Bill Lenehan: Investing in Commercial Real Estate - [Invest Like the Best, EP.306]

My guest today is Bill Lenehan. Bill is the CEO of Four Corners Property Trust, a listed REIT and one of the leading owners of restaurant real estate in the US. Their portfolio is made up of 982 properties across 47 states. Real estate is something most of us own, whether as an investment or a home, and Bill’s insight into the asset class at this particular moment in time is fascinating to hear. Please enjoy my conversation with Bill Lenehan. For the full show notes, transcript, and links to mentioned content, check out the episode page here. ----- This episode is brought to you by Tegus. Tegus streamlines the investment research process so you can get up to speed and find answers to critical questions on companies faster and more efficiently. The Tegus platform surfaces the hard-to-get qualitative insights, gives instant access to critical public financial data through BamSEC, and helps you set up customized expert calls. It’s all done on a single, modern SaaS platform that offers 360-degree insight into any public or private company. I’ve been so impressed by the platform that my firm, Positive Sum, recently made an investment in Tegus. We did so because we feel that Tegus will be the gold standard platform for investing research for decades to come. As a listener, you can take Tegus for a free test drive by visiting tegus.co/patrick. ----- Today's episode is brought to you by Brex. Brex is the integrated financial platform trusted by the world's most innovative entrepreneurs and fastest-growing companies. With Brex, you can move money fast for instant impact with high-limit corporate cards, payments, venture debt, and spend management software all in one place. Ready to accelerate your business? Learn more at brex.com/best. ----- Invest Like the Best is a property of Colossus, LLC. For more episodes of Invest Like the Best, visit joincolossus.com/episodes. Past guests include Tobi Lutke, Kevin Systrom, Mike Krieger, John Collison, Kat Cole, Marc Andreessen, Matthew Ball, Bill Gurley, Anu Hariharan, Ben Thompson, and many more. Stay up to date on all our podcasts by signing up to Colossus Weekly, our quick dive every Sunday highlighting the top business and investing concepts from our podcasts and the best of what we read that week. Sign up here. Follow us on Twitter: @patrick_oshag | @JoinColossus Show Notes [00:03:19] - [First question] - Recent increases in mortgage rates and a frozen housing market [00:08:55] - Projected real estate trends over the next decade [00:13:38] - How a company’s ROI can be more consistent with backing from a real estate firm [00:16:41] - Risk-return rate and risk exposure in real estate compared to other asset classes [00:20:09] - The skills, traits, and circumstances that make a top-level real estate investor [00:22:38] - Stand-out learnings from his time at Farallon Capital Management [00:33:20] - The value of shopping malls and offices in a post-COVID, e-commerce US [00:39:27] - Pros and cons of different types of real estate investments, including REITs [00:43:22] - The impact of climate change on the real estate market [00:45:39] - The role of modern technology in investing and in real estate infrastructure [00:51:10] - Hard costs of building and renovating for the future [00:54:20] - How hard costs and supply levels impact rates of return and housing costs [00:57:17] - How the retail industry is adapting to consumer trends [01:01:23] - Why retailers need to adapt to a changing economy and how they’ll do it [01:04:03] - The relative magnitude of change in today’s real estate market [01:06:51] - The role health and wellness plays in real estate and finance [01:09:28] - What it feels like to be investing in 2022 [01:12:23] - The kindest thing anyone has ever done for him

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Patrick O'Shaughnessy?

  I know firsthand how complex the tech stack is for asset management firms. And seemingly every new tool and data source makes the problem even worse, adding more complexity, more headcount and more risk. RidgeLine offers a better way forward. One unified platform that automates away the complexity across portfolio accounting, reconciliation, reporting, trading, compliance, and more, all at scale. RidgeLine is revolutionizing investment management, helping ambitious firms scale faster, operate smarter, and stay ahead of the curve. See what RidgeLine can unlock for your firm. Schedule a demo at ridgeline.ai. This episode is brought to you by Tegus. Over the years of our partnership with Tegus, they have evolved from a pure expert network into a full company intelligence platform. I've been so impressed by the platform that my firm, Positive Sum, recently made an investment

• 0:45Patrick O'Shaughnessy?

  in Tegus. We did so because we feel that Tegus will be the gold standard platform for investing research for decades to come. Tegus streamlines the investment research process so you can get up to speed and find answers to critical questions on companies faster and more efficiently. The Tegus platform surfaces the hard to get qualitative insights, gives instant access to critical public financial data through BAM SEC, and helps you set up customized expert calls. It's all done on a single, modern SaaS platform that offers 360-degree insight into any public or private company. As a listener, you can take Tegus for a free test drive by visiting tegus.co/patrick. Today's episode is sponsored by Brex, the integrated financial platform trusted by the world's most innovative entrepreneurs and fastest-growing companies.

• 1:30Patrick O'Shaughnessy?

  With Brex, you can move money fast for instant impact with high-limit corporate cards, payments, venture debt, and spend management software, all in one place. Ready to accelerate your business? Learn more at brex.com/best. That's B-R-E-X.com/best.

• 1:50Patrick O'Shaughnessy?

  Hello and welcome, everyone. I'm Patrick O'Neal, and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money. Invest Like the Best is part of the Colossus family of podcasts, and you can access all our podcasts, including edited transcripts, show notes, and other resources to keep learning at joincolossus.com.

• 2:15Speaker 01

  Patrick O'Shaughnessy is the CEO and founding partner of Positive Sum and the CEO of O'Shaughnessy Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of Positive Sum or O'Shaughnessy Asset Management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Positive Sum or O'Shaughnessy Asset Management may maintain positions in the securities discussed in this podcast.

• 2:47Patrick O'Shaughnessy?

  My guest today is Bill Lenehan. Bill is the CEO of Four Corners Property Trust, a listed REIT and one of the leading owners of restaurant real estate in the US. Their portfolio is made up of 982 properties across 47 states. Real estate is something that most of us own, whether as an investment or as a home, and Bill's insight into the asset class at this particular moment in time is fascinating to hear. Please enjoy my conversation with Bill Lenehan.

• 3:15Patrick O'Shaughnessy?

  So, Bill, this is going to be a really neat opportunity to talk with someone that I've probably learned the most from about the asset class of real estate at large. Not my background, not my area of expertise, but I think it's interesting to everyone because we're surrounded by it all the time. We all buy houses or many people do. We work in offices, we visit malls, we do all these things. An interesting, orienting place to begin is actually with something topical, even though I think a lot of what we'll talk about today is a bit more timeless. Just because of the nature of the environment that we're talking in, which is November, what day is it today, like the 18th, 2022? Rates are the obvious place, I think, to begin because everyone's familiarity with the situation of rates have gone up a lot, mortgage rates have gone up a lot.

• 3:57Patrick O'Shaughnessy?

  So, the housing market hasn't really crashed so much as it's sort of frozen. Nobody's moving. No one wants to go from a 2% to an 8% mortgage. It would seem as though this dramatic rate change is very bad for real estate, and it's always more nuanced than that. So, given that that's what's going on in the world, let's start there. Give us your more nuanced take on what is actually happening as rates go up in terms of how it affects real estate.

• 4:21Speaker 02

  Thank you for having me. I'm excited to do this. So rates have increased substantially. Cost of debt has increased substantially. You mentioned mortgages, but for example, the company I run, which is a mid-investment grade company, we borrowed money last December at 3%. Today it would be just shy of 7%. And the availability of that capital is much reduced to begin with. Rates have gone up. I think inflation has gone up. And the Fed's actions to try to combat inflation are beginning to be effective. What do I mean by that? Well, there's the mathematical part of with higher base rates, borrowing costs are higher.

