WEBVTT 00:00:00.000 --> 00:00:01.399 Yeah, I want to try a little experiment to kick 00:00:01.399 --> 00:00:04.000 things off today. No, no, it's a mental exercise, 00:00:04.320 --> 00:00:07.639 but it requires you to be present in your physical 00:00:07.639 --> 00:00:11.279 space. So wherever you are right now, unless 00:00:11.279 --> 00:00:13.720 you're driving, obviously, please keep your eyes 00:00:13.720 --> 00:00:16.379 on the road. But if you can, I want you to just 00:00:16.379 --> 00:00:18.460 stop for a second. Okay. And just look at the 00:00:18.460 --> 00:00:20.760 physical environment around you. If you're on 00:00:20.760 --> 00:00:23.559 a train or a bus, look at the buildings blurring 00:00:23.559 --> 00:00:26.000 by the window. If you're sitting in a coffee 00:00:26.000 --> 00:00:28.600 shop, look at the actual walls, the floor tiles, 00:00:28.820 --> 00:00:31.120 the lighting fixtures. If you're at your desk, 00:00:31.179 --> 00:00:33.060 just look up at the ceiling grid. It's a grounding 00:00:33.060 --> 00:00:35.859 exercise, isn't it? Yeah. We spend something 00:00:35.859 --> 00:00:39.719 like 90 % of our lives indoors navigating these 00:00:39.719 --> 00:00:43.939 boxes. We sleep in them. We work in them. We 00:00:43.939 --> 00:00:46.299 eat in them. We store our junk in them. They're 00:00:46.299 --> 00:00:48.840 the stage sets for our entire lives. They are. 00:00:49.039 --> 00:00:52.359 And here's the thing. We, as a society, are... 00:00:52.909 --> 00:00:55.490 absolutely obsessed with residential real estate. 00:00:56.270 --> 00:00:58.570 I mean, it's the ultimate dinner party topic, 00:00:58.630 --> 00:01:01.189 right? Oh, for sure. Did you see what that house 00:01:01.189 --> 00:01:03.789 down the street sold for? Check out the Zestimate. 00:01:04.049 --> 00:01:07.090 Yes. We treat buying a home like it's the main 00:01:07.090 --> 00:01:09.870 character of the economy, but the backdrop of 00:01:09.870 --> 00:01:13.609 our entire economic life, the places where value 00:01:13.609 --> 00:01:15.969 is actually created, where goods are manufactured, 00:01:16.189 --> 00:01:20.209 where commerce actually happens. That's all commercial 00:01:20.209 --> 00:01:23.430 real estate. Or CRE, as the insiders call it. 00:01:23.609 --> 00:01:26.670 CRE. And yet, for the vast majority of people, 00:01:26.930 --> 00:01:30.810 CRE is completely invisible. It's just the scenery. 00:01:30.909 --> 00:01:33.670 It's just the background noise to the movie of 00:01:33.670 --> 00:01:36.090 their life. That's a perfect way to put it. But 00:01:36.090 --> 00:01:38.409 when you actually peel back the curtain, you 00:01:38.409 --> 00:01:40.090 realize that commercial real estate isn't just 00:01:40.090 --> 00:01:43.840 concrete and steel. It's a massive. massive chunk 00:01:43.840 --> 00:01:46.180 of global wealth. A truly staggering amount. 00:01:46.299 --> 00:01:48.519 We're talking about an asset class that in the 00:01:48.519 --> 00:01:51.200 U .S. alone was valued at approximately six trillion 00:01:51.200 --> 00:01:53.620 dollars. Six trillion. And that was back in 2018. 00:01:53.819 --> 00:01:55.840 So the number is almost certainly higher now. 00:01:55.980 --> 00:01:58.040 Six trillion. That number is so large, it just 00:01:58.040 --> 00:02:00.099 becomes abstract. It's hard to even visualize 00:02:00.099 --> 00:02:02.319 what six trillion dollars even looks like. It 00:02:02.319 --> 00:02:04.920 is. But think of it this way. That six trillion 00:02:04.920 --> 00:02:07.959 dollars explains how your city is built. It explains 00:02:07.959 --> 00:02:10.280 why your favorite taco shop suddenly closed down 00:02:10.280 --> 00:02:13.199 last month. It explains why a new skyscraper 00:02:13.199 --> 00:02:15.439 is going up downtown, even though everyone says 00:02:15.439 --> 00:02:18.379 they're working from home. It frankly explains 00:02:18.379 --> 00:02:21.919 the solvency of your local bank. It is the invisible 00:02:21.919 --> 00:02:23.759 engine that keeps the whole machine running. 00:02:23.979 --> 00:02:27.180 And that is our mission for this deep dive. We 00:02:27.180 --> 00:02:30.319 are going to stop. looking at buildings as just 00:02:30.319 --> 00:02:33.240 scenery and start looking at them as machines. 00:02:33.539 --> 00:02:35.819 Profit generating machines. We're going to decode 00:02:35.819 --> 00:02:38.900 the jargon. We'll talk LOIs, PSAs, cap rates, 00:02:39.020 --> 00:02:41.000 and we're going to break down the mechanics of 00:02:41.000 --> 00:02:43.150 the industry. Because there is a fundamental 00:02:43.150 --> 00:02:45.490 difference between the house I live in and the 00:02:45.490 --> 00:02:47.430 office building I work in, isn't there? That 00:02:47.430 --> 00:02:49.349 is the fundamental distinction. It's right there 00:02:49.349 --> 00:02:52.169 in the definition. Commercial property or, you 00:02:52.169 --> 00:02:54.550 know, investment property is real estate land 00:02:54.550 --> 00:02:57.370 or buildings intended to generate a profit. See, 00:02:57.509 --> 00:03:01.110 that's the shift. My house, the profit, is mostly 00:03:01.110 --> 00:03:03.210 just me emotionally hoping it sells for more 00:03:03.210 --> 00:03:05.189 in 10 years. It's sort of a savings account you 00:03:05.189 --> 00:03:07.590 can live in. Right. It's shelter. But commercial 00:03:07.590 --> 00:03:09.969 real estate is an active business. A money machine. 00:03:10.560 --> 00:03:13.520 Precisely. It is a money machine. And that profit 00:03:13.520 --> 00:03:16.460 comes from two very specific buckets. You have 00:03:16.460 --> 00:03:18.879 capital gains. That's selling the asset for more 00:03:18.879 --> 00:03:20.840 than you bought it for. And then you have rental 00:03:20.840 --> 00:03:24.120 income. And while capital gains are nice, that 00:03:24.120 --> 00:03:27.219 rental income piece is the real engine. That's 00:03:27.219 --> 00:03:29.479 the core of it. It is. It's about yield. It's 00:03:29.479 --> 00:03:31.560 about cash flow. It's about the monthly check 00:03:31.560 --> 00:03:34.680 coming in. OK, so if the definition is property 00:03:34.680 --> 00:03:37.879 intended to generate profit, well, that casts. 00:03:38.330 --> 00:03:41.650 a pretty wide net. When I think commercial, my 00:03:41.650 --> 00:03:44.729 brain immediately defaults to, like, the opening 00:03:44.729 --> 00:03:47.729 credits of a movie Manhattan Skyline. Big glass 00:03:47.729 --> 00:03:50.289 towers. Sure, the iconic stuff. But the source 00:03:50.289 --> 00:03:52.090 material we're looking at breaks this down into 00:03:52.090 --> 00:03:55.360 six distinct... buckets. And I have to say, the 00:03:55.360 --> 00:03:57.680 diversity here really surprised me. It's much 00:03:57.680 --> 00:03:59.539 more diverse than just office towers. And if 00:03:59.539 --> 00:04:00.900 you really want to understand the landscape, 00:04:01.039 --> 00:04:02.680 you have to look at these six buckets individually 00:04:02.680 --> 00:04:04.699 because the economics of each one are totally 00:04:04.699 --> 00:04:07.000 different. An office tower does not behave like 00:04:07.000 --> 00:04:09.419 a warehouse. Not at all. Yeah. Okay, so let's 00:04:09.419 --> 00:04:11.099 start with the classic. Bucket number one, office 00:04:11.099 --> 00:04:14.000 buildings. Right. So yes, this includes the downtown 00:04:14.000 --> 00:04:16.480 skyscrapers, what we call Class A office space, 00:04:16.759 --> 00:04:19.699 high -rises, marble lobbies, secured giggards, 00:04:19.860 --> 00:04:22.310 high -speed elevators. The whole nine yards. 