Doug Kiersey 0:00
But as you think through the consumers being 70%, of the economy of the economic activity in the US, and that all everything we touch, or look at in our office or our home or wear came out of a warehouse, at some point in time that. I’m sitting here looking at my Fiji water, we that was in a warehouse, a week ago somewhere. And so when you talk about the trucking industry, the railroad industry, the warehousing industry, and all of the players that go along with that the shipping business, it is a massive part of our economy. And it’s a growing part of of GDP, and it’s, it’s a growing part of the labor force as well. And if I can make a point about labor, these aren’t the forklift jobs that we’ve maybe have in our mind are still plenty of that. When I walk into an Amazon building, and I’m not saying anything out of school, because they’re publicizing this, but they’re starting their people that something in the high teens to low $20 An hour wage, with benefits with the potential to earn college tuition, with flexible time, and that’s a whole bundle there. And so the, the labor market for these kinds of buildings, by itself has become extraordinarily competitive, and our customers are stepping into that. And we’re part of that offering because we want to build attractive buildings where people want to go to work with amenities. And so, you know, the labor piece is, is is kind of redefining a little bit what we deliver to our customers.
Welcome. to CRE PN Radio for influential commercial real estate professionals who work with investors, buyers and sellers of commercial real estate coast to coast whether you’re an investor, broker, lender, property manager, attorney or accountant we are here to learn from the experts.
J Darrin Gross 2:04
Welcome to commercial real estate pro networks, CRE PN Radio. Thanks for joining us. My name is J. Darrin Gross. This is the podcast focused on commercial real estate investment and risk management strategies. Weekly we have conversations with commercial real estate investors and professionals who provide their experience and insight to help you grow your real estate portfolio.
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Today, my guest is Douglas Kiersey. Doug is the president of Dermody Properties, and oversees all of the company’s operations and strategic initiatives, including capital formation, acquisition, development, and investment management activities. He is a member of the Dermody properties advisory board and chairs the company’s executive and investment committees. Since Mr. Kiersey has joined the firm Dermody Properties has developed and acquired industrial logistics assets with an aggregate value of more than $5 billion. Mr. Kiersey has more than 30 years of experience in logistics properties in more than 20 major US markets. He is a member of the Urban Land Institute, and the society of industrial and office realtors. And in just a minute, we’re gonna speak with Doug Kiersey, about the intersection of work from home and he commerce.
But first, a quick reminder, if you like our show, CRE PN Radio, there are a couple things you can do to help us out. You can like, share and subscribe. And as always, we encourage you to leave a comment, I’d love to hear from our listeners. Also, if you want to see how handsome Our guests are, be sure to check out our YouTube channel. You can find us on YouTube at commercial real estate pro network. And while you’re there, please subscribe. With that I want to welcome my guest, Douglas Kiersey. Welcome to CRE PN Radio.
Doug Kiersey 4:22
Darrin is great to be with you this morning. Thanks for having me.
J Darrin Gross 4:24
I’m really looking forward to our talk. As we spoke before we get started to hear that we have a mutual connection there. And I gotta say this to you congratulations to the Beavers, the Oregon State Beavers alumni there that they’ve had a great season and looking forward to a bowl season. That’s good.
Doug Kiersey 4:44
It makes me and my family very happy. And so it was a wonderful weekend for us. Us Beavs
J Darrin Gross 4:51
Yeah, Go Beavs. Before we get started, though, if you could take just a minute and share with listeners a little bit about your background.
Doug Kiersey 4:59
Sure. Be happy to. I a, as it happens, I was born and for the most part raised in the area of Portland, Oregon in the suburbs of Portland, attended Oregon State University and went into the real estate business as an industrial broker with Cushman and Wakefield in the early 80s. And after 11 years with C and W joined a flood den fledgling Real Estate Investment Trust called Prologis, which is now the world’s largest owner of logistics real estate. I pioneered Prologis entry into the Northwest markets in Seattle and Portland, and then moved my family to Chicago in 1999, and was given a bigger territory to run, ultimately, stayed at PLD for 17 years and 11 years ago, I joined Dermody properties. So I’ve been in the industrial real estate business now for just about 39 years.
J Darrin Gross 5:57
Sounds like you you’ve certainly seen a lot of change. You know, it’s so funny you say Pro logistics, and like centered leader and sound like you were there in the beginning, is that right?
