The AAA Storage Podcast

Join real estate expert Paul Bennett as he breaks down the fundamentals of commercial real estate investing. In this episode, Paul guides listeners through the seven major sectors, reveals the key factors that shape investment returns, and demystifies essential terms like “core,” “value add,” and institutional grades. Listeners will gain a practical framework for evaluating and comparing different property types, helping them make smarter portfolio decisions. Whether you’re new to real estate or refining your strategy, this episode offers clear insights for navigating today’s CRE market.

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Chapters
(00:00) Introduction to Commercial Real Estate Sectors
(04:53) Understanding Asset Classes and Property Grades
(13:47) Investment Strategies and Classifications
(17:11) Building a Portfolio Using Sector and Factor Grids
(20:25) Multifamily Sector Deep Dive
(22:47) Office Sector Analysis and Trends
(27:04) Retail Investment Factors and Mixed Use Concepts
(33:00) Hotels and Medical Office Investment Fundamentals
(39:46) Next Steps and Preview of Industrial and Self-Storage

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Creators and Guests

Host
Paul Bennett
Managing Director at AAA Storage

What is The AAA Storage Podcast?

Investing in self storage gives you the fundamentals and growth you need to grow your portfolio. But skip the opportunities from golf buddies and gurus—invest in a real track record. Started by John Muhich in 1993, AAA Storage has delivered 19% IRR across 90 deals, totaling $450M in exits. Listen to our expert insights on investing from the AAA Storage team. See more at aaastorageinvestments.com.

INTRO HOOK: This is a masterclass
in commercial real estate

from a veteran, Paul Bennett.

A lot of people don't understand
the character or nature differences

in different types of real estate.

If you naturally gravitate to the
hotel investment just because it has

a higher return without understanding
why it has a higher return, you

could make a really big mistake.

If you ask most investors today who
express an interest in multifamily,

for example, why they're interested
in multifamily, they probably

don't have a really good reason.

The security, the dependability of that
revenue stream that drives your NOI

becomes more in question, therefore
more risk, therefore an elevated

cap rate with lower values overall.

We're gonna talk about the biggest
risk in each of these categories.

Some of these risks relate to
what's going on in the economy.

So in one point in time, office
may look like a great investment.

At a different point in time, it may not,
and that could apply to any of the sectors

Welcome to the AAA storage podcast,
your integrated real estate and

development partner, exploring all
things, self storage investing to

bring you diversified success.

Let's dive in.

Brandon Giella: Today, we've got a fun
first of three parts on commercial real

estate, CRE, and a forthcoming investor's
guide we'll link in the show notes to walk

through everything we're about to explain.

This is a master class in commercial
real estate from a veteran, Paul Bennett.

Thanks for joining.

So today, we're gonna be talking
about seven sectors in commercial

real estate and five factors for
each of those sectors to help

investors guide their portfolio mix.

And then we'll talk about
demystifying some terms so that

we all have clarity and alignment
on what we're talking about here.

Paul, uh, before we get into each of
these, uh, asset classes, property

types, the factors that affect
them, talk to me a little bit about

why this topic matters so much.

Paul: Yeah, Brandon, um, you
know, we were talking internally

about, um, things that we could
do on the podcast that have value.

And one of the things I realized is
I think a lot of people don't really

understand the, the character or nature
differences in different types of

real estate, where the risk really is.

I think if you ask most investors
today who express an interest in

multifamily, for example, why they're
interested in multifamily, they probably

don't have a really good reason.

It, it's either it's the deal that
happened to show up in front of them,

or their-- that's what their friend is
doing, or they heard somebody made a

lot of money in multifamily, uh, or, you
know, the, the old line, particularly in

that sector, which is, "Well, everybody's
gotta have pl- have a place to live."

I just think it's important to
understand the, the dynamics and the

nature of each type of real estate,
because I think it can influence

how you construct your portfolio.

Uh, it will help you avoid risks that m-
maybe are outside your risk tolerance.

It'll also help you dial in, um,
the kites or the types and levels of

return that y- you're really designing
your portfolio to, to generate.

And also, like you said, I
think it'll be fun today.

There are terms that get thrown
around a lot that I'm not sure

everybody really knows what they mean.

So hopefully, along the way, we'll
pick off a few of those and help people

understand, you know, when somebody
throws around the term core, core

plus, what they, what they really mean.

Um, and we are gonna talk
predominantly, uh, I think in, in

part two and part three, we'll talk
a little bit about development.

Um, but today, I want you to orient
your brain, if you're listening

to us, really around we're talking
about acquiring existing assets.

Um, it-- A lot of this would apply
to developing these same assets, but

it really is, um, sort of, sort of
existing asset oriented in terms of

how we're gonna approach it today.

We're gonna cover a lot, so fingers
crossed we can actually pull this off.

Brandon Giella: Yeah, we got-- yeah,
there's tons to think about here.

But I, I think the kinda theme of
this is, is, uh, knowledge is power.

Know what you're getting into
because each of these sectors

has different, um, uh, uh, across
the factors, there are different

things that affect each of these.

