How to Invest in Commercial Real Estate

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Episode #026 - How to Evaluate a Commercial Real Estate Deal in 10-15 Minutes or less!

by Criterion, Braden Cheek, Brian Duck
March 9th 2021

How do you find the needle in the haystack? You have to be underwriting, or looking, at 50-100+ deals per week sometimes. You have to find a way to quickly evaluate the deals. We have our hosts Bri... More

I mean if it doesn't have an airport, then I'm not obviously going to be looking at that on retail though. I want a big one. I feel like we Shouldn't pass over that if it doesn't, I've literally, I remember pitching you deals remember pitching deals and you're like, how long is it gonna take to get there? And I was like 12 hours? So it's not a direct flight and you're like past now and you know, could I invest in a small market in Oklahoma that I can go drive to? It may be, but the smaller the market, the more you need to know about it because small markets can go away. Yeah. Welcome back to how to invest in first real estate. My name's brazen cheek. And today we are going over how you're, how you're looking at so many deals. I mean you're probably looking at 1500 meals a week, maybe a little more, maybe a little less. And you've got to figure out a system To efficiently go through these deals to find out if they're good for you. If they're good for your investors. If you can get debt. If you can raise equity, what the, what the returns are? You've got to be able to in 10, 15 minutes say, yeah, this sucks or yeah, that's gonna be awesome. I want to look more. Maybe even quicker if you're looking at uh $100, a month, you may not even be able to spend that long.

Yeah, maybe there's a certain thing that you, you eliminate that, that deal immediately. Maybe it's maybe a couple minutes a minute. So, well for me, everyone's going to have their objectives when investing in commercial real estate. And it may be, uh, that they have a niche because they worked at a development company. So they're looking for development or development land. There may be someone that was had experience with multi tenant retail. So that's what they are going to be looking for. And same with multi family, they may work at a management company and now they're looking to buy a multi family. And so everyone's gonna have to come up with a system on how they find the deals that they want to buy. Uh But for me, I have like, you know, 567 criteria that that helped me get through the inbox of hundreds and hundreds of deals that flow through. And the first one that makes it easy. And we've talked about this term is cooperate. So that's the first thing you look at. You'll you'll you'll see that property, you'll see the cap, right? And then, and how do you evaluate because we're looking for cash flow? Uh Day one. Typically there are all kinds of deals, some deals won't cash flow day one.

Uh But but I'm typically looking for cash flow deals. And so that cap rate is the first indicator that tells me, given the debt I can place is, can I get a cash on cash return where I can distribute to my investors day one. And so if it's a, you know, if it's a really nice brand new retail deal in a good area and it's a 5.5 cap, I I just, I can pass on that right away because it's not going to meet my cash on cash returns. Doesn't mean it's not a good deal. It just isn't what I'm currently looking for because of that low cap. Yeah, retail if it's a retail deal, 5.5 cap now, multi family a little different, you can get better dead on it. So you might get a low, you might be able to stomach lower cap and you can increase rents, you know, maybe quicker. So yeah, that's, that's the first metric that I use and the cap rate, the reason you're using is because it's the most advertised in the most popular determination of value in the market, right? So like when people are advertising, when people are taking something to market their justifying that through some sort of cap rate. And that gives you an indicator of where the purchase price or net operating income, it gives you a day one picture of what, yeah, what you're dealing with the income that you're dealing with.

And so that for me, if I'm looking for cash flow, that that's the first number that I need to be in a range. Otherwise I have to move on and I say what the range was No, I mean I hate to to be too specific on that because it just depends on so many factors, but but multi family deals right now, I want to be, I don't know, 6.5. Um It still is skinny, but you can make it work. And then on retail I need to be at 7.5 or higher for me to make it work. Okay. So if the cap right works for you, what's your next step? Uh next step for me is I'm gonna look at that location. Uh Now it depends last with multi family. Uh we'll go to smaller markets for multi family because people need a place to live and, and so it's a little more secure. You can go to, I may go to 100,000 population market, which is pretty small. I mean it's getting small. We the deal in North Carolina that we had success in, I think it was 80, person market. So that's that's getting small. But we did really well on that property.

Um That's property show up at the Airport with two gates and you're like, Oh wow. Yeah, we may have messed up. I mean if it doesn't have an airport, then I'm not obviously going to be looking at that on retail though. I want a big one. I feel like we shouldn't pass over that. If it doesn't, I've literally, I remember pitching you deals remember pitching deals And you're like, how long is it gonna take to get there? And I was like 12 hours, there's not a direct flight and you're like past, yeah, mountain. And you know, could I invest in a small market in Oklahoma that I can go drive to? It may be, but the smaller the market, the more you need to know about it because small markets can go away uh with with different industries moving in and out and things changing. And so I, you know, I tend to want to be at a location that's that it's going to be here in 10 years and it's gonna be bigger than it was. And once you get critical mass uh in a population in a in a market than it'll grow. But, you know, like drive thru Haskell here in Oklahoma and the downtown is a bunch of empty buildings, like there's there's nothing there. It was better, it was better 20 years ago than it is today.

