In this conversation, Andy McQuade discusses the relationship between Net Operating Income (NOI) and asset value in real estate.
He highlights how some General Partners (GPs) manipulate expense classifications to inflate property values, which can lead to financial discrepancies when securing loans.
The discussion emphasizes the importance of understanding true operating expenses and the implications of misclassifying predictable expenses as capital expenditures.

What LPs Miss About Operations with Andy McQuade

Andy McQuade (00:00)

The more NOI that a property generates, the higher the asset value is. So we've got some GPs that will move a whole bunch of annual expenses that are completely predictable, continually controllable, and in my opinion don't qualify as capital expenditures, down to capital expenditures because it increases the property value. The money is still getting spent either way. It's just a line item on the P&L, essentially, as to where that goes. The problem with that is that then they go and they take a note from a bank at a higher asset value than what the property really is worth, without considering what true operating expenses are for the property.

Pat Zingarella (00:38)

All right, Andy, thank you. Thank you so much for joining me. I had the pleasure of meeting you at Best Ever last year and really excited to chat with you here. Before we get started, why don't you take maybe like 30 seconds, tell us a little bit about yourself and what you do.

Andy McQuade (00:51)

Sure, thanks for having me Pat. First of all, appreciate it. I love doing this kind of stuff and I'm excited for your show and your platform. So I think it's a much-needed service and you're doing great things. So keep it up. So I'm Andy McQuade. I help owners and operators of commercial multifamily properties make more money. Some of that is through better processes, some of that is through better purchasing and procurement, some of that is just

Pat Zingarella (01:01)

Appreciate it.

Andy McQuade (01:18)

through some common sense stuff that they can put in place for themselves and they don't have to pay me. I come from—I'm a reformed sales guy—I had 22 years before I started doing this, I'm up to 28 years now, so 22 years on the supply side. So construction, remodeling, multifamily development, all of that kind of stuff sort of led into what I do now.

Pat Zingarella (01:40)

Awesome. Love the word reformed sales guy. That's good. That's good. Sweet man. Well, the big reason I wanted to have you on this is obviously our LP series and we typically have LPs helping LPs on the show. I know you have a lot of visibility into what GPs may be missing. And I'd love to learn a little bit about like, what do you see the most, right? Where do you see improvements needed the most? So we can in turn advise the LPs like, "Hey, GPs are missing this. Like when you're doing due diligence and underwriting, this is what you should really dial into."

Andy McQuade (02:11)

There's a lot of things. Some of it is as simple as not really understanding the scope of work before they start a project because maybe they don't have the experience or the team in place to really walk them through that. A lot of what I do is I get involved in complex rehabs for multifamily properties. And more often than not, with a GP team who doesn't have a 10, 15, 20 year track record of doing this, they're not planning ahead far enough, they're not working with their service providers or their vendors ahead of time before the project starts. Most of my clients now bring me in during due diligence. When I was doing this for the "Big Orange Box" to provide products—reformed sales guy—I had clients I would fly on a plane with to whatever state they had a property that they were going to turn and do a value-add rehab on. And I would start securing product and locking in pricing and availability, putting stuff into stores before they closed on the property. I was there doing due diligence, picking fixtures, walking with the interior designers and the owners and the management team to figure out how this was going to get onboarded, how it was going to operate. And the planning piece saves so much time and money upfront, not just from products and supplies that have to come in from China, Mexico, wherever, right, Turkey. But for the vendors that are going to come in and do the work for you, right, all those service providers that need to install stuff. The scope of work that's going to be necessary, the sooner they can get a jump on it and secure their side of what they're going to need for the business, the more money it's going to save you. And so a lot of it comes down to not planning ahead far enough and not having those relationships with those key companies and suppliers to make stuff happen quickly, right? Everybody wants a 12 month turn where it doubles the value of the property and they can refi and crystallize equity and pay their investors. That's great, but I've not seen a lot of people really able to deliver on those expectations reliably and consistently the way they could if they were ahead of it just a little bit more than they are now.

