Episode 21 – What is Due Diligence and What are Some Items You Should Cover When Purchasing a Property?

In this post, we are going to be reviewing what is due diligence, what types of questions you should be asking during the due diligence period, and what documents you should be getting from the seller. I am not going to go over the entire due diligence checklist because that is a very long checklist. This is just a very brief overview of some of the items that you will need as you’re going through the due diligence report. In addition to what we will cover today, you’ll also need to be scheduling inspections (which we covered earlier on a couple of other podcasts). What we will be talking about today is just some of the basic items, typically you will have a very extensive list depending on the size of the property.

What is Due Diligence?
It’s a term that you will learn when you are buying your first commercial property, it happens after your offer was accepted and that means that you have a specific number of days to review all the documents that the seller has on the property, schedule all types of inspections and reports, compare rental rates that are ongoing in the market, as well as sales comparables to make sure that you are paying the right price for the property.

If you Google what is due diligence, Google says that due diligence is the “reasonable steps taken by a person in order to satisfy a legal document, especially in buying or selling something”. It’s a comprehensive appraisal of a business undertaken by you (the prospective buyer) to make sure that the assets and the liabilities are correct, and make sure that this is an actual good deal for you to purchase or not. You typically have, depending on the market, 15 days at the very, very minimum to do all of your due diligence, all the way to 30 days, 60 days, sometimes 90 days. If the deal is really, really complex, it can take six months, nine months, or even one year. 

If you get in contract to purchase a property and you get 30 days to do your due diligence, and then you realize that you need more time because you were not given all of the paperwork on time, or that the seller took longer than expected to give you some off the actual paperwork, you can always ask for an extension, which is what we did on my first offer. It was an old, old movie theater that I talked about in a few of the podcasts, and we had to extend the due diligence twice by two weeks each time, so we had to extend it by another 30 days total because it was a very old building and it was taking a little bit of time to get responses from the city, as well as some of the inspections done. The seller was also taking a little bit of time to give us some of the required paperwork so it is always possible to get an extension, as needed. 

What are some example items that you need to cover during the due diligence process?
Now that you know what due diligence is, let’s cover some of the items that you will need to get during that timeframe. Note that there is a ton of different things that you should be asking for, and depending on the asset class that you invest in, you are going to be getting a few more items, or different items than the ones I’m going to describe to you. What I’m going to go over today was for a retail property and a lot of these items could also be used for most purchases. With that in mind, let’s start with what you should be asking the real estate agent as soon as you get in contract to purchase a property:
– The number one thing you should know is who is going to escort everyone to the property, you will have contractors coming over to do inspections and some reports, so you need to know who will be helping these people get in the property.
– The seller’s agent should also provide you with a contact sheet for who is the escrow agent, who is the escrow officer, their phone numbers in case you need to get in contact with any one them.
– You are going to be asking for referrals for structural engineers, architects, roof inspectors and this could be from your own real estate agent because they are familiar with that city and they can refer you to the right people that they have used in the past.
– Sales comps for the area from your real estate agent, and this is for you to understand if you are paying a fair price for the property. How you determined that is by looking at the price per square feet. Prices can vary greatly based on location, so you need to take that into consideration as well. For instance, one of the sales comparables can be three blocks away from your property. However, if you have a property that sold on the main street, it’s definitely going to be more expensive than something that is outside of the main street, and your real estate agents will be able to help you with that.
– Lease comps for the area (also from your real estate agent), if you are purchasing a retail building or an office building, you want to know how much the leases are going forward in that area per square foot, since this will be part of your financial calculation as well.
– You are going to be confirming how many parking spaces there are in the property. For retail and for office you will want four parking spaces per 1000 square feet of property that you’re buying. This is just a standard number in the industry. If you’re buying an industrial building you can definitely have a lot less parking spaces because for an industrial building you will have a lot less people and employees going there per square foot, so that number changes if you are purchasing something that is an industrial building.
– If part of the property has been for lease for a while or some offices have been for lease and there have been a few people that reached out to try to lease it and get more information about renting that property, you want to ask for the contacts of all of these people so that you can follow up with them or so that your leasing agent can follow up with them. We’ll be following up with them in order to try to get some of these leases signed throughout the process, or after you close on the property.
– The title company will provide you a title report on the property showing if there are any liens on the property, and you should send that to an attorney to review. You will be in communication with the title company in order to follow up with any pending items on the title reports that should be removed from the title report prior to closing on that property.
– You’ll need a copy of all of the leases that have been signed for this property. If you’re buying an office building or a retail building, you really want to make sure that your read every single lease and all of the red lines. If you have two national tenants there for example, let’s say you have a Starbucks and you have a Chick-Filet, they will likely require the owner of the property to use their own leases, so Chick-Filet and Starbucks will give their own lease to the owner of the property and then they will negotiate from that. On the other hand, when you’re dealing with smaller tenants, you are the one who will be giving them your lease and then the negotiation will happen from there. So you really want to make sure that you have a copy of every single lease, and that you understand everything that is being said and that was redlined on these leases.
One of the most important things that you need to watch out for when you buy this property, is that the property taxes are going to go up. This cost needs to be accounted for you and for your tenants because in retail, your tenants will probably end up paying for that additional cost. However, a lot of national tenants negotiate their leases by having a clause that says that they will not pay any additional taxes if the property is sold at a higher price than the current owner has paid for (or that there’s a limit on the property tax increase). This is very important and can really damage a lot of financial calculations. This also goes for office leases where the owner is responsible for paying the taxes, it’s really important that you account for that tax increase cost in your financial analysis.
– A breakdown of every single expense that the property has, and for most of these expenses you will want a two year history of all of the bills. For example, you have electricity bills that you need to look at for the last two years and make sure that you understand by how much it has been going up yearly. You’ll also want to understand the maintenance costs over the last couple of years because some months are higher and some months are lower.
– You need to find out if there has been any deferred maintenance. Sometimes the roof will be pretty old and is going to be your responsibility to fix it, so you need to definitely make sure that you understand everything that has been deferred in order to add these things to your financial analysis.
– Find out if there are any issues with drainage on the property.
– Find out if there are any easement agreements. Easement agreements are basically an agreement between you and usually your neighbor to use your property so that their customer’s can get to their property, or vice versa. If there are any easement agreements, you also need to get a copy of that as well.
– Get a description and the model numbers for all HVAC units (heating, ventilation and air conditioning). Sometimes you’ll also need a two year history of their maintenance. Here you’re going to find out if you should also be changing some of these HVAC units or not.
– You will need to find out if the restrooms are ADA compliant or not (Americans with Disabilities Act), meaning all restrooms should be ADA compliant. Sometimes, if the property does not have an elevator and it has more than one floor, you might be required to put on elevator, but you will also have to check with the city. And if the city will require you to put an elevator after the property is sold, you are going to add this into your costs.
– Get a copy of all of the leasing commission documents for all of your leases. For commercial properties you’re going to have a leasing real estate agent who leases out the vacant units. There will be an agreement with that real estate company to lease those vacant units for you. So you need to know if you owe them any future commissions for existing leases or not. This is also for you to be able to put that in your financial document. 
– Get a copy of all ADA work done or needed to be done. If they have made their restrooms ADA compliant, are their elevators ADA compliant or not.
– How often is the parking lot swept. Here you will understand how often is the property maintained, and if you need to increase that or decrease it and either way you go, you’re going to have to add or remove that in your financial calculations.

This is the very, very basic list of due diligence examples that you are going to have to request from the seller, from the seller’s real estate agent, you’re also going to be working with the title company and your attorney on all of these items. That is why typically a due diligence period takes at least 30 days and sometimes it can go to 60 days or a lot longer if the property is a lot bigger or more complicated. As you are walking through your first purchase, there will be more due diligence items that you are going to need to get at the end of the day. But this is a very good start, just so you can get a very good idea of what you will be working with in this super exciting journey!

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Episode 20 – Should You Buy a Home or Invest in Commercial Real Estate, My Project Updates and Lessons Learned


Today we’re going to do a very basic analysis around the question: should you buy your own place, or should you invest in a commercial property? I’ll also going to update you on what I have been up to for the last couple of months, and how are my projects going.

Should you buy your own home, or rent and put the down payment in an investment property?
A friend of mine was asking me if she should buy her own house, or if she should invest in commercial properties and how much money should she save as a down payment. First, let’s start with the disclaimers: I am not providing any financial advice, this is my personal opinion based on the things that I have learned, you should always do your own homework and ask a professional for advice. Here’s my personal opinion on the question around buying a home to live in, or not buying it and putting that money towards an investment property.

I’ll be using numbers that I am living in today in this very extreme side of the world – San Francisco. But this can be applied to any property, in any city, I’m just going to use what I am familiar with as an example, and you guys can do your own calculations depending on where you live today.

Here we go: If I were to buy a one bedroom apartment in San Francisco, I would be paying around $1.2M and I would have to put 20% down, so I would be putting $240,000 as a down payment and my mortgage would be $960,000, the interest rate could be around 4% in today’s market, that’s $960,000 at 4%. My monthly payment would be $4,500 per month plus property taxes of $1,000 per month (1% of the property value in California), and we have another $1,000/month in HOA fees (Home Owners Association). My total payment would be $6,500 per month if I were to own my one bedroom condo. On the other hand, I can be a tenant and rent that one bedroom apartment in today’s market for $4,500 per month. That’s a $2,000 difference – $4,500 if I am renting from someone vs $6,500 if I am the owner of that apartment. On top of that, if I am the owner, I just put $240,000 as a down payment, so I’m not making any money on that $240,000.

Now, let’s say you’d take that $240,000 to invest in a commercial property, and we are going to round this up to make things very simple: let’s say that you are making a 10% return every single year on that $240,000, which is very acceptable for real estate investing. At $240,000 that you were putting as a down payment, you’re instead getting a basic return of 10% every single year. That’s $24,000 that you’re making every year, plus, as a renter, I am saving $2,000 from the $6,500 that I would be paying if I was a homeowner or a condo owner in this case. That’s another $24,000 that I am saving by being a renter every single year, and another 10% on my $240,000 which is another $24,000 that I’m making every year in my commercial real estate investment. That’s a total of $48,000 every single year, that’s almost half a million dollars over ten years.

Again, these are all very basic numbers. I am assuming that both properties will appreciate over time, we’re keeping this calculation very simple, just so you can wrap your head around owning versus renting, and renting plus investing your cash in a property. The difference in this example is $48,000 per year. You can invest $240,000 in a property, you can partner up with people, you can join someone who is raising money from multiple investors to buy a property and operate that property with a group of people. There are all kinds of ways that you can invest a smaller amount of money if you cannot purchase an entire property by yourself. I hope this gives you some clarity on should you rent and invest that money in a commercial property versus should you buy and tie up your money on your own residents and not make any money out of that $240,000 down payment.

How much should you save to buy a home, and to buy a commercial property?
If you are going to own your own house, you typically should put a 20% down payment, there are all kinds of loans that you can get to nowadays, you could probably only have a 10% down payment, and sometimes even less depending on the type of loan that you find. For commercial properties you can do a couple of things: you can join someone who has found a property and is looking for money from investors, and typically the minimum amount to invest is around $25,000, in this case you would just buy a percentage of that property, which is great because you don’t have to do anything besides giving them your money, and you will be getting quarterly checks in your bank account (of course, only if the property is making money). When the deal is completely done, normally around three to five years down the road, and the operator exits the property, you also get a check for a percentage of how much the property made and increased in value. 

You can also invest all by yourself, or with family and friends, and ideally you would want to have around 30% down payment for a commercial property. This number can also change depending on the property income and the type of loan that you get. This is a very standard number: 20% down for your own home, 30% down for a commercial investment, or you can join a syndication where you are investing with quite a few people and you buy a small part of that property.

