This is not a guesswork business.
You can take the risk out of these deals
and I think that's what we try to do on a daily basis.
(upbeat music)
- Welcome to the TRIP Wire podcast.
The show where commercial real estate meets data and insights.
This is a special guest podcast.
I'm Haley King with TRIP,
a data modeling and analytics firm.
For the CNBS, commercial real estate and COLO markets.
I'm with Lonnie Hendry, Chief Product Officer.
Today, we're joined by Jim Dilavue,
co-founder and principal at Paragon Commercial Group.
Prior to co-founding Paragon,
Jim was a real estate and finance attorney
with Latham and Watkins,
advising developers, investors and lenders
on transactions across the country.
He later launched Paragon in the wake
of the global financial crisis
to pursue what he believed was one of commercial real estate's
most compelling, mispricing opportunities,
necessity retail.
More than a decade later,
as institutional capital has increasingly embraced the sector,
Jim brings a unique perspective
on underwriting, development and capital allocation
in today's market.
Jim, we're so excited to have you joining us today.
Welcome to the TRIP Wire podcast.
- Hey, good morning, Haley.
Good morning, Lonnie, nice to see you guys.
- So, we just heard some of your background,
but I'd love to hear it from you.
Walk us through where you came from
and how you got your start in commercial real estate.
I'll try not to spend too much time on myself.
I don't think that's overly interesting,
but I guess the interesting component
is the conversion from being a real estate finance attorney
into the actual business of buying and building retail.
And I think as you stated,
and you guys talk about on the show every time,
this is cyclical business and sitting there
and as a big firm lawyer in 2008, 2009,
realizing that real estate was on sale generationally.
It's one of those times where this only happens,
two or three times in anybody's real estate investing
lifetime and it's all about vintage.
And I figured if we could figure out a way
to begin acquiring properties in that part of the cycle,
it's gonna be really hard to lose.
And so that was when I took the leap,
gave up the big firm salary and went to zero
and decided to start a company.
- That's very cool.
And I think we hear a lot about the negative stories
coming out of the GFC and people not being able to find jobs
or not having a path forward.
And it's kind of cool to hear your perspective
of having a really great gig,
but then seeing an opportunity
and being willing to take the leap at a moment
where probably, you know,
that was the last thing most people were doing
that already had something stable lined up.
- Yeah, well, 100% right.
So everyone told me I was nuts.
I assumed it would take us about 12 to 18 months
to get a property acquired.
I was wrong by about a year.
And so that 12 to 18 quickly turned into about 24 to 36 months
before we actually started generating income.
But, you know, I was young
and that's when you should be taking risks.
And so that was my thesis.
- No, it's great.
And I think, you know,
as you talked about the real estate market
being cyclical by definition,
usually when you're doing something
contrary to everyone else,
especially when there's fear in the marketplace,
that's where the real opportunity lies.
It's just having the internal fortitude
to make those calls when the chips are down.
That's the part that we all,
we know theoretically what to do,
but being able to do it is a different thing.
So maybe before we get into some of the deeper dive stuff here,
you know, we're talking a little bit about necessity retail.
It's kind of like a, you know,
real estate is very jargon heavy.
It's very regionally specific
and how rinse or quoted
and how you call certain things.
Like some firms call capital markets groups
just like the loan origination business.
Capital markets for other groups mean,
you know, anything that's brokerage-related, et cetera.
You know, when you sit in a necessity retail,
just give me what your perspective or purview is
from a definitional perspective.
- Yeah, so this is probably going to be
the single most important thing we talk about today,
which is our industry is in a terrible job
of actually defining what we do.
And what I mean by that is we put everything
under this big giant umbrella called retail,
but as you guys talk about a lot on the show,
that's just incorrect because malls operate very differently
and behave very differently than power centers,
then community centers,
then neighborhood centers, then triple net, right?
We can keep going.
So our corner of the earth is necessity retail.
And so I think nuance is maybe the key word
we're gonna use today.
You have to get very nuanced when you're talking about retail
and you can't talk about it in broad strokes.
So what is necessity?
Our view of necessity is it used to be called
grocery anchored shopping centers
and it was called convenience retail.
It's had a bunch of different names over the years.
It's now called necessity.
So what do we mean by that?
What we mean is convenience retail,
generally anchored by a grocery store,
which generates daily trips, not weekly or monthly,
but this is something that you're gonna go to
a few times a week, sometimes daily.
And our view of that is that consumers will really
prioritize necessity,
whether the macro market is going up or down.
