In the last episode we learned why you should be optimistic about investing in Retail Real Estate, and in this episode I will be giving a review of an event that I went to a couple months ago called the Investors Summit at Sea. I’ll also share a few lessons learned on this cruise that are simply invaluable. I’m doing this review because it was the best event that I have been to not only in terms of content, but most importantly, of getting to know people in the industry.

This review is really from the bottom of my heart, I am sharing this with you because I think that everyone that is in real estate investing should attend. As you may know, I took this year to get into real estate investing full time. I have been learning a ton over the last couple of years, and one of the podcasts that I have been listening to is called the Real Estate Guys Radio Show. As I was listening to their show, they were telling their listeners about this event that they have been doing for the last 17 years called the Investor Summit at Sea, a nine day cruise with over 200 investors (next year it will be seven days). The cruise takes us to a few countries in Central America, but I was not there on vacation, so I did not care about which countries we went to, what I cared about was to learn, and meet people in the industry.

First and foremost, I want to get pricing out of the way because it’s expensive, but there is a huge value behind it. The cheapest option for the cruise is $6,000 if you share a room with someone. When I signed up for this, a couple of friends thought that $6,000 was pretty expensive, and my answer to them was “I am sure that I will learn something that will be worth a lot more than $6,000 for my real estate investments”. And obviously I did! And not only that, you cannot put a price on the network that I came out of this event with. I went all by myself without knowing anybody there, without knowing anything about cruises. Thankfully, my Uber driver told me that the cruise line was one of the best, so that was my first sight of relief as I was arriving at the hotel.

The first night we were on land in Florida, and I have to be honest, during the first get together that evening, I was wondering “What am I doing here? It seems like everyone knows each other. I don’t know anybody. What’s going to happen during this cruise? I’m not a fan of cruises. Do we really need nine days in the middle of the ocean?” So I went to bed at 7:00 PM that night. The next day everything changed. We were in the cruise ship and I started really getting to know people.

Summit at Sea Itinerary
During the days that we were in the ocean we had sessions starting as early as 7:30 AM, these sessions were mostly for people getting started in real estate investing such as how to analyze a deal, and how to protect yourself with your investments. After that, we had a major session around 10:00 AM where speakers like Robert Kiyosaki, the author of Rich Dad Poor Dad would speak. At lunchtime we had breakout sessions, there were about 10 leaders who would be talking about a specific topic during lunch, and you could choose who you would sit down with based on the topic that was interesting to you. These topics ranged from: how you should prepare your investment strategy today if something happens to the economy tomorrow, things to keep in mind when doing syndications, how to analyze and select the right target market, and even things like how to improve your health (which was a very popular topic). In the afternoon there were also breakout sessions based on what topics were interesting to you. These topics could be anywhere from how you can improve your multifamily properties income, things to keep in mind when investing in senior housing, all the way to how to buy gold, and how to invest in oil and gas. For dinner we would be assigned to a table with one of the main speakers, and every single night we had different people in our table – this takes a lot of work on their end – making sure that you don’t sit with the same person at any given night.

Here are some of the people that I had dinner with: Peter Schiff, a well known economist who predicted the 2008 crash exactly as it happened. Ed Griffin, the author of a very popular book that you should read called The Creature From Jekyll Island. He is also the creator of the Red Pill Expo coming up in June (and you should definitely attend if you can). Kyle Wilson, who is an amazing marketer, he was the business partner of Jim Rohn, who was a very popular speaker and the first mentor of Tony Robbins. I also had dinner with Robert Helms and his lovely wife, Kara. Robert Helms is one of the creators and hosts of the Real Estate Guys Radio along with Russell Gray. They are the ones who have been putting this Summit together for the last 17 years and they are just wonderful people (to put it mildly).

During the days that the ship stopped and we were in land you could do whatever you wanted, or you could sign up for some excursions with the group such as snorkeling or going on a real estate tour in Belize for example.

Now I’ll talk about some other activities that we did during the 10 days: we played the Cashflow Board Game, which is a game that Robert Kiyosaki and his wife created. It’s similar to Monopoly but for real estate investors, this game is great for you to get your creativity going for your deals and it’s also great for kids to get them started thinking real estate. We did a book study on the book A New Earth (here is a little shout out to my mentor who gave me this book right before I went on the cruise and it was a very funny coincidence that we had a book study on this book). There were some parties after dinner where some attendees played instruments. One of the evenings we watched the movie The Matrix and had a group conversation about what we all got out of the movie.

There were 200 people that attended the summit and each and every single person in the cruise was amazing. They were salt of the earth, humble, a wealth of knowledge. There were people that had raised over $400 million in syndications all the way to 19 year olds who have read over 30 books so far this year. The conversations were so good, the people were so awesome, that I literally did not want to miss one second with them. For you to have an idea of how good these people are, a few of them came to me at the end of the cruise, they gave me their business cards and they told me “If there is anything that I can do to help you, please reach out to me, and I mean it.” Wow. Just wow.

I now have over 100 new friends that I can contact at any time. A few of them are already helping me with my investing goals. Others have introduced me to people in their network and I really hope to be able to give back to them by maybe helping them bring technology to their properties and to their funds.

Now I want to change gears and quickly share with you a very tiny percentage of topics that I learned during the cruise. By the way, because of the recession in 2008 where everyone lost a lot of money in real estate, they decided to start bringing different forms of investing strategies to the summit and that’s why they now teach you about buying gold, investing in agriculture, investing outside of the United States, they bring economists, etc. So you’ll learn about several other investments strategies besides real estate.

Lessons learned specifically for real estate investing.
– Have a team, management is key, get very good managers.
– When things go wrong, it’s almost always because you had the wrong people in the wrong chairs.
– Don’t try to do things that are too small because you cannot afford to get the right people in the right chairs, so go big in order to be able to afford the right people.
– Really evaluate if you want to get into a tertiary market.
– Cut your losses early.
– A market has thousands of submarkets. Just like within your city, there are very good areas and within that very good area, or that upcoming area.
– Make sure to change your investment strategy if it is reaching a peak.
– Don’t say I can’t do it. Say, how can I do it? (you can do a joint venture deal, you can get a few partners, etc).
– Always be building and growing your team.
– The best time to get started is yesterday.
– Get mentors and ask them questions that you already think you know the answer to.
– FHA HUD loans can take a while to get approved, they have heavier fees, but when it’s done, you get a 40 year loan, fixed, non-recourse debt. This is very good for construction loans and refinance loans.
– Don’t wish for no problems, wish that you get better at solving them (I love it!).
– Statements, close the mind, questions open it. (Double love it!)

How you can prepare for what is coming in the economy.
– You should have five uncorrelated assets. For example: real estate, gold, stocks, and a couple of other things.
– Lock your rates for 10 to 12 years, and get 30 year loans. You should have at least six to 12 months worth of operating expenses as a backup.
– If you are a syndicator, you should always have cash calls in your paperwork.
– Underwrite your deals based on historical rent and historical cap rates (rates similar to when we were in a recession back in 2008).

What have I learned about the economy and government
Here I encourage you to do your own research to learn more about these topics:
– The federal government hasn’t been audited. Has anyone thought about that before?
– Pension funds are America’s greatest retirement crisis in history. State pension funds are not governed.
– Fidelity Investments has $7 trillion under management, $2 trillion of that is in 401k’s, and their fees are $40 billion per year.
– Inflation is a form of taxation. The Fed is committed to increase inflation by 2% every year.
– The money we deposit in the bank is not ours anymore. The bank now owes us that money, this was passed very quietly under the Obama administration.
– The number one asset in a government bank is student debt. It’s the only thing that you cannot remove in a bankruptcy.
– If you want to revoke your citizenship here in the US, you owe the government three times your income. and if you owe $50,000 in taxes or more, they may revoke your passport.
– Asking for help in schools is called cheating, they tell you not to make mistakes, and these things are the complete opposite of what it takes to be successful in this world. And now a days in schools they are telling you that you cannot hurt people’s feelings. Imagine what is going to happen when these kids get out in the real world!
– The stock market is 100% manipulated.
– The Baltic Dry Index is a good indication of where the economy is going and that index is going down right now.
– At a $100,000 income, if you pay 40% taxes, and if you put your remaining money ($60,000) at a 12% return, it will take you 5.5 years to get that money back to $100,000! And that’s why you should invest in real estate – because of the tax benefits.
– The debt in the US is at $180,000 per person.
– Russia makes all of their gold miners sell them the gold, they print money and they get the gold, and now Russia is buying gold outside of Russia.
– The dollar will likely be backed by gold at some point in the near future, for around 20% of the money.
– Carnegie changed the way that we are educated in school within two decades. He funded professors and then made sure that the universities would get more money if their students went on to take high government positions. They did not want the common men to have access to property, and without private property you are dependent on the state.
– If the economy is so strong, why did the Fed stop raising rates?
– Higher taxes and higher inflation in the future will pay for the tax cuts today.
– The budget deficit is higher now than in the Great Recession. We have three times the debt since 2008. In 2008 we had $7 trillion in debt, and today we have $22 trillion in debt.
– A strong economy has surplus, not deficit.
– This upcoming recession will be blamed on Trump because they are for capitalism.
– The Democratic nominee will likely be a socialist in 2020.
– The dollar will plunge, get into foreign stocks.
– Central banks work for the banks. That’s why they bailed them out in 2008.
– The more you research, the crazier you sound to others. And I have to agree with this, as I have been learning a few things over the last couple of years, I saw how some friends think that I’m crazy, especially for saying that the economy will probably tank soon.
– A few years ago when you took a three hour drive, you had to stop at gas stations to wash your windshield from bugs that were all over your windshield, and today you might have one bug or two on your windshield.
– Get off fiat money.
– What can the average person do? Stop being average.

