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Is Industrial Outside Storage the Future of Commercial Real Estate?

How to Scale Commercial Real Estate

Release Date: 12/13/2023

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More Episodes

Today’s guest is Matt McLennan.

 

Matt is an industrial CRE broker in the PNW with multiple running years top producer status and specific knowledge of IOS marketplace.

 

Show summary:

In this episode Matt McLennan explains the benefits of IOS, its impact on the industrial market, and how it is influenced by port activity. He also discusses the challenges in valuing IOS sites due to lack of data and the importance of local market knowledge. Despite current market uncertainties, McLennan sees opportunities for investors in IOS properties.

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The Industrial CRE Market and Tenant Base (00:00:00)

 

Matt McLennan's Background and Career Journey (00:01:00)

 

The Current State of the Commercial Real Estate Market (00:02:18)

 

The rise of industrial outdoor storage (00:09:05)

 

Size and value of IOS properties (00:11:10)

 

Market research challenges for IOS (00:14:14)

 

Tech advancements in industrial outside storage (00:18:23)

 

Impact of port activity on industrial outside storage  (00:19:32)

 

Uncertainty of cap rates in industrial outside storage (00:21:34)

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Connect with Matt: 

Linkedin: https://www.linkedin.com/in/mattmclennan/

IG: @mattm.cre

Twitter: @MattmCRE

TikTok: @mattm.cre

 

Connect with Sam:

I love helping others place money outside of traditional investments that both diversify a strategy and provide solid predictable returns.  

 

Facebook: https://www.facebook.com/HowtoscaleCRE/

LinkedIn: https://www.linkedin.com/in/samwilsonhowtoscalecre/

Email me → [email protected]

 

SUBSCRIBE and LEAVE A RATING. Listen to How To Scale Commercial Real Estate Investing with Sam Wilson

Apple Podcasts: https://podcasts.apple.com/us/podcast/how-to-scale-commercial-real-estate/id1539979234

Spotify: https://open.spotify.com/show/4m0NWYzSvznEIjRBFtCgEL?si=e10d8e039b99475f

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Want to read the full show notes of the episode? Check it out below:

Matt McLennan (00:00:00) - Think of iOS as things that need to be stored over time, but don't necessarily need to be under a roof. And that's that can be trucks, that can be containers, that can be metal piping, that can be your plumbing contractors, 30 fleet vehicles that he needs to park somewhere. Um, all that stuff. That's kind of part of doing business and all these other sectors. But iOS is attractive, especially for call it the tenant base, because, you know, paying for space under roof is exponentially more expensive than paying for just, you know, a gravel lot. Welcome to the how to scale commercial real estate show.

 

Sam Wilson (00:00:36) - Whether you are an active or passive investor, we'll teach you how to scale your real estate investing business into something big.

 

Sam Wilson (00:00:45) - Matt McLennan is an industrial CRE broker in the Pacific Northwest. He has multiple running years as a top producer status and has specific knowledge of the EOS marketplace. Matt, welcome to the show.

 

Matt McLennan (00:00:58) - Thanks for having me, Sam. Glad to be here.

 

Sam Wilson (00:01:00) - Absolutely, man. The pleasure's mine. Matt. There are three questions I ask every guest who comes on the show in 90s or less. Can you tell me where did you start? Where are you now? And how did you get there?

 

Matt McLennan (00:01:09) - I started falling into commercial real estate by happenstance. Hung out with some buddies. I was working a different career and they they talked me into coming here. So I showed up, didn't know what to do or how to do it, but I just cut my teeth and started, you know, working as hard as I could to figure it out. Uh, fast forward to today. It's been seven years, and, uh, things are going great. I'm still learning a ton, but feel like I've got a good knowledge base under myself. Great client base. It's an awesome industry and things have been really good so far. So just trying to keep that train running and and looking ahead really, it's it's continuing to take care of my clients, build the book of business and keep up with this market.

 

Matt McLennan (00:01:46) - I mean, it's been changing a lot. So that's, uh, that alone will keep you busy.

 

Sam Wilson (00:01:50) - Absolutely. You are coming off the tail end of a bull run there in space. So tell me where we are today. For those of you who are listening for recording this on November 7th, 2023. So when this airs, it might be 60 days later. And hopefully things don't change that dramatically in 60 days. But you never know. So just to get a time stamp on this here, but tell me, uh, you know, tell me about I guess maybe you can go back and give me the seven year run up to the day.

