AIPIS 177 - The Current Real Estate Market for Manufacturing, Office, Retail, Industrial and Multi-Family with Andrew Wright

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It's my pleasure to welcome Andrew Wright. He is CEO and Managing Partner at Franklin Street. Andrew, welcome.

How are you doing?

Great.

Thanks for having me.

Good to have you on the show. Give our listeners a sense of geography. Where are you located? I'm guessing somewhere in Florida.

Yeah, I'm headquartered here in Tampa, but we have offices in Orlando, Jacksonville, Miami, Fort Lauderdale and Atlanta and we do.

Business all over the country.

Fantastic. Well, the $64,000 question or maybe $64 trillion question, I don't know is what to expect in the new year, what to expect in the with the new presidential administration. I have been in saying that Trump is our first real estate president. So I think it's going to be pretty positive for deregulation for real estate overall. But I don't know, I don't know if you share my opinions or not. What do you think?

Well, I think it's certainly going to.

Be a lot of unknown.

Definitely with his real estate background, I.

Think he'll be much more informed about.

Real estate economics and policies.

He's already started to deregulate the banking industry, unwinding portions of the Dodd Frank act, and I think that's going to lead to a little bit of increased activity. I think the overall environment for real estate, I'm not sure he's going to have too much impact on operations and.

Supply demand, but I think he's going to make the tax incentives better. I think he's going to again help with the regulations which is going to create increased lending activity which drives real estate. So overall I think it's good for.

The real estate industry.

I think also with his big focus on jobs and job creation, small businesses, I think that's also going to drive a lot of the underlying occupants and tenants. Businesses performing well is good for office product. Businesses performing well is good for retail product. People making more money is good for multifamily. So I think all in all having a business minded president is going to have a very positive impact on real estate.

Yeah, I think so too. I Hope he can totally dismantle Dodd Frank, but if, if not, I'll take gutting it. He's already working on that. I, I don't know if I like where he started with the fiduciary rule though. I, I kind of liked that part of it. But you know, that's just because I'm not a fan of Wall Street, I guess. It's interesting. You know, one of the things you didn't mention, and I don't know if you work in this segment of the market, but is industrial properties. So if manufacturing jobs come back to the US that's obviously going to buoy industrial properties as well as proper, pretty much everything else because all of it matters, of course, but any thoughts there in particular?

Definitely more going back to business activity. The more business activity the better is for all product types specific to industrial. To me that's less about Trump in that space. It's more about the change, how people are consuming, you know, buying things over the Internet, distribution networks, the same day delivery phenomenons. A lot of those things I think.

Are going to have more of an impact than Trump. Particularly I think obviously anything that has to do with driving business, whether it's.

Office tenants or increased manufacturing activity, distribution facilities, more things made and bought in.

America is going to have a positive impact. But the Internet is a crazy phenomenon.

And how it's impacted retail and industrial specifically. So many companies have moved away from the big box stores, the 40, 50,000 square foot big retail facilities in favor of smaller facilities with larger back end distribution facility. So I think that really is going to have more of an impact on the industrial side of things than the increased manufacturing activity. But it's all positive.

Yeah, yeah, very interesting. You know, I remember attending a presentation, gosh, you know, 15, 20 years ago now, where they were talking all about retail properties and so forth. And I asked the question about, you know, what's the Internet going to do to retail properties and it's changed the complexion of them from, you know, just my anecdotal observation of that they're becoming more these entertainment destination type places. Obviously we saw that happen. A big one was where I used to live in Orange County, California. The Irvine Spectrum was one of the big first, you know, successes I think. In that vein. Tell us a little bit about what has happened to retail since, you know, the rise of Internet shopping.

Well, anything that you can't do over the Internet is taken forefront in that and things that you can do over the Internet has started to fade or fall to the wayside. Experiential real estate is a phenomenon that's going on in all product types. Trying to increase people's desire to go there. The live, work and play developments, a lot more urban, mixed use. You've seen in pretty much every market.

Avalon and Atlanta being one of them.

The large Tampa $3.5 billion redevelopment here, pretty much every market you're starting to see mixed use, live, work, play type environments. And it's really all surrounding entertainment and experience.

Things that are integrating shopping and higher end residential all in one location. You've also seen a lot of medical users backfill into retail spaces. Obviously seeing a doctor getting diagnostics done, harder to do over the Internet, although that is evolving with telemedicine. But you've seen a lot of orthopedics.

Urgent care, diagnostics, dialysis centers come and fill some of those spaces.

You really don't see the large, big boxes.

All of those have changed their formats to much smaller formats.

Oftentimes people look at something on at a store, they'll go to Best Buy.

They'Ll look at a TV and they'll.

Get online and they'll order through their phone.

That's called showrooming. They're fed up with that. I think Best Buy is fed up with showrooming for Amazon, right?

