SAM: We want to thank everyone for joining. We’ve got people joining from all over the country and even a few people joining from abroad, I believe, as well. So thank you for joining our inaugural thought leadership presentation. The first topic we’re covering is inflation, which is top of line for everyone since at least the spring of this year, and we wanted to do our own take on it with and how it’s applicable to one of our asset classes, which is logistics and, real estate as well. CJ, do you want to give a quick overview of who you are?
CJ FOLLINI: Hi, CJ Follini, CIO and Managing Principal of Noyack Logistics Income RE and Noyack Capital, the sponsor, external third-party manager of NLI, our RE. I’ve been a commercial real estate investor, developer, and manager for 35 years. Humbly it is My One True Superpower, so my wife continually reminds me. So, I am excited to have debuted something I feel is purpose-built for these times and to bring all of the individual skill sets, networks, um, and knowledge base from these varying asset classes we’re going to go into, into this cohesive theme of supporting the supply chain with its infrastructure.
SAM: Thanks, CJ. My name is Sam Suking. I’m COO of Noyack Capital. I’m a little younger than CJ, a little greener, but I think I bring a lot to the table as well. Um, I have worked in—
CJ FOLLINI: Don’t sell yourself—don’t sell yourself short, Sam.
SAM: Um, I’m responsible for all of our BDS, some of the new builds that we’ll be debuting within the next 60 days—60 to 90 days or so—and, I helped construct NLI as well, which is the primary topic of discussion today.
SAM: So, CJ, one of the things I—
CJ FOLLINI: Yeah, no, go ahead.
SAM: One of the things that I think distinguishes you as a manager is that you have been in the game for 38 years now. I believe your first year was 1984, is that right?
CJ FOLLINI: That’s correct, yes.
SAM: It’s relevant to the discussion today because certainly within my lifetime up until 2022, I think the highest inflation that’s ever occurred has been about 5%. Obviously, we far surpassed that this past year. So, I think the length of your track record is important because it hasn’t been since the early ’80s that we’ve seen inflation at such high levels, comparable to where it is today.
CJ FOLLINI: Well, as a former competitive athlete, I still retain a lot of that competitive attitude, and I’m enthused as a competitor because I realize that a lot of the younger generations that we are competing against for these assets and understanding the marketplace of the asset classes within our supply chain infrastructure theme, they have never experienced, and they don’t have a playbook for, 8%+ persistent inflation. Yes, 1984 was my first large project; I consider it my entry. Obviously, my background coming from a real estate and building family as the first generation of immigrant parents started well before that. I basically was talking—I was learning about commercial real estate in the womb. But 1984–87 were very interesting. It is the last time that we have had this kind of inflation, and I’ll—as a quick anecdote, my family and I were proud of our relationships with our bankers, and we feel that we got their prime rate at the time, as warehouse lending. And we crowed about it. And at that time, our interest rate was 9%. And we—National Westminster, a bank that does no longer exist by itself—said that we had the best rate that they provided any customer. 9%! So, that puts everything into context about where we are now. I also think that I’m in the camp that there’s a lot, lot longer to go with this story to be told currently. Um, using that experience, it tells me that we should not be looking around the corner of January 1st and thinking that, the worst is over. I hate to be—I hate to be a negativist, but that’s what my experience tells me.
SAM: Okay, for the most part, I agree with you, but we’re about to get to that in just a few minutes here. So the goal for this presentation—we’ve got three key points we want to hit on. The first is inflation is here, what’s next, and how long will it be with us? The second is how to protect against inflation. And the third is why are logistics assets, in particular, such a good hedge against inflation, and what can we learn from, the targeting of our portfolio NLI — Noyack Logistics Income RE?
CJ FOLLINI: Well, okay, great segue of what I just said. Inflation is here. I don’t think—I don’t think that’s any revelation that we have to provide. Um, I was curious earlier during the quite tragic pandemic when inflation did rear its head that there was even a discussion about stickiness and transitory. I—I—I felt that was an unserious conversation because it did not under—it did not—it denied a misunderstanding of the core inflation, which is labor wages have not inflated in real GDP terms for decades. There are all sorts of political movements about the labor class, and even the middle class, who have felt that they have, relative to the, um, to the cost of living, slid back, even though their wages stagnated. So once that happened, that the core inflation was caused by labor—and a labor shortage and a skills mismatch more than anything—there was no question that we were in a persistent inflation environment, and that first conversation of, of transitory nature was really, I thought, misappropriate.