00:04:22.430 --> 00:04:24.750 The fancy stuff. The fancy stuff. But it also 00:04:24.750 --> 00:04:27.149 includes the stuff you drive past without a second 00:04:27.149 --> 00:04:30.209 thought. The suburban office parks. The single 00:04:30.209 --> 00:04:32.790 tenant properties where maybe just a local insurance 00:04:32.790 --> 00:04:35.910 agent and a dentist operate out of a, you know, 00:04:35.910 --> 00:04:38.730 a converted brick building. So that little building 00:04:38.730 --> 00:04:40.689 on Main Street with the accountant upstairs and 00:04:40.689 --> 00:04:43.490 the chiropractor downstairs. Yeah. That is CRE. 00:04:43.790 --> 00:04:46.649 Absolutely. One hundred percent. Is it generating 00:04:46.649 --> 00:04:50.060 rental income from a business tenant? Yes. Then 00:04:50.060 --> 00:04:52.160 it's commercial real estate. That's the definition. 00:04:52.259 --> 00:04:54.120 It doesn't have to be 50 stories tall to be a 00:04:54.120 --> 00:04:57.100 commercial office asset. In fact, in terms of 00:04:57.100 --> 00:04:59.839 sheer quantity, those smaller buildings make 00:04:59.839 --> 00:05:02.220 up a huge portion of the market. I never would 00:05:02.220 --> 00:05:03.980 have thought of that. Yeah, it includes everything 00:05:03.980 --> 00:05:06.560 from the Empire State Building down to a small 00:05:06.560 --> 00:05:09.160 structure, housing, and nonprofit. Okay, that's 00:05:09.160 --> 00:05:11.600 a great distinction. Moving on to bucket number 00:05:11.600 --> 00:05:15.149 two, retail. This one felt huge when I was reading 00:05:15.149 --> 00:05:18.509 through the notes because retail feels like a 00:05:18.509 --> 00:05:21.189 dying word sometimes. But the real estate itself 00:05:21.189 --> 00:05:24.509 seems to be just evolving. Evolving is the perfect 00:05:24.509 --> 00:05:27.389 word. Retail is fascinating because of the sheer 00:05:27.389 --> 00:05:30.350 variety of shapes and sizes. It is not just shops. 00:05:30.629 --> 00:05:33.170 You have, for example, what are called pad sites. 00:05:33.410 --> 00:05:35.550 Pad sites. It sounds like something from a sci 00:05:35.550 --> 00:05:38.899 -fi movie. A launch landing zone. Huh. I like 00:05:38.899 --> 00:05:41.259 that. In a way, it is a landing zone for commerce. 00:05:41.459 --> 00:05:44.019 A pad site is usually a standalone building, 00:05:44.259 --> 00:05:47.360 often right on a highway frontage. Think of a 00:05:47.360 --> 00:05:50.259 fast food restaurant, Starbucks, or a bank branch 00:05:50.259 --> 00:05:52.579 that sits just apart from the main shopping center, 00:05:52.699 --> 00:05:54.160 right by the road. Right. The high visibility 00:05:54.160 --> 00:05:56.220 spot. You don't have to drive deep into the parking 00:05:56.220 --> 00:05:58.620 lot maze to get to it. Exactly. And they pay 00:05:58.620 --> 00:06:01.339 a premium for that visibility. Then you have 00:06:01.339 --> 00:06:04.660 inline multi -tenant retail. That's your classic 00:06:04.660 --> 00:06:07.860 strip mall. The dry cleaner, the nail... salon, 00:06:08.019 --> 00:06:10.720 the vape shop, all in a line. But then the sources 00:06:10.720 --> 00:06:13.920 distinguish between two really interesting types 00:06:13.920 --> 00:06:17.079 of larger centers, power centers and lifestyle 00:06:17.079 --> 00:06:19.360 centers. OK, I love the branding here. Power 00:06:19.360 --> 00:06:21.980 centers sounds so intense, like where Wall Street 00:06:21.980 --> 00:06:24.000 traders go to buy their groceries. It's actually 00:06:24.000 --> 00:06:26.470 about drawing power. A power center is dominated 00:06:26.470 --> 00:06:29.509 by what we call category killers or big box anchors. 00:06:29.509 --> 00:06:32.170 We're talking Best Buy, PetSmart, OfficeMax, 00:06:32.470 --> 00:06:36.189 Home Depot. The giants. The giants. The architecture 00:06:36.189 --> 00:06:39.290 is usually strictly functional, big tilt wall 00:06:39.290 --> 00:06:41.829 concrete, massive parking lots, all aimed at 00:06:41.829 --> 00:06:44.350 efficiency. You go there to get stuff. It's transactional. 00:06:44.790 --> 00:06:47.730 Versus the lifestyle center, which sounds like 00:06:47.730 --> 00:06:49.509 it comes with a spa treatment and a glass of 00:06:49.509 --> 00:06:51.649 champagne. Well, some of them basically do. The 00:06:51.649 --> 00:06:53.649 Lifestyle Center is trying to be an experience. 00:06:53.689 --> 00:06:56.129 It's the physical world's antidote to online 00:06:56.129 --> 00:06:59.110 shopping. How so? It often blends indoor and 00:06:59.110 --> 00:07:01.769 outdoor shopping. It might have fountains, nice 00:07:01.769 --> 00:07:04.209 walking paths, upscale restaurants mixed in with 00:07:04.209 --> 00:07:07.089 the stores, maybe a cinema or an Apple store. 00:07:07.269 --> 00:07:10.269 The whole goal is to keep you there hanging out, 00:07:10.350 --> 00:07:12.410 not just buying a printer cartridge and leaving. 00:07:12.670 --> 00:07:14.930 It's the difference between running an errand 00:07:14.930 --> 00:07:17.720 and having an afternoon out. Precisely. And that 00:07:17.720 --> 00:07:20.600 distinction matters immensely to investors because 00:07:20.600 --> 00:07:22.699 the type of tenant and the type of lease you 00:07:22.699 --> 00:07:25.500 get is very different. A power center tenant 00:07:25.500 --> 00:07:29.339 like Home Depot signs a very long SNABLE lease 00:07:29.339 --> 00:07:31.980 because they have massive inventory. Right. They're 00:07:31.980 --> 00:07:34.040 not going anywhere. But a lifestyle center tenant 00:07:34.040 --> 00:07:36.779 might be a trendy boutique that's maybe a bit 00:07:36.779 --> 00:07:39.740 riskier, but they're willing to pay much higher 00:07:39.740 --> 00:07:42.560 rent per square foot for that premium environment. 00:07:42.899 --> 00:07:45.819 That makes sense. Okay, bucket number three. 00:07:45.839 --> 00:07:49.480 This is my big aha moment in the research. Multifamily 00:07:49.480 --> 00:07:51.839 residential. This is where people often get tripped 00:07:51.839 --> 00:07:53.819 up. It's a common point of confusion. Right, 00:07:53.920 --> 00:07:55.920 because people live there. It says residential 00:07:55.920 --> 00:07:58.139 right in the name. Why is it in the commercial 00:07:58.139 --> 00:08:01.600 bucket? If I rent an apartment, I am not running 00:08:01.600 --> 00:08:03.600 a business out of it. You weren't, but the owner 00:08:03.600 --> 00:08:05.959 of the building is. It all comes down to scale 00:08:05.959 --> 00:08:08.939 and intent. Generally speaking, in the U .S., 00:08:08.939 --> 00:08:11.680 the dividing line is the number four. Four units. 00:08:12.250 --> 00:08:15.310 Exactly. Anything larger than a fourplex, that 00:08:15.310 --> 00:08:18.490 is, a building with four units, is almost always 00:08:18.490 --> 00:08:21.009 considered commercial real estate for lending 00:08:21.009 --> 00:08:23.750 and tax purposes. So let's play this out. If 00:08:23.750 --> 00:08:26.930 I buy a duplex and I live in one half and rent 00:08:26.930 --> 00:08:28.709 out the other half, that's still residential? 