415. The Retail Story Everyone Gets Wrong with Jim Dillavou, Paragon Commercial Group

0:00This is not a guesswork business. You can take the risk out of these deals. And I think that's what we try to do on a daily basis.

0:10Jim Dillavou: Welcome to the Trep Wire podcast, the show where commercial real estate needs data and insights. This is a special guest podcast. I'm Haley Keen with Trep, a data modeling and analytics firm for the CMBS commercial real estate and CLO markets. I'm with Lonnie Hendry, chief product officer. Today, we're joined by Jim Dillivue, co-founder and principal at Paragon Commercial Group. Prior to co-founding Paragon, Jim was a real estate and finance attorney with Latham & Watkins, advising developers, investors, and lenders on transactions across the country. He later launched Paragon in the wake of the global financial crisis to pursue what he believed was one of commercial real estate's most compelling mispricing opportunities, necessity retail.

0:59Jim Dillavou: More than a decade later, as institutional capital has increasingly embraced the sector, Jim brings a unique perspective on underwriting, development, and capital allocation in today's market. Jim, we're so excited to have you joining us today. Welcome to the Trapwire podcast. Hey, good morning, Hayley. Good morning, Alani. Nice to see you guys. So we just heard some of your background, but I'd love to hear it from you. Walk us through where you came from and how you got your start in commercial real estate. Yeah, I'll try not to spend too much time on myself. I don't think that's overly interesting.

1:31But I guess the interesting component is the conversion from being a real estate finance attorney into the actual business of buying and building retail. And I think as you stated, and you guys talk about on the show every time, it's a cyclical business. And sitting there and as a big firm lawyer in 2008, 2009, realizing that real estate was on sale generationally. It's one of those times where this only happens two or three times in anybody's real estate investing lifetime. And it's all about vintage. And I figured if we could figure out a way to begin acquiring properties in that part of the cycle, it's going to be really hard to lose.

2:09And so that was when I took the leap, gave up the big firm salary and went to zero and decided to start a company. That's very cool. And I think we hear a lot of lot about the negative stories coming out of the GFC and people not being able to find jobs or not having a path forward. And it's kind of cool to hear your perspective of having a really great, you know, gig, but then seeing an opportunity and being willing to take the leap in a moment where probably, you know, that was the last thing most people were doing that already had something stable lined up. Yeah, 100 % right. So everyone told me I was nuts.

2:44I assumed it would take us about 12 to 18 months to get a property acquired. I was wrong by about a year. And so that 12 to 18 quickly turned into about 24 to 36 months before we actually started generating income. But, you know, I was young and that's when you should be taking risk. And so that was my thesis. No, it's great. I think, you know, as you talked about the real estate market being cyclical, by definition, usually when you're doing something contra to everyone else, especially when there's fear in the marketplace, that's where the real opportunity lies. It's just having the internal fortitude to make those calls when the chips are down.

3:18That's the part that we all, we know theoretically what to do, but being able to do it is a different thing. So maybe before we get into some of the deeper dive stuff here, you know, we're talking a little bit about necessity retail. It's kind of like a, you know, real estate is very jargon heavy. It's very regionally specific and how rents are quoted and how you call certain things. Like some firms call capital markets groups, just like the loan origination business, capital markets for other groups mean, you know, anything that's brokerage related, et cetera. Or, you know, when you say necessity retail, just give me what your perspective or purview is from a definitional perspective.

3:51Yeah. So this is probably going to be the single most important thing we talk about today, which is our industry has done a terrible job of actually defining what we do. And what I mean by that is we put everything under this big, giant umbrella called retail. But as you guys talk about a lot on the show, that's just incorrect because malls operate very differently and behave very differently than power centers, than community centers, than neighborhood centers, than triple net. We can keep going. So our corner of the earth is necessity retail. And so I think nuance is maybe the key word we're going to use today.

4:25You have to get very nuanced when you're talking about retail and you can't talk about it in broad strokes. So what is necessity? Our view of necessity is it used to be called grocery anchored shopping centers and it was called convenience retail. It's had a bunch of different names over the years. It's now called necessity. So what do we mean by that? What we mean is convenience retail, generally anchored by a grocery store, which generates daily trips, not weekly or monthly. But this is something that you're going to go to a few times a week, sometimes daily. And our view of that is that consumers will really prioritize necessity, whether the macro market is going up or down.

