JF2502: How to Make Money with Industrial Investing with Kevin McGrath

After losing $40K in a mixed-use commercial property, Kevin McGrath decided to move into the industrial real estate industry. Kevin talks about how he got started in industrial investing, the pros and cons of single tenant vs. the more risky multitenant industrial net leases, and why he chose the industrial investing industry over multifamily. 

Kevin McGrath Real Estate Background:

  • Principal with Cardinal Industrial
  • Started investing in 2005
  • Invests in both industrial real estate and multifamily properties
  • Currently involved in 10 investments both as an LP and GP
  • Based in Del Mar, CA
  • Say hi to him at: www.mcgrathindustrial.com 
  • Best Ever Book: Abraham Hicks

 

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TRANSCRIPTION

Joe Fairless: Best Ever listeners, how are you doing? Welcome to the Best Real Estate Investing Advice Ever Show. I’m Joe Fairless. This is the world’s longest-running daily real estate investing podcast, where we only talk about the best advice ever. We don’t get into any fluffy stuff. With us today,  Kevin McGrath.

How are you doing, Kevin?

Kevin McGrath: Doing great, Joe. Thanks for having me.

Joe Fairless: Well, I’m glad to hear that. It’s my pleasure. A little bit about Kevin – he’s principal at Cardinal Industrial, started investing in 2005. He invests in Industrial Real Estate and multifamily. He’s involved in 10 investments right now, both as an LP and GP. Based in Del Mar, California. You can go to his website, it’s going to be linked in the show notes of this episode.

With that being said, Kevin, do you want to get the Best Ever listeners a little bit more about your background and your current focus?

Kevin McGrath: Sure, thanks again for having me. My current focus is industrial real estate. I got started in commercial real estate full-time as a broker in 2007, in Columbus, with Colliers International. And that was my, again, first foray into real estate full-time. I started investing in 2005, investing in a flip, and then after we sold the flip, we put that money into a mixed-use commercial property that turned out to be an absolute dog. We can talk maybe a little bit more about that. But I spent most of my career in a brokerage up until about two years ago, where I made the transition from brokerage into full-time investing, with where I am now, with Cardinal Industrial.

We acquire mainly single-tenant net lease industrial assets across the country, typically focused geographically in the Midwest, Southeast. And the industrial market has been really, really competitive for the last couple of years, so we have to search far and wide and rely on our broker relationships to get deals, but it’s been really, really fun so far.

Joe Fairless: For someone who’s not familiar and is listening to the industrial space—

Kevin McGrath: Yes.

Joe Fairless: …or anything commercial outside of multifamil…

Kevin McGrath: Yes.

Joe Fairless: …will you elaborate on what you mean, when you say single tenant net lease industrial?

Kevin McGrath: Sure. So industrial as a whole, when someone thinks industrial, they might think auto manufacturing or an auto plant, and certainly that’s an aspect of it. It’s a small, probably 10-15 percent of the overall industrial market is that type of asset. A lot of the product that is out there today and people might read about is more distribution-related, where companies are more focused on distribution and logistics. And a typical warehouse being built today is about 250,000 square feet or larger, and the industrial market is certainly has gotten more mainstream in the last five or seven years, with the advent and the acceleration of e-commerce, and it’s really, really taken off.

Joe Fairless: Okay. How do you make money as an industrial investor?

Kevin McGrath: There’s more than one way to make money. And it’s similar to multifamily, where there could be a value-add component. So for example, there are single-tenant industrial buildings, meaning if there’s a building that’s 100,000 square feet, there’s one company that occupies all 100,000 square feet. And then there’s also multi-tenant industrial, where that same 100,000 square foot type building could be occupied by three different tenants occupying just over 30,000 square feet each. And the value-add component there could be that you buy this building and only two-thirds of the building is currently leased, so there’s a 33,000 square foot vacancy, and it’s upon you as the owner to come in and lease the unbalanced space. And there’s the value-add right there, because you’re buying it at a basis where it’s going to be less, where income is going to be less than if it was 100% occupied.

