• The House Whis­per­ers

In­de­pen­dent real es­tate de­vel­op­ers were al­most wiped out by the Great Re­ces­sion. These two en­trepreneurs pre­dicted it and thrived—and now they’re bet­ting big on what they say is an in­evitable boom

Inc. (USA) - - FEATURES - By Bill Sa­por­ito

In­de­pen­dent real es­tate de­vel­op­ers were al­most wiped out by the Great Re­ces­sion. These two en­trepreneurs pre­dicted it and thrived. Now, they’re bet­ting big on what they say will be the next boom.

Peter Wells has just re­turned from the Mediter­ranean coast of Spain. It was not a va­ca­tion. In­stead, Wells spent days stomp­ing around An­dalu­sia’s Costa del Sol in work­boots and a hard hat, check­ing up on his lat­est real es­tate project. Along with his long­time part­ner, fi­nance guy Marcel Arsenault, Wells is build­ing lux­ury beach­front con­dos to sell to rich Euro­peans and Mid­dle Eastern­ers look­ing for se­cond

(or third) homes. He shows up pe­ri­od­i­cally to scout new deals and to make sure the con­struc­tion is meet­ing Amer­i­can stan­dards. Af­ter all, some of his lo­cal com­peti­tors “sell units with­out kitchens, no cab­i­nets and ap­pli­ances at all,” he claims. “There’s no light­ing. Just bare wires hang­ing from the ceil­ing.”

Then it’s back to Colorado, where Wells trades water­front con­cerns for the mud rooms and heated floors of skire­sort town­houses in Breck­en­ridge. A life­long skier (and lapsed den­tist), Wells knows this ter­ri­tory par­tic­u­larly well. Wher­ever he’s dis­patched, Wells is used to be­ing Arsenault’s eyes, the one who ac­tu­ally checks on the things they’re build­ing to­gether. “I’m the part­ner on the ground,” he says.

That’s in part be­cause Arsenault isn’t all that in­ter­ested in real es­tate, which is a bit weird for a guy who makes a liv­ing—a for­tune, ac­tu­ally—in the busi­ness. Sure, he’ll travel to meet with in­vestors and bankers, but as for the build­ings them­selves, “I usu­ally don’t look at them any­more,” says the founder and CEO of Real Cap­i­tal So­lu­tions, a Louisville, Colorado–based in­de­pen­dent real es­tate com­pany that in­vested $250 mil­lion in hous­ing last year.

In the past 20 years, Arsenault has built an en­trepreneurial em­pire fi­nanc­ing, de­vel­op­ing, and build­ing houses, apart­ments, and of­fice tow­ers. The pony­tailed mogul, an ag­ing hip­pie by ap­pear­ance and a sci­en­tist by train­ing, runs his com­pany from a charm­less low-rise out­side Boul­der. He does so by re­ly­ing on Wells, his pri­mary de­vel­op­ment part­ner, who doesn’t have a job ti­tle at RCS—but who knows what kind of kitchen you need to build in a Dal­las condo ver­sus one in San Fran­cisco.

What’s more un­usual is that they sur­vived the Great Re­ces­sion, which wiped out the ma­jor­ity of lo­cal builders in some ar­eas, and now are thriv­ing in a much tougher en­vi­ron­ment. That’s es­pe­cially im­pres­sive given the com­pany’s rel­a­tively small size. Res­i­den­tial real es­tate con­struc­tion is a mas­sive sec­tor, gen­er­at­ing about $466 bil­lion an­nu­ally, ac­cord­ing to the Cen­sus Bureau’s most re­cent fig­ures. More telling

than out­right size, though, is that the pub­licly traded builders, such as D.H. Hor­ton and Len­nar Cor­po­ra­tion, have gained mar­ket share since the re­ces­sion but built fewer homes. RCS, on the other hand, is ramp­ing up. Arsenault and Wells, with projects stretch­ing from the Pa­cific to the Mediter­ranean, are us­ing their geeky in­stincts and op­er­a­tional know-how to sur­vive in an in­dus­try that is in­creas­ingly dom­i­nated by gi­ants.

