How to Invest in Commercial Real Estate

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Episode #077- HOME RUN! The Criterion Fund Sells 3 Out-Parcels in Plaza West Deal

by Criterion, Braden Cheek, Brian Duck
September 12th 2022

Today our hosts Braden Cheek, Brian Duck and Joel Thompson discuss how they closed the sale of 3 out-parcels in their Plaza West deal, fully paying back their investor's initial equity investment a... More

we're lowering the loan amount. But the payment of the loan isn't changing. And, and so if you're gonna be growing equity at a faster pace. Uh, and so they're gonna realize much more than the 56% on their equity. That's just, that's just cash flow. It's, they're easily in the double digits on their original investment. But they have 100% Investment in their pocket and they can reinvest that and, and get another 12, return. So they're, they're double dipping and, and now if you add the 10, 12, 15%, they're gonna be making on this deal. And if they reinvest that another 12, there at over 30% on that same money. That's why it's such a win for the investors. Fantastic. Hey, what's up and welcome back to how to invest in commercial real estate. And today is a cool episode because we're talking about a deal that we bought not too long ago at the beginning of the year and we dove deep into that deal on the podcast is called Plaza West. And today we have a cool surprise. Did we just buy it at the beginning of this year. Dude, we bought Like January 11. Isn't that nuts? That is nuts. So here we are, August.

Well, it's actually September one september 1st and we are closing on the sale of three out parcels that was included in that shopping center closing today. If you don't remember, we'll throw up a picture of Plaza West. It's a massive L shaped shopping center, it's anchored by restore, which is owned by habitat for humanity. Dollar general, Dollar general as well. Um, it's probably 100 and 2200 and 23,000 square feet and it's got three out parcels in front of it. And those three out parcels are a taco shop alone max and a Wendy's right. And we bought it. This isn't a deal that, you know, we brag about too often because it's, it's not a sexy deal. We talked about older deal. Some of the extra has been renovated, some of it hasn't been, uh, you know, it's, it's in an okay part of Wichita. It's pretty good frontage and decent traffic counts, but maybe workforce housing or just middle income. Yeah. And we were looking at it, um, you know, we kind of had it in the back of our head of, I like buying things with either pad sites on it, you know, that you can sell off or develop yourself or existing pad sites like a Wendy's like a, like a taco shop, like a loan max because those are typically, they typically are way more expensive.

They trade at a lower cap rate. People are willing to make less money on those because of the inherent single tenant risk. There's the single tenant is typically paying the price taxes directly. A lot of the times they have bigger insurance policies that will ensure it themselves. They'll take care of the campaigns themselves. So for an owner who doesn't want to manage it doesn't want to mess with it. Once the tenants to kind of take care of the property themselves, pad sites are perfect for a lot easier. They're they're perfect for 1031 exchanges where you know, smaller investors have sold a property, don't want to pay the taxes but also want to put their money in something that's easy, no maintenance, no hassle, no real management. And so yeah, they traded a slightly lower cap than the entire shopping center just because of the perceived Risk. You think we sold this one to someone doing a 10:31 I was About to say that it's funny you brought that up because the buyer of this bought it in a 1031 exchange and at 1031 exchange, let's just break that down again. It's when you sell a property and you say I do I don't want to pay the tax right now. This is an I. R. S. Loop, not a loophole, but this is an I.

R. S. Rule and they allow you to put that money in an intermediary, like a title company, an attorney, whatever. And then as long as you don't touch the money and that money buys real property like, you know, similar real property, then you defer the tax until you sell that next property right, definitely, definitely because if you die your heirs right, they inherit the property at exactly which is mind blowing right, They don't, they don't have to pay your depreciation? And typically when you sell a property, you're paying depreciation, recapture and long term capital gains and they don't pay any of that anyway. 10 31 exchange was the viral, but we want to get into it because we bought this shopping center for, for a pretty high cap rate. I think it was an 8.5 cap, wasn't it? 8.5, 8, 7, maybe 8 75. I can't remember. I think it was 8.5 before we got a $300,000 re trade like a seven $.5 million.07 and a half million dollar deal. We bought 100 and 22,000 ft and we sold 11,000 ft, the three pad sites or 11,000 ft and we sold that for 3.6, almost $3.6 million.

