April 2, 2024

JF3498: A New Class of Buyer, the Evolution of Leasing, and How Other Classes Stack Up vs. Industrial Real Estate ft. Chad Griffiths




Industrial real estate broker and investor Chad Griffiths joins host Slocomb Reed on the Best Ever Show. In this episode, Chad discusses the state of industrial real estate, including how businesses have become a new class of buyer, how industrial leasing has evolved in a high-interest-rate environment, and how industrial stacks up vs. other asset classes in 2024.

Previous Episode: JF2779: Why Now Is the Time to Break into Industrial Real Estate ft. Chad Griffiths

Chad Griffiths | Real Estate Background

  • Partner at NAI
  • Portfolio
    • 7 industrial buildings, 160,000 sq ft
  • Based in: Edmonton, Alberta
  • Say hi to him at: 
  • Best Ever Book: Skin in the Game by Nassim Nicholas Taleb

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Slocomb Reed (00:43.116)
Best ever listeners. Welcome to the best real estate investing advice ever show. I'm Slocomb Reed and today we are joined by Chad Griffiths. He's joining us from Edmonton, Alberta. For those of you who have not been around with our podcast for the last two years, I interviewed Chad for episode 2779. Why now is the best time to break into industrial real estate?

That episode aired in April of 2022. So almost exactly two years from the time that this episode will air. Chad, let's make the assumption that our listeners are a little familiar with your background. You are a partner broker and investor in the commercial real estate brokerage NAI based there in Edmonton. You also have seven industrial buildings totaling 160,000 square feet in your own portfolio. Those numbers sound eerily familiar. By the way, Chad, I'll say that. But also, tell us what you've been up to the last couple of years. What's your focus been since the beginning of 22?

Chad Griffiths (02:00.178)
Yeah, that's a great place to start. And first of all, Silke, Matt, thanks for having me on the show. Again, it's always a pleasure getting to chat with you. It's funny when you say that back to me that April 2022, and I was so bullish and so optimistic on industrial and I thought I was going to add two three properties to my portfolio over the next coming years and I've added none. So it's, it's not a function of not trying because I have been aggressive that I've been trying to get deals.

But with the interest rates going up at the fastest pace in decades, and sellers being stubbornly holding on to pricing still in that 2021 2022 range. It's that delta of the bid ask, and the what sellers want and what buyers can pay is so wide that I just haven't been able to get anything to pencil. And there was a number actually that spoke to this nationally in the US. The numbers for industrial sales was down 70%.

So it wasn't just me that was struggling trying to find investment properties. It was most investors on the so on the investment side, fortunately, I have zero vacancies in my portfolio. So that is great on that end, the portfolios humming along, I've had to renew one mortgage now at a higher rate, which that sucks because that eats in the cash flow. I have another one coming up this summer.

So that's also going to be able to bit painful, but just managing the portfolio as it is. And on the brokerage side, investment sales has really slowed down. But there's a lot of owner users now that are in the market that are able to look at properties that they might not have otherwise seen because it would have been gobbled up by a sophisticated investor. So it's there's still movement outside of the investment space that will be a challenge until we have some relief for outlook on what interest rates are going to do.

And I'd love to hear your thoughts on this too. It's, I don't see much relief coming this year. So I've went from being super optimistic about growing my portfolio to now. It's a matter of prices have to get in line for anything to make sense. And I, I just don't know when that's going to come. So still very opportunistic. I'm still long industrial. I wouldn't I haven't even considered selling anything out of my portfolio, and just looking for opportunities, which are very hard to come by right now.

Slocomb Reed (04:37.044)
For sure. And it's always, you know, everyone is saying that the gap between bid and ask has been wide the past couple of years. I always enjoy hearing that most from listing brokers. So thank you, Chad. The, yeah, you know, it's interesting. The fact that the episode aired, I wanna say April 12th of 22.

I'm not that talented. I just looked it up on our website. The, um, that means that we recorded before that, which means that we most certainly recorded while we were still experiencing the height of the market and low interest rates. And even though valuations were higher than they had ever been, everyone felt like they could keep buying because the cost of debt was so low that, um, buying at a 6 cap when your interest rate is in the 3s is much more justifiable of course than buying at a 6 cap when your interest rate is in the 7s.

