Inflation is at an all-time high and we may be on the brink of a syndication bubble. Deciding where to invest your money is crucial in times like these. In this episode, Best Ever Show host Ash Patel discusses how to start investing in non-residential CRE to increase your returns.
What you'll learn:
- Which deals to look for and how to find them
- How to underwrite your deals like a pro
- How to re-tool yourself to look at new deals that will earn your more
- How to find deals from $200K–$7M
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TRANSCRIPT
Travis Watts: Thank you, everybody, for being here to the Best Ever webinar here. We're talking about how to pivot to non-residential commercial real estate in a recession. So your host today is Ash Patel, my friend and fellow co-host here at Best Ever. Ash has been a non-residential commercial real estate investor for over 10 years. He's purchased everything from office, retail, warehouse, mixed-use, industrial, medical and land, so he's sharing with us today the benefits of buying non-residential commercial real estate. And then we're gonna jump into a live deal search at the end, or middle to end, with Ash. So it's going to be followed by a Q&A at the end, but what I want to say about that - just start submitting any questions you have now, and maybe we get to them throughout, or maybe we get to them at the end. We're very flexible, we're very laid back, just us two here today, so thanks again for being here.
There will be a recording, FYI. If you're joining late or not able to join, we will have that. So with that, Ash, thanks for being here, man, and welcome.
Ash Patel: Yeah, Travis, thanks for that intro. Hey, Best Ever, listeners all the first time listeners, thank you guys for joining. I know your time is very valuable. I'm going to do my best to give you as much value for your time as I can possibly do. I may talk fast; I don't want you guys to take notes, I want you to listen. There's only going to be one slide, and then I'm going to share my screen for the live deal surging. So please, just pay attention. I will email everybody my notes, if you want. As a matter of fact, I will email everyone my notes, and this presentation will also be made available. The whole recording will be out there. Sit back, relax, enjoy. Do not take notes, just listen.
Alright, so it's going to be me talking for a little bit, a live deal searching, and then Q&A. I would imagine a lot of you come from the residential or multifamily space, so I'm going to address a lot of you based on that, and I want you to for a minute, imagine if one of your tenants comes up to you and says, "Hey, do you mind if I remodel the bathroom in this apartment?" Or if your residential tenants in a single family house says "Hey, I went ahead and got a quarterly service contract for the HV/AC system. As a matter of fact, if anything breaks on that, I'll just go ahead and repair it at my cost." So this is the world that I invest in, and I want to bring you guys into my world for one hour today.
What will you learn today? You're going to learn to take the blinders off. What does that mean? A lot of you, when you drive by the house that has overgrown grass, the shingles are missing, or if you drive by an apartment building that maybe has a For Lease sign on it, I would imagine a lot of you just hit the brakes, turn around, and "Okay, this could be an opportunity, this could be a deal here." At the end of today, I want you to do that for any asset class, whether it's a warehouse, a strip mall, an office building, or an apartment, or a single-family house. And the problem with doing that is you're going to be making a lot of U-turns, you're going to start asking your passengers to take over the control of the wheel... But I want you to take those blinders off and look at all real estate, not just residential.
Again, I don't want you to take notes; we'll email this out to you. I'm going to give you a quick back-story about me and how I got to where I am today. Born and raised in Jersey, went to college in Southern Indiana, got a job in Cincinnati after school, and I was in the corporate world for 15 years. Always had a side hustle, always knew that I was going to do my own thing at some point. But every time I tried to quit my job, I would get raises, or promotions, or they'd give me an assistant, and they paid me to delay my dream. And it wasn't until many years later, my wife and I every year we went to our CPA, and we said "Hey, we're both W-2 employees. What can we do to offset taxes?" And the guy didn't even look up at us. He just grunted, and he said "If you make it, you've got to pay it." And I'm thinking "Come on, there's got to be a better way." I always heard real estate was a great way to offset taxes. I didn't know how the numbers worked, I didn't know how depreciation worked, cost seg - all of that stuff was so foreign to me. But I knew that if I buy real estate, somehow magic happens and your taxes get reduced. So I went out and bought my first property.
My very first property was a mixed use building in a college town, and it had a grocery store with four apartments above it. The building needed a lot of rehab; the commercial tenant in the store was already there. And it's funny, I didn't buy this just for the real estate. I bought it thinking "That store lease is up in two years. I can put somebody in there, and I can get additional revenue from running the store." So that was my mentality; didn't really know what I was doing.
So here I am, I'm getting apartments rehabbed, getting them ready for college kids to move into... And once they're rehabbed, I get the For Lease signs out, and it turns out in college campuses students will reserve their apartments a semester in advance. So I had these ready in August, ready for move-in day for college kids, but they already had their apartments picked out. So I had a whole semester of vacancy, and when I finally did rent them out, I learned what it was to be a residential landlord. Every big weekend, big football games, I'd be over there, patching holes in walls, unclogging toilets, sinks, and just dealing with drama.
There was one particular afternoon, I think it was a Saturday, I was out unclogging a tenants toilet, and I look out the window, on the roof of the store there's a whole bunch of guys in HV/AC uniforms, and they're replacing the rooftop units for the store. So I go downstairs and I inquire what's going on. And I ask the store owner what's going on on the roof. He says "Our AC went out, so we're replacing our entire HV/AC system." I was blown away. Here my residential tenants are destroying the apartments that I just got put together, and the commercial tenant is putting their own time and money into improving my property.
It gets a little bit better that day... As I'm leaving that day, the store owner stops me, kind of runs after me and says "Ash, do you mind if we remodel the bathroom?" Now I'm thinking "Is this real life?" So of course the answer is yes. I go home that day; at the time I had an IT consulting company that I started... I dropped everything that I was doing, and I became a full-time commercial real estate investor. And that first property was $230,000. Probably another $30,000 into renovations, rehab... And that's how I got started.
Since that day, I've gone on to do industrial, mixed use, all kinds of retail, warehouse, flex restaurants, medical, ground-up development, and I rarely buy fully-leased properties. Like a lot of you, I'm doing value add, so I'm looking for those big home runs.
