Designing a Recession Resilient Commercial Real Estate Portfolio | Investors Round Table
In this episode, we'll explore key strategies to fortify your portfolio, discuss the impact of recessions on various sectors, and identify emerging opportunities in the commercial real estate landscape. Tune in to learn how to navigate uncertainty, minimize risk, and position your investments for long-term success in the face of a potential recession.
Matt Anderson, Anderson Legal
Logan Freeman, FTW Investments
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Key Takeaways:
Multifamily real estate, especially existing Class B and C properties, can be recession resistant due to people always needing a place to live
Healthcare real estate like medical offices is also recession resistant as people will continue needing medical care
Grocery-anchored shopping centers can perform well in recessions as people still need to buy groceries and other daily goods
It's important to underwrite conservatively, scrutinize tenants, and focus on acquiring assets that can withstand economic downturns through flexible leasing terms and creditworthy tenants
Strategies like locking in long-term fixed-rate debt ahead of potential downturns can help make portfolios more recession-proof
About Your Host:
Tyler Cauble, Founder & President of The Cauble Group, is a commercial real estate broker and investor based in East Nashville. He’s the best selling author of Open for Business: The Insider’s Guide to Leasing Commercial Real Estate and has focused his career on serving commercial real estate investors.
Episode Transcript:
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This episode of the commercial real estate investor podcast is brought to you by cre launch Pro. This online commercial real estate program is designed to take you from beginner to pro commercial real estate investor with access to all of my courses, our online community, and monthly group coaching calls. Learn how to confidently buy your first commercial property today at www dot c r e launch pro.com. Welcome back to the commercial real estate investor podcast for this week's investors roundtable. We are diving into creating a recession resilient portfolio. It's a very on topic, conversation, considering where we are in today's environment, you know, logon can't wait to kind of dive into what the Fed is saying as of the last couple of days, because I know you follow that pretty closely. But we're gonna be diving into sectors that are more and some that are less resilient during downturns, strategies that we've employed to protect our assets in all economic climates and alternative asset classes that kind of chug along regardless of the economic environment that we're in, so that you can go out there and invest with confidence. Guys, let's let's touch first on sectors that are more or less resilient. Historically, what we've seen, you know, your your multifamily assets, right, that seems to be relatively recession resistant. How are we feeling about those today? And let's let's kind of break apart multifamily development and existing multifamily value assets. Logan, I'm gonna throw that over to you first. Yeah, I mean, Peter Lindemann said it best, I think in his most recent Lindaman report, but the best thing that multifamily has going for is that single family homes are very, very under built. Right. And so that is an underpinning, obviously a tailwind for the multifamily industry now, everyone has been tracking construction starts and completions and forecasted completions, and I do believe we have spoken on this podcast previously, about the average for the last 10 to 15 years being somewhere between 250 to 350,000 units being delivered in a year in annual period, where we're sitting at in the forecast, and I'm kind of looking at is somewhere between 607 100,000 for this year. And so there are a couple of things to think about on that one, where's the concentration of those units being delivered. And if you look at the concentration, there's, you know, big concentration in coastal markets, and Texas, and your guys's great State of Tennessee. And so there's a lot of, of what you need to do is really understand where they're, where they're being built, and how that's going to impact that. Still, I don't know how we are going to respond to doubling the number of completions in one year. And I wonder what that might do to the asset class just in general from a rent or rental standpoint, right? I mean, these are all likely Class A apartment complexes being developed. And so is that going to put price pressure on the previous class a multifamily developments, and, and so will be interesting to watch. And I think that that's something to keep in, in mind. You know, people still need a place to live, but they need a an affordable place to live. And affordable, is a unique word in the sense that it that is the definition is different for each individual, you know, 2500 3500 might be affordable for somebody. But if we look at the median, household incomes and go back to price to rent ratios, we are starting to see those ratios get pretty high in some, some markets now, that I think is been starting to plateau. And the data would I think suggests that rental rates won't be continuing to increase. However, what the other component of the Feds or the CPI the the measure of, of what the Fed is looking at for inflation does include is housing and why housing continues to get more expensive, is well, the new construction homes are more expensive, you know, 400 600 $800,000, and a lot of different markets. But the cost to finance those is still extremely high, comparatively speaking to the last two to three years. And so that is still pushing up inflation on the CPI. And is why you know, the Fed is still kind of been a little hesitant to necessarily, I think,
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you know, really cut rates. But if you strip that out, and maybe we'll talk about this, you know, here soon, but if you strip out the inflation or the just the housing sector of the inflation, I mean, the CPI inflation rates are only 1.8% and 2.2%. And so, you know, that might, you know, be something else to be keeping
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in mind, where I think places are struggling, I'm speaking from my own example. Not really necessarily having Class A in the, in the, in the portfolio. But brokering those deals and knowing what the rental rates are, we primarily have class C and Class B is, we still have a lot of traffic for Class C type of apartments, and the rental rates are continuing to push up. However, that market is one that people move a lot people skip leases they get if they get evicted, you know, for different reasons. And so you have a lot of turnover in that market. And that's not what's being developed. So what we're really talking about is Class A deals, how's that going to impact the market? And are there enough people to absorb those new units? Well, what type of units are being developed? Are we doing? You know, are we doing garden style, we're doing high rise, you have to look at that concentration, because someone who is going to buy a house may move into a townhome, they move move into a four Plex if it's really nice, what about a row home, you know, something along those lines that feels more like a home? That is still to be seen? That's what I'm watching. But I would have to say just for my prognostication, if, you know, we are doubling the amount of completions, that's going to have a pretty good sized impact on specifically those markets that are getting all those new completions is here this year? Yeah, I'm really interested to see what's going to happen in the multifamily new construction market over the next 24 to 36 months, because if you break it down to purely basic economics, supply versus demand curves, right, the demand is there. The supply, on the other hand hasn't been, which is what has driven up rental rates the way that they have, right. I mean, if we were over supplied, you couldn't continually raise rental rates the way that we've seen over the last five, 710 years. Whereas now, if we're gonna be delivering this many units, the tenants are going to have all the power, right, we're now in a tenant market. So it's actually it's really good for the majority of people, it's really bad for these apartment developers that will be delivering these assets. And you've got to think at some point, they can't lower their rental rates enough to entice tenants to want to sign these leases, without, you know, not being able to hit their debt service coverage ratios, or some other aspects like that. So I mean, I kind of could see an environment where we have a whole bunch of new construction multifamily apartments that are getting, you know, repossessed by banks, or getting bought out distressed situations.
