How to Invest in Commercial Real Estate

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Episode #097 - 5 Ways to AVOID RISK When Purchasing Your FIRST Commercial Real Estate Deal!

by Criterion, Braden Cheek, Brian Duck
February 27th 2023

Today hosts Braden Cheek, Brian Duck and Joel Thompson discuss 5 ways to mitigate risk when purchasing your first ever commercial property!

Time Stamps: 0:00 - Introduction 0:37 - The Criter... More

What is up and welcome back to how to invest in commercial real estate today. And we have a cool topic today because I think a lot of people here are frankly probably not invested in commercial real estate. Maybe this is your stop to get educated, maybe this is your first resource or maybe, you know, you're a first time investor of ours, but I think a decent amount of people listening and watching probably have not bought a commercial real estate deal before. So we've got an interesting topic to help, maybe avoid some risk on to go into that deal. But uh first we wanted to take a minute and stop and talk about the criterion building up in Owasso. It is finally open. We've got Keller Williams, we've got a, a medical spa beauty farm, we've got a hair salon birch and our office is opening up. We finally have furniture in there. It's looking great. And most importantly, our coworking space is about to open. So if you are a local, if you're Tulsa Awas or anywhere on the north side of town, really, we have an amazing new co-working space with state of the art stuff. Um, it's all wireless keyless entry.

Everything is included, tons of cool packages and you can get involved in that for $100 a month. So I know for me when we started our business in Owasso, I need an office space. Right. And the cheapest thing I could find was $600 a month. And it had like this shag green carpet. It worked at the time, but that was just the office. I had to go and get wifi. That was $400 a month. I had to buy my own coffee. I did, I do all my own printer. All of the I didn't have a receptionist. I uh didn't have a place to have conferences, didn't have a conference room. I had to buy my own furniture right at the co-working space. All of that is included $100 a month for $100 a month. A pretty good deal. But wait, there's more, I'm just kidding. Anyway, as you can tell, I am super excited about the new co-working space in Owasso and that is going to be up March 1st. So if you're in Owasso, stop by, check us out the new Criterion building. Do we have any type of uh referral plan uh that if people listening to the podcast, tell someone and they come in and they're like, hey, I wanna, I heard about it from so and so they saw it on your podcast do we give them anything? Uh, yeah. Yeah, I'll give you 25 bucks, $25 just in the page.

My man Aaron will get you taken care of. So you don't get any other money you want to give away live on the fly. I mean, what I want is, uh, you know, using the coworking space. That's what I want. That is the deal. But anyway, back to real life, um, first real estate deal, right? Like we're listening to the deal to get educated, to find out how to get involved. We're learning that this is uh a beneficial asset class or something you may be interested in. So how do we avoid risk on the first deal? The first one you want to hit a homer maybe. But uh practically it's like let's just get on first base. How do we just not mess this up? How do we not lose everyone's money? Like how do I get in my first deal and not have it be an absolute disaster? Right. So we came up with five reasons. Sure, five reasons that way, five ways again. But let me just take a step back, you know, uh why uh haven't people that want to get it in commercial real estate? Uh have they not purchased their first deal? And there may be a bunch of reasons, but I would say a big one is fear, fear of, of losing money, fear of not knowing all the answers, you know, and, and that fear holds them back from taking action and buying that first deal.

So we came up with ways to reduce risk on your very first deal because we think it'll help combat that fear, that knowledge combats that fear and it'll give them the confidence to move forward and finally get in the game. So, yeah. Well, I think the first one is, uh, maybe buying something you think you can afford, right? Like buying the smaller deal, buying the, the deal that's been on the market forever or buying the deal that's in a bad location or buying the deal that's in a small market, right? Like you're going small, you're, you're scared, you're dipping your toe in. But in a sense we kind of need to jump in, right? Because it a nice asset that's worth owning and pays out cash flow that's, that's worth having is probably a bit more expensive than, than you're initially thinking. So you're saying that's uh a fear that people have is they're worried about buying something really small or they're worried about, they're worried about buying something too big. And so they, they go to buy something small, but in doing that, they sacrifice some of the fundamentals and look for, for a seasoned uh commercial real estate investor, they may be able to find a gym that's off the beaten path that nobody knows about.

Uh But that is inherently risky because of where it might be or because there might, you know, be some hair on the deal in some way. So what we're saying, encouraging them is take a step up, buy a better quality asset for your first one. Yeah, I it's gonna feel like you're paying more but it'll hold its value more and then that there's less risk. Yeah, we need to build a track record. We need to have wins. And the idea of this whole episode is let's not mess it up our money, right? So you buy a great asset. At first it's going to be more expensive than the thing in like soul or you know, maybe the middle of nowhere or wherever you live, it's gonna be more expensive than that. You want traffic accounts, you want people living by retail center, something that looks, looks really nice. Right? That's gonna be more expensive than something that doesn't look really nice. So we just need to get that in our head. You don't eat the most expensive thing. I'm not saying go to the best part of your sub market and try to buy the whole foods. Ok? That's not what I'm driving to. I'm just saying at some point, we need some traffic counts, we need some people, we need some jobs focus on some fundamental and so what someone might need to do is instead of thinking, ok, well, I'm gonna buy this by myself.

