Before becoming a full-time commercial investor, Sean Katona worked at Microsoft and EA Sports selling X-Box ads to automotive manufacturers and Hollywood studios. In 2013, he turned his side hustle into a full-time career, and as he says, he’s been “failing forward ever since.” Today, Sean spends his time seeking out fixer-upper commercial deals in the Greater Phoenix area. In this episode, Sean discusses the ins and outs of value-add commercial real estate and the toughest lessons he’s learned in his career so far.
Sean’s Tips for Investing in Value-Add Non-Residential Commercial Real Estate
- Don’t be afraid to say no to deals. Sean wanted his first commercial deal to be a great one, so he remained cautious and said no to several deals over one or two years before closing on a defunct shopping center in 2017, with which he made a profit of $1.5M in 16 months.
- Buy broken deals that you can force substantial appreciation into. Sean has been doing this since his house flipping days, and it still serves him well in commercial real estate. “I just feel like it allows us to build wealth so much faster when I can double the value of a property, or I can effectively own 10% or 11% caps instead of 6% or 7% caps,” he says.
- Don’t worry too much about incoming cap rates. Especially when you’re buying a vacant building at a 0% cap rate. When Sean is done renovating and leasing, he’s often able to turn a 1% or 2% cap rate into a 9%, 10%, or even 12% cap rate.
- Work with brokers to find deals. Sean says he leans heavily on brokers to help him find deals, and he spends lots of time networking and making calls to them. “I try and honor the brokers and I just say look, paying commission is part of the game,” he says. “It’s part of the tax, and I’m going to pay that because I want to do five deals with this broker, and I want to become their favorite buyer around town.”
- Offer a tenant improvement allowance at lease signing. By offering to contribute a certain amount of money per foot to help your commercial tenant build up their space, you can make additional income and increase the value of your property.
- Work with your struggling mom-and-pop tenants. Sean says he uses a “honey and vinegar” approach with mom-and-pop tenants whose businesses might be struggling, offering to help tenants get back on their feet through co-marketing, filling in more vacancies, or relieving a month of rent and rolling it into subsequent months.
Sean Katona | Real Estate Background
- Founder of Simplified Properties, which invests in value-add retail/shopping centers in Phoenix, AZ.
- Portfolio: GP of retail/shopping centers, multifamily, storage, and mobile home parks, having closed 79 deals
- First episode on the show: JF316: How to Solve A Real Estate Problem On the INTERNET
- Based in: Huntington Beach, CA
- Say hi to him at:
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Ash Patel: Hello Best Ever listeners. Welcome to the Best Real Estate Investing Advice Ever Show. I'm Ash Patel and I'm with today's guest, Sean Katona. Sean is joining us from Huntington Beach, California. He is the founder of Simplified Properties which invests in value-add retail and shopping centers in Phoenix, Arizona. Ryan has closed on almost 80 deals including retail, multifamily, storage, and mobile home parks. He is also a return guest. It was on episode 316, almost 2000 episodes ago. If you Google Joe Fairless and Sean Katona, his episodes will pop up. Sean, thank you so much for joining us and how are you today?
Sean Katona: I'm doing great. Excited to be back here, and congratulations on getting thousands of episodes done in between my last visit. That's quite the accomplishment.
Ash Patel: Sean, we're glad to have you back. Before we get started, can you give the Best Ever listeners a little bit more about your background and what you're focused on now?
Sean Katona: Today, I spend most of my time looking for fixer-upper commercial deals in Greater Phoenix. Prior to becoming a full-time commercial investor, I worked at Microsoft and EA Sports, and grinding away in Corporate America. I sold Xbox ads to automotive manufacturers, to Hollywood Studios, and Real Estate was my side hustle. I was moonlighting, and fumbled my way through a couple of rentals and house flips and made a full-time go at it in 2013. I guess it's just been failing forward ever since there. I've got plenty of scrapes and bruises and lessons learned the hard way over the last decade or so.
Ash Patel: Sean, you started out in residential single-family homes?
