Transcript:

Ben Smith:

Welcome everyone to The Retirement Success in Maine Podcast. My name is Ben Smith. Allow me to introduce my co-host, the NextHome and RE/MAX to my Coldwell Banker, Curtis Worcester-

Austin Minor:

All right.

Ben Smith:

... and Austin Minor. How are you guys doing today?

Curtis Worcester:

Doing well, Ben. Doing well.

Ben Smith:

Excellent. Well, speaking of real estate, that's something that's on the top of mind for a lot of people right now is I think going through the pandemic and you had people relocate to different locales because of remote work. You had our clients; their values have gone up of their homes and now they have more equity than they've ever had. So that's part of our financial planning that we've been talking about.

But also, now we've got high interest rates. So if we're buying and selling property, well what does that mean? So lots of questions coming out from the folks that we work with on a daily basis. And that's something that we just have been thinking... I think as our team. Geez. Well maybe we got to get a little bit more insight here for what's going on? So, Austin, what are you seeing from your side here on the real estate end?

Austin Minor:

Well, obviously Maine's very diverse when it comes to real estate and just as a state in general. So we have amazing forests, great small towns, oceanfront properties, and so that presents a lot of unique real estate situations, whether it's finding a rental home or you're looking for just buying land, maybe interested in logging.

There's a lot of things that are maybe unique when you're looking at Maine versus the national real estate situation. So we thought it might be helpful to zoom in a little on Maine today, talk about what we're looking at as Mainers, and then seeing how those issues are reflected on a national scale and if compare and contrast there.

Curtis Worcester:

Yeah, that's fantastic. And we like to do on all of our shows, hopefully our guests know this by now. We like to bring in experts. We're all good at what we do, but I will put my hand up. I am not an expert in real estate. So on today's episode we have a very special guest with us who brings a wealth of knowledge and expertise to the table.

Our guest currently serves as the chief executive officer and chief investment officer at Union Square Capital Partners, which is a firm specializing in real estate fund management. So before working at USQ, he was head of manager research at Nationwide Investment Management Group. Our guest holds a bachelor's degree in business from the Pennsylvania State University and earned his doctorate from Drexel University's LeBow School of Business.

He also holds the chartered financial analyst designation and a certificate in commercial real estate from NYU Schack Institute of Real Estate. So with that, I think we've just laid out how certainly educated and how much of an expert he is. So please join me in welcoming, Tom Miller to The Retirement Success in Maine Podcast. Tom, thank you so much for coming on our show today.

Tom Miller, CFA:

Yeah, thanks for having me.

Ben Smith:

Well, Tom, we are setting up our show here and we have lots of questions we want to ask you and what's happening, but from our audience perspective, we always want to just get to know you a little bit and what's shaped your worldview? So love to hear a little bit about your career history and how long you've been in real estate investing?

Tom Miller, CFA:

Sure. So I've loved real estate for the last 25 years. I put myself through college working for a title insurance company, so closing loans back in the late '90s and early 2000s and then got into investment management in 2006 and then you went through my bio there a little bit, just worked my way through and have been investing in real estate now at Union Square for the last seven years.

Ben Smith:

Awesome. So obviously title insurance, that first piece landing into it, was that something where you're like, "Hey, getting into college..." And it's like real estate was something you're just interested in or look for jobs found like, "Here's one." And needed some income?

Tom Miller, CFA:

A little bit of both, but I've always loved real estate and what I loved about that experience, I was actually able to... Even being in college at the time, I was able to invest in a couple investment properties and I still hold those today.

Ben Smith:

Wow. Nice.

Tom Miller, CFA:

So real estate has been central to everything I've done, even as I got older and got married and we bought our first home, we kept our first home and we rent that out now as well. So we've just been able to build a nice real estate portfolio and now I have the pleasure of investing from an institutional basis in commercial real estate as well. So again, just center to everything in my life is real estate. So I love talking about it and happy to provide whatever insight I can here.

Ben Smith:

Love that.

Austin Minor:

It's awesome. Well, you're definitely the right person for the podcast today, so that's good to hear. So tell us a little bit about Union Square. What does the company do? What differentiates you from other competitors in the field?

Tom Miller, CFA:

Sure. So we run two closed end interval funds. And what that means is we look and feel a lot like a mutual fund, but we redeem quarterly, so a little bit more limited liquidity. But what that does is it allows us to invest in private real estate. And so very different than publicly traded REITs, less volatility. And what it does is it gives us access to some of the best real estate in the country.

And so we invest not exclusively in one of our strategies exclusively, but in the other strategy about 50% in what they call the NFI-ODCE Index. And what that is it's an index that's comprised of 25 private funds, that's the highest quality commercial real estate in the country. And so I just want to make sure that everybody understands what I mean when I say commercial real estate, contrary to what The Wall Street Journal will tell you, that's so much more than just office. Commercial real estate includes retail, industrial, multifamily, and office. And as a matter of fact, in today's environment in the United States office makes up just shy of 20% of the overall commercial real estate market.