I wanna, I'm gonna buy a better property. I'm gonna get some people to invest with me. Right. That reduces the risk. Yeah. Don't worry about not affording it upfront. Like, let's just, you know, at some point you have to set a parameter, you know, like maybe we need to stay under $5 million. But if you're looking at a $2 million asset, but let's expand that to maybe four or five and, and think of some other creative financing options like bringing on investors or bumping up your leverage or whatever. But that's kind of the separate topic, just generally speaking, buy an asset worth having. It's not the cheapest asset that you can afford. Ok. Number two, this is something we focus on a lot and I think it's important is we're not massive speculative deal. People, we don't typically buy the, the empty building and, and go in with the strategy of the massive rehab and this massive lease up. That's typically not our general deal, right? Why? Well, we, we like cash flow and so we try to buy as many deals as we can that cash flow from day one. and that reduces your risk because we're not dependent day one of finding a tenant uh or filling a bunch of vacant space to make the deal profitable.

Yes. So when you're buying a piece of real estate that doesn't produce any cash flow or doesn't have any tenants, you're having to try to underwrite what the cash flow could be because at the end of the day, you don't really care about the inherent value of the real estate. As long as it's in a good enough position to get you the cash flow you need. So you need to, you're trying to like backfill how many tenants you can get in there? What's what rent they're gonna pay? And again, it's all speculative. You have no idea if you're going to get tenants or what they're going to pay at all. Right, we're going and buying a retail center or any other building for that matter. And it is full of tenants, maybe been there in 5, 10, 20 plus years. You know, they've ran that business in that location at that spot, being able to pay their rent and not get kicked out and still make a living. Right? It's a business worth owning. You can underwrite that you can take that to the bank and get a loan on it. You can show your investors, hey, I've got a dozen tenants that have been here on average 10 years. We've got leases rolling, you know, throughout the next five years of our holding period, you know, all we need is a 3% rent increase. That knowledge is helping combat fear. Like you said in the beginning, it's, it's helping raise money from investors. It's helping secure your loan from your lender instead of you trying to tell a story about this empty piece of real estate that doesn't make any money.

Nobody cares about your story and it's way harder to do. And again, on the first deal, we're trying to not mess it up. We're trying to not lose our money. Yeah. Well, the other thing is if you buy something speculative like that, it's gonna take a lot of heavy lifting. Right. And so now you're out doing all this heavy lifting after you've bought this thing and that keeps you from going out and finding your second deal. Probably. Right, because you're, you're working so hard to get at leased up or maybe you have to, um, do a lot of, um, um, rehab or whatever. Yeah, I, I would say that the, the, the least amount of unknowns is gonna be the best for your first deal. And so like you say, you're trying to speculate on how long is it gonna take me to fill a vacancy? Uh You know, how many tenants do I need? And what, what's the rent gonna be when I do fill it? And how much is the T I that they're going to demand? The thing is you don't know that for sure. So, yeah, you may have a good idea and, and even a more seasoned professional might have an even better idea, but it's still, you're adding, unknown after unknown to your very first deal and on your first one, you need to win because that'll keep you going. If you fail on your first deal, it it you know may discourage you.

So that's a perfect segue because i it's you you things are going to fail. Shit happens. Life happens, right? So like in this next point, we need to have some extra cash. You don't go into this thing saying, ok, I'm buying a million dollar property. I'm getting $800,000 in loan loan proceeds. I need $200,000 in cash. Like no dude, you need like three or $400,000 in cash easily. Something is gonna happen. The parking lot gets older, it's gonna snow, it's gonna tear it up. Your roof is gonna leak. Your roof is going to get older. Your HV AC units will stop working eventually. You will need to replace those. Your tenants are gonna ask for money, they're gonna ask for free rent. They may leave. You may have to pay somebody to get a new tenant in there. You may have to pay for the tenant improvements to get the new tenant in there, right? So like stuff is going to happen. That's not a failure. That doesn't mean the deal failed. If you didn't have the money, maybe that would be the end of the deal, maybe that would fail the deal. But if you have the money, you're able to reposition the asset you're able to pay for the new tenant, you're able to pay for the loss of rent you're able to pay for the new roof, you're able to pay for the new parking lot because you said in the beginning, hey, I know something is gonna happen. I need to be prepared. So we're saying just have some extra cash available.