And so before you think about
your portfolio mix and getting

into investing in real estate,

Paul: I probably getting out ahead of
myself, but I mean, for example, if

what you do as an investor is simply
look at the bottom line returns, and

let's say you're looking at a, a, a, a
a retail deal with a grocery anchored

shopping center and a hotel deal, and
the hotel, hotel deal's showing potential

returns in the upper 20 range, and the,
uh, and the retail shopping center's

showing a return in the 14 range.

If you naturally gravitate to the
hotel investment just because it has

a higher return without understanding
why it has a higher return, you

could make a really big mistake.

And so that…

I think that's kind of what we're after
today, is helping people understand

how to evaluate starting with context
and type of real estate, um, what,

you know, what kind of risk may be
embedded in those potential returns.

Brandon Giella: That's right.

It's, uh, it's understanding why
you're about to have the headache or

the joy you're about to experience.

Okay, great.

So, uh, yeah, so second episode on
this series is gonna be, uh, about

small-bay industrial and self-storage.

We'll go into more details on that.

And the third is gonna be
risk and return across these

commercial real estate sectors.

So we'll talk about those.

the seven sectors are multifamily, office,
retail, hotel, hospitality, medical

office, industrial, and self-storage.

So seven sectors.

And five factors for each sector, so
this forms a grid in your mind, a seven

by five, where we have talking about,
uh, cap rates, demand drivers, liquidity

and hold periods, big risks affecting
each of these sectors, and then, uh,

investment grade characteristics.

So let's start on that last one.

So talk to us about these, uh, terms
like core, core plus, and so on when

you're thinking about real estate.

What does that

Paul: Yeah.

And, and we're gonna talk, uh, as we
talk about each of the, uh, uh, of the

sectors, we'll talk about what defines
an investment grade and an institutional

investment grade asset within that sector.

But first, because it is sort of
global, you, you hear the term a lot.

That's a, a class A, uh, multi, uh,
apartment project, or, uh, it's a,

it's a, it's a class B retail shopping
center or a class C multifamily.

And there, there are num-- And it
sort of as broadly applies agrid--

a-across all the sectors, which is why
we're gonna do it globally and not,

uh, specifically with each sector.

But the, the first thing that
often influences wheres-whether

something's an A, B, or C, classified
as, as an A, B, or C, is its age.

Um, the, the age has differing
impacts within different sectors.

For example, the sectors
where age banners the most are

office, industrial, and hotels.

In, in, in office it matters most
because older office projects

tend to have fewer amenities.

Their mechanical systems, um,
tend to be more unpredictable

and need more maintenance.

Um, air quality might be an issue.

You could have a building
that has asbestos in it.

Um, in the industrial sector,
it's really about function.

Uh, older industrial buildings may have,
you know, 18-foot ceilings, where today

a modern facility's gonna almost always
have a 25-foot clear span ceiling.

Um, and, and how the bays are
set up and h-how technologically

adaptive that space is.

There are a lot of, you know, robots
and other things that are used in

warehouse spaces today that an older
facility may not be able to accommodate

or may not be able to accommodate
without a, a significant upfit.

In the hotel industry, age is everything,
um, because hotel properties take

quite a beating from the, the use
that they get, and replacing the

soft goods, the furniture, all…

It-- Reinvesting cash flow from
that real estate on a constant ba…

A, a hotel can go from a Class A, uh,
hotel property to a Class B or C in

a span of five years, uh, if there's,
if there's deferred maintenance

that builds up in that economy.

So those are the three sectors
where age matters the most.

In, uh, uh, the, in the middle of
the spectrum in terms of how much

age matters, you've got multifamily,
retail, and medical office.

Um, age matters in those sectors,
not as much as in the first three,

but for example, in multifamily,
architecture and amenities.

Older facilities tend to have
older-looking architecture, um, and which

isn't as attractive, and they have fewer
amenities than the modern facilities that

are a year, two years, three years older.

Um, similar things in, in retail and
MOB in different, in different forms.

Um, you know, how much parking you
have in retail, um, relative to,

to the amount of square footage
of retail space that you have.

Um, the, uh, uh, you know, retail
property owners spend a fair amount

of money on landscaping and repaving
parking lots and doing things to keep

facilities looking new and polished.

It keeps them, you know, in that
A, B category and doesn't let them

decline into a, a C-level property.

In medical office building, it's often
about cleanliness and technology.

Um, interestingly enough, there's
one sector where age matters the

least, and that's self-storage Um,
but age isn't the only criteria.

There…

I, I'll give you some
quick, quick guidelines.

In multi-family, generally,
a Class A property is gonna

be 15 years old or newer.

A Class B property, uh, 15 to 35
years old, and Class C property,

anything over 35 year old definitely
would fall into Class C, unless it's

in Manhattan, um, you know, and,
and, and has been well-maintained.

Um, and similar retail office and medical
office and industrial all have, a- as well

as self-storage and hotels, all have the
same sort of 20-year window where they

could fall into the Class A category.

Um, and then at 20 to 40, they're in the,
the Class B, and 40 plus, they're, they're

Class C properties in, in most cases.

Uh, but again, age is not the only factor.