Curtis Worcester:

That's great and thank you for that insight there. I want to rewind a touch, Tom, and talking about Union Square Capital Partners. What's the history and really why was the company initially founded?

Tom Miller, CFA:

Sure. So we're a wholly owned subsidiary of a firm called Chatham Financial. And Chatham's been in real estate since 1991 and really Chatham came into existence to bring trust and transparency to the derivatives markets. And what many people don't realize is many real estate owners and operators use derivatives to hedge interest rate risk. And so Chatham was founded in '91 to bring trusted transparency to derivatives markets.

And then in 2017 they launched us because they felt there was no good way at a very reasonable cost to get into private real estate. And so here we sit today, two closed-end interval funds, two of the lowest cost closed-end interval funds on the market and really down the middle in what we do. We're trying to just make what was historically inaccessible more accessible to a broader base of investors, generally speaking through registered investment advisors like yourselves.

Ben Smith:

Awesome. Well, Tom, I note that. So it's really awesome from a background perspective and I know we want to get to the big premise of today's show is really what's the future of real estate locally, but also nationally for us. So I'd love to start with some basics. So in terms of from a trend perspective, what are you seeing for trends that are happening right now nationally in real estate this year?

Tom Miller, CFA:

Sure. So a big push, industrial real estate. So think Amazon and logistics buildings, everybody still loves logistics real estate right now, so industrial. Multifamily has really been a good spot for the last five to seven years as well and looks like it will be in the future as well, as well as Single Family Residential. The headwinds that we're all reading about really are around office and downtown urban areas and will workers return to the office. I think that's still a little bit unknown.

We're only back to about 50% occupancy within office. So that's the challenging part and I think that's really the national picture. So office, there's question marks around office, but multifamily and industrial, really strong operating fundamentals. And then within retail for the last decade we've been saying, "Oh, there's going to be problems in retail. Malls are dead."

And that's really not the case. What happened with retail is class A retail experience-based retail is actually coming back very strong right now. And so I think that's going to be the same thing that happens in office as well. Not all office will survive, but good highly amenitized class A office will be just fine and we're actually seeing tenants flock to those types of buildings.

Austin Minor:

Okay. No, that's interesting. So yeah, my next question is actually around the effects of 2020 and people that started working remotely and then they were able to move away from where their offices were located. So as Maine is a more remote state, we saw a huge influx of people during that time. So you said obviously people are moving back into the offices more now, but what does that look like as far as the residual effect on where they've bought their new homes, maybe? So if I've lived in Massachusetts, worked in Boston and then moved to Maine, am I now having to move back or are we seeing any changes there?

Tom Miller, CFA:

Maine's so beautiful, nobody wants to move back.

Ben Smith:

That's exactly right.

Tom Miller, CFA:

That's the problem. It truly is the problem, but I don't think so. I think the fact of the matter remains and this is in Maine and nationally we're under supplied in homes. So I don't think even as workers do have to get back to the urban areas, having a second home or keeping their real estate is still highly valued. So I don't think you're going to see a big decrease in home prices. It's a supply and demand function. It's going back to ECON 101. We have too much demand for housing and too little supply. And so because you have that even in the environment of higher interest rates right now, those dynamics, those supply and demand fundamentals will win the day. And so we're seeing that right now.

Ben Smith:

Tom, can I ask... This is maybe just a little bit of a rabbit hole, but I think there might be a clarification that would be helpful is so when you say there's limited supply of homes, well I think what could be challenging to think through is like, "Well, how is your limited supply of home?" It's not like you have all these people homeless out here that don't have a home, so they're living somewhere currently to get into a home. So can you just explain that dynamic when you say there's a under supply of homes available to people?

Tom Miller, CFA:

Sure. Household formation is outpaced new homes. So in effect, people are growing up, getting married, having kids, and they would want to buy a home, but they can't right now because there's no supply. And now with interest rates going up, it's much harder to afford. So where are those people living? They're generally living in multifamily or they're renting a single-family home. So when I talk about undersupply of single-family homes available for purchase for the typical starter family.

And so multifamily has filled that void and we think multifamily will continue to fill that void for the foreseeable future. So think in the next five to seven years, multifamily is going to play a big role in this country. And even if the home builders wanted to build new homes today, you don't have the labor force to do it. So even if they went full force today, you still have years of building ahead of you before you bring that back into equilibrium. So before supply and demand meet each other.

Ben Smith:

This is just a question, I didn't know if there's a data point out there in there, but just based on construction rates and is there this projection that the real estate industry has out there about when that undersupply gets corrected? 'Cause obviously there's a market opportunity as if prices are going up or there's demand for it. And when do you think that might ease, is the question?

