Podcast Episode 123 Transcript

Episode 123: Should You Invest In Industrial Real Estate w/ Chad Griffiths

Welcome, everyone, to the Prereal podcast. We're joined today, folks, by Chad Griffiths. We've got an opportunity today to chat with Chad about something that we do quite a bit of and not many of us out there do. So Chad is an industrial real estate broker and a partner at Nai Commercial Real Estate State. He's also the host of the industrial real estate podcast. He's got some great super informative episodes and on his website, which you'll find on the link below, some killer calculators and spreadsheets that really help if you're analyzing or if you're taking a deep dive into a project there. I was shocked at how thorough the calculators were. Are you ready to bring your real estate game to the next level? My name is James Prendamano. I'm the CEO and founder of PreReal. Over the past 25 years, I've closed over a billion dollars in transactional real estate. Each week, I'm meeting with outstanding investors, highperforming individuals and visionaries operating in the real estate space. These are the people that are actually out there in the real estate game right now getting it done. This podcast aims at bringing anyone's game to the next level. This is the prereal podcast. Chad, thank you so much for taking the time and joining us today. Yeah, thanks so much for having me on, James. I'm really excited to talk about industrial real estate and thanks so much for the introduction as well. Yeah, look, there's not many of us that play in this sector, so I was wondering if maybe you could just spend a few minutes, chat and talk to the audience about who it is you are in more depth, how you landed, where you are now and your specialty. And then I thought it would be fun if we could dive into some of the specifics. Yeah, thanks for that. So I started in 2005, which is crazy to think that was already 17 years ago, but I've been at the same brokerage my entire career. Like a lot of people, actually, I knew very little about industrial real estate when I first got into it. I thought I'd be working in office towers or retail shopping centers. The more that glamorous aspect of commercial real estate. And it just so happened that the office that I joined was heavily involved in industrial real estate. So almost by accident, I got into industrial real estate. But I'm very glad that I did, because over the last 17 years, I've not only had a good career representing buyers and sellers, but I started investing my own portfolio in 2014. And that gap was just saving up enough money that I could start deploying it myself and getting that experience, getting that knowledge. So I was comfortable doing it. And with a series of partners, different partners in different projects, we've been pretty much adding a property every year since. And it started by a small industrial condominium. It was about $400,000 and we just closed on a property in January for 4.1 million. And we've been trying to scale up to be buying more of those larger properties. But I got my start with a $400,000 industrial condo. So I love talking about industrial real estate. I always try to be as transparent as possible because I know it can be a daunting arena for people that don't have any familiarity with it. So I'd like to think of myself as just trying to offer as much information and value as I can. And there's virtually no question that I'd say is off limits. So, first of all, congrats on the success. I think that it would be important for us to define for the audience what is industrial real estate? Great question, and I'm glad that you brought that up because I think that there are some misconceptions about what industrial real estate is. And even going back to 2005, when I started, it's changed even considerably since then. It used to be a topic that virtually nobody knew anything about. Unless you work in a factory or you had somebody that was that you knew that worked in one, there's really no reason that people would have had a reason to know about industrial real estate. And there's one guy I talked to a while ago, which I think sums up this attitude quite well. He said, the only thing that I know about an industrial real estate is that if I make a wrong turn off a highway and end up in an industrial park and I'm just trying to find my way back onto the main road, that's all I know about industrial real estate. But it's come a long way over the last two decades or so where now it's a topic at the dinner table. People are talking about supply chain issues and bottlenecks and how product is getting delayed at the sea or there's port delays or there's just warehouse delays. Everybody is driven by a new Amazon fulfillment center, which is like anywhere from 1 million to 3 million square foot building right off the highway, right close to an airport. Everybody's a lot more familiar with these distribution centers now. And I think it's imperative to actually divide industrial real estate into a few subcategories, because while there are similarities, there's also some stark differences. So the two main categories that I always divide industrial real estate into is a manufacturing that could also be like a factory or really just a building where things are