It's, it's really about, uh,
it, it, it again, depends on the

sector, but it, it, it is important
where the property's located.

You see retail facilities that,
um, have, have had a real shift in

their tenant base because the area
around them changed dramatically.

Maybe went from a middle income or a
upper middle income neighborhood to a

lower middle income neighborhood, and
suddenly, the higher end shops that are

willing to pay higher per square foot
rents, um, vacated that area because the

customers that they're looking for aren't
there, and suddenly you wind up with a,

a smattering of local businesses that
serve a particular demographic or, um…

And so you, you see it, um,
in, in lots of, of ways.

The, th- there are ways to override age.

They're different in
each, um, in each sector.

In multi-family, um, the right location.

Like I said, if you're in Manhattan,
you're probably in pretty good shape.

The other thing is renovation.

Um, keeping, you know, the appliances,
keeping the countertops, keeping all

those things up to date, um, can keep a
property in that, that Class A, um, range

out to that 15-year mark we talked about.

Um, if you don't renovate and
you're not in a good location, it

doesn't take an apartment project
long to go from Class A to Class B.

Um, why do classes matter?

Um, they affect the cap rate range.

You'll see in a minute, we're gonna
talk about cap rates, um, and, and

cap rates are tied to a multitude of
things, but one of them is the risk of

the continuance of the revenue stream.

Um, and, and when you get an older
prope- property, the likelihood that

it's either gonna be difficult to
increase rents or you're gonna see

declining rents potentially grows.

And so the security, the dependability
of that revenue stream that drives your

NOI becomes more in question, therefore
more risk, therefore an elevated

cap rate with lower values overall.

So, um, uh- I think the other
thing that can affect…

I'll, I'll give you an
example in self-storage and,

and small-bay industrial.

I tell people routinely,
we build a Class B product.

Uh, even though it's a brand-new building,
it's a slab on grade metal building.

Uh, it is not tilt up concrete.

It is not a brick building.

It is not a poured concrete building.

Uh, Uh and so type of construction
in certain segments can affect

whether something is an A, B or C.

In self-storage, although age is not
really important, um, y- we've all ridden

past a 40-unit self-storage facility that
sits beside a house sort of in a rural

area, and it's obvious that that homeowner
had a couple acres of extra land and

graded it, put buildings on it, threw down
some gravel and put up a chain link fence.

Um, and that's a Class
B or a Class C facility.

Um, our facilities, which are
institutional grade Class A

facilities, have concrete driveways.

Um, they have, you know, they have,
um, automatic gates with, with codes.

Uh, the, the fences aren't chain link.

Um, you can't see through our
fences, so it enhances security.

We have security cameras.

We have…

You know, all of those things, um, matter
in the self-storage world a lot more

than age does in terms of what class,
um, a particular property falls into.

So, um, hopefully that, that gives you
a little bit of, of, of an idea in terms

of when you hear somebody say, "Well,
that's a Class A apartment project," or,

"That's a Class C apartment project."

You know, it has to do with where
it is, how old it is, and how

functionally, um, how well it
performs functionally for the…

How fit for purpose it is.

Uh, and then you add the issues like
architecture and amenities in different

sectors that, that do make a difference.

So a lot of information.

I'm not sure I did a really good
job trying to get through it, but…

Brandon Giella: no, that's helpful.

Uh, it, it, it reminds me of a, a couple
years ago, I was talking to a real

estate investor here in DFW, and I--
he was talking about, you know, demand

and growth and whatever in DFW, and
I was like: "Oh, yeah, I just saw…"

And he said he invests in, in multifamily,
and I was like: "Oh, yeah, I just

saw this, you know, giant apartment

Paul: Yeah.

Brandon Giella: you know,
kinda in that world."

And he goes: yeah, no, we don't do that.

We do, uh, Class C value add properties."

And so I

Paul: Yeah.

Brandon Giella: what kind of, you know,
cap rates and returns and the kind of work

that he has to go into these properties.

And they may be distressed, they may-- he
has to buy them from banks, you know, and

all that kind of stuff that goes into it.

So I, I, I understood there.

There is a sharp distinction between
these classes, uh, as far as investors go.

Paul: And the other part of it is, is
another sort of class ranking that you

hear is core, core plus, value add, and
opportunistic, and at the end of that

would be development, which is ground
up, start with a piece of land and build

on Um, those terms are probably, um…

And you can com-combine them.

But core and core plus are generally,
um, Class A facilities, buildings,

whatever type of real estate it is,
that, that have a, um, a solid, stable

tenant base and are producing revenue,
you know, on a predictable basis.

Um, we had Brandon, um, on the podcast
from Flagship Healthcare Properties.

Um, they, they buy primarily core
and core plus assets, um, with,

you know, with, with, uh, hospital
system tenants for the most part.

So high grade tenants in relatively new
buildings, um, that's their strategy.

They do a little bit of value add to
kind of juice returns a little bit.

Um, and, and really no opportunistic.

Value add, as you said, is the second
sort of category, which is a property

that needs some additional investment,
um, to either move it up the scale

from a B to an A or a C to a B, or
just make it functionally useful.