This is a very, very tiny piece of some of the things that I learned during the summit. These are all life lessons. Your mind should be tickled. Do more research on these items. It was a wonderful summit and I highly recommend it. At the end of the cruise I felt like I had finally met my people, my tribe, people that I’m not used to meeting in Silicon Valley. They will be friends for life.

Lastly, if you are 18 to 25 years old, they give you a very special price of $2,500 for the summit – this is an amazing price! It’s 1/3 of what us, fully grown adults pay, and it’s a very good investment for your future. If for some reason you cannot afford $2,500, and if you are within 18 and 25, they even have a scholarship program that you can apply to. This is how giving, how generous, and how committed these people are.

The next Summit will be from June 11th -20th, 2020.
Sign up for the Summit at Sea here: https://realestateguysradio.com/summit/
Make sure to mention my name Steffany Boldrini to get $100 credit in the ship, which can be very useful for internet usage.

In the last post we learned with James Chung about lease negotiation items that are important for national tenants, we discussed LOI’s, and reviewed what happens when a tenant goes dark. Today we are with Adam Carswell, a Director with Concordia Realty and a Business Development Manager with Asym Capital. He focuses on retail, mobile home parks and self storage. He is also the host of his own podcasts: Dream Chasers, and the Liberland Show, a podcast focused on the country of Liberland. Adam and his associates have done nearly half a billion dollars in repurposing and redeveloping transactions and syndications.

How do you find time to live?
I was going through a coaching session last week and talking about three topics during my conversation with the coach. She said that when you take a look at what you’re working towards, your legacy, your mission, it doesn’t matter what you’re doing, everything that you’re doing is all one thing. It’s all unified. It’s all tied together and it’s carrying you in the direction of you fulfilling this legacy, of you fulfilling your mission, of you obtaining your goals. And that was the first time that I had it explained to me that way. It was very relieving because I am someone that likes to do a lot of things and I normally am pretty good at it, and have a lot of fun with it. So my advice to anyone listening who gets a little bit nervous when someone says find your niche and get rich. It is possible to do a lot.

What is your business model? Why do you guys invest in the properties that you invest in? What is your strategy?
My business partners at each firm go about things in different ways. Starting with Asym Capital, Hunter Thompson (the host of the Cashflow Connections Real Estate Podcast) focuses more on the syndication side of things, we look to partner with experienced operators, and as you can see with our track record, we really take our due diligence with operators and sponsors seriously. The level of due diligence that we do, not only on the asset or the deal that we’re going into, but on our sponsor at underwriting is literally what I would call next level. And that’s one thing that I’ve been fortunate to be in an environment like that, with someone who is this diligent.

Transitioning to Concordia Realty and Michael flight, we are retail focused, shopping center focused, and we look for opportunities to add value to shopping centers anywhere across the US. We normally will stay away from primary markets, but we do like secondary and tertiary markets. We like for our shopping centers to have a grocery store as an anchor, and at least one, and sometimes two discount stores in the plaza as well. So that could be a Family Dollar, Dollar Tree, Dollar General, etc. Drugstores are always good too: CVS, Walgreens. If we see a shopping center that fits that mold and is less than a hundred dollars per square foot, we will take a closer look at it, put it through our financial model, make assumptions and see if it will be a good fit for us and our investors.

Can you share with us why are you optimistic about retail nowadays?
The first reason is that Amazon invested $13.7 billion into brick and mortar. That’s a lot of money! And a company like Amazon has a lot of data that they have access to, and the amount of information that they have access to is also next level. There are very few people that can make a move like that. Sears is also doing a few things in retail.

The second reason is when you look at life in general, and you look at trends, and you look at things that people gravitate towards, retail has had its moment of super success and it’s had its moments of no success. Kind of like what we’re going through right now, but it’s all cyclical. Retail has been around since the Roman Agora. It just evolves and takes a new shape and a new form. You had the general store in the 1900’s, and then you had Sears catalog, which killed that general store. But then Sears did brick and mortar after the catalog with all their department stores. Amazon is like the new catalog that came out and kind of killed the brick and mortar movement. But again, it’s, it’s just very cyclical.

Right now is the perfect time to start at least researching and learning as much as you can about retail real estate because it is going to make a comeback nationally, and it’s not going anywhere. It’s just going to evolve. That’s why I like it because everyone’s kind of looking, looking right and I get a chance to go last and uh, and if I’m wrong then hey, whatever, I’m living life, I’m living a good life, then it’s worth taking risks like this. So that’s my take on it.

Are there any areas that you guys are adding technology to your real estate investment toolkit?
With Asym Capital, we have a mentorship program and I say it’s technology because everything that we do to facilitate the course is based around technology. There’s no way we could do the teaching that we do without the tech. And the same goes for us at Concordia. It’s not ready yet, but we are working on a mentorship program for retail and shopping centers that I know both me and Michael Flight, our principal, are very excited about. And so those are two platforms of learning education that would not be possible without technology the way we have it today. If you’re interested in taking either of these courses, you can definitely contact me after the show.

Let’s say we have an investor who has never done retail. How do they get into diversifying into retail? What are some top two or three things that they should be aware of that are very important to cover in the retail world?
One thing that I got caught up in looking at shopping centers was that I was looking at a very high level data point, like cap rate. I’ll never forget a conversation that I had with Michael one time when he asked me “Why do you think I’m interested in this deal?” And I said: “Is it the cap rate?” He then answered “When have you ever heard me say something about a cap rate?”

What he was looking at was the price per square foot because there was an offering in Anaheim for $80 per square foot, which is very cheap, and the reason why it was so cheap, we found out later, was the shopping center was in a ground lease. You want to look for grocery stores, discount stores, even Ross, Marshall’s, Tj Maxx, etc. But beyond that, looking at things like price per square foot is very important. You know, you really want to focus in on what it is that you’re looking for specifically.

The other thing is in regards to an investor that’s new to retail, is it still comes down to relationships at the end of the day because everything that we do in regards to our deal sourcing and business and partners and this would really be for both firms. Everything has been 100% through someone that we know or have been doing business with for a while. Concordia has been in business since 1990, so when we need to find a deal in South Carolina we contact people that we know. You could still go on crexi or loopnet and maybe look for a deal, but it’s all super word of mouth. Building relationships with people who are in retail real estate is the best way to start. You guys can reach out to me for that first connection to retail.

Is there anything else that you can think of that we should be sharing with our listeners?
I would just say to make sure you subscribe to this show, if you haven’t already subscribed. Steffany is doing some really amazing things and I’m blessed to be one of the first guests on this show because I know that in a few years I’m going to look back and say “I was there first”.

Thank you, Adam!

You can contact Adam Carswell here:
carswell.io 
adam@carswell.com 
iTunes: https://podcasts.apple.com/us/podcast/dream-chasers/id1441685534
Spotify: https://open.spotify.com/show/0fqzz3iJS2uARrz4N6dlmN?si=1Yjisi-JSRK_1vRyU34JWA

In the last post with started to interview James Chung who is a broker focused on retail properties and national tenants, we asked him where he thinks retail is going, tips for pricing a retail space for lease, whether we should give more tenant improvement (TI) money to our tenants or charge less for rent, as well as what should a real estate investor look for when buying a retail property. We also covered things that you should know about during the due diligence process when purchasing a retail property.

In this episode we will continue our conversation with James and discuss what makes a national tenant want to lease your retail space, lease negotiation points for national tenants, LOI’s, deal breakers for national tenants that retail investors should be aware of, and what happens when a tenant goes dark.