So a 10th of a 10th of the square footage for for half 50% of the value value. Yeah, that's incredible. And, and so the cap rate, I believe on the three pad sides was five and three quarters 559585. It was below six for sure. We made almost three points on that income and we didn't even power wash the buildings. We literally did nothing. We renewed the loan max lease. Gonna give us a little credit. We called them and said, hey, I'll give you a free month if you're new for five years. And they were like sure of course. So what what kind of terms on the lease attracted these buyers, what what would it take for someone to come in and buy those three? So that's a great question. It was a combination of a bunch of different things and, and like I said in the beginning, these aren't the sexiest asset you've ever seen. It looks a little rough. The windies was old. The loan max is literally, I mean not literally falling apart, it looks like it's falling apart and the taco shop, I mean it looks like your local little, you know Del Taco whatever. So I'll break them down on each one.

The Lomax was the weakest of the three. It looked the roughest. You didn't have any sales, you didn't have any massive franchisor. We at least term right so we had 2.5 years remaining. I got another five years. So there's 7.5 years worth of lease term there. The next one was the taco shop. That's the very hard corner. The very hard corner. The hardest corner in which shop maybe not. But it was, it was, it was on the very corner. The other ones are kind of down from the corner. Yeah, a little bit of an inside joke there. But this is the hard corner and again when you go out and you buy a property, the first quest you're asking yourself is, what reasons do I have to believe that this tenant is not only going to succeed, but let's just start with honor their lease. Like how do I know this tenant is successful enough for sells enough tacos to pay me well in that lease we have sales reports. So every year they submit a yearly sales reports that say, hey, here's how much we did and here's when we did it. So we were able to get those sales reports this taco shops doing $2.2 million a year in sales and their rent is nothing absolutely nothing.

They paid like 4.5 5.5% percentage rent. Yeah, I would, I would say on all three of these tenants, what what what made it attractive was that the rents were relatively low for single 10ant net leased out parcels. That also helps. And then when we were there, the line around the taco shop was, I mean both times we've been there, I don't know if we've been more than twice, but they had plenty of traffic. It looked like they were doing well. The Windies was doing well. The windies had a new brand new churches. So we bought right next to Wendy's, we bought the center, the cellar, carved out that last out parcel and sold it to church's chicken. So that is actively under construction right now. Brand new. And it was only a matter of time before Wendy's was going to put a brand new facade on this facility, correct? And, and let's get into that story. Right. I get an email one day and it's an article from my property manager in the Wichita Eagle, the local Wichita paper and he said, Hey, did you know Cotti Foods the guy who operates the Wendy's, did you know Wendy's is tearing down the location and building a new one and, and you know, I wish I would've known, right, because it would have made me look smart, but we had no clue, no clue.

The Wendy's is gonna tear down their location and build a brand new one. So again, as an investor who cares about the least term Wendy's has literally, who cares if they're building new building, They're building a brand new building. But we didn't find that out until we had already started negotiations with the buyer. Right? No, it was right before, right before, right before they build new, they just totally renovated. It's not a whole new building. They said they are going to scrape it Down to the Earth. It's complete. It's a 50 year old building and I think they're, they're, they have a little bit of a different floor plan footprint now than they used to. So let's get into the numbers a little bit more. We sell these for 3.6 million. We only paid 7.5 million for the entire center, we got a great loan. We bought the center I think it was only 80% which is still pretty high leverage but we got a low fixed interest rate. We did. And the great thing about the lender is they, they allowed us to not take all of the proceeds and pay down the loan. They were willing to take just a million and a half dollars from the out partial sale. We pay down the loan balance and the rest we can keep in cash which we're gonna use to distribute.

Yeah, let's talk about that a little bit because we talked about that with the lender while we were going through the process of the acquisition. So it wasn't a surprise and so it was kind of pre negotiated and I would highly encourage you if you have Any thought that you are going to segment out a piece of property that you are encumbering with a loan to tell the lender that you may be planning to do that. Hey, I would love to sell this piece. What happens if I sell that, who gets the money because a lot of the times the lender or if that's not specifically written in your lung docks, the lender will say sweet $3.6 million 60% LTV. Well not not 60 on this deal we borrowed I think originally six or six and a quarter and so if we pay that down with 3.5 million it goes all the way down to 3 30 40% Ltv. Right? So it would have been a great deal for the bank. But this is a bank we've worked with numerous times. We've done 345 deals for them. I know criterion maximum out. I don't know about precision, precision is done to deal with them though because we got your contact, their contact info from them, which is another reason to stay in communication with anybody buying commercial real estate that you know, I don't know how many times I call somebody or Joel or anybody else buying commercial real estate.