Yeah, absolutely. I think it's changed many businesses. You know, Bed Bath and Beyond, Sports Authority, you know, a lot of the big department stores, Sears, Macy's, I mean a lot of their futures are really going to be negatively impacted by someone's ability to buy it on, you know, Amazon and have it delivered, you know, next day or same day in some cases.

So there's no question the drive to.

Experiential real estate is really around things you can't do over the Internet. So you see a lot more restaurants, a lot more boutique style restaurants, a lot less of a national chainsaw on those. Really trying to just incentivize people to get out of their homes, get out and beyond their computers and get to a destination.

Yeah, no question about it. You know, I was reading an article recently about even on the ultra high end of retail, Neiman Marcus is noticing that they're having problems with showrooming. Even wealthy people that come into shop and have their personal shoppers at Neiman Marcus and so forth are taking pictures of tags on their phone and you know, scanning barcodes and doing all the stuff that, you know is going on at Best Buy and so forth. And they're trying to make more exclusive products with, you know, their own label that you can't buy anywhere else and this kind of stuff. So they're trying to fight it, but I think ultimately it's a losing battle. I really do. It's just shopping online is just too convenient. It's got to be the experiential thing. I mean it is kind of almost a genetic social activity. You know, back in the times of Rome and Egypt, you know, people would go and shop, right? That's still there. You know, people do want to get out, right. But whether they actually buy much or spend much money out, you know, they're becoming too shrewd for that. Is Amazon just gonna own the world? And, and then maybe the follow on question to that is what is it like in the world of warehouse real estate? You did mention that earlier the demand for that has increased, right, because you got to, you know, these are physical products, they have to come from somewhere. Any thoughts on that? And then of course that there's a huge burgeoning shipping industry has gotten huge, or I should say delivery industry, at least with the FedEx and the UPS and so forth.

I think the strategy for new retail developments is really to anchor it with things that pull people in. You know, restaurants eating still is. People like to go out to dinner.

They like to socialize.

That becomes the main component. Going to the movie theaters, going to.

Do things that are ifly and topgolf.

And these main destination type places, these entertainment and restaurant type spaces are really what's the anchor and driving people to these new retail type mixed use districts and around them, surrounded by them. You're correct. There's a lot more specific brands that you can't buy from Amazon that are Lululemons, Athleticas, the Salt Pines. Very specific tailored brands to surround those experiences. So if someone's walking to go have.

Dinner with their wife and friends, they walk by through stores and try to take advantage of that increased traffic. So pivoting to the second part of your question surrounding warehouses, what you've really seen is a movement from these large.

Distribution facilities that are close to infrastructure, whether it be rail or highways, and a bigger focus on more local, smaller distribution facilities that are really driven for that same day delivery.

You know, in order for someone to.

Be able to get something to you that same day, they need to be closer in to where their ultimate clients are.

So you've seen a lot more activity surrounding that. You've seen a lot less emphasis on the large facilities.

There are exceptions to that.

And Amazon does build large regional distribution facilities, but there has been a lot more Focus on those local infill, more warehouse facilities.

Yeah, it's very interesting.

Pretty big trend going on.

Yeah, yeah, definitely a big trend. Any thoughts on like the distressed real estate market? You know, certainly Florida has been one of the states with their foreclosure process and now I'm talking mostly about the residential side here where you know, those markets with judicial foreclosures have been much slower to recover. Any thoughts on the distressed market? Does it even exist anymore or is it, is it completely cycled through the system? You know, feel free to talk about any product type there. Just an interesting view.

I don't think there really is much of a distressed market today. There are always going to be pockets of it, but they're more situational. Someone over leverages a property, someone has.

A specialty use that goes away, those create distress. But as a broad market distress is really been gone for several years. I mean there was a period of time there where every conference or industry event was around distressed real estate, distressed assets, working with banks, working through bankruptcies. And I think that will return again at some point today I would really.

Call it more of the value add era. Every property that's been put up for.

Sale, all product types are predicated on you buy for X, you improve it a little bit and you get a huge pop in rent. But at some point that's not going to be the case. If you keep adding new supply, brand new supply class a product at the high end and at some point that's going to slow down in this absorption. You can't value add or improve every product up. At some point it will hit a ceiling and start to push back down. We've been seeing that value add trend for several years. It's also been reflected in pricing where as we call it, the cost of blue sky is going up, meaning the opportunity to have that value add is coming at a premium. So oftentimes you see buyers paying for that upside as if it's already happened. So I think that's a big caution for people just when they're looking at a value add property is really trying to understand from a market perspective why is it a value add. Because that's how we ended up in that last downturn was that top end.

Of the market was delivering a lot.

Of on top of the economic collapse and CDOs and CMBSs. What you were seeing more from the investment side of things, from an operational standpoint was that everybody was improving their properties under the same scenario. Everything is a value add play 100% of deals are being sold that way. So I think we really moved out of the distress market really several years ago and are now in the value add market.

