Exploring Office & Industrial Asset Classes feat. Brian Adams

Hello, future billionaires. Welcome back to another episode. Today we brought on one of our friends, Brian Adams of Excelsior Capital, and he comes to share some really interesting insights on asset classes that we haven't focused a lot on. So a traditional office, medical office, and flex industrial. So he has some kind of contrarian opinions and thesis on that. So it's really cool to dive into that. It's also fun, which we didn't plan on doing this, but kind of went into this little trail of thought on how the ultra-wealthy invest. So his, his wife had a family office that he kind of got exposed to and saw how they were running it, but has some really cool nuggets that you're not going to want to miss on secrets of growing your net worth. He shares in this interview, so tune in and enjoy the episode. This is the Invest Like a Billionaire podcast where we uncover the alternative investments and strategies that billionaires use to grow wealth. The tools and tactics you'll learn from this podcast will make you a better investor and help you build legacy wealth. Join us as we dive into the world of alternative investments, uncover strategies of the ultra-wealthy, discuss economics, and interview successful investors. Looking for passive investments done for you? With Aspen Funds, we help accredited investors that are looking for higher yields and diversification from the stock market. As a passive investor, we do all the work for you, making sure your money is working hard for you in alternative investments. In fact, our team invests alongside you in every deal, so our interests are aligned. We focus on macro-driven alternative investments so your portfolio is best positioned for this economic environment. Get started and download your free economic report today. Welcome back to the Invest Like a Billionaire podcast. I am your co-host Ben Frazier, joined by fellow co-host Bob Fraser. And today we have a really fun guest, Brian Adams. He's the founder and president of Excelsior Capital and a good friend of ours, and wanted to bring him on the podcast today to talk about this current environment. So Excelsior Capital, they're an operator in several asset classes, mostly industrial, medical office, and traditional office. And so some, some different asset classes that a lot of our investors maybe haven't invested in. And obviously a lot of headlines around office especially. And so we just want to bring them on and talk about state of the market. What they're seeing, how they're navigating this challenging environment with interest rates and, you know, where they're trying to find value. So, Brian, thanks so much for coming on the podcast.

Yeah, thank you all for having me. It's always fun to actually have met the people that you're talking to. We grabbed lunch in Kansas City not too long ago, and I appreciate the opportunity to, to come on and chat with you guys.

Yeah, no, it's awesome. It's fun because I've been following your group for several years. I ended up on the Capital Club. I can't remember the name of what you did. These virtual— basically you bring on, you know, maybe a venture capitalized firm or unique opportunities and just kind of, you know, creating connections for people, both LPs and operators. And just that was so cool what you're doing. And you just really have similar to us at Aspen where you're going after you know, trying to raise money from individuals, accredited investors, and really have a passion for educating around these types of investments as we do as well. So it's great to— it's fun to meet you in person and have you on here. So talk a little bit about your background. Obviously, you, you know, didn't go the traditional route of going straight into multifamily, Class B or Class C value-add like everybody else. You went to some other asset classes within private equity. And, you know, talk about your journey in this space and we'll kind of get to the current environment here.

Yeah, absolutely. So I'm from upstate New York originally. I grew up out in the country. I went to a very small private military school in Albany, went to college in Connecticut where I met my wife, who is from Nashville. So we met in school. We did the Northeast thing for a little bit, went to law school up there, and then moved back to Nashville about 15 years ago now. And at the time I was practicing law, but my wife's family has a family office that's based in Nashville. And so through our CIO and my father-in-law, I got exposure to private equity, commercial real estate, venture capital, mostly on the LP side, although we did have some co-GP relationships and we're doing some direct deals as well as being fund investors and just learned about that world. And became enamored with commercial real estate specifically. I connected with my business partner who has a Wall Street kind of finance background, and we started the company back in 2010 initially to source deals for the family. And then it became kind of friends and family. Now we have a, like you alluded to, a broad network of investors, all private individuals. So families, high net worth individuals, RIAs, etc. We don't work with institutional folks anymore, but that's been the journey the last 10, 11 years now.

Very, very cool. And then, you know, maybe take a quick minute because, you know, our whole thesis of this podcast, Invest Like a Billionaire, is, you know, the ultra-wealthy invest differently, right? They don't invest like the average high net worth, which is mostly stocks, bonds, mutual funds. You know, the ultra-wealthy, the family offices, the pensions, endowments, they're investing large portions of their portfolios into private alternatives. And it sounds like, you know, with your wife's family office, they were doing the same thing. Talk a little bit about that because that would be a cool perspective to hear coming from not that background and then seeing how they were doing it. Was that kind of an eye-opening experience to see, hey, they're doing not traditional ETFs and, you know, stock portfolios? What was, what was that like?

