Webinar Video: Recession-Resilient Alternative Assets & Sponsors’ Underwriting Standards
“View the market through a long-term lens, right?” Keith Lampi, chief executive officer and president of Inland Private Capital, said to viewers in a webinar titled, Recession-Resilient Alternative Assets & Sponsors’ Underwriting Standards. “Short term thinking can really stymie one’s investment criteria and decision making. Given all the headwinds our market is experiencing, we’ve found through our investment thesis a consistent focus around non-traditional alternative assets… where we’ve began accelerating our assets under management given the macroeconomic climate, anchors on self-storage assets, healthcare related assets, and student housing assets. Each of which, are not in the traditional segment of commercial real estate but the common theme that ties all three of those strategies together is the asset performance is driven by demographic demand as opposed to economic demand.”
In this webinar, four industry leaders, including Lampi, Nate Kuhn, president of Kuhn Wealth Management, Ken Nitzberg, chairman, co-founder, and chief executive advisor of Devon Self Storage and John Wieker, chief investment officer of Core Spaces, discuss what investment strategies are best positioned to outperform the broader market during this period of dislocation. Damon Elder, publisher of The DI Wire, interviews each as they discuss alternatives in what is considered to be one of the most challenging markets since 2008.
Specifically, the industry leaders highlight how performance trends show that recession resilient segments of the commercial real estate market are achieving some of strongest results on record, including self-storage, student housing and healthcare assets as possible long-term options for investments.
Video Transcript
Damon Elder 00:03
Welcome to The DI Wire webinar sponsored by Inland Private Capital. Our topic today is Recession Resilient Alternative Assets and Sponsors’ Underwriting Standards. I’m Damon Elder, publisher of The DI Wire. I’m joined today by Keith Lampi, president and CEO of Inland Private Capital, Nate Kuhn, president and advisor with Kuhn Wealth Management, Ken Nitzberg, chairman and CEO of Devon Self Storage and John Wieker, chief investment officer of Core Spaces. Thanks to all of you for joining us today. As I think we all know the economic environment has changed dramatically in recent months certainly within the last year. The Federal Reserve has been fighting persistent inflation with a series of interest rate hikes the most recent will probably come today during this webinar, and in the last week or two we’ve seen a banking crisis emerge with fears of a looming recession growing ever stronger. So clearly this is one of the most challenging economic environments we’ve seen since the Great Recession of 2008. Of course, this environment makes real estate deal making significantly more challenging and while we have definitely seen a slowdown in real estate deal making there are certainly recession resilient assets that continue to perform well and we’re going to be discussing that today. So generally, you know what’s happening out there and what should investors and advisers be paying attention to in our current environment. I’m going to start with Keith. Keith, given you know the rising interest rate and inflation concerns you know many investors advisors are cautious, you know what opportunities are you seeing out there in the alternative real estate sector?
Keith Lampi 01:35
Sure, thanks Damon. Thanks for having me. So, it’s interesting question and when you when you break it all down and you list the amount of things going on in in the macroeconomic climate, there there’s certainly a lot a lot there to sort of unpack and try to distill and figure out you know where your path forward is. From my perspective and Inland’s perspective, we view the market through a fairly wide spanning lens. As many people know our asset management footprints pretty much stands every segment of commercial real estate, so we don’t necessarily have a dog in the race in terms of one versus another which to which under to push or drive forward. So, we really take a step back and look at things holistically, and I think given all of the economic turbulence that that the market is currently experiencing thing, we remind our investors to you know view the market through a long-term line right. Short-term thinking can really stymie one’s investment criteria and decision making. And given all the all the headwinds are market is experiencing, we’ve found through our investment thesis a consistent focus around nontraditional alternative assets. What I mean by that, uh you know assets that are in the core food groups of a commercial real estate investing. So traditional assets are typically retail, office, industrial, and residential. Where we’ve began accelerating our AUM, given the macroeconomic climate anchors on self-storage assets, healthcare related assets, and student housing assets each of which again are not in the traditional segment of commercial real estate. But the common theme that that ties all three of those strategies together is the asset performance is driven by demographic demand as opposed to economic demand. And again, each are relatively different but when you anchor strategy on demography, which is interesting our industry is kind of anchored on that. But when you anchor an investment thesis on demography, I’m not going to go so far as to say what’s going on in the broader economy doesn’t matter, because it certainly does. But I think you’re insulated from a lot of that. And by experience just looking at the past 12 months, we’ve seen each of these sectors behave and perform differently than your traditional sectors as a result of that demographic driven demand. So, they’re in addition there are a number of tailwinds kind of driving performance which we’re going to get into I think as we go further into each sector. But that that is by and large the simple answer to the question. Our investment thesis near term and through a long-term line is very much anchored on nontraditional alternative property types.
Damon Elder 04:33
Let’s discuss some of those, you know. What assets are continuing to perform well? Which do you continue to think are going to perform well through you know given the headwinds that we’re seeing? Self-storage you referenced; I know that you’ve been investing heavily in self-storage. You know, what… why do you like self-storage so much give us some specifics, what are you seeing there what do you anticipate seeing?
Keith Lampi 04:53
Sure, so storage I mean it’s a poster child for exactly what I’m describing. You know real time update on performance, we just announced distribution increases on our entire self-storage platform. So that gives you a glimpse into the past, you know 12, 18, 24 months of operating performance. We benefited during the early days of COVID, um by again that that needs driven demand based or demographic driven demand. So, we saw occupancy surge, for numerous reasons that work from home phenomenon other kind of behavioral trends. There was a slowdown in new supply, development new construction starts essentially halted so we saw a lot of markets become undersupplied. And it gave landlords incredible pricing power. Now that’s that new from the storage industries perspective and Ken Nitzberg can certainly comment on some of this. But you know we saw the sector thrive during two Black Swan events, first the financial crisis of 08, 09 then then the COVID-19 pandemic. And so, it’s not enough to end the narrative and our bullishness on storage with what occurred. Because I think there’s some concerns that the market is going to flatten out and that things are beginning to normalize, which I think is appropriate and certainly occurring. But we again believe based on the demographic driven demand, you know that this is a sector that is just it’s going to be continuous steady stable performance in a in a market where you may otherwise see turbulence, may seem demand wane as a result of that you know growing macroeconomic concerns. And one last point I’ll make, and this actually is applicable to many of the sectors in a rising interest rate environment, it’s always important to push performance push NOI. But in a rising interest rate environment if your objective is not only to generate income, but also preserve capital your NOI has to grow in accordance with how rates are increasing. And so, we’ve seen self-storage perform incredibly well in that regard, but that’s kind of my high-level assessment on that particular sector.
