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Happy Thursday!
Welcome to this week’s deep dive exclusively for Nexus Pro members. It’s an honor to have you here. This deep dive is a follow up to my recent podcast conversation with Joe Gaspardone, COO at Montgomery Technologies. I learned a lot from this conversation and want to share my takeaways and the full transcript with you below.
In case you missed it in your inbox, you can find the audio or video here:
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Enjoy!
—James
I’m excited to put this episode out there because I think it will be helpful for getting smart building tech approved in organizations across the world. I think we as a smart buildings industry can improve on the rigor we apply to making the business case for the new technology we believe so heavily in. If we’re going to make others believe in it too, especially our financial stakeholders, we need to remove the fluff from our return on investment calculations. Fluffy ROI is mostly caused by not doing the work to put the tangible benefits of the technology in the correct model and terminology.
Not just CRE either—these same insights can also be applied to other industries. A simple framework for doing this work for any industry is to walk through these questions:
My highlights:
What did you think?
Note: transcript was created using an imperfect machine learning tool and lightly edited by a human (so you can get the gist). Please forgive errors!
James Dice: [00:00:00] Hello, friends. Welcome to Nexus, a smart buildings technology podcast for smart humans. I'm your host, James Dice. If we haven't met before, I write a weekly newsletter on the same topic. It's also called Nexus. Each week I share what I've learned, my opinions, and what I'm excited about in the quickly evolving world of intelligent buildings. Readers have called Nexus the best way to stay up to date on the future of this industry without all the marketing fluff. You can check it out and subscribe at nexus.substack.com or click the link in the show notes.
Since starting the Nexus newsletter, many of you have reached out to me wanting to talk shop, and we have. After a few weeks of those wonderful conversations, I realized I needed to record and share them with our growing community. So here we are. The Nexus podcast is born. This is our chance to explore and learn with the brightest in our industry together.
All right. Episode 28 is another conversation with Joe Gaspar, Doni COO of Montgomery technologies. This time, Joe and I dove deep into commercial real estate finance one Oh one. Before you think that doesn't apply to you and turn off the episode? Let me tell you, I think you're probably wrong about that.
If you're interested in smart buildings, the business case for that solution or technology needs to be made at some point. And this episode was show you what it takes to actually do that for one type of building the commercial office This episode of the podcast is brought to you by nexus pro nexus pro is an annual or monthly subscription where members get exclusive writing podcasts and an invite to a monthly members only event.
You can find info on how to join and support the podcast@nexusdotsubstack.com. This episode is also brought to you by nexus foundations, an introductory course on smart buildings. If you're new to the industry, this course is for you. If you're an industry vet, but want to understand how technology is changing things.
This course is also for you. Cohort two is set to kick off in winter 2021, and you can enroll@courses.nexus labs.online without further ado, please enjoy this episode of the nexus podcast.
All right, Joe. Welcome back to the show. in case anyone didn't listen to the last episode, can you go ahead and introduce yourself one last time?
Joe Gaspardone: [00:02:26] Here's the thing, Joe Gasper, Downey, COO of Montgomery technologies. Montgomery is, uh, got to two divisions to it. It's a riser management, which we call the old business.
That's 18 years old. And then we've got intelligent riser, which It's really the assessment design and installation of secure networks. In buildings, dedicated building networks. and that's the new business, which is actually now 10 years old. So it didn't sound so new.
James Dice: [00:02:52] Right. Right. And you go to the last episode of the podcast, we dove into that whole side of the, that whole business, really. so today we're going to talk a little bit about. Commercial real estate finance. you have strong opinions in this matter. And so I thought it'd be good to bring you on and let you share those strong opinions.
I want to share my strong opinion too. Begin with here. So, developing the nexus foundations course, introductory course on smart buildings. And this week happens to be the week where we're talking about making the business case for a smart building technology. And what I've found is that I'm very underwhelmed by not just the existing content out there on this topic.
Like. You know, there's a lot of blog posts, a lot of guys, a lot of reports on white papers. Here's how you make the business case for smart building technology. And I'm just very underwhelmed by it because I don't feel like people are talking about how in the real world, you could be trying to sell something.
You could be, you know, the internal champion, trying to get a project to move forward. You could be the one trying to create a program. Right for smart building technology in your portfolio. And what I've found is that you actually have to get really specific to make the business case. Right? You have to understand the business that you're in or the business that you're selling to.
And
Joe Gaspardone: [00:04:10] my problem
James Dice: [00:04:11] with everything I've seen is that it's, a lot of fluff.
Joe Gaspardone: [00:04:14] Yeah, it's,
James Dice: [00:04:14] it's just a ton of, not only marketing fluff, but also just like ROI fluff. Like the ROI has a lot of issues with it. The way it's calculated in most cases. So this conversation. It shouldn't then, because it requires specificity.
It depends on what business you're selling into or the business that you're
Joe Gaspardone: [00:04:32] talking about. So a lot of this conversation is
James Dice: [00:04:35] going to be focused on CRE. But I think this kind of mindset applies to whether you're selling to healthcare or retail or data centers or whatever you have to get to this level of specificity to be able to make the business case.
And so you have, Several
Joe Gaspardone: [00:04:52] lessons here that we're going
James Dice: [00:04:53] to kind of like, rapid fire through. And, I'll let you kind of lead the conversation and I'll interject questions as we go. So Florida, all yours.
Joe Gaspardone: [00:05:02] All right. Well, this is a, to me, this is like one of the ultimate high bars because, I can imagine so many people out there right now saying.
Really you're going to talk about finance. Like, no, no, yeah. Don't turn it off. How can you do that podcasts? It doesn't even seem possible. I need a spreadsheet. but know what we want to try to do is really just cover, you know, with broad brush strokes. We want to cover some of the basics of real estate finance and commercial real estate one Oh one, because this is to me always been, it's just amazing that this is how it has played out, but you know, in any other industry I've ever been in, when someone comes to sell you something.
They're selling you something, knowing what you do and how it will interface, interact with what you do. And this is the only industry I've ever been in where literally hundreds of people over the years will come in to sell something. And not even know, like the vocabulary of the people they're selling to.
And so two trains in the night, you know, you're saying something and they have no idea what you're talking about, but more importantly, you're not speaking their language. So you're telling them you're not an expert in their business. And so the goal of this is really to cover the basics around.
Vocabulary and meaning, because even if you walk away with like six things, you're going to be able to be far more effective when you communicate. And that's something. We put all our people, everybody in our organization goes through heavy intensive kind of practice vocabulary training, because once it's in here, you're able to use it and we can use it fluently without saying a single word.
You can tell somebody, I know, your business. I also. Understand what it is you have to do. So that's, the first thing. So we're going to talk about, um, a place I love to start is, something I've been like, pontificating about now for awhile, which is, you must know that this market is not, you know, the model that you created you're getting funded on is not CRE.
It's two markets and they're very different. And I, this is what I call them. I call them transactional and non-transactional lesson one is there are two markets transactional, and non-transactional transactional buildings are the buildings that are going to probably sell in the next three to seven years.
that's the vast majority. I call it a kind of a twist on the 80 20 rule. The 20 is the non-transactional buildings, the college campuses, the Amazon campuses, Microsoft campuses, these kinds of buildings that don't have the same bottom line value component.
so the 20, if you get in with the 20, you refine your, technology, you get the costs down to a point. Then you can enter the eighties. So it does, fit the sort of idea of the 80 20 rule, but it's just sort of twisted a little bit. And so the transactional side of the business is the majority component.
And that is not where you start with technology. That's me, my opinion speaking. But I mean, you'd be crazy to try to start on the transaction side because every dollar has a 15 to 20. Multiplier on it in terms of the cost sensitivity. So why would you ever start? You wouldn't, start there because it's too hard when you're developing something, you got to get it to scale first and then bring the cost down and then come into the cost sensitive side.
So a lot of people out there that I've talked to through nexus, lot of the solutions I've heard on the podcast are super smart. They're going right to that part of the business. And they're going, I'm going to go and I'm going to get this right. And it's going to be with people who are willing to walk this road with me and don't have to have every dollar come out in a net operating income fashion.
They don't have the same sensitivity and the other place to go. And a lot of smart people are going there to is New York because new York's got the climate mobilization act. And in 2023, which is right around the corner, they're going to either have to start writing checks. Or they're going to have to start implementing these solutions.
So those are your two markets where, you can go and there's going to be less cost sensitivity for different reasons. And that only a teeny tiny slice of the bigger market. And so if their business case doesn't tell the story that is really going to be like five years before you can really enter the big part of the market, then that's where the there's a lot of finessing going on there. Got it.
James Dice: [00:09:48] And if I'm trying to wrap my head around this concept, how do I figure out whether a given real estate organization is in either bucket?
Joe Gaspardone: [00:09:57] Yeah. Great question. the ownership really rules the routes, right? So if the ownership of a building is Microsoft, then you don't have that.
If the ownership is a college campus of the owners, the college, you don't have that. So ownership drives that if the ownership is a teacher's union, you have a very cost sensitive building, you know, any kind of investor relationship. Is going to mean you're you're right in the, the transactional side.
And every dollar has a, significance in terms of value. there are exceptions and I'm sure people will point that out. You know, you get long-term ownership. They're not looking to sell those exists. It's just that they're a minority of the business. So in this big, broad brush stroke world, 80 20 rule start at the 20, make your way to the 80.
After you've gotten scaled.