Sure.

Yeah.

I mean, I grew up very comfortably, right? My father, was a very successful attorney. My mother is retired but was a child psychologist, which is a totally different can of worms we won't get into on the show. But, you know, I never had any debt. I went to the best schools that I could go to throughout my whole life. But it's a different world, right? And so when they made the disclosure, the financial disclosure, when they negotiated the prenup, it was very much like an oh shit moment of, oh my goodness, like, what does this mean? And I didn't know that world directly, right? And I thought about this before I came on the show. One of the stories that I have about why I started the firm, I was a member of a men's organization, like a networking organization in town when I first joined, or when I first came to Nashville. And we had the opportunity to attend a class that was taught by an adjunct professor at Owen, the business school at Vanderbilt. and it was called Launching the Venture. And the professor's name was Michael Bircham, super successful healthcare venture capital investor, had multiple exits. And he did like an abridged version of this class. So over the course of 8 weeks, one night a week, we would go for 2 or 3 hours and he would teach this. But the first day of class, it's like, you know, 35, 25-year-old dudes, right? They're all like ready to take over the world. And he says, well, you know, I assume you're here because you want to make money. And everyone's like, yes, of course. And so he said, well, I want you to go through an exercise. I want you to look at the Forbes 100, and if you take away folks who inherited the money or married the money, you're left with 3 main buckets of capital of how people actually got on that list. One of them is they had a great idea, like you invent Google or Apple in your garage and you ride that. Another is you do the corporate grind and you get kind of shares and ownership of a corporation, and that stock appreciates and you do really well. And the third is really real assets, and it could be commodities, oil and gas, timber, real estate, etc. And I just thought that was like the smartest thing I ever heard in my life. And I didn't have a great idea and I had come from a law firm background and I'd seen that corporate grind and I didn't really want to do that. And so I thought, well, go into real assets. I know a bunch of people have done really well in real estate and that got me on this train, but when you think through that reasoning and after being able to interface with a number of billionaire individuals and families, what you realize is the story that you hear today about diversification and allocation and what they're doing after they've had the liquidity event is very different than the first chapter of the story, which is kind of how they got there. And the realization I have is They make a couple of, they do a couple things that are all pretty similar fact pattern-wise. One of them is they make massive allocations and concentration risk and they take that on and they ride that risk really hard for a very long time.

Now you're talking about family offices in particular or with the ultra wealthy? Yeah. Gotcha. Okay.

Both.

Either, right? If you're going to make that type of return, kind of like what Ben was saying, it's not as easy to concentrate into a certain set of asset classes. Right. Even though like the Wall Street narrative and the financial services narrative you hear is about diversification and allocation and exposure, typically these people are taking one position into either a company or an asset class and they are very concentrated.

Right.

Net risk and understanding it really.

The old adage is, you know, put, put your, don't put all your eggs in one basket, put them in a lot of baskets or put all your eggs in one basket and really watch that basket.

Yeah. And I just don't think, I just don't think people appreciate like what that concentration is and what that risk profile is for a lot of folks to get to that level. And they usually will take leverage on that concentration as well. And so those were just some takeaways that I got that just were really kind of changed the way that I think about investing my own portfolio.

I mean, I think, I think it's a really key point. I don't want to move too quickly from that because what you're saying is from most of the ultra-wealthy that you've been around and have talked with and learned from, it takes a certain level of concentration to create outsized or asymmetrical returns. But then once you achieve a certain, you know, level of wealth, then to preserve wealth, you generally diversify, right? So what got you to that point of wealth is not necessarily what keeps you at that wealth and growing it. So there's—

that's a great point. Yeah, no, that is such a great point. It also goes to our themes, you know. I mean, you know, I cut my teeth in the dot-com revolution, right? Started a little dot-com with me and my sister-in-law in my attic and grew it up to 300 employees and raised $44 million in venture capital. And, you know, I had a, you know, uh, quarter million dollar— quarter billion dollar valuation and then lost everything. And I learned from that, that timing matters, right? So and Amazon during the crash, right, during the rise, it didn't matter how bad your dot-com was, it went up, right? Didn't matter, right? On the crash, it didn't matter how great your dot-com was and went down. I mean, Amazon, you could have bought for, you know, an adjusted basis, you know, $0.35 a share. Well, if you can buy Amazon at $0.35 a share, guess what you want to do? You know, you want to concentrate, right? And you want to take outsized risk and you want to leverage and everything else. And it just goes to our, to our theme of understanding timing and trends and megatrends. And it's okay to concentrate as long as you know what you're doing and as long as you've done your homework, you know, and, and, and protect your, you know, mitigate your risks through the way you structure your debt and hedging and any other strategies you have.