SAM: Would you say it’s the end of an era? I mean, I would say that era began with Volcker, and I think it probably ended in 2019.
CJ FOLLINI: I—I—I don’t think you can tra—you can trace—I mean, yes, Paul Volcker was a hawk, he—and it—it came from a lot of pain. So maybe like Nietzsche’s “That which does not kill us makes us stronger.” What did not kill us in that time of prior inflation, and what he did to curb that inflation, set us up for this bull run, but that is so anomalous to the history of, of, of, of secularity that it’s hard to say. That’s—that’s a tricky one to draw a connecting line, but there are a lot of factors, and I’ll say this: productivity on the backs of labor—that’s why it stayed low for so long. And what is a new era is that we have wrung all the benefits of technological productivity in this era out. There are going to be new ones. We don’t know what they are. People did think blockchain was one. We’ll see. But we have run the course of technological productivity of the last 20 years. So that’s the—that’s really what I would say is a new era.
SAM: You know, it’s funny, I was just looking at a chart this morning about total factor productivity growth, and it’s been 0.17% annually since about the year 2000, whereas it was above 2% easily for, you know, 20 to 25 years after World War II.
CJ FOLLINI: Yeah, I—I—I’m not sure. I think you have to segment the productivity—that’s total factor—if you do, into certain, um, into certain industries because I do think that there were great gains from, you know, the post-internet era all the way through 2015. I think there were great gains. So, I—I—I think there’s a lot more to that story, but I understand your point.
SAM: Yeah. So, we—we—we didn’t actually—I didn’t want to set up—I’m sorry. Let me—I didn’t want to set up the “Why Logistics?” We’re going to talk about that later.
SAM: So here’s the chart showing—I believe I took this chart back to 1982. You started in 1984. As you can see, we’ve actually surpassed the inflation rate of the early ’80s. I believe as of September, the CPI was rising at 8.2% year-over-year. It was slightly higher in June—I think it was 9.1%—but it was—
CJ FOLLINI: We hit a high point of 8.9%, yeah.
SAM: So, I guess given your tenure as a manager, what comments do you have on reflation and turning? I think your point about the whole narrative that Powell and so many others pushed about inflation being transitory in 2021 was incredibly myopic and shortsighted. And I—I think one of the key questions here is how long will it persist? Do you have a take on that?
CJ FOLLINI: I do. Um, what people forget is that Paul Volcker—if you want to draw a line with Paul Volcker—did cause a recessionary environment. He had to. It’s not—it’s not a—it’s not a criticism. It’s just a factual statement. He had to. Now, as you can see from the chart, the entire swings have gotten tighter. So, the secular nature of all these forces is becoming tighter because the world moves faster, and because of productivity, and because of the free flow of information. Everything moves quicker. So, um, um, low points and high points are tighter—they’re shorter in duration, that is true—but they also can be—they can be of greater depth and greater height, which thus leads to the volatility that we are experiencing.
I think the extreme nature of what the Fed has to do is going to push us into a recessionary definition. So, you know, under 2% growth, and—and negative growth relative to the, relative to the GDP, is a recession. And frankly, I also don’t see—I don’t see productivity growth, and I don’t see innovation growth occurring in a meaningful way, especially when you are decoupling globalization and onshoring back to their relative countries. There is not a lot of potential growth areas that are visible. So we have—we have inflation being tamed by a much higher cost of capital generated by the Fed and slow growth. To me, that smells of stagflation, and I have been saying that for over a year. And obviously, timing is—is difficult in these worlds—no one can do it. If you are, you shouldn’t be on a webinar or a thought leadership series—you should be on an island somewhere. But I believe that we’re heading into stagflation, and I do not know its duration. And I do know that we will tame inflation, but critical assets will be essential. Understanding critical need assets will be essential in a stagflation environment.
SAM: CJ, can you explain for our viewers exactly what stagflation is and how it differs from typical inflation as we might perceive it?
CJ FOLLINI: So, obviously, we are not going to be in a 9%, 8% inflationary environment forever, or even for an extended period. But relative to GDP, 5% is equally—is also painful. And then if growth starts to decline or stagnate to zero or less than 2%, um, well then you have a mismatch between the cost of capital, the cost of goods, and the ability to purchase or utilize those goods based on growth. So what happens is that you don’t have a lot of capex in corporate investment, you don’t have a lot of research and development, and yet you also don’t have the purchasing power for, for your—for your clients, your customers, for them to buy these goods of service.
