Both Sides of the Table Book Discussion with Paul Shannon | The AAA Storage Podcast #47

Paul Shannon has been a general partner, a fund manager, and a limited partner in nearly 45 private real estate deals across 10 years. In this episode, Paul Bennett sits down with him to discuss his new book, Both Sides of the Table, a practical guide to passive investing built from all three perspectives.

They cover the difference between thinking like an investor and thinking like a consumer, why the pro forma is rarely the outcome, how to read the market cycle, how to evaluate a sponsor's character and alignment, and how IRR partitioning and yield on cost can reveal when a value-add deal carries development-level risk.

Paul Shannon closes with his core advice for LPs: lead with risk, not returns, and build a diversified portfolio over time.

Get the book: Both Sides of the Table by Paul Shannon: https://www.amazon.com/Both-Sides-Table-Paul-Shannon/dp/B0H568RKLJ/

Ready to talk about your investment strategy? Reach out at aaastorageinvestments.com

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Chapters
[00:00] Introduction: Paul Bennett welcomes Paul Shannon, author of Both Sides of the Table.
[01:49] Why This Book Is Different: Moving from the principles of passive investing to the practice.
[03:23] Three Seats at the Table: What the LP, GP, and fund manager seats each taught Paul about risk.
[07:31] Investor vs. Consumer: Urgency marketing, the joy of missing out, and the allocator mindset.
[11:08] Second-Level Thinking: Real diversification, personal goals, and why passive investing isn't passive.
[14:22] Getting the Market on Your Side: The market-cycle pendulum and being paid enough for the risk.
[22:16] Character Over Track Record: The worst-deal question, LP empathy, and 50 questions for sponsors.
[27:55] Skin in the Game: Why meaningful sponsor co-investment creates alignment.
[31:02] Value-Add vs. Development: IRR partitioning, yield on cost, and development spread.
[38:30] Lead With Risk, Not Returns: Paul's hopes for readers and how to build a diversified LP portfolio.

Creators and Guests

Host

Paul Bennett

Managing Director at AAA Storage

What is The AAA Storage Podcast?

Investing in self storage gives you the fundamentals and growth you need to grow your portfolio. But skip the opportunities from golf buddies and gurus—invest in a real track record. Started by John Muhich in 1993, AAA Storage has delivered 19% IRR across 90 deals, totaling $450M in exits. Listen to our expert insights on investing from the AAA Storage team. See more at aaastorageinvestments.com.

Paul S: I've never once had a deal
that's actually hit the pro forma.

It's either underperformed
or overperformed.

Passive investing isn't
even really passive.

You have to be actively involved
in evaluating these deals.

I wanna know about their
worst deal, for one.

That's a question I'm gonna ask about,
and not their best deal, because how

they communicate and how they talk
about failure is much more relevant

to me than successes they've had.

Ideally, you want somebody who's
more willing to break their

own arm than lose your money.

I would challenge everybody
to lead with risk.

Welcome to the AAA storage podcast,
your integrated real estate and

development partner, exploring all
things, self storage investing to

bring you diversified success.

Let's dive in.

Paul: Hello, everybody.

Welcome to the AAA Storage podcast.

I am really fortunate to have
Paul Shannon, um, the author of

Both Sides of the Table and a
experienced investor with us today.

And we're gonna walk through some
questions that come out of Paul's

book, Both Sides of the Table, uh,
with the objective of, hopefully, as

a listener, you're gonna leave this
podcast having a better understanding

of how to be successful as a passive
investor, uh, in today's market.

Uh, Paul, just super excited to
have you here and super excited to

talk about the book that's, what,
been out about thirty days now?

Paul S: Yeah, Paul, thanks
for having me back on.

It's great to see you, and, uh, looking
forward to having our conversation today.

Yeah, it launched on June 29th, so
it's been a bit over a month now, and,

Paul: Yeah.

Paul S: what a whirlwind

Paul: Yeah.

Uh, yeah, I bet it has been.

Well, I, I gotta tell you before
we get started, couple things.

Number one, I have never seen a more
comprehensive resource on investing

in real estate that, that comes from
so many different perspectives and

dives deep in a lot of, you know,
fairly technical and important areas.

I w- I was just blown away.

And secondly, um, we bought books for
all of our executive team, uh, because

th- there's a picture that you paint
in the book, I know that really wasn't

your intent, but there's a picture
that you paint of what a sponsor should

look like, uh, as a, as a sponsor
of passive real estate investments.

And, uh, I felt like when I read
the book that that picture was so

clear, it was something I wanted our
team to add to their vision of what

we're working to become every day.

And so it's been a super great resource
for us, and I just really appreciate

the time and effort you put into it.

Um,

Paul S: Yeah, that's
the ultimate compliment.

Appreciate it

Paul: Yeah, well, uh,
I, I mean it sincerely.

We're gonna dive in.

One of the things I noticed early
in the book is y- you made the

comment, I think it was on page 24,
you said, "This book is different."

Talk about why Both Sides of the
Table is different and, uh, and, and

what were you trying to accomplish
when you, when you wrote this book?

Paul S: Well, I think it's
different because there wasn't

anything really out there like it.