Sean Katona: Yep, up in Seattle. I bought a fixer-upper rental that ended up being cash flow negative, but turned into an accidental profitable flip. That's how that one went okay, but not as intended.
Ash Patel: How did you get into commercial?
Sean Katona: I actually had a couple of residential deals go really sideways. Maybe we'll circle back to that, but it reached the point where I had 15 projects going simultaneously. One summer, I started to feel like an adult babysitter when it came to the construction side of things. I just kind of stepped back and said, "Hey, maybe I do fewer, bigger projects that are better suited for a long-term hold." The whole reason I got into this was for cash flow and passive income, like so many of us probably do. That asset class I think just lends itself better. Once you understand the numbers, once you understand the tax advantages, once you understand how to put larger deals together, it just makes sense from an opportunity cost standpoint to focus on bigger deals. I think I work a lot less and I'm making more than all of those residential deals, so that's a win for me.
Ash Patel: When you climbed that ladder to get to commercial - and Best Ever listeners, I think I'm going to speak for Sean as well, but when we say commercial, we mean non-residential commercial. I know the multifamily guys always want to argue that point... But I'm the host, we're calling it commercial. Did you climb over multifamily when you got to commercial?
Sean Katona: I looked a lot for a great apartment deal. I closed that first shopping center back in 2017, but not before looking for at least a year, probably two, at apartments all up and down the West Coast. Just shaking my head going, "Wow, it's hard to find a good value-add deal with significant upside, that I felt comfortable with, that wasn't in a crazy market." So I actually found what I thought was a safer bet, believe it or not, in a defunct shopping center outside of Phoenix, that was bank-owned, that had basically gone month to month on every single tenant. That was my first commercial deal if you want to think of it that way. It was a $2 million purchase that had a seven-figure profit by the time we exited it about a year and a half later, so that was it.
I looked at a lot of deals, and I said no to a lot of deals, I false-started on a lot of deals, LOIs, purchase and sale agreements, and due diligence where I just didn't quite feel comfortable. I said, "Hey, for my first one out of the gate here, I want to nail this and have a nice jumping-off point and something to build a resume, versus maybe going for a so-so deal." I was pretty cautious you might say.
Ash Patel: Sean, can we dive into the numbers on that first shopping center?
Sean Katona: Yeah, I bought that for $1.95 million. As I mentioned, REO from a bank that wanted to get it off their books. It involves a funky lot split which created a really long escrow, but the bank worked with me through that whole process. I went in and renewed all those leases, backfilled a couple of tenants that we had to swap out, got a very stabilized asset by the time it was all said and done, about 16 months later. Then we eventually sold that deal for $3.5 million. We're into it for just about two, sold it for three and a half, so that's where you get that seven-figure profit out of that deal, plus the tax advantages, plus the cash flow along the way. So that one was life-changing for me, for my family, and for the friends who invested alongside us in that deal... It really got us rolling. I've stuck with Phoenix since then. I think I've gone on to buy seven other deals around the town of various shapes and sizes. It's what I spend most of my time working on today.
Ash Patel: That's incredible. So just by renewing leases and improving certain tenant mixes, you were able to profit over $1.5 million in a very short amount of time.
Sean Katona: And I bought it right, the bank gave me a pretty good basis on it, and we probably did some rent bumps and found ways to increase that net operating income of the property. As you know, and many of our watchers or listeners, the value has a direct correlation to the NOI. That drove up the value of the building. We forced appreciation into it by being able to do that. I think that's why so many of us love apartments and love commercial real estate for the same reason. You compare that with remodeling a kitchen or doing a single-family - you're limited by what the neighbor's house sold for the comparable. In this case, it's so much more heavily weighted by the income of the property.
Ash Patel: Sean, I mentor a lot of multifamily people and teach them how to buy commercial real estate, and I really want to turn this episode into convincing my residential and multifamily investors to look at commercial properties. I'm going to try to refrain from that. But if you're okay, I would love to record another episode on that, convincing the multifamily operators out there to look... I'm not saying change their whole mindset, but at least look at commercial deals. Are you good with that coming back for another episode?