For me, stagflation is, is, um, probably the most negative environment because it—it—it’s not negative enough to generate an extreme response, which could help, but it’s not positive enough to actually do—also create behaviors that will help for the long term, like investment and future investment. So, that’s the best way I can describe it. I’ve only experienced it once. Many generations that, that we’re, we’re working with have never experienced it, and there isn’t an easy—there isn’t an easy answer to it.
I actually, if I remember, fiscal stimulus was what brought us out of that—of our stagflationary period in the, um, mid to or late ’80s. And same after—there was a brief, very brief stagflationary period after the first due, crash in 2009, 2020, and it was fiscal stimulus generating investment that brought us out of that again. Both times, real estate—essential need, critical need real estate—outpaced, outperformed all of these other asset classes that were on the screen.
SAM: So, there’s a couple interesting nuggets in there. The first is, fiscal stimulus. And stepping back to the, the point about stagflation, I do think we are in a stagflationary environment now. I am optimistic that productivity growth will increase in the future. I do think that we will be somewhat more inflationary in the next 10 years—more so than we were in the previous 10. Um, but what’s interesting to me is if you look at the causes of inflation, I think historically inflation was typically perceived as something that was induced by excess demand. And the Fed is really good at curbing excess demand because they have demand-side fiscal solutions, like controlling the federal funds rate. Is this a demand-induced inflation that we’re experiencing now, or is it supply-induced? And how does that relate to the asset classes that we’re targeting?
CJ FOLLINI: Excellent point. I’m going to say—this is an—this is my opinion that has been informed with, with research, but I—I have also spoken about this, for many years. This is a supply—and the supply that is constrained is one, land obviously, but more importantly, skilled labor. I have to make that distinction because you will—if you look at—we have a very tight labor market, but that does not tell the real story. It’s the U6—it’s the U6 number of both, um, people who are no longer looking because their skills do not match the, the, the job listings. Um, more importantly, there is no data that can show a skills mismatch, but as our economy has changed from a manufacturing to a service economy, we never—we as a country did not, and—and individual states did not perform the necessary reskilling that needs to move the labor supply with that transition, of our economy. Um, and then we move even from, from a service to then a technology economy, which is a great part of, of what the American economy is, and we yet still did not properly skill and train the labor force.
I could go on for a whole other thought leadership presentation about, about reskilling and its needs. I think we—but that’s another one. But I really believe that the supply of labor is constraining, regardless of what the U2 says. It is more about the people who are dropping out of the workforce because they don’t see their skills matching what, what, what positions are available. And that’s the problem. I mean, that is the problem, because what the Fed is doing is tamping, is dampening demand. But I believe the real problem is creating a supply of labor.
SAM: I—I couldn’t agree more. So, I think that’s a good pivot because we’ve been talking about inflation broadly. Let’s talk about real estate more specifically. In your experience as a manager with inflation, what are some of the strategies to act that make real estate and logistics assets so good at hedging against inflation?
CJ FOLLINI: First of all, I—I’ve said essential need, critical need real estate. Um, I—I can’t stress that enough as the context, for, for this part of the discussion. I don’t think it’s a time of discretionary—especially large discretionary—purchases, nor, um, nor, um, real estate that supports large discretionary purchases, i.e., luxury, i.e., new hotels. I really doubt what is needed are things that, that support the supply chains that keep people moving, that keep people living, keep them fed, essentially, and keep them healthy—obviously healthcare.
So, triple net leases—triple net leases shift the cost to the tenant. Now, so a lot of these inflationary pressures—albeit these are structural, input costs—are put on the tenant. Now, you would say, well, that’s only going to impact your future tenancy. All true. However, these—you know, when you have a tenancy that is critical need, these are larger organizations that have committed their credit to pay for the—to pay for these input costs. So the owners of the real estate don’t have the risk of the higher input cost, and yet they have the credit tenancy to absorb those higher costs. CPI indexation is one way that went out of vogue for, for over maybe two decades. I remember when it was in vogue—I remember, I was there—we’ve already established how old I am. But it’s coming into vogue in the last three years. And there—and there were a lot of proactive, um, real estate attorneys and real estate owners who understood what is coming given all these fiscal stimulus, gee—all the monetary stimulus, excuse me. And so that protects, again, the real estate investment against an uncertain future of where the Consumer Price Index is headed or where inflation is headed. I would say that triple net lease is more effective than CPI.
