t benefit us in the future, but yeah, our traditional relationships have come from the 1031 side. We’ve got, again, a lot of clientele on that side through the DST structure, which I know we haven’t explained yet. And then, typically, a high-net-worth individual is very, very liquid.

Andy: Right. Well, so on that note then, most of your investors, it kind of makes sense that with debt-free and DST, to me those two things, in my mind at least, kind of naturally fit together in the sense that most DSTs are investing in pretty stable assets, cash-flowing, income-producing assets. So, just even the kind of the risk profile of a DST, a good DST anyway, to me aligns pretty well with the debt-free investing. But are there… You know, I guess, I’d have to almost put on my academic hat as I consider this question. Are there certain strategies or types of assets that make more sense when you’re not using debt in real estate investing versus in…? And then, conversely, are there other types of assets or strategies you’d stay away from because you’d say, you know, with that strategy you’d really want, you know, to use debt?

Chay: So, I would say if you had to use debt, you typically, I would think are more safe in the multi-family or multi-tenant world, but more so multi-family or self-storage. Because if you’re in an institutional asset and you have 50 to 300 doors, you know, in theory, everyone’s not gonna pay their rent in the same month or two, right? Where when you’re utilizing debt on a single-tenant deal, even if it’s Walgreens or FedEx, if they go dark, your cash flow’s gone. Almost all loans have a cash flow suite, right?

Andy: So, you’re kind of…I guess, you’re turning my thesis on its head because you’re actually, if what I’m hearing, if I’m hearing you correctly, you’re almost saying because we’re not using debt, we can actually afford to maybe take some risk…

Chay: Correct.

Andy: …that you wouldn’t wanna take if you are, because you’re right. You know, if you’re using debt, if I’m financing an asset at 75% LTV or something, absolutely, I want it to be self-storage, or industrial, or multi-family, you know, Class B multi-family or whatever. And then, you know, even that’s not perfectly safe. But those are relatively safe with all those tenants. But you’re talking about, you know, that triple-net Walgreens, or triple-net this, or triple-net that, if you lose that tenant and you have a note, you know, a debt payment every month, it’s not gonna take very long until you’re in serious trouble. Whereas if it’s debt-free, it’s still not gonna be pleasant, right? It still wouldn’t be pleasant to hold onto, like, a triple-net asset or whatever for 6, 9, 12 months to find a new tenant. But the point is, is that you could. It wouldn’t wipe you out. And it’s probably, you know, a desirable lot of land if you bought it in the first place, right?

Chay: You just need that staying power. And I have a thesis that I don’t know if it’ll be true, but, you know, the triple-net world is something, you know, you have a demographic, we’re kind of running into the 1031 side of the world right now or your typical real estate owner, but people wanna be passive, right? You have a demographic, the baby boomers, very large population, like you said earlier, that happen to buy a piece of real estate. There’s people that weren’t focused in real estate, and there’s very sophisticated people that obviously built a real estate portfolio.

However they arrived, they bought something 20, 30 years ago that’s now worth 10 times more the value, right? And now they’re tired of managing, especially over the last three or so years with all the turmoil. Most of these are apartment owners that did this, or single-family homeowners, and they want a passive investment. So, what does their real estate broker pitch them? Triple-net properties, typically. And one disclaimer, I’m not gonna say all triple nets are bad, but that really only became, in my point of view of what I’ve seen out there, became a big driving focus, you know, coming out of the recession. And that was because there was a flight to quality and there was people wanting to be passive.

And so, over the past decade, if you went back to 2010, a lot of the triple nets you saw in the market had usually 15 or 20-year leases. And nowadays, a corporation doesn’t generally sign as long of a lease. Some do, but now you’re seeing around 10-year loans on the… That’s considered long. But if you think about it, you had probably billions of dollars of mom and pops buy triple-net properties in those, you know, 2010 till now. And they put leverage on them, and financing was good, so they got 10 or 15-year financing. All that debt’s gonna come due between now and the next five or so years. We haven’t had a cycle with mom and pops owning triple-net properties. There’s not a real track record there.