And I know that when I first started
investing passively, if I had a resource

like this, it would have been invaluable
to me and helped me avoid some of the

mistakes that I made along my journey.

There's a lot of stuff out there that
talks about, I'll call them the principles

of passive investing, the nuts and bolts,
the formulas that go into evaluating

underwriting metrics, for example.

But there's really not any books
out there until this book, I feel,

that really prescribe and help
you kind of get counseling on the

practice of passive investing.

So it's much more nuanced, it's subtle,
uh, but it comes from experience that

I've had sitting in three different
seats, that being the general partner

seat, the fund manager seat, and
being an LP myself, which I have

the most experience in the latter.

So kinda combining all those different
perspectives and seeing things from

different angles, uh, really takes
it from just principles and sort of

textbook-type style writing to more, "Hey,
this is how to apply what you learn in a

textbook, and this is what you may come
across, and some of the things you can

get tripped up on or even tricked into,
uh, as you become a passive investor."

Paul: Yeah.

Uh, uh, uh, talk for a minute about…

You, you mentioned the three…

For, for our listeners, break down
the difference between being a general

partner, a fund manager, and an LP.

That one's a little bit obvious.

And, and then let us know which of those
three perspectives change the way you view

investments and opportunities the most

Paul S: Sure.

Uh, so as a limited partner, as an
LP, uh, you know, I think what…

If I could sum it up into one word,
what I learned the most from being an

LP, having invested in now almost 45
deals across 10 different years and

different asset classes, is vulnerability.

And that meaning that you have
some control on the front end, of

course, in deciding whether or not
the investment meets your investment

objectives, your risk tolerance, and
how much you're willing to allocate

to that specific deal if you are
interested enough to get that far.

But once you wire that money, you're
really at the mercy of the sponsor

at that point, and these are illiquid
assets, so it's not like you can go

onto your Fidelity portal and click
sell and liquidate when you feel,

like, a little uncomfortable, right?

So you're locked in for five,
seven, 10 years, maybe even longer.

So the decision carries a lot of
weight on the front end, and that's

the vulnerable part is, like, once you
click send on that wire, you're pretty

much, your decision's been made and
you're along for the ride at that point.

So y- you come to learn things about
how sponsors communicate good and bad

news, what kind of reporting you get.

Uh, you see business plans that
go on track or maybe steer off

track a little bit at, on occasion.

What I've found is that you can
evaluate pro formas and underwriting

and character of sponsors, et cetera,
but I've never once had a deal

that's actually hit the pro forma.

It's either underperformed
or overperformed.

So, uh, the pro forma is really,
uh, hopefully it's rendered useless.

There's enough margin of safety
in the deal where you, you feel

like the outcome's gonna be solid.

Uh, but you are vulnerable as an LP.

Now, as a, as a general partner and
a fund manager, two different seats,

but both on the same side of the
table, you're a fiduciary, right?

So in these roles, you are
the orchestrator of the deal.

You're actually the one that's going to
be executing the business plan as a GP.

And from the GP seat,
I learned operations.

I learned how tempting it can be to take
an underwriting file and manipulate it

to make it say what I'd like it to say.

Um, I, I learned that business plans are,
are very fluid and you have to be, uh,

sort of on top of those business plans
at all times 'cause you're relying on

third-party vendors and construction or
re- renovations, et cetera, et cetera.

And then as a fund manager I, I
waited last to tell you this one

because I, I think this answers your
question, what I learned the most.

I think it's as a fund manager,
and ironically, as a fund manager,

kind of a middleman, because you're
taking capital and investing it from

limited partners into somebody else's
deal, into another sponsor's deal.

So it taught me how to evaluate at scale,
uh, looking at so many different asset

classes, so many different types of
deals, but it also taught me a different

level of fiduciary responsibility,
knowing that this isn't my money.

You know, I'm almost investing as
an LP, but it's not my capital.

So if it were my capital and I'm
investing as a limited partner,

I might take some chances.

I might take some risks that other
people might be less comfortable

with or not comfortable at all with.

But as a fiduciary and being a middleman
fund manager that's taking an LP position,

if I'm going to invest 30, 40 other
people's capital into a deal, I better

know where all the risks are hiding.

I better understand the character
of the track record and the business

plan and know the legal language and
what can arise down the road five

years from now if there's a dispute
or disagreement, et cetera, et cetera.

So the weight of that responsibility and
that decision to be able to look into

a mirror and say, as an operator, "Hey,
if something goes wrong, I know what,

exactly what it is, and I'm going to be
able to communicate it to my investors."

As a fund manager, if something goes
wrong, you're on-- you could be on a

need to know basis with that sponsor,
and you might not have all the facts.

So you really have to be confident in that
deal and that person that's running it

Paul: Uh, that makes a ton of sense, Paul.

It, the, the, the, the role as a
fund manager really encompasses parts

of the dynamic of all three, right?

It, it sort of is the, the crucible.

Um, that makes perfect sense.

One of the things that you talked about in
chapter three, we're gonna switch gears.

We're gonna jump around a lot today.

Really, uh, it…

There's so much information here, A, we'll
never cover it all, and B, we- I wind

up jumping around with my questions sort
of from one set of topics to another.

But this kinda flips to the
investor and our listeners.

You talk about, uh, uh,
their journey as investors.