SAM: Long-term fixed-rate debt?
CJ FOLLINI: Well, I—I feel sorry for any real estate owner that purchased prior to the pandemic and—and did so with floating rate debt. I could not imagine a worse situation than to be at a high purchase price—when things were inflated, in terms of real estate assets—prior to the pandemic, and then the debt now accelerating with inflation. That is a, that is a, um—that, that is a perfect storm.
SAM: And market shakeout. I mean, how many managers get caught with their pants down, so to speak, because they don’t have triple net leases or because they got a floating rate loan in 2018?
CJ FOLLINI: It’s hard to say, because, you know, triple net leases are sort of the norm in the industrial sector. Obviously we have a varied asset class thesis, so I—I could answer that question five different ways for five different asset classes. But generally, triple net—even modified double net—is sort of the norm. So I don’t think that’s—I don’t think that is the area to look for differentiation for us. Um, I do think that we’ve been—I’m proud of the debt management, and our skills in doing so. We all—we, in terms of Noyack and its assets, have long-term 10-year duration fixed debt, and we refinanced at the nadir of the, of the, um, pandemic, which, which brought us the lowest rates in—in my history of, of commercial real estate, and they’re all fixed for 10 years. So that debt itself is an asset. So we have created value just by the nature of the debt, because that debt is no longer attainable. You cannot find it. You’re never going to get it. So now the value of—not just the intrinsic value of the asset—is, is increased, is enhanced by the value of the attractive debt.
SAM: Lease duration—that’s a tricky one, because you never know where you come into the life cycle of a lease duration in an asset. Now, if you’re the developer, obviously you’re at the beginning of that life cycle. But we are—we are minuscule when it comes to development. It is not something that, we believe has a long-term, um, advantageous risk, um, risk-reward profile. But we work with a lot of developers, um, we are sometimes their, their buyer in a forward commitment. When they finish, they find a tenant, we’re standing there ready to take it over so they can turn their dirt value into cash value and move on to the next thing that developers do.
So I do think, in many markets, lease duration can be a, a, a great asset. It can also be a hindrance. So, in markets where the leases are legacy and the, and the market rates are much higher, I want short duration. In fact, I would say that’s a norm. All of the market rental rates in the markets that we are looking at have exceeded the current older legacy leases. So if someone moves out, we’re getting a better tenant. First of all, there’s a constrained supply of, of all these assets. And two, the prices have risen, obviously, so we’re able to then insert a larger value tenant than the one that was there previously. So, frankly, a mix—a barbell approach—of long duration on one end to create a foundation of stability, and a short duration on the other end to create alpha in terms of improving your, your rental net operating income is optimal. And that’s what we see.
SAM: And I know talking about lease duration is—it’s an awfully dry topic, but, uh—
CJ FOLLINI: You didn’t find that the most scintillating conversation you’ve ever heard?
SAM: I mean, it’s, the dogma for so long has been to have stability in these long-term leases, and I think you have a much more nuanced view of why that might not be optimal in terms of how you’re allocating assets. So while it is a dry topic, I—I think there is a lot more nuance there that—that’s easy even when we’re speaking that people gloss over it because it’s—it’s finally talking about, lease durations. There’s a microeconomic nuance to it in that—and that it is specific to asset class. And when you’re looking at, at supply-constrained, demand-supply-imbalanced asset classes, then you—and then when you analyze the data from market by market, making it more micro, you can see that this is a real way and method for the, for the advanced commercial real estate investor to increase the alpha of your portfolio in terms of returns. Because stability is great. We want stability, especially now in a, in a period of high inflation and very high volatility. But there’s another se—segment of the portfolio that can create the higher end of the returns with modest risk. And that—and it depends on, it depends on the type of asset, the asset class, and the location.
SAM: Could you touch on the Noyack property quotient? Because we actually spent a lot of time creating an algorithm to assess lease duration, whether or not it’s attractive, and how that overall affects our portfolio construction within NLI.