Joe Fairless: So why don’t you do multi-tenant instead of single tenant?

Kevin McGrath: We’re starting to. I would say probably 80% of our portfolio is single-tenant, 20% is probably multi-tenant. It’s pros and cons with everything, right, Joe? So with a multi-tenant, you get a little diversity. So if one tenant moves out, you’re not holding the bag for the entire building. But there’s also more risk there as well with management. And then also the single tenant net lease deals that we’re buying typically have long lease terms, seven years or longer. So there’s built-in stability there. And a lot of times the multi-tenant buildings—it’s not always, but most of the time have shorter lease terms, typically five years or less.

Joe Fairless: Why?

Kevin McGrath: Because companies don’t like to sign long-term leases if they don’t have to. And typically when they go into a single-tenant building, not always but sometimes, it could be a built to suit transaction for them, and it only makes financial sense for the developer constructing that building if it’s 10 years of lease or longer.

Joe Fairless: Okay. Clearly there’s parallels to single-family homes and apartment buildings, right?

Kevin McGrath: Yes.

Joe Fairless: I think everyone’s connecting the dots there, where you’re talking about multi-tenant, you could have someone move out, but you’d still be able to have some income…

Kevin McGrath: Yes.

Joe Fairless: …versus a single is not the case. You said there’s more risk in management with multi-tenant. What do you mean by that?

Kevin McGrath: Well, with management risk —I shouldn’t say risk, it’s just more…

Joe Fairless: Work?

Kevin McGrath: Yes, it’s more work. And then let me go back to the single-tenant – we buy a single-tenant, we buy them with substantial reserves in place. So typically, in the deals that we acquire, if we’re not negotiating the leases, in the leases themselves they will have renewal options for the tenant. And the tenant will have to give the landlord 6-9 to sometimes 12 months notice if they’re going to renew or not. If they don’t exercise that renewal option, that’s when we would go out and start marketing that space for lease. So for example, if there was a 9-month window where that tenant has to give us notice if they’re going to renew or not, and they don’t, we go out and we start marking the space. So that gives us nine months to find a tenant.

And then on the backend, if we’re not able to find a tenant in that nine-month period, we have built-in reserves another 6-9 months on the backend. So that gives us anywhere from 12 months to almost two years to find a tenant, which is typically enough time to backfill it. And a lot of times what we’ve found when we backfill it, you backfill it with a better tenant, with better credit and you get a higher rental rate. So the building value increases pretty dramatically, and that’s a value add component right there, in itself.

Break: [06:37] to [08:38]

Joe Fairless: When you say built-in reserves, is that money that your team, the general partnership and limited partners brought to it? Or built-in reserves from—?

Kevin McGrath:  Correct. Correct.

Joe Fairless: Okay, got it. So you really don’t want to dip into those built-in reserves then?

Kevin McGrath: No, definitely not. But they’re there if we need them.

Joe Fairless: Got it. Why not have 6-9 months built-in for notice in multi-tenant? Is that just not a common thing?

Kevin McGrath: No, it is as well.

Joe Fairless: Okay, so regardless single or multi-tenant, you should have at least six months upwards to 12 months notice when the tenant wants to leave?

Kevin McGrath: Yes. Exactly. Typically, the shorter the lease term upfront, the less notice that they’ll—

Joe Fairless: Sure.

Kevin McGrath: —they’ll have to give, yes.

Joe Fairless: Okay. Alright. Why industrial? Why not apartments?

Kevin McGrath: Well, I think for what I do full-time, I’ve been in the industrial space since 2007, so the easy answer, it’s really all I know.  And it just so happens that for the first five years I was in the business, the industrial market, it got hurt, like most other sectors during the Great Recession. And yes, there were a lot of times where I was questioning what I was doing, and sometimes you would look at multifamily and you say, “Hmm, would that be better? Or would office be better?” But I tell you what, really since 2015-2016, I would say that industrial has performed as good if not better than any other sector. This last year in 2020, with COVID, it’s performed extremely, extremely well with all that’s been going on.

