The Graceada Approach
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Episode Transcript:
The truth is there's 7 million people in the Central Valley and nobody's paying attention. Like there's a lot of people that live there and there's billions of dollars of real estate and no one's, no one's, you know, minding the, the, the farm or whatever. This is durable value. Get investing in business insights from industry experts and successful entrepreneurs every week.
Like and subscribe. Now we're in the right place. Like, I love telling our story because it's, you can see in people's eyes when it clicks and, um, And so with that right story, the next part is how do we go about it? Like how do we actually execute, right? And so Joe's gonna come up, invite Joe to come up, and what he's gonna talk about is what we call the grased approach.
Thanks Logan. I forgot to mention earlier, and I wanna do now. Logan, uh, joined us from, uh, he was at Trammell Crow, JP Morgan Partners group and PEG companies. Um, So several billion in real estate assets amongst those. So to have some of his caliber. We, we were talking about this yesterday, leave most of the people that you see, our team now, were at name brands and it's, it's cool to be a part of a big brand, but at some point you want to go build something.
And our company's a place where they can come and make their mark and build something. And it's such a pleasure to be on this journey with them. Let's, let's talk about how we make money. I mean, it, it, the next thing to say is, uh, What do we buy? How do we get leads? And how do we know what to buy? How do we know what a good thing is?
And especially in changing times like this, how do we know what a good thing is? And before I answer those questions, let me start by saying, it starts with who we are. And right now at this moment, it feels like a good pitch to say We're secondary markets. People, capital's gonna be moving into secondary markets.
We, we know this, but the truth is, We started this 15 years ago in a town called Modesto that many of you are from. And at a time when, and maybe now it was not cool to be from Modesto, but it, but now when we talk to investors and we share our story, it's, it's more interesting. The truth is there's 7 million people in the Central Valley and nobody's paying attention.
Like, there's a lot of people that live there and there's billions of dollars of real estate and no one's, no one's, you know, minding the, the, the farm or whatever. Um, so we started there and what I wanna point out is, uh, we built this thing from scratch and we speak secondary markets fluently. So the, the first part is we started this, you know, in a tiny little office and we said, all right, we gotta figure out how to make money.
And we built a brokerage company and we were brokers for a decade where we sat between buyers and sellers in a difficult market and worked deals deal after deal after deal. Some of those were distressed assets. Some of those were bank owned. Uh, some of those were large shopping centers, but we worked deal after deal and we honed our craft.
Alright, how many times do you re-trade? Do you re-trade? What's the seller's motivation? What's the buyer's motivation? What are the stages of grief and what's the greed fear index and where does this deal live? We did hundreds of those deals. Uh, after that we said, alright, most of the owners of these deals live in LA or they live in San Francisco, or they live in New York or something, especially the larger deals.
And they don't wanna live in Modesto. They don't wanna live in the Central Valley, but the, but there's big real estate there and it needs to be managed. And these owners would say, why don't you guys manage it? And we thought, okay, recurring cash flow, that sounds like a thing. So in addition to brokerage, we built a, uh, a property management business where we managed and delivered these statements over and over, um, and, and learned how to manage those tenants.
Worked on the renewals, pushed for the higher end. And in that we, we were able to, to own our skills. Um, Uh, and finally we said, alright, uh, all these people from outta the area are interested in investing in here. And apparently they think we can do it better than they can. Why don't we apply capital to this and, and lead with arc core values and, and do that.
So in that process of building this up from scratch, we got to learn how to invest by watching others, seeing mistakes, seeing upside, and begin to craft our our own story. Um, the second thing is, uh, It's getting more popular to invest in secondary markets, but we're native speakers. I mean, we're from this area, we're from, uh, secondary markets.
It turns out that there are modesto's and Sacramentos all over the country, and there are trillions of dollars in assets that are in these secondary markets, and they're not, uh, well cared for. Uh, most of them are owned by families. They're owned by individuals. They're not owned institutionally, they're not approached with the.
Uh, vigor and the way we approach things, the process, the team that we use to approach things. I'm gonna talk a lot about it, but, um, the sort of local versus scalable approach. So this slide I'm gonna call, what do we buy? Like, what do we invest in? And part of that is saying, uh, I'll, I'll tie it back to we thrive in inefficient markets.
So equities and stocks and bonds are generally pretty efficient. Real estate's a lot less efficient. There's a lot, uh, knowledge is a lot less transparent. Tenant movement's, a lot less transparent. New rents buying and selling is a lot less transparent. And to thrive in real estate, you have to be connected to that local economy and you have to be connected to the deal flow.
