All in the family

While most successful property investors have plenty of experience in the field, Carmel Partners founder Ron Zeff seems to have real estate investing in his genes.

“I grew up in the business of real estate,” says Zeff, whose father, the late Kal Zeff, was a prominent Colorado-based developer and one of the largest apartment owners in Denver. “My father and I would go look at properties [when I was younger]. I used to mow the lawns.”

When Zeff needed a name for his own firm, he once again took a cue from his father, whose extensive Denver practice was called Carmel Development and Management.

My father fought on Mount Carmel during the [1948 Arab-Israeli War],” Zeff says of the name. “He thought he would surely die in the battle—because of that, he carried the name into his company. I also wanted to carry that name forward, because I wouldn't be here otherwise.”

After attending the University of California at Berkley as an undergraduate and receiving his MBA from Stanford University, Zeff originally planned to work for his father in the Denver real estate business. But, as the city sunk into the recession of the late-1980s, he found opportunities in the Mile-High City hard to come by. So Zeff ended up back on the West Coast and joined the residential division of real estate services firm Trammell Crow Company in San Francisco.

Zeff quickly made partner at the firm through his involvement with some of the company's earliest—and groundbreaking— development deals. He worked on the firm's first high-rise development deal, its first condominium development and its first development without a completion guarantee from its partners. He then parlayed this development pedigree into San Francisco-based Carmel Partners, the real estate firm he founded in 1992. From the outset, Carmel was primarily focused on development, with some acquisition work, in the multi-family sector.

“I started looking for development deals,” he says. “I looked at land. I looked at the entitlement, the amount of money I'd have to risk to get those approvals and the construction risk. At the end of the day, what yield would I get? Not in a pro forma book trying to get an investor, but, in reality, what was the yield I could get today?”

In the mid-1990s, Zeff quickly realized something about the California real estate market which would go on to influence the firm's investment thesis: rehabbing could provide higher returns, and lower risk, than development. On one particular deal, for example, he had the option to purchase land in San Mateo, California, build a multi-family project for approximately $215,000 a unit and realize a 7 percent yield.

“At the same time I could buy an existing asset that had current cash flow, maybe with a yield of 5.5 percent, and remodel it to the point where it would be directly competitive with the new construction,” Zeff says. “My total cost would be $135,000 per unit and my yield would be 9 percent. I was able to produce a 200 basis point spread with what I perceived to be lower risk.”

That epiphany has shaped Zeff's real estate investment strategy, which focuses on minimizing risk by thoroughly analyzing downside scenarios. His approach was also formed by his memories of the Denver real estate market in the 1980s, where Zeff saw what happened when the cycle turned

“My basic philosophy has always been not to lose money,” he says. “I want to be able to handle a 150 to 200 basis point increase in cap rates and not lose any capital. Zero. That's my general approach.”

His firm was initially focused on rehabilitation opportunities in San Francisco and ground-up development in Denver, taking advantage of its comparative strengths in each market. In the California market, Zeff felt an advantage could be gained through the state's rigid entitlement process.

“In California, what makes a good developer is [the fact] that they got the entitlement,” Zeff says. “It doesn't matter if they developed the best product. It's that they got it approved and could build something new.”

In this type of environment, Zeff felt his home-grown experience would be an asset: “Having experience developing in Denver with my father… we felt we could easily out-compete the local development community [in California] and essentially give more quality product to the resident for less money.”

“I grew up in the business of real estate.”

And, back in Denver, the connections and local knowledge that Zeff picked up from his father's company also gave him an edge. Carmel Partnerswas able to remain ahead of its competition by keeping costs extremely low on new development projects. “The idea that you can build new for below replacement costs is a nice little advantage,” he says. “That's an advantage we really only have in the Denver area.”

Around 2003, Carmel decidedto continue its multi-family investment strategies via a discretionary private equity real estate fund. “We realized the world is becoming more and more competitive and we felt that we wanted to have our own capital, rather than raise it on a deal-by-deal basis,” Zeff says.

The firm closed its first fund on $215 million (€179 million), mainly from foundations and university endowments, in November 2003. Carmel Partners Investment Fund I is currently close to 100 percent committed; it has invested in 5,700 units with a cost basis of around $650 million and approximately 69 percent leverage. Earlier this year, the firm closed its second fund on $400 million—in addition to picking up 11 new limited partners, 95 percent of the first fund's investors returned.