And so, what are they gonna come up to, the ones that utilize debt? Is these real… And I’ve dealt with these real estate departments, they know if you have a debt component on your triple-net property, they know that they have you up against the wall. And so, when their lease is coming due and you’re trying to renegotiate a new primary term because your lender won’t refinance your property unless you have a primary term on it, an extended term, what does the big corporation do? They’re gonna say, “Hey, we want the roof redone, we want the parking lot restriped, we want you to pay our tenant rep broker.” And all of a sudden, you’re $500 grand on the door to get that lease extension. You may just fire sell the asset, or you may lose the property because you don’t have $500 grand liquid.

And so, I think there’s gonna be a day of reckoning for all of these people who bought triple nets that didn’t realize that you can’t just go refinance it like you’ve done with all of your other properties over the past 30 years. And what we’re doing is a fractional ownership approach. We happen to be debt-free. Some of our friendly competitors out there utilize debt. But I still think that’s a better play in the DST world if you’re gonna use debt. At least you were fractional, and you made a diversified portfolio, right? So, if God forbid something happens, it’s not your entire nest egg. But it’s there’s a lot of work repositioning an asset even for fully vertically integrated firms like us where we have all the resources. And imagine an end user who has just owned a single-family home for 30 years, they have no idea what they’re walking into.

Andy: Yeah. And Chay, that’s interesting that you make that point because we’ve talked about DSTs before on the show, and to me that’s a recurring theme that I mentioned about the DST product, which is it allows a high-net-worth investor, an individual investor, I mean, even for family offices, they can 1031 into institutional quality real estate or just a type of asset that they wouldn’t be able to access otherwise, right? And to your point, certain types of assets, you need a certain amount of scale, expertise, vertical integration to even to acquire and then to operate effectively and to maximize value, both while operating and then upon exit. So, I mean, I’m curious, you know, are your investors, are some of your investors kinda like, are they cross-shopping triple net versus DST? Or when they invest with you, do they already know, like, they’re already sold on the concept of a DST, it’s just a matter of which DST?

Chay: It’s both. But I would say yeah, everybody’s looking at their options. You know, anybody with any level of sophistication is gonna explore their options. So, we have people yes, that arrive to us and they’re gonna do a DST, but I guarantee if you ask them, they looked at triple nets prior, right? The other thing I think a lot of people use debt is purchasing power, right? If you have a 1031 exchange, or even if you just have money in your bank account and you wanna go invest in real estate, if you only have $500 to a million dollars, you can’t really buy too much in today’s market that’s of quality at a million-dollar purchase price. Maybe some stuff out there, but very rare. So, you go lever up at 75% loan to value, so you can afford the $3 million, $4 million property that is of quality, right? So, I think that… I kinda lost my train of thought there, but I think that…

Andy: Well, that’s, again, that’s the advantage of the DST because…

Chay: Oh, yeah. Exactly.

Andy: …when you’re aggregating…

Chay: You’re aggregating.

Andy: …you know, a million from this guy, half a million from this gal, and, you know, 20 other people like that, you end up with $20 million in equity or more, you know, $50 million, $100 million in equity, then you can go shopping at just a totally different level than any of those individual investors. And even at a family office level, you know, maybe they’re exiting an asset at $5 million, or $10 million, or whatever, but even then, you know, a lot of those families are investing in DSTs where they’re accessing just a more institutional quality type asset.

Chay: Oh, yeah, absolutely. And I’ve seen, because we’ve been in this kinda DST, my partner almost 20 years in this realm, the DST realm, and you’ve seen from the industry when it was kinda coming out in the early 2000s after the revenue ruling till now, you have a huge customer base where before you just used to purely be the mom and pop, right? The mom and pop that just didn’t have enough money to buy the, like you mentioned before, the larger property. So, their only option was paying tax or going to something like this. Now, you have family offices, you have small investors. I’ve had $100-plus million investors. And so, it’s pretty unique to see the space grow. And the big institutional players, I’ve seen them come into the space and utilize DSTs for covers. You know, maybe they have a $200 million exchange and they only allocated $150 million on their own, so they’ll cover their exchange with our product.