Damon Elder 07:04
Why don’t we bring Ken into the conversation then obviously I think it’s a perfect time. Ken you clearly been around for a long time, you’ve gone through several economic cycles. What’s so great about self-storage what are you seeing out there?
Ken Nitzberg 07:15
Well, we’ve been at it for 30 years, so we’ve been through a number of ups and downs including what happened in the early 2000s with the uh.com bust and in 2008, 2009, 2010 whatever and of course here with COVID. And in my 30 years the two and a half three best years ever for the industry has been the COVID years. You know when COVID first hit they were pretty scared to death that the world was you know goanna come to an end and chicken little with an optimist. Back in March of 2020, but very quickly we saw that demand went way up. You know as people were clearing out that extra bedroom or closet to use it as an office to work from home, or moving from Manhattan to Iowa because it was cheaper to live, and you could work from home. And they need to put their things somewhere. So, occupancies went to all-time highs. And in in 2020 in 2021, 2022, NOI increases, rent increases were in the 20% per year range. When we underwrite the buyer financial project, we typically use 5% as our traditional bogey. So, we’ve had an unprecedented. Unfortunately, we can’t you know annualize that carried forward 20 years it doesn’t work that way. But even with they were coming back towards normality we’re still looking at 8 to 12% gains this year, which on a historical basis are still exceptional. You got to put it a little context, if you have you know three floors on office building in midtown Manhattan and the rents 80 bucks a foot a year. A 5% raise is awful lot of money, but if you have a self-storage unit that’s costing you $100 a month, the 5% raise is $5. And not many people were going to get upset with you and move out over $5 and the inertia to move everything is pretty strong. So, it’s been a very great. And actually, I’m kind of a fan of the higher interest rates. Because when interest rates are 3% uh and every Tom, Dick, and Harry can get into the market and go to the bank and borrow 80% of the construction costs at 3% that deal screams. But when you have to put up 50% down and you can borrow at 7 for construction loan, that doesn’t scream so much. So, we’re going to shake out some of the people who really shouldn’t be in the business anyway, which is goanna make it better for the for the substantial operators so you’re not very optimistic.
Damon Elder 09:38
So, Ken you’re not necessarily seeing a huge impact in your ability or other large players ability to get deals done in this rising interest rate environment. It’s like you said, really going to shake out some of the smaller players.
Ken Nitzberg 09:50
Right, the ones that are undercapitalized or you know, if three years ago or five years ago you know Damon you and I formed a little partnership went to the bank. So, we want to borrow 80% to build a storage facility the answer was no problem. How soon do you need the money? And today you go do that and the banker says, how many have you done before? And how much you putting down? There’s a bank down the street, let me give you the guys card he might talk to you. We have no interest. So, it’s tightens the market for the less well established, less sophisticated. And we’ve also seen a big sea change in how our businesses is run. You have to look at the industry a little bit it’s because it’s hugely fragmented. Nobody knows for sure how many are out there; the educated guesses are somewhere between 55,000 and 60,000 Facilities. About 2.8 billion square feet which sounds like a lot but it’s less than the square footage of the office floor plans in Manhattan. And it works out to about 8 square feet for every man woman and child in America. So, you look at markets and you see how much is in that market and markets by the way are three miles in diameter. People will drive about 15 minutes or about 3 miles to go to a self-storage facility because in many markets they’ll pass a couple in that drive. So, you know if you talk about a city say Chicago where inlands based, you got to look at little three mile circles all over the place not the whole MSA. Because that’s not the market, someone’s not gonna drive from… I think one of you said you were in Schaumburg today to the north side up to… I don’t know the cities well enough there to be intelligent here, but you know 40 miles away for self-storage. You just don’t do that, it’s like grocery stores you drive to 1/2 mile away, not 40 miles away. So, we’ve seen a whole new group of customers as well.
For a long time, the industry thought that the millennials wouldn’t be our clients. And they still live at home, they have the 80 inch screen TV and mom and dad has the 30 inch black and white screens they can’t afford the 80 inch one. That’s all changed, and the millennials are now using our product big time and they’ve found it, and they like it and it’s not going to go away. So, according to the latest statistics from the self-storage association, which is the industry not for profit trade group, roughly 1 in every 10 ½ – 11 people in the US are currently renting a storage unit. That means we have quite a bit of occupancy to go, quite a bit of market to go after, but 100% of the public know what it is. Everybody knows what it is. You don’t have to educate anybody. You know we did we did a storage facility many years ago in Holland, it was the very first one there and in the you know the Dutch country. And the problem was nobody knew what it was. We had to educate them on to come right but what it was for. We don’t have that problem in the US, everybody knows what it is. So, we’ve got a huge population yet that aren’t currently using it but know what it is, and the demographics are changing. So, we think the future looks very bright. It’s not going to be another 21 and 22 because that happens 5-6 years in a row, we own the whole world. Because of the beauty of compounding that’s there’s no danger of that happening.
Damon Elder 13:03
Self-storage has performed well for a number of years long term. I mean Public Storage and others in the publicly traded realm as well as you know others within the smaller nontrade realm certainly produced well throughout a long period. Let’s talk about one that I think has gained in popularity in recent years, and that’s student housing. Now it’s a very interesting sector I think because obviously during COVID we saw most of the schools shut down I think a lot of the students obviously went home did remote learning, etcetera etcetera. But student housing continues certainly bounced back and then it’s done well. So why don’t we talk a bit about that. Keith, what’s Inland’s play in the student housing arena? You know frankly I don’t know that you’ve been real active there and in recent years but uh please illuminate me, and then bring John in as well. Of course, Core Spaces focuses one of their specialties of student housing.