Sean Katona: I love the idea and I'll approach it from an abundant standpoint, because it's like you think of all the apartment guys operating on razor-thin margins coming into the commercial space... But look, there are a lot of tired old deals out there that need to be revitalized, so we can collectively work at turning that around. I'll give a little teaser. I don't buy a commercial deal unless there's at least a 50% upside in the deal. Usually, those are high vacancy, or kind of defunct, or underperforming, or landlords that are tired or don't want to invest the money into the deal... But I haven't seen too many apartment deals with that much lift, aside from maybe the market insanity and values and what people have been willing to pay for these last couple of years. Maybe it made a lot of folks look good, or they didn't have to do a whole lot of work to realize some of those values.
Ash Patel: I agree. When you say 50%, is that from purchase to sale, a 50% increase?
Sean Katona: I'm just saying, look, I'm going to be into it for 2 million, and I want it to be worth at least 3 million after I'm all said and done. And if I only sell it for 33% more than I bought it for, that's enough margin and cushion and room for error that if I go a little over on construction costs, or leasing commission, or interest rates go up 1% or 2%, that there's still going to be the ability to have some good equity built-in there if we want to hold, or to sell it for a profit if we want to exit sooner than later.
Ash Patel: Also, right now people are still suffering from the post-COVID effects. They all think, "Oh, there's a retail apocalypse. Retail's dead. Amazon." And you're buying half vacant strip centers? What's your answer to those folks?
Sean Katona: I sat patiently through 2020 waiting for opportunities to go in and solve problems. Which is a very thoughtful way to say blood in the streets. I thought, "Hey, there's going to be a ton of distressed landlords. There are going to be people who can't make their rent payments. There's going to be buildings and banks foreclosing." What was insane to me is none of that seemed to happen. Programs like PPP and banks working with borrowers seemed to work so effectively that I didn't see hardly any distressed inventory hit the market. At least where I was looking, which was retail, shopping centers all across Greater Phoenix, talking to dozens of brokers every single week. They're going, "If there was a deal, I would have brought it to you." But I just didn't see that.
Through that process, I lost a gym that we had to backfill and replace, so that was challenging. By the way, that was a guy who was looking to retire and I think used it as a great get-out-of-jail-free card. But I just didn't see I think what a lot of people were hearing in the press and going, "Oh, the sky is falling." My biggest challenge in this business is finding enough distressed deals. I've got gobs of capital sitting on the sidelines, I've got friends and family who want to park money, and I'm just trying to be disciplined to wait for another unicorn to come along, or to source one.
Those are not as easy to find when there's so much capital chasing so few inventory, and so many people trying to get ahead of inflation, and debt that's at insanely cheap levels. All those factors combined are creating just a frenzy or a crazy amount of increase in values, in prices that people are willing to pay, in baking in future rent increases and hoping that cap rates are going to continue to compress. To me, it feels like a little speculative, a little frothy. So being as disciplined as I can to make sure we're buying right. You've heard the saying, “We make our money on the buy and we're going to do the work to increase the value.” But I see a lot of people paying prices that are hard to fathom.
Ash Patel: I'm with you. When we buy properties, there's so much margin for error; we don't have to execute flawlessly. So what if 20% of the roof needs to get redone and we miss that? So what if this tenant leaves? We're buying those unicorns, so there's so much margin for error. What's your threshold on the value-add? Will you buy a former JC Penney with a strip mall attached to it?
Sean Katona: I stayed away from JC Penney. I did just buy a vacant drugstore on a beautiful hard corner in Tempe, Arizona. So I've got no income, I'm bleeding on that every month while I'm working on it. But we are at lease with the user to take over that entire site. So I bought that on spec, but we had so much interest and inquiry from tenants, even while we were in escrow, that it just made me confident that over the course of the year I'd probably land a user and be able to significantly increase the value of that property. I'll give you a little teaser on the number... My basis on that is about 2.6 million, but if we realize this lease and get this user open, the value of the property will immediately jump to over 5 million. So we could turn around and sell it for a nice profit, or maybe I hold on to that for a generational asset that my fellow investors... That sends my kids to college, just that one deal.