Doug Kiersey 6:09
Pretty close to the beginning, I think when I joined the firm, we had about 12 million square feet firm, I believe, something close to a billion square feet now. So I learned a lot along the way, and how to grow a company, formulate strategy and execute that strategy. And I’ve, I’ve been very fortunate to be able to put some of those lessons to work now with a private firm.
J Darrin Gross 6:30
Sounds great. Well, let’s jump into this little bit here. And I think one of the first things that I’d like to ask you and have you speak to is just Can you define what Logistics is? I think people have some sort of a rough idea. But in in for this conversations is there a is there a definition of how or what what we should consider?
Doug Kiersey 6:58
Well, for the benefit of your listeners, and for this conversation, we should we should define logistics as the movement of goods, from their point of origin, all the way through a network of transportation and warehousing until it comes to the ultimate consumer that consumer could be a household, or the consumer could be a business. So you have both B to C business to consumer and b2b business to business logistics. Where we fit in that as the intermediary is providing the brick and mortar to support the distribution networks of our customers.
J Darrin Gross 7:39
Okay, and in the brick and mortar than is that primarily warehouse.
Doug Kiersey 7:44
It is it’s what we do is exclusively warehouses, I’m trying to coined the phrase logistics real estate. If you say industrial to some of our compatriots in Asia or Europe, they look for smokestacks. We say industrial in the US as kind of a catch all for both warehousing and, and manufacturing. But logistics real estate is really our focus. That’s our sole focus. And we spread across most of the major markets in the US.
J Darrin Gross 8:16
And as such, are you developing, managing for others? Are you here by an existing? How are you?
Doug Kiersey 8:24
So what we what we do is we act as a fiduciary for our investors, which are a mix of domestic Canadian and European institutions, pension funds, insurance companies, for the most part, we aggregate those dollars into a large bucket what we call funds. And then as a fiduciary, we go out and invest those monies, those equity dollars in both acquisition and ground up development. Over the course of the last cycle, that mix between acquisitions, and development has skewed towards development, as risk adjusted returns have become more favorable on the on the supply and demand side. And so as a landlord and a developer, we’ve had quite a bit of pricing power over the course of the last cycle.
J Darrin Gross 9:17
Got it in that you mentioned the last cycle is that how long of a timeline Do you consider in a cycle and and are there any specific events or situations that define that?
Doug Kiersey 9:32
Well, if we go back to the great financial crisis in 2008, and 2009, I think most would would consider that the cycle. The upswing in the real estate cycle started in 2010. continued through the beginning of the pandemic, and then really was turbocharged by the Feds activities as they took interest rates on a real basis below zero and on a nominal basis close to zero, which expanded the values have real assets. So that now has come to an end. As of this last spring, I think of all your listeners and follow the Feds actions. And so that’s a very, that’s become some turbulent waters for real estate investors and investors and other assets caused by the increase in interest rates. And so I think most of us would would consider that the, the upcycle, if you will, and valuations ended sometime this spring.
J Darrin Gross 10:33
Yeah, no, I think that’s, that’s fair. And I think everybody’s trying to, you know, gauge what is the value based on where things are at based on interest rates. And, and for the longest time, all I all I heard was cap rate compression, Caffrey, compression, cap rate compression. And I think we’re starting to see a little little change in direction on that. Let me ask you, on the development side of things, you mentioned that you raise capital through institutional sources. When you develop something, is it is it leveraged? Or is it all investor capital? Or how are you
Doug Kiersey 11:15
So what we have a subscription line that’s, that’s secured by the balance sheets of or the contributions of our investors into the fund to its floating rate debt, so we’ll typically buy the land on using the subscription line. And then as over the course of a very few months, we’ll put construction debt, typically loan to cost of 50 to 60%. And the balance will be funded by equity. So if you think of a typical project being 40 to 50%, equity, and the balance debt, that’s typically bank debt that floats has a three year term, and a couple of option years if we make certain certain leasing hurdles.
J Darrin Gross 12:01
Got it, and the on the development side of things. What is a typical timeline for you know, identifying a site to have an actual lights on and people operating inside is at a short timeline, or
Doug Kiersey 12:22
It used to be rather fast for the time that you would conceive a project, but now the entire cycle has extended. And so as we move into infill areas, where entitlements are a little more challenging, we talk about that probably at some length around the logistics center. But then we’ve had, we’ve all read about the supply chain challenges. I’ve never known so much in my life about roof fasteners and electrical equipment and dock levelers. Because every time we turn around, it seems that something is in short supply. And that condition has lasted over the last couple of years, and it’s starting to abate. So as a consequence, what used to be from start to finish, perhaps a year to 18 months now can be from from the time we can see the project and secure a contract on the land now can be two or three years.