Keith Lampi 13:52
Absolutely, so Inland… Inland dabbled in the student segments since I would say 2014. We we’ve sort of had sneaky growth though, our AUM now is north of our right around a billion dollars. So, we do have a pretty reasonable presence. And this has been an area of growth and focus for us, so we’ve been active both on the ground up development as well as purchasing a stabilized properties. All signs are all beginning lead back to COVID. So, to your point Damon, there was a period of time where I think the market was pensive right. Our students go is this remote learning thing going to take off is it going to become a trend line is that how does that look for student housing. And I think what we’ve learned during the early phase of COVID is you know that students generally want there’s more of a college experience of what occurs in the in the classroom. So, we you know through tracking of key cards and kind of understanding how what our resident behavior was. My of our students stayed on campus, even though they were they were learning from their apartments they stayed on campus. They wanted to be around their peers as opposed to back home and mom or dad’s basement. Now there is a bifurcation of the industry, I definitely don’t want to paint with too broad a brush strokes and my guess is John going to get into this a little bit. But you know there we see the growth and enrollment um kind of coming out of the post COVID era and in many respects, it was pervasive leading into around your tier one power five universities. Schools that have a major you know a major presence sort of city built around them, they a major you know football team basketball team. And you know many of the many schools we see playing football on a Saturday or are this are the universities that have really benefited from an acceleration in applicant’s enrollment growth. And what’s been sort of interesting about the sector, it’s a… it’s a play on residential but landlords never had the ability to push rents in student the way we did in the residential sector. What I mean by that is, you basically have one bite at the apple each year right. You’re pre-leasing for the following academic year, and so you’re setting your rents and you might toggle those a bit. But let’s unpack the past few years right. We had COVID, so we need to be measured as landlords so there wasn’t a lot of rent growth between you know 20 and 21. 21 to 22 still kind of measured, Fast forward to today now we’re seeing with the residential market experience we’re looking at inflation. And we’re seeing a remarkable opportunity to push rents in an outsized fashion almost making up for lost time. And we view that as a as a near term tailwind. But again, looking at the demography looking at demographic driven demand and the application surge the shortage and the shortage in supply. It’s a sector that checks all the boxes, similar with a different twist to what we just described with storage. So, it’s definitely an area of focus and something that we continue to attempt to scale within our business.
Damon Elder 17:02
Well John like I preference before, I mean quarter spaces specializes one of its specialties anyways and student housing. You know what’s the secret sauce? What do you really look for I mean. What do you drill down to really underwrite these assets and determine what’s going to work in the near term and in the long term?
John Wieker 17:17
Yeah, that’s a great question, and we’ve seen a lot of tailwinds coming out of COVID in the student housing space that’s similar to self-storage. It starts really with what happened immediately you know back in sort of February or March when COVID was first coming out. We had 96% occupancy at the time and our physical occupancy dipped to 70%. I think that number would probably surprise a lot of people because the common wisdom is that all the students went home. And it’s true if you lived on campus in the dorms the dorms oftentimes shut down, you literally couldn’t get back into the dorm. What that meant was we actually had more demand for our off-campus product, because people who wanted to stay in their university towns for whatever reason they couldn’t stay at the dorms we got applications that day after the dorms closed and increased our occupancy throughout the year, are paying occupancy as a result of COVID hitting. Our physical occupancy I mentioned did drop to 70% for a short period of time, but very quickly went up to 90%. And in the middle of COVID we were pre-leasing for the following academic year. And we were astonished to see the number of leases we were signing every day as the universities were actually shutting down. And So what became obvious to us very quickly within there was going to be a bifurcation in the way on campus and off campus was viewed. While we historically had been you know predominantly in the off-campus student housing you know game but really decided to stick with that and continue to grow in off campus. Because we knew that we could control our destiny and that we would be able to offer you know our residents the protection of some added security and safety measures in COVID. But the ability to be able to continue to use their residences and that would be an attractive option for them.
What else happened in COVID though was that it became harder to finance deals. There was just skepticism broadly speaking about the finance ability of you know real estate multifamily and student housing in particular among the banking community. And student housing is in a sector where the product that is delivered today, the purpose-built product is looks very different than the product that that I’m sure we all went to school in or lived in when we were in school. The kids predominantly don’t live in dorms anymore, they live in something that is looks more like an apartment building but has some special features. Generally, has a little bit more of amenitized product, and what I mean by that is a little bit more social gathering areas, more focus on fitness on wellness on you know social gathering. And then also has you know kind of units and bed types that are more tailored to what the students are looking for. They have their own little private space, where they don’t have roommates, but they don’t need a significant amount of that private space. But they wanted larger common areas to be able to aggregate with their roommates, you know at the end of the day. And so there’s been 45,000 beds delivered per year into the kind of as Keith was describing, the tier one as we call it the power five and large State University markets over the last 15 to 20 years as that new purpose-built product has become the predominant product out there. And as a result of COVID it’s really that that new supply has been cut in half because of bank financing has been more challenging for development deals. So, what’s happened is we’ve had this incredible the bank he’s growing for the product, but there’s been less supply. And that’s really put rent growth for you know in our back as well. We saw about 5 or 6% rent growth last year and we’re you know in the middle of pre-leasing for the next academic year of the academic year that will start in the fall of 2023, we’re currently 87% pre-leased in our portfolio. And at rate growth of 11 to 12%. So we’re seeing incredible tailwinds right now.
Damon Elder 21:07
From a more macro perspective, you know how is the pipeline looking? You know for you, the industry in general, Inland from a development acquisition perspective? How is the new environment changing that flow? Are you seeing some hiccups? Are you seeing some difficulties that were certainly not around you know a year ago?