So there hasn't been a lot to buy. I resonate with that. There haven't been a lot of properties to analyze or to list in your case, Chad. So...

You talked about a couple of financing liquidity events or financing events that you're going to have here coming soon. What have you been up to the last couple of years?

Chad Griffiths (06:19.23)
Yeah, so the I would say industrial leasing has still been what has kept me most busy from just a time standpoint. We've also been quite successful on selling industrial buildings to owner users. So one building we sold to a large Asian company, a very large company who just wanted to own their own building. So they bought a large industrial property just sold another one just closed last week, about an $1 million building, another owner user bought that one.

So that that's been an interesting segment of the market where the owner users, I don't know if it's just there's I think there's a lot of things at play. So I don't want to simplify and make it sound like there's just one force at work, because there's an infinite amount unforeseen amount of forces at work. But lease rates in industrial have escalated considerably across the board, every major market in North America, and presumably even in the world.

But definitely North America, every market in North America has seen considerable upward pressure on rental rates. And I think what that's prompted a lot of companies to do that had otherwise been tenants and would have been happy being tenants is they instead said, well, let's control this variable. Instead of being faced with large hikes in our rental rates going forward, let's buy a property, secure a 10 year note on the debt. And then at least that way, they're not hit with large rent increases every year.

I think that that's what's pushed a lot of companies to move from that leasing side to the ownership side. And it happens to be at a time where there's some pressure on pricing, because the investment space is just hard to make those numbers work. So there's more there's been some downward pressure on prices, all while there's been upward pressure on interest rates, I think companies are saying, or a number of them are saying, we can justify the interest rate environment right now. Because in the grand scheme of the last 40 years, it's not it's not out of line.

It's on par with that trend line actually over the last four years, 40 years, so the interest rates aren't crazy high, they're just high in comparison to the ultra low near zero rates that we had for so long that the market got drunk on. I think companies are saying these rates aren't bad. We could face even more rental rates increases going forward if landlords are trying to continue pushing the envelope on how high they can get rates to go. I think that that's what's causing a lot of companies to consider owning their own real estate. So that's also been a pretty productive spot. And then yeah, again, on our end, one mortgage come up last year, I have another one coming up this year.

It sucks. It takes cashflow right away. We did a three-year extension on the one we did last year. This year, it doesn't come up until the summer, so we'll wait closer to the summer to see if there's any relief. But it's a struggle that everybody's having right now. And it's, to your point, on the investment side why buy a six cap when interest rates are 7% it's you must have a crystal ball that forecast something different than everyone else has seen. Because at the very least that deal looks much worse than it did two three years ago.

Slocomb Reed (09:55.868)
Yeah, or you have to have some other extenuating circumstances forcing you to be a buyer with a heavy prospect of negative cash flow in the short term.

Chad, I want to say back to you what I think I just heard and add a couple of my own assumptions and then tell me whether or not I'm in the right head space before we move on with the conversation. You're primarily a commercial broker, primarily industrial and primarily in Alberta, Canada. The transactional volume in industrial real estate is down across the board, especially where you are. The buyers in the market right now are, I'm gonna use the residential term, owner-occupant buyers, or owner-operator buyers.

And the reason why they are so interested, first of all, across the board, owner-operators, owner-occupants typically have a higher viable price point than non-occupant, non-owner or non-operator, purely investor owners across the board. Feel free to, please do disagree with me if you think otherwise, but the primary concern for them is hedging interest rate inflation against increasing rent rates in the future.

If they buy now, they're effectively locking in that cost instead of having to face continually increasing rents in the future. Is that true?

Chad Griffiths (11:52.302)
That was a perfect summary. I couldn't have said it better myself. You said that very succinctly.

Slocomb Reed (11:57.684)
Great, well maybe Instagram will agree with us too. I was trying to keep it under a minute for the clips, for the reels, but Chad, a couple other things here that I don't want to go, stones I don't want to leave unturned.

Rent rates just keep increasing. We can get into supply and demand factors, things like that, you're still bullish on industrial, but I'm coming from the apartment space and that is definitely not what we have experienced. Where we are not receding, but we are stagnant here in Cincinnati where you don't see a lot of new inventory coming online. You have the supply and demand, balance still leans towards under supply, but we have a fairly economically conscious tenant base here for our apartments in the Midwest and they just haven't been willing to pay increases.

