In large part, the investment strategy of ElmTree Funds LLC, a private equity real estate firm based in Clayton, Mo., aligns with the millennial mindset.
ElmTree Funds focuses on single-tenant net lease properties occupied by investment-grade tenants (such as Caterpillar, FedEx, GE and United Technologies) in the industrial, office and health care sectors. ElmTree’s funds draw investments from high-net-worth individuals, family offices and institutional investors.
The firm’s industrial properties largely serve the millennial-propelled e-commerce movement, while its office properties seek to appeal to millennial workers and its health care properties fit the millennial-driven mold of quick, convenient medical treatment.
The ElmTree Funds portfolio comprises 64 total properties, with $1.4 billion in assets under management. In 2017, ElmTree Funds forged a $950 million joint venture with China Life Insurance Group comprising 50 single-tenant properties. ElmTree Funds retains a 5 percent ownership stake in the JV properties and continues to manage those assets.
Jim Koman, founder and managing principal of ElmTree Funds, says his firm concentrates primarily on industrial properties, and secondarily on office and health care assets.
“We think these are going to be the drivers for real estate, especially net lease, over the foreseeable future,” he says, adding that the firm avoids the highly competitive and “finicky” retail segment.
In a Q&A with NREI, Koman explains his firm’s specialization in net lease properties, its approach to buying industrial assets, its take on the office and health care sectors and its emphasis on cultivating and maintaining relationships.
NREI: Why does ElmTree Funds have a singular focus on net lease properties?
Jim Koman: For us, it’s all about the predictability and the certainty of the yield. When you look at what has gone on in the past economic cycles of real estate, a lot of people at the end of the day look in the rearview mirror of 2007 and 2008 and how that transitioned not only the country as a whole and the economy as a whole, but also real estate as a whole. The way that we looked at [it], in talking to our investors coming out of that cycle, people really want to go to sleep (soundly) at night.
When you look at the household names that we’re investing in and having the corporate guarantees and the predictability of net lease, that allows investors in today’s world to know that they have a 15- or 20-year obligation from some of the best Fortune 50 or Fortune 100 companies in the country. That is a good, diversified portfolio investment that you can make and not worry about it; that’s what net lease can do for you.
NREI: As you look at net lease properties, what are you seeing that’s performing well and that should be on the radar of high-net-worth investors and family offices?
Jim Koman: We all know that industrial is performing extremely well due to the growth of e-commerce, and we think it’s going to continue. That’s driving a lot of opportunities across the country. The whole retail landscape has changed dramatically and will continue to do so with the access and ease of the internet.
Now, the supply of large industrial warehouses out there that serve the needs of these modern e-commerce tenants just can’t keep up with the demand. Once somebody puts a large facility on the outskirts of a market, they typically start looking for the “last mile” opportunities. These are typically smaller industrial facilities in well-located places in top primary and secondary cities across the United States. This is going to drive strong annual rental growth for these properties, which is going to keep providing attractive returns for investors for the foreseeable future.
NREI: How do you prevent your firm and your investors from getting burned by an oversupply risk in industrial and by so much capital chasing industrial assets?
Jim Koman: Every time a market seems or appears to get overheated, it creates a cause for a pause in the marketplace to really look at that opportunity or that investment thesis, and make sure that you’re falling back to your real estate fundamentals. Is it the right location? Is this irreplaceable real estate? Is the tenant credit going to be strong enough to weather various economic storms? How important is this operation? What is the strategic importance and mission-critical nature of this asset?
As an investor, you have to ask the tough questions and you have to be picky. You can’t overpay for property today, because that’s where people fall into this trap of, “Hey, I’m paying the highest price for this real estate. It’s going to be great.” But as time goes on, those highest prices or those rents that are way above market can come back to haunt you 10 to 12 years down the road because the rest of the market doesn’t catch up. And when that tenant exits that location, that results in the downfall of that asset. You have to have sensitivity to your underwriting and your analysis to make sure you don’t bite off more than you can chew.
NREI: What are your thoughts on the office market?
Jim Koman: There’s a strong demand for modern offices and collaborative workspaces that fit the millennial criteria. We believe that over the next five to 10 years, as boomers retire, control of the workplace is going to change over more and more to millennials, and we have to be able to understand how they think and how they want to operate and where they’re at their “happiest point” in the workforce. We take that thought process into our build-to-suit office buildings—making sure that this fits our model, that we are building something that is going to stay in place and be leased up for the next 25 to 40 years, even though we’re signing 12- to 15-year leases.
NREI: And what are your thoughts about the health care market?
Jim Koman: You’ve got Level 1 trauma facilities across the country in which major health care systems have a lot of investment, but they’ve got to reach out to the suburbs, so they create a hub-and-spoke model. You’re looking at health care systems that are out there building bricks-and-mortar, whether it’s a freestanding urgent care center or a micro-hospital. This is a shift toward modern health care delivery, where you’ve got shorter wait times and better service. And should the consumer get sicker, they can be referred to that Level 1 trauma facility, where they have the connectivity back to the doctors and medical staff at these urgent care/retail facilities that we’re investing in.
NREI: How do you decide who to forge joint ventures with and who to do business with?
Jim Koman: Having readily available capital to put to work, we’re kind of at the beck and call of some of our partners, where, on a deal-by-deal basis, they may be looking only for a capital partner, they may be looking only for a takeout partner, they may be looking only for a joint venture.
What we want to do is constantly maintain relationships. For us, this is a relationship game; we believe we’re in it for the long run. In our mind, if there are certain needs—and those needs do change from quarter to quarter—we want to be flexible, we want to be entrepreneurial. We’re extremely opportunistic, but we want to make sure we’re always getting that first or second call from those relationships and partnerships that we have, which in a lot of cases go back 15 to 20 years.