The Private Equity Real Estate Podcast – Show 10

Summary

On today’s episode we have Sean Sharko, a 14 year CRE broker with Marcus & Millichap based just outside of Chicago who has over 610 closed deals worth over 2 billion in his career so far. We are going to be discussing his perspective of CRE in the current environment and he also gives some valuable insight to investors who are seeking sponsors to place capital with.

If you would like to reach out to Sean, you can reach him here:

Sean Sharko of the Sharko|Weisenbeck Team
Marcus & Millichap
630-570-2238
www.swpropertyadvisors.com

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Announcer:
You’re listening to the Private Equity Real Estate Podcast, brought to you by First National Realty Partners, where investors learn from private equity experts and insiders. We share our own real-world experiences so you can know exactly what it takes to be highly successful at investing in passive commercial real-estate opportunities.

Nick Cucci:
Hey, everybody. Welcome to another episode of the Private Equity Real Estate Podcast, brought to you by First National Realty Partners. This is the ultimate resources for passive real-estate investors. I am your host, Nick Cucci, and on today’s show we have Sean Sharko, a senior vice president of investments at Marcus & Millichap and the founding partner of the Sharko|Weisenbeck team. For nearly two decades Sean has been a specialist in multi- and single-tenant net lease retail in medical investments. Since joining Marcus & Millichap Sean has closed over 600 transactions in over 31 states with a total value over $2 billion and received multiple sales recognition awards. We’re really excited to have you on the show, and welcome, Sean. How are you doing today?

Sean Sharko:
Good. Thanks for having me, Nick. Thanks for the kind words.

Nick Cucci:
Yeah. Absolutely. For the listeners who are meeting you for the first time, I’m wondering if you can give us a little bit of background into who you are and how you ended up where you are today.

Sean Sharko:
Sure. So I’m a Chicago native, grew up in Chicago. Actually I was a third-generation restaurateur. So part of me always thought I was going to go down that path and be in the food business, but real estate was always something I was interested in. Ended up joining Marcus & Millichap in the early 2000s and always focused on retail. That’s always been my thing. I was encouraged to go into multi-family early on in my career, and I already knew what I wanted, and that was to sell shopping centers and retail product.

Sean Sharko:
But where are we at today as it relates to my team and my business partner, Austin? We started working together in 2007 right before the crash. Fast forward, the crash happens, and we put our head down in 2010 and ’11 and kind of started doing what we’re doing today, and that’s just meeting people, getting out in the marketplace, forming relationships, and then using the premise that one plus one really equals three and building our team around that and the concept of persistence and consistence, just be out there very day, be talking to people, and time kind of cures a lot of problems in this business.

Nick Cucci:
It’s true that it does. I want to step back for a minute. I have a couple questions for you. You said you were a third-generation family of restaurateurs that you came from. I feel like that must have influenced your desire in commercial real estate in some way. Would you say that it did?

Sean Sharko:
It did. I jokingly tell my family now that, although we were in the food business all those years, my family always owned the real estate, and there were two businesses they were in. One was the food business and then the underlying real-estate business, and the underlying real-estate business actually is where the real money was made. It was always the exit strategy to the restaurants, so it was a … Yeah. I’ve always had exposure to real estate in some capacity throughout my life, but also the restaurant really gave me, probably more than anything else, a work ethic. That was a hard business. We did banquets as well as other things, so the hours were long and the weekends were even harder. So coming into this business where, sure, you have to work weekends, but nowhere like I was used to. It was actually like I was getting some time back.

Nick Cucci:
It’s funny. My first job was as a dishwasher in a kitchen and then a grill cook and then a kitchen manager. So I understand the restaurant world, and it absolutely does instill an incredible work ethic within you, without a doubt, and then … So that’s really interesting that you had exposure not only to the restaurant side, but then the underlying real-estate business, and you were attracted to that, and then you have mentioned that you and your partner, Austin … You got into this business in 2007 just before the crash. So you really had to dig your heels in and learn this business in a very trying time.

Sean Sharko:
So I started my career with Marcus & Millichap, which is the only firm I’ve been with for my professional real-estate career, in 2004, and Austin joined the firm in 2007, and that’s when we started working together. But in 2004 when I started, the business was happening and heating up all around me. So it was kind of like I was scrapping for what was left over, because the relationships were already formed, and then, yes, in 2008, ’09, and ’10 … That’s when we had to go really deep, work really hard on forming new relationships.

