The Private Equity Real Estate Podcast – Show 29
Summary
Listen in and learn about the basics of a great commercial real estate location and why it is so important to CRE investing with Anthony Grosso. He is the co-chairman, managing principal, and founder of First National Realty Partners, one of the nation’s leading commercial real estate private equity firms.
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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 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, we like to sit down with experts in commercial real estate. And every week, we talk about different topics across the commercial real estate landscape. And this week on the program, we’re going to be discussing the basics of a great commercial real estate location, and here to discuss this topic is a returning guest to the program, Tony Grosso. He is Co-Chairman, Managing Principal and Founder at First National Realty Partners, one of the nation’s leading commercial real estate private equity firms. Tony, welcome back to the program. Thanks for being here.
Tony Grosso:
Great to be with you as always.
Eric Murphy:
Well, Tony, since we’re talking about location on the program today, let’s start with, what is it about the location that makes it so vital to commercial real estate investing?
Tony Grosso:
Sure, yeah. And we’ve all heard the cliche in real estate, location, location, location, but I really feel like a lot of people don’t really understand what that means. And just like in any business, location in real estate is all about what would be considered customers in other businesses, the end user in real estate. I’ll give you a couple of examples. When you’re analyzing a location, it all comes down to how a commercial deal perform in that space. How great is the desire for that tenant to be in that space, for multiple different reasons? Let’s just say it’s a retail shopping center. A great location is one where your tenants are going to make a tremendous amount of sales and be successful out of that location. That’s what makes it a great location. That and that alone, nothing else really matters.
Tony Grosso:
Everything is really the traffic towns and parts of the country, and situs, and all this different stuff. It matters, but it really only matters, let’s say we’re talking a retail shopping center here, based on how are you going to deliver a product that’s going to allow your customer, your tenant, to perform like hell out of that location. And if you can find locations where the tenant performs really, really well, you’re going to be able to charge more rent, you’re going to have more value. Same thing goes for industrial, same thing goes for office. What is the desirability for a tenant to want to occupy your space? The higher that desirability, whether it’s the got to be there, or it’s an office that’s got beautiful amenities, it’s got a great access to residential people who are working in the office, whatever the amenities are for office. Or if it’s industrial, where it’s got a proximity, it’s a last mile facility it’s really close to their customers, and they’re going to be able to make a lot of profit out of that location.
Tony Grosso:
It all comes down to how successful your end user can be in that space, and what is the desirability of that tenant to want to occupy that space? That’s the location situation. You flip over to residential, it’s same thing with rental apartment houses, or complexes, and even boiling down to single family homes. If you’re in Palm Beach, Florida, and you’ve got a mansion estate, people want to be there. Why? It’s the view, it’s the location, it’s Florida, which has historically been a hot market. There’s just all these different characteristics, or why somebody wants to be on a mansion on the beach, in Palm Beach, that’s where they get hundreds of millions of dollars for some of these estates because it’s right on the ocean.
Tony Grosso:
If you took that same house and you moved it to Palm Beach Gardens, inland a little bit, it could be a beautiful house, great construction, all this different stuff, and that plays into the desirability of the home. But it’s not on the ocean so now it’s going to be $6 million. It all comes down to whether it’s somebody who’s living there, whether it’s an apartment, or it’s their home, or it’s a tenant, who’s going to be conducting business out of the space. The desirability of that tenant to want to be there, or that person who owns the house to be there, that’s the ultimate location equation.
Eric Murphy:
Mm-hmm (affirmative). Well, you mentioned that desirability. Can you expound on that a little bit? Maybe let us know what are some specific traits that would make a location so desirable.
