How to Invest in Commercial Real Estate

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Episode 112 - Maximizing Returns with Retail Developments!

by Criterion, Braden Cheek, Brian Duck
July 24th 2023
00:00:00
Description

Today hosts Braden Cheek, Brian Duck and Joel Thompson discuss how to maximize investor returns in this current economy by focusing on building & developing retail centers.

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All right. What is up and welcome back to another episode of How to, I can't even finish the intro. What's going on? What's going on? This guy gets so rattled so fast. He has to be the only one that opens the show. He's the only one that can talk. As you can tell, we have been out of pocket for a few weeks. We are back today though. These guys traveled all over the world. This guy, I mean, you were in Europe for like 23 days. It was twice in that 23 days. You got a haircut and grew a mustache in those two weeks. I was alone. I missed you guys. He's got depressed and he cut all his hair off. Didn't know what to do, but we're back here and uh we're still doing deals. We're still shooting podcasts. We're still working. We actually just launched a deal actually, before we get to that distribution time, our favorite time of the year we get to do it four times. Uh But go, we got deals, we got deals to show them.

Yeah, we, we got deals. So if you were on the investor list, which again if you don't know how to do it, it's so easy. It's Criterion fund dot com. There's a big button in the top right corner, it says join the investor list and then you get these emails and you didn't get the massive film that you did just now when I, I realized you missed it. But anyway, we just launched a deal. It is a Grand Prairie learning experience. We're gonna close on it. August 15th and it is a 100% pre lease 10,000 square foot early Childhood Education Center in Grand Prairie Texas. Super easy. We're gonna build it. We're gonna sell it. We'll be in and out in 18 to 24 months. Yep. Um I'm super excited about that one. We're actually doing a series of probably five or six of those. I think this is the first one to go out. The second one will probably be in early October great return profile. What do you think the average irrs are on these deals coming up? I knew I knew you're gonna ask me that. I'll get back to that. Ok. Yeah, we'll, we'll excerpt that in over over the video. So it's, it's showing like over here, let's say.

Um but anyway, um super exciting deal. Uh I think it's like a million two, a million four equity raise, like I said, we're closing August 15th. We're building it to sell it. We'll be in and out in 18 to 24 months. And it is the first one of like five or six. And that is kind of a great segue into today's topic because if you have noticed there has been a massive shift and what we've been acquiring and talking about and, and kind of doing on the criterion home front and even precision, man, you guys are building more now than, than ever really. So this market is providing challenges in our typical model of buying cash flowing real estate, uh whether it was multifamily or multi tenant retail. Our our mo is has been to acquire these properties, raise the equity and distribute day one cash at 11 12% yearly uh right off the bat. Uh But that, that, that's changed with the, the debt uh versus the cap rate spread that we're getting, you know, we used to get debt at 4%.

We'd buy properties at 8, 8.5 cap. Uh And that spread allowed us to create that cash flow to give the investors those deals have become hard to find because the debt is now 7, 7.5 uh could be eight, you know, maybe the, the cheapest debt I've seen is about 63 quarters seven. And so the cap rates, they may have moved to half a point, debts moved 33 points, four points. And so it's really hard to make those deals cash flow like we used to and most of our investors don't want 3% cash on cash or 5% or whatever it would be. Yeah. So I was gonna touch on that, you know, for all of the cap rate haters out there. Let me just acknowledge you for one second. We know that there is more to the return profile than just a cap rate right there. There's an irr there's a discount rate, whatever you wanna call it. We're talking about simplicity the day one. Noy, what cap rate are you buying that property on, on the, on the day one? No, I and what is the spread between your cost of debt? That's that, that's what we're talking about. We know, we know there's more, we know properties go up in value as you increase rents, but that's not guaranteed.

That's a projection. And we, we don't typically uh you know, rely on that to produce the returns. That's just an additive bonus of real estate. We'd love to have that day one cash flow. So what are we to do? Uh in order to provide return returns for our investors that they want when we're not finding those cash flowing deals, you gotta pivot, you gotta pivot, you gotta pivot and lucky for us. Uh We're, we've, we've got contacts that are in the development game and we're finding value in buying land, getting it leased, pre leased by national credit tenants and then selling that and making a return. Ok, But how does that, how does that work? Exactly. Because you're saying you buy land, what if you buy land and then you don't get those tenants? Are you actually under contract with the land and you have 90 days to close and you, and then you get these tenants to sign an lo I how, how does that work? Yeah, that's a great question. So, yeah, don't, you don't have any tenants you don't want. Yeah. Unless you got cash sitting around that's called Speculative and that's called stupid.