CJ FOLLINI: Thank you. Thank you for the setup, and yes. Um, we’re really proud. So we had some very—we had a very, um, talented and smart team, um, data, data, data graduates and scientists from some of the best universities—Carnegie Mellon being one, RPI. And we posited that if we can harness a large number of data points—I think in the, in the quotient we have up to 30, 35—and if we can give them a relative weight, then we are able to create a simplistic score that relatively speaking can value one market vis-a-vis the other, taking into account, like, how far—what is the delta of new market rates, current market rates versus the legacy lease cost? Um, what is the intermodal transport mean—we’re in—we’re in supply chain—so with all of these things, we’re able to put hotspots around a, a nationwide map of saying where the next opportunities are to create alpha both in, um, both in the future development of supply chains as well as the roll-off of legacy leases that will come—will reset to the market, and the market is much higher than they—where it was. So if you add in all these things, you give them a relative weight, you make sure the data is correct, you have a very effective tool that we utilize, um, that we utilize effectively. And, it’s called the market quotient. We have one, obviously, to, to relatively score individual assets across asset classes—very hard thing to do. But the market quotient that scores markets relative to their size and the things I mentioned is equally effective, and it’s the start for us in our underwriting.
SAM: So I want to drill down more into our asset classes. Can you talk about which asset classes we’re targeting, why are they essential, and what’s the key benefit of a diversified approach versus a single asset allocation, which is what most other REITs and real estate investors out there are actually deploying? It’s—they have one asset class, that’s the only thing they do.
CJ FOLLINI: Okay, again, this is the topic for an entire—an entire thought leadership presentation because I have been a—I have—this has been a personal bugaboo for me for a long time, even as I managed a, a large, private investment office for a group—a group of ultra-high-net-worth families. I—there are tomes—specifically modern portfolio theory written by David Swensen, the legendary CIO of Yale—Yale Endowment—that, that proposes diversification as the foundational principle of all portfolio theory. Okay. And then there is every, every talking head on every general business channel speaking about diversification, diversification. And yet we have a bunch of specialists when it comes to REITs and other aspects that are doing one thing over and over again. Well, I don’t—that—it seems both counterintuitive and, and counteractive, frankly, in that if you do one thing and that one thing is no longer effective for a few years—i.e., tragically, um, hospitality during the pandemic, which lasted over two years—and you’re going to still—you’re going to keep doing that because that’s your job, and that is your surgically focused mandate. Well, that seems like the definition of insanity, of doing the same thing you know is not going to work over and over again.
The alternative is to do nothing. Neither of which is good if you’re looking for returns and alpha over a long duration of five to seven years. So diversification, for me, has been a guiding principle in all—even in our private investment portfolio construction—that I have followed, and it is my—it is my North Star for over 30 years. So, knowing that, when we said that we want to aggregate all of the individual skill sets of these asset classes, we—I said it had to have a connecting thesis. The delivery of a good or service had to be critical need. These—all these fit. And then I go back to the barbell approach within that thesis. So, there has to be stability, and then there has to be the opportunity for alpha with a bit more risk that’s, that’s managed and understood. And that’s what these asset classes present.
I would, I would say that dry warehouses and, and medical office buildings—healthcare is the delivery of a service, and again, tragically over the last two years we learned how important the delivery of that service was. Vaccination sites at the point of spear, medical office buildings, um, testing sites, and then obviously cold storage warehouses were—were—were the most important critical need, real estate of the last, of the last, um, of the last two years. They create stability.
CJ FOLLINI: They create stability. Mobility hubs. Mobility hubs are large parking garages that are underutilized and will become logistics depots for micro-fulfillment. They are purchased at a very reasonable rate, even at the peak when credit was—when we were awash in cheap credit—because they were misunderstood. And there—and that created an arbitrage opportunity. The misunderstanding and the mismatch of what they do to what is needed. Well, we have closed that misunderstanding. We have repurposed large structured parking garages into a critical need fulfillment center and thus creating a new category which has a much more attractive pricing—not to mention the enhanced revenue of the greater utilization rate—that is where we get alpha for this barbell approach.
I’m very big on barbell. I do think that there’s a multivariate approach when it comes to diversification, and barbell on stability and alpha is one of those, one of those methods.
SAM: So I think you touched on two interesting themes. The first is this renewed push, I think by both parties in Congress, for onshoring. And I think the second is geopolitical concerns. Because the last two years have been erratic to say the least. We’ve had a global pandemic, total supply chain disruption, a major war fought in Europe, and, we’re seeing that affect our domestic supply chain—not only in terms of disruptions that we’re seeing with, things coming from overseas, but also in terms of a renewed focus on building out our domestic production capacity.