Update on where I am in my real estate journey
I have been very interested in self storage recently. Why self storage? Because I personally think, along with many other people, that something is about to pop in the economy. Self storage is a somewhat “recession resistant” asset class. Asset class is the type of investment, if you invest in retail properties, the asset class that you invest in is retail, if you invest in apartments, the asset class that you invest in is multifamily. The self storage asset class is something that has been very interesting to me, and I reached out to an incredible woman who has been investing in self-storage for several years, I asked her “How can I work with you? You are awesome.” She said that I could just pay her! So I have been having calls with her every week, and we are looking at quite a few properties, I hope to be making an offer very soon on. I am looking in a few different markets because I have learned that the state of California is very difficult (to put it mildly), and we can manage properties in a different state very easily if you have the right team in place. Therefore, I have become very comfortable with that idea, and I’m looking at quite a few different cities that have good demographics: good employment, population growth, property value growth, etc. With her help, we are narrowing down to a few super interesting properties and I will keep you posted as it progresses.

Another project that I’m working on is my Landmark project. Some of you may be familiar with Landmark, which is very similar to Tony Robbins. It’s a self-improvement course that I prefer many times over Tony Robbins because when I took Tony Robbins’s Unleash the Power Within (UPW) seven years ago, it was wonderful. It was wonderful for two weeks and then I forgot everything after that. I took Landmark about a year ago. The first course is called the Landmark Forum, and thankfully they have little courses that you can take after, in order to build your muscle. You cannot go to a course and just expect to change forever over a weekend. You actually have to practice changing and you have to become a better person over time, in order to get used to that new self. I have been taking Landmark courses ever since I took the very first course, and the one that I am taking now, we actually create a project from scratch, so I decided to merge my real estate goals with something that I deeply care about: health and wellness.

My other project besides the Self Storage project is a retail center very similar to the Ferry Building in San Francisco, if you’re familiar with it. We are different in that we are going to have only healthy, organic, nontoxic tenants along with holistic tenants. Some examples are: an organic salad bar and organic smoothie place, a butcher that only sells grass fed meat, an organic coffee shop, and on the holistic side we’re going to have a meditation practitioner, Yoga teachers, chiropractors, homeopaths, etc. The goal is for the community to have everything that they want for their bodies and their minds in one place. I have no idea how this is going to come about but I’m working on it, it will happen. We are currently in the process of looking for the perfect property around Silicon Valley, and this will likely be somewhere in San Francisco, but we are open to expanding to different cities. Another reason why this came about is: a lot of people are scared of investing in retail, right? We have no idea where it’s going. By having a retail center where we can have these kinds of tenants in one place, we will attract the right customer for the tenants. The tenants will be more than happy to sign leases in this holistic center because they know that all of their neighbors are also serving the same customer. With my sales background, I always think “how can people come to me and want my product instead of me going to them?”. By having tenants that are only holistic and healthy, everyone in the community that is interested in this will be going to our building, and they are our tenant’s target customers.

We want to create an application process where we are going to be handpicking who is going to be joining this community as a tenant. The reason why we want to do that is because also we want to attract the best tenants. They will be the highest rated people so that our community will appreciate the quality of the products and services that they’re getting there, and they will also come back for more. The feedback has been great so far! “Oh my gosh, I would spend all day in a place like that”, “Please do this in my neighborhood”, “I want to live next to this place”. I have already spoken with quite a few smaller tenants. They sound very interested in joining this center. The only thing I haven’t done yet is spoken with national tenants because we have not narrowed down on the actual property and we want to have some tenants there first in order to come to the national tenants.

Why are national tenants important?
If you are doing a retail project, the reason they are important is because they give you security, they have good credit, therefore they will likely stay in business for a long time. This makes our building a whole lot safer to survive over time versus only having smaller mom and pop stores where they might be in business only for the last five years and something may happen that they might not make it. Some tenants that we could potentially approach are Sweetgreen, a popular salad place that has expanded to multiple cities, Bar Method, which also is available in several cities.

Another reason why should have national tenants is… let’s pick Jack in the Box, for example. If you have Jack in the Box paying you $100,000 per year in rent, your property will be worth $2.2 million at a 4.5% Cap rate. However, if you have a mom and pop shop paying the same amount ($100,000), the value of your property is going to be $1.5M instead of $2.2M because they don’t have the credit worthiness of that national tenant. If you do not have a national tenant, your cap rates will probably be around six and a half percent, which brings us to a property value of $1.5M, that’s a $700,000 difference by simply getting a national tenant in your property.

Those are the two main projects that I’m working on, I cannot wait to see them come to life. At this moment I have no idea how this will happen financially, but I know that it will happen. One of the things that you learn with Landmark, or at least with this specific course that I’m taking, is how to make bold requests, how to delegate, how to become a leader. I know that it will happen, I just don’t have all the answers right now. This reminds me of Jack Canfield talking in the movie The Secret. Jack Canfield is one of the authors and creators of Chicken Soup for the Soul. When he was being interviewed for The Secret movie, he was telling us “When you are going after your goals and your dreams, it’s like a car driving at night, you don’t need to see the entire road in order to know that you’re going to get there. You just need to see as much as your headlights can see. Everything else will come into place.” This is how I feel right now, I know it will happen, I know it will be an amazing project that we’re going to expand to multiple cities, and I cannot wait to share this with the community.

Reach out to me on Linkedin and ask me any questions or make specific requests. I will continue to keep you updated on my progress on these properties, and lessons learned.

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

Episode 19 – What is Cost Segregation, What Types of Properties Can Benefit From It, What’s Bonus Depreciation, and How Much Would a Cost Segregation Study Cost?

In this post you will learn a very useful tip for tax deduction when you buy a property, it’s useful even if you have already bought some properties. We’re going to be learning about what is cost segregation, what types of properties can benefit from cost segregation, we’ll go over an example of how much you’ll be able to deduct on your taxes, and why it’s important to have cash on hand today versus in five years. We’ll also cover what is bonus depreciation and how much a cost segregation study would typically cost.

We are interviewing Yonah Weiss, a business director at Madison SPECS, a national cost segregation leader. He has assisted his clients in saving tens of millions of dollars on taxes through cost segregation.

What is cost segregation?
It’s a tax benefit for real estate investors and it has to do with depreciation. When you own a property, you get a tax deduction called depreciation. The way that depreciation works is, even though it’s an arbitrary number, the IRS allows you to take the value of the building and the purchase price of the property the day that you buy it and then from that day it has a useful life. If it’s a commercial property, that useful life is 39 years, if it’s a residential property (including multifamily) that useful life is 27 ½ years. I said it’s arbitrary because it doesn’t mean when the building was actually built, but depreciation means something’s going down in value. And it’s not really going down in value, in fact we’re investing in real estate because it’s going up in value, it’s appreciating.

Depreciation is just a tax benefit, it doesn’t really have to do with the intrinsic depreciation of the property. It’s a tax write off based on the value of the building on the day that you bought it, at the purchase price. We have to subtract a small amount for land value because it’s the land that the property sits on, and that does not depreciate – the land value is 15 to 20% of the property price. For the left over, you get a tax deduction every single year, a fraction of that value over those 39 years, or 27 years. That’s regular depreciation. This is what everyone does and some people call it straight line depreciation: you’re going to take 1/39th of the property value and subtract a small amount of that every single year from your income tax.

Where cost segregation comes into play is the fact that the IRS determined that things in the property have different useful lives, anything that is not part of the structure of the building depreciates over five years. Then you have another category of things called land improvements and this can be anything like pavement, asphalt, parking lot, landscaping, fencing, anything outside the building actually depreciates over 15 years instead of 39 years. Cross segregation is really breaking out the components of the property into their cost, and depreciating them at a faster rate. In order to do this, you need an engineer who’s trained and that’s why at firms like ours, Madison SPECS, we have a team of 16 engineers on staff that go to the property, they have training in the tax code, they can determine if you have appliances, furniture, wiring, carpeting, switches, HVAC systems. There are many things that actually depreciate on a five year value. They’ll take that entire value, add it up to all the calculations, and we can now allocate that cost to a five year schedule and get huge tax deductions based on those first five years. That’s cost segregation in a nutshell. 

As soon as they purchase a property, the cost segregation starts from zero, right? So even though the previous owner may have already deducted the depreciation, the new owner will start from scratch again. 
Correct, and I’m glad you reiterated that because that’s such an important aspect of real estate, even though I own a property, I depreciate the whole thing, then I sell it to you, and you start your depreciation from day one, when you buy it. Not only that, it’s probably much higher today than when I bought it, if I bought a property for $100,000, 20 years ago, I can sell it today for $1 million. When you buy it for million dollars, you get the tax benefits of that $1 million. 

What type of properties qualify for this?
Any type of property whatsoever, as long as it’s not your personal residence, it can be commercial, residential and multifamily, office, assisted living, hotels, hospitality, self storage, industrial, shopping malls, golf courses, mobile home parks, etc.

Let’s go over an example. Let’s say that we just purchased a 30,000 square feet office building for $3 million. What can we deduct in the first few years and what should we keep in mind?
We first allocate a certain amount to land, 15%, that’s about $450,000 right off the bat. Now the left over is about $2.5 million dollars. If you were to do a straight line depreciation, we’re taking that value, $2.5 million, and we’re dividing it by 39 years, so we’re going to be depreciating $65,000 every year. Let’s say that the net operating income is $300,000. We’ll subtract $65,000 from the $300,000 NOI, which means you’re only going to be taxed on the remaining $235,000.  Let’s say your tax rate is 35%, that means you’re going to be paying taxes in the range of $82,000 just because you bought this $3 million property.

The cost segregation engineers will be able to reallocate, let’s say a round number, 20% of $2.5 million is about $500,000, we’re going to be able to accelerate the depreciation of that over the first five years, which we get an extra $100,000 each year for the next five years. Alternatively, with bonus depreciation, you can actually deduct that entire amount in the first year. If we’re taking our example, instead of having just $65,000 income tax deduction, we’re going to be looking at more like $165,000 and that reduction could be even more. Every property is different, but usually it’s between 20 and 30% on average.

What is the main benefit of doing cost segregation?
The cashflow. When you have more deductions than you have income, you don’t write a check. We’re not talking about getting free money, what we’re talking about is keeping the money that you made and paying less taxes, or no taxes. In many cases, the main benefit is the cashflow, you’re able to use that money to invest. The second thing is the time value of money because you can take huge deductions early on and make sure that you’re using that money to invest. The time value of money means money today is worth more than it is five years from now. If I were to offer you $50,000 today or $10,000 a year or five years, what would you take? Definitely upfront.

What happens once we sell the property? Does it come back to haunt us? Do we need to pay taxes on it or it’s forever gone?
When you sell the property, there’s something called depreciation recapture tax, which means that you have to now pay tax on the entire amount of depreciation that you took over the course of ownership. That’s capped at 25%, which means there’s usually going to be a spread between – had you not taken depreciation, you would have to pay taxes anyway but at a higher rate. Later on when you sell, you have to pay tax on that amount of money you deducted, but it’s usually going to be less.

There’s another point that’s important to note that when you do a 1031 exchange on the sale of a property, not only are you deferring the capital gains tax, you’re also deferring the depreciation recapture tax. So there’s another way to get around it, which is just that you go to a new 1031 exchange. All of this is very important for us to have cash in our hands to invest in other properties. This is one of the many reasons why people really care about cost segregation, you want to keep as much cash as possible in your own pocket and not give it to the IRS. 

What happens after we deduct everything that we can on a specific property?
When we’re reallocating the depreciation to the early years and we’re taking more deductions early on, you’re going to get less deductions later on. After your sixth year, it starts to reverse itself, and you’re going to have less appreciation. But it’s not a huge amount because we’re only going to be allocating about 20% to take in the first five years, instead of spreading that over 39 years. In our example of the $3 million building, for the following 32 years, instead of taking $65,000 straight line depreciation, you’re going to be closer to $60,000 at year six. It’s not going to be a ridiculous amount because it’s spread out. It’s like taking an interest free loan and then paying it back in a 32 year installment on the money that you borrowed.

Is bonus depreciation related to cost segregation study? And if not, can you share with us what is bonus depreciation? 
Bonus depreciation used to be a rule that when you developed a new property, you could take 50% of the depreciation of that property in the first year of that new construction. The law changed in that it’s now for any property that you buy, not just new developments. All the depreciation that is less than 20 years (in the example that we gave, the five-year personal property and 15 year land improvements) all of that cost segregation is eligible for bonus depreciation, you can actually take 100% of that depreciation in the first year of ownership, instead of spreading it over five years. You have a choice of 100% or 50%, which really gives you a much added benefit to take, to knock off your entire income tax liability in the first year.