I'm going to, again, keep bringing you into my world. So why commercial? One of the reasons is there's a lot less competition. I know a lot of you guys have killed it in residential for so many years. But in today's environment, it's just becoming a lot more competitive. There's properties that constantly go into multiple offers. We're not just talking about single-family homes; multiple offers on apartment buildings... A lot of times deals are off market, and there's still people competing for them. There's people that are putting down hard earnest money on day one, money that they're not going to get back. There's institutional buyers competing for the same residential and multifamily deals that all of you are competing for. We've heard Redfin, Zillow, Blackstone, a bunch of private equity companies buying up entire neighborhoods or towns of real estate. And it's hard to compete against companies that just need to park money, and they can afford to take losses that we can't.
Cap rates have touched the twos and threes. They are going back up now, but that never made sense, right? When you've got assets at two and three caps, it's just people chasing deals because they have to deploy capital.
So a lot of you I'm assuming you're here today because it's gotten hard with multifamily, it's gotten hard with fix and flips, rehabs residential. So again, stay with me; let's pretend we're going to start taking those blinders off, and we're going to look at every asset class. We're going to become deal junkies. Everything is a potential deal. So why is there less competition in commercial?
Travis Watts: Hey, Ash, sorry to interrupt you, man... As I get these Q&A, everybody, if you joined a little bit late, please be putting your Q&A questions in at any point. If they're relevant at the moment in the conversation, I'll go ahead and interrupt Ash and ask them. Otherwise, we'll save it until the end. But you were just touching on cap rates, and we had a question just come in as you were speaking; I wanted to touch on it. Matt asks, "Will you be investing in multifamily when cap rates expand in the current recession and upcoming market to pick up good deals? Or are you all-in with non-multifamily commercial real estate, and why?"
Ash Patel: Man, what a great question, Matt. So there's a two-part answer to that question. One, I have invested in multifamily for many years, but I've done it passively. I don't have a competitive advantage. I can't compete with residential, whether it's single-family or multifamily. I can't compete with a lot of you people that have been doing this for years. You guys and girls have your teams built out. You've got your systems in place. I'd be starting from scratch, and I have no competitive advantage. So I would rather invest in a lot of you doing great deals when multifamily comes back down, and the returns are a lot higher.
When I started investing in multifamily passively years ago, we were hitting 26%, 28% cash-on-cash returns upon sale, or IRR. Today, those returns have just gotten so much lower, and the returns with commercial... And everyone, when I say commercial, I mean non-residential commercial; the returns are just so much higher for us now.
So yes, I am opportunistic, I also don't have blinders on... If I see a multifamily deal, I'll write down the number and shoot it over to somebody that's in that space. So the answer is yes, but I chase high returns. So if the stock market crashes, I'll put a bunch of money into stocks. I'm just opportunistic. Great question. Thank you for that.
Alright, so why is there less competition in commercial? The biggest reason is mindset. So many people think "It's too hard. It's too expensive. I don't know anything about commercial, and there's too much risk." So let's address those. Because I would imagine a lot of you have the same barriers, and it's all mindset. So too hard - yes, there's a steeper learning curve. There's not a lot of good books written on commercial real estate. I try to find YouTube videos, there's not much out there. There's almost no masterminds on commercial real estate. When you look at multifamily - LinkedIn, my emails are flooded with multifamily bootcamps. There's so many good books. Joe Fairless wrote the Bible on multifamily syndication. I can't tell you how many people that I've interviewed, that literally read his 400-page book and have become successful multifamily syndicators. We don't have that for commercial. The masterminds, the conferences... There's one conference really for commercial, it's ICSC, International Council on Shopping Centers; very high-level, very specific niche.
So how do I learn commercial real estate if there's nothing out there to learn from? One great option - and I did a solo Beyond Multifamily podcast on this... It's "Purchase a mixed-use building." I'll dive into that at a very high level. Mixed-use buildings are like the very first property that I bought. Typically, the first floor is retail, office. Second, third, or however many floors are apartments. Why do I tell you to pivot into mixed-use? It's one of those asset classes that nobody likes. Well, what does that mean? Commercial guys and girls don't like them because there's a residential aspect to them. Residential people don't like them, because the commercial scares them. The mindset, right? The fear. Well, again, let's continue to address that.
Why is it? When there's a mixed-use building on the market, it often sits there for so long. I'll give you a quick story... I owned a building, and it was a mixed use building; right next door, another mixed use building came up for sale. We had a restaurant, and I was going to buy the building next door, use the first floor as an event center. Didn't really care about the apartments, maybe make them into Airbnbs... I offered $165,000 for this property, and they wanted 190k. I didn't want this property bad enough, so I let it go. This was on the MLS for six months.
I get a call from a residential investor friend of mine, about a month later, and he says, "Ash, I wonder if you'll help me evaluate this commercial building." Sure, tell me the address. He tells me the address, and I knew the building very well. I told him everything I know about it, and I sent him my due diligence materials. And I said, "Are you going to buy it?" He said "No... The commercial scares me too much." And I said "Well, hold on... The residential scares me, so why don't we partner on this?" He wanted nothing to do with it because of the commercial. But out of curiosity, I asked him, "If this was just four apartments - same shell, same location, same exterior, just kind of chop off the first floor, drop the building down... What would you value this property at?" And his answer was "ARV would be 280k or 290k." And my jaw dropped. You could buy this building for 165k, 170k. And I said, "Hey, look, knowing that, I'll probably buy it. I would love to partner on this with you." He wanted nothing to do with it.
So I buy the building for $150,000, and appraised at 490k, I think, ARV. And, again, this mixed-use building sat still for six months. Nobody wanted it. The residential people - too scared of the commercial. If this was just four units, there would have been a bidding war. It was a great location. A four-unit apartment building does not stay on the market for six months. It doesn't stay on the market for six days. Everybody chases these, and over bids... It's crazy.
So I really implore you, if you're at all interested in commercial - even if you're not, there's huge returns in mixed-use buildings, and the apartments will more than pay for all of your debt. The commercial is just typically all profit, and it's a great way for you to pivot into commercial with having a safety net. Does that make sense?
Travis Watts: There's a question. I appreciate you sharing that... The question came in, "Are there more ways to add value in multifamily, or non-multifamily commercial real estate?"