Um Like let's just not buy, buy land, right? Like I, I bought 10 acres, I'm gonna do something with it and it's like, uh it's probably not the best idea, you know, it's not even really our money. So what's so what's our business plan there? Yeah, we go and get control of land, right? Get control of land control under contract but not closed on it. Yeah, we'll go put up um earnest money. We'll conduct due diligence. We'll, we'll do feasibility, you know, feasibility, gathering tenants, making sure there's um a group of tenants who can pay a, a market rate to offset the cost of construction to where we can make money. You know, that's kind of what we're doing in our feasibility, this land that we're finding, we're trying to find it in good locations of growth, uh existing businesses around it. So you, you let's talk about your feasibility period. Your feasibility period is probably 90 to 100 and 20 days before you have to actually like, buy something come out of pocket with or nonrefundable with the money, which is risky and then you're out the earnest money. So, what we're trying to do is we're trying to get business done and we're trying to get business done fast.

Right. We're trying to get it done in 100 and 20 days. You're trying to get signed letters of intent, at least, ideally, leases probably not gonna happen with tenants that say, hey, if you were to build something here that fit, you know this description and if you were to contribute this amount of dollars in ti I would lease that for 10 years for this rate. That's, that's what you're trying to go do. And is it reasonable to expect that 100% of the size of the building that you want to build is, is has lois on it or what maybe 75 or 80% of it? Um a single, if you're doing a single tenant deal, obviously it's one. Yeah, it it's pretty easy multi tenant deal. You want to substantially complete. You want it to the point where the lender will lend on it, you know, so they have a reasonable debt service coverage ratio, servicing the debt, we have 80% pre leased. Yeah, it it depends on the size, right? If you can get to a 12 to a 13 debt service coverage ratio. I'd I'd go in with, you know, relative vacancy of no more than 20% as long as they, they covered the debt. Ok.

And so then the idea is that once you get this bill, you get these tenants to move in, then, then you wanna sell it while there's still time left on the lease. Is that, is that the end of the business plan? Is that the exit strategy? So it, it can be and it, and it is for us, a lot of, a lot of people can choose to hold on to these assets. That's great. But um it's essentially as easy as what, what we're doing in the retail shopping center game. If we're buying an eight cap shopping center on the day one, Noy. And we're getting debt, which is the majority of the capital stack for 4%. It's a 4% spread. So our unleveraged return on cost is essentially our cap rate on our noy. So if we can get an unleveraged return on costs of 7.5 to 8, and we have a market cap rate of that same income on an exit in a couple of years or whatever, where whenever it is for 575 or, or 6.5. Right. So now you've got 2 to 2.5 point, they have spread and you can make it work that way instead of the four points on that because of your time frame, right? You're doing it so fast.

Are we not worried? Um We, we've talked about on this show before about how existing assets uh We're waiting because of the interest spread. We're waiting for sellers to uh raise cap rates. Are we not worried about these particular assets going up? Uh the cap rates increasing? No, ask me why, why? Yes, of course. I'm gonna ask you why. Two questions, two questions. First of all, the average exit price of a of a pad site development we're doing right now is like $2.5 million. A lot of them are less. Some of them are like 4.5. Most of them don't go over five, right? So in, in that space with this type of credit with typical market pricing, that leads to a very specific buyer profile, a buyer profile of a typical 10 31 exchange seller who's trying to place a lot of capital, very fast and trusted real estate. So they'll go say, hey, uh Marcus and Miller chap or, or hey CBRE buy me as many Chipotle in primary markets across the country as you can. I don't want to pay taxes. I just sold something and a Chipotle, I only have uh 60 days to identify or whatever it is and a chipotle on leverage, you can earn 6% on.

So if they can avoid a massive tax bill and earn 6% on $50 million. I, I mean, you'd buy a lot of Chipotle too if you didn't have something better than, it's not just 6% because it's hopefully going to increase in value over time as the rent increases, the rent increases every year on that Chipotle and 15 year, uh, triple net. So it's just, they, they're not gonna have to think about their investment. And so these are people that just wanna, they, they've sold, they don't want to pay the tax, they just want to get their money invested. So they're not gonna borrow money on these. That's uh that's why or they're gonna get very low leverage 30 40 50%. And so they're not as worried about uh the cap rate because the, the debt doesn't affect the returns that much if you're not putting debt on our very little debt, if you were on our investor list again, if you were on it, man. So much information is to be accessed through the investor list. If only you were on it. We sent out a monthly newsletter and in this last monthly newsletter, we sit down with a guy who's been selling a lot of our single and multi tenant um net lease assets and transaction volume is actually up right now and, and because the relative purchase prices for these deals is low and they're being bought in cash from, from massive exits.

