Risk Perception vs. Reality in Real Estate | Durable Value Ep. 96
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Joe Muratore: For today's podcast, let's, let's go on a journey, a, a journey of risk. Let's talk about secondary markets as a- as opposed to primary markets. For most, uh, institutional allocators, the, the common thought is, well, the juice isn't worth the squeeze. Secondary markets are, uh, distributed, they're expert zones, they're owned by locals, they're hard to understand.
I don't have time for that. It- it's hard to understand what's going on in Spokane from New York or, or Boston. So today we're going to unpack the merits of secondary markets, because our company is largely built on navigating this part of America's largest, uh, one of America's largest asset classes, real estate, but an area that hasn't been institutionalized.
Major capital has not reached these markets the way it has primary markets, so.
Ryan Swehla: Yeah, and we're gonna talk a little bit about that structural mispricing, the, the idea of the perceived risk and the return expected for that versus the actual risk. Risk is fundamentally a proxy for volatility. When we talk about, you know, the ri- the return that we expect to get, it's in relation to the volatility of outcomes that we expect to happen, and there's this idea that in secondary and tertiary markets, they're more volatile, that they are subject to bigger swings in market cycles.
We've spent time through our research to show quantitatively that secondary and tertiary markets are in many ways less volatile markets.
Joe Muratore: How so?
Ryan Swehla: We did a 20-year, uh, study inclusive of the GFC, the COVID pandemic, the rate hike regime, and looked at the key economic, uh, factors, GDP, population, job growth, income growth, employment And, uh, what we saw was, uh, fascinating.
Um, during the, uh, GFC, secondary and tertiary markets in the West saw a lower decline in GDP than primary markets did. During the pandemic, same thing, less of a decline in GDP than the primary markets. And when you look over the 20-year period, lower volatility in GDP growth, uh, stronger GDP growth, stronger population growth, stronger job growth.
And so when you actually look at the data behind that, the perception is different than reality.
Joe Muratore: It does seem to intuitively make sense. I, I sort of think of it as, like Fresno is Fresno. The people who live in Fresno live there because that's where they're from, or that's where they want to be, that's where their life is.
They will find jobs there. And jobs will go there because people are there, workers are there. If you look at, like, a, a tech center, if you look at Silicon Valley, there might be tech booms and busts. It seems like the population in Silicon Valley today is quite different than it was a decade ago. The jobs have shifted.
They're also dispersing in different places, and that population seems to be more mobile. So it would suggest that GDP i- is going to be durable in these hidden population centers where people structurally wanna be. It, they're affordable, it's a quality of life, uh, their family's there. Um, they're, they're, they're less mobile, so it, it does seem to support that.
Ryan Swehla: Yeah, and it's interesting because we also looked at GDP composition because that's one of the other concepts, is this idea that smaller markets are, are more volatile. And when you look at the GDP composition, a place like the Bay Area actually has much greater industry concentration of GDP than Fresno.
Fresno, for instance, just to use that as an example, there's no one industry that is more than 15% of Fresno's GDP.
Joe Muratore: Mm-hmm.
Ryan Swehla: Um, you look at Denver or you look at Salt Lake or you look at Bakersfield or you look at Boise, there, there's no one industry that is the heavy concentration of that economy, which makes for a more resilient economy.
One of the other things that we saw in the, in the data was that there is higher volatility in supply and demand, measured through net absorption, in primary markets than in secondary and tertiary. And again, the, the idea would be in primary markets there's less land available, and so therefore it's more sheltered from oversupply.
Meanwhile, in secondary and tertiary markets, there's more land, it's cheaper, and so it's more at risk of oversupply and that volatility. But what the data shows is the opposite. And what we believe a, a big part of that is presence of institutional capital. Presence of institutional capital is a greater indicator of oversupply than anything else.
We saw this in Austin. We saw this in a lot of the Southeast. I- we saw it in Denver, one of the markets that we're in as well. But even in primary markets, the volatility in supply and demand is much greater than it is in secondary and tertiary markets. And so again, the, this idea that, uh, the perception of volatility or risk is greater than the actual volatility or risk.