So yeah, I mean, people, you know, there's a lot of conversations now. We're recording this in May of 2023. The world's kind of going sideways. But if you have real conviction and a real long time horizon and you know what you're doing, Now is the time to invest into venture, like deep, right? Because you can push valuations, you can push term, and you can get allocation. So if you, if you really kind of know what you're doing, like now is the time to go risk-on in venture. Really easy for me to say as opposed to do it. But to your point, Bob Fraser Fraser Fraser, like we're at that point in the cycle where you're going to get some great deals. There'll be a washout. The good companies will kind of push through here in the next 3 to 5 years, but it's just, it's really scary to do it and actually pull the trigger. All right. Awesome.

Well, let's shift a little bit. So you're kind of made this transition into private equity. You started working with your wife's family, helping them find deals, and then obviously led you to eventually create Excelsior Capital and your own firm where you actually bring it on more than just family, but friends of family and now, you know, a whole bunch of retail investors. So Talk a little bit about that journey and then some of the themes and thesis that you went about to go start acquiring assets and obviously have some contrarian theses around, you know, office and other things. So we'd love to hear some of that.

Yeah. When we first got into the business, we raised these really small funds and they were kind of blind pool, commingled vanilla private equity funds because we just thought that's what we should do, right? That, that funds were the way to do this. What ended up happening was we gave our fund investors access to direct sidecar deal-by-deal exposure on the acquisitions to make— to stretch our dollars. And we realized really—

let me just pause there.

Go.

Just to explain it. So, so this is to create a fund so investors would put their money in. It's a blind pool, which means investors— there's no particular assets and there's discretion in the manager to go place those funds into assets. And when they would purchase then an asset, you go, so you put $1 million into this fund, it's got $10 million from 10 different investors. There's no assets and you go purchase assets. Well, when you buy a $10 million apartment complex, you'll take the fund and you'll invest that money. But you also allow those investors to, to go along pari passu or, or to buy a sidecar, what's called a sidecar. So they can not only have their investment in the fund invest in that deal, but they can take another personal investment in addition at the same terms as the as, as the fund is. So it's a very attractive kind of structure. So just wanted to explain what a sidecar is, right?

Yes, you nailed it exactly. Um, and we realized that we were in the wrong business because the appetite for the deal-by-deal direct sidecar investments were much greater than what I was able to do and attract investors on the blind pool side. And that's not really a criticism against the structure. It was really what I understood later to be informative of who my investor base was and who I was catering to. And there you go. Yeah, I changed the product offering to match who my LP base were, which are, you know, individuals and families, private LPs, private taxable investors. And once I did that and I changed the structure to accommodate and to solve a need in my LP marketplace, that's when I was able to raise much quicker and sooner. Um, and to go a bit deeper, this would have been kind of in the mid-2010s, so 2015 era. Um, at that time we were going to a lot of emerging manager conferences and trying to attract institutional limited partners, endowments, pension plans, whatever. And I went to this conference, uh, called Grovener in Chicago, which is like the big emerging manager conference, and they said that at the time, 85% of all institutional LP capital raised in commercial real estate had gone to 5 brand name GP sponsor fund managers. Wow. And I just realized—

85%?

Yeah, it all had gone to like, you know, KKR, Carlyle, Blackstone, Blackstone, the usual suspects. And I just realized, man, like, I don't want to be in this business. This is a very hard business. And so we spent some time, my partner and I thought, okay, what is the hardest amount of capital to raise and who is the hardest population set to raise from, right, in our world? And we found that most people, that $5 million raise is really challenging, right? It's below private equity. It's above kind of the country club weekend warrior, typical syndicates. And most people, even though they say they want to, they don't really want to work with ultra-high net worth individuals and families because It's a long sales cycle. They're very high-touch clientele and, you know, they don't write huge checks. Most people want to move on from that and they go upstream to these institutional folks. So we thought we will go exactly where most people don't want to go and we will focus all our efforts there, still offering deal-by-deal syndication. And that really fundamentally shifted the growth trajectory of the business, honestly.

Yeah. So talk about some of the investment themes that you kind of initially got into. So you kind of started this more investment firm with other syndicated money in 2015 was kind of the timeframe.

Well, I have a legacy platform that I started in 2010, and that has a lot of traditional office exposure, which I think we're going to get into. And that was a hodgepodge, right? That was a series of funds. We were doing joint ventures with some private equity groups. We did some 90/10, 95/5 allocator type deals. As well as syndication. And it was, it was a, it was a kind of a mess. It was a bunch of different things. I launched Excelsior Capital to be a pure-play deal-by-deal syndication platform to learn from kind of all the mistakes I had made the first iteration. And I launched that in 2019, 20, 2018 timeframe. So that's this kind of— got it, got it.