Pat Zingarella (04:39)

That's really interesting. As an LP, when I'm thinking about this, are some of the questions like, "What are the relationships like with your suppliers? Is the first time you're working with people or do you have these set in stone?" Or how do I determine something like that as someone evaluating a GP?

Andy McQuade (04:55)

Anybody, any GP who has—now this might not be true for the capital raisers or the investor relations people, whatever you want to call them, that they have on the team—they may not know this stuff, but they should be able to get an answer as to what suppliers, what process do you use, how far out is it planned, do you have

Pat Zingarella (05:03)

Vendor funds and stuff, yeah.

Andy McQuade (05:19)

stuff secured ahead of time, you know, do you have a relationship and buying power with these companies that would be loyal to you and carry you through hard times, make sure the service is there, make sure that fingers aren't getting pointed. It's kind of similar to—right, the last couple years we've seen a lot of GPs blaming third party property management for their woes and it's like, "Well, where's your asset manager?" Like, you know how property managers get paid. They don't get paid to increase NOI. They don't get paid to produce a more pleasurable experience for the tenant, right? Their job—they get paid on two things: when they collect rent and when they do a maintenance work order. Their job is not to increase net operating income to add asset value. They don't get paid for it. They have no skin in the game for that side of it. So the sooner you understand how the alignment of interests is between asset management and property management, the more you realize the more control asset management has over what that property manager does, the better your results are going to be. And if they're 2,000 miles away and they've been to the property once, maybe that asset manager needs to be changed. Or maybe you just don't invest with that GP. That's the reality of the situation and we see a lot of finger pointing and stuff like that now, but the reality is control dictates success. And if you have no control, you will not be successful. And that's tough as an LP because you literally sign away your control.

Pat Zingarella (06:34)

Yeah.

Andy McQuade (06:53)

So you're relying on the GP to do that.

Pat Zingarella (06:56)

Yeah, that's really interesting because I hear a lot of LPs bringing up property management, right, as a major focal point. I wonder if many don't realize the differences between asset managers and property managers. Like, is that—I've had plenty of these calls, podcast, people bring up property managers all the time. Nobody brings up asset management in terms of a deep due diligence place.

Andy McQuade (07:21)

Right. And it should fall to the GP. The GP should have an experienced asset manager that's doing more than just being a spreadsheet warrior. Like they should understand how the operations of a property function, what the average costs are to do things, what the possible risks are. Like your asset manager should be doing risk management, procurement. They should be specifying payment terms and stuff like that for contractors doing complex rehabs. Like all that stuff should fall to

Pat Zingarella (07:27)

Yeah.

Andy McQuade (07:50)

asset management, right? And then, like, if they're doing a complex rehab, who's the project manager? Because that's a different skill set than asset management. Asset management is budgets and establishing control. Project management is keeping the thing on track and making sure the work gets done at the right quality, at the right price and on time, which is pretty challenging, just based on personal experience, but it needs to be done. And then the property manager is responsible for lease up and maintenance operations. That's it. Like, their job is to maintain the quality of the property, but their job is not to dictate to the ownership how the asset is managed, what the budgets are. Like, that all comes down from asset management. And, you know, there's some games that I've seen over the last few years where we'll see GPs touting, "Well, we're at 35% OpEx." But are you? Like, most of the product I see, it's 1990s, early 2000s, garden, wood framed, shorter than three stories—or three stories or shorter, I should say—if it's got any type of workforce housing, any type of low income housing or affordable housing development, you're at somewhere between 45 and 55% OpEx in the real world. Asset managers and some of these GPs will write these deals at 35%. And they're not really 35%. What they're doing is they're taking certain key things that come up in the day-to-day operations that are expensive, and they're pushing them down below net operating income into capital improvements. If you don't know and you're underwriting a deal, your net operating income is pretty much all of your expenses minus debt service and your reserves. Everything to operate that property, all the property management, all the overhead, like everything, all encompassing property taxes. Everything goes into that bucket. Top line revenue is whatever you get for rent. NOI is whatever's left after all those expenses prior to what remains for debt service and reserves, which creates your free cash flow. So here's the problem when you take a bunch of stuff that gets billed out every single year anyway—and I was just telling somebody the other day, I've seen people put landscaping and snow removal in capital expenditures, even though it happens every single year. And it costs, yes, it costs five figures for some of these properties. I get that. It's expensive. It is not a capital expenditure. You're not improving the property significantly. Like it doesn't meet the sniff test. But here's the thing.

