How We're Built for Market Flux
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Joe Muratore:
There's a great idea, and it comes to mountain climbing, but it's, you assemble a team of various experts, because you don't know exactly which problem you're going to hit or when, you don't know which anvilet, avalanche or crevice. I'm not a mountain climber, you are. But you don't know what those problems are. But when you assemble an epic team, you know you've got the right pieces to navigate that thing.
Narrator:
This is Durable Value. Get investing and business insights from industry experts and successful entrepreneurs every week. Like and subscribe now.
Joe Muratore:
These are certainly chaotic and interesting times with interest rates moving, or in July of 2022 with tremendous amounts of what seemed to be fear coming from all parts of the news cycle. And it's just a weird time. I think what's interesting about this conversation is, from our point of view, from your point of view, from a boots on the ground and commercial real estate point of view, how do you interpret what's happening in the world and in the economy? And then after that we can talk about how we're navigating that based on how we're contextualizing what's happening.
Ryan Swehla:
Yeah. Yeah, absolutely. I like to think of the work that we do as not being market predictors but being market navigators. So we're not as focused on, what's the right timing and have we hit the peak, have we hit the trough, but rather contextualizing everything that's going on and using those inputs to navigate through the market.
So, where do I think the market's going? What do I think the future is? Bit of a crystal ball, but there are certainly indicators that are concerning. Interest rates rising, inflation continues to grow, and also interest rate effect on cap rates. But then there are also some bright points, like employment continuing to be at historically high levels. The economy, by all indicators, seems to be going strong, and we continue to see many aspects of a supply constrained market.
So if I were to put my crystal ball out, I would say we're probably looking at no near-term recession or maybe some sort of a light or technical recession in certain industries, but the longer-term future is a little bit more uncertain. And I think that gets to, well, how do we navigate that? How do we take these inputs into what we're doing right now to guide toward the future?
Joe Muratore:
I think our point of view is important because we're acting, we're on the streets, so to speak. What's interesting is we're not trained economists. We've been to economic presentations. Sometimes they're right, sometimes they're wrong.
Ryan Swehla:
We get inputs from great economists along the way.
Joe Muratore:
But economists aren't investors, and economists aren't commercial real estate investors. In addition to how they see the economy, there's also a bunch of psychology, and there's also forming and structuring great deals and finding the best deals in the market. Personally, I think this is going to be a decade of growth. I think that we are seeing a slowing right now in certain sectors of the economy. I think this year will be defined by a slowing. I think next year, to some degree, will be defined by slowing, but I don't think it's a major recession. I think that the year after that we'll begin to see some growth, maybe some growth the year after that, and then I think we'll get the recession.
So time may tell. Time will tell. This is a few years in the future, but I think this is not the big event. I think there's slowing happening now. I think there's a recession in a few years. I think there'll be another major event many years down the road. But that's for down the road.
Ryan Swehla:
So then let me ask you a question. If we are operating in a fairly positive mind frame, anticipating that, call it whatever, a soft landing or a slowing or whatever terminology we want to use, what are we doing to mitigate against a deeper downside?
Joe Muratore:
Well, the question is, which levers are we pulling? And the levers that are most important from my perspective are investing in markets that have low vacancy rates and high rent growth and positive population growth. If you have those things and you can buy things right at a discount to replacement cost and you have healthy exit cap rate projections, it's going to be hard to do poorly, I believe. Most of what we underwrite is to a 20 IRR on a five-year hold.
Ryan Swehla:
I think a year from now it would be safe to say that things will have unfolded. So however that unfolding occurs, I think that a year from now we'll have more clarity on the, I guess it's the trajectory. Are we going this way? Are we going this way? Are we going this way? That trajectory will be more vetted out. Personally, I think that what we'll find is that it's more mild than our lovely media sources are wanting us to believe. But we're also, back to our point earlier, we're not operating as though that more positive outcome is the only outcome that could occur.
Joe Muratore:
I think a year from now we'll be getting debt in the high fives, potentially six, but not way worse than today. I think that the market, I think that economic activity will be stronger again, in that groups like ours, capital groups will be, investors will be saying, "Okay, we have a clear picture of the next couple of years, we better get back in the market, we better get moving again." So I think that what's interesting about the deal cycle is it takes 6-18 months to, at least six months to get to great deals. From the time you offer, there's this Ferris wheel of deal making, where you don't just make an offer and get a deal. It never works that way. You make an offer, they go, ah. Then you make another offer, they counter. And it has to go through its cycle while the seller goes through their stages of grief or their decision-making process, and the buyer does as well.
But our groundwork this year will lead to our deal-making next year. So now is, in my opinion, not the time to hunker down. Now is the time to be cautious about the deals we're doing, but aggressively offering, aggressively seeking out opportunity, especially in a time when there's less competition.