And so we look at it as something extremely stable
regardless of market cycles.
As we know and you joke about often, I think,
is we're in a very illiquid business
where real estate should be a long-term asset class.
And yet we constantly talk about interest rates moving
and what's the Fed gonna do
and what's gonna happen with the war and tariffs.
And at the end of the day,
none of that should impact
like a long-term macro real estate investment thesis.
And so as we looked down, we thought,
okay, what's durable through different cycles
and we just loved necessity.
It's just stable.
It's not the sexiest thing by any stretch of the imagination
when it comes to real estate, but it's durable
and we liked the durability.
And so when that went on sale in 2009, 2010
and we thought we could gobble as much of that up as possible
and put a long-term debt on it,
hold it as long as we possibly can,
it turned out to be kind of a good thesis.
But so to answer your question directly,
the necessity stuff is really the neighborhood grocery
anchored used to have a lot of drug stores in those centers.
That business has seen some turmoil,
but generally it's grocery anchored shopping centers.
- I appreciate the nuance there,
because we joke all the time that, you know,
real estate's a local endeavor.
Sometimes hyper-local, two buildings on the same street
can have two completely different outcomes,
depending on who the operator is,
what the capital and debts tax look like, et cetera.
And I think just from a definitional perspective,
to your point, retail broadly,
doesn't get the love that it needs.
Because sometimes the,
if you look at the Lincoln Sea as an example,
regional and super regional model, the Lincoln Sea
is under the retail umbrella.
Well, that's a completely different,
the Lincoln Sea profile than what you're talking about
with these grocery anchored centers.
Because, you know, coming out of the GFC
and even especially through COVID,
I mean, you saw a huge rush towards this necessity
retail that you're describing,
because it was like, when everything was locked down,
people still had to get groceries,
people still needed to get their prescriptions filled, et cetera.
So maybe that leads me to my next question here of,
you know, post GFC, this was maybe a contra play,
fast forward to COVID.
This becomes the darling of the industry.
Obviously for the stuff that was already in your portfolio
or that you held, that's great,
because that increases valuations, et cetera, et cetera.
But how does it change the outlook
from an acquisition strategy, et cetera
when everyone else is trying to put capital into this space?
- Yeah, it's very funny.
If you look at our acquisitions over the years,
starting in the GFC through today,
we acquire more when fewer people are in the market,
not surprisingly.
Now everybody wants to get in the market,
and the really interesting thing that's happened
over the last 24 months is,
so when we started the company,
I spoke to every private equity firm in the United States,
and said, "Would you like to partner with us?"
And you know, 90% of them wouldn't even return my phone call
'cause I'm in the retail business,
and that was not the flavor to Azure.
All of those friends have now in the last two years
really wanted to meet and talk about
how they can get into the business.
There's a huge moat around this business currently.
And the reason there's a big moat
is that most big investors actually let go
of most of their retail specialists,
post GFC, post COVID, you know,
the retail apocalypse narrative.
So a lot of them don't even have specialists,
and so now they're looking to allocate capital
into necessity retail.
It's a very hard business to build a team into
if you haven't been in this business for, you know, 10, 20 years.
It's a very relationship-driven business,
and it's very nuanced business.
And so those people have like spent,
have come and spent a lot of time in our office
trying to get educated on how they can allocate capital.
And it's very, very difficult
because for the first time in over a decade,
those assets are performing well,
so there's not a lot of sellers.
And so, and the asset size is small, right?
You guys talk a lot about office buildings.
We were talking about $2,300, $400 million assets.
All right, our asset size is, you know, $50 million.
And so it's very difficult to scale,
and there's very few portfolio transactions.
And right now, the asset class is, you know,
north of 95% occupied,
depending on where you are in the country.
And so there aren't a lot of sellers,
which makes it, you know, makes it tough to get into at scale.
- Yeah, I think those are all valid points.
And it's, well, we've seen the same thing
with some of this urban infill industrial
and like last mile distribution, you know,
short bay, not very tall clear heights,
but there's not building though.
So if you own a portfolio of those,
it's really well positioned,
but it's very difficult to scale that
because there's just not a whole lot of those
on the market, and the ones that are on the market,
the owners know what they have.
And so it's a difficult proposition.
You know, one thing that I think is very interesting
about your sector here is the grocery anchor component.
I mean, like obviously that brings the stability,
that brings the durability that you talked about, et cetera.
But they have long-term leases in my experience.
There's been a few years since I've actually been,
you know, on the ground with some of these deals.