So let's talk about office. So You know, just reading an article this morning in The Wall Street Journal and they're saying how, you know, hey, we crossed over 50% occupancy in, in office space. And so it was signaling return to work. And landlords are saying, hey, this is now we're normalizing. And the article was saying, well, now it's stalled at 58% occupancy. And so clearly a lot, you know, clearly, you know, work from home is here to stay and and a lot of employees are demanding— in fact, the majority of companies are now offering some work-from-home kind of capability and not a lot of office space needed, not as much needed. And, and it's definitely here to stay. So you're actually an investor in office and you may have a little bit of a different narrative. So what's your perspective on office?

It's a challenging asset class, right? I think oftentimes it can be a value trap. Because even pre-COVID, you would go—

what's a value trap?

Sure. You go into this opportunity saying we're buying value. Yeah, we're buying this asset, right? It's a class— let's call it a Class A property in Kansas City, your neck of the woods. We're buying it at an 8 cap, north of an 8 cap, and we're buying it at a huge discount to replacement costs. Yeah. Okay. So per pound, cheap, nice, juicy, great value. Yeah, good value going in, right? The problem is once you get in the deal, 10 years from now it's still a great value. The way that office is structured with tenant improvement dollars and leasing commissions and operating expenses and modified gross leases, once you roll through that tenancy, so 2 to 3 years in, you start, you start backfilling or extending the current rent roll, it becomes very capital intensive and you realize that it draws down from your cash flow significantly. Meanwhile, rents in most of these markets, like we'll take Kansas City, Mark, I'm familiar with Class A office, which those are probably '90s vintage buildings. I bet rents have, have not moved more than a dollar or two per square foot in the last 20, 25 years for Class A office. And so, wow, you've got a problem where you can't capture upside. It's a tenant market, right? Because there's, there's probably too much office products even back pre-COVID.

Yeah, this is probably still, still pre-COVID you're talking about, right? And then COVID is a whole other—

So you've got to be very careful about going into those opportunities and not being caught in like what we just kind of value-told out, which is that value trap. Now I think developing office and getting in and out of it, it's a good business if you can take the risk. And there are some value-add opportunities, but holding long-term, you have to be very careful on the vintage and the cycle risk. And obviously this is a very different story versus what's happening in gateway markets like New York and San Francisco right now, that's a totally different animal and that's a bloodbath.

Well, I think it's important to talk about too, because like, just like in real estate, oh, the real estate market's been hit really hard. Well, what do you mean by that? Right. You're talking about office. Like, that's what most people are thinking of. But then you think about office, you have different markets, you have the gateway coastal markets, you have the Midwest. And then within each of those markets, you have urban office versus suburban office and You know, it is, it is so many nuances of the asset class. So if you break it down a little bit of like what are the big categories, would you say, in office? Because there's probably different themes and things we're seeing is we're right now I'm sitting in a Class A office building in, you know, the middle of Kansas City in one of the hotter areas. And there's no real other Class A office space available, at least there wasn't a year or two ago. And know, we actually moved spaces during COVID within the same building. We're like, oh, it's going to be great. We're going to negotiate, you know, crazy good lease right now because demand's going to be way lower. And they didn't budge an inch and we still signed. So it's a very different story here.

Yeah.

I mean, like most things, when you talk to investors and you talk about asset classes and food groups and what's doing well and what's not doing well, it really comes back to what is your time horizon and what's your return profile versus your risk that you're willing to take. If you have a 100-year time horizon, you're going to be okay with office. Like you're going to ride that out. It's going to appreciate. You'll figure something out creative to do with it. It's not a big deal if you're trying to hit a big IRR and you've got a 2 to 3 year window to invest and turn a deal. Office is super challenging unless you take on a huge amount of risk. And so I don't think it's the right question to say like what's good or bad. I always ask the LP, well, what is your timeframe and what's your return profile versus the risk you want to take on here? And that will dictate where you allocate capital. Because if you look at like what the REIT market is saying right now, office in Midtown Manhattan is about 80% down on value from the beginning of the year. So if you've got conviction and a long time horizon, you should go buy a bunch of Midtown.

Midtown's buying.

Yeah.

But if you've got liquidity needs and you don't want to take a lot of risk, then you can't do that. You can't allocate to those deals.

Talk about the gateway markets in particular, the bloodbath. Just kind of profile it for us. What's happening?