Your world's very different from that. Tell us what's going on.

Chad Griffiths (13:11.018)
It's a great topic and it does show the differences between beds and sheds or industrial and multifamily, where multifamily for the most part, you're likely doing six to 12 month leases. And I'd say it's probably uncommon, at least in my experience to do longer than a 12 month lease, wherein industrial it's not uncommon to see a five 1015 year lease we still do see some shorter term leases.

So that's not that's not a guarantee that it has to be a longer term lease, but that is more common. So a lot of these leases, and especially if you start looking back now, call it 2019. If someone did a five year lease in 2019, they're coming up for renewal right now. The market is considerably higher than it was in 2019. So there's, there's going to be a lot of sticker shock for companies that are renewing right now.

The challenge is that the inventory is still relatively low, the vacancy rate is still at historic lows. So there's not a lot of options for these tenants. So I think it will be similar on the multifamily and the industrial side where companies or residential tenants have to start doing an analysis on where they can make savings. Is it downsizing? Is it perhaps sharing space? There's options available.

But if a company wants to keep status quo and not make sacrifices in another area, it's going to result in rental increases. So it's a challenge on the commercial side for to deal with those, those things, because it's not a tenant favorable market yet. That might change the way that the economy is trending. And if we have continued high interest rates, which is deliberately putting more pressure on the economy that could change as well. And we might see some relief on rental rates.

But right now, the market is still undersupplied, there's still a shortage of good quality space. And tenants are being forced to pay more than they. And there's always a there's always tension there, right? Like the one thing with landlords and tenants is that there's always tension. landlords want to get the most that they they can tenants always want to pay the very least that they can.

So there's an inherent tension that's always at work there. When you're going to have that spread no different than the bid ask on a sale price. The bid ask is also applicable on lease rates. And it'll be interesting to see whether landlords can continue pushing rental rates up and industrial in the face of some economic pressure that remains to be seen. But I this was a, I guarantee a completely different conversation that we would have had two years ago, where I would have said tenants need to take any space that they can get at any price that they have to pay. Otherwise, they just won't get the space. It's becoming more balanced. But I would say that as of right now in March 2024, it's still more a landlord's market than an attendance market.

Slocomb Reed (16:29.428)
The industrial buildings in your portfolio, Chad, are those leases, triple net?

Chad Griffiths (16:37.482)
Yes. So I think that that's another perk about industrial over multifamily. And the last thing I would want to do is make it seem like industrial is better than multifamily. They're, they're different. So there's pros and cons to both. So when I'm explaining this as a pro, that doesn't necessarily mean that it's a better investment. It's just some it's a perk. And it's something unique to industrial is that every single lease that I have is structured in that triple net basis.

So that, if property taxes or building insurance or common area maintenance, if any of those costs increase, I can pass those increases on to my tenants. That's you can't do that in multifamily. You can't just go and have a one-year tenant with one-year lease with a tenant. And if property taxes go up, you just pass that increase over to them. You might be able to raise rent maybe, but it's not a flow through the same way that a triple net lease is structured.

Slocomb Reed (17:37.352)
Yeah, that makes sense. I would say this conversation might be a little more fun if you were willing to argue with me, but that would go against the generalizations that all Americans make about all Canadians, wouldn't it? Question here, if this were an argument, I feel like I would be punching myself in the mouth saying this if I were pro-apartment.

Let me paint a picture again and then have you tell me where I'm right and where I'm wrong, Chad. Industrial in your market is still experiencing significant rent increases with the exception of interest rates on debt. All of the other expense increases that we have been struggling with as commercial real estate investors the last couple of years, cost of materials, cost of labor to some degree in this case.

Cost of utilities, cost of insurance, those are all expenses that your triple net tenants will be responsible for paying. So you're in a position where your rents continue to increase while you're also not seeing the increased expenses that a lot of us apartment investors have been struggling with the past couple of years. Which effectively means your cash flow is as long as you're not stuck with your hand forced into a refinance into a higher interest rate based on your current debt structure, you're looking at increased cash flow across your entire portfolio. I wouldn't blame you for not selling anything right now. Where am I wrong here, Chad?

