#112 Diversify Your Portfolio With Industrial Investing

Welcome to the Passive Income MD Podcast, where we talk about creating your ideal life through multiple streams of income. I'm your host, Peter Kim. If you enjoy hearing about this stuff, make sure to hit subscribe so I can bring it to you every week. Now, let's get on with the show. Hey, everyone, we have a real treat today. I'm going to really enjoy this interview. We're going to be talking to Andy Sinclair. He's the CEO of Midlock Investment Partners. Many of you probably encountered Midlock at some of our conferences. Just so you know, they're a real estate private equity company. They help investors like you and me make smart investment decisions when it comes to real estate investing. Just so you know, Mr. Sinclair, I'm going to call him Andy. He was a vice president at mlg man. Many of you have heard of that company as well, where he was in charge of of the private equity division. He has a really extensive background in real estate, really involved in billions of dollars of real estate transactions over time. He's a big believer in diversification when it comes to investing in real estate. I know we all love that as part of this group. So we're going to be talking about all these things. We'll be talking about different asset classes within real estate. I'm going to get into a little bit about industrial because I know he's a expert in that area. Something I don't know a ton about. So maybe it's something that you might want to find out more about. So we're going to be talking about all these things today. Andy, how you doing?

Hey, guys. Welcome. Thanks for having me.

Well, thanks for joining us. I really appreciate it. I know you're extremely busy, and obviously today, obviously things are going on, going a little nuts in the economy. There's a lot of uncertainty. And so we're going to be talking about some of the ways you guys are investing in terms of making sure you're well diversified. But hopefully I did your intro okay, meaning that I did you justice. I mean, do you mind sharing a little bit more about you and maybe a little bit about Midlock?

Yeah, no problem. So my name is Andy Sinclair. I'm the CEO of Midlock Investment Partners. We're a real estate private equity firm. Good diversity, by the way, of the people that run Midlock. I'm an investor for the bulk of my career. But my two partners, one's a former lender at Ladder Capital, the public reit. And then I also have another partner named Josh who's a developer. So one Thing I always find unique about midlock, Peter, is that while we are an investment company, our principal team has diverse backgrounds. And so that gives us good perspective when it comes to being diverse and trying to figure out how to approach a market that's ever changing.

I mean, when you talk about being diverse, what kind of things are you investing in? I know you invest in multifamily, but in addition to that in apartment buildings, what else are you investing in?

Yeah, I think similar to most people, Peter, I looked at my own portfolio the other day and I realized at times that I can have a lot of apartments. Apartments, the last 10 years have been a great asset class, remain one of our favorite asset classes. But you know, at midlock we're big believers of being diverse. Right. And that means asset classes that we invest in, like industrial warehouses or a little bit of self storage, some neighborhood retail and occasionally some office buildings. And so, you know, overall commercial makes about 60 to 55% of our portfolio and the rest is still apartments. So pretty well diversified as a group.

I mean, based on your experience, do you, do they tend to cycle together or is there a reason for that, for all that diversification? Cause I think when people talk about real estate in general, again, they use generalizations. The real estate market's in a bubble or things are going to go up, things are going to go down, they're in a cycle. Can you talk a little bit about how some of those investments like may correlate or not correlate with each other and how things move differently?

Yeah, by the way, I understand the connection. My 95 year old grandma still thought I was a realtor until the day she died. So we're always fighting a little bit of the crossover between housing and commercial real estate. You know, certainly they're connected to a degree. You know, interest rates probably being the most common underlying factor. You know, the interest rates that are happening in the economy, whether it be the Treasuries or the lending rates for apartments, it's similar for commercial. Now there's differences. You know, obviously Fannie Mae and Freddie Mac are a lender for apartments and they're not for commercial. And so there's differences in types of lenders. But overall the connection to the economy is, you know, if you have a good market for apartments, it's normally a, probably a pretty good submarket then for industrial warehouses. Right. People live somewhere, they're probably going to want their goods delivered from Amazon or you know, jobs to employ their people. And same would go for some neighborhood retail. Right. As A Starbucks or a Brewers or a Caribou Coffee. Right. You know, if you live and you like where you live in your apartment, you're probably going to want to go get coffee at some point. So there's certainly trends that connect both locally and nationally, but they also diverge. Right. You know, apartments have had a great run the last 10 years. And I would tell you commercial I still think has a lot of tailwinds kind of pushing those investments forward. And we can obviously talk more about that as well.