James Dice: [00:10:47] Got it. Got it. All right. Cool. Great.
Joe Gaspardone: [00:10:49] Let's keep going. Yeah. So my third lesson that was second lesson is, you know, start there. Third lesson is, I'm going to prove that the 80% is transactional because the rest of all of these lessons are going to be about the transactional side.
That is less than three. Everything else we cover here. Is going to be, based on transactional business. So the non transaction is not included in the rest of this. So the next one. Cap rate. It's the least used most important term in the technology space, because a lot of people just don't understand exactly what it means.
You've referenced it
James Dice: [00:11:28] already here. Uh, you almost can't help yourself before you explained it. You already referenced
Joe Gaspardone: [00:11:33] it. I didn't even realize it. I just, I can't help it because it's like every building. The first question out of, if you're looking at acquiring a building, it's like, well, what's the cap rate because it gives you an instant barometer benchmark of what you're talking about.
I know if something is a five cap, I know that it's like a super solid building. It's not going to have a huge return, but it's like, that's a strong building. I know an eight cap has got something wrong. There's hair. In there somewhere. Um, maybe it's vacant. You need a value add, maybe there's, you know, there's there.
The cap rate is this instant barometer that gives you a quick understanding, the lower, the cap rate, essentially the better the bill, location, quality, whatever is driving that. And what it means is what the cap rate is. Is just this it's the net spendable income. So you got income, you've got expenses.
You've got this number before you pay debt before you pay interest. So it's the net, operating income pre debt payments. So that basically tells you I've got this amount of money after expenses and rent expenses. And this is what it is. It's that number divided by the purchase price by the price of the building.
So it's telling you, you know, if you've got a big. Net operating income and a small purchase price. Well, the first thing he says, well, why am I getting such a good deal? Right. That's the idea, this is the relationship. And then the reverse of that is because I've got a little teeny amount and this really big purchase price.
I'm like, why is it so small? Oh, because it's classic and it's right on public transportation. The walk score is 99. You know, that's what. so the cap rate is, not being able to use that in a sales pitch is a mistake, because when you can say that word and throw it in you're able to tell the receiving audience, I know your business.
Because that's just the thing that gets thrown around all the time. Now, the other piece of it, and the dark side of the sort of cap rate is, it creates, it is really the barometer of the sensitivity of that building. So, if you think about it, it's a percentage, right?
If I have $5,000 as the net income and I have a hundred thousand dollars as the purchase price, that's a 5% relationship. But what it really means in our world in technology is. That every dollar, then I'm asking that person to spend, that's going to come out of net operating income. You're going to reduce it is going to affect value by 20 times that dollar 20.
Okay. So if I reduce $1 out of that NOI 5,000, it's 49, 99, I've literally just affected the value of the building by $20. So now if you have that sitting up here, all of a sudden you're like, Hey, the solution is just 10 grand a month. It's like, Oh no, no, no, no, no, no, no. 10 grand for the year, which is 120.
And then you got to multiply by 20. So you're talking two and a half million dollars of value. So now you're asking me to give up. A financeable two and a half billion dollars for your solution. Now, how does that sound when you realize what the audience is doing in their mind, that's just critical, critical.
You, have to have a way to think of that, talk to it, address it in some way, you know, and it can't be like, Oh, we're going to increase the value of your building. Well, that's, that's, that's not a thing. You can't just say that. Right.
James Dice: [00:15:22] And I see a lot of this pop up with like, say a smart building software solution.
They might say it's 10 cents a square foot. Right. So when you, when you hear me say 10 cents a square foot for your SAS fee, What do you think about?
Joe Gaspardone: [00:15:34] I'm like, Oh, here you go. You're right over here with all these guys, the software guys, they have no idea what they're saying. That's never proven true.
I can't quantify that. it's just like, that is the soft stuff. They'll get you put on this list over here, like a thousand vendors that are all trying to sell. These buildings have mid-sized company spent, you know, every year. So you know how many people are selling them solutions every conceivable time.
So the first thing you want to do is not be put over there. And the way you don't get put over there is you, speak to these things, Even if they don't, help sell directly, they are helping sell directly because they're letting the person know. I understand your business.
I'm not going to sell you 10 cents a square foot. Cause that's not really a thing. it hasn't been proven out and, industry doesn't see that that way, so. Hmm.
James Dice: [00:16:25] Okay,
Joe Gaspardone: [00:16:25] cool. so let's see. Yeah, I think it would be like less than five maybe. so that The piece that we've talked to all around that, go back, write it on paper, if you have to, but like really understand that because it's, it's just so fundamental the next step of that. I always call this, the how to get rich quick in real estate stuff is leverage the power of leverage. So if I don't have a loan on a building and I have, let's take the simple numbers of, I get $5,000 a year. On a hundred thousand dollars. That's like if I had my a hundred thousand in the bank, I'd be getting 5%, which is $5,000 coming in.
Okay. But what if I don't have a hundred thousand dollars in, what if I only have $30,000 in and I pay a loan payment on that 70. Right. So now I only have 30,000 in this. And my $5,000 drops, it drops to like three, but what did that just do? I only have 30 grand in, and now I'm getting $3,000 a month.
That's a 10% return. I literally doubled that by getting the loan structure in place. So power of leverage is if you get it right, you can really boost your returns and not be like hung over your skis and lose everything if the market turns, but that's the boom and bust of leverage.
That's why you see, you know, people getting rich quick and real estate and losing everything in real estate, because it always goes back to leverage the people who are leveraged. Right. They beat the market. They have a good path for long-term success. The people who, you know, push the envelope and put 10% down and it looks like, Oh my God, I'm getting 25% on my money.
Well, when the market sours, and if they have to refinance or they're, stuck, they have to sell, they lose everything. So that's the bus side of it is the less you have in the more subjected you are to the cycle, the market cycle. So you can, lose everything. Um,
James Dice: [00:18:32] and how do I figure out where the building owner is in that process?
Cause that that needs to affect how I'm proposing.
Joe Gaspardone: [00:18:40] Totally totally can affect, how you're proposing. if it's a transactional building, you're going to have leveraged. That is always, I mean, almost always except for long ownership, but these buildings that sell every three to seven years, they're always within a 50 to 70% debt to equity ratio, always.
And most often it's even tighter. It's like, 60 to 70. So they're putting enough in where they can outlast any kind of market cycle, but they're not, you know, going out and getting a second loan to get really high up in the leverage stack. You don't want that. And it just becomes big risk.
So the generally accepted debt to equity. As a start point when you buy a building, it's usually 60 to 70% is in that window. Okay. So the boom cycle is, Hey, if I got in with 10% and I added over time, you know, $10 million of value. And I only had a million dollars in, well, I just literally exponentially grew.
And when I exit, I made 10 X my money. So that's the, the boom side of the leverage equation.
James Dice: [00:19:45] Got it. Okay.
Joe Gaspardone: [00:19:46] The, um, the next piece of this. So we talked about sort of cash on cash return, right? Right. So you've got a hundred thousand dollars in something you're getting five grants, 5%, not particularly exciting, but then we can talk about the appreciation aspect over time of a building.
So. If I have, that a hundred thousand and five years later rents have gone up. And all of a sudden that a hundred thousand is worth, you know, 150 or 170,000 while when you sell that building, that's a real factor of your return. That's a 70 grand, a 70% over five years. So you have this additional aspect of the return, which is appreciation of the asset, which is why.
Some buildings are willing to invest in technology and leverage, raise the profile, get Google in as a tenant. And you've just made a fortune on that building when you have Google as a tenant, you're the gold standard. And before, when you had, you know, such and such finance or insurance company, you're, you're not that you've been incredibly enhanced the building when you pull somebody like that.
So, technology can. Directly benefit the building Google's requirements. Now we, deal with them a lot. And when they're taking six floors of a building, they have all kinds of requirements for control over BMS in their, space. lots of fancy bells and whistles. And a big one is security.
they have security, requirements that extend out of the building out into the common areas. it's a huge piece of, sort of what they require when they go in. So, there are ways to do it and to bring in, you know, uh, real credit like that. but when we go back to the, idea of that return, you've got.
A second piece of the return, you know, really it's the third piece. You've got the cash on cash return, like the bank return, then you've got the appreciation return. There's another one. And this is really the cherry on top and why people always see these guys who've been in real estate for 20 years and they're worth like millions of dollars and they don't seem to really done a lot.
And this is really why every building, if you just take a $10 million building. 75% of that 10 million is what they call the asset value. The depreciable, asset value. So $750,000 is going to get chopped up over 39 years. This is the IRS rules. And that number is a direct write-off to your income every single year.
So suddenly my 5% return in the case that you know, that I laid out on this sort of simple spreadsheet, my 5% is not 5% at all. It's eight and a half percent. So it's had a three and a half percent bump or like the other world has gone up like 60% because I have this depreciation that is allowing me.
To shelter, you know, if your tax rate's 40%, you're literally getting 40% more money than you otherwise would have. So, that depreciation aspect of real estate is why buildings sell on a regular basis because after a period of time, People want to trade up and get a higher level of return and depreciation.
And the way the tax laws are structured, you always have to buy equal to or greater than. So there's this constant trading up the chain. It's why you see like, recently, in San Francisco, we saw this, cool building that work with, The entity traded out of that and then just bought a massive Amazon tower, with that equity and they reset their depreciation schedule and they've got this massive new number.