Ash Patel: What's the user coming in? What type of business?
Sean Katona: I can't share that just yet, because it's still in progress. But it wouldn't be that hard to figure out the types of users that want to locate on a hard corner with 60,000 cars a day passing by, in an affluent neighborhood. There are a lot of users that fit those categories. Tell you what - maybe that's worth doing a follow-up with. If that deal is approved by the city, approved by the neighbors, I'll be very excited to announce it.
Ash Patel: Is it a teardown or are they going to keep the existing building?
Sean Katona: In a lot of cases, they would retrofit that. It turns out drugstores are kind of hard to retrofit just because of the shape and the depth. We looked at schools that might be able to retrofit that, there were a bunch of retail users, potentially even gyms, and a couple of automotive folks that took a look at it... A lot of ways to do it; it certainly could be scraped. It almost feels like a tragedy to do that on a pretty nice new beautiful building, but we'll see.
Ash Patel: So you can't answer if it's a teardown?
Sean Katona: I don't think that's a smart thing to do at this time.
Ash Patel: We see a ton of former Rite Aids, a ton of former Walgreens. I've tried to research what people are doing with them. What have you seen out there on repurposing them? Because it's such a unique building. The giant glass in the front... What have you seen in terms of people repurposing former pharmacies?
Sean Katona: Some of the stuff that I see a lot of - and I'll go beyond just the drugstores; in Phoenix, you see a lot of trampoline parks popping up in big boxes, or splitting a bigger box into maybe two different spaces. We had interest from a couple of different schools; this drugstore had a drive-thru attached to it, so there was some interest there from food or beverage users. We had a sports academy that looked at taking over the entire thing.
Really, anyone who's going to benefit from that much traffic and density; and in this case, that neighborhood had a high household income, but that's obviously not every drugstore. Those are the types of users that we got the most interest from on this particular deal.
Ash Patel: Sean, do you look for national tenants strip mall, do you look for mom-and-pops, or both?
Sean Katona: I've probably been two-thirds on the mom-and-pop side throughout my career. I love national credit tenants, because you're probably going to have more compressed cap rates, you've probably got more certainty that they're going to pay the rent every month. A lot of times buyers are more excited by those name-brand tenants. What was wild, particularly during COVID, is you saw mom-and-pops getting scrappy and fighting for their survival and their life, maybe more so than some of the big boys, who just said, "You know what? We're going to put our lawyer on this and stop making payments to you."
I think I've warmed up a little bit towards the local owner-operator whose life is that business, and whose livelihood is that business. It's fun to see folks who live in that community being supported by that community. The center that I'm working on now in Mesa has a mix of a couple of national tenants and a couple of mom-and-pops. We're just thinking about the synergy between those tenants, and are they going to be complimentary? Do they help drive foot traffic for one another? Are they going to survive our five, seven, or 10-year lease term if we make an investment to help build out their space?
Ash Patel: Now, a lot of good points in what you just said; let's start with lease term. When you have a mom-and-pop tenant versus a national tenant, if Starbucks comes in and they sign a corporate guarantee lease, the only way they can typically get out of it is if the entire corporation files for bankruptcy, or their lawyers get creative. But when you have a mom-and-pop tenant and their business fails, what recourse do you have?
Sean Katona: Pretty much every lease that we sign with a mom-and-pop is going to have a personal guarantee. In Arizona, that's the husband and the wife who are pledging their personal assets. The LLC will sign, but they will also personally guarantee. Fortunately, I haven't had too many of these deals go sideways, but you could really go after them for just about everything, like a bank would.
My approach has been a little more honey than vinegar and just say, "Let's work with you. If you're hitting a speed bump or a hiccup, how can we make your business successful here? Do you need more customers? Can we help with some co-marketing? Do you need us to help fill in more vacancies? Do you want us to maybe relieve a month of rent and then roll that into the subsequent months? What's going to allow you to be successful here?" Hopefully, before I've bought a deal, done our due diligence on a tenant, and when we're putting in a new tenant, we've looked at their credit, their FICO, their cash reserves... We know what it takes for them to get open and how long it takes. We'll give them a few months of free rent so they can get operational and start making money before they're really having to start to make those rent payments every month.
