The Art and Science of Real Estate Deals With Rob Solomon, Real Finds Podcast #49 Transcript
Rob Solomon: It’s still the real estate business. We’re all capital allocators. There are cycles, and we’re at the low point of a cycle. Things are terrible right now, and they’ll get better. Then we’ll have a bunch of irrational exuberance, capital will flow back into real estate, we’ll get to another bubble, and it’ll pop again. I don’t think that’s going to change much over the next ten years.
Gordon Lamphere: Hi, I’m Gordon Lamphere, and welcome to the Real Finds Podcast, the podcast that interviews key entrepreneurs, activists, and researchers shaping the real estate industry and, as a result, our world. On today’s podcast, we speak with Rob Solomon. Rob is president and chief legal officer at BLT Enterprises, a waste management and commercial real estate firm with over two billion dollars in commercial real estate investment. We discuss powerful untapped niches in industrial real estate, strategies to invest in last-mile delivery, and why commercial property management is best kept in house. It’s well worth a listen. Rob, thanks for hopping on the podcast.
Rob Solomon: You’re welcome. Glad to be here.
Gordon Lamphere: Why real estate?
Rob Solomon: I’d love to say it’s in my blood, but I graduated from UC Santa Barbara in 1991 with a 4.0, but that was my blood alcohol level. I traveled for a bit, then got a job as a mortgage broker selling residential mortgages in 1992 and 1993, got out of that for a variety of reasons, and went to work for a law firm as a paralegal. I got convinced to go to law school, and when I graduated, I got a job at a great litigation shop in Los Angeles, about eighty lawyers, with a small real estate department. About a month into being a first-year litigator, I figured I was going to get fired because I had no idea what I was doing, but they had an opening in real estate. I moved over, and on the first day I went from the library doing insurance law research to negotiating a purchase and sale agreement. The partner I worked for played a lot of golf and expected his associates to do much of the work, so I got thrown right in and loved it. That’s how I got into real estate.
Cash Flow Over Everything
Gordon Lamphere: As a young associate, you saw a lot of deals from the legal perspective. What’s your ultimate strategy when investigating a deal?
Rob Solomon: Our company is unique in some ways. We don’t have third-party investors, an investment committee, or IRR hurdles. We have two lines of business: we started in waste and recycling and we’re still in it, and we own, invest in, and develop primarily industrial real estate. Our goal is cash flow. When we look at any deal, we’re looking at how quickly we can get to sustainable, durable, long-term cash flow that meets a certain return criteria.
Gordon Lamphere: What is that return criteria?
Rob Solomon: It depends. When interest rates are zero, returns get lower. We look at any project on a ten-year cash flow basis, a ten-year hold. Almost everything we buy, other than a few value-add projects, we buy either as core or value-add-to-core and hold long term. We’re looking for a good spread between the risk-free return on Treasuries and the return we can get on a stabilized ten-year cash flow. In today’s environment, we’ve bought one building in two years, because when Treasuries are at four to five percent, it’s tough to make a deal pencil.
Gordon Lamphere: What was that building?
Rob Solomon: A ninety-thousand-square-foot industrial building in Las Vegas on about nine acres, owned by PepsiCo. They surplused the property, sold it to us, and leased it back short term. It’s in central Las Vegas, about half a mile off the Strip. A lot of other buyers looked at it as a redevelopment opportunity, but for us it’s a great low-coverage site. There’s a lot of need for that use. As our brokers pointed out, don’t redevelop it, because you’d turn a nice low-coverage building with excess land into a maxed-out FAR building, and that’s an apple, and there are a lot of apples. You’re seeing vacancy rise in Las Vegas right now. Keep it an orange. There’s not a lot of competition for that type of site. We’ll do some capital improvements when they move out, but keep it low coverage.
Gordon Lamphere: For listeners who don’t know, what’s a low-coverage site?
Rob Solomon: Think of the size of the building in relation to the land. Traditionally, if you buy a warehouse on a hundred thousand square feet of land, the building is about forty thousand square feet. On a low-coverage site, the building might be five to ten thousand. That gives you the ability to use the land for parking trucks and storing outdoor equipment. As properties in Southern California have been redeveloped into higher and better uses, a lot of industrial land has been lost, which we view as addition by subtraction. Those land sites become much more valuable, especially near the two largest ports in the country, with almost forty million residents in California and the rise of e-commerce and last-mile distribution. You need a place to store trucks and containers coming off the ports.