And I think that it’s—it’s sort of a double, a double layer here. I mean, number one, our fundamental conviction is that many of these—you never, you never asked what the best idea is—you left this slide, but you never asked what the best idea is. What’s the best idea, CJ?
CJ FOLLINI: Cold storage.
SAM: Bingo. That’s it.
CJ FOLLINI: I’m not gonna go—I’m not even going to elaborate. I’m gonna leave that for a follow-up episode.
SAM: Well, yeah, we’ll have a whole—a whole series on cold, a whole series on cold. Go ahead.
CJ FOLLINI: Go ahead.
SAM: Well, so what I’m getting at is that, you know, there are really two secular themes behind our thesis with NLI. The first is that these assets are undervalued due to e-commerce, and that was made abundantly clear during the beginning of the pandemic. The second is that there’s this renewed push for geopolitical reasons to onshore a huge part of our supply chain that had moved abroad over the past 30 years. Both are secular tailwinds that will support this asset class for the next 15, 20, 30 years.
CJ FOLLINI: And—I’m sorry, was there a question there? I’m not sure, okay. Yes and yes. so we are—okay, so year-over-year growth of e-commerce has slowed slightly. But that’s slowed from a white-hot, Phoenix-like level. So, and, and still the supply necessary—the critical need supply to manage, e-commerce—not to mention the changing way e-commerce is transacted, meaning lifestyle change. I can get organic produce—I, obviously, I live in a dense urban environment—but still, I can get same day within an hour, same day delivery. Just that one phrase—same day delivery—which I do believe was a, was, was a marketing idea, then has to be translated to the fulfillment and warehouse, infrastructure. I can only imagine the day when, when, when the warehouse employees saw “same day delivery” is coming, and, and I can only imagine what that day was like for them. Because we are grossly undersupplied when it comes to our changing lifestyles.
Back to cold storage. We are becoming a healthier society in this country. Organic produce, um, um, health, and nutrition—I read article after article, my wife is a, is a nutrition maven, um, due to Lyme disease. Um, even NHL players, of which I used to be a minor one—their nutrition used to be pizza and beer after, after the game. Now they have supplements, they have, they have nutritional guidance, they’re on strict regimens. So this is a movement that is not abating.
SAM: So, I want to pick up on this theme of same day delivery, because I think it’s really easy to talk about it in theory, and it sounds like it’d be a simple buildout from a supply chain perspective, but it’s incredibly capital and resource intensive to actually effect. Can you talk about why that is, and why it takes up so much more square footage in a warehouse than other standard uses?
CJ FOLLINI: May—smaller, closer, colder. And what that means is that historically all supply chains were regional, or even super-regional. That means that they said, “If we can, we—we have time to deliver. We can deliver it the next day. We—an order comes in, we can fulfill, we can, we, we can pack or fulfill and then deliver to B to C at within 24 hours.” So there was a durational understanding of what fulfillment meant. And once upon a time, it was not—back to my early days that we mentioned—it wasn’t 24 hours, it could be 48. Okay, well, all of that timeframe that has, that has shortened brings—you cannot be an hour away from the bell curve of, of the population. You cannot—you cannot wait for a million square foot super-regional center to pick, choose, pack, um, fulfill in a, in an intermediary, delivery van or truck that brings it to another regional center, which then delivers to the customer or—or, or the customer, or the, or the grocery store. That is not possible anymore.
So all of our supply chains have to get closer to people—simplest way. Then when you add things like next day delivery, which we mentioned, and lifestyle change—organic, um, a lot of natural produce, farm to table is another lifestyle, trend—that means we have to receive the food within the shortest period of time, where we live. That is very hard. Our supply chains were not built for that. And they’re going to be retrofitted to accommodate that because that paradigm is not reversing—that is not a fad. At least in my opinion, I—but it is not a fad. So, there is a tremendous amount—not of just of gross building, but of restructuring. And that is—speaks back to our mobility hub—our mobility hub concept of repurposing parking garages is central to the idea of restructuring supply chains to be closer to the population for faster fulfillment, with smaller amounts of goods, and potentially a temperature-controlled, chain of, chain of control of that. And that is, is the smaller, closer, colder thesis that we are putting forth and, and investing upon.
