The global real estate market took a hit in the months after the onset of the pandemic, but as with stocks, a depressed market presents fresh opportunities to “buy low”. Dear Retail chatted with BJ Turner, founder of private LA-based real estate investment and development firm Dunleer, to find out which market segments have the most potential in a recovering economy.
 

1) What made you want to start Dunleer, and how do you think your background has helped you succeed?

Prior to Dunleer I was with a hotel investment firm, and we were buying hotels in top 20 markets across the nation just after the recession – there was an opportunity as many owners were trying to work out legacy assets after the financial crisis. Working with a firm that had fresh capital and investing through the Financial Crisis of 2008 was a pivotal experience . It helped form my investment thesis and my thinking, which would later inform a framework for starting my own platform. Having that experience and track record certainly helped me secure the capital I needed – it would have been difficult had I not had that background.

Another thing that helped me succeed with Dunleer was that my first couple of deals went well – which is really important – as it really is all about how well you did on your last deal. We never really struggled to grow into future deals because of that, and we were able to grow organically. Results and word of mouth was how we grew our investor group.
 

2) What were some of the challenges you faced?

One of the most difficult things was – investments are typically chunky in terms of the pay-back, so I took on additional consulting work early on to keep afloat and pay my bills during lean periods. The timeline for payback in this industry can be 12-24 months or more. When you do your first few deals, you can’t ask for a lot in fees, and you’re effectively working on 100% performance-based income. I didn’t want to make bad decisions because I needed capital, so taking on that consulting work really helped keep funds coming in the door – that was the way I balanced things to give me consistent income.

Making sure our investors were happy first and foremost – ensuring that the first few deals went well, that was essentially our business card for future deals. If they didn’t go well, there was no future – the whole ecosystem has to do well: tenants also have to do well, so do the vendors, contractors, and all other partnerships – it all feeds down the line to successful projects and happy investors. The value chain has to be handled correctly. If you enjoy relationships, there’s a lot of relationships to be formed in real estate, and they can really be accretive to your overall success.
 

3) A lot of people would say Los Angeles is a difficult market to enter – what kind of opportunities are you looking for when you evaluate a property?

LA is a difficult market – it has a high barrier to entry. But LA and SoCal also present tremendous opportunities as they have a massive population and tremendous amounts of liquidity – I think there’s almost 25 million people in SoCal alone – which is almost two thirds of the population of Canada – and it’s the 6th largest economy in the world. When you’ve got that much happening there’s a lot of variables in place, which means opportunity – you have capital from all over the country and all over the world wanting to invest there.

LA has changed a lot in the past 10 years, and it has quickly become a cultural beacon in the last few years. One example is, it is now widely considered to be one of the best food cultures in the country. The art and architecture scenes have come so far in the last 4-5 years. A lot of tech companies are growing here – Apple and Netflix and Amazon and Google offices are being developed here as tech looks to the entertainment capital of the world to develop the content that is driving a lot of their growth. On top of that you’ve got 310 days of 72 degrees and sunny. It’s a very diverse economy as well.

As for opportunities, we’re looking for properties that haven’t seen much TLC recently – maybe they’re undercapitalized, under-managed, maybe not the right use-type, and we’re able to come in with fresh eyes and fresh capital, and we can reposition that property and really enhance the tenant experience of the property, which thereby can help improve property valuation and economics.
 

4) How would you liken real estate investing to small-cap investing?

In small cap investing, you’re often looking for companies that are under-valued, that you see potentially being worth more one day, that have good growth prospects. Similarly, in terms of real estate investing, I’m not following the strategy of a large-cap investor, I’m not buying the stable dividend-paying companies. I’m looking at the deals with inefficiencies and perhaps no near-term cash flow, where I can connect the dots on the going forward business plan and clearly see the path for significant growth and improvement.
 

5) In what ways are they different?

If you have a portfolio of small-cap stocks, you can afford to have a few of them go wrong because when you get a few right they tend to materially outperform and lift the whole portfolio – that asymmetric risk is built into your portfolio. In real estate, we need to do well on every deal.
 

