What should be your acquisition targets and goals as an investor? What are the pros and cons of different asset classes? What should your real estate agent do for you, and what should you do as an operator? Trinity (Trent) Herrera, Commercial Director and Real Estate Consultant at Black Tie Real Estate, shares his knowledge.
Let’s move on to the acquisition targets.
This is incredibly unique to each person. We could talk as broadly, asking, “What’s your appetite? Is it residential or commercial real estate?” Let’s assume it’s commercial real estate. Each economist, economics professor, person who studies economics, and person who works in finance or retail is part of a cycle. Every city, block, town, county, state, and even country is in a different cycle of everything all the time. It is chaos.
One of my favorite topics to talk about is the concept of the three-body problem. When you have one item, it is easy to predict what that item will do. It could be a planet, a financial entity, or a person. When you have one variable, it’s very easy to calculate. When you have two variables interacting with each other, it starts to get a little harder. But when you have three or more, you start to reach an incalculable level of complexity. When scientists study planet orbits or ask whether this asteroid is going to hit us, they’re always calculating a three-body problem. And we have this with real estate in so many ways. It is this chaotic complex, constantly orbiting, always spinning, and shifting off its orbit. It is truly the epitome of a three-body problem, in the sense that it is so vastly complex. It’s extremely hard to time.
What we can do is follow market cycles and data that we can see, feel, touch, and quantify. We can go off gut feelings to a degree, and market dynamics. When it comes to what you’re acquiring, it’s similar to underwriting. 75% of your success in a deal is likely to be predicated on the soundness of your underwriting and your acquisition targets. 75% of your success will depend on your market and the market factors influencing it, as well as the underlying reasons.
A couple of notes I have are that I speak to all levels of real estate investment, starting at green, “hot” does not mean good. It’s a base-level statement that everyone needs a reminder of, even you and I think that there are many times when we’re looking for what’s hot right now. It can easily wash over us. It’s hot; it’s got sizzle, but it won’t sell.
What sells to me is cold, hard math and fundamentals. I do not care what type of hot asset it is. When I hear about this deal, I seek data, and that’s going to tell me if the deal is hot or not. Yield sells deals. Understanding your goals and why you’re looking at this deal and this asset type is the number one acquisition goal you should have. Clarifying by asking the question, “What am I into?” There are a million ways to answer this question, and what you’re after is that one way that’s going to work for you, or those four properties that are your exact or close to your appetite. You’ll have pros and cons for each asset type. For example, with office space, you’re going to have high vacancy, but go back 10 or 20 years, and the office was king. The office was demanding premium rates and was highly sought after. However, it completely flipped after COVID, and you already had high vacancy.
The deal is based on the price and the exact time that is vacant.
Exactly, we’ve seen some historic low sales prices on the office these days. For some people, you may not have a tolerance for vacancy, especially a vacant office. Look at a retail or industrial deal, and this is where the appetite comes into play. Maybe, having a half-office, 17-story building, scares you to death. Maybe you like retail because you love to shop, and so does your family. So, perhaps we look at a retail deal instead, and with deals of all types. You have many classes and types that interest you. You could have a mall, a strip center, a regional center, and we’ve worked on some deals like that together. They can be cool, but they can also be grody, worn down, old, a C minus, and the rents are bad because people are getting shot in that part of town. That has happened to me, and we bought retail centers where we were shocked by the surrounding area.
Those are lessons learned in business that led me to the industrial properties. That’s been my sweetheart lately because it speaks to me. I can understand it. It’s a language I speak. The con is that sometimes, the market, oil fluctuations, price of wood, and all these other business factors can interfere with your business. The pro is, from what we’ve seen through COVID, all the government incentives and policies are shifting toward American-based manufacturing. We likely have a bright future in industrial real estate.
Then there’s this thought of who’s helping you with your acquisition, and why are they helping you? You should not have someone helping you find a deal that you are unfamiliar with. You should at least be able to call that person, ask them questions, consult with them, and have them help you find the data. They should probably be walking you through the reality of the property and the math. And if they can’t do that, then you need to find a person who can handle your acquisitions. If you’re a real estate agent and you’re bringing a deal but not the math, we’re going to have to figure out that math. I do think that’s a disservice as an agent.
Most brokers don’t bring the math with them.