 

Matt McLennan (00:02:18) - I started in 2017, and we were already on the call it upwards inflection curve when I started. So admittedly, all I've ever really known is a good market. Um, the old guys in my office and industry loved to remind me of that. And with that in mind, though, I mean, things are changing, right? And I think anybody who's been paying attention, you can pinpoint exactly when that change came.

 

Matt McLennan (00:02:39) - And it was that first interest rate hike back in early 2022. So we've been in this new environment for the better part of call it 18 ish months. And what does that environment look like today? Um, keep in mind I work specifically on industrial commercial properties, albeit I keep a good pulse on the entire commercial real estate industry. As an industry, all things considered, I think we're actually in pretty good position. The only one I could sit here and knock would probably be office space, you know, large high rise offices and a lot of the metros and core markets. But setting office aside for a minute because that's a whole nother conversation. Most of the product types are doing pretty well. Leasing activity is generally healthy. It might be down here and there. I feel like it's down a little bit in the Puget Sound region where I'm at. Um, values are questionable. And why I say questionable is with the new cost of money via these rising interest rates, everyone's trying to figure out how to make investments, particularly pencil.

 

Matt McLennan (00:03:39) - And that's really hard to do right now when we're in this changing environment. So we've seen transaction volume fall pretty dramatically. And so and cap rates are a big question mark, which is another, you know, typical measurement of investment performance. Right. And so we're kind of just in this flux time at the moment where everyone's sitting a little bit on the sidelines. It's still very interested and eager to participate in the market. Not sure how to participate in the market. So I'm spending a ton of my time educating my clients and trying to give them some of those kind of what I'm seeing at the ground level and some advice. But really, put very simply, at this date, you know, in November of 23, we're all just kind of sitting, sitting and watching and seeing how this whole thing is going to play out. Right?

 

Sam Wilson (00:04:19) - Absolutely. Yeah. It's uh, certainly I've seen a lot of capital sit on the sidelines as well. So you just it's it's kind of a wait and see game.

 

Sam Wilson (00:04:26) - I was even having a conversation with somebody yesterday and they said the same thing. They're like, well, we're just selling stuff off and really going to sit and watch and just kind of, you know, see what happens. So that's that presents an interesting opportunity, though, does it not for those that want to participate in the market right now and if so, big time that.

 

Matt McLennan (00:04:43) - We were talking about this this morning. Actually, it's a good timing for your question. Debt has been the driver of all investments. If we're talking investments specifically, right? I mean, we all have our performers and and it's it's I want to say it's not simple, but it's not overly complicated to figure out if something's a good investment or not. Right. Based on your, your underlying investment criteria. But that's the big question mark. Right. And so what I'm looking at right now is there's a lot of properties that I believe based on that are being evaluated on current debt or the ability to go get future debt on that.

 

Matt McLennan (00:05:18) - And that's driving the value down. For example, the office building that I'm sitting in today, it's one of the better performing office buildings in our downtown market. I think if it were to sell today, if they needed to sell today, it would sell below replacement costs. And it's a great building. And but part of the problem with that is the appetite to invest in a downtown core office building. I mean, sounds scary, right? And and banks think it's scary, um, big, you know, call the biggest investors life insurance, pension funds. They think it's scary because no one knows what the future of office really looks like at this point. So but for those who have a plan and kind of have foresight, I think, into the future, I think there's going to be some fantastic opportunities to pick up property below. Realized value. Value is always measured at the point in time. Right. And and so you could argue that you're paying today's value for said property. But I think things are going to appreciate if you can pick up some of these, these properties now at kind of what I think is current or under realized value, I think appreciation in the future is going to be pretty good.

 

Sam Wilson (00:06:24) - It is. And it's interesting, I think about this a lot. And again, I don't have like the data in front of me to to substantiate this claim. But certainly real estate in the 60s and 70s was a lot cheaper maybe than what real estate is today. And it's like, you know, and of course, you know, most of us don't have a 60 year time horizon for an investment to become a, you know, to become meaningful. But it still just kind of proves your point where it's like, hey, you know what? If you can buy today? And I also think part of this is, is the, you know, the inflation of the dollar. Like, if you're able to borrow today in dollars and repay and dimes over the next 25 years, I mean, I don't think anybody's predicting that the dollar is just going to have some miraculous bull run in value in the near term or even long term future. So sure. Anyway, that's a it's but that's kind of obviously theoretical.

