The Private Equity Real Estate Podcast – Show 17
Summary
On this week’s episode, we have Dr. Eric Tait, the founder and fund manager of Vernonville Asset Management, also the president of the Pinnacle Physician Management Organization, and a practicing physician in internal medicine with a private practice in Houston, Texas.
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Speaker 1:
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 know exactly what it takes to be highly successful at investing in passive commercial real estate opportunities.
Eric Murphy:
Hello and welcome to the Private Equity Real Estate podcast, which is brought to you by First National Realty Partners. I’m your host, Eric Murphy and on this program, every week we’re going to sit down with some experts in the real estate field and we’re going to talk about different topics across the real estate landscape. And this week, we’re going to talk about the basics of net lease investing and to shed some light on that subject is my guest this week. He is the founder and fund manager of Vernonville Asset Management, also the president of the Pinnacle Physician Management Organization, and a practicing physician in internal medicine with a private practice in Houston, Texas, and amazingly, even with all of that on his plate, he has still found the time to join us this morning. So he is Dr. Eric Tait. Thank you so much for being on the program today.
Dr. Eric Tait:
Hey, thank you. Thank you so much, Eric. I appreciate you having me on.
Eric Murphy:
So you have a background in medicine. What made you decide that you wanted to get into real estate and then ultimately create Vernonville Asset Management?
Dr. Eric Tait:
Well, it’s interesting. So I actually did a dual degree program. So I went to medical school and business school at the same time and so I always had entrepreneurial interests, but also wanted to be a physician. So for me, it’s always been a dual track. And once I was in business school, I was a biology major in college. I went to Morehouse College in Atlanta and came to Houston, went to Baylor College of Medicine and then Rice University for business school at the same time. And I realized in business school very quickly that I didn’t kind of want to have money in the stock market. As you like to say, once you understand how the sausage is made, you might stop eating it. And so at that point, it was just a matter of me trying to figure out where I was going to put my own money. And for me, that ended up being real estate from the beginning. And so I’ve pretty much invested in real estate since I left medical school and residency and have gone from kind of single family. And now we’re kind of settled out at kind of the larger triple net projects that we do now.
Eric Murphy:
And what kind of informed your decision not to go into the stock market and instead pursue investments in real estate?
Dr. Eric Tait:
Yeah. A lot of it is and I’m going to try to keep it not super kind of esoterica, it’s really, how do you determine value? People in our country are enamored of price, so they love price movements. Is the market up? Is the market down? But people don’t understand that price and value are not the same thing and that in our world and kind of if you look at Warren Buffet, value is determined by cash flows. And so if you have an asset that generates cash flows, you can determine its value. And the great thing about real estate, it’s a very easy process to do that. And what I mean by that is there’s really only two variables you’re solving for in real estate. And one of them is a personal preference variable and that’s kind of the return that you want to get at least on the cashflow side.
Dr. Eric Tait:
And so everything else is relatively fixed. If you talk about rents, if you talk about mortgages, if you talk about taxes and insurance, all of those end up being plugged numbers for whatever market you happen to be in, but the thing that is not fixed is the price that you’re going to pay for that asset. And so the higher the price that you pay, inversely, the lower the return you’re going to get at least from a cashflow standpoint. And so with understanding that there are only two variables to really deal with, that made investing very easy in my mind in terms of being able to ultimately understand what is the intrinsic value of an asset, not just in the sticks and bricks that go into building it, but also in the cash that it generates and the return that I’m expected to get and then eventually it boiled down to the return we’re able to give to our investors. And so real estate was very easy to whittle down to understand the input variables onto how you were going to make money. There wasn’t a lot of like guessing and other people controlling that process necessarily.
Eric Murphy:
Yeah, that makes sense. Well, let’s get into the main topic that I wanted to discuss today, net lease properties. So let’s start maybe for those who don’t know what is a net lease property and how does that differ from a gross lease property?
Dr. Eric Tait:
Net lease essentially, you’re breaking out… let’s just say triples. Let’s go for the triple net standpoint. The components that you as a landlord are responsible for are minimized. And what I mean by that is the taxes are getting passed through to your tenants. The insurance is getting passed through to your tenant as well as kind of the maintenance is getting passed through to your tenants. So what you’re paying for essentially is the box. And so you’re taking care of the roof. You’re taking care of the exterior. You’re taking care of on an ongoing basis, the parking lot. Everything else that the tenant is using to run their business and triple net is mostly in business commercial aspects of real estate. So you don’t triple net a single family home or an apartment complex. All of those costs are passed through to your tenant.