Ash Patel: Great question, hands-down commercial real estate. Non-multifamily. And we will cover that in here in just a second. So too hard; again, dive into mixed-use. Great segue. A lot of older cities have mixed-use buildings. Too expensive. I can find you commercial buildings that cost less than the average residential home in your area. They're out there. You don't have to buy a $3 million commercial building to get started. You can find small mom and pop strip malls for a couple hundred thousand dollars all day long. So too expensive is not an excuse that we're taking today. Too much risk, that's fair, right? A lot of people think the retail apocalypse, the Amazon effect. Well, the neighborhood strip malls, when COVID happened - they blew up, and we realized the importance of suburban downtowns. Think about that little strip mall where there's a barber shop, a nail salon, the pet groomer, the deli, the pizza place, the neighborhood watering hole, the convenience store... These are internet and recession-resistant businesses. So if you don't want to chase that whole foods, strip mall with a TJ Maxx and a Best Buy, awesome. These smaller neighborhood strip malls often have much higher cash on cash returns.
So when you start going to your neighborhood locations, get that in the back of your mind, "I wonder what they're paying for rent. I wonder what this would sell for." And then start looking at commercial listings. And just how a lot of you could look at a house, look at an apartment building and probably very quickly tell me exactly what it's worth, be able to do that with different asset classes. So when you see a deal, you know it's a deal.
Travis Watts: I want to ask one question real quick that just came in, and I think is also relevant. So in terms of property managers with mixed-use buildings - what's your take on that? Are they easy to find? Are they expensive? How does that work?
Ash Patel: Oh, no, no, no. Hold on. Just so we're clear, we self-manage most of our properties. And with a mixed-use building you have a built-in property manager - whoever is running that business on the first floor is going to be your best property manager, your best boots on the ground ever, because they have customers coming into their business. Again, whether it's retail, office, whatever it is; it behooves them to make sure that the sidewalks are clear of debris in snow. There's no ice dams built up. Potholes in the parking lot are taken care of. Your residential tenants that don't have a car, that may not leave their house for a number of days at a time could care less that there's vines growing on the back of the building near electric lines. Your commercial tenant will let you know. And often, if it's a remote property in a different state, you could have them address it and just pay whichever contractors they use. So no, that's your built-in property manager. Great question.
But in general, Travis, commercial real estate is way easier to manage. We don't need a staff, we don't need leasing people, we don't need a maintenance person for every 50 units... A lot of these tenants take care of their own issues. Great question.
So back to taking the blinders off, pivoting to higher returns. Another reason there's less competition with commercial is it's more difficult to obtain lending. With residential multifamily there's brokers out there, there's banks that love multifamily. There's all kinds of agency debt available for multifamily. With commercial deals, that mixed-use building that you all are going to go look for - the only people that will finance those are local lenders; your Bank of America Chase, they're not going to touch a mixed use building, especially one that's 100 years old, that needs rehab. Even some of your regional banks won't touch those deals.
You have to find a local lender or a community bank, somebody that's within a two three mile radius of that location. And they're portfolio loans. The deals that we do, the originating bank typically keeps the loan on their books for the life of the loan. They don't sell your loans like your residential mortgages, right? So for us, lending is all about relationships, whereas residential and multifamily it's all about the best rate; you guys are okay paying a broker one or two points to get the absolute best deal out there. For us, it comes down to relationships, because when we buy a vacant building, a half-vacant building, or something that needs a massive amount of rehab, it doesn't fit the criteria for any lender, so we have to have relationships with lenders. Some of the benefits of commercial real estate - I'm going to share my screen here, Travis, if that's okay...
Travis Watts: Sure.
Ash Patel: Alright, this is the only slide. And again, I put this up there because I don't want you guys writing stuff down. I will make all of this available to you, but I want it up there just for a reference, for anybody that is not driving. Alright, so benefits. We deal with business owners instead of residential tenants. Why is that better? These are people that their livelihood depends on the building that you own. In the 10+ years that I've been doing this I've never had to evict a commercial tenant. It's almost unheard of. And when tenants are behind on rent, if they can't make it, they have their apartment rent, or they have their store rent, their business rent. They're often going to pay the rent that produces revenue. So you're gonna get paid before their home mortgage or their apartment rent. So tenants - they hold their business in very high regard. We have multi-year leases, versus residential, you have one-year leases.
Now, when a recession is on the horizon, that is a huge benefit. If you buy a strip mall or an office building or industrial building, and there's seven years left on that lease - man, how much better do you feel that we could hit hard times in a year or two, and those hard times can last 2, 3, 4, even 5 years, and you're okay. You're still getting paid. So when it comes to a recession, and shkay economic futures, having those long-term leases is incredibly important.
Travis Watts: That brings up a good point, Ash... We've got a question that just came in, that's relevant here. So what's your typical hold period, and why?
Ash Patel: Yeah, that's a great question. When I started, I was like a lot of residential people that I talked to - "Buy and hold forever. Live off that passive income, accumulate doors, units, whatever." But then I learned as I got into this business, over the years, when you can add 80% of the value, 80% of The upside to an asset, sell it and move on to the next one. So at the end of the day, the one metric that doesn't lie is your balance sheet, your net worth. Our goal is to increase that net worth as fast as we can, as high as we can. And if you do the math, the numbers speak for themselves.
Holding on to a deal, trying to save up money and buy the next deal, saving up your passive income to buy the next deal - it's not the fast-track to growing your net worth, if you compare that to adding 80% of the value to an asset, selling it, doing that all over again. So us value-add investors - that's what we're good at. Adding value. We're not good at buying and holding. We know how to add value, so why don't we add value as much as we can?
So that's the answer to that question. As soon as you can extract most of the value out of an asset, sell it and buy a bigger asset, or buy multiple assets.
Travis Watts: That's a great point. And short plug for the Best Ever Roundtables - we had this discussion, and I've actually made an episode on Passive Investor Tips. I like to call it the velocity of capital, and I'm in 100% alignment with you. I use this example of - I'm a full-time passive investor. I invest, like Ash, in the multifamily space passively, hands off. And I've been in deals for years and years and years, where each year our cash flow has taken up, let's say 1%. So I'm sitting on some deals this year that are cash flowing 14%, 15%, 16%, which sounds amazing, but if you go back to the value-add model that Ash is talking about, and I put in 100k, and that deal sells early in two or three years, and I reinvest it in value-add two, three years later, it sells, and I reinvest again, my results are so far off; it could be a 2x to 3x example, compared to just holding on forever. So great points. And of course, the older a property gets, the more capital it requires, so there's going to come the day that the roof needs replacing again, and you've got to start influxing more capital to keep it running. I didn't want to take too much of that [00:26:03.04] but that's a great point. I appreciate you sharing that.