Chad Griffiths (19:22.506)
Well, we could we could disagree on some things on this. And perhaps as I give my opinion on this, there'll be a strike a cord and I'm happy to have a debate on it. I think it's largely cyclical. I think that industrial is having its time in the sun right now. And it's for a number of reasons. It's you look at commercial real estate broadly, retail has been very tough, although that had there's investors doing well in certain segments of retail, but that's struggled for the better part of 20 years right now, just as e commerce has taken market share away. Office looks terrible. Like that's probably that's got to be the worst market to be investing in, or have had an investment over the last 20 years, just as we went through this last period. So it leaves industrial is multifamily and multifamily had a massive uptick.

But those, that's been a very successful segment of the commercial real estate market. For those reasons, it's the people always need a place to live. There was upward pressure on lease rates, number of reasons to be optimistic with multifamily. That meant a flood of money went into that. And you probably see this where if you're trying to buy a property, maybe it's a little different, the landscape is a bit different right now. But two years ago, if you were trying to buy a property, you were competing against everybody.

Like a guy that owned three houses, all of a sudden decided he wanted to be a multifamily investor. So you're competing against him, you're competing against institutional money, you're competing against large regional money, that drives up prices on everything. And it, it means that there's not a lot of margin for error in there. There's not a lot of margin that if rental rates start seeing a decrease, if expenses start going up more, there's not much of a margin in that multifamily.

Industrial is probably a few years behind that, where it didn't really become a sexy asset class until 2020. But that's when all the attention started saying, okay, we need to redefine our portfolios, we need to look at where we want to be putting money. Industrial looks pretty attractive. And that's why there's been so much institutional money that's poured into it. I think it's a cycle, naively positive, naively optimistic that industrial will continue in its in its current trend line.

I think that at some point, we'll run into issues similar to what multifamily is going through right now. And I don't know when that is, that could be three years, that could be three months, that could be 10 years, I really couldn't put in the exact date on it. But I think, as of right now, I can't think of a better place to have money put than in an industrial building for those reasons and the ones that you mentioned, you've got either stagnant or in some cases declining rent, you've got massive increases in property taxes, building insurance, everything's more expensive. So all everything that you're spending to operate that building is costing more but your rent is staying the same. That's a bad equation for having and then on top of it interest rates have gone up.

That's a tough scenario to actually be positive about multifamily in the short to medium term. I would think 10 years out, I think multifamily is still a very attractive asset class. I can't spread myself thin enough. By doing industrial and doing multifamily, I just only have so much brain capacity to deal with even one asset class hurts my brain sometimes. So I couldn't do two asset classes.

But if I did, multifamily would be the second one that I would be in right now, even in spite of those challenges. But we've been fortunate on the industrial side, at least as of to right now, where we haven't had that declining top line revenue pressure that ultimately leads to lower NOI and then lower price valuations. We haven't had that yet. Does that change? Probably, I think it's a cycle. There's a number of things and reasons why it will change. But it's everything's a cycle. We can't ignore that. And you're cycling in multifamily through you're at a different phase of that cycle, but it's still going to cycle nonetheless.

Slocomb Reed (24:07.668)
Chad, that makes a lot of sense. I can't say that I've bought nothing since we last spoke. Everything I've bought has been small by comparison to the moves I made 2019 to 2021, but I've had the luxury of locking in long-term fixed rate debt with everything that I've purchased.

And so I'm not experiencing a lot of the struggles that other multifamily investors are experiencing. I get where you're coming from too. I have so much expertise built up in my market here, greater Cincinnati, and in apartment investing and in apartment operations that I find myself not able to jump ship into another asset class, regardless of what's happening in mind currently.

Slocomb Reed (25:20.172)
Last question, and then I want to transition the episode here, Chad. As a commercial broker, I know you're focused on your home market, but What are we seeing, What are you seeing with regards to new construction trends within industrial real estate right now?

Chad Griffiths (25:43.03)
Great question. And although I do focus predominantly on my market for deals and data comps, I do follow the North American market quite closely, as there's a lot of overlap between what happens in Cincinnati or Chicago, or my city. So I do follow it pretty broadly. I'd say one important thing for anybody looking at industrial to recognize is that there's different subcategories of industrial which right now they're going in different directions.