Arsenault says he wants to dou­ble down and in­vest $500 mil­lion in real es­tate in 2017, claim­ing an out­size por­tion of a re­bound­ing mar­ket—and help­ing some other en­trepreneurial home­builders flour­ish too. The 90-em­ployee RCS acts solo or teams with other in­vestors and builders to con­struct its apart­ments, stand­alone homes, and va­ca­tion prop­er­ties. The com­pany has some $1.6 bil­lion in as­sets un­der man­age­ment (see “RCS’s En­trepreneurial Real Es­tate Em­pire,” op­po­site page). Though Arsenault will not dis­close to­tal rev­enue, he says it grew 50 per­cent last year and is grow­ing at 20 to 30 per­cent on a com­pound ba­sis. “We could dou­ble from here, no prob­lem,” he says. How? “I bor­row out­ra­geous amounts of money.”

He has $1.8 bil­lion of bank credit lines and is only half­way through them—and be­cause RCS has never de­faulted on a loan, Arsenault says, it’s ex­actly the rare type of big, prime bor­rower that banks are ea­ger to fund.

His com­pany isn’t mak­ing risky bets on com­plex CDOs or liar loan mort­gages. In­stead, it’s re­ly­ing on a coun­ter­in­tu­itive ap­proach to stay in the game. From his of­fice desk, Arsenault watches the macroe­co­nomic pic­ture, look­ing for op­por­tu­ni­ties his larger com­peti­tors have ig­nored or re­jected. “Our unique ap­proach is to fo­cus on the long-term,” he says. “That helps us see pat­terns that oth­ers miss.”

THIRTY YEARS AGO, the Cana­dian-born Arsenault was look­ing at very dif­fer­ent pat­terns. A molec­u­lar bi­ol­o­gist who fits right in with the gra­nola types of Boul­der, he was work­ing on his PhD in the late 1970s when he got dis­tracted by his sweet tooth. In his kitchen he con­cocted one of the na­tion’s first all-nat­u­ral frozen desserts, Moun­tain High Ice Cream. (He had a hard time sell­ing the ba­nana fla­vor be­cause it con­tained no yel­low dye.)

His ice cream ten­ure was short-lived. As big­ger com­pa­nies fol­lowed Arsenault into the nat­u­ral-foods scene, he even­tu­ally sold out to now- de­funct con­glom­er­ate Beatrice. “It was the fear of be­ing over­whelmed by the big boys com­ing in and then do­ing a good job of copy­ing us and putting us un­der,” he says. “Turns out that was com­pletely wrong. We sold the com­pany and they ceased to ex­ist.”

But sell­ing the ice cream com­pany al­lowed Arsenault to turn his hobby of in­vest­ing in com­mer­cial real es­tate into a full-time af­fair. “It was a time when real es­tate was id­iot-proof—and I was an id­iot,” he says. “So I didn’t re­ally know the busi­ness, but I had done quite well.”

Mean­while, Wells was lan­guish­ing in a busi­ness that might have di­rectly ben­e­fited from ice cream cus­tomers. In the 1980s, he was run­ning a “pretty fab­u­lous” den­tal prac­tice in the posh ski-re­sort com­mu­nity of Vail. There was just one prob­lem. He had reached a point at which hav­ing to fill one more mo­lar would have made him press the den­tal drill against his own skull and stomp on the pedal. “I couldn’t stand do­ing it,” he says. “And as a den­tist, you aren’t trained for any­thing else. Those skills just don’t trans­fer.”

He moved to Den­ver to take up real es­tate and got a com­mer­cial bro­ker’s li­cense. One Sun­day af­ter­noon in 1992, he de­cided to cold call one of the known buy­ers in the mar­ket. Arsenault picked up the phone, and Wells kept him talk­ing for more than two hours. While Arsenault had been buy­ing crappy real es­tate, at least he was buy­ing. Most in­vestors weren’t, af­ter a real es­tate crash in the late 1980s tied to the col­lapse of the sav­ings and loan in­dus­try.