5:04And so we look at it as something extremely stable, regardless of market cycles, as we know and you joke about often, I think, is we're in a very illiquid business where real estate should be a long term asset class. And yet we constantly talk about interest rates moving and what's the Fed going to do and what's going to happen with the war and tariffs. And at the end of the day, none of that should impact like a long term macro real estate investment thesis. And so as we look down, we thought, OK, what's durable through different cycles? And we just loved necessity. It's just stable. It's not the sexiest thing by any stretch of the imagination when it comes to real estate, but it's durable.

5:45and we liked the durability. And so when that went on sale in 2009, 2010, and we thought we could gobble as much of that up as possible and put a put long term debt on it, hold it as long as we possibly can. It turned out to be kind of a good thesis. But so to answer your question directly, the necessity stuff is really the neighborhood grocery anchored used to have a lot of drugstores in those centers. That business has seen some turmoil. But generally, it's grocery anchored shopping centers. I appreciate the nuance there, because we joke all the time that you know, real estate's a local endeavor, sometimes hyper-local.

6:19Two buildings on the same street can have two completely different outcomes depending on who the operator is, what the capital and debt stacks look like, et cetera. And I think just from a definitional perspective, to your point, retail broadly doesn't get the love that it needs because sometimes the, if you look at delinquency as an example, regional and super regional mall delinquency is under the retail umbrella. Well, that's a completely different delinquency profile than what you're talking about with these grocery anchored centers, because, you know, coming out of the GFC and even especially through COVID, I mean, you saw a huge rush towards this necessity retail that you're describing, because it was like when everything was locked down, people still had to get groceries.

6:56People still needed to get their prescriptions filled, et cetera. So maybe that leads me to my next question here of, you know, post-GFC, this was maybe a contraplay. Fast forward to COVID, this becomes the darling of the industry. Obviously, for the stuff that was already in your portfolio or that you held, that's great because that increases valuations, et cetera, et cetera. But how does it change the outlook from an acquisition strategy, et cetera, when everyone else is trying to put capital into this space? Yeah. It's very funny. If you look at our acquisitions over the years, starting in the GFC through today, we acquire more when fewer people are in the market, not surprisingly.

7:35Now everybody wants to get in the market. And the really interesting thing that's happened over the last 24 months is, so when we started the company, I spoke to every private equity firm in the United States and said, would you like to partner with us? And 90 % of them wouldn't even return my phone call because I'm in the retail business and that was not the flavor du jour. All of those friends have now in the last two years really wanted to meet and talk about how they can get into the business. There's a huge moat around this business currently. And the reason there's a big moat is that most big investors actually let go of most of their retail specialists post GFC, post COVID, you know, the retail apocalypse narrative.

8:13So a lot of them don't even have specialists. And so now they're looking to allocate capital into necessity retail. It's a very hard business to build a team into if you haven't been in this business for, you know, 10, 20 years, it's a very relationship driven business. And it's very nuanced business. And so those people have like spent have come and spent a lot of time in our office trying to get educated on how they can allocate capital. And it's very, very difficult because for the first time in over a decade, those assets are performing well. So there's not a lot of sellers. And so, and the asset size is small, right?

8:44You guys talk a lot about office buildings where you're talking about two, three,$400 million assets. Our average asset size is, you know,$50 million. And so it's very difficult to scale and there's very few portfolio transactions. And right now the asset class is, you know, north of 95 % occupied, depending on where you are in the country. And so there aren't a lot of sellers, which makes it, you know, makes it tough to get into at scale. Yeah, I think those are all valid points. And it's what we've seen. I've seen the same thing with some of this urban infill, industrial and like last mile distribution, you know, short bay, not very tall, clear heights, but there's not building those.

9:22So if you own a portfolio of those, it's really well positioned, but it's very difficult to scale that because there's just not a whole lot of those on the market. And the ones that are on the market, the owners know what they have. And so it's a difficult proposition. You know, one thing that I think is very interesting about your sector here is the grocery anchor component. I mean, like, obviously, that brings the stability, that brings the durability that you talked about, et cetera. But they have long-term leases, in my experience. It's been a few years since I've actually been, you know, on the ground with some of these deals.

9:52But I mean, I remember back in the day, you would have a grocery tenant that might have an initial 20-year term with a couple of additional, you know, 10-plus-year options. And rent growth on those, the steps on those were fairly nominal relative to what you might get in other asset classes with tenants. So just give us a little bit behind the curtain of what that looks like and how you deal with that. Yeah, Alana, you've done this. I can tell that's an excellent question. And here's why. That was the biggest criticism of the asset class for a very long time, which is, look, you got fixed rent bumps.