Pat Zingarella (10:33)

Got it. Mm-hmm.

Andy McQuade (10:47)

There's no legal requirement that certain categories of expenditures are or aren't capital expenditures. Capital expenditures can be written off on your taxes. Great. The problem is that the more NOI that a property generates, the higher the asset value is. So we've got some GPs that will move a whole bunch of annual expenses that are completely predictable, continually controllable, and in my opinion don't qualify as capital expenditures, down to capital expenditures because it increases the property value. The money is still getting spent either way. It's just a line item on the P&L, essentially, as to where that goes. The problem with that is that then they go and they take a note from a bank at a higher asset value than what the property really is worth, without considering what true operating expenses are for the property. So if you take a $2 million property and you take out a loan at 65% loan to value, your payment is significantly less than a $4 million property with a 65% loan to value. Here's where it gets stupid and where a lot of—I see a lot of these companies struggling right now with these syndications. You don't have any spread left when you do that. If your true operating expenses, including the things I would consider OpEx, is 50%, but then you've got 15% of it moved down to CapEx, you're still spending that money. You're still spending 50% of your top line income, your top line revenue, to operate the property. The problem is your free cash flow is now being eaten up by that extra debt service from having a higher value asset. So all of these deals are basically gambling on crystallization of equity at sale. Well, what happens when you have cap rate compression and nobody wants to buy your property because they think it's overvalued by a million bucks or two million bucks? Are they going to negotiate that down? Yes, they are. Are you going to get that crystallization of equity you counted on? No, you are not. You will be lucky to get your initial piece of the pie back. That's where a lot of these places have fallen flat and just not delivered on their promises.

Pat Zingarella (12:38)

Hmm. Yeah.

Andy McQuade (13:04)

Flat and just not delivered on their promises.

Pat Zingarella (13:07)

This is super interesting, really interesting. So you mentioned landscaping as one of the line items. Snow removal, I think you said as well. Are there any other recurring items that you see being moved from OpEx to CapEx that LPs should be looking out for? This is just—

Andy McQuade (13:23)

It can be anything. Yeah. So like when you're doing a complex rehab, it's not unusual to have the whole CapEx project under CapEx, right? So you're including the flooring, you're including the blinds, you're including the appliances, you're including the cabinets, you're including all the things that go into a complex rehab, including all the labor to make that go. During turns, right, where you're not doing a complex rehab, you're not gutting the entire unit, you're not making everything match to a new standard, a higher standard of quality so you can get that rent bump, people are taking appliances, putting them under CapEx. Dude, it's an appliance, it's a maintenance item. It's going to die, it has a five to 10 year lifespan, you know it's going to happen, you're buying one or two at a time, maybe 10 or 15 a year for your property. That is not a capital expenditure. I'm sorry, it's part of maintenance. Get over it, it's OpEx. Same thing when you have a flooring, like carpeting. It has a three year lifespan. If you have wall-to-wall carpet, I don't know why you do. Stop doing it, get throw rugs, make your tenants supply them. Anyway, enough. Carpeting is depreciated in three years. It is not a capital expenditure. It is a maintenance item because you're only going to change it after that tenant moves out if the carpet is damaged. If it's not, you're going to steam clean that thing as best you can and put the next tenant in it. Like that's reality. That is not a capital expenditure. I'm sorry, it's part of maintenance. All of your cleaning, all of your hardware replacements, toilets, plumbing repairs, unless it's a massive failure where you've got like an entire building's worth of plumbing that just pops all at the same time and there's an insurance claim, you're not going to write that off as a capital expenditure. It's part of maintenance and operations. There's a reason why there's different categories for all those things because it creates a reasonable and realistic expectation of what your cash flow is going to be month to month. And when you start playing the game of hiding things below the line into CapEx, you get dangerously close with a razor thin margin of error to make sure everything works out. And again, if your entire business plan is based around success of crystallization of equity at sale or macroeconomic impacts like low interest rates and whatever else, good luck. That is not a business plan, that is gambling.