In terms of leasing retail space to a national tenant, what makes a national tenant want to lease a particular space?
Every tenant has a different purpose, and each tenant also has a different requirement for the optimal environment for which they can thrive on, and we are often involved in developing a strategy for them in our market. For example, some tenants only want to lease in grocery anchored shopping centers, and they only want to look at a Safeway or Whole Foods anchored center (or the like caliber). Or we could be working with a 100,000 sf box tenant who needs a certain amount of land, they need access to major freeways, and they need the demographic to be above a certain threshold within a 1 – 3 – 5 mile radius ring area. Or we could be working with food tenants who just want to be on downtown, street front environments where they want to be part of a community, there is a lot of foot traffic, and they don’t want to be in a shopping center. In order to help them position themselves in the market it depends so much on the tenant and their process. We also provide analytics on anywhere from psychographic, to demographics, to data on their competitors and sales volume, so there’s a lot of information that goes into the analysis of an opportunity and while one person’s success or failure won’t dictate the success or failure of the tenant at hand, it at least gives a certain starting point of who has done what in a particular market. The appetite for growth is so unique to each tenant that it depends on their requirements, some people are positioning for public events, some are repositioning the market, some people are closing stores, and only want to combine units, so each requirement is truly unique, which makes our job unique. James likes the work he does with a lot of household names that we see, and being able to walk in the stores, shop at them, and eat at them after completing the process. The deal cycles may take a few months to a few years and it’s fascinating when he sees the body of work in the form of storefronts, or a restaurant as a living organism since it creates jobs, it is feeding people, or simply seeing people buying clothes, it’s very rewarding to him and some of the reasons that it attracted him to retail.

What are some typical lease negotiation points for national tenants?
The letters of intent (LOI), which are meant to be non binding, are becoming longer everyday as tenants are trying to incorporate more in the front end of the process rather than putting it back on the end of the legal process where the leases are negotiated. It can be anywhere from rent, term, which is becoming a big one and that’s a big wrestling match because landlords often don’t want to give up control, and in turn tenants want to control properties as long as humanly possible. There is permit contingency language because tenants are afraid that if they can’t get their permits, they don’t want to start paying rent, and landlords don’t want to have open-ended rent commencement dates. Another big one is assignment and subletting – what happens if the tenant wants to close their business, or sublease it – who gets what rights. Tenant Improvement (TI) allowance, signage is always a big one, exclusive parking, no-build areas, and triple net leases are most often the case in a retail setting where the tenant is paying a pro-rata share of tax, maintenance and insurance, but that can be stripped down and negotiated as well because there is a lot baked into those three items that can be hidden. The more sophisticated tenants know how to unwind that a little bit. There is a limitless number of items that can be negotiated in a letter of intent, so for the most part that will ultimately frame the transaction. Once you get those terms agreed to, it typically goes to the attorneys and they negotiate the rest of the legal items.

If I own a retail property and I’m in the process of negotiating a lease with a national tenant, do they typically negotiate with a handful of properties, or a couple of properties? What will be the percentage of national tenants that are negotiating with multiple owners?
They won’t necessary negotiate multiple leases with the intent of signing only one, but when we do a roll out we’re going to have multiple transactions being simultaneously negotiated. If there are two centers next to each other, and they only have the intention to rent one, they won’t be negotiating on both. Once you have the lease document, you shake hands on a deal and it goes to legal, you are more often than not mutually exclusive at that point.

What about when they’re negotiating the LOI? Do they negotiate with multiple people for one location only?
Every tenant has a different strategy, so it depends on the tenant and how they want to blanket the market, but more often than not people want to know that if you are negotiating, you are negotiating exclusively and if you’re not, just disclose it. As long as there is a disclosure, it’s more about fair play and you want to make sure to do that, because this business is long, and the people in the business all know each other and you want to make sure you always maintain that standard of integrity and honesty so that people know that they can take you seriously.

Once we’re past the LOI Are they going to try to renegotiate the price when the lawyers get involved?
Typically no, it is assumed that the business items have been agreed upon, and at that point you’re only negotiating the legal language.

What are some deal-breakers for national tenants that we as investors should be aware of?
It depends on how bad they want the site. For example, for a lot of landlords, termination clauses are deal breakers, that means early kick out language and things like that, but ultimately everything is negotiable, so the deal breakers will be dictated by the opportunity and the players at the table, unfortunately there is no standard there.

Can you help our listeners understand what happens when a tenant goes dark?
Going dark means that they have gone out of business, or temporarily closed the store for any reason such as a remodel, fire, etc. If you have a big box tenant like TJ Maxx go dark, there are consequences to your center because that store is going to be closed: it does not look good for the center, it’s also bad for your other tenants because there will be less foot traffic. Typically you want to negotiate that if they go dark they have to pay around 1.5 times their current rent until the end of the lease, it has to hurt their pockets so that they don’t close the store, and you have a big empty space there for the next 5 to 10 years. Also, the landlord should be able to find another tenant during their go dark period.

When a tenant goes dark there will always be language pre-negotiated about go dark language because a landlord wants the right to recapture the space since they don’t want a black hole in the middle of center. The ramifications to the center are far beyond just the closure of that tenant. It depends on how it’s negotiated, but typically they will be given a certain timeframe to go dark, and typically it’s just for a remodel. But if they go dark for over X number of days, most of the time the landlord will have the right to recapture the premises, but obviously the tenant needs to continue to pay rent on the space. And at the end of the day they cannot just go dark indefinitely. In 2009 when there were a lot of foreclosures and bankruptcies, it was an interesting time because this language was challenged. For most national tenants, even if they close the store they would still be paying rent on it.

Can you tell us a deal that you lost and it still hurts today?
Those deals happen more often than you would like them to, and transactions more often than not won’t get to the finish line (the lease execution) because there could be a change in leadership on either side (whether it’s the tenant or the landlord), there could be a change of heart, there could be a shift in the economy, there are so many influencers in a transaction that are completely out of your control that often times that will ultimately kill a deal. This happens a lot, and the reasons can range from some of these influencers, or something completely unexpected, even in smaller deals: divorces can happen, unpredictable events, there are too many examples. And that’s the funny part of real estate: it’s never done until it’s done. And even when it’s done, sometimes it’s not, because sometimes you’re navigating the waters of various jurisdictions where conditional use permits are required, which is why a lot of this permit contingency language is in place. Until the lights are on, it’s never done.

Is there anything else that you think our listeners should know of, or be aware of any important tips that you think should be shared with them?
In summary, the retail community market is changing and evolving, but we are optimistic and excited about what’s going on. The goal is to be efficient, and to be the best version of ourselves, both on the tenant and the landlord side. Be aware of what you read in the news because a lot of times the media latches onto some headlines and they run with it, when in fact it might not always be the truth. James continues to be incredibly busy as a group in retail, and the requirements that come across his desk everyday are continuing to be new and exciting, and different, and there is always someone doing a better version of what someone was doing yesterday. He enjoys watching that process and to be at the forefront of that. Overall he is nothing but optimistic about the future of retail.

Contact James Chung here: http://www.cushmanwakefield.com/en/people/james-chung

Today we’re interviewing James Chung, he is the Executive Managing Director and Managing Principal for the Western US for Cushman & Wakefield’s Retail platform. He has been with the company for 15 years and has worked with over 30 national tenants and over 9 million sf of retail across the Bay Area in Silicon Valley. Some of his clients are: AT&T, Chase Bank, Adidas, In&Out Burger, and Sur La Table. He not only helps national tenants find space to lease, but he also lists retail properties for lease. James has served as State Director for ICSC, which is the largest Retail organization within the industry, and he is also very involved with other organizations such as ULI.

First I wanted to hear his thoughts on the future of retail real estate and where it is going, he said that it’s all speculative and that there has definitely been a national softening in retail, as well as a gradual shift in the types of transactions that are happening in the retail front: whether that is downsizing, or right-sizing, some have been creatively repurposing outside of retail. Sometimes people are allergic to change, and that uncertainty makes people worried, but retail is going through a metamorphosis. Things are becoming more efficient, the supply and fulfillment side of the business is becoming even more important (which is connecting the e-commerce side of a business with their brick and mortar stores), but while that was once seen as adversarial, he believes it can work in harmony with retail, and the sky is the limit!

Tips for Listing Retail Properties for Lease and What to Charge Tenants per Square Foot
First you need to understand the health of the shopping center, and one way to do that is to understand the health ratio of the tenants. The health ratio is the relationship between gross sales and total occupancy cost. Then go through the health ratio tenant by tenant, and understand if the rent they’re paying is equitable to their sales performance. The challenge with pricing is that geography will often dictate pricing. However, you can have an asset next door to you charging half the rent! Part of that reason is co-tenancy, part of it is how updated the center is, part of it is who anchors the center, as well as how accessible the center is. There are a lot of variables that will dictate the market rent (or at least the asking rent), and oftentimes geography doesn’t dictate that number. Retail is not commoditized in the way where we can say “By virtue of being on this block or that block, your rent should be X”, it’s like when you are getting comps for a home, the price/sf in that area gives you an indication, but it is within 10 to 20 to 30% of where things could be, depending on the home itself. And in retail especially, block-by-block can change dramatically. Other things to look at are how to optimize the merchandising strategy for the center, and what he means by that is: are the tenants in place at highest and best use for the positions that they are in the shopping center? When digging into that exercise, he takes a much higher level look at lease expiration dates, who’s lease is coming up and when, who is healthy or not, where we could reposition tenants, and that sometimes means moving them around in the center to optimize the opportunity for the asset.