00:08:29.089 --> 00:08:32.049 Typically, yes. You would go to a bank and get 00:08:32.049 --> 00:08:34.610 a residential mortgage, like a standard 30 -year 00:08:34.610 --> 00:08:36.769 fixed rate, just like buying a single -family 00:08:36.769 --> 00:08:39.649 house. The bank looks at your personal income 00:08:39.649 --> 00:08:42.519 to see if you can pay the loan. But if I buy 00:08:42.519 --> 00:08:45.019 an apartment complex with five units or a high 00:08:45.019 --> 00:08:48.080 rise with 500 units. Now you've crossed the line. 00:08:48.139 --> 00:08:50.179 You've gone from being a homeowner to an operator 00:08:50.179 --> 00:08:52.480 of a business. Because at that point, the bank 00:08:52.480 --> 00:08:54.379 looks at me differently. Completely differently. 00:08:54.600 --> 00:08:57.200 When you go to buy a 100 unit apartment building, 00:08:57.340 --> 00:08:59.379 the bank is underwriting the building's income. 00:08:59.580 --> 00:09:01.399 They want to see the rent roll. They want to 00:09:01.399 --> 00:09:03.480 see the operating statements. So they're loaning 00:09:03.480 --> 00:09:05.419 money to the business, not to me personally. 00:09:05.929 --> 00:09:08.350 In essence, yes. The building is a business that 00:09:08.350 --> 00:09:11.610 happens to sell shelter as its product. The valuation 00:09:11.610 --> 00:09:14.049 is based on the cash flow it generates, not just 00:09:14.049 --> 00:09:16.230 comparable home sales in the neighborhood. That 00:09:16.230 --> 00:09:17.889 makes total sense. It's a business valuation, 00:09:18.210 --> 00:09:20.409 not a property valuation. Right. That clicks. 00:09:20.690 --> 00:09:25.129 Bucket number four, industrial. This is the invisible 00:09:25.129 --> 00:09:28.370 backbone of the entire modern economy. For a 00:09:28.370 --> 00:09:32.289 long, long time, industrial was the unsexy stepchild 00:09:32.289 --> 00:09:35.539 of real estate. Dusty warehouses. Right. Big 00:09:35.539 --> 00:09:38.379 metal sheds. Big metal sheds. Yeah. But with 00:09:38.379 --> 00:09:40.539 the rise of e -commerce, this sector has just 00:09:40.539 --> 00:09:43.059 exploded. It's become one of the hottest asset 00:09:43.059 --> 00:09:45.500 classes. It's where Amazon lives. It is exactly 00:09:45.500 --> 00:09:47.700 where Amazon lives. Warehouses, distribution 00:09:47.700 --> 00:09:50.960 centers, last mile logistics hubs, all that stuff 00:09:50.960 --> 00:09:53.019 you order online touches multiple industrial 00:09:53.019 --> 00:09:55.340 properties before it gets to your door. And there 00:09:55.340 --> 00:09:57.299 are niches here too, right? The sources mention 00:09:57.299 --> 00:10:00.340 cold storage or cold chain properties. Yes. And 00:10:00.340 --> 00:10:02.539 this is a fascinating subsector. This is for 00:10:02.539 --> 00:10:06.740 food, right? And medicine. Exactly. Food, pharmaceuticals, 00:10:06.740 --> 00:10:08.940 anything that needs precise temperature control. 00:10:09.139 --> 00:10:11.519 These are highly specialized, very expensive 00:10:11.519 --> 00:10:14.179 facilities. You can't just store vaccines or 00:10:14.179 --> 00:10:16.899 frozen seafood in a standard metal shed. What's 00:10:16.899 --> 00:10:19.059 so different about them? Well, you need redundant 00:10:19.059 --> 00:10:22.460 tower systems, massive insulation, specialized 00:10:22.460 --> 00:10:24.639 flooring that can handle extreme temperatures 00:10:24.639 --> 00:10:27.850 and heavy equipment. The infrastructure required 00:10:27.850 --> 00:10:30.929 for cold chain makes these properties very valuable 00:10:30.929 --> 00:10:33.889 and also very specific. You can't easily convert 00:10:33.889 --> 00:10:37.090 a cold storage facility into, say, a furniture 00:10:37.090 --> 00:10:39.549 warehouse. And R &D facilities fall under this 00:10:39.549 --> 00:10:42.139 industrial umbrella, too. They do. Research and 00:10:42.139 --> 00:10:45.279 development. These are often hybrid spaces, part 00:10:45.279 --> 00:10:48.379 office, part lab, part light manufacturing. Think 00:10:48.379 --> 00:10:50.860 of a biotech company. They need a nice lobby 00:10:50.860 --> 00:10:53.159 for investors to walk through. Sure. But they 00:10:53.159 --> 00:10:55.639 need a highly specialized wet lab in the back 00:10:55.639 --> 00:10:58.299 to actually develop the drug. They get lumped 00:10:58.299 --> 00:11:00.240 into industrial, but they're often much nicer 00:11:00.240 --> 00:11:02.159 and much more expensive to build and operate 00:11:02.159 --> 00:11:04.639 than your average warehouse. Okay. Bucket number 00:11:04.639 --> 00:11:08.360 five. The raw material. The very beginning of 00:11:08.360 --> 00:11:10.200 the whole process. And this can be a couple different 00:11:10.200 --> 00:11:13.539 things. Right. It can be undeveloped, raw, rural 00:11:13.539 --> 00:11:15.740 land that's just sitting in the path of future 00:11:15.740 --> 00:11:17.659 development. That's a very speculative play. 00:11:17.840 --> 00:11:19.440 That feels like the highest risk. You're just 00:11:19.440 --> 00:11:21.820 holding dirt and paying taxes on it, hoping the 00:11:21.820 --> 00:11:24.480 city grows towards you. It is high risk, but 00:11:24.480 --> 00:11:26.919 it can be incredibly high reward, if you guess 00:11:26.919 --> 00:11:29.240 right. Or, on the other end of the spectrum, 00:11:29.419 --> 00:11:33.360 it can be infill land. Infill meaning? A vacant 00:11:33.360 --> 00:11:35.620 lot in the middle of a developed city. Exactly. 00:11:35.679 --> 00:11:39.019 A gap in the urban fabric. Maybe an old, derelict 00:11:39.019 --> 00:11:42.340 parking lot or a teardown building in a dense, 00:11:42.399 --> 00:11:45.580 desirable area. That land is incredibly valuable 00:11:45.580 --> 00:11:48.299 because all the infrastructure, the roads, the 00:11:48.299 --> 00:11:51.340 water, the power is already there. You don't 00:11:51.340 --> 00:11:53.000 have to build a highway to get to it. You're 00:11:53.000 --> 00:11:54.840 just plugging into the existing grid. You're 00:11:54.840 --> 00:11:57.039 plugging in. It's much less risky in some ways, 00:11:57.080 --> 00:11:59.139 but the entry cost is obviously much, much higher. 00:11:59.299 --> 00:12:02.299 And finally, bucket number six. The catch -all, 00:12:02.379 --> 00:12:04.679 miscellaneous. This is where everything else 00:12:04.679 --> 00:12:07.940 lives, the oddballs. Hospitality is in here. 00:12:08.320 --> 00:12:12.340 So hotels and motels, medical centers, and a 00:12:12.340 --> 00:12:15.679 huge one recently, self -storage. Oh, self -storage 00:12:15.679 --> 00:12:17.480 is everywhere these days. It feels like every 00:12:17.480 --> 00:12:19.200 time I turn around, a new one is popping up on 00:12:19.200 --> 00:12:21.259 the edge of town. It's a massive industry. And 00:12:21.259 --> 00:12:23.539 financially, it's brilliant. Think about it. 00:12:23.580 --> 00:12:26.039 It's basically just concrete walls, roll -up 00:12:26.039 --> 00:12:28.899 metal doors, very few utilities, and very few 00:12:28.899 --> 00:12:32.039 staff members. Low overhead. Incredibly low overhead. 00:12:32.649 --> 00:12:35.210 And to be a little cold about it, the eviction 00:12:35.210 --> 00:12:37.649 laws for storage units are much, much easier 00:12:37.649 --> 00:12:39.370 and faster for the owner than for apartments. 