J Darrin Gross 13:22
Well, I think that’s that’s one thing that I don’t think people really, you know, grasp when they think about real estate. You know, if you’re, you know, residential oriented, you see the sign yard, you go grab the flyer, make an offer, or something like that you can move in or there’s builder, or even if you have ground, it seems like there’s a relatively short window, but on these larger projects. And then just the timeline. And speaking of the the projects, what is an average size of a, of a facility that you guys are developing?
Doug Kiersey 13:55
I think our average size facility is somewhere around 250,000 feet, minimum might be closer to 100. And the maximum would be close to a million square feet. But if you took the average of the properties that we have, I think around 250 would be a good number.
J Darrin Gross 14:14
And as far as the size of the facilities is at something that’s grown over time, is it is it? Is it continuing to grow mean a million square feet sounds like a lot of mean that’s a pretty significant structure there.
Doug Kiersey 14:34
It is, when you walk into a building of that scale and look around it’s it’s absolutely massive. Building sizes have grown as our customers seek to squeeze efficiencies out of their supply chain. However, as you move nearer to the core of the city, as we like to do and these infill locations, they tend to be a little bit smaller. So those two forces are Working sort of against each other, in what I would call the outer suburbs or the excerpts, buildings are still trending larger in the inner suburbs or the actual urban area, urban core areas, they, they tend to be smaller because the sites are smaller.
J Darrin Gross 15:19
And as far as the the locations, you mentioned, kind of the, you know, more towards the the infill, as opposed to the The Outer Limits? Are, are the facilities you’re you’re developing? Are they single occupant? Or are they multiple tenants, or
Doug Kiersey 15:36
What we build flexibility in the buildings for current or future multi tenant use. And so the designs with respect to where you, where you have the entries and level of dock doors and the parking and, and your utilities and so on, you want to make sure you have the flexibility to lease to multiple customers, either in the first generation of leasing or as you relate the building downstream. Having said that, a lot of our buildings end up as single customer buildings.
J Darrin Gross 16:08
And, and just as a concept, I mean, when we speak with logistics and my mind, I’ve got a warehouse with several dock doors and trucks pulling up and unloading and loading and, and, you know, you guys are the brick and mortar piece and that but the people moving in and out and all this stuff. And thinking Amazon FedEx UPS is that kind of the, the, you know, one of the types of occupant that that would be a potential tenant for your building.
Doug Kiersey 16:41
Well, of course, like other providers of logistics real estate in the US, Amazon has been a huge customer of Dermody properties, and they’re a great customer. And our relationship with them remains very strong. As you may know, they’ve announced recently that they’re going to pull back a bit on their absorption of new space, kind of digest what they have, if you will have even talked about subleasing a handful of facilities. But at their peak couple of years ago, they were absorbing something like 20 or 25%, of all new construction of logistics space, in the in the US, and so they’re a massive customer for for us and for our competitors. The other names you mentioned FedEx and UPS. So that vision that you have around local deliveries is is one of the segments that we play to there are some others that are a little bit less truck intensive, a little more Interstate in nature. So we we work with customers that want last mile facilities, we work with customers that want middle mile, and they work with customers that are focused on regional and super regional distribution. So we span across that entire continuum.
J Darrin Gross 17:57
So you kind of be the different distance points you mentioned last mile as opposed to enter AND and OR I don’t remember the exact phrase used there but that kind of the difference on the the distances there how has that changed a bit because you know, when I was preparing for this and I was kind of thinking through as a kid before the internet you know, there was this the Sears Christmas wish book was kind of like this this thing that was like you know, I can remember like looking at something and like you know, focusing on it and letting Santa whoever know that that’s what I wanted. And I can remember like we go to Sears to pick up that last piece I’m just thinking about it just from the standpoint of you know, Sears is predominantly if they’re still in business I know the mall we’re I bought every pair of jeans and tennis shoes growing up has been destroyed you know demolished and repurpose now I think it’s a Lowe’s or something like that. But it seems like in the model of distribution, it was a fairly significant last mile receptacle there now with like the the Amazon and and, and, you know, FedEx and all of this, the ability to just order something on your phone and have it show up here and, you know, sometimes the same day. Is that is that part of it? Am I Am I thinking right? As far as some of the the the change in the way that the distribution of products to the consumer has, has evolved?