I'm not taking, you know, a dump on Haskell, I'm just saying it had a downtown and now it doesn't have one. And so that's why you need to be in a little bit larger market for retail. I want to be in a in several 100,000 person market uh for me to feel comfortable. Now the next thing is I'm looking at is where in that market it's at, so if the market is big enough and the cap rate works and I start to feel ok about it. I'm for retail, I want traffic counts and I want to be in the growth area. A Lot of traffic counts like a chick flare chipotle. I mean, I think 60,000 cars a day you have to have in front of the chick fil and chipotle. That's an interesting point. If you can look at some of the retailers around you. I think one investor one time, uh, he invested in the deal just because Chipotle or or someone similar was right across the street and he's like, if it's good enough for them, it's good enough for me I'm in because they chose to be there and it was new. And so if they chose to open up their, they know they've done all the market research, that's a great area.

Yeah. You wanna you wanna focus on where people are driving from, from where they're driving to a meaning where they're living, where they're going to work where the highways are? Do they have to pass your retail center? What's around it? What are the jobs like what's the, what's the income of the area or are people more on the flu inside or is it more, you know, workforce housing? Um if its workforce, a workforce housing in the middle of the most affluent area, you know, maybe maybe that's not good either. I mean there's a lot of indicators you can look at just data. raw data without seeing it with your eyes in person of just saying, yeah, this scenario I want to be in and you can either yourself or you can pay a small fee to have someone running economic report on that location which would give you traffic counts, give you population growth, you know, one mile population, three mile population, household income, average household income, that's all that. And I just think people need to think about the markets they're in, you know, where the growth is going, you know, where new development is. And you also know those areas that, that were really great, maybe 30 years ago that, that are really kind of older and not anything, nothing new is happening there.

Now can you invest in those areas? Yeah, you can invest, but instead of getting a 7.5 cap deal, you need to get, you know, an 8.5 or nine uh because the risk is higher. So you want to get, you want to have a higher potential returns. Yeah. And this is where you go visit the property, that's why you fly there or drive there beforehand. You're meeting with banks, your meeting with local brokers, your meeting with management companies again on the area, it's all they're market, they're all hopefully have something to gain from the transaction or or not, you know, so there, hopefully giving you truthful information, they want to work for you. They want your business, they want you to buy you know maybe more in the area. So they're going to tell you about it. They're gonna say man this is a rough part of town. You you really don't want to be here. I look a couple miles over. That's where all the new developments going. That's where the new high schools going. Yeah out of that in New Mexico we went out to see this this deal that was offered at a pretty high cap. And when we got there It was it was the location 20 years ago. And then we we kept driving about three or four miles around the corner. And that that was the the area and that's why this property looked bad and that's why it had more even more vacancy than the broker told us it had.

So that we passed, we were misled to fly out there because on the map it looked good. The data look good. The traffic counts, you know, were decent. But then it's just like this that was a little rough. It's rough. Okay, so next next point um it's past your cap criteria, it's past your market location criteria. So what are you looking at next? The rents doesn't play rents for me. Um The rent roll the rent roll not and I will say rent roll because rents I want them to be lower than market and and so you know I'm gonna need a little bit help if it's outside of my market to understand what those are. Uh but you know there could be on an apartment deal, maybe it's a mom and pop local owner and and they've owned it for a long time. And so they're still cash flowing at a lower rents and they don't know that they could be pushing them because they're just comfortable and they're making money so that that would be a good one on retail. We we kind of know now what uh what the first generation looks like and and rents per foot and then and what the second generation looks like.

And and you know, if I see a lot of upside in those rents, that's that's where I'm going to second generation, you mean of owners or what's 1st and 2nd generation. So in retail, if someone, you know, if you build a brand new center or maybe even a build to suit your building for like a whole foods or you know uh Chipotle and national tenant now what happens, you know, 10 years later when that lease is up and that area isn't as hot maybe uh they'll go and build a new location and then they'll back fill it with a long john silver's well or a local credit. I see uh you know like your local burger joint, let's say instead of Chipotle, they'll go in there doesn't mean it's bad. But let's say uh Chipotle was paying 30 $35 a foot and rent, these people may be paying 15 or 20 which is good. Uh if there if it's still good enough location, but I'm looking at at that and saying, okay, what are the rents for that type? And if like on our village south deal, we bought it with $10 rents and they really should have been 16 15 $16 rents.