But I remember back in the day,
you would have a grocery tenant that might have
an initial 20-year term with a couple of additional,
you know, 10-plus units.
your options and rent growth on those, the steps on those were fairly nominal relative to what you
might get in other asset classes with tenants. So just give us a little bit behind the curtain of
what that looks like and how you deal with that. Yeah, Lonnie, you've done this. I can tell that's
an excellent question. And here's why that was the biggest criticism of the asset class for
very long time, which is look, you got fixed rent bumps, your shops are only grown at 3% annually,
your pads are grown at 10% every five years and your anchors are largely flat. You're not even
keeping with up with inflation. It's just not that interesting. We can't get the growth we need,
right? So that's when their risk on narrative was pervasive in real estate. When risk off became
pervasive and everybody just wanted cash flow, everyone's magically fine with that all of the sudden.
And so, you know, we're growing rents. If we grow at 5% or 6%, that used to be not popular to
talk about at cocktail parties. Now everyone's just staggered by that. It's great because it's durable.
It has you have credit behind most of these leases. And if you're growing at 6% without a lot of risk,
that sounds fantastic. So again, back to vintage, back to cycles, you know, we're in that moment where
people are willing to, you know, make less annual growth in exchange for places to allocate capital
that they view as as durable long term. Yeah, I think it's a fair point. We've written several
pieces a trip just talking about the power of perspective. And I think you just gave us another
example there is when people are are risk on or risk off, it really changes the narrative. The
property and the performance and the rent growth, that doesn't change. It's just their perception
of the value of those things. And I think you mentioned earlier, a lot of these centers are 95
plus percent occupied, which is very difficult right now. Maybe industrial is the only other asset
class that you're seeing that type of stable occupancy, but multifamily, which has been a huge
favorite for the last couple of decades. You're seeing a lot of rent concessions, a lot of new
inventory on the market. And that kind of leads me to another thought here is just, you know,
one of the benefits, I think, for you guys and this is speculation, on my part, you can confirm
this or tell me I'm wrong, but this is not a sector that sees a ton of new supply relative to
the other asset classes. So I think that, you know, probably goes to the moat that you were talking
about earlier as well. Yeah, I mean, we've built ground up over 20 million square feet on the
West Coast, you know, through our careers. It's very difficult to develop ground up right now for,
you know, all the reasons we can talk about. And then I think all the listeners can already know.
That said, I think one of the things we consistently bring to the table, which helps us, is that we
buy every asset from a value add standpoint. We're always looking at moving buildings, looking at
what rents are, we're looking with TIs are, looking at land value is, how can we change the asset
to create a little bit of value? And there is small movement in a lot of these, especially the
larger shopping centers. If you think about, you use the term back in the day, I try not to think
about myself as that old, but I guess I am. But when you think about when a grocery stores were 55,000
square feet, right, that was just the prototype. And everybody was doing 50 to 60,000 square footers.
Well, what's the prototype now? It's much, much smaller than that. Trader Joseph's 12,500, you know,
most grocers are 20,000 feet, 25,000 feet. What does that mean? That means there's a ton of boxes
on the market right now that need some level of construction. What is that, that's demizing,
that's moving boxes. So there is, there is a component there that helps us create value that a lot
of investors don't want to handle. I mean, it's hard, right? You're talking about entitlements,
you're talking about demizing, you're talking about utilities, you're talking about loan draws and
capital costs. And so it, it's difficult. So most of this capital right now that's entering the
space is really more on the core plus and even believe it or not, the core side of the ledger because
they don't even know the market right now has a lot of opportunity and value add capital. They can't
find a home. They're not willing to take the risk. When I tell them that I got to move a building
and slice 20,000 feet off and we're going to retend it. It was something else that like, oh,
that's too difficult. We want that kind of very stable cash flow, not the risk of construction.