00:12:39.789 --> 00:12:42.669 It's a very specific subsector that operates 00:12:42.669 --> 00:12:45.049 very differently from, say, an office building. 00:12:45.309 --> 00:12:48.389 So we have these six buckets, but I noticed the 00:12:48.389 --> 00:12:50.289 sources also talk about how these things can 00:12:50.289 --> 00:12:53.190 blend together, the concept of mixed use. Yes. 00:12:53.230 --> 00:12:55.610 And this is a huge trend, especially in urban 00:12:55.610 --> 00:12:58.870 locations. It's a move away from the rigid separation 00:12:58.870 --> 00:13:01.850 of uses. Right. You'll see a building where... 00:13:02.029 --> 00:13:04.509 The first floor is retail, maybe a coffee shop 00:13:04.509 --> 00:13:06.990 and a clothing store. And levels 2 through 10 00:13:06.990 --> 00:13:10.090 are office space or maybe residential apartments 00:13:10.090 --> 00:13:12.669 on top of all that. It's creating a mini ecosystem 00:13:12.669 --> 00:13:15.529 in one building. But I assume I can't just decide 00:13:15.529 --> 00:13:17.529 to turn my house into a coffee shop office tower 00:13:17.529 --> 00:13:19.389 warehouse just because I want to. Definitely 00:13:19.389 --> 00:13:21.509 not. That is where zoning comes in. Real estate 00:13:21.509 --> 00:13:23.590 is one of the most heavily regulated industries 00:13:23.590 --> 00:13:25.929 there is. So the local government has the final 00:13:25.929 --> 00:13:28.629 say. Local authorities have very strict maps. 00:13:29.200 --> 00:13:32.299 A business must be located in an area zoned for 00:13:32.299 --> 00:13:34.820 commerce. You can't just build a factory in a 00:13:34.820 --> 00:13:37.779 quiet suburb. The government designates the usage 00:13:37.779 --> 00:13:40.080 to keep the city functioning logically. You know, 00:13:40.139 --> 00:13:43.080 keeping the noisy, smelly stuff away from the 00:13:43.080 --> 00:13:45.320 sleeping stuff. Okay, so that's the landscape. 00:13:45.559 --> 00:13:47.700 We know where the buildings are. We had defined 00:13:47.700 --> 00:13:49.840 the playing field. Now I want to get into the 00:13:49.840 --> 00:13:52.679 machinery. The money. The money. Because you 00:13:52.679 --> 00:13:54.720 said earlier, this is all about generating profit. 00:13:55.059 --> 00:13:57.799 Right. That is the entire goal. The outline calls 00:13:57.799 --> 00:14:00.259 this the money machine. And it seems like there's 00:14:00.259 --> 00:14:02.519 a fundamental equation here. There is. If you 00:14:02.519 --> 00:14:04.580 want to understand commercial investment at its 00:14:04.580 --> 00:14:07.100 core. you have to look at four variables, cash 00:14:07.100 --> 00:14:10.779 inflows, cash outflows, timing, and risk. If 00:14:10.779 --> 00:14:13.059 you can master those four, you understand the 00:14:13.059 --> 00:14:15.200 entire industry. Okay, let's take those one by 00:14:15.200 --> 00:14:17.519 one. Cash inflows, this seems obvious. It's the 00:14:17.519 --> 00:14:20.559 rent. The tenant sends a check every month. Rent 00:14:20.559 --> 00:14:22.720 is the big one, yes. It is the headline number. 00:14:22.919 --> 00:14:25.019 But if you only look at rent, you are missing 00:14:25.019 --> 00:14:27.200 some of the hidden streams that savvy investors 00:14:27.200 --> 00:14:30.639 really look for. Hidden streams. What else is 00:14:30.639 --> 00:14:33.330 there? Well, first. Think about operating expense 00:14:33.330 --> 00:14:36.210 recoveries. OK, that sounds like pure jargon. 00:14:36.429 --> 00:14:38.389 Translate that for me. OK, this is a crucial 00:14:38.389 --> 00:14:40.929 concept and it's a huge difference from residential. 00:14:41.129 --> 00:14:44.129 In a residential lease, if the water heater breaks 00:14:44.129 --> 00:14:47.529 or the property taxes go up, the landlord pays 00:14:47.529 --> 00:14:49.830 for it, right? Right. It eats into their profit. 00:14:49.970 --> 00:14:53.350 Exactly. But in commercial, we often have what 00:14:53.350 --> 00:14:56.809 are called net leases or most commonly triple 00:14:56.809 --> 00:15:00.799 net leases, NNN. Triple net. I've heard that 00:15:00.799 --> 00:15:02.799 term. What does it mean? It means the tenant 00:15:02.799 --> 00:15:05.679 pays the base rent, plus they pay a proportional 00:15:05.679 --> 00:15:08.559 share of the building's key costs, the property 00:15:08.559 --> 00:15:10.940 taxes, the building insurance, and the maintenance 00:15:10.940 --> 00:15:13.480 of the common areas. Wait, hold on. So if I'm 00:15:13.480 --> 00:15:16.120 renting space for my bagel shop in a strip mall... 00:15:16.440 --> 00:15:18.919 I am paying the landlord's property taxes in 00:15:18.919 --> 00:15:21.120 a triple net lease. Yes, you are. When the landlord 00:15:21.120 --> 00:15:23.000 gets the tax bill, they pay it and then they 00:15:23.000 --> 00:15:25.279 bill you back for your share. That is an operating 00:15:25.279 --> 00:15:27.720 expense recovery. It's cash flowing back to the 00:15:27.720 --> 00:15:30.120 landlord. That is a massive shift in risk. The 00:15:30.120 --> 00:15:32.059 landlord isn't eating the cost of keeping the 00:15:32.059 --> 00:15:34.240 lights on in the hallway or applying the snow 00:15:34.240 --> 00:15:36.899 in the parking lot. Exactly. It protects the 00:15:36.899 --> 00:15:39.679 landlord's profit margin from inflation or unexpected 00:15:39.679 --> 00:15:42.480 tax hikes. It makes the income stream much more 00:15:42.480 --> 00:15:44.840 predictable. Wow. OK, what else? Then you have 00:15:44.840 --> 00:15:48.779 other fees, parking fees, vending machines. If 00:15:48.779 --> 00:15:51.440 you own a massive office complex, the parking 00:15:51.440 --> 00:15:53.700 income alone can be six or even seven figures 00:15:53.700 --> 00:15:57.080 a year. It's not insignificant. And the sources 00:15:57.080 --> 00:15:59.399 mentioned tax benefits, too. This always feels 00:15:59.399 --> 00:16:02.240 like where the rich person's game is played. 00:16:02.360 --> 00:16:05.110 It is a huge part of the game. the biggest one 00:16:05.110 --> 00:16:07.960 is depreciation explain that In the eyes of the 00:16:07.960 --> 00:16:11.159 IRS, a building is physically wearing out over 00:16:11.159 --> 00:16:14.100 time. So they let you deduct that wear and tear 00:16:14.100 --> 00:16:17.179 from your taxable income as a paper loss, even 00:16:17.179 --> 00:16:18.879 if the building is actually going up in market 00:16:18.879 --> 00:16:21.000 value. So you're getting a tax break on a loss 00:16:21.000 --> 00:16:23.220 that isn't real. Essentially, yes. It's called 00:16:23.220 --> 00:16:25.860 a phantom loss. This lowers your taxable income 00:16:25.860 --> 00:16:28.500 from the property, effectively keeping more cash 00:16:28.500 --> 00:16:30.279 in your pocket. And then there are tax credits. 