The team of Mike O’Meara and Mark Yates have been active in commercial leasing/sales, multi-family (apartment) investing, and commercial and single-family home development with over 70 years of combined experience. In commercial real estate (“CRE”), value is created on the most basic level by the entity paying rent and in most CRE properties this is a company/corporation. As an investor, remember your position/concerns are the exact same as the landlord! Here are a few CRE investment types and items/trends to be aware of:
Technology, trends in co-working “work in the field”, employers offering “work from home” options, and open concepts all lead to more efficient use of office space. Office tenants are using less office space more efficiently. Also, as office vacancies increase in many submarkets, competition across the US, competition to secure office tenant lease renewals puts pressure on the landlord to offer build out refurbishment allowances at renewal. The perpetuates the long breakeven to the landlord side just to keep the tenants in the facility. It is rare that an office tenant renews “as-is” with no request for build out refurbishment allowances.
As stated elsewhere, multi-family leases have low break evens on the front end and many tenants renew “as-is” with no cash outlay from the landlord.
Probably the most popular CFP investment offering due to wide variances in size of the centers from small neighborhood unanchored centers to huge anchored (large users like grocery stores, sporting goods, clothing stores, etc. as the anchor). The vast majority of tenants are local credit with high default risk- remember landlords know this and push the enormous build out costs to the tenant which increases default exponentially. The well-established, high credit anchors get a great economic front end package with artificially low rents- this is to draw the smaller tenants to the center. Anchor tenants are the “icing” on retail investments and will not carry a retail investment. The “cake” of this equation is the “mom and pop” retailers struggling to make rent each month.
The most popular investor subsection within retail is by far the single tenant (“ST”) offerings. ST exposures have been dealt at length elsewhere. The ST investor buys on a capitalization rate based on the ST credit and the net operating income. The ST investor routinely overpays for the ST facility as the rents are extremely bloated (based on land purchase, real estate commissions, construction, engineering/legal costs, etc.) and not market rents.
These are mostly owned by institutional owners/REIT’s so it is doubtful you will have a “opportunity” to directly invest in one of these other than buying stock shares on an exchange. A short analysis will drive home the overall retail market.
Mike attended a retail symposium in the late 1990’s. One expert stated that the internet would make it impossible to track gross sales (part of standard mall lease requiring “percentage rents” the tenant owes the landlord once an annual gross sale threshold is exceeded) and recommended to all landlords to disallow any mention of the company’s website on sack/bags/ or even in the store anywhere to discourage online sales. Obviously that mandate was outdated immediately. Again, online retailing was a treat back then and is currently sucking the life out of the retail industry and hence, the retail landlord/investor.
Sears is mostly gone, Toys ‘R Us is gone and other big box retailers are struggling. You are starting to see trade schools/ community colleges, churches, and other non-traditional retailers move in as mall operators struggle to get someone-anyone- to pay them rent.
The WHY for multi-family property investment
Bottom line, we view it as the lowest common denominator. Everyone needs a place to live/sleep and multi-family checks that box. Everyone needs a job but not everyone needs a traditional place to work and where they do work is changing as stated in the office and retail analysis. Why multi-family?
- Cash outlay to secure a tenant is low; sometimes repaint the inside, steam clean the carpet and a general clean-up/maid service. This is known as “turnover costs” and usually equals about 1 month’s rent.
- Brokerage fees are low and mostly non-existent. Most tenants walk into the leasing office and sign a lease with the landlord’s manager on the payroll. Again- lowering the landlord cash outlay.
- Leases are short-term, 6-12 months are typical. Good management keeps tenants in place with little to no cash outlay to renew the tenant. Most tenants won’t relocate with modest $10-$20 per month increases and each lease renewal.
- Millennials and recent college graduates with crushing student loans and massive credit card debt. This cross section will move in their parents and their obvious next step is to rent an apartment. Personal finances make it near impossible to save a 5-10% down payment to purchase a home.
- Millennials are also delaying marriage and a reasonable assumption would be that they will be renters longer due to this.
- Millennials also do not like to be tethered to a desk in an office and SURE do not want to be anchored to a 30-year mortgage. They tend to divert discretionary spending AWAY from real estate and invest in experiences like trips and have a high emphasis on social activities away from their home. Some new multi-family development is catering to the millennial trend by building a higher percentage (over 50% of the total unit mix) of studio/micro units of approx. 350 square feet. Attracting this segment with high end technology (great internet/WIFI hotspots), environmentally friendly services like LED lighting/recycling/composting, etc. are easy to add on to attract and retain this large segment of renters.