So that's what we're seeing in the market right now. We're super bullish, but I will tell you,
it's very difficult to find deals. And at some point that construction component you're asking about,
that's going to come back right now. We've got everything kind of running against us, right? You've
got high cost, you've got a high cost of debt, you've got scared equity. And then in some markets,
you have entitlement risk, like those are not a recipe for conservative investment and rents have
grown a lot in retail, right? And so rents are high. And that's, you know, you never really want to
develop ground up into a center that consists of a bunch of really high rents that only have downward
pressure. So right now, I think, unless it's a pre-least, so we use the term development,
unless it's a kind of 80 to 100% pre-least deal and development is just going to continue to be slow
until we get some break in one of those metrics. Yeah, I agree with you. And that was kind of the
the thought process is it really bolsters your existing book and portfolio because I think everyone's
going to be facing those same challenges. Even though I read something this last week,
it was one of the public reads I was talking about backfilling some of their big lots and other,
you know, retail tenants that had gone out. And I remember I think they had something like a 50%
increase in rental rates by turning those over. So it was a terrible outcome for the tenant,
but it was a great outcome for the landlord. And I think people underestimate
how some of these legacy tenants that have long term deals in place haven't truly kept up with
market. And when they leave, that construction concern that you just described is real, it's risk,
it's scary, but the reward can be pretty significant if you do it well.
Well, that you guys talk on your show a lot about kind of the narrative. I think that's a
favorite term of yours. The narrative is always is very entertaining to those of us in the business
because you're going to get the front page headlines saying insert name of tenant here is going
bankrupt closing 300 locations, right? Everyone reads that and goes retail is dying. They don't then
read the next one 12 months later where the REITS report that they backfilled all of those at 50%
higher rents. And so it was a blessing in disguise because that tenant was probably pretty weak anyway.
So I don't think I can say in like the last 15 years, there's been a retail, a retailer failure
that everyone in the business didn't know was coming. Like it's very rare that there's a surprise.
You follow the credit, you know what's coming. And frankly, we love buying retailers that we think
are failing. So, you know, back in the day, we were buying office depots. Why? Because they had
20, 15 year leases and they'd be five years into a lease and the rent would be dramatically under
market. And we had a little mouth strap where we could reposition those boxes. There's a couple of
other retailers right now. I won't name that we think will fail. And we're buying those, you know,
rents because they're 50% of market. And if that retailer fails, it's just a market to market
opportunity, especially if we can, you know, we had a center, I'll give you a specific example. We
bought a big locks anchored shopping center in Orange County, California. And we retended it with a
sprouts, right? The big lots rent was less than $10 a foot. And the sprouts rent was north of
$30 a foot. And you changed the character of the shopping center from a non grocery anchored
center to a grocery anchored center. So there's capric compression, you get better debt, you get
better equity blah, blah, blah. So, you know, that's kind of the home run scenario. But you're entirely
correct. I mean, that's, it's, you have to kind of be in the business daily. And that's why I
really like where we sit right now because that moat continues to be real, notwithstanding the
interest in the asset class. No, and I think, listen, your experience in the business through
multiple cycles, I think, lends itself to credibility because like what we've seen and you, you
probably competing with this at some level is as industries change, the sectors fall out of favor
than capital flows to things that are more in demand. And you get people that, you know, enter
the space new and don't really know from a boots on the ground perspective what it takes to operate.
And I think, you know, one thing that we've really latched on to in the latter half of 25 and
through 26 is I think the pendulum has swung now to where this is an operator's market. If you
know how to actually execute value at reposition, retinent, all of these things underwriters are
looking at that differently than the new entrance to the market, even if they have good capital
backing, because operations matter when interest rates are high, when insurance costs are through
the roof, when property taxes go up. So in retail, when you're occupancy cost are hitting the
red line and you got to work something out with your tenants, they need someone that that runs the
center that understands how to navigate those things. That 100% all the investment committees across
the country right now to your point, you brought up industrial multi, they're sitting around looking
at their pie chart and they're saying, wow, we have a big allocation of industrial because the
last 10 years, we've got a big allocation to multi, you know, there's some stress on those sectors.
Where else can we go to get a little bit of yield? And honestly, we're benefiting from that a lot
because those pie charts don't have a lot of necessity retail. So those are the calls we're getting
in terms of how do we get into that sector? And so, you know, as much as I'd like to say, we're,
you know, geniuses and we happen to be, you know, you talk about the pendulum, we happen to be at the
right place at the right time, but for 10 years, we weren't, right? And so what you have to do,
and I, you guys talk about this a lot, you just have to understand that the business is cyclical,
you have to be conservative on capitalization, you have to be long term in your thinking. We try
never to buy anything thinking that we're going to flip the asset, right? We try to take a long term
view of everything and we try to capitalize it accordingly so that we don't have that capital
market pressure because there's two components to all real estate deals, right? You have the real estate
deal and then you have that capital side of the deal. And if you can, in most of the time, a lot of
the time I should say those are mismatched. So if you can match those, it's really a recipe for
long term success in the business. Again, it's not things that want people want to talk about at
cocktail parties when you're talking about, you know, putting a low leverage life company loan on a
grocery anchor shopping center. Nobody's interested in that. But when it's generating, you know, when
there's 200 basis points of spread between your stabilized return on cost and your debt for the
next 10 years, you know, it's not bad. So that's kind of where we try to, where we try to play.