10:22Your shops are only growing at 3 % annually. Your pads are growing at 10 % every five years. And your anchors are largely flat. You're not even keeping up with inflation. It's just not that interesting. We can't get the growth we need. Right. So that's when their risk on narrative was pervasive in real estate. When risk off became pervasive and everybody just wanted cash flow, everyone's magically fine with that all of a sudden. And so, you know, we're growing rents. If we grow at 5 % or 6%, that used to be not popular to talk about at cocktail parties. Now everyone's just staggered by that, it's great because it's durable.

10:57You have credit behind most of these leases. And if you're growing at 6 % without a lot of risk, that sounds fantastic. So again, back to vintage, back to cycles. We're in that moment where people are willing to make less annual growth in exchange for places to allocate capital that they view as durable long-term. Yeah, I think it's a fair point. We've written several pieces at TREP just talking about the power of perspective. And I I think you just gave us another example there is when people are risk on or risk off, it really changes the narrative. The property and the performance and the rent growth, that doesn't change.

11:32It's just their perception of the value of those things. And I think you mentioned earlier, a lot of these centers are 95 plus percent occupied, which is very difficult right now. Maybe industrial is the only other asset class that you're seeing that type of stable occupancy. But multifamily, which has been a huge favorite for the last couple of decades, you're seeing a lot of rent concessions, a lot of new inventory on the market. And that kind of leads me to another thought here is just, you know, one of the benefits, I think, for you guys, and this is speculation on my part, you can confirm this or tell me I'm wrong, but this is not a sector that sees a ton of new supply relative to the other asset classes.

12:08So I think that, you know, probably goes to the moat that you were talking about earlier as well. Yeah. I mean, we've built ground up over 20 million square feet on the West Coast, you know, through our careers. Whereas it's very difficult to develop ground up right now for all the reasons we can talk about. And then I think all the listeners can already know. That said, I think one of the things we consistently bring to the table, which helps us, is that we buy every asset from a value add standpoint. We're always looking at moving buildings, looking at what rents are. We're looking at what TI's are, looking at what land value is.

12:40How can we change the asset to create a little bit of value? And there is small movement in a lot of these, especially the larger shopping centers. If you think about, you use the term back in the day, I try not to think about myself as that old, but I guess I am. But when you think about when grocery stores were 55 ,000 square feet, right? That was just the prototype and everybody was doing 50 ,000 to 60 ,000 square footers. Well, what's the prototype now? It's much, much smaller than that. Trader Joe's is 12 ,500. You know, most grocers are 20 ,000 feet, 25 ,000 feet. What does that mean? That means there's a ton of boxes on the market right now that need some level of construction.

13:15What is that? That's demising, that's moving boxes. So there is there is a component there that helps us create value that a lot of investors don't want to handle. I mean, it's hard, right? You're talking about entitlements. You're talking about demising. You're talking about utilities. You're talking about loan draws and capital costs. And so it's difficult. So most of this capital right now that's entering the space is really more on the core plus and even, believe it or not, the core side of the ledger because they don't, even though the market right now has a lot of opportunity and value-add capital, they can't find a home.

13:47They're not willing to take the risk. When I tell them that I got to move a building and slice 20 ,000 feet off and we're going to re-tenant it with something else, they're like, oh, that's too difficult. We want that kind of very stable cash flow, not the risk of construction. So that's what we're seeing in the market right now. We're super bullish, but I will tell you, it's very difficult to find deals. And at some point, that construction component you're asking about, that's going to come back. Right now, we've got everything kind of running against us, right? You've got high costs. You've got a high cost of debt.

14:14You've got scared equity. And then in some markets, you have entitlement risk. Like those are not a recipe for conservative investment. And rents have grown a lot in retail, right? And so rents are high and that's, you know, you never really want to develop ground up into a center that consists of a bunch of really high rents that only have downward pressure. So right now, I think unless it's a pre-leased, so we use the term development, unless it's a kind of 80 to 100 percent pre-leased deal, I think development is just going to continue to be slow until we get some break in one of those metrics.

14:44Yeah, I agree with you. And that was kind of the thought process is it really bolsters your existing book and portfolio because I think everyone's going to be facing those same challenges. Even though I read something this last week, it was one of the public REITs that was talking about backfilling some of their big lots and other retail tenants that had gone out. And I remember, I think they had something like a 50 % increase in rental rates by turning those over. So it was a terrible outcome for the tenant, but it was a great outcome for the landlord. And I think people underestimate how some of these legacy tenants that have long-term deals in place haven't truly kept up with market.