SAM: And I think, you know, the smaller piece is key in my mind because part and parcel—forgive my pun—with everything you just said is that when you go from these super-fulfillment centers, you’re shipping pallets, which are fundamentally space-efficient. When you go smaller, closer, colder, you’re shipping parcels, which take up far more resources in order to move about than, you know, a large pallet that might be in a—I don’t know how many of our viewers are from the north, but I can assure you to find a 500,000 square foot regional center with 30-foot clear heights and very few columns in Boston or New York, or even Hartford for that matter—no offense to people from Hartford—is not just difficult, it’s impossible. They don’t exist. So if, if they’re going to satisfy these dense urban infill populations, it has to be with a new supply chain. And that is—and we’re at the point of that spear.
SAM: So, with that, I want to pivot to, Q&A. CJ, we’ve got a few questions in the chat I’ll read off for you. The first is: How does real estate stack up compared to other real assets when hedging against inflation?
CJ FOLLINI: Got another—another very big macro question. Obviously good because that’s—that’s the purpose of the presentation and also what we’re doing now. I—I believe that it is not as simple to say “real estate.” For example, there are certain asset classes that I think are, are performing less well. I—I do think—we just went through the whole thought leadership presentation of, of why, um, critical need supply chain infrastructure, logistics infrastructure is ideally suited to an inflationary environment. Um, obviously we can go asset by asset class—bonds, stocks—well, we all know what the stock market is doing. Um, and historically, given my experience from the ‘80s and early ‘90s, commercial real estate was a noted outperformer. Within commercial real estate, you have to pick the best managers and the right asset classes, and I—we believe we have.
SAM: So the next question here, let’s go to: Does the United States’ trend of onshoring versus importing from China, Mexico, etc. impact your acquisition strategy?
CJ FOLLINI: Yes. clearly. I mean, NAFTA has—is a word that hasn’t been spoken or about in a—in a very long time because it was a, um, it was a swear word during the, um, the prior administration, and now it’s just ignored. So it’s interesting. Um, so if NAFTA is not going to be utilized as a—as a pan-continental supply chain movement, well, that just accelerates everything we described. Now, it really speaks to the super-regional and the, and the—and the regional supply chains. And I believe we’re focusing more on the B to C supply chains, which have the highest potential for alpha, i.e., highest potential for, um, for profit expansion and—and margin expansion.
But if we’re no longer transporting goods from a million square foot facility in, in Canada or China or Mexico, and they have to be manufactured here and delivered here, well then the, the gross amount of, of, um, of warehouse manufacturing facilities is a—a much larger amount is needed. We would have a—a severe demand-supply imbalance. And it seems to be, to be occurring, obviously recession—stagflation—is ameliorating that somewhat, but it’s not going to correct it.
SAM: I think your comment about NAFTA is interesting because you’re right, it’s not well-liked on either side of the aisle in Washington these days. I think what’s also telling is that Brexit happened, you know, three, four years ago now, and we still don’t have a free trade deal with the UK—one of our closest allies in Europe that also speaks English. And it—we’re not even discussing it. It’s not even on the table. There’s really no appetite politically from either party to sign these free trade deals, and that’s frankly just a secular trend for us over the next 10, 15 years.
CJ FOLLINI: I—I would comment on that, but again, that’s a whole other thought leadership—the impact of geopolitical consequences on, on investment—so let’s leave that for another day. But, I agree to many of the things you said, but there’s, there’s, there’s a lot more discussion. And guess what? We just have another episode.
SAM: Yep. Okay, next question here: How do you see your portfolio performing in an environment with interest rates rising?
CJ FOLLINI: Excellent, that’s the one that we haven’t spoken about prior to—you know, that’s interesting. I see this opportunity because as a REIT, you have a currency of the shares. The shares could be your purchase methodology. We just yesterday made, $195 million in offers, utilizing our shares in exchange for those assets. And they solve a lot of problems for certain types of buyers—offices, disaffected minority partners, etc., etc. Um, well, we are now becoming the prettiest individual at the dance because of that. Those who are buying with cash or debt are becoming much less competitive.