Tony Grosso:
Ultimately, you look at, let’s say, let’s go to retail as an example, how many cars are driving past per day? How many eyeballs are driving past per day? If you’ve got a hard corner location with multiple traffic signals, and there’s just a tremendous amount of traffic going past, maybe it’s on a commuter path to a major city going out to a suburb. The more vehicles per day and eyeballs per day, and the ingress and egress, and the traffic [inaudible 00:04:12], that plays a big role in the retail space. If you look at a broader location, let’s say for an apartment community, I brought Florida up before, but Florida right now is a very hot market. A lot of people from the Northeast, and the Midwest, and other parts of the country, are coming into Florida. Why? Weather, tax climate, the standard of living. All those different things, make it a great location.
Tony Grosso:
It’s the same thing for office and industrial as well is, people want to be close to for, let’s say it’s a last mile industrial facility, the closer they are to their customers, the more cost-effectively they can deliver goods, which ultimately allows them to make a higher profit versus an inferior location. There’s a million different variables that make up location, all the way up and down the real estate spectrum. But ultimately, like I said earlier, it all comes down to the desirability for a tenant to want to be in that piece of real estate.
Eric Murphy:
And how do you identify things like traffic patterns in a location? What process do you use to identify up and coming markets? And are there certain elements that you focus on?
Tony Grosso:
We have a tremendous amount of technology that analyzes all this stuff for us. So when we’re analyzing a property that we like, we use this, what we call our [inaudible 00:05:21] acquisitions model. And a lot of the different boxes, and we go after grocery-anchored retail, so there’s all these different boxes that need to be checked. Whether it’s traffic counts, we want the number one or number two property in a market, we want the number one or number two grocery anchor in that market. So there’s all these different things that play into it. I mean, there’s 60 of them that we have on our list that all need to be checked off for us to really want to go after a deal. We’re using technology to get data, to see traffic counts, and traffic patterns, and new development, and track all that stuff. And we have a software, Placer, that allows us to track people’s cell phones going in and out of a property, so we can the amount of foot traffic to that property versus a competitive set of properties. Using a lot of technology and data to really understand that location at a micro-level.
Eric Murphy:
Talk about new development. How important is future development when you are selecting a location and how do you go about making those future projections?
Tony Grosso:
There’s just really two ways to look at development. One’s positive, one’s negative. I’ll give you the positive one first. If you own a retail shopping center and there’s a thousand apartment units that are coming in below you, you’ve got instant customers that are going to probably increase the value of your property tremendously. Also, overall, development is good, meaning that there’s more people overall coming to the market, and that the other people believe that the market supports that development, and it’s going to be a cost-effective project, which overall, can be set as a positive. When you see real estate development, historically, it’s developers and speculators that think better days are coming than going. So development really overall is a positive thing.
Tony Grosso:
When you look at it on the negative front, though, let’s say you own a, I keep going back to grocery-anchored retail because that’s our bread and butter, [inaudible 00:06:57] grocery center on a good hard corner, and there’s a lot of across the street, and another center’s coming in, you better hope that you bought below replacement cost because if you paid over replacement cost, what’s stopping that new landlord and developer from poaching all of your tenants, or poaching all of the new tenants that are coming into the market? Which is why replacement cost, not to go on a tangent, is very, very important because it insulates you from new development. Let’s just say for easy math, it costs you $300 a foot to build in a specific market and you buy a property, I don’t know, for $120 a foot, you can charge a much lower rent and make the same return that somebody who’s going to have to come in new and build would have to charge. Now, the theory is it’s a new construction so it’s need more desirable, higher impact facade, look better, maybe better location or whatnot.
Tony Grosso:
But by buying below replacement cost, you’re able to insulate yourself from that new development. It’s very, very important, from a competitive, more micro standpoint, when you’re looking at development in the market, we always like to buy below replacement cost. But yeah, that’s it. You’ve got positives, which is overall economic activity, development is great. But you’ve also got negatives, if you’re an industrial owner and there’s brand new product that’s coming in next door to you, your tenants are ripe for the picking, if they’re going to be able to be more successful in their location, obviously.
Eric Murphy:
Right. When you’re considering a location, how much weight do you put on the business climate? Is it favorable? Or some of the economic drivers that might be unique to a particular area?