• 5:06Speaker 02

  Your ability to pay for an asset is hindered to make the same rate of return. The expectation of returns over a risk-free rate have gone up substantially. What I would say is if you use the mental model of the Federal Reserve sitting on my Zoom calls, would they be happy? Would they be high-fiving each other? Or would they be saying, these guys still don't get it. We need to raise rates more. I would say that the Federal Reserve would be high-fiving each other. They'd be saying companies are hiring in a more measured way. Or in San Francisco, near where I am right now, there's significant layoffs. People's capital spending typically has become more conservative.

• 5:51Speaker 02

  Earnings expectations are down substantially. Equity performance has been weak. That means executive compensation is likely to be hurt. So interest rates are very important. There's a wonderful article that Warren Buffett wrote about the early 80s period of inflation called How Inflation Swindles the Equity Investor. That's a really great read. It's timeless.

• 6:16Speaker 02

  But it's a little bit more nuanced than that. Interest rates being higher inflation is still a net negative for the real estate space. But let me maybe take one more peel at the onion, which is apartment stocks and apartment buildings had a more difficult year than people expected, which is counterintuitive because people would have thought, okay, apartment occupancy is going to be high because people aren't moving out to move into homes. Apartment rents can be reset in most markets relatively easily to meet demand. So you can raise rents and keep up with inflation. People are making more.

• 6:56Speaker 02

  And as long as you didn't have a mortgage that's coming due in the near term, frankly, many of your costs are fixed was the perception and your rents are going to go up. What we found is that the cost of running an apartment has gone up because the cost of personnel has gone up substantially and availability of labor has gone up substantially. So perhaps instead of having a superintendent that is on your payroll now it's a service because you can't source a superintendent yourself. Maybe the repairs and maintenance, which you had budgeted at 2% more than last year are now 15% more than last year, if in fact you can even find the things.

• 7:42Speaker 02

  For a company like mine, we own about a thousand buildings, but the leases are what's called triple net. So the tenant is responsible for all the expenses. What we found is we're retaining tenants at a much, much higher rate. So we're 99.9% occupied because for them to leave and find another building, the construction costs in other buildings are up very substantially. So they have to pay much higher rents to incent a developer. That developer has less access to capital, wants to make a higher rate of return because of inflation and interest rates. So we have had better retention, which then means we don't have to hire as many people to release the buildings.

• 8:23Speaker 02

  There's a little bit more to it than simply inflation bad, interest rates bad. But I would still argue, and I've argued consistently even during periods of very low inflation, that certainly in the short to medium term. The first order effects net to a negative. And then I guess my last comment, and I'm not an expert on single family housing, other than having a house here in Marin County where values have gone up substantially, and having a small house in Montana where that market has similarly boomed post-COVID, is that it is unquestionable that these property values are not sustainable. And as someone who's trying to build a business, which includes recruiting people,

• 9:08Speaker 02

  training them, compensating them, et cetera, doing that in this housing market is substantially more challenging. While I guess it feels good that the house is worth more than you paid for it, net-net, I would welcome a decline in housing to a more normalized level.

• 9:24Patrick O'Shaughnessy?

  Before we start talking about this really interesting list of, I think, big trends that you're thinking about over the next five to 10 years in real estate, which are also trends about the world, there'll be a really interesting section when we talk about that. I'd love to just understand your calculus as a real estate investor, as a proxy for the real estate investor calculus, more generally speaking. Can you just walk us through the machinery? You could use FCPT as the example. When you're looking at a new property, talk about the sources of capital, the capital stack, the sorts of things you're evaluating as you go through, like what a scorecard might look like. Give us just a little flavor of the thinking or the calculus behind new investments or new sales. I think those variables will be really important for the rest of the conversation.

• 10:09Speaker 02

  Talking about real estate at a high level is like if someone said, I'm a doctor. And say, okay, well, are you a battlefield military surgeon? Or are you a PhD in linguistics at a liberal arts college? Because they're both doctors. So let me try to at least frame up different categories. And obviously, real estate is truly global, definitionally.

• 10:31Patrick O'Shaughnessy?

  Yeah.

• 10:33Speaker 02

  Maybe residential versus commercial might be one place to start. I'll focus on commercial. I think people probably have a relatively good sense of how housing works. So we own a thousand buildings. They're leased predominantly to users like restaurants or auto service or medical retail. We own three hundred Olive Garden buildings, as an example. The Olive Garden building that literally seventeen percent of the United States has been in an Olive Garden in the last several months. It's a ubiquitous part of America. What we do, in essence, is free up capital for restaurant companies and others, so that it doesn't have to be sitting there stuck in real estate.

• 11:15Speaker 02

  So that's one use, and you will find that to be very, very common, although maybe not obvious. The Hilton Hotel that you stay at is probably not owned by Hilton Corporation. The mall building that you're walking through, clearly Foot Locker does not own that part of the mall. Apple does not own that part of the mall. In fact, I'm on the board of Macy's. Macy's may own the Macy's box, or it may not. What's happened since I graduated from college in nineteen ninety-nine is there has gone from a hundred and seventy-two publicly traded real estate companies to a hundred and fifty-one today in twenty or so years.

• 11:55Speaker 02

  But the value, the equity market cap of that industry has gone up ten point seven times. Basically, the same slightly less companies, that's very common, there's less public companies because the burden of being public is higher and the availability of private capital is far greater than it was before. But a massive increase in the size, and that increase has not been driven by what was historically referred to as the four food groups: office, apartment, retail.

• 12:25Speaker 02

  Stuff like that industrially, very typical, well-trodden lodging was close to that. It's been driven by publicly traded real estate companies like mine, triple net gaming rates. So when you go to Las Vegas and you go to Caesar's Palace, it's not owned by Caesar's. It's owned by a REIT that was spun out of Caesar's. If you go into Bellagio, it's owned by a private equity firm and is operated by the brand. It's timber REITs, it's healthcare REITs, the hospital you go into is probably not owned by St. Mary's. It's probably owned by a publicly traded company that collects rents from the operations.

• 13:09Speaker 02

  So what's happened in our industry is what's gone from a very normal way, handful of real estate kinds of companies and now very, very diffuse in the different types of companies. And what's happened is specialization and focus has become what investors reward. So many years ago, there might be a REIT that's specific to Southern California, but it might own a mall or two, a hotel or two, some apartment buildings, some industrial buildings. That's not common at all anymore. It's much, much more likely to say, this is a company that owns Manhattan CBD Class A office buildings.

• 13:53Speaker 02

  This is a company that owns cannabis distribution facilities or growth facilities. This is a REIT that owns senior living facilities excluding memory care with medium acuity. That level of specificity.

• 14:08Patrick O'Shaughnessy?

  Maybe a stupid question because in general, like this is how capitalism works. There's division of specialty and things get carved up this way and it makes sense. But can you highlight in this specific example, why this is better for everyone? Like, why is it better for Caesar's or Hilton or Olive Garden or whatever to not be real estate operators and be vertically integrated in that sense of it? Why is it better for them to simply work with firms like yours and focus instead on the operating model?

• 14:35Speaker 02

  I would say sort of math that I think is mostly true, but doesn't have to be true, is that the return on invested capital of the operations is higher than the rate of return of the rent collecting entity. We offer a more predictable stream of cash flows. So during COVID, we collected ninety nine point eight percent of our rent almost immediately, whereas all the operations of the buildings were closed. So we're more consistent and we have a lower return expectation. The operating company, whether it's a restaurant or a collision center or a hospital or a car dealership, can't have more of the higher

• 15:19Speaker 02

  ROIC business if it can free up the capital from our business. So that would be one in what we do. And then in other use cases, I think there's some benefit for a Tesla showroom in a mall to be across from the Apple store in the mall, across from the Lululemon store in the mall. It's just much more convenient for the consumer. Apartments, manufactured housing, you can make the argument that being able to, pun intended, pool amenities, gather together a gym, gather together HVAC and other services, make apartment living

• 16:03Speaker 02

  where the whole is better than the sum of the individual apartments. So I think it depends on what kind of real estate you're talking about. But what's really happened is equity investors, private and public, have pushed for this substantially in the last twenty or thirty years. I'm not saying that's full cycle or that we're done with it, but it's far different in the past. I mean, Darden, which owns Olive Garden, Longhorn Steakhouse, Capital Grill, Bahama Breeze, Cheddar's, Yard House, et cetera, an activist investor said, look, your balance sheet could be optimized by getting the real estate off the balance sheet. The activist fund was named Starboard Capital. They replaced the entire board of this Fortune 500 company with a new slate. I was sort of the real

• 16:48Speaker 02

  estate person involved in so. The willingness for investors to become very engaged to mandate this change is substantial. And the stock of Darden went from, this was seven, eight years ago, $35 to 140. And you get four corners along the way for free.