And again, this, this is a— and I'm not hedging because I'm a GP. This is just the way I think now after doing this for 11 years. It, it's like a tsunami and different asset classes in different markets are on different elevations. The longer interest rates go up, right, the longer rates increase and the more values decrease and the longer operating expenses increase, it's coming after everything. So it doesn't— the office is just kind of the tip on the beachfront right now. It's very challenging because like I referenced about the REIT market, valuations have gone down 30 to 40% on some of those office deals. Meanwhile, operating expenses. So what it costs to run those buildings from insurance, TILCs, just the construction costs, whatever, they've gone up tremendously. Meanwhile, you know, your cost of debt, if you locked in at 4%, if it's now an 8-handle, like those deals are now underwater. And I don't really think it's the GP sponsor's fault. If they locked in debt 3 to 5 years ago and they're not refinancing today, it just happened to be whether that is rolling, there's nowhere to go, right? You cannot get a term sheet from a lender. Nobody wants to touch that stuff. You can't re-equitize it because common equity doesn't want to go there. And you might be able to go to some groups that are really sharp that want to loan to own and charge you a huge amount of debt to get in there. But that's pernicious to your common equity in your capital stack, right? So when you see guys like KKR and Brookfield and Blackstone giving the keys back to lenders on these assets, they're the smartest, well-capitalized guys on the street, right? It's, it's just a function of a macroeconomic window that we're in that these deals like just no longer make sense in today's environment. They're very challenging to handle.

Yeah, I'm definitely a value investor. I love, you know, value thesis, but I, I don't have the gumption for office space, and that's where the value is. It is, you know, when you want to see some light at the end of the tunnel there, you know.

Exactly, Bob. And when LPs come to me and they say, where are the screaming hot deals? Like, well, you can go buy a tower, you know, I think a tower deal in downtown Louisville traded for $60 a square foot. But again, like, what's the plan? What's the ultimate play here? Because again, it can be very tempting to say, oh, that's a great basis to get in on, but you're married to that basis forever. And in 3 to 5 years, it might not look that attractive any longer. Right.

I think some of the challenges are what are the long-term prospects, right? You talk about the occupancy at 58%, but, you know, there's a difference between physical occupancy and economic occupancy. So physical occupancy is probably what they're reporting. But a lot of these buildings are, you know, economically occupied, meaning they have leases in place to where it's a lot higher than that, maybe 70%, maybe 80%. But the challenge is what's going to happen when a lot of these leases, you know, are matured and they're, they're now done. And what do the tenants do? Do they sign leases again? Do they sign the same rates and do they sign for the same amount of space? Right. Because if this hybrid this kind of work from home, you know, thing continues to go on, which I think it's probably hard to argue it doesn't, the amount of space that most businesses need is probably reduced quite a bit. So I think there's still going to be, you know, there's these kind of things on the horizon. It's hard to know where it lands and where, you know, it plays out. And, you know, the thing that comes to my mind is, you know, this— we just saw this huge failed IPO with WeWork, which was kind of going and trying to redefine office. I just saw an article the other day, you know, they're worth, I think it's less than 10% of the original valuation. They're, you know, what do we do? Like this, the model kind of failed, right? And so there's just a lot of things. I think it's, you know, it's hard to see where is the light. So what's caused some of your thoughts on, you know, how does this play out? You know, because you are hearing some, you know, bigger companies that are kind of having a return to work kind of, you know, push and trying to get people back to the office. So where does it kind of land? How does that impact the space over time?

I mean, it's hard to catch a falling knife. And these type of clichés you hear thrown around by, you know, folks have been in the business like, like your dad has for a while. When you're young, you don't really understand, but now you kind of do when you see it playing out. It's, you know, it's hard. And I'll make a comment that, you know, part of this is the Fed's doing right. When you put rates at zero, when you give developers free money, they're going to develop and they're going to give people and users and tenants massive incentives to move to new buildings, which means that legacy product gets left behind. And unless you have some type of tax incentive plan enough and something to do with that legacy product, it's going to become obsolete really quickly. And so that's just a commentary about policy that we've been experiencing in Nashville, which is one of the best commercial real estate markets in the world. We have a Class A building downtown, great building, had a great rent roll. It's now considered a legacy Class A building because we have new product. It's going to be under 50% occupied at the end of the year. And it's owned by one of the biggest office REITs in America. Like, these people know what they're doing. But we have brand new Class A office that just kind of stole that tenancy and continues to do so. At some point, there'll be price discovery, and there is a point at which some large, well-capitalized groups with a long time horizon will come in and find value in these assets. It's going to take some time to shake out. I personally think that a lot of groups are going to give the keys back to the lenders if they operated during '08 and they see the writing on the wall. They're not going to incur those fees and legal costs of fighting with the servicers. And a lot of master servicers and bondholders are going to start being the owners of a bunch of office buildings. And eventually, you know, rents will come to a point where it makes sense for users to come in. And they'll be able to kind of ride that cycle. But it's going to be a rough 5+ years, I think.