Tom Miller, CFA:

Yeah, it's an interesting question and the question really comes down to, "How undersupplied are we?" And that number is really hard to pin down. Some would say 6 million, some would say up to 12 million. So there's definitely limited supply in terms of timeframe to correct that. It depends, and the home builders today are building, but they're building on a limited basis and they're building and what they're doing in the face of higher interest rates, they're adding on and they're buying down the rates for people to get into those homes.

That's not really an environment where they want to build an extra 100 or 150 homes on a site. They're going to build what they know they can sell and that's all they're filing right now. It's not like pre 2008 when home builders were turning everything on and everything was booming. It's much more calculated in this environment.

And anecdotes, general rule of thumb, when the 30-year fixed rate mortgage is above 6%, that's when home builders start to get weary of putting a ton of new supply out there because foot traffic goes down. And so now that you have a 30-year fixed rate mortgage, it touched 8% two weeks ago, it's since come back down to 7.5, 7.30, but still that's pretty high relative to where things have been historically over the last call it 10 to 15 years.

Curtis Worcester:

Yeah, absolutely. And I'm going to rewind us a minute because you said something a couple questions ago that I really want to dive into. So I'm going to rotate us out of the home conversation for just a second and I want to get back talking about office buildings. A couple minutes ago we were talking, Austin teed that up. You made a statement that long term, you don't think they're really going anywhere. Again, maybe not all office survives. Can you just elaborate on that, your outlook for office buildings and then maybe if it's not being used for office buildings, what are some of these other uses for this type of commercial real estate?

Tom Miller, CFA:

Yeah, it's going to be more mixed use moving forward. We've seen that trend happening prior to, "So what does that look like?" An office building is retail on the bottom, couple floors, maybe some multifamily and then office on top. And so that's going to happen. The problem is everybody says, and I think even the administration came out and said, "Hey, we have all of these office buildings out there, why don't we just turn them into multifamily?"

Well, it doesn't exactly work like that. So the floor plates for commercial real estate or for office buildings I should say is very different than multifamily. And think about things, just simple things like bathrooms and windows, some pretty basic needs that you need in a multifamily place. The office building doesn't really lend itself without quite a bit of construction and a lot of money to be put into that.

So you're not going to be able to just convert all old office buildings into multifamily, but I think mixed use will win the day and you're going to continue to see that. And again, highly amenitized class A office is seeing leasing activity pick up basically throughout the country. There's a couple of pockets, a couple cities that are still pretty slow to recover, but generally speaking, highly amenitized class A office is doing okay.

Ben Smith:

Well, Tom, I know one, we're just trying to canvass a lot of the different types of real estate out there and pieces of it. And it's something we have a lot of in Maine is trees. So timber is a theme as well in terms of real estate that people might not think about in terms of, "Hey, land and use." And I know in our state we just having this kind of theme about owning forest land and just having... Maybe there's a use of harvesting that eventually where they go and there's an investment that they can make in terms of going and harvesting that property and using the timber replanted or maybe they're just thematically doing that over time.

Here's the trees that are ready to be harvested and there's a way to get a level of income from the land, not just a buy and sell. And Austin and I had a client meeting the other day and the client was like, "The goal I have..." He's buying up all this timber land and property and he's like, "You know preservation's my thing. I want to preserve this. I don't want vehicles coming and out of it. I want the river's pristine, and I want the trees to be 200-year trees that keep going." So the question is for that specific client where he's gobbling up all this land he wants to preserve, how does that the value of this property and timber, how does that play into, "How you value property in terms of the landscape?" Here is my question.

Tom Miller, CFA:

Sure. And that's hard because commercial real estate, when you think about it, is really valued as net operating income. So everything's run off of a discounted cashflow statement or what they call a cap rate, which is net operating income over purchase price. So what you're asking is, "If you don't have income, how do you value it?"

And generally speaking, I would say the way you think about it is land is a real asset and so as inflation goes up, the cost of land will go up as well. So land is just a great inflationary hedge. So just owning land for those reasons alone from an investment perspective is a great inflationary hedge. And then when you do start to, there are actually... There is an index that does follow timber specifically. So I looked it up in preparation for this podcast.

And when you start to get land that does yield income, generally speaking, it's annualized over the long term about a seven to 8% annualized return to own timber and to harvest it. So that's a good return when you think about it over all the economic cycles. And so I will never be negative on owning land. I think real estate in general is always going to be a good investment over time.

Now, if your time horizon is one year, it's probably not the investment for you unless you're going to try to flip something. But generally speaking, if you're a long-term investor, you really can't go bad with real estate. It's proven itself time and time again throughout history. And I love that many people call real estate an alternative, but let's be clear, real estate ownership existed before stocks and before bonds as well. So-

Ben Smith:

That's true.

