How to Invest in Commercial Real Estate

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Episode #102 - 3 Ways to ADD VALUE to Your Retail Property!

by Criterion, Braden Cheek, Brian Duck
May 1st 2023

Today hosts Braden Cheek, Brian Duck, and Joel Thompson discuss 3 simple & effective ways to increase the value of your retail property.

Time Stamps: 0:00 - Introduction 0:36 - Today’s t... More

How's that? Improve the quality of your lease? Yeah. Yeah, sorry. Busy in the middle of the day. Nobody calls you in the middle of the day. I don't allow them to call me. All right. What is up and welcome back to how to invest in commercial real estate today. We have a super awesome show. What's up? He's so excited. I am excited, man. Somebody's gotta bring the excitement to the show today. It's me. But anyway, um yeah, we're gonna talk about a cool topic today because i it's, it's counterintuitive. A lot of people, there's a lot of, of really cheap people who just don't reinvest back into the property today. And I think that's the general theme of today is how we're reinvesting back in our properties to get more value on the upside. Right. Right. Like to create more value, we're going to spend money to create more value than we spent. And there's three big ways that we're going to concentrate on today of how you can do that. Yeah, you've all seen it. You're driving down the road and it's like an older rundown retail center. We call it mom and pop owned, call it a piece of shit. Well, you can call it whatever you want, but people have owned it for years and they're just siphoning the cash flow, but they're not spending any money on the building.

And so they may be making money, but is there a way that they could increase profit or maximize profit through some techniques that we're going to talk about today? And we think there is. And so we've got three ways we're going to go over how to value add or increase the value of your retail center. Yeah, you want me to just go into them. You ready? Yeah, I, I mean, I think, I think the easiest thing before we get into the, the nitty gritty and, and start to get complicated, people understand that you can buy an old crappy house, you can renovate it for 10 20 $30,000 and then sell it for more than 10, 20 or $30,000 than it took you to renovate it. You may create some sort of value there. So that's the exact same concept we're doing here but with retail shopping centers. So keep that in mind. Yeah. And it's funny because as Joel was saying that I was thinking, you know, sometimes you can just drive down the street and you can think rent house, rent, house, rent, house, rent house, right? Because those people think, oh I just, I'm not gonna put any money into that house, I'm just gonna collect the rent and, and I'm gonna be happy with that. Right. But if they do some renovations then when that renter moves out, they can, they can rent it for a bit more.

Right. So, anyway, anyway, so the first one we're gonna talk about is exterior capital improvements, exterior capital improvements. Yeah. So I've got an example. We're, we've just completed an exter, uh, external renovation on one of our retail centers here in Tulsa. And so if you're watching on the youtube channel, we're gonna have a before and after picture at some point flash up for you to see. Uh but it was kind of an older looking center. It was like a very 1985 style on the exterior, not in bad condition, but we were having a little bit of a hard time renting uh certain spaces and it's a very prominent corner. So we wanted to improve the look. And so then we have to ask the question, well, how much can we spend? And what is the benefit gonna be if we do spend the money? And so it's a little bit of a math calculation that we're gonna talk about. But uh how let, let, let's talk, how you do the math. So let's say uh for instance that uh retail center is about 45,000 square feet. And so then I can say, OK, well, if I renovate the exterior, can I charge more rent, you know. Yes. The answer hopefully is yes.

Like you're, you, you have a newer look, you're more competitive against the older centers around. And so let's say today, the average in that center, let's say it's 15 bucks, uh, a foot or whatever it is. And, and so then I say, well, I think I can get, uh, if I redo the entire exterior, uh, with a new look class a look, can I get $3 a foot in additional rent? Ok. And so let's, let's do the math uh 45 times three while we're doing the math. Yeah. Right. It's easy to go into your mind market and do research on this because you can use a comparable location in your case scenario. This is 71st Domingo. So you can look all up and down the 71st corridor and say, ok, brand new retail class a that looks like I could make mine look what does that lease for? That's that's easy data to get a hold of. So don't use some random number that you think it could lease for. Yeah. Yeah, they'll find one. Sorry, go ahead. Well, it's again, it's like a house, right? When you, if you want to renovate a house and, and you're gonna spend money on it, then you need to know how much you can sell that house for and how do you know that you get comps of of nicer houses in the area And in Tulsa, let's say, uh, class a retail centers, they, they may be renting at $25 a foot or $23 a foot.