Doug Kiersey 19:36
It’s been a massive change over the last 10 or 15 years. And the pandemic was an accelerant to that cultural change, or that secular change, I should say it’s also a cultural change and how we, how we bring goods into our home. I’ll give you another name that to date myself Montgomery Ward. So you could you could say that Montgomery Ward and Sears were the early General ecommerce companies throw JC Penney in there as well back in the day and but what these companies want now is they want to compete and unsettle SATs companies e commerce but also the omni channel retailers. So the Walmart’s you mentioned Lowe’s, the Home Depot’s, etc The tractor supplies, they want to be able to compete based on their ability to deliver to the customer. They don’t want to compete based on price because that puts downward pressure on margins. So they’ve all been racing to optimize their supply chains. And the last mile piece is the hardest piece because the barriers to entry are very, very significant. So we focused a good deal of our energies on identifying sites that serve last mile needs of our customers. And that means we’ve been involved in a lot of you mentioned repurposing, and you mentioned a mall becoming a Lowe’s Well, now you know more tearing down in full on corporate office campuses, and replacing them with logistics. We demolished a General Motors plant we’ve we’ve demolished a milk prod Dean’s foods milk processing plant. So there is sort of a great repurposing occurring across real estate and we’d like to think that we’re sort of at the tip of the spear of that.
J Darrin Gross 21:27
It’s funny because the repurposing, you know, there’s different levels of repurposing, I think a lot of times have just the occupancy of the structure from you know, a to b or, you know, office to warehouse or I know like I’ve seen it happen here recently where like some of these parts are retail single occupant, you know, buildings have changed to either another retailer, which is not really it’s just like returning the building or to storage, self storage or something like that. But but you know, that that the actual just coming in and raising, you know, multi 100 storey or 100 Square 1000 feet, retail mall, and then coming in and building something new. It’s just like, I’m gonna Wow. You know, is it it’s hard to comprehend that in my lifetime, something when it was brand new, and was the the place to be, has fallen out of favor, so much so that like, no, Naka, Dallas doesn’t, you know, put a loser. And, but, but I guess I mean, that’s what it comes down to if the if the demand is no longer there, and there’s no value in the structure, the way that it’s configured, and the land has value, you know, come in and repurpose the land. And I’m assuming that point, it’s more about the location of the land, that’s a value to to you. And, you know, that last mile concept.
Doug Kiersey 22:59
So the number of households that our customers can reach within a certain radius of the facility and the demographics of those households, that all becomes part of the mix, in terms of whether a site is is attractive for one of these sorts of facilities. And so we spent a good deal of time doing research around those metrics, but you hit on something else, and that is that this change really relies on the cooperation of the municipalities, because in states where there are sales taxes, which are most states, when you lose a retail tenant, or even a mall, and you replace that with something else, that local municipality is losing that red, that tax revenue that they’ve relied on for years. So often, there’s the tension between the reality of hey, this mall has been vacant, it’s an eyesore, versus well, we don’t want to lose that as as retail land in our community, because once that tax revenue goes away, it never comes back. So that’s part of this transition, if you will. And I think everybody in their own community you can probably point to one or two notable projects it’s just just when we grew up, there was a mall there now it’s something else.
J Darrin Gross 24:21
Yeah, not at it is just kind of a weird thing. When I mean, how, how fast it’s happened, I guess it’s kind of the thing. I mean, maybe it’s just I’m getting old, but you know, the the fact that something could be something that was such a a pillar of the community and you know, now it’s like there are paths out let’s move on. It’s kind of a you know, are more and more hard for me to under to recognize I guess it’s a you know, somebody that spent a lot of time learn but but as far as so the, you know, the logistics. I guess one of the questions I have How big is the business of Logistics, you know, and from, from manufacturer to consumer, all points in between. Is there a percentage of the GDP? Or is there a number that that, you know, just as a because it just seems like when when I start to think about all the different points from the manufacturers location to whatever the the regional warehouse might be to the, to the ends of the spoke? You know, and then that last mile thing, I mean, it’s a big part of the economy is not,
Doug Kiersey 25:36
Its massive. And that’s a really great question. I wish I had a specific answer for you, but I don’t. But as you think through the consumers being 70%, of the economy of the economic activity in the US, and that all everything we touch, or look at in our office, or our home, or were came out of a warehouse, at some point in time, that I’m sitting here looking at my Fiji water, we that was in a warehouse, so we could go somewhere. And so when you talk about the trucking industry, the railroad industry, the warehousing industry, and all of the players that go along with that the shipping business, it is a massive part of our economy. And it’s a growing part of of GDP, and it’s, it’s a growing part of the of the labor force as well. And if I can make a point about labor, these aren’t the forklift jobs that we’ve maybe have in our mind are still plenty of that. When I walk into an Amazon building, and I’m not saying anything out of school, because they’re publicizing this, but they’re starting, they’re people that something in the high teens to low $20 An hour wage, with benefits with the potential to earn college tuition, with flexible time, and that’s a whole bundle there. And so the, the labor market for these kinds of buildings, by itself has become extraordinarily competitive. And our customers are stepping into that. And we’re part of that offering, because we want to build attractive buildings where people want to go to work with amenities. And so, you know, the labor piece is, is is kind of redefining a little bit what we deliver to our customers.