Ash Patel: Yeah. And let's reiterate what Travis said, again... The one number that doesn't lie is your bottom line, your net worth, your personal financial statement. The numbers that can be manipulated are number of doors, passive monthly income. Again, you can be over-leveraged, get more doors, achieve your goal, but if that's not increasing your net worth, it's not accomplishing your goal.
So for everybody that has the goal, "I want 100 doors by the end of this year, I want to 1,000 doors in five years", go ahead, keep that goal, but please, add a net worth goal to that. It's so important, because that net worth needs to be moving up every year. And again, it's the one metric that never lies. So yeah, great question.
Back to the benefits of commercial real estate. We talked about multi-year leases versus residential leases or one year, and that in a recession, you could ride them out. In addition, when a tenant is going to leave, in their lease oftentimes they have to give you 180 days or 90 days advance notice. So you now have several months to market that space for the next tenant. And ideally, you should not have any gaps at all. As soon as one tenant leaves, the other one should be ready to move in. In your leases, places have to be rental-ready. You don't do turnovers like residential people, where there's a crew that comes in, paint, carpet, all that stuff. The commercial tenants will do all of that on their way out. Tenants improving your buildings 0 we talked about that. Tenants doing their own buildouts... I can't tell you how many times we've given people just a blank box, plywood floors, primed walls, and they've transformed them into incredible salons, churches, restaurants. And they do it on their dime. It's the most amazing thing to watch, where a business owner comes in and just adds so much value to your building. Commercial tenants are much easier to manage. We touched on that a little bit with the mixed-use commercial tenants... But again, you're dealing with business owners. They're going to take care of the exterior, they're going to make sure your property is presentable for their customers. When lights go out, often they take care of it and you don't even hear about it. In a lot of the leases that can be built in, where they're responsible for all of the maintenance, all the snow removal, all the landscaping; they're responsible for HV.AC repairs. So there's varying levels of tenants and landlord responsibility with commercial real estate.
We're also not bound by rent comps. And what does that mean? So back to the original question that I didn't answer at the time, Travis - can you add value easier to multifamily or commercial? And the answer is by far commercial. Let's look at multifamily. If you have A class a building, and there's other class A buildings around you - let's say a one bedroom rents for $1,000 per month. What can you possibly do to increase that rent to $1,200? Maybe put washers and dryers in each unit, do a renovation, it's already class A, dog park, covered parking... You can only push those rents so far. With commercial property, you can take a block building with a metal roof that's vacant, or maybe it has a mom and pop convenience store in it. If you sign a 10-year lease to a Dollar General, you've added over a million dollars in value the day that you sign that piece of paper. So with commercial, we're buying quality of tenants, we're buying lengths of leases.
Travis Watts: I want to draw a quick parallel here for any multifamily folks tuning in, because that's what I primarily focus on... So everything you're discussing and describing to me as a parallel in multifamily is more like an opportunistic play. So to Ash's point, you have A class, new construction, luxury, high-end, you have B class and C Class value-add pre-existing, and then you have what's sometimes referred to as opportunistic. Maybe there's a property that's 400 units, but it's only half filled up, because there's some major problems... So it's kind of higher risk, but higher reward; in some cases, Ash, maybe not so high risk, in what you're describing... But you're coming in, you're getting creative, and you're completely turning something around with potentially a lot of equity upside, instead of just trying to push those average rents from $1,000 to $1,200, to your point.
Ash Patel: Yes. And keep in mind, I'm very, very conservative. I turn down so many other deals that other people jump on. If I turn something away, I'll often hand it off to somebody and they'll absolutely jump on it and be grateful. I'm pretty risk-averse, I'm conservative... So I'm looking for those unicorn deals, but I'm not very risk-tolerant. So just keep that in mind. I'm not just shooting from the hip on these deals.
So back to the length of the leases and the quality of the leases. Now, that Dollar General we hypothetically spoke about, if it's a fresh 10-year lease, anybody in this country would buy that deal. They don't even care where it is or what it looks like, because they're buying an income stream. It's a revenue stream, right? And it's a triple-net lease. If there's one or two years left on that lease, it's high-risk; you're getting a lot lower sale price on that sale, because if they don't renew, you're back to having a $300,000 building. So length and quality of the leases is very important.
A good analogy is, Travis, if you have a high rise apartment building, and Kevin Hart moves into that building, that might increase in value a little bit, because other people may want to live there; it becomes more attractive. It's the same thing with commercial real estate. Our Kevin Harts are Starbucks, Chipotle, Dollar General. If you have a strip mall and a Starbucks comes in, everybody's going to want to be at that strip.
Travis Watts: That's very, very true.
Ash Patel: Yeah. The other way to increase value in commercial real estate is having second-generation spaces. So remember, those buildings where I gave them a blank slate, they built out a restaurant or a salon... If they leave, a lot of that equipment, a lot of the counters, all of that stays behind. Now you've got a second-generation facility to lease out. It's more turnkey; the first tenants had to envision their salon or their business in that space. The second generation tenant goes in there and sees a turnkey place, and you can charge a lot more rent because of that.
One thing I do want to address is when people hear commercial real estate, they immediately flocked to triple net, mailbox money, right? Triple net leases, or net leases, a lot of your national tenants will sign those: Walgreens, McDonald's... It's one of those things where you buy a property like that Dollar General, and there's no landlord responsibilities. Tenants are responsible for roof, parking lot, snow removal, signage, utilities, taxes, insurance. So everybody thinks, "Okay, I'm going to work up to triple net and get that mailbox money." Well, let me deflate that bubble for a second. So if you do find a triple net deal, it's going to be very, very low returns, because there's no risk. And the risk is relative to the rewards. And also, keep in mind, not all triple nets are equal. You may have one where the tenants take care of everything, but then there's gonna be others where the landlord pays for all of the expenses, and then at the end of the year gets reimbursed by the tenants. Or there's varying levels, and brokers often will call deals triple net when they're not, where the landlord is still responsible for roof, parking lot, exterior, sometimes HVAC replacements, but tenant's responsible for HVAC repairs. So there's varying levels of leases. And again, because of all this obscurity, it keeps the competition away.
How many people out of all of our attendees today knew that there was a varying level of triple net leases? Again, there's no books out there. There's just not a lot of good material out there, until you dive in, and get after it, learn it on your own, learn from mentors... So again, benefits of CRE, some of the ways to add a lot of value...