And it's like I said, we're in an environment now that's, you know, risk off and that's becoming
something interesting for people to talk about. Well, you know, I think some of the other tailwinds
that you guys have are just the regulatory pressure is really pushing certain dollars out of multi-family
and to other things. And I think
notwithstanding maybe some stuff that we heard coming out of New York yesterday around, you know,
state-owned groceries and other things. Like, there's not a whole lot of regulatory pressure for this sector that I see on the horizon.
I mean, I think for the most part, this will be a free market kind of endeavor, unlike some of the other property sectors
that are facing that increased political pressure for, you know, various reasons.
So, I wanted to highlight a couple of things that you mentioned.
One was the drug stores and some of the pad-site stuff that you guys have on your lots and your properties.
So, twofold question. One, I agree with you.
I think the drug store, the current drug store kind of construct is broken.
People have evolved. Delivery is now much easier. I mean, drones, mail, whatever.
90-day supplies, six months supplies. You don't have to go to the pharmacy once a week or once a month.
And so, I think that model has to shift and similar to what we've seen with the retailers, the grocery anchor retailer going from 50 or 60,000 square foot to, you know, call it 10 to 25.
Having a 10,000 square foot or 8,000 square foot, you know, CVS on the corner probably doesn't meet today's market standard.
So, one, what is the reposition opportunity for those, those properties?
And two, are there other value add initiatives that you guys are looking at where maybe some of your centers are overparked due to previous parking requirements and other things where you can actually create.
You can actually create some value with some additional parasite offerings.
Yeah. Good questions. The answer to both is yes. So, start with the drug stores. Two things on drug store buildings.
They are, in our business, we talk about single use buildings and multi use buildings.
I mean, is this a good size prototype for other retailers to backfill?
Drug stores have always fallen into the category of they're not great buildings to reuse. They're expensive to redevelop when you're putting another tenant.
Because if they all have their own, you know, Walgreens CVS, right, they all have their very own unique prototypes.
And so, it's very expensive to retenit those, but there's a lot of them on the market, right?
So, we have recently bought three of them, standalone drug stores, and retended those with, in one case, a grocery store.
In one case, a Davidit dialysis, and we're figuring out the third one at the moment, but they're extremely well located, which is the benefit, right?
They usually have, they're usually on a hard corner, but you have to balance that with the fact that drug stores paid very high rents.
For a very long time. And so, you can almost never match the rents. So, what's happening in the marketplace right now is a lot of owners understandably frustrated because they put a cap rate on a high rent.
They bought that. They're into the deal $15 million, whatever the thing is. And now it's worth six, right?
And they just don't understand how they could, you know, it could be worth that much, but because of the cost of retenit, the building and because the new rents going to be lower in the old rent, the math is very difficult.
So, those deals are difficult to retenit because of the occupancy of the market nationally that we mentioned. The market will figure that out, right?
The capital will figure that out because there's just not enough vacancy and retailers need space. So, retailers will figure that out through a combination of ti's and rents and landlord subsidies and everything else that we will figure that out.
And those are getting absorbed relative to your parking question. It's such a good question, Lonnie, target, lows, Home Depot. Remember back in the day where retailers wanted, you know, 10 per thousand parking, right?
And the idea was to have these massive parking fields. And that was going to generate additional sales for your hundred plus thousand square foot box.
Well, that's not a thing anymore. What these retailers have figured out is we'd rather have active retailers in our parking lots, co tenants that drive additional traffic, and then there's cross shopping.
So, if you look at any of those retailers I mentioned, they have now for 10 plus years been selling out parcels to retailers and whether that's a, you know, a drive through Chick-fil-A to bring a lunch crowd in or whether, I mean, we bought an out parcel at a lows in Northern California and put it in and out there.
Because those view was they drive a great lunch crowd and there is some cross shopping there. And so we've done a ton of those getting entitlements creating the parcels.
You're in escrow for a year, but by the same token, you're pre-leased by the time you close. And with the run-up post-COVID in the demand for drive-thrues, they've been really easy to lease.
So, you do have to have a team because you need your engineers and you need your architects and you need your entitlements and you have to take all that through the city and get the approval. And the cities now don't like drive-thrues as much as they used to.