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But who knows, there's so much money in that market. As everybody's been saying for the last few years, there's so much dry powder on the sidelines, somebody will probably step in. Matt, what are your thoughts?
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Yeah, I have some similar thoughts. I mean,
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the development has been heavily in the higher end, you know, including single family. Right, it's been higher end development, Class A development for multifamily. And that's because that's where the most profit was. Right. So everybody wanted to be in that development.
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So I, you know, I'm only in class C as well, as far as multifamily goes. And I think that's pretty recession, recession resistant overall, from my perspective. And then I think the other thing that's important that was also touched on is location, it's so important in this discussion, because, you know, if you're in a, like, there's some pretty good supply coming on in Tennessee, but there's also a lot of population growth in Tennessee, right, and then you go into the sub markets. And that's a whole different story. So I think class affordability and location are hugely important in this conversation. And if you're, you know, if you're in class C multifamily, and you're in a pretty low supply area, I think you're going to be in pretty good shape, no matter what's gonna happen. If on the other hand, you're in downtown, or close to downtown, like in Austin, where there's a lot of supply coming on. It could get scary really quickly.
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Yeah, you definitely want to be cognizant of that, and maybe try and sign some longer term tenants and give some incentives to do that, so that you can weather what's what's really going to be happening over the next 24 months. You know, one thing that I want to point out, too, and Logan, you kind of touched on this as well, construction costs are high. And that's not just in apartments, that is in single family homes as well. And the the multifamily rental market is largely driven by how affordable housing is. If people can buy a house, they're going to buy a house, they're probably not going to rent unless they're moving into a new city and they wanted to see what it's like there for a year, you know, whatever. costs are high in single family residential, and they're not coming down anytime soon. I mean, it's it's tough to see how, you know, if lumber, right, I mean, lumber had its little spike, it came down a little bit, but it's still way more expensive than it was before the pandemic. Once these industries realize, oh, we can charge Y instead of x. They're going to continue to charge as close to y as they possibly can. They're not going to come back down. And so if single family homes are still going to be that expense
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If
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renting is going to be the still the most affordable option for a lot of people, even if it is a relatively unaffordable option, I mean, we've got a housing crisis in this country. And I mean, this is case in point, right? There's not really a good solution anywhere you look
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outside as well, rezoning. Yeah. And I think we are fundamentally potentially talking about two different issues here. One is the actual supply and demand. Nobody, honestly, I think knows if we can absorb as a country 670,000 units, even if they were affordable? I imagine we could, but I don't know. Sure. The bigger question is, we've got a lot of deals that were financially engineered to get completed that are in trouble based off of their debt structure and or the way that they were financed? And I think that is the larger concern is, you know, will they have to just step away from those at par? Or take a loss and let somebody else come? You know, scoop it up. Right. And so I think that's kind of there's two, two kinds of issues here that we might be speaking about, that have different factors that are driving both of them. And, you know, on the latter part, financial engineering side of things, I do believe that, I mean, I just checked before the call here. I mean, there are there is a lot of dry powder, not just allocated for real estate, but in money market accounts alone, United States, Americans have $6 trillion.
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And, you know, stock market, we can talk about that as blown up since October of 2020 to 44%, and continues to reach all time highs, Bitcoin, continuing to reach all time highs and so that money market account, funds are likely starting going to start chasing more risk assets. And so whether that be real estate, whether that be you know, the stock market or other valuations, but I frankly don't know how that's going to play out and very curious to see it. But that is something to think about Americans have $6 trillion in money market accounts on loan. And the big funds have a lot more trillions in that ready to go for real estate assets. So that could like we said many times here on this show, kick the proverbial can down the road just a little bit longer. But we'll see. Yeah, that's the important thing to point out is that that's what makes this so complicated. Nothing is in a silo, right? You can't just say, you know, this is the only factor that matters, there's going to be a dozen other factors that you have to take into account and then figure out how they all going to work together, which makes it much more complicated. Let's get to number two on our list, which is healthcare, real estate, healthcare, real estate has. I mean, look at what happened during COVID. Right? doctors offices did phenomenally well. No matter what kind of a an economic climate you're in. People need their health care, right, they've got to get their teeth cleaned. They may do it a little bit less often than typical, but they still have to do it. They've got to go get their their, you know, annual checkups, still go into the hospital. Matt, what are your thoughts on healthcare, real estate moving forward?
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Yeah, I don't have a ton experience of this. But in our affordable office space, we have a fair number of tenants who are healthcare products, you know, counseling, insurance paid tenants. And I've always felt like that was a pretty nice, recession resistant tenant base. It's hard to imagine a scenario where that doesn't remain relatively stable. Right. You still got to I think you've still got to consider vacancies in the area, right? Because the healthcare may relocate. And that causes stress on your asset. But as a tenant base, it's pretty safe.
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So yeah, I mean, it's pretty straightforward. I don't think there's a lot to it. It's kind of it's hard to imagine why that particular tenant base is going to struggle moving forward. Yeah, I would agree with you, Logan.