I think if we're doing our job as a landlord-operator, then we're underwriting our tenants just like the banks underwrite us as borrowers, conservatively and cautiously, and stress-testing those deals and making sure that they have a high probability of succeeding. No deal is perfect, no operators are perfect, and crazy things happen. But the risk to reward is balanced here, and most of the time I'm looking at it going, "Okay, I'm out leasing commission, I'm out $5 a foot in tenant improvement allowance, I've got a security deposit, I've got the first month's rent, so I'm not that far over my ski tips if this thing were to go sideways, even within the first year of operation."
Ash Patel: Yeah, I love that and there are a lot of different ways to approach that. You can even say, "Listen, let's both try to find another tenant to replace you. Keep paying rent until we do that." So many solutions where you and I are not going to file a judgment against them and take all their assets and destroy their lives. There are a lot of other options. But the benefit is I've seen a lot of Dollar Generals, Rite Aids etc, when they go dark early, that landlord often can get a couple years of rent without the tenant being there. So you almost have two years to find the next tenant.
Sean Katona: I've had some of my colleagues do workouts or buyouts where they're getting 60 or 70 cents for the entire value of the lease. If you've got 2 million bucks scheduled to come in over the next couple of years, they're paying you 1.5 upfront, and then you can go out and hunt for your next tenant in some cases.
Ash Patel: What kind of cap rates are you buying at?
Sean Katona: Oh, man... They seem to be compressing every month. I don't look a whole lot at the incoming cap rate of a deal, especially when you're buying a vacant building; that's a zero cap. The same thing, I just bought a deal with 60%, 70%, 80% vacancy - that's a one or a two cap in some places. You're thinking, "Sean, you're crazy." But I'm buying that because I can turn it into a nine a 10 or a 12 cap after I fill this building up, after I hold on to it, because I've got a really low-cost basis, because I'm buying it busted. I can sit on that and say, "Hey, I have a buy-and-hold in my portfolio effectively at a 10 or 11 cap."
In Phoenix, a market where that probably trades at a six to a seven and a quarter cap, depending on the asset and the neighborhood. You can say "Whoa." That's why you could sell it for twice what you might be into it for. You got effectively a 12 cap, turn around and sell it for a six cap; that's a pretty good business.
What I see stabilized deals trading at in Greater Phoenix in this asset class is I guess 6.5% to maybe 7.25% now. Obviously, there's a wide range there; you'll see single tenant net lease deals getting down into the low fours, but you've got mom-and-pop in so-so areas that might be in the higher sevens.
Break: [00:21:25] - [00:23:12]
Ash Patel: For the Best Ever listeners, what Sean's talking about, single-tenant net lease - imagine your standalone Starbucks or standalone Chipotle. Those trade high threes, I've even seen, and low fours, which is insane. That brings me to my next point, lending. What kind of debt are you able to secure on these properties?
Sean Katona: Okay, so get this... I personally guaranteed the last two loans that we did with a regional bank. Sat down, met with them, dinner, a personal relationship here. But they did 4% loans, interest-only for 18 months on a vacant building. Obviously, that required sponsorship, resume, funds, liquidity, great credit score for them to feel comfortable doing that. It was basically a hard money loan from a bank. But that same exact bank just quoted a refinancing, my other single tenant net lease deal in Gilbert, Arizona for 5.25%.
So in October, when I closed that last deal to now, rates have gone up 1.5%. That's on a stabilized, 100% occupied deal, with a 10-year lease term. Do the math on that. A 1.5% increase in the cost of borrowing, what is that? 20%-30% increase in the cost of debt? It's insane.