Andy: Interesting.

Chay: So, there’s so many different variations you could do.

Andy: Interesting. Yeah, I mean, that makes sense. So, how do you see the DST space? I mean, it was, yeah, I would say white hot. I think I’ve used that phrase before. It was white hot, you know, two years ago. And, you know, even last year, especially in the first part of the year, it seemed pretty strong. Obviously, all of commercial real estate has slowed down in the past 12 months, right?

Chay: Yep.

Andy: Regardless of wrapper. You know, I know wrapper it all has slowed down. But do you see the DST market, let’s say in the next 10 years, you know, regardless of the current whatever, 12, 24-month environment that we’re in, do you see it continuing this, I mean, frankly huge pace of growth that it had for the prior 10 years?

Chay: I do because there’re so many… I don’t wanna open up other cans of worms of long conversations, but…

Andy: No, no, open up the can of worms, Chay.

Chay: …we’re already seeing big institutions come in our space. You know, over the past five years, ginormous institutions, a lot that we’re very friendly with too. And there’s other big institutions I’ve heard, I don’t wanna say any names to get myself in trouble, but there’s like…there’s some of our biggest private equity firms in the world are zeroing in on our space. And the reason why that level of player is looking at our space is because the access to the retail investor. Historically, their rate, I guess, their end user through a pension fund or something is… Or a sovereign wealth fund might be a retail investor. But that’s a whole different capital raising machine that they have, and the retail investor’s a whole nother half that they’ve never tapped into, the direct through just the FA or the advisor channel.

And what do the big institutions wanna do? They wanna raise money for their REITs, right? And their big funds. And with the DST structure it’s something we do too, and God willing, we’ll be right up there with them 20 years from now. But you can transition a DST tax-deferred into a REIT through that 721 exchange or the UPREIT vehicle. And so, you’re trying to…

Andy: So, they’re basically viewing the DST as almost like it could be a feeder pool with UPREITs?

Chay: Exactly.

Andy: And to their… So, interesting.

Chay: And the only thing I would say about that to advisors is… And it’s part of our strategy too, you know, we will utilize it. There’s benefit to a 721, especially in the, not even getting in the tax stuff and estate planning, but in the asset classes. You know, again, we deal with triple nets for a large portion of our portfolio and a lot of institutions do. And if you have a 10-year lease, you’re always gonna have a day of reckoning, a 50-50 chance are they gonna extend that lease 10 years from now, right? Because no one could predict what a decade from now is for whatever that industry is. And so, if an investor can do an UPREIT in three to five years and bring that lease into the REIT structure or the fund structure, and now it’s amongst 100 properties, and then that property doesn’t resign, they don’t lose their cash flow overnight, right? They become ultradiversified.

And so, there’re some advantages to the 721. The only thing I would say is to educate the investor. I’ve seen a lot of investors go into certain programs where they didn’t realize they were gonna be forced into the 721, which basically cut off all their liquidity, right? Because if they, when it goes in the 721, a lot of these are at least upfront non-traded REITs, right? So, there’s no… I mean, they say there’s liquidity, but you read in the news when all of a sudden people want liquidity, they shut down liquidity, right?

Andy: Yep.

Chay: And so, they’re very, I think that whole transition can be considered even more illiquid than the DST being illiquid, right? And so, you just wanna as an advisor and even as an investor, understand that if you’re going to that 721, that is it a forced situation? Or some issuers will give you a option, “Hey, come up in here.” Maybe they give you a sweetheart deal to come up because they wanna get you, you know, in there. Or do you just wanna go do the traditional 1031 exchange? And there’s pros and cons to both. I wouldn’t say one is way worse than the other. It’s just understanding it.

Andy: Yeah, that’s a great point, especially because, you know, from what I understand at least, when you do the 721 exchange through the UPREIT, you end up in the REIT, that’s essentially the terminal events, the terminal tax advantaged event.

Chay: Exactly.

Andy: In other words, because if you recycle it into a DST, I can go from DST one, to DST two, to DST three, I can swap till I drop. But once I’m in the REIT, I’m basically stuck into…you know, I’m stuck in the REIT till I liquidate and then that’s actually going to be a taxable event.