What do most people choose?
It really depends on everyone’s situation. Most people choose the 100% bonus depreciation because they take huge deductions, and they may have more deductions than they actually have income, which will put them in a “passive loss”, meaning you’ll just be in the negative for income tax. This is what was in the recent newspaper’s headlines, that president Trump had billion dollars of losses, but it’s paper losses, depreciation, and it means he was not tax liable. Even if you made huge dollars in profits, you wouldn’t have to pay tax on that because of all the losses, so it’s something that carries forward with you, and it goes with you to the next year. Even if you can’t use it this year, it will release itself next year or at the sale of the property.

Is bonus depreciation going to expire at some point?
The 100% upfront depreciation is only good until 2023, from that point they put it in a kind of reverse. In 2024 it’s going to be 80%, and then the next year it’s going to go down to a 70% bonus depreciation. We’ll see what happens when we get there, but for the meantime it’s good to take advantage of it.

How much would it cost to do a cost segregation study in our example property, our 30,000 square feet office that was purchased for $3 million?
Every firm has different pricing models, so I can speak for our firm. We are one of the biggest in the country, we’ve done over 14,000 studies across all 50 states. We will actually provide a feasibility analysis to anyone that’s interested in seeing not only what the costs would be for that property, because it’s based on the actual square footage, the scope of work that’s involved in the property, and we will tell you our projections of what your tax benefits would be. We will do that just so you can make an educated decision. So, unless the property is massively huge, the cost segregation study would cost $5,000-$6,000 for a type of commercial property. When you’re talking about $100,000 zero tax benefits, it’s a no brainer. 

Do you know if some investors are not even aware of cost segregation? If not, what’s the percentage?
In my experience, I would say the majority are not aware of it, they may assume that their accountants are taking care of it for them, which is a mistake because most of the accounting firms don’t do cost segregation in house. They very large ones will have engineers on staff to do this, but a lot of accountants who aren’t real estate savvy may not really know enough about it to do it for their clients. Unless you’re educating yourself, there really wouldn’t be a way for you to know this. There are so many different aspects of real estate investing that unless you dig in and try to find out, no one’s going to talk to you about it.


One of my mentors was meeting with a friend who is doing a huge project in LA with several housing units, and just by sharing cost segregation with that friend, who had no idea about it, he helped him save something like $25 million, which was insane for someone that is working on something that big, for them to not be taking advantage of it. What are some really important questions we should ask a cost segregation provider before hiring him or her?
You want to know a little bit more about their experience and want to make sure that they have extensive experience in this field because  we’re talking about taxes. Taxes have to be very straightforward and have to be something in line with the tax code. You don’t want someone who’s new at it, they must have industry experience. The second thing is you want to make sure that they stand behind their work, meaning they’re complying with all the rules set out by the IRS, and that in the event of an audit, they’ll stand behind you. 

If something does happen where there was something wrong in an audit, who would be liable for that?
Both the engineers and the client.

How can the person filing it and be responsible when that’s not their business? When you sign off on a tax return or an accountant signs offered, then you sign it off and you’re taking responsibility for everything that’s in there. 

Is there anything else that you would like to share with our audience? 
Anyone that has a property or is thinking about investing in a property – you want to make sure that you find out about cost segregation, reach out to someone like myself to get a feasibility analysis, we’ll show you what the potential benefits would be by doing a full cost segregation study. This allows you to understand a little more in detail, and see what those numbers would look like. What I will leave you with is that it’s not something that needs to be done immediately. You can even retroactively do it for a property that you purchased five years ago. You will be able to retroactively get the deductions that you missed by accelerating depreciation this year.

Yonah Weiss
https://www.linkedin.com/in/cost-segregation-yonah-weiss/
yweiss@madisonspecs.com
(732) 298-9002

Episode 18 – Making a Case for Self Storage Investing

In this episode we’re learning why self storage can be a good real estate investment, what to look for in the area that you’re looking at purchasing, how to hire and manage the onsite manager for a self storage unit. We’re interviewing Ryan Gibson, a co-founder of Spartan Investment Group, he focuses on providing self-storage investment opportunities to individual investors. Ryan has organized over $12M of private equity for SIG to fund self-storage and development projects, he is responsible for investor relations and capital raises for projects. Ryan also owns and manages rentals properties in multiple states and has invested in apartment buildings, self-storage, and land development projects.

Why should real estate investors invest in self storage?
Self storage is something that we looked at back in 2016, we made a pivot from investing in residential real estate, we were building condos, new houses, flipping houses, and we landed in self storage for a couple of reasons: 1. We liked how straight forward it was, how operationally easier it was to manage than a multifamily property. We looked at vacancy trends, rent growth, saturation and all the things that people like about self storage. It is also one of the least foreclosed upon asset classes during the last recession.

There is a retail component to self storage. What would that be?
It’s just becoming more retail oriented, when you come in it’s all about customer service: it’s about providing a clean office environment, it’s becoming a very customer focused industry and there’s a lot of upselling. There’s tenant insurance, notary services, PO Boxes, FedEx, UPS, shipping, etc that you can put at the facility. You can actually sell retail items in the store. For some of our facilities we’re considering putting in propane for example, putting in notary services, things that add value to the customer and are complimentary to the storage business. 

What are some of the biggest lessons that you have learned when fundraising since you are syndicating deals out?
Engage your network, find ways to add value to your investor network to keep people engaged. We’ve actually done a really good job of tracking where we meet our investors and how they end up pulling the trigger to do an investment, and a lot of our investors are personal relationships, people who we used to work with or people that we knew, friends, neighbors, family, people in sports teams, etc. Scott, my business partner is in the military and folks that were in the military with him. People that know us from different capacities and trust that we’re the folks that can get the job done. The other thing is referrals, we don’t really focus on finding investors, we just focus on taking care of the ones that we have. We do go out and try to find new investors, of course, but we really just to put a lot of emphasis on the investors that we have currently by sending them monthly updates, and that has inspired folks to reinvest and refer friends to invest in our businesses.

How do you guys go about deciding where to invest in self storage?
We focus on 150 MSA’s across the United States. And those MSA’s have a key component of population growth. Population growth is the number one driver of self storage utilization, overall market saturation, job growth, demographics of our ideal consumer, income levels, job placement, migration trends, and we look for cities and areas, or an MSA that are trending positive and have a good outlook for population. We look at rental rates as well. We have a hard time justifying building in certain markets, brand new storage, if the rental rates are, say less than $6 a square foot, it would be difficult to do that.

Are there specific things we should be aware of weather-wise, or how the homes are built in those areas?
I think what’s more important is knowing the hyperlocal market, what is the utilization rate based on the population? Is it seven square feet per person or is it six or is it five, and really understanding what the demand is in that specific market and in particular on the cross streets of where you’re looking to buy, or build, or expand a facility, it’s really important to understand what the market demands are in that area and what the current saturation is to make a decision if people are going to be leasing up the units that you build. If you build extra units, or if you want to try to position that deal in another way, or maybe you’re building ground up, or you’re looking to expand the rents. If you’re in a flood zone, we might either pass on a deal because you don’t want to be in a flood zone or perhaps you decide to build climate controlled units versus traditional storage that’s exterior roll up doors because you want to make sure that you can supply the market with what they want. If it’s like in Texas we’re actually adding on about 40,000 square feet of climate controlled storage because that is in a very high demand right now in that area.

What are some of the biggest challenges with self storage?
I would say the number one challenge is finding the right projects. We looked at 880 projects last year, we put out six offers, and we bought three. It’s a very institutionalized asset class. A lot of projects that are over $5 million are getting all cash offers, so it’s very difficult to compete with a lot of the institutional capital, and larger players in the market because they have a lower cost of capital than we do. Because we’re offering our investors a market rate return on equity and they have a good team of folks that can find the same data that we’re finding. Although we’re pretty unique in that we can do all of that in house and we do subscribe to a lot of good data, make fast decisions, on this particular area, you may find a great deal that has an existing storage business and plenty of land to expand the storage business on, but then you go to find out that the market is completely saturated with storage and if you built that storage, the customers wouldn’t come, and you’d have an empty building and a lot of additional expenses on the property without the revenue.  It’s very important that you understand what the demand is in a certain market before you make a decision, little did you know that you didn’t check the building permits in the area, and now there are three other people are building around you, and that’s not going to work. Operationally there has been challenges, but for the most part, we directly run all of our own facilities, we do all of our own in house property management and asset management and that part of it is fairly straight forward for us, and the construction is very straight forward for us because it’s slab on grade single story buildings for the most part.

For ground up development how long does it take from beginning to end on average?
At least three years, but also it depends on the market. The entitlement can get challenging, we’re actually nearing the completion of getting full entitlements on a 127,000 square foot facility just south of Seattle. It takes about three years to go from what we say trees to keys, from the time you find the raw dirt to the time that you open your doors is about three years. If you’re buying an existing facility in a relaxed jurisdiction with matter of right, you can get building permits in a couple of months or maybe less. And then depending on how large the expansion is, depending on how the site work or what site work is needed, you could go out there and you could have an addition completed in a year or less. It also puts up a very large barrier to entry because if it takes that long to start up a business, you’re separating yourself from the competition that may be building behind you.

Would it be easier to actually buy, let’s say, an industrial building and convert it to self storage, or it’s something that you wouldn’t even touch? That’s something that has been very popular right now. A lot of people are doing that, dark conversions, converting old Kmart, Sears, or a car dealership, or something and do a self storage. That is something that the start to finish is a lot less. Obviously if you have an existing building you’ve already got the water and underground utilities in place, you already have the walls, and the roof in the building already up, and you’re basically coming in and retrofitting the corridors we’re actually looking at five or six of those conversion opportunities right now.

I recently visited a self storage facility here in the Bay Area and the owner not only had the self storage buildings, but he also put metal containers and rented them out. If we were to buy any self storage property, do we need permits to put those metal containers on the property up and rent them out?
It depends on the jurisdiction, I would definitely check with the local municipality. We have a 350 point due diligence checklist before we make a decision on any particular deal. Some jurisdictions will allow you to put down portable containers and over easements in areas where you typically put a permanent structure. Some areas have restrictions, they don’t want to see self storage doors from the road, or they just don’t allow temporary buildings. It’s rare to find that, but that land may not have the use approved. I would say yes, it’s definitely possible in many areas, people do that and a lot of the portable storage companies that provide those storage containers will help you find out if it’s feasible in the land that you’re purchasing, or in the storage that you currently own. It just depends, but it’s definitely possible in some areas.

Moving on to property manager, how do you select and hire the best property manager and what do they do all day long?
Some folks will hire third party property management companies like Cubesmart, Extra Space, West Coast Self Storage, Public Storage. They might hire a company like that to come in and do the property management for them, but they’re still going to have to hire somebody that works at the desk, that the owner is responsible for covering that expense. The property management companies will take a fee, usually 6% of gross revenue, to manage that facility. We do the property management asset management in house. Spartan Investment Group has folks on our team that do that in house. We hire somebody to staff all of our facilities, the sweet spot is usually three people for each facility. We like to buy a facility large enough to support three managers: a full time manager and two part time, or maybe one part time and a maintenance person. The day to day of a manager at a facility that’s running the operation is the person that you’re going to talk to book your unit, they’re actually doing lock checks every day to make sure that somebody didn’t hop the fence and grab a unit overnight, or put their stuff in the unit, they’re looking at every unit every day. They answer the phones, interact with our customers, call customers that are delinquent in rent, send letters for rent increases, execute leases, they are doing everything that make the facility run. We have them get certified as notary so they can notarize documents and then they just help with the collection of rent, and items that we may need them to help with.

I only asked that because I recently got my very first storage unit, and it seemed like she had nothing to do all day, which is great, but it just felt like there could be more that the property manager could be doing.
We like to have our managers be as free as possible, we like to give them as much automation as possible: the backing of a call center, backing of our headquarters, for example, we do a lot of the rent increases from headquarters. So the front staff isn’t sitting there and jamming envelopes all day. Having somebody who’s available to the customer, to put that touch in there is important, and we like to give our folks as much training as we can, in sales, customer service, follow up, etc.