• 17:09Patrick O'Shaughnessy?

  If you think about the return profile that investors expect of real estate, how would you characterize it relative to the other major asset classes along risk, return and risk exposure axes?

• 17:22Speaker 02

  So unlevered, I would say it's intended to be a stable, slightly lower rate of return. It is a business that has the capability of being financed very creatively and often at high levels. You could have a REIT like ours that uses the predominantly equity capital and just a little bit of very conservative debt, call it 70% equity, 30% debt, or even more equity than that. To private equity, which I worked at a hedge fund called Farrell on Capital for 10 years. Wonderful experience, learned an enormous amount. We use less debt than most private equity, but a lot of private equity is. The answer to how much debt should we use is, well, how much can we get?

• 18:06Speaker 02

  You may get to a place where a lower ROA investment proposition can turn into a relatively high ROE proposition using financial leverage. This may seem like a really silly point, but it stems from a Sam Zell article that he wrote many years ago that I think has a lot of wisdom in it. And Sam has an enormous amount of real estate experience, running one of the largest office companies, one of the largest manufactured housing companies, one of the largest apartment companies, making opportunistic investments, all sorts of things. He has an awful lot of business experience, absent real estate. And one of the comments that he makes about real estate is that when people say location, location, location, the buzzword of what you should be thinking about in real estate.

• 18:50Speaker 02

  And they're talking about, oh, this is a hotel and it's in Santa Barbara, and that's a lovely place to go and the climate's wonderful and look at the ocean. He said, that's right, I guess. But what's also important about location, location, location is when you buy a building. And it's almost in every case going to be that building or some very close facts similarly thereof in 20 years. That has positive and negative connotations. So if I make widgets and I have a sleepy little business selling widgets and all of a sudden I pick up Walmart, the number of widgets I can sell can go up 5X. All of a sudden, my widget catches on in China. I have a business that's worth 10 times as much. But if all of a sudden my widget is found to have some liability associated with a safety

• 19:33Speaker 02

  liability, all of a sudden my widget business goes to zero. Again, super high level. When I go and I buy a Burger King in Ocala, Florida with a 25 year lease, there's a pretty good chance that 20 years from now, the May rent that's in the rent schedule will be that exact amount as lined up 20 years ago to the penny. And it is highly unlikely, it happens every once in a while, that that Burger King all of a sudden happens to be a site that you can tear down the Burger King and put up a hotel. Rarely. So typically, when you buy real estate, physically, it is what it is.

• 20:14Speaker 02

  And the chance that it becomes 10 times what it was is low. But similarly, Burger King could move out and I could probably, if I didn't make some specific investment mistakes related to that specific investment, I could probably find another tenant, just like it would never be 10X what I wanted it to be on an unlevered basis. It's very unlikely to one day be 1/10 of what I thought it would be.

• 20:37Patrick O'Shaughnessy?

  So the narrower band, setting aside the financial engineering portion, which can obviously create a lot more return and a lot more risk in sort of a straightforward way. If you think about what distinguishes the geniuses of real estate investing, the very best that have ever done it, the Sam Zells, some of the senior people at Blackstone, others that might come to mind, what distinguishes those geniuses or savants of real estate investing from the very good real estate investor? Like how in such a straightforward situation, like the one you just described with the Burger King, where does the genius figure in? What does that look like in your experience?

• 21:13Speaker 02

  I think I might be sarcastically quoting somebody that said, "The most important factor in determining investment success is aligning the date of your birth, your professional birth, with a period in which the Federal Reserve decides to lower interest rates."

• 21:31Speaker 02

  So that might be the sarcastic version, but I think it's very, very similar to all sorts of business professionals, those who think clearly for themselves, which there's so many things you could talk about right now that you could simply say, "This is an effect of many, many people not thinking for themselves about whether something is a rational business proposition." Sam Zell has a great saying that real estate investing is very simple. If you have a chance for a lot of upside with very little downside, you do it. And if you don't, you run away. It's being aligned with great organizations. And Blackstone is unquestionably a great organization. They have very bright people. They're very active in the market. They've invested in technology in a way that no real estate company globally has ever

• 22:16Speaker 02

  done. Being able to be countercyclical and willing to stop investing when times are frothy, and then the willingness to run towards the burning building when everyone else is running away, to be able to take calculated risk when everyone else is risk off. I was at a conference for the last couple of days in San Francisco, and San Francisco as a city is in a difficult place with crime and tech companies leaving. Valuations or difficult financing a building would be very difficult. But if you had a view that in 10 years, that San Francisco would be viewed any way remotely how it was viewed a couple of years ago, you could probably make very high rates of

• 23:00Speaker 02

  return buying great office buildings in one of the nation's premier cities, as an example.

• 23:06Patrick O'Shaughnessy?

  If you think back to your time at Farallon, what big lessons most stand out? Sounds like that was formative for you, those 10 years.

• 23:13Speaker 02

  It was really wonderful. I made a lot of friends. I learned a lot. I was taught a lot. I was given a lot of responsibility at a young age.

• 23:22Speaker 02

  I think that Ferrellon as a firm did much, much better, many, many things than its competitors. But clearly, I started right after nine eleven. I had been a lodging and gaming banker coincidentally. So we started all of a sudden, a month into my tenure. I went there to buy buildings and make loans on buildings and all of a sudden, something I knew a lot about, how to financially model a lodging company was incredibly helpful in making public company investments. So I spent about half my time making public company investments. I think it was a really unique opportunity because I had one set of people I worked for who were traditional private equity real estate investors. They knew how to assess buying buildings.

• 24:06Speaker 02

  And then I had, on the other hand, a set of bosses that I reported to, who were really terrific Warren Buffett style stock pickers. There's sort of an idea, the best way to become really good at a language is to have to translate, to be a translator. And so I had to sit there and explain to one set of bosses who were building buyers, metrics around stocks, or how people assess stocks, what information was available from the company. But they knew a lot about the buildings. And I had to explain to a stock picker, the real estate dynamics. And let me just highlight a really, really simple one. If you have a public company, and let's say it owns two buildings,

• 24:51Speaker 02

  and one building is completely full and one building is completely empty. As a private investor, you would say, I'm going to value the full building on a multiple basis, and I'm going to make some assessment of what the empty building is worth as an empty building. Maybe making a five-year projection to fill it up, et cetera. Public company investor would say, well, that's not right. Because when I look at a software company, if half of its software contracts are really profitable and half of its software contracts don't make money, I put one multiple on the whole thing. It's obviously much more complicated than that in practice, but it was things like that of having to advocate from one to the other. I would say that we did, again, much better than our peers.

• 25:32Speaker 02

  But I think there was a tendency at some points in time to have Wall Street determine our balance sheet more than we should have. And I think that's a key lesson as a real estate investor. You must own your balance sheet. And that's true during the pre-finish crisis in residential housing. People were not controlling their balance sheet. They were hearing the siren songs of lenders say, come here, come here. I'll lend you more than you need, but that will allow you to buy a house that's nicer than you thought you could. You have to be able to say, that is not Wall Street's role in me executing my professional business plan. And again, I think Farrelly did a very good job on this, but what I saw during COVID,

• 26:11Speaker 02

  more specifically than the financial crisis, is Microsoft Excel is a really dangerous tool. There's a saying that computers can accelerate bad decisions faster than anything other than handguns and tequila. Microsoft Excel is a computer program. That's what it is. Now, a lot of people in finance, myself included, get really amped up. You go into investment banking, you learn how to build these financial models. You have a lot of confidence in your ability to forecast cash flows. It can make some really bad decisions happen because you have an analytical framework and that gives you a lot of confidence.

