Demographics Driving Real Estate - [Business Breakdowns, EP.190]

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3:01This is Business Breakdowns. Business Breakdowns is a series of conversations with investors and operators diving deep into a single business. For each business, we explore its history, its business model, its competitive advantages, and what makes it tick. We believe every business has lessons and secrets that investors and operators can learn from. And we are here to bring them to you. To find more episodes of Breakdowns, check out joincolossus .com. All opinions expressed by hosts and podcast guests are solely their own opinions. hosts, podcast guests, their employers or affiliates may maintain positions in the securities discussed in this podcast.

3:43This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Welcome back to Business Breakdowns. This is Matt Russell and my guest today is Fernando de Leon, founder of Leon Capital. When I first came across Fernando and his business, I was interested to see what felt like a mix of a private equity portfolio, a family office, and a diversified conglomerate. And the more I dug in, the more interested I was. Fernando operates 14 different businesses under the Leon Capital umbrella, and they vary across real estate, healthcare, and financial services.

4:21But as you will hear in our conversation, the businesses are connected and instruct one another. I'd say there's an underlying theme or connective tissue throughout this conversation, and it's how demographic insight sits underneath everything. It's the foundation to me of what makes this business possible. And as you will hear, there's no better person to talk about demographic dynamics than Fernando. So please enjoy this breakdown that is part thematic, part insight into a modern day operation. All right, Fernando, very excited to have you here to talk today. You have built a fascinating business.

4:59And when we were discussing where we could go with this conversation, there were truly no ends in sight in terms of how many different topics we could talk about. But one of the main things that I want to get into is your interesting perspective on demographics, real estate, how that's fueled a lot of what you've done. And I thought a good place to start is just with your story. I was hearing some of the anecdotes about it, going to school in two different countries in the same day, some of these fascinating dynamics. So maybe you could just sketch out your path to where you are today and in the thumbnail version, however you think is best to share it.

5:36But I think that background is going to be really helpful to shape the conversation. Sure. First of all, thank you for having me. I'm expecting this to be a lot of fun and I appreciate you inviting me on the show. I was pretty lucky in that I was born in a very interesting part of the world. I was born alongside this Southern Texas and Northern Mexico border. And so I got to straddle two different countries on a daily basis. I got to go back and forth between Mexico and the United States, went to school in the morning in Texas and went to school in the evening in Mexico. And when you do that reflexively, you learn how to contrast people and systems.

6:17And so I've taken a lot of those lessons as almost like a social systems engineer, a person that is able to contrast what happens in either the United States or other countries. And I learned to have a real appreciation for things that are very productive in the United States. And that was a daily thing. I got my learning, my education on demographics, on social structure, on hierarchy, on economics. I got my education at a very realistic, pragmatic level by straddling that border. And that border happens to be an incredibly interesting one, even historically. Texas was a republic in 1846. The border of Texas has changed multiple times.

7:00It was its own country. It was part of the United States. It was part of Mexico. Before Mexico was a country, it was part of the new Spain. And so as these borders change, I think you get a lot of very interesting things happening between the borders that the United States shares that are unlike the borders that you would see in parts of Europe or Asia. There's not that much economic discrepancy to speak of. I think probably the only border that has more economic discrepancy than the United States and Mexico is probably North Korea and South Korea. And so the system where I grew up contrasted a lot and it gave me a lot of lessons about how things could be made to be more productive.

7:41And so I think of myself a little bit in my career as a person that has designed organizations and businesses with those lessons in mind. Yeah, your point on systems definitely rings true just in terms of how you've been building things. And one of the things that we talked about last week, which I thought you framed very well, and I wouldn't dare try to frame it again myself, is the importance of demographics to real estate. So could you sketch that out a bit just in terms of your thought process and viewing real estate through the idea and theme of demographics? Yeah. So real estate is a broad asset class.

8:20In real estate, you have digital, which is telecommunications, equipment, data centers, cell towers, assets like that, that are all generating revenue. You have office buildings, shopping centers, what we call net lease retail, which has restaurants and banks and pharmacies. You have warehousing and logistics. You have housing, rental housing and for sale housing. And so those are primarily the real estate asset classes that govern our self -storage and a few others that govern the real estate industry. And all of those subsets, all of them are effectively spaces that human beings need to conduct whatever life activity that they want to conduct.