So more or less, I just lucked into it, I  fell into it, and it’s turned out to work out really well. Having said all that, I invest passively in multifamily deals as well. So I’m not exclusive to industrial, I still invest in other sectors and I believe in other sectors. But if someone’s out there who wants to diversify a little bit, industrial has been a really, really solid market the last 5-7 years.

Joe Fairless: I’m a broker you’ve been speaking to, and I send you an industrial opportunity. What are the things that you must have in order for you to pursue it further? Talk a little bit about that please.

Kevin McGrath: Sure. I’ll talk about the physical asset. I know I can look at a deal or a building and know within a couple glances if it’s going to work or not. The buildings that we’re looking at, we want them to be as generic as possible. And what that means is that if they were to ever go vacant, that we want them to be able to work for as wide a pool of industrial occupiers as possible. So to put it in kind of layman’s terms for people not as familiar with industrial, generic to me means—again, I’ll go back to the example, a 100,000 square foot building; we want most of that to be warehouse. So maybe a 5%, 5,000 square feet of office or less, with the remainder to be warehouse.

You want as many dock doors as possible, that allows for the occupier to have as efficient of shipping and receiving area as they can. And you want the building to be as tall as possible. So that means 28 clear height or taller. The buildings being built today are much taller than they were 20 years ago.

Joe Fairless: Why is that? Just stack stuff higher?

Kevin McGrath: Yes, exactly. It’s more efficient; companies rack product in the warehouse. And they’re not paying for the space the higher they go up.

Joe Fairless: Yes.

Kevin McGrath: They’re paying for it as they go out, but they’re not paying for it the higher they go. So the buildings being built today, again, are 36, sometimes 40 foot clear. And that’s just because they can be way more efficient with their space and their pocketbooks.

Joe Fairless: In Atlanta, near Lawrenceville, Amazon did Project Rocket. Are you familiar with that? A 70-foot tall building.

Kevin McGrath: I have heard of it.

Joe Fairless: Yes.

Kevin McGrath: And a lot of that is mezzanine space. So yes, Amazon is utilizing as much of the inside shell as possible. Just because, again, it’s more efficient and it’s the way to the future.

Joe Fairless: Okay.

Kevin McGrath: Again, going back 30 years back in the late 70s, early 80s, it’s really common for them to be 18 foot clear, 18-22. That was always the—

Joe Fairless: That’s a hard pass for you?

Kevin McGrath:  Not necessarily. It depends where it is. And it depends what they’re storing in there. So definitely not a hard pass, but there’s got to be something else to it.

Joe Fairless: Okay. Alright. Please continue on what you’re looking for. So in this example, 100,000 square foot building.

Kevin McGrath: Yes.

Joe Fairless: Mostly warehouse, very little office space…

Kevin McGrath: Yes, very little office.

Joe Fairless:  Many dock doors…

Kevin McGrath: As many dock doors as possible.

Joe Fairless: As tall as possible, at least–

McGrath: Yes.

Joe Fairless: 28 feet…

Kevin McGrath: 26-28, clear or higher. I would say, enough auto parking on the exterior. For 100,000 square foot building, you would probably want 80 stripes car parking spaces or more. One thing we’re finding today with the explosion of e-commerce, they’re much more labor-intensive facilities. So they have a lot more people working there. So there may need way more car parking spaces than buildings of old. So you have a lot more trailer parking on the exterior and you have a lot more car parking, so they need bigger pieces of land on which to be built. But for 100,000 square foot building that I’m looking at, that’s not a deal killer, because e-commerce is only 20-25 percent of the overall market. So I would say, again, as vanilla as possible.

Joe Fairless: Yes.

Kevin McGrath: And the way I can compare this as, if you’re going to look at an old residential house, and the houses that tend to stay on the market longer are the ones that are really contemporary or really modern, a little bit funky…

Joe Fairless: Yes.

Kevin McGrath: Those are the type of industrial buildings that we don’t want, the ones that are built specifically for a user that is kind of in a niche industry. So if that building wherever to go vacant, you’re looking for that niche buyer again. So you’re looking for a needle in a haystack. And I learned all of this back in the Great Recession, when there was a lot of supply and very little demand. The buildings that were being leased quickly or sold quickly, again, were the ones that were the most vanilla and had the largest buyer and tenant pool.