00:16:30.379 --> 00:16:32.519 For example, if you renovate a designated historical 00:16:32.519 --> 00:16:34.840 building, the government might give you a dollar 00:16:34.840 --> 00:16:36.730 for dollar credit that acts just like... cash 00:16:36.730 --> 00:16:40.309 inflow so the money comes in from rent from fees 00:16:40.309 --> 00:16:42.629 from the tenants paying you back for expenses 00:16:42.629 --> 00:16:47.769 and from tax breaks now the same part cash outflows 00:16:47.769 --> 00:16:51.149 the money going out the pain right obviously 00:16:51.149 --> 00:16:53.149 you have the initial investment the down payment 00:16:53.149 --> 00:16:55.529 that's a huge chunk of cash then you have the 00:16:55.529 --> 00:16:57.830 operating expenses and taxes we just mentioned 00:16:57.830 --> 00:16:59.429 which you have to pay before you get reimbursed 00:16:59.429 --> 00:17:03.179 and the big one Debt service. The mortgage payment. 00:17:03.399 --> 00:17:06.359 Correct. But there's another specific cost in 00:17:06.359 --> 00:17:07.720 commercial real estate that you don't really 00:17:07.720 --> 00:17:09.500 see in residential, and it can be an absolute 00:17:09.500 --> 00:17:12.200 killer if you don't plan for it. Tenant leasing 00:17:12.200 --> 00:17:15.059 costs. Is that like paying a realtor to find 00:17:15.059 --> 00:17:17.660 a tenant? It includes commissions to brokers. 00:17:17.779 --> 00:17:20.740 Yes. And those can be substantial, often four 00:17:20.740 --> 00:17:23.099 to six percent of the total lease value over 00:17:23.099 --> 00:17:25.480 the entire term. The whole term. So on a 10 year 00:17:25.480 --> 00:17:28.319 lease. The commission is huge, but it also includes, 00:17:28.319 --> 00:17:31.059 to me, tenant improvements. OK, let's say you 00:17:31.059 --> 00:17:33.680 own an empty floor in an office building. It's 00:17:33.680 --> 00:17:36.339 just a concrete box and a prestigious law firm 00:17:36.339 --> 00:17:39.660 wants to move in. That law firm says. We love 00:17:39.660 --> 00:17:41.740 the space, but we need three more conference 00:17:41.740 --> 00:17:45.559 rooms, a glass wall entry, a bigger kitchen, 00:17:45.799 --> 00:17:48.759 and premium carpet. So they want you to build 00:17:48.759 --> 00:17:51.680 it out for them. Exactly. You, the landlord. 00:17:52.200 --> 00:17:54.259 might have to pay for all of that construction 00:17:54.259 --> 00:17:56.859 to get them to sign the lease. That's the TI 00:17:56.859 --> 00:17:59.000 allowance. So you have to spend a ton of money 00:17:59.000 --> 00:18:01.259 just to get the tenant who will eventually pay 00:18:01.259 --> 00:18:03.839 you the money. Exactly. It is a massive cash 00:18:03.839 --> 00:18:06.039 outflow that happens right at the start of a 00:18:06.039 --> 00:18:09.339 lease. You might be out of pocket $100 ,000, 00:18:09.420 --> 00:18:12.380 $500 ,000, even millions of dollars before you 00:18:12.380 --> 00:18:15.420 collect a single dollar of rent from that tenant. 00:18:15.660 --> 00:18:18.160 That's a huge upfront cost. Yeah. And that brings 00:18:18.160 --> 00:18:20.579 us to the third element you mentioned, timing. 00:18:21.039 --> 00:18:23.700 Real estate is fundamentally a game of cash flow 00:18:23.700 --> 00:18:25.680 timing. You have to project when these flows 00:18:25.680 --> 00:18:28.500 happen. You might have a year of massive negative 00:18:28.500 --> 00:18:30.500 cash flow while you're doing those renovations, 00:18:30.559 --> 00:18:33.619 followed by five or ten years of positive cash 00:18:33.619 --> 00:18:36.259 flow from the rent. If you don't have the cash 00:18:36.259 --> 00:18:38.660 reserves to survive that first year of outflow, 00:18:38.799 --> 00:18:41.180 you go bust before you ever get to the good part. 00:18:41.359 --> 00:18:43.420 And that leads directly to the fourth element, 00:18:43.579 --> 00:18:47.299 risk. Risk in CRE is largely a game of prediction. 00:18:47.900 --> 00:18:50.720 It's all about probability. What is the probability 00:18:50.720 --> 00:18:53.799 that this tenant will renew their lease in five 00:18:53.799 --> 00:18:55.900 years? Or what's the probability they'll go out 00:18:55.900 --> 00:18:58.359 of business next year? Exactly. What's the probability 00:18:58.359 --> 00:19:01.140 that the market rent for this type of space will 00:19:01.140 --> 00:19:03.380 go up or down? It feels like weather forecasting 00:19:03.380 --> 00:19:05.779 sometimes. You're trying to predict the future. 00:19:06.039 --> 00:19:08.299 You are. You're analyzing market conditions to 00:19:08.299 --> 00:19:10.700 predict the reliability of those cash flows. 00:19:10.960 --> 00:19:13.559 Yeah. If you have a government agency as a tenant, 00:19:13.599 --> 00:19:15.700 like the FBI or the Social Security Administration, 00:19:16.859 --> 00:19:19.680 the risk of them not paying is basically zero. 00:19:19.880 --> 00:19:21.640 Right. They can bring the money. So the yield 00:19:21.640 --> 00:19:23.940 you get might be lower, but it's incredibly safe. 00:19:24.440 --> 00:19:27.160 On the other hand, if your only tenant is a trendy 00:19:27.160 --> 00:19:29.099 tech startup that has never turned a profit, 00:19:29.319 --> 00:19:32.460 your risk is astronomically high. So you better 00:19:32.460 --> 00:19:34.660 be charging them a much higher rent to compensate 00:19:34.660 --> 00:19:37.700 for that risk. It's all a balancing act. So we 00:19:37.700 --> 00:19:39.099 have the building types. We have the math of 00:19:39.099 --> 00:19:41.950 the investment. Now I want to walk through. how 00:19:41.950 --> 00:19:44.029 you actually buy one of these things. Because 00:19:44.029 --> 00:19:46.569 the sources describe a transaction process that 00:19:46.569 --> 00:19:49.250 sounds way more intense than buying a house. 00:19:49.410 --> 00:19:51.250 I bought a house last year and I thought that 00:19:51.250 --> 00:19:53.789 was stressful. This sounds like a military operation. 00:19:54.230 --> 00:19:57.009 It is much more formal and there are many more 00:19:57.009 --> 00:20:00.289 off ramps. It's designed to protect both sides 00:20:00.289 --> 00:20:02.470 because the stakes are just so high. We aren't 00:20:02.470 --> 00:20:05.089 talking about a $400 ,000 house. We're talking 00:20:05.089 --> 00:20:07.990 about a $20 million or $50 million or $500 million 00:20:07.990 --> 00:20:11.539 asset. Okay, so let's set the stage. Who are 00:20:11.539 --> 00:20:13.660 the players involved here? Well, you have the 00:20:13.660 --> 00:20:15.859 brokers, of course. They're the matchmakers connecting 00:20:15.859 --> 00:20:19.240 buyers and sellers. But the buyers themselves 00:20:19.240 --> 00:20:23.579 vary wildly. You might have an owner -user. An 00:20:23.579 --> 00:20:26.380 owner -user. That's a business buying a building 00:20:26.380 --> 00:20:29.210 to operate out of. Like a bakery buying its own 00:20:29.210 --> 00:20:30.950 building so they don't have to pay rent to a 00:20:30.950 --> 00:20:33.569 landlord anymore. Then you have private investors, 00:20:33.750 --> 00:20:36.690 maybe a wealthy individual or a family office 00:20:36.690 --> 00:20:39.750 buying property for their portfolio. And then 00:20:39.750 --> 00:20:43.009 you have the big guns, private equity firms and 00:20:43.009 --> 00:20:45.529 institutional investors. Like pension funds and 00:20:45.529 --> 00:20:47.690 insurance companies. Exactly. The really big 00:20:47.690 --> 00:20:50.470 money. Okay. So I'm a private equity firm. I 00:20:50.470 --> 00:20:52.950 see a building I like. Do I just write an offer 00:20:52.950 --> 00:20:55.779 on a napkin and slide it across the table? Not 00:20:55.779 --> 00:21:00.099 usually. Step one is almost always the LOI, the 00:21:00.099 --> 00:21:03.140 letter of intent. The sources call this a signal 00:21:03.140 --> 00:21:06.299 of intent. Think of the LOI as the proposal before 00:21:06.299 --> 00:21:09.539 the marriage, or maybe going steady. It outlines 00:21:09.539 --> 00:21:12.759 the major terms, price, closing date, big conditions, 00:21:12.819 --> 00:21:16.799 but it is usually not fully legally binding yet. 00:21:16.859 --> 00:21:18.960 It's a gentleman's agreement on the main points. 