made. And an example I point to all the time is the Boeing factory outside of Seattle in Washington. It's in a town called Everett. It's a 4 million square foot building, which is enormous just to think about, to really wrap your head around how big a 4 million square foot building it is, almost inconceivable. But the whole idea is that all the raw materials, all the unfinished goods, get brought into the factory then they're made, they're assembled, they're produced. Out comes a Boeing 747 that goes out the door and gets sent to a customer. That's the manufacturing side. And it could be anywhere from a 4 million square foot building all the way to a 2000 square foot industrial condo like I owned that happened to be a kitchen equipment repair company that was in there. And all that they did was go around to different restaurants and repair stoves or fridges or coolers or anything that broke down. And if they couldn't repair it on site, they'd bring it back to their shop and they'd tinker away with all the different parts and things that they had there. So that's the manufacturing side. That's not as common, at least in public perception right now, as the other subcategory, which would be warehousing. And warehousing are these big Amazon fulfillment centers. Amazon's the biggest one by far, but they're far from being the only one. There's warehouse facilities everywhere, all over North America, all over the world. These warehouse facilities. You could almost picture a Costco or Home Depot, which actually is a warehouse in itself, just happens to be in a retail location. But these are buildings with high ceilings. There's racking from the floor all the way to the ceiling. And it's stocked with all types of things in a Home Depot or Costco, it's consumer goods. People are going there to pick something up. But a warehouse could be raw material. It could be semi finished goods, it could be finished goods. A warehouse is basically where something is stored for some period of time. It could be an hour, it could be several years. But a warehouse is definitively separate from what a manufacturing property is because what happens in that building is different from a manufacturing property. There's also a third category which it's called different things in different markets, but I refer to it as Flex Industrial. And Flex Industrial would be all the industrial properties that are zoned industrial. So that is, the municipality has designated that that property will have a zoning classification for industrial, but it's not necessarily conducive for manufacturing or warehousing. And I'm sure it's the same with you, James. I'm sure that there's industrial properties in your market that aren't necessarily warehousing or manufacturing. And there's all types of uses. I've seen churches, art galleries, bottle depots, car dealerships, showrooms, you name it, even straight office space. A building that we operate our office out of is actually an industrial zone building. Our space in the building is entirely office. So it's zoned industrial. It's an industrial building, but we're straight office use in there. So those would be the three categories. By far. The two biggest ones, in the context of how big the market is, would be manufacturing and warehousing. Though. When you're analyzing the deal, or just in your experience, what does a typical industrial lease look like? Term rate? What are the metrics that you're finding. Yeah, every lease that I've done has been a triple net lease, and terminology varies across markets. So maybe instead of trying to get hung up on just the nuances of the terminology, I'll just describe what it is. So that would be that the tenant will pay base rent or net rent that is contracted for the term of the lease. So let's say I'm charging them $15 a square foot. They're paying that $15 a square foot for however long the lease is, and it can run anywhere from five to 15 years. You might see shorter term leases in there as well. There's also occasions where you might see 2030 year leases, but for the most part, most leases I've seen have been in the five to ten to 15 year range, and that rent would be contracted for the whole term of the lease. So the tenant knows what they're paying, landlord knows what they're getting. The other part would be the proportionate share of all the operating level expenses of the property. So that's property taxes, building insurance, common area maintenance, landscaping, snow removal, and as I mentioned earlier, property management fees. So the tenant pays all those costs, and any increase in those costs get passed through to the tenant. So if property taxes goes up 10% next year, which seems to be a commonality across the world right now, it seems to be like every municipality is targeting a 10% increase next year. If it goes up 10%, instead of me having to eat that as the owner being in a gross lease, which is what you'd see normally in a residential scenario, this triple net lease will be that the tenant will be responsible for any increases in those costs. So in an environment where we're seeing a lot of inflation, if snow removal or landscaping costs or insurance costs go up, those costs all get passed through the tenant, and they're contractually obligated to pay that