“Most bro­kers are ped­dling some­thing,” says Arsenault. “So there’s al­ways a dis­con­nect be­tween what the cus­tomer needs and what they’ve got to ped­dle. And Peter didn’t have that at­ti­tude. He learned who we are, what we were good at.” What Arsenault wasn’t par­tic­u­larly good at was man­ag­ing the prop­er­ties he bought; Wells looked at one of his build­ings in Boul­der and quickly dis­cov­ered that half the ten­ants weren’t pay­ing rent.

In 1995, Wells heard from the owner of three Den­ver con­do­minium apart­ment build­ings he’d pur­chased from the fed­eral gov­ern­ment, ca­su­al­ties of the S&L cri­sis. The owner wanted out. Wells was skep­ti­cal at first: “I thought, ‘Who in the world am I go­ing to sell this to?’ Then I thought, ‘What the hell—why don’t I do it?’ ”

He pitched Arsenault, who ran the num­bers on the build­ings and—sight un­seen—agreed to go in with Wells. “He didn’t know any­thing about con­dos, and frankly nei­ther did I,” says Wells. Still, the pair man­aged to avoid ma­jor mis­takes, and re­al­ized they clicked as part­ners. As Wells re­calls, “We thought, ‘Well, that wasn’t ter­ri­ble. Let’s try it again.’ ”

It wasn’t all that easy. The pair barely man­aged to make money on their next deal—they did a poor mar­ket anal­y­sis, mis­cal­cu­lated the un­der­writ­ing, and scraped through with only a small profit—but they es­tab­lished an op­er­at­ing pat­tern that would serve them well for the next two decades as they ex­panded to nine other states. Wells would run the projects and make sure that bills got paid, while Arsenault would stay in­doors and look

for the un­der­ly­ing busi­ness op­por­tu­ni­ties.

Af­ter ini­tially stum­bling around the real es­tate busi­ness, the bi­ol­o­gist-turned-id­iot-in­vestor re­al­ized he could ap­ply his sci­en­tific train­ing to a dif­fer­ent kind of dis­ci­pline: macro­eco­nomics. Arsenault no longer wanted to in­vest in things he didn’t un­der­stand—a mis­take that many in the hous­ing in­dus­try would make in the run-up to the real es­tate crash.

“I’m pretty geeky. I like cy­cles, and I like un­der­stand­ing what hap­pens in cy­cles,” he says. “The ad­van­tage was that I was able to see the down­turn com­ing. If we had ex­panded into the crash, we would have been crushed.”

Years be­fore the crash, he be­gan an­a­lyz­ing all the data he could get his hands on, read­ing “widely and deeply”: re­ports from the St. Louis Fed, Fan­nie Mae, Har­vard’s Joint Cen­ter for Hous­ing Stud­ies, and the Or­gan­i­sa­tion for Eco­nomic Co­op­er­a­tion and De­vel­op­ment. And he tapped in­dus­try ex­perts, in­clud­ing Liang Peng at the Univer­sity of Colorado and Greg Lipp­mann, the mort­gage trader made fa­mous by The Big Short for pre­dict­ing (and win­ning huge bets on) the hous­ing cri­sis.

Arsenault was see­ing warn­ing signs, the big­gest be­ing that too many peo­ple were in houses they couldn’t af­ford. The home­own­er­ship rate of 69 per­cent was 2 points too high, he fig­ured, mean­ing that 2.25 mil­lion houses were in the wrong hands. Once prices be­gan to fall, he pre­dicted that mort­gages un­der­writ­ten at high val­ues would start de­fault­ing, caus­ing a cas­cade of fore­closed homes to hit the mar­ket in 2008. “Hous­ing Causes a Hard Land­ing” was the ti­tle of one in­ter­nal pa­per he wrote in 2006.

Mean­while, Wells was find­ing sim­i­lar ev­i­dence in the field. Take the con­dos that RCS was build­ing: A 3 per­cent down pay­ment was stan­dard at the time, but more peo­ple started show­ing up with no money down, tak­ing ad­van­tage of var­i­ous gov­ern­ment- and de­vel­oper-funded pro­grams de­signed to en­cour­age home­own­er­ship. Then there was the out­size de­mand: In 2005, a day be­fore RCS started sell­ing condo units for a build­ing in Tuc­son, Wells stopped by the sales of­fice and was alarmed to find buy­ers al­ready lined up around the block.