Dr. Eric Tait:
And so you as an owner of an asset are responsible, as I said, roof, exterior, parking lots. And there’s some variability in there. Whereas in gross leases, you as the landlord are responsible for much more of that. So the tenant is just coming in and paying you and you’re responsible for pretty much everything else. And so an apartment complex is a way to think about a gross lease if you’re making akin to other things in real estate. Same thing if you own a single family home or a condo. Chances are you’re not passing through water and insurance and those kinds of things. You’re just charging enough on the rental side to cover all of those expenses and put a profit into your pocket when all is said and done.
Eric Murphy:
So we have single, double, and triple net lease. Can you kind of break down the three and tell us the differences between them?
Dr. Eric Tait:
So I only do triple net, but essentially each end is one of those components. So insurance, taxes, and then maintenance. And so one end is one of those two ends, two of those three ends are all three of those. And so we specifically look for triple net. You just have to make sure which net you’re covering. On one of those ends that they say, “It’s oh, single net tenant lease.” Just look at your contract to figure out which of those ends you’re ultimately going to be responsible for because I’m not a broker, I’m an investor. So ultimately, I have to always go back and look at the specific contracts because in different jurisdictions, different places cover different things of those ends, but one end is going to be one of those things, two ends is going to be two, triple net is going to be all three of the taxes, insurance and maintenance.
Eric Murphy:
Okay. What would you say are the biggest advantages to net lease properties and then adversely, what are the biggest challenges that investor might face with them and how would you mitigate some of the risks that are involved?
Dr. Eric Tait:
Yeah, so on the pro side of it, it is probably one of the most passive ways to invest in real estate where you’re an actual owner because essentially what you’re taking care of is making sure the outside of the property is swept and clean. So it’s very, very low management intensity from that standpoint. Also, you may be on the hook for when new tenants are moving in, providing them some money to fix the interiors on the front end, so that’s called tenant improvements. You’re not responsible for the ongoing maintenance internally of that. So that’s a cost that you have to also factor in when putting together these types of projects is that a good tenant may require some upfront capital. I would recommend that the tenant spend the money and then you reimburse them and then you get bills from that. You don’t front the money from that standpoint necessarily, or you’re going to hire the person to do it so that you’re giving the money directly to the contractor to make sure it gets done properly in a way.
Dr. Eric Tait:
Either way, what you don’t want to do is give the money to the tenant before any work is completed, just kind of FYI for people out there from that standpoint. The other pro is… We’re in Texas. We have a lot of property in Texas. Right now on the property tax side in Texas, it’s going up relatively high and Texas is known to have a relatively high property tax jurisdiction because we don’t have a state income tax. So right now, if you’re in multi-family apartments or single family homes, those costs are being born by you and you have to decide whether or not you can raise rents to compensate for that, but you can’t raise your rents in the middle of a lease, so you have to wait till the end to figure out if you can do that, whereas this stuff is ultimately going to get passed through. And depending on your relationship with your tenants, you might decide one year because of something with COVID, you may decide that you’re not going to pass all of that through to a tenant, even though you can, just to give them a break, but ultimately contractually, you can pass it through. You’re not breaking the contract by doing this. So that’s all on the pro side.
Dr. Eric Tait:
On the con side of net leasing, you’re usually dealing with commercial tenants. And so it’s not somebody’s roof. It’s not a place that they have to live in. And so they may be more likely to break that lease because ultimately in the end, if their business goes belly up, the cost to relate is higher than it is for apartments or single family homes or things of that nature. Also, you can go for longer with vacancy because you’re out there looking for commercial tenants that have decent prospects, so you have to have a little bit of understanding of the businesses that are going in as opposed to you just providing a place for somebody to live and realizing if they have a job or not, or if they have section eight housing or not or government funding or not. So there’s a little bit higher level of sophistication that you have to understand and look through your potential tenant to understand who they market to and is that a growing or a shrinking market from that standpoint. Also, to dig down a little bit deeper as it relates to the cost of retenanting, I talked about the tenant improvement dollars. So you have to have a reserve account for those tenant improvement dollars to help people build out whatever it is their business needs for your box space.
Dr. Eric Tait:
And then lastly, if you’re a tenant is having problems and they’re not paying their, what I call CAM, your common area maintenance charges, which is the maintenance we talked about, their own insurance and things of that nature, you may not have visibility into what’s happening. And so you may have an exposure that you’re not realizing and that is accruing on you, meaning you’re going to have to end up paying the taxes, you’re going to have to end up paying maintenance because they’re having problems in their business and they’re not able to give that to you in terms of the rental charges. And so you have some exposure on the business side that you don’t on kind of the residential side from a triple net standpoint.