Okay, so that's what we're, that's what we're quickly trying to assess is is are the rents in line, it doesn't necessarily even have to be that they're below market, but to get to the next step in my my quick underwriting is are they in line, are they too high? And sometimes I see deals, they look good, but the rents are just high and I see there's nowhere for me to take them and they're going to be hard to backfill. So I passed and upside the big thing not to interrupt. I mean, you've got to kind of, the reason why you're doing this because you've got to get a baseline of where the cash flows at today and you've got to get a baseline of where the cash flow is going to be at 357, 10 years from now because you're most likely gonna be owning it. And if there's a massive amount of upside because you have $10 rents. Day one. But you know, you can inch them up to 16, 17, 18 over several years. That's a massive amount of vacancy would be another upside right that you might look at to see if there's a some some vacant spaces that you can, that you can lease out. Yeah, that's when you want to buy a hot center. You know that that seven cap that you know, maybe first generation center that you think he's ready to sell. Um and it's, it's got a vacant or two.

That's when you would want to make the offer. And why you might ask is because that's when the net operating income or it's making less money. So you can give him the same cap rate he wanted when it was full, but it's just making less money and you know, you can go in and replace that income super easy. Maybe even replace it with better income, better tenants. Then we've, we've done that, we've been fortunate to do that. I think there is a is a little bit of a fine line between a good amount of vacancy and too much vacancy. If the center is is you know, 30 or more percent vacant, there's there's most likely a problem. Why would an owner not have worked hard to fill that? And then the answer is they did work hard to fill and they couldn't, but but anything less than than 30 might be opportunity. Uh maybe a couple of tenants just moved out. Um so 10-20% vacancy is probably up, could be upside And and 30 to 40% vacancy May May indicate an issue. Yeah, not always, but but it's just something to be careful with. But I would say that that goes along with the overall upside is after rents.

We've established that those are in line. I'm looking at the property and saying what upside is there on an apartment deal? It could be, hey this is not being managed very well. I think a new fresh coat of paint and some landscaping and a new sign uh could really help me, you know, take the occupancy to the next level or push rents, you know the retail is is kind of the same thing. Maybe there's some tenants that are gonna roll uh and they have really low rent. So there's some really quick upside for me if I can get them to stay at a higher rate. And so that's the next thing is we're just saying, hey is there any upside on this? And of course you're not going to know for sure, you don't need to know for sure. All I'm doing is saying is there potentially any upside, You know, if the answer is like no I see no upside here then you may want to move on and if there is some upside then it kind of okay let's go to the next step and see what it is and for me that's that's debt probably next let's back up right because when you're looking at the upside, I'm always looking at the downside and I know, I know that's not, you know, maybe a whole point we have here, but you have to constantly be weary of where it could go.

You need to constantly look for, okay, it's got a little vacancy. What happens if that vacancy doubles? Okay, it doesn't have any vacancy? What happens if I get some, you're throwing a vacancy factor on there and you're saying, hey, I can lose the senator to worst case scenario, I'm making the debt. I'm paying the investors. You know, the preferred term, Maybe not any splits above and beyond that. But you need to constantly be asking yourself what's the worst thing that could happen and just like mentally take a, take a crap on that deal because you have to think of everything that could go wrong and assume it could go wrong. I think one obvious thing that you might look at is if you have one huge tenant, uh, taking up a lot of space, what would happen if you lost them? Right. Is that part of the downside you're looking at always, I would tend to steer beginners away from, from a huge tenant. They Shouldn't go by an 80,000 square foot poles. No, I don't think so. What about a Sears? Because you're, you're really just betting kmart obviously everything is at risk and everything is managed bet. But if your strategy is, I hope they stay and if they don't I'm screwed, go to Vegas and put on black a tough position.

And you know we've done that, we've we've had a couple of properties with bigger tenants. Um We have a big lots that moved out in our one of our Vegas deals and now we knew that was a possibility actually. I didn't think it would happen. Uh But they were doing so well they needed more space and so they moved to a bigger space down. Uh So My inclination was right that the area is good and that they wanted to stay. It just happened that the 30,000 square foot that I was running them. You know wasn't enough backhanded compliments. Like you're too good. Yeah but yeah I would say say stay away from really big box retail right now if I had a suggestion. So okay so you mentioned debt after you've passed all that criteria, you mentioned debt. What debt is going to be where most of the money comes from. And so there's better be yeah there's certain deals that are just going to be easier for me to finance and the higher L. T. V. I can get the better of the cash on cash return is going to be for my investors. Do we need to go back to the coals example like what bank is gonna is gonna land on an 80,000 square foot poles.

