How a Pharmacist Bought a Five Million Dollar Strip Mall
Tanh Truong discusses the differences and similarities between the residential and commercial real estate spaces and why he purchased a five million dollar strip mall.
About Today’s Guest
Tanh Truong is a full-time commercial real estate investor. He graduated from the University of Cincinnati PharmD program in 2017 and has practiced as a community pharmacist for approximately three years. A thoroughbred of Cincinnati, he invests locally in high-yielding assets and higher-yielding relationships. Aside from investing, Tanh is a connoisseur of finance with a macro focus, an expert foodie, and a lover of self-improvement books.
Episode Summary
Nate Hedrick and David Bright welcome Tanh Truong back to the show for his second appearance on the YFP Real Estate Investing Podcast. With an impressive history in real estate investing, Tanh raises the investment bar among pharmacists, having jumped in with a five million dollar building and a goal to buy even more than that throughout the year. During the conversation, Tanh shares the final details of the deal with us and lets us in on where he found it. He unpacks how commercial real estate investors can use cap rates to gauge how well a property is doing and what you should base your research on. Tanh tells us why it is so valuable to bring tenants into the commercial space and increase rents for the benefit of the property value. He talks us through some of the differences between residential and commercial investments. Tanh then shares what led him to invest in commercial real estate over residential homes. He explains that he sees his role as going beyond being a landlord, helping tenants succeed within their businesses. Tanh shares the process of navigating the due diligence phase in commercial investments and how ownership is divided among investment partners.
Key Points From This Episode
- An introduction to today’s guest, Tanh Truong, and his five million dollar investment.
- The building’s location, size, tenants, and price.
- How he discovered the deal on a poorly marketed website.
- The two anchor tenants: Dollar Tree and Loman’s Furniture.
- What led him to consider investing in commercial property over residential homes.
- How cap rates are used to measure how well a property is doing.
- Why a higher cap rate usually means that a property is operating well.
- Which cap rate you should look for and what you should base this on.
- The total expenses involved in the five million dollar deal and what this translates to.
- How bringing tenants into a space and getting the rents up increases the value of the property.
- How the deal flow differs between single and multi-family property and commercial property.
- How Tanh had to leverage his partners in order to qualify for the loan he needed.
- Why traffic count is important for your plaza to actually succeed.
- Navigating the due diligence phase in commercial investments.
- Why he sees his role as a landlord as helping his tenants to succeed.
- How Tanh feels about the future of cap rates.
- The typical division of ownership among partners.
- Why Tanh is choosing to focus his energy on the commercial realm.
Highlights
“For me, jumping into the commercial space was more of a higher quality of investment if you will, because you know, when you’re investing in residential, you get all the horror stories.” — Tanh Truong, PharmD [0:06:07]
“In terms of which cap rate you should look for, the term is dependent upon the investor themselves. If for me, I generally like to aim for a cash-on-cash return that’s roughly around 20% or so, whereas a coastal investor might be content with 10%.” — Tanh Truong, PharmD [0:09:52]
“In the due diligence phase, you obviously want to know where the heavy items are. The asphalt, the roof, those are very, very expensive fixes from what I found out.” — Tanh Truong, PharmD [0:27:14]
“We want our tenants to succeed so that the power of giving keeps recycling itself, so that the tenants stay there for a long or even if they don’t, maybe word of mouth can improve our tenant flow.” — Tanh Truong, PharmD [0:33:44]
Links Mentioned in Today’s Episode
- YFP Real Estate Investing 04: How (and WHY) One Pharmacist Got Started in Real Estate Investing
- YFP Real Estate Investing
- Join the YFP Real Estate Investing Facebook Group
- Your Financial Pharmacist Disclaimer and Disclosures
Episode Transcript
[INTRODUCTION]
[0:00:00.4] NH: Hello and welcome to the Your Financial Pharmacist Real Estate Investing Podcast, a show all about empowering pharmacists to achieve financial freedom through real estate investing. I’m Nate Hedrick and each week, my co-host David Bright and I explore stories from pharmacists all over the country, who are achieving their real estate goals while maintaining a meaningful career in pharmacy.
Whether you’re a first-time investor or a seasoned pro, we’re here to provide education and inspiration about the world of real estate. Please note, this podcast is intended for educational purposes only and should not be considered financial or investment advice.
[INTERVIEW]
[0:00:42.5] NH: Hey, David, how’s it going?
[0:00:44.7] DB: Hey, good thanks, how are you doing man?
[0:00:46.3] NH: I am quite well, sir. We’re snowed in here up in Ohio but otherwise doing really well.