Break: [00:35:06.13] to [00:36:06.29]
Ash Patel: Let's take a couple questions... But I do want to get to the live deal surging. Any repetitive questions that you see out there?
Travis Watts: Well, yeah, we've got one that's really relevant to exactly what you've just said. They asked "So there's so much to know about non-residential, office space in Atlanta, versus industrial in Charlotte, versus medical in Tampa... You can't be an expert in everything, so what do you do? Just have broker contacts everywhere? Who are the experts? Or do you just choose something and go with it?"
Ash Patel: Start. Just start. So if you start with your mixed-use building, you might get comfortable doing additional retail. If you start with a small office building -- now, I know everyone's scared of office, but I've gotta tell you, small offices in suburban areas, especially walkable suburban downtowns are on fire. After COVID, people realize that, especially in the summertime, "I can't work from home, my spouse works from home, my kids are home from school, I've got pets running around... Not a conducive environment to work from home", especially for multiple people. So those singular or small offices are very easy to rent out, especially ones that are in suburban locations. People don't want to drive to city centers anymore. Even when we go out to the bars for dinner, how often are people going downtown? They're going to their downtown suburbs, right?
So offices close to where people live, small offices - on fire. But again, same way I started, I learned things overly the hard way. I'm just not one of those people that learns easily, so I've made so many mistakes... But just go to one asset class after another... The fundamentals remain fairly similar. You dissect the leases, you try to achieve the highest NOI. You look at "How long will it take to lease out a property?" If it is a high rise office building, you could be sitting for years with vacancy. If it is a flex space, that we talked about just before this call got started - flex space is typically a metal building where they have bay doors and a man door. It can be used - anybody from plumbers, HVAC companies, Car Audio, window tinting, exterminators, all kinds of tradespeople, woodworking shops... They're so versatile, they're so easy to lease out... And the smaller, the better. 1,000, 1,500 to 2,500 square foot flex spaces - if you get one of them, do you know what the going rate is? In your pro forma discount that a little bit, be conservative, and know that with very little effort you can get that leased out. So just start diving into deals.
There's a site called 10x. No affiliation, but 10x, LoopNet, Crexi - get on those sites, and often they'll have a due diligence vault. 10x has the most comprehensive, because those are auction properties. They want the highest price at auction. So they'll include copies of leases, appraisals, historic P&Ls, rent rolls, everything. It's an easy way to practice underwriting. A lot of them will even have pro formas. Take the brokers proforma with a grain of salt, but at least it gives you a starting point.
So start underwriting deals... That neighborhood strip mall that you drive by every day, on your way home - figure out what it's sold for last. Call them up, ask them what they're paying in rent, or just estimate what the going rent is. Look at neighboring For Lease signs, find out what spaces you're going for, and back into a pro forma. It's free, it doesn't take a lot of time... Spend 20 minutes a week, 30 minutes a week doing that, and you'll start looking at commercial assets a different way. When you drive by a strip mall, you'll start [unintelligible 00:40:01.06] yourself. Office buildings, warehouses... I want you guys - please, take the blinders off.
Travis Watts: A couple things real quick... I appreciate that, great advice. Let's talk about financing. This is one of the questions, and then FYI, on the Q&A, I think you can see as well, someone posted a LoopNet link. I don't know if that's how you want to start your deal search, or look at some properties you've already identified... But Q&A first. Is seller financing available on commercial real estate, like there is in multifamily and single family?
Ash Patel: 100%. The advice that I give everybody is find out what the seller is going to do with their money. If they've got a ton of money, they probably don't want to take the tax hit. If they're selling their whole portfolio, they probably don't want to get an additional tax burden, so they would be more likely to do seller financing. We had a crazy story where a lady had listed her commercial property for sale; we asked her what she was going to do with the money, and she had to close within 25 days on the commercial property. It was off market, it wasn't listed, sorry. And she said she wanted the money to buy a house in North Carolina, in Hilton Head. And we're like, "Okay, we can't get a commercial deal done in 25 days, but we can buy that house for you in Hilton Head, and essentially hold the note until we pay off the commercial deal, until we get the transaction done."
So you can get creative, just like you can with residential. And the higher the dollar amount, the more taxes people are paying, so there's so much more opportunity for seller financing. And also, seller financing to commercial real estate investors is not that much of a foreign concept as it could be to a lot of residential people.
Travis Watts: Great answer. New Q&A and then we'll move on to the deals search here. Someone's asking 0 and I'm going to add a little bit of context to this for the listeners... When you do these deals, are you doing a joint venture with a few handful of investors? Are you syndicating deals? And if so, what does your structure look like in terms of splits, or preferred returns, depreciation, anything you want to share about the GP/LP site? Or are you buying individually just for yourself?
Ash Patel: All of the above. I buy individually... People that I've mentored, if they find a deal, and they asked me to come in, I'll go in on it with them. I do a lot of joint ventures. So a lot of my joint ventures are residential, where people buy apartment buildings, and they want a capital partner, or -- really a capital partner, because they have no expertise with apartments. Or if they're deals that people just want a couple of partners on, we'll do that; we've done syndications... So really, all of the above. The deal structure is different; based on what the property is kicking off, we bought a $5 million strip mall that was such a homerun. We gave our investors an 18% preferred return every year. But then it's a 70/30 split; 70 goes to us, whereas normally it would go to the LP. We have another deal where the total cash-on-cash for the strip mall is 15%, and it's triple net, fully leased, five-year leases, and there's 3% rent increases every year. So I think on that one it's a 9% pref, 50/50 split at the end of that... But where that deal makes a lot of sense is there's no renewals built in. It's a brand new strip mall. The builder didn't put any renewals in. So in year five, these people have established businesses, their space was fully built out by us and the builder, and now we can charge them at or above market, which should be a huge homerun. So that's the deal that you don't make a lot of money in five years, but at that five year mark it's just a lot of return.
Travis Watts: I love it.
Ash Patel: So it's deal by deal, because all of our deals are so unique. And again, that's what's great about commercial real estate. A lot of the deals are very unique, and it keeps the competition away because of some of the complexity. But I'm telling you, listen, if I can do it, it's not that hard. Dive into deal flow?
Travis Watts: Let's do it. Yeah. Either starting with the link submitted, or anything you want to start with is fine.