9:05It's either where they live, where they work, where they shop, or it's the data center where they upload their photos, or the self -storage facility where they put some of their valuables, and so on and so forth. Every space that is developed in real estate has a purpose, and the people that use those spaces constitute a market that is all about the demographics of that consumer base. So if you think about in the rental housing business, we have renters that typically are 24 to 35, 37 years of age. They have disposable income. They usually spend 25 or 30 percent of their income on housing. And then they allocate their budgets, their disposable income based on their preferences.

9:53But we understand how they consume everything. For instance, I'll give you an example. We were really befuddled by the fact that we saw the budgets of renters change from housing, their housing cost is the biggest part of their budget, then car payments, school loans, you have food. But their second biggest payment cost was technology. That's not that surprising. So Netflix accounts and cloud services, everything that people pay for. But inside the technology spend, one of their biggest sub line items was gaming. And we saw that the gaming business was going to get a big part of the wallet share of our renter base.

10:36And so we see these trends in real time because we understand them as our customers in the housing business. And so many times when we have moved to make investments outside of real estate, we learned how to underwrite credit from the demographics of our tenants. So for instance, when we got into the dental business, we entered the dental business because we had a shopping center. We learned about the dental office. We learned their P &L. We learned that they were generating about $2 million in revenue in that location. They had about a 30 % margin. So we said, oh, well, why don't we build the second one and support this business?

11:18So we did the second one, third one, and then that business. Eventually, we used our real estate capabilities to build a 300 location dental business, but we underwrote the credit of the tenant in the shopping center. So everything we've learned in business, we've learned it through the ownership of real estate, whether it's households or individual renters, or it's tenants in our shopping centers, or tenants in our warehouses. We learn the demographics. For instance, the warehouse, when we develop warehouses, we develop them close to the rooftops because people want delivery of their goods. It used to be that the expectation for all of us was a three or four or five day turnaround for the delivery of a product.

12:01Now the expectation is you want it the same day. And that means that the warehouses that we develop have to be much closer to the rooftops that order these goods. And so all of these things are about human beings consuming things, buying things, living somewhere, how they spend their money. And so we learned through the real estate business about everything that relates to the American consumer that way. I think you have 14 different businesses now that essentially feel So like their offshoots, they're very much tied into real estate, but they have some complementary pieces to them that can be associated with real estate, like you just described.

12:42I'm curious, when you go back to the idea of the systems thinking, has it been the case that you can take that model of the dental practice and apply that generally elsewhere nationally? Is it something where there's limitations to certain regions? I know you have global businesses. So just thinking about that, where the system either works incredibly well and where it starts to break down when you think about those various borders I just discussed. First of all, our businesses mainly are encapsulated in three verticals. We own three businesses in real estate where we build warehouses, housing, and healthcare real estate.

13:21We own three businesses in the financial services sector, so insurance, financing premiums, and medical device leasing and consumer lending. And then we own six operating companies in healthcare that provide services in ophthalmology, dental, cardiology, mental health, etc. So those businesses, I think about them as complementary in some sense, but also most importantly, we consider them essential services, essential needs, whether it's housing or healthcare. These are things that Americans really want and need. And we have about 6 million Americans that consume our goods and our services. And so I think about them that way.

14:09yes, I think many of them, when we've entered them, we start by understanding what's happening in that business, what's happening in that industry, where are their imperfections, where are their productivity gains, where can we do something different than the status quo or the state of the art and where we can improve it according to our advantages. We have some advantages that others don't. For instance, if we wanted to grow a dental business, we would say, hey, let's leverage our real estate teams to find those locations that we think have the best demographics. And so in pediatric dental care, we find that those locations are in suburban locations that have household formation.

14:53We like places in Nashville and Dallas and Austin and Tampa and Denver that are receiving a lot of immigration, a lot of household formations where families are relocating from other coastal markets, and we can go build dental clinics where there is strong household formation. We know there's families there, so pediatric dental care can benefit from those demographic tailwinds. And so we can leverage our real estate teams, build a clinic, a facility, build a brick and mortar. We don't think that Amazon is going to disrupt dental care because we think that it's hard for an algorithm to put braces on a young man or woman.