[0:00:51.6] DB: Yeah, it is winter for sure which I know in my land means fewer things going up for sale, fewer things going up for rent but I know you just got a project done that you’re starting a market for rent here.
[0:01:02.3] NH: Yeah, just finally finished a project. It was dragging on for a little while just because we had some eviction issues and just the project took a while but now we’re up and running and up for rent and should be tenanted pretty soon according to my property manager so excited about that one. What about you guys?
[0:01:17.6] DB: We’re seeing the market opening up a little bit here with a few more things out there so we recently got another project under contract, it’s a fixer upper and before we talk to today’s guest, I was really excited that this property we’re able to find under $50,000 and I thought, that was a big win but now I feel like my dreams are completely insignificant and way too small because today’s guest jumped in with a five million dollar building and a goal to buy even way more than that throughout the rest of the year.
[0:01:44.3] NH: Yes, before you fall out of your chair with those numbers. I promise, we’ll bring it back to relevance and you’ll actually recognize this guest if you’ve been following the show for a while so we brought Tanh Truong back on the show from episode four, and just super inspirational guy, I’ve been following Don for years and been friends ever since we got connected and just an awesome guy that took the single-family, simple house hack idea and it’s just grown and grown his real estate investing.
[0:02:12.0] DB: Yeah, because he came out of that residential space, he does a good job too of tying back. Even though this is a five million dollar building which is probably 4.9 million dollars will a lot of people want to spend right now. He brings it back very nicely and talks about some of the advantages to buying something like that and why there’s some value in partnerships and not having to go to loan, all kinds of things that are great, nuggets for thought for people that are trying to figure out how and where they want to get started in real estate investing.
[0:02:41.0] NH: Yeah, I know this is a space that we’ve not covered a lot in commercial real estate investing, it’s just not been on the show very much so Tanh will dive in quick, the guy knows so much about the space but stick with it because after a couple of minutes, we really started to dive into the details, he’s really great about defining terms along the way and starting to really share his why’s. Sit tight, enjoy the ride and hope you guys get a lot from Tanh like we did.
[INTERVIEW]
[0:03:05.2] DB: Hey Tanh, welcome back to the show.
[0:03:06.6] TT: Thanks guys, pleasure to be on.
[0:03:08.1] DB: Yeah, great to have you back. When we last talked, you were a house hacking residential rental property powerhouse but now you’ve upgraded and we’re excited to have you back to talk about commercial real estate, you’ve taken a sharp left turn on us, you bought a five-million-dollar strip mall with some partners just pretty recently and really excited to have you back on, can you tell us a little bit about that property and why you made that shift.
[0:03:29.8] TT: Sure. The property is a strip mall plaza located in Fairfield, Ohio, which is northeast of where I am in Cincinnati, it’s roughly 30 minutes or so away. It has 13 total tenants and when it was advertised, there were three vacancies. 10 units were occupied, three were vacant. When we actually got it under contract, now, the list price was five million two hundred and twenty-five, listed out in 8.8 cap, so when we got it on our contract which was, if my memory serves me correctly, end of September, the listing brokers actually got another tenant to sign a lease while we were under contract.
I found this deal from a broker site who marketed it very poorly. They’re unsophisticated, if you will, a little bit more old school, they don’t list, if you looked on Loop Net or if you looked on Crexy, which are two of your larger commercial MLS websites, you would not have seen a trace of this property. I just did my little browsing on realtor websites, like people that sometimes can find them on residential sites. This one, in particular, was strictly commercial and I was just digging and this one stuck out to me because I knew the area pretty well, the street that it’s on, it’s super busy, I think it’s like –
I want to say, probably 80,000 vehicles per day or something like that, something crazy. I lied, it’s 45,000 vehicles per day but I think that number came from my prior number was square footage, it’s roughly 95,000 square feet or so. Current vacancy, percentage-wise, when I saw, it was 16.9.
That did include the new tenants that signed when we got it under contract. Large parking spot, it’s anchored by a Dollar Tree and one of the other anchor tenants was Loman’s Furniture. Those are the two biggest tenants that are occupying the space. I think they’re roughly occupying maybe 30,000 square feet or so off the total place.
[0:05:47.7] DB: What made you even look at the property like this, we were talking last time about single-family homes and so on, you pivot really hard, right? In the commercial side, we’ve been looking at this for a while and this one just really intrigued you or it was kind of the deal that came along that you couldn’t pass up or what made you even go this direction?