Eric Murphy:
Mm-hmm (affirmative). So the way you evaluate a net lease property does that differ from say how you might with a gross lease property?
Dr. Eric Tait:
No, not net and gross. It would really be more residential versus commercial. We shy away from gross lease property. I mean, the industry is moving away from gross lease properties. Just in general, older buildings tend to have gross leases, but newer construction, newer buildings, A and B class, those are almost all going to be triple net if you’re talking about… because gross really in my experience, and again, I don’t own office. Most of what we own are light industrial and retail, but I’ve seen a lot of gross leases in office buildings are more towards single nets in office buildings and we’ve just shied away from that standpoint. The reason why we’re in commercial is to offload a lot of that stuff because if we wanted to deal with gross leases, we would just own apartments and own residential things from that standpoint.
Dr. Eric Tait:
And so I wouldn’t make the comparison between gross versus kind of triple nuts because the industry is moving away from gross leases, so you’re going to see less and less of them over time. And if you can convert from gross to triple net if you’re taking over a property, that is a way to potentially increase the value. You just have to be careful to make sure that the other similar property that someone else would be looking at isn’t gross and you’re putting yourself at a disadvantage because you’re end up charging them more rent when it’s all said and done.
Eric Murphy:
In regards to the triple net lease, is it fair to say that it’s more important when it comes to like selecting and screening a potential tenant? And if so, what are you looking for? What kind of traits are you looking for in a tenant?
Dr. Eric Tait:
Well, absolutely. And the good thing about this on the triple net side is depending on what asset class you’re playing in, A, B or C. If you’re in the A and B classes, you got a leasing broker who essentially is out in the marketplace looking for businesses and they’re coming through and the brokers oftentimes are doing some amount of screening or they’re bringing in national credit tenants or regional credit tenants that have multiple locations already. And so it’s a higher level of kind of I would say professionalism and due diligence. Now, if a mom and pop business is just opening up, then yes, you have to understand kind of what their credit worthiness is, you’re going to get a deposit, you may look and ask for tax returns and things of that nature. So you’re going to do a little bit more due diligence through the business to understand kind of how that business ultimately runs, but you’re not the only one who’s doing that because like I said, leasing brokers are going to be bringing you tenants and they’re going to have a package on that tenant that shows you kind of their history and things of that nature.
Eric Murphy:
Well, you had mentioned that there’s this trend towards net lease properties. And I read that commercial real estate properties that are net lease are a bigger share in the US than they have ever been before. Why do you think that is the case?
Dr. Eric Tait:
Contrary to popular belief and people don’t realize this, and again, we’ll see kind of post COVID, but right before COVID hit, the number of retail outlets every year was growing. We’re still an expanding population. We’re still an expanding country. We’re one of the few Western countries that has still relatively a positive birth rate. And so, as I say, demographics are destiny. Ultimately, if you look at kind of especially in the Sunbelt region through Southern Virginia, through Arizona, that’s where the population is moving. And so these are all newer cities that are being built out. You look at the suburbs, those are all being built out and people tend to shop where they live. And so if you have new kind of homes going up somewhere, you’re going to ultimately have new retails going up to satisfy the market for those people, even though there is an Amazon effect, even though there is an effect of home delivery. That’s one of the reasons why we’re in light industrial because that last mile fulfillment is going to be growing and that’s a triple net commercial type property. It’s for business. It may not be a retail triple net, but it’s still a triple net type property.
Dr. Eric Tait:
And so as our shopping habits move, the need for fulfillment space, warehouse space and to get people kind of last mile delivery is growing. But even beyond that, just our natural population is growing. And so even the delivery services like Amazon and those places are creating more fulfillment centers, they are creating actual storefronts. And so, consumer buying habits, there are still certain things that people want to touch and feel, there are still certain levels of services that still require you to leave your house, getting a haircut, getting your tires changed, those kinds of basic things all are still going to be there even post COVID.
Eric Murphy:
Yeah. You mentioned COVID. How do you think the pandemic affects net lease properties? Do you think that there’s going to be an even more heightened interest in them going forward?
Dr. Eric Tait:
Yeah. So on the commercial side, you’re going to have to be careful. We’ve been lucky in that we were in B class retail triple net, which has held up very well. We found that those that are Amazon resistant tend to be COVID resistant as well. And again, we’re in Texas. We have a little bit more of a, I would say laissez-faire attitude when it comes to the pandemic, so we’ve been open a little bit more than other states maybe and so that may have played into that, people’s ability to still shop some, but definitely right now, the hottest sector is industrial properties and those are all triple net and it’s a sector that has done very well through the pandemic and was doing well before the pandemic and will do well after the pandemic. Because again, as we do more and more direct to consumer products where it’s coming to your home, there’s going to be more and more places from a fulfillment standpoint that because we’re a big importer of our goods and services, those finished goods and services have to sit somewhere before they’re delivered. That’s just kind of the nature of things. And so that’s why industrial properties are very high on people’s radar and institutional investors’ radar screens.
