Durable Value: An Investor's Podcast

How We Apply Ray Dalio's "Holy Grail" of Investing to Commercial Real Estate

March 04, 2021 Graceada Partners Season 1 Episode 18
Durable Value: An Investor's Podcast
How We Apply Ray Dalio's "Holy Grail" of Investing to Commercial Real Estate
Show Notes Transcript

Billionaire Ray Dalio, is well known for articulating his investing philosophies publicly. Ray is perhaps most well known for what he calls "The Holy Grail of Investing", and in this episode, we talk about how we apply it to commercial real estate.

Ryan Swehla:
We know about trends or other opportunities before anybody else does. So we can mitigate a lot greater risk. It's kind of like being the insider trading in the stock market. If you knew everything that was going to happen, you'd have a competitive advantage. So that's the kind of correlation we're willing to accept.

Narrator:
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Ryan Swehla:
So, today, we're here talking about Ray Dalio's concept of the holy grail of investing and his video's available on YouTube. But essentially it talks about this idea that if you have one asset that has a 10% return or you have a basket of 15 to 20 assets that have a expected return of 10% and how you get a greater return overall by having that basket of assets. So it's this idea of diversification. And the lower correlation you have, the greater the expected return.

Joe Muratore:
So that prompted the question: what does this look like for real estate and what does this look like for our portfolio? And I think that's what we're going to talk to today. Let's start with the first idea, which is that invest in areas where you're smart. So we start by having a very correlated approach to where we invest and that is we invest in Northern California very specifically. And so we start by working in area that we've been in a long time, we have a lot of relationships in, and we understand very deeply. Any thoughts on that?

Ryan Swehla:
Yeah. So on the one hand that is correlation by definition. We're buying assets that are in a very specific geography, but that's a correlation we're willing to accept. And the reason is because we're trading risk because of our knowledge. We're market experts in that geography. We know the ins and outs, we know about trends or other opportunities before anybody else does. So we can mitigate a lot greater risk. It's kind of like being the insider trading in the stock market. If you knew everything that was going to happen, you'd have a competitive advantage. So that's the kind of correlation we're willing to accept. So how do we then apply that to de-correlating as we're buying in our portfolio?

Joe Muratore:
Yeah. I'd start with adding one more thing to the correlation side though, which is that there's about 20 broker relationships in the various markets and sub-markets. In every week, we get a fountain of deals, most of them off market, that we then select from. So we have a broad geography and group of people that are very invested in our's and the firm's success.

Ryan Swehla:
Yeah. So on the de-correlating, we start by looking at our portfolio. And we'll look at our portfolio and the various assets that we have: apartments, office, retail, industrial. And we're balancing both the current return profile, because if we can invest in a particular asset, but it yields a low return, that's not an asset that we're pursuing. But then we also look at: do we have too much concentration of a particular type of product?

Joe Muratore:
Right. So we tend to invest in themes. So we allocate by asset type, but we think of themes first. What are the trends that we want in our portfolio? For example, during COVID, large populations moving from the Bay area towards Sacramento, that was a trend that was happening before COVID, but it was exacerbated during COVID. How about office tenants moving from downtowns into adjacent sub-markets? That's a trend that we've been working on for a long time.

Ryan Swehla:
Another counter-trend is during COVID, I think everybody spent more time on Amazon, more time buying. And because of that the in vogue or in favor asset type was industrial or is industrial. And that continues to be bid up to these levels where we feel like the return that we're able to garner for the risk that we're incurring isn't worthwhile.

Joe Muratore:
Or diversified shopping centers. We're not currently investing heavily in shopping centers, but we currently own shopping centers and we previously invested in shopping centers with large government tendencies, because those are very sticky, healthcare, dialysis, restaurants, everyday use, salons, and that sort of thing, but creating that right mix too has also been great. So we start with being in an area where smart, adding themes to that, and then allocating in advance. So as we plan for our next year, we think about how are we going to allocate, how much office, how much retail, how much industrial, how much multi-family. So...