15:20And when they leave, that construction concern that you just described is real. It's risk. It's scary. But the reward can be pretty significant if you do it well. Well, you guys talk on your show a lot about kind of the narrative. I think that's a favorite term of yours. The narrative is always very entertaining to those of us in the business because you're going to get the front page headlines saying, insert name of tenant here is going bankrupt, closing 300 locations, right? Everyone reads that and goes, retail is dying. They don't then read the next one 12 months later where the REITs report that they backfilled all of those at 50 % higher rents.

15:55And so it was a blessing in disguise because that tenant was probably pretty weak anyway. way. So I don't think I can say in like the last 15 years, there's been a retail, a retailer failure that everyone in the business didn't know was coming. Like, it's very rare that there's a surprise. You follow the credit, you know, it's coming. And frankly, we love buying retailers that we think are failing. So, you know, back in the day we were buying office depots. Why? Because they had 20, 15 year leases and they'd be five years into a lease and the rent would be dramatically under market. And we had a little mousetrap where we could reposition those boxes.

16:29There's a couple other retailers right now I won't name that we think will fail. And we're buying those, you know, rents because they're 50 % of market. And if that retailer fails, that's just a mark to market opportunity, especially if we can, you know, we had a center, I'll give you a specific example. We bought a Big Locks Anchored Shopping Center in Orange County, California, and we retended it with a Sprouts, right? The Big Locks rent was less than$10 a foot and the Sprouts rent was north of$30 a foot. And you change the character of the shopping center from a non-grocery anchored center to a grocery anchored center.

17:00So there's cap rate compression, you get better debt, you get better equity, blah, blah, blah. So, you know, that's kind of the home run scenario, but you're entirely correct. I mean, that's, it's, you have to kind of be in the business daily. And that's why I really like where we sit right now, because that moat continues to be real, notwithstanding the interest in the asset class. No, and I think, listen, your experience in the business through multiple cycles, I think lends itself to credibility because like what we've seen and you probably competing with this at some level is as industries change, as sectors fall out of favor, then capital flows to things that are more in demand.

17:34And you get people that, you know, enter the space new and don't really know from a boots on the ground perspective what it takes to operate. And I think, you know, one thing that we've really latched onto in the latter half of 25 and through 26 is I think the pendulum has swung now to where this is an operator's market. If you know how to actually execute value add, reposition, retenant, all of these things, underwriters are looking at that differently than the new entrance to the market, even if they have good capital backing, because operations matter. When interest rates are high, when insurance costs are through the roof, when property taxes go up.

18:08So in retail, when your occupancy costs are hitting the red line and you got to work something out with your tenants, they need someone that runs the center that understands how to navigate those things. That 100%. All the investment committees across the country right now, to your point, you brought up industrial and multi, they're sitting around looking at their pie chart. And they're saying, wow, we have a big allocation of industrial because the last 10 years, we've got a big allocation of multi, you know, there's some stress on those sectors, where else can we go to get a little bit of yield.

18:34And honestly, we're benefiting from that a lot, because those pie charts don't have a lot of necessity retail. So those are the calls we're getting in terms of how do we get into that sector. And so, you know, as much as I'd like to say, we're, you know, geniuses, and we happen to be, you know, you talk about the pendulum, we happen to be at the right place at the right time, but for 10 years, we weren't, right. And so we what you have to do, and you guys talk about this a lot, you just have to understand that the business is cyclical, you have to be conservative on capitalization, you have to be long term in your thinking, we try never to buy anything, thinking that we're going to flip the asset, right, we try to take a long term view of everything.

19:09and we try to capitalize it accordingly so that we don't have that capital markets pressure because there's two components to all real estate deals, right? You have the real estate deal and then you have the capital side of the deal. And if you can, and most of the time, a lot of the time I should say, those are mismatched. So if you can match those, it's really a recipe for long-term success in the business. Again, it's not things that people wanna talk about at cocktail parties when you're talking about, you know, putting a low leverage life company loan on a grocery anchored shopping center.

19:33Nobody's interested in that. But when it's generating, you know, when there's 200 basis points of spread between your stabilized return on costs in your debt for the next 10 years, you know, it's not bad. So that's kind of where we try to play. And it's, like I said, we're in an environment now that's, you know, risk off, and that's becoming something interesting for people to talk about. Well, you know, I think some of the other tailwinds that you guys have are just the regulatory pressure is really pushing certain dollars out of multifamily and into other things. And I think notwithstanding maybe some stuff that we heard coming out of New York yesterday around, you know, state-owned groceries and other things, like there's not a whole lot of regulatory pressure for this sector that I see on the horizon.