J Darrin Gross 27:28
I’m curious on that that labor piece, you mentioned previously, the municipalities, you know, the resistance to losing a retail facility, because of the lack of of, you know, tax base, if they if they have retail tax. But I’m curious, is there a shift in thinking in the recognizing the jobs that the facility is bringing, and the ability or the income tax from the the employees, and all of the, you know, supported, you know, industry around around the facilities at? Is there any recognition of that as far as their municipalities? Are they shifting their their sense of, of a revenue stream,
Doug Kiersey 28:13
The real beneficiaries of the municipalities directly and indirectly as the property tax revenue. And so we’re massive pairs of property taxes. And when you hear the word, the term property taxes, think schools, because schools absorb, in most areas, fully 40 to 60% of the property tax revenue dollar. And so we’re, we’re wonderful for schools, we don’t bring any children into the neighborhood, but we pay a massive amount of property taxes. So there’s a strong recognition around the value of that the income tax side is a little a little different, because most of that benefit goes to the state and the feds, of course,
J Darrin Gross 29:00
gotcha. But on to I’m just knows that the shift on the tax is there, that makes sense. It’d be more of the property tax here. So I got that. So that we’ve talked about the some of the players and some of the lifestyle things that have changed as far as you know, the ability to order something online. And you mentioned that that a lot of the pandemic and some of the, the funds that that were distributed by the the government through the pandemic and that was this. You also said the pandemic kind of accelerated this the change if the pandemic did not happen, and the the the funds weren’t given to people the way they were. Or the elements is it more of a technology thing and that the people have have kind of just accepted a new way. I mean, our, our people’s buying habits changed my kids, they would rather not talk to you. They’d rather just click a button. And and I mean, I even had to coach like to go to the line, we have to talk to them.
Doug Kiersey 30:19
Yeah, there’s that there is a club that there was a generational swing there. But I think across all the demographic groups, the adoption of E commerce prior to the pandemic, that adoption was running doctrine rate was running at about a 15% annual compounded rate, so about a 15% CAGR than the pandemic hit. And it accelerated that at about four to five years of growth was accelerated into into two years, during the pandemic, now, the growth rate has leveled off because what happened was, that pulled a lot of that adoption. Forward. And so that’s, that was not a sustainable rate. But it is all about behavior, consumer behavior, and why do we need to go to the store to have, you know, daily items brought to our or to go buy pampers or ketchup. And so that, that creates a particular challenge for the omni channel and E commerce, folks, because the kind of distribution that you do, if you’re Walmart, when you have kitchen, a Kitchen Aid mixers, that are brought in by the train load, into Joliet, Illinois, then broken down to the truckload, and ultimately, the pallet load. And then the pallet size is delivered to the stores. That’s a very different order fulfillment than having someone go on their phone and say, I want a KitchenAid mixer, package of Pampers, a box of pens and a case of coke. So you see how companies are having to modify their supply their customer fulfillment, the omni channel folks in particular, where they’ve had that model that I described earlier, where they’re bringing bulk to the stores, and then the consumer walks in, versus being able to fulfill individualized orders. And so that’s the transition that’s been occurring and different firms have a different take on this Target, Walmart, for instance, have done a good deal of that fulfillment out of their existing stores. In addition to buildings and E commerce specific distribution buildings, Amazon, as you know, is ecommerce only. So that’s, that’s what they’re set up to do. But every time I describe one of these models, it’s a different set of material handling equipment, different set of labor challenges, and a different kind of brick and mortar that needs to house all that.
