What are the pros and cons of office, retail, and industrial spaces? What are the roles of commercial real estate agents? What is the strategic approach to understanding and investing in office properties? Trinity (Trent) Herrera, Commercial Director and Real Estate Consultant at Black Tie Real Estate, shares his knowledge.
What are the pros and cons of the office, retail, and industrial assets?
The pros and cons of the office
Professionals need an office, so it’s a staple in downtown areas. A stabilized office can fetch a premium. Some of the most expensive and impressive buildings in the world are office buildings. The cons are that we have a lot of office vacancies, and we have more work-from-home opportunities post-COVID, which completely turned the office upside down in some cities, counties, and towns. We have many cities with a lot of impending office vacancies. However, as another pro, I’m hearing about a lot of discussion about multifamily conversions and turning these office buildings into high-quality multifamily units, which also serve a need. The singular scariest thing about offices as products is being left responsible for the building. If it’s 30% vacant or more, that’s the single most frightening thing.
That is the risk-reward. I believe that in the offices in San Francisco, it’s already picking up. Can you hold on to the expenses? Can you buy all cash and hold on for a couple of years? The reward could be significant.
I agree. Recently, we had a record low price in Fort Worth for a high-rise downtown. When the developer finishes their plan, it’s going to be amazing. This is around a 40-story building. It’s going to be some of the most impressive multi-family buildings the city’s ever seen. What was cool is that when they bought the property, there was not much exciting news. A year later, we’re having a huge college expansion just down the street. There will be thousands of students living there. It’s like a four-building project.
There is a huge pro to all that con. That’s the crux of the balance that we walk, the tightrope that we’re on all the time, that it’s going to be an incredible return. I wish I could be privy to their underwriting so that I could see how that project is going to skyrocket.
The pros and cons of retail
The cons we’re talking about here are the opportunities. What scares us are often the opportunities. While the scariest part of an office could be holding the bag, paying the property taxes on a building that’s assessed for what it’s worth is a little frightening. But when you lease it, when you hold and plan correctly, you have a good team, and you have it for 10 cents on the dollar because it’s been vacant, it’s a whole different story.
If you want to be extremely safe, you’ll put your money in a savings account. If you want a slightly higher risk, you put in a retail triple-net tenant that will give you the mailbox money, but it’s at 5%. It goes for everything.
I love retail. Everyone loves to buy things. This is America. Pricing on retail centers, especially with some vacancy or an owner who’s over their head but has a good property, can be amazing. They’re easy to add value to. If you’re leasing and you’re underwriting correctly, they’re straightforward. You throw a retail tenant in there who has good credit, they do a good job selling their products, and they pay their rent. Now, the con is that Amazon has scared everybody in the retail space, and while I love shopping, I’m doing more Amazon shopping than ever. And it’s true, I hit a lot of local retail, but I work in commercial real estate. I want to work with my local people. I care about that, but I don’t think retail will ever die. We just love to spend money; the marketplace has always been around. This is a human staple. Humans need to sell things.
That is a tough one for me, because I don’t have kids. But I do think anyone wanting to invest in retail should be talking to teenagers because they are not hanging out in person as much. They prefer to text. My uncle has a university in Brazil, and when a student had a problem, he said, “Okay, come to the office. Let’s have a conversation.” The student told him, “I prefer via text.” So, I encourage people to talk to the younger kids because I’m shopping for shoes online nowadays; the alternative to retail is more of an experience. Are you going to be out there experiencing it? That’s the question that they can answer better than we can.
And it’s a fair question. You’re showing me your appetite here, and it’s not retail, and that’s okay. Each one of us has a different appetite, and this is what we’re talking about. I would go in on retail spaces, but many retail businesses fail. These are facts. You can have a great retail center, but maybe the shoes are being bought online now.
The pros and cons of industrial
The biggest pro for me is that there has been a recent focus on the domestic industry. We have a lot of local infrastructure being built around US-based industries, such as manufacturing, warehousing, new Amazon distribution, data centers, and OpenAI Stargate. A lot of money is being invested in it. There is this sentiment that each country should be able to manufacture its products, and I think we’re sensing that now. Hopefully, we continue to see this trend.
Americans love buying things. The same reason that retail works is why the industrial works. So much industry is built around shipping products, getting them from A to B, warehousing for Amazon, etc. Even if people stop going to the retail store, Amazon is always going to need warehouses. There will be many companies providing other forms of distribution and accessory services to Amazon. As long as Americans love buying stuff online or in person, the industry will likely remain strong.
And then there’s opportunity. There are a lot of small towns, especially here in Texas, that have 100 to 300,000 people, where you can buy quality industrial for 30 dollars a foot. If you can tolerate a hold and lease it up in a year or two, those deals can be had all day, and there are lots of more stabilized national credit tenant deals to be had. There are all sorts of things that can be found with a propensity for appreciation.
