Matt Innes is the managing director of ElmTree Funds, a private equity firm that specializes in investment and development of net-lease industrial space. Innes has been sourcing capital from high-net-worth individuals and sovereign wealth funds from Asia and the Middle East as ElmTree has grown to be one of the prime players in industrial real estate across the Southern and Midwestern U.S.
ElmTree’s tenants include several Fortune 500 firms, and the company has initiated a unique fundraising strategy over the last decade or so, with funds that have captured $250 million, $350 million and $880 million, respectively. Innes sat down with CO to discuss his investment strategy and how he secures foreign dollars.
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This interview has been edited for length and clarity.
Commercial Observer: Can you tell us about the origins of the firm?
Matt Innes: Going back to 2003 is the real genesis of ElmTree, and our predecessor company, Equity Capital Management. Our founder, James Koman, started the business and solely focused on the net-lease space in the Midwest. We were the preferred developer of Walgreens out there. It was about to go public and Reality Income Trust, the largest net-lease real estate investment trust [REIT] bought it pre-IPO. Then the financial crisis happened and Jim saw it as an opportunity to create a net lease business — where we effectively sit as the balance sheet or the financing solutions for these developments.
We sit between the regional developer, and the tenant, and we facilitate the transaction by providing the balance sheet capital via equity or debt, usually both, and facilitate the construction of these assets. Over time, we migrated and changed our strategy — we used to do office, industrial, retail and medical office — investment grade and non-investment grade — but today we’re solely focused on the industrial investment grade space.
What has been your investment strategy since we experienced the interest rates upheaval beginning in 2022?
Our investment strategy hasn’t changed. If anything, we’ve doubled down and focused more on our core competency and narrowed our bandwidth. With some strategies and managers, who are looking to expand their capital base, they go further afield, but we’ve solely focused and narrowed our aperture to stay in the industrial build-to-suit space. On the net lease side, there’s been a sea change in the structure of the leases, which comes with fixed escalations, or contractual rent increases. Historically that sat at 1 percent or 1.5 percent, and today we’re getting somewhere between 3 percent and 4 percent [annual] escalations.
If anything, the corporate equivalent bond [the 10-Year Treasury], the proxy moved with rates, so we’ve been following that closely, but by and large, we’re still acquiring assets where we were previously, and still deploying capital. We haven’t had a lack of opportunity, that’s for sure.
Industrial is a big asset class. What are the specific types of assets you acquire?
The assets that we focus on are industrial, so think about the distribution, manufacturing facilities. We’re not out there speccing development or tying up land prior to developing assets. These are often tenant-identified or developer-identified assets. Where we sit at the nexus of the tenant relationship and the developer relationship — that’s where we step in.
We’re not in the construction business on a speculative basis. If anything, we are led to the opportunity, though oftentimes we dictate the opportunity, but it’s more driven by tenant demand and the needs of where they’re going. The onshoring and reshoring narrative is certainly playing out across the border states, but there’s tremendous opportunity on the consumer side and consumer branding side of Fortune 500 companies domestically [for industrial].
Ultimately, it’s the “smile states,” the Southern and Western half of the United States, is where most transactions we’ve been having fall. And also in the Midwest — just from a tri-mobile opportunity, from a distribution perspective, being in industrial, you’re thinking about, “How can I access the majority of our population by rail, by, freight or by air?”
What’s it like sourcing capital from other countries, primarily the Middle East?
You have to be committed to spending time on the ground. Real estate is still a relatively opaque, interpersonal-focused sector, and as a result, people invest with those they have relationships with. When you go abroad, you have to be willing to show up and spend the time consistently as an individual and as a brand for recognition, as some of those largest markets over there are very brand-focused and specific. So you have to be willing to commit lots of time, effort and travel. We have a consultant in South Korea who spends time there. And then in the Middle East — the UAE, Kuwait, Bahrain, Qatar — we have relationships there that have been existing for a long period of time, and it’s a natural gravitation.
Our evolution and maturation, as a firm, is that we’ve gotten to a certain size and scale, and we’ve become more relevant for those investors, and that’s something we’ve started to take advantage of over the past 18 months.