And now with Amazon revenue, they can shelter a huge piece of that, bottom line revenue. So. When you factor in the cash on cash return with the depreciation return, the sheltered income, the after tax equivalent, right? And then you add in the appreciation, like some kind of straight line appreciation of value.
It's very common for these buildings to easily get into high. double digits. if times are good or low double digits in normal times, I mean, 18% that really happens a lot in boom times 40%. Absolutely. I mean, people, in this last run-up have made an incredible amounts of money.
And they often have hard time to find, what to buy next because the market for a long time was so hot so That's really what I probably would call big picture of the ROI, because all three of those are components and they lead to an ROI that's really a lot higher than people realize.
Wow. Okay. I know that was a lot, sorry.
James Dice: [00:24:37] No, no, no. Don't say, sorry. Is that all
Joe Gaspardone: [00:24:40] the lessons, your phone number? I got one more for ya. or
James Dice: [00:24:44] really just a bunch of questions, but I'll let you get through your,
Joe Gaspardone: [00:24:46] I'll hit you with this one. And this is what I call the dark side of cam charges.
Um, a lot of people, when you Google, you know, camp char the buzz word is split incentives, right? Because you've got. the building, who's passing their costs to the tenant. Yeah. And from a purely financial Angela's standpoint, that seems like a fine set up. Like you occupy this much space, You're going to pay this much of the total. It all works out it's great. But now we're seeing that dark side and that is that the building really does not have an incentive. To upgrade to put some metering and you know, really only New York has a full fledged system when there's a TEI, the sub-metering is commissioned for that space and it gets put in as part of the TEI.
And that's really the only place that they do that like lock step with anything that gets added. but yeah, the rest of the market's like, well, why would I ever spend, a half a million dollars doing that? I'm already recouping my pro-rata. Nobody's asking me to, and nobody's making me, so the dark side of that, that Dan cam charge is the fact that there's no incentive for the building.
Altruism alone, is not going to do it. Right. Um, the betterment of the world is just not going to do it. So I think we're looking at as high as Monday. I hate to say it. I just think we're, we're looking at a world where until legislatively. You got to get off your butt and do it. I just, I can't see really how that happens otherwise, because these goals are just so not in alignment.
so that's
James Dice: [00:26:21] the dark. Yeah. And it shows up with energy efficiency, all the time. Like why would the tenant care. When, if they're going to pay for some sort of energy efficiency improvement, it just barely benefits them, benefits the whole building.
Right. But they're paying for, right. So there's all these types of. I mean energy engineers, call them split instead of do you think that's a bad word, uh, for, for the real estate industry?
Joe Gaspardone: [00:26:44] Here's what I would say about it. if you were talking to anybody on the operation side and you said split incentives, they'd either politely nod their head and not know what you're talking about, or they might know what you're talking about, but then they say, say, this guy doesn't even understand what I'm taught in my business.
Well, what does Kam stand for? My business is cam charges, common area maintenance charges. That's what my world is. Every year I have to scoop up all of those charges for everything that's related. I have to amortize some CapEx. And push that into the complex spreadsheet that I have to reconcile and then give each tenant their detailed reconciliation of what they paid versus what actually was, uh, incurred.
So that, that is the cam charge world. The split incentives kind of describes the problem and that's an app description, but if you're in any meeting and you say the word splitting sentence to better be a meeting of tech people.
James Dice: [00:27:43] Okay. Got it. All right. Yeah. The terminology is super important. There's a ton of terms that we could maybe hit at the end.
Joe Gaspardone: [00:27:51] Yeah. Maybe we come up with a glossary at some point you can pass it out. Cool. Um, last thing and we kind of touched on it, so I'll keep it super short. But, uh, the last lesson is for 80% or more of the market value. The overriding principle of value is the net income. Um, and, and in some cases, really the net spendable.
So after I pay my debt, what's left after that the net income or net spendable numbers relative to the amount of money I've invested in this building those two, that relationship or the purchase price is another way of saying it. So I'm going to sell this building in seven years. So if I sign up for a long-term solution, that's going to cost me recurring dollars.
I have to be thinking about that. if I'm going to lose $5 million of value, I have to think about how am I going to get that back? Because I'm going to sell this building in five years. I can't just give it up because that's a real $5 million. Right? So, that the fundamental principle of value is, it's predicated on the fact that I'm going to exit this.
Deal at some point in the relative near future. And therefore I must understand what I'm spending and why, and whether I'm going to get it back before I sell. So
James Dice: [00:29:11] that requires you to trace the, so a lot of times people have spreadsheets. I know you have one just to illustrate this, but you're tracing your operating expenses through, to your net operating income.
And then from that to. Using your cap rate to your, the value of the the building.
Joe Gaspardone: [00:29:29] Good. That's what the next guy is going to use to look at it and analyze it and then finance it and leave it. This is a great concept. Imagine if you could keep your expenses exactly flat for five years and your lease is all, have three or 4% increases in them.
That alone, just letting that play out and keeping this flat that generates like a 30 to 40% return over the five years. So you can imagine the tremendous pressure on a building to flatten that expensive side out because. The lease rates are going up, the financing is fixed rate. So there's only thing that's changing is, if you have, I can keep these expenses as flat as possible.
I'm going to make a lot of money on this building. So that's the pressure. That's the uphill battle that we all face and the more we can connect real ROI, it has to be real, but it even can be at the margins real, like I'm going to save you a little on your insurance from leak detection, like it works and it's working, people are rolling that out across the country.
you just have to find that strategy, you know, the BMS has got a great model for that, but you've got the split incentive issue, the cam charge issue. And so that's, the battle that has to be fought. and that's the world we're in. I don't shoot the messenger. Just like that's the reality of those are the pressures facing the operational side.
James Dice: [00:30:50] Got it. and now that we have sort of like laid out these lessons, let's bring it down to the ground for the technology companies out there. So I want to start with. just like defining NOI. So I'm continually amazed by how many people haven't heard of this term, net operating income.
Can you like, put it back into the context of these lessons?
Joe Gaspardone: [00:31:12] God, it's so true. I mean, and that's the thing, right? There are probably 20 and you don't want to like kill everybody in one podcast, but that's why these terms and knowing them and being able to fluidly use them so important.
so net operating income, then really two, one is really simple. It's the revenue of the building. Minus the expenses of the building, not including like cap CapEx one-time expenses, it's really looking at what is the recurring revenue of the building minus the recurring expenses of the building that is the baseline NOI pre debt pre debt.
So then the second version of NOI is now I made interest payments. So I'm going to throw those interest payments in as a line. And I'm going to look at my. Net operating income, inclusive of debt. And so very often people are looking at both of those for different reasons, because obviously financing can be a factor that, you know, if I can get a better rate than you can, I'm going to pay more for that building.
Right. So that affects the value. Right. So you've got NOI pre debt and then NOI NOI, which is sort of including the interest payments on the debt. Yeah. That's net operating income. So when you say those words, you can know in your head, it's just revenue minus expenses at the fundamental level. Debt is really an expense, right?
So you're paying that. So it's just revenue minus expenses. That's net operating income.
James Dice: [00:32:39] And, and what I've heard from you before is one of the ways that companies mess up is they might say we're going to increase your rent revenue. Right. And, how is that like a, no-no in your mind?
Joe Gaspardone: [00:32:50] Yeah. So you would have to, you know,
James Dice: [00:32:53] is that what increased the NLI?
That would be one of the ways to create value.
Joe Gaspardone: [00:32:56] Totally. And look, when we're selling strategies to the transactional market, you must dress. Increasing revenue or decreasing expenses. Somehow it cannot be left in the tenant's satisfaction realm, because it's just not enough to move it forward.
so yes. if you ever say we're going to to create your revenue or your, rent per square foot by X. I've yet to see somebody. Throw a like bonafide way they do that. it tends to get very soft and squishy very fast. And you, if you could be in my head and see the hundreds of presentations where people said, they're going to increase my, rent per square foot by a dollar 50, $2 30 cents.
it's like, you know, my rent per square foot would be like, $5,000 a month now. Yeah. Or $5,000 a square foot. So, I would stay away from that because it really doesn't have a provable metric behind it. And it puts you in the long list of others who have gone down that road. If you've got a way that actually, you know, the expense side, it's a lot easier for people to prove out.
Right. I, if I have a utility bill and there's my baseline. And I see it go down year over year. That's real. I can quantify that. If you're telling me I'm going to take these six internet circuits and make it to, I can quantify that. So there are ways you can get your solution in. Um, you know, we talked about leak detection.
If you tell me I'm going to get, uh, 5% reduction on my insurance premium by putting this solution in. And I go and verify that with my insurance company. Door's open. Right? So finding the way It's very difficult on that side of the
James Dice: [00:34:39] business. You mentioned tenant experience.
That leads me into my next question. So I'm reading the book, healthy buildings right now, which is like a very popular book to be reading right now during the time of the coronavirus. it's almost like a little, uh, scary how they released it, like right before the pandemic, it a little bit scary. but, so.
This ties into sort of JLLs three 30, 300 rule where the 300 bucket is basically saying like the main cost of a business is the salaries paid to, um, employees, which are the tenants of office buildings. Right. So how do you think about, when people make ROI claims around that, 300 bucket, which is.
A little bit fluffy.
Joe Gaspardone: [00:35:21] Right. I, I really do feel badly saying it, but people need to know like if anybody is on the operational side and you're pushing that, it's just not a good place to go. it can be true fundamentally. but it just doesn't translate in real dollars and cents the way that everybody on the operational success thinks it's about that piece of it.
