Investing in Inefficient Markets
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It's really important like you spoke about sort of the hub and spoke idea, which is that we have to buy the things that are right for our company. It's not just is this the right market or sub-market, but is this the right place for our company right now? This is durable value. Get investing in business insights from industry experts and successful entrepreneurs every week, like and subscribe now.
Let's talk today about operating in inefficient markets, knowing how and where to invest in inefficient markets, how to spot opportunities. This inefficient markets are interesting 'cause they're, they're asymmetrical. The information is not widely disseminated. Yep. There's nuances to it. You have to develop a lens on how to look at it, and then you have to have a, an execution ability.
That allows you to execute on that information to make great, great investments. Well, and I, I'd add that, that this is really absolutely central and core to our thesis. This is, this is the type of market that we love investing in, is these inefficient markets because you, you really can develop a special amount of alpha or knowledge and execution that, that you can't in a more efficient market.
Yeah. Most of our investing strategy these days is value add multifamily and value add, small bay industrial. And as we are working on selecting markets to invest in you have to sort of start with worldview and then work down to execution. But in worldview, We filter in a few different ways. The first and most important filter that we're looking for out there is demand, high demand, and that's measured by low vacancy.
Mm-hmm. So I've been working a lot on these charts where we sort submarkets and tertiary markets by vacancy rate across the Western us, across the western us and start with where is there, you know, 1, 2, 3, 4% vacancy rate. These are markets where there's room to run. Clearly there's not enough. Property for what, what the market wants.
I, we follow that up by, where are rents still on the affordable side for multifamily? That might mean where are rents? Average rents at 1400 or 1300 mm-hmm. Per month on the industrial side annualized, maybe that's seven 50 or mm-hmm. $8 mm-hmm. Per square foot per month. And then on the multifamily side, after that it's, or, or on both sides, it's where, where's the price per door or the price per square foot.
So what we're looking for too is where where there's good bang for the buck on affordability for your basis. On the real estate mo most what we look for is price compared to replacement cost. Looking for safety in there when you're getting near replacement cost. You know, you don't have that.
Be scared. You should be nervous. You should be nervous. So those are some of the. Key ways. I'd say one other thing we've used is like ARP score or quality of life score to measure how sticky these locations are. Like Yeah. Once we know it's affordable or, or once we know it's in demand and it's affordable.
Is this a, a reasonably good place to live? Yeah. Yeah, absolutely. And then we will look at more qualitative things like. If they're employment drivers and universities or other kind of you know, economic engines in the, in the markets as well. Mm-hmm. And then the last thing is we look for clusters. Yeah.
You know, we look for parts of the Western US where we see a cluster of these. Because for us, you know, I think kind of also stepping back philosophically, We are not a, a group that helicopters are dabbles in markets. We're not looking to buy one asset here, one asset there, one asset there because we view that as risk.
We, we ultimately look to develop scale in the markets where we're investing. And so finding those clusters is important because it allows us to know that there's enough of a market that we can buy multiple multi-family assets or, and multiple industrial assets in those markets. Developing the economies of scale and also the you know, the market knowledge that gives us that competitive advantage.
There's a great reward for being number one in a market. You know, in Sacramento over the last few years, there've been times where we've been the most active buyer in Sacramento. What that means is we saw every deal. Mm-hmm. We've, we've seen every deal and we know every nuance and we get all the very best information, which lets you see little spots to invest that others won't see.
Yeah. You know, if prices as prices have gotten higher and higher, we've paused a little bit there. Yeah. But I think in these next 6, 8, 12 months, as prices are coming down a little bit, it'll be a great time to reenter that market. Let's talk maybe a little bit about the acquisition process in an inefficient market, and then we can talk a little bit about the execution and how that looks different in an inefficient market.
Sure. It's really important like you spoke about sort of the hub and spoke idea, which is that we have to buy the things that are right for our company. It's not just is this the right market or sub-market, but is this the right place for our company right now? And, and that means buying in clusters and Yeah.
You know, working to buy a, a hub where there's, where you can staff and then add on smaller stokes or, or spokes rather. Sorry. Mm-hmm. And so, so sometimes that means buying a big property and then buying a bunch of small ones where returns might be higher than that bigger one, but because they're all in the same area, you can execute better.
Yeah. Yeah. So it, it also means you understand the rent movement better. Sometimes oftentimes better than the brokers. They have an idea. They might have CoStar data, but they're not seeing the real time on the ground information that you may be seeing based on the renewals you're getting, the rents you are charging.
Yeah. The operating efficiencies that you're actually achieving. Well, a good example we owned an asset in Modesto, California and as the market rents were growing at a very fast clip, We also, we then were looking at another property to buy in Modesto, another 160 unit community. And because we knew in real time what the actual market rents were, we were able to underwrite the, the next property in a much more efficient manner than a group kind of, you know, helicoptering in and pulling reports to, to gain their conviction around what market rents are Yeah.