There's sort of two waves. There's the, a retail in the wholesale. You can, anyone can get on LoopNet. Anyone can see the, the retail deals. Anyone can get the C B R E updates. Anyone can join the auction. But to do what we do, you have to live in that undercurrent that, that, uh, scuttlebutt as they say it.
Like what, who's, who's feeling what. And so our, our opportunity and what we built process around is living in that second layer, that, that expert zone where you're not at the auction table, you're, uh, in the know. So what do we buy? Uh, lemme start by saying, what did we historically buy? Historically we bought, uh, office and retail.
That's, uh, mainly where we got our start. And this touches on local versus, uh, scalable real estate with office and retail, just our opinion. Um, but this is more of a, this tends to be more of a local play. Um, the local way to think about real estate is, alright, we've got this asset. This is an arc project.
What are we gonna do with this? How are we gonna like, move some walls there? Maybe we can attract this tenant. You know, do we build a sculpture out front? I, I, I don't, but it's this idea that this is gonna be, it takes a lot of focus for not a lot of reward over time. We've moved to where almost all of our investing is in two things.
Multi-tenant industrial, also called small Bay Industrial and apartments, which is also called like multi-tenant housing. What do these things have in common? There's lots of people there. There's no big tenant that can move out. There's no big thing that can go wrong. There's lots of either industrial tenants or, uh, families and individuals living there.
And so what do we tend to buy? We tend to buy eighties and nineties vintage. We tend to buy in markets where vacancy is tight, so the vacancy rate is 2, 3, 4, 5%, meaning that demand exceeds supply. Meaning if you have a space, there's somebody who probably wants it. There in some, in some of our complexes, uh, properties.
Uh, a vacant space gets filled in hours In most of our complexes, there's a waiting list. Alright? This is beautiful real estate. This is a place you can start from. There is a demand for the product we have. Secondarily, we look for affordability. We need rents that have room to run. So these are not Bay Area rents that are super high and people are barely squeaking by.
These are secondary market rents. There's affordability there on the, on the multifamily side, maybe it's 20 or 23% of their income. It's not 30 or 40% of their income. So, so lemme get this straight. All right. There's, there's a waiting list for what we got, what we have, and rents are still relatively affordable going in.
Okay. We're starting with something. That last part is value and that's, uh, rep, uh, value relative to replacement cost. So we look to buy assets at 50 to 60% of replacement costs. Uh, on a per square foot basis, that means, what does that mean? That means it's, uh, it doesn't necessarily, if we can buy it half of what it would cost to build a new thing, then it probably means rents haven't gotten to a, a point yet where it justifies building a new thing.
That means, okay, we bought it at 50 or 60% of replacement cost. We could exit at 70% of replacement cost after we do our value adder 75, and it'll still be a value to the next person. So after we know what to buy, those two things, with those two characteristics, uh, what are we gonna do with it? You know, as Ryan mentioned, our job is then to lead with value and attack our first, when we start with an asset, it changes quickly.
We don't just say, oh, we bought an asset. No, the paint color changes within 30 days and it looks great 'cause we use a designer. We used to, we used to pick it ourselves that that was a bad idea. The landscaping gets better immediately. The, we often say like, if you've been to Disneyland, it was built in the sixties, but like everything's in place.
The railings are painted, the flower beds look nice, like those little touches communicate value. We work to make our properties look like Disneyland. I mean, they're older. They're not brand new, they're not class A, but they're clean and they're well managed. And we buy from, almost always, we buy from dysfunctional owners, uh, owners that have not managed it with a plan and a vision Owners that have often owned it for 10 or 20, sometimes 40 years, sometimes this has been inherited once or twice.
Like the, the people we're buying from do not understand commercial real estate. They understand, they get a check, but they do not understand how to run a property. So when we come in and we lead, we, we don't lead with, we need more writ, we lead with. Whoa, you, you drive up to the asset, uh, next Tuesday, and it looks a lot different.
It looks modernized, it looks different, um, and we operate institutionally. So we use, often we use dynamic rent pricing. Uh, we use, uh, amenity codes so that we're capturing the value of each apartment differently so that in some cases, the, the rent on the apartment, uh, adjusts daily to match the market. Um, Uh, and we've got, uh, AI on some of our HVAC units.
We've got electric vehicle charging at some of our complexes, but we lead with new, uh, institutional tools that make our properties run more efficiently and communicate more value to the tenants. Finally, on the, like, what do we buy? We are in the business of buying wholesale and selling retail. What does that mean?
How do you buy wholesale and sell retail? What it means is we look. For chaos that we can put in into a box and put a nice bow on. We look for the type of thing that we are really good at doing over and over and over again. So remember back to local. Local is this is an arc project scale is, oh, we do the same things over and over every time in the same characteristics.