20:10I mean, I think for the most part, this will be a free market kind of endeavor, unlike some of the other property sectors that are facing that increased political pressure for various reasons. So I wanted to highlight a couple of things that you mentioned. One was the drugstores and some of the pad site stuff that you guys have on your lots and your properties. So twofold question. One, I agree with you. I think the drugstore, the current drugstore kind of construct is broken. People have evolved. Delivery is now much easier. I mean, drones, mail, whatever, 90-day supplies, six-month supplies.

20:45You don't have to go to the pharmacy once a week or once a month. And so I think that model has to shift. And similar to what we've seen with the retailers, the grocery-anchored retailers going for 50 or 60 ,000 square foot to, you know, call it 10 to 25, having a 10 ,000 square foot or 8 ,000 square foot, but CVS on the corner probably doesn't meet today's market standard. So one, what is the reposition opportunity for those properties? And two, are there other value-add initiatives that you guys are looking at where maybe some of your centers are over-parked due to previous parking requirements and other things where you can actually create some value with some additional pad site offerings?

21:20Yeah, good questions. The answer to both is yes. So we'll start with the drugstores. Two things on drugstore buildings. They are, in our business, we talk about single-use buildings. and multi-use buildings mean, is this a good size prototype for other retailers to backfill? Drugstores have always fallen into the category of they're not great buildings to reuse. They're expensive to redevelop when you're putting another tenant because they all have their own, you know, Walgreens, CVS, right? They all have their very own unique prototypes. And so it's very expensive to re-tenant those, but there's a lot of them on the market, right?

21:53So we have recently bought three of them, standalone drugstores and re-tenanted those with, in one case, a small grocery store, in one case, a DaVita dialysis. And we're figuring out the third one at the moment, but they're extremely well located, which is the benefit, right? They usually have, they're usually on a hard corner, but you have to balance that with the fact that drugstores paid very high rents for a very long time. And so you can almost never match the rent. So what's happening in the marketplace right now is a lot of owners understandably frustrated because they put a cap rate on a high rent.

22:23They bought that, they're into the deal,$15 million, whatever the thing is. And now it's worth six, right? And they just don't understand how they could, you know, it could be worth that much. But because of the cost to retenant the building, and because the new rent is going to be lower than the old rent, the math is very difficult. So those deals are difficult to retenant because of the occupancy of the market nationally that we mentioned. The market will figure that out, right? The capital will figure that out because there's just not enough vacancy and retailers need space. So retailers will figure that out through a combination of TIs and rents and landlord subsidies and everything else that we will figure that out.

22:55And those are getting absorbed. Relative to your parking question, it's such a good question, Lonnie. Target, Lowe's, Home Depot. Remember back in the day where retailers wanted 10 per thousand parking, right? And the idea was to have these massive parking fields, and that was going to generate additional sales for your hundred plus thousand square foot box. Well, that's not a thing anymore. What these retailers have figured out is we'd rather have active retailers in our parking lots, co-tenants that drive additional traffic. And then there's cross shopping. So if you look at any of those retailers I mentioned, they have now for 10 plus years been selling out parcels to retailers.

23:34And whether that's a drive-through Chick-fil-A to bring a lunch crowd in, or whether, I mean, we bought an out parcel at a Lowe's in Northern California and put an in and out there because Lowe's view was they drive a great lunch crowd and there is some cross shopping there. And so we've done a ton of those, getting entitlements, creating the parcels. You're in escrow for a year, but by the same token, you're pre-leased by the time you close. And with the run-up post-COVID and the demand for drive-thrus, they've been really easy to lease. So you do have to have a team because you need your engineers and you need your architects and you need your entitlements and you have to take all that through the city and get the approval.

24:12And the cities now don't like drive-thrus as much as they used to. So that's become a thing. But you're entirely right. Like that space, that parking lot space has value to it. And so it's been actually kind of a fun little line of business that we've kept since we started the company. And we own a handful of them. Now we bought a Office Depot that was an out parcel to a Target. We tore it down and we put a, you know, a Chick-fil-A that has 50 car stacking in it. And so they need that much real estate. And so it's a value creation mechanism for these big boxes that own a lot of real estate that don't need that real estate anymore.

24:48Yeah, no, I've seen it in practice. And it's an interesting dynamic. But I think you hit on a couple of things. And we'll circle back to that. But I just wanted to point out, people underestimate, like take Walgreens as an example. Their slogan is on the corner of happy and healthy. I mean, it's purely a real estate plate. It's just kind of hidden in the message. But they are on the corner. The problem is just the business model has shifted, and so it doesn't have as much value. And to your point, a lot of those are built to suit with inflated rents and other things that cause problems. But I think like the dialysis, I've seen several of those go backfill those.

