A Different Kind of CFO

Actually there are all kinds, but few with duties as specialized as those of this young finance chief for a burgeoning real-estate investment busin...
David McCannJuly 16, 2013

Near the far end along one of the many spectrums that collectively define just what a CFO is dwells Sean Shanahan, a 26-year-old partner (and finance chief) of a small but fast-growing specialty hedge fund.

What CFOs at investment firms do with their time is certainly much different from what those at more mainstream products and services companies do. But the business of Shanahan’s firm, Iridium Capital Group, separates him even further from the norm.

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Iridium is in what’s known as the triple-net-lease segment of the commercial real estate market. The fund buys mostly newly constructed buildings leased by well-known retailers like Walgreen, Dollar General and AutoZone, as well as bank branches, with lease terms of at least 15 years. The term “triple-net” refers to leases under which tenants pay all real-estate taxes, insurance and property-maintenance costs. That means the rental income from the properties correlates closely to net income.

That is part of what Shanahan says has enabled returns of 10% to 11% in each of the past three years for the fund’s investors, who are high-net-worth individuals. Other factors in the strong returns include a sophisticated tax strategy, the historically low interest rates that have held down Iridium’s borrowing costs, and a buying strategy of committing to purchase properties months in advance of their completion in order to win discount pricing.  (He cautions, though, that such returns likely won’t be attainable if interest rates were to rise significantly.)

The fund started in 2009 as a mainly “family and friends” type of investment vehicle that envisioned raising $5 million to $10 million in capital to buy a handful of properties. But its success to date is driving new investment from other sources, including endowments and religious groups. The fund is currently worth $37 million, and Shanahan expects the number of owned properties to swell from 28 in mid-July to about 50 by the end of September. “We’ve garnered at lot of interest,” he says, and going forward Iridium will be “trying to clip about $15 to $20 million dollars worth of acquisitions every two to three months.”

Part of Shanahan’s job involves coordinating with various third-party firms that provide fund administration, accounting, tax, legal and other core business services. But he doesn’t spend nearly as much time on such matters as he would if they were handled in-house. “We don’t have to worry much about day-to-day operations,” he says of himself and his two partners, longtime real-estate professionals Marilyn and David Kane. “That means we can focus almost exclusively on deal transactions.”

Shanahan spends up to two weeks per month on the road meeting with developers of properties that Iridium may be interested in purchasing. The fund lessens risk for investors by only buying properties to be leased by investment-grade companies like the ones mentioned above. The developers are what the real-estate industry calls preferred developers, which build all of the properties a retailer plans to use for new locations in a particular state or region. “I spend a lot of my time meeting with those developers, going through their future pipelines and then essentially constructing new investment portfolios,” he says.

The CFO’s work extends well into evenings, when he spends hours reading tax code, leases, legal cases and other “stuff that’s not the most exciting.” But, he says, “I’ve talked to a lot of CPAs and lawyers who get kind of stuck in the way they think about things. So in my reading, I’m looking for ideas. How can I use this tax strategy? How can I take this case study and make it work for us? I call up our tax accountants, for example, and say, ‘First tell me if this is legal.’ Sometimes they say ‘Yeah, you can’t do that.’ Other times they say ‘OK, that’s interesting, we haven’t looked at it that way, let’s take a look.’ I find that very invigorating.”

For example, Shanahan read about something called an UPREIT transaction, where UP stands for “umbrella partnership” while a REIT, of course, is a real estate investment trust. With UPREITS, which are allowed under IRS Section 721 and were in vogue in the early 1990s, an investor who transfers a piece of real estate to a limited-liability corporation (LLC) or partnership recognizes no immediate gain or loss on the property.

“We’re an LLC,” he says. “So if you buy a property for $1 million and give it to us, and we give you $2 million worth of LLC interest, even though you’ve made $1 million there’s no recognition of gain until you leave the LLC. This was big back when REITs were collapsing, but it petered out and people weren’t looking at it much.”

But the company had a couple of investors who wanted to do transactions under IRS Section 1031, which lets real estate owners defer capital gains taxes when they sell a property and buy another of comparable value within 180 days. The investors were trying to buy a property but didn’t want to manage it. They also owned a property they had inherited and didn’t want to either manage that, either.

“They had zero basis in it, so every dollar they sold it for would have been taxable as long-term capital gains,” Shanahan says. “So I said, let’s combine the 1031 and 721 tax laws. You sell the property, buy the other property right away and transfer it to us, and you get to defer all of your taxes [on both transactions]. We got a property we would have bought for the fund anyway, and they receive quarterly distributions from the fund and zero real-estate management responsibilities.”

Part of Iridium’s regular tax strategy involves cost segmentation, an accounting technique that involves depreciating the value of the individual components of a building – not just the physical structure itself, but also the carpets, the light fixtures, the glass, the wires in the wall and more.

“Generally commercial real estate owners use 37-year or 38-year baseline depreciation,” Shanahan says. “But cost segmentation isn’t used nearly to the extent that it should be. You can effectively offset one to three years’ worth of ordinary income tax on a property, which lowers your basis across the board.”

All of this from someone who says he taught himself about real-estate taxation. Shanahan received a finance degree from Fordham University, where he minored in economics, in 2009. He had planned to go into investment banking, but the global financial crisis that exploded in late 2008 put the kibosh on that idea. His father’s friend Rand Sperry, who himself was a self-made millionaire in his 20s who co-founded national real estate brokerage Sperry Van Ness and later two investment companies, Sperry Commercial and Sperry Equities, arranged an interview for Shanahan with Marilyn and David Kane.

So impressed were the Kanes with Shanahan’s work that they made him an equity partner without requiring him to pay into the business – even though, says Shanahan, “I figured at the start that I was a little underqualified for what I was doing.”

 The young CFO sounds like he’s planning to stay in real estate rather than branching into a more traditional finance career. His graduate-school plans don’t include going for an MBA degree but rather perhaps a master’s in economics. “I thought about going for the [New York University] master’s in real estate, which a lot of people in my sphere have,” he says. “But given what we’re doing [at Iridium], looking at long-term strategies and long-term trends in our tenants and what’s going on in markets, I think a master’s in econ would be more important.”

Vincent Ryan contributed to this report.