And we add value in the same ways we look to exit in the same period of time. And so wholesale generally means, uh, properties off market. It means. We're buying from a family. Uh, there's a story behind it. There's a messiness to it that we believe we have the ability to clean up. This is not, we sell retail, which means we move rents to market.
The asset looks great, we sell it on market in a bidded environment. So we, we buy off market and a non bidded, you know, uh, asset, and we sell it in its perfect, cleanest condition at the highest net operating income that we believe we can achieve. Okay? So that's what you do. How do you, how do you get your deal flow?
Our background comes in to this, uh, strongly. So 90% of what we buy is off market. Truthfully, I can't remember the last asset we bought on market. It is rare. Um, what does on market mean? Well, brokers are in the business of creating an auction. A market is people, multiple people wanting a thing, and when multiple people want a thing, The highest bidder wins.
Our job is to avoid anything that feels like a highest bidder situation. Ours is to be in a situation that's non-bid. So 90% of what we buy is off market now. Now almost everything we buy is through brokers, but, but usually it's a phone call that says, Hey, I've got a lead. Hey, have you heard about this one?
So sellers, when they sell, they go through a sort of, especially families, they go through a sort of stages of grief process. There's life situations that make them want to consider why they should sell, or it's, you know, I need to do some, uh, estate planning or something. There's some in motivation that's happening behind the scenes there, and usually that's a multi-year process.
So you've got that happening. You've also got the trust factor. They're looking for solutions and they need trusted advisors who can help provide those solutions and. For us to develop trusted relationships with distress sellers in 10 markets is really inefficient and not a good use of, of time. Uh, we can buy that and, and add that as a discount to our price.
Um, so brokers are building, uh, developing these relationships. Meanwhile, sellers often have these, uh, unrealistic expectations of price, and our job is to get 'em to another price. So usually this is a six to 18 month process from getting a lead to getting a deal. Um, so what's really important is we were brokers for 10 years, and I think a lot of people I see in this business, uh, they, they, they treat real estate agents not well.
I mean, ah, they get paid too much and all they did was, you know, answer a phone call or that sort of thing. We are the opposite. We like see these people as our customers and we develop these relationships like they're a hundred percent in the market developing, developing relationships and seeing opportunity and.
Every now like I was a broker for a decade. Every now and then you get a golden nugget. You're like, oh my gosh, this, this thing's amazing. Like if I could buy this myself, I would buy this myself. That's when I want my cell phone to ring right at that moment. 'cause they're gonna go through their Rolodex in their mind of who's getting this golden nugget.
It better be our cell phone that rings. And if we laid the groundwork, if we were easy to work with, if we paid on time, if we treated them like a customer. Our phone rings and some of these deals you see on these boards around here, uh, phone rang and it was like, wow, this is way below market. There's a, there's a story to this.
And it's like that story comes and it's like we, that's it. Go, go, go, go, go. Part of the reason we're gonna talk about, uh, moving into other markets is just developing the number of times the phone rings with great stuff. Uh, the Central Valley only has so many, uh, buildings and only so many great opportunities, and we see other secondary markets where we can develop the same sort of approach.
So, okay, the phone rang, market's changing times are weird. How do you know what to buy? How do, okay, someone called you with a lead, how do you know it's great? You just have an intuition or something like that? Well, obviously there's more to it than that. This is a pattern recognition process, so I'd say we underwrite two to three deals a week.
Some of those are great leads. Some of those are just okay leads, but what we're really doing is we're sampling. We're sampling all the time. We're looking for that thing that doesn't line up. This is an inefficient process. There's a, there's a family story behind almost every asset. This it, it's not like the stock market where the whole world sees it and it's dynamically priced all the time.
These are people's lives, and so we're sampling all the time looking for those deals. And so we underwrite them, we put 'em through our process. We see what it comes out to. An I R R and an equity equity multiple. We think about, alright, does this fit to the strategy of the company? Does this fit to our skillset?
Is this a good use of our staff's time? Is it the right scale? Is it near other assets? Is it, uh, moving in the, in the geographic direction that we wanna move? Um, And then we write lots of offers. So lots of offers. And when we send an offer, we send our our CLO deal closings page behind it, 523 million in closed assets.
It's a powerful page. Here's an offer, here's a brand. You've got a broker that's saying, I know these guys. They're good. And here's a page that says we close this one, this one, this one. And they think, okay, but we see it as like a Ferris wheel. So you put in the offer and they're gonna think about it for a while.
They're gonna share with their family, they're gonna think about it. But you're, you're. You can't show up at the last minute and get great deals. It just doesn't work like that off market. You have to enter the Ferris wheel. You have to engage with them. And so the deals we were offering on nine months ago are the deals we're doing today.