So, I mean, let's, let's let's give some people, some details of, of what this looks like because Braden used a lot of words that maybe people didn't quite follow. But let's just say we have a half acre pad site and we can put a national tenant on their national credit tenant, like uh a salad and go or a taco casa or something. And so let's say that we know that, that those tenants is that, that's gonna sell at a six cap. Ok. So now we lock up the land for $18 a foot, let's say, and then we go to uh leasing brokers that are working with national tenants that are expanding into new areas. And we say, hey, we've got this great pad site that's in a growing market. Tell me if you have any interest and they'll come back and they'll say, yeah, we got interest, taco costs has interest. Starbucks has interest and go has interest. Ok, great. Let's negotiate the, the lease rate. How, so let, let's pause there. How are we finding these sites? Right? Like where would you go to build a new quick service retail? Like a Chipotle or Hawaiian Brothers or a brand new Dunkin Donuts?

Where would you go to begin finding the land to do one of those? Right? Find one that's being built, find one that's being built, find a brand new Dunkin Donuts. There's a piece of land next to it, get it under contract crowd areas like, you know, if you have a Chipotle that, that's going in, you can bet that other retailers are gonna want to be there. Are there excess pad sites around there? And that's exactly what happened in oso, we locked up the piece of land on both sides of that. Yeah, we bought 2.5 acres and it led to another 2.5 acres that led to another two acres that's leading and we're gonna have 10 acres, but it's all said and done. And then Princeton, we, we kind of like foreshadow that and we're just like, ok, let's just buy all 10 acres now and we'll launch them as we figure it out. So that's what we're doing. Ok, Jola. And as you're going through this, um, one step that we've, that we haven't talked about is who's building the building. Well, uh do they build the building? And Chipotle says, ok, we, we want, we've got a preferred um vendor that builds all our buildings we want them to build or it could be either way they, they, some, some national tenants have a preferred builder and so great.

They're gonna have their, their, their specs, they're gonna have their builder and we're getting ahead of where I was going. But then you're gonna be able to price it. You're gonna have, if they have a preferred uh GC that, that builds all their stores, then they're gonna be able to tell you, hey, our store costs, you know, $500,000 to build, let's say it's a small and go. Uh So that's what it costs. Great. So now let's go back to we, we're negotiating the rent and let's say that we can get uh a rent of $70,000 a year, right? Triple net. So that's my income. Ok. So then I can say, ok, 70,000 a year. And let's say that these tenants, they sell out a six cap. So it's real easy to decide what my sale price is. So I just divide that by a six cap. That's a um almost a million two in a purchase price or, or a sale price? Ok, I have a million two. Well, I know what I have the land. I know I have the land under contract for now. I can, I can take their, their specs this is the store they want me to build or their GC. And so they have specs. Yeah, I mean Chipotle may be bigger than this example that I'm doing.

But uh and we, and we just say, ok, how much is the, the building? Plus how much is the land? And, and can I uh you know what does that, what does that cost to complete? Because I know I'm gonna sell it for +12. And so then if we, we say, ok, well, the land is, is 400,000 and let's say the building is 500,000 uh we're simplifying this but we're in at 900,000. Uh then we say, ok, I'm gonna sell it for 12, there's 300,000 in potential profit. Let's rock. Let's go. And, and so 900,000, uh on the, what I say, 70,000 in income, that's how it's like a 12, it's like a 12 cap on. Did I do that? Right. Um Sounds right. Uh It, it made sense until we started using actual numbers. Yes. But in any event, what you're typically going to do is build to an 8.5 or a nine and sell it a six. Once again, the same type of thing, we're just making a spread. So we're building for 900,000 or a million and we're, we're selling at 12 and we're pocketing the 200,000. Uh That's a small example. Some of the deals we're doing are 3 $4 million but it's really that simple.

And, you know, going back to what we always tell you guys is, you're, you're, you're one contact away from learning a piece of information that changes your life. We weren't developing these deals. This wasn't an area that we knew, but getting involved with Woodmont and then getting in, uh hiring Andy down in Fort Worth and then hooking up with retail partners down in Fort Worth as well, attending I CS C meeting people there. Yeah. And so we're, we're putting these connections together with people that are doing this and then we start looking for land on our own market. And, and so uh it really is the same kind of math that we were doing with shopping centers before. It's just, it's just new development, ground up development. But the numbers are the same, the math is the same. So why when we're buying a shopping center, are we comparing our cap rate to the the cost of the debt? But when we're doing a retail development, we're comparing the unleveraged return on cost, which is essentially the cap rate compared to the exit. Why do we not use the cost of debt? Like why is debt more irrelevant in the single tenant or multi tenant retail development space? Because we're, we're selling it, you know, eight months after we get it and, and we're not borrowing it all immediately, right?