So I may not say, well, I can get $25 a foot. All I'm wanting is I'm starting a, an analysis with $3 a foot, which is a 20% increase in my current rent of $15 a foot. Ok. So if I have 45,000 ft and I increased uh the rent across the center and I won't be able to do that day one because I have, I have leases. But like I say, over the next two or three or four years, uh that increases my noy uh by 100 and 35,000. And so you say, well, what, what kind of value does that generate? Well, if I assume a 7.5 cap exit, that's $1.8 million if I did the math, right? So 100 and 35,000, I divide that by 0.075 to get a cap rate, uh or a sale price. And the, the value of that income that I've increased is 1.8 million. So we're not gonna spend the entire 1.8 million, right? We're going through this exercise to do what we're owning the business and we're buying real estate. We're trying to, we're trying to justify whether I should do renovation. And so now what I have to do is I go and I get bids from contractors and say, ok, how much is a brand new facade that makes this look like uh, a new building, a class, a retail, but how much does it cost me to do that?

And uh, you know, in this example, I don't remember exactly what we paid, but I think it was in the neighborhood of $750,000 once you love before and after. So not a, not a million eight. And so then, you know, it, it becomes a, a game of investment. Do I want to make a $750,000 investment? If I think it's gonna give me $3 a foot more in rent on average. And in this case, you would say yes, because the value generated is gonna be 1.8 million approximately. So uh you're gonna, you're gonna gain about a million bucks. So, um it didn't take long with a number like that for people to say, oh, well, you were gonna get, you were gonna get increases anyway, right? Just because of the yearly two or 3% bumps. Those are never gonna add up to a 20% increase that you might get over the next three or four years. So, yeah, and the increases need to be uh over and above any inflationary increases that you have built into your leases. But that's the first thing that you guys should be looking at is if you find an older center that has below market rents, you can do, you can quickly do this exercise and say, ok, that's got a 19 eighties look, a 19 seventies look, even if we put a new facade on it, how much do I think I could get the rents up to?

And then you just go get bids and, and see how much it's gonna cost. And you do the quick math and you, you say, ok, if I can get $2 a foot in rent, this makes sense. And that's not, that's not all that much. Maybe, you know, you can get four or $5 a foot in rent. And so that's a simple exercise that you can do. That'll help give you the confidence maybe to buy an older center with the plan of improving it uh with the exterior renovation. Yeah. All right. Anything else on that one? I I'd say make sure you have the market comp for the poster innovation, right? Like I, I wouldn't be the person to go in and, and justify a new market comp if there's not a nicer center, nicer looking center with higher rents in your immediate area or trade area where your center is, maybe that trade area can't justify the higher rent. So at least ask yourself that question is what I would say. No, that's, that's definitely good feedback we purchased uh an apartment building where guys from out of town had done all these interior renovations to the apartment units thinking that they were gonna get, you know, 2 $300 a month rent bump.

But they didn't realize the area of town they were in. They weren't gonna be able to do that right by the gathering place, dude. So they, they spent a million, 2 million bucks and they found out they couldn't get any more rent or they got very little extra rent given the area and we ended up buying it from them when their project failed. So a highly walkable area. Yeah, I mean, it was a good idea, it seemed like, but it's a good idea on paper and didn't quite do all the research. All right. Next one, next one. So this is an interesting one because II I not maybe know, but you hear of a lot of owners and we look at a lot of real estate deals and, and you can kind of see this on paper where owners have kept their rents too low and they, they're keeping their rents low because they have no tenant improvement dollars to spend. And a lot of these tenants, you know, we talk about the difference in a couple of episodes earlier about the difference between ground leases and uh pad sales and build to suits what that does for the tenant and how fast they're able to expand based on what scenario they're doing right. Like if they're doing a complete build to suit just doing rent, they can open way more stores than if they're spending all of their money to do it.

So, if the tenant doesn't have 50 $100,000 to remodel a suite in an old shopping center, they're gonna have to go to a shopping center where the landlord will front those improvements for them and they, it will in turn pay a higher rental rate. Right. So it's the exact same thing as a new roof. If you've got a good looking center or maybe even not, maybe not even a good looking center, but you've just got uh a vacancy and it's a, it's a rough vacancy. You know, somebody needs to come in here and spend $50,000 to get a workable business in there. You, you know, you need to be willing to do that and there's math just like we did with the exterior renovation where it, you know, may be paying the tenant $50,000 to do that renovation, but you got an extra $4 or $5 per square foot in rent that played out at scale at sale in five years is way more than the $50,000 you paid in tenant improvements because the value of the cash flow they pay you is way more. Yeah. So is it, is it the same math as it is on the exterior or is it a little different?