John Wieker 21:27
Yeah, I mean not in the fundamentals at all which is you know incredible. Like I mentioned we were 87% pre-leased for next year. If you go back 12 months ago to the same date, we were only 76% pre-leased for the following academic year. So, we’re 11% ahead on pre-leasing year over year and we’re experiencing 11 or 12% you know rent growth at that in time. So, the fundamentals are fantastic and that’s really driven by the supply being down and the demand continuing to be up. And really, you know what’s happening you know among the various universities is students are more interested in going to these tier one power five schools today than they were historically. And so, while enrollment across the country is you know only up slightly enrollment at the tier one university the university that we predominantly focus on is up significantly it’s like 2-3 percent. And that’s happening in the face of limited supply growth and that’s you know created some imbalances that you know create great opportunities for rent growth.
Damon Elder 22:30
Nate, I want to bring you in. You bring…oh sorry Keith go ahead.
Keith Lampi 22:33
Yeah, I just wanted to comment on your question too, I mean you know so fundamental sound is whether it’s we’re talking about student or storage applicable we covered that but to your question around getting deals done. Right, I mean I think on the development side of the aisle that that’s a little bit more straightforward maybe you lower your leverage, maybe you maybe you absorb a higher carrying cost. On the stabilized front there there’s still a friction there right, I mean cap rates have widened out modestly, but they haven’t widened out enough to where it’s a no brainer to obtain positive leverage. And sellers are looking at what we’re describing and they’re saying look at how well I’m doing if I don’t get my price, I’m not selling. And buyers are saying, your price doesn’t allow me to borrow money at a freed level so there’s this disconnect that I think has created a friction. This has slowdown stabilized transaction, there’s not a lot of sellers you know selling their asset and through desperation. Not a lot of distressed sellers. So I think it’s going to take a while for that to come together. So, there’s kind of a tale of two energies, if you will. Developments wants things stabilize is another and that’s what makes this not easy and something that we have to continue to navigate as an industry.
John Wieker 23:53
Yeah, I think there’s a great point, and if I could just add one more thing. What we’ve been seeing is absolutely been an increase in the cap rates that are happening on the market and transactions today. And student housing has probably gone up 100 to 125 basis points in the last 12 to 15 months. And even still with that increase, that you could you know Keith’s right there’s negative leverage out there in the marketplace. So, what we’ve been doing is we’ve been buying deals on unlevered basis where we where we can, because of that negative leverage knowing that we are pre-leasing for next year at high rent growth. And that we’re going to be able to grow into a place in the next you know there were two years where there won’t be negative leverage anymore. And you know and then put financing in place when you don’t have that that negative leverage situation anymore. And I think that’s sort of one of the creative ways that we’ve seen deals getting done right now, although you know it is absolutely true that volume has been down significantly.
Keith Lampi 24:53
What’s is interesting about that though, I’m sorry Damon I know you’re trying to get in there. You know it’s interesting about that though is I think a lot of people look at cap rate as a as the ultimate metric on price. And it doesn’t necessarily translate that way, right. Like if you’re talking about selling $100 million asset at a 4 cap and now today your maybe need to sell that asset at a 5 cap. If your rent growth has increased by 10%, your higher cap rate is being applied to the higher NOI. So, you might still get your $100 million right, and I think that’s the that’s creating the disconnect. Buyers are saying no, I’ll hang on because even if cap rates widen out on me, my value my value may return or stay the same. So, there’s a timing element of this and that’s the dichotomy we talk about right. It’s normally when we’re in this period of dislocation performance is strained and everybody’s trying to find their footing on valuation in this regard values may be up in the air and a lot of fronts because people are looking at macroeconomic conditions but the fundamentals on some of the asset types were describing are phenomenal. In some instances the best we’ve seen on record in a number of years so it’s creates an interesting environment.
Ken Nitzberg 26:09
I would add one other thing in there Damon if I could, I think cap rates are extremely overrated. If you give me the P&L for any property and tell me what cap rates you want, I can prove it to you. I mean we bought a site actually with Inland about four years ago, and the going in cap rate was five. And it was this one off owned by one family that actually was a Korean family that lived in the office. And they charged the kids tuition, and the family car, and the wife’s hair appointments and everything else to the site. When we got in there and cleaned it up the cap rate was eight. Because you can play with that P&L and do all kinds of strange things especially on assets that are in the you know 8-to-15-million-dollar range instead of the 100 million range. There there’s just a lot of and there’s a whole other set of cap rates that’s called the brokers cap rates. Because when they’re selling something, they adjust the P&L to reflect what they want to get the cap rate the buyer they think the buyer wants to pay. So, we look at something different, we look at replacement costs we look at competition in that immediate market. We look at deferred maintenance that needs to be implied. Cap rates interesting but it’s only one of many metrics and it’s usually not the best, at least in our sector.
Damon Elder 27:27
I want to bring Nate because Nate brings a very unique perspective, I think is a wealth advisor who obviously you know you’re open to alternative investments the nontraded etcetera. What do you look for? What are you know advising your clients to invest in? Currently you know obviously multifamily has been very popular for a number of years, industrial we’re seeing the emergence of storage in recent years, student housing medical office buildings other health care facilities. What are you looking at Nate? What keeps you up at night? what are you confident in from your perspective as a wealth advisor?