What that's going to do to the value of the property is insane, too. I think as we're all pursuing new deals, we need to be underwriting 5% to 6% or 6%+ debt, and then think about as the Fed does six, seven, eight rate hikes over the next couple of years, what is your next buyer going to be paying if they're picking it up from you in two years, if you're someone who's turning around and flipping these deals? Or lock in as much long-term fixed-rate debt for as long as you possibly can if you can get deals in the fours or even the fives. I think that'll probably be looking pretty good if you go out a year or two or three, if the trend continues; with them trying to [unintelligible 00:25:09.23] down inflation, rates are probably going to continue to rise pretty quickly. What that does to the value of the buildings has a direct correlation.
Ash Patel: That's across every asset class. You have to underwrite for your exit cap to be higher, or worse than your entrance cap. So important. Good point. In terms of your loan, how long is that rate locked for?
Sean Katona: I think I bought up the one to a seven-year deal. I paid a little higher interest rate to have that certainty, that extra two years. Most of the banks that I've talked to want to see your lease terms correlate to your loan term. They're not going to give you seven or 10-year money when you only have five-year leases. If you've got 10-year leases, you're more likely to get that 10-year money, so that seems to be their comfort level. The brokers or the banks will price that all in. I asked for a couple of options, "Hey, what's five-year money cost me? What's seven-year? What's 10-year money cost me?" I think at this point, my stance is to pay a little more to have that long-term debt, because 5% three years from now is probably going to be sounding real good.
Ash Patel: Sean, that seems like a perfect storm. Your lease expires in seven years, and your loan comes due in seven years. What do you do?
Sean Katona: You go find deals like that and you buy them from people who've not been able to renew those, or in a position where maybe they busted their loan covenant, maybe their debt service coverage ratio is no longer in line, maybe they're having to come out of pocket, the appraisal didn't come in and now they have to bring money to the table to get the refinance done, or they're having to do bridge capital. That's not a good situation to be in for anybody. So I would want to be out ahead of that, and if I have a multi-tenant building, have those leases staggered, so I'm not having all my income go out at once, but give yourself some time to backfill those, or get a jumpstart on it. I've done early renewals with a lot of tenants, and in some cases even bumped rent; say, "Hey, let me help you with a new sign on your building. Let me give you a TI package to freshen up your suite, and we'll do some things. And I make an investment in you, and you commit to another seven years with me at this slight increase in rent, but you've got a much better space, and we've got a collectively much better-looking shopping center here, too."
Ash Patel: How are you finding deals?
Sean Katona: My number one channel is through brokers. I've spent a lot of time just networking and calling the folks who are doing deal-making around town. In fact, I did a little show this last year called Dealmakers where I was predominantly chatting with leasing brokers, with buy-sell brokers in Greater Phoenix who focus on shopping centers and retail. So I could learn, my audience could learn, my investors could learn, so I could forge deeper relationships with those brokers. They see stuff off-market, they're calling landlords all day long for listings... The folks working on leasing know who's going out, know what's coming in, know landlords who aren't willing to do tenant improvement allowance, who may be cheap on commissions, and who are slow to respond...
There's no one that I probably lean on more heavily than active brokers in the community. I've got so many amazing brokers that I've been fortunate to build relationships with, who've brought me off-market deals, who's been in a position to represent me on the buy-side, to help with the lease-up, to turn around and relist the property for a substantial increase in value... And if they're smart, they've got enough lead time to go find a 1031 buyer to go buy that property on the back end. There's an opportunity for four sides of the commission if they're working with me through that whole process.
I certainly dabbled in direct mail; it's been a little less fruitful for me. In some cases, I'll do some outreach. But I try and honor the brokers and I just say, "Look, paying commission is part of the game, it's part of the tax, and I'm going to pay that because I want to do five deals with this broker, and I want to become their favorite buyer around town; the easiest to work with, the guy who gets deals done, who does what he says he's going to do." I think that will over the long haul probably pay the most dividends.
Ash Patel: Sean, several times you've mentioned TI and tenant improvement allowance. Can you share with our Best Ever listeners how that works and what that is?