Tom Miller, CFA:

... it's an alternative to stocks and bonds in one capacity, but it's been the single biggest wealth creator in history. Owning real estate has been the single... Not the only way, but one of the only ways or has generated more millionaires than any other investment scheme out there. So real estate, I'll definitely long on real estate and definitely long on acquiring land if that's something that your clients can do.

Austin Minor:

Sure. Interesting. No, that makes a lot of sense. I wanted to get back to some rental real estate questions. So you had mentioned earlier that you see multifamily rentals having a strong demand for the next say five to 10 years, somewhere in that window. How does that translate to vacation rental properties, things like Airbnbs 'cause Maine's a very heavy seasonal tourism state, so that's something that a lot of people are questioning. "Should I buy a house to invest and then I stay there sometimes too?" What does that demand look like in the future?

Tom Miller, CFA:

That's still very strong. I think it got a little bit ahead of itself. Everybody wanted an Airbnb, so they were buying them all over the country, and that's since weakened a bit. But over the long term, again, I think if you have realistic expectations, you're exactly right. A place like Maine should always have demand for people to come in Airbnb. Now, are you going to be able to rent it for $5,000 a week if you... That's yet to be seen.

But I think demand will ebb and flow, but generally speaking, you're always going to be able to rent really well-maintained properties in areas that are attractive. And so I still think that's a good investment. Again, as part of an investor's overall portfolio, they shouldn't sell everything else and just go, "Hey, I'm going to go an Airbnb strategy." But as an overall well diversified portfolio, I think it's still a good investment.

Ben Smith:

So, Tom, I want to maybe ask another question here 'cause you're talking about Airbnbs, and I know one thing that we're just seeing locally, and we've had conversations actually with one of our former teammates, Abby, she's bought this [inaudible 00:21:09] thing. She bought a multifamily on her own and then they turned that into here's like a office building she's looking to buy. And so she's created this using equity of one and to buy the next, to buy the next.

And you see that theme happening even more right now because there's a lot of success that's been built over the last few years. And we laugh a little bit because the real estate agents, they got their TikToks and they got the... Here's a minute of you just take your equity and you just flip that in on the next thing and then that creates all the income and it's just easy, and it's all good debt.

Tom Miller, CFA:

What could go wrong with that?

Ben Smith:

What could go wrong?

Tom Miller, CFA:

Exactly.

Ben Smith:

So what I'd love from your side 'cause I know as you said, you have done this personally where you've owned some of your own properties and then professionally here you said, "Hey, I can apply my talents and my knowledge of real estate to create more diversification, create a fund for investors." I would just love to hear a little bit about compare and contrast here from this personal investing.

People want to own it and touch it, and feel it, and see it, and be able to use their hands and their talents to get that ROI versus the invisibility I think of here's a paper investment that goes up or down that they don't really see the improvements on. So can you just talk about compare and contrast, maybe Risk Return Profiles of those two things? I think locally we just see there's just a trend towards just buy up everything locally and we're going to be-

Tom Miller, CFA:

See what happens.

Ben Smith:

... millionaires.

Tom Miller, CFA:

No, it's different. I think the way to evaluate real estate, we talked a little bit about it. And I don't love talking about cap rates because they're misunderstood and oftentimes misquoted in the media, but cap rate in its simplest form is NOI over purchase price. And so on an institutional cap rate today, when you think about, "What should a commercial property yield?" Well, because office has more risk, the cap rates should be a little bit higher, so think seven to 8%, so 7% to 8% income off of the purchase of that property, whereas multifamily and industrial less risk right now.

So those cap rates are going to be lower. So when you evaluate real estate across the board, you can still apply that same technique over to buying your own rental property and say, "Okay, I'm going to spend X dollars. So let's just use simple math. I'm going to spend $100,000; I'm going to buy a property. And I know that's very low, just use it for simple math, follow me here. And I'm going to make $8,000 a year in income." That's what we would say is an eight cap, so an 8% cap rate.

And so you have to evaluate that and say, "Okay, well with an eight cap, if I could take that same money and invest it somewhere else, would I make more than 8%?" And that's the question that you would have as you're going into the investment. But I would say leverage and debt used appropriately and prudently is a very, very powerful tool. And so with what we do, the funds we invest in keep leverage 35% or lower, and in today's environment, they're only levered at about 25%.

But on the residential side, if you can lever and take that money and apply it to another home, again used prudently, that will really magnify returns. What you don't want to do is go buy an investment property and then lever it all the way up to a loan to value ratio is nothing more than the amount of the loan relative to the value of the property. So when you think about when you buy your first home, generally speaking, you need 20% down, so that would be an 80% LTV.