Tony Grosso:
It’s huge. It’s really huge. And you can just see it when you look at more business-friendly climates versus less business-friendly climates. It’s not uncommon to see 200 basis points, 250 basis points, and cap rate spread versus a friendly climate to maybe a more negative business environment. The overall population growth of a… And people move and population grows, and capital flows to places where there’s less tyranny. So they want to move to places where the business climate is better, the tax rate may be lower. That historically is a driver of population growth, and we track all that stuff because it’s very, very important. That being said, if there’s population, if there’s density, if there’s people in a market, there’s great pieces of… You could go to a market that maybe could be less in vogue and make a superior return.
Tony Grosso:
The same way that you can go to the hottest market out there and lose your shirt. Just because you’re looking at… It’s good to track all that and buy in areas were better days are coming than going, I think that’s a great real estate strategy, but it doesn’t necessarily tell the entire story on a deal. You could go into the hottest new multi-family development in Las Vegas, Nevada, which has a strong market right now as of this recording, and you could lose your shirt. And you could go to Upstate New York, which maybe could be viewed as less in vogue, and buy a property at the right rate, with all the right economics and all this different stuff, and be highly successful in that property in Upstate New York. It’s one component, it’s not the entire component, and we’re looking at a bunch of different, as I say, boxes that need to be checked for us to want to go after a deal.
Eric Murphy:
Well, Tony, we’ve been talking about markets, let’s move on to submarkets, Those areas may be just outside of the hot markets. How do you evaluate a submarket?
Tony Grosso:
Submarket is huge. Can’t be overlooked. We’ve all heard there’s good parts of town and bad parts of town, obviously. That’s why local market knowledge, it’s so important because you may say this part of South Florida, and it’s just been painted with this broad stroke that it’s South Florida so all these people moving here, it’s an incredible market, but then you start to examine the submarket of where the property is. And you say, “You know what? This really isn’t the greatest part of town. Now I know why it’s selling for that price,” why it’s selling for a cap rate you thought maybe is higher than what it should’ve been. Painting markets with broad strokes is good to do at a high level, but then you need to really drill down into the submarket and make sure that you’ve got expert local knowledge boots on the ground, that can really fill you in and give you the story, because there’s so much that you can glean by really having those boots on the ground, and understand what’s going on with the submarket.
Eric Murphy:
Okay. We’ve reviewed a little bit about markets and submarkets. I’m curious about the property itself. Are there certain amenities in the property that you are looking for?
Tony Grosso:
Well, it all varies from deal to deal, but it is an important factor when you’re valuing real estate. Let’s say you’ve got two office buildings and they’re side by side, or you could use this for any property, I’ll just use office as an example. You’ve got two 100,000 foot office buildings, side by side. One is brand new, the other one’s 1970s vintage. One has all the hot amenities, it’s got a gym, that’s got beautiful lobbies, people come down, walk your dog at your office. All kinds of crazy stuff these offices are coming out with these days. And then you’ve got the 70s product, which is dated, needs to be updated. Let’s just say they’ve got the same situs, their location in the submarket. You’re obviously going to be able to charge much higher rents for the building with the rich amenities versus the 1970s vintage product that doesn’t have the same amenities.
Tony Grosso:
And it’s different for each product class. A lot of times, the Class A office buildings have prestigious companies in them, that are perceived as credit-worthy, and they want to make a certain impact with their customers. Where, you go to maybe an inferior product, it’s maybe not this national conglomerate with the A+ credit. There’s different amenities for each property, same thing for apartments. All the buildings that have beautiful amenities, and they look a certain way, they’re going to get higher rents than somebody that doesn’t have all those different things. There’s an opportunity sometimes in doing value-add stuff and taking these older vintage buildings, with less risks than going ground up, and repositioning them, and adding animal these amenities to create value. But it’s very, very important. It’s just one of those boxes that needs to be analyzed, or before it can be checked, before you go after a property. Product-type agnostic.