• 26:53Speaker 02

  You have to be able to sit back and say, let's think dispassionately about this. There's never in the history of private equity, and this is an astonishing fact that I can't verify, but I'm pretty sure it's true. There's never in the history of private equity ever been an investment that was modeled for lower than a 15% levered return. Most investments have lower than that. So Excel is a very valuable tool to learn how to use in the beginning of your career. You should have an Excel model for everything you buy, but don't overemphasize it. Similarly, Don't underinvest in your analytical framework and your Excel because what will happen when the financial crisis hits or COVID hits, it will be too late to build that analytical

• 27:36Speaker 02

  framework. What do I mean by that? So my stock at Four Corners went from $33 a share to $1,250 in one week during COVID. That is a market cap decline equivalent to all of the rent we would have collected from all of our, at the time, 900-ish buildings for 9.3 years. Wow. So if every tenant just sent their checks into a safety deposit box and we couldn't touch it, it would be nearly a decade. We were back to collecting 99.9% of our rent within a couple of months. We really didn't have more than a penny or two of impact on our income statement. We ended the year up. At that time, had you developed a five-year, 10-year financial

• 28:17Speaker 02

  model for my company, you could have made assumptions, simply deleting three, four years of cash flow dividends from the existence. I mean, just really machete-like assumptions changes to a model. And you would have said at $1,250, it's obvious that you should buy it. Don't overthink Excel or analytical frameworks, but don't underthink it. The last point I'd make is maybe comparing what I learned to Farallon to what I do today, is that Farallon was incredibly opportunistic and global. So I worked on developing an island in the Bahamas. I worked on financing a lava field in Hawaii. We bought companies that were under federal investigation. We bought empty buildings. We did all sorts of things.

• 29:01Speaker 02

  And it was really fascinating. But it wasn't replicable in the sense of, I've developed a second island in the Bahamas. My knowledge that I gained from flying to the Bahamas almost on a monthly basis for a while, I haven't been able to reuse. In its specifics, obviously, there's some general learnings. When we started Four Corners, I knew that we would be buying lots of small buildings that were relatively similar. We bought a building at Four Corners every 2.1 business days last year. So we bought 122 buildings in a year. Let that sink in. So in order to do that in a sensible way, where I wasn't constantly in a dialogue with

• 29:41Speaker 02

  my investment team, where they were advocating, this is a Chili's on the out parcel of a Walmart, and it's a beautiful building, and if we don't buy this building, I don't know what I'm doing here, I'm gonna leave. And then the next person is sitting there saying, yeah, but the rent on that Chili's is really high, and the lease term is short, and the lease has this provision in it that is really unfavorable to the landlord. Does Bill really understand what the other acquisition person is telling him? I said, that's just gonna be exhausting to do at scale. So what we did is we took a step back, and we tried to decide all of the factors in buying a real estate building, and have it all add up to 100, give different weightings to different

• 30:25Speaker 02

  things, so that when we talk about buildings, we can talk about them in a consistent manner. So we don't say, it's a Chili's on the out parcel of a Walmart, and wait for the other person to say, but the rents are too high, Bill, don't forget about the rents. We would say, this is a 71. It's a 71 because of brand, because of location, because of demographics, but it's not higher than that because of the amount of rent, the lease term, a provision in the lease that makes it lose score, et cetera. And we've scored 30,000-plus buildings using that scale. And the 500 that we've bought, we now have better organized information, we have comparables,

• 31:09Speaker 02

  so if you wanted to know what the right rent is for KFC in Ohio, within 15 minutes, I could give you a pretty good answer. So unlike Farallon, where you dove in and you figured out that the real risk to financing lava fields is that when you try to build something on lava, the lava compresses, so you need to figure out the compression ratio, and I could tell you more about the risks of lava compression than anybody you've ever talked to. But I'll never use that again. So really interesting. I learned a lot, but now it's much more methodical and repeatable as a process, perhaps less exciting in some ways, but there's some excitement in figuring out how do you raise the capital? How do you think about that the right way?

• 31:53Speaker 02

  Building a business going from, you know, six people to thirty, buying 500 buildings. And then the world throws things at you like COVID, which I'll tell you, running a restaurant reeling COVID, I'm really happy. I went through the financial crisis because COVID would have been really stressful, but having gone through the financial crisis, COVID was not nearly as challenging as perhaps would have been.

• 32:18Patrick O'Shaughnessy?

  If I had to look at the granular hundred point scale and the variables that go into it and the weights that each of those has, are there any variables whose presence would surprise the listener or whose weight would surprise the listener?

• 32:30Speaker 02

  Yeah, I think the really interesting way to put that is half the things you'd be able to see with your eyes and half the things you wouldn't. And we tend to over emphasize the things that we can actually see. So you would look at, I'll specifically answer your question, just one second. You would look at it's a Burger King and it's busy and it has a drive through and there's line out the door and it's next to a Costco and it's in a wonderful town. What you wouldn't see is how high the rent is. And I can show you Burger Kings that have $60,000 worth of rent and I'm sure there are Burger Kings with $260,000 worth of rent. There are Burger Kings that are owned by public companies. There are Burger Kings that are owned by the parent company of Burger Kings and there are Burger

• 33:15Speaker 02

  Kings that are owned by a one person franchisee who has a lot of financial leverage and isn't someone you'd want to partner with in business. You can't see that looking at the Burger King. So I think rent and credit are the two things that wouldn't necessarily be logical to someone who's just thinking about it really quickly. Terms of the lease would be another. Guarantor, which is part of credit. Perhaps it's operated by a small entity, but there's a guarantee from a larger entity that's ensuring payment.

• 33:48Patrick O'Shaughnessy?

  Before we talk about a bigger trend that might last a bit longer, there's one you brought up from the conference that you were just attending the last couple of days that I thought was interesting, which is this notion of offices being the new malls. You talk about that very catchy sounding turn of phrase, and whether or not you think it's true, we all know what's happened to malls and COVID seems to have thrown a torpedo into the side of the office ship, so to speak. What do you think about that analogy?

• 34:12Speaker 02

  So I'm on the board of Macy's. When I was a fellow, and we bought a big mall company with Simon. So I thought a lot about malls. Let me just start with anytime anyone talks about malls as if malls are one kind of thing, you should run away. They don't know what they're talking about. There's 1,070 malls in America, roughly. So let's just say 1,000. The top five are worth more than the bottom 200. Alamoana Center, Roosevelt Field, Aventura, Sawgrass Mills, Houston Galleria, unbelievably valuable, irreplaceable, incredible retail

• 34:51Speaker 02

  demand, et cetera. When someone talks about a mall, they are one mall each. So too is the mall of Walla Walla, Washington, a mall in Helena, Montana, that's both very small, was never worth much to begin with, and the smaller, more tertiary malls, especially there's more than one mall in a town, are very, very damaged. But how much does that really matter? Well, it doesn't matter a lot unless you were a tenant in one of those malls, or you were the family that owned one of those malls. The best malls in America that where all the value is are, in my mind, very different. So talking about malls by

• 35:31Speaker 02

  number is silly. Get to your question about office. I think what they're saying is a sector that has become structurally disadvantaged by an external catalyst, in the case of office, COVID, remote work. In the case of malls, it was Amazon online shopping. What they're probably underappreciating is the level of capital investment having as much, if not more, impact on the sustainability and viability of the real estate. You look at malls, when I graduated from college, you could have chosen a subsector to specialize in, unquestionably, it would have been malls. They were the creme de la creme. It's what all European investors

• 36:14Speaker 02

  wanted to invest in because they were perceived to be very safe. What happened over a very long period of time is the malls were not invested in. At some point, it might be in a good neighborhood, but wasn't nearly as valuable as the remaining houses. The problem is that retailers spend roughly 10% of their revenue on rent. As the productivity of that retailer declines, there is a point in which even for free, it is not viable for the retailer to operate. On malls, substantial starving of the properties for capital and reinvention,

• 36:54Speaker 02

  because mall owners were super focused on distributing cash flow to investors. The thing they say, well, the thing about malls is you don't need to reinvest in them much, and therefore that's why they're so attractive. Office is potentially going through a relatively similar dynamic that Class B undifferentiated office is really, really difficult to draw team members to. And I say this with some experience because I'm sitting in a suburban Class B minus undifferentiated office building that has had no investment in. I'll give you as an example of that, in our bathrooms, there are still ashtrays.