Um, value add plays that you can
often see is you'll see somebody

buy an apartment project that's a,
a Class B or a high Class C project.

Maybe it's not in a horrible
location, but the previous owner

kind of milked the cow and didn't
put a lot of money back into it.

And so they'll buy a property like
that at a higher cap rate, they'll

pay less for it, and then they'll
raise additional capital to go in

and replace cabinets, countertops,
um, carpets, um, you know, windows

and doors if, if those are an issue.

They'll, they'll make structural capital
expenditures to upgrade the, the facility.

And we've talked a lot about, at different
times on the podcast, yield on cost.

In a value add scenario, you can actually
run yield on cost to see if I spend this

much money to upgrade it, and I think
I can get this much more in rents, what

kind of yield on cost am I getting on that
value add component of the investment?

You kinda separate the cost of the
underlying real estate from the

improvements that you're gonna make
and the incremental revenue and NOI

that they're gonna generate, and
you can sort of calculate what your

return's gonna be, your projected
return on that value add component.

Um, opportunistic, uh, I think
is just sort of a catch-all

category for unusual circumstances.

Maybe it's, uh, uh…

Well, I mean, you know, uh, uh, there,
there's a group out there now that's

doing workforce housing, and what
they're doing is buying hotels, uh, that

aren't performing well as hotels and
converting them to workforce housing.

That's more of an opportunistic
type of investment.

It's a,

Brandon Giella: Hmm.

Paul: a complete change in use.

Uh, you buy, you know, a hotel that's
not performing well or maybe one that's

been foreclosed on by the bank Um, at
a fairly low price, probably under what

you could build it for, and then you
invest in it to convert it to a different

use where you, your, you know, your,
your thesis is you can get higher rents

and therefore higher overall returns.

Um, but anyway, that, that's
sort of a very broad…

Uh, we, we burned
seventeen minutes already.

We hadn't even really gotten
started, so we better get going.

But,

Brandon Giella: Yeah, so just to
expand the, the framework or the

grid that we're talking about here.

So there's seven sectors: multifamily,
office, retail, hotel, medical

office, industrial, and self-storage.

Within each of these, there
are five sectors or five,

Paul: Yep.

Brandon Giella: factors, which

Paul: yeah.

Brandon Giella: which is cap
rates, demand drivers, liquidity

and hold period, big risks, and
investment grade characteristics.

those, you have different classes.

So there's A, B, C, and then you've
got, uh, different, uh, investment

grade, I don't know what you would
call it, classes, if you will,

where you've got core, core plus,
value add, and opportunistic.

And so when you're thinking about
investing in commercial real estate,

you have this grid or this framework
to place these different, uh,

opportunities that become available,
which all have different characteristics

and factors involved with them.

And that helps, you assess how
to invest in them, think about

them, analyze them, and where
you place them in your portfolio.

Did I summarize that correctly?

Is that,

Paul: Yeah, you did a really good job.

And my hope is, as we go through
these factors, people will get a

better understanding of how well any
one of these sectors fits in their

portfolio based on their return
objectives and their risk tolerance.

Brandon Giella: Great.

Paul: because there are some hidden
things in there that if you're not

aware of them, like I said, you
look at the bottom line returns,

one return is higher than the other.

You think that's the better
deal, and in fact, it may not

be the better deal for you,

Brandon Giella: Yep.

Paul: because it may have some
characteristics to it that, um, don't…

And the other piece is context.

We're gonna talk about the biggest
risk in each of these categories.

Some of these risks relate to
what's going on in the economy.

So in one point in time, office
may look like a great investment.

At a different point in time, it may not.

And that could apply
to any of the sectors.

I'm not picking on office.

But

Brandon Giella: are great.

Paul: yeah.

Brandon Giella: we'll see.

Paul: Yeah.

Brandon Giella: Okay.

Paul: and, and, and post-COVID,
again, back to the classes.

Class A offices that are well-located
in major met- major metropolitan

areas are doing pretty well.

Brandon Giella: Yes, right.

Paul: What's struggling is the, the
low Bs and Cs in suburban markets

because th- they're outdated, uh, they
don't have the amenities, and because

there are fewer tenants and fewer
people working in offices, they're

the ones that are getting left out.

And so it, it, that's a contextual
issue and also a grade issue in terms

of where you might want to invest.

Brandon Giella: And then location too.

We haven't explicitly
called that out exactly,

Paul: Oh

Brandon Giella: location, location.

Paul: I was gonna say, the old,
old joke is there are only three

things that matter in real estate:
location, location, and location.

So,

Brandon Giella: goes

Paul: yeah.

Brandon Giella: but that is a major factor

Paul: Yeah, that certainly applies to,
to every one of them, for sure, so…

Brandon Giella: That's right.

All right, so let's talk about,
let, let's take multifamily.

We've talked about that a bit, um,
uh, but, but I think a lot of people

that are listening to this show
are very familiar with multifamily.

They see the opportunities.

They see it's, it's been a big trend for
the last, you know, several decade or two.

So talk to us about cap
rates, the demand drivers.

Like, go through these factors so
that we can analyze multifamily.