25:20And you kind of get the benefit of both, like still pretty high rents, good credit, long-term tenants. We've seen some family dollars and some other things backfill some of those with some success. So it's good to see that there are some alternative uses, even though I agree with you. it's very difficult to find that second generation user there anywhere close to the level of rent that you were seeing before. On the mix of tenants, though, and the cross-selling, I want to get back to that. We've heard a lot from folks that are developing. We just had Justin Stein on with Tanger, and he was talking about how their strategy broadly was to bring more of an experience to their open-air retail centers, and food was a huge component of that.

26:01They really need to up their game with having lunch and dinner options available for shoppers. In your grocery anchored centers, that maybe isn't the same potentially, but how do you find that perfect tenant mix in those inline spaces that complement the grocery, that also the grocery benefits those inline spaces? Like, is there a formula? Is there data that you're looking at? Like what's driving some of those? Is it market specific based on demographics? Like what is the thought process that goes behind that? Yeah. So I actually thought it was interesting. Justin Stein and Tanger, you guys had a great podcast.

26:34He talked a ton about merchandising and experiential retail and his view of the business. And I listened to that and I thought, man, it's different. We're in the same business and we come at it from totally different angles, right? Because he's got big centers that he has to fill and drive traffic into. And we think about the business completely differently. Experience and merchandising, of course, is important to us. What's more important is daily trips, getting people on site on a regular basis, right? The Tanger visits aren't nearly as frequent as your grocery store visits. And so it's a totally different approach to the exact same asset class, which goes back to the very beginning of the podcast when we talked about the fact that we all call ourselves retail investors, but we do totally different things.

27:14So the answer to your question is it is absolutely nuanced. So our investment thesis is we have to be able to visit any of our centers in that same day. So I can get on a Southwest flight in LA and I can be at any of our centers, spend the entire day there and then be back. The reason we think that local nuance is important is exactly what you're asking. What is the thing about that local area that is specific to that area that you can't learn from Google Earth, right? Is it a traffic pattern that you can't tell from Google Earth? Is it a right-hand, left-hand turn that you can't tell? Or is it just something in the demographics and the makeup of that local neighborhood that you need to be aware of so that you can merchandise, so that you can put that local mom and pop next to the grocery store that drives traffic and the people then go to the grocery store, put the groceries in the car, then run next door and pick up dinner.

28:03Like what's that thing that actually does create the cross shopping? Interesting things Lonnie and Haley that we saw during COVID that I was totally unexpected at the time, but in retrospect should not have been, is the fact that our mom and pop tenants tenants were the best tenants we had during COVID, right? They paid their rent. They called every day and they wanted to make sure that they were doing their part, working through this. We were partners in that. And that was so unexpected because in our business, when you sign a lease with a credit tenant, the thesis is it's financeable. The credit's there.

28:36They're always going to pay the rent. We don't have to worry about them. Well, actually that was flipped on its head when all of the credit tenants wanted to come back to us for rent breaks. And the mom and pops want, paid their cams, paid everything. So it kind of indirectly supported our investment thesis, not something we intended at all, but we realized, wait a minute, these things are way more durable than we thought, right? And then you put that next to a grocer. And by the way, those shop tenants, those will have your annual rent bumps in them, right? CPI bumps, 3 % bumps. So that's really where you get a lot of lift in your shopping center.

29:05And you mix that component with maybe the more boring grocer component, which is more stabilized from an income standpoint. You mix those two things together. And that's how you get kind of a stabilized that annual growth. To answer your question about merchandising. Yeah, I think my answer is it's nuanced, right? It's quick serve food has become a thing, high quality quick serve food. But if you're talking about a shopping center in West LA versus a shopping center in Salt Lake City, I'm gonna have a different answer for you because it's really gonna depend on the demographic. Yeah, I think I think we see that play out.

29:35And I agree with you 100 % on the local mom and pops during COVID. I mean, And, you know, you have, you know, in my experience, I teach at the university at Texas Tech University. I've been teaching for about 13 years. And it's really interesting how you get some of these like lifelong academics that are so theoretical that everything has to be credit, credit, credit, credit, credit. Everything in real estate is credit. But when you're when you're working with credit tenants, like it's great because you get the certainty at some level. But anytime there's a curveball, they're not set up for that.