• 37:36Speaker 02

  Okay, so a tenant who has said, I want to take every penny of distributable cash flow and put it in my pocket. I don't want to reinvest. So what is the only lever as a tenant who is rent? I will either move across the street to an amenitized building where they're providing reasons for my team members to come in, where they're perhaps thinking about things like food and beverage, or amenities, or health and wellness for me, or I will only focus on cost, and therefore I have to probably put some of those things back into the system in order to attract team members to me. So I think what they're saying, when they say office is the new mall, is external catalyst.

• 38:18Speaker 02

  Difficulty investing capital because rates are higher, uncertainty about future rents, and therefore, an asset class that has deteriorating fundamentals over a very long period of time. I would point out in malls, that happened over a very, very long decade-like period of time. In office, potentially will happen faster. Then one final comment of the similarities between even Trophy City, CBD office, and what's happened in malls is downtown areas in the United States right now are not nearly as safe as they were five years ago, pre-COVID. Malls are not as safe as they were. And I think that that is something beyond the mall industry, beyond the office industry.

• 39:02Speaker 02

  We need help, but to the extent that you don't feel safe going to a mall, you don't feel safe going to your office, the alternative of staying home and ordering online, or the alternative of seeking out a workplace that is fully remote, becomes much more attractive. And I will tell you that the talk of the conference, not to get too in the moment, the talk of the conference, and this is a conference that had most of the publicly traded real estate companies, most of the financial advisors to those companies that arranged capital on Wall Street, and most of the investors, was this city isn't showing very well. This city is dangerous. The anecdotes were challenging. That's not great for our industry.

• 39:47Speaker 02

  It's not great to help catalyze investment and a return to arguably one of the greatest cities in our country.

• 39:55Patrick O'Shaughnessy?

  A while back, you sent me this really interesting grid of the trade-offs, if you will, or the variable considerations for the different kinds of real estate investing. Let's say somebody listens and says, I need or want a bigger real estate portfolio. And there's lots of ways you can do that. You can buy buildings directly and manage them yourself, or outsource it. You can buy a single REIT that owns all real estate, like an index fund. You could create a portfolio of REITs. There's public, there's private, there's funds. You could be an LP in a private fund. Like, there's lots of ways of doing it. I think the most interesting question around those various trade-offs is really just around REIT versus everything else. The REIT itself as a technology, if you will, Sam Zell, having played a big role in its origination. And maybe the right way to frame it is if you're interested in real estate,

• 40:39Patrick O'Shaughnessy?

  why would you do anything but buy REITs which are liquid, publicly traded, get you the exposure, have a unique tax structure? What are the reasons to not just do those?

• 40:50Speaker 02

  I had dinner last night, actually, with a just retired tax attorney, who, over his career, we went through all the different subsectors of REITs that this individual basically helped create. There wasn't a such thing as a timber REIT. And if you wanted exposure to that, you had to buy a forest. Or you had to buy into a partnership and deal with all the complexities of handling different partners and K1s and all this stuff. And now you can just go and buy a REIT. So one of the reasons is this is relatively new as an asset class compared to other kinds of stocks. And it takes a while, I think, for people to think about

• 41:34Speaker 02

  new sectors intelligently. I think we're there, but 10 years ago, there was still an evolution. So as you mentioned, it's just like if you said, I want to get exposure to companies. You could say, well, I could start a company. I could invest in a company that already exists, but perhaps I don't want to be limited to local companies. And you could go buy an individual stock. Well, that's considered pretty risky. But, you know, after 10, 15 stocks, the benefits of diversification are already there. But perhaps that's too much work and you are a surgeon and you want to spend your time thinking about that. You could go buy, historically, you buy a mutual fund. Those mutual funds had substantial economics

• 42:17Speaker 02

  related to the person who's running the fund. That has largely been disintermediated by index funds, but you could still invest in a fund that's actively managed by professionals who spend their whole life thinking about the 20 companies that are in net lease. And could tell you why Four Corners is different than one of its competitors, down to the minutia. You could invest in a private equity fund. That private equity fund could be very broad, global, all asset classes. It could be a student housing fund that focuses predominantly on a Sunbelt markets. I think REITs provide a terrific way to get exposure to real estate.

• 43:02Speaker 02

  I think they provide a terrific way to learn about real estate. I talk on college campuses all the time and people ask, what would you do to learn more? Pick four or five companies in the real estate space that you have a natural interest in. Read their annual letter, read their reports. We put out supplemental reports in addition to our normal way, company reports has all sorts of information in it. So you could learn a lot about these companies and you could get financial exposure. They pay dividends. They're typically pretty conservative. I think it's a great way. And again, as I mentioned, much more diverse. It's not just apartments. It's not just malls or just offices. It's very, very diverse.

• 43:44Speaker 02

  You could put together a very large portfolio and have none of those four food group property sectors if you wanted to.

• 43:50Patrick O'Shaughnessy?

  I'd love to spend a chunk of time now talking about maybe the most important trends in real estate that might affect everything that we've talked about up to this point. And I'd love to start with a really big one, which is climate. Climate, of course, is a big topic for everyone, everywhere. Some of us, depending where we live, have maybe felt the impacts of this more or less. There's visible examples of erosion or changes in weather and so on. How do you think climate impacts the world of real estate real large?

• 44:17Speaker 02

  Yeah, it's a difficult one because while I think there's scientific consensus, there isn't individual consensus. There isn't regulatory consensus, although it's building. When global warming impacts what I'll call felt temperature, you're going to see things like, will Phoenix be as attractive? All else being equal, and it won't all be equal, but if all else was equal, will Phoenix be attractive? If it's over a hundred degrees, 120 days a year versus 100. Will Tahoe be as interesting a place to go skiing 15 years from now as it was 15 years ago?

• 45:00Speaker 02

  What's the chance that if you went up the first week of December now, you would have skiing versus in the past? I also think climate is going to really speak to building buildings that are more efficient, utilizing solar, which has come down very substantially in cost, and having some level of accountability to the impact of the buildings that we own. And that is something that is absolutely a big trend within public companies. So perhaps another reason to own REITs is that we're more focused on these things than private owners are. We'll have SEC reporting requirements on the impact of our buildings in the very near term.

• 45:44Speaker 02

  Again, none of these trends we're going to talk about, should anyone say, "Climate, okay, so let's just buy things in Saskatoon, because it's definitely going to be cold there for many, many years." Or, "Climate's going to happen, so we can't invest in South Florida." I just think it's something to put on the palate of considerations in a more real way than 10, 15 years ago.

• 46:07Patrick O'Shaughnessy?

  Two comments make me think of the next one. The first is, you mentioned solar, which is a form of technology for energy, but also the lack of reinvestment in some buildings, maybe like the one you're sitting in. What role does technology play in all of this? In the management of buildings and in the experience of buildings and real estate, it seems like technology has come fairly late to it. Your examples from China, I have a friend who manages real estate in China, and it sounds very futuristic relative to what we see here in the US, just in terms of apps that help you manage your life in your building and so on and so forth. How do you think about the role of technology? Obviously, I think more technology would probably be good for the customer. Is it also good for the businesses? Because it's expensive, you have to update it all the time.