Yeah, I would, I would love to talk about that even right now. I mean, you know, obviously we've seen apartment buildings do well. We've probably all heard about industrial and things like that and we've heard how office space has done during the pandemic and all these things. Do you mind going into it a little bit for someone who's probably new to this? They might even never have heard the word industrial. And you mentioned warehouses, but you might go into a little bit about what is an industrial investment? What does that mean?

Yeah, so the word industrial is this catch all terms for different types of buildings that typically either manufacture goods, store goods, or ship goods. On one end of the spectrum you have Amazon, FedEx, UPS, right. They have trucks coming and going, they have boxes wrapped up or as high as the ceiling will let them. And then on the other side of the spectrum you might have tenants such as, for instance, someone who might make peanut butter jars. Right. The little plastic jars, you see, right. They're putting all those jars together so they could put peanut butter in it. And so how does that impact the industrial market? So warehouses, I think everyone thinks of E commerce, but they're only a fraction. Even though they're an outsized amount of the demand that's been happening lately, they're only a fraction of what's occurring. Right. And so we have a lot of other tenants. You know, sometimes you might not even realize that there's a warehouse tenant, bakery, a manufacturer, E commerce tenant in your local neighborhood that's using a where house space. I toured a building last week, Peter, that Midlock Fund 2 has under contract multi tenant warehouse building. And we have a range of tenants. It's very chopped up, which is the good thing. Means it's highly diversified. You know, we have a medical tenant that has a clean room, which has been one of the big trends Blackstone's been following, which means they can, they can do their pharmaceutical things. And then we had a building contractor that builds buildings that had their, you know, equipment in the warehouse building. As well. So he had definitely two ends of the spectrum in that regard.

So, I mean, where do you think the market is right now for industrial? Like, how's that changed over the last, know, five, ten years? And where do you see that going in the next 5, 10, 15, 20 years for us, like, looking at that as investors?

Yeah, I think the markets changed a lot. So if you go back even a step further, Peter, go over 20 years, you know, rental rates have really not grown. Industrial used to be considered kind of the lower tier. You know, you think of what's sexy, right? Office buildings are sexy, right. New apartment buildings, new hotels, really Sexy. Warehouse buildings 20 years ago were kind of an afterthought. Right. If you have a tenant in there, whether they're shipping or building or whatever, not a very sexy thing. But over the last, I would say the last 10 and even more recent last five years, we've seen a huge trend and part of it's been the markets, whether it be locally or nationally, they've been about 95% occupied. No matter what type of building you own, if it's 95% full, the rents are going to go up. Right. And I think you're seeing two demands, Peter, here, E commerce being one. We've talked about that a little bit. But then also you're seeing a lot of onshoring and that's been a real big trend. You know, whether you had a supply chain, let's say you had a little.

Yeah. Do you mind explaining that a little bit? What does on shoring mean? I'm not.

Yeah, totally. So, you know, onshoring means you're bringing your supply chain back home to the U.S. you know, so for instance, let's say you were hardware manufacturer and you used to source a screw from China. Well, I think if you turn on the news today, there's a lot of lockdowns going on in the world. You know, China, even though the US has come out of COVID China is still very seriously taking Covid and keeping their economy shut down. Well, if you're some type of a part distributor, you know, you can't get those parts. How do you get them there? So you're going to see people bring the supply chain back home and you combine that with E commerce and all the other tenants that need warehouse space, like those contractors we talk about to all these tailwinds of people that need space. And so what we've seen the last five years is you've seen rental growth really exceed in a lot of cases, even apartment rental growth. And so we think you're only going to see more tailwinds. And by the way, it's hard to build an industrial building. It's not like you can just go plop a building anywhere you want to. You know, if you think about your neighborhood, there's probably not a lot of space for a half a million square foot building. That's a big building. And so you see more buildings go further out because there's no space the closer you get into the community. But rental growth for sure and then I think demand from E commerce as well as supply chain people coming home, those are the big trends.