So as long as you keep that leverage profile down. So in investment properties when you're borrowing, most lenders want to see 25% down. So if you can meet that hurdle, put 25% down, rent it out, and make sure that your income is exceeding the cost of that leverage and the cost of the maintenance of that property, then yes, that's a good investment.

And over time, that will certainly yield benefits. So I'm a big proponent of using debt prudently. What I'm not a big proponent of is using debt irresponsibly and then going up to that 100% LTV, and then just saying, "This can never go wrong." That's where things exactly go wrong. So if in your mind you're saying, "This is a great investment, this could never go bad." You should probably stop. So that's same techniques across both. And I know that was a long-winded answer and I apologize.

Ben Smith:

No-

Curtis Worcester:

That's good.

Ben Smith:

... I think that's perfect, Tom. So in just the ROI is, that's a net ROI. As you said, interest rates are now approaching say 8, 8.5 or whatever it is, I need to have that level of income after those costs, those maintenance costs, and the debt, and the interest payments, and all of that. It's got to be my net payment to basically pay for the level of risk that I'm getting out of this is to... I think that's a key part, but two is...

So people are good about the building. So they're all excited about the building and I turn one property into two and I turn two to three. Well, I think one thing that just we see as we're talking to folks that have this is they have not thought about how do they unwind that chain. So they build up to, "I'm going to get 20 properties and then I'm going to get all this income out of it and I can sit at home and I can just cash checks. I'm just doing the Uncle Scrooge thing of just checks coming in the mail. I just cash it and it's all good."

I think at some point where, "Hey, I'm going to be 60, 65, 70, 75. I'm not able to manage this or I'm might have a property management, I'm not able to maybe get the value. I don't want to give it to my kid that maybe doesn't know real estate the way I do or these properties specifically, how do I unwind it to get liquidity?" So I want to ask the question of the difficulty of unwinding that empire that you build versus again, the work you do through your fund and "Hey, here's how I can try to achieve a different return risk profile, but also the unwinding moment of that too."

Tom Miller, CFA:

And so our product does not allow for this, mutual funds don't allow for this, but there are other real estate firms that offer what they call 1031 exchange programs. So where you can sell real estate and as long as you roll it into a comparable property, you don't have the tax, the capital gain tax implications for that. Take that a step further. There are companies that will help you effectively manage your tax liability by transferring your property into a real estate investment trust and then taking shares of that.

But generally speaking, you really have to be careful on that because there's a lot of fees and a lot of people in the way of that return, if you will. So you don't want to build up this great empire and then have it eroded by everybody else taking a cut of that as you unwind it. So you have to be careful. It's something to pay attention to. Generally speaking, my thought is think about real estate as a long-term investment and hopefully you are going to leave it to your heirs. You should think about it as a generational investment stepped up basis, tax basis when you do roll it.

And so that's the way to think about it. That said, if you do want to unwind it, I think just like anything else, talk with your advisor, talk with the local real estate agents about, "When the appropriate time to sell is?" And, "What are you going to do with that liquidity?" So it's part of the overall financial plan. And again, capital gains. Nobody loves to pay taxes, but at the end of the day, it's a necessary evil of investing as well.

So I would caution as people unwind their real estate, it's okay to pay a little bit of tax by the time you're trying to do the tax avoidance strategies, oftentimes you're eroding the returns away anyway of just paying the tax. So you really have to think that through. And so it's something that we look at these products all the time and we see layers and layers of fees and we say, "Well, in some cases the investors would be better off just paying the cap gains tax and moving forward."

Ben Smith:

So, Tom, I want to take that just one step further because I think to one point it's like, "Well, I'm going to retire, and I want cash out eventually." We've actually had a client experience where they've been pretty successful with commercial real estate. They've done really, really well. So much so that the value of that commercial real estate is going to create a sizable estate tax. So it's like here's a very large estate tax number that's going to come out of it.

If they pass away today, it's going to be tens of millions of dollars that they're going to have to pay the IRS with a nine months after passing. So that creates another challenge where it's like, "I die with this portfolio." And as you said, "It's a long-term investment in..." You go to the worst-case scenario, it's the financial crisis. And now you've got to liquidate all this property at the wrong time to create enough cash and liquidity to pay the IRS tax bill on your estate tax. So how have you seen folks think about that as well to make sure that, "Hey, I got liquidity to pays it." Or, "I'm not fire sailing stuff at the wrong moment."

Tom Miller, CFA:

Yeah. So in the portfolio, I wish we could all be that lucky then to have-

Ben Smith:

Yes, I know. I want that problem.

Tom Miller, CFA:

Yeah, I certainly want that problem as well. But I think what you're talking about there is a very, very unique, less than... I don't even know a 0.1% of people are going to have that problem. In that case, I would suggest, especially in the commercial real estate space, that's where you can get a little bit more crafty in terms of transferring that property, taking shares of what they call an UPREIT transaction.