Yeah. You know, being in the real estate brokerage industry for all my life virtually, I've never felt that there is a time where things are balanced. It always seems like it's imbalanced. Either you have too much inventory and too few buyers, or which is most of the time, it seems like you have too little inventory and too many buyers and you can't satisfy the buyer demand. How do you feel right now in the marketplace and in which direction do you think that's going?

Well, we talk about a lot and.

Steal something from Warren Buffett. It's fear and greed. That's what drives markets in the bottom. Everyone's afraid of everything, very reluctant to go forward. And in a market like today, where things are much more difficult, you know, you feel like you're missing out on something. You hold back a little bit because.

You think you're at the top of.

The market and then it runs for another couple years. So you feel that you're missing out. And many people in the real estate business, their incomes, their entire companies are set up to do deals and be active and be involved. And that kind of comes back to the greed end of the spectrum where people are buying into these pro formas, solving for a result. As we talk about that, really, you can make numbers say anything you want.

But the probability of success is really.

What is a greater concern and where I think we are in the market. I don't have a crystal ball. I wish I did. But I do have a sense that we got to be closer to the top than we are to the bottom.

You don't make money by buying high and selling low.

It's the opposite.

Doesn't mean that there's not opportunities out.

There in specific pockets with specific uses which we could get more into. But as a whole, for quite some time, we've been seeing rents increase across the board in almost all product types. We've seen a lot of capital improvements. On many product types, you've seen appreciation at a very, very high level. We've had this low interest rate environment for a decade at this point. And even the interest rate increases that.

Are dominating the real estate conversation today.

Well, I 100% agree. In the short term, if someone's eminently closing on a deal in the next couple months, it's going to affect their acquisition pro forma. But pretty much all pro formas I see on the exit side of things are assuming an increase in interest rates.

So I think that is not going.

To be as impactful as people think. I think it definitely does change the analysis, but people have been planning for that and building that into their projections.

For quite some time.

To me, the bigger challenge is the demand versus supply. We were very constrained between 2008 and 2012 on the supply side of things. We're now delivering products pretty much across the board. There's been compounded rent growth for quite some time. A lot of the new construction is being based off of that continuing.

At the same time, you had a.

Substantial increase in construction costs. So things are. There's a big competition for materials skills. Meanwhile, the Fed has been trying to control some of that development pipeline by restricting loan to values and underwriting criteria for construction loans. You've seen some significant movement on that in the past couple years. So you put that all together, you have slowing rents, slowing growth on the rents, maybe flattening, increasing construction costs and lower loan to values, higher costs, more regulation in the construction loan segment. That is a formula for really an overall slowdown. So I want to get addition of existing product.

Make sure we get a perspective as to what you're talking about when you say that. What's your average sales price? What's your average deal size?

Around 7 to 10 million.

7 to 10 million. So are those pretty much all institutional buyers or is that kind of a mix? You sort of seem like you're on that borderline of, you know, you'd get some wealthy individual investors and then some institutionals that would dip into your, your size market too. What's the mix there?

We're more heavily favored into the private client space in the institutional market. You know, institutions want to cut checks of $20 million for equity.

Right.

So they're not really in playing in the space of where they're putting in 2 to 3 million dollars.

But with the appreciation.

Yeah, even on private client deals, those are, you know, the deals that were definitely private clients. You know, 10 million have appreciated to 15, 16 million bucks. So you're starting to see a little.

Bit of a transition.

Also on the construction loan side, institutions have large balance sheets, so they're able to maneuver through that a little bit easier.

Really.

The change in construction lending has impacted private clients more than institutions.

Interesting. So definitely we're in a market of cap rate compression. I think you'd agree with that. What's the typical deal, what kind of cap rate you're selling a deal on nowadays? Is it 4 or 5 cap or what kind of numbers are you talking about?

Well, cap rates are always an interesting thing because if you ask four people what the cap rate is, you get four different answers. Current cap rate, stabilized cap rate, cap.

Rate, form a cap rate. And I think that's the real cap.

Not the, not the optimistic future cap rate. The cap rate at say at the time of sale, you know, I think is the fair one, right? Wouldn't you?

Well, you know, you could buy a vacant building that's a zero cap where you're able to turn around going back to that value add where no one's buying it off of a current cap rate, they're buying it off of a stabilized cap rate. So it depends on the nuance of what we're talking about. But to answer your question more generally, I would say on the apartment side of things, multifamily for class A buildings, depending upon the markets, you're seeing them somewhere between a 5 to 6 cap for a product, sometimes lower. In the major metros, B and C class properties, you're really seeing those between.

Six and a half to seven caps.