Ash Patel: Alright, so I'm cheating a little bit here... I have a mastermind where I was doing this same example for them... And I said "Somebody give me a city, any city that you live in" and one of the students yelled out "Wilmington, North Carolina. There's no good deals there." I said, "Okay, let's go." So what do we do? Well, we're gonna type in Wilmington, North Carolina commercial real estate. So we're searching for deals... I don't go to LoopNet, I don't go to Crexi, I don't go to 10x... There's too many eyes on those properties. They're marketed by professional brokers, they're priced by professional brokers. One of the best ways that I've found deals, Travis, in the last 10 years is when you go to a residential website and search for commercial deals; here's one that we have in our local market. This brokerage covers several states in the Midwest. So if we go to this residential website - and they changed their site... Often on residential websites you can search by commercial deals.
So let's see... I'm not going to waste a lot of time here, but go to Residential Realtors, and if they have a way to search the commercial MLS, do that, because these are deals listed by residential realtors. They're often mispriced and mismarketed. So that's a great way to find deals. Back to Wilmington, North Carolina. We don't want to hit these ads, because somebody's paying to get their listings out there, which means they're professionals; they're not going to be mispriced, they're not going to be mismarketed. CBRE, professional broker, we don't want them... LoopNet - sorry, there's too many eyes on those deals... CoStar same thing. Now we're going to the non-sponsored listings; again, we have LoopNet... We have something called MWM Real Estate. Cool. This looks like a little boutique real estate firm. We go to property search, and they've got commercial and residential property; we are going to do a For Sale, and let's focus on retail.
Alright, so the first thing we have - $1.2 million for 6,600 square feet. Interesting. I'm assuming this is two buildings. I'm assuming you get both of them. 1.2 million, occupancies should be 100%.. Good... Let's see if they give us a cap rate. Let's read about this one. This property is in Whitesboro... The shop has four bays, a small office and a waiting area. It looks like there's only one building here. Maybe two. Well, we're not going to dive too much into this. It's also listed retail for lease. Interesting.
Travis Watts: As you mentioned cap rate, and you're kind of scrolling around there, I just want to read you out a question that came through... So with interest rates rising and looking at value-add, how much spread do you like between cap rate and interest rates to make a deal work, or aka to be conservative? This person asking would like to have a property that cash-flows as is to satisfy passive investor goals, while taking advantage of value-add component to capture upside later on. Do you look at the spread between interest rates in pro forma cap after you add value to determine if you're going to take down the deal?
Ash Patel: Yeah... Travis, the only way you can apply a blanket formula is if it's on triple net properties. So if we look at this Dollar General right in front of us - let's assume they have 10 years left on their lease; then yes, that spread can be a formula that you can use repetitively to find good deals. But there's so many variables in commercial real estate... One, you can't rely on the brokers cap rate, because they're often wrong. And two, you can't rely on one formula because of the variables here.
So let's see what we have here... Good - Dollar General, it's occupied. Obviously, single tenant, 10,000 square feet... Alright, so this is at a six cap. I'm going to assume there's about six years left on the lease. And they have four or five year options. Okay. So if you buy this for $1.4 million, you're going to hope that they continue to renew their options. Because if it is 9,000 square feet -- so $100 per square feet is $900,000. $150 per square foot would be about 1.4 million. But if this was vacant, it would probably sell for $50 to $60 per square foot. So this is a big risk. Yes, for six years you get guaranteed payments, but if they choose not to renew... Or upon renewal, if they say "We'll renew, but we want a discounted rent." They can certainly do that. So for me, this is too big of a risk. I would not do this deal.
Travis Watts: Question on that that came through... So with a tenant like a Dollar General or a stable long term tenant, what's a typical annual renewal increase, and what are your thoughts on inflation being 8%, 9%, and how that factors into a long-term lease with lower than that amount for a lease renewal?
Ash Patel: Yeah, great question again. So right now we're building in 6% renewals annually; and we might get some pushback... We might drop it down to 5% or 4%. Historically, it's been a 3% annual increase, but with inflation... And we have long-term leases. So when you have long-term leases with built-in renewals, you have to have those increases because of inflation.
Now, if you want to cut your tenants a break, and if that 6% increase ends up meaning they're paying above market, I would cut that back a little bit. You don't have to enforce that.
Travis Watts: Right.
Ash Patel: So let's keep going. Here's another Dollar General. Same square footage, but $400,000 cheaper. My guess is they have less years remaining. We have no details... Ah. Very busy location, upgraded exterior... They don't give us a cap rate, they don't give us anything.
Travis Watts: That's the 400k discount. That's why.
Ash Patel: Yes.
Travis Watts: You don't know what you're buying.
Ash Patel: So this is what numbers of years remaining on a national tenant lease does, right? Let's keep going... We have a restaurant for $2.2 million; it looks like a very specific niche. We'll avoid that. A 5,000 square foot strip center. Okay. Let's see how much occupancy they have... 100%. And it is 5,000 square feet for how much money? 1.25 million. So half the size of the Dollar General, but about the same price as the one with six years remaining. Why is that? Okay, so no details, right? Now, let's think about this for a second... We don't know the occupancy of this, because this broker gave us nothing. Most people, when they're browsing for listings - "Next. This listing sucks. There's no details here." There's 12 photos; let's see what they have. Perfect. A For Lease listing that's on the broker's photo. Horrible marketing. Now we know this property is mis-marketed. Shame on the broker. But call this number, this could be a deal.
So we have some vacancy... When you call that number, let's see how receptive they are. If they don't call you back for three or four days, if they don't call you back at all, you know that one of the reasons it might be vacant is because nobody's paying attention. They're asleep at the wheel. And you know that maybe with a little bit of marketing, a little bit of attention, you might be able to fill this spot. So these are the properties that you want to call on, because a lot of people will just bypass this. 5,000 square feet for 1.25 million.
Travis Watts: Someone's asking, Ash, "Is there an underwriting template that you'd recommend to get started? Where can I get a copy of it?"
Ash Patel: Yes. If you guys are okay with receiving an email from me with the notes, I'll include the template as well. And I'll give everybody my personal email address. It's AshBPatel [at] gmail.com. Happy to hear from any of you guys. If there's things that you want me to dive into more on these Beyond Multifamily podcasts, please let me know.