Nate Kuhn 28:02
Great question, and again thanks for having us. I think you know as everyone here, and John and Ken were talking to Keith. As an advisor you know we don’t know any of these assets typically a mile deep like John and Ken obviously were able to speak to. And so even today like I’m taking more and more talking about these underwriting standards. It really comes down to you know knowing who you’re working with going back to that high level of you know what do we need to underwrite to. Like really understanding diving in with these guys and making sure you’re understanding is an advisor that these guys know what the heck they’re doing when they’re buying properties. And that’s really what we’re looking for to start with when we’re deciding we’re going to work with and working with a company like you know with hearing from Keith from inland and the kind of products they’re bringing. I think also the term alternative investments a lot of times we’re talking with the client, even a year ago an alternative could have been an alternative source of income, right. Because interest rates were so low you have retirees searching for income, and maybe you know get it always comes down to what’s appropriate to the client. But maybe an alternative investment that had a higher cash flow than say what you could get a bank, or a CD was the reason why you’re maybe considering an alternative investment. And where we’re at today with interest rates higher perhaps the reason you’re looking for alternative investments is an alternative to what happened in the stock market last year right. So, there’s different reasons we’re using alternative investments and it should all be driven by what the client needs. So, it’s certainly not a one-size-fits-all solution. And what we want to do for our clients is have a kind of repertoire knowledge base of a variety of different investments that are alternatives that might be income focused or total return focused that again we would know based on what the clients looking for what solution might be appropriate for them. And I think you know really today we’re looking at this where you could say hey CDs are not paying 4 or 5% maybe that’s close to what some of these alternative investments are paying. So, then you have to go back to the sort of what’s the fundamental reason why we have these alternative investments. It’s because they’re not correlated to what’s happening in other asset classes, and I think that’s really what John and Ken and Keith really spoke about earlier. And that’s why we continue to look at these alternative investments. And I think it’s important to note too with not only interest rates being higher but inflation still being here. Where we look at these alternative investments again, diversification from our traditional assets that we’re managing for clients hopefully generating some income along the way depending on the structure. But also, you’ve got that opportunity to maybe keep pace with inflation versus something like maybe just something at the bank where you’re getting nice income but all you’re getting back at the end is your principle. So, I think that’s another consideration when we’re looking at these alternative investments for our clients.
Damon Elder 30:31
How have you seen the openness of the adoption rate from your clients when it comes to alternatives? Has that been growing? I mean we constantly hear, and The DI Wire reports constantly that demand for alternatives continues to grow among individual investors, institutions, and advisors are certainly adopting them more readily. What are you seeing in your practice Nate, from that perspective?
Nate Kuhn 30:52
Yeah, I mean I guess our clients have been used to us sort of always from the beginning of our relationship with our firm we kind of hammered the alternative investments as a necessary part of a person’s allocation depending on their net worth you know kind of depending on where they’re at. So, I think our clients are kind of used to that over the years of working with us in alternatives. But I think what I’ve seen seem maybe more uh different in the industry is just the accessibility to alternatives that different sponsors are trying to bring to the market and put in front of advisors that maybe in the past hasn’t been as receptive to alternative investments. And maybe making them more approachable meaning like lower minimum investments for clients, maybe more easy to use for how you’re going to get these applications in and going for investors. So certainly, that’s some of the stuff we’ve seen kind of penetrate into the market is just more accessibility to more advisors as well.
Damon Elder 31:42
OK, let’s turn back to real estate asset classes and one that I’m particularly interested in and have a bit of a background in is healthcare real estate. I know Inland is entered that space fairly aggressively in recent years. What do you like about that Keith? You know I mean obviously COVID had a dramatic impact on various sectors of the healthcare space. You know assisted living senior housing and others were obviously hammered hard and inflation has certainly hurt the performance of many of those assets medical office has been more resilient, I think. What do you like about healthcare? What are you looking at? What’s inland think?
Keith Lampi 32:16
Sure, at the risk of sounding like a broken record again. It’s the demographic driven demand, that that each of these sectors benefit from right. So, you made the point medical office I mean that’s been kind of a bell out throughout the COVID you know believe credit behind the tenant and the lease. These are areas that have continued to service you know clientele did you pay rent on time, and you know has that durability and income. But more bond like characteristics honestly, so our shift in focus in in healthcare sector has been mostly in the senior living segment of the market. our sort of sweet spot within that that segment is Class A low acuity continuum of care type facilities. What we’ve observed is yes to your point Damon, early days of COVID there was some there was some turbulence but as the market began finding its footing a lot of the same characteristics are pervasive. There’s pent up demand, there was limited or muted supply and now the market is benefiting from capturing that kind of demand. And then so we’re seeing occupancies surge, we’re seeing an opportunity to push rental rates handful of other tailwinds. And Social Security it just got increased 8.7% right yeah, which is a big jump from where it’s historically reset. So, in the right market, with the right operator, with the right kind of operating structure, we see we see green shoots. And again, viewing the market through a long-term lens we believe that demand is sustainable durable and should provide you know a fair amount of resilience in in operating performance on a on a forward-looking basis. Now this is out of the three categories is probably the one sector where it never it still hasn’t really returned from a tightening and cap raise perspective. So, there are there are opportunities I think out of the three there’s still a stigma with certain buyers. So, you could actually find some opportunities to buy us that’s a higher cap rates, within this the senior living sector it isn’t as difficult to obtain accretive leverage to think is a unique kind of unique slant to that particular sector. So, it’s an area of focus, like I said not just near term but long term which is the lens through which we view the market.
Damon Elder 34:40
Well let’s go to some classes that are typically and remain very popular among real estate alternative investments and that supports multifamily and industrial. Which are both you know seemingly performed you know on a macro level view very well and people continue. We know there’s a massive demand for housing that is unmet in this country. Why aren’t we talking about multifamily. Why are we talking about industrial office I think everybody understands the challenges there but. Why aren’t why aren’t we diving deeply into industrial and multifamily. I’ll open it up to the group but I think Keith, probably perfect for you to start?