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Well, I've got some thoughts on this. And the first one I'll start with is Peter Lindemann again, and I thought this was really interesting, watching trends, hearing people taking, you know, drugs like ozempic, and things like this,
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you know, to help weight loss, I mean, so one of the things that he mentioned in his letter was that ozempic and other weight loss drugs could save the United States two to 3% of GDP and an overall health care spending. And that 70 to 80% of all medical spending is somehow related to associated being overweight, but that still doesn't mean that we are getting younger, we are getting older. And so I think healthcare specific types of health care could do very well. And you know, one thing that maybe you and I will touch on later in the month is one of our brokers here does focus on
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on healthcare, real estate, and last night at my oldest daughter's soccer practice, I'm talking to one of the seven banker, dads there. And I'm like, What are you guys working on? And he goes, Well, you know, our overall spending our overall budget for the bank this year to outlast 40 million. And I looked at him and I kind of said,
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was that maybe your quota, you know, two years ago for yourself? He goes, not even. And I said, Well, what are you You lending on he's like, health care owner user type of real estate. And so that means I think that we might start seeing trends like older Office product that is single storey, maybe next to a shopping mall or something along those lines, it could be a retail space as well searching out and focusing on health care tenants, because one really interesting value add strategy is to take an old office building and repurpose it if possible, if you can get the bases low enough to attract those healthcare tenants. And, you know, we have been signing, we've signed two different dentists in our shopping centers here recently. And yeah, it takes a lot of money to get them in there. And but they typically, you know, sign seven to 10 year leases, they're doing a major build out themselves, they're building their clientele. And they don't want to leave because it's really expensive for them to leave. And so I frankly, think that that's a really unique, interesting opportunity for folks that might have an in with tenants and or that business model to be able to drive traffic from, from a tenant and business perspective to go add value to older shopping centers, older office buildings, if, of course, if they're specifically around the hospital even better, right. And that's where I think we're starting to see that because you take an older office building, and maybe let's just talk talking about a single storey office building that has four to six spaces in it, and you put all, you know, medical tenants in there, you might have just taken the cap rate from an 11 to a six or a seven, you know, once it's done. So that could be a really interesting strategy for someone that might be interested in adding value in a unique way. Overall, though, I think the space is, you know, quite resilient. But again, it just kind of depends on location, on that, on that asset class, and then what else it can be used for, because just talking through, you know, a multi tenant or multi story office building and saying, we're going to turn this into, you know, you know, a dentist or a medical office building, it's a lot harder than you might think. And so I frankly, haven't seen that many dentists or chiropractors or physical therapists on second, third and fourth floors of buildings. I mean, think about that, right? We're talking about real estate here. I mean, if you're a physical therapy company, do you want your clientele having to get on an elevator or maybe even having to use stairs? I don't think so. They're probably they're rehabbing an injury, right. So yeah. And I've never been to a second storey dental office to maybe that's different, you know, outside of Kansas City. But typically, I just walk in and go to the dentist office. And that might be because they don't want to move all that equipment up the stairs. Yeah, the only time I've seen like, second floor dental orthodontics is in, you know, high, high density shopping markets, right. So like, your green hills here in Nashville. It's there's a lot of shopping going on there. And you know, my orthodontist, I mean, this is way back in the day. But he had the full second floor of this building, because there was a bank that occupied the entire ground floor. And it was, you know, I mean, back then, it was Class A, it had been considered like class double way back then. But nobody called it that. It was really, really nice. But yeah, I agree with you. I mean, I love the idea of converting older office buildings into medical office space, the biggest thing like you pointed out, you've got to get a really good basis on it, because it's unbelievably expensive. And you may not even know what to do to that building to convert it into medical office space, because it's gonna depend on the user. Right? I mean, as in the heyday of my brokerage, you know, when I was brokering more than, you know, doing investments, or, you know, running a YouTube channel, which is a very interesting career path for me now. I was, you know, the guys that you wanted to work with were the dentists. I mean, they come out of dental school, and Bank of America is like, here's $400,000, please open up your own dental office, because they don't fail. I mean, they get all this free money thrown at them. They have all of these these resources, and they're great tenants to have. But, I mean, we've been getting a bunch of calls to the brokerage here lately. I don't know if it's because we've been talking about it on the podcast or what? From investors wanting to buy medical office buildings. And the problem is, everybody in the country wants to buy medical office space now and cap rates are still really low. So it's, it's, you know, you really have to do your own right if you want to get the yield. That's going to be attractive. We got a we got a comment from
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Kyle, between high construction costs and interest rates floating around seven 8%, which do you see having the longest impact on investing moving forward through 2024, as well as years to come? I mean, in my opinion, it's going to be like the longest impact is gonna be construction costs, I can see interest rates coming down in the next 12 to 24 months. And, you know, the great thing about interest rates is you have an immediate impact on the volatility of the market. Whereas construction costs, I just don't see him coming back down, I think that we've got a new reset this is how expensive things are going to be moving forward. And so now we've got to just kind of adjust to the market. Matt, what are your thoughts?
20:43
I kind of agree with you. But I can also see the other side to where maybe it could be interest rates, because, you know, construction costs are in line with inflation, they're in line with over all costs there. I mean, basically in line with the dollar becoming weaker, right? So that's kind of kind of balance out across everything. Whereas interest rates, you know, if we're gonna see higher interest rates indefinitely, even if they go down a little bit, presumably, they'll be higher than they were for a while. Well, that's going to impact a lot of things that may impact cap rates for an asset class for the next 20 years. Right. So that's one way that I could see the interest rates really making a significant impact. We're in a price discovery phase right now, right, where not a lot of things have have moved. We don't really know what the proper cap rate is, for a lot of assets in certain locations. We don't know what the proper prices are for a lot of things. And I think if we set a lot of hot, you know, if we settle at a significantly higher interest rate, across all asset classes, then depending on how it all shakes out, we may be you know, these five cap buildings may be trading at seven caps for extended periods of time. Right? So I'm not sure it could go different ways. And it I guess, it's a little bit of a loaded question, because it depends on how long these rates are. High, right? If they go back down, well, then maybe it doesn't have a big impact for very long, if they keep going up. Maybe it gets really ugly for extended period of time. So I could see it being either way, I'm just afraid that it's going to take us a while to see how dramatic the ShakeOut is, from the interest rate jump, just because there's so much so many purchases have been made off of these projections. And so much money has flooded some of these markets, based upon cash flow, that will not be there anymore, right? A lot of these assets are going to negatively cashflow for the indefinite future based on how they were bought in the last five years. So we'll see. I could see it going either way, I guess is my answer.