15:36And therefore, we think some of these businesses are less disruptable by technology. So we need those physical spaces. And so we can leverage our real estate teams and continue to grow that dental business. And there's quite a bit of synergy there. And then we can work on things like insurance for our properties, and so on and so forth. Or the medical device leasing business may lease a medical device to that dental clinic. And so that's how we think about these ecosystems. We think about them as systems. And that logic sometimes applies better than others. But yeah, we tend to understand what's happening in those industries and find these openings where we can develop value for people, for customers, for human beings that can benefit from our services.

16:22And then if they like what we deliver to them, then they'll reward us. Yeah, very much many growing economies in their own ways and building the ecosystem for them. On your point of managing these different businesses, there's clearly synergies just in terms of information and visibility. When you think about underwriting as a conglomerate, there's always the question of where do the benefits come in? It sounds like these are operated as separate businesses. But I'm just curious on that point, are there ways that you can shift your underwriting strategy to view it as a mix of these multiple businesses and the net result is going to be better, even if it's at the expense of one in the short term.

17:00Do you change your approach at all when you think about underwriting? Let me back up a little bit. So I started this business with very little resources. I didn't have a lot of capital. So every time I started a business or my initial business, I was operating with very finite resources, like all entrepreneurs do when they're getting started. And that scarcity of resources makes you very efficient. And I think we have always maintained that DNA of we have finite resources, we have to use them wisely. We have a couple of rules. We say there is no such thing as a small cost. cost. The indiscipline of having an unnecessary cost means that it undermines everything that we do.

17:44There is no such thing as a small piece of revenue because small revenues can turn into larger companies. Every single large company in America came from a small piece of revenue and it emerged and evolved into a large piece of revenue. So I tell you that because my mentality has always been, I need to protect my downside when I start something new. I'll give you a couple examples. When we started in the veterinary business, I said, well, the demographics of urban areas have this skyrocketing pet ownership, but urban areas are very difficult to find real estate locations. And our team went into these urban areas and found difficult to develop real estate.

18:28And then we made that into a vet clinic, which resulted in great operating gains for the practice. But when we developed the real estate, we made a profit on that real estate. And then we use that profit to open a new store with the profits from the real estate. So we could sort of predict that if we built a clinic for $100, that we could sell that real estate for $130 and then use that $30 of gain to open up the actual operating location in that real estate or in another location. So we had some downside protection and that's how we built all of our businesses with a little bit of downside protection, maybe some Propco profits that we reinvested into the gains of an operating business.

19:12And frankly, all the people that I've always admired in business have used some version of that to protect their downside and to go and pursue some kind of research and development gain. If you look at Amazon Web Services or who started doing it for their own account and then grew into a massive business or LVMH that developed Propco Opco strategies when their first investment in Dior and things like that, there was always a downside protection from an ancillary business where you could be bold enough and have that audacity to go explore a new business line. And that's how I've tried to do that.

19:51Same thing in insurance. I was tired of paying huge premiums. And I said, we need to start building an insurance business to protect the value of our real estate because those premiums keep escalating and growing. And our real estate always buys property and casualty insurance. And so little by little, we went into that business. And we also, to your question on systems, we understood that the insurance system had a supply chain where there were intermediaries that made the cost of the policy more expensive. So as you had insurance brokerage and insurance, reinsurance, all of those incremental costs made it more expensive.

20:32And I could build a business that didn't need a broker to sell me insurance. I could remove some of that cost because I was my own customer. And so things like that, that we understood about fleshing out a system and dissecting it and deconstructing that system to understand where value was. And then we could merge it with something we were already doing so we can build a self -sufficient company that also benefited something else we were already doing. Yeah, it's an interesting framing of reinvestment opportunities. Anything that needs scaling, you require the profit from the actual asset and then the reinvestment opportunity that's attractive ROI.

21:09Particularly interesting here when you have those examples of the vet clinics and the real estate itself and how that can trickle on. You mentioned some of those markets, and it feels like there's a real secular story behind what's happening there. I'm curious, is that primarily your focus, these regions which might be changing and have a lot of opportunity, basically, as you go through the list of businesses that you've built out? I tend to think of real estate as this historically cyclical thing that the cycles may be various periods long in terms of years. But I'm just wondering, do you differentiate between the two?