00:21:19.160 --> 00:21:21.420 Why do this extra step? Why not just go straight 00:21:21.420 --> 00:21:24.039 to the big scary contract? Because lawyers are 00:21:24.039 --> 00:21:25.700 expensive. You don't want to spend $10 ,000, 00:21:25.700 --> 00:21:28.559 $20 ,000, $50 ,000 having attorneys draft a 100 00:21:28.559 --> 00:21:31.180 -page purchase and sale agreement if you and 00:21:31.180 --> 00:21:33.460 the seller are still $5 million apart on the 00:21:33.460 --> 00:21:36.119 price. So it's a cost -saving measure. It saves 00:21:36.119 --> 00:21:39.240 unnecessary costs. It makes sure you're both 00:21:39.240 --> 00:21:41.720 on the same page and serious about the big picture 00:21:41.720 --> 00:21:44.019 items before you get the legal clock ticking. 00:21:44.240 --> 00:21:46.319 That makes sense. It's a let's see if we're serious 00:21:46.319 --> 00:21:49.599 phase. Yeah. Okay. So we agree on the LOI. Everyone 00:21:49.599 --> 00:21:53.539 signs. Then comes step two, the PSA. The purchase 00:21:53.539 --> 00:21:55.779 and sale agreement. Now we are in the serious 00:21:55.779 --> 00:21:58.559 legal territory. This is the binding contract. 00:21:58.900 --> 00:22:01.039 This is for real. This is for real. And unlike 00:22:01.039 --> 00:22:03.319 buying a house where you might use a standard 00:22:03.319 --> 00:22:05.240 fill -in -the -blank form from the state realtor 00:22:05.240 --> 00:22:08.400 association, a commercial PSA is almost always 00:22:08.400 --> 00:22:11.460 custom. It is highly negotiated. Every clause, 00:22:11.599 --> 00:22:14.000 every timeline, every representation and warranty 00:22:14.000 --> 00:22:16.660 is up for grabs. Once that is signed, we enter 00:22:16.660 --> 00:22:18.660 what I'm calling the danger zone. Yeah. Step 00:22:18.660 --> 00:22:21.470 three, escrow and due diligence. This is where 00:22:21.470 --> 00:22:24.150 the real work happens. The buyer puts down an 00:22:24.150 --> 00:22:26.789 escrow deposit. Usually this is refundable at 00:22:26.789 --> 00:22:29.589 first. At first. That sounds ominous. It is the 00:22:29.589 --> 00:22:32.329 investigation phase. The buyer has a set period 00:22:32.329 --> 00:22:35.329 of time, maybe 30, 60, 90 days to tear the property 00:22:35.329 --> 00:22:37.210 apart. Figuratively and sometimes literally. 00:22:37.470 --> 00:22:39.769 They are reviewing all the financial statements. 00:22:39.910 --> 00:22:42.250 Like what? They're asking. Are the tenants actually 00:22:42.250 --> 00:22:43.910 paying the rent they're supposed to be paying 00:22:43.910 --> 00:22:46.809 or are they all three months behind? They are 00:22:46.809 --> 00:22:49.730 looking at the rent roll. They are getting estoppels. 00:22:50.390 --> 00:22:53.140 Estoppels. What is that? An estoppel is a legal 00:22:53.140 --> 00:22:55.420 document where the tenant themselves confirms 00:22:55.420 --> 00:22:58.119 the key terms of their lease. You want to hear 00:22:58.119 --> 00:23:00.279 it directly from the tenant, not just take the 00:23:00.279 --> 00:23:02.660 landlord's word for it. Oh, wow. If the landlord 00:23:02.660 --> 00:23:06.720 says the rent is $5 ,000, but the tenant sends 00:23:06.720 --> 00:23:09.819 back the estoppel saying, no, I have a side deal 00:23:09.819 --> 00:23:12.019 for $3 ,000 and the landlord owes me for a new 00:23:12.019 --> 00:23:14.339 air conditioner, you have a problem. So you're 00:23:14.339 --> 00:23:16.519 basically fact -checking the seller. Ruthlessly. 00:23:16.759 --> 00:23:19.220 You are also checking all the vendor contracts. 00:23:20.460 --> 00:23:23.980 Is the landscaping contract overpriced? You're 00:23:23.980 --> 00:23:25.859 checking the zoning to make sure it's legal. 00:23:26.059 --> 00:23:28.200 And of course, you're checking the physical condition 00:23:28.200 --> 00:23:31.180 of the building itself. A roost, the HVAC. All 00:23:31.180 --> 00:23:34.079 of it. And crucially, environmental reports. 00:23:34.500 --> 00:23:37.799 This is huge. Why is that so important? Is there 00:23:37.799 --> 00:23:41.420 an old leaky oil tank buried under the parking 00:23:41.420 --> 00:23:43.519 lot from a gas station that was there in 1950? 00:23:44.079 --> 00:23:46.920 If that tank is leaking contaminants into the 00:23:46.920 --> 00:23:49.900 groundwater, you, the new owner, could be on 00:23:49.900 --> 00:23:52.220 the hook for millions of dollars in environmental 00:23:52.220 --> 00:23:55.180 cleanup. That is an absolute deal killer. And 00:23:55.180 --> 00:23:58.359 this is where contingencies come in. Yes. A contingency 00:23:58.359 --> 00:24:01.059 is a clause that says, I, the buyer, will buy 00:24:01.059 --> 00:24:03.279 this building unless I can't get a mortgage, 00:24:03.480 --> 00:24:06.440 unless the roof is falling in, unless the environmental 00:24:06.440 --> 00:24:09.799 report comes back glowing green. These clauses 00:24:09.799 --> 00:24:11.920 are the buyer's escape hatches. They let you 00:24:11.920 --> 00:24:13.819 back out and get your deposit back if you find 00:24:13.819 --> 00:24:16.839 something scary. But then there's a turning point, 00:24:17.000 --> 00:24:20.099 a point of no return. The sources mentioned the 00:24:20.099 --> 00:24:22.539 deposit becoming non -refundable. This is the 00:24:22.539 --> 00:24:25.019 most crucial moment in every single deal. It 00:24:25.019 --> 00:24:27.619 is often called going hard. Going hard? It sounds 00:24:27.619 --> 00:24:30.500 intense. It is. The hard deposit. There is a 00:24:30.500 --> 00:24:32.779 specific date in the contract. If you, the buyer, 00:24:32.940 --> 00:24:35.259 have not terminated the deal by 5 p .m. on that 00:24:35.259 --> 00:24:37.500 date, your deposit money, which could be hundreds 00:24:37.500 --> 00:24:39.519 of thousands or even millions of dollars, becomes 00:24:39.519 --> 00:24:42.180 non -refundable. It goes hard. So if I wake up 00:24:42.180 --> 00:24:44.359 the next morning and get cold feet for any reason 00:24:44.359 --> 00:24:47.099 at all, the seller just keeps my money. The seller 00:24:47.099 --> 00:24:50.140 keeps your money. Exactly. They keep it as a 00:24:50.140 --> 00:24:53.119 fee for your failure to close. They took the 00:24:53.119 --> 00:24:55.220 property off the market for you. They lost time. 00:24:55.319 --> 00:24:58.000 They opened up their books to you. So as a buyer, 00:24:58.099 --> 00:25:00.759 you have to be absolutely 100 percent sure before 00:25:00.759 --> 00:25:02.839 you let that date pass. You need to know where 00:25:02.839 --> 00:25:05.059 all the bodies are buried. That is incredibly 00:25:05.059 --> 00:25:07.799 high pressure. It is. But if you pass that date 00:25:07.799 --> 00:25:10.259 and everything is OK, you move to step four, 00:25:10.380 --> 00:25:12.400 closing. This is where the funds are exchanged 00:25:12.400 --> 00:25:14.099 through escrow and the title is transferred. 