22:53
Yeah, so interesting. Logan, what about you? You know, I think that interest rates are obviously a main component to, to making a deal. And so however, construction costs, that is not just the the supplies, right, the goods that are needed to create these, it is also a function of the labor that is inputted into that system. And so that's a larger conversation, because, you know, that's, that's hard to create a skilled laborer out of thin air, you know, and that's not something that I think is happening. And so that might be a bigger factor in the long run is how do you actually get construction costs, normalized and or down? What I think actually happens is, you know, interest rates come back down, and people have money. And so the returns look like that something there'll be, you know, okay. stomaching. And so then they're okay with the new construction costs, right? And the other component is to think about is, well, if it's so expensive to build new, then what does that what does that do for existing assets? In regards to demand, it probably goes up. And so if that happens, then what happens to the actual prices? Well, why would they come down? I don't know why they would come down anytime soon. If the demand is still high, and you're able to push rental rates, you know, your NOI is going to be able to continue to increase potentially. And so then if we're talking about a multiple on on, you know, capitalization rates, then where the cap rates kind of shake out at Well, I think that the one component to that or factor variable that can be solved is the financial engineering once again. So you might start to see more investors buy cash, and say, I'm going to hold on to this for longer and just buy cash and wait for the interest rates to come down before
25:00
You know, the continued prices might continue to go up. As you know, I studied the 18.6 year real estate cycle. And I have no inclination that commercial real estate prices are going to drop, you know, through the roof until sometime in 2026 as my kind of thought process right now. And I would say that the 18.6 year real estate cycle is playing out very well in regards to other assets, continuing to climb in price. I mean, look at the s&p look at Bitcoin. Look at the NASDAQ look at Japan's stock market. I can't even pronounce what it's called look at Germany's all time highs and all of those. So I also follow Ray Dalio very closely and Ray Dalio kind of put out a report just recently, saying, you know, I don't even feel like we're in a stock market bubble yet. So the thing that Howard Marks always talks about is, are we are we in a point where it's irrational exuberance, or irrational exuberance, and right now, it doesn't seem like anything's slowing down. From that standpoint, obviously, artificial intelligence is really pushing a lot of these companies forward. I mean, the, the numbers on the market cap for Nvidia are just unbelievable. It took them 25 years to be worth 1 trillion in like three months or something like that to be worth two. That's when I'm starting to say kind of wow, you know, we're kind of getting into a point in time where it's like, man, that's, that's crazy. But the reason I'm looking at that stuff is because commercial real estate's a lagging industry, right. And so what's happening in other asset classes, is probably unlikely could rollover to commercial real estate at some point, and let me be clear, there will be losers, there already are losers in asset classes, we've already discussed that, I think on the show multiple times. But I kind of wonder the bigger overarching cycle and theme, how that impacts commercial real estate, and maybe that's tied for, you know, perfectly when the Fed, you know, cuts rates, and then we start to get a lot of players back in the market. So it's just, it's kind of mind boggling just to try to think through and try to understand. But if you can step back and take a bigger picture view of it, and try to look at other asset classes and what's happening there and say, hmm, maybe that's gonna rub off on commercial real estate a little bit. I think that that's where a lot of people have a lot to gain here in the next two years. And I think that's pretty interesting. Kyle, I'm gonna give you a different take, as well. I mean, this isn't really quite what you're asking. But
27:42
between the two higher construction costs, being high, could actually have a more positive impact overall in the commercial real estate industry. And I say that, because construction has been relatively cheap for 3040 50 plus years.
27:59
Which means that we haven't innovated in the construction industry for 3040 50 plus years. Now, you know, there's been a lot of talk about modular construction, sips construction, you know, creating these manufacturing facilities where we're actually building the majority of these components within warehousing. And it's been more novelty than anything else. And when construction costs are as high as they are today, I think some bigger money is going to start taking, you know, manufactured construction a little more seriously. And I would love to see that because it would be so much more fun. I mean, come on. I know I've said this on this podcast before. But can you imagine if you ordered a car, and Ford showed up, dropped all of the pieces in your driveway and started sending people out to assemble the car right there. It makes no sense at all how we build houses today, at all. So we need to fix that.