Nick Cucci:
Yeah. I’m sure, and now we find ourselves in COVID-19, and we’ve all been thrown this curve ball, and I’m wondering, from your perspective, if you can kind of tell us some of the trends that you’re seeing nationally and then locally in the Chicago area, what you’re starting to see from a commercial real-estate standpoint.

Sean Sharko:
Trends are evolving. Trends that were in place in March and April are kind of evolving to new things early summer to where we’re at today. The good things is it appears to be evolving positively. Early COVID, the trend was just defense, pure defense, talk to your tenants, make sure that … Work out your deals. Landlords were very focused on rent collections or getting a path to rent collections going forward. So then early summer it became more information sharing, “Hey. What did you do here? What did you do here? Are you feeling things are getting better?” and right now the trend is actually turning positive, more investors coming back to the marketplace.

Sean Sharko:
But throughout this also the idea of credit has been changing. For the last several years everybody’s been focused on recession-proof tenants. Now all of a sudden you hit COVID where … What was a recession-proof tenant? That was a face-to-face, consumer-retailer experience, and now you hit COVID and that’s exactly the opposite of what people have been chasing for the last couple years. So a sit-down restaurant, by example, is kind of a very cautious tenant marketplace where anything with a drive-through or very understandable credit is where all the activity is at right now.

Nick Cucci:
Absolutely. Yeah. That’s a really good call out that anything that we knew as that recession-proof tenant … The definition is now changed. I’m seeing investors turn and eye towards “Well, who’s essential? Who’s essential that’s going to be around, the grocery stores, the pharmacies, that we know are going to be there for years and years?”

Sean Sharko:
Yeah. Who stayed opened throughout this? Who stayed open? Who paid rent? Who asked for rent reductions when they didn’t need it? Who asked for rent reductions because they did need it, and who’s really going to be the winner and the loser throughout this? That’s the questions that everyone’s asking, and we’re still trying to figure that out, but it’s become clearer every day.

Nick Cucci:
Regarding Chicago specifically, the headlines in New York that you’re seeing every other day is “New York’s never going to be the same,” and it’s too soon to tell what’s going to happen in New York in the coming years, but there’s a lot of people that are exiting currently. What are you seeing in Chicago? Are you seeing any sort of exodus? Are you seeing a lot of people come to the areas?

Sean Sharko:
A little bit of exodus from the city. As you probably know, Chicago had also the civil unrest that happened, and between that and COVID there is a segment of the downtown market that is looking to gravitate to the suburbs. But overall I actually think our communities are pretty positive. We’re trying to open up things. School’s been a little tough. Some communities are open for school. Some are completely e-learning. But do I think that there’s … Is it ever going to be normal? I do. I think that actually the perception of the marketplace is that we’d like to get back to normal. We’re just going to be cautious in how we do it.

Nick Cucci:
Yeah, and we’ll see. I mean, with schools right now that’s definitely a big question mark as to how that’s going to play out in the coming months, and I’m sure that’s going to be very telling in the next three to six months as to how we end up moving forward.

Sean Sharko:
I think that’s going to be key to all of us. If that becomes successful in certain places … My kids happen to go to private school. They are in class. They’ve been in class for the past two days. They’re taking off tomorrow, and then Monday they’re full time, five days a week. So as long as those settings become successful, hopefully we as a community can build on that.

Nick Cucci:
Yeah, and I do agree with you. It’s going to be key. We’re going to take our learnings from that and apply them nationally, I’m sure. Now, how have you and your team pivoted during COVID? What have you had to change in your day-to-day approach?

Sean Sharko:
A little bit I mentioned earlier, taking cues for what we did in the Great Recession. Right out of the gate in March and April, the first thing we had to do was keep our current deals together. The really nice thing about … I won’t say nice, but it was a positive. Going into this the market was strong. So we had a great pipeline. Deals were in escrow. People were doing things, and so the key for us immediately was make sure those deals stay intact, and for the most part, I can only think of one deal that we had on our contract that didn’t close. That was under contract right before this all started, and then the second thing we did was we immediately turned to understandable credit. We went to our clients and customers that had Starbucks, McDonald’s, drug stores, and listed and brought that kind of product to market, which shored up our pipeline for a period of time, and all that product transacted. There is a lot of money that needed to get placed.