Keith Lampi 35:14
Sure, from a multifamily perspective I think that the market knows we do have a very positive outlook. It represents 40% of our AUM, and that’s the traditional multifamily as well as within the BTR, build to rent segment of the market. That said, I feel very good about the assets we’ve purchased we’ve experienced over the past 24 months you know 10 – 15 years’ worth of rent growth all truncated in that one period of time. So that performance has been surging. We are starting to see rents taper level off a little bit. I think it was a sector that lenders and developers you know quickly reembrace, and so new supply was probably a little further along in terms of new construction starts and ultimate deliveries. So, there’s still a housing shortage, I think it’s still a great sector. I don’t characterize it in the same universe as what we’re describing mainly because it’s a traditional sector, it’s not an alternative. So, there is demographic driven demand. We’re start we’re seeing you know your average American willing and sometimes desiring to rent at the later stage in life, where there used to be a stigma around that. So, it’s a good sector, it’s just it’s outside of this this scope a little bit. A comment quickly on the industrial side, I mean by and large most of our activity and industrial has been net lease you’re anchoring it threaded you know tenants like Amazon and FedEx, and you know just logistics, or you know distribution have been kind of pervasive throughout that market. I think it was a darling during the COVID era because we saw supply chain shortages and we saw all of that went into getting product into consumers hands. I think some of that has weighed a little bit and so I think we are starting to see cameras why not a little bit throughout that segment of the market. I think it’s still durable I think it’s considered a fairly conservative investment strategy, but it has it has kind of lost a little bit of steam now that we’ve seen the market normalized. And again, it’s probably more of a bond alternative if you’re looking at credit long term lease. You know landlords we don’t have the same ability to push rents on a on a fixed income lease the way we would within an operating asset like storage, senior, or student. So that that’s my comments I’m curious to hear from the rest of the group.
John Wieker 37:47
Yeah, I mean another thing that jumped out to me would be that you know all the sectors we’ve been talking about today, you know sign what’s in in the real estate world generally shorter-term leases right. Maybe 6, 12, 18, 24 months. But it’s all leases that we can lean into what’s happening in inflation right now, and you know take advantage, capitalize on the fact that we can reprice our rents on a very regular basis to capture the current market dynamic. If you were in industrial or office or retail and signing much longer-term leases going down with inflation, then it wouldn’t exist you may not be able to take advantage of it in the same way.
Ken Nitzberg 38:24
We have a whole different dynamic in storage sector, and I’ve been in all the other categories in a in a previous real estate life 30 years ago. We can raise rents every month, we don’t have any leases. Technically We have rental agreements. They’re 30-day in duration, with an automatic evergreen clause. And so, we have some 55,000 tenants today across America, and we have a revenue management system that’s analogous to what airlines use and hotels use for pricing. And we go through especially during the so-called leasing season for our industry which is about April till about August. People don’t usually go running out running storage Christmas time or if they live in a kind of weather constrained area like Minnesota or something. But during the leasing season we typically raise rents every seven months on every tenant, assuming that the market and where that story is will support it. And again, very little changes make huge differences, and I don’t know if we have time, I’ll give you a simple example. If you had 100,000 square foot storage facility and forgetting hallways and offices and restrooms. They were all what we call in our industry attending my 10×10 all 100 square feet and you had 90% occupancy which is considered above stabilized 85 percent considered stabilized in the storage business. And they were all running for $100 a month and you came in and raised everybody 5% or $5. You would lose a couple of tenants not because of the $5 but because you forced them to think about what they’re storing is it worth the 100 bucks not the 5 bucks. But if you could do that you would probably be able to backfill pretty quick and now you have 900 units at $105.00. That’s $4500 a month more, that’s 54,000 a year. You didn’t add a penny of expense to do that and add a 6 cap you just added $1,000,000 of value to your building. You can’t do that with any other real estate asset that I’m familiar with. So, the storage sector has, and we’ve always been looked at as kind of the pardon my French the bastard stepchild, but we’re now considered an institutional quality asset. And we have great ability to raise rents to the other asset categories simply can’t do as frequently or with this with the least amount of tenant disruption.
Damon Elder 40:44
Nate, I want to come back to you again because you have a pretty unique perspective. So, we’re talking about, again as Ken said with these formally considered more niche real estate plays that are becoming much more popular. Do you have a problem in the education process with your clients or your advisors in introducing some of these you know heretofore more unique investment asset classes? Or are they embracing them readily and understanding you know the potential benefits they can bring?
Nate Kuhn 41:11
Yeah, I mean I think it’s a good. I think I want to start by saying you know we don’t it’s not like we’re opposed to multifamily at this point. So maybe the alternative assets as alternatives to multifamily, or not you know all these assets are alternative to what I consider as the wealth manager. Which would be you know your traditional stocks and bonds. And we still allocate to multifamily, it’s just again these more niche areas. But again, having these examples and diving into on the phone calls with persons like John or Ken or my contacts at different sponsors. You know getting us up to speed on sort of the advantages and some of the risks of these different asset classes. I mean evaluating different investment profiles while they’re different assets it doesn’t change right. We want to take a look at what are the potential tailwinds, what are the potential hiccups along the way. And then kind of analyze what makes sense for a client understanding those risks. And I think it’s also important to know like Keith pointed out, you know if you’re going out and developing a deal the risks are much different than if you’re buying something that’s stabilized, right. So, for somebody who’s looking for cash flow development deal doesn’t make any sense, but a stabilized asset would. For somebody looking for total return probably that development deal makes more sense. So, it’s important as an advisor I think to understand and know these different products and have comfortability with being able to implement them into a client’s allocation when appropriate. I think it’s also important we look at these different asset classes to understand that they can be held in different structures, right. I want to look at things differently if I’m doing a 1031 exchange for somebody where it makes up 60% of their net worth, or a substantial amount of their net worth. Versus if I’m doing something like a younger client who’s investing $50,000 but they’re making $1,000,000 a year, they might have a different risk profile. And how these assets function in a DST versus a fund versus, an opportunity zone. Those fundamentals are goanna change greatly and that’s really where we want to reach out and talk with the sponsors to understand. Like hey what what’s the opportunity here? What’s the time horizon? When my income start on these investments and what and what are you going to do to manage these assets right? Because like a DST, we already know what we’re buying. But an OZ, a lot of times that you’re going into it they might not own all the properties yet or fund they probably don’t own all the properties yet. So, you kind of I’d be looking forward as to what they’re seeing as those opportunities as the fund continues to develop.
Damon Elder 43:20
Well let’s stay with you Nate for a second. So again, the environment has changed dramatically in a very short period of time. And so, I want to look, I want to ask you from a micro and a macro perspective from a shorter term and longer-term perspective. What do you look at when somebody like Keith or one of the other sponsors in the industry brings you a deal? You know, how do you underwrite that? How do you determine if this is acceptable for your clients, your firm and you know again what are your key touchstones to your perspective from your perspective?