28:55
Okay, last one on this list. I know we're kind of burning through some time here. And last one on the list of you know, relatively recession resilient assets, is grocery anchored shopping centers. I love grocery anchored shopping centers, even through the, you know, 2010 2012 era when everybody was terrified that retail was dead because of Amazon. grocery anchored shopping centers did really well, because they are serving the daily weekly needs of families, which means that they are bringing those customers in multiple times a week and other retail tenants that want to kind of, you know, survive off the crumbs right there. The remoras have these giant groceries. They want to, you know, continue to be in the shopping centers and they're doing pretty well. So Logan, I'm gonna lob this over to you first, what are your thoughts on grocery anchored shopping centers moving forward? Yeah, well, the biggest thing to think about when you're underwriting these projects, and if your cost of capital is cheap enough to go compete with the larger institutions, kudos to you because the
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They are low on the cap rates because of this, but you always want to check what what is the market presence look like online, because a lot of these retailers and shopping centers are really focusing on an omni presence type of business mentality, which means they've got to be able to have some sort of online presence, they need to capture your information, they need to be able to market to you with coupons. You know, it's kind of weary, like I was in target with my wife the other day, unfortunately. And when I left, I, you know, two days later, I got a mailer from target that, you know, was really focused on, you know, diapers and things like that. And I'm like, Man, were they tracking where I was when I was in target? Or how did they know that I anyways, that's to the level, I'm not gonna get conspiracy theory. But that's the level that I think that national retailers, like Target are tracking you. And it's probably because my wife has in the app, and they got some geo code on her app or anything, something like that. And they actually do know where we're at. And she probably, you know, said, That's okay when she signed up for it. But regardless, I think that's really important for you know, grocery stores, because a lot of people are buying online picking up on the curb, they might have shoppers now. I mean, I go to the grocery store, and people are out there and they got you know, hy vee on their, their shirt, and they're just chopping away putting stuff in the cart. And or, you know, I haven't bought groceries at a grocery store in a long time. We use what is one of those apps that sends me my groceries? Like it's not Instacart? Yeah, I mean, we just have Instacart straight to our house. Most of the time, taking three kids through a grocery store is like a no, it's a no brainer. We don't do that. So at the end of the day, I think it's really important to know, does this grocery store have a online presence? Are they in what percentage of their sales are online versus in store? That's, that's really important. That being said, there's different level of retailers as well, right? I mean, if the traffic counts in your nan place or.ai In their traffic counts, and or the people counts are not where they want to be, they will move, they will leave, and you are stuck with a large building with a grocery store footprint that is very difficult to fill in some scenarios. And so what I have been seeing, and I think is really cool is smaller footprints. And so starting to see these grocers kind of test out smaller footprints, going into more suburban retail shopping centers, and you know, cutting their footprint in half and testing that out and seeing how it's going. And I think that's a really cool opportunity for investors because of what you mentioned earlier, you know, the cross pollination of people coming to that grocery store, so but I've looked at a number of grocery store, grocery anchored shopping centers have never been competitive on those it really is going to be a coupon and you're looking at the lease and the guarantor and making sure that that person or that company feels really good about being in that location. But man, I will tell you what people don't stop eating during recessions they don't stop going in Kansas City, I still remember wearing my mask and going and picking up my my groceries because we didn't know if you know, you know we needed to spray down all of our groceries after somebody delivered them to us or that might have not even been an available option for us at that time. So I think it's a great asset class to be in. I would if I were an investor, I'm likely looking at a mid to large size operator who has 25 3040 of these that can bring some pricing you know I guess prowess to the deal and see if they have the ability throughout their other shopping centers if they do leave to be able to backfill that space really quickly. So wanting to have national you know, relationships with those tenants so they they can negotiate really well with them and lease structures as you guys both know I'm sure are very important to review understand. CC and ours in regards to grocery stores can be somewhat strong sometimes because they do now sell clothes and they sell flour and they sell sometimes shoes and random stuff like that. So all things that are pertinent to to looking at one of those deals. Yeah, I mean I remember dealing with with Kroger back in the day they were in a shopping center that we were leasing and you know, Kroger of all places had a restriction on bakeries in this 550,000 square foot shopping center. We couldn't put a cupcake shop because Kroger had a restriction on that, which is you know, I get it for from Kroger's perspective because they're going Well hey, we are the anchor here we are occupying the most space we're gonna bring the most traffic you know we need items like this but man to knock out a 1200 square foot cupcake shop because your grocery store is a little wild to me. But Matt what's what's your take on growing
35:00
shrinkage shopping centers? Yeah, I mean, in general, I guess I liked them, I had a deal under contract we didn't go through because this was when the interest rates were going crazy while we were under contract on a on a retail space shadow anchored by a target. And I generally liked them. And you can see why they're recession resistant, obviously, people need to continue to buy groceries. But as an investor, they kind of scare me at the same time, right. And it was hinted at earlier, you've got these large spaces that are mostly designed for this use with a certain amount of parking spaces, and they've got these covenants and restrictions, you certainly got to be very careful, when you buy these sorts of properties, you need to review the leases and the restrictions very carefully.
35:46
And I guess for me, I have a very personally, I understand why people would want to buy them. But I have a very simple philosophy as far as recession resistant purchases, which is I want to buy affordable stuff, right. And so that's the other trick for me is I don't love the idea of buying something that's already been leased up as a shopping center, and you've got the shadow anchor tenants, and you're hoping they renew in you're buying it at a lower cap rate. And then if they leave, you have a lot of liquidity events to turn these units over. So I don't love that aspect of it, actually, I would personally prefer to have my assets be something that's affordable, you know, below replacement costs flexible. There's, there's a lack of flexibility. And there's a you know, high risk of liquidity that comes with some of these things, should the tenants not renew, or should the restrictions cause you issues when you're trying to replace tenants leaving, and that I think that's only going to be potentially exacerbated to with so many things are changing so quickly, with technology. And with how people shop, it's really hard to predict what that's going to look like in 10 years. So now all of a sudden, you add that layer on top of the restrictions and the leases. And in eight years, you have a few tenant spaces come vacant. And you don't really know what the tenant landscapes gonna look like at that point. But you know, you've got an anchor tenant with all these restrictions in your lease, you know, you don't know what that's going to cause for those spaces, if that makes sense. So, to me, I understand why people like him, and I have nothing against buying them. But personally, I would prefer a more affordable and flexible asset.
37:36
Man, leave it leave it up to the attorney out of the three of us to come up with all the potential bad scenarios of heavy.