Debt, usually for the best—for the best managers—could have been attained at 2% in the last two years. It was literally a wash—free. I mean, 2% of P-rate. We refinanced in the threes, which is still pretty, pretty amazing. But now that debt is five, six, and a lot of the lesser players are no longer active. And frankly, a lot of the larger alts—Blackstone, Carlyle, um, some of the REITs—they’re hemorrhaging assets because they realize that they cannot hold on through this duration of high interest rate environment. So, there’s a lot of potential opportunity in supply, in transaction. There’s fewer competition because they, they cannot get cheap debt of 80% of the purchase price at 2%, and we’re here waiting to pick up the pieces of both.
So, I think it is a tremendous competitive advantage. It is something we have to manage, but we don’t rely that much on debt. Our average loan-to-value was 65%. It’ll become probably 55 to 60. So this is a competitive advantage for us, personally. Overall, unless you have to sell in the next year or two, it’s not going to affect because our duration is going to surpass the length of this interest rate disturbance.
SAM: And just to clarify for our viewers, what CJ is alluding to is what’s called a 721 UPREIT exchange. We have a lot more collateral on that—you can certainly request it from us—but effectively what he’s saying is that we can acquire assets with REIT shares as opposed to cash and debt alone. And as—now that Blackstone and everyone else has to compete with Treasury bills in terms of yield, they’re going to have to unroll a lot of their positions, and we’ll be here to pick up the pieces moving forward.
CJ FOLLINI: Thank you for that closed captioning interpretation or, or transl—you know, I want to give the—the right text code. You’re right, thank you. Sometimes I, I forget to, to be a little explanatory.
Just by the way, I want to just follow up with the yes—and I’m not here to bash all the alts. I love them, worked there. Um, but they—they pitched these large dollar items—$50 million, $100 million dollar umop—DR warehouses which are really easy to manage. In fact, you can manage from that building right across the water that I’m looking at right now—never leave that building in, in, in Midtown Manhattan. Um, there’s not a high barrier to entry. All you need is capital, cheap, cheap debt, and away you go. And that’s what just happened.
And when the, when all of the risk-free trades—Treasuries, German Bunds, London Gilt—was at zero and—and negative—German Bund, negative 25 basis points—then these big boxes at 3 and 4%, which are in insanely high prices, but 3 or 4% returns seem very attractive with modest risk. That is true, and they used it as a proxy to move large pools of capital around the world. That was the large private alt, Blackstone, concept. And it worked for two years.
When the Treasury goes from zero to 4.2%, well, there’s a lot of sovereign wealth funds calling up Jonathan Gray and saying, “You know, that, it worked for a year or two, but you gotta get me out of those boxes because I’m going to go buy the Treasury, and I don’t need that 3 or 4% return from something that is a physical asset with—with concomitant risk. I’m just going to go buy the Treasury.” And then someone has to tell them, “Oh, you know, you don’t sell them one, two, three.” And there’s a lot of that going on right now. So, you know, buckle up, it’s going to be a bumpy ride, and—and that’s going to cause a lot of internal distress amongst that group. And for, for us—plug, shameless plug here—a lot of opportunity for Noyack Logistics Income RE.
SAM: So I think we’ve got one more question we should finish on here, CJ. The question is: How certain are you that growth will be driven for the next 10 years? Could it impact your hold period?
CJ FOLLINI: I don’t want to be glib about this, but I—I’m pretty certain. And it goes back to the demand-supply imbalance. All—everything we said about supply chains, the, the changing of the way people live, where they live, um, lifestyle changes, corporate, commercial changes—same-day delivery, onshoring—every trend in a multitude of areas, whether it’s personal or commercial or corporate, is moving in the direction that simply we do not have enough supply chain infrastructure. And—and I don’t mean like a small delta, I mean an exponential delta of not enough. So that is not going to be corrected over 10 years. That’s why I feel pretty certain.
SAM: Well, I think that’s all we have time for, CJ. I mean, I certainly enjoyed our conversation, and I think there’s a lot of topics we could follow up on in, future presentations as well.
CJ FOLLINI: I’m smelling series here. I’m smelling we’re getting—I—I sense we’re getting picked up for season two.
SAM: Certainly hope so. So we want to thank everyone for joining us. This has been our first thought leadership presentation, and we certainly hope you enjoyed it as much as we did. I certainly liked speaking to CJ, and I appreciate that.
CJ FOLLINI: Shout out to our home country, Italy, for joining, for joining the presentation. That’s great to see that we have—that we have some European attendees. Great. Thank you, Sam. That was a fantastic discussion, and I appreciate your moderation skills. They can only get better with time, and they will.
SAM: And we’re gone.