So, that's become a thing. But you're entirely right. Like that space, that parking lot space has value to it. And so, it's been actually kind of a fun little line of business that we've kept since we started the company.
And we own a handful of them. Now we bought an office depot that was an out parcel to a target. We tore it down and we put a, you know, a Chick-fil-A that has 50 car stacking in it. And so they need that much real estate.
And so, it's a value creation mechanism for these big boxes that own a lot of real estate that don't need that real estate anymore.
Yeah, I know. I've seen it in practice and it's an interesting dynamic. But I think you hit on a couple of things and we'll circle back to that. But I just wanted to point out, people underestimate, like, take Walgreens as an example.
Their slogan is on the corner of happy and healthy. I mean, it's purely a real estate plate. It's just kind of hidden in the message. But they are on the corner.
The problem is just the business model has shifted. And so it doesn't have as much value into your point. A lot of those are built to suit with inflated rents and other things that cause problems. But I think like the dialysis, I've seen several of those go back for those. And you kind of get the benefit of both, like, still pretty high rents, good credit, long term tenants.
I've seen some family dollars and some other things backfill some of those with some success. So it's good to see that there are some alternative uses, even though I agree with you, it's very difficult to find that second generation user there.
And you were close to the level of rent that you were seeing before on the mix of tenants, though, and the cross selling, I want to get back to that.
You know, we've heard a lot from folks that are developing. We just had Justin Stein on with Tanger and he, you know, he was talking about how their strategy broadly was to bring more of an experience to their open air retail centers and food was a huge component of that.
Like they really need to up their game with having lunch and dinner options available for shoppers in your grocery anchored centers. That maybe isn't the same potentially, but how do you find that perfect tenant mix in those in line spaces that complement the grocery that also the grocery benefits those in line spaces.
Like, is there a formula? Is there data that you're looking at? Like what's driving some of those? Is it market specific based on demographics? Like what is the thought process that goes behind that?
Yeah, so I actually thought I was interesting. Justin Stein and Tanger, you guys had a great podcast. He talked a ton about merchandising and experiential retail and his view of the business. And I listened to that and I thought, man, it's different.
We're in the same business and we come at it from totally different angles, right, because he's got big centers that he has to fill and drive traffic into. And we think about the business completely differently.
Experience merchandising, of course, is important to us. What's more important is daily trips, getting people on site on a regular basis, right, the Tanger, the Tanger visits aren't nearly as frequent as your grocery store visits.
And so it's a totally different approach to the exact same asset class, which goes back to the very beginning of the podcast when we talked about the fact that we all call ourselves retail investors, but we do totally different things.
So the answer to your question is it is absolutely nuanced. So our investment thesis is we have to be able to visit any of our centers in that same day. So I can get on a Southwest flight in L.A. And I can be at any of our centers, spend the entire day there and then be back.
The reason we think that local nuance is important is exactly what you're asking, what is the thing about that local area that is specific to that area that you can't learn from Google Earth, right, is it a traffic pattern that you can't tell from Google Earth, is it a right hand left hand turn that you can't tell, or is it just something in the demographics and the makeup of that local neighborhood that you need to be aware of so that you can merchandise so that you can put that local mom and pop next to the grocery store that drives traffic.
And the people then go to the grocery store, put the groceries in the car, then run next door and pick up dinner like what's that thing that actually does create the cross shopping.
The interesting things, Lonnie and Haley that we saw during COVID that I was totally unexpected at the time, but in retrospect, should not have been is the fact that our mom and pop tenants were the best tenants we had during COVID, right, they paid their rent, they called every day and they wanted to make sure that they could they were doing their part working through this, we were partners in that.
And that was so unexpected because in our business, when you do it, when you sign a lease with a credit tenant, the thesis is it's financeable, the credits there, they're always going to pay the rent, we don't have to worry about them.
Well, actually that was flipped on its head when all of the credit tenants wanted to come back to us for rent breaks and the mom and pop's want paid their cams, paid everything.
So it kind of indirectly supported our investment thesis, not something we intended at all, but we realized, wait a minute, these things are way more durable than we thought, right, and then you put that next to a grocer and by the way, those shop tenants, those will have your annual rent bumps in them, right, CPI bumps, 3% bump.
So that's really where you get a lot of lift in your shopping center and you mix that component with maybe the more boring grocer component, which is more stabilized from an income standpoint.
And mix those two things together, and that's how you get kind of a stabilized that annual growth to answer your question about merchandising.
