Our Investing Strategy Explained | Episode 35

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Joe Muratore:
There are very few deals that are perfect. For every buyer, there is a seller. For every market, there is a group that thinks the market has reached its peak, and there's a group that thinks it has a runway to go. At the end of the day, our investors challenge us to have the conviction and the track record to find great opportunities and execute on them.

Moderator:
This is Durable Value. Get investing in business insights from industry experts and successful entrepreneurs every week. Like and subscribe now.

Ryan Swehla:
Today, we decided we want to talk a little bit about our strategy and how we got there, how we've developed our strategy over time and through the experiences that we've had. I thought I'd start by talking about what is our strategy. We're focused on institutionalizing secondary markets. We're very much a relationship-driven company. We're focused on adding value, doing it in a creative manner, and I'd say kind of a tactical aspect of what we do is we focus on multi-tenant properties and we focus on private owners, owners that have owned properties for a long time. So, maybe we can speak a little bit about how did we get to there. How did we get from where we were before to the strategy that we employ today?

Joe Muratore:
Mm-hmm. Well, I think I would start by saying we're a relationship-based company, and many of the properties we buy, almost all of them are off market and buying properties off market is a six to 18-month process. And often, the sellers we buy from, we are repeat sellers. We prove to be a great buyer for them. We treat them well. We do what we say we're going to do and we pay a fair price.

Often, we buy properties that have been owned by families for a very long time, and their vision of why they would want to exit the property is very well aligned to why we might think it's a great opportunity. Often, properties, whether they be industrial or multi-family have been managed in the way that a family would manage them, if they'd own them and managed them for cash flow for a very long time. We're able to buy them and execute more precisely and create additional value.

Ryan Swehla:
Mm-hmm. Yeah. One of the other aspects of our strategy is focusing on that secondary, tertiary market, and how we got there is I think fairly straightforward but interesting. We were both born and raised in Modesto, California, Central Valley of California, which is definitely a secondary or tertiary market and-

Joe Muratore:
Pretty tertiary.

Ryan Swehla:
Pretty tertiary, definitely. I remember when we started our business, we were focused on third-party property management, third-party brokerage. We were helping other people with their kind of larger $10 to $50 million assets in our geography, and what we found is the clients that we worked for typically were based in LA, San Francisco, New York. These were out-of-area owners in our markets. I think somewhere along the way, it really clicked in our minds that there is no one doing that value add that we're providing for other owners out of the area. There's no one doing that value add based in the market. They're coming in from out of the market, out of the area, and that, for me at least was a real eye-opener, that being in the market, knowing the market well, being able to know aspects and nuances of assets and geographies that someone out of the area just doesn't know. And I think as we grow, that's been something that has resonated a lot with our strategy is being deeply entrenched in those markets and knowing those markets and developing that over time.

Joe Muratore:
I'd see a little bit different. I think we are a tremendous partner for local brokers. Personally, I was broker for 10 years, and what I experienced is that every broker over time has a few incredible deals in their lifetime or a few incredible deals every few years. My goal is to find those incredible off-market leads that a broker gets only once every few years, and be the trusted partner that gets the call to get that deal. A key part of our strategy is our culture and our ability to make decisions. One of the joys of being a business founder and taking the company to this part is you have the authority and the credibility to develop a tremendous conviction muscle, which is to know when you believe in a thing and to have the credibility within the organization and with your investors, to channel the company, to attack that thing.

There are very few deals that are perfect. For every buyer, there is a seller. For every market, there is a group that thinks the market has reached its peak, and there's a group that thinks it has a runway to go. At the end of the day, our investors challenge us to have the conviction and the track record to find great opportunities and execute on them. So, what I enjoy about this job and what I think our greatest calling is the courage to point to a thing, a deal, a city, a town, a secondary or tertiary market, and say, "We're going there." I believe, and I'm willing to stake my reputation and my career and my track record, on let's go here and here's the 10 reasons why. And then, investment committee can push back. They can say no, but I enjoy the responsibility and the authority to say, "I believe we should do this."