And where they're going. It's a sampling process. You're seeing deal after deal after deal, and you can see the ones that for some reason are mispriced or favor what we do better than than others. So maybe you could talk a little bit about how that happens when we go into new markets. Yeah. Well we recently bought 168 apartments or more likely single family homes or townhouses in Bakersfield.
A lot of that happened because we were seeing deals in Visalia and Fresno and Modesto. And, and the prices were getting much higher, but Bakersfield seemed to be lagging also. This particular asset came up with very new construction, and our price per square foot was incredible. So, you know, it was, it was a, it was seeing a, a deal pop up.
And, and by that I mean we were one of the first bidders to bid on it. It didn't hit the market. Yeah. And we were able to lock it up and go into escrow and close on it. But yeah. And, and it's not uncommon like what happened there. You know, we underwrote a particular market rent based on the, the, our best information.
And then we actually get into the market we operate. Yeah. We have our team and staff and we have that feedback loop. That's so important and why, why we manage our own properties and we, we find that market rent is growing at an even faster clip than, than we had originally anticipated. So, so a few things were happening.
Number one we were comparing the price per unit in Bakersfield to what we were seeing, especially in Visalia and Fresno, which were rising much higher. And secondarily, we are, we're able to see this asset through a different lens. Mm-hmm. These were townhouses with garages with. Driveways and city streets.
This was much more like single family home development than it was apartments. But we were able to beat a price that was much lower than apartments we're trading at in, mm-hmm. In other nearby market. Mm-hmm. So, for a couple of reasons, this was much better. Also, our price per square foot was, was excellent.
Yeah. Our replacement, our cost compared to replacement cost is, is outstanding. So, yeah. So maybe we can speak a little bit about execution and, and what operating in inefficient markets looks like on execution. I, I, the way I, I often speak of it is, it's, it's kind of like going into a market and having a toolkit or a quiver full of arrows that nobody else in the market has.
Yeah. And that's, that is such an important aspect of our execution because, We're operating in markets that generally are unins institutionalized Generally the, the most active participants in the market are private families, maybe out of area private families, but certainly private families and other local groups.
We come in and we use simple tools that have been pretty regularly deployed in primary markets. Just to have not been deployed in secondary, tertiary markets. I mean, dynamic rent pricing for one you know, where, where rents are marked to market on a daily basis based on demand throughout the market instead of on a monthly basis.
And a lot of the markets we operate in, maybe five, 10% of the communities are on dynamic rent pricing. Whereas you go to primary markets, you know, 80, 90% of them are on dynamic rent pricing. Yeah. I think we live on the edge of institutionalization in that some of our assets fit that already. Some are just on the other side, but we, we live on that piece of tension and we're able to build a construction constructive portfolio that.
Gets the returns of both sides and blends those together and we're able to bring some slightly non-institutional properties in, into the institutional fold. And I think we get better scale and opportunity because from properties on the other side Yeah, each, each market's different. Their property taxes are different, insurance rates are different.
Staffing availability is different. Mm-hmm. Municipal, municipal costs and taxes and water and sewer are all different. Marketing costs can be very different. So as you enter a market, you develop a sensitivity for how properties are run and how they should be run. And you can find a pretty good delta there between how some companies run their properties and others.
Run their properties and if you run them more efficiently you can really achieve greater return. Yeah. And, and that also speaks to the, the owner pool again, we're, we have kind of an overlay across multiple markets to be able to utilize, you know, utilize toolkits and strategies in that we use in current markets and deploy them in other markets.
I think what we're saying is there's a greater return in operating in inefficient markets if you know how to operate in inefficient markets. Yeah. Yeah. It, it is more of an expert zone. Yeah. It requires a firm to be an, an active and quick learner. Mm-hmm. You have to have the right mindset to know which inefficient markets to play in and then how to enter quickly.
Yeah. There's always the challenge of locals operate in those markets and. I think we hear all the time, oh, it's hard to get in this market. Everything's owned by a couple families, blah, blah, blah, blah, blah. We, we hear that every single time. But the answer is, well, they also operate them like families.
Yeah. They don't operate them like seasoned professional owners often. Yep. They have multi-generational challenges, is they? Different owners own different properties. And so for us getting into that scrum, starting with getting executing on one property and being in the market and then beginning at 2, 3, 4, 5 lets us enter that market.
And it, it takes a few years, but we've done it over and over again. Yeah. And, and in times like this, We we're not relying on an institution to come and buy the property from us. We're operating in these markets where it is primarily private family. So a lot of times our buyer is a 10 31 exchange buyer or some other private capital and During times like this, when you've got institutional capital, perhaps, you know, withdrawing a little bit.
Yeah. Or, or on pause at least. It gives us that optionality that we're not reliant on, you know, some institutional exit.
Summary
Joe and Ryan share their thoughts on finding opportunities in inefficient markets and how inefficient markets are at the core of Graceada's investing thesis.