Eric Murphy:
And what about with the 1031 exchange? Is that a good option with the triple net property?
Dr. Eric Tait:
Yeah. Actually, they’re probably one of the best options and one of the more popular options for 1031 exchanges, again because they tend to be less management intensive and you can hire a professional management company to run them for you. Oftentimes, investors go through a continuum. They’ll go from… we’re talking about individual investors, let’s just say. I’m not talking about institutions right now, but we’re talking about individual investors. You’ll go from kind of single unit, single family condos to multi-family apartments and then you ultimately end up where all professionals end up, which is in commercial real estate. And so as you’re rolling your money and your equity, you tend to roll it to less management intensive things as you get older and as you move up the continuum, I would say, and so money ending from a 1031 into a triple net is a very common occurrence and as people become more sophisticated, that’s oftentimes what they look for when they are engaging in a 1031 exchange.
Eric Murphy:
Before I let you go, if there’s someone listening to this, and they’re thinking about investing in a net lease, and maybe even more specifically, a triple net lease since that’s what’s what you mainly deal with, why would you recommend it to them?
Dr. Eric Tait:
Ultimately, first we’re always going to start with, you want to get with an expert team. I mean, you can always go onto LoopNet or something like that and try to buy your own triple net, but you’ve got to have experienced people kind of guiding you through the process because I like to say the triple nets are where big boys and big girls go to invest in real estate. And so this is where the professionals land, and yes, you can buy a neighborhood strip center and try to make it into a triple net, but if you don’t understand kind of the dynamics and variables of kind of what national franchise tenants are looking for in terms of kind of the income of the surrounding areas and kind of what else is around that, and kind of what are the foot traffic patterns and things of that nature, things are easy to buy, but the money’s made in management.
Dr. Eric Tait:
And so if you’re not with a team or with a group that is already doing this, or you haven’t kind of been mentored through it, or you don’t have deep pockets and are willing to kind of learn on your own dime and make mistakes and try to figure it out, you can get hurt in triple nets, just like you can get hurt in anything else. And the problem is because you’re dealing with commercial clientele, they don’t have to lease. Someone has to have a roof over their head. Someone doesn’t have to have a business. And so the availability of tenants and your understanding of where to go and find them and to find good ones and what constitutes a good one, if you’ve not been trained in that, I would caution you in jumping into this without some amount of experience or some amount of guidance in the process, unless you’re going to have like very deep pockets and willing to pay your way through the experience curve from that standpoint.
Dr. Eric Tait:
And so, while I’m a big proponent of it, I am not a big proponent of people just trying to jump out there and do it on their own necessarily from that standpoint. Get with a team, get with a group that has done this successfully, that is sending checks out to investors from that standpoint and you’ll have a much better time and a much better experience from a triple net standpoint in my experience. And we tell our investors that all the time, who try to jump out there and do it on their own and like realize, “Oh, crap.” It’s easier to do it with the team because teams usually are able to get bigger projects and bigger projects tend to have less risk.
Eric Murphy:
Dr. Eric Tait, thank you for being on the podcast today. You actually have a podcast of your own. Do you want to tell us about that?
Dr. Eric Tait:
Yeah. I mean, again, I’m a physician. I still see patients one day a week at least pre COVID I was, now it’s all virtual. And so I have a podcast called The Physicians Road podcast. It’s geared towards medical professionals, but there’s only one topic that we talk about that’s specific to physicians and that’s kind of around their practice. The other topics we talk about are purely for busy professionals and are applicable to almost anyone from that standpoint. And so you can find it on Apple iTunes, Google Play, or you just go to thephysiciansroad.com and we have it on there as well.
Eric Murphy:
We’ll be sure to check it out. Thank you very much Dr. Tait for joining us.
Dr. Eric Tait:
Thank you for having me appreciate it.
Eric Murphy:
My thanks again to our guest, Dr. Eric Tait, and thank you for listening to the Private Equity Real Estate podcast, which is brought to you by First National Realty Partners. If you’d like to find out more about First National Realty Partners, visit the website, fmrpusa.com. Don’t forget to subscribe, rate, and review the podcast, and we’ll talk to you again next week.