And so you can definitely think that through ahead of time, which solves some of the problems that you're talking about. So you get liquidity. You don't have to sell all that and recognize all that taxable gain, but it gives you flexibility from an estate planning perspective as well. And so that's, again, not the prop for the band. My earlier-

Ben Smith:

Yes, [inaudible 00:31:28], Tom.

Tom Miller, CFA:

... comments, yeah, my earlier comments there were much more about you don't have a huge portfolio. You have maybe a couple million dollars' worth of real estate and that's the way you do that. But as you start to get tens of millions of dollars, that's a little bit different and those strategies will be much more beneficial for you as you get into those tax deferral strategies, if you will.

Curtis Worcester:

Got it. I appreciate that. I want to rotate to something that we think is pretty specific to us here in the state of Maine. So obviously Ben, Austin, and I all are currently sitting in the state of Maine. Maine has a lot of smaller close-knit communities. Naturally being as rural as we are, sometimes these communities can be a bit skeptical of the... And I'm going to put in quotes here, "The out-of-staters." Or, "The out-of-towners." Or, the out-of-state money." Whatever you want to call it. So I want to ask you, Tom, what does your boots on the ground process look like when you're trying to evaluate investment opportunities in these types of locations?

Tom Miller, CFA:

So we invest in funds, remember that have teams and teams of people that are certainly local and talking to the local brokers. And so very, very thorough investment process. And what I would say there is oftentimes, generally speaking for commercial real estate, you're staying in your major metros. So a lot of what we do is in your major metropolitan areas.

But in your case, I totally understand, and it's interesting, if you look at some of the out-of-towner cities. So this pandemic, a lot of people moved into places like Boise, Idaho, and you've seen an exodus come back out. Perhaps that's culture, perhaps they have to go back to the office. That I'm not sure of. Look, at the end of the day, having more interest in the real estate that you all own or in your communities is a good thing.

So out-of-towners coming in, having more demand for that real estate is only going to be net beneficial over time. And I know nobody likes the out-of-staters to move in and all of that, but generally speaking, I view it in much more of a silver lining perspective and say, "That's actually a very good thing." Because that means that the area that you own in is in high demand and that is going to push values up. So I would say that's definitely a different way to think about it. I know not everybody listening to this podcast would agree, but I would say try to see the silver lining in some of that.

Ben Smith:

Yeah. Awesome. Well, Tom, I know one thing because you've talked about this a little bit already, is shopping malls. The retail side is, that's been an area that the internet effication, if that's a word of retail, where we're all pushed to go click on an Amazon link in three to five business days or next day or same day, you get that package. So, "Why do I have to go to the store and make it a big thing?"

So shopping malls have long been a decline. This is not a 2023, '24 theme. This is well there, but I think what's interesting we read right now, like Carl Icahn is he's making these big bets shopping malls are going away. They're going to go all bankrupt and he's going to make all the... This was his biggest bet and he doubled down on it. And, "Maybe not so fast." My friend is what Lee Corso would say. Is that something where-

Tom Miller, CFA:

Totally.

Ben Smith:

... that's not totally going away. So a question to you is obviously he viewed it that way and he viewed it was going to go completely under. What trends are you seeing with real estate inventory with current malls or closing malls? What do you see?

Tom Miller, CFA:

Yeah, so class A malls experience based. So think high-end retail, good locations, farm to table restaurants that retail is doing just fine. So class A malls. And if you look at the publicly traded REIT space, Simon Property Group is one of the biggest mall owners in the country. Their properties are doing just fine. And if you read their earnings reports, they'll tell you occupancy in many of their locations is 90, 95%, which is very strong.

And so I would say not all retail is dead. Class A experience-based retail is going to do fine. Class B and class C is a little bit interesting, and I can tell you just anecdotally and what we've seen that does lend itself to other areas and other industries moving in. And so one local mall here in the Philadelphia area, it's what we would call a class B, maybe even class C mall, the entire bottom floor has been turned into medical office and imaging.

So MRI imaging where you need a lot of space, you need very... A good air conditioning or HVAC unit to keep the equipment cool. And then so the hospitals don't have to keep all of the imaging equipment there. It's in the bottom floor, people go there for their outpatient services. That's been a tremendous tailwind for some of these larger spaces that you need to rent. So things like that.

The one thing that I would remind people, a lot of the trends in real estate take a long time to develop, and real estate owners don't just sit there and say, "Well, we had a mall, it's not good anymore. We're just going to go by the wayside. It is what it is." That just doesn't happen. They're going to find ways to reinvent that space. And so that's just one example. So medical office in the lower floor of the mall, multifamily in some capacity, some of the malls have been removed and highest and best use of that land will ultimately things will be redeveloped there.