And this is new. I've been in the industry for 20 years and I haven't seen a movement like this since and that's if you divide industrial state into two main subcategories like warehousing or logistics centers. And then on the other side, the manufacturing or the factory space. There's other sub categories, but those two take up the vast amount of the industrial real estate inventory. Warehousing has been overbuilt and there's a lot of markets right now where they're sitting on inventory that they weren't expecting to. So I don't see a lot of that speculative warehouse development going to continue for the next year, two years, perhaps, especially when you factor in higher interest rates. A lot of developers have just hit the pause button.

But on the warehousing side there is that the US government is incentivizing companies to reshore onshore manufacturing back to the US. That's creating a considerable amount of demand for that manufacturing side of space. And that hasn't kept pace on the build side, that inventory hasn't been added to much at all. So now there's this huge run up in demand for manufacturing space with limited inventory.

That's where I can see a lot more product being built. Perhaps not speculatively, because it's challenging for developers to speculative build in a higher interest rate environment. You have to have a lot of faith in your ability to lease that up. But I can see a lot of demand coming. I can see a lot of that manufacturing property being built. And even just looking at some of the major projects around North America, all the big projects right now with the $10, $20 billion projects, they're all manufacturing space.

So that will trickle down, there'll be there'll be much smaller projects all over North America that add to that inventory. But I think that is the key thing there is that the warehousing side has probably been overbuilt a bit. And it's going to take some absorption before that triggers the next round of developers adding to that inventory. But on the manufacturing side, there's a huge amount of demand for it. So that's where I can see most of the growth coming in the foreseeable future.

Slocomb Reed (29:20.18)
That makes a lot of sense. Chad, are you ready for the best of our lightning round?

Chad Griffiths (29:24.315)
Oh yeah, absolutely.

Slocomb Reed (29:27.128)
It has, you have been through the lightning round before, so the questions will be a bit modified. But what is the best ever book you've recently read?

Chad Griffiths (29:37.378)
Great question. Deep work, deep work. I believe the author is Cal. I'm drawing a blank on that. That's it. Cal Newport. He wrote another book so good, they can't ignore you, which I just picked up actually, because of the deep work. You have awesome book, I can't recommend it enough, actually.

Slocomb Reed (29:45.851)
Cal Newport.

Slocomb Reed (30:07.232)
Chad, within your investment portfolio, the properties you already own, in the last two years what's the biggest mistake you've made and the best ever lesson that has resulted from it?

Chad Griffiths (30:21.686)
Biggest mistake. I don't know if I've made any mistakes per se, but there's things that if I could do over again, I would modify and probably the biggest one would be just more client communication. Tenant communication. It's, it's easy when you have a portfolio that has 100% vacancy to have things on cruise control. But I, and this is something that I should be doing more going forward is just keeping more regular lines of communication with the tenants.

If for no other reason, just to check in, just see how their business is going, see if they have any issues with the building, just more regular communication. And I think we do it as a as an ownership group. I think we do it well. But doubling down on that is a pretty good return on investment.

Slocomb Reed (31:16.936)
And Chad, what is your best ever advice?

Chad Griffiths (31:22.126)
Think long term. It's too easy to make decisions in a vacuum on what's going to happen tomorrow or what's going to happen next month. And those are important considerations. But I've been guilty of this and I've found other people have as well as that they exclusively think trying to solve short term solutions, short term problems. So think long term ties in with that book title of deep work.

It's thinking long term is has been very beneficial in my career. And it's something I still continue to do. I still have goals 20 years out right now.

Slocomb Reed (32:03.508)
Nice. And Chad, where can people get in touch with you?

Chad Griffiths (32:09.302)
I'm pretty active on Twitter, X as it's now called, and YouTube. So I talk about industrial real estate on YouTube and all kinds of things on Twitter, whatever the topic of the day is.

Slocomb Reed (32:25.6)
Nice. And those links are in the show notes. Chad, thank you. Best ever listeners, thank you as well for tuning in. If you've gained value from this update with Chad Griffiths today, please do subscribe to our show. Leave us a five-star review and share this episode with a friend you know we can add value to through our conversation today. Thank you and have a best ever day.

Chad Griffiths (32:47.862)
Thanks again, Slocomb, I appreciate it.

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