J Darrin Gross 32:57
Yeah, she was saying that I just occurred to me that, you know, in the traditional model, you go to the store, you buy the three items, whether it be the mixer, the coke and the Pampers or whatever, and you leave, you put them in your car, you drive home. Now, if you’re going online, and your click, click, click, kind of thing, it may appear as one order because you submitted all in one order, but just occurred to me that that perhaps not all of those three items are coming from the same single location because like an Amazon or even Walmart or whoever, they could have a number of mixers on the shelf in the the community you’re in. And maybe they have pampers cross town and maybe they have the ketchup or whatever else it is you ordered somewhere else. And so that, you know, they’re able to utilize all of their you know, different different points and I know I had a situation where I had ordered some clothes or something is pre pandemic, but I remember the size is wrong or something and and I went online or called to to do the exchange I thought they’re gonna have me ship it back they said why don’t you take it to the retail store? And I found out I was part of the logistics for them, I was taking it to their retail store to restock their shelf as opposed to the the ship back and forth and that can so it as I kind of relate that is that is that a reality is is it are the I mean are the the district distributor distributors distribution network are the retailers are they now having to monitor inventory from all points and kind of watch the movement you know to fill the need and or to return the product or is that
Doug Kiersey 34:56
An entire industry has grown up around on reverse logistics, which is what that’s called, what we would call returns. And it’s massive, because as ecommerce and omni channel retailing grow as a percentage of total retail sales, and by the way, that percentage is now well north of 20% of all retail sales X autos, as that grows, this whole universe around reverse logistics has to grow with it. And you just gave some very good examples. I know people who in their own lives routinely order two or three garments, maybe the same kind of garment and a different color or slightly different size, keep one and the other three, go back. But where did they go? And how do they get there? How does it get restocked? I’ve had one retailer I won’t mentioned, send us. We ordered something from my granddaughter’s, like a backpack or something, they sent us something completely different. And when we went called to say, how do we return this, they just said, You know what, just keep it. We’ll send you what you wanted, but keep that other thing, because it’s cheaper for them, just to let us keep that $50 backpack than it was for them to try to handle it. That’s rather eye opening. So I would say that those are challenges that are building for our customers. No pun intended. But the other challenge is, what are we going to do with all these cardboard boxes? And so you have all this fresh cardboard delivered to your home every week? And sure we can recycle it. But how do we get to a place where we reuse some of that or get to a place where we use reusable cartons? If someone can figure that out, that’s the next billion dollar business
J Darrin Gross 36:53
that’s a great point because I swear I’m breaking down more boxes now I feel like I’m you know, back when I was in high school working at Kmart and you know, the unboxing put the stuff on the shelves you had to tear it all down or all the boxes and take them to the east to burn the boxes when I was a kid they didn’t even you know there was no recycling it just get rid of the trash kind of thing.
Doug Kiersey 37:11
Well, at least I think most people are diligent about recycling that but you’ll One wonders what what that market looks like there’s so much product coming in.
J Darrin Gross 37:21
Yeah, cuz it like said there’s boxes are there. I mean, it’s a perfectly good box that I would ship something else in or wrap a Christmas present or something and if I had a need for it, right, but the just the supply is so high. That’s a great, that’s a great idea. And a great point. I’m hopeful somebody figures it out.
Doug Kiersey 37:38
We have a lot of bright people around I think somebody will somebody will unlock that key to that.
J Darrin Gross 37:43
Yeah, yeah. So the the move from kind of the the brick and mortar retail to now more of the logistics model and the you know, the the E commerce model? How much of that? Do you feel like is is driven or does work from home? support that or create that demand?