To shift a little bit to medical office, because that's kind of another subset of the space that you are in, but maybe it's a little bit of a different story than kind of traditional office space.

Yeah, it is. And it's really— I mean, nothing that you all aren't familiar with demographically. You know, the US population is getting older really quickly. And get— getting sicker very quickly, right? And so it's riding the, the tailwinds of those demographic shifts of this aging baby boomer population that is going to continue to need services. And we see just from my healthcare folks, these larger campuses and providers are trying everything they can to get outpatient services off of main campuses and distributed to different locations to service those populations directly as opposed to folks coming in to a centralized location. There are some different dynamics in medical office, just given the nature of the buildouts and the fixtures and the requirements there. They tend to be very sticky tenants as opposed to office, which is really commoditized and people can move to different locations and doesn't really mean much. If you're a dentist or a LASIK eye center, like an asset we own in Kansas City on College Boulevard, Those buildouts are very, very expensive for the tenants to bring somewhere else, and landlords can't really afford to incentivize them to go to a new location. So we like the dynamics there. They are, they are much more core plus as opposed to value add. And cap rates haven't really moved from a return profile, right? Correct. Yeah. Yeah, correct. So we, that's probably 25% of the portfolio. And we also think they're very resilient, right? If, if people are going to cut something from their lives, it's— if they still have discretionary capital or income, they are going to continue to pay for their healthcare expenses as opposed to maybe going out to dinner or, you know, shopping or something like that.

What are the negatives?

Well, there is— there's not as much upside there, right? Because people know that these tenants are going to be kind of steady Eddie. They've got the baked-in lease rate increases. There's not a huge ability to create a ton of new value in those assets, right? Because those tenants don't tend to leave and it can be hard to attract a new user. So if you're looking to hit big IRRs, unless you're doing a big aggregation roll-up play, medical is a very challenging place to do that. But if you're looking for consistent yield and good kind of long-term appreciation, it can be a good place to put capital, but you're not going to hit these, these big home runs like you can in, in industrial or, or kind of the value-add office right now.

And what kind of cap rates are they, the medical office trading at relative to, say, traditional office?

Yeah, hugely dependent on the credit of the tenant. Right. So if you're looking at something that's non-credit, so what I would say is like a regional local user, like a LASIK group that's a partnership or a dentist that's a sole proprietorship, you're probably going to be somewhere in the 6 cap range. If you've got a medical, like a university system who's a sole tenant in that building and has a 15-year lease, cap rates are going to be in the 4s probably. They're still very competitive. Yeah.

Interesting. Wow. And then shift a little bit to industrial. So that's probably an area that we're obviously very aligned in from a thesis standpoint. And, you know, but you have a unique strategy. So we've done a lot of kind of Class A new development, you know, kind of more big box industrial, which we also going after older vintages, more Class B value-add type projects. And so talk a little bit about what, what that's like and the flex industrial space.

Yeah, so we've talked quite a bit about large industrial, right? Big box industrial, which we like because it's capturing this reshoring trend. And the big box industrial can be both distribution centers or manufacturing, heavy manufacturing or even light manufacturing. And, you know, typically it's 300,000+ square feet, you know, and up and that kind of thing. And our thesis, you know, the distribution boom has driven so much of the The, the absorption and the extremely low vacancy rates and the, you know, but in the future it's not going to be distribution that drives us, going to be the reshoring trend. So over $1 trillion spent in reshoring last year and it's not, it's not going to slow down for at least the next couple of decades. So we're, we really think that's a very, very powerful trend. So we focus a lot on the Class A big box industrial, which we really like. But what you're talking about is flex industrial. So kind of paint a contrast for our, for our listeners and and what you love about this asset class.

Yeah. And for what it's worth, I completely agree with you about the reshoring and the rebirth of manufacturing in the US, just given the geopolitical scene that we're seeing play out and the volatility there. It no longer makes sense for us to have that distributed manufacturing network. And so I'm a believer in terms of Flex Industrial. The way I put it is it's like the mullet of commercial real estate. It's like business in the front. So you've got office, retail, like your traditional usage, and then you've got the party in the back, right? Which is distribution warehouse, could be an HVAC space where you just use it for storage. The typical user that we see would be like a landscaping services firm or a chimney repair shop. Something where they—

square footages are we talking about? That's kind of a sweet spot.

Yeah. So we do multi-tenant. So on the asset size, you're looking at 50,000 to 150,000 square feet. Quite a bit smaller. Yeah, quite a bit smaller. Single story typically. So the product that you see around airports, typically it's not the sexiest stuff in the world. It can be usually kind of Class B, '80s, '90s vintage when a lot of it was stood up. Yeah.