And so I think what's super interesting about the pandemic, we were all locked in our homes, and it certainly put fuel on the fire for Amazon and home delivery of all goods. And that's certainly helping in a tailwind for industrial properties. But what the pandemic also taught us was you can't lock us in our homes. So you want to get out there, you want to spend money. For goodness' sake, right now you have a Fed trying to slow the consumer down, and what are we saying? "Nope." We still want to go out and spend more money.

So when you think about it, as long as its experience based and people are going to something that they want to go to, whether it be open air or the nice restaurant or whatever they want to go experience, that type of retail is going to do just fine. I think we've proven that there's a balance. So over the last decade as we've read, "Oh, all brick and mortar is going to go away." That's just simply not the case.

Austin Minor:

Yeah. No, thank you. That makes a lot of sense. And actually, so going along with the trend of experience-based Maine, like we talked about with my question about vacation rentals and things like that, it's very scenic whether you like lakes or mountains or oceans. So residents of Maine, but then also people in other states look at Maine as a place for maybe a second home or a vacation home. And I live in Kennebunk, so by the coastal, there's a lot of really huge luxury properties. What has the market been like for second homes or luxury properties and does that move in tandem with normal residential real estate or is that its own thing?

Tom Miller, CFA:

It's really its own thing. And what's again interesting about that is generally speaking, when interest rates have gone up in the past, that's hit the higher end of the market. People have said, "All right, let's take a pause." So usually, your higher end gets hit first because there's plenty of demand that still will outshine there in the call it the lower range, the middle-income range. We haven't seen that in this downturn, if you will.

You have so many cash buyers out there right now. The economy is flush with cash, and so it really, second homes are still going strong. High-end luxury homes are still going strong. You're starting to see that wane a little bit, not so much in the second home market, but in the luxury primary residence market, that demand is starting to wane a little bit right now, but generally speaking, because you have so much cash in the economy, those second homes and those luxury homes are still holding up. That's not to say that will continue, but to date they've held up pretty well.

Ben Smith:

So you raised the point there that I think is a good question there 'cause you saying that, "Hey, when interest rates go up and obviously that can hurt." Maybe some of the higher end of the market is all of a sudden that. 'Cause obviously interest payments on larger values can make it much more unaffordable, especially when it's a superfluous purchase. Is this like, "I don't need it." But now I really can't afford it because the high level of interest rates.

So I want to ask, maybe zoom out on the interest rate question here about just generally I could see where from a myth busting perspective, I could just throw out, geez, well rule of thumb, interest rates are higher bad time to be in real estate 'cause you pay more interest. Can you talk about how you as a fund manager look at that of obviously interest rates are higher. Well, that does not mean that the whole asset class is now not touchable and not investible, and not a great place to be. So can you talk about that dynamic? 'Cause I could see where that would be the thinking that would be out there.

Tom Miller, CFA:

Sure. So certainly, within commercial real estate that the equation is... Remember I said NOI over purchase price. So if you're growing NOI, that's taking the cap rate up as well. And so that's what everybody always misses. They say, "Oh, higher interest rates." But in inflationary times, and generally throughout most years, you're going to see income growth within commercial real estate. And so multifamily rents are up, industrial rents are up, and they were record setting in the last couple of years.

Now, things are certainly moderating and coming back down to normal levels, but within a commercial real estate space, that's the piece you have to understand. Higher interest rates don't necessarily mean doom and gloom. In this environment, what I would say about interest rates, and the consumer did it as well, and most commercial real estate operators did it as well, they locked in longer dated debt at low interest rates. And quite candidly, it's why the Fed's interest rate hiking cycle hasn't worked. If I talk to 10 of your clients, nine of them have probably locked in fixed rate mortgages at 3% or below.

Austin Minor:

Absolutely.

Tom Miller, CFA:

And so why would you sell? So you have a supply problem that's helping the supply problem. And you've lost a lot of buyers coming into the space as well because the interest rates are higher, and you don't want to refinance. You don't want to go buy a new home yourself and lock in at 7%, which is a bit of a psychological thing as well. Even if your home appreciated in value by $300,000, you don't want to take that gain and go buy something else 'cause you can't stomach having a 7% mortgage when you just had a two and a half percent mortgage.

So a lot of interesting dynamics in this cycle. Basically, every corporation that takes debt across the country has locked in low fixed rate debt for the most part. Even think about some of your big conglomerate corporations, Coca-Cola, Pepsi, they all issue a lot of debt, but it's at low rates right now. What I think will be challenging moving forward, and so right now everything's worked as it's supposed to, income has grown, interest rate payments have not really taken too much of it.

There hasn't been too much of an issue in the markets that said, as corporations have to refinance that debt, so that looks more like 2026, 2027. If that has to happen and these interest rates stay higher, then I think you're going to have a bigger problem. And that would hold in all real estate. That would hold in commercial real estate as well.