All right. I just want to understand the investment a little better. I think that when people think about apartment buildings, it's pretty easy to understand you. Cause we've all been renters before. So you buy apartment building whether you build it or whether you buy it and try to increase rent. People come in and have leases and you got to take care of everything, have property management and all that stuff. Like how does it work with industrial buildings? Let's say both from. Let's talk about development, but let's also talk about like, let's just say you buy a warehouse, you just rent it out. Somebody. What do you have to cover? What do you have to manage? You know, what do you, what are the situations that you have to deal with? Like owning that thing. Yeah.

And so it differs from apartments. You know, I agree everyone's been a tenant at some point and normally you sign a 12 month or a one year lease, you know, for warehouse buildings, industrial. Right. You have businesses or your tenants. Right. Very rarely do you have, you know, Andy Sinclair just going to rent a warehouse space just for the heck of it, to store stuff. Right. So what you see is, you see businesses looking for space. And businesses don't usually operate in a one year timeline. Right. Because what happens if someone else wants that space in a year? So you don't want to be moving every year. Normally you have tenants that commit, you know, as little as three years up to 15 years. I would say the most common is a five to a seven year lease. So there's a lot of security in having a long term lease. Now most landlords, including midlock, you. Right. You try to have staggered leases because you don't want all your leases to come due at the same time. And what we're seeing right now, we bought a building, last mile, warehouse building, which means it's really close to where people live and the city center. We have some old seven year leases where the tenants locked in seven years ago, low rent. Well, guess what, the rent's up 40 to 50%. And if they don't want to stay, you know, our neighbor, neighboring buildings owned by Blackstone, the largest investment company in the world, their rent's even higher. So, you know, so certainly you have leases that are quite a bit different. Now your tenants though, what I like about that though, Peter, you have what they call credit in the business. You have businesses that have money to pay for leases, payroll, you know, they keep cash on hand. They're not just some fly by night, you know, swipe their credit card to make sure they can get by. You know, ultimately the real estate portion of their business, it's a small part. You know, you think about a business, most of their costs are spent on people and product versus the real estate. So those types of tenants we have, and frankly, you know, I'll take a seven year lease. When the economy is volatile over a one year lease any day, I mean.

How does that work with, I know that with apartment buildings, if every year the lease comes up and depending on how the market is, if it's a hot market, obviously if inflation is up or these are the kind of things you can make some changes to, or your property taxes go up or whatever it is, you can make changes to the lease and go up over time. And that's one way you can increase value of that. What about for like industrial? If you're signing these seven or 15 year leases, are they typically locked in at the same rate the whole time or how does that work?

Yeah, so there's two parts of it. So commercial leases and industrial in particular, what's known as net. Sometimes you also hear this referred to as triple net, which refers to different types of expenses, right? So for apartments, for the most part, you know, maybe you might be paying your own utility bill, but the landlord covers most of the expenses, right? The maintenance guy, the landlord pays for that. They don't. You don't get a bill for the maintenance guy to your apartment every day. But for warehouse buildings, commercially, you have these net leases. And what that means is the tenants all share in the, the, essentially the expenses of the property. As a, you, as the landlord end up with just a net check, right? You just get the same amount fixed. Now, let's say inflation increases your insurance amount, right? You know, say your insurance goes up $100,000. You know, for apartments, you can definitely reset the rent. You can increase it 100 grand to recoup your insurance bill, you know, maybe 200 grand to make some profit on that. But for warehouse buildings, what you can do is you can say, hey, our cost of increase. And usually once a year you will send an expense report out to your tenants and you will say, okay, our costs went up 100 grand for insurance, you know, if you're 10% of the building, you owe a check for 10 grand to cover your portion of the cost increase. And that goes the same for taxes, by the way. Now, usually most leases, Peter, they have a built in increases. You know, the best leases have what's called a CPI inflation index. You know, there's a, one of our, one of our senior analysts that works here for midlock, he talked about his previous firm. That was the number one thing they asked for in leases, which is they wanted the greater of, you know, either 3, 4% or inflation. What you're seeing today, Peter, though, is that new leases that get signed, the rent's much higher and then the average rental increase is 4 or 5%. So they're making up for inflation being more than 2% by having higher annual increases. So pretty good increases. But you also know you're protected on your expenses too. That's a good thing as an investor and a landlord, I mean.