because of the way that the lease is structured. So, again, I think that's another great reason to have industrial real estate over multifamily. Not saying that multifamily is a bad investment whatsoever. Just for me, I like the comfort of knowing that any increase in those expenses isn't going to erode my profit level, but instead, it's responsibility of the tenant. What are you seeing on the horizon? Are you anticipating as we start to explore more and more green energies, rebirth in these manufacturing and industrial zones, or what are you forecasting? Yeah, I think that there's a couple of key factors that are going to drive that market. First being oil prices. We're $90 a barrel right now. If Putin invades Ukraine today or sometime this week, we might see $100 oil in the immediate near future. So I think oil prices are going to cause an uptick in drilling activity. And when drilling activity goes up, whether it's in the shale play or whether it's in the traditional oil and gas plays. As soon as drilling goes up and all the service companies that are servicing all this equipment, they start picking back up. That whole manufacturing side hinges quite heavily on the oil and gas industry. And the second factor that I think will drive this as well is that we're going to start seeing, or I suspect that we'll start seeing more reassuring or onshoring towards North American made goods. And part of the problem is that the supply chain is broken right now with getting things from overseas. So for companies that need to have goods and they need to have product in place, they can't necessarily rely on a multiple week or multiple month cycle to get these goods from overseas. So I suspect that we are going to see more onshoring and more locally made products and that's going to require more manufacturing space. So whether it's in Mexico and Mexico starts manufacturing a lot more things to still take advantage of some less expensive labor and that comes upwards into North America, I think we'll see more demand for warehouse space, we'll see more demand for manufacturing space. I think that there's going to be several good years of industrial real estate still to be had, barring anything unforeseen. And I guess these past couple of years have taught us that virtually everything is unforeseen. We can't seem to predict what's going to happen tomorrow, let alone two years from now. But I think if borrowing anything catastrophic, I think that the industrial real estate market is going to be steady for the foreseeable future. So the passive income moniker is tossed around all the time and it depends on the structure of the deal. As you had said earlier, there's a lot of syndications, GPS versus LPs. Who's doing what works in these deals? But in the industrial side, when you're looking at just a common transaction, I know every transaction is unique to itself. What are the cap rates? What can an investor expect as they look in this market? Are these things trading at two and three caps or eight and ten caps? Yes. Over the past few years we've seen a lot of downward pressure on cap rates. And that's predominantly just as other asset classes have looked a little bit more scary. And all of a sudden, industrial real estate looks like the darling at the ball because it's steady, it's conservative. There aren't the big swings that you see in retail or office. So there's been downward pressure as more players have entered the industrial space. I used to say that cap rates were always in an operating band between 6% and percent eight. That's just for my entire career. I've seen them 6%. When the market's really hot, they might increase to 8%. Like the capital market crisis of 2008. As an example, you saw them crest in that 8% range or perhaps even a little bit higher. But for the most part they've always been in that operating band of 68%. Now all bets are off. There was an institutional great portfolio in our market that had big distribution centers, fortune 100 companies as tenants. It went to market and there were, I believe there were 15 or 16 different institutional grade buyers that bid on it. And the rumor is it's supposed to close anytime. So we'll have that comp data pretty soon. The rumor is closed in a low forecast, even if it's mid forecast, which you got to wait till the dust settles before you can actually claim that even if it's mid. Four cap, we've never seen that type of cap rate on an industrial property. So that band is starting to increase where now you got to say that cap rates could be four to 8%, probably be more in a smaller rural setting, or maybe it's just a smaller town. But if you're in one of those big markets, new York, Chicago, Austin, some of these big cities right now, you're going to start seeing sub five cap rates. And what type of credit are you seeing in these deals? They're not all Fortune 100 companies, right? I mean, what type of credit are you seeing just in typical larger deal, smaller deal? Who are we dealing with here? Yes, those big institutional grade ones. Then you're definitely getting a high quality tenant. And if you're not, the effect of it is that you're going to get a better cap rate. If you're getting a really good property with a really strong covenant as the tenant, then it's going to drive