Royal Oak Conversations – Matt Zappia

Welcome to the second episode of Royal Oak Conversations. This discussion features Matt Zappia, Royal Oak's Chief Operating Officer.

We're also excited to share that Royal Oak Conversations is now available on Apple Podcasts, Spotify, and Amazon Music. Please click to subscribe to the show in your favorite podcast player.

Transcript

Josh Foladare (Host): So before we start, I just want to remind everyone that this is for informational and educational purposes only. This should not be used as a direct solicitation to invest, or make any type of financial decision. Please consult with your advisor - tax, financial, and other - before making any decisions.

So welcome back everyone to our Royal Oak Conversations. This is the second, and again, what is hopefully a long series with partners, investors, employees, and others related to Royal Oak Realty Trust. Today, I am thankfully joined by our Chief Operating Officer, Matt Zappia. So Matt, thanks for joining us.

Matt Zappia (Guest): Thanks, Josh. Happy to be here.

Josh: So Matt, just to level set, we'll start with your background. I think a lot of folks listening may know you from their interactions with Royal Oak, but a lot won't. Just tell us, what you were doing before Royal Oak, and then what made that opportunity compelling to jump on board.

Matt: Sure. Thanks, Josh. I took an interesting path to Royal Oak. I was actually an accounting major in college. Actually had a teammate in college on the Penn State lacrosse team who had done an internship for Goldman Sachs in London, and when he returned from the internship, he told all the younger guys on the team: "The finance is the easy part. Accounting is the hard part."

So there was a whole group of guys in my class at Penn State on our team who, actually we were accounting majors simply because of this older guy who scared us in terms of how hard accounting was. So naturally when I graduated from Penn State, I went to work in the accounting world.

I started for, started with a regional firm called Resnick, Feder and Silverman, who actually had a strong exposure to real estate. And then actually moved on to KPMG in Chicago and worked in their advisory group. So in sum, I actually had about a 15-year career in professional services prior to joining Royal Oak.

There's a lot of people in the professional services world who, they provide information to business owners, and they help business owners make business decisions. But you always, when you're in that role as a professional services provider, you always crave being the guy, being a principal, making those decisions or, and so when I had an opportunity to join Royal Oak, being part of the team, being in the room, making real investments - investment decisions - that's what really attracted me to Royal Oak at the time.

Josh: Makes a ton of sense. And, and again, part of that background was on the valuation side of the world, right? So you actually - the fun story is you worked for the firm that did our valuation process, set that price, helped us set that price. Even before you joined Royal Oak, you were on the valuation side.

So you were familiar with Royal Oak, but once you got in and started operating in the business what was unique about the industrial real estate space that you hadn't really thought about before you joined?

Matt: Yeah, so I had mentioned my career in professional services, and coincidentally, one of my clients was, Larry Glazer and Dan Goldstein back in 2012 and '13 when they were thinking about setting up Royal Oak.

So in the early days, I was actually able to help them structure some of the fee paradigms and then also some board compensation, and actually helped out with the stock valuation also in the early days. But at that time I really viewed the business through a valuation prism as you mentioned.

And they kept saying to me, "this is meant to put together a collection of properties that would function like a bond for the most part, a bond backed by hard assets." The light bulb went off for me that if you can aggregate strong properties with strong tenants, it's even better than a bond because if something were to ever go wrong, you actually still own a hard asset, that you can then work to maximize its value and have a second or third life maybe beyond an existing tenant.

So I was always intrigued by the collateral value, the residual value, the underlying value that was really just a bonus to the bond feature of our product.

Josh: And that's, that's the day-to-day, for you is it's managing that underlying collateral and making sure that there's value, it can perform. There's a whole lot that goes into it.

What's the average Matt Zappia week look like? what are you doing? What are you managing on a day-to-day basis to help make sure that bond-like function can exist and perform the way it does?

Matt: So it's interesting because, we are a white-collar landlord, right? We're a net lease landlord, so we're not out plowing driveways. We're not cleaning snow off of a roof. So I often do get the question, "What is it that you do as a net lease landlord?" And there is a lot that we do. First and foremost, gathering information on all of our tenants is what we spend a lot of time doing.