The industrial cons are a shorter list than I have for other product types. You could have an environmental contamination that you don’t know about that compromises your whole plan. And market conditions can severely affect tenants in the industrial world. A tariff, for instance, could be very intimidating for an industrial tenant, and I’m working with some now who are scared by them. Another good example is oil. The price of oil changes in Houston, too much, and might get frightening. These are cons that are found everywhere, but that’s my take on each asset type. And I didn’t cover multi-family because that’s not a focus of mine, particularly. In general, there’s merit to each; you can make a 20, 30, or 40% IRR in each of those deals. The path to how you get there matters: the sponsor, their ability and experience, your goals, and whether or not you want to proudly own that retail center that you will not go to buy shoes at.
What should your commercial real estate agent or broker do for you as a buyer?
There’s a responsibility level, a professional level, and a performance level that each person practicing as a commercial agent or commercial real estate professional should achieve.
- They need to understand the real estate market in which you’re working. You can look at deals throughout the nation, and those could be viable. It gets a little tricky because as your sophistication level and adventurous spirit go up, being willing to go into other states, you’re going to have other requirements of your representative.
- Your agent should bring value to each deal with expert knowledge, opinions, and advice on real estate. They should be doing the same thing on the math and helping me by explaining it.
- Creative ideas are so important in commercial real estate, but they are so easy to get away from you. You talk to some people in the commercial real estate world, and they’re the most creative people ever. However, they’re going to get carried away with the creativity of their ideas. It’s not reality. There’s this balance between creative and practical that’s hard to strike.
- They should be a resource for underwriting to help you plan market intelligence.
- They should not have any scent of sizzle or commission breath on them. There’s a difference between excitement and sizzle. It’s hard to quantify, but you don’t want to feel like they’re selling you something every time you talk to them. You have to have a genuine relationship.
- They should give you advice, but they should also keep their fiduciary duty to you and protect you and your decision-making. I have come to see myself as an accessory, similar to the relationship you have with your council, advisor, consultant, or CPA. It’s someone that you come to rely on, someone who has a high ethical standard. I’m not practicing law, but I’m practicing my real estate with the same moral integrity, ethical integrity, loyalty, and fiduciary respect that a lawyer would. If your agent isn’t doing that, that’s a problem. Just because of the nature of the relationship, your CPA, your lawyer, and your real estate agent have a fiduciary duty to you.
The most common person to be dropping the ball in that equation is the real estate agent. Your council and your CPA are probably doing you right. That’s important. You should trust someone’s judgment. You should feel confident that they have your best interests in mind and are working in your favor, not to earn a commission.
What should you do?
Each person who’s investing is going to do it differently. At the base level, understand real estate and continue to try to understand it as an owner and through your agent’s eyes. Make sure you are working with one you trust, one who trusts you too, and is loyal to you, and looks out for you. You see it through their eyes or the syndicator. Then, if you’re doing deals on your own, you’re working with a lender, and you’re starting to look at deals through their eyes. Their underwriting teams are going to have words for you especially on your first deal of what you forgot to underwrite for like market vacancy and cash reserves, things like that are pretty easy to miss, but as you get more and more sophisticated, you should be learning more, applying it and generally just trying to understand it more. The wealthiest people I know have a learner’s mindset, and they’re some of the most humble and willing to learn people that I’ve ever worked with in business.
The math part is not fun for some of us, but understanding it over time is better than struggling when you need to understand it. We’re all working on building our wealth and managing our finances. If you end up in a situation where you’re already committed to a deal, and you find that you need to understand the real estate math, you’re going to have a hard time. It’s doable. You can call someone like me or you for advice. Sticking to your investment plan and using discipline based on those two first foundations is such a simple thing that some of us can vary from. Only look at stuff you want to buy, only underwrite things that make sense to underwrite, only commit to projects that you underwrite and understand, and make a good workflow with your team. That simple principle of being disciplined to “This is the plan. This is how we’re executing it, and this is how I’m going to make money” works if you stick to it. The best money managers and wealth builders I know work for that every day. Only commit to deals that you understand and that you can commit to, and only gamble with money that you can afford to lose. If a real estate investor did those things, along with getting to know your syndication team, I think that’s all it takes.
The first investment that you make in real estate is not always your last, but it could be the last investment you ever make. The entry you make into investing is really important. Having a trusted team, money managers, and sponsors is important, especially if this is your first time placing private equity or buying a deal.
In equity, you have to have done your deals first with your own money before taking investors’ money.
