July 8, 2019
Interviewed by: David Snow
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Flexibility: Crucial for Real Estate Investing

When investing in changing neighborhoods – especially in rising US cities to which young people are flocking – it is important to invest in “flexible” real estate, meaning real estate that can be repositioned for changing tastes and uses. Three real estate investment professionals discuss the focus they put on flexible real estate when considering investments. They also discuss their deal killers, notably low ceilings.

When investing in changing neighborhoods – especially in rising US cities to which young people are flocking – it is important to invest in “flexible” real estate, meaning real estate that can be repositioned for changing tastes and uses. Three real estate investment professionals discuss the focus they put on flexible real estate when considering investments. They also discuss their deal killers, notably low ceilings.

TRANSCRIPT Flexibility: Crucial for Real Estate Investing Privcap: Today we’re joined by Laura Deitzel of RSM, Derek McGavik of Newport Capital Partners, and Preston Sergeant of Bailard. Welcome Privcap everyone. Thanks for being here. I’m interested as professional investors, as you underwrite a deal, what are the most important things that you’re looking at? The indicators, what kind of due diligence are you performing to get comfortable that your investment is going to be a good one, and that the downside risk is protected?

Sargent: So, the important things for us are the quality of the real estate. Access, visibility, the physical structure, what is it? Is it designed in a flexible way so that as the economy changes, and uses change, can it be reconfigured conveniently and relatively inexpensively? Parking is still very important. And so we want to make sure that there’s ample parking.

Privcap: And Preston, you mentioned flexibility. In these cities like Austin, Nashville, with young people flooding in, I presume a lot of these properties, let’s say multi family, you are adding amenities and you’re refreshing the look and the way that the tenants interact with the property in a way that is attractive to these younger families and individuals.

Sargent: That’s exactly right, and obviously with an apartment, say a suburban garden style apartment, there’s not a lot that you can do to that physically, other than you can upgrade the guts, but frankly, some of the older products, some of the product that’s sort of 30 plus years old with eight foot ceilings, we won’t touch any of those, because eight foot ceilings feel confined and boxed in. So there’s something that is a great example of a complete lack of flexibility.

McGavic: From our perspective, the very brief macro is, what are the employment drivers? Which we’ve talked about. Because we don’t invest in gateway cities, we do invest in non gateway cities, we do need to know what’s the employment drivers, and where are they located? That helps get us to the neighborhoods. Okay, what’s the neighborhood? The other big thing for us at this point, it becomes critical, what’s the supply in the market? So the first thing we do is, what’s going on at the sub market level, and then we get to the property, and then it gets really focused. Is it at least 85% leased? Property is not 85% leased today in the retail world. You know what, it’s broken and you can’t fix it, at least we can’t.

Privcap: What if it just lost a tenant? What if Toys R Us just moved out?

Dietzle: Then it’s a repositioning opportunity.

McGavic: Then gets into the second question, which is, we just did something we’ve never done before, but we bought 180 thousand foot vacant department store. Now the reason why we did that is because we have a long list of people who want to come in and it’s in such a supply constrained area, we might just knock the building down. But to your point, that’s where you get into the second question of flexibility. Can the space be reconfigured to accommodate the needs of tenants today? We don’t have the issue of eight foot ceiling heights, but we have looked at assets, and we had to price them appropriately to literally rip the roof off, reinforce the walls, and go a little bit more vertical to get ceiling height that frankly retailers need in today’s world. And if it doesn’t make sense at that point, we’re probably not going to be good investors for it.

Privcap: I’m picking up that ceiling height is an issue from one generation to another. The rising generation of millennials and beyond don’t want low ceilings anywhere. At home, while they’re shopping, and presumably in the office.

McGavic:  I’ve always been somebody who doesn’t like closed in spaces, so I’m a bad person to ask, but I do think you’re definitely, in all food groups, you’re seeing for a variety of reasons, ceilings go up a little bit higher.

Privcap: Laura, maybe final question for you. Both of these experts have mentioned deal killers, as they’ve been looking at their respective types of properties, whether it’s multi family, or retail, have you seen some interesting deal killers as people have sought to underwrite properties in non gateway cities?

Dietzle: Sure. Especially at this point in the cycle, you really want to ensure as you’re underwriting, you’re stress testing that model. So can you weather the downturn? What will financial conditions be like five to 10 years from now? We don’t have a crystal ball, so we’re always advising our clients to really make sure that they understand if they can weather the storm if it comes. We hope it doesn’t, but certainly a stress test is really necessary to understand what will interest environment be, fed policy has hit pause currently but will they continue their rate hike cycle later on this year or will there actually be a rate reduction going forward? The key here is stress testing, understanding your ability to weather a storm, whether it’s through a refinancing, and maintaining that property for a longer hold period than maybe you originally assumed if you can’t get out of your position.

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