Uh a great amount of extra cash on your first deal you need, you need to go in and that will reduce the returns. Once again, you, you don't, I wouldn't worry on your first commercial deal about maximizing returns. I would worry about insuring the returns, whatever those are it up, don't lose your money. Um And so if you have to, let's say the deal will return 12% cash on cash, but you're gonna have to raise extra money to be really safe and secure on this first one in case something goes wrong and it drops your returns to eight, well, eight on your first deal. If you can secure that kind of return, that's gonna be just fine and your assets going up in value. So it's better than eight. The cash flow is eight. Uh So make sure you have plenty of cash on that first one. A rule of thumb. Let's try to give him a rule of thumb if, if, if I'm buying a million dollar just to, to make it easy, a million dollar deal and I'm getting an 80% loan that's 200,000 in equity that I need. Uh I tend to, you know, probably go with 25 to 40,000 in closing costs, uh, various things from the legal docs to the closing fees and title insurance and then on a million dollar property, I would probably go in with an extra $100,000 in reserve.

Now that goes up a, a $2 million deal. Maybe it's not 200 maybe it's 100 and 50 175 $3 million deal. maybe it's $205 million deal. Maybe it's 300. So let's continue to break that down a little bit because you're gonna say $100,000 on a million deal, an extra 10% some might say. But on a million dollar deal, you know, let's just maybe $100 a square foot, maybe you have 10,000 ft, right. So 10,000 ft of roof roofing right now is maybe $7 a foot, $70,000 gone. Now, you don't even have enough money to replace your parking lot. So your $100,000 is guaranteed to be spent right there. Yeah, but hopefully you're, you're making sure that, that if it needs that stuff going in, you're going to reserve for that as well. This is an excess, uh, for the unknown because this is your first deal and you're in experience, you don't, you may not know any, anything and everything that could go wrong. So let's set the roof in the parking lot aside because if that needs your place, you have to race for that as well. This is for, uh, you know, someone ramps the building with a truck when they're drunk. Like, we've had some of our centers or, uh, a tenant or two move out and, and you've got to re tenet that space with brokerage fees and, and leasing commissions and leak or something.

Yeah. So that, it's just for that stuff. Yeah, just for everyone's reference. We'll, we'll overdub the clip of somebody smashing through our building in a U haul truck at 2 a.m. But like life happens, right. It took us 90 days to get the insurance check from that. We're still working with getting it repaired and getting the tenant happy. Like stuff's gonna happen and that property pays out great cash flow. It's a good thing. We have the cash to flow the repairs until we get the insurance money in. Anyway. I know at this point you're thinking guys, I've listened to almost 100 of your episodes. I'm invested in several of your deals. I'm a pro in commercial real estate. I'm gonna go buy my first one. I've read the books Rich at Port. You know, I know what I'm doing. I'm gonna manage it. II I know what to do. You guys talk about lease renewals, camp caps. I'm a pro but I'm telling you, I don't manage a lot of my deals for a reason. Your first deal, you should not manage, you're gonna miss something. If you try to manage it yourself right now, don't, don't manage your first one. you want to hire a third party manager in the market that you're buying in and you want to learn from them and they're, they may even miss something. Uh, there's just things that, that are gonna come up, but the thing is you won't know if you've missed it and, and we just want to make sure that you don't get into a situation that you are trying to manage it.

You missed it. You didn't do the cameras, right? Uh You know, things went and you get behind the eight ball and it ruins your first experience. Plus it's, that's not your job. Like Brian said earlier, your job is to go buy these deals and make sure they're paying out their scheduled cash flow. You set the property manager up with a, a budget and a tolerance and, and they've got the cash to make decisions, you know, maybe +257 $10,000 whatever parameters you set, they work on a fee that your tenants are probably already paying for. So yeah, if you want to save that money, uh then take a year, learn what they do, learn the reports, get a good handle on it and then maybe take it over in a year or two years. But if you don't, if the deal doesn't work without third-party management, you shouldn't be buying it as a, as a beginner. But if you're local and you don't like headaches, call Joel. He loves headaches and he, uh, third party property manage third party management for you. Boom. All right. Next point. Um, underwriting, right. Like we, we've got to look at this. We've got to figure out what the cash flow is. We're not buying an empty building. So there's tenants, there's leases, there's, there's income we need to be making. Uh I would say a three year budget, at least of income and expenses off of the, the leases, a three year budget, three years of, of principal and interest payments.

Three years of what your expenses are. Three years of your income, three years of your net cash flow to your investors or at least what you hope it to be any capital expenditures that you may spend, excuse me. But, and so that you should know how to do all that before you're buying a multi-million dollar commercial real estate deal. What we're saying is uh get help with that first deal underwriting. There are third parties uh that will do help you do that underwriting to make sure you didn't miss anything. We can recommend some. Uh You can also have your banker if you, let's say you really know your lender well, uh as a buddy or something, then have them underwrite it and see if they can see anything, any risk points. Uh but don't go in and just say, well, I'm, I'm the only one that's looked at this and I, I watched all the, the classes and I read all the books and I'm just, I'm not gonna miss anything on the underwriting. Uh, that, that, that sets you up for risk. You may get it right. But if you don't, uh, you, you could lose, I think on my first deal, I'd like to study it, like you said, personally, come up with my own then maybe get a third party. And then of course, uh the bank's gonna do it as well, right?