What is TI and How is it Negotiated?
TI is Tenant Improvement Allowance, it is a funny item because there is no rule of thumb per se.
For ground up development what ends up happening is that you will have a certain delivery condition that you will provide to the tenant, and then you’ll earmark cash for the tenant to ultimately finish the space. What that means is that it’s a good idea to deliver the space in a shell condition (which may not include a restroom, or drywall, and will often have electricity, but not distributed) and the reason for that is that tenants are very specific in their build-outs and they will often end up ripping everything out to their own specs, so we should save all that money, earmark that cash, and give that to the tenant for their build out.
For existing spaces it all depends on the financial position of the owner: is the owner in a place where they have cash? Can they underwrite those dollars to the tenant? Are they willing to write that check to the tenant? There is obviously a risk if the tenant does not succeed (the cost of capital), and the financial position of the landlord is also important. When you work with institutional landlords, there’s a lot of cash earmarked, but when you’re working with a local private owner who may not be able to write a huge check, there’s often a push and a pull as it relates to the base rent (and therefore TI), so a lot of times that capital is amortized at a money factor, and underwritten like a loan. The capital improvements in the space are depreciable, not the TI, the TI is amortized at a money factor like any other kind of loan. Often times when negotiating a lease with large institutional banks for example, their cost of capital is cheaper than anyone else’s, so they don’t want any TI. They would rather pay a lower base rent and deal with everything themselves. On the other hand, restaurants and fitness centers require the most TI, and it’s challenging because when you’re dealing with these types transactions you’re providing $50 to $100/sf in TI over 5,000-80,000 sf. That’s a very large check, and those checks are typically not used to finance the deal, they’re typically given after the tenants receive their certificate of occupancy and all the liens have been released, but it’s really not intended to be used to finance the project.

What are Good Types of Tenants to Have in Your Center?
It depends on the opportunity, if it’s a neighborhood shopping center, the most coveted asset class would be a grocery anchored shopping center. One of the most desirable investment opportunities for people, especially in the Bay Area are grocery-anchored centers in the retail space. If you’re in any neighborhood, if there is a strong national grocery tenant who is the hub of the center – that is typically the most desirable. Besides that, there are lots of asset classes like malls, lifestyle centers, outlet malls, and so many different types of shopping centers, but if he had to pick one, he would probably say grocery anchored.

From a Real Estate Investor’s Perspective, What Should We be Looking for When Purchasing a Retail Property?
Geography is one, there is always demand for all asset classes in places like the Bay Area where the fundamentals and the demographics are sound, and you have a lot of reasons that will survive the flow of business cycles. But when you get into the fundamentals of a shopping center, it really is driven by your purpose. Is your purpose to value-add, reposition, create the lift, create the value and enjoy that, or sell it? Or is your purpose to have fixed and safe income, where you have a lot of good credit in your center and you’ll be able to enjoy it for whatever a typical hold period time is? Depending on what you’re looking for will dictate the type of opportunities you’ll be asking, but as it relates to the quality of the investment, it’s going to be credit-based, and dependent on the value of the signature on the leases.

How Can We Make Money in Retail When the Cap Rates Are so Low in This Market, and What Should We Look For in a Deal?
Low cap rates are actually not necessarily a bad thing if the income on the property is under market. Even if you’re paying 3.5% cap on a deal but the rent is 50% of what it should be, that’s when market intelligence comes into play, and understanding how things are being underwritten. There is currently a compression in cap rates just by virtue of geography and being in Silicon Valley, but there still are great opportunities out there, you just may not find them listed openly. It’s about understanding how to unlock the value in whatever asset you’re looking at because there are many ways to skin the cat, and oftentimes people are looking at it very one-dimensionally, when in fact there may be multiple ways to create value.

What Are Some of the Ways to Create Value?
Understanding the latitude of the land that you are on is one of them, so that maybe retail is not the highest and best use, maybe it’s a large enough parcel to build something. When you understand how high you can build, there is a considerable delta in what land value is for pure retail, and what land value is for high density residential, so there is potential for an entitlement play where maybe the retail on the property is X, but there is a strong multiple for repositioning it for high-density residential.

Lastly, even though you may be buying something at a low cap rate, maybe there is a 2-3 year carry, and you know that the value in three years can be at a 7% cap, even in today’s market rent. Or maybe there is a repositioning opportunity at a certain price, be it based on it being on X corner, which is one of the best in the Bay Area, and knowing that there’s a large tech tenant coming across the street, or that there are things happening down the road and public transportation is coming in. You have to understand the whole landscape in order to properly evaluate something because what may appear today, is not going to be what appears 2 years from now, and having that knowledge is power.

What Are the Top Things We Should Make Sure to Cover During the Due Diligence Process Before Closing on a Retail Property
You should see if there’s any history of hazardous materials in the property, or any current hazardous material because that can undermine anything you could ever want to do on the property. Make sure you’re doing a full circle around a property, and understanding all the latitude that you have with the opportunity. It’s hard to generalize because there are so many ways to buy a property, and sometimes you’re buying on a speculative basis where maybe it’s an empty property. Some of the things are:
– Understand if you’re buying on income
– What does that income really mean
– What the signature is really worth
– Who signs it
– Is the signer a shell entity that has a single purpose for this property and despite being a billion dollar company, the actual signature is not worth anything?
– Who has signed the LOI

Those are some things to check off during the process. But, depending on where you’re buying and how you’re buying will really dictate your due diligence process.

The only constant thing in life is change.

François de La Rochefoucauld

In the last post we went over the things that we did on our own during the due diligence process of my first offer, as well as all the reports that we had to get done, what those reports came back with, we also covered all of the items that our attorney objected to under the title report exceptions. In this and final post, I’ll go over the financials and how I made the decision to move forward (or not!) with the purchase, and then we’ll come to a conclusion at the end.

When we made an offer on this theater that had been abandoned for 30 years, we had three options in mind:
1. Do a very basic remodel and sell it.
2. Go all the way with the remodel, bring the property up to an impeccable state, and run it as a business: running events such as corporate events, weddings, parties, etc.
3. Remodel as much as we should, rent it out to a tenant, and decide then if we would sell it or keep it.

Since we were unsure how the economy was going to go by the time the construction was done, we had to be very conservative. At the time of purchase, the cap rates were at around 6% for the area, and we wanted to think ahead and in case the economy took a hit, so we also ran the numbers at an 8% cap rate. Why? When the economy tanks, cap rates to go up because people are able to buy less property (because interest rates are higher and banks are more conservative), and there are more “discounts” happening (because less people are buying), that’s why we had to calculate an increase of 2% in the cap rate, just in case that there be something going on in the economy by the time that the property was fully remodeled. This is a very important calculation for all of us at this time in the economy.

Because this property had a few possible endings, and because the construction costs could end up varying greatly once we got started, we ran quite a few numbers: it ended up being 36 different possible pricing outcomes that I came up with. Out of all these 36 numbers, we would be negative on two of them, and that would be a worst case scenario of losing $400,000, and a best case scenario of making $2,000,000. Everything else was in between these two numbers. What did these 36 numbers entail? A best case scenario, a medium case scenario, and a worst case scenario for all three options (again: remodel the least we could and sell right away, remodel to the max we could and run it as a business, and remodel what we should in order to rent it out to a tenant).

Calculation breakdown for construction costs:
Construction costs: the best case scenario was $780,000 of renovation costs, the medium case scenario was $1,000,000 of renovation costs, and the worst case scenario was $1.5M of renovation costs, plus the purchase price of $430,000. At the worst case scenario, we could have ended up with almost $2M in total costs, in which case we’d definitely have to sell above that number.

Options for what to do after renovations, and their associated costs:
1. With our first option of doing the very basic remodel of $780,000 of minimum renovation and selling the property for a worst case scenario of 8% cap, we would be making around $200,000 – at this number it was not worth the headache for us.
2. The number two option was to remodel incredibly well and run it as a business and do events. For this option, I contacted quite a few events places in the area and I found one place that was very comparable to ours. They were charging around $5,500/event which included security, tables, chairs, linen, staff, water bill, electricity bill. I estimated that out of that $5,500 we would probably end up keeping around $2,000-$3,000 per night. In the worst case scenario we would rent it for 40 nights per year, and in the best case scenario we would rent it for 60 nights per year. I was also adding a revenue for a church to hold services on Sundays for a few weekends during the year. At the end of the calculations, our net income on the worst worst case scenario would have been around $110,000/year, in the best-case scenario would have been around $160,000/year, however this was very conservative at a net revenue of $2,000/night.

Out of these three options, we were calculating the least amount of construction costs that we were going to incur, as well as the highest amount of construction costs. Because we didn’t know exactly how much the construction cost would end up being until we started the construction, we had to understand the minimum cost, and the maximum costs we could end up incurring.