• 46:50Patrick O'Shaughnessy?

  Sounds like more money you have to plow back versus put in your pocket.

• 46:54Speaker 02

  I'm chuckling because when I started in real estate 20 years ago, everyone had these kind of calculators, HP12C. And I was told, almost overtly, "Don't trust any CFO who uses a different kind of calculator." It was really, really old school. And we thought of ourselves as, "We're the bricks and sticks guys, we're cash flow oriented, we buy buildings, it's based upon local market knowledge."

• 47:21Speaker 02

  That's being very quickly replaced. And real estate is now catching up. If you want to attract talented people, young people to where you work, they want technology. They want it to be technologically enabled, not just the real estate, but what they do for a living. So we could talk maybe a little bit about how we use technology in our process. But one of the major reasons to use technology in our process is because it allows us to track really talented people who do not want to do the job the way their parents or grandparents did it. But the physical real estate, they also want it to be technologically enabled. What does that mean? They don't want the drive through to be simply a human. They want their orders to be checked by AI.

• 48:06Speaker 02

  They want to be able to check into the hotel without talking to a human. They want to be able to resolve disputes with a retailer without talking to a human. They want to be able to go into a Macy's and use their smartphone to navigate the store to learn about product. App development for retailers is marketing. The app is our most important marketing tool. By the way, the efficacy of traditional app spending is just declining at rates. It would be hard to comprehend 20 years ago. We're very, very desirers of technologically enabled buildings. We're catching up as an industry to the smartphone. People who do it better have the capital to invest in it better. And this doesn't have to be super complicated stuff to really make a difference.

• 48:51Speaker 02

  I'll give you a simple example. I was in an Apple store, which is obviously super technologically enabled. They were able to say, we can't see you now. We're very busy, but we will contact you and it will be seamless. Go enjoy your time at the mall. Feel very confident that you don't have to stand in line to get the service you need. And they gave me forty minutes of my day. Those types of things are going to be table stakes for retailers, for real estate owners. That's what the expectation set has become. And young students are going to say things like, did you expect me to just stand in line?

• 49:33Speaker 02

  Did you expect me to just wander around to find what I was looking for? Do you expect me to be walking around a conference with a printout? That's just part of every aspect of life. I think if you're not as a senior decision maker in business, saying, how am I using technology to make this better? Is this the same way as we could have done it a hundred years ago? And if the answer is yes, you should feel like it's going to change because the rate of change of technology is really substantial. We're catching up as an industry. I'll give you an example. I have a friend who's on the board of a large publicly traded company that invests in a very substantial city in the United States. They were building a big, big building.

• 50:17Speaker 02

  The approach to filling that building was the same as it would have been a hundred years ago. We're going to build a really nice building in a market that has very, very low occupancy. It'll be the best building. It's super well located. We will charge the market's highest rents. Tenants will come to us. We will have intermediaries called leasing brokers and wah, one day it will be full. That's as easily as nineteen twenty-two as twenty twenty-two. One of my friends is very technologically savvy. Her comment was, no, we should be using the internet to find everything there is to know about all of the tenants that we're trying to attract. If the founder of this firm, who we really want to land,

• 51:02Speaker 02

  has a favorite restaurant, we should ensure that favorite restaurant isn't on the bottom floor of the building. If we're going to charge, in this case, it was mostly hedge funds, market-leading rents, how do we make this building the most cyber-secure building in the United States? Because those hedge funds, they want really nice space, but they'd love to be able to tell the universe endowments that invest with them. The reason we're in this building is because your money is safer in this building than any other building in the United States. That's really next level, thinking about technology that our industry isn't there yet, it's getting there, is how I would put it.

• 51:37Patrick O'Shaughnessy?

  I love the various takes on it, which bleeds into the, there's some software costs, let's say, the hard costs, the construction costs themselves of building, renovating, improving, all the actual physical hard costs that go into real estate itself and trends in that area. I mean, obviously, COVID has been the unique era for that with supply chain problems, with labor problems, with all sorts of stuff. How do you think about this over the next decade? And also how that relates to just supply in general? You mentioned earlier, you could sign a 25-year lease with Burger King, you get the same rent 25 years from now. These things just change slower. It's not generative AI where there's something popular and tomorrow there's five new companies. There's not five new great office buildings. So, construction costs and supply seem like critical, critical variables in this.

• 52:22Patrick O'Shaughnessy?

  How do you think about those two things?

• 52:24Speaker 02

  One just side point on technology and real estate. There's a really interesting venture capital firm, I'm not associated in any way, called Fifth Wall, and that might be a website that folks could check out, really alone in many ways, thinking about technology for a built world and advancing some of these companies. The construction of buildings is quite similar to what it was 50, 100 years ago. I'm putting architecture aside. I think that we are going to see more technology-enabled construction. It will change. Let me give you just a simple example of that. If you put a charger for your Tesla in front of a building, a couple of years ago, that might have cost $40,000.

• 53:08Speaker 02

  So, you're taking the best parking spots you have, you're spending a ton of money, and you don't know whether there'll be adoption. And it's difficult to regulate because what if a great customer who drives a diesel pickup truck parks in that spot? And you can only have a couple because they cost $40,000. The idea then was that you would charge empty to full a Tesla in 30 minutes. And that's why you needed this very powerful device to do that. Now chargers might be $4,000 and they may not even intend to go from zero to full. They're just used because you happen to be going to the store and you plug it in for eight minutes while you get your coffee and you come back and your car has gone from 60%

• 53:52Speaker 02

  charged to 68% charged. Well, now when they're $4,000, you don't need to use your best parking spots. You can have 10 of them and perhaps the top of the charger provides marketing. Here's a QR code for half off a glass of wine at the bar while you wait. There's that level of technology that we're right at the cusp of it. I'll give you a silly example. I have, as I mentioned, a little house in Montana. I just built a Zoom room in that house in a unused closet because I feel like we're going to be doing this for a long period of time and adding some technologies so the lighting's a little better, it's soundproofed, et cetera, is going to become part of how we live.

• 54:33Speaker 02

  And it wouldn't surprise me at all if Zoom rooms are like wine cellars were 30 years ago as a use case that didn't exist in mainstream and then became pushed down to quasi-mainstream.

• 54:46Patrick O'Shaughnessy?

  If you think about overall big picture construction costs, let's say you're building a new Class A office building downtown San Francisco or something. How do you think that will evolve and impact the rates of return, how much gets built, the onboarding of new supply? Everyone talks about us needing more housing in this country. How do you think about all of that? Just like the big picture materials, labor stuff side of all this?

• 55:10Speaker 02

  Gosh, living it personally and professionally. Redid a kitchen at my house this summer, completed in August. I hope that the stove will be installed tomorrow. I had a brand new kitchen for four months with a 25-year-old stove. We couldn't get the stove. We installed a refrigerator. We bought it used because we couldn't find a new one. That's changing quickly. We're catching up. Whether it's chips in China or supply chain, or all of a sudden a rush of demand, that'll be caught up, my guess is, by the beginning to the middle of next year. Lumber prices spiked and have now receded. I'm using my personal anecdote, but I could tell you anecdotes about HVAC,

• 55:54Speaker 02

  air conditioning shortages at Chick-fil-A, meaning that they can't open otherwise completed Chick-fil-A's. Or I can tell you stories about branded restaurants having to buy bags of ice at local convenience stores because they couldn't get ice makers into their restaurants. Those things never happened, other than in very rare emergencies. That being said, the real question, long term, if it costs 140, 150% of 2019 costs to ground up, build an Olive Garden, Burger King, office building hotel, what are the implications of that? One is, they'll build less. The second is, they will remodel more.

