"Does this building have the problems that we are outstanding at solving?"
In Episode 7 of Durable Value, Joe and Ryan discuss investing discipline, how to develop it, and how it should inform your evaluation of commercial properties.
Learn more at graceadapartners.com
"Does this building have the problems that we are outstanding at solving?"
In Episode 7 of Durable Value, Joe and Ryan discuss investing discipline, how to develop it, and how it should inform your evaluation of commercial properties.
Learn more at graceadapartners.com
Start Transcript
Joe Muratore:
Part of the reason a building should be exciting when we drive up to it is because we're going to have to put a lot of work into this thing. And for me, when I wake up in the morning, I want to wake up in the morning, excited about a building's future. I want to wake up thinking about the cool ways we're adding value and the great traction we're getting with tenants and the positive impact we're having. I feel like life's too short to work on bad buildings, and life's too short to work on buildings that don't motivate you in some way. And ultimately, I think that'll impact your success. If you're working on C class buildings that might get to C plus that's not good enough, or at least I don't really enjoy working in that space.
Ryan Swehla:
Well and I think that resonates on our, the why for why we do what we do. We create environments that transform people's lives, and we need to feel like we drive up to a property and we're doing something fun and exciting. And coincidentally doing that fun and exciting work also means that your property is more desirable and that makes it more leaseable, but life is short, like you said, and we want to see the impact of the work we are doing.
Narrator:
From Graceada Partners, this is Durable Value: An Investor's Podcast where host Joe Muratore and Ryan Swehla demystify commercial real estate with safe, sound investment strategies to help you balance your portfolio.
Ryan Swehla:
So Joe, when you think of investing discipline, what do you think about?
Joe Muratore:
Investing discipline is essential to our business. This is the act of consistently making good decisions, this is the act of going through a process that you believe in and that you've built over time. It allows you to build something repeatable, scalable, consistent, something that you can count on.
Ryan Swehla:
Yeah, absolutely.
Joe Muratore:
What's it mean for you?
Ryan Swehla:
I think it's practicing a muscle and going at it day in and day out with the same methodology, regardless of what exterior inputs you receive. It's a process of being able to factor in your current reality, but also not being overly emotionally drawn by the current circumstances or fads or popularities or whatever, maybe.
Joe Muratore:
Do you think we approach it differently?
Ryan Swehla:
Yeah, yeah, absolutely. I think I look at it maybe a little bit more like the matrix where it's a set of numbers and we need to be able to parse through those numbers and be able to do it in a agnostic way. I love being able to wrestle over our assumptions, our leasing assumptions, our construction costs, that sort of thing, and narrow down to what we feel really comfortable about and then just letting all the numbers fall into place and see if it's a go or a no go, seeing where it does make sense, where it doesn't make sense. And I know my experience with you is very much a market based and a physical approach to investing, would talk a little bit about that?
Joe Muratore:
Yeah. We have an intern in our office, [Curt 00:03:54], and I was talking to him yesterday while we were in Fairfield looking at a building, and I noted that you and I have different approaches, and for you an offering memorandum can be very insightful in understanding a property, and that's usually where you like to start, a lot of detailed written information on a property. For me, I like to start with an idea, I like to go to the property, usually print the OM, offering memorandum, and bring it with me, but I like to touch and feel and see the building, when I've seen the office space, when I've seen the workers in the space, how they feel, how they react to the building, it informs how I read the offering memorandum, provides additional color, it helps me spot red flags and problems.
Joe Muratore:
But fundamentally, I start with an idea that comes from the book, Essentialism, which is there's enough decisions that in life things should either be a hell yes or a no. And generally when I drive up to a building, it needs to start with a, "Okay, this is great, we're in the ballpark." This feels, and by feel I mean, a career's worth of decisions and ideas about how things should be when I come up to a property, it checks enough boxes that I know, "Okay, we're in the ballpark here. Let's dig in on this." That's where I start, what about you?
Ryan Swehla:
People talk about themes in investing and popularities, demographic trends, that sort of thing, and that certainly has to inform how we operate. But I also know that in any given asset class, in any given geography, you can find great investments and you can find lousy investments. So I also find it helpful, we invest in office and people say, "Oh my gosh, COVID, no one's going to be in offices anymore." We invest in retail and people say, "Oh my gosh, Amazon, there's no reason for retail to exist."
Ryan Swehla:
And then on the flip side, people say, "Oh, wow, apartments, industrial, everybody should be investing in those asset types." Which we do invest in as well. But it always comes down to the individual asset and understanding that asset, it's location, it's dynamics, it's functionality. And regardless, we need to be aware of the macro trends and how they will influence the market, but we also, most importantly, need to zero in on how this particular asset will work within its market, within the broader demographic trends to make good investment decisions. And that's why every asset class has strengths and weaknesses at certain times, every geography has strengths and weaknesses at certain times.