So I'll give you a good example. and it ties into your healthy billings book. So, th there's a way of, buildings are out there. Owner ownership, management companies are trying to find, you know, healthy. Building solutions so that people can come back.
That's there's a giant wave of this. It's about to get funded across the country. So everybody's looking at technologies and what are they doing? again, don't shoot the messenger, but we're, living it. They're solving for the lowest requirement. So they're not trying to do it holistically by and large.
I know there are exceptions, please. Don't pepper me with them. I know, but I'm just talking about like the 80 or 90% of the market. They find a plasma solution that can be put on each air handler it's $15,000 per air handler. And it's, whatever times 20. So we're looking at $300,000 solution.
That's it done? We've got a healthy building. We're going to tell everybody that we've done it. It meets all the requirements that the city and County have laid out and.
James Dice: [00:36:48] Done
Joe Gaspardone: [00:36:48] done or you've been wired. We got a UV lighting. It's going to cost this much per it goes here and okay. It's a $200,000 solution checks all the boxes.
Yeah, that's I, you know, that's what's happening, so it's not ideal.
James Dice: [00:37:07] Wow,
Well, I think back on the three 3,300, I think where it breaks down is like the 300 is talking about the tenant, right. And the tenants business. Right. And making the tenants business. Revenue higher,
Joe Gaspardone: [00:37:23] but where it gets
James Dice: [00:37:24] stuck is like there's two different stakeholders here.
Joe Gaspardone: [00:37:27] And, and let me tell you how that came across. this is one of the well-known institutional investors. I just talked to him in this last week. And when we were talking about this, his response was. The tenant space is the tenant space. It's their premises. They pay for that. you know, whatever they're going to install is going to be their solution for their space.
My responsibility is this common area space and anything I'm delivering I E air quality into the town and space. And so my responsibilities are here and I had a hard time arguing. I mean, at the fundamental level, it's not ideal. but that is really how these leases are written. So it's a very, God, I don't want to say disheartening, but it's, it's like, you're left with if you know, health scanners and touchless tech is coming in, so you don't have to fit elevators.
So all of those to some degree are being explored and will be implemented, but, it's a little bit of a bummer that there's not a, bigger awareness as to, Hey, what can be done here more holistically?
James Dice: [00:38:33] And from all the lessons we've laid out here, what is this plasma, you know, bandaid basically, what is that a symptom of which one of the lessons what's causing the, the owner to do
Joe Gaspardone: [00:38:44] it's right.
It goes right back to cap rate. I mean, it is a one-time cost, so you can kind of write it off as that. But all of those have some recurring component to them, you know, everything does now. Right. So, the plasma solution on the air handler will.
make clean, healthy air at a standard that meets or exceeds the requirements. but it's just, that's the solution for this problem. And therefore I met that and I've built in whatever little additional costs over time is going to be plugged in there. And so my value is preserved and that's the bummer because you would like them to we'll say.
Well, actually just do this a little bit more, but then as soon as you do that, you're like, well, I just gave up $2 million of value. When I sell this in three years, you just are having me write a check for $2 million out of my pocket. Cause that was real money that I gave up. So that's the battle.
That's the battle. it's the ultimate struggle, the encouraging thing people out there I promise you is if you crack this, you're good. You're good for the long, long haul. Once you're in. It's almost like an annuity. You'll be there forever if you don't mess it up. So that's the great side of coming through the tunnel is once you come through that tunnel, you can do it and you will do it.
And people will come to this cheap will follow and they will all come to you. So it's just cracking. That one is tough. So
James Dice: [00:40:09] I got two more questions we want these lessons to be kind of long-term lessons, but while we're on the COVID, uh, you see a lot of announcements, on, you know, Deloitte is, reducing their offices. So how does that then hit. the landlord's business. And how do you recommend people start to talk to their landlords then when they have, these decreasing tenancy going on
Joe Gaspardone: [00:40:31] the reason, the fundamental reason why buildings are going to spend money. Period is twofold.
It's to get the building to a healthy standard, but it's also, and the main driver and everybody's experiencing this, moment of, terror is that, that what if they don't come back? so money is having to be spent in ways to make that space. Healthy and message healthiness and comfort.
So that is an opportunity. I mean, the opportunity is there and the money is going to be spent, whether it's going to be spent the way we would love it to be spent or not, it's really almost secondary. The money is going to get spent because it has to be spent because this is a sort of one-time shot to make people feel comfortable to come back to the office.
And if you believe that there's, one or more vaccines coming, and that, that gets distributed through the spring and then people kind of feel like, Oh, okay. And then the summer sort of bumps along, maybe occupancy rates rise a little bit. And then I would say by August of next year, for sure.
Like when school starts. Parents are going to be like, well, that's it, that's it. I got to go back, but how they go back and how often is really where the buildings are right now? How do I entice them you know, without breaking the bank? what can I do and say, and message to bring those people back.
But I will predict it. I I'm going to predict that by August of next year. we're back to 80 to 90% occupancy. If, you know, if we had a baseline at what existed pre. COVID, there'll be about 10%, 15% that are going to do a longer-term experiment with, work from home and rotating.
And, but I think people have short memories and you know, when things sort of settle back in and a few months have passed and they can go back and feel comfortable. I think that's probably gonna happen in math.
James Dice: [00:42:25] Got it. Okay. A lot, actually I have two more questions. So one of them is around, um, I think a lot of these transactional buildings, people will, when they, when they go in and they start to make the business case, they'll also going to run into someone besides the owner, which is the property manager.
so JLL, Cushman, Wakefield, CVRE, you know, whoever else. A bunch of different companies around the world. How do they sort of play into this? without a whole nother set of lessons?
Joe Gaspardone: [00:42:51] Yeah. No, you know, another really hard aspect to a sale, you know, everybody always jokes about the 18 month sales cycle or three-year sales cycle.
And that is real that's why you have to have hundreds more prospects in the pipeline than you would in another industry because they fall, it's such a longer timeline. And one of the reasons for it is different people in different organizations have.
basically veto power. It's a very dis-aggregated decision tree. So you could have, like, we talked about CTOs will have kind of position, but a lot of times that position is to stamp and approval on a plan. But then the property manager has ultimate veto and they don't have the money. And so they're not going to spend it and they're going to kick it to the next budget cycle, the next budget cycle.
So you've got that. You've got asset managers looking over this small portfolio and saying, I can't, it's hard to make a use case for that and so they have the potential to slow it down or try it on a building or two. And then you've got layers that a lot of people don't know exist, but they're like regional it managers and a lot of these larger companies and they can help push stuff along if they're on board with what you're doing.
But again, they don't really have budgets to, say we're doing this for this amount of money, ultimately. the property manager has an outsized influence, too many decisions, many, many, many tech decisions. and unfortunately, a lot of them are not familiar with what the tech decisions are. They write RFPs, they get three responses and they're just looking at price on most of the time because they don't really understand the differences of those.
So that's a real aspect on this side of the. Equation is sort of the outsized influence the property manager has. And sometimes the chief engineer, you know, those the chief engineer does have a budget and they do spend it on technology. So, you've got this sort of very, dis-aggregated decision-making and finding, discovering each organization's real.
Decision tree. And what can really be accomplished is again like a first step when you're getting into a sale and not to be discouraged by it, but just to learn about it and figure it out. That's that's what I would
James Dice: [00:45:12] purchase. That's a big one. The foundations courses, the mapping out the stakeholders. So last question, thank you for kind of going a little bit longer today.
So last question, um, this trend of all of these corporations making, and REITs making. long-term climate change commitments and then the movement towards requiring, certain ESG standards. How does that sort of play into all of this, and trickle down to say an individual building or portfolio?
Joe Gaspardone: [00:45:45] it's ultimately it's super positive because, you are going to have to at one point or another address, the deployment of these solutions across the board to achieve. Those goals, like it's gonna have to happen. you know, the, skepticism and the skeptic in me says, well, if it follows history, it's going to get kicked and kicked and kicked until, you know, The timeline gets extended, or they just have to slam something home to meet the need.
And, again, it doesn't really, it blossom the way that you would want it to. Um, you know, the, the optimist in me pushing back is saying what's different from the past is you really do have hundreds of people that are talented. Lot of them venture backed, um, better capitalization with better targeting and understanding of what they're going after much, much better than we ever have, but the underlying talent pool.
It's still small, but it's much, much stronger. And I do think that, the opportunity to deliver and meet those timelines and actually kind of help it along in maybe fits and starts, but to get there, I do think it's the first time I can say, like, it can be done. if you'd asked me like 10 years ago, I'd say there's no, there's no possible way.
Right, right. That's exciting. That's exciting. Yeah,
James Dice: [00:47:06] it does feel like there's quite a bit of momentum in that area,
Joe Gaspardone: [00:47:08] which
James Dice: [00:47:10] there's a lot of bad news to happening. So you don't want to get too excited, but it's definitely a good time to be in this, in this world. So. All right, Joel, I learned a lot. Thanks so much and, uh, anyone can reach out to, Joe to, learn more, I guess. So thanks a lot, Joe. And talk to you later.
Alright, friends. Thanks for listening to this episode of the Nexus podcast. For more episodes like this and to get the weekly Nexus newsletter, please subscribe at nexus.substack.com. You can find the show notes for this conversation there as well. As always, please reach out on LinkedIn with any thoughts on this episode.
I'd love to hear from you. Have a great day
Happy Thursday!