You talk about the difference between
being an investor and a consumer

in chapter three of the book.

I thought that was really an interesting
way to talk about the different mindsets.

Tell our listeners a little bit a-
a- about the difference between the

two and why you think it's important

Paul S: Sure.

Well, you know, I call it the syndication
marketing engine in the book, and if

you think about what defines that, as
investors, you've probably seen glossy

pitch decks, fancy webinars, urgency
language, like only a few spots remain

or, you know, most of the capital's been
raised, there's room for another two

hundred thousand, et cetera, et cetera.

These are all tactics that the
sponsor's using to try to get

you to act on a short fuse.

And it's the same type of
marketing strategy that is used

in consumer marketing, and it's
used because it works, right?

People are feeling like, "Oh, I'm gonna
miss out," the fear of missing out.

Well, I would argue that you should have
the joy of missing out, and I steal that

from a, a book that I just recently read.

Because there's so many different choices,
you have to choose something, and there's

always gonna be alternatives that you
wish you had, but you can't do everything.

So you want to avoid the feeling
of having to make a decision

on a short fuse, for one.

Uh, but I think when I distinguish between
the consumer and the allocator, uh, or

investor, it's that the consumer thinks
of, "What can I make on this deal?"

They see the floss- the,
the glossy metrics, right?

They see IRR.

"19%?

Wow, that sounds fantastic."

It sure does, right?

But what the allocator is
thinking about is, what is the

margin of safety of this deal?

What's the reality of that
19% IRR coming to fruition?

What are the inputs in the
underwriting file that allow

that 19% IRR come to fruition?

Are those realistic?

That's the allocator mindset.

The consumer believes that the track
record is the track record, and they take

that as gospel, where the allocator might
look at things differently and say, "Hey,

when has this operator been in business?

Were they-- did they catch, you know,
major tailwinds between 2014 and 2020?"

That's a little bit different than
somebody that's been along or, or a

company that's been around as long as
AAA Self Storage for 30 years, right?

That's a different level of track record.

The consumer shops, quote unquote, based
on that marketing urgency we talked about.

They've got cash burning a hole in
their, their pocket, for example,

and they need a place to store it.

They need a place to put it to work.

Where the allocator looks at where we are
in the mar-market cycle and toggles their

aggression between risk on and risk off,
depending on what factors are at play.

Sometimes the best policy is to
not act at all, is to sit there

and say, "Hey, this doesn't look
like the right time to invest."

Even though it's a great sponsor and
a decent deal, uh, you know, to have a

lot of headwinds coming at you at full
force, gale force winds, that doesn't

lead to a recipe for success many times.

So, uh, you know, thinking more like
an investor just means being patient

and questioning a lot of things versus
just accepting things at face value.

Paul: Yeah.

Yeah, that's so, that's so pro- it's
so important and, and, uh, you know, my

dad told me long, long, long time ago
there's never one of anything, right?

So the urgency language, y- y-
there's not one great deal out there.

Uh, there are lots of great deals
and, uh, and, and so not, not being

pushed to make a decision quickly
and taking the perspective you just

talked about, um, is so critical
to long-term success in our world.

You took the thought of the difference
between an investor and a consumer to

a di- even a higher level in the book.

You talk about being a
second level thinker.

What, for our listeners, what is a, what
is, what does a second level thinker look

like and, and what are they focused on,
and how are they thinking differently

than the average investor or maybe
that consumer, quote unquote, investor?

Paul S: Well, it ties right into
what we were just talking about.

I think it's looking at
things from a little bit more

of a skeptical lens, right?

And really understanding what
it is that you're investing in.

I think a lot of investors make the
mistake that, you know, let's say they

have a couple million dollars in the
stock market, they're tired of the

volatility, and they want a little bit
more diversification in their portfolio.

So they look to passive investing, and
they write a $100,000 check to a single

asset multifamily deal, for example.

Well, did they really get diversification
in that sense that they sold a

basket of 500 stocks in an S&P
500 mutual fund for a single asset

with a single company running it?

Uh, I would argue no.

So, uh, I think it's just looking
at things a little bit more

critically and deciding what it
is that you want out of not just

investing, but out of life, right?

And then reverse engineering how money
can be a tool for you and how investing

leads into that, of course, and kind
of looking at where you wanna be in,

say, 10 years or 20 years, and then
reverse engineering backwards from there

to come up with a plan to get there.

And I think if you do that intentional
exercise, you'll start to realize, like,

"Hey, this, this deal isn't right for me,"
uh, or, "This is the right deal for me."

It's not about appreciation.

It's more about cash flow, if you're
somebody that is looking to kind of

escape the, the rat race, for example.

But if you're a,

Paul: Yeah

Paul S: if you're a, a doctor
making, you know, half a million

dollars a year and you're looking
for diversification, you may have

a different risk tolerance for one.

You may be looking for more
appreciation than cash flow.

You've got plenty of cash flow.

You don't need that right now.

So I think it's just being more
intentional about what it is you want

out of investing, and then looking to
passive investing in real estate as an

opportunity to fill that void, but being
very careful about how you do it and, and

looking at it from a critical lens and
being skeptical about what you see and

what you hear and what an offering can…

You know, in the most basic
sense, you hear financial freedom.