down the cap rates. If you're looking for, call it a 300 square foot building in a major market, perhaps not one that has some 1% vacancy, but just call it an average market right now, 30,000 square foot tenant with a decent company in there. Maybe it's a local company or maybe it's a regional company. You might be getting that in the six to seven cap rate range. But so there definitely is a correlation between type of tenant, type of the property and the cap rate that's going in there. And that's why I think it's responsible investing to always be looking at cap rates as a range, as opposed to just saying, well, I heard that this property sold for a four and a half cap rate, so that means I can apply that cap rate to every property that has a certain amount of that's reckless and irresponsible. So I would say whether you're a seller or buyer of a property, just keep in mind that comparing apples to apples is pretty important. So there's risk factors, folks, right. Term of the lease, if there's any kick outs, strength of the tenant, these rates are significantly more attractive even as you get in the four to six range. They're significantly more attractive than multifamily, for sure. And even many of the retail assets. Why do you think there there is still such abundant opportunity or upside in this particular asset class. I think, again, it's important to distinguish warehousing from manufacturing the warehousing. I think that there's less opportunity now just because it's had such a big increase that anyone considering buying a warehouse portfolio right now is buying at the top of the market. If you're paying in the low forecast rate for a good institutional grade property, it's hard for me to think that there's a whole lot of upside on that because those are probably ten to 15 year leases. So you're basically buying a stream of income at those cap rates with very little room to add value to it. So I think that warehousing, unless you can find a specific deal where you can add some value to it, you're buying at the top of the market, which for me, I don't necessarily want to be the guy that's buying at the top of the market. Where I see opportunity is on the manufacturing side, just because a lot of these properties haven't priced in yet that oil prices have risen. There's going to be more demand for manufacturing space, whether it's oil and gas related or just companies trying to onshore manufacturing. I see more opportunity from a value add standpoint in the manufacturing side. Where I still think that there's value in warehousing is that you're getting really strong companies that are on long term leases where your income is going to be predictable and if the lease is structured accordingly, you can pass through any increases in the expenses. I still think that that's actually a very sound investment decision. I just don't know if there's as much opportunity to increase the value, at least in the near to medium term. So we've advised folks against buying payments, what I call buying payments, where they're only looking at because interest rates are as low as they have been and there are some really aggressive bank products out there, especially if it's not stabilized money, if it's bridge money. It's easy to get lured into the attractive upside of the delta between your debt service and how a property is cash flowing. For us, there's the other side of the coin. Having been through multiple cycles in multiple markets, we know what it looks like when the phone stops ringing and when things shift. So what metrics are you looking at in a deal chat to keep it balanced? Is it your cash on cash that you're looking at? What are the factors that are keeping you from making some of those decisions where people are saying, well, look, rates are at 3%. If I put 2020 5% down, I'm still plus 810 thousand a month on this transaction. Sometimes that leads to not the most sound fundamentals in buying real estate and letting some of those traditional metrics go out the window. So what is it that you're looking at that's keeping you balanced when you're acquiring a new site? Yeah, great question, and I think that there is some unique elements on how I'll do it. I'll be different from other people, particularly from like a big institutional investor buying a portfolio. They're not going to be as concerned about some of the metrics that I am and vice versa. So when I'm looking at a property and I'm a small investor, I'm looking at properties that don't have these big Amazon type tenants in there. The first thing I always look at is the price per square foot. That's the first number that I'll look at before I even consider doing a pro forma or discounted cash flow analysis. I'll always look at the price per square foot because that speaks to that downside risk mentality that I mentioned earlier where I'm more concerned with losing capital than I am necessarily about extracting out how a ten year pro forma might look and make a bunch of assumptions. And if everything goes according to plan, I might spit out a 15% IRR. I think that there's so many assumptions that go into that that's almost better to look at that on like a backward looking basis to say, okay, this is what my numbers were. Here's what the IRA was. I don't necessarily