Welcome to this week’s deep dive exclusively for Nexus Pro members. It’s an honor to have you here. This deep dive is a follow up to my recent podcast conversation with Joe Gaspardone, COO at Montgomery Technologies. I learned a lot from this conversation and want to share my takeaways and the full transcript with you below.
In case you missed it in your inbox, you can find the audio or video here:
Nexus site | Apple Podcasts | Spotify | YouTube | Add to other podcast apps
Enjoy!
—James
I’m excited to put this episode out there because I think it will be helpful for getting smart building tech approved in organizations across the world. I think we as a smart buildings industry can improve on the rigor we apply to making the business case for the new technology we believe so heavily in. If we’re going to make others believe in it too, especially our financial stakeholders, we need to remove the fluff from our return on investment calculations. Fluffy ROI is mostly caused by not doing the work to put the tangible benefits of the technology in the correct model and terminology.
Not just CRE either—these same insights can also be applied to other industries. A simple framework for doing this work for any industry is to walk through these questions:
My highlights:
What did you think?
Note: transcript was created using an imperfect machine learning tool and lightly edited by a human (so you can get the gist). Please forgive errors!
James Dice: [00:00:00] Hello, friends. Welcome to Nexus, a smart buildings technology podcast for smart humans. I'm your host, James Dice. If we haven't met before, I write a weekly newsletter on the same topic. It's also called Nexus. Each week I share what I've learned, my opinions, and what I'm excited about in the quickly evolving world of intelligent buildings. Readers have called Nexus the best way to stay up to date on the future of this industry without all the marketing fluff. You can check it out and subscribe at nexus.substack.com or click the link in the show notes.
Since starting the Nexus newsletter, many of you have reached out to me wanting to talk shop, and we have. After a few weeks of those wonderful conversations, I realized I needed to record and share them with our growing community. So here we are. The Nexus podcast is born. This is our chance to explore and learn with the brightest in our industry together.
All right. Episode 28 is another conversation with Joe Gaspar, Doni COO of Montgomery technologies. This time, Joe and I dove deep into commercial real estate finance one Oh one. Before you think that doesn't apply to you and turn off the episode? Let me tell you, I think you're probably wrong about that.
If you're interested in smart buildings, the business case for that solution or technology needs to be made at some point. And this episode was show you what it takes to actually do that for one type of building the commercial office This episode of the podcast is brought to you by nexus pro nexus pro is an annual or monthly subscription where members get exclusive writing podcasts and an invite to a monthly members only event.
You can find info on how to join and support the podcast@nexusdotsubstack.com. This episode is also brought to you by nexus foundations, an introductory course on smart buildings. If you're new to the industry, this course is for you. If you're an industry vet, but want to understand how technology is changing things.
This course is also for you. Cohort two is set to kick off in winter 2021, and you can enroll@courses.nexus labs.online without further ado, please enjoy this episode of the nexus podcast.
All right, Joe. Welcome back to the show. in case anyone didn't listen to the last episode, can you go ahead and introduce yourself one last time?
Joe Gaspardone: [00:02:26] Here's the thing, Joe Gasper, Downey, COO of Montgomery technologies. Montgomery is, uh, got to two divisions to it. It's a riser management, which we call the old business.
That's 18 years old. And then we've got intelligent riser, which It's really the assessment design and installation of secure networks. In buildings, dedicated building networks. and that's the new business, which is actually now 10 years old. So it didn't sound so new.
James Dice: [00:02:52] Right. Right. And you go to the last episode of the podcast, we dove into that whole side of the, that whole business, really. so today we're going to talk a little bit about. Commercial real estate finance. you have strong opinions in this matter. And so I thought it'd be good to bring you on and let you share those strong opinions.
I want to share my strong opinion too. Begin with here. So, developing the nexus foundations course, introductory course on smart buildings. And this week happens to be the week where we're talking about making the business case for a smart building technology. And what I've found is that I'm very underwhelmed by not just the existing content out there on this topic.
Like. You know, there's a lot of blog posts, a lot of guys, a lot of reports on white papers. Here's how you make the business case for smart building technology. And I'm just very underwhelmed by it because I don't feel like people are talking about how in the real world, you could be trying to sell something.
You could be, you know, the internal champion, trying to get a project to move forward. You could be the one trying to create a program. Right for smart building technology in your portfolio. And what I've found is that you actually have to get really specific to make the business case. Right? You have to understand the business that you're in or the business that you're selling to.
And
Joe Gaspardone: [00:04:10] my problem
James Dice: [00:04:11] with everything I've seen is that it's, a lot of fluff.
Joe Gaspardone: [00:04:14] Yeah, it's,
James Dice: [00:04:14] it's just a ton of, not only marketing fluff, but also just like ROI fluff. Like the ROI has a lot of issues with it. The way it's calculated in most cases. So this conversation. It shouldn't then, because it requires specificity.
It depends on what business you're selling into or the business that you're
Joe Gaspardone: [00:04:32] talking about. So a lot of this conversation is
James Dice: [00:04:35] going to be focused on CRE. But I think this kind of mindset applies to whether you're selling to healthcare or retail or data centers or whatever you have to get to this level of specificity to be able to make the business case.
And so you have, Several
Joe Gaspardone: [00:04:52] lessons here that we're going
James Dice: [00:04:53] to kind of like, rapid fire through. And, I'll let you kind of lead the conversation and I'll interject questions as we go. So Florida, all yours.
Joe Gaspardone: [00:05:02] All right. Well, this is a, to me, this is like one of the ultimate high bars because, I can imagine so many people out there right now saying.
Really you're going to talk about finance. Like, no, no, yeah. Don't turn it off. How can you do that podcasts? It doesn't even seem possible. I need a spreadsheet. but know what we want to try to do is really just cover, you know, with broad brush strokes. We want to cover some of the basics of real estate finance and commercial real estate one Oh one, because this is to me always been, it's just amazing that this is how it has played out, but you know, in any other industry I've ever been in, when someone comes to sell you something.
They're selling you something, knowing what you do and how it will interface, interact with what you do. And this is the only industry I've ever been in where literally hundreds of people over the years will come in to sell something. And not even know, like the vocabulary of the people they're selling to.
And so two trains in the night, you know, you're saying something and they have no idea what you're talking about, but more importantly, you're not speaking their language. So you're telling them you're not an expert in their business. And so the goal of this is really to cover the basics around.
Vocabulary and meaning, because even if you walk away with like six things, you're going to be able to be far more effective when you communicate. And that's something. We put all our people, everybody in our organization goes through heavy intensive kind of practice vocabulary training, because once it's in here, you're able to use it and we can use it fluently without saying a single word.
You can tell somebody, I know, your business. I also. Understand what it is you have to do. So that's, the first thing. So we're going to talk about, um, a place I love to start is, something I've been like, pontificating about now for awhile, which is, you must know that this market is not, you know, the model that you created you're getting funded on is not CRE.
It's two markets and they're very different. And I, this is what I call them. I call them transactional and non-transactional lesson one is there are two markets transactional, and non-transactional transactional buildings are the buildings that are going to probably sell in the next three to seven years.
that's the vast majority. I call it a kind of a twist on the 80 20 rule. The 20 is the non-transactional buildings, the college campuses, the Amazon campuses, Microsoft campuses, these kinds of buildings that don't have the same bottom line value component.
so the 20, if you get in with the 20, you refine your, technology, you get the costs down to a point. Then you can enter the eighties. So it does, fit the sort of idea of the 80 20 rule, but it's just sort of twisted a little bit. And so the transactional side of the business is the majority component.
And that is not where you start with technology. That's me, my opinion speaking. But I mean, you'd be crazy to try to start on the transaction side because every dollar has a 15 to 20. Multiplier on it in terms of the cost sensitivity. So why would you ever start? You wouldn't, start there because it's too hard when you're developing something, you got to get it to scale first and then bring the cost down and then come into the cost sensitive side.
So a lot of people out there that I've talked to through nexus, lot of the solutions I've heard on the podcast are super smart. They're going right to that part of the business. And they're going, I'm going to go and I'm going to get this right. And it's going to be with people who are willing to walk this road with me and don't have to have every dollar come out in a net operating income fashion.
They don't have the same sensitivity and the other place to go. And a lot of smart people are going there to is New York because new York's got the climate mobilization act. And in 2023, which is right around the corner, they're going to either have to start writing checks. Or they're going to have to start implementing these solutions.
So those are your two markets where, you can go and there's going to be less cost sensitivity for different reasons. And that only a teeny tiny slice of the bigger market. And so if their business case doesn't tell the story that is really going to be like five years before you can really enter the big part of the market, then that's where the there's a lot of finessing going on there. Got it.
James Dice: [00:09:48] And if I'm trying to wrap my head around this concept, how do I figure out whether a given real estate organization is in either bucket?
Joe Gaspardone: [00:09:57] Yeah. Great question. the ownership really rules the routes, right? So if the ownership of a building is Microsoft, then you don't have that.
If the ownership is a college campus of the owners, the college, you don't have that. So ownership drives that if the ownership is a teacher's union, you have a very cost sensitive building, you know, any kind of investor relationship. Is going to mean you're you're right in the, the transactional side.
And every dollar has a, significance in terms of value. there are exceptions and I'm sure people will point that out. You know, you get long-term ownership. They're not looking to sell those exists. It's just that they're a minority of the business. So in this big, broad brush stroke world, 80 20 rule start at the 20, make your way to the 80.