So here's the deal... And again - fair disclosure, I've found this one earlier... But let's dive into this one. 34,000 square feet. And I know nothing about Wilmington, North Carolina. I couldn't point that out on a map if you told me. I can point out North Carolina. But $1.6 million, 2.4 acres - these guys list a 10.12% cap rate. So we have way more square footage than anything that we've seen previously on this site... And in-line with the other prices, so let's dive in and figure this one out.
11 photos... So this looks like it's an entire block. Again, why would a broker do this? Put a For Rent sign on their listing... Again, this is telling us it's miss-marketed a little bit. A NAPA Auto Parts. Awesome. National tenant, right? So hopefully NAPA Corporation signed this lease, so it is a corporate guaranteed lease. And we were Quick N Chicken... We've got a Fast Tax, we've got some mom and pop businesses... A single family house... Okay, so the single family house is right here, tucked behind the strip mall. Weird. So this is that flex space that we were talking about earlier. You have this retail upfront, a single family house - this is your on-site property manager right there - and I'm going to call this flex space, or storage space. This is weird, and it looks like there's a demarcation line here, so this was probably built afterwards. Awesome. Rent this out separately. Again, how many landscapers and tradespeople do we know that would love to get a spot like this? And look, right here, there's some trucks here... My guess is some kind of contractor is occupying the space. That's great.
Having a semi-trailer here gives you an idea of the size of this parking lot. Alright, so we have not much information at all on this... But we know that there's a NAPA there. So how do we dive into this deal? So let's do this... We want to see how well-marketed this deal is; if you google the address... I'm hoping that this property will not come up anywhere, and that this boutique real estate firm listed it and they're the only ones that are marketing it. But when we do a search for that address, if Mapquest comes up and Waze comes up, it's not marketed. LoopNet, let's see what they have... Uh-oh, "Retail property for sale." Is this on LoopNet? 1.6 million. Ah, it is marketed. But again, the same lack of information. Okay, Home Life Care, that's good... NAPA... And there's that house again. So let's do this. Let's dive in a little bit deeper.
Travis Watts: A lot of parallels here, Ash, to -- my wife and I just bought a couple cars... When you think about marketing in a similar way, you know, if you go to a dealership, you've got the markup, you've got lack of discounts, you're not these days going to be able to really hardly negotiate anything... So it's like you're looking for the vehicle that's the mom and pop owner, that's listed in one place, like maybe on Craigslist or something, outside of the city, and then you're gonna go there and try to negotiate and be a little opportunistic and creative with the deal... So same parallels apply, I think, in the real estate space.
Ash Patel: I agree. Here's our house, right? $80,000 house. It's a three bedroom, one bath, 1,500 square feet... Let's see what it's sold. This is on Zillow... Sales; where are sales? Some of my residential people helped me out. Where is Zillow?
Travis Watts: Sometimes it's under the property tax area, the price history, somewhere in there...
Ash Patel: Okay, so look, there's a listing for rent, okay? $850 for rent. So, hey, that's beyond the 1% rule. So I know a little bit of residential... So look, let's agree, this is valued at $80,000, right? Cool. But now, here's why I like Zillow; it very quickly gives you parcel lines. So this was that NAPA Auto Parts... And that Napa looks like it's parceled separately. So if we go to Crexi and type in NAPA Auto Parts...
Travis Watts: Yeah.
Ash Patel: Okay. Let's see what kind of cap rates they're selling for. National company. Here we go... Oh, on the market for 100 days. 1.1 million, and there's 7.2 years remaining on the lease. 6% cap rate. Let's keep going. Here's one that looks a little bit older... And look, I think the footprint that we have in our listing is bigger than this, and it's at $1.6 million. So they're asking $1.6 million for that whole block that we just saw, and here's a NAPA with how many years left? Is that a 5.6% cap rate, corporate lease... Come on, how many years left? I don't think they tell you. Let's keep going just a little bit more... So this NAPA is for 1.6 million. Let's find another older, crappy NAPA. Here we go... 1.1 million. They have three locations. I can't imagine they're selling them all for that much. Let's skip this one... Alright. Oh, look at this. This is a weird Napa. Look at this, our Plaza comes up. What are they doing here? Interesting. Retail center anchored by NAPA Auto Parts. Do they give any more information? 34,000 cars per day, which is good... Okay, let's dive in to a Google Street View.
Travis Watts: As we're pulling this up, everybody attending, I appreciate you hanging out here. We're a little past the hour. We appreciate you still being online... So if you want to go ahead and dive into any Q&A, go ahead and submit those... And Ash, maybe we'll do like a quick fire round, just to keep it short and simple...
Ash Patel: I'm sorry. Listen, I get excited when I see this kind of stuff... Okay, so Google Streetview - they took a picture June of 2022. The center does not look bad. It does not look neglected. Where's my -- okay, so there's some vacancy... No, maybe not. Everything looks fully leased here. Oh, here we go, For Rent. Okay, an [unintelligible 00:59:38.15] for rent. Weird. Let's look at historic view. Let's go back to 2018... And we have some of the same tenants. The chicken place, NAPA is still there... Okay, so it looks like NAPA had expanded at some point. And here we go. Okay, cool. This used to be East Carolina Computers. And NAPA had this dated facade here. Between 2017 and 2018 and 2022, NAPA freshened up their front, and they took over more space. Look, this is great. If you're going to parcel off that NAPA, you can say they've already expanded their footprint, they've redone their facade... And that shows a commitment to that space. So somebody dive into this deal offline. I like this. $1.6 million for a city block, and you could probably sell that NAPA, even if you sell it for 700-800 pennies on the dollar, you're now only into this center for $800,000. That's commercial real estate, guys.
Travis Watts: Awesome. Let's do a quick fire round. I appreciate that... And let's start with thoughts on medical real estate, is the first question.
Ash Patel: Medical is on fire. I did a solo Beyond Multifamily Podcast on this, Travis... Medical is on fire, because when do you ever see a doctor's office going out of business sale? They don't close. They trade at such low cap rates... And one of the ways to find deals in medical is in your own areas look for those regional medical groups - the Orthopedic Group, the podiatry group, the regional optometrists group... They're not a national tenant, but you know if they have 6, 7,8 ,9, 10 locations, and they have a corporate signed lease, they're not going out of business. And the beauty is if a medical tenant decides not to renew their lease, you can get a replacement medical tenant just like that. Imagine a dentist leaving - all the plumbing is there, the electric is there for the chairs... If they leave, there's so many customers used to coming to this location once every six months; you can get another dentist in just like that. If a veterinarian leaves, you can easily get another veterinarian in that location. Same thing with primary care, you can easily backfill with a similar specialty, because people are used to going to that location for whatever care they require.