Under the best case scenario of $780,000 renovation costs, under all of these options, we would have made anywhere from $345,000 all the way to $2M – this was a big range. In the middle case scenario, our construction costs would end up being around $1M, here we were going to make anywhere from $125,000 to $1.8M dollars. In the worst case scenario of construction costs ending up being $1.5M, we could lose $375,000 and make a maximum of $1.5M. With these numbers in mind, there were very few risks and I’m sure we would have not lost money on this property, however at that point we were seeing that it was going to be a huge project, and despite the fact that we had a very good contractor. We decided to try to to get a reduction of $100,000 on the price, and if the seller was not willing to do that, we were just going to walk away because this was going to be a big project, and we would not end up making a ton of money if construction costs started to add up.

Another important thing to calculate is the fact that you are parking your money for at least 6 months to 1 year because of the construction, so we would not be cash-flowing during that time. Alternatively, if we buy a property today that has tenants in it, we would be making money right away – so this is very important for you to consider when you are evaluating a construction project versus a project that already has tenants in it.

After all was said and done, we got sales comps, rent comps, we had a really good idea of what we could do in all of the options, and we decided to ask for the additional $100,000 discount because it was going to be such a huge project and it would not be worth our time if they weren’t willing to give us a discount. I wrote a very extensive email that I sent to our broker explaining everything about the property: that the property was in a downtown area which does not have assigned parking, that we needed to install a fire sprinkler system, we got all reports done and this is what the results were, we did an asbestos and lead survey, our attorney reviewed all of the items on the title report, we found out about the party wall agreement, etc. The broker said that the email was great and that she would share it with the seller.

Unfortunately (or fortunately!) the seller said no to our $100,000 price reduction ask, they didn’t want to go below a $400,000 sales price. So we cancelled the purchase agreement.

What was the due diligence process like for a first time buyer?
During the process, we signed two extensions so that we could continue doing the due diligence. We had to contact the fire department, the fire contractor, we had to do a wall inspection, deal with the city, and all of that took a very long time to get scheduled, and because the property was abandoned for 30 years, there were a lot of things that we had to go over in order to understand what the costs would end up being. I ended up talking to at least five different people that worked for the city, and followed up with some of them quite a few times. We spent around $10,000 in reports and legal fees, and throughout the entire time I had to reach out to the real estate agent multiple times asking for things that they owed me, such as all kinds of documents from the property, rent comps, sales comps for the area, I also had to reach out multiple times to the title company asking for things that they owed me such as the party wall agreement which was an exception on the title report, they did not have the agreement and then they finally (somehow miraculously) found the agreement. Another difficult part was that the entire process was so old-school. Being in Silicon Valley, I was expecting it to be a bit more updated, but nothing except the ability to use email was being done with technology! My real estate agent was writing things down on a notebook and she very often missed things that I asked for multiple times. The title company was another story, the paperwork that they “couldn’t find” was sent over after several emails requesting it, and after them sending me the wrong documents.

Conclusion
Part of me wanted to buy the property because it was my first deal and it was a very beautiful building: when you walked in, you could really feel the property coming to life and the place being incredible. I was also eager to get going on my first deal, but I am also very responsible, and I knew that I could not let my heart lead when the numbers were not there. And as they say: there will always be another property!

In hindsight for my next purchase, I should have asked to meet the seller in person so I could genuinely explain all of the expenses that we had to have in order to bring the property up to par, so that the seller could feel that we were interested and that we were doing our homework. Maybe that would have changed things, maybe not, but it’s one thing that I would have done differently. Lastly, this happened almost a year ago, and the property is still for sale! One of the reasons why we think it’s still for sale is because when you take on such a project, banks won’t lend you money for the construction, so you need to find hard money lenders and that could be very expensive at 10-12% interest rate. This alone can eat a lot of your return, and unless you have cash to invest, this is probably not a good investment. At the end of the day the seller will probably have to drop the price even further because the property is going downhill fast, and the people in the city aren’t having the patience anymore, and they are starting to give all kinds of fines on that property.

Sometimes, not getting what you want is a wonderful stroke of luck.

Dalai Lama

In the last post we learned how I decided to put an offer on my very first commercial purchase – an old movie theater in the downtown area of a secondary market in the city of Salinas. In this post I’m going to share the things that we had to do on our own during the due diligence process of this purchase, as well as the things that our attorney looked at and objected to on the title report.

What did we on our own:
1. Checked Geotracker which is a website to see if there is contamination near the property. This helps us understand what our Phase I report will probably look like. The Phase I report is an environmental report that costs around $3,000-$4,000 and that you must do in order to see if the ground of the property is contaminated. If it is contaminated, it’s going to be very costly to decontaminate the property, and the city will make sure that you eventually decontaminate the grounds. It’s very important to know if your property is contaminated or not. When you search Geotracker, you’re able to have a preliminary idea if it is contaminated or not, based on existing data.
2. Checked the current assessed value of the property to see how much taxes they were paying.
3. Reached out to the City Department Services Division, and the Community Development Division and asked to see if there were any approved permits for the property. I also had to find out information on zoning in the downtown area to see if we could do what we wanted to or not.
4. Because we were potentially going to run this as a business and do events in the property, I had to check prices for the following: audio and visual installation, new chairs, how much it would cost to level the floor, how to dispose of the existing chairs (could we sell it or not?). I also had to find out how much we could charge per event and the costs associated with that (tables, catering, security, electricity, water, etc).

Below is a list of the reports that we paid for during the due diligence process, and the contractors that we had come by to give us quotes:
1. Phase I Environmental report: the report came out clean (as we expected after checking Geotracker).
2. Roof survey: we found out that it was going to cost us around $127,000 for a new roof since the existing roof already had three layers on it, and we could not add another layer. We had to redo the roof from scratch.
3. Structural engineer: we had one come by to assess the structural damage and do a shear wall test – this meant that he was going to test how strong or how weak the wall was and he was going to tell us if we had to redo the wall entirely, or just reinforce it.
4. Architect: the architect came over to assess some of the costs that we were going to incur during the renovation.
5. I had to find a person that was working at Calwater (California Water Service) in order to find out where there was a water source for the building. Also, where was the line, and if there were fire hydrants near the property. During this process I learned that in California the businesses are the ones who have to pay for installing a public fire hydrant if the property does not have one nearby! This alone can cost at least $50,000. We had to understand how much it would cost for us to pull in water for the fire sprinklers because the property was not up to code and we would have to install fire sprinklers.
6. Fire sprinkler contractor: he came over to give us a quote on how much it would cost to install the fire sprinklers. We ended up finding out that we would have to bring water from the back of the building to the front, and that was going to cost quite a lot of money (I believe it was around $100,000).
7. I also tried to get someone in the city to see if we could ask for some credit to renovate the property because the property was in the downtown area and the building had been abandoned – and the community would have benefitted from bringing that property back. Unfortunately, we didn’t manage to find people there up until the end of the process.

The property had several code violations – not surprisingly since the owners did not keep up with maintaining it up-to-date. During our due diligence process, the city started issuing fines (rightfully so), and if the seller did not respond within X number of days, the city was  going to start charging them $2,500/day. The seller did say that they were going to pay any outstanding fines prior to close of escrow.

Next, I’m going to go over what the title report said, but before I do that I want you to know what the title report means. The title report means that the title company will compile a report from a search in the County records in order to issue you a title insurance and any liens against the property will be listed in the title report as exceptions to the title insurance. This means that the title company is not responsible for those items! Our attorney reviewed all of the exceptions and objected to four of them.

Items we objected to on the title report exceptions:
1. We were in what’s called the “Monterey Regional Water Pollution Control Agency” and we had to reach out to them to see if there were any past due amounts and to make that there were no restrictions on our intended use of the property.
2. There was a “Party Wall Agreement” that was dated 1999 and it ended up being actually dated 1919. This party wall agreement meant that we were sharing one wall with our neighbor and that there was an agreement out there that the title company did not find, so they were making an exception to that. After a lot of back-and-forth, we requested the title company to find the agreement (because that’s their job!) and after several days they gave us an agreement that had nothing to do with the party wall agreement – or that property as a matter of fact! After another two weeks of back and forth with the title company, they somehow managed to find that party wall agreement (yes, it’s amazing how many people don’t do their job), and this agreement was dated 1919.
3. The next exception stated that we were in a Redevelopment Agency, our attorney said that most Redevelopment Agencies were extinguished as a result of a law signed by Governor Jerry Brown. However, the title company was not removing this exception because the city of Salinas was in debt, and this would not be removed until the city of Salinas was out of debt, which they said it was going to be around 2033.
4. The last exception was a notice that the County of Monterey proposes to Annex the property into the California Home Finance Authority Community Facilities District No. 123, Clean Energy. The attorney said that he does not have such documents and the title company did not provide them. So we had to find those documents and see what the impact would be on our property.

In the next episode, I’m going to go over the financial calculations for all three options that we had in mind for the property, review the conclusion, and lessons learned.