 

Sam Wilson (00:07:12) - And, and uh, you need to have just a little bit more, um, courage probably now to, uh, get out there and keep acquiring. So yeah, I like that. I really like that. That's let's talk a little bit, um, the types of industrial. This is a question I had for you, and it's kind of a loaded question because again, here in Memphis, industrial is incredibly hot. But I had lunch with two industrial brokers last week, and we were just talking about the types that are leasing. I want to hear what it's like in your neck of the woods, the type of type of stuff that is still, uh, highly in demand.

 

Matt McLennan (00:07:43) - Yeah. So the Puget Sound market is comprised primarily. If you look anywhere on the map, everyone thinks of us as Seattle and Seattle specifically. We have two ports here. It's the Port of Seattle and then the Port of Tacoma. Tacoma is a sister city to Seattle, about 35 miles south. And a lot of our industrial activity happens between those two ports.

 

Matt McLennan (00:08:01) - And because we're a port driven market, uh, we're a heavy distribution market. So think containers coming in overseas, those containers are getting picked up the ports, they're going to these warehouses. The product is coming into the warehouse being stored eventually, then go elsewhere, whether that's local or anywhere else in the country. So we're a heavy distribution market. We have a pretty good manufacturing presence as well. Um, Boeing has always been probably one of our top, one of our top employers up here in Washington state. And consequently, I mean, they have a huge manufacturing base. And then there's a lot of those subcontractors of Boeing that also occupy space and have manufacturing jobs. So I'd say we're distribution first, manufacturing second, uh, one sector that I spent a lot of time in is, is what we commonly referred to these days as EOS, which stands for Industrial Outside storage. iOS is basically a derivative of port activity, probably at its at its finest. And really what that means is it's think of iOS as things that need to be stored over time, but don't necessarily need to be under a roof.

 

Matt McLennan (00:09:05) - Right. And that's that can be trucks, that can be containers, that can be metal piping, that can be your plumbing contractors, 30 fleet vehicles that he needs to park somewhere. Um, all that stuff. That's kind of part of doing business and all these other sectors. But iOS is attractive, especially for call it the tenant base, because, you know, paying for space under roof is exponentially more expensive than paying for just, you know, a gravel lot. And consequently, the investor base called at the institutional level the again, the pension funds, the life insurance companies, the REITs, they've started to take notice of this iOS sector, which has been really interesting to watch. Because it's almost funny because iOS is not new. I mean, there's always been semi-trucks have always needed a place to park. Containers have always needed a place to live outside of the port. Um, but what the investment market figured out, and I've taken advantage of this a little bit personally, too, is that owning these iOS sites, the barrier to entry is relatively low because you're kind of paying land value or slightly above land value.

 

Matt McLennan (00:10:05) - If there's some improvements, the maintenance a.k.a the money that goes into tending the property pretty minimal. I mean, a lot of them, it's fencing, gravel, lighting. Maybe you have a small building on there that you need to maintain, but it's not like going and buying a piece of land and building a new concrete, you know, tilt warehouse. That's pretty exorbitantly expensive. Um, so a lot of people and then meanwhile, the rents have gone up pretty dramatically because tenants need this space and the institutional money has come in and driven rates up as it typically does. So in any event, that's that's been really interesting. But I think if you pegged to answer your question simpler, Seattle's market, it's it's distribution tenants. It's manufacturing tenants and it's iOS groups. That's that's kind of the meat and potatoes of our market.

 

Sam Wilson (00:10:48) - iOS. This is a fun conversation. I've got many, many questions on this. So yeah, I mean how do you let's let's start with the size of properties that were typically seeing people use this for maybe maybe we'll start there.

 

Sam Wilson (00:11:01) - And then I got two questions on how you value these. Um, you know where they're located, like you said, maintenance I got. Yeah. So let's start on size and how you value them.