Joe Fairless: Dumb question, but why does it matter if it’s generic on the inside, if you’re going to get a build to suit tenant?

Kevin McGrath: What do you mean, a build to suit tenant?

Joe Fairless: Well, earlier we were talking about if you find a prospective tenant…

Kevin McGrath: Yes.

Joe Fairless: Or at least, I thought we were talking about this. If you find a first prospective tenant and you get under contract with them to build out what they’re looking for—

Kevin McGrath: I see what you are saying.

Joe Fairless: —Then why does it matter if you’re buying a generic property, if ultimately you’re going to be getting a tenant who is going to build out what they want anyway?

Kevin McGrath: Well, when they build it, all material all looks the same Joe; they’re just racking on the interior. So you could walk into a warehouse and not know who the tenant is. They’re all going to kind of look the same, they all kind of do the same thing, essentially.

Joe Fairless: Okay.

Kevin McGrath: So we’re not building anything out on the interior; we might put some neutral carpet and new carpet, new paint in the office, and besides that, we don’t do anything. We maybe upgrade the lighting if it needs it, and that’s really about it. Make sure everything’s in good working order. And then it’s kind of plug and play for any tenant. And that’s what I mean by generic. There’s not much we have to do as owners on the interior. It’s already been done. It’s just one open box. Does that make sense?

Joe Fairless: Yes, it does, thank you. Going back to what you mentioned earlier, after your 2005 flip, you got into mixed-use commercial property that you call it dog…

Kevin McGrath: Yes.

Joe Fairless: How much did you lose? And why did you lose it?

Kevin McGrath: We bought it in 2005. I ended up getting out of it three years ago.

Joe Fairless: Wow.

Kevin McGrath: I know, I know. It wasn’t one of those deals—

Joe Fairless: You didn’t—you didn’t rip that band aid off. It was a slow burn.

Kevin McGrath: Trust me, I tried. I tried so many times I lost count.

Joe Fairless: How much did you lose and how did you lose it?

Kevin McGrath: And, you know, I probably lost 40 to 50 grand. So it’s not the amount of money. At the time, I didn’t really have it. But it’s not the amount of money. It was the length of time I had it. So imagine having a dog property for that long. The mental anguish, right?

Joe Fairless: Yes.

Kevin McGrath:  I got it with two partners of mine, they’re buddies from high school; they weren’t real estate, they didn’t know anything about real estate. They looked at me because I was the real estate guy at the time. I didn’t know what the heck to do with a mixed-use commercial property, so I was the one who had the responsibility of always leasing it out. We went through tenants left and right, so it took so much of my time. And my mortgage was only like 1,200 bucks a month, so I guess that was the saving grace. But it was just more than anything, the mental anguish. And I think they still own today, I’m not sure. I paid $10,000 to get out of it. And it’s still to this day, that’s probably over my 13-year career the most pleasure I felt in a real estate transaction,  was getting out of that deal. It’s true.

Joe Fairless: [laughs] Alright.

Kevin McGrath: Yes.

Joe Fairless: So if you had to do it over again, and you were deciding to purchase this property,—

Kevin McGrath: Yes.

Joe Fairless: —what would you have done differently prior to the transaction to set it up correctly?

Kevin McGrath: Besides not buying it, I’m not sure if we could have done anything differently.

Joe Fairless: You would just buy for less, I guess. What happened? Why did you lose money?

Kevin McGrath: There was two properties on the parcel. There was a house upfront, and the back, it was built specifically as a music recording studio.

Joe Fairless: Okay…

Kevin McGrath: So it’s about a 2,000-2,500 square-foot structure that was built specifically for a music recording studio. So we had everyone in there, from—the initial guy blew out; we bought it at a Sheriff’s sale in Columbus, so we thought we were getting a good deal. And it was located right inside the outer belt Columbus right across from a Lowe’s, right next to a waffle house. So we thought the location was okay at the time, and then when the initial tenant moved out, we had a couple other music recording people on there, and then we had a church, we had some office use type tenants, and it was just musical chairs of different tenants through the years that I—

Joe Fairless: Were they all using it as a recording studio?