Gordon Lamphere: Is the push for development what’s driving the decline of low-coverage sites, or is community opposition a factor too?
Rob Solomon: We’ve had a massive expansion of industrial development in Southern California over the last fifteen years, so part of the community pushback is that industrial has moved into the urban interface, with little separation from residential. Also, the uses for a low-coverage site, which now that private equity is involved is called IOS, industrial outdoor storage, people don’t like next to their house or apartment.
Gordon Lamphere: PE loves a good brand name.
Rob Solomon: Once it’s branded, I’m behind the curve. Too much competition.
Why Industrial, and Why Supply Stays Constrained
Gordon Lamphere: Is your focus on niche asset groups that haven’t been branded or mainstreamed, or do you dabble in mainstream classes too?
Rob Solomon: We spend most of our time on industrial. When the company started buying industrial in the late eighties and early nineties, that was niche. There was no institutional appetite to acquire a hundred-thousand-square-foot industrial building. In 1991, you could buy one in Los Angeles for three million dollars; now it’s thirty-five million. They were dirty and not sexy, and the real estate business wasn’t as institutionalized. As institutional capital came in, you couldn’t write a big check for an industrial building, but you could for a million-square-foot office building in Manhattan. So we were niche, and industrial has happened to come into favor over the last ten to fifteen years. It was never that we were looking for a niche. It came from our other core business, entitling, building, and operating transfer stations and recycling centers for municipal solid waste, generally in the urban core next to transportation nodes in Los Angeles and California. Entitling a transfer station took two to ten years, and meanwhile we could buy an industrial building and get cash flow immediately. That’s why we started buying industrial.
Gordon Lamphere: Why hasn’t there been nearly as much development as demand in Southern California? Is it regulatory?
Rob Solomon: A lot of it is no land. We’re out of land. And land prices in the urban core. Downtown Los Angeles has a lot of Class B and C industrial with twelve-to-fourteen-foot clear heights, not earthquake retrofitted, built in the thirties and forties, but land prices were so high you couldn’t pencil aggregating old buildings, tearing them down, and building new. Over the last ten years, there’s been massive development not on the coast but in the Inland Empire, which is probably overbuilt. A lot of buildings were built during COVID, and now there are probably two hundred buildings above two hundred thousand square feet vacant there. So the regulatory environment, the cost of land, and the lack of land have kept coastal California constrained, but out in the Inland Empire there was so much land that building got ahead of the regulatory pressures.
Gordon Lamphere: What are the primary regulatory pressures?
Rob Solomon: In California we have CEQA, the California Environmental Quality Act. Most projects over a certain size trigger a CEQA analysis, which requires at minimum an environmental impact report that can take one to two years. It has a really low standard of review, which opens you to challenge by project opponents. It’s pervasive over any project of scale in California because of NIMBYism, whether industrial or apartments. We need two hundred thousand residential units a year in California just to keep up, and we’re far behind. I won’t make it purely a regulatory issue, but the regulatory pressures are very difficult.
Tenants Are Customers
Gordon Lamphere: You’ve been effective with a wide range of tenants, particularly Fortune 500 partnerships. What are your keys to acquiring and maintaining those relationships?
Rob Solomon: The most important thing, embedded in our DNA, is that a tenant is our customer. In high school I was a waiter at a Mexican restaurant in LA, and there was a sign in the kitchen: rule number one is the customer is always right, and rule number two is if the customer is wrong, check rule number one. Our founder, Bernie Huberman, liked to say when meeting tenants, we want to be your first landlord and your last landlord. We may not be your only landlord, but that’s how we look at you and how we want you to look at us. If your building isn’t large enough, let’s expand it, find another in our portfolio, or go buy a building and rent it to you. If you need to downsize, we’ll find you a smaller building or go buy one and let you out of the lease. We listen intently to our customers’ needs. We do most things in house, and the most important is asset and property management. We don’t outsource it. Our in-house teams visit our buildings once a month and stay in front of our customers. When a lease comes up for renewal, we don’t have to get the highest price per square foot. With no investment committee, no outside investors, and no hurdle rates, we’re happy with higher rates, but we can leave some money on the table in exchange for a win-win relationship.
Gordon Lamphere: Why is in-house management important? I ask as someone whose own portfolio is managed in house.
Rob Solomon: Two things. They’re our customers, and we want to deal with our customers, not have someone else do it. We have a certain way of approaching things. And we can better control the quality and the cost of property and asset management.