Learning is not attained by chance, it must be sought for with ardor and diligence.

Abigail Adams

In the last post, we learned about what types of real estate investments you can make on the residential side, as well as the commercial side. We also learned why I decided to invest in commercial properties instead of residential properties. In this post I’ll go over my very first offer (which happened about 4 months into my real estate education).  I have to break it down into a few episodes because it’s going to be a detailed explanation from beginning to end, and it will be as follows:

1. How did we decide to make an offer on this property
2. What did we ask the real estate agent to send us during the due diligence process
3. Are we running this as a business or selling after remodeling, plus all the financial calculations
4. Which items our attorney looked at and objected to from the title report
5. What ended up happening and conclusion

How do I decide if this is a potential property I want to end up buying or not is as follows:
I keep track of all the properties that I find interesting on Loopnet and Crexi, I then call all of the seller’s real estate agents and I ask them the questions that we covered in our last episode. If I find that these properties could have potential, I send them to my mentor, along with the answers that the real estate agents gave me. My mentor then tells me yes / no / let’s find out more. I then call the real estate agents again to get the additional information needed. On average, out of 10 properties that I reach out to, I follow up again on 2 of them to ask additional questions.

This property was one of these 10, and he quickly said that he really liked it, and for us to take a look at it that weekend. The property was an old movie theater in the city of Salinas, CA, which is considered the salad bowl of America – this is where a lot of our vegetables are grown. It’s also a city that is very close to Carmel Valley which is a beautiful area and very expensive. Salinas is about 20 minutes from Carmel, and they get a nice breeze from the ocean, so the weather is quite nice. The price was $500,000, around $83/sf. The theater was abandoned for the last 30 years, and nobody had been using the property or keeping up with code for 30 years and it was literally falling apart. That’s why the price was about one-third of the price that other properties were selling for in that area (on the low end). It was in a very cute downtown area which I personally like, and I think that of all retail real estate, cute downtown areas are the ones that will definitely survive, so we could potentially turn his property around and make a good amount of money in a short period of time.

We took a look at the property, and the first thing that you notice is that a lot of movie theaters have two little stores on the sides (to the left and right of the main entrance), they were probably ticketing booths back in the day, but nowadays the movie theaters have an actual tenant on both sides, and these little stores are pretty small at ~500 to 700 sf each. On this property, one of them was actually rented out to a nail salon that had been there for a while, and they were on a month-to-month lease paying below-market rent. The other side was remodeled and vacant, and the inside of the movie theater had not been touched for 30 years, so you can imagine that things were really falling apart. However, as soon as you walk in, you can tell that if this building was remodeled it would be such a beautiful property and you just start wondering what you could do with it: one option was to remodel the bare minimum, bring it up to code (i.e. the bathrooms had to be ADA compliant, install fire sprinklers, install a new roof, etc) and sell it right away. Another option was to remodel it to the maximum and bring the property to the best shape it could be, and then rent it out to parties, events, corporate gatherings, etc, here we could potentially run the business ourselves or partner up with someone who would run that business with us. And lastly, we could remodel, bring a very good tenant and give them some TI (tenant improvement) money to bring the place up to what they needed. Note that if you can bring a national tenant, you typically have to give them a lot of money for TI, but if it’s a small mom and pop tenant, you don’t need to give a lot of TI money.

With these three options in mind, we decided to put an offer and then figure out what we could do with it as we went through the due diligence process. If the numbers didn’t make sense, we could always withdraw our offer and just end up paying for the inspections. We made an offer of $430,000 and decided to use the seller’s real estate agent as our agent because we found the properties ourselves, and it would be easier to work with one real estate agent. The seller ended up accepting our offer, but they didn’t want to pay for the inspections (this request was part of our offer, because if we didn’t end up buying it, we didn’t want to have to pay for it). However, we just let it go since they accepted our price.

Things to note on the offer agreement
We used the standard commercial offer agreement, and as noted above, we had to give the seller all of the inspections if we didn’t end up buying the property, so they could give them to the next buyer. A few other things that I highlighted on the purchase agreement were: 1. We needed to deliver the removal of contingencies or cancel the agreement within those 45 days, 2. If there was any problem with his purchase, we would have to resolve it through arbitration, 3. Both buyer and seller pay for escrow fees, the seller pays for County transfer fees, the seller pays for the city transfer fee, the buyer pays for all the reports, and the buyer also pays for the title insurance policy. These are just standard terms and we agreed to them.

I then went to the title company and got the escrow opened, I gave her the $15,000 refundable deposit and then I went to see the property again – this time I took pictures and I recorded videos of the property – it was one of my mistakes and I should have recorded the very first time we were there. When you go take a look at a property there are many things going on, and we can easily forget them, so make sure to take pictures and videos on the very first time you go there. Also, if you can, bring someone with you – there was a lot of information that the real estate agent was giving us while we were touring the property and some of that information I remembered and some I forgot, some information he missed and some of it he also remembered, so together we remembered a lot more than we would have if we had gone alone. For example, the real estate agent said that quite a few people had been contacting her and were interested in renting out the small area next to the nail salon, and she said that she would give all that information from these people to us once we completed the purchase – I never remembered her saying that, but my mentor did so I took notes so that I wouldn’t forget to ask her once the escrow was closed.

Here are the things that I asked the real estate agent to send me during the due diligence process:
1. Recommendations for Structural Engineers, roof inspector, and contacts in the city of Salinas since she had been a broker there for a very long time, and she knew quite a few people.
2. The last structural report done on the property.
3. The blueprints so we can give them to our architect, otherwise if the architect did not have the blueprints we would have to pay around $10,000 to get have them redone. I needed those blueprints not only in paper format, but also in digital format since I wanted to forward it to our architect digitally via email. Both of these cost money so since she had the original blueprint (and it was about 11 pages long) she had to scan the blueprints and send them to me.
4. Rent comps, and sales comps in the area. Both of these are important in order for us to understand what we could rent the property for (and therefore what we could sell the property for), and what were people paying in that area once the property was fully leased and fully remodeled. All of this information was used in my financial analysis to do a best and worst case scenario so we could see what was going to be an ideal price for this property. Note that I asked for leased comps and sales comps from two different real estate agents and both of them provided me different numbers so I had to average them out to come up with the final number. You really want to make sure that you ask for comps from more than one real estate agent.
5. The lease for the nail salon, they were on a month-to-month lease and I wanted to understand if they were below market or not. It’s also important for us to have a copy of that.
6. Who the owner of the building next door was, because we were sharing a wall with them and we needed to understand if they did anything to the wall or not.

In Part 2, we’re going to go over how we approached our decision regarding what we were going to do with the movie theater: are we going to remodel it and run it as a business ourselves, are we going to remodel the very basics and just sell the property, or are we doing some remodeling, bringing a very good tenant and giving them some TI. I’ll also go over the financial calculations that we did, what did our attorney ended up objecting to on the title report, what was our final decision, and how much did we end up spending on this property.

It has to start somewhere, it has to start sometime, what better place than here? What better time than now?

Zack de la Rocha

Listen to this episode here

In this post, I’ll explain in detail why I picked commercial properties for my real estate investments and not residential properties. But before I do that, I want you to learn that there are many types of investments that fall under residential and commercial. First, let’s learn what types of properties fall under “residential investments” and what types of properties fall under “commercial investments”.

Residential Properties:
Residential are properties where people live in, where people have their bed and pillow to sleep on at night, so it’s not only single family homes, it’s also duplexes, triplexes, fourplexes, mobile home parks, multi family properties like apartment buildings, high rises, lofts, student housing, and senior housing – and each of these categories have their own pros and cons! Also, each of these categories can be good or bad investments depending on the state that you invest in because of things like property prices, local economy, and state and city laws (for example some states have laws that benefit the tenants and you cannot kick them out, some states have laws that benefit the property owners, so if a tenant doesn’t pay the rent, they are out of the property within days).

Commercial properties:
There are several types of commercial properties that you could focus on:
1. Industrial: distribution center, warehousing, or manufacturing
2. Office: you can have a regular office that you lease it out to several companies, lawyers, etc, or you could have a medical office building (for example) where you lease to a hospital, or to dentists, dermatologists, psychologists, etc
3. Retail: within retail you can have a single tenant building, for example in the downtown area of where you live, you can own a building that is leased out to a coffee shop for instance, or you could have a restaurant in your building, so that’s a single tenant retail. Another type of retail is the small neighborhood service center, like the places that have 5-10 tenants where you go to the dry cleaner, and there’s also a nail salon, or a cash advance business for example. Another type of retail can be a strip mall with let’s say 20-40 tenants, like the place where you go grocery shopping and they also have a bank as a tenant, some food places like Burger King, etc. Or it can be a big box shopping center where they’ll have a Target, Macy’s, a food court, etc
4. Storage units: this is where people pay you a monthly fee to keep things they’ll never need in your building, and within storage you could focus on storing wine for instance, because people like to collect, but don’t have a lot of space to have a temperature controlled storage at home. If you have a lot of courage, you could store gold for people!
5. Land: you could lease your land to all kinds of businesses. For example: for agricultural purposes, to wind farms, for RV’s to park for a few days, for truck drivers to park their trucks when they’re on the road, and many other things.