Ryan Swehla:
Yeah. We're dealing in a space that by its very nature is contrarian. We're operating in secondary and tertiary markets, so the whole area where we operate is by its nature contrarian. So, kind of developing and refining that contrarian muscle is a really important aspect of what we do because we can't focus or we can't rely on broad market trends and themes that are broadly accepted by others because we're already in a space that we have conviction around the long-term growth and the merits, but it is absolutely not a broadly accepted paradigm.

Joe Muratore:
Yeah. They say companies reflect their owners. I believe our team is a reflection of us, and I believe the number one reason to invest with us is us, and the founder ethos and X factor that comes with what we've built. Many of the competitors we compete with have been around for two or three generations. They're large companies. They're run by committees. They're run by professional managers. And we are professional managers, but we also are gritty founders because we had to build something from scratch. These days, we're professional managers, but we had to be gritty founders first, and because of that, we have that drive or that scrappy nature that I think gives us a piece of edge over our competitors.

Ryan Swehla:
Mm-hmm. A lot of our team is, I would call, refugees from large institutions. When I say that, what I mean is these are folks who have been at Shorenstein. They've been at JLL. They've been at John Hancock. They've been at these large organizations, who execute very well at what they do, but they lack the culture and the care and the ability for that exceptionally talented person to be who they are. So, kind of tying this back to our strategy, one of our focuses is being institutional in everything that we do. So, it's an interesting juxtaposing that grittiness of growing a company from the ground up, with the sophistication of institutional best practices.

You kind of get a little bit of the best of both worlds because the people that we have been able to attract into our organization are exceptional. They're world-class. And we learn from that, our organization. We're not doing our job well, if every time we have a new hire, we're not learning something new from that person, where the culture is around, when I say institutional or when we say institutional, we mean best in class.

Joe Muratore:
We have the ability, and in fact, we do act in an institutional way, but we have an entrepreneurial founder's mindset. I think that's what serves us and serves our investors because we can deliver their needs at an institutional scale and sophistication, but we can achieve results that come with that founder's mindset.

Ryan Swehla:
Well, some of the strategies we employ, dynamic rent pricing, green auditing, artificial intelligence, and HVAC. There's a whole slew of what I'd call tools or arrows in the quiver, that we employ on properties because of the background, expertise, knowledge that we and our team members have. So, we're able to employ these very sophisticated tools in what we do, and it ultimately allows us to yield better results, than would another kind of local boots-on-the-ground operator or competitor. But we also have the flexibility in the entrepreneurial-ness to be able to allow those new ideas, those new thoughts to rise to the surface without being pushed down by a more kind of top-down bureaucratic larger organization.

You want to talk a little bit about one of the other aspects of our strategy is I would say a preference toward multi-tenant or highly multi-tenant properties, which is a little bit counterintuitive in kind of the broader institutional market. It's large floor plates, credit tenants, easy to manage, long lease durations. We have a tendency and a preference toward multi-tenant. How did that evolve and why do we like that?

Joe Muratore:
Well, we're trying to manage supply and demand in secondary markets, but we're also trying to maintain a defensive posture as a landlord. So, we're looking for areas, where, as a landlord, we have an advantage. These tend to be lower TI properties. Often, that's industrial or multi-family. These tend to be very multi-tenant properties, where there isn't a tenant or two or three that can break us. We look for properties where we can create a community, where we can improve the overall asset in such a way that the network of tenants, apartment, office, retail, industrial is enhanced by the overall asset in the community that's created there.

We are experts at creating leadership within a community, and that means leading with capital, so that the asset is improved, that it's a great place to be. That means leading with communication and connecting with tenants in such a way that they feel like, "Oh, this building is well led. This is the kind of place I want to be. If a light goes out, I know who to call and I know it will be fixed." And then, once we've created that community, once we've led with capital and developed the asset, and once we've worked with tenants that are in the community, not where they're the boss, but where they're in a community and being in a community is important for them, now we have pricing power. Not to be unfair, but to value what we have created. I mean that is fundamentally what we do. We make the community better and we reflect that in the price, and it's a fair deal.

Ryan Swehla:
Yeah. I'd say kind of getting to where this strategy evolved, particularly in the office market, I would say this strategy was, I don't know, crystallized during COVID because during COVID, a few things we learned. We looked at our office portfolio and we have some properties that have large tenancies and other properties that have a lot of small tenancies. We looked at our portfolio and the properties that performed the best through... If you pick an asset class that was most stressed by COVID outside of hotels, it was probably office. Everybody left. They were gone. So, you look at an asset class that had this large external shock to it, and the assets that performed well in that environment were the highly multi-tenant.