[0:06:05.3] TT: Initially, yes, I wasn’t residential, for me, jumping into the commercial space was more of a higher quality of investment if you will, because you know, when you’re investing in residential, you get all the horror stories like, tenants trashing the units, tenants are calling because of bathroom, et cetera, all your nightmare stories I’m sure, everyone has them. For me, I wanted to transition away from the residential side to get away from some of those headaches and move on to larger, higher quality investments.
Now, you guys are for the old adage that says, if you want to go fast, go alone, if you want to go far, you go together. For me, I always thought bigger, I always wanted to look at larger properties, I always wanted to build wealth quickly but I know I couldn’t do it alone.
Something like this that kind of came up. It came up because I joined a mentorship. I reached out to a local guy who has been doing commercial for 10, 15 years or so. A lot of knowledge behind him and he was gracious enough to kind of take me under his wing, kind of teach me everything that he knew and utilizing all of his tricks and knowledge, I was able to find this deal and then, from there, just kind of pull some people together and make it happen.
[0:07:32.5] NH: I can tell in there that this mentor must have been teaching quite a lot because there’s a lot of terms in here that are in the commercial space that are very different that a lot of our listeners are probably not used to hearing. You jumped in with a property that was over five million dollars, which I’ll bet like – well, I’m hoping no one might crash their car right there because that’s like a big number, right?
Then, you threw out things like cap rate and so even anchor store. Can you just unpack some of the terms a little bit for someone that like you, started in the residential space but might be thinking, you know what? Someday, maybe some commercial real estate might be an interesting investment.
[0:08:08.7] TT: Yeah, absolutely. Cap rate stands for capitalization rate. It’s essentially a measure of how well the property is doing. For example, let’s say this property is a flat five million bucks and the cap rate is listed at 8.8%, you take the five million, multiply it by .088 and you get what’s called an NOI which is your net operating income. Your net operating income, once again, tells you how well that property is performing or operating.
That is what you should expect on an annual basis. Now, keep in mind, your net operating income does not take into account debt service. Whatever your debt service is on your loan, you have to subtract that from your NOI in order to get your profit for your cash flow.
[0:09:00.9] NH: What were the questions that comes up a lot I think is higher cap rate, always better, right? If I see a 20% cap rate property, should I buy that versus a 5% cap rate property? What’s the difference there and when might you actually want to target a lower cap rate necessarily or look at those as an opportunity?
[0:09:17.0] TT: If you see a 20% cap rate, buy it, don’t even think about it, just buy it. No, I’m kidding. No, yes, a higher cap rate generally means that the property’s operating well or better and that translates to a higher cash on cash return for an investor. A lower cap rate will be the opposite. At a five-million-dollar property, if it were listed at a five cap, your NOI would be whatever, 250 grand, right? 5% of five mil. Yeah, somewhere around there, right?
In terms of which cap rate you should look for, I think that the term that is dependent upon the investor themselves. If for me, I generally like to aim for a cash-on-cash return that’s roughly around 20% or so, whereas, somebody who might be a coastal investor, they might be content with 10%. Then, they’re able to purchase at a lower cap rate so lower cap rate being in your five, 6% range versus your higher cap rates being nine, 10% or so.
[0:10:19.3] DB: Then, from there, how do you get from 8.8% cap rate to 20% cash on cash? Can you walk us through how you get to that math?
[0:10:27.8] TT: Absolutely. The asking price for the property was 5.2, we got her under contract for, it started somewhere in the mid fours but ended up around five at the contract price. Typically, you would bring 20 to 25% as a down payment to the table, correct? You kind of have to utilize a mortgage calculator online or whatnot but if you type in that number, whatever your debt service is on an annual basis, you have to take that away once again from your NOI. In this case, on the purchase price at five million, our down payment with our bank was 20% which is roughly a million and 5,000.
The loan is roughly four. The annual debt service on that number comes out to 264,000. The gross revenue of the property, that’s top line, was 588,864. Roughly 590 so then, we factor in taxes, insurance, a 4% management fee and that’s being conservative, repairs, maintenance, your utilities, irrigation and snow removal, and lawn care.
After all those expenses, the total expenses comes out to 141,071. That leaves an NOI of $447,793. Our debt service at the 20% down of the loan amount of roughly four million dollars and that’s at four and a half percent amortized over 25 years. The debt service is $264,000 which gives us a net profit annually at $183,793 which when translated to a cash-on-cash return is roughly 18.3%. When we did a proforma at 15% down, those numbers looked a little bit better, it was roughly 22% and the reason why we did those two proformas was because we had two banks that were kind of fighting for the loan.