Chay: It will. Now, you can go DST to DST to DST. You could also go, “DST, oh, now I wanna own my own property,” right? You’re not stuck in DST land. The 721 currently, always talk with your CPA tax, because I don’t know how everyone individually does their estate planning, but currently from a high level you do get a step up in basis in the 721 structure as well still. So, you do…it does work. And that’s why some people are like, “You know what, I’m just gonna be in this passive real estate game anyways. I don’t wanna have after every five to seven years do DST to DST to DST. I just wanna get up in that 721 vehicle and live my life, right? I’m retired.” That’s where there’s the potential pro of that structure.

Andy: Absolutely. It’s perpetual.

Chay: But sophisticated investors, like I said, there’s been a whole new population that has come in where they’re coming to us not because they wanna be passive investors. They’re coming to us to cover their exchange. They’re coming to us because they can’t find a replacement property and they don’t wanna pay taxes. They still may want control in the future, right? So, that investor may not wanna get stuck in the 721 story.

Andy: Totally. Totally. Okay. Well, as long as we’re talking about DSTs, and you mentioned where you see a lot of the growth coming from with these larger alternative asset managers who are looking at DSTs, probably moving into that market maybe with UPREIT-type products. Where do you see the growth in terms of sectors, you know, or even within your own company? You know, what sectors, what types of assets do you think, you know, you’ll see a lot of the growth in, in the next 5 to 10 years? What sectors interest you the most?

Chay: So, a large amount of our portfolio’s anchored in the more traditional long-term lease, net lease structure. We have a lot of industrial, like FedEx distribution, logistical facilities for a handful of different corporations. We have retail. We’re a little more picky on the retail, right? We wanna be careful with retail just with the internet world of today that we’re all aware of. I think going forward we are zeroing in on low-hanging fruit and that can be retail, right? Because lenders are afraid and specifically shopping centers. So, we’re looking at…

Andy: When you say low-hanging fruit, do you basically just mean, you know, you’re finding deals like strong value?

Chay: Correct. Yeah. So, we’re finding deals because if you have a shopping center, most leases are between three, five or seven-year terms. Maybe you have an anchor tenant that has a 10 or 15-year lease, but a lot of your inline is all shorter term, and a bank is a lot more hesitant on that in today’s world, right? There’s a lot of…you know, a lot of those tenants may be wanting to shrink or square footage or whatever. So, we’re going in trying to find stuff that does have strong anchors. So, you know, again, it does have current cash flow, but it’s got maybe vacancy because the previous operator ran out of capital. They have no more access to bridge or lines of credit to… They were starting a value-add play and they ran out because of floating rate debt or something along those lines.

And so, we will come in, buy all cash, hopefully we’re buying, you know, really well, because they need to exit or maybe they have a loan coming due in a year and they just see the writing on the wall, and they can still get out. You know, a lot of these people still bought the assets 5, 10 years ago at a much lower market. So, even though they’re in theory selling at a discount, the sellers are still getting out whole in a lot of cases, at least right now. So, they’re not getting a bad deal, they’re just facing a future bad deal if they don’t get out.

And then we’re buying deals that, you know, hopefully… We bought a deal recently in Texas that was in the 80% occupancy, and it’s trending really well. We’re about 4 to 6 months into the business plan and we’re already in the 90s. And we have a couple other leases we’re negotiating right now and then we’ll… There were some out parcel opportunities that we’re gonna ground lease out. So, we have some LOIs on that. And this is all stuff that would be very… We did all of this in under six months. If we had a lender again, that would’ve…

Andy: Yeah. I mean, Chay, what I’m hearing, like, with this, you know, the last example that you provided me, that’s just the advantage of having money. I mean, because so many of the other, you know, situations you referenced, other owners of these assets, they’re stretched. You know, when you’re financially stretched, when your balance sheet is stretched, a lot of times you can’t make optimal decisions anymore. Your decisions are constrained by your debt payment. You know, it sounds like when you guys are coming in, you’re not spending money foolishly, I’m not implying that, but there’s just enough cash, again, because of the structure, your overarching philosophy, it’s basically, “We have the cash,” right? And so, when you have cash, you can just, you know, I guess, make more intelligent capital allocation decisions because you’re not constrained by debt.