You hear that word thrown around or that
phrase thrown around quite a bit, and I

think it's, it's marketing jargon, right?

This is not, you know, passive
investing isn't even really passive.

You have to be actively involved in
evaluating these deals and looking

at them through that skeptical lens.

So I know that's sort of a vague
answer, but it really encompasses

the whole kind of theory behind this,
that is, um, you know, be a student

of the game and be on top of this
stuff and, and have a skeptical eye.

Paul: Yeah.

W- and I'm not gonna stay here much
longer, but, uh, y- there's a place in

the book where you talk about sponsors
in their marketing talking about building

generational wealth, and you sort of, I, I
think really w- w- wisely said, you know,

"If you wanna build generational wealth,
go own real estate d- directly, uh,

and own it over a long period of time."

And, you know, you're not gonna
build generational wealth th-

through passive investing.

Um, but you can increase the overall
returns and, and reduce the volatility in

your portfolio over time i- in your effort
to build wealth, but it's not, it's not

a general weal- generational wealth play.

I thought that was super interesting.

I, I'm gonna s- stay on information that's
hopefully helpful to our listeners, but,

uh, change direction just a little bit.

At one point in the book you talk
about … There's a whole chapter

called Getting the Market on Your Side.

Um, and it was really interesting to me.

We've done, on this podcast recently,
uh, a series on commercial real estate

investing, and talking about the different
sectors and the different factors that

affect them, and thinking about when
you're gonna make an investment, the

context that you're investing in, and
does that context have the right demand

drivers and dynamics for a multifamily
deal, for example, to be successful.

You really cover that
really well in the book.

Talk for, just for a minute at what it
means to have the market on your side and,

um, and, and, you know, the, the top f-
or three things that people need to look

at or know or understand to get that box
checked in their whole investment process.

Paul S: Sure.

Well, I think it's, it's
multilayered, right?

Of course, when you say get the
market on your side, are we talking

about the geographic market?

Because you certainly wanna have
a handle on population, migration

trends, demand, supply and
demand, what's happening locally.

Um, you wanna have an idea of the
sponsor and their track record and

their capability to get the deal done.

That certainly plays into
the outcome of the deal.

But there's also the macro
picture, and I think that may

be where you're going with this.

And we talked about tailwinds and
headwinds a minute ago, but I almost,

I almost ask my que- my question
myself is, should I be going in

the other direction from the herd?

And more often, the answer is yes.

Uh, one of the, one of the books that
I read that left a big mark on me was

Mastering the Market Cycle by Howard
Marks, and he talks about market swings.

Uh, and there's almost like a pendulum,
to use an analogy, where that pendulum is

swinging between euphoria and fear back
and forth, and it never really stops.

Uh, but there are certain periods in
time when it's more tilted towards one

side of the pendulum than the other.

So if you think about the euphoria
stage at market peaks, this is, you

know, these are periods of time where
cap rate spreads are compressed, uh,

leverage is cheap and abundant, low
interest rates, everyone's chasing deals,

sponsors are projecting 20 plus IRRs.

To me, that's when you start
to question things where, "Hey,

everything seems so ripe right now.

Maybe I should be getting defensive."

So in those scenarios, I'm
actually going the other way.

I'm tilting towards investing in
debt, moving down the capital stack.

I'm investing in more stabilized assets
than value add deals, lower leverage.

Uh, I'm deploying less capital as well
and kind of holding more cash to be

opportunistic for when that pendulum
swings back in the other direction.

On the other, other side of the
table, when there's, uh, no pun

intended, uh, at market troughs, uh,
this is a different scenario, right?

This is where cap rate spreads
widen, sentiment is really,

really down and depressed.

Uh, lending is much more conservative.

You see that from lenders.

Assets have been repriced, so
there's been a decline in values,

and you're hearing a lot of bad news,
uh, in, in publications on the web.

Uh, that's when you actually lean
in, in my opinion, uh, when you

can actually get a margin of safety
and there's a better entry point.

There's wider risk premiums.

So, uh, it's not necessarily a
question of, you know, market timing.

Uh, that's not what you're
trying to accomplish here.

But the question you should be
asking is, am I adequately being

compensated for the risk I'm taking?

And I think most investors
get that backwards.

And it's not just about the market.

It's sometimes that they don't necessarily
understand their own risk tolerance,

which I think is a big factor as well

Paul: Yeah.

no, I, I, I totally agree.

And, uh, yeah, I think it was Warren
Buffett who said, "Be greedy when

others are fearful and fearful when
others are greedy," which is sort

of the contrarian view of the world.

But I think it's also about context.

Um, example, hospitality does better in
a, in an economy that is robust, right?

People travel more.

Um, they, they, they're, you know, they
have more dollars to spend on, on, on

leisure travel and that type of thing.

Um, doesn't perform very well in
a, in a down, in a sort of less

robust economic environment.

on the other side, um, very well
in a, in a more difficult economy.

And u- understand that's just two
little sort of quick examples, but

there are a list of demand drivers
and things that impact the value

and performance of different types.

And they're all different.

Multifamily moves different than
self-storage, which moves different

than hospitality, which moves
different than They, they all thrive

in slightly different environments.