I mean, it's pretty, pretty similar. We have a couple of different scenarios. Let's say you have, uh AAA tenant that's in there and they're not sure if they want to renew, but let's say they're paying, you know, $10 a foot. And, uh, they say, hey, uh, I'd really like some money to renovate my store and, but they're already a tenant. They're probably gonna stay anyway. You as a landlord, you could just say no, no, I'm not gonna give you any money, you know, pay me 10 50 in rent from you per square foot. But another way to look at it is to say, hey, what if you gave them $75,000 to renovate their store? Now you have a nicer suite. What do I need to charge in rent to make that worth it as the landlord? So that's the second uh equation that we need to work on. And when you look at that, do you normally say? Uh ok, I I want to spend as much and get that increase in rent from them or do you, I mean, I guess you just try to maximize the increase in rent you can get over what you're spending and what they need is that right? I think most of the time it's disclosed, right?

Like most of the time there's options, hey, it's uh I did this with the lease renewal, the other day, they needed an HV AC replacement. It was like $20,000 and the lease clearly states that the tenant is responsible for replacing the H AC. I'm like I can replace the HV AC, but your rent's immediately going to go to X, you know, and that was uh I did this calculation and he's like, no, no, no, I'll, I'll, I'll keep it down and I'll pay for the HV AC replacement. So it's not like you're trying to pull one over on the tenant, you're essentially giving them financing option. Ok. So everything's pretty out in the open and just not always, I'm sure, not always, not always a lot of the times and especially the bigger, more sophisticated tenants, they definitely know, they know. But let's, let's talk about a specific example if you have a 2000 square foot uh retail uh suite and let's say they're at $10 just to make it easy and they're wanting $25,000 which is 10 $11 a foot or $12 a foot to, to renovate their space. Ok. So let's just think about that. Well, what would I need to charge them in order to make that a worthwhile transaction for the landlord?

And so let's just take $2 a foot. If I get another $2 a foot, that's $4000 a year. Ok. Over the life of the, the lease, let's say it's a five-year lease, I'm only getting 20,000 back in my pocket. So I have to think, well, uh, it only benefits me if they lease again and we can start at the $12 a foot instead of at the $10 a foot. Um, you, when you take $4000 and you put that on a 7.5 cap, if I'm gonna sell the property, the four $1000 in additional rent, the cash flow, the additional cash flow. If I put that on a 7.5 cap, that's $50,000 in value approximately. And so there's an equation there that says, well, ok, uh I don't quite get all my money back in five years, but at any time, if I sell and let's say the going cap rate is 7.5, well, then I'm gonna get 50,000 in value. So then it's a worthwhile to exercise to say, ok, not only does he have to spend it in my space, improving my space. He's spending your money improving your building. Yeah, improving your building and you're gonna get paid 80% of it over the life of that five year lease.

And if you sell at the end of that five years or any time, uh before that, with the higher rent, you're gonna get an additional 50. So that's kind of how you have to do that math. You can also assume it's a more marketable space even if this tenant bails. You still have arguably a $12 per square foot marketable space. It's not 10, you did the improvements on it. If you find somebody who can utilize the use and see the value in it, it's still a $12 an hour space. And then to your point on selling II, I would expand on that a little bit and say there's a lot of people out there who, who don't want to sell their properties, right? Real estate is something a lot of people collect a lot of people store value and that's, that's the beauty of real estate. So you don't have to be selling it and it produces cash flow. The beautiful thing about real estate is leverage, right? So at some point that loan's gonna come due and you're gonna refinance that if you have this additional cash flow, you're going to be able to leverage that on the same cap rate and get additional loan dollars even if you didn't, even if you didn't sell, right? So it's not just about the sale, it's about every 5 to 7 to 10 years, you're gonna have to recapitalize that asset with a new loan and they're getting an appraisal and that is based on a market cap rate and your net operating income.

So the higher that is the more cash you're gonna be able to pull out of that and might I add that is tax free because it's a loan, it's a loan, right? Yeah, and here's another way to look at it, let's say that you don't even consider the bump in sales price. Ok. Uh, if you're gonna spend $25,000 which once again he's gonna, they're gonna spend it on your building, improving that space. But what kind of return do you want, uh, on that money? Let's say that you could get $3 a foot on that 2000 square foot space, that's 6000 a year. Ok. And so if I can get 6000 a year in rent, well, divide that by the 25,000, that's 24% return. Ok. So who isn't gonna spend uh, a little bit of money if they can get 24% return in a year? Uh And in every year of that lease, you have your, your full money back in four years. But in addition, once they get used to that higher rent, you build on that over time. So there's, you know, there are a couple of different ways to, to look at that equation. Uh And, and a lot of times it makes sense to offer T I dollars if you can get higher rent.