Doug Kiersey 38:11
Yeah, so work from home, which I think we all agree was a byproduct of the pandemic. Although there’s always been a segment of the working population that has worked from home that has made available some of the main excuse me, I should say, made obsolete. Some of the existing especially suburban office stock, that’s no longer attractive to companies whose employees want either want to work from home full time, or wanting to come into the office on Monday and Friday and work from home in the middle of the week. So my brethren in the office side of the real estate space are trying to figure out what that means for their business. But in the meantime, it means that a lot of Class B and C office buildings are obsolete. And the question is, what do we do with them? In the suburbs? Potentially they could be torn down and repurposed. In the cities, there’s been discussion of conversions to multifamily residential, which is that that kind of stock that we all all of our cities need. The challenge is the physical challenge of converting that which we don’t have time to talk about this morning. And those barriers are fairly high to take an office building and converted into apartments, it would seem like it’d be very intuitive, but the execution is difficult. So yeah, the work work from home is the other main secular change that’s driving the real estate business, the first being ecommerce and the second being worked from home and sometimes those those secular trends intersect as they did for us at the Allstate campus in May in suburban Chicago in Glenview, Illinois, so that was a 232 acre corporate headquarters campus. Allstate made a decision during the pandemic that we’re going to move to a work from home model, which made that the over 2 million square feet of pristine office space then became vacant. And because of the value of the land for logistics space, we were able to acquire the property. And we’re in the process of converting all of it to a logistics campus, which I never thought in the 10,000 times I drove by the Allstate headquarters campus, which is an iconic property in the Chicago area and never occurred to me that I would live to see a day where industrial land would be worth more than class a suburban office space, but but here we are.
J Darrin Gross 40:59
Yeah, that’s wild. I’m assuming that the location of that primary to to the value for you guys, I’m assuming is Is it near like an interstate Exchange, or is that uh,
Doug Kiersey 41:12
So, it’s right at the interchange of the tri state Tollway, which is a 294, which is the major North South thoroughfare running through the Chicago suburbs, up to Wisconsin down to Indiana, at the willow Road interchange, and so it sits right in the middle of some of the most affluent housing in the northern suburbs of Chicago. And there’s a million people that live within a 10 mile radius of the campus. So when you combine that sort of scale, at over 230 acres, with that kind of infill location, it’s really, it’s really a generational investment for a firm like us. It’s something that we’re very, very excited about, it’s I wouldn’t know how to replicate that in any other major city in the country. Unless a if you think about your, your regional mall, you’re the I guess, in the Portland area, if you took like Washington Square, and that no longer existed. That’s the scale of development that we’re talking about.
J Darrin Gross 42:24
It is, it’s just kind of blows my mind. And you know, because you get used to it being kind of what it is. And then to realize it’s no longer in demand. Pretty weird.
Doug Kiersey 42:34
We’re in the process of, of demolishing. There’s a large handful of buildings that over 200 Over 2 million square feet in the aggregate. And the demolition has begun. And everyone from your Uber driver to your neighbor is talking about it because it’s such an iconic property and to see it come down sort of one bucketful at a time. I think it’s jarring for people naturally.
J Darrin Gross 43:02
Yeah. Well, and like said the work from home kind of change, I think, you know, I think pre pandemic they probably wouldn’t ever thought even thought about that.
Doug Kiersey 43:13
I can’t speak for all state because they’ve made their own public announcements. But one could imagine that, if that had been thinking about that sort of change, that the pandemic was an accelerant. So the pandemic was an accelerant for E commerce, it was an accelerant from work for Home, just to have the massive changes. But the two that I, I think about when I think about our little business,
J Darrin Gross 43:38
Yeah. Now the whole work from home thing I know, forever, I’ve had friends and people and I used to work, you know, from the spare bedroom all the time. And that was when I had a outside sales job and and then the technology was there, I just don’t think that there was the demand to use the technology and the scale that we do now. I mean, awareness, and, you know, talking on Zoom, right? But it’s fascinating. Hey, Doug, if we could, I’d like to shift gears here for a second. By damn an insurance broker. And as such, I work with my clients to assess risk and determine what to do with the risk. And there’s three strategies we typically consider. We look to see first if we can avoid the risk. And that’s not an option. And we’ll see if there’s a way we can minimize the risk. And when those are not options, we look to see if there’s a way we can transfer the risk. And that’s what a an insurance policy is. It’s a risk transfer vehicle. And as such, I like to ask my guests, if they can look at their own situation could be your clients investors, interest rates, public policy, what how whatever you would like to identify, or whatever you consider to be the biggest risk. And again, for clarity, while I’m an insurance broker, I’m not necessarily Looking for an insurance related answer? And so if you’re willing, I’d like to ask you, Doug Keirsey. What is the biggest risk?