No, they don’t. And it’s a big gripe of mine because I work with my peers in the real estate world every day, and as soon as you get to any level of sophistication in commercial real estate, you’re crunching numbers pretty hardcore. When you have a fiduciary responsibility to somebody to protect their wealth and their money and make money for them, how can you do that if you can’t deeply understand the math? It’s one of my cardinal sins in the commercial real estate practice. As an agent, you should understand math and be able to explain it to everybody.
And my wrap-up on acquisitions: find a good partner, stay away from sizzle and hot. You want to be cold in your thinking and logical, knowing your asset types and your “why.” This is partly what you’re looking to your sponsor for, and part of the relationship you have with your sponsor. The appetite your sponsor has will have a bearing. If you’re doing LP or investments like that, then you’re going to want to work with a sponsor who has deals that you like.
Moving on to California money in Texas, or just California people in Texas, we were just checking out the latest deal that we’re looking at in Dallas. My partner has been investing in Dallas for over 20 years, and I’m truly impressed with Dallas and how the politicians thought so far ahead that it is not going to benefit them in their career to make such a great city and state. It’s extremely clean for a huge city, and it’s bringing in so many companies, headquarters, and other businesses in between. There has been so much thinking ahead, and these things take a long time to see the results.
California money in Texas is a tale as old as time. I spent my childhood in Texas, California, and Arizona. I think Texas can be considered honorary. It’s like the West Coast of the Midwest. When this country was first settled, we had people coming from New York, the Boston area, and the East Coast, and many of them stopped in Texas. It’s a great place to live, and Texas started to collect a huge number of people and build forts, such as Fort Worth. Then, you have even more intrepid explorers who didn’t stop there. They went on to California, and they continue to explore the digital spaces. Some may regret that decision, and some of them are moving back to Texas now. Money tends to sit in a couple of states: Texas, California, New York, and Florida. Those are the big four states where I’m doing a lot of real estate, and this has been happening for a long time. In our circles, we’ve known that since the 90s. WIP has been taking this California equity, placing it in Texas with great success. There are a lot of reasons why there is no business income tax in the state, which is huge.
The politics is 50-50, I don’t know if people are moving here because of the politics, but certainly the politics affect the business, and that’s what I focus on. The business treatment here is just incredible. There is no sizzle to me saying that; it’s just facts. It’s just what it is. It’s an awesome business environment, and I’ve championed it for a long time. You know the famous people who are moving here, and why they’re moving here.
Then, we have some fundamentals. When you look at a land appreciation chart in Dallas or in Texas, it goes up fast all the time. And that’s a really beautiful number. Let’s say you have a 2000- or 3000-square-foot home in California that sells for a million dollars. You’re likely going to spend 300, 400, maybe 500, or 700k on the same home in the right area of Texas. For the most part, you could replace that home for 400 or 500k, maybe less on a good day. And so, you have a lower basis cost. You have a lower price per foot, an easier cost of living, and all these other factors, like being in the central part of the US, rather than on a coastline. Cali money is just worth more here. When you invest in real estate here, instead of paying 360 dollars a foot, you’re going to pay 120 or 140, and some of this industrial property that we’re looking at in Dallas is 160 or so dollars a foot on average, and we’re finding deals at 80 or 90.
How does the rent compare? If you’re paying more, you’re getting more income.
We find that the cap rates are comparable, so your capitalization rate will be similar; additionally, the rents are strong. In Dallas, there’s a high demand, although it’s not going to be as high-dollar as California. And that is also a fact because of the market economies we have here. We are finding good returns and scenarios with IRR between 20% and 40%, or more, which is a mixture of the low basis and strong lease rates. This is just one example in Dallas, but those deals are available. You can find them in other states. I find good cap rates and good low basis deals all the time in other states. However, in some of those states, there’s not much going on, and it is scary. When I think about doing investment real estate in Wyoming, for instance, that scares me a little bit. There’s just not a whole lot of market action happening there.
That’s why the cap rates are compressed in markets with less risk.
It’s been happening for a long time. It certainly isn’t stopping. There’s going to be another segment one day with Cali money in Florida because that’s also happening. This is one of those areas where we have to be careful of trends. You call this warm because it’s been simmering for 30 or 40 years. This plan is to take this Cali money and put it in Texas. It has been working, and it continues to work.
Trent Herrera
trinity@blacktie-re.com
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