And are these typically 36-foot clear height like the big box, or can be shorter?

Not always. Yeah, there can be huge variability there. Sometimes we see kind of the standard clear height and we see everything in between, right? Or sometimes they'll even have like full warehouse roll-ups in the back. It can just depend.

And, and these are probably more steel buildings as opposed to concrete tilt-up like the Class A big box we're talking about.

Correct. Yeah. From an insurance standpoint, you know, you can't do wood frame really any longer. It's just— it doesn't work. But yeah, this is typically kind of steel, steel frame structure. Correct.

Gotcha.

So, okay, how are you driving value? What's kind of the story here? How do you kind of make these properties—

these are value-add. You're not— you're not favoring development here. You're buying value-add deals.

Yeah, correct. So these are existing properties, again, multi-tenant. So typically we're seeing anywhere from 5 to 10 users per deal, anywhere from 2,000 to 10,000 square foot per tenant. The reason we like it is kind of a function of what I referenced before, lessons learned from doing traditional office where You know, elevators are a killer. You're talking about $150,000 to $250,000 per elevator cab in replacement costs. Nobody wants to put money towards elevators to maintain them or to fix them. So you always inherit problems. Modified gross leases where you can't control the operating expenses and you can't push through those expenses to the tenants like you can in a triple net deal where we see is market on the industrial flex side. And then just this common area, this CAM load that you end up having to handle and distribute out. Typically these don't have any common areas. So what you're, what you're really kind of focused on is roof, foundation, and parking lot are your big kind of CapEx expenses because HVAC, insurance, etc. gets pushed through to the users and they typically have their own metered on the HVAC side, which helps a lot. And no elevators, obviously, because it's a single-story product. So really a function of being informed by kind of one of some of the things that we found problematic in traditional office brought us here. And then what we see fact pattern-wise often is these are very much— so we're talking $10 million purchase price type properties here. So smaller deals. Very often owned and operated by an individual who may or may not be a real estate professional. They're probably leasing and/or managing the building themselves. And so what we find is they are just trying to keep the building full. They're not pushing rent, they're not pushing credit, they're not pushing term. They'd rather just do a 1-year extension and keep the user in at the same lease rate they were before. As opposed to go risk on, take the vacancy, go dark for 12 months and get market, right? And so oftentimes we're seeing a $5 a square foot on a triple net basis between what current in-place rents are versus market. And so we go in, we, we just bring like—

and from a percentage, percentage standpoint, I mean, that's pretty high, right? Because these are, you know, it's probably what, 30 to 50% above, right? So in contrast to office, which hasn't really had, you know, rents grow over the past 20, 25 years because of this surge of industrial absorption and, you know, reducing vacancy, it's pushed lease rates up a lot. And so the terms as they kind of come due, you're seeing this pretty big gap in the market relative to the rent roll.

100%.

That's exactly right. And what you also see is the benefit of as traditional office has become out of favor. This is a much more inexpensive option for people to come in. And we see some traditional office users just choose, you know, this option as opposed to going to a suburban office building as well, because they do have more flexibility in how they use it. The layout parking load is typically not a problem, and because they're not the prettiest things in the world, they're not building a lot of new ones, right? Because people don't want these. It's kind of like self-storage. It can be very hard to build kind of a flex industrial property in an existing neighborhood because people are the NIMBYs. They don't really want that to be there. And so you can push rent pretty aggressively. And again, when we look at risk versus reward, if we're just underwriting to bring it to market, nothing more, right? We're not trying to overreach or be superstars or be incredible asset managers or really, really savvy real estate people. Just bring it to what we find market to be. And if we can still hit upper teens IRRs, then yeah, I think that deal makes a lot of sense to us on a risk-adjusted basis.

Yeah, that makes a lot of sense. And what we've seen on the development side, kind of your point on supply, the flex is a difficult animal to build, right? Because one, maybe you have some just pushback from neighborhoods, but two, it's quite a bit more expensive than the big box. And so you know, if you're a developer, you're trying to maximize your spread, your value, you know, just in your cost to build and what you can sell on a per square foot basis. So, you know, Flex is an interesting animal because it's, it's got likely limited development supplies. There's not much being brought to the market, you know, so it's, it's got some, some other positive trends as well.

But, but I will say the pain in the neck factor is pretty high. For the first 12 to 36 months, right? Because you're converting leases from modified gross to triple net, which no tenant likes, and that's horrible. You're probably kicking some users out, right, that are probably in arrears or, you know, are problematic for whatever reason. And so you do need an asset management team that can like take on that brain damage and do that work. But if you do it 24, 36 months and you kind of execute on it, it can be really good.