Okay, I mean, that's really interesting. So if again, a lot of people, when they invest in real estate, let's say they own it themselves, they're kind of worried about the hassle and the time and that sort of thing. So it sounds like for industrial, like a lot of it's really on the tenant themselves. The business to take care of all the inner workings. Is that. Do I have that about right?

Yeah, not quite. So the landlord still will contract out, you know, the roofer, the maintenance person, the cleaner, all those things. But the tenant's responsible for paying. So it's use the landlord, you take care of getting all those things. You're the parking lot person. Right. But at the end of the day, you just get a bill for it.

Okay, interesting. All right, so do you guys invest in just like, you know, taking over existing warehouses or, you know, the other side of it development? Like what does that look like in terms of building these type of things?

So our preference, Peter, is to buy existing buildings and grow their value. Right. Either by growing the rent, right, as those leases come due, you know, increasing the rent or trying to find other, you know, things that people don't see, like is there excess parking? We can sell or build another building on, you know, midlock. We own a building right now. It came with a whole Extra parking lot that's next to the building we're currently building, a warehouse building for a Fortune 100 tenant that nobody valued. The parking lot. Right. Totally, totally worthless. But for the most part, Peter, we prefer to buy existing buildings and grow their cash flow. One, it provides a stable, you know, investment dividend. We pay monthly dividends here at midlock. And so you get a stable dividend and usually growing as you grow the income. And then also we think there's tailwinds where the buildings are going to appreciate in value, both from a rent and building value perspective. There's nothing wrong with development. It's certainly been the hot area of warehouse buildings, but inflation's a real thing. Right. And so until a building's built, the landlord or the developer bears all the costs to build that building. Right. And so if construction materials go up materially, you know, your only way to recoup it is to charge more rent. I do think tenants are going to pay it. That's why at midlock, almost everything we do is existing buildings we can increase the value of.

I mean, in today's environment, everyone's talking about inflation, rising interest rates, all that stuff. And so people are pretty obviously, they're, they're, they're scared and they're hesitant about investing in almost anything right now, is what I get the sense. Right. There's a challenge to every bit of investing. Like for the industrial sector, when you talk about that, how does the outlook look when things like inflation's high or when interest rates are seemingly going up and that sort of thing? What does that whole area look like? And are people optimistic still when it comes to industrial?

Yeah, I think industrial has a few more tailwinds than maybe any other property type. Right. There's still a lot of demand. Lots of tenants want to be in the buildings. And so from one hand, if you're worried about inflation hurting your, you know, your dividend check, you know, you have those great tailwinds. Also, one thing we consistently hear from all lenders right now, if they don't want to lend an apartment, they likely want to lend on industrial. Right. Because they see all these tailwinds. And so the cost, excuse me, the cost to borrow for an industrial building is not materially different than it is to borrow an apartment building. And that's because you're the two favored property types right now. So I think even though inflation is going to be persistent here, until there's some changes, I think industrial is the spot to be. By the way, part of what might fix inflation is bringing more goods. Right? And so, you know, right now there's an issue in agricultural. There's not enough goods, you know, not enough food out there. Right. There's not enough baby formula, you know, that's in the news right now and think all those things. As, you know, you need warehouse buildings to store those goods and ship them, which actually means part of what might fix inflation is actually more demand for warehouse space. So I feel bullish on it. Peter, what might occur.

All right, now I want to talk a little bit about the due diligence for this. Like, as an investor like me or people listening to this, like, let's talk about things to look for and things, I guess, to, I don't know, I wouldn't say red flags, but things to kind of, in terms of due diligence, understanding what not to look for when you look for. I mean, I doubt many of us are probably going out and buying our own warehouse. I mean, it's possible. I would say it's probably possible, but most of the times I would say probably people are investing with other people and other sponsors who are buying these warehouses and these kind of things when somebody's doing the due diligence for this. What are some of the big key points that we should be asking of a sponsor, an operator, and asking to say, hey, this is something that would fit with us or would be a good sponsor to invest in. What kind of questions should we be asking?