37:43
I love that man. That's why it's so helpful. Make sure you have an attorney, whenever you are buying real estate, you've got to think through these things. It's a good point, right? Like, you know, a lot of investors are willing to put up with that. But there are potentially some scenarios out there where that actually really comes back to shoot you in the foot. And the other thing is to like those CCR is like funny enough, can can almost be like a self fulfilling death cycle. Because you know, Kroger or not, you know, any, any grocery store could have restrictions that basically say, hey, we don't want any of these kinds of tenants. But we also have a co tenancy clause, where if you hit a certain amount of vacancy in the shopping center, we can cut our rent in half, or we can vacate, well, if you can't fill any of those spaces, because the only tenants that will want to waste from you are tenants that they are restricting in their lease, you could end up in a really bad spot.
38:33
Real quick, the other thing that as you know, as these building age, you know, you see some of them that used to be grocery centers, and they've got the urban air, you know, the trampoline parks, and in the in, you know, like the, you walk into
38:48
churches, and that scares me to, you know, because it's, it's to me, I hate the idea of having being 20 years into that asset. And you're kind of in one or two situations, which is your lease, remaining lease terms are shortening, right, which makes the asset less attractive, or, you know, the tenant you can put in there becomes less and less viable, right. So, you know, I don't think we've really seen the full lifecycle of that yet played out and what that looks like after these urban areas.
39:24
So that's something I think would be fun to watch and see what happens with those buildings because I see a lot of buildings that feel like they're kind of hanging on their last legs that are being supported by unique tenants in these large spaces. And by unique tenants, you're seeing advanced check cashing and vape shops and
39:42
Yeah, what a euphemism right there. Real quick. For the sake of time, we'll just nail these three that are the least resilient and if anybody has anything to discuss in any of those three, let's do it. Hospitality, so Travel and Leisure typically impacted by economic uncertainty.
40:00
Which is interesting, we kind of had the opposite effect and COVID people wanted to get the hell out of their house. Luxury retail discretionary spending tends to decline during recessions and speculative office space. I don't think anybody is remotely surprised at that being an issue. And there's probably nothing more to be said about that. Anything else on hospitality and luxury retail guys?
40:21
All right, these all these guys with all these, you know, short term rentals scare me to
40:28
short term rather worried about that for years. I mean, especially because they're, you know, a lot of them have been underwriting the real estate as if they were a business, right? So they'll take a, they'll take a single family home asset, what would typically be a single family home asset, and treat it like it's a commercial property or a business, right? And they'll look at it. And they'll say, Okay, well, this made
40:52
$100,000 in income. And we all know that. None of this not even all of this is even true, right? Maybe it didn't even really gross 100. That's what they put on the piece of paper. And here's your, you know, short term rental managers projections, we're going to do 130 next year. And so based on that this bill, you know, this single family house is worth $1.5 million.
41:13
That is a scary asset to be buying, because, you know, the underlying fundamentals of the real estate itself, you know, perhaps that house on a comp sale would only sell for half a million dollars, and you're paying 1.5 That is a scary asset class to be in, in my opinion. And I just, I just would want to be getting out if it were me, you know, unless you could show some real sound fundamentals that you can rely on that income. And personally for me, unless you can show that without this business income, the underlying asset is worth a similar amount.
41:48
That is not that's the opposite of recession resistant to me. Yeah, in my opinion, you've got to be the 1% operator in Airbnb, you've got to be the person that knows exactly how to do this, you have to be the person that knows how to create a very unique experience. And 99% of properties out there are not that it is rinse, wash and repeat. There is no differentiation between your house and that house next door. And once you start adding all the hidden fees, I'm going to hotel, right unless I'm like wanting to book a 10 or 12 person cabin. The other thing that I want to say too, and you heard it here first, the lowest cap rate that a an Airbnb should ever trade for is 10%. The 1% operators Sure, you could probably push that lower, the overwhelming majority of Airbnb ease are worth a 10% cap rate or higher. Everybody has been lying to themselves over the last few years. They are very, very management intensive, which is why it trades for a higher cap rate. There's just more work involved multifamily apartment complexes trade at four and a half percent cap rates because I know I don't have to do a damn thing. It runs like a well oiled machine. And it's going to continue to do that. And I'm buying that for that. Airbnb is risky. Logan, what are your thoughts? Well, we have recently in Kansas City and other sub markets gone through a big change in Airbnb regulations. And they are just they're just crushing operators left and right saying, Hey, if you didn't get your permit two years ago, you're shut down, hey, there's some market right here, this neighborhood, we're just shutting it down. And so, you know, I do have about 2526 of these in Kansas City, but they are all either a true Bed and Breakfast Hotel. Or they are, you know, in a mixed use building where the highest and best use legitimately was to be residential, on the second floor, third floor because we're not getting office or anything up there. And they're in high traffic entertainment districts where people want to kind of be, but from the management standpoint, completely agree on that front. So the ones that I do have have a little bit of diversification of income, they might have a commercial tenant and then residential on top, or they've been operating as a true Bed and Breakfast Hotel, which is just a little bit different as well. So I think that's really scary to from that component is just having your local municipality say, Nope, we're not we're not doing Airbnbs here anymore. You got to shut down in the next 30 to 60 days. And, you know, just like, just like you said, you know, now you've got a $1.5 million debt obligation on a $500,000 house, and that's a really tough spot to be in. Yeah, you really want to look at the valuation on a price per square foot basis. You're gonna buy existing Airbnb, it's the same thing with triple nets, right? You don't want to go buy a Starbucks at $1,500 a square foot just because they've got a really nice lease. I mean, a lot of these tenants have two year kick outs, right? And if they don't perform, then they get to just walk away from the lease and now you paid $1,500 A foot for something that's probably worth 500. I mean, it's the same thing no matter what asset class you're looking at. Okay, Orpheus I saw that you've got a question. We'll get to it here in a second brother, but I want to make sure that we get into the strategy behind what we employ
45:00
Boy, we're deploy on our assets to make sure that we make them recession resistant, I'm hesitant to say recession proof, because there's always something that comes along like COVID, where nobody could have possibly anticipated that. And, you know, as great of investors, as we all would like to think of ourselves to be, there's things that just happen, right. So I'll kind of kick it off, while you guys are thinking through, you know, what are the specific items that you do? The first thing I do is I underwrite everything unbelievably, conservatively, I beat the hell out of the numbers to make sure Okay, in a worst case scenario, am I able to get my investors 8%. If we only get this to 60, or 70% occupancy, if I'm only able to get 80% of the rental rates that I think that we're going to get, if it takes me 12 months longer to finish construction on this asset and actually get at least up are we able to cover our debt service, as we're going through that process. So I really do beat it up. I mean, to put it, you know, here's an example right here. When we were underwriting our hotel,
46:05
we were working with other professional consultants on on this asset because it was the first hotel we did, and I like to make sure I get things right.