So, because you're likely having to pay up for the in-place cash flow, right? Because there's this potential value to capture between the in-place rents versus the market rents. And if they're a sophisticated seller, they know at least to a certain degree that, hey, I know there's some more value. I'm not pushing rents. So you may have some limited cash flow going in because the current rent roll is paying up for that. But then if you have to kick tenants out, you know, if you have only 5 tenants in the building versus a multifamily where you have, you know, a lot more, you know, one of those vacancies probably reduces cash flow even further. So you kind of have, I would guess, limited cash flow from an investor standpoint for the first few years as you kind of re-re-retenant the property, work through all those conversions from gross to triple net. And but the back end can be pretty, pretty nice.

Yeah, I mean, the savvier owners and sellers will do like one lease where they get market and they'll show that it's doable and they'll show that delta and they'll say, hey, like you can capture this, but there's a lot of meat on the bone, right? Which I think is a good play. But to your point, year 1 or 2 can be very limited cash flow. But honestly, in today's environment where I'm pitching against people putting money into a T-bill and getting 5%, the yield story doesn't really play that well anyways. So we're looking for shorter duration, deeper value-add, IRR-driven opportunities. And so it plays well in today's environment because cash flow isn't as meaningful as it was a couple of years ago.

Talk about demand drivers. So the big box industrial, you know, we mentioned distribution, you know, the e-commerce trend, it's continuing and albeit at a slower pace. And then the reshoring trend driving a massive demand. And we're seeing vacancy rates reflecting that. I mean, we're seeing Basically, Class A, big box industrial Class A, is vacancy rates are effectively zero. And but what's driving demand? It wouldn't— I don't think it's reshoring, right? It feels like it might be more correlated to retail, right? And it's servicing retail clients and, and retail sales more. So what is it correlated to? What are the, what are the key demand drivers here?

Yeah, I mean, yeah, I think you nailed it. Seems so cliché to throw out there, but this last mile distribution facilities and centers, you know, I think what's happened is because e-commerce and what Amazon has done, it's pushed through the entire ecosystem. Meanwhile, they just haven't built a lot of new flex product. And so you're just seeing more demand, less availability. I mean, we just did a deal in Charleston, South Carolina, where the submarket vacancy rate was 1% for our product type. Right. So you're— they're not building— they're not building new product. The demand continues to— as people just want stuff delivered to them à la carte or service services provided to them as the economy grows, there's nowhere for these users to go. Meanwhile, location is really important, right? Because it's all about speed to the customer, speed to the end user. And so if you need to be in a certain part of town and there's no other availability, that's where you're seeing that, that rent kind of push through, that NOI growth occur within the property.

That makes sense. And surprising to a lot of people, you know, I mean, we track retail sales and I mean, you've seen for the last really 12, 15 years of steady, steady uptrend in retail sales and services. And but then since COVID it's taken a hockey stick up. And this is contrary to kind of, you know, what most people would think, you know, but retail is on fire. And to me, that would— if that's— if you're talking about services like, you know, landscaping and I mean, it's basically going to— it's going to track retail, right? It's going to track the retail kind of, kind of spending. And maybe it's wholesale, but it's once, you know, wholesale buys or wholesale sells to retail. So it's going to be right there.

You probably have a lot of service-based clients too, right? The HVAC companies and others that are servicing.

Again, it's going to start with retail.

Yeah. Sure.

Yeah, I mean, we're not going to put on our tinfoil hats for this episode, I don't think, but I mean, the government's giving us all this money we've become a consumer-oriented economy. And this is the— this is one of the results is, you know, we have to— we have to have companies and services to, to kind of meet that demand. So here we are.

I like the thesis. I think— I think it holds water. You know, I like it. I love the value-add play and the fact that, you know, that it's not being built anymore. If it's not being built, we're seeing a ton of that. We're talking about that in the retail strip centers. None of this stuff has been built in the last 15, 20 years. And so replacement cost is just way higher and, and demand continues to grow right through, through recessions. You had a little dip, but then it just keeps growing, you know, with the economy. So yeah, I love the thesis.

Yeah.

Well, Brian, I think we also came up with the name for your next fund. I know you don't do funds, just syndications, but I think Mullet Capital or Mullet Fund. I think that that's going to go far.

And everyone on the team, party in the back, everyone on the team grow mullets. We can do a whole branding thing about it. Yeah, it'll be great. I'll pitch that to my marketing folks. I think they'll love it. Yeah, absolutely.

I love it. Awesome. Well, Brian, thanks so much for coming on. It's always fun to just chat with you, hear your thoughts, and obviously well-informed and appreciate your perspective. So thanks for sharing with our audience here.

Yeah, thank you all for having me on. Really appreciate the opportunity.

All right. Thanks.