Gordon Lamphere: We’ve seen construction labor costs driving deals and making things difficult. Are you seeing the same in California?
Rob Solomon: Prices go up like a rocket and down like a feather. You’d think we’d see lower prices, but we’re bidding out projects right now and they’ve come down only a little on the margins, not what you’d expect after two years of slowdown. Labor is a huge part of it. We have a labor problem in our business. And commodity prices, even though lumber has come down from COVID peaks, framing isn’t that much cheaper, and concrete is more expensive than a year ago. I don’t know why prices aren’t lower, but they’re not.
The Amazon Value-Add Deal
Gordon Lamphere: How do you approach value-add in such a tight market?
Rob Solomon: The last two years have been extremely difficult to find value-add or core projects that make sense. But at the end of the day, you make your money on the buy. Find assets at the right basis where you can be relatively certain of your rehab cost. It always takes longer and costs more than the original budget. We’ve done a number of value-add projects, including taking a 220,000-square-foot manufacturing facility on sixteen acres, converting it to a distribution facility, and leasing it to Amazon. We said it would probably take six months to rehab and six to lease, so let’s budget a year for each and build two years of vacancy into the pro forma. It’ll cost $65 a square foot, so make it $100. Does it still work? Our philosophy is figure out the downside and the upside takes care of itself, and we’ve been fairly successful with that.
Gordon Lamphere: What drove you to that site? Did you buy it thinking of Amazon, or was it spec?
Rob Solomon: A combination. When we first saw it, we weren’t the successful bidder. What attracted us was a moment in the northern San Diego market when there was a premium for large buildings on excess land. Historically in San Diego, larger buildings had lower rates, but there were a number of large tenants in the market, Amazon among them, and no large buildings available. As the number two bidder, the first loser, we tracked the deal with our brokers, found out it was falling out of escrow, and re-engaged with the seller. Because we’d already done our due diligence, we put up a million dollars hard, non-contingent, on execution of the purchase agreement, while the original buyer was trying to retrade the seller. The building was 220,000 square feet on sixteen acres, so lots of room for trailer parking. It was also demisable, which addressed the downside: if we were wrong about demand for a 220,000-square-foot facility, could we split it into two hundred-thousand-square-foot spaces? Yes, easily. That got us comfortable on downside risk, and the upside was the premium for a larger building at the time.
Gordon Lamphere: How did you go about the rehab?
Rob Solomon: Part art, part science. We had plans and schemes prepared for converting it to distribution, but we didn’t initially tear out all the manufacturing space. We had beautiful boards from our architects and marketing materials showing what we could do, but when you walked the site, it was hard to envision. Six months in, in a market on fire for tenant demand, we hadn’t received a single written offer. We walked it again and said, nobody can see what this is. You could see the thirty-two-foot clear height in one portion, but not that it was the entire building. So we demoed everything, leaving a few bathrooms because they’re expensive to put back, and we bought a golf cart. On tours, we’d drive people around the whole open warehouse and the whole site, and people had vision. It was much easier to get to lease execution.
Gordon Lamphere: Did you have a short list of potential tenants?
Rob Solomon: An aspirational list. Eric Starck from Cushman & Wakefield in San Diego did a phenomenal job. He knew who was in the market, targeted them, and we landed Amazon. We were fortunate. With Amazon, the deal is never done until the lease is signed. I’ve had leases on their desk for signature and they’ve walked away.
Gordon Lamphere: I can say from both the real estate and venture capital worlds, they’re an interesting bunch, to be politically correct.
Rob Solomon: Once you get a lease signed, they’re a great tenant.
Interest Rates and the Bid-Ask Gap
Gordon Lamphere: What’s driving the market right now isn’t an individual site; it’s interest rates. What are you seeing?
Rob Solomon: I’m glad you didn’t ask me to forecast, because my crystal ball is broken. Rates have come down a bit on both ends of the curve, less so on the short end. Most of our deals are core projects where we want ten-year financing based on long-term rates. The problem on the acquisition side is that sellers’ price expectations don’t match where rates are, so you’re still in a negative arbitrage environment if you use debt. If you’re an all-cash buyer with low return hurdles, it’s a really good time to buy. If you need debt or have a higher hurdle, it’s still very difficult. And in Southern California there aren’t many quality projects for sale. Prologis, Rexford, and other large PE real estate firms have bought a lot, and the REITs don’t need or want to sell; they need cash flow. The private equity firms that bought industrial over the last few years face a terrible time to sell, mostly value-add projects, and if they’re not at the end of their fund life, they won’t sell. If you bought $500 million of projects in the last three years and sell one at market, you have to mark the rest to market and you’ll have a problem with your investors. So not a lot transacts.