So understanding the context,
the market, um, and the timing,

uh, makes a lot of sense.

And, um, it, it's also, uh, about
timing, but it's about watching to

see what's happening in the market.

Right now we've been through, like
multifamily and self-storage, a, a more

difficult period with some headwinds
since the, you know, post-COVID period.

But we're seeing occupancy and rates
stabilize, and we're seeing significant

amounts of institutional capital come
off the sidelines, which to me is a

confirming signal w- we're not gonna go
straight up from here, but we're bouncing

along the bottom and, and what's coming
next is a, is a good period in the cycle.

So watching those types of things
I think is what's important.

Paul S: 100%.

I was just gonna build on that 'cause I
think what you said was really important.

I think y- you don't necessarily
wanna get in too early and try to

catch a falling knife, but timing
the bottom is very, very difficult.

It's probably easier than real es- in real
estate than, say, the stock market, where

things move so quickly and irrationally.

Uh, real estate's a little bit more
rational, but I think, you know,

we've seen a decline in multifamily
in some markets of 30, 35%.

You know, 20% I think
is the national average.

If you are interested in investing
in apartment buildings, now is a much

better time than, say, 2022 when interest
rates were at zero, you know, and the

federal funds rate was, was positioned
to go up 'cause inflation was at 9%,

uh, and that was gonna put downward
pressure on all the people that were

still acquiring a floating rate debt.

So today, lenders are much more cautious.

You're probably gonna
go into fixed rate debt.

You've already seen a 20% decline.

If property values decline another
5%, let's say in the next one to

two years, and you've got a five
to seven-year business plan, do

you think you'll come out okay?

Probably.

So I'm not too worried about what happens
in the next six to 12 months necessarily,

'cause I'm not gonna sell that quickly.

So, um, I think you have to have
a longer time horizon in real

estate and look out to the future
and project a little bit farther

Paul: Yeah.

I, I'll never forget, one of the first
times we were together, you used that

phrase, "Catching a falling knife."

I have…

I've never forgotten it.

I, I, I steal it every now and then, so,

So let, let's switch gears and, and
for a minute and talk about still

information that's helpful for
our, our listening audience as they

are evaluating opportunities and,
and making investment decisions.

But what are the top three attributes…

Uh, you have a, a, a, a chapter in the
book called Character Over Track Record.

What are the top three, or maybe
there's, you know, four or five

attributes of a sponsor that matches
your profile of somebody that you want

to invest with and, and partner with?

Paul S: Good question.

Um, you used, uh, Warren Buffett's name
earlier in our conversation, and to

quote him, "We've never succeeded in
making a good deal with a bad person."

Uh, that is paramount, and I'd say
this is probably the hardest part about

choosing which sponsor to get involved
in, whether it's a, an organization

like AAA Self Storage or it's, you
know, a couple guys that are just

getting going that don't maybe have
the same track record, um, but have,

you know, good character in your eyes.

And how do you evaluate that character?

It's very, very difficult because you
don't know how people are going to react

when you know what hits the fan, right?

That's not the part of them that they
project, that they advertise on social

media, that they bring to a conversation
when you're having an introductory call.

So What you have to do is do your
best to evaluate that person, uh,

and, and try to predict what they
might do in that type of a scenario.

So how do I do that?

Well, I, I wanna know about
their worst deal, for one.

That's a question I'm gonna ask about,
and not their best deal, because how

they communicate and how they talk
about failure is much more relevant

to me than successes they've had.

'Cause there's-- it's easy to
cherry pick the good stuff, right?

How have they communicated bad news?

I think that's really important,
and, uh, I think it's okay to

ask for an example of that.

Like, if they've had a bad deal,
have they communicated along the

way with their investors how that
deal went sideways, and what they're

doing to rectify the situation?

Very important.

I think that should be shared
with a prospective investor.

I wanna know that, uh, a sponsor has
been an LP themselves, and I don't

mean just an LP in their own deals.

I mean an LP in other people's deals,
in other asset classes potentially.

Not necessarily as important that
they've had, you know, 50 positions

over time, because, you know,
everybody has a different level of,

you know, diversification desires
and liquidity needs, et cetera.

Uh, but I wanna know that they have
empathy for a situation, and that

they can understand what it's like
to be in that LP seat and know what

it's like to wire $50,000 and have no
control over the, the deal afterwards.

That to me is very important, because
that's sitting on the other side of the

table and understanding that perspective.

If they're going to serve those
investors the right way, they

need to have that perspective.

Paul: Yeah

Paul S: in the book I have a, a list of
50 questions that I would ask a group,

and it's hard to do it for an introductory
call for 30 minutes, but depending on the

situation, depending on the relationship
you may or may not have with that sponsor,

depending on what's most important for
that deal, these questions will help

you kinda navigate the conversation.

And one of the biggest mistakes I made
when I was first getting started investing

passively 10, 12 years ago was I let
the sponsor kinda dictate the call.

I let them tell me about their track
record, their deals, their market

thesis, why they like this market,
et cetera, et cetera, when, you know,

our 30 minutes was up, I really didn't
have a chance to get into the, the

nitty-gritty of what was important to me.