And so I would feel a lot more comfortable if I had three independent people underwriting my first deal. You had a lot of this stuff. It's not like you, you are doing it in consecutive order right after another, you're, you're doing it coterminous, right? Like you're underwriting the deal initially, you're saying, ok, this looks good. This passed the sniff test. I may go ahead and get this in contract. I may start inspecting it. But as soon as you get it in contract, one of those inspections is AAA third party underwriting your lender who's gonna do it. Obviously, you're gonna start to look for property managers, you send it to them. Hey, I've got this property under contract. Here's the due diligence, materials. Here's what I'm thinking I should bring in that jive. You know, you're gonna have these conversations before you get the closing you're not gonna close on this thing without some sort of budget from, from somebody, somebody's gonna help, but just make sure it's sooner rather than later have those conversations. Is that all the ones we have for today? No. Uh, last one. So we buy a lot of stuff out of market. But for your first deal, you should probably stay in your pocket. Yeah. Yeah, you should probably stay local. You should probably have a good understanding of what area the town, what what area of the town is in is doing where the growth is going, where the new jobs are, where the main traffic corridor is through your cities, where the suburbs are where the city is.

You know, you need to be able to pinpoint this and, and tell that story to yourself, to your investors, to your lender, to your property manager. It needs to be something you believe in and going out of market. I think you said it before the show, you're just adding risk when you another layer of risk and another layer of expense because you've got to get there. Uh and, and it takes time and money just to go view the asset and maybe view that market. And also if you're going to buy in a market you don't live in, you're gonna have to get advice on that market and how that the property that you're looking at and where, where it is and how good it is and what school do it and trap accounts. Well, that's, you're depending on another human now. So it just adds another layer of risk, even though they're probably telling you, you know, what's accurate, if you can just buy in the market you live in as long as that market is sufficient size. So, if you, if you live in a small, a really small town, don't, don't buy your first deal local, uh, you know, go to a town that uh for retail, I like to have about uh a million people. M MS A especially on your first one.

Uh So the town, the city can be half a million. But if it has a, a metro area of about a million people, that that's a probably a good sufficient size multifamily, you can go a little lower, maybe, maybe a couple 100,000 people just because it's a more stable asset class. But you know, a lot of these small towns, uh the winds, so to speak, can, can shift and change as far as population growth, they're may be dependent on a factory or, or some other big business. And so the towns that were booming 100 years ago, we see them all the time. They're dead today. And you don't want to be in a position where your market starts declining because it's just too small. Once it, once markets get to a certain critical mass, they're gonna grow or they should theoretically continue to grow for decades. Plus the goal is to not mess it up, not lose your money at the end of the day. If something happened, which something's gonna happen. But it's just a matter of whether or not you were prepared and whether or not it took you down. But if something happened, do you want your first deal? Your first one, all of your investors coming back to you? They're thinking, what are you thinking? Why would you buy your first deal? 500 miles away from you?

Like, why would you do that? You're gonna have a hard time convincing investors on the second deal if you mess up the first one. So, and like Joel said, you're gonna get discouraged and if you, if you buy in a small, uh you know, a small market, you may not have a uh a buyer when you want to sell. Uh because there's just a limited buyer pool for, let's say, you know, Wagner here in Oklahoma, outside of Tulsa, like, you know, it's gonna not gonna be easy to sell deals uh like that. So pick a good size market that you either live in or are really close to. All right. Well, I, I think that's helpful on your first deal. You want to go big, you don't want to buy something empty. You wanna have plenty of access capital for reserves because something's gonna happen. You're gonna go in with the management team with you, they're gonna help you underwrite it. Your lender is gonna help you underwrite it. You're gonna have this team of people helping you underwrite it, seeing the same things you do as far as free cash and it's gonna be local guys. I mean, it makes sense for your first deal. Those five reasons should keep you like if you're going into your first deal with those five things at the top of your mind. Yeah, we're trying those things will reduce your risk.

It's not gonna be zero. Your risk isn't gonna be zero, but it's gonna be way lower if you follow some of the points that we're trying to convey to you anyway. I think that is it for this week's episode of how to invest in commercial real estate. We will see you guys next week.

Episode #097 - 5 Ways to AVOID RISK When Purchasing Your FIRST Commercial Real Estate Deal!
Episode #097 - 5 Ways to AVOID RISK When Purchasing Your FIRST Commercial Real Estate Deal!
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