Yeah, I think my answer is it's nuanced, right, it's quicker food has become a thing, high quality, quicker food, but if you're talking about a shopping center in West LA versus a shopping center in Salt Lake City, I'm going to have a different answer for you, because it's really going to depend on the demographic.
Yeah, I think I think we see that play out and I agree with you 100% on the local mom and popster in COVID, I mean, you have, you know, in my experience, I teach at the university at Texas Tech University, I've been teaching for about 13 years, and it's really interesting how you get some of these like lifelong academics that are so theoretical that everything has to be credit, credit, credit, credit, credit, everything in real estate is credit.
But when you're when you're working with credit tenants like it's great
you get the certainty at some level but anytime there's a curve ball they're not set up for that
and they really don't care because they're running a larger economic engine where some stores may
fail in their business model and that's okay but it's not great for you as the owner of that
retail center whereas when you're dealing with mom and pops like that's their livelihood that's
their business that's how their kids go to college that's how they pay their mortgage payment
every month and so it was refreshing to see kind of a resurgence of people's understanding that
these local mom and pops actually are what drive community and at some level I think part of
this resurgence in in grocery anchored and just some of the community strip center type of retail
is people's realization that that eclectic combination of like super local married with some national
credit exposure get you the best results because you maybe like a certain burrito place or taco place
you're going to go there three or four times a month and that drives you know to your point
that gets you that that multiple visit type of experience whereas if you just had a large chain
in there it probably doesn't elicit the same type of response to some of the locals in certain markets
and so I think we've seen that play itself out it is I don't think you're going to get lenders
that are super on board with that like they still want the credit you know broadly but I do think
there's a mix that's required in order to maximize those local market factors and so it's great
to hear you guys are doing that as well so maybe just a couple more questions and we'll finish up
here you know we we've talked a lot about nuance we talked a lot about some of the things that we
think make this a differentiated asset class etc etc what are some things that are that you thought
maybe we're going to be easier you thought maybe we're more obvious that have proven to be challenging
or that you've had to like figure out on the fly as you've gotten yourself into this business now
for the last decade or two so we spend a lot of time diligently and I guess this flows right
from our mom and pop and national tenant conversation when you're going to sign a 10 or 15 year lease
that's a long time right I think people forget that it's a really long time in fact it's like
a lot of people aren't even the business that long and so what you need to do is you need to do
your diligence on the tenant right so if it's a credit tenant it's public information that's easy
right the question gets more interesting when you're talking about tenants without public
information or mom and pop tenants so you need to diligence if it's a little local restaurant
who's the chef who's running the restaurant do they have experience are they in other markets
you know what are their sales and other stores if this is their first store why do they think they
can be successful in this location what's their track record do they have a business plan what are
the financial standing behind the lease so there's I would say that part we spend a ton of time
on that which if you would ask me 15 20 years ago if we'd be spending time on that the answers
no and the reason is and I think you guys have talked about this a lot that turnover cost is high
all right so if I'm going to spend a bunch of time and money and you know TIs doing a landlord
build out giving the tenants some money signing a lease legal cost engineering entitlements all of
the stuff to put it let's just call it a two thousand foot tenant in there I don't want to lose
that tenant the turnover costs are high that space goes dark for six to twelve months I got a lease
that I got to pay another brokerage commission I got to pay another so we try to invest heavily
up front and put tenants in that we think we can actually stay there for 10 years and I've seen
this big divergence in the business where a lot of landlords will sign 10 year leases full well
especially with restaurants full well knowing that tenant is not going to be there in 10 years right
and they're giving them big TIs because a really cool chef driven restaurants and they generate the
the daily traffic and it's really cool to talk about a cocktail parties right that's just not what
we do we're looking for durability and so that you really have to diligence how successful and it's
hard to do right it's very subjective there's not a trip type database where you can punch in
the local burrito guy and figure out what their credit is going to be right oftentimes you're
getting personal guarantees so you got to understand where that's coming from so I would say that's
probably unanticipated but is also part of the value creation is important that's a great you
know look back on on kind of our pulling the curtain back on just the reality you know because
I'm with you it's that's the part that that maybe doesn't pay on the front end but does pay in
the long run and and beyond just the turnover cost which are very real and those are hard hard
dollars you get a psychological stigma at some level if you have constant tenant turnover in
your centers where people are thinking there must be something wrong here or the management must
not be very good at their job here because they're getting a new restaurant every a year and a half
or whatever like that I would assume has some long lasting negative implications for the center