Sean Katona: Right. In retail, it's pretty common - not always - for the landlord to offer a tenant improvement allowance at a lease signing. Let's say we have a plain vanilla shell, it's a box, and if it's a restaurant going in there, they need a grease trap, they need plumbing, they need electrical. They're going to spend probably well into the six figures to get a place built out. Think about some of the nice restaurants you've been in and what they've spent on just the decorations, the fixturization, and the finishes. So the landlord can contribute to that, or you can say, "I'm willing to spend $10 a foot towards this, or $25 a foot", or... What does medical want now? $80 a foot towards their buildout. But they're going to sign a 10-year lease, and it's with a corporate tenant. You look at that you say "Hey, I'm going to make my money back over X number of years". What I might be able to do is even buy up the rent and say, "Hey, rather than getting $15 a foot, I'm going to be able to charge $18 a foot." We're financing that build-out costs back into their lease. Oh, by the way, now that I've got that much additional income, what happens to the value of my property? Obviously, every month we're getting more income and more cash flow, but you take that NOI, you do the math at a six cap, and you say, "Hey, by doing that TI improvement, that increases my building by another three, four, five hundred thousand dollars, potentially."
Ash Patel: For the multifamily guys out there, it's the equivalent of giving your tenant 500 bucks and telling them, "Paint the apartment, renovate the kitchen, and we're going to increase your rent as well." It's essentially what it is.
Sean Katona: And what's beautiful with the structure is we're reimbursing them for the work that's already done and completed. They have their contractor go do it, they get the lien waivers signed, they show proof of payment and the job's complete. Then you cut them a check and say, "Great, you're now open for business."
Ash Patel: That's incredible. Sean, what's your best real estate investing advice ever?
Sean Katona: Probably my guiding North Star is to buy broken deals that I can force substantial appreciation into. I think those would be the main lesson that I would try and instill in my kids, my younger self. If I think back, I've been doing that since the house flipping days. I do it today in the commercial days. I just feel like it allows us to build wealth so much faster when I can double the value of a property. Or I can effectively own 10 or 11 caps instead of six or seven caps. If I can realize 10 or 12 years of cashflow in 14 months turning around a deal, that opens up doors that wouldn't be possible just going out and paying full retail price, seven cap all day long based on existing income.
That works for me, because I do this full-time, because I've got relationships, teams, contractors, and vendors. I can make that work. It doesn't make sense for folks who are doctors or dentists doing their careers all day long every day. You need someone to go in there and -- these are just grinders. I spend over a year getting these things renovated and leased up, and nonstop calls with brokers and contractors, all the vendors and the architects, and everyone in between, to get them there, to realize that seven-figure profit. But that's made me the most money over the years that will continue. It's at an eight-figure skill annually that we can exercise. And I think it helps to de-risk some of the deals, too. If I'm buying something well below replacement costs, I've got a ton of equity, I've got a great debt service coverage ratio, and the zombie apocalypse comes along - okay, I could hold this deal and still be in pretty good shape. Stuff that we have in our portfolio now is stuff that I'd be happy to hold for a longer time.
We've rejiggered our portfolio a little bit recently because of that. It's just like, "Hey, let's get into some stuff that feels even safer, that's higher quality, that's better locations, that's going to be in demand for leasing for years to come. Add all those things together, I think we're going to be in good shape."
That's whether you're doing houses, apartment buildings, warehouse, shopping centers, I just think that's a good philosophy. You can do like value-add, you could be doing heavy value-add, and that's how hard someone wants to work at it or even what their risk tolerance is. It's going to be different for everyone, every asset class, every market.
Ash Patel: Sean, what's an example of a hard lesson that you learned? Not like surface hard lesson; one that you got your teeth kicked in on? A really, really tough lesson that you learned.
Sean Katona: My lowest low was in residential. Thank God, it was a six-figure versus a seven-figure mistake. But I lost over 100 grand on a house flip just outside of Seattle. About everything went wrong that could in terms of surprises. I'll give you the specifics. Didn't realize we had a bum septic tank - there's 35k. Oh, by the way, it was four months to get it through permitting while I got a 12% hard money loan on it, so add up what that works out to be. Then we were ambitious on the exit value, construction costs obviously ran over, so you had the perfect storm of high carrying cost, lower exit price, higher construction costs - obliterated profit, and I'm writing a six-figure check just to get out of that deal.