The reason why we went with the 20% own is because the bank that we were working with, we had a long-standing relationship with them and we knew that they were able to close. 18%, yes. When we looked at this, the upside was the vacancies that we were able to fill. We thought that if we could fill it with better tenants, higher end tenants, national tenants, then, the value of the property would increase dramatically and once stabilized, the cash on cash would become even better and once those numbers come in, I think it would roughly be around 25% cash on cash return. With a huge upside on the NOI and therefore the valuation. When we ran those numbers, once we get those tenants in, it would be roughly worth seven to seven and a half million.
[0:13:27.6] DB: That’s super helpful to jump into that breakdown there of the $588,000 revenue that that five million dollar asset produces and I think that as we talk through these numbers, there’s a lot of people that have been in the single-family space or own their own home and are thinking about buying a first investment home or something like that and those numbers are still just mindbogglingly big but I think that really, if you just move the decimal point tow places over, that’s some of the first single families that we bought as investments were $50,000 houses and they were under market rent and so we would get in there and we would try to bring up the rent either through when the tenant moves out, we have a new tenant move in that’s not paying market rent, those kind of things and that is kid of a really similar story to what you’re doing here because you have some vacancy, you have some tenant turnover, you’re jumping back in.
As you do that, I think, one big difference that I’m seeing in how this is working in the commercial space is, as you increase that rent, the value of the property itself increases because when I do this with a single-family house, I’ve got to do something to the property to make it nicer in order for the value to go up. In this case, the way that you’re describing the cap rate, correct me if I’m wrong but you’re saying that when you put a tenant in there, into that vacant space and you get the rents up essentially, you’re increasing the value of the property, is that right?
[0:14:50.4] TT: That’s absolutely correct. In terms of residential and commercial, I think that’s where the big difference lies, the big difference is where in the commercial realm, you’re operating a business and I’m not saying land-lording is not a business. I’m saying, you’re dealing with an asset that’s performing like a business whereas in the residential realm, you can only control so much. You could control, to an extent, your expenses, you control the type of tenant you put in there, you control how much you rent it out for. Once again, to an extent.
In the commercial space, how the property is valued is how well you generate income or cut your expenses and once again, the quality of the tenants that you put in there has a big factor in how your property is valued. Once again, once we get these two tenants in there, the NOI jumps up dramatically to the point where the valuation jumps incrementally as well whereas if you put X tenant in a residential home or white tenant in a residential home, I can’t see the jump in price for residential because you’re constricted by comps, right?
When you value residential, it’s based on what other properties are selling for, what other people are willing to pay for it. Along those lines, I think commercial is a whole different animal when you’re comparing it to residential. Sure, there’s a lot of similarities but at the end of the day, there is bigger numbers and there’s a lot more vocabulary and there’s a lot more work that goes into it. That kind of all ties into how much effort you’re willing to put in, in order to reap the fruits of your labor.
[0:16:31.1] NH: Walk us through, I guess, for a second, the general deal flow and how that differs maybe or how that’s the same as a residential property buying because I think, a lot of us can grasp the idea of, I can go buy a house, I put an offer down, I inspect it, I weigh my contingencies, I go to the bank, sign some papers and get a mortgage and I’m done, right? That’s a general deal flow for a single-family or a multi-family property. What does that look like in the commercial space, how did that differ?
[0:16:57.7] TT: I think that at the end of the day, it’s very similar, one of the main differences is that, in a commercial deal flow or negotiation if you will, when you initially want to buy a property, you have to throw out what’s called a letter of interest or an LOI and that’s like, I think it’s a waste of time to be honest, it’s pretty much a piece of paper that tells you, “Hey, I’m interested” when you can literally just call them and say, “Hey, I’m interested.”
A lot of these brokers that I’ve been dealing with, they require the LOI. It’s like, something on paper with your signature so they know you’re serious. That’s one part before even your purchase agreement. LOI kind of just – it puts down the purchase price, your typical contingencies, how much due diligence time you are requesting, how long it would take you to close and a couple of other miscellaneous things that you can put in there. For example, I will visit the site in 30 days or 14 days.
A lot of those is very dependent upon how you’re operating your business and obviously, the broker and seller has the ability to negotiate on those terms. After that, it would – if everything is all fine and dandy, you go into a purchase and sale agreement, kind of very similar to your residential but a lot more words, bigger words.
From there, you go into your due diligence period, very similar to residential, you know, your appraisal, your inspections. A little bit different here on the commercial side is that for this deal in particular, we were requesting what’s called estoppels, estoppels are essentially a legal document that confirms the tenant’s rent is what they’re actually paying. Sometimes banks require those and we did it just because we wanted to make sure everything was fine and dandy, get our Ts crossed, eyes dotted, et cetera.