So

Paul: Yeah

Paul S: questions kinda help navigate,
uh, you know, whether it's questions

about the team, questions about their
track record, questions to ask them

about the underwriting, questions to
ask them about their risk tolerance.

It's all there.

So I think ultimately when it comes
to character, you, you do end up

having to take a chance on somebody.

Ideally, you want somebody who's
more willing to break their

own arm than lose your money.

That's the that's the goal, right?

Um, but it's, it's hard to
find, uh, more often than not.

And, uh, you know, I've been, I've been
in scenarios where, uh, there's been fraud

involved in a couple deals that I've been
in out of the 45 or so that I've invested,

and I talk about that in the book.

And it's hard to take away lessons from
that type of a scenario because You

can look at a deal and read the PPM and
the operating agreement, and if a deal

goes awry three or f- four years ago
and you look back at that information,

you can probably point to something
in there that said, "You know what?

I knew that when I signed up.

That was part of the risk."

'Cause no deal comes without
any risk at all, right?

Or maybe the, the deal was risky and
you put it in that little pocket of your

portfolio or say, "Hey, you know what?

I'm gonna roll the dice on this
one," and it's clear as day.

You know, "Hey, I, I knew
this could happen," right?

But when, when fraud happens and it's a
character issue, it's very challenging

to go back and say, "Boy, these
documents, they were, they were really

well-written, highlighted the risks,"
but they didn't, you know, tell you

about the person that could just take
the money out of the bank and run, right?

Paul: Yeah

Paul S: it comes down to trust
that needs to be extended.

I've extended trust too, too soon in
relationships in the past as a mistake.

Um, but, you know, in summary, to answer
your question, it's, it's a very, very

difficult thing to do, but I think the
more information you have, the more, uh,

you can understand about that sponsor's
character in difficult situations.

And I would add, too, the more of a
community you have, uh, to lean on

and ask questions to other investors
who may have already participated

in that said sponsor's deals, uh,
that, that's great feedback, right?

'Cause they've been there.

They've seen the communication.

They've had maybe some outcomes with
that sponsor that are either good or bad.

And if you can find, like, a community
like Passive Pockets, for example,

uh, or Best Ever or some of the other
communities of LPs that are out there,

those communities share information
and, uh, you know, you can find pretty

quickly if there's bad news on a sponsor,
and you can steer clear of that person

before you get your money invested.

Paul: Yeah.

Yeah.

That, uh…

Yeah, how, how important is alignment?

How, how important is a significant
co-invest with a sponsor?

I kn- I know that doesn't necessarily
run to character, but it's sort of

part of the whole picture of, am
I comfortable with this sponsor?

How important is that to you?

Paul S: I think it's huge.

I mean, I, you know, if they're not
willing to put their own money on the

line to invest in a deal that they
supposedly have conviction in, then

that right there is a misalignment.

It doesn't make sense, right?

If you really feel like you have
conviction towards something and

the outcome is probable, and these
returns that you're advertising

are, you know, likely, uh, you would
think that they would put them out

there, they would be likely, right?

Uh, then why wouldn't you put
your own money out there, Mr.

Sponsor?

That's what I'd be asking, or Mrs.

Sponsor.

Um, so I think skin in the game is
really important, and everybody has,

you know, different levels of, of
wealth, liquidity, resources, um, and

you can't expect them to, to go all
in on, on a single deal, of course.

But I think meaningful skin in the
game is, is important, and I've had…

You know, I had a conversation
with a young sponsor one time,

and they were really interested
in us participating as a fund.

And I knew right away that I, I couldn't
invest with this person because they were,

you know, not to, not to be an ageist, so
to speak, but they were in their mid-20s.

You know, they didn't have kids, and I
just didn't think their life experience

was that of someone that I would be
willing to, to risk my capital on

because I thought that they had a, a
different risk tolerance because they

were in a different stage of their life.

They just didn't have a chance yet.

Um, and, you know, that skin in the game
conversation came up, and he was honest.

He said, "I, you know, I can't
put any capital in because I'm not

in a position to at this point."

And I said, "Well, I'm not in a
position to invest because I couldn't

put my capital on the line for
somebody who, you know, wouldn't have

any consequence if they lost it."

So, um, you know, I think
that's really, really important.

I think skin in the game creates some
alignment and, you know, sometimes

sponsors will put in an acquisition fee.

They'll basically just recycle that fee
right back into the deal or part of it.

Uh, I don't think that's
necessarily as meaningful.

Uh, $50,000 to somebody who has a $200,000
net worth is a lot of money versus

somebody that might put a million dollars
in but has a $50 million net worth.

It's a different, it's a different story.

So, um, that's, you know, up to
the, uh, the eye of the beholder to

evaluate and see what makes sense.

But I think generically speaking,
skin in the game matters, yes.

Paul: Yeah.

I, I, I, the most successful investments
I've made as an LP have been with sponsors

who are actually investors themselves,
and they're simply leveraging other

people's capital to, to scale beyond what
they might be able to do on their own.

Um, and, and I think that's the mindset
we try to have at AAA Storage is we invest

heavily in every deal because we love
self-storage and small-bay industrial.

We believe in it.

Um, and the investor's capital
simply allows us to do more than

we could have done on our own.