Nate Kuhn 43:46
Yeah, I mean it’s not just me looking at the deals. We have a broker dealer that we’re affiliated with that really specializes in alternative investments. And I’ve been very fortunate throughout my career, I’ve worked at I’ve been affiliated with three different broker dealers. And each one of the um due diligence officers at those different firms has brought me a wealth of knowledge. And those guys I mean I’m spending a lot of my time meeting with clients; they’re spending a lot more of the time reviewing deals. So, I lean on them a lot and I’ve been very fortunate as I said to really be at three places where we’ve just had outstanding due diligence officers. I think don’t just say give me the sales pitch, they want to dive into the numbers and understand that. But then even after they take their cursory look, I’m also looking at that with my team. We have a couple guys on our team that are also reviewing these deals. we’re going to reach out to the sponsor, we’re going to review things. And I think you know the pro forma is very important, look at what type of assumptions are being made to compare and contrast that. Make sure it’s reasonable. And start to look at if there’s something like a DST look at the specific property trying to get to some of the properties. And really do your you know feet on the ground due diligence as well on some of the properties and meeting with the sponsors. So, I think all those things I mean no amount of due diligence is going to eliminate risk but understanding the risks and being able to explain those risks to a client. And then knowing how the deal is likely to perform will probably at least get you help you decide which investments might be the right alternative investments for a specific client situation.
Damon Elder 45:10
Let’s flip the other side of the coin then to the real estate folks. How has your underwriting changed when you’re looking at a deal or considering a deal. Again, giving the near-term changes, and let’s factor in you know what is just occur in the last couple of weeks, which is this banking crisis I mean how is that impacting things how’s that changing your perspective how is that changing your process? Keith, I’m just gonna actually turn to you because again you’re one of the biggest sponsors in the space. So how has your process changed changing anticipated to change?
Keith Lampi 45:41
Well, I think you’re starting point is you maintain a disciplined approach and you don’t you don’t compromise on that based upon you know market fluctuations. Again, long-term lenses is how most real estate is bought and financed. That said, you can’t be you can’t operate in the vacuum you certainly can’t ignore what’s going on in the market. So, we draw from not only third-party research but also our own experiences within it within a sector or market to help guide our underlying assumptions, which are going to be important in pricing and asset being maintaining a competitive level achieving leverage that is acceptable obviously we touched on that. So, there’s always an element of fluidity, but your financial model and your investment thesis is something that I you know we really anchor on subscribe to. And if you stay disciplined on that and you, don’t you don’t vary from that which usually only occurs if you’re looking at the market through a long-term lens, we’ve come out the other side. The appropriate way so I again just sticking with that that long term view is a big part of which drives our process.
Damon Elder 46:50
John, Ken you have anything?
Ken Nitzberg 46:53
Sure, happy to. We haven’t changed our process hardly at all with the change in interest rates. When we look to acquire either an existing storage facility or do a development. We look at typically it’s three-mile market around the location of the site. We check for the number of competitors. So, we see what the square footage of storage is available per person, the national average is about 8 square feet. So, if we’re looking at a market where there’s 20 square feet per person, probably never going to get your occupancy or rent increases you want. Because that little micro market is probably overserved. So, we look at the competitive level, we look at basic demographics traffic counts. How many people are there is there? Is in the population growing or is it going down? What are the barriers to entry? Many cities don’t like storage, so a lot of the mom and pops in our business don’t have the sophistication, the time, the money, the people to go do a location that’s problematic. We love those because that’ll be a barrier of entry to competitors in the future. So, we really haven’t changed much. We’re not um greatly depend upon interest rates. And again, if you look back with the historical vein, we’ve been doing this for 30 years. If interest rates are 6% today, ten years ago you would have killed for 6% rate. That was great you were a hero, you were genius. We got so used to 3 and 4% rates we forgot how the world really works. And as Keith referenced, we typically look at these 5- to 10-year-old periods. So, what’s happening in one day or one week or one even one year, as long as you stick to the basics and don’t do stupid things or make outrageous assumptions, you’ll probably be OK. And in in the real estate world, it’s very simple you make money when you buy not when you sell. If you buy it wrong, you’re probably will never get out of it. If you buy it right, even in a terrible market you can probably get out intact. So, it’s very careful and we’re really very careful about how we make ourselves and what we do and having done them for 30 years and done over 300 of these across the country and in Europe. We got a pretty good feel for what things work and what don’t. So, I think one of the important things which kind of why we’re here today, is you need to look at who’s sponsoring it. In the case of Inland or who they’re working with you whether it’s someone like us or one of their other Co-sponsors. You know what’s their experience level? How long have they been doing it? what’s their track record? you know are they overnight sensations have they’ve been doing it for a couple of weeks now.
Nate Kuhn 49:27
And I’ll add on to that too with what just Ken said, and echo that. I mean, I don’t know if I said it as clearly in in my heart there about the due diligence. I mean we want to underwrite every single deal we’re looking at a fund or DST whatever the case may be. But certainly, knowing the people you’re working with whether you’re working with them the first time and really diving you know obviously diving very deep the first time, or you know for my case with working with somebody like Inland where we’ve been working with them for years. It’s sort of also goes a long way to know the people you’re working with and having that experience and seeing their track record. It’s one thing to see a track record on a piece of paper and see what someone’s done. It’s another thing to have clients been in those previous deals and know what they had to do to achieve those numbers. So sometimes a return that doesn’t look that great on paper might have taken a lot of effort from a sponsor because of the timing didn’t work out well or something like that. So that’s another thing we really you know consider when we’re looking at deals that we’re bringing to our clients.
Damon Elder 50:18
Let’s pause there for a second there Nate, because you know I mean dozens of folks have been rushing into space in recent years of all the equity that’s been flowing in and the greater acceptance of alternatives by from the investors. So, you know somebody can be waving a deal that you that they found online somewhere or whatever that’s promising a 7 ½ to 8% yield and maybe more conservative deals coming along with 5%. You know, how do you, what’s the conversation you have with the clients either to dissuade them from a deal you think maybe a little overhyped or not the sound is maybe that lower deal, you know. What’s that conversation like?