So it's one thing to, you know, negotiate the rent before the T I and then you know what the baseline is and then, then you can quickly add T I and you know how much you need to increase the rent in order to pay for that. Do you ever worry about that? The T I that they want you to spend is so specialized to that particular suite that nobody else would want to come in just like that. And then you'd have to spend more T I dollars coming through. It's a very good point. All right. So let's pick something weird. Let's, let's get really weird just to prove your point. Uh, we have a 20,000 square foot vacancy and, and this guy comes to me and wants, you know, to open a trampoline park and ask for a million dollars. Would you be skeptical of that? Of course, skeptical of 20,000 square feet. So let's use it the opposite extreme like a grease trap, right? Like that's, that's more marketable. Uh, hair salons can be really funky. You know, you get water and plumbing everywhere. You can have to bust up concrete. They put all the half walls up there. It can get really weird. So you don't want in, you're investing in this company, right?

Because if they succeed, they can pay you back. If they don't succeed, you're screwed. Right. And you're just left with this space that hopefully you can release. So I would want to make sure it's a marketable leasable space without the tenant. Like without that operator, my building, what do I want my building to look like? And can I lease it out to those tenants? We're looking at that and we're acquiring them? Like does this tenant belong in the center in this market? That's kind of weird. Yeah, there's a lot of factors that go into how we evaluate if we're gonna give a tenant T I dollars tenant improvement dollars. And you know, it could come down to, hey, is this space, is it bastard space? Is it old? Does it have, you know, concrete floors and, and no drywall? You have to spend money in order to get the tent in there, if not. And it's a rentable space and somebody comes in and wants, you know, 50,000 $100,000 to make it a specialty, you know, store. Like we, we spend a bunch of money putting in a, a kid's gaming, uh, store where kids come in and they can play, you know, Xbox and other computer games. That was pretty special. It turned out pretty cool though. Yeah, but it was pretty specialized use.

And so really, then, then what I'm looking at is ok. Well, how strong is this guarantor? Because I need to get my money back over the life of this lease. And I can't afford to spend all this money building it out for their specialty use to have him back in the year 234. So the things that we're gonna look at there is the strength of the, the guarantor is, is if they, the business doesn't work, does he have the funds to pay the rent for the next so many years and you want to lengthen the, the term of that lease. Uh And so that you're, you're, you're guaranteed that specialty use that you're paying for is there for maybe seven years, 10 years. And that allows you time to recoup all that money back. Yeah. Add in security measures. But you need to underwrite this business and understand that if the business succeeds, you get paid and if the business doesn't succeed, you don't get paid and you need to be prepared for that. We build in security measures. We can have the tenant sign a AUCC one filing statement and that just allows us to put a lien on all of the personal property in the space. It's not always necessary. It's kind of built in the lease, but sometimes they'll lien their personal property anyway, even though they may not supposed to. So that just kind of gets it on record.

And then the other thing we had is we had a specific paragraph that says these tenant improvement dollars are used for enticement for there's this lease and if you default on this lease, we're gonna come after you for those tenant improvement dollars. Um Again, if somebody's declaring bankruptcy, it's, it's irrelevant. It, it's kind of more just protecting your swindler risk and, and stuff like that. All right. Last point. Last point. Um So another way to value A is to improve the quality of the lease uh that you have on your space that improve the quality of your lease. Sorry, busy in the middle of the day. Nobody calls you in the middle of the day. I don't allow them to call you. Um Yeah, so adding value through your lease. So uh the o office building industrial is probably easy to think about, right? Because they're gross leases. They're typically paying $10 per square foot and the owner pays for all of the owner associated expenses like the owner's insurance, property insurance. The owners really state taxes, the owner's commentary maintenance. So you see gross leases a lot. You see single, double, triple net leases a lot.

But triple net is kind of this wide umbrella that everyone loves to say, oh, it's triple net deal. Oh, it's a triple net deal every single time. I look at a triple net deal. There's leases in there that aren't triple net every single time. Just a one off. Somebody signed a gross lease or somebody's like, oh, I'll cap your cam at this. But it's like in 1980. So their cam is like $2 a foot and everyone else is paying seven. So making sure everyone is paying their full pro rata share of Triple Nets is how precision equity and criteria have both added value through these retail centers for so long and it's just easy. No, I dollars slipping away. They occupy the space, they have a successful business in the space. They should be paying their proportionate share of insurance, real estate taxes, com maintenance. And we even add a 5 to 15% admin fee. Most of the time it's 15%. If it's five, you got a deal, but a 15% admin fee. Right? Because we have to pay infrastructure to negotiate those tax bills every single year to get them as low as possible. We have to bundle all these insurance policies together into one massive policy to get buying power to negotiate with the insurance companies to get lower.