Like, picture an apartment in your

Paul: Okay.

Brandon Giella: go through that,
and then we'll go to the next

sector and, and see what we can do.

We got about 15 minutes left, so, uh,

Paul: Okay.

We'll, we'll try to…

Yeah, we'll see how far we get.

So cap rates in the multifamily
today are in the 4.5

to six range.

That's a pretty big spread.

And I would say you could see some class
C properties in certain markets that go

north of six in terms of their cap rate.

Um, that would be an expectation.

The things that drive, uh, demand in,
in the multifamily world are population

growth, housing affordability,
household formation, and wage growth.

The first three are really
about driving demand.

The, the last one's really about
the ability to raise rents.

Um, if the economy's stagnant, wages
aren't growing, it can be very difficult

to raise rents, which then makes it
difficult to create incremental value

and ultimately exit with a profit.

Liquidity and hold period is a function
in all these sectors of w- how favored

are they with institutional buyers.

The institutional money in,
in real estate today is by far

the largest source of capital.

And so you really look at how long
you're gonna have to hold something

and how liquid that given sector
is based on institutional interest.

Uh, multifamily is very, very liquid,
very big institutional market, and

a f- anywhere from a five to 10
year hold period is common, um,

in the multifamily, uh, world.

The biggest risk, re- regulation,
supply surges like we saw post-COVID

in a lot of markets, um, and rising
operating expenses and insurance costs.

Uh, the two biggest costs in a
multifamily project, and this is

true in a lot of real estate, are
property taxes and property insurance.

Um, and so those are your
risks 'cause those eat at NOI.

Uh, rent regulation in certain
markets, particularly in large metro

markets, can cap your ability to
raise rents and therefore grow value.

Uh, and then the last thing is a, a,
an institutional grade multifamily

project is a, is an A or B+ grade that's
in a growth market with, with really

strong demographics and affordability.

Um, that's what the institutional
buyers are looking at.

So that's a quick run across the
multifamily factors and, and what

really, uh, what really drives them.

Brandon Giella: Great.

Okay.

Let's compare that with

Paul: Okay

Brandon Giella: or an office investment,
how does those factors to each other?

Paul: Cap rates in the office world
start above the high end of the

range in multifamily, so six and
a half to 10, uh, are sort of the

common cap rates in today's market.

The, the drivers aren't population
growth, uh, and wage growth, it's

really employment growth, corporate
expansion, and return to office

trends, which is something we wouldn't
have talked about before 2019,

Brandon Giella: Yep.

Paul: certainly is a,
is a hot topic today.

Um, currently, the office
market has less liquidity.

There's, there are fewer
institutional investors, uh, that

are interested in that market.

And so you're looking at longer hold
periods in the seven to 12-year range

versus five to 10 in, in, in multifamily.

Um, the biggest risk, remote work.

I mean, that's, you know,
that's one that is obvious.

Uh, obsolescence and
capital expenditure needs.

Um, people today are more concerned
than ever about air quality.

Um, how old is that HVAC system?

What's the quality of the
air in those buildings?

Brandon Giella: That's

Paul: like?

Um, you know, how convenient is it?

And location matters, uh, in,
in, in office, um, as well.

And, um, uh, on the, on the
investment grade side, trophy Class

A assets in gateway markets like
New York, LA, San Francisco, um, or

medical research-oriented suburbs.

The Research Triangle Park in r- in
Raleigh, North Carolina, Raleigh-Durham

area, North Carolina would be a great
example of a, a medical/research, uh,

suburban market where offices remain
strong in, in spite of the fact that,

you know, on a, on a national basis,
offices struggled in a lot of cases.

Brandon Giella: perfect.

Yeah, when I, I have in mind of a, a great
office to go to, it's one of these big

tech companies that have this beautiful
billion-dollar building, you know.

It's got all

Paul: Yeah.

Brandon Giella: coffee shops and all.

That sounds great.

I'll go work there.

But, you know, not every
building's like that.

Different, different risk and, and demand

Paul: Yeah.

Brandon Giella: those.

Paul: there's some guys that,
uh, bought a, an old Wachovia.

It was Wachovia headquarters
in Winston-Salem.

It was a building that nobody would touch.

Uh, it had asbestos in it.

Brandon Giella: Hmm.

Paul: and they bought
it for almost nothing.

And it, it is a Class C,
maybe C+, B- building.

Old architecture, the lobbies
and common areas are old.

But they went in and encapsulated
all the asbestos, upfitted, you know,

the building as much as they could.

And because they were able to
buy it really inexpensively-

They've done pretty well.

Um, they sold it to a private
equity group, a small private

equity group about three years ago.

Um, and, and they, they…

It was a, it was a good
investment for them.

But that's not the kind of investment that
an institutional player is gonna make.

Brandon Giella: Yeah.

Paul: it's a local market play in a
very specific unique circumstance, sort

of more one of those opportunistic…

It falls into that opportunistic
cl- category, more than core,

core plus, or even value add.

Brandon Giella: Mm-hmm.

Yeah, I've heard over the last couple
years, uh, people looking at office

buildings that aren't doing well
and converting them into apartments

or hotels, kinda like what you were

Paul: Yeah.