Joe Muratore:
Yeah. We have a specific set of needs we solve. We solve construction issues, we solve deferred maintenance issues, we solve marketing and positioning of a building issues, we solve tenant issues, we solve capital issues. When we approach a building, I start with saying, "Okay, we've got these arrows in our quiver, does this building have the problems that were outstanding at solving?"
Joe Muratore:
Normally we look for B plus locations, with a building that could be a B plus, but is stuck at B minus for some reason. Normally that has to do with the previous ownership, they didn't approach it like a B plus building, they didn't invest in the building. So I look, as we evaluate buildings, can we get this from a B minus to a B plus, and beyond that, is it possible we could make it an A minus, can we move it to that next level? And so do the skills we possess in our company, can they solve the building's problem? And can we take it a little bit further than that? And if so, I start to feel like we're in the right ballpark. But we generally lead with quality, we're looking for great buildings, buildings we'd want to have our office in, apartments where I could see myself living.
Ryan Swehla:
Yeah, yeah. And I would almost argue, we operate on location, we operate in the A space. We are looking for the properties that have fundamentally strong advantages compared to their competitors, but the property is in B condition or B minus condition, because those are the problems we can solve. Where we're having the video today is a prominent three story building, very centrally located within a sub-market, and yet it was two thirds occupied. We're sitting in a room with wood trim-
Joe Muratore:
Old paneling.
Ryan Swehla:
From the 1970s that is soon to be demolished. And it's reflective of an ownership that wouldn't make the prudent in an otherwise strong property.
Narrator:
You're listening to Durable Value: An Investor's Podcast. We understand the world of commercial real estate can be daunting, but we want to make it as simple as possible for you, get the free 56 Point Checklist for Evaluating Investment Properties that Graceada Partners uses every day, at graceadapartners.com/guides.
Joe Muratore:
One thing I find, as we're disciplined in our investing, is that we iterate. So when we find a building, we model it, sometimes it doesn't reach our return threshold of a 15% IRR within five to seven year hold. And that used to really discourage me, we'd model it, and it'd be a 10 or 12, and I would know this building is a good fit, but we're just not quite there. And what I've learned, I think these last couple of years, is you have to iterate and iterate and iterate. And by that, I mean, if there was an easy path, someone else would have already done it. That means our market assumptions need to be dead on, our TI budget needs to be well dialed in, our expenses need to be understood, our property tax, our Mello-Roos, those little pieces all need to be factored in before we make a decision.
Joe Muratore:
And ultimately you can fluctuate on price, you can fluctuate on where you think rents might be, you can fluctuate on the amount of TI, tenant improvements, you're willing to do to accomplish those rents. But the expert zone, as we often call it, comes from you build an instinct for investing, but then you have to iterate and iterate and iterate. And with each building we do, we get a little bit better and a little bit tighter, we get better, which is great.
Ryan Swehla:
And that iteration also involves iteration with the seller. It's the long game, it's not the short game. We don't expect that we're going to put an offer and all of a sudden, everything falls together and works perfectly. Instead, it's that process of seeing another buyer fall out, having some challenges, and being there and ready to execute at the underwriting that we feel comfortable with.
Joe Muratore:
Yeah. That's often an 18 month process, from the time we first hear about a building to closing escrows tends to be about 18 months. There's an offer, there's a response, we go away, we might think about it, it might be a fit, but we work towards it, but it takes 12 to 18 months. One thing I thought about too, is that part of the reason a building should be exciting when we drive up to it is because we're going to have to put a lot of work into this thing.
Joe Muratore:
And for me, when I wake up in the morning, I want to wake up in the morning, excited about a building's future. I want to wake up thinking about the cool ways we're adding value and the great traction we're getting with tenants and the positive impact we're having. I feel like life's too short to work on bad buildings, and life's too short to work on buildings that don't motivate you in some way. And ultimately, I think that'll impact your success. If you're working on C class buildings that might get to C plus, that's not good enough, or at least I don't really enjoy working in that space.
Ryan Swehla:
Well, and I think that resonates on our, the why for why we do what we do. We create environments that transform people's lives. And we need to feel like we drive up to a property and we're doing something fun and exciting. And coincidentally doing that fun and exciting work also means that your property is more desirable and that makes it more leaseable, but life is short, like you said, and we want to see the impact of the work we're doing and feel good about it. And not just sit back with a stagnant portfolio of real estate.
Joe Muratore:
Yeah. Well, I drove up to this building today, and we'll add a pan shot of it here in this video, but when we started, it was a brown clay dismal building painted last in the 1990s. As you look now, we have a pretty radical design, there's not another building that looks like this in Sacramento. But this had a pyramid design, an inverted pyramid designed to the building, and one challenge we had is it had really small windows that dated back to about 1980, we didn't want to highlight that feature, we wanted to draw the eye up to the top of the building, we wanted to make an older building look more modern. So to do that, we worked with a designer who modeled espresso paint on the first floor, which blended in with the windows, but then gray columns that moved to a second floor, and finally white for this large top cap, and then there's a light blue accent piece, a trim piece. And all of that creates a modern, interesting building that draws the eye up. And there's not another building in the Sacramento market that looks like this.