After the inspections and whatnot, there’s a lot of communications that you’re having between you, the broker, the sellers, as well as the title agency to get all those documents in place because bank underwriting for something this large is a little bit more strenuous compared to your residential side.
Even then, sometimes dealing with commercial brokers can be a nightmare as well. In my experience here, the brokers we were working with, once again, they were unsophisticated, a little bit more old school but a lot of the documents that we were requesting, it took them ages to actually get them to us and they just weren’t organized, no dropbox, no drive link, everything was kind of scanned in manually and sent to us, that was a fun experience.
I think those were the main differences. One other main difference between this deal and a typical residential deal is that, we were raising money for this deal. A lot of the communication had to come from the attorneys where we’re drafting up the money that we raised were from friends and family. The attorneys had to draft up your LP and GP operating agreements and LP stands for limited partners, GP stands for general partners, being that we were operating on pretty much managing the properties, we are on the general partner side, the investors that we brought on were on the limited partner’s side.
[0:20:22.6] NH: The financing is definitely different in this case because trying to get a four million dollar loan, that sounds hard, trying to raise a million dollars of a down payment form a bunch of people that maybe know, maybe you don’t know super well, that also sounds hard, all that sounds time-consuming, all that sounds complicated, walk us through how do you even begin that process and how do you establish credibility with a bank that says, “Hey, I like to borrow four million dollars” and then you actually have banks competing to give you four million dollars in this case?
[0:20:55.8] TT: I myself, I don’t think I would be credible or eligible for even a four-million-dollar loan. In this scenario, I have to leverage my partners. My main partner in this deal is the same guy that I reached out as a mentor. He’s had a long-standing relationship with the same bank for over 10 years. A lot of the things that he invest in, they really don’t question it because of the relationship that he’s built with them.
For him to acquire that loan is a lot easier than someone who is in my position, you know, with no W2, just pretty much full-time real estate. I would say in any scenario to acquire a loan of that size, you would have to have the right partners in place. Now, whether or not they were on the general partner side or not doesn’t really matter because you can always have someone on the loan and think creatively of how they can get a piece of the deal. For example, let’s say I didn’t have my partner who I’m working with.
If I were to leverage another partner who is very credible in the business space and I would reach out and ask him if you would be the guarantor on this loan, you could get X percent of the deal, so that’s another big difference in commercial real estate. You can get a lot creative with how you structure deals so that everyone wins versus in the residential side, it’s a little bit easier to get a smaller bite-size loan.
[0:22:28.6] DB: Right, like that $50,000 house example, that was something my wife and I are able to buy that without a partner. That’s just, I mean, two orders of magnitude different than this kind of deal. Here, you are looking for partners that have that presumably some net worth and things like that that the bank would look at and say, “Okay, you’re safer to lend to some experience in that space.
They are underwriting the building itself but they’re also underwriting the partners and it sounds like in this kind of world, limited partners and general partners, general partners are doing a little bit more of the work. Limited partners are more limited in their involvement but it is still a partnership and you’re not, I’m assuming, not many people are going in and buying a $5 million building just by themselves.
[0:23:14.2] TT: Right and that’s the beauty of it when you are able to bring in partners, everyone gets a piece of the pie and everyone wins, right? Once again, to touch on the GP and the LP side, as GPs we’re primarily responsible for obviously the loan, managing the property, making sure everything operates well and making sure our LPs are not losing any money. LPs on their side, they are more so passive investors.
They get a percentage equity of the building but it’s kind of set it and forget it type deal, so they benefit from the cash flows that the property is generating and they’re also benefiting from the upside at the sale point, which for us were targeting at three-year sale.
[0:24:01.1] DB: Okay, so this is a little bit more of like a long-term flip. You are looking to build up the value of the property, a lot of that through getting those vacant places tenanted, bring up the rents, bring up the value and then sell the property. If you can buy for five million, sell for seven or eight in three years, you’re going to do pretty well it sounds like.
[0:24:23.2] TT: Yeah, that’s what we try to target for investors making sure they’re happy so that they can continue to invest with us.
[0:24:29.8] DB: It sounds like in this type of thing too, when I am driving around and I am looking for a house that we want to buy, I kind of know the things that I’m looking for, right? I’ve set my criteria, I really like three bed, one and a half bath like very basic houses that just about anybody would want to rent. What kind of things are you looking for? I know you already mentioned like traffic count and you mentioned a number of parking spaces and a number of tenants that would occupy a strip mall. How does something like this look better or worse than any other property out there?