I mean, some of the deals we're really excited about right now, we first offered on six or eight months ago. And, uh, I hope you'll hear about them at our, at our, at our next meeting. But, um, especially in times like these with our process, it's really important that we continue to, to offer. I mean, ultimately to get next year's price at today's interest rate, um, ultimately our goal is to buy in some sort of dip that we think is going to recover because of the market or the demand.
Um, so our, our job is to recognize to, to sample. And one of the best ways to sample is to be active in that market. When you already own assets in a submarket and you're collecting rents there already, you know, something that brokers don't know. You know, something firsthand. And a lot of times the deals we buy, we have a stronger conviction about than the brokers.
'cause they're not living it, they're not collecting rents, they're not engaging with those, those tenants. But when we buy something and we forecasted $200 a month in rent growth and we achieved $400 a rent a month in rent growth, and nobody knows about it yet, but it's like we got this secret. Like, bye bye bye.
Go buy the other stuff that's around it. Um, a, another tool we use off is to buy a core asset and then buy a cluster around it. Buy the small assets, the ones that are sort of hard to manage but are adjacent or nearby. So it gives us scale. We're able to take the team we already have on site and manage those efficiently.
Whereas if it was just a small assets by itself, um, we couldn't, so what, what's next for us? Um, where do we go? Where do we go from here?
We, we've done this in the Central Valley. We see other Modesto's. Uh, as of tomorrow we will be owners in or Utah of a, a light industrial complex. It fits our model. Uh, our price per square foot is good. There's room to grow the rents. We got it off market. And, um, alright, first step, we're in escrow in Lakewood, Colorado on a portfolio there.
We've put offers in in Eugene and Corvallis, Oregon. We've put offers in in El Paso, Texas. Why El Paso, Texas? Well, there's 52,000 apartment units there, and they're all managed by Mom and pops. That market is the second biggest in the southwest, and it is totally unins institutionalized. Our, our job is to not, uh, we, we recently bought in Bakersfield.
We're so excited about Bakersfield. Who in here can raise their hands, say they're excited about Bakersfield, Claire. All right. We got Bakersfield's Amazing. It turns out it's like pretty close to LA but rents are like from the 1990s. It's, uh, We should buy all of Bakersfield. But, but like, that's why we're here.
And that's, that's why we get paid is to have conviction about Bakersfield in El Paso, Texas and Eugene, Oregon, where we see tight vacancy, relative affordability and value for the dollar. We're excited to, we call it bullets and cannonballs, but, uh, to test our conviction. And as we see, as we, as we see the thing, 'cause we're there, it's like, alright, attack, attack, attack, and then test another thing.
And you know, it's like a learning environment. And once you're in this business, once you own things, your phone starts to ring. Once you own in Lakewood, Colorado, believe me, I'm mean, here in Modesto, phone rings and you start sampling. And over a multi-year process you built, you build up a portfolio and you become an expert in those markets.
So we're really excited. I said earlier, I think we're in the second inning of this. Ball game game. I think Paul actually, who's on our board, told us that. And, um, I'm really excited about third, fourth, fifth, sixth, and seventh. I think we've got something that's got some runway here. The, the best part about this is going to be building out the team.
That operates on our operating system with great conviction that spots these opportunities. And as we have, uh, people in Salt Lake, it's gonna be great to have people in, in Denver and to carefully build out people that are sending in more deal flow that fits our model. So that's it.
Thanks Joe. I, I. I hope you can feel Joe's enthusiasm and it's, uh, it's contagious. It's contagious into the whole, the whole firm. Uh, one thing I will say that again, you know, talking with investors, something that resonates probably the most with everybody is, and, and differentiates us as a firm, is the fact that our deal flow is off market, right?
Like it's, if there was one thing I would want to say about our firm, I'd say, Hey, we go in secondary markets and second nutrition markets. And 90% of our deal flows off market, proprietary deal flow, we don't bid on. Right. And that's all of a sudden, I don't care who I'm talking to. Someone wants to listen when they hear that, you know, even like, like Joe said, we're not getting in line and just making bids on properties that we think we like.
Right. That everyone else likes. We usually, if you're bidding on it, we probably passed on it. Right. And it's a, and that's a really, really unique characteristic of our firm. So thank you for highlighting that. Thank you for listening to Durable Value an Investors podcast. Where we demystify commercial real estate with safe sound investment strategies to help you balance your portfolio.
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Summary
Taken from Graceada Partners' recent investor meeting, Joe Muratore gives a deeper look at how Graceada approaches CRE investing and strategy.