yeah and then I got to your point about debt I need to go convince the lender now of that same story
right because the lenders ask you well wait a minute who's this tenant and then you give him the
diligence package and show them hey this is why we really believe in this tenant and by the way
generally speaking you know we've had a lot of success we haven't received a lot of pushback
as long as maybe that non-credit tenant is offset by some more credit in the center elsewhere
yeah I think that's where we go back to this the blend has to be right for the lender appetite
so so last question here Jim and this has been incredible so I really appreciate your insights
I mean it's the reason we do these guest podcasts is really to bring people with real time
experience because we see the data at a high level but you're living this every single day right
and so you know you just spoke about some of the diligence and everything that you have to do my last
question for you is this and it's maybe a little bit of a funny question the elbow space in a retail
center everyone knows what that is it's not a funny question at all it shows it shows that you're
a professor so give us so maybe maybe give our audience that maybe don't know what I'm talking about
what what is the elbow space and how do you deal with that are there some strategic things is it
when you see a center that has that kind of like are you maybe a little less excited about it or
do you guys feel like you can navigate it yeah so for those who don't know he's talking about and
he's being a little professorial here he looks at site plans and he thinks when you're looking at
a site plan that the building is shaped like an L he's asking about that corner space that has
very little frontage pinched parking and it's almost unleasable and the question is how do you
underwrite that and the answer is I have no idea if we see a shopping center that has that in it
more than 90 percent of the time we're just not going to get there because that space should have
never been built and we've seen this movie so many times over the decades of that space you know
everyone has a local karate studio who wants to take it or a destination mom and pop you know
yoga tenant who can take it because they're destination and they don't need the visibility it just
doesn't work out that way like retail is actually not that complicated you need some parking you need
some signage you need some visibility and then there's some cross shopping involved in all of that
and if you were the tenant that has five feet of visibility in the corner even if you have a 10,000
square foot space it's just not going to work it scares the heck out of us and so we just try to
stay away from it but yes you're showing your your Texas tech professorial skills is refreshing
actually to hear that you kind of just avoid it because I think it's I think there's I don't think
there is a solution a good solution and the options that you mentioned or what everyone goes to
is I always put a karate center in there it's like great but they they put no work into the space
they're not a great tenant and if anything goes bad they could probably kick your butt if they
had to practically speaking we put a zero on it so we'll bid on the set yeah we'll just put a zero
on it which means we never buy yeah and then you you hit on one other thing and then I will turn
this over to Hayley but I have a good friend of mine that develops retail centers down in the
Houston market in Texas and he has an acronym at his firm it's called VAPS and you just hit all
of them is vacancy access parking and signage he's like those are the four ingredients that are
required for productive retail investment it's not complicated well Jim this has been incredible
your themes of the nuance of retail the need for durability and your outlook have just been so
clear here today maybe give us your one final take and share you know what gives you the most
conviction in the retail space or what keeps you moving forward every day so my frustration with
this business has always been the amount of hyperbole in storytelling that in this business
and it doesn't need to exist look I understand the power of storytelling we do it everybody does
it every day I would say make sure you're looking at the data because a lot none of what we're talking
about should be or is a surprise to anyone if you're actually looking at the data and so what we
try to do is spend more time most and of course there's a storytelling component to that and a
conviction component to that but history repeats itself the pendulum swings history rhymes whatever
phrase you want to use and overlay that with capital markets and then just the actual data from
the retailers and a lot of this is public right you can spend the time especially now with AI it's
super easy to access you can figure out expansion plans you can figure out prototypes you can figure
out rents but it's data driven and so what I tell and I do some guest lecturing Lonnie down at SMU
in Dallas on a regular basis and I tell him like just spend the time to get the data and you know
this is not a trep commercial but like you guys do that like that data is available look at the data
and then take a lot of the guesswork out of it this is not a guesswork business you can take the risk
out of these deals and I think that's what we try to do on a daily basis so I guess that would be my
my final take and it's great I'm sure our listeners will have even more questions for you or want
to reach out and see how they can work with you or your firm so can you just share a good
way for them to get in touch or learn more about Paragon. Yeah sure just go to our website
paragoncommercialgroup.com LinkedIn we're all there and just reach out we love to hear from you.
Awesome thank you so much Jim this has been incredible as I said and listeners please reach out
if you have any questions we can also direct you to the team at Paragon.
Thanks, Ailey Hague.
Thanks Lonnie, nice to see you guys.
- So with that, we'll close this special podcast.
Thank you, Jim, for joining us today.
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