[0:25:00.1] TT: Traffic count is important, you want heavy traffic count so that you want your plaza to actually succeed. You want the tenants in your plaza to be able to do business so that they can generate income in order to pay rent. The higher the traffic count, the more customers you’re potentially exposed to. Now, signalized traffic is also good. If they are stopping, they’re looking, they’re seeing and the other thing that I always look for is what is around your business that will help increase visibility or increase traffic count.
In this scenario, the street that the property is on is very busy and there’s a ton of businesses around, a lot of automobile used car salesmen, restaurants and it has a large international marketplace called Jungle Gyms, if anyone is familiar with that and they are always busy. Any day of the week that you go there it’s like Christmas, so I was fortunate for this deal here because it was in my backyard and I knew the area very, very well.
Whereas if it were something that’s out of state, I would still kind of try to target the same demographics if you will, that being high vehicle per day count. On the street, busy streets, a lot of surrounding businesses. The demographics residentially has to also support that. If you are having retail spaces, you want residential that’s around in order to support those businesses and complementary businesses is also important.
[0:26:37.6] NH: One of the things that I love is I can see this due diligence that happens before, right? You’re looking at traffic counts and like you said, looking for something that signalized or what’s the neighborhood doing or what are the things that are drawing business in your area. That is kind of your pre-inspection so to speak but once you get into that due diligence process, one of the things that you are looking at in terms of the things that I would look for, right?
In a single family home for example, the roof needs to be repaired or the asphalt needs to be redone in the parking lot and one of those things are covered by you guys and one of those are covered by your tenants through the triple net leases.
[0:27:12.6] TT: Sure, so in the due diligence phase, you obviously want to know where the heavy items are. Like you mentioned, the asphalt, the roof, those are very, very expensive fixes from what I found out. They are in, you know, the six figured numbers so you got to look at your HVAC as well, those are big items. Now, you also want to look at the interior space because you want to see how long the tenants have been there and you want to see if it is going to need any build-outs or any repairs when they do move out or if they’re going to move out.
For us, some of the vacant spaces did need some love, so when you’re looking at the leases as well, this is also one of the main things that’s different from residential is that in the commercial realm the leases, there is three different types of leases whereas in the residentials, it’s just your typical lease. The first type of lease is called a gross lease, the second is called a modified gross lease and the third is a triple net lease like you touched on Nate.
Your gross lease is pretty much like your typical standard residential lease. You pay X amount and you get to occupy the space. A modified gross lease is that but it also tacks on a few expenses to the tenants. For example, some of the maintenance or a little bit of a tax or a little bit of the insurance and then a triple net lease is a lease where the tenant pretty much pays rent for the occupied space plus pretty much every other expense that the property incurs.
You know, your landscape, snow removal, tax, insurance, utilities, everything and a lot of times, I’ve seen that the triple net leases are that but the owner also takes care of the exteriors. That being the asphalt and the roof, so some of the bigger items that the landlord would be responsible for that.
In this case, a lot of the expenses are tacked on to the tenants and will touch on build-outs too because build-outs is another thing that’s different in the commercial realm because sometimes, when you have a space that’s open you can put money into it to renovate it for an upcoming tenant or you can have the tenant pay for those expenses for pro-rate rent. There is a lot of creativity when you’re negotiating with tenants because at the end of the day, the tenants are business owners.
You can come to a compromise in some way, shape or form where both of you benefit. For example, let’s say a tenant comes in for their negotiating five dollars a square foot on an annual basis and they need a build-out. They are asking let’s say $200,000 from the landlord to put in the renovations for the property so that they can pretty much do business as soon as everything is done.
If that makes great business sense, by all means but if not, you could say, “Okay, let’s split the improvement cost right down the middle and we’ll drop your rent to four dollars” or something like that. Every single lease is different and every property is also different, so it’s not a cookie-cutter this is how it operates with every single property. It changes with each asset class and it changes with what type of tenants are coming in, whether it be class A, B, C, mom-and-pop tenants or credit tenants.
Mom-and-pop tenants, I’ll clarify that, those are your smaller business owners. Your national credit tenants are kind of like your Dollar Tree, your Wendy’s, your big large tenants that are pretty much guaranteed to not go out of business. There is one thing there too with credit tenants, sometimes you can get a corporate guarantee so the business itself will guarantee the lease so that you’re kind of covered there whereas you won’t get that with the mom-and-pop tenant.