After you've gotten scaled.
James Dice: [00:10:47] Got it. Got it. All right. Cool. Great.
Joe Gaspardone: [00:10:49] Let's keep going. Yeah. So my third lesson that was second lesson is, you know, start there. Third lesson is, I'm going to prove that the 80% is transactional because the rest of all of these lessons are going to be about the transactional side.
That is less than three. Everything else we cover here. Is going to be, based on transactional business. So the non transaction is not included in the rest of this. So the next one. Cap rate. It's the least used most important term in the technology space, because a lot of people just don't understand exactly what it means.
You've referenced it
James Dice: [00:11:28] already here. Uh, you almost can't help yourself before you explained it. You already referenced
Joe Gaspardone: [00:11:33] it. I didn't even realize it. I just, I can't help it because it's like every building. The first question out of, if you're looking at acquiring a building, it's like, well, what's the cap rate because it gives you an instant barometer benchmark of what you're talking about.
I know if something is a five cap, I know that it's like a super solid building. It's not going to have a huge return, but it's like, that's a strong building. I know an eight cap has got something wrong. There's hair. In there somewhere. Um, maybe it's vacant. You need a value add, maybe there's, you know, there's there.
The cap rate is this instant barometer that gives you a quick understanding, the lower, the cap rate, essentially the better the bill, location, quality, whatever is driving that. And what it means is what the cap rate is. Is just this it's the net spendable income. So you got income, you've got expenses.
You've got this number before you pay debt before you pay interest. So it's the net, operating income pre debt payments. So that basically tells you I've got this amount of money after expenses and rent expenses. And this is what it is. It's that number divided by the purchase price by the price of the building.
So it's telling you, you know, if you've got a big. Net operating income and a small purchase price. Well, the first thing he says, well, why am I getting such a good deal? Right. That's the idea, this is the relationship. And then the reverse of that is because I've got a little teeny amount and this really big purchase price.
I'm like, why is it so small? Oh, because it's classic and it's right on public transportation. The walk score is 99. You know, that's what. so the cap rate is, not being able to use that in a sales pitch is a mistake, because when you can say that word and throw it in you're able to tell the receiving audience, I know your business.
Because that's just the thing that gets thrown around all the time. Now, the other piece of it, and the dark side of the sort of cap rate is, it creates, it is really the barometer of the sensitivity of that building. So, if you think about it, it's a percentage, right?
If I have $5,000 as the net income and I have a hundred thousand dollars as the purchase price, that's a 5% relationship. But what it really means in our world in technology is. That every dollar, then I'm asking that person to spend, that's going to come out of net operating income. You're going to reduce it is going to affect value by 20 times that dollar 20.
Okay. So if I reduce $1 out of that NOI 5,000, it's 49, 99, I've literally just affected the value of the building by $20. So now if you have that sitting up here, all of a sudden you're like, Hey, the solution is just 10 grand a month. It's like, Oh no, no, no, no, no, no, no. 10 grand for the year, which is 120.
And then you got to multiply by 20. So you're talking two and a half million dollars of value. So now you're asking me to give up. A financeable two and a half billion dollars for your solution. Now, how does that sound when you realize what the audience is doing in their mind, that's just critical, critical.
You, have to have a way to think of that, talk to it, address it in some way, you know, and it can't be like, Oh, we're going to increase the value of your building. Well, that's, that's, that's not a thing. You can't just say that. Right.
James Dice: [00:15:22] And I see a lot of this pop up with like, say a smart building software solution.
They might say it's 10 cents a square foot. Right. So when you, when you hear me say 10 cents a square foot for your SAS fee, What do you think about?
Joe Gaspardone: [00:15:34] I'm like, Oh, here you go. You're right over here with all these guys, the software guys, they have no idea what they're saying. That's never proven true.
I can't quantify that. it's just like, that is the soft stuff. They'll get you put on this list over here, like a thousand vendors that are all trying to sell. These buildings have mid-sized company spent, you know, every year. So you know how many people are selling them solutions every conceivable time.
So the first thing you want to do is not be put over there. And the way you don't get put over there is you, speak to these things, Even if they don't, help sell directly, they are helping sell directly because they're letting the person know. I understand your business.
I'm not going to sell you 10 cents a square foot. Cause that's not really a thing. it hasn't been proven out and, industry doesn't see that that way, so. Hmm.
James Dice: [00:16:25] Okay,
Joe Gaspardone: [00:16:25] cool. so let's see. Yeah, I think it would be like less than five maybe. so that The piece that we've talked to all around that, go back, write it on paper, if you have to, but like really understand that because it's, it's just so fundamental the next step of that. I always call this, the how to get rich quick in real estate stuff is leverage the power of leverage. So if I don't have a loan on a building and I have, let's take the simple numbers of, I get $5,000 a year. On a hundred thousand dollars. That's like if I had my a hundred thousand in the bank, I'd be getting 5%, which is $5,000 coming in.
Okay. But what if I don't have a hundred thousand dollars in, what if I only have $30,000 in and I pay a loan payment on that 70. Right. So now I only have 30,000 in this. And my $5,000 drops, it drops to like three, but what did that just do? I only have 30 grand in, and now I'm getting $3,000 a month.
That's a 10% return. I literally doubled that by getting the loan structure in place. So power of leverage is if you get it right, you can really boost your returns and not be like hung over your skis and lose everything if the market turns, but that's the boom and bust of leverage.
That's why you see, you know, people getting rich quick and real estate and losing everything in real estate, because it always goes back to leverage the people who are leveraged. Right. They beat the market. They have a good path for long-term success. The people who, you know, push the envelope and put 10% down and it looks like, Oh my God, I'm getting 25% on my money.
Well, when the market sours, and if they have to refinance or they're, stuck, they have to sell, they lose everything. So that's the bus side of it is the less you have in the more subjected you are to the cycle, the market cycle. So you can, lose everything. Um,
James Dice: [00:18:32] and how do I figure out where the building owner is in that process?
Cause that that needs to affect how I'm proposing.
Joe Gaspardone: [00:18:40] Totally totally can affect, how you're proposing. if it's a transactional building, you're going to have leveraged. That is always, I mean, almost always except for long ownership, but these buildings that sell every three to seven years, they're always within a 50 to 70% debt to equity ratio, always.
And most often it's even tighter. It's like, 60 to 70. So they're putting enough in where they can outlast any kind of market cycle, but they're not, you know, going out and getting a second loan to get really high up in the leverage stack. You don't want that. And it just becomes big risk.
So the generally accepted debt to equity. As a start point when you buy a building, it's usually 60 to 70% is in that window. Okay. So the boom cycle is, Hey, if I got in with 10% and I added over time, you know, $10 million of value. And I only had a million dollars in, well, I just literally exponentially grew.
And when I exit, I made 10 X my money. So that's the, the boom side of the leverage equation.
James Dice: [00:19:45] Got it. Okay.
Joe Gaspardone: [00:19:46] The, um, the next piece of this. So we talked about sort of cash on cash return, right? Right. So you've got a hundred thousand dollars in something you're getting five grants, 5%, not particularly exciting, but then we can talk about the appreciation aspect over time of a building.
So. If I have, that a hundred thousand and five years later rents have gone up. And all of a sudden that a hundred thousand is worth, you know, 150 or 170,000 while when you sell that building, that's a real factor of your return. That's a 70 grand, a 70% over five years. So you have this additional aspect of the return, which is appreciation of the asset, which is why.
Some buildings are willing to invest in technology and leverage, raise the profile, get Google in as a tenant. And you've just made a fortune on that building when you have Google as a tenant, you're the gold standard. And before, when you had, you know, such and such finance or insurance company, you're, you're not that you've been incredibly enhanced the building when you pull somebody like that.
So, technology can. Directly benefit the building Google's requirements. Now we, deal with them a lot. And when they're taking six floors of a building, they have all kinds of requirements for control over BMS in their, space. lots of fancy bells and whistles. And a big one is security.
they have security, requirements that extend out of the building out into the common areas. it's a huge piece of, sort of what they require when they go in. So, there are ways to do it and to bring in, you know, uh, real credit like that. but when we go back to the, idea of that return, you've got.
A second piece of the return, you know, really it's the third piece. You've got the cash on cash return, like the bank return, then you've got the appreciation return. There's another one. And this is really the cherry on top and why people always see these guys who've been in real estate for 20 years and they're worth like millions of dollars and they don't seem to really done a lot.
And this is really why every building, if you just take a $10 million building. 75% of that 10 million is what they call the asset value. The depreciable, asset value. So $750,000 is going to get chopped up over 39 years. This is the IRS rules. And that number is a direct write-off to your income every single year.
So suddenly my 5% return in the case that you know, that I laid out on this sort of simple spreadsheet, my 5% is not 5% at all. It's eight and a half percent. So it's had a three and a half percent bump or like the other world has gone up like 60% because I have this depreciation that is allowing me.
To shelter, you know, if your tax rate's 40%, you're literally getting 40% more money than you otherwise would have. So, that depreciation aspect of real estate is why buildings sell on a regular basis because after a period of time, People want to trade up and get a higher level of return and depreciation.
And the way the tax laws are structured, you always have to buy equal to or greater than. So there's this constant trading up the chain. It's why you see like, recently, in San Francisco, we saw this, cool building that work with, The entity traded out of that and then just bought a massive Amazon tower, with that equity and they reset their depreciation schedule and they've got this massive new number.