So naturally, if a tenant is a public company, we're acting just like a Wall Street analyst would. We're reading the 10-Q. We're reading the earnings release. We're visiting the property. We're trying to make sure that our investment thesis stays intact, right? If we see a credit downgrade from a rating agency, all of a sudden there's some flashing yellow lights. What's going on? Is our thesis still holding?

And then we use those same tools for private companies. How do we do that? Our leases require our tenants to submit their financial statements to us, because for private companies, you obviously can't go on the SEC website and download audits, so we get them directly from our tenants So I use the term "gathering information."

So it's reading news articles about our tenants to the extent that they're in business journals. It's running credit ratios on their financial statements. It's picking up the phone, right? The power of the phone call cannot be understated. We'll call and say, "How are you doing? How's the business doing? What are you excited about? What concerns you?"

And through that process, again, we're testing and retesting our investment thesis and making sure that those assets can continue to produce long-term durable cash flow for Royal Oak.

Josh: And when I talk to Mark, again, that relationship building is such an important part of Royal Oak on the investor side, right? Again, people are doing business with us because they trust that what we say we're gonna do, we're gonna do. It's the exact same on the portfolio and property management side. So how do you guys think about those relationships? Obviously, we're a landlord. There is a professional relationship that needs to develop. But how do you think about that?

How can you make those become proactive opportunities to manage through a cycle of a lease and a cycle of a property that we might have in the book?

Matt: We always say we can handle any challenge as long as we know about it. And that's what keeps me up at night is what don't I know about, right?

So that's the point of picking up the phone, visiting properties, establishing relationships. It's cliche but it is so important. When I go visit a property, I always try and bring a Royal Oak hat with me, right? Handing someone something that they weren't expecting. Our logo's pretty, pretty unique. They love that. Sometimes I'll even give them our annual report so they can learn a little bit more about what we do. A lot of our tenants used to own the building, so they do understand what it takes to manage a building and take care of it properly.

But when they sell that building to us, those responsibilities don't change. They just have an extra stakeholder, that's really… we care about their business and the health of their business, and sometimes they ask, "Why are you asking these questions?" And I say, "We have a 20-year lease. I'm making a 20-year bet on the health of your company." And then the light bulb goes off because, then they understand, oh, wow, we really are long-term partners.

Josh: It's always striking to me when I get to visit properties and talk with operations folks or the owners if they're on site, and they're amazed at the care we put into those relationships and those conversations. But to your point it is a financial relationship. It's different than a bank 'cause we're betting on this massively long-term opportunity. So yeah, so we need to stay in touch and pay attention across the lease length.

And so that's probably the next question, and I know we can dive into what the triple net lease means, but typically we've got, what - 15, 20 year relationships on these properties - but at some point they become less than 10, less than five, less than three. How do we think about that process? Again, it's not something that we go to sleep and we buy it and 20 years later we wake up and hope for the best. Talk through that leasing process and how we think about renewals as stuff kinda gets towards the end of life.

Matt: So when a lease has more than 10 years remaining, there's a whole set of buyers out there that buy cash flow, right?

So when that lease gets below 10 years, there's a whole different pool of buyers because the lease is shorter and those folks may have to start preparing for some sort of potential non-renewal down the road. Then when a lease gets below five years, there's a different set of buyers. Then when it gets below three years, two years, one year, the buyer pool continues to change.

And as you would imagine, kinda risk and returns go up as the lease term gets shorter. So what my team is doing is we're making sure that if we're holding a lease down to a shorter remaining term, that we're comfortable that we're gonna get a renewal. We can't guarantee our tenants are going to renew, but we want there to be a high probability.

Or we have high conviction that if the tenant didn't renew, that we could find a replacement tenant within a reasonable period of time.

Josh: So talk through some of the levers that you can use to get those renewals.

Matt: I love asking tenants what their wish lists are. Is it a crane to move heavy materials around the inside or the outside of the building? Is it a generator, right? Because obviously power is very important to these manufacturing companies. Is it a larger door, roll-up door, dock door? What's your wish list?

And then just pause, let them tell you. And a lot of times we can help with that. When I say help, that's the lever, the tool you're talking about. Hey guys if we bought the generator, would you add five, seven, 10 years to the lease?