[0:31:11.2] DB: Now, that sounds like there is some stuff in there that takes the risk down, right? Because obviously a bunch of risk-averse pharmacists are listening and I think they are still probably trying to wrap their mind around some of these major differences but I think on the upside, what you’re describing is a lot of creativity that can be done and especially if you’ve got good people around you that know the space like what you’ve done by finding mentors and partners that know this well and can help train you.
You’ve obviously learned a ton in this and by doing that, you can harness that creativity to make sure that you’re building safety into that because some of the things that I have heard that have made me just honestly nervous about some of this type of investing and so I am curious on your take on this is some of the big vacancies like you mentioned the anchor stores, where just a couple of stores represent like what?
Almost a third of the square footage and probably a big chunk of the rent. In this post-COVID world or we’re seeing malls going out of business and some of these kind of things so what makes this kind of attractive right now where you’re not quite as scared of this big vacancies.
[0:32:15.5] TT: I think that at the end of the day, it would have to come down to how the business is operating. One of the things that we would do is look at the financials of each individual company to see what the trends are, are they trending upwards, are they trending downward, how did they operate during COVID. If they survived during COVID, that gives us a really good idea that they will continue to survive.
If they are borderline bankrupt or going bankrupt, then that would be a risk that we would not want to take on. In this scenario, every business here has been there for a long time, and looking at their financials, yes, 2020 had a toll on them but it wasn’t to the point where it took them out of business. It wasn’t at a point where they suffered a little bit but not to a great extent where they would have to close down shop or move or whatever.
That gave us the assurance that this would survive, the tenants would survive and at the end of the day, we being landlords, we’re not only landlords. We’re here to help them succeed as much as possible, whether it be improving their space somehow, whether it be helping the market, whether it be keeping their rent at a reasonable rate or having more visibility or helping the market in some way that at the end of the day, is how we are doing business.
We want them to succeed so that the power of giving keeps recycling itself, so that the tenants stay there for a long or even if they don’t, maybe word of mouth can improve our tenant flow.
[0:33:56.7] DB: I like that a lot. I think that you have said a lot of things if they are very safety oriented there like looking at those financials even kind of the COVID stress test that a bunch of these businesses went through and you can see who’s lived through that even the strip mall kind of concept, in general, creates a lot of opportunity for businesses that are a little more Amazon-proof, a little more COVID proof.
Had a shopping center you just pop in and grab something from the Dollar Tree that you may not be able to get at that same price on Amazon, so I think that makes a lot of sense. Looking at those financials that I think another thing that makes people nervous about the commercial space is where cap rates if come down and it is driven up evaluations is it’s been really easy to borrow money and I know right now in early 2022, we’re seeing interest rates go up.
Are you scared that cap rates may also go up driving down values and making it a little harder to exit as we see some of these market condition shift or is there so much upside here that you’re not really worried?
[0:34:55.8] TT: For this particular property, I am not too worried but you pose a really good question. I think as an investor, we have to look at market shifts, market cycles and we’ve heard that the fed is going to increase rates. I don’t know how sustainable that is. I think they’ll jump up once or twice but I think at the end of the day they’re going to realize that it’s not sustainable and that they’re going to taper again but what’s beautiful about commercial real estate is there are different asset classes that does not all move in synchrony.
For example, in commercial real estate you have your retail, you have industrial warehouses, you have office space, medical office space and a slew of other mixed used/flex spaces. Even if you were investing in one asset class, you can always hedge your bet by diversifying your portfolio because for example what we’re seeing now is that office spaces are kind of selling for pretty cheap but over the past 12 months, it’s made a serious comeback.
Retail kind of the same way, industrial is super-hot right now. Those cap rates are just insane, same thing with multi-family, those cap rates are severely compressed. I am seeing three and four percent cap rates from multi-family, probably roughly five, six percent for the industrial spaces. I would say, you have to zig when everyone zags. If people are buying three and four cap rates, those are the things that I don’t want to touch.
I want to buy the ten cap rates, I want to buy the nine cap rates, anything that generates those cash flows and over the years, yes, we’re going to see the market do some ups and downs where we have to kind of proactively manage that, right? We know that in three years we’re going to exit this property and I think looking at that timeframe, it’s not going to be too drastic to the point where we would not make our initial investment back.
I think that is our safety net there and at the same time, we can also look for other opportunities to purchase, so I guess the short answer to your question is that you have to keep in mind what the market is doing and you have to move in a way where you’re not going to lose everything.
[0:37:29.1] NH: I think that is relatable no matter what asset class you’re investing in, right? I mean, that could be true of stocks. That could be true of single-family homes, multi-family homes. I think all of that is really good to keep in focus is that macro level, right? Not just evaluating this deal but evaluating the neighborhood that deal resides in, evaluating the state that that neighborhood is within.