Um, and I think that's the right
mindset that you wanna, that you

wanna see in a, in a sponsor.

Um, we're, we're starting
to run long here.

We're 31 minutes in, but I got
a couple more quick things.

You, you make a, a point at one pl-
at one place in the book that, uh, uh,

a value add deal's return is really
pretty much predicated on the eventual

sale, and the risk profile starts
to look comparable to development.

Do you think investors sometimes
automatically think development is,

is inherently more risky, um, than,
than investing in an existing asset

just 'cause the asset already exists?

Um, you know, if you're doing a, a value
add deal or, or buying an existing asset.

Talk about sort of how you think about
the difference between investing in

ground-up development and investing,
um, in an existing asset, be it a

value add or a core, core plus asset

Paul S: I think that investors do think
inherently that development deals are

riskier than value add, and on the whole,
they could be correct only in the sense

that A existing deal has cash flow, right?

So you're, you're getting cash flow
from day one, and if you're counting

on cash flow today versus appreciation
in the future, like you might be for

a development deal where it's not
gonna be completed for three years or

so, uh, then you do have some safety.

But I would challenge that, I think
to your point here, some of these

value add deals are, are described
in ways that are misleading.

And there's a couple of formulas that
I think investors can use to help them

decide, does this value add deal look
more like a development deal, or is

it actually, you know, a cash flowing
asset that just needs a cosmetic

upgrade to be taken to the next level
and it's, it's got a better margin

of safety than a development deal?

Um, one formula is IRR partitioning.

And IRR partitioning is useful in the
sense that you can see how much of the

overall returns are derived from cash flow
from operations versus the sale at exit.

So this is something you can
calculate if you're an investor,

if you get the underwriting file
and you see the whole period and

how cash flow lines up each year.

Uh, if a deal has, you know, most
of the, uh, appreciation coming

from the sale at exit, well, you
know, you'd have to look at the

exit cap to see if it was realistic.

You're, you're already basing your
assumptions on things that are, you

know, five years out, potentially
three years, five years out.

Um, so, you know, if, if cash flow
represents maybe 5% to 10% of the deal,

uh, of the total proceeds of the deal
at exit, uh, it starts to look a lot

more like a development deal, right?

And it's got some execution risks that
a development deal might not have,

because you've got probably an older
property that has old property problems,

where a newer property, you know, is
gonna be pretty maintenance free going

in for, call it seven or 10 years.

So, um, that's one thing.

And then taking a, a calculation from
the development world, I'm sure you guys

are very familiar with, is yield on cost
and the subsequent development spread.

These are typically formulas that
are used in development, hence

the name development spread.

But what yield on cost is,
essentially the, uh, total

project cost, uh, including, you
know, renovations, including…

Well, if it's ground up,
it's, it's everything, right?

It's, it's the cost of the land, it's the
cost of the horizontal construction, the

permitting, uh, putting up the property,
the vertical construction, all the soft

costs, the FF&E, the everything, right?

Uh, you can apply that same
formula to value add, right?

It's the cost of the property itself,
the existing structure, then the

renovation schedule, et cetera,
and the budget for that renovation,

closing costs, all this stuff.

So you take that total project
cost and What's the yield?

You know, the stabilized NOI essentially,
uh, based off of that total project cost,

and that gives you your yield on cost.

Now, the spread between the yield on
cost and the market cap rate for similar

product, whether that's stabilized
property that's value add or has been

a value add that's not stable, it's
older, or if it's a development deal,

existing new development, the spread
between the market cap rate and the

yield on cost is your development spread.

So that's where you make your money.

That's the appreciation.

That's the upside.

If the market cap for a, a self-storage
property is, let's say, a five cap in

Austin, Texas, and you can build it and
operate it at a seven cap when you're

complete, that's a 200 basis point spread.

That's your development spread, and that's
how you know you're making a profit.

What I've seen a lot of times with
value add deals is that the going-in

cap rate is somewhat irrelevant 'cause
it really depends on so many different

factors with, with deals like that.

But the sponsor will advertise
it as a value add because it

looks like one from the outside.

You know, it's a…

the place is a dump, right?

It needs a lot of work.

It's got upside.

There's market rents in that area
that are higher because those other

comp properties have nicer product.

Tenants are willing to
pay more for the leases.

The problem is, is that they don't
create any development spread

when they, when they do the deal.

They buy the property
s- for, say, $4 million.

They put $1 million into it.

It generates a s- a operating cap
rate, a yield on cost, total project

cost, operating cap rate of 6 and
the market cap rate is a 6 So they've

essentially created no value whatsoever.

They've just done a whole heck of
a lot of sweat, hard work, equity

to create nothing, uh, except a
nice, you know, coupon, essentially.

So at that point, you have essentially
the comparison between, let's say, a

1980s value add property that's running
stably versus a 2026 new construction.

What would you rather have, right?

You'd want the 2026 pro-
project, all things being equal.

So I, I…

hopefully, I communicated that, uh,
a- as, as reasonably as possible.

But essentially, you want to actually
be creating value in a value add

deal, and if you're not, it's probably
better to go into a development

deal and have a new property.

And I, I'm not saying that one
or is better than the other.

I think this comes down to
a diversified portfolio.

You wanna have some stuff that has a
little bit more appreciation potential.