What is your second favorite asset class after self storage and why?
We own an RV park in west Texas and that has been my favorite deal ever. Very similar in characteristics to a mobile home park in that the tenants are there full time and they live there right now, rent is about $800 a month (and utilities are included in that). Not to have a whole lot of amenities and have the lowest entries for housing, we just collect a lot rent and the folks bring in their own RVs and mobile homes, they purchase their own homes, it does well in good times, and in bad times. We’re actually in the middle of putting up a brand new mobile home park development under contract, which is very unique because you truly can’t really build mobile homes anymore. It’s a declining asset class, so you’re actually taking them away and we have an opportunity to potentially have all city water on it too. So it’s a very good asset class and it’s something that a lot of folks are getting into at this point.

It does sound very interesting at $800 per month. That is crazy actually for Texas. Does that attract a lot of trouble tenants? And how do you guys go about dealing with that?
Our tenants have been great, we have 116 units. You know, you’re going to have issues. But I really love Texas and people there are just the hardest working people that that I know and they work really hard. A lot of them are in energy and oil.  

Is there anything else that you think our audience should know?
If you’re looking into the self storage asset class, just be aware that there is a lot of competition in it. Just make sure you do your demand analysis, or your feasibility study before you get too far down the road in the project.

www.spartan-investors.com
ryan@spartan-investors.com


Episode 17 – Should You Invest in Silicon Valley? What Does the Future of Office Space Look Like? What Happened to Office Spaces During the Last Downturn?

In this interview, we’ll learn why investing in Silicon Valley could be a good idea, what happened to office spaces during the last downturn, things an investor should cover when looking at purchasing an office, what types of leases are standard for office space, and what does the future of office space look like. We’re interviewing Eduardo Zepeda, he began managing commercial properties in downtown San Francisco in 2008 as a part time property manager for a family office and was instrumental in the expansion of the portfolio. He is now the full time asset manager and leasing director for the group’s holdings, managing north of $100M in combined assets comprised of multi-tenant office and retail property. He’s currently leveraging the knowledge he’s acquired to pursue his own real estate investments as a principal with a focus on light to moderate value add multi-family or small commercial projects in the Bay Area.

Making a case for investing in Silicon Valley: Why do you like this area? 
I didn’t really know at the time, since I was still pretty young, but I was entering this profession during one of the worst recessions locally and nationwide. I’ve witnessed how much the local economy here in the Bay Area has grown over that time, whether it’s in residential, multifamily and on the commercial side as well. One thing that I’ve learned about the Bay Area is that it’s the perfect storm of supply and demand economics where you have a finite fixed amount of land and a very strong demand not only for housing but also for space to occupy, whether it’s office, industrial or just land to develop and improve.

The macroeconomic factors for the Bay Area are very compelling, whether you’re looking for a short term value add project with an exit, or a long term hold, there’s a compelling argument in both cases for investing in this area even during this economic times. The challenges is that prices are very lofty. The environment here is very competitive and there’s a lot of capital that is chasing deals. The groups that really like real estate are willing to transact even in low yields, and low cap rates. It’s challenging on a short term basis because there may not be enough yield to justify a short term hold. I do think that if you’re a long term investor, you’re going to be in a really good position in a few years once you start to realize that cashflow and the increase in NOI, or the increase in value of the property.

What was the vacancy rate like during the 2008 recession and what were some of the major issues that the properties that you were managing were facing?
My first couple of years was really focused on junior tasks, I was doing a lot of interacting with the tenants, coordinating vendors, sending notices of late rent payments and so forth. On the leasing aspect of it we were doing deals somewhere in the $20’s/year/sf, sometimes even in the high teens and there was a lot of inventory space back then. The demand was pretty low, especially compared to now where the vacancy rate in San Francisco is around 5% for office. The demand didn’t stay very strong throughout, on a rental rate basis it was quite different than what it is now, from $20 per square foot back then.

What are offices charging per square foot nowadays?
It depends on the building type, my area of focus is in downtown San Francisco. Within our portfolio we have multi-tenant, and class B and C properties. Depending on the part of town and the part of the Financial District, or South of Market, anywhere from the high $40’s/sf/year all the way up to the high $60’s- low $70’s for a class B. For a high rise, you can go anywhere from the mid $70’s-low $80’s all the way up to the low $100’s or higher, depending on the building and the area. 

What should investors look for when buying an office building? 
If you’re getting started and you’re a mom and pop, or individual, or a family that is looking to get into office, there are many different aspects of an office building, especially if it’s multi-tenant, that you have to be aware of.

Just to name a few:
1. Getting a working knowledge of the building systems: the HVAC , boilers, chillers, electrical, and those types of systems that depending on the way that the leases are structured could be an expense of the landlord, or they could be expensive to the tenant. 2. Having some working knowledge as to the way that they are operating at that property.
3. Have a decent working knowledge as to the different types of leases that are active in the market, or typical for this kind of building. 
4. Knowing how to review a lease, knowing the difference between a full service gross lease, an industrial gross lease, a net lease, or any variation thereof. That’s pretty important because it will dictate how much is going to be an expense to you as a landlord. There are provisions in the lease that can allow you to recapture a lot of your operating expenses as well.
5. If it’s a building that has some vacancy, or that has some holes in the leases in the next one to three years – knowing what the market is doing in order for you to able to pretty accurately predict what you’re going to be able to lease those spaces for on a per square foot basis, as well as what the market is doing in terms of tenant improvements. If you buy a building with 10,000 square feet of vacancy, it’s important to know what the market is doing, what other landlords are offering in terms of concessions to fill those vacancies on the retail market. For example, in certain parts of San Francisco such as in the Marina district and Union Street, these high end shopping corridors, landlords can get away with not offering any concessions, or any tenant improvement allowance. But on the office market, it’s not rare to find anywhere from $10 – $30/sf for tenant improvement allowance or tenants buildouts. Having some sort of a working knowledge of that is also very helpful and allowing you to accurately predict what your cashflow for your holding period is going to be. 

Can you shed light in terms of the type of leases that the tenants and the landlords prefer?
For Class A and even class B buildings in the Financial District or the central business district of San Francisco, it’s pretty common to have full service gross leases, which means that the rent covers the base rent, the operating expenses, utilities, and janitorial is all provided by the landlord, so it’s kind of an all inclusive lease. That’s pretty typical for Class A and class B buildings that are multi-tenant. That could also present an opportunity, for example, if you’re looking at an asset or a building that is a class B building and all the leases are full service gross, and you’ve had an absentee owner that wasn’t managing all the expenses well, it could present an opportunity for a new buyer to come in and renegotiate some of the vendor contracts, and optimize the way that those operating expenses are being handled. A full service gross lease could present a lot of expenses to landlord, and it could also present opportunity when they’re being mismanaged.

What is a full service gross lease?

It is when the landlord is paying all of the building operating expenses, including the janitorial and the utilities and all that. 

What are some things that an investor should make sure to cover during the underwriting process of an office building?
– It’s important to look at the leases and be able to understand what the recapture ability is going to be, if any, and if the lease has provisions in which the landlord or a new owner is able to recapture. For example, the increase to the basis of the property tax is usually the biggest expense that a landlord that has a full service gross lease building like an office building will have to pay.
– Knowing what your rental projections are going to be for filling any vacancies.
– What’s a realistic number of what the market is doing for this type of product in this location? Talk to brokers that are active in the community, they can give you a pretty good sense as to what that’s going to be. A lot of brokers will readily give that information hoping to work with a new building owner that’s going to be buying an asset. They want to build a new relationship with you in the hopes that you end up working with them to fill those vacancies.
– Look at the operating expenses of the building and look at the historicals: how was the building operated? You want to make sure that those expenses aren’t missing anything that you may want to implement into your operating expenses as well. If you’re acquiring it from an institutional or sophisticated operator or investor, then chances are that their numbers are going to be pretty sound, but if you’re acquiring it from a family, an individual, or an absentee owner, then there may be some operating expenses that they weren’t including that you may want to include in your calculations. 

In terms of taxes, I want to highlight that if you’re buying a property from an owner that has owned it for, let’s say a decade, and they bought the property for $1 million back then, and now you’re buying it for $10 million – the property tax base is going to increase quite significantly, especially for some tenants if they’re responsible for it. That’s something that you should always keep in mind and be mindful of for your tenants, and for yourself as the new owner.
If the tenant is sophisticated, or properly advised when they negotiated the lease, this is something that they will often seek protection from. When you are reviewing the leases, you want to make sure that you look through all of them carefully because even if the leases appear like they’re boilerplate template leases, a lot of times there could be provisions that were amended or modified pertinent to that specific lease negotiation. You could have a tenant that has a provision added that they have protection against an increase to the property tax basis if the property is sold. That’s something that could just be included in one lease out of 10, if they occupy 50% of the building, and you miss that one part and you were expecting to be able to recapture a part of that, it could be a pretty significant amount of money that you’re missing out on in that first or two years of operation of your new investment.

It’s always advisable to have an attorney review the leases. Equipping yourself with as many qualified eyes on this legal document as possible, whether it’s an experienced broker in tandem with an attorney that specializes in real estate, this is going to give you the best chance that you can really catch something that could end up affecting you five years down the road during an acquisition when you want to sell or change control of your company. These leases get very specific sometimes with the rights and remedies that a landlord has, even with change of control of a tenant’s company, for example.

What are some things that we as landlords should keep in mind when leasing office space to companies? What are some things that are important to companies when looking for office space? 
The tech industry has been the predominant driver of the economy and with that, the demand for tech friendly creative space has been in high demand. The physical attributes that are highly associated with that are the ceiling height and natural lights. When I first started, we used to be able to lease space with solid walls and standard ceiling height quite easily. Tech tenants are a lot more picky with the aesthetic that they’re after, and there’s a disparity between very similar locations just based on aesthetic alone that a lot of these companies are willing to lease.

You can have two similar sized spaces in identical location buildings right next to each other where one has 8-10 foot ceilings, limited natural light, and the other one has 14 foot ceilings with abundant natural light and there can be a $30% swing in that rental rate that one tenant is willing to enter a lease vs the other. Just based on that alone, I would say that when you’re negotiating on tenant improvement allowance or tenant improvements in general, you can give a tenant improvement allowance in which the tenant conducts a buildout with landlord approval or the landlord can provide a turnkey buildout for the tenant when you’re negotiating on the tenant improvement in general.

Be aware of what can provide residual value in the future. If the tenant vacates at the expiration of your lease or defaults, you don’t want to end up with a space that has low utility to a wide variety of tenants. It’s ideal to have a space that still has residual value – a buildout that can be suitable for a lot of different kinds of tenants. That way it saves you money at the expiration of the lease, if you can reuse the existing buildings for new tenants. 

Retail is having a bit of a hard time because people don’t know what is going to happen to retail. What do you think the future of office space is?
In San Francisco and further down South in Silicon Valley there has been an emergence of co-working spaces that are leasing huge blocks of office space. It’ll be interesting to see how that shapes the landscape. I think that the type of tenants that they’re going after are going to be growth companies where they’re able to offer flexibility when the companies may not want to sign a three year lease, which is the minimum that many landlords in this market are willing to enter a lease on.

As far as the rest of the leasing around office space, it’s strong around here and there was a little bit of a slow down in 2016, because people always have their speculations. “Are things are slowing down, where’s the economy going?”. Here we are in 2019 with a 5% vacancy rate in San Francisco. The office market here is stronger than ever. As long as the economy continues to grow and businesses continue to hire and expand, the demand for office space is going to be strong. With the vacancy rate so low, it doesn’t seem that we’re able to even meet the demand with the construction of new office space. It’s hard for me to provide any sort of blanket statement, whether it’s going to be in California, the West Coast or other top tier cities, but I’m pretty optimistic about the office market here in the Bay Area.

Because there is such low supply, where are companies willing to go outside of San Francisco?
Companies are still very much wanting to be in areas where other tech is, which is the core market of San Francisco. The core areas of South of Market, South Park, the East Cut of San Francisco, and the Financial District of San Francisco. So I wouldn’t say that a lot of companies are really getting pushed out. 