Brandon Giella: But I've heard that's
more of a headache than people really

realize how hard that would be to
actually do or how much capital it

would take to really do that well.

So anyway,

Paul: Yeah, w- we, we gotta stop
'cause we're gonna run out of time.

But,

Brandon Giella: keep talking, yeah.

Paul: I, I spend a fair amount of time in
Beaufort, North Carolina, and, and the old

elementary school in Beaufort was bought
by a local developer about four years ago,

and they've converted it into townhouses.

Brandon Giella: Yeah.

Paul: a,

Brandon Giella: That's

Paul: it's a beautiful project, but
it took a lot, or it took four years.

Uh,

Brandon Giella: Yeah.

Paul: but they bought the building,
the, the shell, basically, 'cause

they really gutted it and, and re-
you know, redid it, repurposed it

completely, but for, for almost nothing.

Brandon Giella: Hmm.

Paul: and, uh, and they've, they've
created a really beautiful project, and I

think their units are selling pretty well.

So another great example of sort of a,
a, an opportunistic investment where

you converted from one use to another.

Um, and, uh, and they're, they're
actually selling those condos, so

it's not an income producing piece…

Well, it is from the standpoint
of sales proceeds, but it's not a

typical where you're renting space or
they didn't turn it into apartments.

They turned it into townhomes,
and they're selling those units.

So

Brandon Giella: Yeah,

Paul: anyway.

Brandon Giella: example.

Yeah, to drive the point
home, different risks,

Paul: Yeah.

Brandon Giella: at with investments like

Paul: Yeah.

Brandon Giella: to us a little
bit, uh, about retail and compare

that to the office and multifamily
across these different factors.

Paul: Cap rates in the
retail world are in the 5.5

to 7.5%

range.

There, there are a lot
of flavors of retail.

So just to be clear, we're kind of
talking about grocery anchored shopping

centers here, um, because you can…

Malls are a different animal.

Uh, multi-story retail in urban
markets is a different animal.

Um, but so just sort of point of
reference really talking about.

And what drives them is consumer spending,
population density, and traffic patterns.

Just like in self-storage, the traffic
count in front of that shopping center

matters in terms of how successful
your tenants are gonna be and how

much rent they're willing to pay.

Um, liquidity, uh, and, and hold periods
are in the, in the moderate range.

Fairly good liquidity.

There are a number of institutional
buyers and some publicly traded REITs,

uh, that like that grocery anchored,
um, uh, type of retail product.

And so you're looking at a five to
10 year hold on average to be able

to get enough rent growth and NOI
growth- Um, to create the return,

uh, that you're really looking for.

Biggest risk, e-commerce.

Um, tenant bankruptcies because
although you often have a major drug,

um, you know, pharmaceutical, uh,
retailer and a grocery store in those

centers, and those are generally
Class A, uh, tenants, uh, credits.

You know, they're, they're,
they're strong credits.

Uh, but you also then have a lot
of shop space, and the money's

really made in the shop space.

A, a grocery store that's gonna anchor
your shopping center is gonna rent

that space for four, five, six bucks
a foot 'cause they know the value

that they bring and the foot traffic
they're gonna bring to that center.

Where you're gonna make money is on the
shop tenants that are paying 20, 25, $30

a square foot for rent, and those are a
much bigger credit risk 'cause they're

usually local businesses and, you know,
they don't, they don't have a lot of depth

in terms of their financial resources.

So, um, bankruptcies, uh,
and then re-tenanting cost.

It's, it's a thing most people
wouldn't think about, but

when a tenant moves out…

If, if you have a, um, if you have, uh,
a jewelry store in a, you know, in a

3,000 square foot space and they move
out and your next tenant's a Chinese

restaurant, um, there's a fair amount of
CapEx spend that has to be done, uh, in

order to get that new tenant moved in.

And so, uh, those are, those are risk.

Uh, and then, and, and the, the,
the lease commissions that you

pay, um, are not, not small.

So not only do you have the CapEx
cost of refitting the space, but

then you've gotta pay the, the, the
broker that brought that tenant to

you a pretty handsome commission.

So those are costs that
can eat away at, at NOI.

Um…

Brandon Giella: I, I'm curious
real quick, uh, just give me like

30 seconds on w-what, uh, I hear a
mixed use, uh, apartment and retail

space, 'cause I think those are, uh,
becoming a lot more popular right now.

How do you, how do you think
about that kind of space?

Typically, I, I'm assuming Class A,
you know, kind of their newer spaces

where you've got shops along the bottom
and then you got three or four stories

of apartments or condos above that.

I see those everywhere here in DFW.

I mean, w- how do you, how do
you process that as an investor?

Paul: It's a really interesting concept.

Um, I was part of a group that developed
an $80 million mixed-use project

outside Charlotte, North Carolina.

And we inherited a land plan.

It was a, uh, a planned community
that had been zoned and, set up

years before when that concept
was more popular than it is today.

It's still, in really urban
markets it's popular, but- We

wound up with 162 apartment units

Brandon Giella: Hmm.