 

Matt McLennan (00:11:10) - Size is probably it can vary quite a bit. Um, I'd say the sweet spot is kind of 1 to 5 acres. That's where let's use the 8020 rule. Probably 80% of the tenants live in that 1 to 5 acre space. And and frankly, leaning towards the smaller side. Um, but part of that smaller side has to do with where rental rates have gone. And, and so tenants can't afford these huge yards. There are a lot of them that want to lease, you know, these mega yards think like the big the the Walmarts, the masks, the use and logistics, the targets of the world to have just huge fleets of vehicles and trucks and all that. I mean, they need the big yards and they're happy to pay for it. Um, but if but then at your most basic sense, the, you know, Joe's plumbing down the street that needs a little office, a little maintenance shop and somewhere to park their 30 vehicles that they go to show it, you know, that their service guy shows up to your house and fixes your toilet at home, right? So how do you value these? Um, location wise is a big one, and a lot of times depending if it's if it's a port driven activity, they obviously want to be near the ports.

 

Matt McLennan (00:12:18) - The other one would be close to population centers, because if you're Joe's Plumbing, for example, you know, you want you don't you don't want to be way out in the boonies where it takes your service guys an hour to drive to any of your customers you're facing. So location is a huge driver, probably the number one driver in price. And then I'd say the the biggest one is the utility that the yard provides. And what I mean by that is. Quality and really buildings, I would say, because a lot of these yards in their most simplest form and we iOS, I usually use the term yard to describe it. That's that's another phrase we use. A lot of these yards can be very simple. It can be literally a square lot with a fence around it. And it's gravel, no buildings, no utilities, nothing. And for some guys, that's all they need. But there's a lot of guys that have staff that need at least some kind of, you know, small, even if it's just a simple Job Shack trailer all the way up to a full on office space.

 

Matt McLennan (00:13:13) - They need a building to set up a desk and occupy, right? They need a bathroom, right? At the end of the day, if you're gonna have people working on this site and you don't have a restroom and it's just a gravel lot, all that yard, really, the utility it provides is just somewhere to park stuff or lay down material all the way up to a lot of groups. Want at least a small warehouse building like a shop, is what we'd commonly referred to as something that you could go do some basic maintenance, store some parts in, store some goods in all the above. So as you start adding these things to these iOS sites, they start, in my opinion, gathering a lot more value. They command more rent, they lease faster. And that's that's been a trend amongst the market as of late. So it's it's it's really location utility. That's that's what's driving the equation.

 

Sam Wilson (00:13:58) - Okay. So how do you how well that's just some uh, how do you do market research for that.

 

Sam Wilson (00:14:02) - Like how do you and obviously you said location is important, but how do you even begin to determine who the tenant type would be. And if they want to come to your yard?

 

Matt McLennan (00:14:14) - The simple answer is you call me. But no jokes aside, actually, I make that joke because there really isn't a formula for it. I mean, it's it's a property sector. I mean, you go, you pick any of the big research firms, CoStar, CBRE, you know, whatever it is, right? I mean, they capture infinite amounts of data on industrial markets, apartment markets, vacancy rates, absorption, um, anything. Right. No one's doing that for iOS. And it's and it's particularly because it's been kind of a forgotten quote unquote. I mean, I legitimately think you could call it an asset class these days, but it's still it's in its infancy, so there isn't a ton of data on it. Tracking it is difficult. So really, for me, doing a lot of iOS work in my market, it's it's it's up to me.

 

Matt McLennan (00:15:00) - It's it's putting my boots on the ground, researching zoning codes, tracking down lease comparables. What are what are what's land trading for? What can you do on that land? What utility is it provide? Like I mentioned, I have a checklist that I use. They kind of helps me work with my clients to determine what those values are. Um, so I've kind of come up with a little bit of a proprietary method to doing it, but that but that's really what it is, is it's it's still very subjective.

 

Sam Wilson (00:15:26) - Right. Yeah. That's, that is that is interesting. So you really need to find somebody, you know, if you're not looking to invest in the Pacific Northwest, you need to find somebody that knows a local market that can tell you. Yes, because I can only imagine that you're like, oh, hey, you know, you know, somebody like me that doesn't know it, you're gonna go, that looks like an amazing spot for this. And it could be just two miles in the wrong direction.

 

Sam Wilson (00:15:47) - Yep. Exactly. And you have a you now have a you're proud owner of a lot that's worthless. So that that's cool. What about access? I know you mentioned this a little bit. Like how how are people automating access to it. Because you don't want somebody out there lock and unlock it a gate if you even have a gate. But what's that look like?