00:25:14.700 --> 00:25:18.339 And then step five. Post -closing. It's not over 00:25:18.339 --> 00:25:20.339 yet. What's left to do? You have to formally 00:25:20.339 --> 00:25:22.700 notify all the tenants to start sending their 00:25:22.700 --> 00:25:24.519 rent checks to the new address. You have to transfer 00:25:24.519 --> 00:25:26.240 all the vendor relationships. You have to secure 00:25:26.240 --> 00:25:28.880 the keys, change the locks. You officially take 00:25:28.880 --> 00:25:31.900 over the asset. It really is a massive operation. 00:25:32.259 --> 00:25:34.680 Makes buying a house look like buying a candy 00:25:34.680 --> 00:25:37.660 bar. The level of diligence is just on a completely 00:25:37.660 --> 00:25:39.420 different planet because the liabilities are 00:25:39.420 --> 00:25:41.640 so much higher. And the mistakes are infinitely 00:25:41.640 --> 00:25:44.359 more expensive. So we know how the machine works. 00:25:44.480 --> 00:25:47.190 We know how to buy the machine. But I want to 00:25:47.190 --> 00:25:48.970 talk about how the machine is running right now, 00:25:49.069 --> 00:25:51.490 because we have some data here. Some of it is 00:25:51.490 --> 00:25:53.250 historical, but some of it is very recent, from 00:25:53.250 --> 00:25:57.730 April 2025. And the picture it paints is, well, 00:25:57.950 --> 00:26:00.430 it's complex. And this is where it gets really 00:26:00.430 --> 00:26:02.890 interesting and, frankly, a little scary, because 00:26:02.890 --> 00:26:05.230 commercial real estate is a slow -moving ship. 00:26:05.390 --> 00:26:08.630 But when it turns, it creates massive waves throughout 00:26:08.630 --> 00:26:10.990 the entire economy. Let's start with the scale 00:26:10.990 --> 00:26:13.779 again, just to ground us. In the U .S., the total 00:26:13.779 --> 00:26:18.039 value was around $6 trillion back in 2018. But 00:26:18.039 --> 00:26:20.140 the sources highlight some pretty significant 00:26:20.140 --> 00:26:22.779 distress signals. They do. According to Real 00:26:22.779 --> 00:26:24.819 Capital Analytics, which is a big data firm in 00:26:24.819 --> 00:26:27.759 this space, MSCI owns them now, there is over 00:26:27.759 --> 00:26:32.079 $160 billion in properties currently in some 00:26:32.079 --> 00:26:34.579 state of distress. What does distress mean in 00:26:34.579 --> 00:26:36.700 this context? It means they're in default on 00:26:36.700 --> 00:26:39.160 their loan, they're in foreclosure, or the owner's 00:26:39.160 --> 00:26:42.740 in bankruptcy. $160 billion. That is not just 00:26:42.740 --> 00:26:44.619 a few bad deals here and there. That sounds like 00:26:44.619 --> 00:26:47.099 a structural issue. It is. And there's a specific 00:26:47.099 --> 00:26:49.240 paradox happening in the office sector that really 00:26:49.240 --> 00:26:51.859 explains some of this. The data shows that in 00:26:51.859 --> 00:26:55.220 2024, office leasing volume actually rose to 00:26:55.220 --> 00:26:57.819 its highest level since 2020. Sounds good on 00:26:57.819 --> 00:26:59.660 the surface. That sounds great. People are going 00:26:59.660 --> 00:27:02.079 back to the office. The return to work mandates 00:27:02.079 --> 00:27:04.759 are working. Ideally, yes. The headlines look 00:27:04.759 --> 00:27:07.450 good. But here's the catch, and this is a critical 00:27:07.450 --> 00:27:10.250 nuance that really, really matters. The sources 00:27:10.250 --> 00:27:13.329 point out that roughly 60 % of the active office 00:27:13.329 --> 00:27:15.809 leases currently in place date back to pre -pandemic 00:27:15.809 --> 00:27:18.109 times. Wait, walk me through why that's a problem. 00:27:18.250 --> 00:27:20.309 Think about a standard office lease. It's not 00:27:20.309 --> 00:27:23.210 one year. It's often 7 to 10 years long. Okay. 00:27:23.500 --> 00:27:26.839 If a big company signed a 10 year lease in 2018 00:27:26.839 --> 00:27:30.000 or 2019, they are still paying rent on that lease 00:27:30.000 --> 00:27:34.359 today in 2025 or 2026. They are contractually 00:27:34.359 --> 00:27:37.559 obligated to pay for space based on 2019 headcounts 00:27:37.559 --> 00:27:40.599 and 2019 work habits. Even if the office is half 00:27:40.599 --> 00:27:42.839 empty because everyone is hybrid now. Even if 00:27:42.839 --> 00:27:44.680 they are only using 20 percent of the space, 00:27:44.859 --> 00:27:47.039 they are legally on the hook to pay that rent. 00:27:47.140 --> 00:27:49.420 So the landlord's revenue looks stable on paper. 00:27:49.559 --> 00:27:51.420 The checks are still coming in. But when those 00:27:51.420 --> 00:27:54.970 leases expire. Exactly. That is the cliff. That 00:27:54.970 --> 00:27:57.750 is the storm on the horizon. When those leases 00:27:57.750 --> 00:27:59.509 come up for renewal over the next few years, 00:27:59.670 --> 00:28:01.970 those companies are not going to renew for 50 00:28:01.970 --> 00:28:04.509 ,000 square feet. They might downsize to 20 ,000 00:28:04.509 --> 00:28:07.769 or go fully remote and not renew at all. So the 00:28:07.769 --> 00:28:09.630 current revenue that these buildings are showing 00:28:09.630 --> 00:28:12.960 is a mirage. It's a mirage in many cases. It's 00:28:12.960 --> 00:28:15.640 built on old agreements that do not reflect the 00:28:15.640 --> 00:28:17.819 current reality of work. And that's a ticking 00:28:17.819 --> 00:28:21.160 clock. Because if the revenue drops, the building's 00:28:21.160 --> 00:28:24.319 value drops. And if the value drops below, the 00:28:24.319 --> 00:28:26.920 loan amounts. The loan goes underwater. Now let's 00:28:26.920 --> 00:28:29.119 look across the ocean. Let's go to Europe. Because 00:28:29.119 --> 00:28:31.579 this is a global phenomenon. And Europe is facing 00:28:31.579 --> 00:28:34.700 its own set of challenges. First off, the economic 00:28:34.700 --> 00:28:36.839 engine there is huge. We're talking about CRE 00:28:36.839 --> 00:28:40.759 contributing about 285 billion euros to the economy 00:28:40.759 --> 00:28:44.779 and securing about 4 million jobs based on 2012 00:28:44.779 --> 00:28:47.779 figures. So it's a huge employer. A massive part 00:28:47.779 --> 00:28:50.279 of their economy. But the sources mention a debt 00:28:50.279 --> 00:28:52.980 wall. A debt wall. That sounds even worse than 00:28:52.980 --> 00:28:55.519 a ticking clock. It is a very serious situation. 00:28:56.059 --> 00:29:00.019 The sources state that half of the 960 billion 00:29:00.019 --> 00:29:02.660 euros of debt that is backed by commercial real 00:29:02.660 --> 00:29:05.200 estate needs to be refinanced in the next three 00:29:05.200 --> 00:29:07.980 years. Half of it. So we're talking about, what, 00:29:08.059 --> 00:29:11.640 roughly 480 billion euros? Correct. 480 billion 00:29:11.640 --> 00:29:15.059 euros in loans are coming due. Now, think about 00:29:15.059 --> 00:29:17.319 interest rates. A lot of these loans were taken 00:29:17.319 --> 00:29:20.940 out five, seven, maybe 10 years ago. What were 00:29:20.940 --> 00:29:22.940 interest rates doing back then? They were near 00:29:22.940 --> 00:29:25.819 zero, historically low. Money was basically free. 00:29:26.119 --> 00:29:28.779 Exactly. Now, these property owners have to go 00:29:28.779 --> 00:29:31.420 back to the bank and refinance in a completely 00:29:31.420 --> 00:29:33.599 different interest rate environment. If your 00:29:33.599 --> 00:29:37.279 interest rate goes from, say, 2 % to 6%, your 00:29:37.279 --> 00:29:39.539 debt service payment can double or even triple. 