21:48Yeah, look, I think there are certainly cyclical elements of real estate, although those have changed significantly over the years as the pool of capital has broadened to support real estate development. So one of the things that we've seen over the last 20 years is that large pools of capital, whether they're insurance companies, asset managers, wealth management firms, RIAs, private equity, asset managers, pension funds, corporate and public pension funds have all allocated more and more dollars to a real estate asset class. And so as that has become institutionalized, you have this underlying support of capital that supports values in certain segments.

22:33Some are more institutional than others. I would say digital infrastructure, housing, and logistics are the primary beneficiaries of that capital support. And as all of that capital has come into the real estate industry, the cyclicality of those valuations has been diminished somewhat. The other consequence of the cyclicality of real estate and the incorporation of new capital sources into those industries and asset classes, what has also happened is that it's made it more competitive, where you have a lot of buyers that are insurance companies and asset managers and all of those pools of capital, and they are buyers of the assets from manufacturers like us.

23:20In that supply chain, we are manufacturers of housing. We develop that housing. And then ultimately, that housing is acquired by a large pool of capital, eventually acquired by the large asset managers or insurance companies or pension fund separate accounts with an asset manager. But our job is to do all of that groundwork to buy a piece of land, to entitle it, to get zoning permits and to do all of that work. And then ultimately to design that housing in that jurisdiction and then develop it, build it, understand all of the supply chain of construction. And then ultimately, once we've done building it, we have to lease it and then manage it and then cash flow it.

24:08And then that asset, eventually, we own some for the long haul, but most of the time they are acquired by large institutional investors who own large portfolios of these kinds of assets. And what we do is pretty difficult. In housing, for instance, every jurisdiction is different. So if we build in Dallas or in Tampa or in Phoenix, every small town, remember a city like Phoenix could have five different suburbs or a city like Dallas could have 20 different suburbs. And every one of them has different jurisdictions and building codes, has different laws that govern how to build housing. And so if Tesla's trying to build a car in a factory, they have a contained environment.

24:52This is where we make the chassis. This is where we make the IP. This is where we make the glass. This is where we assemble it. And they're all contained environments that you can replicate over and over. But the housing business does not allow us to do that. Every new place where we build has different topography, different building codes, different city restrictions. And so that makes it very hard to manufacture housing at scale. And we're one of the few that are private developers and manufacturers of housing that do it at scale every year. We build 3 ,000 units of housing, almost a billion dollars of housing every year that we develop.

25:31And it takes a while to do that. Every project has a three or four year life cycle, and it's very difficult to do at scale. So we've perfected those systems to build that housing at scale. And we do that understanding that there are markets that have much higher growth potential than others. So we look at markets in the Sunbelt primarily. So places like Raleigh, North Carolina, or Austin, or Denver. If you'd like, we can go into why we picked those markets. But I think it's fascinating what's happening in those sittings from a demographic standpoint. Yeah, maybe you can elaborate. What would the characteristics be that you look for?

26:12And maybe what's happening there that drives that? Those cities have primarily four ingredients. One is that they are business -friendly states where companies have been setting up their operations. So you go to a place like Phoenix, you have, in terms of digital infrastructure, TSMC is building a giant facility in the Northern Valley of Phoenix where they're creating thousands of jobs. And so evidently, we're going to develop housing nearby. But you have a near shoring of companies like TSMC that are building chip plants in the Northern Valley of Phoenix. You have the same happening in Austin, where Taylor, Samsung has done the same, build a giant facility there.

26:58You have biotechnology companies in Raleigh that have changed dramatically the demographics of a place like Raleigh, North Carolina, where it used to be the main industries in a place like North Carolina were tobacco and furniture and old school industries like that that are no longer. Now you have a vibrant biotechnology industry in the research triangle in Raleigh. And that's primarily because you have universities like Duke, Wake Forest, UNC Chapel Hill. You have this giant educational ecosystem that is developing engineers and talent that when they graduate from those colleges, they go straight into these businesses.