Is there anything else that our audience should know? 
If you’re looking to get into investing in the office space market, there’s a decent amount of information to learn. Partnering with the right brokers, attorneys, and other professionals that are knowledgeable can be a huge help during the due diligence process, knowing how to underwrite the deal, knowing the different aspects of a lease, what to look for in terms of how it affects the income and the cash flow, knowing how to look at and analyze your expenses, looking at your whole ownership period and how you’re going to increase the income, increase the NOI, fill vacancies, etc.

Partnering with the right people is going to be critical to execute on that plan. Having a sound business plan that is realistic and in line with your goals, whether you’re raising capital to acquire the asset, or if it’s going to be funded on your own. You must have the right team in place to execute the business plan when buying an office building. Working with the right vendors and advisors for all the building systems in order to operate the building and the asset in a way that is going to maximize your net operating income is going to be very important. 

Eduardo Zepeda
Email: ez@cma-re.com
Meetup: https://www.meetup.com/SFREConnection/

Episode 16 – What are Opportunities Zones, How to Hire the Best Team, What Types of Asset Classes to Invest in Today’s Market

In this episode we’ll learn how you can manage multiple companies at the same time, how to hire and inspire the best people, what types of asset classes and what markets are interesting to invest in today’s market, and we will also learn what are opportunities zones and how you can leverage opportunities zones in your investments. We’re interviewing Greg Dickerson, a serial entrepreneur, real estate developer, coach and mentor. Over the last 20 years he has bought, developed and sold over $200 million in real estate. He built and renovated hundreds of custom homes and commercial buildings, and started 12 different companies from the ground up.

Can you share a little bit more about your background?
I started in 1997, I joined the navy out of high school in 1985, and in 1989 I got out of the navy. I worked in restaurants and had a construction company on the side. The two things I had done in my entire life prior to starting my entrepreneurial journey was restaurants and construction. I learned all about business, management and leadership, how to recruit, hire, train, manage, motivate, and lead people.

In 1997, I moved to the East Coast, I bought a house and was trying to get an addition built on the house, but I couldn’t get anybody to call me back and show up to give me a quote. So I started talking to my neighbors and they said that everybody’s so busy, they can’t even return your phone call. So I said “Where there’s a problem, there’s an opportunity”, and started a construction company. 

It was a little remodeling company and it was just me, my truck, and tools and I would do whatever I could do. In my first year I did $250,000 in sales by myself. By my seventh year, I was one of the largest builder/developer in the area at $30 million in revenue per year. I started 12 other companies along the way during that seven year period, all related to the construction industry, except for a couple of restaurants: plumbing, landscaping, electrical, hurricane shutter, painting. I like to help people, to coach and mentor them. That’s how I did so many things at the same time, by leading, motivating and delegating to others, teaching them how to be entrepreneurial, and helping them build the businesses. 

People that have been in the military are one of the best partners you could ever get, similar to people that have founded their own startups or companies because they have great work ethics.
Work ethic, diligence, discipline, and a “stick-to-it-ness” that a lot of people don’t have these days. 

How do you make sure that you’re successful when you’re doing everything from fundraising to investing in all kinds of asset classes? You have done multifamily, retail, medical center, offices, etc, how do you make everything move forward? 
First and foremost, it’s education. I didn’t go to college but I am very highly self-educated, I’ve always developed myself personally and professionally. I’ve never owned one song, only audio books and courses. Business and personal professional development are important in order to accomplish things. You need to be a visionary, a leader. What is it that you’re trying to accomplish? Create the vision, communicate that vision in a way that people understand it and can see it even though it’s not there. Put together the right team, inspire the results out of that team, delegate, motivate, and lead. 

How do you make sure that people are inspired, and how do you pick the best people to work for you? 
You find winners and champions and coach them to success. Usually the best people are the ones that approached me on a business level, or my own intuition. When I’m talking to somebody, or working with somebody, I know whether they’re good people or not, whether they’re going to actually be able to accomplish something or not. When I’m interviewing somebody, I let them do all the talking. One mistake that a lot of people make in the interview process is that they spend all their time pitching their company or their idea. Lastly, I give them an audition, we have an agreement up front that this may or may not be the right fit for you. We may not be the right company, you may not be the right person, so we’re going to try this.

I then tell them how the job gets done, I measure performance and hold people accountable. I provide a clear direction and exactly what’s expected. That’s our job as leaders, to serve the individuals in the organizations and give them everything they needed: tools, training, systems and support to be successful – and more importantly, a clear direction and exactly what’s expected.

When you measure their performance, compare it to the goal that was set and have an accountability session: maybe they achieved it or not. And then you look back at the leader, and make sure that they gave them everything that they need to be successful, did they know exactly what was expected, and when? When you measure that, you either got the result that you’re looking for or you didn’t. And if you did everything as a leader that you were supposed to do and you didn’t get the result, then you had the wrong person, or you had the right person in the wrong position. Not everybody is right for every job.

Is now a good time to invest in commercial real estate? If yes, what are your favorite markets? 
It’s always a good time to invest in commercial real estate, but it’s not always a great time to invest in every asset class. And every market is specific. Everybody says that real estate is local, I call it hyperlocal, real estate is local down to the block of the neighborhood within the city and the subdivision you’re investing in. You could say that multifamily is a great, safe place all across the country, which it is, it’s the safest bet from a real estate investment standpoint, especially at the low A, high B level. That’s an asset class that’s probably never going to go away, people need housing, so when you start going down in the B, C, D classes it can get a little risky in certain areas, but they can be slam dunks in other areas. In the commercial side, you’ve got multifamily, office, retail, industrial, land, hospitality, and there are different classes within all those assets. 

Look at what the interest rates are doing, and what the institutional investors are doing – they’re going for primary markets and going after class A assets in this economy. A lot of them are just buying bonds and they’re paying for low cap rates, 3% cap rates in some areas. Sovereign wealth funds are coming into this country and buying properties in New York, San Francisco, San Diego, Seattle, Charlotte, DC. They’re going to the major markets and buying these trophy class A assets because they feel like that’s a safe long term bet. And then for the rest of us we have to look at a different angle because we’re not going to be able to compete on that level, with those buyers.

We have to look at the secondary and tertiary markets, within those secondary and tertiary markets, I really like certain kinds of offices, such as destination offices where you have medical, dental, a professional office space where tenants need an office and can’t work out of their house. When you think about investing in office, you have to think about the environment that we’re in now, and how everything is outsourced, everybody’s working remotely, you want to invest in types of office spaces that cannot be used out of the home.

Similarly in retail – that landscape is really changing right now, and you’ve to be very careful where your retail investment is. I love suburban strip centers where you’ve Starbucks, Chipotle, a hair salon, a nail salon, those are core services that, in any economic cycle, people are always going to need them and they’re always going to go to them, up to a certain level. There will never be a time when Starbucks has zero customers, people are going to go out for a cup of coffee every once in a while. They’re going to use those small core services like the McDonald’s of the world.

I’m not a fan of single tenant, NNN assets like pharmacies and restaurants. The problem with that is that you have one tenant and when they’re gone it’s very difficult to fill that space. Regional malls and power centers in certain areas can be good, but I’m not going into that asset class. I’d rather do the smaller strip centers, spread that out, and diversify in in several markets.

Warehouse is a great space to be in right now with the growth of Amazon and online shipping, those companies are looking for industrial parks and satellite warehousing areas because everybody’s competing for that instant delivery. So they have to have warehouse fulfillment centers close to the suburban markets all over the country.

You coach investors as well, what are some common characteristics of mentees that become very successful? 
People that educate themselves, that learn everything that they can, and that are doers. I find champions and coach them to success. I look for people that will get out there, get it done and take action. I like to help people do things in their life that they never thought was possible. Mindset is a big part of it, and I help people open their minds to think of ideas and opportunities that they just didn’t even know existed, much less that they could do. You’ve to be able to take action.

There are so many facets to opportunity zones. Can you to explain what it is in detail, and how can people leverage opportunity zones within their own investments?
The Tax and Jobs Act from 2017 gave governors of all the states in the United States the ability to designate certain areas as opportunities zones. The idea behind it was to incentivize investment into lower areas, primarily in business and in real estate assets. Each governor was able to go through their state and pick zones within cities of the state as opportunities. You can Google it and look at opportunity zones in your area. It was created to spur investment in businesses and in real estate in lower income, distressed areas.

With opportunity zones, you get to defer capital gains, let’s say that you sell stock, art, or property – anything that generates capital gains. You then can invest into an opportunity zone fund, and for the first five years 10% of that gain is a written off. After seven years you get an additional 5%, and an after ten years anything that you make on that gain is tax-free. You can also refinance, sell assets and reinvest in another opportunity zone within a year and roll it over. You could invest $1 million, make $10 million within a year, reinvest that gain and just keep on going, and going, and going. The other thing is that you will never pay capital gains on that initial million dollar gain after the 10 year period. If you do a project and, let’s say you’ve a $1 million gain, you invest it and it becomes $2 million, or you sell it in a year or two and then you reinvest that $2 million, then the clock starts ticking again on the five, seven, and ten years. 

Every time you reinvest you have to hold it for ten years to get the full benefits of that gain, in order for it to be tax free.

Do opportunity zone funds buy properties?
They do not buy property and almost all of the opportunities zone funds are equity investors, they invest equity into projects because it’s all about leverage, they’re not direct buyers. They raise equity to be used for projects and opportunities zones. The other thing to keep in mind is that not all opportunities are created equal, and not all opportunity zone properties are going to exponentially be worth more. Property owners think that their properties can double in price, but it doesn’t work that way. It still needs to be in a good area, it still needs to be a good project on its own merit. 

The opportunity zone aspect is just icing on the cake, so it’s not any capital chasing opportunities on deals, it’s actually even more intelligent and patient capital. The 1031 exchange money can be “not smart” capital, they’ll buy properties and pay more just because they have an exchange to make. You’ve to look at the market and the rating. You can find a website where they rate opportunity zones, look at income levels, and different zones in different states and cities. You want to make sure that you’ve a good, highly rated opportunity zone, and make sure that your project stands on its own, that it’s going to generate a minimum of 18-22% IRR for the investors.

There are some caveats to it: you have to invest a certain dollar amount in that building in order to get the tax breaks. It’s called the substantial improvement test. You can’t just buy a performing multi-family asset and shelter that gain. The idea was to spur investments, you have to either invest in a business (any business), and there is no substantial improvement test for a business. But there is for real estate assets, if it’s a vacant building, it has to have been vacant for five years, and then you can go in there and sweep it out, paint it, etc. But if it’s a performing asset that has been in service in the past five years and has not been vacant, or it has only been vacant for two years in the past, then you have to spend an equal amount of capital that’s equivalent to the value of the asset, not including the land. If you buy a building that’s worth $5 million and the land is $3 million of that, the building itself is valued at $2 million. You have to spend $2 million on that building – this is only if it’s a building that has been in service and has not been vacant. If it’s a vacant building, it has to have been vacant for more than five years, and then you don’t have to meet that substantial improvement test. Steve Glickman’s website has a lot of great information on that.

Is there anything else that our audience should know? 
What it boils down to is education: understand the asset classes. Each of them have their own nuances, their own language, their own metric, and they each have their own opportunities, especially in the opportunity zones.

I love commercial real estate, I think there’s a lot of opportunity in retail, offices, warehouses, and land can also be really good. Find out where the demand is. Don’t go by the mantra like opportunities zones, a lot of them are in rural areas, people say “I can go build in this little town in the middle of nowhere, 45 minutes outside of town.” It doesn’t work that way. Don’t think that you can build it and they will come. In today’s world, it doesn’t work that way. 

You’ve to go where the demand is and fill the need in the niche of that demand. You’ve to find out what people want and give it to them, and if you can marry that with an opportunity zone, or the right kind of asset, that’s a big thing.