And the sevens being few and far between. On the retail side of things, it depends. If you're talking about urban infill versus suburban, more neighborhood type centers, the urban infill is going at a substantial premium. To me, that's one of the hottest markets because of that experiential concept we were talking about and the high demand to be in those locations from retailers willing to pay very large rents in that space. You're seeing those deals trade again between five and a half to six and a half cap rate, more just neighborhood, suburban shopping centers. You're seeing trade around 7 and a.

Half cap rate range on office buildings.

Suburban office has definitely fallen out of favor with the push to be more urban in its locations. So you'd see suburban offices trading somewhere.

Between an 8 and 8 and a.

Half cap, with urban offices trading between pretty wide range depending upon what you're looking at. But somewhere between a six and a seven and a half cap rate range depending upon the amount of turnover and the rent rolls and ti that would.

Be required to get at least back up.

I don't know if you are, Ken, or are willing to answer this question, but I'm going to ask it anyway. And then we got to wrap it up. Obviously, in your world, in the commercial real estate world, what is your favorite product type, you know, for your own portfolio, for example?

Well, it changes a little bit.

I guess that's the benefit of being in multiple Product types. I mean, as a standard rule, I would say apartments multifamily are my favorite.

Yeah, I would agree.

People need a place to live, they need four wall sitting on the floor.

They don't need to go to Best.

Buy and in this day and age, they don't even need to go to an office building. They work from their home on the Internet.

Yep.

So as an overall concept, apartments would be my favorite. That being said, they're definitely not my.

Favorite today because they're so overpriced.

Everybody is paying. You know, on that value add going back, people aren't really buying on current cap rate, they're buying on blue sky.

Yep.

And there's so much money in that space current.

Oh, it's just insanely competitive.

There's also a lot of so much supply coming online that's going to really make those operating fundamentals not look so hot here for the next couple years. That apartments, you know, today are not my favorite. My favorite product type today would be mixed use retail infill. There's a high competition. You're going back to the old rule of real estate.

Location, location, location.

Well, in today's world, being in the high demographic areas, high barrier to entry and having sufficient parking lot, those are very safe companies that are not threatened by the Internet. They're having record revenues. We're seeing corporate profits continue to drive up. And I think there's a lot of room still to run inside that space because it's just a harder one for.

It to break into.

Yeah, that's, that's really interesting. I want to ask you two questions about that. Number one, are you concerned about the self driving car and autonomous vehicles changing that location, location, location dynamic that has been with us since the beginning of time. And number two question is, when you say mixed use on those urban infill, what do you mean mixed? Do you mean retail and residential or retail and office?

First question on the automated cars, I.

Think it's going to have substantial impacts.

To real estate development. Parking ratios, municipal revenues, a lot of municipalities, large parking garages that drive a lot of revenues. I think it's going to absolutely disrupt it. I'm not sure it's going to change the location, location, location piece because to me that's really more about proximity to where people live or where they want to be. And even if I have to take an automated car to get there, I still want to go to those hot areas. What it may allow to do is, you know, rather than going to the place that's a mile from your house you may look to go across town, you know, 20, 30, 40 minute drive because you can enjoy the company of people while you're going to the hot spot that's across town.

Right.

But I don't think it changes the fact that for retail, this experiential retail, the location of it will not be impacted at all by the automatic car. Now as you start getting into again the development, how they're designed, parking is always a top concern for all product types. Parking ratios are a struggle for all developers, particularly in urban locations. So what it may do is it may allow for a lot more activity actually as a result, as parking requirements come down, you're allowed to pay more or brings down construction costs. You'll be able to pay more for that and, and really would drive that market instead of the opposite. What was your second question?

I'm sorry?

Well, just that what's the mix? Is it office and retail or is it residential or in retail?

Yeah, you really see them as both. In many of the developments you have all three product types, office, retail and multifamily. You are seeing more of a trend.

If you're only going to pick two.

It'S really more retail and residential paired together. But this live work play concept, this urban movement is really all of them. And many developments I've seen around you see ground floor retail, maybe second floor office and then residential, you know, on top. It also helps with the parking ratios to have them blended together. Typically office is more of a daytime traffic retail restaurants is more of a nighttime traffic demand. So it also helps with your parking ratios in terms of what you can develop with density. But I think people want to live work play. They want to be able to walk to work and walk to their restaurant, walk to their gym and then you know, walk home. So I think that's more of what's driving that mixed use piece.

Very interesting. Give out your website and tell us where people can find out more about you.

Www.franklinst.com franklinst.com we do a whole host of services. We do property management, leasing, tenant rep, investment, sales, debt and equity appraisal across office, apartments, retail and industrial. We are accessible all the time. We are very client centric business. So we consider ourselves to be advisors. You know, we don't make widgets or sell iPhones. We sell people knowledge and real estate services. So love for people to check us out.

Fantastic. Well Andrew Wright, thank you so much for joining us.

My pleasure and thanks a lot for having me.

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