Paul: two different buildings
with ground floor retail.

Brandon Giella: Hmm.

Paul: we also had some excess land.

We wound up having a Lowe's grocery store.

Uh,

Brandon Giella: Cool.

Paul: a 51,000 square foot grocery store
for Lowe's, uh, that has done super well.

And then about another 100,000 square
feet of just general retail, um,

and one medical office building.

Um, so w- it was a true mixed use project.

It's gone very well.

Um, it has been impacted by the
fact that, um, you know, the, the…

in the post-COVID era, there was a
period where apartments, where there

was a little bit more competition.

And, uh, in that particular
circumstance, this isn't 30

seconds, I know I'm going long.

But we have…

W- we, we happened to get
the last sewer permit.

The sewer plant to serve that,
that area was almost at capacity.

They were able to get, uh, a, a change in
how their capacity was calculated with the

state, and we got the last sewer permit.

So what…

While there was a bit of competition in
the market when we, when we opened, it

was impossible for anybody to build a
new apr- apartment project for the next

three or four years 'cause they were
gonna have to upgrade the sewer facility.

Which kind of gave us a
little bit of an advantage.

But it was…

It's, it's…

The, the, the residential over retail
concept works in a lot of markets.

It doesn't work in every market.

Brandon Giella: Okay, interesting.

Yeah.

I, I bring that up because we're
talking about, you know, multifamily

office and retail and, and these mixed
use facilities that I see popping up

everywhere are kind of a mix of all of
those, kind of pushing all these factors

Paul: And th-

Brandon Giella: is kinda interesting.

Paul: this, this project that I'm
talking about was a mix of all of them.

We had medical office,

Brandon Giella: It's

Paul: we had retail, and we had
apartments all in the same 17 acre site.

Brandon Giella: Hmm.

So to say, you know, this grid, this
framework is very helpful, but there's

a lot of projects that kind of mush
them together, and you gotta analyze

each one separately, 'cause it's
diversified incomes, diversified risk.

You know, you gotta think through it.

Paul: And, and when you're doing a
multi-use pro- If you're investing

in a multi-use project, you really
have to assess the risk of each

component differently, right?

Because the apartments may
do great, the retail may not,

Brandon Giella: Yeah.

Paul: impact returns.

Brandon Giella: So the
blended return is the

Paul: yeah.

Brandon Giella: there.

Paul: Yeah.

Brandon Giella: blended.

Paul: Yeah.

Brandon Giella: Thanks for that.

Um, okay, let's, uh, we just in the
last few minutes here, talk to me a

little bit about hotels and medical
office, and then we'll reserve

industrial and self-storage for the
next episode, and we'll go through those

Paul: Okay.

Brandon Giella: and kind of
compare them to the previous

Paul: Yeah.

That's a great idea.

Hotels, um, the data showing
right now that the hotel cap rates

are in the seven to nine range.

I would tell you historically
they've been often north of 10.

Brandon Giella: Okay.

Paul: and one of the reasons is, uh,
I mentioned a minute ago that cap

rates, a component of cap rates are a
reflection of the continuance, uh, uh,

the stability of the revenue stream.

Um, we've talked about retail
and 20-year grocery anchored,

you know, shopping center leases.

Um, you, you rent a 51,000 square
foot, uh- grocery store to Lowe's,

and you may not get, you know,
but six bucks a foot, but it's a

20-year lease from a triple A credit.

Brandon Giella: Yeah.

Paul: I- in, in hotels, your tenants
turn over every night, and your rates

can move every day, uh, depending on,
you know, the competition that comes in,

whether it's a Monday night or a Friday
night, uh, all the different things.

So revenue in the hotel space, and
therefore NOI, can be really volatile.

Brandon Giella: Thanks.

Paul: it can climb rapidly,
which can be a really good thing.

It can also decline rapidly, which
is obviously not a good thing.

So s- yeah, 7 to 9 is what
the data shows right now.

I, I, I'm probably more
conservative than that.

I've done hotels.

It's been a long time.

I've invested in hotels back in
the, the '80s, early mid-'80s.

Um, but, uh, but it's a,
it's a space where you…

I would expect to see cap rates
above almost any other sector.

Um, the things that drive cap rates,
and so, um, we, we talked about

population growth and, and, and
household formation driving multi-family.

Whole different dynamic.

The economy has a lot to do
with what happens in hotels.

It's travel demand, tourism,
business activity, conventions.

Brandon Giella: Hmm.

Paul: Um, when the economy shrinks
and things tighten up, people

have less disposable income.

They're less likely to go somewhere
for a weekend stay in a hotel.

So it's subject to a whole different
set of risk in terms of demand.

Um, highly operational and less liquid
than, than most of the other categories.

Typical hold period, not that
long, but three to seven years.

Um, and economic downturns
are the number one risk.

Um, labor cost in a hotel, uh, you're
seeing more and more limited service

hotels, the Hampton Inns, the, you
know, the, the, the, you know, Hilton

owns multiple brands in that space
where labor is not as much of an issue.

But if it's a full service hotel
with a restaurant and a bar and

a, a, a gym or a, a, a, a, a spa,
um, employee costs can be a risk.