Kevin McGrath: No. One was using it as a church, one general office, and nothing stuck.

Joe Fairless: Huh. Why didn’t anyone want to stick around?

Kevin McGrath: I don’t know. I just think that in the nature of that industry, the music recording studio—

Joe Fairless: Oh, no, I get that. I think that’s obvious. I’m recording this podcast—

Kevin McGrath: Right.

Joe Fairless: — looking at some water in Marco Island, so I get that.

Kevin McGrath: Yes.

Joe Fairless: But when it was repurposed, why didn’t the church stay? Why didn’t the other tenants stay? Is it the location?

Kevin McGrath: The location was probably suspect; it was on a busy street, South High Street in South Columbus, so a busy location. And the access in and out of it was difficult, again, because it was a residential house in front, and you got to the real property through like a shared driveway.

Joe Fairless: Okay.

Kevin McGrath: They just give me nightmares thinking about it. [laughs] And I used to go down there like on gray, cold January days, and I’ll be like, “What am I doing with my life?” And it would just make me question real estate investing. At this time, this was the only property, only deal I was in. And my buddies were starting to have a lot of success with what they were doing and it was just a low period for me.

Joe Fairless: Oh well, bravo for getting out of there. So the lessons learned from my standpoint is it was just awkward to get to because you have to pass by a single-family house. And so it’s very weird for church to be there really any business…

Kevin McGrath: Yes. There was no parking. Exactly.

Joe Fairless: Yes. So lack of parking and unconventional way to get there. Plus the area didn’t sound like it’s the best area, so…

Kevin McGrath: It’s not, yes.

Joe Fairless: Alright. Well, that’s helpful. And now that we have officially stressed you out, but as a reminder to you that you’re no longer in that property, so there we go…

Kevin McGrath: Thank you. I woke up from my nightmare.

Joe Fairless: Yes. What is your best real estate investing advice ever for investors, as it relates to your industrial experience?

Kevin McGrath: I would say, continue to take action, and this goes through all different property types. Just continue to take action and keep moving forward. Like we just talked about with that property that I was involved with, I could have easily quit and I certainly thought about it, but keep moving forward, because whoever is listening is destined to do great things. And I’m just really grateful that things have turned out well for me.

Joe Fairless: We’re going to do a Lightning Round real quick. Are you ready for the Best Ever Lightning Round?

Kevin McGrath: Yes. Let’s do it.

Joe Fairless: Alright. First, a quick word from our Best Ever partners.

Break: [20:21] to [20:55]

Joe Fairless: What’s the best ever book you’ve recently read?

Kevin McGrath: I’ve been reading and listening a lot to Abraham Hicks. It doesn’t sound like you’re familiar with him.

Joe Fairless: No, I’m doing a little Google search actually.

Kevin McGrath:  Yes, it’s a husband and wife and they’ve been around for a while; the personal development, kind of more spiritual-based…

Joe Fairless: I’ll check them out. What is the best ever way you like to give back to the community?

Kevin McGrath: Volunteering. I’ve been involved in coaching Special Olympics for probably the last 7-8 years, and I love it.

Joe Fairless: How can the Best Ever listeners learn more about what you’re doing?

Kevin McGrath: The easiest way is, I have a personal website which is just https://mcgrathindustrial.com/, and if they want to sign up to see some of the deals that we have, if they want to get on our distribution list, they can do that there.

Joe Fairless: Awesome. And that is the website I have in the show notes, so Best Ever listeners, you go check that website out. Kevin, thank you for being on the show and thank you for educating us on industrial, specifically what you look for and why you look for it. And the pros and cons of single versus multi-tenant in industrial. As well as a lesson learned a long time ago on the mixed-use property that you no longer own, just as a reminder to you… Thanks for being on the show. I hope you have a best ever day and talk to you again soon.

Kevin McGrath: Thanks, Joe.

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