Yeah, well, first off, you obviously want to trust the sponsor. You want to know they have a good track record on executing that goes unsaid. But for warehouse buildings in particular, there's really three things I would point out. The first is, are the tenants credit worthy? You know, midlock. We recently had a deal that we really liked, right? You know, great building, you know, we actually owned the neighboring building and the tenant, the main tenant, we didn't think was credit worthy. So even though we love the building, you know, we looked at each other at our table here in our conference room and said, well, what happens though if the tenant just stops paying rent? You know, just no different than it being difficult. If you had to evict a tenant out of an apartment building, now you got to evict a business and get them out of the warehouse. So we opted to pass on that building. So I think the first thing is to say, is the tenant credit worthy? Right. Are the tenants able to pay the rent that you can hedge some of that, Peter, with multi tenant buildings, if you lose one tenant in a multi tenant building, Just like if you lose a tenant in a park, really not a big deal, right? You can deal with that. So that's the first thing. The second thing that hurts people with warehouse buildings are, have you checked your capital costs? The number one thing when we're doing due diligence with my team, I always say, have we checked the roof? Have we got a professional roofer up there? Have we had a professional parking lot person, you know, H vac, those big air conditioning and heating units you see on the roof? Have you had a professional engineer go check on it? You know, and so those are the big things. Have you thought through all these expenses? Obviously, if your roof goes bad and caves in, which nobody wants that to happen, that's something that could have been preventable had you checked with a roofer before you buy in. And the third thing I think for Industrial is do you have the right team, whether it be you as a person and, and you have the right management and leasing team or the right sponsor to lease the building? Right. And so the question is, if you get it vacant, because it does happen, right? Tenants don't always stick around. You know, what's your downtime assumptions? How much money is it going to take? Now, one thing I think Industrial is nice on, generally tenants don't want a lot of money for their warehouse space. You know, they're not looking for, they're not looking for a brand new kitchen to move in and store their goods. So. But there still is a cost and people should be ready for that.

Just to set the expectation for investors. What's the timeline for some of these investments? You mentioned that you guys end up paying monthly because of that set income check that comes in, but for the investor, is that what should be expected? Just steady distributions? How long are these deals typically in terms of lifespan of these and what does that look like?

So we go on every deal, Peter, and we're looking to hold it between as little as three years to seven years, right? And so everything we do, one thing we consistently say at midlock is we're looking for kind of two to four ways to make money.

Right?

And the reason is, is that cash flow is always important, but if you have other levers to pull, especially as you look at inflation, you know you're going to have other things that can help you grow your building's value. Everyone wants to appreciate just because you bought a good location. I always say instead of location, location, location, it should be business plan, business plan, business plan to grow the building's value. So we go in for three to seven years with a plan to grow the value. Now usually after the first few months, we do start regular distributions. And so we're constantly evaluating how we can get our net income up so we can pay more. We try to set our dividend level at Peter, our distribution rate at a level that's sustainable. And then as we grow our net income, we grow it right. We try to grow that, you know, that net income a little bit higher so people get a higher payout. What's nice versus apartments, you know, apartments. Let's say everyone moves out during the summer and we all. A lot of apartments. So I've seen this happen. You might have a month where there's no money to distribute. You know, for these warehouse buildings we've been talking about, you do have those leases that are a little bit longer term. And so you can plan months, quarters out, you know, so as you look at dividends, but three to seven years. And the reason we're not going to own indefinitely is at some point, you know, we want to see our investors make money, take a profit and then decide if they want to reinvest with us or elsewhere. You know, the last thing you want, and this goes for the midlock or another sponsors. You do not want your money to be held hostage. You want to have freedom and flexibility to reinvest it. Where you see that.

All right. I mean, I felt like this was a quick master class industrial. So thanks for taking the time. This is.

Yeah, no problem.

What other areas are you looking at? You know, we know that you have multifamily industrial. What are some of the other asset classes you're looking at?