Sean Sharko:
So that was the best thing, and then from there and continuing on to today we’ve been really focused on just consulting with our clients. I said it earlier. Information sharing has been key. “How did you deal with this tenant, mister owner?” So you can kind of share that with the next owner and talk about best practices, and then on an individual basis kind of strategize as to where’s your property at, what I’ll call the middle of COVID or hopefully post-COVID here, what needs to change for you to be able to make some decisions, and what decisions do you want to make, buy, sell, refinance, so right now a lot of consulting.

Nick Cucci:
I think that’s huge because the communication sharing … When this first happened, what everybody does is they kind of clam up, like “What am I going to do?” and as soon as you start having those conversations, it eases the mind of owners to say “Okay. These people are going through this. This is how they’re handling it. I can deal with it this way,” and then there just starts to be … You start greasing the wheels and there just starts to be movement across all the different markets.

Sean Sharko:
As a landlord, I can imagine a lot of these guys feel isolated because they don’t … A lot of landlords don’t have peers to talk about the specific situations that they’re in. So to be able to share best practices again, what other landlords are doing for the same situation with the same tenant … It helps quite a bit.

Nick Cucci:
I imagine you work with a good amount of syndicators and owners, and I’m wondering … As you have deals going out there, what kind of separates the doers from the people who are just sort of window shopping, and how do you weed that out? How do you know a doer when you meet one?

Sean Sharko:
For starters they’re responsive. Doers actually engage. They talk about it, and there’s usually a tone in the voice or the tone of communication right from the beginning that tells you you’re dealing with somebody who’s sincere, and usually that tone starts with … They’re looking for some positives. They’re looking for reasons to do a deal. Obviously they’re going to be pragmatic in today’s world, and they’re going to be asking questions about who got deferments, who got abatements, and how health are the tenants. That’s natural. That’s due diligence, but looking for a way to overcome those things is very different than the other side where you just start getting beat up right out of the gate, “This is wrong with it. This is wrong with it. This is wrong with it.” You can quickly tell who is experienced. Or I shouldn’t say experienced, because that’s not really the right word. It’s really who’s acting positive.

Nick Cucci:
That makes really good sense actually, because it’s almost like the people who are coming at you with the “This is wrong and this is wrong” are almost talking themselves out of the deal as opposed to trying to find the way to make the deal work.

Sean Sharko:
Exactly so, and then there’s a handful of other qualifying questions that are pretty normal to ask. What was the last transaction you did? What was the last transaction you wrote on? Just asking people about their perception of the debt markets … I mean, if somebody comes to me today and says “Well, I’m going to put an 80 percent LTV loan on this multi-tenant shopping center with 80 percent of the tenants are mom-and-pop credit,” pretty quickly you know that they’re not in the market and haven’t really done their due diligence as to what’s available out there, and if they’re not willing to move off of that position, you have to move on. You just don’t have a good buyer.

Nick Cucci:
I got it. That’s great insight. So from an investor’s perspective, if we put our investor hat on real quick, what advice would you have for them as to what makes a great operator?

Sean Sharko:
What makes a great operator? You said a key word earlier that stuck out, and that’s communication. I think communication is key. I think transparency … That’s another thing that, both for a qualifier of a good investor, is … How transparent are you being? Everybody’s always going to find out the problem. It’s just a matter of when. If there’s an issue, it’s better to be up front, transparent. Talk about it, and then you can work through solutions. The other thing is I think in a good operator actually is involved in things right now. A good operator has things going on. They’re talking to the tenants across the board. They know what the tenants are doing, and they’re able to take one experience and move it over to another. Those are the traits and the things that I see that make a good operator.

Nick Cucci:
There’s a few qualifying questions that I think I can pull out of that info that you just gave us, but if I had to ask you two to three questions that you would want to ask a potential sponsor that you were considering investing with, what would be the top questions that you would ask them?

Sean Sharko:
Caught me off guard. Track record. I’d like to talk about the last couple deals that they did. That’s an easy one. Frankly, I’d like to talk to other investors that they’ve worked with. I’d like to talk with them about how they handled COVID, and especially today right now, and what did they do with their tenants. What I’d be looking for out of that part of the conversation would be did they partner with their tenants or did they bully their tenants, and I would gravitate towards an operator that partnered with their tenants rather than kind of put the hammer down on them when times were tough. Now, obviously that’s a reciprocal conversation with the tenant and the landlord. You have to have a tenant that’s willing to partner with the landlord as well, but that’d be part of the dialogue. What would be the third question I’d ask? How are you morphing in today’s world as well? What are you doing different today or looking at differently in investments than you did a year ago?