Doug Kiersey 45:11
Well, it’s interesting, you should ask to ask that question. A question that I asked myself and I asked our team when we’re considering an investment is, what is our risk adjusted return look like? And so I know, or my investors know, if they want to put their money in the so called Risk Free investment, that’s also known as the US 10 year treasury, that presently they can get a return of about 3.7% a year? Well, I’m taking a lot more risk than that. And so what kind of a risk premium Dubai and Dubai investors and our company demand in order to take a number of risks. And here are some of the risks, the risk that we build these buildings and no tenants show up. So I’m taking demand risk. There’s the execution risk of building the buildings, can I build them on time and on budget, so I’m taking construction risk. While we try to mitigate that as much as we can. I’m taking interest rate risk, because our construction loan is on a floating rate basis. So I have to be able to understand what that looks like over the course of a three year construction loan term. And I’m taking long term interest rate risk, because I put permanent debt on the project, what does that look like three or three to five years from now. And lastly, I’m taking valuation risk. So when I create this income stream, when I build these buildings, and I listen to great companies, and they pay me rent, and I’m creating this massive income stream, what does that income stream going to be worth five years from now. And that’s really the biggest risk. So I can I can, I can do all these things and manage all these risks. But I don’t really know, five years from now, what that income stream is going to be worth because a lot of that is reflective of the Feds activities and where our interest rates going to be. So we tried to skate to where that we think that puck is going to be in five years. But that’s the biggest risk in our business. So we can have taken all that into account. When we look at levered returns for a project, like the logistics campus in the Chicago suburbs. We’re looking for high teens and low 20s kind of pro forma returns with appropriate and conservative underwriting on each one of those stocks that I mentioned. And so if my risk free investment is 3.7%, for the 10 year Treasury, and I’m going to do all this, I want something in the teams, that least.
J Darrin Gross 47:53
Now, a lot of a lot of risky, just identified there and make sense that you’d be looking for, you know, rate of return that makes it worthwhile. You know, it’s scary when you think about just that, that notion of the future value of what you’re doing and in how important it is that you’re attuned to what, you know, what the Federal Reserve monetary policies, you know, going to be. And that’s, that’s interesting,
Doug Kiersey 48:23
anyone that had been prior part of the cycle, we can generate, just to make the math simple $4 A year of return. And the investment, the institutional investors would pay me $100 for that property, they’d pay me $100 For a property where they would get $4 A year and return it if everything went well. And so that’s a massive inflation of asset values, which was directly the result of the Feds actions since the great financial crisis, and certainly during the pandemic. And now, they’re unwinding that. And so, now, I may have to provide $6 of income to generate that $100 sale to the investor community. So it’s a pretty significant change.
J Darrin Gross 49:20
And 50% additional return.
Doug Kiersey 49:23
Right, which is okay, we could plan for that. But for those projects that are existing, where costs are fixed. Yeah,
J Darrin Gross 49:31
I think that’s that’s really kind of the shift as to how do you adjust that that you know, that base are the bases there? I think the new projects where you’ve got to priced in from the ground, and all of your other stuff. I mean, it makes sense but that Yeah. And existing stuff. Again, I
Doug Kiersey 49:48
You hope that rents grow and there certainly rent growth in the US logistics markets, we may have historically, low vacancies, and so supply and demand were means in a great place fundamentally for landlords, we’re gonna see probably see continued rent growth, but you can’t grow rents fast enough to overcome the very steep increase in interest rates.
J Darrin Gross 50:16
Right, right. I think that’s that is the riddle we’re faced with.
Doug Kiersey 50:22
And as a consequence, you’ll whole slug of projects that were kind of in process that we’re just getting ready to start, have now been put on hold. And so that’s going to suppress supply in late 23 and 24. Because the pipeline has been disrupted, which will in turn, I think, grow rents in those those years. And so when we think about how to navigate these cross currents, there’s good news and bad news and everything. But what happens is, as you get caught short during the transition, that’s where people get hurt. Right, right.
J Darrin Gross 50:59
No good to have a strong balance sheet. In these times of turmoil here, Doug, where can listeners go if they’d like to learn more or connect with you?
Doug Kiersey 51:09
Well, our website dermody.com drmody.com has everything you need to know about our firm our history, the key associates, as well as information and a link to the project that I’ve referred to which we call the logistics campus in Glenview, Illinois and and my contact information is there as well. So if any listeners want to email or phone, be happy to continue the conversation offline. Awesome.
J Darrin Gross 51:45
Well, Doug, I can’t say thanks enough for taking the time to talk today. I’ve thoroughly enjoyed it. Learned a lot, and I look forward to doing it again soon.
Doug Kiersey 51:55
That’s wonderful. Darrin, thanks for having me.
J Darrin Gross 51:57
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