The pair con­sid­ered it “a sign from God,” says Arsenault. They agreed to start liq­ui­dat­ing as fast as they could, ul­ti­mately sell­ing about 85 per­cent of RCS’s res­i­den­tial prop­er­ties.

For the next two years, Arsenault and Wells waited out the worst of the hous­ing bust over­seas. In Spain, which had suf­fered an even worse down­turn than the U.S., they scooped up dis­tressed water­front prop­er­ties that they could re­sell to in­vestors look­ing for cheap va­ca­tion homes. By 2009, while much of the U.S. was still reel­ing from the Great Re­ces­sion, Arsenault and Wells started see­ing new op­por­tu­ni­ties. And, they re­al­ized, they were among the few in­de­pen­dent play­ers poised to take ad­van­tage of a com­ing real es­tate re­bound.

SINCE ARSENAULT AND WELLS started rein­vest­ing in the U.S. hous­ing mar­ket, they’ve counted on two di­verg­ing trends: a com­ing surge in de­mand for new homes, and a plum­met in the num­ber of en­trepreneurs who can build them.

While home­own­er­ship rates are widely de­clin­ing, more than 62 per­cent of Amer­i­cans re­main own­ers. The 84 mil­lion– strong Mil­len­nial gen­er­a­tion has the po­ten­tial to be­come the largest home-buy­ing gen­er­a­tion ever. Mean­while, their par­ents in the Baby Boomer gen­er­a­tion—the na­tion’s se­cond largest at 80 mil­lion, and by far the rich­est Amer­i­can gen­er­a­tion ever—are fast be­com­ing step- down buy­ers, trad­ing in their larger homes for smaller pads, as they progress through to adult com­mu­ni­ties and as­sisted liv­ing.

RCS is bet­ting on what it, and econ­o­mists gen­er­ally, see as the next hous­ing boom, driven by a cy­cle of new de­mo­graphic and econo­met­ric forces. “We be­lieve fa­vor­able de­mo­graph­ics and the re­al­iza­tion of pent-up de­mand will drive a strong up­ward tra­jec­tory in hous­ing de­mand through 2020,” Morn­ingstar an­a­lyst Brian Bernard wrote in a July re­port on Len­nar Cor­po­ra­tion, one of the big pub­lic home­builders. (Morn­ingstar and Inc. share an owner.)

Arsenault calls it a “sil­ver age” of hous­ing—sil­ver, be­cause there are still enough un­knowns in the global and do­mes­tic economies to pro­duce a re­ces­sion at some point, but con­di­tions are re­bound­ing suf­fi­ciently to have his firm pre­par­ing for a surge in de­mand and in­vest­ing in once- dis­tressed mar­kets like Las Ve­gas. House­hold for­ma­tions are grow­ing at 1.3 mil­lion to 1.4 mil­lion an­nu­ally, ac­cord­ing to re­cent Cen­sus Bureau fig­ures; new con­struc­tion is at 700,000 to 800,000 units an­nu­ally; throw in de­mo­li­tion of old hous­ing stock, and you come up short some 700,000 units.

“If you take those long-term de­mo­graph­ics, then an ab­nor­mally large num­ber of peo­ple are mak­ing de­ci­sions around home buy­ing,” says Jonathan Smoke, chief econ­o­mist for Real­tor.com. “At the very least, we are go­ing to have above-av­er­age his­tor­i­cal num­bers be­ing re­quired on the new con­struc­tion front.”

This hous­ing short­age isn’t re­stricted to the fa­mously ridicu­lous San Fran­cisco mar­ket. Go up the coast to Ta­coma, Washington, where RCS has sev­eral condo projects, and home prices are up 25 per­cent in two years. Or travel to rapidly grow­ing Jack­sonville, Florida, near where RCS is build­ing homes; the city’s av­er­age prop­erty sells in 51 days, nearly 30 per­cent faster than the na­tional av­er­age, ac­cord­ing to Real­tor.com.