Now that you know all kinds of investments you could focus on, let me explain why I decided to focus on commercial, and specifically in retail and office.

Why commercial and not residential?
First and foremost, part of it is that I don’t like dealing with people, and yes, you can have a property manager deal with people for you, but I really just don’t want to be in that world. Over my career in sales, I realized that when people are paying for anything out of their own pocket, they get a lot more sensitive and that can lead to more complaints and upset people, than when their company is paying for something. So that’s one of the main reasons why I picked commercial – because I’ll be dealing with people that are working within an organization, and they don’t take things to heart as much as someone paying out of their own pocket.

Also, I live in California where the tenant basically rules, if they don’t pay rent it can take months to get them out of your building, AND the state of California will very likely implement rent control statewide, rent control laws are getting passed in several cities here in California, and it’s just a matter of time when the entire state has rent control laws. I recently met a couple that owns quite a few single family homes in California, and they said that they’ll be selling all of their homes as soon as their tenants leave just because of the rent control laws.

Secondly, I also just landed in commercial real estate by chance because my mentor has been investing in retail for over 20 years, so that’s what I have been learning from him.

Other reasons for choosing commercial are:
1. NNN: this means that your tenants will pay for property taxes, insurance and common area maintenance (also known as CAM), this doesn’t happen in residential
2. With commercial properties you also get better tenants, you can get big companies such as Jack in the Box, or a bank, or a supermarket, and if you can get big name tenants to lease from you, you can increase the value of your property significantly. Why? Because these big companies are unlikely to out of business and the rent is pretty much guaranteed to come in, and the next investor buying your commercial property values that.
3. Commercial tenants also sign longer leases: commercial leases can vary from 10-20 years, and sometimes more, and yes, there are yearly price increases that are negotiated on those leases, the leases typically start to get increased after year 5 for commercial properties.

As a conclusion, part of it can be personal preference. Most investors focus on a specific area, and they end up becoming experts in that area, and some other investors adjust their strategy based on the market. For example I met someone recently who typically does multi-family investments, but because the market is so hot with multi-family properties, these properties are very expensive, and he changed his strategy to retail where he can get a 2% higher return than with multi-family projects. So you can be flexible on your strategy as well.

And flexibility is important, another example, my mentor recently purchased an office building to leverage his retail properties because there’s a lot of fear in retail nowadays. Personally, I think that retail won’t go away for many reasons, but they will be on sale when the economy takes a hit, AND they will be on sale as more big box stores go out of business because of the internet (hello Sears), and until these properties get repurposed for another use, I think you’ll be able to find good deals in retail. Also, when the economy takes a hit (which a lot of people are predicting will happen anytime soon, and some people are saying it already started) we will have many opportunities to buy real estate – SO if you are here learning all you can – KUDOS to you because you’ll be ready to go on a shopping spree when the time arrives.

I hope this gives you clarity on why I personally picked commercial. If you’re learning something, make sure to subscribe to this podcast, and if you could please do me a favor and write a review I’ll be very grateful because only when we have enough good reviews they will show our podcast when people search for commercial real estate advice.

It is better to be prepared than to get ready

Will Smith

Listen to this episode here

In the last episode we learned what is a cap rate and what should you be looking for when you see a property on Loopnet.

Today we’re going to be learning the questions that I ask a seller’s real estate agent after I take a look at a property on Loopnet and think that this could be interesting. You don’t necessarily need to ask all these questions every single time, but it’s a good idea to go over most of them when you call the seller’s real estate agent. Here it goes.

1. The first thing you want to do is to introduce yourself and explain that you are a real estate investor. This way the real estate agent knows who they’re dealing with and can answer your questions appropriately.
2. How long has the property been on the market? The reason you’re asking this is for you to understand if it has been on the market for a while, or if there has been any offers on the property, and if yes, why didn’t the purchase go through. Here you’ll want to understand why are people not buying this property, or if there were any offers, why did the purchase not go through. This way you can determine if the problems from the previous buyer is going to be a problem for you, and you can decide if you want to deal with that or not.
3. What is the potential you see for this property from an investor’s perspective? The reason you’re asking this is to see what is in it for you as an investor. For example, when I call properties in California, sometimes they have a very low cap rate, so I really want to understand what is the reasoning behind this incredibly low cap rate, and why should an investor buy this property. A lot of times the real estate agent cannot answer this question! This is very important because if there’s no meat in the bone, AND the market is incredibly hot, you don’t want to get yourself in trouble by paying a very large price for a property that is already charging top rent (and you won’t get much upside when the leases are over), so you really want to be careful here. The things you’re going to be looking for as an answer will be “This property has been at a 95% occupancy rate and right now it’s at 90% so you have another 5% that you could add to the property”, or “There’s an upside in rent if you could paint the property and do some remodeling in order to increase the rent”, or  “It’s in a great corner location and you can actually put a couple of billboards up and get some additional income”. So there are all kinds of answers you’re going to be looking for.
4. Are you local? You’re just going to ask them this question if you don’t think that the real estate agent is local to the property’s location. The reason behind it is, you want to know if they can talk about the area, do they really understand what’s going on in that area, is there really an upside for that area of the city or town, etc.
5. How did you come up with the price? Here you’re also going to get all kinds of answers, sometimes people do get offended with this question – maybe because it’s overpriced! And when a real estate agent cannot explain how they priced the property, to me it means that it is overpriced, and to me, they’re just expecting a foreign investor who doesn’t know much about the market to buy it without asking a lot of questions. A good answer to this question on the other hand is “we’ve taken a look at five other properties that have recently sold in this area and that’s the price that is going per square footage” or “we’re basing this price on a cap rate of 5% because we have Burger King as a tenant” all of which are legit answers, as long as there has been some work that has been done in order to come up with this price. A lot of times real estate agents will go a little bit deeper and explain that “properties here sold for $170/sf and we’re actually listing this one for $150/sf, and it’s also a corner unit which is a whole lot better than the one that sold for $170/sf.”
6. Who is the seller and how long have they owned the property? Here you want to understand if they’re just “flipping the property” or if they’ve been in it for the long run, or if they’re going through a 1031 exchange (and I’ll explain what a 1031 exchange is at a later time), but what what you need to know on a 1031 exchange is, the seller has to sell the property relatively fast, and this could potentially give you some leverage in negotiating the price when you’re putting down the offer. Other things that you want to look for, especially if you’re buying in an economic downturn is if there has been a death in the family, because the family has to sell in order to pay inheritance taxes – and these taxes are due really fast since the government doesn’t wait around! When we are in a down economy, and the seller needs to sell, there’s definitely a huge room for negotiation and I have heard of properties that were listed during the downturn for an incredibly low price and ended up being sold at half that price because the family simply had to sell – this is when you can get the deal of a lifetime that is going to set you up for life.
7. Is there any known contamination in the property? The reason you’re asking this is you really don’t want to be spending thousands and thousands of dollars removing contamination. Whether they know if there is contamination or not, you’re going to have to end up doing what they call a “Phase 1 environmental report” and sometimes the seller does that in advance when the property is incredibly expensive, however, for the most part you’re the one who’s going to have to order the environmental report. This report tells you if there is any contamination on the ground or not. If there is contamination on the ground, it’s going to cost you a lot of money to remove it and you probably don’t want to be dealing with that. A couple of other things for you to know here is if the property is next to a gas station, or if it’s next to a dry cleaner, it is probably contaminated. However if it’s next to a big corporation such as Chevron or Texaco, they will take care of it, but if it’s a small mom-and-pop gas station you are unlikely going to get the the property decontaminated by them.
8. Does anyone have the right of first refusal (aka ROFR)? This means that when you are buying a center with a big tenant such as Walmart, Walmart could potentially have on their lease a right-of-first-refusal – this means that once you submit an offer to buy the property, Walmart is going to say either “Yes, I want to buy this property for the price that this person is offering” or “No, I don’t want to buy this property for the price that this person is offering”. What does this imply to you is that when you are submitting an offer for something like that, you’re going to be spending a few thousand dollars writing the offer with your attorney, and of course we’re talking about more sophisticated investors, when you’re buying a smaller center you’re probably not going to have to deal with this price tag – but it’s good to know and it’s good to always ask.
9. Are there any easement agreements? What’s an easement agreement? It’s when you let someone else use your property without giving up your ownership. For example, when you have a farm and you want to let someone drive through your farm on a road in order for them to get to their farm. It can also happen in a strip center when the center has been divided into three parcels and the original owner sold each parcel separately. You now all share the parking spaces and parking area. It can also mean that the city could potentially have a road through your property and they are able to use it at their own will. You really want to make sure that you understand if there is an easement agreement on the property, because one of the consequences is that you’re probably going to have to pay for the maintenance of that road while other people use your property.
10. Please send me the rent roll. Sometimes they’re going to ask you to sign an NDA before sending you the rent roll, but for the most part you’re not going to have to sign one. When you get the rent roll, you’ll have to take a look at the following: how much they’re charging each tenant per square foot, when were the last few leases signed (and at what price), has the price of rent gone up or down, etc. I recently came across a property for sale that I initially thought was very interesting, it was around 80% full and they had recently emailed me saying that they just signed new tenants, bringing the cap rate from 7.5% to 8%, however, this new lease was for $1/sf/month, when they were previously leasing it for $1.50/sf/month, and I had to find out why they lowering the rent per square foot and why did they lock someone in at that low price – you really need to study the rent row. I have missed this many times and my dear mentor has had a lot of patience with me and brought it to my attention “look at the rent row, look at what they were charging in rent before, and look at what they’re charging right now, look at all the leases that are going to expire in 3 years, and there are quite a few of them – and in three years we could very well be in a very bad economic downturn – do you really want to have a vacant property when things are not doing that well?”
11. Is the building historical? In many downtown areas there are several historical buildings, and the reason you need to know this is because you cannot tear it down you cannot do much on that property, and a lot of times you cannot change the usage on the property either.
12. Has the building been retrofitted (if older building)? Do you have any estimates to retrofit the building if it hasn’t been retrofitted yet? Some cities have made it mandatory to retrofit buildings. For example, after a couple of earthquakes happened in San Francisco, the city made it mandatory for several buildings to be retrofitted so the risk of the building collapsing decreases during the next earthquake. What does retrofitting mean? It means that you have to reinforce the first story of the building because it’s substantially weaker and more flexible than the stories above. It it is very weak because there are not a lot of walls or frames on the first floor, so what you have to do when you need to retrofit a building is you have to hire a structural engineer or an architect that specializes in retrofitting, plus you need to spend anywhere from $60k-$130k and that can take a while to get finished. Not only that, the city of San Francisco will charge you a percentage of your work construction costs as a fee when you apply to get the permit to retrofit your building! Oh and one more thing! If you have a multi-family property in San Francisco, and your tenants lose their parking spaces during the retrofit, you will have to take care of that yourself!