It's not gonna happen. They're gonna be like, dude what do you what what's happening here? The bank doesn't wanna lose your money. Well you may have someone lend on it but it may be at 65% lTv with you know, and so now you're bringing 35% of the money to the table yourself. And so that's tough. Where contrast that with another deal you can get 80 85% lTv years of interest, Only super long Amateur ization schedules. Non recourse Yeah. And and so in part of the debt will will have been factored out in those first few reasons the market size, the location, the rent, how it looks and where it's located. All of that will help you determine when you get to the debt. Okay, I think I can get an 80% LTV deal. Um you know if you're gonna go a multi family To get really good agency debt, I think you need to have 90% occupancy for the prior three months. Otherwise there are other options to pay for it or to buy it. But it's, it's more of a bridge loan at higher interest. It's like dating. I mean let's be honest, when you get the lender involved, you need to wine and dine him.

You need to take them out for a nice steak and you show them a property that's that's winning and and beautiful and producing so well making so much money for us and then you know, I'm not saying it could go downhill. I'm just saying like, you know, it's really important in underwriting that everything looks good or else, yeah, alone is gonna cost you more money. Let's, we need to sell the lender on it to get the best terms for sure. Okay. Last last thing that we may do get the debt. Yeah. We think we think it's at least 75% ltv I can get, which is kind of a benchmark for me. If I can't get 75% there's too many other deals I can get that debt on and I don't want to have too much of my money on anyone deal so I can get the debt. Now. I've gotta, I've gotta turn it around and say, okay, how will this property present to the equity partners because we want to be able to raise money. Obviously we're going to invest some, but I don't wanna be 100% of the equity. And so we have to think about, okay, are my investor is gonna feel safe with this? Will it return enough money for them? Do I feel comfortable pitching this deal? The deal we did in north Carolina was a really small market and I've never been to the state of north Carolina before.

So I may have thought it was a good deal, but just imagine me pitching that to the investors, Hey guys, this is a great deal. It's a super small market. I've never seen the property. I've never been to the state of north Carolina. But I, I just really think we should, we should go for it. Are you with me? Uh, you know, so that's gonna be a really tough selling. So we didn't, what crazy guy would do that. So we didn't go out to our broad investor group because I, yeah, I did. I think it was gonna work. Yes. But if it didn't work and they say now Joel, this didn't work. I wouldn't be able to defend why I did it. Uh, at the downside. Yeah. So I want to be able to defend why I'm investing their money. And, and so that all these reasons that you kind of really briefly gone through should help you on this last point to say, okay, my investors, I can get them to return. They want, the market's good enough. They're gonna like Vegas. So they're gonna like, you know, phoenix, um, this is a good part of tulcea, um, you know, the returns are good. What else? There's some, I can pitch them some upside because I've identified some key, you know, upside indicators.

And so that's the, those are the steps that I, I go through to help me weed through hundreds of deals because many of the deals won't meet one of those and I can determine that in a matter of minutes. Uh, and then you're left with, uh, deals that you then have to go further into the underwriting, going through the lease is, uh, the market, things like that. And, and take even more time. But you just can't do that on every deal. Yeah, Okay. But every now and then you catch a live one, you yell down the hallway. I got a live one. Yeah, I got it. And once you, once you find one that checks all the boxes, you may have to move very, very quickly because somebody else is out there doing the same thing you're doing. Yeah. But again, I mean, there's 56 points you're, you're going through fairly quick on each one. You know, you maybe have your preferred Excel model open of choice, just kind of hold some inputs or whatever. Give you some rough, I our our cash on cash outputs, you know, different debt or amortization timelines. There's a lot of variables and assumptions, But if you can just go through this and, and learn what questions to ask. Quickly, learn a system that's comfortable for yourself that works with your investors and your ability to get dead and your property types, you're going after, you can work through this 10, 15 minutes or less.

You're going to know whether or not you want to buy this property whether or not you think you can get debt, raise equity and then you just keep pursuing that, right? You keep going until something is too wrong where you gonna pull the club right? That's that's how we do it. And going back to an earlier episode, uh They're always going to be reasons to talk you out of buying every deal. Uh And so be be prepared. This is convincing you to buy. But looking at the downside, you will want to do that, but you're always gonna have reasons not to buy. So when you find one that checks a lot of boxes at one at some point, you're gonna have to go for it. Yeah, it's it's uh it's hard work to hard work to keep buying sure. All right, well, um if you are listening, if you're an audio listener, make sure it checks out on Youtube, we film it every week. Um make sure it checks out on the web how to invest in sierra dot com. Other than that. Thanks for joining us. And we will see you next week. Thanks guys. Thanks. Mhm. Yeah.

Episode #026 - How to Evaluate a Commercial Real Estate Deal in 10-15 Minutes or less!
Episode #026 - How to Evaluate a Commercial Real Estate Deal in 10-15 Minutes or less!
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