Gordon Lamphere: We’re seeing the same in Chicago. I’ve gone out with all-cash buyers and some prices are predictable given demand, but some are outrageous. Is there value in other asset classes, or do we wait for more distress?
Rob Solomon: We’ve been waiting for distress in industrial for two years and haven’t seen much. I don’t think we’ll see thematic distress in industrial, unless, using the Inland Empire as an example, those two hundred vacant buildings, probably forty million square feet, stay without demand for the next twelve to twenty-four months. That’s thirty-six to forty-eight months of no demand on forty million feet, even in a billion-square-foot market. You’ll find situational distress. But we don’t need distress. We just need positive arbitrage between our cap rates and our debt. It’s not a good business if your cost of debt exceeds your yield on rent.
Gordon Lamphere: Outside industrial, where’s the arbitrage better?
Rob Solomon: Depending on risk tolerance, multifamily. There’s a bit more distress there than in industrial, and a good arbitrage opportunity. Then office, but you’re much further out on the risk curve. If you believe everything reverts to the mean, office is a good bet, but be prepared for losses. High risk, high return. If we get to six and a half or seven percent unemployment and the equilibrium between employer and employee shifts and employers demand everyone come back, offices start filling up.
Gordon Lamphere: For office, it comes down to entry price. We’ve turned buildings from red to green quickly by buying low enough. Have you done that in creative or traditional office?
Rob Solomon: Not in this cycle; in past cycles, yes. We sold a large value-add project in March 2022, a great time to sell and a terrible time to buy, but we wanted to defer the gain with 1031 exchanges and bought some really great creative office projects that are still vacant. Our price discovery has been on leasing. We recently cut our lease rates, we’re getting more tours, and we’re in negotiations right now on one of those buildings.
Gordon Lamphere: What drew you to creative office?
Rob Solomon: We got into it around 2012 when we moved our corporate offices to Santa Monica, which was in the path of creative office conversions: old industrial buildings that serviced the Santa Monica airport during World War II and before, and a convergence of entertainment, technology, and media in Southern California. We saw opportunities to buy at a pretty low basis. We had great brokers who found them, and I can’t stress this enough: relationships with tenants as customers are huge, and equally important are relationships with brokers, who I’d call our partners. They’re the lifeblood of finding great opportunities. We found good entry points in great locations with good bones and parking to satisfy an office need rather than an industrial need, which is a huge selling point in a creative office conversion, satisfying both the code and the tenant demand for parking. In early 2022, we saw a differentiation between traditional mid- and high-rise office and single-story brick-and-timber, bow-truss buildings, and we were seduced by the opiate of that. The market was still doing fairly well for creative office leasing in early 2022, and then it fell off a cliff.
Where the Next Ten Years of Opportunity Are
Gordon Lamphere: Has converting and repositioning been a large feature of your market?
Rob Solomon: The best opportunity to grow our balance sheet is conversions, not necessarily creative office; I’m not sure we’d do one without a tenant right now. But taking an antiquated industrial building, maybe acquiring adjacent property, and building a new Class A project. I think that’s the opportunity over the next ten years. Infill C and D properties we can get at a reasonable land basis, tear down, and build new Class A. That’s how you make outsized returns compared to buying an existing hundred-thousand-square-foot, thirty-two-foot clear, ESFR building with a tenant in tow, which is just a yield play with maybe a little arbitrage over debt, maybe a little negative. If we’re trying for a ten, eleven, twelve percent ten-year average unlevered return on equity, you can’t do that buying existing Class A.
Gordon Lamphere: Sometimes the most money is in what people see as waste. Your firm was originally known for waste management. Can you speak to that and your philosophy of finding wasted opportunity?
Rob Solomon: I love the comparison. Our company started in the early eighties. Our founder, Bernie Huberman, started out of high school driving a trash truck and built a collection business with his partner Dan Rosenthal, then moved into infrastructure in the mid-to-late eighties. We got out of collection and into building and operating transfer stations, because most in-region landfills in Southern California were closing and there was a need for a halfway point between collection and the landfill. You want collection trucks collecting trash, not driving seventy miles to a landfill. They pick up more per day if they deposit at a transfer station, where we consolidate five trucks’ worth and take it to the landfill. That was the wasted opportunity we saw in the eighties.