Chay: Yeah. And you don’t need to rush. You don’t have a payment and you’re just rushed into certain terms, or rushed into a tenant you should have never signed up, or things along those lines. And in the DST structure, and we do funds too, but our asset class is the same. So, whether we’re in a fund structure or DST, we still kinda focus on our style box. But with that said on the DST structure, and this goes with all sponsors, at least in my world that I see, you precapitalize your reserve. So, a lot of syndicators out there will have a master plan to go buy the center, and they thought in the back of their mind they were gonna be able to get a construction loan or some sort of line of credit to do this probably successful business plan. And all of a sudden, this world happens, and they can’t do it. Where we’re coming in, like you said, day one, we have the cash in our reserve account. We’re not reliant on the construction loan, we’re not reliant on the line of credit.

Andy: Yeah. Yeah. Chay, I gotta say, your perspective is so unique and it’s amazing to me that you all have grown very successful with some of these larger DSTs. I understand you have several funds that are not DSTs, that are just, you know, for, you know, cash investors essentially. So, it’s very clear that this is resonating with people. I know we’re short of time, but, I guess, I would just ask you when you’re talking with family offices or individual investors, how many investors are investing with you just because of that underlying philosophy, the sort of sleep well at night factor where they just love the concept of debt-free investing?

Chay: Yeah, I mean, ultimately, everybody arrives at that. I think today everyone showing up has that already just because the one blessing out of this whole situation has kind of been unique for us. Before, we would just have to walk… Everything I explained in this podcast. It would be an hour-long conversation about the pros and cons. And again, full disclosure, we’ve utilized debt on the other side when we used… You know, raised money for DSTs, and some 1031 investors have to take on debt. A lot of people don’t realize that. Once you take on debt, you basically have to continue that on unless you wanna add a bunch of cash in, because you have to replace your purchase price, right?

Andy: Right.

Chay: And so, some people, it just doesn’t work for debt free and that’s unfortunate, but there are, I would say most of the high-net-worth population today is very lowly leveraged. And there’s no reason, at your point in your life cycle, to push that. You know, it’s about protecting the nest egg at this point. And so, yeah, it resonates. Again, we still have risks in the underlying real estate, but I would like to think we’ve mitigated the catastrophic risk outside of, I guess, a tornado just taking away the building or a ginormous hurricane or something. But then again, we still have the land, right? We could still pivot, you know, and try to fix that situation.

Andy: Yeah, it’s very interesting, you know, that emphasis on capital preservation. We have an upcoming investor show here. I believe it’s on May 4th. And we’re doing a whole panel on capital preservation because I think you’re exactly right. You know, most high-net-worth investors, as you transition to very high net worth, ultra-high net worth, family office level, the emphasis becomes more on capital preservation. You know, I always say protect and grow your wealth. You know, that’s… But I think the emphasis can begin to shift towards protect, because you can always grow it, but you can’t grow what doesn’t exist, right? So, I can see why that resonates with so many high-net-worth investors. That being said, where can our audience of high-net-worth investors go to learn more about Cove Capital investments?

Chay: Yeah, so, you know, our website is pretty simple. It’s just On there you’ll find our contact information. I’m always happy to jump on phone calls. We have a great team and we’re fully integrated from in-house accounting to legal, to asset management, so we’re all available and an additional resource for the advisor and for the investor.

Andy: Love it. And I’ll be sure to link to that in our show notes as always. Chay, thanks again for joining the show today.

Chay: Yeah, I really appreciate you giving me time, and have a great rest of your week here.

Andy Hagans
Andy Hagans

Andy is a co-founder of WealthChannel, which provides education to help investors achieve financial independence and a worry-free retirement.

He also hosts "WealthChannel With Andy Hagans," a podcast featuring deep dive interviews with the world’s top investing experts, reaching thousands of monthly listeners.

Andy graduated from the University of Notre Dame, and resides in Michigan with his wife and five children.