What’s miss­ing from the equa­tion are lo­cal home­builders. Prior to the melt­down, the top 200 builders con­trolled just 43 per­cent of the home­build­ing mar­ket, ac­cord­ing to Builder, an in­dus­try trade pub­li­ca­tion. In many com­mu­ni­ties, lo­cal builders tied to lo­cal banks did the bulk of the home- con­struc­tion busi­ness. But af­ter the re­ces­sion, many such en­trepreneurs never got a chance to re­boot. They had no fund­ing to do so: The melt­down wiped out na­tional sub­prime lenders such as Washington Mu­tual and hun­dreds of lo­cal banks that had large real es­tate port­fo­lios. For many sur­viv­ing lenders, real es­tate be­came ra­dioac­tive.

That’s where RCS and its spigot of fi­nanc­ing comes in. By sur­viv­ing in this con­sol­i­dated mar­ket, Arsenault and Wells are also boost­ing the prospects of other real es­tate en­trepreneurs. Take Bob Com­stock, CEO of Com­stock Homes and a vet­eran Cal­i­for­nia de­vel­oper-builder, who says the vast ma­jor­ity of the builders in his state were vic­tims of the die-off.

“I WAS ABLE TO SEE THE DOWN­TURN COM­ING,” SAYS ARSENAULT. “IF WE HAD EX­PANDED INTO THE CRASH, WE WOULD HAVE BEEN CRUSHED.”

In 2011, Com­stock al­most be­came one of them: His bankers told him to get lost, right as he was putting to­gether two projects with more than 600 units. But af­ter a six-month search to find re­place­ment fi­nanc­ing, Com­stock landed RCS.

“Marcel and I part­nered up on fin­ish­ing off two projects, which turned out to be a grand slam,” re­calls Com­stock, who now has 14 ac­tive projects with RCS. “And then we be­came friends,” he adds. “We’re both a lit­tle bit odd, but he sees things dif­fer­ently.”

FLUSH WITH CASH BY 2011, RCS be­gan to ex­pand its port­fo­lio again, but there was a ma­jor ob­sta­cle: Where was it go­ing to find the builders who were good enough to ex­e­cute its plans? Some de­vel­op­ers had run into road­blocks with fi­nanc­ing, but many oth­ers were just bad at run­ning a busi­ness.

Arsenault and Wells had had sev­eral un­happy ex­pe­ri­ences. For ex­am­ple, in Spain: Not know­ing lo­cal con­tract law or build­ing codes, RCS had ex­pected to make some mis­takes that would cost it along the way. It did. Span­ish banks, for in­stance, did some real es­tate de­vel­op­ment them­selves. (Imag­ine ask­ing for a con­struc­tion loan from a com­peti­tor.) The Amer­i­cans also dis­cov­ered that “ev­ery­body still wants a ‘com­mis­sion,’ ” says Wells. Their ini­tial in­vest­ment in a lo­cal builder went south when the firm turned out to be tak­ing kickbacks from con­trac­tors.

“The deals go wrong around the peo­ple,” says Arsenault. “So the idea is to try to hand­i­cap the part­ner.” He set out to de­velop a for­mula for a model en­tre­pre­neur, just as you might for a model home. It starts with trans­parency: RCS de­signed a dis­clo­sure form that’s some­where be­tween a job ap­pli­ca­tion and an FBI se­cu­rity clear­ance. (See “How This Real Es­tate Com­pany De­mands Rad­i­cal Trans­parency,” page 70.)

Be­sides de­mand­ing trans­parency, RCS looks for signs of weak­ness. For ex­am­ple, it avoids in­vest­ing in those who come to the ta­ble with cheap cap­i­tal. That could in­vite am­a­teurs or dab­blers. It also shuns those who are too di­ver­si­fied to pay at­ten­tion to the project.

On the other hand, the com­pany takes cal­cu­lated risks on un­der­val­ued en­trepreneurs. In the case of a lux­ury condo project in Dal­las–Fort Worth, RCS de­cided to work with Realty Cap­i­tal, an es­tab­lished lo­cal builder that couldn’t find a lender for its am­bi­tious project. “They couldn’t get a 40 or 50 mil­lion– dol­lar loan,” says Wells. “But we were im­pressed by sev­eral things, in­clud­ing the num­ber of pre­sales.”