These questions have been my go-to questions when I call a seller’s real estate agents, if you forget to ask a couple of questions it’s not a problem, you can just call them later or send them an email asking the questions you forgot to ask! In the next episode we’ll be going over my first offer experience and what happened with that first deal.

“Most of the successful people I’ve known are the ones who do more listening than talking.” ― Bernard M. Baruch

Click here to listen to Episode 3

In the last episode we learned how to save searches for properties for sale in your area on loopnet.com and you also created an account on biggerpockets.com in order to start reading some blog posts and meet real estate people in your area. In this episode, we will be learning what is a cap rate and what you should be looking at when you see a notification from Loopnet that a new property is available for sale in your area.

What is a cap rate?

A cap rate is a variable rate that varies per property, and is determined when you are selling the property. As a buyer, you will be looking at various cap rates, and the very basic explanation is that it is the net income on the property divided by the price of the property. For example, there is a property for sale for $400,000 and the cap rate is 8% – this means that your income on the property is $32,000 per year. There are other intricacies about cap rates when you are selling the property, but what you need to know is that cap rates can vary greatly. For example, it depends on the location of the property, in California you’ll find cap rates of around 4- 5%, and are there others states you may find cap rates of 8, 9, 10, 11%.

Cap rates also vary based on where the property is located in a particular city. If the property is in an incredible location, the cap rates are going to be lower, if the property is leased to a national tenant (for example Starbucks, Burger King), the cap rate will still be even lower because your rent is going to be guaranteed and you can easily sell this property. However, when you have a local tenant, and the property is not in such a great location, or is the location isn’t very visible, then your cap rate can be higher because the seller is incentivizing you to buy the property.

Cap rates are also determined by the interest rates on loans: when interest rates are low your are able to lend more money to buy property – meaning you qualify for a higher mortgage – however, when interest rates are higher, you can afford less property because you’re getting a smaller loan. You need to look at all of these things not only when you’re buying, but also when you’re selling a commercial property because when you’re selling that’s when it’s going to determine what the cap rate for the property is.

To elaborate more on cap rates varying by location: for example here where I am in California you can find cap rates as low as 2.5% in Santa Monica which means that you’re making a 2.5% income per year based on the price of the property. You can also find 7% cap rates in some areas of Berkeley for instance. However, in Alabama, you can find cap rates at 10% and that’s because it’s harder to sell the properties there than in California, so the sellers typically want to make the rate pretty attractive to the buyer.

When you’re looking into buying a property, you want the properties with the highest cap rates as possible, but there are situations where that’s not really the case, and we will cover those details in another episode (for example, you find a value add property where rents are currently low – the cap rate may be low when you buy, but you can add a lot of income to the property by managing it properly).

If you’re completely lost about what a cap rate is, fear not, it can be a bit complicated! In a future podcast I’m going to be breaking it into two separate areas: 1. What is a cap rate and how should you determine what a cap rate is when you’re selling the property and 2. What does a cap rate mean when you are buying the property. But, if you haven’t understood it yet, the basics of it is: when you’re buying a property the cap rate is the net income that you’re making on that property / the price of the property, so for example, if you’re buying a property for $1,000,000 and your cap rate is 10%, your net operating income as $100,000 – it is the money you’re making every year on the property divided by the price of the property. Hopefully this makes it pretty clear to you on what a cap rate is.

How do you evaluate a commercial property for sale at first glance?

Now we’re going to go and take a look at a property that is available for sale on Loopnet. By now you should be getting email alerts from Loopnet on properties that are for sale in your area, so let’s open one of those emails and click on one of the properties in your area. I’m looking at a property I found in the city of Redwood City and it’s for sale at $825,000 which is pretty affordable here in the Bay Area, let’s scroll down, I see that the property type is retail and the property subtype is storefront retail / residential. I’m not particularly interested in managing residential tenants that are living in a property, but let’s find out more about the opportunity. Under the description is says “rare stand-alone building on Woodside Road. Two-story mixed-use building can be easily divided into three bedroom apartment upstairs and office / retail underground”. So this property has a retail component on the ground floor, and on the top floor it can be a three-bedroom unit that I could rent out. It sounds interesting to me because it’s in a very good city and I could potentially get at least $3,000 for rent upstairs, but I’ll have to do some research on what I could get for the lease for the downstairs retail unit.

Below the pictures I’m looking at the gross leasable area, 1,566 sf, now I can do a very quick calculation to see the price per square foot for the property. So that’s $825,000 / 1,566, the price per square foot is $526. This is a good price considering that we are in Silicon Valley, for you to have an idea, in the city of San Francisco a typical price per square foot can be around $1,000, this property is a few miles south of San Francisco, so this is a pretty standard price per square foot. This building has two stories, it was built in 1940 and there is a parking ratio of 1.92 per 1,000 square feet (a good parking ratio is 4 spaces per 1,000 sf. I see the APN / parcel ID number of the property, and it gives me a walk score of 79 (very walkable), this means it’s in a pretty decent neighborhood where people can walk down the street and it’s safe. As I keep scrolling down there’s not much more information besides “great visibility” and under “sales notes” it shows us when they’re having an open house. Now that I know the total square footage, I know how much I’m paying per square foot, this means that the unit upstairs is probably 800 sf and the unit downstairs is also 800 sf, I have no idea how a three-bedroom can fit in 800 sf, but we’re going to have to take a look at this property in real life.

On the right side of the pictures, you’ll see the map, what we’re going to do is click on this map and once you’re there, you’re going to click “street view” and you’re going to drag the arrow up and down this street in order to see what the neighborhood looks like (thank you Google). I see a Wells Fargo near this property, I see a dry cleaner, I see a US Bank, and note that the dry cleaner could be a red flag because there could be contamination on the grounds of the property. A contaminated property is very expensive to clean and the city will make you clean up the site – and if it’s not the clean it could ding the value of the property later when you’re trying to sell it.

By now I’m taking mental notes to ask the real estate agent how big the unit upstairs is, how big the unit downstairs is, how could it be that there is a potential 3 bedroom upstairs, and is this property contaminated or not. I’m also going to ask him if a “Phase I” report has been done, this is an environmental report that costs around $3,500-$4,000 that you need to get done in order to see if the property is contaminated or not. Sometimes sellers do that report in advance, and sometimes you’re going to have to pay that out of pocket when you’re doing the due diligence  after your offer is accepted. Now you have a very basic understanding of what you should be looking for when you get those Loopnet alerts in your inbox. In the next episode, we’ll be going over the questions that we should be asking the real estate broker that is selling the property in order for you to understand if it’s a property you should pursue or not.

He did each single thing, as if he did nothing else. — Charles Dickens

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