How do you even determine highest and best use?
The way you determine the highest and best use is by demand in the area that you’re in. If you’re looking at a piece of land in an area ask yourself: what do you have around you? Do you have a lot of rooftops or do you have a lot of commercial? If you see commercial, you probably need more rooftops. If you have a lot of rooftops, and not a lot of commercial, then you probably need some commercial. Make sure that you always look at what’s around you, and what is surrounding that asset. What is the demand in the market? Where are things going? Look at common sense, simple things. Make sure you understand the metrics, the language, and the nuances of each asset type and then the class of each asset in those types, and the demographics surrounding them. Then it’s hard to go wrong. 

What type of mentees do you look for to mentor?
I’m looking for people that want to do big things, that wanted to achieve results and success, and that are ready to take action. I coach some of the most successful investors in the industry and I’ve some beginners that are starting out. The best fit for me is somebody that has some level of sophistication, some level of business success, and the ability to take action. They’ve to have some capital to work with, or be able to raise it, and be able to take advantage of a higher level project, whether it’s commercial, multifamily, or businesses. I coach business owners and help them grow and scale their business and sometimes I get involved if it’s something that’s really scalable. I’ll come in from an intellectual capital standpoint. We help them develop their teams and a lot of times we see profits double, triple, or even more in a very short period of time. 

gregdickerson.com
Cell: (434) 326-3903

Episode 15 – How to Get Started in Real Estate Investing With No Money

In this episode you’re going to learn how to get started in real estate investing with zero money down. If you’re feeling a little overwhelmed by the fact that you need a lot of money to get started in real estate investing, fear not! There are opportunities out there where you can partner up with people and this is something I had no idea was possible in the beginning of my career. 

We are interviewing Ellis Hammond, the founder of ellishammond.com, he began his career as a Christian missionary but soon saw the need to create wealth building vehicles to support the causes that he and his wife were passionate about serving. Ellis started investing passively in commercial real estate deals in 2018 with a few other partners and he now manages a network of investors that focuses on acquiring commercial real estate properties in California and Arizona.

What are some things that you did to get to where you are, and what are some things that you wish you did when you were starting?
Build your network before you need your network is the best advice I can give to someone who wants to get started into real estate. That’s really how I went from owning no real estate to doing a $2 million deal last year, and we have two deals right now that will be over $15 million in real estate. I found a mentor, and that mentor opened me up to his network and other networks. I showed up at conferences that have people that you want to connect with. The second thing that helped me out a lot is Linkedin, connecting with people, and not in a sales way. Early on you have nothing to sell them. All you’re looking for is advice and mentorship and help getting started, so that’s still the approach I take. “I’m looking for more help, I’m looking for advice, can we talk, can we jump on the phone, can I connect with you, buy you a coffee or a beer and just pick your brain?” That for me has been life changing. 

One of my mentors always tells me that if you ask for money, you get advice, and if you ask for advice, you get money. And that’s true. Building that brand, building that reputation is important, because if you’re just always asking for something that they have to dish out of pocket for, they’re going to start avoiding you. But if they feel like they’re really needed, not just for their money, then there’s a relationship. And that’s key. 

What are some ways that people can get into real estate investing without any money? 
It’s finding the deals or finding the money. That’s essentially what it comes down to. So which one of those can you really begin to play a part in? I think the nice thing about commercial real estate is that it’s a team sport and there are multiple roles within commercial real estate. That’s why I like it. That’s why I really got out of the single family space because commercial real estate allows you to specialize in what your superpower is. What is your superpower? What are you really good at doing? For me, I’m really good at networking. I’m really good at building relationships. 

When I was a missionary, I was raising funds to support our nonprofit. I was building relationships with people and helping them grow spiritually. As I got into commercial real estate, I saw that one of the roles I could take on was raising money. And so I went out and networked with the guys who were finding the deals, who are good deal finders, who had the relationships with the brokers, and I said “If I can bring you $1 million or $2 million because of my network, would you be interested? Could we partner together?” And I made that phone call enough times, I showed up to enough enough conferences where I finally met a few people who I trusted, who were doing really great deals, who would be mentors for me. 

And they’d say “I’d love to, I’d love to bring you along into our next deal”. That’s essentially how I got started, I then reached back to my network of supporters and people who had been friends at our nonprofit and I said to them “If I was able to put something like this type of deal together, would you be interested?” The key here is that I had already built a network before and it wasn’t even about real estate. This was about the nonprofit space. Because there was a trust that had been built, and a reputation that had been built, it wasn’t that hard to go and ask them for a sizable amount of money to go and invest in a deal. That first deal, I didn’t get a ton of people, but I got a few and it got me started, and that was key. 

Can you share with us the finances? How does that work? If our listeners were to raise all of the funds, or raise 50% of the funds for a particular deal, how much would they own of that deal?
For big commercial deals, the person who raising the capital can normally get paid 2-3% on the money that they raise. If you raised $1 million, you could make 2-3% or right off the get go on that million dollars you bring into the deal. So that’s nice to get some money right away. But you want to be a partner in the deal and with the people that you’re investing with.

And then you want to make sure you’re building long term partnerships with the operators so you also want to negotiate an equity piece. For syndications there are two sides of the deal: the general partner who’s the sponsor, or the operator, the ones who are putting together the deal. And then there are the investors, which is it called the limited partnership. So you then negotiate for a percentage of the general partnership and the equity so that you have consistent cash flow throughout the life of the project. If you’re raising all of the money, you would look to have about 10% of the deal or 25-40% of the general partnership equity. 

There is another side to this that you could also start with: finding deals. Can you elaborate on that?
If you don’t like asking people for money, the best thing you can start doing is looking for deals. In this market, if you get really good at finding deals, you’re gold. People will pay to find good deals because good deals are hard to find, especially in this market. This is a super power, it takes a ton of follow up, it takes a ton of detailed work. I tried to do both sides and I just realized that a lot goes into this one. So to get started learning how to find deals, go to a website called listsource.com – it’s a database website where you can filter real estate by asset class. 

You line up a couple buyers and figure out the property criteria that they’re interested in, say, they focus on 30,000 square foot office, retail, or mixed use, in urban areas. Then at listsource.com you filter the properties you’re aiming at by: equity, size of the deal, square footage, etc. The reason you want to start here is because if you’re just getting started, a lot of people try to work with brokers, but don’t have a track record. Why would brokers want to talk with you, when you don’t have any money? So you’ve to figure out how to go directly to the seller. Let’s say you go and you look at Phoenix, you draw up the radius of Phoenix on listsource and you type in “anywhere from 20,000 to 50,000 square foot properties that have not been sold in the last 10 years”. The reason I like 10 years is because there’s a lot of equity in the deal for the sellers, people might be ready to sell, it’s an older seller, they might be looking to get out. You then download that list for a small price. That gives you the addresses of all those qualified properties, then you would go to the secretary of state website (or you can hire a VA to do this) and you type in those addresses, and that will give you the name of the LLC and the person who owns that LLC. And now you have the owner of this office or retail place. Unlike single family, most of these places are owned by an LLC, so you’re not just going to easily find their names. You have to go to the secretary of state website, find the owner’s name and now that you have their name, you can use a skip tracing software and get all their contact information, and now you just implement a marketing strategy. You can call them, email them, send them letters, and just start building relationships with these owners.

If you can get good at that and you can build a system of finding deals and building relationships with these owners, and maybe they’re not ready to sell right now. Six months later you follow up, they’re not ready. Six months later, they’re not ready. Maybe a year and a half from now, there’ll be ready to sell. Boom, you do a $10 million deal. Someone pays you 2% on that, that’s a lot of money. It’s a lot of work, but it pays off. This does take work, and it’s why most people don’t get into this. It’s not something you can just sit down for a day and do, it takes relationship building, it takes time, but we’re talking about a $10 million transaction. It doesn’t take 40 of them to get rich. If you can figure out how to get in front of one deal, find the deal or find the money, the snowball effect of that can change your life. 

It only takes one and then once you get started, it begins to get easier. Just like raising money you get better at it, you get introduced to other people. Or if you’re finding deals, you start doing a couple of deals in the market, and you can get your name out, then you can go to a broker and say “I did a couple of deals” and now you have some credibility. It takes some hard work in the beginning, but it gets easier to raise money or find partners who want to invest with you because there’s a track record. In the beginning, I didn’t have anything to show, it was just me. So it’s all about getting started, it’s all about relationships.

Is there anything else that our audience should know? 
Figure out what your superpower is, figure out what you’re really good at and then try it out.

Ellis Hammond
Email: invest@ellishammond.com
Linkedin: https://www.linkedin.com/in/ellis-hammond-435b40156/

Episode 14 – What is a Syndication, How to Underwrite Deals, What is Replacement Cost

In the last episode we interviewed Reuben Torenberg and learned specific details about office leases such as lease negotiation points, what makes for a good office landlord, and what does base year mean on a lease. In this episode we are interviewing Matt Shamus. Matt is the founder of Driven Capital Partners, a real estate private equity firm based in California. Driven Capital Partners maintains a diversified portfolio that includes 700 multifamily units, 40,000 square feet of office space, and a mixed use opportunity zone development project. With Matt, we’re going to learn what is a real estate syndication, what types of asset classes are safer for us to be prepared for when we go into a recession, how do they underwrite and pick deals, as well as what does replacement cost mean.

Matt and his partner Dan run Driven Capital Partners, they invest their own money and bring passive investors along for many deals, they pool money and other assets together from multiple people so that we can buy bigger, higher quality assets than they couldn’t buy on their own. They focus mostly on markets outside of California that have strong growth dynamics, and places where people are moving. Typically that happens as a result of job creation, and job creation typically happens as a result of local municipalities incentivizing jobs to be created in that region. These are places where businesses are investing or are moving to, where jobs are being created, where people are moving as a result, where there’s opportunity. These areas are largely in the Southeast United States: the Carolinas, Georgia, Tennessee, Alabama, and Florida.

How did you find your partner and how did you guys decided to become partners?
This business is all about partnerships and relationships. I actually believe that your partners are more important than the asset class, the property, or even the market that you buy in. We didn’t find each other per se, we’ve been in each other’s lives for many years since our wives are best friends, so over the last 12 years we had no choice but to hang out with each other, and get to know each other very well. We have very complimentary skillsets, complimentary views, we don’t always agree on everything, but we have a relationship that is strong enough that we can disagree thoughtfully with each other, which I think is very important. We also enjoy doing different things. Dan is very outgoing, he likes to take action and to move quickly. I’m very analytical, I like to get just a little bit more information before I make a decision. So our skills balance each other out, and they’ve allowed us to achieve a lot more in a shorter period of time that either of us would have been able to do on our own.

What is a syndication?
A syndication is pooling assets together to achieve something that neither of us could achieve on our own. That term is used very commonly, especially today in real estate investing for a structure where you have the sponsor who is outsourcing the deal, underwriting the deal, packaging it together, and then raising money from individual passive investors, that structure is called syndication. I actually don’t love the term syndication or syndicator, and I don’t really apply that to what we do because it has a bit of a connotation. In fact, one of our investors recently told me that he considers our group a little bit more like an investing club than a syndication, and I think that’s the approach that we’re taking. We started Driven Capital Partners because Dan and I were investing in real estate for ourselves on the side and we thought that we could achieve something better by pooling resources together. We are investors first, we put our own money into every deal that we do, so it has a different feel than some other syndicators. Broadly, it’s simply pooling together resources so that the group can accomplish something greater than the individual, and real estate is very well suited for this structure because you have some people that are very experienced in the operational components of real estate, that are highly analytical, that understand how to underwrite properties, how to negotiate and win a property at a price that makes sense. These are all just a small portion of the skills required to run a successful real estate investing operation. But you can imagine that not everyone has these skills or even wants to have them, and even if you have the skills, do you have the time and inclination to go out there and do it? Even if you did have the time and inclination, is the return on the investment of your time going to be worth it?

What we’ve found is that a lot of our investors want the benefits of investing in real estate, they understand them, but they don’t have the time, the knowledge, or the expertise to do it on their own. And we offer a partnership where we bring in the expertise, the deals, the deal flow, the due diligence process, and it’s a project that we are putting our own money into. This allows investors to be invested passively, and everyone has a chance to play a role in, to be better off than they would if they would’ve done it on their own. It is very important that the sponsor put some money in the deal because that shows that they have skin in the game.