Realty Cap­i­tal also had no ex­pe­ri­ence in build­ing con­dos, and the sub­ur­ban lo­ca­tion was a red flag. “We were turned down by dozens of peo­ple for fi­nanc­ing,” says Richard Myers, a man­ag­ing di­rec­tor of Realty. “RCS was able to get be­yond the con­ven­tional think­ing to ‘maybe there’s a mar­ket here.’ ” RCS fig­ured that Realty met 60 per­cent of its re­quire­ments—but what Myers’s com­pany lacked, RCS could sup­ply. “There’s just so much that goes into a condo build­ing, whether it’s de­sign or work­ing with home­own­ers as­so­ci­a­tions, that they just haven’t done,” says Wells. “We’re able to con­trib­ute greatly.”

Arsenault as­serts that ev­ery en­tre­pre­neur in a part­ner­ship has a dis­torted re­al­ity field, in­clud­ing him. One of the big­gest dis­tor­tions is op­ti­mism, which to an en­tre­pre­neur can be the same as breath­ing. Learn­ing to hold your breath is a key to suc­cess, he says: “In real es­tate, ‘go’ will get you into trou­ble if you’re go­ing at the wrong time. You gotta have ‘stop’ and ‘re­verse’ and ‘get the hell out.’ ” Or as Wells puts it, “We al­ways look at the down­side on ev­ery deal. We look at that 10 times more dili­gently than the up­side.”

This may mean pass­ing up some po­ten­tially lu­cra­tive op­por­tu­ni­ties. Even as RCS and its part­ners plunge ever more money into sin­gle-fam­ily hous­ing, Arsenault’s macro­mod­el­ing is telling him that the cy­cle is be­com­ing less fa­vor­able for apart­ments, es­pe­cially in his home mar­ket of Den­ver. So he’s tak­ing a pass lo­cally for now.

Arsenault and Wells are too ex­pe­ri­enced to think there won’t be any hic­cups in the real es­tate mar­ket over the next decade. Arsenault’s best guess is for a mild re­ces­sion in 2019 as growth slack­ens. Iron­i­cally, the fact that a Repub­li­can real es­tate de­vel­oper is now pres­i­dent doesn’t nec­es­sar­ily bode well for the in­dus­try: Mort­gage rates are al­ready ris­ing, and the Fed has sig­naled its in­ten­tion to raise in­ter­est rates again this year. But there’s less risk of an­other melt­down, be­cause sub­prime buy­ers are un­able to get mort­gages. Bar­ring that, if Arsenault’s early-warn­ing sys­tem re­mains tuned, they’d be among the first to exit.

Ever the con­trar­ian, Arsenault is now sniff­ing around the beaten-down oil patch. In places like Hous­ton, Cal­gary, Al­berta, and Ok­la­homa City, where of­fice vacancy rates ap­proach 30 per­cent, “we’ll be look­ing for part­ners to buy res­i­den­tial and of­fice.” He’s even con­sid­er­ing di­rectly in­vest­ing in oil and gas prop­er­ties, be­cause his macro anal­y­sis sees a cy­cle change that will push oil up to near $60 a bar­rel within a cou­ple of years.

“As you grow, things change. Your en­vi­ron­ment changes, the scale changes, your prob­lems change, and each time they change, you have a new learn­ing curve,” says Arsenault. “That’s one of the rea­sons why I love the busi­ness.”

Then again, once you learn how to ride a busi­ness cy­cle, you never for­get.

THE LONG VIEW Arsenault and Wells have built a 20-year part­ner­ship in­vest­ing in and con­struct­ing apart­ments, town­houses, and re­sorts like the Cor­ri­ente Con­dos in Scotts­dale, Ari­zona (be­low). Com­pleted in 2015, it boasts eight build­ings with a to­tal of...

THE FI­NANCE WHIZ RCS founder Marcel Arsenault went from mak­ing all-nat­u­ral ice cream to run­ning a real es­tate com­pany with a $1.6 bil­lion port­fo­lio.

MR. OUT­SIDE Peter Wells, a for­mer den­tist and Marcel Arsenault’s long­time part­ner, trav­els the coun­try—and some­times the world—to over­see RCS con­struc­tion projects.

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