Joe Muratore: Makes me wonder why capital clusters in some markets over others. It's interesting to think about, this is like behavioral dynamics, but think if you're, you're an analyst and you're recommending do we invest in the Bay Area or Manhattan? Like, this is something you can recommend. If you say Stockton or Sacramento or, you know, Boise or, or something else, I mean, this is, this is like career risk.
Like on the one hand you're, you're suggesting something acceptable. On the other hand, you're making a call. You're parting from the crowd and crowds don't get parted easily.
Ryan Swehla: All of the institutional benchmarks are predicated on primary markets. So if your measure, what you're measured against and, and what is considered the market is only primary markets, and it doesn't include all of these smaller markets, there's a disincent- a built-in disincentive to invest in these smaller markets.
The benchmark by which you're measured, even if that benchmark Does worse during a downturn than another market, you're being measured by the benchmark, so at least you're with the benchmark. Mm. So there's kind of this built-in, uh, self-reassuring cycle.
Joe Muratore: I guess what we're trying to do, in many ways, is get away from the, the trends or the capital markets movement and more towards, uh, the durable long-term thesis.
The idea that it's increasingly hard to buy a house in, in America, and people will move towards affordability, that there are trends that are making secondary markets durable for the long term, less volatile. And we're working to be outside of the capital market cycles and into where there's a permanence thesis that can survive capital cycles because that, the populations that are renting there don't particularly have another place to go and prefer to be where they are.
Ryan Swehla: It's interesting, one of the other concerns that we hear is, uh, liquidity. There's this, again, perception that where institutional capital is, that's where liquidity exists, and where there isn't institutional capital, that's where liquidity doesn't exist. The data shows the opposite because during downturns, institutional capital is the one that pulls back the most.
Private capital certainly pulls back during downturns, but private capital is also transacting because of estate planning or 1031 exchange, or the patriarch passed away and the kids want the money. You know, there, there are all these other dynamics that are precipitating transactions in the private capital world that don't happen in institutional capital.
So what's interesting is liquidity actually exists better in that smaller asset size, which is harder to transact. It's harder for institutional capital to deploy meaningfully using that smaller asset size, but that really is where liquidity exists.
Joe Muratore: Well, it seems like capital's always looking for a home.
Maybe take us to, "We'll come back in five years or come back in 10 years." Have secondary markets institutionalized more greatly? Like, speak to that.
Ryan Swehla: It's interesting because we are definitely seeing more and more interest in secondary and tertiary markets. In the southeast, there's a broader acceptance of, you know, markets like Charlotte and Huntsville and Jacksonville and things like that.
In the west, not as much. It's, it's still a- an area that is growing. But I think as we fast-forward with the acceleration of data availability, with the acceleration of technological change that makes it easier to transact at a smaller asset size, I do think that we'll continue to see more interest in these markets.
Joe Muratore: I do think we are a leader in institutionalizing these markets. I think we're a few years ahead of our time, but we're sort of on the cusp of being the right amount ahead with both having an increased institutional exit from these properties, but also we still have, uh, you know, family offices and local syndicators and private capital.
So it's a, it's a mix of deal size and, you know, buyer size that, that that institutional side i- is growing. Uh, there ... People are moving to where there's less competition, and that's these smaller markets that are often, you know, an hour outside- Yeah ... outside the major markets. They're not forever away.
They're, they're within distance.
Ryan Swehla: It's interesting because I'll, I'll use kind of a, a real-time example. We just sold an office building. We don't invest in office anymore, but we, uh, we are slowly divesting of our last, uh, office assets. But we sold an office asset this year, 2026. We sold, uh, part of it in 2025 and part of it in 2026 for a 16 gross IRR and a 1.9 equity multiple.