Ryan Swehla:
Yeah. And so this next year, we continue to see the theme of office space uncertainty playing out. So, we think that that's a worthwhile theme to invest in. We see a tailwind in our market as it relates to multi-family, as people move out of the urban geographies adjacent the Bay area or Southern California, and they move into our geography. So those are a couple of themes that we're investing around coming into 2021.

Joe Muratore:
So at this point, we diversify by sub-market and asset type. So within our geography, there's dozens and dozens of sub-markets. And we hopscotch a little bit. We find ones we believe in, we invest, and we incubate there, and we learn. So, for example, in Greater Sacramento, we've got a few buildings in one sub-market and currently we're working on a building in Folsom. And we're going to let those other buildings incubate. We're adding tenants, we're de-risking them, we're improving the assets, and we're working on another sub-market. And at the same time, we're watching this one closely and we're learning. And then we might switch back, or we might move over this way a little bit, but we keep triangulating in on themes and assets that really work for us. And we work to be at the very leading edge of those themes. And because we're actively investing all the time, we're on the front end of these trends and we see them before other people do.

Ryan Swehla:
We also look at kind of the, I guess you could say the class of the neighborhood. So whether it be, in this case, office or multifamily at other times other assets, we look at at times we want to be in a neighborhood that is higher income, more affluent, because that brings some level of risk profile. But then we also look at neighborhoods that are more working class or more class B, because that provides some diversification as the market changes.

Joe Muratore:
Yeah. So, especially in multi-family right now, we're working at a little bit more working class or a little bit more middle market, because there's a lot of other groups that are chasing that in the higher end. So we're seeing more opportunity there. But in everything we do, we work to go in and make it more valuable and more desirable than what we started with. So commonly, we'll look for an asset that doesn't match its geography, an asset that's a few steps behind its location. And our job is to take that asset, which has been neglected and bring it up to being worthy of its location.

Joe Muratore:
So that's another key part of our investing is that we add value to everything we do. So, there's riding the top of the wave, which is writing the macro-trends or the micro-trends, but then there's the activist, the value add, the middle of the wave where we have a top-line trend we believe in, but then we go in and we take something that we can buy at a discount because of current problems that we know how to solve. So now we've got what we believe is a tailwind or a wind at our backs pushing us with the macro. And we've got an activist strategy that we're really good at doing and that de-risks the opportunity.

Ryan Swehla:
Yeah. Yeah, absolutely. And I'd say one other layer of our kind of de-correlating assets is tenant mix. We're very conscious about the type of tenants, particularly as we're working in office, or in retail, or in industrial, the type of industries that they're in. And as much as possible, we try and cultivate a diversification in the asset base. So, for instance, we've made a large investment into a single-tenant state of California leased building. But then we also, a few months later, we made an investment into a building that has a lot of, you could say maybe mom and pop offices. So you get that de-correlation between those two different industries.

Joe Muratore:
Right. Well, what's important is that we're working more than one strategy at a time. So with the single-tenant large state asset, while it's a headquarters building, it's brand new, there's a lot of reasons we really believed in this asset, but at the same time, it opens up a broader relationship with the state, which will keep working for many years to come in addition to four or five other office strategies. So it gives us another golf club to swing, so to speak, or another option. Well, I think maybe we end with the Ray Dalio idea of do the simple thing. Find 15 to 20 uncorrelated return streams. In many ways, that's our strategy, 15 to 20 uncorrelated return streams. Now we're not uncorrelated in the same way that Ray is, but we're also activists in that we're actively adding value to the assets that we have.

Ryan Swehla:
And to borrow from Warren Buffet, better to have a few eggs in the basket that you watch very closely than to have a plethora of eggs that you can't watch so closely.

Joe Muratore:
Yeah.

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 Melodic, with intro music by Ian Post. Thanks again for listening and we'll see you next time.