46:13
And they were saying that on the exit, we're likely going to be able to hit a six and three quarters to a 7% cap rate, probably more aggressive.
46:24
I underwrote it at an exit of an 8% cap rate. I don't care. Like that's great, it'd be amazing. I would love to hit a six and three quarters or even a six and a half. But I'm not going to bank on the numbers that I'm going to tell my investors at 8%. Because look at what happened today, what if I was trying to sell my hotel last year,
46:44
we would have been very happy to get an 8%. So you always want to think through the worst case scenarios as you're going through that. The other thing too, is you are leasing to tenants for the downturn, not for the cash flow.
46:59
And I say that because a lot of landlords I've noticed will take any kind of tenant that they can just to get the cash coming in. We scrutinize all of our tenants through, you know, multiple different ways like one how much cash do they have on hand to how well do they operate? Three, if a recession hits, if they lose business, will they be able to continue paying this rent. And you know, there's a lot of risk that we take on as landlords by putting capital into these buildings, and signing leases with these tenants. You don't want to have all of that money invested all that time, all of that effort on a tenant that could just disappear overnight. And walk away completely unscathed, leaving you holding the bag as a landlord.
47:47
So those are a few things that I do to kind of make my investments more recession proof. It's not foolproof. But I'll tell you this, when we went through COVID, we had a less than 3% default rate. And that default rate wasn't even necessarily full defaults. Like they disappeared, it was more of hey, we need a couple of months to catch back up on our rent. We work with us. Absolutely, we will.
48:10
So it's it's because of those two things that I said there. Matt, what are your thoughts?
48:16
Yeah, I mean, you touched on a lot of great things there. You know, corporate guarantees, personal guarantees are enormous. And it's amazing how how many Mom and Pop landlords don't pay attention to that. Hugely important and that ties to the credit worthiness, right? You need to know that somebody is able to pay your rents, and the remainder of the lease no matter what happens. And that ties to a great lease is, you know, especially the smaller the tenant, the more Mom and Pop type of tenant, the more aggressive the lease should be in your favor. So that's, that's another aspect of that you need to have a pretty aggressive lease, the riskier the tenant, yes. Right? You're not going to get away with that for Starbucks. But if you've got the, you know, paint company, that local painter who's renting your space, you better have a really good lease in your favor. Right? So those are a couple things.
49:09
For me, I mean, I say it again, I just, it mostly comes down to buying it right, right? For me, I want to when I buy it, I want to be able to envision the worst case scenario. And you know, it's a little bit different, because I'm pretty much holding everything I'm a part of or has have the ability to hold. You may not have that luxury, if you're having to return capital within a certain time period, period. Right. But from that vantage point, I want to just make sure I know that no matter what happens, I'm never forced to sell anything. Right? So that's a simple way I think about it is with this purchase, if the interest rates go up, if I get some prolonged vacancy, if I have capex problems. Can I hold through that to the other side? Without a doubt? And if I can answer yes to that question, then I know I'm going to build wealth indefinitely, right
50:00
If it's if I don't ever find myself in a situation because of vacancy or interest rates, or lack of cash flow or lack of liquidity, that I don't have to sell something at a lower price than I would like to, I'm going to be fine. So, I know that's a simple perspective, but it helps me create a framework where I'm looking at the worst case and making a decision based on that on the front end. And then throughout, of course, you got to put all these safeguards in place to, to your laces, your your credit worthiness, all this stuff to ensure you're maximizing the, the upside and limiting the downside
50:36
of it. I got smart, of course, the attorney coming in with the guarantees.
50:41
I got asked the other day, why? Why would I have somebody that has an LLC, personally guarantee a lease? And you know, to us, we do this every day, we're like, well, that's so like, obvious as to why I would do that.