That's, to me, just like the ultimate example of liquidity because we're dealing with a challenging asset, office. We're dealing with a small market, and yet there are buyers. And the reason for that is because private buyers continue to transact during challenging times. They, they-
Well,
Ryan Swehla: and
Joe Muratore: of those two buyers, one was a government agency that was an occupier, and one was a 1031 exchanger.
So they both had legitimate user or specific personal capital needs that were driving their- Yeah ... their motivation.
Ryan Swehla: And meanwhile, obviously most of the transactions occurring in the office market today are deep, deep distress, deep, deep discount. But the fact that you can still transact an office building during a challenging environment really underscores that.
And I think that's where when we really peel all of this away from a risk perspective, if the markets themselves are deemed to be investable, you know, perceived liquidity risk is understood not to be as, as, uh, challenging as it is. If you strip all of that away, we're, um, buying assets at a higher cap rate Using the same debt cost as primary markets.
So we have a built-in higher return just by operating in markets that are, you know, less perceived favorable.
Joe Muratore: So how do we apply this actually? I mean, honestly, it's... It, it, the thesis makes sense, but tactically- It's not easy ... it's hard to do. I mean, it's, it is a bunch of markets in a bunch of places. I mean-
Ryan Swehla: And a bunch of small assets.
Joe Muratore: Yeah. So how do we actually get this mispriced risk and deliver, you know, alpha? The easiest way to look at it is both from a macro perspective and a, and a local perspective. I mean, all real estate is local, but it's important to see it in a macro way. You have to see the macro trends, you have to see where the, where people are moving and why, and, uh, you have to observe the West broadly to know which cities and towns.
The good news is that we're currently in 12 markets, and over time we'll be in 20 or 30. But when you are actually in those markets, when you actually have employees in those markets, when you actually have buildings beaming you data by the day, you are not looking at CoStar and Green Street and saying, "What's going on?"
You're looking at your own data, your own boots on the ground data, and observing the West, and able to say, like... And also seeing the concentration of your current portfolio and saying, "Well, let's, let's pivot this way. We see this trend happening here." That's 60%. You want the trends, you want a tailwind. To achieve success, you have to buy actual properties.
To buy the right actual properties, you have to be in those markets getting leads, knowing which owners are aging out or thinking of selling, talking to brokers and boots on the ground, and hearing about where there's distress or underperformance, and having the, the brand presence and the people presence to actually get the very best leads and to be the best closer and get them done, add them into the portfolio, staff them, and deliver that alpha.
And that's why we exist. If it were an easy job, our company wouldn't have this opportunity, but there is that mispriced risk, and we exist to broadly and very narrowly, uh, solve it.
Ryan Swehla: And that alpha generation is fundamentally why there is growing interest in our strategy and growing interest in our markets.
One of the top 25 or 30 public pensions, uh, recently made a $90 million investment with us, and part of their analysis looked at all of our realized and unrealized track record. And compared to their benchmark, their beta, uh, we generated 752 basis points of alpha. It is that structural mispricing that allows the ability to generate significant alpha above the market.
And of course, their benchmark is based on primary markets and, and that sort of thing, so you have this ability to achieve something, uh, exceptional, uh, relative to the market
In this episode of Durable Value, Joe and Ryan discuss how most institutional investors skip secondary and tertiary real estate markets; but what if the "perceived risk" is actually lower than primary markets? Here we break down the data behind secondary market investing: why volatility is lower, why liquidity is stronger than you'd expect, and why institutional capital clustering in gateway cities may be the real risk. We also share a real-world example of selling an office building in 2026, and generating a 16% gross IRR, to prove the thesis.
0:00 – Introduction: Secondary Markets & The Risk Mispricing Thesis
1:28 – The 20-Year Data Study (GFC, COVID, Rate Hikes)
4:36 – Institutional Capital as a Predictor of Oversupply
5:07 – Why Capital Clusters in Primary Markets (Career Risk & Benchmarks)
7:01 – The Liquidity Myth: Where Transactions Actually Happen
8:04 – Are Secondary Markets Becoming Institutionalized?
11:34 – How to Execute: Macro Trends + Local Boots on the Ground