6) What are the benefits of investing in real estate versus stocks, or vice versa?

I think it’s all part of a broader portfolio – they each present different return profiles and different risk profiles. Real estate is less volatile, and it can be healthier mentally – stocks you can check all day every day, and sometimes that’s not necessarily beneficial. Small-caps carry a certain amount of risk, but the returns can be much higher. There is an opportunity where the asset classes work in tandem to provide the investor with a healthy, well balanced portfolio.
 

7) What shifts have you seen in the real estate market during COVID?

Significant shifts. In hospitality, hotels, retail, office – they’ve all been impacted in enormous ways, and those impacts will continue to be felt for months ahead, and in some cases entire business plans and models will need to change.

The Industrial [real estate market] was not affected negatively – it was almost all positive. During Covid e-commerce exploded – what’s interesting is, I think about my parents and their generation and they never really took to have something sent to their doorstep. They would rather go out and physically shop for the things they need. But because they were the most at-risk demographic during Covid, there was a behavioral change and they started getting things delivered. Retailers also started shutting down their storefronts and switching to an e-commerce model and routing their entire business through industrial buildings instead of storefronts – I think a lot of those behavioral changes are here to stay.

Multifamily apartments are a tale of 2 different worlds. First, in certain cities you had a large “out” migration – people moved out of San Fran, New York, etc., which meant a lot of apartments in these cities suddenly became empty, so it impacted the supply. Secondly, there was a regulatory framework during Covid where tenants didn’t have to pay rent in the event of COVID hardships, which hurt landlords. As a result, there was a certain level of distress. But the counter balance was capital getting reallocated from other asset classes such as hotels that started to flow into multifamily units. So there were certain markets that did well – Phoenix, Denver, Salt Lake City, and many other Secondary and tertiary cities were all beneficiaries of the outflow from some of the larger cities. Because of the cheaper rental rates, people realized they can pay less to live in larger spaces .

Then there are the no-tax and low tax states – there was certainly a population inflow to Texas and Florida, Utah and Idaho – people leaving high-tax states like California and companies deciding they could leave too. Beyond the simple economics of taxation, some entrepreneurs and companies were feeling they were getting treated better in these other states – the mayor of Miami’s tweet asking “How can I help you?” laid the foundation for Silicon Valley relocation to Miami.

In California, there were no doubt headline companies that moved out, but I do think there will be a snap back to core cities like LA and San Fran. In fact, we are already starting to see it, leasing velocity is improving and rates – while still impacted – are starting to recover slowly. For example, the USC campus – there is a huge drive of people moving back to this area after it was a ghost town during Covid. Businesses around the campus are re-opening, students are coming back and so are on-campus employees. USC is also one of the biggest private employers in LA. Jobs are coming back so people are moving back – so you’re seeing some areas start to experience new population inflow.
 

8) What trends are you seeing as the market recovers?

In Retail you’re seeing the continued shift to outdoor malls which are experiential, which will perform much better than indoor malls moving forward. A lot of America was over-retailed to begin with, and this was a secular decline where COVID ripped the Band-Aid off, but retail is also going to recover in certain pockets.

In Office, you’re seeing a shift in preference to single-user, campus-style offices over larger, multitenant business towers – anything with common elevators, common washrooms, common lobbies could be seen as less desirable. Employees are telling management they don’t want to share their workspace with other companies in a multi-tenant tower, where they don’t know the other tenants’ policies on Covid. What happens if there is a variant, or another virus that breaks out? These concerns are also coming from C-level management too, they’re saying ‘we don’t want to be liable for staff getting ill’.

As for apartments – you’re seeing more demand for one-bedroom or two-bedroom units with a den, so tenants have a home office to work from.

Industrial might meet some supply constraint issues as the economy recovers – zoning limitations, for example. There isn’t enough zoned land for industrial use in some cities, so these cities will have to reconcile how they deal with that going forward.
 

9) What advice would you give to someone who wants to buy their first investment property?