Nick Cucci:
I like all of those questions. Question number two really sticks with me because I think it shows the approach that your owner is going to have with the tenant to kind of show the sort of relationship that they’re after immediately. Is it going to be a relationship where they’re looking to bully somebody around, or they’re looking to partner? The people that are looking to partner are just going to have those longer-term, better relationships with all of their tenants, and in the final question that you would ask, what I really like about that … It reminded me of a question that our chief investment officer, Jared, mentioned a few weeks ago on one of our shows where he said, “I like to understand how the tenant is morphing in this economy. But also what are they doing so that in 10 to 15 years time they’re still going to be well ahead? What is it that they’re doing that is going to keep their business not only relevant, but really put it in demand in that 10 to 15 years?” because then you know that you can sign that 20-year lease and not have any concerns moving forward.

Sean Sharko:
I think that’s great. It’s funny. I was just talking earlier this morning about some of the innovation that’s starting to take place with tenants. Last night I was out to dinner. We dined outside, but it was a traditional sit-down restaurant, and it was a small, two-unit operator, but they had a lot of different innovative ways of going about seating, handling COVID, and I was pretty impressed. So I think a lot of innovation is going to come out of this and a lot of entrepreneurialism.

Nick Cucci:
You have to, right? Evolve or die. That’s what has to happen.

Sean Sharko:
Especially in retail.

Nick Cucci:
Yeah. Exactly. So creative deal-making is just a huge piece of the real-estate game, and I’m wondering … In the years that you’ve been doing deals and working with all of these owners and operators, what are some of the most creative deals that you’ve seen come together?

Sean Sharko:
Two things come to mind. One is actually … We have a book of business right now that we’ve been working on is … Back in the early 2000s CVS did a huge sale-leaseback program where the sales were in concert with self-amortizing debt with Wells Fargo. Fast forward 12, 15 years later. There was a lot of untapped equity stuck in these things and a lot of tax consequences for the self-amortizing debt, and now the cap rates though dropped. So if you can get rid of the debt and sell this on a cap-rate basis, there was a ton of equity in these things.

Sean Sharko:
So we’ve been doing these pretty complicated deals where we’re unwinding the debt through defeasance, selling them at market rate cap rates, allowing ownership to get that equity that’s stuck out and get a new owner, because there’s some underlying, unintended consequences when the lease was written with the debt that have to stay in the lease, like some free rent periods and such. So it’s pretty fun to be able to navigate through those, become an expert in those deals, and educate lenders and buyers alike, even sellers, just to educate them that they can do this and get to that equity. So those have been fun deals for us to work on right now.

Nick Cucci:
What sort of cap rate compression have you guys been able to take advantage of? What kind of drops have you seen or did they see?

Sean Sharko:
Those deals were sold kind of uniquely. Those deals were sold 10 to 12 percent over the debt when they were originated. So they weren’t really cap-rate driven. It was just a function of a certain amount of equity over the debt, but if you had to put a cap rate to it, they were selling at eight and a quarter, eight and a half cap. So today, fast forward and a lot of these have had rent bumps. You’re getting a six and a half cap, so maybe up to 200 basis points of spread. Plus it’s been under a self-amortizing loan, so a ton of pay down has occurred, and plus these guys have now had phantom income. So to get rid of the phantom income, get to the equity, it’s a pretty good thing for them.

Nick Cucci:
That’s impressive that you guys are able to make it happen, and then what was the second one that came to mind?

Sean Sharko:
Second one was a deal we had under contract right before COVID started, and we maintained through, and talk about … We had everything thrown at us. We had an environmental issue. We had a larger cell-phone tenant who merged and was going dark in that location. Then we had COVID hit, which took three tenants to non-paying, and we had to sort out who we thought was going to come back and not, and then the final straw was we actually had a dry cleaners, a very large dry-cleaning chain, on the end cap that was right next door to a barbecue restaurant, and the dry cleaners said the barbecue smoke was getting sucked in and scenting all the clothes. So we had everything thrown at us, and-

Nick Cucci:
That’s amazing.

Sean Sharko:
We had multiple creative solutions to get through it, but the underlying theme was we had a lender who was willing to get creative, we had a seller who was willing to get creative, and we had a buyer who was willing to get creative. So we had some hold backs. We had a little bit of price reduction. We had to have a round-table discussion on barbecue smoke and ventilation, but we worked through it because everybody wanted the same goal.