Just curious. Yeah, so 40% of what we do is apartments. I still think you're going to see a lot of people. Everybody has a place to live and it's more expensive to build places. My only thing to be cautious on apartments is right now is just the cost to buy. And so right now cap rates have been very low. So the lower the cap rate, the higher the price. So just being really careful about what people pay. Also I mentioned to Peter, you know, right before we jumped on this call is I still think there's some very good tailwinds for things like self storage or retail. You know, people have tons of stuff that they need to store and retailers, you know, even though malls are dead, don't invest in malls is my advice. You know, you probably went picked up your Starbucks cup somewhere, right? You probably went and got your Chipotle burrito. And so I think having A little bit of retail and anyone's portfolio is not a bad thing, especially if it's what we call neighborhood retail, which means Chipotle, Caribou, Bruggers, you know, all those tenants, those cap rates are much higher. You know, we looked at a Bruggers investment today, Bruggers, Verizon, it's a 9 cap. That's a lot higher than apartment cap rate, which might be at a 3 or 4 or 5 cap rates. There's a lot of, there's a lot more income before you've even started your business plan.

All right, I mean, that's been super helpful. Now, just so we know how you guys are thinking about mitigating risk in this time. I mean, that's something I'd love for you to talk a little bit about because again, with inflation, with the market, with people thinking it's a bubble, interest rates rising, definitely there's some concern there for a lot of people. How are you looking at investments overall, just generally in terms of philosophy? And are you still investing right now? Are you holding back? What does it look like for you as a company from midlock to actually mitigate risk and still try to get some returns moving forward?

Yeah, I think the biggest thing, Peter, and how we mitigate risk is you gotta be really careful about what you pay. And also that goes for industrial too. You can't just pay any price. I say that every week when I walk into our investment committees. We can't just pay any price just because we like apartments or warehouse buildings. The second thing you can control is not taking on too much debt. You know, the world is littered with companies, or real estate for that matter, that took on too much debt. Midlock's portfolio is about 61%, which is a lot better. Most people buy their homes with 80%, you know, buy real estate between 70 and 75. So we're only at 61 as a group. I think the other ways you can mitigate debt too and mitigate your risk is making sure you pay a little bit extra for prepayment flexibility. And so many groups, they just want the lowest interest rate. I was on a call today on a property, Peter, and I was saying, okay, what's your assumptions for this type of loan? And they said, we're going to have a 10 year loan, no way to sell it. That's a mistake. I think that you need to be really careful about having the right lender that matters as much as is making sure you pay a good price for stuff. And so we limit our leverage. We're careful about what we pay. And then also one last thing I would add about mitigating risk, it's having a little bit of a good offense strategy. We do hold to having two to four ways to make money on a per property basis. Because if your only way to make money is location and cash flow, just be prepared to be disappointed. And so you want to make sure maybe the rents are below market. I brought up having a vacant parking lot that nobody valued, that we had a tenant wanted it for their own building. Right. We're always looking for a different way that maybe the market's not appreciating because people are so focused on just the building they sometimes need to look. What are the other ways to make money other than cash flow?

All right, I think this has been super helpful. I think people listening to this are going to get a ton out of this. I know I've learned a lot. Where can people reach out to you, connect with you if they want to find out more about what you do, your investments and things like that?

Yeah, if people are interested, reach out to us@midlock.com that's M I D L O C H so just like the lock nest monster m I-l o c h.com Midlock currently has our second value fund open, the one that's interesting. Our fund are co GP oriented, meaning that each fund, when you invest in the fund you're actually investing with the friends and family or the developer stake. You get a little bit of the carry interest, which is a good thing, without explaining all the exact math of that and then every other deal. Peter we try to have an open either a co investment or a sidecar where you can invest. Pick and choose what property you want to be in. So reach out to us and we've got a great team here at Midlock and happy to tell you more.

That'd be awesome. Well, again, I want to thank you for your time. This has been amazing and hopefully people have learned a lot and you know, they'll check you out and find out more about Midlock. So thank you so much, Andy. Really appreciate your time. Take care. Let's talk again soon. Enjoy the show. Let me know by dropping a review in the podcast app you're listening to us in. And if you haven't already, make sure to hit subscribe. Are you part of our community yet? Join thousands of physicians who are also on this journey to creating their ideal lives through multiple streams of income. You can join us on our Facebook group Passive Income Docs and you can open. Learn more at our website passiveincomemd.com thanks again for allowing me to be a part of your journey. See you next time.