What are the benefits of sourcing capital from sovereign wealth funds?
When you’re thinking about sovereign wealth funds, they’re the largest investors in the world. Oftentimes, we’ll only look at funds of a certain size, because of investment limitations and restriction, they can’t be more than X percent of an investment structure, generally its 10 or 20 percent, and they want to invest in $100 million increments, so your fund that you’re looking to raise has to be over $1 billion.
Then on a direct investment side, oftentimes they have a direct investment business, as well, due to size and scale of how they deploy capital. So they’re trying to balance having direct investment holdings and doing fund investments. From a tax structuring perceptive, you have to be very aware of how to structure things, whether that’s creating offshore theater vehicles through the Cayman Islands or Luxembourg, or creating a REIT class or a REIT share — so you’re selling REIT shares and not the undying assets to trigger different tax structures — that’s more [IRS Section] 892 [foreign] investors, or the largest echelon of sovereign wealth funds across the world. So those are some of the considerations you have to bring in. Being in blind pool, commingled fund business, if you’re doing REIT shares, that’s harder, which is why those investors do joint ventures, but as an 892, on a direct basis, they can only be 49 percent, they can’t be in a majority control position.
So, if you’re looking to do a joint venture, you need to find matching capital for them, and that can oftentimes be challenging. But they often travel in herds or a pack, and they do business with each other a significant amount of time.
How do international investors view the U.S. regulatory environment?
When I was in the Middle East in September, there was an interesting conversation going on with regulation and what’s happening domestically with different political outcomes [regarding the 2024 election]. Now that that’s been decided, we’re still the market of choice for investors. The U.S. is one of the most transparent markets from a real estate perspective in the world. It’s still viewed as the cornerstone or the main arena of investment, especially when you think of different asset classes. It’s still seen as the largest opportunity from a capital markets perspective.
From a regulatory perspective, it’s seen from a macro level and a micro level, and it depends on which geography or sector you’re in and how you’re looking to evaluate opportunities. There’s some states where development is cost-prohibitive because of regulator burdens, or it takes an increasing two- or three-year period, whereas for us, being in industrial built-to-suit, our construction timeline is limited.
If that’s the case, then how have you differentiated yourself as a firm?
From ElmTree’s perspective, we get involved much earlier in the life cycle of these assets. Being in the build-to-suit space, we structure things efficiently enough so there’s appropriate protection from a development perspective. We do development, but it’s much more downside protected. And when you think about the competitors in net lease space for us, from an investment manager perspective, it’s the Blue Owl Capitals, the Angelo Gordons, the New Mountain Capitals. Our return profile is different — we’re value-add and they’re slightly lower in the 10 percent to 12 percent range. And I think we’ve done a really good job of being a first mover and creating relationships that are durable and transferable across organizations. We move with individuals to different developments and different corporations.
I would also say, the nuances of our conversations and relationships are more tenant-driven and tenant-specific because they want us involved and they have us around as the landlord of choice for their industrial build-to-suit. One other thing that’s unique is our ability for sustained capital and deployment. During periods when transaction volume has been muted, I’d argue that we’ve been able to stay disciplined by continuing to invest capital at a measured pace with very strong returns.
How has the industry evolved in your career?
It’s become one of the darlings of the real estate sector. The “beds and sheds” narrative [residential and industrial] continues to win the day, and I’d argue that most firms, on a diversified basis, have focused on beds and sheds. For most investors, it’s one of the most meaningful sectors within their underlying portfolios. The narrative has also expanded, and it depends how you want to play it: from market-to-market perspective, from development perspective to a last-mile industrial perspective, there’s also a commentary where it’s seen as a proxy to the retail market — you see retailers have become more knowledgeable and educated of where they need to have their distribution nodes to access consumers as quickly as possible, and you’re seeing the play out on evolution of the cold-storage side.
The industrial sector is slowly starting to migrate out and expand beyond bay and warehouse to become specifically used and purpose. The big evolution is the automation and technological implementation of these assets today. Also, the average age of industrial assets in the U.S. today is 46 years old, so retrofitting is more important than ever.
Brian Pascus can be reached at bpascus@commercialobserver.com