What gets people in trouble is debt – too much debt, and high octane debt – so limiting your exposure to debt is key. If you’re buying a property to improve it, you have to really understand what you’re doing. Depending on the jurisdiction, it can get complex in terms of zoning, permits and vendors – people think they can just go renovate. If you’re in a highly regulated city and you need permits, it can become a lot more complex, expensive, and time consuming than one thinks. It really comes down to knowing what you’re getting into and having a good team working with you. There are so many vendors, consultants, etc you need to rely on, so inevitably you need subject matter experts – whether engineering, architecture, or contractors — you need to spend time up front to understand who those partners are and who can add value.
 

10) Given your experience, what should retail investors be looking for when considering investing in a REIT?

It’s pretty sage advice to stick to understanding management, their track record, and having visibility into their pipeline. Understanding what asset classes they perform in, and how they are going to be affected in the near-term as their assets and sector emerge from Covid. Is the REIT going to be undoing a bunch of legacy deals that they are committing internal resources to, or do they have a fresh balance sheet which gives them the flexibility and freedom to go out and acquire discounted assets as the broader economy improves?
 

11) What is one of the best investments you’ve made?

The best ones are the investments when we’ve had to have the mental fortitude to buy when the market is really down. It’s really easy to say buy low, sell high. It’s a whole other thing to be feeling the weight of a pandemic around you and not knowing when it’s going to end, but having the confidence in your asset class. Probably some of the best deals are going to be the ones we made during Covid, when there was fear in the market and we could find assets priced at a discount and the space was less competitive. It’s amazing how quickly the market has shifted.
 

12) Aside from Los Angeles, what other cities do you think have a lot of potential for growth in future, and which do you think might be over-valued?

A lot of secondary and tertiary cities like Salt Lake City, Boise, Austin, can offer lower cost living, and a great outdoor lifestyle – hiking trails, ski hills, lakes, rivers – they offer a compelling work-life balance. Because of the kind of jobs they’re offering, they’re attracting a young, talented workforce, so they’re building a population base that will be strong for years to come.

I’m still incredibly bullish on California – the incredible amount of liquidity and capital that’s prevalent, the diversity and type of jobs that the state offers, the food, art, culture – the lifestyle. And so many great places within the state like San Diego to Palm Springs to Santa Barbara, the Bay Area, Big Sur, Yosemite. The list is almost endless.

Cities that could have a tough time after Covid are cities that are highly over-regulated. From a corporate perspective, many companies voted with their feet and relocated quickly once they realized they could. It served as not only a path for other companies to follow but also a bit of a warning shot across the bow given the local tax implications.
 

13) What is your opinion on the Canadian real estate market vs the US market?

I think they both present tremendous opportunities and will for years to come. The Canadian market is interesting because there’s so much demand in a few key markets, mostly in British Columbia and Ontario. I think the concern for many is the debt to income ratio in Canada, especially with housing prices so high and the debt burden that homeowners carry. If interest rates increase to 4-5% in the future, it can put homeowners at risk when it comes to servicing their debt. That said, there is continued demand as Canada has done well from an immigration perspective, getting talent into the country. There are huge attributes for Canada, and it has done a great job of branding itself. Canada is perceived incredibly well on the world stage, which helps make it attractive when international talent is looking to relocate abroad.

A big difference between the US and Canadian market is the 1031 exchange. This is a section of the US tax code which allows an investor to avoid paying capital gains taxes when they sell an investment property and reinvest the proceeds from the sale within certain time limits into a property or properties of like kind and equal or greater value. This provides a lot of liquidity in the US real estate market as it can provide incentive to keep buying bigger properties. That coupled with the sheer population, size of the economy and amount of capital in the US come together to create a real estate market that is unmatched in terms of scale and liquidity.
 

14) How can Canadians invest in US properties?

It is easy for Canadians to invest – they can do it through public vehicles, or private vehicles. What one needs to keep in mind is while the two might seem similar, they are two different tax jurisdictions, so you would want to set it up correctly – a tax advisor can help you do that.

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