How Core Hedges Against Inflation

Wally Smith:
All right. Tell me about full-cycle programs. Do you have full-cycle programs you’ve gone through?

Jeff Montgomery:
On the DST side, our first acquisition was 2016. So 10 year we’re coming up, 2026 is our full-cycle. None of those have gone full-cycle yet. We’ll anticipate those coming soon. But what we are seeing on those assets, we’re exceeding pro forma on every single one.

Wally Smith:
Okay.

Jeff Montgomery:
Our investors are happy. We’re meeting all the returns. We haven’t had any hiccups, really, on that side, which is great.

Wally Smith:
Okay. So you do generally hold them close to the full 10 year?

Jeff Montgomery:
We-

Wally Smith:
Or do you anticipate five to seven?

Jeff Montgomery:
No, we try and get out, get the full ownership of it. So seven, 10 years.

Wally Smith:
Okay. That’s good to know. And the investors did well. I think we were talking earlier about the kind of the 80-20 hitting the bonus-

Jeff Montgomery:
Bonus round.

Wally Smith:
… potential. Yeah.

Jeff Montgomery:
Yeah. So this is a new aspect to [inaudible]-

Wally Smith:
To interrupt, we’re trying today to keep things as general as we can. We’re not talking about a specific property or address or building, more conceptual. But I think that’s something that’s woven into a lot of your projects. Right?

Jeff Montgomery:
Yeah. We’ll try not to get the compliance officers too excited.

Wally Smith:
Absolutely.

Jeff Montgomery:
No. From a high-level aspect, one of the things we heard the DST investors, clients ultimately asking for was inflation… This was a couple months ago. It was inflation’s going to happen. It’s going to be an aspect. It’s not a short-term, transitory inflation deal. So what happens to our investment as inflation starts to increase? How do we hedge against any inflation impact to our equity in our investment? Our answer to that, and the market’s ask for this was, “Well, we’d like to participate on additional cash flow, over and above threshold.” So we worked with our attorneys and our compliance groups and everything, came up with this structure, where over a certain threshold, we’ll split. 80% of the additional profit goes to our investors.

Wally Smith:
That’s excellent.

Jeff Montgomery:
Yeah.

Wally Smith:
That’s a question that’s come up so much, just with the last $6 trillion dumped into the economy. Not that there’s anything wrong with that, of course. But folks are asking, well, just, “Gee, what about inflation? I can see the yield and the numbers they talk about on the TV about inflation are higher than the yields we’re talking about. Does that mean I’m going backwards?”

Jeff Montgomery:
Right.

Wally Smith:
We’re in a good position because we like to contrast projects that have a master lease, that have that pricing elasticity built into it, against a fixed-lease, triple net, that’s going to be there for… Maybe there are rent bumps of a couple percent a year, but they’re definitely not going to keep up with inflation. So I think you got a very competitive edge there.

Jeff Montgomery:
Yeah. I mean, our goal, at the end of the day, our pure focus is to the investors. So we’re buying these assets. We’re putting our own money in it from the start. Our investors are coming in and taking us out. We want to be sure that we’re structuring a deal that is attractive to that investment group and is going to be a safe investment, a good shelter of capital for that long-term hold period. So-

Wally Smith:
It strives to be the safe investment.

Jeff Montgomery:
Right.

Wally Smith:
Yeah. Oh, okay.

Jeff Montgomery:
Compliance.

Wally Smith:
Okay. Very good. Let’s see. Interest rates, I mean, that’s certainly been a hot button.

Jeff Montgomery:
[inaudible] a topic, huh?

Wally Smith:
Let’s talk about that. Turned on the TV the other day. They said inflation’s done.

Jeff Montgomery:
It’s done.

Wally Smith:
Talking to Art Laffer a couple of months ago at an event, got a couple of minutes with him, and he said that we’ve never brought inflation under control in the country without raising interest rates at least one point higher than the rate of inflation. And at the time, inflation was somewhere between 8 and 10, depending upon if you included those pesky things that keep going up or not. Right? So, how are you guys positioned, then, with inflation, with interest rates?

Jeff Montgomery:
Sure. On existing assets, we’re placing fixed debt. We have been fixing interest rates for the whole hold of the assets. So existing assets, we’re good there. From an acquisitions point of view, it’s probably echoed throughout the industry. It’s frustrating because you’re looking at a market that has good employment, good fundamentals. Property fundamentals are great. The market fundamentals are great in all of our markets. But you’re looking at a capital environment where you run into interest rates being quoted at higher rates than what cap rates are at. So how do you make that work? We are getting creative on the acquisition side of looking at doing interest rate swaps, potential caps. Or one of the things that we’ve started to chase heavily that I don’t know if this is a secret as much anymore, but was looking for debt assumption. So early on we had pivoted to start targeting, “Hey, is there a group that’s already placed debt [inaudible]?”

Wally Smith:
Are you finding much of it?

Jeff Montgomery:
We have, on a few markets, very market-specific.

Wally Smith:
Yeah. Don’t tell anybody.

Jeff Montgomery:
Yeah.

Wally Smith:
[inaudible].

Jeff Montgomery:
Can’t tell you which-

Wally Smith:
All right.

Jeff Montgomery:
… which opportunities we’ve been chasing right now. But no, we’ve been in discussion with some off-market groups and off-market properties to try and acquire one that has much lower interest rate than what you can get on the market today.