Nate Kuhn 50:51
Yeah, I mean, I think you know it all starts with a I think if inland needed to chase yield or they that they needed to do something that had a huge cash flow on it. We could all buy really bad property in the middle of really bad neighborhood to probably have a higher cap rate on something. But it’s helping understand helping clients understand. Because a lot of times I use the analogy people without the information almost like bugs that bug zapper you know. It’s still 50 degrees out here in Chicago but give it about two months where mosquitoes everywhere, and you just see those bugs just going right for the bug zapper. And that’s how they are with that high yield sometimes, they’re like the highest cash flow. But they don’t realize they can get burned by that, and I’m not saying every deal with a higher yield or higher cash flow is bad maybe it’s right for the specific investor. You have to understand the differences between why one is paying a 5% initial cash flow or 4% the other ones paying 6% or 7% right. I mean you just got to look at the real estate, and then beyond the real estate if that doesn’t tell the story then a lot of times the underwriting will. And you start looking at things like, what are they doing to maybe supplement the cash flow? Some of those different tricks that are used. I almost say tricks but underwriting manipulation, if you’re messaging if you will to increase that cash flow to maybe move product and we just want to be aware of what those numbers are. And again, make sure that they’re based on some sound underwriting. Not saying that that doesn’t mean the cash flow can’t change it maybe change to a negative degree, but hopefully you’re trying to avoid that as much as possible by doing some good underwriting deals and informing clients on the differences and comparing them passing them.
Damon Elder 52:19
OK, answering questions that was actually just come in that I wanted to stick with you on Nate. And actually, and Keith, and everyone of course. You know there are a number of opportunities in the you know in in this alternative investment space. You know there’s qualified opportunity zones, there’s 1031 exchanges, there’s straight funds, etcetera etcetera. There’s non-traded REITs, BDC but in general and it may apply to all of them. Do you prefer offerings that are solely focused on from a deal-by-deal basis, you know it’s a sole property fund or do you look for commingled funds? What’s the positives and the negatives from either approach?
Nate Kuhn 52:58
Well, I mean I guess for the 1031 exchange are typically going to be you know DST. Which generally is going to be one property. Sometimes a small portfolio of properties with most of sponsors we look at. But certainly, it’s not a… you’re going in and you know specifically which properties you’re buying and the city case the DST we work with. I mean I’m not sure what they mean by commingled and we would never commingle our fine assets…
Damon Elder 53:22
Well, let’s go to a QOZ for instance. So, a qualified opportunity zone funds you typically see either you know single asset QZ, but you also see large funds tied to QZ that are aggregating multiple assets within that fund. What are the positives and negatives from either approach? What do you prefer if you prefer one over the other?
Nate Kuhn 53:41
Yeah, I mean there’s a lot of advantages to knowing what the specific property might be, I guess. Because you can kind of look at it and say this one specific area, and you’re looking at underwriting more of a property. When I’m looking more to fund approach, we want to typically the funds will usually have an asset or two in them that have been seeded. So, you can kind of look at that one example and start looking at what they’re maybe using as their underwriting or their pro forma on those specific properties. But then you’re really going to want to understand what they’re looking for going forward. You know to Ken’s point looking at what’s the saturation like in that market and understand where they’re looking and targeting it’s an opportunity zone where do they see these places that they can buy and have an opportunity zone. And then like John’s point you know like what universities are you are you looking at what are the criteria you’re looking at for where you’re going to be putting in these properties that are going to presumably be coming into the final later. So, you really want to understand what metrics they’re going by as far as the different assets are going to eventually bring into that fund.
Damon Elder 54:39
Keith what’s your take? What’s Inland’s take on deal-by-deal funds versus you know pools?
Keith Lampi 54:45
Yeah, we we’ve done it we we’ve been on both sides of that right. So, we’ve done it we’ve done it both ways. I think it from a sponsor perspective it’s efficient or more efficient to scale a strategy that is scalable by taking the fund structure. And there’s some those efficiencies in my opinion lead to better performance on behalf of investor. Take storage for example, I mean your average storage total project cost per properties there between 10 and $20 million, it’s a really small amount of equity to structure an entire offering around and go to market and then you know there’s costs and expenses associated with that. So that was that was a structure we scaled in our in our QC fund type rapper. To Nate’s point, you still it’s still important to show the market a meaningful sampling size of what the portfolio is ultimately going to look like out the gate. But you know there’s there are pros and cons to both. Another nuance is timing, I mean we’ve seen some self QOZ funds in our market that the cap raises you know it was launched when the legislation was passed back in 2019, they’re still raising capital with a billion-dollar open-ended target. And that’s a long time to raise capital through a different spectrum of pricing and your ten-year hold period environment is really anchored on when the last semester gets in, right. So, I think there are there are balancing nuances where you have to think about not probably not too long a shelf life but I think some amount of shelf life does give the sponsor an opportunity to deliver diversification and efficiencies which should ultimately deliver you know hopefully a better performance.
Nate Kuhn 56:28
And the key points are generally going to be a single strategy and these opportunities own funds that we see, or maybe a blend of a couple similar strategies. But diversification for our clients also is a key. Whether that’s doing a couple single asset, an example of opportunity zones are going into a fund with the strategy it may be a different fund with a different strategy as well.
Damon Elder 56:49
Gentlemen we’re right up against the hour. I thank you very much, I mean I have tons of notes and questions that I want to pursue, and we just don’t have the time. But thank you for all of your insights and thank the audience for tuning in. There will be replays of this available on The DI Wire website and the social media from different realms. But again, thanks so much. If you have any additional questions feel free to e-mail us at info@thediwire.com and we’ll share them with the panelists and perhaps we’ll get some more further insights. Look forward to do this again Keith, gentlemen. Really appreciate your time, thank you so much.
Keith Lampi 57:23
Thanks, Damon.
John Wieker 57:24
Thank you.
Ken Nitzberg 57:25
Catch you later.
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