All of those things play into it and then what is the general market conditions, like David said is are ensure it’s something on the rise, are homes are being bought or commercial properties being on tenanted. I really like that you’ve had those thoughts already and you’re kind of going through that because I think it’s relatable no matter what asset class you’re in. One of the things that I did want to touch on because we didn’t get a chance to mention it earlier and I think it’s important to bring up us just the deal itself and the partnership that you’ve built.
We talked about the difference in the GPs and the LPs, traditionally when you’re building something like this with a number of partners, what is the typical amount of percent of that deal to own? Is it 5% for a GP? Is it 25%? I mean, what does that look like in a typical deal?
[0:38:29.5] TT: In a typical deal, your typical syndication is going to look like 30% split to the general partners and 70% would be split to the limited partners and the percentage that you own depends on what the raise is and for example, there is always going to be a minimum investment because it has to hit a flat one percent, you can’t own like 0.75%. Let’s say minimum investment is 20,000 for easy numbers.
It just depends on how much you’re willing to invest and then that is your portion equity of the deal, so then you get your – there is also a preferred return. Typically, what I see is a 8% preferred return, 10% preferred return and once again, in this space you can kind of get creative with your terms are well because sometimes, you can get a higher upside after your preferred return depending on how the property operates.
If the property is generating 20%, the GP can say after 10%, the LPs would get another portion of that 10% upside and obviously at the end of the day, you also get the upside from the sale whatever portion equity you own.
[0:39:49.1] NH: That makes a lot of sense, so thank you for clarifying that because I think we talk about all of these big numbers, it’s easy to kind of get lost in it and to lose sight of how much you’re actually invested or involved and so that helps a lot, so I appreciate that. I know Tanh, you’ve been really busy guys since we last brought you on and I really appreciate you joining us today to get us up to speed on commercial and this is really not a space we’ve touched on very much, so thank you for covering so many different aspects of it.
With all these pivoting man, what’s next for you? What are we going to see come out from Tanh’s shop after this?
[0:40:18.4] TT: For me, I think this I’m sticking primarily to the commercial realm. I am going to focus a lot of my energy on that. Our goal this year is 50 million dollars in acquisitions, we would love to find more partners, we’d love to find more deals. All of our partners are itching for additional deals so hopefully at the end of the year that is something that I can acquire and I know I’ve touched on this in the last episode but I am also still keeping in mind.
I want to start a fund that helps in primarily pharmacist or any investor in general to invest passively, so kind of similar to your syndication route but it’s a little bit more dry cut. It is pretty easy, you just pretty much – from what I’ve gathered, you just push money this way. You don’t have to look at all these OMs all day every day. It’s kind of a set it and forget it type deal but it’s been in the back of my mind, I just haven’t gotten to it and that’s just me being lazy I guess.
[0:41:16.5] NH: I don’t know. I don’t know if lazy qualifies, you’ve been pretty busy guy since we last spoke. Again, I really appreciate you sharing all of these insights and I look forward to seeing what you bring next and I’m sure we’ll have you back on to talk with you more here in the future. Thanks again for joining us.
[0:41:30.3] TT: Yeah, absolutely. I appreciate your time guys.
[END OF INTERVIEW]
[0:41:32.7] ANNOUNCER: Thanks for listening to the YPF Real Estate Investing Podcast. If you like what you heard on today’s show, please leave us a review and subscribe to the show so you never miss an episode. If you have a question, know someone that would make a good guest or want to connect with Nate or David, head on over to yfprealestate.com and join the growing YFP Real Estate Investing Facebook group.
[DISCLAIMER]
[0:41:54.0] ANNOUNCER: As we conclude this week’s episode of the YFP Real Estate Investing Podcast, an important reminder that the content on this show is provided to you for informational purposes only and it is not intended to provide and should not be relied on for investment or any other advice. Information of the podcast and corresponding materials should not be construed as a solicitation or offer to buy or sell any investment or related financial products. We urge listeners to consult with a financial advisor with respect to any investment.
Furthermore, the information contained in our archived newsletters, blog posts, and podcast is not updated and may not be accurate at the time you listen to it on the podcast. Opinions and analysis expressed herein are solely those of your financial pharmacist unless otherwise noted and constitute judgments as of the dates published. Such information may contain forward-looking statements, which are not intended to be guarantees of future events. Actual results could differ materially from those anticipated in the forward-looking statements. For more information, please visit yourfinancialpharmacist.com/disclaimer.
Thank you again for your support of the YFP Real Estate Investing Podcast. Have a great rest of your week.
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