Sometimes they don't realize we can. It's a win for both of us. I can deploy more capital at the return our shareholders expect. I can help them improve the building and it keeps it off their balance sheet. It's win-win.

Josh: It almost makes too much sense sometimes. And you wonder why more people aren't coming to us to ask those questions. And maybe they will now after they hear this.

So we talked about the triple net lease. I assume most people listening are familiar. Dive into that a little bit and just talk about how that affects our property management process. What are we doing internally? What's handled externally? What's handled by the tenant? How does that work? Because it's not the same as if people listening own a duplex somewhere in the city and they're changing light bulbs and the flood comes and they get a call at 2:00 in the morning. It's a very different process. So let's dive into that a little bit just so people can understand what we're looking at daily.

Matt: The point of the triple net lease is for the landlord to really have no responsibilities. And when I say no responsibilities, I mean: the landlord's not gonna shovel your driveway, the landlord's not gonna pay the taxes, the landlord's not gonna pay the insurance. The tenant is actually going to do all those things.

So it makes it a very attractive passive investment where you're really buying a cash flow stream. From a property management perspective, a net lease landlord really is, in addition to what I had mentioned earlier about continuing to ensure your thesis is intact, you're monitoring to make sure the tenant made the tax payments.

You're asking the tenant to send in their insurance certificate so you know that they've paid for the insurance. You're sending engineers out to the property once a year to just make sure that the tenant's complying with the obligations that they have signed up for. So again, it's kinda, it's white collar, it's more compliance-oriented. And again, then there's the investment strategy part of it as well.

Josh: And we don't have to dive too much into that, but I think it's important to highlight the triple net strategy. It's consistent, but it helps us avoid the surprises we talked about. What don't you know? If a bunch of light bulbs go out or there's… We wanna know what's happening. But we don't have to worry about different cost outlays in different years given that's borne by the tenant. So that triple net strategy for us, we think about our durability, our consistency. That's paramount to making sure that can happen. So it's a really important feature of Royal Oak.

Similar vein, same idea. We're monitoring the properties. Some are doing better than others. How do we assess that, right? How do we tell if it's a good investment still, we like this property, we like the tenant? What tools are we utilizing to evaluate that situation?

Matt: Yeah. So we're, we're doing a lot of credit analysis, right? we're looking at leverage, we're looking at rent coverage, right? We're looking at, can the tenant pay their own banks and lenders and stakeholders. So we do maintain those ratings across, across the board.

And then rent collections are paramount, right? So you can certainly understand, the financial health or attractiveness of someone, but is that rent coming in? Is it coming in on the first day of the month? Is it coming in on the fifth day of the month? Our healthiest tenants all pay their rent early, right?

It may be due on the first, but they'll pay it five days in advance. It's so simple. It's such an easy tool to follow. The tenants that need a little bit more float, they'll pay on the fifth. So we always pay closer attention to those.

Josh: Talk a little about - I think it's the coolest thing that we do, for lack of a better technical term - and I think it's also one of the most important things you implemented when you first started was this scorecard that we have. Something we use before we invest in a property. It's something we use continuously after the fact. Talk a little bit about the scorecard, why we like it, and what it helps us do.

Matt: I was taught very early on in my career at some of the big four firms that I worked for to just keep it simple, right? Just cut through the complexity, keep it simple. And so we've created a scorecard to help us just distill down what makes our investments successful.

So our scorecard has four factors. They're very simple. They're observable. They're measurable. Factor one is the tenant's credit rating which we establish on our own.

Factor two is the, the market that the building sits in. There is a difference between, say, Albany, New York, and Columbus, Ohio, right? Both markets have pros and cons. We score those markets. How much industrial activity is there? What's the vacancy rate? What's the rent growth? All those factors go into the strength of the market.

The building's also not gonna get up and walk away. So your tenant may change, but your building's not gonna change, So that factor is very important in our scorecard.

Another leg of the scorecard stool is the actual functionality of the building, right? A building built in 2015 is gonna have a different functionality than a building built in 1960. We score that. That's measurable, right?