30:04And they really don't care because they're running a larger economic engine where some stores may fail in their business model, and that's okay, but it's not great for you as the owner of that retail center. Whereas when you're dealing with mom and pops, like that's their livelihood. That's their business. That's how their kids go to college. That's how they pay their mortgage payment every month. And so it was refreshing to see kind of a resurgence of people's understanding that these local mom and pops actually are what drive community. and at some level I think part of this resurgence in grocery anchored and just some of the community strip center type of retail is people's realization that that eclectic combination of like super local married with some national credit exposure gets you the best results because you may be like a certain burrito place or taco place you're going to go there three or four times a month and that drives, to your point, that gets you that multiple visit type of experience.

31:01Whereas if you just had a large chain in there, it probably doesn't elicit the same type of response to some of the locals in certain markets. And so I think we've seen that play itself out. I don't think you're going to get lenders that are super on board with that. They still want the credit broadly, but I do think there's a mix that's required in order to maximize those local market factors. And so it's great to hear you guys were doing that as well. So maybe just a couple more questions and we'll finish up here. You know, we've talked a lot about nuance. We've talked a lot about some of the things that we think make this a differentiated asset class, et cetera, et cetera.

31:34What are some things that are, that you thought maybe were going to be easier or you thought maybe were more obvious that have proven to be challenging or that you've had to like figure out on the fly as you've gotten yourself into this business now for the last decade or two? So we spend a lot of time diligencing, and I guess this flows right from our mom and pop and national tenant conversation. When you're going to sign a 10 or 15 year lease, that's a long time, right? I think people forget that. It's a really long time. In fact, it's like a lot of people aren't even in the business that long.

32:06And so what you need to do is you need to do your diligence on the tenant, right? So if it's a credit tenant, it's public information, that's easy, right? The question gets more interesting when you're talking about tenants without public information or mom and pop tenants. So you need to diligence. If it's a little local restaurant, who's the chef, who's running the restaurant? Do they have experience? Are they in other markets? You know, what are their sales in other stores? If this is their first store, why do they think they can be successful in this location? What's their track record? Do they have a business plan?

32:33What are the financials standing behind the lease? So there's, I would say that part, we spend a ton of time on that, which if you would ask me 15, 20 years ago, if we'd be spending time on that, the answer is no. And the reason is, And I think you guys have talked about this a lot. That turnover cost is high. So if I'm going to spend a bunch of time and money and TI's doing a landlord build out, giving the tenants some money, signing a lease, legal cost, engineering, entitlements, all of the stuff to put a, let's just call it a 2000 foot tenant in there. I don't want to lose that tenant. The turnover costs are high.

33:05That space goes dark for six to 12 months. I got a lease that I got to pay another brokerage commission. I got to pay another. So we try to invest heavily upfront and put tenants in that we think can actually stay there for 10 years. And I've seen this big divergence in the business where a lot of landlords will sign 10-year leases, especially with restaurants, full well knowing that tenant's not going to be there in 10 years. And they're giving them big TIs because they're really cool chef-driven restaurants, and they generate the daily traffic, and it's really cool to talk about at cocktail parties.

33:35That's just not what we do. We're looking for durability. And so you really have to diligence how successful. And it's hard to do, right? It's very subjective. There's not a TREP type database where you can punch in the local burrito guy and figure out what their credit is going to be, right? Oftentimes, you're getting personal guarantees. So you've got to understand where that's coming from. So I would say that's probably unanticipated, but it's also part of the value creation is important. That's a great look back on kind of pulling the curtain back on just the reality, you know, because I'm with you.

34:07It's that's the part that that maybe doesn't pay on the front end, but does pay in the long run. And beyond just the turnover costs, which are very real, and those are hard, hard dollars, you get a psychological stigma at some level if you have constant tenant turnover in your centers where people are thinking there must be something wrong here or the management must not be very good at their job here because they're getting a new restaurant every year and a half or whatever like that, I would assume has some long lasting negative implications for the center. Yeah. And then I got to your point about debt.

34:35I need to go convince the lender now of that same story, right? Because the lenders ask, well, wait a minute, who's this tenant? And then you give them the diligence package and show them, hey, this is why we really believe in this tenant. And by the way, generally speaking, we've had a lot of success. We haven't received a lot of pushback as long as maybe that non-credit tenant is offset by some more credit in the center elsewhere. Yeah, I think that's where we go back to just the blend has to be right for the lender appetite. So last question here, Jim, and this has been incredible. So I really appreciate your insights.