What is your investing strategy?
We have a bit of a unique strategy since we are investing for our own account, meaning we are investing our own money into deals. We want to be diversified across asset classes and across markets. What typically happens is that a real estate syndicator or sponsor will specialize in a particular market or on a particular asset class, and typically both. You might have a syndicator that focuses exclusively on multifamily properties in Houston, and maybe even further specializes in a certain size range, 100 to 200 units, multifamily in Houston, class B apartments. That’s the only thing that they do. There’s tremendous value in that approach because they can be a specialist. The downside is that you have all of your eggs in one basket. What we decided to do from the start was to have a diversified approach where we want to create a portfolio of multiple asset classes in multiple markets. We want exposure to the markets that we like, and we want exposure to the asset classes that we like, what we don’t want is to be specialists in any one of those. We want to be knowledgeable enough to be dangerous in the industrial space, in multifamily, medical office space, and various other asset classes. Our approach is probably unique.

Is there a particular asset class that you prefer today?
“Today” is a very important modifier to the question because we are in May, 2019 and in the middle of a trade war between the United States and China, there’s a lot of uncertainty in the stock market. There’s a lot of uncertainty with regard to when are we going into a recession, and our belief is that we will be entering a recession at some point. What that means as a real estate investor is that you have a choice: Do I stay on the sidelines and see what happens and forgo potential gains for the sake of being “conservative” and waiting it out? Or do I take the approach that everything that I’m investing in, I’m looking at a little bit more closely, specifically through the lens of “we’re going to enter a recession at some point”.

For the properties that I’m underwriting today, I need to be able to hold through a recession. We’re going to buy very selectively, and this means we’re going to say no to some projects that would be profitable. But the projects that we say yes to are going to be projects that we’re very excited about because we feel like we understand the downsides, and we feel like we are appropriately and conservatively leveraged with debt, that we have enough in operating reserves in case we have more vacancy than we expected, for instance. We’re essentially becoming more conservative the longer that this market runs. We’re also looking at some of the asset classes that we think will fare better in a recession. For example, we have two medical office projects under contract, medical offices where you have dentists offices, optometrists, physical therapists and outpatient center for a hospital. 

Any kind of place where you have office space that is occupied by someone in the medical services profession, we think that it’s going to fare very well in a recession because in a recession you still need to go to the dentist and you still need to go to the physical therapist. Your insurance is going to pay for a large portion, if not all of those costs. So we think that that asset class is probably relatively conservative in a recessionary environment, whereas we’re less interested in something like multifamily simply because it’s so highly priced today. There’s so much demand and new investors in the market bidding up prices for apartments that we just feel like we are at a disadvantage buying multifamily versus some of these other asset classes that we think are still a little bit undervalued comparatively.

How do you guys decide to move forward on a deal? 
I covered a good portion of that with the previous question, but we’re looking at everything through the lens of “can we and do we want to hold this asset through a recession?” We only buy a deal when we are confident that we are buying it below its actual value. Oftentimes this is replacement cost, or there’s something fundamental about the property that is undervalued and we can see and capture. We only buy something when we have a very strong plan in place to improve the value after we acquire it. If those two conditions are not met, then we just won’t proceed on the project. We say no to a good chunk of projects that probably would be really good projects for us, but there’s something just not quite right about it that we can’t wrap our heads around and therefore we’re willing to pass on it.

And I think this is an important characteristic that we want to maintain. We don’t want to feel like we have to go buy a project just to do a deal. We want to maintain quality over quantity of deals.

Can you elaborate on what does it mean when a property is below replacement cost?
I’m writing an offer today on an industrial warehouse, it’s 86,000 square feet, it’s mostly warehouse in a great location appealing to someone that needs a distribution center, high height space, which is essentially space that a large truck can back up into and you can stack the merchandise very high so you can maximize the square footage, and also has office space. That combination is very appealing in this particular market. We are looking at buying this property for less than $60 a square foot.

If I were to build this exact same property on a similar parcel, I couldn’t build it for $60 a foot. I’d have to pay more just to build the property and then I would have a vacant property sitting there waiting to be leased. So the risk associated with the development is meaningful. What we look for is where can we buy something that is below the cost to replace it. That’s one way of determining if it’s undervalued, and it’s one way that a lot of brokers will use if you look at an offering memo. One thing to watch out for is that brokers are salespeople. It’s easy to say that this asset is below replacement cost, but what they will never they tell you is “this actually would be replacement cost, and here are the real numbers that we used”. Below replacement cost is a term that is used very loosely with a lot of brokers.

You should really have an understanding if you’re going to use that yourself, or if you’re going to believe it, you should have a pretty good understanding of what you think the replacement cost would be.

Where do you go to triple confirm that it is indeed below replacement cost?
This is the beauty and the pain of real estate, there are very few sources of truth. The market is inefficient, it changes day to day. It doesn’t really come from a website, it comes from asking a lot of questions and gaining experience, and then using your own judgment at the end of the day. I wish it was a cleaner, simpler answer, but that’s really the truth.

Let’s go over a deal that you guys have done from beginning to end.
Right now we own just under 700 multifamily units, we have 40,000 square foot of office space and we have one opportunity zone development deal. We have three projects under contract, and they total about 80,000 square feet of industrial and medical office space.

I’ll share a little bit more about the opportunity zone development deal because I think this is probably the most interesting. There are major tax incentives for taking capital gains and investing that money into an opportunity zone project. Opportunities zone projects can be real estate related, and we look for where are the opportunities zones in the country in the markets that we like. In other words, where are places that are designated opportunities zones, but are not really economically distressed and the project probably would have penciled out anyway. The tax benefits associated with investing in an opportunity zone project simply makes the overall development project just much more appealing. We happened to find one of these opportunities and we own it now. It’s a four acre parcel on a very high traffic corner lot and it currently has a vacant building. It’s a building that was built in the 60’s and it’s just been neglected for the last handful of years. We originally bought it with the intention of refurbishing the existing building, and putting a significant amount of money into the renovation. But as we got further down the due diligence process before we actually closed on the property, we realized that the location is so strong and the particular city that we are working with is very motivated to see something big and exciting happen at this location. We actually sat down with several city officials including the mayor, had some great conversations with them, and realized that this is actually a development opportunity, not a renovation opportunity.

We’re in the early stages of putting together design concepts and it’s going to be a multi-use projects, that means two or more uses. In this case it’ll probably be retail and office. It’s located in an office park and we’re excited about going through this process and bringing something brand new into the world that wasn’t there before. That’s the one deal that I would highlight just because I think it’s the most interesting and exciting.

Where is this deal?
In Huntsville, Alabama, which is the fastest growing city in the state of Alabama, and somewhere that we are pretty excited about.

Is there anything else that our audience should know?
We covered a good range here. I certainly don’t want to portray myself as an expert, I’m learning everyday and I love sharing whatever knowledge and information I have, I just encourage everyone to continue to learn more.

If you’re interested in what we’re doing, one thing that I do recommend is finding a few sponsors, subscribing to their email lists and getting a feel for how they communicate with their investors and potential investors, getting a feel for the kinds of deals that they have. And the more deals that you look at, you’re incurring more repetitions. And in this business you need a lot of repetitions in order to feel confident. I would encourage you to sign up for our email list if it’s something that you’re interested in learning more about, and you’ll learn pretty quickly if it feels like you click with their style and if you’re aligned with them. 

Reach out to Matt Shamus here:
matt@drivencap.com
www.drivencap.com

Episode 13 – Office Leases: Lease Negotiation Points, What Makes for a Good Landlord, What Does “Base Year” Mean on a Lease

In the last episode, we started interviewing Reuben Torenberg, a commercial real estate broker with CBRE in San Francisco, he specializes in helping startups, technology companies, and venture capital firms find and manage office space in the San Francisco Bay Area and beyond. We discussed what do startups look for when leasing an office, as well as what are the current price points for all kinds of offices in tech hubs. In this episode we are covering what does the base year mean in office leasing, what are specific things that startups want to negotiate on a lease, what happens when a startup goes out of business, we will also cover LOI’s, lease negotiation & TI’s (also called lease concessions), and lastly, we will cover what makes for a good office landlord.

For offices, are the leases typically NNN?
No. It’s typically what’s called a “full service lease” where you pay your rent, and it’s pretty much in all in rent. The landlord covers the utilities, the janitorial, the operating expenses, and real estate taxes. The way that it works is you get what’s called a base year. So let’s say we completed our lease in 2019 and we do a three year term. You get a “base year” and 2019 is your first year, you don’t need to pay any real estate taxes and operating expenses. But in the following year you are responsible for paying your proportionate share of the increase in operating expenses and real estate taxes. So let’s use round numbers, for example let’s say that you occupied 10% of a building. The operating expense in real estate taxes were $100 in 2019 and they went up to $200 in 2020, a $100 increase. All you need to pay is your proportionate share of $100, in this case $10, it’s usually a nominal number. But as you do a long term lease, 7-10 years, it’s growing every year, and that number can become significant. So a lot of companies will renegotiate their lease, they will do what’s called an extension, or they’ll expand and renegotiate the lease to get a brand new base year so that they don’t have to incur those costs. The original base year is pre-negotiated, but if you want to renegotiate your deal, that part is not. 

Who wants to renegotiate? The startup? 
The startup would come to the landlord and say that they would like to renegotiate after the lease expires in order to get a new base year. And there will be other terms involved such as the rent, and if they need any tenant improvements such as a new carpet, flooring, paint, adding conference rooms, adding phone rooms, redoing the kitchen, security deposit, subleased rights, free rent. Usually when negotiating a lease, we’ll try and get an option to renew (also called an extension option) where you’ll have the right to exercise by a certain date, usually 12 months or 9 months before a lease ends. So there are other terms that get negotiated at the beginning which can also be renegotiated when you’re coming back to the landlord to extend your lease.

Has it ever happened that a startup went out of business, and what happened to that contract? What are the recourses for the landlord? 
They go into what’s called a default and the landlord eventually ends up needing to collect their money. This situation has come up numerous times and what we do is find a new tenant to sublease the space. We market it for sublease, and once you come to an agreement on terms, the landlord will say “Okay, instead of subleasing from this company who has gone bankrupt, we’ll wrap up that lease and do a new direct deal with this new tenant”. So we’re able to bring a new tenant into the space and, by doing that, cut our client out of any rent responsibility moving forward.

How often does this happen?
One out of fifty, so very rare. Breaking a lease is rare. Subleasing a space is very common. Last year, over 50% of all our deals where subleases, for the most part because the startups were expanding.

What are some specific things that startups want to negotiate in a lease that we haven’t covered yet?
The few things that we’ve covered so far are the big items such as rent, term, free rent, tenant improvement allowance, and the security deposit. Things we haven’t talked about yet are: let’s say a landlord is forcing us into a five year deal, but we know we’re not going to be able to make it for the full five years. We try to negotiate a termination option where after three years we can terminate with no penalty, or a very small penalty such as two months rent. Another item is sublease rights, a landlord will generally give you the right to sublease, but any profit that you get for that sublease is split 50-50 between the tenant and the landlord since they want to discourage tenants to take space and sublease for a profit. When you’re in rapid expansion mode and there’s only so much availability on a certain building, for example in San Francisco office spaces are at a 4% vacancy right now, we try to negotiate what’s called a right of first refusal, where if a space becomes available in the building, the landlord is required to present it to the startup first at a fair market value, and the startup has the choice to take it or not.

Who determines what is fair under “fair market value”?
It’s determined by the landlord. It’s on the startup whether to agree or disagree. They don’t have to accept the expansion option. They can say that they reject the option, but would still like to negotiate on the lease terms. That’s a little bit more dangerous because in an expansion option you can take it and it’s yours. If you choose not to, the landlord has the right to negotiate with all other parties. And in a market like San Francisco where there’s so much more demand than there is supply, you risk losing the space to somebody else. You need to move very, very quickly in order to secure the space. 