Travis Watts: Love it. Thoughts on warehouse.
Ash Patel: Warehouse is interesting. If it's a large warehouse, the closer you can get to an airport, the closer you can get to an interstate, the closer you can get to intersecting interstates, where two interstates cross, as long as there's a workforce, they're on fire. If you can get warehouse close to city centers, that last mile delivery... So when you order something for same-day delivery, it's not coming from Memphis or Louisville, it's coming from a local warehouse, or at least that local warehouse will serve as a distribution depot. So on fire. Warehouse is on fire.
Travis Watts: Next question - "Ash, this is awesome. What are some of your most important factors in underwriting, and what are your deal breakers? For example, traffic counts, mom and pop versus national tenant, lease length, location, exterior condition, etc.?"
Ash Patel: Yeah, the one metric that you really can't overcome... Crime, all that stuff, traffic counts, you can overcome; the one metric you can't is a declining population. That's often a deal breaker for us. So anything else - it's like buying a classy apartment building; you know there's going to be some issues. You can have broken windows, you can have crime in your parking lot, you might have to hire security... Things you can overcome. Even if it's a rural Mom and Pop strip mall, you know that going into it, so the returns better be higher.
Some of my best returns have been those rural properties that nobody else is chasing; the coastal buyers, the REITs, the institutional money - they're not chasing stuff out in the middle of the suburbs, or out in rural areas. So don't be afraid to chase any of that. Declining population - sorry, it's the one deal-breaker.
Travis Watts: Yep, totally agree. That's a huge one that not a lot of people talk about. Do you ever put in your contracts that you can market the property before you close on it to help fill a vacancy and/or lower your risk?
Ash Patel: Yes. Whoever asked this question, I love you. It's one of the greatest ways to test-drive a deal. And we're honest about that. If we don't put it in the contract, we'll at least verbalize that. Look, if you're buying a property out of state, get it under contract and put out not ads, but posts on Facebook, Craigslist. If you do an ad, you're pushing. We want just to be out there, we want people to come to us, because that gives us a true idea of demand. And then, every town has a local Facebook page. And I'm talking about not the official page, the unofficial one where people go there to gossip, they talk about the crime, the schools, the politics, the neighborhood bullies - get on those sites and say "I'm looking at buying this building. What are your thoughts?" Or hey, "Do you know anybody that can help me lease a vacancy? Do you have any friends that are business owners looking for office space, or that have an interest in leasing this retail spot for me?" Man, that's where things go to get done, and we push our brokers to do that. Often it's above them, or it's beneath them; we have to supplement it.
So if we give a listing to a broker, we'll still get on Facebook, Craigslist, and we'll do some guerilla marketing on our own. So I love that; yes, test-drive properties for free. You'll get your earnest money back; be honest with whoever it is that you're dealing with, and let them know what you're doing.
Travis Watts: Great answer.
Ash Patel: And a follow-up. If somebody's hesitant about that, just say, "Look, when this deal is done, if I don't end up buying it, I will turn over all of the context to you."
Travis Watts: Great point. How and when is the optimal time to bring up seller financing, so brokers and sellers can discuss that?
Ash Patel: Man, you guys are killing me with these questions. They're incredible. Great, great question. So the first thing you want to do is establish yourself. You don't want to leave with the offer seller financing. You want to say "Hey, look, I love this property. Tell me about the tenants." Ask some questions that show you're a bit seasoned. And if you're not, say "I'm working with a team", or "We're looking to take down similar types of properties." Ask them about is there fire suppression, number of parking spots, how old is the roof? How old are the HV/AC units? You go in there, act as if you know what you're doing to establish some credibility, and then say, "Are you flexible on price?" All that normal things. Get a lot of their time, their due diligence materials, and then find out as much as you can; stalk this person on social media, look at the history of the property, find out everything you can, and then find out if there's a pain point that you can address. What are you going to do with the money? Are you going to buy something else? Are you going to 1031 it? And the more you know, the more ammunition you have for that seller financing question. If somebody leads with that, if they shoot too early, I think you'll blow the deal.
Travis Watts: Great point. Last two questions here... What markets are you focusing on in 2022 and/or 2023?
Ash Patel: I love these questions. I am afraid of the markets that have had meteoric rises. Not buying in Scottsdale, not buying in Miami... I love suburbs. We're doing a lot in suburban Atlanta. Indiana suburbs... There's an exodus of people leaving Chicago, similar to what's going on with Californians moving to Texas, Chicagoans are moving to Indiana to get out of the political climate, the high tax rates, the lack of services... So look where no one else is looking. Don't be afraid to look in suburbs that are not on anyone's radar. Look for a deal. We don't buy markets. We don't buy areas, we buy deals. So look for that deal, the high cash on cash return.
Travis Watts: Love that. Last question, from David, when does your next mastermind open up?
Ash Patel: I will send you guys an email. We only take 20 people at a time, and it's four months long, it's intensive, and you have to be an established real estate person. You've got to be experienced, otherwise it's overwhelming. It's not for you. I want to make sure we don't waste your time and money... So I'll email you guys info on that.
Travis Watts: I appreciate that. And Ash, this has been amazing, man; you're such a wealth of knowledge. This is such a great educational series. Everybody, thanks for hanging out till the end. We almost retained a full retention rate all the way through, even though we're over an hour and 15 end of this. So again, if you joined later and want a repeat of this, we're going to have the recording. Ash is going to reach out with the details that he discussed.
I just want to thank everybody once again... This was how to pivot to non-residential commercial real estate during a recession. I'm your moderator, Travis Watts. Your host has been Ash Patel. Have a Best Ever week, everyone. Any closing thoughts, Ash?
Ash Patel: Yeah. Travis, you are awesome. Thanks for doing this with me. And to all of my Best Ever listeners - guys, thank you. I wish we can go another six hours and would keep doing this, but I'm so grateful for the time that you guys spent with me today. I hope you got a lot of value out of it. And remember, please take the blinders off; start looking at deals that are outside of your comfort zone. Push yourself. There's different times coming, there's different asset classes that might become very appealing, that might have great returns, so get rid of those blinders and start looking at everything. Guys, thank you.
Travis Watts: Thanks, everyone.
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