Hey, you have a lender for me, I have this deal and everyone's got somebody who's hungry to make a loan or yeah, this guy was just telling me he was looking for, you know, whatever. Exactly. So anyway, talk to the lender about the equity pay down. We talked to them about it and we worked up this model and they said what do you need? And I said, well I definitely don't need the whole thing, an ultimate home run for us as we raised a 0851 million, 850,000 to buy this property. If we could get that money out, we'd be ecstatic, you can have the right. And they said, okay, let's re appraise it. And if it appraises sounds like a win win scenario, which we talked about in our previous podcast, right, They need less risk because the ny is going down. So they need a little bit. But at the same time, we need a little bit. Even if we couldn't get 100% of the equity sent back out to our investors, even 80 90% of it would be amazing. And then when you talk about a sponsor of the deal, so how how does this benefit somebody with a preferred return situation? Both the investor and the sponsor. Well, for us, if we can get the investor 100% of their money back, the pref goes away and then it's just a straight split of cash flow.

So we're incentivized as sponsors to get the money back to the investor correct. Now, what, what you would say, what is the benefit to the investor? Well, because because they're eight prep is going away, so they're going to get a slightly lower return on the sale. But the thing is whenever they get 100% of their money back Without having to relinquish their ownership, they keep distributions from the property and they've got no risk. We've eliminated their risk and they have 100% of the capital to go reinvest on another deal. They're still earning on the deal that they invested with. So that's a great question. We we are great statement, I guess, I would say The investors will pay out 100% of their equity and they'll still get about 5% on their original investment in perpetuity because we're keeping the property, it's going to continue to more than that because we're lowering the loan amount. But the payment of the loan isn't changing. And, and so if you're gonna be growing equity at a faster pace, uh, and so they're gonna realize much more than the 56% on their equity.

That's just cash flow. It's, they're easily in the double digits on their original investment, but they have 100% the investment in their pocket and they can reinvest that and, and get another 12 15 20% return. So they're, they're double dipping. And, and now if you add the 10 12 15% they're gonna be making on this deal. And if they reinvest that another 12 15% there at over 30% on that same money. That's why it's such a win for the investors. Fantastic. So we like to call this equity farming right? You plant your equity in this nice gorgeous property where you think it has the potential to grow. And then we, we harvested a big piece of that plan out. We're gonna shove it in another deal, right? We took the equity out of the original deal, we're gonna put it in the next deal, but we didn't sell the first deal. And that's so important. It's so important, everyone thinks when they get into commercial real estate. Oh the exit is when we sell the property. I'll get my money back when we sell the property guys. The ultimate home run in commercial real estate is keeping the property collecting, collecting the property, letting it continue to appreciate continuing to appreciate it on your taxes, continue to pay down the mortgage.

It still pays you cash flow and you take the money you bought that shopping center with and buy another shopping center and you do that until you have tons. And as a sponsor we still maintain some amount of risk. But the investors have zero risk because the only thing they risk in the first place was their initial equity. That's the only thing they risk. And so if you give them 100% of that back now it's just cash flow with no risk. It's an infinite return on non invested cash. Yeah. And we and we personally guarantee guarantee the mortgage. So I would make a point to say that our risk actually went down because we paid down that personally guaranteed liability by a million and a half right? And we have less risk because we returned all of our investor equity every time we raised a dollar. You know that's a risk against us that we have to give back. And we have to make sure we give back. But I I want to make sure we all understand the power of this. So I I did the I. R. R. Summary on this investment for this year, we bought it january 11th, we're selling a big chunk of it in september. We've already done two full distributions.