Ryan Swehla:
Let's say this plays out a year from now and we're seeing signs of a deeper recession. How does that change our decision-making?
Joe Muratore:
Well, the first answer is we underwrite 20 IRRs and we put what we believe to be reasonable exit capital assumptions.
Ryan Swehla:
Generally conservative assumptions.
Joe Muratore:
So the first answer is we have tremendous margin of safety between what we are projecting in zero and we're an active... We drive value, it's what we do. I know that we're able to continue to move rents, because we're doing it. I see the lists for people wanting to rent apartments. I see the leasing times on industrial. On our smaller suite office buildings, I see our downtime. There's still strong demand.
So I think if it seems to be getting worse, if consumers are spending less, number one, we're diversified, we're in multi-family, industrial and office. Number two, we underwrite to a high IRR threshold. Number three, we're in submarkets where we're specialists. Number four, in the submarkets we're in, we're often the biggest player in that submarket, which means we're seeing more deal flow, more tenant activity. We have more staff and teams and brokers that care about our account, that care about our business, than the local people, the wealthy families that own properties, the institutional that are spread out.
Being a local sharp-shooter in multiple submarkets, I think we're the kind of group that does the best.
Ryan Swehla:
Case in point, I guess, out of that, is Response Road. We bought a property that was 35% occupied. Not 35% vacant, 35% occupied, and we closed in April of 2020, right as the COVID pandemic was fully unleashing, and that should have been a poster child for a bad investment. And here we are today, it's 84% occupied, trending towards stabilized occupancy.
Joe Muratore:
Big thank you to new Newmark in Sacramento. They worked so hard.
Ryan Swehla:
But part of that ultimately is knowing the right asset, knowing the right market, knowing your micro market that allows even during times of substantial headwind to be able to take that substantial headwind. Now, did it lease as quickly as we had originally proformad? No. Were construction costs higher than we had originally proformad? Absolutely. I mean there are absolutely externalities that affected the outcome, but ultimately it's a successful investment outcome in the midst of that headwind.
Joe Muratore:
We can't ever forget though that we are in a trust and a people business. And number one, buildings exist to house people and house businesses. But number two, our extent to work with our brokerage teams, our extent for our staff to drive leasing, to creatively come up with TI packages. I remember, we got a tenant touring next Tuesday, let's blow out these walls in advance because we know this is a really important tenant and this is how it's going to show for them. And in a week, the suites looked different. I mean the way our staff acted during COVID to get spaces leased, and the way the brokers we work with, I mean it was incredible. So I want to say that there's, what do they call it? Emotional intelligence. There's a people intelligence that's a big part of our business, and it is 50% of our success, maybe more.
Ryan Swehla:
And arguably, it's even more so when we're in a headwind environment versus a tailwind environment. Tailwind rewards all market participants. Doesn't matter how you operate. We've seen this time and time again, but a headwind environment rewards the best operators.
Joe Muratore:
Yeah, the best culture, the best teams.
Ryan Swehla:
And so ultimately, I think that gets back to how we navigate the future. Regardless of what we think the future is going to unfold, we are prepared for however the future is unfolding because of how we operate in the markets that we know.
Joe Muratore:
There's a great idea, and it comes to mountain climbing, but it's, you assemble a team of various experts, because you don't know exactly which problem you're going to hit or when, you don't know which anvilet, avalanche or crevice. I'm not a mountain climber, you are. But you don't know what those problems are. But when you assemble an epic team, you know you've got the right pieces to navigate that thing. And I think that's what makes us different, is our team is epic and our culture here is incredible, and it's our job to buy things right. You do make a lot of your money going in, but man, we are well equipped to navigate the journey to get to that sale event and to drive that IRR.
Ryan Swehla:
Regardless of the future.
Narrator:
Thank you for listening to Durable Value, an Investor's podcast where we demystify commercial real estate with safe sound investment strategies to help you balance your portfolio. If you enjoyed this podcast, be sure to rate it on iTunes or wherever you get your podcasts. To learn more, visit graceadapartners.com, where you'll find more information, investors tools, case studies, and more. This podcast is hosted by Joe Muratore and Ryan Swehla. It's produced, edited, and mixed by Melodic, with intro music by Ian Post. Thanks again for listening and we'll see you next time.
Summary
It's on the tip of every investor's tongue: where are markets headed? Graceada Partners started during the global financial crisis in '08. In this episode Joe and Ryan share the specific ways Graceada Partners is proactively set up for uncertainty.
In this Episode
How we deal with market uncertainty
Our long-term outlook
Mitigating risk in recession
Our one year picture
Deeper recession’s affects on decision-making
Runtime
13:34