50:55
But to a lot of new investors, they don't think about that. They're like, well, the LLC is signing on it. Here's the thing, LLC is can be dissolved overnight, and people can walk away, or they could just be left there. And they're limited liability companies, you can sue the company, but you can't they they're not going to pay you rent, you want to get a personal guarantee, because then that person, the only way that they can get out of paying the rent is by filing personal bankruptcy, most people are not willing to take that drastic of a step. And so it protects you to at least bring them to the table to negotiate with you on getting out of the lease. So very important to get personal guarantees. That's a great point. Logan, what are your thoughts? Yeah, I think you guys hit the the main ones here, you know, going through it after you to geniuses is a little bit tough. But at the end of the day, I think that one thing to kind of keep in mind is recession resistant your your capital structure, I had a mentor of mine. This was pre COVID. He was kind of going in he was looking at and he has about 65 single family homes and another 50, you know, multifamily building and some other stuff. And he's I'm like, What are you up to this time? You know, it's hard to, you know, buying deals and he's like, I'm going through I'm I'm locking in debt right now, because I don't know what's going to happen. It was already on its downward trend, right. But he didn't wait till it got to, you know, 3%. He went ahead, locked in 4%. And felt very good about that, because he went from 6% to 4%. So he didn't get greedy. And he had no inclination, no reason no, no need to have to think about selling anything during a downturn. So if you feel like something is coming, and you think that there might be tougher times ahead and you're in a position to potentially go lock in some fixed rate debt or refinance your asset at this time, that might be a good, good thing to think about. And what we try to do is a quarterly, you know, wholesale refinance analysis on every single asset to kind of see what where we're at in the position, sometimes, you can't, right, it's just like, Okay, we don't have an option here. But if you do have a few assets, and you have options, definitely something to think about to limit your exposure in regards to maybe a downturn. And then on the multifamily side, you know, if you are operating in Class B minus C, D type of locations, just making sure that you you step up the tenant communications and the resident communications of available options to them. While they might not find not be able to find work, whether that be if you're, you know, got an apartment complex next to a warehouse, you know, can you go, you know, canvass the warehouse and talk to all the tenants, they're saying, Hey, guys, do you are you looking to hire man we are trying to hire so much, okay. You have some fliers. Now the flyers are at under every single, you know, residents store thing, things like that other rental assistance programs that you might have access to. So making sure that your team is up to speed on that. And being proactive is also another measure that you can take to try to get in front of a big wave of vacancy on the multifamily side. I love it. Great points all around guys. You know, the other thing is to like when you're buying real estate, buy it for the recession. Right? It's very easy to get caught up in oh man real estate's going up 10 20% year over year, it's, you know, it's never coming down, it comes down. It might not necessarily come down in a way that you're expecting it to in terms of valuations. But look at what just happen with interest rates. There's a lot of guys that thought, Oh, I'm just gonna get an adjustable rate mortgage on this $50 million, multifamily asset. It's, you know, real estate's hot, it's never gonna go up. Well, guess what? Who's that was the nightingale portfolio out of Houston. The guy went from like 4% interest to 8% interest within like three or four, five months something crazy, gave the keys back to the bank and walked away lost all like several 100 million dollars. So you don't want that to happen to you. Orpheus is asking being a property manager. I'm trying to keep up with dinner table talk with my broker, father in law and developer brother in law. Do you all have any suggestions on material to read and keep up? Man that's a that's a hell of a dinner table to be sitting out. Let me tell you what you're at the right table. We can
55:00
Dean Kurtz over here like, Dude, you're sitting in the right room, I could not agree more.
55:04
I mean, Orpheus right off the bat, I'll tell you, I always want to be the dumbest and the poorest person in the room. Because if I'm, if I'm checking those two boxes, that means I'm surrounded by some awesome people that I can learn a whole bunch from. So that's a, you're in a good spot. Matt, what are your thoughts? I was literally thinking the same thing. I'm like, you know, he said, How do I keep up, I was like, Don't worry about keeping up, you know, be happy that you're at the table with somebody you can learn from. But the other thing too is, everybody's got value added to add, right. So just think about how you can add value. If you've got property management background, I guarantee you, you've got value to add on that. So don't try to be something you're not just add the value where you can.
55:45
Morgan? Yeah, you know, I think that there are some really good books out there. As I'm bringing on kind of newer team members, that may not be as familiar, I found a good overview from crowd Street. I've got the book sitting right here. But anyways, look at crowd Street's commercial real estate book, it does a really good job. Diving into probably what the developer and the broker are talking about how to structure deals, it dives into different asset classes, breaks down, IRR, NPV, ROI, AAR all of the different return on investment calculations, that's really helpful. It's a, it's an easy read, and it's an it's relatively cheap one. So that's a good one to kind of start. And then I mean, podcasts, just like you're doing right here. I think that's huge right here, and people talk about the game. And so obviously, we've got, you know, a lot of there's hundreds of 1000s Probably now podcast to go, you know, check out and review. So I think education is crucial. You know, there's, if you're a, if you're a property manager, maybe looking into other designations through the National Association of Realtors, maybe that's CCI M, or certified property management, I'm sure they touch on some of those things as well. So always leveling up and finding some, you know, different educational sources is great, I use Audible all the time. You know, right, whenever I get off this call to go pick up the kids, I'm going to put on probably an audible book and, and start listening to one. So I think that's a great time, you know, great place to do that. But also, you know, as you're, you're spending time with them Don't feel bad about asking a question. If they start running through, you know, hey, you know, I got this three, three year refinancing or pull a cash out on my by this, I'm going to do that, say, hey, talk to me, like I'm an eighth grader and just break that down for me, because I just tell me a little bit more about that I would not feel bad about that. They're not going to look at you like you're an idiot or anything. You're just trying to learn and be able to, to kind of add some some value to that conversation. And people love to be asked questions if they know something, and explain it and tell you about it. So I think that take that approach as well. Yeah, I'm gonna, I'm gonna re emphasize that ask the damn questions. I mean, I love like, genuinely love. I mean, that's one of the fun things about doing this podcast live, is because people jump in and ask us questions, and we love answering them. Because it's, it's fun, right? Like, we're, we're, you know, 10 plus years into our careers here in real estate. We forget what it's like to be at the very beginning sometimes. And I mean, honestly, like, it kind of brings me back to like, when you're asking that, I mean, the first thing that came to my mind was when I was sitting in my, you know, old boss's office and he's talking about all this stuff. And I'm like, What in the hell is happening? Right? I don't under this is a different language. You know, so it's kind of fun to reminisce on that. So yeah, ask the questions. Man. It you're in a great spot. Well, that brings us up on the hour. Appreciate you guys for joining us for how to build a recession resilient portfolio. We keep these live every Wednesday at 330 every other Wednesday at 3:30pm Central Standard Time. So come back and join us ask your questions live, and we will see y'all in the next one. This episode of the commercial real estate investor podcast is brought to you by cre launch Pro. This online commercial real estate program is designed to take you from beginner to pro commercial real estate investor with access to all of my courses, our online community and monthly group coaching calls. Learn how to confidently buy your first commercial property today at www dot c r e launch pro.com
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