The investor got 12% cash on cash for the first quarter, even though we didn't know it at the first quarter, the second quarter, they'll most likely get that for the third and get all of their money back and they will still get 1/4 quarter distribution. They will still get 1/4 quarter distribution. The I. R. R. For this year on the investor that invested in Plaza West is over 35% this year. And they're going to take that money and shoving in another deal. I guarantee it, that's fantastic. So Brandon um step back just real quickly because we didn't have people just approach us and say hey we want to buy these out parcels. We didn't tell the listeners kind of what steps we took to get these things sold. Yeah that's a great question because we went to multiple different brokers to get brokers opinions of value. They're called a B. O. V. Brokers opinions of value and what that is. It's just like if you were selling a house, you call three realtors and say hey what's my house worth? Right and you'll kind of take the cumulative average of those and then decide on your own number. It's the exact same thing with listening commercial property. You go to brokers who you think can sell your asset. We went to several, we went to a massive, massive group locally and in Tulsa, you know, they sell a lot in this region.

They're based in this region and then we went to another guy in southern California and the guy in southern California and this is really kind of fascinates me. The guy in southern California has a list of buyers that buy low cap rates. Southern California triple net deals. The guy in the middle of the country has a list of buyers that buy properties in the middle of the country for similar to what we buy properties for. So I want to go to the guy that's got the list of people who over pay maybe not over pay like its market right? He was, he didn't do this under duress. They didn't do this under duress. It could easily be a woman. So you want to get those brokers opinions value. We saw the guy from southern California, his name is Jeff left Co, he's with Hanley, you should use him if you have a property sale. He would give you an amazing B. O. V. And and we got that and it was like, wow if you can sell it for that, I would sell in a heartbeat. He said, well I think I can what we as we arm wrestled a little bit over commission. I said, hey, I'll pay you. I think it was 3% base, I'll pay you 3% base, but anything you get over this number, I'll give you like 15% of 10 10 12% of, I don't know the exact number, but it was triple or four times as much because my cap was, I don't want to say it, but my cap was lower than what we sold the property for.

So it incentivized him even more to deliver on his broker's opinions of value because I didn't want him to just quote me a high number. Like, yeah, you should be able to sell us for $3.6 million and then I walk away with like 28 or three million bucks. That would, that would have been a bad case scenario and he would have lost a little bit of, you know, something. But when we tear his commission in a way that incentivized him to give me a higher purchase price, he went out and got it and we got several offers. Um, and you're picking through them, you know, which one's got the longest amount of due diligence time. Like this guy wants 45 days for free is offering no earnest money. He's the lowest price, threw that one away. Okay. These two are pretty close, let's do it best and final see if anybody will come up. I think 11 of the to sweeten their terms a little bit and we locked it up and went with him. It was a group out of Texas. Well, it's just good for, um, you know, new investors when they're looking at deals, be looking for opportunities, How do you grow the, the income? How do you reduce expenses? But how do you carve off potential out parcels to farm out your equity and reinvested and keep the main asset?

It's literally the definition of arbitrage. We bought something in which saw were from Tulsa and we sold it to somebody in a different part of the country who values it differently than we do. I wouldn't have bought these deals at six cap. I'll never buy six caps single tenant retail deals. That's not my cup of tea. Right. But if we can buy an 8.5 cap deal that's got that upside, I really wouldn't have cared if we didn't sell them. We had no intention of selling them. The investors ecstatic getting their money back because these guys and girls were planning on locking up their money for, you know, 357, 10 years until we could add enough value to the center to refinance out this equity. But instead we just sold, you know, less than 10% of the square footage, pay down the note and gave them all of their equity back. That is the power of a home run in commercial real estate. We need to appreciate that awesome anyway. If you like that deal, if you say, hey, I want 35% returns. Brandon. If you say, hey, I want to invest in the deal and get my money back nine months later. The first and only step is to go to the websites, how to invest in CRE dot tv precision equity dot com.

The criterion fun dot com join our investor list. You'll get an email when we launch a deal. And if it seems interesting, if you like us, if you like our deals, if you like the way it sounds, send us the flyer right. Put the minimum investment in one deal and, and, and watch it. Read some reports, get some cash flow the next deal. You may be more excited to maybe less excited, who knows? But you'll be involved and you'll be learning right anyway, smash the like button, share, subscribe, ring the bell and catch us next time on how to invest. In theory.

Episode #077- HOME RUN! The Criterion Fund Sells 3 Out-Parcels in Plaza West Deal
Episode #077- HOME RUN! The Criterion Fund Sells 3 Out-Parcels in Plaza West Deal
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