The funds continue to focus on the multi-family residential sector, because, as Zeff says, it is where the firm has experience, as well as being a property type that offers bigger returns with less volatility and less risk. The firm typically looks for underperforming assets valued between $10 million and $300 million, with a focus on acquisition and repositioning. Still, reflecting the current market, the allocation to development has increased from 10 percent of the initial fund to 25 percent of the second vehicle.

The fund also has an allocation to condominium conversions: Carmel recently acquired and converted the 202-unit Aloha Surf Hotel in Honolulu's Waikiki District into condominiums, spending $2 million to renovate the common areas of the 1967-vintage hotel. But Zeff considers new development and condo conversions riskier projects that need higher margins; the fund is largely focused on bringing the firm's management and development ideas to existing properties— and, through extensive repositioning, making those properties competitive with new development.

“Basically, our approach is a value-add approach, but not a carpet-and-paint-type approach,” Zeff says. “We look at each asset like a developer. We think about what we can do to a property, not just the going-in yield.”

He continues: “There are a lot of people who call themselves value-add players. But if you do carpet and paint as your valueadd and you have a five-year sale horizon, in five years your property is as out-of-shape as when you bought it.”

Understandably, when sourcing projects the firm seeks out underperforming assets where it can leverage its repositioning strengths. “Typically, an asset that will meet our criteria is one that has everything wrong with it,” Zeff says. “Management is wrong. Cash flow is low. There is a reason why we're getting it at a discount, because there is really something wrong with it. What we're looking at is what we create.”

As well as expanding into the realm of private equity real estate funds, Carmel has also diversified its geographic scope: the firm has recently added offices in Honolulu and Washington, DC and has made investments in a number of cities across the country. According to John Williams, the firm's managing partner for capital markets, the cities Carmel is focusing on have a distinct profile in terms of market fundamentals and demographics. “Our target markets have a young population, are 24-hour cities, have good job growth and have a big disconnect between rents and the purchase price of single-family homes and condos,” he says.

The firm also likes areas with high barriers to entry, so in addition to San Francisco, Denver, Honolulu and Washington, the firm is also investing in Southern California and Seattle. Carmel also has an eye towards possible expansion into the New York and Boston markets.

Even before expanding across the country, Carmel made quite a mark in its own backyard, particularly with projects like the high-profile acquisition and sale of the Villas at Parkmerced: when the firm acquired the complex in 1999, it was the largest multi-family residential purchase in the US. The complex has 3,500 units and around 8,000 residents, roughly one percent of the population of San Francisco.

Zeff says that the firm approached Parkmerced with its value-add strategy in mind, realizing that the project could be purchased for $90,000 a unit when comparable replacement costs were approaching $300,000 per unit.

After purchasing the property, Carmel worked with the building's management to increase efficiency and made $35 million in improvements to the building's infrastructure, including the plumbing system. The firm added amenities at Parkmerced, including a modern clubhouse with a fitness center and movie theater. The repositioning paid off and this autumn the property was sold for $700 million, chalking up a strong return for Carmel.

But Parkmerced also proved to be valuable dry-run for later investments, as well. Williams notes that the complex was a test of the various components of Carmel's business, like its inhouse construction company and property management capabilities. “Parkmerced was a good laboratory for us,” he notes, adding that the deal's success was also helpful out on the fundraising trail.

“We had a good story to tell,” says Williams. “We say that deal in particular gave us our PhD.” Zeff agrees, adding, “When we went to our investors, we could say ‘We have experience. There's not a lot we can't tackle.’”

As the firm follows through on its investment strategy, Zeff says keeping the end user in mind is essential. “People do not rent apartments per square foot,” he says. “They rent a oneor two-bedroom apartment. They look at three to five choices in the neighborhood they want to live in [which are] in their price range. That's what we do. You've got to put yourself in the mind of the consumer at the end of the day.”

With investments like Parkmerced, as well as more recent projects like the Clarendon Hills condominium-conversion project in suburban San Francisco and the acquisition of the Aero Flats complex in a gentrifying area near Denver's Stapleton Airport, Carmel continues to focus on those consumers in its core markets, as well as others around the country.

Despite a lifetime in the real estate business, Zeff has outside interests, many of which revolve around his four sons and weekend lacrosse, basketball, football and soccer games. But even after all these years, multi-family real estate remains high on the list.

“You can see I'm pretty excited about apartments,” he says.