• 56:38Speaker 02

  Remodeling costs are cheaper. In some cases, that will have an impact on land because land is sort of the residual factor in real estate construction. So when you read about someone paying $30 million for an oceanfront pad of land next to Tom Brady in Florida, certainly, they're going to put up an expensive, nice house. But the calculus is backing into, this is what the per-square-foot value of a already-built new house would cost. Subtract construction costs, which are relatively calculatable, and the residuals, the land. Well, the opposite happens. If it costs that much to build a new building, and you haven't had substantial appreciation of the existing building stock,

• 57:23Speaker 02

  land should be impacted negatively. But technology will have a purpose in that as well, in trying to find ways to construct things in a more cost-efficient, prefabricated way, perhaps. Finding ways to remodel buildings, get more use out of buildings through technology, et cetera.

• 57:44Patrick O'Shaughnessy?

  As you think about the changing nature of some of these functions that retail has helped us fulfill, we talked about malls earlier and how that's changed for the most part, although some are still incredible. What about just the general form factor of retail? We see smaller stores, lower SKU stores. How do you think retail itself will continue to evolve alongside this very secular e-commerce adoption trend that accelerated during COVID and now seems to have fallen back on its trend line? What do you think retail will look like, say, 10 years from now versus today? How will it change the most?

• 58:16Speaker 02

  Retail is very complex and fashion retail is very, very complex, having to sort of reinvent a business every 13 weeks as the seasons change. What I would say is we are dramatically over-retail in the United States. We have much, much more retail square footage than in other places. We are a big country. In Europe, if you were to start a supermarket chain, you would very likely be taking over other people's supermarkets and putting your branded supermarket in a remodeled version of an old supermarket. In the United States, you're likely to find raw land and build a new supermarket. Question is, are we overbuilt or are we under demolished? We are definitely under demolished in the United States. And

• 58:59Speaker 02

  that's okay, because when it gets to even asking that question, the real estate that you think you might be demolishing has already lost most of its value and the basis will be reset substantially. What do I mean by that? The average loss on a Class B mortgage, so obviously the equity is gone. The equity loss was 100%. The average loss on a Class B mortgage is something like 85% when it goes into foreclosure. You eliminate all the equity and you turn the debt into 15 cents, 20 cents, 30 cents on the original dollar, all of a sudden, it can be something totally different. It can be self-storage. It can be the Chick-fil-A that's put in the parking lot. And by the way, we're way overparked

• 59:41Speaker 02

  in retail and technology is going to impact how parking lots are used, but subject maybe for another day. That basis reset opens up all sorts of possibilities. But as far as great retail, very well executed, where capital is reinvested to keep it fresh and interesting, tenanted with fresh and interesting tenants.

• 1:00:02Speaker 02

  Great retail is still great. And it's a terrific, evocative, emotional experience to go to really great retail, discover products, receive services. And I think another trend that will be hard to see, but A, as there's more level playing field around taxation, which has really happened only in the last handful of years. One. Two, that perhaps there'll be some more level field around shipping. This is the only country that I know of where free shipping on any online order is sort of like an American birthright, despite physics. So if I ordered a bag of charcoal, I would be irritated if I had to pay for shipping.

• 1:00:46Speaker 02

  Low value, heavy, awkward. And I would tell you that if I were to ship a bag of charcoal to you, if I went to the local UPS store and tried to ship you a bag of charcoal, I would pay an enormous amount. But if I ordered a bag of charcoal on charcoal.com, I would expect it to be shipped to me for free. So level playing field on tax, new thing. Perhaps a little bit more of a level playing field on shipping. And lastly, the wave of VC money that was invested in a lot of these things going away. Let's see how physical retail does. I'm not saying that online shopping is going to go anything but up. I'm sure it will. But I think there'll be a little bit more of a level playing field.

• 1:01:30Speaker 02

  And obviously, we think of a lot about this at Macy's, having both stores and online, this omni-channel enabled ecosystem, I think will be very critical. And sort of a customer expectation that I can return in store, I can buy in store, I can ship to store, I can ship to home, that sort of dynamic.

• 1:01:50Patrick O'Shaughnessy?

  I'm picturing that funny meme you see on Twitter all the time of the Grim Reaper going door to door and the doors are labeled different things. It came for malls, maybe it's coming for office now. It came for everything briefly in the first bit of COVID.

• 1:02:03Speaker 02

  There's a saying, every morning in the jungle, a gazelle wakes up and it has to be faster than the lion or it'll get eaten. And every morning, a lion wakes up and it has to be faster than the slowest gazelle or it won't be able to survive. That's true in real estate, that's true in business, that's true in football games. You have to innovate and you have to be running fast because there's constant change. You asked a really provocative question of what makes great investors. I think it's understanding that there's change, not having FOMO. Because change is really interesting, you can spend your life thinking the world's being reinvented every 10 days.

• 1:02:43Speaker 02

  But you can also get so locked into something that you know or something that worked previously or something that makes you feel comfortable, something that you heard someone one day say, and get locked into those things, that can be as equally dangerous. So to the comment about malls, the dogma was malls produce great cash flow and you don't need to reinvest in them. And the whole purpose is to get the retailer tenants to market. That was dogma. If you let that be dogma, that created issues. The saying in malls was they're at least not building any more of them. That's not true. We build new malls in America all the time. What we do is we build them on top of existing malls.

• 1:03:24Speaker 02

  And I mean that literally one mall on top of the other, but we invest an amount of money many times greater than the original construction cost of the mall, modernizing the mall. Phipps in Atlanta, Century City in Los Angeles as just two examples. So those that are investing and making those malls interesting, dense, new tenants, exciting restaurant concepts, win. Those that allow the mall to become 70% teen apparel, a mall that has 19 different places where you can buy a pair of Nike shoes, but no exciting places to eat, those malls die. It takes a long time, but those malls die. Similar thing might be what they're alluding to in offices, the new mall. If you do not innovate, if you do not invest the capital, and some of these businesses

• 1:04:09Speaker 02

  and some of these buildings don't have a capital structure that facilitates reinvestment. Your value is below the debt. Your company as a REIT must distribute 90% of its cash flow to investors to maintain its REIT status. But reinvesting in the building really ensures, as my pet theory, reinvesting in the building is the path in order to maintain and increase value.

• 1:04:31Patrick O'Shaughnessy?

  Do you think that right now is the highest period of required change for real estate ever due to the combination of the deployment era of a lot of these technologies and the societal norms shakeup that COVID represented pushing hybrid or remote work and some of the safety concerns and some of these other things? Like is now the biggest time ever for real estate owners to have to embrace what you just said and innovate and change?

• 1:04:57Speaker 02

  I don't think so. I think that it is human nature to always feel like now is the time that in the many millions of years that this world has existed, it happens to be this Friday that requires the most, and I'm the person to come up with it too. That's the human condition, the human conceit. I think there's always been a tremendous need for change and those who embrace it succeed. But to say that it's more important post-COVID than it was post the flu pandemic of X to focus on health and wellness is a logical fallacy. I'm sure there was an enormous amount of change during the industrial revolution.

• 1:05:42Speaker 02

  I'm sure there was an enormous amount of change post the invention of electricity. I think there's probably an enormous amount of change after the institutionalization of agriculture, where in our country we were predominantly farmers. Now, how many farmers do you know? I know some from Montana, but pretty limited. It used to be we would have both been farmers. So there's been an enormous amount of change that will continue. I'm really, really excited to see as venture capital money goes away from funding things predominantly on what will obtain the highest valuation within a year or two. Okay, let's create another crypto exchange. I heard they're always worth a billion dollars. As that capital goes away from that.

• 1:06:26Speaker 02

  To probably a period of less investment, but then back to things like, can we address real problems in society? That will be really, really interesting to see what the impact of that is. Because I think we've spent an enormous amount of money and time on things that were relatively distracting. And that's not valuable, especially, and I'm not a macro expert at all, but especially as we begin to compete much, much more heads up with a state-controlled M and E in China, that while they're not necessarily the best capital allocators, and I'm not saying that they're anywhere near what the free market system can do if left to its own devices over the long term.