35:03I mean, it's the reason we do these guest podcasts is really to bring people with real time experience, because we see the data at a high level, but you're living this every single day, right? And so, you know, you just spoke about some of the diligence and everything that you have to do. My last question for you is this, and it's maybe a little bit of a funny question. The elbow space in a retail center. Everyone knows what that is. It's not a funny question at all. It shows that you're a professor. So maybe give our audience that maybe don't know what I'm talking about. What is the elbow space and how do you deal with that?

35:40Are there some strategic things? When you see a center that has that, are you maybe a little less excited about it or do you guys feel like you can navigate it? Yeah, so for those who don't know what he's talking about, and he's being a little professorial here, he looks at site plans and he thinks when you're looking at a site plan that the building is shaped like an L, He's asking about that corner space that has very little frontage, pinched parking, and is almost unleasable. And the question is, how do you underwrite that? And the answer is, I have no idea. If we see a shopping center that has that in it, more than 90 % of the time, we're just not going to get there.

36:20Because that space should have never been built. And we've seen this movie so many times over the decades of that space. You know, everyone has a local karate studio who wants to take it or a destination mom and pop, you know, yoga tenant who can take it because their destination and they don't need the visibility. It just doesn't work out that way. Like retail is actually not that complicated. You need some parking. You need some signage. You need some visibility. And then there's some cross shopping involved in all of that. And if you are the tenant that has five feet of visibility in the corner, even if you have a 10 ,000 square foot space, it's just not going to work.

36:55It scares the heck out of us. And so we just try to stay away from it. But yes, you're showing your Texas Tech professorial skills. It's refreshing, actually, to hear that you kind of just avoid it, because I think it's I think there's I don't think there is a solution, a good solution. And the options that you mentioned are what everyone goes to is I always put a karate center in there. It's like, great. But they they put no work into the space. They're not a great tenant. And if anything goes bad, they could probably kick your butt if they had to. Practically speaking, we put a zero on it. So we'll bid on this.

37:25center. We'll just put a zero on it, which means we never buy it. Yeah. And then you hit on one other thing, and then I will turn this over to Haley, but I have a good friend of mine that develops retail centers down in the Houston market in Texas, and he has an acronym at his firm. It's called VAPS, and you just hit all of them. It's vacancy, access, parking, and signage. He's like, those are the four ingredients that are required for productive retail investment. It's not complicated.

37:50Jim Dillavou: Well, Jim, this has been incredible. Your themes of the nuance of retail, the need for durability, and your outlook have just been so clear here today. Maybe give us your one final take and share what gives you the most conviction in the retail space or what keeps you moving forward every day. So my frustration with this business has always been the amount of hyperbole and storytelling that's in this business. and it doesn't need to exist. Look, I understand the power of storytelling. We do it, everybody does it every day. I would say, make sure you're looking at the data because none of what we're talking about should be or is a surprise to anyone if you're actually looking at the data.

38:34And so what we try to do is spend more time most. And of course, there's a storytelling component to that and a conviction component to that. But history repeats itself. The pendulum swings, history rhymes, whatever phrase you want to use and overlay that with capital markets and then just the actual data from the retailers. And a lot of this is public, right? You can spend the time, especially now with AI, it's super easy to access. You can figure out expansion plans, you can figure out prototypes, you can figure out rents, but it's data driven. And so what I tell, and I do some guest lecturing, Lonnie down at SMU in Dallas on a regular basis.

39:10And I tell him like, just spend the time to get the data. And, you know, this is not a truck commercial, but like you guys do that. Like that data is available. Look at the data and then take a lot of the guesswork out of it. This is not a guesswork business. You can take the risk out of these deals. And I think that's what we try to do on a daily basis. So I guess that would be my final take.

39:29Jim Dillavou: That's great. I'm sure our listeners will have even more questions for you or want to reach out and see how they can work with you or your firm. So can you just share a good way for them to get in touch or learn more about Paragon? Yeah, sure. Just go to our website, paragoncommercialgroup.com, LinkedIn. We're all there. And just reach out. We'd love to hear from you. Awesome. Thank you so much, Jim. This has been incredible, as I said. And listeners, please reach out if you have any questions. We can also direct you to the team at Paragon. Thanks, Haley. Thanks, Lonnie. Nice to see you guys. So with that, we'll close this special podcast.

40:04Jim Dillavou: Thank you, Jim, for joining us today. Join us later this week as we look at what's happened during the week and how it may be impacting you. If you have a question or a comment, send an email to podcast.truck.com. Until then, visit truck.com for more info and subscribe to the Truckwire podcast with your favorite provider. Thank you for listening and stay well. All right.