Fear in real estate
There is always fear in real estate. The reason we have this feeling of fear is because it’s appropriate. It’s a scary thing. It’s the most important decision many of us make, and the biggest dollar amount we sometimes spend. Then, we talked about the absolute chaos that is the market cycle constantly orbiting around us. Like this three-body problem, a market that can never be calculated, and we’re playing in it. It’s appropriate for us to feel fear. But you have to ask, “How am I going to proceed? I can’t just feel fear. How am I going forward? Am I done?” We have the market, the policy, the administration, the geopolitical health, and everything else going on, but what isn’t changing is the math. Math stays the same. Math is cold. IRR is IRR today and tomorrow, whether the market is good or bad.
If you’re making real estate investments based on feeling, you’re doing it wrong. That includes fear, happiness, and delight. Instead, base decisions on the math, your goals, your risk tolerances, and the reason you feel those things when your brain is telling you that something’s wrong. Let’s fix it. Let’s figure out what gives us heartburn and understand why our brain is making us feel fear. Is it legitimate? Did my appraisal just fall through? Did it come through a million dollars less than I needed, and now I cannot do this deal? That’s a legitimate fear, and your team of advisors will help you see that. You’re probably going to have to kill that deal or negotiate a price or pivot, and your team can help you in that moment when you feel fear. Or maybe the fear is not legitimate. Maybe we run the math 10 times, and all of our friends look at the deal, and we still feel a little bit. But maybe just because we’re new. We walk away when the fear is legitimate. It’s also true that sometimes you can only make money when other people feel fear. But when you feel fear, take a pause, work through it, and if it’s legitimate, walk away.
Try not to make decisions based on emotions because greed is also an emotion. Delight in a deal or being extremely happy and satisfied are also emotions. There’s just this huge gamut of emotions that we could find ourselves feeling. I focus on math when it comes to real estate, and then when the math works and everything looks good, I’m happy.
Exiting a deal
When you exit a deal, it’s something we don’t talk about all the time, but that’s really where you’re capturing all the value that you’ve put in for so long. It could be years of dozens of people working on a deal, positioning, and negotiating. It’s really important to exit properly. If it’s a deal that you’re an LP in or in a junior position, that’s probably going to be a pretty simple exit. Work with your sponsor team. Typically, your sponsor will determine the terms of an exit. Sometimes, they’ll ask you for input. If they do, give it. You should understand the deal enough to give your input if they ask. Otherwise, just go with them if they control the deal. If you’re working on a private deal, you need to know when your plan is to exit, and you have to strategize it.
Do you prefer to buy and hold or flip deals?
It depends. I am in a different place than some investors. I’m an opportunistic guy. My philosophy is to work with what’s there. In some cases, there’s a really good opportunity. But if I’ve got a 10-year lease in place, and my IRR is going to be strong, if I hold for 10 years and it’s appreciating, maybe I’ll hold it. But if I’m having issues, or if I’m scared, if I’m feeling fear, and then I’ve thought through it, and it’s legitimate, I might exit that property.
In general, you’re more of a “buy and hold”?
It depends. I’d let the math tell me because there are some deals where you’re calculating IRR and refinancing, etc., and based on deal mechanics, you know your timing. You’re constrained to it if you want your IRR; you work for it. However, other deals are simpler, that maybe I enjoy the mailbox money, maybe it’s a high lease rate on this deal, and maybe I like getting that cash every month. I could go either way on an asset.
The only thing I wanted to add on the fear side is my observation on how people go with the flow so much. If the economy is great, they’re all throwing money at multi-family deals, at three-and-a-half cap rates. Or, in the last two weeks that the stocks were down, people were so scared. I’m thinking, “That’s temporary. It’s time to buy stocks.”
Yeah, I bought a bunch of stocks. They were on a discount.
The top people see through that; they know these are cycles. I cannot comprehend how intelligent investors can sometimes go with the flow. It just blows my mind how people forget that these are all cycles. If it’s down, it’s a great time to buy, like in 2008. As Warren Buffett said, “I am buying America.”
Is there anything else that you think is important for our audience to know that we haven’t covered yet?
I tend to think of things as groups. I think there are groups like the ones you and I are in: the people we know, the friends we have, and the deals we’re in. Those people are not feeling fear; in fact, everyone I know right now is pretty amped on the current market. There are many people who are off by themselves, reading a lot of information online and researching by themselves. They all see the same articles, and that leads them to the same place. But I feel for those people. If I could have 10, 15, or 20 minutes with those people, it would be productive because there’s so much bad advice out there.
Also, regardless of how you feel about the media, I love the media and I hate the media, and then everywhere in between. But we are going to feel some way based on what we’re seeing in the media. And notice I didn’t say the media is making us feel this way because I don’t think the media makes us feel any way. I think we feel a certain way because of what we see that’s within our control. And if everyone that I talked to educated themselves the way I’ve talked about, there’d be a lot less fear in real estate and a lot more math. We’d all be sitting around talking about our spreadsheet data and the IRR data that we’re examining. That is the world that I would like to live in, and that’s the world I do live in my day-to-day.
Trent Herrera
trinity@blacktie-re.com