Joe Muratore:
So we're about to start the lobbies, you'll see a lot of this wood trim go away that you're seeing now, we're going to be adding channel lettering and new signage, and we've got one tenant that's moving, and a tenant that's looking at the whole second floor of this building, but this is a building that I'm excited about, and I wake up in the morning thinking like, "This is going to be so cool."
Ryan Swehla:
Yeah. Yeah, and the Fairfield building that you mentioned earlier underscores how many buildings we have to look through to get to that right one. There a lot of on- market, off-market buildings that we have to pour through to find that one that we really feel excited about. Maybe you could talk a little bit about that filtering process.
Joe Muratore:
Well, you mentioned earlier, A buildings versus B buildings versus C buildings. As investors, our job is to own the highest quality portfolio we can, but also the highest quality portfolio that meets our investment thresholds. We strive to be great investors, and buying trophy buildings is wonderful, but the returns tend to be very low. So we found success in that, at least to date so far, in the B to A minus space, where buildings can be re-imagined, re-envisioned, often these buildings were built in the 1980s and we can bring them to today's standard and add fresh life to them. And often they're in great locations.
Joe Muratore:
But to your earlier question, I was in Fairfield yesterday, and to be candid, the building was advertised as being 45 miles from Sacramento and 45 miles from San Francisco, as if great it's right in the middle of things. But what I found when I was there was I felt like it was in the middle of nowhere, exactly in the middle of nowhere. And Fairfield seems like a fine town, it's great, but I didn't see the movement and the excitement and the momentum that made me think, "We can take this B building and move it into the As."
Ryan Swehla:
And the market isn't deep enough, we have to be operating in markets where there's enough depth to be able to see that movement from one level to the next.
Joe Muratore:
Things either need to be a hell yes or a no, and that was not even a yes, let alone a hell yes, that was a, "All right." Well, one thing I continue to learn about this business and about investment discipline, is that we're in the people business. We exist because of people, we exist to serve people, and our business works with people. So the investment discipline, is definitely about making great building decisions, but it's also about making great people decisions, both in our team, but also as we'll be seeing in a earlier podcast, working with great brokers, great third parties, great loan people, but these are people that add wind to our sales, so to speak, they're there to help the process go faster. And some of the brokers we've worked with have really become partners of ours. When they're out in the markets, they're shortening our 18 month window because they're pre-thinking buildings, they're bringing existing relationships to our relationship, and that's wonderful.
Joe Muratore:
So later today we'll be looking at a very large building downtown, we'll be looking at a building out in the Thomas, but it's great to see that investment discipline timeline shorten as we bring great partners to the table who wants to be with us for the long run.
Ryan Swehla:
Something else I was thinking about is the balance between that passion or intuition that it's the right deal, and letting the numbers flash themselves out too, and you touched upon it a little bit with the iteration, but there definitely is also a balance, and we found it on some properties where it feels like the right property, it feels like the right circumstances and situations where we can bring to bear our expertise on it, but we just can't get the numbers to work. They just can't get to that threshold. And I think that it takes an equal amount of discipline to be able to know that we're passionate about a project, we think that it has the right fundamentals or the right problems that we can solve, but we just can't get the seller to economics where it makes sense, and to be able to have that walk away discipline as well. I think that's benefited us along the way as well.
Joe Muratore:
Well, I think that's a key part of our partnership and we're able to encourage investment discipline amongst the two of us. I know there's been times when I've been excited about a building and you've pushed back, and I know there's been times you've been excited about a building and I pushed back, and in the end that's been for the best.
Ryan Swehla:
Absolutely, and I think having that sounding board is a really critical part of the investment process. A lot of investors operate in their own silo, but being able to have those, whether it be trusted advisors, partners, investment committee, whatever the case may be, having some sounding board to be able to help clear off the ego or the passion part of it so we can make good sound investment decisions too.
Joe Muratore:
I've also learned, to counter that, that as leaders, there are times when it makes sense to go out on a limb. And in fact, that's a key part of what we're here to do, is know which buildings to fight for, which buildings to push just a little bit more to get a concession or to solve a problem. And frankly, most of the buildings we buy end up getting above that noise because one of us believes this is a building worth fighting for, and we push and we push and we push and we get there. And truly great buildings that meet our strategy are worth doing, and I love coming to work, to work on buildings that are worth fighting for, that gets me going in the morning. It's a natural tension and it's helped us a lot.
Narrator:
Thank you for listening to Durable Value: An Investor's Podcast, where we demystify commercial real estate with safe, sound investment strategies to help you balance your portfolio. If you enjoyed this podcast, be sure to rate it on iTunes or wherever you get your podcasts. To learn more, visit graceadapartners.com where you'll find more information, investors tools, case studies, and more. This podcast is hosted by Joe Muratore and Ryan Swehla, it's produced, edited, and mixed by [Melodiq 00:21:35] with intro music by Ian Post. Thanks again for listening, and we'll see you next time.