When it comes to residential real estate, no one wants to buy ugly. You want to focus on pretty things. When investing in commercial real estate, however, the same principles don’t necessarily apply.
In real estate, ugly comes in two forms: physically ugly and market ugly. I like them both. I know that where there is value, there is potential return.
A lot of investors approach commercial real estate with the same approach they would use when buying a house. That’s why real estate that looks shiny and pretty tends to trade for more money. People are attracted to things like Class A retail or office and medical space. Marble floors, high ceilings, big foyers and high-end finishes.
It takes time and money to maintain a Class A building. You need janitorial service. You have to wax those marble floors and shine everything up so you can continue to attract tenants. It doesn’t always generate the best return.
That’s why I like industrial real estate. Metal frame and walls. Prefab structures on a concrete slab. Ugly. Most tenants don’t care how it looks. It could be light industrial for storage, heavy industrial or manufacturing. It could be flex space for a construction services company. They don’t care that it’s dirty or has a lot of wear and tear. Industrial tends to trade at much better prices and better cap rates. There’s not a lot of competition because most buyers don’t understand it.
Prior to the pandemic you could buy beautiful industrial space for $50 a square foot versus $200-$300 for retail. That was our favorite asset class to buy. Then during the pandemic people started shopping online more while on lockdowns. Demand for retail space evaporated and demand for industrial distribution and drop ship facilities skyrocketed. Suddenly, industrial was attractive, and the market got flooded. Billions in capital lined up to buy industrial properties. As a result, industrial space that used to trade at $50 a square foot began trading at $150, $200 a square foot.
By contrast, retail got a black eye during the pandemic and now, two years later, still has not fully rebounded. Many businesses were shuttered. Shopping centers faced foreclosure. Asset prices plummeted. Properties that used to trade at $200, $300, $400 per square foot can now be seen trading at under $100 a square foot. What once were Class-A institutional-grade cream-of-the-crop assets, are now trading for $70, $60, or even $50 a square foot in some markets. As market conditions shifted, so did our acquisition strategy. We’re now heavily focused on retail.
We have about $50 million dollars in retail property under contract to purchase over the next 90 days and are on target to purchase around $250 million over the coming year. Larger regional shopping centers, grocery-anchored centers, neighborhood centers, inline strip centers. Even the occasional abandoned or struggling malls that have become dinosaurs over recent years. The prices are just too good. The key is knowing the future potential for the location. In some cases, the land is the real underlying asset. Value is value.
It reminds me of what Warren Buffett said: “Be fearful when everybody’s greedy and be greedy when everyone is fearful.” We watch where everyone is going, then go the other way.