The last piece of the scorecard is the lease. Leases have different provisions. We negotiate our leases. There is a counterparty, so we can't completely dictate lease terms. So is there a security deposit? Is there a guarantee? You can score that. You can observe that. So those four factors when taken together, the credit, the market, the building, and the strength of the lease, that's the simplicity that I'm referring to.

If you can check those four boxes, it's very likely you'll have a successful investment.

Josh: It's my favorite way to present Royal Oak is the 30-second pitch to people. It's just we have a good tenant who's making money in a good functional building, a good active market, on a strong, landlord-protected lease.

If we do, we're good. That's all we're trying to do ultimately, right? And I think, again - there's more detail to that - but I do appreciate how you've distilled that down. That's what we're trying to do. That's what we're going after.

Again, the portfolio's performing well. This is not to say things are exploding, but Matt Zappia gets into the office, he opens up his email. What's something that can go wrong that people don't think about that really is something we have to manage through and think about on a day-to-day, or maybe not day-to-day, but week-to-week, month-to-month basis?

Matt: So our tenants operate in different industries, and there's different economic cycles. Some industries benefit, some do not. So sometimes we will see, tenants who actually have maintenance that they're supposed to do on the building. It's just it's not in their capital budget, right? Or maybe it was, but they just can't allocate capital to that. That's something that our property management team spends a lot of time on.

We want there to be communication. We want the tenant to reach out and just say, "Hey: This was in our budget this year. We're having some cash flow constraints. How can we work together to make sure that this work still gets done? But recognizing that, again, we need a little more time."

We generally - as long as there's a plan and there's communication and the integrity of the building is not being compromised in any way - we're generally on board with working productively with a client, or a tenant.

Could there be a situation where a tenant didn't have the money for a very important repair? There could be and then that's where we would actually probably step in and do the work to protect the integrity of the building.

Josh: And that's something that, again, we can get reimbursed. We can bill that back. It's not a thing that we have to bear on our own. But yeah, we wanna make sure that things get taken care of.

Zooming out, 'cause I think we didn't double-click it when you mentioned the scorecard. It's not graded per se, but a huge piece of your job, of our business is diversifying that portfolio. You mentioned it super early on, right?

That was Dan and Larry's goal was to have this diverse book of properties that function like a bond. What does diverse mean to us? It's a word you can use in a bunch of different ways. What does it mean, and then how do you guys make sure - and you guys is pretty royal you - make sure that's happening in the portfolio?

Matt: First and foremost, the way that I counsel my team to look at investments is we need to make sure each investment stands on its own merits. If we don't believe that a single investment still fits in the portfolio, we will look to dispose of that asset and recycle that capital.

But assuming that an asset still meets our criteria, the investment thesis is intact, and you combine it with dozens of other investments who have a thesis we still believe in, I think that's really where the diversification occurs. And then you're in a very healthy situation where if something does go wrong, you have the rest of the portfolio to till, to still support the dividend.

And again, this all goes back to dividend sustainability, managing risk. We also, when we talk about diversification, we want diversification of tenant industries, okay? We have tenants who operate in the packaging industry. We have tenants who operate in the food service industry. We have tenants who make sporting equipment. That's another element of diversification that we really do focus on.

One of the industries that we've moved away from in recent years is automotive, right? We felt like that industry was really under a lot of pressure, so maybe if you went back five years ago, maybe we had four auto-related companies in the book. Now we have maybe one. So we don't mind a little exposure, but we want diversification, we wanna manage concentrations. Those go hand in hand.

Josh: That makes a ton of sense. I think one of the biggest pieces for us is that we can't be trend followers, right? We can't look and just see what's in the news today and only do that, right? We have to be a little agnostic and just go out and buy good buildings again with good businesses that can function no matter what's in the news, right?

But things are in the news. Manufacturing is important. Tariffs now, there's wars, there's a whole lot going on that could be concerning. What are you focused on right now? And it can be broader macroeconomic ideas. It can be just operationally within our portfolio. What's the focus from the operations side of the world?

Matt: Certainly as we just talked about, certainly managing concentrations, continuing to increase diversification. That's just table stakes. Let's be honest, that's table stakes.