Like we're drawing on it slowly, there's interest carry that's funded to the loan and, and we're not borrowing it that long, right? Yeah. So let's let's let's talk about that real quick. So we, we get the land under contract, we get the lease or at least the LO I and we're negotiating the lease, we take that lease and the contract for the land to a lender. And we say, hey, what will you loan on this? And they're gonna say, well, based on the cap rate that this retailer sells at uh this project is gonna be worth $4 million when it's done all loans, 75% of that or $3 million or a 125 debt service coverage ratio whichever is least. Yeah and so then we say ok, we got a $3 million loan and so you can use that loan to fund the purchase of the land and to fund the development of the building, you're gonna pay your 25% or 30% along the way. And, and so that, that's how you get it done and, and we're gonna be out, you know, maybe 20% 25% cash upfront and it works. Here's where I see people go wrong with this and here's where I think we went wrong with this in the beginning and, and it's a very reasonable mistake and I think it's very applicable to even getting into commercial real estate, right.

We try to make it approachable, we try, we try to get like the midfield or like that, you know, like not really close, but, you know, could be something here. This could be interesting. Maybe I could make something work like for this to work. It really needs to be an amazing spot. It, it really does because it's kind of the, the nature of, of development, you know, if you're trying to lock up a piece of land kind of in the middle of nowhere with nothing going on. I mean, don't be surprised if nobody's jumping on board super fast to say, hey, we're gonna do this. Obviously, that doesn't mean it doesn't exist. We were working on um, a light kind of office warehouse development for a long time. We were able to pre lease tens and tens of thousands of square feet of that. But at the end of the day, the, the project just kind of didn't make sense and, and that wasn't in the middle of town, I mean, but it was a warehouse office development, it was a little bit different. You know, if you're trying to go and, and build uh a brand new multi tenant retail that leases for 30 or $40 per square foot, it, it better be amazing.

Yeah, we're, we're buying land at prices that that really are, are tough for me to stomach, you know, not having purchased land in the spot before. But when you pay that price, you, you better be getting a good location. But if you are in the right location and before you close on the loan, retailers are gonna justify that purchase for you, right? If Starbucks says I I wanna, I wanna be there, build me a building and I'll pay you $40 a foot in rent, triple net. Well, then they justified the purchase of that land. They justified the purchase price for you in that, in that little scenario before you've gone non-refundable. So that's what's been interesting about this game. Is it used to be an unknown for me. Maybe a little bit scary to be paying higher prices for land, but we're only getting control of the land and letting the retailers, retailers decide if it's a good deal or not. And then only then do we close once we have the backing from a national retailer and a lease that is sellable. You have to be really careful with this strategy as well because you will very quickly be known as the group that ties up all the amazing real estate in your market and never closes on it if you never close on it.

So we're, we're always worrying about that reputation, right? Like I don't want to go get a bunch of stuff in contract. I tell people actively I don't get stuff in contract and, and not close on it, right. So we have every intention of closing on the stuff we put in contract. Don't go out there and just tie up stuff and have no intention of closing on it, right? Like work hard at, at what you're doing and don't just do it for no reason. And if you do for some reason have to cancel a contract, don't cancel with nothing, right? Like cancel with some sort of due diligence, some feasibility. Hey, here's an appraisal. I got, I got the phase one for you. I got this survey, I I got all these tenants, you know, at the end of the day I just, I couldn't make it work. I'm sorry. And that broker's gonna know you tried, you know, you didn't just waste their time. Yeah, I got, I had 10 retailers that passed on your site because of these reasons. Uh That's, that's why I'm not closing because you're asking a price but the retailers aren't coming on board. It's not making sense. They're not, they're not willing to, to jump on shit on board with it. Well, um we have a lot more of those in the pipeline, a lot more of those in the pipeline and the investor base seems to, to really kind of like them. I know everyone is, is itching for another shopping center.

We, we are too, we want to buy a big shopping center and I would say in the past month or two, we've underwritten a dozen. I mean models rates are starting to move on shopping centers. I I anticipate that in the next six months, we're gonna find some opportunities or some cash flowing day, one day, one properties. Yeah, we've, we've got Lois. So um hopefully one sticks and, but it makes sense if you guys are out there active in your market and you are driving by a brand new construction for, for a quality national tenant retailer and you see a pad next to it, inquire about it. Hit us up. Let's partner on that like, you know, you know, you, you guys are out in your markets and we, we love partnering with you guys on deals. So let's do it. Alrighty guys. Well, I think that wraps it up for this episode of how to invest in commercial real estate. Until next time. Thanks. Bye.

Episode 112 - Maximizing Returns with Retail Developments!
Episode 112 - Maximizing Returns with Retail Developments!
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