Nick Cucci:
That’s amazing. So dress shirts were smelling like barbecue for a little while. How did they ultimately navigate that?

Sean Sharko:
Again, we did a little bit of price reduction. For the tenants that were down because of COVID, we put up escrows kind of backstopping those tenants. Now, if they started paying and start paying the deferment, we put in mechanisms so the seller, the previous landlord, would get reimbursed any money that he became out of pocket during the downtime, and then we hired some ventilation experts to put a plan of action together to handle the barbecue smoke, build a bigger stack, and then work on some other mechanisms to help that happen. So it was interesting.

Nick Cucci:
You’re not kidding. You really did have everything thrown at you in that one.

Sean Sharko:
But it closed.

Nick Cucci:
There you go, and that’s what counts. You guys got it to the closing table. So in this new world that we’re in with COVID, and maybe thinking outside of COVID as well in the couple years down the line, is there any asset class in commercial real estate that you’re bullish on for the foreseeable future and why?

Sean Sharko:
I’m a retail guy. That’s where I put my money, and I still like retail as an investment. I’ll say that’s morphing as we all know. I tend to gravitate personally towards medtail, retail locations that are starting to get the medical type tenants, whether an eye doctor, a dentist, suites that have good amount of infrastructure put in by the tenants, but they want that retail visibility. I think, long term … I know dentists really suffered in early COVID, by example, but everybody needs their teeth cleaned. Everybody [crosstalk 00:22:58] cavity. So they’re recovering. They’re coming back. So those are going to be, to me, the long-term survivors. So again, I still like retail. I do like it to have that medical component, and if I’m really specific, I actually really like retail centers that are built just pre-recession, because you can usually buy them below replacement cost today, great locations, still built to all the modern specs that a shopping center would be built today, but usually you have rents that are 20 percent below a brand-new construction asset.

Nick Cucci:
That’s very nice. Now, before we close it up and I ask you three quick questions, are there any final thoughts for investors who are investing in commercial real estate? Any words of wisdom to leave them with?

Sean Sharko:
I think look long term. I think that actually sometimes people get focused on looking for this big, huge, magical opportunity where there’s an immediate pop or big add value, but I think, if you just find something that’s fundamental to your beliefs and you understand it, and then if you use things like today’s cap rates versus today’s interest rates … The debt markets are still here, which is very different than the last downturn, so when you can get … I just did this with a client. He’s buying an acap. He’s getting debt in the mid threes. He’s going to have a 14-plus cash-on-cash. I mean, to me that is a great opportunity.

Nick Cucci:
Wow. Yeah, it is.

Sean Sharko:
So I think just invest in what you believe in, but don’t be looking for the big, huge home runs. Singles and doubles are great right now.

Nick Cucci:
Yep. I think that’s extremely sound advice. So we close every podcast by asking three quick questions. So I’m going to hit you with them real quick. What was your first real job?

Sean Sharko:
Bus boy.

Nick Cucci:
Nice, and was this in your family’s spot?

Sean Sharko:
Yep. I was nine years old. December 6th, 1985.

Nick Cucci:
Nice. What’s your favorite food?

Sean Sharko:
Pasta.

Nick Cucci:
Any specific type?

Sean Sharko:
I love me some tortellini.

Nick Cucci:
There you go. If you could travel anywhere in the world tomorrow, where would you go?

Sean Sharko:
Spain.

Nick Cucci:
Any specific area in Spain?

Sean Sharko:
Southern Spain. I spent two weeks there with my sister right when I got out of college, and just a beautiful place.

Nick Cucci:
Very cool. I hope you get back there sometime soon. Well, there we go. Sean, thanks so much for taking the time and joining us on the show today. We hope you continue to see so much success.

Sean Sharko:
Well, thank you for having me. I appreciate the conversation.

Nick Cucci:
Without a doubt, and hey, thanks to everyone for listening to the Private Equity Real Estate Podcast. If you like what you’re hearing, please leave a review, subscribe, and share the show. If there’s anything you want to hear us discuss, please reach out and let us know. The show is brought to you by First National Realty Partners, one of the top syndicates of private, institutional quality commercial real estate in the country. If you’re interested in learning more about FNRP or would like to access our private offerings, please click the link in the shows notes or visit fnrpusa.com. Remember that this show is for educational purposes only and should not be considered a solicitation to purchase securities or be construed as tax, legal, investment, or accounting advice. Thanks for listening, everyone. We’ll see you next week.

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