Then what's worse is probably I just put my head in the sand on that, and instead of really facing it, I drug it out. I was just like, "Let's hold out for the price or let's do this." Meanwhile, 12% carrying costs every single day is just eating you alive. I've gotten more conservative with my high-interest loans and the amount of debt that I'll carry. Immediately following that, I lost another six figures on the next deal. So I have over 200,000 in deals gone sideways near the end of my residential career. We've done 50 deals successfully, we knew what we were doing, but I think I got going too fast, I think contractors overpromised... I moved down to Southern California in the middle of flipping houses in Seattle... All those things, just horrible.
Commercial is ultimately what helped me to recover from that. That one deal down in Arizona that had seven figures of profit allowed me to get whole, get caught up with all my investors, and probably more important than anything, rebuild a lot of confidence that was just obliterated through that process. I mean, that was miserable, that's tough on you personally, that's tough on your marriage, that's tough on your psyche, and everything in between.
Ash Patel: I got chills as you're telling that story. Thank you for sharing that. I think it's so important that you share that. These are the battle-hardened scars that help you in your decision-making today. It's an amazing thing. We've all had those experiences where we've gotten our teeth kicked in. Amazing. Sean, are you ready for the Best Ever lightning round?
Sean Katona: Let's hit it.
Ash Patel: Sean, what's the Best Ever book you've recently read?
Sean Katona: One that I really liked is called Who, Not How by Dan Sullivan. I'm in a program called Strategic Coach, so he chairs that program. He authored that book, and it just makes so much sense, or maybe even dollars, if you want to think about it that way. Kind of a similar concept to what you learned over an E-Myth, but it was nice to hear it from a different viewpoint. It really just reiterated to me that I am so bad at so many things. Really surrounding myself with a great team with incredible vendors, specialists, and masters of their craft is really going to allow me and us collectively as investors to accomplish so much more, to probably be a lot happier, to spend more time in our unique ability, doing what we love, what we're good at, what fires us up, and trying to get as much of the stuff that bogs us down off of our plate as possible.
Ash Patel: That's a game-changing book. Sean, what's the Best Ever way you like to give back?
Sean Katona: I love anything that helps kids get financial education, literacy, motivation. Just prepares them to be ready to face the real world, to be resourceful. I've done a lot of teaching in real estate seminars - not just to kids, but to other aspiring investors. I've been sharing a little bit more on social media of just what we have going on on a week-by-week basis, in hopes that someone else learns a few gems or lessons that I learned the hard way and they don't have to go through that same experience, but giving more folks the exposure to what's possible in this business.
That's real estate investing, but maybe even more so commercial. Because one or two of these deals in portfolio could literally retire a spouse, or set up a family for a generation or generations to come if we can put a handful of these together. I think about that with my own kids, I think about it with the next generation of kids, and anything that can help get them set up to be ambitious and go pursue things like that, I think is awesome.
Ash Patel: Sean, how can the Best Ever listeners reach out to you?
Sean Katona: I love LinkedIn, because I can see who people are and who we know, so definitely search me up on LinkedIn. If you go to simplifiedproperties.com, all my information is up there, all my social media is there, and you can see some of the stuff that I have going on at any given moment. I've got information on investing there, what my buying criteria are there, and we started to do even more around information for tenants. Aspiring business owners who are opening their first location or their 15th location to understand what it's like to open a brick-and-mortar store in a commercial building or a shopping center.
Ash Patel: Sean, thank you so much for spending your time with us today, showing us some of the ins and outs of value-add commercial real estate, inspiring my residential and multifamily audience to look at commercial real estate. Thank you again for your time
Sean Katona: Absolute pleasure. Thank you, guys, for organizing this. I know it takes a lot of work. I'm grateful and I know all the listeners are as well. Thank you so much.
Ash Patel: Best Ever listeners. Thank you so much for joining us. If you enjoyed this episode, please leave us a five-star review, and share the podcast with someone you think can benefit from it. Also, follow, subscribe, and have a Best Ever day.
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