 

Matt McLennan (00:16:04) - Yeah. It depends. I mean, it's it's probably not as complicated as you would think on the surface. I mean, a lot of people have keycard systems or I mean, really it's it's secured fencing that's kind of checkbox number one. And then is it automated entries. Do you have a guard shack that somebody sits there 24 over seven seeing who comes in and out? Or do you just give the key employees, you know, a key to the padlock and do you leave it open from 9 to 5 Monday through Friday and just assume that everything's going to be okay? I mean, frankly, it's it's usually more simple than you would think.

 

Sam Wilson (00:16:35) - Interesting. And what about I mean, I would think that you aren't necessarily especially I'm picturing, you know, 20 bucks trucks, ten semi-trailers, whatever it is, you're not necessarily leasing to just one entity or one firm if the lot's big enough, is that typically the way that works? Uh, and if so, you know, how how do you do that?

 

Matt McLennan (00:16:55) - Great question. It varies a little bit. I'd say more often than not, you're leasing to one operator. As an owner of some of these sites, I want at least one operator, because trying to have 30 different semi truck tenants on my property and manage that is a nightmare. But I've personally leased space to the one operator who then sub leases to those 30 groups, and he manages that component. So he he's basically running call it a side business where he's leasing my property, paying me rent, then he's collecting rent from all of, you know, his his 30 Co businesses in town. And he he makes additional profit off of you know what I'm theoretically charging him.

 

Matt McLennan (00:17:34) - So it's good for me and that I only have to deal with one guy. I get a rent that I'm happy. It's great for him because he can upcharge and make more money off breaking it down to, you know, call it the single parking spot, which is something I have no interest in doing. I'll take the hit on the income to not have to manage that. So we see both.

 

Sam Wilson (00:17:51) - Oh, absolutely. So so there's even property management companies out there. It sounds like I mean, that's exactly what you're dealing with.

 

Matt McLennan (00:17:57) - To a degree. I mean, since it's still in its infancy there, you would never if you tried to Google, you know, iOS property management. I actually I should take that back. I should really take that back because there have been a couple companies that are making a business of this where they will go master lease a site and, and then do exactly what I just talked about and, and I mean, there's ones that have apps now on your phone where a truck driver could be, you know, in another state that he's not in, he doesn't know it.

 

Matt McLennan (00:18:23) - And he needs, you know, it's ready to he's he's ready to call it a day. And he needs somewhere to park his truck and just sleep for 12 hours before he continues on his route, pulls up the app, sees within, you know, whatever mile radius, what's available and what the cost is per night, which is probably a supply and demand model. And it's based on an algorithm these days because everything is, you know, tech and fancy. And, uh, and then he, he can book a spot, go show up there. Park, you know, gets gets the key code access or whatever it is, goes into the facility. Parks, comes back out the next day and goes on his way. I mean, we're we're getting to that level of sophistication that hasn't been there until recently. Before that, it could just be, you know, your local mom and pop guy just kind of leasing it out to all of his buddies. But we're getting there.

 

Sam Wilson (00:19:04) - That is really cool.

 

Sam Wilson (00:19:05) - I love that it's, um, yeah, it's another take on the parking market in its own right. It's just a little bit a little bit different. And you call that iOS? Or industrial outside storage.

 

Matt McLennan (00:19:16) - That's it.

 

Sam Wilson (00:19:17) - Okay, cool. Well, we'll keep our eyes on that front. Uh, do you think one last question. Maybe on this. Do you think that. Property type will move in tandem with how industrial is performing overall.

 

Matt McLennan (00:19:32) - I think generally speaking, yes. I mean, I would argue right now it's probably being impacted more than the general industrial class, and at least in my market specifically because iOS is so tied to port activity. And if you look across the country right now, port activity to use, um, 20 or 20 foot equivalent units, that's how you measure. Um, that 20 foot container comes into the port ports, measure their volumes and everything based on TEUs. And so if you look at TEUs across pretty much every major port, which is a lot of the West Coast ports, a lot of the northeast ports, the ports on the southeast, um, everybody's down year over year, plus or -15 to 20%, which is a pretty big swing.