want to make my decision based on trying to extract ten years worth of data and make all these assumptions and then say, okay, looks great, we're going to have an 18% IR on this. My mentality is if I can buy the property at the right price on a price per square foot basis, and I know that even if the property were to go vacant, that I know that I can rent it out for X and still cover my expenses, still cover everything that I need to from a solvency standpoint. If I can buy the right property and know that I'm not going to lose my shirt on it, then I can start having fun by manipulating numbers and saying if I put my discount rate here and if I can renew this lease in five years at X. Then all of a sudden, I spill this really sexy looking IR number. Then I can start doing that. But first things first, I always look at that price per square foot. What's my downside if the tenant goes bankrupt or does not renew their lease? How much money am I going to have to spend to get another tenant in there and really just make sure that I hedge as much of that risk as possible? And then you can always do your cash on cash returns and factor in scenarios about what type of debt structure you can put on and how they'll look in the grand scheme of things. But I'm always cost per square foot before I do anything. Love it. Price per square foot sound metric that seems to have gone by way of the dodo bird on some of these performers. We were joking on the show the other day. You've never seen a performer that didn't look good, right? These things are designed to look good for a reason. So you touched on something super important. Am I going to be able to fill that space if this tenant goes bankrupt or they don't renew or whatever the reason is? Where are you looking for those tenants? Where are you finding tenants in such a highly specialized field? I love the topic on that because that is what makes industrial real estate unique. And compare it to office as an example, right? Like an office space is going to be compatible for a lawyer, an accountant, or real estate brokerage or any conceivable amount of users. An office space might need some cosmetic work, but aside from that, it's going to be compatible for a lot of different uses. Industrial real estate is not the same. You could have one property that was specifically built for a manufacturing type of tenant. And one that comes to mind, actually, is there's a building that we did the leasing on a while ago. And it was an 80,000 square foot building, but it was custom made for a fiberglass manufacturer. So it had really awkward ceiling heights in different areas. It had sunken floors in some areas. It had cutouts in the concrete where it went to like a sub floor underneath where all the process that they had involved and I'd never be able to explain this as well as they would, but it was custom built for their purposes. And when that company left, the landlord ended up having to spend probably half of what the building was worth just retrofitting it so that it was compatible for the next type of use that was going in there. So there are certain buildings that are going to be conducive for all types of different uses. And like a Flex property, like we talked about earlier, is a good example. If you've got an industrial building in an urban core and there's traffic nearby, there's all types of uses that can go in there that will be a lot more accommodating than that fiberglass building was. But that all goes back to the cost per square foot. What am I buying this building at and what's it going to take for me to make this building attractive for other types of uses? Because there's not many fiberglass companies in the world looking for fiberglass space at that exact time that we had that one. So if the building isn't compatible for a wide array of uses, that should be factored into your decision when you're buying a property. And what's it going to take for me to retrofit it so that it is compatible for other types of tenants? And that might just be having a consistent ceiling height, that might be having adequate power that's in there, having enough yard space or loading area. There are things that you can do to make a building attractive for a general amount of tenants. But if you're buying a unique building, I think that is the single biggest risk an investor can take in any asset class in commercial real estate is buying a building that was designed specifically for one type of company. So Coronavirus, if we can transition for a minute, has impacted everything that we're doing and everywhere that we do it. What has the impact been on your side of the table in this industry? Specifically, what type of effects has the Pandemic had? I think we could break it almost down into stages. So the first stage I remember a well, it was March 15 of 2020, I was out with some friends. I was at a little scotch bar. It was on a reservation so you could actually smoke in it as well. So I remembered I was having a cigar, having a Scotch with a couple of my friends. An NBA game was on that night and news flashed that the season was being canceled. And by that point, everybody knew that this was getting serious. So it wasn't that. This came out of the blue. Like we were all sitting around with our