Who pays for TI in an office lease?
In office leasing we call concessions. Tenant improvement and free rent are all a function of how much term you take. The longer term you sign the better, for example if you sign a five to seven year lease, the more likely a landlord will be willing to give you a tenant improvement allowance. Or they will turnkey the space completely for you, which means they’ll build it out and just give it to you, which is ideal. In shorter lease situations, like one to two years, or a sublease, the tenant is responsible for everything. They usually don’t get any free rent, and if they want to build anything, it’s on them. They need to go get the permits, they need to hire the contractor, they need to go through the whole process. We really advise our clients against doing their own work and going into construction because it’s much more costly than you think, especially here in San Francisco and in New York. And it takes much longer than you think: you need to go through the whole permit process, so that is a minimum of three to four months.

Do your tenants typically prefer to get more TI and pay higher rent or vice versa?
The answer is vice versa because rent is not appreciating. We always want to minimize rent and maximize flexibility. We advise our clients to do a short term deal, and this is against the ethos of brokers because we are paid based on the amount of term they take, in San Francisco it’s $2 per square foot per year. So on a five year term, you commission will be higher than a three year. But we recommend shorter terms because it’s better for our clients and if you do good by your clients, you keep their business. They go for lower rent as opposed to more TI. We advise our clients against doing TI work until you surpass the 10,000 square foot threshold, because it is going to cost you a lot more than you want, it’s going to be really tedious, this is not your business, you need to run your business, and you need to be in the space within a certain timeframe. When you’re doing construction, almost 90% of the time it gets pushed out. So we really try and advise our clients against TI’s and try and find them the perfect space that they can plug in and play until they’re large enough to design their own space and make it what’s perfect for them, such as the Airbnb’s, the Dropbox’s in, the Coinbase’s, etc.

Does that mean that the landlords also prefer to give less TI?
No, the landlord would probably prefer to give more and to get a higher rent because that will increase the value of their building. They’d prefer to give a higher TI allowance because it gives you the ability to make that space, which is their space, gorgeous. And 95% of the time, the amount of TI they’re going to give you is not as much as you need for the work. So it’s usually going to come out of your pocket, you’ll have to spend your own money to help finish the job. So for them it’s a win win. They’re giving you the money to make their space perfect, they’re getting a higher rent, and they’re getting more term out of it. They’re always going to push you to do more TI, which we can understand. But we prefer that our clients try to stay flexible and nimble and have the ability to move during periods of rapid growth. 

What makes a good landlord that you guys like to work with? 
A great landlord will be responsive. Sometimes they can be a little bit unresponsive because a lot of the time they aren’t based here in San Francisco. A lot of landlords here are mom and pop landlords who own buildings but live elsewhere, do their own thing, have their own lives, they don’t necessarily understand the process as well as someone who goes through it every day. Sometimes they don’t have much regard for a tenant’s timelines, specifically a startup. Startups generally come up to us and say, “We need space tomorrow, we’re busting at the seams here”. You may need to be in tomorrow and we’re at the whim of a landlord who can take a day or a week to answer. So a good landlord is responsive, a good landlord understands the market, knows where rents should be, and is willing to work with brokers to get to the numbers that they need. Whether it’s conceding free rent, conceding TI, getting a better security deposit, allowing for pets, allowing for bikes. There are many nuances that landlords with experience are able to get through a whole lot quicker than landlords without a lot of experience. They must also have an experienced real estate attorney because they’re very important and are the end negotiators. They give the tenant and the landlord the final sign off.

Is there an LOI that gets signed, similar to retail, and then the lease? And how long does each take to get done on average?
Yes, initially you send an LOI, or what’s called a proposal that just says “We want to lease space in your building. Here are the terms at which we want to lease it.” This usually takes two to four weeks to negotiate. Once that gets signed, it is non binding, but it’s a gesture of good faith that both sides will work exclusively with each other and they won’t continue to tour, market, or accept other proposals. Then the landlord drafts the lease (or sublease) and real estate attorneys are hired on both sides. They review it and go back and forth. Insurance brokers are also hired by the tenant to make sure that they have the proper insurance coverage, general liability coverage, commercial liability, etc. That process usually takes another two to four weeks. So now we’re at four to eight weeks of negotiation. And then once a lease is signed, if you have negotiated well, the tenant has two weeks of early access to install FF&E, which stands for furniture, fixtures and equipment, before they can occupy the space. So far that is six to ten weeks and then add another two to four weeks in the front end for touring, finding spaces, running surveys. On the quick side you’re looking at at least two to three months. As you grow bigger and things get tighter and more competitive, we advise our clients to start looking six to twelve months out. And once you’re bigger, if you have a tenant improvement job or you need to redesign a space, that’s another three to six months that you need to add. That’s why for anything 20,000 square feet and up, we’re reaching out to our clients 12 months in advance to get started, begin the planning from the financial analysis, run the head count projections, etc.

I can see how much work you guys have and how valuable your job is. 
It’s a huge decision. And this is probably the top three biggest costs for any company. And we need to earn our client’s trust in order to keep their business, so we take it really seriously. We really care, and we’re going to do everything it takes to make sure that our clients have great outcomes and are happy. 

You can reach out to Reuben Torenberg here:
Email: reuben.torenberg@cbre.com
Linkedin: https://www.linkedin.com/in/reuben-torenberg-b985b646/
Twitter: rtorenberg021
Instagram: rtorenberg021

Steffany’s Linkedin: https://www.linkedin.com/in/steffbold/

Episode 12 – What Do Startups Look for When Leasing an Office

In the last episode, we reviewed the Investors Summit at Sea and shared a few lessons that we learned while at the Summit. In this episode, I will be interviewing Reuben Torenberg, he is a commercial real estate broker with CBRE in San Francisco and specializes in helping startups, technology companies, and venture capital firms find and manage office space in the San Francisco Bay Area and beyond. We interviewed him at the Salesforce Tower in San Francisco, which is the tallest building in the city, and will be for the next fifty years.

Reuben is an avid basketball player, he loves to travel and explore with friends. He is from New Jersey, born right outside New York City, and went to school in Florida at the University of Miami. After coming back from New Jersey, he immediately started working for CBRE, the largest real estate firm in the world, where he currently works now.

What do startups look for when leasing an office?
Every startup is in rapid growth mode. At the very beginning you don’t know exactly what your projections are 12 months out, even six months out. So you are looking for space to do a few things:
1. The main one is to attract talent.
2. The second is to manage your growth. You don’t want to get an office that’s too big and be hemorrhaging money.
3. The third thing is staying flexible. It’s very hard both in San Francisco and throughout the world to find space that will let you stay flexible as you continue to grow larger, as landlords are looking for three to five year terms.

So you have to be creative in how you’re able to position your client to stay short term. One of the things you can do is actually get into subleasing. A lot of companies that are growing too quickly or shrinking faster and they’d hope need to offload space for 12 months, 18 months, which tend to be very, very attractive situations for our clients.

Who would be responsible for subleasing that space? The tenant or the landlord?
The tenant is responsible. They become a sub landlord in that instance, and they put the space in the sublease market, usually at a premium here in San Francisco because it is so attractive to startups. And then once they managed that whole leasing process, they need to get the landlord’s consent where they present the sublease to the landlord and the landlord has 30 days to say, yes we would like this new tenant, or no. Another huge thing for startups is being near public transit. Attracting talent in San Francisco has become extremely difficult. They’re now looking to the East Bay. There’s also a lot of talent down in the South Bay with Stanford, with Berkeley in the East Bay. Being near Caltrain and being near Bart is a huge plus, and rents are much higher near those areas. So startups try and find something in between. Subleasing is one option. 

Another big one, at least while you’re small (let’s say under 20 employees) is finding these live works. A lot of live works have popped up in San Francisco near Caltrain where you aren’t required to live in them. They’re a little bit cheaper than traditional office space here, which is getting more and more expensive every year since 2010 – it has more than doubled – and they will offer you a flexible term. Live works will only do a one year deal, so it’s the ideal situation for a growing startup that’s between five and 15 people and doesn’t know where they’re going to be in a year, it’s something that can help them maintain flexibility. The final one, which is becoming more and more popular and is now the biggest discussion point in San Francisco and maybe in the country is the concept of co-working spaces. The We Work‘s of the world, the Knotel‘s, Industrious, and Regus. They are presenting solutions that are very attractive to startups. You pay on a monthly basis, you don’t need to buy any furniture, you don’t need to pay for internet. It is all just managed for you.

Let’s go over the pricing in San Francisco, which we’ll probably translate to the same step pricing in other locations.
This is a moving target, it changes pretty much every quarter in markets like this. Right now the average asking rate for space is $83 per square foot per year. This is over 100% from 2011 when we were at the high thirties, maybe $37 a square foot. So you can see that if you were to put it on a chart, it would just go straight up. And maybe we’re due for a downturn, and I expect in that downturn it will go straight back down, like how it did after the .com boom.

When you enter these co-working spaces, they tend to be more expensive on a per square foot basis because they cover everything. Picture anything from $105 a square foot, up to $140 a square foot. So about 1.5 times the standard office lease. But when you take into account buying your own furniture, build out, paying for internet and maintaining the space, it can get a little bit closer.

The cheaper ones, the live works, those tend to be closer to $60 a square foot or $65 a square foot. And those options are really attractive for companies that have just gotten their seed funding and don’t want to spend a ton of money on office space. Office space is a sunk costs, like when you’re renting an apartment, you’re paying this monthly rate, you’re not getting anything back, there’s no appreciation. So we advise our clients to really pay as little as you can until you get big and need to pay for office space to attract the legitimate talent and stay as flexible as you can. Don’t get yourself stuck in a five year lease where you’re going to grow out of in a year and be forced to either sublease or or take a hit.

As you get closer to public transportation, rents go up from let’s say $78 up to $95 per square foot. And this can be totally different in two or three months, it fluctuates more on the upside than on the downside.

And as you go out further and further away from public transportation, it can get all the way down to $55, $60 a square foot.

Other variables to take into consideration when deciding on the price per square foot:
– The condition of the space: is it in shell condition and needs a ton of work? Did the landlord do what’s called a spec build and build it out completely in advance for a new tenant to say “Wow, this is beautiful, I’ll take it”? Does it have a dropped ceiling, which is very unattractive to startups and tech companies? (and those are priced much cheaper). So if you’re in financial services in San Francisco, you’re probably getting a deal. The spaces that tend to be the most expensive are the ones that all the tech firms want.
– Is it creative? Does it have high ceilings, brick wall, polished concrete floors, tons of meeting rooms and things like that. So besides 

What are some other things that they look for when leasing an office?
It all ties into the big main question: will this place help us attract talent? Once you get past that, it goes into a lot of the comfort stuff, so a big one is how many meeting rooms are in this space. A lot of times startups like to be in wide open environment to maximize the amount of people you can fit in, and to endorse collaboration, to have everyone talking, hanging out, help the culture. But everyone at some point needs to enclose themselves in a room to have a private conversation. The question is, are there enough meeting rooms for us to fit? This is frequently a pain point. We have a metric actually for it, and it will vary between companies, but we say that startups should have at least one meeting room for every 7 – 10 employees. So if you have 50 employees, you should get at least five meeting rooms.

Another one is size. Can we fit all of our employees for the duration of the term? If this is a three year lease, but we’re going to be blowing out of it in a year, do we need to take on more space? These two have become really big recently. But the first is are there enough restrooms? Because these tech companies are trying to jam as many people as they can into spaces in buildings that weren’t necessarily built for that. You can have one of these industrial buildings that’s zoned for office with only one restroom, and you have 40 people that you fit in the space, in about 5,000 square feet, and there’s lines for the bathroom, or you need to go to a nearby cafe to use the bathroom, or it’s just one unisex bathroom. These are smaller pain points that tend to be really important once you have experienced it. On that same vein, most buildings in San Francisco don’t have HVAC (heating, ventilation and air conditioning) because San Francisco is a very temperate city that generally doesn’t have much of a need for it. But for a few weeks during the summer it gets pretty hot. And if your windows don’t open and you don’t have any HVAC, it becomes very difficult to work. So these living conditions of the space are also very important.

You can reach out to Reuben Torenberg here:
Email: reuben.torenberg@cbre.com
Linkedin: https://www.linkedin.com/in/reuben-torenberg-b985b646/
Twitter: rtorenberg021
Instagram: rtorenberg021