Gordon Lamphere: Have you seen a big push toward last-mile delivery in your portfolio, and how are you using creative destruction to drive opportunity?
Rob Solomon: A huge push. We just got lucky, because our transfer stations were built in urban cores next to transportation nodes, freeways and ports, and freeways especially are great for last-mile distribution. Put a facility in downtown LA and within a one-hour drive you reach ten million customers; two hours, twenty million. We happened to have waste facilities in those areas, and that’s where we started buying industrial. The last-mile market has changed dramatically in ten years, and we’ve tried to stay in front of it. We didn’t have the term last mile ten years ago, which itself is a dramatic change. Ten or fifteen years ago, we talked about large facilities taking everything off the port and distributing from there. Now it goes from manufacturing or port of entry to a distribution facility, gets picked and packed, and goes to a last-mile facility. The incursion of last-mile facilities closer and closer, embedded in communities, is one of the biggest changes.
The Final Four
Gordon Lamphere: Where do you see real estate going over the next ten years?
Rob Solomon: My crystal ball is cracked, but as the French say, the more things change, the more they stay the same. Over the next ten years, you’ll see technology trends make changes, and continued consolidation of capital and assets among institutional owners, fewer owners in the business. But it’s still the real estate business. We’re all capital allocators. There are cycles. Right now we’re at the low point. Cycles are usually seven years and memories are five. Things are terrible now, they’ll get better, then we’ll have irrational exuberance, capital will flow back in, we’ll get another bubble, and it’ll pop. I don’t think that changes.
Gordon Lamphere: A lot of our listeners are under thirty-five, starting their careers or transitioning from adjacent industries like finance or law. If you could give yourself one bit of advice starting out, what would it be?
Rob Solomon: Take more risk. Don’t be so serious, and take more risk.
Gordon Lamphere: Is there a book our listeners should pick up?
Rob Solomon: I’ll give you three. First, Danny Kahneman’s Thinking, Fast and Slow. Kahneman and his partner Amos Tversky were the fathers of behavioral economics. It’s long but fantastic, and it explains how we make decisions. We have a fast-thinking brain and a slow-thinking brain, and while the fast brain is good for intuitive decisions, we make bad probabilistic decisions because of biases, and it’s when we think slowly that we work through those biases. Second, Peter Bernstein’s Against the Gods, another fantastic read on decision making. Before the great mathematicians, there was no concept of risk; everything was luck and the gods. Mathematicians showed probabilistic thinking, and that’s how we came to price risk much better. Third, Annie Duke’s Thinking in Bets. She was a professional poker player with a PhD in behavioral psychology, and she uses poker to show decision making under uncertainty. Her big theme is don’t look at results to judge whether a decision was good, because poker has known information, unknown information, risk, and luck, and it’s about how you use all of those in decision making.
Gordon Lamphere: Three phenomenal books. One last thing, and the whole reason for the podcast: the men and women in the arena know who to reach out to. Who should be next?
Rob Solomon: It should never have been me, because I’m not sure I’m a great voice. But if you could get Howard Schwimmer and Michael Frankel, the co-founders of Rexford Industrial, for your industrial audience, they’ve done a phenomenal job over twenty-plus years growing from zero to forty-eight million square feet, all in Southern California. And since we’re going for a moonshot, try Jon Gray, president of Blackstone. He has very good insight into global real estate and capital flows.
Gordon Lamphere: I’m in real estate, so I make a lot of cold calls, and I’ve made more than one moonshot already today. One last question: what’s the best way to reach you?
Rob Solomon: My email is [email protected], or go to our website, blt-enterprises.com.
Gordon Lamphere: Rob, thank you so much for hopping on the podcast today. I truly appreciate it, and we’ll have to have you on in the future.
Rob Solomon: My pleasure. Thank you.
Gordon Lamphere: Thanks again to Rob. We appreciate his insights. If you enjoyed the podcast, please give us a like, a five-star rating, and a review. Your comments, interactions, and subscriptions truly matter and help us continue to provide quality guests. You can find us on YouTube, Spotify, or wherever you get your podcasts. I’m Gordon Lamphere with the Real Finds Podcast. Thank you for listening.
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