cigars and scotch being like, this might be it, boys. And sure enough, NBA canceled the season the next morning and NHL canceled the season. And then the world just seemed to shut down. Like, there is a period from mid March to mid May, call it, where there was no activity going on whatsoever. Nobody wanted to make any decisions. Even people that had to make decisions weren't making decisions. So there was three months there where I was very concerned. I started looking at all the properties that I had and I started thinking, if all these tenants stop paying their rent, what happens? Like, I've financed a good portion of this, so I've got my name personally, guaranteeing a good chunk of this debt. Like, what's going to happen to my business if the whole world shuts down now and this lasts longer than any of us expect? I was very concerned. Those three months were probably the most scared I've ever been in my entire life. Just trying to think what was going forward. But I just kept the same mentality as you can't really change this right now. So instead of panicking and trying to sell your properties at the worst time, I just carried through with it. I didn't want to make any forced decisions. I didn't want to force any decisions on anyone else either. So it just stuck through it and incidentally and unfortunately, the market picked up again pretty quickly. Like as you start going into the summer, the government turned on their money printer and started printing at an incredible pace, given free money to everybody, and that seemed to stimulate the economy. There are still areas where there should be concern. I think the office market is still going to have some concerns going forward. Bricks and mortar retail. I have. A hard time seeing where there's going to be growth in that sector. I think people are still going to go back, there's still going to be demand for that bricks and mortar retailer, but I think growth is going to be halted. Industrial real estate has surged. Like, the last two years now have been incredible. And like we talked about earlier, the warehousing side has just gone crazy. It's driven by high demand, by these companies that need more warehousing space. So demand increases, vacancy drops, rental rates go up. So the first stage was absolute panic. I have no idea what's going to happen. I should take out some money in the bank just in case I don't have anything to pay. At least have some money in a safe kind of panic all the way to now thinking, who would have predicted in a once in a century Pandemic that you'd also have the best possible industrial real estate market we've ever experienced? So it goes back to that real estate roller coaster mentality. We really have no idea what's going to happen six months from now. But you just keep doing the things that have made you successful and try to adapt where necessary, but stick to your core values, stick to your core mission of a long term goal and just think that any aberrations along the way are hopefully just short term and you just move around it. Yeah. So what we found during the Pandemic, pretty quickly, retailers and just in general, merchandise providers took a hard look at their logistics and distribution. They took a hard look at some challenges in getting product to certain markets. And we found even supermarkets now that are looking in market there, instead of having, say, a 50 or 600 square foot footprint for the retail portion, they are down to retail portion and the balance is being used as a logistics center. This was a way for them to localize and distribute in a hyperlocal way. So it's interesting as this evolved, and you're right, there was a few months there where it was like, gosh, what's going to happen next? But we took solace in that it was everyone and every industry, unlike other instances where there were these market shifts, dramatic market shifts, this was just the whole dang world. So we were kind of all in it together and it was like, hey, if it's going to go, it's going to go, and if it's not, it's not. So, thankfully, here we are on the other side of it. Chad, this was a great conversation. What's the best way for folks to find you could tell I just love talking about industrial real estate. So right after the Pandemic kicked in, during that patch where I just had some more time on my hands, I put in Wheels in Motion just to start a YouTube channel. So my whole premise on my YouTube channel is I just talk about as much value as I can to try and give people value. I like to say that I don't even talk about what company I work for. I don't talk about even what city I live in. I want it to be just a resource where people can go and learn more about industrial real estate. It's crazy to actually know that. I've done over 100 videos now on industrial real estate, so there's a lot of information on there. If you just go to Chad Griffith CRE is the YouTube channel. Or if you just search industrial real estate on YouTube, you're bound to come across one of my videos. Yeah, he's a great follow, guys. And as I said, check out the website. He's got amazing calculators and spreadsheets that are super helpful. Chad, thank you so much for the time. Thanks a lot, James. Appreciate it. Absolutely. As always, folks, please stay safe.