Those are the ones that, a lot of times, you're not dealing with credit tenancies. You're dealing with mom and pops. You're dealing with smaller regional companies, some national, but those are the companies that had a stronger need to be operating in the most effective way possible. And in the markets where we serve, you're not dealing with long commute times, you're not dealing with high cost of real estate. You have all these factors that make people more comfortable getting back in the office. But these multi-tenant properties allowed us optionality. If we had one tenant that's growing and expanding, we can accommodate that. If we have another tenant that's downsizing or moving out, we can accommodate that. When you have these large floor plate, single tenancies, or a few large floor plate tenants, much harder to be flexible in that environment. We prefer flexibility over kind of rigidity in our investments.

The other thing that we noticed is we have an asset that we're getting to full stabilization right now, that involved a heavy TI component. We bought the building 33% occupied. We're getting it up to the high 80% occupancy level. It's been a big lift, and one of the things that we found is with inflation, construction costs keep going up. So, we have a preference now for properties where that construction cost risk is lower, where like you mentioned, lower TIs, generally the overall need is not as high. So, we're not out to risk on construction cost.

Joe Muratore:
Ultimately, I think we move to a multi-tenant investing strategy for the sleep-at-night factor. As you do this more and more, you just quickly learn what works well and what doesn't work well. The things that were hanging up on our organization and frankly, the challenges we deal with today are large tenants with tremendous power within buildings, that choose to flex that on every single renewal. And then, we would have these other buildings where we had lots of smaller tenants, and yeah, we had a lot of renewals and extra work. I wouldn't call it extra work, but those were very smooth. We had tremendous pricing power. We had leverage. They didn't want to move. It went really well. So, to scale an organization and deliver the types of returns we do over and over and over again, we found it worked great to work with lots of smaller tenants with buildings that were compelling and in great locations, where tenants wanted to be.

What makes multi-tenant buildings work is location and quality of asset. As I've said, you're creating a community and for smaller tenants, that aren't national tenants but are regional tenants, they want to be in great locations and they want to be amongst other great tenants. Over the next few years and certainly for the last few years, we've sought to buy higher and higher quality buildings. It's in those buildings where our style, our leadership piece, our capital piece is most effective and leads to the greatest outcomes and returns.

What we really enjoy in our strategy is a dynamic environment, where there's different submarkets within a larger market, that play together in different ways, and often, we're able to find value in the transitions. That's worked well for us both in the Bay Area and in Sacramento, and as we looked at other secondary markets that fit that model, we saw Greater Denver and are currently in the process of acquiring some assets there. Personally, I really like that between Fort Collins and Colorado Springs, the smaller towns in between, there's a lot of similarity to how Sacramento works, commute times, quality of assets, little micro markets within the major market. That favors us. We're not a CBD group. We like that secondary and third wave out from the city, so I look forward to that going well.

Ryan Swehla:
Yeah. In using the East bay, as an example, people think of Oakland, Alameda, San Jose. We like operating in Martinez, Walnut Creek, Livermore, Vacaville. So, as we look into the Colorado market, again, it's kind of these aspects of the market that are less developed. It's not the Boulder, Colorados of the world. It's the Greeleys and the Fort Collins and the Auroras, where we find interest. That's again, just based on our experience in the Central Valley.

Joe Muratore:
Yeah.

Moderator:
Thank you for listening to Durable Value: An Investor's Podcast, where we demystify commercial real estate with safe and sound investment strategies to help you balance your portfolio. If you enjoyed this podcast, be sure to rate it on iTunes or wherever you get your podcasts.

To learn more, visit graceadapartners.com, where you'll find more information, investors' tools, case studies and more. This podcast is hosted by Joe Muratore and Ryan Swehla. It's produced, edited, and mixed by Melodic with intro music by Ian Post. Thanks again for listening and we'll see you next time.

Summary
Our investing strategy, while continually being refined, has essentially stayed the same for the past several years.

Runtime
20:06