We will learn the pros and cons of investing in a few asset classes: retail, office, self storage and mobile home parks. We are interviewing Jeremy Roll, a passive real estate investor since 2002. Because of his investments, he was able to leave the corporate world in 2007 to become a full-time passive cash flow investor. He is currently an investor in more than 70 opportunities across more than $1 Billion worth of real estate and business assets.
What are some pros and cons of the following asset classes: retail, mobile home parks, self-storage and office?
I'm happy to cover those, but I want to make sure that everybody out there understands that I am heavily biased towards cashflow and stabilized cash flow. That's what I target. So the perspective I'm going to share is going to be from a passive stabilized cash flow. Let's go asset class by asset class.
Retail
I actually have a number of retail investments that I've made over the past decade. Most of them are performing really well, I have about seven to ten investments. I am kind of hyper diversified. So I'm in over 70 LLC's, a lot of small slices is how I like to put it. What I don't like about retail going forward is what's going on in the next 10 years, as far as predictability. Some of the challenges that I see, some of them are continuing and some will be in the future include: are people going to continue to go stores or are they actually going to migrate online even more and more? And if the answer is online more or more, what does that mean for the retailers?
Let me give an example: if there's a Domino's Pizza in a retail strip center that I'm looking at, and there's another one five miles away, which can be common, what's going to happen? Is Domino's going to say "We don't need all these locations, no one is coming to them, they're all ordering online and they're not coming in. And we're just going to have a centralized manufacturing hub because we're going to have self-driving cars in 10 years, and it's going to be much more efficient. The cost is going to be lower, etc.." Now you've lost that tenant. If you have self driving cars coming up in the next five to ten years. And I use five to ten years because when I invest, I normally invest with a 10 year outlook, because I'm often in a ten year type of scenario.
What's going to happen in five or ten years for retail if there are self-driving cars? Are people going be more apt to drive further to go to a location because they're not driving? And does that mean that the corner store around the corner is going to be as attractive anymore? Are self-driving cars going to make deliveries? And now Amazon has this corner store hub, and the actual corner store is irrelevant because Amazon does it cheaper. I don't know the answers to any of these questions. The reason why I'm pointing all of these things out is because it's not very predictable at the moment, in my opinion. So if you agree with that, then that is a challenging asset class for me. And I'm not saying I wouldn't make any investments in retail at all, but I would say it's kind of a second tier asset class for me right now because of the harder to predict nature of it for the next 10 years.
Mobile Home Parks
I love mobile home parks. And the reason why I say that is because if you do your research, you'll find that it probably has the lowest turnover ratio in terms of tenancy of any asset class I can think of. I believe the national average turnover ratio is about 9%, which is very low. There are certain apartment classes that have 40 to 60% turnover, depending on the type of building and location. I love mobile home parks because of that. And I love the fact that they're serving lower income people, and that I see a need for lower income housing and affordable housing for a very long time going forward. So there is that predictability that I was talking about. There is predictability of demand. Predictability in lack of turnover in terms of cash flow. And, if you buy the right profile, which is very important, where most of the tenants are owner occupied and not renter occupied. You're probably going to have more predictability in terms of having less problems.
I'm in many investments in mobile home parks right now, I hope to be in many more. But I will say this. This interview is being done in 2019. I believe mobile home parks have become far too expensive. I stayed away from mobile home parks, with the exception of just a few, since the end of 2016. That's when I thought that cap rates got too low, and I'm expecting a big adjustment in mobile home park cap rates at some point once we have an economic downturn because they've come so far. I think it's the asset class that has had the most cap rate compression that I'm aware of during this cycle. Therefore, in my opinion, it has the furthest to go back essentially. I love mobile home parks and I look forward to investing in a lot more of them. I just don't believe that the current timing is necessarily good, unless there's some type of unique pricing or scenario associated with it.
That's the first time that I hear someone thinking that mobile home parks cap rates are the most compressed. I just interviewed someone that does mobile home parks investments and he said the opposite, that they're the best cap rates out there.
I want to give you an example, because I've been investing in mobile home parks since roughly 2010. I used to be able to invest in what's called a three star park in the Midwest, which is like a class-B park that was mostly or fully occupied and between a 10-13 cap rate. That was not "oh, that's a great deal". That was the market average, right now that exact same park is likely going to be between a 5 to 5.5 cap. Find me another asset class that has compressed from a 10 to 13 cap to 5 to 5.5 cap, or if you want to be really generous, a six cap, but I think that's even unrealistic at this point. And I will probably be proven wrong, but I just don't see another asset class that has done that.
Self Storage
That's another asset class that I really like. When you think about how the US is changing from a demographic profile, we're aging over the next 10 years. We have a lot of people moving, and projected to move to Florida and to Texas to retire. What I love about self-storage is that when people retire, they typically downsize. And I see that there will be a need for self storage as a result when these people move, or even if they're living there and they downsize. In certain locations, I think they can be great.
One of the challenges with self-storage is that it's very low cost to build and it can be built relatively quickly. The barriers to entry are low. If you're going to invest in self-storage, the supply and demand factors in the market you're looking at at the time are critical, because you may have a competitor pop up in a year or two that you weren't expecting. And the question is, can the market afford to have that and still be balanced, or not in terms of supply and demand?