• 1:07:07Speaker 02

  But it's probably a good thing that we're going to be focused on building real businesses that have a real reason to exist versus some of the nonsense that we've been done in the last five years.

• 1:07:19Patrick O'Shaughnessy?

  Last category, and then I'll turn to my traditional closing question, which is around health and wellness. This is one that's really near and dear to my heart. I find really interesting. It seems to be an important topic and trend for the country for sure. Like, if you just look at some very depressing stats around health and wellness, obesity, things like this. What do you think role this plays in the world of real estate? Because gym businesses have been the same for a long period of time. There's been some connected fitness stuff. Health and wellness seems really important. How do you think it impacts real estate?

• 1:07:49Speaker 02

  Let's start with the overall trends are enormously positive. And there's a great book called Ten Important Trends That Every Smart Person Should Know.

• 1:07:56Patrick O'Shaughnessy?

  Such a good book.

• 1:07:57Speaker 02

  Unbelievable book. I mean, we're going to live longer. Our children are more likely to be healthy. We're going to be active longer. All these wonderful, important trends. You're not going to read about that on the New York Post, but these are important trends. How we live our life has changed. As at this conference, we were providing lunch to people. Everyone's having salads. No one requested a soft drink. The three martini lunch is a thing of the very, very distant past. When I got out of college, someone would have said, you should learn to play golf because business deals are consummated on the golf course. Today, be into running or cycling or CrossFit because business deals happen at the CrossFit gym or on the squash court.

• 1:08:39Speaker 02

  I think people have thought much more openly and talked more openly about mental health. I think that's really positive. And work-life balance, I think if you're going to get ahead, that's always going to be a challenge. There's not some switch that you can flip and have a very successful career, but also a stress-free life, but people are much, much more focused on it. I think as a company, Four Corners, we encourage people to take vacation. If people are sick, they are very much encouraged not to come into the office. That wasn't the case 20 years ago. Vacation in many ways felt like days you were stealing from your employer. The answer to how many days a week that you should work was work on all days that end in Y. And that's what your employer wants you to do.

• 1:09:24Speaker 02

  And now it's, I think, very different. And I think if real estate doesn't accept that, it's going to have challenges. All those trends sitting on top of incredibly positive trends for the human condition makes it really, really exciting to see what's going to happen. I tried my absolute best to be the most positive person you could be during COVID. I would reflect that the most successful people I know are as positive as you possibly can be within the realm of reality.

• 1:09:55Patrick O'Shaughnessy?

  Maybe one timely closing question, and then my typical one. What does it feel like right now on the capital market side? We're at the end of November, just about Thanksgiving 2022. And it feels gnarly. And I think like most market crises, this one too shall pass. And on a long enough time horizon, things will improve. But right now, what does it feel like to be operating as someone that does partner with banks, that does need availability of some capital and cares about the cost of capital and all these sorts of things? From the ground floor, tell us what it feels like right now.

• 1:10:29Speaker 02

  Gnarly, I think, is the technical term for the market environment. Cost of capital is very important for my company. We raise equity, we raise debt. We can calculate to the third decimal what the weighted average cost of capital of our equity is, and that's perpetual. We can look at what the financing is, look at the bank's tombstone and to celebrate the deal, it goes out a couple of decimal points of what the cost was. And we buy buildings that have hopefully very consistent cash flows. So what we pay for them, we can estimate. So in many ways, cost of capital is my cost of goods sold. Cost of capital is like if you were in the oil business, what it costs for you to get it out of the ground. If you can get out of the sand in Saudi Arabia for $3 a barrel, you're going to look a heck of a lot smarter than it costs you $65 a barrel to get it out

• 1:11:13Speaker 02

  of the tar sands in Saskatchewan. The easier the cost of capital there is, the more successful we would be. We have an advantage in that we raised a bunch of equity this summer and we have very attractive hedges in place. But overall, it is a seized up capital markets where stocks have gone down and access to equity has gone from very ample to non-existent for most venture capital. I was with a prominent venture capitalist a couple of weeks ago and her comment was 70% of these companies are walking dead. If nothing changes, they will

• 1:11:54Speaker 02

  not be able to raise money to continue, or if they do, there will be substantial down rounds. Now, not to be sarcastic, the only place that hasn't seen massive markdowns commensurate with risks that was taken is private assets. So you look at LBO funds, venture capital funds, non-traded REITs that are like us but don't have a New York Stock Exchange listing, and miraculously, they're not down a lot. So obviously, 2023, that's what's going to happen. I mean, it's just writings on the wall. And the credibility that these firms have with investors, I think, will be shaken because of it. But at the very basic level, when firms

• 1:12:34Speaker 02

  like Blackstone or Prudential, TPG, wonderful, wonderful institutions of real estate investing, can't get loans from Wells Fargo, City Route, Barclays to buy buildings, there's a serious problem. And that is the state of play in America right now.

• 1:12:50Patrick O'Shaughnessy?

  Bill, this has been so much fun, as I knew it would be a wide-ranging tour of a really interesting asset class. I ask everyone the same traditional closing question. What is the kindest thing that anyone's ever done for you?

• 1:13:01Speaker 02

  Obviously, my spouse, we're a partnership and any scintilla of success I have is shared with her because of that. Whether it was when I was losing my job at a hedge fund and through some cosmic spark of luck, was able to get a job as a CEO of a pretty big company. So, not unemployed, but CEO of a pretty big company. But it happened to be in an hour north of Toronto. And we had two, soon to be three, young daughters. And we had made the decision that that's something I knew we need to attack and that it would be very

• 1:13:41Speaker 02

  hopeful to do that. That would be one answer. Another answer would be, obviously, an enormous amount of investment at a young age by my parents and my education would be a terrific one. Classic Irish Catholic. My grandparents lived in a triple decker in Boston and my parents moved to the suburbs. My parents were the first ones to go to college, my mom to medical school. Ton of investment in me and to go to boarding school, to go to Claremont McKenna, which was incredible experience. What I would say is even the things that at the time that seemed brutal, financial crisis, I lost 70 pounds in 2009, 2010. Wow.

• 1:14:22Speaker 02

  It was brutally difficult fighting tooth and nail to get investors money back and be good fiduciaries, far along. And the deals ended up being good ones. Taking those experiences, really reflecting on them and getting a ton of value later in life. And I still get a long ways to go, hopefully to learn from. Let me give you one final one. And I know I'm giving you more than one. Five years or so ago, I hired a coach. He's a very private person, so I'm not going to name him, but I hired a coach. And really dedicated to getting better at things and learning from other people's experience. And that has had a profound impact on my effectiveness personally and professionally.

• 1:15:04Speaker 02

  So what I would say is to the extent that you can get coaching and you can find someone who can help you take that on, there's so much that you can benefit from other people's experiences versus having to sort of accumulate all those experiences yourself, oftentimes from hard knocks and not wanting to repeat hard knocks. And that's, I think, super helpful. Get coaching, just be committed to continuous learning. And there's just so much amazing content out there. I remember when I was at Farallon, it would be like an amazing day, someone finds some kernel of information. And I remember like it was yesterday, someone found a facsimile of the old Warren Buffett partnership letters with hand scribbled notes

• 1:15:49Speaker 02

  from an investor in the sixties in the corner. We all copied them and we read them like crazy. It was terrific. It was hard to find that stuff. Now it is overwhelming. Like your podcast, I mean, the ability to just go on vacation and come back, having talked to 20 interesting people is just phenomenal. So be committed to continuous learning. And my coach has really pounded that into my skull and it's made for a much more fulfilling time.

• 1:16:13Patrick O'Shaughnessy?

  Bill, it's been awesome. Thank you so much for your time.

• 1:16:16Speaker 02

  Yeah, great. Thank you. Cheers.

• 1:16:18Patrick O'Shaughnessy?

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