And now with Amazon revenue, they can shelter a huge piece of that, bottom line revenue. So. When you factor in the cash on cash return with the depreciation return, the sheltered income, the after tax equivalent, right? And then you add in the appreciation, like some kind of straight line appreciation of value.
It's very common for these buildings to easily get into high. double digits. if times are good or low double digits in normal times, I mean, 18% that really happens a lot in boom times 40%. Absolutely. I mean, people, in this last run-up have made an incredible amounts of money.
And they often have hard time to find, what to buy next because the market for a long time was so hot so That's really what I probably would call big picture of the ROI, because all three of those are components and they lead to an ROI that's really a lot higher than people realize.
Wow. Okay. I know that was a lot, sorry.
James Dice: [00:24:37] No, no, no. Don't say, sorry. Is that all
Joe Gaspardone: [00:24:40] the lessons, your phone number? I got one more for ya. or
James Dice: [00:24:44] really just a bunch of questions, but I'll let you get through your,
Joe Gaspardone: [00:24:46] I'll hit you with this one. And this is what I call the dark side of cam charges.
Um, a lot of people, when you Google, you know, camp char the buzz word is split incentives, right? Because you've got. the building, who's passing their costs to the tenant. Yeah. And from a purely financial Angela's standpoint, that seems like a fine set up. Like you occupy this much space, You're going to pay this much of the total. It all works out it's great. But now we're seeing that dark side and that is that the building really does not have an incentive. To upgrade to put some metering and you know, really only New York has a full fledged system when there's a TEI, the sub-metering is commissioned for that space and it gets put in as part of the TEI.
And that's really the only place that they do that like lock step with anything that gets added. but yeah, the rest of the market's like, well, why would I ever spend, a half a million dollars doing that? I'm already recouping my pro-rata. Nobody's asking me to, and nobody's making me, so the dark side of that, that Dan cam charge is the fact that there's no incentive for the building.
Altruism alone, is not going to do it. Right. Um, the betterment of the world is just not going to do it. So I think we're looking at as high as Monday. I hate to say it. I just think we're, we're looking at a world where until legislatively. You got to get off your butt and do it. I just, I can't see really how that happens otherwise, because these goals are just so not in alignment.
so that's
James Dice: [00:26:21] the dark. Yeah. And it shows up with energy efficiency, all the time. Like why would the tenant care. When, if they're going to pay for some sort of energy efficiency improvement, it just barely benefits them, benefits the whole building.
Right. But they're paying for, right. So there's all these types of. I mean energy engineers, call them split instead of do you think that's a bad word, uh, for, for the real estate industry?
Joe Gaspardone: [00:26:44] Here's what I would say about it. if you were talking to anybody on the operation side and you said split incentives, they'd either politely nod their head and not know what you're talking about, or they might know what you're talking about, but then they say, say, this guy doesn't even understand what I'm taught in my business.
Well, what does Kam stand for? My business is cam charges, common area maintenance charges. That's what my world is. Every year I have to scoop up all of those charges for everything that's related. I have to amortize some CapEx. And push that into the complex spreadsheet that I have to reconcile and then give each tenant their detailed reconciliation of what they paid versus what actually was, uh, incurred.
So that, that is the cam charge world. The split incentives kind of describes the problem and that's an app description, but if you're in any meeting and you say the word splitting sentence to better be a meeting of tech people.
James Dice: [00:27:43] Okay. Got it. All right. Yeah. The terminology is super important. There's a ton of terms that we could maybe hit at the end.
Joe Gaspardone: [00:27:51] Yeah. Maybe we come up with a glossary at some point you can pass it out. Cool. Um, last thing and we kind of touched on it, so I'll keep it super short. But, uh, the last lesson is for 80% or more of the market value. The overriding principle of value is the net income. Um, and, and in some cases, really the net spendable.
So after I pay my debt, what's left after that the net income or net spendable numbers relative to the amount of money I've invested in this building those two, that relationship or the purchase price is another way of saying it. So I'm going to sell this building in seven years. So if I sign up for a long-term solution, that's going to cost me recurring dollars.
I have to be thinking about that. if I'm going to lose $5 million of value, I have to think about how am I going to get that back? Because I'm going to sell this building in five years. I can't just give it up because that's a real $5 million. Right? So, that the fundamental principle of value is, it's predicated on the fact that I'm going to exit this.
Deal at some point in the relative near future. And therefore I must understand what I'm spending and why, and whether I'm going to get it back before I sell. So
James Dice: [00:29:11] that requires you to trace the, so a lot of times people have spreadsheets. I know you have one just to illustrate this, but you're tracing your operating expenses through, to your net operating income.
And then from that to. Using your cap rate to your, the value of the the building.
Joe Gaspardone: [00:29:29] Good. That's what the next guy is going to use to look at it and analyze it and then finance it and leave it. This is a great concept. Imagine if you could keep your expenses exactly flat for five years and your lease is all, have three or 4% increases in them.
That alone, just letting that play out and keeping this flat that generates like a 30 to 40% return over the five years. So you can imagine the tremendous pressure on a building to flatten that expensive side out because. The lease rates are going up, the financing is fixed rate. So there's only thing that's changing is, if you have, I can keep these expenses as flat as possible.
I'm going to make a lot of money on this building. So that's the pressure. That's the uphill battle that we all face and the more we can connect real ROI, it has to be real, but it even can be at the margins real, like I'm going to save you a little on your insurance from leak detection, like it works and it's working, people are rolling that out across the country.
you just have to find that strategy, you know, the BMS has got a great model for that, but you've got the split incentive issue, the cam charge issue. And so that's, the battle that has to be fought. and that's the world we're in. I don't shoot the messenger. Just like that's the reality of those are the pressures facing the operational side.
James Dice: [00:30:50] Got it. and now that we have sort of like laid out these lessons, let's bring it down to the ground for the technology companies out there. So I want to start with. just like defining NOI. So I'm continually amazed by how many people haven't heard of this term, net operating income.
Can you like, put it back into the context of these lessons?
Joe Gaspardone: [00:31:12] God, it's so true. I mean, and that's the thing, right? There are probably 20 and you don't want to like kill everybody in one podcast, but that's why these terms and knowing them and being able to fluidly use them so important.
so net operating income, then really two, one is really simple. It's the revenue of the building. Minus the expenses of the building, not including like cap CapEx one-time expenses, it's really looking at what is the recurring revenue of the building minus the recurring expenses of the building that is the baseline NOI pre debt pre debt.
So then the second version of NOI is now I made interest payments. So I'm going to throw those interest payments in as a line. And I'm going to look at my. Net operating income, inclusive of debt. And so very often people are looking at both of those for different reasons, because obviously financing can be a factor that, you know, if I can get a better rate than you can, I'm going to pay more for that building.
Right. So that affects the value. Right. So you've got NOI pre debt and then NOI NOI, which is sort of including the interest payments on the debt. Yeah. That's net operating income. So when you say those words, you can know in your head, it's just revenue minus expenses at the fundamental level. Debt is really an expense, right?
So you're paying that. So it's just revenue minus expenses. That's net operating income.
James Dice: [00:32:39] And, and what I've heard from you before is one of the ways that companies mess up is they might say we're going to increase your rent revenue. Right. And, how is that like a, no-no in your mind?
Joe Gaspardone: [00:32:50] Yeah. So you would have to, you know,
James Dice: [00:32:53] is that what increased the NLI?
That would be one of the ways to create value.
Joe Gaspardone: [00:32:56] Totally. And look, when we're selling strategies to the transactional market, you must dress. Increasing revenue or decreasing expenses. Somehow it cannot be left in the tenant's satisfaction realm, because it's just not enough to move it forward.
so yes. if you ever say we're going to to create your revenue or your, rent per square foot by X. I've yet to see somebody. Throw a like bonafide way they do that. it tends to get very soft and squishy very fast. And you, if you could be in my head and see the hundreds of presentations where people said, they're going to increase my, rent per square foot by a dollar 50, $2 30 cents.
it's like, you know, my rent per square foot would be like, $5,000 a month now. Yeah. Or $5,000 a square foot. So, I would stay away from that because it really doesn't have a provable metric behind it. And it puts you in the long list of others who have gone down that road. If you've got a way that actually, you know, the expense side, it's a lot easier for people to prove out.
Right. I, if I have a utility bill and there's my baseline. And I see it go down year over year. That's real. I can quantify that. If you're telling me I'm going to take these six internet circuits and make it to, I can quantify that. So there are ways you can get your solution in. Um, you know, we talked about leak detection.
If you tell me I'm going to get, uh, 5% reduction on my insurance premium by putting this solution in. And I go and verify that with my insurance company. Door's open. Right? So finding the way It's very difficult on that side of the
James Dice: [00:34:39] business. You mentioned tenant experience.
That leads me into my next question. So I'm reading the book, healthy buildings right now, which is like a very popular book to be reading right now during the time of the coronavirus. it's almost like a little, uh, scary how they released it, like right before the pandemic, it a little bit scary. but, so.
This ties into sort of JLLs three 30, 300 rule where the 300 bucket is basically saying like the main cost of a business is the salaries paid to, um, employees, which are the tenants of office buildings. Right. So how do you think about, when people make ROI claims around that, 300 bucket, which is.
A little bit fluffy.
Joe Gaspardone: [00:35:21] Right. I, I really do feel badly saying it, but people need to know like if anybody is on the operational side and you're pushing that, it's just not a good place to go. it can be true fundamentally. but it just doesn't translate in real dollars and cents the way that everybody on the operational success thinks it's about that piece of it.