 

Matt McLennan (00:20:14) - And so consequently, freight volumes are down. The probably the number one tenant of iOS space is truck and trailer parking companies. And so if these companies have less work because there's less containers to go pick up in the port, they're they're not making as much money. They can't afford to pay as much rent or lease as much space as they would when times were great. So iOS is definitely taking a hit right now, in my opinion. General industrial, kind of in tandem with the rest of the commercial market in my opinion, is in this period of flux. But I've seen at least iOS actually take a little bit more, um, take a little bit more damage than I guess you would expect. But I think to answer your question simply, yeah, I mean, it falls pretty in line with where the general industrial market goes.

 

Sam Wilson (00:20:56) - Matt, this has been absolutely fascinating. I've loved learning about the iOS base, something that, uh, I really didn't know a whole lot about. I know I've had some other guests who have alluded to this asset class, but never even actually heard it defined in that acronym, iOS.

 

Sam Wilson (00:21:11) - We've talked a lot about where industrial is, what's happening in the markets overall. Actually, I did have one one further thought on that iOS space, which is it was cap rates. And then, um, is now a good time to buy if revenues are down. So before I completely summarize our call here today, tell me on that front, you know, what are the cap rates you're seeing these lots trade at. And then do you think now's a good time to buy if revenues are down?

 

Matt McLennan (00:21:34) - Great question. Cap rates are I can't tell you because it's a big question mark. Frankly, I don't even know if I could tell you a cap rate on on, you know, existing big box industrial. I could I could give you some indicators and point my finger. But iOS, because it's as an investment class is still a little bit in its infancy in my opinion. There just aren't a lot of data points out there to support what the cap rate would be. Um, a lot of these sites are bought and sold by owner users.

 

Matt McLennan (00:22:01) - The investment market is going in there a lot of the times, but they are taking more of a value out approach where they're typically buying something either vacant or soon to be vacant, and then adding value via building and proving the site. You know, some of those metrics that I mentioned earlier that provide utility to the site, and then they're going to go lease it out. And, you know, by the time you do a value add equation, I mean, their cap rate could be well into the high single digits to low double digits, probably is kind of the the metric. I mean, if you were to buy a purely fully stabilized call lease to Amazon five acre iOS yard that checks all the boxes. What's the cap rate? Slightly above your debt costs, probably not much more. It might even be on par with with debt on assuming you know that you're going to get some upside and as the lease progresses. So that's how I'd answer that one.

 

Sam Wilson (00:22:48) - All right. Fantastic. And it.

 

Matt McLennan (00:22:50) - Is. And it is a good time to buy. Um, you got to find the right price. Like any investment, you want to make sure that you're going in under the right basis. But yeah, because I don't see this asset class going away. I think it's still in high demand. It's still in high need for the tenant base. I mentioned why the tenant need for the space is fluctuating a little bit at the moment. But I'm I'm a believer in it. Go buy it.

 

Sam Wilson (00:23:11) - Absolutely. Well yeah. And again you know going back to the opportunity, the time to buy is when, you know, revenues are down and valuations may be faltering. So that's uh, that's a really compelling, uh, thesis you have there. Matt, I've really enjoyed having you come on the show today. I certainly appreciate it. I've learned a ton from you. If our listeners want to get in touch with you and learn more about you, what is the best way to do that?

 

Matt McLennan (00:23:33) - You can always reach me by email or cell phone.

 

Matt McLennan (00:23:36) - Both of those are on my website that you can find through Kidd or Matthews, my company. I'm pretty active on LinkedIn. If you ever want to reach out to me there and see some of my content that I'm posting, feel free to engage with me there. But I'm an open book call. Email me. I'm always available.

 

Sam Wilson (00:23:50) - Awesome. And Keter is spelled with two D's. For those of you who are wondering and just listening, it's Kidder. Kidder, Matthews comm. Is that right?

 

Matt McLennan (00:23:58) - Uh, kidder.com kid.com.

 

Sam Wilson (00:24:01) - Okay, there it is. Kidder comm. Well, scratch that, you guys, uh, got it wrong for me the first time. Matt, thank you again for coming on the show today. I certainly appreciate it.

 

Matt McLennan (00:24:09) - Thank you for having me, Sam.

 

Sam Wilson (00:24:10) - Hey, thanks for.

 

Sam Wilson (00:24:11) - Listening to the How to Scale Commercial Real Estate podcast. If you can do me a.

 

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