That could be development.

You wanna have stuff that's
more cashflow generating.

That could be, you know, your core,
core plus multifamily asset that's

relatively new, that's not gonna have
major upside, but it's really stable.

So I think constructing a portfolio
that's well-diversified includes both

development and existing product.

Paul: Yeah, we, we preach that and it
sounds like it's a bit self-serving

because we're focused on development.

But I, I, I do think being very
intentional, and as a portfolio

grows, I think it's hard to make the
argument that development doesn't

have a place in that portfolio.

Because if you look at the numbers
historically, buying existing assets

will consistently keep pace inflation
over reasonable periods of time.

But they generally
won't outpace inflation.

Um, development gives you the opportunity
because there is, uh, the dynamic of

manufacturing value through the yield
on cost and development spread, um,

that isn't dependent upon appreciation.

It's really disconnected from inflation
that gives ground-up development

deals with the right risk profile the
opportunity, um, to outpace inflation.

And I, I think having part of your
portfolio that can perform that

way, again, as you build it, maybe
not the first deal, um, but as

you build it makes a ton of sense.

We're, we're gonna run out of
time here, which I really hate.

But as we close, telling you, man,
you, you covered the waterfront

like nothing I've ever seen, and
so this is gonna be a really hard

question to pick three or four things.

But w- what's your hope for
readers of both sides of the table?

What's the three or four things that
when you got finished with it, and

you pushed back from the table, in
your heart that you hoped people would

get from the hard work that you did
to put all that information together?

Paul S: Well, certainly understanding how
to put the principles into practice like

we talked about at the beginning of the
show, but what does that actually mean?

I think you have to, um, number
one, understand that passive

investing isn't necessarily what
it's What it's described as, right?

It's, it's a little bit more active.

Uh, you have to look at a lot of different
deals to understand pattern recognition,

some of the games frankly, that some
sponsors play to attract your attention

and, and try to get you to invest.

Um, so I think it's, it's looking at a lot
of deals and being a active participant

in passive investing, and then having
ongoing due diligence and tracking these

deals to see how they perform over time.

And the book outlines how
to ag-exactly do that.

Uh, I would, I would challenge everybody
to lead with risk, not lead with

returns and what could I earn or what
are the, you know, different cash on

cash, equity multiple, IRR measurements.

It's what's the risk in this deal?

That's the first question, and it starts
with the operating partnership and the

documents, and then it goes into the
underwriting and the market itself.

And kind of being able to evaluate
it from a risk perspective standpoint

versus a potential upside perspective
is, is really what the book is all about.

It's, it's more about, uh, talking
you out of investing in a deal versus

trying to attract you to the sector.

So I think it applies both to newer
passive investors as well as those

that have had and done a few deals.

Uh, and then I would say it's, it's about
how to build a diversified portfolio.

If you've got a big chunk of your
nest egg in the stock market, I'm

not arguing that you should take it
all out and put it into real estate.

I'm arguing that you should be
very intentional about what portion

of that portfolio you're willing
to allocate to LP positions.

Take that nest egg or that, that
percentage of the nest egg and

then be very intentional over the
next ten years and look out beyond

and say, "Okay, what are my goals?

Is it cash flow?

Is it appreciation?

Is it to retire from
my W2 job," et cetera.

And then find a strategy that works
for you to achieve those goals and look

at it from not a, "Hey, I've got…

I'm gonna take a million dollars
and plug it into LP positions.

I need to deploy it in year one
and hope everything goes well."

No.

You have to diversify by asset class,
by sponsor, by geography, by property

type A, B, and C, by debt maturities.

Anybody that did the, the, the former
and loaded up in one year in 2022 is

certainly regretting things, right?

Because all their debt may have been
short-term floating rate, and it's

maturing all at the same time, and
they're in a huge hole at this point.

So staggering your investments over,
you know, do two, three, four deals a

year potentially over the course of 10
years, that's how long it'll take to

build out that diversified portfolio.

And then at that point, you can
continue to recycle the returns that

you're getting and the exits that
you've had into new deals and keep

that diversification strategy fluid.

So, uh, that would be what I would
want most out of people to, uh,

to get most out of the book and,
uh, and hopefully it delivers.

Paul: Yeah.

Well, I can tell you from
my standpoint, it does.

As we wrap up, I'm gonna give everybody
a visual of the book so you'll

recognize it when you find it on Amazon.

That's where it's available.

So I would really encourage
you, if you've enjoyed today's

conversation, to go to amazon.com

and, and, uh, search for Both
Sides of the Table or Paul Shannon.

I think either one will get you there.

Uh, because I think it's must reading
for, uh, if you're actively investing or

considering investing, I can promise you,
you'll learn some things and gain some

perspective that you didn't have before
you, b- before you picked up the book.

So congratulations to you, Paul.

I think you've done a fantastic job.

Thanks for spending
some time with us today.

Um, and, uh, and hopefully,
uh, we'll, we'll get to do

this again before too long, so

Paul S: Yeah, I really enjoyed it.

It's always good to catch up with you,
Paul, and thank you for having me on

the platform today, uh, and giving me
an opportunity to discuss the book.

Very much appreciate it

Paul: it, ma'am.

My pleasure