Pat Zingarella (15:49)

Yeah, that is great stuff. That is great stuff. I would love to kind of shift a little. You talked a lot about supplies, right? Like almost, you know, you were reform—reformed from being on the supply side, but you also talk about the role of asset management and vendor relationships, lining up supplies and things like that. One of the big reasons we started Invest Clearly was to really separate the media noise from the reality. Like, "Hey, the world's ending. Is it?" Or like, "Hey, everything's great. Is it?" And there's a lot of macro factors right now, I guess, on supplies with tariffs and things like that, what are you seeing—and I ask this to the effect of like, LPs are underwriting deals now for the future, right? Maybe like a development or value-add, you know, multifamily that rehab is happening over an extended period of time. Is the media narrative around tariffs as impactful to what we're hearing, or like what are you seeing on prices around that from the mind of the LP thinking about how to underwrite these things with a fixed number in front of them now, or what is it going to be in three to six months and things like that?

Andy McQuade (16:49)

So a lot of it is overblown. For new construction, the stuff that's impacted by tariffs maybe will impact the price between like 3 and 5%. It's not significant because so much of it goes into pre-development work, site work, and labor, and then insurance overhead and all the other crap that goes into it, that the building materials themselves that are actually impacted have a pretty—like, yes, they can break a budget for certain phases, right? Like if your flooring all of a sudden goes from

Pat Zingarella (17:08)

Sure.

Andy McQuade (17:18)

a buck and 79 a square foot to three bucks a square foot. Yeah, that's going to suck. You're going to take that on the chin. That's going to blow your flooring budget. You're going to try to find a cheaper solution. But it's a flooring budget. In the grand scheme of things, you're talking about a buck or two a square foot when construction costs are anywhere from $200 to $300 a square foot. Like, where is that moving the needle? It's not, right? Like, it's a big deal for the project manager who wants to make his bonus at the end of the project. Not as much of a big deal from a dollars and cents standpoint for an LP. The big stuff is in like a rehab, complex rehab of an older property because so much of the cost isn't defrayed by site development and everything else. You've got a higher percentage of total spend going into product. It can be 15, 20% of the entire job. And so that does impact things or can impact things. You're trying to, you know, rehab a low income property, it's going to cost you 10 to $15,000 a door. You're going to get maybe a two or $300 rent bump. Every penny counts at that point, right? Like I think as a side note, I think the days of spending 20, $25,000 to get a $200 a month rent bump are going to be over very shortly. If they're not already over, I think we're going to see a return to trying to get some ROI on spend, but that's neither here nor there for this particular part of the discussion. I think we're going to see tariff impacts continue. Trump is going to do what Trump does. It is what it is. The world's not going to end. Business will go on. The biggest impact I'm still seeing is we're still strapped on HVAC costs and materials from the pandemic. We have not recovered. And electrical switchgear, same thing. HVAC is a little better. Electrical switchgear is still a nightmare for any big development project. You could be a year, 18 months out

Pat Zingarella (19:00)

Interesting.

Andy McQuade (19:11)

for certain things on new builds. And if you have to retrofit something and there's a major failure, God bless you. Good luck. It's going to hurt.

Pat Zingarella (19:20)

Yeah, yeah, interesting. So you mentioned earlier in the call, getting, I guess, asset management involved in the planning phase is the highest impact for GPs. I always think like LP mind, right? Like, "What do I look out for? What are things that I'm missing when I'm underwriting?" When you think about having to come in at the reactive stage, where are mistakes made the most? You know what I mean? Like, "Hey, I wasn't in the planning phase. You missed all of these things." Whether you talked about supply costs and vendors and things like that. But if you go back and almost look strategically, like, "You should have done this, which then impacted this," what do you see the most there?