So I'll give you a good example. and it ties into your healthy billings book. So, th there's a way of, buildings are out there. Owner ownership, management companies are trying to find, you know, healthy. Building solutions so that people can come back.
That's there's a giant wave of this. It's about to get funded across the country. So everybody's looking at technologies and what are they doing? again, don't shoot the messenger, but we're, living it. They're solving for the lowest requirement. So they're not trying to do it holistically by and large.
I know there are exceptions, please. Don't pepper me with them. I know, but I'm just talking about like the 80 or 90% of the market. They find a plasma solution that can be put on each air handler it's $15,000 per air handler. And it's, whatever times 20. So we're looking at $300,000 solution.
That's it done? We've got a healthy building. We're going to tell everybody that we've done it. It meets all the requirements that the city and County have laid out and.
James Dice: [00:36:48] Done
Joe Gaspardone: [00:36:48] done or you've been wired. We got a UV lighting. It's going to cost this much per it goes here and okay. It's a $200,000 solution checks all the boxes.
Yeah, that's I, you know, that's what's happening, so it's not ideal.
James Dice: [00:37:07] Wow,
Well, I think back on the three 3,300, I think where it breaks down is like the 300 is talking about the tenant, right. And the tenants business. Right. And making the tenants business. Revenue higher,
Joe Gaspardone: [00:37:23] but where it gets
James Dice: [00:37:24] stuck is like there's two different stakeholders here.
Joe Gaspardone: [00:37:27] And, and let me tell you how that came across. this is one of the well-known institutional investors. I just talked to him in this last week. And when we were talking about this, his response was. The tenant space is the tenant space. It's their premises. They pay for that. you know, whatever they're going to install is going to be their solution for their space.
My responsibility is this common area space and anything I'm delivering I E air quality into the town and space. And so my responsibilities are here and I had a hard time arguing. I mean, at the fundamental level, it's not ideal. but that is really how these leases are written. So it's a very, God, I don't want to say disheartening, but it's, it's like, you're left with if you know, health scanners and touchless tech is coming in, so you don't have to fit elevators.
So all of those to some degree are being explored and will be implemented, but, it's a little bit of a bummer that there's not a, bigger awareness as to, Hey, what can be done here more holistically?
James Dice: [00:38:33] And from all the lessons we've laid out here, what is this plasma, you know, bandaid basically, what is that a symptom of which one of the lessons what's causing the, the owner to do
Joe Gaspardone: [00:38:44] it's right.
It goes right back to cap rate. I mean, it is a one-time cost, so you can kind of write it off as that. But all of those have some recurring component to them, you know, everything does now. Right. So, the plasma solution on the air handler will.
make clean, healthy air at a standard that meets or exceeds the requirements. but it's just, that's the solution for this problem. And therefore I met that and I've built in whatever little additional costs over time is going to be plugged in there. And so my value is preserved and that's the bummer because you would like them to we'll say.
Well, actually just do this a little bit more, but then as soon as you do that, you're like, well, I just gave up $2 million of value. When I sell this in three years, you just are having me write a check for $2 million out of my pocket. Cause that was real money that I gave up. So that's the battle.
That's the battle. it's the ultimate struggle, the encouraging thing people out there I promise you is if you crack this, you're good. You're good for the long, long haul. Once you're in. It's almost like an annuity. You'll be there forever if you don't mess it up. So that's the great side of coming through the tunnel is once you come through that tunnel, you can do it and you will do it.
And people will come to this cheap will follow and they will all come to you. So it's just cracking. That one is tough. So
James Dice: [00:40:09] I got two more questions we want these lessons to be kind of long-term lessons, but while we're on the COVID, uh, you see a lot of announcements, on, you know, Deloitte is, reducing their offices. So how does that then hit. the landlord's business. And how do you recommend people start to talk to their landlords then when they have, these decreasing tenancy going on
Joe Gaspardone: [00:40:31] the reason, the fundamental reason why buildings are going to spend money. Period is twofold.
It's to get the building to a healthy standard, but it's also, and the main driver and everybody's experiencing this, moment of, terror is that, that what if they don't come back? so money is having to be spent in ways to make that space. Healthy and message healthiness and comfort.
So that is an opportunity. I mean, the opportunity is there and the money is going to be spent, whether it's going to be spent the way we would love it to be spent or not, it's really almost secondary. The money is going to get spent because it has to be spent because this is a sort of one-time shot to make people feel comfortable to come back to the office.
And if you believe that there's, one or more vaccines coming, and that, that gets distributed through the spring and then people kind of feel like, Oh, okay. And then the summer sort of bumps along, maybe occupancy rates rise a little bit. And then I would say by August of next year, for sure.
Like when school starts. Parents are going to be like, well, that's it, that's it. I got to go back, but how they go back and how often is really where the buildings are right now? How do I entice them you know, without breaking the bank? what can I do and say, and message to bring those people back.
But I will predict it. I I'm going to predict that by August of next year. we're back to 80 to 90% occupancy. If, you know, if we had a baseline at what existed pre. COVID, there'll be about 10%, 15% that are going to do a longer-term experiment with, work from home and rotating.
And, but I think people have short memories and you know, when things sort of settle back in and a few months have passed and they can go back and feel comfortable. I think that's probably gonna happen in math.
James Dice: [00:42:25] Got it. Okay. A lot, actually I have two more questions. So one of them is around, um, I think a lot of these transactional buildings, people will, when they, when they go in and they start to make the business case, they'll also going to run into someone besides the owner, which is the property manager.
so JLL, Cushman, Wakefield, CVRE, you know, whoever else. A bunch of different companies around the world. How do they sort of play into this? without a whole nother set of lessons?
Joe Gaspardone: [00:42:51] Yeah. No, you know, another really hard aspect to a sale, you know, everybody always jokes about the 18 month sales cycle or three-year sales cycle.
And that is real that's why you have to have hundreds more prospects in the pipeline than you would in another industry because they fall, it's such a longer timeline. And one of the reasons for it is different people in different organizations have.
basically veto power. It's a very dis-aggregated decision tree. So you could have, like, we talked about CTOs will have kind of position, but a lot of times that position is to stamp and approval on a plan. But then the property manager has ultimate veto and they don't have the money. And so they're not going to spend it and they're going to kick it to the next budget cycle, the next budget cycle.
So you've got that. You've got asset managers looking over this small portfolio and saying, I can't, it's hard to make a use case for that and so they have the potential to slow it down or try it on a building or two. And then you've got layers that a lot of people don't know exist, but they're like regional it managers and a lot of these larger companies and they can help push stuff along if they're on board with what you're doing.
But again, they don't really have budgets to, say we're doing this for this amount of money, ultimately. the property manager has an outsized influence, too many decisions, many, many, many tech decisions. and unfortunately, a lot of them are not familiar with what the tech decisions are. They write RFPs, they get three responses and they're just looking at price on most of the time because they don't really understand the differences of those.
So that's a real aspect on this side of the. Equation is sort of the outsized influence the property manager has. And sometimes the chief engineer, you know, those the chief engineer does have a budget and they do spend it on technology. So, you've got this sort of very, dis-aggregated decision-making and finding, discovering each organization's real.
Decision tree. And what can really be accomplished is again like a first step when you're getting into a sale and not to be discouraged by it, but just to learn about it and figure it out. That's that's what I would
James Dice: [00:45:12] purchase. That's a big one. The foundations courses, the mapping out the stakeholders. So last question, thank you for kind of going a little bit longer today.
So last question, um, this trend of all of these corporations making, and REITs making. long-term climate change commitments and then the movement towards requiring, certain ESG standards. How does that sort of play into all of this, and trickle down to say an individual building or portfolio?
Joe Gaspardone: [00:45:45] it's ultimately it's super positive because, you are going to have to at one point or another address, the deployment of these solutions across the board to achieve. Those goals, like it's gonna have to happen. you know, the, skepticism and the skeptic in me says, well, if it follows history, it's going to get kicked and kicked and kicked until, you know, The timeline gets extended, or they just have to slam something home to meet the need.
And, again, it doesn't really, it blossom the way that you would want it to. Um, you know, the, the optimist in me pushing back is saying what's different from the past is you really do have hundreds of people that are talented. Lot of them venture backed, um, better capitalization with better targeting and understanding of what they're going after much, much better than we ever have, but the underlying talent pool.
It's still small, but it's much, much stronger. And I do think that, the opportunity to deliver and meet those timelines and actually kind of help it along in maybe fits and starts, but to get there, I do think it's the first time I can say, like, it can be done. if you'd asked me like 10 years ago, I'd say there's no, there's no possible way.
Right, right. That's exciting. That's exciting. Yeah,
James Dice: [00:47:06] it does feel like there's quite a bit of momentum in that area,
Joe Gaspardone: [00:47:08] which
James Dice: [00:47:10] there's a lot of bad news to happening. So you don't want to get too excited, but it's definitely a good time to be in this, in this world. So. All right, Joel, I learned a lot. Thanks so much and, uh, anyone can reach out to, Joe to, learn more, I guess. So thanks a lot, Joe. And talk to you later.
Alright, friends. Thanks for listening to this episode of the Nexus podcast. For more episodes like this and to get the weekly Nexus newsletter, please subscribe at nexus.substack.com. You can find the show notes for this conversation there as well. As always, please reach out on LinkedIn with any thoughts on this episode.
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