Net Leased Real Estate Investing

EMS:

Hi, Justin. Thank you so much for being with me today.

Justin Arasin:

Thanks for having me.

EMS:

Absolutely. So, to kick off the conversation, tell us a little about the firm and how you got to where you are today.

JA:

Sure. So, U.S. Realty Advisors, we're a 35-year-old single-tenant, triple-net leased real estate firm. Most of our investors think of us as a hybrid investment between traditional fixed income as well as real estate. Our goal is straightforward. We're striving to generate long-term stable inflation-hedged cash flow that's backed by operationally critical assets, where the underlying tenant is creditworthy in nature. Since 1989, we've done about $12.5 billion dollars of transactions. Today, in the way of assets, we oversee $6.5 billion, and we work primarily with institutional clients as well as RIAs and family offices. For me specifically, I've been in private markets for the last 20 years. I started at Goldman Sachs as an analyst. Thereafter, worked at a few boutique hedge funds, building and managing distribution teams. Most recently I came over from Nuveen where I was Head of Alternative Investment Distribution there. That included the real estate, real assets and private capital platforms, and I couldn't be more excited to join USRA. I think the culture being tight-knit, and then also what we focus on and the environment and the ability for us to execute, is highly attractive.

EMS:

Justin, that segues nicely into the follow-up question I have for you. Given the firm's focus on net leased real estate, I would love to hear your overall high-level outlook for this space.

JA:

Take a step back. I think whether it's an institutional or high-net-worth individual that I talk to today, there's usually three primary concerns they have, either a combination of them or all of them. Number 1, how do I generate a durable, consistent stream of cash flow that's not eroded by inflation? And if I'm a high-net-worth individual and that cash flow can be tax advantaged all the better. Secondly, how can I build a ballast or anchor in my allocation that complements my traditional equity and fixed income allocation? It has low correlation to those traditional markets and therefore offers diversification. And then thirdly, can that same investment over time generate some form of capital appreciation? And if you consider net leased investment being that hybrid between traditional fixed income as well as real estate and or an equity surrogate, that really helps to address a lot of those needs from clients today.

And if you think about a triple net leased, the underlying tenant, they deem that asset to be operationally critical to their day-to-day operations. They have no intent to move out of that facility, so renewal rates tend to be high, but the initial lease term usually is more than 15 years. They then also have renewal options to extend that and year over year, they also agree to some form of annual rent escalators. And so, you see that income that a manager's collecting, moving upward over time and helps to stave off some of those inflationary pressures or if interest rates even decline, could be an attractive income generator. The underlying asset being real estate, that's the low correlation to traditional markets I mentioned earlier and offers that form of diversification. And then finally, for upside potential, if we've performed as a manager to execute our investment philosophy, choose and select high quality assets in the right markets, then that offers the potential for asset appreciation over time.

EMS:

Justin, more specifically, where do you see some of the greatest opportunities in this space and why?

JA:

We actually just did a webinar, and it was called Assessing the Entry Point, Is Now the Time For a Net Lease? And if you look at historically, cap rates for net leased investments tend to trade in a narrowband of 6%-8%, six on the low end, and that was really 2014 to 2021. Today we're more in that 8%, maybe just north of that range, and really because of interest rate activity and capital market issues. If you look at net leased assets in general and particularly certain sectors, they're still fundamentally strong, the likes of industrial. And to us that cap rate expansion, it's just simply an opportunity to buy those same high-quality assets and income stream at roughly a 25% discount. And if you think about the inverted nature of the yield curve, most believe by the end of this year or early next year, you start to see that normalize and stabilize and as it does, investors will be rewarded with asset appreciation if they take advantage of this entry point in our opinion.

From a sector standpoint specifically, as noted, we like net leased industrial. We're seeing historical demand from tenants in industries like semiconductors, biomanufacturing, electric vehicles. You're particularly seeing a lot of demand from occupiers in the manufacturing space. That's evidenced by the annual construction spend on manufacturing facilities, which is now 300%. That's 3x historical levels. And so, what's driving that is a lot of the geopolitical tensions, the fact that there's government incentive programs to onshore and reshore a lot of the production capacity here in the states. That's again, a tailwind that we look to take advantage of.

EMS:

Justin, on the other hand, what are some of the greatest challenges you face in this space and why?

JA:

Maybe I'll talk about USRA in a moment, but I think just more broadly from an allocator standpoint, I think manager selection is even more of a challenge today. And I do think there'll be a dispersion of outcomes in any asset class, and it's going to stem from investment approaches of individual managers. And so, as an allocator, just asking those questions relative to track record, "What's the tenure of it? Is it the same investment team? Is it different that have driven those returns? What have those historical market cycles looked like?" And then in net leased specifically, the fact that you have unique sourcing of underlying properties that are not competitively bid on, the level to which you do credit as well as real estate underwriting, and then the ability to monetize assets stems from asset management.

So, what does that process exactly look like? From our standpoint, broadly speaking, we've tended to avoid urban-based skyscraper office assets, particularly in gateway cities well before COVID. But we can all agree now with work from home, hybrid work models, also continued out migration and urban centers, there's been more favor placed on suburban located low-rise office space with flexible floor plans that are highly amenitized. That probably will be the trend moving forward, medium-to-long-term. Some of those urban-based CBD skyscrapers will probably be refurbished for other use cases. So, for us, we're not allocated there, but until we get price discovery, more clarity on interest rates, it'll be too early to call bottom.

EMS:

Justin, to shift gears a bit, as perpetual vehicles have become so prominent amongst both institutional and wealth management allocators, why should one consider a capital call drawdown structure?

JA:

That's an interesting way you phrased that, because you said institutional and high-net-worth. This is the first time in my career where both sets of investors are considering diversifying within an asset class like net leased that they deem attractive across different managers, but also different structures. The reason for which is that's a differentiated return in income stream, something that offers quarterly liquidity like a non-traded REIT, a BDC, or an interval fund relative to capital call drawdown. If a manager executes on the latter, then that's that illiquidity premium. The ability to hold something long-term and see that IRR compound and starting to see, and it's the first time I have where managers are being paired together for structural benefits and therefore can offer that potential for upside, but also liquidity to fund those capital calls from the perpetual vehicles.

EMS:

Justin, we've covered a lot of ground today and wanted to see if you have any final thoughts you'd like to share with us.

JA:

I just couldn't be more excited. We have a tight-knit team, my partners and I, we're really looking to build a culture, continue to build one. We've had a 35-year legacy. We want people that want to come to work. We're in five days a week. This is something where we want to breed innovation and creativity and teamwork. If we do that within, then we're able to drive results for our existing investors, which we have historically, but we want to do for the next three decades and also thoughtfully scale the business with the right new business partners. Then lastly, we want to be known as a thought leader, whether that's the content we publish more on our perspective, it's product agnostic, all the way to the capital solutions that we're able to create for underlying tenants and the developers we work with as well as our underlying investors.

EMS:

Justin, I wanted to thank you so much for sharing your perspective with our listeners.

JA:

Thank you for having me.

EMS:

And thank you for listening to the EisnerAmper podcast series. Visit EisnerAmper.com for more information on this and a host of other topics and join us for our next EisnerAmper podcast when we get down to business.