Andy McQuade (19:59)

So there's two things on the LP side. I think we look at a lot of decks and we're seeing returns that are inflated because of 2019 to early 2023—we have the rising tide lifting all boats, right? The easiest way to cut through the chaff on that is to go to unlevered yield on cost and find out if they actually added value or if they just rode the wave of inflation and increased rent prices and everything else without actually creating value at that property. Like that's your number one easiest indicator if a GP is full of crap or not. Like they can say they've done all these things, they can put on paper that this was the result. Maybe it was, maybe it wasn't. Assuming that they're telling the truth from their point of view, easiest math you can do as an LP is to go unlevered yield on cost, do the math, find out if there was real value added or if they were just taking advantage of a situation. As far as the planning stages and what gets missed, a lot of the typical stuff we see in older housing, right, the prime target for value-add operators is to find something, you know, maybe built after 1980, hopefully, but I work with clients who love stuff from the 40s, the 50s, the 60s, the 70s, because people don't want to touch it because it's a lot of work and if they're not familiar with it, it can be completely hazardous. The copper plumbing throughout a property—you see this just happened probably two months ago—I had a client who had a 1970s build with all copper plumbing everywhere, was beautiful, nice cast iron drops in the whole nine yards. They replace those with foam core and some other stuff just technical whatever, then they put water softeners in. You know what happens to copper when you take out all the hard water and minerals that's been sitting for 50 years? You have a catastrophic failure where the entire building floods because there's pinholes and thin copper and high pressure and all of that green and white calcified stuff you see around valves and whatever. That all goes away with water softeners and then you have a lot of leaks and a

Pat Zingarella (21:58)

Yeah. Jeez.

Andy McQuade (22:20)

very expensive bill to go through and put PEX everywhere. So that's not an atypical one as we see these products come together and proposals to put water softeners in because tenants love them and they can get a rent bump for it. Make sure you know what you're getting into mechanically before you do stuff like that. There are side effects to a lot of things that you upgrade in these buildings. It's not all—it's just simple. "We just put it in." No, no, that's not a good idea.

Pat Zingarella (22:35)

Very interesting stuff.

Andy McQuade (22:49)

Same thing with workforce housing, people putting in a lot of appliances with fancy bells and whistles, water in the door, et cetera. They're not checking to see if number one, if the products can be warrantied and repaired, or if they have to be replaced. Like some of the import brands, unfortunately have three to six month part waits and now 50% cost increases. And even if it's in warranty, good luck. You're better off just throwing the appliance away and getting a new one. If you're going to use a repair network, make sure one exists. There isn't one for the import companies really. They don't have manufacturer service. They have subcontractors they hire in local markets. So it creates a different level of delivery and it can cost a whole lot of money. But additionally, you're putting water in the door of a C property, multiple stories, wood frame construction. If somebody moves the refrigerator, do they turn the water off and disconnect the tube to the back of the fridge?

Pat Zingarella (23:34)

Sorry.

Andy McQuade (23:54)

No. No. And then there's always the other stuff that we hear about like insurance costs and everything else. People not underwriting to current insurance levels going off of a pro forma for somebody who's got 10 times the doors with a 20 year relationship with a provider. You've got no relationship. You've got whatever doors are on this deal and nothing else. New provider, your costs are going to double but you don't see it. And that's the same with

Pat Zingarella (23:55)

Yeah.

Andy McQuade (24:24)

you know, property taxes. Sure, Texas is a non-reporting state, but if you file a lien at the county with a big fat note that all of a sudden inflates the value of that property by a couple million bucks, notwithstanding any of the other stuff, well, they can go look at that lien and they can figure out what you paid for that property pretty quickly and then your taxes are going to go up. So don't like play the games, run your numbers off of what the worst case scenario would be, which would be insurance rates at market levels with no relationship and no pre-planning and taxes going to the purchase price of the property. Whether it's a reporting state, a non-reporting state, you think you can fudge the numbers—doesn't matter. The bank will file a lien. People can read and do math.