It's on our properties. So the tenants pay less insurance and we have to get infrastructure to competitively bid. All of the vendors make sure they get paid on time, make sure it's taken care of made uh file the taxes. So a 15% admin fee and operating expenses is a deal when you think about it, but a lot of landlords don't ask for it. I've got a great example for you guys. As you guys know, I um rent warehouse space just about three miles up. So uh it's, it's fairly new warehouse space. So I signed a contract. It said I was supposed to pay for CAM charges, but they never charged it. So this guy owned it for about three years and he sold it. The first thing the new owner did was start because it's in my lease was to add the 5% for cam. So that's the very first thing they did then when it came time to sign a new, new lease, he turned it into, to triple net and he's increasing the camp at 5% a year. And then, um, you know, I'm just responsible for my portion of the taxes and the, and the insurance. So whoever is just, has really, you know, is doing exactly what we're talking about. Yeah. And, and they should. Right, because these pieces of real estate are, are businesses and investments and businesses and investments are built to service the owner of those businesses and investments, right?

So that's what it is. And it was in your lease and they had the right to charge it. It's a slippery slope as a landlord though and you shouldn't feel like slime ball but just a reasonable conversation. Hey, your old landlord didn't charge you for this, you know, and then like I said, the new lease came around uh and now it's time for me to, they're, they're increasing it because now I'm paying property insurance and taxes and look, there's gonna be people that complain about some of these measures that we're using to maximize value. Uh You know, we obviously want to put as many of the cost spread across all the tenants as possible. So we have the best leases geared in our favor uh to make sure that anything associated with operating that, that pro that retail property, the tenants pay for it. They're the ones using it. They're the ones using HG AC, they're the ones that need the roof to be leaked. Uh Yeah, the parking lot not to have holes. And so all of those costs we want to pass on to the tenant, but the tenant, they look at their base rent and they say, well, the landlord, I'm paying rent here so they should take care of all of this. So there's a disconnect between who should pay. Uh But the thing is, here's how I look at it as a landlord is that we're providing a uh competitive environment rental, you know, situation where if they don't like it, if they are unhappy with the charges, if they can go find better space for less money, they'll do it.

Ok? And so you don't have to worry about uh what you can charge or what you can't charge. Of course, tenants are going to complain and it's their right to complain. But at the end of the day, if, if you, if, if you're providing a better space for lower cost, they are gonna, they're gonna stay and they're gonna pay. And if, if you're not, they're gonna leave. And so you can be, you know, an overbearing landlord without any tenants. But if you're, if you're, if you're 100% occupied, that's telling the market something is that you're providing a product and the service at a price that's competitive. So it doesn't matter if someone complains because the, it's a good price overall. Anyway, I can tell all our listeners it was, it's a lot more fun being on the landlord side than the, than the tenant side. So I encourage everybody to be on the landlords side. Yeah. Well, hopefully on the other side, the future landlords or current landlords listening and if you're a tenant listening, I'm sorry, we're just trying to maximize profit. They get, they're getting all the insider uh tricks and how to, how I was pissed at my landlord. I'm not paying no triple nets. I don't see no. Brian said I don't pay triple nets. I don't pay admin fees.

He said it just a few ways that you guys can all be looking at retail deals. Uh when you're driving by, how could I maximize the value of this? Someone isn't taking advantage of these things? And, and so that's an opportunity for you to make an offer, put an lo I in, buy it and improve that value and then you get the profits and the rewards. That's how you know, you have the itch too because uh that's when I'm in the car, it's literally just looking at a piece of real estate. Oh, that's a piece of shit. I wonder what you could do with that. Oh, that'd be, that'd be cool here, man. If they did this in this building, that would be sick like there's this old uh at sixth in Utica there's this old big brick industrial warehouse that looks like a mill silo. I think that would just be the coolest office space. Anyway. Well, when you, when you lease up the office space in was fully lease. Clean the third floor. Yeah, shit's leased. It's just not subleased. All right, we will catch you next time on how to invest in commercial real estate. Thanks guys.

Episode #102 - 3 Ways to ADD VALUE to Your Retail Property!
Episode #102 - 3 Ways to ADD VALUE to Your Retail Property!
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