And the thing I've already
talked about, revenue volatility.

Probably the…

I would almost put revenue volatility
one, um, and then economic downturns

two, 'cause they're gonna create
econom- I mean, uh, revenue volatility.

Brandon Giella: Yeah.

Paul: from a, a standpoint of what's
an investment grade hotel, if you're,

if you're getting into a deal and
they tell you that the target buyer's

gonna be an institutional buyer,
it better be a premium branded

hotel in a high barrier market.

Uh, institutional investors, uh, really
don't look beyond that in the hotel space.

Um, and, uh, and so those are…

that's what kind of defines
an, a institutional grade,

uh, property in that space.

Medical office, um, very attractive
space, very stable space.

Cap rates in the five and a half to
seven range, that sort of reflects that.

Um, the things that are driving it are,
uh, demographics, aging population Um,

the, the, the fact that my generation's,
you know, rapidly getting older and,

and we're the largest generation
out there, we need more healthcare.

And so…

And there's been a real move in healthcare
to push the delivery of healthcare off the

hospital campus and out into the suburbs
where it's more accessible to the people.

So that has really fueled the
popularity of medical office buildings.

Um, uh, you know, supply chain…

Uh, excuse me, but, um, I'm, I'm
looking at my notes real quick.

But healthcare spending,
outpatient migration.

You know, it used to be if you
had a knee replacement, you

stayed in the hospital three days.

Uh, today, you go to a surgical center,
and you might be there three hours.

Brandon Giella: Yep.

Paul: and so the delivery of care
has changed, driving the combination

of, of less hospital stays and, and
more clinical delivery of healthcare,

combined with pushing that delivery
out into the suburbs, has really

made medical office a, a, a very
strong, uh, sector in, in real estate.

Very strong institutional liquidity in
this space, um, because your rent, your,

your leases tend to be intermediate to
long-term, often with hospital systems.

Um, hold period's a little bit longer
at seven to 12 years 'cause it takes a

little while to get the rent increases
that you need to drive NOI and value.

Um, risk tenant concentration,
hospital system changes, uh, and,

and very specialized build-out
cost are the three biggest risks.

Obviously, a surgical center in
the state of North Carolina rep-

requires a certificate of need, which
actually becomes a barrier to entry.

The, the state government
regulates how many surgery centers

there can be in a given market.

Um, and so if you have a certificate of
need, it's like gold because it, it, it's

a barrier to entry to any competitors.

Nobody can come in just because they
want to build a, uh, an imaging center

or a surgical center next door to yours.

Brandon Giella: Interesting.

I didn't know

Paul: uh,

Brandon Giella: that.

Paul: but, but those buildings require
a very specialized, you know, build-out,

so th- those costs can be a risk.

Um, for an institutional buyer in this
space, it's really, um, on campus, that

means on the hospital campus-located
buildings or hospital system tenants.

Um, they're looking…

They, they, they don't invest in buildings
that, um, you know, are, are populated

by a local physician group, um, who's not
affiliated directly with the hospital.

They want that, that, you know,
A-grade credit behind the, that lease

to ensure that the revenue's gonna
be there, you know, and be there

for the intermediate to long term.

So that, that covers the
first five sectors anyway.

We, we did it in 39 minutes.

We're 10 minutes long, and we
didn't get through it all, so

Brandon Giella: amazed we
actually got through it.

Um, no, this is super, super helpful.

Again, this is, uh, uh, like a
master class on just analyzing the

different kinds of things that you can
invest in in commercial real estate.

And so we'll send, uh, in the show
notes, we'll have this reference

guide so that you guys can look at it.

Um, but we will cover in the next
section of this series the industrial

and self-storage factors and how
folks think about those investing.

Obviously, we talked about that a
lot on the show, but in comparison

to these others, it's helpful to see
what's, what's coming, what's going.

So

Paul: Yeah.

Yeah, one of the other things we'll
do in the next, on the next episode

too, um, Brandon, is, is really kinda
compare each sector in terms of how

they perform during a recession, their
income stability, their operational

complexity, uh, and the level of
institutional capital interest, which I've

mentioned today as we went through it.

But maybe we'll summarize these
five at the beginning of the next

episode, then really dive deep,
uh, on self-storage and, and, and

small-bay industrial in particular.

So, um, but it's been fun.

I, I, I don't know if we accomplished
our objective or not, but I, I would

encourage you to go to our website,
uh, aaastorageinvestments.com.

F- you can fill out a contact form
there, and we'll send you, uh, the

document that Brandon was talking
about that has … It'll be in the show

notes as well, but you can request it
directly from the website, and we'll

send you, uh, the, the, the grid that
we talked about that sort of breaks

down everything, uh, all the different
aspects and characteristics of each of the

factors for the seven different sectors

Brandon Giella: That's right.

That's right.

And if you're listening and you
wanna sponsor this show to do

an episode on every single one
of these, we'll take that too.

Paul: of real estate.

Brandon Giella: right, man.

Well, thanks so much, Paul.

Uh, we will talk at you next time.

Paul: Awesome, Brandon.

Thanks.