But I love self-storage because the turnover rates can be really favorable as well if they're managed really well, especially in the right locations. They're harder to run, so you have to make sure that you have a really good manager who both understands how to run them well onsite, but also understands how to optimize them. For example, most people will tell you that if you have a self-storage property, and it's 100 percent occupied, you're running it wrong because you're actually not maximizing the revenue because there's going to be turnover, etc, and you're probably not charging enough in that case. You want to have occupancy maybe in the 88 to 90 to 93 percent rate. It's definitely a different asset class. It takes a different understanding and a certain experience to run properly.
I would say very similarly to what I said with mobile home parks, this is my general philosophy across everything right now, I've been mostly on the sideline since early 2017 because of cap rates across the board. I have been a big proponent of pushing my operators to sell, I have been involved in over twenty five sales in the last 2.5 years, and I've been waiting for a downturn. I had four self-storage properties that we bought between 2013 and 2015 and we've now sold three of them off. We currently have the fourth one listed locking in really fantastic cap rates. I believe in self-storage. The cap rates actually peaked in 2017. They adjusted a little in 2018. They've held steady in 2019, but I think there's a lot more room to go as far as cap rates going up during a downturn. I'm waiting on that. And like I would tell you with everything else, a market rate deal to me just doesn't make sense right now with where cap rates are in self-storage or anything else. So I think they're great for the next 10 years. I think they can provide a lot of predictable cash flow. And I think they're really good in the right markets. But I think the timing is challenging right now.
I agree wholeheartedly with you, I see so much nonsense out there. My heart goes out to investors that don't understand the nonsense and how operators are doing their due diligence and evaluating a deal. So I appreciate you talking about that.
By the way, that doesn't just apply to self storage, that's across the board. I saw an apartment deal this morning that I was just in awe. It was several hundred units. It was large, but it was class C. It was actually written up as a class C offering in Houston. And the cost per door was something like $101,000 or $120,000. It just blew my mind that it's a class C property. Everyone's going to have their own opinion, but to me, it just doesn't make sense from a pricing perspective.
There's a lot of that going on. And I tell people that the #1 thing is that now is the right time to study and learn, and #2, be really careful with who you deal with because there are a lot of nonsensical numbers going on out there.
Office
I have multiple office investments right now as well. But I have the same challenge with office that I have with retail, for a couple reasons. And we didn't get into one aspect of retail that's a little bit of a predictability challenge, which is the same in office, which is tenant improvements. When you have a tenant that leaves, typically there's some money to be spent to turn the unit around and make it ready for the next tenant. In retail, it can be quite substantial if they're changing the entire use. Let's say you have a record store that's being turned into a restaurant. There's a lot of money that has to go into that. And often you're sharing that cost with the tenant upfront. The same thing goes with office. Between the tenant improvement requirements that may come up if you have tenants leave unexpectedly, that may come out of cash flow or reserves.
But sometimes, often with the reserves, is trying to get a balance between maybe some unexpected expenses, but it could be worse if it's coming from cash flow. And all a sudden, the predictability of cash flow isn't as certain as some other asset classes because of that. For office, too with the advent of self-driving cars with people telecommuting more for work and people changing from suburban to urban, and back to suburban. It's very hard to predict where demand is going to be for office in the next five or 10 years, in my opinion. Because of that alone, that puts it into a second tier category for me. And, again, with the right circumstances, with unique pricing, and what I call a no brainer deal, I would still do it. But office is very challenging for me on predictability for the next 10 years. In most cases, I would say the timing is also not good from a cap rate perspective. That's not true across all the markets for office. But I would say that it's still a blanket statement I would make. So there's some interesting aspects about office, especially with a diversified tenant base and a larger building. But predictability for the next 10 years due to many different factors is not there for me.
Would it be fair to say that your top number one through four favorite asset classes would be: 1. mobile home parks, 2. self-storage 3. office, 4. retail?
I would say that retail and office are tied for third. I'd say the rest of that's correct. I want to say, though, that for me personally, for the next 10 years for predictability, my top four asset classes in general are 1. mobile home parks, 2. self-storage, 3. apartments and, 4. senior living. I think that none of them necessarily make sense today from a pricing perspective. And I think you've to look at the locations carefully, and the demographic shifts in the nation, and getting the right type of building in the right location. But those are my top four favorites for predictability for the next 10 years.
Is there anything else that you think is important for our audience to know?
I think we've touched upon this a little today, but I cannot stress enough how imperative it is to be very careful right now. It's a fantastic time to learn. It's a dangerous time to invest because you're not missing out on much while you're learning, because real estate is cyclical, and timing in real estate is critical. So if you haven't formulated an opinion of where we are in the cycle, a really well thought opinion about where you think we are in the cycle, and what makes sense from your perspective, do not invest until you do that, because in my opinion, we're in the ninth inning of a cycle.
So you've to formulate your opinion, you have to do that to make sure that you're protecting yourself and understanding where you think we are in the cycle. I think that's really critical. Just be very careful right now. Understand the market you're in. Understand what timing we're in, and get to know the asset classes before you invest.
Jeremy Roll
jroll@rollinvestments.com