But right now, I think it's been prudent management with leverage and locked in at low rates for the next few years. Things should be okay. Again, if the Fed continues to take rates higher or if the long end of the curve, more importantly, the tenure continues to go higher, you could see some problems. But that's not a commercial real estate problem. That's an economic problem across all industries.

Ben Smith:

Tom, I want to make another point to that too is obviously from a financing perspective, just because... So obviously when rates go down, we refinance into lower rates. Obviously from the buyer perspective where we go from one property to another, I'm talking residential, you might be newly financing into higher rates, but you always have the ability to refinance back down into lower rates.

Just because you bought it, say an 8% mortgage doesn't mean that you're locked in for 30 years and an 8% mortgage. Now, to what you just said is if it just kept going up and up and up, well, yeah, you would be, but it cyclically, there might be opportunities there over a 30-year time horizon, 20 year, whatever the mortgage rate is to then refinance down, which I think some people forget or that's why they get scared to enter into debt at a certain level too.

Tom Miller, CFA:

Certainly, and that's definitely on the residential side. Commercial real estate lending works a little bit different. You can't just prepay on a commercial real estate loan in most cases. So a little bit different of a thought process on that side, but you're absolutely right. On the residential side, you do have to remember rates. Even the Fed right now is saying, "Yeah, we're keeping rates here because they're restrictive. We may have to take them higher to be restrictive."

Eventually they won't need to be restrictive anymore. And hopefully that doesn't come with a deep recession, but rates should start to come back down. And at that point, you're right, you can refinance. But even though you've seen big gains in real estate, even though that point certainly exists, we haven't seen the movement that you've seen in past cycles. You just haven't seen people sell out of their homes and buy new homes. And I think it's just psychologically different this time in terms of... But if people believe that rates are going to stay at 7.5 or 8% for a 30-year fixed rate mortgage, maybe you start to see some of that pickup now, but yet to be determined.

Curtis Worcester:

That's great. No, I appreciate the insight there. And I know a couple times we took you a little bit into these rabbit holes, but I think it's really helpful. So we've reached the end here of our conversation. So I first want to say thank you again so much for coming on the show. The knowledge and expertise you provided was phenomenal. I do have one last question for you that I try to ask all of our guests. So the name of our show again is Retirement Success in Maine. So I want to ask you, how are you going to find your personal retirement success, Tom?

Tom Miller, CFA:

You gave me a softball on that one. Real estate naturally.

Curtis Worcester:

There it is.

Tom Miller, CFA:

I alluded to that in the beginning as well. Look, real estate is in my veins. I have rental properties myself. Like I said, have the benefit of investing more institutional capital. So there's no other asset class that has shown that consistency as commercial real estate. So if you go back to 1978 and you look... There's only been three drawdowns and we're in one of them right now. And so generally speaking, real estate's going to appreciate. So from my perspective, that's a key part to my retirement success. Obviously, I'm diversified. I do invest in equities and fixed income as well, but will certainly be key to my retirement.

Curtis Worcester:

I love that.

Ben Smith:

Tom. Perfect answer. Thank you so much for coming on our show. I know we really appreciate all you provided here today and looking forward to maybe at some point to hear a little update as well. So thanks so much.

Tom Miller, CFA:

You got it. And I'll be up in Maine soon because I do love the state. I might've missed it now. Have the leaves all fallen at this point or is it still the, okay.

Ben Smith:

Yeah, it's there, but that's okay. We'll have to schedule you when it's maybe a better season. So thanks so much.

Tom Miller, CFA:

You got it. Thanks guys.

Ben Smith:

You're welcome. So I was pretty excited we were able to connect with Tom Miller today. I thought he was amazing. Again, Union Square Capital Partners there has this not only just real estate, but also a fund in terms of private real estate as well. It's its own thing. I think the opportunities and some of the risks that you see in different types of real estate, especially I think where it's just so hot right now in terms of prevalent of thinking that people are looking for opportunities and they think they're missing out. So we wanted to have an expert that come on and really gave us the good and the bad and the ugly in terms of real estate. So I thought, Tom, captured that really, really well today.

Austin Minor:

Agreed.

Ben Smith:

So I know obviously we're episode 93, so-

Austin Minor:

Getting up there.

Ben Smith:

... we're getting up there. We're approaching the century mark-

Austin Minor:

I know.

Ben Smith:

... almost a golden podcast I think is what you'd call it. So we're getting close to that. So to find a little bit more out, we're going to have some links to Union Square. We're going to have a little bit more about our show if you go to blog.guidancepointllc.com\93 for episode 93, so you can find all that there. We really appreciate you tuning in. Again, I know real estate is something that people are really passionate about and we wanted to make sure we were true and honoring that passion here today and exploring it and all that's glory. So thank you for tuning in. We really appreciate it. We hope to catch you next time.