Eric Murphy:
Tony, what do you think are some of the biggest mistakes an investor can make when they are evaluating a location?
Tony Grosso:
I think people can get bogged down with broad markets and just make these broad statements that, “Oh, that’s a good market.” And then everything in that market is good. I find that you got to really get down to the operating performance of the property. And that tells probably the greatest story. There’s only so much you can see from the high level 30,000 foot view. When you drop down to the property level and you say, “Hey, this thing’s a hell of a performer,” why is it you can start to reverse engineer? The path of least resistance, on the retail front, of getting that information is really looking at tenant sales and how they’re trending, and analyzing new development in the market and all that stuff.
Tony Grosso:
If you can get down to their health ratio, which is how a tenant is performing from a revenue rent to sales standpoint, you can really understand how that property’s performing. And to me, property performance and buying the number one or number two site, or the number one or number two tenant, is almost more important than just taking a broad swab and saying, “Oh, I got to go to Austin, Texas, or South Florida, or Nevada or Salt Lake City, Utah,” and pay some ridiculously inflated valuation and super low cap rate. I like to look at property, trending property performance, more than anything, when I’m looking at sites to acquire.
Eric Murphy:
Well, before I let you go, Tony, we’ve gotten an idea from our conversation, but if you could sum it up, what would you say is First National Realty Partners philosophy when it comes to assessing a location?
Tony Grosso:
Yeah, and I mentioned it a little bit earlier, but very, very simple. We’re going after grocery-anchored, neighborhood or community retail centers. We want to find the number one site for a bunch of different reasons. We’ve got our whole scorecard of sites in a market, but we want the number one or number two location, I should say, in a market. And we want to have the number one or number two grocers from a market share standpoint. A lot of times, we’re not even going after number two. A lot of times, we’re finding the number one or number two sites with the number one grocer from a market share standpoint. And that’s really the overarching, that’s what kind of gets the conversation started for us, when we’re analyzing them all over the country. If you can have those two things, now the deal’s worthy of a look. Now you got to let the pricing. If they want some ridiculous LSD pricing, we’re not going to go after that deal, so that knocks it off the box.
Tony Grosso:
Or if the sales looks like it’s the number one property, it’s the number one anchor in that market, and then the sales are crap, that’s going to knock it off the block. Those are the higher arching criteria, and then there’s all these different things that knock stuff off the block, or don’t allow the boxes to get checked, that we discard. We’re hyper-focused, but we’re looking at a lot of deal flow, which I think gives us a chance to be successful.
Eric Murphy:
All right, Tony, if someone wants to learn more about First National Realty Partners, or just get in contact with you directly, how do they do?
Tony Grosso:
Yeah, if you’re looking to work with us, we’re always looking to hire top talent and A players. If you’re a tenant that is looking to put their business into a space that’s a really high performing space because we’ve got this very specific criteria of buying high performing locations, please go on our website, you’re an investor who wants to potentially partner with us, or if you’re an institution or high-net-worth accredited investor, or finally, if you have a property to potentially sell us, we want to talk to you as well. Talk to our acquisitions team. You can go to fnrpusa.com, F-N-R-Pusa.com, like First National Realty Partners. FNRP USA, Eric, is the site, and all the contact information is on there.
Eric Murphy:
Fantastic. Tony Grosso, Co-Chairman, Managing Principal and Founder of First National Realty Partners. We always appreciate the time, thanks for being on the program.
Tony Grosso:
Pleasure, thank you so much as always.
Eric Murphy:
My thanks again to our guests today, Tony Grosso. And thank you for listening to the Private Equity Real Estate Podcast, brought to you by First National Realty Partners. I’m your host, Eric Murphy, reminding you, if you haven’t already, please subscribe, rate and review the podcast. And if you know anyone in your life who might be interested, please share the podcast with them. Thanks again, and we’ll talk to you again next week.