00:29:39.680 --> 00:29:42.359 The cash outflows for debt service just explode. 00:29:42.400 --> 00:29:45.319 And suddenly the profit is gone. The money machine 00:29:45.319 --> 00:29:47.779 we talked about earlier breaks down. The building 00:29:47.779 --> 00:29:49.960 might not generate enough rent to cover the new, 00:29:50.059 --> 00:29:52.460 much more expensive mortgage. And the source 00:29:52.460 --> 00:29:54.880 explicitly mentions that any future interest 00:29:54.880 --> 00:29:57.339 rate hikes could complicate refinancing even 00:29:57.339 --> 00:30:00.240 further and put even more pressure on valuations. 00:30:00.420 --> 00:30:03.140 It's a squeeze from both sides. It is a massive 00:30:03.140 --> 00:30:05.180 squeeze. And if the owners can't refinance, they 00:30:05.180 --> 00:30:07.539 default. And the banks are the ones left holding 00:30:07.539 --> 00:30:09.619 the bag. Which brings it right up to the present 00:30:09.619 --> 00:30:13.079 day, April 2025. We have a specific snapshot 00:30:13.079 --> 00:30:15.220 from the Board of Governors Sentiment Index. 00:30:15.500 --> 00:30:18.059 This is a survey that measures how the leaders 00:30:18.059 --> 00:30:20.039 in the industry are feeling about the future. 00:30:20.200 --> 00:30:23.009 And it's, well... It's not great. It's a pretty 00:30:23.009 --> 00:30:25.650 significant drop. The data says confidence fell 00:30:25.650 --> 00:30:30.369 from 126 .5 % in late 2024 all the way down to 00:30:30.369 --> 00:30:35.269 87 .9 % in April 2025. That is a massive slide 00:30:35.269 --> 00:30:37.529 in just a few months. That's a huge swing in 00:30:37.529 --> 00:30:39.730 sentiment. It is cited directly in the report 00:30:39.730 --> 00:30:42.869 as the sharpest drop since the COVID -19 pandemic. 00:30:43.250 --> 00:30:46.009 And does the data point to a reason why the sudden 00:30:46.009 --> 00:30:48.920 gloom and doom? It does. The report we're looking 00:30:48.920 --> 00:30:51.720 at attributes it directly to the Trump administration's 00:30:51.720 --> 00:30:54.160 latest tariff policies. OK, so let's look at 00:30:54.160 --> 00:30:56.119 this neutrally, just as a reported cause and 00:30:56.119 --> 00:30:59.740 effect. Why would tariff policies scare the commercial 00:30:59.740 --> 00:31:03.779 real estate market so badly? Well, markets absolutely 00:31:03.779 --> 00:31:06.299 hate uncertainty and they hate rising costs. 00:31:07.259 --> 00:31:10.160 Tariffs, generally speaking, mean that key construction 00:31:10.160 --> 00:31:13.000 materials get more expensive. Steel, aluminum, 00:31:13.279 --> 00:31:16.650 lumber. So the cost to build a new building goes 00:31:16.650 --> 00:31:18.990 up. The cost to build goes up, which means projects 00:31:18.990 --> 00:31:21.529 get delayed or canceled. And it's not just new 00:31:21.529 --> 00:31:24.269 construction. If global trade slows down because 00:31:24.269 --> 00:31:26.990 of tariffs. Then demand for warehouses and industrial 00:31:26.990 --> 00:31:30.029 space drops. Right. Demand for space near courts 00:31:30.029 --> 00:31:32.809 drops. Exactly. And if tariffs impact the tenants 00:31:32.809 --> 00:31:34.950 themselves, the retailers, the manufacturers, 00:31:35.049 --> 00:31:37.170 and their businesses suffer, well, that hits 00:31:37.170 --> 00:31:39.269 the landlords directly. They can't pay their 00:31:39.269 --> 00:31:41.410 rent. It is all connected. You can't separate 00:31:41.410 --> 00:31:43.769 real estate from the broader economy. It really 00:31:43.769 --> 00:31:46.230 shows how sensitive this entire ecosystem is. 00:31:46.390 --> 00:31:49.309 We think of buildings as solid, stable, immovable 00:31:49.309 --> 00:31:51.869 objects. But the value of those buildings is 00:31:51.869 --> 00:31:53.930 incredibly fluid. It's tied to interest rate 00:31:53.930 --> 00:31:56.230 policy. It's tied to work from home trends. It's 00:31:56.230 --> 00:31:59.230 tied to global trade. And that really is the 00:31:59.230 --> 00:32:01.769 synthesis here. If we connect this all back to 00:32:01.769 --> 00:32:05.029 the bigger picture, commercial real estate isn't 00:32:05.029 --> 00:32:07.369 just about the bricks and the mortar. It is a 00:32:07.369 --> 00:32:12.680 living ecosystem of debt. risk, zoning, and maybe 00:32:12.680 --> 00:32:15.640 most importantly, human sentiment. It's the ground 00:32:15.640 --> 00:32:18.099 beneath our feet, literally and economically. 00:32:18.359 --> 00:32:20.500 It is. So let's bring this home for the listener. 00:32:20.660 --> 00:32:22.599 What does this all mean for you? Why should you 00:32:22.599 --> 00:32:25.180 care about debt walls in Europe or sentiment 00:32:25.180 --> 00:32:27.559 drops in the U .S. if you aren't out there buying 00:32:27.559 --> 00:32:29.539 a skyscraper? Because it affects everything. 00:32:29.740 --> 00:32:31.559 It affects the stability of the very bank that 00:32:31.559 --> 00:32:33.279 holds your savings, because that bank is almost 00:32:33.279 --> 00:32:36.400 certainly holding billions in CRE loans on its 00:32:36.400 --> 00:32:38.680 balance sheet. It affects the vibrancy of your 00:32:38.680 --> 00:32:41.359 city center. If those office buildings go empty 00:32:41.359 --> 00:32:43.140 because of that lease cliff we talked about, 00:32:43.339 --> 00:32:45.559 what happens? The coffee shop on the ground floor 00:32:45.559 --> 00:32:48.339 closes. The dry cleaner that served the office 00:32:48.339 --> 00:32:51.319 workers closes. The city's tax revenue plummets. 00:32:51.440 --> 00:32:54.720 And when city tax revenue drops, public services 00:32:54.720 --> 00:32:57.980 get cut. Potholes don't get fixed. Schools lose 00:32:57.980 --> 00:33:00.420 funding. Police and fire departments face budget 00:33:00.420 --> 00:33:03.680 cuts. Exactly. It is the invisible thread connecting 00:33:03.680 --> 00:33:06.740 every part of the economy. You can ignore it, 00:33:06.779 --> 00:33:09.140 but you are living inside of it every single 00:33:09.140 --> 00:33:12.019 day. So I want to leave everyone with a final 00:33:12.019 --> 00:33:14.279 thought, a little bit of a provocation to chew 00:33:14.279 --> 00:33:17.420 on. Go for it. Right now, wherever you are, unless 00:33:17.420 --> 00:33:19.940 you happen to be in your own home, you are likely 00:33:19.940 --> 00:33:23.559 standing or sitting inside a piece of commercial 00:33:23.559 --> 00:33:25.839 real estate. So just look at the floor, look 00:33:25.839 --> 00:33:28.750 at the walls and ask yourself. Who owns this 00:33:28.750 --> 00:33:31.390 building? Is the lease that this business signed 00:33:31.390 --> 00:33:34.089 pre -pandemic? And considering the massive debt 00:33:34.089 --> 00:33:36.230 walls we talked about and that sharp drop in 00:33:36.230 --> 00:33:39.190 sentiment, just how stable is the ground beneath 00:33:39.190 --> 00:33:41.430 the economy's feet right now? That is the multi 00:33:41.430 --> 00:33:43.450 -trillion dollar question, isn't it? Thanks for 00:33:43.450 --> 00:33:45.490 diving deep with us. We will see you on the next 00:33:45.490 --> 00:33:46.029 one. Take care.