Pat Zingarella (25:16)

Yeah, this is great. I feel like this show went by very, very quick. We got about five minutes left. I want to ask you my favorite question on every call. What part of passive investing do you think needs to die?

Andy McQuade (25:26)

Trusting everything somebody says because they saw them on a podcast—no offense to people on podcasts. I have a podcast, you have a podcast. This is a great show, but don't believe it just because somebody says it. You got to vet it. You got to make sure number one that they are who they say they are and they've got the background to support what they say they're doing. And number two that they're actually doing it. So you know, people say background checks are a little extreme; they can be, but if you're talking about handing five or six figures of your money over to somebody to take care of it and make you more, you better be sure that they actually have the qualifications to do what they say they're going to do. Like there's plenty of evidence out there. You can find some people who report on it all the time where syndicators put properties they don't own on their portfolios because one of the partners has an LP stake in it somewhere. They have no control. They have no ownership stake as a company, but one of the people somewhere has a 2% share, 1% share, or 0.005% share of a thousand doors, and they'll put the properties up on their website like, "We own these." No, you don't. One of your partners happens to have a stake in those, and you're claiming that you own them, but you have no actual control, your name's not on the deed, you've got no title interest. Don't go down that road. And if people are listening and they are those people, clean up your shit. People are coming for you.

Pat Zingarella (26:46)

Yeah. There you go. It's crazy you bring up that example. I've seen things go as far as like people will put their advisors or if they're like fund managers, the fund, the company that they've placed capital with—almost like they message it in such a unique way where it looks like it's their own. Like assets under management. And they'll be like, almost like, "partnered with so-and-so" that has—it's in big numbers on their website. And it's like, "Partners with X amount of assets under management, 30 years experience." It's not actually them; they're brand new, but they're representing their advisors on their own websites. Like, this is nuts. Like, it's wild. And if you don't really dig into that subtext, it looks like they're that big and it looks like they're that experienced. It's crazy. I always tell people—like you talked about the podcasting, but like my line that I've said from the beginning of this company is that social influence is not social proof. Like, do your DD on these guys. I've talked to so many LPs lately, more and more keep popping up where it's like, "I bought into the charisma, I bought into the marketing." And there is fault on the LP—like you shouldn't have done that, you shouldn't have done that. But again, you've got to dive in. I'm just kind of going on my soapbox now. But like, yeah, I 100% agree with you. But Andy, awesome. Thank you so much for coming on here. If people want to find out more about you, both especially the GPs that are looking for services like yourself, but even the LPs that want to follow along with the hot takes you throw on LinkedIn all day that I love, where do they go?

Andy McQuade (27:57)

Yeah.

Andy McQuade (28:18)

So you can find me on LinkedIn, you can find me on Instagram and other places. It's fine, just Google my name, Andy McQuade. I come up from like the first five pages, pretty much fill the entire thing of Google with my results, but you can hit my website, andymcquade.com. It's in the process of being gutted and updated, so it may not be as complete as it should be, but Arm Companies is where I do most of my consulting work. You can hit that website and kind of see what we offer and go from there.

Pat Zingarella (28:45)

Yeah, awesome. You were recognized recently as like a voice on social media, right? You got a badge from something recently.

Andy McQuade (28:50)

A few times, yeah. I have a couple from the CREI, which is the commercial real estate influencers, the CREI summit, and then I've got—I just hit GlobeSt's multifamily list last month. Yeah. GlobeSt is pretty big, so I was pretty tickled to see that. Still have no idea how I got on the list, but it was pretty accurate, so I'll run with it. It's good.

Pat Zingarella (29:00)

Nice, very cool. Good stuff, well awesome. That's good. As long as you're there. Good stuff. Andy, thank you again. Looking forward to staying in contact with you and I would encourage anybody to reach out to you.

Andy McQuade (29:19)

Awesome, I appreciate it. Thanks, Pat.