But one of the things that I'm focusing on right now is this emerging defense super cycle, okay? So when I talk to our tenants who operate in the aerospace and defense industry, the last four or five years they've been treading water. In 2026, they're on a rocket ship. Their backlogs have gone through the roof.

Do we want a, global wars to continue? No. But it's like I mentioned earlier, there are some tenants who do benefit from that. And those tenants again, are really expecting to propel earnings in the short to medium term.

And just, I think it's, I think it's natural and logical to think that yes, defense will be an important part of the future of our country as it has been for a long time. Yeah. And we don't wanna be over-weighted in defense in any way, but it is an industry we do expect to benefit in the near term.

Josh: So thinking of what we're paying attention to in the news, there's also been talk of slowdown in development, issues with some of maybe the larger platform build-outs for warehousing and distribution. That's made people spooked, I think broadly when they hear the word industrial. That's not the space we play in.

Just spend a little bit of time talking about the type of building that we buy, because I think that's what makes us unique. And I think it really adds a lot of value to the investment, but also adds a lot of specificity to what you guys are doing every day.

Matt: I'll joke just for a second, my kids think I sell houses. You say you work in real estate and "Oh, you sell houses?" "No." And then, when I talk to other people who maybe don't work in this, in finance or, or real estate, they instantly think that you build Amazon warehouses. I don't sell houses, and I don't build Amazon warehouses, right?

What we do is we really invest into the middle market of industrial, right? Think about, 100,000 square foot Class B, Class A minus industrial facility. That's really what Royal Oak focuses on. Because of inflation it's been really, it's been too expensive and not cost-effective for the country to keep up with industrial demand for buildings of that size.

Everything that's being developed is, they call them the big box, right? The million square foot. That's not what we do. Those assets price at cap rates that are, 5%. We're a core plus product, so we're investing in the smaller buildings.

Again, our tenants are the backbone of America. We always talk about that. But these buildings are difficult and expensive to recreate, which is a huge part of our investment thesis. Because it's just not cost-effective to build a hundred thousand square foot building.

Josh: No, it's the question we get a lot, and it's the question I think I feel maybe the most confident in answering is: what's the downside of something like this? And right now that downside, knock on wood, it's pretty minimal. We're seeing the buildings that we buy fully leased, they sell vacant for nearly 90% of that value. In some cases more than we bought them for fully leased. And there's a lot of protection because of the asset class that we play in, and there's not a lot of new stocks. It's been a nice place to be.

Matt: And just maybe one more comment on that. We have buildings we bought 10 years ago for $40 a square foot. Those may be insured at $150 a square foot. Now, insurable value isn't always what you would sell an asset for. But think about that. That's almost $100 of increase per square foot in replacement cost or insurable value. That is directionally correct in terms of what we've seen in terms of the demand, for our own assets.

Josh: And that's the benefit again of having a very consistent investment thesis, buying assets for the long term, and then letting the value accumulate. The value is our ability to compound over time. It's not the quick spurts. And it's nice to see that has played out over time.

Matt, before we let you go, last question, maybe the standard closing question. To be determined, there's only been two of these, but what is getting you excited right now about Royal Oak? What would you want someone to take away from this if they're listening and hearing about us for the first time?

Matt: We have so much momentum. Royal Oak is at a huge inflection point. We just hit a billion dollars in assets, okay? But one of the reasons I say we have so much momentum is two words. It's repeat business.

We have tenants who value their relationship with us so much that they're asking us to go out and find them new buildings in new markets that will fall under the same lease program that we currently have with them. So they view us as a valuable partner.

We have brokers. We've closed transactions with all the major net lease brokers in the country, okay? We have folks who are bringing us transactions now before they hit the market. That wasn't happening 10 years ago. It's taken a long time to get into that zip code of status.

And then we have investors adding to their positions because they just really appreciate what we do. And we do what we say we're gonna do. So the repeat business across many aspects of our business is just giving us so much momentum right now. And I'm so excited to see where this goes over the next several years because this really could become even more special than it is today.

Josh: I love it. It's an exciting time to be a part of Royal Oak for sure. Matt, thanks for joining.

Matt: My pleasure.

Josh: Appreciate the time. Appreciate the information. It's been fun.

Matt: Thanks, Josh.